Prior to the introduction of the Insolvency and Bankruptcy Code, the law of insolvency was a ropey, humdrum discipline, well-described by the name of the Act that governed it, the now-defunct Sick Industrial Companies Act. Upon the passing of the Code, however, bankruptcy law suddenly found itself in the headlines, with some of the country’s largest companies being dragged through its merciless restructuring process. The reason why so many prominent companies (Essar Steel, Binani Cement, Reliance Communications, to name a few) were simultaneously thrown into the furnace was not because of a sudden spurt of zealousness on the part of the banks that had lent them the billions that they had now defaulted on.

It was because the Reserve Bank of India, the puppeteer of all banks, (thanks to the Banking Regulation Act), had willed it so.

On 15 June 2017, RBI directed that companies with debts over Rs. 5,000 crore of which over 60% was overdue, would be sent to court under the IBC. It turned out there were twelve such (cheekily referred to by the press as “the Dirty Dozen”). Subsequently, RBI decided that there needed to be “a framework” for resolution of stressed assets in a time-bound manner. This framework was detailed in a Circular dated February 12, 2018. The February Circular took direct aim at NPAs arising from debts of over Rs. 2,000 crore – the big fish. If these companies couldn’t come to terms with their lenders within 180 days, declaimed the RBI, they were to be sent lock, stock and barrel to the IBC.

Now, I have earlier criticised RBI’s non-discretionary attitude in sending big companies to insolvency court. It fails to distinguish between wilful defaulters and victims of circumstance, such as the power companies that are in financial doldrums because of regulatory mismanagement. But I could never have dreamed that the February Circular could be struck down by any court, as being ultra vires, and the reason is simple – it is plainly legal. On 4 May 2017, the government introduced Section 35AA of the Banking Regulation Act, which explicitly says that the Central Government may authorise RBI to issue directions to banks to initiate action under the IBC. Crucially, the very next day, the Central Government gave the Reserve Bank carte blanche under Section 35AA: “the Central Government hereby authorises the Reserve Bank of India to issue such directions to any banking company or banking companies which may be considered necessary to initiate insolvency resolution process…”

The February Circular was issued by RBI using the power granted to it by Section 35AA, and with the consent of the Central Government, a pre-requisite for the exercise of that power. Yet, somehow, on 2 April this week, the Supreme Court, speaking through the redoubtable Justice Nariman, struck down the Circular, holding that it did not comply with Section 35AA and was therefore illegal. The gist of what the Court held is that Section 35AA is not a general power, and only applies to specific defaults. This the Court got from the use in Section 35AA of the term “a default”, as opposed to many defaults, and the Press Note introducing Section 35AA, which referred to “specific” cases of NPA resolution. Fair enough.

But why wasn’t the February Circular specific enough? Clearly, not every company in India has defaulted on loans that amount to over Rs. 2,000 crore. The few that have are easily identifiable. And if they are identifiable, the Circular is specific. For instance, a report by ICRA, a rating agency could even predict that 70 companies would be sent to insolvency resolution as per the Circular by September 2018. The Supreme Court’s judgement shows that Counsel for the RBI produced the Oxford dictionary and Black’s Law dictionary meanings of the word “specific” to convince the Supreme Court that the Circular fitted the bill. These meanings included “clearly defined” and “conformable to special requirements” – the Circular was both these things. The Court dismissed the argument, ruling that the meanings belied the case of the RBI, without saying more.

The case can be looked at from another angle. If instead of this one circular, RBI had come out with a series of circulars naming each individual company which had defaulted on loans over Rs. 2,000 crores, the Supreme Court could never have interfered on the ground that the circulars weren’t specific enough. Then why not one circular that has the same effect?

Borrowing from Hamlet, what a noble circular is here o’erthrown.

The upshot is that all the time and money spent on complying with the February Circular is wasted. More’s the pity. The Supreme Court held that there was no power in RBI, besides Section 35AA, to direct that companies be sent to insolvency resolution. Following this logic, the direction to send the first batch of twelve companies to the IBC is also illegal, as Section 35AA wasn’t even on the statute book at the time.

Courts should brace themselves for an avalanche of litigation.