Group Insolvency: Moving from “Entity” to “Enterprise”

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-Sikha Bansal (resolution@vinodkothari.com)

 

Recently, the Working Group led by Shri U.K. Sinha, submitted its Report on group insolvency, recommending a complete framework to facilitate insolvency resolution and liquidation of corporate debtors in a “group”. The Report was submitted by the working group on 23.09.2019.

See our presentation here on various aspects of group insolvency proceedings as suggested by the Working Group, and includes discussion on procedural coordination versus substantive consolidation along with case laws and case studies.

Special Window Fund for Affordable Real Estate Segment: Achche Din for Home-buyers?

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– Sikha Bansal and Priya Udita

(finserv@vinodkothari.com)

Relief has come to the builders of stalled housing project and distressed homebuyers in in the form of establishment of a ‘Special Window‘ fund by the Government to provide priority debt financing for the completion of stalled housing projects that are in the affordable and middle-income housing sector. See the press release here. The announcement came after this package was introduced on September 14 by the Finance Minister. The Government has also issued FAQs on the same, which can be viewed here.

The write-up discusses salient features of the plan.

KEY FEATURES OF THE FUND

  1. Fund will be set up as Category II-AIF (Alternative Investment Fund) with initial amount of Rs. 25,000 crores and registered with SEBI.
  2. The government acting as a sponsor shall infuse Rs. 10,000 crore and the remaining amount to be contributed by State Bank of India, Life Insurance Corporation of India and other institutions.
  3. Investors can be Government and other private investors including cash-rich financial institutions, sovereign wealth funds, public and private banks, domestic pension and provident funds, global pension funds and other institutional investors.
  4. The SBICAP Ventures Limited is proposed to the Investment Manager.
  5. Project declared as non-performing assets (NPAs) or which have been dragged to the NCLT for insolvency proceedings will be included. Apart from that any projects undergoing corporate insolvency resolution process before the NCLT will be considered for funding through the Special Window upto the stage where the resolution plan for such insolvency resolution process has not been approved / rejected by the committee of creditors. However, cases pending in the High Courts or Supreme Court will not be considered.
  6. The retail loans of the selected stalled projects will be restructured as per RBI Guidelines and bank board approved policies.
  7. The investments will be in the form of non-convertible debentures subject to legal, regulatory or other considerations.

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Case Update: SC extended the CIRP by exercising Article 142 of the Constitution

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-Priya Udita

(resolution@vinodkothari.com)

The Supreme Court (SC) in the case of Jaiprakash Associate Ltd. & Anr. v. IDBI Bank Ltd. & Anr. dealt with 2 issues. Firstly, whether the National Company Law Tribunal (NCLT) or National Company Law Appellate Tribunal (NCLAT) can exclude any period from the statutory period in exercise of inherent powers sans any express provision in the Insolvency and Bankruptcy Code (I&B Code) in that regard. Secondly, whether the bidders can submit revised resolution plan after they were originally rejected by Committee of Creditors (CoC).

 

Dealing with the first issue, the SC in its order dated November 6, 2019 held that an extraordinary situation had arisen because of the constant experimentation which went about at different level due to lack of clarity on matters crucial to the decision making process of CoC. Besides that, the SC held that the case on hand is a classic example of how the entire process got embroiled in litigation initially before court and adjudicating authorities due to confusion or lack of clarity in respect of foundational processes to be followed by the CoC. Depending upon the uniqueness and unanimity of the stakeholders and resolution applicant to eschew the liquidation of corporate debtor, the SC by exercising its power under Article 142 of the constitution reckons 90 days extended period from the date of this order instead of the date of commencement of the Insolvency and Bankruptcy Code (Amendment) Act, 2019.

With regard to second issue, the SC relied on the sub clause (7) of Regulation 36B inserted with effect from 4th July, 2018, dealing with the request for resolution plans. It postulates that the resolution professional may, with the approval of the CoC, reissue request for resolution plans, if the resolution plans received in response to earlier request are not satisfactory, subject to the condition that the request is made to all prospective resolution applicants in the final list. Consequently, applying the principle underlying Regulation 36B(7), the SC found it appropriate to permit the interim resolution applicant to reissue request for resolution plans to the two bidders and/or to call upon them to submit revised resolution plans, which can be then placed before the CoC for its due consideration.

However, the SC has clarified that this order is issued in an exceptional case and it will not be construed as a precedent. Further, the SC made it clear that this order does not answers to the question of law as to whether NCLT or NCLAT has the power to issue direction or order inconsistent with the statutory timelines and stipulations specified in the I&B Code or regulations.

Though the SC has extended the CIRP period in an exceptional case, it is still not sufficient to complete the process within the stipulated time period as there are constant amendments being done for the effective implementation of the I&B Code. The NCLT/NCLAT is burdened with the application for clarification on the various procedures or regulation while the time for resolution flies. There are numerous cases pending before adjudicating authorities whose stipulated time period for the resolution has been surpassed.

Working Group proposal for stricter vigilance on CICs

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-By Anita Baid

anita@vinodkothari.com, finserv@vinodkothari.com

Regulators and stakeholders have been seeking a review of Core Investment Companies (CIC) guidelines ever since defaults by Infrastructure Leasing and Financial Services Ltd (IL&FS), a large systemically important CIC. In August 2019, there were 63 CICs registered with the Reserve Bank of India (RBI). As on 31 March, 2019, the total asset size of the CICs was ₹2.63 trillion and they had approximately ₹87,048 crore of borrowings. The top five CICs consist of around 60% of the asset size and 69% borrowings of all the CICs taken together. The borrowing mix consists of debentures (55%), commercial papers (CPs) (16%), financial institutions (FIs) other corporates (16%) and bank borrowings (13%).

Considering the need of the hour, RBI had constituted a Working Group (WG) to Review Regulatory and Supervisory Framework for CICs, on July 03, 2019. The WG has submitted its report on November 06, 2019 seeking comments of stakeholders and members of the public.

Below is an analysis of the key recommendations and measures suggested by the WG to mitigate the related risks for the CICs:

Existing Provision & drawbacks Recommendation Our Analysis
Complex Group Structure
Section 186 (1) of Companies Act, 2013, which restricts the Group Structure to a maximum of two layers, is not applicable to NBFCs

 

 

 The number of layers of CICs in a group should not exceed two, as in case of other companies under the Companies Act, which, inter alia, would facilitate simplification and transparency of group structures.

As such, any CIC within a group shall not make investment through more than a total of two layers of CICs, including itself.

For complying with this recommendation, RBI may give adequate time of say, two years, to the existing groups having CICs at multiple levels.

 A single group may have further sub-division based on internal family arrangements- there is no restriction on horizontal expansion as such.

Further, the definition of the group must be clarified for the purpose of determining the restriction- whether definition of Group as provided under Companies Act 1956 (referred in the RBI Act) or under the Master Directions for CICs would be applicable.

To comply with the proposed recommendations, the timelines as well as suggested measures must also be recommended.
Multiple Gearing and Excessive Leveraging
Presently there is no restriction on the number of CICs that can exist in a group. Further, there is no
requirement of capital knock
off with respect to investments in other CICs. As a result, the step down CICs can use the capital for multiple leveraging. The effective leverage ratio can thus be higher than that allowed for regular NBFCs.		 For Adjusted Net Worth (ANW) calculation, any capital contribution of the CIC to another step-down CIC (directly or indirectly) shall be deducted over and above the 10% of owned funds as applicable to other NBFCs.

Furthe, step-down CICs may not be permitted to invest in any other CIC.

Existing CICs may be given a glide path of 2 years to comply with this recommendation.

 Certain business groups developed an element of multiple gearing as funds could be raised by the CICs and as well as by the step down CICs and the other group companies independently. At the Group level, it therefore led to over-leveraging in certain cases.

A graded approach, based on the asset size of the CICs, must have been adopted in respect of leverage, instead of a uniform restriction for all.
Build-up of high leverage and other risks at group level
There is no requirement to have in place any group level committee to articulate the risk appetite and identify the risks (including excessive leverage) at the Group level Every conglomerate having a CIC should have a Group Risk Management Committee (GRMC) which, inter alia, should be entrusted with the responsibilities of

(a)   identifying, monitoring and mitigating risks at the group level

(b)   periodically reviewing the risk management frameworks within the group and

(c)   articulating the leverage of the Group and monitoring the same.

Requirements with respect to constitution of the Committee (minimum number of independent directors, Chairperson to be independent director etc.), minimum number of meetings, quorum, etc. may be specified by the Reserve Bank through appropriate regulation.

 There is no particular asset size specified. Appropriately, the requirement should extend to larger conglomerates.

 

 

 

 

 

 

 
Corporate Governance
Currently, Corporate Governance guidelines are not explicitly made applicable to CICs i.     At least one third of the Board should comprise of independent members if chairperson of the CIC is non-executive, otherwise at least half of the Board should comprise of independent members, in line with the stipulations in respect of listed entities. Further, to ensure independence of such directors, RBI may articulate appropriate requirements like fixing the tenure, non-beneficial relationship prior to appointment, during the period of engagement and after completion of tenure, making removal of independent directors subject to approval of RBI etc.

ii.   There should be an Audit Committee of the Board (ACB) to be chaired by an Independent Director (ID). The ACB should meet at least once a quarter. The ACB should inter-alia be mandated to have an oversight of CIC’s financial reporting process, policies and the disclosure of its financial information including the annual financial statements, review of all related party transactions which are materially significant (5% or more of its total assets), evaluation of internal financial controls and risk management systems, all aspects relating to internal and statutory auditors, whistle-blower mechanism etc. In addition, the audit committee of the CIC may also be required to review (i) the financial statements of subsidiaries, in particular, the investments made by such subsidiaries and (ii) the utilization of loans and/ or advances from/investment by CIC in any group entity exceeding rupees 100 crore or 10% of the asset size of the group entity whichever is lower.

iii.  A Nomination and Remuneration Committee (NRC) at the Board level should be constituted which would be responsible for policies relating to nomination (including fit and proper criteria) and remuneration of all Directors and Key Management Personnel (KMP) including formulation of detailed criteria for independence of a director, appointment and removal of director etc.

iv.  All CICs should prepare consolidated financial statements (CFS) of all group companies (in which CICs have investment exposure). CIC may be provided with a glide path of two years for preparing CFS. In order to strengthen governance at group level, if the auditor of the CIC is not the same as that of its group entities, the statutory auditor of CIC may be required to undertake a limited review of the audit of all the entities/ companies whose accounts are to be consolidated with the listed entity.

v.   All CICs registered with RBI should be subjected to internal audit.

vi.  While there is a need for the CIC’s representative to be on the boards of its subsidiaries / associates etc., as necessary, there is also a scope of conflict of interest in such situations. It is therefore recommended that a nominee of the CIC who is not an employee / executive director of the CIC may be appointed in the Board of the downstream unlisted entities by the respective CIC, where required.

 The extent of applicability of NBFC-ND-SI regulations is not clear. The FAQs issued by RBI on CICs (Q12), state that CICs-ND-SI are not exempt from the Systemically Important Non-Banking Financial (Non-Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2015 and are only exempt from norms regarding submission of Statutory Auditor Certificate regarding continuance of business as NBFC, capital adequacy and concentration of credit / investments norms.

Further, no asset size has been prescribed – can be prescribed on “group basis”. That is, if group CICs together exceed a certain threshold, all CICs in the group should follow corporate governance guidelines, including the requirement for CFS.

Most of the CICs are private limited companies operating within a group, having an independent director on the board may not be favorable.

Further, carrying out and internal audit and preparing consolidated financials would enable the RBI to monitor even unregulated entities in the Group.

Currently, the requirement of
consolidation comes from the
Companies Act read along with
the applicable accounting
standards. Usually, consolidation
is required only where in case of
subsidiaries, associates and joint
ventures.

However, if the recommendation
is accepted as is then even a
single rupee investment
exposure would require
consolidation.

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Review of Exempt Category and Registration
Currently there is a threshold of ₹ 100 crore asset size and access to public funds for registration as CIC
  1. The current threshold of ₹ 100 crore asset size for registration as CIC may be retained. All CICs with public funds and asset size of ₹ 100 crore and above may continue to be registered with RBI. CICs without access to public fund need not register with the Reserve Bank.
  2. The nomenclature of ‘exempted’ CIC in all future communications / FAQs etc. published / issued by the Reserve Bank should be discontinued.
 Since the category of ‘exempted CICs; were not monitored, there was no means to detect when a CIC has reached the threshold requiring registration.

This remains to be a concern.
 Enhancing off-site surveillance and on-site supervision over CICs
There is no prescription for submission of off-site returns or Statutory Auditors Certificate (SAC) for CICs Offsite returns may be designed by the RBI and prescribed for the CICs on the lines of other NBFCs. These returns may inter alia include periodic reporting (e.g. six monthly) of disclosures relating to leverage at the CIC and group level.

A CIC may also be required to disclose to RBI all events or information with respect to its subsidiaries which are material for the CIC.

Annual submission of Statutory Auditors Certificates may also be mandated. Onsite inspection of the CICs may be conducted periodically.

 The reporting requirements may help in monitoring the activities of the CICs and developing a database on the structures of the conglomerates, of which, the CIC is a part. This may assist in identification of unregulated entities in the group.

 

 

Our other related write-ups:

RBI to strengthen corporate governance for Core Investment Companies.

Our write-ups relating to NBFCs can be viewed here: http://vinodkothari.com/nbfcs/

 

 

 

Timely Realisation of Assets by Secured Creditors- IBBI’s Discussion Paper on Liquidation Process Regulations

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-Megha Mittal

(resolution@vinodkothari.com) 

The Insolvency and Bankruptcy Board of India (“IBBI”/ “Board”) has invited comments on its Discussion Paper on Corporate Liquidation Process[1], dated 03.11.2019 (“Discussion Paper”), which essentially deals with two issues which have been the focal point of contrasting opinions as well as judicial interpretation at various instances, i.e. (a) Relinquishment of Security Interest in Corporate Liquidation Process; and (b) Applicability of section 29A of the Code to Compromise and Arrangement.

In this article, the author has delved into the said issues based on the problem statement presented by the Board, and has also attempted to analyse the propose amendments in the Insolvency and Bankruptcy Code, 2016 (“Code”) w.r.t. relinquishment of security interest in corporate liquidation.

We shall discuss the applicability of section 29A of the Code to Compromise and Arrangement in a separate article.

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Liquidity Risk Management Framework- Snapshot

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Applicability

  1. Non-deposit taking NBFCs with asset size of Rs.100 crore and above
  2. Systemically important Core Investment Companies
  3. Deposit taking NBFCs irrespective of their asset size

All other NBFCs are also encouraged to adopt these guidelines on liquidity risk management on voluntary basis

Exclusion:

  1. Type 1 NBFC-NDs- NBFC-ND not accepting public funds/ not intending to accept public funds in the future andnot having customer interface/ not intending to have customer interface in the future
  2. Non-Operating Financial Holding Companies and Standalone Primary Dealers

Action to be taken:

The Board of Directors must revise the existing ALM policy or adopt a new LRM Framework to put in place internal monitoring mechanism for the following:

  • Adopt liquidity risk monitoring tools/metrics to cover
    1. concentration of funding by significant counterparty/ instrument/ currency[1],
    2. availability of unencumbered assets that can be used as collateral for raising funds; and,
    3. certain early warning market-based indicators, such as, book-to-equity ratio, coupon on debts raised, breaches and regulatory penalties for breaches in regulatory liquidity requirement.
    4. The Board / committee set up for the purpose shall monitor on a monthly basis, the movements in their book-to-equity ratio for listed NBFCs and the coupon at which long-term and short-term debts are raised by them. This also includes information on breach/penalty in respect of regulatory liquidity requirements, if any.
  • Monitor liquidity risk based on a “stock” approach to liquidity
    • Board to set predefined internal limits for various critical ratios pertaining to liquidity risk.
    • Indicative liquidity ratios are
      • short-term liability to total assets;
      • short-term liability to long-term assets;
      • commercial papers to total assets;
      • non-convertible debentures (NCDs) (original maturity less than one year) to total assets;
      • short-term liabilities to total liabilities; long-term assets to total assets.
    • Put in place process for identifying, measuring, monitoring and controlling liquidity risk.
      • It should clearly articulate a liquidity risk tolerance that is appropriate for its business strategy and its role in the financial system
      • Senior management should develop the strategy to manage liquidity risk in accordance with such risk tolerance and ensure that the NBFC maintains sufficient liquidity
    • Develop a process to quantify liquidity costs and benefits so that the same may be incorporated in the internal product pricing, performance measurement and new product approval process for all material business lines, products and activities.
    • Conduct stress tests on a regular basis for a variety of short-term and protracted NBFC-specific and market-wide stress scenarios (individually and in combination)
    • Ensure that an independent party regularly reviews and evaluates the various components of the NBFC’s liquidity risk management process

Revision in the existing ALM framework to incorporate granular buckets

As per the existing norms, the mismatches (negative gap) during 1-30/31 days in normal course shall not exceed 15% of the cash outflows in this time bucket. Pursuant to the revised framework, the 1-30 day time bucket in the Statement of Structural Liquidity is segregated into granular buckets of 1-7 days, 8-14 days, and 15-30 days. The net cumulative negative mismatches in the maturity buckets of 1-7 days, 8-14 days, and 15-30 days shall not exceed 10%, 10% and 20% of the cumulative cash outflows in the respective time buckets.

Revision in interest rate sensitivity statement

Granularity in the time buckets would also be applicable to the interest rate sensitivity statement required to be submitted by NBFCs.

Composition of Risk Management Committee

The Risk Management Committee, which reports to the Board and consisting of Chief Executive Officer (CEO)/ Managing Director and heads of various risk verticals shall be responsible for evaluating the overall risks faced by the NBFC including liquidity risk.

Asset Liability Management (ALM) Support Group

The existing Management Committee of the Board or any other Specific Committee constituted by the Board to oversee the implementation of the system and review its functioning periodically shall be substituted with ALM Support Group. It shall consist of operating staff who shall be responsible for analysing, monitoring and reporting the liquidity risk profile to the ALCO. Such support groups will be constituted depending on the size and complexity of liquidity risk management in an NBFC.

Public Disclosure

To enable market participants to make an informed judgment about the soundness of its liquidity risk management framework and liquidity position-

  1. Disclose information in the format provided under Appendix I, on a quarterly basis on the official website of the company and
  2. In the annual financial statement as notes to account

Responsibility of Group CFO

The Group Chief Financial officer (CFO) shall develop and maintain liquidity management processes and funding programmes that are consistent with the complexity, risk profile, and scope of operations of the ‘companies in the Group’- as defined in the Master Directions.

MIS System

Put in place a reliable MIS designed to provide timely and forward-looking information on the liquidity position of the NBFC and the Group to the Board and ALCO, both under normal and stress situations.

Liquidity Coverage Ratio- Snapshot

Applicability:

  1. Non-deposit taking NBFCs with asset size of Rs.5,000 crore and above,
  2. Deposit taking NBFCs irrespective of their asset size

Exclusion:

  1. Core Investment Companies,
  2. Type 1 NBFC-NDs,
  3. Non-Operating Financial Holding Companies and Standalone Primary Dealer

Computation:

Liquidity Coverage Ratio (LCR) is represented by the following ratio:

Stock of High Quality Liquid Assets (HQLA)/ Total net cash outflows over the next 30 calendar days

Here, “High Quality Liquid Assets (HQLA)” means liquid assets that can be readily sold or immediately converted into cash at little or no loss of value or used as collateral to obtain funds in a range of stress scenarios.

Timeline:

Effective date of implementation of the LCR norm is December 01, 2020, as per the timeline mentioned herein below. The LCR shall continue to be minimum 100% (i.e., the stock of HQLA shall at least equal total net cash outflows) on an ongoing basis with effect from December 1, 2024, i.e., at the end of the phase-in period.

  1. For non-deposit taking systemically important NBFCs with asset size of Rs.10,000 crore and above and all deposit taking NBFCs irrespective of the asset size, LCR to be maintained as per the following timeline:
From December 01, 2020 December 01, 2021 December 01, 2022 December 01, 2023 December 01, 2024
Minimum LCR 50% 60% 70% 85% 100%
  1. For non-deposit taking NBFCs with asset size of Rs. 5,000 crore and above but less than Rs. 10,000 crore, the required level of LCR to be maintained, as per the time-line given below:
From December 01, 2020 December 01, 2021 December 01, 2022 December 01, 2023 December 01, 2024
Minimum LCR 30% 50% 6

0%

 85% 100%

Disclosure Requirements:

NBFCs shall be required to disclose information on their LCR every quarter. Further, NBFCs in their annual financial statements under Notes to Accounts, starting with the financial year ending March 31, 2021, shall disclose information on LCR for all the four quarters of the relevant financial year.

[1] A “Significant counterparty” is defined as a single counterparty or group of connected or affiliated counterparties accounting in aggregate for more than 1% of the NBFC-NDSI’s, NBFC-Ds total liabilities and 10% for other non-deposit taking NBFCs

A “significant instrument/product” is defined as a single instrument/product of group of similar instruments/products which in aggregate amount to more than 1% of the NBFC-NDSI’s, NBFC-Ds total liabilities and 10% for other non-deposit taking NBFCs.

 

Our other related write-ups:

RBI issues draft framework to strengthen liquidity of NBFCs

Schemes under Section 230 with a pinch of section 29A – Is it the final recipe?

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-Sikha Bansal (resolution@vinodkothari.com)

Note: This article is in continuation of/an addition to our earlier article wherein the author discussed various aspects pertaining to schemes of arrangement in liquidation under section 230 of the Companies Act, 2013 read with various provisions of the Insolvency and Bankruptcy Code, 2016. The author has described various factors and principles which the judiciary may consider while sanctioning a scheme of arrangement for companies in liquidation, how a scheme is different from a resolution plan or a going concern sale, what constitutes ‘class’ in the context, whether the waterfall under section 53 will apply to such schemes, etc. The author also pointed out the lack of clarity as to applicability or inapplicability of section 29A on such schemes. However, very recently, NCLAT has clarified that persons ineligible under section 29A are not qualified to propose a scheme during liquidation. This Part discusses this ruling and ponders upon some questions which still remain open-ended/unanswered.

The conundrum as to whether section 29A of the Insolvency and Bankruptcy Code, 2016 (‘Code’) will apply to schemes under section 230 of the Companies Act, 2013 (‘Companies Act’) has been put to rest, at least for the time being, by a recent ruling of the National Company Law Appellate Tribunal (‘NCLAT’). In  Jindal Steel and Power Limited v. Arun Kumar Jagatramka & Gujarat NRE Coke Limited (Company Appeal (AT) No. 221 of 2018), vide order dated 24.10.2019, NCLAT held, while a scheme under section 230 is maintainable for companies in liquidation under the Code, the same is not maintainable at the instance of a person ineligible under section 29A of the Code. The NCLAT relied on the observation of the Hon’ble Supreme Court in Swiss Ribbons Pvt. Ltd. & Anr. v. Union of India & Ors., WP No. 99 of 2018, that the primary focus of the legislation is to ensure revival and continuation of the corporate debtor by protecting the corporate debtor from its own management and from a corporate death by liquidation.

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