Authored by CSL Chambers, New Delhi: Sumeet Lall (Partner), Sidhant Kapoor (Senior Associate), Nikhil Lal (Associate)
Over the years, a multitude of changes in the economy, has increased the need for trade credit and enhanced the scope for the credit insurance sector, manifold. Particularly, Micro, Small, Medium enterprises have started largely relying on this model for their working capital facility and secure their payments for the supplies made.
To give fillip to the growth of credit insurance market and bolster the credit insurance business in India, the guidelines on Trade Credit Insurance dated 10 March 2016 were published by the Insurance Regulatory and Development Authority of India (‘Guidelines’).
Traditionally, trade credit insurance protects suppliers against the risk of non-payment of goods or services by their buyers. These buyers may be situated in the same country or another country. The risk of non-payment could be a result of insolvency of the buyer or non-payment after an agreed number of months after due-date or non-payment following an event outside the control of the buyer or the seller.
The essence of a Trade Credit Insurance policy is that it is directly related to an underlying trade transaction, which is either the delivery of goods or of services. The correct fulfilment of this trade transaction and satisfaction of the contract terms is essential for credit cover to exist.
Unprecedented times - Covid-19
In the wake of the COVID-19 pandemic, the Government of India adopted several measures to help contain the spread of the disease. To that end, it announced a nationwide lockdown for 21 days with effect from 25 March 2020. This lockdown was subsequently extended on multiple occasions. On 30 May 2020, the Government issued an order directing phased reopening of activities prohibited by the initial lockdown. India is presently in the fourth phase of the gradual reopening of the economy.
Coming back to the initial period of the nationwide lockdown when several Government notifications and advisories were issued declaring the distribution of certain merchandise as essential services. Meaning thereby distribution related to such services would not be disrupted. This included the distribution of commodities such as coal, steel, etc. and there were no restrictions on their movement in all ports. Further, port related activities including the movement of vehicles and manpower, operations of Container Freight Station and warehouses and offices of Custom Houses Agents were also declared as essential services.
Notably, by virtue of the aforesaid Government notifications, most industries barring a few have re-commenced operations including agricultural and related activities, and all inter and intra movement of goods/ cargo is slowly witnessing progress to the pre-lockdown level.
Although, the phased unlocking of the economy could augur well for supply chains, yet the cascading effects of one of the most stringent lockdowns in the world witnessed India’s merchandise exports to slump by a record 34.6% in March 2020. While imports declined 28.7% as countries sealed their borders to combat the Covid-19 outbreak.
The spread of Covid-19 and the consequent lockdowns has without a doubt, disrupted supply chains. In turn, this may lead to a situation where buyers fail to pay their dues to manufactures or make delayed payments. Therefore, one could witness organisations operating, both at a large scale and small scale turning to their trade credit insurance policies.
At a time when the Covid-19 has wreaked havoc on businesses across the globe affecting practically every sector, the risk associated with recovering payments is imminent and catastrophic.
We thus proceed to examine the implications of Covid-19 on Trade Credit Insurance in India.
All trade credit insurance policies issued by Insurers in India except for the Export Credit Guarantee Corporation are issued on a "Whole turnover trade credit insurance policy" which means a trade credit insurance policy that covers all trade credit receivables of all buyers, pertaining to a seller. Given the ramifications of Covid-19 on buyers, it is now possible that Insurers will want to withdraw such whole turnover trade credit insurance policies.
Trade credit insurance claims that arise from Covid-19 induced situations may have an impact on the risk management guidelines of the insurer to assess the trade credit risk on the buyer, giving credit limits. The Guidelines do prescribe for trade credit insurers to review certain parameters such as buyer’s past turnover, yearly profitability trends, gross, operating and net margins etc.
Weakening consumer demand, delays in shipments, potential future bankruptcies and business closures are some significant factors which could lead to a surge in trade credit insurance claims. Since most trade credit insurance policies include a “waiting period” after an invoice is due before a policyholder can make a claim which is typically 180 days, it is anticipated that Insurers may see a wave of trade credit claims coming their way.
Considering the above, Insureds could seek to make claims for losses related to Covid-19 under trade credit policies, as the trigger for the policy is default or non-payment by the buyer after a stipulated period.
It will be interesting to see how Trade Credit Insurers respond to losses related to Covid-19. Insureds should act as prudent un-Insureds and should not continue to perform acts which could result in foreseeable losses.
Another important facet of the Guidelines is that, where the buyer resides outside India, the Guidelines authorize Insurers to offer political risk coverage which includes coverage for losses due to the order of any government placing restrictions on trade transfers. Claims coverage in each case would indeed involve, a careful scrutiny of the policy terms, conditions and exclusions.
Claims and Force Majeure
Policy holders must look at their underlying contract to anticipate whether the buyer can invoke a force majeure clause, if any. A force majeure clause may allocate risk between the contracting parties if performance becomes impossible or impracticable. It is further pertinent to note that force majeure clauses in Contracts may include orders of any government placing restrictions on trade.
The aforesaid inclusion may allow buyers to trigger the force majeure clause where the trade is for merchandise that does not fall in any exempted categories, allowing the buyer to safe guard its business interest by either circumventing their onus to make payment completely or in the alternative, to defer payment until the situation normalises.
Alternatively in cases where the contract is governed by Indian law and does not contain a force majeure clause, buyers may look to Section 56 of the Indian Contract Act, 1872 which pertains to the doctrine of frustration to make out a case whether purchase of the merchandise has become an impossibility.
Since the trade credit insurance policy is a conditional contract dependent upon the correct fulfilment of the trade transaction and satisfaction of the contract terms, underlying contracts where the force majeure clause is found to be correctly triggered may not be covered under the trade credit insurance policy.
Additionally, in case of a dispute between the seller and buyer regarding the force majeure mechanism under the underlying contract, a policyholder may not be covered for buyer's non-payment of a trade receivable until the dispute gets resolved.
The High Court of Bombay recently dismissed a petition filed by Indian Steel Importers seeking directions to restrain the encashment of letter of credit by the Steel Exporters. The Steel Importers sought to rely upon Section 56 of the Indian Contract Act, 1872, averring that in view of the Covid-19 pandemic and the lockdown, their contract was terminated as unenforceable on account of frustration, impossibility and impracticability. The Court observed that the Government notifications/ Advisories issued, declares the distribution of Steel as an essential service and therefore, the lockdown cannot come to the rescue of the Steel Importers so as to resile from their contractual obligations of making payments.
Therefore, in case, the trade of the concerned merchandise falls within the exempted category as notified by the Government from time to time, it may not be possible to seek recourse to the force majeure clause or the doctrine of frustration, as the trade, manufacture or transport of the concerned merchandise would not be affected by the lockdown.
On the other hand, the High Court of Delhi, passed an interim order against an Indian mining and natural resource company restraining it from invoking bank guarantees of its oil field service provider. Although the injunction was ad-interim in nature, which was subsequently vacated, the Court acknowledged that the same was granted due to the completely unpredictable nature of the lockdown, and its sudden imposition, which the petitioner could not legitimately be treated as having been aware of in advance. The Court prima facie opined that the countrywide lockdown was in the nature of force majeure. It is however, necessary to point out that the case pertained to the development of a project rather than the supply to commodity.
It is also possible that owing to the fluctuation in commodity prices, buyers who have entered into fixed price contracts may seek to abandon the purchase on account of the windfall losses and financial incapacity. In such cases, it will be imperative to examine the underlying contract along with the Trade Credit Insurance policy and fulfilment of its terms for seeking indemnification.
Importantly, Policyholders should strive to minimise all potential losses at this time. Credit Insurers could respond to legitimate claims made for a loss event insured under a policy from companies who are policy compliant. Further, a Policyholder shall be obliged under the Policy to notify adverse information about the Buyer to the Insurer.
The Guidelines prescribe that every trade credit insurance policy shall carry a subrogation condition and no waiver under any circumstances shall be allowed.
Currently, most High Courts and District Courts in India are functioning in a restrictive manner, taking up only matters of utmost urgency, with the docket of cases expanding gradually.
Therefore, once the courts are fully functional, equipped with the right of subrogation, insurers being placed in the shoes of the insured may consider moving the appropriate forums of initiate action against the wrong doers.
The most time and cost-efficient tool explored prior to the Covid-19 pandemic used be the provisions of the Insolvency and Bankruptcy Code 2016 (‘Code’). A Trade Credit Insurer as a subrogee could have invoked the mechanism under the Code since the receivables invariably met the test of a “Debt” as well as a “Default” under Code. However, as recent as 17 May 2020, the Hon’ble Finance Minister of India announced with the view to insulate Micro Small and Medium Enterprises, a slew of amendments to the framework of the Code. These include:
While one could argue that this is a set back for debt recovery for the trade credit insurer, however, one must revisit the object of the Code which is that it is not a tool of debt recovery but to ensure asset maximization of a distressed entity.
The Courts do not appear to be in favour of allowing buyers to trigger force majeure clauses on account of the limited nature of the lockdown and especially in cases the relevant industry finds mention in the exempted category which was/is allowed to function during the lockdown.
During the extended period of its lockdown and the present phased reopening, India has re-commenced key sectors of the economy, including commodities trading, agriculture, logistics and infrastructure. These measures may help restore disrupted supply chains.
However, many businesses are already seeking means to exit contracts due to insufficiency of funds or placing reliance on force majeure clauses or doctrine of frustration.
Considering the adverse effect nationwide lockdowns had on global supply chains, Insurers can expect to see a wave of claims being notified by policyholders in the coming months. Both Insureds and Insurers would be well advised to revisit their policy terms and conditions to deal with modalities regarding coverage of claims.