The Covid-19 pandemic has left numerous businesses grappling with liquidity and survival challenges. While on one front, we are battling a health crisis, on the other, businesses around us are dying an untimely death, being pushed to the brink by a lack of demand, disrupted supply chains and falling investor confidence. Some of the oldest cafes and restaurants have shut down, airlines have been mounting losses and laying off its staff, the hospitality and tourism industry is in a conundrum, uncertain about its future, and overall there is palpable depression throughout the business community. After several phases of lockdown, the world is witnessing phased unlocking. Businesses which were severely affected by the lockdown are still trying to find their feet in the unlock phase. Their recovery is tepid and unsteady.
Going forward, the full impact of the health crisis is yet to unfold. Corporate delinquencies are likely to rise with several estimates being made by various industry and research groups. In normal times, the markets and bankruptcy courts serve to triage amongst the financially distressed firms, categorising those which may need to be liquidated for lack of any economic value and those that can be restructured. However, in times of a crisis as huge as the Covid-19 pandemic and its grave fallout, the task appears daunting. Given the unprecedented distress being faced by many firms, the markets and court infrastructure may not be able to deal with all such distressed firms, making the implementation of this triage difficult. In such a situation, the possibility of some firms being wrongly liquidated, while other firms being kept artificially alive cannot be ruled out. Hence, the government has acted swiftly and applied a break on the insolvency law i.e. the Insolvency and Bankruptcy Code, 2016 (IBC), by suspending its use for a year, to save companies from premature death.
The end of the present crisis is still uncertain. International organisations and think-tanks like the IMF, the World Bank and BIS have, through their various publications, talked about the need to continue to provide liquidity support to illiquid but solvent firms and facilitating restructuring of insolvent firms to ensure swift resource reallocation. They further suggest the need to ensure efficient out-of-court agreements or less-formal restructuring mechanisms, with fast-track procedures to support such debt restructuring. The just released report of G30, an independent consultative group on international economic and monetary affairs, titled “Reviving and Restructuring the Corporate Sector post Covid”, makes a clarion call for policy makers around the globe to imperatively set out policy responses to tackle the corporate solvency crisis visible on the horizon in the aftermath of the Covid crisis and makes several recommendations.
Every crisis presents a window of opportunity to undertake reforms in an economic system. History has shown that insolvency laws have developed amid economic turmoil. The US insolvency law evolved while being enacted, repealed and re-enacted four times during the economic downfalls of the 1800s. Likewise, the East Asian financial crisis of 1997 had triggered insolvency reform with the enactment of improved bankruptcy laws in Malaysia, Thailand, and the Republic of Korea to facilitate the rehabilitation of corporates and prevent liquidations. Countries such as Indonesia and Thailand also set up specialised bankruptcy courts in response to the crisis. One of the responses to the crisis was the introduction of new mechanisms to reduce reorganisation costs by providing for quicker and cost effective out-of-court resolution processes and reducing reliance on formal judicial processes. Another trigger for the review of insolvency laws came with the 2008 sub-prime crisis which witnessed some of the big financial institutions fail. The crisis also led to a sharp increase in the number of corporate insolvencies around the world, ranging from a 40% increase (y-o-y) in bankruptcy filings in US in 2009 to 11% in Germany and 6% in Great Britain. Countries such as France, Italy, Poland, Estonia and Philippines, among others, took recourse to out-of-court resolution processes to tide over the corporate insolvency. The G30 report also makes an important point that insolvency laws in most countries are not suited to meet the requirements as are being presented by the Covid-19 crisis, where several businesses may just fail to stand on their feet, though being economically viable, for lack of financial viability. Providing broad support to the corporate sector has the danger of the creation of zombie firms. Hence, while the suggestion is for targeted support, a further recommendation is to “pilot new schemes that would facilitate contractual debt restructurings without the use of bankruptcy procedures”.
The rise in corporate insolvencies in the wake of the Covid-19 crisis in India is presently not visible due to immediate preventive action taken as listed above. But there is a need to be prepared to tackle a possible rise in insolvencies once this hibernation is over. India has limited options for out-of-court insolvency resolution in the form of the RBI’s prudential framework for resolution of stressed assets and informal understanding between a debtor and creditor. It is the right time to act swiftly to fill this space by providing for a semi-formal or hybrid option which is a blend of informal procedures with sanctity and advantages of a formal process. The most popular form of such a semi-formal option is pre-pack under the umbrella of the IBC, which can help tide over the likely rise in insolvencies. The current crisis presents an opportunity to bring in a framework for such an option in insolvency law in India. We are fighting on two fronts today, one to ensure “sustainable” recovery from Covid-19 on the personal health front and the other to aim for “sustainable” restoration of livelihoods. Both are equally precious.
Anuradha Guru belongs to the Indian Economic Service and Neeti Shikha is head, Centre for Insolvency & Bankruptcy, Indian Institute of Corporate Affairs. Views expressed are personal.