While India has been making great economic strides in the last decade or so, financial indiscipline has continued to be our nation’s biggest bane. Though India has moved ahead at a heady pace, our existing legal framework relating to commercial transactions has lagged behind, especially because of the Non-Performing Assets (NPA) or bad loans that have been steadily on the rise.
Blame it on our sheer numbers or a tendency to dupe the system, but every fifth borrower is a defaulter in India. Thus the government had no option other than to make adequate provisions for the recovery of these loans and also to foreclose such security. In 1993, the Recoveries of Debts due to Banks and Financial Institutions Act was passed and a special Debt Recovery Tribunal (DRT) was set up for the recovery of these NPAs.
In 2002, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act or more commonly known as the SARFAESI Act was passed to achieve these goals. It was passed after the recommendations of the Narsimham Committee I were submitted to the government. It has since lead to a robust system of financial practices when dealing with NPAs. In a recent statement by the finance minister Nirmala Sitharaman, under the provisions of the SARFAESI Act, 2002, action has been initiated in 6,251 cases involving secured assets. According to this article, ‘bad loans of public sector banks have declined by Rs 89,189 crore to Rs 8.06 lakh crore during the financial year 2018-19, according to government data.’
What is the SARFAESI Act 2002?
In simplest terms, the SARFAESI Act or the Securitisation Act allows banks and other financial institutions to auction residential or commercial properties for the purpose of recovering loans. The properties in the auctions belong to borrowers who have failed to repay their loans. By doing so, the bank reduces its NPAs.
These defaulting borrowers are given notice by their bank to discharge their liabilities within a period of 60 days, failing which the SARFAESI Act comes into action. Here on, the bank does the following:
- The bank takes possession of the security for the loan.
- The bank sells or leases or assigns the right to the security.
- The bank manages or appoints an official to manage the same.
Scheme of the Act
In mathematical terms, the Securitisation Act comprises of 41 sections in 6 Chapters and a Schedule. Contained in the Act are:
- Dealing with the applicability of the Securitisation Act
- Definitions of various terms
- Providing for regulation of securitisation and reconstruction of financial assets of banks and financial institutions
- Setting up of securitisation and reconstruction companies and matters related
- Providing for the enforcement of security interest and allied and incidental matters
- Providing for the establishment of a Central Registry
- Registration of securitisation, reconstruction and security interest transactions and matters related
- Providing for offences, penalties, punishments and routine legal issues.
Methods of Recovery under SARFAESI 2002
Under the SARFAESI Act, 2002, the Reserve Bank of India (RBI) is responsible for regulation and registration of ‘Asset Reconstruction Companies’(ARC). Authorization is given to these companies to raise funds by issuing security receipts to qualified institutional buyers. This consequently empowers the banks and financial institutions to take possession of securities which are given for financial assistance. They can also sell or lease the same to take over the management in case of a default. As per the SARFAESI Act, two methods help in recovery of non-performing assets:
Securitisation: In ‘Securitisation’ of assets, there is a lending institution termed as the ‘Originator’. The originator’s loans and receivables are converted into securities and a trust or Special Purpose Vehicle (SPV), through which the former liquefies its assets. This originator then picks a pool of assets similar in nature from the balance sheet and passes them to the SPV. It is then converted into marketable securities for investment. The cash flow through this enables the originator to create further assets and periodical cash flows from the underlying collaterals by the way of repayment of loans and interest payments enables the SPV pay off its obligations of principal and interest to its debtors.
Asset Reconstruction: Under the SARFAESI Act, Asset Reconstruction Companies meant to be regulated by the Reserve Bank of India (RBI), have been established. Either by proper management of the business of the borrower, or by taking over, selling a part or whole of the business, or by the rescheduling of payment of debts payable by the borrower, asset reconstruction is done by these ARCs.
Features of SARFAESI Act, 2002
- Procedural in nature, SARFAESI Act provides the correct procedure to remedy and enforce security in secured assets without going to court, directly through the secured creditor.
- The provisions of the SARFAESI Act are retrospective in nature as they cover up all the prior transactions of loan already entered into the subject to the provisions within the period of limitation. This also includes the defaults in making repayment and the debts already classified as non-performing assets and such future contingencies too.
- Supreme Court also upholds the validity of SARFAESI Act, 2002 and has done so in some important cases in the past.
- Even during the pendency of a civil suit by the bank, it can resort to simultaneous action under Section 13(4) of the SARFAESI Act, 2002.
- Writ Jurisdiction – The remedy of appeal is available under the Act against actions relating to recoveries of dues of banks and financial institutions. Hence, it is not necessary to resort to writ jurisdiction under Article 226 of the Constitution.
Exceptions to the Act
- SARFAESI Act, 2002, provides that the banks are allowed to seize the property of any borrower without going to the court, except one with agricultural land. This might be set to change.
- The SARFAESI Act, 2002 is applicable only in the cases of secured loans where banks are in a position to enforce underlying securities such as mortgage, pledge etc. In all such cases, order from the court is not required unless the security is fraudulent. For unsecured assets, the bank will need to move the court to file a civil case against the defaulter.
- SARFAESI 2002 is not applicable to regional rural banks, nationalized banks, co-operative banks , State Bank of India and its associate banks. The validity of the Securitisation Act so far as inclusion of co-operative banks is concerned cannot be challenged on the ground that since provisions for recovery by a co-operative bank is already made under Gujarat Co-operative Societies Act and therefore remedy under any other law is excluded.
- An amendment in the SARFAESI Act, 2002, was made – vied the enforcement of the Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016. Since then, the act has new definitions to SARFAESI, wider scope of debts and secured creditors. Also, the RBI has got new powers in relation to making of policies through this amendment.