Gujarat High Court Rules on RBI’s Powers Relating to Corporate Insolvency

[Guest post by Saurav
Roy
, IV B.A.LL.B, ILS Law College, Pune.]
 
Introduction
Last week,
the Gujarat High Court ruled on some interesting issues under the Insolvency
and Bankruptcy Code 2016 (“IB Code”) while adjudicating upon a writ petition
filed by Essar Steel Ltd., (“Essar”) against the Reserve Bank of India’s (“RBI”)
decision to initiate insolvency proceedings against Essar and 11 other
companies.  
Background
In light of
the growing concerns surrounding non-performing assets (“NPAs”), the RBI had issued
a
press release in June 2017, wherein it decided to initiate
insolvency proceedings against certain companies that had high exposure to NPAs
based on certain criteria laid down by the RBI. Accordingly, 12 companies
(including Essar) came within the purview of the criteria. It is pertinent to
note that approximately 25 per cent of the total NPA value of banks was owing
to the accounts of the aforementioned 12 companies.
The RBI had
also clarified that a consortium of lenders (led by the State Bank of India (“SBI”))
had decided to initiate proceedings under section 9 of the I&B Code, as
there was a clear failure to effectively implement the debt restructuring
scheme that was approved by Essar’s board of directors.
Soon after
the lenders, led by the SEBI initiated insolvency proceedings before the
National Company Law Tribunal (“NCLT”), Essar approached the Gujarat High Court
seeking to quash the press release of the RBI issued in June 2017 calling upon
the banks to initiate proceedings against the 12 borrowers, based on which the SBI
had initiated insolvency proceedings against Essar.
Contentions as raised by Parties
1.         Essar
Essar primarily
contended that the rationale, process and justification provide by the RBI in
determining which cases are to be referred to the NCLT is arbitrary and unjust.
Another concern raised by Essar was that if an Insolvency Resolution
Professional (as mandated by the I&B Code) were to be appointed to take
over the management of the company, it would place the company at great risk,
particularly given the extent and magnitude of the business operations of Essar.
Moreover,
Essar contended that the RBI had completely ignored the fact that the debt
restructuring scheme as planned and agreed by Essar was in its final stages of
negotiation and would be ready soon, thus negating the need for RBI
intervention.
2.         RBI
The RBI’s
contentions relied on the contextual scenario with regard to the Indian
economy. As of 31 March 2017, the gross NPAs of Indian banks was over Rs. 728,768
crore (almost 5% of India’s Gross Domestic Product).
The RBI
further contended that Section 35AA of the Banking Regulation Act, 1949 (“Banking
Act”) (introduced by way of the Banking Regulation (Amendment) Ordinance, 2017
(the “Banking Ordinance”)) empowered it to initiate insolvency proceedings
before the NCLT and there is no restriction on initiation of proceedings even
if negotiations between the borrower and the financial creditor were ongoing
(as was the case in the present dispute).
The RBI
informed the Court that the NPAs of Essar rose from Rs. 31,671 crores till 31
March, 2016 to Rs. 32,864 crores till 31 March, 2017. Through it arguments, the
RBI sought to clarify that it will seek to focus on cases which have the
profile of being the largest and longest-standing NPAs.
Court’s Decision
Through its order, the Court dismissed the petition filed by Essar by
stating that Section 35 AA of the Banking Act empowered the RBI to intervene in
cases wherein it deems initiation of insolvency proceedings to be the most
practical solution, and that there was nothing wrong with the RBI’s decision to
initiate insolvency proceedings.
However, the
Court was quick to observe the carelessness and haphazard construction of the
RBI’s press release, by noting that the usage of the phrase “such cases will be
accorded priority by the National Company Law Tribunal…”

was
a serious issue, as “nobody is entitled
or empowered to advise, guide or direct the judicial or quasi-judicial
authority in any manner whatsoever
”. The Court, thus, demanded a more
cautious approach to release of official RBI documents and press releases,
which led to the RBI releasing a corrigendum on 8 July 2017 to
delete the sentence in question.
As an important issue was one of the
commencement of insolvency proceedings before the NCLT, the Court clarified
that Essar must be given a fair and equal opportunity to be heard, and that the
substantive issues of the case would be dealt with by the NCLT itself. In other
words, the insolvency petition cannot be admitted mechanically.
Conclusion
Keeping in mind the ballooning NPA problem
that has confronted India’s economic growth, the faith reposed by the Gujarat
High Court on the I&B Code in general and the specific insolvency process
pertaining to Essar would be welcomed by the banking community. The Court’s
recognition of the importance of the Banking Ordinance reaffirms its status as
an effective legislative tool to counter the menace of bad loans. At the same
time, the Gujarat High Court was not called upon in the Essar case to rule on
the constitutionality of the I&B Code or the Banking Ordinance. Whether any
of the affected debtors
would
venture that far remains anybody’s guess, although it cannot be ruled out.
– Saurav Roy

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.

3 comments

  • The Application would be filed under Section 7 of the Code, and not Section 9 as stated here. Interesting piece, nonetheless.

  • There aren't too many constitutional challenge arguments on I&B Code, that can be made at this stage.

    Such arguments could be made much later, if and when the NCLT rules on the Section 7 application.

    • I agree. Apologies for the delayed response. However, I do anticipate a constitutional challenge to the IBC in the near future.

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