Finance

Experts suggest 'prepackaged deals' after banks lose IBC tool to pandemic

Updated : May 18, 2020 10:49 PM IST

The threat of IBC alone has often been enough to get difficult promoters to co-operate, feel many bankers.

Suspension of fresh insolvency proceedings for up to one year without an alternative resolution mechanism in place could lead to further stress in the banking system, several experts CNBC-TV18 spoke to opine.

As far as debt resolution is concerned, the four-year-old Insolvency and Bankruptcy Code (IBC) with all its flaws and limitations, is still by far one of the most powerful tools in the hands of creditors. The threat of IBC alone has often been enough to get difficult promoters to co-operate, feel many bankers.

The Finance Minister on Sunday announced a slew of changes to the Insolvency and Bankruptcy Code, primarily to insulate small businesses impacted by COVID-19 from insolvency proceedings. The biggest of these was the announcement of a suspension of fresh initiation of insolvency proceedings up to one year, depending on the pandemic situation.

“To let companies go under bankruptcy in the present situation would not be in the public interest, and therefore these temporary measures of suspending fresh IBC proceedings up to one year have come in,” explained L Vishwanathan, Partner, and Chair-Insolvency, Finance and Projects at Cyril Amarchand Mangaldas.

Vishwanathan added, “I think the government should seriously consider putting in place a pre-pack regime right now. This is the time for it. I don’t think we can suspend IBC without creating an effective alternative way to resolve companies. I think one way to do that would be to provide a pre-pack arrangement as is prevalent in other countries. The other alternative would be to encourage companies to go for debt restructuring under the Companies Act that option is always available so that companies can use existing legal mechanisms. “

Prepack or a prepackaged deal is an arrangement whereby a stressed company, its potential buyer, and creditors negotiate the sale of all or part of the business, or a restructuring plan to resolve the debt issue, before appointing administrators to facilitate the process or approaching the National Company Law Tribunal in this case. This ensures a more speedy, mutually agreed-upon resolution, and has successfully been in use in countries like the United States, Canada, England, and others.

The other alternatives to IBC could be debt restructuring under the Companies Act or one-time settlements, as per experts. Abizer Diwanji, Leader, EY India Financial Services told CNBC-TV18, “I believe the one-year suspension of IBC could be a precursor to the regulator allowing one-time restructuring.”

Bahram Vakil of AZB & Partners told CNBC-TV18 that while the relaxation was expected, “a blanket one-year extension of IBC exemption is worrying because COVID may be a long drawn affair,”

The Finance Minister’s IBC announcement on Sunday also raised the question of whether companies who voluntarily want to exercise their right to exit or wind up due to financial stress would be allowed to file for bankruptcy or not.

“We believe this will cover all references to IBC. Whilst there may be a logical difference between voluntary and involuntary filings, the press release (from the Ministry of Finance) suggests that all filings will be covered under this,” said L Vishwanathan of Cyril Amarchand Mangaldas when asked exactly who would be precluded from invoking IBC proceedings.

He added that these measures cannot be seen in isolation, but should rather be seen along with RBI’s move to permit moratorium to borrowers who had been economically hit due to the pandemic.

“All these measures have to be seen in totality (IBC changes along with RBI moratorium) to give a lifeline to many companies that would otherwise be impacted by the present circumstances, ” he said.

Another challenge may come in the form of differentiating “COVID related debt” from the overall debt when excluding it from the definition of ‘default’ for the purposes of the bankruptcy code.

The Finance Minister announced that all COVID-19 related debt would be kept out of the definition of default, and the Ministry of Corporate Affairs would notify the same via a circular soon.

Experts believe this may prove to be a challenge, as differentiation of COVID-19 impacted debt alone may be virtually impossible, unless the MCA clarifies if it includes only, for instance, additional loans taken during the lockdown period for business continuity. This measure may have been announced to encourage genuine borrowers to borrow without the fear of losing their companies if they default, explained Vishwanathan.

Under the existing RBI June 7 circular for resolution of stressed assets, banks are given an incentive to resolve cases via the IBC by allowing them to reverse additional penal provisions made for delays in resolution when they file a petition for insolvency with the IBC. Whether banks will be given relief under this circular is also something the regulator would have to clarify, opined banking executives CNBC-TV18 spoke to.

Correction: A previous version of this article misspelt Abizer Diwanji's name. The error is regretted.

Experts suggest 'prepackaged deals' after banks lose IBC tool to pandemic

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