Consensual restructuring of debt obligations, due to COVID disruption, not to be taken as default, clarifies SEBI

Vinod Kothari

finserv@vinodkothari.com

The global economy, as also that of India, is passing through a systemic disruption due to the COVID crisis. The Reserve Bank of India in its Seventh Bi-monthly Monetary Policy Statement 2019-20 dated March 27, 2020[1] has permitted banks and non-banking financial institutions to provide a moratorium to borrowers for a period of 3 months.

As a result, cashflows of banks and financial institutions from underlying loans will be disrupted, at least for the period of the moratorium. It is a different thing that the disruption may actually prolong, but 3 months as of now is what is explicitly regarded by the RBI has COVID-driven.

The financial sector is admittedly one the major issues of debt securities in India. Therefore, an issue that has arisen is, if the financial sector entities, or other issuers of debt obligations, are not able to repay the same on a due date, due to the pandemic crisis, will the same be a case of a default, and will the credit rating agencies (CRAs) report the same as a default?

In response, SEBI, vide Circular dated March 30, 2020[2], addressed to the CRAs, has clarified as follows:

  • If the delay in payment of interest/ principal has arisen solely due to the lockdown conditions creating temporary operational challenges in servicing debt, including due to procedural delays in approval of moratorium on loans by the lending institutions, CRAs may not consider the same as a default event and/or recognize default.
  • The above shall also be applicable on any rescheduling in payment of debt obligation done by the issuer, prior to the due date, with the approval of the investors/ lenders.
  • The above relaxation is extended till the period of moratorium by RBI.

The above circular is, though, addressed to the CRAs, the intent of the regulator is quite clear. If a restructuring of debt obligations happens due to the disruption caused by the pandemic, it is not a case of default.

“Default” is a credit event, mostly analogously referred to as “failure to pay”. A “failure to pay” is a credit event under ISDA Master Agreement, globally followed as the standard for derivatives documentation. Even under ISDA master agreement, there is an exception in case of a force majeure event. It is being contended, and with lot of force according to the author, that the widespread disruption in activity due to the COVID 19 constitutes a force majeure event[3]. If the same is taken as a “default’ leading to serious implications for the issuer, it will be exacerbating the problem of the present disruption. Therefore, a clarification from the regulators that any failure to pay under the present circumstances, solely connected with the disruption, is not itself a credit event.

On a reading of the definition of default under Guidelines for CRAs issued by SEBI[4] it can be derived that “Debt obligations” refers to an obligation to repay a debt on the scheduled repayment date, failing which, the same will be treated as default. If the payment is not required to be made as per contractual terms between the borrower and lender in the first place, then the same is not a debt obligation.

It may therefore be implied as follows:

  • Debentures/ Bonds – In case delay in payment of interest/ principal components of debentures by borrowers, is solely due to the lockdown conditions which create temporary operational challenges in servicing debt, the same may not be considered as a default event;
  • Commercial Paper – The above is implied even in case of commercial paper;
  • Pass through certificates – any rescheduling in payment obligation, if the waterfall clause is modified to reflect the reschedulement of the underlying cashflows, done by the issuer, prior to the due date, with the approval of investors/lenders shall not be treated as a default in PTCs, during the period of moratorium.

[1] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49582

[2] https://www.sebi.gov.in/legal/circulars/mar-2020/relaxation-from-compliance-with-certain-provisions-of-the-circulars-issued-under-sebi-credit-rating-agencies-regulations-1999-due-to-the-covid-19-pandemic-and-moratorium-permitted-by-rbi-_46449.html

[3] See an article by Richa Saraf on this issue here:  http://vinodkothari.com/2020/03/covid-19-and-the-shut-down-the-impact-of-force-majeure/

[4] https://www.sebi.gov.in/legal/circulars/nov-2016/enhanced-standards-for-credit-rating-agencies-cras-_33585.html

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