CA Pooja Sagar

Pooja SagarIndian Banks are facing rising NPA’s due to slowdown in the Indian economy and high interest cost. Therefore, in order to deal with the defaulting companies the Reserve Bank of India has introduced the scheme of “Strategic Debt Restructuring” (SDR). This scheme will give the right to lender to convert the loan dues to equity shares. The general principle behind it is that shareholders should bear the first loss rather than the debt holders

RBI made it clear that this scheme will come into play when bank observes that even after restructuring of accounts, the borrower company is not able to come out of stress due to operational/managerial inefficiencies despite substantial scarifies made by the lending banks. Therefore, the preferred route to overcome this issue will be change in ownership.

For invoking SDR, Joint Lender Forum (JLF)/CDR have to incorporate the option of conversion of loans dues into equity shares in the terms and conditions at the time of initial restructuring. Accordingly if the borrower is not able to achieve the viability milestone and/or to adhere to critical conditions stipulated in the restructuring package, the banks will be forced to opt for the conversion option.

The salient features of Strategic Debt Restructuring are:

  • Conversion option stipulated in terms and conditions should be supported by necessary approvals/authorizations from the borrowing company as required under the rules and regulations of the Companies Act or any other law.
  • The decision of invoking SDR should be well documented and approved by the majority of JLF member i.e. minimum of 75% of creditors by value and 60% of creditors by number.
  • Post the conversion, all lenders under the JLF must collectively hold 51% or more of equity shares of the borrowing company.
  • Conversion of outstanding principal as well as unpaid interest into equity instrument should be at a Fair Value. Fair value will not exceed the lower of the following, subject to the floor of face value:

a) Market Value (for listed companies): Average of the closing prices of the instrument on a recognized stock exchange during the ten days preceding the reference date.

b) Break-up Value (for unlisted companies): Book value per share to be calculated from the company’s latest audit balance sheet adjusted for cash flows and financial post the earlier restructuring. Revaluation reserve will be ignored for the calculation. The balance sheet should not be more than a year old. In case of balance sheet is not available the break- up value will be Re1.

  • The pricing formula under SDR would be exempt from SEBI’s Substantial Acquisition of Shares and Takeovers and Issue of Capital and Disclosure Requirements Regulations 2009.
  • On completion of conversion under SDR, the asset classification existing on the reference date (i.e. the date on which JLF made decision to undertake SDR) will continue for a period of 18 months from the reference date. Thereafter the bank will follow IRAC norms for the classification of asset.
  • Joint Lender Forum will appoint suitable professional management to run the affairs of the company.
  • Divestment: JLF and lender should divest their holding in favour of new promoter as soon as possible. On divestment, the asset may be classified as Standard Asset subject to new promoter clause which states that :

a) Bank should ensure that new promoter whether domestic or overseas should not be person/entity/subsidiary/associate etc related to the existing promoter/promoter group.

b) The new promoter should acquired atleast 51% paid up equity capital of the borrowing company. In case of non-resident as a new promoter, the promoter should atleast own the equity capital as per the applicable foreign investment limit.

After divestment to new promoter, bank may refinance the company on account of change in the risk profile subject to provision for diminution in fair value of the debt which is refinanced.

Bank may reverse the provision held against the said account on satisfactory servicing of principal and interest amount as per the specified terms and conditions. In case of deviation from the terms, the asset classification of the restructured account would be governed by the IRAC norms as per the repayment schedule that existed as on the reference date.

  • Equity shares acquired and held by bank under the scheme shall be exempt from the requirement of periodic mark to market for 18 months period.
  • Conversion of debt into equity will also be exempted from regulatory ceilings on capital market exposures, investment in para-banking activities and intra- group exposure.
  • As per the applicable accounting standard, conversion may result in investor –associate relationship due to banks holding more than 20% of voting power. Since the objective of the bank is to implement the scheme of SDR which is in protective nature and not participative, therefore such investment will not be treated as investment in associate.

The scheme has received mixed reviews from the bank experts. Some have the opinion that borrower will start exercising diligence in managing funds fearing the loss of management to the bank. Others are of the view that it will be tedious and time consuming to run a company. Also it would be difficult to find buyer for floundering company.

For any query contact at [email protected]

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September 2021