Corporate Law Journal [CLJ, Vol 2, Issue 2]

Theme - “CORPORATE LAW & ITS ENVIRONMENT”

Subtheme- Problem Of NPA In The Indian Economy And Solution To It In

Its Legal Perspective

Paper Submitted By- Deepanshu Shakargaye

University- Faculty of Law, Jamia Millia Islamia, New Delhi, 110025

Mob no- +91 7982706845

Email address- dshakargaye.jmi@gmail.com

 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

ABSTRACT

The Indian banking Sector has been facing serious problems of raising Non-performing Assets.
The NPAs growth has a direct on the profitability of banks. Non-performing assets are one of the
major concerns for scheduled commercial banks in India. The recommendations of Narsimhan
Committee and Verma Committee had taken few steps to solve the problem of old NPAs in the
balance sheet of banks. There seems to be no unanimity in the proper policies to be followed in
resolving the concerned problem. NPAs reflects directly in the performance of banks. There is a
direct relation between NPAs and high profitability with a large number of credit defaults that
affect the net-worth of the banks and also erodes the value of assets. It affects the liquidity and
profitability, in addition to incur threat on quality of assets and survival of banks. The incumbent
problem of NPAs doesn’t only affect the banking sector but also the whole economy. It is pertinent
to assert the fact that the high level of NPAs in Indian banks is nothing but a counter reflection of
the state of health of the industry & trade. It is necessary to surmount NPAs to improve the
financial health in the banking system. NPAs increases risk perception and thereby liquidity
positions of the bank. This paper attempts to first examine the level of NPAs in the banking sector
in India and then analyzing the causes for increasing NPAs. It also emphasis on the comparison of
the performance of public sector banks with the private sector banks also cases related to NPAs
and debt recovery in the present day scenario and the solutions ought to it. It also attempts to enlist
the challenges owing to different tribunals, legislations, enacted codes in devastating the problem
of non-performing assets. It encompasses the role of RBI in strengthening the problem of NPA
under the regime of different enacted legislations such as SARFAESI Act and Insolvency and
Bankruptcy Code (IBC).

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

Research methodology

The research paper has been written by adopting a purely doctrinal method of research. The
researcher has accessed library and other online resources extensively for preparing the research
paper.

Objectives

The research paper focuses on the Problem and solution to the case of increasing non-performing
Assets in India.

Sources of data

The researchers has accessed primary, secondary & tertiary sources of data to prepare the
research paper.

Method of writing

The method of writing the paper is primarily based on analytical and critical approach.

Mode of Citation

The researcher has used Bluebook citation edition 20th through the course of the research paper.

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

CASES REFERRED

S.NO. CASE NAME PARAGRAPH

1. Arun Kumar Nayak v. Union of India, (2006) 8 SCC 111………………………………...18

2. Central Bank of India v. State of Kerala & Ors., (2009) 4 SCC 12………………………..29

3. Chennai Petroleum Employees Union v. General Manager, HR, Chennai Petroleum

Corporation Ltd, 2018 SCC OnLine Mad 1991…………………………………………..54
4. Cochin v. Kochi Refineries Ltd., 2006 Lab. I.C 2592……………….…………………53,56
5. Common Cause v. Union of India,(2010) 11 SCC 528……………………………………48

6. D.C Wadhwa (Dr.) v. State of Bihar, (1987) 1 SCC 378…………………………………...7

7. Dena Nath v. National Fertilizers Ltd., (1992) 1 CLR 1 (SC)……………....……………...4

8. E.P Royappa v. State of Tamil Nadu, (1974) 4 SCC 3……………………..……………...16

9. Excise Superintendent v. K.B.N Visweshwara Rao, (1996) 6 SCC 216…………………...18

10. Federation of Central Government SC/ST Employees (Kerala) Kochi Refineries Unit,
Cochin v. Kochi Refineries Ltd., 2006 Lab. I.C 2592………………………………….53,56

11. G.M, South Central Railway v. A.V.R Siddhanti,(1974) 4 SCC 335…………….………….8

12. Ganea Ram v. Union of India, (1970) 1 SCC 377………………………………………...34

13. I.R Coelho v. State of Tamil Nadu, (2007) 2 SCC 1……………………………………….55

14. IDBI Bank Ltd. V. Lanco Infratech Ltd. 2017 SCC OnLine NCLT 12503……………….7,8

15. Indira Sawhney v. Union of India, (2000) 1 SCC 168……………………..…..............14,23

16. ITC Limited v. Blue Coast Hotel Ltd Civil Appeal Nos. 2928-2930 OF
2018………………………………………………………………………………………42

17. J.K Jute Mills Company Ltd. V. M/s. Surendra Trading Co. 2018 SCC OnLine NCLAT
219………………………………………………………………….............................12,13

18. JM Financial Assetre Construction Company v. State of Maharashtra, 2016 SCC OnLine
Bom 9099………………………………………………………………………………….43

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

19. Keshavlal Khemchand & Sons Pvt. Ltd & Ors. v. Union of India, 2015 1 SCC
68…………………………………………………………………………………………55

20. Keshvananda Bharati v. State of Kerala, (1973) 4 SCC 225……………………………...53

21. M. Nagaraj v. Union of India, (2006) 8 SCC 212…………………….…………………...50

22. M.N Shanmugasundaram v. The Authorised Officer Bank of Baroda Nambiyur Branch
Coimbatore & K.C Sivakumar, 2012 SCC OnLine Mad 1569……………………………33

23. M/s. Annapurna Infrastructure Pvt. Ltd. & Anr. v. Soril Infra Resources Ltd., 2017 SCC
OnLine NCLAT 380…………………………………………………………………..22,23

24. M/s. Kirusa Software Pvt. Ltd v. M/s. Mobilox Innovations Pvt. Ltd., 2017 SCC OnLine
NCLT 314…………………………………………………………………………….19,20

25. Macquarie Bank Limited v. Shilpi Cable Technologies Limited (2018) 2 SCC 674 Civil
Appeal 15135/2017…………………………………………………….......................20,23

26. Mardia Chemicals Ltd. v. Union of India (2004) 4 SCC 311……………………………..21

27. Nagendra Chandra v. State of Jharkhand, (2008) 1 SCC 798………..…...……………...47

28. Neelkanth Township & Construction Pvt. Ltd. v. Urban Infrastructure Trustee Ltd. 2017
SCC OnLine NCLT 517………………………………………………………………..9,10

29. Oriental Bank of Commerce v. Sunder Lal Jain, (2008) 2 SCC 280………………………25

30. Prabhod Verma v. State of U.P, AIR 1985 SC 167…………………………......................9

31. Pravin Kumar v. State of Bihar, 2015 SCC OnLine Pat 2214…………………………….55

32. Rajesh Roushan v. State of Bihar, 2015 SCC OnLine Pat 1107…………………………..55

33. Sandeep Reddy & Anr. V. Jaycon Infrastructure Ltd. 2017 SCC OnLine NCLAT
303……………………………………………………………………….……………42,43

34. Sarva Shramik Sanghatana v. State of Maharashtra, (2008) 1 SCC 494…….…………..48

35. Secretary, State of Karnataka v. Uma Devi, (2006) 4 SCC 1………………….4, 15, 23, 45

36. Shyam Ice & Cold Storage Pvt. Ltd. V. Syndicate Bank, 2012 (92) ALR 139…………….30

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

37. State of Bihar v. Upendra Narayan Singh, (2009) 5 SCC

65…….……………………………………………………………………...18,22,26,30,45

38. The State (ELM DEVELOPMENTS LIMITED) v. An Bond Pleanala, (1981) ILRM
108……………………………………………………………………………………..…39

39. Transport Union v. Mumbai Port Trust, 2009 Vol. 3 CLR 1007 (BOM) (DB)…………...51

40. Union of India v. N. Hargopal, (1987) 3 SCC 308………………………………..............19

41. Union of India vs. DRT Bar Association, 2000 SCC OnLine Raj 407…………………12,15

42. Union Public Service Commission v. Girish Jayantilal,(2006) 2 SCC 482……………….18

43. UTC v. Mansaram Nainwal, 2006 (111) CLR 585 (SC)………………………………….49

44. Vishwapriya Financial Service and Securities Ltd v. Commissioner Of Income Tax,(2003)
179 CTR Mad 334………………………………………………………………………..38

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

TABLE OF CONTENT

1. Introduction…………………………………………………………………...…………..p08

2. Recommendation and Early Scenario of NPAs……………………………………………p09

3. Establishments of the Adjudicating Bodies to Curb the Problem of NPAs………………...p09

4 .Legal aspects of Non-Performing Assets………………………………………..................p11

i. 4.1 SARFAESI ACT, 2002………………………………………………………...p11

ii. 4.1.1 Measures under SARFAESI Act to determine the securitization……………p12
iii. Amendment strengthening the position of borrower whose account is declared as
NPA……………………………………………………………………………..…p13

5. Growth of Banking Practice in India………………………………………………………..p14

6. Reasons for the growth of NPAs…………………………………………………………….p15

7. Reason for the Low recovery growth of NPAs……………………………………………...p15

8. Challenges and recommendation for the Reform……………………………………………p17

9. Insolvency and Bankruptcy Code, 2016…………………………………………………….p18

9.1 Role of RBI In ascertaining the recovery of NPAs……………………………………...p20

9.2 Procedure hurdles on the face of operational creditor under Section 8 & 9 of the
code……………………………………………………………………………………..p22
10. Insolvency & Bankruptcy Code (Amendment),2017…………………………………….....p25

11. Conclusion………………………………………………………………………………….p26

12. Bibliography...……………………………………………………………………...............p28

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

INTRODUCTION

The banking system is the genesis of the financial system. The most crucial function of the
financial system is the mobilization of the public savings and its allocation in different sectors of
the economy as an investment. The conversion of financial savings in to investment is known as
the process of capital formation in the economy. How the process of financial intermediation (i.e.
collecting scattered savings and using it in to productive purposive) is carried out shall reflect the
efficiency of the financial institutions and their role in socio-economic transformation of the
country.

Asset quality was not the only concern in Indian banking sector till 1991, but it was mainly focused
on performance objectives such as opening wide network/branches, development of rural areas,
priority sector lending, higher employment generation, etc. whereas the primary function of banks
is to lend funds as loans to various sectors such as agriculture, industry, personal loans, housing
loans etc., but in the recent past the banks have become very cautious in extending loans. The
reason being mounting NPA. Bankers are the custodian and disburser of the liquid capital of the
country. Therefore, it is considered to be the most important function of the banking system is to
mobilize the savings of the person by accepting deposits from the public. The banker becomes the
trustee of the surplus balances of the public. The Non-Performing Asset (NPA) concept is
restricted to loans, advances & investment. As long as an asset generates the income expected
from it and does not disclose any unusual risk other than normal commercial risk, it is treated as
performing asset, and when it fails to generate the expected income it becomes a “Non-performing
Asset”. In the subsequent manner, a long asset becomes a Non- Performing Asset (NPA) when it
ceases to generate income, i.e., interest, fees, commissions or any other dues for the bank for than
90 days. An NPA is an advance where payment of interest or repayment of installment on principal
or both remains unpaid any of the credit facilities is to treat as past due when it remains unpaid for
30 days beyond due date.

Recommendation and Early Scenario of NPAs

Narasimham Committee that mandated identification & reduction of NPAs to be treated as a

national priority because NPA direct toward credit risk that faces and its efficiency in allocating

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

resources. Profitability and earnings of banks are affected due to NPA numbers. A quick glance
on the numbers of non-performing assets in the year 1995 it was Rs. 33885 crores.

One of the major concerns is that the challenges in the performance of commercial banks in the
late 90s adversely affecting was the accumulations of the huge non-performing assets. The growth
of Indian Bank’s lending to priority sector is more than that of the Public Sector Banks as a whole
Indian Bank has slippages in controlling of NPAs in the early years of the decade. The origin of
the problem of burgeoning NPA’s lies in the system of credit risk management by the banks. Banks
are initiated to have adequate preventive measures in fixing pre-sanctioning appraisal
responsibility and an effective post-disbursement supervision. Banks must keep a continuous
surveillance and monitor loans to recognize accounts that have potential to become non-
performing. Also, each bank should have its own independence credit rating agencies, they must
evaluate the financial condition of the client on a regular basis. There were instances where
corporate borrowers even after defaulting on a regular basis were given credit. This is because
there was no legal framework to safeguard the real actual interest of the banks. One current
scenario has given a gist that the banks should find out the original reasons/purposes of the loan
required by the concerned borrower. The proper identification and full concealment of the
guarantor must be checked by the banks including scrutiny of his/her actual wealth. It is pertinent
to mention that NPA’s are considered to be as the most significant parameter to judge the
performance and financial health of the banks.

Establishments of the Adjudicating Bodies to Curb the Problem of NPAs

In the year 1992, the Government of India introduced a number of reforms to deal with the
incumbent problem of growing NPAs in banking sector. The major crucial steps include,
introduction of Debt Recovery Tribunal, Securitization Act 2002, Lok Adalats, Compromise
Settlement Scheme and introduction of Credit Information Bureau. In the year 2016-17, 10.3% of
the total amount referred to for recovery is recovered through all the recovery channel. Whereas
9.2% through DRT’s as compared to 16.5% alone from SARFAESI Act. This gives to a direct
conclusion that strong banking sector is crucial for a flourishing economy.1

1
Legal Aspect of NPAs, G J BULSARA, Submission date, May 2017.

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

In the case of Common Cause v. Union of India2, The petitioner has stated that the aggregate figure
of NPAs worked out on the basis of data compiled by the Banking Division of the Ministry of
Finance is Rs. 43,577 crores. Non-recovery of such huge amount of NPAs has resulted in
substantial funds of banks not being available for development of the country's economy and this,
in turn, has affected the citizens. Mostly the bad debts are on account of defaults 3 made by men
of substantial means and influence and if proper checks are introduced to ensure that loans and
advances are not given to fraudulent borrowers, NPAs will get substantially reduced. 4 The court
emphasized that the loans and advances must not be given without fully checking the
creditworthiness and past record of the borrowers and that companies, which have been “willful
defaulters” in the past or whose subsidiary companies and promoters have willfully defaulted in
the past in repaying the loans and advances, should not be given fresh loans and advances.

JM Financial Asset Reconstruction Company v. State of Maharashtra, 20165 In this case, the
petitioner submitted that the banks and financial institutions were suffering considerable
difficulties in recovering their loans and advances due to the fact that the procedure existing then
for recovery were extremely time consuming and burdensome, and the debts due to banks and
financial institutions blocked a significant portion of their funds in unproductive assets, The
Recovery of Debts Due to banks and financial Institutions Act, 19936 was enacted.

Legal aspects of Non-Performing Assets

1. SARFAESI ACT, 2002

The concept of securitization has been adopted more recently from the American financial system
and has been described as processing of acquiring financial asset and packaging the same for
investments by several other investors. The actual term ‘Securitization’ has not been defined as
such, but has been used in certain rules, regulations & notifications. In the recent past the

2
(2010) 11 SCC 528: (2010) 4 SCC (Civ) 514 at page 529.
3
Section 2(1)(j) of NPA Act, 2002 “default” means non-payment of any principal debt or interest thereon or any other
amount payable by a borrower to any secured creditor consequently upon which the account of such borrower is
classified as NPA in the books of account of the secured creditors.
4
Id. 2.
5
2016 SCC OnLine Bom 9099.
6
An Act to provide for the establishment of Tribunals for expeditious adjudication and recovery of debts due to banks
and financial institutions and for matters connected therewith or incidental thereto. be called the Recovery of Debts
Due to Banks and Financial Institutions Act, 1993.

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

parliament has enacted the Securitization and Reconstruction of financial Assets and Enforcement
of Security Interest Act, 2002. The term securitization has been defined as “acquisition of financial
assets by any securitization company or reconstruction company from qualified institutional
buyers by issue of security receipts representing undivided interests in such financial assets or
otherwise”.
The Securitization Act has been enacted mainly for tackling the growing menace non-performing
assets by securitization of assets by sale to ARC, which is to issue of security receipts to the
investor and for enforcement of security interest by banks and financial institutions: Initially, many
were delighted to find that the securitization process as a class has come to stay in the Indian legal
system, and the problem of the non-performing assets of banks and financial institution would
stand resolved since the banks and financial institutions would be able to enforce its security
interest without intervention of the courts. The quantum of non-performing assets has been
growing rapidly by leaps and bounds and it has been playing as a havoc on the Indian finance
system since as at the end of the year 2001, the sum total amount of outstanding NPAs stood up
to Rs. 83,500/- crores. After the enactment of the Securitization Act, 2002 the willful defaulters
cannot now hide behind long-winded judicial process but at the same instance the bank also cannot
recover dues arising out of underwritten commitments obligations and equity finance by way of
share subscriptions, also the shares acquired by exercising the option for conversion of loan into
equity.

The IT tribunal in the case of Vishwapriya Financial Service and Securities Ltd v. Commissioner
of Income Tax7. The Hon’ble court held that jolt development of asset securitization in auto finance
and housing finance sector. The company was utilizing funds obtained from the investors for
deployment in fixed income security and had guaranteed fixed rate of return. The contention of
the company is that it was only agent for the investors and has evolved only a paythrough structure
which was not accepted by the tribunal and held that the company was liable for the withholding
taxes on the payments made to the investors.

1. Measures under SARFAESI Act to determine the securitization

7
(2003) 179 CTR Mad 334, 2002 258 ITR 496 Mad.

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

Section 13 of SARFAESI Act, 2002 specifically gives right to the secured creditor with the legal
authority/power of great import, without creating sufficient accountability mechanism. The
measures that can be taken the recourse by the secured creditor under Section 13(4) which includes
the power to take over the management of the business of the borrower and to appoint any person
to manage the secured assets. There is a total absence of any check against the abuse of any
opportunity to control the property and business of the borrower in the hand of the creditor. The
creditor and the manager would undoubtedly be in the position of “trustees” while in control and
they should be subject to all civil and criminal consequences for the breach of trust.

Indian Parliament has amended the Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interests Act, 2002 (SARFAESI Act) and the Recovery of Debts Due to
Banks and Financial Institutions Act, 1993 (DRT Act) in 2016. These amendments aim to create
an enabling infrastructure to affectively deal with stressed assets. It also confers more powers to
the Reserve Bank of India (RBI) to regulate asset reconstruction companies (ARCs). An ARC’s
primary goal is to manage and to make profitable those assets which have been underperforming,
or which have been formally classified as NPA’s. Selling stressed and NPA accounts to ARCs has
been increasing since March 2014, because of the regulatory support extended to banks under the
Framework to Revitalize the Distressed Assets in the Economy. It is proposed to give RBI powers
to audit and inspect ARCs and freedom to remove the chairman or any director and appoint central
bank officials to the board. RBI will be empowered to impose a penalty for noncompliance with
its directives, besides regulating the fees charged by these companies to banks at the time of
acquiring such assets.8

2. Amendment strengthening the position of borrower whose account is declared as NPA

Section 13 gives the secured creditor to unilaterally “determine” the amount dues. On the basis of
this ex parte determination, secured creditor is entitled to issue and serve a demand notice at the
end of the 60 days period. It adopts the measures for recovery which includes taking over the
business of the borrower. In the case of Mardia Chemicals Ltd. v Union of India & Ors.9, the court

8
Insolvency & Bankruptcy Code: Debt Restructuring & Managing NPA In India, Sameera Saurabh , July 6, 2017
http://www.businessworld.in/article/Insolvency-Bankruptcy-Code-Debt-Restructuring-Managing-NPA-InIndia
9
Mardia Chemicals Ltd. v. Union of India (2004) 4 SCC 311.

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

lucidly mentioned that the parliament through amendment in Section 13(3)A10 that to provide for
an obligation on the part of the secured creditor to consider the representation/objection of the
borrower to the demand notice served.
The SARFAESI Act, 2002 is a mighty tool of the secured creditor for the recovery of the
outstanding debt. The genesis of this act is to take recourse to the provision of the act as a first
resort for recovering loans. However, the banks have also been prevalently misusing the provision
of the Act, by using the unfair means of coercion and throwing overboard the due process as
prescribed under the Act.

In the case of ITC Limited v. Blue Coast Hotel Ltd.11 the question which was required to be decided
by the Hon’ble Supreme Court was that whether the parliament intended for a total invalidity to
result from the failure to reply and give reasons for the non-acceptance of the borrower’s
representation. The Hon’ble Supreme Court held that once the proceeding has been initiated by
the secured creditor to consider the representation made by the debtor under section 13(3)A of the
NPA Act.

Growth of Banking Practice in India

In the semi-permanent scenario from the concept of ancient money lenders, India march forward
to the realm of the banking, which has ever since branched out in the concept of the development
banking, the narrow banking and the universal banking. Also from simple current and savings
bank accounts, the bank finance has extended to structured finance, trade finance and export
finance & finance for infrastructure, also the last few years have seen an emergence of the fee
based services in the form of merchant bankers, financial advisors and managers to the public issue
and private placement of shares debentures and bonds, syndication of loan facilities, external
borrowings, forex services, services in takeover, mergers, acquisitions & amalgamations, mostly
through the bank subsidiaries or associates arms.

10
If, on receipt of the notice under sub-section (2), the borrower makes any representation or raises any objection,
the secured creditor shall consider such representation or objection and if the secured creditor comes to the conclusion
that such representation or objection is not acceptable or tenable, he shall communicate within one week of receipt of
such representation or objection the reasons for non-acceptance of the representation or objection to the borrower:
Provided that the reasons so communicated or the likely action of the secured creditor at the stage of communication
of reasons shall not confer any right upon the borrower to prefer an application to the Debts Recovery Tribunal under
section 17 or the Court of District Judge under section 17A.
11
CIVIL APPEAL Nos. 2928-2930 OF 2018 [Arising out of SLP (C) Nos. 1021510217/2016].

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Reasons for the growth of NPAs

The development and the proliferation in the activities of the bank has led to ever increasing non-
performing assets that has surmounted to an enormous amount in the last few decades. The
quantum of NPAs has been calculated and put at different figures mainly due to the absence of
proper statistical knowledge and the method on which the basis adopted for calculating the
percentage of NPAs in relation to either the total assets of the bank or the amount of loan portfolio
or on the basis of the accounts or the size of the outstanding advances. But the pragmatic question
lies under this is the real reasons as to why and how NPA appears in the books of the banks &
financial institutions. For a large number of years, the banks have been taking credit in its books,
on the basis of accrued income, even for the amount of the amount of periodic interest that was
not actually paid by the borrower. Our existing legal framework relating to commercial
transactions has not kept pace with the changing commercial practices & financial sector reforms.
This has resulted in slow pace of recovery of defaulting loans and mounting levels of NPA of
banks & financial institutions.12

Reason for the Low recovery growth of NPAs

It is very pertinent to mention that the public banks record around Rs.1,50,960 Crores reduction
in the NPA levels from the beginning of the financial year 2017-18. However, the data also showed
that the same period has seen Rs.2,37,475 Crores of the loans being added to the NPA list, thereby
leading to an overall worsening of the NPA situation. Further, within the Rs. 1,50,960 Crores
‘reduction in NPAs’, at about 55% or Rs.84,272 Crores as due to write-offs. Only about 27% of
the reduction in NPA levels was due to actual recoveries. Private sector bank on the other hand
saw a significant reduction of Rs.46,091 Crores in the NPA levels as according to December 2017.
For the private sector banks, at about 40.2% of the reduction in the NPA levels was due to write-
offs. Actual recoveries for 34.2% of the reduction. Hence the data showed that the bank frauds
were increased in both numbers & value over the last three years.13

12
Keshavlal Khemchand & Sons Pvt. Ltd & Ors. v. Union of India LAWS (SC)-2015-1-68.
13
The Hindu, Low Recoveries of NPAs: RBI Data, T.C.A Sharad Raghavan, June 12 2018.
https://www.thehindu.com/business/Economy/rbi-data-show-low-nparecovery/article24146708.ece

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

Also, in one of the cases named as Central Bank of India v. State of Kerala & Ors.14,The company
borrowed a certain sum from the appellant Bank by creating equitable mortgage of its properties
in favor of the bank. The company failed to repay the amount, its account was classified as NPA
& the bank had initiated the proceeding under the Securitization Act under Section 13(2). The
bank held the possession of the properties and sold the same. The ACST informed the Bank that
sales dues constituted a first charge against the company &, therefore, the ban could not have taken
possession of the mortgaged properties and sold them. The High court held that since there was
no provision in the securitization act providing for the first charge in favor of the banks, Section
35 of the securitization act could not be held to override Section 38-C of the Bombay Sales Tax
Act.

It has been prevalently stated in the case of Shyam Ice & Cold Storage Pvt. Ltd. v. Syndicate Bank15
that even a defaulter has his rights and can be proceeded against him only in accordance with law.
The division bench further held that merely because a defaulter had made some willful default in
payment of the instalments and EMIs it would not mean that he should be dealt with double &
multiple blows and that he had a right for consideration of a One Time Settlement under the RBI
guidelines.

Subsequently, in the case of M.N Shanmugasundaram v. The Authorized Officer Bank of Baroda
Nambiyur Branch Coimbatore & K.C Sivakumar16 states to struck down the SARFAESI Act, the
concept of judicial review has developed so far, even the validity of the statutes mentioned in
Schedule IX to the Constitution of India can be tested by the Courts with the power of judicial
review to decide as to whether such statues satisfy the rule of law, As it was held in I.R Coelho v.
State of Tamil Nadu,17. Therefore, the impugned Section 14 of the SARFAESI Act does not satisfy
the principle of the rule of law and hence, it is subject to be struck down.

CHALLENGES AND RECOMMENDATION FOR THE REFORM

14
(2009) 4 SCC 12.
15
2012 (92) ALR 139.
16
2012 SCC OnLine Mad 1569.
17
(2007) 2 SCC 1.

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

In recent years, several committees have given recommendations on NPAs. We discuss these
below.

Action against defaulters: Willful default refers to a situation where a borrower defaults on the
repayment of a loan, despite having adequate resources. As of December 2015, the public sector
banks had 7,686 willful defaulters, which accounted for Rs 66,000 crores of outstanding loans.
The Standing Committee of Finance, in February 2016, observed that 21% of the total NPAs of
banks were from willful defaulters. It recommended that the names of top 30 willful defaulters of
every bank be made public. It noted that making such information publicly available would act as
a deterrent for others.

Asset Reconstruction Companies (ARCs): ARCs purchase stressed assets from banks and try to
recover them. The ARCs buy NPAs from banks at a discount and try to recover the money. The
Standing Committee observed that the prolonged slowdown in the economy had made it difficult
for ARCs to absorb NPAs. Therefore, it recommended that the RBI should allow banks to absorb
their written-off assets in a staggered manner. This would help them in gradually restoring their
balance sheets to normal health.

Improved recovery: The process of recovering outstanding loans is time consuming. This
includes time taken to resolve insolvency, which is a situation where a borrower is unable to repay
his outstanding debt. The inability to resolve insolvency is one of the factors that impacts NPAS,
the credit market, and affects the flow of money in the country. As of 2015, it took over four years
to resolve insolvency in India. This was higher than other countries such as the UK (1 year) and
USA (1.5 years).18

INSOLVENCY AND BANKRUPTCY CODE, 2016

The Insolvency and Bankruptcy Code, 2016 notified by the Government of India reflects a clear
intent to resolve and restructure bad debts in a time bound manner and plug loopholes available to
borrowers who have defaulted on their payments. The Code is being understood as the new
Bankruptcy Law of India which seeks to combine the existing framework by creating a single law

18
The PRS Blog, The Official Blog site of PRS Legislative Research, http://www.prsindia.org/theprsblog/?p=3652.

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

for insolvency and bankruptcy. Two separate tribunals are recommended - the National Company
Law Tribunal (NCLT) for companies and limited liability partnership for firms, and the Debt
Recovery Tribunal for individuals and partnership. The code enlisted the proper procedure and
mechanism of dealing with stressed assets in a more promising way. Until the Insolvency &
Bankruptcy Code came into force in India, lenders were exercising recovery proceedings through
special laws such as the ‘Recovery of Debts Due to Banks and Financial Institutions Act 1993’, or
the ‘Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest
Act (“SARFESI”) 2002’, and restructuring options as per RBI guidelines such as Corporate Debt
Restructuring (“CDR”), Strategic Debt Restructuring, Scheme for Sustainable Structuring of
Stressed Assets (“S4A”) etc. However, legal remedies did not empower the creditors to control the
company in the event of default.19

The Code intends to initiate an Insolvency Resolution Process (IRP) for a period of 180 days when
a default takes place. The Insolvency Resolution Process (IRP) is over seen by an Insolvency
Professional who has to ensure that no asset removal has taken place from the company by
checking transactions for last two years.

The NCLT in the case of IDBI Bank Ltd. V. Lanco Infratech Ltd.22 was criticized that the
insolvency professional should be very judicious and careful in accepting too many assignments.
If they do so, they may make some money in the short term but are running a huge risk of losing
their reputation, respect and credibility in the long run, if they are not able to handle such
assignment effectively and to the satisfaction of the stakeholders.

One of the issues before the Hon’ble NCLAT in the case of J.K Jute Mills Company Ltd. V. M/s.
Surendra Trading Co.20 was that the time limit prescribed in IBC, 2016 for admitting or rejecting
a petition or initiation of insolvency resolution process is mandatory. The court magnificently
pointed out the objective behind the time period prescribed under Section 7(5) & Section 9 (5) also
Section 10(4), like Order VII Rule 1 of CPC is to prevent the delay in hearing the disposal of the
cases. The Hon’ble court held that “the time is the essence of the code and all the stakeholders,

19
Paradigm Shift in Banking Future Strategies Confederation of Indian Industry September 2017
https://www2.deloitte.com/content/dam/Deloitte/lk/Documents/financial-services/ik-fs-paradigmshiftbankingfuture-
strategies-noexp.pdf. 22 2017 SCC OnLine NCLT 12503.
20
2018 SCC OnLine NCLAT 219.

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including the Adjudicating Authority are require to perform its jobs within the time prescribed
under the code except in exceptional circumstances if the adjudicating authority for one or other
good reason fails to do so.

The law also enshrines a period where in the Committee of Creditor is expected to analyses the
records of the company, hear rival proposals and make up its mind on the issue. A Revival Plan is
binding on all creditors and stake holders if 75% of Creditors Committee agrees to it. On the other
hand, if 75% of the Creditors Committee decide that the complexity of the case requires more time
for resolution, a onetime extension of 90 days is possible with the approval of the Adjudicating
Authority. Whereas, if in 180 days no Revival Plan achieves support of 75% of creditors, the firm
goes into liquidation. Most importantly, it provides for resolution of insolvency in a speedier and
time-bound manner, and also specifies prioritization of settlements of debts owed by a corporate
debtor.

In the case of Sandeep Reddy & Anr. V. Jaycon Infrastructure Ltd.21the question before the court
was that whether NCLT has power to appoint an IRP, without obtaining suggestions from IBBI
on its own, and where the name of an IRP has also not been suggested by Operational Creditor in
the application for CIRP. It was held that since the parties had settled the disputes and initiation of
resolution process under section 9 of the code was not maintainable, in view of existence of
disputes, NCLAT left the question open as to whether the NCLT had power to appoint any person
of its own choice or not.

1. ROLE OF RBI IN ASCERTAINING THE RECOVERY OF NPA

The Reserve Bank of India has issued various instructions aimed at resolution of stressed assets
in the economy, including introduction of certain specific schemes at different points of time. In
view of the enactment of the Insolvency and Bankruptcy Code, 2016 (IBC), it has been decided
to substitute the existing guidelines with a harmonized and simplified generic framework for
resolution of stressed assets. The details of the revised framework are elaborated in the following

21
2017 SCC OnLine NCLAT 303.

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

paragraphs. Lenders shall identify incipient stress in loan accounts, immediately on default, by
classifying stressed assets as special mention accounts (SMA) as per the following categories:22

SMA Sub- Basis for classification – Principal

categories or interest payment or any other
amount wholly or partly overdue
between

SMA-0 1-30 days

SMA-1 31-60 days

SMA-2 61-90 days

The list clearly mandates that after the period of 90 days the account wholly turned to be as
nonperforming Account. The reserve bank of India replacing the regime of voluntary restructuring
for Indian Banks by introducing the Revised Framework on ‘Resolution of Stressed Assets’. Under
this new framework, the RBI has primarily focused on NPAs of the borrowers where the banking
financial assets exceeds Rs 2000 crores and to effectuate the same within the period of six months,
failing which the creditor have to mandatorily refer the borrower to the National Company Law
Tribunal (NCLT) for corporate insolvency under the Insolvency and Bankruptcy Code, 2016. The
new restructuring norms are in many ways a condensed version of the SDR, outside SDR and S4A
schemes of the past, with more relaxed parameters as to the extent of equity conversion.

The policy brings a great success in the short tenure of the Code with a commendable work on
resolving the stressed account that any of the withdrawn restructuring schemes. The RBI's policy

22
Resolution of Stressed Assets – Revised Framework Reserve Bank of India February 12, 2018
https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11218.

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

is a nod to the efficacy of the statutory process and its own preference to have that followed instead
of a bank-led restructuring.23

The RBI also reinforced its supervisory and enforcement frameworks by revising the prompt
corrective action (PCA) framework and establishing an Enforcement Department. Once PCA is
vitiated by the regulator, the bank faces restrictions on spending money on opening branches,
recruiting staff and giving increments to employees. Further, the bank can disburse loans only to
those companies whose borrowing is above investment grades. With the new framework in place,
the RBI aims at a harmonized and simplified mechanism for the resolution of stressed assets. This
framework has been introduced keeping in mind the regulator’s stance on ensuring speedy
resolution of bad loans in the future. A predominant theme of the new framework is reliance on
the IBC to resolve stressed assets while doing away with a number of interim schemes introduced
before India adopted as bankruptcy code in 2016.24

2. PROCEDURAL HURDLES ON THE FACE OF OPERATIONAL CREDITOR

UNDER SECTION 8 & 9 OF THE CODE

Under the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as, the "Code"), for
operational creditors to initiate a corporate insolvency resolution process (hereinafter referred to
as "CIRP"), two steps are required to be followed. The first step is that the creditor has to deliver
a demand notice under Section 825 of the Code to the Corporate Debtor regarding the non-payment

23
Resolution of Stressed Assets – Revised Framework, Kumar Saurabh Singh & Rajeev Vidhani April 4, 2018
http://www.businessworld.in/article/Resolution-Of-Stressed-Assets-Revised-Framework.
24
RBI’s revised framework for resolving stressed assets: Building transparency and accuracy PwC Feb. 2018
https://www.pwc.in/assets/pdfs/services/ras/financial-services/rbi-s-revised-framework-for-resolving stressed assets-
building-transparency-and-accuracy.pdf.
25
Insolvency resolution by operational creditor. — (1) An operational creditor may, on the occurrence of a default,
deliver a demand notice of unpaid operational debtor copy of an invoice demanding payment of the amount involved
in the default to the corporate debtor in such form and manner as may be prescribed. (2) The corporate debtor shall,
within a period of ten days of the receipt of the demand notice or copy of the invoice mentioned in sub-section (1)
bring to the notice of the operational creditor— (a) existence of a dispute, if any, and record of the pendency of the
suit or arbitration proceedings filed before the receipt of such notice or invoice in relation to such dispute; (b) the
repayment of unpaid operational debt— (i) by sending an attested copy of the record of electronic transfer of the
unpaid amount from the bank account of the corporate debtor; or (ii) by sending an attested copy of record that the
operational creditor has encashed a cheque issued by the corporate debtor. Explanation. —For the purposes of this
section, a “demand notice” means a notice served by an operational creditor to the corporate debtor demanding
repayment of the operational debt in respect of which the default has occurred.

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

of dues and then subsequently if there is no dispute raised by the Corporate Debtor or there is the
absence of payment, the CIRP can be initiated under the provisions of Section 9 of the Code. In a
recent judgment, the Hon'ble Supreme Court had the opportunity to settle the law on two issues
that were impeding the right of the Operational Creditors in initiating the CIRP against the
Corporate Debtors.

In the case of Macquarie Bank v. Shilpi Cables26, wherein the Hon'ble Supreme Court settled the
law on two important issues under the Code. The first issue was whether the provision under
Section 9 (3) (c)27 of the Code which mandates that in order to trigger CIRP against the Corporate
Debtor, ""a copy of the certificate from the financial institutions maintaining accounts of the
operational creditor confirming that there is no payment of an unpaid operational debt by the
corporate debtor." is mandatory or not? This issue is specifically connected to the foreign
operational creditors who could not maintain accounts with the recognized financial institutions
and thus were prevented from initiating the CIRP since such institutions were unable to produce
the requisite certificate. The second issue for consideration before the Hon'ble apex court was that
whether a demand notice of an unpaid Operational Debt under Section 8 can be issued by a lawyer
or an authorized representative on behalf of the Operational Creditor.

Hon’ble Supreme Court took a very pragmatic approach and differed with the narrow view taken
by the NCLT/NCLAT and concluded that the requirement under section 9(3) (c) is not a "condition
precedent to triggering the insolvency process under the Code". The certificate is only a piece of
evidence to confirm the existence of the debt rather than being a precondition. The Hon'ble Court
held that the provision in question is merely directory in nature, and not mandatory. In this way
court took a forward step in incentivizing the role of creditors to ponder upon the debt in a
smoother manner and also dealt with the problem of non-performing assets in a legal effect.

The NCLAT has overruled the decision of the adjudicating authority in the case of M/s. Annapurna
Infrastructure Pvt. Ltd. & Anr. v. Soril Infra Resources Ltd.28 on the very ground that the

26
Macquarie Bank Limited v/s Shilpi Cable Technologies Limited (2018) 2 Scc 674 Civil Appeal
15135/2017.
27
Application for initiation of corporate insolvency resolution process by operational creditor
a copy of the certificate from the financial institutions maintaining accounts of the operational
creditor confirming that there is no payment of an unpaid operational debt by the corporate debtor.
28
M/s. Annapurna Infrastructure Pvt. Ltd. & Anr. v. Soril Infra Resources Ltd 2017 SCC OnLine NCLAT 380.

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

Adjudicating Authority had arrived at an erroneous conclusion regarding “existence of dispute”.

NCLAT observed that an order of an arbitral panel adjudicating on the default under the heading
‘Particulars of Operational Debt (Documents, Records & Evidence of Default)’. It must be
specified as a document which can be an evidence debt & non-payment of which amounts to
’default’ of the debt. Also, NCLAT states that CIRP under IBC is not a suit for recovery or a suit
for execution of any decree or award, and therefore, the finding of the Adjudicating Authority on
the question of alternate remedy was not based on any sound principle of law. Therefore, as per
NCLAT, pendency of proceedings by Operational Creditor for execution of the arbitral award
would not bar its application under Section 9 of the IBC.

It has been lucidly mentioned in the case of Kirusa Software Pvt. Ltd. V. Mobilox innovations Pvt.
Ltd.29 the definition and interpretation of “disputes” and ‘existence of disputes” in favor of
corporate debtors, the definition of ‘dispute’ under the IBC is an inclusive definition and not
exhaustive; the expression ‘includes’ used in the definition of ‘dispute’ should be read as ‘means
and includes’; dispute will embrace not only the suits or arbitrations but its ambit will extend to
proceedings initiated or pending before consumer courts, tribunals, labour court or mediation,
conciliation etc. Such actions, suits, arbitrations, proceeding before any court, tribunal, or
mediations etc. must be in the context of a debt, or quality of goods or services or breach of
representation or warranty. It must be raised prior to the notice for insolvency resolution by an
operational creditor under section 830 of the IBC. Raising of a pending ‘dispute’ cannot be a
malafide dispute to stall the insolvency resolution process.

In the instant case the adjudicating authority has acted mechanically and rejected the application
under sub-section (5) (ii) (d) of section 931 without examining & discussing the issue. If the
adjudicating authority would have noticed the provisions as to what constitute “dispute” in relation
to services provided by operational creditor then it would have concluded that condition of demand
notice has not been fulfilled by the corporate debtor and the defense claiming dispute was not only
vague but got up and motivated to evade the liability.

29
M/s. Kirusa Software Pvt. Ltd v. M/s. Mobilox Innovations Pvt. Ltd. 2017 SCC OnLine NCLT 314.
30
Supra 25.
31
Section 9 (5)(ii)(d) states that the notice of dispute has been received by the operational creditor or there is a record
of dispute in the information utility.

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

3. INSOLVENCY AND BANKRUPTCY (AMENDMENT) ACT, 2017

The significance of the code and the horizon to which it expands in almost two years since the
enactment of the code has resulted in the full-fledged recovery of stressed financial assets. The
amendment act has a retrospective effect as to the past proceedings under IBC and purpose being
to strengthen the Corporate Insolvency Resolution Process (CIRP).

• The amendment act has amended Section 2 of the code, which extends the application of
the code to personal guarantors of the corporate debtor and proprietorship firms who were
earlier immune from any liability under the code. Hence the inclusion of these firms will
reduce the scope of default by such firms which resulted in the compliance of NPA to them
in case of default.

• Further, the amendment amends the liberty provided to the resolution professional to invite
any resolution applicant as prospective lender, investors and any other person to put
forward a resolution plan. This resulted in the addition of Section 29A to curb the
unscrupulous promoters of corporate debtors to themselves submit a resolution plan in a
CIRP for their own distressed company and thereby be the biased resolution applicant.

The objective of Amendment act prima facie is to prevent unscrupulous person from vitiating the
provision of the code. It ensures the transparency in the CIRP by imposing the eligibility criteria
for being a resolution applicant with multiple layers of safeguards. This step provides the viability
in the procedure laid down under Insolvency and Bankruptcy Code.

CONCLUSION

It must be concluded that the incidence of non-performing assets is affecting the performance of
credit institutions both financially & psychologically. Imbibing the credit management skills has
become significant for the improvement from the bottom-line of the banking sector. Skills of NPA
management, include working out negotiated settlements, compromises constituting active
settlement, advisory committees, restructuring and rehabilitation, effective recourse to suitable
legal remedies are to be supplemented with most suitably legal reforms by banks to recover dues

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

well in an appropriate framework so that the financial soundness of the banking sector will not be
undermined.

The legal reforms to curb the NPAs (viz., BIFR/SICA, lok adalats, DRTs, OTS, SARFAESI etc)
but nothing has hit the mark in tackling NPAs. The effectiveness of both DRT/ Securitization act
was challenged and still hangs in dilemma, in many Indian cases the actual position of the defaulter
was not determined. There should be a real crackdown on willful defaulters and their assets
whether or not charged too banks should be declared as national assets and be disposed in a
transparent manner, without major legal hurdles. Hence, therefore there was a need for more
stringent law in order to curb the higher growing NPAs in the nation which is directly hampering
the growth of the economy.

The Insolvency and Bankruptcy Code, 2016, is a progressive legislation that is intended to improve
the efficiency of insolvency and bankruptcy proceedings in India. The new legislation provides
for the early detection of financial distress and a time bound process for resolution. However,
many facets on the IBC's implementation need to be worked out in the regulations, and its success
will depend to a large extent on recruitment of insolvency resolution professionals will emerge
with the time bound process for insolvency resolution will be adhered to in practice. The code
substantially brought to a course the much-awaited reforms that needs to be looked upon in
resorting solutions to the non-performing assets. The amendments are perhaps the most significant
set of changes to the SARFAESI Act since its enactment in 2002. The Bankruptcy Code and the
amendments to the SARFAESI Act together reflect a clear legislative intent to shift the needle in
a distressed situation towards the creditors by plugging various loopholes available to borrowers.

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 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

Bibliography

1. Dr. Ambuj Gupta - Non-Performing Assets (NPAs) in Indian Banks: Issues, Perspective &
Future Directions
2. Bidani S.N. – Managing NPA- in Banks 2002, Vision Books Pvt Ltd. New Delhi
3. Kothari, V.- Securitisation, 2005, Nadhwa & Company, New Delhi
4. Mukherjee, Paramita, (2003),- “Dealing with NPAs: Lessons From International Experience”
Money & Finance, Vol.12,No.12, March 2017
5. M.R. Umarji,- 7th Edition 2017- Law & Practice Relating to Secutisation & Reconstruction of
Financial Assets & Enforcement of Security Interest
6. Vinod Kothari- Edition 2016 - Laws Relating to insolvency & Bankruptcy Code 2016 (revised
2017)
7. The Bare Act, SARFAESI ACT, 2002
8. The Bare Act, Insolvency & Bankruptcy Code, 2016

Dailies

1. The Hindu
2. The Indian Express
3. Business World

Journals

1. Narsimham Committee Report-I (1991)

2. Narasimham, M., 1998. Report of the committee on Banking Sector Reforms.
3. RBI Bulletins, RBI Reports on trend & Progress of Banking in India. (Various Years)
4. Trend & Progress in Banking, 1998-2017, RBI.
5. Verma Committee Report- (1999)

WEBLOGRAPHY

WWW.Bankersindia.com

WWW.IndiaInforline.com

Corporate Law Journal 25.)

 Problem Of NPA In The Indian Economy And Solution To It In Its Legal Perspective

WWW.RBI.Org.in

WWW.PRS.Org.in

Corporate Law Journal 26.)