CHAPTER : 1

INTRODUCTION

“The Securitization and Reconstruction of Financial Assets and Enforcement of Security

Interest Act, 2002” is a Indian legislation that helps financial institutions in recovery of
Non Performing Assets (NPA). It provides different process and mechanisms for
recovery of bad assets. It address the interests of secured creditors like Banks and Non
Banking Financial Institutions.

The SARFESI Act empowers Banks / Financial Institutions to recover their non-
performing assets without the intervention of the Court. The Act provides three
alternative methods for recovery of non-performing assets, namely: -

 Securitization

 Asset Reconstruction

 Enforcement of Security without the intervention of the Court

All the three methods are discussed in detail in Chapter 2 of this dissertation

“Non-performing assets should be backed by securities charged to the Bank by way of

hypothecation or mortgage or assignment. Security Interest by way of Lien, pledge, hire
purchase and lease not liable for attachment under sec.60 of CPC, are not covered under
this Act”

The Act empowers the Banks and Financial Institutions :

 “To issue demand notice to the defaulting borrower and guarantor, calling upon them
to discharge their dues in full within 60 days from the date of the notice.”

 “To give notice to any person who has acquired any of the secured assets from the
borrower to surrender the same to the Bank.”

1
 “To ask any debtor of the borrower to pay any sum due or becoming due to the
borrower.
Any Security Interest created over Agricultural Land cannot be proceeded with.”

 “If on receipt of demand notice, the borrower makes any representation or raises any
objection, Authorised Officer shall consider such representation or objection
carefully and if he comes to the conclusion that such representation or objection is
not acceptable or tenable, he shall communicate the reasons for non acceptance
WITHIN ONE WEEK of receipt of such representation or objection.”

Legal Remedy for Borrower

“A borrower / guarantor aggrieved by the action of the Bank can file an appeal with DRT
and then with DRAT, but not with any civil court. The borrower / guarantor has to
deposit 50% of the dues before an appeal with DRAT.”

“With an aim to provide a structured platform to the Banking sector for managing its
mounting NPA stocks and keep pace with international financial institutions, “The
Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest Act” was put in place to allow banks and FIs to take possession of securities and
sell them. As stated in the Act, it has "enabled banks and FIs to realise long-term assets,
manage problems of liquidity, asset-liability mismatches and improve recovery by taking
possession of securities, sell them and reduce non performing assets (NPAs) by adopting
measures for recovery or reconstruction." Prior to the Act, the legal framework relating to
commercial transactions lagged behind the rapidly changing commercial practices and
financial sector reforms, which led to slow recovery of defaulting loans and mounting
levels of NPAs of banks and financial institutions.”

Methods of NPA Management

“The SARFAESI Act has been largely perceived as facilitating asset recovery and
reconstruction. Since Independence, the Government has adopted several ad-hoc
measures to tackle sickness among financial institutions, foremost through nationalisation
of banks and relief measures. Over the course of time, the Government has put in place

2
various mechanisms for cleaning the banking system from the menace of NPAs and
revival of a healthy financial and banking sector. Some of the notable measures in this
regard include:”

“Sick Industrial Companies (Special Provisions) Act, 1985 or SICA: To examine and
recommend remedy for high industrial sickness in the eighties, the Tiwari committee was
set up by the Government. It was to suggest a comprehensive legislation to deal with the
problem of industrial sickness. The committee suggested the need for special legislation
for speedy revival of sick units or winding up of unviable ones and setting up of quasi-
judicial body namely; Board for Industrial and Financial Reconstruction (BIFR) and The
Appellate Authority for Industrial and Financial Reconstruction (AAIRFR) and their
benches. Thus in 1985, the SICA came into existence and BIFR started functioning from
1987.”

“The objective of SICA was to proactively determine or identify the sick/potentially sick
companies and enforcement of preventive, remedial or other measures with respect to
these companies. Measures adopted included legal, financial restructuring as well as
management overhaul. However, the BIFR SARFAESI ACT 2002: An Assessment
process was cumbersome and unmanageable to some extent. The system was not
favourable for the banking sector as it provided a sort of shield to the defaulting
companies.”

“Recoveries of Debts due to Banks and Financial Institutions (RDDBFI) Act, 1993: The
procedure for recovery of debts to the banks and financial institutions resulted in
significant portions of funds getting locked. The need for a speedy recovery mechanism
through which dues to the banks and financial institutions could be realised was felt.
Different committees set up to look into this, suggested formation of Special Tribunals
for recovery of overdue debts of the banks and financial institutions by following a
summary procedure. For the effective and speedy recovery of bad loans, the RDDBFI
Act was passed suggesting a special Debt Recovery Tribunal to be set up for the
recovery of NPA. However, this act also could not speed up the recovery of bad loans,
and the stringent requirements rendered the attachment and foreclosure of the assets
given as security for the loan as ineffective.”

3
“Corporate Debt Restructuring (CDR) System : Companies sometimes are found to be in
financial troubles for factors beyond their control and also due to certain internal
reasons. For the revival of such businesses, as well as, for the security of the funds lent
by the banks and FIs, timely support through restructuring in genuine cases was
required. With this view, a CDR system was established with the objective to ensure
timely and transparent restructuring of corporate debts of viable entities facing
problems, which are outside the purview of BIFR, DRT and other legal proceedings. In
particular, the system aimed at preserving viable corporate/businesses that are impacted
by certain internal and external factors, thus minimising the losses to the creditors and
other stakeholders. The system has addressed the problems due to the rise of NPAs.
Although”

“CDR has been effective, it largely takes care of the interest of bankers and ignores (to
some extent) the interests of borrower's stakeholders. The secured lenders like banks
and FIs, through CDR merely, address the financial structure of the company by
deferring the loan repayment and aligning interest rate payments to suit company's cash
flows. The banks do not go for a one time large write-off of loans in initial stages.”

“SARFAESI ACT 2002: By the late 1990s, rising level of Bank NPAs raised concerns
and Committees like the Narasimham Committee II and Andhyarujina Committee
which were constituted for examining banking sector reforms considered the need for
changes in the legal system to address the issue of NPAs. These committees suggested a
new legislation for securitization, and empowering banks and FIs to take possession of
the securities and sell them without the intervention of the court and without allowing
borrowers to take shelter under provisions of SICA/BIFR. Acting on these suggestions,
the SARFAESI Act, was passed in 2002 to legalize securitization and reconstruction of
financial assets and enforcement of security interest. The act envisaged the formation of
asset reconstruction companies and Securitization Companies.”

Objects of SARFAESI Act, 2002 :

 To enable the banks and FI to realise long-term assets, manage liquidity problems,
correct the balance sheet from problems of asset liability mismatch, to improve

4
 recovery of debts by exercising powers to take possession of securities and sell them
thereby reducing NPAs.

 To provide for setting up of asset reconstruction companies (ARCs) which are
empowered to take possession of assets mortgaged by the borrower with creditor.

 To remove the shackles over the rights of the secured creditors.

 To speed up the debt recovery process and to remove hurdles coming in the way
of debt realisation under the DRT Act.

 To provide the banks/FI with options to protect its assets from being alienated,
transferred or disposed of in any other manner.

 As per Section 17(2) of the SARFAESI Act, the DRT shall see whether measures
taken by secured creditor under Section 13(4) for enforcement of security secured
by borrower for recovery of bad loan are in accordance with the provisions of the
SARFAESI Act.

Applicability of SARFAESI Act, 2002

Following factors are necessary to apply the provisions of SARFAESI Act:

 Loan Account must have been declared NPA

 The amount of NPA Loan Account must exceed One Lakhs rupees
 Loan must have been granted against Secured Asset

Constitutional validity of SARFAESI Act

Mardia Chemicals Ltd v. Union of India1

This SLP was a result of various writ petitions filed in high courts that were clubbed
together. In this case the constitutional validity of the SARFAESI Act, 2002 was
challenged (specifically sections 13 &17).

1
(2004) 4 SCC 311

5
A notice under Section 13 was issued by IDBI to Mardia chemicals to pay back the
money within 60 days, failing which IDBI would be entitled to enforce security interest
without intervention of court or tribunal under section 13(4). After which, the possession
of Vatva plant of Mardia Chemicals in Surendranagar, Gujarat was taken by IDBI.
Similar notices were issued by other Financial Institutions (FIs) and Banks to different
parties.

Main contention- Banks and FIs have been vested with arbitrary powers, without any
guidelines.
Also no opportunity is given to the borrower.2

Also, Section 17(2) barred judicial remedies until 75% of claim amount was deposited.
The Supreme
outstanding
upheld by the
throughout the Court
loans withheld
Supreme
country. DRT that
Court, borrowers
forputting
making a 7large
would
endappeal
to no number
longerthe
. Whereas, have
of to deposit
validity
pending ofand 75%wasof
thelitigations
Act
“SC observed that though a loan transaction may have a character of private contract,
but money of general public is involved here as financing is done through Banks and
Financial Institutions. Therefore, where public interest is involved to such a large extent
individual rights may have to give way. Public interest has always been considered to be
above the private interest. Even if few borrowers are affected by the enactment, it would
not impinge upon validity of the Act, which otherwise serves larger interest.”

Issues in SARFESI Act

Right of Title

“A securitisation receipt (SR) gives its holder a right of title or interest in the financial
assets included in securitisation. This definition holds good for securitisation structures
where the securities issued are referred to as 'Pass through Securities'. The same
definition is not legally inadequate in case of 'Pay through Securities' with different
tranches
.”
Thin Investor Base
“The SARFAESI Act has been structured to enable security receipts (SR) to be issued
and held by Qualified Institutional Buyers (QIBs). It does not include NBFC or other
2
(2004) JULY PL (Jour) 22

6
bodies unless specified by the Central Government as a financial institution (FI). For
expanding the market for SR, there is a need for increasing the investor base. In order to
deepen the market for SR there is a need to include more buyer categories.”

Investor Appetite

“Demand for securities is restricted to short tenor papers and highest ratings. Also, it has
remained restricted to senior tranches carrying highest ratings, while the junior tranches
are retained by the originators as unrated pieces. This can be attributed to the
underdeveloped nature of the Indian market and poor awareness as regards the process of
securitisation.”

Risk Management in Securitisation

The various risks involved in securitisation are given below:

“Credit Risk: The risk of non-payment of principal and/or interest to investors can be at
two levels: SPV and the underlying assets. Since the SPV is normally structured to have
no other activity apart from the asset pool sold by the originator, the credit risk
principally lies with the underlying asset pool. A careful analysis of the underlying credit
quality of the obligors and the correlation between the obligors needs to be carried out to
ascertain the probability of default of the asset pool. A well diversified asset portfolio can
significantly reduce the simultaneous occurrence of default.”

“Sovereign Risk: In case of cross-border securitisation transactions where the assets and
investors belong to different countries, there is a risk to the investor in the form of non-
payment or imposition of additional taxes on the income repatriation. This risk can be
mitigated by having a foreign guarantor or by structuring the SPV in an offshore
location or have an neutral country of jurisdiction”

“Collateral deterioration Risk: Sometimes the collateral against which credit is

sanctioned to the obligor may undergo a severe deterioration. When this coincides with
a default by the obligor then there is a severe risk of non-payment to the investors. A

7
 recent example of this is the sub-prime crisis in the US which is explained in detail in
the following sections.”

“Legal Risk: Securitisation transactions hinge on a very important principle of

"bankruptcy remoteness" of the SPV from the sponsor. Structuring the asset transfer and
the legal structure of the SPV are key points that determine if the SPV can uphold its
right over the underlying assets, if the obligor declare bankruptcy or undergoes
liquidation.”

“Prepayment Risk : Payments made in excess of the scheduled principal payments are
called prepayments. Prepayments occur due to a change in the macro-economic or
competitive industry situation. For example in case of residential mortgages, when
interest rates go down, individuals may prefer to refinance their fixed rate mortgage at
lower interest rates. Competitors offering better terms could also be a reason for
prepayment. In a declining interest rate regime prepayment poses an interest rate risk to
the investors as they have to reinvest the proceedings at a lower interest rate. This
problem is more severe in case of investors holding long term bonds. This can be
mitigated by structuring the tranches such that prepayments are used to pay off the
principal and interest of short-term bonds.”

“Servicer Performance Risk: The servicer performs important tasks of collecting

principal and interest, keeping a tab on delinquency, maintains statistics of payment,
disseminating the same to investors and other administrative tasks. The failure of the
servicer in carrying out its function can seriously affect payments to the investors.”

“Swap Counterparty Risk: Some securitisation transactions are so structured wherein

the floating rate payments of obligors are converted into fixed payments using swaps.
Failure on the part of the swap counterparty can affect the stability of cash flows of the
investors.”

“Financial Guarantor Risk: Sometime external credit protection in the form of

insurance or guarantee is provided by an external agency. Guarantor failure can
adversely impact the stability of cash flows to the investors.”

8
CASE STUDY

Kingfisher Airlines Ltd. vs. State Bank of India & Ors3

FACTS :
“The said Application was filed contending that by invoking the jurisdiction of the this
Court for winding up, the Banks are deemed to have relinquished and surrendered all
security interest and therefore seeking to invoke Sec. 14 of the SARFAESI Act after
filing the Petition for winding up is wholly illegal and without jurisdiction. Further the
proceedings under SARFAESI may jeopardize the interests of a large number of
creditors, employees, shareholders and the company as well.”

ISSUES :
The following points were considered in this Judgment :-

 Whether there is a bar on jurisdiction of the High Court as a Company Court to grant
relief in the light of Sec. 34 & 35 of the SARFAESI Act?
 Whether the Banks could choose to stand outside the winding up, in seeking to
enforce the security assets and simultaneously prefer a Company Petition seeking for
winding up of the Company in respect of the balance debt not covered by such
security?

 Whether the Company Court could exercise jurisdiction over the secured assets
whether before or after a winding up order is passed when possession of the property
is sought to be taken by recourse to SARFASEI Act in the capacity of a secured
creditor?
HELD :
“After applying Sec. 34 & 35 of the Act with Sec. 446 (2), it was held that the Karnataka
High Court as a Company Court did not have jurisdiction to interfere. The Single Judge
held that a secured creditor can choose to stand outside the winding up and yet

3 Karnataka High Court Company Application No. 2214/2013 in Company Petition No. 164/2013

9
simultaneously prefer a company petition and also that the Company Court could not
exercise jurisdiction over the property when recourse is sought to be taken against the
secured asset by a secured creditor under SARFAESI Act. The Court held that the
Company Court could not exercise jurisdiction over the secured assets whether before or
after the winding up order is passed when the secured creditor has taken recourse under
SARFAESI Act. This so because the secured creditor does not need to relinquish his
secured asset if he files petition for a winding up. When the stage of proving his debt
does arise, he will only have to prove the balance due to him after he has realized the
secured assets. Thus secured creditor may pursue the remedies available to him
irrespective of the winding up.”

Punjab National Bank v. Raju M. Thomas4

ISSUES :
Whether guarantor can be construed as “borrower” under section 2 of the
SARFAESI Act, 2002?
“The guarantor is very much a ‘borrower’ as defined under Section2 (f) of the Act which
states: “borrower means any person who has been granted financial assistance by any
bank or financial institution or who has given a guarantee or created any mortgage or
pledge as security for the financial assistance granted by any bank or financial institution
and includes a person who becomes borrower of a securitization company or
reconstruction company consequent upon acquisition by it of any rights or interest of any
bank or financial institution in relation to such financial assistance”.

Whether Authorized officer has an obligation to serve notice to the guarantor too
under the Act?
“Rule 8(6) of the Rules casts a duty on the Authorized Officer to serve a notice on the
borrower about the proposed sale of the property at least 30 days ahead. That such a
notice has to be served on each of the borrower is evident from Rule 3(3) and Rule 3(4)
of the Rules. Any failure to issue notice as stated above shall invalidate the sale.”

4 O.P.(DRT).No.1390 OF 2012 and O.P.(DRT).No.2835 OF 2012

10
 CONCLUSION
“The Act addresses the interests of secured creditors. Its purpose is to promote the setting
up of asset reconstruction/securitization companies to take over the NPAs accumulated
with the banks and public financial institutions. It is the SARFAESI Act that brought a
greater change in the debt recovery scenario in the country. One of the important
changes that SARFAESI has brought is that it allowed the banks to take over possession
from the defaulter, without going through the stringent court procedure, once the loan
account has been categorized as a Non- Performing Asset.”

Deepthi Trading Company vs The Authorised Officer5

FACTS :

“The first petitioner is the borrower. The second and third petitioners are husband and
wife. The second petitioner is running the business of the first petitioner/trading
company. The third petitioner is doing some other business. According to the first
respondent/bank, the amount that has been borrowed from the bank was declared as a
non-performing asset and consequent to the same notice under Section 13(2) of the
Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002 was issued calling upon the petitioners to pay certain amount and
since the said notice has not been properly responded and no amount was paid,
possession notice under Section 13(4) of the SARFAESI Act was issued and that was
challenged by the petitioners before the Debts Recovery Tribunal-III, Chennai. The
Tribunal came to the conclusion that it had no jurisdiction over the subject matter of the
case placing reliance on decision of the Delhi High Court in Amish Jain and another v.
ICICI Bank Limited, 2012 (6) CTC 369, wherein it was held that where Tribunal has no
jurisdiction over a case, it is legally bound to dismiss the application. The Tribunal
decided on merits of the case and came to the conclusion on the validity of the notice
issued under Section 13(4) of the SARFAESI Act.”

5 C.R.P.No.1956 of 2013

11
ISSUES :

The following issues were formulated for consideration:

 Whether the applicant in the above SARFAESI Application is entitled to get the
relief as prayed for?

 Relief and costs?

JUDGEMENT :

“The Hon’ble Madras High Court held that once the Tribunal found that it had no
jurisdiction to entertain the SARFAESI Application, it is bound to return the papers and
as such is not empowered to pass any order touching upon the merits of the case. The
court placed reliance on decision of the Supreme Court in Sri Athmanathaswami
Devasthanam v. K.Gopalaswami Aiyangar6, and held that when the Tribunal had no
jurisdiction over the subject matter of the suit it cannot decide any question on merits. It
can simply decide on the question of jurisdiction and once concluded that it has no
jurisdiction over the matter has to return the plaint. Update Thus, in view of the above,
the law on the issue can be summarized to the effect that if the court where the suit is
instituted, is of the view that it has no jurisdiction, the plaint is to be returned in view of
the provisions of Order VII Rule 10 CPC and the plaintiff can present it before the court
having competent jurisdiction. In light of the same the court further held that the period
during which the case was before the Tribunal having no jurisdiction shall be excluded
in view of Section 14 of the Limitation Act and also the Petitioner may seek adjustment
of court fee paid in that Tribunal.”

6 AIR 1965 SC 338

12
Devi Ispat Limited & Another v. State Bank of India & Ors.7

FACTS

Petitioner No.1 (Devi Ispat) is engaged in the manufacture and trade of iron and steel
products while petitioner no.2 is one of its Directors. Devi Ispat had availed of credit
facilities from the State Bank of India with an overall limit of Rs. 29.5 crores. This credit
facility was enhanced from time to time to Rs. 68.5 crores and Devi Ispat sought a further
enhancement to Rs. 93 crores but that was not sanctioned. While the Bank was
processing the request of Devi Ispat, it issued a letter to it on 10th January 2013
informing that its cash credit account is irregular inasmuch as the outstanding was about
Rs.11.7 crores against the permissible limit of Rs. 5.6 crores. Devi Ispat was also
informed that it was not servicing the interest of cash credit, Foreign Currency Non-
Resident Bank Account etc. It was also informed that its account was heading for
becoming a non-performing asset (NPA) and Devi Ispat was requested to regularize all
its accounts by 14th January 2013 failing which there would be no alternative but to call
up the advance. Devi Ispat replied to the above letter but since the response was not
satisfactory another letter was issued by the Bank on 14th January 2013 calling upon
Devi Ispat to regularize its accounts position failing which the Bank would be
constrained to take appropriate action. Since there was again no positive response from
Devi Ispat, the Bank issued a letter on 18th January 2013 intimating Devi Ispat that its
account had been classified as an NPA on 16th January 2013 and it was requested to
regularize the accounts position within seven days. Instead of regularizing its accounts,
Devi Ispat sent a reply on 22nd January 2013 pointing out that the cash credit account

had been operated on 19th October 2012 and therefore its declaration as an NPA on 16th
January 2013 (that is on the 90th day instead of on completion of 90 days) was in
violation of the guidelines issued by the Reserve Bank of India. The Bank then issued a
notice to Devi Ispat under Section 13(2) of the Securitization and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002 (the SARFAESI Act) on
28th January 2013 demanding payment of the outstanding liabilities due to the extent of
7 [Special Leave Petition (Civil) No. 19466 of 2013]

13
about Rs. 17.9 crores, $ 1.11 crores (of the FCNB account ) and interest. Devi Ispat
reacted by filing a writ petition in the Calcutta High Court challenging, inter alia, the
declaration of its being an NPA and for setting aside the previous letters issued by the
Bank.

The learned Single Judge hearing the writ petition dismissed it by an order dated 19th
March 2013 on the sole ground that Devi Ispat had an alternate statutory remedy under
Section 13(3A) of the SARFAESI Act to make a representation against the letter issued
under Section 13(2) thereof. After the dismissal of its writ petition, Devi Ispat made a
representation to the Bank under Section 13(3A) of the Act on 22nd March 2013. This
was followed almost immediately thereafter by an intra court appeal filed against the
order of the learned Single Judge. Although the appeal was filed on 1st April 2013 (and
we have gone through the contents of the appeal memo) there is no mention of Devi Ispat
having made a representation to the Bank under Section 13(3A) of the Act. Be that as it
may, the representation was considered by the Bank and rejected on 2nd April 2013. The
Division Bench was informed of this during the hearing of the intra court appeal on 26th
April 2013.

JUDGEMENT :

The Division Bench was of the opinion that in view of the observations by this Court in
Mardia Chemicals v. Union of India[1] as well as the provisions of Section 13(3A) of
SARFAESI Act, the writ court was right in not entertaining the writ petition and
permitting the issues raised by Devi Ispat to be considered by the Bank through the
statutory mechanism. While upholding the view of the learned Single Judge and despite
the fact that the representation made by Devi Ispat had been rejected on 2nd April 2013,
the Division Bench heard the matter on merits. However, it did not deal with the merits of
the case since Devi Ispat had availed of the statutory remedy available to it. Accordingly,
the appeal filed by Devi Ispat was dismissed on 26th April 2013. While challenging the
order dated 26th April 2013 passed by the Division Bench, learned counsel submitted that
Devi Ispat had no alternative but to file a writ petition challenging the notice issued by
the Bank on 18th January 2013. We find no merit in this contention. Firstly, Devi Ispat

14
had an alternate remedy to make a representation to the Bank under the provisions of
Section 13 (3A) of the Act and there was no reason to by-pass the statutory
mechanism.Secondly, Devi Ispat did in fact make a representation to the Bank under
Section 13(3A) of the SARFAESI Act and that representation was rejected on 2nd April
2013 during the pendency of the intra court appeal. The statutory remedy having been
availed of by Devi Ispat, nothing really survived in the dispute raised. Thirdly, we now
find from the written submissions submitted by the Bank that it has taken possession of
the secured assets of Devi Ispat on 25th May 2013 and 27th May 2013 under the
provisions of Section 13(4) of the SARFAESI Act and a possession notice has also
published in the newspapers on 31st May 2013. On the facts on record and the statutory
remedy having been availed of, we see no reason to interfere with the impugned order
passed by the Calcutta High Court. However, it is left open to Devi Ispat to take such
appropriate steps as may be considered necessary for safeguarding its interests.There is
no merit in this petition and it is accordingly dismissed

CHAPTER : 2

METHODS OF RECOVERY OF NPA UNDER SARFESI ACT 2002

As already discussed in above Chapter, SARFESI Act prescribes different methods for
recovery of Bad Loans by secured creditors. The following are the methods for recovery
of Non performing Assets prescribed under SARFESI Act :-

15
 Securitization

 Reconstruction

 Enforcement of Security Interest without Intervention of Courts

Securitization

As per Kenneth Cox, in the securitisation process a pool of individual loans or

receivables or actionable claims is created, underwritten and distributed to the
prospective investors in the form of securities. In this process assets of a bank/FI are
liquidized by issuing marketable securities against them. It involves conversion of cash
flow from a portfolio of assets in negotiable instruments or assignable debts which are
sold to investors8

It is called securitization because funds are obtained from investors by delivering them
securities. Any asset which is associated with cash flow can be securitized. Therefore, the
securities which are the outcome of securitisation processes are called asset-backed
securities (ABS).

Securitisation is thus a method for selling the assets where the assets are combined into a
pool and that pool is split into shares. These shares are then sold to investors who share
the reward and risks associated with the performance of those assets. It can be seen as
similar to a company selling one of its business units to a separate entity together with
profits and losses that might come in future for current cash needs.
An example to further explain this: SBI gives loan to 20 people of 1 crore each to buy
homes. Here, SBI has invested in the success and failure of these people. If these people
pay off their
loans, SBI will make profit but there is a risk that some of them won’t repay. For taking
such a risk SBI takes interest from these people on the money they borrow. Now, if the

8
Vrinda Aghi, Securitisation – concept and practices, 3 ILJ 2 (2007)

16
loan fails, SBI can take the ownership of the house. And, if the loan succeeds, SBI will
get its money along with the interest charged.

SBI can now do two things with this loan. First, it can hold it for 25 years and hope to
make a profit upon its investment. Second, it could sell this loan to some other investor
and leave the tension. In the second option though SBI will make less profit than the first
option but it would benefit in the way that it would make some profit while getting its
original investment back. Here it gives away some of the profit in exchange of not having
to face the risk and deciding rather to have case.

Benefits of securitisation:

 
Liquidification:

It generates liquidity for the sleeping assets in the market.


 
Avenue for investment:

It helps in creation of investment opportunities for people to augment their money.


 
Foreign funds:

GDR or IDR can be issued to attract foreign investors through which India can
generate foreign funds.

Securitisation Globally

Asset securitization began in the 1970s by financing of pools of mortgage. Before this banks
held loans until they were paid off. Such loans used to be funded by deposits and sometimes
by debt that was in a way direct obligation of the bank. This scenario started changing after
the World War.

17
When banks could not match up the demand for housing loans. They saw the opportunity
and sought ways for keeping up to the demand. The investment bankers eventually
developed an investment vehicle which isolated mortgage pools, segmented the credit
risk and structured the cash flows from underlying loans. It took many years to develop
efficient securitization structures, the loan originators sensed that this process was
transferable to other types of loans as well. Securitisation started in US in February,
1970. It reached Europe in late 80s but it majorly developed in the late 90s and early
2000 across the asset classes.

Securitisation has been in practice in India since the early 90s for acquisitions of
portfolios of finance companies. There were quasi-securitizations where there weren’t
securities and portfolios simply ended from originator’s balance sheet to another. The so
called securitisation investors were taking exposure on the balance sheet of the originator.
Securitisation has been growing since then reaching new peaks every year.9

Why is Securitization preferred?

Reasons for undertaking securitisation:

1. Improve capital returns:

Securitisation requires less capital than the traditional concept of on-balance sheet
funding so it improves their return on capital.
9
Anuk Teasdale, The process of securitisation (January, 2003)

18
 2. Raise finance:

In case where banks are not able to meet the demands for funds, securitisation helps
in raising finance.

3. Better return on assets:

Securitisation can sometimes be a less expensive source of funds depending upon the
costs of alternative funding.

4. Diversify portfolio:

Securitisation can diverse the source of funds which can reduce dependence upon
retail source of funds.

5. To lower risk:

Securitisation can reduce credit exposure to particular assets if for instance, a

particular class of lending becomes large in relation to the balance sheet as a whole,
then securitisation can remove some of the assets from the balance sheet.

Types of Asset backed securities:

 Home equity loans

In this type of loan the borrower uses the equity of his home as a collateral and the value
of the property is used to determine the loan amount whereas, the property’s value is
determined by an appraiser of a lending institution. The securities that have home equity
loans as collateral are the most prominent in the ABS market. Earlier most of the home
equity loans were second lien sub-prime mortgages, whereas now majority of issuance is
through first lien loans. Sub-prime mortgage borrowers do not have a perfect credit
history and are therefore required to pay higher interest rates than other borrowers.

 Auto loans

19
Auto loans constitute the second largest subsector in the ABS market. Securities are
issued by the Auto finance companies that are backed by an underlying pool of auto-
related loans. These loans are classified in three categories:

o Prime auto ABS (these have the loans made to borrowers having best credit
history as
collaterals).
o Non-prime auto ABS (it consists of loans made to customers with lesser credit
quality and
which may have higher cumulative losses).
o Subprime ABS (where borrowers have low incomes, or bad credit history, or
both).

 Credit card receivables

These securities were first introduced in 1987. They are backed by credit card
receivables. Credit card holders can borrow funds upto an assigned credit limit and they
pay the principal and interest as desired, along with the required minimum monthly
payments. They are considered as non-amortizing loans because the principal repayment
is not scheduled and the credit card debt does not have an actual maturity date.

Process of Securitisation

Securitisation was initially introduced for funding mortgage banks in the US but it has
now become a well-known practice all over the world. It was subsequently applied to
other things such as credit card payments, auto loans, etc.

Following are the main players involved in securitisation process:

20
  Originator: who’s assets are to be securitized

 Issuer: who acquires assets from the originator

 Special purpose vehicle (SPV): company formed for securitisation purpose.

 Credit Rating Agency: To provide value addition to security Insurance Company

 Underwriters: To provide cover against redemption risk to investor and / or
under-subscription

 Investor: The party to whom securities are sold.

SPV ensures that the underlying assets are being held as separate from the assets of the
originator so that the assets aren’t affected of the insolvency (if occurs) of the originator.
It also helps the originator to establish trust with the bondholders.

Originator

Asset Pool

SPV
Credit enhancement

Issue proceeds

Class A notes Investors

Note Issue
Class B notes

Class C notes

21
The underlying assets of the originator are sold on the balance sheet of the SPV which
further acts as issuer of notes. The process involves:

 Doing “due diligence” of the quality and future prospects of the assets;

 Setting up of SPV and transfer of assets to it;

 Underwriting of loans for credit quality and servicing;

 Determining the structure of the notes, in accordance with the requirements of
originator and investor;

 Getting the notes rated by credit rating agencies;

 Placing the notes in capital markets.

Illustration (showing issues considered in structuring the deal)

Originator: ABC Airways

Transaction: receivables from future tickets of the airline
Issuer: “Airways No 1 Ltd”
Arranger: XYZ Securities

Due diligence
XYZ Securities will examine the performance of ABC airlines for past years as well
as projected future figures which would include:

 
 total ticket sales
 
 total credit card receivables
 
geographical split of ticket sales

In the present example, the credit card purchases have been securitized which is a higher
risk asset than residential mortgage as the airline industry has greater volatility of
earnings than banks.

Marketing approach

22
 All the receivables from the credit card purchase of the tickets would be given by
the airlines to the SPV. Then notes would be placed with the prospective
investors.

Deal structure

Customers Future ticket receivables

Debt service
Bond-holders Trustee services

Bonds Proceeds

P
le
d
g
e
o
f
a
ss
et
s

SPV
“Airways No.1 Ltd”

Sale Excess cash

23
 ABC Airways

The process of issue of notes:


 ABC Airways sold itsfuture receivables from credit card to SPV incorporated
as Airways No.1 Ltd
 
 SPV then issues notes to fund its purchase of receivables
 
 For the benefit of the bondholders, the SPV pledges its right to receivables to a trustee
 
 The funds are then accumulated by the trustee as and when received by the SPV


After which the  bondholders will receive their principal along with interest on
a quarterly basis

The trustee will act to safeguard the interest of the bondholders in case of a default.

Financial guarantors
The investment bank considers to approach or not an insurance company for getting a
guarantee of backing the SPV for default. This is done by the insurance company in
return of fee.

Financial modelling
A cash flow model would be made by XYZ Securities for estimating the size of issued
notes. It would consider past sale values, seasonal factors affecting the sales, cash flow
from credit cards, etc. Assumptions as to growth projections, inflation, tax rate, etc. are
made. Various scenarios are considered and minimum asset coverage levels required to
service the issued debt is calculated.
The more conservative DSCR (debt service coverage ratio) will be, the more comfort
there will be for investors of notes. Therefore, this model will calculate amount of
notes that can be issued against assets, while maintaining DSCR.

Credit rating
The securitisation deals are generally rated by 1 or more credit rating agencies. It
would thereby make it easier for XYZ securities to attract investors. These CRAs take

24
into account different qualitative and quantitative factors and differ according to the
asset class being securitized. The main issues in such a deal such would include:

Corporate credit quality: it includes risks associated with originator, factors that affect
its ability to continue operations, meeting the financial obligations, generating future
receivables. They may be analyzed as following:
(i) ABC Airways’ historical financial performance,
(ii) Whether it is state-owned;
(iii) Economic conditions prevailing in the aviation industry;
(iv) Record of safety of the airlines and condition and age of its planes;
 the competition and industry trends: market share of ABC Airways and
competition with others;

 regulatory issues, involves need to comply with upcoming legislations which
could impact the cash flow;

 transfer of assets and legal structure of SPV;

 Cash flow analysis.

Upon the findings of the rating agencies, the arranger may or may not re-design the deal
structure so as to get the issues rated at the required level. The process from inception to
closure may take more than a year depending upon market conditions, legal issues and
sentiment of investors. Once the notes are issued, the arranging bank’s role relating to
issue is finished. Whereas, there are number of agency services required by the bonds
until they are matured and paid off.

Asset Reconstruction

25
According to the provisions of SARFESI Act, Asset Reconstruction has been defined
as “Asset Reconstruction means acquisition by any securitisation company or
reconstruction company of any right or interest of any bank or financial institution in
any financial assistance for the purpose of realisation of such financial assistance ”

Asset Reconstruction Companies

Asset Reconstruction Company (ARC) is a company registered under Section 3 of the
SARFAESI Act, 2002 for management and recovery of bad assets of Banking
Companies.They are regulated by RBI. These are the specialized agencies with a main
role of resolving the stressed assets issue of the Indian banking system.They are
involved in buying bad loans from Indian banks to turn them around. ARCs are
similar to the asset management companies present in countries like Malaysia, Korea
and several other countries. The main advantage of ARCs is they help the banks to
concentrate on normal banking operations rather than dealing with stressed assets

The global equivalent of the word asset reconstruction company is asset management
companies. The word “asset reconstruction” in India has its origin in Narsimham
Committee Report I. The Committee recommended the setting up of a central Asset
Reconstruction Fund with money contributed by the Central Government. This Fund
will assist the banks to clean up their non-performing loans. The idea of Asset
Reconstruction Fund failed. Subsequently The Narsimham Committee Report II came
up and recommended setting up of asset reconstruction companies. The idea of Asset
Reconstruction Company was already successful in several other countries of the
World. The Asset Reconstruction Companies were not formed merely for realisation
of bad loans but also to do “reconstruction”, i.e to try and resurrect bad loans into
good ones.

In reality, the ARCs were not doing substantially more than mere realisation of non
performing loans. It is difficult to see Asset Reconstruction Companies doing any
“reconstruction” also due to insufficiency of funds.

Importance of Asset Management Companies

26
The primary purpose of setting up of Asset management companies in various
countries internationally was to curb the global menace of non performing assets.
There are two types of Bad loans (I) bad loans generated out of the usual banking
operations or bad lending, and (II) bad loans which emanate out of a systematic
banking crisis. It is in the latter case that banking regulators or governments try to bail
out the banking system of a systematic accumulation of bad loans which acts as a drag
on their liquidity, balance sheets and generally the health of banking. So, the idea of
AMCs or ARCs is not to bail out banks, but to bail out the banking system itself.
There are essentially two approaches to take care of these systematic bail out efforts :
one, Decentralized Approach meaning leave the banks to manage their own bad loans
by giving them incentives, legislative powers, or special accounting or fiscal
advantages. The second approach is Centralized Approach meaning to do the same
thing on a concerted, central level, through a centralised agency or agencies. Asset
Management Companies arise out of the centralized approach – that is, a centralised
agency for resolving bad loans created out of a systematic crisis. Each approach has
its own advantages and disadvantages and there is no clear evidence of any of the two
being better over the other. Various countries have tried either of the two approaches
with success stories and failures in either case.

Functions of Asset Reconstruction Company (ARC)

The Functions of Asset Reconstruction Companies are as follows :-

 Acquisition of Distressed financial assets from Banks

 Change or takeover of Management / Sale or Lease of Business of the Borrower

 Rescheduling of Debt

 Enforcement of Security Interest (as per section 13(4) of SRFAESI Act, 2002) for
recovery of acquired NPA.

27
 Settlement of dues payable by the borrower10

Evolution of Asset Reconstruction Companies

The major reason for evolution of Asset Reconstruction Companies was the problem
of Non Performing Assets. The late 1990s and early 2000s marked the emergence of
the problem of Non Performing Asset in the Indian banking industry. In 1998, the 2nd
Narasimham Committee Report highlighted that the huge backlog of NPAs had
severely impacted profitability of Banking Sector. The report also recommended the
creation of an asset recovery fund which would acquire and recover stressed assets
and enable banks to focus on their core business. Due to problem of NPA’s, The
Financial Institution were not able to focus on its core Lending Business function. As
a result, SARFESI Act was passed in the year 2002 and pursuant to this, many ARCs
were formed in India, with ARCIL being the first. These ARCS were set up as private
entities, mostly with the support of banks and as on November 2017, there were 24
operating ARCs.

The evolution of the ARC landscape in India is summarised in the figure below

1987 : Board for Industrial and Financial Reconstruction (BIRF) was formed to revive
sick industrial companies and wind up unviable units.

1993 : Debt Recovery Tribunals (DRT) was set up under (RDDBFI Act)
1998 : Narasimham Committee Recommended setting up of Asset Reconstruction
Companies.

2002 : SARFAESI ACT was passed and Allowed Indian banks and Financial
Institutions to recover non performing assets.

2002 : First Asset Reconstruction Company i.e ARCIL was set up by ICICI bank,
State Bank of India and IDBI

2005-2006 : The Indian Government allowed Foreign investment in ARCs at 49%

10 RBI Notification No. DNBS.2/CGM (CSM)-2003, dated April 23, 2003

28
2007-2017 : 24 Asset Reconstruction Companies were registered with RBI till
November 2017, the list of all the companies is mentioned below

List of Asset Reconstruction Companies registered with RBI

 Asset Reconstruction Company (India) Limited

 Assets Care & Reconstruction Enterprise Ltd

 ASREC (India) Limited

 Pegasus Assets Reconstruction Pvt Ltd

 Alchemist Asset Reconstruction Company Limited

 International Asset Reconstruction Company Pvt Ltd

 Reliance Asset Reconstruction Company Limited

 Pridhvi Asset Reconstruction And Securitisation Company Ltd

 Phoenix ARC Private Limited

 Invent Assets Securitisation & Reconstruction Pvt Ltd

 JM Financial Asset Reconstruction Company Private Limited

 India SME Asset Reconstruction Company Limited

 Edelweiss Asset Reconstruction Company Limited

 UV Asset Reconstruction Company Limited

29
 Meliora Asset Reconstruction Company Limited

 Omkara Assets Reconstruction Private Limited

 Prudent Asset Reconstruction Company Ltd

 MAXIMUS ARC Limited

 CFM Asset Reconstruction Private Limited

 Encore Assets Reconstruction Company Private Limited

 Rare Asset Reconstruction Pvt. Ltd

 Suraksha Asset Reconstruction Private Limited

 Ambit Flowers Asset Reconstruction Private Limited

 Indiabulls Asset Reconstruction Private Limited

Which is the first Asset Reconstruction Company in India ?

 The first Asset Reconstruction Company in India is ARCIL (Asset

Reconstruction Company (India) Limited ) established in the year 2003.
 AARCIL is sponsored by prominent banks and financial institutions such as State
Bank of India (SBI), IDBI Bank Limited (IDBI), ICICI Bank Limited (ICICI) and
Punjab National Bank (PNB).

 It is headquartered in the city of Mumbai and currently spread across 17 locations

in India.

30
 The ARCIL commenced operations to resolve the problem of corporate NPAs,
ARCIL was among the first one in the industry to capitalize upon the issue of
rising Non Performing Assets in retail and SME segment.

Key Challenges faced by Asset Reconstruction Companies

 Valuation mismatch

ARCs seeks higher discounts to acquire NPAs however on the other hand banks are
unwilling to agree to such demands and seek Higher prices for selling the stressed
assets, resulting in an expectation mismatch. This has led to a sharp decline in the
transaction closure rate. The main reason for this gap appears to be the vastly different
discounting rate used by banks and ARCs

 Capital inadequacy

The funds available with Asset Reconstruction Companies are minuscule in

comparison with vast NPA market. The current capitalization of all ARCs would be
not be sufficient to acquire all stressed assets. As per Industry estimates, With the
gross NPA and restructured advances of banks touching approximately 8,00,000 crore
INR, ARCs can acquire approximately only 3% of these assets from banks.
 Inter-creditor issues

“The Indian banking system is characterised by a consortium/multiple lending with

different classes of security. As a result, inter-creditor issues arises, which inhibits
the prompt implementation of the most appropriate resolution strategy. Most
resolution approaches require the consent of secured lenders, representing 75% of
the total debt by value. The intermediation by ARCs towards aggregations and
bringing all stakeholders to a common ground is often painstakingly slow and causes
a loss of value to everyone concerned ”

 Lengthy resolution

31
“NPA resolution in India is complex, tedious and time consuming. The World Bank’s
Doing Business 2018 report reveals that in terms of insolvency resolution, India
holds a dismal 174th rank out of 212 countries. Further, it takes 4.3 years, on an
average, for any resolution. Even economic laggards such as Latin America, South
Asia and North Africa take between 2.9, 2.6 and 1.7 years, respectively”

 Lack of industry expertise for turnaround

“Professionals such as bankers, lawyers and chartered accountants who join ARCs
usually expect employee stock ownership plans (ESOPs) as a major mode of
compensation. Since any person with more than 9% shareholding in an ARC is
designated a ‘deemed promoter’ by the RBI, this actually deters professionals from
joining ARCs because of the responsibility associated with the ‘promoter’ status.
This only increases the cost of functioning of ARCs. The general dearth of talent and
skill sets required to revive and turn around a unit is also a big challenge.”

 Focus on the agency model

“Indian ARCs were driven completely by the agency business model of generating
plush internal rates of return (IRRs) based on the management fee, as described
earlier in this paper. Since IRRs were topping 20%, ARCs had no real incentive to
really opt for recoveries or rehabilitation. However, after the keynote change of
increased investment to 15% and basing the management fee on the lower spectrum
of NAV, ARCs are gradually turning to fund-based models, with a focus on
recoveries and realistic pricing.”

 Lack of a mature market for SRs

“Due to an unrealistic pricing mismatch, intense scrutiny and regulatory changes,

there is a general lack of investor appetite that is leading to the absence of a

32
 secondary market for SRs. Banks are hence forced to buy SRs backed by their own
stressed assets. Currently, over 80% of SRs are held by seller banks themselves
(refer to the table below).

Benefits for a bank to enter into an ARC transaction

 “Balance sheet clean-up | Focus on core activities”

 “Lower share of stress loans on balance sheet”

 “Provisioning benefits will partially take care of low capitalization and ROE
concerns”

 “Focus on core business and freeing up of top management bandwidth”

 “One of the main advantages for banks is a lower GNPA/restructured number as

the assets are offloaded from bank’s balance sheet and transferred to an ARC
trust. However, considering the high sale transactions, investors will start ooking
at stress loans (including SRs) on the balance sheet. Assuming an ARC paid a
consideration equal to net book value; banks would get some relief on
provisioning if the asset is likely to get downgraded further. However, this benefit
has reduced under the 15/85 structure as ARCs have lowered the consideration
offered as IRR for ARCs have come down meaningfully.”

 “In case a bank sells an asset below net book value, RBI allows banks to amortize
losses over eight quarters. This is beneficial especially in accounts where
recovery is likely to be long drawn (lower) and provision requirements likely to
increase further. This benefit is available to banks for the sale transactions up to
4QFY16.”

 “Selling assets to ARC frees the senior management’s time and effort on
recovery, and helps it to focus on core functions of business growth/profitability
and revival / recovery.”

33
 “Once the ARC aggregates 60% debt, it can enforce SARFAESI and thereby pace
up the resolution; arriving at a consensus is a major hurdle for banks.”

 “In a portfolio sale approach, banks get an opportunity to dispose of older-

vintage NPAs along with lesser-vintage NPAs (thereby reducing the level of
stress on the balance sheet). Typically, high-vintage accounts are written off and
banks have been unable to recover the money. Any recovery will add to profits
and, in turn, capitalization.”

 Reputational risks associated with aggressive recovery mechanism,

 Release of blocked capital with lowering of RWA.

 No long legal battle

RBI Guidelines on Sale of Stressed Assets by Banks

RBI issued Guidelines on Sale of Stressed Assets by Banks on 1st September 2016 for
to improve the existing framework for sale of stressed accounts by Banks.The essence
of the Guidelines is urging banks to create mechanism for timely identification of
stressed accounts and take appropriate actions to ensure there is low vintage and better
price realization for banks

The RBI Guidelines on Sale of Stressed Assets by Banks are as follows :-

 Policy on Sale of stressed assets

The board of banks shall lay down detailed policies and guidelines on sale of their
stressed assets to Securitisation Companies (SCs) and Reconstruction Companies
(RCs). The policy shall cover the following aspects: Financial assets to be sold;
Norms and procedure for sale of such financial assets; Valuation procedure to be
followed to ensure that the realisable value of financial assets is reasonably estimated;

34
Delegation of powers of various functionaries for taking decision on the sale of the
financial assets etc.

 Early Identification

Identification of stressed assets beyond a specified value, as may be determined by

bank’s policy, for sale shall be top-down i.e., the head office/corporate office of the
bank shall be actively involved in identification of stressed assets, including assets
which are classified as Special Mention Account, to be put on sale. Early
identification will help in low vintage and better price realization for banks and to
enhance transparency in the entire process of sale of stressed assets.

 At least once in a year, preferably at the beginning of the year, banks shall, with
the approval of their Board, identify and list internally the specific financial assets
identified for sale to other institutions, including SCs/RCs;

 At a minimum, all assets classified as ‘doubtful asset’ above a threshold amount

should be reviewed by the board/board committee on periodic basis and a view,
with documented rationale, is to be taken on exit or otherwise. The assets
identified for exit shall be listed for the purpose of sale as indicated above;

 Prospective buyers need not be restricted to SCs/RCs. Banks may also offer the
assets to other banks/NBFCs/FIs, etc. who have the necessary capital and
expertise in resolving stressed assets. Participation of more buyers will result in
better price discovery;

 In order to attract a wide variety of buyers, the invitation for bids should
preferably be publicly solicited so as to enable participation of as many
prospective buyers as possible. In such cases, it would be desirable to use e-
auction platforms. An open auction process, apart from attracting a larger set of

35
 borrowers, is expected to result in better price discovery.. Banks should lay down
a Board approved policy in this regard;

 Banks must provide adequate time for due diligence by prospective buyers which
may vary as per the size of the assets, with a floor of two weeks;

 Banks should have clear policies with regard to valuation of assets proposed to be
sold. In particular it must be clearly specified as to in which cases internal
valuation would be accepted and where external valuation would be needed.
However, in case of exposures beyond Rs.50 crore, banks shall obtain two
external valuation reports;

 The cost of valuation exercise shall be borne by the bank, to ensure that the
bank's interests are protected;

 The discount rate used by banks in the valuation exercise shall be spelt out in the
policy. This may be either cost of equity or average cost of funds or opportunity
cost or some other relevant rate, subject to a floor of the contracted interest rate
and penalty, if any.

 Review of Extant Policies on Sale of NPA

Banks shall review the efficacy of their extant policies on sale of NPAs, with focus on
valuation of stressed assets, and rework their policies by appropriately adopting the
above principles.

 Investment by banks in security receipts backed by assets sold by them

In order to make sure that sale of stressed assets by banks actually result in ‘true sale’
of assets and to create a vibrant stressed assets market, it has been decided to
progressively restrict banks’ investment in SRs backed by their own stressed assets.

 Disclosure of Investment in Security Receipts

36
In addition to the existing disclosure requirements, banks shall make following
disclosures pertaining to their investments in security receipts:

Particulars of Security Receipts issued within past 5 years, Security Receipts issued
more than 5 years ago but within past 8 years, Security Receipts issued more than 8
years ago.

i. Book value of SRs backed by NPAs sold by the bank as underlying Provision
held against I

ii. Book value of SRs backed by NPAs sold by other banks / financial institutions /
non-banking financial companies as underlying Provision held against II

Total (i) + (ii)

 Debt Aggregation – First right of refusal

To enhance SC/RCs ability to aggregate debt faster, a bank offering stressed assets for
sale shall offer the first right of refusal to a SC/RC which has already acquired the
highest and at the same time a significant share (~25-30%) of the asset, for acquiring
the asset by matching the highest bid. This requires the process of price discovery via
auction, as described elsewhere, to be done first.

 Swiss Challenge Method – Enabling Low Vintage and Debt aggregation

Swiss Challenge Method is the prime focus of the RBI guidelines. In order to bring
down the vintage of NPAs sold by banks as well as to enable faster debt aggregation
by SC/RCs, banks shall put in place board approved policy on adoption of Swiss
Challenge Method for sale of their stressed assets to SCs/RCs/other
banks/NBFCs/FIs, etc. For this purpose, the board/committee of the board shall
conduct periodic review (at least once in a year) of their stressed - asset portfolio, with
a view to decide on the proposed course of action to resolve the portfolio in terms of
their loan recovery policy. During such review, the bank should identify the assets

37
which will be offered for sale among prospective buyers and an authenticated list of
such assets shall be maintained by the bank. The list may, at the discretion of the
bank, be disclosed to prospective bidder on entering into confidentiality agreement.

The broad contours of the Swiss Challenge Method are as under:

I. A prospective buyer interested in buying a specific stressed asset may offer a bid to
the bank;

II. If the asset features in the list of assets for sale maintained by the bank, and if the
aforesaid bidder offers more than the minimum percentage specified in the bank’s
policy (say, 30 percent of outstanding loan) in the form of cash, the bank shall be
required to publicly call for counter bids from other prospective buyers, on
comparable terms;

III. Once bids are received, the bank shall first invite the SC/RC, if any, which has
already acquired highest significant stake (as indicated at paragraph 6 above) to match
the highest bid. Ceteris paribus, the order of preference to sell the asset shall be as
follows: i) The SC/RC which has already acquired highest significant stake; ii) The
original bidder and iii) The highest bidder during the counter bidding process.

IV. Bank will have the following two options:

i. Sell the asset to winning bidder, as determined above;

ii. If the bank decides not to sell the asset to winning bidder, bank will be required to
make immediate provision on the account to the extent of the higher of:

The discount on the book value quoted by the highest bidder; and

The provisioning required as per extant asset classification and provisioning norms.
 Buy-Back of Financial Assets

38
The extant guidelines of Reserve Bank do not prohibit banks from taking over
standard accounts from SCs/RCs. Accordingly, in cases where SCs/RCs have
successfully implemented a restructuring plan for the stressed assets acquired by
them, banks may, at their discretion, with appropriate due diligence, take over such
assets after the ‘specified period’ provided that the account performed satisfactorily
during the ‘specified period’. Banks may frame a board approved policy containing
various aspects governing such take over viz., type of assets that may be taken over,
due diligence requirements, viability criteria, performance requirement of asset, etc.
However, a bank cannot at any point of time take over from SCs/RCs the assets they
have themselves earlier

Excel Deal comm Pvt. Ltd. v. Asset Reconstruction Company (India) Ltd. &
Others.11

FACTS

This appeal has been preferred against the judgment delivered by the Division Bench
of the Calcutta High Court on March 8, 2013 whereby the High Court while holding
that the Calcutta High Court does not have jurisdiction to try civil suit, assumed
jurisdiction for non- suiting the appellant and also held that the Agreement dated
13.2.2007 is not concluded and thus not enforceable, and dismissed Civil Suit No.299
of 2007 filed by the appellant.

Uniworth Apparel Limited (hereinafter referred to as 'Uniworth'), being

Respondent No.3 herein, was a company registered in Maharashtra under the
Companies Act, 1956. It had an industrial unit in Thane District of Maharashtra. It
availed credit facilities from ICICI Bank. Uniworth could not clear the Bank's dues, as
a result the Bank assigned their claim in favour of Asset Reconstruction Company
India Limited (hereinafter referred to as 'ARCIL'), being Respondent No.1 herein, a
company incorporated under Companies Act, 1956 and registered with the Reserve
Bank of India as a Company under Section 3 of the Securitization and Reconstruction
of Financial Assets Enforcement of Security Interest Act, 2002 (hereinafter referred to

11 [Civil Appeal No. 3272 of 2015 arising out of S.L.P. (C) No.15900 of 2013]

39
as the 'SARFAESI Act'). ARCIL took steps under Section 13 of the SARFAESI Act
and took possession of the assets. Allegedly the ARCIL entered into a Private Treaty
Agreement dated 13.02.2007 (hereinafter referred to as 'the Agreement') with the
appellant Excel Dealcomm Pvt. Ltd. (herein after referred to as 'Excel'), for sale of the
said properties for a consideration of Rs.7.50 Crores.

This was to be a sale under SARFAESI Act wherein the sale was to be conducted by
execution of sale certificate by the ARCIL in favour of Excel. The Excel alleges that
it had even issued a cheque of Rs. 9.5 Crores dated March 1, 2007 to the ARCIL. In
reply thereto, Mr. Sanjoy Gupta, Vice President of the ARCIL (Respondent No. 2
herein) had vide letter dated 20-03-2007 informed Excel to collect its cheque since the
deal could not be materialised as the management of ARCIL did not approve such a
proposal. Thus, the sale could not get through and the present appellant brought out a
suit for specific performance of the Agreement against ARCIL, being C.S. No.299 of
2007, in the High Court of Calcutta in December 2007. Initially, there were three
Defendants in the said suit, namely, ARCIL, Mr. Sanjoy Gupta (Vice President of
ARCIL) and Uniworth.

However, later on it was found that ARCIL had sold the suit property to one Webtech
Industries Pvt. Ltd. (hereinafter referred to as 'Webtech'), Respondent No.4 herein, on
10.02.2011. So Webtech was impleaded as Defendant No.4 in the said suit after the
application for impleadment, being G.A. No.3574 of 2010 was allowed on 06-01-
2011. It is to be noted that the suit property was the one mentioned in the Schedule of
the Agreement and included both movable and immovable properties as mentioned
below: Mortgage on immovable properties of the Uniworth situate at Plot No. A606,
TTC Industrial Area, MIDC, Shil Mahape Road, New Mumbai,
Maharashtra. Hypothecation of the whole of movable assets of Uniworth situate at
TTC Industrial Area, MIDC, Shil Mahape Road, New Mumbai, Maharashtra
including the movable plant and machinery, machinery spare tools and accessories
and other movables both present and future (save and except book debts).
ARCIL filed an application, being G.A. No.1225 of 2011, for revocation of leave
granted under Clause 12 of Letters Patent by the High Court of Calcutta to the Excel
and asking return of the plaint in C.S. No.299 of 2007 to be filed before the Court
having jurisdiction to try the same. The said application was based on following

40
grounds: The suit was effectively a "suit for land" and the immovable property was
situate in New Mumbai, Maharashtra. Therefore, as per clause 12 of Letters Patent the
suit should be filed in a Court having territorial jurisdiction over the immovable
property. That the alleged Private Treaty Agreement between ARCIL and Excel was
entered into pursuant to Section 13(4) of the SARFAESI Act and even the sale was to
be conducted by execution of sale certificate as provided in Security Interest
(Enforcement) Rules, 2002 (hereinafter referred to as "Rules").

Therefore, the jurisdiction of civil court is excluded. That the Private Treaty
Agreement provided that Mumbai Court would have exclusive jurisdiction. The
learned Single Judge of the Calcutta High Court under Original jurisdiction, vide his
judgment and order dated 22.12.2011 dismissed the application for revocation of
leave and refused to return the plaint for the following reasons: The suit was not a suit
for land as the Private Treaty Agreement required creation of security or charge of the
assets mentioned in the schedule i.e. "mortgage of immovable properties" and
"hypothecation of movable properties"; the nature of this security was not mentioned
in the agreement and thus, any security could be created on the said mortgage or
hypothecation. Therefore, the learned High Court came to the conclusion that the
enforcement of terms of agreement would not lead to the decree in suit for land.

With respect to Forum Selection Clause, the High Court held that the ARCIL had
waived its right to object to the lack of jurisdiction by participating in application for
impleadment of Respondent No.4, wherein orders were passed on 06.01.2011. The
learned High Court noted that ARCIL had made no objection to the jurisdiction while
the impleadment application was argued.
On the question of the jurisdiction of Civil Court being ousted by the SARFAESI Act,
the High Court found that the breach of present agreement would not fall under
Section 17 of the SARFAESI Act wherein the Debt Recovery Tribunal is given the
jurisdiction to rule only that whether the sale was a correct measure adopted and
conducted properly.

In the present case, even if it is assumed that ARCIL was the assignee of ICICI and a
third party sued for specific performance against such assignee, the case would not
fall under Section 17 of the SARFAESI Act. Aggrieved by the judgment and order

41
dated 22.12.2011 passed by the learned Single Judge of the Calcutta High Court,
dismissing the application for revocation of leave granted under Clause 12 of Letters
Patent, ARCIL filed an appeal before the Calcutta High Court, being A.P.O. No.180
of 2012. The High Court in this appeal, analysed the judgment of the learned Single
Judge in the Original Jurisdiction of the High Court of Calcutta.

Calcutta High Court Observation

The High Court came to following conclusion while allowing the appeal: The Private
Treaty Agreement was not to be considered a concluded contract as it was subject to
the approval of the Board of Directors of the ARCIL. Since, the approval was not
given and even the cheque supplied by Excel was made available for return, the said
agreement was at best a term sheet. On the point of suit for land the High Court found
the alleged sale of assets was to take place by issuing "sale certificate" in terms of
Rule 5(6) of the Rules which pre-supposes the handing over of the possession.
In view of above two conclusions, the High Court found it was not necessary to
answer the question regarding forum selection clause. On the basis of these
conclusions, the Division Bench of the High Court reversed the order of the learned
single Judge holding that the contract could not be specifically enforced as it was not
a concluded one and also that it would be a suit for land if, at all, the suit is
maintainable. Therefore, the Division Bench revoked the leave granted under Clause
12 of the Letters Patent. In the above factual backdrop, following questions arise for
our consideration: Whether the suit for specific performance filed by Excel was a
"suit for land"?
Whether the Private Treaty Agreement conferred an exclusive jurisdiction on the
Court of Mumbai and if so, Whether or not ARCIL waived this clause by participating
in impleadment application without protest? Whether the jurisdiction of civil Court is
barred in the present case by virtue of Section 17 of SARFAESI Act? Suit for land
Clause 12 of the Letters Patent of the High Court of Calcutta reads:
"12. And we do further ordain that the said High Court of Judicature at Fort William
in Bengal in the exercise of its ordinary original civil jurisdiction shall be empowered
to receive, try and determine suits of every description, if, in the case of suits for land
or other immovable property, such land or property shall be situated, or, in all other
cases, if the cause of action shall have arisen either wholly, or in case the leave of the

42
Court shall have been first obtained, in part, within the local limits of the ordinary
original jurisdiction of the said High Court, or if the defendant at the time of the
commencement of the suit shall dwell or carry on business, or personally work for
gain, within such limits; except that the said High Court shall not have original
jurisdiction in cases falling within the jurisdiction of the Small Cause Court at
Calcutta, in which the debt or damage, or value of the property sued for does not
exceed one hundred rupees."

JUDGEMENT
A plain reading of the provision suggests that ordinary original civil jurisdiction of the
High Court of Calcutta will extend in following cases: In a suit for land or other
immovable property- where such land or property is wholly situated in the territorial
jurisdiction of the High Court of Calcutta; where such land or property is situated in
part only within the said territorial jurisdiction of the Court, if the leave of the Court
shall have been first obtained. in suits other than suit for land if the cause of action has
arisen wholly within the said limits; where the cause of action has arisen in part only
within the said limits, if the leave of the Court shall been first obtained; If the
defendant at the time of the commencement of the suit dwells or carries on business or
personally works for gain within such limits.

In the present case, a suit was filed for the specific performance of the Agreement
which contemplated the sale of property, as has been described in para 1 under
Section 13 of SARFAESI Act in terms of the Rules. The question with respect to
Clause 12 of Letters Patent in the present case is that whether the present suit is suit
for land. The suit for land is a suit in which the relief claimed relates to the title or
delivery of possession of land or immovable property, [See: Adcon Electronics Pvt.
Ltd. vs. Daulat and Anr., (2001) 7 SCC 698]. Further it is an established rule that to
determine whether it is a suit for land, the Court will look into barely the Plaint and no
other evidence, [Indian Mineral & Chemicals Co. and Others vs. Deutsche Bank,
(2004) 12 SCC 376]. If by the averments in the plaint and prayers therein, it appears
that the suit is one for land, it shall be so held and if it does not so appear, then the suit
shall continue under leave granted under clause 12.

43
In the present case, the prayer in the plaint was couched in following words: "A
decree for specific performance of the agreement for sale recorded in the document
dated February 13, 2007 being Annexure "A" hereto by directing the Defendant no. 1
and 2 to issue in favour of the plaintiff Sale Certificate in respect of assets mentioned
in Schedule 1 to Annexure A hereto and on as is where is basis in terms of the said
agreement" The learned counsel for the Respondent
has very emphatically argued that this prayer is in effect a prayer for possession of the
said properties since the procedure under the Rules for execution of the sale
certificate, the transfer of possession is pre-requisite.

Therefore, he has submitted that although, the possession is not asked for in direct
words but that would be the obvious corollary to granting of the prayer. Further,
another point which has been emphasized on behalf of respondent is that the prayer
requires sale to be effected in terms of the Agreement, and therefore, the entire
agreement may be read as a part of the prayer. On the question of suit for specific
performance of an agreement to sell being a suit for land, this Court has laid down a
clear principle in Adcon Electronics Pvt. Ltd. vs. Daulat Ram and Anr., (2001) 7 SCC
698, that a suit for specific performance simplicitor without a prayer for delivery of
possession is not a suit for land as Section 22 of the Specific Relief Act, 1963
categorically bars any Court to grant such relief of possession in a suit for specific
performance unless specifically sought. In view of this judgment, in the present case,
the only question for our determination in the plaint is whether a prayer for delivery of
possession is sought or not ? The prayer sought is issuance of sale certificate which is
provided in Appendix V to the Rules under SARFAESI Act. The sale certificate reads
as follows:
"Whereas the undersigned being the authorized officer of the ............................ (name
of the institution) under the Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002 and in exercise of the powers conferred
under Section 13 read with Rule 12 of the Security Interest Enforcement Rules, 2002
sold on behalf of the ........................... (name of the secured creditor/institution) in
favour of the ............................ (purchaser), the immovable property shown in the
schedule below secured in favour of the ............................ (name of the secured
creditor) by ........................ (the names of the borrowers) towards the financial facility
............................. (description) offered by ............................. (secured creditor). The

44
undersigned acknowledge the receipt of the sale price in full and handed over the
delivery and possession of the scheduled property. The sale of the scheduled property
was made free from all encumbrances known to the secured creditor listed below on
deposit of the money demanded by the undersigned."

It may be noted that the sale certificate sought under the prayer requires the delivery
of possession of the suit property. Thus, we find that the prayer for delivery of
possession was an implicit one in the present case. The prayer as sought in the plaint
could not have been granted without the delivery of possession of the suit property as
the sale certificate itself contemplates the delivery of the immovable property. Thus,
in view of this we find that the Adcon Electronics
would not apply as there was a prayer for delivery of possession in the present case.
Therefore, we hold that the present suit was indeed a suit for land. Exclusive
jurisdiction Now, we shall consider as to which court has the jurisdiction to entertain
and try the suit. Clause 5 of the Agreement entered into between the parties reads as
under :
"The payment/cheque shall be drawn and made payable in Mumbai. The jurisdiction
shall be Courts of Mumbai." Clause 9(e)(viii) of the Agreements further reads as
follows: "Disputes, if any, shall be subject to the jurisdiction of Mumbai
Court/Tribunals only" It is clear from these two clauses that the intention of the
parties to the Agreement was to restrict limitation to the forums/courts of Mumbai
only. This Court in Swastik Gases P. Ltd. vs. Indian Oil Corporation Ltd., (2013) 9
SCC 32, has held as under: "The very existence of a jurisdiction clause in an
agreement makes the intention of the parties to an agreement quite clear and it is not
advisable to read such a clause in the agreement like a statute. In the present case,
only the Courts in Kolkata had jurisdiction to entertain the disputes between the
parties."

HELD

Therefore, we are of the opinion that the Courts of Mumbai were granted exclusive
jurisdiction as per the Agreement and we find no reason to create any exception to the
intention of the parties. In view of the above-mentioned two findings that the present
suit is a suit for land, and that the parties had granted exclusive jurisdiction to the

45
Court of Mumbai, the jurisdiction of the Court at Calcutta is clearly ousted as per law.
Thus, from the above conclusion it appears that the plaint will have to be returned by
the Calcutta High Court as it does not have the jurisdiction. Therefore, we are of the
view that the question of jurisdiction of the Debt Recovery Tribunal need not be
answered. Consequently, this appeal is dismissed. The parties may proceed to take
any appropriate measure in an appropriate forum as provided in law to enforce their
rights.

Enforcement of Security Interest

Meaning
Enforcement of Security Interest without intervention of court of law is one of the
methods of recovery of Non Performing Assets prescribed under SARFESI Act ,2002.
It enables Banks and other Financial Institutions to recover Bad Assets from defaulted
borrowers.

Under this method, The SARFESI Act empowers secured creditors to issue demand
notice to defaulted borrowers to clear dues within 60 days of the date of notice. On
failure to clear dues, the secured creditor is empowered to take possession of the
security provided for the loan and sell the security to recover the amount of dues
without permission of court.

What Security Interest cannot be enforced ?

The following Security Interest cannot be enforced :

 “Agricultural land”

 “Debt due is less than Rs. 1,00,000/-”

 “Debt due is less than 20% of the principal amount and interest thereon”

46
 “Time barred Debt under the Limitation Act.”

 a “Lien on any Goods, Money or Security given under the Indian Contract Act,
1872 or the Sale of Goods Act, 1930 or any other law for the time being in force;”

 a “Pledge of Movable Property within the meaning of section 172 of the Indian
Contract Act, 1872”

 “Creation of any security in any aircraft as defined in clause (1) of section 2 of

the Aircraft Act, 1934;”

 “Creation of security interest in any vessel as defined in clause (55) of section

3 of the Merchant Shipping Act, 1958;”

 “Any Conditional Sale, Hire-purchase or Lease or any other contract in which

no security interest has been created;”

 “Properties not liable to attachment (excluding the properties specifically

charged with the debt recoverable under this Act) or sale under the first proviso
to sub-section (1) of section 60 of the Code of Civil Procedure, 1908”

 “Rights of the unpaid seller under section 47 of the Sale of Goods Act, 1930;”

Procedure of Enforcement of Security Interest under " SARFESI Act 2002” &
"Security Interest (Enforcement) Rules, 2002"

 Bank/FI to give a Power of Attorney/ Letter authorizing its concerned official to

take steps under the Act.12

 Sending of Demand Notice to Borrower for clearance of dues within 60 days of

date of notice13

12
Sec 13 (12) of SARFESI Act read with Rule 2 (a) of Security Interest (Enforcement) Rules, 2002
13
Sec 13 (2) of SARFESI Act read with Rule 2 (b) & 3 of Security Interest (Enforcement) Rules, 2002

47
 Notice can be sent by Registered Post or Speed Post or Courier or Fax or E-mail14

 If Borrower avoids notice, service shall be made by affixing the notice in some
conspicuous place of his residence/ business and by publishing the notice in two
leading newspapers, one in a vernacular language having sufficient circulation15

 If more than one Borrower (which includes guarantor), individual notice to be

served on each of them.16

 In case any reply/representations are received, the Bank to suitably adjudicate

upon and decide.17

 If Defaulted Borrowers fails to clear dues, Issue Notice for taking possession of
Secured Asset u/s 13(4) of Act .18

 Take symbolic possession of the Secured Assets19

 File an application before the Chief Metropolitan Magistrate or District

Magistrate for taking actual possession of the property20

 Comply with the order of the Chief Metropolitan Magistrate or District

Magistrate21

 Liaisoning with the Court Receiver, Police authorities, etc.

 Deposit of fee with Police authorities, if any, in case the police force is to be
made available by police station in Utter Pradesh

14
Rule 3 (1) of Security Interest (Enforcement) Rules, 2002
15
Proviso to Rule 3 (1) of Security Interest (Enforcement) Rules, 2002
16
Rule 3(4) of Security Interest (Enforcement) Rules, 2002
17
Section 13(3A) of SARFESI Act
18
Sec 13 (4) of SARFESI Act
19
Sec 13 (4) of SARFESI Act
20
Sec 14 (1) of SARFESI Act
21
Sec 14 (2) of SARFESI Act

48
 After taking the possession a notice in terms of Appendix IV will be sent to the
Borrower, which will also be affixed on the Property.22

 The said notice will also be published in two leading newspapers one in
vernacular language within 7 days.23

 Name of Bank or Financial Institution (Secured Creditor) to be displayed on the

Property.24

 Insurance cover to be arranged25

 Take Photographs

 Security Personnel to be deployed at the site of the Property.26

 Valuation of property by an approved valuer before effecting the sale27

 Serve on the Borrower a notice of 30 days for sale.28

 Obtaining Quotations/Inviting tenders/Holding Public Auctions/ Signing Private

Agreement for sale of the property.29

 If sale is by way of inviting tenders from public or holding of public auction, a

public notice to be published in two leading news papers one in vernacular
language, having sufficient circulation, setting out the terms of the sale30.

22 Rule 8 (1) of Security Interest (Enforcement) Rules, 2002

23
Rule 8 (2) of Security Interest (Enforcement) Rules, 2002
24
Rule 8(1) of Security Interest (Enforcement) Rules, 2002
25
Rule 8(4) of Security Interest (Enforcement) Rules, 2002
26
Rule 8(4) of Security Interest (Enforcement) Rules, 2002
27
Rule 8(5) of Security Interest (Enforcement) Rules, 2002
28
Rule 8(6) of Security Interest (Enforcement) Rules, 2002
29
Rule 8(5) of Security Interest (Enforcement) Rules, 2002

30
Proviso to Rule 8 (6) of Security Interest (Enforcement) Rules, 2002

49
 Notice and Publications to be affixed on conspicuous part of the property and put
on the website of the Bank.31

 Sale other than public auction/tender to be on terms settled between the parties in
writing.32

 Sale to be confirmed in favour of highest bidder33

 No sale to be confirmed on less than reserve process. However sale at less than
Reserve price can be made with the consent of Borrower34

 25% of the sale price to be deposited forthwith and balance within 15 days 35

 If balance is not deposited the deposit would be forfeited and the property be
resold.36

 Sale of Property to be made effective from execution of Sale Deed

 If the terms of payment have been complied with, the Bank/FI shall issue a
certificate of sale in favour of the purchaser37

 The certificate of sale to specify whether the property is free from encumbrances
known to the Bank

 Acknowledgement from buyer of having taken over the physical possession of

property to be obtained by the Bank/FI.

31
Rule 8(7)of Security Interest (Enforcement) Rules, 2002
32
Rule 8(8)of Security Interest (Enforcement) Rules, 2002
33
Rule 9(2)of Security Interest (Enforcement) Rules, 2002
34
Proviso to Rule 9(2) of Security Interest (Enforcement) Rules, 2002
35
Rule 9(3) and (4) of Security Interest (Enforcement) Rules, 2002
36
Rule 9(5) of Security Interest (Enforcement) Rules, 2002
37
Rule 9(6) of Security Interest (Enforcement) Rules, 2002

50
 In case the dues of the Bank/FI are not fully met with the sale proceeds of the
property, Bank/FI may file an application before Debt Recovery Tribunal or
Court having jurisdiction, for recovering the balance amount.38

Mathew Varghese vs. M. Amritha Kumar

Facts

Jerry Merry Exports Pvt. Ltd.’ (‘Borrower’) acquired a credit facility from the
respondent 4 before the Supreme Court (‘Bank’) while the first and second
respondents stood as guarantors (‘Guarantors’) in respect of the debt. Guarantors
created an equitable mortgage on certain properties (‘Properties’) by deposit of title
deeds. When the debt became a non-performing asset (‘NPA’) the Bank filed an
Original Application before the Debt Recovery Tribunal, Ernakulam (‘DRT’) for
recovery of dues to the tune of Rs. 33,77,053/- along with interest @ 18% per annum.
The Bank also filed an application under Section 13(2)5 of the SARFAESI Act on
11.08.2006 for a sum of Rs. 70,77,590/-. On 20.02.2007 the Bank sought to take
possession of the Properties under Section 13(4)6 of the SARFAESI Act read with
Rules 8 and 9 of the Rules. The Guarantors subsequently filed an application under
Section 177 of the SARFAESI Act (‘Application’) before the DRT challenging the
action under Section 13(4) taken by the Bank. An attempt was made for a One Time
Settlement (‘ÓTS’) of Rs. 55,00,000/- but the attempts failed and Bank also withdrew
the offer.”
“Subsequently on 23.08.2007 the Bank published a notice for sale of Properties as
mandated under Rule 9 of the Rules (‘Notice of Sale’). The appellant before the
Supreme Court (‘Appellant’) submitted its tender on 30.08.2007. On 20.09.2007 the
Guarantors filed a writ petition before the Single Judge in Kerela High Court
challenging the actions of the Bank under SARFAESI Act. The Kerala High Court
disposed off the writ petition by its Order dated 20.09.2007 (‘Single Judge’s Order’)
directing the DRT to dispose the Application expeditiously and that the proposed sale
scheduled on 25.09.2007 be deferred by six weeks by imposing a condition on the
Guarantors to deposit Rs. 10,00,000/- before 25.09.2007. The Bank was directed to

38
Sec 13(10) of SARFESI Act Read with Rule 11 of Security Interest (Enforcement) Rules, 2002

51
accept the OTS amount of Rs. 55,00,000/- if the Guarantor made the payment within a
reasonable time. Pursuant to Single Judge’s Order, the sale was postponed and
Guarantors deposited Rs, 10,00,000/- with Bank. On 27.12.2007 DRT dismissed the
Application with cost and the following day the Bank accepted the offer of Appellant
for Rs. 1,27,00,101/- The sale was subsequently confirmed by the Bank and the
Guarantors were directed to collect balance consideration from the Bank.”
“Guarantors filed a review petition against Single Judge’s Order which was dismissed
and an appeal against this order was also dismissed. Guarantors challenged the sale in
a fresh writ petition. The Single Judge dismissed the writ petition and in appeal, the
Division Bench passed a detailed order dated 08.03.2010 allowing the appeal
(‘Division Bench Order'). The Ruling was passed by the Supreme Court in an appeal
against the Division Bench Order.”
“The Division Bench Order provided that the sale was not conducted in a fair manner,
as procedures under the SARFAESI Act and Rules were not followed. It observed that
when the sale was initially postponed by six weeks from 25.09.2007, the Bank ought
to have renotified the sale as mandated under Rule 9 of the Rules or at least extended
the time to receive further tenders especially in light of the fact that only one valid
tender was received. The Division Bench also set aside the sale in favour of Appellant
and directed Guarantors to furnish a demand draft of Rs. 2,00,00,000/- within a
stipulated period. Subsequent to the Division Bench Order, the Guarantors did not
comply with the directions but instead filed applications seeking extension of time
and in pursuance of the same, respondent No. 8 before the Supreme Court
(‘Subsequent Buyer’) was awarded the sale. The Division Bench Order and grant of
extension were challenged by the Appellant in Supreme Court.”

Issues
“The Supreme Court had to consider the procedure for sale of property secured by a
creditor as set out in Section 13 (8) 8 of SARFAESI Act and Rules 8 and 9 of Rules.”

Decision
“The Supreme Court acknowledged the constitutional right to hold property and that
this right could not be deprived in a manner which was contrary to the procedure
established by law (Article 300A of the Constitution of India). The Supreme Court
further observed that a secured creditor was like a trustee of the secured asset and

52
could not deal with the security in a ‘whimsical’ or ‘arbitrary’ manner. Section 13 (8)
of SARFAESI Act was provided to protect interest of borrowers and it was important
to balance the right of borrowers and creditors. The Supreme Court further observed
that Rule 8 and Rule 9 of the Rules had twin objectives: ”
 “Provide 30 days clear notice to the borrower regarding the date and time of the
proposed sale or transfer. This is to provide the borrower adequate opportunity to
take all steps to repay his dues prior to such sale.”
 “Inform the intending purchaser of the nature of the property, extent of liability,
floor price and other encumbrances”.
“In light of this reasoning, the Supreme Court held that unless 30 days’ clear notice
was given to the borrower, sale or transfer could not be effected by a secured creditor
under the SARFAESI
Act. If a sale is notified after due notice but sale does not take place, the secured
creditor cannot effect the sale or transfer of the secured asset on any subsequent date
relying upon earlier notification. It is also important to keep in mind the provisions of
sub-rule (8) of Rule 8 according to which sale by any method other than public action
or public tender may be on terms that are settled between the parties in writing”.
“While the Supreme Court upheld the interpretation given to SARFAESI Act and
Rules given by the High Court, it set aside the cancellation of the sale made in favor
of Appellant and held that the safeguards that were applicable to a property owner,
were equally applicable to the auction purchaser. The Supreme Court held that
Guarantors had failed to take measures as per the Division Bench Order and
consequently, the sale in favor of Appellant had to be confirmed. However, in view of
the passage of time (sale had been confirmed in 2010), Supreme Court directed that
Appellant pay an additional amount of approximately Rs. 70 Lakhs towards sale
price.”

The Enforcement of Security Interest and Recovery of Debts Laws and

Miscellaneous Provisions (Amendment) Bill, 2016

“The Enforcement of Security Interest and Recovery of Debts Laws and

Miscellaneous Provisions (Amendment) Bill, 2016” was introduced in Parliament in
the year 2016 to incorporate amendments in the laws of (I) “Recovery of Debts Due

53
to Banks and Financial Institutions Act, 1993” and (II) “The Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002”
to expeditiously resolve the pending cases of debt recovery by Banks and Financial
Institutions.

List of Amendments proposed in SARFESI Act

 The enforcement of collateral security under SARFESI Act is done with the
assistance of the District Magistrate (DM), having jurisdiction over the security.
The absence of the time-limit for the District Magistrate to dispose such
applications has resulted in delays. The 2016 Bill proposes to introduce a 30-day
time limit within which the DM must pass an order for the takeover of a security.
Under certain circumstances, this time-limit may be extended to 60 days.

 The 2016 Bill proposes to exempt the payment of stamp duty on transfer of
financial assets in favour of Asset Reconstruction Companies.This step will
encourage the Asset Reconstruction Companies to acquire Bad Financial Assets
of Banks and Financial Institutions due to the low cost cost of acquisition. This
benefit will not be applicable if the asset has been transferred for purposes other
than securitization or reconstruction (such as for the ARCs own use or
investment).

 The Bill also seeks to provide greater powers to the Reserve Bank of India to
regulate Asset Reconstruction Companies. This includes the power to carry out
audits and inspections either on its own, or through specialised agencie of
Reserve Bank of India.

 The Bill provides for Registration of creation, modification and satisfaction of

security interest by all secured creditors and provision for integration of
registration systems under different laws relating to property rights with the
Central Registry;

54
 The Bill seeks for creation of a central database to integrate records of property
registered under various registration systems with the Central Registry. This
includes integration of registrations made under Companies Act, 2013,
Registration Act, 1908 and Motor Vehicles Act, 1988.

 Secured creditors will not be able to take possession of the secured assets unless
the secured assets are registered with the Central Registry;

 After registration of security interest with Central Registry , the secured creditors
will have priority over others in repayment of dues;

 In addition to the existing powers of the Reserve Bank of India (RBI) to examine
the statements and any information of Asset Reconstruction Companies (ARCs)
related to their business, the amendment further empowers the RBI to carry out
audit and inspection to regulate ARCs. The RBI may penalise an ARC if the
company fails to comply with any directions issued by it;

 To enable a non-institutional investors to invest in security receipts of Asset

Reconstruction Company.

 Provide a specific timeline for taking possession of secured assets;

 In case the secured creditors have acquired controlling interest in the borrower
company by converting part of its debt into shares of the borrower company, it
shall not be necessary for the secured creditors to restore the business to the
borrower.

55