Supreme Court declares RBI Circular on revised framework for resolution of stressed assets ultra vires . All cases proceeded declared to be non-est
ABCAUS Case Law Citation:
ABCAUS 2857 (2019) (04) SC
Important Case Laws Cited/relied upon by the parties
RBI by Notification/circular dated 12.02.2018 had promulgated a revised framework for resolution of stressed assets.
The revised framework requires banks/Financial institutions for early identification and reporting of stress in loan accounts as special mention accounts into different categories starting from even one day default as under:
Basis for classification – Principal or interest payment or any other amount wholly or partly overdue between
Further, the revised framework calls for immediate implementation of Resolution Plan as soon as there is a default in the borrower entity’s account with any lender.
A number of petitions had been filed in the Hon’ble Supreme Court challenging the the constitutional validity of Sections 35AA and 35AB of the Banking Regulation Act, 1949 [Banking Regulation Act] introduced by way of amendment w.e.f. 04.05.2017 viz-a-viz the said RBI Circular issued on 12.02.2018.
The salient features of the circular were that restructuring in respect of borrower entities de hors the Insolvency and Bankruptcy Code, 2016 (Insolvency Code) can only occur if the resolution plan that involves restructuring is agreed to by all lenders, i.e., 100 per cent concurrence. Secondly, the subject matter of the circular was debts with an aggregate exposure of INR 2000 crore and over on or after 01.03.2018. With respect to such debts, if default persists for 180 days from 01.03.2018, or if the date of first default is after 01.03.2018, then 180 days calculated with effect from that date, lenders shall file applications singly or jointly under the Insolvency Code within 15 days from the expiry of the aforesaid 180 days.
In short, unless a restructuring process in respect of debts with an aggregate exposure of over INR 2000 crore is fully implemented on or before 195 days from the reference date or date of first default, the lenders will have to file applications as financial creditors under the Insolvency Code.
The Hon’ble Supreme Court had ordered the status quo to be maintained resulting in the circular in effect, been stayed on and from 11.09.2018.
It was contended that to apply a 180-day limit to all sectors of the economy without going into the special problems faced by each sector would treat unequals equally and would be arbitrary and discriminatory, and therefore, violative of Article 14 of the Constitution of India. Also, picking up at random all defaults amounting to INR 2000 crore and above, as well as the fact that even a lender whose stake is only 1 per cent can stall a resolution process de hors the Insolvency Code make the circular manifestly arbitrary and violative of Article 14 on this score as well.
It was argued that the impugned circular was ultra vires the provisions of those Acts. According to him, Section 35A and Section 35AB of the Banking Regulation Act cannot possibly be the source of power for the impugned circular. Section 35A was introduced by an Amendment Act of 1956 and cannot, therefore, be used to empower the RBI to relegate companies to insolvency under the Insolvency Code as it did not exist at the time, or to give directions for resolution of stressed assets.
The Hon’ble Supreme Court observed that when it comes to lack of any guidelines by which the power given to the RBI is to be exercised, it is clear from a catena of judgments that such guidance can be obtained not only from the Statement of Objects and Reasons and the Preamble to the Act, but also from its provisions.
Accordingly, the Hon’ble Supreme Court rejected the pleas of constitutional validity.
The Hon’ble Supreme Court observed that generally, statutes are recognised as Acts of Parliament that should be deemed to be “always speaking”. However, guidance on whether a statute can apply to new situations not in contemplation of Parliament when the statute was enacted was set out in a UK judgment
The Hon’ble Supreme Court opined that even a cursory reading of Section 35A makes it clear that there is nothing in the aforesaid provision which would indicate that the power of the RBI to give directions, when it comes to the Insolvency Code, cannot be so given.
The Hon’ble Supreme Court observed that Section 35AA makes it clear that the Central Government may, by order, authorise the RBI to issue directions to any banking company or banking companies when it comes to initiating the insolvency resolution process under the provisions of the Insolvency Code. The first thing to be noted is that without such authorisation, the RBI would have no such power. There are many sections in the Banking Regulation Act which enumerate the powers of the Central Government vis-à-vis the powers of the RBI.
The Hon’ble Supreme Court opined that prior to the enactment of Section 35AA, it may have been possible to say that when it comes to the RBI issuing directions to a banking company to initiate insolvency resolution process under the Insolvency Code, it could have issued such directions under Sections 21 and 35A. But after Section 35AA, it may do so only within the four corners of Section 35AA.
The Hon’ble Supreme Court pointed out that if a statute confers power to do a particular act and has laid down the method in which that power has to be exercised, it necessarily prohibits the doing of the act in any manner other than that which has been prescribed.
The Hon’ble Supreme Court opined that the RBI can only direct banking institutions to move under the Insolvency Code if two conditions precedent are specified, namely,
(i) that there is a Central Government authorisation to do so; and
(ii) that it should be in respect of specific defaults.
The Section, therefore, by necessary implication, prohibits this power from being exercised in any manner other than the manner set out in Section 35AA.
The Hon’ble Supreme Court pointed out that the power to issue directions given by Section 35AB is without prejudice only to the provisions of Section 35A, i.e., it has to be read in conjunction with Section 35A. What is of even greater significance is that Section 35AB is not without prejudice to the provisions contained in Section 35AA. This being so, it is clear that the power under Section 35AB, read with Section 35A, is to be exercised separately from the power conferred by Section 35AA.
The Hon’ble Supreme Court noted that the Press Note dated 05.05.2017, set out supra, explained the new Sections 35AA and 35AB as the grant of two distinct and separate powers. Section 35AA has been inserted “to resolve specific stressed assets by initiating insolvency resolution process where required”. On the other hand, Section 35AB has been enacted so that the “RBI has also been empowered to issue other directions for resolution……”
The Hon’ble Supreme Court noted that Section 35AA is enacted exactly as it is in the Ordinance. So is Section 35AB, except for a minor addition in sub-section (1), which adds the words “any banking company or”. Even the Statement of Objects and Reasons introducing the same Sections by way of an Amendment Act made it clear that the powers conferred for resolution of stressed assets, either by invoking the Insolvency Code or by other means, are separate and independent powers, as set out in paragraphs 3(a) and 3(b) of the said Statement of Objects and Reasons.
Therefore, the Hon’ble Supreme Court explained the scheme of Sections 35A, 35AA, and 35AB as follows:
(a) When it comes to issuing directions to initiate the insolvency resolution process under the Insolvency Code, Section 35AA is the only source of power.
(b) When it comes to issuing directions in respect of stressed assets, which directions are directions other than resolving this problem under the Insolvency Code, such power falls within Section 35A read with Section 35AB. This also becomes clear from the fact that Section 35AB(2) enables the RBI to specify one or more authorities or committees to advise any banking company on resolution of stressed assets. This advice is obviously de hors the Insolvency Code, as once an application is made under the Insolvency Code, such advice would be wholly redundant, as the Insolvency Code provisions would then take over and have to be followed.
The Hon’ble Supreme Court pointed out that When one section of a statute grants general powers, as opposed to another section of the same statute which grants specific powers, the general provisions cannot be utilised where a specific provision has been enacted with a specific purpose in mind.
The Hon’ble Supreme Court opined that the stressed assets can be resolved either through the Insolvency Code or otherwise. When resolution through the Code is to be effected, the specific power granted by Section 35AA can alone be availed by the RBI. When resolution de hors the Code is to be effected, the general powers under Sections 35A and 35AB are to be used. Any other interpretation would make Section 35AA otiose.
The Hon’ble Supreme Court opined that the argument that the RBI can issue directions to a banking company in respect of initiating insolvency resolution process under the Insolvency Code under Sections 21, 35A, and 35AB of the Banking Regulation Act, would obviate the necessity of a Central Government authorisation to do so. Absent the Central Government authorisation under Section 35AA, it is clear that the RBI would have no such power.
The Hon’ble Supreme Court observed that a reading of various definitions of Insolvency Code would make it clear that default would mean non- payment of a debt when it has become due and payable and is not paid by the corporate debtor. Therefore, what is important to note is that it is a particular default of a particular debtor that is the subject matter of Section 35AA.
Therefore, the Hon’ble Supreme Court opined that the expression “issue directions to banking companies generally or to any banking company in particular” occurring in Section 35A is conspicuous by its absence in Section 35AA. Hence Section 35AA refers only to specific cases of default and not to the issuance of directions to banking companies generally, as has been done by the impugned circular.
The Hon’ble Supreme Court pointed out that the above reasoning is also clear also from the Press Note dated 05.05.2017, which introduced the Ordinance which specifically referred to resolution of “specific” stressed assets which will empower the RBI to intervene in “specific” cases of resolution of NPAs. The Statement of Objects and Reasons for introducing Section 35AA also emphasises that directions are in respect of “a default”.
The Hon’ble Supreme Court opined that the directions that can be issued under Section 35AA can only be in respect of specific defaults by specific debtors. This is also the understanding of the Central Government when it issued the notification dated 05.05.2017, which authorised the RBI to issue such directions only in respect of “a default” under the Code. Thus, any directions which are in respect of debtors generally, would be ultra vires Section 35AA.
The Hon’ble Supreme Court observed that the impugned circular states as one of its sources, the power contained in Section 45L of the RBI Act insofar as non-banking financial institutions are concerned. However, there is nothing to show that the provisions of Section 45L(3) have been satisfied in issuing the impugned circular.
The impugned circular applies to banking and non-banking institutions alike, as banking and non-banking institutions are often in a joint lenders’ forum which jointly lend sums of money to debtors. Such non-banking financial institutions are, therefore, inseparable from banking institutions insofar as the application of the impugned circular is concerned. It is very difficult to segregate the non-banking financial institutions from banks so as to make the circular applicable to them even if it is ultra vires insofar as banks are concerned.
For the above reasons, the Hon’ble Supreme Court declared the impugned circular as ultra vires as a whole, and declared to be of no effect in law.
Consequently, the Hon’ble Supreme Court held that all actions taken under the said circular, including actions by which the Insolvency Code has been triggered must fall along with the said circular. As a result, all cases in which debtors have been proceeded against by financial creditors under Section 7 of the Insolvency Code, only because of the operation of the impugned circular will be proceedings which, being faulted at the very inception, declared to be non-est