CRAs as resolution seekers under the BAC? – Insolvency/Bankruptcy

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The mounting of non-performing assets (“NPAs”) in India has led the Committee on Banking Sector Reforms (Narasimham-II Committee) to recommend the creation of a new class of companies called Asset Reconstruction Companies (“ARCs”). ”) in 1998. CRAs were envisioned as specialist companies that acquire NPAs from banks at a present value and attempt to achieve the same, allowing banks to clean up their balance sheets.

In 2002, Parliament enacted the Securitization and Reconstruction of Financial Assets and Enforcement of Collateral Act (“SARFAESI Act”), with the aim of accelerating and revamping the process of rebuilding financial assets in favor of secured creditors, by implementing the recommendations of the Narasimham Committee-II by giving the green light to the establishment of ARCs in India. The SARFAESI Act provided for the registration and regulation of CRAs by the Reserve Bank of India (“RBI”).

The need to enact SARFAESI was felt to expedite the slow pace of resolution of defaulting loans as the SARFAESI Act allowed creditors/CRA to initiate proceedings regarding secured debt, the need arose to encourage the reviving failing entities as a going concern in tandem with the purpose of the Companies Act, 2013. As a result, the Insolvency and Bankruptcy Code, 2016 (“IBC”) was enacted in as a single code to consolidate the entire insolvency and bankruptcy framework, allowing operational and financial creditors to initiate proceedings for Insolvency Resolution and Businesses, Businesses in Partnership and Individuals. The objective of the IBC is the rapid follow-up/resolution of corporate debtors.

Relevant provisions:

Section 9 of the SARFAESI Act grants the RBI regulatory powers over CRAs with respect to actions that may be taken by CRAs’for the purpose of asset recovery”that’s to say –

“(a) the proper management of the Borrower’s business, by changing or taking over the management of the Borrower’s business;

(b) the sale or lease of part or all of the Borrower’s business;

(c) the rescheduling of the payment of debts owed by the borrower;

(d) the enforcement of security in accordance with the provisions of this Act;

e) the payment of the contributions due by the borrower;

(f) take possession of the secured goods in accordance with the provisions of this law;

(g) conversion of any part of the debt into shares of a borrowing company:”

Article 10 of the SARFAESI Act restricts the initiation or exercise of any activity other than securitization or asset reconstruction without the prior approval of RBI.

Therefore, the SARFAESI Act not only provides for the specific activities that can be undertaken by CRAs, but also prohibits CRAs from engaging in any other activities without the prior approval of the RBI.

IBC Section 29A contemplates that CRAs registered under the SARFAESI Act are eligible to apply as a resolution applicant
1 as long as these entities are not related to the Debtor Company.

In the matter of the process of resolution of the corporate insolvency of Aircel Ltd and its subsidiaries in CP (IB) No 298/MB.II/2018, UV Asset Reconstruction Company Limited (“UVARCL”) emerged as the successful resolution2. Following the approval of its resolution plan, UVARCL sought RBI’s approval for the acquisition of shares in the applicant companies.

Importantly, under current RBI guidelines, CRAs are only allowed to hold up to 26% of the post-converted equity of the borrowing company.3 Only in certain prescribed circumstances can the 26% limit be waived.4

On 12.11.2020, RBI issued a show cause notice to UVARCL requesting an explanation as to why the registration certificate issued to UVARCL under Section 3 of the SARFAESI Act should not be canceled for violating the provisions of the SARFAESI Act and guidelines issued by RBI. The show cause notice was based on the allegation that, by submitting and proceeding with the resolution plan, UVARCL had ‘started an activity which he was not authorized to undertake under the law’.

UVARCL challenged the show cause notice of 12.11.2020 in the Delhi High Court through WP(C) 9537/2020 mainly on the grounds that IBC, being subsequent legislation, would prevail over the SARFAESI Act. The Delhi High Court stayed the enforcement of the show cause notice of 12.11.2020 in the order of 27.11.2020 in WP(C) 9537/2020. The case is currently pending.

In the past, resolution plans submitted by CRAs have been approved by contracting authorities in the past in the cases of Maxim Infrastructure & Real Estate Private Limited
5Aparant Iron and Steel Private Limited6and Palm Lagoon Backwater Resorts Private Limitedseven.

The Delhi High Court in its order dated 18.03.2021 in WP(C) 9537/2020 filed by UVARCL observed that there is a need to reach consensus between two ministries namely the Department of Financial Services under the Ministry of Finance, and the Ministry of Corporate Affairs for the approximation of the provisions of the two legislations.

Recently, the RBI formed a committee to review the functioning of the ARCs. The report of the committee responsible for reviewing the operation of the IECs8 recommended that CRAs be allowed to participate as resolution applicants in the resolution process, either through a security receipts trust (SR) or through the alternative investment fund (AIF) that they sponsor.

At present, there are no RBI framed guidelines/regulations to grant approval to CRAs to apply as a resolution applicant under Section 30 read with Section 29A of the IBC. In light of the specific provisions of the IPC providing for CBOs to be candidates for resolution, there is an urgent need for the RBI/relevant legislative authorities to issue the necessary guidance/directives in this regard.

Footnotes

1. Section 29A of the Insolvency and Bankruptcy Code, 2016.

2. Order of 09.06.2020 adopted by NCLT, Mumbai in CP (IB) n°298/MB.II/2018

3. RBI/2015-16/94 DNBR.(PD).CC.No. 03/SCRC/26.03.001/2015-16 of 01.07.2015

4. RBI/2017-18/101 DNBR.PD(ARC)CC. No. 04/26.03.001/2017-18 of 23.11.2017

5. 2019 CSC Online NCLT 666

6. 2019 CSC Online NCLT 28724

7. Order of 10.09.2020 in MA/113/KOB/2020 in TIBA/9/KOB/2019 NCLT, Kochi Bench

8. Report of the Review Committee for the operation of asset reconstruction companies dated 02.11.2021 https://rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=1188

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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