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Transfer of Non-Performing Assets between Banks and Beyond
Niloy Pyne comments on the recently issued ruling of the Supreme Court, in the case of ICICI Bank Limited Versus Official Liquidator of APS Star Industries Ltd. & Ors. on whether non-performing assets (NPAs) can be transferred between banks without the concurrence of the borrowers.
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Background |
This case involved a transfer of Non Performing Assets (NPAs), relating to the borrower, APS Star Industries Ltd., from ICICI Bank to Kotak Mahindra Bank. The borrower was a company in liquidation. Upon the Assignee, Kotak Mahindra Bank seeked to substitute its name in place of one of the erstwhile creditors being ICICI, the Assignor of the debt, before the Company Court and that the borrower objected on several grounds, including the insufficiency of the stamp duty paid on the instrument of Assignment. The Company Court refused to recognize the Assignee on account of improper presentation of the document of transfer. On appeal, a Division Bench of the Gujarat High Court upheld the Company Court’s decision, but on a different ground, being that the assignment of debts by banks is not an activity permissible under the Banking Regulation Act, 1949. On further appeal, the Supreme Court considered chiefly two issues, which were, whether inter se transfer of debts between banks is an activity permissible under the Banking Regulation Act, 1949 and whether the Assignee Bank is entitled to substitution in place of the original lender / Assignor in proceedings relating to liquidation of the borrower company.
Assignment of debts and the Banking Regulation Act, 1949
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Considering the issue whether the inter se transfer of debts between banks is permissible, the Court examined in detail the scheme and provisions of the Banking Regulation Act, 1949 and concluded that assignment of NPAs is within the purview of a bank’s permitted business activity. According to the Supreme Court, the Reserve Bank of India (RBI) can lay down parameters enabling banking companies to expand its business; apart from accepting deposits and lending, The Banking Regulation Act, 1949 leaves ample scope for banks to venture into new businesses being subject to the control of RBI. Further, section 6(1) (n) of the Banking Regulation Act, 1949 enables “a banking company to do all things that are incidental or conducive to promotion or advancement of the business of the company”.
The Guidelines on Purchase/Sale of NPAs dated 13 July 2005 issued by the RBI allow banks to deal inter se in NPAs, which makes the activity a bona fide business. After going into the rationale for declaring a loan as an NPA, the Court went on to hold that the guidelines were issued as a restructuring measure in order to avoid setbacks in the banking system. The sale of NPA s is indeed profitable given that it is economically viable for the banking system and works positively in the interest of monetary stability or economic growth, keeping in mind the interest of the depositors and optimum employment of their deposits. The Supreme Court, after analyzing the provisions of the Banking Regulation Act, 1949, held that the issue in question in this regard appeared to be whether trading in NPAs has the characteristics of a bona fide banking business. In case, trading in NPA s fell within the scope of bona-fide banking business, there is no provision of law barring the same.
Sections 21 and 35A of the Banking Regulation Act, 1949 empower the RBI to issue various guidelines determining the policy in relation to advances to be followed by banking companies. The guidelines issued by RBI authorizing banks to deal inter se in NPAs have a statutory force of law. They have allowed banks to engage in trading in NPAs with the purpose of clearing the balance sheets and raising the capital adequacy ratio. These activities comes within the ambit of Section 21 of the Banking Regulation Act, 1949 which enables the RBI to frame the policy in relation to Advances to be followed by the banking companies and which empowers RBI to give directions to banking companies under Section 21(2) of the Act.
When a delegate is empowered by the Parliament to enact a Policy and to issue directions which have a statutory force and such delegate, being the RBI in this case, issues such guidelines having statutory force, such guidelines have to be read as supplemental to the provisions of the Banking Regulation Act, 1949. Such "banking policy" as enunciated by RBI cannot be said to be ultra vires the Act. The Supreme Court held that Section 6(1) of the Banking Regulation Act, 1949 is a general provision and enumerates the fields in which banks can carry on their business, being core banking business. However, RBI, being the regulator, under Section 21 and 35A can issue directions having statutory force, laying down parameters enabling banks to expand their business. Such parameters define `banking business'.
According to the judgment of the Apex Court, Section 6 of the Banking Regulation Act, 1949 describes what activities banks can take part in. The 1949 Act allows banking companies to undertake activities and businesses as long as they do not attract prohibitions and restrictions like those contained in Sections 8 and 9 of the Banking Regulation Act, 1949. The Court further went on to state that RBI is empowered to enact a policy which would enable banking companies to engage in activities in addition to core banking process it defines as to what constitutes ``banking business''.
Assignment of Debts and the SARFAESI Act, 2002
In respect of the assignment of debts to banks, the Court further held that the provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) are not applicable to the case. The SARFAESI Act relates to a transfer of financial assets from banks to specific types of financial vehicles being securitization companies and asset reconstruction companies, but not banks. The applicable laws in this regard, according to the Apex Court would be the Transfer of Property Act and the Banking Regulation Act.
Prima-facie it could be argued that the Section 5 of the SARFAESI Act is the only legal mean of transferring financial assets. The section reads as follows:
``Notwithstanding anything contained in any agreement or any other law for the time being in force, any securitization company or reconstruction company may acquire financial assets of any bank/Financial Institution.''
It is true that the SARFAESI Act does not per se provide that banks have the power of assignment of financial assets. The SARFAESI Act was enacted in 2002, to help carry out securitization transactions. However, in view of the said enactment, one cannot afford to turn a blind eye towards pre-existing law on transfer of financial assets for instance the Banking Regulation Act and the Transfer of Property Act. The SARFAESI Act was enacted enabling specified special purpose vehicles to buy the NPAs from the banks. However, from that it does not necessarily follow that banks cannot transfer their own assets.
Section 5 of the SARFAESI Act recognizes securitization as acquisition of any financial assets; that, securitization is a matter of contract and Section 5 of the SARFAESI Act provides for special machinery through which financial assets of banks are acquired. The Court held that the SARFAESI Act has no relevance as far as the issue in hand is concerned. The Supreme Court in this case, overruled the order of the High Court which had wrongly held that the trading of NPAs would mean transfer of NPA from one banks balance sheet to another without any resolution and therefore against the health of the banking industry. The High Court had also held assignment of debts impermissible in view of the fact that in case of debts being assigned in groups or portfolios and individual loans being lumped together and bought, there was no way to ascertain the value of individual loans and the amount recovered from them. This made such transactions essentially speculative trading.
Striking down the impugned judgment, the Supreme Court held that the RBI Guidelines treats inter se NPA assignment between banks to be a tool for resolving the issue of NPAs and in the interest of banking policy under Section 21 of the Banking Regulation Act, 1949. The object of such assignment is to minimize credit risk. Corporate debt restructuring, being allowed under the RBI Guidelines, is a matter of banking policy and could not be treated as "trading". Keeping in mind the object of the Banking Regulation Act, the RBI Guidelines fall under Section 21 of the 1949 Act and as such form a part of Credit Appraisal Mechanism. Thus, assignment of NPAs inter se between banks is an activity which could not be termed as speculative trading and was permissible under the provisions of the Banking Regulation Act, 1949.
Transfer of Debts vis-à-vis Transfer of Obligations
The Apex Court, in this matter, distinguished between the transfer of rights to realize the debt due, and transfer of obligations. As far as the transfer of debts due is concerned, it can be effected without concurrence of the borrower, for the mere fact that such an assignment which subsequently leads to the substitution of the creditor, does not amount to novation in the contract of loan agreement and therefore, such a substitution is valid under law. Assignment of obligations on the other hand, requires a novation of the contract, thereby necessitating concurrence of the borrower.
The rationale followed by the Court in this regard was perhaps the fact that in a case where a debt is assigned to another party without the transfer of obligations, the rights of the borrower to proceed against the original Lender remains unaffected. Whereas, a transfer of obligations to the Assignee would mean that the terms and conditions of the contract between the borrower and the original Lender are being altered. It would thus amount to novation. In the present case, the Court found that the assignor is only transferring the rights under contract, representing its assets and no transfer of obligations of the assignor towards the assignee, has taken place and they continue to be borne by the assignor. Hence, according to the Court, there was no necessity to obtain the borrower’s consent before such transfer of debts.
Conclusion
In the judgment, the Apex Court clearly ruled that the RBI directives and guidelines have a statutory flavour and the Guidelines clearly indicate that ‘banking business’ is not only confined only to the core activities enumerated in Section 5(b) of the Banking Regulation Act, 1949. In exercise of the powers conferred by Sections 21 and 35A of the said Act, RBI can issue directions having statutory force of law. Section 36 deals with further powers and functions of RBI. Under Section 39, it is the RBI who shall be the Official Liquidator in any proceedings concerning winding up of a banking company. In this context, it can be said that the said judgment has interpreted the RBI to have completely unfettered powers in respect of determining the scope of ‘banking business’ vide the issue of directions.
Though the judgment places in perspective, the economic viability of assignment of debts inter se between banks, jurists fear that the definition of ‘banking’ cannot be altered by the Central Government without Parliamentary supervision. Further, questions have been raised regarding the unregulated empowerment of the RBI, as interpreted by the Supreme Court. The declaration that RBI Guidelines themselves have statutory force and can define the scope of ‘banking business’ probably threatens to render the provisions of Section 6(a) to (o) of the banking Regulation Act, 1949 as infructuous.
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NILOY PYNE is a Partner with Amarchand Mangaldas Suresh A. Shroff & Co. at its Kolkata office.
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