The Reserve Bank of India ("RBI") vide Circular No.131 dated February 12, 2018 ("Circular") issued a generic framework and instructions to resolve the stressed assets in the economy. The Circular was issued by the RBI in exercise of its power under Section 35AA of the Banking Regulation Act, 1949 ("Act"), which section was inserted through the Banking Regulation (Amendment) Act, 2017 ("Amendment Act").
The Circular, inter alia, directed banks to resolve debts within specified time limit, failing which compulsory insolvency proceedings was to be initiated by the banks. It basically took away the bank's discretion to not to act on a bad loan, and therefore quickly became a ground of contention between the government, the majority owner of most of these banks, and the RBI.
Upon the Circular coming into effect, the validity of the Circular has been challenged on numerous grounds, and in multiple petitions, which have been brought before the Supreme Court. The Supreme Court, while hearing the contentions in these cases, have ordered to maintain the status quo for the Circular and had stayed the validity of Circular.
On April 2, 2019, the Supreme Court in its judgement in the case of Dharani Sugars And Chemicals Ltd. v/s Union of India & ors (Transfer Petition (Civil) No.1399 OF 2018) ("Case") finally answered the question of validity of the Circular ("Judgement").
Supreme Court judgement:
In the present Case before the Supreme Court, the validity of the Circular was challenged mainly on the basis of the following two contentions:
- Constitutional validity of the Amendment Act: The constitutional validity of the Amendment Act which provided the powers to the RBI to issue the impugned Circular was challenged on the grounds of being arbitrary and in the absence of any guidelines; and
- The Circular is ultra vires: The impugned Circular was challenged to be ultra vires to the Act as it was not in compliance with the provisions of Section 35AA of the Act.
The matter was heard by two bench judge Justice Rohinton Fali Nariman and Justice Vineet Saran and the above two contentions were addressed in the Judgement. While the Supreme Court upheld the constitutional validity of the Amendment Act, it declared the Circular to be ultra vires to the Act.
The Supreme Court stated in the Judgement that RBI can issue direction to the banks for initiating insolvency proceedings if the following two condition precedents of Section 35AA are met:
- When the central government has authorised RBI to do so; and
- When the directions are in respect of specific defaults.
Since there was no order or instruction to RBI from the Central Government to issue any directions under Section 35AA, the Circular issued by RBI was not in compliance with the conditionalities of Section 35AA, and was held ultra vires.
ARA LAW View
While we believe that the intent behind the Circular was a progressive one, and a forward step in streamlining the process of classifying bad debts and recovery of debts in a time-bound manner, at the same time, it also contained stringent provisions which added to the difficulties of the banks, and was without consideration of the sector specific difficulties.
Now that the Circular has been declared ultra vires, each bank may have their own restructuring framework for bad debts which may give due regards to the sector specific difficulties.
We'll be happy to assist you with any query or assistance in relation to the above.
For ready reference: Web-link to the Original Ordinance: BS_CircularIndexDisplay
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