A Division Bench of the Hon’ble Supreme Court comprising Justices R.F. Nariman and Vineet Saran in the matter of Dharani Sugars and Chemicals Limited v. Union of India and Others, REED 2019 SC 04589, while upholding the constitutional validity of Section 35AA and 35AB of the Banking Regulations Act, 1949, has struck down the Reserved Bank of India Circular dated February 12 2018, containing the revised framework for resolution of stressed assets, on the ground of it being ultra vires Section 35AA of the Banking Regulation Act, 1949. This post elaborately elucidates the salient facts of the case, the issues involved, and the judgment pronounced by the Supreme Court.
A batch of writ petitions were filed assailing the Reserve Bank of India (RBI) Circular dated 12 February 2018 (impugned circular), by which the RBI promulgated a revised framework for resolution of stressed assets. Reserve Bank of India issued the aforesaid circular in exercise of its power conferred by Section 35A of the Banking Regulation Act, 1949 read with the Central Government’s circular dated 5 May 2017, Sections 35AA and 35AB of the Banking Regulations Act, and Section 45L of the Reserve Bank of India Act, 1934 (RBI Act). Further, the constitutional validity of Sections 35AA and 35AB of the Banking Regulation Act introduced by way of the Banking Regulation (Amendment) Act, 2017 was also challenged.
It is pertinent to note that while Section 35AA enables the Union Government to authorize the RBI to direct banking companies to resolve specific stressed assets by initiating insolvency resolution process, under Insolvency and Bankruptcy Code, 2016 (IBC), Section 35AB empowers the RBI to issue directions to any banking company for resolution of stressed assets. The impugned circular stipulates that restructuring in respect of borrower entities de hors the IBC can only occur if the resolution plan that involves restructuring is agreed to by all lenders, i.e., 100 percent concurrence. Further, this circular is applicable on debts with an aggregate exposure of INR 2000 crore and over on or after 1 March 2018. Moreover, it mandates that unless a restructuring process in respect of debts with an aggregate exposure of over INR 2000 crore is fully implemented on or before 185 days from the 1 March 2018 or date of first default after the 1 March 2018, the lenders will have to file applications within next 15 days as financial creditors under the IBC.
The issues that arose for the consideration of the Supreme Court (SC) were as follows:
Whether the Banking Regulation (Amendment) Act, 2017 that introduced Sections 35AA and Section 35AB to the Banking Regulations Act is constitutionally valid?
Whether the RBI Circular dated February 12 2018 is ultra vires the provisions of the RBI Act and the Banking Regulations Act?
Constitutional validity of Sections 35AA and 35AB
The petitioners had argued that the Banking Regulation (Amendment) Act, 2017 was unconstitutional on two grounds: (i) that the Sections 35AA and 35AB introduced are manifestly arbitrary; and (ii) that they suffer from absence of guidelines. Insofar as the first challenge is concerned, the Supreme Court adverted to its ruling in Swiss Ribbons Pvt. Ltd and Another v. Union of India and Others, REED 2019 SC 01504, to note that economic legislations are to be viewed with great latitude and a great leeway must be given to Parliament to deal with the problems which affect the national economy as a whole. The Supreme Court, in Shayara Bano v. Union of India, (2017) 9 SCC 1, has also made it clear that Article 14 may be infracted by legislation on the ground of such legislation being manifestly arbitrary and manifest arbitrariness must be something done by the legislature capriciously, irrationally and/or without adequate determining principle.
In the present case, the amendments were in the nature of amendments which confer regulatory powers upon the RBI to carry out its functions under the Banking Regulation Act, and are not different in quality from any of the Sections which have already conferred such power. For instance, Section 21 makes it clear that the RBI may control advances made by banking companies in public interest, and in so doing, may not only lay down policy but may also give directions to banking companies either generally or in particular. Similarly, under Section 35A vast powers are given to issue necessary directions to banking companies in public interest, banking policy, and to prevent the affairs of any banking company being conducted in a manner detrimental to the interest of the depositors. It is clear, therefore, that Sections 35AA and 35AB which give the RBI certain regulatory powers cannot be said to be manifestly arbitrary.
When it comes to lack of any guidelines by which the power given to the RBI is to be exercised, it is clear from a catena of judgments, including Harishankar Bagla v. State of MP, (1955) 1 SCR 380, that such guidance can be obtained not only from the Statement of Objects and Reasons and the Preamble to the Act, but also from its provisions. The SC observed that Sections 14A, 17, 18, and 20 of the Banking Regulations Act impose various restrictions on a banking company. A banking company is obligated to hold a license that is issued by the RBI, by which the RBI can impose such conditions as it thinks fit under Section 22 of the Act. These and other regulatory sections such as Sections 25, 29, 30, and 31, all give guidance as to how the RBI is to exercise these powers under the newly added provisions. Therefore, the Supreme Court concluded that there was no dearth of guidance for the RBI to exercise the powers delegated to it by these provisions and consequently, the plea of constitutional validity failed.
Impugned Circular being ultra vires Section 35AA of Banking Regulations Act
The Supreme Court clarified the distinction between Section 35A, 35AA and 35AB of Banking Regulations Act and noted that: (i) when it comes to issuing directions to initiate the insolvency resolution process under the IBC, Section 35AA is the only source of power; and (b) when it comes to issuing directions in respect of stressed assets, which directions are directions other than resolving this problem under the IBC, such power falls within Section 35A read with Section 35AB. Further, reiterating the principles laid down in J.K. Cotton Spinning & Weaving Mills Co. Ltd. v. State of U.P., (1961) 3 SCR 185 and Commercial Tax Officer, Rajasthan v. Binani Cements Ltd. and Anr., (2014) 8 SCC 319, the Supreme Court observed that when one section of a statute grants general powers, as opposed to another section of the same statute which grants specific powers, the general provisions cannot be utilized where a specific provision has been enacted with a specific purpose in mind. Hence, when resolution through the IBC is to be affected, the specific power granted by Section 35AA can alone be availed by the RBI and not Sections 35A and 35AB.
Interpreting Section 35AA of the Banking Regulations Act, the Supreme Court held that the RBI can only direct banking institutions to move under the IBC if two conditions precedent are specified, namely, (i) that there is a Central Government authorization to do so; and (ii) that it should be in respect of specific defaults. The definition of ‘default’ in accordance with Banking Regulation Act and the IBC state that it corresponds to a particular default of a particular debtor and not to the issuance of directions to banking companies generally. Applying this interpretation of Section 35AA, the Supreme Court highlighted that the impugned circular is ultra vires the powers of the RBI as it pertains to issuance of directions to banking companies generally and was also not authorized by the Central Government.
The impugned circular also stated as one of its sources, the power contained in Section 45L of the RBI Act insofar as non-banking financial institutions are concerned. However, the Supreme Court concluded that 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 hence not possible 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.
In view of the foregoing reasons, Supreme Court declared the impugned circular ultra vires as a whole and accordingly struck it down.