Our article has been published by Chambers and Partners at Debt Finance 2025 – India | Global Practice Guides | Chambers and Partners

Introduction

The young Indian lending ecosystem has evolved significantly in recent years, with a diverse range of lenders entering the market and borrowers demonstrating a greater willingness to take risks. Through the 90s and early 00s, public sector lending dominated this ecosystem with returns, in most cases, linked solely to the interest paid on the principal amounts. The Reserve Bank of India (RBI) data indicates that public sector banks controlled about 85% of the bank credit in India in 1991, on the eve of liberalisation policies in India. Though their share declined steadily, public sector banks still held about 72% of the total bank credit in 2002 and about 75% in 2010; the public sector banks’ share has now reduced to 51% of the total bank credit in India today; the decline being commensurate with an increase in the share of private sector lenders.

Returns tied exclusively to interest are due to a combination of the legal and regulatory framework and market conditions. This situation effectively prevents financial institutions from directly owning and controlling another company’s business. For example, Section 19 of the Banking Regulation Act of 1949 prohibits banking companies from forming subsidiary companies, except for certain permitted businesses. Additionally, this provision restricts banks from holding more than 30% of the paid-up share capital of any company, whether as an owner, pledgee, or mortgagee.

With the advent of private sector lenders and quasi-banks, the lending ecosystem began to mature, with more players and a larger appetite amongst borrowers to venture beyond public sector lending. Per RBI data, quasi-banks, in the form of non-banking financial companies (NBFC), have increased their share in total commercial credit from about 12% in 2011 to about 25% in 2024, and credit from NBFCs has also grown at a rapid pace, despite the sectoral crisis and regulatory tightening.

As India moved into the late 2010s, public sector lending became more cautious due to increasing levels of non-performing assets, leading to a decline in overall bank credit growth. As a result, access to debt capital has increasingly shifted to private credit players. According to RBI data, the share of industry in total bank credit has dropped from 44% in 2011 to just 28% in 2024, and the growth of industrial credit has also slowed. This transition has led to a shift in institutional sources of corporate credit towards retail lending. Although NBFCs have made strides to partially fill the gap, they primarily concentrate on retail lending, which creates additional opportunities for private credit players to meet the financing demands of the industrial and corporate sectors.

According to an EY report, private credit in India reached USD9.2 billion across 163 deals in 2024, significantly higher than USD8.6 billion in 2023. These private credit players brought with them the ability to be flexible on their returns through PIK, non-principle-backed bonds, equity upside, and the ability to see equity as a form of return.

From Equity Upside to Equity Deals

The sacrosanct divide between credit and equity transactions began to blur with the advent of structures revolving around equity to provide a return on debt capital. The change in law around the same time as this macroeconomic change also fueled this change in the outlook of Indian financiers.

Prior to the promulgation of the Insolvency and Bankruptcy Code, 2016 (IBC), the legal/regulatory framework in India allowed banks/financial institutions with limited avenues for restructuring and resolution of debt, which involved methods such as conversion of debt into equity and change in management as part of restructuring strategies. These avenues, which became particularly essential due to the rising levels of non-performing assets in the country, include the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI), 2002, and schemes by the RBI such as Corporate Debt Restructuring (CDR) and Strategic Debt Restructuring (SDR).

Change in management or reorganisation of a debtor is not preferred for restructuring or enforcing debt, as banks and financial institutions are often not seen as well-equipped to manage a borrower’s operations. For instance, over 80% of the recoveries made by Asset Reconstruction Companies (ARC) under the SARFAESI have involved methods which do not lead to a revival or reorganisation of the debtor’s business. ARCs have infrequently used methods, such as change in the debtor’s management or conversion of debt into equity, for making recoveries under SARFAESI.

Firstly, with the advent of the IBC and consequent developments in the Indian market (such as the development of the corporate bond market, the rise of private credit firms, etc), financiers see equity positions and control of borrowers as necessary tools for maximisation of returns. The IBC, for instance, which puts the creditors in the driver’s seat and gives them complete control of the business of the borrower, has increased recoveries for creditors as against their total claims (per data released by the Insolvency and Bankruptcy Board of India) – until December 2024, creditors, on average, have realised 31% of their admitted claims under resolution plans; the number increases to 163% and 97.5% when measured against the liquidation value and fair value of the debtor respectively.

These outcomes under IBC have played a major role in the outlook of Indian financiers, who now seriously consider equity not just an upside but also the driving factor for making their return on a debt financing deal. The impact of IBC has changed creditor-debtor relationships, as debtors face a credible threat of change in ownership/management of their company, allowing creditors to have greater negotiating power.

Secondly, enforcing pledges over dematerialised shares has become fairly simple, allowing creditors a reliable enforcement option. The Supreme Court of India provided much-needed clarity on the legal position held by such financiers in 2022 in PTC India Financial Services Ltd. v Mr Venkateshwarlu Kari, which lets financiers enforce the pledge while at the same time not having to settle their outstanding dues. The ability to sell the business post-enforcement of the pledge is now factored into by the creditor while negotiating with the borrower.

Thirdly, covenants to pay, such as guarantees, have become increasingly common and are now easily enforceable. Recently, the Supreme Court clarified that a “shortfall undertaking” – an obligation by a guarantor or chargor to cover any deficiency in the amounts collected by the creditor – would be considered a guarantee. As a result, the creditor is regarded as secured. This interpretation by the judiciary broadens the understanding of such covenants, creating a favourable environment for debt investments.

A net result of these changes has been the development of a certain level of maturity in the debt market, which allows financiers to increase their appetite for more risks and use varied tools to extract their returns.

Ownership as a Deal Driver

While there has been exponential growth in the supply side for credit, the demand for the said credit has seen its ebbs and flows. As competition drives the market, the return on capital has changed with the demand. As debt funders look for avenues to maximise returns, quasi-equity structures such as convertible debt, equity upsides, and equity-linked returns have become common. An increasing trend has been loan-to-own transactions (LTO), which refers to an acquisition strategy wherein a lender takes a  lending role in the target company with the intent to control the said company. In an LTO scenario, the lender is not concerned with cash returns, which can be generated through the loan; instead, they are motivated by the returns the borrower’s business can generate to maximise their returns.

An LTO transaction can be implemented  at three stages:

• financing, wherein the lender can provide the financing and control the business through the debt terms to ultimately acquire an equity stake in the company;
• enforcement, wherein the lender can enforce their debt post-default through appropriate legal/contractual avenues and establish its control; and
• insolvency/bankruptcy, wherein the lender, with a substantial stake in the company’s debt, can bid for the target company in such process.

A subset of LTO transactions also arises in a post-origination scenario, wherein the lender can purchase a majority of the existing debt in anticipation of, or during, financial distress or the insolvency/bankruptcy process and subsequently bid for the target company in a subsequent sale/reorganisation process.

Stage I: financing

In the first stage – ie, financing, the transaction documents, unlike an ordinary credit arrangement, include active cash control mechanisms and covenants geared towards continuous monitoring of the debtor’s business. The events of default under such documents are typically linked to these covenants, wherein any breach would allow the lender to take enforcement actions – which would typically include enforcement of a pledge, conversion of debt into equity, change in management, ability to file for insolvency, etc.

It is important to be mindful of any overarching control covenants, such as influence on the day-to-day functioning of the target’s business, the right to appoint majority directors, the affirmative vote requirement for a large number of decisions taken by the target, etc. Recent jurisprudence suggests that the court may construe the combination of such covenants as positive control and classify the lender as a “related party” of the target, which could have adverse consequences at the time of enforcement, given that a related party does not have any right to participate or vote in any committee of creditors meeting convened pursuant to initiation of insolvency of the borrower.

Similarly, structured products with an equity flavour could trigger the related party classification, and lenders must consequently monitor these triggers closely.

Stage II: enforcement

In an enforcement scenario, lenders can:

• convert its debt into equity and acquire ownership of the company; or
• bid the face amount of the debt (enhancing the possibility of a successful bid vis-à-vis other bidders) in a foreclosure scenario/sale of the business to acquire company’s material assets, also known as credit bidding.

However, we have noted that credit bidding in a scenario outside of the insolvency framework has its challenges arising because there is no direct option to undertake it under SARFAESI or the requirement to take leave of adjudicatory tribunals.

The (Indian) Companies Act, 2013 permits the conversion of loans/debentures into the company’s equity in the event of default subject to the satisfaction of certain conditions; therefore, it is common for lenders to seek these rights prior to the financing deal itself. However, such conversion would require cooperation from the existing management, which may not be forthcoming in an enforcement scenario. The lenders would, therefore, need to exercise a combination of invocation of pledge along with replacement of the existing board by exercising its shareholder rights.

Stage III: insolvency/bankruptcy

Under the IBC, a financial creditor is allowed to submit a resolution plan and vote on it as part of the committee of creditors. For a smooth takeover, the lender may, at the financing stage, ensure that it holds a controlling tranche of the debtor’s exposure or purchase loans/exposures from existing lenders to constitute a significant percentage of the committee of creditors. While the IBC recognise the right of a lender to bid for the borrower, it would be prudent for the lender to maintain ethical walls (between its role as a creditor and as a resolution applicant) to avoid any conflict of interest while wearing the different hats. The lender would have to ensure that the plan is feasible/viable, with a view to resolve the debtor and maximise its assets, and is otherwise compliant with the IBC to prevent successful challenges to such a plan.

Purchase of Existing Loans

A subset of an LTO transaction is where the lender can purchase existing loans/exposures in a post-origination scenario, during/in anticipation of insolvency proceedings, and submit a restructuring plan to acquire the borrower’s assets/business, which it can then approve as a majority lender.

Certain restrictions, such as FEMA considerations and others under RBI’s regulations, may also apply to the purchase of existing loans, which the lender must account for before developing an LTO strategy.

Conclusion

As discussed in this article, lenders are increasingly viewing ownership of the borrower as a means to maximise their returns under a lending transaction. These transactions have ranged from linking their returns to an equity upside to utilisation of a combination of instruments and debt covenants to take a controlling position in the borrower and maximise returns from the intrinsic value of the borrower’s business itself. LTO transactions are gaining traction due to the changing nature of credit arrangements and favourable regulatory and judicial treatment. As the Indian debt market matures, the market players need to keep a close watch on the nature of their transaction to ensure that a debt deal does not trip up the wires, leading to it being classified as an equity transaction, which could lead to adverse consequences in an enforcement scenario.