This article has also been published in the LawStreetIndia blog – http://www.lawstreetindia.com/experts/column?sid=466 Liability Acknowledgment & Limitation Period for IBC Applications – Deciphering the Enigma -Sikha Bansal (firstname.lastname@example.org) The applicability of the Limitation Act, 1963 (Limitation Act) to the applications under the Insolvency and Bankruptcy Code, 2016 (Code) has been settled long back, after a series of […]
On September 03, 2020 the Hon’ble Supreme Court (the “court”) while dealing with several petitions on account of Covid related stress from various stakeholders, passed an interim order that that the accounts which have not declared NPA till August 31, 2020 shall not be declared NPA till further orders of the court. Further in its September 10, 2020 order the court asked the government and RBI to file affidavit within two weeks to the court, on issues raised and relief granted thereto.
The primary contention raised before the court for consideration was that the moratorium postpones the burden and does not eases the plight. It would be a double whammy on borrowers since Banks are charging compounded interest, and banks have benefitted during moratorium by charging compounded interest from customers. The court in its order dated September 10, 2020 observed that individuals are more adversely affected during this period of pandemic. Therefore, the court from the government and RBI, with regard to charging of compound interest and credit rating/downgrading during moratorium period, has sought specific instructions.
Though the matter is sub judice, this write-up aims to provide a legal analyses to the contentions raised in front of the court on the above counts, since any action or direction on the above issues will have an impact on the wider financial system including all, i.e. borrowers, government, banks and other financial institutions as a whole.
Before directly getting into the analyses, it is important to consider material reliefs and incentives announced by RBI and Government of India in respect to COVID19 related regulatory package. A brief history of timelines on series of regulatory reforms to cope with the disruptions caused due to COVID19 is provided below:
Waiver of Interest on Interest during moratorium and Systemic Implications
The moratorium scheme deferred the repayment schedule for loans, and the residual tenor, was to be shifted across the board. This essentially meant that all the liabilities of customers towards their repayments (principal plus interests) were to be rescheduled and shifted across the board by the Banks and NBFCs. However, the scheme clearly stipulated that the interest should continue to accrue on the outstanding portion of the term loans during the moratorium period. Moratorium granted to the customers of banks and NBFCs was to reprieve borrowers from any immediate liability to pay. However, charging of interest on outstanding accrued amount is the center of concern in the matter.
The money has time value, which is often expressed as interest in banking parlance. This is one of the most fundamental principles in finance. Rupee 1 today is more valuable from a year today. If interest is not paid, when it accrues, this in effect means, right to receive interest, which is a predictable stream of cash flow, is not available for reinvestment. Therefore, interest earned but not paid, should earn interest until paid. In debt markets, an obligation towards debt is valued in reference to yield to maturity or present value, all these rest on the compounding interest. These are generally in form of obligations on Banks and NBFCs on the liability side of their balance sheet. Bank deposits and interest thereon also attracts interest, which is adjusted towards total deposit amount of the customer. Therefore, interest on interest is a rule in finance and not a selective event.
Banking is no different to any other commercial business, besides it involves liquidity and maturity transformation and hence is highly leveraged. The short-term demand deposits from customers are converted into long-term loans to borrowers (‘maturity transformation’). Similarly, the customer deposits (liabilities of banks) are payable on demand, while on asset side receivables (repayment of principal and interest) are fixed on due dates (‘liquidity transformation’). It would be wrong to presume that NBFCs are any different from commercial banks. NBFCs largely rely on borrowings from Banks and other financial institutions by way of issuing debt instruments (CP, bonds, etc.), which is reflected on the asset side of the investing commercial banks and other financial institutions. Though obligation of payment on these debt instruments is not payable on demand, but they carry a substantial roll over and default risk. Hence, these institutions are highly leveraged and inherently fragile by nature of their business. Needless to state that receivables on asset side of banks and NBFC also carry certain risk of default and therefore are inherently risky in nature.
Financial institutions and other investors in market, (like Money Market Funds, Pension funds and etc.) invest in debt of Banks and NBFCs on the basis of strength of assets held by them. These assets are in form of receivables from pool of loans or by way advances to underlying borrowers. Thus, participants in financial markets are highly interlinked and are adversely affected by asset deterioration as a rule. Banks and financial institutions bear credit risk (default risk) of the underlying borrowers on their balance sheet. This credit risk has already increased substantially and would be unfolding further due the impact of pandemic on wider economy.
The waiver of interest charged on interest accrued but not paid during the moratorium, would not only be a loss for the banks and NBFCs, but would also substantially dilute the value of assets held by them. This could lead to an asset liability mismatch on balance sheets of banks. Such waiver of interest on accrued amount could exacerbate the risk of banks and NBFCs defaulting on other financial institutions (‘systemic risk’). The foregoing of charging of interest on interest accrued during moratorium would mean banks and financial institutions partially baling out borrowers either from their own limited funds or from the borrowed funds of other financial institutions. Such a move could entail systemic risk and wider financial catastrophe. As risk of default from comparatively large diversified group of borrowers will be shifted and get concentrated in the balance sheets of banks and financial institutions.
Credit Rating Downgrades and Stressed Assets Resolution
The RBI moratorium notification dated March 27, 2020, freezes the delinquency status of the loan accounts, which have availed moratorium benefit under the scheme. This essentially meant that asset classification standstill will be imposed for accounts where the benefit of moratorium have been extended. As it stands, the RBI, March 27, 2020 circular clearly stipulated that moratorium/deferment/recalculation of loans is provided to borrowers to tide over economic fallout due to COVID and same shall not be treated as concession or change in terms and conditions due to financial difficulty of the borrower. In essence the rescheduling of payments and interest is not a default and should not be reported to Credit Information Companies (CICs). A counter obligation on CIC was also imposed to ensure credit history of the borrowers is not impacted negatively, which are availing benefits under the scheme. The relevant excerpt from the notification stipulates as follows:
“7. The rescheduling of payments, including interest, will not qualify as a default for the purposes of supervisory reporting and reporting to Credit Information Companies (CICs) by the lending institutions. CICs shall ensure that the actions taken by lending institutions pursuant to the above announcements do not adversely impact the credit history of the beneficiaries.”
Further through notifications dated August 06, 2020 RBI introduced a special window scheme for Resolution of stress on account of COVID 19 (“Special Window”). Banks and financial institutions could restructure the eligible accounts under the Special Window without any asset classification downgrade of borrowers. The Special Window scheme included personal loans to individuals and other corporate exposures. It is relevant to realize that the resolution of stressed assets is highly subjective to borrower’s leverage, sector specific risks, and other financial parameters. Banks and Financial institutions are better placed to implement the resolution or restructuring of the assets (loan accounts) at bank level.
The moratorium scheme and the Special Window resolution framework dated August 06, 2020 (the “Schemes”) were highlights of discussions during the court proceedings extensively. The primary contentions were in respect to limited applicability of these schemes. The schemes and their benefits were available to borrowers whose accounts were standard and not more than 30 DPD as on March 01, 2020 with their respective banks and financial institutions. Though the legal validity of the schemes were questioned directly in front of the court, but selective nature of schemes conferring benefit on to standard accounts (which are not more than 30 DPDs) only. The exclusion of other borrower accounts was criticised extensively. But this could form as a part of separate issue, the primary concern here being asset down gradation and credit rating scores.
The Special Window restructuring scheme notification under its disclosures and credit reporting section made an onus on lending institutions to make disclosures on such re-structured assets in their annual financial statements along with other disclosures. However where accounts have been restructured under special facility, and involve ‘renegotiations’, it shall qualify as restructuring and the same shall be governed under credit information polices as applicable. The relevant clause is produced as is herein below:
“54. The credit reporting by the lending institutions in respect of borrowers where the resolution plan is implemented under this facility shall reflect the “restructured” status of the account if the resolution plan involves renegotiations that would be classified as restructuring under the Prudential Framework. The credit history of the borrowers shall consequently be governed by the respective policies of the credit information companies as applicable to accounts that are restructured.”
It is argued that the area of application and scope of both the schemes are entirely exclusive and independent remedies available to respective eligible borrowers. Under moratorium scheme the borrower gets benefit of liquidity since all the payments due during the period are deferred. While in the latter, i.e. restructuring scheme the borrower under stress can get their accounts restructured by way of implementing resolution plan without facing any asset classification downgrade upfront. In the latter case, only such restructurings involving ‘renegotiations’ will affect the credit history of the borrowers.
The intention of the RBI and the government was to provide relief to the borrowers, who were gasping for relief after the disruptions caused due to COVID 19. There is no doubt that the COVID-19 outbreak and subsequent lockdown has impacted all level of borrowers, ranging from small to large borrowers, including, individuals to corporates. It would be wrong to presume that those accounts, which were NPA or otherwise ineligible under the schemes, are not affected by the pandemic. Therefore it is always open for the government and RBI to introduce or implement any other scheme or some sort of reprieving mechanism for the ineligible borrowers. However, it is important to consider that even banks and financial institutions are no exception like any other businesses that have been affected by the pandemic; moreover they have been exposed to severe liquidity crunch and on the flip side are witnessing asset quality problems on their balance sheets. Any attempts to tamper or distort with the fundamental principle of finance (‘interest on interest’) or shifting the burden of it on banks and other financial institutions could have a much wider systemic ramifications than the current economic stress.
 Our detailed write up asset classification standstill is available at < http://vinodkothari.com/2020/04/the-great-lockdown-standstill-on-asset-classification/>
April 2018, the Reserve Bank of India (RBI) issued a “Statement on Developmental and Regulatory Policies” (‘Circular’) dated 06.04.2018, thereby prohibiting RBI regulated entities from dealing in/ providing any services w.r.t. virtual currencies, with a 3-month ultimatum to those already engaged in such services. Cut to 4th March, 2020- The Supreme Court of India strikes down RBI’s circular and upheld crypto-trading as valid under the Constitution of India.
Amidst apprehensions of crypto-trading being a highly-volatile and risk-concentric venture, the Apex Court, in its order dated 04.03.2020 observed that RBI, an otherwise staunch critic of cryptocurrencies, failed to present any empirical evidence substantiating cryptocurrency’s negative impact on the banking and credit sector in India; and on the basis of this singular fact, the Hon’ble SC stated RBI’s circular to have failed the test of proportionality.
In this article, the author has made a humble attempt to discuss this landmark judgment and its (dis)advantages to the Indian economy.
The Apex Court, vide its order dated 22.01.2020, in the matter of Maharasthra Seamless Limited vs. Padmanabhan Venkatesh & Ors. held that there is no requirement that the resolution plan should match the maximized asset value of the corporate debtors. Reiterating the principle laid down in the case of Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta, the Hon’ble Supreme Court held that once a resolution plan is approved by the committee of creditors (CoC), the Adjudicating Authority has limited power of judicial review.
The judgment of the Supreme Court boldly brings out the object of the Insolvency and Bankruptcy Code, 2016 (“Code”), i.e. “resolution before liquidation”. However, it will be pertinent to understand whether this ruling should be considered as a benchmark? Further, what will be the situation in case of liquidation? Whether sale under liquidation can be done for a value lower than the reserve price?
Below we analyse the ruling, seeking to answer the aforementioned questions.
The Supreme Court (SC) in the case of Jaiprakash Associate Ltd. & Anr. v. IDBI Bank Ltd. & Anr. dealt with 2 issues. Firstly, whether the National Company Law Tribunal (NCLT) or National Company Law Appellate Tribunal (NCLAT) can exclude any period from the statutory period in exercise of inherent powers sans any express provision in the Insolvency and Bankruptcy Code (I&B Code) in that regard. Secondly, whether the bidders can submit revised resolution plan after they were originally rejected by Committee of Creditors (CoC).
Dealing with the first issue, the SC in its order dated November 6, 2019 held that an extraordinary situation had arisen because of the constant experimentation which went about at different level due to lack of clarity on matters crucial to the decision making process of CoC. Besides that, the SC held that the case on hand is a classic example of how the entire process got embroiled in litigation initially before court and adjudicating authorities due to confusion or lack of clarity in respect of foundational processes to be followed by the CoC. Depending upon the uniqueness and unanimity of the stakeholders and resolution applicant to eschew the liquidation of corporate debtor, the SC by exercising its power under Article 142 of the constitution reckons 90 days extended period from the date of this order instead of the date of commencement of the Insolvency and Bankruptcy Code (Amendment) Act, 2019.
With regard to second issue, the SC relied on the sub clause (7) of Regulation 36B inserted with effect from 4th July, 2018, dealing with the request for resolution plans. It postulates that the resolution professional may, with the approval of the CoC, reissue request for resolution plans, if the resolution plans received in response to earlier request are not satisfactory, subject to the condition that the request is made to all prospective resolution applicants in the final list. Consequently, applying the principle underlying Regulation 36B(7), the SC found it appropriate to permit the interim resolution applicant to reissue request for resolution plans to the two bidders and/or to call upon them to submit revised resolution plans, which can be then placed before the CoC for its due consideration.
However, the SC has clarified that this order is issued in an exceptional case and it will not be construed as a precedent. Further, the SC made it clear that this order does not answers to the question of law as to whether NCLT or NCLAT has the power to issue direction or order inconsistent with the statutory timelines and stipulations specified in the I&B Code or regulations.
Though the SC has extended the CIRP period in an exceptional case, it is still not sufficient to complete the process within the stipulated time period as there are constant amendments being done for the effective implementation of the I&B Code. The NCLT/NCLAT is burdened with the application for clarification on the various procedures or regulation while the time for resolution flies. There are numerous cases pending before adjudicating authorities whose stipulated time period for the resolution has been surpassed.
-Sikha Bansal (email@example.com)
Note: This article is in continuation of/an addition to our earlier article wherein the author discussed various aspects pertaining to schemes of arrangement in liquidation under section 230 of the Companies Act, 2013 read with various provisions of the Insolvency and Bankruptcy Code, 2016. The author has described various factors and principles which the judiciary may consider while sanctioning a scheme of arrangement for companies in liquidation, how a scheme is different from a resolution plan or a going concern sale, what constitutes ‘class’ in the context, whether the waterfall under section 53 will apply to such schemes, etc. The author also pointed out the lack of clarity as to applicability or inapplicability of section 29A on such schemes. However, very recently, NCLAT has clarified that persons ineligible under section 29A are not qualified to propose a scheme during liquidation. This Part discusses this ruling and ponders upon some questions which still remain open-ended/unanswered.
The conundrum as to whether section 29A of the Insolvency and Bankruptcy Code, 2016 (‘Code’) will apply to schemes under section 230 of the Companies Act, 2013 (‘Companies Act’) has been put to rest, at least for the time being, by a recent ruling of the National Company Law Appellate Tribunal (‘NCLAT’). In Jindal Steel and Power Limited v. Arun Kumar Jagatramka & Gujarat NRE Coke Limited (Company Appeal (AT) No. 221 of 2018), vide order dated 24.10.2019, NCLAT held, while a scheme under section 230 is maintainable for companies in liquidation under the Code, the same is not maintainable at the instance of a person ineligible under section 29A of the Code. The NCLAT relied on the observation of the Hon’ble Supreme Court in Swiss Ribbons Pvt. Ltd. & Anr. v. Union of India & Ors., WP No. 99 of 2018, that the primary focus of the legislation is to ensure revival and continuation of the corporate debtor by protecting the corporate debtor from its own management and from a corporate death by liquidation.