RESERVE BANK OF INDIA COLLEGE OF AGRICULTURAL BANKING UNIVERSITY ROAD, PUNE COMPROMISE AND SETTLEMENT

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1 RESERVE BANK OF INDIA COLLEGE OF AGRICULTURAL BANKING UNIVERSITY ROAD, PUNE COMPROMISE AND SETTLEMENT After introduction of prudential norms the focus has been to reduce the NPAs by all banks. Measures to reduce the NPAs include i) Recovery of dues, ii) Upgradation of sub-standard assets to standard assets iii) Compromise in selected cases of NPAs IV) Rehabilitation / restructuring of accounts V) Write Offs under provisions of the statute Among the non-legal remedies to reduce NPAs an important one is compromise. Compromise according to Oxford dictionary, is an agreement attained by mutual concession. As compared to the slow legal process a compromise offers quick solution to reduce the level of NPAs. Compromise can be reached at all the three stages; pre-litigation, post-litigation and post-decree. Circumstances Warranting Compromise The following are some of the circumstances when the compromise option could be considered. i) Unit is closed for long and is difficult to revive; debit balance keeps on increasing due to penal interest, inspection charges, etc. etc. ii) The borrower is absconding and the guarantor is willing to clear the debt if some relief is granted. iii) The earning capacity of an otherwise regular borrower is impaired due to some accident. iv) The account has gone bad due to circumstances beyond control of the borrower, therefore, the recovery is doubtful. v) Primary asset or collateral is not sufficient to cover the outstanding dues. vi) Legal costs to recover the dues are likely to be disproportionately high. vii) There is a flaw in documentation.

2 2 Advantages of Compromise Recovery through compromise is favoured mainly for the following reasons : i) Less cumbersome as compared to the legal action. ii) Easy and speedy recovery as it is based on understanding the genuine problems of the borrower. iii) The blocked funds are available for recycling and the realized amount is more profitable than deposit mobilization. iv) It saves lot of time and manpower of the bank and the banker is motivated as he can get rid of the NPAs and concentrate on other aspects of lending. Steps in Compromise The over-riding consideration for the settlement through compromise is to ensure that it is beneficial to the bank. The bank should analyse the costs (sacrifice) and benefits (the realisable amount) on the basis of time value of money comparing the situations as with and without compromise (i.e. by legal action) and thus assess whether the compromise would be beneficial to the bank. Method (steps) to analyse the compromise proposal by applying the discounted cash flow technique (or opportunity cost) is briefly stated below : 1. Outstanding balance of the loan in the bank s account books 2. Pedentilite interest (for the estimated period of 5 years of litigation) 3. Expenses on the suit filed (insurance, legal fees, etc.) 4. Total of 1, 2 & 3 5. Net present worth of the amount of 4 above discounted at the rate of interest as decided by the bank. 6. The amount offered as compromise. 7. The interest amount which would be earned on compromised amount by recycling it for litigation period (5 years) 8. Saving on costs (on Item 3 above) 9. Total of 6 to Net Present Worth of the amount of 9 above. 11. Net gain/loss to the bank on compromise = 5-10 or 10-5

3 3 Similarly, the effect of the situation without compromise on the banks profitability may be calculated by providing for the annual cost on the suit filed and provisions to be made on substandard assets during the litigation period (5 years). Other steps that may be followed to compromise are listed below : i) Ascertain whether the compromise would be beneficial to the bank. ii) Conduct oral negotiations without any commitment by the bank. iii) Obtain the proposal of compromise in writing. Also obtain concurrence of the guarantor, if any. iv) Obtain letter of acknowledgement of debt both from the borrower and the guarantor. v) Obtain concurrence of borrower as well as guarantor on the compromise settlement. vi) Based on merits of the case consider concessions discreetly viz. waiver of penal interest, reduction in contractual rate of interest, scaling down the debt amount. vii) In case of DICGC covered cases, the compromise offer should be higher than the amount available from the DICGC (in case of already settled account, refund to DICGC its dues after deducting the legal charges incurred, if any). General Guidelines The bank should lay down certain procedures to ensure efficient functioning of credit administration for maintaining quality of loans and advances. The Reserve Bank of India has issued certain guidelines which include : i) The Board of Directors of individual banks should delegate suitable powers to write-off bad debts/compromise to its various functionaries, subject to such safeguards/conditions as the Board may prescribe. ii) The authority approving the write-off/compromise should not have sanctioned the loan in his individual capacity. iii) Each proposal of compromise/write-off should cover, inter alia, following aspects for consideration by appropriate authority : a) That the sanctioning authority had exercised his powers judiciously, adhered to the guidelines of the bank in the matter of granting advances and the normal terms and conditions were stipulated.

4 4 b) That there was no laxity in the conduct of post-disbursement supervision and follow-up of the advances. c) That there was no act of commission or omission on the part of the staff leading to the debt becoming NPA d) That all possible steps to recover the dues had been taken and there are no further prospects of recovering the debt, and e) That compromise/write-off is in the larger interest of the bank. Line of approach to be adopted: Do a SWOT analysis of all factors concerned Approach should be tact with problem solving attitude Determine attendant circumstances, environmental factors, alternate future scenarios and need for negotiated settlement before embarking on compromise and negotiation A Banker should always demand the entire sum due to it. No banker s claim is implicit. Making the claim only marks the commencement of negotiation. Besides above, some further aspects may be taken into account by the bank while framing its policy. These aspects are listed below : 1. The circumstances and conditions under which any remission in the debt could be made. 2. The cut-off date from which the question of remission could be considered (one of the possible cut-off dates could be the date on which the loan is classified by the bank as NPA). 3. The circumstances under which future interest may be waived. 4. The documentation needed to put the compromise settlement into effect. The documents should always have a default clause stating that in case the borrower does not fulfil the obligation within a specified period of time, the bank has right to revoke the compromise settlement. In case of suit filed cases it is necessary to obtain a decree which should also include a protective clause against default as mentioned above. 5. While delegating the powers (in this regard) to the various authorities in the bank, mention the safeguards which should be observed while exercising such powers. 6. A system of accountability should be clearly laid down for pinpointing the factors responsible for an account becoming NPA. 7. Once decided the compromise steps are needed to be expedited to close the account

5 5 within specified time frame which should be as short as possible. 8. The compromise option should be the last resort and should be normally thought of only in respect of casual defaulters or victims of natural calamities. Under no circumstances it should be offered to willful defaulters. Compromise Agreement A compromise agreement should incorporate the details of the terms, including the default clause, entered into with the borrower. In addition, the following clauses should be incorporated in it as a preamble : 1. That the borrowers had borrowed monies under various credit facilities, the details of which, the amounts outstanding inclusive of interest and other charges on the date of this agreement, the terms of repayment, and the securities therefor are given in the schedule to this agreement. 2. That the borrowers have verified the details including outstanding balances given in the schedule hereto with their books of account and admit, confirm and acknowledge such balances and the securities thereof. 3. That the various borrowal accounts are out of order as the borrowers have not been able to make the necessary payments therein from time to time and have also been unable to pay the interest and/or other charges from time to time due to business losses etc. incurred and/or suffered by them. 4. That the borrowers are now sincerely interested to pay and settle their dues to the bank as aforesaid and have requested for certain reliefs and concessions as provided below and the bank has consented and agreed for the same subject to compliance of the borrowers to the terms and conditions provided hereunder. 5. That the borrowers understand and agree that but for their averments, undertakings and agreements, the bank would not have agreed to allow the below mentioned remissions, concessions and reliefs. 6. That in the event of any breach of any term of this agreement by the borrowers, all the reliefs, remissions and concessions allowed to them shall be deemed to have been withdrawn by the bank and the original liabilities of the borrowers as shown in the Schedule hereto shall stand reinstated and become payable forthwith by the borrowers alongwith interest and other charges as given in the Schedule from the date of this agreement.

6 6 7. That notwithstanding the withdrawal by the bank of all or any of the reliefs, remissions or concessions as hereunder provided, the securities hereunder provided shall continue as continuing security till the repayment of all the dues by the borrowers to the bank. 8. That the decision of the bank as to which act or acts of the borrowers constitute(s) a breach of the terms of this agreement shall be final and binding on the borrowers. Compromise schemes announced by RBI: RBI had announced two schemes viz., with outstanding balance of Rs. 10 crore and below & with outstanding balance of more than Rs.10 crore. Regarding the former, guidelines were issued as to fixation of the compromise amount for NPAs classified as Doubtful or loss as on March 31, 2000 as also for NPAs classified as Sub-Standard as on March 31, 2000 which became doubtful or loss subsequently. Similarly guidelines were issued for settlement of NPAs over Rs 10 Crore. However these schemes were one-time settlements and their cut off dates have already lapsed. Recent OTS scheme involving small borrowers- RBI has requested the State Govts. to notify the UCBs within their jurisdiction, a simplified mechanism for OTS of loans where Principal amount is less than Rs25000/- and which have become doubtful or loss as on 30 September 2005.RBI has also issued similar circulars to multi-state co-op banks. Conclusion The NPAs adversely affect profits and financial viability of banks. Compromise is one of the measures to reduce the NPAs. It has its limitations and may have adverse effects and hence has to be used judiciously with proper understanding of the genuine problems and concerns of each other. The bank and the borrowers can rebuild the trust between them after compromise and start a new relationship for their mutual benefits. (H.O. originally prepared by Shri M V Patro, Faculty Member, revised by Shri D D Garg, Faculty Member and subsequently updated by Smt. Uma Sankar, Faculty Member)