Supreme Court Quashes RBI Circular on Stressed Assets: Dharani Sugars and Chemicals Ltd. vs. Union of India (2 April 2019)

Introduction

Date of the Judgment: 2 April 2019

Citation: 2019 INSC 305

Judges: Justice R.F. Nariman and Justice Vineet Saran. The judgment was authored by Justice R.F. Nariman.

Can a regulatory body like the Reserve Bank of India (RBI) impose a blanket rule for resolving stressed assets across all sectors, or should it consider the unique challenges faced by each sector? This question was at the heart of the Supreme Court’s deliberation in the case of Dharani Sugars and Chemicals Ltd. vs. Union of India & Ors. The Court examined the constitutional validity and legality of an RBI circular that mandated strict timelines for resolving stressed assets, failing which companies would be pushed into insolvency proceedings. The judgment has significant implications for how stressed assets are handled in India, particularly for sectors facing unique economic challenges.

Case Background

The case arose from a challenge to the RBI circular dated 12.02.2018, which introduced a revised framework for resolving stressed assets. This circular mandated that if a resolution plan for large accounts (₹20 billion and above) was not implemented within 180 days of default, lenders were required to file for insolvency under the Insolvency and Bankruptcy Code (IBC). The petitioners, representing various sectors including power, telecom, steel, and sugar, argued that the circular was arbitrary and did not account for the specific challenges faced by different sectors. They contended that factors such as government policy changes, fuel non-availability, and delayed regulatory responses contributed to their financial stress, not mismanagement.

Timeline

Course of Proceedings

The petitioners challenged the RBI circular in various High Courts, including the Allahabad High Court. The Allahabad High Court, in its order dated 31.05.2018, requested the Ministry of Finance to hold a meeting to consider the grievances of the power sector. Subsequently, on 27.08.2018, the Allahabad High Court directed the constitution of a High Level Empowered Committee to submit a report within two months. Following these proceedings, the cases were transferred to the Supreme Court, where the Court, on 11.09.2018, ordered a status quo, effectively staying the circular.

Legal Framework

The judgment primarily revolved around the interpretation of the following legal provisions:

• Section 35A of the Banking Regulation Act, 1949: This section empowers the RBI to issue directions to banking companies in the public interest, in the interest of banking policy, or to prevent the affairs of any banking company from being conducted in a manner detrimental to the interests of depositors.
• Section 35AA of the Banking Regulation Act, 1949: Introduced by the Banking Regulation (Amendment) Act, 2017, this section allows the Central Government to authorize the RBI to direct banking companies to initiate insolvency resolution processes under the Insolvency and Bankruptcy Code, 2016, in respect of a default. The term “default” is defined as per Section 3(12) of the Insolvency and Bankruptcy Code, 2016.
• Section 35AB of the Banking Regulation Act, 1949: This section, also introduced in 2017, empowers the RBI to issue directions to banking companies for the resolution of stressed assets. It also allows the RBI to specify authorities or committees to advise banking companies on stressed asset resolution.
• Section 45L of the Reserve Bank of India Act, 1934: This section empowers the RBI to call for information from financial institutions and to give directions to them for regulating the credit system of the country.
• Section 3(12) of the Insolvency and Bankruptcy Code, 2016: Defines “default” as non-payment of debt when due.

Arguments

Petitioners’ Arguments:

• The petitioners, led by Dr. Abhishek Manu Singhvi, argued that the RBI circular was arbitrary and violated Article 14 of the Constitution by treating unequals equally. They contended that the power sector, unlike other sectors, is heavily regulated, with tariffs determined by regulatory commissions and power purchase agreements (PPAs) being essential.

• They highlighted that various factors beyond their control, such as government policy changes, fuel non-availability, and delayed payments by distribution companies (DISCOMs), led to their financial stress.

• They argued that the 180-day timeline was impractical and that the requirement for 100% lender consensus for restructuring was unrealistic.

• The petitioners submitted that Section 35A of the Banking Regulation Act, 1949, cannot be the source of power for the circular as it was enacted much before the Insolvency Code, 2016.

• They contended that Sections 35AA and 35AB are part of one composite scheme, with Section 35AA being the sole source of power for directing companies to file applications under the Insolvency Code, while Section 35AB deals with resolution of stressed assets outside the Insolvency Code.

• They argued that the Central Government’s circular dated 05.05.2017 empowered the RBI to issue directions qua individual defaults, and not a general circular applying to all defaults above INR 2000 crore.

• They also argued that Sections 35AA and 35AB are manifestly arbitrary and suffer from excessive delegation of power.

• They relied on Parliamentary Standing Committee Reports, which highlighted the specific issues of the power sector and recommended sector-specific measures.

RBI’s Arguments:

• Shri Rakesh Dwivedi, representing the RBI, argued that the regulatory regime under the RBI Act and Banking Regulation Act must be broadly construed in public interest and in the interest of depositors.

• He submitted that the RBI circular was an attempt to provide a reasonable period of six months to resolve stressed assets before resorting to the Insolvency Code.

• He contended that the circular was not manifestly arbitrary but was in the interest of the national economy to prevent the evergreening of debts.

• He argued that the Parliamentary Standing Committee Reports were for the purpose of Parliament and had not been acted upon by either Parliament or the Central Government.

• He asserted that the circular was traceable to Sections 21, 35A, 35AA, and 35AB of the Banking Regulation Act and Section 45L of the RBI Act.

Union of India’s Arguments:

• Shri Tushar Mehta, the Solicitor General for India, argued that Sections 35AA and 35AB were regulatory provisions made in public interest and not manifestly arbitrary.

• He contended that the RBI received sufficient guidance from the Preamble and other provisions of the Banking Regulation Act.

• He submitted that the Central Government’s authorization under Section 35AA had to be general, and the RBI was to exercise its power with due deliberation and sector-specific care. He also agreed that the power sector should have been treated differently.

Sub-Submissions Categorized by Main Submissions:

Issues Framed by the Supreme Court

The Supreme Court considered the following key issues:

1. Whether Sections 35AA and 35AB of the Banking Regulation Act, 1949, are constitutionally valid.
2. Whether the RBI circular dated 12.02.2018, is ultra vires the provisions of the Banking Regulation Act, 1949, and the Reserve Bank of India Act, 1934.

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Supreme Court considered the following authorities:

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

• The Court distinguished Indian Banks’ Association v. Devkala Consultancy Service [CITATION], stating that the RBI can give directions to banks to move under the Insolvency Code if a specific provision empowers it.
• The Court relied upon Swiss Ribbons Pvt. Ltd. and Anr. v. Union of India and Ors. [CITATION] to support the constitutional validity of Sections 35AA and 35AB.
• The Court cited Shayara Bano v. Union of India [CITATION] to define the test of manifest arbitrariness.
• The Court relied upon Harishankar Bagla v. State of M.P. [CITATION] to show that there was no dearth of guidance for the RBI to exercise the powers delegated to it.
• The Court cited Gwalior Rayon Silk Mfg. (Wvg.) Co. Ltd. v. The Assistant Commissioner of Sales Tax and Ors. [CITATION] to explain the limits of delegated legislation.
• The Court cited Senior Electric Inspector v. Laxminarayan Chopra [CITATION], Royal College of Nursing of the United Kingdom v. Department of Health and Social Security [CITATION], Comdel Commodities Ltd. v. Siporex Trade S.A. [CITATION], McCartan Turkington Breen (A Firm) v. Times Newspapers Ltd. [CITATION], and Birmingham City Council v. Oakley [CITATION] to explain the concept of ongoing interpretation of statutes.
• The Court cited Central Bank of India v. Ravindra [CITATION], Sudhir Shantilal Mehta v. Central Bureau of Investigation [CITATION], and ICICI Bank Ltd. v. APS Star Industries Ltd. [CITATION] to support the argument that the RBI has wide powers to issue directions.
• The Court relied upon State of U.P. v. Singhara Singh [CITATION] to show that the RBI can only direct banks to move under the Insolvency Code as per Section 35AA.
• The Court cited Bharat Sanchar Nigam Ltdv. Telecom Regulatory Authority of India and Ors. [CITATION] and Union of India and Anr. v. Pfizer Ltd. and Ors. [CITATION] to explain the meaning of “without prejudice.”
• The Court cited Eera (through Dr. Manjula Krippendorf) v. State (NCT of Delhi) and Anr. [CITATION], ArcelorMittal India (P) Ltd. v. Satish Kumar Gupta [CITATION], Asian Resurfacing of Road Agency (P) Ltd. v. Central Bureau of Investigation [CITATION], Macquarie Bank Ltd. v. Shilpi Cable Technologies Ltd. [CITATION], and State (NCT of Delhi) v. Brijesh Singh [CITATION] to explain the theory of creative interpretation.
• The Court relied upon J.K. Cotton Spinning & Weaving Mills Co. Ltd. v. State of U.P. [CITATION] and Commercial Tax Officer, Rajasthan v. Binani Cements Ltd. and Anr. [CITATION] to show that specific provisions of Section 35AA will prevail over general powers.
• The Court cited Utkal Contractors & Joinery (P) Ltd. v. State of Orissa [CITATION] to show that Section 35AA was not introduced ex abundanti cautela.
• The Court distinguished Maru Ram and Ors. v. Union of India and Ors. [CITATION], stating that the specific provision to the contrary would refer to a particular section, not a category.

Ratio Decidendi

The Supreme Court held that while Sections 35AA and 35AB of the Banking Regulation Act are constitutionally valid, the RBI circular dated 12.02.2018, was ultra vires Section 35AA. The Court reasoned that Section 35AA empowers the RBI to direct banks to initiate insolvency resolution processes only in respect of a specific default. The circular, however, was a general direction applicable to all defaults above a certain threshold, without considering the unique circumstances of each case or sector. The Court emphasized that the RBI’s power to issue directions under Section 35AA is tied to a specific default, and not a general power to impose a blanket rule for all defaults above a certain threshold. The Court also noted that the RBI had not followed the procedure laid down in Section 35AA and had acted beyond the authorization granted by the Central Government.

Final Order

The Supreme Court quashed the RBI circular dated 12.02.2018.

Implications

The judgment had significant implications for banking regulation and stressed asset resolution in India:

• Sector-Specific Approach: The judgment emphasized the need for a sector-specific approach to resolving stressed assets. It highlighted that a “one-size-fits-all” approach is not suitable for all sectors, especially those facing unique challenges.

• Limits on RBI’s Power: The judgment clarified the limits of the RBI’s power under Section 35AA of the Banking Regulation Act. It established that the RBI cannot issue general directions for initiating insolvency proceedings but must act on specific defaults.

• Need for Nuance: The judgment underscored the need for a more nuanced approach to resolving stressed assets, taking into account factors beyond the control of borrowers, such as policy changes and regulatory delays.

• Impact on IBC: The judgment indirectly impacted the Insolvency and Bankruptcy Code (IBC) by highlighting that it should not be the default recourse for all stressed assets, especially in sectors facing genuine difficulties.

• Regulatory Framework: The judgment called for a review of the regulatory framework for stressed assets, emphasizing the need for a more flexible and sector-specific approach.

Flowchart of the Court’s Decision-Making Process