Stressed firms accuse ARCs of asset stripping in complaint to RBI

They say ARCs are giving backdoor entry to vulture funds through an effective "benami structure" after taking over debt from banks

Stressed firms have complained to the Reserve Bank of India (RBI) that asset reconstruction companies (ARCs) are indulging in asset stripping with the help of foreign funds. 

In a letter to the RBI, one of the stressed companies pointed out that after taking over the debt from banks, ARCs are giving backdoor entry to vulture funds through an effective “benami structure”, which is currently available only for reconstruction or securitisation companies. 

Stressed companies say ARCs are failing to restructure in up to 12 months prescribed by the RBI and have asked the central bank whether an unregistered foreign credit fund is allowed to utilise the registration and platform of a local ARC to acquire Indian rupee debt under the Sarfaesi Act. 

In fact, the letter to the RBI said ARCs are allowing global funds to utilise their platform to acquire distressed debt from mostly public sector lenders at deep discounts with an underlying premise that the value paid for the company would effectively become the enterprise value, and a restructuring would be undertaken in a time-bound manner. 

“However, a fraud is being played on public sector lenders, as the funds are refusing to restructure the debt at sustainable levels and are instead seeking super-normal returns. To this extent, they have failed to appoint consultants to assess the correct sustainable debt levels and have also failed to complete the restructuring within the mandated period of 12 months,” said the letter.

Finally, there is a huge loss in value for equity stakeholders because unsustainable debt becomes a value trap, from which equity shareholders can never get any possibility for debt into equity and the vulture funds are looking to dilute them by converting a small amount of recovery of losses. 

“As soon as the loans are taken over, ARCs are first taking out the cash available in the company to pay themselves. This is a classic example of asset stripping and would certainly end up in courts,” said one of the promoters of a stressed company.

While the intention of the Sarfaesi Act was to resolved the issue of bad debt, it is being used for vested commercial interests of foreign funds that are taking over the assets via a complex trust structure.

An ARC is defined under the Sarfaesi Act as a company registered with the regulator for carrying on the business of asset reconstruction. 

The Act says any entity that is not registered with the RBI may conduct the business of securitisation or asset reconstruction, but outside the purview of the Sarfaesi Act.

It is a settled law that the Sarfaesi Act is a complete code and provides for various remedies for creditors and institutions, such as ARCs. 

But several foreign funds that are not registered under the provisions of the Sarfaesi Act but, nevertheless, attempting to do indirectly, with the help of local ARCs as a facade to do what it cannot do itself and without being registered with the RBI.

“This raises serious questions as to whether the ARC platform, which has been recognised by statute and provided various rights and benefits under the Sarfaesi Act, can be effectively transferred to an unregistered foreign portfolio investor,” the letter to the RBI said.