A Solution With Its Own Problems
The SDR provides that the conversion of shares is done at fair value (lower of market price or book value) or face value, whichever is higher
Babu Sivaprakasam, Partner-Economic Laws Practice, Advocates and Solicitors
At CII’s first Banking Summit on 11 February 2016, RBI governor Raghuram G. Rajan mentioned while speaking on issues on Banking, “In sum, to the question of what comes first, clean up or growth, I think the answer is unambiguously ‘Clean up!’ Indeed, this is the lesson from every other country that has faced financial stress.” This sums up the situation today — companies are underperforming, they are overleveraged and unable to service debt, financial institutions have stressed accounts and are unable to recover, cost of funds is increasing and the economy is suffering.
Keeping in mind the requirement for clean-up of stressed assets of financial institutions, the RBI introduced the Strategic Debt Restructuring scheme (SDR) on 8 June 2015 and made relevant modifications on 25 February, 2016. The SDR gave a right to the lenders of a stressed company to collectively convert all or part of their outstanding loan into at least 51 per cent of the borrower in the event of a breach of certain critical conditions, which would be duly captured in the restructuring/rectification agreement entered into under the Joint Lenders’ Forum.
The RBI has indicated that the SDR provides an effective tool to lenders to tackle operational/managerial inefficiencies of the companies by removing them. Apart from losing controlling interest in the company, SDR suggests that (i) The company cannot be ever sold to the promoters or anyone related, (ii) Resolutions in relation to the share transfer are taken upfront and (iii) Personal guarantees of promoters are to be kept alive till the banks divest the entire stake to a buyer.
Currently, reports suggest that banks have invoked SDR for over 17 companies and have not yet been able to divest their interest in even a single company. It would be important to analyse the issues being faced qua implementation of SDR. At the outset, the decision of conversion by the lenders is difficult (since the conversion should amount to at least 51 per cent of shareholding) and can at no point of time satisfy all lenders. Considering that SDR still mentions that the conversion would be subject to Section 19(2) of the Banking Regulation Act, 1949, SDR would never work when there is a single lender.
The SDR provides that the conversion of shares is done at fair value (lower of market price or book value) or face value, whichever is higher. In Electrosteel Steels and Shiv-vani Oil and Gas, the conversion took place at a premium to the share price. Such pricing requirements have an adverse effect on the banks’ clean-up process.
On conversion, the shares would be held with a common agent and the lenders would be required to replace the existing management with an interim management. Apart from the upfront resolutions, SDR does not detail anything on the corporate processes to be followed. The Companies Act, 2013 highlights several steps to be taken for issuance of shares and change of management for which the lenders would still have to depend on the promoters/borrower.
Additionally, one of the biggest risks in SDR is on the issue of liability. Being an ailing company, the borrower is bound to have (or has the potential to have) other unsecured creditors, statutory dues, ongoing proceedings/investigations, labour issues, product issues and third party claims. There may also be ongoing obligations that the borrower may have with existing shareholders. None of such implications are dealt with in the scheme proposed by the RBI. Banks have to appreciate and mitigate such liabilities and be aware that certain liabilities may extend to the management/directors. The financial institutions are looking to appoint professionals for the interim management of such borrowers. Such professionals are deliberating on whether directors’ and officers’ insurances are satisfactory to mitigate the possible liabilities. Such liabilities are also not beneficial for the valuation of the borrower.
The fact that lenders have to find buyers for at least 26 per cent of the shareholding of the borrower within 18 months to maintain the asset classification, has opened up the market for acquisition of stressed companies. However, in reality the lenders are finding it difficult to sell the stakes without taking a haircut of over 50 per cent. For Electrosteel, lenders had offers from FIG to take a Rs 2,559-crore waiver and a Rs 6,000-crore waiver from Tata Steel. There are sectoral issues (as in steel or infrastructure) which are hampering revival of borrowers and leading to a situation in which there are no interested buyers. The issue of providing relevant warranties and indemnities to the new buyer is also causing a huge concern. The SDR does not provide exemption from the takeover regulations at the time of divestment by banks. Accordingly, there may be a scenario in which delisting may be required.
Given the above, SDR is still valuable for companies that are setting up stressed asset funds (SREI, IDFC, etc.) and for those who are looking to buy into the risk.
With inputs from Deep Roy, Associate Partner, Economic Laws Practice and Sharmila Ratnam, who is an Associate with Economic Laws Practice (ELP), assisted with research and inputs.
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