Corporate Debt Restructuring In India: A Critical Analysis

Abstract 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? The paper shall study the practice and theory associated with corporate debt restructuring. Particular emphasis shall be laid on the RBI instituted CDR mechanism in India. The author shall present a comparative survey of other insolvency and restructuring laws in India, and present a critique on the CDR system apart from discussing current trends along with the scope of CDR in India and its future prospects. 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. The total references received by the cell at the end of December 2009 stood at 208 with an aggregate of Rs 90,888 crores. 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, the number of cases received for restructuring tripled in the year 2009-10.
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It is believed that investments earmarked for CDR constitute 60% of the total industrial investments. Waajid Siddique, 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.
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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, its 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.

Part I 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 todays 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. 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.
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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.

1.2 An Illustrative Example: Incentives for CDR 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 AB-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 companys 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, 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.
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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.

Part II A look at the Indian 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. Currently, the regime is highly fragmented and consolidation would be a move in the right direction.
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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 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.
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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 companys 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, its 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. Efforts are under way to reform the law in this regard and to make the Act a potent mechanism to address sick companies.
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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 commentators are of the opinion that its 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 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 1990s, Thailand and Korea around 1997-1998.
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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 of economic developments from the year 2000.
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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 1990s, 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. 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.
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Soon, the model was replicated in India.

Part III The CDR System: From Theory to Practice 3.1 Eligibility Initially, all those cases which were pending before the Board for Industrial and Financial Reconstruction (BIFR) and the Debt Recovery Tribunal (DBT) were ineligible for CDR. However, such cases with outstanding exposure in excess of Rs 25 crore have been made eligible mid 2008 onwards. The scope has also been expanded insofar as those NPAs which are rated doubtful are now also covered under the system.
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3.2 The Structure The mechanism established comprises of a 4 tier structure.

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The first tier consists of a Standing Forum. It primarily deals with the issue of laying down guidelines and is a self empowered general body in which all financial institutions and banks from within the CDR system find representation. It serves as an important platform where creditors and borrows participate in the formulation of guidelines. Apart from this, it also monitors the CDR process. Out of the Standing Forum, a Core Group is carved out. It is designated with the task of convening meetings and taking policy decisions. The Core Group also ensures that companies which have had fraudulent dealings or approach the CDR system with mala fide intent are excluded. The Empowered Group, which comprises of Executive Director level representatives from the participatory institutions, considers individual cases for CDR. It decides on the preliminary reports to ascertain where all restructuring is feasible, and hands over selected cases to the CDR Cell. Therefore, while the Standing Forum issues guidelines, the Empowered Group executes them. The CDR Cell is responsible for assisting the Standing Forum and the Empowered Group with all their tasks and for making the initial scrutiny of proposals. It is the Cell which prepares the detailed rehabilitation plans for those proposals which are selected by the Empowered Group. 3.3 A step-by-step Look at the Functioning The steps through which a company reaches the Restructuring Mode can be divided into the following steps: Step 1 The Proposal [Time Frame: 30 days] The company may approach the CDR Cell with a preliminary restructuring plan prepared by either the lead institution (one of the banks) or by the majority stakeholder in the company. The selected proposal is binding on all the participating creditors. The agreement between the creditors usually notes that such plan as is decided by 75% of secured creditors by value or by 60% of creditors by number shall be executed. The proposal contains within itself the Preliminary Plan in addition to other relevant details. Step 2 Preliminary Scrutiny [Time Frame: 30 days] The CDR Cell undertakes a scrutiny of the proposal submitted before it. Step 3 Detailed Review [Time Frame: 90-180 days] Pursuant to this scrutiny, the Cell puts the plan before the Empowered Group for its prima facie consideration on its feasibility and for suggestions for modifications. 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. Extent of Sacrifice 4. Break Even Point 5. Gross Profit Margin 6. Loan Life Ratio 7. Gap between Internal Rate of Return and the Cost of Fund Step 4 The Restructuring Mode [Time Frame: Variable]

If approved by the Empowered Group, the proposal is now in the Restructuring Mode. The Cell would now prepare a detailed Rehabilitation Plan for which it may seek the assistance of experts as well as consultations with the lead institution. Throughout this process, the guidelines issues by the Standing Forum are applied under the leadership of the Core Group.

3.4 Other Aspects of the Process At any time prior to a commitment by the Empowered Group, an exit option is made available to the creditors through which they are given a free hand to take all necessary steps to secure their dues (for instance, seeking liquidation or winding up) whether individually or collectively.
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The bulk of this mechanism hinged on the entering into certain contracts: The DCA (Debtor-Creditor Agreement) and the ICA (Inter-Creditor Agreement). A unique feature of the mechanism is its non-dependence on facts such as sickness of the company or previous default over any time period. Decisions are made solely on the basis of their potential, making it a flexible system for timely action. To ensure the smooth working of the system, DCAs usually incorporate what have come to be known as 'stand still clauses'. Through these, the parties acknowledge that both the parties shall not proceed with other remedies available, outside of the agreed terms of the CDR process.
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Should the need for any additional finance be required, the creditors are obliged to collectively provide it on a pro-rata basis. For creditors who fall within the minimum 75% (by value) or 60% (by number) who have opted in favor of going for debt restructuring, the pledging of this additional finance is mandatory. For those creditors who many be have been unwilling to proceed with the CDR, an exit option is available. 3.5 The Category 2 inclusion
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This category of CDR was introduced in view of the fact that there may be viable cases for restructuring despite the creditors records showing such companies as doubtful assets. This category differs from ordinary restructuring since the creditors are not bound to provide any additional finance which is worked out under the package. Such a decision is left at the sole discretion of the specific creditor.

3.6 A Look into the CDR Packages Packages often involve waiver of interest amounts or other concessions. While these may be necessary at times, they must be used sparingly since they compromise the commitments made to the creditors. In situations where an outstanding interest amount is converted into a term loan, the imposition of an interest rate on such a loan would amount to an addition burden on the company and therefore such a device must be weighed careful before implementation.
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The above two circumstances highlight the need for an equitable and just working out of the package. A rehabilitation plan which meets the existing facilities of the company and sets realistic goals yields better returns for the company and the creditors. Another focus area is usually the reduction in capital at the cost of expanding the working capital of the company.
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Naturally, the intricacies of a particular package are specific to that case and the final decision must be based on a positive interaction between the company and its lenders. 3.7 Monitoring Restructuring Packages A Monitoring Committee is instituted to oversee the implementation of the package which files a report to the CDR Cell informing it of the success every month. Since the Committee is a company specific body constituted by the Empowered Group, the package is kept under the reins of the CDR system. This committee constitutes of various lenders with a varying degree of exposure to the company, thus ensuring that all interests are equally served. In the course of its functioning, the committee also invites experts and other representatives. For every major decision taken by a restructured company, due approval is required from the Committee and recommendations are invited from the Empowered Group. In turn, the Empowered Group receives information and recommendations based on which it directs the company to act. Concluding Remarks In conclusion, the CDR mechanism attempts to be a one-stop forum for lenders and creditors to arrive at mutually agreeable terms to secure their interests, however varied they may be. With the involvement of multiple lenders, there is every chance that any restructuring process would face obstacles and time-delays. These are the very problems that the RBIs informal CDR system aims to address by setting up a framework for swift and timely action. Through the course of this paper, the author has attempted to understand the incentives for creditors and the borrowers to opt for corporate debt restructuring. In the course of this discussion, he has presented a comparative analysis of how different jurisdictions have evolved their restructuring regimes. He has also presented a comparison, along with observations, of the various insolvency and restructuring laws in India. At the core of this analysis has been the theoretical groundwork on which the practice of restructuring is founded. CDR has gained even more significance in a time of global financial turmoil, which only highlights the need to ensure that our CDR structure is given its due importance and allowed to play a more prominent role in the lifetime of a company. Debt restructuring holds immense potential for turning around viable entities which face temporary constraints and the RBI must ensure that the machinery remains well oiled. A thrust area which needs a further look-in is the post-restructuring phase which demands heavy monitoring. With the number of participants expected to see an unprecedented growth, we must bolster the mechanism to make it capable for handling the demands of the near future. Attempts need to be made to maintain the leanness of the CDR supervisory bodies and to prevent bureaucratic hurdles from being created. Industry members can only be incentivized to participate in this project through the success of rehabilitation plans which are under way. Therefore, a strong monitoring body and strict adherence to time stipulations are necessary. Insolvency and restructuring laws in India need to be brought together under one code. The multiplicity of remedies has led to a chaotic situation which has the tendency to encourage uncertainties and of allowing unscrupulous elements to delay proceedings. The inclusion of doubtful NPAs through the Revised CDR Guidelines deserves a special mention and the system must be proactive in responding and adapting itself to the industry needs.

Evidently, the most unique feature of a CDR system is the neutrality of its involvement and its strong invisible hand in the negotiations between debtors and creditors. The RBI must continue to ensure, as it has, that this hand must remain firm, and this neutrality must not be compromised.