Bombay High Court Upholds RBI's 2019 Stressed Assets Framework, Finds No Arbitrariness

The Bombay High Court recently upheld the Reserve Bank of India's June 7, 2019 circular on the Prudential Framework for Resolution of Stressed Assets, refusing to interfere with the policy decision that repealed multiple earlier restructuring circulars.

The court found no arbitrariness in the RBI's decision to withdraw earlier schemes, including those relating to corporate debt restructuring, restructuring of advances by banks, and restructuring of dues of small and medium enterprises, holding that the RBI, as an expert body, was best placed to take decisions involving economic policy.

A division bench of Justices Bharati Dangre and Manjusha Deshpande said:

"On perusal of the scheme, we are of the view that it is the Expert Body like Reserve Bank of India, which has taken the aforesaid decision, in larger interest and since it is in a better position to take decision involving the economic policy of the country, since we do not find any arbitrariness in the said scheme, as it has repealed the earlier circular alongwith 27 other circulars, including the circular pertaining Corporate Debt Restructuring as well as Restructuring Advances by banks and the Restructuring of Dues of the Small and Medium Enterprises (SMEs) etc., in absence of any mala fides being attributed or arbitrariness being established, it is not within our powers to grant any indulgence.”

The case arose from a petition filed by S.E. Transstadia Pvt Ltd along with its managing director, director and its holding company Transstadia Holdings Pvt Ltd, challenging the June 7, 2019 circular. The petitioners contended that the circular removed benefits available under earlier restructuring frameworks applicable to infrastructure projects.

The company had undertaken development of a multipurpose sports stadium and infrastructure project at Kankaria in Ahmedabad in partnership with the Government of Gujarat and the Tourism Corporation of Gujarat. The project, for which a lease was granted in 2012, was financed through loans obtained from banks, with construction commencing in 2014 and the project being completed and inaugurated in June 2017.

The petitioners relied on RBI circulars issued in 2014, which permitted flexible structuring of long-term project loans in infrastructure and core sectors, including longer amortisation periods and periodic refinancing under what came to be known as the 5/25 scheme. According to them, these measures were intended to address the long gestation periods and cash flow constraints typical of infrastructure projects.

A Joint Lenders Forum had also found the project to be technically feasible and economically viable and proposed application of the 5/25 structure. However, before the restructuring could be implemented, the RBI on February 12, 2018 revoked the existing framework, including the 5/25 scheme, and introduced a new regime.

The petitioners had initially approached the Supreme Court challenging the 2018 circular. While the Supreme Court in Dharani Sugars and Chemicals Ltd v Union of India set aside the 2018 circular, the RBI subsequently issued the June 7, 2019 circular introducing a fresh framework for resolution of stressed assets, which was challenged in the present proceedings.

The petitioners argued that the 2019 circular failed to account for the specific needs of the infrastructure sector and arbitrarily withdrew the benefits available under earlier circulars permitting flexible structuring of loans. They contended that the withdrawal of these mechanisms had adversely impacted their project and financial position.

Opposing the petition, Senior Advocate Venkatesh Dhond, appearing for the RBI, submitted that the earlier framework had led to “evergreening” of loans, where fresh lending was used to mask defaults instead of recognising stress. He argued that the new framework was intended to ensure early detection of stress and timely resolution.

The court examined the 2019 circular and noted that its stated purpose was to provide a framework for early recognition, reporting and time-bound resolution of stressed assets. It recorded that lenders are required to identify incipient stress by classifying accounts as Special Mention Accounts and to report such information to the Central Repository of Information on Large Credits for borrowers with aggregate exposure of Rs.50 million and above on a monthly basis.

The framework also requires lenders to undertake a review of a borrower's account within 30 days of default and to formulate and implement a resolution plan, including through restructuring, change in ownership or other measures. It further provides for inter-creditor agreements and lays down voting thresholds for approval of resolution plans.

The court also noted provisions relating to restructuring, classification of accounts, and the possibility of upgrading accounts upon satisfactory performance during the monitoring period. It observed that the framework permits additional finance and interim finance under specified conditions.

Rejecting the challenge, the court held that the RBI's decision to replace earlier circulars with the 2019 framework could not be termed arbitrary or mala fide. It emphasised that the RBI, as an expert regulator, is better placed to frame and implement economic policy and that the court would not interfere in the absence of arbitrariness.

The court concluded that the circular applies across the sector and not merely to the petitioners and dismissed the writ petition, upholding the impugned circular.