Supreme Court backs the new insolvency regime, upholds action against Essar Steel

Jul 26, 2017


With the aim of having a robust and efficient insolvency process and to remedy the appalling credit default situation in India, the Indian government enacted the Insolvency and Bankruptcy Code, 2016 (the “ Code”). The Code introduced sweeping reforms by consolidating the law on insolvency in India, and providing an effective and time bound mechanism for recovering debts due to both, financial as well as operational creditors.

Reserve Bank of India’s direction to banking companies

In order to supplement the effectiveness of the Code and to empower the Reserve Bank of India (the “RBI”), India’s Ministry of Finance amended the Banking Regulation Act, 1949 (the “ BR Act”) and authorized the RBI to issue directions to banking companies to initiate the insolvency resolution process against defaulters under the provisions of the Code.

Pursuant to the amendments of the BR Act, the RBI constituted an Internal Advisory Committee (the “IAC”) to advise it on big ticket bank loan default cases that could be considered for resolution under the Code. Based on the recommendations of the IAC, the RBI issued a Press Release dated June 13, 2017 (the “Press Release”) and specified the criteria for banks to mandatorily initiate a reference under the Code. The Press Release directed banks to initiate action against all loan defaulters having an outstanding amount greater than INR5,000 crores (US$775 million approximately) and with 60% or more of the outstanding amount classified as a non-performing asset (“NPA”) as on March 31, 2016. The Press Release further mentioned that the IAC had identified twelve (12) such loan accounts, which constituted about 25% of the gross NPAs in the Indian banking system, against which an immediate reference under the Code should be made. For the other NPAs, the RBI asked the banks to finalize a resolution plan within six (6) months, failing which, to initiate a reference under the Code. The Press Release also provided that the National Company Law Tribunal (“NCLT”) should give priority to all the foregoing cases. However, as the RBI does not have the authority to give instructions to a judicial or quasi-judicial body like the NCLT, the foregoing sentence was deleted by the RBI through a corrigendum dated July 8, 2017.

Challenge of the Press Release by Essar Steel India Limited

Essar Steel India Limited (“Essar”) challenged the Press Release and contented that the RBI could not issue a directive to the banks to initiate insolvency proceedings under the Code when a restructuring proposal was under consideration based on the RBI’s prior restructuring circular, viz., the Strategic Debt Restructuring and Scheme for Sustainable Structuring of Stressed Assets. Being aggrieved by the Press Release and the insolvency proceedings initiated by two lenders, State Bank of India (“SBI”) and Standard Chartered Bank (“ SCB”), Essar filed a writ petition before the Gujarat High Court (the “Court”) inter alia praying for issuance of a writ to quash the Press Release and the actions commenced by SBI and SCB under the Code. Essar also sought a restraining order against the NCLT (being the adjudicating authority under the Code) from hearing the insolvency proceedings initiated by SBI and SCB. It should be noted that the validity of the Code was not challenged by Essar.

Brief legal arguments on behalf of the parties

On behalf of Essar, it was inter alia argued that, (i) when the restructuring proposal of Essar was under “active consideration” by the banks and was on the verge of “being finalized,” the RBI could not have issued the Press Release directing the banks to take action under the Code; (ii) the classification of loan accounts under the Press Release solely on the basis of the quantum of the outstanding amount (being greater than INR 5,000 crores) violated Article 14 of the Constitution of India; (iii) the impact of the initiation of proceedings by SBI and SCB pursuant to the Press Release would be severe as it would result in a suspension of the board of directors and handing over the management of the company to the Insolvency Resolution Professional (“RP”), who may not be well equipped to run Essar; (iv) long term supply contracts of finished products and, consequently, Essar’s turnover, could be adversely affected due to the possible disruption of production; and (v) SCB, as a foreign bank, had initiated proceedings without any directive of the RBI, and therefore, these proceedings needed to be quashed.

In response, on behalf of the RBI, it was inter alia argued that the Press Release was issued in public interest as the high value of NPAs in the Indian banking system required urgent attention. Moreover, the RBI’s directives in the Press Release were not arbitrary, but based on a process, which included the twin criteria of outstanding amounts being more than INR5,000 crores and for more than fifteen (15) months, following which the twelve (12) entities had been identified. As such, the directives in the Press Release were reasonable and necessary to give effect to India’s economic policy and achieve the objectives of the Code. Further, various banks had initiated proceedings against other loan defaulters, and therefore, any adverse order passed in Essar’s petition would have far reaching ramifications on all proceedings under the Code. Furthermore, Essar was aware that insolvency proceedings under the Code were being initiated, which Essar had accepted, and it was free to submit its revival package to the RP under the provisions of the Code. In addition, although the RP would be in-charge of the management of the company, it would still be run by the same officers under the supervision of the RP with no adverse effect to Essar.

The RBI’s counsel also highlighted that the process under the Code was time bound and designed to ensure that a company be made viable, if possible, and even in the absence of the Press Release, the Court could not take away a bank’s statutory rights to initiate proceedings under the provisions of the Code.

SBI’s counsel also argued on similar lines and highlighted that a writ of prohibition could not be issued against a judicial authority unless it has exceeded its jurisdiction (which was not Essar’s allegation).

Finally, on behalf of SCB, it was inter alia argued that SCB’s loan facility was an offshore one, which had only been guaranteed by Essar. Foreign loans were not regulated by the RBI, and SCB’s action was independent of the RBI’s directives. Moreover, the Code did not prevent a foreign lender from initiating proceedings while settlement negotiations were ongoing between the borrower and other financial creditors, and the provisions of the Code could not be interpreted to mean that a foreign lender could not initiate proceedings under the Code on its own in the absence of directives from the RBI. If so interpreted, the provisions of the Code would be rendered otiose. Finally, as SCB was not a state within the meaning of Article 12 of the Constitution of India, the reliefs sought by Essar should not be granted.

The Ruling

The Court heard all the arguments and passed a detailed judgment ruling that, (i) the RBI had the authority to direct banks to initiate recovery proceedings against defaulters pursuant to the amendments to the BR Act; (ii) the Press Release was not arbitrary, manifestly unjust, outrageous, or directed to an unauthorised end; (iii) the Press Release did not classify accounts, and there was no direction that insolvency proceedings had to be initiated only against Essar or any particular company and not against any other company; (iv) the provisions of the Code had not been declared unconstitutional and, therefore, had to be observed; and (v) SCB, being a private bank, was not subject to the writ jurisdiction of the Court; therefore, the petition against SCB was not maintainable. Accordingly, the Court disposed off the writ petition filed by Essar leaving the NCLT to decide all the substantive issues of the case on merits.

As such, the insolvency proceedings initiated by SBI and SCB under the Code will proceed before the NCLT.

Our Comments

In our view, the Court’s judgment in the Essar case is a positive affirmation and gives legal sanction to the bold action taken by the RBI to further the objects of the Code. The Press Release (as amended) makes it obligatory for creditors to immediately initiate insolvency proceedings against their defaulting borrowers (where the outstanding amount is more than INR5,000 crores). Further, it upholds the right of foreign lenders to initiate action under the Code to recover their legitimate dues from Indian companies who have either borrowed or given security overseas. However, it needs to be seen if Essar Steel challenges the judgment in India’s Supreme Court. Even if it does, in our view, the chances of success are less. Slowly but surely, the law is catching up with errant Indian promoters.

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