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The banking and finance sector has been the key player in India’s efforts to develop the economy more quickly and efficiently. The legislative framework regarding the financial transactions were not at the same pace as the changing business transactions and financial reforms. This led to a setback in the speed of recovery of defaulted loans and a rise in the number of non-performing assets of banks and non-banking institutions.

The Central Government established the Narasimham Committees I and II and the Andhyarujina Committee to examine banking sector reforms and determine what alteration needs to be done in the current legal system in relation to these issues.

These committees, among others, proposed new legislation for securitization that would allow banks and other financial non-banking institutes to acquire the securities and to sell them without any court intervention. These suggestions led to the enactment of the SARFAESI Act of 2002.

What is SARFAESI Act, 2002?

The SARFAESI Act stands for – “Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act ”. The  Act allows banks and non banking financial institutions to acquire the possession of the securities kept in consideration of any loan taken by the borrower and auction them to recover the loan amount. This enables the banks and non banking financial companies (NBFCs) to reduce their non-performing assets (NPAs).

Methods of Recovery under the SARFAESI Act.

The SARFAESI Act provides the following three methods of recovery of Non-Performing Assets (NPAs):

  •         Securitization
  •         Asset Reconstruction
  •         Enforcement of security


According to the SARFAESI Act, securitization is the acquisition of financial assets from any financial institution or bank by any securitization company (SCO). Only banks and financial institutions are permitted under the Act to securitize their financial assets with a securitization firm. The necessary funds for such acquisition may be acquired from ‘qualified institutional buyers (QIB)’ by the issuance of security receipts reflecting an undivided interest in such financial assets, or through other means.

The following are financial assets:

  • A claim on any debt or receivables, whether secured or unsecured.
  • A moveable property mortgage, charge, hypothecation, or pledge.
  • Any obligation or receivable secured by mortgaged against, or charged against the immovable property.
  •  Any right or interest in the security underlying such debt or receivables, whether whole or partial.
  • Any beneficial interest in the property, whether mobile or immovable, or in obligations and receivables, whether existing, future, accruing, conditional, or contingent.

The Act established a very important provision for the securitization of financial assets. It is a financial instrument that allows lenders to securitize their future cash flows from secured assets and therefore lets them free up funds that have been held in such assets. The secured assets become “merchandise” in the hands of the SCO, and their realization provides them with their return. This feature adds much-needed skill in effective management in the realization of secured assets. By enabling the enforcement of the secured assets, the legal hurdles of conventional civil law procedure to seize the mortgaged assets have thus been successfully removed.

Reconstruction of Assets

Asset reconstruction can be done by managing the borrower’s business by selling or acquiring it or by rescheduling payments of debt payable by the borrower as per the provisions of the Act.

According to RBI standards, an SCO or RCO may carry out asset reconstruction in any of the accompanying directions:

  •       Taking over the operation of the borrower’s business.
  •       Restructuring the borrower’s management of his or her firm.
  •       Selling or leasing a portion or all of the borrower’s business.
  •       The debt payment schedule has been rescheduled.
  •       Putting the security interest into action.
  •       Entering into a debt settlement agreement with the borrower.

Enforcing Security Interests

  • The Act allows the enforcement of security interests, which means taking ownership of the assets kept as collateral for the loan. Section 13 of the Act gives detailed provisions allowing a lender (the secured creditor) to seize the borrower’s security. The provisions are as follows.
  • At first instance the secured creditor must send a notice of demand to the defaulter, stating the details about the amount payable and the secured assets that will be enforced in the case of non-payment.
  • After receiving the notice, the borrower cannot transfer the assets in any way without the creditor’s prior permission. The borrower must fulfill the obligations within 60 days of receiving notice of demand.
  • In the case that the borrower fails to pay, the creditor may seize the borrower’s secured assets with the right to transfer them via lease, assignment, or sale in order to realize the secured asset. It shall select a manager to administer the secured assets. It may require any individual who has purchased any of the secured assets from the borrower and owes money to the borrower to pay a portion of the money necessary to settle the secured debt.
  • The secured asset transfer made by the creditor is assumed to be done by the secured asset’s owner.
  • If the borrower pays all of the dues, as well as any costs, charges, and expenditures paid by the creditor, before the date specified for the sale of the secured assets, the creditor is not required to transfer or sell the secured assets.
  • When there is joint financing, the permission of the creditor(s) representing at least 75% of the amount due is necessary before taking any steps to enforce the security interest, and such approval is obligatory on all creditors.
  • The sale revenues from the secured assets must be allocated in the case of a corporate borrower in liquidation.
  • If the creditor chooses to realize his security rather than surrender it and prove his obligation, he may keep the selling profits of his secured assets after settling the workmen’s dues with the liquidator.
  • If the profits from the sale of the secured assets do not entirely fulfil the obligation due, the creditor may file a claim with the DRT or a competent court to collect the deficit.
  • The creditor also has the option of pursuing any of the guarantors or selling the pledged assets without pursuing the borrower.
  • The lender may seek the aid of the Chief Metropolitan Magistrate or District Magistrate in obtaining control of the secured assets from the borrower.
  • If any individual, including the borrower, is dissatisfied with any of the creditor’s actions, he may file an appeal with the DRT within 45 days by depositing at least 75% of the lender’s claim. The DRT’s judgment can be appealed to an Appellate Tribunal.
  • Unless his claim of the financial asset is lodged within the term provided by the Limitation Act of 1963, the creditor cannot begin any procedures to enforce the security interest.

Hence, SARFAESI enables the reconstruction of financial assets that are obtained by the banks and NBFCs taking measures for proper management, debt restructuring settlement, or taking possession for recovery of debts.

Written By: Maharshi Shukla  



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