The Reserve Bank of India’s stressed asset directions (RBI stress directions) celebrated their first anniversary recently (they were issued on June 7, 2019). They have become fundamental and focal for the resolution of debt—given the amendments to the Insolvency and Bankruptcy Code (IBC) precluding insolvency proceedings for defaults occurring in a designated period. The initial issuance of the RBI stress directions was momentous as well, as it came in the wake of the Supreme Court striking down the RBI’s revised framework on the resolution of stressed assets issued February 12, 2018—holding that they did not comply with the statutory conditions of the provisions of the Banking Regulation Act, they were issued under.

The RBI stress directions represented an evolution of regulatory governance as well as an alignment of approaches between the IBC and the RBI’s approach of resolution to precede or obviate formal insolvency proceedings. With the preclusion of filings under IBC, strengthening the RBI stress directions for effective resolution is more critical than ever. While transitory amendments regarding asset classification, provisioning, and credit rating requirements contained in the RBI stress directions are believed to be contemplated, a more structural review must also be considered by the RBI to fortify their efficacy.

Central bank-led workout regimes outside or prior to the insolvency framework have been deployed since the Bank of England’s London Approach and its equivalents in Hong Kong, Jakarta, and elsewhere. In India, the RBI had to fashion a collective resolution/restructuring process for debt in the absence of a well-functioning insolvency law (pre IBC), particularly one that gave primacy to creditor rights—the predecessors to the RBI stress directions, including the 2014 Framework for Revitalising Distressed Assets – Guidelines on Joint Lenders Forum (JLF framework). As among the few remaining means of debt resolution, the RBI directions must be buttressed.

The principle of collective resolution is at the heart of the workout regime, and it is therefore imperative that all lenders participate. Several RBI-regulated lenders do not sign an inter-creditor agreement (ICA) as required by RBI stress directions and do not participate in collective resolution attempts—this is an affront to the RBI and could potentially even open up penalties under Section 46 of the Banking Regulation Act (for not complying with directions of the RBI).

Further, the application of the RBI directions only to RBI-regulated lenders significantly impedes resolution of stress where there are diverse and heterogenous creditors. SEBI and RBI have both prodded companies to raise funds by issuing corporate bonds and to facilitate the corporate bond market. Accordingly, borrowers whose debt is being resolved by way of the stressed asset guidelines have often borrowed funds through the issuance of debentures which may be held by a range of investors such as insurance companies, asset management companies, mutual funds, pension funds, gratuity funds, and the debenture trustee holding debentures for retail investors.

Such heterogenous creditors may not all be bound by the stressed asset directions, and in that absence no uniform guidelines for collective action and to frame a resolution presently exist. Regulators must act cohesively and coordinate to facilitate differently regulated lenders to participate in a collective process to obviate regulatory arbitrage and holdouts during the resolution process. Given the lack of availability of IBC, the RBI could engage with SEBI, IRDAI and PFRDA to require that regulated entities of these financial regulators are also required to sign an ICA and be bound by the approval thresholds and protection for dissenting shareholders. Such a discussion could be undertaken under the aegis of the Financial Stability Development Council, which is mandated to foster regulatory cooperation and detect and address systemic risk—financial stress among them. Given recent restrictions on the enforcement of security by debenture holders, a collective process is likely to yield more value.

The thrust of the ICA is a collective solution rather than piecemeal individual enforcement action. Accordingly, a framework between multiple regulated entities could provide that where it can be demonstrated that a collective process will yield more value than individual enforcement/liquidation, it should be binding on all creditors with additional safeguards for minority creditors—such as the payment of liquidation value to dissenting creditors—prescribed in the RBI stress directions and universally recognised, among others, by the United Nations Commission on International Trade Law and the World Bank as a safeguard for minority creditors.

Given the present preclusion on the filings under the IBC, the RBI stress directions could be augmented to provide a resolution framework that aligns as closely as possible to the creditor-in–control model of the IBC. Resolution by creditors requires a robust mechanism for securing the cooperation of existing shareholders, management, and promoters of the defaulting debtor on which IBC is predicated. A similar but more agile device requires to be imported in resolution under the RBI stress directions.

Debt being resolved through the RBI stress directions is often legacy stress where appropriate corporate authorisations for conversion of debt into equity may not exist, pledge over shares may not be perfected, and other infirmities may impede lenders from securing the cooperation of the company, its management, and shareholders to ensure that the value business and assets of the company are preserved. Effecting this in the absence of a statutory framework is challenging and to overcome this, lenders have sought contractual workarounds. However, this approach is also sub-optimal since it relies on promoter cooperation to sign the document and contractual enforcement. To give this process some more teeth, the RBI could consider amending the stressed asset directions to provide the execution of the binding undertaking and a trust and retention account agreement by the borrower a precondition to any resolution or restructuring.

The JLF framework had introduced the concept of “non-cooperative borrowers” and provided for specific prudential measures and reporting requirements in respect of non-cooperative borrowers—those who do not constructively engage with lenders for resolution. The non-cooperative borrower framework may be resuscitated and expanded to include not signing deeds, agreements, and documents or passing corporate authorisations to facilitate a resolution/restructuring process. The consequence of being a non-cooperative lender could be augmented to include consequences similar to the wilful defaulter framework—such as being precluded from raising any fresh funding from lenders by the borrower, shareholders, and management. This will act as a significant deterrent to borrowers, their shareholders, and management and ensure their cooperation for an effective resolution. Coupled with the SEBI’s recent amendments encouraging promoter funding into their companies, this could provide the framework of incentives and disincentives for promoters to facilitate a turnaround.

Finally, resolution under the RBI directions should be permitted to be on the continuum for a more formal resolution—whether though a scheme of arrangement under the Companies Act, 2013, or under a new framework for prepacked resolution that may be introduced by the IBBI and MCA. Once a resolution plan is “stitched together” by the ICA signatories, it may be used to bind all stakeholders by a fast-track approval by the NCLT, subject to limited judicial review. This will serve to bind all stakeholders, including shareholders, employees, operational creditors, and other third parties.

The bolstering of the RBI stress directions is a central reform that must supplement the IBC amendments to guard against the build-up of stress. Their first anniversary brings an opportunity and compelling case for a reset and version 2.0.

Views are personal. The authors are partners at Cyril Amarchand Mangaldas.

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