Banking business continuity and much ado about force majeure in the times of the coronavirus

Even before the pandemic began, many sectors were already stressed and doomsday predictions of recession were looming over economies all over the world.

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Much has been said about force majeure. From being touted as a panacea for all contractual breaches to being rightfully cautioned that it is easier said than done. If we were to summarise the law governing force majeure, it would be this. Force majeure in laymen’s terms means an act of God beyond the reasonable control of a human being which makes performance of contracts impossible. As was clarified by the Supreme Court of India in Satyabrata Ghose v. Mugneeram Bangur & Co.,1 the performance of an act may not be literally impossible but it may be impracticable and useless from the point of view of the object and purpose of the parties. If an untoward event or change of circumstance totally upsets the very foundation upon which the parties entered their agreement, it can be said that the promisor finds it impossible to do the act which he had promised to do.

It was further held that where the Court finds that the contract itself either impliedly or expressly contains a term, according to which performance would stand discharged under certain circumstances, the dissolution of the contract would take place under the terms of the contract itself. Since the commencement of the pandemic, many business borrowers have rushed to court to obtain a stay on downgrading of their credit rating and EMI payments till lockdown does not end.2 Most of these cases are from the construction, infrastructure and real estate industry which was already staring at the barrel of a gun before the pandemic took hold of the world. Others from sectors such as FMCG have had to get orders for restraining banks from dumping their shares which have reached one-third their pre-COVID market value.3 The court sentiment is presently in favour of the borrower most of the times because the fact that default is not intentional is obvious.

Most of these cases have relied on the principles of availing urgent interim relief basis the prima facie case instead of arguing force majeure. This is also because regulated sectors are specifically regulated because they are governed by special considerations. One wrong action allowed can lead to a spiral effect to the entire market and sometimes internationally as has been proved time and again and discussed going forward. Reference has also been placed on the circulars and notifications of the Reserve Bank of India which allow banks and other financial institutions discretion to grant moratorium on repayment of loans i.e. instalments including interest and other charges due post March 1, 2020 for a period of three months. The circulars also put a pause on the downgrading of credit ratings for the term of the moratorium. However, what is interesting to note is that the parties have had to argue on the interpretation of these circulars basis the intention of the regulator to avail this relief. This is because most of these borrowers have had defaults commencing before March 1, 2020. Much before the pandemic began, many sectors were already stressed and doomsday predictions of recession were looming over economies all over the world. The first relief in the form of moratorium came only on March 27, 2020. Even after the relief was announced by the regulator, the banks, NBFCs and other actors required a week to formulate their corporate game plan and come to decisions. Meanwhile, many borrowers have become victims of domino effect.

The more important question to ask here is this—is it commercially feasible for banks to try to recover a debt of Rs 610 crore by dumping shares in the share market during a market crash and recover not more than Rs 350 crore? One can argue it both ways. For a bank that predicts a darker time ahead, recovering only 50% of their debt today may be a better idea than recovering nothing at all few months from now. There is also the question of liquidity. As banks stare in the face of a moratorium period and expected defaults post moratorium, quick big-ticket recoveries may be the only means of maintaining adequate liquidity to stay afloat. But is this commercially viable if banks and other financial institutions are considering a long-term perspective? It is interesting to note that although RBI has released stimulus packages for the banking and finance industry, it has not yet instructed them at least through a public notification to strategise business continuity plans. There is only one circular dated March 16, 2020 which advises banks in relation to protecting employees and ensuring business continuity in relation to following social distancing norms. But if we see international statistics and trends, the coronavirus pandemic is not going to be bleached out of the world all of a sudden. There is going to be a long transition phase and financial institutions should ideally prepare for the same with a business continuity plan which goes beyond staffing issues. Some guidance in this regard is available in the High-level principles for business continuity by Basel Committee on Banking Supervision.4 According to the guidance note, a financial industry participant that experiences a major operational disruption might affect the ability of other financial industry participants and possibly the financial system to continue normal business operations. Examples include a payment and settlement system operator on which financial industry participants depend to process and complete transactions, particularly where there are no others capable of substituting for that operator or financial industry participants that play a significant role in providing financial services within a particular region.

Financial industry participants should establish recovery objectives that are proportionate to the risk they pose to the operation of the financial system. The board and senior management are ultimately accountable for the organisation’s recovery objectives, although in practice recovery objectives that apply to individual business lines are often developed by, or in consultation with, business line management. In assessing the reasonableness of an organisation’s recovery objectives, financial authorities are strongly encouraged to consider the increased risk of failed transactions, liquidity dislocations, solvency problems, and loss of confidence that accompany prolonged disruptions in the financial system. The banking industry in this regard needs to take a leaf from the aviation industry. According to studies, had the aviation industry decided to stop international flights originating from the first Covid-19 affected nations in the very beginning, the loss they would have suffered would have been substantially less than the loss they are now suffering. So, the business continuity plan of a financial institution should be symbiotic with other market participants including the borrowers and indirect stakeholders like stock markets. Recovery actions by banks and interim relief for borrowers should not be based on the legal fiction of force majeure but on the need to have sustained liquidity and money flow in the economy without resort to indiscriminate recovery of loans which will lead to collapse at macro level. This collapse shall be most harmful to the banking ecosystem. Once a policy is framed, its trickle-down implementation also needs to be regularly monitored to see real impact.

To quote, Nassim Nicholas Taleb, a system that is rigid does not survive. Only those systems that are anti-fragile survive—those systems that emerge stronger due to market shocks and disruptions. (Endnotes) 1 . 1954 SCR 310 2. Anant Raj Limited v. Yes Bank Ltd. order dated April 06, 2020 in W.P.(C) URGENT 5/2020 before the High Court of Delhi; Transcon Skycity Pvt. Ltd. and Ors. v. ICICI Bank and Ors. order dated April 11, 2020 in Writ Petition LD-VC Nos. 28 and 30 of 2020 before the High Court of Bombay; Ideal Toll & Infrastructure Pvt. Ltd. v. ICICI Home Finance Co. Ltd., order dated April 08, 2020 in Interim Application in Commercial Suit No. LD-VC-7 OF 2020 before the High Court of Bombay. 3. Rural Fairprice Wholesale Limited v. IDBI Trusteeship Services Limited., Order dated March 30, 2020 in Interim Application in Commercial Suit No. (L) 307 of 2020 before the High Court of Bombay. 4. Principle 3 of High-level principles for business continuity, Basel Committee on Banking Supervision, Bank for International Settlements (August 2006). Justice Kurian Joseph, Former Judge, Supreme Court of India and Anuroop Omkar, Founding Partner, AK and Partners