[Sachin Santuka is a B.B.A LL.B. candidate at the National Law University Odisha]
After the Supreme Court in Dharini Sugars v Union of India struck down the Reserve Bank of India (RBI) circular dated 12 February 2018, the RBI on 7 June 2019 introduced a revised framework for the resolution of stressed assets. The provisions of the framework are applicable to Scheduled Commercial Banks, All India Term Financial Institutions, Small Finance Banks, Systemically Important Non-Deposit taking Non-Banking Financial Companies (NBFCs) and Deposit taking NBFCs.
The framework mandates that lenders undertake a prima facie review of the borrower’s account within thirty days of default. During such period, lenders shall decide upon the resolution strategy, which may include implementation of a resolution plan (RP) or initiation of legal proceedings against borrower for insolvency or recovery. The framework further provides that in cases where an RP is to be implemented, the lenders shall mandatorily enter into an inter-creditor agreement (ICA) during such period. The ICA shall inter alia provide that any decision consented to by lenders representing 75 per cent by value of total outstanding credit facilities and 60 per cent of lenders by number shall be binding upon all the lenders.
It is commonplace to find borrowers, especially within the non-banking finance industry, who have raised considerable portion of their borrowings through issuance of debt securities such as non-convertible debentures (NCDs), which are subscribed to by mutual funds, pension funds, and similar institutions. One such example is Dewan Housing Finance Limited (DHFL) whose debt as of February 2019 of Rs 1 trillion constituted borrowings from banks to the tune of Rs. 38 billion and the rest through debt securities.
Therefore, in a situation such as this, any effective RP would require the participation of the banks as well as the holders of the debt securities. In this light, the post seeks to examine whether bondholders or debenture-holders (typically mutual funds, insurance companies and pension funds) can become a part of the resolution framework under the 7 June Circular and accord consent to the inter-creditor agreement.
DHFL is probably one of the first large accounts to come for resolution under the circular. Bankers, led by the Union Bank of India, have already signed an ICA and, since a majority debt was raised through NCDs which are held by mutual funds, insurance companies and pension funds, the bankers approached the debenture trustee, Catalyst Trusteeship, to accord consent to the ICA on behalf of the holders of NCDs. Catalyst Trusteeship, accordingly, sought consent from the NCD holders to sign the ICA on their behalf.
However, the legality of mutual funds and pension funds signing the ICA was also not clear and accordingly various applications and representations were made to Securities and Exchange Board of India (SEBI) and Insurance Regulatory and Development Authority of India (IRDA). The IRDA has, through a letter to the Indian Banks Association, allowed insurance companies to sign the ICA. In a reply to the Association of Mutual Funds of India’s (AMFI) request to allow signing of ICA by mutual funds, SEBI stated that mutual funds may sign an ICA subject to certain conditions.
First, mutual funds may only sign an ICA if they have already ‘side-pocketed’ i.e. created a segregated portfolio within a day from an adverse credit event (for example, default) which also requires giving an exit option to unit-holder. Any such segregation will also be subject to various requirements under SEBI’s circular dated 28 December 2018. Second, if the RP is not in consonance with SEBI’s regulations or circulars governing mutual funds, they may exit the resolution process. Third, SEBI has also given liberty to mutual funds to exit the resolution process if the RP is not implemented within 180 days. However, mutual funds may extend the timeline to a maximum of 365 days subject to approval of the board and trustees of the AMC.
The consequence of SEBI’s reply is that most mutual fund schemes, barring three schemes of Tata Mutual Fund, cannot now sign the ICA and join the DHFL resolution process since they had not side-pocketed their exposure to DHFL initially when its securities rating were downgraded to default. DHFL’s debt is almost equal to that of the IL&FS entities, and hence poses huge systemic risk. Considering this very fact and the prior lack of clarity, SEBI should have made a one-time exception and allowed these funds to join the resolution process. This rigidity of the regulator results in the fact that an effective resolution now seems far-fetched since the funds who lent a considerable portion of DHFL’s debt would have to opt for the legal route of recovery or insolvency which might affect the resolution process led by banks.
What is also perplexing is that both IRDA and SEBI have not issued any formal direction or circulars in this regard, and that such nuanced conditions have been laid out rather informally in the form of responses to representations made by industry bodies. To add to this, even the said responses have not been made accessible to public. Indeed this casts doubt on the legality of the conditions laid down.
– Sachin Santuka
“The consequence of SEBI’s reply is that most mutual fund schemes, barring three schemes of Tata Mutual Fund, cannot now sign the ICA and join the DHFL resolution process since they had not side-pocketed their exposure to DHFL initially when its securities rating were downgraded to default.”
As per news reports, Tata MF side-pocketed its exposure to DHFL and hence was eligible to join the ICA.
No other AMC did so.