Banks can now take control of distressed firms

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distressed-2The Reserve Bank of India has notified that banks can convert existing debt into equity resulting in 51% or more stake in a distressed company if the Joint Lenders Forum (JLF) decides that the account can be rendered viable by effecting a change in ownership.

Earlier this year, the Securities & Exchange Board of India (Sebi) had also given clearance to the scheme, allowing banks to convert debt into equity “at a price that is fair, but not below face value”.

RBI Governor Raghuram Rajan confirmed the central bank’s decision by saying: “The scheme has our approval and Sebi’s too, so lenders can now use it.”

In the notification issued on June 8, the RBI said the JLF should incorporate the option to convert the entire or a part of the loan, including unpaid interest into shares in the company if the borrower is not able to achieve the viability milestones or adhere to “critical conditions” as stipulated in the restructuring package. The inclusion of such a clause is contingent to the company’s shareholders agreeing to it under a special resolution.

The lenders under the JLF should collectively become the majority shareholder by conversion of their dues from the borrower into equity, according to the notification.

The conversion of debt into equity will be at a ‘fair value’, which is not either the market value of shares, in case of a listed company, or the book value of share, subject to certain conditions.

The notification said the JLF must approve the SDR conversion package within 90 days from the date of deciding to undertake SDR and the conversion should be completed within another 90 days from the date of approval.

“The invocation of SDR will not be treated as restructuring for the purpose of asset classification and provisioning norms,” RBI said.

After conversion of debt into equity, banks will retain the existing asset classification of the account for a period of 18 months from the date of JLF’s decision to undertake SDR.

The RBI said that lenders in the consortium should divest their holdings in the equity of the company as soon as possible and the asset classification of the stressed company may be upgraded to standard after a new promoter comes on board.

“At the time of divestment of their holdings to a ‘new promoter’, banks may refinance the existing debt of the company considering the changed risk profile of the company without treating the exercise as ‘restructuring’ subject to banks making provision for any diminution in fair value of the existing debt on account of the refinance,” read the RBI notification.