The Indian Ministry of Finance has recently announced numerous economic relief measures for businesses to mitigate risks to their operations and viability. The measures have arisen out of disruptions caused by the COVID-19 pandemic and the consequent imposition of a nation-wide lockdown. Among these, significant changes to the domestic insolvency and bankruptcy regime have been carried out, including by way of an ordinance on 5th June 2020:
- a one hundredfold increase (from INR 100 thousand to INR 10 million) in the threshold for commencement of any corporate insolvency resolution proceedings;
- the suspension of up to one year of the initiation of fresh insolvency proceedings pursuant to the (Indian) Insolvency and Bankruptcy Code, 2016 (IBC); and
- the exclusion of ‘COVID-related debts’ from the ambit of defaults that may trigger the insolvency resolution process.
In addition, a separate insolvency framework for medium and small enterprises is also being considered.
Prima facie, the rationale for these particular changes appears to be two-fold. First, it reflects the central government’s priority to maintain the status of businesses impaired by the pandemic as a ‘going concern’ without the threat of insolvency (or winding up) hanging like a Damocles’ sword. Second, and more significantly, it accounts for the current difficulty in implementing certain aspects of the IBC, such as ensuring a time-bound resolution process or arranging for bridge financing. Specifically, given liquidity concerns and operational hurdles, the continued filing of insolvency applications may multiply the caseload of the already overburdened National Company Law Tribunals (NCLTs).
Impairment of creditor positions?
To their merit, these changes may provide some much-needed respite for debtors. However, neither the central government nor the banking sector regulator—the Reserve Bank of India (RBI)—have provided regulatory measures to alleviate the operational and lending risk confronted by creditors. With the IBC route (ie initiating insolvency proceedings under the Code) unavailable, creditors will have to fall back on pre-existing restructuring, recovery and security enforcement mechanisms to recover dues in an environment where the probability of default appears to be heightened.
However, these extant mechanisms suffered from some drawbacks. These drawbacks mattered less once the IBC was introduced. Without the overarching framework of the IBC and the resolution mechanics available under it, these mechanisms are unlikely to be able to adequately address the needs of all creditor classes.
Alternate restructuring mechanisms
For example, in mid-2019, the RBI set out the Prudential Framework for Resolution of Stressed Assets (the Framework) as a comprehensive framework applicable to banks, non-banking financial companies (NBFCs) and some other institutional creditors for early recognition, reporting and resolution of stressed assets through several restructuring tools (including change of management or ownership of the borrower, bifurcation of debt and write-off unsustainable debt). The RBI has announced an extension to the time-bound processes set out in the Framework, recognising the impact of COVID-19 on businesses and financial institutions.
However, for the Framework to comprehensively address stressed debt while also allowing businesses to continue functioning as a ‘going concern’, the Framework will need some other modifications as well. Perhaps the most important modification needed is to widen the scope of the Framework to include other classes of creditors such as companies, mutual funds and foreign portfolio investors. The necessity of this revision under the current circumstances arises from the fact that the principal distinction between creditors under the IBC is not based on the nature of the creditor entity but on the nature of the debt. Consequently, such exclusion is not as significant when recourse to the IBC remains open. It is also noteworthy that widening the applicability of the Framework to these excluded creditors will require a concerted and specific intervention of the central government with the Securities and Exchange Board of India as these entities are not regulated by the RBI.
It is well possible that issues arising out of such a selective application under the only available comprehensive restructuring framework may galvanize excluded creditors to rely more significantly on contractual arrangements for strengthening their positions. Such contractual arrangements may include access to restructuring tools, enforcement options and hierarchy in repayment, especially through upfront inter-creditor agreements, in order to balance out their interests with the creditors included under the Framework.
Are pre-packs desirable?
In contrast to established restructuring tools, in recent weeks, there has been clamour for introducing new frameworks for dealing with stressed assets such as pre-packaged insolvency processes (pre-packs) which have seen success in other countries. While their introduction could go some distance towards addressing the selective applicability of the Framework (since any such pre-packaged process would presumably apply to all creditors), pre-packs might not be as effective as they are in other jurisdictions such as the United States or the United Kingdom.
This may be because banks and NBFCs (as included within the mandate of the Framework) do not have much incentive to turn to pre-packs for resolution. In addition, any pre-pack formulated by a creditor not covered under the Framework is likely to become subject to prior approval from the institutional creditors covered under the Framework, which may not be immediately forthcoming.
In addition, although pre-packs might be initiated bilaterally between a dominant creditor and debtor, there will inevitably be subsequent involvement by a regulatory authority or judicial tribunal who will need to approve the proposed pre-pack before it is binding on others. In the case of India, the NCLT is likely the authority to best undertake this mandate. However, delegating this responsibility to the already-overburdened NCLTs is unlikely to yield approvals in a time-bound manner.
What can be done?
Given that the admission of cases under the IBC is proposed to be suspended temporarily, the need of the hour is to find an interim solution to tackle non-performing debt by providing restructuring frameworks to creditors that reduce the likelihood of a bottleneck of bad assets until the resumption of the admission of cases under the IBC. New frameworks traditionally bring with them an adjustment period during which market actors understand the new product, its value to their particular circumstances and the mechanics of using it. The uncertainty left in the wake of the pandemic, in addition to the suspension of admission of cases under the IBC, could dampen the impact of any new framework and may not lead to achievements of the aforementioned objectives. Existing restructuring, recovery and security enforcement mechanisms, however, have the advantage of being the ‘known devil’ and are likely to produce more desirable outcomes with limited market disruptions.
A detailed discussion into some necessary modifications to the Framework appears to be the next logical step in the replacement of insolvency resolution in an IBC void, perhaps by expanding their application, at least in the short term.
Ganesh Gopalakrishnan is a Research Fellow in the Department of Economic Affairs (Ministry of Finance) Research Programme at the National Institute of Public Finance and Policy (NIPFP), New Delhi.
Neeti Bhatt is a graduate of the West Bengal National University of Juridical Sciences and is part of the banking, finance and debt restructuring practice of a law firm based in Mumbai.