The author is Shalin Ghosh, first year student at Maharashtra National Law University (MNLU), Mumbai.
The enactment of the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as “IBC” or “the Code”) was a watershed moment in India. It suggested the restoration and revival of a distressed corporate entity—a paradigm and welcome shift from an inefficient system that merely allowed creditors to recover lost loans from errant, defaulting debtors. Since its enactment, a pertinent and contentious aspect regarding the IBC’s operation relates to an Asset Reconstruction Company (ARC) acting as a resolution applicant under the Code. The issue has attracted considerable judicial intervention and has called for an interpretation of the IBC and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) — the two applicable laws governing the issue.
A recent circular issued by the Reserve Bank of India (RBI) paves the way for ARCs to act as resolution applicants under the IBC, albeit with a few conditions binding on those wishing to participate in the process. A resolution applicant, under the IBC, is any person who submits a resolution plan to the resolution professional. A major policy shift, the move was introduced by the RBI after a committee constituted by the central bank first proposed the idea in November 2021. The revised guidelines interestingly come at a time when the central bank has been increasingly throwing a spanner in the works of many resolutions involving ARCs as resolution applicants.
In this article, the author seeks to analyse the significance of the RBI’s directive and its commercial implications on the insolvency regime prevailing in the country.
IBC v. SARFAESI- Resolving a legislative and regulatory inconsistency
ARCs in India are established under and regulated by the SARFAESI Act. Section 2 (1) (ba) defines an “asset reconstruction company” as an entity established for the purpose of “securitisation”, “asset reconstruction” or “both”. Under SARFAESI, “securitisation” has been defined as the acquisition of financial assets by an ARC from an originator, either by the ARC raising funds from qualified buyers by issuing security receipts reflecting an undivided interest in such financial assets or otherwise. “Asset reconstruction” refers to an ARC’s acquisition of a bank or a financial institution’s right or interest in any financial assistance to realise such financial assistance. Section 10 of the SARFAESI Act forbids an ARC from engaging in any business other than those of asset reconstruction and securitisation, without the concerned ARC getting an approval from the RBI. The only exception to this rule carved out by the legislation, as mentioned under Section 10 (1), is when an ARC acts as a manager, receiver or a recovery agent.
Therefore, the legal position under SARFAESI on the ambit of an ARC’s operation is clear— being an undertaking created for a specific purpose, an ARC can only function in relation to the acquisition of financial assets, interests or rights to obtain their reconstruction or realisation. Section 29A of the IBC, on the other hand, stipulates that those ARCs registered under the SARFAESI Act can also participate in the insolvency resolution process as a resolution applicant, provided that they are not a related party to the corporate debtor. This legal and regulatory ambiguity led to the rejection of several cases where the resolution plans were submitted by an ARC.
A prominent example is that of the RBI rejecting the resolution plan submitted by UV Asset Reconstruction Company Limited (UVARCL) during the resolution of the debt-ridden telecom entity, Aircel Ltd. Upon being challenged, the Delhi High Court stayed the RBI’s prohibition while the matter remains sub-judice. There have been several other examples of the central bank’s intervention in resolution processes involving ARCs as resolution applicants. Considering the absence of any regulations on the matter, the RBI’s latest circular remedies a crucial regulatory and legislative inconsistency by allowing ARCs to participate in the insolvency resolution process as resolution applicants under Section 30 read with Section 29A of the IBC. The directive resolves the quandary regarding the scope of an ARC’s operative domain while preventing those resolution processes from falling apart which might have benefitted from the participation of an ARC.
The effect of the policy shift may be strongly felt on the judicial front. The regulatory inconsistency between IBC and SARFAESI on the participation of ARCs as resolution applicants was a major bone of contention in several matters before various courts and tribunals. In the absence of any clarification on the issue, the question of an ARC’s eligibility to participate in the insolvency process remained unresolved. This increased the number of pending cases in forums like NCLT, with matters awaiting resolution due to the persisting conundrum. This directive, by clearing the air, could go a long way in smoothening adjudication and reducing the backlog of cases. Importantly, the directive plugged a logical gap arising from conflicting interpretations of IBC and SARFAESI governing the participation of ARCs as resolution application. The former includes ARCs as ‘resolution applicants’ while the latter’s restrictive definition of an ARC seemed to prohibit ARCs acting as resolution applicants. In giving ARCs the nod to function as resolution applicants under IBC, the policy resolves the conflict thereby clarifying an ARC’s functioning ambit.
Impact of the RBI’s directive
Firstly, the RBI’s decision to allow ARCs to participate as resolution applicants in the process is a welcome step for the development of the country’s insolvency framework. The eligibility of an ARC to provide a resolution plan marks the entry of a new contender in the process which could potentially increase both the probability and the frequency of resolutions under the Code. This is because big ARCs with considerable financial stability and wherewithal can draw up more commercially robust resolution plans for a distressed entity improving its resolution prospects. The introduction of a new investor category—by including ARCs—will increase participation and competition in the bidding process, leading to better price realisation which resultantly would improve the scope for resolution.
Recent market activity suggested the need for the policy shift. There have been several instances when ARCs have been interested to bid for stressed assets under the IBC process—the UVARC’s resolution plan to acquire Aircel and the proposals moved by Palm Lagoon Backwater Resorts Private Limited and Aparant Iron and Steel Private Limited being notable cases in point. It points to a market reality indicative of the fact that key players like ARCs were keenly waiting for the RBI’s clarifications and directives on the matter for a long time. The new guidelines provide a fillip to the resolution processes of companies in distress, improving their chances of being revived and continued instead of letting the entity bleed to corporate death via liquidation.
Secondly, the move could also aid banks in securing a more lucrative value for a stressed asset. An increase in the number of participants in the IBC process would ordinarily result in a corresponding increase in the bidding amounts and the chances of a more profitable value being realised by banks, leading to sizeable reductions in the quantum of haircuts suffered by lenders. The arrival of ARCs in the process could also prevent distress sales. For instance, in a case involving an asset which, at the moment, does not enjoy considerable interest from buyers but has the potential of generating sufficient interest later, an ARC can act as a warehousing agent, thereby assisting sellers or investors in getting a better realisation value on the asset’s sale. Fundamentally, ARCs have typically been associated with distressed sales. With the RBI approving an ARC’s participation in the IBC process, there is a greater possibility that the bidding will turn more competitive and the value of the stressed asset will not be eroded.
Thirdly, an important condition binding on those ARCs participating in the process, as stated in the RBI circular, is that with respect to a particular Corporate Insolvency Resolution Process (CIRP), the participating ARC in question shall not retain any substantial influence or control over the management and affairs of the corporate debtor after five years from the date the Adjudicating Authority approves the resolution plan under the Code. This regulation will ease the insolvency resolution process by providing the ARC concerned with an option of continuing in a distressed asset for an adequately long period by participating in the bidding under the IBC and having five years to turn around the business and make it viable. This is quite different from the earlier framework where ARCs had to mandatorily exit investments, by an acquisition of the debt, within one to two years, in cases where the asset was resolved through insolvency where the concerned ARC was unable to bid or participate.
Hurdles before the new policy
While the step can certainly enhance the scope of resolutions under the IBC, it has its own share of concerns. The set of conditions listed by the RBI would require ARCs to make considerable alterations to their regulatory framework and hire and appoint a committee of professionals having the expertise and training in managing companies and firms. These changes might translate into higher business costs for an ARC. Apart from higher compliance costs (which remain an obvious concern), the success of a resolution will significantly depend on the policy adopted by an ARC. Furthermore, since ARCs can acquire bad loans even before banks move the bankruptcy courts, the extent of resolution will largely be a function of the type of the asset and its market value obtained (compared to the price at which the ARC earlier took over some of the assets) during the process under the IBC.
This article evaluates the impact of RBI’s decision—allowing ARCs to function as resolution applicants—on the Indian insolvency regime. To this end, it argues that the policy resolves an important regulatory conundrum arising from conflicting interpretations of IBC and SARFAESI on the matter. Fleshing out some positive commercial implications of the move, the piece argues that the changed policy could firstly, improve the prospects of resolutions under the Code; secondly, help in attracting a lucrative value for stressed assets and thirdly, improve an ARC’s chances of rescuing a distressed entity due to the sufficiently-long five-year period wherein the ARC retains control over the entity. Finally, it enumerates some pertinent challenges confronting the policy regarding increased costs and the influence of other relevant variables governing resolutions under the IBC.