FCCB – OPTIONS TO TACKLE REDEMPTION WOES
The recent Financial Stability Report (FSR) published in June 2011 by the Reserve Bank of India (RBI) has alluded to the high probability of default in repaying 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 in fact endorsed the apprehension which has loomed like a dark cloud over Indian corporate world’s ability to redeem its debt. With the global and Indian economy staring at the prospect of a double dip recession, overseas lenders (FCCB holders) are worried about the ability of Indian bond issuers redeeming their investments. This article is an attempt to explore the financial and legal options available to FCCB holders and the issuer companies to reach a settlement.
The lure of easy foreign debt
In the heady days of a rising stock market and low interest rates Indian corporates found the FCCB an irresistible route to satisfy their hunger for funds to finance their expansion plans. The FCCB is a mix of debt and equity and provides the bondholders an option to convert bonds into equity and is attractive to both the issuer company as well as to the FCCB holders. Convertibility option, low but guaranteed returns, redeemable if not converted, etc. were the pulling points for overseas investors to subscribe to FCCBs. On the other hand, cheaper source of borrowing, no requirement for security, lower servicing cost because of convertibility option drove the Indian corporates overseas in their mad scramble for funds. During the period from 2005 to 2008, large amounts were raised through FCCBs by many Indian companies; most of them are nearing maturity by March 2013. As per FSR, FCCBs worth more than US$ 7 billion are maturing by March 2013.
Party poopers
Quite suddenly and now increasingly the pitch is getting queered by factors that no one either foresaw or lacked the prescience to predict. At one level the repayment crisis is attributable to the companies’ excessive borrowing, and to the southward dive of stock prices, which neither the issuers nor the FCCB holders expected and which now makes the convertibility option a no-no option. With the stock market booming through 2003-05, there was a general euphoria that share prices would continue to soar and the conversion of FCCBs was taken for granted. But now that the shares of many of these borrowers have started to plummet and are trading below the conversion price, it is highly unlikely that FCCB holders would go in for conversion. All of a sudden the champagne has lost its fizz and the players must return to the table and do some hard headed review of their options.
The borrower companies would need to shore-up their liquidity positions to improve their repayment capability at maturity, atleast partly if not wholly, in instalments if not at one go. But in these turbulent times when the RBI has repeatedly hiked interest rates finding finance would be a daunting task, and replacing low cost debt with higher cost debt may not be a feasible option.
Companies and FCCB holders would be better of exploring avenues by which companies can avoid redemption default and FCCB holders can protect their interest, even if not wholly. Some of the options which are available to the issuer companies and FCCB holders are discussed below:
(i) Raising of equity
(ii) Raising of debt
(iii) Refinancing through New FCCB/external commercial borrowings (ECB)
(iv) Restructuring of FCCBs
(v) Buyback/premature repayment at discount
(i) Raising of equity: The borrower company may raise fresh equity in order to redeem FCCBs. However, this option involves many issues. Firstly, fresh equity would lead to dilution of existing shareholding base which the existing shareholders may not want. Secondly, considering the liquidity position and FCCB repayment liability, outsiders may not be inclined to invest in the company. In such a case, it is therefore the existing shareholders only who may have to bring in more cash into the company.
(ii) Raising of debt: The borrower company may consider raising fresh debt to pay off FCCBs. Though workability of this option depends upon the cost at which such debt could be raised and their servicing burden. Considering the present credit squeeze and high cost regime, raising fresh debt may prove expensive. It may further deteriorate the financial health of the borrower company if it resorts to an expensive borrowing to redeem less expensive (in terms of servicing) FCCBs.
(iii) Refinancing through New FCCB/ECB: Under this option, a company may come out with a new issue of FCCBs or raise ECB to redeem existing FCCBs. The new FCCB may be issued with lower conversion price by linking it to more realistic price levels.
To enable companies to raise new FCCB/ECB for redeeming existing FCCBs, RBI has recently issued a Circular - A.P. (DIR Series) Circular No.01 dated July 4, 2011. The Circular provides that ECB/FCCB up to 500 USD million for redemption of existing FCCB would be considered under automatic route. ECB/FCCB beyond USD 500 million would be taken up under approval route. The amount of fresh ECB/FCCB shall not exceed the outstanding redemption value at maturity of the outstanding FCCBs. Further, fresh ECB/FCCBs have to be raised within six months prior to the maturity date of the outstanding FCCBs and not before that. Other conditions mentioned in the Circular relating to ECB also have to be complied with to raise fresh ECB/FCCBs.
Raising fresh FCCBs/ ECB may be preferable to option at (ii) above since cost of raising new FCCB/ECB may be lower. However, raising fresh ECB/FCCB would depend upon a company’s ability to find new lenders and convince them about the safety of their money despite company’s present inability to redeem its existing FCCB.
(iv) Restructuring 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, e.g. extension of maturity period, lowering of premium payable at redemption, waiver of a part of principal/interest, etc., or may even include exchange of existing FCCBs with the new FCCBs. However, as per A.P. (DIR Series) Circular No.01 dated July 4, 2011, while restructuring FCCBs, change in the existing conversion price is not permissible. The Circular further provides that proposals for restructuring of FCCBs not involving change in conversion price would be considered under the approval route.
Therefore, essentially the companies have been deprived of most critical component of restructuring FCCBs, i.e., change in 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 actual price levels prevailing currently.
(v) Buyback/premature repayment at discount: This option is more viable for those companies which are facing lesser liquidity and are not in position to redeem FCCBs fully but may redeem them substantially. To facilitate the buyback, RBI has been issuing circulars from time to time. Of late, RBI has extended the premature buyback of FCCBs up to 31st March, 2012 through A. P. (DIR Series) Circular No.75 dt. 30th June, 2011. The buyback is allowed both under the automatic route as well as under the approval route. Under automatic route, buyback has to be done at least 8% discount of the book value of FCCBs. Under approval route which is applicable when buyback is sought to be done through internal accruals, buyback has to be done at discount ranging from 10 to 20 percent depending upon the redemption amount.
Legal proceedings not the best but often the only option
The decision to elect any one of the options at (i) to (v) above would depend upon the financial capabilities of the companies, their financing and business plans and also the negotiations between the companies and FCCB holders. It is possible that companies and FCCB holders may agree to a compromise in a way that FCCB holders get repaid at least part of their dues, if not the entire redemption value. It is also possible that in a particular case none of the above options are implemented. In the latter case, question arises as to whether there is any other option available to FCCB holders. Can they approach courts or other authorities, moving them to direct companies to repay FCCBs forthwith or face ‘winding up’ action?
One course of action could be to file a winding up petition under the Companies Act, 1956. But as is usual in winding up proceedings, even after admission of petition by the court, it may take several years to completely liquidate a company and repay FCCB holders. It is also worth noting that generally FCCBs are unsecured and FCCBs would rank lower in terms of repayment of debt and receive anything only when the secured creditors and statutory dues of the liquidated company are fully paid off. The delay in getting repayment through this mode is also evident in some of the recent high profile debt cases as in the dispute between Wockhardt and its investors.
Depending on the option chosen by the FCCB holder and the issuer company, analysis of the legal options open would also be one of the components of any strategy to be employed in pursuing a debt restructuring plan. This may entail the following:
• Conducting due diligence;
• Organizational meetings with the issuer company, its bankers, lead managers, auditors;
• Drafting and review of offer memorandum, applications, agreements and other documents;
• Obtaining regulatory approvals;
• Providing assistance in the form of legal advice/opinion on issues that may arise at any stage of the restructuring process.
Conclusion
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 yet have to include the legal option which has its own value in bringing parties to the table, particularly when there is refusal to negotiate or dictation of unreasonable terms. The legal route Experience shows that recourse becomes inevitable when the terms of settlement are unacceptable to one set of lenders.
About the Author
Sunil Kumar, Senior Partner, Singhania & Partners LLP, www.singhania.in
Sunil has over two decades of post qualification experience. He is a partner with the firm and heads Tax practice at the New Delhi office. He is a former officer of the Indian Revenue Services. Prior to joining the firm he was with Arthur Anderson and subsequently with Ernst & Young. He counsels several multinational corporations on matters relating to Mergers & Acquisitions, Joint Ventures, Regulatory Matters, Cross Border Transactions, Foreign Direct Investments and Trade.
His main area of practice is Taxation and General Corporate & Commercial with focus on Public Private Partnership, Joint Ventures and Acquisitions .He has been recognized by Asialaw magazine as a Leading Lawyer for Taxation.
Hitesh Kumar, Senior Associate, Singhania & Partners LLP, www.singhania.in
Hitesh is a Senior Associate with the firm. He is a part of the corporate group in Delhi and works in the team headed by Mr. Sunil Kumar , Partner at S&P. He assists the team in matters relating to joint ventures, mergers & acquisitions, general corporate &commercial, project finance, securities law and tax.
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