Bad loans: Supreme Court ruling a big blow to banks, defaulters rejoice

By: and |
Updated: April 3, 2019 7:23:56 AM

“Voiding of the circular is credit negative for Indian banks. (The circular) may now have to be watered down...The resolution of stressed loans impacted by the circular will be further delayed as the process may have to be started afresh." —Srikanth Vadlamani, VP, Moody’s Investors Service.

While the IBC process requires the existing promoters to step out, they could feel more secure of being in the saddle if bankers decide to use the non-IBC route.

India’s new insolvency regime, which has proven in a short span to be much more efficacious than the unwieldy one it superseded in resolving stressed assets, has hit a speed-breaker, with the Supreme Court on Tuesday quashing the Reserve Bank of India’s (RBI) February 12, 2018, circular that sought to quicken the process and add more rigour to it. With the apex court declaring the central bank’s fiat ultra vires, the lenders will now be under no compulsion to take the Insolvency and Bankruptcy Code-mandated process to resolve scores of stressed assets in various industries.

Instead, they could bide time and adopt the resolution plans of their own choice.
While the IBC process requires the existing promoters to step out, they could feel more secure of being in the saddle if bankers decide to use the non-IBC route.

In view of the SC order, the central bank may decide to modify its directive, while still not digressing from the objective of efficient resolution of stressed loan accounts, analysts said. However, till the RBI comes up with a new policy, its previous circulars and schemes like SDR could get revived.

The apex court held that the Section 35AA introduced by the government in the Banking Regulation Act in early May 2017 (which the RBI used to issue the circular) allowed directions that “can only be in respect of specific defaults by specific debtors” and not those meant for debtors generally. It also held that reference under the IBC has to be with authorisation from the central government.

Through the circular, the RBI stipulated a one-day default rule on term loans in general — it said that a borrower missing repayment even for a day will be treated as a ‘defaulter’ and added that banks will finalise a resolution plan for such defaults of over `2,000 crore within the next 180 days and if they fail in doing so, the account will be subject to the IBC process.

Among the immediate beneficiaries of the SC order are the promoters of nearly three dozen stressed power sector assets with a combined capacity of over 40,000 MW and a debt exposure of some `2 lakh crore and those of a clutch of sugar and shipping firms. Rating agency Icra had earlier said the RBI circular required as many as 70 large corporate accounts, with loans worth `3.8 lakh crore, to come up for IBC resolution by September 1, 2018.

The SC ruling will provide relief to the promoters of even those firms that have already been taken by lenders to the National Company Law Tribunal (NCLT) under the RBI circular including the cases admitted by the tribunal — some power assets of RattanIndia, GMR, GVK, ILFS and Coastal Energen are in this category. Of course, the high-profile insolvency cases such as Essar Steel, Bhushan Power and Steel and Jaypee Infratech, which had reached the IBC arena before the RBI issued the contentious circular, won’t be impacted by Tuesday’s SC order.
Through the circular, the RBI practically had said if a resolution plan wasn’t found for the ‘default’ cases by August 27, 2018, the accounts should be sent to bankruptcy courts. However, the apex court on September 11 last year asked banks to maintain status quo and not to initiate insolvency proceedings against the defaulting companies under the circular.

While the circular was challenged first in the Allahabad and Madras High Courts, latter the cases were clubbed and heard by the SC. During the hearings, the RBI has been categorical in its defence of the circular.
The RBI said it wanted to address the “serious malady of evergreening of stressed accounts being resorted to by lenders in order to avoid provisioning” as well as “preserve the economic value of assets and enable banks to extend a holding hand to various companies which are under stress”. According to the central bank, since stressed assets and NPAs in the banking system had reached “unacceptably high levels”, it was incumbent upon it to take urgent measures for their speedy resolution in order to improve the financial health of banks.

On March 14 this year, the RBI pointed out that none of the corporate defaulters, who deferred the insolvency process, thanks to the SC’s status quo order, managed to come up with any resolution plan that could be considered by banks. “It is apparent that they don’t have any resolution plans,” the RBI said. “It is noteworthy that the additional period of 180 days also came to an end on 28.02.2019. Barring 2 or 3 cases which have been resolved and some more cases which have been referred to the NCLT, the position remains the same,” it said.
Since the circular has now been quashed, all consequential proceedings, including IBC proceedings, initiated under Section 7 of IBC have been quashed.

The SC bench comprising RF Nariman and Vineet Saran said, “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 these reasons also, the impugned circular will have to be declared as ultra vires as a whole, and be declared to be of no effect in law.”

“The effect of this judgment will be far reaching, in the cases which are affected by the impugned circular, the banks will have to return the money as the entire proceedings are non-est. The banks will have to start the resolution of such companies from scratch that may be either under the IBC or under RBI scheme for SDR, etc,” said Ashish Pyasi, principal associate with Dhir & Dhir Associates.

Icra had said in a November 2018 report the lenders for the initial 12 companies on the RBI’s list of June 2017 are estimated to have lost out on about `4,000 crore in additional income due to the delays in the resolution process.
Power plants which have already been admitted for resolution by NCLTs under the RBI circular include East Coast Energy Bhavanapadu (1,320 MW), Lanco Vidarbha (1,320 MW), Essar Power Tori (1,200 MW), Visa Power Raigarh (1,200 MW), Monnet Power Angul (1,050 MW) and Lanco Amarkantak (600 MW).

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