Continuous growth of a robust secondary market and creation of additional avenues for raising liquidity have been the key requirements of the Indian loan market. To achieve this, the Reserve Bank of India (“RBI”) has rolled out the Master Directions - RBI (Transfer of Loan Exposures) Directions, 2021[1] (“Master Directions”) on 24th September 2021.

The Master Directions have replaced the existing instructions on the matter of sale / transfer of loan exposures. It also consolidates various instructions on transfer of loans and aligns the relevant provisions on the subject matter with the Insolvency and Bankruptcy Code, 2016 and the RBI (Prudential Framework for Resolution of Stressed Assets) Directions, 2019 (“Prudential Framework”).

The Master Directions are applicable to all banks, non-banking financial companies (“NBFCs”) and financial institutions as specified thereunder. The Master Directions provide for the transfer of 2 categories of loans - standard loans and stressed loans.

TRANSFER OF STANDARD LOANS:

Transfer of standard loans by way of assignment, novation and participation is expressly dealt under the Master Directions. Following are the key developments in case of transfer of standard loans:

• Recognition of loan participation:

Under the erstwhile framework, the concept of true sale explicitly excluded loan participation. Loan participation can prove to be a preferred mode for assignors who want to retain the relationship and/or for assignees who do not want to directly deal with the borrower. It is important that the loan participation documents are drafted appropriately, and the roles and responsibilities of the transferor and transferee are clearly delineated contractually. The key aspect for the documentation would be protection of rights of participants when the borrower (or even the transferor) is under stress.

It is worth noting that the Master Directions expressly cover only funded risk participation and not the unfunded risk participation. Accordingly, while entering into risk participation structures, parties may refer to the requirements of the Master Directions and its applicability.

• Dispensation of Minimum Retention Requirement (“MRR”):

The Master Directions have waived the MRR except in cases where a buyer undertakes partial due diligence at portfolio level.

In a portfolio buyout transaction, if a buyer is only able to undertake due diligence at the individual loan level for not less than 1/3rd of the portfolio by value and number of loans and remaining at portfolio level then, 10% MRR has been prescribed.

• Minimum Holding Period (“MHP”):

The MHP requirement for transfer of loans is generally 3 months for loans with a tenor of 2 years and 6 months for the loans with a tenor of more than 2 years. In case of secured loans, the aforementioned timelines start from the date of registration of the underlying security interest. This move should be seen in line with what the Securities and Exchange Board of India (“SEBI”) has stipulated for listing of debt issuances: security perfection as condition precedent.

The MHP requirement is not applicable to loans transferred by arranging banks under a syndication arrangement.

• Exception list:

The erstwhile norms created exceptions based on origination or tenor of a loan by prohibiting assignment of revolving credit facility, facility with bullet repayment and assets purchased from other entities. However, the new Master Directions do not provide for any such exception list.

This change will increase the number of loan products which can be transferred under the current norms.

• Representation & Warranties:

The transferor will not be required to hold capital where it makes representations and warranties in accordance with the Master Directions. Further, in case of exercise of representations and warranties for replacement of loan, the same should be undertaken within 30 days of such transfer. In case of claiming damages for breach of representations and warranties by transferor, the onus of proof for breach remains with the alleging party and only direct losses can be claimed as damages.

TRANSFER OF STRESSED LOANS:

Transfer of stressed loans by different modes is permitted except by way of loan participation. Following are the key developments in case of transfer of stressed loans:

• Bilateral Negotiations:

While the Master Directions permit negotiations on a bilateral basis, such bilateral negotiations shall be subject to the price discovery and value maximisation approaches to be adopted by the transferor.

• Swiss Challenge:

The Master Directions mandate compulsory auction through a Swiss Challenge in both of the following cases:

1. In case of bilateral negotiations, if the aggregate exposure of the lenders towards a particular borrower whose exposure is being transferred is more than INR 100 crores; and
2. Transfer pursuant to a resolution plan approved in accordance with the terms of the Prudential Framework (irrespective of the monetary threshold).

• Corporates permitted to take on loan exposures:

The RBI has specifically permitted corporates to acquire stressed loans undertaken as a resolution plan under the Prudential Framework. There was no bar previously, but most lenders were unwilling to so assign.

This will not only help with better price discovery but also with early assignments.

• MHP for stressed loans:

The holding period for stressed loans has been reduced to 6 months as opposed to 12 months as under the erstwhile norms, except in case of transfer to an asset reconstruction company (“ARC”) and pursuant to a resolution plan under the Prudential Framework.

• Stressed assets transferred to ARCs:

Loans which are in default for more than 60 days / classified as non-performing assets (NPAs) can be transferred to ARCs. This now includes loans classified as fraud, provided the transferee is not from the existing promoter group.

This provision will provide an opportunity to loan accounts having an element of fraud which could not have been assigned earlier. Previously, restrictions around loans classified as fraud proved to be an issue for some big ticket stressed asset acquisitions.

Key Takeaway:

In addition to combining the various requirements for loan sales into one comprehensive framework, the RBI has now in a pivotal move, through the Master Directions, turned its hand to recognising loan participation transactions, sale of stressed assets to corporate entities and transfer of fraudulent accounts to ARCs. The nascent stage of these concepts in the loan sales framework means that clarity from the RBI on certain aspects which are open to more than one interpretation and actual execution of the Master Directions is crucial to determine the success of the Master Directions. All things considered, such well-founded regulatory framework governing the sale of bank loan exposures will encourage market participants, provide comfort to the lenders and consequently, boost secondary market for bank loans.

Authors

Saurabh Sharma
Partner, Juris Corp
Email: [email protected]

Rupul Jhanjee
Associate Partner, Juris Corp
Email: [email protected]

Divya Dhage
Associate,  Juris Corp
Email: [email protected]

[1] https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=12166