January 03 2012
The Financial Stability Report (FSR) published in June 2011 by the Reserve Bank of India alluded to the high probability of default in the repayment of foreign currency convertible bonds (FCCBs) by Indian companies. The FSR says that "more than a few firms potentially face severe funding problems in the next two years which may not remain confined to their industries". The FSR report has endorsed the apprehension that has loomed over the Indian corporate world's ability to redeem its debt.
With the global and Indian economies facing the prospect of a double-dip recession, overseas lenders (including FCCB holders) are worried about the ability of Indian bond issuers to redeem their investments. This update explores the financial and legal options available to FCCB holders and issuer companies to reach a settlement.
In the heady days of a rising stock market and low interest rates, Indian corporates found FCCBs an irresistible way of satisfying their hunger for funds to finance their expansion plans. The FCCB is a mix of debt and equity that provides bondholders with the option to convert bonds into equity and is attractive to both the issuer company and the FCCB holder. The convertibility option, low but guaranteed returns and the fact that the FCCBs are redeemable if not converted all tempted overseas investors to subscribe to FCCBs. In addition, a cheaper source of borrowing, no requirement for security and lower servicing costs because of the convertibility option drove Indian corporates overseas in a scramble for funds. From 2005 to 2008 large amounts were raised through FCCBs by many Indian companies; the FSR has suggested that FCCBs worth more than $7 billion will mature by March 2013.
The situation is now being affected by a number of unforeseen circumstances. At one level, the repayment crisis is attributable to companies' excessive borrowing and the continued fall in stock prices, which neither the issuers nor the FCCB holders expected and now makes the convertibility option impossible. With the stock market booming from 2003 to 2005, there was a general expectation that share prices would continue to soar and the conversion of FCCBs was taken for granted. However, as the shares of many of these borrowers have plummeted and are now trading at below the conversion price, it is highly unlikely that FCCB holders will choose the conversion option.
Borrower companies would need to shore up their liquidity positions to improve their repayment capability at maturity - at least partly if not wholly, and in instalments if not in one go. However, as the Reserve Bank of India has repeatedly raised interest rates, finding finance would be a daunting task and replacing low-cost debt with higher-cost debt may not be feasible. Companies and FCCB holders would therefore do better to explore avenues by which companies might avoid redemption default and FCCB holders might protect at least part of their interest. Some of the options available to issuers and FCCB holders are discussed below.
The borrower company may raise fresh equity in order to redeem FCCBs. However, fresh equity would lead to the dilution of the existing shareholding base, which the existing shareholders may not want. Moreover, considering the liquidity position and FCCB repayment liability, outsiders may not wish to invest, resulting in only existing shareholders being willing to bring more cash into the company.
The borrower company may consider raising fresh debt to pay off its FCCBs, although the workability of this option depends on the cost at which such debt could be raised and the servicing burden. Considering the present credit squeeze and high-cost regime, raising fresh debt may prove expensive and may further handicap the financial health of the borrower company if it resorts to an expensive borrowing to redeem FCCBs that are less expensive in terms of servicing.
Refinancing through new FCCBs or ECBs
Under this option, a company may issue new FCCBs or raise external commercial borrowings (ECBs) to redeem existing FCCBs. A new FCCB may be issued with a lower conversion price by linking it to more realistic price levels.
To enable companies to raise new FCCBs or ECBs for redeeming existing FCCBs, the Reserve Bank of India has recently issued AP (DIR Series) Circular 01, dated July 4 2011. The circular provides that:
The quantity of fresh FCCBs or ECBs must not exceed the outstanding redemption value at maturity of the outstanding FCCBs. Furthermore, fresh FCCBs or ECBs must be raised within six months of the maturity date of the outstanding FCCBs and not before. Other conditions mentioned in the circular relating to ECBs must also be complied with to raise fresh FCCBs or ECBs.
Raising fresh FCCBs or ECBs may be preferable to raising debt, since the cost of raising new FCCBs or ECBs may be lower. However, raising fresh FCCBs or ECBs will depend on a company's ability to find new lenders and convince them of the safety of their money, despite the company's present inability to redeem its existing FCCBs.
Under this option, both the FCCB holders and the company may negotiate and restructure the FCCBs. The restructuring may include changing the terms of existing FCCBs (eg, extending the maturity period, lowering the premium payable at redemption or waiving part of a principal or interest), or may include the exchange of existing FCCBs with the new FCCBs. However, under the circular, change in the existing conversion price is not permissible while restructuring FCCBs. The circular further provides that proposals for restructuring of FCCBs not involving change in conversion price would be considered under the approval route. Companies have therefore been deprived of the most critical component of restructuring FCCBs - namely, a change in the conversion price. By changing the conversion price, FCCBs holders (if they approved it) would have preferred to exercise the conversion option, as the changed conversion price would be closer to the current price levels.
Buyback or premature repayment at discount
This option is more viable for those companies that face lesser liquidity and, while not in a position to redeem FCCBs fully, may redeem them substantially. To facilitate the buyback, the Reserve Bank of India has issued a number of circulars. The bank has recently extended the premature buyback of FCCBs up to March 31 2012 through AP (DIR Series) Circular 75, dated June 30 2011. The buyback is allowed under both the automatic route and the approval route. Under the automatic route, buyback must be carried out at no less than an 8% discount of the book value of the FCCBs. Under the approval route, which is applicable when buyback is sought through internal accruals, buyback must be carried out at a discount ranging from 10% to 20%, depending on the redemption amount.
The choice of any of the above options will depend on the financial capabilities of the companies, their financing and business plans and negotiations between the companies and FCCB holders. It is possible that companies and FCCB holders may agree to a compromise through which FCCB holders are repaid at least part of their dues, if not the entire redemption value. It is also possible that in some cases none of the above options would be implemented, leading to questions as to whether there is any other option available to FCCB holders - for example, can they approach the courts or other authorities, asking them to direct companies to repay FCCBs forthwith or face a winding-up action?
One course of action is to file a winding-up petition under the Companies Act 1956. However, as is usual in winding up proceedings, even after an admission of petition by the court, it may take several years to complete the liquidation of a company and repayment to FCCB holders. In addition, FCCBs are generally unsecured and would rank lower in terms of repayment of debt, receiving repayment only when the secured creditors and statutory dues of the liquidated company have been fully paid. The delay in receiving repayment through this approach is also evident in some recent high-profile debt cases (eg, the dispute between Wockhardt and its investors).
Depending on the option chosen by the FCCB holder and the issuer company, analysis of the available legal options would be one of the components of any strategy to be employed in pursuing a debt restructuring plan. This may entail the following:
FCCB holders are no doubt interested in recovering their money, whatever it takes. Although the judicial route is seldom the first choice (as court proceedings are notoriously protracted), any resolution may be forced to include the legal option. Litigation has its own value in bringing parties to the table, particularly when there is a refusal to negotiate or dictation of unreasonable terms. Experience shows that recourse to the courts becomes inevitable when the terms of settlement are unacceptable to one set of lenders.
For further information on this topic please contact Sunil Kumar or Hitesh Kumar at Singhania & Partners LLP by telephone (+91 11 4153 1000), fax (+91 11 4153 1001) or email (email@example.com or firstname.lastname@example.org).
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