Yes Bank's ₹8,415 Crore AT-1 Bond Write-Down After Reconstruction Scheme Took Effect Was Illegal: Supreme Court

The Supreme Court on Thursday held that the Administrator of Yes Bank could not write down ₹8,415 crore worth of Additional Tier-1 (AT-1) bonds after the bank's reconstruction scheme came into force.

The court ruled that the requirement to write down the bonds “before reconstitution” meant before the scheme took effect.

“Had the intention been otherwise, the clause ought to have read 'before reconstitution is complete',” a bench of Justices Dipankar Datta and Augustine George Masih observed. It rejected the argument that the Administrator's power continued until every obligation under the scheme had been fulfilled.

The court dismissed appeals filed by Yes Bank, the Reserve Bank of India (RBI) and the Union government against the Bombay High Court's January 20, 2023 order quashing the write-down.

Yes Bank issued AT-1 bonds worth ₹3,000 crore on December 23, 2016, followed by another tranche worth ₹5,415 crore on October 18, 2017. As the bank's financial position deteriorated, the Central Government imposed a moratorium on March 5, 2020. The RBI appointed an Administrator under Section 36ACA of the Banking Regulation Act, 1949, on the same day.

The Central Government notified the Yes Bank Limited Reconstruction Scheme, 2020, on March 13, 2020. A provision in the draft scheme proposing a permanent write-down of the bonds was omitted from the final version. The Administrator nevertheless wrote down the entire ₹8,415 crore the following day, relying on the RBI's Master Circular on Basel III Capital Regulations.

Central Government consciously left bonds untouched

The court noted that the RBI had received objections from investors after the draft scheme proposed writing down the bonds. Axis Trustee Services, which represented bondholders, had suggested converting the bonds into equity instead. The RBI considered the proposal, and an internal note recorded that a majority of investors were agreeable to conversion.

However, the proposal to write down or convert the bonds was abandoned when the scheme was considered by the Central Government.

The bench observed that the government had consciously chosen not to include a provision affecting the bonds in the final scheme. It added that the government was presumed to have been aware of the effect this would have on Yes Bank's Common Equity Tier 1 (CET1) ratio.

The court found it unreasonable to assume that the RBI and the Central Government would undertake the lengthy process of framing the reconstruction scheme but leave the crucial question of the AT-1 bonds to be decided later by the Administrator.

“If the appellants' arguments were to be accepted, the Reconstruction Scheme would be akin to a half-baked pie, where the last step of the process is left to the Administrator,” the bench observed.

It further held that the Central Government had taken a conscious decision to exclude the write-down clause after considering objections from investors.

“We do not, for a moment, think that the Central Government intended to have the AT-1 Bonds written down, having regard to the turn of events right from 3rd March, 2020,” the court observed.

The Administrator, it held, acted under an “erroneous impression or mistaken belief” that he retained the power to write down the bonds even after the reconstruction scheme came into force. The action was “an impermissible act and ultra vires the Master Circular read with the Reconstruction Scheme”.

The bench also rejected the argument that the scheme's general provision preserving existing contracts and other instruments allowed the Administrator to write down the bonds. Such a provision, it held, could not confer a specific power that had not been granted under the applicable regulatory framework.

'Before reconstitution' means before scheme takes effect

The appellants had argued that reconstruction was a continuing process that would remain incomplete until all obligations under the scheme had been discharged. On that reasoning, the Administrator's power to write down the bonds would continue for years after the scheme was notified.

The court rejected this interpretation. Under clause 2.15 of Annex 16 to the RBI's Master Circular, AT-1 instruments had to be written down or converted permanently before reconstitution.

The bench held that the trigger at the point of non-viability was deemed to have been reached when the relevant authorities decided to reconstruct Yes Bank. The bonds should therefore have been written down before the reconstruction scheme took effect.

“True, the effects of a reconstruction scheme may run for years together; but that, by itself, cannot be read as empowering the relevant authority to write down the AT-1 Bonds at any point within the following three years,” the court observed.

It added that interpreting the clause in the manner suggested by the appellants would defeat the purpose of AT-1 bonds. It would also leave investors uncertain about when their investments could be wiped out.

The bench also referred to the treatment of bonds issued by Lakshmi Vilas Bank before its amalgamation with DBS Bank India. In that case, bonds worth ₹318.20 crore were written down a day before the amalgamation scheme took effect. The court noted that it remained unexplained why the same course had not been followed in Yes Bank's case.

The administrator could not exercise RBI's regulatory power.

The court examined the two triggers under the bond terms for absorbing losses.

At the pre-specified trigger level, which is reached when the bank's CET1 ratio falls below the prescribed threshold, Yes Bank could decide whether to write down or convert the bonds, subject to the terms of the Information Memoranda.

The second trigger, the point of non-viability, operated differently. Under the bond terms, the RBI was responsible for determining whether the bank had reached or was approaching non-viability and exercising the relevant power.

Yes Bank's CET1 ratio had fallen to 0.6% by December 31, 2019, against an applicable requirement of 7.375%. The bank had the option to write down or convert the bonds at the pre-specified trigger level but chose not to do so.

When the point of non-viability was triggered, the RBI was required to exercise the relevant power. Instead, the Administrator wrote down the bonds.

The court held that the Administrator, appointed under Section 36ACA of the Banking Regulation Act, acts as a substitute for the bank's board of directors and must remain within the powers conferred on him by law.

“Any act performed by the administrator beyond the powers clothed upon him would be wholly illegal and void,” the bench observed.

It concluded that the Administrator could not assume the RBI's regulatory role or exercise a power that had not been conferred on him.

RBI criticised for allowing bank's capital ratio to fall

The bench strongly criticised the RBI's handling of the matter, observing that the bank's financial position had deteriorated considerably before the reconstruction scheme was introduced.

“The RBI was a mere bystander, allowing the CET1 ratio of YES BANK to drop to an astonishing low of 0.6% while the business of YES BANK was being carried out in a clandestine manner,” the court observed.

It noted that material irregularities in Yes Bank's functioning had been identified earlier and criminal prosecution had been initiated against bank personnel. The court held that investors should not be made to bear the consequences of administrative lapses.

“However, to have the investors at the receiving end of the administrative lapses would be highly unfair,” the bench observed.

The court also questioned whether the RBI, the Administrator, Yes Bank, the State Bank of India and the Central Government knew that the final reconstruction scheme omitted the write-down clause. SBI was involved in infusing capital into the bank as part of the reconstruction exercise.

The bench clarified that the issue was not whether the AT-1 bonds could or should have been written down, but whether the action had been taken in accordance with the applicable rules.

“The question is the manner in which it was done, de hors the Master Circular and the Information Memoranda,” the court observed.

It also noted that Yes Bank had offered high-risk AT-1 bonds to individual investors despite the RBI's framework requiring such instruments to be offered only to institutional investors. The court observed that closer scrutiny should have been exercised before individual investors were sold such securities.

Dismissing the appeals, the court clarified that annual coupon payments on the bonds would remain unaffected. The payments must continue in accordance with the Information Memoranda.