Supreme Court Strikes Down RBI’s Feb. 12 Circular

Supreme Court says RBI’s February 12 circular on defaulting companies is illegal.

A view of Supreme Court of India in New Delhi. (Source: PTI)
A view of Supreme Court of India in New Delhi. (Source: PTI)

The Supreme Court struck down the Reserve Bank of India’s Feb. 12 circular on defaulting companies, calling it illegal. “We found RBI's February 12 circular to be ultra vires,” the apex court ruled today.

The Supreme Court’s decision will essentially mean that there is no longer any imperative for banks to complete the resolution process within a specified period or go down the insolvency route.

The February 12 circular had attempted to lay down a rule-based stressed asset framework which asked banks to resolve stress in large accounts within 180 days or refer them for insolvency proceedings. The Supreme Court struck down the circular on grounds that the law permits the regulator to give directions to banks on stressed assets only upon the central government’s authorisation and in case of a specific default. Whereas the circular applied to all stressed assets and was not accompanied by any specific government authorisation.

“The challenge was mounted to the RBI circular and nothing beyond that. The court today has quashed the RBI circular as being unconstitutional and ultra vires,” said senior advocate Sajjan Poovayya who appeared for the petitioners. Private power producers were among the challengers to the circular.

The net result of this is the following — in the legal ecosystem, the absolute discretion to take a debtor into the insolvency system or to wind the debtor down is with the banks and it is the banks that must take that decision based on rational considerations. That rationality by banks was being removed and there was an external impetus by the RBI to say that you will necessarily take the companies down the insolvency route at the end of 180 days. That fiat or that certainty is now gone. This means that banks have come back to taking decisions based on the extant regulation available.
Sajjan Poovayya, Senior Advocate (Appearing For The Petitioners)
Supreme Court Strikes Down RBI’s Feb. 12 Circular
RBI Can’t Issue Umbrella Directions To Banks To Initiate Insolvency, Says Supreme Court

The Supreme Court’s decision means that as of now there is no RBI-sponsored scheme to restructure stressed accounts. Schemes such as Strategic Debt Restructuring and the Scheme For Sustainable Structuring of Stressed Assets had been discontinued after the circular.

“This means that, as of now, it is up to every bank to devise a scheme as it sees fit as long as it takes provisions once the account is restructured and stick to the rules as defined under the ‘Income Recognition and Asset Classification or IRAC’ rules,” said Abizer Diwanji, the national leader for financial services at EY.

Diwanji added that he believes that the RBI’s circular was a progressive one. While specific provisions could have been tweaked, the thinking behind the circular was progressive, he said.

Supreme Court Strikes Down RBI’s Feb. 12 Circular

Thinking Behind February 12 Circular

The February 12 circular had come at the end of a bruising bad loan cycle for Indian banks. Years of ever greening and delay in recognition of bad loans had led to a pile-up of nearly Rs 10 lakh crore in bad loans.

To avoid a repeat of the mistakes, the RBI under former governor Urjit Patel, had revised stressed asset restructuring rules using the February 12 circular.

In a speech in April 2018, RBI Deputy Governor NS Vishwanathan defended the rules. “We don’t want to end up in a similar situation a few years down the line,” Vishwanathan said while speaking at the National Institute of Banking Management in Pune.

“The Reserve Bank believes that a focused framework for resolution of distressed borrowers which respects and enforces the sanctity of the debt contract is required to make sure that the excesses observed during the last credit cycle are not repeated and we don’t end up in a similar situation few years down the line.  
N.S. Vishwanathan, Deputy Governor, RBI (Speech In April 2018)

Cyril Shroff, managing partner at Cyril Amarchand Mangaldas said that while details of the order will offer greater clarity, the broader message is that everyone who operates within India, whether it is the private sector or the regulator, is subject to the rule of law. “Whoever you are, the law is above you,” said Shroff.

Supreme Court Strikes Down Feb.12 Circular: What It Means For Banks

Challenge To The Circular

Despite the RBI’s efforts to explain its thinking, the circular saw a push-back from the government, banks and industry. It was among the thorny issues that emerged between the RBI and the government last year, which eventually led to the exit of former RBI governor Urjit Patel.

Around 50 petitions by power, shipping and sugar companies were filed in the top court challenging this circular. They were clubbed together and heard by a bench of Justice Rohinton Nariman and Justice Vineet Saran. The bench reserved its judgement on March 14, 2018.

The petitioners argued that the RBI circular is unconstitutional as it creates inequality by lack of any classification. “The circular is applicable to all sectors of industries irrespective of the particular problems faced by these sectors,’’ the petitioners had argued.

In particular, power producers had argued that stress had built up due to external factors and this should be taken into account while determining the resolution plan.

“The circular does not differentiate between cases where entities have become NPA due to poor management, decision making and inefficiencies and power sector entities which has become NPA due to external factors including lack of PPAs (power purchase agreements), insufficient fuel, delay in payment, delayed adjudication of claims etc.,’’ said the power companies challenging the circular in court.

The striking down of the circular will set back the attempts to improve the credit culture in India, said Sunil Srivastava, former deputy managing director at State Bank of India. Banks are still free to take accounts to NCLT but the time-bound process put in place will no longer hold, he said.

Supreme Court Strikes Down RBI’s Feb. 12 Circular

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Posted by BloombergQuint on Monday, April 1, 2019