Corporate Debt Restructuring Framework – Revisiting Options Post IBC Suspension

The development of an effective framework or alterations to the current mechanisms to undertake Corporate Debt Restructuring is crucial to revive and safeguard the Indian economy in the ongoing pandemic...

Introduction: The ongoing pandemic has taken a toll on the Indian economy and put the country into unprecedented economic crisis. Even though the exact economic impact of the pandemic is still counting, it is likely to have a major impact on the credit supply and asset quality in the financial market. Due to the sudden demand and supply shock, a lot of companies would be financially stressed, thereby drifting into an insolvency situation. In this prevailing financial environment, Corporate Debt Restructuring ("CDR") mechanism assumes a greater role as liquidation would not be an economically viable option for the creditors. The ongoing recession would suppress the actual value of the assets of a stressed company, thus, liquidation would not fetch the creditors commensurate value of their outstanding facilities. It is also pertinent to note that there would be many companies who may be able to service the debt uninterruptedly if some time is granted with concessions by the creditors thereby avoiding the insolvency and liquidation risks. The Government of India has suspended fresh filings of cases, for the defaults occurring post March 25, 2020, under Insolvency and Bankruptcy Code, 2016 ("IBC") for an interim period. In the backdrop of IBC suspension, this article analyses the frameworks available to undertake CDR until the IBC is resumed.

Corporate Debt Restructuring: CDR is a mechanism by which the financial dues of a stressed company are reorganized to revive the company and increase its liquidity. Typically, CDR mechanism involves mutual negotiations between the creditors (like banks and financial institutions) and the distressed company to restructure and reorganize the existing debt of the company to keep it a going concern and simultaneously avoid default risk.

There are various modes of implementing CDR of a company like:

• conversion of unsustainable debt to equity,
• conversion of preference shares,
• through inter-creditor agreement, and
• haircuts in different forms.

In India, basis the existing regulations there are three well-known frameworks available through which CDR can be undertaken:

• Insolvency and Bankruptcy Code, 2016 ("IBC")
• Scheme of arrangement under the Companies Act,2013 ("CA Scheme")
• Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions 2019 (popularly known as "June 7 Framework")

Suspension of IBC &its implications on CDR On June 5, 2020, Ministry of Law and Justice, as a measure to tackle economic distress due to the ongoing pandemic, passed an ordinance¹ suspending the initiation of Corporate Insolvency Resolution Process (CIRP) under IBC for a period of six (6) months, which could be extendable upto one year. The suspension is particularly for the fresh filing under IBC in relation to the defaults arising post March 25, 2020. Since its enactment, IBC has become a preferred route among the creditors seeking restructuring of the debtor as it offers various benefits, like time-bound disposal of cases, creditor-controlled process, imposition of moratorium on recovery action by all claimants etc. However, due to the June 2020 ordinance, the route under IBC would not be available to the creditors for any default arising post March 25, 2020. Thus, it would be pertinent to explore other routes available to the creditors and stressed companies seeking debt restructuring during the IBC suspension period.

Scheme under Companies Act, 2013 The Companies Act, 2013 (CA) provides for a scheme of arrangement and compromise² between a company and its creditors under the purview of the National Company Law Tribunal (NCLT). The CA Scheme can be initiated by an application to the NCLT by the creditors of the company or the company itself. One important aspect of the CA Scheme is that a scheme could only be accepted by the NCLT if it has been approved by at least three-fourth (3/4^th) in value of the creditors or creditors in class, in writing. Moreover, once a plan is approved by the NCLT it becomes binding on the company, its shareholders, the creditors and even on the creditors who voted against the scheme. The requirement of holding a meeting and requiring approval of creditors having 3/4^th value can be dispensed by the NCLT if creditors or class of creditors, having at least 90% value, agree and confirm, by way of affidavit, to the scheme of compromise or arrangement.

Benefits under the CA Scheme The CA Scheme, even though, a more time consuming process when compared to the IBC, offers certain benefits to the creditors looking to use this route for debt restructuring. Some of the distinct advantages of proceeding under this route are:

• Collective Process-The schemes sanctioned under this route are approved by the three-fourth in value of creditors in the meeting (or the creditors in class), making the process more collective in nature. This would ensure that the final scheme adequately reflects the interest of the majority creditors and the process becomes more efficient than individual action by the creditors.
• Narrow Scope for Objections -NCLTs hold the power to stay the proceedings under the CA Scheme, however, they utilise such powers only in exceptional circumstances. Moreover, once the scheme is approved by the NCLT it takes a larger role than a contract and it also binds the persons who are not parties to the scheme, provided that the scheme is in consonance with general prevailing laws.³
• Debtor-in-Control- The process under the CA Scheme would relatively ensure amicable relations between the creditors and the management of the company, as the scheme is the result of successful collaboration and agreement between the creditors and the management of the company. Moreover, the management continues to run the company even after the implementation of the scheme. It is different from the proceedings under IBC, where the creditors are in complete control of the company.
• Faster Prospects due to IBC Suspension- Due to the suspension of IBC it may be expected that the NCLTs will have less burden of fresh cases and therefore disposal of matter is likely to be much faster.

Key Issues and Considerations under the CA Scheme Even though the CA Scheme can be a viable alternative, there are certain issues and consideration that the parties must be aware of before opting for this route. Few pertinent of them are discussed below:

• Complications in Clubbing Creditors under a Similar Class – In cases where the arrangement and compromise is not between all the creditors, companies would have to carefully consider clubbing of the creditors under a similar class. The CA itself does not provide what would constitute creditors under a same class and reliance would have to made to judicial interpretations which make a broad categorisation. The discretion and acumen to categorise different creditors has been left on the companies and same would have to be carefully exercised.
• No Stay on Creditors' Recourse to other Forums – A major drawback under the scheme is that once the application has been filed in NCLT, there is no automatic moratorium on the recovery actions in other forums. NCLTs might be able to grant such moratorium vide the judicial powers enjoyed by them, however, the issue has not arisen in the past and clarity would only be possible when NCLT decides on this particular issue.
• Power of Review with the NCLT - NCLT has the final discretion to sanction a resolution plan and in doing so, it is often guided by the interest of all the shareholders and the interest of public at large. Hence a scheme might be rejected by the NCLT if the scheme does not take into account the interest of all the stakeholders.
• Less scope for Individual Creditor – Unlike IBC, an individual creditor cannot initiate any action under the CA Scheme unless such creditor will have the support of other creditors having requisite majority.
• Less clarity on appropriate time to raise objections– The CA provides that an objection to a scheme can be raised only by persons holding at least 10% of shareholding; or having outstanding debt of at least 5% of total outstanding debt. It is pertinent to note that Courts have held that objections to the scheme should be postponed until the meetings have been convened by the company. However, there have been contrary judgments to the same.

Reserve Bank of India's June 7 Framework The Prudential Framework for Resolution of Stressed Assets or the June 7 Framework is a set of guidelines by Reserve Bank of India (RBI) which provides a framework for the resolution/restructuring to be followed by the lenders for any stressed assets. The June 7 Framework is only applicable to the following entities:

• Schedule Commercial Banks (excluding regional rural banks);
• All India Term Financial Institutions (NABARD, NHB, EXIM Bank, and SIDBI);
• Small Finance Banks; and
• Systemically Important Non-Deposit taking Non-Banking Financial Companies (NBFC-ND-SI) and Deposit taking Non-Banking Financial Companies (NBFC-D).

An important aspect of the June 7 Framework is that prior to the implementation of a resolution plan the lenders are mandatorily required to enter into an inter-creditor agreement (ICA). Moreover, the decisions under the ICA which are made with the consent of the lenders holding 75% of the value of the total outstanding credit facilities (including fund based and non-fund based) and 60% of total lenders in number are binding on all the lenders. Additionally, the financial institutions are required to implement the resolution plan within an initial period of 180 (one hundred and eighty) days.

Key Issues and Considerations in the June 7 Framework Some of the important considerations and issues in the June 7 Framework are discussed below:

• Need for Greater Focus on Asset Revival - The resolution plan should be carefully envisaged by the lenders. It should be done with an overall objective of reviving the financially distressed borrower and not with sole objective of recovering the debt by selling off the assets. Moreover, the resolution plan should actually work out over a period of time and a sustainable amount of debt should be serviced to the lenders.
• Credit Evaluation of the Resolution Plans - The June 7 Framework requires Independent Credit Evaluation (ICE) of the resolution plans by the credit rating agencies which are approved by the RBI. Only the resolution plans having "RP4" rating (the resolution plans having moderate degree of safety regarding timely servicing of financial obligations) or better could be considered for implementation. RP4 ratings can sometimes throw up red herrings and additionally the cost of ratings is also to borne by the lenders.
• Hurdles in Timely Resolution- One big challenge that comes in the way of timely implementation of the June 7 Framework is getting all the lenders to agree on the term & conditions of the inter-creditor agreement. The drag along rights of the majority lenders can only be exercised after all the lenders have entered into an inter creditor agreement. These issues drag the process for a longer time resulting in untimely implementation.
• Need for Greater Clarity – June 7 Framework requires the inter-creditor agreement to provide for a payment of not less than the liquidation value to the dissenting lenders; however, the Framework does not provide a structure in which such payments are to be made. Moreover, lenders may also face issues in proper valuation of assets of the borrower as no such mechanism is devised under the June 7 Framework for valuation of the assets. Obscurity on these provisions may act as major bottleneck for the lenders and consequently affect the efficacy of the whole process.
• Stringent Provisioning System - Lenders should also be cautious of the provisioning system in the June 7 Framework, wherein, if the lenders fail to implement the resolution plan within a period of 180 days post the review period, a further additional provision of 20% would have to made of the total outstanding. Similarly, if the plan is not implemented for more than 365 days post review period, the provisioning is further increased to 15%. Such high provisioning might impact the profitability of the lenders in cases where the resolution plan is not implemented in a time-bound manner.

RBI has recently eased certain requirements under the June 7 Framework for an interim period through some of the Covid-19 regulatory package introduced between the months of March, 2020 and May, 2020. Some important relief measures taken by RBI, inter-alia, are extension in the initial 180-day timeline to implement the resolution plan and reduction to 10% provisioning. However, the June 7 Framework still needs certain modifications from the RBI to make it an effective and efficient mechanism for timely restructuring of the distressed companies.

Pre-packaged Resolution – A way forward?

The financial instability and limited restructuring options coupled with overburdened judiciary have led the Government to consider implementation of the "Pre-packaged Insolvency Resolution Process"⁴ or pre-pack. Pre-pack mechanism is process where the creditors and borrowers finalise a restructuring plan and subsequently move to a tribunal to get a formal approval on the pre-negotiated deal. NCLTs are already burdened with cases and economic distress due to the current pandemic is likely to exasperate the current problem due to surge in insolvency related filings before the NCLTs. Pre-pack can be a constructive tool in such times as it makes the entire resolution process swifter due to pre-negotiated resolution plans between the creditors and the borrowers. Additionally, pre-pack would be much more cost effective when compared to the resolution process under other mechanisms. Hence, pre-pack could prove to be an overall effective mechanism provided the Government effectively blends it with the existing resolution frameworks and fills the existing gaps in them.

Conclusion:

The suspension of IBC for an interim period leaves only the CA Scheme available with the creditors (as the June 7 Framework is only applicable to certain entities). It could be as viable and effective as the IBC, if the Government comes out with certain amendments to it, like making a provision for imposition of moratorium on any recovery action by the claimants, introduction of the time-line to make the process swifter etc. The aftermath of Covid-19 and lifting of moratorium could possibly see a surge in the default and recovery related actions by the creditors. Furthermore, recovery actions under the current circumstances are adversarial and ineffective for both the creditors as well as the borrowing companies. Hence, the development of an effective framework or alterations to the current mechanisms to undertake CDR is crucial to revive and safeguard the Indian economy.