Will the RBI’s Revised Circular on Stressed Assets Sustain its Validity?

[Surya Rajkumar is a BA LLB student at Jindal Global Law School]

The Reserve Bank of India (RBI) had on 7 June 2019 issued its revised circular on the resolution of stressed assets following the decision of the Supreme Court of India in Dharini Sugars and Chemicals Limited v. Union of India, (2019) 5 SCC 480, in which it quashed the RBI’s previous circular dated 12 February 2018 as ultra vires the provisions of the Banking Regulation Act, 1949 and the Reserve Bank of India Act, 1934. While an earlier post in this Blog has examined the contents of the new circular, the aim of this post is to highlight its infirmities that could potentially render the new circular ultra vires the provisions of the RBI Act.

Background

In Dharani Sugars the Supreme Court quashed the 12 February circular for three reasons. Firstly, whereas under section 35AA of the Banking Regulation Act the RBI could not issue directions on the initiation of insolvency resolution process under the Insolvency and Bankruptcy Code, 2016, (IBC) without the authorization of the Central Government, there was no such authorization for the 12 February circular (see paras 29, 30 of the Supreme Court’s judgement). Secondly, whereas any direction issued on the initiation of insolvency resolution process under the IBC could pertain “only to specific cases of default and not to the issuance of directions to banking companies generally”, the 12 February circular applied to defaults generally (see para 41). Thirdly (and most relevant to this post), whereas under section 45L(3) of the RBI Act the RBI is required to have due regard to the conditions of a financial institution’s establishment, the 12 February circular did not have any regard to such conditions (see para 45). While the new circular sustains its validity to extent that it: (a) disassociates itself from section 35AA of the Banking Regulation Act and (b) remains silent on the initiation of insolvency resolution process under the IBC, as I shall lay down in the next section, it may not conform to section 45L(3) of the RBI Act.

The RBI Act and the new circular

Section 45L(3) of the RBI Act requires the RBI to “have due regard to the conditions in which, and the objects for which” a financial institution “has been established, its statutory responsibilities, if any, and the effect the business of such financial institution is likely to have on trends in the money and capital markets” while issuing directions to such institutions. In Dharani Sugars, the Supreme Court found the 12 February circular ultra vires section 45L(3) of the RBI Act as it applied to “to banking and non-banking institutions alike.” The like treatment to banking and non-banking institutions has not changed with the new circular. By virtue of clause 3(a) of the new circular, it applies to scheduled commercial banks and, by virtue of clause 3 (d), its application also extends to “Systemically Important Non-Deposit taking Non-Banking Financial Companies (NBFC-ND-SI) and Deposit taking Non-Banking Financial Companies (NBFC-D)”. Therefore, there is no significant departure from the 12 February circular on this score which applied to all scheduled commercial banks as well as all-India financial institutions. In any case, like the 12 February circular, the new circular too applies to banking and financial companies alike. Hence the vires of the new circular may still be assailed for not conforming to the conditions laid down in section 45L(3) of the RBI Act.

While it is true that the RBI can issue directions to banking companies under section 21 of the Banking Regulation Act which does not impose conditions such as those appended to section 45L(3) of the RBI Act, as a creature of the RBI Act it is duty-bound to adhere to these conditions. This is more so when the RBI issues directions to non-banking finance companies. Moreover, when the introduction to the new circular sources its powers from the RBI Act, it cannot be contended that the RBI can issue directions without having adhered to section 45L(3) of the RBI Act.

Conclusion

The new circular, as far my research can show, has not yet been challenged. This is probably because the obligations imposed by the new circular are confined to making additional provisions as a percentage of the total outstanding debt in case the implementation of a resolution plan surpasses 180 days from the review period as opposed to the 12 February circular that mandated the initiation of insolvency proceedings within 15 days had a resolution plan not been implemented within 180 days. The latter was severely criticized particularly by companies in the power, sugar and fertilizer sectors whose reasons for default were beyond their control. While the new circular is susceptible to challenge when examined from the touchstone of section 45L(3) of the RBI Act, such a challenge may be resisted if the RBI shows that it has conformed to the conditions laid down in section 45L(3) despite making its application similar to banking and non-banking institutions.

Surya Rajkumar

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