SC Strikes Down RBI’s Feb 12 Insolvency Circular: Demystifying the Decision

A bench of the Hon’ble Supreme court of India comprising of Justices R. F. Nariman and Vineet Saran, in the case of Dharani Sugars and Chemicals Ltd. v. Union of India (“Dharani”) have invalidated the Reserve Bank of India’s (“RBI”) Circular titled ‘Resolution of Stressed Assets – Revised Framework’  (issued on 12.02.2018) (“Feb 12 Circular”) as being ultra vires the Banking Regulation Act, 1885 (“BR Act”) and the Reserve Bank of India Act, 1934 (“RBI Act”). This Circular had overhauled the Indian regime of stressed asset resolution and introduced the generic scheme of a resolution plan to be implemented within 180 days from the date of the default on the loan. Furthermore, where the aggregate exposure of the account stood at Rs. 2000 Crores or more, the banks were directed to refer such defaults under the Insolvency and Bankruptcy Code, 2016 (“Code”) where there was a failure in the implementation of the Resolution Plan within the stipulated 180 days.

We have done a thorough analysis of the Feb 12 Circular and the resolution framework therein in this series of articles.

[Author’s Note: The judgement in this case authored by Hon’ble Justice Mr R. F. Nariman is an excellent read on various aspects of the modern jurisprudence on the interpretation of statutes and the judicial review of executive action. The specific rules of interpretation referred to in the Judgment have been compiled by us and can be found here.]



In 2017, Amendments were made to the BR Act to insert Sections 35AA and 35AB. These changes were first made through an Ordinance which was later replaced by an Act of the Parliament. These Sections are reproduced hereunder:

Section 35AA – Power of Central Government to authorize Reserve Bank for issuing directions to banking companies to initiate insolvency resolution process-

The Central Government may, by order, authorize the Reserve Bank to issue directions to any banking company or banking companies to initiate insolvency resolution process in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016 (31 of 2016).

Explanation- For the purposes of this section, “default” has the same meaning assigned to it in clause (12) of section 3 of the Insolvency and Bankruptcy Code, 2016. 

Section 35AB – Power of Reserve Bank to issue directions in respect of stressed assets –

(1)  Without prejudice to the provisions of section 35A, the Reserve Bank may, from time to time, issue directions to any banking company or banking companies for resolution of stressed assets.

(2)  The Reserve Bank may specify one or more authorities or committees with such members as the Reserve Bank may appoint or approve for appointment to advise any banking company or banking companies on the resolution of stressed assets.

Thereafter, the Ministry of Finance vide Notification dated 05.05.2017, “authorized the Reserve Bank of India to issue such directions to any banking company or banking companies which may be considered necessary to initiate insolvency resolution process in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016”. This was done in exercise of its powers under Section 35AA of the BR Act.

The RBI then issued a Press Release dated 13.06.2017 whereby it identified certain accounts for reference by banks under the Code. It had noted therein that the Internal Advisory Committee (“IAC”) constituted by it had identified 12 top exposure accounts that had (a) both funded and non-funded outstanding exposure of Rs. 5000 Crore and more and (b) more than 60 per cent of the total outstanding being declared as NPA, to be directed to the insolvency resolution process under the Code. These accounts, prominently, represented 25 per cent (Rs. 1,97,769 Crores) of the NPAs of the Indian economy. The list included companies such as Essar Steel Ltd., Bhushan Steel Ltd., Monnet Ispat and Energy Ltd., etc.

Finally, the RBI came up with a general framework for stressed asset resolution in the form of a Circular titled ‘Resolution of Stressed Assets – Revised Framework’ (issued on 12.02.2018). By this new framework, the RBI introduced a timeline of 180 days from the date of the default to implement a ‘resolution plan’ aimed at resolving the default. However, beyond the 180 days, the banks were obligated under this framework to refer the defaulting company for CIRP under the Code where the aggregate exposure of the account stood at Rs. 2000 Crores. Among various other highlights, this new framework scrapped the extant tools for resolution of stressed assets like the Joint Lenders Forum, Strategic Debt Restructuring, Corporate Debt Restructuring, etc. and in their place, evolved the concept of a “resolution plan” that could be an assimilated exercise of all of the outgoing instructions, enforced generically.


Facts of the Case

The charge of the challenge, in this case, was led by the Association of Power Producers, representing the power sector in general. Various other entities from other sectors had followed almost the same arguments. Each of them had highlighted the difficulties faced as a result of Government policies and other reasons for financial stress in all these sectors, which have nothing to do with the efficiency of management of companies operating in these sectors.


Decision of the Court

The Petitioners had challenged the constitutionality of Section 35AA and 35AB of the BR Act and the vires of RBI’s Feb 12 Circular vis-à-vis the BR Act and the RBI Act. The Court decided the issues as follows:


1. Constitutional Validity of Section 35AA and 35AB of the BR Act

The Apex Court upheld the Constitutionality of Sections 35AA and 35AB of the BR Act as being just and reasonable along with being guided by definite statutory considerations. The Court also followed its decision in the case of Swiss Ribbons Pvt. Ltd. and Anr. v. Union of India and Ors. reasoning that economic legislations are to be viewed with great latitude.


2. Vires of the Feb 12 Circular

The Supreme Court made an important delineation of the mandate of the RBI under Sections 35AA and 35AB, holding that when it comes to issuing directions to initiate the insolvency resolution process under the Insolvency Code, Section 35AA is the only source of power. However, when it comes to issuing directions in respect of stressed assets, which directions are directions other than resolving this problem under the Code, such power falls within Section 35A read with Section 35AB. Therefore, in so far as the RBI had mandated banks to direct its defaulters to the insolvency Court under the Code, it amounted to an exercise of power under Section 35AA of the Act.

The Apex Court made it clear that the RBI can only direct banking institutions to move under the Code if two conditions precedent are specified, namely, (i) there is a Central Government authorization to do so; and (ii) it should be in respect of specific defaults. The Section, therefore, prohibits this power from being exercised in any manner other than the manner set out in Section 35AA. To this end the Court relied on the Taylor Principle enunciated in the case of Taylor v. Taylor[1] where it was established that if a statute confers power to do a particular act and has laid down the method in which that power has to be exercised, it necessarily prohibits the doing of the act in any manner other than that which has been prescribed.

The Apex Court then struck down RBI’s Feb 12 Circular as being ultra vires the BR Act and the RBI Act. The same was done on the following grounds:

i. Lack of Central Government authorization: The Court noted that since the power of the RBI to direct banking institutions to move under the Code is predicated upon the authorization of the Central Government to this effect, the lack of the same behind the Feb 12 Circular renders it ultra vires Section 35AA of the BR Act. The Court noted that this was unlike RBI’s direction of the 12 mega defaulters to the insolvency courts by way of the Press Release dated 13.06.2017 for which the RBI was specifically authorized by the Central Government vide Notification dated 05.05.2017.

ii. Only specific defaults, not general: The Court looking to the definition of the terms “Default”, “Debt”, “Corporate Debtor” under the Code held that the RBI’s power to issue directions, presuming government authorization, is limited only to specific defaults by specific debtors. Therefore, insofar as the Feb 12 Circular mandates the IBC reference of all defaulting accounts with aggregate exposure of Rs. 2000 and more upon failure of implementation of the resolution plan, the same falls foul of Section 35AA of the RBI Act.

iii. Falling Foul of Section 45-L of the RBI Act: The impugned Circular states as one of its sources, the power contained in Section 45L of the RBI Act insofar as directing non-banking financial institutions is concerned. Section 45L(1)(b) of the RBI Act empowers the RBI to give to such institutions either generally or to any such institution in particular, directions relating to the conduct of business by them or by it as financial institutions or institution if the Bank is satisfied for the purpose of enabling it to regulate the credit system of the country to its advantage it is necessary so to do.

However, Section 45L(3) of the RBI Act provides that in issuing directions to any financial institutions under Section 45L(1)(b), the RBI shall have due regard to the conditions in which, and the objects for which, the institution has been established, its statutory responsibilities, if any, and the effect the business of such financial institution is likely to have on trends in the money and capital markets. The Court held that there is nothing to show that the provisions of Section 45L(3) have been satisfied in issuing the impugned circular and therefore, it falls foul of the same requirement under the RBI Act.



The decision of the Supreme Court in Dharani has far-reaching implications upon the RBI’s fight against NPAs. As is very much the case with challenges to executive actions, the Court in striking down RBI’s Feb 12 Circular has not targeted the mandate of the RBI but rather the decision-making process behind it. It is not the case that the RBI has no power to direct defaulters of banks for CIRP under the Code, however, the same is to be exercised within the limitations enshrined under Section 35AA of the BR Act.

Arguably the biggest cause of concern raised by this decision is that as the Feb 12 Circular has been held to be ultra vires, the actions taken thereunder not only under the Code but also at the stage of the implementation of a Resolution plan after default are to be treated as being non est. This decision takes away the legal backing behind all of the actions taken under the Feb 12 Circular and the same must fall along with the said circular. As a result of the Court invalidating all of the proceedings under the Feb 12 Circular, it has also opened a Pandora’s box of challenges to the insolvency process by borrowers before the insolvency Courts to abate the same claiming that the proceedings against them were actually a result of RBI’s defunct Feb 12 Circular as it becomes practically very difficult to discern whether or not the action was in fact taken under the Notification or not.

Even though RBI’s Feb 12 Circular has been struck down due to ultra vires, the fact still remains that India has for the very first time in this decade seen a consistent decline in the Gross NPAs in the economy. While the same may be attributed to the Code as well as various other economic measures, the role of the Feb 12 in this decline cannot be denied. The International Monetary Fund has indicated that there has been a fall of Rs. 31,168 Crores in the gross bad loans in the country between Aril – December 2018-19, however, there is still a long way to go. The RBI, in its biannual Financial Stability Report (31.12.2018) has stated that the asset quality of banks has shown an improvement with the gross non- performing assets (GNPA) ratio of Scheduled Commercial Banks declining from 11.5 per cent in March 2018 to 10.8 per cent in September 2018.

In the case of the reference of the 12 mega defaulters to the insolvency process under RBI’s Press Release dated 13.06.2017, the same falls in line with the requirements of Section 35AA as firstly, the same was clearly authorized by the Central Government vide Notification dated 05.05.2017, and, secondly, it directed the 12 companies for insolvency based upon specific contextual criteria and not merely in generality.

It must be noted that India already has an insolvency regulator in the form of the Insolvency and Bankruptcy Board of India and while the mandate of the RBI does rightly extend to the systems of banking and finance, the extent of its involvement in the insolvency process is definitely venturing on to questionable turf. Before the 2017 amendment to the BR Act, it could be argued that the RBI, under Section 35A of the BR Act, very well could have directed the Banks as it had under the Feb 12 Circular even with regard to the insolvency process. However, it can only be concluded that the legislature in its wisdom had introduced Section 35AA as a specific tool to govern the scope of interference of the Central Government and the RBI in the insolvency process. Moreover, Section 35AA had placed just limitation upon the exercise of these powers by way of the requirement of clear authorization and establishing a case-to-case approach. The same view was taken by the Apex Court in Dharani.

This judgement has once again vested bankers with the discretion to determine the fate of the defaulters of their advances, vis-à-vis Section 7 of the Code, keeping in view the RBI directives on this matter that preceded the Feb 12 Circular. While it may be argued that it is the banks themselves that should have the ultimate discretion to decide upon the fate of the insolvency application but, history has clearly shown that this power in the hands of the bankers leads to indecision, corruption, and abuse by the parties on either side of the default. An instance of this has recently been evidenced on a large scale as it has been reported that in an attempt to show lower bad loans, banks have engaged in a very regular practice of writing off bad loans. Over the course of the last decade, over 7 Lakh Crore of bad debts have been written off by the banks and out of the same, 80 % of the write-offs have taken place in the last 5 years. In the 3 quarters of 2018-19 itself, the quantum of bad debts written off has soared to Rs. 1.56 Lakh Crores. While it may be argued that the write-offs may be technical in nature, not foreclosing upon the right to recovery, the banks’ incentive to recover is heavily depleted by this move. Furthermore, while recapitalization of banking institutions is surely very important, this practice, in reality, has led to the evergreening of bad loans and indirectly promoted the banks’ practices of writing off bad loans, while still being stuck with roughly 10 Lakh Crores worth of NPAs. All this comes at the expense of the taxpayer. Furthermore, there are numerous instances of corruption and fraud in the case of loans and NPAs in the Indian banking system that cannot be ignored in the present analysis.

[1][1875] 1 Ch. D. 426.

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Siddharth Kumar
Siddharth is the Founder of CorpLexia and serves as its Editor. He is a student of BBA LL.B (Hons.) and has a special focus on corporate, commercial, insolvency, arbitration, securities and competition laws. He can be reached at

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