• Sara Jain

Summary: Dharani Sugar and Chemicals Ltd. v. Union of India

Background:

In the wake of the deteriorating condition of India’s financial stability, the Government had enacted the Insolvency and Bankruptcy Code, 2016 (‘IBC’) to achieve speedy resolution in insolvency matters. In order to complement the IBC, amendments were also made in the Banking Regulation Act, 1949 by introducing provisions Section 35AA and 35AB.

In this judgment, the constitutional validity of Sections 35AA and 35AB and a circular dated February 12, 2018, issued under these provisions was challenged. This case summary and analysis provides a detailed analysis of the said judgment and its implications on the Indian banking, finance, and power sectors.


Facts:

In order to revise the existing framework for resolution of stressed assets, the RBI issued a circular dated February 12, 2018. Some of the salient features of the circular are as follows:

(a) It instructed the lenders to identity default, immediately on the occurrence of default, and classify the assets as special mention accounts.

(b) The lenders or creditors were required to report information regarding such classification to the Central Repository of Information on Large Credits (CRILC) for borrowers having aggregate exposure of Rs. 50 million.

(c) Restructuring outside of the mechanism of the Insolvency and Bankruptcy Code, 2016 (“IBC”) would be permissible only if it is agreed by 100 percent of the creditors.

(d) In case of defaults exceeding Rs. 2000 Crore as on March 1, 2018, if the default persists for 180 days from March 1, 2018 or if the date of default is after March 1, 2018, then 180 days calculated from such date, creditors are required to file an application under the IBC within 15 days from the expiry of the said 180 days.

(e) The RBI withdrew the existing mechanisms for resolution of stressed assets including Change in Ownership outside SDR, Strategic Debt Restructuring Scheme (SDR), Scheme for Sustainable Structuring of Stressed Assets (S4A) etc.


Owing to this circular, the Indian power sector was majorly affected as due to restriction of supply of coal, failure of the Government to fulfill its commitments, delay inn regulatory response and non-payment of dues by state electricity distribution companies etc., the entire power sector was in stress and the NPA account was huge. Thus, aggrieved by the impugned circular, the petitioners in the instant case, challenged the constitutional validity of the same along with Sections 35AA and 35AB of the Banking Regulation Act, 1949.


Issues:

(a) Whether Section 35AA and Section 35AB of the Banking Regulation Act, 1949 are unconstitutional in law?

(b) Whether the circular dated February 12, 2018 is ultra vires the power conferred to the RBI under the Banking Regulation Act, 1949? Judgment: Issue 1- Constitutional validity of the newly inserted provisions

In the case at hand, the petitioners contended that Sections 35AA and 35AB of the Banking Regulation Act, 1949 are unconstitutional as firstly, they are manifestly arbitrary, and secondly, they suffer from want of guidelines for the RBI to function. While emphasizing the fact that economic legislations should be viewed “with greater latitude”, the Court categorically rejected both these contentions of the petitioners.

Referring to the first contention regarding arbitrariness, the Supreme Court held that like any other provision of the Banking Regulation Act, 1949 (such as Section 21 and Section 35A), the impugned provisions also merely confer power to the RBI to perform its functions. Pertaining to the issue of lack of guidance, the Supreme Court observed that various provisions in the Banking Regulation Act, 1949 including Sections 14A, 17, 18, 20, 22, 25, 29, 30, and 31 provide ample guidance to the RBI to exercise its powers under Sections 35AA and 35AB.

Therefore, the Supreme Court reinforced the doctrine of presumption of constitutionality of a provision as a measure of respecting the wisdom and integrity of the legislature. This presumption serves as self-restraint to the power of judicial review of the Courts. The Court not only construed the provisions by observing the overall structure of the statute but also utilized external aids of interpretation such as the Statement of Objects and Reasons to reach its decision.


Judgment: Issue 2- Validity of the impugned circular dated February 12, 2018

The Supreme Court sought to explain the purpose of introducing Sections 35AA and 35AB and the distinction between them. Clarifying the relation between Section 35A, 35AA and 35AB, the Court made the following significant observations:


(a) When it comes to issuing directions to initiate the insolvency resolution process under the Insolvency Code, Section 35AA is the only source of power.

(b) When it comes to issuing directions in respect of stressed assets..other than resolving this problem under the Insolvency Code, such power falls within Section 35A read with Section 35AB. This also becomes clear from the fact that Section 35AB (2) enables the RBI to specify one or more authorities or committees to advise any banking company on resolution of stressed assets. This advice is obviously de hors the Insolvency Code, as once an application is made under the Insolvency Code, such advice would be wholly redundant, as the Insolvency Code provisions would then take over and have to be followed.


Thus, the Supreme Court observed that if the circular is to be held intra vires the powers conferred to the RBI, it has to comply with Section 35AA as only the said provision can be the source of power for issuing directions pertaining to the IBC.

Interpreting the powers conferred to the RBI under Section 35AA, the Court held that the same is subject to two restrictions- firstly, the Central Government is required to authorize the RBI to issue such directions in respect of default and secondly, it should be for specific defaults The definition of ‘default’ in accordance with Banking Regulation Act, 1949 and the Insolvency and Bankruptcy Code, 2016 corresponds to a particular default of particular borrowers and not to the issuance of directions to banking companies generally. Applying this interpretation of Section 35AA, the 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 not authorized by the Central Government.

This judgment skilfully clarified the scope of powers of the newly inserted provisions and enlightened the RBI about the scope of its powers. The Court applied the ‘Taylor’ rule stating that when a statute prescribes a particular method, it necessarily prohibits the usage of all other methods. Thus, contrary to what was originally believed, the insertion of Section 35AA actually restricted the powers of RBI by specifically laying down the manner in which the same was to be exercised. Such a method was not prescribed under Section 35A which provided vast powers to issue necessary directions to banking companies in public interest or in the interest of banking policy etc. This explanation provides significant guidance to the RBI for exercising its powers in the future.

Conclusion:

Section 35AA and 35AB of the Banking Regulation Act are constitutionally valid. On the other hand, the impugned circular was struck down as it was outside the scope of the powers of the RBI.


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