Suchismita Pati, NUJS, Kolkata
In recent decades, banks have been experiencing difficulties which are reflected in high levels of non-performing loans that require a major and expensive overhaul of their banking systems ((Marinela E. Dado and Daniela Klingebiel, Decentralized Creditor-Led Corporate Restructuring Cross-Country Experience)). Healthy asset management policies provide for bank restructuring by accelerating the resolution of nonperforming assets and promote corporate restructuring by providing the right incentives for voluntary debt restructuring.
In India, Reserve Bank of India ((The Reserve Bank of India (RBI) had issued guidelines in March 2001 allowing banks/financial institutions to restructure/reschedule credit facilities extended to industrial units which are fully secured by tangible assets, subject to certain conditions.; Report of the Working Group to review the existing guidelines on restructuring of advances and align them with the guidelines on CDR Mechanism, http://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=595.))introduced a scheme for the revival of corporate entities as well as for the safety of money lent by banks and financial institutions (FIs) known as the Corporate Debt Restructuring Mechanism ((CDR is a non-statutory mechanism which is a voluntary system based on Debtor- Creditor Agreement (DCA) and Inter-Creditor Agreement which provide the legal basis to the CDR mechanism.; The Inter-Creditor Agreement would be a legally binding agreement amongst the creditors, with necessary enforcement and penal clauses, wherein the creditors would commit themselves to abide by the various elements of CDR system.; Revised Guidelines on Corporate Debt Restructuring, etc Pg 1145)). If a company finds itself in financial distress because of factors beyond its control, the bank can revive the corporate as well as for the protection of banks and financial institutions from becoming insolvent through timely support by the restructuring mechanism.
This paper has been divided into different sections. The first segment gives a brief on the origin and need of corporate debt restructuring thereby the legal basis to CDR mechanism. The next part throws light on the three tier structure introduced by Reserve Bank of India (RBI) for the smooth functioning of the mechanism. The last part portrays the misuse of this mechanism and various regulatory concerns. It would conclude by stating the remedies to the issues regarding the CDR mechanism.
INTRODUCTION OF CDR SCHEME
Origin of CDR Scheme
In spite a corporate entity’s best efforts and intentions, it faces financial difficulty because of factors beyond their control and also due to certain internal reasons. Debt restructuring mechanism ((Dr. K.C Chakrabarty, Deputy Governor, Corporate Debt Restructuring- Issues and Way Forward Reserve Bank of India at the Corporate Debt Restructuring Conference 2012 organized by Centrum Group at Mumbai on August 11, 2012. Assistance provided by Shri M.P.Baliga, Ms Dimple Bhandia and Shri M. K. Poddar in preparation of this address is gratefully acknowledged.))is conducted by the banks through efforts to develop a plan of action to handle the viable accounts in such a manner so as to preserve the economic value of their loans ((Report of the Working Group to Review the existing prudential guidelines on restructuring of advances by banks/financial institutions, Reserve Bank of India, July 2012.)). In India, Reserve Bank of India ((Resereve Bank of India as defined under Reserve Bank of India Act, 1934.))designed CDR mechanisms similar to the mechanism of U.K ((Revised Guidelines issued by RBI in August 2003.)), Thailand, Korea, etc. for restructuring of corporate debt and also issued ((vide circular DBOD No. BP.BC 15/21.04.114/2000-01 dated August 23, 2001.))detailed guidelines for the implementation by banks. Later, based on the recommendation ((Circular number DBOD No. BP .BC. 68/21.04.114/2002-2003.))by the Working Group ((The group was constituted pursuant to the announcement made by the then Finance Minister in the Union Budget, and consultations with the Government, the guidelines on Corporate Debt Restructuring system were revised on February 5, 2003.)), amendments were made to make the operations of the CDR mechanism more effective.
Legal basis of CDR Scheme
As the CDR scheme is an informal workout mechanism, it is backed by mutual consent of parties rather than by any law ((The legal basis of the scheme is a debtor-creditor and inter-creditor agreement; infra note 29)). There are legal provisions ((Sections 391/393 of Companies Act, 1956))that provide for arrangements ((However, the scheme under section 391/393 requires judicial intervention, besides meetings of members and creditors, and is generally viewed as being cumbersome.))between the company and its creditors. Corporate debt restructuring scheme ((R.C Kohli, Practical Approach to Recovery Management in Banks/FIs & Securitization Act, Taxmann Publications.))was brought to ensure timely and transparent mechanism for restructuring the corporate debts ((The Scheme provides that any of the lenders with an exposure of at least 20% in either working capital or term finance may apply.))of viable entities facing problems, outside the purview of BIFR ((Board for Industrial and Financial Reconstruction was set up in January, 1987 and functional with effect from 15th May 1987; www.bifr.nic.in)), DRT ((Debt Recovery Tribunal; The Debt Recovery Tribunal are governed by provisions of the Recovery of Debt Due to Banks and Financial Institutions Act, 1993, also popularly called as the RDB Act. Rules have been framed and notified under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993; http://bankdrt.net/))and other legal proceedings, for the benefit of all concerned. The following two categories ((Master Circular- Income Recognition, Asset Classification, Provisioning and Other Related Matters – UCBs, July 2012))of debt restructuring are available under this mechanism.
(i) Accounts, which are classified as “standard” ((Prudential Guidelines on Restructuring of Advances by Banks, RBI Circular dated August 27, 2008))and “sub-standard” in the books of the creditors, would be restructured under the first category (Category 1).
(ii) Accounts which are classified as “doubtful” in the books of the creditors would be restructured under the second category (Category 2).
Impact of rising Non- Performing Asset
A bank’s strength is not by the size of its balance sheet but also the return on its assets. NPAs generate no interest income for the bank; the bank is required to provide for future loan losses arising from its bad assets, out of current profits. The interest on NPA ((Available at http://www.cab.org.in/Lists/Knowledge%20Bank/Attachments/34/INCOME.pdf, last visited on24.09.2013))loans can be considered as income only when actually paid by the borrower. So, it affects profitability and liquidity of bank as it has fewer funds to lend out or recycle. Due to the current trend of CDR mechanism, rise in NPAs is seen thereby indicating that the credit market is going down. RBI announced that every bank must maintain a capital adequacy ratio (CAR) ((Master Circular No. DBOD.BP.BC.17/21.01.002/2010-2011 dated July 1, 2011)), which is the ratio of total capital to risk weighted assets, of 9% ((Master Circular – Basel III Capital Regulations, RBI/2013-14/70, DBOD.No.BP.BC.2 /21.06.201/2013-14, 1st, July, 2013.))(10% for new private banks) or higher. Today banks are having difficulty in meeting CAR norms ((Non-performing assets: An Indian Perspective; Infosys Finacle)).
Various Restructuring Options/ Methods Employed in Corporate Debt Restructuring System
The corporate debt restructuring system has three different aspects broadly i.e., promoter sacrifice, creditor sacrifice and creditor’s assistance. It requires the creditors to renounce some of their rights and money, and in a few cases it extends to concerned promoters and shareholders too. The methods of extricating sacrifice entailed from the promoter enumerated here are not exhaustive. But from the sacrifice entailed by the promoters, what is analyzed is whether the promoters are as keen and interested in revival of the unit as the creditors or whether the promoters are more free riders. The sacrifice also ensures that the moral hazard of indifferent/ bad management being rewarded with better and more lenient deals due to the operations of the CDR system.
The second aspect is the sacrifice by the creditors. It can entail extension of the repayment period of the existing debt and rescheduling it, reduction of the high interest charged on loan [either the interest rate might be lowered uniformly for the full amount or loan might be divided in two parts] ((One part of the loan might an early repayment schedule ans so low interest is charged on it while the other part of the loan could have a longer repayment schedule and so a higher interest rate is charged on it.)), deferring the interest charged on loan or taking up zero coupons bonds in lieu of part of it, converting part of debt or accrued interest into capital from company either as equity shares or cumulative redeemable preference shares (sometimes the promoter or promoter group company is required to guarantee its representation of future returns, i.e. internal rate of return on capital employed, by providing that it would buy the converted equity shares at a particular rate in future whenever offered to it) ((For example a key feature of the JVSL debt restructuring scheme was the imposition of a requirement on promoters to purchase equity shares worth INR 1,080,000,000 of the company by a certain fixed date.; Introduction: South East Asian Crisis and Adoption of the Corporate Debt Restructuring Mechanism in India by Rajiv Luthra; Expedited Debt Restructuring: An International Comparative Analysis, Edited by Rodrigo Olivares-Caminal))and waiver of penalty. The package usually would be an amalgamation of the above with the weightage given to different components/methods taking into account the peculiarities of the case ((In the Essar Steel corporate debt restructuring, debt owed by Essar Steel to secured Indian lenders was restructured in the following manner: A) All amounts towards penal interest and liquidated damages that remained due and unpaid up to a cut off date were waived off. B) Overdue and unpaid compound interest overdue and unpaid as on a fixed cut off date was converted to zero coupon debt repayable in 48 equal monthly installments and secured by first pari-passu charge on the fixed assets of Essar Steel. C) Simple interest charged in excess of 14 percent per annum in respect of Rupee term loans and non convertible debentures, between a fixed time-period was converted into 10% cumulative redeemable preference shares (CRPS) redeemable in 12 equal monthly installments. D) All amount of rupees debt, including, simple interest due and accrued as on a fixed cut off date, devolved deferred payment guarantees and lease assistance and non-convertible debentures after waiver and conversion as discussed above was restructured as follows: (i) Pro rata conversion of rupee debt aggregating upto INR 1,750,000,000 to equity share capita at par; (ii) 40 percent of the Rupee debt was converted to fixed rate foreign currency loan or reduced rate rupee term loan, carrying fixed interest rate of 8% per annum. (iii) The balance amount of the rupee debt continued as rupee term loan, carrying fixed interest of 14 per cent per annum and repayable in 156 monthly installments.)).
The third aspect is provision of additional finance that may be required by the concerned corporate that is to be revived. Here, the CDR system ((Vinod Kothari, Securitisation Asset Reconstruction & Enforcement of Security Interests, Lexis Nexis, 3rd Edn., 2010, Pg 348.))discriminates between the types of debtors referred to it. Category I CDR scheme is applicable to those concerned account which is either a standard ((As per RBI’s Master Circular dated 1 July 2005 on Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances(‘Prudential Norms’), if arrears of interest and principal are paid by the borrower in the case of loan accounts classified as non-performing, the account should no longer be treated as non-performing and may be classified as ‘standard’ accounts.))or sub-standard account ((As per Prudential Norms, a sub-standard asset would be one, which has remained non-performing for a period less than or equal to 12 months.))(it is of this category if it is so in the books of minimum 90 percent of its creditors by value). Since, the account is standard ((Any additional finance may be treated as ‘standard asset’, upto a period of one year after the first interest/ principal payment, whichever is earlier, falls due under the approved restructuring package))or substandard and 75 percent of creditors by value have agreed it is perceived that further lending to the concerned company is not that risky. So all creditors, whether working capital or term finance lenders, if there is in the package any provision for additional finance, have to provide loan at a pro-rata basis. Of course, they can arrange for a new or existing lender to take up their commitments. In case the concerned creditor is not the one which has voted for the proposal, then it also has the option of not providing the additional finance. But to ensure that the concerned creditor does not have free rider advantage, in lieu of it, it would have to forego the first year’s interest payable as per the restructured ((The accounts classified as ‘standard assets’ should be immediately re-classified as ‘sub-standard assets’ upon restructuring.))package and it would be paid, without compounding along with the last installment of the principal. It not only entails a small financial price but also means the uncooperative bank or institution would be prevented from cleaning up its book for a year more. Category II CDR Scheme is classified as doubtful. There is no requirement that under the package, the existing creditors shall provide any additional finance. It would be for the creditor to arrange for it. Lastly, all corporate debt restructuring which are approved would give a right to the debtor to prepay the credit and to accelerate the payment.
THE WORKING OF CDR MECHANISM
For the proper functioning of the CDR scheme, three different bodies work with one another which are explained below.
Three tier structure
CDR Standing Forum
The CDR Standing Forum is the representative general body of all financial institutions and banks in CDR system. It is a self-empowered body that lays down policies and guidelines, and monitors the progress of corporate debt restructuring. It provides an official platform for both the creditors and borrowers to amicably and collectively evolve policies and guidelines for working out debt restructuring plans in the interests of all concerned.
Composition
It compromises of Chairman and Managing Director, Industrial Development Bank of India (IDBI); Chairman, State Bank of India(SBI); Managing Director and CEO, ICICI Bank Limited; Chairman, Indian Banks’ Association as well as Chairmen and Managing Directors of all banks and financial institutions participating ((Institutions like Unit Trust of India, General Insurance Corporation, Life Insurance Corporation may have assumed exposures on certain borrowers; these institutions may participate in the CDR system.))as permanent members in the system. The forum elects its Chairman for a period of one year and the principle of rotation is followed in subsequent years. However, the Forum may decide to have a working Chairman as a whole-time officer to guide and carry out the decisions of the CDR Standing Forum.
Meetings and Functions
The Forum meets once every six months to review and monitor the progress of corporate debt restructuring system. They lay down the policies and guidelines including those relating to the critical parameters for restructuring, (for example, maximum period for a unit to become viable under a restructuring package, minimum level of promoters’ sacrifice etc.) to be followed by the CDR Empowered Group and CDR Cell for debt restructuring and ensure the smooth functioning and adherence to the prescribed time schedules for CDR. It reviews any individual decisions of the CDR Empowered Group and CDR Cell. The CDR Standing Forum has power to formulate guidelines for dispensing special treatment to those cases which are complicated and are likely to be delayed beyond the time frame prescribed for processing. The administrative and other costs are shared by all financial institutions and banks and the sharing pattern is being determined by the Standing Forum.
CDR Core Group
A CDR Core Group forms an imperative part of the CDR Standing Forum and assists the Forum in conducting meetings and taking decisions relating to policy.
Composition
It consists of Chief Executives of IDBI Ltd, SBI, ICICI Bank Ltd., Bank of Baroda, Bank of India, Punjab National Bank, Indian Banks’ Association and Deputy Chairman of Indian Banks’ Association representing foreign banks in India.
Functions
The core group lays down the policies and guidelines to be followed by the CDR Empowerment Group and CDR Cell for CDR. These guidelines lay down the operational difficulties experienced in the functioning of the CDR empowered group. It prescribes the PERT ((Project Evaluation Review Technique))chart for processing of cases referred to the CDR system and decides on the modalities for enforcement of the time frame. It also lays down guidelines to ensure the over-optimistic projections are not assumed while preparing/approving restructuring proposals especially with regard to capacity utilization, price of products, profit margin, demand, availability of raw materials, input-output ratio and likely impact of imports/international cost competitiveness.
CDR Empowered Group
The individual cases of corporate debt restructuring are handled by the CDR Empowered Group.
Composition
The group consists of Empowered Group executive director (ED) level representatives of IDBI Ltd., ICICI Bank Ltd. and SBI as standing members. In addition to ED level, representatives of financial institutions and banks who have an exposure to the concerned company are part of the group.
Functions
While the standing members facilitates the conduct of group’s meetings, voting takes place in proportion to the exposure of the creditors only. For proper functioning of CDR Empowered Group, it ensures that the participating institutions/ banks approve a panel of senior officers to represent them in the CDR Empowered Group and make sure that they depute officials only from among the panel to attend the meetings of CDR Empowered Group. Further, such nominees who attend the meeting pertaining to one account also invariably attend all the meetings pertaining to that account instead of deputing their representatives. For better efficiency, a general authorization by the respective Boards of the participating institutions/banks is to be given in favour of their representatives on the CDR Empowered Group, authorizing them to take decisions on behalf of their organization, regarding restructuring of debts of individual body corporates.
Working
The Group considers the preliminary report of all cases of requests of restructuring submitted by the CDR Cell. After the Empowered Group decides that restructuring of the company is prima facie feasible and the enterprise is potentially viable in terms of the policies and guidelines evolved by Standing Forum, the detailed restructuring package would be worked out by the cell in conjunction with the lead institution. However, if the lead institution faces difficulties in working out the detailed restructuring package, the participating banks/financial institutions should decide upon the alternate institution/ bank which would work out the detailed restructuring package at the first meeting of the Empowered Group when the preliminary report of the CDR Cell comes up for consideration. The Group is mandated to look into each case of debt restructuring, examine the viability and rehabilitation potential of the company to approve the restructuring package within a specified time frame of 90 days, or at best within 180 days of reference to the Empowerment Group. It decides on the acceptable viability benchmark levels on certain parameters ((The following are the parameters: (i) Return on Capital Employed (ROCE) (ii) Debt service coverage ratio (DSCR)(iii) Gap between the Internal Rate of Return (IRR) and the Cost of Fund (CoF)’ (iv) Extent of sacrifice. Where; the Return on Capital Employed (ROCE) reflects the earning capacity of assets deployed. ROCE is expressed as a percentage of total earnings (return) net of depreciation to the total capital employed. The Debt Service Coverage Ratio (DSCR) represents the debt servicing capability of the borrower. In the normal course, DSCR is the ratio of gross cash available to meet the debt servicing requirement. The Internal Rate of Return (IRR) is compounded as the post-tax return on capital employed during the project life based on discounted (net) cash flow method. Cost of capital is the post tax weighted average cost of the funds employed.)), which may be applied on a case-by-case basis, based on the merits of each case.
The Board of each bank/financial institution authorizes its CEO and/or ED to decide on the restructuring package in respect of cases referred to the CDR system, with the requisite requirements to meet the control needs. It meets on two or three occasions in respect of each borrowal account. This provides an opportunity to the participating members to seek proper authorizations from their CEO/ED, in case of need, in respect of those cases, where the critical parameters of restructuring are beyond the authority delegated to him/her. The decision of the CDR Empowerment Group remains final. If restructuring of debt is found to be viable and feasible and approved by the Empowered Group, the company would be put on the restructuring mode. If restructuring is not found viable, the creditors would then be free to take necessary steps for immediate recovery of dues and/or liquidation or winding up of the company, collectively or individuality.
CDR Cell
The CDR Cell assists the CDR Standing Forum and the CDR Empowered Group to carry out their functions. It makes the initial scrutiny of the proposals received from borrowers/creditors, by calling for proposed rehabilitation plan and other information and put up the matter before the CDR Empowered Group, within one month to decide whether rehabilitation is prima facie feasible. If the plan ((RBI guidelines prescribed that all restructured accounts which have been classified as non-performing assets upon restructuring, would be eligible for upgradation to the ‘standard‘ category after observation of ‘satisfactory performance’ during the ‘specified period’. However, in situation where the satisfactory performance after a specific period is not evidenced, the asset qualification of the restructured account is as per prudential norms with reference to the pre-restructuring payment schedule))is found feasible the CDR cell proceeds to prepare detailed Rehabilitation Plan with the help of creditors and, if necessary, experts that have to be engaged from outside. If not found prima facie feasible, the creditors may start action for recovery of their dues. All references for corporate debt restructuring by creditors or borrowers is made to the CDR Cell. It is the responsibility of the lead institution/major stakeholder to the corporate, to work out a preliminary restructuring plan in consultation with other stakeholders and submit to the Cell within one month. It prepares the restructuring plan in terms of the general policies and guidelines approved by the CDR Standing Forum and place for consideration of the Empowered Group within 30 days for decision. The Empowered Group either approves it or suggests modifications and final decision is given in the prescribed time.
CDR Cell has members of staff deputed from banks and financial institutions as required, also can take outside professional help. The cost in operating the CDR mechanism including CDR Cell is covered from combination from the financial institutions and banks in the Core Group at the rate of Rs 50 lacs each and contribution from other institutions and banks at the rate of Rs. 5 lacs each.
Decision process in CDR system
A decision of the CDR Empowered Group ((Decision Process in Corporate Debt Restructuring System, CDR Master Circular, 2012, page 9))relating to prima facie feasibility and/or final approval of a Restructuring Scheme ((In case any change/alteration/modification to the Approved Restructuring Scheme is required, the Referring Lender/CDR Cell shall refer the same to the CDR Empowered Group and the decision of the CDR Empowered Group relating to such changes/alteration/modification shall be taken by a Super-Majority Vote at a duly convened meeting, after giving reasonable notice, to the Lenders and to the Eligible Borrower))shall be taken by a Super-Majority ((Super-Majority Vote” shall mean votes cast in favour of a proposal by not less than sixty percent (60%) of number of Lenders and holding not less than seventy-five percent (75%) of the aggregate Principal Outstanding Financial Assistance))Vote at a duly convened meeting, after giving reasonable notice, to the Lenders and to the Eligible Borrower. The Standing Members in the CDR Empowered Group does not have any voting rights in respect of the matter specified unless the institution they represent is also a Lender to the Eligible Borrower.
Once the Monitoring ((Supra note 39, page 14))Institution presents the restructuring proposal and establish the need for additional exposure and has approval by Empowered Group, the same must be followed by all the participating lenders in without any deviation. Conditional mandates and mandates not agreeing for need based additional exposures are treated as negative votes in respect of final packages. To avoid delay in communication of decision of CDR Empowered Group after approval of restructuring package, following procedure is considered for the issuance of Letter of Approval ((Lenders shall have the right to convert up to 20% of the loan outstanding (interest-bearing term loan) beyond seven years into equity at any time after seven years from the date of Letter of Approval issued by CDR Cell; supra note 39, page 20.)). By reducing the number of lenders, implementation of the package could be smoother and compliances of terms and conditions including security creation could be expedited.
Exit of cases from CDR system
After the end of the restructuring period, the borrower-Corporate has to exit from the CDR System. It can be done when the financial performance of the borrower-Corporate is more than 25% of the EBIDTA projections for two consecutive years. Any borrower-Corporate seeking exit from CDR can agree to make payment of recompense amount as per CDR guidelines and proceed to exit.
CDR MECHANISM: ABUSE AND CONCERN(s)
The data on restructuring suggest that when it comes to restructuring, our banks are substantial bias towards more privileged borrowers’ vis-à-vis small borrowers. It seems that restructuring of accounts is being resorted to avoid classification of accounts as NPA. Even the best of intentions gets defeated when a system is not used judiciously. It is found that unscrupulous borrower ((CS Gaurav Rajouria, Corporate Debt Restructuring: Need to Review or Redefine Policy, April’12 http://taxguru.in/corporate-law/corporate-debt-restructuring-mechanism-review-redefine-policy.html, last visited on 23.09.2013))companies take undue advantage by diverting, misusing siphoning their funds for the personal benefit of directors/promoters. Moreover, the information regarding the factum of CDR proposal is provided without details about the revival draft by companies. The shareholders/non CDR lenders are not informed thereby shading out the transparency factor. Moreover, those companies with a very small paid-up capital and reserves go for this mechanism to protect themselves against heavy loans of their huge ambitious projects. Furthermore, such small companies try to escape their liabilities by taking recourse under this mechanism but this harms the bank’s health due to increase in NPA. Another issue regarding the mechanism is that the basic idea of this mechanism included the term “all concerned” but it seems the interest of other stakeholders is not protected especially those who do not participate in the scheme but their name is inserted and outstanding dues of such lenders are not paid under the guise of this mechanism. There is no provision with regard to repayment of unsecured lenders and suppliers who are not CDR members and therefore fails to serve its very purpose. To end the above commotion, transparency can be improved by making the restructuring proposals available in the public domain. Also, RBI is to be the final authority of CDR Proposals and it should provide detailed information to stakeholders mentioning each bit of information to maintain transparency. The Financial Viability Parameters as defined in clause 3 of CDR Master Circular dated June 3, 2009 have to included and strictly adhered to define the viable corporate entities. Companies may be allowed to take advantage of CDR Mechanism with sufficient paid up capital+ reserves against its debts.
CONCLUSION
Corporate debt restructuring was introduced in 2001 and under this mechanism around 549 cases involving INR 33, 55,711 crores ((available at http://www.cdrindia.org/downloads/CDR%20Performance%20upto%20June%202013.pdf, June 2013))have been taken place out of which 48187 crores have been restructured. CDR mechanism has been helpful in arresting and to some extent reversing the ballooning of non-performing assets in the balance sheets of the banks. One of the reasons for the smooth running and relative success of the mechanism has been that almost all big lenders (except ICICI Bank) were owned or controlled by Government. RBI ((Supra note 27, page 340-341))plays a very important role and it makes sure that the mechanism follows its very objective. So while the success of corporate debt restructuring has promoted the RBI to envisage its continuance n future, the evolution of Indian capital and financial markets might not make its operation as smooth in future and one may have to revert to Companies Act to resolve the problem.