Introduction:
To cope up with the new regime Of stressed assets, RBI issued a circular dated 12.02.2018 whereby it withdrew existing guidelines and schemes dealing with stressed assets and issued revised guidelines on the same subject in exercise of the powers conferred under sections 35A, 35AA (read with S.O. 1435 (E) dated May 5, 2017 issued by the Government of India) and 35AB of the Banking Regulation Act, 1949 (“Bankmg Regulation Act”) and section 45(L) Of the Reserve Bank of India Act, 1934 (“RBI Act”).
The intent of the circular was to primarily bring a structure to the burning issue of resolution of stressed assets keeping in mind several aspects of the Insolvency and Bankruptcy Code, 2016 (“Code”) and give certain directions which could act as an extension of the provisions of the Code.
Two peculiar aspects Of the circular are as follows:
(i)The circular provides an indicative list of signs of financial difficulty;
(ii)The circular repeals more than 2S existing circulars issued by the RBI from 2001 to 2017 and serves as one exhaustive circular which covers all aspects of the earlier circulars.
Under the circular, lenders were required to classify a loan account as stressed if there was even a day of default. They were required to mandatorily refer all accounts With an aggregate exposure of Rs. 2,000 crore and over to the National Company Law Tribunal (“NCLT”) or the bankruptcy court if defaults in the aforesaid accounts persisted for 180 days from 01.03.2018 or where the date of first default is after 01.03.2018 then 180 days calculated w.e.f. the date of first default Lenders were required to file an insolvency application under the Code within 15 days of completion of the 180 days deadline.
The circular made provisions for the methodology for identification and reporting of stressed assets and the implementation of the resolution plan The timeline for accounts with aggregate exposure of the lenders at Rs. 20 billion and above on or after 01.03.2018 is as follows:
(i) Where the borrower was already in default as on 1st March 2018, the lenders were required to make a reference under the Code in the event of failure to implement the RP within 180 days from 01.03.2018;
(ii) In cases where the date of first default was after 1st March 2018 , the lenders were required to make a reference under the Code in the event of failure to implement the RP against the borrower within 180 days from the date of such first default
Pertinently, the arrangement contemplated in the circular did not apply to borrowers in respect of which specific instructions have already been issued by RBI to the banks for reference under the Code. In such cases, the lenders must continue to act as per the earlier instructions issued by RBI
The circular was known to have negative repercussions on the infrastructure, power, iron and steel and textile sectors (among others) as most non-performing loans were in these sectors. Within that segment, the stressed assets of the power sector stood out.
Discussion by the Supreme Court:
The circular and the provisions of law under which the circular was issued were discussed at length in the judgment dated 2.04.2019 passed by the Supreme Court of India in the case of Dharani Sugars and Chemicals Ltd . Union of India (Writ Petition (Civil) No. 339 of 2018. Petitions were filed raising questions relating to:
(i) The Constitutional validity of sections 35AA and 35AB introduced by the Banking
Regulation (Amendment) Act, 2017.
(ii) The scope of power conferred on the RBI under section 35AA vis-a-vis the impugned circular.
(iii) The Constitutional validity of the circular dated 12.02.2018 issued by the RBI.
It was primarily submitted that extraneous reasons such as lack of availability of coal, gas, raw materials, policy decisions of governments played a key role in the functioning of companies and the repayment of their loans. These factors were independent of the efficiency in management of the affairs of these companies operating inter alia in the telecom, steel, infrastructure and sugar sectors and m view thereof the companies could not be classified as wilful defaulters.
It was argued on behalf of the Petitioners that:
It was argued on behalf of the Respondents that:
* The circular was only an attempt to tell the banks that in so far as large accounts of over Rs. 2000 crores were concerned, they would be given a reasonable time of six months to resolve the stress assets. If the same could not be done, the banks ought to initiate proceedings under the Code
* The circular was issued in public interest and in the interest of the national economy.
* The circular was issued under sections 21, 35A, 35AA and 35AB of the Banking Regulation Act and 45L of the RBI Act in so far as NBCs are concerned and was well within the scope of the powers conferred thereunder.
Outcome:
With reference to the constitutional validity of sections 35A.A and 35AB introduced by the Banking Regulation (Amendment) Act, 2017 the Supreme Court of India held that these provisions were not excessive or unconstitutional and that they were amendments which conferred regulatory powers upon the RBI to carry out its functions. The Court held observed that these provisions are essentially similar to provisions already contained in the Banking Regulation Act which confer power on the RBI inter alia for issuing necessary directions to banking companies in public interest, in the interest of banking policy and to prevent the affairs of any banking company from being conducted in a manner which is detrimental to the interest of the depositors. It was further observed that under section 35AA, the Central Government may authorise the RBI to issue directions to any banking company with regards to initiating the insolvency resolution process under the Code Therefore, without the authorization of the Central Government, no such directions can be issued by the RBI and the powers conferred were not unfettered.
With reference to the constitutional validity of the circular, the Supreme Court observed that the circular is ultra vires and has no effect in law. It has been categorically observed that section 35AA enables the Central Government to authorise the RBI to issue such directions in respect of a default (non-payment of a debt when it has become due and payable), which would mean a default of a particular debtor. Thus, directions issued generally in respect of debtors at large would be ultra vires section 35AA. The Supreme Court further observed that the power to be exercised under the authorization of the Central Government requires “due deliberation and care” and hence it refers to specific defaults. In the instant case, the Supreme Court observed that although the circular mentions section 45L of the RBI Act as one of its powers in so far as non-banking financial institutions are concerned, the provisions of section 45L had not been satisfied in issuing the impugned circular. Section 45L inter alia deals with the power of the RBI to call for information from financial institutions and give directions. The Court was of the view that the impugned circular did not indicate that the RBI has had regard to the conditions in which and the objects for which such institutions have been established, their statutory responsibilities, the effect of financial institutions on the financial markets. It was observed that the impugned circular applies to banking as well as non-banking financial companies and that it would be difficult to segregate the non-banking financial companies from the banking companies to make it applicable to them, even if it is held ultra vires in so far as the banking companies are concerned.
Analysis:
As a consequence of the circular being declared ultra vires, all cases in which borrowers have been proceeded against by financial creditors under section 7 of the Code specifically on account of the operation of the circular, will be declared as non-est. All other proceedings before the NCLT will continue unabated.
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