FAQs on refund of interest on interest

-Financial Services Division (finserv@vinodkothari.com)

The Supreme Court of India (‘SC’ or ‘Court’) had given its judgment in the matter of Small Scale Industrial Manufacturers Association vs UOI & Ors. and other connected matters on March 23, 2021. The said order of SC put an end to an almost ten months-long legal scuffle that started with the plea for a complete waiver of interest but edged towards waiver of interest on interest, that is, compound interest, charged by lenders during Covid moratorium.  While there is no clear sense of direction as to who shall bear the burden of interest on interest for the period commencing from 01 March 2020 till 31 August 2020. The Indian Bank’s Association (IBA) has made representation to the government to take on the burden of additional interest, as directed under the Supreme Court judgment. While there is currently no official response from the Government’s side in this regard, at least in the public domain in respect to who shall bear the interest on interest as directed by SC. Nevertheless, while the decision/official response from the Government is awaited, the RBI issued a circular dated April 07, 2021, directing lending institutions to abide by SC judgment.[1] Meanwhile, the IBA in consultation with banks, NBFCs, FICCI, ICAI, and other stakeholders have adopted a guideline with a uniform methodology for a refund of interest on interest/compound interest/penal interest.

We have earlier covered the ex-gratia scheme in detail in our FAQs titled ‘Compound interest burden taken over by the Central Government: Lenders required to pass on benefit to borrowers’ – Vinod Kothari Consultants>

In this write-up, we have aimed to briefly cover some of the salient aspects of the RBI circular in light of SC judgment and advisory issued by IBA.

FAQs

(updated based on the IBA Advisory dated April 19, 2021)

Applicability on Lenders:

1. Which all financial institutions are covered by the RBI Circular?

The RBI Circular is directed to the following lenders :

  • All commercial banks (including Small Finance Banks, Local Area Banks and Regional Rural Banks)
  • Co-operative Banks- Urban Co-operative Banks,  State Co-operative Banks and District Co-operative Bank
  • All India Financial Institutions
  • All Non-Banking Financial Companies (including Micro Finance Companies, systemically important NBFCs, non-systemically important NBFCs and Housing Finance Companies)

2. What exactly is the relief to be given?

The Relief is relief against compound and/or penal interest for any failure to pay, or delay in payments, by the Borrower, during the Moratorium Period, that is, 1st March 2020 to 31st August, 2020.

Thus, the compound interest and/or penal interest charged, explicitly or implicitly, during the Moratorium Period, for payments which were either delayed or failed during such period, will be replaced by simple rate of interest, at the rate contractually fixed between the parties.

3. How exactly is the relief to be given?

The Relief may be given by either refunding the amount of relief to the Borrower, or adjusting the same against any dues payable by the Customer. In case there are any payments already due, the Lender generally has the right to appropriate the amount payable to the Borrower against amounts which have already fallen due under the facility.

4. I was not a party to the litigation in the Supreme Court, and therefore, can it be contended that the SC has passed an order against all financial institutions, even if they were not before the Court, and therefore, had no opportunity to make or plead their case?

Pursuant to the Supreme Court Order, the RBI had issued a circular on April 7, 2021 directing all lending institutions (specified above) to abide by the instructions of the SC. Hence, irrespective of a lending institution being a party to the SC order, the RBI Circular is intended to be implemented uniformly by all lending institutions.

Of course, it remains a contentious question as to who shall take the burden of the Relief – whether the lending institution itself shall bear it, or lay the claim on the government. Pending clarity on that, we are assuming that the lending institution will have to shoulder the burden of Relief.

5. I am an investment company; I don’t have loan transactions with the public. Am I covered by the RBI Circular?

Pure Investment Companies, though registered as an NBFC, may not be carrying out lending activities. Hence, there does not seem to be any actionable on their part under the RBI Circular

6. I am an NBFC; my borrower has given an explicit waiver that the borrower does not want to avail the benefit of Relief on compounding interest. Do I still have to give that relief to the borrower? Can my policy, for example, say that the benefit of compound interest relief will be given to all borrowers, except those who have explicitly waived off their right to the same?

The benefit under Supreme Court order is to be extended to all the Eligible Accounts (covered in FAQ 8) uniformly. The burden of refunding the interest on interest amount to the customer, is on the lender. It seems counter intuitive that a Borrower will waive off what is clearly for relief to the borrower. Such waiver by the borrower will give rise to apprehension of use of pressure tactics.

7. I am a retail lender and none of my borrower accounts had outstanding loan facilities of more than 2 crores as on 29 February 2020. I have already extended the interest on interest benefit to my customers under the ex-gratia scheme. Do I still have to comply with the actionables under the RBI Circular?

In cases where the outstanding amount for all the loan accounts of the lender were below  2 crore as on 29 February 2020, there may be 2 reasons why the 7th April circular may still have to be complied with:

  1. The benefit was not extended to a Borrower, though the Borrower was eligible for the same.
  2. The benefit was not extended to a Borrower, if the Borrower belonged to the classes which were not eligible for the relief under ex-gratia owing to aggregate exposure of such borrower to all the lenders being more than Rs. 2 crore.

Hence, a Lender may see whether there is any actionable, including any provision to be made in the financials of 20-21.

Facility Covered

8. Which all classes or categories of loans/facilities are eligible under the RBI Circular?

All “standard accounts” have to be given the benefit of relief. The determination date for this purpose is 29th Feb., 2020. That is, the days past due (DPD) status should be less than 90 DPD as on 29.02.2020 (“Eligible Accounts”). While NPA classification is mostly done on account of DPD, there should not have been any other reasons for which the account was classified as an NPA as on 29 February 2020.

Accounts not eligible for Relief under RBI Circular:

  • Accounts classified as NPA as on 29 February 2020.
  • Loan facilities which were charged with simple interest.
  • Accounts already refunded interest on interest under ex-gratia scheme
  • Non-Funded facilities (bank guarantee, Letter of Credit) not eligible for any refund.

9. Are non-performing assets as on 1st March 2020 ineligible for the Relief?

The IBA Circular creates a confusion by use of the following expression: “NPA Accounts as on 29.02.2021 (presumption being no interest or no compound interest is changed in case of NPA accounts).

The presumption that compound interest is not charged on NPA accounts is fallacious. While interest is not accrued for accounting purposes, contractual right of the lender to charge interest continues even while the loan is an NPA.

However, the question is, was an NPA borrower actually eligible to avail the moratorium at all? The intent of the moratorium was to grant relief against difficulties arising due to the pandemic.

10. In case the lender is collecting EMIs and not charging any penal interest, will such loans be eligible?

The language of the RBI Circular para 2 is that all lending institutions shall immediately put in place a Board-approved policy to refund/adjust the ‘interest on interest’ charged to the borrowers,irrespective of whether moratorium had been fully or partially availed, or not. The RBI Circular intends to provide a relief on ‘interest on interest’ charged to the borrowers during the moratorium period, i.e. March 1, 2020, to August 31, 2020. That is to say, the intent of the RBI, following the directive of the SC, seems to give relief to a borrower who has been charged compound interest during the Moratorium Period.

Now, assume the following situation: A borrower did not avail of the moratorium, and was regularly paying loan instalments, and interest on the outstanding principal during the Moratorium Period. As there were no instalments that were overdue during the period, the question of the lender charging any interest on interest did not arise. Interest was being charged, but that was on the outstanding principal. Hence, if no compound interest has either been charged or posted to the account of the borrower, no benefit/refund is applicable to such borrower.

11. In the answer to the question immediately above, will it make any difference if the loan agreement provided for payment by EMIs rather than by equal instalments of principal or interest?

In EMIs too, the interest is inherently computed on outstanding principal (POS), and as there was no deferral of payments by the borrower, there was no interest on interest charged during the Moratorium Period.

12. Para 1.1 of the IBA Circular dated April 19, 2021  says : “where compound interest/interest on interest/ penal interest for non-payment/delayed payment was applied during moratorium”. This seems to imply that the relief is applicable only where (a) there has been a non-payment or (b) there has been a delayed payment during the Moratorium Period. In line with the SC ruling, the non-payment or delayed payment may either be covered by the mutual moratorium, or there may not have been a moratorium and still there may be a delay in the payments.

In essence, it seems from the reading of the IBA Circular that there are 2 conditions to be satisfied to grant the relief:

There was:

  1. Either a delayed payment or non-payment during the Moratorium Period, or there was a moratorium period availed and granted, and therefore, the compound interest was imposed on the restructured payment schedule
  2. And, the Lender has charged either compound interest or penal interest or both on account of either the delay, or non-payment, or shifting of payments due to the Moratorium.

Is it a correct interpretation to say that the relief under the IBA Circular is not applicable where the first or the second condition is not satisfied?

Yes, this understanding is correct. In fact, it becomes even clearer by reading the “remarks” column against entry 1, where it says, “Account eligible for refund only if compound interest/interest on interest/penal interest has been applied during the moratorium.” A similar comment appears against entry 2: “Accounts where compounding interest/interest on interest/ penal interest for non-payment/ delayed payment has not been applied during the moratorium will not be eligible for refund of interest.”

13. The facility in question did not have any payments due during the Moratorium Period. As there was no payment due during the Moratorium Period, the question of any compound interest or penal interest charged during the Moratorium Period, for payments delayed or failed during such period, does not arise. The following are some examples:

a) A loan was extended on 1st Jan., 2020 and the instalments were to begin from 1st October as the loan was under original moratorium. 

b) A loan was given on 1st Jan., 2020 but a bullet repayment at the end of 1 year. 

In both the cases, the intrinsic computations involve compound interest but as there was no failure to pay or delay during the Moratorium Period, there was no implication on any of the payments to be made by the borrower. Further, since no payments were due, the question of any moratorium did not arise.

In these cases, is it correct to contend that the 7th April circular does not apply?

Yes. As there is no case of delay or failure to pay during the moratorium period, there is no case for applying the 7th April circular.

14. The loan was standard as on 1st March, but was already 60 DPD as on that date. Hence, the overdue instalments were already attracting a penal rate, say at the rate of 24%. From 1st March to 31st August, can such penal interest, on instalments due and payable before 1st March, 2020, continue?

While it is possible to have a different interpretation, the intent of the SC ruling and the RBI Circular is that the time clock had stopped during the moratorium. The borrower could not pay till 1st March 2020 – that was a case of failure to pay. However, during the moratorium period, it was a case of inability to pay due to a supervening difficulty. Hence, neither compound interest nor penal interest can be charged during the Moratorium Period.

15. In case a lender does not charge compound interest on loan, will such loans still be eligible for refund/adjustment?

In cases where the lender does not charge compound interest on its loan facilities, this essentially means that there is no compounding of the principal amount by such lender over the tenure of such loan. Hence there is no question of refund of interest on interest on such loan facilities. However, if any penal interest has been charged with respect to such loan facilities, during the moratorium period, the same is liable to be refunded.

16. In case a borrower did not avail the moratorium in respect to the loan facility and such borrower defaulted on its EMI during the moratorium period, will such borrower be covered under the RBI Circular?

The refund of interest on interest is available to the Borrower under RBI Circular, irrespective whether the moratorium has been availed or not by such Borrower.  A Borrower who did not avail the moratorium and subsequently defaulted on its EMI.

Then in such cases:

  • Either the account is subjected to penalty on its EMI after such default by the customer, OR
  • In case no penalty is charged, even in such a case EMI includes a compound interest component

Therefore, in cases where penalty is charged during the moratorium period all the amount towards penalty including interest on such penalty (if any) should be refunded/adjusted by the lender in addition to the differential amount payable in respect to interest on interest ( Six months compound interest on amount outstanding as on 29.02.2020 minus simple interest on amount outstanding as on 29.02.2020).

17. Will guarantee arrangements be covered under the RBI Circular?

Guarantee is an unfunded support. Hence, there is no question of any payments due, except for payments for by way of guarantee commission.

The IBA clarification dated 19 April 2021 clearly provides in its annure 1 column 2 that non-funded facilities are not eligible for refund.

Note that guarantee commission is not subject to a moratorium

18. Will it make a difference if the guarantee has been invoked and become a funded facility?

If the guarantee is a funded facility, on account of the guarantee having been invoked, it will certainly be covered by the Circular.

19. Will the accounts not eligible for benefit under the ex-gratia scheme, qualify for the refund of interest on interest under RBI Circular? 

The ex-gratia scheme excluded certain accounts out of its ambit, such as agricultural and allied activities loans including tractor loans. The RBI Circular makes no distinction on such basis, hence interest on interest benefit should be passed to all the Eligible Accounts even if they were ineligible earlier under the ex-gratia scheme.

20. Will the loan facilities by banks to NBFCs/HFCs, qualify for the refund of interest on interest under RBI Circular? 

The RBI Circular does not distinguish the loan accounts on the basis of end-use or the purpose of the loan account. Therefore, Eligible Accounts should also include loan facilities extended by banks to the NBFCs/HFCs, or loan facilities by one NBFC to another NBFC provided there was delay or failure to pay during the moratorium period and interest on interest or penal interest was charged.

Borrowers covered

21. Which all borrowers are eligible to be benefitted under the RBI Circular?

All borrower accounts that are eligible, have aggregate fund based activities with all the lenders of Rs. 2 crore and above and below. Subject to following conditions:

  • Such accounts were not NPA as on 29 February 2020
  • The interest/EMI on the borrower account is based on compound interest
  • Interest has been charged on such interest/EMI payment during the moratorium period, either penal interest for delayed payment or non-payment has been charged on such interest/EMI.
  • No refund of interest on interest was provided under ex-gratia scheme to such account.

22. In case an Eligible Borrower was not extended the benefit under the Ex-Gratia Scheme due to any reason, (such as non availability of bank account details for borrowers whose loan account have been closed), can the borrower avail the benefit under the RBI Circular?

All the Eligible Accounts of the Borrowers should be entitled to refund/adjustment of interest on interest under the RBI Circular, even if no benefit to such accounts was granted under the ex-gratia scheme.    

23. What will be the eligibility of a borrower who has not availed any moratorium?

The fact that the borrower has availed the moratorium, or not, is inconsequential for the purpose of RBI Circular. All Eligible Accounts, whether moratorium was availed, or not, are entitled to refund of interest on interest for the period commencing from 01-03-2020 till 31-08-2020, provided there was delay or failure to pay during the moratorium period and interest on interest or penal interest was charged.

Computation

24. How will the computation of the relief be done?

(a) Identify the sums which have been failed or delayed during the Moratorium Period (Unpaid Amounts).

(b) Compute, based on actual rate charged, the compound interest and/or penal interest (Actual Charge) on Unpaid Amounts.

(c) Compute, on Unpaid Amounts, simple interest at the contractual rate of interest. Note that the contractual rate of interest may itself be a compound rate. There is no need to transform the compound rate into an equivalent simple interest rate. The compound interest rate itself may be applied on simple interest basis.

(d) The difference between step (b) and (c) is the Relief.

25. On what date is the Borrower entitled to get the benefit of the Relief? If the credit of the amount of Relief is to be given at the end of the Moratorium Period, then the compound interest charged on an amount equal to the Relief may have extended beyond the Moratorium period too. 

In our view, the intent of the SC ruling followed by the RBI Circular is that the compound interest ought not have been charged at all during the Moratorium period. If the compound interest has been charged during the Moratorium Period, it will obviously have impact after the moratorium period too. In our view, the credit, therefore, has to be given at the end of the Moratorium Period.

26. On what rate of interest will the difference between compound interest and simple interest be calculated?

The difference between the compound interest and simple interest shall be calculated on the contractual rate (loan agreement rate) between the lender and borrower as on 29 February 2020.

27. Will there be any refund/ adjustment in case the contractual rate of interest is 0%?

In case the contractual rate is NIL or 0%, there is no question of granting any benefit to the borrower, given that the borrower has not paid any interest at all.

Accounting Provision

28. What is the exact manner of passing on the benefit to the borrower? Is it merely a credit to the account of the borrower, or does it lead to any cash benefit being transferred to the borrower?

The benefit has to be passed on to the borrower by either adjusting the differential amount with the future payables by the borrower or in case the loan account has been closed, the amount shall be refunded to the borrower. In either case, the lender is required to create a provision in its books of accounts for the financial year ending March 31, 2021.

29. When is the impact of such relief to be recognised in the books of accounts of the lender?

As per the RBI Circular, lending institutions shall disclose the aggregate amount to be refunded/adjusted in respect of their borrowers in their financial statements for the year ending March 31, 2021.

 

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12071&Mode=0

No compound interest during moratorium: RBI directs lenders pursuant to SC order

Anita Baid | Vice President, Financial Services (anita@vinodkothari.com)

Overview

The Supreme Court of India (‘SC’ or ‘Court’) had given its judgement in the matter of Small Scale Industrial Manufacturers Association vs UOI & Ors. and other connected matters on March 23, 2021. The said order of SC put an end to an almost ten months-long legal scuffle that started with the plea for complete waiver of interest, but edged towards waiver of interest on interest, that is, compound interest, charged by lenders during Covid moratorium. From the miseries suffered by people due to the pandemic, to the economic strangulation of trade and activity – the unfinished battle with the pandemic continues. Nevertheless, the SC realised the economic limitation of any Government, even in a welfare state. The SC acknowledged that the economic and fiscal regulatory measures are fields where judges should encroach upon very warily as judges are not experts in these matters. What is best for the economy, and in what manner and to what extent the financial reliefs/ packages be formulated, offered and implemented is ultimately to be decided by the Government and RBI on the aid and advice of the experts.

Compound interest continues to elude judicial acceptance – there are several rulings against compound interest pertaining to arbitral awards, and a lot more for civil awards. In the present ruling as well, observations of the Apex court seem to be indicating that compound interest is penal in nature. This may be surprising to a person of finance, as in the financial world, compound interest is ubiquitous and unquestionable.

In the concluding part of the judgment while dismissing all the petitions, the Court lifted the interim relief granted earlier, pertaining to the NPA status of the borrowers. However, the last tranche of relief in the judgement came for the large borrowers that had loans outstanding/ sanctioned as on February 29, 2020 greater than Rs. 2 crores, and other borrowers who were not eligible to avail compound interest relief as per the Scheme for grant of ex-gratia payment of difference between compound interest and simple interest for six months to borrowers in specified loan accounts (1.3.2020 to 31.8.2020) dated October 23, 2020 (“Ex-Gratia Scheme”). The Court did not find any basis for the limit of Rs 2 crores while granting relief of interest-on-interest (under ex-gratia scheme) to the borrowers. Thus, the Court directed that there shall not be any charge of interest on interest/ penal interest for the period during moratorium for any borrower, irrespective of the quantum of loan, or the category of the borrowers.  The lenders should give credit/ adjustment in the next instalment of the loan account or in case the account has been closed, return any amount already recovered, to the concerned borrowers.

Given that the timelines for filing claims under the ex-gratia scheme have expired, it was expected that the Government would be releasing extended/ updated operational guidelines in this regard for adjustment/ refund of the interest on interest charged by the lenders from the borrowers. Further, it seemed that the said directions of the Court would be applicable only to the loan accounts that were eligible and have availed moratorium under the COVID 19 package.

However, as a consequence of the aforesaid ruling, the Reserve Bank of India (‘RBI’) has issued a circular on April 7, 2021 (‘RBI Circular’) instructing the financial institutions to take steps for refund/ adjustment of the interest on interest. While the SC order clearly pertains to the Ex-Gratia Scheme of MoF, the RBI does not talk anywhere about the burden being passed to the GoI.

The RBI Circular is applicable on all lending institutions, that is to say, (a) Commercial Banks (including Small Finance Banks, Local Area Banks and Regional Rural Banks), (b) Primary (Urban) Co-operative Banks/State Co-operative Banks/ District Central, Co-operative Banks, (c) All All-India Financial Institutions, (d) Non-Banking Financial Companies (including Housing Finance Companies).

Interest on Interest

More than 20 writ petitions were filed with the Supreme Court and the relief sought by them can broadly be classified in four parts – waiver of compound interest/ interest on interest during the moratorium period; waiver of total interest during the moratorium period; extension of moratorium period; and that the economic packages/ reliefs should sector specific. Our write on the issue can be read here.

The contention of the petitioners was that even charging interest on interest/compound interest can be said to be in the form of penal interest. Further, it was argued that the penal interest can be charged only in case of wilful default.  In view of the effect of pandemic due to Covid­19 and even otherwise, there was a deferment of payment of loan during the moratorium period as per RBI circulars, hence, it cannot be said that there is any wilful default which warrants interest on interest/penal interest/compound interest. The appeal was that there should not be any interest on interest/penal interest/compound interest charged for and during the moratorium period.

The Central Government and RBI had already provided the following reliefs to mitigate the burden of debt servicing brought about by disruptions on account of Covid­19 pandemic:

The nature of moratorium was to provide a temporary standstill on payment of both, principal and interest thereby providing relief to the borrowers in two ways, namely, the   account   does   not become NPA despite nonpayment of dues; and since there was no reporting to the Credit Information Companies, the moratorium did not adversely impact the credit history of the borrowers.

It is important to understand the concept of “moratorium”- the word “moratorium” is categorically defined by the RBI, while issuing various circulars. The relevant circulars of RBI show that “moratorium” was never intended to be “waiver of interest”, but “deferment of interest”. In other words, if a borrower takes the moratorium benefit, his liability to make payment of contractual interest (both normal interest and interest on interest) gets deferred for a period of three months and subsequently three months thereafter. After a very careful and major consideration of several fiscal and financial criteria, it’s inevitable effects and keeping the uncertainty of the existing situation in mind, the payment of interest and interest on interest was merely deferred and was never waived.

Further, it is to be noticed that while the standstill applicable to bank loans results in the bank not getting its funds back during the period of moratorium, the bank continues to incur cost on bank’s deposits and borrowings. Since a moratorium offers certain advantages to borrowers, there are costs associated with obtaining the benefit of a moratorium and placing the burden of the same on lenders might just shift the burden on the financial sector of the country. If the lenders were to bear this burden, it would necessarily wipe out a substantial and a major part of their net worth, rendering most of the banks unviable and raising a very serious question over their very survival. Even on the occurrence of other calamities like cyclone, earthquake, drought or flood,  lenders do not waive interest but provide necessary relief packages to the borrowers. A waiver   can only be granted by the Government out of the exchequer. It cannot come out of a system from banks, where credit is created out of the depositor’s funds alone. Any waiver will create a shortfall and a mismatch between the Bank’s assets and liabilities.

Considering the same, the Government had granted the relief of waiver of compound interest during the moratorium period, limited to the most vulnerable categories of borrowers, that is, MSME loans and personal loans up to Rs. 2 crores. Our write up on the same can be viewed here.

However, the SC felt that there is no justification to restrict the relief of not charging interest on interest with respect to the loans up to Rs. 2 crores only and that too restricted to certain categories. Accordingly, the SC had directed that directed that there shall not be any charge of interest on interest/compound interest/penal interest for the period during the moratorium and any amount already recovered under the same head, namely, interest on interest/penal interest/compound interest shall be refunded to the concerned borrowers and to be given credit/adjusted in the next instalment of the loan account.

The ruling however, did not clarify as to who shall bear the burden of the waiver of such interest on interest. Further, the RBI Circular seems to place the burden on the lenders and not wait for the Government to come up with a relief scheme or extend the existing ex-gratia scheme.

RBI Circular

Coverage of Lenders

All lending institutions are covered under the ambit of the RBI Circular. The coverage includes all HFCs and NBFCs, irrespective of the asset size. Clearly, non-banking non-financial entities, or unincorporated bodies are not covered by the Circular.

Coverage of Borrowers

The borrowers eligible as per March 27 Circular (COVID-19 – Regulatory Package) were those who have availed term loans (including agricultural term loans, retail and crop loans) and working capital financing in the form of cash credit/ overdraft. Certain categories of borrowers were ineligible under the March 27 Circular such as those which were not standard assets as on 1st March 2020. Hence, loans already classified as NPA  continued with further asset classification deterioration during the moratorium period in case of non-payment.

The question that arises is whether the benefit under the RBI Circular is limited to any particular type of facility? The benefit of the RBI Circular is to be provided to all borrowers, including those who had availed of working capital facilities during the moratorium period. Further, the benefit is irrespective of the amount sanctioned or outstanding and irrespective of whether moratorium had been fully or partially availed, or not availed. However, this should include only those loans that were originally eligible to claim the moratorium but did not claim it or claimed partially or fully.

Thus, all corporate borrowers, including NBFCs who may have borrowed from banks, are apparently eligible for the relief.

Another crucial aspect is whether the benefit is applicable to facilities which have been repaid, prepaid during the moratorium period? If so, upto what date? The benefit must be provided to all eligible loans existing at the time of moratorium but has been repaid as on date.

Coverage of facilities

Both term loans as well as working capital facilities are covered. Facilities which are not in the nature of loans do not seem to be covered.  Further, facilities for which the Covid moratorium was not applicable also do not seem to be covered. Examples are: unfunded facilities, loans against shares, invoice financing, factoring, financial leases, etc. In addition, borrowing by way of capital market instruments such as bonds, debentures, CP, etc are not covered by the RBI Circular.

Questions will also arise as to whether lenders will be liable to provide the relief in case of those loans which are securitised, assigned under DA transactions or transacted under co-lending arrangement? We have covered these questions in our detailed FAQs on the moratorium 1.0  and 2.0.

Since the moratorium benefit was to be extended only to such installments that were falling due during the said moratorium period. Hence, only those borrowers were eligible for availing moratorium who were standard as on February 29, 2020 and whose installments fell due during the moratorium period. Accordingly, there can be the following situations:

 

Burden of interest on interest

The SC order was with reference to the Central Govt decision vide Ex-Gratia Scheme. Among other things, the petitioners had challenged that there was no basis for limiting the amount of eligible facilities to Rs 2 crores, or limiting the facility only to categories of borrowers specified in the Ex-Gratia Scheme. As per the GoI decision, the benefit was to be granted by lending institutions to the borrowers, and correspondingly, there was a provision for making a claim against SBI, acting as the banker for the GoI.

The SC order is an order upon the UoI. Neither were individual banks/NBFCs parties to the writ petition, nor does it seem logical that the order of the Court may require parties to refund or adjust interest which they charged as per their lending contracts. The UoI may be required to extend a benefit by way of Covid relief, but it does not seem logical that the burden may be imposed on each of the lending institutions, who, incidentally, did not even have the chance to take part in the proceedings before the apex court.

Hence, it seems that the impact of the SC order is only to extend the benefit of the Ex-Gratia Scheme to all borrowers, but the mechanics of the original circular, viz., lending institutions to file a counterclaim against the UoI through SBI, should apply here too.

Accounting disclosure for FY 20-21

The RBI Circular talks about a disclosure for the adjustment or refund to be reflected in the financial statements for FY 20-21.

In terms of accounting standards, the question whether the liability for refund or adjustment of the compound interest is a liability or a provision will be answered with reference to Ind AS 37 Provisions, Contingent Liabilities and Contingent Assets. Since the RBI Circular may be seen as creating a liability as on 31st March, 2021, the lending institution may simply adjust the differential amount [that is, compound interest – simple interest on the Base Amount] into the ongoing account of the customer. If such a liability has been booked, there is no question of any provision.

The computation of the differential amount will have to be done for each borrower. Hence, any form of macro computation does not seem feasible. Therefore, there will not be much of a difference between a provision and a liability.

Accounting for the refund in FY 20-21 by the borrowers

If the lending institution makes a provision, can the borrower book a receivable by crediting interest paid or provided? The answer seems affirmative.

Mechanism of extending the benefit

Methodology for calculation is to be provided by IBA. In this regard, representation has been made to the Government to bear the burden.

Base amount: If the mode of computation as provided in the RBI Circular is to be followed [IBA’s methodology will be awaited], then the computation will be based on the amount outstanding as on 1st March 2020.

Computation: On the Base amount, the differential amount will be CI- SI.

If the facility has been fully repaid during the moratorium period, the Differential Amount will run upto the date of the repayment.

Actionables

A board approved policy is to be put in place immediately. In this regard, the concern is whether the lenders can modify existing moratorium policy or adopt a new policy altogether? In our opinion, the existing policy itself may be amended to give effect to the RBI Circular or alternatively a new policy may be adopted.

Also, there is no timeline prescribed as to by when are these actionables required. However, since there are certain disclosure requirements in the financials for the FY 2020-21, the policy must be in place before the financials are approved by the Board of the respective lenders.

The lender may await the instructions to be issued by the Government and the methodology to be prescribed by IBA. Logically, the same method as was provided under the Ex-Gratia Scheme should be applicable. Accordingly, lenders may create provisions for the refund of the excess interest charged and whether corresponding receivable will be shown would depend on whether the same is granted by the Government.

Asset Classification

The RBI moratorium notifications freezed the delinquency status of the loan accounts, which availed moratorium benefit under the scheme. It essentially meant that asset classification standstill was imposed for accounts where the benefit of moratorium was extended. A counter obligation on Credit Information Companies (CIC) was also imposed to ensure credit history of the borrowers is not impacted negatively, which are availing benefits under the scheme.

Various writ petitions were filed with the SC seeking an extended relief in terms of relaxation in reporting the NPA status to the credit bureaus. Hence, while hearing the petition of Gajendra Sharma Vs Union of India & Anr. and other writ petitions, the SC granted stay on NPA classification in its order dated September 03, 2020. The said order stated that:

“In view of the above, the accounts which were not declared NPA till 31.08.2020 shall not be declared NPA till further orders.”

The intent of granting such a stay was to provide interim relief to the borrowers who have been adversely affected by the pandemic, by not classifying and reporting their accounts as NA and thereby impacting their credit score.

In its latest judgment, the SC has directed that the interim relief granted earlier not to declare the accounts of respective borrowers as NPA stands vacated. We have also covered the same in our write up.

As a consequence of the SC order, the RBI Circular has clarified the asset classification as follows:

This would mean that after September 1, 2020 though there was a freeze on NPA classification, the same cannot be construed as a freeze on DPD counting. The DPD counting has to be in continuation from the due date of the EMI. The accounts classified as standard, but in default of more than 90 DPD may now be classified NPA, since the freeze on NPA classification is lifted by the SC and directed by the RBI as well.

FAQs on Resolution of Loan Accounts under COVID-19 stress

– Team Vinod Kothari Consultants P. Ltd. (finserv@vinodkothari.com)

Updated as on October 17, 2020

Background

As a part of measures for combating the effect of COVID-19 on the economy, the Reserve Bank of India (RBI), on August 6, 2020[1], introduced Resolution Framework for COVID-19 Related Stress (‘ResFraCoRS’), a special window for resolution of assets undergoing stress due to COVID-19 disruption[2]. This special window was introduced in addition to the Prudential Framework on Resolution of Stressed Assets issued on June 7, 2019 (FRESA)[3]. We have earlier covered FRESA in a separate write up titled “Prudential Framework for Resolution of Stressed Assets: New Dispensation for dealing with NPAs”[4]

The ResFraCoRS notification (‘Framework’) referred to an expert committee which shall identify suitable parameters, recommend sector-specific parameters, recommend financial and non-financial conditions to be incorporated in the RP, and to vet the RP as discussed above.

Further, the ResFraCoRS notification requires the RP with an amount of Rs. 1500 crores or more to be vetted by the expert committee.

Based on the recommendations of the expert committee submitted to RBI on September 4, 2020[5], the RBI issued a follow-up circular on September 7, 2020[6], which shall be complied, in addition to and as a part of the ResFraCoRS.

We have prepared below, a set of FAQs on ResFraCoRS, based on the aforementioned circulars issued by the RBI.

Furthermore, the RBI released FAQs with respect to the said scheme on October 14, 2020. The below FAQs have been updated after considering the clarifications provided by the RBI in its FAQs.

Timeline of events under ResFraCoRS

Frequently Asked Questions (FAQs) –

General

1.If loan modification/restructuring is a mutual contract between the lender and the borrower, why should I be seeing the regulatory framework?

True, loan modification is a mutual contract between the lender and the borrower. However, the Prudential Guidelines provide that if a facility is restructured, with a view to averting a credit weakness, then the restructured facility is regarded as a non-performing facility. This is a general feature of prudential regulations that assets are to be immediately classified as substandard upon restructuring. Hence, if a restructuring is done without adherence to the regulatory framework, then the facility will be treated as non-performing, immediately upon restructuring,

2. How does the loan modification help the lender, borrower, or both?

Loan modification restructures the servicing requirements of a loan, so that the borrower may meet the obligations. If the terms of the loan remain unconnected to the cashflows of the borrower, the borrower may not be able to perform. A non-performing borrower soon starts attracting penal clauses of the loan facility, thereby pushing the borrower further into the realm of non-performance. Eventually, the problem becomes incapable of resolution and may result in the insolvency or chronic default. A chronic default, while meaning exorbitant cost on the borrower, also causes a clog on the books of the lender, and eventually, results in an inefficient economy.

A good credit system is what can be serviced – there is no point in creating credit that cannot be serviced. Therefore, a loan modification, where required, should be encouraged.

Applicability – lenders and borrowers

3. On what lenders shall the ResFraCoRS be applicable?

ResFraCoRS shall be applicable to all banks, NBFCs, HFCs, AIFIs, etc. who have extended loans to eligible borrowers.

4. Are all NBFCs considered as eligible lenders for the purpose of this Framework?

The FRESA was addressed to only systemically important NBFCs and deposit-taking NBFCs. However, the ResFraCoRS, which is a special window to deal with COVID-related disruptions is applicable to all NBFCs. Unlike FRESA, the ResFraCoRS deals with personal loans also, and NBFCs are a key provider of personal loans.

5. Who shall be the eligible borrowers?

Following shall be the eligibility criteria for the borrowers:

  • The borrower/loan account should not be falling under the list of ineligible loans/exposures provided in the ResFraCoRS notification;
  • In case of resolution of personal loans, the Loan Account should, as on March 1, 2020, be:
    • classified as ‘standard’ in the books of the lender
    • not be in default for more than 30 days with the lender
  • In case of other than personal loans, the loan account should, as on March 1, 2020, be:
    • classified as ‘standard’ in the books of all the lenders
    • not be in default for more than 30 days with any of the lenders
  • The loan accounts should continue to be classified as ‘standard’ in the books of the lender or all the lenders, as the case may be, till the date of invocation of RP.

5A. What kind of personal loans would be covered under the Covid-19 restructuring window? Would it be applicable to car loans/ education loans, etc.?

Under the framework, personal loans refers to loans given to individuals and consist of –

Sr. No. Type of loan covered Definition/ remarks, if any
a. Consumer credit Consumer credit refers to the loans given to individuals, which consists of –

(a)    loans for consumer durables,

(b)   credit card receivables,

(c)    auto loans (other than loans for commercial use),

(d)   personal loans secured by gold, gold jewellery, immovable property, fixed deposits (including FCNR(B)), shares and bonds, etc., (other than for business / commercial purposes),

(e)    personal loans to professionals (excluding loans for business purposes), and

(f)     loans given for other consumptions purposes (e.g., social ceremonies, etc.).

 

However, it excludes

(a)    education loans,

(b)   loans given for creation/ enhancement of immovable assets (e.g., housing, etc.),

(c)    loans given for investment in financial assets (shares, debentures, etc.), and

(d)   consumption loans given to farmers under KCC.

b. Education loan While the above definition of consumer credit excludes education loans, housing loans and loans for purchase of financial assets, these loans are covered within the overall definition of “Personal Loans”
c. Loans given for creation/ enhancement of immovable assets (e.g., housing, etc.)
d. Loans given for investment in financial assets (shares, debentures, etc.)

Thus looking at the above definition of personal loans, car loans, education loans, and several other types of loan exposures would be covered under ResFraCoRS.

5B. From a lender’s perspective, will an entire category of borrowers be eligible to avail the restructuring benefit?

The restructuring option is applicable for personal loans and other eligible exposures, where the borrower account is classified as standard, but not in default for more than 30 days (SMA-0) as on 1st March, 2020. Accordingly, the restructuring benefit would be applicable only to those who are not excluded under the RBI circular- such as MSME borrower with less than Rs.25crore exposure, are classified as SMA-0 as on March 1, 2020 and are having stress on account of Covid19.

In this regard, an entire category of borrower may be said to be facing stress due to the Covid disruption and subject to fulfillment of the eligibility conditions the restructuring benefit may be extended to them.

5C. Will Loans Against Property (LAP) be eligible under this Scheme?

The end use of LAP is usually for personal purposes. In such a case, personal loans secured by immovable property and other than for business /commercial purposes shall be considered as a personal loan.

For an MSME borrower availing LAP for business purpose and having aggregate exposure of more than 25cr, the same shall be covered under the said framework under Part B- other than Personal Loans.

In case the borrower is a non-MSME, such as an individual or an entity, there is no limit on the exposure and accordingly, there can be two situations-
a. the borrower is availing a LAP facility for personal use- this will be eligible under the framework under the head Personal Loan
b. the borrower is availing a LAP facility for business/commercial use- this will be eligible under the framework under Part B- Other than Personal Loans.

5D. Can restructuring under this framework be done for loans granted after March 1, 2020?

The idea behind this framework is to provide benefit to the accounts which are likely to suffer owing to COVID-19 disruption. If a loan was granted after March 1, 2020, the lender must have had established a preliminary view of the impact of disruption and would have taken the same into consideration before deciding the terms of the loan.

Hence, loans given after the beginning of the disruption should not be eligible for restructuring benefit under this framework.

6. Is a “financial service provider” an eligible borrower, to avail the benefit of the restructuring under the Framework?

 The ResFraCoRs specifically exclude exposures to financial service providers. Therefore, financial service providers are not eligible borrowers. The definition of the term “financial service provider” has been drawn from the Insolvency and Bankruptcy Code, 2016. Apparently, NBFCs are covered under the definition of Financial Service Provider.

6A. Is the scheme applicable to MSMEs as well?

The scheme is applicable on MSME borrowers whose aggregate exposure to lending institutions collectively, is Rs. 25 crores or more as on March 1, 2020. The reason for the criteria of Rs. 25 crores or more collective exposure is because there is a separate notification for Micro, Small and Medium Enterprises (MSME) sector – Restructuring of Advances dated August 6, 2020, which is applicable on MSME borrowers having loan limits up to Rs.25 crores.

6B. The criteria for classification of enterprises as MSMEs was revised in July 2020. Should the revised criteria be considered for the purpose of this scheme?

The RBI has in its FAQs clarified that- “For the purpose of eligibility for resolution under the Resolution Framework, the definition of MSME that would be applicable is the one that existed as on March 1, 2020.”

The erstwhile definition of MSMEs prescribed the criteria based on investment limits for manufacturing and service sector entities. There has been a revision in the limits of investment and the addition of turnover limits as an additional requirement. However, for the purpose of determining eligibility under the Scheme, borrowers who were classified as MSME as on March 1, 2020 as per the then existing definition shall be considered.

Pursuant to the notification dated August 21, 2020, registration is a mandatory requirement for MSME borrowers. For this Scheme, since the erstwhile definition is to be considered, which implies that even unregistered MSMEs as on March 1, 2020, shall be eligible.

However, in our view, based on the RBI instructions vide August 21 notification, it is recommended to require all existing MSME borrowers to register on the Udyam portal.

7. Will all exposures be eligible for restructuring under this scheme, say investment exposures in form of Debentures, CP etc.?

Para 3 of the guidelines for the scheme states that the scheme is for all eligible corporate and personal exposures. Hence, the ResFraCoRS may be invoked for the resolution of all exposures to eligible borrowers, including investment exposures.

The same has also been clarified by the RBI in its FAQs.

7A. How will restructuring of debentures, CP etc. be done?

The terms determined at the time of issue of debentures, CP etc. are the final terms. Any change in the same shall be done with the approval of the investors. We have separately dealt with the manner and procedure for restructuring of debentures in our write-up- http://vinodkothari.com/2020/04/covid-19-and-debenture-restructuring/. Similar procedure may be applied to other instruments such as CP as well.

7B. A bank has given a loan to an NBFC, and discovers that due to the prevailing situation, the NBFC will not be able to meet its obligations as they currently exist. Can the bank restructure the facility?

 As stated above, the ResFraCoRS exclude exposures to FSPs. Therefore, the benefits under the said framework shall not be available in case of restructuring of loans extended to such entities.

However, banks can, at their discretion, consider restructuring of loans extended to FSPs, in such case, the general principles relating to restructuring of loans shall apply, including downgrading of account to NPA etc.

8. Under what circumstances or with what underlying motive is the ResFraCoRS applicable?

Any borrower, whose ability to service loan/credit facilities has been disrupted because of the COVID disruption may be covered by the Framework.

In our view, the types of borrowers may be classed into:

  • Those who had credit weakness/deterioration in credit prior to the beginning of the crisis
  • Those who did not demonstrate credit weakness before the COVID disruption (that is, before March 2020) but have had cashflow stress (mild, moderate of severe) during the COVID disruption; once the moratorium period is cover, their business is normal are not having any issues in their ability to service the facility
  • Those who did not demonstrate credit weakness before the COVID disruption (that is, before March 2020) but have had cashflow stress during the COVID disruption, which now seems to having a lasting impact on their servicing ability;
  • Those who did not demonstrate any credit weakness either before, during or after the COVID disruption

In our view, type (a) does not qualify for the present framework, as the intent of the present framework is only to modify those loans that have been disrupted due to the Covid-19 related stress.

Type (b) also does not require any restructuring. During the 6 months of moratorium, a standstill was granted, and that sufficiently helped the borrower. The borrower is back to the same cashflows as before the crisis/

Type (d) borrowers obviously do not require any restructuring.

It is type (c ) where the Framework requires help. That is where the present Framework operates.

To give an example,

  • A personal loan, home loan or car loan was given to a borrower, which was deducted from his monthly salaries. During the month of April to June, the borrower was given a moratorium as his office was shut and the borrower did not get salaries. From the month of July, the office is back in operation and the borrower keeps on getting salaries as before. Obviously there is no need for restructuring in the present case.
  • An infrastructure sector contract had taken a loan for an excavator. The excavator was lying idle during the months of April- June. July -Aug-Sept are typical monsoon months. It is expected that from October, normal construction activity may pick. The borrower’s servicing ability does not require any loan modification.
  • A loan was given for a CRE project. The project was stuck during April to July. While construction has begun in the month of August, however, it is apprehended that the demand for real estate may remain very sluggish at least over the next 12 months. This seems to be an appropriate case for ResFraCoRS.

Further, under the ResFraCoRS, the eligible borrowers may be divided into 3 categories:

  • Category 1- Borrowers of personal loans;
  • Category 2- Other than personal loan borrowers, which have availed loans from a single financial institution only;
  • Category 3- Other than personal loan borrowers, which have availed loans from more than one financial institution;

9. Is it applicable to both term loans as well as working capital facilities?

The eligibility criteria for ResFraCoRS is based on the asset classification of the borrower and not on the type of loan facility. The demarcation of term loans and working capital facility has to be done for the purpose of granting moratorium, however, for considering restructuring under this framework, any exposure to the borrower shall be covered. Hence, irrespective of the loan account being a term loan or working capital facility, in case it fulfills the eligibility criteria and the lenders have established that the stress in the account is due to covid disruption, the loans may be restructured under this framework.

 Formulation of RP

10. The August 6, 2020 as well as the June 7, 2019 circulars refer to a resolution plan – what exactly is a resolution plan?

The objective of a loan modification is not merely to grant concessions – it is to ensure that the terms of the loan are restructured so as to make the loan serviceable, at the same time, without compromising the interests of the lender(s). Hence, the “resolution plan” is the structured approach of the lender in modifying the terms of the loan so as to make the terms mutually agreeable, and mutually beneficial.

Quite often, in cases of large exposures, a resolution plan may involve capitalization of interest, partial conversion of debt into equity, change in terms of security, infusion of capital by the borrower, etc. Therefore, the resolution plan is a comprehensive approach to loan modification.

It is also notable that there are, often, cases of multiple lenders to the same borrower. Therefore, the loan modification is expected to take care of the interests of multiple lenders in a cohesive approach.

11. What are the different options/approaches in the resolution plan?

In case of personal loans covered in Part A, the resolution plans may inter alia include the following:

  • rescheduling of payments;
  • conversion of any interest accrued, or to be accrued, into another credit facility;
  • granting of moratorium, based on an assessment of income streams of the borrower, subject to a maximum of two years.
  • Modifying the overall tenor of the loan.

In case of other exposures covered in Part B, the RP may involve any action / plan / reorganization including, but not limited to:

  • regularisation of the account by payment of all over dues by the borrower entity;
  • sale of the exposures to other entities / investors;
  • sanctioning of additional credit facilities;
  • allowing extension of the residual tenor of the loan;
  • granting moratorium;
  • conversion of debt into instruments such as equity, debentures etc.
  • change in ownership and restructuring, except compromise settlements which shall continue to be governed by the provisions of the Prudential Framework or the relevant instructions, if any, applicable to specific categories of lending institutions.

The resolution plan may also include sanctioning of additional credit facilities to address the financial stress of the borrower on account of Covid19 even if there is no renegotiation of existing debt.

12. What is the meaning of “invocation” of an RP? Who invokes it? Borrower or lender? If there are multiple lenders, can it be invoked by any lender?

In case of personal loans the borrower and lender should agree to proceed with RP. The date on which the borrower and lender agree to proceed with the RP shall be the date of “invocation”.

In case of other exposures, where there is only one lending institution with exposure to the borrower, the decision regarding the request for resolution by the borrower may be taken by the lending institution as per the Board approved policy of the institution and within the contours of this framework.

This is similar to the existing Corporate Debt Restructuring scheme of RBI where the borrower does not have the inherent right to ask the lenders to restructure, however, the borrower may certainly request lenders to consider the same. Further, for this purpose, the date of invocation shall be the date on which both the borrower and lending institution have agreed to proceed with a resolution plan under this framework.

In case of multiple lenders with exposure to the borrower, the resolution process shall be treated as invoked in respect of any borrower if lending institutions –

  • Representing 75% by value of the total outstanding credit facilities (fund based as well non-fund based), and
  • not less than 60% of lending institutions by number agree to invoke the same.

13. The facility is currently not in default. It was within 30 days past due as on 1st March and thereafter, the facility was covered by moratorium. On 1st September, the lender realises that the cashflows of the borrower may be strained. Does the lender have to wait for any default? Can there be restructuring even when there is no default?

In our view, the resolution may be done for an imminent or incipient, or even apprehended default. The whole idea of resolution is to resolve a problem before it becomes unsurmountable. Hence, the fact of any default is not a precondition.

14. Who will frame the repayment plan?

In case of category 1 and 2 borrowers, the lender shall frame the RP. In case of multiple lenders i.e. category 3 borrowers, execution of ICA is a mandatory requirement wherein all the lenders shall agree on a resolution process, based on which a RP shall be formulated. Further, the Expert Committee shall verify the RP implemented in case the aggregate exposure of the lending institutions is Rs. 1500 crore or more.

15. What are the different stages of the loan restructuring process?

  • Realisation that a restructuring is required
  • Invocation of restructuring plan
  • Framing of restructuring plan
  • Signing of an ICA
  • Implementation of the restructuring plan including putting in place an escrow mechanism etc
  • Review period
  • Post-review period

 16. What are the preconditions for invocation of RP?

For categories 1 and 2:

  • The borrower should be eligible; and
  • The borrower and lender should agree to proceed with RP.

For category 3:

  • The borrower should be eligible;
  • Lending institutions representing at least 75 % by value of the total outstanding credit facilities (fund based as well non-fund based) agree to invoke the RP; and
  • At least 60 % of lending institutions by number agree to invoke the RP.

 17. In case of borrowers with business loans, is there any classification/ categorisation of borrowers based on the size of the exposure?

Under the Framework, it may be useful to classify borrowers into the following sizes:

  • Aggregate exposure of Rs 100 crores or more – Independent credit evaluation (ICE) by any one credit rating agency (CRA) authorized by the RBI under FRESA to be carried out.
  • Aggregate exposure of Rs 1500 crores or more- the RP shall be subject to vetting by the expert committee.

17A. In case of accounts for which ICE is conducted, is there a prescribed rating that an account must achieve in order to be restuctured?

The RBI released its FAQs regarding restructuring on October 14, 2020. The FAQs state that – “Only such resolution plans which receive a credit opinion of RP4 or better for the residual debt from a CRAs shall be considered for implementation under the Resolution Framework. In case credit opinion is obtained from more than one CRA, all such credit opinions must be RP4 or better.”

17B. What does the RP4 rating indicate?

RP is a rating indicator used by rating agencies for ICE of residual debts of borrowers. RP4 rating indicates that the debt facility/instrument has a moderate degree of safety regarding timely servicing of financial obligations and carries moderate credit risk.

18. One of the measures is providing a moratorium on loan repayment. Will this moratorium be a part of the existing moratorium facility provided to borrowers?

The ResFraCoRS notification provides that in cases where moratorium is granted to eligible borrowers, such moratorium shall be subject to a ceiling of 2 years. It is to be noted that the resolution under this framework is independent of any moratorium or other relief provided to the borrowers under other frameworks introduced by the RBI.

Hence, the above mentioned period of 2 years shall be in addition to the earlier moratorium granted to the borrowers. The earlier moratorium is not to be included in this period of 2 years.

This has been further clarified by para 28 of the ResFraCoRS notification, which states that the moratorium shall come into force immediately upon implementation of the resolution plan.

19. Can the debt be converted into equity instruments?

Conversion of debt into equity may be done provided the amortisation schedule and the coupon carried by such debt securities must be similar to the terms of the debt held on the books of the lending institutions, post implementation of the resolution plan.

Further, equity instruments are to be valued at market value, if quoted, or else, should be valued at the lowest value arrived using the book value or discounted cashflow valuation methodologies. Equity instruments, where classified as NPA shall be valued at market value, if quoted, or else, shall be collectively valued at Re.1. [Refer para 19 (c) and (d) of Annex to the Prudential Framework dated 7th June, 2019].

20. Can the debt be converted into NCDs/ preference shares or any other instrument?

Yes, the special window makes it clear that conversion of debt into NCDs or preference shares or any other instrument may be done. The debentures/ bonds would be valued on the YTM basis as per para 3.7.1 of the Master Circular – Prudential Norms for Classification, Valuation and Operation of Investment Portfolio by Banks[7] dated July 1, 2015 (as amended from time to time) or would be valued as per other relevant instructions as applicable to specific categories of lending institutions.

In case of conversion of any portion of the debt into any other security, the same shall collectively be valued at Re.1.

ICA and Escrow Arrangement

21. Is signing of Inter-Creditor Agreement (ICA) mandatory?

The notification clarifies that signing of ICA is a mandatory requirement for all lending institutions in all cases involving multiple lending institutions, where the resolution process is invoked.

22. Is there any time limit for signing the ICA?

The ICA should be signed within 30 days of invocation of RP.

 23. What will happen if ICA is not signed within the time limit?

In case the ICA is not signed within the prescribed time limit, the invocation of RP shall lapse. Further, additional provision of 20% will have to be maintained in respect of the carrying debt of the borrower in question, i.e. total outstanding of the borrower to all its lenders.

24. How should escrow accounts be maintained in case of ICA?

Escrow accounts shall be required only in case of category 3 borrowers. Para 10 of the follow-up circular states that the escrow account shall be maintained after implementation of RP on borrower-account level, i.e. the legal entities to which the lending institutions.

25. What are the limitations of the restructuring under the ResFraCoRS Framework?

The main limitation of the restructuring under ResFraCoRS is the tenor restrictiction of 2 years, in case of granting of moratorium under resolution plans. Further, the ratios prescribed under the financial parameters by the expert committee are required to be met by 2022 and on an ongoing basis thereafter. It must be noted that the expert committee suggested that the  TOL/Adjusted TNW and Debt/ EBIDTA ratios should be met by FY 2023. Further, some of the conditions (discussed later) of the Prudential Framework of June, 2019 are also additionally applicable in case of ResFraCoRS.

Relevance of the 7th June 2019 – Prudential Framework for Resolution of Stressed assets

26. Is the COVID-related framework a special case within the 7th June 2019 Directions, or is it an independent restructuring proposition?

The ResFraCoRS is a special window under the 7th June, 2019 – Prudential Framework for Resolution of Stressed Assets issued by RBI. Accordingly, the requirements specified in the Prudential Framework of June, 2019 would also apply in case of ResFraCoRS.

It is further clarified that accounts which do not fulfill the required eligibility conditions to be considered for resolution under the ResFraCoRS may continue to be considered for resolution under the Prudential Framework of June, 2019, or the relevant instructions as applicable to specific category of lending institutions where the Prudential Framework is not applicable.

27. What are the major provisions of the June, 2019 Directions which are applicable to the Covid-related restructuring as well?

The ResFraCoRS specifically mentions that without prejudice to the specific conditions applicable to this facility, all the norms applicable to implementation of a resolution plan, including the mandatory requirement of Inter Creditor Agreements (ICA) and specific implementation conditions, as laid out in the Prudential Framework shall be applicable to all lending institutions for any resolution plan implemented under this facility. Terms used in this document, to the extent not defined in the ResFraCoRS, shall have the same meaning assigned to them in the Prudential Framework.

Accordingly, the following major provisions of the Prudential Framework of June, 2019 would apply to the ResFraCoRS as well –

 

Para No. Particulars Requirement
9 Policy for resolution of stressed assets Lenders must put in place a Board approved policy for resolution of stressed assets.

 

This is apart from the policies mentioned in the COVID-related framework and these may be combined into a single policy as well.

10 Inter Creditor Agreement (ICA) The ICA shall provide that any decision agreed by lenders representing 75% by value of total outstanding credit facilities (fund based as well non-fund based) and 60% of lenders by number shall be binding upon all the lenders.

 

Additionally, the ICA may, inter alia, provide for rights and duties of majority lenders, duties and protection of rights of dissenting lenders, treatment of lenders with priority in cash flows/differential security interest, etc. In particular, the RPs shall provide for payment not less than the liquidation value due to the dissenting lenders.

Further, para 13 of the Prudential Framework dealing with inclusions in the RP are also applicable to ResFraCoRS with some modifications/ exceptions stated in para 27 of ResFraCoRS. Furthermore, it seems that para 16 of the Prudential Framework would also apply in case of ResFraCoRS (para 16 deals with deemed implementation in case of RP involving lenders exiting the exposure by assigning the exposures to third party or a RP involving recovery action).

28. The Prudential Framework mentions other requirements such as “Review Period” and “Prudential Norms”. Would these apply in case of ResFraCoRS?

Para 6 of ResFraCoRS states that all norms applicable to “implementation of a RP” under the Prudential Framework of June, 2019 would apply to ResFraCoRS. Accordingly, prudential norms would not be applicable in case of ResFraCoRS as this is already specifically taken care of in ResFraCoRS itself.

Furthermore, other requirements such as review of the borrowers account within 30 days of default would not apply as the ResFraCoRS already prescribed specific eligibility norms in its framework.

Financial Parameters

29. What financial parameters are to be considered while formulating the RP?

The notification has defined a set of 5 key ratios that must be mandatorily considered while finalising the resolution plan in respect of eligible borrowers. While the mandatory ratios must be followed, lenders have the liberty to consider other financial parameters as well, while finalizing the resolution assumptions in respect of eligible borrowers.

The Key ratios and definitions along with additional remarks on the same are presented below –

 

Sr. No. Key Ratio Definition
1 Total Outside Liabilities / Adjusted Tangible Net Worth (TOL/ATNW)

 

(Ceiling)

Addition of long-term debt, short term debt, current liabilities and provisions along with deferred tax liability divided by tangible net worth net of the investments and loans in the group and outside entities.
Remarks – In respect of those sectors where the sector-specific thresholds have not been specified, lending institutions shall make their own internal assessments regarding TOL/ATNW.

 

Compliance to TOL/ATNW agreed as per the resolution plan is expected to be ensured by the lending institutions at the time of implementation itself.

 

Nevertheless, in all cases, this ratio shall have to be maintained as per the resolution plan by March 31, 2022 and on an ongoing basis thereafter.

 

Wherever the resolution plan envisages equity infusion, the same may be suitably phased-in over this period.

 

Another concern in this regard is that the definition of Adjusted Tangible Net Worth provides for deduction of investments and loans in the group and outside entities. Considering a large proportion of the eligible borrowers for this framework will be infrastructure companies, this could be a major problem. Most of the entities engaged in the infrastructure space operate through SPVs, instead of working directly. Therefore, the majority of their assets are deployed in the equity of the SPVs. If the above definition of ATNW is to be followed, these entities will become ineligible for the purpose of this framework.

2 Total Debt / EBITDA

 

(Ceiling)

Addition of short term and long-term debt divided by addition of profit before tax, interest and finance charges along with depreciation and amortisation.
Remarks –

In respect of those sectors where the sector-specific thresholds have not been specified, lending institutions shall make their own internal assessments regarding Total Debt/ EBITDA.

This shall have to be maintained as per the resolution plan by March 31, 2022 and on an ongoing basis thereafter.

3 Current Ratio

 

(Floor)

Current assets divided by current liabilities
Remarks –

Current ratio in all cases shall be 1.0 and above.

This shall have to be maintained as per the resolution plan by March 31, 2022 and on an ongoing basis thereafter.

4 Debt Service Coverage Ratio (DSCR)

 

(Floor)

For the relevant year addition of net cash accruals along with interest and finance charges divided by addition of current portion of long term debt with interest and finance charges.
Remarks –

This shall have to be maintained as per the resolution plan by March 31, 2022 and on an ongoing basis thereafter.

5 Average Debt Service Coverage Ratio (ADSCR)

 

(Floor)

Over the period of the loan addition of net cash accruals along with interest and finance charges divided by addition of current portion of long term debt with interest and finance charges.
Remarks –

ADSCR shall in all cases be 1.2 and above.

This shall have to be maintained as per the resolution plan by March 31, 2022 and on an ongoing basis thereafter.

30. Are the financial parameters required to be considered in all the cases?

The financial parameters shall be considered in case of RP formulated for borrowers eligible under part B of  ResFraCoRS.  Part B of the ResFraCoRS deals with borrowers falling in categories 2 and 3.

31. What are prescribed thresholds to be maintained in respect to the ratios?

The expert committee has prescribed thresholds specific to the nature of the various industries. The annexure to the follow-up circular contains the ceilings/floors prescribed with respect to 26 sectors/industries.

32. What should be done in case there are no sector-specific parameters prescribed with respect to a certain industry?

While the follow-up circular prescribes ratio limits for a wide variety of industries, certain borrowers may not fall in any of those sectors. Further, in the annexure, certain ratios for some sectors have not been prescribed. For such kinds of borrowers, the lenders shall determine the limits considering the financial situation of the borrower, viability of borrower’s business, and the stress on the borrower. However, the current ratio and DSCR in all cases shall be 1.0 and above, and ADSCR shall be 1.2 and above.

33. The sectors specified in the framework do not include financial services, does this mean financial services entities (such as NBFCs, HFCs, who have availed loans from other NBFCs/banks) are not eligible for restructuring under this framework?

The sector specific ratios are provided as general parameters to be considered while formulating RP. This in no way indicates that the borrowers belonging to such sectors shall not be eligible for restructuring.

In case of borrowers falling in the sectors for which the ratios are not specified, the lender shall decide its own limits based on the assessment of the borrower.

However, please refer to our response on eligibility of loans to FSPs under this framework.

34. Who shall meet the ratios?

The borrower is required to meet the ratios at entity-level and the lenders are required to ensure that the same is being met as per the timelines.

For the real estate sector, the expert committee recommended that the ratios with respect to particular projects be met since the loans are usually granted for a project. However, the RBI, in the follow-up circular has not laid any such provision.

35. At what point of time shall these ratios be considered?

The above mentioned key ratios shall have to be maintained by the borrower as per the resolution plan by March 31, 2022 and on an ongoing basis thereafter.

Additionally, TOL/ATNW shall be required to be maintained by the borrower at the time of implementation of the RP itself, as per the resolution plan by March 31, 2022 and on an ongoing basis thereafter.

36. As discussed above, TOL/ATNW shall be maintained at the time of implementation. What should be done in case the ratio is not met?

In case the TOL/ATNW ratio is not met at the time of implementation, the same may require equity infusion by the promoters or conversion of outstanding debt to equity to meet the criteria.

 37. Several instruments are treated as debt due to Ind-AS, would these instruments be considered to be included in the definition of TOL/ATNW?

The definition of TOL/ATNW provided under the notification dated 07th September, 2020 seems to be hinting towards what is legally considered to be a debt. Thus, for the purposes of TOL/ATNW, instruments considered as a debt as per Ind-AS would not come under this definition.

For instance, redeemable preference shares are considered as a debt as per Ind-AS 32. However, for the purpose of TOL/ATNW, redeemable preference shares would not be considered.

38. What parameters shall be considered other than the ratios prescribed by the follow-up circular?

Lenders shall, in addition to the above mentioned ratios, consider pre-Covid-19 operating and financial performance of the borrower and impact of Covid-19 on its operating and financial performance at the time of finalising the resolution plan. Further, they shall also assess the expected cashflows in subsequent years, to ensure that the ratios will be complied with on an ongoing basis.

39. Should these ratios be met by the borrower at the time before covid?

The ResFraCoRS is for the borrowers whose business is otherwise viable but has been affected due to covid disruption. Hence, financial institutions considering to restructure loan accounts under ResFraCoRS, shall evaluate the financial condition of borrower pre and post covid.

These ratios provide a quantifiable basis for evaluating the financial condition of the borrower. Going by the intent, the borrower should positively meet the ratios before crisis and thereafter reach the ratios in the prescribed time.

40. What if ratios are not met in the pre-covid period?

In case the ratios are not met pre covid, it is an indication that financial strength of the borrower was not very stable even before the crisis. Hence, it is not because of the crisis that the borrower is unable to pay. Considering this, the account of the borrower should not be restructured under ResFraCoRS.

It is noteworthy that the ratios are not the sole indicators of financial strength of a borrower. Several other parameters as suitable to the nature of the borrower should also be considered.

 41. What if out of 5, only 3 ratios are met in the pre-covid period?

In case the borrower meets some of the ratios and not all, the lenders shall assess other parameters as well to evaluate financial condition of the borrower and decide whether restructuring shall be done for such borrower account.

42. In case there is only a single lender to a borrower, what ratios or parameters shall be met by such borrower?

Para 5 of the follow-up circular clearly states that the above mentioned ratios shall be met even in case a borrower has availed loan from only one lending institution. These kinds of borrowers shall fall under category 2 discussed above. Even though certain provisions of the ResFraCoRS may not be applicable on this category, maintenance of ratios shall certainly be applicable.

43. What happens if the borrower fails to meet the ratios at any time after implementation of RP?

If the borrower is unable to meet the prescribed ratios it shall be construed as a default on its part to comply with the terms of the RP. This would result in downgrade of asset classification of the borrower to NPA, with all lending institutions, including those who did not sign the ICA, from the date of implementation of the RP or the date from which the borrower had been classified as NPA before implementation of the plan, whichever is earlier.

Provisioning requirements

44. Para 39 of the Framework states that a provision of 10% shall be applicable on accounts which have been restructured in terms of the Framework. How is the restructuring, under this Framework, then different from any other restructuring?

In case of any other restructuring, the classification of the asset gets downgraded to NPA status. The provision requirement on NPAs may be 10%, but that 10% is for a sub-standard asset.

In case of restructuring under the Framework, if the restructuring is done, the asset retains its standard status and the 10% provision shall be a ‘provision specific to the asset’ created considering the risk involved in the asset after restructuring.

It is also notable that there was no requirement of the 10% provision under the June 2019 Directions. There were disincentives against not implementing the resolution plan within the timelines in para 17 of the Directions.

44A. What will be the treatment of additional provisions in the books of NBFCs which are IndAS compliant?

NBFCs that are required to comply with IndAS shall continue to be guided by the guidelines duly approved by their Boards and as per ICAI advisories for recognition of significant increase in credit risk and computation of Expected Credit Losses.

The additional provisioning requirement discussed above shall be treated as the prudential floor for the purpose ECL computation.

45. Will there be a case for reversal of the provision as referred to above?

Yes, half of the provisions may be reversed if the borrower repays 20% of the residual debt outstanding to the lender or lenders as the case maybe, provided the asset has not slipped into NPA post implementation of the RP.

Further, the remaining half may also be reversed when additional 10% of the carrying debt is repaid. However, it shall be ensured that such reversal does not result in reduction of provisions below the provisioning requirements as per IRAC provisions.

Credit information reporting

46. Does the fact of restructuring under the Framework have to be reported to CRILC or anywhere else?

 As per the ResFraCoRS, for the purpose of credit reporting, the accounts shall be treated as restructured if the resolution plan involves renegotiations that would be classified as restructuring under the FRESA. The credit history of the borrowers shall consequently be governed by the respective policies of the credit information companies as applicable to accounts that are restructured.

Other Considerations

47. As per ResFraCoRS, a policy is required to be adopted for resolution of assets under the said framework. Will the follow-up circular require amendment to the policy adopted by a company in this regard?

In our view, considering that the key ratios are mandatory, a suitable modification to the policy would be required to be made.

 48. The follow-up circular talks about gradation of borrowers. On what basis shall the gradation be done?

The follow-up circular states that lenders may carry out a gradation of the borrowers. This gradation shall be done based on the impact of the pandemic on a specific sector or the borrower. As per the recommendation of the expert committee, borrowers may be graded into mild, moderate and severe impact borrowers.

While considering the gradation of the borrowers, the amount and risk involved, extent of legal/regulatory compliances involved in the resolution process etc. should also be factored in.

 49. What is the purpose of such gradation?

Gradation of borrowers based on the severity of impact, extent of compliances and the amount and risks involved, enables the lenders to distinguish the accounts that require more attention. Based on the gradation, lenders may decide upon internal procedures such as delegation, time involvement etc, for various categories of accounts.

 

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11941&Mode=0#FT2

[2] Our write-up on the Framework may be referred here- http://vinodkothari.com/2020/08/resolution-framework-for-covid-19-related-stress-resfracors/

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11580&Mode=0

[4] http://vinodkothari.com/2019/06/fresa/

[5] https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=1157

[6] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11961&Mode=0

[7] https://www.rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9904#371

Additional relief from COVID-19 disruptions

Based on the recommendations of the Monetary Policy Committee

-Financial Services Division (finserv@vinodkothari.com)

Extension of the restructuring norms for MSME debt

The RBI via a notification on 1st January 2019[1] had allowed NBFCs and banks to restructure their advances to MSMEs, classified as ‘standard’, without any asset classification downgrade and the same was extended further on 11th February 2020.[2]

Through the notification dated August 6, 2020[3], the RBI has again extended the timeline for restructuring till March 31, 2021.

Further, the notification dated August 6, 2020 provides that the accounts which may have slipped into NPA category between March 2, 2020 and date of implementation i.e. from August 6, 2020 to March 31, 2021, may be upgraded as ‘standard asset’, as on the date of implementation of the restructuring plan.

For accounts restructured under these guidelines, the lenders are required to maintain an additional provision of 5% over and above the provision already held by them with respect to standard assets. Though, the extension notification does not specifically provide such provisioning requirements for NBFCs, however, reading in consonance with the January 2019 notification, it can be said that the requirement is for both banks and NBFCs.

The extension of relaxation would chiefly benefit the MSME borrowers who are having sound businesses as well as repayment capabilities however, are unable to meet their obligations post 1st March 2020, due to widespread disruption caused by the pandemic. The move would ensure that MSMEs that are having a viable business standing are not hit by negative classification just because of short term volatilities.

Advances against Gold Ornaments and Jewellery

The existing RBI guidelines[4] require that for the loan granted by banks against the security of gold jewelry i.e. gold loans a Loan-to-Value (LTV) Ratio of maximum upto 75% has to be maintained. Through notification dated August 6, 2020[5], LTV requirement has been relaxed temporarily. Accordingly, banks may now lend up to 90% of the amount of gold jewellery pledged until March 31, 2021.

Banks may, while sanctioning new loans, grant relatively more amount of loan. Further, using the advantage of extended LTV, banks may also consider providing top-up loans to the existing borrowers, on existing security of gold jewellery.

After March 31, 2021, the LTV requirement shall be restored back to 75%. While the notification mentions that fresh loans granted after such date shall have an LTV of 75%, it is silent about the treatment of existing loans. Clarification in this regard is expected from the RBI.

In the absence of any clarification, the loans given before March 31, 2021 shall also be bound by the LTV of 75% after such date. Accordingly, the banks should either structure the loan in such a manner that the LTV comes down to 75% after receiving repayments up to March 31, 2021 or the banks may have to call back a certain portion of loan so as to meet the LTV requirement after such date.

It may also be noted that despite the high amount of market penetration of NBFCs in gold loan sector[6], no such relaxation has been provided to NBFCs.

Priority Sector Lending by Banks

The RBI has revised the existing guidelines on priority sector lending (PSL) by banks[7]. While the detailed PSL guidelines are yet to be released, following are a few major changes that will be introduced:

  • Start-ups would be a new sector to come under the ambit of priority sectors
  • The limits for renewable energy, including solar power and compressed bio-gas plants, small and marginal farmers and weaker sections are proposed to be increased.
  • An incentive-based system shall be introduced, which shall address the regional disparities in the flow of priority sector credit. Under this system, higher weight will be assigned for incremental priority sector credit in the identified districts where credit flow is comparatively lower and vice versa.

 

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11445&Mode=0

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11808&Mode=0

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11942&Mode=0

[4] https://www.rbi.org.in/Scripts/BS_CircularIndexDisplay.aspx?Id=9124 and https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=8701&Mode=0

[5] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11944&Mode=0

[6] https://assets.kpmg/content/dam/kpmg/in/pdf/2020/01/return-of-gold-financiers-in-organised-lending-market.pdf

[7] https://m.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=10497

Resolution Framework for Covid-19-related stress

Other related write-ups:

 

 

SEBI extends deadline for June quarter results amid COVID-19

Companies to manage the dual requirement of holding board meetings and submission of financial results

Shaifali Sharma
Vinod Kothari & Company
corplaw@vinodkothari.com

In the wake of the continuing impact of COVID-19 pandemic, SEBI vide circular[1] dated June 24, 2020, granted relaxation to listed entities and extended the timeline for submission of financial results for quarter / half year / financial year ended March 31, 2020 to July 31, 2020.

Since, now the first quarter of the FY 2020-21 has come to an end, companies are expected to finalize, approve and submit their financials to the respective stock exchange(s) within 45 days from the quarter ended June 30, 2020 as per Regulation 33 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) i.e. on or before August 14, 2020.

Considering the shortened time gap of 14 days between the two due dates stated above i.e. July 31 and August 14, SEBI vide its circular[2] dated July 29, 2020, has extended the deadline to submit financial results for the first quarter from August 14 to September 15, 2020 thereby allowing additional 32 days to the listed companies which will in turn provide extra time to companies and its auditors working on reporting the quarterly financial results.

It is pertinent to note here that the board of directors, as per Regulation 17(2) of the Listing Regulations, must meet at least four times a year, with a maximum time gap of 120 days between any two meetings. In this regard, the SEBI vide circular[3] date June 26, 2020 had exempted the listed entities from observing the stipulated time gap between two board meetings for the meetings held/proposed to be held between the period December 01, 2019 and July 31, 2020.

Considering no further extension has been granted by SEBI yet, the board meeting for approving the financial results should be scheduled keeping in mind the maximum time gap of 120 days prescribed under the Listing Regulations. For example, if we take a case of a listed company which held its last board meeting on May 02, 2020, the next board meeting shall be scheduled on or before August 31, 2020  instead of the extended due date of September 14, 2020.

As regards for unlisted companies, the maximum time gap for conducting board meetings had been relaxed vide MCA circular[4] dated March 24, 2020 to 180 days from present 120 days for the first two quarters of FY 2020-2021.

[1] https://www.sebi.gov.in/legal/circulars/jun-2020/further-extension-of-time-for-submission-of-financial-results-for-the-quarter-half-year-financial-year-ending-31st-march-2020-due-to-the-continuing-impact-of-the-covid-19-pandemic_46924.html

[2] https://www.sebi.gov.in/legal/regulations/jun-2009/securities-and-exchange-board-of-india-delisting-of-equity-shares-regulations-2009-last-amended-on-april-17-2020-_34625.html

[3] https://www.sebi.gov.in/legal/circulars/jun-2020/relaxation-of-time-gap-between-two-board-audit-committee-meetings-of-listed-entities-owing-to-the-covid-19-pandemic_46945.html

[4] http://www.mca.gov.in/Ministry/pdf/Circular_25032020.pdf


Other reading materials on the similar topic:

  1. ‘COVID-19 – Incorporated Responses | Regulatory measures in view of COVID-19’ can be viewed here
  2. ‘Resources on virtual AGMs’ can be viewed here
  3. Our other articles on various topics can be read at: http://vinodkothari.com/

Email id for further queries: corplaw@vinodkotahri.com

Our website: www.vinodkothari.com

Our YouTube Channel: https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

Recent Trends in Crypto-Industry: India & Abroad

-Megha Mittal

(mittal@vinodkothari.com)

“Opportunity amidst tragedy” would likely be the most suitable phrase to summarise the journey of cryptos during the Global Pandemic- with disruption taking a toll on people and economies, and physical proximities massively restrictred, cryptos have outshone traditional assets, by virtue of its inherent features- easy liquidity, access and digitalisation.

Further, as countries around the globe attempt to stimulate their economies by opening floodgates of liquid funds, the ‘digital natives’ have and are expected to increasingly venture into adventure-some investments- think, cryptos. And while such adventurous investing may be short-lived, the results may infact have a long-lasting impact- it is this expected impact that has sets the ‘bull’ stage for cryptos in times to come.

In this brief note, we cover the recent highlights and developments in the crypto-industry, also discussing developments in the relatively new concepts of stablecoins, crypto-lending.

Read more

Limits on creeping acquisition by promoters increased during COVID-19 crises

Shaifali Sharma | Vinod Kothari and Company

Introduction

SEBI has been taking several proactive measures to relax fund raising norms and thereby making it easier for companies to raise capital amid the COVID-19 pandemic. With a view to further facilitate fund raising by the companies, SEBI vide its notification dated June 16, 2020[1], has relaxed the obligation for making open offer for creeping acquisition under Regulation 3(2) of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (Takeover Code).

The relaxation allows creeping acquisition upto 10% instead of the existing 5%, for acquisition by promoters of a listed company for the financial year 2020-21. The relaxation is specific and limited to acquisition by way of a preferential issue of equity shares and therefore excludes acquisitions through transfers, block and bulk deals etc. Also recently, SEBI in its Board Meeting[2] held on June 25, 2020 has proposed to provide an additional option to the existing pricing methodology for preferential issue under which the minimum price for allotment of shares will be volume weighted average of weekly highs and low for twelve weeks or two weeks, whichever is higher.However, this new rule shall apply till December 31, 2020 with 3 years lock-in condition for allotted shares. Further, by way of the same notification, SEBI has also relaxed the provisions of voluntary open offer where an acquirer together with PAC will be eligible to make voluntary offer irrespective of any acquisition in the previous 52 weeks from the date of voluntary offer, this will promote investments into various companies in future.

This article tries to discuss on whether the relaxation given by SEBI to the promoters are as encouraging as it seems to be, when connected with the pricing norms for preferential issue under the SEBI (Issue of Capital and Disclosures Requirement) Regulations, 2018 (‘ICDR Regulations’) and how the new pricing methodology proposed by SEBI can leverage the situation.

What is Creeping Acquisition?

Creeping acquisition, governed by Regulation 3(2) of the Takeover Code, refers to the process through which the acquirer together with PAC holding more than 25% but less than 75%, to gradually increase their stake in the target company by buying up to 5% of the voting rights of the company in one financial year. Any acquisition of further shares or voting rights beyond 5% shall require the acquirer to make an open offer. Further, for the purpose of creeping acquisition, SEBI considers gross acquisitions only notwithstanding any intermittent fall. The same is projected in Figure 1 below. Also, in all cases, the increase in shareholding or voting rights is permitted only till the 75% non-public shareholding limit.

Figure 1: Creeping acquisition limit increased from 5% to 10%

Rationale for easing the norms of Creeping Acquisition

While the companies are currently struggling to manage their cash flows due to the financial challenges faced on account of COVID-19, the amendment will allow companies to raise funds from promoters to tide over their difficulties for the financial year 2020-21. This revision will also boost the sagging stock market and help sustain the stock prices of the company.

Promoters, on the other hand, owning 25% or more of the shares or voting rights in a company will be able to increase their shareholdings up to 10% in a year versus the previously allowed threshold limit of 5%.

Permutations and Combinations of Creeping Acquisition during FY 2020-21

Since the enhanced 10% limit applies only in case of acquisition under preferential issue, the total acquisition of 10% may be achieved by any of the following combinations:

Option 1: Acquire upto 5% shares via open-market purchase or any other form and the remaining 5% shares can be acquired through subscribing to a preferential issue.

Option 2:Acquire 10% shares through preferential issue

Accordingly, in a block of 12 months of financial year 2020-21, if the promoterwants to acquire share through open market, bulk deals, block deals or in any other form, the 5% threshold shall remain in force and additional 5% can be acquired through preferential issue.

Identified below are the permitted acquisitions through open market, transfers or other forms in case promoter opts for preferential issue:

Whether the relaxation in open offer is actually encouraging when read with the pricing norms under ICDR Regulations?

As stated above, the relaxation can be availed only in the cases where the investments are done undera preferential issue. Regulation 164 of the SEBI (Issue of Capital and Disclosures Requirement) Regulations, 2018 (‘ICDR Regulations’) deals with the pricing norms under preferential issue. It provides that the issue price in cases where the shares have been listed for more than 26 weeks on a recognized stock exchange as on the relevant date, the issue price has to be higher of the following:

  1. the average of the weekly high and low of the volume weighted average price of the related equity shares quoted on the recognized stock exchange during the twenty six weeks preceding the relevant date; or
  2. the average of the weekly high and low of the volume weighted average prices of the related equity shares quoted on a recognized stock exchange during the two weeks preceding the relevant date.

The computation of the prices as per the above stated regulation will lead to a wide gap between the pricing at the beginning of the twenty-six week period and the current price when the company raises funds.

During this time of stock market crises, the stock prices of many companies have dropped sharply from their respective all-time high values recorded 6 months back. Further, in the cases where the market price is lower than the minimum price calculated as per ICDR Regulations for preferential issue, the promoters will be discouraged to acquire shares under preferential allotment as they will end up paying higher values.

Due to the challenges faced by the economy in view of COVID-19, the trading prices of the listed companies have gone down sharply. Accordingly, the price determined under ICDR Regulations may not be a motivating factor for the promoters to subscribe to the additional shares though, elimination of the costs involved in a public offer may compensate the same.

However, to curb the above situation, SEBI in its Board meeting held on June 25, 2020, has proposed an additional option to the existing pricing methodology for preferential issuance as under:

In case of frequently traded shares, the price of the equity shares to be allotted pursuant to the preferential issue shall be not less than higher of the following:

  1. the average of the weekly high and low of the volume weighted average price of the related equity shares quoted on the recognized stock exchange during the twelve weeks preceding the relevant date; or
  2. the average of the weekly high and low of the volume weighted average prices of the related equity shares quoted on a recognized stock exchange during the two weeks preceding the relevant date.

The new option will consider the weighted average price of equity shares preceding 12 weeks instead of the preceding 26 weeks and therefore reflect the accurate price during the pandemic period.  This may prove to be the solution to above crises,making fundraising through preferential issue easier for the corporates and simultaneously encouraging the promoters as well to infuse funds.

Compliances for preferential issue to promoters under PIT Regulations

Considering the fact that promoter is one of the designated person as per the SEBI (Prohibition of Insider Trading) Regulations, 2015 (‘PIT Regulations’), the companies, in addition to the procedural requirements for preferential issue prescribed under the Companies Act, 2013, ICDR Regulations and other applicable laws, shall also comply with the provisions of PIT Regulations.

Closure of trading window in case of preferential allotment

Designated persons and their immediate relatives shall not trade in securities when the trading window is closed. The trading restriction period shall apply from the end of every quarter till 48 hours after the declaration of financial results.

Further, the trading window shall also be closed when the compliance officer determines that a designated person (DP) or class of designated persons can reasonably be expected to have possession of unpublished price sensitive information (UPSI). Therefore, the trading window shall be closed and communicated to all DPs as soon as the date/notice of board meeting to approve issue of share via preferential allotment is finalized upto 2nd trading day after communication of the decision of the Board to the Stock Exchanges.

Accordingly, promoter/ class of promoters acquiring shares under preferential issue shall conduct all their dealings in the securities of the company only in a valid trading window i.e. once the trading widow is open subject to the pre-clearance norms prescribed under PIT Regulations and the Code of Conduct for prevention of insider trading of the Company.

Concluding Remarks

Given the lack of liquidity in the market, the proposed amendments maybe seen as an opportunity for target companies to raise capital from its promoters. Further, promoters can also infuse funds through equity issuance and will be able to increase their shareholding in the target company without the formalities of making the open offer.

Having said that since the market might take some time to recover, this relaxation provides a gateway for promoters to avoid open offer requirements which would otherwise have involved compliance burden on the promoter. However, the pricing factor may seem to be the only hindrance or a demotivation for actually availing this relaxation which seems to be resolved through the new pricing method proposed by SEBI in its Board meeting.

[1]To view the notification, click here

[2]https://www.sebi.gov.in/media/press-releases/jun-2020/sebi-board-meeting_46929.html

Other reading materials on the similar topic:

  1. ‘SEBI revisits Takeover Code’ can be viewed here
  2. ‘Takeover Code 2011’ can be viewed here
  3. ‘Decoding Takeover Code’ can be viewed here
  4. Our other articles on various topics can be read at: http://vinodkothari.com/

Email id for further queries: corplaw@vinodkothari.com

Our website: www.vinodkothari.com

Our Youtube Channel: https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg