Role of Reserve Bank of India in the Conundrum of Resolution of Stressed Assets

Introduction

The term stressed assets means the summation of non-performing assets, restructured loans and written off assets.

India’s financial position with respect to stressed assets and non-performing assets (SAs & NPAs) started becoming volatile and weak with the scams and financial frauds of Sahara, Vijay Mallya, Nirav Modi and the likes of them, and so on. A lot of corporates had taken loans from banking/financial institutions which over the years had become NPAs and the banks found it extremely difficult to deal with the low cash reserves and the management of stressed assets. As per the latest financial reports the position of stressed assets in India is estimated to be more than 135 million USD. Further, as per the statistics, as of 31-3-2017 the recovery rate of NPAs had drastically gone down to 20.8% from 61.8% in 2009.

The Government of India introduced amendments in Sections 35-AA and 35-AB of the Banking Regulation Act, 1949 w.e.f. 4-5-2017. The Reserve Bank of India (RBI) based on the aforesaid amendment issued a revised framework for resolution of stressed assets vide Circular dated 12-2-2018.

The aforesaid circular was struck down by the Supreme Court vide judgment in Dharani Sugars and Chemicals Ltd. v. Union of India¹. Thereafter the RBI issued a Circular dated 7-6-2019 wherein the RBI acknowledged the findings of the Supreme Court in the aforesaid judgment. The authors through this article intend to analyse the judgment of the Supreme Court in Dharani Sugars² and the position qua resolution of stressed assets under the revised regime which was introduced vide Circular dated 7-6-2019.

Analysis of the judgment of Supreme Court in Dharani Sugars

The RBI Circular dated 12-2-2018 was challenged by several power companies, many telecom companies on the anvil of Article 14 of the Constitution of India. The main contentions of the petitioners were threefold which are as follows:

(i) The 180 days timeline for resolution along with the mandate for the lenders to take the route of Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as the “Code”) by filing application under Section 7 of the Code were argued to be manifestly arbitrary.

(ii) The lack of segregation between different sectors which were reeling under the problems of stressed assets, which was based on the reports of the Parliamentary Standing Committees (37th, 40th and 42nd) was contended to be arbitrary. The threshold of the contention was based on the report of the 40th Standing Committee which had recommended RBI to take sector specific approach and sector friendly assets for resolution of stressed asset. The report further opined that the present revised framework of RBI was done ignoring the prevailing realities.

(iii) Further the petitioners contended that Sections 35-AA and 35-AB could not be the omnibus source of power of RBI to mandate/direct banks to approach NCLTs under the Code in cases of default.

The Supreme Court in the said matter held that the Circular dated 12-2-2018 was bad in law and ultra vires to Article 14 of the Constitution as it failed to make distinction between banking and non-banking companies with respect to “default”. The Supreme Court held that such an omnibus rule while dealing with defaults, wherein both banking and non-banking financial companies are treated alike fell foul of the doctrine of “unequals being treated equally” and therefore was held to be against the mandate of Article 14. However, the Supreme Court, upheld the power of RBI to issue directions under Sections 35-AA and 35-AB. The Supreme Court declared that the entire circular was being struck down and the actions taken under the circular shall stand quashed. Further, the resolutions plans, which were given effect under the said circular, would stand quashed or will have to follow the old prudential norms save and except those, which were consensual in nature.

The aforesaid judgment is seen and perceived as path-breaking, as the circular did not address the most obvious distinction in the branch of constitutional law read with the statutory norms under the Banking Regulation Act, 1949 i.e. the definition of “default”. The cases of stressed assets and NPAs which are a result of the default committed by the borrowers to the banks and non-banking financial institutions/companies could not have been treated alike and even the resolution scheme could not have been the same. Hence, as soon as the circular was declared to be unconstitutional and was quashed, the RBI had announced that the apex banking institution shall adhere to the judgment and shall bring out a circular in line with the aforesaid ruling of the Supreme Court.

Forward steps taken by Reserve Bank of India

The RBI taking a cue from the aforesaid judgment, introduced a new Circular dated 7-6-2019.³

The broad contours of the new circular are early recognition of stress, complete discretion of lenders to decide on a resolution plan, but no revival of the earlier failed schemes like strategic debt restructuring (SDR), sustainable structuring of stressed assets (S4A), etc., signing of a binding inter-creditor agreement (ICA) to finalise and implement the resolution plan and an accelerated provision if the time-bound resolution fails. It is not mandatory for banks to refer cases under the Code to the NCLT.⁴

According to the new guidelines, in the event of a borrower defaulting to any lender, all the lenders would put in place a resolution plan (RP) within 30 days of such default. During this 30-day review period, the lenders would decide on a resolution strategy (sale of loan, legal action for debt recovery, immediate referral to NCLT, etc.) which could also include restructuring and change in ownership as well. In case an RP is implemented, the lenders would sign inter-creditor agreement (ICA) during the review period. An agreement signed by lenders representing 75 per cent by value of outstanding or 60 per cent of lenders by number would be binding on all lenders. The RP shall provide for payment not less than liquidation value (estimated realisable value of the assets) due to the lenders. For most large borrowers, the resolution plan will have to be implemented within 180 days from the end of the review period.⁵

One key feature of the June 7 circular was that the dissenting financial creditor would be given the liquidation value and that, the lenders were not bound by the ICA, meaning thereby it was mandatory to agree to the majority of the lenders for devising a method to recover or restructure the stressed asset/NPA.

The aforesaid question fell for consideration before Bombay High Court in GTL Infrastructure Ltd. v. Canara Bank,⁶ wherein the High Court dismissed the writ petition preferred by GTL Infra by holding that, it was not incumbent on any creditor to take a route of recovery (SARFAESI or IBC) even if the majority of the creditors in joint lenders forum (JLF) had chosen that particular route/avenue while signing the ICA. In the aforesaid matter, the Canara Bank had approached the NCLT under Section 7 of the Code, while the other members while signing the ICA had preferred to approach the DRT under SARFAESI, 2002.

Being aggrieved by the judgment and order dated 3-2-2020 of the Bombay High Court, GTL Infrastructure approached Supreme Court of India. The Supreme Court vide judgment dated 6-12-2021⁷, while dismissing the appeal held as under:

“Paragraph 6.4 (d)(i) itself makes the position quite clear that each bank/ financial institution must make its own assessment of the value offered by the SC/RC for the financial asset and decide whether to accept or reject the offer. The High Court was, therefore, right in holding that there would be no obligation upon the bank/FI in terms of paragraph 6.4 (d)(ii) as was contended on behalf of the appellant. Thus, the High Court was absolutely right and justified in rejecting the claim made on behalf of the appellant. We, therefore, see no reason to entertain this appeal, which is accordingly dismissed without any order as to costs.”

Therefore, the contention, that if the maximum lenders in the JLC (Joint Lenders Forum/Committee) follows a particular path of recovery or restructuring, it is not incumbent on any other member (dissenting) to follow that avenue, was negated and the primacy of the choice of path/avenue by the creditor(s) was upheld as provided for in the circular. Hence, the revised regulatory framework dated 7-6-2019 was upheld.

In addition to the aforesaid, it was reported in a news article on The Hindu Businessline⁸ on 30-9-2022, that the RBI is looking to introduce a discussion paper on the framework of resolution of stressed assets in addition to the route specified under SARFAESI i.e. the resolution through asset reconstruction companies (ARCs). The route of a framework for securitisation of stressed assets in addition to that of ARCs under the SARFAESI shall pave path for more investors with more rational pricing.

Conclusion

The step taken by RBI to introduce the revised regulatory framework dated 7-6-2019 after the judgment of the Supreme Court, has proved to be a welcome move as the lenders’ primacy has been upheld and the financial honchoing/hara-kiri, which was prevalent among some of the lenders, who would have teamed up with some of the debtors to wriggle out of the debt-ridden structure. Under the old regime and prior to introduction of the Code in 2016, the debt-ridden companies would have managed some lenders in the JLF to settle the debt and re-enter into the management. However, subsequently the amendments of 2018 and 2019 wherein Section 29-A was introduced in the Code to stop the erstwhile management or even its associate companies to re-enter into the management of the debt-ridden companies. Hence, now with the choice and primacy given to the lender(s) to opt-out of the majority and decide the mode of recovery as provided for in the circular.

The authors hope that with the primacy given to the lenders under the said circular, would help the ARCs and the lenders to restructure the debt without allowing the erstwhile management to re-enter the management. It shall only help the move of restructuring and increase the recovery of assets/debts and the level of stressed assets shall improve which shall in turn help in the growth of Indian economy.