Corporate Debt Restructuring (CDR) is more than a mere fad for India Inc. As the global economic resurges after several months of an economic slowdown, analysts fastidiously evaluate the impact of debt restructuring processes on the overall well being of the economy. It may be argued that these prevailing conditions are perhaps the appropriate litmus test to assess the success of the CDR system in emerging economies such as India.
This, in turn, has thrown up some interesting questions for debate - what contributions has CDR made, other factors aside, in enabling Indian companies to cope with these stressing times? Has it been able to fulfill its mandate and shoulder the expectations of the policy makers and the industry participants? Or, does CDR offer any incentives over other forms of restructuring under the present regime? Most importantly, what shall be the prospects of CDR in India as the global economy makes a transition from a crisis economy to a post-crisis economy?
I. CDR & India: A Fad which is here to Stay?
For Corporate India, CDR has remained at the receiving end of constant media-attention. With a formalized CDR system which was put in place over half a decade ago by the RBI, and an ever growing number of corporations taking refuge under its provisions, CDR has established a strong foothold in the field of banking and finance.
Current Trends: The Global Crisis & Debt Restructuring
What do giant companies such as Wockhardt, Vishal Retail, India Cements, HPL, Subhiksha, Sakthi Sugars, Jindel Steel, Essar Steel, have in common? They are all recent participants of the Indian CDR system.
In between 2001 and 2005, the CDR Cell restructured 138 cases with an aggregate debt of over Rs 75,000 crore. Of these, 75% of the cases were a success - they performed well and met their debt obligations in time. [1]
The total references received by the cell at the end of December 2009 stood at 208 with an aggregate of Rs 90,888 crores. [2] Of these, 29 cases totaling Rs 5,018 crores were rejected and 173 cases with a total debt of Rs 84,510 crores were implemented under the program. These proposals came from all quarters of the industry. While in the year 2008-09 alone the CDR Cell in India received proposals from 34 companies, [3] the number of cases received for restructuring tripled in the year 2009-10.
It is believed that investments earmarked for CDR constitute 60% of the total industrial investments. [4] Waajid Siddique, [5] in his comment published in a popular business law magazine, observed that at a macro level, the current situation (referring to the global economy in the wake of the sub-prime crisis) constitutes the largest global restructuring ever attempted.
The primary reason for this surge has been attributed to the mounting debt of companies along with a drop in the returns causing a sustained period of debt. Although India outperformed expectations riding through the global economic slowdown relatively unaffected, it's exposure to the crisis was unavoidable. Therefore, CDR has had, and shall continue to play, an integral role in the Indian restructuring efforts in the post-crisis phase. The paper shall put this premise to test.
II. A Brief Outline of the Research Paper
This paper shall look at the CDR mechanism in India and shall seek to critically analyze its performance in the backdrop of a financial year marked with bail-out packages and industry speculation in the wake of the global economic crisis. It shall discuss the nuances of the various procedures evolved by the Reserve Bank of India (RBI) and present a comparative analysis with regard to other similar protection laws, such as insolvency laws. Moving further, the paper shall also look at some of the grey-areas which have been attributed for the systems less-than favorable outlook in the past and the reason why many corporations and/or their lenders steer clear of this route. [6]
Chapter 1
In Support of Restructuring
1.1 CDR: What is it and why do we hear so much about it?
"… it is a proactive step to avoid companies from slipping into a mess from where it may become difficult to make any recovery."
- An executive, quoted by a leading Indian financial daily.
Adam Smith, way back in the late 18th century, spoke about the invisible hand of self-interest that motivated the proliferation of business. Today, the situation has changed, but not by much. In the working of corporations within today's complex mechanisms, it is the self-interest of the various creditors and the members of the company which are the driving force.
Simply put, CDR is a non-statutory and voluntary method for companies to resolve their unmet financial obligations. [7] It is founded on the understanding that making such restructuring facilities available to companies in a timely and transparent matter goes a long way in ensuring their viability which is sometimes threatened by internal and external factors. Corporate debt restructuring as a remedial measure prevents incipient delinquency in corporate accounts. Therefore, this system resolves the financial difficulties of the corporate sector and enables entities to become viable. [8]
Other available options to restructuring may include re-financing or filing for bankruptcy. In practice, restructuring brings to the table the interests of the company along with those of the creditors. This is what sets restructuring apart from other creditor friendly approaches.
This restructuring is multi-faceted. It usually involves the waiver of part of interest or concessions in payment, or converting the un-serviced portions of interests into term loans, re-phasement of recovery schedules, reduction in margins, reassessment of credit facilities including working capital, restructuring the management, reduction in equity capital to make more capital available for expansion, conversion of debentures into equity to give relief on the compulsory payment of interest on the debentures. In addition to these, often, additional finance may be sought for bringing about change in the working of the corporation.
An Example: How Restructuring Scores Over Other Remedies
Assume that there is a Company A-B-C which has an outstanding debt which it cannot meet. Company A-B-C owes this debt to three lenders - X, Y and Z.
From the Point of View of Company A-B-C:
The company can pursue a few courses of action in such a situation. It can consider re-financing, i.e. take on further debt in the hope of turning profitable and to pay off its original debts. However, this may not be possible if Company A-B-C is not in a position to sustain such levels of debt.
Another way out could be for Company A-B-C to cease its operations and to undergo winding up. This has the obvious defect of afflicting an unnatural death on the company's existence. At this point, Company A-B-C could also consider a structured plan to re-negotiate the terms of its current debt with the lenders. This is where restructuring gains prominence.
From the Point of View of Lenders X, Y and Z:
CDR gives lenders a unique opportunity to avoid being encumbered with non-performing assets (NPAs) arising out of corporate accounts. The lenders interest lies in recovering the principle amount lent to Company A-B-C along with returns on that investment.
Liquidation proceedings are notorious for yielding low returns for creditors. In a situation where the company in question is a viable proposition which is facing financial difficulties for factors beyond its control, [9] as companies often do, the lenders may agree to put the company through a phase of restructuring to facilitate a revival. Therefore, CDR becomes an instrument for the lenders, i.e. the banks, to aid the transformation of otherwise Non-Performing Assets into productive assets.
However, does this justify the need to support their restructuring? The answer is an emphatic affirmative with a caveat - the decision should be based on a thorough examination on a case to case basis. Wherever the demand for restructuring is legitimate, and there is a good reason to believe that the corporation may be revived, it must be considered for restructuring. This is imperative for the safety of the money which has been lent by the investors, i.e. the financial institutions, along with the interests of those directly associated with the working of the company.
The following chapter shall look at the various restructuring options available to companies under the Indian insolvency and restructuring laws.
Chapter 2
Indian Laws:
A look at the Insolvency
& Restructuring Regime
2.1 A Look at the Insolvency / Restructuring Laws
A need has long been felt for India to develop a comprehensive code of insolvency and restructuring laws. [10] Currently, the regime is highly fragmented and consolidation would be a move in the right direction.
When companies in India are faced with financial turmoil, they may consider a number of options to achieve restructuring or liquidity. There are six ways [11] for them to attempt to achieve the desired results. These include winding up, arrangements or compromises under the Companies Act, restructuring under the Sick Industrial Companies (SIC) Act, reconstruction of assets under the Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest (SRFAESI) Act, and restructuring as per specific governing statutes which is mostly in the case of public sector banks and insurance companies. Lastly, informal debt restructuring as per the RBI guidelines also provides a forum to address these concerns.
A. Winding-Up
Background:
The Companies Act, 1956 lays down procedures for companies to wind-up. The winding up may be ordered by the court in circumstances where the company is unable to pay its debt or it may be consequent to a petition filed by the creditors or the shareholders or by the company itself. Voluntary winding up may also follow the occurrence of a trigger- event as specified in the articles of the company.
After the appointment of a liquidator, in whom the estate of the company vests, assets are distributed in a preferential order. While the winding up process is under way, the operations of the company are halted and there is a bar on initiating any other legal proceedings against the company without the leave of the court.
Foremost priority is given to the dues of the workmen and debts owed to secured creditors who often choose to enforce their securities outside of the winding up process. From the proceeds of the company's estates, amounts owed to the government are paid first. Thereafter, the dues of the unsecured creditors and those secured creditors who participate in the winding up process are settled. Any remaining surpluses are then divided amongst the shareholders.
Drawbacks:
One of the major drawbacks of this process is that the Act as such does not provide for a time frame for winding up. The average time taken for the procedure to complete is as high as 10 years. In addition to this, the recoveries are often low and the creditors usually suffer losses.
B. Schemes of Compromise or Arrangements
Background:
The Companies Act also allows for formation of schemes of compromise or arrangements, facilitating the entering into such schemes in between debtor companies and their creditors or members. In the course of such an arrangement, the creditors who stand to be affected by the proposed scheme are divided into appropriate classes. These individual classes must consent to the scheme with a 75% majority. Once approved, the scheme needs to be sanctioned by the court which reserves the right to modify the scheme. Pending the execution of the scheme, companies are usually granted moratoriums on actions their pending dues to the creditors.
Drawbacks:
Once again, this procedure involves convening several meetings and court approvals and is therefore time consuming. Nonetheless, since the court does not look in to the commercial benefits of the scheme and only assesses whether the scheme is in the interest of the company or not, constructive schemes can be implemented. For these reasons, and its ability to bind dissenting creditors, this process has been successful in the past.
C. Restructuring under the Sick Industrial Companies (Special Provisions) Act, 1985
Background:
An industry is considered to have become sick when it accumulates losses equal to, or more than, it's net worth. Under the SIC Act, if a company turns sick, the directors of the company must refer the matter to the BIFR (Board of Industrial and Financial Reconstruction) which has extremely broad powers. BIFR, on its satisfaction that the company may be restructured, sanctions a scheme which is binding on the members and the creditors.
Drawbacks:
In practice, this process has been widely implemented by debt-struck companies. Unfortunately, the process rarely culminates in a successful restructuring because of the inordinate delays in the implementation. Companies, in fact, use the reference to BIFR as a tactic to defeat debt claims. [12] Efforts are under way to reform the law in this regard and to make the Act a potent mechanism to address sick companies.
D. Reconstruction of Assets under the SRFAESI Act, 2002
Background:
The Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SRFAESI) envisages private sector participation in asset reconstruction companies to manage NPAs acquired from creditors and grants them certain special rights to aid in the reconstruction of the assets. The secured creditors may exercise their rights outside of this mechanism without interference from the BIFR.
Drawbacks:
Although the Act dates back to the year 2002, this process has not been fully tested and the success rate as such remains unknown.
E. Statute specific Remedies
Background:
Where the corporation in question has been incorporated under a specific statute, which is the case with public sector banks and insurance companies, they may reconstruct as per the provisions of that specific statute.
Drawback:
To the creditors of these corporations, other aforementioned remedies are not available.
2.2 Corporate Restructuring: United Kingdom, Korea & Thailand
The RBI guidelines [13] which govern the CDR system in India make a reference to the corporate restructuring programs in countries such as the United Kingdom, Thailand and Korea. The corporate restructuring practices in these countries date back to the time of their respective economic crisis. England in early 1990's, Thailand and Korea around 1997-1998.
During the Asian financial crisis at the close of the 20th century, certain South-East Asian countries were faced with their greatest economic challenges since the Great Depression. After decades of unprecedented economic growth, unemployment and poverty had led to food riots, labor unrest and political instability.
To look into the strategy adopted by these crisis-struck countries, we may consult the Asian Development Bank's Annual Survey [14] of economic developments from the year 2000.
The strategy, broadly speaking, incorporated a two-step approach. Firstly, the governments attempted to revive market and investor confidence to contain the situation. Secondly, to escape from the crisis, an attempt was made to address the structural weaknesses which had led to the situation. In their search for an efficient manner to allocate losses and facilitate asset mobility to remove the paralyzing debt, they explored different models of restructuring corporate debt.
The first was a Centralized Approach, adopted by countries such as Sweden and Hungary, which was centered on the government assuming a lead role in the restructuring process. However, this model was unsuitable because it necessitated high levels of confidence in the government, and the success of this model for complex restructuring in cases of large debt was unknown.
Then there was the Decentralized Approach, like the one implemented in the USA. This approach entailed an informal and voluntary process without governmental involvement. This model was known to be more appropriate for complex restructuring and high levels of debt.
However, the Asian countries chose to favor what came to be known as the London Approach to corporate restructuring. At the time of its economic crisis in the early 1990's, UK had developed a model for restructuring wherein the creditors and the company would work in close coordination with a governmental institution, the Bank of England. The charm of this model was that it retained the informality of the Decentralized Approach by keeping the process outside of the judiciary process, while including a representative role of the government, accruing the benefits of the Centralized Approach.
The implementation of the restructuring process was one of the principle factors behind the swift economic turnaround in countries such as Korea, which implemented the system in 1998, after the Asian crisis. [15] The fundamental principles involved were simple - there was to be full information disclosure between the companies and the creditors, binding agreements with penal clauses, collective participation from creditors, well laid-out schedules for implementation of packages and a policy of shared-pains for losses amongst creditors.
Soon, the model was replicated in India.
Chapter 3
The CDR System
3.1 Introduction
Eligibility
Initially, cases pending with the Board for Industrial and Financial Reconstruction (BIFR) and the Debt Recovery Tribunal (DBT) were not eligible for CDR. However, mid 2008 onwards, cases pending with the BIFR with a minimum of Rs 25 crore in outstanding exposure have been considered for CDR.
Category 2 [16]
Basis for Determination
While determining the viability of the company, a multitude of factors are taken into consideration. These include:
1. Return on capital employed
2. Debt Service Coverage Ratio
3. Gap between Internal Rate of Return and the Cost of Fund
4. Extent of Sacrifice
5. Break Even Point
6. Gross Profit Margin
7. Loan Life Ratio
A Look into the CDR Packages
Often, restructuring includes the use of devices such as waiver of interest amounts or giving concessions in the interest amount or the non-enforcement of penal interest charges. Such moves may seem necessary for a comprehensive restructuring of the company, they also constitute a failure on part of the lenders to realize the commitments made to them. Therefore, wherever possible, these moves must be avoided. [17]
Where a lender seeks to convert the outstanding amount of interest into a term loan, the burden on the company to repay the loan, in addition to an interest rate, still exists. This may also have certain undesirable consequences. [18]
Instead, the thrust of the restructuring should be on other equitable solutions. Re-working a recovery schedule to suit the existing facilities along with a change in the management, wherever necessary, may yield better results. Also, reduction in the capital to boost the working capital. [19]
Of course, the actual nitty-gritties of the restructuring package vary from case to case, as they should. It is up to the lenders and the company to ascertain the terms which are most likely to help them serve their interests.
Monitoring Restructuring Packages
The responsibility of monitoring CDR packages is shared between a three-tier mechanism.
The Monitoring Instution monitors all aspects of implementation and furnishes a consolidated report to the CDR Cell every month.
The Monitoring Committee is a company specific recommendatory body constituted by the Empowered Group and comprising of the lenders, including the referring lender(s), and other lenders with a varying exposure to the case along with the CDR Cell. Other representatives and experts may be included as special invitees in the meetings. At the time of any major proposal, such as merger / demerger, issue of equity, settlements, etc, the company submits a proposal to the Monitoring Committee for due scrutiny and to the Empowered Group for recommendations.
At all the stages of implementation of the Restructuring Package, the Empowered Group received information and recommendations on the basis of which it may direct the lenders or the company to take certain actions.
Conclusion
In conclusion, the
