This article has been written by Shiphali Patel, a 4th year B.A. LL.B (Hons.) student at Dr. Ram Manohar Lohiya National Law University, Lucknow.
BACKGROUND
A strong banking sector is an important prerequisite for a strong economy. The Indian banking sector has been crushing under the Non-Performing Assets (“NPA”), a disastrous problem in India. In order to tackle the burgeoning problem of the NPAs, the government has on several occasions infused capital to the Public Sector Banks using taxpayers’ money. However, it is all more important to keep these banks stable so that the growth of the economy is not negatively hampered. Therefore the RBI and the Government have taken some correctional steps like SARFESI Act and Corporate Debt Restructuring, to improve it but the results have always reflected a very unsatisfactory story. Instead of plunging, NPAs are surging at an alarming level. High-profile cases like that of Vijay Mallaya and Nirav Modi acted like a spark to this gunpowder for RBI to release a circular on 12th Feb 2018 (“Previous Circular”) which included Insolvency and Bankruptcy Code (“IBC”) in the resolution process of the stressed assets. Under the section 35 AA of the Banking Regulation Act, 1949 RBI directed banks to declare accounts as NPA if they are in default even by one day and to initiate insolvency proceeding against the borrowers if a Resolution Plan (“RP”) is not implemented within 180 days after the declaration. The circular came out as very stringent and arbitrary. It was declared ultra-vires the power of RBI under sec 35 AA by the Supreme Court (“SC”) in the case of Dharani Sugars and Chemicals Ltd. v. UOI.[1] RBI issued the revised framework on 7th June 2019 (“Revised Framework”) which filled in the loopholes of the Previous Circular yet maintaining its spirit.
INTRODUCTION
The Previous Circular was a general circular, applicable to all defaults of loans above INR 2000 crore, without going into the different nuances of each individual case or sector, following a one-size-fits-all approach. It applied a 180-day limit to all sectors of the economy without going into the special problems faced by each sector hence, treating un-equals equally. For example, the Previous Circular would treat a Cement Factory and a Thermal Power Plant in the same way. If applied mechanically, the Previous Circular would have pushed diverse projects further into trouble without any hope of recovery. All these issues were discussed first by the Allahabad High Court in the case of Independent Power Producers Association of India v. UOI [2] and then finally the SC in the case of Dharani Sugars [3] declared the Previous Circular arbitrary and ultra-vires. RBI took the suggestions made by the courts and the banks and released the Revised Framework. In this background the author has attempted to compare the two set of RBI guidelines and bring out how the shortcomings of the Previous Circular have been eliminated by the RBI in their Revised Framework.
COMMENT
One of the salient features of the Previous Circular was that an account had to be declared an NPA from the very first day of its default. This feature was done away with in the Revised Framework giving the lenders as well as the borrowers some breathing space. The Revised Framework has also included the Term Financial Institution, Small Finance Banks, systematically important non-deposit and deposit-taking Non- Banking Financial Companies therefore, streamlining the process of resolution. The other reason for seeing the previous circular as arbitrary was largely because of its 180-day timeline. It said that the only way of resolving a stressed asset outside IBC was if the RP for that asset is implemented within 180 days. The 40th Parliamentary Standing Committee Report observed that a 180-day period is too less and it would doom all the borrowers to National Company Law Tribunal (“NCLT”). The Revised Framework came up with a 30 day Review Period as a solution to this problem. It said that once an account has been declared an NPA, the lenders need to review the borrowers account for 30 days. In this time they can strategize the RP or can even choose to initiate insolvency proceeding.
The other loophole the previous circular had was that a resolution without IBC could have happened only if the RP was agreed by all the lenders i.e, 100% concurrence. Hence, a lender whose stake is as miniscule as 1 per cent can also thwart a resolution process taking place without an insolvency code. This stringent and arbitrary action was removed in the Revised Framework by introducing the Inter-Creditor Agreement (ICA) that all creditors will have to enter into during the Review Period. This agreement would give ground rules for the implementation of the RP on both the borrowers and the lenders. It said that any decision agreed by the lenders representing either 75% of the total outstanding debt or 60% in number would be binding upon all the lenders. Any dissenting lenders under the RP would be paid at least the amount which they would receive on liquidation.
While working on the Revised Framework, RBI kept in mind the reason why the Previous Circular was declared ultra-vires. The SC pointed out that under the section 35AA of The Banking Regulation Act, 1949 RBI cannot give a general instruction to the banks, as was given in the Previous Circular, to initiate the insolvency proceeding. Therefore, in the Revised Framework, RBI introduced an incentive-disincentive system. In this system, if an RP is not implemented within 180 days after the Review Period then the bank would be dis-incentivised through additional provisioning of 20 per cent after 180 days and 35 per cent after 365 days in the interim. Meanwhile, if the insolvency proceedings have been initiated then the banks can return the additional provision, half of it once the insolvency proceeding is initiated and another half once they are admitted. This improvisation gave flexibility to the lenders rather than following a universal diktat of sending all stressed assets to the NCLT after six months. It is noteworthy that after the SC judgement the RBI at the time of issuance of the Revised Framework also issued a press release clarifying that the RBI has reserved its power to issue specific directions to banks/financial institutions to refer a defaulting borrower to the resolution process under IBC in terms of Section 35AA of the Banking Regulation Act 1949.
CONCLUSION
It can be clearly seen that the RBI has kept in mind the shortcomings mentioned by the banks, institutions and the SC regarding the Previous Circular. The Revised Framework came out to be more pragmatic as it gives banks a fair choice between the resolution of the stressed assets either by requisite majority or through NCLT. The one-day-default-NPA declaration plus the 180-day tight timeline, both these features of the Previous Circular created a lot of chaos and led almost every borrower to the gates of NCLT. The 30 day Review Period gives banks the headroom where they can take important decisions like whether or not they want to initiate insolvency proceedings against a particular borrower. Hence, RBI finally treats banks like adults and allows them to decide what is best for them.
Though RBI is giving banks the space to make their own decisions, its Revised Framework makes sure that these decisions are efficient and quick. Hence, though it did not directly give a universal instruction to the banks it did come up with an incentive-disincentive recommendation regarding the initiation of the insolvency proceeding. RBI makes it work in the classical way of stick and carrot where the additional provisions are the stick and their return on the initiation of the insolvency proceedings is the carrot. The only problem which appears in this pragmatic Revised Framework is that how will it deal with a situation where a dissenting lender files an insolvency proceeding during the 180-day implementation period. Perhaps, the solution would come up via judges as we can expect litigation on this issue.
Overall the Revised Framework strikes a balance between the freedom of banks and the authority of RBI. This move has been welcomed by the lenders as it provides room for resolution of stressed assets outside IBC without compromising upon its efficiency. It saves time and prevents value erosion of assets which can happen in an obligatory insolvency process.
ENDNOTES
[1] (2019) 5 SCC 480.
[2] 2018 SCC OnLine All 4611.
[3] Dharani Sugars and Chemicals Ltd. v. UOI, (2019) 5 SCC 480.
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