India: The Viewpoint: ARCs & Stressed Assets: A Glimpse Of A Better Tomorrow

Last Updated: 20 April 2017
Article by Nilesh Chandra and Abhinav Mishra

INTRODUCTION

With the volume of stressed assets in India almost doubling in last five years, Asset Reconstruction Companies (ARCs), which act as intermediaries between the borrower and the lender, have been bestowed with the imperative responsibility to clean-up stressed assets by adopting effective resolution and recovery mechanisms and relieve lenders from the mountainous burden.

Backed strongly by the RBI, ARCs are a creation of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests (SARFAESI) Act, 2002 more than a decade ago. Despite the RBI's encouraging measures towards promoting sale of stressed assets by banks to ARCs, the ARC sector is yet to mature in Indian jurisdiction. This can be witnessed from the fact that in the face of stressed assets verging on an alarming figure of close to INR 700 trillion, only 14 functional ARCs on date have a considerably minimal stressed asset portfolio.

This dismal performance of the ARCs can be attributed to a barrage of issues such as stringent legal and regulatory compliances, inadequate capital, restriction on foreign investment, valuation mismatch, huge stamp duty implications on assignment documents and so on; in addition to inadequate regulatory support for effective resolution/recovery of stressed assets and poor average recovery rate (of about 30% over a period of at least 4 to 5 years) due to inter-alia an overburdened adjudication system.

This has also acted as a roadblock to investors from investing in the ARCs and their security receipts (SRs). Under the current regulatory framework, in contrast to the regulatory freedom for ARCs envisaged under the SARFAESI Act, adoption of resolution mechanism by taking over the borrower's management or initiation of recovery proceedings, sans interference of courts, have been largely defeated. Borrowers, investors and other secured/unsecured creditors have been successful in creating various long lasting legal and regulatory hurdles in the way of the ARCs.

MANAGEMENT FEE ROUTE AND THE IMPACT

To recoup with the adverse impact on their own balance sheets, discouraged ARCs have transitioned towards relying on the 'management fee' based model, defeating the prime objective of resolution/recovery of stressed assets. This can clearly be witnessed from the fact that under the previous regulatory regime i.e. the 5:95 structure, ARCs were buying stressed assets at aggressive book value price with a minimal upfront payment of 5 percent; and balance in the form of SRs, to be redeemed from recovery of the stressed assets. On account of the (annual) management fee of 1.5% charged on the 'asset under management' (AUM), the ARCs were ensuring the return of around 18-20% over a 4-5 year period with minor upfront investment of 5%, managing only about 25-30% recovery rate of stressed assets. This not only defeated the object of creation of ARCs but adversely affected the lenders as unredeemed SRs, due to recovery shortfall, were written off without any recourse to the ARCs. This led to introduction of a more stringent regime in 2014, whereunder cash commitment of the ARCs was increased from 5% to 15% (i.e. a 15:85 structure) and the management fee was linked with NAV to ensure better price discovery of stressed assets and to keep the ARC's skin in the game. This regulatory change led to increased upfront investment requirement from ARCs, substantially reduced the return on investment, whereas no measures were taken to improve the resolution or recovery mechanism of the stressed assets on a regulatory front.

Another significant issue being faced by ARCs pertains to levying of stamp duty on the assignment/transfer of stressed assets especially if the same is coupled with power of attorney (POA), transferring all rights title and interest in the security, to facilitate recovery in the event of enforcement, which is largely prevalent in retail loan portfolio. Recently, a stamp reference petition was placed before the Hon'ble Gujarat High Court, regarding applicability of stamp duty on such POA as an independent document and liable to be charged under as conveyance, which is 6-8% of the value of such assets. This judgment was subsequently challenged before the Hon'ble Supreme Court and pending adjudication, which shall be important in terms of determining the payment of stamp duty on pre-2016 transactions, as the recent amendments in the SARFAESI Act and the Indian Stamp Act, 1899, exempts payment of stamp duty on any document executed by any bank or financial institution in favour of ARCs for the purposes of asset reconstruction or securitisation.

POSITIVE FUTURE TRAJECTORY

Despite the hitches faced by ARCs thus far, the current sentiment among the stakeholders is positive on several accounts. Pursuant to the RBI's September 2016 guidelines, "other banks, non-banking financial companies (NBFCs) and financial institutions (FIs) etc." shall also be allowed to bid for stressed assets for 'better price discovery' – expanding the arena of stressed-asset-resolution for more players.

Significantly, the new framework under the Insolvency and Bankruptcy Code, 2016 (IBC Code), empowers the RBI to carry out financial audits of ARCs, appoint their board of directors, penalize ARCs for non-compliance and regulate their management fee. IBC code further consolidates and amend several connected laws, including significantly the Companies Act, 2013, relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximisation of value of assets of such persons. The IBC Code also mandates registration of security interest with the central registry, which is expected to significantly ease the process of diligence thereon.

In addition, 100% FDI in ARCs (and SRs) and exemption from levying of stamp duty on debt-assignment transactions further add to the increased viability and future potential success of ARCs. Recently, three additional ARCs have been added to the existing portfolio of India's institutional arsenal for stressed-asset resolution/recovery, and more are set to follow suit as several corporate houses too are gearing up.

In the wake of introduction of IBC, relaxed regulatory measures and a positive market sentiment for ARCs among the relevant stakeholders, it will be interesting to observe whether the dark clouds looming over ARCs finally move and make way for a more effective asset de-stressing/recovery mechanism.

Originally published by Bar & Bench.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.