The battle with COVID-19 is not only to save the country and its people but also to ensure that the banking channels are working round the clock to cater to the needs of the public as well as financial market. Needless to say, that banking system is the backbone of any country and its failure or slowdown could lead to multiple issues for developing countries like India.
Prior to the outbreak, the financial institutions in India were already reeling under the delinquency of loan defaults. This problem has prevailed despite various schemes and measures introduced by the RBI from time to time. Interestingly, the measures have been for both the financial institutions as well as the defaulting entities. Post covid, the challenges would be multifarious.
Page Contents
Will COVID-19 affect acquiring distressed businesses in India?
Due to the pandemic, the financial year 2019-2020 ended terribly providing a body blow to the sale of bad assets as there were hardly any takers. This disturbed the maths of the banks and NBFCs who were expecting to lessen their bad loan burden. Going forward, both the liquidity and the valuation aspects shall become critical as regards the functioning of the distressed assets business in India. One may not be entirely incorrect in apprehending that the next quarter or so could provide a hint as regards the impact on businesses whose viability and resilience would be tested. The near future could see a surge in the availability of distressed assets in India, especially in the travel and tourism, entertainment and other consumer dependent businesses. This may pose a good investment opportunity for private equity investors, ARCs and alike. This is in fact a ‘good time’ for these ‘pack of hunters’ to acquire distressed assets at ‘drool worthy’ valuations. This looks apt time to grab a strategic/controlling interest in businesses with fair fundamentals if one thinks from the perspective of private equity players. Many cash rich entities, venture capitalists, private equity investors and fund managers may be willing to jump and grab the opportunity which will arise due to a drop in valuation of otherwise well to do businesses and assets in India – albeit this time probably their efforts may be reduced since their task would be akin to picking up the pearls when the sea dries up. The challenge would be to pick up the ‘real pearls’. One of the biggest Indian conglomerates is witnessing series of private equity investments in its new age businesses as the conglomerate had publicly declared about its target to cut down on its huge debt pile. It’s a rarity to witness such back to back deal making especially in these extremely torrid times. One may see this as early signs of economic recovery and may imagine that all is not lost at the end and the resilience of the country can stand the test of the time. One may even reckon this as a mere aberration.
Relaxations in IBC to help ease debt restructuring and distressed businesses
Apart from the various reforms enacted by the current regime in India, the insolvency law too has seen some reforms, as a result of the pandemic. The government is in the process to provide a formal suspension on commencement of new insolvency proceedings – for a period of at least 6 months to 12 months. The intent propagated is to shield the MSMEs and small businesses amongst other objectives. The requisite notification is yet to be made public and thus the details of such further IBC amendments cannot be analysed at this juncture. The moot question is whether the suspension will be applicable to the defaults occurred during the lockdown period or whether to the defaults that have occurred prior to the lockdown period i.e. existing (pre-covid) defaults. Also, whether the suspension will apply to applications already filed with the NCLT but where such application is yet to be admitted. Moreover, whether there would be any additional time for matters where resolution plans have already been filed with the NCLT and the NCLT is yet to decide on the same. Such additional time period may be felt necessary by the Resolution Applicants – essentially to reanalyse their resolution plans in the aftermath of the pandemic situation. In light of the RBI Circular of February 12, 2018, dealing with the restructuring of stressed assets, being struck down by the Supreme Court, RBI came out with the new regime on June 07, 2019. Under such new regime, many creditors and the borrowers would have entered into Inter Creditors Agreements and a time period of 180 days was provided. The moot question is what would be the fate of the cases where the restructuring has already been agreed upon by the parties but were yet to be enforced? Whether the ratings of these businesses would suffer as a result of this pandemic needs to be seen or whether their pre-COVID situation would be considered considering they were in a position to restructure their loans only to become one of the fatalities of this pandemic.
Dealing with debt restructuring post COVID-19 The government of India has been coming out with various measures including certain temporary regulatory relaxations such as loan moratoriums, liquidity support which will definitely act as a catalyst for the economy to gather some strength and aim to stand back on its feet, both during and post the COVID-19 era. At this moment, this appears to be a work in progress, to say the least.
Some options for debt restructuring and the importance of legal guidance To reiterate, some sectors would be more affected than the others due to the pandemic. The removal of impact of legacy of non-compliances by the promoters on the potential buyers, under the insolvency regime, should prove to be a morale booster for the acquirers as they are insulated from the erstwhile violations. Though, the bidders who had already submitted their resolution plans would need to re-look into the same as a matter of its feasibility post covid 19 as many bidders may cite force majeure/ frustration for fulfilling their commitments. Further, the possible suspension of new insolvency filings coupled with the enhancement of threshold for initiating insolvency proceedings may be viewed as another opportunity by the defaulting companies/ promoters to restructure their debts, preferably by out of court means, by entering into fresh arrangements with their bankers/creditors backed by recently announced RBI measures. By such restructuring/ cleaning of the house, the borrower companies can also make themselves attractive targets for investors. Schemes of Arrangements under Companies Act In the event of suspension of new IBC filings, the lenders and/ or the borrower companies may even consider approaching the NCLT with Schemes of Arrangement under Section 230 of the Companies Act to restructure the debts. This way creditors can also pray for safe custody of assets of the borrower company till such scheme of arrangement is made effective. Basically, arrangement similar to a moratorium under IBC can be envisaged.
RBI Circular of June 07, 2019 The debt restructuring can also happen under the RBI Circular of June 07, 2019 (Prudential Framework for Resolution of Stressed Assets) which applies to Scheduled Commercial Banks, All India Term Financial Institutions, Small Finance Banks and others. However, the said RBI Circular does not apply to Mutual Funds, AIF, Overseas Lenders/ banks and other sectoral regulated entities. From a regulators perspective, the scope of this Circular could be widened so as to include entities which are governed by other sectoral regulators such as Insurance regulator, SEBI, pension regulator etc. This would pave way for more restructuring of debts thereby clearing bad assets scenario. Needless to state, this would require concerted efforts of various regulators who have already provided certain relaxations under their respective regimes with respect to restructuring of stressed assets/loans – such as relaxations under SEBI Takeover Code, SEBI Delisting Regulations et al.
Measures under SARFAESI Act Since fresh IBC proceedings may not be permitted, the IBC option would be ruled out for the creditors, at least for the time being. The Operational Creditors, subject to the provisions of their respective contracts, may have to resort to either arbitration or file civil suits. As regards the Financial Creditors (depending whether secured or otherwise), may have to review their collateral, the probable valuation of the same in current times and enforcement of the same under SARFAESI Act. SARFAESI Act provides various measures such as enforcement of security, debt into equity conversion and taking control and charge of management of the borrower etc. SARFAESI Act also permits sale of assets of the borrower company by way of public auction or private treaty. In case the security is shared, then all such security holders would have to assent so as to resort to any of the SARFAESI Act enabled security enforcement tools.
In order to prevent companies to be dragged into insolvency under the Insolvency and Bankruptcy Code, 2016 (“Code“) due to the present pandemic, certain announcements were made by the Government under the Code. In this article, we have analysed the effect of these announcements on possible scenarios that the creditors or corporate debtors may be faced with. Before proceeding with our analysis, it may be worthwhile to have a brief recap on the announcements by the Government.
- March 24, 2020 – The Union Finance Minister announced that the threshold for invoking insolvency proceedings was raised from Rs. 1 lakh to Rs. 1 crore, which was subsequently notified on same date. In the same announcement, it was mentioned that the Government may consider suspension of Sections 7, 9 and 10 of the Code;
- May 17, 2020 – The Union Finance Minister announced: (i) Special insolvency resolution framework for MSMEs under the proposed Section 240A of the Code; (ii) Suspension of fresh initiation of insolvency proceedings upto 1 year depending upon COVID-19 situation and (iii) Empowering the Central Government to exclude COVID-19 related debts from the definition of “default” under the Code for the purpose of triggering insolvency proceedings.
Keeping in mind the aforesaid announcements and various insolvency measures adopted by countries like U.S.A1, United Kingdom.2, Australia3 etc., the Central Government has now introduced an ordinance dated June 5, 2020 (“Ordinance“) to suspend initiation of corporate insolvency resolution process of a corporate debtor under Sections 7, 9 and 10 of the Code for any default arising on or after March 25, 2020 for a period of six months, or such further period not exceeding 1 year (“suspension period“), as may be notified in this regard.
The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 (Ordinance) has come into force on 5 June 2020. The Ordinance envisages insertion of a ‘non-obstante provision’ to Section 7, 9 and 10, by way of Section 10A of the IBC, which provides that for occurrence of any default between the period commencing from 25 March 2020 till expiry of 6 months or such further period as may be notified, not exceeding 1 year (Exemption Period), creditors/corporate applicants shall not have the right to file applications to initiate the corporate insolvency resolution process.
The proviso to Section 10A further clarifies that there shall be a permanent ban on filing of applications for any default which may occur during the Exemption Period. In other words, the rights available to the creditors/corporate applicants under Section 7, 9 and 10 of the IBC have been permanently taken away, so far as any default during the Exemption Period is concerned.
For abundant clarity, the Ordinance has also inserted an Explanation to suggest that Section 10A shall not have any application on any default that has occurred before 25 March 2020. Therefore creditors/corporate applicants are still entitled to file appropriate applications to initiate the corporate insolvency resolution process, for any default which may have occurred prior to 25 March 2020.
The Ordinance also suspends filing of an application by the resolution professional under Section 66(2) of the Code against directors or partners of corporate debtors in respect of such default against which initiation of corporate insolvency resolution process would be suspended by virtue of the Ordinance.
Newly inserted Section 10A and its proviso: Different treatments for the same subject matter?
The newly inserted Section 10A by which the suspension is given effect reads as follows:
“Section 10A: Suspension of initiation of corporate insolvency resolution process
10A. Notwithstanding anything contained in Sections 7, 9 and 10, no application for initiation of corporate insolvency resolution process of a corporate debtor shall be filed for any default arising on or after 25th March, 2020 for a period of six months or such further period, not exceeding one year from such date, as may be notified in this behalf.
Provided that no application shall ever be filed for initiation of corporate insolvency resolution process of a corporate debtor for the said default occurring during the said period.
Explanation: For removal of doubts, it is hereby clarified that the provisions of this section shall not apply to any default committed under the sections before 25th March, 2020.”
- It is apparent from the above reading of Section 10A that the operative part of the section as well as its proviso deal with the same subject matter i.e. default arising on or after March 25, 2020. While the operative part of the section provides for a temporary suspension on initiating corporate insolvency for any default arising on or after March 25, 2020, it appears that the proviso seeks to give permanent immunity to such defaults from the Code.
- Does the immunity mean that the creditors will never ever be able to proceed against the corporate debtor for such default under the Code? – As the Ordinance reads now, it seems that the Ordinance, literally, debars the creditors from proceeding under the Code in relation to defaults occurring during the suspension period. However, one plausible view could be that ‘default’, as defined under the Code, continues to remain a ‘default’, until it is paid in full, or as agreed. So, a default that has occurred during the suspension period, may continue even beyond the suspension period.
The proviso to section 10A attempts to widen the scope of the operative/enacting part of the section in so far as it protects any default occurring during the suspension period even beyond the expiry of such suspension period. It is a settled principle of interpretation of statutes that the ambit and the scope of the enacting section cannot be widened or curtailed by the proviso when the enacting part is not susceptible to several possible meanings. One can hope that ambiguity arising under the Ordinance may be clarified when the Ordinance becomes an amendment act or by judicial review.
- The underlying rationale of the newly inserted sub-section 3 to Section 66 of the Code, via the Ordinance, is to boost the confidence of the directors or partners of companies to use their best endeavours to continue trading during this unprecedented market situation, without the threat of personal liability, if at all the company goes into insolvency.
- Pending applications i.e. those applications which are already filed with the NCLT, but are yet to come up for hearing or applications which have come up for hearing(s) but are pending admission or rejection, will remain unaffected. The NCLT, Kolkata Bench in the matter of Foseco India Ltd. vs. Om Boseco Railproducts Ltd.4 has held that the increased threshold limit of Rs.1 crore under the Code does not apply retrospectively. This order proceeds on the well-settled law that a statute is presumed to be prospective, unless it is held retrospective, either expressly or by necessary implication. Even NCLT, Chennai Bench has concurred with this view in the matter of M/s. Arrowline Organic Products Pvt. Ltd. vs. M/s. Rockwell Industries Ltd.
- The Ordinance is in consonance with the aggregate moratorium of 6 months on payment of instalments in term loans as well as exclusion of the period for classification of an asset as NPA under the RBI’s COVID-19 Regulatory Package. Thus, majority of the financial creditors may not be moved by the Ordinance. However, the Ordinance is likely to be detrimental to the interests of operational creditors. Be that as it may, it will be interesting to see what treatment is accorded to MSMEs, vis-a-vis special framework for MSMEs under the proposed Section 240A.
- The Ordinance could have provided clarity on the possible issues that may arise due to COVID-19 with regard to various stages specific to a resolution plan viz. where resolution proposal is submitted to the CoC, but not approved by the CoC; where resolution application is approved by the CoC, but pending approval of the NCLT and where the resolution plan is approved by the NCLT, but remains to be implemented.
- The Government could consider bringing into force the fresh start process chapter and also have a statutory amendment qua pre-package insolvency regime under the Code.
Now that the cat is out of the bag, what could be the way forward?
- Financial creditors may pursue (i) restructuring/rearrangement schemes like one-time settlement (OTS), (ii) scheme under Section 230 of the Companies Act, 2013, (iii) inter-creditor agreement in accordance with the RBI’s circular dated June 7, 2019 on ‘Prudential Framework for Resolution of Stressed Assets’, (iv) filing an application against the debtor before the DRT under the SARFAESI Act, 2002, (v) proceeding against the ‘personal guarantors’ of the corporate debtor under the Code.
- Corporate debtors whose rights are being taken away by the Ordinance for initiation of insolvency process under the Code may avail other remedies like voluntary liquidation under the Code and the winding up mechanism for specified companies defined under the Companies Act, 2013 read with the Companies (Winding up) Rules, 2020 which have come into force from April 1, 2020.
- Operational Creditors could opt for debt recover mechanisms such as filing Summary Suits under Order XXXVII of the Code of Civil Procedure, 1908; regular recovery civil suits under the Commercial Courts Act, 2015 before the civil courts; remedies under the MSME Act, 2006 and arbitration proceedings under Arbitration & Conciliation Act, 1996 subject to the existence of arbitration agreement/clause etc.
Conclusion:
Amid the highly uncertain situation due to the pandemic, Banking Industry need to stress test their portfolios, for each of the defined scenarios, to better understand the impact. The current economic and market environment warrants additional stress testing that will have direct implications for decisions that Banks make in real time.
A report by the Reserve Bank of India notes that the pandemic “has affected the best of companies” and businesses that were otherwise viable before the outbreak.
Experts believe that banks may be more risk-averse to restructuring loans this time around, having already suffered big losses in previous restructuring efforts.
As per the Financial Stability Report of the RBI , if the financial system of India “remains sound”, gross non-performing asset (NPA) ratio of all commercial banks is likely to increase from 8.5 per cent in March 2020 to 12.5 per cent by March 2021 under the baseline scenario in the wake of the disruption caused by the covid-19. But “if the macroeconomic environment worsens further, the NPA ratio may escalate to 14.7 per cent under the very severely stressed scenario,”
Author Bio
