By Dr. Sailaja. Petikam
After liberalisation of the Indian economy in 1991, Banks and Financial Institutions (FIs) have been experiencing considerable difficulties in recovering loans and enforcement of securities charged with them. The procedure for recovery of debts due to the banks and FIs, which was then followed, was by the filing of civil suit in a court of law, which has resulted in a significant portion of the funds being blocked.
The Narasimham Committee on reforming the Financial System has considered the setting up of Tribunals with special powers for adjudication of such matters and speedy recovery 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 FIs, could be realised. Keeping in view the recommendations of various Committees, the Recovery of Debts due to Bank and Financial Institutions Act, 1993 (DRT Act) was passed by the Parliament, which resulted in the establishment of Debt Recovery Tribunals, exclusively for recovering debts of Banks and FIs.
Debts Recovery Tribunals have been established for expeditious adjudication and recovery of debts due to banks and FIs and functions under the DRT Act. The DRTs were empowered to adjudicate claims of banks and FIs involving rupees ten lakhs and above.
Where a bank or FI has to recover any debt from any person, it makes an application called Original Application (OA) to the Tribunal against such person. After adjudication, the DRT issues order and Recovery Certificate, certifying the amount payable by the borrower to the bank or FI. This Recovery Certificate is thereafter executed by Recovery Officers attached to the DRTs as per the procedure for recovery of tax under Second Schedule of Income Tax Act, 1961.
Under RDB Act, Any debt can be recovered. Whereas, under SARFAESI, only secured debts i.e., debts secured by way of underlying assets can be recovered.
Despite the establishment of Debt Recovery Tribunals (DRTs) across India, there was no speedy recovery of debts by the Banks and FI’s through these tribunals as adjudication process was time-consuming and this situation had crippled the viability and strength of Banks and FIs. There were several loopholes in the DRT Act and these loopholes were misused by the borrowers as well as the lawyers. The defaulting borrowers also took shelter of ‘Board for Industrial and Financial Reconstruction’ (BIFR) created under Section 4 of Sick Industrial Companies (Special Provisions) Act, 1985, where the Lender has no power to take over the possession of the secured property.
This led the government to appoint another committee under Mr Andhyarujina to examine banking sector reforms and consider changes in the legal system.
The Supreme Court has held that NBFC is entitled to initiate both arbitration proceedings and SARFAESI proceedings with respect to a loan account, and that the ‘doctrine of election’ was not attracted in such a scenario.
The Andhyarujina Committee recommended the enactment of a new legislation for the establishment of securitisation and reconstruction companies and to empower the banks and FIs to take possession of Non-Performing Assets (NPAs).
With an intention to speed up the process and convert the NPAs of Bank and FIs, the Parliament has enacted The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act), which empowers the Banks and FI’s to recover their NPAs without the intervention of the Court.
New Law On Debt Recovery – The Enforcement Of Security Interests And Recovery Of Debt Laws And Miscellaneous Provisions (Amendment) Act, 2016
The Recovery of Debts due to Banks and Financial Institutions Act, 1993 (RDDBFI Act) and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) were enacted for expeditious recovery of loans of banks and Financial Institutions (FIs). However, due to various reasons, these laws were unable to give the desired outcome, resulting in the bad debts of Banks and FIs mounting day by day. In order to facilitate quick disposal of recovery applications and thereby speed up the recovery process, Government has initiated steps to amend the RDDBFI and SARFAESI Acts and also to make consequential amendments to the India Stamp Act, 1899 and the Depositories Act, 1996.
SARFAESI Act empowers the Financial Institutions (Banks and NBFC’s) to recover non-performing assets by three alternatives, namely; Securitisation, reconstruction and by sale of collateral without intervention of the court.
SARFAESI empowers banks and other financial institutions to attach secured assets of a loan defaulter and sale, auction or manage them without requiring court intervention. The Act is a paradigm shift in the sense that it allows the financial institutions to take possession of the collateral without approaching the Court/Tribunal which till then was expressly disallowed by SICA.
SARFAESI Act is enacted in addition to DRT (RDB Act). Here are the key differences between them.
Under RDB Act, Recovery of debts is made through quasi judicial bodies called Debt Recovery Tribunals. Whereas, under SARFAESI, collateral security can be recovered by the Bank/NBFC itself without approaching any court or tribunal.
It seeks to amend four laws: Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; Recovery of Debts due to Banks and Financial Institutions Act, 1993; Indian Stamp Act, 1899; and Depositories Act, 1996.
Amendments to the SARFAESI Act
The amendments in the SARFAESI Act, are proposed to suit changing credit landscape and augment ease of doing business which, inter alia, include:
Registration of creation, modification and satisfaction of security interest by all secured creditors and provision for integration of registration systems under different laws relating to property rights with the Central Registry;
Creation of a central database to integrate records of property registered under various registration systems with the Central Registry. This includes integration of registrations made under Companies Act, 2013, Registration Act, 1908 and Motor Vehicles Act, 1988.
Secured creditors will not be able to take possession of the secured assets unless the secured assets are registered with the Central Registry;
After registration of security interest with Central Registry, the secured creditors will have priority over others in repayment of dues;
In addition to the existing powers of the Reserve Bank of India (RBI) to examine the statements and any information of Asset Reconstruction Companies (ARCs) related to their business, the amendment further empowers the RBI to carry out audit and inspection to regulate ARCs. The RBI may penalise an ARC if the company fails to comply with any directions issued by it;
To enable non-institutional investors to invest in security receipts of ARCs;
Provide a specific timeline for taking possession of secured assets;
Mandates that District Magistrates shall pass suitable orders in an application for assistance for taking possession of the secured assets, under Sec. 14, within 30 days from the date of the application; and
In case the secured creditors have acquired controlling interest in the borrower company by converting part of its debt into shares of the borrower company, it shall not be necessary for the secured creditors to restore the business to the borrower.
Amendments to the RDDBFI Act
The amendments proposed in the RDDBFI Act, inter alia, include:
Expeditious adjudication of recovery applications;
Electronic filing of recovery applications, summons, documents and written statements;
Priority to secured creditors in repayment of debts;
Debenture trustees are also included in the definition of financial institutions, thereby enabling them to initiate action under the RDDBFI Act;
Empowering the Central Government to provide for uniform procedural rules for the conduct of proceedings in the Debts Recovery Tribunals and Appellate Tribunals;
Increase in the retirement age of Presiding Officers of Debt Recovery Tribunals from 62 years to 65 years. Further, it increases the retirement age of Chairpersons of Appellate Tribunals from 65 years to 67 years. It also makes Presiding Officers and Chairpersons eligible for reappointment to their positions.
Allows banks to file cases in Debts Recovery Tribunals having jurisdiction over the area of bank branch where the debt is pending, instead of filing cases in tribunals having jurisdiction over the defendant’s area of residence or business.
The amendment provides for exemption from stamp duty on transactions undertaken for transfer of rights or interest in financial assets of banks or FIs in favour of ARCs. Financial assets include debts or receivables as defined in the SARFAESI Act.
Amendments to the Depositories Act
The Depositories Act, 1996 is proposed to be amended for facilitating the transfer of shares held in pledge or on conversion of debt into shares, in favour of ARCs by banks or FIs.
However Section 14(1)(c) of the Insolvency and Bankruptcy Code, 2016 clearly provides that during the insolvency resolution process as defined in the Code, the Code takes precedence over the DRT Act and SARFAESI Act.
Key changes of The Enforcement of Security Interests and Recovery of Debt Laws and Miscellaneous Provisions (Amendment) Act, 2016
The Enforcement of Security Interests and Recovery of Debt Laws and Miscellaneous Provisions (Amendment) Act, 2016 to improve the efficacy of Indian debt recovery laws. Key changes introduced they are as follows
A. Changes to the ARC Framework
(i) Ownership and Control of ARCs: Till now, ownership and control of an asset reconstruction company (ARC) had to be diversified and no sponsor could hold a controlling interest (more than 49%) in an ARC or appoint a majority of its board of directors. These restrictions have been removed and sponsors are now allowed to hold up to 100% equity in an ARC as well as exercise majority control over its board. Correspondingly, the Reserve Bank of India (RBI) has also been given greater powers of oversight over an ARC’s operations including, the right to appoint RBI officers as observers to the board of directors of an ARC and if required, change/replace its directors.
(ii) Eligible Purchasers of Security Receipts: Until now, only ‘qualified institution buyers’ (i.e. banks, financial institutions, insurance companies, state finance corporations, mutual funds and foreign portfolio investors) were permitted to purchase security receipts issued by ARCs. With the amendment, the scope of eligible investors has been widened to include non-institutional investors as identified by RBI from time to time.
With non-performing assets (NPAs) and stressed assets of Indian banks exceeding INR 8 trillion (approx. USD 125 billion), these changes to the ARC framework could help remove distressed assets from the balance sheets of Indian banks by developing a robust secondary market for distressed debt in India. Removal of the sponsor ownership restrictions could incentivize more players to set up ARCs and allow existing ARCs to raise necessary capital to expand their portfolios. Further, the widening of the investor base for security receipts may possibly generate more interest in these instruments and allow banks to offload their NPAs on an arms’ length basis, as opposed to self-funding securitization transactions to restructure their exposure.
B. Wider group of SARFAESI Eligible Lenders
Until recently, the benefits under the SARFAESI Act and the DRT Act were available to a limited group of lenders – i.e. scheduled commercial banks, International Finance Corporation, Asian Development Bank and identified Housing Finance Companies. The government has made two significant additions to this group: NBFCs: On 5 August, 2016, the Ministry of Finance has specifically notified and named those non-banking financial companies (NBFCs) with an asset size of more than Rs. 500 crores, as SARFAESI eligible lenders. Listed Debt Securities: The benefits of the SARFAESI Act and the DRT Act have been extended to the listed bond market in India. Debenture trustees appointed in respect of debt securities listed in accordance with applicable SEBI regulations have been specifically included as ‘secured creditors’ under the SARFAESI Act, and corresponding changes have been made to various provisions of both the SARFAESI Act and the DRT Act.
C. Central Registry for Security Interests
Once the amendments are notified, all secured creditors (including creditors who do not have enforcement privileges under the SARFAESI Act) will be required to register their security interests with the Central Registry of Securitization Asset Reconstruction and Security Interests of India (Central Registry). This will facilitate implementation of the Bankruptcy Code and will increase overall transparency in respect of security interests.
D. Increasing efficacy of SARFAESI and DRT Proceedings
While the SARFAESI Act and DRT Act are intended to expedite recovery of secured debt, there have been various procedural issues which have limited the efficacy of these legislations. Accordingly, various modifications have been made to both the legislations to deal with this problem. For instance: timelines for various steps in the adjudication process before the debt recovery tribunals such as filing of written statements, passing of orders, appeals, etc. have been reduced.
The cost on a borrower to delay recovery timelines through protracted appeals and proceedings has been increased. Borrowers will now be required to deposit at least 25% of the outstanding amounts with the debt recovery appellate tribunal (DRAT) under the DRT Act to prefer an appeal. Previously, (a) this floor of 25% on the deposit obligation applied only to appeals made under the SARFAESI Act, and (b) borrowers could request the DRAT for a waiver of the entire deposit obligation under the DRT Act.
Conclusion
The amendments are perhaps the most significant set of changes to the SARFAESI Act since its enactment in 2002. The Bankruptcy Code and the amendments to the SARFAESI Act together reflect a clear legislative intent to shift the needle in a distressed situation towards the creditors by plugging various loopholes available to borrowers.
We believe that the inclusion of listed bonds within the SARFAESI Act could significantly deepen the listed debt market in India by generating interest from a wider variety of investors – including retail investors, insurance companies, domestic funds and foreign portfolio investors.
While the amendments are a welcome move, they fall short of creating a level playing field for all participants in the Indian debt market. The entire external commercial borrowing (ECB) framework, which is comparatively more regulated than the listed bond framework, continues to remain outside the scope of the SARFAESI Act. In an environment where foreign companies, individuals and retail investors holding listed bonds would ultimately benefit from the self-help remedies under SARFAESI Act, it is unclear why regulated foreign banks, bilateral or multilateral financial institutions and other eligible ECB lenders should have to resort to traditional court proceedings to recover their dues.