Indian Banking Sector: Inter-Creditor Pacts

The Indian banking sector has seen a sudden increase in the number of bad loans. Several of these bad loans were taken by high profile corporate bigwigs, many of whom have exited the country. High profile businessmen such as Vijay Mallya and Nirav Modi have left the country leaving many banks with big holes in their balance sheets. They have left behind assets which are meager when compared to their liabilities. This is the reason why banks now have to scramble through the remains.

These borrowers have not taken loans from individual banks. In fact, several banks have exposure to such loans. Many times, they are holding similar collateral. This is the reason why recovering these loans has become so complicated. Not only do the lenders have to fight with the borrowers, but they also have to fight amongst each other.

The problem was that each bank was acting on its own accord, trying to maximize its own recovery. The problem with this approach was that sometimes they were pitted against other banks and lenders. This would lead to litigation amongst the bankers. The litigation was delaying the realization of the dues of all bankers. In order to stop this infighting and to expedite the realization process, Indian banks have come up with an agreement called the “Inter-Creditor Pact.”

In this article, we will have a closer look at what an inter-creditor pact really is and what are its effects.

What Is an Inter-Creditor Pact?

An inter-creditor pact is an agreement which is reached between lenders who have lent their money to the same borrower. This agreement specifies ahead of time, how disputes related to conflicts of interest amongst lenders will be settled in a timely and fair fashion. While entering inter-creditor agreements each bank has to accept the common rules regardless of their exposure related to a particular borrower.

In a country like India, where litigation is both time consuming as well as expensive, inter-creditor pacts are a boon. They save the banks litigation costs as well the opportunity loss which arises when their money is stuck for years. This is the reason why 24 Indian banks, both from the public as well as the private sector have signed the inter-creditor pact.

What Would Happen In The Absence of This Pact?

In the absence of this pact, there would be a lot of infighting amongst the creditors. This is because if the borrower is not able to fully repay the interest as well as principal of even a single borrower, they have the right to ask for the liquidation of the company under the Indian Bankruptcy Code. However, the problem with this is that the legal process is lengthy in India. Even if one lender files a case, the money of all other lenders also gets stuck in the process. Hence, in the absence of this pact, resolving the bad loan crisis in India would be very difficult since the lenders will end up stuck in a sea of litigations and standoffs.

Common Features of Inter-Creditor Pacts

Some of the common features of inter-creditor pacts have been listed below:

• Creditors who sign the pact are legally bound to give up their right to enforce their debt independently. After the agreement, the banks act as a consortium when they try to collect their dues. This standstill begins from the day when the lender has signed the pact
• Creditors are prohibited from accepting any payments from their borrowers from the day they sign such contracts. This means that even if the borrower is willing to pay back loans, the bank is not supposed to accept the funds. It is the bank’s responsibility to route the money through the consortium of creditors. Inter-creditor agreements prevent banks from dealing with the borrowers on the side.

Details of the Inter-Creditor Pact amongst Indian Lenders:

More than 24 Indian banks have recently signed an inter-creditor pact. The deal has been stuck between diverse institutions. Some of them are public sector bank, others are private sector banks, and yet others are multinational banks. The details of the inter-creditor pact amongst Indian lenders are as follows:

• If more than 66% of the lenders (by value) agree to a resolution plan for a particular borrower, then the plan would be binding on all lenders. Once this pact is signed, lenders with small interests cannot really hold up the resolution process of big banks.
• The inter-creditor pact also makes it binding for larger banks to buy the loans from banks that have a smaller exposure. The loans can be bought at a maximum haircut of 15%. This means banks with minority exposure can sell their loans to other banks at 85% of the net realizable value. If they do not want to sell their stake, they also have the option to buy the stake of everyone else at 125% of the net realizable value.
• Banks with minority exposure can also sell their loans to third parties. There are no restrictions on the price at which this stake can be sold.

Hence, the agreement is fair in nature. It protects the interests of banks with minority interests. However, it also prevents any bank from creating litigation that would waste the time of all parties involved.