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Recovery Process & Enforcement Of Security Interest In India

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DEBT RECOVERY – LEGAL FRAMEWORK IN INDIA

Indian Legal system encompasses varied legal provisions for recovery of debts by the Banks and Financial Institutions as follows :-

  • Summary suits under Order XXXVII of the Code of Civil Procedure, 1908.
  • Ordinary suits for recovery, under Civil Law.
  • Original Applications to be filed by Banks and Financial Institutions before Debt Recovery Tribunal for debt not less than Rs. 10 lakhs, under Recovery of Bank Due to Banks & Financial Institutions Act, 1993 (DRT Act).
  • Action under Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (Securitisation Act).
  • Arbitration proceedings under Arbitration & Conciliation Act 1996, for recovery of outstanding amount as under Arbitration Agreement / clause in the loan documents, in cases where the Recovery of Debts due to Banks and Financial Institutions Act, 1993 is not applicable.
  • Initiation of criminal action in addition to civil proceedings for prosecution and punishment as per the Indian Penal Code and other laws where debt is also tainted with fraud, cheating, misfeasance etc.
  • Filing of criminal complaint under Section 138 of Negotiable Instruments Act, 1881 for dishonor of any cheque issued by borrower to the bank in discharge of legally enforceable liability.

BROAD CLASSIFICATION OF THE DEBT WORK OUT PROCESS IN INDIA

Amount to be recoveredProcedure
Does not exceed Rs. 10,00,000/-
  1. Filing simple suit for recovery before Civil Court.
  2. Filing of summary suit under Order XXXVII of CPC, 1908.
  3. Filing suit for foreclosure of mortgage.
  4. Arbitration proceedings if arbitration agreement exists.
Exceeds Rs. 1,00,000/-In case the “Security Interest” has been created in specific movable / immovable property provisions of the Securitization Act may be invoked to repossess the mortgaged property, without intervention of the court, and sell the same, provided the account has been classified as NPA.
Exceeds Rs. 10,00,000/-Original application is to be filed before the DRT for recovery of dues. Bank can simultaneously initiate proceedings under Securitization Act as well.  Civil court / Arbitrator will not have jurisdiction to entertain such claim.

DEBT RECOVERY TRIBUNALS & PROCESS OF RECOVERY

Debts Recovery Tribunals (DRT) and Debts Recovery Appellate Tribunals (DRAT) have been constituted under the provisions of the DRT Act for establishment of Tribunals for expeditious adjudication and recovery of debts due to Banks and Financial Institutions and for matters connected therewith.

DRT has also been given the power to adjudicate  the applications filed by the Borrower/Mortgagor against the action of the Secured Creditor initiated under the Securitization Act

ESTABLISHMENT OF  DRTs

The Central Government by notification has established Tribunals known as Debts Recovery Tribunals (DRT) to exercise the jurisdiction, power and authority confers under the Act at:

Mumbai, Delhi, Kolkata, Chennai,

Bangalore, Allahabad, Ahmedabad, Aurangabad,

Chandigarh, Madurai, Coimbatore, Cuttack,

Orissa, Patna, Bihar, Ernakulam,

Guwahati, Hyderabad, Vishakhapatnam, Jabalpur,

Jaipur, Lucknow, Nagpur, Ranchi

Pune.

Establishment of DRATs

In exercise of powers, the Central Government has established DRAT at places :-

  • Allahabad – Jurisdiction over DRTs functioning at Allahabad, Lucknow and Jabalpur.
  • Chennai – Jurisdiction over DRTs functioning at Bangalore, Chennai, Coimbatore, Hyderabad, Vishakhapatnam and Ernakulam.
  • Delhi – Jurisdiction over DRTs functioning at Delhi, Chandigarh, Jaipur.
  • Kolkata – Jurisdiction over DRTs functioning at Cuttack, Guwahati, Patna, Kolkata and Ranchi.
  • Mumbai – Jurisdiction over DRTs functioning at Ahmedabad, Aurangabad, Mumbai, Nagpur and Pune.

Composition of DRT and DRAT

DRT is presided over by a Presiding Officer, who is qualified to be a District Judge, and is appointed by notification by Central Government.

DRAT is presided over by a Chairperson, who is qualified for appointment or who has been a Judge of a High Court, or has been member of the Indian Legal Services who has held the post of Grade I of such services for at least three years.

The Recovery Of Debts Due To Banks And Financial Institutions Act, 1993

Applicability (DRT  Act)

  • The Act applies to whole of India except State of Jammu & Kashmir.
  • The provisions of Act applies where the amount of debt due is not less than Rs. 10,00,000/-.
  • Original Application for recovery of Debts can be filed only by Banks and Financial Institutions.

Applications to be made to DRT  under DRT  Act

  • Only Banks and Financial Institutions defined under the DRT Act, (which includes Public Financial Institutions within the meaning of Section 4A of the Companies Act, 1956, Securitization company / Reconstruction company under the Securitization Act), can file an application before the DRT. Normal fees, based on amount claimed in O.A., has been fixed as court fee which does not exceed Rs. 1.50 lakhs.
  • Summary procedure is adopted by the DRTs for adjudication of dispute.  Evidence is taken on affidavit and cross examination is not permitted except in few deserving cases.
  • The defendants can file counter claim or claim of set off against the claimed amount.
  • The final order is passed by the Tribunal directing the borrowers to pay the amount.  In case, the borrower does not pay the ordered amount, recovery certificate is ordered to be issued against the borrower which is then executed by Recovery Officer of the DRT.

Powers of DRT

DRT has power to:

  • summoning and enforcing the attendance of any person and examining him on oath;
  • requiring the discovery and production of documents;
  • receiving evidence on affidavits;
  • issuing commissions for the examination of witnesses or documents;
  • reviewing its decisions;
  • dismissing an application for default or deciding it ex-parte.
  • make interim order by way of injunction, stay or attachment against the defendant to debar from transferring, alienating or otherwise dealing with the property or asset without permission of Tribunal.
  • direct the defendants to provide security sufficient to satisfy the debt.

Willful disobedience of powers of Tribunal are punishable under Contempt of Court Act.

Appeal against the order of DRT

Any person aggrieved on account of order passed by DRT may file an appeal before DRAT.

However, the DRAT does not entertain the appeal unless the Appellant deposits with the Appellate Authority, 75% of the amount or such other lesser amount as directed by DRAT.

Overriding Effect

Provisions of the DRT Act has overriding effect over any other law for the time being enforced except :

  1. IFCI Act
  2. State Financial Corporation Act,
  3. Unit Trust of India Act,
  4. Financial Reconstruction Bank of India Act,
  5. Sick Industrial Companies (Special Provisions) Act and
  6. Small Industries Development Bank of India Act.
  7. The Industrial Reconstruction Bank of India Act, 1984

Applicability  of Securitization Act

  • The Act applies to whole of India.
  • The provisions of the Act shall apply to  Security  Interest created in favour of Secured Creditor, except on :-
    1. A lien on any goods, money or security given by or under the Indian Contract Act, 1872 or the State of Goods Act, 1932 or any other law for the time being in force;
    1. A pledge or movables within a meaning of Section 172 of Indian Contract Act.
    1. Creation of any security in any aircraft as defined in clause (1) of Section 2 of Aircraft Act, 1934.
    2. Creation of security interest in any vessel as defined in clause (55) of Section 3 of the Merchant Shipping Act, 1958.
    1. Any conditional sale, hire purchase or lease or any other contract in which no security interest has been created.
    1. Any rights of unpaid seller under Section 47 of the Sale of Goods Act, 1932.
    1. Any property 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.
    1. Any security interest for securing repayment of any financial asset not exceeding one lakh rupees.
    1. Any security interest in agricultural land.
    1. Any case in which the amount due is less than twenty per cent of the principal amount and interest thereon.

Compliance under “The Securitization & Reconstruction of Financial Assets & Enforcement of Security Interest Act 2002” (“Securitization Act”) & “Security Interest (Enforcement) Rules, 2002″(“Rules” )

CHECK LIST FOR ENFORCEMENT OF SECURITY INTEREST IN CASE OF IMMOVABLE ASSETS

SR. NO.COMPLIANCESRELEVANT PROVISIONS
1Bank/FI to give a Power of Attorney/ Letter authorising its concerned official to take steps under the Act.Sec  13 (12) read with Rule   2(a)
2Sending of Demand Notice for enforcement of Security Interest.Sec 13(2) read with Rule 2(b) & 3
3Notice can be sent by Registered Post or Speed Post or Courier or Fax or E-mailRule  3(1)
4If 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 circulationProviso to Rule 3 (1)
5If more than one Borrower (which includes guarantor), individual notice to be served on each of them.Rule 3(4)
5AIn case any reply/representations are received, the Bank  to suitably adjudicate upon and decide.Section 13(3A)
5BIssue Notice for taking possession of Secured Asset u/s 13(4) of Act .Sec 13(4)
5CTake symbolic possession of the Secured AssetsSec 13(4)
6File an application before the Chief Metropolitan Magistrate or District Magistrate for taking actual  possession of the propertySec  14(1)
7Comply with the order of the Chief Metropolitan Magistrate or District MagistrateSec  14(2)
8.Liaisoning with the Court Receiver, Police authorities, etc.
9.Deposit of fee with Police authorities, if any, in case the police force is to be made available by police station in Utter Pradesh
10After taking the possession a notice in terms of Appendix IV will be sent to the Borrower, which will also be affixed on the Property.Rule 8(1)
11The said notice will also be published in two leading newspapers one in vernacular language within 7 days.Rule 8(2)
12Name of Bank/FI to be displayed on the Property.Rule  8(1)
13Insurance cover to be arrangedRule 8(4)
14Take PhotographsNot specified
15Security Guards to be deployed at the site of the Property.Rule 8(4)
16Valuation of property by an approved valuer before effecting the saleRule  8(5)
16AServe on the Borrower a notice of 30 days for sale.Rule 8(6)
17Obtaining Quotations/Inviting tenders/Holding Public Auctions/ Signing Private Agreement for sale of the property.Rule  8(5)
18If 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 sale.Proviso to

Rule  8(6)

19Notice and Publications to be affixed on conspicuous part of the property and put on the website of the Bank.Rule 8(7)
20Sale other than public auction/tender to be on terms settled between the parties in writing.Rule 8(8)
21Sale to be confirmed in favour of highest bidderRule 9(2)
22No sale to be confirmed on less than reserve process. However sale at less than Reserve price can be made with the consent of BorrowerProviso to Rule 9(2
2325% of the sale price to be deposited forthwith and balance within 15 daysRule 9(3) and (4)
24If balance is not deposited the deposit would be forfeited and the property be resold.Rule 9(5)
25Sale  of  Property to be made effective from execution of  Sale DeedNot specified
26If the terms of payment have been complied with, the Bank/FI shall issue a certificate of sale in favour of the purchaserRule  9(6)
27The certificate of sale to specify whether the property is free from encumbrances known to the Bank
28Acknowledgement from buyer of having taken over the physical possession of property to be obtained by the Bank/FI.Not specified
29In 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.Sec  13(10)

Read with

Rule  11

Applications to be made to DRT under said Securitisation Act

  • Any person, aggrieved by any of the measures referred to in sub-section (4) of sector 13 taken by the secured creditor may make an application under section 17 of the Act to the Debts Recovery Tribunal, within forty-five days from the date on which such measures had been taken.
  • Procedure prescribed under the DRT Act is to be adopted by the DRT for disposal of such applications filed un/s 17 of the Act.

Appeal against the order of DRT under Securitisation said Act

Any person aggrieved on account of order passed by DRT may file an appeal before DRAT.

The DRAT does not entertain the appeal unless the Appellant deposits with the Appellate Authority, 50% of the amount or such other lesser amount as directed by DRAT.

  • Powers of DRT  under Securitisation Act
  • In addition to the power of the DRT under DRT Act, a DRT has following additional powers:

a.to restore for ordering restoration of the management of the secured assets to the borrower or restoration of possession of the secured assets to the borrower.

b.to order payment of cost/compensation to the borrower if it holds that the possession of the secured assets by the secured creditor is not in accordance with the provisions of the Act.

Disposal of Application /Appeal by DRT/DRAT

  • Any application made by the Banks and Financial Institutions is to be dealt with by the Tribunal as expeditiously as possible and endeavor is to be made by Tribunal to dispose off the application finally within a period of 180 days from the date of receipt of application.
  • The appeal filed before the Appellate Tribunal is to be disposed off as expeditiously as possible and endeavor is to be made by Tribunal to dispose off the appeal finally within a period of six months from the date of receipt of appeal.
  • On practical side the proceedings before may take from 1 (one) year to 3 (three) years depending upon the facts and circumstances of the case.

IMPORTANT PRECEDENTS

  • Mardia Chemicals Ltd. Vs Union Of India (AIR 2004 SC 2371)

Ratio:  The constitutionality of the Securitisation Act was upheld except  17(2) of the Act.

  • Transcore Vs Union Of India  (AIR 2007 SC 712)

Ratio:  Withdrawal of suit pending before DRT under DRT Act, 1993 is not a pre-condition for taking recourse to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 is an additional remedy, which is not inconsistent with DRT Act, 1993 and, therefore, doctrine of election has no application.

Central Bank of India Vs State of Kerla (JT 2009 (3) SC 216)

Statutory first charge over property under any law will prevail over rights created in favour of secured creditors such as banks and other financial institutions.

United Bank of India Vs Satyawati Tandon and Others (AIR 2010 SC 3413)

Where statutory remedies are available under a fiscal statute then exercise of jurisdiction under Article 226 by High Court for passing orders, which could have serious adverse impact on the right of banks and other financial institutions to recover their dues, is not warranted

OTHER IMPORTANT JUDGMENTS

  • Rajshree Sugar and Chemicals Ltd. Vs Axis Bank

AIR 2011 Madras 144

  • State Bank of India Vs Sharda Spuntex ;

I(2010) BC 562 Rajasthan

Transactions in derivatives, fall within the category of “business activity undertaken by the Bank” as they are covered by Section 6(1) of the Regulation Act . If the transaction in question gives rise to a claim by the Bank, of any liability, on the part of the Company, the Bank may certainly be able to invoke the provisions of  DRT Act. Further held that what is expressly permitted by law, cannot be held to be opposed to public policy

  • BOI Finance Ltd. Vs Custodians and Others;  AIR 1997 SC 1952

The non-compliance of the directions issued by the Reserve Bank may result in prosecution/or levy of penalty under Section 46, but it cannot result in invalidation of any contract by the bank with the third party.

  • ICICI Bank Ltd. Official Liquidator of APS Star Industries Ltd. (2010) 10 SCC 1: 

The Hon’ble Supreme Court held that an outstanding in the account of the borrower is a debt due and payable by the borrower to the bank and the bank is the owner of such debt.   The bank can always transfer its assets and such transfer in no manner affects any right or interest of the borrower.

  • Inderjeet Arya Vs. ICICI Bank Ltd., Writ Petition No. 7253/2011 

The Hon’ble Delhi High Court held that the action against the Borrower in the Debt Recovery Tribunal is not a suit and, therefore, such Guarantor cannot take protection under Section 22 of SICA.

  • Effect of the Act on the Economy / Banking Sector
  • The enactment of the Act has been a major factor in improving the health of Banks and Financial Institutions by enabling the bank to reduce their NPAs to substantially lower level.  On account of availability of dual remedy, i.e. remedy under the Securitization Act and DRT Act, the Banks and Financial Institutions have been able to substantially resolve the NPAs.
  • We have handled close to 600-650 default cases under Securitization Act for various Banks viz., Standard Chartered Bank, HDFC Bank, China Trust Commercial Bank, HSBC, Axis Bank etc. and have successfully recovered the outstanding dues in more than 80% of the cases.

How banks misuse SARFAESI Act provisions for loan recovery

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How banks misuse SARFAESI Act provisions for loan recovery

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act 2002 is a powerful instrument in the hands of the banks and financial institutions (FIs) as secured creditors. This Act helps them enforce securities held as collateral to loans disbursed by them should such loans turn out as non-performing assets (NPAs) during the currency of the loan without interference from the Courts. Section 13 of the Act gives power to the secured creditor even to evict the tenant. It is our observation that the banks have been overenthusiastic in taking recourse to SAFRAESI Act provisions as a first resort of recovering the micro, small and medium enterprises (MSME) loans, mostly violating guidelines of Reserve Bank of India (RBI).

The entire process under the Act involves several factors of fairness and technicalities. During our interactions with the borrowers and banks in the State Level Inter-institutional Sub-committee (SLIIC), we have noticed the banks jumping into coercive actions throwing overboard the due processes.  It is surprising that tech-savvy systems of banks have not put in the measured timelines before pressing the red button to put the credit traffic of the MSMEs on halt.

RBI’s timelines are as follows:

  • If the account does not reflect credits into the account, 90 days preceding the date of balance sheet of the firm. Temporary deficiencies like late/ non-submission of stock statements or balance outstanding exceeding the drawing power, non-renewal of limits should not get categorised as NPA.
  • If the borrower does not pay three instalments continuously after 90 days but up to 12 months the account becomes sub-standard and NPA. Section 13 (2) empowers the Bank/ FI to serve a notice to the borrower for taking possession of the assets held as security for the money lent by it. But there is precursor to this action: the Bank/FI shall serve notice to the borrower to discharge his full liabilities within 60 days from the date of notice that should also detail out the legal consequences and penal provisions.

Going by these two directions under the Act, the borrower should be getting at least 17 months’ time before the Bank could proceed against the defaulting MSMEs.

If the borrower becomes a ‘wilful defaulter’ as defined by the RBI Master Circular on wilful defaulters vide RBI circular (RBI/2014-15/73 DBR.No.CID.BC.57/20.16.003/2014-15 dated July 1, 2015) SARFAESI Act proceeding can be issued even without notice to the borrower.

Who is a wilful defaulter?

  • Deliberate non-payment of the dues despite adequate cash flow and good net worth;
  • Siphoning off of funds to the detriment of the defaulting unit;
  • Assets financed either not been purchased or been sold and proceeds have been misutilised;
  • Misrepresentation / falsification of records;
  • Disposal / removal of securities without bank’s knowledge;
  • Fraudulent transactions by the borrower.

Banks/ FIs throwing overboard these norms, classify all the MSME NPAs as wilful defaulters to apply the SARFAESI lever. As per the Act, valuation of the asset has to be done and notify that valuation to the borrower before issuing public notice for auction of property. Bank has to give 30 days’ notice to the borrower regarding its right to proceed against the mortgaged property if he does not pay up the entire principal and interest.

However, we have noticed that in most cases all the above timelines are followed more in breach with impunity by the banks. For example, a public sector bank (PSB) proceeded with sale of property within 15 days of declaring the asset as NPA. They have also fixed a reserve price without consulting the impugned borrower or without taking into consideration any objections raised by the borrowers as required under section 13 (3) (A) and proceed for auction of the properties. This is the case with most collateralize MSME NPAs. On top of this, almost everywhere the bank has also engaged agents for enforcing coercive recovery measures.

In quite a few other cases, the banks sold off assets to asset restructuring companies (ARCs). Here the process is that the bank bundles a few NPAs and sells them off at a discount, which is not disclosed either to the borrower or to the SLIIC sub-committee. Although it may be in order for the bank to entertain request of the enterprise under one-time settlement (OTS) within the rules of the RBI, its preference is to transfer to ARC at a far lesser price than OTS would have got to the bank.

What is ARC and how does this operate?

All transactions of securitisation, reconstruction and creation of security interest shall be registered with a Central Registry maintained with the Union Government. Within 30 days of securitising the asset, details of securities have to be filed with the central registry by paying the required fees.

RBI has issued guidelines in 2003 on the form of offer and details to be incorporated therein. The most usual form is the Security Receipt (SR) and an agreement with the originator to continue to service the assets of the securitisation. It can also take the form of a debenture at no less than 1.5% above the Bank Rate. The ARC should notify a separate scheme for each financial asset acquired or proposed to be acquired. Scheme-wise the account shall be maintained. Although Security Receipt is a tradable receipt among the investor institutions there is no such evidence thus far.

Realization of the asset is held and applied towards redemption of the investments as assured while issuing the security receipt. It acts like a trustee managing the assets and does not become the owner of the assets. ARC can sell or lease out the assets for realising the value of the assets. The recovered amount of the discounted price of the asset will be shared between the Bank and ARC in 85:15. For example, if a loan of Rs100 lakh is sold for Rs60 lakh to the ARC and the ARC realises only Rs50 lakh on sale or the entire armoury at its command, the Bank will get Rs42.50 lakh for fully wiping out the account from its books. Once the asset is sold off, it ceases to be NPA in its books.

If the intention of the Bank were to recover as much as possible from the stressed asset, it would be wise to explore OTS as first option within the RBI guidelines. We have noticed that in no more than 5% of cases that this option is exercised as the bonafides in OTS transaction is suspect. It would be prudent on the part of the RBI to ensure that the OTS option is exhausted before going for securitisation and sale of the asset.

The other option is to seek the Banking Ombudsman’s intervention as Arbitrator to settle the distressed asset closure in cases where either the borrower or the bank has reason to believe that a mutually agreed price of the loan would be a better option than proceeding against the asset under SAFRAESI Act.

 

SARFAESI ACT, 2002- Applicability, Objectives, Process, Documentation

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The financial sector has been one of the key handlers in India’s efforts to achieve success in rapidly developing its economy. Since our existing legal framework relating to commercial transactions has not kept pace with the changing commercial practices and financial sector reforms. This ensures the slow pace of recovery of defaulting loans and escalating levels of nonperforming assets of banks and financial institutions.

  • Applicability Of SARFAESI Act, 2002
  • Role of SARFAESI Act, 2002
  • Objectives of SARFAESI Act, 2002
  • Documents Required
  • Formation of SARFAESI Act, 2002

Narasimham Committee I and II and Andhyarujina Committee was constituted by the Central Government for the purpose of examining banking sector reforms have considered the need for changes in the legal system in respect of these areas. Amongst the other committees, these Committees have made suggestions to form new legislation for securitization and empowering banks and financial institutions to gain possession of the securities and to sell them without any intervention of the court here.

Applicability Of SARFAESI Act, 2002

The amendment to this Act is “an act to regulate securitization and reconstruction of financial assets and enforcement of security interest and to provide for a central database of security interests created on property rights, and for matters connected therewith or incidental thereto.”

The Act deals with the following:

  • Registration and regulation of Asset Reconstruction Companies (ARCs) by the Reserve Bank of India
  • Facilitating securitization of financial assets of banks and financial institutions with or without the benefit of underlying securities
  • Promotion of seamless transferability of financial assets by the ARC to acquire financial assets of banks and financial institutions through the issuance of debentures or bonds or any other security as a debenture
  • Entrusting the Asset Reconstruction Companies to raise funds by issue of security receipts to qualified buyers
  • Facilitating the reconstruction of financial assets which are acquired while exercising powers of enforcement of securities or change of management or other powers which are proposed to be conferred on the banks and financial institutions
  • Presentation of any securitization company or asset reconstruction company registered with the Reserve Bank of India as a public financial institution
  • Defining ‘security interest’ to be any type of security including mortgage and change on immovable properties given for due repayment of any financial assistance given by any  bank or financial institution
  • Classification of the borrower’s account as a non-performing asset in accordance with the directions given or under guidelines issued by the Reserve Bank of India from time to time
  • The officers authorized will exercise the rights of a secured creditor in  this behalf in accordance with the rules made by the Central Government
  • An appeal against the action of any bank or financial institution to the concerned Debts Recovery Tribunal and a second appeal to the Appellate Debts Recovery Tribunal
  • The Central Government may set up or cause to be set up a Central Registry for the purpose of registration of transactions relating to securitization, asset reconstruction and creation of the security interest
  • Application of the proposed legislation initially to banks and financial institutions and empowerment of the Central Government to extend the application of the proposed legislation to non-banking financial companies and other entities
  • Non-application of the proposed legislation to security interests in agricultural lands, loans less than rupees one lakh and cases where eighty per cent, of the loans, is repaid by the borrower

Role of SARFAESI Act, 2002

 

Objectives of SARFAESI Act, 2002

  • Efficient or rapid recovery of non-performing assets (NPAs) of the banks and FIs.
  • Allows banks and financial institutions to auction properties (say, commercial/residential) when borrower fail to repay their loans.

 

Documents Required

e-Form CHG-1 or e-Form CHG-9  is required to be filed for application of

  1. Registration of creation
  2. Modification of charge (other than those related to debentures) including particulars of modification of charge by Asset Reconstruction Company in terms of Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 [SARFAESI]

The documents in this context are as follows :

  1. Particulars of charge
  2. Certificate of registration

iii.  An Instrument created for the charge

  1. Copy of the instrument – creating or modifying the charge
  2. Hypothecation Deed
  3. Sanction Letter

In case of any e-Form to be digitally signed, either of the following is required-

  1. DSC of the charge holder
  2. Director Identification Number [DIN]of the Director
  3.  Permanent Account Number [PAN] of the manager, CEO, CFO
  4.   Membership Number of the Company Secretary

Formation of SARFAESI Act, 2002

Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) was circulated –

  1. To regulate securitization and reconstruction of financial assets
  2. Enforcement of the security interest for

iii. Matters connected therewith or incidental thereto

It extended to the whole of India.

Amendment in the (SARFAESI) Act, 2002 vide the enforcement of the Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016.

The Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisional information in the Official Gazette, s (Amendment) Act, 2016 was published

It is an Act further to amend four laws:

  1. Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI)
  2. Recovery of Debts due to Banks and Financial Institutions Act, 1993 (RDDBFI)
  3. Indian Stamp Act, 1899
  4. Depositories Act, 1996, and for matters connected therewith or incidental thereto

CHECKLIST FOR ACTION UNDER SARFAESI ACT

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CHECKLIST FOR ACTION UNDER SARFAESI ACT

 

Authorized Officer who is given the statutory power has to exercise higher degree of caution and care in following the prescription law while taking action under the Act. Taking action in any other manner than the prescription is not permissible in law. This cardinal principle is covered by Latin Maxim “expressio unius est exclusio alterius”. This is followed by Supreme Court and High Courts as can be seen from catena of judgments. The Authorised Officer may follow the check list for initiating the action. That any error or omission on the part of the authorized officer, makes the action of the bank liable to be striked down by DRT under Section 17 of the The Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002.

 

Sl.N.STAGE WISE ACTIONSUGGESTION/ADVISE
1Sarfaesi Act  poroceeds on the basis that borrower created security interest in favour of bank and his liability stood crystalised on account of his default and his account is classified as NPASec.13(2): Where any borrower, who is under a liability to a secured creditor under a security agreement, makes any default in repayment of secured debt or any instalment thereof, and his account in respect of such debt is classified by the secured creditor as non-performing asset, then, the secured creditor may require the borrower by notice in writing to discharge in full his liabilities to the secured creditor within sixty days from the date of notice failing which the secured creditor shall be entitled to exercise all or any of the rights under subsection(4)
1Initiation of action begins on service of demand noticeThe opinion Supreme Courtin Mardia Chemicals Ltd. &Anr. Vs. Union of India &Ors.:AIR 2004 (4) SCC 311)that the demand notice is show cause is clarified by Supreme Court in (Transcore Vs. Union of India &Anr. AIR 2007 SC 712) as initiation of action
2How to calculate the quantum of claim amount in the demand noticePlease ensure that, the balance outstanding in the bank’s book and the un-debited portion of interest accrued but not reflected in the bank’s book (on account of status of the loan account as NPA) are added and incorporated in the demand notice. The Authorised Officer (for short “A.O.”) need not approach any Court or Tribunal for determination of the quantum of amount of claim.

 

3Demand notice and its contents:i). Please ensure that the demand notice covers all the details of the facilities granted to the borrower(s), dues and securities and measures to be taken in the event of default as stated in the guide and all the borrowers are addressed correctly as per the records.

ii). The Act or the Rules have not prescribed any format of demand notice.

4Whether action under RDDB & Fi Act 1993 or a suit/ claim already filed in civil court/drt/transferred from civil court, saves limitation for initiating action under SARFAESI ActAction under RDDB & FI Act 1993 or a suit/claim already filed in civil court/DRT/transferred from civil court, does not save limitation for taking action under SARFAESI Act.
9Whether action initiated under SARFAESI Act 2002 saves limitation for filing claim for recovery of the unrealised portion of debt.No.
10How many demand notices a secured creditor can issueThere is no bar. Any number of notices can be issued provided the security interest sought to be enforced is not barred by limitation.

 

11Res JudicataNo application. Action under the Act can be taken any number of times if the secured debt or security interest is not barred by limitation.
12Service of demand notice: Please note changes in the addresses of the borrowers if any before addressing the demand notice. Change of address of borrower(s) must be obtained in writing. Oral information is not reliable as it is construed as not born out of record. Servedemand notice as contemplated in Rule 3 of Security Interest (enforcement) Rules 2002.3(1) The service of demand notice shall be made by delivering or transmitting at the place where the borrower or his agent, empowered to accept the notice or documents on behalf of the borrower, actually and voluntarily resides or carries on business or personally works for gain, by registered post with acknowledgement due, addressed to the borrower (or his agent empowered to accept the service) or by Speed Post or by courier or by any other means of transmission of documents like fax message or electronic mail service.

 

 ii). Procedure where borrower avoids service of demand notice or for any reason notice could not be served.Proviso to Rule 3(1):Where authorised officer has reason to believe that the borrower or his agent is avoiding the service of the notice or that for any other reason, the service cannot be made as aforesaid, the service shall be effected by affixing a copy of the demand notice on the outer door or some other conspicuous part of the house or building in which the borrower or his agent ordinarily resides or carries on business or personally works for gain and also by publishing the contents of the demand notice in two leading newspapers, one in vernacular language, having sufficient circulation in that locality.

Evidence of this exercise is to be reduced to writing (record panchanama).

Preserve full page of the relevant Newspapers as the same are required in evidence.

 iii) Service of notice to wife of borrower is sufficient serviceIf borrower’s marital relationship is not judicially separated or dissolved by order of competent court
 iv). If borrower is abody corporateRule 3(2): Where the borrower is a body corporate, the demand notice shall be served on the registered office or any of the branches of such body corporate as specified under sub-rule (1).
 v). The manner of service of any notice Rule 3(3) of S.I.(E) RulesRule 3(3): Any other notice [i.e. Possession notice under 13(4) of SARFAESI Act or Rule 8(6) of S.I.(E) Rules] in writing to be served on the borrower or his agent by authorised officer, shall be served in the same manner as provided in Rule 3.
 See Sec.2 (2) of SARFAESI Act.According to Section 2(1)(f) of SARFAESI Act “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

 

According to Sec.2(2) of the Act the Words and expressions used and not defined in this Act but defined in the Indian Contract Act, 1872 (9 of 1872) or the Transfer of Property Act, 1882 (4 of 1882) or the Companies Act, 1956 (1 of 1956) or the Securities and Exchange Board of India Act, 1992 (15 of 1992) shall have the same meanings respectively assigned to them in those Acts.

3Inspection of secured assetsIt is advisable to inspect the secured asset(s) and find out its/their status / situation.
4Computation of 60 daysThe date of service of the demand notice or publication of the demand notice after affixing it (as stated in the proviso to Rule 3(1) of S.I.(E) Rules) and the 60th day to be expired are to be excluded for computing the 60 days.

 

 

5Representation/Objection: against the demand notice Sec13 (3A).

 

Communication of reply is mandatory in both the events.

After service of the notice if the borrower makes any representation or objection against the demand notice the A.O. should immediately send it to the secured creditor who in turn should send a reply or advise the A.O. to communicate reply to the borrower within “fifteen days” (recent amendment substituted for one week) of receipt of such representation or objection by registered post with AD or Courier. Evidence of communication is to be preserved for evidence.

 

Representation: seeking for extension of time for payment or OTS.

Objection: Challenging the validity of the demand notice on various grounds.

6PROCEDURE FOR TAKING POSSESSION OF MOVABLE SECURED ASSETSTaking symbolic possession of movable secured assets is not permissible in law. Procedure for taking possession of movable secured assets is different from the procedure relating to the immovable secured assets.
  i). In case the secured assets are movable, the A.O. has to take possession of them in the presence of two witnesses and draw a  panchanama, as nearly as possible as given in Appendix-I [ See Rule 4(2) of S.I.(E) Rules]

(Evidence to be preserved).

 INVENTORY REPORTii). After taking possession of the movable secured assets, the A.O. has to record ‘Inventory Report’ as per Appendix–II [See Rule 4(1) of S.I.(E) Rules] and deliver it or caused to be delivered it to the borrower any person entitled to receive on behalf of borrower. In the inventory report the A.O. has to mention the name of the person appointed by him in whose custody the secured assets are preserved.
 PRESERVATIONTo take care to preserve movable secured assets which owner of ordinary prudence would take. In case of factories or stores the secured creditor has to entrust the same for custody of an authorised person or approved re-possessors / security persons.
 INSURANCE COVERA.O. has to take insurance cover if necessary until sale is completed. Comprehensive policy with a clause to pay the sum assured to the company which would discharge the insurance company against adverse claim of borrower if any.
7CIRCUMSTANCES FOR IMMEDIATE SALEThere are two circumstances for immediate sale of movable secured assets.

1.   If movable secured assets are subject to speedy or natural decay

2.   or the expense of keeping such property in custody is likely to exceed its value, the authorised officer may sell them at once.

 

(Issue sale notice but need not wait for expiry of 30 days of the sale notice).

 

AO has to record reasons if necessary by drawing a panchanama in this regard.

 

8

 

PLANT AND MACHINERY ATTACHED TO EARTHPlant and machinery should be treated as part of the immovable secured asset if they are fastened to the earth with cement and concrete as on the date of taking possession. In the possession notice (Appendix-IV) the same must be mentioned specifically giving brief description of the particulars of the machinery vide separate annexure attached to it.
 PLANT AND MACHINERY IF DETACHED FROM EARTHIf Plant and machinery are detachable from earth as on the date of taking possession then A.O. has to record ‘Inventory Report’ as per Appendix–II [See Rule 4(1) of S.I.(E) Rules] and deliver it or caused to be delivered it to the borrower any person entitled to receive on behalf of borrower. In the inventory report the A.O. has to mention the name of the person appointed by him in whose custody the secured assets are preserved.
 VALUATION OF MOVABLE SECURED ASSETSAfter taking possession under sub-rule (1) of rule 4 and in any case before sale, the authorised officer shall obtain the estimated value of the movable secured assets and thereafter, if considered necessary, fix in consultation with the secured creditor, the reserve price of the assets to he sold in realisation of the dues of the secured creditor.
8REQUIREMENTS TO MOVE CMM/DMFOR ASSISTANCE1.   Application making a request to render assistance.

2.   List with copies of documents.

3.   Affidavit disclosing all the particulars.

9PROCEDURE IN CASE OF IMMOVABLE SECURED ASSETSTake possession of immovable secured asses (whether symbolic or physical), serve possession notice (Appendix-IV) under Sec.13(4) read with Rule 8(1) and(2), obtain acknowledgment of service, affix it to secured asset and publish it in two leading newspapers(one in vernacular) having sufficient circulation in the locality.

 

  If borrower refuses to acknowledge service of the possession notice, then the AO may send it by registered post /courier and preserve evidence and the same may be recorded at the foot of the possession notice and obtain signature of two witnesses.
10VALUATION OF IMMOVABLE SECURED ASSETS BY APPROVED VALUER

 

 

 

 

Rule 8(5) of S.I.(E) Rules contemplates valuation of immovable secured assets by approved valuer before effecting sale.
11APPROVED VALUER:1.Registered under Sec.34AB

of Wealth Tax Act 1957

2.Approved by the Board of the

company.

12RESERVE PRICEValuation minus 15% or 20%

See Swastic Agency Vs. State Bank of India

 

13SALE NOTICE-PERSONAL Rule 8(6)The Authorised Officer shall serve to the borrower a notice of thirty days for sale of the immovable secured assets, under sub-rule (5)

 

14SERVICE OF SALE NOTICESale notice must be served in the same manner as the demand notice and possession notice are served in the same manner as contemplated in the sub rule(1) of Rule 3 of S.I.(E) Rules 2002. See Rule 3(3) demanding the borrowers to pay the debt as demanded in the demand notice and possession notice together with interest
15PUBLICATION OF SALE NOTICEIf the sale of such secured asset is being effected by either inviting tenders from the public or by holding public auction, the secured creditor shall cause a public notice in two leading newspapers one in vernacular language having sufficient circulation in the locality by setting out the terms of sale, which shall include, –

(a) the description of the immovable property to be sold, including the details of the encumbrances known to the secured creditor

(a) the description of the immovable property to be sold, including the details of the encumbrances known to the secured creditor;

(b) the secured debt for recovery of which the property is to be sold;

(c) reserve price, below which the property may not be sold;

(d) time and place of public auction or the time after which sale by any other mode shall be completed;

(e) depositing earnest money as may be stipulated by the secured creditor;

(f) any other thing which the authorised officer considers it material for a purchaser to know in order to judge the nature and value

of the property.

16AFFIXTURE OF SALE NOTICEEvery notice of sale shall be affixed on a conspicuous part of the immovable property and may, if the authorised officer deems it fit, put on the website of the secured creditor on the Internet.

 

17SALE  BY OTHER METHODSSale by any methods other than public auction or public tender, shall be on such terms as may be settled between the parties in writing.
18SALE CANNOT BE EFFECTED BEFORE EXPIRY OF THIRTY DAYSNo sale of immovable property under these rules shall take place before the expiry of thirty days from the date on which the public notice of sale is published in newspapers as referred to in the proviso to sub-rule (6) or notice of sale has been served to the borrower.

 

19IDENTIFICATION OF SUCCESSFUL BIDDERA bidder who has offered highest prize shall be identified as successful bidder and he has to deposit 25% of the bid amount immediately
20CONFIRMATION OF SALE BY SECURED CREDITORThe sale shall be confirmed in favour of the purchaser who has offered the highest sale price in his bid or tender or quotation or offer to the authorised officer and shall be subject to confirmation by the secured creditor
21SALE BELOW RESERVE PRIZENo sale shall be confirmed, if the amount offered is less than the reserve price
22PAYMENT BY BIDDER IN WHOSE FAVOUR THE BID IS CONFIRMEDThe balance amount of purchase price payable shall be paid by the purchaser to the authorised officer on or before the fifteenth day of confirmation of sale of the immovable property or such extended period as may be agreed upon in writing between the parties.
23BIDDER’S NOMINEEBidder cannot appoint nominee for obtaining sale certificate
24FORFEITURE AND RESALE OF SECURED ASSETIn default of payment within the period mentioned in sub-rule (4), the deposit shall be forfeited and the property shall be resold and the defaulting purchaser shall forfeit all claim to the property or to any part of the sum for which it may be subsequently sold.
25CONSENT OF BORROWERIf the authorised officer fails to obtain a price higher than the reserve price, he may, with the consent of the borrower and the secured creditor effect the sale at such price.

 

26PARTIPATION OF THE BORROWER IN THE PROCESS OF SALE AS TENDERER/BIDDERBorrower can participate as tenderer / bidder to purchase the secured asset in the process of sale
 PARTIPATION OF THE BORROWER IN THE PROCESS OF SALE AS SPECTATOR OR WITNESSBorrower cannot participate as spectator or witness in the process of sale
27SALE CRTIFICATEOn confirmation of sale by the secured creditor and if the terms of payment have been complied with, the authorised officer exercising the power of sale shall issue a certificate of sale of the immovable property in favour of the purchaser in the Form given in Appendix V to these rules.

(Note: The sale is caused under the Act in “as it is what it is and where it is basis. Hence the S.I.(E) Rules devised the sale certificate. Sale Certificate does not contain any indemnity clause as in case of sale deed and the rule “sans recourse” is not applicable to the sale i.e. the secured creditor is not answerable for any defects in the title to the secured asset sold). The sale certificate shall be the prima facie evidence of title of the purchaser

28ENCUMBERANCESThe purchaser has to deposit the encumbrances if any in respect of the secured asset sold. Where the immovable property sold is subject to any encumbrances, the authorised officer may, if he thinks fit, allow the purchaser to deposit with him the money required to discharge the encumbrances and any interest due thereon together with such additional amount that may be sufficient to meet the contingencies or further cost, expenses and interest as may be determined by him.
29NOTICE TO PERSONS INTERESTED IN THE AMOUNT OF (CROWN DEBTS) ENCUMBRANCESOn such deposit of money for discharge of the encumbrances, the authorised officer shall issue notices to the persons interested in or entitled to the money deposited with him and take steps to make, the payment accordingly
30NON PRIORITY DUESThe following are not crown debts:

1.Electricity dues

2.Custom & Excise Duty

3.Income Tax dues prior to creation of mortgage

 

31PAMENT OF SURPLUS TO THE PURCHASERProvided that if after meeting the cost of removing encumbrances and contingencies there is any surplus available out of money deposited by the purchaser such surplus shall be paid to the purchaser within fifteen day, from date of finalisation of the sale.

 

What went wrong with Yes Bank?

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In this article we will discuss wrong with Yes Bank? We know the ongoing troubles with Yes Bank but in this article we aim to discuss the reasons behind what went wrong with Yes Bank. Yes Bank’s problems started two years ago, when the regulator forced it to disclose that nonperforming loans were $630 million more than the $113 million reported in the company’s audited accounts for the year ended in March 2016. The divergence widened to almost $1 billion a year later.

Account holders queue up outside Yes Bank to withdraw money, in Mumbai, Saturday, March 7, 2020. (Credit: PTI)

Account holders queue up outside Yes Bank to withdraw money, in Mumbai, Saturday, March 7, 2020.

The Reserve Bank of India (RBI) on March 5 placed Yes Bank under moratorium and restricted withdrawals to a maximum of Rs 50,000, sending its customers into a wave of confusion and panic.

Shares of the lender fell to its lowest on Friday, at Rs 5.65 a share, down by over 84% in intraday trading before paring losses and closing at Rs 16.15 on the NSE. Depositers queued up to withdraw their money and fintech platforms partnered with the bank suffered outages and suspended their services.

Here are some reasons behind the crisis:

1. Bad loans – wrong with Yes Bank

Yes Bank, a medium-sized private sector bank, first ran into trouble following the central’s bank’s asset quality reviews in 2017 and 2018, which led to sharp increases in its impaired loans ratio and uncovered significant governance lapses that resulted in a complete change of management.

Yes Bank, yet to report its third-quarter financials, has struggled to raise the capital that it needs to stay above regulatory requirements as it battles high levels of bad loans. It has been trying to raise more than $1 billion in fresh capital since late last year.

2. Sluggish economic sector

Indian authorities have been struggling to contain a crisis among shadow lenders, less tightly regulated lending and lending for riskier businesses, which has choked credit to consumers and small businesses, slowing economic growth to a 11-year low, according to Fitch Ratings.

“In the absence of a credible revival plan, and in public interest and the interest of the bank’s depositors, it had no alternative” but to seize Yes Bank, the RBI said in the statement.

In its 2020 Outlook for ‘Asia-Pacific Emerging Market Banks’, Fitch maintained a negative outlook on Indian banks, based on its expectations of continued weak performance despite trends showing the trough might have passed, and ongoing capital requirements.

3. Governance issues – wrong with Yes Bank

The bank has experienced serious governance issues and practices in recent years that led to its downfall. According to a Business Today report, the bank under-reported Non-Performing Assets to the tune of Rs 3,277 crore in 2018-19.

4. Deferring regulatory restructuring -wrong with Yes Bank

Two years ago, co-promoter Rana Kapoor was asked to step down by the RBI. Despite continued poor performance, the RBI did not place the bank under the Prompt Corrective Action framework and chose to move directly to a moratorium. According to a report in The Hindu, the central bank had flagged several concerns in recent years, including a distinct divergence between the bank’s reported financials and the RBI’s findings.

5. High withdrawals

Yes Bank’s financial condition dissuaded many depositors from keeping funds in the bank over a longer term. The bank showed a steady withdrawal of deposits, burdening its balance sheet and adding to its woes. The bank had a deposit book of Rs 2.09 lakh crore at the end of September 2019.

Here are some important things to know about the Yes Bank crisis:

  1. Depositors rushed to ATMs for withdrawing funds from their accounts following the RBI’s move last Thursday to cap the withdrawals at Rs 50,000. While many customers claimed that the bank had not given any prior information about the move, some complained that the ATMs were out of cash.
  2. Currently, the RBI has capped Yes Bank withdrawals at Rs 50,000 till April 3 and imposed limits on withdrawals to protect the depositors.
  3. During this period, RBI has not allowed Yes Bank without prior permission of the RBI to make payments in excess of Rs. 50,000 to its savings, current or other account holders.
  4. The government has prodded State Bank of India – the country’s largest bank by assets – to step into the breach and lead the planned rescue of Yes Bank.
  5. SBI chairman Rajnish Kumar told NDTV on Monday that the current cap on withdrawals from Yes Bank accounts could be lifted “within a week”.
  6. “I want to assure Yes Bank customers that once we (SBI) step in, they shouldn’t worry about money… The financial system is sound,” he said.
  7. SBI has agreed to immediately invest Rs 2,450 crore to buy a 49 per cent stake in Yes Bank as part of the RBI-backed rescue deal for the troubled private sector lender.
  8. Yes Bank’s founder and former managing director, Rana Kapoor, is in police custody until March 11 after he was arrested on money-laundering charges.
  9. Yes Bank, weighed down by an increasing pile of bad debt, had struggled for months to raise the capital it needs to stay above regulatory requirements, without any success.
  10. Initially, Yes Bank wanted to raise $2 billion, which was later brought down to $1.2 billion as it could not rope in any investor. In February, the bank delayed the release of its financial results for the October-December period.

Journey of the definition of NPA – Non Performing Assets

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Non Performing Assets

Definition and Journey-of-NPA

Definition and Journey-of-NPA

The definition of NPA has seen a journey in the form of amendments to its originally conceived definition and various constitutional challenges. RBI issued notification, DBOD No. BP.BC/ 20 /21.04.048 /2001-2002 defined NPA – Non Performing Assets, namely, Prudential Norms on Income Recognition, Asset Classification and Provisioning – Pertaining to Advances, which summarily defines the NPA as below:

Definition: 

A non performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.

Description: 

Banks are required to classify NPAs further into Substandard, Doubtful and Loss assets.
  1. Substandard assets: Assets which has remained NPA for a period less than or equal to 12 months.
  2. Doubtful assets: An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.
  3. Loss assets: As per RBI, “Loss asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted, although there may be some salvage or recovery value.”

Historical Journey of the definition of NPA

That the Concept of NPA has seen a journey from its original definition to what it stands today.After a decade of working of the “The Recovery of Debts due to Banks and Financial Institutions Act, 1993” (“RDDBI Act”), it was felt that RDDBI Act was unable to achieve the desired result of efficiently recovering monies from the borrowers. This led to the enactment of “The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002” (“SARFAESI Act”) in the year 2002, with an attempt to revamp the slow pace of recovery of defaulting loans and mounting levels of non-performing assets of banks and financial institutions. The SARFAESI Act provides the “Secured Creditor”, the right to enforce the security without the intervention of either the court or tribunal by following the procedure prescribed under Section 13 of the SARFAESI Act. Thereafter, the constitutional validity of SARFAESI Act was challenged in Mardia Chemicals Ltd. & Others v. Union of India & Others1 and the Supreme Court of India (“Supreme Court”) upheld the constitutional validity of SARFAESI Act save that of sub-section (2) of Section 17.2

Amendment to Section 2(1) (o) of the SARFAESI Act

Section 2(1) (o) of the SARFAESI Act defines “non-performing assets” (“NPA”) and the said definition came to be amended in 2004.3 The amended definition has been the bone of contention in various high courts across the country. While Gujarat High Court by a common judgment dated April 24, 2014 held that the amended Section 2 (1) (o) of the SARFAESI Act is unconstitutional, on the other hand, in another common judgment dated May 18, 2014, the Madras High Court rejected the challenge. Hence, aggrieved parties (i.e. borrowers or the secured creditors) filed various writ petitions invoking Article 32 of the Constitution before Supreme Court.

Constitutionality Of The Amended Definition Of NPA Upheld

  • Supreme Court upholds the constitutional validity of amended definition of “non-performing assets” under SARFAESI Act;
  • Supreme Court holds that the function of prescribing the norms for classifying a NPA is not an essential legislative function and since all creditors do not form a uniform/homogeneous class, therefore by prescribing different norms for the identification of a NPA with reference to different creditors, does not amount to unreasonable classification;
  • Supreme Court provides much required clarification as there existed conflicting decisions by two different High Courts on the constitutional validity of the amended definition of NPA.
  • Recently, by a common judgment in Keshavlal Khemchand and Sons Pvt Ltd & Ors v. Union of India & Ors, the Supreme Court decided on the writ petitions and has upheld the constitutionality of the amended definition of NPA under the SARFAESI Act.

Definition of NPA

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002The Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Act, 2004
2. Definitions

(1) In this Act, unless the context otherwise requires:

(o) “Non-Performing Asset” means an asset or account of a borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss assets, in accordance with the directions or under guidelines relating to assets classification issued by the Reserve Bank.

2. Definitions

(1) In this Act, unless the context othe rwise requires:

(o) “Non-Performing Asset” means an asset or account of a borrower, which has been classified by a bank or financial institution, as sub-standard, doubtful or loss asset.-

(a) In case such bank or financial institution is administered or regulated by any authority or body established, constituted or appointed by any law for the time being in force, in accordance with the directions or guidelines relating to assets classifications issued by such authority or body;

(b) In any other case, in accordance with the directions or guidelines relating to assets classifications issued by the Reserve Bank.

Brief proceedings before Madras High Court

Madras High Court rejected the submission that the amended definition suffers from the vires of excessive delegation on the following premises:

  1. In the year 1992, Reserve Bank of India (“RBI”) introduced the prudential norms of “income recognition, asset classification, provisioning and other related matters” and such norms were revised periodically keeping in mind various developments in the banking system, both nationally and internationally.
  2. RBI in exercise of the statutory authority under Sections 21 and 35A of the Banking Regulation Act, 1949 prescribes norms for the various aspects of banking specified under the SARFAESI Act.
  3. Parliament while defining a non-performing asset under Section 2 (1) (o) of the SARFAESI Act only adopted the norms prescribed from time to time by the RBI for the purpose of identifying the NPA.

Brief proceedings before Gujarat High Court

Gujarat High Court (“Gujarat HC“) opined that the amended definition of the expression “NPA” creates two classes of borrowers and in this context, while one class of borrowers are governed by the guidelines issues by the RBI, the other class of borrowers are governed by the guidelines issued by different authorities4. Gujarat HC relying on the statement of objects and reasons of the SARFAESI Act, held that the Parliament deviated from the original aims and objects propounded by it. It also took note of the fact that Supreme Court in Mardia Chemicals repelled the attack on the original definition of a NPA on the ground that the creditors are bound by the policy guidelines issued by the RBI, and therefore, there is no possibility of the creditors arbitrarily or whimsically classifying the account of any borrower as a NPA. Accordingly, it was concluded that the deviation from the original objects and reasons would be violative of Article 14 of the Constitution of India.

Issues

The issue before Supreme Court was to test the constitutional validity of the definition of NPA. In particular, the Supreme Court examined the following aspects:

  1. Whether by delegating the responsibility to an authority or body to frame the guidelines for asset classification under the amended definition of NPA amounts to delegation of essential legislative function?
  2. Whether the different standards for arriving at the definition of NPA (in effect the differentiation between two classes of borrowers) amounts to a violation of Article 14 of the Constitution?

Contentions

Petitioner:

The Petitioner submitted that:

  1. by authorizing various bodies to frame guidelines for classifying borrower’s account as “NPA“, the same abdicated Parliament’s essential legislative function by making an excessive delegation;
  2. the un-amended Section 2(1)(o) of the SARFAESI Act provided an uniform standard for classification of “NPA” by applying the guidelines issued by the RBI, while the amended provision enables different Creditors to adopt different guidelines prescribing different standards for NPA classification. Such an amendment is violative of Article 14 of the Constitution of India as it amounts to a class legislation forbidden by Article 14 of the Constitution;
  3. The SARFAESI Act recognizes the possibility of acquisition of a “financial asset” of a Creditor by either a “securitization company” or a “reconstruction company” creating uncertainty in the application of the guidelines appropriate for classification of an account of a borrower as a NPA and purely depending on who the current holder of such financial asset is when the proceedings under Section 13 are sought to be invoked.
  4. The SARFAESI Act does not provide for a reasonable opportunity to demonstrate that the classification of the borrower’s account as a NPA is untenable, the power to make such a classification itself becomes arbitrary and violative of Article 14 of the Constitution.

Respondent:

The Respondent submitted that:

  1. the assessment of an account of borrower as NPA depends upon innumerable factors which constantly keep changing, as a result it was deemed fit that such assessment should be made in light of the guidelines made by either the RBI or various other regulators regulating the activities of various creditors. There is no delegation of any essential legislative functions.
  2. the classification of NPA to be made on the basis of the guidelines framed by different bodies regulating different creditors is not constitutionally permissible having regard to the nature of the different credit facilities extended by various creditors to different categories of borrowers and on different terms and conditions.
  3. even assuming that assets are acquired either by a secularization company or a reconstruction company and therefore governed by guidelines other than those promulgated by the RBI, it has not been demonstrated that such guidelines are less favourable to the borrowers than the guidelines prescribed by RBI.

Judgment

Supreme Court upheld the amended definition of NPA considering the below mentioned aspects and analyzing them at length.

  1. First, Supreme Court observed that if NPA is sought to be defined and holistically made applicable to millions of cases of loan transactions of various categories of loans and advances, lent or made by different categories of Creditors for all times to come, it would not only be an impracticable task but could also simply paralyse the entire banking system thereby producing results which are counter productive to the object and the purpose sought to be achieved by the SARFAESI Act. Realizing the same, the Parliament left it to the RBI and other regulators to prescribe guidelines from time to time in this regard.
  2. Second, the Supreme Court held that the function of prescribing norms for classifying a borrower’s account as a NPA is not an essential legislative function. According to Supreme Court, Parliament is only stipulating that the expression “NPA” must be understood by all the Creditors in the same sense in which such expression is understood by the expert body i.e., the RBI or other Regulators which are in turn is subject to the supervision of the RBI. Supreme Court held that the amended definition of NPA is not bad on account of excessive delegation of essential legislative function.
  3. Third, Supreme Court held that it is not necessary that legislature should define every expression it employs in a statute. If such a process is insisted upon, legislative activity and consequentially governance comes to a standstill. Supreme Court observed that if a statute does not contain the definition of a particular expression employed in it, it becomes the duty of the courts to expound the meaning of the undefined expressions in accordance with the well-established rules of statutory interpretation.
  4. Finally, Supreme Court held that as all the creditors do not form a uniform/homogeneous class, and therefore by prescribing different norms for the identification of a NPA with reference to different creditors does not amount to unreasonable classification. According to Supreme Court, there are innumerable differences among the creditors based on the legal structure of the creditors’ organization, differences based upon the nature of the loan advanced by them, and differences based on the terms and conditions subject to which such loans or advances are made by each of those creditors, etc.

Analysis

This is a landmark decision by the Supreme Court so far as it provides clarification on the conflicting approaches taken by various High Courts while deciding on the constitutional validity of the amended definition of NPA under the SARFAESI Act. The decision of the Supreme Court is well reasoned and based on the premise that there is a need for some amount of delegated legislation in the modern world considering the banking norms and guidelines laid down by various regulatory bodies for different class of creditors. Supreme Court`s analysis towards upholding the constitutional validity of the amended definition of NPA, while relying on the classification protected under Article 14 of the Constitution and principles of administrative law is appealing to say the least. More importantly, the Supreme Court has once again opined that the powers delegated to RBI for rule making are consistent with Section 21 and 35-A of the Banking Regulation Act, 1949.

Footnotes

  1. 2004 4 SCC 311
  2. Subsequently, Section 17 (2) was amended by The Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Act, 2004
  3. The Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Act, 2004
  4. Extract from Gujarat High Court Judgment: “23. Thus, borrowers are divided into two different classes; First, the borrowers in respect of the Banks and Financial Institutions which are administered or regulated by an authority or body established, constituted or appointed by any law for the time being in force, and in those cases, it will be for that authority or body to frame the guidelines for asset classification and, secondly, the borrowers in respect of all other cases not covered by clause (a), and in respect of those cases, it will be in accordance with the directions or guidelines issued by the Reserve Bank for asset classification.
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Indian Banking System

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Evolution of the Indian Banking Industry:

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Evolution of the Indian Banking Industry:

The Indian banking industry has its foundations in the 18th century, and has had a varied evolutionary experience since then. The initial banks in India were primarily traders’ banks engaged only in financing activities. Banking industry in the pre-independence era developed with the Presidency Banks, which were transformed into the Imperial Bank of India and subsequently into the State Bank of India. The initial days of the industry saw a majority private ownership and a highly volatile work environment. Major strides towards public ownership and accountability were made with nationalisation in 1969 and 1980 which transformed the face of banking in India. The industry in recent times has recognised the importance of private and foreign players in a competitive scenario and has moved towards greater liberalisation.

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In the evolution of this strategic industry spanning over two centuries, immense developments have been made in terms of the regulations governing it, the ownership structure, products and services offered and the technology deployed. The entire evolution can be classified into four distinct phases.

  • Phase I- Pre-Nationalisation Phase (prior to 1955)
  • Phase II- Era of Nationalisation and Consolidation (1955-1990)
  • Phase III- Introduction of Indian Financial & Banking Sector Reforms and Partial Liberalisation (1990-2004)
  • Phase IV- Period of Increased Liberalisation (2004 onwards)

Current Structure

Currently the Indian banking industry has a diverse structure. The present structure of the Indian banking industry has been analyzed on the basis of its organised status, business as well as product segmentation.

Organisational Structure

The entire organised banking system comprises of scheduled and non-scheduled banks. Largely, this segment comprises of the scheduled banks, with the unscheduled ones forming a very small component. Banking needs of the financially excluded population is catered to by other unorganised entities distinct from banks, such as, moneylenders, pawnbrokers and indigenous bankers.

Scheduled Banks

A scheduled bank is a bank that is listed under the second schedule of the RBI Act, 1934. In order to be included under this schedule of the RBI Act, banks have to fulfill certain conditions such as having a paid up capital and reserves of at least 0.5 million and satisfying the Reserve Bank that its affairs are not being conducted in a manner prejudicial to the interests of its depositors. Scheduled banks are further classified into commercial and cooperative banks. The basic difference between scheduled commercial banks and scheduled cooperative banks is in their holding pattern. Scheduled cooperative banks are cooperative credit institutions that are registered under the Cooperative Societies Act. These banks work according to the cooperative principles of mutual assistance.

Scheduled Commercial Banks (SCBs):

Scheduled commercial banks (SCBs) account for a major proportion of the business of the scheduled banks. As at end-March, 2009, 80 SCBs were operational in India. SCBs in India are categorized into the five groups based on their ownership and/or their nature of operations. State Bank of India and its six associates (excluding State Bank of Saurashtra, which has been merged with the SBI with effect from August 13, 2008) are recognised as a separate category of SCBs, because of the distinct statutes (SBI Act, 1955 and SBI Subsidiary Banks Act, 1959) that govern them. Nationalised banks (10) and SBI and associates (7), together form the public sector banks group and control around 70% of the total credit and deposits businesses in India. IDBI ltd. has been included in the nationalised banks group since December 2004. Private sector banks include the old private sector banks and the new generation private sector banks- which were incorporated according to the revised guidelines issued by the RBI regarding the entry of private sector banks in 1993. As at end-March 2009, there were 15 old and 7 new generation private sector banks operating in India.

Foreign banks are present in the country either through complete branch/subsidiary route presence or through their representative offices. At end-June 2009, 32 foreign banks were operating in India with 293 branches. Besides, 43 foreign banks were also operating in India through representative offices.

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Regional Rural Banks (RRBs) were set up in September 1975 in order to develop the rural economy by providing banking services in such areas by combining the cooperative specialty of local orientation and the sound resource base which is the characteristic of commercial banks. RRBs have a unique structure, in the sense that their equity holding is jointly held by the central government, the concerned state government and the sponsor bank (in the ratio 50:15:35), which is responsible for assisting the RRB by providing financial, managerial and training aid and also subscribing to its share capital.

Between 1975 and 1987, 196 RRBs were established. RRBs have grown in geographical coverage, reaching out to increasing number of rural clientele. At the end of June 2008, they covered 585 out of the 622 districts of the country. Despite growing in geographical coverage, the number of RRBs operational in the country has been declining over the past five years due to rapid consolidation among them. As a result of state wise amalgamation of RRBs sponsored by the same sponsor bank, the number of RRBs fell to 86 by end March 2009.

Scheduled Cooperative Banks:

Scheduled cooperative banks in India can be broadly classified into urban credit cooperative institutions and rural cooperative credit institutions. Rural cooperative banks undertake long term as well as short term lending. Credit cooperatives in most states have a three tier structure (primary, district and state level).

Non-Scheduled Banks:

Non-scheduled banks also function in the Indian banking space, in the form of Local Area Banks (LAB). As at end-March 2009 there were only 4 LABs operating in India. Local area banks are banks that are set up under the scheme announced by the government of India in 1996, for the establishment of new private banks of a local nature; with jurisdiction over a maximum of three contiguous districts. LABs aid in the mobilisation of funds of rural and semi urban districts. Six LABs were originally licensed, but the license of one of them was cancelled due to irregularities in operations, and the other was amalgamated with Bank of Baroda in 2004 due to its weak financial position.

Business Segmentation

The entire range of banking operations are segmented into four broad heads- retail banking businesses, wholesale banking businesses, treasury operations and other banking activities. Banks have dedicated business units and branches for retail banking, wholesale banking (divided again into large corporate, mid corporate) etc.

Retail banking

It includes exposures to individuals or small businesses. Retail banking activities are identified based on four criteria of orientation, granularity, product criterion and low value of individual exposures. In essence, these qualifiers imply that retail exposures should be to individuals or small businesses (whose annual turnover is limited to Rs. 0.50 billion) and could take any form of credit like cash credit, overdrafts etc. Retail banking exposures to one entity is limited to the extent of 0.2% of the total retail portfolio of the bank or the absolute limit of Rs. 50 million. Retail banking products on the liability side includes all types of deposit accounts and mortgages and loans (personal, housing, educational etc) on the assets side of banks. It also includes other ancillary products and services like credit cards, demat accounts etc.

The retail portfolio of banks accounted for around 21.3% of the total loans and advances of SCBs as at end-March 2009. The major component of the retail portfolio of banks is housing loans, followed by auto loans. Retail banking segment is a well diversified business segment. Most banks have a significant portion of their business contributed by retail banking activities. The largest players in retail banking in India are ICICI Bank, SBI, PNB, BOI, HDFC and Canara Bank.

Among the large banks, ICICI bank is a major player in the retail banking space which has had definitive strategies in place to boost its retail portfolio. It has a strong focus on movement towards cheaper channels of distribution, which is vital for the transaction intensive retail business. SBI’s retail business is also fast growing and a strategic business unit for the bank. Among the smaller banks, many have a visible presence especially in the auto loans business. Among these banks the reliance on their respective retail portfolio is high, as many of these banks have advance portfolios that are concentrated in certain usages, such as auto or consumer durables. Foreign banks have had a somewhat restricted retail portfolio till recently. However, they are fast expanding in this business segment. The retail banking industry is likely to see a high competition scenario in the near future.

Wholesale banking

Wholesale banking includes high ticket exposures primarily to corporates. Internal processes of most banks classify wholesale banking into mid corporates and large corporates according to the size of exposure to the clients. A large portion of wholesale banking clients also account for off balance sheet businesses. Hedging solutions form a significant portion of exposures coming from corporates. Hence, wholesale banking clients are strategic for the banks with the view to gain other business from them. Various forms of financing, like project finance, leasing finance, finance for working capital, term finance etc form part of wholesale banking transactions. Syndication services and merchant banking services are also provided to wholesale clients in addition to the variety of products and services offered.

Wholesale banking is also a well diversified banking vertical. Most banks have a presence in wholesale banking. But this vertical is largely dominated by large Indian banks. While a large portion of the business of foreign banks comes from wholesale banking, their market share is still smaller than that of the larger Indian banks. A number of large private players among Indian banks are also very active in this segment. Among the players with the largest footprint in the wholesale banking space are SBI, ICICI Bank, IDBI Bank, Canara Bank, Bank of India, Punjab National Bank and Central Bank of India. Bank of Baroda has also been exhibiting quite robust results from its wholesale banking operations.

Treasury Operations

Treasury operations include investments in debt market (sovereign and corporate), equity market, mutual funds, derivatives, and trading and forex operations. These functions can be proprietary activities, or can be undertaken on customer’s account. Treasury operations are important for managing the funding of the bank. Apart from core banking activities, which comprises primarily of lending, deposit taking functions and services; treasury income is a significant component of the earnings of banks. Treasury deals with the entire investment portfolio of banks (categories of HTM, AFS and HFT) and provides a range of products and services that deal primarily with foreign exchange, derivatives and securities. Treasury involves the front office (dealing room), mid office (risk management including independent reporting to the asset liability committee) and back office (settlement of deals executed, statutory funds management etc).

Other Banking Businesses

This is considered as a residual category which includes all those businesses of banks that do not fall under any of the aforesaid categories. This category includes para banking activities like hire purchase activities, leasing business, merchant banking, factoring activities etc.

Products of the Banking Industry

The products of the banking industry broadly include deposit products, credit products and customized banking services. Most banks offer the same kind of products with minor variations. The basic differentiation is attained through quality of service and the delivery channels that are adopted. Apart from the generic products like deposits (demand deposits – current, savings and term deposits), loans and advances (short term and long term loans) and services, there have been innovations in terms and products such as the flexible term deposit, convertible savings deposit (wherein idle cash in savings account can be transferred to a fixed deposit), etc. Innovations have been increasingly directed towards the delivery channels used, with the focus shifting towards ATM transactions, phone and internet banking. Product differentiating services have been attached to most products, such as debit/ATM cards, credit cards, nomination and demat services.

Other banking products include fee-based services that provide non-interest income to the banks. Corporate fee-based services offered by banks include treasury products; cash management services; letter of credit and bank guarantee; bill discounting; factoring and forfeiting services; foreign exchange services; merchant banking; leasing; credit rating; underwriting and custodial services. Retail fee-based services include remittances and payment facilities, wealth management, trading facilities and other value added services.