IL&FS to be taken over government

The Account That Must Not Be Called An NPA

The resolution process for Infrastructure Leasing and Financial Services has seen many twists and turns since the company first defaulted on its dues in September 2018.

The company’s board was dismissed and replaced by an interim board appointed by the Government. The parent and its 348 subsidiaries and special purpose vehicles were placed under a court-ordered moratorium. But that moratorium was partially lifted when lenders raised concerns that the commonly used ring-fenced SPV structure for infrastructure financing was being challenged. Subsidiaries were then categorised into three buckets based on their repayment abilities and some subsidiaries were allowed to restart payments.

On Monday, the National Company Law Appellate Tribunal threw another curve ball in the firm’s resolution saga by saying that none of the group firms would be tagged as non-performing assets even if they are not making repayments to banks. An account is tagged as an NPA when its overdue by over 90 days. In this case, loans to the parent company and to some of the subsidiaries would have turned into NPAs over the third and fourth quarters of the current financial year.

But going by the NCLAT order, banks will no longer need to classify these accounts as NPAs even if they are 90-days overdue.

...we make it clear that due to non-payment of dues by the ‘Infrastructure Leasing & Financial Services Limited’ or its entities including the ‘Amber Companies’, no financial institution will declare the accounts of ‘Infrastructure Leasing & Financial Services Limited’ or its entities as ‘NPA’ without prior permission of this Appellate Tribunal.
NCLAT Order Dated Feb. 25

It’s unclear what led to this decision. The NCLAT did not explain the rationale behind its decision. Sanjay Shorey, Director (Legal Prosecution) at the Ministry of Corporate Affairs (MCA) told BloombergQuint that the decision made by the NCLAT was not prompted by any application from the ministry to dilute asset classification norms for IL&FS.

The RBI did not immediately reply to an email sent to them seeking clarity and asking whether the regulator would challenge the order. Former RBI deputy governor R. Gandhi believes it should.

The order does not quote any arguments. This is a court direction. In my view, it looks like either lenders or the Reserve Bank of India may have to go to Supreme Court against the appellate tribunal.
R. Gandhi, Former Deputy Governor, RBI

The rules to determine what gets classified as a NPA are laid down in the RBI’s Income Recognition and Asset Classification norms. Apart from laying down the 90-day NPA recognition rule, these norms also specify the extent of provisioning needed once an account is tagged as non-performing. In the first year, banks have to set aside 25 percent as provisioning against these accounts.

But what happens now when the NCLAT has said that banks should not tag IL&FS accounts as NPAs? Can banks avoid provisioning against these accounts even though prudent banking dictates otherwise?

According to Abizer Diwanji, partner and head of financial services at EY, the question of extending a moratorium on provisioning should only be considered if the underlying company is able to pay its dues, but the lenders cannot access the funds for a period of time due to a restructuring plan being implemented.

In all other scenarios, banks must set aside provisions.

The companies which do not have the ability to pay, which is the red and some of the amber ones, those should not have been part of the moratorium (on provisions). If those companies are inherently bad, then they deserve a provisioning requirement.
Abizer Diwanji, Partner and Head - Financial Services, EY

A lot will depend on the RBI’s view since the power to decide whether an account should be tagged as an NPA or not lies with the regulator, Diwanji said. The regulator also has the powers to specify a necessary amount of provisioning against a specific account if needed.

Not everyone agrees that the NCLAT has acted in a way which treads on regulatory territory.

On the face of it, it may seem like the NCLAT is overreaching, but that is not the case, said Sudipta Routh, partner at law firm IndusLaw. He explained that the NCLAT has “wide amplitude” under Section 242 of the Companies Act, especially in the context of a reference by the central government under Section 241, he said.

Section 241 deals with oppression and mismanagement cases and allows the government to apply for an order if the affairs of a company are carried out in a manner that is prejudicial to public interest. The government used this provision to seek a moratorium on debt payments by the IL&FS group.

In this situation, the underlying rationale is that reference has been made because in the opinion of the Central Government the affairs of IL&FS were being conducted in a manner prejudicial to public interest. Other than its wide ranging powers under Section 242, the Central Government reference arms the NCLAT to pass orders of this type.
Sudipta Routh, partner at law firm IndusLaw

Stuck between the regulator and the court, how should banks approach the account?

“Ultimately non-declaration of NPAs will lead to contravention of RBI’s IRAC norms and will invite supervisory action. But the NCLAT order will override and it is difficult to find flaw,” said Routh.

Ridhima Saxena contributed to this report.