As the COVID-19 pandemic worsens, we’ve shifted much of our focus at FAI to how we can use our expertise and networks to share resources, evidence, and analysis in response to the crisis.
Thinking about the devastating effects of the economic lockdown on vulnerable households, microbusinesses, and the lenders that serve them, one big question that comes to mind is: what have we learned from past financial crises and outbreaks, and how may those lessons serve us here?
This morning we spoke with Deborah Burand, Professor of Clinical Law and Co-Director of the Grunin Center for Law and Social Entrepreneurship at the NYU Law School. She has a wealth of knowledge on how to support MFIs and investors after an economic crisis.
She shared with us summaries of two papers that look back on 2009-10 when MFIs ran into trouble following the 2008 global financial crisis.
Today’s COVID-19 crisis is different and still unfolding, but the papers are a valuable reference for designing strategies and principles that could be adapted for today’s situation.
First is Charting the Course: Best Practices and Tools for Voluntary Debt Restructurings of Microfinance from IAMFI and Morgan Stanley.
The second, Deleveraging Microfinance: Principles for Managing Voluntary Debt Workouts of Microfinance Institutions, by Deborah Burand.
Read summaries that Deborah has provided below, and the full articles are available at the links provided.
IAMFI Microfinance Voluntary Debt Workout Principles
Preamble: The following principles have been developed to guide struggling debtor Microfinance Institutions (MFIs), their creditors and other stakeholders as these parties participate in voluntary debt workouts rather than turning to litigation or court-administered insolvency or bankruptcy proceedings for the enforcement of claims against debtor MFIs. These principles are meant to inform the entire workout process; accordingly, they are most effective when consulted as soon as a debtor MFI’s weaknesses appear to be threatening its overall creditworthiness or ongoing viability.
(The document offers annotations to each of the below to clarify the principles’ purpose and application. These annotations are NOT reproduced below).
1. Shared Goal of a Long-Term, Going Concern Solution
Voluntary debt workouts are aimed at preserving and maximizing the long-term, going-concern value of the debtor for the benefit of all involved parties. The voluntary workout for viable debtor MFIs should be structured such that all relevant parties have an incentive to cooperate towards a successful workout solution within a reasonable time horizon.
2. Creditor Coordination
Creditors should coordinate their actions at the outset of the proceedings. Timely and effective creditor coordination helps to ensure an efficient and viable debt workout. In some workouts where there are a significant number of creditors, this coordination may be achieved best through the creation of a committee composed of a small number of creditors (often those with particular expertise in managing informal workout negotiations) that will lead the negotiations and ensure the efficient progress of the voluntary workout proceedings.
3. Legal and Regulatory Regime Applicable to the Debtor MFI
Ideally, reliable local counsel should be engaged by both creditors and the debtor MFI at the point in time when financing is first provided to the debtor MFI in order to ensure that the applicable loan documentation is enforceable and that the financing being extended to the debtor MFI comports with all applicable legal and regulatory requirements. Similarly, the local laws and regulations in the home jurisdiction of the debtor MFI may affect a voluntary debt workout. Accordingly, reliable local counsel should be retained by both creditors and the debtor MFI to ensure that the agreed debt workout solution is enforceable in the jurisdiction where the debtor MFI operates.
4. Conflicts of Interest Disclosed
Each creditor or equity holder that participates in the voluntary workout process should disclose, at the outset of the proceedings, to the other creditors and equity holders the extent and nature of its relationship to the debtor MFI.
5. Standstill Period
All relevant creditors should be willing to cooperate in giving a reasonable period of relief (‘Standstill Period’) to a viable debtor MFI that is acting and negotiating in good faith. Creditors participating in the Standstill Period should agree to refrain during that time period from enforcing their claims against, or reducing their exposure to, the debtor MFI.
6. Debtor MFI’s Responsibilities During the Standstill Period
A debtor MFI that is benefiting from the Standstill Period should not take action that affects the prospective return of relevant creditors (either collectively or individually) as compared with their positions at the commencement of the Standstill Period. The debtor MFI also should provide and allow creditors and their advisors reasonable and timely access to all relevant information relating to its assets, liabilities, business and prospects, as well as inform creditors of any formal communications between the debtor MFI and its local supervisory authority.
7. An Achievable Restructuring Proposal
The voluntary workout should be based on an achievable restructuring proposal that addresses governance, operational and financial weaknesses of the debtor MFI, as well as the investment horizons and any relevant social objectives of the creditors participating in such workout.
8. Fair Burden Sharing among Stakeholders and Observance of Pari Passu Principle
Creditors should be willing to absorb a fair share of any losses that result from the debtor MFI’s difficulties; provided, however, that equity shareholders of the debtor MFI bear the ultimate risk of such MFI’s failure. Creditors cannot be expected to bail out shareholders or management of the debtor MFI. On the other hand, creditors that engage in a successful turnaround of a debtor MFI should receive a fair portion of the financial benefits of the turnaround. Creditors in identical or similar positions should receive identical or similar treatment during the voluntary debt workout.
9. Priority Status of Additional Debt Funding
If additional debt funding is provided, whether during the Standstill Period or under any restructuring proposal, the repayment of such additional funding, so far as practicable, should be accorded priority status as compared to other claims of indebtedness of the debtor MFI.
10. Debtor MFI’s Responsibility for Workout Costs
The debtor MFI should be responsible for the costs of the voluntary workout when creditors are enforcing their claims. To the extent such costs are under the control of creditors, however, these costs should be both clearly defined and minimized.
Deleveraging Microfinance: Principles for Managing Voluntary Debt Workouts of Microfinance Institutions
Abstract: The following are several principles for consideration that could guide future, voluntary debt workouts of microfinance institutions.
First Principle: Where possible, look to INSOL Principles to guide the structure by which the debt negotiation will be organized.
Second Principle: Adhere to a transparent process that includes all interested stakeholders.
Third Principle: Demand fair and good faith dealings by the debtor with its creditors, and among creditors.
Fourth Principle: Encourage speedy and simple solutions.
Fifth Principle: Favor "new" money over old such that creditors that provide new financing to the troubled borrower enjoy a priority over other creditors of the borrower.
Sixth Principle: In the absence of fraud or bad faith conduct by the borrower, favor long-term, going concern, out of court resolutions.
While these six principles may seem to state the obvious, the capacity of microfinance managers and other stakeholders to abide by these principles will be severely compromised if the microfinance sector as a whole does not now embark on a training and education process. The speed with which a microfinance institution can collapse makes it clear that a "learning by doing" approach to managing debt workouts is bound to be fraught with difficulties. Anticipating and preparing for the possibility of debt crises in the microfinance sector is more important than ever if we hope to avoid broader damage to the sector. Accordingly, perhaps the most important step for successfully managing a deleveraging of the microfinance sector is to develop an education agenda for all stakeholders in the microfinance sector-one that applies to microfinance institutions, creditors, investors, guarantors, donors, and government actors. That education agenda should aim at developing consensus around principles for managing voluntary debt workouts of microfinance institutions. Setting these expectations now, and securing consensus by all significant stakeholders to such principles, should help to minimize the adverse impact that any badly managed debt workouts will have on the microfinance sector as a whole.