Corporate Debt Restructuring (CDR) is a mechanism used to avoid insolvency and give a potentially viable entity an opportunity to regain the financial independence; most importantly it allows the creditors /Financial Institution/Banks to take a call on potential of the firm.
Introduction:
The recession which in the US economy faced in 2007 had a worldwide domino effect. Many companies were brought down to their knees and some of the succumbed to the market pressure resorting to bankruptcies. Bankruptcy spells the financial death of a company and along with it brings an entire spectrum of legal hassles affecting everyone associated with the company in some manner. Bankruptcy is filed in the court when the company or the creditor realises the insolvency of the company, i.e. its inability to pay back its creditors. The next line of action is to generate the amount to pay back by liquidating all the assets of the company. However there might be cases where the slump in the company is only temporary or market created and based on the potential and the past performance of the company the creditors think that it would be possible to recuperate the company and make it a viable option for the future, in those cases there is an alternative for the creditor called Corporate Debt Restructure (CDR). CDR is a non-statutory voluntary mechanism applicable only to standard and sub-standard assets of banks and financial institutions with high priority given to potentially viable cases. Thus, the main concern of CDR is revival of units with future prospect. Since the process of CDR involves huge investment and manpower one needs to be very careful about what unit to approve for this [1] . It is relatively a newer mechanism adopted in India after its success in United Kingdom and some Asian countries like South Korea and Thailand. CDR mechanism evolved in India based on the recommendation of the working committee headed by Shri Vepa Kamesan, Deputy Governor of Reserve Bank of India [2] . The idea was to ensure timely and transparent debt restructuring of potentially viable entities suffering from external and internal financial distresses. CDR is applicable only to multiple banking accounts/syndicates/consortium accounts with outstanding credit of Rs 10 crores and above, with banks and financial institutions. As initially decided, CDR would not consider cases pending with Board for Industrial Financial and Reconstruction (BIFR), Debt Recovery Tribunal (DRT) and other legal redressal forums, however, the recent trend shows that BIFR cases with minimum limit of Rs 25 crores of aggregate outstanding exposures have been considered for the restructuring under its aegis.
Objective of CDR:
The main objective of a debt restructuring is to provide for formal workouts between borrowers and Financial Institutions by way of adjustment of debts in a manner that the company or any business entity can bear the heat of financial downturn and use it resources for the re-growth rather than paying off its creditors, however the entire process is carried out on the consensus of its creditors. It lays down the guidelines for the creditors that if the debtor entity has the prospect of growth and financial viability then its debts should be restructured of managed in a manner that it is given sufficient time and resources to work its way out of the downturn.
Structure of CDR:
CDR system in the country will have a three tier structure:
• CDR Standing Forum:
It will be a self empowered representative general body of all financial institutions and the banks that will be part of the CDR system. CDR standing forum shall lay down policies and guidelines for this purpose and shall also monitor the entire process of credit restructuring. It shall also provide the creditors and borrowers with a common platform so that they can commonly and amicably evolve the process for the efficient running of the system.
The Forum will elect its chairman for a period of one year and the principle of rotation will be followed in the subsequent years. However, the Forum may decide to have a Working Chairman as a whole-time officer to guide and carry out the decisions of the CDR Standing Forum.
• CDR Empowered Group:
It's the duty of the Empowered Group to assess the all the request for the restructuring. They are mandated to examine the viability and rehabilitation potential of the Company and approve the restructuring package within a specified time frame of 90 days, or at best within 180 days of reference to the Empowered Group. Empowered Group is chaired by ED level representatives of Industrial Development Bank of India Ltd., ICICI Bank Ltd. and State Bank of India as standing members, in addition to ED level representatives of financial institutions and banks who have an exposure to the concerned company. The assessment made by the Empowered (EG) is done on the detailed report on the companies' in question financial viability by the CDR Cell. The EG's stand on the restructuring is reached under the policies and guidelines set by the Standing Forum.
However, if the lead institution faces difficulties in working out the detailed restructuring package, the participating banks / financial institutions should decide upon the alternate institution / bank which would work out the detailed restructuring package at the first meeting of the Empowered Group when the preliminary report of the CDR Cell comes up for consideration.
The CDR Empowered Group shall decide on the acceptable viability benchmark levels on the following illustrative parameters, which may be applied on a case-by-case basis, based on the merits of each case [3] :
• Return on Capital Employed (ROCE),
• Debt Service Coverage Ratio (DSCR),
• Gap between the Internal Rate of Return (IRR) and the Cost of Fund (CoF),
• Extent of sacrifice.
• CDR Cell:
In order to execute the debt restricting in the most feasible and efficacious way the Standing Forum and the Empowered group are assisted by this wing called CDR Cell. The CDR Cell will make the initial scrutiny of the proposals received from borrowers or creditors, by calling for proposed rehabilitation plan and other information and put up the matter before the CDR Empowered Group, within one month to decide whether rehabilitation is prima facie feasible. If found feasible, the CDR Cell will proceed to prepare detailed Rehabilitation Plan with the help of creditors and, if necessary, experts would be engaged from outside. If not found prima facie feasible, the creditors may start action for recovery of their dues.
CDR Cell will have adequate members of staff deputed from banks and financial institutions. The CDR Cell may also take outside professional help. The cost in operating the CDR mechanism including CDR Cell will be met from contribution of the financial institutions and banks in the Core Group at the rate of Rs.50 lakh each and contribution from other institutions and banks at the rate of Rs.5 lakh each.
CDR: How Does it Work?
CDR follows several innovative methods to carry out the restructuring process; some of them are as follows:
Debt-Equity Swap: the idea behind this principle is restructuring of the balance sheet of the debtor in a manner that the relevant participating creditors (financial creditors in our case) receive equity interests in a reorganised capital structure in consideration for reducing or completely doing away with their debt claims against the company [4] . This method gives a much needed stimulus to the stressed company by relieving them of the burden of loan and at the same time it gets another chance to turn around. This method has been successfully followed in UK especially in the 1990s when the institutional investors rather than going for the immediate return of the credit they applied this process [5] . In most of the cases this method worked successfully thus helping the debtor to come out of the shadow of the financial distress.
Extension in the time period for the repayment of loan: This most commonly followed process as the risk involved for either party are reduced. Given the fact that CDR is applied only to the firms with strong potential for growth, it makes much more sense to the creditors to merely give a extension for the repayment rather than going for something more adventurous like putting its own stake in the entity. This process reduces the pressure of loan repayment looming over the debtor company, within specified period of time. in the event of such extensions the debtor company can efficiently use its limited resource which otherwise would have been exhausted in the repayment process, for the build of the investment and as capital resource to build up. It essential to save these viable entities from insolvency by offering them such promising bailouts.
Reducing rate of interest for the unpaid portion of the loan: Sometimes a company under the financial distress might not be able to pay back its loans because of its limited resource for income and the mounting rate of interests. However, if the creditors combined with the extension for repayment period and reduction in the rate of interest can manage to get back its investment without pushing the debtor company to the brink bankruptcy. Again the cardinal rule of CDR would be applicable that such options should only be provided to the entities that show prospects of bounce back.
Probable Loopholes:
Since, CDR is a non-statutory body there is no direct recourse for the creditors to follow in case of failure of the agreement with the debtor under the CDR. All the restructuring process is basically a contractual agreement between the parties which the guidelines does not talk about.
CDR being relatively new feature in the Indian scenario the extent of success can always be questioned. Creditors' primary object will be to get at least their investment back if not the profit, therefore looking from their perspective any move to stretch the period of loan or say for that matter credit-equity swap will be akin to getting further deep into trouble in the absence of any express guidelines.
In the events of recent demise of global stalwarts like Lehman Brothers or General Motors, creditors will be much more sceptic about putting or leaving their investment in the troubled market in place leaving when the going is still good. The only assuaging factor for the creditors to go for restructuring is that the companies which are approved for the CDR have potential for bounce back or are likely to be profitable in the longer run, which still is not enough from creditors' perspective.
In order to make CDR more viable, provisions regarding creditor's recourse in case of failure of CDR arrangement should be included in the CDR guideline. In the current scheme its creditors who face maximum brunt if the CDR fails to work out in the planned manner.
The CDR system provides for an exit route so long as other institutional participants are prepared to buy out these loans. Once the CDR package is finalised, loan takeouts would also follow. However, banks/financial institutions would suffer some losses, as the discounting for such takeout is likely to be high, especially as the assets are actually nonperforming [6] . Moreover, the CDR only increase the fund flow and not the cash flow, as the creditors are not adding to the liquid capital all they are doing is providing momentum to the already existing capital in the market [7] .
To conclude one can safely state that capital market worldwide is the most risk prone area with all the likelihoods of financial crest and troughs it becomes next to impossible to come up with a policy which could take pre-emptive measures to prevent the shenanigans of the market. There mechanisms like Corporate Debt Restructuring come as a saviour for both the investors and the entrepreneur. Even though laced with few short comings, the CDR mechanism in India will go a long way in instilling the creditors as well as the investors' faith in the market even in the times of economic gloom. It gives the strong entity in the face of financial pressure a chance to recover and get back in the business besides saving them from becoming insolvent.
Reverences:
Revised Guidelines on Corporate Debt Restructuring (CDR) Mechanism
Rohit Tandon, Corporate Debt Restructuring: Mechanism Needs a Relook, available at <www.zeus.firm.in/Corporate-Debet-Restructuring.pdf> last visited on April 2, 2010.
Karl Clowry, Debt for Equity Swap, available at < http://globelawandbusiness.com/RW/sample.pdf> last visited on April 2, 2010.
O. N Singh, Corporate debt restructuring - Mechanism that needs a relook, May 28, 2004, available at < www.thehindubusinessline.com/.../2004052800041000.htm> last visited on April 2, 2010.
Edward M. Kerschner, Thematic Investing-Corporate Restructuring,
