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Supreme Court strikes down RBI’s Revised Framework on the resolution of stressed assets

Finsec Law Advisors

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On February 12, 2018, the Reserve Bank of India (RBI) had issued a circular (RBI Circular) which overhauled and revised the framework for the resolution of stressed assets in India. The RBI Circular had inter alia laid down a uniform and strict timeline for banks to initiate resolution proceedings under the Insolvency and Bankruptcy Code, 2016 (IBC). Under the RBI Circular, banks were required to classify any default of loan of ₹ 2000 crore and above as a non-performing asset and provide a defaulter a period of 180 days to repay the dues. In case of failure to recover dues within the stipulated period, the banks would have to initiate insolvency resolution process against the defaulter under the IBC. The RBI Circular also withdrew all previous schemes of the RBI with respect to the resolution of stressed assets, including the Strategic Debt Restructuring Scheme and the Scheme of Sustainable Structuring of Stressed Assets. In the past, RBI has also recommended banks to initiate action against specific defaulters under the IBC. For instance, in June 2017, RBI had identified a list of 12 specific defaulters which made up 25% of the non-performing assets of the banking systems at the relevant time and recommended banks to refer the matters for resolution under the IBC.

However, on April 02, 2019, the Supreme Court of India (SC) in the matter of Dharani Sugars and Chemicals Ltd. v. Union of India & Ors. set aside the RBI Circular in its entirety (SC Order). With respect to RBI’s direction to refer matters under the IBC, the SC held that under Section 35AA of the Banking Regulations Act, 1949 (Banking Act), RBI could only issue directions on a particular default of a debtor pursuant to receiving the authorisation of the Central Government and not pass generic instructions mandating banks to initiate insolvency process against defaulters.

The SC Order distinguishes RBI’s powers to issue directions under Section 35AA and under Section 35A & Section 35AB of the Banking Act. Section 35AA is a specific provision related to cases wherein RBI can direct banks to initiate insolvency resolution process for stressed assets under the IBC. Whereas, Section 35A and 35AB deal with resolving stressed assets through other mechanisms/directions. For passing directions under Section 35AA, RBI requires specific authorisation from the Central Government. Whereas, the general powers of RBI to issue directions to banks under 35A and 35AB do not require any specific authorisation from the Central Government.

The SC Order has brought a big sigh of relief for corporate debtors especially those from the power and infrastructure sectors. The SC Order grants more precious time to the promoters and management of defaulting companies to renegotiate recovery plans with banks as they no longer need to comply with the strict timeline laid down in the RBI Circular. Further, lenders too continue to enjoy their discretionary rights to initiate proceedings against defaulters as per the terms of the IBC.

In the SC Order, the SC has distinguished Section 35A & Section 35B from Section 35AA and clarified that RBI can exercise powers under section 35AA subject to certain conditions. SC’s interpretation of section 35AA has curtailed RBI’s power to the extent that directions issued to banks under this section must now i) be authorised by the Central Government and ii) it must relate to a particular default of a particular debtor. RBI directions under Section 35AA cannot be generic instructions issued to banks.

Pursuant to the SC Order, the RBI must strive to exercise its powers reasonably and judiciously. Regulatory bodies may have the right intentions however, they cannot exercise powers beyond what is conferred upon them. Regulators in the financial sector including RBI and SEBI must ensure that they judiciously operate within the realm of their respective regulatory framework which also governs them. RBI’s recent decision to issue a revised circular taking into account the SC Order is a move in the right direction.