Saturday, February 28, 2015

Constitutionality of the Amended Definition of “Non-Performing Asset” Upheld

[The following post is contributed by Prachi Narayan of Vinod Kothari & Company. She can be contacted at]

The Supreme Court in its judgment dated January 28, 2015 in Keshavlal Khemchand & Sons Pvt Ltd & Ors v. Union of India disposed off seventy petitions challenging the validity of the amended definition of Non Performing Asset (“NPA”) provided under section 2(1)(o) of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002  (the “Act”). 

The Case

The core issue on appeal to the Supreme Court was whether the definition of NPA as amended by Act 30 of 2004 is constitutionally valid and is not violative of Article 14 of the Constitution.

The constitutionality of the amended definition was the subject matter of challenge before the High Court of Gujarat (“Gujarat HC”) as well as before the Madras High Court (“Madras HC”). It further involved the question whether the power of prescribing guidelines endowed upon the Reserve bank of India (“RBI”) from time to time, with respect to classification of NPA would tantamount to excessive delegation.

Parliament by amending the definition of NPA made it possible for different sets of guidelines made by different regulators to be followed by creditors depending upon the administering or regulating authority of such creditor. The question thus for consideration before the court was whether such delegation of legislation amounts to excessive deletion by the legislature.


The Supreme Court while taking into consideration the ratios of both the High Courts held that laying down of norms regarding classification of an account as NPA is not essentially a legislative function as it requires expertise in public finance and banking and may require periodic revision and a constant monitoring of financial system.

With regard to the question involving excessive delegation with respect to definition of NPA the court held that “if the Parliament chose to define a particular expression by providing that the expression shall have the same meaning as is assigned to such an expression by a body which is an expert in the field covered by the statute and more familiar with the subject matter of the legislation, the same does not amount to any delegation of the legislative powers. Therefore, the submission that the amendment of the definition of the expression ‘nonperforming asset’ under Section 2(1) (o) is bad on account of excessive delegation of essential legislative function, in our view, is untenable and is required to be rejected.”

Author’s Analysis

The judgment aims to redress certain basic and important questions: (a) whether the amended definition of NPA is violative of Article 14 of Constitution; (b) whether the power to define or prescribe norms with regard to NPA from time to time amounts to excessive delegation by legislature; and (c) if the answers to the above are in affirmative, is it possible to have a universal definition of NPA applicable to all cases?

Article 14 of the Constitution ensures equality before law. It states that:

“The State shall not deny to any person equality before the law or the equal protection of the laws within the territory of India”

The article deals with two aspects: (a) equality before law; and (b) equal protection of laws. What Article 14 aims to achieve is that every person, in similar circumstances shall be treated alike. The article empowers the State to recognize a certain class and accordingly have separate set of legislation for them. Of course, this may come across as inequality to other classes; however, law recognizes that based on the needs and demands of society a classification based on “intelligible differentia”, which is not arbitrary or evasive may be permitted. Further, the definition on NPA underwent an amendment subsequent to the decision of Apex Court in Mardia Chemicals wherein the constitutionality of the Act was upheld. Accordingly, the basis of challenge in the instant case was that according to certain parties the amended definition tried to create two classes of NPA, which according to such parties was arbitrary and evasive in light of equal protection of laws.

Moving to the question of excessive delegation, Black’s Law Dictionary defines ‘delegation’ as ‘the act of entrusting another with authority or empowering another to act as an agent or representative’. The Dictionary further defines ‘Doctrine of Delegation’ as “the principle (based on the Separation of Powers Concept) limiting Legislature’s ability to transfer its legislative power to another Governmental Branch, especially the Executive Branch.

In case of Ajoy Kumar Banerjee & Ors vs Union Of India & Ors, the Apex Court held that:

The principle which has been well-established is that legislature must lay down the guidelines, the principles of policy for the authority to whom power to make subordinate legislation is entrusted. The legitimacy of delegated legislation depends upon its being used as ancillary which the legislature considers to be necessary for the purpose of exercising its legislature power effectively and completely. The legislature must retain in its own hand the essential legislative function which consists in declaring the legislative policy and lay down the standard which is to be enacted into a rule of law, and what can be delegated is the task of subordinate legislation which by very nature is ancillary to the statute which delegates the power to make it effective provided the legislative policy is enunciated with sufficient clearness a standard laid down.

Therefore, in light of the above, it can be safely assumed that delegation of legislative powers is permissible only when legislature has adequately laid down the framework of law. The delegate only has the power to make such a policy laid down by legislature effective and enforceable. The legislature lays down the broad tenets of law and confers the power of rule making on the Government or upon such bodies and agencies of its choice. Applying similar rationale here, the legislature passed the broad framework of the Act covering general principles relating securitization, assets reconstruction and enforcement of security interests and conferred the power to define and prescribe guidelines for classification of NPA on RBI.

Delegation becomes excessive, when the essential legislative functions are delegated to executives. The term “essential legislative function” would mean determination or choosing of the legislative policy and thereby enacting that policy into a binding rule of conduct. It is open to the legislature to formulate the policy as broadly as and with as little or as much details as it thinks proper. The legislature may then choose to delegate the rest of the legislative work to a subordinate authority who will work out the details and fill in the gaps within the framework of that policy.

The very intent to empower RBI to prescribe guidelines on classification of NPA was that the concept of NPA itself is dynamic - it changes with the changes in the financial regime and thus requires continuous monitoring and updating. Providing a static definition from the very time when the enactment came into force would have created a lot of confusion and disparity with regard to the classification norms being changed every time. And more so, legislative amendments as evident is a time consuming process as compared to the functions performed by the executive or specialised bodies.

The Act further empowers the secured creditor to be the sole authority to adjudge the amount due and outstanding from a borrower. However, such a grant of power to the secured creditor to evaluate the outstanding amount is not unfettered and comes with proper checks and balances in the Act by way of obligations cast under section 13 and the right to appeal under section 17 of the Act. It is apt to mention herein that ascertainment of outstanding amount by the creditor does not grant the creditor the right to initiate proceedings against the borrower but the creditor has to also undertake the obligation to classify such an account of the borrower as NPA in line with the directions of RBI. The intent behind casting an additional obligation on the creditor to classify accounts as NPA is the very fact that this classification subsumes utmost importance in the process of recovery and is further important for the decision making process of the creditor. This is further important to protect larger interests of society or those associated with the secured property. Had such fetter not been there and a direct possession was envisaged, this would have been detrimental to interests of other people associated with secured property. Further, this is also important from the secured creditors point of view wherein these balances force the creditor to reassess whether the default in repayment by the borrower is due to any factor, which is a temporary phenomenon, and that the same could be managed by the borrower if some room is given.

This is also corroborated by the fact that even before the enforcement of the Act, creditors were classifying accounts as NPA in line with directions of RBI. Further, the classification of NPA is not direct or one- the guidelines provide for a 4-stage classification depending upon the length of time for which they remain non-performing and the type of institution classifying the same, before an action under 13(4) is resorted.

Thus, the very nature and character of classification of NPA differs from one secured creditor to the other. For example, asset reconstruction companies have different guidelines to follow for classifying account as NPA while banks and financial institutions have different. Therefore, to make an attempt to codify a universal definition for NPA applicable to all cases would not only be an impracticable task but could also paralyze the entire recovery system thereby producing results which are counter productive to the object and the purpose sought to be achieved by the Act.


The Act was brought into the Indian legal regime keeping in mind the financial health of the country and to speed up the sluggish recovery process, which to larger extent also suffered the brunt of inefficient legal machinery. Before an action is initiated by the secured creditor, a secured creditor is under an obligation to evaluate and assess a borrower as defaulting borrower on several factors as the magnitude of the amount due and outstanding in a given case, the reasons which prompted the borrower to default in the repayment schedule, the nature of the business carried on by the defaulting borrower, the overall prospects of the defaulter’s business, national and international market conditions relevant to the business of a defaulter. So the spirit of law herein is that before an action is finally taken, a good measure of logical and rational consideration and reconsideration are to be undertaken by the secured creditor.

However, what seems prevalent in practice is something very opposite to what the intent of law is in paper.The initial steps of issue of demand notices and the replies to the representations of the borrowers in many cases just do not seem to come across as a reasoned decision of bank. It is many a times comes as a hasty piece of hasty pertaining only to recovery.  The spirit of law has to be shown in action too to uphold the real intent of this piece of legislation.

- Prachi Narayan 

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