With tweaks, June 7 circular will fly

The framework for resolution of stressed assets under the Reserve Bank of India’s (RBI) June 7, 2019, circular offers an alternative to formal insolvency proceedings to resolve financial distress. It outlines a scheme for resolving financial difficulties through ‘out of court’ or a ‘negotiated restructuring’ mechanism.

This complements the formal insolvency framework by reducing the burden on judicial infrastructure, a significant challenge being faced under the Insolvency and Bankruptcy Code (IBC). To be effective, out of court restructuring also requires ‘coordination among the participants’, ‘recognition of priorities inter se the creditors’ and ‘agreement to suspend adverse actions or agreeing to a standstill’ by the creditors against a debtor. Therefore, the circular read with the Intercreditor Agreement (ICA) apparently seems to have all the bells and whistles required to facilitate a negotiated restructuring.

The results have been far from promising. Further, 180-day timeline for resolving accounts above a certain threshold has also elapsed. Lenders are grappling with uncertainty on the future course of action which ranges from exploring the option of exiting the ICA, continuing with restructuring, or initiating proceedings under IBC. 

It is early days to pass a verdict and attempts to bin the negotiated restructuring framework available under the circular should be avoided. The circular and the ICA have some gaps which need to be addressed.

One of the critical aspects is the omission of non-banking financial companies (NBFCs) from the list of lenders who can initiate the 30-day review period upon occurrence of a default. Many NBFCs can therefore adopt a position that this period and the timeline of 180 days to arrive at a resolution plan is not applicable to them.

Additional funding is a key component of any debt restructuring and absence of it may push a debtor company to resort to formal insolvency proceedings due to lack of liquidity. The circular provides for asset classification of additional funding, but it is silent on the priority, if any, to be accorded to the same.

The RBI is yet to come out with the reference date for loan accounts less than Rs 1,500 crore. Also, as a relaxation to lenders and to avoid further clogging of the National Company Law Tribunal, the RBI may consider lowering the increase in provisioning norms, when a resolution plan is not implemented.

A noteworthy feature of the circular is that the RBI has not been prescriptive in its approach other than providing key principles which must be adhered to. One such principle is to enter into an ICA and stipulation of its essential elements. Those signing the ICA should not treat it as cast in stone, and lenders may consider making the necessary modifications to make it more effective. An important aspect which is missing in the ICA is the flexibility of lenders to continue with standstill on the expiry of the 180-day period. The ICA should provide for a situation where the lenders continue with the formulation of a resolution plan beyond the 180-day timeline, while adhering to additional provisioning, and any decision of the majority of lenders in this regard should be binding on all creditors. Above all this, negotiated restructuring is successful if all the significant stakeholders participate, and requires all financial regulators to arrive at a common understanding.

Inputs from Arpita Garg, Partner at J Sagar Associates