Asset Reconstruction Companies as Resolution Applicants: Revisiting the SARFAESI’s Limitations

[Arshit Kapoor and Srilagna Dash are 5th year B.B.A. LL.B. (Hons.) and 3rd year B.A. LL.B. (Hons.) students, respectively at National Law University Odisha, Cuttack]

Asset Reconstruction Companies (“ARCs”) are financial institutions which reconstruct and securitise bad assets of banks and financial institutions. They are regulated by the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI”). Under the scheme of the SARFAESI, any other function that the ARCs intend to perform (apart from securitisation, reconstruction, and statutorily allowed functions) require prior approval of the Reserve Bank of India (“RBI”).

Previously, pursuant to this scheme of the SARFAESI, many ARCs approached the RBI seeking approval to be classified as ‘Resolution Applicants’ (“RAs”) under the Insolvency and Bankruptcy Code, 2016 (“IBC”), but were disallowed. While the RBI has not published orders rejecting such applications for approval, tribunals in certain cases (see here and here) have noted such orders, observing that ARCs cannot legally act as RAs under the IBC.

Recently, the RBI took a sharp U-turn in its ‘Review of Regulatory Framework for ARCs’ (“RBI Framework”), allowing ARCs to act as RAs under the IBC. To act an RA, the RBI has prescribed several conditions for ARCs, including a minimum net owned fund, board-approved policy, additional disclosures and foregoing any significant influence or control within five years.

This post will analyse the RBI’s sharp U-turn and spotlight several issues with this change of stance.

Issues concerning the RBI’s U-turn

ARCs require a ‘specific’ permission to initiate a new business

As stated earlier, apart from securitisation and reconstruction, ARCs are only allowed to conduct the businesses mentioned in section 10(1) of SARFAESI. This provision does not specifically allow ARCs to act as RAs. However, section 10(2) of SARFAESI enables any ARC to commence or carry on any other business, pursuant to approval of the RBI. Interestingly, RBI has now utilised this provision to allow ARCs to act as RAs, in the RBI Framework. This is problematic for two reasons.

First, the use of the phrase “…no asset reconstruction company” in section 10(2) of SARFAESI connotes that it is a restrictive provision. Hence, it prevents ARCs from commencing or carrying on any business, other than the ones statutorily provided, without prior approval of the RBI. It does not provide a positive power to the RBI for issuing directions in respect of the same. The use of the word ‘approval’ (and not ‘direction’ or ‘guidelines’) in section 10(2) of SARFAESI, only strengthens this argument. Further, since ‘approvals’ can only be specific, allowing all ARCs at once to commence any business does not fall within the scope of this provision.

Second, the power to issue directions to ARCs has, in fact, been vested with the RBI by virtue of section 12 of SARFAESI. This provision is exhaustive and nowhere empowers RBI to ‘generally’ allow all ARCs at once to commence or carry on any business other than the ones statutorily provided.  As per section 12(1), the RBI is empowered to give directions to ARCs concerning income recognition, accounting standards, bad and doubtful debts, capital adequacy, and deployment of funds.

Further, section 12(2) empowers RBI to issue directions with respect to the kinds of financial assets that may be acquired by an ARC. This provision also could not have been used in the RBI Framework as the role of a RA entails more than just the acquisition of financial assets. For instance, Section 5(26) of the IBC, which defines a ‘resolution plan’, states that resolution plans are proposed by resolution applicants for resolution of the corporate debtor as a going concern. To achieve this, the ARCs shall actively participate on the operational side to revive the debtor company. Therefore, it is unclear whether RBI could have used its general direction-making powers to issue the RBI Framework.

ARCs’ role was never envisaged to be beyond debt recovery

Except the specific power to issue directions granted under section 12 of SARFAESI, the RBI also derives such power from section 45L of the Reserve Bank of India Act, 1934 (“RBI Act”).

However, this power comes with certain riders, including consideration of the conditions and objectives for which the financial institution in question was established and its statutory responsibilities.   

It is worth noting that the ARCs were established on the recommendation of the Narasimham Committee II, which envisaged the role of ARCs as effecting recoveries on behalf of the banks and ultimately addressing the backlog of non-performing assets. Later, the Expert Committee for Recommending Changes in the Legal Framework concerning Banking System (1999-2000) suggested that ARCs can perform such tasks by way of securitisation. Consequently, the SARFAESI was enacted with the objective of regulating securitisation and reconstruction of financial assets and ARCs were tasked with performing such functions.

Nowhere was it envisaged that ARCs undertake functions such as insolvency resolution of any entity. This observation was also noted in the Bankruptcy Law Reforms Committee Report (2015) (“BLRC”).  The BLRC further opined that the mechanism of ARCs can only be viewed as debt recovery tools and not as insolvency resolution tools. Therefore, the recent guidelines issued by RBI are seemingly inconsistent with both section 45L of the RBI Act and the original conception of ARCs. 

ARCs require statutorily provided tools to facilitate insolvency resolution

Apart from the fact that the objectives of SARFAESI only envisage debt recovery, it is also worth noting that the provisions of SARFAESI do not permit ARCs to venture beyond debt recovery. For instance, the very definition of an ARC in SARFAESI states that they are formed for the purposes of carrying on the business of asset reconstruction or securitisation, or both.

Further, the rights granted to an ARC in section 9 of SARFAESI which include conversion of debt into equity and taking over the management of any business are subject to the restriction that such rights can only be availed strictly for the purpose of ‘asset reconstruction’.

Additionally, even if an ARC takes over the management of the borrower’s business pursuant to section 9 of SARFAESI, it has to be restored on realisation of the debt of the borrower as provided in section 15(4) of SARFAESI.

The only exception to this is a situation where secured creditors (including ARCs) jointly with others have converted the borrower’s debt into equity to an extent of acquiring a controlling interest in the borrower company. Consequently, ARCs can acquire other entities in extremely limited cases and envisaging the role of ARCs as RAs for resolving insolvent entities appears to be an imagination beyond the provisions of SARFAESI.

ARCs losing control of the insolvent entity is untenable and against the objectives of IBC

The next question is whether the RBI Framework allowing ARCs to participate as RAs in IBC proceedings is likely to achieve desired outcomes.

The RBI Framework allowing ARCs to act as RAs contains an onerous requirement of giving up any significant influence or control over the acquired insolvent entity within five years of the date of approval of the resolution plan. This requirement does not seem to align with the objectives of the IBC for two reasons.

First, ARCs having significant influence or control on the insolvent entity only for a period of five years would not allow them to make structural and long term changes in the insolvent entity. Consequently, this harms the ultimate resolution of the insolvent entity. Second, it can lead to a situation where ARCs invest in an insolvent entity only to sell it at a higher price, instead of reviving it.

The aforesaid two points are apprehensions flowing from Superna Dhawan v. Bharti Defence and Infrastructure Ltd,where it was stated that the RA shall not downsize the operations of the corporate debtor, but revive it. It was further observed that the RA shall strive towards ‘insolvency resolution’ and not for addition of value with the intent to sell it. Such purposes were found to be against the basic objectives of the IBC. Interestingly, in this case, the RA was an ARC.

The mandate to compulsorily divest control over the debtor company implies that ARCs may not be able get a fair price for their stakes. The ARCs may instead be forced to sell their stakes in a fire sale, in the debtor company, after having revived it, at a lower price. This is because prospective buyers, being aware that ARCs are mandated to sell the stake in five years, will generally offer low prices.


Based on the above discussion, we believe that allowing ARCs to participate as RAs in an IBC proceeding warranted a legislative amendment as opposed to a mere generic direction under the SARFAESI. Further, notwithstanding the legalities, the measure also seems to be a half-hearted attempt to provisionally increase the pool of RAs, without giving ARCs the opportunity to participate meaningfully in revival of distressed Indian companies in the long term. For instance, the condition to divest significant influence or control over the insolvent entity within five years can prove to be economically counterproductive.

This condition is also untraceable in the recommendations of the ‘Report of the Committee to Review the Working of Asset Reconstruction Companies’ (“RBI Committee”) that recommended ARCs to be eligible RAs in IBC proceedings. However, the RBI Committee, while allowing ARCs to be RAs, expressed their concern of ARCs eventually not having reconstruction and securitisation as their primary businesses. This could be the possible rationale behind enacting the aforesaid five year divestment requirement on ARCs.

That said, the RBI could have better addressed this concern by considering the solution offered by the RBI Committee itself – ensuring securitisation and reconstruction as ARCs’ Principal Business Requirement (“PBR”) wherein asset under management (“AUM”) by the ARC acquired under IBC should not exceed the AUM acquired via the PBR.

Arshit Kapoor and Srilagna Dash

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