Supreme Court on RBI’s Circular Relating to Insolvency: A Critical Analysis

[Rishabh Sant Tiwari is a 5th year B.A. LL.B. (Business Law Honours) student at National Law University, Jodhpur, India]

The 12 February 2018 circular of the Reserve Bank of India (RBI) was assailed as ultra vires the powers given to it under the Banking Regulation Act, 1949 and the Reserve Bank of India Act, 1934 in Dharani Sugars and Chemicals Ltd. v. Union of India.

The Challenge

Curious Case of the Power Sector

Unlike sectors such as the steel and cement sector, the power sector is substantially regulated and tariffs can be fixed after they are adopted by Electricity Regulatory Commissions under section 62 or Section 63 of the Electricity Act. The power sector, therefore, is a player in a restricted market – power can only be purchased by distribution licensees or trading licensees under section 12 of the Electricity Act, which can only be done with the prior approval of State Electricity Regulatory Commissions. Even transmission of power requires prior approval of transmission licensees and, therefore, the substitutability of buyers is impossible since the means to supply power are not readily available.

The 37th Parliamentary Standing Committee Report on Stressed / Non-performing Assets in the Electricity Sector dated 7 March 2018 recorded that in the private sector there were 34 stressed projects amounting to 40,130 megawatts (MWs) out of 85,550.30 MWs which have a debt exposure of INR 1,74,468 crore. Out of these, non-performing assets amounting to 34,044 crores are primarily on account of government policy changes, failure to fulfil commitments by the government, delayed regulatory response and non-payment of dues by DISCOMs, non-availability of fuel and lack of independent power producers and power purchase agreements.

Hence the primary contention of the petitioners before the Supreme Court was that the growth of non-performing assets (NPAs) in the power sector is primarily because of governmental control and policy failure rather than mismanagement or malfeasance on the part of the promoters or managerial boards of these companies.

No Sector Specific Applicability of the Circular

The petitioners claimed that the peculiar challenges faced by the power sector were not taken into account by the RBI and the circular was issued without any due consideration. It was argued that applying a 180-day limit to all sectors of the economy without going into the special problems faced by each sector would treat unequals equally and would be arbitrary and discriminatory, and therefore, violative of article 14 of the Constitution of India.

Circular being ultra vires Sections 35AA and 35AB

The petitioners argued that sections 35AA and 35AB of the Banking Regulation Act, 1949 are part of one composite scheme. Section 35AA alone refers to, and can alone be the source of power for, directing banking and non-banking companies to file applications under the Insolvency and Bankruptcy Code, 2016. Section 35AB clearly refers to resolution of stressed assets in a manner which is de hors the Insolvency Code. They then referred to the circular of the Central Government dated 05 May 2017 which empowered the RBI to issue directions on account of individual defaults that are committed. This being so, a general circular applying to all defaults of loans above INR 2000 crore, without having reference to the facts of each individual case, would therefore be ultra vires and bad in law.

The Judgment

The Supreme Court perused various aids to construction (Finance Minister’s speech, Statement of Objects and Reasons, framework of the RBI Act and the Banking Regulation Act) and came to the following conclusion in relation to the scheme of sections 35A, 35AA, and 35AB:

1. When it comes to issuing directions to initiate the insolvency resolution process under the Insolvency Code, Section 35AA is the only source of power.

2. When it comes to issuing directions in respect of stressed assets, which directions are directions other than resolving this problem under the Insolvency Code, such power falls within Section 35A read with Section 35AB. This also becomes clear from the fact that Section 35AB(2) enables the RBI to specify one or more authorities or committees to advise any banking company on resolution of stressed assets. This advice is obviously de hors the Insolvency Code, as once an application is made under the Insolvency Code, such advice would be wholly redundant, as the Insolvency Code provisions would then take over and have to be followed.

[emphasis added]

The Supreme Court also held:

Stressed assets can be resolved either through the Insolvency Code or otherwise. When resolution through the Code is to be effected, the specific power granted by Section 35AA can alone be availed by the RBI. When resolution de hors the Code is to be effected, the general powers under Sections 35A and 35AB are to be used. Any other interpretation would make Section 35AA otiose.

After this discussion, the Court came to the following conclusion:

RBI can issue directions to a banking company in respect of initiating insolvency resolution process under the Insolvency Code under Sections 21, 35A, and 35AB of the Banking Regulation Act, would obviate the necessity of a Central Government authorisation to do so. Absent the Central Government authorisation under Section 35AA, it is clear that the RBI would have no such power.

[emphasis added]

Consequently, the February 12 Circular was declared as ultra vires section 35AA of the Banking Regulation Act, 1949 as a whole. Hence, in all cases in which debtors have been proceeded against by financial creditors under section 7 of the Insolvency Code, only because of the operation of the impugned circular, such proceedings, being faulted at the very inception, are declared to be non-est.

The February 12 Circular was struck down mainly because of two reasons:

  • The power was to be exercised under the authorization of the Central Government; and
  • Power was to be exercised only after ‘due deliberation and care’ and only in relation to ‘specific defaults’.

In this case, the RBI did not exercise this power under any authorization of the Central Government and there was no due deliberation and care exercised in relation to specific defaults or sector specific needs. A blanket circular was hence ultra vires the delegated legislation.

Critical Appraisal of the Judgment

Revival of All Restructuring Schemes Prior to February 12 Circular

Since the entire circular is struck down as ultra vires section 35AA of the Banking Regulation Act, 1949, the schemes affected by the Circular are again revived in law. However, in the following days, the RBI has to come up with a different circular on the subject. There are broadly two possibilities that the RBI may resort to:

  • It may introduce sector specific timelines for insolvency resolution and may make it optional to resort to proceedings under the Insolvency Code.
  • It may bring back the previous restructuring schemes with an option of resorting to proceedings under the Insolvency Code.

In addition to any of the above, it may occasionally seek authorizations from the Central Government to direct specific cases of defaults to the Insolvency Code proceedings.

Banks Can Still Refer Cases under the Insolvency Code Voluntarily

It would be premature for debtors to rejoice as the banks and financial institutions can still proceed against the debtors under Insolvency Code. The difference introduced by this ruling is that they can now exercise discretion as they could prior to this circular. They may or may not resort to the process under Insolvency Code. This also offers a chance for banks and financial institutions to reflect on their relationship in the contractual agreements.

Is 66% More Practical for the Banks?

The resolution of the large accounts in the power sector, for instance, requires consent of a larger group of creditors under any restructuring scheme (although new thresholds are to be notified yet). It is quite possible that the lenders, irrespective of the available discretion, may still move the National Company Law Tribunal (NCLT) under the Insolvency Code as the consent threshold is still lower, i.e., 66%.

Provisioning Norms?

The RBI has tweaked the provisioning norms in the February 12 Circular. This was a departure from the provisioning norms under the JLF Guidelines or the Asset Classification and Provisioning Norms. Now, since the circular has been rendered ultra vires the Banking Regulation Act, 1949, the RBI has to issue a separate provisioning norm. It may or may not be same as the current thresholds. It will not be right to say that the judgment has affected that power of the RBI to tweak and regulate provisioning norms.

Technical Interpretation and the Ironical Series of Events

The Banking Regulation Amendment Ordinance of 2017 was largely perceived as clarificatory in nature as even the Supreme Court in this case held that, had it not been introduced, the RBI would still have powers to refer the cases of default to NCLT under section 35A. However, after this technical interpretation of the amendment, the problem lies with the fact that the Central Government and the RBI both have to use their discretion to refer matters to the NCLT; moreover, specific directions have to be issued in this regard. The politicization of the process is a substantial threat now.

Fate of 12+30 Companies referred by the RBI

Exercising the powers given to it under the amendment, the RBI constituted an Internal Advisory Committee (IAC) and it recommended after analyzing the accounts that 12 companies should be referred to NCLT. One could argue that since the cases of ‘individual default’ have been referred to the NCLT and due care and deliberation in form of IAC was taken, this was a valid exercise of power. Also, since the February 12 Circular has been struck down, these companies were not referred to the NCLT solely because of this circular (as it never existed at that time).

However, if one would consider the ratio of the judgment, it could be concluded that for a valid exercise of power under section 35AA both authorization from the Central Government as well as ‘due care and deliberation’ is required to be considered by the RBI. Since in these cases the authorization from the Central Government was missing, these references could also be considered non-est. However, in order to achieve clarity on the issue, further adjudication may be necessary at this point.

Rishabh Sant Tiwari

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