The Reserve Bank of India (RBI) recently introduced a circular no. RBI/2023-24/40 DOR.STR.REC.20/21.04.048/2023-24 dated 8 June 2023 on the Framework for Compromise Settlements and Technical Write-offs (Framework). The Framework is a comprehensive guideline on compromise settlements and technical write-offs undertaken by: (i) Commercial Banks (including Small Finance Banks, Local Areas Banks and Regional Rural Banks); (ii) Primary (Urban) Co-operative Banks/State Co-Operative Banks/ Central Co-operative Banks; (iii) All-India Financial Institutions; and (iv) Non-Banking Financial Companies (including Housing Finance Companies) (together referred to as Regulated Entities/ REs).

Background:

The Prudential Framework for Resolution of Stressed Assets dated 7 June 2019 (Prudential Framework) permits some of the REs to consider any action / plan / reorganization including but not limited to regularization of account by (a) payment of all overdues by the borrower entity, (b) sale of exposure to other entities/investors, and (c) change in ownership and restructuring; as part of a resolution plan. Further, the Indian Accounting Standards provides for writing-off of an asset once the RE has no reasonable expectations of recovering the financial asset in its entirety or a portion of the financial asset.

The Framework seeks to rationalize and harmonize instructions in relation to compromise settlements under the Prudential Framework and technical write-offs of stressed assets, thereby ensuring greater transparency. The Framework is applicable to Local Area Banks and Co-operative Banks, thus covering a wider set of creditors than the Prudential Framework.

Compromise Settlement and Technical Write-Offs:

As per the RBI, compromise settlement refers to any negotiated arrangement with the borrower to fully settle the claims of the RE against the borrower in cash; it may entail some sacrifice of the amount due from the borrower on the part of the REs with corresponding waiver of claims of the RE against the borrower to that extent. Compromise settlements where the time for payment of the agreed settlement amount exceeds 3 (three) months or where the arrangement involving part settlement with the borrower is treated as restructuring under the Prudential Framework. Further, wherever REs had commenced recovery proceedings under a judicial forum and the same is pending before such judicial forum, any settlement arrived at with the borrower is subject to obtaining a consent decree from the concerned judicial authorities.

As per the RBI, technical write-offs refer to cases where the non-performing assets remain outstanding at borrowers' loan account level, but are written-off (fully or partially) by the RE only for accounting purposes, without involving any waiver of claims against the borrower, and without prejudice to the right of the RE to the recovery of the same.

The Framework has also outlined certain checks on the REs required to be undertaken for compromise settlements or technical write-offs inter alia:

- Board-approved policy:

The REs are required to undertake compromise settlement or technical write-off in accordance with board approved policies. Such policy shall lay down a comprehensive process such as minimum ageing, deterioration in collateral value, putting in place a graded framework for examination of staff accountability in such cases with reasonable thresholds and timelines as may be decided by the board, etc. Additionally, the policy for compromise settlements shall contain provisions in relation to permissible sacrifice, while arriving at the settlement amount taking into account the current realizable value of the security/ collateral available in order to maximize the possible recovery from the borrower.

- Future contingent contracts:

Compromise settlements or technical write-offs undertaken by REs shall be without prejudice to any mutually agreed contractual provisions between the RE and the borrower relating to future contingent realizations or recovery by the RE. However, such claims shall not be recognised in any manner on the balance sheet of REs at the time of the settlement or subsequently till actual realization of such receivables.

- Delegation of Power:

The authority (individual or committee, as the case may be) for approving compromise settlement shall be at least one level higher in hierarchy than the authority who had sanctioned the credit/ investment exposure. It is clarified that the officials who were part of the sanctioning of the loan (as individual or part of the committee) shall not be part of any proposal for settlement of such loans in any manner.

- Cooling Period:

The REs are restricted from granting fresh exposure to the borrower (other than farm credit exposure) for a minimum period of 12 (twelve) months from the date of undertaking a compromise settlement, or such other higher period as determined by its board approved policy. In respect of compromise settlements of borrowers for farm credit exposure and technical write-offs, the cooling period shall be as per the Board approved policies of the REs.

- Wilful Defaulters or Fraud:

REs are permitted to undertake compromise settlements or technical write-offs in respect of accounts categorized as wilful defaulters or fraud, without prejudice to the criminal proceedings underway against such borrowers or penal measures applicable in respect of such borrowers.

- Other provisions:

Any settlements with the borrowers under the Framework are without prejudice to the provisions of any other statute in force. Further, where REs have initiated judicial or recovery proceedings against the borrowers, the compromise settlement is subject to obtaining consent degree from the concerned judicial authorities.

Comment

Through the Framework, the RBI has once again stressed the importance of REs entering into compromise settlements as part of normal resolution process. The Framework encourages the REs to lay down a clear policy on compromise and settlement to ensure greater transparency. The Framework will streamline the process followed by the REs as a normal banking practice. The Prudential Framework did not deal with settlements undertaken by borrowers whose accounts were classified as 'wilful defaulter' or 'fraud'. Since the incentives for recovery for REs are no different when it comes to recovery from borrowers classified as fraud or wilful defaulter, the Framework now helps such borrowers to settle debts availed from the REs out of the internal accrual of the borrowers or funds brought in by such borrowers from their promoters or non-RE creditors, thereby granting an additional mechanism for reducing stress faced by the banking sector.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at legalalerts@khaitanco.com