Top court’s order upends India’s fledgling bankruptcy resolution process

The Supreme Court on Tuesday quashed a central bank circular that had set strict norms for the resolution of bad loans, easing the concerns of some debtladen companies and upending India’s fledgling bankruptcy resolution process.

A two judge-bench comprising justices Rohinton F. Nariman and Vineet Saran said the Reserve Bank of India (RBI) acted beyond its powers in issuing the 12 February 2018 circular. “We have declared the RBI circular ultra vires,” Nariman said.

The RBI circular directed banks to refer defaulters to bankruptcy courts if they were unable to find a resolution plan within 180 days for stressed accounts where the outstanding amount was more than ₹2,000 crore.

Tuesday’s judgement said the Banking Regulation Act allows banks to initiate insolvency when there is authorization from the central government or when RBI gives directions to banks for specific default cases.

“There was nothing to show that these provisions were satisfied in issuing the circular,” the Supreme Court said, adding that the central bank does not have the authority to issue a general directive regarding bankruptcy cases.

RBI didn’t respond to a request seeking comment till the time of going to press.

There is little clarity on whether the central bank will now come up with a fresh policy for banks to tackle the mounting bad debts on their balance sheets. RBI may throw some light on its plans when it announces the monetary policy on 4 April.

“RBI will have to come up with a new restructuring framework following the court order. Lenders are now free to initiate fresh bankruptcy proceedings against companies, which were otherwise mandatorily referred for insolvency resolution under the circular,” said L. Viswanathan, partner at Cyril Amarchand Mangaldas.

The Supreme Court order gives many corporate defaulters the breathing space they were looking for, saving them from having to submit to a time-bound insolvency process—at least for the time being. Many cases already submitted to insolvency courts under the circular also may get a fresh lease of life. At the same time,banks will now be free to pursue insolvency proceedings against many defaulting companies—especially power companies—which were put on hold because of the Supreme Court hearings.

The court said provisions of Section 45L(3) of the RBI Act (power of RBI to call for information from financial institutions and to give directions) were not adhered to in framing the circular. “The impugned circular nowhere says that the RBI has had due regard to the conditions in which and the objects for which such institutions have been established, their statutory responsibilities, and the effect the business of such financial institutions is likely to have on trends in the money and capital markets,” the order said.

Several companies and lobby groups, including GMR Energy Ltd; RattanIndia Power Ltd, a textile company; Association of Power Producers; Independent Power Producers Association of India; Sugar Manufacturing Association of Tamil Nadu and a shipbuilding association from Gujarat, had challenged the RBI circular in different courts.

“Now as a result of the Supreme Court judgement, banks can autonomously undertake a restructuring process that is best suited as a tool for an individual borrower. This attempt to issue an all-encompassing, first-of-itskind circular was probably not the best approach,” said Sapan Gupta, national head-banking and finance practice at Shardul Amarchand Mangaldas.

In September, the Supreme Court granted interim relief to stressed power firms, directing lenders to maintain status quo on the RBI circular for banks to resolve these cases within 180 days. The court directed that all pleas filed by RBI related to the 12 February circular should be transferred to it.

In April last year, RBI deputy governor N.S. Vishwanathan defended the circular. He said that if a borrower delays coupon or principal payment on a corporate bond even for a day, the market would penalize the borrower heavily, but defaults in bank borrowings had not led to a similar reaction. “There is a need to change this and restore the sanctity of the debt contract, lest bank debt becomes subordinate even to equity,” he said.