SEBI Circular on Signing of Inter-Creditor Agreement

Introduction

The Reserve Bank of India (“RBI”) had issued the Prudential Framework for Resolution of Stressed Assets Directions dated June 7, 2019 (“RBI Directions”) for early recognition, reporting and time bound resolution of stressed assets. The RBI Directions are applicable only to banks and certain specified financial institutions (hereinafter collectively referred to as the “ICA Lenders”).

Since the resolution process under the RBI Directions is contractual in nature, the ICA Lenders are required to enter into an inter-creditor agreement (“ICA”) to implement any debt restructuring. However, the RBI Directions do not apply to holders of debt securities. As a result, such investors largely refrain from executing the ICA and it becomes difficult to implement a comprehensive debt resolution package.

With a view to broad-base the resolution process under the RBI Directions and make it more meaningful, the Securities and Exchange Board of India (“SEBI”) has issued a circular titled Standardisation of procedure to be followed by Debenture Trustee(s) in case of ‘Default’ by Issuers of listed debt securities dated October 13, 2020 (“SEBI Circular”).

The SEBI Circular enables a debenture trustee (“Trustee”) to execute an ICA on behalf of holders of listed debt securities (“Investors”) and also prescribes the procedure to be followed by the Trustee for seeking consent of the Investors on whether to proceed with enforcement of security and/or participate in a resolution process by executing the ICA with other ICA Lenders in case of an event of default. In this update, we discuss some of the key features of the SEBI Circular and certain ambiguities that need to be ironed out to make the restructuring process more effective

Hallmarks of the SEBI Circular

The hallmarks of the SEBI Circular are as follows:

(a) It comes into force with immediate effect from October 13, 2020.

(b) It applies to debt securities that are listed on a stock exchange. Therefore, issuers that have issued unlisted debt securities and debenture trustees of such unlisted debt securities are not bound to follow this circular.

(c) In case of multiple series of debt securities issued by an issuer, the determination of an event of default and Majority Investors (as defined below) has to be reckoned at an ISIN level (whether or not the debt securities bearing the same ISIN are issued under multiple offer documents).

(d) It provides the Majority Investors the option (but does not make it mandatory for them) to require the Trustee to enter into the ICA or opt for security enforcement.

(e) Signatories of the ICA will be bound by the standstill period provided in the ICA.

Procedure by the Trustee for seeking consent of the Investors

The Trustee should follow the following procedure for seeking consent of the Investors for enforcing security and/or entering into the ICA:

Notice: The Trustee should send a notice to the Investors within a period of 3 days from the date of the event of default. Event of default has been defined with reference to the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“SEBI LODR Regulations”). Under the SEBI LODR Regulations, a ‘default’ is non-payment of interest or principal amount in full on the pre-agreed date which shall be recognized at the first instance of delay in the servicing of any interest or principal on debt.
It remains to be seen whether provisions under the SEBI Circular will be triggered where an event of default arises as a result of a covenant default or breach of representations or a material adverse effect, which results in the acceleration of the debt by the Investors.

Further, given that the notice has to be issued within 3 days of the event of default, it is not clear whether the process under the SEBI Circular has to be followed for issuers where an event of default has already occurred or whether it only applies to events of default that will take place after the date of the SEBI Circular.

Mode of delivery of Notice: The notice should be sent by (i) registered post/acknowledgement due, (ii) speed post/acknowledgement due, (iii) courier, (iv) hand delivery with proof of delivery, or (v) email as a text or as an attachment to the email with a notification including a read receipt. The proof of dispatch of such notice or email must be maintained.
Contents of the notice: The notice should contain the following:
(i) negative consent for proceeding with the enforcement of security;

(ii) positive consent for signing the ICA;

(iii) time period of 15 days from the date of the notice to be given to the Investors for providing their consent; and

(iv) the date for a proposed meeting of the Investors.

Since the notice has to provide for a dissent from security enforcement and a positive consent for signing the ICA, it is unclear whether such notice has to be issued only when the Trustee or Investors have been approached by the ICA Lenders to adhere to an ICA, or whether such notice must be issued as a pre-emptive measure to obtain the consent from Investors should the need for adhering to the ICA arise in the future.

It is also unclear whether such a notice must be issued only for enforcement of security where there is no ICA contemplated or possible (for instance in an issuer where there is no bank or non-banking financial company that has provided any debt). If indeed a notice has to be served for mere enforcement of security as well in such situations, it may result in some delay in the enforcement process for liquid assets, especially in situations where listed debt securities have been issued on a private placement basis to individual or a small group of investors. A clarification from SEBI in this regard would be helpful.

Investors meeting: The Trustee has to convene a meeting of all the Investors within a period of 30 days of the event of default. If the default is cured after the issuance of the notice but before the date of the meeting, then such meeting can be dispensed with. The purpose of holding the meeting is unclear as the Investors are expected to notify their decisions on these issues within 15 days of receiving the notice. Ideally, the SEBI Circular should have provided that the meeting should be convened only where the relevant consent of the Majority Investors is not obtained.

Public issue of debt securities: Where the debt securities have been issued by way of public issue, the Trustee does not have to issue a notice for negative consent for proceeding with enforcement of the security or convene a meeting of the Investors.

Implementation of decision of the Investors

Majority Investors: The Trustee is bound to act as per the decision of majority of the Investors i.e. 75% by value of the outstanding debt and 60% by number at the ISIN level (“Majority Investors”).
Since the SEBI Circular introduces a new threshold for decision making for security enforcement and adhering to the ICA, it is unclear on what happens in situations where the majority thresholds agreed and documented in the financing documents (especially for privately placed debt securities) with Investors are at variance to the SEBI Circular.

Decision of Majority Investors:
(i) If the Majority Investors dissent from enforcing security, then the Trustee will not enforce the security.

(ii) If the Majority Investors consent to enter into the ICA, then the Trustee will enter into the ICA.

The requirement for a positive consent for entering into the ICA implies that where Investors abstain from providing their consent to the Trustee within the prescribed time period, the requisite majority may not be available for the Trustee to enter into the ICA. SEBI’s thought process clearly seems to be that Investors must not be forced into signing the ICA and the circular provides them more control over the process as compared to banks and financial institutions who are mandated under the RBI Directions to enter into the ICA.

(iii) If the Majority Investors do not consent to security enforcement and do not consent to enter into an ICA, then the Trustee may take further action as agreed by the Majority Investors at the meeting.

Therefore, it appears that if the Majority Investors do not agree to any course of action, the Trustee will not be able to sign the ICA and the ICA Lenders will have to move ahead with a resolution process without the Investors.

Committee of Investors: The Trustee may form a representative committee of the Investors to participate in the ICA or enforce the security or take any other action decided at the meeting of the Investors.
The SEBI Circular does not set out how such a committee will be constituted and what the role of such committee will be. We assume that this will be the decision of the Majority Investors at the meeting.

Conditions for signing the ICA by the Trustee

Once the Majority Investors have approved, the Trustee may sign the ICA and consider the resolution plan upon compliance with the following conditions:

Interest of Investors: Firstly, the signing of the ICA and agreeing to the approved resolution plan must be in the interest of the Investors.

This appears to cast a responsibility on the Trustee to determine whether signing the ICA is in the interest of the Investors and may deter Trustees from taking any definitive steps. Once the Majority Investors have consented to signing the ICA, there should not be any further onus on the Trustee to ensure that the ICA is in the interest of investors. Further, given that the ICA is generally in the format agreed by the Indian Banks Association and must include the provisions mentioned below, this requirement of the ICA being in the interests of the Investors appears unnecessary and ought to be removed to facilitate the process.

As far as the resolution plan is concerned, it would be advisable to have a clear process where the Trustee is required to seek consent of the Majority Investors for approval of the resolution plan. Most Trustees are unlikely to take an independent view on whether a resolution plan is beneficial to the Investors and will want the Majority Investors themselves to confirm on how the Trustee should vote on the plan.

Compliance with Securities Laws: Secondly, the resolution plan must be in compliance with the provisions of:
(i) The Companies Act, 2013 and the rules made thereunder;

(ii) the Securities Contracts (Regulations) Act, 1956; and

(iii) the Securities and Exchange Board of India Act, 1992 and the rules, regulations and circulars issued thereunder from time to time (hereinafter collectively referred to as the “Securities Laws”). If the resolution plan imposes conditions on the Trustee which are against the provisions of Securities Laws, then the Trustee has the right to exit the ICA with the same rights as if it had never signed the ICA. Under these circumstances, the approved resolution plan will not be binding on the Trustee.

Finalisation on the Plan in a Definite Timeline: Thirdly, the resolution plan should be finalized within a period of 180 days from the end of the ‘Review Period’1 (“Implementation Period”). If the resolution plan is not finalized within the Implementation Period, the Trustee has the right to exit the ICA with the same rights as if it had never signed the ICA. If the finalization of the resolution plan extends beyond the Implementation Period, the Trustee also has the right to consent to an extension if approved by the Majority Investors, subject to an overall time limit of 365 days from the date of commencement of the Review Period.

It is interesting to the note that he RBI Directions require that the resolution plan must be implemented within 180 days of the Review Period. However, the SEBI Circular only requires the resolution plan to be finalised within 180 days of the Review Period, thereby implying that implementation of the plan may take much longer. It is important for SEBI to clarify whether they require the resolution plan to be finalised or implemented within the Implementation Period.

Contravention of the resolution plan: If any of the terms of the approved resolution plan are contravened by any of the signatories to the ICA, the Trustee may exit the ICA and seek appropriate legal recourse or any other action as it may deem fit in the interest of the Investors.

The SEBI Circular casts an obligation on the Trustee to ensure that the conditions specified in paragraphs (b), (c) and (d) above are suitably incorporated in the ICA prior to signing the ICA.

As per the RBI Directions, the ICA Lenders are required to enter into the ICA within the Review Period. However, no prescribed timeline for entering into the ICA by the Trustee on behalf of the Investors is provided under the SEBI Circular. The absence of a definitive time-period within which the Trustee must adhere to the ICA (or provide its negative consent) may pose a challenge the ICA Lenders to work on a feasible resolution plan.

The SEBI Circular is also not clear on whether it applies to bank or financial institutions who are bound by the RBI Directions and are holders of listed debt securities. Prior to the SEBI Circular, we understand that such entities signed the ICA as they were bound by the RBI Directions. However, now that SEBI has issued a specific circular in connection with listed debt securities, would such entities have to sign the ICA as per the RBI Directions or do they need to first complete the process set out in the SEBI Circular before signing the ICA? Clarity on this from SEBI and the RBI would be useful.

Conclusion

The SEBI Circular is a welcome move as it enables the Trustee, acting on behalf of the Investors, to sign the ICA as per the decision of the Majority Investors, and participate in a restructuring process under the RBI Directions.

The contractual stand- still period will certainly bolster the chances of an effective implementation of the approved resolution plan. However, as discussed above, the SEBI Circular lacks clarity on some aspects which should be clarified or resolved at the earliest so that its benefits can be optimised.