After months of anticipation, the Supreme Court has quashed the RBI circular of February 12 last year that had required lenders to strictly implement the timeline set out in the Insolvency and Bankruptcy Code. The circular, which contained a revised framework for the resolution of stressed assets, had entirely replaced the RBI’s earlier instructions on the subject and introduced a one-day default norm.

“As soon as there is a default in the borrower entity’s account with any lender, all lenders — singly or jointly — shall initiate steps to cure the default,” it said. Upon default in accounts over Rs 2,000 crore, banks were required to immediately start working on a resolution plan that had to be finalised within 180 days. In case that plan could not be implemented, lenders had to file an insolvency application.

It had thus taken away any discretion that lenders had to not act tough on soured loans, forcing defaulting businesses to either opt for resolution, or file for insolvency.

Several companies from the power and shipping sectors had challenged the circular, arguing that the time given by the RBI was not enough to tackle bad debt. Power producers argued that they had to confront external factors that were beyond their control, and which made an early revival difficult for them. The circular had identified 34 stressed power projects with an outstanding debt of about ₹2 lakh crore.

The Supreme Court had said that the circular is unconstitutional because it was ultra vires the recently introduced Sections 35AA and 35AB of the Banking Regulation Act, that is, it went outside the remit of what those provisions allowed the RBI to do.

The judgement does not disturb the rights of creditors to insolvency proceedings and would bring in behavioural changes, making creditors more responsible for their actions and inactions, the Insolvency and Bankruptcy Board of India Chief MS Sahoo said.

The good work that has begun on bankruptcy resolution has not been undone and the judgment has only required the banking regulator to draft its regulations with more care, one newspaper argued stating, “if the court ruling nudges RBI to make changes in its policymaking process, it would be a good outcome.”

While banks may now proceed under the IBC at their own discretion on a case-to-case basis, past experience suggests that a proactive move by lenders is unlikely, one critique of the Court’s order argued.

Because the Court has set aside the entire circular, older debt restructuring schemes have been revived, creating new opportunities for banks and borrowers to ‘ever-green’ their loans, another critic noted. It also shines a light on the probable reasons for the reluctance of banks to use the mechanism of a modern insolvency statute – banks may have perverse incentives to retain obsolete systems for the valuation of defaulted loans.

According to the RBI’s latest monetary policy report, recapitalisation of public sector banks, the ongoing improvement in their financials, and resolution of stressed assets under the Insolvency and Bankruptcy Code are expected toimprove bank credit offtake.

A maturing code

The Insolvency and Bankruptcy Board of India has signed a memorandum of understanding with the Securities and Exchange Board of India for sharing information and resources. There will be periodic meetings to discuss matters of mutual interest, including regulatory requirements, enforcement cases, research, data analysis, information technology and data sharing.

Defaults had resulted in a high cost of capital for small and medium firms because banks were accounting for an anticipated probability of default on those without a credit record, the government’s chief economic advisor Krishnamurthy Subramanian said. The attitude of companies has changed after the Insolvency and Bankruptcy Code and borrowers are now coming forward to settle their dues, fearing loss of control over their business, he said.

Borrowers are now cautious about taking more money from banks, V.G. Kannan, chief executive of the Indian Banks’ Association (IBA), said.

As many as 12,000 cases have been filed since the implementation of the Insolvency and Bankruptcy Code (IBC) and setting up of the National Company Law Tribunal (NCLT), Corporate Affairs Secretary Injeti Srinivas said.

Adding capacity and expertise to the severely strained NCLT, pre-packaged insolvency arrangements, and moving ahead with a resolution plan while some contentious issues take longer to adjudicate, are some improvements thatAmitabh Kant, the NITI Aayog CEO, has proposed.

There are concerns in the government and among regulators that Section 12A, which was recently included in the IBC to permit the withdrawal of insolvency proceedings against a debtor if at least 90 per cent of the committee of creditors agrees, is being misused.

By amending the Insolvency and Bankruptcy Code to treat buyers at par with banks and other creditors, the government has safeguarded the interests of affected buyers. But the new government of India has a mammoth task aheadto revive buyers’s trust in under-construction properties, which has been severely weakened by delayed projects.

Due processes

Twenty-six lenders to the floundering Jet Airways, led by the State Bank of India, have invited expressions of interest for selling stakes in the airline. Jet has various payment obligations from salaries to lease payments. Bidders or investors may get a better valuation through an insolvency resolution process  as banks could be forced to take a haircut.

The government is not yet keen to explore insolvency proceedings for the airline and has also indicated to its lenders that it favours an Indian player holding a majority stake in the troubled airline.

The Committee of Creditors of the Korba West Power Company, which had been undergoing an insolvency resolution process, has approved the resolution plan submitted by Adani Power.

Lakhs of investors whose savings were parked in toxic IL&FS bonds by their respective pension and provident fund (PF) trusts, may get some relief.

IL&FS is currently under resolution process at the National Company Law Tribunal (NCLT) to decide the order of priority for the distribution of proceeds of the process. Under the resolution plan, the government has categorised IL&FS group companies into green, amber and red categories based on their financial position. Firms classified as “green” would continue to meet their payment obligations, while “amber” category firms can meet only operational payment obligations to senior secured financial creditors.

More than 50 retirement funds covering over 15 lakh employees have exposure to IL&FS.

The National Company Law Appellate Tribunal has observed that Ericsson India would have to refund the Rs 576 crore including interest payment it received from Reliance Communications, in case the insolvency proceedings against it were revived. On February 20, the Supreme Court had directed RCom to pay Rs 576 crore to Ericsson by March 19 or risk letting Anil Ambani, the chairman of the Anil Dhirubhai Ambani Group, face a three-month jail term.

Having admitted to outstanding amounts in excess of Rs. 90,000 crore to Indian banks led by the SBI, the Videocon Group may be the largest corporate bankruptcy case in Indian history. After it defaulted on its loans, the company has been suspended and a resolution professional has been appointed to run the company’s daily operations.

From the docket

In Jai Balaji Industries v. SBI and Others, the Supreme Court held that the corporate debtor’s right to be heard will be violated if it has not been served with notice of appeal before the NCLAT or been given a hearing before it.

In Deputy Director Directorate of Enforcement Delhi v. Axis Bank and Others, Delhi High Court held that an order of attachment under the Prevention of Money-Laundering Act, 2002 (PMLA), if it meets with the statutory pre-requisites, is as lawful as an action initiated by a bank or financial institution, or a secured creditor, for recovery of dues legitimately claimed or for enforcement of secured interest.

The PMLA will prevail over the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest, Act 2002 (SARFAESI Act), and the IBC. The Court held that “the objective of the legislation in PMLA being distinct from the purposes of the three other enactments”, the latter could not prevail over the former. An order of attachment under PMLA is not rendered illegal only because a secured creditor has a prior secured interest (charge) in the subject property.

Any amount due to the operational creditor prior to the date of the corporate insolvency resolution process cannot be appropriated during the moratorium period, the NCLAT held in MSTC Limited and Others v. Adhunik Metalliks. Any outstanding claims which relates to the period prior to that date cannot be treated as a resolution process cost.

The NCLAT has held that if the Income Tax Department of the Central Government and the Sales Tax Department(s) of the State Government and local authority are entitled to dues arising under law, then they are ‘operational creditors’ under the IBC. In Pr. Director General of Income Tax v. Synergies Dooray Automotive, it said that such statutory dues had a direct nexus with operation of a corporate debtor and held that all statutory dues including ‘Income Tax’ and ‘Value Added Tax’ come within the meaning of ‘Operational Debt’”.

A member of the Committee of Creditors can change their opinion even after a final decision has been made, the NCLAT has held in Sharad Sanghi v.Vandana Garg. For example, if a viable resolution plan fails to get enough votes in the committee, a member who realizes that this failure could lead to the liquidation of the corporate debtor, can change its stance and approve the plan.

In Punit Garg v. Ericsson India, the NCLAT held that no direction can be given to any party to the settlement (particularly the third party) to perform any duties to ensure settlement between other parties.

In Hemanth Meka Rao v. Asset Reconstruction Limited (India), the NCLAT held that once the resolution process has been completed, a settlement between the promoters and the creditors could not be permitted. At the stage of liquidation however, a liquidator is bound to act if a member or creditor approaches for a compromise or settlement under Section 230 of the Companies Act, 2013.

In Andhra Bank v. Provogue (India), the Mumbai bench of the NCLT held that a payment made by a corporate debtor through a postdated cheque sent after the initiation of the CIRP, was a clear case of a recovery prohibited during the the moratorium under Section 14(1)(c) of the IBC.

In Alchemist Asset Reconstruction v. Moser Baer India, the NCLT held that dues of provident fund dues, pension funds dues and gratuity fund dues are not to be treated as a part of the liquidation estate and would not, therefore, be recovered by Section 53 of the Insolvency Code, which provides for a waterfall mechanism.

That’s all we have for you this month. We hope that this update on India’s insolvency laws has been useful and that you will be watching out for these again next month.

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