PAVING WAY FOR ASSET RECONSTRUCTION COMPANIES TO SUBMIT RESOLUTION PLANS

Background

Prior to the October Circular, RBI guidelines under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) provides the legal basis for the setting up ARCs in India. The regulatory guidelines issued by the RBI under SARFAESI did not provide the enabling framework for participation of ARCs as resolution applicant primarily because their main function was perceived as purchasing Non-Performing Assets (NPAs) from banks and financial institutions and acting as a recovery agent.

ARCs are, however, not ineligible under IBC to submit resolution plan as resolution applicant, as long as the ARC submitting the resolution plan is not a related party to the corporate debtor. In the CIRP of Aircel Ltd and its subsidiaries ² UV Asset Reconstruction Company Limited (UVARCL) emerged as the successful resolution applicant ³. UVARCL sought approval of RBI for acquiring equity shares in corporate debtor as part of approved resolution plan. Pertinent to mention that in terms of then applicable RBI guidelines, ARCs were only allowed to hold up to 26% of the post-converted equity of the borrower company ⁴. Only under certain prescribed circumstances, the 26% limit could be exempted⁵. <style=”color: #000000; font-family: Hind, sans-serif; font-weight: 100;”>RBI instead issued a show cause notice to UVARCL why its registration under the SARFAESI Act be not cancelled for undertaking an activity (read, submitting resolution plan under the IBC) which it was not permitted to undertake under the law. UVARCL challenged RBI’s decision before the Delhi High Court. The Delhi High Court, noting the dichotomy between the IBC and the SARFAESI, observed there is a need for reconciliation of provisions of both the legislations ⁶.

Sudarshan Sen Committee

On April 19, 2021, RBI constituted a committee under the chairmanship of Shri Sudarshan Sen, former Executive Director of the RBI, to undertake a comprehensive review of the working of ARCs (Committee). The terms of reference of the Committee were as under:

• Review of existing legal and regulatory framework

• applicable to ARCs and recommend measures to

• improve efficacy of ARCs

• Review of role of ARCs in resolution of stressed assets including under the IBC.

• Suggestions for improving liquidity in and trading of security receipts.

• Review of business models of the ARCs.

• Any other matter relevant to the functioning, transparency and governance of ARCs.

The Committee submitted its report to RBI in September 2021, following which comments were invited from public and stakeholders ⁷.

Recommendations of the Committee

The Committee noted that against the backdrop of significant build-up of NPAs in the financial system, ARCs are expected to play a critical role. The ARC framework is also designed to help borrowers revive their businesses, which protects the viable and productive assets of the economy and often ensures a better return to lenders, from their stressed assets. However, data shows that the performance of ARCs has been lackluster, both in terms of ensuring recovery and revival of businesses. Banks and other investors could recover only about 14.29% of the amount owed by borrowers in respect of stressed assets sold to ARCs during the FY 2004 – FY 2013 period. Similarly, data shows that approximately 80% of the recovery made by ARCs has come through deployment of measures of reconstruction that do not necessarily lead to revival of businesses.

The Committee further noted that Section 9(1) of SARFAESI, “prescribes the measures of asset reconstruction that ARCs can deploy under the guidelines issued by RBI. Data indicates that approximately 80% of the recovery for the sector, so far, has come through deployment of methods of reconstruction that do not necessarily lead to revival of the business. ARCs have rarely used change or takeover of the management of business of the borrowers or conversion of borrowers’ debt into equity as measures for reconstruction. Rescheduling of payment of debts was also involved in only 19.9% of the recovery made by ARCs. This trend has been consistent over the life of the sector. The only change in this trend is use of IBC as a resolution mechanism after it became available. ARCs get the power to use IBC from the provisions of IBC and not SARFAESI. Assets bought after FY14 are increasingly being resolved through IBC.”  The Committee further noted, “while ARCs as secured creditors are allowed to resolve their financial assets through the IBC process, the current regulatory and legal framework does not allow them to act as resolution applicants under IBC. The fundamental reason behind the same is that the legal and regulatory design of ARCs is focused on recovery of debt from the borrower and not on resolution of the borrower’s insolvency. At the same time, SARFAESI does provide tools to ARCs which could be used for insolvency resolution (e.g., change in/takeover of management, debt to equity conversion, etc.). However, as mentioned earlier, ARCs, in general, have not been using these tools.” 

 “Envisaging ARCs as a prime vehicle for resolution of stressed assets,” the Committee recommended that RBI regulations, “should allow ARCs to also use IBC framework for this purpose. This can be facilitated by allowing ARCs to participate as a resolution applicant. Expertise acquired through IBC in resolving borrower insolvency will help ARCs in maximising recovery of dues. However, ARC should remain asset-light in order to avoid conflict of interest in resolution of assets acquired in the trusts managed by them vis-à-vis acquired in their own balance sheet.”  

Key features of October Circular

I. ARCs as a Resolution Applicant

In Order to qualify as a Resolution Applicant, the companies need to have a Minimum Net Owned Fund of ₹1000 crore and a board-approved policy to take up the role of an Applicant under IBC which are not specifically allowed under the SARFAESI Act.

Formation of committee

The ARC shall constitute a committee comprising of a majority of independent directors to take decisions on the proposals of submission of resolution plan under IBC. If needed, ARC shall explore the possibility of preparing a panel of sector-specific management firms/ individuals having expertise in running firms/ companies which may be considered for managing the firms/ companies.

Resolution Plan

With respect to the control over the corporate debtor, the ARCs, after five years from the date of approval of the resolution plan by the Adjudicating Authority under IBC, shall not retain any significant influence or control over the corporate debtor with respect to specific CIRP. 

In case the ARC does not comply with this condition, the ARCs shall not be allowed to submit any fresh resolution plans under IBC either as a resolution applicant or a resolution co-applicant.

Disclosures

The ARC shall make additional disclosures in the financial statements with respect to assets acquired under IBC in addition to the existing disclosure requirements. These would include the type and value of assets acquired under IBC, the sector-wise distribution based on business of the corporate debtor, etc.

The ARC shall disclose the implementation status of the resolution plans approved by the Adjudicating Authority on a quarterly basis in their financial statements.

II. Corporate Governance

Board Meetings

The Chair of the Board will be mandatorily an Independent Director and in absence of the Chair of the Board, the meetings shall be chaired by an Independent Director.

Quorum for the Board Meetings

 One Third of the total strength of the Board.

• Three Directors or whichever is higher.
• Half of the directors attending the meetings of the Board shall be Independent Directors.

Maximum Tenure, Age, Performance Review of the Directors and /Officers

• The tenure of Managing Director (MD)/Chief Executive Officer (CEO) and Wholetime Director (WTD) will not be of more than five (5) years. The individual would be eligible for re-appointment continuously for not more than 15 years.
• The cooling off period is three years. Subject to other conditions, the individual shall be eligible for re-appointment in the same ARC as MD/ CEO or WTD.
• The overall age limit for appointment is of 70 years. However, the Boards may prescribe a lower retirement age and annually the performance shall be reviewed.

Fit and Proper Criteria for Directors and CEO

• The ARC shall undertake due diligence to determine the suitability of the person for the post. Prior approval of RBI required for appointment/reappointment of a Director/MD/ CEO.
• The track record, integrity and other ‘fit and proper’ criteria would be looked into while appointing/ re-appointing. The information shall be obtained on annual basis from the director and MD/CEO and any change shall be communicated to the Department of Regulation of the RBI.
• The necessary information shall be declared by the ARC in the prescribed Format which shall be scrutinised by the Nomination and Remuneration Committee.
• At the time of joining the directors to execute a covenant in the format at the time of joining the ARC.

Audit Committee

•  The Audit Committee to comprise of non-executive directors only and chair of the Board will not be a member of the Audit Committee.
• It shall ensure that accounting of management fee/ incentives/ expenses is in compliance with the applicable regulations.
• The Audit Committee shall periodically review and assess the effectiveness of internal control systems, especially with respect to the asset acquisition procedures and asset reconstruction measures followed by the ARC and matters related thereto.
•  The chair of the Audit Committee shall be an independent Director and shall not chair any other committees of the Board. The Audit Committee shall meet at least once in a quarter with a quorum of three members.

 Skill

The members of the Committee to have the ability to understand the financial statements as well as related documents and one of the members should have the requisite professional expertise/ qualification in financial accounting or financial management.

Powers, functions and duties

They will be same as provided under Section 177 of the Companies Act, 2013 (Act, 2013).

Nomination and Remuneration Committee

The members of this committee shall have the same powers, functions and duties as provided undersection 178 of the Companies Act, 2013 and shall ensure ‘fit and proper’ status of proposed/ existing directors and sponsors.

Independent Advisory Committee

This committee consists of professionals having technical/ finance/ legal background. It shall examine the proposals related to change in or takeover of management of business of the borrower.

It shall also now examine the proposals of settlement of dues with the borrower.

Change in shareholding and prior approval

Fresh issuance of shares may lead to change in sponsor (s) which would require prior approval of RBI. On account of change in shareholding due to transfer of shares in terms of the RBI Circular dated 24.02.2015, ARCs are required to obtain prior RBI approval ⁸.

Disclosure requirements in offer document ⁹

The offer document shall disclose the following additional information:

• Summary of financial information of the ARC for last 5 years or since commencement of business of the ARC, whichever is shorter.
• Track record of returns generated for all Security Receipt (SR) investors on the schemes floated in the last 8 years.
• Track record of recovery rating migration and engagement with rating agency of schemes floated in the last 8 years.

Credit Rating Agencies (CRA) and Security Receipts (SRs)

The ARCs shall retain a CRA for at least six (6) rating cycles (of half year each), in case it is changed mid-way through the rating cycles then the ARC shall state the reason of the same. The ARC shall obtain recovery rating of the SRs

from CRAs and disclose the assumptions and rationale behind such rating to SR holders.

III. Other Guidelines

One-time Settlement- Settlement of Dues

(a) The proposal for settlement shall be examined by the IAC, which will give its recommendations to the ARC regarding settlement of dues with the borrowers.  The settlement shall be done after assessing the financial position of the borrower, the time frame available for recovery of the dues from the borrower, projected earnings and Cashflows of the borrower and other relevant aspects.

(b) Deliberation on the recommendations of IAC would be done by the Board of Directors including two Independent Directors for considering the various options available for recovery of dues before deciding whether the option of settlement of dues with the borrower is the best option available under the existing circumstances. The details shall be specifically recorded in the minutes of the Board Meeting.

(c) Only after all possible steps to recover the dues have been taken and there are no further prospects of recovering the debt the Settlement with the borrowers will be done.

(d) In case there is a significant variation between the valuation of securities recorded at the time of acquisition of financial assets and the realisable value assessed at the time of entering into a settlement, the reasons for such variation should be recorded as the NPV of the settlement amount should not generally be less than the realizable value of securities.

(e) The IAC to make specific recommendations about minimum upfront lump-sum payment and maximum repayment period especially in cases where the borrower is unable to pay the entire amount in lump sum.

(f) Based on the framework the ARC to frame a policy which shall be approved by the Board.

Calculation of the Net Present Value (NPV)

In case of significant variation between the valuation of securities recorded at the time of acquisition of financial assets and the realisable value assessed at the time of entering into a settlement, reason should be recorded as the NPV of the settlement amount should generally be not less than the realizable value of securities.

The ARCs shall frame a Board-approved policy in case the borrower is unable to pay the entire amount in lumpsum   and the IAC shall make specific recommendations about minimum upfront lump-sum payment and maximum repayment period.

Management fee/ incentives charged by ARCs

The ARCs shall adopt these additional measures with respect to any management fee/ incentives charged towards the asset reconstruction or securitisation activity:

1. Shall come only from the recovery effected from the underlying financial assets.
2. The Board-approved policy shall indicate the quantitative cap/ limit on the
   management fee/ incentives under various scenarios, any deviation from which shall require approval of the Board.

Minimum Net Owned Fund (NOF) Requirement

The ARCs obtaining the certificate of registration on or after the date of this Circular shall not commence the business of securitisation or asset reconstruction without having a minimum NOF of Rs.300 crore (Rupees Three Hundred Crore Only) from Rs. 100 Crore (Rupees One Hundred Crore) and in case of non-compliance, ARC shall be subject to supervisory action, including prohibition on undertaking incremental business till it reaches the required minimum NOF applicable at that time. The glidepath is under:

Deployment of Surplus Funds

The ARC, subject to the fulfilling these conditions:

firstly, Maximum investment is capped at 10% of the NOF of the ARC and

secondly the ARC should have a Board-approved policy.

Only then is permitted to deploy the available surplus funds in short-term instruments viz., money market mutual funds, certificates of deposit and corporate bonds/ commercial papers which have a short-term rating equivalent to the long-term rating of AA- or above by an eligible CRA.

Investment in SRs issued by ARCs

ARCs can invest in the SRs, by transferring funds of each class of SRs issued by them under each scheme on an ongoing basis till the redemption of all the SRs issued under such scheme subject to these conditions:

(i) minimum of either 15% of the transferors’ investment in the SRs, or

(ii) 2.5% of the total SRs issued, whichever is higher.

Transfer of Stressed Loans to ARCs

All stressed loans which are in default in the books of the transferors are permitted to be transferred to ARCs.

The Master Direction- Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 are updated ¹⁰