By Dr. Sailaja Petikam
Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest, 2002 (SARFAESI Act, 2002) has created a new legal framework, new concepts about security and new procedures for recovery of dues by banks and financial institutions.
This Act extends to the whole of India including the State of Jammu & Kashmir. It is effective from June 2002. The Act is applicable also to housing finance companies whose names are notified by the Central Government for such applicability.
The provisions of the Act relating to enforcement of security interest apply to cases in which security interests are created for due repayment of financial assistance. The Act has presupposed a simple thing: there is an obligation on the part of the borrowers to repay loans and, if they are unable to repay, the securities for the loans are to be sold for recovery of loans.
The Act has retrospective application, i.e. it applies to loans and securities created prior to the Act coming into operation.
Prior to this Act, no Indian law had defined the term hypothecation, though hypothecation is a very common type of charge on a security for a bank’s lending. This Act clearly defines hypothecation as a charge in or upon any movable property, existing or future, created by a borrower in favour of a secured creditor, without delivery of possession of the movable property to such creditor as a security for financial assistance, and includes charge and crystallization of such charge into a fixed charge on movable property.
Financial Assistance and Financial Institutions
Whenever any bank or financial institution grants a loan or advance or makes subscription of debentures or bonds or gives a guarantee or issues letters of credit or extends other credit facility, it is called financial assistance.
All banking companies, nationalized banks, the State Bank of India as well as its subsidiary banks and co-operative banks are within the meaning of bank for the purpose of this Act. This definition has excluded the Regional Rural Bank, so SARFAESI Act, 2002 is not applicable to RRB.
The financial institutions include:
- A public financial institution within the meaning of the Companies Act, 2013.
- Any institution specified by the Central Government under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993.
- The International Finance Corporation, established under the International Finance Corporation (Status, Immunities and Privileges) Act, 1958.
- Any other institution or non-banking financial company as defined in the Reserve Bank of India Act, 1934, which the Central Government may specify as a financial institution for the purpose of this Act.
Banks and financial institutions lend money by obtaining security, except for the category of clean loans. The security obtained acts as a protection for the money advanced and, in case of need, the money can be realized by the sale of securities.
The lender’s rights over the securities, both movable and immovable, for realization of the amount advanced were limited and less effective since they were required to take help of the legal system, which was taking unduly long time to complete prior to the passing of the SARFAESI Act, 2002.
Changes Introduced by the Act
This Act introduced major changes in the legal framework for recovery of dues by laying hands on securities. The Act is a major step in financial sector reforms.
It has brought a legal framework for the following important activities in the credit market:
- Securitization of financial assets.
- Reconstruction of financial assets.
- Recognition of any ‘interest’ created in the security for due repayment of loan as ‘security interest’, irrespective of its form and nature, but when it is not in the possession of the creditor.
- Power to enforce such a security for the realization of money due to banks and financial institutions in the event of a default, without the intervention of the Courts.
- Enabling provisions for setting up a Central Registry for registration of transactions of securitization, reconstruction and creation of security interest.
Constitutional Validity of the Act
In Mardia Chemicals v. Union of India (2004) 21 ILD 521 SC, a three-member Bench of the Supreme Court declared this Act constitutionally valid, except a part of Section 17(2).
Section 17(2) had laid down that when the lender intends to take action of taking possession of the secured asset, the borrower can file an appeal to the DRT (Debt Recovery Tribunal) only after depositing seventy-five percent of the amount claimed by the lender.
The Supreme Court declared this condition of deposit of 75 percent of the claim amount unreasonable, oppressive, arbitrary and violative of Article 14 of the Constitution.
After the Supreme Court decision in the Mardia case and its fallout on the intention of the legislation, which gave importance to recovery and prevention of long legal battles, the Government of India issued a notification amending Section 17(2) of the SARFAESI Act, 2002.
The amendment stipulated payment of fifty percent of the amount instead of seventy-five percent as originally enacted. An aggrieved person now has a right to refer the matter to the DRT and then to the Appellate Tribunal by depositing fifty percent of the claimed amount.
When the secured creditor takes over the management of the business of a borrower, he may publish notice in a newspaper published in the English language and in a newspaper published in an Indian language in circulation in the place where the principal office of the borrower is situated, for appointment of a director if the borrower is a company, or an administrator empowered to take such steps as may be necessary to take into custody or under control all property, effects and actionable claims to which the borrower is entitled.
Proceedings before the DRT
Any person, including the borrower, aggrieved by any of the measures taken by the secured creditor or his authorized officer for taking possession of the security may make an application, along with prescribed fees, to the DRT within forty-five days from the date on which such measures are taken.
There can be different prescribed fees for the borrower’s application and the application from a person other than the borrower. The right to file an application is provided not only to the borrower but also to any person aggrieved by the action taken by the secured creditor.
The DRT has to dispose of the application in accordance with the provisions of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 and the Rules made thereunder.
The application has to be disposed of as early as possible, but within sixty days. If for any reason it is not possible to dispose of it within that period, the Tribunal has to record the reasons for delay, but such delay should not be beyond four months from the date of filing of the application.
If any such application is not disposed of within four months, the aggrieved party can prefer an appeal to the Appellate Tribunal for seeking directions for the early disposal of the application.
Any person aggrieved by an order of the DRT can prefer an appeal, along with the prescribed fees, to the Appellate Tribunal within 30 days from the date of receipt of the order of the DRT.