India: Relief For Stressed Companies As Supreme Court Of India Declares RBI Circular Dated 12th February 2018 Ultra Vires

Last Updated: 29 May 2019
Article by Renjith Nair, Sonam Mhatre and Bankim Gangar

Introduction

The Hon'ble Supreme Court of India ("Supreme Court") has on 2nd April 2019 held in the matter of Dharani Sugars and Chemicals Ltd. v. Union of India & Ors.[1], that the Circular issued by the Reserve Bank of India ("RBI"), being "Resolution of Stressed Assets-revised Framework" dated 12th February 2018 ("Circular") bearing number RBI/2017-18/131, DBR.No.BP.BC.101/21.04.048/2017-18 is ultra vires to the provisions of the Banking Regulation Act, 1949 ("BR Act"). Consequently, all actions taken by lenders under the said Circular, including institution of applications under Section 7 of the Insolvency and Bankruptcy Code, 2016 ("IBC"), have been declared to be non-est.

RBI Circular dated 12th February 2018:

On 12th February 2018, RBI issued the Circular to all Scheduled Commercial Banks and All-India Financial Institutions providing a revised framework for resolution of stressed assets within the framework of Insolvency and Bankruptcy Code, 2016 ("IBC"). The said Circular effectively substituted the "Framework for Revitalising Distressed Assets in the Economy-Guidelines on Joint Lenders' Forum (JLF) and Corrective Action Plan (CAP)" dated 26th February 2014 ("2014 RBI Circular") and subsequent circulars/amendments in this regard. RBI relied upon the powers conferred upon it by Sections 35A, 35AA and 35AB of the BR Act and Section 45(L) of the Reserve Bank of India Act, 1934 ("RBI Act").

Challenges posed to the said Circular:

It was argued by the petitioners that the said Circular was arbitrary and discriminatory on the ground that a 180-day timeline was imposed by RBI without considering the issues faced by specific sectors of the economy and this, it was contended, amounted to treating unequals equally. Further, it was also averred that the landmark of Rs. 2000 Crores provided under the said Circular coupled with the fact that a lender whose stake is merely 1 per cent of the total outstanding can stall a resolution process outside IBC made the said Circular manifestly arbitrary and violative of Article 14 of the Constitution of India. It was also argued that the said Circular suffers from absence of guidelines.

Further, it was argued by the Petitioners that the said Circular was ultra vires the provisions of the BR Act and RBI Act. It was contended that Section 35A of BR Act, which was introduced by way of Amendment Act of 1956, could not have empowered RBI to relegate the companies to insolvency under IBC as IBC did not exist at the time. It was also submitted that a general circular applicable to all defaults of loans above Rs. 2,000 Crores, without considering the facts of individual cases, would be ultra vires and bad in law. It was argued that Sections 35AA and 35AB are manifestly arbitrary and violative of Article 14 of the Constitution of India and suffer from excessive delegation of power.

Findings of the Hon'ble Court:

The Hon'ble Apex Court held the Banking (Amendment) Ordinance, 2017 and Banking Regulation (Amendment) Act, 2017, whereby, Section 35AA and 35AB were inserted in the BR Act to be constitutional on the following grounds:

- The Hon'ble Court observed that provisions such as Section 21 and 35A of the BR Act afford regulatory powers to RBI for issuance of directions to banking companies which are similar in nature to that of Section 35AA and 35AB and therefore, the Hon'ble Court held that the said provisions cannot be said to be manifestly arbitrary.

- As for lack of guidelines by which the power given to RBI is to be exercised, the Hon'ble Court relied upon the judgment of Harishankar Bagla v. State of M.P.[2] to hold that the regulatory provisions embedded in the BR Act in addition to Statement of Objects and Reasons and the Preamble to the BR Act provide adequate guidance to RBI to exercise its powers under Section 35AA and 35AB. Thus, it was held that the ordinance and the amendment act are constitutionally valid.

However, the Hon'ble Apex Court held that the said Circular was ultra vires Section 35AA of the BR Act on the following grounds:

- It was observed by the Hon'ble Court that the authorisation from Central Government is a sine qua non for the RBI to issue directions under Section 35AA of the BR Act and this is in keeping with various other provisions of the BR Act such as Sections 36ACA, 36AE, 36AF, 45Y, 52, 53 and 55A. Thus, the sequitur that follows is that RBI may issue directions to a banking company to initiate resolution process under IBC within the boundaries of Section 35AA.

- The Hon'ble Court relied upon the Press Note dated 5th May 2017, wherein the purpose of inserting Sections 35AA and 35AB have been stated as "to resolve specific stressed assets by initiating insolvency resolution process where required" and "RBI has been empowered to issue other directions for resolution...". The Hon'ble Court held that the power to issue directions under Section 35AB is without prejudice to Section 35A. Thus, the power under Section 35AB read with Section 35A, is to be exercised separately from the power conferred by Section 35AA. The Hon'ble Court relied upon from the Statement of Objects and Reasons to find that Section 35AA is the sole provision which confers powers upon RBI to issue directions to initiate insolvency resolution process under IBC while Sections 35A and 35AB allow RBI to issue directions for resolution of stressed assets de hors the IBC.

- The Hon'ble Court observed that it is clear that Section 35AA enables the Central Government to authorise RBI to issue direction in respect of "a default". The explanation to Section 35AA clarifies that the term "default" has the same meaning as provided under Section 3(12) of IBC. Therefore, it was held that RBI may exercise the powers conferred under section 35AA in respect of a particular default of a particular debtor and not by issuing directions to banking companies generally, as with the said Circular.

Comments and Observations:

The Hon'ble Supreme Court, by holding the said Circular ultra vires, has put a wrench in the works for the lenders who have already acted upon the said Circular. Although the judgment passed by the Hon'ble Supreme Court has found the said Circular to be bad in the eyes of law, it does not enumerate the treatment to be accorded to the resolution plans effected pursuant to the said Circular.

It is also likely that the petitions referred to NCLT by the lenders on the basis of the said Circular will now be challenged by the promoters on the ground that the petitions have been referred to the Hon'ble Tribunal by virtue of the said Circular, which is ultra vires to the BR Act and RBI Act. One might also argue that without the said Circular, Corporate Debtors might have been able to resolve their defaults through the resolution mechanisms provided under the 2014 RBI Circular.

By pointing out the defects in the said Circular, the Hon'ble Apex Court has in fact charted a detailed roadmap for the RBI for issuing circulars which are intra vires to Sections 35A, 35AA and 35AB of the BR Act. Given the response of the Central Government[3] and RBI[4], it seems that new circular may be issued on similar lines within a short span of time.

In the meanwhile, it is unclear as to whether lenders would start applying the parameters provided in the RBI Circular dated 26th February 2014. Since the said Circular has been held ultra vires in its entirety, the substitution of exiting mechanisms aimed at resolution of stressed assets would also be set aside. However, one must also consider the fact that the said Circular was issued by RBI on account of the failure of the 2014 RBI Circular to resolve the stressed assets situation.

The ball is Now back in RBI's court to come up with a novel set of guidelines which encourage a robust credit culture while being in consonance with the provisions of the BR Act and the RBI Act.

[1] Transferred Case (Civil) No. 66 of 2018 in Transfer Petition (Civil) No. 1399 of 2018

[2] (1955) 1 SCR 380

[3] "Supreme Court's judgment on RBI Circular procedural, not a major crisis: Arun Jaitley" The Economic Times, 4th April 2019 available at : https://economictimes.indiatimes.com/news/economy/policy/supreme-courts-judgment-on-rbi-circular-procedural-not-a-major-crisis-arun-jaitley/articleshow/68714443.cms (last checked on 11th April 2019)

[4] "Rethink on stressed asset rule" The Telegraph, 5th April 2019 available at: https://www.telegraphindia.com/business/rethink-on-stressed-asset-rule/cid/1688161 (last checked on 11th April 2019)

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