Supreme Court declares February 12 RBI Circular ultra vires [Read Judgment]

Supreme Court strikes down RBI's controversial February 12 circular on bad loans

Therefore, in an effort to warn banks and borrowers that they will be penalised for defaulting on loans, the RBI issued a controversial circular.

Section 35AA, introduced through amendments to the Banking Regulation Act in 2017, states, "The Central Government may by order authorise the Reserve Bank to issue directions to any banking company or banking companies to initiate insolvency resolution process in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016".

The notice came on the heels of banks finalising resolution plans for the "Dirty Dozen", a list of 12 Indian companies that went bankrupt and qualified for immediate resolution. Power producers, for instance, had argued that the RBI's "one-size-fits-all" approach was impractical since the sector was having to confront external factors that were beyond its control, and which made an early revival hard for them.

Now, the RBI can ask for a review from the SC on whether its circular can still work without the specific clauses that the court disagreed with.

In February 2018, the RBI put out a circular on classification of non-performing assets that required banks to refer any account with a loan of more than Rs 2,000 crore to bankruptcy court if it is not resolved within 180 days of a default.

The RBI governor said on Thursday the Supreme Court had not doubted the powers of the central bank under Section 35AA. Shipping and sugar sector companies had approached other High Courts against the circular.

Moody's said resolution of stressed assets may now be delayed. "We will read it and I am sure the RBI will also decide what is to be done with the various aspects contained in the circular", Jaitley had said.

"All this, due to no fault of the power companies who were denied coal, railway wagons, PPAs, payment security in highly regulated sector". Since banks will have the choice of devising resolution plans or going to the National Company Law Tribunal under the IBC, the urgency that the RBI's rules had introduced in the system could be impacted. According to the circular, lenders had to classify a loan account as stressed if there was even a day of default.

Experts have said quashing of the February 12 circular, could lead to delays in the resolution of stressed assets. Bankers argued on Tuesday that the quashing of the RBI circular was unlikely to impact ongoing cases at NCLT.

"It is only the punitive action or coercive action under the circular which will get affected by this", the lawyer said.

The circular had mandated banks to take into account all stressed companies with loan exposure above Rs 2,000 crore even if the period of default was for one day.

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