Debt Restructuring Legal Obligations - RBI Prudential Framework 2019 + IBC + Case Laws

Debt Restructuring is NOT mercy. It is a statutory obligation under RBI's Prudential Framework for Resolution of Stressed Assets dated 7th June 2019 [which replaced Feb 12, 2018 circular after it was struck down]. If you are a Bank/NBFC with exposure above Rs 5 Cr, you HAVE to follow it, otherwise you face additional provisioning penalty.

I. What is Restructuring Legally?

Restructuring means changing original terms of loan to make it viable:

• Rescheduling - Extend tenure, reduce EMI
• Interest reduction / Funding of Interest - FITL
• Part waiver - OTS / Compromise Settlement
• Debt to Equity conversion
• Additional finance

Types under RBI:

1. Restructuring under Prudential Framework 2019 - For Standard, SMA, NPA accounts
2. One Time Settlement [OTS] / Compromise Settlement - Under RBI Master Direction June 2022
3. Resolution under IBC Sec 54A - Pre-pack for MSME
4. SARFAESI Reconstruction - Sec 9 - Via ARC

II. Legal Obligations of Lenders - RBI June 7 Circular 2019 - Mandatory

This circular applies to All Commercial Banks, NBFCs, SFBs, ARCs.

Step 1 - Early Recognition - SMA Classification - Obligation to Monitor:

• SMA-0: 1-30 days overdue
• SMA-1: 31-60 days
• SMA-2: 61-90 days
• Report to CRILC for exposure > Rs 5 Cr within 7 days of SMA

Step 2 - Review Period - 30 Days from Default - Obligation to Act:
Within 30 days from default, Lenders must review account and decide:

• Resolution Plan [RP] to be implemented?
• Initiate IBC?
• Recovery under SARFAESI?

Board-approved policy must exist. If no decision in 30 days, additional provisioning starts.

Step 3 - Resolution Plan Implementation - 180 Days from Review Period:
If RP decided, must be implemented within 180 days.

Conditions for Valid RP:
a) Inter-Creditor Agreement [ICA]: Mandatory for all lenders if multiple banks. Decision by 75% by value and 60% by number. ICA must be signed within 30 days of first default.

b) Independent Credit Evaluation [ICE]: For exposure > Rs 100 Cr, 2 ICE from external rating agencies. For Rs 500 Cr+, 2 ICE mandatory.

c) Provisioning: If RP not implemented in 180 days, additional 20% provision, another 15% if extended 365 days.

d) Board Policy: Every lender must have Board-approved policy for compromise settlement and restructuring - RBI Direction June 2022. For Wilful Defaulters, compromise only after 1 year cooling period and with Board approval.

Step 4 - Viability Conditions:

• DSCR >1, Loan Life Coverage >1.25
• Promoter sacrifice >20%
• Personal guarantee of promoter must continue
• No evergreening - Additional finance must be genuine.

III. Legal Obligations of Borrower

1. Disclosure Obligation: Provide cash flow, stock audit, forensic if fraud suspected.
2. Cooperation for ICE: Give data to rating agencies.
3. Interim Finance Priority: If borrower takes interim finance during RP, it gets priority under Sec 20 IBC.
4. No Alienation: Cannot sell mortgaged property during Review + Implementation period without consent.

IV. Difference Between Restructuring and OTS - Legal Impact on CIBIL

• Restructured Account: Shows as "Restructured" in CIBIL for lifetime of loan - Future borrowing impacted, but not as bad as Settlement.
• OTS / Compromise Settlement: Shows as "Settled" - Treated as negative. Under RBI 2022 direction, compromise for wilful defaulters shows as "Wilful Default" even after settlement.

V. Landmark Case Laws

A. RBI Circular Validity

1. Dharani Sugars & Chemicals Ltd. vs Union of India & RBI - Madras HC 2018 / Supreme Court 2019
Dharani Sugars challenged RBI Feb 12, 2018 circular which mandated compulsory IBC filing for default > Rs 2000 Cr. Madras HC and later Supreme Court in April 2019 struck down Feb 12 circular as ultra vires Sec 35AA of Banking Regulation Act.
Result: RBI issued new June 7, 2019 circular with discretion to lenders, not mandatory IBC. This is why current framework gives lenders 30+180 days discretion.

B. IBC vs Restructuring - Borrower's Right to be Considered

2. Vidharbha Industries Power Ltd. vs Axis Bank - Supreme Court 2022 (Civil Appeal 4633/2021)
Most important case for debtors. Axis Bank filed Sec 7 IBC against Vidharbha for default. Borrower argued it had Rs 1730 Cr receivable from MSEDCL, awarded by APTEL, so default not wilful, should be allowed to restructure.
SC Held:

• Sec 7 application is NOT mandatory to admit, NCLT has discretion.
• If borrower shows that restructuring is viable or dues are under serious dispute/bonafide, NCLT can reject Sec 7 and allow time for restructuring.
• Principle of "Existence of Debt + Default" not enough, must examine if default is wilful and if restructuring possible.

This judgment gives legal right to borrower to argue for restructuring instead of IBC admission.

3. Swiss Ribbons Pvt. Ltd. vs Union of India - Supreme Court 2019 - (4 SCC 17)
Upheld constitutionality of IBC. Court held restructuring under RBI framework and resolution under IBC are complementary, not mutually exclusive. Lender can choose restructuring outside IBC if viable.

4. SBI vs V. Ramakrishnan - Supreme Court 2018
Even if principal borrower's loan is restructured / moratorium under IBC, personal guarantor's liability continues, not restructured automatically. Guarantor must separately seek restructuring.

5. Essar Steel India Ltd. vs Satish Kumar Gupta - SC 2019 - 2 SCC 1
On resolution plan vs restructuring - Supreme Court held commercial wisdom of CoC in approving restructuring / resolution plan cannot be interfered by Courts unless against Sec 30(2) IBC. Establishes lender's commercial discretion in restructuring.

C. SARFAESI vs Restructuring

6. Phoenix ARC Pvt. Ltd. vs Vishwa Bharati Vidya Mandir - Supreme Court 2022
Borrower argued that once restructuring proposal submitted, Bank cannot proceed under SARFAESI Sec 13(4). SC held Bank can proceed with SARFAESI if restructuring proposal not approved within time, but must consider proposal in good faith as per RBI Fair Practices Code.

7. Keshavlal Khemchand & Sons vs Union of India - Supreme Court 2015
Restructuring under CDR Mechanism - Supreme Court held that if borrower complies with restructured terms, Bank cannot recall entire loan for old default. Restructured terms create new contract, old default extinguished.

8. Kotak Mahindra Bank vs Kothari Industrial Corporation - NCLAT 2020
If ICA signed by 75% lenders and restructuring approved, dissenting lender bound to implement? NCLAT held ICA binding, dissenting lender cannot file separate IBC if majority approves restructuring and implements within 180 days.

VI. Consequences of Non-Compliance by Bank

• Additional Provisioning: 20% + 15% as per June 7 circular.
• RBI Monetary Penalty: Under Banking Regulation Act Sec 47A - Rs 1 Cr+ per violation.
• Consumer Court / DRT Defense: Borrower can take defense that Bank did not follow mandatory Review Period and ICA, so recovery action is premature - as in Vidharbha principle.
• CIBIL Correction: If bank shows account as NPA without offering restructuring as per policy, borrower can get CIBIL corrected to Standard Restructured.

VII. Practical Checklist - If You Want Restructuring

For Borrower MSME / Corporate:

1. On Day 1 of SMA, write to Bank: "Request Review under RBI Prudential Framework 2019, within 30 days Review Period"
2. Submit Viability Report + Cash Flow + Promoter Sacrifice proposal
3. Quote Vidharbha Industries judgment - Request NCLT to keep Sec 7 in abeyance till RP considered
4. Ensure ICA is signed - If multiple banks, 75% must agree

For Bank:

1. Board Policy for Restructuring & Compromise - Mandatory from June 2022
2. CRILC Reporting within 7 days for >5 Cr
3. ICE for >100 Cr
4. Do not proceed with SARFAESI during 30+180 days if RP under consideration - else action can be set aside as per Phoenix ARC case