Section 35AA's hidden trap: the case-specific authorization the RBI missed.

When the RBI’s 180-Day Deadline Collapsed

Dharani Sugars and Chemicals Ltd. was a company under stress. Its lenders had classified its loan as a non-performing asset. Then, on 12 February 2018, the Reserve Bank of India issued a circular that changed everything. For any default above INR 2000 crore, banks had exactly 180 days to resolve the stress. Fail, and they had to file an insolvency application within 15 more days. No exceptions. No sector-specific relief. Dharani Sugars, along with power sector companies, telecom firms, and sugar mills, faced a one-size-fits-all guillotine. The stakes were existential: their businesses, their assets, and the jobs of thousands hung on whether the Supreme Court would uphold or strike down the RBI’s most aggressive tool for cleaning up bank balance sheets.

The Circular That Was Meant to End All Circulars

Before February 2018, the RBI had issued multiple schemes for stressed asset resolution — the Corporate Debt Restructuring (CDR) scheme, the Strategic Debt Restructuring (SDR) scheme, the Scheme for Sustainable Structuring of Stressed Assets (S4A). Each had its own timeline, its own loopholes. Banks used them to kick the can down the road. The 12 February 2018 circular replaced every single one of them with a single, rigid framework: 180 days to resolve, then mandatory IBC filing.

The circular was issued under the RBI’s general powers — Section 35A of the Banking Regulation Act, 1949, and Section 45L of the RBI Act, 1934. It was a general direction to all banks. It did not name any specific borrower. It did not require any specific authorization from the Central Government. It simply said: if a default exists, and the loan is INR 2000 crore or above, you must follow this timeline. No discretion. No sectoral carve-out.

The petitioners — Dharani Sugars, the Association of Power Producers, telecom companies, and others — approached the Allahabad High Court. On 31 May 2018, the High Court made interim observations and directed the Ministry of Finance to hold a meeting with stakeholders. The circular was effectively stayed for non-wilful defaulters. But the matter was quickly transferred to the Supreme Court. On 11 September 2018, the Supreme Court ordered status quo, effectively freezing the circular from that date. The final hearing took place on 2 April 2019, before a two-judge bench authored by Justice R.F. Nariman.

What Each Side Argued

The petitioners’ case was built on two pillars. First, the circular was ultra vires the Banking Regulation Act. They argued that Section 35A, which gives the RBI power to issue directions to banks, was a pre-IBC provision. It could not be used to force banks to file insolvency applications under the Insolvency and Bankruptcy Code, 2016. They relied on Indian Banks’ Association v. Devkala Consultancy Service (2004) 11 SCC 1, which held that the RBI’s functions under Section 35A are confined to the boundaries of the RBI Act and the Banking Regulation Act. The IBC was a separate code with its own triggers — Section 7, which allows a financial creditor to file an application. The RBI could not, through a circular, compel a bank to exercise that right.

Second, they argued that the circular was manifestly arbitrary under Article 14 of the Constitution. The power sector, for instance, was stressed not because of mismanagement but because of government policy failures — coal block cancellations (as seen in Manohar Lal Sharma v. Principal Secretary (2014) 9 SCC 516), tariff determination issues under the Electricity Act, 2003, and delayed payments from state distribution companies. A 180-day deadline, they said, took no account of these external factors. It was a sledgehammer where a scalpel was needed.

The Union of India and the RBI defended the circular. They argued that the RBI had the power to issue such directions under Section 35A read with Section 35AB of the Banking Regulation Act. Section 35AB, introduced by the 2017 Amendment, specifically empowers the RBI to issue directions for resolution of stressed assets. The circular was a valid exercise of that power. They also relied on Swiss Ribbons Pvt. Ltd. v. Union of India (2019) 2 SCALE 5, where the Supreme Court had upheld the IBC as constitutionally valid and held that economic legislation must be viewed with great latitude. The circular, they said, was a necessary tool to clean up the banking system and ensure timely resolution of bad loans.

The Doctrine That Mattered: Section 35AA’s Hidden Trap

The Supreme Court’s analysis turned on a provision that had received relatively little attention: Section 35AA of the Banking Regulation Act. This provision, also introduced by the 2017 Amendment, reads:

“The Central Government may, by order, authorise the Reserve Bank to issue directions to any banking company or banking companies to initiate insolvency resolution process in respect of a default, under the provisions of the IBC, 2016.”

Justice Nariman read this provision with surgical precision. Section 35AA, he held, requires the Central Government to specifically authorize the RBI to issue directions in respect of specific defaults. It is not a general power. It is a case-specific power. The Central Government must identify the default, authorize the RBI, and only then can the RBI direct a bank to file an insolvency application.

The 12 February 2018 circular did nothing of the sort. It was a general direction to all banks, covering all defaults above INR 2000 crore, without any specific authorization from the Central Government. It was, in effect, a blanket order. And that, the Court held, was ultra vires Section 35AA.

The Court also examined Section 35AB, which empowers the RBI to issue directions for resolution of stressed assets. But Section 35AB, the Court noted, is “without prejudice to Section 35A.” It does not override the specific requirement of Section 35AA. The RBI could issue general directions under Section 35AB for resolution of stressed assets — but it could not use that power to mandate IBC filings. That power was reserved for Section 35AA, and Section 35AA required case-specific authorization.

As for Section 35A, the Court held that it could not be the source of power for directing banks to file applications under the IBC. Section 35A was a pre-IBC provision. The IBC was a separate code with its own mechanisms. The RBI could not, through a general direction under Section 35A, compel a bank to exercise its right under Section 7 of the IBC.

Why the Circular Was Struck Down

The operative order was clear: the RBI Circular dated 12.02.2018 was declared ultra vires as being issued without authority of law. All IBC proceedings initiated under the circular were quashed. Sections 35AA and 35AB were upheld as constitutionally valid — the Court found them neither manifestly arbitrary nor suffering from excessive delegation. They were regulatory provisions in public interest, with adequate guidance from the Act’s Preamble and provisions.

The Court applied the manifest arbitrariness test from Shayara Bano v. Union of India (2017) 9 SCC 1, which held that Article 14 can be infracted on the ground of manifest arbitrariness, and that this test applies to both plenary and subordinate legislation. But the Court found that Sections 35AA and 35AB passed this test. They were not arbitrary. The problem was not the law — it was the circular that exceeded the law.

THE PLAY: If you are a borrower facing IBC proceedings initiated solely under the 12 February 2018 circular, those proceedings are now quashed. The circular was ultra vires Section 35AA because it lacked specific Central Government authorization for specific defaults.

What This Means in Practice

For advocates, this judgment is a masterclass in statutory interpretation. The Court did not strike down the circular because it was harsh or because the power sector had special problems. It struck it down because the RBI had used the wrong tool. Section 35AA required case-specific authorization. The circular was a general direction. That distinction matters.

For CFOs and founders, the message is more nuanced. The circular is gone, but the underlying law — Sections 35AA and 35AB — remains. The Central Government can still authorize the RBI to issue directions for specific defaults. The RBI can still issue general directions for resolution of stressed assets under Section 35AB. What it cannot do is use a general circular to force mandatory IBC filings without case-specific authorization.

The Court also made an important obiter observation: the Solicitor General submitted that ideally there ought to be sector-wise contingency analysis by RBI before exercising power under Section 35AA. This could guide future RBI exercises of power. If the RBI wants to revive a similar framework, it will need to go back to the Central Government, get specific authorizations for specific defaults, and perhaps adopt a sector-specific approach.

The judgment also highlights an unused executive power: the Central Government could have acted under Section 7 of the RBI Act to give directions to the RBI in public interest. It chose not to. That door remains open.

The Bottom Line

The RBI’s 180-day deadline for INR 2000 crore defaults was struck down not because it was too harsh, but because the RBI issued it as a general direction without the specific Central Government authorization that Section 35AA of the Banking Regulation Act requires — and any future attempt to revive a similar framework must now go through that case-specific authorization process.