A Comparative Study and Applicable Laws in the Light of the Judicial Reforms
The economic meltdown, being faced by the Western world and the consequent retardation, has raised alarms for everyone connected with the financial world and India is no exception. It is strongly felt that judicial reforms are required to ensure that the rights of the banks and financial institutions (FI), popularly referred to as `lenders’, lending money to the corporates and individuals, are adequately protected. India has a plethora of legislations, which govern and regulate the laws relating to recovery of money by the lenders. It may be important to note that although at a nascent stage, various judicial reforms have been carried out from time to time, which have controlled the burgeoning non-performing assets (NPAs) with the lenders.
It may be interesting and worthwhile to examine how the laws of the land have undergone changes to suit the current requirement of the banking and finance industry to protect the money lent by them and the consequent financial exposure undertaken by them.
Historically, in India the remedy available to lenders has been to file an ordinary money suit for recovery against the defaulting borrower for the outstanding amounts or to file a summary suit as provided for under Order 37 of Code of Civil Procedure 1908. Both these options have been time consuming. Another option available to the lender was to apply for foreclosure of mortgage, where borrower or guarantor had provided security by way of mortgage, in respect of outstanding towards the lender. Foreclosure and money suits have proved to be a long drawn battle in the court, consuming several years in litigation, owing to the delay on account of various reasons. The Indian courts, lower courts as well as high courts, were saddled with cases filed by the domestic banks, foreign banks and FIs. The delay in the disposal of such cases was deplorable.
In the late eighties, some landmark reforms were introduced. Chapter XVII of the Negotiable Instrument Act 1881 was amended and sections 138-142 were inserted by Act 66 of 1988 w.e.f. April 1, 1989. This amendment had a humongous impact on the financial world at large. By virtue of this section, dishonour of cheques, issued by any party in discharge of any lawful obligation, was made a criminal offence. This Act has certainly helped the lender to a great extent, as today the dishonour of cheque or the instructions given to the lender to recover the dues by way of Electronic Clearing System (ECS) amounts to a criminal offence, making the delinquent person liable for penalty including imprisonment. This has, therefore, been a useful and important judicial reform addressing the serious concern of the Lender arising on account of dishonour of cheques. Particularly, the consumer banks having financial products like auto loans, personal loans, home loans, loan against property etc, are benefited because of the onerous obligation on the customer to ensure that post dated cheques or ECS instructions given by them are honoured.
Since the courts were overburdened with the money suits, inter alia, impacting the lender in a very serious way, it was deemed necessary to carry out changes in the law to support the lender in recovering the outstanding from delinquent borrowers.
The Committee on Financial Systems, headed by Shri M Narasimhan, had considered the setting up of the ‘special tribunals’ with special powers for adjudication and speedy recovery of such matters as critical to the successful implementation of the financial sector reforms. An urgent need was, therefore, felt to work out a suitable mechanism through which the dues to the banks and financial institutions could be realised without delay.
In 1981, a committee under the Chairmanship of Shri T Tiwari had examined the legal and other difficulties faced by banks and financial institutions and suggested remedial measures including changes in law. The Tiwari Committee had also suggested setting up of special tribunals for recovery of dues of the banks and financial institutions by following a summary procedure.
Consequently, the Recovery of Debts Due to Banks and Financial Institutions Act 1993 (DRT Act) was passed. The DRT Act definitely eased the pressures on the courts at an all India level and the Debt Recovery Tribunals (DRT) are today deemed to be effective tribunals to redress the grievances of the lenders.
With the enactment of the DRT Act, the banking sector expected that most of the NPAs would be easy to recover, as against the conventional system of recovery of loan through civil courts, where considerable time, money and efforts were required to recover debt. However, in spite of DRT Act, on account of nonrealisation of the NPAs, the banks and financial institutions were facing problems relating to liquidity and asset liability mismatch, since their assets were blocked for considerable time in unproductive asset. There was no legal provision for facilitating securitisation of financial assets, and banks had no power to take possession of securities created in their favour in order to secure the facilities. Therefore, to improve the health of the economy as well as the banking sector, stimulus was required to be given in the form of legal provisions, empowering banks with more powers to recover the assets blocked in NPAs. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (‘SARFAESI’ or ‘Act’) was enacted with the objective of regulating securitization and reconstruction of financial assets and enforcement of security interest created in favour of secured creditors. The Act provides for three alternative methods for recovery of NPAs: (a) securitisation; (b) asset reconstruction; and (c) enforcement of security without intervention of court.
More recently, the current Minister for Law and Justice has made statements assuring that the pendency in the courts will be checked and that the average time spent on litigation pending in the courts will be brought down. He has also indicated setting up of commercial courts to speed up the disposal of commercial disputes. It is also heartening to note that in the Budget 2010-2011 speech, the Finance Minister indicated towards carrying out further judicial reforms in the interest of the financial world.
Under the SARFAESI, NPAs should be backed by securities charged to the banks by way of hypothecation, mortgage or assignment. An exhaustive procedure has been laid down under the SARFAESI along with rules defining the manner in which banks may exercise against the delinquent borrower to enforce the security interest in the asset.
Invocation of Act for enforcement of security is triggered by classification of the account as ‘NPA’ by the banks and financial institutions (referred to as the ‘secured creditors’). In terms of the present RBI guidelines, in case any amount which is due and payable by the borrower and has not been paid for more than 90 days, the said account can be classified as NPA. Upon classification of action as NPA, the secured creditor can issue notice to the borrower including the mortgagors and guarantors calling upon them to pay the entire due amount within a period of 60 days.
In case the payment is not made by the borrower in full within the stipulated 60 days time period, the secured creditor has right to take possession of the secured asset including the right to transfer by way of lease, assignment or sale for releasing the secured asset. Further, the secured creditor can take over the management of the business of borrower, where substantial part of the business of the borrower is held as security for the debt. In case any financial asset has been financed by more than one secured creditor, the notice can be issued only with the consent of secured assets representing not less than three-fourth in value of the amount outstanding.
In case upon issuance of notice, the borrower makes any representation against the proposed action of the bank, the authorised officer of the secured creditor needs to examine the representations with a judicious mind. Before this exercise is done and the borrower has been suitably replied to, the secured creditors cannot take possession of the secured asset and management of business of the borrower. Any person aggrieved on account of taking over the possession of the secured asset and business of the borrower, may file an application under Section 17 of the Act before the concerned DRT seeking declaration that the recourse taken by the secured creditor is invalid and for restoration of possession of secured asset to the borrower.
It is pertinent to note that strong checks and balances have been put in place to ensure that there is no abuse of powers vested in the lenders. The following chart shows the procedure as to how the security interest can be enforced against the delinquent borrower:
The Supreme Court of India and several high courts have delivered important judgments on various contentious issues, which arise under SARFAESI. Some of the issues and judgments are briefly discussed as under:
Mardia Chemicals Ltd Vs. Union of India reported as (2004) 4 SCC 311, laid down a strong foundation for the enforcement of SARFAESI. The Supreme Court upheld the validity of the Act, thereby putting an end to a large number of pending and expected litigation on the vires of the Act throughout the country. The Hon’ble Supreme Court observed that though a loan transaction may have a character of private contract, yet the question of great importance behind such transactions, as a whole having far reaching effect on the economy of the country, cannot be ignored when financing is through banks and financial institutions, utilising the money of people in general. Therefore, where public interest is involved to such a large extent, and it may become necessary to achieve an object which serves the public purpose, individual rights may have to give way. Public interest has always been considered to be above the private interest. Even if few borrowers are affected by the enactment, it would not impinge upon validity of the Act, which otherwise serves larger interest.
In Transcore Vs. Union of India reported as (2008) 1 SCC 125, it was held by the Supreme Court that the object of SARFAESI and DRT Act is the same, namely recovery of debts. Conceptually, there is no inherent or implied inconsistency between the remedies provided under the two Acts and they are cumulative in nature for secured creditors. Secured creditors are given the right to choose one or more of them. Though the DRT Act is a complete code in itself for recovery of debts and provides for various modes of recovery, it does not provide for expeditious enforcement of security interest of a non-adjudicatory process as has been provided for under the SARFAESI in order to prevent asset-liability mismatch in the balance sheet of the lender. It is for this reason that SARFAESI is treated as an additional remedy, which is not inconsistent with the DRT Act. These two Acts together constitute one remedy and, therefore, the doctrine of election does not apply and banks and financial institutions are
Nilanjan Sinha General Counsel, YES Bank Limited, Mumbai
While I am sure that numbers will support my view, I feel that the success and impact of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) is best felt today by the way borrowers sit up and take notice of a notice, sent by secured creditors u/s 13(2) of the Act.
The overall efficacy of this notice is far greater than a demand notice sent before filing of recovery application under DRT or notice of winding up. Given that the Debt Recovery Tribunals have already become overburdened with a stretch on their resources, the number of cases pending have, to a large extent, led to a delay in resolution and recovery.
I am told that it takes approximately two to three years to obtain recovery certificates in DRT (i.e. if lenders do not file a plethora of interim applications). Then there are a separate set of proceedings to be pursued for enforcement of recovery certificate, issued by DRT. SARFAESI on the other hand (as I call it) is a ‘Do It Yourself’ tool for recovery. To a large extent, efficacy of this tool depends on how intensely and meticulously it is used. I do not think anybody expected that borrowers would gulp this legislation, its effect and the powers being given to secured creditors under the Act without protesting. Therefore, it is only expected that this legislation would face all kinds of judicial challenges, scrutiny and examination of various aspects of the Act by Hon’ble High Courts and the Hon’ble Supreme Court. The Hon’ble Courts have upheld the constitutional validity and appreciated the need for such legislation, which is necessary to ensure economic growth by taking effectual action against recalcitrant and chronic borrowers.
There are many success stories for recovery and lenders have seen instant results. Therefore, undoubtedly this enactment has had an impact on disciplining delinquent borrowers while providing a structured platform and efficacious remedy to the banks and FI to deal with Non Performing Assets (NPAs).
A simple proof of the positive impact of the Securitisation Act can be found in the report published in Doing Business 2010, a co-publication of the World Bank and the International Finance Corporation. This publication has reported that India’s ranking has improved one notch (from 133 to 132). The report notes, “In India, procedures under the 2002 Securitisation Act have become more effective, easing the process and reducing the time required to close a business.”
There are a couple of stated objectives of this Act: Securitisation, Asset Reconstruction and Enforcement of Security Interest. While I feel that, in spite of some hurdles, this legislation has done well in enforcement of security interest, it has not met with as much success in the other areas i.e. asset reconstruction and securitisation. Therefore, the government needs to consider innovating further to make these effective.
It is imperative that we find ways to attract more capital to invest in ARC businesses, to create a market for instruments like security receipts, facilitate transfer of more and more NPA to ARCs to enable debt aggregation, leading to more efficient asset reconstruction and resolution. Clearer guidelines are required to enable banks and FIs to transfer NPAs to ARCs in a transparent and commercially prudent manner.
ARCs, on the other hand, need to focus on reconstruction of assets as opposed to mere recovery of loans by way of enforcement of securities and also needs to share upsides with originating bank and FIs to make this palatable for the transferring creditor. Stamp duty and high transactional costs, judicial intervention in the process of reconstruction and enforcement remain the areas of concern, which need to be addressed in order to improve implementation of legislative intend of the Securitisation Act.
To sum up, NPAs are like an ice cream in a cone. The longer you hold, the less you get. Therefore, the mantra has to be quick resolution.
permitted to invoke one Act notwithstanding pendency of proceedings under the other Act. Therefore, simultaneous proceedings for the recovery of debt under the DRT Act as well as SARFAESI are permissible.
In ICICI Bank Vs. Shanti Devi Sharma reported as (2008) 7 SCC 532, while acknowledging that banks have vast powers under the Act, the Supreme Court held that the banks also have equal responsibilities and banks/financial institutions cannot adopt unfair practices for repossession of secured assets. Unfair trade practices have no place in India, which is civilised society governed by the rule of law.
In ATV Projects India Ltd. Vs. State of Maharashtra reported as (2007) 6 Mah LJ 231 (Bom) the Division Bench of Bombay High Court held that statutory and equally efficacious remedies are available to a borrower under section 17 of the SARFAESI by filing application before the DRT against the action taken by secured creditor under section 13(4) of the Act. Therefore, a borrower cannot invoke extraordinary jurisdiction of the high court under article 226 to circumvent the legal process provided under special statute.
Where the borrower is a company, there is a strong mechanism in place to verify the charges created by a company on its assets by way of searching the records of the company maintained with the concerned Registrar of Companies. However, there is no mechanism to verify such charges/encumbrances created by any individual, person, HUF, association of persons or any other entity (other than incorporated company). Therefore, it was a welcome step when the SARFAESI envisaged the establishment of a ‘central registry’ for maintaining data relating to the charges created on any asset by any person.
Sections 22-26 of SARFAESI relate to the concept of central registry. (Please refer to the endnote)* The Act came into force in the year 2002, but it is disappointing to note that the government has till date not notified the sections on establishing the central registry. Once the central registry is established and notified, substantial benefits will accrue to the lenders and innocent third parties. Some of these benefits are listed below:
As of date, the land records are not computerised in all the states and thus tracing the title to all the properties is still a complex problem. With the creation of a central registry, the lender can have a fair sense of the risk being undertaken by them to provide finance against the property, thereby making lending more easily and safely. Occurrences of bureaucratic delays and fleecing on account of lack of transparency and procedure to determine the encumbrances can be reduced or eliminated, which in turn will restore the faith in the land record system as well in respect of assets other than real estate.
The enactment of SARFAESI has been a major factor in improving the health of banks by enabling the banks to reduce their NPAs to substantially lower levels. As per the information available with the RBI, the net NPA which stood at 7.63 per cent as in year 1998 has been reduced to 1.12 per cent by March, 2009. On account of availability of dual remedy, i.e, remedy under the SARFAESI and DRT Act, the banks and financial institutions have been able to substantially resolve the NPAs and the statistics revealed in the following tables is a clear proof thereof:
The above tables indicate that on account of initiation of action under the SARFAESI, the banks have been able to recover a sum of Rs.19396 crores besides receipt of Rs.11249 crores through compromised proposals. Additionally, DRTs have adjudicated cases to the extent of Rs. 65585 crores; out of which the banks have been able to recover Rs. 24889 crores by end March, 2009.
Provided that the Central Registrar may allow the filing of the particulars of such transaction or creation of security interest within thirty days next following the expiry of the said period of thirty days on payment of such additional fee not exceeding ten times the amount of such fee.
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