Saving a Bank: Amalgamation and Reconstruction

Section 44A(3) gives the dissenting shareholder his exit. A shareholder who has voted against the scheme, or has given notice in writing to the company at or before the meeting that he dissents, is entitled to claim from the banking company the value of his shares determined as the section provides.

Section 44A(4) is the control. The scheme of amalgamation, after approval by the shareholders, shall be submitted to the Reserve Bank for sanction, and shall, if sanctioned by the Reserve Bank by an order in writing, be binding on the banking companies concerned and also on all their shareholders.

Section 44A(6) provides that on the sanctioned scheme coming into effect, the property of the amalgamated company vests in, and its liabilities become the liabilities of, the transferee bank.

Sections 42 and 43 sit just before, and they close the other exits. Section 43 restricts voluntary winding up: a banking company may be voluntarily wound up only if the Reserve Bank certifies in writing that it is able to pay in full all its debts to its creditors as they accrue. Section 42 gives the High Court its powers in a voluntary winding up, and section 44 deals with a court-sanctioned amalgamation, requiring the Reserve Bank's certificate before a compromise or arrangement is sanctioned. Section 44B provides that no High Court shall sanction a compromise or arrangement between a banking company and its creditors unless the Reserve Bank certifies in writing that it is not detrimental to the interests of the depositors.

Put those together and the picture is complete: a bank cannot leave the system, merge, or compromise with its creditors without the Reserve Bank's certificate or sanction. Every door out is guarded.

The compulsory route: section 45

Section 45(1). Notwithstanding anything in the foregoing provisions of the Part or in any other law or any agreement or other instrument, where it appears to the Reserve Bank that there is good reason so to do, the Reserve Bank may apply to the Central Government for an order of moratorium in respect of a banking company.

Section 45(2). The Central Government, after considering the application, may make an order of moratorium staying the commencement or continuance of all actions and proceedings against the company for a fixed period, on such terms and conditions as it thinks fit, and may extend the period, so however that the total period of moratorium shall not exceed six months.

Section 45(3): what the bank may not do while frozen. Except as otherwise provided by directions given by the Central Government, the banking company shall not during the period of moratorium make any payment to any depositors or discharge any liabilities or obligations to any other creditors, or grant any loans or advances or make investments in any credit instruments.

The words "or grant any loans or advances or make investments in any credit instruments" were inserted by the Banking Regulation (Amendment) Act, 2020, with effect from 26 June 2020, as this print's own footnote 13 records. The gap they closed is obvious once stated: before 2020 a frozen bank was forbidden to pay out to creditors but not clearly forbidden to lend, so it could still put money at risk while its depositors were locked out.

Section 45(4): the scheme. During the period of moratorium or at any other time, if the Reserve Bank is satisfied that it is necessary (a) in the public interest, (b) in the interests of the depositors, (c) in order to secure the proper management of the banking company, or (d) in the interests of the banking system of the country as a whole, the Reserve Bank may prepare a scheme (i) for the reconstruction of the banking company, or (ii) for its amalgamation with any other banking institution, called the transferee bank.

The words "or at any other time" were also inserted in 2020, by the same Act and with the same commencement, and they are a larger change than they look. Before the amendment the scheme power was tied to the moratorium; after it, the Reserve Bank may prepare a scheme without first freezing the bank, which allows a rescue to be arranged while the bank is still trading and its depositors are still being paid.

Section 45(5) lists what the scheme may provide for, and the list is very wide: the constitution, name, registered office, capital, assets, powers, rights, liabilities and duties of the reconstructed bank or the transferee bank; the transfer to the transferee bank of the business, properties, assets and liabilities of the banking company; changes in the Board of directors or the appointment of a new Board; the alteration of the memorandum and articles; the continuation of legal proceedings; the reduction of the interest or rights of the members, depositors and other creditors to such extent as the Reserve Bank considers necessary in the public interest or in their interests; the payment in cash or otherwise to depositors and other creditors in full satisfaction of their claims; and the terms on which employees continue.

Section 45(6) and (7) require the scheme in draft to be sent to the banking company and the transferee bank and, where the Reserve Bank thinks fit, to the members and creditors, for suggestions and objections within a period of not less than fifteen days, and the Reserve Bank may modify the scheme in the light of them before it is sanctioned by the Central Government.

Section 45(9) is the effect. On and from the date of the sanctioned scheme coming into force, or such later date as it specifies, the scheme is binding on the banking company, the transferee bank, their members, depositors, creditors and employees, and on any other person having a right or liability in relation to them.

The case that tests it

Facts. Ganesh Bank of Kurundwad Ltd. v. Union of India, (2006) 10 SCC 645, decided on 28 August 2006. Ganesh Bank of Kurundwad, an old private bank, was placed under a moratorium which was advertised on 7 January 2006. The Federal Bank submitted its proposal the very next day, 8 January 2006, and the Reserve Bank prepared a scheme amalgamating Ganesh Bank with the Federal Bank. The bank and its shareholders challenged the scheme, complaining of the haste, of inadequate consultation, and of the terms on which their interest was extinguished.

Held. The Supreme Court dismissed the challenge and upheld the amalgamation. Once a moratorium is imposed, the Reserve Bank is under a duty to prepare a scheme of reconstruction or amalgamation, and the speed with which it acted was a consequence of the statutory scheme rather than a defect in it: the section contemplates that the bank is frozen and that the freeze cannot last beyond six months, so the exercise must be quick. The statutory requirements of notice and of inviting objections had been complied with, and the shareholders' complaint about the value attributed to their shares did not vitiate a scheme framed in the interests of depositors.

Why it matters. It is the only reported Supreme Court decision testing a section 45 scheme, and it shows the section operating at speed, which is its characteristic. It also identifies where the depositor and the shareholder part company: the scheme protects the first, and the second bears the loss, which is exactly what the section is for. An answer on section 45 that does not work this case is missing its only real authority.

A worked example

Sahyadri Co-operative Bank Ltd. has been lending heavily to a group of related builders, and an inspection under section 35 shows its capital is exhausted. Depositors begin to withdraw.

Step one. The Reserve Bank forms the view that there is good reason, and applies to the Central Government under section 45(1). The Government makes an order of moratorium under section 45(2), initially for three months, extendable but never beyond six months in total.

Step two. From that moment section 45(3) freezes the bank: no payment to depositors, no discharge of liabilities to other creditors, and, since the 2020 amendment, no fresh loans or advances and no investment in credit instruments.

Step three. The Reserve Bank invites proposals, and Godavari Bank Ltd. offers to take the business. The Reserve Bank prepares a scheme under section 45(4)(ii) for amalgamation with Godavari Bank as transferee, satisfied that it is necessary in the interests of the depositors and of the banking system.

Step four. The draft goes to both banks, and to members and creditors where the Reserve Bank thinks fit, with not less than fifteen days for objections under section 45(6). Objections are considered, the scheme is modified, and the Central Government sanctions it.

Step five, and the point of the whole exercise. On the appointed date the business, properties, assets and liabilities of Sahyadri vest in Godavari. The depositors become Godavari's depositors and can operate their accounts the next morning. Sahyadri's shareholders find their interest reduced, possibly to nothing, under section 45(5). On Ganesh Bank, that is lawful, and their complaint about speed will not succeed.

Compare the alternative. Had the Reserve Bank instead applied under section 38, the High Court would have had to order winding up, the Reserve Bank would have become liquidator under section 39, and the depositors would have waited for a dividend, with only the section 43A preference and their insurance cover.

Voluntary against compulsory

What it does NOT mean

Section 45 is not a winding up. The bank's business survives inside the transferee; only the corporate shell and the shareholders' interest are dealt with.

A moratorium under section 45 is not the same as one under section 37. Section 37's is granted by the High Court on the bank's own application with a Reserve Bank report; section 45's is made by the Central Government on the Reserve Bank's application. Both are capped at six months, and confusing them is the commonest error on this topic.

The scheme does not need the shareholders' consent. That is the whole difference from section 44A, and Ganesh Bank is the authority that it does not.

And since 2020 a scheme does not require a moratorium first. The words "or at any other time" in section 45(4) mean a rescue can be arranged without freezing the bank, which is the more depositor-friendly sequence.

Limits and criticism

Six months is a short time to value and sell a bank, and Ganesh Bank is the proof: a proposal arrived the day after the moratorium was advertised. The Court treated that speed as inherent in the scheme, but the criticism that shareholders cannot realistically test the valuation in that window is a fair one to make in an answer.

The transferee is usually a stronger bank being asked to absorb a weak one, and the price of its cooperation is paid by its own shareholders. That is a hidden cross-subsidy in the system, and it is one reason the Reserve Bank has moved towards resolution tools that impose the loss on the failed bank's own creditors.

The 2020 amendment answered a real gap and created a question. Allowing a scheme "at any other time" is better for depositors, but it gives the Reserve Bank power to restructure a bank that is still trading and whose shareholders may dispute that it is failing at all. The safeguard is the objection procedure in section 45(6), and whether fifteen days is adequate is a legitimate criticism.

Quick revision

Section 43: voluntary winding up only if the Reserve Bank certifies ability to pay debts in full. Section 44: court-sanctioned amalgamation needs the Reserve Bank's certificate. Section 44B: no compromise or arrangement with creditors sanctioned without a Reserve Bank certificate that it is not detrimental to depositors.

Section 44A: voluntary amalgamation; draft scheme to shareholders of each company; majority in number representing two-thirds in value in each; dissenting shareholder may claim the value of his shares; Reserve Bank sanction makes it binding.

Section 45(1) and (2): Reserve Bank applies to the Central Government; moratorium not exceeding six months in total.

Section 45(3): during the moratorium, no payment to depositors, no discharge of liabilities, and, since 26 June 2020, no loans, advances or investments in credit instruments.

Section 45(4): on four grounds, public interest, depositors' interests, proper management, or the interests of the banking system, the Reserve Bank may prepare a scheme for reconstruction or amalgamation, and since 2020 may do so at any other time and not only during a moratorium.

Section 45(5) to (9): the scheme may transfer the business and reduce the rights of members, depositors and creditors; draft circulated with not less than fifteen days for objections; sanctioned by the Central Government; binding on everybody.

Ganesh Bank of Kurundwad, (2006) 10 SCC 645: the only reported test of a section 45 scheme; moratorium advertised 7 January 2006, Federal Bank's proposal 8 January 2006, scheme upheld.

Test yourself

1. What majority is needed for a voluntary amalgamation under section 44A? A resolution passed by a majority in number representing two-thirds in value of the shareholders of each banking company, present in person or by proxy at a meeting called for the purpose; and the scheme must then be sanctioned by the Reserve Bank.

2. Who makes a moratorium order under section 45, and for how long? The Central Government, on the application of the Reserve Bank, for a fixed period which may be extended so that the total does not exceed six months.

3. State the four grounds on which the Reserve Bank may prepare a scheme under section 45(4). That it is necessary in the public interest; or in the interests of the depositors; or in order to secure the proper management of the banking company; or in the interests of the banking system of the country as a whole.

4. What did the Banking Regulation (Amendment) Act, 2020 change in section 45? It inserted, with effect from 26 June 2020, the bar on granting loans or advances or investing in credit instruments during a moratorium in sub-section (3), and the words "or at any other time" in sub-section (4), so that a scheme may now be prepared without a moratorium being in force.

5. Why did the shareholders of Ganesh Bank fail? Because once a moratorium is imposed the Reserve Bank is under a duty to prepare a scheme and must act within the six-month limit, so the speed complained of was inherent in the statutory scheme; the notice and objection requirements had been complied with, and a scheme framed in the depositors' interests is not vitiated by the shareholders' complaint about the value attributed to their shares.