[Aayush Mitruka and Vividh Tandon graduated from ILS Law College, Pune and are currently working with law firms in Delhi and Mumbai respectively. They can be reached at [email protected] and [email protected]]
The Reserve Bank of India (RBI) announced the much-awaited revised circular on resolution of stressed assets on 7 June 2019. It may be recalled that the Supreme Court had earlier in Dharini Sugars and Chemicals Limited v. Union of India struck down and declared a circular issued by the RBI on 12 February 2018 ultra vires the provisions of the Banking Regulation Act, 1949. Following this, the RBI had declared that it will take necessary steps, including issuance of a revised circular, as may be necessary, for expeditious and effective resolution of stressed assets.
12 February 2018 Circular
The 12 February Circular was aimed at resolution of stressed assets and was issued in exercise of RBI’s powers under the provisions of Banking Regulation Act and the Reserve Bank of India Act, 1934. Under the 12 February Circular, all existing frameworks (such as the Framework for Revitalizing Distressed Assets, Corporate Debt Restructuring, Flexible Structuring of Existing Long-Term Project Loans, Strategic Debt Restructuring (SDR), Change in Ownership outside SDR, and Scheme for Sustainable Structuring of Stressed Assets (S4A)) for addressing stressed assets were withdrawn and the institution of joint lenders’ forum (JLF) that was overseeing these schemes was abolished. The most contentious feature of the 12 February Circular was that it directed the lenders to institute a board approved policy for resolution of stressed assets. It required all lenders (100%) agreeing to the resolution plan as against 60% under the JLF mechanism and 66% under the Insolvency and Bankruptcy Code, 2016 and it allowed 180 days (from 1 March 2018) for debt resolution of big stressed accounts (wherein loan in default was in excess of INR 2,000 crore), failing which the distressed asset would have to be dealt with in accordance with the provisions of the Code. The deadline of 180-days had elapsed on 27 August 2018.
Challenge to the 12 February Circular
Petitions challenging the 12 February Circular were filed by power producers and some textiles, sugar and shipping companies before different High Courts. These companies argued that the central bank’s “one-size-fits-all” approach did not account for innumerable exogenous factors that impacted their ability to repay. They also claimed the 12 February Circular was arbitrary and that the RBI had exceeded its remit in issuing the 12 February Circular. While the Allahabad High Court denied any relief, it however suggested that the Government could deploy Section 7 of the RBI Act and direct it to modify the order – something which the Government threatened to do.
Following the High Court order, the power producers’ associations had moved the top court in August 2018, which transferred all the pending cases in the High Courts to itself. The Apex Court had then stayed the ongoing as well as potential insolvency proceedings against these companies until further orders. The 12 February Circular has, in effect, been stayed since then.
The contentious provisions and the Supreme Court judgment
The Supreme Court analysed and interpreted sections 35AA and 35AB of the Banking Regulation Act which were relied upon by the banking regulator to issue the 12 February Circular. Notably, the Banking Regulation Act was amended in May 2017 to insert sections 35AA and 35AB.
At the very outset, the Supreme Court relied on its judgment in Swiss Ribbons Pvt. Ltd. v. Union of India and made it clear that “economic legislation is to be viewed with great latitude”. The Supreme Court held that these provisions of the Banking Regulation Act are constitutionally valid and are not excessive in any way nor do they suffer from want of any guiding principle. The Supreme Court recorded that stressed assets can be resolved either through the IBC or otherwise and when it comes to resolution through the IBC, section 35AA is the only power available with the RBI.
On section 35AA, the Supreme Court held that the RBI could direct banks to initiate insolvency only if the following two conditions are met:
(a) there is a central government authorization to do so; and
(b) that such direction should be in respect of specific defaults.
The 12 February Circular which issued directions in respect of debtors generally was held to be ultra vires section 35AA. All cases or proceedings in which debtors had been proceeded against by financial creditors under section 7 of the Insolvency and Bankruptcy Code because of the operation of the 12 February Circular were declared to be non-est. It was ironical that the very provisions of the Banking Regulation Act which were inserted by way of abundant caution to empower the RBI to issue directions to the banks to initiate insolvency had tied their hands.
As regards section 35AB, the Supreme Court observed that it empowers the RBI to issue directions to banks to resolve stressed assets outside of the Code. In addition, the Court also concluded that the 12 February Circular did not satisfy the pre-requisites of stipulated under section 45L of the RBI Act. For that reason, also, the 12 February Circular was quashed.
The Revised Circular
To remedy the situation and fill up the void created by quashing of the 12 February Circular, the RBI has now come up with a fresh set of guidelines known as Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions, 2019. Some of the significant changes brought about by the Revised Circular are as follows:
(a) Applicable to large group of lenders: Unlike the 12 February Circular, the Revised Circular applies to a larger universe of lenders as it now brings within its purview, non-banking financial companies and small finance banks. This effectively means that these lenders will also have to follow the early stress recognition guidelines of RBI. However, for now, the Revised Circular will only apply to accounts worth INR 2,000 crore and above and, from 1 January 2020, the Revised Circular will be applicable to accounts of INR 1,500 crore or more. This will further increase the lender pool.
(b) Wide discretion to lenders: The Revised Circular has introduced a 30-day review period for analysing the asset quality after default and a further 180 days to execute the resolution plan (as it was under the 12 February Circular). In this regard, the Revised Circular contemplates that lenders must obtain a policy approved by their respective boards for resolution of the distressed accounts and lenders will have complete discretion to strategize and implement resolution plans. Additionally, the Revised Circular contemplates signing of an inter-creditor agreement (ICA) by all lenders, which will provide for a majority decision making criteria. However, the signing of the ICA within the prescribed 30 days period in such large accounts seems to be ambitious and may not possible in cases where there are large number of lenders forming part of the consortium. That said, it is also unclear if an ICA would have to be executed for each account individually or the ICA envisaged under the Sashakt framework would suffice. However, the latter view seems to be a more logical and a practical approach. In such a scenario, the ICA issued under the Sashakt framework will have to be modified to align it with the terms of the Revised Circular.
The Revised Circular has given complete discretion to lenders with regard to design and implementation of resolution plans, in supersession of earlier resolution schemes (S4A, SDR, 5/25 etc.), subject to the specified timeline and independent credit evaluation. To that end, the lenders may choose to employ any resolution strategy including sale of debt, change in ownership, and the like. However, any change in ownership under the Revised Circular will have to be in accordance with the provisions of section 29A of the Insolvency and Bankruptcy Code and the relevant regulations issued by the Securities and Exchange Board of India.
(c) Approval of creditors: Unlike the 12 February Circular, the resolution plan need not be approved unanimously, and decision agreed upon by 75% lenders by value of total outstanding credit facilities and 60% lenders by number will be binding upon all the lenders. This will expedite the resolution process since a number of resolution plans had been stuck for want of 100% lender approval in the past under the earlier regime. As far as the dissenting creditors are concerned, they will have to be paid at least the liquidation value.
(d) Removal of compulsory reference to National Company Law Tribunal (NCLT): The mandatory reference of the defaulting accounts to the NCLT under the Bankruptcy Code after the expiry of 180 days (which was required under the 12 February Circular) has been removed. Needless to say, the lenders are free to voluntarily insolvency initiate at any point in time. However, it appears from past experience that the lenders would initiate bankruptcy proceedings only as the last resort.
(e) Punitive measures: The RBI has also introduced punitive measures in the nature of additional provisioning. As there is no long-stop date for resolution, the implementation of a resolution plan or invocation of Insolvency and Bankruptcy Code can be delayed if the lenders make an additional provisioning of 20% at the end of 210 days period (i.e. 180 days + 30 days) and 15% at the end of 365 days (i.e. the total additional provisioning of 35%). That said, if the lenders invoke the provisions of the Code, the additional provisioning can be freed and written back. While the aim of this carrot and stick approach is to prompt the lenders to work towards restructuring, this may however not prove to be a strong deterrent in accounts which are already nearing to 80% – 100% provisioning.
(f) Disclosure in financial statements: The Revised Circular also mandates the lenders to make ‘appropriate disclosure’ in their financial statements relating to the resolution plan. However, the form and substance in which such disclosure has to be made has not been clarified.
(g) Specific directions by RBI: Finally, in line with the Supreme Court judgment, the Revised Circular spells out that the RBI will have the discretion to issue specific directions to the lenders for initiation of insolvency proceedings against specific defaults, wherever necessary, to maintain the momentum towards effective resolution.
The Revised Circular is sector agnostic and does not give any extra leeway to any particular sector. This will obviously disappoint the power producers. However, it was beyond RBI’s brief to allow any special treatment to a particular sector as RBI could not have discriminated among different sectors. Any differential treatment will pose a very high risk of running into legal challenges, which would defeat the intent behind debt resolution. That said, the relief has to be sought from elsewhere – the lenders may consensually allow some wiggle room to lenders from specific-sectors. Additionally, the Government may provide them the necessary relief at a policy level.
The RBI has taken proactive steps on the regulatory and supervisory front keeping in mind the requirements of the present time. Significantly, the Revised Circular has strengthened the financial sector with an aim to maintain stability and avoid regulatory arbitrage. Moreover, in terms of the Revised Circular, lenders are expected to work on a resolution plan based on the financial health of borrowers even before a default. It is clear that if there is a default by a borrower only in one of its loan, all lenders are required to review the account of the borrower within 30 days. Essentially, this brings more responsibility on the lenders along with wide discretion. As discussed in this post above, lenders are mandated to develop a resolution plan within the 30 days period and enter into the ICA during this period. Though this timeline has to be tested in view of the practical laches that lenders may face in executing the ICA during the stipulated timeline. In any event, the Revised Circular provides for provisioning norms should there be any delay.
Pertinently, the Revised Circular has taken ample care of defaults which may occur or have occurred due to some unforeseen events, as it attempts to strike a balance for all stakeholders with an aim to identify the best fit resolution. The over-all tenor of the Revised Circular seems to be positive and in the right direction. Undoubtedly, this brings lot of cheer among the lenders as this Revised Circular gives out lot of freedom and discretion to the lenders. More importantly, this Revised Circular fills up the void and steer clear of most of the objections and concerns that were raised by the Supreme Court in Dharini Sugars. That said, there are however, certain issues and questions which would require some more clarity like the ICA, form of disclosures to be made by the lenders, etc. It remains to be seen how this Revised Circular pans out in practice.
– Aayush Mitruka & Vividh Tandon
 This provision allows the Central government to issue directions to the RBI that it may consider necessary in public interest.