Covid 19 Outbreak And Its Impact On Debt Financing In India

With the pandemic outbreak of COVID-19, the governments of various countries and jurisdictions, including India have taken emergency measures and imposed curfews and lockdowns of all social, commercial and industrial activities. The Indian business and economy are not oblivion to widespread impact of such lock downs and curfews, which has triggered concerns over performance of prevailing and ongoing contractual obligations to be fulfilled by the parties under various commercial arrangements.

The transactions involving debt financing will be no exception to such non-performance of obligations by the borrower entities for servicing the debt obligations under their debt/loan arrangements with lenders. The article analysis various measures undertaken by the government and possible disputes/issues that may arise in relation to debt financing transactions as a result of COVID-19 outbreak in India.

2. Developments in India

The National Disaster Management Authority, under the provisions of Disaster management Act, 2005 ("DM Act"), vide its Order dated March 24, 2020^[1] ordered for a 21 day lockdown within India. Thereafter, the Reserve Bank of India, to mitigate the burden of debt servicing, has issued a notification RBI/2019-20/186^[2] on March 27, 2020 ("Notification") permitted lending institutions, including commercial banks, co-operative banks, all-India Financial Institutions, and NBFCs (including housing finance companies), to allow a moratorium of 3 months on the payment of instalments (which includes principal and/or interest components and bullet repayments) in respect of all term loans (the payment of which was due between March 1, 2020 and May 31, 2020). The intention of the RBI seems to be to shift the repayment dates for payment of instalments by 3 months, i.e., the moratorium should start from the due date, falling immediately after March 1, 2020, against which the payment has not been made by the concerned borrower. Accordingly, under the Notification, the repayment schedule, subsequent due dates as well as the tenor for the loans may be shifted across the board by three months by lending institutions. However, as per the Notification, it is to be noted that the moratorium is a 'payment holiday' and the interest shall continue to accrue on the outstanding portion of the term loans during the moratorium period, which will be payable after the moratorium period as per the revised terms of repayment schedule.

Many banks were offering the option to defer the payment of loan interest and principal only to borrowers who specifically asked for it. However, the RBI provided instructions to the banks, that the moratorium period of 3 months should be given to all unless a borrower informs the bank or NBFC that it is not willing to opt for the moratorium^[3].

In the matter of Anant Raj Limited vs. Yes Bank Limited^[4], the Delhi High Court, while dealing with a petition filed by a borrower, whose instalments, payable on January 01, 2020, were not paid till March 31, 2020, and accordingly its account was classified as 'Non Performing Asset' by the respondent/bank, interpreted the provisions of Notification and held that the account of the petitioner/borrower could not have been declared as a 'Non Performing Asset' in case the instalment is not paid during the moratorium period i.e. between March 1, 2020 and May 31, 2020 and that for the said period of 3 months, there will be a moratorium from payment of instalment. However, stipulated interest and penal charges shall continue to accrue on the outstanding payment even during the moratorium period.

3. Invoking 'Force Majeure' – the defence for non-fulfilment of obligations under lending transactions

There is a probability that the borrowers may assert that COVID-19 outbreak is a force majeure ("FM") event, and invoke the FM clause under the lending documents (where such clause is in built in such lending documents) or invoke the provisions of the Indian Contract Act, 1872^[5] ("Contract Act") (where there is no provision of FM under the lending documents) to defer or terminate, depending upon the nature and effect of COVID-19 outbreak on its ability to prevent the performance of obligations under the debt financing documents, its obligations to pay the interest and principal loan/debt amount to the lender.

Being a commercial arrangement between the lender and the borrower, the obligations of the parties under debt financing transactions in India are largely regulated by the commercial arrangement entered into by them, which could be in the form of a loan agreement, a debenture subscription agreement/debenture trust deed or an inter corporate deposit along with security documents ("Financing Documents").

3.1 Where there are FM clauses in Financing Documents

Most Financing Documents do not contain any specific FM clause. As the primary obligation of the borrower is to repay the principal along with the interest or redemption premium, the lenders do not incorporate any FM provisions in the Financing Documents and ensure water tight provisions for ensuring the fulfilment of obligations by the borrower. Where there are provisions relating to an FM event, any occurrence of such event would be governed by such FM clauses read with Section 32 of the Contract Act. Under Section 32 of the Contract Act, performance of certain obligations are contingent on occurrence of certain events. If such an event becomes impossible, such contracts become void.

Financing Documents may set out an exhaustive list of events/circumstances including "epidemic/pandemic", man-made interventions like wars, blockades, strikes, act of terrorism and Acts of God, while in some contracts FM events are an inclusive list that provides for events or circumstances for illustration only. In contracts where "epidemic/pandemic" is not specifically included as a Force Majeure event, aid can be sought from other terms of the clause such as "act of god" or "natural calamity". Thus, in cases where the Financing Documents have FM provisions, whether COVID -19 would qualify as an FM event would demand upon the way the FM clause is structured.

3.2 Where there are no FM clauses in Financing Documents

In a scenario where the Financing Documents are not having FM clauses, in order to invoke a FM situation, the borrower will have to invoke Section 56 of the Contract Act. In order to make a Financing Document void under Section 56, it will have to prove that the contract becomes impossible to perform. Section 56 of the Contract Act, contemplates a situation where a contract to do an act, which after the contract is made, becomes impossible, by reason of an event which the promisor could not prevent, such contract becomes void. Section 56 of the Contract Act promulgates the doctrine of frustration or impossibility of the contract, i.e. the contract becomes void on account of being frustrated or impossible to perform the obligations which are beyond the control of the promisor.

In the landmark decision of Satyabrata Ghose vs Mugneeram Bangur & Co.^[6], the Supreme Court held that the word "impossible" has not been used in the Section 56 of the Indian Contract Act, 1872 in the sense of physical or literal impossibility. The performance of an act may be impracticable and useless from the point of view of the object and purpose which the parties had in view and if an untoward event or change of circumstances totally upset the very foundation upon which the parties rested their bargain, it can very well be said that the promisor found it impossible to do the act which he promised to do. Thus any remedy that the borrower seeks under Section 56 of the Contract Act, would be available, where the performance of its obligations under the Financing Documents becomes impossible to perform.

4. Invoking Force Majeure – Contention of the borrower and lender

Borrower's contention - It will be a contention of borrower that as a result of COVID-19 pandemic outbreak,

• it has become impossible for the borrower to perform its obligations, since its business of construction/supply of goods and services and/or sales (particularly in case of special purpose vehicles incorporated for a particular purpose) will be jeopardized as a result of the lockdown and curfew;

• there is a disruption of sales and supply chain which forms quintessential for running of business of the borrower;

• the economy in general has been hit and that the market is down, which has largely effected the business of the borrower,

and all of which has rendered its fulfilment of obligations under the Financing Documents impossible to be performed.

Lender's case - On the contrary, the lender will contend that:

• COVID-19 pandemic outbreak is not an event making the obligations of the borrower impossible to be performed to call for a situation under Section 56 of the Contract Act (as most lending documents do not have an FM clause);

• The terms of the Financing Documents are typically so structured that it is the obligation of the borrower to honour and service the debt and interest without any link to success of business or economic slowdown;

• It is the affirmative and primary obligation of the borrower to service and honour the debt and interest, without any resort to sales of a particular project/supply of goods or services and the promoters of the borrower are typically obligated to honour the debt from their own resources in the event the principal borrower fails to do so. In such a case the lender may invoke default provisions under the Financing Documents and take necessary actions namely enforcing of security, claim interest/default interest for the delayed payments, across Financing Documents.

On all footings, the case of lender will stand on a higher pedestal as against the borrower as the requirement to pay the debt emanates from a commercial arrangement and the borrower has to honour the debt as per the repayment schedule. However, to assess whether COVID-19 outbreak or a lockdown situation (as a result of such outbreak) triggers frustration or impossibility of the performance of obligations of the borrower under Financing Documents, will have to be tested on the touchstone of nature of the pandemic outbreak, its duration, its effect on the specific sector and other case to case factors that may be relevant.

So far as the non-fulfilment of any technical obligation or covenant is concerned as a result of COVID-19 outbreak is concerned, it will have to again evaluated on whether the obligation at that point of time was impossible to perform. The possibility of technical defaults or sales/supply milestones not being fulfilled by the borrower during the lockdown and as a result of various actions taken by the Government under various acts, like DM Act, Epidemic Act, etc., in relation to COVID-19 pandemic outbreak, if landing in dispute might give an upper hand to the borrower, as on those specific instances, the specific covenants became impossible to be performed. However any payment related default would be difficult to justify as the obligation to honour and service the debt is not linked to any contingency or an FM event.

Looking things from a commercial perspective, it will be extremely unlikely that the borrower will opt for frustration of the Financing Document because upon frustration of the contract, the said Financing Document will become void. In such a scenario, the borrower will be required to make the payment of the unpaid principal amount to the lender from the date on which the Financing Document becomes void. The borrower in the first place might not be ready to immediately repay the outstanding principal amount. Any delay in making such payments may give the lender to claim the principal amount along with the interest at the prevailing RBI/SBI rate (as the interest under the Financing Document would not be applicable for delay as the Financing Document becomes void).

The most common outcomes/impact of the COVID-19 pandemic on the borrower/investee company could be:

• making a payment default under the terms of the Financing Documents. This would be the result of the near drying up of all sales of inventory/supply of services and the borrower facing a severe cash flow crunch. In the absence of an FM clause in the document, the only available legal remedy for the parties would be to approach the courts and invoke Section 56 of the Indian Contracts Act, 1872. However it is to be borne in mind that in the event the parties manage to prove before the courts that COVID-19 pandemic would make the performance of the contract impossible, the remedy under Section 56 is that the agreement shall be declared as void. This is an outcome that none of the parties to the agreement may find desirable.

A simpler and safer option for the parties would be to renegotiate the repayment schedule/redemption schedule and defer scheduled payments in a manner mutually acceptable to them.

• Many loan agreements include an event of default where the lender believes that there has been a 'material adverse change' (MAC) in circumstances, or that a change in circumstances has caused, or is reasonably likely to cause, a 'material adverse effect' (MAE). The concept of MAE/MAC under debt financing agreements are generally linked to the representations and warranties and covenants of the borrower and the obligors.

Any such provisions will have to be considered carefully on a case by case basis. However, they often refer to events or circumstances that, in the lender's opinion, could affect the 'business, operations, property, condition or prospects of the borrower' or 'the ability of the borrower to perform its obligations.' Accordingly, the pandemic by itself should not cause a MAC/MAE breach, but the impact of the pandemic on the borrower and its operations could be a MAC/MAE. The way these provisions are drafted will be important for interpretation in this regard. For example, reference to a MAC/MAE occurring in 'the lender's sole opinion (or words to that effect) will make it easier for the lender to invoke the provision than if it had referred to 'the lender's reasonable opinion', where there is more room for the parties to argue whether or not a MAC/MAE has occurred.

• Undertakings by the borrower to provide information to the lender should be checked. In addition to the provision of ongoing information relating to the borrower's financial condition, there may be obligations to keep the lender informed of other matters, such as an occurrence of FM, potential breaches under its material contracts and any 'key persons' within management ceasing to perform their duties due to ill health. If a borrower does not comply with its information undertakings, it is likely to trigger an event of default under the loan agreement.

Therefore, a notice to the lender, intimating the occurrence of any such event that serves impediment on the borrower to fulfil its obligations under the Financing Documents should be a safe move by the borrower.

5. Remedies available to the Lender and Borrower

5.1 Considerations to be borne in mind and remedies:

The following could be the practical considerations to be borne in mind while assessing the situation, where a borrower calls for a refrain from servicing principal amount and interest on account of COVID-19 outbreak:

• Assessment of impact of COVID-19 pandemic and whether the same qualifies as an FM event;

• Whether the contract contains an FM clause or not. If yes what are the remedies which are contractually provided under the same and whether the definition is wide enough to cover the COVID-19 pandemic;

• Whether the invocation of the FM clause could or should lead to the termination of the Agreement or renegotiations of the terms of the same. A practical solution would be, depending on the nature, duration, geographical effect, etc. of lockdown, curfew, actions under the DM Act and/or Epidemic Act in relation to the COVID-19 pandemic outbreak, to re-negotiate the terms of the Financing Documents and execute addendums to revise the payment schedule;

• The lender may suspend the payment of principal amount and interest during the moratorium and re-schedule the repayment schedule. However, the interest on the outstanding amounts to accrue and be payable on expiry of lockdown or any such action taken by the Government of India or of States;

• Also, relying on Notification, the lending institutions should shift the repayment schedule, subsequent due dates as well as the tenor for the loans by three months.