Mitigating the Effect of COVID-19 on MSMEs and Business Loans: Lawyers Advice
Medium, Small and Micro Enterprises (MSMEs) have contributed immensely to our economy and with investment at low levels, it has been giving the highest employment in the country giving a wide range of services and products.
Due to the lockdown, the MSMEs are one of the worst hit because of the sudden pause on all operations, thereby creating a state of alarm.
Regulations regarding Secured Lending in India: –
Secured lending is regulated in India. A number of institutions are authorized to participate in lending activities. These include:
• scheduled and non-scheduled commercial banks;
• non-banking finance companies (NBFCs);
• cooperative society banks;
• small finance banks;
• microfinance institutions; and
• money lenders.
These regulations involve lending agencies to uphold principles relating to capital competence, cash reserve ratio, sensible norms, credit ceiling, statutory liquidity ratio and know-your-customer guidelines – even if each of these standards would apply to each class of lending agency in a diverse manner. Each agency plays a unique role in terms of the kind of lending and borrowing.
Specific Legal Issues for the Prospective Borrower to Consider: –
A company instituted in India may borrow funds in agreement with the Companies Act 2013. A public limited company in India would need the endorsement of 75% of its shareholders if the projected borrowing, along with the amount already borrowed by the company, would surpass the cumulative of its paid-up share capital and free reserves. This would exclude momentary loans which can be repaid either on demand or within six months of the date of payment, such as interim, cash credit measures or bill discounting services obtained in the natural course of business. Relevant corporate permissions must be given along with legal filings.
Specific Legal Issues for the Prospective Lender to Consider?
Potential lenders should be registered with the RBI as a bank or NBFC. The RBI controls the banking sector by delivering various guidelines regulations, policies and notifications from time to time. However, some intercompany loans are acceptable without a company being registered as a bank or NBFC with the RBI.
The lender should undertake customer due diligence procedures on the assets given up as security to guarantee the security provider’s ownership over the same. A lender should confirm that the borrower or a third-party security provider and/or guarantor has the actual capability to use the financing documents and that these are legally enforceable as per their respective governing laws.
Laws Restricting Guarantees in India
The Companies Act 2013 limits the issuing of guarantees by companies to assure the loan availed by a company’s Director or any other individual with whom the company’s director is concerned. However, the law offers practical exceptions to this rule, under which a holding company might give a security or guarantee for a loan availed by a exclusively owned subsidiary or any other type of subsidiary availing the loan from a bank or finance institution, given that the loan is used by the exclusively owned subsidiary or any other type of subsidiary for its primary business dealings. The Companies Act also proposes restrictions on the number of guarantees that can be distributed.
It must be understood however, that with the coming of COVID-19, the willingness of parent or holding companies or even personal sponsors, to act as guarantors for a potential borrower or in this case, an MSME reduces significantly considering the repression like condition of the Indian economy. With the number of avenues available to generate income declining at a rapid rate, it will not be surprising to see MSMEs and other potential borrowers thinking twice about entering loan activities considering they do not have a guarantor to fall back on.
Steps Taken by the Concerned Authorities
The Reserve Bank of India has declared a proper list of COVID-19 business continuity measures and operations to be put into place by scheduled commercial banks, non-bank financial entities, payment banks etc. Financial institutions have been told to evaluate the effect of the pandemic on their asset quality, balance sheets, liquidity, etc. and present possible steps to mitigate risks.
The Central Bank has allowed a moratorium on term loans, relieved working capital financing and delayed interest payment on working capital facilities without an asset classification demotion. In terms of ad-hoc respite, a lot of public sector banks have announced emergency credit lines through which a maximum loan amount of up to Rs 200 crore or 10 percent of the current fund-based working capital parameters can be utilised by MSME borrowers.
The Small Industries Development Bank India has declared a concessional interest rate of 5 percent for loans taken up MSMEs under the SIDBI Assistance to Facilitate Emergency Response against COVID-19. These loans would be given within 48 hours, with no security and least amount of paperwork but this only extends to those MSMEs that are into delivering services and manufacturing products or operate in any relation to the COVID-19 fight for eligibility. The Central Government has also announced steps for allowing delayed GST payments until June 2020, without any application of penalties, interest or late fees.
RBI Guidelines of Loan Rescheduling
The Reserve Bank of India, vide Circular No. RBI/2019-20/186 dated 27.03.2020, broadcasted a regulatory relief package for the lending institutions and the borrowers. MSMEs as well as all other borrowers, can get the benefit of the package announced by the Reserved Bank of India.
Relief in relation to Tax Laws
The Finance Ministry has announced a number of steps relating to regulatory and statutory compliances in view of giving relief during the COVID-19 outbreak.
The Centre has introduced the Taxation and other Laws (Relaxation of Certain Provisions) Ordinance, 2020 on 31st March, 2020 which offers extra time for various time restrictions under the Taxation laws as well as the Central Excise Act, 1944, Income Tax Act, 1961, the Customs Act, 1962 etc. Additionally, a number of circulars and notifications were issued for the relaxation in compliances under the GST law.
Relief in relation to Insolvency and Banking Code, 2016
Due the outbreak of COVID-19, the Ministry of Corporate Affair, vide Notification S.O. 1205 (E) dated 24th March, 2020, boosted the “minimum default limit from INR One Crore up from INR One Lakh.
The said notification was issued after the statement made by the Hon’ble Finance Minister on 24th March 2020, wherein the Hon’ble Minister talked about the amendment as a measure for protecting the interests of MSMEs during the COVID-19 outbreak.
Therefore, the amendment has proved to be a supporting medium for MSMEs to save them from insolvency proceedings due to default in payment because of COVID-19 situation.
Important points to remember when drafting an ideal Legal Framework: –
A policy framework should be well-thought-out for the Indian MSME sector, a framework that is based on nurturing their flexibility to the dangers of this health emergency, not just addressing the short-term but also addressing the medium- and long-term problems – giving due consideration to both the supply and demand effects.
- Addressing Impact on Labourers
With almost 99 percent of MSME sector entities categorised as micro enterprises, it is fairly apparent that a huge percentage of the 11-crore people employed in this sector work in these immensely informal industries. The question of what could be done for workers employed in such units can be answered in the form of wage support. In India, the Centre is yet to declare a wage support or subsidy package to specifically designed to give incentive to employers to retain their employees during this global health crisis despite the fact that it has ordered employers in all commercial institutions to carry on paying wages, as per the stipulated date, without any deductions.
While structural problem of identifying these enterprises exists, a framework that considers wage support during these difficult times, will help counter the problems of MSMEs.
- Addressing Impact on Self-Employed
It must be noted that it is essential that self-employed MSME units be provided the safety cover required to survive this crisis. There may be space to reimburse self-employed businesses who are able to prove a decrease in gross revenue. The government can allow for such compensation on the condition that there is proof of reduced income, for instance, by way of a documented fall in projected revenues because of restricted movement of goods, cancelled orders and reduced labour workforce etc.
The policy framework should also make it necessary for businesses to chalk out cash flow predictions for how they will work if compensation were approved for a fixed time. The policy framework must also take into account self-employment separately since this includes small shopkeepers, hawkers, and those providing private services such as drivers, electricians, plumbers etc. who will surely not fall into the category of casual or regularly paid workers in other enterprises.
- Addressing Payments Related to Social Security
Problem of commercial electricity, water, and other utility bills could be scrutinized especially in a situation where lockdown is further extended. It will be very useful for units to be presented with deferment or be allowed to only pay property taxes, rent and other utilities partially in order to avert more costs and liquidity failures, since payment of salaries to workmen should be given a priority over these expenditures. Many countries like Singapore, China, and Belgium have allowed such interference for small businesses.
- Addressing Enhancement of Credit
Proper channels for gaining credit such as banks will have to perform a much bigger part in ensuring financing is available to this sector without any difficulty. MSME credit already makes up for a very small division of the overall outstanding bank credit with amount of credit given to this sector showing signs of decline long before this pandemic had hit India.
Structural changes to lending mechanisms for such a sector are much needed. The framework should be designed to expand the role played by fintech lenders. Considering the current economic conditions, digital platforms for finance lending will be much better prepared to give unsecured loan products considering the fact that most enterprises in the micro and small business arena have high risk profiles. Since such digital platforms will check future enterprise potential and use historical cash flows, it makes sense that they are permitted to be made a core part in the lending system for MSMEs.
Along with these long overdue steps, it is also important that a revival plan be chalked up for the facilitation of businesses wanting reopen activity, in a phased procedure, with the application of social distancing norms. Routine and uninformed checks can also be introduced to implement state guidelines. What is most important now is to study the idea of slowly resuming business mechanisms in areas with visibly low levels of infection, although essential and dynamic regulatory measures should be put in place.
Authored By: Adv. Anant Sharma & Parinay Gupta