A crisis in India’s banking sector induced an inordinate increase in the burden of bad loan provisioning and the decline in profitability of commercial sector banks, especially the public sector banks. Banking services are key to the proper functioning of any business enterprise in addition to being at the heart of the country’s economic growth. According to the statistics released by the Reserve Bank of India, the annual growth of bank credit in India had declined from a whopping 30% in 2004-2007 to a mere 9.7% in 2014-2015. This decline in the growth of credit has negatively impacted commercial and public sector banks, in terms of profitability. A breather in the form of SARFAESI ACT 2002 was introduced by the recommendation of Narasimham Committee II has been instrumental in recovering the identified NPA without the intervention of the court. The Act empowers banks to recover loans by acquiring and overtaking the financial assets mortgaged by the borrowers at the time of availing the loan.
It is undisputedly true that India owes much of its rapid economic growth in the past few decades to the financial sector. But it is also pertinent to note here that despite the growth, the legal framework pertaining to commercial transactions is inadequate against the ever-changing commercial practices and financial sector reforms. Subsequently, recovering defaulting loans is slow-paced, and the levels of non-performing assets of banks and financial institutions is rapidly escalating.
In light of the same, the government appointed the Narasimham Committee I and II and Andhyarujina Committee seeking to examine the grounds and purpose of banking sector reforms considering the need for changes in the legal system. Upon their appointment, these committees have detailed suggestions to formulate new legislation in order to securitize banks and financial institutions against loans by empowering them to overtake mortgages and subsequently auction them with no court interventions.
The purpose of the amendment Act revolves around the need to regulate securitization and reconstruction of financial assets and enforcement of security interest. Further, it aims to provide a central database of security interests created on property rights and all the matters related to such aspects. The Act deals with the following:
- Provisions for the regulation and registration of Asset Reconstruction Companies (ARCs) to be done by the Reserve Bank of India
- Ensuring the security of financial assets of banks and financial institutions regardless of underlying securities’ benefits
- Promoting transferability of financial assets by the ARC to acquire financial assets of banks and financial institutions through the issuance of debentures or bonds
- Provisions for the Asset Reconstruction Companies empowering them to raise funds by issue of security receipts to qualified buyers
- Providing for the reconstruction of financial assets in light of the powers and rights proposed to be conferred on the banks and financial institutions
- Provisioning to present all securitization companies or asset reconstruction companies as a public financial institution given that they are registered with the Reserve Bank of India
- 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
- Provisioning the classification of a 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
- Provision for appeal against the action of any bank or financial institution to the concerned Debts Recovery Tribunal and a secondary appeal to the Appellate Debts Recovery Tribunal
- Provisioning the establishment of a Central Registry for the purpose of registration of transactions relating to securitization, asset reconstruction, and creation of the security interest by the central government
- Targeting banks and financial institutions while also empowering the government to extend the application of the proposed legislation to non-banking financial companies along with other related enterprises/entities
- Provisioning the application of the new legislation for non-application to the security interests in agricultural lands, wherein loans less than rupees one lakh and cases where eighty percent, of the loans, is repaid by the borrower
The Act was amended by the Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Act, 2011 The amendment brought about big changes under the SARFAESI Act which are outlined further:
Lenders were now allowed to convert any part of the debt of the defaulting individual/company into equity, consequently making them equity holders in the borrowing company as opposed to the position of creditors to the company. Further, it allows banks to bid for any immovable property (of the defaulting borrower) they have put out for auction themselves if they do not receive any bids during the main auction. According to the provisions of the amendment, the banks will be empowered to utilize the amount paid for that particular property to adjust the debt. Multi-state Co-Operative Banks were now brought under the ambit and meaning of “a bank”.
A securitization or reconstruction company may have its name substituted in place of the name of the original lender in any pending suit in the Debts Recovery Tribunal or the Appellate Recovery Tribunal, which may be done by the tribunal itself as a suo-moto case or by the company. In the case of multiple creditors, Rights can be exercised by the individual creditors only if that creditor represents at least 60% of the debt amount.
Further, the Act provides for the filing of a Caveat by a secured creditor in the tribunal if an appeal is expected to be preferred against it based on the proceedings of the lender under the Act. Subsequently, the borrower has to inform the creditor of details about such an appeal after its filed.
It has also been provisioned that the District Magistrate can be approached by any secured creditor seeking to take possession of a secured asset and particular essentials and guidelines for such a scenario have also been outlined by the amendment Act. Creditors are required to provide an affidavit providing that the debt they wish to resolve is proportional to the property being possessed and that the borrower is at the default in payment. It is also mandated that the creditor shows that the borrower has created a security interest over the property being possessed and has been provided with a 60-day notice before taking any action. These provisions have been put in place to ensure that all actions of creditors and banks are justified and non-arbitrary, while also ensuring that they can be held accountable for any false allegations that they make.
The Court can take cognizance of wherein a lender fails to inform the Central Registry/Central Government about the securitization of an asset as laid down in Sections 23, 24, 25 of the Act, but only with the approval of the Reserve Bank of India or the Central Registry. Further, if there are any discrepancies or limitations in filing details about creating a security interest, there is a provision for its rectification at a later date upon an application to the Central Registry.
The Act has been criticized to date because it does not take into account the interest of the borrower’s, on account of it being arbitrary and biased towards lenders. However, under Section 17 of the Act, borrowers can appeal against any actions by their lenders.
The Courts through various judgments have interpreted Section 17 of the Act in a liberal way providing borrowers relief in various scenarios. Anyhow, appeals rarely get accepted and in certain circumstances, banks even get the opportunity to rectify the matter against which the appeal has been preferred.
In addition to the numerous changes brought about by the Amendment, change concerning the lack of safeguards to protect the rights of the borrowers and curbing the arbitrary misuse of powers by the lenders is still long overdue. Furthermore, Section 18C of the new Act allows for the filing of a caveat by the lender in cases of expected appeal. This sweeps away a majority of borrowers’ rights since they will be unable to procure an ex-parte order if a caveat has been filed as the tribunal will compulsorily be required to hear the lender.
The Caveator in such a circumstance shall have full opportunity to oppose any order which might be averse to its interests, as opposed to the disregard of the borrowers’ interests.
However, Section 14 provides for a certain degree of rights to the borrowers by mandating the submission of an affidavit covering exhaustive details of the property that is sought to be possessed, by the lenders. These details must conform with the fundamentals laid down in the Act. Section 14 thus, helps safeguard the borrowers against any actions taken by the lenders based on partial satisfaction of the requisite conditions.
There is a complex procedure in place for the resolution of any default on part of the securitization company, once an asset has been securitized and the same has been registered with the Central Registry. Furthermore, such a procedure requires approvals of the Reserve Bank of India and can be heard by a superior court only. All the while, lenders are also provided with the liberty to rectify any fallacies in securitization applications at a later date, which is extremely advantageous since they can subsequently avoid penalties.
Such a provision is also viewed as one that suppresses the rights of the borrowers since the process of rectifying any such fallacies is complicated making it really difficult to take action against defaulting companies.
In the case of an unsuccessful auction of a non-performing asset, banks are allowed to buy the said asset at the reserve price set by them, which is beneficial for them as they can satisfy that debt with their own money. This enables the bank to secure the asset in part or complete fulfilment of the defaulted loan. Banks can then sell off this property to a new bidder at a later date to clear off the remaining portion of the debt if any. Previously there was almost always a delay in the selling off of a property as buyers did not want to buy debt assets in auctions. This gave the defaulting lenders a window of opportunity to satisfy their debts and recover their property. However, now that the lenders themselves are allowed to buy out the assets, they may do so in most cases leaving the borrowers hardly any time to settle their debts.
The clause which allows the lender to acquire equity in the defaulting borrower’s firm up to the extent of the debt allows the lender to effectively take control of the borrower’s company in certain circumstances. This is again a severe drawback of the new law which greatly prejudices the interests of the borrower. In certain situations, the lenders may end up procuring major controlling shares in the company in the event of large loan defaults.
On the other hand, lenders in many situations may not want to exercise this right as it would involve buying taking control of the equity of a company, whose share value might already have dropped, given the loan defaults.
In light of the facts above, the amendment, in a certain way, may be said to empower the banking institutions to recover their non-performing assets by suppressing the rights of the borrowers. Further, with this amendment to the SARFAESI Act, the apparent outcome is the advent of unregistered financial institutions which directly affect lenders by putting them in a much more secure position since the borrowers’ assets are not at the threat of being possessed and they are given other options in case of loan default.
In conclusion, even though the Act provisions to ensure the penalization of errant borrowers and empower lenders in recovering their debts effectively, there is a great scope concerning potential regulations to create a greater balance between the lenders’ and borrowers’ rights and duties.
About author –
This article has been authored by Vidhit Verma, 2nd year BBA LLB(Hons.) student at School of Law, Christ University, Bengaluru.