RBI’s Circular Invalidated: A Potential Watershed Moment in the Indian Insolvency Regime

[Saurav Roy is a final-year law student [V B.A.LL.B] at ILS Law College, Pune]

On 2 April 2019, a Supreme Court bench of Justice Rohinton Nariman and Justice Vineet Saran delivered a landmark judgement in the case of Dharani Sugars and Chemicals Ltd. v. Union of India which deals with the pertinent issue of a controversial circular issued on 12 February 2018 titled “Resolution of Stressed Assets – Revised Framework” (“Circular”) released by the Reserve Bank of India (“RBI”) which instructed lenders to take defaulting companies into insolvency proceedings immediately after 180 days of default.

The Circular was challenged by petitioners such as The Association of Power Producers (“APP”) and Independent Power Producers Association of India, who argued that the Circular clearly suffers from non-application of mind, as it is unable to draw crucial distinctions between various types of ‘stressed assets’ from different industrial sectors. Moreover, it was also contended that the Circular fails to distinguish between genuine and wilful defaulters


In February 2018, the RBI put out a circular on the classification of non-performing assets, which declared that banks ought to not waste any time whatsoever when it comes to referring accounts with more than Rs. 2,000 crores to the insolvency and bankruptcy regime, if they are not resolved within 180 days of a default. Among other things, the Circular also laid down that banks would have to disclose defaults if interest re-payments were defaulted on by a single day, and will have to ensure a resolution plan is in place within 180 days. Additionally, all previous schemes laid down by the RBI (JLF, SDR, S4A), were abolished by the Circular. This decision by the banking regulator was met with panic and confusion by various power and energy firms, who immediately began efforts to lobby for some form of relaxations from the RBI.

In August 2018, the Allahabad High Court refused to grant interim relief to various large power projects which were going to be affected by the Circular, and went ahead to direct the Central Government to consider the initiation of a consultative process envisaged under section 7 of the RBI Act. The order also clarified that rights and powers of a financial creditor under section 7 of the Insolvency and Bankruptcy Code, 2016 (“IBC”) would not be curtailed. Moreover, the Court also stated that the RBI would retain its power to issue directions in specific cases under section 35AA of the Banking Regulation Act, 1949 (“BR Act”) to initiate corporate insolvency resolution process under chapter II of the IBC.

Important Considerations

The key pointers from the Supreme Court’s judgment that are of relevance to the distressed market in India are as follows:

– The Banking Regulation (Amendment) Act, 2017 which introduced sections 35AA and AB to the BR Act was clarified to be constitutional in nature. The Supreme Court reaffirmed the principle laid down in Swiss Ribbons Pvt. Ltd. v. Union of India, which holds that economic laws should be granted greater latitude.

– The Supreme Court held that, keeping in mind the tenor of sections 35AA and AB, it was obvious that the RBI can issue directions to banks only within tenets which are to be laid down by the Central Government. This means that the RBI’s power can only be exercised after specific authorisation by the Central Government. The Court stated that, in the future, the RBI can only direct banks to initiate insolvency proceedings against defaulters if (a) there is specific Central Government authorisation to do so, and (b) if it pertains to a specific default committed by a specific debtor. Generalised directions would not be in accordance with section 35AA.

– It is pertinent to note that the Supreme Court invalidated the entirety of the Circular and essentially stated that it will have no effect in law. This means that any insolvency proceedings which were initiated by financial creditors in pursuance of section 7 of the IBC under the auspices of the Circular are now, from their very inception, non-existent. However, the Supreme Court has not curtailed any lenders’ statutory rights under the IBC to initiate insolvency proceedings as a financial creditor.

Analysing the Way Forward

From a regulatory point of view, it is pertinent to observe that the judgement most certainly dilutes the power of India’s banking regulator. The ability to direct banks to refer cases to insolvency courts will now be restricted to situations where Central Government authorisation is received. Generalised directions can no longer be issued by the RBI, which would now be forced to analyse specific cases and issue directions only in regard to those situations. The RBI governor Shaktikanta Das has recently stated that the regulator will comprehensively review the judgment and release a revised circular which deals with non-performing assets.

From a commercial standpoint, banks and promoters of defaulting companies could possibly welcome the judgement as having relieved a substantial amount of pressure which was attributable to the rigid time periods set out in the Circular. The invalidation of the Circular could assist in lenders and borrowers entering into consensual restructuring schemes, which can be achieved in lengthier timespans, allowing for complex restructuring transactions with more pragmatic timelines. Given that the Circular is now struck down, it remains to be seen whether previous recovery regimes such as the S4A, SDR, JLF etc. would automatically revive. However, it would be poignant to presume that stakeholders would be wary of acting under these previous regimes without specific guidelines and directions given by the RBI.

It is the author’s belief that the judgment laid down by the Supreme Court will facilitate a greater occurrence of pre-IBC settlements, especially where effective resolutions can happen with lenders receiving up to 50-60% in terms of recovery. Moreover, it is now very clear that resolution of debt cannot possibly have a generalised, one-size fits all approach. Additionally, the author believes that the RBI should come out with revised guidelines, especially to do with lowering the 66% voting threshold required under the IBC regime, in order to facilitate a quicker resolution of these cases.

Saurav Roy

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