Constitutionality of the Amended Definition of “Non-Performing Asset” Upheld

[The following post is contributed by Prachi Narayan of Vinod Kothari &
Company. She can be contacted at [email protected].]
The Supreme Court in its judgment dated January 28, 2015 in Keshavlal
Khemchand & Sons Pvt Ltd & Ors v. Union of India
disposed off
seventy petitions challenging the validity of the amended definition of Non
Performing Asset (“NPA”) provided under section 2(1)(o) of the Securitization
and Reconstruction of Financial Assets and Enforcement of Security Interest
Act, 2002  (the “Act”). 
The Case
The core issue on appeal to the Supreme Court was whether the
definition of NPA as amended by Act 30 of 2004 is constitutionally valid and is
not violative of Article 14 of the Constitution.
The constitutionality of the amended definition was the subject matter of
challenge before the High Court of Gujarat (“Gujarat HC”) as well as before the
Madras High Court (“Madras HC”). It further involved the question whether the
power of prescribing guidelines endowed upon the Reserve bank of India (“RBI”)
from time to time, with respect to classification of NPA would tantamount to
excessive delegation.
Parliament by amending the
definition of NPA made it possible for different sets of guidelines made by
different regulators to be followed by creditors depending upon the
administering or regulating authority of such creditor. The question thus for
consideration before the court was whether such delegation of legislation
amounts to excessive deletion by the legislature.
The Supreme Court while taking into consideration the ratios
of both the High Courts held that
laying down of norms regarding classification of an account as NPA is not
essentially a legislative function as it requires expertise in public finance
and banking and may require periodic revision and a constant monitoring of
financial system.
With regard
to the question involving excessive delegation with respect to definition of
NPA the court held that “if the
Parliament chose to define a particular expression by providing that the
expression shall have the same meaning as is assigned to such an expression by
a body which is an expert in the field covered by the statute and more familiar
with the subject matter of the legislation, the same does not amount to any
delegation of the legislative powers. Therefore, the submission that the
amendment of the definition of the expression ‘nonperforming asset’ under
Section 2(1) (o) is bad on account of excessive delegation of essential
legislative function, in our view, is untenable and is required to be
Author’s Analysis
The judgment
aims to redress certain basic and important questions: (a) whether the amended
definition of NPA is violative of Article 14 of Constitution; (b) whether the
power to define or prescribe norms with regard to NPA from time to time amounts
to excessive delegation by legislature; and (c) if the answers to the above are
in affirmative, is it possible to have a universal definition of NPA applicable
to all cases?
Article 14 of
the Constitution ensures equality before law. It states that:
State shall not deny to any person equality
before the law
or the equal
protection of the laws
within the territory of India”
The article deals with two aspects: (a) equality
before law; and (b) equal protection of laws. What Article 14 aims to achieve
is that every person, in similar circumstances shall be treated alike. The
article empowers the State to recognize a certain class and accordingly have
separate set of legislation for them. Of course, this may come across as
inequality to other classes; however, law recognizes that based on the needs
and demands of society a classification based on “intelligible differentia”, which is not arbitrary or evasive may be
Further, the definition on NPA underwent an amendment
subsequent to the decision of Apex Court in Mardia
wherein the constitutionality of the Act was upheld. Accordingly,
the basis of challenge in the instant case was that according to certain
parties the amended definition tried to create two classes of NPA, which
according to such parties was arbitrary and evasive in light of equal
protection of laws.
Moving to
the question of excessive delegation, Black’s Law Dictionary
defines ‘delegation’ as ‘the act of entrusting another with authority
or empowering another to act as an agent or representative
’. The Dictionary
further defines ‘Doctrine of Delegation’ as “the principle (based on
the Separation of Powers Concept) limiting Legislature’s ability to transfer
its legislative power to another Governmental Branch, especially the Executive
In case of Ajoy Kumar Banerjee & Ors vs
Union Of India & Ors
the Apex Court held that:
The principle which has been
well-established is that legislature must lay down the guidelines, the principles
of policy for the authority to whom power to make subordinate legislation is
entrusted. The legitimacy of delegated legislation depends upon its being used
as ancillary which the legislature considers to be necessary for the purpose of
exercising its legislature power effectively and completely
. The legislature must retain in its own hand the essential legislative
function which consists in declaring the legislative policy and lay down the
standard which is to be enacted into a rule of law, and what can be delegated
is the task of subordinate legislation which by very nature is ancillary to the
statute which delegates the power to make it effective provided the legislative
policy is enunciated with sufficient clearness a standard laid down.
in light of the above, it can be safely assumed that delegation of legislative
powers is permissible only when legislature has adequately laid down the
framework of law. The delegate only has the power to make such a policy laid
down by legislature effective and enforceable. The legislature lays down the
broad tenets of law and confers the power of rule making on the Government or
upon such bodies and agencies of its choice. Applying similar rationale here,
the legislature passed the broad framework of the Act covering general
principles relating securitization, assets reconstruction and enforcement of
security interests and conferred the power to define and prescribe guidelines
for classification of NPA on RBI.
becomes excessive, when the essential legislative functions are delegated to
executives. The term “essential legislative function” would mean determination
or choosing of the legislative policy and thereby enacting that policy into a
binding rule of conduct. It is open to the legislature to formulate the policy
as broadly as and with as little or as much details as it thinks proper. The
legislature may then choose to delegate the rest of the legislative work to a
subordinate authority who will work out the details and fill in the gaps within
the framework of that policy.
The very
intent to empower RBI to prescribe guidelines on classification of NPA was that
the concept of NPA itself is dynamic – it changes with the changes in the
financial regime and thus requires continuous monitoring and updating. Providing
a static definition from the very time when the enactment came into force would
have created a lot of confusion and disparity with regard to the classification
norms being changed every time. And more so, legislative amendments as evident
is a time consuming process as compared to the functions performed by the
executive or specialised bodies.
The Act further empowers
the secured creditor to be the sole authority to adjudge the amount due and
outstanding from a borrower. However, such a grant of power to the secured
creditor to evaluate the outstanding amount is not unfettered and comes with
proper checks and balances in the Act by way of obligations cast under section
13 and the right to appeal under section 17 of the Act. It is apt to mention
herein that ascertainment of outstanding amount by the creditor does not grant
the creditor the right to initiate proceedings against the borrower but the
creditor has to also undertake the obligation to classify such an account of
the borrower as NPA in line with the directions of RBI. The intent behind
casting an additional obligation on the creditor to classify accounts as NPA is
the very fact that this classification subsumes utmost importance in the
process of recovery and is further important for the decision making process of
the creditor. This is further important to protect larger interests of society
or those associated with the secured property. Had such fetter not been there
and a direct possession was envisaged, this would have been detrimental to
interests of other people associated with secured property. Further, this is
also important from the secured creditors point of view wherein these balances
force the creditor to reassess whether the default in repayment by the borrower
is due to any factor, which is a temporary phenomenon, and that the same could
be managed by the borrower if some room is given.
This is also
corroborated by the fact that even before the enforcement of the Act, creditors
were classifying accounts as NPA in line with directions of RBI. Further, the
classification of NPA is not direct or one- the guidelines provide for a
4-stage classification depending upon the length of time for which they remain
non-performing and the type of institution classifying the same, before an
action under 13(4) is resorted.
Thus, the very nature and
character of classification of NPA differs from one secured creditor to the
other. For example, asset reconstruction companies have different guidelines to
follow for classifying account as NPA while banks and financial institutions
have different. Therefore, to make an attempt to codify a universal definition
for NPA applicable to all cases would not only be an impracticable task but
could also paralyze the entire recovery system thereby producing results which
are counter productive to the object and the purpose sought to be achieved by
the Act.
The Act was
brought into the Indian legal regime keeping in mind the financial health of
the country and to speed up the sluggish recovery process, which to larger
extent also suffered the brunt of inefficient legal machinery. Before an action
is initiated by the secured creditor, a secured creditor is under an obligation
to evaluate and assess a borrower as defaulting borrower on several factors as
the magnitude of the amount due and outstanding in a given case, the reasons
which prompted the borrower to default in the repayment schedule, the nature of
the business carried on by the defaulting borrower, the overall prospects of
the defaulter’s business, national and international market conditions relevant
to the business of a defaulter. So the spirit of law herein is that before an
action is finally taken, a good measure of logical and rational consideration
and reconsideration are to be undertaken by the secured creditor.
However, what
seems prevalent in practice is something very opposite to what the intent of
law is in paper.The initial steps of issue of demand notices and the replies to
the representations of the borrowers in many cases just do not seem to come
across as a reasoned decision of bank. It is many a times comes as a hasty
piece of hasty pertaining only to recovery. 
The spirit of law has to be shown in action too to uphold the real
intent of this piece of legislation.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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