India: ARCs As Resolution Applicants Under IBC ?

Mounting Non-Performing Assets (“NPAs”) in India lead the Committee on Banking Sector Reforms (Narasimham Committee-II) to recommend the creation of a new class of companies called Asset Reconstruction Companies (“ARCs”) in 1998. ARCs were envisioned as specialized Companies that acquire NPAs from Banks at a discounted value and attempt to realize the same, allowing Banks to clean up their balance sheets.

In 2002, the Parliament enacted the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (“SARFAESI Act”), with the object of expediting and overhauling the process of reconstruction of financial assets in favour of secured creditors, implementing the recommendations of Narasimham Committee-II by greenlighting the setting up of ARCs in India. The SARFAESI Act provided for registration and regulation of ARCs by the Reserve Bank of India (“RBI”).

The necessity of enacting SARFAESI was felt to expedite the slow pace of resolution of defaulting loans while the SARFAESI Act enabled the Creditors/ARCs to initiate proceedings with regard to secured debt, need arose to encourage revival of defaulting entities as a going concern in tandem with the object of Companies Act, 2013. As a result, the Insolvency and Bankruptcy Code, 2016 (“IBC”) was enacted as a single code to consolidate the entirety of the insolvency and bankruptcy framework, allowing Operational and Financial Creditors to initiate proceedings for Insolvency Resolution and Corporates, Partnership Firms and Individuals. The IBC has been aimed for the speedy revival/resolution of the Corporate Debtors.

Relevant provisions:

Section 9 of the SARFAESI Act confers regulatory powers on RBI over ARCs with regard to the measures that can be taken by ARCs ‘for the purposes of asset reconstruction' i.e. -

Section 10 of the SARFAESI Act restricts the commencement or carrying on of any business other than that of securitisation or asset reconstruction without prior approval of RBI.

Therefore, the SARFAESI Act, not only provides for the specific activities that can be undertaken by ARCs, but also restrains the ARCs from carrying any other business without prior approval of RBI.

Section 29A of the IBC envisages ARCs registered under SARFAESI Act to be eligible for applying as Resolution Applicant ¹ , as long as such entities are not a related party to the Corporate Debtor.

In the matter Corporate Insolvency Resolution Process 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. Subsequent to the approval of its Resolution Plan, UVARCL sought approval of RBI for acquiring equity shares in the Corporate Applicants.

It is important to note that in terms of present RBI guidelines ARCs are only allowed to hold up to 26% of the post-converted equity of the borrower company.³ Only under certain prescribed circumstances, the 26% limit can be exempted.⁴

The RBI, on 12.11.2020 issued a Show Cause Notice to UVARCL seeking an explanation as to why the Certificate of Registration issued to UVARCL under Section 3 of the SARFAESI Act should not be cancelled for having violated the provisions of SARFAESI Act and guidelines issued by RBI. The Show Cause Notice was premised on the allegation that by submitting and pursuing the Resolution Plan, the UVARCL had ‘commenced an activity which it was not permitted to undertake under the law'.

UVARCL challenged the Show Cause Notice dated 12.11.2020 before the Delhi High Court by way of W.P.(C) 9537/2020 primarily on the ground that IBC, being subsequent legislation would prevail over SARFAESI Act. The Delhi High Court stayed the operation of Show Cause Notice dated 12.11.2020 vide Order dated 27.11.2020 in W.P.(C) 9537/2020. The matter is presently sub-judice.

In the past, Resolutions Plans submitted by ARCs have been approved by Adjudicating Authorities in the past in the matters of Maxim Infrastructure & Real Estate Private Limited ⁵, Aparant Iron and Steel Private Limited⁶ and Palm Lagoon Backwater Resorts Private Limited⁷.

The Delhi High Court in its Order dated 18.03.2021 in W.P.(C) 9537/2020 filed by UVARCL has observed that there is a need for building consensus between two ministries i.e., the Department of Financial Services under the Ministry of Finance, and the Ministry of Corporate Affairs for reconciliation of provisions of both the legislations.

Recently, the RBI constituted a committee to Review the Working of ARCs. The Report of Committee to Review the Working of ARCs⁸ has recommended that ARCs must be allowed to participate as Resolution Applicants in the resolution process either through a Security Receipt (SR) trust or through the Alternative Investment Fund (AIF) sponsored by them.

Presently, there are no guidelines/regulations framed by the RBI for granting approval to ARCs for applying as a Resolution Applicant under Section 30 read with Section 29A of IBC. In light of the specific provisions under IBC envisaging ARCs to be Resolution Applicants, it is the need of the hour that RBI/relevant legislative authorities issue necessary directions/guidelines in this regard.

Footnotes

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

2. Order dated 09.06.2020 passed by NCLT, Mumbai in CP (IB) No.298/MB.II/2018

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

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

5. 2019 SCC OnLine NCLT 666

6. 2019 SCC OnLine NCLT 28724

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

8. Report of the Committee to Review the Working of Asset Reconstruction Companies dated 02.11.2021 https://rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=1188

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