India Ratings and Research (Ind-Ra) seeks legislative clarity on the loan clauses that ensure ring-fencing of special purpose vehicles (SPVs) that operate public assets. This is in the wake of the recent default by Jharkhand Road Projects Implementation Co. Ltd (JRPICL) and the management’s treatment of sponsor loans lent to the project finance SPVs owned by IL&FS Transportation Networks Ltd (ITNL). Ind-Ra rates more than INR1.6 trillion of debt issued by various SPVs in India.
default has challenged the rating assumptions based on ‘ring-fencing’ of the
SPVs and the ring-fencing rights of the senior debenture holders in the SPVs in
accordance with the legal agreements.
Ind-Ra is reviewing the following parts of the infrastructure rating criteria under the current limited context:
- Efficacy of the SPV and ring-fencing structure.
- Treatment of sponsor’s subordinated loans as ‘near-equity’
- The need to analyse the ‘weakest’ entity at the group
level and factor its risks despite the lending being towards the strongest
Ind Ra had highlighted the risk of default for JRPICL pursuant to its interpretation of the National Company Law Appellate Tribunal (NCLAT) Ruling in its commentary dated 15 January 2019.
Subsequently, Ind-Ra has downgraded the following NCD issuances of ITNL SPVs:
Jharkhand Road Projects Implementation Co. Ltd (JRPICL)
Hazaribagh Ranchi Expressway Limited (HREL)
Jorbat Shillong Expressway Limited (JSEL)
North Karnataka Expressway Limited (NKEL)
West Gujarat Expressway Limited (WGEL)
The rationale for the downgrade has been provided in the subsequent sections of the report. NKEL, however, is still in the investment grade because of the following reasons:
- Unlike JRPICL, NKEL had not issued any letter for
non-payment to the debenture trustee
- Unlike JRPICL, NKEL has given specific instructions to
service the NCDs on time and payments were made on 15 January 2019
- There is no sponsor sub-debt in this project
- The amount outstanding is INR630 million (face value
of INR289 million). There are two more redemptions, of which one redemption
along with interest is covered by the debt service reserve account (DSRA).
key rating assumptions are being reviewed?
A: Three basic assumptions are being re-examined. First, the ring-fencing of the SPV from the sponsor. The recent episode challenges the remoteness of the SPV from the sponsor, even when there are clauses in the debt agreements that state that any event at the sponsor level will not affect the project-level entity and the SPV’s debt is being governed by an independent trustee monitored mechanism. The second assumption pertains to the efficacy of the structured mechanism itself, wherein, by virtue of the agreements, the issuer has to make the payment (or the escrow account has to be debited) on the due dates. A cash flow water-fall mechanism is typically governed by binding agreements. For example, escrow agreements stipulate the establishment of well-structured payment mechanisms and creation of liquidity reserves. The third assumption concerns the status of the subordinated debt (sponsor sub-debt) in the SPV ring-fenced structure, including the treatment of subordinated debt as near-equity instruments. These instruments cannot initiate a default and do not have the right to claim payment until the final redemption of senior bonds. However, the sponsor itself has initiated a default in the case of JRIPCL. The JRIPCL downgrade to ‘IND D’ factors in the default despite the availability of the cash flows as well as the ‘must-pay’ clauses stipulated in the financial agreements.
Q: Would Ind-Ra have retained the same ratings for the SPVs (HREL and JSEL) but for this episode?
A: Ind-Ra had maintained a Rating Watch Negative on these entities on the back of the sponsor (ITNL) downgrade and based on ITNL’s ability to support the maintenance contracts. Debt investors are monitoring the operations and maintenance (O&M) aspects, and by virtue of the contracts, they have the right to replace the O&M contractors. These projects have sufficient cushions that provide for O&M expenses. An annual apportionment towards major maintenance from the cash flows of the project and sufficient liquidity have been maintained. Ind-Ra has been monitoring the maintenance of the roads and the deficiencies being recorded by the independent engineer in their monthly inspection reports. Under normal circumstances, Ind-Ra would have resolved the Watch based on the replacement aspects and performance impact. We would not have anticipated a steep downgrade with respect to those SPVs under normal circumstances, since the actual DSCRs and other metrics were largely in line with the base case assumptions. Also, the DSRA and major maintenance reserve account (MMRA) were provisioned for in accordance with the documents.
Q: Why did Ind-Ra downgrade the ratings of Senior NCDs of HREL and JSEL?
A: Ind-Ra had monitored the debt service of JRIPCL with the expectation that the debt will be serviced on time. However, the trustees informed us that, although the investors had requested the transfer of monies from the trustee, and trustee had given adequate information to the escrow bank, the payment was not processed by the bank. This event triggered a downgrade in two other issuances (HREL and JSEL), as applying the same principles as JRIPCL means that these entities may also default when their next debt repayments become due (HREL: 12 April 2019; JSEL: 1 March 2019).
During the interaction with JRIPCL/ITNL, the management stated that, based on legal advice, they have prohibited the trustees/escrow bankers from debiting any money towards the debt service of the NCDs based on the NCLAT’s interim order dated 15 October 2018. The management mentioned that the solvency test, which would factor in the sponsor’s subordinated debt, is being applied; if ITNL decides that the entity is solvent, payments to senior debenture holders will be made.
The downgrades of ITNL’s SPVs take into account the management’s stance that the solvency test will be conducted after factoring in the sponsor’s subordinated debt. However, where there is no sponsor sub-debt, instructions have been issued to make the payment. Where there is sponsor sub-debt, in case of JRIPCL at least, the company has prevented the escrow banker from making the payment, quoting the NCLAT order.
Q: Is the sponsor sub-debt really subordinated? Why should it be treated as a near-equity instrument?
A: In line with its standard approach, Ind-Ra treats the sponsor sub-debt as being near to equity and not as a senior debt. The summary presented below (based on the subordination agreements and sponsor support agreements) may be useful. This is based on a particular SPV’s agreement; however, other SPVs have similar arrangements
· The sponsor-subordinated debt will not be due and payable until the final redemption date of the senior facilities. Even in case of a bankruptcy, liquidation or insolvency of the company, the sponsor sub-debt will remain subordinated to the senior debt and will not become due and payable until the senior debentures are fully paid off. Also, the sponsor does not have the right to call for an event of default. Further, even if there is a surplus, and the sponsor is paid from that surplus (in respect of the subordinated facilities), it should be held under trust by the sponsor for the benefit of senior debenture holders.
· The sponsor sub-debt cannot benefit from any lien or security interest or guarantee of payment. Also, the sponsor, by virtue of the agreements, has consented not to ask for or demand or receive payments from the project until the obligations related to the senior debentures are fully settled.
· It is also interesting to note that the sponsor cannot initiate or support any steps that may lead to reorganisation, administration, litigation, dissolution, winding up proceedings or any voluntary arrangement for the benefit of any of the company’s creditors
· In the event of default, any amount payable to the sponsor will automatically cease to be outstanding and the sponsor cannot make any claims. Further, the sponsor cannot initiate legal proceedings in the event of delay in debt service.
These clauses, in our opinion, provide sufficient grounds for not treating the sponsor sub-debt on par with the senior debt, but to treat it as a near-equity instrument.
note that there are two kinds of subordinated debt. The rated subordinated debt,
termed ‘Junior Financing’ in the agreements, is a part of the external
borrowing similar to the senior debt and has the same rights as the senior
debenture holders. Only termination payment rights are different between senior
and junior financing. This note refers to sponsor sub-debt, which is not rated.
Q: What could be the impact of this default?
A: According to the project company, this is the result of the NCLAT’s interim order; however, as per the financing agreements, this is an event of default. The investors may have several recourses, including the right to accelerate. An event of default in the financial documents may also result in an event of default in the concession agreement. This could have spiralling effects on infrastructure financing as a whole and needs to be clarified urgently.
Q: What is the way forward?
A: The JRIPCL default and the JRIPCL management’s stance on the ‘solvency’ have brought to light a new dimension regarding the risks involved in infrastructure and project financing. Government and regulatory intervention may be required to provide further clarity on these mechanisms.
In India, several public private partnerships (PPP), including environmental infrastructure projects, resort to the SPV and ring-fencing model to finance infrastructure. The absence of clarity on the above-mentioned risks may have a negative impact on the infrastructure investment climate in India, in Ind-Ra’s opinion.
Ideally, specific provisions that define an SPV should be incorporated into the corporate legal framework. A publication from the Reserve Bank of India suggests an ideal framework for an SPV would be to have an identity that is totally distinct from that of its promoters/ sponsors/ constituents/ shareholders. (https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?ID=164)
India Ratings is monitoring the situation against the limited context of this episode. A plain analytical (not legal) reading of the Sections 241 and 242 of the Companies Act shows that only the members of the Companies and the Central Government can file an application with the Tribunal under these sections.
Additional information is available at www.indiaratings.co.in.
Ratings are not a recommendation or suggestion, directly or indirectly, to you or any other person, to buy, sell, make or hold any investment, loan or security or to undertake any investment strategy with respect to any investment, loan or security or any issuer.