In ICICI Bank Ltd v Official Liquidator of APS Star Industries Ltd & Ors the Supreme Court considered whether the transfer of non-performing assets (NPA) by banks was permissible under the Banking Regulation Act, 1949 (BR Act).
ICICI Bank and Kotak Mahindra Bank entered into a deed of assignment by which ICICI Bank assigned to Kotak certain debts that were credit facilities granted to various borrowers. The debt was assigned on an “as is where is” basis, for which Kotak paid approximately Rs520 million (US$11.7 million). Accordingly the assignee, Kotak, became the secured creditor for the debt.
Subsequently one of ICICI Bank’s borrowers, APS Star Industries, went into liquidation and Kotak requested (by way of a company application) to be substituted as the secured creditor. Kotak’s position was that debt can be sold by creditors and purchased by banks and financial institutions. Although ICICI Bank supported Kotak in this application, the borrower – APS Star – contended the deed of assignment had not lawfully given Kotak the right to replace ICICI Bank. Agreeing with APS Star, the Company Court held that the rights had not been conveyed legally.
Kotak appealed this decision before Gujarat High Court. The court held that the transfer of debts was not permissible under the BR Act and assignee banks were not entitled to be substituted in place of the assignor banks in proceedings related to companies in liquidation.
Alleging this decision was wrong, ICICI Bank appealed to the Supreme Court. The bank insisted that it never traded, purchased or sold debts, but instead advanced loans against security as a part of its “business of banking”.
The acts and regulations referred to by both parties and the court were the Transfer of Property Act, 1882, sections 5, 6, 8 and 130; the Reserve Bank of India Guidelines of 13 July 2005; and the BR Act, sections 2 – 46.
ICICI Bank argued that none of the provisions in the BR Act were contravened by the assignment of debt. This was particularly as section 5(b) of the act, which refers to the core activity of a bank, is not exhaustive and does not specify the exact range of activities a bank can carry on. Also, nothing else in the BR Act prohibits such assignments of debts.
APS Star in turn maintained the assignment of ICICI Bank’s financial instruments to Kotak transfers more than the right to recover debt and in fact includes a transfer of obligations under the financial instruments. Such obligations cannot be assumed under the BR Act or the Transfer of Property Act unless a new contract is signed by all the parties. APS Star further contended the “business of banking” entails only the traditional concept of banking and cannot include assigning debts by accepting deposits.
The court noted the BR Act is open-ended. It empowers the Reserve Bank of India (RBI) to develop a healthy secondary market and so allows banks to deal in NPAs in order to clean their balance sheets. Thus it cannot be said that an assignment of debts or NPAs is not permissible under the BR Act. The court held the test to be applied is whether trading in NPAs is bona fide banking business, which it said was met in this case. In addition, the RBI guidelines of July 2005 authorize banks to deal in NPAs. The court noted this showed that the RBI considers NPA assignment between banks to be a tool for improving the profitability of the banks.
The court rejected APS Star’s contention that the assignment of financial instruments transfers obligations as well. It noted that the bank is the owner of the debt, which is an asset in its hands. As such the bank can transfer the asset without affecting the right or interest of its customer. The debt that is being assigned by the assignor bank was never purchased by the bank; it acquired the debt when it advanced loans against security, which it did as part of its banking business.
The court went on to explain that rights and obligations associated with debt are similar to the rights and obligations associated with a contract. However, there is a well-recognized distinction between obligations and rights under a contract. While the former cannot be assigned except by consent or novation of the promise, the latter are readily assignable unless the contract is personal in nature. In this case the deed of assignment between the banks dealt only with accounts receivables in the books of ICICI Bank and so did not transfer ICICI Bank’s obligations to its customers.
Thus, the Supreme Court set aside the judgment of Gujarat High Court and held that the assignment of debts is a permissible under the BR Act.
This judgment will give a huge boost to banks as they will now be able to deal effectively with NPAs, which ordinarily would not yield any profits. It virtually transforms the banking business by expanding the definition of the “business of banking”. As it is also conducive and productive for the economy to have bank debts recycled, banks, asset reconstruction companies and other intermediaries will welcome this decision.
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