A weak resolution environment is negative to promote entrepreneurship

COVID 19 exposes the vulnerability of MSMEs in the face of uncertain events. This shows a need for a robust resolution mechanism to deal with creditors and find a viable path forward.

I met with a group of partners of a restaurant business who had been doing extremely good till the COVID 19 pandemic started.  The format was very unique in the industry and has the potential to be replicated elsewhere. In fact, the promoters had drawn an ambitious plan to expand the footprint through the franchisee route to take it is to different parts of the city as well as pan India. Pandemic and consequent sudden lockdown had made the calculations go haywire.

The business just slipped out of control. They could not salvage the business. The creditors and suppliers demand was too much to bear with. The bank loan which was well within the normal level till the lockdown suddenly became too much to digest as there was no income flow. The leased property, wherein they invested more than Rs 1 crore to create a unique theme, had to be demolished as the rent payment becomes burdensome. With the removal of the store from the place which was part of their brand, there was no chance to return to the normal business. The condition deteriorated to the level beyond their imagination in the wildest of dream and all happened in just a matter of a few months.

Now the partners are helplessly watching the unfolding of recovery actions from the multiple lenders who have extended business loan at a high rate of interest with a short maturity.

The absence of policy support to deal with uncertain times is the central issue

The pandemic was unanticipated rather an uncertain event. Equally the lockdown was sudden and there was no time to think of alternative options.  None of these was under their control.

Today we are in a situation wherein there is no regulatory or legal framework to enable entrepreneurs troubled by uncertain events to carve out a viable path to return to normalcy. The uncertain events affect all in equal measure. However, what is missing is a legal framework that will distribute the pain without letting anyone in the contract to be benefitted or remain unaffected whereas another the party will remain in an advantageous position at the previous level or better. For instances when the lender is a party to the contract, the borrower undergoing the uncertain event will remain indebted to the fullest extent because there is no statutory binding for the bank to sacrifice a fraction of the loan to make the business viable or allow to service the debt with a haircut and a longer schedule.

This unequal position in fact deteriorates the situation further as it will bring in too much uncertainty in the minds of entrepreneurs who will have to deal with the enlarged ego of the other party.  This will divert the focus away from resurrecting the troubled business and end in the destruction of the enterprise. Destruction of an economic enterprise brings agony to not only the entrepreneurs & his family but also but the larger society as it will also suffer loss in many ways.

This unequal position is not a stand-alone event affecting a few. It is visible very widely. The entrepreneur will have to answer the same question from many others such as suppliers, unsecured creditors, tax authorities etc. They in turn will have to face a similar situation with others. In all, it is a challenge for the whole society.

Thus there is a need for a standing mechanism to support those victims of uncertain events. The mechanism should be able to help them to withstand the immediate pressure on cash flow and stabilise the business. Once the business returns to normalcy they should be compelled to make the payment to obligors be it bank, creditors suppliers alike.

In the face of uncertainty, the most important support an entrepreneur require is to stand firmly against the wind flow and thus preventing the run on the business. This will create breathing space and allow the firm to review its business and find a viable path forward.

In the process, it may require the creditors have to make a sacrifice in the immediate future with or without a clawback option to recover the loss in the medium to long term depending upon the circumstances and viability.

Resolution support in India:

There were few attempts to create a window of opportunity for distressed firms to review and rework a path forward.  The very comprehensive support mechanism was enshrined in the 2015 circular of the Govt of India (Framework for Revival and Rehabilitation of MSMEs). It indeed addressed the concerns. Unfortunately, it suffered from the lack of enforceability of the guidelines. Rather it remained a wishful policy framework and its adoption is purely voluntary.

However, enactment of the Bankruptcy Code in 2016 had raised hope for many. Though Insolvency and Bankruptcy Code (IBC) has the power and scope for stressed business firms to seek relief as in many advanced countries,  it is not fully implemented covering all types of the constitution rather limited to LLC(Limited Liability Companies) and LLPs(Limited Liability Partnerships).  For the rest, though the law provides for, Govt has not notified yet.

It is time for Govt makes IBC law accessible to all forms of businesses uniformly. There were apprehensions that bankruptcy tribunals will be overwhelmed with litigations. It is not the correct position. Because having an option in the hand will facilitate dialogue among the creditors with the firms and will help to find a viable solution voluntarily. If you look at the history of litigations in Bankruptcy Tribunals(NCLTs), the voluntary understanding that arrived among the stakeholders forms a significant proportion of resolutions than otherwise.

MSME Prepack- A welcome step

There are discussions in various fora that the Govt will bring in a Prepackaged resolution solution under IBC to simplify the process and expedite the resolution for the benefit of MSMEs. The process under the pre-pack insolvency envisages formulation of a resolution plan before the initiation of a formal court process. It is a welcome step and it should be made available to all forms of the business including proprietorship firms and partnership firms along with LLCs and LLPs.

Resolution support de-risks the operating environment and hence promotes entrepreneurship:

A populous country like India needs to encourage entrepreneurship to create employment opportunity and improve the competitiveness of the economy. However the journey of entrepreneurship is filled with experiments, adventurism, and itself is a learning curve for many. It is unlikely to be smooth and cannot be predicted to proceed as planned.

Having a support mechanism for those who may suffer along the path of the entrepreneurship journey to revisit the journey will create a great enabling environment for many to take entrepreneurship. In the long run, the country will win.

Conclusion:

A law like IBC is much needed for businesses at this point in time than ever in the history of organized business because the uncertainty in the operating environment is at an elevated level. The entrepreneurs require a sense of assurance through the legal framework to seek a solution if the business proposition fails to yield the desired result. This way the resolution support can promote entrepreneurship.

Non-classifying stressed MSME Loan as NPA- It is not enough

Non-classifying stressed MSME Loan as  NPA-  It is not enough

Govt’s recent decision to direct banks not to classify stressed MSME loans as NPA is just a temporary relief and it is not enough to stabilize the segment reeling in distress.

Recently Union Finance Minister announced that banks will not classify stressed loans in MSME segment as NPA till March 31, 2020, thus restraining them from initiate recovery action anticipating that this will help the stressed entities to recover themselves.

Though her concern to assist MSMEs to come out of distress is appreciable, the measure in itself is not enough to stimulate the revival of the stressed entities.

MSME segment is reeling under massive slowdown beginning from 2018 due to steep decline in the demand for their products and services. Many of the MSMEs are part of the production and marketing value chain of the large companies in sectors like automobiles. The slowdown is witnessed in the sectors like the automobile has a cascading impact on the financial viability of many MSMEs countrywide.

The ongoing slowdown is unlikely to recede in the near future.  Though the experts are having divergent views on the course of likely time period the slowdown will persist, it appears that demand recovery will take a few more quarters to gain momentum and this is expected to cause disruptions to many MSMEs.

Secondly, the segment is also experiencing the negative impact of the structural changes happening in the many industries due to changes in the way the buyer-seller interact on account of technology-driven processes and solutions.

Thirdly the segment is still experiencing the challenges from the lingering impact of economic measures such as demonetization and other policy actions either industry-specific or broader economic.

MSME Segment requires more than the standstill from the recovery:

The promise of standstill in recovery action can be a good measure provided the economy is in recovery or growth mode. That would have created more breathing space for many temporarily stressed entities and would have helped them to set right their finances in the next two quarters. However, given the present circumstances of negative sentiment about the economy prevailing in the country, this measure is of no help either to banks or entrepreneurs.

What are the most feasible solution for reviving MSME segment?

There were few measures announced by the Govt in the last few years and more recently on January 1 2019. These measures coupled with few more amendments can become a strong anchor to promote the revival of MSMEs. We discuss them as below:

Enforce  rigorously the RBI guidelines issued on January 2019 to restructure  stressed entities:

RBI had issued guidelines to support the restructuring of stressed MSME loans on January 1, 2019, without classifying the restructured loans as NPA. The guideline incentivizes the banks by allowing them to not to treat such restructured accounts as NPA  The new guidelines will be available on up to March 2020.

Effective implementation of these provisions definitely of help to stressed MSMEs. They will get breathing space and can reset the growth strategy. However, the implementation so far is far from satisfactory.

Extend resolution support to revive the stressed entities to give rebirth to them that involves writeoff/waiver of a part of dues to banks:

Many of these MSMEs are victims of the inability to adjust to expected and unexpected changes in the external environment like Demonetisation and GST implementation.

These stressed MSMEs have the potential to turnaround and can contribute significantly to the national economy as well as local communities in terms of job and earnings. However, the accumulated debt burden during the last few years of distress makes them unviable to face the competition. The level of debt (from the bank and others put together) is beyond the sustainable level.

These units require broad-based resolution support. The resolution support must have enabling provision for reassessing the debt servicing capacity and identifying the level of sustainable debt.

Taking a cue from the performance of IBC (Insolvency & Bankruptcy Code), we feel that MSMEs may be extended support through write off/waiver of dues as a measure to revive the segment. The big loan accounts are resolved with substantial haircuts under IBC route. In some cases, it is more than 50%.  A similar provision for sacrifices needs to be extended the MSME to revive the potentially viable MSME units outside IBC purview. The lenders are aware that the market for the assets of stressed units is very poor. The recovery under the regulatory mechanism is unlikely to provide any substantial gain to the lenders. The contribution of revived MSME units to the economy is expected to be more than the amount of possible sacrifice made by the lenders.

MSMEs needs structured support to tide over financial support:

Many of the stressed MSMEs have the potential to turnaround. There are many regulatory and administrative guidelines from RBI and Govt to help these stressed MSMEs to overcome the challenge. However, these MSMEs require a very comprehensive framework that addresses their financial woes and helps to find a structured approach to cover the gamut of issues, something akin to Insolvency and Bankruptcy Code 2016 without the need to through the process of Insolvency.

“Framework for Revival and Rehabilitation of MSMEs” – A better alternative:

Govt of India & RBI had implemented the above framework in the year 2016 (RBI/2015-16/338 FIDD.MSME & NFS.BC.No.21/06.02.31/2015-16 Dated March 17, 2016). The framework addresses the financial issues holistically and is capable to assist stressed MSMEs to recover the lost ground.  The framework can help the stressed MSMEs to firmly anchor themselves to come out the challenges. The framework may be amended to make it versatile and become an anchorage to stressed MSMEs. Some of the amendment can be as below:

a)      Add the provision of waivers/write-offs:  If this framework is amended to discover the sustainable debt and thereafter setting a stage for resolution, this can be a quick and supportive avenue for stressed MSMEs to seek turnaround.  

b)      Extend a fresh round of finance especially working capital: Also these MSMEs are normally at the receiving end and unlikely to generate liquidity to support. Thus the working capital facility is paramount to make restructuring and turnaround support meaning full and constructive. To make it better it is desirable that the firms may be given another avenue of support in terms of extending an additional round of working capital finance to revive the business. Though the framework allows extending additional funding, it is not implemented and thus remains a bottleneck for revival.

c)       New debt may be supported by CGTMSE: There is always an element of hesitation to extend fresh support for stressed firms. This requires explicit policy support to extend additional finance that may involve CGTSME.

d)      Simplify its administration: Present guidelines seek to involve people from outside including  Govt dept in the process of approving restructuring. Involving others may delay the process and resolution of stressed debts require timely intervention. Further having comprehensive framework backed by regulation and laws itself can create a conducive environment for enabling the arrival of a mutually understanding solution. Hence the participation may be limited to engagement between lender and borrower and/or their advisors without inviting outsiders can improve the speed of the process.

e)      Allow the advisors to assist: Bank loan restructuring alone is not sufficient. The turnaround of stressed business requires more than delaying loan repayment.  The turnaround of stressed business requires support from experts from fiancé, legal, and /or the subject matter.  It is better to involve the experts to structure a resolution plan and enable speedy implementation.  

Conclusion:

Distress in MSMEs requires a more holistic approach to assist the stressed units to come out successfully.  Instructions for standstill will not help. The present guidelines need to be reviewed and amended to support a speedy revival of the potential units and bring the buoyancy in the segment. Framework for Revival and Rehabilitation of MSMEs impended by the Govt with few amendments can be a robust platform to achieve that goal.