Open Access Research Article
RECOVERY OF DEBTS DUE TO BANKS AND FINANCIAL INSTITUTIONS WITH SPECIAL EMPHASIS ON SARFAESI ACT, 2002
Published Paper
Article Details
RECOVERY OF DEBTS DUE TO BANKS AND
FINANCIAL INSTITUTIONS WITH SPECIAL EMPHASIS ON SARFAESI ACT, 2002
AUTHORED BY
- SHREYANSH ANAND
Amity Law
School, Noida
Abstract
Our nation has also turned into a
never-ending whirlpool of intense economic competitiveness as a result of the
strengthening global economic integration and the internationalization of
production. The rapid movement of money necessitates the implementation of
realistic legislation to protect against its anomalies and similar issues.
There was a strong need to provide help to banks and other financial
institutions in recovering loans, especially those that had grown bad and were
of sub-standard quality. As a result of this, these institutions were
experiencing significant financial losses. Therefore, on June 21, 2002, the
President issued the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Ordinance, 2002 to regulate the process of
securitisation and reconstruction of financial assets and the enforcement of security
interest. This Ordinance subsequently became an Act, which was approved by the
President on 07.12.2002.
Subsequently, the lenders initiated
the process of issuing a notice of default to enterprises that were failing to
meet their financial obligations, even in accordance with the ordinance. Mardia
Chemicals was one of the corporations that failed to meet their financial
obligations and fought against the introduction of this Act in a court of law.
M/s Mardia Chemicals Ltd. appealed to the Supreme Court and the Apex Court
regarding the constitutionality of this Statute in the case of Mardia Chemicals
Ltd.v. The Union of India examined and analyzed most of its components and
confirmed the constitutionality of the Act. However, it invalidated Section
17(2), which required borrowers to deposit 75% of the claim amount as a
prerequisite for contesting the actions of lenders at the Debt Recovery
Tribunal.
The Act encompasses three primary
elements: securitization, asset reconstruction, and the enforcement of security
interest. The purpose of the Act is to govern the operations of securitisation
and asset reconstruction businesses. Securitisation is a recently introduced
financial instrument in the Indian market. The act's provisions pertain to the
overall approach that securitisation businesses would employ to offer security
receipts or debentures to qualified institutional buyers (QIBs). The receipts
will be privately allocated to them without any public offering.
Furthermore, the implementation of
security measures has been streamlined in cases when borrowers consistently
fail to meet their obligations and their accounts have been categorized as
non-performing assets (NPA) in the records of banks/financial institutions that
have provided the financial support. This Act, being a specialized legislation,
has the potential to significantly reduce the number of Non-Performing Assets
(NPA). Moreover, it has the potential to change the dynamic between the borrower
and the secured creditors. The Act may also aid in monitoring and controlling
Non-Performing Assets (NPAs) in the future, while also introducing a new
financial culture into the system.
In addition, an earnest effort was
undertaken to scrutinize the SARFAESI Act, as well as the recovery laws and
mechanisms, including the shortcomings of civil court, DRT, and RDDBFI Act,
1993. Furthermore, recommendations were given for enhancing the recovery
process. Nevertheless, agricultural loans have been omitted from this
undertaking.
Keywords: Non-Performing Assets, Banks,
Financial Institutions
INTRODUCTION
The banking sector in
India is crucial for the economic development of the country. The banking
sector plays a crucial role in facilitating the distribution, production,
consumption and exchange processes within the economic system. It enhances the
circulation of capital in the economy and drives economic expansion. The
efficiency of the financial system directly influences the rate at which the
economy develops. Like any other business, a bank's performance is assessed by
its profitability and the quality of its assets. However, Indian banking
distinguishes itself from other commercial companies by incorporating social
responsibilities into its operations. The banking system in India has been
tasked with achieving the objectives of fair income distribution, even regional
economic development, and the mitigation and eradication of private sector
monopolies in commerce and industry.
The financial sector has
played a crucial role in India's endeavours to achieve rapid economic
development. Due to the lack of updates in our current legal framework for
commercial transactions, which has not kept up with the evolving commercial
practices and financial sector changes. This guarantees the gradual rate of
improvement of delinquent loans and increasing levels of non-performing assets
of financial organisations and banks.
The Central Government
instituted the Narasimham Committee I and II, along with the Andhyarujina
Committee, to investigate and assess reforms in the banking industry. These
committees were specifically tasked with assessing the necessity for legal
system modifications in these sectors. The Committees have suggested new
legislation to empower Financial Institutions and Banks to purchase and trade
securities without judicial intervention, as part of their efforts to enhance
securitization.
The SARFAESI Act was
enacted on December 17, 2002, with the purpose of establishing procedures to
facilitate the prompt recovery of outstanding debts by Indian lenders. The
SARFAESI Act grants banks and other financial institutions the authority to
conduct direct auctions of residential or commercial properties that have been
used as collateral in order to recoup loans from borrowers. Prior to the
implementation of this legislation, financial institutions were had to resort
to litigation in order to recover the money owed to them, a procedure that was
protracted and consumed a significant amount of time.
According to the SARFAESI
Act, if any borrower fails to repay the loan that was provided by a bank and
secured by collateral, the bank is granted extensive authority to retrieve the
outstanding amount from the borrower. Upon providing a 60-day notice period,
the lender has the authority to seize the pledged assets of the borrower,
assume control over their administration, designate a person to oversee them,
and demand payment from the borrower's debtors in relation to the asset. This
recovery approach significantly reduces the time required by banks and
financial institutions to resolve issues that would otherwise be prolonged
owing to court involvement.
A significant limitation of the Act is its lack of applicability to unsecured creditors. The Insolvency and Bankruptcy Code, 2016 addressed these and other limitations in the recovery methods. Asset Reconstruction Companies (ARCs) are utilised by banks as an alternate method to transfer troubled assets, so ensuring a more targeted and effective settlement of questionable debt.
A significant limitation of the Act is its lack of applicability to unsecured creditors. The Insolvency and Bankruptcy Code, 2016 addressed these and other limitations in the recovery methods. Asset Reconstruction Companies (ARCs) are utilised by banks as an alternate method to transfer troubled assets, so ensuring a more targeted and effective settlement of questionable debt.
Chapter 2 :
Main Features of SARFAESI ACT
The Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest Act,
2002 (‘the Act’) seeks to streamline the procedure for recovering unpaid loans
from intentional defaulters. The SARFAESI Act established the structure for the
establishment of asset reconstruction companies (ARCs) that specialise in
securitizing troubled assets acquired from banks/financial institutions. It
also offers the initial legal framework that acknowledges securitization, asset
recovery, and reconstruction. The specific procedure outlined in the rules
imposed under the requirements of the Transfer of Property Act was eliminated.
The Act now includes a clause that addresses the enforcement of rights over
movable property that has been hypothecated or charged to banks/financial
institutions. Banks and financial institutions have the authority to seize and
take direct control of these assets.
The Act provides a comprehensive
legal structure for transactions involving securitization and asset
reconstruction in India. The legislation encourages the establishment of asset
reconstruction and securitization firms to assume control of the Non-performing
Assets amassed by banks and public financial institutions. It grants lenders
and securitisation/asset reconstruction businesses the authority to acquire the
assets of debtors without the need for legal intervention. Banks and financial
institutions (FIs) have been granted the authority to enforce their security
without resorting to litigation in court, allowing them to promptly recover
their loans.
This Act is intended to
achieve three specific purposes, namely.
a.
Securitisation:
Establishes a legal structure for the securitisation of assets.
b.
Asset
Reconstruction: Involves the transfer of non-performing assets (NPAs) to an
asset reconstruction firm, which will subsequently dispose of these assets and
generate returns.
c.
Enforcement
of security interest: The act of implementing and carrying out the rights of
secured creditors (such as banks and financial institutions) to protect their
interests in the event of default or non-payment.
To achieve the
aforementioned goals, it is necessary to register special purpose firms, namely
Securitisation firms and Reconstruction Companies, under the Companies Act and
also with the Reserve Bank of India. A Registry will be established to record
the transactions involving Asset Reconstruction, Securitisation, and details of
security interest.
Another facet of the Act
pertains to the transfer of security interest to securitization and rebuilding
businesses. They are considered as lenders and obtain financial assistance by
enforcing the security interest. These corporations can also function as a recovery
agency with the authority to seize assets and collect the financial aid.
The secured creditor has
two viable choices for enforcing the security interest in this manner. One
possible course of action is for him to exercise his legal entitlement by
assuming control of the secured asset and personally selling it. Another
possible choice is to transfer the right to a Securitisation Company or
Reconstruction Company that is registered with the Reserve Bank of India. This
transfer would allow them to handle the disposal of the secured asset and
collect the outstanding payments. The secured creditor has the authority to
enforce the security interest by sending a notice under Section 13(2) of the
Act. This allows them to take ownership of the security assets, assume control
of the borrower's business, or designate someone to administer the security. It
is important to mention that a secured creditor has the ability to exercise
this right if the debt is categorised as Non-performing Assets according to the
rules provided by the RBI.
According to the Act,
once the secured asset is sold and all the dues of the secured creditor, along
with any associated costs, charges, and expenses, are accounted for, any
remaining balance is given to the rightful person. If there are any remaining
outstanding balances to be collected, the creditor with security can request
assistance in recovering such amounts by submitting an application to the Debt
Recovery Tribunal or the relevant civil court against the debtors and
guarantors. Banks and financial institutions have the authority to directly
assume control of security assets and transfer them to a securitization or
reconstruction firm to act as their representative.
After the secured creditor has taken
action as specified in sub-section (4) of section 13, the borrower or any
affected party has the choice to lodge an appeal before the Debt Recovery
Tribunal. Civil courts have no jurisdiction. An appeal against the order of the
Debt Recovery Tribunal can be made to the Debt Recovery Appellate Tribunal
(DRAT) under section 18. The borrower is ineligible to seek protection under
the Sick Industrial Companies Act (SICA) if the secured creditor initiates
recovery actions and if there is any outstanding reference with the Board for
Industrial and Financial Reconstruction (BIFR).
The Act was passed with the aim of expediting
the collection of outstanding debts. However, because to the incorporation of
three distinct concepts into a single law, it is likely to encounter challenges
in its implementation. Nevertheless, the judiciary will fulfil its
responsibility to protect public funds when addressing issues such as the
collection of outstanding debts by banks and financial institutions. The
SARFAESI Act, 2002 was designed to facilitate the recovery of debts classified
as Non-performing Assets by Banks/Financial Institutions, without the need for
court action. This act aims to simplify and streamline the debt collection
process.
The Act includes a
judicial oversight by granting appellate authority to the Debt Recovery
Tribunal and DRAT. In the future, legislation must address specific flaws by
modifying the Act and establishing complete rules for banks and financial
institutions to carry out recovery activities without any legal obstacles.
Non -Performing Assets
A non-performing asset
refers to any asset, including a leased asset, that no longer generates income
for a bank or financial institution. According to Investopedia, it is a
situation in which a borrower has failed to make the agreed-upon interest and
principal payments to the designated lender for a lengthy period of time. The
non-performing asset is thus not generating any revenue for the lender in terms
of both principle and interest payments. If the borrower fails to return the
principal amount and interest payments within 90 days, the loan will be classified
as a Non-Performing Asset. Section 2 (1) (o) (a) of the Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest Act,
2002, defines a Non- Performing Asset as an asset or account of a borrower that
has been categorised by a financial institution or bank as doubtful, sub-standard,
or loss asset. This classification is based on the directions or guidelines
issued by the relevant authority or body responsible for administering or
regulating the bank or financial institution, or by the Reserve Bank in other
cases."
The banks' profits are
derived from the interest differential between what they receive from borrowers
and what they pay to savers. On a bank's balance sheet, loans given to
customers are categorised as assets. However, Non-Performing Assets pose a
significant liability for banks. This is because they put the bank's profit and
income at risk, making it difficult to pay interest to savers. Additionally,
Non-Performing Assets cause the economic value of the loan assets to decrease.
The loans provided to
consumers do not immediately become non-performing debts. For most loans,
customers are given a specific period of time called a grace period. Once this
grace period ends, any outstanding bills are considered late. Additionally,
once a specific amount of days have passed, the loan in question is classified
as a Non-Performing Loan. The duration might vary from 90 to 180 days. Banks
often classify a consumer loan that is overdue for more than 180 days and a
commercial loan that is overdue for more than 90 days as Non- performing
Assets.
In order for an
agricultural loan to be classified as a non-performing asset, it must meet the
requirement that the interest and/or installment payments, as well as the
principle amount, stay unpaid for two consecutive harvest seasons. However, the
designated timeframe must not exceed two years, and any outstanding loan would
be classified as a non-performing asset after two years.
Classification
of Non- Performing Assets
I.
Standard
Assets: Standard Assets refer to assets that exhibit no signs of distress and
provide no greater than average risk associated with the firm. These assets are
classified as performing assets.
II.
A
sub-standard asset is an asset that has been classified as non-performing for a
period of one year or less. Another instance in which an asset class or a loan
account of the bank is categorised as a sub-standard asset is when the terms
and conditions pertaining to the loan account are modified or renegotiated.
Based on the satisfactory performance of the examined terms, the account must
be classified as a sub-standard asset for a minimum of 12 months. Hence, just
changing the conditions of the account without sufficient compliance does not
lead to the improvement of the asset category.
III.
An
asset is classified as a questionable asset if it has remained in the
sub-standard asset category for a consecutive period of twelve months. A loan
classified as doubtful shares all the inherent drawbacks of assets categorised
as sub-standard, but with the added characteristic that the limitations make it
highly doubtful and unlikely that it can be fully liquidated or collected based
on currently known facts, circumstances, and values.
IV.
A
non-performing asset is classified as a loss asset when the bank, internal or
external auditors, or the RBI inspection acknowledge the loss, but the total
amount has not been completely written off. In essence, this type of asset is
deemed uncollectible and has so negligible value that it is not rational to view
it as a viable asset, although there may be some potential for reclamation or
recovery.
Importance of the Issue of Non
-Performing Assets
The bank's revenue system
in the economy would be weakened as the amount of non-performing assets
increases. The majority of banks have the ability to handle a rise in
non-performing assets in the near term because they have significant reserves
or capital available to offset any losses. However, after the reserved capital
has been depleted, non-performing loans would start to impede a bank's
expansion.
Examining the problem of
Non-performing Assets is crucial due to its detrimental effects on the return
on assets. Banks will experience a decline in their interest income since it is
recorded solely based on when it is received. The profitability of banks will
be negatively impacted due to the allocation of dubious loans and subsequent
write-off as bad debts. Additionally, the Return on Investment (ROI) would
decrease and the cost of capital or interest on loan will increase.
Non-performing assets
have a detrimental impact on the economic system, causing instability and
hindering its growth. An increase in the non-performing assets of banks will
result in a shortage of funds in the Indian securities markets. In addition, if
the banks are not confident in the repayment of the money they have lent, only
a limited number of banks will be inclined to provide loans.
The presence of
non-performing assets will ultimately result in significant financial losses
for the banks' shareholders, as the institutions themselves will struggle to
remain viable in the market. This will subsequently lead to a crisis of trust
and certainty in the market. The interest rates on the loans will experience a
significant hike. An increase in interest rates will have a direct impact on investors
seeking financing for the establishment of projects such as infrastructure and
industrial projects.
The general populace
would be similarly impacted since retail consumers will now have to pay a
higher interest rate for loans such as home loans and vehicle loans. This would
result in a series of reduced withdrawals of cash from the security market,
which will negatively impact the overall demand in the Indian economy.
Ultimately, this will lead to decreased growth rates and increased inflation due
to the elevated cost of capital.
Legal Mechanism to solve the Problem of Non
-Performing Assets
One straightforward
approach to reduce the number of non-performing assets is to successfully
retrieve the defaulted debts. In an attempt to address the issue of financially
struggling companies, the Government introduced The Sick Industrial Companies
(Special Provisions) Act, 1985. However, instead of resolving the challenges
faced by these companies, the act instead worsened the problem of
Non-Performing Assets. During the period of September 1990, public sector banks
filed approximately 1.5 million cases, while financial institutions had 304
cases ongoing in several courts for the purpose of debt recovery. An
outstanding amount of Rs. 6,013 Crores was discovered. To address the
situation, the Government established a committee led by Mr. Narsimhamand. This
committee proposed the creation of Debt Recovery Tribunals, resulting in the
enactment of the Recovery of Debts Due to Banks and Financial Institutions Act
in 1993. The outcomes resulting from the establishment of Debt Recovery
Tribunals and Appellate Tribunals under the Act can be described as somewhat
promising. The Government of India is implementing financial reforms based on
the recommendations of the Narasimham Committee report I and II. In order to
improve the credit monitoring process of banks and financial institutions, the
Reserve Bank of India has introduced prudential requirements.In order to
enhance the process of banks and financial institutions collecting outstanding
debts, the Government of India enacted The Recovery of Debts Due to Banks and
Financial Institutions Act, 1993 and The Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002.
Sick
Industrial Companies (Special Provisions) Act (SICA), 1985
The Sick Industrial
Companies (Special Provisions) Act, 1985 introduced the definitions of a 'sick
company' and a 'possible ill firm'. According to the Act, the corporation was
considered sick if there was a total depletion of its net worth. According to Section
3 (1) (o) of the Act, a "sick industrial company" is defined as an
industrial company that has been registered for at least five years and has
accumulated losses at the end of the financial year that are equivalent to or
greater than its entire net worth.
[Explanation – To
eliminate any uncertainties, it is stated that an industrial company that was
in existence just before the enactment of the Sick Industrial Companies
(Special Provisions) Act, 1993, and has been registered for a minimum of five
years, will be considered a sick industrial company if, at the end of any
financial year, its accumulated losses are equal to or greater than its entire
net worth.]
The SICA (Sick Industrial
Companies (Special provisions) Act, 1985 established two quasi-judicial
entities, namely the "Board" for Industrial and Financial
Reconstruction and the "Appellate Authority" for Industrial and
Financial Reconstruction. These bodies are defined under Section 3(a) and 3(b)
of the Act. Section 15 of the SICA stipulated that if a firm became a
financially distressed industrial company within sixty days after finalising
its duly audited accounts, it could be referred to the Board for Industrial and
Financial Reconstruction. The SICA was unsuccessful as a result of its antiquated
methodology in addressing bankruptcy matters. The method used to identify a
financially distressed unit was based on a balance sheet analysis rather than a
future cash flow analysis. The erosion of net worth occurred over a
considerable period of time, and the serious problems with liquidity were never
resolved.
Recovery
of Debts Due to Banks and Financial Institutions (RDDBI) Act, 1993
Before the implementation
of the Recovery of Debts Due to Banks Act, it was customary to file a lawsuit
in a Civil Court to recover debts owed to Banks and Financial Institutions.
These lawsuits were conducted and resolved following the guidelines outlined in
the Civil Procedure Code of 1908. The decree issued by the Civil Courts was
also implemented in compliance with the method outlined in Order XXI of the
Civil method Code. The litigation process was protracted and arduous.
Frequently, it required several years or even decades to fully recuperate the
sum. The average duration for the resolution of a civil lawsuit, either for
determining liability or obtaining a judgement, ranged from five to fifteen
years. Following an extensive period dedicated to determining responsibility,
significant challenges arose during the process of collecting the loan amount
or selling the goods/property.
A significant proportion
of banks' balance sheets contain a substantial amount of Non-Performing Assets,
some of which are irrecoverable. The Non-Performing Assets were classified as
Bad Debts. Retrieving these debts through the regular legal process is an
arduous undertaking for banks and can take many years.
In order to address these
challenges and provide Banks/Financial Institutions with an advantage over
debtors, the Government enacted the "Recovery of Debts Due to Banks and
Financial Institutions Act, 1993" (RDDBFI Act, 1993). The Act had
amendments in 1995, 2000, 2003, and 2013. The Act was revised once again in
2016.The Act underwent a name change and was subsequently referred to as the
"Recovery of Debts Due to Banks and Financial Institutions and Bankruptcy
Act, 1993".
The primary objective of
the Act is to establish Tribunals for prompt resolution and collection of debts
owed to Banks and Financial Institutions. The primary characteristics of the
Recovery of Debts Due to Banks and Financial Institutions Act 2016 are as
follows:
1. The definition of property and
security interest now includes Financial Leasing and Conditional Sale
agreements (similar to Hire buy) as well as transactions involving intangible
assets.
2. Debenture Trustees and Assets
Reconstruction Companies have been included in the definition of
"Financial Institutions" and "Secured Creditors".
3. The Debt Recovery Tribunal Act has
been modified to encompass obligations related to debt securities and security
interest.
4. File an appeal against the order of
the Debt Recovery Tribunal before the Debt Recovery Appellate Tribunal (DRAT)
with a requirement to deposit 50% of the amount, as opposed to the previous
requirement of 75%.
5. The proposal is that the Presiding
Officer of the Debt Recovery Tribunal Act should also serve as the Adjudicating
Authority under the Insolvency and Bankruptcy Code, 2016.
6. The Chairperson of DRAT will also
serve as the Appellate Authority under the Insolvency Code.
The Tiwari Committee,
established under this Act, recommended the creation of specialised Tribunals
known as the Debt Recovery Tribunals and the Debt Recovery Appellate Tribunals.
These Tribunals aim to resolve the issue of recovery faced by Banks and
Financial Institutions. Their main objective is to unlock a significant amount
of public funds and ensure their proper utilisation for the country's
development.
The requirements of this
Act do not apply to Banks and Financial Institutions with outstanding amounts
less than Ten lakh rupees. According to Section 2(g) of the RDDBFI Act, 1993,
"Debt" is defined as any amount of money (including interest) that is
claimed to be owed by a bank, financial institution, or a group of banks or
financial institutions during the course of their business activities. This
debt can be in the form of cash or other assets, and can be secured or
unsecured. It can also be assigned to another party or be payable under a court
decree, arbitration award, mortgage, or any other legally enforceable agreement
at the time of the application.
Section 19(19) of the
RDDBFI Act, 1993 grants the Tribunals the authority to give a certificate of recovery
to the recovery officers who are specifically appointed under this Act. This
certificate is issued against companies that are registered under the Companies
Act, 1956. The many methods of recuperation, as regulated by Section 25 of the
Act, encompass:
1. Seizure and auction of both moveable
and immovable assets.
2. Detention of the accused
3. Designating a receiver to oversee the
management of the defendant's properties.
Difference between SARFESI Act, 2002 and RDDBFI Act, 1993
The RDDBFI Act, 1993
empowers the Bank to seek recourse from the Tribunals in cases where the debt
beyond the specified threshold. According to the RDDBFI Act, the Debt Recovery
Tribunal will determine the amount owed and issue the final decision. The SARFAESI
Act, 2002 establishes a process in which the Bank or Public Financial
Institution will independently resolve the debt. The borrower is granted the
right to appeal to the Tribunal under the SARFAESI Act, 2002 only after the
Bank has made a decision. Financial institutions are only able to utilise the
provisions of the SAFAESI Act, 2002 for assets that are secured, rather than
for all assets. Therefore, according to the SARFAESI Act, Banks are granted
authority under Section 13 to conduct the process of adjudication. The process
is as outlined:
1. The Bank or Financial Institution
issues a notification in accordance with Section 13 (2) to the borrower who has
defaulted and whose account has been classified as "NPA".
2. The recipient of the notice under
Section 13 (2) has the option to submit their objections to the Bank's claim
within the specified timeframe. The Bank will evaluate the complaints, but it
is not obligated to provide any decision after reviewing them. This allows the
Bank to rectify any errors it may make during the adjudication process.
3. When the Bank determines that the
objections are not valid, it has the authority to seize the secured asset by
issuing a notification under Section 13 (4). Regarding the acquisition of
property, there are two distinct actions: symbolic possession and actual
possession.
The borrower is granted
the opportunity to appeal to the Debt Recovery Tribunal under Section 17 and
thereafter to the Debt Recovery Appeal Tribunal under Section 18, as per the
provisions outlined in Section 13(4). Both the borrower and any other
individual who is harmed by the Bank's actions under Section 13 of the Act have
the right to seek recourse through the Tribunal, following the prescribed
procedure.
The SARFAESI Act, 2002
requires a specific amount to be deposited prior to filing an appeal. The
constitutionality of the SARFAESI Act, 2002 was contested in the Supreme Court.
The Supreme Court has ruled that the Act is lawful, but has decreased the
required deposit amount for filing an Appeal under section 17. The Bank will
dispose of the secured asset if there are no legal orders from the Debt
Recovery Tribunal or any competent court preventing it.
Despite its apparent
simplicity, the SARFAESI Act, 2002 has faced significant criticism. The criticism
is around the allegation that banks and financial firms are misusing it. Can a
borrower seek recourse in the High Court to contest the actions taken by a Bank
or Financial Institution under the SARFAESI Act, 2002? Is it accurate to assert
that the provisions are being misused? Is the borrowers' right to safeguard
against wrongdoing guaranteed?
The High Court wields
exceptional authority as per Article 226 of the Constitution of India. Once
again, the courts have ruled that since the Act itself provides an alternative
remedy, the High Court does not have jurisdiction under Article 226 with
regards to SARFAESI cases. However, the ability to dispute the actions of Banks
or Financial Institutions under the SARFAESI Act, 2002 in the High Court is contingent
upon the specific facts and circumstances of the case. There is no definitive
answer as to whether such recourse is possible.
While it may appear that
the Act is being misused, it is not justifiable to claim that the Act oppresses
the borrowers. The task at hand is a unique and delicate endeavour with a clear
and commendable goal, which must be executed effectively. Due to numerous
transactions and issues, Banks and Financial Institutions may make errors,
prompting the Borrower to seek a stay of proceedings from the Tribunal.
APPLICABILITY OF THE SARFAESI ACT
The Act pertains to the
following:-
1. Registration and regulation of Asset
Reconstruction Companies (ARCs) by the Reserve Bank of India.
2. Enabling the process of securitizing
financial assets held by banks and financial institutions, regardless of
whether there are underlying securities involved.
3. The objective is to facilitate the
smooth transfer of financial assets from banks and financial institutions to
Asset Reconstruction Companies. This is achieved by allowing the acquisition of
these assets through the issuing of debentures, bonds, or other securities in
the form of debentures.
4. Authorising Asset Reconstruction
Companies to generate cash by issuing security receipts to eligible purchasers.
5. Assisting in the restoration of
financial assets obtained through the use of enforcement powers over securities
or changes in management, or other powers that may be granted to banks and
financial institutions.
6. Display of any securitization firm or
asset reconstruction company that is officially recognised by the Reserve Bank
of India as a public financial institution.
7. The term "security
interest" is defined as any form of collateral, such as a mortgage or lien
on real estate, provided as a guarantee for the return of financial aid
provided by a bank or financial organisation.
8. The borrower's account is classified
as a non-performing asset based on the recommendations or guidelines provided
by the Reserve Bank of India.
9. The authorised officers will exercise
the privileges of a secured creditor in this matter, in accordance with the
regulations established by the Central Government.
10. A challenge to the actions of a bank
or financial institution can be made to the relevant Debts Recovery Tribunal,
with a subsequent appeal possible to the Appellate Debts Recovery Tribunal.
11. The Central Government has the
authority to establish or facilitate the establishment of a Central Registry to
register transactions related to securitization, asset reconstruction, and the
development of security interest.
12. The proposed legislation will first
be applied to banks and financial institutions. The Central Government will
have the authority to extend the application of the Act to non-banking
financial enterprises and other entities.
13. The proposed regulation does not
apply to security interests in agricultural lands, loans that are less than one
lakh rupees, and circumstances where the
borrower has already repaid 80% of
the loan.
Exemptions to the
legislation
1.
The
SARFAESI Act does not apply to the following entities:
a.
Regional Rural Banks;
b.
Nationalised
Banks;
c.
Co-operative
Banks;
d.
State
Bank of India and their Associate Banks.
2.
This
Act is not applicable in the following situations:-
i.
A
lien can be placed on any goods, money, or security given under the Indian
Contract Act, the Sale of Goods Act, or any other current law.
ii.
A
pledge can be made on movable assets.
iii.
A
security interest can be created on aircraft and vessels.
iv.
Any
contract such as conditional sale, hire purchase, lease, or any other contract
that does not create a security interest.
v.
A
security interest can be created to secure repayment of a financial asset, as
long as it does not exceed Rs. 1,00,000/-.
vi.
A
security interest cannot be created on agricultural land.
vii. If the amount due is less than 20% of
the principal amount, it is not considered a case for security interest.
viii.
The
rights of an unpaid seller and any property that cannot be attached or sold
according to the Civil Procedure Code are also exempt from security interest.
Constitutional validity of SARFAESI Act 2002
Examining and understanding the
constitutional vires of a statute is essential since the constitution is the
highest and supreme law of the land. A law that is inherently unconstitutional
cannot provide any meaningful rights or impose any legally binding responsibilities.
Since no act may be constitutionally beyond the powers of the government, it is
important to analyse the significant court rulings on the validity of the
SARFAESI Act 2002.
[(2004) 4 SCC 311]
The Supreme Court of India, in the
case of Mardia Chemicals Ltd V Union of India, made a significant ruling
stating that the SARFAESI Act 2002 is legal, with the exception of subsection
(2) of section 17, which is in violation of Article 14 of the Constitution of
India. The decision is thoroughly examined since the purpose of enhancing the
Creditors Protection Regime was legally evaluated based on the Constitution.
The Petitioner Borrower's contentions
were that
a. That the secured creditors are
granted arbitrary powers.
b. There is a lack of a suitable and
sufficient method to challenge the accuracy of the demand, its legitimacy, and
the exact amount of the outstanding debts that are being sought to be
collected.
c. The document does not include any
provision of the Natural Justice Principle of hearing for the borrower.
d. The RDDBFI Act 1993, which is
intended for the recovery of dues, already exists.
e. The need of a 75% pre-deposit in an
appeal is arbitrary and violates Article 14.
The Respondent Banks argued that:
a. The objective of the Act is to reduce
Non-Performing Assets (NPA) in the interest of the economy.
b. A swift law for the enforcement of
security interest is crucial.
c. The borrower has the opportunity to
raise objections after receiving a notice.
d. The requirement of a 75% pre-deposit
is not mandatory and can be waived.
e. The exclusion of civil courts'
jurisdiction was necessary to avoid wasting valuable time and resources due to
judicial delays.
The important factor in the decision of the Mardia
Chemicals case was-
i.
Although the transaction may resemble a
private contract, it is crucial to consider the significant impact it has on
the country's economy as a whole. This is especially important when the
financing is done through banks and financial institutions using public funds.
ii. The outstanding debts of banking
firms and financial institutions that used public funds for loans were
increasing. In light of recommendations from expert groups, it was deemed
necessary to establish a statute that would offer a faster solution before any
significant financial setback happens. Enacting such law would serve the
greater good of the public, with individual interests being secondary to it.
iii. In cases where there is significant
public interest and it is required to achieve a goal that benefits the public,
individual rights may need to be compromised. The primacy of public interest
over private interest has always been acknowledged.
iv. Individual interests may be
influenced to a certain degree, but they cannot surpass the importance of
public interests, which have a significant impact on the socio-economic
development of the country. Legislative actions implemented in the public
interest have frequently infringed upon the existing rights of individuals.
Although a small number of borrowers may be impacted sporadically, this would
not undermine the legitimacy of the Act, which ultimately benefits the broader
public interest.
v. In today's global economy, it might
be challenging to adhere to traditional methods of funding and collecting
outstanding payments. Therefore, it is necessary to acknowledge that there was
a need to take action to develop methods for expediting the recovery of
non-performing assets (NPA's). Given the current global financial situation, if
it is deemed necessary to implement a faster legal process for debt recovery,
such a policy decision should not be criticised or questioned by the courts in
terms of its legitimacy as a financial policy measure.
vi. The Reserve Bank of India has
established certain terms, conditions, and circumstances under which a debt is
categorised as a non-performing asset. Therefore, the claim that there are no
standards for categorising the debt as a non-performing asset is unfounded.
vii. Upon the implementation of actions
specified in paragraph (4) of section 13 and prior to the property's sale or
auction, the borrower has the option to submit an appeal under Section 17 of
the SARFAESI Act 2002 to the Debt Recovery Tribunal. Upon receiving a 13(2)
notice, if the borrower presents any objection or provides facts for the
secured creditor to consider, it is necessary to carefully consider the
response and provide the borrower with clear reasons for not accepting the objections,
regardless of how concise they may be.
viii.
The
need of a 75 percent deposit at the beginning of the proceedings appears to be
excessive and unfair. The demand for a substantial deposit based only on one
party's claim cannot be considered a fair condition prior to the commencement
of dispute resolution. Granting the Tribunal the authority to waive or decrease
the amount does not address the inherent flaw that heavily favours the party
that has been solely responsible for determining the amount, establishing the
default, and categorising the dues as non-performing assets, without involving
or including the borrower in the process.
2.
Keshavlal Khemchand and Sons Pvt. Ltd Vs. Union of India &
Others [(2015) 4 SCC 770]
In this case, the borrowers raised several
contentions before the Hon'ble Supreme Court of India, challenging the
constitutionality of the modified definition of the phrase 'NPA' under Section
2(1)(o) of the SARFAESI Act.
a. The Parliament relinquished its fundamental
legislative role by granting authorization to other entities to establish
standards that determine whether a borrower's account might be categorised as a
Non-Performing Asset (NPA).
b. The revised definition of Non-Performing
Assets (NPA) allows various creditors to implement diverse guidelines that
establish distinct criteria for determining whether a borrower's account
qualifies as an NPA.
c. The SARFAESI Act does not allow for a
fair chance to prove that the categorization of the borrower's account as
Non-Performing Asset (NPA) is unfounded. As a result, the authority to
establish such a classification becomes arbitrary and in violation of Article
14 of the Constitution.
Principles evolved through judicial decisions on
Constitutionality of SARFAESI Act 2002
Over
time, principles regarding the constitutional legitimacy of the SARFAESI Act
2002 have developed. These principles serve as the basis for all other judicial
decisions that support the rights of both creditors and debtors.
a. Section 9 is constitutionally valid
despite the absence of a show cause chance for the borrower prior to the
takeover of management.
b. The pre deposit requirement of 75%
under section 18 is deemed unlawful and unjustifiable.
c. The pre-deposit requirement of 50%
under section 18 is deemed constitutionally sound, while the Debt Recovery
Tribunal (DRT) has the authority to lower it to 25%.
d. The Debt Recovery Tribunal is
responsible for determining whether the actions taken by banks and financial
institutions under section 13(4) comply with the provisions of the Act and the
rules established under it.
The borrower has the right to make objections
regarding any actions taken by the bank that may be considered illegal, such as
a. When the adjustment of the amount is
not accurately stated in the notice.
b. The interest calculation does not
adhere to the agreed terms.
c. The bank's action is prohibited due
to the statute of limitations.
d. The bank's actions are not in line
with the provisions of section 13(4). Thus, the revised section 17 is not a
mere 15 formality and is therefore constitutionally legitimate.
e. The assignment of debt will not be
deemed against public policy just because the assignee has acquired the
obligation at a significantly reduced price.
f.
The
borrower does not have the right to dispute the assignment of the obligation,
and no court order can be made to enforce the contractual right.
g. Section 14 of the SARFAESI Act is
legally legitimate under the constitution. The absence of an adjudicatory
procedure in section 14 does not automatically make Article 14 invalid. The
DM/CMM is required to authenticate the presence of factual information in
accordance with the affidavit provided by the 18 secured creditor.
h. The authority to categorise an asset
as a non-performing asset (NPA) is not in violation of the constitution.
Securitization
According to Section
2(1)(z) of the SARFAESI Act, 2002, "Securitization" refers to the
process of acquiring financial assets by a securitization company or
reconstruction company from an originator. This can be done by raising funds
from qualified institutional buyers through the issuance of security receipts
that represent a share in the financial assets, or by other means. In other
words, securitization means :-
a.
Securitization
is a financial market innovation that involves transforming contractual debt
into tangible securities, packaging and underwriting them, and then selling
them to end investors.
b.
Receivables
securitization is a transaction in which the owner of receivables (known as the
originator or seller) sells those receivables to a third party (known as the
purchaser or SPV, which stands for special purpose vehicle). In exchange, the
seller receives an instant payment for the purchase price.
c.
Securitization,
in its broadest meaning, refers to any procedure that transforms a financial
relationship into a transaction.
Advantages of
Securitization:
(i).
For
banks and financial institutions:
a.
Asset
liability management refers to the strategic management of a company's assets
and liabilities to ensure financial stability and minimise risk.
b.
Reduced
cost of capital and exemption from capital adequacy requirement are benefits
that result in lower expenses and regulatory obligations for a company.
c.
Enhanced
liquidity
d.
Attaining
skill and specialization
e.
Income
generated from special purpose vehicle
(ii).
For
individuals seeking to borrow funds or individuals looking to invest:-
a. Utilisation of securities for
targeted risk mitigation objectives
b. Investment marketability and ease of
converting assets into cash
c. Enhanced safety and increased yields
d. Third party surveillance
Securitization is the procedure of
combining and reorganising financial assets, such as loans, into tradable
securities that may be offered to investors. Securitization refers to the
conversion of illiquid assets, such as loans, into tradable securities, within
the framework of poor asset management. The securitization business assumes
responsibility for holding the mortgaged assets that serve as collateral for
the borrower's loan. It might commence the subsequent actions:
a. The act of obtaining financial assets from any
source, such as a bank.
b. The act of obtaining funds from
qualified institutional buyers by issuing security receipts, which are used to
acquire the financial assets.
c. The act of obtaining funds in a
manner that is specified by regulations.
d. The act of acquiring a financial
asset while also taking custody of the mortgaged land, building, etc.
ASSET RECONSTRUCTION
According to Section 2(1)(b) of the
SARFAESI Act, 2002, "Asset Reconstruction" refers to the
securitization or acquisition by a securitization company or reconstruction
company of any rights or interests of a bank or financial institution in any
financial assistance, with the intention of realising that financial
assistance.
Asset reconstruction refers to the
process of transforming a non-performing or bad asset into a performing asset.
The asset reconstruction process entails multiple stages, such as the
acquisition of distressed assets by a specialised Asset Reconstruction Company
(ARC), which includes the underlying hypothecated asset. The bad asset is then
transformed into a good asset through the utilisation of bonds, debentures,
securities, and cash. Finally, returns are obtained from the hypothecated
assets. The loans provided by banks are categorised as either performing or
non-performing assets based on the following criteria:
1. Performing Assets
Standard assets refer to assets that are free from any issues
and bear only the regular level of risk associated with the business. A
performing asset is an asset that creates revenue for the bank. An asset is
considered as such when neither the interest nor the principal have been late
for more than 180 days (reduced to 90 days starting from March 2004) by the end
of the financial year.
2. Non-performing assets
According to Section 2(1)(o) of the SARFAESI Act, a
"Non-Performing Asset" refers to an asset or account of a borrower
that has been classified by a bank or financial institution as sub-standard
[doubtful] or lost asset. This classification is based on the directions or
guidelines issued by the relevant authority or body established by law, or by
the Reserve Bank in other cases. In this study, the term "non-performing
asset" refers to an asset or account of a borrower that a bank classifies
based on the recommendations or guidelines of the Reserve Bank of India.
An amount is classified as a
non-performing asset when it no longer generates income for the Bank. An asset
can be classified as a Non-Performing Asset (NPA) if the interest and/or
principal installment remain unpaid for more than 180 days (changed to 90 days
starting from March 04). Banks and Financial Institutions are not allowed to
include the interest earned on such Non-Performing Assets in their income
unless it has been actually received or recovered. Non-performing assets are
categorised into
a.
substandard
assets :- It refer to loans that have been non-performing for a maximum of two
years. In this case, the borrower's current net worth or the current market
value of the collateral used for the loan is insufficient to guarantee full
debt recovery.
b.
Doubtful
Assets :- Loans that have been non-performing for more than two years and are
not categorised as loss assets by the management or the internal/external
auditor selected by RBI.
c.
Loss
Assets :- Assets that have been identified as having incurred a loss by either
the bank's internal or external auditor, or by the RBI. However, the loss
amount has not been completely or partially written off. These assets are
deemed irretrievable and hold minimal value for the loan institution.
OFFENCES AND PENALTIES
The Securitisation Act outlines the
offence and penalties :-
a. Failing to file details of revisions
or transactions related to asset securitisation, asset reconstruction, and the
creation of security interest in case of failure to file the aforesaid
transaction details, both the company and its officers, as well as the lender
and its officers, may be subject to a fine of up to Rs. 5,000 per day for the
duration of the default.
b. Failure to provide notification of
specific contentment.
c. Failure to comply with RBI directions
by SCO and RCO. Failure to comply with the orders of the RBI will result in
penalties for both the firm and its officers. The company may be fined up to
Rs. 5,00,000/-, and for each day that the non-compliance persists, an
additional fee of Rs. 10,000/- would be imposed.
Only a Metropolitan Magistrate or
Judicial Magistrate of the First Class possesses the authority to acknowledge
and adjudicate upon a crime under the Securitisation Act.
RIGHTS OF THE BORROWER
a. The SARFAESI Act has successfully
provided secured creditors with effective means to recover their long overdue
debts from Non-Performing Assets. However, the rights of the borrowers have
also been appropriately included in the law and cannot be disregarded.
b. The borrowers have the option to
settle their outstanding debts at any point before to the sale, thereby
preventing the loss of their securities.
c. If the Authorized Officer engages in
any unlawful or unethical behaviour, he will be held accountable for legal penalties.
d. The borrowers shall have the right to
get compensation for such actions.
e. For addressing their complaints,
debtors have the option to seek recourse through the Debt Recovery Tribunal
(within 45 days) and subsequently the Debt Recovery Appellate Tribunal (within
30 days) for an appeal.
The Act establishes four conditions
that must be met in order for a creditor to enforce their rights.
a. The debt is backed by collateral;
b. The banks have categorized the debt
as Non-Performing Assets;
c. The unpaid amount exceeds one lakh
and represents more than 20% of the original loan amount, including interest;
d. The collateral to be utilized does
not consist of Agricultural land.
CONCLUSION
The
SARFAESI Act is enacted with a distinct purpose to facilitate banks and financial
institutions to recover dues in a speedy manner by enforcement of security
interest without intervention of the court. The object of the debt recovery
laws is to reduce non-performing assets and increase liquidity in the market.
Though the enactment of the SARFAESI Act sought to mobilise blocked funds of
the banks in the non-performing assets, the various provisions of the acts have
created deep sorrows for the genuine buyers. The various provisions meant to
balance the requirements of the borrowers and the banks, have their balance of
favour tilted towards the banks. These powers are, at majority of the times,
mis-utilised by the banks to appropriate their interests against the interests
of the buyers. Commendably, the Ruling has attempted to preserve the right to
property of the borrower by ensuring that a borrower is not disposed without
due process of law, the underlying premise being that secured creditors are not
allowed to abuse the wide powers provided to them under the SARFAESI Act.
BIBLIOGRAPHY
Primary Sources
Statutes/Conventions/documents/Reports
·
Report of Narasimhan Committee – I and II on NPA and
Assets Reconstruction Fund (ARF)
·
Reports of Andhyarjuna Committee
·
Reports of the working group on development of the
market for Asset Securitisation set up by the RBI under the chairmanship of
Sh.V.S.N Murthy in June 1999 to examine issues involved and recommend as to how
asset securitisation could be introduced in the Indian Financial System.
·
Securitisation in India: Next Steps: Inaugural address
by Dr. Y.V.Reddy, Deputy Governor, RBI at seminar on Governments securities
markets at Chennai, on April 1999.
·
The NPA overhand- Magnitude, solutions, Legal reforms:
Text of address by Deputy Governor, (Sh. G.P.Maniappa) at CII Banking Summit
2002 at Mumbai on April, 2002.
·
Mardia Chemical Ltd.vs. UOI: Case No. Transfer Case
(Civil) 92-95 0f 2002 Reported in (2004) 16s ILD 516 (SC)=2004(4) SCC
311=204(3)ACD 50 (SC)=11(2004) BC 397 (SC)
Acts and
Bills
·
The Securitisation and Reconstruction of Financial
Assets and Enforcement of Security Interest Act, 2002.
·
The Recovery of Debts due to Banks and Financial
Institution Act, 1993.
·
The Companies Act, 1956
·
The Companies Act, 2013
·
The Securities Contracts (Regulation) Act, 1956.
·
The Sick Industrial Companies (special Provisions)
Act, 1985.
·
Transfer of Property Act,1882.
·
Indian Contract Act,1872.
·
The Security Interest (Enforcement), Rules,2002.
·
The Enforcement of Security Interest and Recovery of
Debt Laws (Amendment) Ordinance, 2004.
Secondary
Sources
Books
·
Avtar Singh, “Company Law” (2023), Seventeenth
edition, Eastern Book Company.
·
Avtar Singh, “Law of Contracts and specific Relief”
(2022) Thirteenth edition. Eastern Book Company, Lucknow.
·
Dr. H.P.Gupta (2005), Debt Recovery Laws, (first
edition), publisher- Deval Publishing House, Allahabad.
·
Justice B.P.Banerjee(2003), Guide to Securitisation,
Reconstruction of Financial Assets and Enforcement of Security Interest, Wadhwa
and Company, New Delhi.
·
Justice Y.V.Chandrachud and Dr.S.M.Dugar, “Guide to
the Companies Act (2004), A Ramaiya Sixteenth edition, Part I,II,III,
publisher: Wadhwa and Company, Nagpur.
·
K.Panduranga Rao, (2004), Law relating to
Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest, Asia Law House, Hyderabad.
·
M.L.Tannan, “Taxman’s Banking Law and Practice in
India” (2021), twenty-ninth edition,
Volume 1 and 2, India Law House, New Delhi.
·
Mulla, “The Transfer of Property Act”, (2023),
Fourteenth edition Lexis Nexis Butterworths.
·
Vinod Kothari, Securitisation, Asset Reconstruction
and Enforcement of Security Interests; Incisive Commentary on the Law and Rules
and comprehensive Introduction to securitisation, asset reconstruction and
enforcement of security interest, (2003), Academy of Financial Assets,
Kolakata.
Internet
Websites
Article Information
RECOVERY OF DEBTS DUE TO BANKS AND FINANCIAL INSTITUTIONS WITH SPECIAL EMPHASIS ON SARFAESI ACT, 2002
Authors: SHREYANSH ANAND
- Journal IJLRA
- ISSN 2582-6433
- Published 2024/05/01
- Issue 7
About Journal
International Journal for Legal Research and Analysis
- Abbreviation IJLRA
- ISSN 2582-6433
- Access Open Access
- License CC 4.0
All research articles published in International Journal for Legal Research and Analysis are open access and available to read, download and share, subject to proper citation of the original work.
Disclaimer: The opinions expressed in this publication are those of the authors and do not necessarily reflect the views of International Journal for Legal Research and Analysis.