Securitisation & Reconstruction of Financial Assets & Enforcement of Security Interest (SARFAESI) Act, 2002

Group Members
Ninad Pradhan Pankaj Rewatkar Mahendra Waghmare 07347 07350 07364

Civil Courts Era
  Prior to 1993, the Banks had to approach Civil Courts for recovery of dues. The process was 1. the Time consuming 2. Did not adapt to changing demands of the economy – It resulted in pendency of about 15 lakhs cases filed by the Banks and Financial Institutions till 30th September 1990. – The fund blocked in the litigation was about Rs. 5,622 crores of Public Sector Banks and about Rs. 391 crores of Financial Institutions. – Civil Courts failed to deliver both in ascertainment of dues & execution of decree.

Recovery of Debts Due to Banks and Financial Institutions (RDDBFI) Act,1993
  It brought down the time span for adjudication of dues. Of the two ills of the Civil Courts, 1. non ascertainment of dues in an speedy manner was cured by the RDDBFI Act, 2. failed to cure the other ill, i.e. effectively executing the decree. This is evident from the fact that till about 30th September, 2001, 22 Debt Recovery Tribunals (DRTs) of the country had adjudicated 9814 cases, thereby issuing the Certificate/Decree for Rs.6265 crores, however, actual recoveries could be made only of Rs.1864 crores.

The SARFAESI ACT
In late 2002, the Parliament passed the Act, which extends to the whole of India, giving banks the power to aggressively recover loans from defaulters by seizing their assets. The 2002 Act provides a procedure by which banks can serve notice to a borrower for payment of a defaulted loan. In the event of non-compliance, the bank may proceed with actions to take possession and dispose of the securities. The Act deals with three aspects : • 1. Enforcement of Security Interest by secured creditor (Banks/Financial Institutions) • 2. Transfer of non- performing assets to asset reconstruction company, which will then dispose of those assets and realize the proceeds. • 3. To provide a legal framework for securitization of assets.

 

This Act lays the emphasis on recovery of the money, even without the intervention of Court. The Banks were empowered to take possession of Secured Assets of the Borrower including the right to transfer by way of lease, assignment or sale for realizing the Secured Asset. The role of the Court was limited to challenge the measures by way of Appeal, that too on deposit of 75% of amount claimed on the notice. In effect the Securitisation Act, 2002 1. Did away with the first aspect of recovery of dues i.e ascertainment of dues 2. It concentrated only on the second aspect i.e. executing the decrees.

PURPOSE
 Is to promote the setting up of asset reconstruction/ securatisation companies to take over & liquidate the 80000 crores of NPA accumulated with the commercial banks and public financial institutions.  It envisages ARC’s to undertake reconstruction functions.  It lays emphasis on recovery of the money, even without the intervention of Court. The Banks were empowered under Section 13(4) of Securitization Act to take possession of Secured Assets of the Borrower including the right to transfer by way of lease, assignment or sale for realizing the Secured Asset.  The role of the Court was limited to challenge the measures under Section 13(4), by way of Appeal, that too on deposit of 75% of amount claimed on the notice under Section 13(2) of Securitization Act.

NEED
• Impact of ballooning non performing assets on the health of the financial sector  Urgent need for legal reforms to keep pace with the changing industrial & financial scenario.  Piling up of overload of cases with Debt Recovery Tribunals & low courts resulting in slower process in the Debt recovery.  Urgent measure in problem of NPAs for tackling willful defaulters.

RDDBFI V/s SARFAESI
 The RDDB&FI Act is for expeditious adjudication at the hands of Tribunals, while the SARFAESI Act bypasses intervention of the courts for expeditious recovery of dues of banks and financial institutions.  SARFAESI shows that it is an act to regulate securitisation and reconstruction of financial assets and enforcement of security interest; whereas RDDB&FI is there to establish Tribunals for expeditious adjudication and recovery of debts due to banks and financial institutions.  Moreover, only secured creditors can refer to SARFAESI, whereas RDDB&FI is for all types of creditors whether or not they are secured or unsecured.

Some Basic Definitions
SECURITISATION:
means acquisition of financial assets by any securitisation or reconstruction company from any originator, whether by raising of funds by such reconstruction company from qualified institutional buyers by issue of security receipts representing undivided interest in such financial assets or otherwise;

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

FINANCIAL ASSETS:
means debt or receivables and includes— (i) A claim to any debt or receivables or part thereof, whether secured or unsecured; or (ii) Any debt or receivables secured by, mortgage of, or charge on, immovable property; or (iii) A mortgage, charge, hypothecation or pledge of movable property; or (iv) Any right or interest in the security, whether full or part underlying such debt or receivables; or (v) Any beneficial interest in property, whether movable or immovable, or in such debt, receivables, whether such interest is existing, future, accruing, conditional or contingent; or (vi)Any financial assistance.

ENFORCEMENT OF SECURITY INTEREST:
In case the borrower fails to discharge his liability in full within the period specified in sub-section (2), the secured creditor may, (a) take possession of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale for realizing the secured asset; (b) take over the management of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale and realize the secured asset; (c) appoint any person (hereafter referred to as the manager), to manage the secured assets the possession of which has been taken over by the secured creditor;

Other Definitions:
SECURED ASSETS :
means the property on which security interest is created.

BORROWER :
means any person who has been granted financial assistance by any bank or financial institution or who has given any 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 securitisation 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.

SECURITY INTEREST: means right, title and interest of any kind whatsoever upon property, created in favour of any secured creditor and includes any mortgage, charge, hypothecation, assignment other than those specified in section 31.

WILLFUL DEFAULTERS:
means, A) Default on debt obligation despite having the capacity to honour repayment obligation B) Funds deployed for reasons other than availed C) Siphoning/ diversion of funds and thereby defaulting on debt obligation D) Funds not present with the unit in the form of other assets.

SECURED CREDITOR:
means any bank or financial institution or any consortium or group of banks or financial institutions and includes— (i) debenture trustee appointed by any bank or financial institution; or (ii) securitisation company or reconstruction company, whether acting as such or managing a trust set up by such securitisation company or reconstruction company for the securitisation or reconstruction, as the case may be; or (iii) any other trustee holding securities on behalf of a bank or financial institution, in whose favour security interest is created for due repayment by any borrower of any financial assistance

Provisions of the act
 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.  Any Security Interest created over Agricultural Land cannot be proceeded with.

Sec 13 (1)
Any security interest created in favour of any secured creditor may be enforced, without the intervention of court or tribunal, by such creditor in accordance with the provisions of this Act

Sec 13 (2)
The borrower is a defaulter in repayment of the secured debt or any installment of repayment and further the debt standing against him has been classified as a nonperforming asset by the secured creditor. It further provides that before taking any steps in direction of realizing the dues, the secured creditor must serve a notice in writing to the borrower requiring him to discharge the liabilities within a period of 60 days failing which the secured creditor would be entitled to take any of the measures as provided in sub-section (4) of Section 13.

Sec 13 (3)
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 1 week of receipt of such representation or objection.

Sec 13 (4)
The Act provides for four measures which can be taken by the secured creditor in case of non-compliance with the notice served upon the borrower. Under clause (a) of sub-section (4), the secured creditor may take possession of the secured assets including the right to transfer the secured assets by way of lease, assignment or sale. Under clause (b) of sub-section (4), the secured creditor may take over the management of the secured assets including right to transfer.

2.

3.

3. Under clause (c) of sub-section (4), a manager may be appointed by the secured creditor to manage the secured assets which have been taken possession of by the secured creditor. 4. Under clause (d) of sub-section (4), the secured creditor may require any person who has acquired any secured assets from the borrower or from whom any money is due to the borrower to pay the same to him as it may be sufficient to pay the secured debt.

Sec 13 (10)
Where dues of the secured creditor are not fully satisfied with the sale proceeds of the secured assets, the secured creditor may file an application in the form and manner as may be prescribed to the DRT having jurisdiction or a competent court, as the case may be, for recovery of the balance amount from the borrower/guarantors. Without prejudice to the rights conferred on the secured creditor under or by this section, the secured creditor shall be entitled to proceed against the guarantors or sell the pledged assets without first taking any of the measures specified in clauses (a) to (d) of sub-section (4) in relation to the secured assets under this Act.

Sec 17
 The Secured Creditor will be able to take possession of the secured assets only after reasons for not accepting the objections of the borrower have been communicated to him in writing.  After possession of the secured asset has been taken, the borrower can file an application before the DRT without any deposit.  Earlier the borrower had to deposit 75% of the amount claimed by the secured creditor before his appeal can be entertained. But later on this condition was removed.

Sec 18
 If the DRT does not dispose off the petition within 4 months, the borrower or the Secured Creditor can move the Debt Recovery Appellate Tribunal (DRAT) for directing the DRT for expeditious disposal of the application.  After the disposal of the case by the DRT the borrower, if aggrieved, can appeal to the DRAT with a deposit of 50% of the decreed amount or as determined by the DRT but not lower than 25%.

Case: MARDIA CHEMICALS Vs ICICI BANK
 Rs 1,000-crore company, Mardia Chemicals is the flagship of the Mardia Group, has facilities to manufacture a range of products including dyes, dye intermediates, basic chemicals and caustic soda.  It owed over Rs 1,450 crore (including a principal of Rs 800 crore and unpaid interest forming the balance) to 22 lenders, including Bank of Baroda, Bank of India, Corporation Bank, Union Bank, IDBI, Life Insurance Corporation, IFCI and New India Assurance.

Allegations against Mardia Chemicals
 Mardia Chemicals had bought property worth Rs 34 crore and converted them into company guest-houses, but there is no information available on the source of funds, there are allegations of diversion of funds against the company.  Also, the company has not been responding to the notices severed by the Registrar of Companies, Ahmedabad  A notice was issued to the petitioner – Mardia Chemicals Ltd.(‘Mardia’) by the Bank, requiring it to pay the amount of arrears indicated in the notice within 60 days, failing which the Bank as a secured creditor would be entitled to enforce the security interest without intervention of the court or Debt Recovery Tribunal. Mardia was also required not to transfer by way of sale, lease or otherwise any of its secured assets.

Mardia Group’s challenges to the Act
 It claimed that the banks and the financial institutions have been vested with arbitrary powers, without any guidelines for its exercise and also without providing any appropriate and adequate mechanism to decide the disputes relating to the correctness of the demand, its validity and the actual amount of dues, sought to be recovered from the borrowers.  The offending provisions as contained under the Act, are such that, it all has been made one sided affair while enforcing drastic measures of sale of the property or taking over the management or the possession of the secured assets without affording any opportunity to the borrower.

 The exposure of ICICI Bank to the Ahmedabad-based dyes and dyes intermediaries company is Rs 110 crore (principal) and with interest works out to Rs 293 crore.  In year 1999 ICICI filed a suit before the High Court of Judicature at Bombay against Mardia Chemicals Limited for recovery of amounts totaling Rs. 1.4 billion (US$ 33 million) due from Mardia Chemicals.  ICICI Bank issued a notice under Securitisation act for recoveries of Rs.293 crore within 60 days of the notice being delivered & then acquired some assets from Mardia, after which the latter filed a case against ICICI Bank.

 The court said that bank can acquire the lender could not part with the assets in any way.  Mardia Chemicals appealed to the Supreme Court that while the law permitted banks to attach assets, they may not sell them.  The Debt Recovery Tribunal of Mumbai issued an order to Mardia Chemicals to pay up 25 per cent of the outstanding amount to ICICI Bank by October 21, 2003.  India’s Supreme Court disposed off the case filed by Mardia Chemicals against a consortium of bankers led by ICICI Bank.

 However, the Supreme Court struck down the provision contained in section 17(2) of the Act that required borrowers to deposit 75 per cent of the amount claimed by lenders before they could file appeals with debt recovery tribunals.  The Debt Recovery Tribunal (DRT), Ahmedabad, issued an ex-parte order against the sale of Mardia Chemicals property by ICICI Bank. However, the receiver appointed by the Mumbai High Court had already taken charge the of the property.

Amendments in the 2002 Act
Under the 2004 Act, a borrower may appeal a bank's actions before the Debt Recovery Tribunal (DRT) without making a 75% deposit of the amount claimed. The DRT is required to dispose of such an application within 4 months. Any person aggrieved by a DRT order can file an appeal to the Debt Recovery Appellate Tribunal after depositing 50% of the debt due from it as claimed by the secured creditor or determined by the DRT, whichever is less.

Amendments in 1993 Act
The 2004 Act also enables banks or financial institutions to withdraw, with the permission of the DRT, the application made to it and thereafter take action under the 2002 Act. This amendment refers to the situation where a bank or financial institution which may have initially applied to the DRT for recovery of its debt later decides to enforce its security interest under the 2002 Act.

Amendments in Companies Act, 1956
The 2004 Act proposes that any reference made to the National Company Law Tribunal to revive and rehabilitate sick industrial companies under section 424A of the Companies Act will abate if the secured creditors representing threequarters in value of the amount outstanding have taken recourse to obtain recovery under the 2002 Act.

Current Problems
• Difficulty in taking possession of the properties of the defaulters; • The properties are in the possession of third parties, who are not the defaulters; • Inability to fetch the market price as against the White declared price in auction sale; • Failure to attract bidders at the auction sale; • Disposal of objections takes eternity; and • Recovery officers are not trained in law, hence unable to deal with difficult questions of law.

• Striking down of provision of deposit of 75% of amount before entertaining the appeal has led to greater confusion & complication in the legal proceedings. The appeal has become cheaper to prefer • The legislature's failure to include the aspect of ascertainment of dues, ahead of aspect of execution of ascertained figure may be single most important factor for failure of the Secrutisation Act

Transaction Structure
 Arcil sets up a trust (The Trust) for the purpose of acquiring Non-Performing Assets on the books of the Bank (Assets)  The Assets would be acquired at fair value based on assessment of realizable amount and time to resolution  The Trust raises resources through formulation of schemes by issuing SRs to the eligible investors under SARFAESI (banks/ FIs etc.).

 Such monies received from QIBs are utilized towards payment of purchase consideration for the FAs to the sellers  The Trust is the legal owner of the Assets and the SR holders are beneficial owners of the same. Security Receipt represents undivided right, title and interest in the Trust Fund, including the Initial Trust Fund, the Contributions received by the Trustee, the Assets proposed to be acquired by the Trustee .

Arcil acts as a trustee and the asset manager of the Special Purpose Vehicle (SPV) trusts to fully leverage empowerments to ARCs under the SARFAESI for resolution of the Assets. The SR holders have no recourse against Arcil

Factors critical to the success of ARCs
• Ability to aggregate debt • Ability to attract funding – both domestic and foreign investors • Credibility of the sponsors

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