28.

THE SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS

AND ENFORCEMENT OF SECURITY INTEREST {SARFAESI} ACT, 2002

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 (SARFAESI) 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.
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 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:-
i. 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.
ii. 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
out of 1, 50,503 cases filed by Commercial Banks upto 31 March 2014
involving Rs. 2,60,100 cr., 66971 cases involving an amount of Rs. 1,41,500
 were pending with DRTs on that date. The total number of DRTs and Debt
Recovery Appellate Tribunal (DRAT) at mere 33 and 5 respectively in the
country were also a limiting factor. Some of the issues affecting the system
were grant of time to the borrower for effecting repayment & stay of action
under SARFAESI Act, non-adherence to the prescribed time schedule of 4
months for disposal, non-insistence on deposit of prescribed 75% of the dues
for hearing appeal and DRAT even entertaining applications beyond their
jurisdiction.
The recent amendment in the Act has brought Multi-state Co-operative Banks within
the ambit of DRT Act. A new provision has been added to the effect that if there is a
settlement prior to commencement of hearing before DRT or at any stage, before
final order is passed, the applicant (Bank) may be granted refund of fees at such
rates as may be prescribed. Stipulation has been made that defendants shall file
their written statement within 30 days of date of service of summons and in
exceptional cases, Presiding Officer (PO), for reasons to be recorded in writing,
allow not more than two extension to file the written statement. Likewise, it has been
clearly stipulated that after the hearing of Recovery Application commences, it shall
be continued on day to day basis until hearing is concluded. The DRT may grant
adjournments, if sufficient cause is shown / made out, but no adjournments shall be
granted beyond three times and if there are more than one party, the total number of
adjournments shall not exceed 6. Such adjournments also shall only be on cost
being imposed. Further, if it is proved to the satisfaction of DRT that claim of the
Bank / FI is adjusted wholly or partly by lawful agreement or compromise in writing,
the DRT shall pass orders recording such agreements / compromise or satisfaction
of the claim.

iii. 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.
iv. 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
securitisation, 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 legalise
securitisation and reconstruction of financial assets and enforcement of
security interest. The act envisaged the formation of asset reconstruction
companies (ARCs)/ Securitisation Companies (SCs).
Provisions of the SARFAESI Act
The Act has made provisions for registration and regulation of securitisation
companies or reconstruction companies by the RBI, facilitate securitisation of
financial assets of banks, empower SCs/ARCs to raise funds by issuing security
receipts to qualified institutional buyers (QIBs), empowering banks and FIs to take
possession of securities given for financial assistance and sell or lease the same to
take over management in the event of default.
The Act provides three alternative methods for recovery of NPAs, namely :-
Exemption from registration of security receipt: The Act also provides,
notwithstanding anything contained in the Registration Act, 1908, for enforcement of
security without Court intervention: (a) any security receipt issued by the SC or ARC,
as the case may be, under section 7 of the Act, and not creating, declaring,
assigning, limiting or extinguishing any right, title or interest to or in immovable
property except in so far as it entitles the holder of the security receipt to an
undivided interest afforded by a registered instrument; or (b) any transfer of security
receipts, shall not require compulsory registration.

SARFAESI ACT 2002 -How it is useful to Banks

The Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002 (SARFAESI) 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: -

i. Securitisation: It means issue of security by raising of receipts or funds by

SCs/ARCs. A securitisation company or reconstruction company may raise
funds from the QIBs by forming schemes for acquiring financial assets. The
SC/ARC shall keep and maintain separate and distinct accounts in respect of
each such scheme for every financial asset acquired, out of investments made
by a QIB and ensure that realisations of such financial asset is held and
applied towards redemption of investments and payment of returns assured on
such investments under the relevant scheme.
ii. Asset Reconstruction: The SCs/ARCs for the purpose of asset reconstruction
should provide for any one or more of the following measures:-
a. the proper management of the business of the borrower, by change in, or
takeover of, the management of the business of the borrower
b. the sale or lease of a part or whole of the business of the borrower
c. rescheduling of payment of debts payable by the borrower
d. enforcement of security interest in accordance with the provisions of this
Act
 e. settlement of dues payable by the borrower
f. taking possession of secured assets in accordance with the provisions of
this Act.
iii. Enforcement of Security without the intervention of the Court
The provisions of this Act are applicable only for NPA loans with outstanding above
Rs. 1.00 lac. NPA loan accounts where the amount is less than 20% of the principal
and interest are not eligible to be dealt with under this Act.
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 Bank:
 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.
 To ask any debtor of the borrower to pay any sum due or becoming due to the
borrower.

The Enforcement of Security Interest and Recovery of Debts Laws

(Amendment) Act, 2012 - The Act came into force with effect from 15 January
2013. The act brought about the following major changes:-
 The Multi State Co-operative Banks are brought within the ambit of SARFAESI
Act.
 An enabling provision has been made (Sec.5) that on acquisition of financial
assets by an ARC, the ARC may file an application and based on the same,
orders for substitution may be passed.
 The time period to give a reply for any objection /representation made by the
borrower / guarantors / mortgagors to the demand notice has been extended to
‘within 15 days’ instead of one week. (Sec. 13 (3) (A)).
 Where the sale of an immovable property under SARFAESI is postponed for
want of bid or the amount quoted has been less than Reserve Price, it has been
specifically provided that Bank /Secured Creditor may bid for the property at any
subsequent sale. Where the Bank / Secured Creditor so participates in the
bidding and is declared to be the purchaser of the immovable property / security,
the purchase price shall be adjusted towards the amount of claim of the Bank for
which such an action has been taken (New Sub-Sections 5A, 5B & 5C under
Sec.13) . Such assets are treated as Non-Banking Asset under Sec.9 of Banking
Regulation Act.
 In instances of Consortium Lending / Multiple Financing involving more than one
secured creditor at present Secured Creditors representing not less than 3/4th in
value of amount outstanding should agree / give consent for Sec.13(4)
measures, to make it binding on other Secured Creditors. The amendment has
reduced this to 60%. (Sec.13(9))
 The manner and details of application to be moved before CMM / DM seeking
assistance has been spelt out. The application by the Secured Creditor should
be
accompanied by an affidavit, duly affirmed by Authorised Officer on the following
aspects;
- details of security interest (with correct description of the properties / securities)
created in favour of the Bank pursuant to which Bank has a valid subsisting
security interest
- declaring the aggregate amount of financial assistance granted and the total claim
of the Bank as on the date of the application,
- details of security interest (with correct description of the properties / securities)
- created in favour of the Bank pursuant to which Bank has a valid subsisting
security interest
- declaring that action taken is within limitation period
- Borrower has committed default in repayment and consequent to the same, the
loan account has been classified as NPA and indicating the total amount
outstanding as on the date of the application
- Sec.13(2) notice giving 60 days clear time has been served on the borrowers.
- In the objections / representations, if any, to the demand notice under Sec.13(2)
has been duly replied after consideration, with reasons.
- Borrower has not made repayment despite demand notice and therefore AO is
entitled to take possession of the assets under Sec.13(4) read with Sec.14.
- The provisions of the SARFAESI Act and the rules framed there under have been
complied with.

On filing of such an affidavit by the AO, the DM or CMM, as the case may be, shall
after satisfying themselves of the contents of the affidavit, pass suitable orders for
the
purpose of taking possession.

> The CMM / DM has been empowered to authorize officer sub-ordinate to them to
take possession of the assets and documents and hand it over to the Bank / Secured
Creditor.
> Specific enabling provision have been added to the effect that when an application
under Sec.17 or an appeal under Sec.18 is likely to be filed or expected to be made,
Bank / Secured Creditor may lodge a caveat before DRT / DRAT or Court of Dist.
Judge or High Court, as the case may be. This caveat will have validity period of 90
days. The implications thereof are no ex-parte interim orders can be passed, without
giving an opportunity of hearing to Secured Creditor Bank.

> Sec.23 of SARFAESI Act deals with registration of transactions viz. creation of
security interest, securitization or asset reconstruction with Central Registry. New
provision has been added by which such transactions that are subsisting on or
before the date of establishment of Central Registry is also mandatory.
> The omission to file with Central Registry of any particular transaction normally
attracts penalty. However, provisions have been added to the effect that if such
omissions were only owing to inadvertence or accidental nature and there are other
just and equitable grounds, the Central Govt. on an application from Secured
Creditor or ARC company may extend time frame. However, it has also been made
clear that such extension of time and / or non-registration shall not prejudice any
rights of the Secured Creditor.

Some Developments

Asset reconstruction companies are set up, and registered with the Reserve bank of
India (RBI) as a securitisation company (SC) and reconstruction company (RC) to
acquire distressed secured financial assets (both movable and immovable).
The banks which transfer the assets are paid off by way of security receipts (SRs),
debentures, bonds, etc. as stipulated in the Act, which are subscribed to by only
Qualified Institutional Investors and redeemed in due course of time, some of which
would mature soon. These are treated as non-SLR securities and their valuations,
provisions against fall in value, etc., are to be done as per the rules applicable to any
other non-SLR security.
ARCs are deemed to be the lenders and have all the rights of the original lending
banks. Some of them are promoted by some banks coming together; the first one
was ARCIL, sponsored by SBI, ICICI Bank, IDBI Bank and PNB.
The underlying idea of bringing into fruition ARCs under SARFAESI Act is to enable
banks to clean up their balance sheets, pass on the burden of recovery to an agency
which could give full-time attention  to realize a higher amount than what the
borrower is willing to offer and thus generally help faster resolution of NPA.
Where the assets are charged to several banks under multiple banking
arrangements, ARCs endeavour to aggregate them to help better realisation from
the eventual buyers which individual banks might not be able to get. In the case of
security charged to a consortium of banks, once 75% of lenders (by value) agree to
sell the assets to ARCs, other members do not have option to differ. Despite the
apparent advantages of transfer of assets to ARCs, banks, after the initial period
now seem reluctant to pass on the NPAs to them for various reasons. There is a
feeling that ARCs’ offer price is low and worse still that the assets are sold by them
eventually to original promoters of the companies or their relatives in some “sweet
heart deal” as they know the value of the assets especially of the land and buildings.
Besides, bank officials have a fear that if the realisation of NPAs is low, they could
be questioned on the deals struck with ARCs.
The banks have found that when they issue notices to borrowers under SARFAESI
Act, the response is much better. The amount of recoveries done under the Act has
been significantly higher comparatively speaking than under BIFR, and faster. The
one major problem the banks experience in pursuing SARFAESI permitted action is
that an aggrieved party, generally the borrower, can make an application to a DRT
and get a stay order on sale which is not difficult to obtain. Nevertheless, the banks
have felt use of SARFAESI has been more effective than other legal provisions.
The bank officials feel that by strengthening the recovery department, they can show
greater success than by handing over NPAs to ARCs. All said and done, the loyal
bank officials definitely have greater commitment to the health of their bank than the
ARCs. CDR is a ‘success’ if one were to judge it by the statistics of progress: As at
March 2012, the CDR cell approved 292 cases and another 41 are in advanced
stage of approval, involving an aggregate amount of Rs1.86 lakh crore of debt. The
number of cases referred each year has been moving up and in 2011-12 it reached
the highest figure of 87 cases with a debt of Rs. 68,000 crore.