A regulatory mechanism for asset reconstruction companies (ARCs) was implemented in India through the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act). The Act intended to create a mechanism for the clearing-up of non-performing assets (NPAs) from books of banks and financial institutions. Around a decade later, with the intention of reorganization and settlement of insolvent companies, the Insolvency and Bankruptcy Code, 2016 (I&B Code) was introduced. Though the common purpose of both of these laws seems to be cleaning or rehabilitation of bad loan portfolios, the distinction between the fundamental principles of these two laws is important to understand. While the SARFAESI Act deals with 'recovery' and is more of a 'class' remedy, the I&B Code is about 'resolution' and aims to constitute a collective mechanism. Given a similar collection of stakeholders involved under each of these rules, the likelihood of overlaps remains evident.
Recently, the rejection of a resolution plan submitted by ARCs, by the Reserve Bank of India (RBI) emphasized an important regulatory or interpretative gap. The issue essentially revolves around investment by an ARC in the equity of an insolvent entity. It is indeed a misfortune that this issue has come to disturb the insolvency ecosystem four years after the IBC came into existence. Since the inception of I&B Code, over 250 companies have seen resolutions under IBC, out of which some of them have successfully been acquired by ARCs. The issue came to fore after the RBI denied ARC from submitting resolution plan in the Aircel insolvency stating SARFAESI Act, which apparently says that ARCs cannot carrying on any business other than that of asset reconstruction and/or securitization. Apart of these two, an ARC needs to take RBI permission to carry on any other business.
Notwithstanding the provisions of SARFAESI Act, the I&B Code has provisions for submission of resolution plan by financial entities including an ARC. The question arises here is, that if I&B Code allows financial creditors to submit resolution plan, why can’t ARCs, who are also categorized as financial creditors, do the same?
Recently, the Delhi High Court stayed a RBI notice warning possible cancellation of UV Asset Reconstruction company Ltd.’s (UVARCL) registration, and stated that an illegal bankruptcy resolution proposal was moved by the ARC for Aircel. UVARCL approached the court against the show-cause notice issued by RBI. According to the SARFAESI Act, ARCs that take over stressed assets from lenders cannot infuse equity into an insolvent company at the resolution stage. They also cannot act as resolution applicants. UVARCL contested that, the I&B Code allows for such investments and supersedes the rules stated in the SARFAESI Act.
Equity infusion by ARCs: A bar under SARFAESI?
In accordance with the definition of "asset reconstruction company" u/s 2(1)(b)(a) of the SARFAESI Act, an ARC is created for the purposes of "asset reconstruction" or "reconstruction" or both." The term 'asset reconstruction' here refers to the acquisition by the ARC of any right or interest of any bank or financial institution in any financial assistance for the purpose of making such financial assistance available, while the term 'securitisation' refers to the acquisition of financial assets by the ARC from any originator, whether or not the ARC raises funds from interested purchasers by issuing security receipts reflecting security receipts from any originator.
An ARC will have to obtain RBI approval to start or carry on any other "business" except the above two businesses. There are however, exceptions under clauses (a), (b and c) of section 10(1) to the degree that the ARC serves as an agent, manager or receiver of recovery. It is also evident from the law that the ARCs are specialist undertakings which are supposed to focus on the acquisition of financial properties, rights or interests for the purposes of their implementation or restoration.
Notably, the ARCs would have to be fitted with incidental rights in addition to the inherent right to carry out the asset restoration business that will help to promote the business. As such, Section 9 of the SARFAESI Act sets out the steps which the ARC may take 'for the purposes of the rehabilitation of properties,' which include 'proper management of the borrower's business by modifying or taking over the management of the borrower's business, and 'conversion of any portion of the debt into shares of the borrower's business.'
A connected provision is section 15(4) of the SARFAESI Act which states that the secured creditor (in this case, an ARC) shall, on full realization of debt, “restore the management of the business of the borrower to him”. The Bankruptcy Law Reform Committee (BLRC) also emphasized on this factor while reviewing ARCs as potential instruments for insolvency resolution. The mechanism is largely seen as a debt recovery tool and not an insolvency resolution tool. In the report, a thin line between 'realization' and 'rescue' was therefore drawn. Because the purpose and the aim of ARCs is to 'realize the dues' and reposition the creditor, in its truest sense, it does not amount to' rescue '.
However, by way of the Amendment Act, 2016, in SARFAESI Act a major change was introduced. Section 15(4) now provides that if any secured creditor has converted part of its debt into shares of a borrower company together with other secured creditors or any asset rehabilitation company or financial institution or any other assignee and thus gained a controlling interest in the borrower company, such secured creditors shall not be liable to restore the management of the borrower company's debt.'
ARCs as resolution applicant under the I&B Code
Under I&B Code, a Resolution applicant may be any person who submits a resolution proposal individually or jointly with any other individual. The person should not, however, be an ineligible U/s 29A of IBC. Explanation I of section 29A should be referred to in the first provision. Similarly, provided that nothing in clause (iii) of Explanation I applies to a resolution applicant where that applicant is a financial person and is not a related party to a corporate debtor' shall refer to that resolution applicant. The 'financial body includes an ARC registered under the SARFAESI Act, as stated in Explanation II.
The language of the statute, as set out above, makes it very clear that an ARC may be an applicant for a resolution under the I&B Code. Although the opening words of Explanation II require certain organizations to comply with the requirements or conditions which may be notified by the central government, however, no such notification or criteria have been provided to date.
Today, the very role of an applicant for a settlement is to establish a resolution strategy. The resolution strategy, pursuing the corporate debtor's insolvency resolution as an ongoing issue, may include a number of steps, including different forms of restructuring options and share acquisition. Therefore, it should not be a matter of concern whether the settlement occurs by way of debt or by way of equity. As already defined by way of landmark court rulings, the I&B Code is in itself a complete code, having as its main objective, the resolution and resurrection of insolvent entities. The resolution proposal must not, however, contravene any other clause of legislation according to see section 30(2) (e).
Clearly the SARFAESI there is nothing that is preventing the injection of equity into an individual through an ARC. There is therefore arguably no discrepancy between the provisions of the SARFAESI Act and the IBC and as such, the provisions of the SARFAESI Act cannot be said to be ultra vires in a plan which provides for an ARC's equity participation. This again is subject to the condition that such a relationship between the ARC and the corporate debtor is impermanent.
From the above debate, there does not seem to be any bar on ARCs on being equity partners under resolution plans. The only factor that needs attention is that when ARCs take over the management of a company, they can only run the company until the company is revive and not beyond that. A resolution process is to revive the corporate debtor, and putting restrictions on resolution applicants only lessens the chances of revival. In order to address this issue there must be adequate clarification under the SARFAESI Act or one provided by RBI on the same.