SC validates assignment of debt between banks

By Ameya Khandge and Vardaan Ahluwalia, Trilegal
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Readers will recollect the APS Star litigation that arose from a transfer, by way of assignment, of a pool of non-performing loans (NPAs) along with their underlying security, from ICICI Bank (the assignor) to Kotak Mahindra Bank (the assignee).

Ameya Khandge Partner Trilegal
Ameya Khandge
Partner
Trilegal

Putting the brakes on

The transfer was contested by one of ICICI Bank’s borrowers, APS Star Industries, which went into bankruptcy. During liquidation proceedings the company court refused to recognize the assignment and the rights of the assignee with respect to the loan. On appeal, a division bench of the Gujarat High Court held that the transfer was illegal, being speculative in nature and contrary to what a bank is permitted to undertake within the framework of the Banking Regulation Act (BR Act). As a consequence, the court observed that the assignment deed was illegal and that Kotak Mahindra was not entitled to substitute ICICI Bank.

Seeking a way out

This potentially prohibitive ruling had a far-reaching impact. It created uncertainty in the market and raised questions in relation to the legitimacy of transactions where any debt (i.e. both NPAs and standard assets) was transferred by a bank. The banks involved had appealed against this judgment to the Supreme Court and the Supreme Court, in its interim order on 16 February 2009, stayed the operation of the order of the Gujarat High Court pending final resolution of the dispute.

The key issue has finally been addressed by the apex court. In its judgment dated 30 September 2010 the Supreme Court overturned the decision of the Gujarat High Court and clarified that it cannot be said that such assignments are unsustainable in law.

Vardaan Ahluwalia Associate Trilegal
Vardaan Ahluwalia
Associate
Trilegal

In the judgment, the Supreme Court clarified that assignment of all debt is not an activity that is either contrary to public policy or prohibited under law. Before specifically delving into the issue of legality of assignment of debt by banks, the court sought to build its reasoning by briefly discussing the scheme of the banking regulatory framework in India. The bench took cognizance of section 2, 5, and 6 of the BR Act and recognized that in addition to the business of banking, the BR Act also permitted the banks to do “all such other things as are incidental or conducive to the promotion or advancement of the business of the company”. The bench observed that “while interpreting the Act, one needs to keep in mind… the growth and the concepts that have emerged in the course of time”.

Discussing the role of the Reserve Bank of India (RBI), the apex court held that the BR Act empowered the RBI to enact policy that enabled banking companies to engage in activities that may not be specifically mentioned as core banking activities. Citing the example of derivative transactions, the bench stressed that while certain transactions may not fall within the confines of section 6 of the BR Act, there is still “ample scope for banking companies to venture into new business subject … to the control of the Regulator viz. RBI”.

Looking at legalities

In the context of legality of assignment of debt, the court held that the BR Act “is an open ended Act” and that that “it cannot be said that assignment of debts/ NPAs is not an activity permissible under the BR Act”. The bench held that such activities should be viewed as a measure to minimize the problem of credit risk among the banks. Relying on guidelines on purchase and sale of NPAs issued in 2005 by the RBI, the court added that corporate debt restructuring is a method to reduce NPAs and such restructuring cannot be treated as trading. The bench observed that any regulations issued by the RBI are to be “read as supplement to the provisions of the BR Act” and that it cannot be beyond the scope of the BR Act as they also define what constitutes “banking business”.

Referring to Camdex International Limited v Bank of Zambia, the court highlighted that the mere fact that such debt may be purchased at a discounted price or the assignee may make a profit on the transaction will not render such assignment contrary to public policy. From a private law perspective, the court reasoned that debts are the assets of the assignor bank and any assignment of rights in respect of these assets under a contract without prejudicing the rights of the borrower cannot be held to be illegal.

Further roadblocks?

While the Supreme Court has set aside the judgment of the division bench of the Gujarat High Court on the issue of assignment of debts, the court remitted issues relating to stamp duty payable for such assignments and the applicability of the Registration Act, 1908, to such transactions, to the division bench of the Gujarat High Court for a ruling. Thus, while the order itself is a much needed development, these two points could prove to be deal breakers from a commercial perspective.

Ameya Khandge is a partner at Trilegal in Mumbai where Vardaan Ahluwalia is an associate. Trilegal is a full-service law firm that advises on corporate and commercial law in India. The firm has offices in Delhi, Mumbai, Bangalore and Hyderabad and has over 120 lawyers.

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