Managing Defaults During Covid-19: Was There No Other Way Apart From Temporary Suspension Of The IBC?

Much has been discussed and written about the changes to India’s newest law on resolution of bank loans — the Insolvency and Bankruptcy Code.

The law, which came into effect in November 2016, was a watershed moment for our country.

The main purpose of the law was to provide a time-bound process for insolvency resolution. This would provide confidence to investors and bankers, and also make business entities run with a degree of discipline in loan utilisation and repayment.

The law, which is in its infancy, has brought about resolutions, and the fundamental tenet which has been re-emphasised in various cases which were filed with the National Company Law Tribunal, National Company Law Appellate Tribunal and the Supreme Court was to ensure maximum value of assets and businesses, while liquidation was to be considered as a last resort.

The law, modelled on similar laws in developed countries, was to provide India with a much-needed relief on the resolution of bad loans.

It provided for a regulatory agency i.e. Insolvency and Bankruptcy Board of India, and also for private entities to work out resolution plans.

The resolution process was clearly delineated with an Insolvency Resolution Professional (IRP), Adjudicating Authority and Appellate Authority.

For the first time, we had government dues being subordinated to secured loans and worker dues.

The law required an amendment to 11 existing laws including the Income Tax Act, among others.

In all, it was well drafted and well conceived and was welcomed by the banking fraternity.

It was also a confidence-booster to investors and bankers and was thought to better instil a culture over borrowing in the country.

The latest amendments providing relief for the loss of cash flows during the lockdown period and the period taken to recover is where we seem to have not given enough thought.

In our country, compliance as a process is observed more in breach than in practice.

In my banking experience, both for the borrower and the lender, any unprecedented event is an opportunity to review loan covenants and seek to correct the same.

The amendment states that a default during the Covid period cannot be treated as ‘default’ under the Insolvency law.

This opens up a can of worms, as borrowing entities can ‘create’ a default during the said period to seek immunity under the provision, as it provides time in the future (until September 2020 initially) for repayment.

The success, however limited, of the insolvency laws can be attributed to the fact that the entire process of resolution is in the hands of private individuals and they have to follow strict compliance set out by the regulator — IBBI.

There are penal provisions with the IBBI to deal with misconduct by the IRP.

Our basic indifference to compliance stems from the fact that the breach of any provision, particularly under the above mentioned laws, takes a lifetime for judgement, especially from the civil courts.

This is what also needs to have been addressed, particularly with citizens now adapting to the new normal of dealing with life with ‘online’ processes.

It is time for the government to fix this gaping loophole by ensuring timely selection of judges across the spectrum by creation of a similar authority like the Union Public Services Commission (UPSC), Bank Board Bureau (BBB) and make the process adhere to a time schedule.

This will bring about a better compliance structure as it would lead to timely relief for curing breach and thus better regard to written contracts and agreements.

Many of us who were in the banking profession in the early 2000s would recall the then new ‘Sarfesi Act’ and how within a couple of years, the Supreme Court struck down some provisions and the subsequent dilutions that the Act suffered to make it toothless.

It is an earnest expectation that the latest amendment to the Insolvency Law does not go down the same path and erode the shoots of confidence it has provided.

In my opinion, the way to ensure that business entities get the much-needed relief from the pain that the pandemic has caused, could have been to not just retain the compliance culture, but to also lead to an improvement, given the PM’s call for an ‘Atma Nirbhar Bharat Abhiyan’.

The shortcoming in our financial system is because the monetary authority is also the regulator of the banking system.

The lack of a financial services regulator prevents thorough bank supervision and proper checks and balances in regulations, as seen in many examples of poor compliance, which is well known.

The regulator of financial services should have proactively conceived of a scheme to address the issues faced by the economy, particularly of business entities.

A simple tweak to the regulations concerning asset classification, along with a ‘one time’ window for restructuring due to depletion of cash flows during the period March 2020 to March 2021 would have better addressed the issue.

Also, to incentivise better compliance, a credit-related score card can be created, which will lay emphasis on the ability of the entity to bounce back to normal as early as possible.

Those entities which can bounce back faster, display robustness in their financial structuring and the business model, can be rewarded with a ‘reverse recompense’ clause of a reduction of interest rates in the future with a subvention (which is a grant of money), from the government.

A true ‘cash back” would be the best incentive which business entities could be attracted to and which would lessen the burden on banks too.

The government could also think of passing the burden of subvention by quantification and subsequent sale as equity/long term bonds in the concerned business entity, to domestic and overseas investors.

This will also open our domestic entities to strategic partnerships with larger overseas entities in the related field of activity.

This would lead to institutional investors getting a taste of our better managed MSMEs.

Just as we have Micro, Small and Medium Enterprises, the recompense and subvention can be tweaked for better financial discipline and compliance.

Large borrowers who are in the listed space can have a lower subvention and the conversion of the quantified amount as saleable equity.

The gains can be offset against the benefits passed on to small, micro and medium enterprises.

All it required was for the government to set up a fund like the one for infrastructure already in place, and ensure that it is ‘profit neutral’ so that there is no additional burden on its fiscals.

Such a fund entity would be simple to create and with the quality of talent in the country, envisaging a scheme along such principles would be a better solution than allowing for a default to attain proper legal status.

The opportunity of a ‘reset’ needs to be utilised by us well.

Our MSMEs are the lifeline of our economy, and a well-conceived programme of relief, which will contour future road maps, is what should have been done instead of the simplistic tweaking, which will have far-reaching negative connotations.