India - Resolution Of The Stressed Assets In Post-covid Era- A New Challenge On The Cards.

Legal News & Analysis - Asia Pacific - India - Insolvency & Restructuring

20 May 2020


Aside of the human cost, COVID-19 pandemic has pushed the world into another economic recession, with stock markets and oil prices plummeting. The pandemic has resulted in suspension of economic activities in several parts of the world (including India), which has pushed many companies on the verge of facing insolvency on account of lack of adequate liquidity.
Recognising the financial difficulty being faced by the companies, especially the mirco, small and medium enterprises (MSMEs), the Indian Government has taken various measures which include increasing the threshold to invoke insolvency proceedings from INR 100,000 to INR 10 million.
Additionally, as a part of economic relief package announced on 17 May 2020 (1), the Indian Government announced the suspension of the provisions of section 7, section 9 and section 10 of the Insolvency and Bankruptcy Code, 2016 ("IBC"). As a result of this, the initiation of insolvency proceedings against companies (and not just MSMEs) shall stand suspended for a period of 12 months. The suspension, once implemented, will result in the creditors (operational as well as financial) with no remedy to recover their dues under IBC. Other key announcements under the economic relief package include the introduction of a special insolvency framework for MSMEs and the exclusion of COVID-19 related debt from the definition of 'default' under IBC. These amendments are likely to be introduced through notifications/ordinance. 
While the details of the proposed amendments are not available, the lenders may have to face a lot of challenges in resolving the stressed assets going forward due to suspension of IBC proceedings. It is important to note that the insolvency proceedings under the IBC framework offer certain advantages ensuring maximisation of value of stressed assets. Once the insolvency proceedings are admitted, the moratorium kicks in so as to protect the corporate debtor against any suit or legal proceedings. The supply of essential goods and services as may be necessary to keep the business ongoing cannot be suspended during the moratorium period. Any governmental or regulatory authority cannot suspend any licence, registration, permit, quota etc. on the ground of insolvency. All these provisions protect the corporate debtors from any coercive action which could otherwise affect the valuation of their business and assets.
Timely resolution of stressed assets is not only in the interest of the creditors but it is beneficial for the borrowers as well. As per the data published by the insolvency regulator(2), a total of 190 financially distressed entities have been rescued under the IBC framework (since the date of coming into force of the provisions of corporate insolvency resolution process, being 1 December 2016). The realisation by financial creditors under the resolution plans (approved under IBC framework) in comparison to liquidation value is 197.81%, whereas the realisation in comparison to their claims stands at 43.15%.
With the suspension of IBC proceedings, the creditors would need to look for alternate ways for resolution of stressed assets. One such alternative may be the prudential framework issued by the Reserve Bank of India ("RBI") on 7 June 2019 which allows the lenders to opt for resolution of stressed assets outside the IBC. The prudential framework sets out a period of 30 days from the occurrence of default ("Review Period") wherein the lenders have to undertake a prima facie review of the borrower’s account and decide on the resolution strategy, including the nature of the resolution plan as well as the approach for implementation of the resolution plan.
Under the prudential norms issued by the RBI, lenders need to sign an inter-creditor agreement and have a period of 180 days after the expiry of the Review Period to implement a resolution plan which needs to be approved by 60% of lenders (by number) representing 75% by value of total outstanding credit facilities (fund based as well as non-fund based). Failure to implement the resolution plan within the 180 days period would attract additional provisioning norms thereby affecting their financial position. However, the RBI has recently granted relaxations from these timelines in view of the challenges that could be faced by lenders in resolving the stressed accounts in the current volatile environment caused by Covid-19.
The resolution plan under the prudential framework of RBI may provide for, inter alia, regularisation of accounts by payment of all over dues, debt restructuring, sale of the exposures to other entities / investors, and change in ownership of borrower entity. Thus, the prudential framework offers an opportunity for the interested acquirers to acquire stressed assets outside of the court proceedings.
However, the prudential framework is currently applicable to the scheduled commercial banks, all India term financial institutions, small finance banks and certain categories of non-banking financial entities only and that too, where the aggregate exposure to the Indian borrowers is INR 15 billion and above. Other categories of lenders such as mutual funds, insurance companies and overseas lenders are not covered under the prudential framework and therefore, they may have to resort to restructure debt through bilateral arrangements in terms of relevant regulations applicable to such lenders. Alternatively, the lenders may opt to restructure their outstanding dues through a scheme of arrangement under section 230-232 of the Companies Act, 2013 ("Companies Act") wherein all the lenders may participate in the restructuring exercise. A debt restructuring exercise under the Companies Act would, however, require separate approval of creditors (secured as well as unsecured) and the shareholders in their separate meetings with the approval threshold being majority in number representing 75% in value of the creditors or members, as the case may be, present in their respective meetings.
The recent amendments to the IBC ring-fence the acquirer and the properties of a corporate debtor (which are covered under the resolution plans approved by the tribunals) from the offences committed by previous promoters/management provided that there is change in control and management of such corporate debtor pursuant to the resolution plan, and the acquirer is not connected to the ex-promoters/management. Under the IBC framework, the acquirers do not face the risk of any contingent claim arising in future post approval of the resolution plan by the tribunal. Besides, the Indian regulators have granted a host of relaxations with a view to facilitate the resolution of stressed assets under the IBC framework.
The suspension of IBC could aggravate the situation for entities which do not have access to adequate liquidity in order to meet their funding requirement for day-to-day business affairs. This may result into depletion in quality as well as value of assets of such business. Sale of such assets may yield lesser than the expected realisation, forcing the lenders to take a larger hair-cut.
While some investors did acquire some of the stressed assets outside the IBC framework in the past, the recession caused by COVID-19 is likely to force the acquirers/investors to change their investment strategy and impact the availability of capital for the stressed assets. Although there could be a rise in merger and acquisition opportunities in the distressed asset sector outside the IBC framework, there is a possibility that not many investors, be it financial or strategic, may come forward to take risks associated with the acquisition of stressed assets in the absence of benefits and relaxations (such as protection to business of corporate debtor during moratorium period, ring-fencing from past period offences, clean slate protection and the regulatory relaxations which are otherwise available under IBC framework).
This could throw a challenge for the lenders as far as resolution of stressed assets and recovery of their outstanding dues is concerned in the post COVID-19 era, especially on account of suspension of IBC proceedings. Although news reports suggest that the Government is evaluating the option to introduce the pre-pack sales for resolution of distressed entities under the IBC framework, only time would tell whether, and to what extent, pre-pack sales, if introduced, would succeed in the existing Indian regulatory and business environment.

Disclaimer: This publication is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to herein. This publication has been prepared for information purposes only and should not be construed as a legal advice. Although reasonable care has been taken to ensure that the information in this publication is true and accurate, such information is provided ‘as is’, without any warranty, express or implied, as to the accuracy or completeness of any such information.