COVID-19: Dos and don’ts for Borrowers and Lenders
It
is an understatement that Covid-19 has wreaked a havoc in all major economies
across the globe. While nations (including India) are grappling to keep their
citizens safe, the impact this pandemic will have on the financial health of
businesses is unimaginable at this stage. The stock markets are highly volatile,
valuations are plummeting, businesses are suffering from the domestic and
global lock-down and financial defaults are likely to rise. In these
circumstances, if you are a borrower or a lender, it is imperative that you
take immediate stock of the financial repercussions of this pandemic and what
steps you can take to mitigate the impact. Below are some points to consider.
Points
for borrowers and promoters
1. Review
existing debt obligations:
Borrowers must carefully review the documents under which they have incurred
any indebtedness. The review should be, at the bare minimum, to check (a)
impending payment obligations, (b) any existing or potential covenant breaches,
and (c) any existing or potential events of default. Lending documents may have
various provisions including those on default interest, mandatory prepayment,
material adverse effect, financial covenants, non-compliance with law,
deterioration of the financial health, credit rating downgrade, termination of
material contracts and delays in project implementation. They seldom contain
provisions that will permit non-compliance due to force majeure situations. It
is important for borrowers to acknowledge their obligations and the
consequences of the breach of those obligations.
2. Assess
cashflows: Once
borrowers have re-confirmed their obligations, they should also asses their
cash flow position. In the Indian context, lenders usually do not press the
trigger unless there are payment defaults (and that too, generally, after a
considerable delay in payments). If the cash flow situation is robust or not
worrisome, then even if there are existing or potential covenant breaches,
lenders may be willing to grant waivers. If the cash flow situation is
troublesome, then borrowers need to assess if this is a temporary situation or
whether the effects will be long lasting. They should also evaluate ways in
which the situation can be improved. For example, they may decide to cut back unnecessary
expenses or halt expansion plans and save the resources they have for servicing
debt and paying their employees. They may consider selling non-essential assets
and use the sale consideration to deleverage. Each sector and each borrower will
have its own peculiarities and it is important to assess this at the earliest.
Under the Insolvency and Bankruptcy Code, 2016 (“IBC”), a payment
default of Rs. 100,000 is sufficient for creditors to initiate the insolvency
process. The IBC also currently has no carve-out for a payment default due to force
majeure situations.
3. Reach
out to customers: Customers are the lifeline of any
business. It is important to keep them assured. During this time, your
customers may also be suffering and may need some leniency. If you are in the
real estate construction business, you may need to provide your customers (who
have lost a chunk of their financial wealth due to tumbling of the markets) some
grace period or adjustments in their payment schedules. If you are in the
retail business, you may be able to provide them home-deliveries of items (subject
to relevant lock-down restrictions) and continue to the revenue flow. If you
are in the services business, you may still be able to continue to provide
services through electronic communication. If some customers can give you
advances for goods to be sold or services to be rendered, those advances could
alleviate some of your debt servicing burden.
4. Re-assure
your suppliers:
For your business to continue functioning, your suppliers are a key stakeholder.
Re-assure them of your business prospects, inform them of the steps you are
taking to keep your business running or of the pitfalls due to which your
business may be undergoing temporary stress. Try to negotiate longer payment
periods with your suppliers. Re-look at any existing take or pay provisions in
long term supply contracts and try to seek waivers or relaxations.
5. Take
care of your employees:
The strains of the pandemic are likely to be felt to a much greater degree by
employees than the promoters of businesses. This is a time when promoters and
businesses need to provide their employees with job security. Ultimately, if
these employees aren’t around, you will not be able to service your debts and
your business may crumble.
6. Re-assess
business plans:
This is the time to re-assess business plans for the foreseeable future. Annual
or multi-year plans that were formulated a few months ago may not be relevant
today. You may have to revisit any future fund-raising options given that
investors may be cautious in the interim few months and lenders may be tight pursed
given the global impact of this pandemic. However, if you are a cash rich entity,
this period may also give rise to opportunities to acquire businesses at
cheaper valuations in India and other geographies across the world.
7. Impact
on promoters:
Promoters of borrowers must also evaluate their contractual and legal liabilities
when companies under their management or control are facing potential defaults
or insolvencies. They must consider if they have provided any guarantees,
indemnities, sponsor support undertakings or comfort letters, or any
quasi-security or security on their assets. They need to re-confirm their
obligations and evaluate their ability and readiness to perform such
obligations.
8. Work
together with creditors: Last but not the least, it is
important that borrowers keep a constant dialogue with their creditors (through
audio or web-based video apps, not in person please!) Borrowers who foresee
that Covid-19 will have a minimal impact on their operations may want to
provide the necessary comfort to their creditors. For those who are likely to
be adversely impacted because of Covid-19, it is important to discuss the same
with creditors and understand what can and can’t be done. Borrowers may also
need to provide more information to creditors than they are used to doing to
give the latter comfort about the operations and stability of the borrower. In
case of pedigree borrowers or borrowers who had sound financial health
pre-Covid-19, several lenders are likely to be supportive and understanding.
Some of them may even be willing to grant temporary reliefs, waivers or
moratoria. Some may also be willing to provide an additional credit line to
ease out the temporary stress. For instance, State Bank of India has already introduced
a scheme to provide additional working capital at attractive interest rates for
existing customers impacted by Covid-19.
Points
for lenders
1. Review
existing portfolios:
Lenders need to take a hard look at their existing portfolios and determine
which of their accounts are or may be adversely impacted. Besides meticulous monitoring
the financial health of their borrowers and assessing their capability to
service their debt obligations, lenders must immediately assess their remedies
under their existing lending documents and under law. It would also be a good
time for them to re-confirm whether their loan documents are validly executed,
whether their existing security package is created and perfected and whether
there are any bottlenecks that need to be ironed out (should they decide to
take any action).
2. Evaluate
options:
Lenders also need to evaluate their options. While accelerating the debt may
seem to be the only way out, before pressing the trigger, the lenders should
consider whether that is the best approach. Generally, lenders may have the
following options available:
a) Reservation
of rights: If
the lenders believe that any event of default has occurred under the terms of
their lending documents, they may consider issuing reservation of rights
letters. This does not necessarily mean that the debt is being accelerated.
However, it is a warning to the borrower that the lender is reserving its
rights under the lending documents and under law and the non-exercise of any
such rights immediately would not tantamount to a waiver of such rights.
b) Levy
default interest:
They can charge default interest (if the terms of their debt permit) without
accelerating the debt. Borrowers may be willing to pay the default interest for
a short duration rather than prematurely repaying the entire debt.
c) Grant
waivers: They
can provide a waiver of a default if there is a covenant default or relax the
covenant to avoid any potential default. Payment of any waiver fees for lenders
of external commercial borrowings (“ECBs”) will need to be examined from
an exchange control perspective.
d) Restructure
the debt: In
certain cases (primarily where the debt is in the form of bonds or debentures),
creditors may be able to grant a moratorium on interest or principal payments
or restructure the principal payment schedule. Creditors who are foreign
portfolio investors or lenders of ECBs need to assess the viability of any
restructuring given exchange control regulations. Indian banks and non-banking
finance companies need to consider the impact of the circular dated June 7,
2019 of the Reserve Bank of India on the prudential framework for resolution of
stressed assets before agreeing to any restructuring proposals.
e) Recovery
proceedings:
Where lenders are unable to find any other suitable options and debt recovery
action seems to be the only plausible option, lenders should determine what
steps they need to take for such action. Certain classes of lenders may be able
to take action under the Securitisation and Reconstruction of Financial Assets
and Enforcement of Security Interest Act, 2002, whereas some lenders may have
to approach civil courts. However, before initiating any action, it is
important to check with your legal advisors on whether the courts and tribunals
are functioning and whether they are only taking on urgent applications or all
applications.
f) Enforcement
of security:
Certain lenders may have security which can be enforced. Before enforcement of
security, it is vital that lenders confirm that the security has been validly
created and all steps required for perfection of security have been taken. Any
imperfections may adversely impact the security enforcement process. Certain
types of security can be enforced without recourse to courts, such as
enforcement of pledge on securities. However, certain security enforcement
actions will have to go through a court process, such as enforcement of an
equitable mortgage. Lenders (especially those who hold a pledge of listed
securities) may also find it beneficial to wait and watch before enforcing
their pledges if the value of their security has fallen substantially (with the
hope that stock markets will correct themselves in the coming months). Security
enforcement may also need consents of, notifications to or filings with
existing lenders, shareholders, governmental authorities or third parties. In
the current scenario, if security enforcement needs reliance on any third
parties, then the enforcement process may be delayed given the general
lock-down and work from home policies. These aspects need to be carefully
evaluated or else the enforcement process may become unproductive.
g) Insolvency
proceedings:
Given the general lock-down, admission of corporate insolvency resolution applications
may be delayed. Preparation of the insolvency applications and filing these
applications may also be delayed. Further, general considerations for
initiating insolvency proceedings such as the level of financial and
operational debt, the viability of the business and availability of suitors,
constitution of the committee of creditors etc. will continue to apply.
Lenders
should note that that the Supreme Court has in an order dated March 23, 2020
extended the limitation period for various proceedings before any courts and
tribunals with effect from March 15, 2020 until further orders. This should
provide a breather for lenders who are unable to proceed with enforcement proceedings.
3. Cross
defaults:
Triggering an event of default by a lender under one facility may result in
triggering cross defaults across other facilities to the same borrower group by
that lender, or for that matter cross defaults across other facilities to the
same borrower or borrower group by other lenders as well. Therefore, lenders
must evaluate the possibility of such cross defaults and their ability to take
any effective enforcement action against the borrower / borrower group.
4. Refinancing
and priority financing opportunities: While borrowers grapple with the turmoil, they may
either need to refinance their existing debts, or may require priority
financing or last mile financing to complete certain projects. This may provide
an opportunity to distressed debt lenders and investors. They need to assess
the viability of the borrower, the value of the security and their ranking when
providing any new debt. Also, given the recent judgement of the Supreme Court
in the case of Jaypee Infratech, incoming lenders must conduct their due
diligence and evaluate the risks of any avoidance transactions under the IBC
before providing such debt.
5. Consent
requirements:
Certain borrowers may approach their existing lenders for consents, for
instance, for incurring new debt (including any refinancing or priority
financing mentioned above) or creation of new security. At the time when banks/financial
institutions are under lock-down and operating with marginal staff, it may be
difficult to obtain necessary internal approvals for banks/financial
institutions in a timely manner. Internal committees may find it difficult to
co-ordinate and meet and internal processes for sanctioning of approvals may
get delayed. At times such as this, it may be prudent for borrowers to err on
the side of caution. Incoming lenders from whom the borrower proposes to raise
new debt or in whose favour the borrower proposes to create security must also
be wary of lending and accepting security where the consents required from
existing lenders are not obtained. Otherwise, this could lead to disputes in
the future, especially if the borrower undergoes corporate insolvency
resolution proceedings under the IBC.
The
above are just some of the steps that borrowers and lenders can take to
minimise the impact. While our Government is taking several measures to shield
the virus explosion, one fact that Covid-19 has brought to the forefront is
that we all need to (and must and can) work together to fight this pandemic.
Borrowers and lenders also need to work together during this phase. Borrowers
and their promoters will need to be co-operative, conservative and constructive
in their approach, whereas lenders will need to be patient. Borrowers and
lenders have always shared a symbiotic relationship – let’s hope that the virus
does not kill it.