In a big relief to cash-starved firms, India government said insolvency proceedings against fresh defaulters would remain suspended for up to one year and Covid-19-related debt would be excluded from the definition of default. The breather, however, will potentially hit financial and operational creditors hard. Also, it will bleed their balance sheet, apart from temporarily depriving them of a credible mode of bad debt resolution. Lenders may be forced to seek regulatory forbearance on provisioning and capital requirements.

Initially, proceedings under the Insolvency and Bankruptcy Code (IBC) can’t be invoked for six months, which can then be extended by another six months, depending on the pandemic situation. There will be a special insolvency framework under section 240-A of the IBC. Already, in a bid to insulate small businesses from being dragged to the NCLT, the default threshold for triggering insolvency has recently been raised to Rs 1 crore from just Rs 1 lakh earlier.

Veena Sivaramakrishnan of Shardul Amarchand Mangaldas questions the move: “The blanket suspension of defaults on account of Covid could lead to unintended consequences. Questions like why should an entity not refer itself to insolvency, what is the parallel regime of resolution… what is the framework for creditors to come up with a viable resolution plan outside of IBC, continue to remain unanswered.”

Finance minister Nirmala Sitharaman said an ordinance will be promulgated soon to implement the proposed changes. However, proceedings in the cases already admitted will remain unaffected by the latest move. Data available with the IBBI show, proceedings in 1,961 cases were going on as of December 2019.

Despite risks of a sharp deterioration in credit quality of banks and cash flows of operational creditors due to the suspension of IBC initiation, many experts believe that given the unprecedented crisis, the existence of companies must take precedence over the resolution of stressed assets.

The suspension on fresh initiation of insolvency proceedings for one year is likely to increase provisioning for banks. “The advantage we were getting to refer a case to the National Company Law Tribunal (NCLT) was reversal of additional provisioning, now that option will not be there,” an MD & CEO of a bank who did not wish to be named told FE. According to the June 7, 2019, circular of the Reserve Bank of India (RBI), banks can reverse 20% provisioning for unresolved cases, after referring a case to the NCLT.

“NCLT was anyway the last option for us, so now will try to resolve cases outside court through inter-creditor agreement (ICA) as much as possible,” another senior banker told FE. “We may see more cases getting resolved through one-time settlement (OTS), he further added. Sanjeev Krishan, partner & leader, deals, PwC, said, “We expect banks to use the restructuring route a lot more over the next year or so.”

Casting the IBC as a landmark law, the government asserted that just the threat of the legislation has ensured recovery of as much as Rs 5 lakh crore up to February 29 since its inception in 2016. The figure was arrived at by aggregating the default involved in as many as 13,556 cases where insolvency applications were withdrawn from the NCLT before they were admitted, as defaulting promoters rushed to settle dues for fears of losing their companies once the proceedings started. In the 221 cases resolved so far via IBC, about Rs 1.84 lakh crore was recovered, against the admitted claims of Rs 4.13 lakh crore, marking a recovery rate of 44%, Sitharaman said.

Once the Ordinance comes into force following the Presidential assent, sections 7,9 and 10 of the IBC will remain suspended. Section 7 of the code allows a financial creditor, either by itself or jointly, to make an application for initiating the corporate insolvency resolution process against a corporate debtor. Section 9 of IBC gives power to the operational creditors to initiate the corporate insolvency resolution process after default. Under Section 10 of the IBC, a defaulting company has the right to approach the adjudicating authority to declare it insolvent, giving protection from creditors.

While the RBI has allowed borrowers a three-month repayment holiday for term loans, keeping insolvency proceedings in abeyance would be an additional breather for borrowers who may default on loan repayments thereafter.

Even before the pandemic, the slowdown in the economy had caused a deterioration in credit quality. For instance, SMA-2 loans – those where repayments are delayed by 61-90 days – increased by about 143% between March 2019 and September 2019, the RBI data cautioned. Any repayment default post 90 days sees the exposure slip into a non-performing asset (NPA) and banks need to make bigger capital provisions.

Veena Sivaramakrishnan, partner at Shardul Amarchand Mangaldas, said, “The blanket suspension of defaults on account of Covid could lead to unintended consequences. Questions like why should an entity not refer itself to insolvency, what is the parallel regime of resolution… what is the framework for creditors to come up with a viable resolution plan outside of IBC, continue to remain unanswered.”

Corporate lawyer Sumit Batra the proposals will “surely benefit corporate entities who genuinely want to pull themselves out of an economic slump or slowdown but will ultimately hamper the recovery prospects of financial institutions in cases of existing defaults and in those cases as well where the accounts have already been declared NPAs”.

Ashish Pyasi, associate partner, Dhir and Dhir Associates, said that the suspension of provision of filing by the company under IBC may worsen the situation as these businesses will be forced to run the show with means not available. Makarand Joshi, partner, MMJC and Associates LLP, said that the government should have provided an option to those companies to choose IBC, who are not confident of sailing through this period.

There is also fear of number of cases to rise after one year. Abhishek Dafria, vice president, Icra, said, “If the severity of the pandemic were to increase, thus delaying economic revival, then we could see a sudden surge in cases being referred under the IBC after the one-year period.”