– Shruti Khetan*
Recently, the Reserve Bank of India (‘RBI’) stirred a debate regarding the role of an Asset Reconstruction Company (‘ARC’) in insolvency resolution by rejecting the bid submitted by an ARC for a distressed telecom player under the Insolvency and Bankruptcy Code, 2016 (‘IBC’). UV Asset Reconstruction Company Limited (‘UVARCL’) emerged as a successful resolution applicant in the Corporate Insolvency Resolution Process (‘CIRP’) of Aircel Limited and its subsidiaries and received the nod of the National Company Law Tribunal (‘NCLT’) in June 2020.
Soon after, in a major setback, the RBI furnished a show-cause notice to UVARCL on the ground that the acquisition did not conform to the guidelines under the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (‘SARFAESI Act’). Though RBI’s notice has been currently stayed by the Delhi High Court, the debt industry is shrouded in doubts and speculations about an ARC’s eligibility as a resolution applicant.
This piece seeks to examine the merits of RBI’s objection by analysing the position of ARCs as resolution applicants under the IBC and SARFAESI framework. The public discourse is heading in the wrong direction — the question is not whether an ARC can submit a resolution plan, but what restructuring measures can be resorted to in an ARC’s resolution plan? The author argues that ‘ARCs can be resolution applicants within both frameworks, provided they act within their permitted realm of activities’. The status quo prohibits an ARC from injecting fresh equity into a distressed borrower as part of its resolution strategy. However, the current restrictions in relation to equity infusion are untenable and require serious consideration.
1. ARC’s Eligibility as a Resolution Applicant under IBC
A resolution applicant has been defined broadly to mean any person who individually or jointly with any other person, submits a resolution plan and satisfies the criteria identified by the resolution professional and the committee of creditors. Further, section 29A of IBC prohibits a person from submitting a resolution plan if such person suffers from any of the disqualifications prescribed under this section. An ARC, as an entity, falls within the wide definition of a resolution applicant and can submit a resolution plan under IBC, if it otherwise meets the lenders’ criteria and does not get hit by section 29A.
Further, by way of an amendment in IBC, a financial entity (which includes an ARC) has been exempted from section 29A(c), which deals with holding NPA accounts. A carve-out has also been created for an ARC from the definition of ‘connected person’. Association of ARCs has argued that the legislature, by exempting ARCs from certain disqualifications, has expressly recognized ARCs as resolution applicants.
2. ARC’s Eligibility as a Resolution Applicant under the SARFAESI Act
2.1. Role of an ARC under SARFAESI Act
ARC is a creation of the SARFAESI Act, registered with and regulated by the RBI. It was introduced to acquire and resolve the non-performing loans of banks and institutional lenders and assist them in cleaning up their balance sheets. Section 9 of the SARFAESI Act empowers an ARC to take certain measures for the realization of dues, including a right to convert debt into equity of the Borrower Company and change or takeover of the management of the business of the borrower. Though originally conceptualized as a parking lot for stressed assets, where the focus was on recovery, the role of an ARC has significantly evolved with the changing business environment. Since its inception, a host of relaxations have been granted to ARCs. For instance, ARCs did not originally enjoy a right to convert the outstanding debt, which was introduced in 2013, upon the recommendations of a Key Advisory Group (‘KAG’) set up by the government. However, the equity shareholding of an ARC in the borrower company post-conversion of debt was restricted to 26%.In order to equip ARCs with greater control and flexibility in turning around sick units, this 26% limit was relaxed in 2017 subject to certain conditions. Further, in the event an ARC took over the management of the borrower company, it was obligated to restore the management to the borrower on the full realisation of the debt. Subsequently, a proviso was added to section 15(4) stating that an ARC shall not be liable to restore the management if it acquires a controlling equity stake in the borrower company upon conversion. This carves out implied that an ARC can enjoy a permanent equity position in the borrower company.
These developments have enabled ARCs’ participation in the long term revival of the stressed assets. They also complement the intent and objective of the SARFAESI Act, which is the reconstruction of financial assets, and not mere recovery. Reconstruction encompasses, and is not the antithesis to, resolution. Moreover, allowing ARCs to undertake debt-equity swap, was recommended by KAG as part of a ‘resolution strategy’ for such financial assets which have restructuring and turn around potentials. Thus, there is nothing under the act that impedes an ARC from offering restructuring solutions with an objective to resolve and revive a distressed company. Submitting a resolution plan as a resolution applicant is not a nature of the business or a realisation measure but a mere route available to an ARC. As long as they stay within the contours of permitted activities prescribed under section 9 of the SARFAESI Act, ARCs are free to acquire and hold loans whether as a resolution applicant under IBC or outside IBC.
2.2. Equity infusion by ARC — Shifting Discourse
As reported in the news, RBI’s key objection to UVARCL’s plan is that an ARC is not permitted under the SARFAESI Act to infuse equity in an insolvent company at the resolution stage. The current legal framework does not expressly prohibit or allow an ARC to make equity infusion in a stressed company. In this scenario, does RBI’s justification hold water?
There is no provision under the SARFAESI Act or its underlying guidelines enabling an ARC to infuse equity in the borrowing entity. If a statute confers the power to do an act and lays down the manner of exercising such power, it necessarily prohibits doing the act in any other manner. Moreover, where a specialized body has been created by law for a limited purpose and that purpose is clearly defined, the body must act within the four corners of the specified purpose.
An ARC is formed for the purpose of carrying on the business of asset reconstruction or securitisation or both. In fact, section 10 of the SARFAESI Act prohibits an ARC from undertaking any other business without the prior approval of the RBI. The term ‘asset reconstruction’ has been defined as acquiring any right or interest of any bank or financial institution in any financial assistance (such as loans, guarantee, credit facilities extended by such bank or financial institution) for repayment of such financial assistance.
The statutory regime under SARFAESI Act is restrictive of the roles that an ARC can play in the realisation of outstanding dues. ARCs have been granted specific powers for asset reconstruction with a specific purpose in mind. To allow debt-equity swap as an asset reconstruction measure to ARCs, an extensive review and consultation process was undertaken, and a specific amendment was enacted by the Parliament. Even today, it continues to be regulated as ARCs have to comply with certain conditions in order to hold more than 26% post-converted equity. Likewise, for taking over the management, ARCs are subject to eligibility conditions, procedural and reporting requirements under the RBI guidelines. Hence, the sphere of activities permitted to an ARC, remain a regulated affair and the language of the SARFAESI Act must be strictly construed.
Equity infusion does not fall within any permitted business of an ARC under SARFAESI Act, including asset reconstruction, and hence is barred. Asset reconstruction presupposes the acquisition of a right or interest in ‘financial assistance’ and not equity of the company. Besides, the object of an ARC currently contemplated under the statute is narrowly defined to mean the realisation of dues and not own and control stressed companies. Any equity investment by an ARC can be only in the manner envisaged under SARFAESI Act, that is, by way of conversion of debt and not the direct purchase of equity.
3. Potential Resolution Structures for ARCs
To sum up, though an ARC is eligible to be a resolution applicant, the acquisition structure proposed in the resolution plan will be the key factor in determining whether the plan will pass muster under the provisions of the SARFAESI Act. Some of the potential routes an ARC can explore for bidding in an insolvency process have been discussed below.
a. Joint bidding with another entity without equity interest:
An ARC can partner with a non-ARC entity to acquire only the debt of the corporate debtor, whereas the non-ARC entity would infuse the funds to acquire and hold the equity shares in its name. Any new money to be infused by an ARC can be as part of the debt and not equity. This structure has successfully been tested in the CIRP of Shaifali Rolls Limited, where Omkara Assets Reconstruction Company Private Limited along with its consortium partner Fitcast Founders & Engineers Private Limited (‘Fitcast’) was voted as the successful resolution applicant for a steel manufacturing company. To acquire the debt of the existing bankers, Omkara ARC infused Rs. 10 crores into the company which was recorded in the company’s accounting books as ‘restructured term loan’. The equity shares of the corporate debtor were held in the name of Fitcast alone.
b. Acquiring equity stake pursuant to debt conversion:
In accordance with the conditions stipulated in the RBI guidelines on debt conversion, an ARC can propose as a resolution applicant to swap its debt into equity of the corporate debtor at commercially agreeable terms. This arrangement is feasible where the ARC acquires or holds the debt of the corporate debtor and stands in the position of its creditor. Alok Industries Limited, one of the top twelve loan accounts identified by the RBI for CIRP, was resolved under this route. In a joint bid with Reliance Industries Limited, JM Financial Asset Reconstruction Company Limited (‘JMF ARC’) proposed to pay Rs. 200 crores for purchasing the outstanding financial debt of the corporate debtor. JMF ARC converted a portion of such acquired debt into equity and invoked a pledge on certain other shares in order to hold a total of 47.09% equity share capital in the corporate debtor. Both the resolution applicants jointly acquired control over the corporate debtor.
4. Dissecting Past Precedents
In the case of Aircel Limited, UVARCL’s proposal envisaged a direct equity investment into the distressed company. To fund a part of the total resolution amount, UVARCL proposed to infuse Rs. 11 crores as an upfront equity commitment and acquire 76% shareholding in the corporate debtor. If successful, UVARCL would retain a fraction of the business of the corporate debtor and utilize its 2G and 3G licenses by leveraging the brand recall of Aircel.
There have been successful insolvency resolutions in the past where ARCs as resolution applicants, either individually or as a part of a consortium, have proposed a structure similar to that of UVARCL and infused direct equity into the distressed company. A snapshot of the commercials of such resolution plans, as discussed in the respective NCLT orders, has been set out in reverse-chronological order.
On September 10, 2020, NCLT approved the resolution plan submitted by Invent Assets Securitisation and Reconstruction Private Limited for the acquisition of a Kerala based holiday resort as a going concern for a total amount of Rs. 1 crore. The resolution plan proposed that the resolution amount will be infused by Invent ARC from its own funds and Invent ARC would hold 100% shareholding in the corporate debtor pursuant to a fresh issuance of equity shares to Invent ARC. The control and management of the affairs of the corporate debtor were to vest with Invent ARC.
b. CIRP of Aparant Iron and Steel Private Limited
Bank of India, the sole creditor of a distressed pig manufacturing company, approved the bid of Rare Asset Construction Company Limited to acquire 100% equity of the restructured capital of such company. As a part of the resolution, Rare ARC proposed to take over the entire debt of the sole creditor by way of assignment for a cash consideration of Rs. 60 crores, and further make an equity infusion of Rs. 2.50 crores towards payment of operational creditors, capital expenditure and day to day working of the company. Rare ARC, along with its associates, proposed to subscribe to a fresh allotment of equity shares of an aggregate value of Rs. 25 crores and to control and manage the affairs of the company through its nominees on the board of directors
In a CIRP of a real estate construction company in Meghalaya, Rare ARC’s resolution plan for acquiring and restructuring the dues of the financial creditors was approved. The resolution plan proposed that Rare ARC would make a fresh infusion of Rs. 50.14 crores towards equity and hold 98.3% of the equity shares of the corporate debtor and purchase the balance 1.7% from the existing shareholders at a nominal value. Thus, the entire equity stake of the corporate debtor would vest in Rare ARC.
d. CIRP of Mohak Carpets Private Limited
Alchemist Asset Reconstruction Company Limited submitted a resolution plan in respect to a textile enterprise, which received NCLT’s blessing on October 10, 2019. Alchemist ARC together with its nominees proposed to hold 100% shareholding in the restructured share capital of the corporate debtor and appoint directors and core management and technical team to manage the operations. The proposed payment obligations under the resolution plan were to be discharged by Alchemist ARC by infusing funds into the corporate debtor
e. CIRP of Haldia Coke & Chemicals Limited
The resolution plan for Haldia Coke & Chemicals is one of the first successful plans submitted by an ARC under the IBC regime. Rare Asset Reconstruction Company Private Limited proposed to acquire the secured debt of the corporate debtor for a cash consideration of Rs. 98.50 crores. The resolution amounts were to be funded from the proceeds of security receipts subscribed by Rare ARC (along with its associates) and outside investors in the ratio 15:85. Further, Rare ARC proposed to hold 51% equity shares in the revised shareholding structure of the corporate debtor and carry out the management through its nominees on the board of directors.
5. Suggestions and Conclusion
5.1. Does equity infusion by ARCs need a rethink?
Though the existing laws do not favour a direct equity purchase by an ARC, there is a strong case for introducing enabling provisions in the SARFAESI Act and the underlying guidelines to allow the same. In an ecosystem saddled with non-performing loans, the focus should be to build a more inclusive insolvency resolution regime. ARCs are an essential tool in insolvency resolution. In the past, both the RBI and the government have expressed their intentions to revitalize ARCs to enable them to play a greater role in resolving distress. They not only ensure more vibrant and competitive participation but also bring in the requisite resources, skills and expertise in restructuring accounts across varied sectors. Besides, in cases where no resolution applicant other than an ARC has expressed interest in bidding for the corporate debtor, it rescues the company from a liquidation scenario. The costs of liquidations cannot be overstressed. In Aircel’s case, where UVARCL was the only resolution applicant, liquidation would destruct the value of Aircel’s assets, including cancellation of its telecom license, and impair creditors’ attempt to get a satisfactory realisation of their dues.
With the shift in the thorough process of ARCs from being recovery agents to reviving and turning around stressed assets, ARCs are looking for greater flexibility in structuring their resolution strategies, based on their strengths and weaknesses. It would ultimately result in higher bids and better resolution values and may also attract greater interest from overseas investors bidding for distressed assets, who prefer ARCs as investment vehicles. Moreover, a corporate debtor would require substantial support over the next few years for turning around its assets. Since any money infusion by an ARC can be in form of debts only, it will put an additional burden on the already stressed company.
RBI as a regulator is accountable to keep ARCs in check. Unlike other countries where ARCs are government-backed, India allows private players to own and operate ARCs. There have been concerns that if ARCs are permitted to make equity investments, they may end up owning the stressed assets in perpetuity, which is not the intent and purpose of an ARC. However, these concerns should be addressed by establishing appropriate safeguards as opposed to an absolute restriction.
5.2. Final thoughts
The nuances of the rejection of UVARCL’s resolution plan remain unclear. As discussed above, there have been successful resolutions from ARCs contemplating equity investment which have not been hit by regulatory hurdles. Seemingly, these cases have been overlooked by the RBI as they dealt with smaller distressed loan accounts. However, it has been suggested that the RBI is playing a gatekeeper in this instance for reasons other than equity infusion, such as the sale of the telecom spectrum to a third party, ARC investing into a non-financial entity etc. Regardless, RBI’s inconsistent approach in regulating ARC’s participation in CIRP is discomforting.
Equally troublesome is its failure to clarify its standpoint which has led the market participants to misconstrue the rejection as a complete bar on ARCs from being resolution applicants. Until the RBI offers a clear and consistent view on the issue, ARCs will continue to remain at its mercy. Not only will the current climate have a deterrent effect on the ARCs to bid in the insolvency process, but may also stall the ongoing CIRPs where ARCs have expressed interest, such as JMF ARC’s bid for Reliance Naval and Engineering, Suraksha ARC’s bid for HDIL and Prudent ARC’s bid for Punj Lloyd. There is an urgent need for the RBI to issue clarifications to conclusively settle the debate and provide much-needed comfort to the ARCs.
* Shruti Khetan is a graduate of W.B. National University of Juridical Sciences and is currently working at L&L Partners Law Offices. The views expressed in this article are personal and do not reflect the views of the firm. The author is grateful to Varsha Koshy and Priyanka Sunjay for their inputs.
 Insolvency and Bankruptcy Code 2016, s 5(26).
 This essentially means that in case the resolution applicant is a financial entity, the disqualification under section 29A shall be restricted only to such financial entity and those in immediate control of the financial entity.
 Other than the measures discussed above, RBI relaxed the norms allowing non-institutional investors to invest in security receipts issued by ARCs and allowing ARCs to raise capital from foreign investors. In June 2019, RBI permitted ARCs to acquire financial assets from other ARCs, which was so far allowed for limited purposes.
 SARFAESI Act 2002, s 15(4).
 Dharani Sugars and Chemicals Ltd. v Union of India & Ors Nazir, 2019 SCC OnLine SC 460 (While adjudicating on the RBI’s power to initiate insolvency proceedings under the Banking Regulation Act, the Supreme court upheld this principle, citing Taylor v. Taylor 1 Ch. D. 426 and State of UP v Singhara Singh, AIR 1964 SC 358).
 Anand Prakash and Anr. v Assistant Registrar, AIR 1968 All 22.
 Some exceptions recognised under section 10(1) include: (a) acting as a recovery agent for a bank or financial institution (b) managing assets taken over by secured creditor under section 13; and (e) acting as a court appointed receiver.
 SARFAESI Act 2002, s 2(b).
 These conditions include — (i) minimum net owned fund of Rs 100 crore, and (ii) half of the board comprising independent directors; (iii) a board approved policy on debt conversion and (iv) securities shall be periodically valued and marked to market.
 For contrary views, see Sikha Bansal, ‘ARCs and Insolvency Resolution Plans: The Enigma of Equity v. Debt’ (IndiaCorpLaw, 19 September 2020) <https://indiacorplaw.in/2020/09/arcs-and-insolvency-resolution-plans-the-enigma-of-equity-vs-debt.html> accessed 17 March 2021.
 In another instance, other than those discussed above, an ARC was successful in acquiring a distressed mining and metal company in Meghalaya under the IBC regime. Although the approval order records that the resolution applicants were eligible under section 29A of the IBC and the resolution plan met the statutory requirements of the IBC, the nature of interest acquired by the ARC in the corporate debtor and the source of funds infused therein have not been disclosed. Bank of India v. RNB Cements Private Limited, NCLT (Guwahati Bench) I.A. No. 29/2020 in CP (IB) No. 18/GB/2019.
 There is a view in the market that to prevent an ARC from holding assets in perpetuity, India may explore sunset provisions, which is a practice in other jurisdictions such as Malaysia, Indonesia and Thailand.