India, like the entire world, is suffering from an economic slowdown the likes of which have never been seen – because it owes its genesis to a virus. The spread of novel Coronavirus has led to a complete lockdown of all commercial establishments which has hit at the core of our economy. Industries have had to grapple with supply breakdown as well as a slowdown in demand. Sectors such as hospitality and aviation are and will be impacted severely due to the reluctance of the populace in indulging in such activities and will likely experience stress. The unfortunate by-product of this slowdown will be increased stress and default by Indian corporates.
The government has decided to suspend for six months, provisions of the Insolvency and Bankruptcy Code, 2016 (IBC) that trigger that corporate insolvency resolution process against insolvency corporate debtors. On a review of situation, the six-month period may be increased to twelve months. This means that for a period of six to twelve months, creditors will be barred from initiating insolvency proceedings against corporate debtors. The intent of this relaxation is to provide relief to corporate debtors, already beleaguered by prevalent circumstances, against the spectre of IBC.
Suspending IBC – Sound move?
Although the decision to suspend IBC has already been made, it must be said that suspending IBC may not be the best move under these circumstances. IBC is not a draconian law. It is a wholistic legislation aimed at revival and does not penalise or oust the promoters unless they have been at the helm of a company which is a non-performing asset for a significantly long period of time or have defaulted in their guarantee obligations. During this period of turmoil, IBC would have provided a valuable opportunity to corporate debtors and their promoters to resolve their defaults in a manner which addressed the interests of all classes of their stakeholders and did so in a time-bound manner.
Alternatives to IBC
Notwithstanding the government’s move, in the coming times the stress in the Indian economy is expected to rise and so are the defaults. The creditors who will not have the benefit of IBC would turn to other available mechanisms to address defaults. The most commonly availed avenue in this scenario would probably be the Prudential Framework for Resolution of Stressed Assets issued by the Reserve Bank of India on 7 June 2019 or the 7 June framework. This framework is applicable to commercial banks, large non-banking financial companies, all India term financial institutions, small finance banks and in one key respect, asset reconstruction companies. This comprises a wide spectrum of creditors who are likely to be the source of credit provided to corporates.
The creditors that do not have the benefit of the 7 June framework may look to other recovery mechanisms in case of default. Recovery would typically depend on whether or not the creditor has the benefit of security in relation to the loan provided. The Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (also known as the SARFAESI Act) is the most favoured means to enforce security but access to it is restricted to a select group of creditors. Foreign portfolio investors may take the benefit of security enforcement provisions of the SARFAESI Act if they have lent under secured debentures.
Creditors who do not have the benefit of the SARFAESI Act or are unsecured and operational creditors with unpaid operational debt have the option of litigating or arbitrating to seek the recovery of their debt as per the dispute resolution mechanism contemplated in their contract. Needless to say, with both of these options, the time period for recovery is long while the capital remains locked.
7 June framework
In case of a default, the most preferred option of the promoters of the debtors would be to arrive at a settlement under the aegis of the 7 June framework. Despite the availability of other options, it is possible that the creditors may prefer this option so as to reach a consensus with the promoter and avoid dispute.
The 7 June framework requires the lenders to undertake a prima facie review of the debtor upon the occurrence of a default and decide on the future course of action which may be formulation of a resolution plan or even initiation of legal proceedings for insolvency or recovery. If the lenders decide that the formulation of a resolution plan is the best course of strategy, then they must enter into an inter-creditor agreement which governs their inter-se dealings on how to agree on and approve a resolution plan and provides for related standstill provisions until the plan is implemented, etc. Asset reconstruction companies are not covered under the 7 June framework but are required to enter into the inter-creditor agreement. Lenders not covered under the 7 June framework are not bound to enter into the inter-creditor agreement and would need to do so voluntarily. Their entry into the inter-creditor agreement may be impacted if they are governed by different sector regulators and have different considerations as compared to the remaining creditor pool. Most importantly, the trade creditors or government authorities cannot be party to the inter-creditor and participate in the resolution plan for the corporate debtor even if they are owed money by the corporate debtor. This would mean that any resolution arrived at under the 7 June framework would only provide partial relief to the debtor and may get impacted by the recovery action taken by the other creditors of the company that are not bound by the terms of the resolution plan.
A popular means of resolution under the 7 June framework may involve the sale of exposure of the banks to asset reconstruction companies (ARC) followed by the reconstruction of such exposure outside of the 7 June framework. Following such structure would also allow private equity investors to participate in restructuring of stressed debt by investing in security receipts issued by the ARC. Thereafter, such investors and their chosen ARC may work out a deal with the existing promoters of the stressed debtor for resolving the stress. This would allow the promoters greater flexibility as compared to the IBC process in resolving the stressed debt of their companies. However, one key question is whether this route would be as time-efficient as the IBC process is in resolving the stressed situation in relation to the debtor. Also, as with the 7 June framework mentioned above, this would not lead to a complete resolution which addresses the requirements of all classes of creditors. The needs of the operational creditors would not be met, and such creditors would then have the option of waiting for the IBC provisions to come back in force or take their chances in litigation or arbitration.
SARFAESI and litigation
Lenders having the benefit of security may look to recover their unpaid dues by enforcement of security under the SARFAESI Act. Unsecured lenders and operational creditors would look to recover their dues through arbitration or litigation. In both of these cases, the chances of the corporate debtor and its promoters challenging the action of the creditors are high and this may lead to protracted litigation making these avenues highly inefficient as recovery mechanisms. It remains to be seen whether the creditors will choose to go down the path of instituting these recovery actions or wait out the period of suspension of the IBC to avail the benefit of the IBC process.
What does the future hold?
IBC’s suspension has been slated to be a relief measure but the fact remains that IBC process not only provides for revival of the corporate debtor but also provides for all stakeholders of the corporate debtor in a timebound manner. The suspension of IBC will not stop creditors from attempting to recover their capital but the alternative means that the creditors would resort to might lack the protean nature of the IBC process. Moreover, those mechanisms may not lead to an efficient resolution of stress which is the need of the hour during this economic slowdown. Another factor to consider is that the deterrent effect typically attained by lenders by threatening IBC action would no longer remain leading to at least some mala fide gaming of the system.
In order to ensure speedy resolution of distressed cases, it is imperative that creditors should look towards consensual resolutions in a time bound manner rather than recovery actions involving prolonged legal proceedings.
IBC has proven to be a successful legislation and the go-to mechanism for creditors for achieving results. We are entering an interesting time when defaults are going to abound without the recourse to IBC. It remains to be seen whether the alternative mechanisms will be able to suffice and will be enough to bolster investor sentiment.