CORPORATE RESTRUCTURING – The Struggle and it’s value

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This article was written by Kamakshi Gupta, a student of UPES.

BACKGROUND

  • The Banking Structure.

Indian banking sector comprises of public sector banks, private sector banks and foreign banks. In the 1950s, the limited regulatory control over interest rates and trivial pre-emption of funds in the financial system resulted inequitable distribution and misallocation of credit. To ensure proper allocation of credit in the priority sectors, Indian government tightened its control over credit allocation and introduced administered interest rates both on deposits and loans, high reserve requirements and rigorous statutory liquidity restrictions, which culminated with the nationalisation of 20 major commercial banks between 1969 and 1980. The net effect of this overregulation resulted in an inefficient allocation of resources, high operating costs, declining profitability and deteriorated asset quality. In 1992, the RBI started the liberalisation process stressing deregulation and opening up of the banking sector to market forces aimed at providing operational flexibility and functional autonomy. Since then it has been consistently working to establish a sound regulatory framework in order to facilitate effective supervision and institutional infrastructure. The diversification of ownership through considerable dilution of capital by the government reduced overpowering of state-owned banks, and yields a level-playing field for all. This first phase of reforms improved the competitiveness and efficiency in the resource allocation process of the banking sector and strengthened the transmission mechanism of monetary policy including reduction in statutory liquidity ratio (SLR), cash reserve ratio (CRR), permission for de novo entry of banks in the private sector, and deregulation of interest rates.

The second phase of reform started in 1998 with the aim enhancing banking stability through improved banking regulation, increasing competitiveness, adoption of capital adequacy norms, prudential norms for asset classification and provisions for delinquent loans in line with global practices. To adhere to the stipulated capital adequacy norms, substantial amount of capital

were injected by the government of India to the public sector banks. To this end, there has been a wave of mergers and acquisitions conducted both according to the market principles and with the assistance of government.

  • Restructuring

 Restructuring have existed from late 1970‟s when RBI i.e. Reserve bank of India have issued guidelines and instructionfor the people who were affected by natural calamities.Since then the instruction are turned into guidelines that have to be followed to restructure the debt of companies facing financial difficulties.In 2001, RBI came up with the certain guidelines that will be followed by banks and other financial institutions.

  • In the guidelines RBI stated that the Corporate Debt Restructuring mechanism is voluntary and if 75%of creditor decide to aid the company rest 25% will have to agree. Corporate Debt Restructuring is also available to only those companies which have taken loan from multiple creditors, the outstanding amount of debt of all the creditors and lenders should be 100 million or above in aggregate. It covers all categories of assets categorized by the RBI in terms of prudential assets classification standards. Cases which are filed with the Debt Recovery Tribunal, The Bureau of Industrial and Financial Reconstruction or any other case are qualified for reconstruction underCorporate Debt Restructuring.

  • A bank or a financial institution can refer for Corporate Debt Restructuringif it has a 20% share in working capital or term loan of the company.Corporate Debt Restructuring group atits meeting held on April 29, 2015 update all the Restructuring have existed from late 1970‟s when RBI i.e. Reserve bank of India have issued guidelines and instruction for the people who were affected by natural calamities.Since then the instructions were turned into guidelines that have to be followed to restructure the debt of companies facing financial difficulties.

  • After the slowdown of 2008, there has been a spurt in the number of companies going for Corporate Debt Restructuring. The heart of the mechanism, the Corporate Debt Restructuring cell, had 401 cases as on March 2013, involving a debt of Rs 2,29,000 crore, compared with 292 cases involving Rs 1,50,000 crore up to March 2012, a rise of 50%. This amount was half as on March 2009.While restructuringa loan bank give a borrowerlonger time loan to repay old loan converting working capital outstanding into terms loan.

  • Traditionally, banks have preferred to restructure the debt of stressed borrowers through the CDR or JLF mechanisms. While the CDR mechanism was used extensively, the objective seems to have been to provide temporary relief to the borrower rather than make active efforts to revive businesses. CDRs have met with limited success (only 17% exits as of June 2016) in reviving stressed assets due to poor evaluation of business viability and the lack of effective monitoring.

INTRODUCTION
Corporate debt restructuring is the restructuring of a company’s outstanding obligations, often achieved by reducing the burden of the debts on the company by decreasing the rates paid and increasing the time the company has to pay the obligation back. This allows a company to increase its ability to meet the obligations. Also, some of the debt may be forgiven by the creditors in exchange for an equity position in the company.

In the era of globalization, Indianindustries arestarving to survive because of the competition. Due to which companies are facing financial hardships so to revive these industries it is necessary to restructure their debts corporate debt restructuring is one of such mechanism.

Corporate debt restructuring in which banks, financial companies aid those companies which are facing financial difficulties due to external and internal affairs. Corporate Debt Restructuring is a non-statutory mechanism .The real motive behind this mechanism is to provide timely support to a company and revive them so that interest of shareholders, investor, stakeholders and parties who are acting as stake holders can be protected. If the trouble of financial hardship poseshigh risk of insolvency one can negotiate with lenders and decrease their chance of insolvency. Corporate debt restructuring is used by companies facing such financial hardship.

HISTORY AND ORIGIN OF INSOLVENCY LAW IN INDIA

 The history of credit is probably as long as the history of humanity.

[1]“When an individual applies for credit or borrows money, he or she enters some kind of written or oral agreement. If there is no repayment, the debtor breaks a contract that is considered fundamental in every economy.”“The treatment of people who have become insolvent can thus give us an indication of how those who failed or could not fulfill their borrowing contracts have been considered from the point of view of the legislator.” “Already in Classical Antiquity, different systems were created to deal with insolvency. “Bondage, corporal punishment and debtors’ prison were used.”“Europe remained without a (well-) functioning bankruptcy system for a long time. Such a system did not develop until the period of the prosperous Italian medieval commercial towns.”“An insolvent person was thus dealt with according to common law or according to regulations that had emerged before or outside a bankruptcy system. The debtor was dealt with in harsh terms and insolvency was thus considered as equal to theft from the creditor.”“A reason for this was that in Europe the Roman notion fallitus ergo fraudator (insolvent thus a swindler) worked like a distorting shadow to explain how insolvency had occurred. This continued late into the nineteenth century. Thus, undesired characteristics, such as pride, vanity and an exaggerated tendency to speculate, were often considered as reasons for insolvency.”“Debtors’ prison was created to force a debtor who a priori was considered a swindler to reveal possibly hidden sources. The system of debtors’ prison allowed time-limited custody in jail or “debtors’ prison” for a debtor who did not fulfill his or her financial obligations.”“For several centuries, the system coexisted with a slowly emerging bankruptcy system. Corporal punishment and prison sentences were disappearing and the debtor was less and less subjected to social stigma during the eighteenth and nineteenth centuries.” “The emergence and spread of joint stock companies, changes in the credit market and knowledge about the existence of the business cycle movements were factors that served to depersonalize further the notion of the reasons for insolvency.” “A more varied picture of the reasons for economic failure slowly emerged and many countries established modern bankruptcy laws in the mid-nineteenth century. From the mid-nineteenth century and onwards, bankruptcies are increasingly seen as an economic rather than as a moral failure. It became easier for entrepreneurs who had failed to return with a new business after a bankruptcy.”

 

INSOLVENCY AND BANKRUPTCY CODE, A NEW CORPORATE BANKRUPTCY REGIME FOR INDIA

The concept of restructuring holds relevance in the context of insolvency when the company is in financial distress as restructuring of a company is done when the company essentially has a viable business but owing to external factors, it has a bad balance sheet and therefore incurs losses. These external factors may be factors such as government policy, change of interest rates, pressure on the domestic currency, among other factors. These situations are beyond the company’s control and when a company tends to have a bad balance sheet owing to such unfavourable conditions, it has to be given another opportunity to manage its assets and liabilities and therefore here the role of debt restructuring is important. The basic objective of debt restructuring is to ensure that the company’s business stays viable in the long term and the creditors in turn enter into different arrangements with the company with respect to foregoing a part of the loan, or exchanging a part of the debt for equity shares in the company, which is also referred to as the debt equity swap, or creditors agreeing to a fixed moratorium period where both the company and the creditors agree to refrain from taking any action against each other during the fixed period. The concept of corporate debt restructuring is part of the external restructuring mechanism of the company where it has to ensure that it has the assets to back the restructuring program, because once the company enters into the zone of insolvency, it has little choices to make and prolonged insolvency then becomes a ground of winding up the company and it loses its separate legal identity. However, if proper arrangements are made with the creditors, both the company and the lenders are satisfied with it and the company is able to keep its business thriving

THE NEED:

“The principal focus of modern insolvency legislation and business debt restructuring practices is not the liquidation and elimination of insolvent entities but on the remodeling of the financial and organizational structure of debtors experiencing financial distress so as to permit the rehabilitation and continuation of their business.” “In some jurisdictions, it is an offence under the insolvency laws for a corporation to continue in business while insolvent. In others (like the United States with its Chapter 11 provisions), the business may continue under a declared protective arrangement while alternative options to achieve recovery are worked out.”

“Ultimately the basic objective of insolvency laws is the distribution of the effects of a debtor in the most expeditious, equal and economical mode and liberation of his person from the demands of his creditors when he has made a full surrender of his property.”

[1]Karl Gratzer& Dieter Stiefel ,History of Insolvency and Bankruptcy , 6-10

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