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A debate is gathering steam about whether banks must not charge interest if they decide to provide a moratorium to a borrower, and whether the banks would in turn get a right to deny interest payable to depositors who are the source of the money they lend. In parallel, the President has promulgated an Ordinance to suspend the right to invoke the Insolvency and Bankruptcy Code, 2016 (“IBC”) for defaults occurring after March 25, 2020 for a period of six months or such further period as may be notified.
Thinking Aloud not an Opinion
To begin with, thanks to breathless reporting of court proceedings in tweets (increasingly, “threads” of multiple short messages), questions from a bench thinking aloud tend to get projected as judicial expression of views. Until hearing is concluded and judgment rendered, a judge’s questions and remarks should not be taken to be an expression of judicial opinion. When a question is posed in a petition by a litigant, the court may seek a response. The answers may or may not convince the court, but until proceedings are done and dusted with final judgement rendered, a projection of what gets said as a conquest or a defeat, can only provide temporary (and potentially misleading) pleasure or pain for observers.
Bespoke Regulatory Formulation
That said, it is time to meditate on the policy response to the Covid-19 pandemic in the Indian financial sector. The Reserve Bank of India (“RBI”), the regulator of the banking system has formulated a discretionary framework for commercial banks to consider postponing timely payments by borrowers. A decision to provide a moratorium from timely payment is that of the commercial bank that has lent funds. But for the RBI’s framework, if the payment is not made in time, the bank would have to recognise the loan as non-performing.
Different regulators have to take their policy decisions based on the dynamics and empirics involved in the sectors they regulate. The Securities and Exchange Board of India (“SEBI”) has recognised the impact of a delay in servicing loans on credit rating by rating agencies regulated by it. SEBI has provided for repairing a downgrade by credit rating agencies once the delayed payment of interest is cured. The Insurance Regulatory and Development Authority of India (“IRDAI”) is focused on ensuring that insurance companies do not back off their obligations when claims relating to Covid-19 are made. These are examples – multiple regulatory measures for timeliness of performance are being taken by regulators across the board, taking into account the equities that need to be adjusted to balance competing interests of stakeholders in the ecosystem.
Adjustment of Equities
The sovereign right to decide whether to allow a borrower not to pay on time, necessarily has to rest with the lender on the basis of facts and circumstances of the case. A bank that grants a waiver on timely payment could get to postpone treatment of the asset as non-performing. So long as the bank meets its own solvency requirements, the bank’s health would not be hit. If the bank itself may get insolvent, it would obviously not be possible for the bank to waive its rights without hurting the rights of others to whom the bank owes obligations.
This is true for every financial markets intermediary. For example, a mutual fund or an insurance company may find it impossible to compute the value the assets it holds and liabilities it owes if every loan security held by it is mandatorily excused from being serviced. When a new unit holder or policyholder is let in, it is on the basis of the value of the corpus. If existing unit holders and policyholders desire to leave the corpus it can only happen on the basis of the valuation of the corpus.
If valuation becomes impossible, the fund would need to “shut the gate” as has been done by Templeton Mutual Fund, with a bunch of schemes not allowing fresh entry or exits – also subject matter of litigation across courts. If financial institutions have to lose discretion over granting time for payment of interest, or discretion for granting a waiver on interest, in turn, depositors would need to lose the right to get their lending to the financial institution serviced. Such a position would then hurt householders and pensioners and their rights to get returns on their investments. Unit holders and insurance policyholders would need to lose the right to enter or exit corpuses of assets and give up their pre-existing rights. Likewise, government employees and voluntary contributors to the national pension system regulated by the Pension Fund Regulatory and Development Authority too would necessarily have to be hit.
Hasty Suspension of the IBC
In fact, the only legal way a creditor could be forced to compromise and take a “haircut” on its dues is contained in the IBC. The Ordinance promulgated on June 5, 2020 inserts a new Section 10A that takes away the ability to initiate corporate insolvency resolution under Section 7 (which empowers financial creditors to initiate it); Section 9 (initiation by operational creditors) and Section (initiation by the corporate debtor) “for any default arising on or after” March 25, 2020. Such suspension would operate for a period of six months or such further notified period.
The blanket suspension of all three entry points to the resolution process would mean that even if a corporate borrower were desirous of seeking a moratorium permitted by law, it would now be barred. A legitimate and tried-and-tested framework to make creditors sit around a table and work out a compromise to save the enterprise now stands suspended. The moratorium under the IBC is mandatory and statutory, overseen by a quasi-judicial tribunal, with two rounds of appellate review. Throwing that framework away can only mean that a moratorium framed by regulatory edict outside the IBC, would entail having to deal the injury that may be inflicted on one stakeholder or the other. Necessarily, this would place such regulator-made framework outside the pale of a mandatory regime, unless the interests of every stakeholder in the system is dealt with – precisely the “in rem” position that Parliament-made legislation would ensure.
Need to Reorient IBC Amendment
Indeed, the IBC in its current form was not intended for a pandemic situation but that called for amending it appropriately, not throwing away the baby with the bathwater. The piquant situation this creates is that a corporate debtor that has already defaulted before March 25, 2020 may indeed seek the protection of the statutory moratorium by invoking Section 10 of the IBC while one made ends meet before March 25, 2020 but is unable to do so now, cannot be a protectee under the IBC.
Perhaps one has to rethink and invert the entire approach to the discourse – pull back the decision to suspend the IBC and let borrowers who want a waiver on interest use the IBC to get a statutory moratorium and thereby benefit from a ban on initiating recovery proceedings. What is needed is an amendment to enable a voluntary initiation of a moratorium with attendant checks and balances on the ability of the borrowers to use the assets under their control. What would then be necessary is a framework for fiduciary duties to borrowers and other stakeholders rather than to shareholders alone – for example, provisions to ensure prevention of a large dividend to shareholders by saving on payment of interest to lenders.
Any other approach would necessarily spark a chain of adjustment of equities across stakeholders down the food chain. Unless a carefully balanced formulation is reached, there would be no check and balance on the injury that can be inflicted on pre-existing rights hitherto belonging to other segments of society. It is time to rethink and to do it rapidly – as the Supreme Court remarked in Swiss Ribbons, crudities and inequities in the IBC have had a history of being addressed in its evolutionary journey.
The author is a practising advocate.