Debt Recovery and Securitization

Introduction

During the era where debt securitisation was one of the capital markets’ emerging strategies, there was a need for regulations to introduce and control this new debt or asset securitisation technique. Under the debt securitisation scheme, financial institution creates a pool of individual’s loan, creates securities against them, rates them, and sell them to the market investors. The article will deal with debt recovery and securitization under the SARFAESI Act, 2002.

SARFAESI Act, 2002

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002, allows banks and other financial institutions to sell residential or commercial assets for debt recovery purposes. This allows the banks to sell the lenders’ assets if they refuse to repay their loan sum. It includes specific rules for Asset Securitization Companies (SCs) and Reconstruction Companies (RCs) establishment and activities. The Act provides for the scope of their operations, capital needs, funding etc.

The Central Government set up the Narasimham Committee I and II and the Andhyarujina Committee for the purpose of examining reforms in the banking sector considered the need for changes in the legal system in these areas. Among the other panels, these panels also recommended that new securitization laws be developed, and that banks and financial institutions be empowered to purchase and sell securities without any court interference. Therefore, the SARFAESI Act, 2002, was enacted. The Act requires the bank to reduce its non-performing assets by restructuring and rehabilitation measures.

Objectives of the SARFAESI Act

The principal objectives of the SARFAESI Act are as follows:

The Act provides the legal framework for Indian securitisation activities
It gives the procedures for passing NPAs to asset restoration companies to rebuild the assets.
The Act provides authority to banks and financial institutions to take over the hypothecated or chargeable immovable properties and achieve debt recovery.

Pre-requisites

The default loan or advance should follow certain pre-requisites in order to qualify for action under the SARFAESI Act:

Banks or financial institutions should have their outstanding duties above 1 lakh, which should also account for more than 20 per cent of the principal amount of the loan.
The debt at issue would have securitised money.
The banks have to classify the debt as a Non-Performing Asset.
Loan / advance defense would not be an Agricultural land.

Exception

The SARFAESI Act is, however, not applicable to:

Regional Rural Banks,
Nationalized Banks, and
Commercial Banks.

Methods of Recovery under SARFAESI Act, 2002

The Reserve Bank of India (RBI) is responsible for controlling and registering the securitisation or reconstruction companies according to the SARFAESI Act, 2002. Such businesses have been granted authorisation to collect funds by providing security receipts to an eligible institutional buyer. This has allowed banks and financial institutions to take ownership of securities issued for financial assistance and, in the event of a default, can sell or lease the same to take over the management.

The two main methods provided in the SARFAESI Act for recovery of non-performing assets:

Securitisation: Securitisation is the process of issuing marketable securities that is backed by a pool of existing assets such as auto or home loans. It is sold once an asset has been converted into a marketable security. A securitisation or reconstruction company may collect funds from only the Qualified Institutional Buyers (QIB) by developing schemes to obtain financial properties.
Asset Reconstruction: It is the acquisition of any bank or financial institution’s right or interest in loans, advances issued, debentures, guarantees or any other credit facilities provided by banks for the purpose of its realization. These deposits, bonds, guarantees and other credit services are identified together by a word – ‘financial aid.’ This may be accomplished either by careful administration of the creditor ‘s estate, or by taking over it, or by selling part or entire of the estate, or by rescheduling the payment of debts owed by imposing security interest by the creditor in compliance with the provisions of this Act.

Certificate of Registration

Section 3 of the SARFAESI Act, 2002, provides that a Securitization company or Reconstruction company shall not commence or carry on the business of Securitization or Asset reconstruction without obtaining a Certificate of Registration form RBI and adhering to other standards such as having an owned fund of not less than two crore rupees or such other amount not exceeding fifteen per cent of the total financial assets acquired or to be acquired by the Securitization company or Reconstruction company.

The main intention of acquiring debts is to ultimately realise the debts owed by them. However, the process is not a simple one. The Asset Reconstruction Companies have the following options in this regard:

Change or takeover of the management of the business of the borrower,
Sale or lease of such business,
Rescheduling the payment of debts – offering alternative schemes, arrangements for the payment of the same,
Enforcing the security interest offered in accordance with the law,
Taking possession of the assets offered as security, and
Converting a portion of the debt into shares.

Enforcement of Security Interest under Section 13 of the SARFAESI Act 2002 read with Security Interest (Enforcement) Rules 2002

Section 13(2) of the SARFAESI Act states that a notice shall be sent to the borrower after the secured creditor classifies a loan as a Non-Performing Asset (NPA). It must be in compliance with Rule 3 of Security Interest Enforcement Rules, 2002. This notice must mention the amount that the borrower will have to reimburse in full within 60 days. If the borrower refuses to comply with it, then the creditor will be entitled to exercise his rights under Section 13(4) of the Act by taking custody of the secured asset including the right to move the asset by lease, take over the management of the company or nominate another individual to manage the secured asset.

The actions under Section 13 (4) are appealable as enumerated in S. 17- 18. Therefore, the borrower can appeal the actions of the secured creditor in Debt Recovery Tribunal (DRAT), writ in High Court and SLP in Supreme Court.

Debt Recovery Tribunal

Debts Recovery Tribunals (DRT) and Debts Recovery Appellate Tribunals (DRAT) were established in accordance with the provisions of the Debts Recovery Tribunals (DRT) Act, for the establishment of tribunals for the speedy adjudication and recovery of debts due to banks and financial institutions and related matters. Debt Recovery Tribunal (DRT)’s primary purpose and function is to collect money from lenders that is owed to financial institutions and banks. Appeals against banks and financial institutions where they misused their powers will be heard by the debt recovery tribunal. When a person is aggrieved by the order of Debt Recovery Tribunal, such person can file an appeal before the Appellate Tribunal within 30 days from the date of the order of Debt Recovery Tribunal.

Purpose and role of the DRT

The main purpose and role of the DRTs was to recover all outstanding loans owing to banks and financial institutions. The following are the powers of the DRTs under the Act:

The jurisdiction of the Tribunal is limited to attempting to resolve cases relating to the recovery of loans and sums from NPAs listed by the banks under the RBI guidelines.
The Tribunal has all the powers of a district court and to follow the same procedure of issuing summons, examining witnesses, and such other procedures, under the Act which constituted it, i.e., the Recovery of Debts Due to Banks & Financial Institutions Act, 1993.

Filing of Application

An application can be made to DRT either through direct application or through SARFAESI Act. The transition to DRTs happens where the financial assets are not adequate to satisfy the

creditors’ obligations. In these situations, the creditors can apply to the DRT for the recovery of the remaining part of the dues. Borrowers can appeal against any action taken by the borrower under section 13(4), according to Section 17 of the SARFAESI Act.

Judicial Perspective

In M/s Mardia Chemical Ltd. v. Union of India and others[1], the Supreme Court ruled that the SARFAESI Act was not unconstitutional, primarily because it was a statute that favoured banks and financial institutions as lenders and provided creditors with minimal relief and remedies. The Court also struck down section 17(2) and stipulated that the objections raised by the borrower regarding the notice should be considered and not ritually rejected. The reasons for such refusal of the borrower’s objections shall be communicated to him.
In M/s. Dr. P.B’s Health & Glow Clinic Ltd. & Ors v. Oriental Bank of Commerce[2], The Petitioners, being the debtors in this case, had availed the credit facilities from the respondents. To some extent, but not entirely, the petitioners made repayment of the loan, and accordingly the respondent took recourse under the provisions of Section 13(2) of the SARFAESI Act , 2002. Consequently, possession of the mortgaged property was taken over and duly advertised. The petitioners, however, filed an appeal before the Debts Recovery Tribunal pursuant to Section 17(1) of the SARFAESI Act , 2002, which was thereby, been rejected by the Tribunal. The petitioners, therefore, being aggrieved, addressed the High Court at Calcutta.

The petitioners submitted that the Reserve Bank of India issued instructions for a one-time settlement of the debt, and accordingly the Respondent would have properly accepted the instructions. The respondent, however, had taken ownership of the land without following the procedure for arbitration. The respondent issued the payment statement to show the amount of dues from the petitioner. In response to the notice pursuant to Section 13(2) of the SARFAESI Act , 2002, the petitioners also sent a letter dated 18 December 2012, requesting the bank to allow them to repay the dues in small weekly instalments and also depositing 10 cheques amounting to Rs.25.50 lakhs.

The court held that the notice was properly tendered to the petitioners under section 13(2) of the 2002 Act. When the people occupying the property refused the notice, the same was appended to the conspicuous portion of the said premises. It was stated that in the presence of the owners of the said properties, the notice was duly given. With respect to loan settlement, the court held that some post-dated cheques had been issued, but not all cheques had been honoured and some of them had been bounced for the fund’s non-availability. On 30 June 2012, the loan sum had been listed as NPA, and as such steps had been taken to recover the loan under the provisions of the SARFAESI Act, 2002. The court thus, found the claim to be on lack of merits and therefore, rejected the same.

In Axis Bank v. SBS Organic Pvt. Ltd. & Ors.[3], the Supreme Court held that the DRAT appeal can only be entertained on the condition that the borrower deposits the 50% of the amount in terms of the order passed by DRT or 50% of the amount owed by the borrower as asserted by the secured creditor, whichever is less. The DRAT could reduce the sum to 25 per cent at its discretion.

Conclusion

The securitization of assets or debts is thus, a method of constantly accelerating assets into securities and securities into liquidity on an ongoing basis, increasing company profitability and income, while also offering consistency in the yield, cost, trend, scale, risk, and marketability of products.

The object of the SARFAESI Act is therefore, to allow and motivate the secured creditors to take possession of the securities and deal with them without the intervention of the court itself or to move them to an asset reconstruction firm for unblocking their assets.

While the implementation of the SARFAESI Act aimed to leverage the banks ‘blocked funds in the non-performing assets, the various clauses of the acts created the legitimate buyers into deep sorrows. The various provisions aimed at balancing the borrowers ‘and banks’ requirements are found to be majority of the times, mis-utilised by the banks to appropriate their interests against the interests of the buyers. In such a case it is necessary for the civil courts, on the one hand, to take a more collective obligation for the better good of the lenders and, on the other hand, to share the obligations of the banks to recover their funds from the various non-performing assets.

References:

[1] M/s Mardia Chemical Ltd. v. Union of India and others, (2004) 4 SCC 311 (India).

[2] M/s. Dr. P.B’s Health & Glow Clinic Ltd. & Ors v. Oriental Bank of Commerce, (2013) (India).

[3] Axis Bank v. SBS Organic Pvt. Ltd. & Ors., Civil Appeal No. 4379 of 2016 (India).