Message from Jaisalmer: Lower judiciary reforms are urgent

Illusions & Delusions

This is the Diwali weekend — the time when homes are cleaned and renewed. It is thus a good time to focus on some of the structural flaws in our economy requiring renewal or remedial action. Schumpeter had depicted well how the strength, if not the very bedrock, of a country’s economic success rests on its ability to engage in what he called ‘creative destruction.’ In this, unprofitable or unviable businesses are closed down and their creditors repaid with seamless efficiency, paving the way for new ventures to emerge. It is somewhat akin to the age-old Ayurvedic belief that all ills of the human body are linked to a malfunctioning digestive system.

One of the critical flaws of the Indian economy is that its credit cleansing process frequently malfunctions. As a result, banks are bedeviled by a large number of zombie loan accounts that neither service their dues nor get repaid, eroding the system’s capacity to lend freely.

Repeated attempts at reform have been made, but with limited success. The earliest reform came soon after liberalization, with the enactment of ‘The Recovery of Debts and Bankruptcy Act, 1993’ (RDB Act) to provide speedy redressal to lenders and borrowers. However, the malfunctioning continued.

The ‘Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act’ was enacted in 2002 to effect reconstruction of bad assets without the intervention of courts. This Act provides the legal basis for the setting up of Asset Reconstruction Companies (ARCs). An ARC is a specialised financial institution that buys the NPAs or bad assets from banks and financial institutions so that the latter can clean-up their balance sheets. Since then, 29 ARCs, regulated by the RBI, have been formed.

But the desired system efficiencies still did not materialise. As a result, in 2016, the Insolvency and Bankruptcy Code (IBC) Act was implemented, along with the replacement of the previously existing Company Law Boards (CLB) by the new National Company Law Tribunal (NCLT) under Section 408 of the Companies Act. This did have a significant initial impact but delays and bottlenecks have re-emerged to dog the system. Coincidentally, only this week, a new RBI panel -- the Sudarshan Sen Committee -- has recommended speeding up the recovery mechanism by further empowering ARCs and reiterating the importance of early sale of NPAs to ARCs.

However, the recent episode of a lower court in the desert town of Jaisalmer ordering the arrest, without prior hearing, from faraway Delhi of a director of an ARC executing a recovery process has exposed the real reason why attempts at reform have been unaccountably failing and will continue to fail, unless cleansed at the root. It is not because the banks do not wish to support reform. Quite the contrary. The banks are keen; they want healthy balance sheets. The resistance to NPA resolution comes not only from the delaying tactics of recalcitrant borrowers but is reinforced by their easy ability to influence the lower judiciary and bureaucracy to intervene in the debt recovery process.

Let us examine the reported facts of the case. A Term Loan of Rs 24 crore and Working Capital of Rs 1 crore were sanctioned by the State Bank of India (SBI) for a hotel project in 2008. But the business failed, making the loan an NPA in 2010. Subsequently, after other measures failed, a loan recall notice was issued in 2012. Apparently, a SARFESI notice had also been issued but it could not secure magistrate clearance, forcing the bank to file a Debt Recovery Tribunal (DRT) suit in 2013. The bank assigned the loan to an ARC in March 2014.

Repeated litigation by the borrower kept delaying the process, forcing the ARC to invoke the IBC in 2017. After prolonged litigation, a resolution plan considered suitable by the NCLT seems to have finally emerged — which the borrower seems to be trying to subvert.

The ARC director’s arrest was not ordered for any convicted wrongdoing but on the ground that he was the Chairman of SBI, the country’s largest bank with network of over 24,000 branches with a loan book size of over Rs 20 lakh crore, when this Rs 24 crore loan was made. The order failed to take cognizance of the fact that he had retired from the SBI with not only an unblemished record but also with all-round appreciation and honours in September 2013, much before the ARC transaction under discussion. The ability of that court to visualise, without cross-examining, that such a high-ranking person, who never worked anywhere near that desert town, would have a personal interest in such a low-value – relatively speaking — case, is also quite noteworthy. A severe miscarriage of justice seems to have occurred – the banker has been ordered arrested at the instigation of the loan-defaulter. This needs urgent remedial action.

Also, the prolonged, yet incomplete, recovery process of a relatively small-value NPA case needs attention at our highest levels of decision-making. Over Rs 7 lakh crore of stressed assets are still in need of resolution. There is little point in creating institutions like the NCLT or ARCs if our lower courts are allowed to claim simultaneous jurisdiction over the same cases and create terror by effecting one-sided arrests in a civil dispute. Lower judicial reforms must take place urgently. The lower courts should now be totally excluded from any claim of jurisdiction in corporate debt recovery cases.