COVID 19 and consequent lockdowns have caused economic disruptions across the world, on account of disrupted supply chains and altered consumption patterns. In India, this disruption has been aggravated by the migrant labour crisis, and the prevalence of slow growth and high unemployment even prior to the lockdown. This is likely to exacerbate the existing twin balance sheet problem.
At present, the strategy to deal with distress has been to give businesses as well as banks time to overcome stress caused by COVID 19 disruptions, with the Reserve Bank of India (“RBI”) permitting banks to give a temporary moratorium on the repayment of loans to corporates.
Banks are also not required to count this moratorium period for the purpose of asset classification. As per the Financial Stability Report of the RBI, this has proved very popular with a large percentage of assets under moratorium. To provide further time to businesses, the Government has also suspended the initiation of insolvency proceedings under the Insolvency and Bankruptcy Code, 2016 (“Code”) for defaults occurring on or after 25th March 2020 till 25th September 2020 (extendable to 25th March 2021). However, this time is set to expire on 31st August 2020 and the true extent of the challenge is likely to emerge in the months after this, since many businesses are suffering distress that mere time cannot overcome.
In this scenario, it is critical that robust strategies for the proactive resolution are pursued. At least three measures will assist in this:
First, the Government should provide a framework for holistic restructuring of debts. Presently, no framework in India provides a platform to bring together and bind all creditors of a business to pursue a restructuring. Even the mechanism under the RBI’s June 7, 2019 circular only brings together RBI regulated creditors. This means that key creditors such as statutory creditors are not bound by this framework. Even the Code does not allow for restructuring and largely focusses on third-party rescue, with section 29A preventing existing promoters and management from proposing resolution plans. Further, restructuring under the RBI’s June 7, 2019 circular does not immediately take away the NPA status of accounts, making it harder for businesses to raise new finance that can help them restart their activities. Given this, it is imperative for a framework be proposed by the Government that can enable and incentivise restructuring when it is the most value maximising outcome i.e. when a third-party resolution is not feasible, or would be too costly.
Secondly, since it may not be possible for banks to be able to absorb the entire impact of real sector distress, it is important that a market be created for banks to be able to transfer their stressed assets to entities that may have a higher risk appetite. This will help by both reducing the stress on bank balance sheets, thereby promoting credit availability and by inviting new players in the distressed asset eco-system, that will likely bring more innovative ways to deal with distress on the table, and may have a positive effect on governance and lending practices in the long run. The RBI’s proposed Guidelines on Sale of Loans, are a welcome step towards enabling this, but need to be supplemented by inter alia, a more robust information dissemination system that can make it easy for investors to identify assets for investment.
Finally, it is crucial for the Government to restart insolvency processes under the Code for new assets, with sufficient modifications to make it a feasible mechanism to resolve distress in this changed macro-economic scenario for both assets already being resolved under it as well as new assets. Ideally, the Government should first take steps to increase the capacity of the National Company Law Tribunals to deal with an increase in the number of cases under the Code and also introduce mechanisms such as ‘pre-packs’ in a manner that significantly reduces scope for litigation. The Government should also put in place mechanisms to make it easier to achieve resolution under the Code, by reinforcing/ increasing flexibilities in the type of resolutions possible under the Code, including through credit bids and going concern sales of business, by incentivising players to use mechanisms like information utilities to make information of proceedings under the Code and assets for sale under the Code available in a standard manner and by giving single-window clearance to all approved resolution plans under the Code. This will go a long way towards ensuring that the Code can provide a less costly and more robust insolvency resolution process in this new environment, where access to third-party resolution applicants may be more difficult.
If these strategies are implemented by the Government, the challenge of ‘distress’ can be turned into an opportunity for strengthening the foundations of the stressed assets eco-system in India, that can cater to the evolving needs of the Indian economy.
Contributed by: Shardul S. Shroff, Executive Chairman; Shreya Prakash, Associate
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