Time to learn, unlearn and relearn NBFC resolutions

Non-Banking Financial Companies (NBFCs) in India have been quite mysterious in their existence, and remain regulated with a comparatively soft touch. They sustain mainly by financing the mid-segment and are regularly checked by the regulator for fit and proper operation. These institutions are primarily promoter or relationship-driven, occasionally attracting bad repute and, most importantly, while the NBFCs as a group are supposed to be torchbearers for sectoral financial inclusion, they enjoy near monopoly to lend to the unbanked sectors of capital market and real estate.

NBFCs work on the simple principle of borrowing to on-lend for financing. Being asset-poor, the NBFCs are completely reliant on the discipline of the borrowers, strength of the security they take for the loans they give, and the overall health of the economy. A downturn in the economy or any specific sector will lead to a direct impact on the NBFCs, as is evident from the stress that we continue to witness among these companies.

In the Indian economy, where security enforcement is challenging on multiple grounds, it is imperative to be two steps ahead in studying the winds of the sector, and to know the borrowers at a micro level to ensure recovery and resolution. While one may view the business as merely a licence, given the role that the NBFCs have played in the unbanked sectors, they did become “too big to fail”. Therefore, it is no surprise that the Reserve Bank of India (RBI) is looking to rewrite the NBFC regulations.

Seeing the amounts of funds involved, and the direct impact on the banks, the government was quick to extend the Insolvency and Bankruptcy Code, 2016 (IBC) to NBFCs with significant asset size. The IBC as legislation was never written with the intention of extending to financial service providers. NBFCs continue to face stress and the only company that got referred to the IBC was Dewan Housing Financial Limited (DHFL), with the others being left to fend for a resolution outside the IBC. A handful were successful, and few chose to give up the assets and the licence, while many continued negotiations for a meaningful resolution.

In the resolution journey, the main trump card is the valuation game. An NBFC is as good (or as bad) as the borrowers it has lent to, and the security it has taken. Promoters genuinely feel that they know their asset book the best, as was recently seen when the existing shareholders submitted a bid for a marquee NBFC, but were not selected by the lenders.

In the DHFL case, the National Company Law Tribunal (NCLT) in Mumbai allowed an application filed by Kapil Wadhwan, the promoter of DHFL, and directed the RBI-appointed administrator of DHFL to place a settlement proposal made by the promoter before the committee of creditors (COC) of DHFL for its consideration.

The NCLT, in allowing the promoter’s request, observed:

(1) The status of the applicant as a promoter does not bar him from presenting a settlement proposal, as a settlement by its very nature is offered by the promoters of a company, and the present application is not one under section 12A, which allows 90% of the COC to withdraw a corporate insolvency resolution process and enter into settlement with the promoter, but is merely a precursor to a prospective settlement;

(2) The settlement offered by the applicant envisages a significantly higher payout in comparison to the approved resolution plan, and hence ought to be considered on its merits and voted upon by the COC; and

(3) The claim of the administrator that the settlement proposal had been considered and rejected by the COC was not supported by any evidence, and failure to adequately communicate the alleged rejection.

While the National Company Law Appellate Tribunal (NCLAT) has stayed the NCLT order, and given that any challenge to the commercial wisdom of the COC is unlikely to succeed in light of the Supreme Court decision in the Essar Steel case, there are still learnings for the NBFC sector. Lenders, or the COC, or administrator and/or the decision makers, should ensure that any settlement proposal received by them, however non-feasible at a prima facie level it may seem, is duly tabled and deliberated. In a formal process, there must be a vote, with the reasons and rationale documented and the decision communicated.

Given the sector, the promoter, or shareholder, or management role and relationships with the borrowers, will continue to remain critical factors. After all, asset stripping is not a resolution. Therefore, fresh growth capital, a micro view of the sector, relationships to ensure discipline among errant borrowers and, most importantly, a clean background of the white knights will each need innovative measures for a meaningful resolution.

Veena Sivaramakrishnan and Soummo Biswas are partners at Shardul Amarchand Mangaldas & Co