(a) Is it more usual for the financing needs of these types of corporates to be satisfied out of capital (equity) raisings; retained earnings; or external borrowings?

 

Out of all the listed sources of financing for the corporates, the most common method is through equity. This is done by a Company by issuing two types of securities-Preference shares and Equity shares. Equity shares provide the risk capital or venture capital and are the real risk bearers and controller of a Company. Major business corporates also go for offshore sources of lending and financing as they are cheaper than domestic loans (because of the interest rates being lower than in India).

(b) What are the main sources for borrowing for these types of corporates?

 

The main sources for borrowing are detailed as under:

1. Public deposits-Public deposits have been a peculiar feature of industrial finance in India. Companies have been receiving public deposits for a long time in order to meet their medium-term and long-term requirements for finance. This system was very popular in the cotton textile mills of Bombay, Ahmedabad and Sholapur and in the tea gardens of Assam and Bengal. In recent years, the method of raising finance through the public deposits has again become popular for various reasons. Rates of interest offered by the Companies are higher than those offered by banks. At the same time the cost of deposits to the Company is less than the cost of borrowings from banks.

While accepting public deposits, a Company must follow the provisions of the Companies Act and the directions issued by the Reserve bank of India. According to the Companies (Acceptance of Deposits Rules, 1975 as amended in 1984), no Company can receive secure and unsecured deposits in excess of 10% and 25% respectively of paid up share capital plus free reserves. The Central Government has laid down that no Company shall invite a deposit unless an advertisement, including a statement showing the financial position of the Company, has been issued in the prescribed form. Under the new rule, deposits cannot be invited for a period of more than 5 years. However, deposits can be renewed. The rate of interest payable on deposits must not exceed 15% per annum. In order to repay the deposits maturing in a particular year, the Company must deposit 110% of the deposits with a scheduled bank or in specified securities. Companies accepting public deposits must regularly file returns giving details of such deposits. Since April 1, 1980, public sector Companies have also been permitted to invite public deposits. There have been some large failures to make payment to public depositors and recently Government has made further proposals to the RBI for strengthening the security for such depositors and members of the public.

2. Hire Purchase-The Hire Purchase Act, 1972 defines a hire purchase as an "agreement under which goods are let on hire and under which the hirer has an option to purchase them in accordance with the terms of the agreement and includes an agreement under which certain conditions are listed". Initially, manufacturers and dealers themselves financed hire purchase transactions. Subsequently, commercial banks, public financial institutions e.g. ICICI, IDBI, etc. and hire purchase Companies started offering finance for hire purchase deals.

3. Term Loans from Banks-In recent years, commercial banks have started term lending. A term loan is a loan granted for periods ranging from 3 to 7 years. Nationalization of banks, refinancing facilities by the IDBI, increasing deposits and institutional arrangements for investigation and appraisal have enabled the commercial banks to grant medium-term finance in particular to small scale units in the priority sector.

Generally banks insist on security while granting facilities to business firms. The security is provided in the form of a pledge, mortgage or hypothecation, and other charges over the receivables. The main types of security accepted by banks are goods or stock in trade; documents of title to goods; railway receipts etc, property title deeds, insurance policies etc.

4. Bank Credit-commercial banks in the country serve as the single largest source of short-term finance to business firms. They provide it in the form of Outright Loans, Cash credit, and Lines of Credit.

5. Lease financing by banks/NBFC is also fairly common in India and equipment leasing has a wide customer appeal.

The Government has a declared policy on external commercial borrowing, and the proceedings are published for availing foreign debt. There is a "queuing system", and an informal ceiling of foreign debt availability for the corporate borrower. High risk for covering foreign exchange risks is a deterrent. In order to meet the growing financial needs of industry, the GOI decided to establish special financial institutions both at the national and the state levels. At the national level, the IFCI, the ICICI, the IDBI, the NIDC, the NSIC were set up. SFC's and SIDC's were established at the State level. Moreover, the LIC and the UTI were established to mobilize public savings and to channelise them in to industry.

Industrial Finance Corporation of India (IFCI)- The IFCI is the first industrial financing institution to be set up in India soon after independence. It was set up as a statutory corporation in July, 1948. But was later converted in to a Government Company. The IFCI provides financial assistance to any public limited company and co-operative society registered in India. Such units must be engaged in the manufacture, preservation or processing of goods, or in the shipping, mining or hotel industry, or in the generation and distribution of electricity or any other form of power. Public limited companies in the public sector are also eligible to receive assistance from the IFCI. But proprietary concerns, partnership firms and private companies are not eligible for financial assistance from the corporation. The corporation may grant assistance ranging from Rs.30 lakhs to Rs.2 crores to a single enterprise. Assistance may be given in any one or more of the above forms for a maximum period of 25 years.

State Financial Corporations (SFC's)- As the Industrial finance Corporation does not provide industrial finance to all types of enterprises, the need was felt for state level financial institutions to finance the needs of non-corporate and other small enterprises. On September 28,1951, the Parliament passed the State Financial Corporations Act. The Act came in to force with effect from 1st August, 1952. It empowers the State Governments to establish financial institutions for their respective States.

State Financial Corporations can provide financial assistance to public and private limited companies, co-operative societies, partnerships and sole-proprietary concerns. The maximum amount of financial assistance to a single concern is Rs.60 lakhs for companies and Rs.30 lakhs for partnerships and sole proprietary concerns. Now SFC's have been authorized to subscribe the equity shares of weaker small and medium industrial concerns. They can also meet the foreign exchange requirements of such industrial units.

Industrial Credit and Investment Corporation of India (ICICI)- In view of the limited risk capital which IFCI and SFC's provide, need was felt for a more enterprising and flexible institution to facilitate industrial development in the private sector in India. A World Bank-cum-American Investment Mission visited India in 1954 and recommended the establishment of special institution for the purpose of assisting industries in the private sector. Accordingly, the ICICI was set up on January 5, 1955 as a public limited company under the Companies Act. The Corporation was set up as a privately owned institution but later on the Life Insurance Corporation of India (a statutory corporation) became its major shareholder.

The ICICI has wide powers. It can provide any amount of financial assistance to any public or private company in the private sector. It can now give assistance to projects in the joint sector and co-operative sector. It is authorized to provide foreign currency loans to partnerships and proprietary concerns also. Ordinarily Rs.5 lakhs is the minimum limit and Rs.1 crore is the higher limit for financial assistance to a single concern. Loans are given generally for the purpose of buying capital assets like land, buildings and machinery. In fact, the ICICI specializes in providing loans in foreign currency. The Corporation helps in the promotion of new enterprises as well as in the expansion and modernization of existing concerns so as to build up a sound industrial basis in the private sector. The Corporation is a leading supplier of credit in foreign currency. About 57.2% of the total assistance has been provided in the form of foreign currency. The ICICI also subscribes to the industrial securities on a large scale. It has emerged as the pioneer in the field of underwriting in the country. It has also developed consortium underwriting in co-operation with other financial institutions.

The Industrial Development Bank of India (IDBI)-The IDBI was set up as apex institution and started its operations with effect from July 1, 1964. The needs of rapid industrialization, long term financial needs of heavy industry beyond the resources of the then exist6ing institutions, absence of a central agency to co-ordinate the activities of other financial institutions and gaps in financial and promotional services were the main causes behind the establishment of the IDBI.

The IDBI has been given wide powers and it enjoys full operational autonomy. The bank can provide financial assistance directly as well as through other institutions to all types of industrial concerns irrespective of their size or form of ownership. There are no maximum or minimum limits on the amount of assistance or security. The bank has he freedom to deal with any problem relating to industrial development in general and industrial finance in particular.

Several new institutions like the SIDBI [Small Industries Development Bank of India], the IDFC [Infrastructural Development Finance Corporation of India] have come up which cater to specific market needs. IDFC has commenced credit enhancement and guarantee facilities to banks & institutions for their customers and undertakes risk participation assistance and take out financing also.

In addition to the above mentioned sources, there are also present local banks, non banking financial companies as sources of borrowing for these corporates.

(c) Is there significant competition among lenders and significant choice of sources for borrowing available to these types of corporates?

 

There is a lot of competition amongst the various sources of corporate lending, to be able to disperse loans to these corporates. This is primarily due to the presence of the private banks. In addition to the mainstream Indian banks which are nationalized, there are several private banks operating in India presently. This competition is manifesting itself in the form of lower and more lucrative interest rates for lending, better services and other similar attractive packages.

(d)What is the present average rate of interest payable in respect of unsecured and secured debt?

 

The present average rate of interest varies from 14% to 16% for the unsecured and secured debt.

(e) Is finance generally available for long, medium and short-term borrowings?

 

Finance is available for long, medium and short term borrowing at varying rates. A debt market for Government securities is available, but for the private debt market steps for creating such a market are being undertaken by Government rates of interest vary in each market segment.

(a) What part does the central bank of this economy play in the regulation of the banking and finance sector? Would it intervene or seek to influence the outcome or course of events if, for example a large corporate with debt exposure to a number of banks was in financial difficulty?

 

The Central Bank of India is the Reserve Bank of India, which is mainly responsible for regulation of the banking and finance sectors. The RBI was established under a law promulgated by the Parliament in 1934. This is done by the RBI by acting as the agent for the Government. An exclusive control is exercised on the business of banking by the RBI as only the RBI has the power for the issuance of bank noes and the supply of currency in the country. What denomination and in what amounts is also determined by the central board of the RBI. All the scheduled banks are also required to maintain with the RBI an average daily balance that shall not be less than three percent of the total of the demand and time liabilities of such bank. It is also in the power of the RBI to be able to purchase, sale and rediscount bills of exchange and promissory notes. Also the RBI is authorized to purchase from and sell to scheduled banks foreign exchange. The RBI can also make loans and advances to scheduled banks and to state co-operative banks. This power extends to making such advances to State financial corporations as well as the above mentioned special institutional bodies such as IFCI etc. again as part of its function of controlling the banking business in India the RBI keeps deposits with the State Bank of India for specific purposes as may be approved by the Central Government in this behalf. It also has custody of monies, securities and other articles of value and collects proceeds, whether principal, interest or dividends, of any such securities.

The RBI has the power to control the policy in relation to advances by banking companies when it is satisfied that it is necessary to do so in the public interest, or in the interests of depositors, or when banking policy demands it. No banking company can carry out banking business in India unless it holds a license issued for that purpose by the RBI. In respect of a company incorporated outside India, the RBI should be satisfied that the carrying out of business by such company will be in the public interest, and the Government or law of the country in which it is incorporated does not in any way discriminate against banking companies registered in India. Further the RBI had the power to cancel a license granted to a Banking Company. The RBI also has the power to, on its own initiative and on being directed by the Central Government, conduct inspection of a banking company and its books and accounts. The RBI's approval is mandatory in matters relating to amendment of provisions regarding the number of Directors, appointment or re-appointment or termination or remuneration of the Chairman, Managing Director or any other director of a banking company.

The RBI may determine the policy and give directions to all or any of the non-banking financial companies relating to income generation; accounting standards; marketing of proper provision for bad and doubtful debts; capital adequacy based on risk weights for assets; credit conversion factors for off-balance sheet items; relating to deployment of funds by a non-banking financial company or class of such companies, or such companies generally. The RBI may file for winding up of a non-banking company on being satisfied that a non-banking financial company on fulfillment of certain criteria such as being unable to pay its debt; or that the continuance of the non-banking financial company is detrimental to the public interest or to the interest of depositors of the Company. The RBI has also introduced prudential norms & capital adequacy ratios for banks, to ensure or observance of some norms to reduce the risk of exposure to a single sector, or for Company or group. This is strictly monitored and the auditors are obliged to report such exposures. RBI has full powers to oversee the banking business in India.

(b) Is there any tradition in this economy for a 'main' or 'house' or 'lead' bank to become involved as a chief negotiator or leader in the case of the financial difficulty or insolvency of a large corporate borrower with debt exposure to a number of banks?

 

In consortium financing or syndicated loans, there is usually a lead bank or financial institution. Banks enter into inter creditor arrangements whereby a Security Agent is responsible for marshalling the security and be the chief negotiator or leader in case of financial difficulty of likely insolvency of a corporate borrower. Banks also insert contractual covenants to appoint nominee directors and other representatives on the boards of the corporate borrowers. And as they are, statutory corporations in the first place therefore they can be suitably expected to represent the interest of the public and the directions of the Central Government. Private banks are increasingly taking upon themselves such a role of Security Agent, or Administrative Agent or Monitoring Agent to regulate the information flows and security of the Borrower.

(a) Is assessment or analysis of lending risk widely practised in this economy?

 

In India, banks normally never review/verify securities.

(b) If so, does the average lending bank make adequate assessment of risk analysis when contemplating lending to a corporate borrower?

 

There is no specific policy to analyze lending risk practiced by the banks. While granting credit, a commercial bank generally takes in to consideration the factors such as nature and size of the enterprise, financial soundness of the concern, profitability of the business, quality of management, ability to repay its loan, technical and commercial feasibility of the project, security offered by the business unit. But this is all general and standard evaluation and cannot be compared to a step by step analysis of the credit worthiness of a borrower. A similar procedure is followed by the specialized institutions such as IFCI, IDBI, ICICI and other similar lenders. Pledges and mortgages are commonly accepted by the banks as forms of security. The banks may ask for the depositing of the mortgaged property deeds or the agreements drawn up for the pledge of securities. Only the large banks have trained project and risk appraisal departments, and usually the smaller banks rely upon the larger banks for such appraisal and reports.

(c) Would it be usual or common for a lending bank to regularly monitor the financial performance of a corporate borrower?

 

Once the average bank sanctions its loans etc, under the loan covenants there are reporting requirements which facilitate the Banks and lenders to monitor the financial performance of a corporate borrower.

(d) Would it be usual or common for a lending bank to be regularly supplied with copies of the financial statements of a corporate borrower?

 

It is a usual stipulation of large loans that Banks be furnished with corporate compliance reports and certificates and bank statements of the Bank accounts for fuller information on the applications of funds and fund flows and current expenditure. In smaller loans, the monitoring by Banks is weaker though Banks are contractually empowered to monitor the performance of a Borrower, and oversee fund application. Banks are to be regularly posted with the financial statements and records and balance sheets.

(a) Is there a significant source of foreign bank lending in this economy?

 

There is an ever increasing presence of foreign banks in India. These banks offer an altogether different method of functioning, and operations as opposed to the work ethic of the main Indian nationalized banks. However it is doubtful, whether these banks are being used for significant corporate lending. One reason for this is that their risk evaluation is more advanced as compared to that practiced by the nationalized banks. Though these banks are used frequently for disbursing credit to individual businessmen and high managerial officers in corporate enterprises. Almost all major foreign banks have a presence in India. Their forte is in investment banking and specialized facilities for finance servicing, high networth individuals and they have made major forays in project financing.

(b) If so, is it usual for this funding to be provided by the foreign bank/s alone or in combination with funding from local or domestic bank/s?

 

It is unusual for a foreign Bank to be involved as a sole banker for any major term lending or syndicated lending financing deals. Due to the prudential norm guidelines exposures are usually spread among a syndicate security, in special sectors is normally held by domestic banks. Unless the amounts drawn/drawable are within the prudential norms and group exposure norms the single bank lender relationship cannot work in India. There are limits of exposure prescribed for loans and investments in a company, in a group and in the sector to manage the risks, and hence the single lender who would develop the clients' opportunity and subsequently spread the risk by down selling its debt or investment.

Due to the prudential norms policy, a single borrower exposure and effect of insolvency is rare. The risk sharing and consortium or syndicated lending spreads the banks risks. Takeout financing and risk participation assistance has just been introduced to the domestic market by IDFC & SBI (State Bank of India) and these facilities will further spread risk and diminish the exposures, and resolve deposit/debt mismatches.

(c) Are you able to detect whether there are significant differences in approach and funding terms when a foreign bank is involved in the lending (as compared with a purely local or domestic funding)?

 

Yes there is a significant difference in approach and funding terms where a foreign bank is involved in the lending, in comparison to purely local or domestic funding. The main difference in approach is that these foreign banks undertake greater risk analysis, project appraisal. Their cost of borrowing is cheaper, as they have access to cheaper. They have introduced greater controls and innovative forms of receivables financing for e.g. introduced Trust & Retention Accounts, Escrow Accounts etc.

(d) If so, what are the main differences?

 

(a) Is 'related' or 'exclusive' lending (ie where a corporate borrower and a bank have an established commercial relationship such that only that lender is looked to as the source of borrowing by the corporate borrower) common in this economy?

 

Same as B-4. (b).

(b) If no, what effect does this have if the corporate borrower is in financial difficulty or is insolvent?

Same as B-4. (b).

(a) Is 'syndicated' lending (ie where a group of banks or financial institutions join together to provide funding for a corporate borrower) common in this economy?

 

It is not uncommon to find a borrower availing term loans as well as working capital limits from a number of financial institutions and commercial banks. A term loan to a borrower may be sanctioned jointly by all India financial Institutions and Banks. Similarly, working capital limits may also be availed by the borrower from a number of banks partly because of the large size of borrowing and partly to have degree of flexibility in its operations with different banks.

In other cases the borrower may have a multiple banking relationships where it has independent arrangement with each bank, security offered to each bank is separate and no formal understanding exists between. Under this arrangement banks may not be exchanging information on the borrower and limits may have been sanctioned on different terms and conditions. This arrangement may be preferred by the borrower and as it affords him a great flexibility in operating his accounts with different banks but goes contrary to the expectations of Reserve Bank of India which desires that a holistic view of entire operations of a customer must be taken by the banks and the assessment of credit needs to be done in totality. Interse Creditor Arrangements for Security Sharing, appointment of Security Agents for control of the assets and recovery modes and sharing of proceeds are carefully contracted in the consortia/syndication. Participation certificate and partial assignments have not been successful in these Schemes.

The other arrangement for sanctioning of credit limit to such a borrower may be to form a consortium of banks to take care of the entire needs of the borrower. No definite guidelines on formation of a consortium of bank, however existed in the part and it was generally left to the borrower to decide this composition and the proportion of sharing. The system of consortium lending is well developed among the public financial institutions like IDBI, ICICI and IFCI, on a sectoral and regional basis.

(b) If so:

(i) does a lead bank perform the role of 'agent' on behalf of all the lenders; and/or

 

(ii) is the concept of a 'trustee' (or similar) for a syndicate of banks (ie where the 'trustee' holds any security for the syndicated funding on trust for the syndicate of banks) known and/or practised in this economy?

 

(i) and (ii) Role of the Lead Bank

The appraisal of credit proposals will be done by the lead bank. The borrower has to submit all the necessary papers and data regarding appraisal of its proposed limits to the lead bank which in turn will arrange for preparation of necessary project appraisal reports and its circulation to other member banks. Lead bank must complete the entire work relating to approval within the specified time frame. Lead Bank will also be responsible to submit the proposal to Reserve Bank of India for post sanction scrutiny under ' Credit Monitoring Arrangement' on behalf of the consortium members and will further attend to correspondence with Reserve Bank of India in this regard.

There may be some times be disagreement between the member banks on the quantum of permissible bank finance terms and conditions or any other matter. In such cases, decision of the consortium will be binding on the Lead Bank as also other members. Lead Bank will however, enjoy the freedom to sanction an additional credit upto a pre-determined, percentages in emergent situations. The Lead Bank should however inform other members immediately together with their pro-rata share. It performs the role of an agent, but recent trends indicate several new agency relationships with the Banks. The new syndication models contemplate agency for administrative responsibilities for the consortium, and a separate Security Agent or Trustee Agent for the monitoring of security of the Lenders.

The quarterly opening statements required under the "Chore Committee" for fixation of quarterly operative limits will also be required to be sent to the lead bank who shall in association with the bank having the next largest share in the credit facilities should meet at quarterly intervals and fix the operative limits and also individual banks share thereof for the next quarter. The information regarding quarterly operative limits fixed in such a manner would be communicated by the lead bank to other member banks.

In a consortium, lead bank or the lead bank and the bank with the next highest share will be the final authorities in cases of the differences of opinion and their views will prevail in all cases of disputes among the members relating to terms and conditions.

Therefore it will be appreciated that the borrower under the consortium arrangements in required to deal with the lead bank and banks having second largest share in total credit limits for all practical purposes. The borrowers were put to inconvenience for execution of various types of document etc. with various banks in the consortium. On the recommendation of "Mahadevan Committee" who submitted its report in April, 1988 Reserve Bank revised guidelines in relation to consortium advances and the estimate idea set for the banking industry in to achieve single window concept for lending (SWCL), to minimum delay and inconvenience to the borrower. Single window concept has now been brought into operations in respect of two important areas of lending like term loans and working capital finances.

It may be mentioned that the Reserve Bank of India has permitted the lead bank to charge a suitable fee (say 0.25 per cent of the limits) per annum for various services rendered to the borrower. However, the Borrower negotiates these fees, which may in fact be higher, depending on arranger's fees being charged. The concept of a Trustee holding security for other Lenders is fairly common in India.

The Agent and Trustee relationship is for the protection of the syndication/consortium of Lenders. The Agent/Trustee has no duty to the Borrower. However, in practical terms, at the instance of the Lenders, or subject to the commercial terms, the Agent and Trustee does facilitate rehabilitation by making variations to contractual commitments.

(iii) if the corporate borrower is in financial difficulty or is insolvent what function does the 'agent' or 'trustee' perform?

(a) Is the concept known as 'debt subordination' (ie, a contractual arrangement between lenders in which there are 'layers' of 'senior' and 'junior' debt and which has the effect of postponing repayment of the 'junior' debt until payment has been made of the 'senior' debt) recognised and practised in this economy?

 

For Corporate borrowings, usually no single individual or corporate borrower may in normal circumstances be in a position to meet the loan requirements of a corporate. Loan money has therefore to be raised from a large number of individuals very much in the same way as share capital. Loans may have to be obtained in a sequence based on capital needs. The Transfer of Property Act in India recognizes the concept of debt subordination and layering between senior and junior Lenders. By the terms of registration of the charges under the Companies Act, the priority of the charge can be stipulated contractually. The commercial terms, debt service coverage ratio and debt/equity ratio determine the extent to which subordinated debt can be availed. The law provides for ranking charges. The same assets can be charged to several lenders and also to several lenders in a series.

Since all the creditors have also to seek payment only out of the company's assets, the problem that has to be tackled is to how they should know before supplying credit what assets would be available as security for their payments?. The Companies Act prescribes for registration of charges with the Registrar of Companies and it also gives the list of assets on which a charge is required to be registered. Registration of charges functions as notice to the public at large and identifies the assets which are subject to the charge. It becomes a source of public knowledge on enquiry and therefore, operates as constructive notice and a protection, to all classes of persons interested in knowing the assets position of the Company. It makes the charge effective against all persons (a declaration in rem) including the liquidator.

As per Section 125 of the Companies Act "every charge created on or after the 1st day of April, 1915 by a company, so far as any security on the companies property or undertaking is conferred thereby, be void against the liquidator and any creditor of the company under the prescribed particulars of the charge, together with the instrument if any by which the charge is created or evidenced or a copy thereof verified in the prescribed manner, are filed with the Registrar for registration in the manner required by this Act.

Under this is done, the charges shall be shall be void. This requirement is for;

a) a charge for the purpose of securing any issue of debenture;

b) a charge on uncalled share capital of the company.

c) a charge on any immovable property where ever situate, or any interest therein.

d) a charge on any of the book debts of the company.

e) a charge not being a pledge, on any movable property of the company.

f) a floating charges on the undertaking or any property of the company including stock in trade.

Therefore it can be seen, that the abovementioned and statutory requirement extends to almost all kinds of securities the simplified procedure involves:-

i) filing the prescribed particulars together with copy of the instrument creating the modification thereof or satisfaction along with the registrar is form 8 etc. in triplicate.

In addition to this section 130 requires a register of charges to be kept by the registrar section 131 requires an index of charges to be maintained. The registrar is to keep a chronological index in the prescribed form and with the prescribed particulars of the charges. Registered with him.

(b) If so, is debt subordination recognised and/or enforced under the insolvency regime of this economy?

 

Yes, debt subordination is recognised and/ or enforced under the insolvency regime of this country. The concept of marshalling of debt is recognised under the Transfer of Property, Act, 1882 dealing with security interests on property."

Section 81 of this Act, deals with marshalling securities if the owner of two or more properties mortgages them to one person and then mortgages one or more of the properties to another person, the subsequent mortgagee is, in the absence of a contract of the contract entitled to have the prior mortgage debt satisfied out of the properties not mortgaged to him, so far as the same will extend but not so as to prejudice the rights of the prior mortgage or of any other person who for consideration acquired an interest in any of the properties.

This section applies to several properties subjected to a charge or multiple charges and to several successive mortgages, however, it should be noted this section applies to the mortgages of immovable property and not to the hypothecation of moveable.

Marshalling as described above settles the rights of competing mortgages, while contribution settles the rights of mortgages of several properties or of several shares in one property. According to Section 82 of the Transfer of Property Act stipulates that:

'Where property subject to a mortgage belongs to two or more persons having distinct and separate rights of ownership therein, the different shares in or parts of such property owned by such persons are, in the absence of a contract to the contrary, liable to contribute ratably to the debt secured by the mortgage and for the purpose of determining the rate at which each such share or part shall contribute, the value thereof, shall be deemed to be its value at the date of the mortgage after deduction of the amount of any other mortgage or charge to which it may have been subject on that date.'

 

(a) Is it permissible for banks to own equity in a corporate borrower?

 

Under the Banking Regulation Act, banks cannot own more than 30% of the issued equity of any borrower. The prudential norms and capital adequacy norms do not permit a bank to exceed 30% ceiling in investment in a corporate borrower. However, in relation to a pledge, for enforcement of security, and as a security interest, banks do take the entire equity of a corporate borrower as collateral security for the benefit of the group or consortium.

(b) If so, is it permissible for a bank to convert debt to equity?

 

Under the Companies Act and Section 81 thereof, it is permissible for a bank to convert its debt into equity. The law requires that a convertible debt should be approved by the shareholders prior to the issue or placement of the debt or approval of the Central Government should be taken for conversion of the debt into equity.

(c) Are there instances where this has in fact occurred, particularly in the context of either:

(i) in the context of an 'informal work out' as a result of the insolvency or approaching insolvency of a corporate borrower; or

(ii) in the context of a formal insolvency administration of a corporate borrower?

 

Under the provisions of the Sick Industrial Companies (Special Provisions) Act, 1985, a measure of rehabilitation it is provided that a sick company can seek is the conversion of debt into a fixed funded debtor with a zero coupon rate or equity so as to convert the debt into a risk capital. There are instances of this happening in schemes of reconstruction by the Board of Industrial and Financial Reconstruction as also in the context of formal insolvency administration of a corporate borrower.

(d) In such a case, is it usual for the bank to be then represented on the management or board of the corporate borrower?

 

Most of the large all- India public financial institutions normally reserve the right to appoint their nominee directors on the Boards of the assisted concerns. The actual appointments for directors are, however made generally after mutual consultation among the institutions depending upon the extent of their combined shareholdings, the size of aggregate debt and individual debt, the role of the lead institution etc. They do not exceed certain number of the total strength of the Board, nor do they assume executive positions since they do not want to be burdened with management responsibilities. Detailed guidelines are issued to the nominee director appointed by institutions. The nominee directors are not to interfere in the day to day affairs of the assisted concern, but are expected to keep themselves fully acquainted with the affairs of the assisted concern and extend full co-operation to the management. They are also to ensure that, among other things, the following issues are reviewed at periodical board meetings.

i) Financial performance;

ii) payment of dues to institutions

iii) payment of statutory and other dues to Government

v) transactions in shares.

iv) Inter corporate instrument including deposits, loan and advances.

vi) contracts, purchaser and sale of raw materials, finished goods, machinery etc. and

vii) Major items of expenditure particularly those relating to management.

They are also appointed to the membership of audit committees or share transfer committees to regulate the proceedings.

(a) Is there a market for 'debt trading' (ie, where a bank might sell or trade the debt owed to it by a corporate borrower) in this economy?

(b) If so, is debt trading common in this economy, particularly where the corporate borrower is insolvent or near insolvent?

 

The National Stock Exchange has introduced debt trading for instruments like bonds, debentures and debt instruments. There is a separate market for inter-bank debt instruments which is capable of being participated in by other banks and authorized money market brokers. These markets are under developed in India since the incidence of stamp duty for transfer of instruments is very high. The assignment of a debt with the securities interest and the underlying property is cumbersome and a high cost. Debentures are, therefore, the accepted form of debt instruments in the corporate sector as their transfer, transfers a proportionate underlying security interest in the mortgages and charged assists also to the holder of the instrument.

Securitisation is recently introduced in India.

Debt trading is not common in India when the corporate borrower is insolvent or near insolvent. Discounted instruments in the debt market or junk bonds have not been introduced in India.

(a) Is the concept of a third party 'guarantee' (as distinct from a security over property) to support corporate borrowing known and practised in this economy?

 

The concept of a third party guarantee or a promoter guarantee or a sponsor guarantee is well known in India. Sponsors or the promoters having large stakes in the corporate entity are usually asked to secure project short falls or project performance or guarantee the repayment of the debt in support of corporate borrowing and this is fairly well practiced in the field of working capital finance and short term loan financing. The distinction between non-recourse and recourse is well recognised in India. The Indian Contract Act and the Companies Act regulates the manner in which guarantee can be given. Recent amendments in the Companies Act have changed the regulations concerning the extent of guarantees which can be given by one corporate borrower for another corporate borrower by imposing financial limits or ceilings. The consent of the shareholders by way of a special resolution is required specifically for extending a corporate guarantee.

(b) Is there a law which regulates the power to take or give a guarantee?

 

Both the Indian Contract Act and the Companies Act read with the constitution of the Company regulate the authority to give a guarantee, the limit upto which a corporate guarantee can be given and the terms and conditions upon which the guarantee is to be enforced and made binding.

(c) Is it common or usual for corporate borrowing to be supported by guarantee/s?

(d) If so, are these guarantees usually taken from owners/directors of the corporate borrower; from other corporates associated with the corporate borrower (eg subsidiaries or holding company); or from unrelated third parties?

 

Corporate borrowing is usually supported by sponsor guarantees which are usually taken from the promoters owners/ directors of the corporate borrowers, and even from other corporate borrower (e.g. subsidiaries or holding companies) Guarantees from unrelated third parties are not the norm and are rarely offered or even accepted by the banks, due to the low capitalization of corporate (affecting the ability to guarantee others). The Banks have cover for their lending from the Guarantee Corporation of India or from the Export Guarantee Corporation of India, when the litigation recovery does not result in recovery.

(e) Is there a law which regulates the enforcement of guarantees?

 

The provisions of the Civil Procedure Code contemplate summary trials or actions in relation to the guarantee claims. The Indian Contract Act is the substantive law which regulates the terms and provision for enforcement of guarantees. The procedural law is embodied in the Civil Procedure Code 1908 as amended in 1973 and in the Recovery of Debts Due to Banks and Financial Institutions Act, 1993.

(f) Is it easy or difficult in practice to enforce guarantee obligations?

 

It is difficult in practice to recover upon guarantee obligations as the guarantor's lenders would resort to cross default clauses for the Guarantors business debts and a guaranteed debt is an unsecured debt in so far as the guarantor is itself concerned. The guarantor's Secured Creditors would have priority over the guarantors assets.

(g) Is it usual to require that a guarantor should give security over the property of the guarantor as an additional comfort to the lender?

 

It is unusual for a guarantor to give security over the property of the guarantor as an additional comfort to the Lender.

(h) Does the insolvency of a corporate borrower have any effect on the enforcement of a guarantee?

 

A guarantee can exclude the consequences of insolvency of a creditor borrower. (the principal debtor) The Guarantor's right of subrogation and the effect of insolvency on the right of subrogation cannot invalidate a guarantee as it is quite common to contractually provide for the guarantor to be capable of being sued as if it is a principal debtor. The guarantor in the case of corporate borrower's insolvency can claim recovery in the proceeds or dividend in insolvency.