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

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.
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.
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.
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.
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.
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.
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.
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

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).
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.

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.
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.
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.