Let the market decide

Efficient and speedy resolution of NPAs needs Sebi's help

Last week, the Securities and Exchange Board of India (Sebi) took some important decisions to facilitate the turnaround of distressed companies with the underlying intention of providing relief to shareholders and lenders. However, although these proposals will help in the resolution of bad loans, they might not go far enough. Some of these steps are in line with the Reserve Bank of India’s guidelines on strategic debt restructuring (SDR). If a bank exercises its rights to take over a defaulting debtor under the SDR scheme, it is exempted from making either an open offer to minority shareholders or a preferential issue to increase its stake, as is otherwise obligatory. However, and this is crucial, the rules made it obligatory for the new strategic acquirer to make a mandatory open offer. Sebi’s board has relaxed this requirement. The need for making a preferential issue, too, has been relaxed, provided that the acquisition is under a resolution plan approved by the National Company Law Tribunal. These relaxations considerably reduce the financial commitments for investors in distressed listed companies and make it easier for lenders to realise some return on non-performing assets (NPAs). It will also provide investors some leeway to commit more funds to run the business. 

However, Sebi has retained a couple of provisions that could still prove to be hurdles to such distress sales. One, the sale must be subject to approval of the shareholders by a special resolution. Two, the new investor must lock in their shareholdings for a minimum period of three years. The lock-in period presumably arises from an assumption that such an investor will wish to run the business. But this may not be the case always. In many cases, the distressed company cannot be rescued because the business model is not viable — for instance, several stalled infrastructure projects were set up on the basis of unrealistic assumptions. In such cases, it would be sensible for a “vulture capitalist” to buy the business at a deep discount from lenders and then break up the company and sell off whatever assets possible for whatever profit it can realise. That is the most efficient way of utilising blocked assets. Clearly, the lock-in condition is restrictive and it severely limits the resale potential of such distressed companies.

The concept of approval by a special resolution arises from a laudable desire to protect the rights of minority shareholders. However, this provision is cumbersome and will likely lead to deals being scuppered by vested interests. While the rights of shareholders should be protected, the rights of creditors cannot be compromised either. Sebi should look to guard the rights of minority shareholders by ensuring that there is no differential treatment in a case of asset-stripping. Whatever is left after settling debts should be shared equally among equity-holders. The NPA situation has been brewing for a decade and it has reached a crisis point. It cannot be solved without lenders and shareholders taking haircuts. In such a situation, the regulator should go the whole hog to ensure speedy resolution.