How a one-time loan recast policy may lead to a spate of litigation

In a fortnight from now, a one-time loan recast policy for India Inc. may be on offer to take care of pandemic-related stress. But how is it to be ascertained that the pain was, indeed, triggered by the pandemic?

“The preamble to the Insolvency and Bankruptcy Code’s (IBC’s) Ordinance (suspending it for the time being) refers to an ‘unprecedented situation’ and business suffering on account of ‘reasons beyond their control’. In the absence of any parameters, this could lead to disputes,” says Divyanshu Pandey, partner at J Sagar Associates.

His observation should be seen in the context of the Reserve Bank of India’s (RBI’s) Financial Stability Report (FSR: July 2020). It noted that the gross non-performing assets ratio may move up to 12.5 per cent (14.7 per cent in a very severe stress scenario) by FY21, from 8.5 per cent in FY20. And for the same period, the system-level capital to risk-weighted assets ratio may slip to 13.3 per cent (11.8 per cent in a very severe stress scenario).

Says Rajiv Anand, executive director and head-wholesale banking, Axis Bank: “It can be inferred that if a borrower is in default today, it is primarily on account of pre-Covid issues. The stress may have been aggravated on account of Covid, but clearly the initial cause of default would not be Covid-related. We have been careful in differentiating, borrower by borrower, the stress which has been worsened due to the Covid crisis from the stress which was already in place.”

The management committee of the Indian Banks Association feels banks should be given the discretion to decide how the recast is to be customised and the eligibility criterion. The bankers’ lobby has sent its views to the RBI, but a few critical aspects need to be fleshed out before the framework is operationalised.

 

The legal minefield

Assume a situation in which a default had happened prior to the lockdown, which has affected its chances of being set right. Are such cases not to be seen as Covid-induced stress? Then, neither the IBC Ordinance suspending referral by banks to the National Company Law Tribunal (NCLT), nor the RBI’s circular on moratorium, extends relief to pre-Covid stress cases. Given the lack of clarity on how cause and effect is to be addressed, companies that are turned away from the recast window could well take legal recourse against their lenders. You will see more trouble: Can cases in which default has occurred during the suspension phase of the IBC be referred under it when the period of abeyance goes? The Ordinance says it cannot be referred after that.

“This is one place where there would be litigation in the coming da­ys. A company that was already in default pre-suspension and moratorium timelines will have no real argument for taking legal recourse, and forcing a loan recast. There are instances of IBC cases being filed for default pre-suspension and are now pending admission hearing at various arms of the NCLT,” notes Veena Sivaramakrishnan, partner at Shardul Amarchand Mangaldas & Co. You have another layer of complexity.

 

Says Neerav Merchant, partner at Majmudar & Partners: “If the default has occurred prior to March 25, 2020, then appropriate proceedings can be initiated against the defaulting companies under the IBC if the value of the default is more than Rs 1 crore. It is pertinent to note that these protections are granted to companies only under the IBC. In other words, they continue to remain liable for action under various other civil recovery and criminal proceedings.” What about non-bank creditors?

It is pointed out that giving a loan moratorium or recast is not a compulsion for lenders but an option. “While borrowers may still go to court to seek orders asking for a moratorium from creditors that are not in the RBI framework, some recent court orders favour them on the matter,” adds Rajeev Suneja, partner at Deloitte India.

The other variables

A view gaining traction is granting longer timelines under the central bank’s June 7 circular, of, say, up to a year before additional provisioning norms kick in, and reducing it by, say, 10 per cent in both cases — from 20 per cent after 180 days from the end of the review period; and from 15 per cent after a year; or a reduction in total additional provisioning to 15 per cent from 35 per cent under the circular. This, senior bankers point out, is because “the thresholds under the circular are almost impossible to adhere to after the outbreak of the pandemic”. This is of particular import, because many resolution plans could not be implemented, and banks are in capital conservation mode.

A related issue is that the inter-creditor agreement (ICA) framework is stillborn, and this will prove critical when loan-recast proposals come before consortia. A mo­ve to weave in ICAs from the start of relationships has not reached anywhere, as differences continue to pla­gue banks on how priorities are to be set. There is as yet not a single ICA in place wherein financial creditors of all hues have found a seat at the table. This calls for a joint meeting of the RBI, the Securities and Exchange Boa­rd of India, the Insurance Regulatory and Develop­ment Authority, and the Pension Fund Regulatory and Deve­lop­ment Authority. Lack of co-ordination among regulators also opens the barn door for prolonged litigation.

It is clear from a closer reading of the banking regulator’s FSR that recast plans will be strictly in line with the Basel Committee on Banking Supervision’s stance — “As long as supervisors make sure that banks use them prudently and due disclosures are made to enable market participants to assess the rationale and potential impact of such actions.”

What’s at stake is that a quick economic recovery will hinge on how well the loan-recast policy is crafted. Everybody has to be on the same page.