As the number of COVID-19 infections in India reaches new highs, and various states go into lockdown, the Government must consider another set of measures to address the economic disruption caused by this wave. A key pillar of these measures would be adapting the Indian insolvency resolution framework to deal with the new wave of distress.
This article traces the debt recovery and insolvency-related measures that the Government had taken last year when the first wave of the pandemic had hit. It then goes on to enumerate how the industry has expected debt recovery and insolvency resolution mechanisms to evolve, as the number of COVID-19 infections dipped and economic activity picked up. Finally, it explores how these expectations must be readjusted in view of the recent surge of cases, and makes suggestions on some steps the Government and/ or courts can take in relation to debt recovery/ insolvency resolution measures.
In 2020, the first wave of the COVID-19 pandemic and the consequent national and international lockdowns resulted in unprecedented economic disruption. In the financial year 2020-2021, India’s GDP contracted an estimated 7.7%. To deal with this disruption, the Government of India and the Reserve Bank of India (“RBI”) announced a series of measures to support businesses. Key amongst these, were forbearance measures.
RBI gave banks an option to provide a six-month loan repayment moratoria, and retain asset classifications of accounts. This ensured that banks would not take coercive action for defaults that occurred due to COVID-19, a measure crucial for the survival of both small businesses and individual borrowers. As per the RBI’s Report on Trends and Progress of Banking in India, as on August 31st, 2020 customers accounting for 40% of outstanding bank loans had availed the benefit of this moratorium; with the number of Micro, Small and Medium Enterprises (“MSMEs”) availing of this moratorium being as high as 78%.
Simultaneously, the Government of India announced that insolvency proceedings under the Insolvency and Bankruptcy Code, 2016 (“IBC”) cannot be initiated on the basis of defaults that occurred between 25th March 2020 and 25th March 2021. The Government also announced that even for defaults that had occurred prior to this period, insolvency proceedings under the IBC could not be pursued unless a default of at least INR 1 crorehad taken place (up from the previous INR 1 lakh). These measures were taken up largely to prevent businesses from being forced to default or enter into insolvency proceedings due to temporary distress that would be attributable only to COVID-19. This became particularly important in context of insolvency proceedings under the IBC since these proceedings result in a change of control, and in many cases, existing management/ promoters are barred from presenting resolution plans to resolve the distress of the company. Given the global macro-economic scenario, there was a concern that third-party resolution applicants would not be forthcoming for businesses, and a large number of businesses would be pushed into liquidation due to paucity of applicants, even where the business should have been saved. Arguably, recourse to insolvency proceedings under the IBC was also suspended to ‘flatten the bankruptcy curve’ and ensure that the National Company Law Tribunals (“NCLTs”) that were already combatting infrastructural and capacity constraints did not have to deal with large volumes of applications filed for initiation of insolvency proceedings, particularly when they had to limit their functioning to only hear urgent cases in view of COVID-19 related restrictions. Operationally, too, the Government and courts took various measures to ensure that timelines under the IBC were relaxed. The strict requirement to complete corporate insolvency resolution processes (“CIRP”) within 330 days was also relaxed by an order of the National Company Law Appellate Tribunal [LSI-485-NCLAT-2020(NDEL)], while the requirements to take various steps in CIRP and liquidation processes within stipulated timelines were eased by regulatory changes.
These measures had effect. Between April- December 2020 only 283 CIRPs were initiated as compared to 1517 CIRPs initiated between April-December 2019. While insolvency proceedings were not available, the RBI, on 6th August 2020, announced a special resolution scheme for COVID-19 defaults that allowed easy restructuring with existing management while classifying accounts as standard, including by extending the residual tenor of the loan by 2 years, with or without moratorium. However, this framework too was subject to criticism, as many businesses were not eligible for this scheme and some argued that the financial parameters applicable to plans approved under this scheme were too stringent. While the RBI had taken steps to ensure that this framework would present an improvement of the standard resolution framework, in which problems of hold-outs were rampant, other issues such as the inability of this framework to bind creditors not regulated by RBI remained. Given this, there remained a need for a framework that would allow comprehensive resolution of distressed businesses that could not access the RBI special resolution framework successfully.
In this context, the end of the suspension period for initiation of IBC proceedings on 25th March 2021 was welcomed. For one, while there was continued confusion over whether insolvency proceedings under the IBC can be initiated for defaults that first occurred during the period of suspension and continued after 25th March, 2021, there was a view that IBC activity would increase at least due to resumption of physical hearings by NCLT. Secondly, development of jurisprudence over the last year on issues such as limitation periods, primacy of commercial wisdom of the committee of creditors under the IBC and the binding nature of a resolution plan settled some key issues that had been pending resolution. Given this greater certainty on the law, there was also a belief that resolution under the IBC would become less time consuming over a period of time. Thirdly, it was expected that this new phase of activity would lead to new Government facilitation that would further settle the IBC regime. Specifically, it was expected that the Government would intervene to make it easier to receive approvals for resolution plans, provide greater guidance on implementation of resolution plans and introduce the much-awaited group insolvency and cross-border insolvency legislation.
Moreover, early this year, the Government also introduced a special pre-packaged insolvency resolution process (“PPIRP”) to deal specifically with distress of MSMEs. Under this new regime, MSME debtors that have committed default of at least INR 10 lakh are eligible for the PPIRP, and may negotiate a “base plan” with their creditors. Once 75% of its members and 66% of its unrelated financial creditors, approve the proposal to initiate PPIRP, the MSME may approach the NCLT to initiate the process. Once a PPIRP has been initiated, a limited moratorium is declared, and a Resolution Professional is appointed to oversee the process. During a PPIRP, the pre-existing management continues to stay in possession of the company, albeit with the oversight of the Committee of Creditors (“CoC”). The CoC itself is formed on the basis of a list of claims provided by the debtor. Additionally, the debtor must provide a Preliminary Information Memorandum containing all information relevant for formulating a resolution plan, as well as the negotiated base plan. The CoC retains the decision to approve the base plan, or to invite other plans to challenge it. Any plan that receives not less than sixty six per cent approval from the CoC is considered approved and is submitted to the NCLT. A PPIRP must be concluded within one hundred and twenty days of commencement. If the PPIRP does not conclude within the prescribed timeline, or if the CoC does not approve any plan, an application may be filed before the NCLT for termination of the PPIRP. The PPIRP would not ordinarily result in liquidation of the debtor, but this may be the case in certain circumstances where the management is recalcitrant or an approved resolution plan is contravened. This raised expectations that the IBC activity in the MSME sector would increase.
However, on account of the new wave of COVID-19 infections, activity in the IBC and debt recovery space could shape up differently.
It is expected that due to the human cost of this new COVID-19 wave, stakeholders may not be able to resume commercial activity, including restructuring activity, both within and outside IBC till infection rates reduce. Given this, emergency operational measures should be put in place to relax timelines for ongoing insolvency proceedings under the IBC. This will ensure that companies are not forced into liquidation and actors are not penalised for being unable to carry out activities on account of state lockdowns and/or COVID-19.
In the medium term, even when infection rates stabilise, we may continue to see a slump in economic activity particularly if COVID-19 related restrictions are not eased by governments to prevent another wave. In this scenario, it would do well for the Government to extend monetary support to distressed sectors, particularly the retail and hospitality sectors. The Government should consider the creation of funds to provide grants and liquidity support to prevent redundancy and promote reconstruction, particularly of priority sectors.
Moreover, restructuring activity, including under the IBC should not be completely suspended. Instead, greater emphasis should be placed on consensual restructuring. Participants should be prepared to make full use of the new PPIRP framework. Banks and insolvency professionals should also prepare themselves to use this, and create SOPs. The Government, for its part, should consider extending the PPIRP to non-MSME enterprises as well. This should be accompanied with appropriate modifications to the PPIRP to allow out-of-court admissions resulting in a moratorium for a limited period at least, so that NCLTs are not overburdened with applications, particularly as their activity is likely to be restricted. Government may also consider relaxing the need to conduct Swiss Challenge in all cases where statutory creditor dues are not fully paid out as long as other operational creditors are paid. Even where a normal CIRP is initiated, certain relaxations to Section 29A, which prevents pre-existing promoters and management from proposing resolution plans should be contemplated. To facilitate greater comfort of lenders to restructure with existing promoters, the RBI should also consider relaxing some asset classification requirements for such restructuring in the IBC.
Out-of-court restructuring, and one-time settlements should also be attempted by participants. While it is unlikely that another loan moratorium can be granted by the RBI, it can facilitate such out-of-court restructuring by creating another scheme, similar to the August 6th scheme, with potentially more inclusive standards.
Moreover, even though domestic enterprises and businesses would be affected by COVID-19, international commercial activity is picking up as vaccination increases. In this background, more foreign investment should be attracted, particularly to reduce distress. The PPIRP would be one mechanism that could excite foreign investors to work with the debtor to purchase equity. Within the CIRP, this foreign investment may be attracted by allowing a greater number of resolution options. For instance, clarity may be given that ‘turnaround and sell’ resolution plans may be proposed. Outside the IBC too, foreign investment in stressed loans may be attracted either through the bad bank route or by introducing a more liberal framework for sale of loan exposures.
The Government should also ensure that the facilitations expected by industry in the growth scenario a few months ago are not left unaddressed. For instance, platforms to fast-track receipt of government approvals for implementation of plans should be launched and legislation to deal with cross-border and group insolvency issues should be introduced. Similarly, it should continue to expend resources to build capacity of NCLTs, not merely by increasing benches, but by improving their virtual hearing and case management tools.
These changes will be crucial to ensuring that the IBC remains effective in resolving distress in the economy. While the Government implements policies to prevent further stress in time of such unprecedented crisis and uncertainty on all fronts, industry participants should also cooperate to ensure that Government initiatives are successful.
This article was originally published in Law Street India on 30 April 2021 Co-written by: Misha, Partner; Shreya Prakash, Associate; Sanjika Dang, Research Fellow. Click here for original article
Contributed by: Misha, Partner; Shreya Prakash, Associate; Sanjika Dang, Research Fellow
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