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January 11, 2016

How Easy Is Implementation Of SDR For Change In Management?


Santosh B. Parab

The SDR Scheme requires the JLF to incorporate, in the terms and conditions attached to the restructured loan/s agreed with the borrower, an option to convert the entire loan (including unpaid interest), or part thereof, into shares in the company in the event the borrower is not able to achieve the viability milestones and/or adhere to 'critical conditions' as stipulated in the restructuring package.

Increase in Non-Performing Assets and restructured accounts in the banking system prompted Reserve Bank of India (RBI) to formulate a Framework for Revitalising Distressed Assets in the Economy ("the Framework") to ensure that the banking system recognises financial distress early, takes prompt steps to resolve it, and ensures fair recovery for lenders and investors. This Framework was placed on RBI's website on January 30, 2014. The Framework was to outline a corrective action plan (CAP) for incentivising early identification of problem account, timely restructuring of accounts which are considered to be viable, and taking prompt steps by lenders for recovery or sale of unviable accounts. Thereafter on February 26, 2014, RBI released detailed guidelines on formation of Joint Lenders' Forum (JLF) and adoption of CAP for operationalising the Framework (Guidelines). Change of management was also envisaged as a part of restructuring of stressed assets pursuant to the Framework.

Irrespective of the Framework and the Guidelines, in many cases of restructuring of accounts, borrower companies were not able to come out of stress due to operational/ managerial inefficiencies despite substantial sacrifices made by the lending banks. Therefore on June 8, 2015, RBI came with a Strategic Debt Restructuring Scheme ("SDR Scheme") pursuant to which the lending banks were allowed change of ownership as a preferred option at the time of restructuring and JLFs were instructed to actively consider change in ownership under the above Framework.

As per the SDR Scheme, the JLF is periodically required to review the account for achievement/nonachievement of milestones which were stipulated in the restructuring package and consider initiating suitable measures including recovery measures as deemed appropriate. With a view to ensuring more stake of promoters in reviving stressed accounts and provide banks with enhanced capabilities to initiate change of ownership in accounts which fail to achieve the projected viability milestones, banks are now allowed, at their discretion to undertake a SDR by converting loan dues into equity shares.

The SDR Scheme, requires the JLF to incorporate, in the terms and conditions attached to the restructured loan/s agreed with the borrower, an option to convert the entire loan (including unpaid interest), or part thereof, into shares in the company in the event the borrower is not able to achieve the viability milestones and/or adhere to 'critical conditions' as stipulated in the restructuring package. Necessary approvals/authorisations (including special resolution by the shareholders) from the borrower company, as required under extant laws/ regulations, to enable the lenders to exercise the option effectively are to be obtained by the borrower company. Restructuring of loans without the said approvals/authorisations for SDR is not permitted. If the borrower is not able to achieve the viability milestones and/or adhere to the 'critical conditions', the JLF is required to immediately review the account and examine whether the account will be viable by effecting a change in ownership. If found viable under such examination, the JLF may decide on whether to invoke the SDR, i.e. convert the whole or part of the loan and interest outstanding into equity shares in the borrower company, so as to acquire majority shareholding in the borrower company.

The decision on invoking the SDR by converting the whole or part of the loan into equity shares is required to be taken by the JLF as early as possible but within 30 days from the above review of the account. Such decision is required to be well documented and approved by the majority of the JLF members (minimum of 75% of creditors by value and 60% of creditors by number);

In order to achieve the change in ownership, the lenders under the JLF are required to collectively become the majority shareholder by conversion of their dues from the borrower into equity. However the conversion by JLF lenders of their outstanding debt (principal as well as unpaid interest) into equity instruments is subject to the member banks' respective total holdings in shares of the company conforming to the statutory limit in terms of Section 19(2) of Banking Regulation Act, 1949. Post the conversion, all lenders under the JLF are required to collectively hold 51% or more of the equity shares issued by the borrower company. After the conversion of the outstanding debt into equity, JLF and lenders are required to divest their holdings in the equity of the borrower company as soon as possible in favour of new promoter. The new promoters are required to acquire at least 51 per cent of the paid up equity capital of the borrower company. The banks implementing the SDR are provided with asset classification benefits

The conversion price of the equity is to be determined as per the guidelines given below:

(i) Conversion of outstanding debt (principal as well as unpaid interest) into equity instruments should be at a 'Fair Value' which will not exceed the lowest of the following, subject to the floor of 'Face Value' (restriction under Section 53 of the Companies Act, 2013):

a. Market value (for listed companies): Average of the closing prices of the instrument on a recognised stock exchange during the ten trading days preceding the 'reference date' indicated at (ii) below;

b. Break-up value: Book value per share to be calculated from the company's latest audited balance sheet (without considering 'revaluation reserves', if any) adjusted for cash flows and financials post the earlier restructuring; the balance sheet should not be more than a year old. In case the latest balance sheet is not available, this break-up value shall be `1.

(ii) The above Fair Value will be decided at a 'reference date' which is the date of JLF's decision to undertake SDR.

The above pricing formula under SDR has been exempt from the Securities and Exchange Board of India (SEBI) (Issue of Capital and Disclosure Requirements) Regulations, 2009 subject to certain conditions, in terms of SEBI (Issue of Capital and Disclosure Requirements) (Second Amendment) Regulations, 2015 notified vide the Gazette of India Extraordinary Part–III–Section 4, published on May 5, 2015. Further, in the case of listed companies, the acquiring lender on account of conversion of debt into equity under SDR will also be exempt from the obligation to make an open offer under regulation 3 and regulation 4 of the provisions of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 in terms of SEBI (Substantial Acquisition of Shares and Takeovers) (Second Amendment) Regulations, 2015. This has been notified vide the Gazette of India Extraordinary Part–III–Section 4 published on May 05, 2015. Banks should adhere to all the prescribed conditions by SEBI in this regard.

Practical Difficulties In Implementation Of SDR


After analysing the SDR Scheme, let's look at the difficulties the banks may face while implementing the SDR.

The SDR Scheme makes it necessary to incorporate, in the terms and conditions in all loan agreements including that of the restructured loan, an option to convert the entire loan (including unpaid interest), or part thereof, into shares in the borrower company. Here it is important to understand the provisions of the Companies Act, 2013.

The right to convert loans or debentures into equity share capital of the company is a contractual right conferred by the company upon its debenture holders/creditors in terms of the lending documents executed between the company and its creditors. The conversion of debt into equity entails an increase in the subscribed share capital of the company on account of issuance of further shares by the company. The procedure for further issuance of shares is governed by Section 62 of the Companies Act, 2013. Sub-clause (3) of Section 62 is in the nature of exception to the process to be followed for issuance of further shares under the section and excludes its applicability to cases where issuance of shares is pursuant to conversion of debt into equity.

Such conversion has to be however authorised by the shareholders of the company by way of a special resolution before the issuance of the relevant debentures or raising of loan by the Company.

Therefore special resolution passed in the general meeting of the shareholders of the company before entering into any loan agreement with provisions entitling the bank to convert its outstanding debt into equity of the company is a must. Getting a special resolution at each and every time while entering into a loan agreement with the conversion clause would be practically impossible and more so in case of the listed companies where the process for calling of the shareholders meeting is cumbersome. The way to tackle this issue is that the borrower company can pass a special resolution of the shareholders which will allow the company and the board of directors to borrow future loans with a right to convert such loans into equity upto a specific limit (i.e. the special resolution passed by the company in the general meeting in relation to the right of conversion of loan into equity shall specify the total amount upto which monies may be borrowed by the board of directors or the company with the conversion rights). The borrower company can then provide to the lender the above mentioned special resolution along with a certificate confirming the balance limits upto which the composite special resolution can be used.

Even after passing of the special resolution, co-operation of the borrower company would be required for all the corporate actions required for the conversion of the loan into equity at the time when the bank or the lenders intends to exercise the right of conversion. Without the cooperation of the borrower company, this right cannot be exercised.

How then in case where special resolution covering the conversion is not in place, the lender can exercise SDR rights. This again is possible with the co-operation of the borrower company. The borrower company can do a preferential allotment of equity shares and issue equity shares to the lender bank treating the outstanding loan as consideration for issuance of equity shares. Not sure, whether in such an event the pricing formulae for conversion would get exempt under SEBI regulations and would get benefit under SDR Scheme.

 

Disclaimer - The views expressed in this article are the personal views of the authors and are purely informative in nature.

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