Brief Analysis on recent Supreme Court's judgement striking down RBI’s Circular on debt resolution

CS Peer mehboob  on 23 April 2019


Introduction:

On April 2, 2019, Supreme Court, in the matter of Dharani Sugars and Chemicals Ltd. Vs. Union of India, delivered a landmark judgement, which deals with the controversial circular issued on 12th February, 2018 tilted “Resolution of Stressed Assets-Revised Framework” released by Reserve Bank of India (RBI). Vide its judgement, Supreme Court struck down the said RBI circular (Circular) which directed banks to take defaulting companies (with a debt size of Rs. 2000 crore or more) into insolvency proceedings immediately after 180 days of default.

The Circular was challenged by petitioners such as the Association of Power Producers and Independent Power Producers Association of India, who argued that the circular clearly unable to draw distinctions between various types of ‘stressed assets’ from different industrial sectors. Moreover, it was also contended that circular does not distinguish between genuine and wilful defaulters.

With the Feb 12 Circular, a uniform standard was imposed across industries and banks had no discretion but to refer companies to IBC if they met the prescribed objective criteria. The circular had imposed a stringent 6-month deadline for resolving defaults with the threat of IBC. The striking off of the Feb 12 circular in its entirety means bankers will have to evaluate each case on its particular merits as per their commercial wisdom, which is likely to elongate negotiations with promoters and cause inconsistent and unforeseeable resolutions. 

Impact of the Judgement:

The Supreme Court held that RBI circular is ultra vires Section 35AA of the Banking Regulation Act, and declared to be of no effect in law. Consequently, all actions taken under the said circular by which insolvency code has been triggered, have hence forth become null and void.

As per Section 35AA, RBI can only direct banking institutions to move under the insolvency code if two conditions are specified:

That there is a Central Government authorisation to do so; and
That it should be in respect of specific defaults.

Supreme Court said that while issuing the impugned circular, RBI needed Central Governments authorisation, which it did not obtain. Further, RBI could not have issued general omnibus order, as it is only authorised to issue orders on “specific defaults”.

Effect of Judgement passed by Supreme Court can be summarised as follows:

All actions taken under RBI circular becomes void. But does not mean cases in NCLT go away automatically but parties in NCLT will have to prove if insolvency was under circular or not. If else, process will continue;

Huge relief for stressed assets in sectors such as power, sugar and fertiliser;

Ruling restores banks’ discretion to take a call on whether to invoke insolvency proceedings in IBC on case to case basis. Having that this could delay resolution proceedings because of the greater discretion given to lenders impacting loan recoveries;

Lenders can now use IBC as a tool as per their commercial wisdom and they no longer required to initiate proceedings under IBC compulsorily.

It will also facilitate a greater occurrence of pre-IBC settlements.

However, the RBI vide its press release dated April 4, 2019 declared that it will take necessary steps, including issuance of revised circular, for expeditious and effective resolution of stressed assets.

Concluding Remarks

It is essential to note that Supreme Court invalidated the entirety of the circular and essentially stated that it will have no effect in law. This means that any insolvency proceedings which were initiated by financial creditors in pursuance of section 7 of the IBC under the auspices of the Circular are now, from their very inception, null and void. However, Supreme Court has not curtailed any lender’s statutory rights under the IBC to initiate statutory rights under the IBC to initiate insolvency proceedings as a financial creditor, regardless of the powers of RBI and the Central Government and any specific instruction issued by any authority.

From commercial standpoint, banks and promoters of defaulting companies could possibly welcome the judgement as having relieved a substantial amount of pressure which was attributable to the rigid time frame set out in the circular.


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