The Supreme Court, in Dharani Sugars and Chemicals Ltd v Union of India, quashed the Reserve Bank of India’s (RBI) directions of 12 February 2018 on resolution of stressed assets on certain grounds such as a reference to the Insolvency and Bankruptcy Code, 2016 (IBC), can be made only in specific cases and pursuant to the direction of the central government. This put the ball back in the RBI’s court to address the lacunae pointed out by the Supreme Court and reissue directions on resolution of stressed assets.
The RBI issued revised directions on 7 June, which, unlike the 2018 directions, apply to both banks and systemically important non-deposit taking non-banking financial companies, as well as small finance banks and all Indian term financial institutions. The 2019 directions are issued with the intent of “providing a framework for early recognition, reporting and time bound resolution of stressed assets”.
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Lenders are required to recognize and classify stress as special mention accounts (SMA) – SMA-0 (principal or interest overdue between 1-30 days), SMA-1 (principal or interest overdue between 31-60 days), and SMA-2 (principal or interest overdue between 61-90 days). A lender must have a board-approved policy (including timelines) for resolution of stressed assets.
Where a borrower is reported as a “default” by a bank, a small finance bank, or an all India term financial institution, all lenders must review the borrower within 30 days of the default (the review period), and decide on the resolution strategy, the nature of the resolution plan (RP), implementation of the RP, and whether legal proceedings for insolvency or recovery will be initiated. Where an RP is to be implemented, lenders must enter into an inter-creditor agreement (ICA) to provide for the finalization and implementation of the RP. The ICA must provide that any decision by 75% of lenders (by value) and 60% of lenders (by number) will be binding on all other lenders. The ICA can also provide rights and duties of majority lenders, protection of dissenting lenders, and the payment of not less than the “liquidation value” (the value of the assets of the borrower if it were liquidated on the commencement of the review period) to dissenting lenders.
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The RP should cover any actions to be taken or plans for regularization of overdues of the borrower, including reorganization, sale of loan exposure to other entities, change in ownership and restructuring. Any RP that proposes restructuring or change in ownership for accounts where the outstanding amounts exceed ₹1 billion (US$14.3 million) must be evaluated by a credit rating agency authorized by the RBI. Such evaluation must be done by two credit rating agencies for cases where the outstanding amounts exceed ₹5 billion.
Notably, perhaps with the intent of avoiding conflict of interest situations and possible suggestions of misdemeanour in a distressed assets scenario, the 2019 directions require that the credit rating agencies are engaged and paid for by the lenders. An RP will be deemed to be implemented only if, 1) where there is no change in ownership, if the borrower is not in default at the end of 180 days from the review period, 2) where the RP requires restructuring or change in ownership, if all documentation requirements have been completed, the borrower is not in default, and the changes in loan terms have been reflected in the books of the lenders and the borrower, and 3) where the RP requires the lenders to exit, when the exposure to the borrower is closed following assignment of the debt.
Where the implementation of an RP is delayed, additional provisioning of 20% of the outstanding loan amount will be applicable commencing at the end of 180 days from the review period, and additional provisioning of 35% of the outstanding loan amount will be applicable commencing at the end of 365 days from the review period.
This additional provisioning can be reversed in certain circumstances such as the implementation of the RP (if the RP does not involve a process under the IBC). Similarly, where the RP involves a process under the IBC, half of the provisioning can be reversed on filing of the application under the IBC, and the remaining on admission of the application under IBC.
The new directions are welcome as they provide clarity and direction to banks on dealing with stressed assets. By concentrating on provisioning rather than mandatory reference to insolvency, the RBI appears to have left the discretion to banks, thereby, mitigating potential legal challenges.
Sawant Singh and Aditya Bhargava are partners at the Mumbai office of Phoenix Legal.
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