In 1918, the world had a more devastating pandemic than Covid-19 dubbed the Spanish flue. A pandemic can trigger a global recession, depending on where it hits. If the Spanish flue helped humanity to discover the germ theory of disease, nothing was done after this pandemic to provide a blue print on how to help businesses navigate through, and after a pandemic 100 years ago.
Covid-19 will surely help humanity discover what to do – not to wipe trillions off global GDP. The Spanish flue reduced global GDP by 5%, 3 trillion in current value if you consider the time value of money over time. A lot remains to be seen how much of GDP covid-19 will reduce.
If these measures to help businesses avoid insolvency work, they will be the blue print of what should be done to help businesses stay afloat in the wake of pandemics. This certainly will not be the last pandemic – more are coming.
In Uganda, however, I don’t see any steps being taken by way of emergency legislation to prevent ‘unnecessary’ insolvency proceedings. Businesses that are only temporarily facing a cash flow crisis do not need to have recourse to complicated restructuring or liquidation proceedings.
The 2008 financial crisis started because of too much debt. But even before this pandemic, by 2019, the problem had even become worse – with total debt exceeding four times the size of the global economy which is 100 trillion dollars higher than before 2008.
Globally, companies are more indebted than before the 2008 crisis and their profits are lower. Even most businessmen in Uganda also indicate they are also heavily indebted with too much leverage on their balance sheets.
According to the Uganda Registration Services Bureau (URSB), about 89 companies commenced the liquidation process between January 2018 and June 2019. But only 33 companies had completed the liquidation process by early October 2019.
In the wake of Covid-19, expect that figure to go up, because government is not doing enough to avert these insolvencies that will increase. Certainly, derivatives played a great role in spreading the contagion of toxic assets or mortgages of the American housing markets (subprime mortgages) that were securitized and hedged through Over the counter (OTC) derivative contracts.
Since most banks operating in Uganda are foreign, my only prayer is that in their off balance sheet transactions, they don’t have any exposure to these off-shore derivatives transactions. Covid-19 might provide the spark for these time-bomb derivatives to explode into massive defaults, after all, Billionaire Warren Buffet called derivatives “financial weapons of mass destruction.”
According to the Bank for International Settlements, in mid-june last year, all global OTC derivative contracts outstanding were still unimaginably large at $640 trillion, a massive sum in anyone’s book.
Deutsche Bank’s 2019 balance sheet gives us an excellent example of how they are accounted for in commercial banks. It conceals derivative exposure under the headings “Trading assets” and “Trading liabilities” on the balance sheet.
You have to go into the notes to discover that under trading assets, derivative financial instruments total €80.848 Bn and under trading liabilities, derivative financial instruments total €81.910 Bn – a difference of €1.062 Bn. This is relatively trivial for a bank with a balance sheet of €777 Bn.
Having said that, let me delve into the measures the government has undertaken to avert Covid-19 insolvencies.
Effective 1st April 2020, the country is under a total lock down, other than essential workers such as medical personnel, all the other persons are required to stay at home. It has now been two months of lock down. Both on the fiscal and monetary side, government has done the following:
On the Monetary Policy end, BOU issued a communication on 20th March 2020 titled: ‘Measures to mitigate the economic impact of COVID-19.” Government undertook to ensure financial institutions supervised by BOU continue to operate effectively;
- Ensure that contingency plans by financial institutions guarantee the safety of customers and staff;
- Intervene in the foreign exchange market to smoothen out excess volatility arising from the global financial markets;
- Put in a place a mechanism to minimize the likelihood of sound business going into insolvency due to lack of credit;
- Provide exceptional liquidity assistance for a period of up to one year to financial institutions supervised by BoU that may require it.
Additionally, BoU ordered to waive limitations on restructuring of credit facilities at financial institutions that may be at risk of going into distress due to the COVID-19 pandemic; Continue to engage Mobile Network Operators (MNOs) and commercial banks to further reduce fees on mobile money transactions and other digital payment charges in order to limit the use of cash and bank branch visits.
The Covid-19 Crisis has caused a very real economic slowdown and it is not premature to believe that a post-Covid-19 world is an economically uncertain world, with implications for the viability of pre-lockdown business. Therefore, these measures are inadequate to save businesses.
On the fiscal side, The Uganda Revenue Authority (URA) has put in place measures of a tax administration nature to support taxpayers in meeting their obligations during this unprecedented time. Effectively, the only thing that has been done is extension of time. But reading though the tax bills that were passed last month, taxes especially excise duty were increased and new income taxes were introduced.
Interestingly, these fiscal measures assume that the economic impact of covid-19 is temporary and won’t be with us for long. They will definitely be in for a shocker. Even more advanced economies estimate that the economic disruptions will go on for at least 2 years. The Bank of England last week estimated that the British economy will rebound after at least 2 years. Yet in Uganda, they are just increasing taxes. No sufficient stimulus packages have been put in place by government.
The COVID-19 pandemic has impacted firms by reducing demand for their products and services, disrupting the supply of inputs and tightening the provision of credit. On the corporate insolvency side, government should do much more.
Already in Uganda, Financial distress, or what our Insolvency Act under Section 3 calls inability to pay, is already being reported in numerous sectors, particularly tourism, transport, hospitality, retail and manufacturing. Many countries, including Australia, Germany, Spain, India, Singapore, the United Kingdom and the United States, have proposed or implemented several changes to their insolvency frameworks.
But in Uganda there is no public discourse on the insolvency legislation. Even Academics are largely silent. Even my former commercial law Professor D.J Bakibinga neglected the subject in his recent paper on the impact of the measures of covid-19 on businesses. Even though the current insolvency law can be a useful tool to help certain companies facing financial trouble due to the coronavirus, some insolvency and insolvency-related reforms are still needed.
As phase one, government should be increasing the barriers to creditor-initiated insolvency filings for a limited period. Parliament should also suspend creditors’ rights to file involuntary bankruptcy petitions against companies affected by the coronavirus.
Therefore, legislators should go beyond the response adopted by Australia and India, where creditors will still be allowed to force companies into bankruptcy albeit subject to a higher quantitative threshold. And if these rights are not suspended, at least parliament should adopt a very stringent approach to allow involuntary bankruptcy petitions initiated by creditors, as it has been suggested by Singapore.
It also goes without saying that rights of preferential creditors like URA and NSSF should be suspended in as a far as putting businesses in receivership to recoup their money. It’s not enough to just defer payments to URA because businesses aren’t just going to recover the instant the President re-opens the economy.
Due to URA’s usual aggressive tax collection, it’s very possible that just one month after the economy is re-opened, it can put businesses in receivership just to recoup monies that businesses owe it.
Government creditor’s rights or even all creditors’ rights to initiate insolvency proceedings for a limited time period should be suspended, while preserving the debtor’s right to voluntarily open proceedings.
Secondly, Courts should adopt a more permissive approach to rescue (or Debtor In Possession) financing, even if the authorization of rescue financing affects pre-existing rights from secured creditors or administrative expense claimants.
Now more than ever, government should promote the culture of debt restructuring. For long, insolvency practitioners have been “ talking the talk” of debt restructuring. But Covid-19 should give government the opportunity to “ walk this talk of restructuring.”
In the UK, one such option that businesses might benefit from is the UK Government’s impending legislation that introduces a moratorium on creditor winding-up petitions and enables businesses to create a ‘vehicle’ to implement a restructuring plan. Although the exact details of the legislation are not yet clear, the moratorium will temporarily suspend creditor winding up petitions and particularly bar creditors from introducing such petitions where the debtor’s inability to pay is due to Covid-19.
This is a welcome measure that can be adopted by Uganda, it potentially protects businesses from the threat of creditor action.
While these reforms may provide companies with a valuable breathing space, they do not solve the fundamental economic problems faced by companies affected by the coronavirus: the existence of losses (due to fixed costs and lack of revenues) and lack of cash-flows.
Therefore, in order to effectively respond to this Covid-19 pandemic, government should implement these insolvency and insolvency-related reforms in conjunction with a more comprehensive package of legal, financial and economic measures such as certain tax cuts and stimulus packages it’s reluctant to give.