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A blow to IBC…

IBC’s emergence was one of the primary reasons for the rapid revival of a great deal of confidence in our financial discipline. It’s dangerous not to have control measures to ensure fiscal discipline. India has witnessed several high-profile defaults attributed to many reasons, including violation of the end use norm. The impunity with which certain offenses have been carried out called for actions sufficiently punitive.

The ruling has nixed the RBI circular on bad loans. The impugned circular had stipulated that banks had only 180 days to arrive at a debt-resolution plan for loan accounts of Rs. 2000 crore and more, failing which the company would have to go to the bankruptcy court under the Insolvency and Bankruptcy Code (IBC). It also introduced a one-day default rule on term loans, which mandates treating a borrower who misses repayments as a defaulter the very next day.

The RBI defended the 12 February circular, saying that the intention behind the circular was to give banks more powers in resolving stress. It also noted that the 1-day default rule is to ensure banks and borrowers put a risk management framework in place. However, the top court wasn’t amused and said that while the RBI has the power to issue instructions on specific companies, it cannot issue a blanket direction.

The extend and pretend cycle…

The quashed circular was essential to break the cycle of extend-and-pretend that has been the hallmark of the Indian banking system. Bankers were content to kick the can down the road and delay the recognition of bad loans to show a rosy bottom line. The circular sought to clean up the credit culture and bring discipline, both among banks and borrowers. However, implementing this circular would have meant that a lot of promoters were in danger of losing their firms. That made it extremely unpopular.
Earlier in the year, the Supreme Court upheld the constitutional validity of the IBC saying, “the defaulters’ paradise is lost” and the economy’s rightful position has been regained. On Section 29A, which dealt with the rights of erstwhile promoters to participate in the recovery process of a corporate debtor, the court said: “a resolution applicant has no vested (automatic) right for consideration or approval of its resolution plan.” Ironically, the latest ruling simply negates the positions held so far in all spheres, including in the judiciary.

Loan discipline would now take a back seat

The latest ruling may have provided relief to the regulated sectors but is a significant setback to the IBC. The stringent criteria for identifying bad loans have so far seen Rs 3 lakh crore coming back to the banks. Experts say the judgment is a one step back for banks, as the loan discipline would now take a back seat.
Effectively the Apex Court, whose ruling we have to adhere to in letter and spirit, is effectively saying that there are occasions when the economic activities are impacted by circumstances and behaviors of players not direct parties to the business operations perse, yet these factors influence the economic activities undertaken by the corporates. Not having a stringent framework to curb the economic offenses is no argument however it may be a travesty of justice if the same brush is used to paint all without an appropriate due diligence mechanism to objectively categorise the borrowing community based on relevant parameters.
Just to contextualise. It’s dangerous not to have equal control measures to ensure fiscal discipline. Over the decades, India has witnessed several high-profile defaults attributed to many reasons, including violation of the end use norm. The impunity with which certain offenses have been carried out called for actions sufficiently punitive. It is in that sense many think that this judgment punctures RBI’s efforts to fight bad loans. IBC’s emergence was one of the primary reasons for the rapid revival of a great deal of confidence in our financial discipline. A regulator without an effective and efficient enforcement mechanism is akin to a toothless tiger meant for only limited publicity devoid of its real purpose of existence.

The menace of default remains…

The Apex court order may have undone the perceived ruthlessness embedded in the impugned circular. But the menace of default remains and hence requires to be dealt with appropriately through an alternative framework. Let’s hope RBI and government work together to come up with alternative measures to arrest the menace in the broader interest of the economy.Sabysachee Dash [The author is Supreme Court Lawyer]

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