May 11, 2019

Supreme Court ON RBI Circular Of 12th February, 2018

- Nabik Syam, Partner [ P&A Law Offices, Mumbai ]


For the purposes of making The Insolvency and Bankruptcy Code, 2016 (Code) effective in its execution, the Government issued, The Banking Regulation (Amendment) Ordinance, 2017, which was legislatively introduced and notified by The Banking Regulation (Amendment) Act, 2017 (Amendment), vide which, Section 35AA and 35AB were inserted

The law, is a cudgel when necessary and a balm where appropriate. It seems this has found its reflection in the ongoing evolution of IBC visà-vis allied statutes, their amendments and interpretations.

For the purposes of making the Code effective in its execution, the Government issued, The Banking Regulation (Amendment) Ordinance, 2017, which was legislatively introduced by The Banking Regulation (Amendment) Act 2017 (Amendment), vide which, Section 35AA and 35AB were inserted. At about the same time period, the Reserve Bank of India (RBI), by way of the Press Release of 13th June, 2017, identified certain accounts for reference by banks under the Code. An “Internal Advisory Committee” (IAC), was constituted for the purposes of recommending to the RBI the large stressed accounts which were classified partly or wholly as non-performing from among top 500 exposures in the banking system. Consequently, certain accounts were identified, which itself constituted around 25% of the NPAs in the system. It is mentioned in this context that the essence of the Amendment was that the Central Government may, by order, authorize the Reserve Bank of India (RBI), to issue directions to any banking company or companies to initiate insolvency resolution process in respect of a default under the provisions of the Code. The explanation to Section 35AA provides, that for the purpose of this section, “default” shall have the same meaning as assigned to it in Section 3(12) of the Code, while Section 35AB provided that RBI, without prejudice to the provisions of Section 35A, may issue directions from time to time to any banking company or companies, for resolution of stressed assets and for such purpose, RBI may specify one or more authorities or committees to advise the banking company or companies, on resolution of stressed assets.

Riding on the crest of the said Amendment and the powers conferred under Section 35AA of the Banking Regulation Act and Section 45L of the Reserve Bank of India Act, the RBI issued the circular of 12th February, 2018 (Circular), which in one stroke inter alia, completely erased the erstwhile resolution framework of stressed assets like corporate debt restructuring scheme, flexible structuring of existing long term project loans, strategic debt restructuring scheme, scheme for sustainable structuring of stressed assets, etc., with immediate effect. This also rendered an institutional mechanism of Joint Lenders Forum as redundant. As a result, an entire regime of circulars/directions/guidelines in regard to such restructuring of assets stood repealed from the date of Circular.

The salient features of the Circular may be stated as here under: -

• Restructuring in respect of borrower entities, de hors the IBC, will happen if only the Resolution Plan (RP) that involves restructuring, is agreed to by all lenders, that is 100% concurrence.
• The subject matter of the Circular are debts, aggregate exposure of which is `200 Crore and above, existing on or after 1st March, 2018. For such debts, if default persists for 180 days from 1st March, 2018 or if the date of First default is after 1st March, 2018, then 180 days from the date of such default, lenders shall file applications singly/jointly under the Code, within 15 days from the expiry of 180 days. The circular mentions the sources of power for issuance of the same to be Section 35A, Section 35AA and Section 35AB of the Banking Regulation Act and Section 45L of the Reserve Bank of India Act. The Circular was thus a “one-sizefits-all” arrangement for all kinds of stressed assets across the economy.

The Challenge filed before the Supreme Court was on the broad spectrum of constitutional validity of the Ordinance and the Amendment stating inter alia that Section 35AA and Section 35AB are:

(i) ‘Manifestly arbitrary’.
(ii) Suffer from absence of guidelines.

The real bone of contention from which the questions as to constitutional validity of the above stated sections of the amended Banking Regulation Act arose was the Circular. The challenge was led by the power sector, later joined in by various other specialized sectors like telecom, steel, infrastructure, sugar, etc., stating the peculiarity and distinct character of those sectors and the difficulties faced as a result of Government Policies, leading to financial stress, despite efficient management of the companies in those sectors.

The Hon’ble Apex Court now needed to give a dynamic interpretation of the very premise of contemporary socioeconomic legislations. The socio-economic legislations of contemporary times have provided for delegated legislations so as to obtain flexibility and elasticity, which gives executive the power to make subordinate legislations within a prescribed sphere, keeping in mind the practical necessity, pragmatic needs of a modern welfare state on one side and the effect of excessive delegation of legislative authority leading to arbitrariness of the executive on the other.

The Hon’ble Apex Court in this exercise noted the scope of Section 35A of the Banking Regulation Act, 1949, wherein RBI is empowered to issue directions to the banks in public interest or in the interest of banking policy etc. The Section hinges on the satisfaction of RBI that in the interest of banking policy, it is necessary to issue directions to Banking companies. This exercise of statutory power of RBI thus arises from the satisfaction of RBI itself and this power of RBI is not servile to that of any other executive authority. While interpreting Section 35A as above, the Hon’ble Apex Court however could not find in Section 35AA and 35AB any ingredient which could make the effect of these newly inserted Sections to be in nature, ‘manifestly arbitrary’. The Impugned Amendment Act did not confer any such power which may be said to be excessive in any manner nor can it be said to suffer from want of any guiding principles. The Amendment was held in the nature of conferring regulatory power to RBI for carrying out its functions under the Banking Regulation Act and was not held to be any different from the other Sections of the Banking Regulation Act, which have already conferred such powers to RBI. The Hon’ble Apex Court held, that the guidelines by which the power given to the RBI is to be exercised emerged clear from the statement of Objectives and Reasons of the Amendment Act read along with various other provisions, which are regulatory in nature and giving guidance as to how RBI is to exercise these powers under the newly added provisions.

After coming to the aforesaid conclusion, the Hon’ble Apex Court now embarked on to examine the ingredients of Section 35AA and various other Sections in Banking Regulation Act which enumerates powers of the Central Government vis-à-vis powers of RBI. On this, the Hon’ble Court concluded that, the Banking Regulation Act specifies, that the Central Government, is either to exercise powers along with RBI or by itself by directing RBI. In reference to Section 35AA, when it comes to initiating the insolvency resolution process under the Code, the role assigned by the newly inserted Sections is clear, that it is only on the authorization of the Central Government, can such directions be issued by RBI. So following the well-settled rule, that if the statute has conferred power to do an act in a particular method, it necessarily prohibits the doing of the act in any manner otherwise, RBI can thus only direct banking institutions to move under the Code under two conditions:

• There is a Central Government authority/directions to do so; and
• It should be in respect of ‘specific defaults’. Section 35AA therefore, by necessary implication, prohibits this power to be exercised in any manner other than the manner as set out in Section 35AA itself wherein the Central Government exercises authority to direct RBI to issue such directions in respect of ‘a default’. This ‘Default’ is as per the meaning assigned to it under Section 3(12) of the Code, wherein default would mean non-payment of debt when the whole or any part of that debt becomes due and payable. What is important to note is that, it is a particular default of a particular debtor that is subject matter of Section 35AA. The Apex Court also observed that the expression occurring in Section 35A i.e. “issue directions to banking companies generally or to any banking company in particular” is conspicuous by its absence in Section 35AA. Thus it is clear that directions can be issued under Section 35AA only in respect of specific defaults by specific debtors and any directions which are issued in respect of debtors generally, would be ultra vires Section 35AA. The Hon’ble Apex Court also examined Section 45L of the RBI Act, which specifies power of RBI inter alia to give directions and in the process of issuing such directions, RBI shall have to give due regard to the conditions in which and the objects for which, the institution has been established, its statutory responsibilities and the effect that the business of such financial institutions is likely to have on the money and capital markets. Accordingly, the Hon’ble Supreme Court held, that in the exercise of issuing the Circular there is nothing to show that the requirements of Section 45L were satisfied, since the Circular nowhere mentions, that RBI had given due regard to the conditions in which and the objects for which, such institutions have been established.

On the aforesaid premises and reasoning, the Hon’ble Apex Court declared the Circular, ultra-vires as a whole and to have no effect in law. In view of the above, all actions taken under the said Circular including those cases wherein IBC was triggered was declared as non est along with the said Circular.

The Hon’ble Apex Court by this Judgment, recognized, that approaching issues which have profound socio-economic implications in a dynamic liberal economy, linked by the thread of sectoral requirements, can only be based on existence of reasonable and objective laws, which may not be achieved through the universal ‘cudgel’ of “one size fits all” policy and that law should emerge from the collective conscience of the legislature, treading the due process as mandated therein, instead of a sharp command from any Hobbesian Leviathan.

Disclaimer – The views expressed in this article are the personal views of the author and are purely informative in nature.


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