An opportunity in Covid-19 crisis: Revisit all loan repayment contracts

It is a chance for stakeholders in the banking sector to revisit contractual obligations, say experts

The prospect of wide-scale defaults in banking-related contractual obligations on account of the pandemic has stirred lenders into action. The Indian Banks’ Association (IBA) plans to recommend to the Reserve Bank of India and the government a host of relaxations in repayment of loans and relief in classifying accounts as non-performing assets.

What makes any banking-related defaults complicated, both for lender and borrower, is that banking laws and regulations are typically centred on security cover, and do not deal with pandemic situations, say experts.  

“Most loan-related contractual agreements do not have force majeure clause that could be triggered to terminate the loan agreement and seek relief from repayment obligations,” says Leena Chacko, partner, Cyril Amarchand Mangaldas.

Experts note banking-related contractual obligations primarily pertain to lending agreements. “Such agreements describe the manner of repayment of the loan, along with the applicable rate of interest. In case the terms of banking-related contractual obligations aren’t met, the default clause is triggered,” says Varsha Banerjee, partner, Dhir & Dhir Associates.

Experts say there do not seem to be specific banking regulatory guidelines for dealing with pandemics. Some lending agreements, especially those related to corporate or balance sheet funding, have force majeure clauses that provide protection to the lenders in terms of their obligation to fund. Similarly, financing contracts, such as those dealing with EPC (engineering, procurement, and construction), O&M (operations and maintenance) and supply, generally contain force majeure clause.

While the government through a notification has clarified that the COVID-19 pandemic is a force majeure event, legal experts say this relief does not in most cases impact the repayment obligations of the borrower under the financing documents. 

For lenders, a payment default by a borrower could trigger a number of other events of default across the financing documents. This could include occurrence of material adverse event, breach of financial ratios, failure to comply with underlying project documents, and inability to achieve commercial operations on time, among others, say experts. “Inability to recover dues by lenders may also affect the lending ability of banks even under already committed loans,” says Siddharth Srivastava, partner, Khaitan & Co.

Srivastava advises lenders encountering a potential default situation to carefully review the underlying the project documents and analyse the impact on timelines on account force majeure before approving fresh funding for greenfield projects.  In its suggestions to the RBI and the government, the IBA has highlighted the need for an extension of 90 days in classifying loans as NPAs, six-month deferment in interest of term loans and working capital loans, and longer resolution period for companies under the IBC, among others.

Legal experts say borrowers must immediately revisit all their critical loan agreement to analyse if they can claim any genuine concession from the lender on account of the COVID-19 pandemic. “There are information covenants in the loan agreement which obligates borrower to inform about a material or a force majeure event. The borrower may immediately send such intimation to the lenders and also request for a moratorium on account of this,” says Srivastava.

In addition to seeking waiver of payment defaults, borrowers may have to seek specific covenant reliefs and ensure that such defaults don’t result in defaults across other financings, says Chacko.

Typically, in contracts that do not include the force majeure clause, the India Contracts Act recognises the doctrine of frustration – under Section 56 – to terminate a contract. Banerjee, however, points out that in case of banking-related contractual obligations, it might be difficult to achieve the termination of the contract on account of applicability of doctrine of frustration as it is premised on prepayment of the loan amount.

Many legal experts feel the COVID-19 pandemic event is an opportunity for all the stakeholders in the banking sector to revisit their contractual obligations. “It will help them crystallise their respective rights and obligations so that they are better prepared for a COVID-19- like situation in the near future” says Srivastava.

Trouble with  defaults on bank loans

*There are no specific banking regulatory guidelines for dealing with pandemics

*Most loan-related contractual agreements don’t have force majeure clause

*A payment default could trigger default in other financing documents

*Inability to recover dues may also affect the lending ability of banks

What should lenders & borrowers do:

Lenders: Must carefully review the underlying project documents and analyse the impact on timelines

Borrowers: Immediately revisit all their critical loan agreement to analyse if they can claim any genuine concession from the lender

*The borrower should intimate the lender of any impending default and request for a moratorium on payments