Judicial Reforms- Non Performing Assets and Related Issues in The Banking System in India

In Depth

Judicial Reforms- Non Performing Assets and Related Issues in The Banking System in India

Rajesh Narain Gupta | April 2015

LENDING PARAMETERS IN INDIA

Scheduled Banks (including branches of Foreign Banks in India designated as Schedule Banks) are permitted to lend in India. Presently there are about 43 Foreign Banks operating in India. Foreign banks are permitted to have their branches in India under the current regime. Further, Foreign banks have also been permitted to create wholly owned subsidiaries in India. Some of the Foreign Banks are considering to establish their own wholly owned subsidiaries in India and to shift and to transfer their existing business in India to the WOS.
The second kind of lending which takes place in India is by way of Foreign Currency loans/external commercial borrowings i.e. the foreign currency loans extended by Foreign Banks outside India to borrowers in India, under the permitted rules.
Additionally, Foreign Banks outside India also regularly issue guarantees and stand by letters of credit for various transactions in India. Similarly the Scheduled Banks in India including branches of Foreign Banks in India extend non-fund based facility including by way of guarantee facility and SBLC facility to the borrowers in India.

LAWS IN INDIA

In the event of any default /enforcement situation in India the legal remedies available to the banks in India including branches of Foreign Branch is as under:

Summary Suits Order XXXVII of the Code of Civil Procedure
Ordinary Suits for Recovery
Debt Recovery Tribunal – recovery applications filed by banks and financial institutions in India for debt not less than Rs.10 lakhs.
Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (Securitization Act). In case any Secured Creditor has charge over specific movable / immovable properties, not being exempt properties under Section 31 of the Act, and where the amount to be recovered is not less than Rs.1,00,000/-, the Secured Creditor can enforce the security without intervention of Court. The most expeditious and effective mode of recovery for a Secured Creditor in India. In addition to the above, the other recourse available is as follows:

Petition for winding of the Company under the Companies Act on the ground of non-payment of debt.
Apply for Corporate Debt Restructuring subject to the guidelines of Reserve Bank of India.
So far as foreign lenders are concerned, the remedies available in the event of default include:

Filing Civil Suit for recovery in the Appropriate Court in India.
Filing petition for winding up of the Company under the Companies Act on the ground of non-payment of debt.
Initiate steps for Corporate Debt Restructuring on case to case basis with appropriate permission from CDR forum.
Initiate arbitration proceedings if the contract provides for arbitration. It is important to mention that the

recourse under the Securitization Act is not available to the foreign lenders in respect of Foreign Currency loans etc.,
It may also be clarified that branches of Foreign Banks operating in India can avail recourse under the Securitization Act.
Foreign lenders can also provide for arbitration clause in the loan documents where the venue of arbitration and the law applicable to such arbitration can be agreed by and between the bank and the borrower.
It may be clarified that the above arbitration may not be opted by scheduled banks in India including branches of Foreign Banks in India as the recovery mechanism is to be followed as per the laws and procedure defined in the Recovery of Debts Due to Banks and Financial Institutions Act 1993 (“DRT Act”).

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 XXXVII 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.

JUDICIAL REFORMS

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 realized without delay.

In 1981, a committee under the Chairmanship of 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 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 non-realisation 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 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 Securitisation Act provides for three alternative methods for recovery of NPAs: (a) securitization; (b) asset reconstruction; and (c) enforcement of security without intervention of court.

Presently, there are 33 DRTs and 5 DRATs functioning all over the country. The recent Amendment to the DRT Act vide the Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Act, 2012 have been carried out to improve the functioning of the DRTs, to prescribe time frame for filing of pleadings, adjournments etc., and to give recognition and validity to the settlements/compromises entered into between the banks and the borrowers.

MORE RECENTLY, AS PER THE BUDGET SPEECH (2105):

The Government has announced to bring a comprehensive Bankruptcy Code in fiscal 2015-16, that will meet global standards and provide necessary judicial capacity.
For the quick resolution of commercial disputes, the Government proposes to set up exclusive commercial divisions in various courts in India based on the recommendations of the 253rd Report of the Law Commission. The Government proposes to introduce a Bill in the parliament after consulting stakeholders in this regard.

As per the above analysis, we may make few conclusions:

First of all the judicial system in India is robust enough to handle bank litigations.
State-wise Debt Recovery Tribunals have been established which are doing good job for the banks.
As per the budget speech of the FM the recovery mechanism is further being tightened.

It may also be worthwhile to mention that in order to reduce NPAs and credit risk default, banks may adopt following legal mitigants:

Due Diligence on Borrower/Company:

Registrar of Companies
Other Bank Referrals
Market Reputation
CERSAI
CIBIL
Defaulter List

Due Diligence on securities proposed to be provided
Tight Security Documents
Registration of Charges with Registrar of Companies and Central Registry
Filings / registrations with concerned Registrar of Assurances
PariPassu exchange of letters / NOC’s from other Lenders (where other lenders are involved)
Closure Report from in house/ external lawyers of documents having been properly executed; legally enforceable; securities are being properly checked

The high profile corporate cases which include Sahar and some of the scams like NSEL etc., show that the Criminal Justice System also gets involved very quickly where the economic offence are involved. There is an increasing trend of the bank reaching out to financial authorities where any financial fraud is un-earthed. There are known several precedents where the borrowers have been implicated under Criminal laws which act as deterrents.

Undoubtedly there have been several cases filed in the Courts of India against Borrowers having availed foreign currency loans; however the same cannot be seen as lenders not doing the banking business in India.

There have been cases in India where the payments under bank guarantees had been stopped by the Courts. It may be worthwhile to mention that in comparison to the total volume of activities undertaken by the banks in India, the cases wherein injunctions have been granted by the Court are insignificant. It may also be worthwhile to mention that in matured Cities like, Delhi, Bombay, Chennai, Bangalore, Calcutta, the Courts generally refrain from giving any such injunction in view of the established law as below and the judgments given by the High Courts and Supreme Court of India. “Courts ought not to grant injunctions restraining the performance of the contractual obligations flowing out of a letter of credit or a bank guarantee between one bank and another.” [United Commercial Bank v. Bank of India and Ors]

“In case of any irrevocable bank guarantee or letter of credit, the Buyer cannot be granted an injunction against the bank on the ground that there was a breach of contract by the Seller. The bank, who issued the bank guarantee or with whom the letter of credit is opened, has no authority to dishonour the bank guarantee or the letter of credit if the party complies with the terms and conditions of the bank guarantee or letter of credit. Where the bank is satisfied about the documents presented to it and finds them in conformity with the documents mentioned in the letter of credit, the bank is bound to honour the demand made by the seller of encashment of letter of credit. The bank cannot refuse payment on the ground that the buyer is claiming that there was a breach of contract. The bank cannot decide the question of breach and refuse payment to the seller.”[Federal Bank Ltd. v. V.M. Jog Engineering Ltd.; Impex Trading Gmbh v. Annunay Fab. Ltd. And Ors]

In some of the States and the smaller courts in India, on account of lack of understanding on the legal and commercial implications and legal environment and system, there have been cases where such injunctions have been granted. However, if the appropriate legal remedy is invoked and right lawyers are engaged these types of frivolous cases can be suitably tackled. Established principle is that Court injunction for bank guarantees are given only in cases of fraud and not otherwise.

About Author

Rajesh Narain Gupta

Rajesh Narain Gupta is the Managing Partner of S.N. Gupta & Co., Advocates. He specialises in commercial, real estate, and banking laws. Mr. Gupta represents major international, private and public sector banks and financial institutions in India and abroad. He has been actively involved in framing of policies, procedures and guidelines for various Banks with regard to implementation on the procedural aspect of SARFAESI.