Essar Steel insolvency issue vs RBI: What lies ahead?

In this case, RBI's low capacity in legal drafting is unlikely to lead to a serious legal problem

The Banking Regulation (Amendment) Ordinance, 2017 recently empowered RBI to issue directions to banks for resolution of stressed assets. After this, RBI issued a Press Release dated June 13, 2017 explaining the process it is following to direct banks to refer certain accounts for resolution under the Insolvency and Bankruptcy Code, 2016 (IBC). Essar Steel has challenged this process before the Gujarat High Court.

A single judge of the Gujarat High Court admitted the challenge at a preliminary level since it found two legal issues in the RBI Press Release. The first stems from poor legal drafting of the press release and the second issue stems from the retrospective criteria of classification of accounts.

Poor drafting
 

One of the fundamental features of the Indian Constitution is separation of the judicial wing of the State from the executive wing. The judiciary, i.e. courts and tribunals, is supposed to be independent from the executive (government and regulators). When NCLT was being set up, its constitutionality was challenged for violating this basic principle. After a decade-long court battle, and consequent modifications to NCLT's structure, the Supreme Court was finally satisfied with the independence of NCLT from the executive wing.

RBI's Press Release dated June 13, 2017 walked into this delicate situation. While identifying certain accounts for reference by banks under the Insolvency and Bankruptcy Code, 2016 (IBC), the RBI mentioned:

Such cases will be accorded priority by the National Company Law Tribunal (NCLT).
 

In this, RBI, which is part of the executive wing, is directing NCLT, which is part of the judicial wing, on how it should list and allocate cases before itself. This direction concerns a core judicial function. This is beyond the powers of RBI. The newly inserted section 35AB(1) of the Banking Regulation Act, 1949 empowers RBI to issue directions to banks only.

In addition, a press release is not a legal instrument, and it appears overbearing to put this direction into a press release.

Hence, the Gujarat High Court found this direction 'quite shocking'.

Retrospective criteria of classification
 

RBI constituted an Internal Advisory Committee (IAC) to advise it regarding which cases should be considered for reference for resolution under the IBC. The Press Release dated June 13, 2017 says that the classification criteria developed by the IAC is as follows:

In particular, the IAC recommended for IBC reference all accounts with fund and non-fund based outstanding amount greater than Rs 5000 crore, with 60% or more classified as non-performing by banks as of March 31, 2016.
 

Essar argued that after March 31, 2016, it has taken various measures to ameliorate its financial stress. It was submitted that RBI's Press Release dated June 13, 2017 did not take these developments into account since it chose March 31, 2016 as the cut-off. RBI did not explain the reason for this retrospective criteria of classification - why did RBI in June 2017 choose to classify accounts based on their non-performing status as on March 31, 2016? This lack of explanation in RBI's Press Release gave Essar the opportunity to argue that RBI is acting arbitrarily.

Interpreting the order of the Gujarat HC
 

The order by the Gujarat HC clearly explains the legal concerns about RBI's Press Release. Their action is mild: they have listed the matter for July 7, 2017, so that RBI gets an opportunity to present its version before the court. Till then, if Essar's matter comes up before the NCLT, it is required to be adjourned.

Standard Chartered Bank, one of the respondents in the case, appealled against the order of the single judge before a division bench of the Gujarat High Court. Reportedly, this matter was heard and then adjourned to July 11, 2017.

Conclusion
 

RBI suffers from low capacity in legal drafting. In this case, however, it is unlikely to lead to a serious legal problem. RBI's lawyer should ideally request the court to permit it to expunge that one line from the RBI's Press Release. That should allay the court's concern about separation of powers.

The second issue is more serious. RBI's Press Release does not explain why the IAC chose to use the non-performing status of the accounts as on March 31, 2016 for classifying the accounts in June 2017. However, if RBI's lawyers can provide the court with a clear rationale for choosing that particular date, the court may dismiss Essar's challenge. If RBI's lawyers fail to do so, the matter could drag on, causing much uncertainty in the stressed asset resolution regime.

Pratik Datta is a researcher at the National Institute of Public Finance and Policy, New Delhi.

This piece was originally published on Ajay Shah's blog. Read the original piece here