Asset Reconstruction Companies as Resolution co-applicant – Interplay of SARFAESI and Insolvency and Bankruptcy Code

[By Aritra Mitra]

The author is a student at National Law University, Odisha.

 

Introduction

In the recent judgment of Puissant Towers India (P.) Ltd. v. Neueon Towers Ltd., the Chennai bench of the NCLAT overturned the order of the Adjudicating Authority and held that ARCs (hereinafter “Asset Reconstruction Companies”)  can act as Resolution Co-Applicant in an Insolvency and Bankruptcy Code, 2016 (IBC) resolution process, even without the permission of RBI.

It observed that the Adjudicating Authority ought not to have placed reliance on Section 10(2) of the SARFAESI Act, 2002 as Section 238 of the IBC would prevail over the provisions of the SARFAESI Act, 2002, if there was any inconsistency with any provisions of the IBC.

But the conundrum arises because ARCs are regulated under the SARFAESI Act and ARCs intending to perform any activity other than securitisation, reconstruction, and statutorily allowed functions, prior approval of the RBI is a must. Hence, even though there have been judicial precedents that state that IBC will override other conflicting other acts, but permitting ARCs to act as Resolution co-applicant without RBI approval creates issues, which the NCLAT has failed to consider before passing the order, and which the author shall discuss  in the following paragraphs.

ARC as Co-Resolution Applicant – Beyond objectives under SARFAESI

ARCs were introduced with the objective of helping banks and financial institutions manage their stressed assets by reducing the non-performing assets on their books. Whereas IBC was introduced to perform the function of reorganisation and resolution of insolvent entities.

Since both IBC and SARFAESI perform a similar objective of reconstruction of bad loans, there are chances of inconsistencies and overlaps.

The petitioners relied upon ARCIL v. Viceroy Hotels Limited, Manish Kumar v. Union of India, and the Delhi HC judgment in UV Asset Reconstruction Company v. Union of India, where it was clearly held that ARCs have to take RBI approval. But the appellate authority completely rejected the submissions of the appellants. But by passing such judgment it failed to discuss certain points which should have been considered before passing such a decision.

The legal and regulatory design of ARCs is primarily focused on recovery of debt from the borrower and not on resolution of the borrower’s insolvency. Under Section 2(1)(ba) of the SARFAESI Act, ARCs are set up solely for the purpose of asset reconstruction or securitisation, or both. Further restrictions have been provided in Section 10(1) in the form of business that ARCs are allowed to perform. There is no mention of resolution applicant. Furthermore, Section 10(2) of the SARFAESI restricts ARCs from performing any business without prior RBI approval. It clearly denotes the specific purpose of ARCs. Allowing ARCs to act as resolution applicant without RBI approval seems to go against the provisions of SARFAESI.

Also, Section 12(2) lays out the RBI’s power to issue directions to ARCs. And the implied meaning of those directions cannot go beyond the business provided in the SARFAESI Act.

Section 15(4) of the SARFAESI Act states as following:

if any secured creditor jointly with other secured creditors or any asset reconstruction company or financial institution or any other assignee has converted part of its debt into shares of a borrower company and thereby acquired controlling interest in the borrower company, such secured creditors shall not be liable to restore the management of the business to such borrower.”

Thus, there is no such obligation on the ARC to return the business to the borrower where it has already acquired a controlling interest in the entity. This goes against the very objective of the Code and should have been considered before allowing ARC to act as resolution applicant without RBI approval.

Beyond Legislative Intent

The idea of establishing ARC was recommended for the sole purpose of performing recovery of NPAs of banks. The Expert Committee for Recommending Changes in the Legal Framework concerning Banking System, and the BLRC Report, 2015 had clearly demarcated the functions of the ARC to reconstruction and securitisation. There was no mention of roles in insolvency resolution. It was clearly explained that the intent and objective of an ARC is to ‘realise the dues’ and reposition the borrower, and not ‘rescue’.

The NCLAT also failed to consider the legislative intent behind establishing the ARCs. Allowing them to act as resolution professional in IBC would effectively go beyond the purpose of the ARCs. This may

Furthermore, the resolution of stressed assets under IBC is expensive. the resolution applicant has to burn cash for an elongated timeline before being able to derive profits from these assets. However, ARCs are required to redeem SR’s within a period of maximum 8 years, meaning that ARCs cannot burn holes in their pocket and are required to recover their dues within a tight timeline. Accordingly, the luxury of a long gestation period is not available with ARCs making them unsuitable for resolution of stressed assets under IBC.

Inefficiencies in RBI notification

Now even though the NCLAT did not even discuss it, but RBI on 11th October, 2022 came out with a new notification ‘Review of Regulatory Framework for ARCs’, which permits ARC to act as Resolution Applicant under IBC. But even such permission is conditional upon fulfilment of certain grounds.

The NCLAT did not even consider whether the ARC has a minimum Net Owned Fund of ₹1,000 crore and a committee, consisting mostly of independent directors, to make decisions about proposals for the submission of a resolution plan under the IBC.

Since the RBI notification was not considered to grant permit to the ARC, the NCLAT made another error in granting permit without even considering whether the statutory requirements were fulfilled.

Furthermore, the RBI notification also mandates that ARCs cannot exert significant control over the acquired insolvent entity and has to dilute such control within five years of the date of approval of the resolution plan. This ultimately means that a situation may arise where the ARC will look to sell the insolvent entity at a high price instead of reviving it. This goes against the basic tenets of IBC. The mandate of diluting control effectively means that the ARC will try to sell at a higher price instead of putting efforts to revive the entity. Therefore, allowing ARC as resolution applicant may very well go against the primary tenets of IBC.

Overriding effect of IBC

Under Section 238 of IBC, the Code has been provided with an overriding power over any other law for the time being in force.

In Deep Chand v. State of U.P,[1] the apex court had held that that even though two different statutes operate in the same field and on same subject matter, the invalidity of one act would only be to the extent it contradicts the provisions of the other act.

The inconsistency should be of such a magnitude that the legislations appear to be in ‘direct collision’ with each other and it is impossible to obey both of them simultaneously.[2]

IBC permits ARCs to act as resolution professional under Section 29A of the IBC, but the SARFAESI prohibits ARC from engaging in any other business other than reconstruction and securitisation. But with the release of the RBI notification granting permit to the ARCs based on fulfilment of certain conditions, it is yet to be seen as to how courts interpret it.

In this the RBI notification is not in direct collision with the IBC Code, but has added requirements. It cannot be said that they are in conflict of each other and the Code should be given precedence. It is yet to be seen how the Courts interpret the RBI notification with the Code in terms of permitting ARCs to act as resolution applicant.

Conclusion

ARCs were established to control the NPA crisis in the country, but allowing them act as resolution applicant under IBC based on the sole reason that the resolution process will be faster, denotes a lack of clear approach in addressing the issue of rising NPAs in banks.

Throughout the paper I have laid down several reasons which clearly show why ARCs should not be given the permission to act as resolution applicants. Even though there are benefits in allowing ARCs, but there is a clear incompatibility between two statutes and various issues, which do not make it ideal to allow ARCs to act as resolution applicants.

The NCLAT could have taken this opportunity to clarify various issues as the current provisions even though allows ARCs to participate as resolution applicants, but it does not give the ARCs the opportunity to participate meaningfully in revival of distressed Indian companies in the long term. For instance, the condition to divest significant influence or control over the insolvent entity within five years can prove to be economically counterproductive.

 

[1] AIR 1959 SC 648, ¶39

[2] Innoventive Industries Limited v. ICICI Bank Limited, AIR 1959 SC 648, ¶39

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