Hon’ble Finance Minister Nirmala Sitharaman announced on Sunday, as part of the fifth press conference, suspension of fresh initiation of insolvency proceedings up to one year. This announcement comes as part of the government of India’s Rs 20 trillion Covid-19 economic package.
While the announcements were made today, the seeds of the repeal of Sections 7, 9 and 10 of the IBC had already been sown in April. Effectively, this will prevent a borrower from being dragged into insolvency by a financial and/or an operational creditor. Ever since the proposal came in, arguments have been made for it and against it.
Why the suspension maybe a good thing
There is no doubt that even some of the most resilient businesses were experiencing demand contraction in the pre – Covid era, and post Covid-19 will struggle with supply side and labour disruptions as well. The Covid-19 period will of course severely impact almost all industries besides being a washout with some sectors such as automobiles showing zero sales. In such circumstances, businesses which were less resilient and did not have enough balance sheet strength or the ability to maintain solvency during the Covid period would be severely challenged. The enhancement of the minimum threshold to initiate insolvency proceeding to Rs 1 crore while welcome, may not have been sufficient. Most businesses would also need to reassess their near to medium term business plans post Covid – this is an area where less resilient businesses will struggle as they attempt to re-ignite and re-generate demand, which is expected to come slower than ever. Potential investors are likely to observe this and factor their own assumptions in putting bids for these stressed businesses and quite likely that in an uncertain environment, bake in a lot more of a buffer in their offers. This will undermine the resolution and recovery percentages for the banks from the IBC process. Another point is the time insolvency proceedings have taken thus far in India – amongst the large cases, only Electrosteel India Limited was resolved within 270 days. In times of crisis like the Covid-19, an active and well-meaning management team will have a better chance to steer the business, as opposed to an insolvency professional even if armed with the best sector experts. Finally, the lack of interim funding for insolvent assets is now an established practical fact. All of the above will make achieving resolutions tougher over the course of next year.
An argument which also gets made is that lenders still have options to “recover” their dues through invocation of SARFAESI and taking borrowers to the Debt Recovery Tribunal (DRT). They also have the right to “resolve” with lenders under the provisions of Section 230 of the Indian Companies Act.
The counter view
A case has been made for continuance of the Insolvency Code through the times of Covid-19. It bases its arguments on the “loss of momentum” the resolution process has had since the IBC came in. The Government’s announcements today indicated 44% recovery since the inception of the Insolvency Code and this process should be continued. Another argument is predicated on the relief measures not lifting the economy, and / or the demand and supply side issues to continue for longer than a year. This would effectively create an even larger number of stressed businesses in a year’s time which our judicial processes and the investor community may find hard to deal with – the former owed to the volume and the latter owing to the wide choice it may present to them. Most importantly, for the lending community which is already offering a three month moratorium (likely to be extended by another three months at the minimum), where would they get their accruals from and what it would do to their balance sheets? Lenders, whether banks or NBFCs mirror the strength of the economy and any worsening of their health may cause the same challenges that the Government is attempting to avoid by not expanding its fiscal deficit. Finally, the MSMEs are already getting some relief, so why put the whole process in abeyance even for a year?
In summary ….
There is no doubting the fact that the economy will go down before it goes up, as demand particularly in discretionary sectors is unlikely to come back anytime soon, and the economics may look very different from the pre Covid times. Neither can one undermine the fact that the banking system, which is the main credit delivery system, needs to continue to regain health. Under the circumstances, there is a compelling case for allowing banks to restructure loans whether pursuant to the June 7, 2019 circular or a new Covid specific mechanism. As the purpose for admittance to the insolvency process is primarily timely debt resolution and not just liquidation, there is a strong merit to put in place for speedy resolution outside NCLT in this period of abeyance.
The June 7 circular was a progressive one and if aided by making the inter – creditor agreements (ICA) mandatory, if say 75% sign the same or make a Master ICA which is signed by entire lending community, relaxations on a) the rating criterion with applicability only when the loan comes up for upgradation and b) applicability of Section 29A of the IBC to the restructuring cases, could make for a compelling alternative over the course of the next one year. It will also ensure that we do not lose the resolution momentum and IBC survives the Covid scare.
The need of the hour is to come up with a resolution framework which focuses on aligning the capital structure of the stressed companies to the viability of the enterprises and not only focus on recovery of loans. Given the overall macro situation it is important to provide adequate support to the industry so that the genuine bonafide companies can come out of it in a quick and efficient manner. Clearly this will involve sacrifice from the financial creditors and therefore the GoI/ RBI should provide lenders corresponding relief by permitting them to undertake restructuring of Covid impacted companies without the same getting classified as NPA. The same would on one hand preserve the precious capital of lenders from NPA provisioning but also incentivize them to quickly put in place a proper restructuring package.
(Sanjeev Krishan is Partner & Leader – Deals, PwC India)