Shreyashi Tiwari is currently working as a Legal Officer in Export-Import Bank of India and completed her B.A.LLB(H) from National University of Study and Research in Law in 2019.
In light of the recent debacles faced by the Debenture Trustees (“DTs”) in the enforcement of their security interest secured by the Non-Banking Financial Companies(“NBFCs”), despite the existence of SEBI (Issue and Listing of Debt Securities) Regulations, 2008 and other rules thereunder have put SEBI in a difficult position. Several instances have arisen recently which has further put a question mark on the effectiveness of the existing regulations providing safeguard to the debenture and bondholders in this regard, such as the recent Dewan House Financing Limited (“DHFL”) Case, where the debenture holders faced issues in enforcing their interest due to claims by the banks and financial institutions on the same assets and others; the ILFS crisis where the chances of bondholders gaining their money back seemed so uncertain that the DT is on the road to initiate legal action  and the recent action brought before the Bombay High Court by DT against the Reliance Capital to protect its investments.
Accordingly, considering the failure of NBFCs in the creation of enforceable security in favour of bondholders or the DT, SEBI has proposed introduction of stricter norms via ‘Consultation Paper on Review of the Regulatory Framework for Corporate Bonds and Debenture Trustee’ (“Consulting Paper”). The Consultation Paper primarily aims to introduce better compliance measures in order to do away with various apprehensions which eventually holds the Debenture Holders back in becoming a part of say Inter- Creditor Agreement (“ICA”) or enforcing security considering the assets are not identified etc.
Creation of Charge on Identified Assets by NBFCs
SEBI proposes that NBFCs must create a charge on the identified assets i.e., identified receivables, investment and cash and do away with the practice of creating a floating charge on the entire balance sheet as the latter can be crystallised only when the event of default takes place. A window of 3-5 years has been provided for the NBFCs to undertake the transition.
The rationale behind identifying the specific assets which are secured for the debentures and bonds issued lies in the opacity of the details of such security. Even though floating charge on the entire balance sheet is created, the lack of specific identification leads to ambiguity when it comes to enforcement of such security at the time of default. The certified copies submitted to the DT by independent Chartered Accountants also fail to specify the exact assets secured and hence puts such debenture holders at risk of non-realisation of their investments, or fall behind in priority in comparison to other lenders such as banks or financial institutions. Thus, the Consulting Paper also mandates a granular asset cover certificate certified by a statutory auditor to be submitted on a half-yearly basis wherein the assets and receivables will be listed in compliance with the Debenture Trust Deed (“DTD”) /Information Memorandum and the DT would fix a benchmark delinquency rate the breach of which would necessitate replacement of the asset listed as security for charge.
Debenture Holders Accession to Inter-Creditor Agreement
SEBI proposes the option for the DT to enter into the ICA subject to the approval of the majority of the debenture holders. However, certain conditions have been suggested as pre-requisite, the non-compliance of which would provide the DT (on behalf of debenture holders) to exit the ICA such as in case the Resolution Plan imposes certain conditions on the DT not in line with SEBI Regulations or circulars. Similarly, in case any party to ICA violates the terms of Resolution Plan or the finalisation of the resolution is beyond 180 days without extension agreed upon by the DT (1 year), the DT will reserve the right to exit the ICA and resort to any other legal recourse.
ICAs are essentially agreements entered into amongst the banks to achieve a time-bound resolution of stressed assets in case defaults occur introduced as per RBI’s circular providing for ‘Prudential Framework for Resolution of Assets.’ With the recent invitation by the lenders in the DHFL matter to the debenture holders to accede to the ICA for a faster resolution process of the assets, SEBI proposes to regulate the same. Currently, debenture holders are vulnerable to the various risks such as delay in the timely completion of the resolution process, barring the debenture holders from seeking any legal recourse once it accedes to the ICA, action plans under the resolution being disadvantageous to the debenture holders considering the majority of the lenders are banks and it is essentially a bank-led process. Further, the debenture holders will not be made to forcibly accede accept the liquidation value during the resolution in case dissent arises on their part. The consulting paper recommends that the DT shall obtain the consent to accession of the ICA and consent for security enforcement to be taken in the same letter in the reduced time period of 15 days.
Debenture Issuer to Create Recovery Fund
SEBI has further proposed to create an obligation on the issuer of the debentures to create a recovery fund of 0.01 % of the total issue capped at Rs. 25 lakhs during such issuance to facilitate easy recovery for the debenture holders in the event of default. The DT will be responsible to oversee the fund.
The only exception to the aforementioned criteria is for AAA-rated bonds. However, the issuer is obligated to create the fund as soon as the ratings are downgraded. In the recent insolvency of DHFL, the release of Cobrapost led to the fall in the ratings of the bonds issued in February 2019 however, no due course was undertaken by the DT to immediate effect as is required. Hence, the recovery fund would act as fail-safe protection for the investments of the debenture holders.
Compliance Measures & Disclosures
The market regulator has further introduced monitoring measures wherein the DT and the issuer will be subject to a number of compliance measures so as to ensure better access to vital information to the debenture holders regarding the status of their security such as it would be the duty of the DT to provide on its website information w.r.t defaults of the company, compliance of the covenants, status of ongoing proceedings if any etc. Similarly, with the recent rise in issuance of side letters by the NBFCs to certain lenders containing covenants related to accelerated payments has often been responsible for creating a financial burden on the NBFCs thereby affecting their capacity of repayment and increasing their probability of default. SEBI has also suggested a model draft form of DTD to be finalised which would be two-part document consisting of general covenants in the first part and transaction-related specific covenants in the second part to avoid any loopholes which might negatively affect the bondholders. Thus, the measures are essentially aimed at creating accountability on the part of DTs and bond issuers.
Despite SEBI’s recent efforts to increase the margin of the net worth of the DTs, penalty imposed in the issuers in case of violation of regulations etc. the delay in security enforcement when it comes to the debenture holders have not led to positive results. As per the data from the Trustee Association of India (TAI), more than 90% defaults by the issues are secured debentures out of which only 10% have been successfully enforced, 60% are engaged in the legal tangle and around 30% are still pending in the stage of recovery stage due to lack of communication. Considering the sad state of affairs and the recent non-compliance, the consultation paper is nothing short of the need of the hour. The incorporation of the norms in the form of rules and regulations under the aegis of SEBI will ensure that investor confidence is retained when it comes to issuing the bonds.
 “Bombay High Court Allows DHFL To Make Payments To Lenders With Securitisation Arrangements”, Bloomberg Quint. [Available on: https://www.bloombergquint.com/law-and-policy/dhfl-case-lenders-move-bombay-high-court-seeking-vacation-of-order-restraining-payments]  “Debenture trustee plans legal action against IL&FS”,Saikat Das, Economics Times. [Available on: https://economictimes.indiatimes.com/markets/stocks/news/debenture-trustee-plans-legal-action-against-ilfs/articleshow/68554726.cms?from=mdr]  “Reliance Capital debenture holders’ trustee moves HC to protect investments”, Maulik Vyas, Saikat Das, Economics Times. [Available on: https://economictimes.indiatimes.com/markets/stocks/news/reliance-capital-debenture-holders-trustee-moves-hc-to-protect-investments/articleshow/74432677.cms?from=mdr]  SEBI Consultation Paper, February 25, 2020 [Available at: https://www.sebi.gov.in/reports-and-statistics/reports/feb-2020/consultation-paper-on-review-of-the-regulatory-framework-for-corporate-bonds-and-debenture-trustees_46079.html] Prudential Framework for Resolution of Stressed Assets, RBI/2018-19/203 DBR.No.BP.BC.45/21.04.048/2018-19 [Available at: https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=11580&Mode=0]  “Retail Investors Hurt in DHFL Free-For-All”, Aarti Krishnan, The Hindu Business Line [Available at: https://www.thehindubusinessline.com/opinion/columns/retail-investors-stranded-in-dhfl-free-for-all/article29974543.ece] [Last Accessed: 20.04.2020, 5:30 pm]
The opinions expressed herein are those of the author in their personal capacity and are not intended to be construed as legal, financial or investment advice.