India – Asset Classification – Be-hold.

With the outbreak of the COVID-19 pandemic and the consequential countrywide lockdown, economic activities of almost all corporates, except those falling under essential services, have witnessed an unprecedented slowdown. As a result, cashflows and debt servicing capabilities of most borrowers have been seriously impacted, necessitating the Reserve Bank of India (“RBI”) to intervene and introduce a regulatory framework, enabling lenders to provide much needed relief to their borrowers.

 

This blog analyses the relaxation of the asset classification norms to be followed by a bank, with respect to a term loan[1] on account of the measures introduced by the RBI on March 27 and April 17, 2020 and related judicial pronouncements.

 

Usual Regime for Asset Classification 

 

Simply put, asset classification is a system for identifying and recording good or performing assets and bad or non-performing assets of a lender based on several identified characteristics. Banks are required to classify loan accounts in accordance with the Prudential Norms on Income Recognition, Asset Classification and Provisioning, pertaining to Advances dated July 1, 2015 (“IRAC Norms”) issued by the RBI. A ‘non-performing asset’ as per the IRAC Norms is a loan or an advance where interest and/ or instalment of principal remains overdue for a period of more than 90 days with respect to a term loan. The non-performing asset (“NPA”) is further classified into: (a) sub-standard, (b) doubtful and (c) loss asset, depending on the time period for which such an account has remained non-performing.

 

In addition to the aforesaid, Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions, 2019, dated June 7, 2019 (“June 7 RBI Directions”), direct banks to recognise incipient stress in loan accounts, immediately on default, by classifying such accounts as special mention accounts (SMA), basis the number of days for which the default has continued. If the default continues for a period of: (a) 1–30 days, account is required to be identified as SMA-0; (b)  31–60 days, account is identified as SMA-1; and (c)  61-90 days, account is identified as SMA-2; beyond which, the account is classified as an NPA.

 

Asset classification relaxations announced by RBI on March 27, 2020

 

In an attempt to give a breather to borrowers affected by the COVID-19 pandemic, the RBI introduced certain reliefs for borrowers by way of the COVID-19 Regulatory Package, which was announced on March 27, 2020 (“RBI COVID Package”). Under this package, all commercial banks, co-operative banks, all-India financial institutions and non-banking finance companies (together, the “Lending Institutions”) were permitted to grant a 3 (three) month moratorium on payment/ repayment obligations falling due between March 1, 2020 and May 31, 2020 (the “Specified Period”).

 

With regard to asset classification, the RBI COVID Package clarified that if a borrower was provided a moratorium with respect to repayment of term loan instalments falling due during the Specified Period, asset classification of such term loan will be determined on the basis of revised due dates and revised repayment schedule. This, in effect, meant a temporary suspension of the usual asset classification norms for payment/ repayment obligations falling due during the Specified Period.

 

The ‘grey-zone’ and the subsequent Judicial Pronouncements

 

The RBI COVID Package did not provide any clarity on whether the asset classification relaxations will be extended to a loan account where a default had occurred prior to the Specified Period, thereby resulting in a ‘special mention account’ (SMA) classification.

 

This resulted in several borrowers approaching the courts to consider the aspect of asset classification in case of defaults on payments that fell due prior to March 1, 2020.

 

Among the first such cases to be decided, in Anant Raj Limited vs. Yes Bank Limited[2], while the default in repayment of instalments had occurred prior to the Specified Period, the 90-day period for NPA classification was falling within the Specified Period. The borrower argued that applying the moratorium as per the RBI COVID Package, the lender should automatically withhold from declaring the account as an NPA. Expectedly, the lender argued that default having taken place prior to the Specified Period, the asset classification should be done based on the June 7 RBI Directions and IRAC Norms. However, the Hon’ble Delhi High Court, after looking into the intent and objective of the RBI in issuing the relief package, held that the moratorium on asset downgrade should also apply to accounts that were overdue prior to March 1, 2020, and ordered that a status quo be maintained for the borrower’s account.

 

The very next day, the Hon’ble Bombay High Court issued an order in a similar case in the matter of Ideal Toll & Infrastructure Pvt. Ltd., Mumbai and Anr. vs. ICICI Home Finance Co. Ltd., Mumbai & Anr[3], wherein the lender had invoked the pledge of shares created for its benefit on account of a default by the borrower in repayment of instalments falling due prior to the Specified Period.

 

The Hon’ble Court held that the moratorium, as prescribed under the RBI COVID Package, was no doubt to be made applicable to instalments falling due post March 1, 2020. The Court, however, directed payments be made by the borrower in terms of the revised repayment schedule instructed by the Court, keeping in mind the interest of both parties.

 

The different findings by the Delhi and Bombay High Courts on the interpretation and application of the RBI COVID Package to asset classification for loan accounts in default prior to March 1, 2020, led to lack of clarity for a short while. Fortunately, greater clarity and consistency emerged in the matter of Transcon Skycity Pvt. Ltd. & Ors. vs. ICICI Bank Limited[4], the facts of which are similar to that of Anant Raj Limited (supra). The Hon’ble Bombay High Court in this matter agreed with the position taken by the Delhi High Court and issued an order to maintain status quo as on March 1, 2020, with respect to asset classification for the loan account where the default had  occurred prior to the Specified Period. Further, the Hon’ble High Court directed that the period of the moratorium (March 1 to May 31, 2020) will be excluded from calculation of 90 (ninety) day for NPA classification, subject to the lockdown being in force for the entire duration of the moratorium. The Court further clarified that should the lockdown be lifted anytime during the moratorium period, the clock on the 90 (ninety) day period would once again start to tick and the protection made available to Transcon would cease to operate.

 

The Transcon judgment was also followed by the Hon’ble Delhi High Court in Shakuntla Educational & Welfare Society vs. Punjab & Sind Bank[5].

 

Clarification issued by the RBI and the subsequent Judicial Pronouncements 

 

The initial differing judicial interpretations were put to rest when the RBI issued a circular on April 17, 2020 (“Asset Classification Circular”). The Asset Classification Circular provides that for term loan facilities, in respect of all accounts classified as standard as on February 29, 2020, even if overdue, the moratorium period, wherever granted, shall be excluded by the Lending Institutions from the number of days past-due for the purpose of asset classification under the IRAC Norms. This means, for accounts, which were classified as standard (even if they were classified as SMA-2) as on February 29, 2020, there would be an asset classification standstill and such accounts are not required to be classified as NPA until the end of the Specified Period.

 

On the very same day that the RBI released the Asset Classification Circular, in the matter of JR Toll Road Private Ltd. vs. Yes Bank Limited, the Delhi High Court, dealing with a similar question of asset classification of a borrower defaulting on its obligations prior to the Specified Period, came to the conclusion that the issue at hand was covered by the coordinate Bench of the Hon’ble Delhi High Court in the matter of Anant Raj Limited (supra) and therefore, passed an Order[6] restoring status quo as regards classification of JR Toll’s account, by directing Yes Bank Limited to revert to the classification of account as SMA-2.

 

Conclusion 

 

While the position on the applicability of asset classification relaxations as provided in the RBI COVID Package to a loan account already overdue as on February 29, 2020, was unclear for a few days, the issue has been put to rest upon issue of the Asset Classification Circular by the RBI.

 

Interestingly, while both the Delhi and Bombay High Courts have been empathetic and issued protective orders in favour of the borrowers, they have not hesitated in limiting the relief to borrowers by requiring them to clear overdue payments within a specified period after lifting of lockdown restrictions. Clearly, considerations of equity have played a big part in the judiciary’s approach to deal with the unprecedented impact of COVID-19 on most segments of the economy.