Recently, the news headlines have highlighted how Indian Banks’ Association (IBA) is devising a specific restructuring proposal to be advanced to companies affected by economic fallout induced by the Covid-19 crisis. The need for such a proposal shall be attributed to the companies reeling under the loss of earning capacity as well as the destruction in demand prompted by the pandemic. The present article aims to throw light upon the concept of, and schemes for the restructuring of such debts and how these are affected by the pandemic, elaborating upon various regulatory and judicial reliefs for the same.
Debt restructuring refers to a mechanism resorted to by corporate debtors undergoing cash crunch to abate the risk of default, for instance, by seeking an extension of tenor or reduction in the rate of interest. It may also be carried out by swapping debt for equity, i.e. the creditors of the company settle on canceling the debt wholly or partly in return for equity in the company. The companies facing such financial distress may have limited options to avoid such risk of default, that is, filing for bankruptcy or restructure its debts through the abovementioned methods. In such a scenario, both the company and its creditors would prefer restructuring of debt because it would enable the company to avoid its bankruptcy and the creditors would recover the amount higher than what they would’ve availed through bankruptcy proceedings. For example, where there are substantial debt and assets in the company, the creditor would, rather opting for bankruptcy, prefer a debt-for-equity swap and take control of such company on a going concern basis.
IMPACT OF COVID-19 ON DEBT RECOVERY IN INDIA
The concept of debt restructuring has gained more significance and momentum during the Covid-19 pandemic as the business of various companies, especially those involved in non-essential goods and services, is severely affected. Consequently, there is limited cash flow restricting the ability of such companies to service the debts. For this purpose, relief packages are announced by Reserve Bank of India as well as Finance Ministry in order to suppress the monetary impact of Covid-19 on both lenders and borrowers.
1. Debt Restructuring under Insolvency and Bankruptcy Code, 2016 (“IBC”)
IBC provides a mechanism for debt restructuring of corporate debtors by initiating a Corporate Insolvency Resolution Process (“CIRP”). It can be initiated by creditors, both financial and operational, by filing an application before National Company Law Tribunal under Section 7 and Section 9 of the Code where the outstanding debt is above the minimum threshold. According to Section 4 of IBC, the minimum threshold for this purpose is one lakh rupees which can be further increased up to one crore rupees by the Central Government (Proviso to Section 4). Section 10 of IBC further empowers a defaulting company itself to apply to NCLT to initiate its own CIRP. Taking into consideration the money crunch crippling upon corporates in general and Micro Small and Medium Enterprises (MSMEs) in particular, the Central Government has announced certain temporary modifications in this legal regime.
➢ The Central Government, in the exercise of its powers under Proviso to Section 4, has increased the minimum threshold for default from one lakh rupees to one crore rupees, vide its notification dated March 24, 2020. This change may be temporary or even be made permanent, and predominantly safeguards small businesses and MSMEs under default from initiation of multiple insolvencies against them. It can further be ascribed to the increasing misuse of the low threshold limit by creditors. Some of its key implications are as hereunder:
a) On a plain reading of Section 7 of IBC, it can be inferred that where the combined outstanding debt of all the financial creditors meets the minimum threshold of one crore rupees, then the creditor itself or jointly with other creditors, can initiate CIRP against the corporate debtor. However, the same does not apply to operational creditors, in whose case the operational creditor alone has to meet the minimum threshold of one crore rupees. The Section is reproduced below:
“7. (1) A financial creditor either by itself or jointly with other financial creditors may file an application for initiating corporate insolvency resolution process against a corporate debtor before the Adjudicating Authority when a default has occurred.
Explanation— For the purposes of this sub-section, a default includes a default in respect of a financial debt owed not only to the applicant financial creditor but to any other financial creditor of the corporate debtor.”
For example, ABC Pvt. Ltd. has defaulted payment of rupees fifty lakhs to financial creditor A and rupees seventy lakhs to another financial creditor B. Now A and B, individually or jointly, can file an application for initiating CIRP against ABC Pvt. Ltd. as the combined outstanding debt is above one crore rupees. However, had A and B been operational creditors, they could not initiate insolvency against ABC Pvt. Ltd. as operational creditors are required to meet the threshold in their individual capacity.
b) Such protection is unilateral in nature and safeguards small debtors while completely overlooking the plight of small creditors who are equally suffering under the financial crisis. In Swiss Ribbons Ltd. v. UOI [1], Hon’ble Supreme Court while deliberating upon the objective behind the Code observed that “preserving the corporate debtor as a going concern, while ensuring maximum recovery for all creditors being the objective of the Code.” Therefore, such modification is lopsided in nature and runs against the basic tenet on which the Code stands.
c) There is a lack of clarity on whether the notification has a prospective or retrospective application. As a general rule, it must apply prospectively, as neither Section 4 nor Section 239[2] of IBC specifically empowers the Central Government to make rules retrospectively. Further, in the case of S.L. Srinivasa Jute Twine Mills v. Union of India and another [3], Supreme Court observed that “It is a cardinal principle of construction that every statute is prima facie prospective unless it is expressly or by necessary implication made to have retrospective operation.”
➢ On May 17, 2020, an announcement from Finance Minister Nirmala Sitharaman called for Covid-19 induced debts not to be treated as ‘default’ for the purpose of Insolvency and Bankruptcy Code, 2016. It further provides for the suspension of fresh initiation of insolvency proceedings up to one year, depending on how the pandemic situation unfolds. Special procedure for initiation of insolvency against MSMEs under Section 240A shall be devised and notified and further empowers Central Government to exclude Covid-19 induced debts from the definition of ‘default’ for the purpose of triggering insolvency.[4] An ordinance shall be passed to bring these changes into effect. Further, Central Government shall specify what amounts to ‘COVID-related debt’ and the time period for its exemption.
Relief package by Reserve Bank of India- Moratorium on Payment of Term Loans
The Monetary Policy Committee of Reserve Bank of India devised a Statement on Developmental and Regulatory Policies evaluating economic distress caused by Covid-19. In pursuance of the policy, vide its circular dated March 27, 2020, RBI has provided for Covid-19 regulatory package which permits all Commercial Banks, Co-operative Banks, All-India Financial Institutions, NBFCs (including Housing Finance Companies) to grant moratorium of three months (stretching from March 1st to May 30th) on payment of installments of all term loans outstanding as on March 1, 2020, and thus has retrospective application. On May 22nd, RBI extended the moratorium period further for the months, till August 31st, 2020.
➢ It is pertinent to note that the circular only covers lending institutions regulated by RBI, and excludes institutions under the control of other regulators like Securities and Exchange Board of India (SEBI) or Insurance Regulatory and Development Authority (IRDA). However, IRDA vide circular dated April 8, 2020, has permitted insurers to grant similar moratorium to borrowers of term loans. SEBI on the other hand, vide its notification dated provides that differentiation in treatment of default, on a case to case basis, needs to be made as to whether such default occurred solely due to the lockdown or loan moratorium. It issued guidelines to rating firms, asking them to avoid assigning a default tag to companies that are unable to pay owing to the ongoing nationwide lockdown.
➢ The advisory is applicable on loans under default as on March 1, 2020, and not limited to installments falling due after the said date, as held in the case of Anant Raj Limited vs. Yes Bank Limited[5]. In the present case, Delhi High Court observed that “the intention of RBI to maintain status quo with regard to classification of accounts of the borrowers as they existed on 01.03.2020”
➢ Another significant observation is that such deferment was supposed to be discretionary upon banks until recently RBI conveyed to all such lending institutions that borrowers shall be deemed to be ‘under moratorium by default’ and it is up to the borrowers to opt-out of it. This has created a liquidity crunch for the lenders who are otherwise willing to extend the benefit to genuinely stressed borrowers. It is further claimed by bankers that such communication by RBI is different from its original regulatory package which required banks to extend moratorium according to “boards-approved policies” of the individual banks.
➢ In order to inject liquidity in banks, RBI has slashed the repo rate by 75 basis points (further by 25 basis points) and reverse repo rate by 90 base points ((100 basis points amounts to one percent). Now, the repo rate stands at 4.4 percent and reverse repo rate at 3.75 percent respectively. This shall help commercial banks that may face a liquidity crunch on account of such moratorium.
➢ The circular grants protection to lenders as the moratorium on loans is temporary suspension and not a waiver of principal and interest due. The interest shall continue to accrue during the moratorium period as well. Furthermore, such moratorium shall not amount to modification in the original terms and conditions of loan agreements due to the financial hardship of borrowers. Therefore, this does not amount to debt restructuring and hence no asset classification downgrade.
➢ In Gajendra Sharma vs. Union of India, a writ petition has been filed before the Supreme Court challenging the levy of interest on loans during the moratorium period, pleading that the purpose of moratorium, that is to safeguard the financial interests of borrowers, stands defeated due to subsistence of interest in this period. Petitioner further averred such an act to be antithetical to Article 21 of the Constitution. Hon’ble Supreme Court has issued notice to Centre and RBI in the case.
Judicial Relief
Extension of Period of Limitation:
RE : COGNIZANCE FOR EXTENSION OF LIMITATION[6]
Hon’ble Supreme Court, while taking suo moto cognizance of the Covid-19 situation causing difficulty in filing proceedings physically in Courts, has extended the period of limitation w.e.f. March 15, 2020, until further notice. Exercising powers under Article 142 of the Constitution, the order is made binding within the meaning of Article 141 on all the Courts/Tribunals and authorities.
Pursuant to this, NCLAT in the exercise of its powers under Rule 11 of National Company Law Appellate Tribunal Rules, 2016[7] r/w the decision of this Appellate Tribunal rendered in Quinn Logistics India Pvt. Ltd. v. Mack Soft Tech Pvt. Ltd. in Company Appeal (AT) (Insolvency) No.185 of 2018[8], passed an order excluding the period of lockdown for calculating the period of ‘Resolution Process under Section 12 of IBC’, where the registered office of the corporate debtor is located is under lockdown in whole or part, by the order of Central or State Government. This order is applicable in all cases where CIRP has been initiated and pending before NCLT or in Appeal before NCLAT. The order further provides that any interim order or stay passed by NCLAT under IBC shall continue till the next date of hearing which shall be notified.
Further, the Insolvency and Bankruptcy Board of India (IBBI) notified Insolvency and Bankruptcy Board of India (Liquidation Process) (Second Amendment) Regulations, 2020 in order to insert Rule 47A in the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 to exclude the period of lockdown from the calculation of timeline of the liquidation process.
47A. Subject to the provisions of the Code, the period of lockdown imposed by the Central Government in the wake of COVID-19 outbreak shall not be counted for the purposes of computation of the time-line for any task that could not be completed due to such lockdown, in relation to any liquidation process.”
➢ Exclusion of lockdown period for purpose of classification of the account as Non-Performing Asset-
▪ ANANT RAJ LIMITED VS. YES BANK LIMITED[9]
Delhi High Court, in the present case, held that banks cannot classify the account of the borrower as Non-Performing Asset (NPA) during the period of RBI-imposed moratorium running from March 1, 2020 to May 31, 2020, which prevents asset classification downgrade. The Hon’ble High Court further relied upon the FAQs uploaded by The Press Information Bureau[10] in support of its order.
However, in this case, it pertinent to note that the account had been classified as SAM-1 as on January 1, 2020, and SAM-2 as on February 1, 2020, and would’ve been classified as NPA on March 1, 2020.[11] The relief relied upon by the Court is available if the account was ‘standard’ as on March 1, 2020, which was not the case here. Seemingly, Court erred in considering the fact that the account had already been under default since November 31st and had already been classified as SAM-2.
▪ TRANSCON SKYCITY PRIVATE LIMITED VS. ICICI BANK [12]
Relying on the above judgment of Delhi High Court, the Bombay High Court also held that the moratorium period must be excluded even during computation of balance days of the 90-day period for NPA declaration, irrespective of the fact that the account was under default before the lockdown period started.
CONCLUSION
The Government, RBI and Courts have been proactive in watering down the financial crunch caused by Covid-19. Presently, we are in a survival stage, where such reliefs are granted for the bare survival of the economy. After this comes the recovery stage, then comes the revival and thereafter the stage of growth. However, such temporary measures during the survival stage might leave long term impact on the further stages as well, which must be carefully deliberated upon before introducing such relief measures. For example, the moratorium is granted in order to relieve the borrowers from loan repayment for a certain period, however experts suggest that this might alter the overall credit behavior of the customer and create moral hazard.
Further, the regulatory and judicial reliefs appear to be tilted towards borrowers, while overlooking the plight of lenders. For example, the abovementioned decisions of the courts favour borrowers by excluding period of the moratorium from the computation of balance days of the 90-day period for NPA declaration, causing prejudice to the lenders, which is completely untenable. There is a dire need to bring clarity to such provisions for proper implementation of the relief measures and to alleviate the ongoing uncertainty.
Due to the above shortcomings, it is felt that a more prudent relief would be to provide for a one-time restructuring option. Where moratorium allows more time to borrowers, restructuring would allow the lending institutions to restructure debts to the extent it matches their cash flow, which would be a relief more specific in nature.
Authored by
Ridhi Suri
Amity Law School, Delhi
[2] 239. Power to make rules.—(1) The Central Government may, by notification, make rules for carrying out the provisions of this Code
[3] Section 239 of IBC empowers Central Government to make rules, with respect to the matters provided therein, for the purpose of carrying out the provisions of this Code.
[4] Debts Incurred Due To COVID-19 Not To Be Treated As ‘Default’ For IBC; No Fresh Insolvency For A Year : Finance Minister, available at https://www.livelaw.in/top-stories/debtscovid-19-not-to-be-treated-as-default-for-ibc-no-fresh-insolvency-for-a-yea-156892?infinitescroll=1 (last visited May 25, 2020)
[5] W.P.(C) URGENT 5/2020 in the High Court of Judicature at Delhi
[6] W.P. (C) No. 3/2020 in the Supreme Court of India
[7] Rule 11 of NCLAT Rules saves inherent powers of NCLAT to pass orders or directions to meet ends of justice or prevent abuse of process of NCLAT.
[8] It was held that if an application is filed by Resolution Professional or Committee of Creditors or any aggrieved person for justified reasons, Adjudicating Authority or Appellate Tribunal concerned have the power to exclude certain period for the purpose of calculating total period of 270 days.
[9] Supra note 5
[10] “QUESTION 8 of FAQs: What will be the impact of this relief by RBI on borrowers as far as reporting of default is concerned?
ANSWER: Any delay in payment leads to default and gets reported to Credit Bureaus. For business loans of Rs. 5 Crores and above, the banks report the overdue position to RBI also through CRILC. As a result of this relief package, the overdue payments post 1st March 2020 will not be reported to Credit Bureaus/CRILC for three months. No penal interest or charges will be payable to the banks. Similarly, SEBI has allowed that Credit Rating Agencies (CRAs) may not consider the delay as default by listed companies if the same is owing to lockdown conditions arising due to COVID-19.”
[11] According to Income Recognition and Asset Classification Guidelines (IRAC Guidelines) of the Reserve Bank of India, if an instalment is overdue by a period of 30 days, the borrower’s account is classified as Special Mention Account – 1 (SMA-1) and if the instalment is overdue by 60 days, the account is classified as Special Mention Account – 2(SMA-2) and if the instalment is overdue by a period of 90 days, the account is classified as Non-performing Asset (NPA).
[12] Writ Petition LD-VC No. 28 of 2020 in the High Court of Judicature at Bombay.