03 June 2019

The resolution process for Infrastructure Leasing and Financial Services many twists and turns since the company first defaulted outstanding loan of the IL&FS group is about Rs 60,000 crore, while the debt is over Rs 91,000 crore. IL&FS Group firms have been categorized as green, red and amber based on their ability to pay. Recently, National Company Law Appellate Tribunal (NCLT) Justice S J Mukhopadhaya lifted the embargo on the banks to declare the accounts of the debt-ridden IL&FS and its 300 group entities, which are unable to pay their debt. However, the appellate tribunal has also clarified that although the banks would declare the IL&FS accounts as Non-Performing Assets (NPA) but cannot initiate the recovery process and debit money. The bench has observed that lenders must not withdraw support until a resolution is found of the IL&FS and its group companies. This order effectively modifies the appellate body had ruled that no bank or the financial institution (FI) shall declare the accounts of cash-strapped IL&FS and its group companies as NPAs without its prior permission.

What is an NPA and why is it important?

As per banking regulations, an account is tagged as an NPA when payments remain due for 90 days. Once declared as an NPA, the Reserve Bank of India (RBI's) Income recognition and Asset Classification norms require banks to make provisions against the account. In the first year, banks have to set aside 25 percent as provisioning against these accounts.

RBI’s issue with the NCLAT order dated February 25, 2019

The NCLAT order diluted the provisions of the banking regulations and set a precedent that could also have a bearing on asset resolution process in other cases. The prudent practice would call for all accounts which delay interest servicing by 90 days to be tagged as non-performing even if a resolution is underway. An earlier demand by lenders for a stand-still on asset classification had been rejected by the regulator. This meant that banks would have classified a number of IL&FS accounts as NPA in December 2018- March 2019 quarter. The NCLAT’s order put a halt to this process.

Consequently, the RBI moved to NCLAT, filing a plea to modify the order allowing the banks to declare the defaulting accounts of IL&FS as NPAs as per the banking regulations. It contended that banks had an obligation to mark bad loans as NPA in cases of non-payment, after the default of 90 days as per the existing circular and they could not be relieved of this
duty. RBI submitted to the bench that the order dated Feb 25 2019 would obligate the banks to act contrary to the provisions of master resolution with respect to the declaration of NPAs.

Beneficiary of the NCLAT order

The order came as a big relief to both financial institutions and IL&FS as it prevented banks from making higher provisioning required for bad assets while also giving the debt entity more breathing space to find investors and prevent the fire sale of companies.

NCLAT’s order: An example of Judicial Overreach.

NCLAT justified its decision by saying that this is done in the interest of IL&FS debt resolution plan. While powers of NCLAT to pass any order in interest of justice and for revival of corporates cannot be questioned, the moot question was can bank be forced to make payments even when the account has become NPA.

This issue is also relevant for the banking supervision regime of the country. If a regulator issues tough regulatory norms
overreach, then expectations of a tax regulatory regime will set in with serious and long-term adverse consequences. Fortunately, for now, the order has been modified and banks can now declare the IL&FS accounts as NPAs.