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In a landmark judgment on April 12, 2012, the Supreme Court upheld the constitutional validity of the provision in the Right to Education Act, 2009 that makes it mandatory for all schools (government and private) except private, unaided minority schools to reserve 25% of their seats for children belonging to “weaker section and disadvantaged group”.  The verdict was given by a three-judge bench namely Justice S.H. Kapadia (CJI), Justice Swatanter Kumar and Justice K.S. Radhakrishnan.  However, the judgment was not unanimous.  Justice Radhakrishnan gave a dissenting view to the majority judgment. According to news reports (here and here), some school associations are planning to file review petitions against the Supreme Court order (under Article 137 of the Constitution, the Supreme Court may review any judgment or order made by it.  A review petition may be filed if there is (a) discovery of new evidence, (b) an error apparent on the face of the record, or (c) any other sufficient reason). In this post, we summarise the views of the judges. Background of the petition The 86th (Constitutional Amendment) Act, 2002 added Article 21A to the Constitution which makes it mandatory for the State to provide free and compulsory education to all children from the age of six to 14 years (fundamental right).  The Parliament enacted the Right of Children to Free and Compulsory Education Act, 2009 to give effect to this amendment. The Act provides that children between the ages of six and 14 years have the right to free and compulsory education in a neighbourhood school.  It also lays down the minimum norms that each school has to follow in order to get legal recognition.  The Act required government schools to provide free and compulsory education to all admitted children. Similarly, aided schools have to provide free and compulsory education proportionate to the funding received, subject to a minimum of 25%. However, controversy erupted over Section 12(1)(c) and (2) of the Act, which required private, unaided schools to admit at least 25% of students from SCs, STs, low-income and other disadvantaged or weaker groups.  The Act stated that these schools shall be reimbursed for either their tuition charge or the per-student expenditure in government schools, whichever is lower.  After the Act was notified on April 1, 2010, the Society for Unaided Private Schools of Rajasthan filed a writ petition challenging the constitutional validity of this provision on the ground that it impinged on their right to run educational institutions without government interference. Summary of the judgment Majority The Act is constitutionally valid and shall apply to (a) government controlled schools, (b) aided schools (including minority administered schools), and (c) unaided, non-minority schools.  The reasons are given below: First, Article 21A makes it obligatory on the State to provide free and compulsory education to all children between 6 and 14 years of age.  However, the manner in which the obligation shall be discharged is left to the State to determine by law.  Therefore, the State has the freedom to decide whether it shall fulfill its obligation through its own schools, aided schools or unaided schools.  The 2009 Act is “child centric” and not “institution centric”.  The main question was whether the Act violates Article 19(1)(g) which gives every citizen the right to practice a profession or carry out any occupation, trade or business.  However, the Constitution provides that Article 19(1)(g) may be circumscribed by Article 19(6), which allow reasonable restriction over this right in the interest of the general public.  The Court stated that since “education” is recognized as a charitable activity [see TMA Pai Foundation vs State of Karnataka (2002) 8 SCC 481] reasonable restriction may apply. Second, the Act places a burden on the State as well as parents/guardians to ensure that every child has the right to education.  Thus, the right to education “envisages a reciprocal agreement between the State and the parents and it places an affirmative burden on all stakeholders in our civil society.”  The private, unaided schools supplement the primary obligation of the State to provide for free and compulsory education to the specified category of students. Third, TMA Pai and P.A. Inamdar judgments hold that the right to establish and administer educational institutions fall within Article 19(1)(g).  It includes right to admit students and set up reasonable fee structure.  However, these principles were applied in the context of professional/higher education where merit and excellence have to be given due weightage.  This does not apply to a child seeking admission in Class I.  Also, Section 12(1)(c) of the Act seeks to remove financial obstacle.  Therefore, the 2009 Act should be read with Article 19(6) which provides for reasonable restriction on Article 19(1)(g).  However, the government should clarify the position with regard to boarding schools and orphanages. The Court also ruled that the 2009 Act shall not apply to unaided, minority schools since they are protected by Article 30(1) (all minorities have the right to establish and administer educational institutions of their choice).  This right of the minorities is not circumscribed by reasonable restriction as is the case under Article 19(1)(g). Dissenting judgment Article 21A casts an obligation on the State to provide free and compulsory education to children of the age of 6 to 14 years.  The obligation is not on unaided non-minority and minority educational institutions.  Section 12(1)(c) of the RTE Act can be operationalised only on the principles of voluntariness, autonomy and consensus for unaided schools and not on compulsion or threat of non-recognition.  The reasons for such a judgment are given below: First, Article 21A says that the “State shall provide” not “provide for”.  Therefore, the constitutional obligation is on the State and not on non-state actors to provide free and compulsory education to a specified category of children.  Also, under Article 51A(k) of the Constitution, parents or guardians have a duty to provide opportunities for education to their children but not a constitutional obligation. Second, each citizen has the fundamental right to establish and run an educational institution “investing his own capital” under Article 19(1)(g).  This right can be curtailed in the interest of the general public by imposing reasonable restrictions.  Citizens do not have any constitutional obligation to start an educational institution.  Therefore, according to judgments of TMA Pai and PA Inamdar, they do not have any constitutional obligation to share seats with the State or adhere to a fee structure determined by the State.  Compelling them to do so would amount to nationalization of seats and would constitute serious infringement on the autonomy of the institutions. Rights guaranteed to the unaided non-minority and minority educational institutions under Article 19(1)(g) and Article 30(1) can only be curtailed through a constitutional amendment (for example, insertion of Article 15(5) that allows reservation of seats in private educational institutions). Third, no distinction can be drawn between unaided minority and non-minority schools with regard to appropriation of quota by the State. Other issues related to the 2009 Act Apart from the issue of reservation, the RTE Act raises other issues such as lack of accountability of government schools and lack of focus on learning outcomes even though a number of studies have pointed to low levels of learning among school children.  (For a detailed analysis, please see PRS Brief on the Bill).

The Financial Resolution and Deposit Insurance Bill, 2017 was introduced in Parliament during Monsoon Session 2017.[1]   The Bill proposes to create a framework for monitoring financial firms such as banks, insurance companies, and stock exchanges; pre-empt risk to their financial position; and resolve them if they fail to honour their obligations (such as repaying depositors).  To ensure continuity of a failing firm, it may be resolved by merging it with another firm, transferring its assets and liabilities, or reducing its debt.  If resolution is found to be unviable, the firm may be liquidated, and its assets sold to repay its creditors.

After introduction, the Bill was referred to a Joint Committee of Parliament for examination, and the Committee’s report is expected in the Winter Session 2017.  The Committee has been inviting stakeholders to give their inputs on the Bill, consulting experts, and undertaking study tours.  In this context, we discuss the provisions of the Bill and some issues for consideration.

What are financial firms?

Financial firms include banks, insurance companies, and stock exchanges, among others.  These firms accept deposits from consumers, channel these deposits into investments, provide loans, and manage payment systems that facilitate transactions in the country.  These firms are an integral part of the financial system, and since they transact with each other, their failure may have an adverse impact on financial stability and result in consumers losing their deposits and investments.

As witnessed in 2008, the failure of a firm (Lehman Brothers) impacted the financial system across the world, and triggered a global financial crisis.  After the crisis, various countries have sought to consolidate their laws to develop specialised capabilities for resolving failure of financial firms and to prevent the occurrence of another crisis. [2]

What is the current framework to resolve financial firms? What does the Bill propose?

Currently, there is no specialised law for the resolution of financial firms in India.  Provisions to resolve failure of financial firms are found scattered across different laws.2  Resolution or winding up of firms is managed by the regulators for various kinds of financial firms (i.e. the Reserve Bank of India (RBI) for banks, the Insurance Regulatory and Development Authority (IRDA) for insurance companies, and the Securities and Exchange Board of India (SEBI) for stock exchanges.)  However, under the current framework, powers of these regulators to resolve similar entities may vary (e.g. RBI has powers to wind-up or merge scheduled commercial banks, but not co-operative banks.)

The Bill seeks to create a consolidated framework for the resolution of financial firms by creating a Resolution Corporation. The Resolution Corporation will include representatives from all financial sector regulators and the ministry of finance, among others.  The Corporation will monitor these firms to pre-empt failure, and resolve or liquidate them in case of such failure.

How does the Resolution Corporation monitor and prevent failure of financial firms?

Risk based classification: The Resolution Corporation or the regulators (such as the RBI for banks, IRDA for insurance companies or SEBI for the stock exchanges) will classify financial firms under five categories, based on their risk of failure (see Figure 1).  This classification will be based on adequacy of capital, assets and liabilities, and capability of management, among other criteria.  The Bill proposes to allow both, the regulator and the Corporation, to monitor and classify firms based on their risk to failure.

Corrective Action:  Based on the risk to failure, the Resolution Corporation or regulators may direct the firms to take certain corrective action.  For example, if the firm is at a higher risk to failure (under ‘material’ or ‘imminent’ categories), the Resolution Corporation or the regulator may: (i) prevent it from accepting deposits from consumers, (ii) prohibit the firm from acquiring other businesses, or (iii) require it to increase its capital.  Further, these firms will formulate resolution and restoration plans to prepare a strategy for improving their financial position and resolving the firm in case it fails.

While the Bill specifies that the financial firms will be classified based on risk, it does not provide a mechanism for these firms to appeal this decision.   One argument to not allow an appeal may be that certain decisions of the Corporation may require urgent action to prevent the financial firm from failing. However, this may leave aggrieved persons without a recourse to challenge the decision of the Corporation if they are unsatisfied.

Figure 1: Monitoring and resolution of financial firmsFig 1 edited

Sources: The Financial Resolution and Deposit Insurance Bill, 2017; PRS.

 

How will the Resolution Corporation resolve financial firms that have failed?

The Resolution Corporation will take over the administration of a financial firm from the date of its classification as  ‘critical’ (i.e. if it is on the verge of failure.)  The Resolution Corporation will resolve the firm using any of the methods specified in the Bill, within one year.  This time limit may be extended by another year (i.e. maximum limit of two years).   During this period, the firm will be immune against all legal actions.

The Resolution Corporation can resolve a financial firm using any of the following methods: (i) transferring the assets and liabilities of the firm to another firm, (ii) merger or acquisition of the firm, (iii) creating a bridge financial firm (where a new company is created to take over the assets, liabilities and management of the failing firm), (iv) bail-in (internally transferring or converting the debt of the firm), or (v) liquidate the firm to repay its creditors.

If the Resolution Corporation fails to resolve the firm within a maximum period of two years, the firm will automatically go in for liquidation.  The Bill specifies the order of priority in which creditors will be repaid in case of liquidation, with the amount paid to depositors as deposit insurance getting preference over other creditors.

While the Bill specifies that resolution will commence upon classification as ‘critical’, the point at which this process will end may not be evident in certain cases.  For example, in case of transfer, merger or liquidation, the end of the process may be inferred from when the operations are transferred or liquidation is completed, but for some other methods such as bail-in, the point at which the resolution process will be completed may be unclear.

Does the Bill guarantee the repayment of bank deposits?

The Resolution Corporation will provide deposit insurance to banks up to a certain limit.  This implies, that the Corporation will guarantee the repayment of a certain amount to each depositor in case the bank fails.  Currently, the Deposit Insurance and Credit Guarantee Corporation (DICGC) provides deposit insurance for bank deposits up to 1 lakh rupees per depositor.[3]  The Bill proposes to subsume the functions of the DICGC under the Resolution Corporation.

[1].  The Financial Resolution and Deposit Insurance Bill, 2017, http://www.prsindia.org/uploads/media/Financial%20Resolution%20Bill,%202017/Financial%20Resolution%20Bill,%202017.pdf

[2]. Report of the Committee to Draft Code on Resolution of Financial Firms, September 2016, http://www.prsindia.org/uploads/media/Financial%20Resolution%20Bill,%202017/FRDI%20Bill%20Drafting%20Committee%20Report.pdf

[3]. The Deposit Insurance and Credit Guarantee Corporation Act, 1961, http://www.prsindia.org/uploads/media/Financial%20Resolution%20Bill,%202017/DICGC%20Act,%