The Gujarat High Court’s verdict rejecting Essar Steel’s petition seeking reprieve from the initiation of bankruptcy proceedings against it over loans totaling Rs 45,000 crore (of which Rs 32,000 crore are NPAs) that it owes to banks has been seen as a major shot in the arm for the Reserve Bank of India and banks in the fight against bad loans. However, a minute reading of the observations of the court in its verdict may throw up some unexpected challenges for the central bank.
But first, a look at what has happened so far. On Monday, July 17, the Gujarat High Court set aside a petition by Essar Steel challenging the initiation of insolvency proceedings against it by a consortium of two banks – the State Bank of India and Standard Chartered Bank. The decision by Justice SG Shah effectively empowers the lenders to begin proceedings against the company at the National Company Law Tribunal under the Insolvency and Bankruptcy Code.
The RBI had on June 13 identified 12 large accounts of corporate borrowers with a combined debt of Rs 1,75,000 crore – approximately one-fourth of the total NPAs – for proceedings under the newly enacted Insolvency and Bankruptcy Code 2016. Subsequently, directions were issued to banks to file for insolvency proceedings under the IBC in respect of the identified accounts. The move was seen as a definite step to rid the banking sector of the menace of Non-Performing Assets. The banking sector is saddled with NPAs worth over Rs 8 lakh crore, of which Rs 6 lakh crore is with public sector banks (PSBs).
When Essar Steel challenged its inclusion in the list of 12 defaulters that were to be taken to the National Company Law Tribunal for bankruptcy proceedings, there were jitters over which way the court ruling would go. However, with the decision coming in favour of the RBI, there was a sigh of relief that the measures initiated to tackle NPAs could go on as planned now.
Or so it would seem.
For, the Gujarat High Court’s observations has some cause of worry for the RBI. A between-the-lines reading of the court’s observations indicates a possibility of the legal tussle between borrowers and creditors over insolvency proceedings being far from over. The first worry comes from a rather unintended error on part of the RBI. The central bank’s June 13 press release said that the NCLT would accord priority to the top 12 cases. “Such cases (bankruptcy proceedings) will be accorded priority by the National Company Law Tribunal (NCLT),” the release read. Once referred to the NCLT, the resolution of the case in terms of either a sell-off of assets or revival or winding up will have to be completed within 180 days.
The plaintiff, Essar, in the course of the petition, brought this up and was taken due note of by the court. In its verdict, the court said that the RBI had no business offering "advice, guidelines or directions to judicial or quasi-judicial authorities in any manner whatsoever." What this sought to suggest was that the RBI was encroaching on the domain of the NCLT, something that the court did not take too kindly to. The RBI, sensing this, was quick to rectify its error and admitted to it on July 7 in court, before making necessary amends a day later.
“RBI is a statutory authority to make rules and give directions to the intermediaries under it. In exercise of the powers given to it under the ordinance, RBI issued directions to banks to refer these cases to NCLT. RBI directive can be questioned to the extent of directing NCLT to accord priority to these cases as the two—NCLT and RBI—come under a different acts and RBI does not exercise power on NCLT,” Mint quoted Sitesh Mukherjee, partner, Trilegal as saying.
While that worry may be over for now, the court did go ahead and say something that could open a can of worms as far as litigation against the central bank’s measure is concerned. The court, in its observations, said that “it would be appropriate for RBI to see that the benefit of all its schemes is equally offered and extended to all without any discrimination.”
As harmless as that may appear, there is a catch. A Bloomberg report notes that the observation could “allow errant debtors to hang on to their assets indefinitely.” Here’s how.
In June last year, the RBI after due consultation with lenders, formulated what it called the ‘Scheme for Sustainable Structuring of Stressed Assets’ (S4A) as an optional framework for the resolution of large stressed accounts. “The S4A envisages determination of the sustainable debt level for a stressed borrower, and bifurcation of the outstanding debt into sustainable debt and equity/quasi-equity instruments which are expected to provide upside to the lenders when the borrower turns around.
“In order to make sure that that the entire exercise is carried out in a transparent and prudent manner, S4A envisages that the resolution plan will be prepared by credible professional agencies, while an Overseeing Committee, set up by the Indian Banks Association, in consultation with the RBI, comprising of eminent experts will independently review the processes involved in preparation of the resolution plan, under the S4A, for reasonableness and adherence to the provisions of these guidelines, and opine on it,” the RBI said in a press release at the time of its introduction.
Now, if you read the court’s observations closely, the focus is on ensuring that the schemes of the RBI are applied to “all without discrimination.” The S4A is also a scheme introduced by the RBI and the restructuring that Essar is seeking also falls under this scheme. However, by dragging select companies to bankruptcy proceedings while ensuring that the court’s observation in terms of equitable extension of its schemes to all could turn out to be a tough ask for the RBI. Essar Steel had contended in court that it should have been included in a second category of 488 defaulters that had been given six months to restructure debt, failing which they would be taken to the NCLT for the start of bankruptcy proceedings. One can’t rule out the possibility of other companies taking the same route too.
While that argument may have been turned down for Essar Steel, it remains to be seen how other companies react. If dragged to court, the RBI will need to explain its rationale behind pushing 12 accounts for insolvency while allowing 488 others six months to restructure their debt. In the case of Essar, its petition noted that it was already discussing a restructuring proposal with its lenders. The petition said the central bank chose “objective and non-discretionary criteria” for selection, which ignored factors such as operational performance and the resolution process that was underway.
Experts believe that the case will provide crucial inputs for other cases where banks have dragged companies to the NCLT. Pertinent to note here is that the observations of the court could act as precedent for other cases too. The bankruptcy law and proceedings under it are untested so far and will have its fair share of challenges as the central bank goes after big business houses backed by billionaire families. For the RBI, it will be crucial to ensure that its directives to banks regarding initiation of proceedings are well-drafted and backed by sound legal advice.