The S4A: Genuine progress or a mere flash in the pan?

By Sawant Singh and Aditya Bhargava, Phoenix Legal
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With catchy acronyms such as SDR (strategic debt restructuring), JLF (joint lenders forum), and CAP (corrective action plan), the alphabet soup of the measures taken by the Reserve Bank of India (RBI) over the past 18 months has caught the imagination of industry watchers who had been clamouring for broad-based regulatory measures to assess problematic loans before these became non-performing assets (NPAs) and to clean up Indian banks’ balance sheets before a debt-fuelled financial crisis ensued.

Sawant Singh
Sawant Singh

While initially – and to some extent still – criticized by naysayers, these measures have been critical in arresting the growth of NPAs for Indian banks. As a follow-up to its now publically lauded battle to clean up the balance sheets of Indian banks, the RBI on 13 June issued the Scheme for Sustainable Structuring of Stressed Assets (S4A), with the intent of creating a separate mechanism to allow banks more time to write down debt and make provisions for “large accounts”. The S4A is in addition to the JLF mechanism and is only available for borrowers that fulfil the eligibility criteria prescribed in the S4A.

Accounts will be eligible to be resolved under the S4A where: (a) the project has commenced commercial operations; (b) the aggregate exposure (including accrued interest, rupee loans, foreign currency loans and external commercial borrowings) of all institutional lenders is more than ₹5 billion (US$74.5 million); and (c) the stressed facilities fulfil the criteria of “sustainability”.

The S4A prescribes that debt will be considered sustainable if the relevant JLF or lenders conclude, on the basis of an independent techno-economic viability study, that the principal amounts of the borrower’s facilities (both funded and unfunded) from institutional lenders can be serviced over the same tenor as the existing facilities even if the borrower’s future cash flows remain at their current level. For the S4A to apply, 50% of the borrower’s funded facilities should fulfil this test.

If the account is eligible, the lenders will categorize the current debt of the borrower as part A debt (being the current level of debt that can be serviced within the current maturity based on cash flows from current operations and future operations up to the next six months) and part B debt (being the difference between the aggregate current outstanding debt from all sources and part A debt).

Aditya Bhargava
Aditya Bhargava

For debt that is eligible to be resolved, the lenders must engage “credible professional agencies” to conduct a techno-economic viability study in respect of the borrower, and to prepare a plan to resolve the stress in the borrower. This resolution plan must be agreed by a minimum of 75% of lenders by value and 50% of lenders by number. For part A debt, the resolution plan must not grant a fresh moratorium on interest payments or principal repayments, extend the repayment schedule or reduce the interest rate.

The resolution plan must also consider whether there will be a change in the promoter and management of the borrower. Notably, the S4A prescribes that the scheme “shall not be applicable” if there is wrongdoing on the part of a promoter and a change in the promoter or the management is not contemplated.

The resolution plan must further consider converting part B debt into equity or redeemable cumulative optionally convertible preference shares. If the plan does not contemplate a change in promoter, the lenders can also consider converting part B debt into optionally convertible debentures.

The S4A also provides for the constitution of an independent overseeing committee (OC), to be constituted by the Indian Banks’ Association in consultation with the RBI. Apart from stating that the OC must comprise eminent persons, the S4A has not prescribed any eligibility criteria for OC members. Perhaps with a view to insulate the OC from any external compulsions or factors, the members of OC cannot be changed without the prior approval of the RBI.

The lenders must submit the finalized resolution plan to the OC, which will review the process involved in its preparation for reasonableness and adherence to the S4A. Once the OC approves the resolution plan, it will be binding on all the lenders.

Unlike the SDR mechanism, the S4A does not prescribe a limit of 18 months for banks to dispose of the equity they hold in lieu of outstanding loans. Further, the S4A allows banks to classify facilities as “standard” as long as these were classified as such prior to measures being taken under the S4A and also subject to banks making the required provisioning. This “wriggle room” provided under the S4A has been welcomed by banks. While some see the S4A as allowing banks to more effectively resolve rectifiable debts, it has also been criticized as merely postponing the inevitable.

Sawant Singh is a partner and Aditya Bhargava is a principal associate at the Mumbai office of Phoenix Legal.

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