Bloomberg described India as holding the “world’s worst bad-debt pile” in September 2019, with Indian banks holding USD 130bn of “bad loans” in December 2019. More than 2.4 per cent of the total loans in India’s banking system are under stress and, as of June 2019, the country had a 9.6 per cent bad debt ratio.
In November 2019, India’s bad loan ratio of 9.3 per cent was the highest of the world’s top 10 economies. Indian banks wrote off a record USD 39bn of distressed loans in the 18 months through to September 2019 in an attempt to improve their balance sheets.
These stressed asset volumes are not the only challenge Prime Minister Narendra Modi will have to face. Modi won a general election in May 2019 to retain his position, on a promise of business-friendly politics and continuing with reforms from his earlier victory, including the insolvency and bankruptcy reforms.
The bankruptcy and insolvency reforms (as discussed further in the Indian Insolvency Law Reform update) were billed as a “vital economic reform” in March 2019. They were seen as a way to strengthen the position of creditors and encourage foreign investment through adopting practices more common in Europe and the USA. Many Indian companies previously relied on the simplicity of rolling over existing debt and ease of obtaining additional funding. This, however, increased the number of ‘bad loans’ in the Indian financial sector.
The new processes have suffered challenges and delays. As of 8 September 2019, only six of the 12 largest delinquent Indian borrowers which the RBI asked lenders to force into insolvency in 2017 were resolved. Bloomberg reported on 16 December 2019 that only 15 per cent of cases submitted to the bankruptcy court set up in 2016 had been resolved.
Prime Minister Modi will also continue to be challenged by an economic slowdown and a shadow banking crisis. Growth of the USD 2.7tn Indian economy is at its slowest rate in six years. The Indian economy only grew by 5 per cent between April and June 2019 and 4.5 per cent between July and September - down from 7 per cent for the same period in 2018. This resulted in the Reserve Bank of India (“RBI”) cutting interest rates by 135 basis points in 2019 in an attempt to stabilise the economy. However, the RBI surprised economists in December 2019 by announcing no further rate cuts.
A wave of defaults of large, non-bank lenders has prompted a liquidity squeeze for businesses already struggling to raise funds. Infrastructure Leasing & Financial Services Ltd. was the first major shadow bank to default on payments in October 2018. This was followed by the collapse last year of Dewan Housing Finance Limited (“DHFL”), a major real estate lender. The RBI took over DHFL in November 2019 following concerns regarding its ability to meet payment obligations. DHFL will be the first non-bank lender to be reviewed by the National Company Law Tribunal (the “NCLT”).
The Indian Government has asked the RBI to consider de-stressing the sector by creating a special fund to buy stressed assets of the top Non-Banking Financial Companies. Discussions are said to be ongoing but, in November 2019, Reuters reported that the RBI was against the idea.
There are, however, positive signs in the Indian economy. The Supreme Court’s November 2019 decision in respect of Essar Steel (as discussed further in Notable Transactions) is seen as setting a precedent for how the court will interpret India’s bankruptcy code and that future cases should be dealt with more efficiently.
Furthermore, it was announced on 16 December 2019 that Indian banks are set to receive USD 7.6bn following the resolution of several notable insolvency proceedings, including: (a) INR 415.5bn in respect of INR 470bn loans extended to Essar Steel; (b) INR 54bn in respect of INR 120bn loans extended to Prayagraj Power Generation Co.; (c) INR 43.5bn in respect of INR 120bn loans extended to Ruchi Soya Industries Ltd.; and (d) INR 27bn in respect of INR 70bn loans extended to RattanIndia Power Ltd.
INDIAN LEGAL SYSTEM
The Indian legal system fuses English common law together with civil law aspects and customary (religious) laws. This framework is governed under the Constitution of India, adopted in 1949.
Indian contract law is largely based on English contract law principles. Its key legislation, the Indian Contract Act of 1872, was passed under British governance. Indian company law likewise has its origins in the English Companies Acts and is today governed under the Indian Companies Act 2013.
Indian trust law differs from English law by not recognising a distinction between legal and beneficial ownership. Accordingly, under Indian law, a trustee is the sole legal and beneficial owner of the trust property. However, it is possible for the beneficial interest only in trust property to be transferred under the Indian Trust Act of 1882. Indian law generally recognises trust arrangements under different legal systems.
KEY POINTS FOR TRADERS
- Foreign purchasers of Indian debt are required to comply with the External Commercial Borrowing (“ECB”) regulations.
- A transfer of an existing ECB-compliant lending position may need to comply with specific guidelines which set out the categories of foreign lenders that may enter into ECB arrangements.
- Assignment is generally the preferred method of transfer for fully funded loans, whilst novation is preferred for partially or fully unfunded loans.
- Security may be granted either directly to the lender or in favour of a third party security trustee who holds security for the benefit of the lenders from time to time.
- There are registration requirements in order to perfect the transfer of debt and ensure the enforceability of security.
- Withholding tax on interest is charged at up to 20 per cent but may be reduced subject to reliance on applicable double taxation treaties. Stamp duty is also payable on the transfer of a loan.
The Indian debt market is highly regulated, with foreign purchasers of Indian debt required to comply with the ECB regulations. The RBI delegates much of its regulatory responsibilities for ECB activity to Indian-resident banks.
Non-Indian residents can also invest in Indian debt securities upon obtaining a registration as a Foreign Portfolio Investor from the Securities and Exchange Board of India (“SEBI”) in accordance with the SEBI rules and under the Foreign Exchange Management Act.
A foreign investor may only take a direct transfer of an ECB if it is a “recognised lender” and if the other terms of the relevant ECB remain unchanged. The term “recognised lender” covers a range of entities, such as international banks and “prudentially regulated financial institutions” (“PRFI”). Whether an entity will be treated as a PRFI may be decided by any “AD Category I” bank - essentially banks to which certain regulatory functions have been delegated by the RBI - by reference to certain guidelines discussed below. If a foreign investor is not a recognised lender in the opinion of the AD Category I bank considering the transfer, then the transfer must instead be approved by the RBI.
Therefore, if funds intend to enter the Indian ECB market, they should consider using entities in their structure which are regulated (in the relevant jurisdiction) and particularly focus on whether they are capable of meeting the standard of “prudentially regulated” under Indian law.
METHOD OF TRANSFER
A transfer, whether by assignment or novation, of an existing ECB-compliant lending position may need to be compliant with the Master Direction on External Commercial Borrowings, Trade Credit, Borrowing and Lending in Foreign Currency by Authorised Dealers and Persons other than Authorised Dealers (the “Guidelines”).
In broad terms, the Guidelines prescribe the categories of Indian borrowers and foreign lenders which may enter into ECB arrangements, as well as parameters such as the minimum maturity, permitted uses and cost ceilings (being interest and other costs) of such arrangements. The ECB framework has two classifications:
- Foreign Currency denominated ECB; and
- INR denominated ECB.
The framework applies differently depending on the classification in which the relevant lending is made.
Assignment is generally preferred for the transfer of fully funded loans, whilst novation is preferred for partially or fully unfunded loans.
Notice of assignment is often given to the borrower but not required at law. Furthermore, there are registration requirements. If the underlying security of the loan being transferred does not include immovable property (i.e. real estate), filings must be completed with the Registrar of Companies. If the underlying security does include immovable property, filings must be made with the Sub-Registrar of Assurances and the Registrar of Companies to ensure that the transfer of the loan is perfected and enforceable.
Participation agreements constitute legal and valid obligations in India. However, such agreements are less prevalent in commercial use.
SECURITY AND TRUSTS/ AGENCY
As set out above, the concepts of trust and agency are recognised under Indian law and are widely applied in commercial lending transactions in India.
Security may be granted either directly to the lender or in favour of a third party security trustee who holds security for the benefit of the lenders from time to time.
If the security is created in favour of the lender directly, then it must be assigned by the existing lender to the new lender or recreated in favour of the new lender by the borrower. If the security is created in favour of a security trustee, then the security will not have to be assigned separately.
In the event that a security trustee or agent becomes insolvent, any property held on trust for a third party would not fall into the estate of the trustee or agent under the Insolvency and Bankruptcy Code.
TAX AND STAMP DUTY CONSIDERATIONS
Withholding tax on interest is charged in India at rates of up to 20 per cent. However, India has a wide network of double taxation treaties which could reduce the amount of tax withheld to 10 per cent or less in certain circumstances.
Stamp duty is payable on the transfer of a loan, with rates varying under local state laws. In most states the amount payable is capped at INR 100,000 (approx. GBP 1,090). The payment of stamp duty is a requirement before any associated security can be registered.
Investors should consider Indian tax advice in relation to any particular transaction.
INDIAN INSOLVENCY LAW REFORM
INSOLVENCY AND BANKRUPTCY CODE 2016
India's Insolvency and Bankruptcy Code (the “IBC”), established in 2016, is aimed at making insolvency in India more investor-friendly. The IBC has since been amended by the Insolvency and Bankruptcy Code (Amendment) Act 2019 (the “Amendment Act”).
The IBC has been put to the test as high-profile, high-value insolvencies make their way through the system (including the Essar proceedings discussed further under Notable Transactions).
Under section 29A of the original IBC, persons or entities that are connected to an undischarged insolvent entity (a “related party”) are prevented from bidding for stressed assets.
Key changes to the IBC brought about by the Amendment Act include:
- Clarification that resolution plans can provide for restructuring by way of mergers, amalgamations and demergers.
- Requirement that the NCLT must record reasons if it is unable to determine the existence of a default within 14 days of the application for initiation of corporate insolvency resolution process.
- The overall timeline for completion of the corporate insolvency / bankruptcy resolution process has been increased from a maximum of 270 days to 330 days. However, the Supreme Court announced in its 15 November 2019 Essar Steel decision that the timeline for insolvencies could be extended in exceptional circumstances and that the 330-day deadline prescribed by the Indian Government for insolvency proceedings (including litigation) could not be mandatory.
- The requirement that an authorised representative must vote separately for, and in accordance with the instruction of, each of the financial creditors that it represents, has been changed. Now an authorised representative shall vote in accordance with the decision of more than 50 per cent of the financial creditors that it represents.
- Section 30 of the IBC, which deals with resolution plans is amended so that operational creditors receive at least the higher of the following amounts under a resolution plan:
-the amount that they would have received in a case of liquidation, under section 53 of the IBC; or
-the amount they would have received in case the amounts being paid under the resolution plan were being distributed as if they were proceeds available from the liquidation assets and distributed in accordance with section 53.
Furthermore, payments to financial creditors who do not vote in favour of a resolution plan will be determined in accordance with regulations framed by the Insolvency and Bankruptcy Board of India; such payments will not be less than the amount that would have been paid to such creditors in the event of liquidation of the corporate debtor.
Additionally, the Amendment Act clarifies that any plan conforming to the above shall be construed as being fair and equitable to such creditors. This is expected to reduce judicial intervention and appeals against resolution plans.
The above provisions now also apply to cases where the resolution plan has not been finalised or the plan is under challenge or within the period for appeal.
The amendment has further provided that while approving a resolution plan, the committee of creditors may also consider the order of priority amongst creditors, as set out in section 53, and specifically clarifies that the resolution plan shall also be binding on governmental authorities and statutory dues.
ESSAR STEEL INDIA LIMITED ("ESSAR STEEL")
ArcelorMittal announced on 16 December 2019 that it had formed a joint venture with Nippon Steel Corp (with whom it bid jointly for Essar Steel) - ArcelorMittal Nippon Steel India Ltd. ArcelorMittal will hold 60 per cent of the new company.
This followed the ruling made by the Supreme Court on 15 November 2019 which cleared the way for ArcelorMittal to takeover Essar Steel. Justice Rohinton F. Nariman, one of the Supreme Court judges, surmised that “[t]here is no principle of equality between secured and unsecured creditors”. The Supreme Court held that bankruptcy courts do not have a say in deciding distributions in funds between creditors, and that courts can only examine the legality of a resolution plan approved by a panel of lenders of an insolvent company. This was highly-anticipated as it was a critical test of the country's new debt resolution process following the appellate court, the National Company Law Appellate Tribunal (“NCLAT”), deciding to place secured creditors (such as banks) on par with unsecured creditors (such as suppliers), which raised concerns from foreign banks and hedge funds.
The decision marks a victory for banks, which are estimated to make a 90 per cent recovery. Theron Alldis, an Asia loan trader at SC Lowy commented on the Supreme Court’s judgment noting that “[i]t’s the right judgment…For distressed debt investors, it gives the certainty to commit capital”. The ruling upholds key provisions of the three-year-old bankruptcy code, intended to strengthen India's state-dominated banking system in dealing with politically influential defaulters, long accustomed to forbearance and debt rollovers.
Essar Steel was forced into insolvency proceedings in August 2017 along with 12 other large steel and infrastructure companies after falling behind on debt repayments, with debts of around INR 500bn (around GBP 5.43bn). It is the biggest case so far to be dealt with under the new Indian insolvency and bankruptcy legislation and, as such, the rulings handed down are expected to create a precedent for future cases to follow. Although the Essar Steel case took 830 days to exit the courts, analysts suggest that future cases will be resolved more expeditiously given the number of points challenged in the Essar Steel case.
RATTANINDIA POWER LTD. ("RATTANINDIA")
Rattanindia announced on 31 December 2019 that it had reached a one time settlement agreement with its lenders for INR 40.5bn (GBP 568.32m) of debt by way of a debt transfer to new lenders. This is the largest resolution of stressed assets outside of the NCLT structure.
A consortium of 12 lenders (led by Power Finance Corp. and State Bank of India) assigned INR 65.74bn of debt (in principal amount) to a new group of lenders led by Goldman Sachs and Varde Partners for a sum of INR 40.5bn. This is the first successful scheme to close under the RBI’s prudential framework for resolutions of stressed assets (the “Framework”). The Framework, brought in by the RBI in its 7 June 2019 circular, has effected 3 major changes to the resolution regime: (i) a longer 30-day review period for borrowers in default, followed by a 180-day resolution period; (ii) a lower consent requirement for a resolution plan to be binding on all parties - lenders holding 75 per cent of the facility and 60 per cent of the number of lenders; and (iii) additional provisioning has been introduced in case of delay to the resolution process.
PREMIER OIL UK LIMITED (“PREMIER OIL”)
Premier Oil announced on 14 November 2019 that, as of 31 October 2019, net debt was reduced by USD 300m to USD 2.03bn. The company’s net debt has consistently fallen from USD 2.33bn at the end of 2018 to USD 2.15bn by 30 June 2019. Premier Oil also intends to sell its 25 per cent stake in the Zama offshore field in Mexico (which analysts estimate could sell for more than USD 430m) as well as part of its 60 per cent holding in Sea Lion Project off the Falkland Islands.
It was also announced that production in 2019 would come in at the top end of the forecast – with production averaging 79,400 barrels of oil equivalent per day. Premier Oil’s Investor Presentation of 6 December 2019 highlighted its continuing debt reduction with a target leverage ratio of 1.5x. The company noted that it would continue to maintain a low cost base whilst funding certain selected projects. One such project, as reported by Reuters on 19 December 2019, is certain Petrobras oil fields in Brazil known as Polo Garoupa that Premier Oil is reported to be interested in purchasing.
Energy sector press reported on 16 December 2019 that Premier Oil needs to sell off further assets due to an approaching repayment date for almost GBP 2bn worth of loans. Premier Oil dismissed this report. The loans are due for repayment in May 2021; however, Premier Oil has announced that it is engaging early with banks and other creditors to optimise refinancing prior to this date. Bloomberg reported on 18 November 2019 that management of Premier Oil commenced discussions with Citigroup Inc, Deutsche Bank AG, Fortress Investment Group and Varde Investment Partners who collectively have exposure of around USD 2.5bn to Premier Oil. However, reports suggest that hedge funds owning around 40 per cent of Premier Oil's loans have hired investment bank Lazard and Akin Gump as legal representatives to push for divestments and could block debt restructuring moves by Premier Oil.
RALLYE SA ("RALLYE")
DIIS Group, representing the masse of holders of Rallye bonds, has issued a notice to convene a general meeting on 16 January 2020 where bondholders will vote on whether or not to approve the safeguard proposals made by Rallye. If the quorum is not reached, a further meeting will take place on 27 January 2020. The full notice issued by DIIS Group can be accessed here.
INSOLVENCY LAW UPDATE
AIRCRAFT REPOSSESSION UPON A DEFAULT - A REVIEW OF THE ISSUES IN THE UNITED KINGDOM, USA, INDIA AND NIGERIA
In association with INSOL International, Brown Rudnick Partner Henry Kikoyo has written a technical paper, titled “Aircraft repossession upon a default - a review of the issues in the United Kingdom, USA, India and Nigeria”, published November 2019.
The paper examines the various procedural and jurisdictional steps and challenges in relation to aircraft repossession following default across four jurisdictions - India, the UK, the US and Nigeria. It is intended to be a practical analysis written with contributions from local counsel in these jurisdictions.
The paper also addresses the very recent legislative developments in India in the bankruptcy domain which have arguably led to a more efficient procedure. For example, in the case of Jet Airways, from March 2019 to July 2019 the company's fleet went from having 100 aircraft grounded to only 11; a much swifter rate of repossession than seen in previous cases. Quite how the Jet Airways' insolvency pans out is yet to be seen. In particular, lessors/interested parties will be looking carefully at how the Resolution Prefessional of Jet Airways (India) Limited handles the claims which have emerged from the insolvency of one of India's major airlines.
Brown Rudnick has been representing aircraft leasing platforms in the insolvency of Jet Airways in India, and is well positioned to advise in relation to airline insolvencies generally.
LOAN MARKET ASSOCIATION ("LMA") UPDATES
REVISED DEFINITION OF DELAY PERIOD COMMENCEMENT DATE
This was produced as a response to demand from participants in the secondary loan market. To incorporate the rider, parties must agree to do so at the time of trade and then reflect such agreement in the associated trade confirmation. The new definition aims to provide that the Delay Period for par trades for the purposes of calculating Delayed Settlement Compensation in respect of a particular traded portion of a loan does not commence until the first investor in primary syndication has either become the legal and beneficial owner of that traded portion or has otherwise become entitled to receive such interest and recurring fees in respect of that traded portion. If the first investor sells its position in the secondary market, the rider ensures that it will not be required to account to its counterparty for the economic equivalent of the interest and recurring fees that it may otherwise be required to deliver pursuant to the LMA Standard Terms and Conditions if it does not receive such amounts itself.