Current Developments in Monetary and Financial Law, Volume 6
Chapter

Chapter 19: Out of Court Corporate Debt Restructuring Framework in India: An Overview

Author(s):
International Monetary Fund. Legal Dept.
Published Date:
February 2013
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Author(s)
Research assistance by Kanisshka Tyagi, Senior Associate, Kesar Dass B. and Associates, is gratefully acknowledged.

The financial crisis posed major challenges to policy makers and regulators as they worked towards stabilizing financial markets and prevent a further meltdown and the slide of the global economy from its deepest synchronized recession in six decades into possible depression. As countries now move from the initial crisis containment phase, a period of sustained corporate and operational debt restructuring can be expected in order to repair corporate balance sheets and to realign the corporate sector to the post-crisis economy. The insolvency law is the most important tool to support orderly corporate debt restructuring. Many countries have enacted reforms to their legal frameworks relevant to corporate debt restructuring over recent years. In fact, the major thrust of insolvency reform across many jurisdictions over the last twenty years has been the development of legislation to facilitate business reorganizations. However, in many emerging economies, the corporate restructuring regime does not even exist. These countries would have realized the need for introducing legal reforms to introduce efficient and effective corporate restructuring regimes. Given that changes to insolvency laws and the underlying institutional structure take time to effect, country authorities need to begin diagnosis of the debt problem and to anticipate the legal bottlenecks at an early stage. Furthermore, the onset of a crisis could present an opportunity for the authorities to galvanize relevant stakeholders into reform mode.

The global financial crisis has highlighted the need to provide for framework for out-of-court restructurings which would facilitate wide scale debt restructurings. This would need the support of the policy makers. There is substantial international experience from which to draw in this area. The London Approach introduced the evolution of government sponsored guidelines for multi-creditor out-of-court debt restructurings. In 2000, INSOL International published the Statement of Principles for a Global Approach to Multi-Creditor Workouts. Many countries drew from the London Approach and INSOL Principles as a basis to develop their own guidelines to encourage out-of-court corporate debt workouts. To be optimal in the aftermath of a crisis, such guidelines will likely need to operate in a structured framework involving government enhancements, such as regulatory suasion on banks to sign on to the workout principles.

Out of Court Corporate Restructuring in India

India sought inspiration from the London Approach and INSOL Principles to introduce Corporate Debt Restructuring (CDR) Scheme in August, 2001 to provide for a voluntary out of court restructuring mechanism in cases of multiple-creditors financing. As the formal insolvency law failed to provide quick and timely restructuring, the banks and financial institutions, and the corporates have found the CDR mechanism as an effective and fast track tool for work outs, in particular because it can be invoked even before an asset turns non-performing. The Scheme has since been revised in 2003, 2005, and 2008. The guidelines as issued and revised by the RBI offer complete insight into the working of the CDR system by detailing the process of initiation, working and conclusion of the CDR mechanism. Though the CDR guidelines attempt to provide comprehensive mechanism the system cannot be said to be one without any loopholes and some amends are desirable in wake of ever changing economic scenario. Prior to the introduction of the CDR mechanism, the options available to the corporate crippled with huge debt burden were the ones which necessarily involved the intervention of the judicial authorities. Further under the already available routes a company could resort to restructuring only in extreme circumstances. Thus the precondition for taking recourse under the previous solutions was that either the borrower’s account should have been an NPA or the borrower company should have been a sick company under SICA. All this and more made it necessary for India to adopt a formal restructuring model for promoting economic stability and growth by aiming at saving the viable business from mess of closure.

Legal Basis of CDR

CDR is a non statutory mechanism and a voluntary system for which corporate coming within the purview of eligibility criteria set by the guidelines of RBI can opt for provided they reach an understanding with their creditors. The system of CDR is based on two agreements namely (a) Debtor-Creditor Agreement (DCA); and (b) Inter-Creditor Agreement (ICA). These two documents form the very basis of the mechanism and provide legal basis to the system. The debtors or the corporate for the purpose of availing benefits of the CDR mechanism are required to accede to the DCA either at the time of original loan documentation (for future cases) or at the time of reference to Corporate Debt Restructuring Cell. Similarly all the participating creditors shall have to enter into a legally binding agreement—ICA, with necessary enforcement and penal clauses, to operate the System through laid-down policies and guidelines. The ICA signed by the creditors will be initially valid for a period of three years however the same can be renewed for further periods of 3 years thereafter. If 75 percent of creditors by value and 60 percent of the creditors by number, agree to a restructuring package of an existing debt (i.e., debt outstanding), the same is binding on the remaining creditors. Creditors not signatory to ICA may also be bound by the CDR mechanism if they join for restructuring in a particular case.

The DCA also entails the duties and responsibilities of the borrower in form of an undertaking by virtue of which the borrower undertakes to adhere to the terms and conditions of the restructuring scheme which is approved by the CDR Empowered Group. One of the most important elements of Debtor-Creditor Agreement would be “stand still” clause which remains binding for 90 days, or 180 days by both sides. Under this clause, both the debtor and creditor(s) agree to a legally binding “stand-still” whereby both the parties commit themselves not to taking recourse to any other legal action during the “stand-still” period, this would be necessary for enabling the CDR system to undertake the necessary debt restructuring exercise without any outside intervention, judicial or otherwise. However, the stand-still clause will be applicable only to any civil action either by the borrower or any lender against the other party and will not cover any criminal action. Further, during the stand-still period, outstanding foreign exchange forward contracts, derivative products, etc., can be crystallized, provided the borrower is agreeable to such crystallization. The borrower will additionally undertake that during the standstill period the documents will stand extended for the purpose of limitation and also that he will not approach any other authority for any relief and the directors of the borrowing company will not resign from the board of directors during the stand-still period.

Reference to CDR System

Reference to Corporate Debt Restructuring System can be triggered by:

  • Any or more of the creditors who have a minimum twenty percent share in either working capital or term finance, or

  • Concerned corporate, if supported by a bank or Financial institution having stake as in (i) above.

The above eligibility criterion is further qualified by the following conditions:

  • The CDR mechanism is available only in case of multi-creditor financing.

  • Corporates indulging in frauds and malfeasance even in a single bank are ineligible for restructuring under CDR mechanism.

  • Willful defaulters are not entertained under the CDR mechanism.

  • Cases of borrowers against whom recovery suits have been filed by lenders are eligible only if supported by at least 75 percent of the lenders (by value).

  • Cases in formal restructuring before the Board for Industrial & Financial Reconstruction (BIFR) cases are not eligible for restructuring under the CDR system.

The CDR mechanism is not available to those cases that involve only one financial institution or one bank. It is an organizational framework institutionalized for speedy disposal of restructuring proposals of borrowers availing finance from more than one banks and financial institutions. The CDR mechanism is aimed for restructuring of debt availed by large borrowers having exposure of a hundred million rupees and above by banks and institutions. The financial exposure covered is both fund-based and non-fund based. There is no requirement of the borrower’s account being a NPA or the borrower company being a sick company under SICA or being in default for a specified period before reference to the CDR mechanism. However, potentially viable cases of NPAs get priority.

As a general principle, willful defaulters are not entertained under the CDR mechanism. But modifications introduced in the system have been laid down for the identification of the willful defaulters. In deserving cases therefore, the Core Group may review the reasons for classification of the borrower as willful defaulter and satisfy itself that the borrower is in a position to rectify the willful default provided he is granted an opportunity under the CDR mechanism. However, corporates indulging in fraud and malfeasance even in a single bank continue to remain ineligible for restructuring. The restructuring of such cases under the CDR mechanism may be carried out with the approval of the Core Group only.

Cases of borrowers against whom recovery suits have been filed by the lenders may be eligible for consideration under the CDR system however the initiative to resolve the case under the CDR system must be supported by at least 75 percent of the lenders (by value). Nevertheless, for restructuring of such accounts under the CDR system, it should be ensured that the account meets the basic criteria for becoming eligible under the CDR mechanism.

Cases before BIFR are not eligible for restructuring under the CDR system. However, large value BIFR cases may be eligible for restructuring under the CDR system on specific recommendation being made by the CDR Core Group. The Core Group shall recommend exceptional BIFR cases on a case-to-case basis for consideration under the CDR system. It should be ensured that the lending institutions complete all the formalities in seeking the approval from BIFR before implementing the package.

In August 2008, the RBI decided to make the CDR mechanism also available to the corporates engaged in non-industrial activities, if they are otherwise eligible for restructuring as per the criteria laid down for this purpose. Subhiksha, the retail giant having around 1600 outlets in India, approached CDR for corporate debt restructuring in January 2009 since their balance sheet did not keep pace with their growth. Subhiksha is the first non-manufacturer to opt for CDR. RBI’s move to allow realty companies to restructure their loans in a bid to stimulate the sector and avoid accumulation of bad loans at the lenders has helped the developers. Indian real estate developers are in talks with lenders to restructure debt and lower interest cost to tide over the cash crunch.

Structure of CDR Mechanism

The edifice of the CDR mechanism in India stands on the strength of a three-tier structure: (i) CDR Standing Forum; (ii) CDR Empowered Group; and (iii) CDR Cell.

CDR Standing Forum

CDR Standing Forum is at the upper most tier of CDR mechanism in India and is a general body which represents the all financial institutions and banks participating in the CDR system. It serves the purpose of providing an official platform for both the creditors and borrowers by consultation to amicably and collectively evolve policies and guidelines for working out debt restructuring plans in the interests of all concerned. CDR Standing Forum is a self-empowered body, and it is placed under an obligation to lay down policies and guidelines, and monitor the progress of corporate debt restructuring. The composition of the Forum, frequency of meeting, powers and duties are all well defined under the guidelines issued by RBI. The heads of some important financial institution of the country such as Industrial Development Bank of India, State Bank of India, ICICI Bank Limited, Indian Banks’ Association as well as Chairmen and Managing Directors of all banks and financial institutions participating as permanent members in the system. Principle of rotation is followed for filling up the post of chairman of the Forum. Forum undertakes review and monitoring of the progress of the corporate debt restructuring by meeting once every 6 months. It reviews the individual decisions of the CDR Empowered Group and CDR Cell. The CDR Standing Forum may also formulate guidelines for dispensing special treatment to those cases which are complicated and are likely to be delayed beyond the time frame prescribed for processing.

A CDR Core Group is carved out of the CDR Standing Forum to assist the Standing Forum in convening the meetings and taking decisions relating to policy, on behalf of the Standing Forum. The Core Group consists of Chief Executives of IDBI, SBI, ICICI Bank Limited, Bank of Baroda, Bank of India, Punjab National Bank, Indian Banks’ Association, Deputy Chairman of Indian Banks’ Association representing foreign banks in India and a representative of Reserve Bank of India. The CDR Core Group also lays down the policies and guidelines to be followed by the CDR Empowered Group and CDR Cell for debt restructuring. These guidelines must suitably address the operational difficulties experienced in the functioning of the CDR Empowered Group. The CDR Core Group shall also prescribe the PERT chart for processing of cases referred to the CDR system and decide on the modalities for enforcement of the time frame. The CDR Core Group also has a responsibility to lay down guidelines to ensure that over-optimistic projections are not assumed while preparing / approving restructuring proposals especially with regard to capacity utilization, price of products, profit margin, demand, availability of raw materials, input-output ratio and likely impact of imports / international cost competitiveness.

CDR Empowered Group

The CDR Empowered Group is entrusted with task of deciding individual cases of corporate debt restructuring which consists of ED level representatives of IDBI, ICICI Bank Ltd. and SBI as standing members, in addition to ED level representatives of financial institutions and banks who have an exposure to the concerned company. While the standing members perform the function of facilitating the conduct of the Group’s meetings, voting is done in proportion to the exposure of the lenders only. In order to make the CDR Empowered Group effective and broad based and operate efficiently and smoothly, it must be ensured that participating institutions/banks approve a panel of senior officers to represent them in the CDR Empowered Group and ensure that they depute officials only from among the panel to attend the meetings of CDR Empowered Group. Further, nominees who attend the meeting pertaining to one account should invariably attend all the meetings pertaining to that account instead of deputing their representatives.

The level of representation of banks/financial institutions on the CDR Empowered Group should be at a sufficiently senior level to ensure that a concerned bank/FI abides by the necessary commitments including sacrifices, made towards debt restructuring. There should be a general authorization by the respective boards of the participating institutions / banks in favor of their representatives on the CDR Empowered Group, authorizing them to take decisions on behalf of their organization, regarding restructuring of debts of individual corporate. The primary responsibility of the CDR Empowered Group is to consider the preliminary report of all cases of requests of restructuring, submitted to it by the CDR Cell. After the Empowered Group decides that restructuring of the company is prima-facie feasible and the enterprise is potentially viable in terms of the policies and guidelines evolved by Standing Forum, the detailed restructuring package is worked out by the CDR Cell in conjunction with the lead institution. However, if the lead institution faces difficulties in working out the detailed restructuring package, the participating banks / financial institutions can decide upon the alternate institution / bank which would work out the detailed restructuring package at the first meeting of the Empowered Group when the preliminary report of the CDR Cell comes up for consideration.

The CDR Empowered Group is mandated to look into each case of debt restructuring, examine the viability and rehabilitation potential of the Company and approve the restructuring package within a specified time frame of 90 days, or at best within 180 days of reference to the Empowered Group. The CDR Empowered Group decide on the acceptable viability benchmark levels on the some critical parameters, which may be applied on a case-by-case basis, based on the merits of each case. The parameters include Return on Capital Employed (ROCE), Debt Service Coverage Ratio (DSCR), Gap between the Internal Rate of Return (IRR), the Cost of Fund (CoF), and Extent of Sacrifice.

Usually the CDR Empowered Group meets on two or three occasions in respect of each case referred to it. This provides an opportunity to the participating members to seek proper authorizations from their CEO / ED, in case of need, in respect of those cases where the critical parameters of restructuring are beyond the authority delegated to him/her. The decision of the CDR Empowered Group is final. If restructuring of debt is found to be viable and feasible, the company would be put on the restructuring mode. If restructuring is not found viable, the creditors would then be free to take necessary steps for immediate recovery of dues and/or liquidation or winding up of the company, collectively or individually.

CDR Cell

The CDR Standing Forum and the CDR Empowered Group are assisted by a CDR Cell in all their functions. The CDR Cell is at the lowest rung of the structure of the CDR mechanism and it is entrusted with the primary duty to undertake the initial scrutiny of the proposals received from borrowers/lenders, by calling for proposed rehabilitation plan and other information and put up the matter before the CDR Empowered Group, within one month to decide whether rehabilitation is prima facie feasible. If the plan is found to be feasible, the CDR Cell will proceed to prepare detailed Rehabilitation Plan with the help of lenders. The CDR Cell is also empowered to engage experts from outside, if necessary. If not found prima facie feasible, the lenders may start action for recovery of their dues.

All references for corporate debt restructuring by lenders or borrowers are be made to the CDR Cell. It shall be the responsibility of the lead institution / major stakeholder to the corporate, to work out a preliminary restructuring plan in consultation with other stakeholders and submit to the CDR Cell within one month. The CDR Cell must ensure that the restructuring plan is prepared in terms of the general policies and guidelines approved by the CDR Standing Forum and the same is placed for consideration of the Empowered Group within 30 days for decision. The Empowered Group can approve or suggest modifications but must reach a final decision within a total period of 90 days. However, for sufficient reasons the period can be extended up to a maximum of 180 days from the date of reference to the CDR Cell.

Categories of Debt Restructuring

The debt restructuring under the CDR system was categorized into two categories by virtue of revision of the guidelines in 2003. Accounts, which are classified as “standard” and “sub-standard” in the books of the lenders, are restructured under the first category (Category 1). Accounts which are classified as “doubtful” in the books of the lenders are restructured under the second category (Category 2). The difference between Category 1 and Category 2 is that additional finance, if any, is to be provided by all creditors of a Category 1 irrespective of whether they are working capital or term creditors, on a pro-rata basis. While, in case of Category 2 cases it is not binding on creditors to take up additional financing worked out under the debt restructuring package.

Hence a second category of CDR is introduced for the cases where the accounts have been classified as doubtful in the books of the lenders and if a minimum of 75 percent of creditors (by value) and 60 percent creditors (by number) satisfy themselves of the viability of the account and consent for such restructuring, subject to the following conditions:

  • It will not be binding on the creditors to take up additional financing worked out under the debt restructuring package and the decision to lend or not to lend will depend on each creditor bank/FI separately. In other words, under the proposed second category of the CDR mechanism, the existing loans will only be restructured and it would be up to the promoter to firm up additional financing arrangement with new or existing creditors individually.

  • All other norms under the CDR mechanism such as the standstill clause, asset classification status during the pendency of restructuring under CDR, etc., will continue to be applicable to this category also.

All the other features of the CDR system as applicable to the First Category will also be applicable to cases restructured under the Second Category.

Sanction and Implementation of the Approved Packages

In order to enhance the efficacy of CDR mechanism a realistic time schedule has been prescribed by the CDR Standing Forum. Once the final restructuring plan is approved and confirmed by the Empowered Group, CDR Cell issues a Letter of Approval (LOA) for the Restructuring package to all the concerned lenders. The individual lenders are required to sanction the restructuring package within 45 days from the date of issue of LOA and thereafter fully implement it in the next 45 days. The status of sanction and implementation of restructuring packages is reviewed frequently at Empowered Group meetings. However, in order to place greater emphasis on implementation of the approved packages, a Standing Committee of Core Group Member Banks constituted by the Core Group takes up close monitoring to ensure that the packages are implemented expeditiously.

Monitoring Mechanisms

The success of CDR mechanism depends essentially on close monitoring of each and every package approved by the CDR Empowered Group (EG). The monitoring mechanism comprises (i) Monitoring Institution (referring institution); (ii) Monitoring Committee; and (iii) external agencies of repute to complement monitoring efforts and also to carry out concurrent audit, special audit/valuation etc. The Monitoring Institution is required to monitor all aspects of implementation of the package and furnish a consolidated report on the status of sanction and implementation of the approved package to CDR Cell every month, in the prescribed format.

The Monitoring Committee (MC) is company-specific and is constituted by the Empowered Group at the time of approval of a restructuring package. It comprises representatives of the referring bank/institution, one or two other CDR lenders having major exposure in the case, one lender with minor exposure and the CDR Cell. The promoters/representatives of the company besides representatives of the concurrent auditor, lenders’ engineer, if considered necessary, are invited for the meetings as special invitees. Whenever larger issues such as relating to sharing of charge, matters relating to working capital tie-up, permission for expansion/modernization, etc. are to be discussed then other lenders including consortium members are invited for the meetings. The concerned companies are required to refer all proposals for expansion, diversification, mergers/demergers, equity raising, one time settlements, partial pre-payment to CDR members/non-CDR lenders to the Monitoring Committee for due scrutiny and recommendation to Empowered Group for taking appropriate decision.

The MC is purely a recommendatory body and does not have powers for according approvals. The Monitoring Committee meetings are expected to be convened by the Monitoring bank/institution every month while the package is under implementation by the concerned lenders and thereafter at an interval of every two-three months to review the progress of implementation and also to discuss and resolve outstanding issues connected with the case. The implementation of the package means giving effect to the approved package by the lenders and compliance of the terms and conditions (stipulated in the package) by the borrower/promoter, to ensure that the package is in place in the true spirit of CDR mechanism. The objective of the CDR is to keep the package working as envisaged and review the need for changes/corrections required in deserving circumstances. In certain situations, the need for invoking various stipulations of security or events of default might arise which also is examined by MC and suitable recommendations are made to EG including withdrawal of the package, if necessary.

The Monitoring Committee provides the requisite feedback to the lenders regarding performance of the company vis-a-vis CDR projections, various developments such as industry-level comparison, growth prospects, production/marketing constraints, disputes faced by the company, managerial efficiency, etc. The Monitoring Committee’s views/recommendations on various matters concerning the package/company are presented to the CDR Empowered Group by CDR Cell/Monitoring Institution for approval/information. The decisions of the CDR Empowered Group are communicated to the lenders and company/promoter by CDR Cell for action at their end.

The Monitoring Mechanism under CDR plays a dynamic and important role in review of the approved packages, resolution of various issues concerning lenders and borrowers and obtaining feedback on the performance of the company. The monitoring process has greatly contributed to ensuring success of the approved packages.

Exit Option

A creditor (outside the minimum seventy-five percent by value and sixty percent by number) who for any internal reason does not wish to commit additional finance will have an option to exit the CDR. At the same time, in order to avoid the “free rider” problem, it is necessary to provide some disincentive to the creditor who wishes to exercise this option. Such creditors can either (a) arrange for its share of additional finance to be provided by a new or existing creditor, or (b) agree to the deferment of the first year’s interest due to it after the CDR package becomes effective. The first year’s deferred interest as mentioned above, without compounding, will be payable along with the last installment of the principal due to the creditor.

In addition, the exit option will also be available to all lenders within the minimum 75 percent and 60 percent provided the purchaser agrees to abide by restructuring package approved by the Empowered Group. The exiting lenders may be allowed to continue with their existing level of exposure to the borrower provided they tie up with either the existing lenders or fresh lenders taking up their share of additional finance. The lenders who wish to exit from the package would have the option to sell their existing share to either the existing lenders or fresh lenders, at an appropriate price, which would be decided mutually between the exiting lender and the taking over lender. The new lenders shall rank on par with the existing lenders for repayment and servicing of the dues since they have taken over the existing dues to the exiting lender. In order to bring more flexibility in the exit option, One Time Settlement can also be considered, wherever necessary, as a part of the restructuring package. If an account with any creditor is subjected to One Time Settlement (OTS) by a borrower before its reference to the CDR mechanism, any fulfilled commitments under such OTS may not be reversed under the restructured package. Further payment commitments of the borrower arising out of such OTS may be factored into the restructuring package.

Prudential and Accounting Issues

Restructuring of corporate debts under CDR system may take place in the three different stages: (a) before commencement of commercial production; (b) after commencement of commercial production but before the asset has been classified as “sub-standard”; and (c) after commencement of commercial production and the asset has been classified as “sub-standard” or “doubtful.” Accounts restructured under CDR system, including accounts classified as “doubtful” under Category 2 CDR, is eligible for some regulatory concession in asset classification and provisioning on writing off/providing for economic sacrifice, which are detailed below, only if:

  • Restructuring under CDR mechanism is done for the first time,

  • The unit becomes viable in 7 years and the repayment period for the restructured debts does not exceed 10 years,

  • Promoters’ sacrifice and additional funds brought by them should be a minimum of 15 percent of creditors’ sacrifice, and

  • Personal guarantee is offered by the promoter except when the unit is affected by external factors pertaining to the economy and industry.

A rescheduling of the installments of principal alone at any of the aforesaid first two stages does not cause a standard asset to be classified in the sub-standard category, provided the above mentioned conditions are complied with and the loan/credit facility is fully secured.

A rescheduling of interest element at any of the foregoing first two stages does not cause an asset to be downgraded to sub-standard category on writing off—providing for the amount of sacrifice, if any, in the element of interest measured in present value terms.

If a standard asset is taken up for restructuring before commencement of production and the restructuring package provides a longer period of moratorium on interest payments beyond the expected date of commercial production/date of commercial production vis-à-vis the original moratorium period, the asset can no more be treated as standard asset. It may, therefore, be classified as sub-standard. The same regulatory treatment will apply if a standard asset is taken up for restructuring after commencement of production and the restructuring package provides for a longer period of moratorium on interest payments than the original moratorium period.

Under CDR a rescheduling of the installments of principal alone, renders a substandard/“doubtful” asset eligible to be continued in the substandard/“doubtful” category for the specified period provided the above mentioned conditions are complied with and the loan/credit facility is fully secured. Further a rescheduling of interest element renders a sub-standard/“doubtful” asset eligible to be continued to be classified in substandard/“doubtful” category for the specified period, i.e., a period of one year after the date when first payment of interest or of principal, whichever is earlier, falls due under the rescheduled terms, provided the above mentioned conditions are complied with and the amount of sacrifice, if any, in the element of interest, measured in present value terms computed is either written off or provision is made to the extent of the sacrifice involved.

The substandard/doubtful accounts which have been subjected to restructuring, etc. whether in respect of principal installment or interest amount, by whatever modality, are eligible to be upgraded to the standard category only after the specified period, i.e., a period of one year after the date when first payment of interest or of principal, whichever is earlier, falls due under the rescheduled terms, subject to satisfactory performance during the period.

During the specified one-year period, the asset classification of substandard/doubtful status accounts will not deteriorate if satisfactory performance of the account is demonstrated during the specified period. In case, however, the satisfactory performance during the specified period is not evidenced, the asset classification of the restructured account would be governed as per the applicable prudential norms with reference to the pre-restructuring payment schedule. The asset classification would be bank-specific based on record of recovery of each bank/FI, as per the existing prudential norms applicable to banks/FIs.

SME Debt Restructuring Mechanism

Apart from CDR mechanism, there exists a much simpler mechanism for restructuring of loans availed by Small and Medium Enterprises (SMEs) which was introduced by RBI in year 2008 (vide Circular DBOD No. BP.BC.No.37/21.04.132/2008-09, dated December 8, 2008, on “Prudential Guidelines on Restructuring of Advances by Banks”). This mechanism is applicable to all the borrowers which have funded and non-funded outstanding up to Rs. 10 crore (one hundred million rupees) under multiple/consortium banking arrangement. Under this mechanism, banks may formulate, with the approval of their Board of Directors, a debt restructuring scheme for SMEs within the prudential norms laid down by RBI Banks may frame different sets of policies for borrowers belonging to different sectors within the SME if they so desire. While framing the scheme, banks may ensure that the scheme is simple to comprehend and will, at the minimum, include parameters indicated in the guidelines issued by RBI. The scheme envisages that the bank with the maximum outstanding may work out the restructuring package, along with the bank having the second largest share. Banks should work out the restructuring package and implement the same within a maximum period of ninety days from date of receipt of requests. The SME Debt Restructuring Mechanism will be available to all borrowers engaged in any type of activity. Banks may review the progress in rehabilitation and restructuring of SMEs accounts on a quarterly basis and keep the Board informed.

Performance Report of the CDR Mechanism

CDR mechanism has worked well since inception. Its provisions were relaxed recently to enable enhanced access to the scheme. The SME mechanism is recent and its experience is yet to be known. Since inception CDR has approved 215 cases corporate cases for restructuring with a cumulative debt of Rs. 104,299 crore. As per the statistics available on June 30, 2010, the CDR has witnessed an increased inflow of cases seeking debt restructuring after the global and domestic economic slump. The total number of references received under CDR till December 31, 2008 was 208 cases (aggregate debt: Rs. 90,888 crore), while the number of references increased by 56 cases (Aggregate debt: Rs 27,666 crore) post 2008, similarly there has also been jump in number of approved cases which has increased from 173 (Aggregate debt Rs. 84510) to 215 cases after December 2008. A Detailed industry wise break up of cases is appended hereto as Annex 1.

Since the institution of CDR mechanism it has proved to be beneficial for corporates for number of factors which make it viable for all the stakeholders to opt for procedure provided under the CDR system. The system appears to be attractive because of the following strengths:

  • CDR system is a voluntary mechanism which is outside intervention, judicial or otherwise, and it is triggered only once the terms and conditions of the scheme are acceptable to both borrower and lenders.

  • The system does not make it obligatory for all the lenders to accede to the scheme and the system also provides an exit route for lenders who wish to exit.

  • There’s no requirement of the borrower’s account being an NPA or the borrower company being sick company under SICA or being in default for a specified period before reference to the CDR system.

  • Another positive aspect of CDR mechanism for the borrowers is that the debts with high rate of interest can be transferred to lenders with a lower rate and potentially over prolonged payment terms.

  • The interest of creditors under the “doubtful” category is protected because it is not binding on such creditors to take up additional financing.

  • Providers of additional finance, whether existing creditors or new, have a preferential claim, over the providers of existing finance with respect to the cash flows out of recoveries, in respect of the additional exposure.

The CDR mechanism, though beneficial for the stakeholders, it is not without its limitations, some of which are discussed below in brief:

  • One major deficiency in CDR mechanism is that the procedure provided under the system lacks transparency.

  • Lead bankers have been provided a very major role in the whole process envisaged under the system due to which lead bankers are the ones who usually dictate the terms of the CDR Scheme.

  • Stand-still clause is a very potent device for successful working of the CDR mechanism, but the lacuna which diminishes the efficiency of the stand-still clause is that it is not applicable to cover any criminal action but only civil action.

  • Though the exit route has been provided in the mechanism it is available only so long as other institutional participants are prepared to buy out these loans.

  • CDR mechanism is a multi-lender system and this it does not apply to borrowers having accounts involving only one FI or one bank.

Since the inception of CDR mechanism, it has shown some advantages and benefits for all the stakeholders; however, the system cannot be said to be a perfect mechanism for restructuring debt-ridden viable entities. There are some areas in which the following improvements may be considered in CDR and SME debt restructuring mechanisms:

  • In addition to financial restructuring, more operational restructuring should be encouraged. Financial restructuring involves the evaluation of the business cash flow capabilities and determination of the optimum capital structure required to balance cash flow availability with debt service requirements. But the speed with which non-performing loans (NPLs) are getting resolved has been rapidly decreasing in individual countries. Once they are resolved through out-of-court workouts or other restructuring measures, a substantial proportion of NPLs have reverted to their non-performing status, and that new non-performing loans have been generated. Operational restructuring involves an increase in economic viability through methods such as merger integration, sale of divisions, rationalization of product lines and cost-cutting measures. It includes sale of noncore business and assets to reduce debt levels, large reduction of employment and production capacity, and changing the lines of business. Therefore, operational restructuring would lead to a better working of the debt restructuring mechanism.

  • An individual bank may be allowed to settle its dues upfront based on discounted cash flows. The RBI scheme provides that basic objective of CDR should be revival of units, by increasing their production within a specific timeframe and, if necessary, by changing the management with government support.

  • There is a need to provide super priority to any lender in post work-out schemes. In other words, in case of a stressed or impaired account if any, the lender provides any further finance for the revival of the account then such finance should have a priority over all other existing secured lenders. Such a statutory provision would encourage lending to such account and improve the prospects of turning around such stressed industrial units.

It can be asserted without doubt that the CDR mechanism resolves the financial difficulties of the corporate sector and enables entities to become viable. 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 multifaceted. 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-phasing of recovery schedules, reduction in margins, reassessment of credit facilities including working capital, 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. Nevertheless, the system has its share of deficiencies, which have been pointed above in this paper, and if the Indian government along with Industry could attack at these problem areas, CDR system could prove to be beneficial not just for lenders or borrowers but for economic system as whole.

Annex I. Classification of Approval By Industry
Sr. No.IndustryNo.Aggregate Debt

(Rs. crore)
% of

share
1Iron & Steel253667335.16
2Fertilizers884548.11
3Textiles4789028.54
4Petrochemicals354935.27
5Refineries148744.67
5Cements646634.47
6Telecom752505.03
7Sugar2053285.11
8Power738363.68
9Chemicals1327172.61
11Metals (Non-ferrous Metals)521712.08
12Electronics221322.04
13Infrastructure951664.95
14Pharmaceuticals621302.04
15Paper/Packaging1111991.15
16Cables77650.73
17Automobiles25510.53
18Auto Components75630.54
19Wood Products14630.44
20Engineering64540.44
21Ceramic Tiles53330.32
22Ship-Breaking11760.17
23Rubber31670.16
24Hotels21470.14
25Forgings11120.11
26Glass2820.08
27Plastic22140.21
28Retail14700.45
29Battery1350.03
30Other (Dairy, Jewelry)47790.75
TOTAL215104299100.00

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