Despite several existing schemes and interventions by the Reserve Bank of India (RBI), the problem of bad debt has plagued the Indian banking system. For years, various high value accounts have undergone restructurings that have not resolved stress or the underlying imbalance in the capital structure, or addressed the viability of the business.

The existing RBI stipulated resolution mechanism included corporate debt restructuring (CDR), strategic debt restructuring (SDR), change in ownership outside the strategic debt restructuring (Outside SDR), the scheme for sustainable restructuring of stressed assets (S4A), etc. All of these were implemented under the framework of the Joint Lenders’ Forum (JLF).

On February 12, 2018, the RBI decided to completely revamp the guidelines on the resolution of stressed assets and withdrew all its existing guidelines and schemes. The guidelines/framework for JLF was also discontinued.

The New Framework

The new framework requires that as soon as there is a default in a borrower entity’s account with any lender, the lenders shall formulate a resolution plan. This may involve any action, plan or reorganisation including change in ownership, restructuring or sale of exposure etc. The resolution plan is to be clearly documented by all the lenders even where there is no change in any terms and conditions.

Pending Transactions

For accounts that are in default either prior to or after March 1, 2018, where the aggregate exposure of the eligible lenders in such account is in excess of INR 2000 crores (including the accounts that are subject to the old schemes), the lenders have to initiate and implement a resolution plan within the prescribed timelines. If such plan is not implemented, or implemented but a default occurs within the ‘specified period’, then such account is required to be mandatorily referred to the process under the Insolvency & Bankruptcy Code, 2016 (IBC).

One major impact of the new framework is that the transactions that have been initiated under the old regime but not “implemented” would require implementation of a resolution plan under the new framework within the prescribed timelines. “Implemented” is now defined to avoid any ambiguity.

Account Classification & Upgrade

The new framework does not provide any stand still benefit for the asset classification, as was available under the old schemes. An account can be upgraded only when all the outstanding loans or facilities in the account demonstrate “satisfactory performance” during the “specified period”. However, for cases involving change in ownership, lenders may continue or upgrade the asset classification to ‘standard’ after implementation of change in ownership whether pursuant to a resolution plan under the new framework or under the IBC subject to satisfaction of certain conditions.

 Applicability to Banks, NBFCs and other Financial Creditors

The new framework is currently only applicable to scheduled commercial banks and All India Financial Institutions (being Exim Bank, SIDBI, NABARD etc.), and therefore non-banking financial companies (NBFCs), asset reconstruction companies or other financial institutions, which were able to participate in the process of resolution under the old schemes, will have to join on a consensual basis. Historically, the RBI has extended applicability of similar circulars to NBFCs and the same may be expected for the new framework as well.

Overseas creditors (including overseas banks, FPIs, bond holders, etc.) continue to be outside the purview of restructuring under the schemes prescribed by the RBI. This, in practical terms, means that consents will be required to implement a resolution under the new framework. Going forward, inter creditor agreements will gain significance in the absence of the JLF mechanism.

Moving towards a viable Resolution or IBC

While the new framework may appear to be revolutionary, it seems consistent with the recent approach of the government and the regulator in dealing with stressed loan accounts, which included measures like enactment of the IBC, mandating the banks to refer certain large loan accounts into insolvency resolution proceedings and disqualifying delinquent promoters from bidding for their assets.

On a positive note, the new framework is less prescriptive about the method of resolution but is prescriptive about the outcome. It does not define the parameters of resolution, which was a significant issue with the old regime. Many restructurings could not bear fruit under the old regime because of prescriptions on personal guarantees and sizing of debt and equity in particular. The key theme of the new framework is that if a commercial solution is found that leaves a residual debt that meets a minimum rating requirement, then the banks can proceed to implement the resolution.

The timelines are strict and default thresholds are low. This may well mean that most of the cases will go under the IBC leaving limited time to banks and promoters to find a sustainable solution. Whilst the solution within the prescribed time requires unanimous consent, it seems that the IBC will act as a deterrent for all stakeholders to find the right solution.

* The author was assisted by Principal Associates, Nikunj Maheshwari and Pururaj Bhar.