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1 Chapter-7 Assets (Reconstruction of the Sichfndustriat Companies through the Securitisation and Reconstruction oftinandac jlssets and!enforcement Security Interested, _ 1 Tu... - [f

2 CHAPTER 7 ASSET RECONSTRUCTION OF THE SICK INDUSTRIAL COMPANIES THROUGH THE SECURITRSATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST ACT, 2002 A. INTRODUCTION One of the major problems being faced by banks and financial institutions in India is that of bad debts, termed in glorified phrase as Non Performing Assets (NPA) in official terminology. There are many reasons for the sorry state of affairs, major among them are as follows: (a) (b) (c) (d) Political interference; Poor law enforcement; Archaic laws and procedures; and Corruption at various levels. Luckily, Government is aware of the problem. RBI is becoming stricter and is tightening the norms in respect of Non Performing Assets. The financial sector has been one of the key drivers in India s efforts to achieve success in rapidly developing its economy. While the banking industry in India is progressing complying with the international prudential norms and accounting practices, there are certain areas in which the banking and financial sector do not have a level playing field as compared to other participants in the financial markets in the world. There is no legal provision for facilitating securitisation of financial assets of banks and financial institutions. Further, unlike international banks, the banks and financial institutions in India do not have power to take possession of securities and sell them. Our existing legal framework relating to commercial transactions has not kept pace with the changing commercial practices and financial sector reforms. This 261

3 has resulted in slow pace of recovery of defaulting loans and mounting levels of nonperforming assets of banks and financial institutions. Though SICA was enacted in 1985 to solve the problem of Sick Industrial Companies. SICA became facilitator in aggravating the problem of NPAs as companies found Safe Haven in section 22(1) of SICA. The immunity available under this section against coercive measures for recovery by secured creditors was misused by the debtor companies. The Recovery of Debts Due to Banks & Financial Institution Act 1993 (IRBD Act) which was passed to expedite the recovery of the dues of the Banks/FIs could not yield the desired results in recovery of the dues of the Banks and FIs from the Sick Industrial Companies because of the available statutory protection under Section 22(1) of SICA. One such attempt to alleviate the problem, as dealt with herein before had been in the SICA Repeal Bill and most of the provisions of SICA have been incorporated in the provisions of Companies Act which aims at expediting the revival of the company and in the event of the company being not able to revive itself, direct the winding up of the company which shall facilitate in liquidation of the non performing assets of the Banks/FIs. However, the policy makers felt that the debt recovery tribunals were having huge pendency of work and the mounting cases involving huge funds were creating a dent on the financial health of the country and thus in order to resolve the problem of the huge Non-Performing Assets burdening the financial sector and based on the recommendations of the two Narasimhan Committee reports besides the Andhyarujina Committee report and the recommendations of the working group of Reserve Bank of India set up for this purpose, the Ordinance was promulgated twice and subsequently the act was introduced. The said enactment derives its basis from the Uniform Commercial Code of the United States of America.1 The Securitisation & Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) thus came into being to combat the mounting the problems of the NPAs and improving the health of the financial sector by reducing NPAs. 1 Datey, V.S. : Law Relating to Securitisation & Reconstruction of Financial Assets & Enforcement of Security Interest (2003), Taxmann Allied Services Pvt. Ltd,

4 The Act broadly combines three distinct aspects into a single Legislation viz. Securitisation2, Assets Reconstruction3 and Enforcement of Security Interest4. The act provides a legal framework for the business of Securitisation of financial assets and provides a regulatory framework for the said business. The second aspect pertaining to Assets Reconstruction also relates to conducting of business of Assets Reconstruction in the country and the regulatory framework for such a business. The third aspect is in respect of the Enforcement of Security Interest by the secured creditors mainly Banks and Financial Institutions without the intervention of Courts/ Statutory Authorities. The Act as such aims at ensuring the recovery of the non-performing assets and facilitating circulation of the said liquidated assets in the economy thereby improving the health of the financial sector in the country. The modality of enforcement of security interest results in the assets being procured by the banks/fis either directly or through the Securitisation Company5 where financed by more than one bank or FI have the charge over the assets of the companies and it is not possible for one to take over the exclusive possession of the assets on invoking the rights as per the enforcement of security interest, the banks/fis pool their loan together and the right to receive future payments from the borrowers of the loans. These loans are termed as securitised loans and are sold to the Securitisation Company, which can also act as asset Reconstruction Company (ARC)6. The main role of Securitisation Company is to acquire the financial assets of the company from the banks and FIs and that too by issuing debentures/ bonds or by entering into an arrangement with the bank/fis. And the main focus is to dispose of financial assets and distribute the 2 Section 2 (z) Securitisation- means acquisition of financial assets by any Securitisation company from any originator, whether by raising of funds by such Securitisation company or reconstruction company from qualified institutional buyers by issue of security receipts representing undivided interest in such financial assets or otherwise. 3 Section 2 (1) (b) 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 purpose of realization of such financial assistance. 4 Section 2 (zf) Security Interest means right, title and interest of ant kind whatsoever upon property, created in favour of any secured creditor and includes any mortgage, charge, hypothecation, assignment other than those specified in section Section 2 (za) Securitisation Company means any company formed and registered under the Companies Act, 1956 for the purpose of Securitisation. 6 Section 2 (v) Reconstruction Company means a company formed and registered under the Companies Act, 1956 for the purpose of the asset reconstruction. 263

5 proceeds to the lenders as per Section 529A of the Companies Act, It is pertinent to state that the Securitisation and enforcement of security interest when read together aims at the liquidation of the financial asset. The SARFAESI Act, 2002 provides for the abation of the proceedings pertaining to a sick industrial company if more than 75% of the secured lenders initiate action for recovery of their dues. Further, if any secured lender has taken any action under SARFAESI Act a sick company cannot file its reference under the provision of SICA. As such in case of the Sick Industrial Company the act is likely to benefit the secured lenders who shall get an instrument for realizing their dues by taking over the assets of the sick industrial companies in the event of the company not offering the settlement of the dues of the Banks and FIs. However, the concept of asset reconstruction in the SARFAESI Act, 2002 provides a financial tool for takeover of financial / non-financial assets and rebundling them to achieve maximum recoveries and as such is likely to facilitate the asset of the sick industrial companies to be utilized through rebundling them into operating units for optimum gain and in case they cannot be converted into economic operating units, then disposing off the assets either on lump-sum basis or on piecemeal basis while catering to the purpose of reducing the non performing assets (NPA).7 The asset reconstruction company can take the following amongst other measures for the purpose of asset reconstruction which include the proper management of the business of the borrower by change in or takeover of the management of business of borrower, sale or lease of the part or whole of the business, rescheduling of the payments of debts payable by the borrower settlement of the dues and taking possession of the secured assets for the aforesaid purposes. It is worthwhile to state that the assets of the sick companies can in this manner be utilized for the purpose of debt recovery while aiming at the utilization of the assets for the productive purposes. 7 Section 2(o). Non-performing assets means, "an asset or account of a borrower, which has been classified by a bank of financial institutions as sub-standard, doubtful or loss asset, in accordance with the directions or guidelines relating to asset classification issued by RBI. 264

6 B. SECURITISATION IN INDIA: THE STORY SO FAR AND THE WAY FORWARD8 With an aim to provide a structured platform to the Banking sector for managing its mounting NPA stocks and keep pace with international financial institutions, The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 was put in place to allow banks and FIs to take possession of securities and sell them. As stated in the Act, it has enabled banks and FIs to realise long-term assets, manage problems of liquidity, asset-liability mismatches and improve recovery by taking possession of securities, sell them and reduce non performing assets (NPAs) by adopting measures for recovery or reconstruction. Prior to the Act, the legal framework relating to commercial transactions lagged behind the rapidly changing commercial practices and financial sector reforms, which led to slow recovery of defaulting loans and mounting levels of NPAs of banks and financial institutions. The SARFAESI Act, 2002 has been largely perceived as facilitating asset recovery and reconstruction. Since Independence, the Government has adopted several ad-hoc measures to tackle sickness among financial institutions, foremost through nationalisation of banks and relief measures. Over the course of time, the Government has put in place various mechanisms for cleaning the banking system from the menace of NPAs and revival of a healthy financial and banking sector. Some of the notable measures in this regard include: Sick Industrial Companies (Special Provisions) Act, 1985 or SICA'. To examine and recommend remedy for high industrial sickness in the eighties, the Tiwari committee was set up by the Government. It was to suggest a comprehensive legislation to deal with the problem of industrial sickness. The committee suggested the need for special legislation for speedy revival of sick units or winding up of unviable ones and setting up of quasi-judicial body namely; Board for Industrial and Financial Reconstruction (BIFR) and The Appellate Authority for Industrial and Financial Reconstruction (AAIFR) and

7 their benches. Thus in 1985, the SICA came into existence and BIFR started functioning from The objective of SICA was to proactively determine or identify the sick/potentially sick companies and enforcement of preventive, remedial or other measures with respect to these companies. Measures adopted included legal, financial restructuring as well as management overhaul. However, an assessment process was cumbersome and unmanageable to some extent. The system was not favourable for the banking sector as it provided a sort of shield to the defaulting companies. Recoveries of Debts due to Banks and Financial Institutions (RDDBFI) Act, 1993: The procedure for recovery of debts to the banks and financial institutions resulted in significant portions of funds getting locked. The need for a speedy recovery mechanism through which dues to the banks and financial institutions could be realised was felt. Different committees set up to look into this, suggested formation of Special Tribunals for recovery of overdue debts of the banks and financial institutions by following a summary procedure. For the effective and speedy recovery of bad loans, the RDDBFI Act was passed suggesting a special Debt Recovery Tribunal to be set up for the recovery of NPA. However, this act also could not speed up the recovery of bad loans, and the stringent requirements rendered the attachment and foreclosure of the assets given as security for the loan as ineffective. SARFAESI ACT 2002: By the late 1990s, rising level of Bank NPAs raised concerns and Committees like the Narasimham Committee II and Andhyarujiva Committee which were constituted for examining banking sector reforms considered the need for changes in the legal system to address the issue of NPAs. These committees suggested a new legislation for securitisation, and empowering banks and FIs to take possession of the securities and sell them without the intervention of the court and without allowing borrowers to take shelter under provisions of SICA/BIFR. Acting on these suggestions, the SARFAESI Act, was passed in 2002 to legalise securitisation and reconstruction of financial assets and 266

8 enforcement of security interest. The act envisaged the formation of asset reconstruction companies (ARCs)/ Securitisation Companies (SCs). C. PROVISIONS OF THE SARFAESI ACT, 2002 The Act has made provisions for registration and regulation of securitisation companies or reconstruction companies by the RBI, facilitate securitisation of financial assets of banks, empower SCs/ARCs to raise funds by issuing security receipts to qualified institutional buyers (QIBs), empowering banks and FIs to take possession of securities given for financial assistance and sell or lease the same to take over management in the event of default. The Act provides three alternative methods for recovery of NPAs, namely: Securitisation: It means issue of security by raising of receipts or funds by SCs/ARCs. A securitisation company or reconstruction company may raise funds from the QIBs by forming schemes for acquiring financial assets. The SC/ARC shall keep and maintain separate and distinct accounts in respect of each such scheme for every financial asset acquired, out of investments made by a QIB and ensure that realisations of such financial asset is held and applied towards redemption of investments and payment of returns assured on such investments under the relevant scheme.9 Asset Reconstruction: The SCs/ARCs for the purpose of asset reconstruction should provide for any one or more of the following measures10: V the proper management of the business of the borrower, by change in, or take over of, the management of the business of the borrower ^ the sale or lease of a part or whole of the business of the borrower V rescheduling of payment of debts payable by the borrower V enforcement of security interest in accordance with the provisions of this Act 9 Section 2(z) of SARFAESI Act, Section 9 of SARFAESI Act,

9 S settlement of dues payable by the borrower S taking possession of secured assets in accordance with the provisions of this Act. Exemption from registration of security receipt: The Act also provides, notwithstanding anything contained in the Registration Act, 1908, for enforcement of security without Court intervention: (a) any security receipt issued by the SC or ARC, as the case may be, under section 7 of the Act, and not creating, declaring, assigning, limiting or extinguishing any right, title or interest to or in immovable property except in so far as it entitles the holder of the security receipt to an undivided interest afforded by a registered instrument; or (b) any transfer of security receipts, shall not require compulsory registration. The Guidelines for SCs/ARCs registered with the RBI are11: > act as an agent for any bank or FI for the purpose of recovering their dues from the borrower on payment of such fees or charges > act as a manager between the parties, without raising a financial liability for itself; > act as receiver if appointed by any court or tribunal. Apart from above functions any SC/ARC cannot commence or carryout other business without the prior approval of RBI. D THE SECURITISATION COMPANIES AND RECONSTRUCTION COMPANIES (RESERVE BANK) GUIDELINES AND DIRECTIONS, 2003 The Reserve Bank of India issued guidelines and directions relating to registration, measures of ARCs, functions of the company, prudential norms, acquisition of financial assets and related matters under the powers conferred by the SARFAESI Act, O Defining NPAs: Non-performing Asset (NPA) means an asset for which: 11 Section 10(1) of SARFAESI Aet,

10 > Interest or principal (or instalment) is overdue for a period of 180 days or more from the date of acquisition or the due date as per contract between the borrower and the originator, whichever is later; > interest or principal (or instalment) is overdue for a period of 180 days or more from the date fixed for receipt thereof in the plan formulated for realisation of the assets > interest or principal (or instalment) is overdue on expiry of the planning period, where no plan is formulated for realisation of the any other receivable, if it is overdue for a period of 180 days or more in the books of the SC or ARC. Provided that the Board of Directors of a SC or ARC may, on default by the borrower, classify an asset as a NPA even earlier than the period mentioned above. Registration: Every SC or ARC shall apply for registration and obtain a certificate of registration from the RBI as provided in SARFAESI Act; A Securitisation Company or Reconstruction Company, which has obtained a certificate of registration issued by RBI can undertake both securitisation and asset reconstruction activities; Any entity not registered with RBI under SARFAESI Act may conduct the business of securitisation or asset reconstruction outside the purview of the Act. Net worth of Securitisation Company or Reconstruction Company: Net worth is aggregate of paid up equity capital, paid up preference capital, reserves and surplus excluding revaluation reserve, as reduced by debit balance on P&L account, miscellaneous expenditure (to the extent not written off), intangible assets, diminution in value of investments/short provision against NPA and further reduced by shares acquired in SC/ARC and deductions due to auditor qualifications. This is also called Owned Fund. Every Securitisation Company or Reconstruction Company 12 Section 2(o) of SARFAESI Act,

11 seeking the RBI s registration under SARFAESI Act, shall have a minimum Owned Fund of Rs 20 mn. Permissible Business A Securitisation Company or Reconstruction Company shall commence/undertake only the securitisation and asset reconstruction activities and the functions provided for in Section 10 of the SARFAESI Act. It cannot raise deposits. Some broad guidelines pertaining to Asset Reconstruction are as follows: Acquisition of Financial Assets: With the approval of its Board of Directors, every SC/ARC is required to frame, a Financial Asset Acquisition Policy, within 90 days of grant of Certificate of Registration, clearly laying down policies and guidelines which define the; norms, type, profile and procedure for acquisition of assets, valuation procedure for assets having realisable value, which could be reasonably estimated and independently valued; plan for realisation of asset acquired for reconstruction The Board has powers to approve policy changes and delegate powers to committee for taking decisions on policy/proposals on asset acquisition. > Change or take over of Management/ Sale or Lease of Business of the Borrower: No SC/ARC can takeover/ change the management of business of the borrower or sale/lease part/whole of the borrower s business until the RBI issues necessary guidelines in this behalf. > Rescheduling of Debt/ Settlement of dues payable by borrower: A policy for rescheduling the debt of borrowers should be framed laying the broad parameters and with the approval of the Board of Directors. The proposals should to be in line with the acceptable business plan, projected earnings/ cash flows of the borrower, but without affecting the asset liability management of the SC/ARC or commitments given to investors. Similarly, there should be a policy for settlement of dues with borrowers. 270

12 > Enforcement of Security Interest: For the sale of secured asset as specified under the SARFAESI Act, a SC/ARC may itself acquire the secured assets, either for its own use or for resale, only if the sale is conducted through a public auction. > Realisation Plan: Within the planning period a realisation plan should be formulated providing for one or more of the measures including settlement/rescheduling of the debts payable by borrower, enforcement of security interest, or change/takeover of management or sale/lease of a part or entire business. The plan should clearly define the steps for reconstruction of asset within a specified time, which should not exceed five years from the date of acquisition. Broad guidelines with regards to Securitisation are as follows: > Issue of security receipts: A SC/ARC can set up trust(s), for issuing security receipts to QIBs, as specified under SARFAESI Act. The company shall transfer the assets to the trust at a price at which the assets were acquired from the originator. The trusteeship remains with the company and a policy is formulated for issue of security receipts. > Deployment of funds: The company can sponsor or partner a JV for another SC/ARC through investment in equity capital. The surplus available can be deployed in G-Sec or deposits in SCBs. > Asset Classification: The assets of SC/ARC should be classified as Standard or NPAs. The company shall also make provisions for NPAs. E ISSUES UNDER THE SARFAESI ACT, Right of Title A securitisation receipt (SR) gives its holder a right of title or interest in the financial assets included in securitisation. This definition holds good for securitisation structures where the securities issued are referred to as Pass through Securities. The same definition is not legally inadequate in case of Pay through Securities with different tranches. 271

13 Thin Investor Base The SARFAESI Act has been structured to enable security receipts (SR) to be issued and held by Qualified Institutional Buyers (QIBs), It does not include NBFC or other bodies unless specified by the Central Government as a financial institution (FI). For expanding the market for SR, there is a need for increasing the investor base. In order to deepen the market for SR there is a need to include more buyer categories. Investor Appetite Demand for securities is restricted to short tenor papers and highest ratings. Also, it has remained restricted to senior tranches carrying highest ratings, while the junior tranches are retained by the originators as unrated pieces. This can be attributed to the underdeveloped nature of the Indian market and poor awareness as regards the process of securitisation. Risk Management in Securitisation The various risks involved in securitisation are given below: > Credit Risk: The risk of non-payment of principal and/or interest to investors can be at two levels: SPV and the underlying assets. Since the SPV is normally structured to have no other activity apart from the asset pool sold by the originator, the credit risk principally lies with the underlying asset pool. A careful analysis of the underlying credit quality of the obligors and the correlation between the obligors needs to be carried out to ascertain the probability of default of the asset pool. A well diversified asset portfolio can significantly reduce the simultaneous occurrence of default. > Sovereign Risk: In case of cross-border securitisation transactions where the assets and investors belong to different countries, there is a risk to the investor in the form of non-payment or imposition of additional taxes on the income repatriation. This risk can be mitigated by having a foreign guarantor or by structuring the SPV in an offshore location or have a neutral country of jurisdiction. 272

14 > Collateral deterioration Riski Sometimes the collateral against which credit is sanctioned to the obligor may undergo a severe deterioration. When this coincides with a default by the obligor then there is a severe risk of non-payment to the investors. A recent example of this is the sub-prime crisis in the US which is explained in detail in the following sections. > Legal Risk: Securitisation transactions hinge on a very important principle of bankruptcy remoteness of the SPV from the sponsor. Structuring the asset transfer and the legal structure of the SPV are key points that determine if the SPV can uphold its right over the underlying assets, if the obligor declare bankruptcy or undergoes liquidation. > Prepayment Risk: Payments made in excess of the scheduled principal payments are called prepayments. Prepayments occur due to a change in the macro-economic or competitive industry situation. For example in case of residential mortgages, when interest rates go down, individuals may prefer to refinance their fixed rate mortgage at lower interest rates. Competitors offering better terms could also be a reason for prepayment. In a declining interest rate regime prepayment poses an interest rate risk to the investors as they have to reinvest the proceedings at a lower interest rate. This problem is more severe in case of investors holding long term bonds. This can be mitigated by structuring the tranches such that prepayments are used to pay off the principal and interest of short-term bonds. > Servicer Performance Risk: The servicer performs important tasks of collecting principal and interest, keeping a tab on delinquency, maintains statistics of payment, disseminating the same to investors and other administrative tasks. The failure of the servicer in carrying out its function can seriously affect payments to the investors. > Swap Counterparty Risk: Some securitisation transactions are so structured wherein the floating rate payments of obligors are converted 273

15 into fixed payments using swaps. Failure on the part of the swap counterparty can affect the stability of cash flows of the investors. > Financial Guarantor Risk: Sometime external credit protection in the form of insurance or guarantee is provided by an external agency. Guarantor failure can adversely impact the stability of cash flows to 11 the investors. F IMPLEMENTATION OF SARFAESI THROUGH JUDICIAL PRONOUNCEMENTS The brief facts of United Bank of India v. Satyawati Tondon and others14 are as follows. The Division Bench of the High Court had restrained the appellant from proceeding under Section 13(4) of the SARFAESI Act against the property of respondent No.l. A perusal of the record shows that the appellant sanctioned a term loan of Rs.22,50,000/- in favour of M/'s. Pawan Color Lab [through its proprietor Pawan Singh (respondent No.2)] some time in November, 2004, Respondent No.l gave guarantee for repayment of the loan and mortgaged her property bearing House No. 752/062, Bakshi Khurd, Daraganj, Pargana and Tehsil Sadar, District Allahabad by deposit of title deeds. She also submitted an affidavit dated and executed agreement of guarantee dated making herself liable for repayment of the loan amount with interest. After one year and six months, the appellant sent letter dated to respondent Nos.l and 2 pointing out that repayment of loan was highly irregular. After another one year, the account of respondent No.2 was classified as Non- Performing Asset. On , the appellant sent separate letters to 14 respondent Nos. 1 and 2 requiring them to deposit the outstanding dues amounting, to Rs.23,78,478/-. Thereupon, respondent No.l deposited a sum of Rs.50,000/- and gave written undertaking to pay the balance amount in instalments. However, she did not fulfil her promise to repay the remaining amount. This compelled the appellant to issue notice to respondent Nos.l and 2 under Section 13(2) requiring them to pay Rs.23,22,972/- along with future interest and incidental expenses within 60 days. Upon receipt of the notice, respondent No.l (Arising out of SLP(C) No of 2010) 274

16 offered to pay a sum of Rs.18 lakhs for settlement of the loan account, but the appellant did not accept the offer and filed an application under Section 14 of the SARFAESI Act, which was allowed by District Magistrate/Collector, Allahabad vide his order dated Thereafter, the appellant-issued notice dated to respondent Nos.l and 2 under Section 13(4) of the SARFAESI Act. Faced with the imminent threat of losing the mortgaged property, respondent No.l filed C.M.W.P. No of 2009 and prayed that the appellant herein may be restrained from taking coercive action in pursuance of the notices issued under Section 13(2) and (4) and order dated passed by District Magistrate/Collector, Allahabad. She pleaded that the notices issued by the appellant for recovery of the outstanding dues are ex facie illegal and liable to be quashed because no action had been taken against the borrower i.e., respondent No.2 for recovery of the outstanding dues. In the counter affidavit filed on behalf of the appellant, it was pleaded that action initiated against respondent No.l was consistent with the provisions of SARFAESI Act and writ petitioner (respondent No.l herein) was bound to discharge her obligations to pay the outstanding dues and there was no merit in her challenge to the notices issued under Section 13(2) and 13(4) or the order passed under Section 14. It was further pleaded that the writ petition is liable to be dismissed because an alternative remedy is available to the petitioner under Section 17 of the SARFAESI Act. The Division Bench of the High Court did not even advert to the appellant's plea that the writ petition should not be entertained because an effective alternative remedy was available to the writ petitioner under Section 17 of the SARFAESI Act and passed the impugned order restraining the appellant from taking action in furtherance of notice issued under Section 13(4) of the SARFAESI Act. The reason which prompted the High Court to pass the impugned interim order and operative portion thereof are extracted below: "Learned counsel for the petitioner has urged that the loan was taken by respondent No.4 for opening a colour lab at 50/43, Raj Complex, K.P. Kakkar Road, Allahabad, but the loan has not been repaid by respondent No.4 and the bank is proceeding against the petitioner who is the guarantor of the loan. It is not clear from the documents produced by learned counsel for the bank as to what steps have been taken by the bank against the borrower of the loan and merely issuance of notice under section 13(2) of the Securitization and Reconstruction of Financial Assets and 275

17 Enforcement of Security'Interest Act, 2002 against the borrower is not sufficient. The bank should have proceeded against the borrower and exhausted all the remedies against him and thereafter the bank could have proceeded against the guarantor. Until further, orders of this court, the respondents are restrained from proceeding under section 13(4) of the Act 2002 with regard to petitioner's property who was the guarantor of the loan. However, if any possession has been taken by the bank then the property shall not be sold to any one else and the petitioner shall be continued in possession of the property. In United Bank of India v. Satyawati Tondon and others15 Court held, with a view to give impetus to the industrial development of the country, the Central and State Governments encouraged the banks and other financial institutions to formulate liberal policies for grant of loans and other financial facilities to those who wanted to set up new industrial units or expand the existing units. Many hundred thousand took advantage of easy financing by the banks and other financial institutions but a large number of them did not repay the amount of loan, etc. Not only this, they instituted frivolous cases and succeeded in persuading the Civil Courts to pass orders of injunction against the steps taken by banks and financial institutions to recover their dues. Due to lack of adequate infrastructure and non-availability of manpower, the regular Courts could not accomplish the task of expeditiously adjudicating the cases instituted by banks and other financial institutions for recovery of their dues. As a result, several hundred crores of public money got blocked in unproductive ventures. In order to redeem the situation, the Government of India constituted a committee under the chairmanship of Shri T. Tiwari to examine the legal and other difficulties faced by banks and financial institutions in the recovery of their dues and suggest remedial measures. Supreme Court further in the above case held16, The Tiwari Committee noted that the existing procedure for recovery was very cumbersome and suggested that special tribunals be set up for recovery 15 (Arising out of SLP(C) No of 2010) 16 (Arising out of SLP (C) No of 2010) 276

18 of the dues of banks and financial institutions by following a summary procedure. The Tiwari Committee also prepared a draft of the proposed legislation which contained a provision for disposal of cases in three months and conferment ofpower upon the Recovery Officer for expeditious execution of orders made by adjudicating bodies. The issue was further examined by the Committee on the Financial System headed by Shri M. Narasimham. In its First Report, the Narasimham Committee also suggested setting up of special tribunals with special powers for adjudication of cases involving the dues of banks and financial institutions. After considering the reports of the two Committees and taking cognizance of the fact that as on more than 15 lakh cases filed by public sector banks and 304 cases filed by financial institutions were pending in various Courts for recovery of debts, etc. amounting to Rs.6000 crores, the Parliament enacted the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (for short, 'the DRT Act'). The new legislation facilitated creation of specialised forums i.e., the Debts Recovery Tribunals and the Debts Recovery Appellate Tribunals for expeditious adjudication of disputes relating to recovery of the debts due to banks and financial institutions. Simultaneously, the jurisdiction of the Civil Courts was barred and all pending matters were transferred to the Tribunals from the date of their establishment. Supreme Court further held, An analysis of the provisions of the DRT Act shows that primary object of that Act was to facilitate creation of special machinery for speedy recovery of the dues of banks and financial institutions. This is the reason why the DRT Act not only provides for establishment of the Tribunals and the Appellate Tribunals with the jurisdiction, powers and authority to make summary adjudication of applications made by banks or financial institutions and specifies the modes of recovery of the amount determined by the Tribunal or the Appellate Tribunal but also bars the jurisdiction of all courts except the Supreme Court and the High Courts in relation to the matters specified in Section 17. The Tribunals and the Appellate Tribunals have also been freed from the shackles of procedure contained in the Code of Civil Procedure. To 277

19 put it differently, the DRT Act has not only brought into existence special procedural mechanism for speedy recovery of the dues of banks and financial institutions, but also made provision for ensuring that defaulting borrowers are not able to invoke the jurisdiction of Civil Courts for frustrating the proceedings initiated by the banks and other financial institutions. For few years, the new dispensation worked well and the officers appointed to man the Tribunals worked with great zeal for ensuring that cases involving recovery of the dues of banks and financial institutions are decided expeditiously. However, with the passage of time, the proceedings before the Tribunals became synonymous with those of the regular Courts and the lawyers representing the borrowers and defaulters used every possible mechanism and dilatory tactics to impede the expeditious adjudication of such cases. The flawed appointment procedure adopted by the Government greatly contributed to the malaise of delay in disposal of the cases instituted before the Tribunals. The survey conducted by the Ministry of Finance, Government of India revealed that as in 2001, a sum of more than Rs. 1,20,000/- crores was due to the banks and financial institutions and this was adversely affecting the economy of the country. Therefore, the Government of India asked the Narasimham Committee to suggest measures for expediting the recovery of debts due to banks and financial institutions. In its Second Report, the Narasimham Committee noted that the non-performing assets of most of the public sector banks were abnormally high and the existing mechanism for recovery of the same was wholly insufficient. In Chapter VIII of the Report, the Committee noted that the evaluation of legal framework has not kept pace with the changing commercial practice and financial sector reforms and as a result of that the economy could not reap full benefits of the reform process. The Committee made various suggestions for bringing about radical changes in the existing adjudicatory mechanism. By way of illustration, the Committee referred to the scheme of mortgage under the Transfer of Property Act and suggested that the existing laws should be changed not only for facilitating 278

20 speedy recovery of the dues of banks, etc. but also for quick resolution of disputes arising out of the action taken for recovery of such dues17. Supreme Court in the above case further observed, The Andhyarujiva Committee constituted by the Central Government for examining banking sector reforms also considered the need for changes in the legal system. Both, the Narasimham and Andhyarujiva Committees suggested enactment of new legislation for securitisation and empowering the banks and financial institutions to take possession of the securities and sell them without intervention of the court. The Government of India accepted the recommendations of the two committees and that led to enactment of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 for short 'the SARFAESI Act), which can be termed as one of the most radical legislative measures taken by the Parliament for ensuring that dues of secured creditors including banks, financial institutions are recovered from the defaulting borrowers without any obstruction. For the first time, the secured creditors have been empowered to take steps for recovery of their dues without intervention of the Courts or Tribunals. Supreme Court discussed in detail the provisions of SARFAESI Act and held the following, Section 13 of the SARFAESI Act contains detailed mechanism for enforcement of security interest. Sub-section (1) thereof lays down that notwithstanding anything contained in Sections 69 or 69-A of the Transfer of Property Act, any security interest created in favour of any secured creditor may be enforced, without the intervention of the court or tribunal, by such creditor in accordance with the provisions of this Act.. Sub-section (2) of Section 13 enumerates first of many steps needed to be taken by the secured creditor for enforcement of security interest. This sub-section provides that if a borrower, who is under a liability to a secured creditor, makes any default in repayment of secured debt and his account in respect of such debt is 17 (Arising out of SLP(C) No of 2010) 279

21 classified as non- performing asset, then the secured creditor may require the borrower by notice in writing to discharge his liabilities within sixty days from the date of the notice with an indication that if he fails to do so, the secured creditor shall be entitled to exercise all or any of its rights in terms of Section 13(4). Sub-section (3) of Section 13 lays down that notice issued under Section 13(2) shall contain details of the amount payable by the borrower as also the details of the secured assets intended to be enforced by the bank or financial institution. Sub-section (3-A) of Section 13 lays down that the borrower may make a representation in response to the notice issued under Section 13(2) and challenge the classification of his account as nonperforming asset as also the quantum of amount specified in the notice. If the bank or financial institution comes to the conclusion that the representation/objection of the borrower is not acceptable, then reasons for non- acceptance are required to be communicated within one week. Subsection (4) of Section 13 specifies various modes which can be adopted by the secured creditor for recovery of secured debt. The secured creditor can take possession of the secured assets of the borrower and transfer the same by way of lease, assignment or sale for realising the secured assets. This is subject to the condition that the right to transfer by way of lease, etc. shall be exercised only where substantial part of the business of the borrower is held as secured debt. If the management of whole or part of the business is severable, then the secured creditor can take over management only of such business of the borrower which is relatable to security. The secured creditor can appoint any person to manage the secured asset, the possession of which has been taken over. The secured creditor can also, by notice in writing, call upon a person who has acquired any of the secured assets from the borrower to pay the money, which may be sufficient to discharge the liability of the borrower. Subsection (7) of Section 13 lays down that where any action has been taken against a borrower under sub-section (4), all costs, charges and expenses properly incurred by the secured creditor or any expenses incidental thereto can be recovered from the borrower. The money which is received by the secured creditor is required to be held by him in trust and applied, in the first 280

22 instance, for such costs, charges and expenses and then in discharge of dues of the secured creditor. Residue of the money is payable to the person entitled there to according to his rights and interest. Sub-section (8) of Section 13 imposes a restriction on the sale or transfer of the secured asset if the amount due to the secured creditor together with costs, charges and expenses incurred by him are tendered at any time before the time fixedfor such sale or transfer. Sub-section (9) of Section 13 deals with the situation in which more than one secured creditor has stakes in the secured assets and lays down that in the case offinancing a financial asset by more than one secured creditor or joint financing of a financial asset by secured creditors, no individual secured creditor shall be entitled to exercise any or all of the rights under sub-section (4) unless all of them agree for such a course. There are five numbered provisos to Section 13(9) which deal with pari passu charge of the workers of a company in liquidation. The first of these provisos lays down 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 529-A of the Companies Act, The second proviso deals with the case of a company being wound up on or after the commencement of this Act. If the secured creditor of such company opts to realise its security instead of relinquishing the same and proving its debt under Section 529(1) of the Companies Act, then it can retain sale proceeds after depositing the workmen's dues with the liquidator in accordance with Section 529-A. The third proviso requires the liquidator to inform the secured creditor about the dues payable to the workmen in terms of Section 529-A. If the amount payable to the workmen is not certain, then the liquidator has to intimate the estimated amount to the secured creditor. The fourth proviso lays down that in case the secured creditor deposits the estimated amount of the workmen s dues, then such creditor shall be liable to pay the balance of the workmen's dues or entitled to receive the excess amount, if any, deposited with the liquidator. In terms of the fifth proviso, the secured creditor is required to give an undertaking to the liquidator to pay the balance of the workmen's dues, if any. Sub-section (10) of Section 13 lays down that where dues of the secured 281

23 creditor are not fully satisfied by the sale proceeds of the secured assets, the secured creditor may file an application before the Tribunal under Section 17 for recovery of balance amount from the borrower. Sub-section (11) states that without prejudice to the rights conferred on the secured creditor under or by this section, it shall be entitled to proceed against the guarantors or sell the pledged assets without resorting to the measures specified in clauses (a) to (d) of sub-section (4) in relation to the secured assets. Sub-section (12) of Section 13 lays down that rights available to the secured creditor under the Act may be exercised by one or more of its officers authorised in this behalf Sub-section (13) lays down that after receipt of notice under sub-section (2), the borrower shall not 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 consent of the secured creditor. In terms of Section 14, the secured creditor can file an application before the Chief Metropolitan Magistrate or the District Magistrate, within whose jurisdiction the secured asset or other documents relating thereto are found for taking possession thereof If any such request is made, the Chief Metropolitan Magistrate or the District Magistrate, as the case may be, is obliged to take possession of such asset or document and forward the same to the secured creditor. Section 17 speaks of the remedies available to any person including borrower who may have grievance against the action taken by the secured creditor under sub-section (4) of Section 13. Such an aggrieved person can make an application to the Tribunal within 45 days from the date on which action is taken under that sub-section. By way of abundant caution, an Explanation has been added to Section 17(1) and it has been clarified that the communication of reasons to the borrower in terms of Section 13(3-A) shall not constitute a ground for filing application under Section 17(1). Sub-section (2) of Section 17 casts a duty on the Tribunal to consider whether the measures taken by the secured creditor for enforcement of security interest are in accordance with the provisions of the Act and the Rules made thereunder. If the Tribunal, after examining the facts and circumstances of the case and evidence produced by the parties, comes to the conclusion that the 282

24 measures taken by the secured creditor are not in consonance with subsection (4) of Section 13, then it can direct the secured creditor to restore management of the business or possession of the secured assets to the borrower. On the other hand, if the Tribunal finds that the recourse taken by the secured creditor under sub-section (4) of Section 13 is in accordance with the provisions of the Act and the Rules made thereunder, then, notwithstanding anything contained in any other law for the time being in force, the secured creditor can take recourse to one or more of the measures specified in Section 13(4) for recovery of its secured debt. Sub-section (5) of Section 17 prescribes the time-limit of sixty days within which an application made under Section 17 is required to be disposed of. The proviso to this subsection envisages extension of time, but the outer limit for adjudication of an application is four months. If the Tribunal fails to decide the application within a maximum period of four months, then either party can move the Appellate Tribunal for the issue of a direction to the Tribunal to dispose of the application expeditiously. Section 18 provides for an appeal to the Appellate Tribunal.18 held19, Supreme Court further discussed in detail the other provisions of the Act and Section 34 lays down that no Civil Court shall have jurisdiction to entertain any suit or proceeding in respect of any matter which a Tribunal or Appellate Tribunal is empowered to determine. It further lays down that no injunction shall be granted by any Court or other authority in respect of any action taken or to be taken under the SARFAESI Act or the DRT Act. Section 35 of the SARFAESI Act is substantially similar to Section 34(1) of the DRT Act. It declares that the provisions of this Act shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law. However, effective implementation of the SARFAESI Act was delayed by more than two years because several writ petitions were filed in the High Courts and this (Arising out of SLP(C) No of 2010) Ibid. 283

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