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Political Economy

SC Order on Bad Loans Sets Stage for Future Battle Between RBI, Centre

While defaulting promoters may celebrate temporarily, after elections, the Centre must divest itself of the power to authorise specific cases of default for bankruptcy proceedings.

On the face of it, the Supreme Court judgement quashing the Reserve Bank of India’s (RBI) 2018 circular on bad loans may seem like a big setback to the Insolvency and Bankruptcy Code (IBC) reforms, which sought to shift the balance of power from defaulting corporate promoters to ordinary bank depositors.

But in actual fact, the apex court has quashed the circular merely on technical grounds and the central bank can continue to reissue such rules in a correct legal format.

Indeed, in the short-run, many defaulting promoters known to be very close to the ruling regime in sectors like power, infrastructure, sugar, shipping will celebrate as they will not have to immediately face India’s bankruptcy courts where, once admitted, they lose control of their companies and independent auditors bring out many skeletons in their balance sheets. But this is only a temporary reprieve for these promoters.

The RBI circular of February 2018 gave a six-month deadline for all defaulting companies with loans of over Rs 2,000 crore to settle with banks, failing which they would be forced to enter the bankruptcy process. Many of the big corporates, particularly in the power sector, went to court calling the circular arbitrary and one which treated them all as wilful defaulters.

Big promoters in the power sector – including the Adanis, Essar and Tatas – argued that government policy glitches had been largely responsible for the non-performance of electricity investments worth Rs 1,74,000 crore.

Also read: India’s Operational Creditors May No Longer Be Discriminated Against in Bankruptcy Cases

The important thing to note here is that the Supreme Court hasn’t gone into the merit of this argument while quashing the RBI circular. All that it has done is merely ruled that the central bank had erred in issuing a general, omnibus circular which forces all defaulting companies to go into bankruptcy proceedings if they don’t do a settlement with the bank within six months.

The apex court has said the RBI had technically erred on two counts. One, Section 35 AA of the amended Banking Regulation Act 2017 clearly says the RBI can only refer a specific case of default for bankruptcy. Which means the RBI could, if needed, have referred a specific defaulting company separately rather than issue a general diktat for all potential defaulters. 

Two, under the same provision (35 AA) the RBI needed to take the authorisation from the Centre.

Both these pre-conditions were not satisfied, according to the SC.

Thus, it stands to reason that if these two requirements are fulfilled, the RBI can force specific cases of default to enter bankruptcy. Therefore, hypothetically speaking, the regulator can still refer all defaulting power sector companies separately to go into bankruptcy proceedings.

Of course, the one fundamental problem with 35AA is why the Centre should sign off on such a move when the RBI is convinced these companies have been given enough time and opportunity to settle the matter with the banks.

What’s worse is that by keeping this power, the Centre is in a position to influence events. It is no secret that the BJP-led government was unhappy with the RBI circular because it came a year before the 2019 elections and that the big promoters that were involved are also known to be big election funders.

So if the RBI had followed the correct procedures, as per the SC order, the onus would have been on the Centre to give consent for sending these companies to bankruptcy proceedings.

This would have placed uncomfortable power in the Centre’s hands in a pre-election year. This is a flaw in the amendments which are aimed at facilitating bankruptcy in order to shift the balance of power toward the depositor and taxpayer. A new government after May 2019 must take away this discretion vested with the Centre to authorise specific cases of default that may be referred by RBI for bankruptcy proceedings. This is a must to preserve the integrity of the insolvency code.

Some legal experts have suggested that the Banking Regulation Act gave more powers to the RBI before the amendment under 35AA was enacted. The amendment actually diluted RBI’s power by making Centre’s authorisation mandatory. Finance minister Arun Jaitley has complicated the process with this amendment. One hopes a new finance minister will correct this.