Non Performing Assets Legal Paradigm

PART ONE
Dr. Nandimath Omprakash V.,
Professor in Law,
National Law School of India University,
Bangalore-560 072
Email ovnandimath@nls.ac.in

Contents
PART ONE
Understanding NPAs and its implication
SICA & DRT
PART TWO
concept of securitization; and
SARFAESI an overview
PART THREE
SARFAESI legal framework

Non performing assets what are they?

A loan asset, which has ceased to generate any
income for a bank whether in the form of an asset or
interest
Master Circular of July 2010 (DBOD. No. BP. BC.
21/21.04.048/2010-11) defines a NPA

 An asset, including a leased asset, becomes non

performing when it ceases to generate income for the
bank

 NPA is a loan or advance where

Interest and/or installment of principal remain overdue for
a period of more than 90 days in respect of a term loan
The account remains out of order, in respect of an
OD/cash credit
The bill remains overdue for a period of more than 90
days in case of bills purchased and discounted
The installment of principal or interest thereon remains
overdue for two crop seasons for short duration crops
The installment of principal or interest thereon remains
overdue for one crop season for long duration crops

 The amount of liquidity facility remains outstanding for

more than 90 days, in respect of a securitization
transaction undertaken in terms of guidelines on
securitization dated February 1, 2006
In respect of derivative transactions, the overdue
receivables representing positive mark-to-market value
of derivative contract, if these remain unpaid for period of
90 days from the specified due date for payment

Banks should, classify an account as NPA only if the

interest due and charged during any quarter is not
serviced fully within 90 days from the end of the quarter

Categorization of NPAs
1. Substandard assets
1. The NPA which has remained so for a period of 12 months or
less

2. Doubtful assets
1. The NPA which has remained as substandard for a period of
12 months

3. Loss assets
1. A loss asset is one where loss has been identified by the bank
or internal or external auditors or RBI inspection, but the
amount has not been written-off fully
2. Such an asset is considered uncollectable and of such little
value that its continuance as a bankable asset is not
warranted although there may be some salvage or recovery
value

Mandate to account on receipt basis

Internationally income from NPA is not recognized on
accrual basis
But booked as income only when it is actually received
Therefore, banks should not charge and take to income
account interest on any NPA

How NPA would impact

Bound to create an adverse repercussion for the
economy of the country
Interest income of banks will fall
Banks profitability is affected adversely
Return on investment is reduced
The cost of capital will go up
Asset and liability mismatch will widen
It limits recycling of the funds

Remedying NPAs
1981 Tiwari Committee
Examined the means of recovering NPAs;
Recommended for setting up of special tribunals to
expedite the recovery process

1991 Narsimhan Committee

Reemphasized few of recommendations of Tiwari
Committee
Called for the definition of NPA
Setting up of Debt Recovery Tribunal
Creation of Asset Reconstruction Fund

 1999 Andhiyarjuna Committee

Submitted four reports for
1. On Debt Recovery Tribunals
2. Amendment to Sec. 28 of the Indian Contract Act;
3. Taking possession and sale of securities without
intervention of courts by Banks and Financial
Institutions
4. Special law for securitization

Development of regulatory regime

The FIRST PHASE
the Sick Industrial Companies (Special Provisions) Act,
1985
Based on the recommendations of Tiwari Committee
(basically to deal with Industrial Sickness);
The enactment inter alia
Established Board for Industrial and Financial
Reconstruction (BIFR); and
Appellate Authority for Industrial and Financial
Reconstruction (AAIFR).

 The SECOND PHASE

The Recovery of Debts due to Banks & Financial
Institutions (RDDBFI) Act, 1993
Special Debt Recovery Tribunals were established
Summary proceedings to help banks and FIs to realize
their debts
Effective and speedy recovery of bad loans

 The THIRD PHASE

The Securitization and Reconstruction of Financial
Assets and Enforcement of Security Interest Act, 2002
Stressed the need for overall change in the legal system
to address the issue of NPAs
Empowering the banks and FIs to take possession of
securities and sell them without the intervention of the
courts; and
Without allowing the borrowers to take shelter under the
provisions of SICA/BIFR

First phase
The Sick Industrial Companies (Special Provisions)
Act, 1985
An Act to make in public interest, special provisions
with a view to securing the timely detection of sick and
potentially sick companies owning to industrial
undertakings, the speedy determination by a Board of
experts of the preventive, ameliorative, remedial and
other measures, which need to be taken with respect to
such companies and the expeditious enforcement of
the measures so determined and for matters connected
therewith and incidental thereto

Recovery of Debts due to Banks &

Financial Institutions Act, 1993

An Act to provide the establishment of tribunals for

expeditious adjudication and recovery of debts due to
banks and financial institutions and for matters connected
therewith or incidental thereto

Few preliminaries

Came in to force from June 24, 1993

Act to cope with the requirement of time
The Act is procedural in nature
The jurisdiction of DRT is at present form above
Rupees Ten Lakhs
In UOI v Delhi High Court Bar Association (2002)4
SCC 274 the Constitutionality of the Act was upheld
by the Supreme Court

 The Act is applicable for the debt to

Any bank; or
Financial Institution; or
A consortium of them

 Expression debt shall cover [S.2(g)]

Any liability inclusive of interest, whether secured; or
Any liability inclusive of interest, whether unsecured; or
Any liability payable under a decree or order of any Civil
Court or any arbitration award or otherwise; or
Any liability payable under a mortgage and subsisting on
and legally recoverable on the date of application

The Tribunal
The Central Government is empowered to establish
one or more Tribunals to be known as Debt Recovery
Tribunal (DRT)
Central Government to decide and specify the areas
within which the Tribunal may exercise jurisdiction

Tribunal - composition
Consists of only one Presiding Officer
Qualified to be appointed as a District Judge

The Presiding Officer holds office for five years from

the date of which he enters upon his office; or until he
attains the age of 62 years, whichever is earlier

 Currently each DRT has two Recovery Officers

The work among the Recovery Officers is allocated by
the Presiding Officer
There is no mandate that the Recovery Officer shall be
a judicial officer

Appellate Tribunal
Central Government is empowered to establish one or
more Appellate Tribunals
The Appellate Tribunal is held by Chairperson
Who shall be qualified to be judge of the High Court; or
Has been member of the Indian Legal Service and has
held the post in Grade I of that service for at least three
years; or
Has held office as the Presiding Officer of a Tribunal for
at least three years

Express bar
No court or other other authority shall have any
jurisdiction to deal with any cases pertaining to
recovery cases above Rupees 10 lakhs

Procedure of the Tribunal

Application of the Tribunal
Where to apply? - The Tribunal in whose jurisdiction
The defendant at the time of making the application
for loan reside or carry on business or personally
work for gain; or
Any of the defendant at the time of making application
for loan reside or carry on business or personally
work for gain; or
Any of the defendant, where there are more than one
defendant, reside at the time of making application for
loan or carry on business or personally work for gain;
or
The cause of action, wholly or in part, arises

 Issue of summons on receipt of application Tribunal

has to issue summons to the defendant [Sec. 19(4)]
The defendant has to present a written statement at or
before the first hearing or within such time as Tribunal
may permit [Sec. 19(5)]
The Tribunal may pass such interim order against the
defendant [Sec. 19(12)]
At any stage of the proceeding the Tribunal if
satisfied by affidavit or otherwise that the defendant,
with the intent to obstruct or delay or frustrate the
execution of any order for the recovery of debt that may
be passed against him [Sec. 19(13A & B)]

Appeal to the Appellate Tribunal

Any aggrieved party may prefer an appeal against the
order of the Tribunal (but not in case the order made
with consent of the parties)
Within 45 days from the date on which the copy of the
order is received;
50% of the amount shown as due shall be deposited

After hearing both the parties the Appellate Tribunal

shall pass such an order as it thinks fit
Tribunal shall deal with an appeal as expeditiously as
possible, within six months from the date of receipt of
the appeal

 The Tribunal and Appellate Tribunal are deemed to be

a Civil Court for all purposes of Section 195 and
Chapter XXVI of the Code of Criminal Procedure, 1973
However, for approaching the Tribunal the Limitation
Law is applicable
Application must be filed by the bank or the financial
institution within three years from the cause of action

SARFAESI Act, 2002

Background
SARFAESI Act, 2002 a third step in the governments
initiative towards NPA management
The existing law was found to ineffective
Sec. 22 of SICA was identified to be an impediment
The enactment of RDDBFI was felt to be somewhat
ineffective due to
Lengthy process
Inadequate infrastructure

Objective of the Act

To introduce legal framework
Securitization of financial assets
Reconstruction of financial assets
Power to ensure security for realization in the event of
default without intervention of the courts
Enabling for setting up of Central Registrary for
registration of transactions of securitization,
reconstruction and creation of security interest

Three concepts
SECURITIZATION

RECONSTRUCTION

ENFORCEMENTOFSECURITYINTEREST(withoutintervention
ofcourt)

The fundamental premise

That, three is an obligation on the part of the borrowers
to repay loans and if they are unable to repay; then the
securities for the loans are liable to be sold for recovery
of loans
The provisions of this Act shall have overriding effect,
notwithstanding anything inconsistent in any other law
for the time being in force

What is securitization?
A process of pooling and repacking of homogeneous,
liquid financial assets into marketable securities
It is a structured financial instrument and a means of
raising funds by transfer of assets
This allows the securitizing organization/bank to get
fund up front, which can be put to more productive use
in the business

 S. 2(1)(z) Securitization means acquisition of

financial assets by any securitization company or
reconstruction company from any originator, whether
by raising of funds by such securitization company or
reconstruction company from qualified institutional
buyers by issuing security receipts representing
undivided interest in such financial assets or otherwise
S. 2(1)(za) securitization Company means any
company formed and registered under Companies Act,
1956 (1 of 1956) for the purpose of securitization

POSTSECURITIZATION

ORIGINATOR

SERVICER

HIGHQUALITYRECEIVABLES[EX.HOME
MORTGAGELOANS,CONSUMERCREDIT
RECEIVABLESETC.,]

SERVICEFEE

PURCHASEPRICE
SPV

GRANTOFSECURITY
BANKS

FUNDING

BANKS

OTHERINVESTORS

CREDITENHANCEMENT

THIRDPARTYMAYGIVEGURANTEETOSPVORTHE
ORIGINATORMAYAGREETOMAKESUBORDINATED
LOANTOSPV

Securitization

Registration of SC/RC
Sec. 3 Mandatory Registration with RBI
Minimum stability requirement
Owned fund of not less than rupees two crores; or
Up to 15% of the total financial assets acquired or to
be acquired

 SC sets up SPVs for different schemes by constituting

trusts of which it is a trustee
SPV holds the assets for the sole and simple benefit of
the investors

 SPVs are submitted to the following qualifications

It shall not get into any business, other than the business
of holding the assets and realize them;
It is not allowed to issue liabilities (bankruptcy remote)
Cant have any permanent employees and for any
outsources services it shall obtain an undertaking from
the service provider that the later will not file a petition for
winding up of the SPV for non-payment of the fees
Rights of the equity holders of the company to resolve for
voluntary winding up is restricted

 Only QIBs (Qualified Institutional Buyers) can only be

intended buyers (Act recognizes only private
placement) S. 2(1)(u)

Asset Reconstruction

Asset reconstruction of financial assets

The word asset reconstruction company is an Indian
equivalent to asset management company
Therefore an ARC will perform
Buy NPAs at a discounted price; and
Restructuring of bad debts.

Asset Reconstruction Company (India) Limited [ARCIL]

was the first ARC to be incorporated in India

 Asset Reconstruction means acquisition by any

SC/ARC of any rights or interests of any bank or
financial institution in any financial assistance for the
purpose of realization of such financial assistance [Sec.
2(1)(b)]
Therefore, asset reconstruction is much broader term
than Securitization

 Act provide some measures for asset reconstruction,

which can be taken up having regard to the guidelines
framed by RBI
Proper management of the business of the borrower;
Sale or lease of a part or whole of the business of the
borrower;
Rescheduling of payment of debts;
Settlement of dues;
Enforcement of security interest;
Taking possession of the secured assets

Enforcement of Security Interest

Steps
Notice by secured creditor to the borrower whose
account has been classified as NPA
60 days notice;
On receipt of such notice, borrower cant transfer the
secured assets without the consent of the secured
creditor.

Objections by borrower for the consideration of the

secured creditor after considering the objections
creditors will covey reasons for not accepting them
Failure continues the bank or FI may take recourse to
any of the measures u/s 13(4)

Measures u/s 13(4)

Take possession of the secured assets including the
right to transfer by way of lease, assignment or sale
Takeover the management of the business of the
borrower
Appoint Manager to manage the security
Ask any debtors of the borrower to pay any sum due to
the borrower
NOTE if all the dues with costs and charges and
expenses incurred by the creditor is tendered before
the date fixed for sale of the assets no further steps
be taken for sale of the property

Right of appeal Sec. 17

Any person who is aggrieved by any of the measures
u/s 13(4) may appeal to the DRT within 45 days from
the date on which such measures were undertaken
Appeal is only entertained only after 50% of the
amount claimed is deposited by the borrower with DRT

 Mardia Chemicals Ltd., v UOI, JT 2004 (4) SC 308

Issue No. 1 whether the provisions u/s 13 & 17,
provide adequate and efficacious mechanism to consider
the objections raised by a borrower against the recovery,
particularly in view of bar to approach the civil court
under Sec. 34 of the Act?

HELD
Bank/FI must apply its mind while considering the
objections of the Borrower and should not just
mechanically reject
The matter is contractual between the two parties and
they are supposed to act in accordance to the terms of
contract

The insertion of Sec. 13(3A)

Now there is a statutory duty upon the creditor to
consider the objections raised by the borrower and to
communicate the reasons for non acceptance of
borrowers objections.
It is now expressed that the borrower has a right to
know the reasons for non-acceptance; but cant
challenge these reasons unless right to approach DRT
u/s 17 matures

 Issue No. 2 whether remedy available u/s 17 of the Act

is illusory for the reason it is available post-action u/s
13(4); & the appeal would be entertainable only on
deposit of 75% of the claim raised in the notice of
demand?

 HELD
Condition of pre-deposit was held to be bad
As it is imposed while approaching adjudicating authority;
and not in appeal
There is no determination of the amount due as yet
The secured assets or its management is already taken
over and under the control of the secured creditor
It will leave the borrower in a position where it would not be
possible for him to raise any funds to make deposit of 75%
of the undetermined demand
Such conditions are not alone onerous and oppressive; but
also unreasonable and arbitrary

Conclusions
SARFAESI has proved to be a strong legislative
initiative; however the issue of NPA is still to be
resolved to the level of satisfaction
The market for securitized NPA is yet to be developed
Due to unrealistic high book value & low realizable
value the NPAs acquired by the ARC/SCs cant be
disposed of (lack of appropriate secondary market)
No regulatory framework for investment by QIBs
No specific capital market regulatory framework is in
place to govern the QIB investments (which is essential
for the development of the market)

Thanks very much

Questions
Clarifications
Suggestions for improvements