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At One Fell Swoop: SC's Quashing of RBI’s Debt Resolution Circular

Counsel, Cornellia Chambers
Apr 21, 2019 8:09 AM 4 min read

Players across power, sugar, shipping, infrastructure and other sectors heaved a sigh of relief after a recent judgment of the Supreme Court of India (SC) was passed in the Dharani Sugars and Chemicals case, which struck down a circular dated February 12, 2018 (“Impugned Circular”), issued by the Reserve Bank of India (RBI). The Impugned Circular mandated banks and non-banking financial companies (NBFCs) to take defaulting companies to insolvency.


Back in Time


In the wake of the discovery of massive non-performing assets (NPAs) in the banking sector which had risen to about INR8 lakh crores, the RBI took several steps to contain and resolve the situation. These included schemes and mechanisms like corporate debt restructuring, strategic debt restructuring and a scheme for the sustainable structuring of stressed assets.


However, all of these objectively failed to have the desired effect. Consequently, the Parliament passed the Insolvency and Bankruptcy Code, 2016 (IBC) to devise clear and strict mechanisms to resolve the problem of stressed assets plaguing the Indian banking industry. The IBC envisages, inter alia, the resolution of insolvency matters within 180 days, plus an extension of 90 days, if required.  


Following the implementation of the IBC, an Internal Advisory Committee (IAC) was constituted to consider the stressed assets within the top 500 exposures of the banking system as on March 31, 2017. (This set of 500 accounts was arrived at as per the statement generated from the Central Repository on Information on Large Credits). Of the 500, it was noted that 71 accounts had been partly or wholly classified as NPAs while the other 429 were not classified as NPA by any bank.


At One Fell Swoop: SC's Quashing of RBI’s Debt Resolution Circular


The Dirty Dozen


On June 13, 2017, the RBI identified certain accounts for reference by banks under the IBC. Basis the criteria laid down, 12 accounts were referred for resolution under the IBC. These 12 were colloquially referred to as the “dirty dozen”, and included names such as Bhushan Steel, Electrosteels Steel, Essar Steel and Lanco Infratech.


After the dirty dozen, the IAC decided that out of the 59 remaining NPA accounts, those which were materially NPA (i.e. where 60% of the total outstanding had become NPA) may be given an additional time of about 4 months for resolution. If the banks were to fail to finalise and implement a viable resolution plan by then, they would be required to file applications for resolution under the IBC.


The Impugned Circular


On May 4, 2017, sections 35AA and 35AB were added to the Banking Regulation Act by the Banking Regulation (Amendment) Ordinance, 2017. A day after the introduction of these new sections, the Ministry of Finance issued a circular under Section 35AA permitting the RBI to issue such directions to any bank “which may be considered necessary to initiate insolvency resolution process in respect of a default”, under the provisions of the IBC. This gave the debtors little wiggle room to explain their situation to creditors.


Proceedings Before the SC


Certain power companies had first approached the Allahabad High Court to quash the February 12 Circular. However, the HC had denied the petition following which the petitioners including the Independent Power Producers’ Association of India, the Association of Power Producers, Essar Power, GMR Energy, and Rattan India Power moved a writ petition before the SC against this Circular. The SC had passed an order in September 2017 ordering status quo be maintained in relation to the implementation of the circular.


The SC noted that RBI could only rely on section 35AA to push companies into insolvency proceedings if the Central Government authorised it, and if it specified which businesses were to qualify for such insolvency proceedings. The RBI had patently failed to do so and consequently, the February 12 Circular was deemed unconstitutional. The SC also observed that the RBI’s “one size fits all” approach to address the NPA problem was detrimental to the Indian economy, and defaulters need to be treated on a case by case basis.


The petitioners before the SC threw light on some on the uncontrollable circumstances in their respective sectors, and pleaded that they were not “wilful defaulters”. For instance, some power companies blamed the unavailability of coal and inefficiency on the part of the State governments for their plants not working effectively and running into losses. The SC agreed with this contention of the petitioners and observed that individual solutions should be found for individual borrowers, given these exceptional circumstances.


The SC went on to add that its judgment was to only impact those insolvency cases which were specifically referred to under the Circular. This means that only those borrowers who were impacted after the Circular was implemented are free from insolvency proceedings. The borrowers under insolvency proceedings before the implementation of the Circular would not be impacted by this.   


Fallout of SC’s Decision


There are mixed voices in the market on the SC’s decision. Some industrialists and manufacturers are pleased with the line of reasoning taken by the SC. Others, mostly in the financial sector, think that this decision undermines the position of the RBI to resolve such cases. The only point everyone seems to agree on is that the issue of bad loans needs a nuanced and careful approach by the RBI. Even now, the RBI may file a review petition before the SC against the judgment and ask the Court to have a re-look in the matter. Regardless of how that may pan out, there is an increased dialogue and awareness on bankruptcy and accountability of bank loans, which is a rather good sign in itself.   


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