Strategic Debt Restructuring Scheme by transferring equity of the company by promoters to the lenders: RBI

RBI/2014–15/627 DBR.BP.BC.No.101/21.04.132/2014–15

June 8, 2015

Strate­gic Debt Restruc­tur­ing Scheme

Please refer to our cir­cu­lar DBOD.BP.BC.No.97/21.04.132/2013–14 dat­ed Feb­ru­ary 26, 2014 on “Frame­work for Revi­tal­is­ing Dis­tressed Assets in the Econ­o­my – Guide­lines on Joint Lenders’ Forum (JLF) and Cor­rec­tive Action Plan (CAP)”, where­in change of man­age­ment was envis­aged as a part of restruc­tur­ing of stressed assets. Para­graph 5.3 of the cir­cu­lar states that the gen­er­al prin­ci­ple of restruc­tur­ing should be that the share­hold­ers bear the first loss rather than the debt hold­ers. With this prin­ci­ple in view and also to ensure more ‘skin in the game’ of pro­mot­ers, JLF/Corporate Debt Restruc­tur­ing Cell (CDR) may con­sid­er the fol­low­ing options when a loan is restructured:

• Pos­si­bil­i­ty of trans­fer­ring equi­ty of the com­pa­ny by pro­mot­ers to the lenders to com­pen­sate for their sacrifices;
• Pro­mot­ers infus­ing more equi­ty into their companies;
• Trans­fer of the pro­mot­ers’ hold­ings to a secu­ri­ty trustee or an escrow arrange­ment till turn­around of com­pa­ny. This will enable a change in man­age­ment con­trol, should lenders favour it.

2. It has been observed that in many cas­es of restruc­tur­ing of accounts, bor­row­er com­pa­nies are not able to come out of stress due to operational/ man­age­r­i­al inef­fi­cien­cies despite sub­stan­tial sac­ri­fices made by the lend­ing banks. In such cas­es, change of own­er­ship will be a pre­ferred option. Hence­forth, the Joint Lenders’ Forum (JLF) should active­ly con­sid­er such change in own­er­ship under the above Frame­work issued vide the cir­cu­lar dat­ed Feb­ru­ary 26, 2014.

3. Fur­ther, para­graph 5.1 of the cir­cu­lar states that both under JLF and CDR mech­a­nism, the restruc­tur­ing pack­age should also stip­u­late the time­line dur­ing which cer­tain via­bil­i­ty mile­stones (e.g. improve­ment in cer­tain finan­cial ratios after a peri­od of time, say, 6 months or 1 year and so on) would be achieved. The JLF must peri­od­i­cal­ly review the account for achieve­men­t/non-achieve­ment of mile­stones and should con­sid­er ini­ti­at­ing suit­able mea­sures includ­ing recov­ery mea­sures as deemed appro­pri­ate. With a view to ensur­ing more stake of pro­mot­ers in reviv­ing stressed accounts and pro­vide banks with enhanced capa­bil­i­ties to ini­ti­ate change of own­er­ship in accounts which fail to achieve the pro­ject­ed via­bil­i­ty mile­stones, banks may, at their dis­cre­tion, under­take a ‘Strate­gic Debt Restruc­tur­ing (SDR)’ by con­vert­ing loan dues to equi­ty shares, which will have the fol­low­ing features:

1. At the time of ini­tial restruc­tur­ing, the JLF must incor­po­rate, in the terms and con­di­tions attached to the restruc­tured loan/s agreed with the bor­row­er, an option to con­vert the entire loan (includ­ing unpaid inter­est), or part there­of, into shares in the com­pa­ny in the event the bor­row­er is not able to achieve the via­bil­i­ty mile­stones and/or adhere to ‘crit­i­cal con­di­tions’ as stip­u­lat­ed in the restruc­tur­ing pack­age. This should be sup­port­ed by nec­es­sary approvals/authorisations (includ­ing spe­cial res­o­lu­tion by the share­hold­ers) from the bor­row­er com­pa­ny, as required under extant laws/regulations, to enable the lenders to exer­cise the said option effec­tive­ly. Restruc­tur­ing of loans with­out the said approvals/authorisations for SDR is not per­mit­ted. If the bor­row­er is not able to achieve the via­bil­i­ty mile­stones and/or adhere to the ‘crit­i­cal con­di­tions’ referred to above, the JLF must imme­di­ate­ly review the account and exam­ine whether the account will be viable by effect­ing a change in own­er­ship. If found viable under such exam­i­na­tion, the JLF may decide on whether to invoke the SDR, i.e. con­vert the whole or part of the loan and inter­est out­stand­ing into equi­ty shares in the bor­row­er com­pa­ny, so as to acquire major­i­ty share­hold­ing in the company;
2. Pro­vi­sions of the SDR would also be applic­a­ble to the accounts which have been restruc­tured before the date of this cir­cu­lar pro­vid­ed that the nec­es­sary enabling claus­es, as indi­cat­ed in the above para­graph, are includ­ed in the agree­ment between the banks and borrower;
3. The deci­sion on invok­ing the SDR by con­vert­ing the whole or part of the loan into equi­ty shares should be tak­en by the JLF as ear­ly as pos­si­ble but with­in 30 days from the above review of the account. Such deci­sion should be well doc­u­ment­ed and approved by the major­i­ty of the JLF mem­bers (min­i­mum of 75% of cred­i­tors by val­ue and 60% of cred­i­tors by number);
4. In order to achieve the change in own­er­ship, the lenders under the JLF should col­lec­tive­ly become the major­i­ty share­hold­er by con­ver­sion of their dues from the bor­row­er into equi­ty. How­ev­er the con­ver­sion by JLF lenders of their out­stand­ing debt (prin­ci­pal as well as unpaid inter­est) into equi­ty instru­ments shall be sub­ject to the mem­ber banks’ respec­tive total hold­ings in shares of the com­pa­ny con­form­ing to the statu­to­ry lim­it in terms of Sec­tion 19(2) of Bank­ing Reg­u­la­tion Act, 1949;
5. Post the con­ver­sion, all lenders under the JLF must col­lec­tive­ly hold 51% or more of the equi­ty shares issued by the company;
6. The share price for such con­ver­sion of debt into equi­ty will be deter­mined as per the method giv­en in para­graph 4 of this circular;
7. Hence­forth, banks should include nec­es­sary covenants in all loan agree­ments, includ­ing restruc­tur­ing, sup­port­ed by nec­es­sary approvals/authorisations (includ­ing spe­cial res­o­lu­tion by the share­hold­ers) from the bor­row­er com­pa­ny, as required under extant laws/regulations, to enable invo­ca­tion of SDR in applic­a­ble cases;
8. The JLF must approve the SDR con­ver­sion pack­age with­in 90 days from the date of decid­ing to under­take SDR;
9. The con­ver­sion of debt into equi­ty as approved under the SDR should be com­plet­ed with­in a peri­od of 90 days from the date of approval of the SDR pack­age by the JLF. For accounts which have been referred by the JLF to CDR Cell for restruc­tur­ing in terms of para­graph 4.2 of cir­cu­lar DBOD.BP.BC.No.97/21.04.132/2013–14 dat­ed Feb­ru­ary 26, 2014 cit­ed above, JLF may decide to under­take the SDR either direct­ly or under the CDR Cell;
10. The invo­ca­tion of SDR will not be treat­ed as restruc­tur­ing for the pur­pose of asset clas­si­fi­ca­tion and pro­vi­sion­ing norms;
11. On com­ple­tion of con­ver­sion of debt to equi­ty as approved under SDR, the exist­ing asset clas­si­fi­ca­tion of the account, as on the ref­er­ence date indi­cat­ed at para 4(ii) below, will con­tin­ue for a peri­od of 18 months from the ref­er­ence date. There­after, the asset clas­si­fi­ca­tion will be as per the extant IRAC norms, assum­ing the afore­said ‘stand-still’ in asset clas­si­fi­ca­tion had not been giv­en. How­ev­er, when banks’ hold­ing are divest­ed to a new pro­mot­er, the asset clas­si­fi­ca­tion will be as per the para 3(xiii) of this circular;
12. Banks should ensure com­pli­ance with the pro­vi­sions of Sec­tion 6 of Bank­ing Reg­u­la­tion Act and JLF should close­ly mon­i­tor the per­for­mance of the com­pa­ny and con­sid­er appoint­ing suit­able pro­fes­sion­al man­age­ment to run the affairs of the company;
13. JLF and lenders should divest their hold­ings in the equi­ty of the com­pa­ny as soon as pos­si­ble. On divest­ment of banks’ hold­ing in favour of a ‘new pro­mot­er’, the asset clas­si­fi­ca­tion of the account may be upgrad­ed to ‘Stan­dard’. How­ev­er, the quan­tum of pro­vi­sion held by the bank against the said account as on the date of divest­ment, which shall not be less than what was held as at the ‘ref­er­ence date’, shall not be reversed. At the time of divest­ment of their hold­ings to a ‘new pro­mot­er’, banks may refi­nance the exist­ing debt of the com­pa­ny con­sid­er­ing the changed risk pro­file of the com­pa­ny with­out treat­ing the exer­cise as ‘restruc­tur­ing’ sub­ject to banks mak­ing pro­vi­sion for any diminu­tion in fair val­ue of the exist­ing debt on account of the refi­nance. Banks may reverse the pro­vi­sion held against the said account only when all the out­stand­ing loan/facilities in the account per­form sat­is­fac­to­ri­ly dur­ing the ‘spec­i­fied peri­od’ (as defined in the extant norms on restruc­tur­ing of advances), i.e. prin­ci­pal and inter­est on all facil­i­ties in the account are ser­viced as per terms of pay­ment dur­ing that peri­od. In case, how­ev­er, sat­is­fac­to­ry per­for­mance dur­ing the spec­i­fied peri­od is not evi­denced, the asset clas­si­fi­ca­tion of the restruc­tured account would be gov­erned by the the extant IRAC norms as per the repay­ment sched­ule that exist­ed as on the ref­er­ence date indi­cat­ed at para 4 (ii) below, assum­ing that ‘stand-still’ / above upgrade in asset clas­si­fi­ca­tion had not been giv­en. How­ev­er, in cas­es where the bank exits the account com­plete­ly, i.e. no longer has any expo­sure to the bor­row­er, the pro­vi­sion may be reversed/absorbed as on the date of exit;
14. The asset clas­si­fi­ca­tion ben­e­fit pro­vid­ed at the above para­graph is sub­ject to the fol­low­ing conditions: 
    1. The ‘new pro­mot­er’ should not be a person/entity/subsidiary/associate etc. (domes­tic as well as over­seas), from the exist­ing promoter/promoter group. Banks should clear­ly estab­lish that the acquir­er does not belong to the exist­ing pro­mot­er group; and
    2. The new pro­mot­ers should have acquired at least 51 per cent of the paid up equi­ty cap­i­tal of the bor­row­er com­pa­ny. If the new pro­mot­er is a non-res­i­dent, and in sec­tors where the ceil­ing on for­eign invest­ment is less than 51 per cent, the new pro­mot­er should own at least 26 per cent of the paid up equi­ty cap­i­tal or up to applic­a­ble for­eign invest­ment lim­it, whichev­er is high­er, pro­vid­ed banks are sat­is­fied that with this equi­ty stake the new non-res­i­dent pro­mot­er con­trols the man­age­ment of the company.

4. The con­ver­sion price of the equi­ty shall be deter­mined as per the guide­lines giv­en below:

(i) Con­ver­sion of out­stand­ing debt (prin­ci­pal as well as unpaid inter­est) into equi­ty instru­ments should be at a ‘Fair Val­ue’ which will not exceed the low­est of the fol­low­ing, sub­ject to the floor of ‘Face Val­ue’ (restric­tion under sec­tion 53 of the Com­pa­nies Act, 2013):

1. Mar­ket val­ue (for list­ed com­pa­nies): Aver­age of the clos­ing prices of the instru­ment on a rec­og­nized stock exchange dur­ing the ten trad­ing days pre­ced­ing the ‘ref­er­ence date’ indi­cat­ed at (ii) below;
2. Break-up val­ue: Book val­ue per share to be cal­cu­lat­ed from the com­pa­ny’s lat­est audit­ed bal­ance sheet (with­out con­sid­er­ing ‘reval­u­a­tion reserves’, if any) adjust­ed for cash flows and finan­cials post the ear­li­er restruc­tur­ing; the bal­ance sheet should not be more than a year old. In case the lat­est bal­ance sheet is not avail­able this break-up val­ue shall be Re.1.

(ii) The above Fair Val­ue will be decid­ed at a ‘ref­er­ence date’ which is the date of JLF’s deci­sion to under­take SDR.

The above pric­ing for­mu­la under Strate­gic Debt Restruc­tur­ing Scheme has been exempt­ed from the Secu­ri­ties and Exchange Board of India (SEBI) (Issue of Cap­i­tal and Dis­clo­sure Require­ments) Reg­u­la­tions, 2009 sub­ject to cer­tain con­di­tions, in terms of SEBI (Issue of Cap­i­tal and Dis­clo­sure Require­ments) (Sec­ond Amend­ment) Reg­u­la­tions, 2015 noti­fied vide the Gazette of India Extra­or­di­nary Part–III–Section 4, pub­lished on May 5, 2015. Fur­ther, in the case of list­ed com­pa­nies, the acquir­ing lender on account of con­ver­sion of debt into equi­ty under SDR will also be exempt­ed from the oblig­a­tion to make an open offer under reg­u­la­tion 3 and reg­u­la­tion 4 of the pro­vi­sions of the Secu­ri­ties and Exchange Board of India (Sub­stan­tial Acqui­si­tion of Shares and Takeovers) Reg­u­la­tions, 2011 in terms of SEBI (Sub­stan­tial Acqui­si­tion of Shares and Takeovers) (Sec­ond Amend­ment) Reg­u­la­tions, 2015. This has been noti­fied vide the Gazette of India Extra­or­di­nary Part–III–Section 4 pub­lished on May 05, 2015. Banks should adhere to all the pre­scribed con­di­tions by SEBI in this regard.

6. In addi­tion to con­ver­sion of debt into equi­ty under SDR, banks may also con­vert their debt into equi­ty at the time of restruc­tur­ing of cred­it facil­i­ties under the extant restruc­tur­ing guide­lines. How­ev­er, exemp­tion from reg­u­la­tions of SEBI, as detailed in para­graph 5 above, shall be sub­ject to adher­ing to the guide­lines stip­u­lat­ed in the above paragraphs.

7. Acqui­si­tion of shares due to such con­ver­sion will be exempt­ed from reg­u­la­to­ry ceilings/restrictions on Cap­i­tal Mar­ket Expo­sures, invest­ment in Para-Bank­ing activ­i­ties and intra-group expo­sure.  How­ev­er, this will require report­ing to RBI (report­ing to DBS, CO every month along with the reg­u­lar DSB Return on Asset Qual­i­ty) and dis­clo­sure by banks in the Notes to Accounts in Annu­al Finan­cial State­ments. Equi­ty shares of enti­ties acquired by the banks under SDR shall be assigned a 150% risk weight for a peri­od of 18 months from the ‘ref­er­ence date’ indi­cat­ed in para­graph 4(ii). After 18 months from the ‘ref­er­ence date’, these shares shall be assigned risk weights as per the extant cap­i­tal ade­qua­cy regulations.

8. Equi­ty shares acquired and held by banks under the scheme shall be exempt from the require­ment of peri­od­ic mark-to-mar­ket (stip­u­lat­ed vide Pru­den­tial Norms for Clas­si­fi­ca­tion, Val­u­a­tion and Oper­a­tion of Invest­ment Port­fo­lio by Banks) for the 18 month peri­od indi­cat­ed at para 3(xi).

9. Con­ver­sion of debt into equi­ty in an enter­prise by a bank may result in the bank hold­ing more than 20% of vot­ing pow­er, which will nor­mal­ly result in an investor-asso­ciate rela­tion­ship under applic­a­ble account­ing stan­dards. How­ev­er, as the lender acquires such vot­ing pow­er in the bor­row­er enti­ty in sat­is­fac­tion of its advances under the SDR, and the rights exer­cised by the lenders are more pro­tec­tive in nature and not par­tic­i­pa­tive, such invest­ment may not be treat­ed as invest­ment in asso­ciate in terms of para­graph 10.2.3 of Annex­ure to cir­cu­lar DBOD.No.BP.BC.89/21.04.018/2002–03 dat­ed March 29, 2003 on ‘Guide­lines on Com­pli­ance with Account­ing Stan­dards (AS) by Banks’.

Yours faith­ful­ly,

(Sudar­shan Sen)
Chief Gen­er­al Manager-in-Charge