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IBC and Sarfaesi once again in conflict

Poornima Advani

The conflict between the Insolvency and Bankruptcy Code (IBC) and the Sarfaesi Act has once again come to the fore as the RBI rejected a resolution plan submitted by UV Asset Reconstruction (UVARCL) to acquire Aircel’s assets. The plan proposed by the Asset Reconstruction Company (ARC), although approved by the NCLT, was rejected by the RBI because it “did not conform to the guidelines under the Sarfaesi Act”, hence contributing to the ambiguity surrounding the application of the two legislations.

The Sarfaesi Act was enacted in 2002 to regulate the securitization and reconstruction of financial assets, as well as the enforcement of security interest, without court intervention. It provides a framework within which financial institutions can recover bad loans and it is regulated by the Ministry of Finance and the RBI. Under the Act, secured creditors can take possession over the collateral against which loan was provided, if there is a default in payment. Accordingly, under Sarfaesi, banks and other financial institutions can recover loans by auctioning commercial or residential properties. On the other hand, the IBC was introduced in India as a collective mechanism to resolve insolvency through a time-bound process, regulated by the Insolvency and Bankruptcy Board of India. Under the code, creditors are given the opportunity to make insolvency resolution an economically viable arrangement and entities can apply for insolvency, liquidation or bankruptcy. While the Sarfaesi Act addresses the manner in which assets can be dealt by financial institutions, the IBC addresses the concerns of all creditors; both operational and financial as well as the secured and unsecured creditors. As the resolution or recovery of bad debts is the central focus of both, the two legislations have often come in conflict with each other. However, the IBC provides for a non-obstante clause in section 238, giving the Code’s provisions precedence over any other provision in law. The same has been confirmed by the Supreme Court in Encore Asset Reconstruction Company Pvt Ltd v. Ms Charu Sandeel Desai, where it stated that the IBC clearly prevailed over the Sarfaesi Act.

Despite this, there are certain regulatory gaps and overlaps which have not been addressed by the authorities. The issue of ARCs is one such gap which, if it had been adequately addressed, may have caused the RBI to arrive at a different decision when determining the UVARCL resolution plan. The Sarfaesi Act provides for the setting up of ARCs, which are specialised financial institutions acquiring non-performing assets or bad assets from financial institutional and banks. However, it does not allow ARCs to submit resolution plans and its guidelines prohibit ARCs to infuse equity in insolvent companies at the resolution stage. Contrary to this, Section 29A of the IBC permits ARCs to become resolution applicants. The Sarfaesi guidelines, invoked by the RBI in justifying the rejection of UVARCL’s resolution, precede the enactment of IBC and as such, should not prevail. And yet, the RBI has seemingly ignored the non-obstante clause in the IBC in its decision. Due to a lack of harmonisation between IBC and Sarfaesi provisions, ARCs such as UVARCL may suffer similarly when taking part in resolution processes. Therefore, the Association of ARCs has taken note of this conflict and asked the RBI to issue new guidelines for ARCs which would be in consonance with IBC provisions and not cause conflict between IBC and the Sarfaesi Act.

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