Hon’ble Supreme Court, in Dharani Sugars and Chemicals Ltd v Union of India and Others, on 02 April 2019 held the constitutional validity of Ss. 35AA and 35AB of the Banking Regulations Act, 1949 (the Banking Regulation Act) and also held that the RBI circular of 12.02.2018 directing banking and non-banking companies to initiate action under the Insolvency and Bankruptcy Code 2016 (the Insolvency Code) as invalid being violative of Section 35AA of the said Act and hence action under the said circular shall fail. Here is the brief analysis of the said judgement.

The Banking Regulation (Amendment) Ordinance, 2017 introduced Sections 35AA and 35AB as amendments to the Banking Regulation Act on 04.05.2017. The same reads as under:

“35AA. The Central Government may by order authorise the Reserve Bank to issue directions to any banking company or banking companies to initiate insolvency resolution process in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016. 

Explanation. – For the purposes of this section, “default” has the same meaning assigned to it in clause (12) of section 3 of the Insolvency and Bankruptcy Code, 2016. 

35AB. (1) Without prejudice to the provisions of section 35A, the Reserve Bank may, from time to time, issue directions to the banking companies for resolution of stressed assets. 

(2) The Reserve Bank may specify one or more authorities or committees with such members as the Reserve Bank may appoint or approve for appointment to advise banking companies on resolution of stressed assets.” 

Hon’ble Supreme Court has upheld the constitutional validity of Sections 35AA and 35AB of the Banking Regulation Act, 1949.

The constitutional validity is upheld by replying upon the following principles:

(i) economic legislation to be viewed with great latitude (referring to para 85 of Swiss Ribbons Pvt. Ltd. and Anr. v. Union of India and Ors., 2019 (2) SCALE 5).

(ii) Petitioners failed to point out how either of these provisions are manifestly arbitrary [referring to ‘manifestly arbitrariness’ as in Shayara Bano v. Union of India, (2017) 9 SCC 1]. And further observing that these provisions (Ss. 35AA and 35AB) are not different in quality from any of the sections which have already conferred such powers (Sections 14A, 17, 18, 20, 21, 22 – Sec.22(3) in particular, 25, 29, 30 and 31 of the Banking Regulation Act). Further, Hon’ble Court also found that the amendment does not suffer from adequate guidelines [referring to Harishankar Bagla v. State of M. P., (1955) 1 SCR 380 – para 9]; and Gwalior Rayon Silk Mfg. (Wvg.) Co. Ltd. v. The Assistant Commissioner of Sales Tax and Ors. – paras 13, 15, 17 and 18].

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. 

In exercise of power under section 35AA, the Central Government authorised the RBI vide its order dated 05.05.2017 to take defaulters to NCLT under the Insolvency and Bankruptcy Code, 2016 (‘the Insolvency Code’). Thereupon, the RBI issued circular dated 12.02.2018.

The salient features of the RBI circular dated 12.02.2018 are that restructuring in respect of borrower entities de hors the Insolvency and Bankruptcy Code, 2016 can only occur if the resolution plan that involves restructuring is agreed to by all lenders, i.e., 100 per cent concurrence. Secondly, what has been chosen to be the subject matter of the circular is 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.

It was contended before Hon’ble Supreme Court that the RBI already had such power under Section 35A of the Banking Regulation Act, however it was countered by the Petitioners that when section 35A was introduced in the said Act, at that time the Code was not prevalent and hence RBI directing banks and NBFCs to take action under the Code u/s.35A cannot be accepted.

Held, all statutes are to be interpreted as “always speaking statutes”, unless they reveal a contrary intention. Meaning with change of time meaning in words in statute also gets changed. And thus, has section 35AA not been brought to the Statute book, RBI could have exercised its power u/s. 35A of the Banking Regulations Act, even for IBC.

“The corollary of this is 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 matter can be looked at from a slightly different angle. 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 contention that though RBI had enough power u/s. 21 and u/s.35A, new section 35AA was introduced to the Banking Regulation Act as an abundant caution, was not accepted. Hon’ble Supreme Court held that it cannot be so accepted as (i) two conditions precedent introduced in section 35AA, without which, powers cannot be exercised by RBI; and (ii) it is well settled that Parliament does not legislate when no legislation is called for.

Further Hon’ble Supreme Court concluded that “Therefore, the scheme of Sections 35A, 35AA, and 35AB is 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. 
• Further Hon’ble Supreme Court concluded that it is clear also from the Press Note dated 05.05.2017 of the Central Government (Ministry of Finance), which introduced the Ordinance and 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”. Thus, it is clear that 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. 

Then Section 13 of the General Clauses Act, 1897 [“General Clauses Act”] was relied upon to state that the singular would include the plural. To which Hon’ble Court noted that there is no doubt whatsoever that this would be so unless the context otherwise requires, as is provided by Section 13 of the General Clauses Act itself. In the present case, the context of Section 35AA makes it clear that the power to be exercised under the authorisation of the Central Government requires “due deliberation and care” to refer to specific defaults. 

Finally it is held that “Consequently, 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, are declared to be non-est.”

Our comments:
Consequently, proceedings taken by banks and /or NBFCs by virtue of the RBI Circular by taking corporate persons to NCLT under the Insolvency Code has become nullity and without support of law. However, that does not mean that banks / NBFCs are not entitled to recover their debts. Banks/ NBFCs may decide to restructure the debt of such cases outside the Insolvency Code, including under the Sashakt Project. And also equally possible that any one of the Banks / NBFCs may initiate fresh action under the Insolvency Code.

It is believed that the RBI may issue a fresh circular and thereby direct banks and/or NBFCs on steps to be taken due to strike down of its Circular dt. 12.02.2018 by Hon’ble Supreme Court.

Genesis of the RBI Circular 12.02.2018 and impact of the judgement in Dharani Sugars case: To better understand the situation, it is relevant to know the genesis in brief.

Asset Quality Review (AQR) for banks was implemented by RBI in the second half of 2015 and it revealed the true picture of NPA problem. The gross NPAs of Scheduled Commercial Banks (SCBs) rose to Rs.10.4 trillion in March 2018 from Rs.3.2 trillion in March 2015. The problem was more severe for the Public Sector Banks (PSBs) with gross NPAs reaching Rs.9 trillion from Rs.2.8 trillion during the same period.

RBI tried to resolve the NPA problem through several initiatives, including CDR, SDR, S4A, JLF etc.  Two major initiatives have been the Prompt Corrective Action (PCA) by RBI and the recapitalisation of the PSBs by the Government. In April 2017, RBI revised the PCA framework and in October 2017 the Government announced Rs.2.11 trillion recapitalisation package for ailing PSBs, of which Rs.1.53 trillion would be infusion by Government and balance to be raised from the market. 

As these experiments failed, and upon implementation of the IBC, the RBI scrapped all these initiatives and issued a revised guideline on 12 Feb. 2018 for early resolution of stressed assets.

Thereafter, in July 2018, the scheme, called ‘Sashakt’, was recommended by a bankers’ committee and accepted by the government. It is inter-lenders agreement. And it proposes to have a resolution plan for defaulting borrowers and the same to be implemented in a time bound manner. The nature of the resolution plans approved under the inter-creditor agreements would be similar to those under consideration as part of the Insolvency process. However, in this case promoters would continue to be in-charge.

Since this was not enough, particularly after remaining in ICU under PCA for over two years, merger of PSBs is also adopted, as has been done since bank nationalisation. A compulsory merger of banks under section 45 of the Banking Regulation Act, 1949. Amalgamation of Vijaya Bank and Dena Bank with Bank of Baroda has been notified on January 2, 2019. The notification has come into force on April 1, 2019.

And now comes the ruling of the Hon’ble Supreme Court of India, whereby it precludes the RBI from issuing any general directions to banks to initiate insolvency under the Insolvency and Bankruptcy Code, 2016. What is now left for the RBI and the Government is action under Section 35AA and 35AB of the Banking Regulations Act. The Central Government may now analyse specific cases of defaults and issue directions to the RBI in respect of those specific cases. 

Technically, the judgment revives the ability of borrowers to rely on CDR, SDR, S4A, JLF and other restructuring measures (“Traditional Measures”), which were repealed by the RBI Circular of 12 Feb. 2018. However, the market awaits clarity from the RBI on these Traditional Measures.

Given that these Traditional Measures have not achieved much success in resolving NPA issue, Banks are likely to exercise their rights to initiate insolvency proceedings on their own, being their statutory right under section 7 the Code as a financial creditor, probably after taking defaulting borrowers through the Sashakt framework. However, in deserving cases, Banks may take defaulting borrowers directly to NCLT under the Code instead of the Sashakt framework. The Code has given lenders ‘stick’ to deter enough the defaulting Corproate Borrowers to remain on edge.

Way forward: 

Upon request of RBI, from time to time, the Central Govt. to consider ‘specific’ cases for taking under the Insolvency Code and authorise RBI to issue direction to banks and NBFCs to take such specific defaulting borrowers to NCLT under the Insolvency Code. Obviously, such ‘specific’ cases could be where banks on their own are not taking companies to NCLT under the Code.

Alternatively, the Government (mostly after election) may either modify / scrap section 35AA of the Banking Regulations Act and thus enable RBI to bring back the general circular, based on observation of Hon’ble Supreme Court in Dharani Sugars case that RBI could have issued circular similar to circular dt. 12.2.2018 had section 35AA was not legislated. And before deciding on such actions, the Government need to take policy decision on whether to allow further time to specific sectors like power, cement etc. considering their contribution to employment and the economy.

While some of the defaulting corporate borrowers might be happy for now, it’s not going to last long.