When the banks and financial institutions indulge in their lending activities with or without securities, it improves its economic base and competes with the sister concerns. The element of recklessness crept into the system when prudential norms seldom followed, damaging its very existence in the rat race to earn profits and business.
The country’s laws are sufficient and efficient enough to protect the Banks and FI’s interests. Due to mushrooming number of trade and business activities flourishing, it was necessary for the speedy recovery of the dues of the Banks, as liquidity would be affected, ruining the very existence of the concerned financial institution.
And then there was a thought of empowering such Banks and FI’s to recover its dues on its machinery and mechanism, to prevent the excessive delays involved in court proceedings.
SARFAESI Act 2002 was a great boon to the Financial sector, enabling them to recover their dues through an in-house procedure and process.
Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Act is known as SARFAESI Act.
The act was just the answer to the long-pending lamentations from the lending institutions suffering from the time delays in court procedures. Especially when time is money, the days of delay precariously affects the lending institution.
Under SARFAESI ACT 2002, the banks got empowered to recover their loans without the court’s intervention.
However, some of the fiscal Acts provide for recoveries of the dues through their mechanism, as provided under the respective legislation, like the Revenue recovery Act, The Income Tax Act, and similar laws in vogue. But the banking sector did not get empowered with such a tool till the enactment of the above Act.
Then the Central Government constituted the Narasimham Committee I and II and the Andhyarujina Committee to examine banking sector reforms to find a solution to the growing defaults and recoveries to consider the need for changes in the legal system in respect of those areas.
What does the SARFAESI Act provide?
- securitise the financial assets (securitisation)
- Fund the securitisation.
- Incorporate companies as SCO (Securitization Company) and RCO (Reconstruction Company)
- Enforce Security interest by the secured creditor (without court intervention)
- Act as an agent of banks.
The SARFAESI Act 2002 allows registering and regulating Asset Reconstruction Companies (ARCs) by the Reserve Bank of India.
It gets intended for Facilitating securitisation of financial assets of banks and financial institutions with or without the benefit of underlying securities.
It provides for the promotion of seamless transferability of financial assets by the ARC to acquire financial assets of banks and financial institutions through issuing debentures or bonds or any other security as a debenture.
It empowers for entrusting the Asset Reconstruction Companies to raise funds by issuing security receipts to qualified buyers.
It facilitates the reconstruction of financial assets which are acquired:
- while exercising powers of enforcement of securities or
- change of management or
- other powers proposed to get conferred on the banks and financial institutions and the presentation of any securitisation company or asset reconstruction company registered with the Reserve Bank of India as a public financial institution
It defined ‘security interest’ as any type of security, including mortgage and change on immovable properties given for repayment of any financial assistance provided by any bank or financial institution.
It suggests the classification of the borrower’s account as a non-performing asset per the directions given or under guidelines issued by the Reserve Bank of India from time to time.
It gives power to the officers authorised, who will exercise the rights of a secured creditor on this behalf following the rules made by the Central Government.
It provides for 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.
It gives the Central Government powers and may set up or cause to get set up a Central Registry to register transactions relating to securitisation, asset reconstruction, and creation of the security interest.
The Act applies 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.
It excludes security interests in agricultural lands, loans less than rupees one lakh, and cases where the borrower repays eighty per cent of the loans.
In a nutshell, the SARFAESI Act 2002 has the following objective
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 the borrower fails to repay their loans
Important Definitions under the SARFAESI Act 2002
Section 2(1) b
It defines Asset reconstruction: “asset reconstruction” means acquisition by any securitisation company or reconstruction company of any right or interest of any bank or financial institution in any financial assistance for the realisation of such financial aid.
Section 2(1) c
It defines a Bank: “bank” means—
- a banking company; or
- a corresponding new bank; or
- the State Bank of India; or
- a subsidiary bank; or
- such other bank which the Central Government may, by notification*, specify for this Act.
As per the schedule, Financial Institutions also gets included to come within the SARFAESI Act 2002 purview from time to time. It is a great relief to non-banking financial Institutions too to recover the dues enforcing the provisions of the SARFAESI Act 2002
Section 2(1) f
It defines a borrower: “borrower” means any person:
- who gets financial assistance by any bank or financial institution or>
- who has given any guarantee or created any mortgage or
- Who pledged as security for the financial assistance granted by any bank or financial institution and included a person who:
- becomes borrower of a securitisation company or
- reconstruction company consequent upon acquisition by it of any rights or
- The interest of any bank or financial institution concerning such financial assistance
Section 2(1) i
It reads “Debts Recovery Tribunal” means the Tribunal established under sub-section (1) of section 3 of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (51 of 1993).
Section 2(1) j
It defines “default”:
- A non-payment of any principal debt or interest thereon or
- Any other amount payable by a borrower to any secured creditor consequent upon which the borrower’s account gets classified as a non-performing asset in the account’s book of the secured creditor.
Section 2(1) m
It speaks about Financial Institutions covered under the SARFAESI Act 2002.
Section 2(1) n
The section defines the meaning of hypothecation, which is a present or future charge on the borrower’s assets.
Section 2(1) o
It is essential in as much as the “non-performing asset” gets defined therein.
“Non-performing asset” means an asset or account of a borrower, which gets classified by a bank or financial institution as sub-standard, — [doubtful or loss asset]
- 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, per the directions or guidelines relating to assets classifications issued by such authority or body;
- in any other case, per the directions or guidelines relating to asset classifications issued by the Reserve Bank.
Section 2(1) t
The definition of Property is essential as to what gets covered under the SARFAESI Act 2002 upon which the lender agency could bank upon and take recovery measures.
According to the section, “property”; means—
- immovable property;
- movable property;
- any debt or any right to receive payment of money, whether secured or unsecured;
- receivables, whether existing or future;
- intangible assets, being know-how, patent, copyright, trademark, license, franchise or any other business or commercial right of similar nature;
The SARFAESI Act 2002 also defines a Reconstruction company that takes charge of the non-performing assets and sells it away to recover the dues of the lender concerned.
Section 2(1) z
According to the section, “securitisation” means the acquisition of financial assets by any securitisation company or reconstruction company from any originator. It’s done either by raising funds by a securitisation company or reconstruction company from qualified institutional buyers by the issue of security receipts representing an undivided interest in such financial assets or otherwise.
Similarly, a Secured creditor also gets defined, which includes the notified banks and Financial institutions whose lending have been secured with security tangible or intangible as may be applicable.
The procedure of enforcement under the SARFAESI Act 2002:
Section 13 of the SARFAESI Act 2002 is the enabling section under which the Banks and Financial Institutions could recover or reconstruct their non-performing assets.
As such, the creditors enjoy the power to recover their NPA’s through its machinery.
Under the SARFAESI Act, 2002, the creditors get conferred with the right to seize the secured asset and sell off the same to recover dues promptly by passing the costly and very time-consuming legal process through courts.
The legal provisions get quoted below:
Enforcement of security interest.-
- Notwithstanding anything contained in section 69 or section 69A of the Transfer of Property Act, 1882 (4 of 1882 ), any security interest created in favour of any secured creditor may be enforced, without the intervention of the court or tribunal, by such creditor per the provisions of this Act.
Any borrower, under 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 gets classified by the secured creditor as- 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 the notice, failing which the secured creditor shall be entitled to exercise all or any of the rights under sub-section (4).
The notice referred to in sub-section (2) shall give details of the amount payable by the borrower and the secured assets intended to be enforced by the secured creditor in the event of non-payment of secured debts by the borrower.
In case the borrower fails to discharge his liability in full within the period specified in sub-section (2), the secured creditor may take recourse to one or more of the following measures to recover his secured debt, namely:-
- take possession of the secured assets of the borrower, including the right to transfer by way of lease, assignment or sale for realising the secured asset;
- take over the management of the secured assets of the borrower, including the right to transfer by way of lease, assignment or sale and realise the secured asset;
- appoint any person (hereafter referred to as the manager), to manage the secured assets the possession of which has been taken over by the secured creditor;
- require at any time by notice in writing, any person who has acquired any of the secured assets from the borrower and from whom any money is due or may become due to the borrower, to pay the secured creditor, so much of the money as is sufficient to pay the secured debt.
- Any payment made by any person referred to in clause (d) of sub-section (4) to the secured creditor shall give such person a valid discharge as if he has made payment to the borrower.
- Any secured asset transfer after taking possession or takeover of management under sub-section (4), by the secured creditor or by the manager on secured creditor’s behalf, shall vest in the transferee all rights in, or concerning, the secured asset transferred as if the owner had made the transfer of such secured asset.
Where any action has been taken against a borrower under the provisions of sub- section (4), all costs, charges and expenses which, in the opinion of the secured creditor, have been properly incurred by him or any expenses incidental thereto, shall be recoverable from the borrower.
And the money received by the secured creditor shall, in the absence of any contract to the contrary, be held by him in trust, to be applied, firstly, in payment of such costs, charges and expenses and secondly, in the discharge of the dues of the secured creditor and the residue of the money so received shall be paid to the person entitled to that per his rights and interests.
- If the dues of the secured creditor together with all costs, charges and expenses incurred by him are tendered to the secured creditor at any time before the date fixed for sale or transfer. In that case, the secured asset shall not be sold or transferred by the secured creditor, and he shall take no further step for transfer or sale of that secure asset.
In the case of financing of a financial asset by more than one secured creditors or joint financing of a financial asset by secured creditors, no secured creditor shall be entitled to exercise any or all of the rights conferred on him under or pursuant to sub- section (4) unless exercise of such right is agreed upon by the secured creditors representing not less than three- fourth in value of the amount outstanding as on a record date and such action shall be binding on all the secured creditors: Provided that in the case of a company in liquidation, the amount realised from the sale of secured assets shall be distributed in accordance with the provisions of section 529A of the Companies Act, 1956 (1 of 1956 ): Provided further that in the case of a company being wound up on or after the commencement of this Act, the secured creditor of such company, who opts to realise his security instead of relinquishing his security and proving his debt under proviso to sub- section (1) of section 529 of the Companies Act, 1956 (1 of 1956 ), may retain the sale proceeds of his secured assets after depositing the workmen’ s dues with the liquidator in accordance with the provisions of section 529A of that Act: Provided also that liquidator referred to in the second proviso shall intimate the secured creditor the workmen’ s dues in accordance with the provisions of section 529A of the Companies Act, 1956 (1 of 1956 ) and in case such workmen’ s dues cannot be ascertained, the liquidator shall intimate the estimated amount of workmen’ s dues under that section to the secured creditor and in such case the secured creditor may retain the sale proceeds of the secured assets after depositing the amount of such estimate dues with the liquidator: Provided also that in case the secured creditor deposits the estimated amount of workmen’ s dues, such creditor shall be liable to pay the balance of the workmen’ s dues or entitled to receive the excess amount, if any, deposited by the secured creditor with the liquidator: Provided also that the secured creditor shall furnish an undertaking to the liquidator to pay the balance of the workmen’ s dues, if any. Explanation.- For the purposes of this sub-section-
- ” record date” means the date agreed upon by the secured creditors representing not less than three- fourth in value of the amount outstanding on such date;
- “amount outstanding” shall include principal, interest and any other dues payable by the borrower to the secured creditor in respect of secured asset as per the books of account of the secured creditor.
- Where dues of the secured creditor are not fully satisfied with the sale proceeds of the secured assets, the secured creditor may apply the form and manner as may be prescribed to the Debts Recovery Tribunal having jurisdiction or a competent court, as the case may be, for recovery of the balance amount from the borrower.
- Without prejudice to the rights conferred on the secured creditor under or by this section, the secured creditor shall get entitled to proceed against the guarantors or sell the pledged assets without first taking any of the measured specifies in clause (a) to (d) of sub- section (4) concerning the secured assets under this Act.
- The rights of a secured creditor under this Act may be exercised by one or more of his officers authorised on this behalf in such manner as may be prescribed.
- No borrower shall, after receipt of the notice referred to in sub-section (2), transfer by way of sale, lease or otherwise (other than in the ordinary course of his business) any of his secured assets referred to in the notice, without prior written content of the secured creditor.
Amendments to the SARFAESI Act 2002
Important amendments to the SARFAESI Act 2002 is Section 13(8), which provides as follows:
13(8) If the dues of the secured creditor together with all costs, charges and expenses incurred by him are tendered to the secured creditor at any time before the date fixed for sale or transfer, the secured asset shall not be sold or transferred by the secured creditor, and he shall take no further step for transfer or sale of that secured asset.
Thus the debtor has a last resort to get back his assets taken over in the SARFAESI proceedings by paying the secured creditor before the sale thereof.
After issuing notice to the defaulting debtor, the Banks and FI’s could initiate their recovery mechanisms through the appointed Recovery officer of the institution. He acts with quasi-judicial powers and puts the process of recovery in motion.
Under Section 13(2) of the SARFAESI Act 2002, a time limit of 60 days is given to the borrower to answer the notice. On the other hand, the borrower could approach the Debt Recovery Tribunal constituted under the DRT Act on various grounds of irregularities and other valid reasons against the process initiated by the recovery officer. Even after such possession of the properties, the borrower can apply to the DRT under Section 17 of the SARFAESI Act 2002 for redressal of grievances due to irregularities conducted by the Bank or FI exercising powers for attachment and sale of the properties charged.
The minimum amount for the claim in the DRT is Rs 20 lakhs. No upper limit. Below such an amount, the creditor will have to approach the civil courts for recovery.
Another essential feature of the SARFAESI Act 2002 is to take symbolic possession of the properties in question when actual physical possession becomes difficult or impossible. Symbolic possession restrains others than the possessor from acting in any manner with the properties attached.
Important Case Law
When the borrower approaches the High court or Supreme court, such courts shall pass no interim order without hearing the creditor in detail in appeals and cross-appeals. This intervention by higher judiciary fails the very purpose of the SARFAESI Act 2002 as was held by the Honorable Supreme court
“The Supreme Court has observed that interim orders in writ petitions challenging SARFAESI proceedings should generally not be passed without hearing the secured creditor. Interim orders defeat the very purpose of expeditious recovery of public money, said the bench comprising Justices L. Nageswara Rao, Hemant Gupta and Ajay Rastogi. Therefore, the High Court should be extremely careful.”
To conclude, the SARFAESI Act 2002 has been a blessing for the Banks and Financial Institutions to recover their dues in a summary manner without entwining in long civil battles in the courts of law.