Asset Reconstruction Company- A way ahead as a Resolution Applicant under IBC
Advocate and a student of Graduate Insolvency Programme(GIP)
In the 1990s, the banking sector in India faced a significant increase in the number of NPAs due to a number of factors such as economic slowdown, liberalization, and the adoption of innovative lending practices. In order to manage this rising trend of NPAs, the Indian government on the recommendation of Narasimham Committees II introduced the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest, 2002 (the SARFAESI Act, 2002), which paved the way for the formation of ARCs in India. Asset Reconstruction Companies (ARCs) are specialized financial institutions established to acquire and manage the non-performing assets (NPAs) of banks and financial institutions. These companies were established in India in 2003 under the SARFAESI Act, 2002.
Functioning of ARCs
ARCs play a critical role in resolving the NPAs crisis in India by providing a mechanism for banks and financial institutions to transfer their NPAs to a third party, freeing up their balance sheets and enabling them to focus on their core banking activities. Furthermore, ARCs also help in the resolution of NPAs by bringing in their expertise in managing, resolving and recovering the same. They facilitates this by either buying the NPAs from the original lender at a discounted price or by acquiring a security interest in the asset. The ARCs then takes steps to recover the dues from the borrower and also to restructure the loan if necessary. ARCs operates in a highly regulated environment and they are required to adhere to strict guidelines and norms decreed by the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI). Moreover, they are also required to comply with the provisions of the SARFAESI Act, 2002.
Need for a Unified Insolvency and Bankruptcy Law
While The SARFAESI Act focuses on the resolution of non-performing assets (NPAs) and the enforcement of security interests by banks and financial institutions in India by providing a legal framework for these institutions to recover their loans by taking possession of and selling the assets offered as collateral by the borrower, there was yet a requirement of a unified and comprehensive Insolvency and Bankruptcy law system in the country. The legislature came up with recommendations of Bankruptcy Law Reforms Committee (BLRC) which was headed by T.K. Viswanathan and enacted an Insolvency and Bankruptcy code (IBC), 2016 to address the problem of mounting non-performing assets (NPAs) and stress in the economy and to provide a timely and effective mechanism for resolving insolvency issues.
Prior to IBC, the insolvency and bankruptcy process in India was fragmented, time-consuming, and largely ineffective, resulting in a significant backlog of cases and hampering the efficient functioning of the economy. IBC provides a comprehensive legal framework for the resolution of insolvency cases, including a time-bound process for resolving cases, promoting entrepreneurship, and protecting the interests of creditors and investors while keeping the entity as a going concern.
Section 9 of the SARFAESI Act prescribes the measures that can be adopted by an ARCs for the purpose of asset reconstruction under the directions and regulation of RBI while Section 10 restricts the ARCs for the commencement or carrying of any business other than that of Securitization or Asset Reconstruction without the prior approval of RBI. Therefore, the SARFAESI act not only deals with the measures to be provided by the ARCs for the purpose of Asset Reconstruction but also restricts any business other than securitization or Asset reconstruction to be undertaken by ARCs without the prior approval by RBI.
Section 29A of the Insolvency and Bankruptcy Code, 2016 (IBC) is a provision that lays down eligibility criteria for resolution applicants. The section was introduced through an amendment in 2018 to strengthen the resolution process and to prevent certain categories of persons from taking over distressed companies. Under the IBC, sub-clause (d) of Explanation II r/w the Provisos to Explanation 1, under Section 29A(j), in effect, does not prohibit an Asset Reconstruction Company from submitting a resolution plan and an ARC can become a resolution applicant by submitting a resolution plan for the distressed company. When an ARC becomes a resolution applicant, it is essentially bidding to take over the distressed company that is being revived and resolved as a going concern. However, serious concern arose on the issue of participation of ARCs as a resolution applicant in the corporate insolvency resolution process under the Code.
ARCs as a Resolution Applicant
In the matter of Corporate Insolvency Resolution Process (CIRP) of Aircel Ltd and its subsidiaries in CP (IB) No.298/MBII/2018, UV Asset Reconstruction Company Limited (“UVARCL”) turn up as the successful Resolution applicant. The resolution plan was submitted by UVARCL and was approved by the Adjudicating Authority consequent to the approval of COC. However, the UVARC had to obtain the approval of RBI to acquire shares in the corporate debtor as part of the resolution plan. When UVARC sought the RBI’s approval, it was denied and a show cause notice was issued on 12th November, 2020, as to why action ought not to be taken for violating section 10 of the SARFAESI Act. The UVARC challenged the show cause notice before the Delhi High Court in UV Asset Reconstruction Company Ltd. Vs. Union of India & Ors., reported at(2021) ibclaw.in 139 HC, and a stay order was granted by the Delhi High Court on November 27, 2020.
Meanwhile, the Delhi High court also observed the need for consensus between two ministries i.e. the Ministry of Finance and the Ministry of Corporate Affairs as they would involve the reconciliation of the provisions of the SARFAESI Act and the IBC set out above. There have been other instances where ARCs has served as the resolution applicants. However due to the stand taken by RBI before the Delhi High Court that the prior approval of the Reserve Bank of India would be required before submitting a Resolution Plan, and since the said approval was not obtained by the ARCs, the Resolution Plan submitted by them is invalid in law.
Committee to Review the Working of Asset Reconstruction Companies
In April 2021, the Reserve Bank of India (RBI) established a committee led by former Executive Director of RBI, Shri Sudarshan Sen, to evaluate the role of ARCs in debt resolution and to recommend measures to improve the efficacy of Asset Reconstruction Companies. The Committee submitted its report on September 14, 2021, which includes several recommendations aimed at improving the current legal and regulatory framework, optimizing asset acquisition, securitization and reconstruction measures, enhancing liquidity and trading of security receipts, and improving operational efficiency of ARCs. The Committee reviewed the role of ARC in distressed asset resolution under the IBC (Insolvency and Bankruptcy Code).
The Committee acknowledged that in the interest of better value realization for the lenders and to improve the efficiency of Asset Reconstruction Companies (ARCs) in recovering debt, it may be useful for lenders to sell their ownership stake in a borrower company to ARCs that have already purchased the borrower’s debt. The Committee proposed that ARCs be permitted to participate in the Insolvency and Bankruptcy Code (IBC) process as a Resolution Applicant, either through a SR trust or through an Alternative Investment Fund (AIF) sponsored by them.
RBI Notification on ARC as Resolution Application
The RBI formulated a new regulatory framework for Asset Reconstruction Companies (ARCs) via notification RBI/2022-23/128 DoR.SIG.FIN.REC.75/26.03.001/2022-23 on 11th October, 2022 allowing them to be resolution applicant (RA) entities under the Insolvency and Bankruptcy Code, 2016 (IBC), marking a significant change to the existing policy. ARCs were only allowed to engage in securitization or asset reconstruction business or any other business mentioned in Section 10(1) of the SARFAESI Act with the prior approval of the Reserve Bank of India (RBI) although according to Section 10(2) of the SARFAESI Act, it has now been decided to allow ARCs to carry out activities as a Resolution Applicant (RA) under the IBC, which were previously not permitted under the SARFAESI Act.
However, the ARC is required to have a minimum Net Owned Fund (NOF) of Rs. 1,000 crores to act as Resolution Applicant. Further The ARCs must have a policy approved by its Board outlining its scope of activities, internal limits for sectoral exposures, and other relevant matters related to taking up the role of Resolution Applicant. The ARCs must establish a committee, consisting mostly of independent directors, to make decisions about proposals for the submission of a resolution plan under the IBC and consider creating a list of management firms or individuals with specific sector expertise that can be hired to manage firms or companies that may need such services.
The ARC is prohibited from retaining significant influence or control over the corporate debtor after five years from the date of the Adjudicating Authority’s approval of the resolution plan under the IBC for a specific CIRP. Failure to comply with this rule will prohibit the ARC from submitting any new resolution plans under the IBC as a resolution applicant or co-applicant.
Further, the ARC must provide additional disclosures in its financial statements regarding assets acquired under the IBC, including the type and value of assets, sector-wise distribution based on the business of the corporate debtor and must include in its financial statements quarterly disclosures on the implementation status of the resolution plans approved by the Adjudicating Authority.
The measures discussed are the significant steps towards strengthening and streamlining India’s ARC framework in order to resolve the distressed company as a going concern under the IBC. Allowing ARCs to bid as the resolution applicants can bring in their expertise in managing distressed company, which can help in quicker and more effective resolution of company on default. ARCs typically offer higher recovery with low haircuts to creditors as compared to other applicants. This is because ARCs inculcates a better understanding of the value of distressed assets and can offer a higher bid based on their ability to manage and turn around such assets. Allowing ARCs as resolution applicants can, therefore, result in higher recovery for creditors. By the same token allowing ARCs to bid as resolution applicants can increase the competition for distressed companies, which can result in better pricing for such companies.
The entry of major ARCs in the resolution process is likely to improve the response of the resolution scenario, as these entities are well-equipped with the requisite knowledge and expertise to manage and turn around non-performing assets. However, it is crucial to note that the effectiveness of this move will depend on the policies that each ARC decides to finalize, especially with respect to their respective sectoral exposure limits. In essence, the success of allowing ARCs as resolution applicants will hinge on the specific policies and procedures that they put in place, particularly with regards to their sectoral focus and how much exposure they are willing to take on in a particular sector. These policies will play a critical role in determining the level of competition, speed, and effectiveness of the resolution process.
- The Securitisation and Reconstruction of Financial Assets And Enforcement Of Security Interest Act, 2002
- Insolvency and Bankruptcy Code, 2016
- RBI/2022-23/128 DoR.SIG.FIN.REC.75/26.03.001/2022-23
- (2021) ibclaw.in 139
- Report of the Committee to Review the Working of Asset Reconstruction Companies
- Committee on Banking Sector Reforms (Narasimham Committee II)
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