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The Strategic Debt Restructuring Regime in
India: Does It Need Strategic Restructuring?
By Pravesh Aggarwal and Rahul Bajaj*
This article seeks to enunciate several important ways in which Indias
strategic debt restructuringregime can be made more robust, transparent,
practical,and relevant.
Even though the Indian economy has grown at a robust pace over the last
decade, regulators have struggled to put in place efficacious processes and
systems for the absorption of risks and the protection of the financial market
from incipient challenges, without which the financial system cannot grow in
an inclusive and sustainable manner. One critical problem which has, in some
sense, significantly undercut the appeal of the India growth story has been the
rapid rise in non-performing assets ("NPAs").' Indeed, the recent events in
Greece have certainly taught us that the success of any economy, at a micro as
well as macro level, is in large part shaped by the strength of the mechanisms
2
that are put in place for the allocation, monitoring and recovery of debts.
Therefore, for securing the growth of a financial system on a solid foundation,
it is imperative that financial regulators put in place effective frameworks within
the confines of which a concerted effort can be made to balance the competing
claims of different stakeholders involved in a loan and for ensuring that the
interests of creditors are given the importance and priority that they deserve,
while at the same time providing debtors adequate opportunities for unlocking
the potential latent in their business which can allow them to repay their debts
and make a meaningful contribution to the growth of the economy at large.

Pravesh Aggarwal, a third year student pursuing a B.A.LLB (Hons.) at Rajiv Gandhi
National University of Law, Punjab, and Rahul Bajaj, a fourth year student pursuing a B.A. LLB
(Hons.) at Dr. Ambedkar College of Law, Nagpur University, may be contacted at
praveshaggarwal08@gmail.com and rahul.bajaj 1038@gmail.com, respectively.
1 See Section 2(o) of the SARFAESI Act which defines "non-performing asset" as "an asset or
account of a borrower, which has been classified by a bank or financial institution as
sub-standard, doubtful or loss asset,-(a) in case such bank or financial institution is
administered or regulated by any authority or body established, constituted or appointed by any
law for the time being in force, in accordance with the directions or guidelines relating to assets
classifications issued by such authority or body; (b) in any other case, in accordance with the
directions or guidelines relating to assets classifications issued by the Reserve Bank"; also see
http://www.livemint.com/Industry/xPuLSOoxWckzmLk8RhnrGJ/Bankers-expect-NPA-crisis-
to-worsen-in-next-few-years-EY-su.html.
2 See http://www.rediff.com/business/column/the-greece-crisis-and-its-lessons-for-india/
20150703.htm.
 PRATT'S JOURNAL OF BANKRUPTCY LAW

To this end, regulators in recent years have developed a potent tool known
as strategic debt restructuring ("SDR") which allows creditors to actively assert
their interest by reshaping the functioning of the debtor in a positive and
mutually beneficial manner. On account of the increased scope and depth of the
Indian financial market, coupled with the adoption of aggressive lending
policies by banks, SDR has emerged as a powerful stabilizing force by making
the debt recovery procedure more predictable, uniform and less adversarial.
It is dismaying to note, however, that the substantial potential of the SDR
regime to improve the quality of the extant credit culture in India is
significantly undercut by the lack of proper articulation of a set of concise
policy goals and long-term vision which ought to underpin the regime coupled
with the procedural delays that the regime, in its present form, is crippled with.
Therefore, this article seeks to iron out the creases in the existing regime by
enunciating several important ways in which it can be made more robust,
transparent, practical, and relevant. It is divided into four main parts. In
addition to analyzing recent attempts by financial regulators aimed at making
India's credit culture more stable and secure, the first part seeks to situate the
need for a robust SDR framework within a broader economic context. The
second part examines measures by the Reserve Bank of India ("RBI") to
promote corporate debt restructuring and the third part succinctly analyzes the
contours of the SDR regime, with special emphasis on its key merits and flaws.
Finally, the fourth part concludes by enunciating the possible steps that can be
taken to make the existing regime more purposeful and efficient.

STRATEGIC DEBT RESTRUCTURING AS A TOOL FOR

IMPROVING THE CREDIT CULTURE IN INDIA:
A HISTORICAL PERSPECTIVE
The progressive liberalization of the Indian economy over the last two
decades, coupled with the creation of more interconnected trans-national
supply chains and business linkages, have brought into sharp focus the need for
Indian financial regulators and lawmakers to institutionalize robust processes
and mechanisms for the efficacious absorption of risks in order to put the India
growth story on firmer moorings. To this end, the Parliament of India and the
Reserve Bank of India have, through a set of regulatory and pre-emptive
measures, sought to balance the twin imperatives of creating conditions
conducive to asset growth and business expansion along with incentivization of
well-structured risk management processes. In light of the aforesaid, it would be
instructive to refer to at least four key steps that have been taken in recent years
to usher in a paradigmatic shift in the manner in which debts are negotiated
and recovered, floundering businesses are provided a sense of direction and
46
 THE STRATEGIC DEBT RESTRUCTURING REGIME IN INDIA

purpose and the stability of the financial system is safeguarded. These steps
include enactment of Sick Industrial Companies (Special Provisions) Act, 1985,
Recovery of Debts due to Banks and Financial Institutions Act, 1993,
Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest ("SARFAESI") Act, 2002, and creation of a framework by RBI
for the declaration of wilful defaulters.
Sick Industrial Companies (Special Provisions) Act, 1985
In keeping with the forward-looking recommendations of the Tiwari
Committee,3 the Sick Industrial Companies (Special Provisions) Act, 1985
("SICA") was enacted in the year 1985 in order to institutionalize a robust
machinery to efficaciously detect, analyse and mitigate administrative and
financial risks faced by sick industrial companies 4 which were rising at a
rampant pace at or prior to the time of enactment of the SICA. The Board for
Industrial and Financial Reconstruction ("BIFR") and the Appellate Authority
for Industrial and Financial Reconstruction ("AAIFR") that the SICA brought
into existence were tasked with the principal responsibility of finding concrete
ways of transforming sick industrial units from passive consumers of scarce
public resources to active engines of economic growth.5 To this end, the Act
empowers the BIFR to effectuate a large set of structural and functional
alterations in a company, such as restructuring the management and board of
directors, sale/leasing of surplus assets to generate more resources, structuring
merger and amalgamation agreements and adopting solutions involving mul-
tiple stakeholders who can contribute finances, expertise and resources that are
critical for unlocking the potential latent in floundering businesses. 6 However,
the BIFR has been largely unsuccessful in accomplishing the goals for which it
was set up-a conclusion best evidenced by the fact that only 8.9 percent of the
companies registered by the BIFR within the first 15 years of its inception could
be rehabilitated and the success rate was a mere 39 percent even for companies
for which a comprehensive rehabilitation scheme was designed after appropriate
7
viability studies.
Recovery of Debts due to Banks and Financial Institutions Act, 1993
The Recovery of Debts due to Banks and Financial Institutions Act ("RDDB

3 See http://www8.gsb.columbia.edu/ciber/files/Sujata%/20Visaria.pdf.
4 See Preamble, the Sick Industrial Companies (Special Provisions) Act, 1985.
5 See Chapter III of the Sick Industrial Companies (Special Provisions) Act, 1985 which deals
with References to the Board (BIFR), Inquires into working of sick industrial companies and
various schemes that can be prepared to revive sick companies.
6 See Section 18, the Sick Industrial Companies (Special Provisions) Act, 1985.
7 See http://shodhganga.inflibnet.ac.in/bitstream/ 10603/6846/11/1 1-chapter%203.pdf.

47
 PRATT'S JOURNAL OF BANKRUPTCY LAW

Act"), enacted in 1993, is the most comprehensive code grappling with debts
exceeding 10 lakh rupees.8 The Act, whose codification was actuated by the
twofold objective of facilitating expeditious recovery of large debts and putting
in place a well-structured legal machinery for the adjudication of such disputes,
empowers banks and other financial institutions to recover debts ideally within
a period of 180 days of filing their original application if they are able to
substantiate their claims. 9 The capacious scope of the Act is best epitomized by
the fact that the definition of the term "Debt" in Section 2 (g) of the Act is
couched in very expansive language and includes any "liability, including
interest due from any person by a Bank during the course of any business
activity undertaken by the Bank under any law for the time being in force in
cash or otherwise, whether secured or unsecured, or whether payable under a
decree or order of any civil Court or otherwise subsisting or legally recoverable
on the date of the application."' 10 However, the RDDB Act has failed to bring
about a transformational shift in the manner in which debts are recovered
because of the fact that the law is heavily tilted in favour of creditors, making
debtors feel less invested in the system, coupled with the inability of the law to
delineate clear, fair and simplified processes for the proper attachment and
foreclosure of assets linked with loans." In addition, within a decade of the
DRTs being set up, it became amply clear that they were exacerbating, as
opposed to alleviating, existing problems, and that the only meaningful way in
which the problem of debt recovery could be solved would involve the vesting
of greater powers in the lenders themselves. 12 More specifically, even though
DRTs are mandated to dispose applications within a period of 60 days of their
filing, extendable to 120 days, 13 they have shown themselves to be woefully
inadequate to the job because of absence of appropriate resources and

8 See http://www.manupatra.co.in/newsline/articles/Upload/80938A41-3558-4A9F-BB18-
FD5C692CA00.pdf. Also prior to 1993, banks had to take recourse to the long legal route
against defaulting borrowers, beginning with the filing of claims in the courts. Many years were
therefore spent in the judicial process before banks could have any chance of recovery of their
loans: See https://www.rbi.org.in/scripts/BS-SpeechesView.aspx?id-931.
9 See Section 19(24), the Recovery of Debts due to Banks and Financial Institutions Act,
1993.
2
10 Section (g), the Recovery of Debts due to Banks and Financial Institutions Act, 1993.
11 It was also observed in the year 2014 that there are over 40,000 cases worth Rs 1.73 lakh
crore pending before various courts and Debt Recovery Tribunals: See http://www.dnaindia.
com/money/report-rbi-gets-tough-says-even-guarantor-to-be-tagged-as-wilful-defaulter-if-
obligations-not-met-20175 10.
12 https://www.rbi.org.in/scripts/BS-SpeechesView.aspx?id-931.
13 Section 17 (5), the Recovery of Debts due to Banks and Financial Institutions Act, 1993.
 THE STRATEGIC DEBT RESTRUCTURING REGIME IN INDIA

manpower coupled with the problem of rapidly rising cases, a large portion of
which are filed frivolously and are dismissed in limine. 14 This thereby defeats
the very object of the Act which provides for expeditious adjudication and
5
recovery of debts due to banks and financial institutions by the DRT.1
Securitisation and Reconstruction of Financial Assets and Enforcement
of Security Interest (SARFAESI) Act, 2002
After the government realized that extant legal frameworks were inadequate
and ineffective in addressing the pressing problems of rising NPAs, it
constituted various committees, most notably the Narasimham Committee II
and Andhyarujina Committee to find ways of facilitating the sale of collateral
securities in ways that were consistent with the need to circumvent protracted
litigation and institutionalize market-driven solutions to the problems of rising
defaults. 16 To this end, the Securitisation and Reconstruction of Financial
Assets and Enforcement of Security Interest (SARFAESI) Act, 2002, was
brought in force to pave the way for the robust securitization and reconstruc-
tion of financial assets that undergird debts.' 7 The Act envisages the creation of
securitization and reconstruction companies which are empowered to enter into
agreements with banks to acquire the debts which banks are entitled to recover
from borrowers.' 8 Not only are such companies better positioned than lender
banks to expedite the recovery of debts through the adoption of more
innovative techniques, but the Act also empowers them to take a set of powerful
measures to facilitate quicker recovery of debts, such as restructuring the
borrower's management, selling or leasing their business, rescheduling the
amount of debts, settlement of dues and taking possession of underlying
securities. 19 More significantly, in order to circumvent complicated legal
processes, the Act empowers secured creditors to take over the possession of the
underlying security or business of the debtor and sell, lease or assign the same
for the purpose of recovering the debt amount if the debtor fails to pay the same

14 http://www.cppr.in/wp-content/uploads/2012/ 1O/A-STUDY-ON-THE-
EFFECTIVENESS-OF-REMEDIES-AVAILABLE.pdf pg, 18; Also see supra note 11.
15 See Preamble, the Recovery of Debts due to Banks and Financial Institutions Act, 1993.

16 See http://www.isec.ac.in/WP%/0202520/%20-%/20Meenakshi%/o20Rajeev%/o20and%/o20H%/
20P%20Mahesh.pdf.
17 See Preamble, the Securitisation and Reconstruction of Financial Assets and Enforcement

of Security Interest Act, 2002.

18 See Section 5, the Securitisation and Reconstruction of Financial Assets and Enforcement

of Security Interest Act, 2002.

19 Section 9, the Securitisation and Reconstruction of Financial Assets and Enforcement of

Security Interest (SARFAESI) Act, 2002.

 PRATT'S JOURNAL OF BANKRUPTCY LAW

within 60 days of the receipt of notice.2 0 However, asset reconstruction

companies have largely been unable to usher in the paradigmatic shift in India's
credit culture that they were touted to be capable of-an assertion best
evidenced by the fact that 15 of the most influential asset reconstruction
companies in India only boast of a net worth of Rs. 4,000 crores while the
2l
country's distressed assets run into multiple lakhs of crores.
Framework by RBI for the declaration of Wilful Defaulters
The RBI has created a framework for the declaration of wilful defaulters2 2 in
order to disincentivize financial tendencies that are productive of great public
mischief by erecting barriers to access to the credit market and the financial
system in general for those who repeatedly fail to repay their credit obligations
in a meaningful manner. However, the measures of the RBI have failed to
inspire lender confidence, as most proceedings for the declaration of wilful
defaulters are often mired in procedural minutiae and lack expedition. For
example, United Bank of Indias relentless efforts to get Kingfisher declared as
a wilful defaulter were dented by the Calcutta High Court for the simple reason
that the bank had one more member than the prescribed number on its
identification committee for detection of wilful defaulters, making the proceed-
23
ings of the committee a nullity.
Conclusive Stand
Despite the aforementioned gamut of ameliorative, corrective and progres-
sive measures, India continues to possess an exceptionally poor credit culture,
characterized by systemic and structural flaws, low credit appetite and inability
of borrowers and lenders to structure lending arrangements that are flexible,
transparent and designed in ways that are mutually beneficial for the concerned
parties. It is submitted that this sorry state of affairs is attributable to at least two
principal factors. Firstly, Indian regulators, which are still struggling to recover

20 Section 14, the Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest (SARFAESI) Act, 2002.
21 See http://www.financialexpress.com/article/industry/banking-finance/npas-why-rbis-
flexibility-may-not-be-an-optimal-solution/141741/.
22 A wilful defaulter is somebody who has essentially not used the fund for the purpose it has

been borrowed or when he has not repaid when he can do so; when he has siphoned off the funds
or when he disposed of the assets pledged for availing of loan without the bank's knowledge: see
http://articles.economictimes.indiatimes.com/2015-04-19/news/61304025 1 defaulters-psu-
banks-gross-npas; Also see https://www.rbi.org.in/scripts/BSViewMasCirculardetails.aspx?id-
9907.
23 http://www.business-standard.com/article/opinion/kingfisher-case-shows-why-india-

needs-strong-debt-recovery-laws-i 14123000077 1.html.

 THE STRATEGIC DEBT RESTRUCTURING REGIME IN INDIA

from the command-and-control mode of formulating and monitoring eco-

nomic policy, have hitherto completely failed to put in place appropriate legal
structures that view borrowers and lenders as constructive partners committed
to the cause of economic growth and not as adversaries whose interests can
never be reconciled. As a result, even legal instruments such as the SARFAESI
Act which claim to promote a healthy credit culture by simplifying and
streamlining arcane legal procedures are fundamentally predicated upon the
belief that the only way to promote a strong credit culture is by institutional-
izing a system which can facilitate more expeditious recovery of debts and not
by finding ways of building networks of cooperation between debtors and
creditors for resolving conflicts amicably. Secondly, credit instruments in India
have traditionally been viewed with great suspicion by the society at large,
principally because of values of risk aversion which are deeply rooted in ancient
Indian culture, resulting in most policies being structured in ways that
disincentivize large-scale borrowing and instead promote self-sustaining models
of economic expansion. This has not only posed practical impediments for
businesses that need to borrow large sums of money for competing with their
global counterparts, but has more importantly prevented financial regulators
from viewing credit instruments as strategic tools which can, through appro-
priate support structures, be efficaciously leveraged to reshape businesses in
positive ways.
It is no surprise, then, that gross non-performing assets ("NPAs") of
commercial banks rose from Rs. 2.4 lakh crore in March 2014 to Rs. 3.02 lakh
crore in March 2015, resulting in a gradual fall in annual returns from assets
from 1.09 per cent during 2010-11 to 0.78 per cent during 2014-15.24 This
problem is all the more acute in the context of public sector banks, whose gross
NPAs amount to Rs. 296321.4 crore as compared to private banks, where the
25
figure is Rs. 34,805 crore as per their reports for the quarter ending in June.
Therefore, if we are to transform India into a powerful, sustainable, and
inclusive creditocracy, we must reconceptualize debts, foster mutual respect
between banks and businesses, find ways of aligning the often competing
interests of different stakeholders and recognize the unexceptionable proposi-
tion that a stable and transparent financial infrastructure cannot be created
unless we find ways of unleashing market forces for the efficacious management
of businesses that possess enormous potential but whose growth has hitherto

24 http://www.financialexpress.com/article/industry/banking-finance/npas-why-rbis-
flexibility-may-not-be-an-optimal-solution/141741/.
25 http://articles.economictimes.indiatimes.com/2015-08-20/news/65667139-1-psu-banks-

npa-sme-loans.
 PRATT'S JOURNAL OF BANKRUPTCY LAW

been stultified by ineffective, inactive and ill-advised managers and decision

makers.

ANALYZING THE CONTOURS OF CORPORATE DEBT

RESTRUCTURING REGIME IN INDIA PRIOR TO SDR REGIME
While the corporate debt restructuring ("CDR") regime envisaged by the
Reserve Bank of India in 200126 marked a paradigmatic shift in the way in
which debts are viewed and recovered, the scheme wasn't able to usher in the
type of deeper, pervasive structural changes that are a sine qua non for making
businesses more efficient, reducing bad loans and structuring more fair,
equitable and beneficial debtor-creditor relations. The primary reason why the
CDR regime was unable to achieve the desired result stems from the RBI's
failure to institutionalize robust processes for grappling with companies unable
to meet critical milestones set out in the CDR packages. As a result,
outstanding CDR failures dramatically increased from Rs. 29,980 crores in
March 2014 to a staggering Rs. 56,995 crore in March 2015, with the shocking
failure of CDR packages of as many as 44 firms amounting to a debt of Rs.
27
27,015 crore.
The RBI's increasing focus on finding more robust ways of facilitating debt
recovery and safer lending arrangements is best epitomized by Dr. Raghuram
Rajan's unequivocal assertion in the 2013-14 Second Quarter Monetary Policy
Review that one of the five cardinal pillars of the RBI's efforts to secure the
Indian economy on firmer moorings would be by "improving the system's
ability to deal with corporate distress and financial institution distress by
strengthening real and financial restructuring as well as debt recovery."28 To this
end, the "Framework for Revitalising Distressed Assets in the Economy"
released by the RBI on January 30, 201429 envisaged at least five transforma-
tional changes that laid the groundwork for the new SDR regime that the RBI
has institutionalized.
First, the framework vide Para 2.1.1 helped create a three-tier structure of
borrower Special Mention Accounts ("SMA") based on period of non-payment
and incipient stress: SMA-0, in which the principal or interest is overdue for not

26 See http://www.cdrindia.org/downloads/CDR-RBI-Circular%/o20-%/ 20230/%2OAugust%/0

202001 .pdf; also see https://www.rbi.org.in/upload/notification/pdfs/67158.pdf.
27 See http://indianexpress.com/article/business/business-others/debt-recast-banks-can-now-

take-5 1-in-stressed-firms/.
28 https://rbi.org.in/scripts/NotificationUser.aspx?Id-8532&Mode-0.

29 https://rbidocs.rbi.org.in/rdocs/content/pdfs/NPA300 11 4RFF.pdf.
 THE STRATEGIC DEBT RESTRUCTURING REGIME IN INDIA

more than 30 days but the account shows incipient stress; SMA-1 in which the
principal or interest is overdue for a period between 31 and 60 days and SMA-2
in which the principal or interest is overdue for a period between 61 and 90
days.
Second, it paved the way for the creation of a Central Repository of
Information on Large Credit ("CRILC") which would be replete with
information of all banks having borrowers with aggregate fund-based and
non-fund based exposure of Rs.50 million and above and current accounts of
their customers with outstanding balance (debit or credit) of Rs. 10 million and
above. Further, Para 2.1.4 makes it mandatory for all banks to report the SMA
status of their borrowers to the CRILC and to take appropriate remedial steps
for accounts classified as SMA-0 and SMA-1.
Third, as soon as an account is classified as SMA-2, the Regulations envisage
the creation of a Joint Lenders' Forum ("JLF") for formulating a Corrective
Action Plan ("CAP") for early resolution of the stress in the account. For
borrowers having multiple lenders, the lender with the highest exposure must
act as the leader of the JLF and be tasked with the responsibility of convening
the JLE While the Regulations make it optional for lenders to form a JLF for
SMA-0 and SMA-1 accounts, they mandatorily require the setting up of a JLF
where the aggregate fund-based and non-fundbased exposure exceeds Rs. 100
million. Further, all the lenders are required to sign an agreement delineating
the terms governing the working of the JLF and are empowered to work with
government authorities and other interested stakeholders for the purpose of
devising efficacious ways of facilitating expeditious recovery in cases where the
loan facilitates large projects.
Fourth, the most potent tool that the Regulations create for addressing the
problem of bad debts is CAP which the JLF can form for either:
" Rectification, i.e., by asking the borrower to take robust steps for
preventing the account from being declared an NPA and for facilitating
its removal from the SMA classification. This could be done through
provisions for additional finance or equity and strategic investments;
" Restructuring, i.e., by creation of an Inter-Creditor Agreement ("ICA")
by the JLF and a debtor-creditor agreement ("DCA") which would
provide the legal foundation for any restructuring process. Further, it is
worth noting that the decisions taken by 75 percent of creditors by
value and 60 percent by number would animate and inform the
restructuring process. The parties would also be required to sign a
stand-still agreement which would ensure that all other things-such as
the management of the borrower and civil judicial proceedings-
remain equal and unchanged during the restructuring process and
53
 PRATT'S JOURNAL OF BANKRUPTCY LAW

would, in essence, provide parties greater leeway and freedom to

restructure debts in a more meaningful way.
Recovery, wherein if the first two options do not yield concrete results,
the JLF must find ways of recovering debts in the most optimal fashion.
Finally, the Regulations impose strict timelines and compliance require-
ments in order to give concrete shape to the principle set forth in Para
9.2 which states, in relevant part, "Banks are custodians of public
deposits and are therefore expected to make all efforts to protect the
value of their assets." More specifically, the Regulations require the JLF
to develop consensus on the contours of the CAP within 30 days of an
account being classified as SMA-2 or a request from a borrower for the
setting up of a JLF and to prepare the final plan within a further period
of 30 days. Further, the JLF is required to carry out a detailed
techno-economic viability ("TEV") study and finalize the restructuring
within 30 days of the same and convey the same to the borrower within
a period of 15 days if the aggregate exposure does not exceed Rs. 5000
million.
In keeping with the broad vision outlined in the aforementioned circular, the
RBI issued a circular on February 26, 2014 titled "Framework for Revitalising
Distressed Assets in the Economy-Guidelines on Joint Lenders' Forum (JLF)
and Corrective Action Plan (CAP)" 30 which reaffirmed the broad propositions
set forth in the January 30th circular, gave concrete shape to the principles
asserted therein and unequivocally asserted the key principle that should
animate and inform the restructuring process: shareholders should ideally bear
the first loss rather than debt holders and the promoters must have a "skin in
the game" to guide and shape the restructuring process in a meaningful way. To
this end, the Circular outlined three chief ways of concretizing this principle:
1. Possibility of transferring equity of the company by promoters to the
lenders to compensate for their sacrifices;
2. Promoters infusing more equity into their companies; or
3. Transfer of the promoters' holdings to a security trustee or an escrow
arrangement till turnaround of company to effectuate a change in
management control. Crucially, para 5.1 of the Circular emphasizes
the critical importance of integrating into the CDR packages fixed
deadlines for meeting critical milestones such as positive change in
important financial ratios on a six-monthly/annual basis and tasks the
JLF with the responsibility of taking appropriate recovery measures in

30 https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id-8754&Mode-0.
 THE STRATEGIC DEBT RESTRUCTURING REGIME IN INDIA

case the borrower is unable to comply with the prescribed milestones.

Despite the setting up of such a complex and sophisticated machinery by the
RBI, the problem of bad loans could not be appropriately resolved due to the
chronic malaise of inefficient management that besets most sick companies.
This is best evidenced by the example of REI which was offered a working
capital finance of Rs. 4,000 crore by the JLF as part of the CAP to address the
issue of distressed assets. However, the inability of the company to get its house
in order eventually led to a winding up petition being filed by one of the
31
lenders, United Bank of India in the Calcutta High Court.
Therefore, recognizing that the extant structures were clearly ineffective in
resolving the problem of bad debts, the RBI introduced the SDR regime in
order to infuse greater flexibility and efficiency in the restructuring process. As
the authors below demonstrate, while the regime is founded upon robust values
and unexceptionable principles, it suffers from several technical, practical and
conceptual flaws which must be appropriately addressed if it is to realize its full
potential.

SDR REGIME IN INDIA: A CRITICAL ANALYSIS OF ITS ROLE

AND ENVISAGING A NEED FOR ITS RESTRUCTURING
Against the aforementioned backdrop, the RBI recognized the need to rectify
the fundamentals of floundering companies by overhauling management
structures and personnel which are inefficient, incompetent and lacking the
sense of direction, vision and purpose indispensable for generating the resources
needed to repay loans vide its Circular dated June 8, 2015, which laid the
groundwork for the transformation of debt into equity through the medium of
SDR.3 2 More specifically, Para 3 of the Circular empowers the JLF to include
in the restructuring package the option of partially or fully transforming the
loan into equity in case the borrower fails to meet the "viability milestones"
and/ or "critical conditions" set out therein. The JLF is required to assess
whether the account could be made viable by effecting a change in ownership
and to decide whether or not the conversion is to take place within a period of
30 days from such examination. Such a decision must be sufficiently substan-
tiated, contain the approval of 75 percent of creditors by value and 60 percent
by number, and the final conversion package must be approved within a period
of 90 days from the decision being taken. Crucially, the lenders in the JLF must

31 http://www.dnaindia.com/money/report-rbi-gives-banks-provisioning-leway-for-

reporting-frauds-on-time-2087009.
32 https://rbi.org.in/Scripts/NotificationUser.aspx?ID 9767.
 PRATT'S JOURNAL OF BANKRUPTCY LAW

become majority shareholders of the company by effectuating such a change in

ownership, but their holding must not exceed the threshold prescribed in
Section 19(2) of the Banking Regulation Act, 1949. 3 3 It is critical to note that
the conversion of debt into equity must, at least, be equal to the face value of
shares in keeping with the mandate of the Companies Act 34 and the fair value
at which the conversion must take place would be the lowest of the market
value (average of the closing price of the share in the preceding 10 days) and the
break-up value which would be a function of the book value of the share in the
audited balance sheet after excluding revaluation reserves. After having acquired
a functional understanding of the intricacies of the SDR regime, it would be in
the fitness of things to briefly examine the arguments in favour of and against
this regime.
Arguments in Favor of SDR Regime
There are at least three reasons why the SDR regime is likely to become the
option of first resort for lenders who are compelled to deal with difficult
debtors.
First, the regime provides lenders the ability to directly control the working
of borrower companies in ways that they deem feasible which would give them
considerable autonomy and freedom to put such companies on the path of
sustainable growth. Unlike the solutions provided by the RDDB Act and the
SARFAESI Act, this solution has the potential to allow lenders to negotiate
from a position of strength. Notably, while the SICA and SARFAESI Act also
envisage a change in the management of defaulting companies, they did not put
in place objective methods of determining the entities to whom the manage-
ment would be transferred. By clearly empowering lenders to exercise this
crucial right, the new regime can effectively overcome the pitfalls that stultified
the growth of the aforementioned regimes.
Second, at a time when banks are displaying increasingly worrying risk-averse
tendencies on account of rising NPAs 35 the new framework can go a long way
in inspiring greater lender confidence and making them feel more invested in

33 Section 19(2) of the Banking Regulation Act, 1949 provides that "Save as provided in

sub-section (1), no banking company shall hold shares in any company, whether as pledgee,
mortgagee or absolute owner, of an amount exceeding thirty per cent of the paid-up share capital
of that company or thirty per cent of its own paid-up share capital and reserves, whichever is less."
34 See Section 53 of the Companies Act, 2013 which prohibits a company
to issue shares at
a discount except as provided for issue of sweat equity shares under Section 54 of the Act.
35 http://artices.economictimes.indiatimes.com/2 15-08-20/news/65667139 1-psu-banks-

npa-sme-loans.
 THE STRATEGIC DEBT RESTRUCTURING REGIME IN INDIA

the system by providing them new tools which can help them fashion more
efficacious solutions.
Third, the regime explicitly prevents lenders from selling their equity stake to
the promoter group which controlled the working of the company prior to the
conversion of debt into equity. This safeguard is critical from the perspective of
ensuring that the culture of the company does not fall prey to the same
tendencies and patterns of decision making that led to its downfall and will
allow more skilled and competent investors to accelerate the growth of the
company.
Indeed, the positive impact of the SDR regime is already visible for all to
see-it has helped facilitate the conversion of a substantial portion of a loan of
a consortium of 21 lenders to a manufacturer named Jyoti Structures 36 and
made it possible for the lenders of Electrosteel Steels Limited ("ESL") to convert
their debt worth approximately 9500 crores into equity after the CDR process
37
failed to yield any desirable results.
Flaws in the SDR Regime
Notwithstanding the aforementioned advantages, the regime has several
lacunae which merit immediate attention. It would be instructive to examine
the most glaring ones to substantiate this claim.
Control over Borrowing Companies: A Difficult Task to be
Accomplished
It is pertinent to note that while the fundamental goal underpinning the
regime is to allow banks to acquire a 51 percent stake in borrower companies,
it may be practically difficult for them to do so because of diverse dynamics that
are at play in such an exercise. 38 For instance, let us assume that a company
owes a debt of Rs. 1500 crores and the book value of its shares is Rs. 3,000
crores, divided into 10 crore shares of Rs. 300 each. Now, on account of the
conversion of debt into equity, the lenders would get five crore shares, while the
existing shareholders would continue to hold 10 crore shares, as a result of
which the former's stake would be approximately 33 percent, nowhere close to
the desired 51 percent.

36 http://www.financialexpress.com/article/industry/companies/lenders-jyoti-structures-
agree-on-strategic-debt-restructuring/122411/.
37 See http://www.financialexpress.com/article/industry/companies/lenders-to-swap-debt-for-
a-stake-in-electrosteel/109063/.
38 http://capitalmind.in/2015/06/the-strategic-debt-restructuring-rules-by-rbi-banks-will-

convert-debt-to-majority-equity/.
 PRATT'S JOURNAL OF BANKRUPTCY LAW

Unfavorable Regulatory Conditions

Interestingly, the JLF is mandated to divest its stake as soon as possible, while
ensuring, as mentioned earlier, that the acquirer is not from the existing
promoter group and that the former acquires at least a 51 percent equity stake
in the company or the maximum FDI ceiling in case of a foreign acquirer.
While this has the potential to open many hitherto unexplored avenues for
strategic and financial investors which they can optimally use by devising new
and innovative business structures within the confines of which they would be
able to act as investors or lenders, there are at least three key challenges that can
impede the full realization of the potential that the new regime seeks to create. 39
First, even though the Circular explicitly exempts the share price calculation
formula from the SEBI (Issue of Capital and Disclosure Requirements)
Regulations 2009, this exemption would only be available to the JLF and the
transferee-acquirer would still be required to comply with the cumbersome
compliances set out in the Regulations. Second, transferee investors would be
required to observe the minimum lock-in period of one year and would also
have to comply with the constraints and fetters imposed by various legal and
regulatory mechanisms, such as the compliances set forth in the Foreign
Exchange Management Act in case of foreign investors. Third, and most
important, while lenders do not have to meet open offer requirements set out
in Regulations 3 and 4 of the SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 20114o on crossing the prescribed thresholds, transferee
investors would not enjoy such exemptions.
Therefore, the restrictions on the activities and structures that transferee
investors can engage in, coupled with the limitations imposed on the ability of
banks to engage in business activities imposed by Sections 641 and 19(2)42 of

39 http://articles.economictimes.indiatimes.com/201 5-08-04/news/65204648 1 sdr-

market-value-jilf.
40 Regulation 3 of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations,

2011 provides for making open offer to the shareholders of the target company on substantially
acquiring the shares or the voting rights of the target company subject to certain conditions as
prescribed therein.
Regulation 4 of the aforesaid SEBI Regulation provides that "Irrespective of acquisition or holding
of shares or voting rights in a target company, no acquirershall acquire, directly or indirectly, control
over such target company unless the acquirer makes a public announcement of an open offer for
acquiringshares of such target company in accordance with these regulations."
41 See Section 6 of the Banking Regulation Act, 1949, which imposes restrictions on the bank

by prescribing certain business activities in which banking companies can indulge in.
42 See Section 19(2) of the Banking Regulation Act, 1949, which imposes restrictions on

nature of subsidiary companies that can be formed by the banking companies.

 THE STRATEGIC DEBT RESTRUCTURING REGIME IN INDIA

the Banking Regulation Act, 1949, along with the Reserve Bank of India Act, 43
would make it difficult for lenders and investors to find suitable ways of tapping
into the potential latent in floundering companies.
Difficulty in Building Consensus Among Lenders-
Possible Coordination Hurdles
Further, it may be very difficult for lenders, each of whom may have different
priorities and targets, to forge consensus on the need to undertake SDR and
then to determine the precise ways in which the same is to be carried into effect.
For instance, if the JLF consists of 10 lenders, the norms require at least six
lenders to give their consent to the SDR process for the process to actually
commence which may be difficult because of differing levels of access to
information about the borrower's financial position and differing views about
the JLF's ability to find a third-party buyer after it has to divest its share. In
other words, there is likely to be information asymmetry among different banks
concerning the extent of liabilities and claims on the borrower's balance sheet
and uncertainty surrounding finding a buyer for the purchased equity. While
the RBI has taken significant steps to lend greater credence to the SDR process,
by tasking SBI and ICICI bank to be part of the JLF where they are among the
lenders and by requiring that the representatives of lenders in the JLF must
typically not be below the rank of executive directors, 44 it remains to be seen
how they would be able to reconcile their frequently conflicting interests in
borrower companies.
Other Key Problems
It is also imperative that the financial infrastructure in India be sufficiently
deepened and broadened to create the conditions necessary for SDR schemes to
work effectively. For example, 74 percent of the security receipts sold from the
period between March 2010 and March 2015 were subscribed by lender banks
and financial institutions, indicating the absence of a sufficiently developed
secondary market for debts in India. 45 Sans a vibrant interest in the lending
process, banks may not want to engage in innovative experiments to exploit the
SDR regime to its fullest potential. Similarly, the transfer of management of

43 See Chapter HID (Sections 45U to 45X) of the Reserve Bank of India Act, 1934, which
grants power to the Reserve Bank of India to regulate transactions in derivatives, money market,
instruments, securities, etc.
44 See http://epaperbeta.timesofindia.com/Article.aspx?eid-31818&articlexml-Banks-get-
Right-to-Turf-Out-Owners-Before-25092015001014.
45 http://www.financialexpress.com/article/industry/banking-finance/npas-why-rbis-
flexibility-may-not-be-an-optimal-solution/141741/.
 PRATT'S JOURNAL OF BANKRUPTCY LAW

companies to banks may not necessarily yield positive results, because banks
often lack the commercial expertise and relevant skills necessary for effectively
managing sick companies. As one writer has rightly noted, it would be
counterintuitive to expect managers "who can't run their own banks that well
to actually be able to run the businesses they lend to." 46 In addition, some debts
are structured in ways that make them simply unserviceable even in favourable
economic conditions, so change in management may not be able to solve the
47
problem in such circumstances.
Also, while the Circular requires a special resolution from the borrower
company to approve the restructuring, it may be difficult for banks to convince
shareholders to dilute their holdings in the company and to handover the
company's management to a set of individuals whose only goal would be to find
ways of recovering their own money while ignoring the company's medium-
term and long-term interests.
Finally, many banks subscribe to the belief that conversion of debt into
equity actually has a negative impact on their ability to recover loans, because
as the RBI has itself noted, the interests of shareholders must be subservient to
those of debt-holders, so banks believe that they might be shooting themselves
in the foot by exercising this remedy. This is the reason why banks have typically
refrained from gaining a stake in the ownership of companies even in cases
where promoters have pledged their shares as a part of debt deals. Therefore, if
the fundamental goal is to enable banks to have a greater say in the recovery of
debts, it might make greater sense to find ways of giving them a more powerful
voice in the process instead of converting them into shareholders which may
not be beneficial unless the price of shares goes up substantially post-
conversion.

NEED FOR REFORM IN SDR: CONCLUSION AND THE PATH

AHEAD
If we are to transform the sound principles and broad goals that the SDR
mechanism espouses into concrete and substantive deliverables, there are at least
five key steps that must be taken to improve the existing system.
First, in order to grapple with the problem of lack of consensus in the JLF
about the need to restructure debts, it is critical to empower the lender with the
highest debt to buy the debts of other lenders so as to be able to convert the

46 See supra note 38.

47 See http://www.thehindubusinessline.com/money-and-banking/strategic-debt-
restructuring-is-no-onestop-solution/article729885 0 ece.
 THE STRATEGIC DEBT RESTRUCTURING REGIME IN INDIA

consolidated debt into equity. This would not only provide a panacea for
coordination issues, but would also make it easier for strategic and financial
investors to eventually buy the converted equity as they would only be required
to deal with a single lender. Similarly, such consolidation could also be judicially
enforced, in a manner akin to the "cramdown" process envisaged in the United
48
States Bankruptcy Code.
Second, while it may be desirable in certain circumstances to prevent the
promoter group from purchasing equity from lenders, a blanket ban may result
in economically pernicious effects. More specifically, while it is desirable to
prevent the management of a company from falling into the hands of promoters
who have a history of committing frauds or engaging in other egregious forms
of unlawful conduct, it would not be desirable to apply this principle where the
company's failure to meet viability milestones is on account of factors beyond
the control of the promoter group. Therefore, it is necessary to create
bright-line rules which would make it possible for the company to avail of the
services of promoters who are ideally positioned to manage the company in
49
ways that are in alignment with its history and ethos.
Third, while SDR may help improve the financial health of the company, the
main goal must continue to be to allow banks to recover the amount lent
effectively. Therefore, in order to facilitate full and fair recovery, it is necessary
to provide banks the right to recompense which would empower them to
recover any principal or interest earlier waived when the company is in good
financial health. This is critical to prevent leakages and will play an instrumental
50
role in improving India's credit culture.
Fourth, in order to create an enabling legal mechanism for third-party
investors, it is necessary to extend the exemptions granted under the ICDR
Regulations, 2009, and the Takeover Code, 2011 to lenders to third party
investors as well in order to incentivize the purchase of debt converted into
equity.
Fifth, while the SDR mechanism may provide some reprieve to banks
saddled with rising NPAs in the short-term, we cannot hope to usher in a new
paradigm in India's credit culture without addressing the problems of opacity,
lack of trust and inability/unwillingness to plan for different consequences that

48 See http://www.livemint.com/Opinion/ZbCBzExjbHnKyvoj2rlt7K/India-needs-a-
realistic-debt-restructuring-framework.html.
49 Ibid.
50 See http://www.rediff.com/business/column/column-why-india-needs-bankruptcy-code-
urgently/ 2 0150619.htm.
 PRATT'S JOURNAL OF BANKRUPTCY LAW

characterize debtor-creditor relations today. More specifically, if banks and

borrowers are unable to internalize and fully embed into existing processes the
principles of sound credit management, the SDR regime may actually result in
protracted legal battles and would be equivalent to putting the cart before the
horse.
To conclude, as India emerges as the world's fastest-growing major
economy, 5 1 the moment has never been more ripe for Indian regulators to tap
into the enormous potential that the SDR regime possesses to unlock
significant value for businesses, banks and investors by suitably amending its
provisions in ways that would bring them in line with the policy's fundamental
principles and would help transform the policy from a mere tool of financial
engineering into a robust charter of lender rights.

51 http://www.thehindu.com/business/Economy/at-7-per-cent-india-remains-fastest-

growing-major-economy/article7601141.ece.