[The following update has been brought to you by our Editor, Dibya Behera.]
On 2 April 2019, the Hon’ble Supreme Court (Court) held the Reserve Bank of India (RBI) circular dated 12 February 2018 on ‘Resolution of Stressed Assets’ (Circular) to be ultra vires. The Court recognized that each sector has its peculiar stress factors and all sectors cannot be viewed in the same manner in relation to recovery of bad debt. The Circular was criticized primarily because of its one-day rule, according to which the lenders were required to initiate a resolution plan (RP) immediately upon default. This resulted in a high number of "default" accounts being reported to the Central Repository for Information on Large Credit. In view of the same, the RBI has on 7 June 2019 issued the RBI (Prudential Framework for Resolution of Stressed Assets) Directions 2019 (Directions).
Fundamental Principles
The primary fundamental principles underlying the regulatory approach for resolution of stressed assets are as under:
early recognition and reporting of default in respect of large borrowers by banks, FIs and NBFCs;
complete discretion to lenders in respect of design and implementation of resolution plans, in supersession of earlier resolution schemes (S4A, SDR, 5/25 etc.), subject to the specified timeline and independent credit evaluation;
a system of disincentives in the form of additional provisioning for delay in implementation of resolution plan or initiation of insolvency proceedings; and
signing of inter-creditor agreement (ICA) by all lenders to be mandatory, which will provide for a majority decision making criteria.
Comparative Analysis
The norms pertaining to the resolution of stressed assets were earlier made applicable only to the banks. However, under the Directions, the norms have been also made applicable to banks, small finance banks as well as NBFCs. The net being widened brings in a gamut of additional defaulters which might have slipped earlier.
The Directions require the lenders to initiate the process of implementing a resolution plan even before a default takes place. In any case, once the borrower is reported by the lenders to be in default, lenders shall undertake a prima facie review of the borrower account within 30 days from such default. Remarkably, in the erstwhile Circular, there was no such requirement of 30 days' review period. Under the earlier regime, the lenders were only required to initiate a resolution plan immediately upon default, with the resolution to be reached within 180 days.
Earlier, it was mandatory for the banks to initiate proceedings under the Insolvency and Bankruptcy Code 2016 (IBC). However, under the present regime, the lenders have been vested with a sole discretion to decide and formulate a resolution strategy, including the nature of the RP, the approach to implementation of the resolution plan and even the discretion to initiate legal proceedings for insolvency or recovery.
All lenders are now required to enter into an ICA, during the review period. Under the ICA, decision of lenders representing 75% by value of total outstanding credit facilities (fund or non-fund based) and 60% of lenders by number shall be binding on all the other lenders. The directions also mandates protection of the rights and interests of dissenting lenders.
The timeline for implementation of RP in respect of large accounts (accounts with aggregate exposure of the borrower to the lenders being INR 20 billion and above) has been mandated to be 180 days from 1 March 2018 after expiry of which the lenders could file insolvency application within 15 days. Notably, under the present scenario, the 180 days starts after the end of the 30 days review period.
The implementation conditions under the Directions intrinsically remain the same as that under the Circular. Under the Circular, the RP was considered to be deemed to be implemented if the borrower was no longer in default, and if the all the documentation are completed and new capital structure/ changes are reflected in the books of all lenders and borrowers, in case the RP included restructuring. However, certain changes have been made specifically to synchronize with the introduction of the 30 days' review period.
An RP not involving restructuring / change in ownership shall be deemed to be implemented only if the borrower is not in default with any of the lenders as on the 180th day from the end of the review period. Any subsequent default after 180 days shall be treated as a fresh default, triggering a fresh review. Nevertheless, in a RP involving restructuring/ change in ownership, the conditions with respect to the completion of documentation, regularisation of books of accounts of lenders and borrowers and no default remain intact.
An RP involving lenders exiting the exposure by assigning the exposures to third party or an RP involving recovery action shall be deemed to be implemented only if the exposure to the borrower is fully extinguished.
Under the erstwhile Circular, the lenders were mandated to initiate proceedings under the IBC within 15 days, if the RP was not implemented within 180 days. The RBI has introduced significant changes in this aspect in the Directions. Pertinently, if a viable RP in respect of a borrower is not implemented within 180 days from the end of the review period, all lenders with exposure to such borrower have been obligated to make an additional provision of 20% of the total outstanding. Furthermore, if the RP is not implemented within 365 days from the commencement of the review period, lenders have been mandated to make additional provisioning of 15%, i.e., a total of 35%. Moreover, the Directions also provide for reversal of additional provisioning.