Authorization From Central Govt Necessary For RBI To Direct Insolvency Process Against Stressed Assets : SC [Read Judgment]

In the judgment of the Supreme Court which quashed the general circular of Reserve Bank of India issued on February 12, 2018 on insolvency process against stressed assets, much turned on whether the power to issue such circular flew from Section 35A or Section 35AA of the Banking Regulation Act.

While Section 35A talks about general powers of RBI to issue directions to banking companies, Section 35AA gives power to the Central Government to authorize RBI to direct any bank to initiate insolvency process in respect of a default.

The petitioners, which comprised association of companies from the sectors of power, sugar, shipping, etc, argued that the direction in February 12 circular to initiate insolvency process if bad debts over Rs.2000 crores are not resolved within 180 days could not have been issued without the authorization of the central government. The RBI sought to sustain the circular by tracing its source to the general powers under Section 35A, instead of Section 35AA, which is inserted as per 2017 amendment. Since no authorization from Central Government is needed to exercise powers under Section 35A, the circular was valid, argued the RBI.

Though the judgment agreed that Section 35A could be a source of power for the impugned circular, it said that after the insertion of Section 35AA in 2017 with a specific condition of authorization from central government, recourse cannot be made to general powers under Section 35A for issuing directions to take insolvency action in respect of bad debts.

The bench of Justices R F Nariman and Vineet Saran explained the position as follows :

"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...."

"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 Court further applied the principle that when a statute prescribes a specific manner for doing a thing, it should be done only in that specified manner.

"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.

Following this principle, therefore, it is clear that the RBI can only direct banking institutions to move under the Insolvency Code if two conditions precedent are specified, namely, (i) that there is a Central Government authorisation to do so; and (ii) that it should be in respect of specific defaults. The Section, therefore, by necessary implication, prohibits this power from being exercised in any manner other than the manner set out in Section 35AA."

The Court also held that Section 35AB, which spoke of powers of RBI to issue directions for resolution of stressed assets, cannot be a source of power for the circular. That Section, which opened with the words "without prejudice to", was held to be a general provision, which is to be read along with Section 35A. It was held that Section 35AB dealt with directions for debt resolution outside Insolvency and Bankruptcy Code(IBC).

"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.", explained the judgment authored by Justice R F Nariman.

Section 35AA can be used only in respect of specific debts

The general application of Circular to all debts above Rs. 2000 crores was challenged by petitioners as suffering from non-application of mind, as it failed to draw a distinction between various forms of "stressed assets" from different industrial sectors. They further contended that the circular failed to distinguish between genuine and wilful defaulters.

The Court held that reference to IBC under Section 35AA can be made only on a case to case basis, and that there cannot be a blanket direction to that effect. This was because Section 35AA used the phrase "in respect of a default".  'Default' has been given the same meaning as in Section 3(12) of IBC.

"...what is important to note is that it is a particular default of a particular debtor that is the subject matter of Section 35AA", observed the Court.

The Press Note dated 05.05.2017 along with the 2017 Ordinance(which introduced Section 35AA , 35AB) 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", held the Court.

The circular was struck down, and all proceedings under Section 7 of the IBC taken by financial creditors on the basis of it were declared as "non-est".

The manifest legal infirmity in the circular forced the Court to consciously step away from the "judicial hand's off approach vis-à-vis economic regulation" and proceed to quash the circular..

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