SC makes loan recovery tougher for banks, despite having valid collateral

The Supreme Court has done some further damage to the cause of bad loan recoveries by banks in a recent case involving the interpretation of two special laws - the Sick Industrial Companies (Special Provisions) Act, 1985 (SICA), and the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (RDDB).

Under a key SICA section (section 22) a company gets protection from all creditors while a revival plan is in the works. However, under the RDDB, which is also a special act intended to aid debt recoveries, section 34 allowed lenders to recover their dues from defaulters even if other laws gave some succour to the borrowers.

The Supreme Court was in a dilemma because both SICA and RDDB had special provisions to override other laws - Section 22 in SICA and Section 34 in RDDB. It has opted in favour of giving SICA priority over RDDB - something banks will now have to fret about.

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In a recent case involving Arihant Threads Ltd (read the full judgment in the case here), the apex court held that SICA would take precedence over RDDB, which means reviving a company that may (or may not) be in terminal decline will be given priority over the right of banks to recover their dues by selling the collateral pledged with them.

This, following quickly in the wake of another judgment by the court giving precedence to cane growers' dues over banks' right to enforce collateral , means that courts are putting their own spin on who gets precedence over pledged assets. If this trend continues, it would mean the whole purpose of lending against collateral will become less valuable to banks, since borrowers (or people with other claims on borrowers) can get courts to junk the collateral on the basis of which banks had lent money in the first place.

It can make banks more reluctant to lend since collateral will be of doubtful value.

In both cases - the Arihant case and the sugar mills one - the orders were delivered by benches headed by Supreme Court Chief Justice HL Dattu.

In the latest case, the facts are as follows; IDBI gave a loan to Arihant Threads for an export-oriented spinning unit in Amritsar district in the 1990s. When the company started defaulting on loan repayments, IDBI moved the Debt Recovery Tribunal (DRT) and got an order in its favour to dispose of Arihant’s assets in July 2003. Arihant stayed away from the DRT despite being given a chance to explain its position. It was only when IDBI put up the collateral for auction that Arihant appealed against the DRT order.

The auction for the assets was won by KSL Industries, but meanwhile Arihant tried another ploy, and moved the Board for Industrial and Financial Reconstruction (BIFR), constituted under SICA to oversee the revival of sick companies. Under a key SICA provision (section 22) a company gets protection from all creditors while a revival process is on. The move clearly was intended to nullify the DRT’s decision to sell the underlying assets . When the matter went into appeal, the Debt Recovery Appellate Tribunal (DRAT) also upheld the sale.

The matter then reached the Delhi High Court, which ruled that SICA trumped RDDB, and hence the money could not be recovered by the sale of assets as the company was seeking a revival plan.

That’s when KSA took the matter to the Supreme Court, where a two-judge bench of Justice Altamas Kabir (later to become Chief Justice) and Justice CK Thakker was hopelessly split - though both ruled that Arihant could not stall the debt recovery process since it went to BIFR only after the process was almost complete.

But while Justice Thakker ruled that in debt recovery matters, the RDDB, which was a later law, would prevail, Justice Kabir said that SICA would prevail in view of section 22, which superseded other extant laws.

It was Justice Kabir’s position which the current three-judge Supreme Court bench headed by CJI HL Dattu upheld: that SICA would prevail over RDDB. The other two judges on the bench, which delivered its verdict on 27 October, were Justices SA Bobde and Abhay M Sapre.

Even thought IDBI and KSA have won in this specific case, the precedence given to SICA over RDDB has implications that go beyond this one case.

First, the court orders, including the one involving and Arihant and the earlier one involving sugar mills, have dented the value of banks’ collateral and their enforceability. With courts also frequently staying banks’ efforts to recover dues in other ways - the Calcutta High Court’s stay on United Bank of India’s decision to declare Vijay Mallya as a willful defaulter comes to mind - it means the recovery climate for dues can be delayed by courts.

Second, if SICA trumps RDDB, it means any defaulter can game the system by seeking a revival package from BIFR. This was what Arihant attempted at a late stage, after losing the case in the DRT.

Three, if a loan that went bad in the 1990s cannot be collected nearly 20 years later, one wonders what value collateral can have anyway.

Four, governments also seem careless in how they word legislation. If two laws relating to the mid-1980s and mid-1990s are found to be in contradiction in 2014, surely the drafting is poor. In this case, clearly the legislature has to confirm if the court’s interpretation - that SICA special provisions will supersede RDDB’s - are what it intended.

Meanwhile, banks will have to shoulder the burden of carrying more bad loans than they can afford on their books.