Distressed Asset Transfer Rules in India - Detailed Framework

The governing law today is the Master Direction - Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 issued on 24th September 2021 and updated on Dec 5, 2022 and Dec 28, 2023. It replaced all earlier RBI circulars on sale of NPAs, assignment, securitization and bought out entire stressed assets regime under one roof, aligned with IBC 2016 and Prudential Framework for Resolution of Stressed Assets, 2019.

The MD-TLE has two parts:
Part B - Standard Assets and Part C - Stressed Assets (Chapter III)

1. Core Definitions

Clause 9(k) defines "Stressed Loans" as loan exposures that are classified as Non-Performing Assets (NPA) or as Special Mention Accounts (SMA). This definition is litigated repeatedly - see Atibir Industries case below.

Stressed loan which is in default is eligible for transfer to ARCs. Clause 73 provides that subject to circulars mentioned therein, all stressed loans which are in default in the books of transferees are permitted to be transferred to ARCs.

2. Who Can Transfer? Who Can Acquire?

Clause 3 - Eligible Transferors:

• Scheduled Commercial Banks
• Small Finance Banks
• NBFCs including HFCs
• Primary (Urban) Cooperative Banks, State Cooperative Banks, Central Cooperative Banks have been recognised as eligible transferors of stressed loans

Clause 9 & 54 - Permitted Transferees:
Stressed loans can ONLY be transferred to:

1. Permitted Transferees as per Clause 9 - other Banks, NBFCs, AIFs, Finance companies registered etc.
2. Asset Reconstruction Companies (ARCs) under SARFAESI Act, 2002

Crucially, Clause 54 restricts the transfer of stressed loans to permitted transferees and ARCs. Transfer to any private individual, NBFC not permitted, or unregistered entity like Savannah in Bombay HC case is void.

RBI Principle: "a loan transfer should result in immediate separation of the transferor from the risks and rewards associated with loans to the extent that the economic interest has been transferred"

3. Key Rules for Distressed Asset Transfer

A. True Sale & No Recourse:
Transfer must be true sale. Transferor cannot have any buy-back arrangement except as per warranties. It must notify RBI Department of Supervision of all instances where it has replaced loans transferred or paid damages arising out of representation or warranty.

B. Minimum Holding Period (MHP) does NOT apply to stressed loans - only to standard assets. Stressed loans can be transferred anytime after classification.

C. Minimum Retention Requirement (MRR): Transferor must retain at least 10% economic interest in case of stressed loans transferred to non-ARC transferees.

D. Pricing & Swiss Challenge Method:
For loans > Rs 100 cr, transferor must conduct Swiss Challenge auction if aggregate exposure is under consortium/Multiple Banking Arrangement. Two-stage process:

1. Anchor bid discovered
2. Other ARCs/Banks invited to better anchor by at least 5%
   Transparency required. Board-approved valuation policy mandatory.

E. No Transfer to Borrower-linked Entities:
Loan cannot be transferred to:

• Borrower, promoter, or their related parties
• Disqualified under Section 29A of IBC
• Entities who financed acquisition of same asset (to prevent evergreening)

F. Board-Approved Policy & Due Diligence:
Lenders must have board-approved policy on identification of loans for transfer, valuation methodology, and must conduct independent due diligence by transferee.

G. Restructuring after transfer:
Any rescheduling, restructuring or re-negotiation attempted by permitted transferee(s) after the transfer shall be as per RBI Prudential Framework for Resolution of Stressed Assets Directions, 2019.

4. Modes of Transfer

1. Assignment Route: Direct assignment of loan with transfer of underlying security. Requires consent of all lenders in consortium if >75% by value.
2. Novation / Loan Participation: Not permitted for stressed assets - only assignment.
3. To ARCs against Security Receipts (SRs): Banks can sell against SRs. PUCBs/StCBs/CCBs question settled - Yes, they can sell to ARCs against SRs as per MD-TLE.

5. Landmark Case Laws

1. Atibir Industries Co. Ltd. vs State Bank of India & Anr. - Calcutta High Court, 5 Oct 2023 [WPO 1322/2023]

Facts: Borrower challenged assignment of its loan by SBI to ARC arguing account was not NPA/SMA.
Held: Court examined Clause 9(k). Since account was admittedly classified as NPA as of transfer date, it qualified as stressed loan. Transfer to ARC valid. Court also held loans identified for transfer shall be listed for purpose of transfer and due process followed. Petition dismissed. Affirmed by Division Bench in July 2024 - SBI vs Atibir Industries Co. Ltd. [25 July 2024] referring to 9(k) of Master Direction.

Ratio: NPA status on date of transfer is sufficient; SMA not mandatory.

2. Bombay High Court - RBI Directives Prevail over Private Compromise - Savannah Case (2024)

Justice Marne meticulously examined RBI's 2021 Directives, noting Clause 3 which specifies entities to whom these directives apply, including cooperative banks, and Clause 9 defining 'permitted transferees'.
Transfer of stressed loan by cooperative bank to one M/s Savannah, a private debt fund not recognized as ARC or permitted transferee, was held unlawful. Court recalled compromise decree based on such transfer.

Ratio: Clause 54 is mandatory. Transfer outside permitted transferee/ARC list is void ab initio, even if borrower consents.

3. Supreme Court on ARC-Bank-Borrower Nexus - 2024-25 (Rs. 1537 Crore case)

Supreme Court flagged deep-rooted nexus. Bench observed: "This is a deep-rooted nexus between the borrowers, ARCs and banks".
Plea alleged Rs 1,537 crore PSB debt settled through two ARCs for mere Rs 73.50 crore. Court issued notice to Centre, RBI and observed need to investigate operational conduct of ARCs and mechanisms used to settle large liabilities for significantly lower values.

Ratio: Commercial wisdom of banks not absolute; RBI directed to tighten Swiss Challenge transparency, valuation disclosure and related-party checks. This led to 2023 amendment tightening SR valuation.

4. Dharani Sugars & Chemicals Ltd. vs Union of India - Supreme Court (2019) 5 SCC 480

Though pre-dates 2021 directions, foundation stone. Supreme Court struck down RBI circular dated 12 Feb 2018 which mandated 6-month timeline to resolve stressed assets above Rs 2000 cr or refer to IBC. Court held RBI cannot issue directions under Section 35AA without specific authorization for each default.

Result: RBI issued new Prudential Framework 2019, which is now parent framework for MD-TLE 2021.

5. NCLAT - Validity of Cooperative Banks Assignment to ARCs under SARFAESI

NCLAT affirmed that cooperative banks could assign their debts to ARCs. Relied on RBI circular 15 March 2019 advising cooperative banks to utilize SARFAESI for recovery, supporting entitlement to assign. Tribunal dismissed reliance on later 2021 circular as irrelevant to existing framework.

Ratio: Cooperative Banks are SARFAESI secured creditors and eligible transferors.

6. SBI vs Atibir Industries - Locus of Borrower to Challenge Transfer

High Courts have consistently held borrower has no right to object to assignment unless transfer violates 29A or permitted transferee rule. Loan is property of lender; assignment is lender's prerogative under Section 130 Transfer of Property Act read with SARFAESI.

6. Practical Checklist for Valid Transfer Today

1. Is account NPA/SMA? Document classification date.
2. Is transferee ARC with valid CoR or permitted transferee under Clause 9?
3. Is transferee unrelated to borrower under 29A?
4. Have you done two independent valuations? For >100cr, Swiss Challenge?
5. Has JLF consent >75% obtained? Board-approved policy referenced?
6. Have you retained MRR and disclosed to RBI DS?
7. Immediate reporting in CRILC and removal from books.

Violation attracts supervisory enforcement under Section 47A Banking Regulation Act, 1949 and transaction can be unwound as in Savannah case.