NPA

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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