No one knows with certainty when the world will overcome the Covid-19 crisis and the growth of real economy will resume. “Experts” propound theories on the subject, and one tends to believe the idea that resonates closely with their echo chamber. Predictably, in such an environment, the Government is struggling with economic matters like an unprecedented GDP contraction, disagreements on GST compensation, size of fiscal stimulus, etc. However, vis-à-vis insolvency proceedings, either by design or accident, the Government has executed a textbook solution, possibly, one of the better ones amongst the nation states.
Gazette notification dated 5th June had suspended the insolvency invocation sections i.e. section 7, 9 and 10 of Insolvency and Bankruptcy Code, 2016 (IBC) with effect from 25th March. This gave the impression that the insolvency proceeding mechanism has come to a halt and India may go back to the pre-IBC regime. The fear was compounded by publication of Urjit Patel’s book Overdraft in July. He said, “The disposition with respect to the IBC or, more generally, in the conviction in the pathways, perceptibly changed – conceivably on defensible grounds – in mid-2018. Instead of buttressing and future proofing the gains thus far, an atmosphere to go easy on the pedal ensued.” He added, “I suspect the government may have felt that the deterrence effect – ‘future defaulters beware , you may lose your business’ – of the IBC had been achieved, and resolute follow-up to help complete the task was, therefore, unwarranted.”
However, Reserve Bank of India (RBI) Resolution Framework for Covid-19 Related Stress (RBIFC) of 6th August brought us back into the realm of what can be described as insolvency proceedings. Thus, the extension of suspension announced on 24th September is different from the initial one as explained below.
United Nations Commission on International Trade Law (UNCITRAL), a subsidiary body of United Nations General Assembly, works towards harmonization and modernization of the law of international trade and commerce, including insolvency. UNCITRAL Legislative Guide on Insolvency Law (ULGI) refers to “insolvency proceedings” that can be initiated to resolve a debtor’s financial difficulties.
ULGI states, “These proceedings take a number of different forms for which uniform terminology is not always used and may include both what might be described as “formal” and “informal” elements. Formal insolvency proceedings are those commenced under the insolvency law and governed by that law. Informal insolvency processes are not regulated by the insolvency law and will generally involve voluntary negotiations between the debtor and some or all of its creditors. Often these types of negotiations have been developed through the banking and commercial sectors and typically provide for some form of restructuring of the insolvent debtor. While not regulated by an insolvency law, these voluntary negotiations nevertheless depend for their effectiveness upon the existence of an insolvency law, which can provide indirect incentives or persuasive force to achieve reorganization.” ULGI also lists the main elements and different steps for an effective voluntary negotiation. RBIFC mirrors the aforesaid steps and elements in-toto.
Commencement of voluntary negotiations as per ULGI requires “creating a forum in which the debtor and creditors can come together to explore and negotiate an arrangement to deal with the debtor’s financial difficulty”. The RBIFC is essentially the forum where the debtor and all lending institutions governed by RBI can come together.
Whilst on the matter of standstill ULGI states “a contractual agreement to suspend adverse actions by both the debtor and the main creditors may be required. That agreement would generally need to endure for a defined, usually short period, unless inappropriate in a particular case.” Intercreditor agreement (ICA) presumably would provide for such a contractual agreement on standstill. Also, the agreement would endure for a short period, i.e. 180 days from the day of invocation. The borrowers who are unable to reach an agreement on voluntary restructuring would ultimately be subject to IBC, post revocation of suspension.
Furthermore, “The voluntary negotiations would need to involve all key constituencies; generally the lenders’ group and sometimes key creditor constituencies that may be affected by a voluntary restructuring agreement are critical to the negotiations.” RBICF, ICA mandates participation of all key constituents, representing 75 per cent by value of the total outstanding credit facilities (fund based as well non-fund based), and not less than 60 per cent of lending institutions by number.
Thereafter, on the aspect of engaging advisors, ULGI recommends “involvement of independent experts and advisors from various disciplines”. RBICF’s Kamath committee fulfilled this function. The committee not only recommended a list of sector specific financial parameters related to leverage, liquidity and debt serviceability but also would vet the resolution plans to be implemented where the aggregate exposure of the lenders is INR 1500 crore or more. Also, debtors too may choose to independently hire experts and advisors, if required.
Another crucial matter that ULGI highlights relates to adequate cash flow and liquidity. “A debtor that becomes a candidate for voluntary restructuring negotiations will often require continued access to established lines of credit or the provision of fresh credit.” RBICF provides for sanction of additional credit facilities to address the financial stress of the borrower even if there is no renegotiation of existing debt. In addition, aforesaid credit may be classified as standard asset till implementation of the plan regardless of the actual performance of the borrower with respect to such facilities in the interim.
Issue of dealing with differing interest of creditors is also commented upon by ULGI, i.e. “persuading those creditors which have already commenced recovery or enforcement action against the debtor that they should participate in the negotiations may be possible only if there is a prospect of a better result through those negotiations or if the threat of formal insolvency proceedings will restrain creditors from pursuing their individual rights.” Though, RBICF does not have a persuasive clause to desist creditors from enforcement action, the note to the framework mentions, that the impact of Covid19 could impair the entire recovery process posing significant financial stability risks. Thus, it is highly unlikely that the creditors other than bankers like insurance companies or debt mutual funds will take recovery actions, especially when enforcement in the past had abysmal recoveries. A restructuring would entail budgeting of creditors payments in the debtors’ forecasted cash flow, an outcome better than enforcement. Also, RBICF by mandating higher provisioning requirements for non-ICA signatories, subtly nudges creditors towards negotiations.
Thus serendipitously, India finds itself in the right spot vis-à-vis insolvency proceedings. It is likely that had IBC continued, it may have resulted in oligopolies and monopolies, an increasingly visible trend. Informal voluntary reorganisation-based insolvency proceedings will result in larger number of active entrepreneurs surviving in the eco-system. This would be in consonance with the preamble of IBC, of promoting entrepreneurship, or in the words of Joel Kotkin it would slow The Coming Age of Neo Feudalism.
(The writer is a Registered Insolvency Professional and Restructuring Advisor. Views expressed are personal.)