Promoters of small and medium enterprises (SMEs) are the real entrepreneurs in India, because they put their personal assets on the line to build an enterprise that provides some value to society. Yet, when the chips are down, they end up making costly mistakes that often destroy their finances and their business. What are the various financial issues that a small or medium entrepreneur can expect to encounter in business and how can he give himself a fighting chance of survival and revival during bad times?
This is a situation that most entrepreneurs do not think about until it is too late. Advocate Manoj Harit, a multi-faceted personality who practises at the Bombay High Court and has specialised in helping businesses to deal with various recovery actions, offered some invaluable lessons to entrepreneurs at a unique seminar organised by Moneylife Foundation and Capital First on 30th March in Mumbai.
India has 49 million SMEs that employ 40% of our workforce and contribute 45% of our gross domestic product (GDP) and, yet, lenders use recovery laws with draconian efficiency against them, while large defaulters, like Vijay Mallya and Nirav Choksi, manage to flee the country. Advocate Harit says that the laws provide plenty of opportunity for entrepreneurs to successfully defend themselves without being dispossessed of their homes and other assets pledged with the bank. But it is up to the entrepreneurs to avoid traps that end up closing their legal options for a successful defence.
His first, and obvious, lesson was to tell entrepreneurs that every loan is sanctioned on the basis of the project report and an assessment of the projected ability of a business to generate revenue and profits and add value to society. So after the loan is sanctioned, there is no need for additional collateral like a personal guarantee or mortgage of home and other personal property. The fact that entrepreneurs are asked to pledge personal assets is only an additional security and not the basis of the bank loan. The Reserve Bank of India (RBI) acknowledges this too and its master circulars provide clear guidance on how to deal with SMEs when there is a downturn. But this works only when SMEs themselves avoid dangerous mis-steps. Here are some tips from advocate Harit on how to avoid becoming sick and dealing with a downturn.
Under-financing: The seeds of sickness are sown right at the beginning when an SME under-finances the project to get it going. Often, this is based on the expectation that he will be able to get expanded credit limits once the business is operational. Sometimes, bankers themselves misguide SMEs to get started with less than essential funding and it, eventually, destroys the business. So never under-finance your business; this is the first lesson for successful entrepreneurship, says advocate Harit.
Do Not Avoid Your Lender: Often, entrepreneurs fail to understand the first signs of sickness. When they are unable to repay their lenders, SMEs begin to avoid the banker instead of discussing the situation with them and working at a resolution. Many entrepreneurs also fail to understand the gravity of recovery proceedings and fail to respond in time.
The debt recovery tribunal (DRT) has a set procedure to handle recovery cases. Advocate Harit said, “When an account becomes non-performing, the lender issues notice under Section 13(2) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI) Act. It is unfortunate that many borrowers fear responding to the 13(2) notice or, sometimes, indulge in prolonged discussions with the bank to resolve the matter by way of a onetime settlement.”
Under the SARFAESI Act, the remedies provided to the borrower against the recovery measures invoked by the bank are within a clear timeframe; the bank is vested with unilateral powers under the statute to initiate action without the intervention of any court. Hence, “when the borrower is occupied in negotiations, the bank officer has his eye on the calendar all the time and catches him/her off-guard by promising to enhance credit limit if he pays certain dues. The fate of the borrower’s case depends on how swiftly he responds to every measure, else the bank will overpower him even before he is prepared for the contest,” says advocate Harit.
“Many borrowers fail to understand and respond to this notice and run to a lawyer only when recovery proceedings begin. Many are in such a sad financial condition at that time that they don’t even have funds to pay a lawyer. The entrepreneur’s failure to respond to the first notice also makes it difficult to defend him. And his lawyers end up pleading for time instead of arguing on merit to help the unit find its feet again.”
Measures under Section 13(4) include symbolic possession, physical possession, takeover of management, appointment of an agent or manager, sale, and transfer of the asset after sale. The borrower can file appeal after 45 days before the DRT, but it should be accompanied with a written application giving sufficient cause to condone the delay. However, when an appeal is beyond the first chance of 45 days, the borrower loses a huge opportunity to contest with all valid grounds right from the inception of the recovery action.
Do Not Fudge Your Accounts: An all too common problem, which kills the defence of SMEs, is the tendency to fudge books to paint a rosy picture. Advocate Harit says, this is usually done at the instance of chartered accountants, who inflate earnings and reduce costs to fit into the formula that makes it eligible for SMEs to borrow more. This eventually goes against them during recovery proceedings and prevents them from taking advantage of RBI’s circulars that protect them in bad times.
Avoid Borrowing from Private Lenders: Never borrow from private lenders to raise additional funds when in trouble and do not take personal loans to pump money in the business, because of mistaken notions about public appearances. This is a frequent mistake made by entrepreneurs that drags them further into debt.
Cut Costs, Keep the Business Going: When a business runs into trouble, many entrepreneurs are focused on getting the bank to extend more credit rather than on their business. That is the time to focus on the business. Cut all unnecessary costs and run a tight ship, advised advocate Harit. He said that many entrepreneurs stop paying employees and suppliers to pay the last rupee to a bank in the hope of raising more funds. If they desert the company, it eventually damages the business irrevocably, if the bank does not cough up additional funds.
RBI Circulars that Help SMEs: RBI is clear that banks must identify sickness at the incipient stage and must restructure the debt, or rehabilitate the unit with additional finance, or take measure to nurse it until it comes out of sickness (RBI Circular RPCD. No. PLNFS. BC. 88/ PS.72-91/92).
“There are master circulars and guidelines issued by regulators; but banks do not follow them. For example, a debt is considered a non-performing asset (NPA) if there is no repayment over a 90-day period; it also specifies how the 90-day period is to be calculated. But this is often ignored.” On 8 February 2018, RBI has extended the 90-day deadline to 180 days for MSMEs; but they are still being dubbed as NPAs after 90 days.
Advocate Harit mentioned three other important circulars issued by RBI that are relevant for MSMEs. 1) Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances dated 1 July 2015 (https://goo.gl/fJzfkA
), 2) Lending to Micro, Small & Medium Enterprises (MSME) Sector dated 1 July 2014 (https://goo.gl/NKN9eA
) and 3) Master Circular on Wilful Defaulters dated 1 July 2015 (https://goo.gl/eDf1Sf
“MSMEs are providing employment and generating revenues for everyone, including the government. Unfortunately, under-financing at each stage, besides unacceptable practices followed by banks, lead to failures of MSMEs,” advocate Harit concluded.