This article is written by Amritha Priya, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.com.

Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002

Firstly in this paper, I would like to set the background of the Act; the objective of the enactment/ the necessary for an enactment; and secondly I would discuss the main objective behind the enactment; thirdly few important definitions under the act; fourthly I would discuss the enforcement procedure under Section 13 of the act; fifthly I would discuss Section 17: the right to appeal. 

Introduction

The Indian banking industry is progressively complying with the international prudent norms and accounting practices. However, there were certain areas in which the banking and financial sector did not have a level playing field as compared to other participants in the financial markets of the world. 

The following were the grey areas:

1. There was no legal provision for facilitating securitisation of financial assets of banks and financial institutions. 
2. Unlike international banks, the banks and financial institutions in India do not have the power to take possession of securities and sell them.

Moreover, our existing legal framework relating to commercial transactions did not keep pace with the changing commercial practices and financial sector reforms. This resulted in a slow pace of recovery of defaulting loans and mounting levels of non-performing assets of banks and financial institutions. Narasimham Committee I and II and Andhyarujina Committee constituted by the central government for the purpose of examining banking sectors reforms have considered the need for changes in the legal system in respect of these areas. 

Consequently, the SARFAESI ACT 2002 was promulgated on 21 June 2002 to regulate securitisation and reconstruction of financial assets incidental thereto. The act is also known as NPA Act. 

Main Objective

The legal mechanism available was insufficient for recovery of outstanding dues of banks and financial institutions. Public sector banks are trustees of public funds. They are duty-bound to recover the amount due from borrowers by adopting all legally permissible methods. Those who take loan and avail financial benefits from banks are duty-bound to repay the amount strictly in accordance with the terms of the contract. 

In Mathew Varghese v Amritha Kumar, it was held that enforcement of security interest in a secured asset by a creditor should strictly be in conformity with the provisions of SARFAESI Act, 2002 and 2002 rules. They cannot be exercised arbitrarily and whimsically to the utter disadvantage of the borrower. Secured creditor as a trustee cannot deal with entrusted property in any manner it likes and secured property can be disposed only in the manner prescribed under the SARFAESI Act, 2002 and the rules 2002. 

Important Definitions under the Act

1. Section 2(b): Asset Reconstruction means the acquisition by asset reconstruction company of any right or interest created in favour of any bank of financial institutions in any loan or advance granted or created in any debentures or bonds subscribed or guarantee given or rights created in favour of the banks or financial institutions under letter of credit. 
2. Section 2(z): Securitisation: the securitisation of credit exposures of banks and credit institutions involve a transfer of outstanding balances in loans/ advances and packing them into transferable and tradable securities. In the case where the borrower has bought an asset with the finance of a bank/ financial institution, the latter is treated as a lender and on assignment the securitisation company/ asset reconstruction company steps into the shoes of the lender bank/ financial institutions and it can recover the lent amounts from the borrowers. 
3. Reconstruction company: it can acquire right and interest in the financial assets of a bank or financial institutions. It can exercise the rights of secured creditors. It need not be notified as a financial institution to enable it to exercise such rights.
4. Section 2(zc) Secured Assets: the property on which the security interest is created 

How can a Bank or Financial Institution enforce Security? 

Section 13 provides for how a bank/ financial institution can enforce security under this act. Such enforcement shall be made without the intervention of court or tribunal.  

The same shall be explained with an example: In the given situation Mr. Ram approaches ABC bank for 2crore loan. The banks will approve the same and sanction loan, for purchasing a villa. 

Now in this case Mr. Ram becomes the debtor to the bank and he is duty-bound to repay the loan, that is the principle amount along with interest. This shall be paid to the bank in instalments as agreed by Mr. Ram while grant of loan. His house will be the secured asset to the bank, and if he pays the loan as agreed that becomes the performing asset to the bank. In case if the loan is not paid as agreed, then it becomes a non-performing asset to the bank. 

Now when there is non-performing asset to the bank/ financial institutions, how will they recover it? Section 13 provides for this. The banker/ financial institution shall send a notice to the borrower to pay the money within 60 days from the date of receipt of notice. However, the borrower shall reply to the notice served within a week from the date of receipt of notice. In case the borrower pays within 60 days, then there is no problem. But what if the borrower fails to pay the dues: 

1. He can write to the bank making a representation that he cannot pay within 60 days, but he would pay to the bank as soon as possible. If the bank/ financial institution agrees then there is no problem. 
2. If the bank does not agree and sends back a reply to the borrower stating valid reasons then the borrower is left with no option. The bank/ financial institution shall take any action prescribed under section 13(4). This cannot be challenged before any court/ tribunal/ DRT.
3. If the bank/ financial institution merely rejects the representation made without stating any valid reasons then the same shall be challenged before the DRT. The DRT shall pass a stay order or support the borrower. 

This section also specifies that once the borrower receives notice from the bank for non-payment of loan taken, he loses the right over the property. He cannot sell, lease, transfer to any third party as it’s a secured asset of the bank/ financial institution. 

Default of 60 days period: if the borrower cannot pay the amount within 60 days then what can the bank/ financial institution do? 

1. Take possession of the secured asset.
2. The bank/ financial asset shall have the right to sell/ rent/ transfer the property.
3. Take over the management of the borrower.
4. Appoint a manager for security assets under Section 10.
5. In case a third party has acquired the secured asset of the bank, and the acquired party desires to pay the loan amount then that can be paid to the bank. The liability of the borrower is discharged; and the right of property is transferred to the third party. The third party is not obliged to pay the loan amount to the borrower. 
6. Security creditor/ bank/ financial institution can take possession and sell the security asset. How? Auction. 

Suppose, in a certain case, banks offer a base price (that is below that price one shall not bid), and none of the bidders quote more than the base price. Then the auction went for a toss. Then the bank/ financial institution shall have a subsequent bid, where the bank appoints an officer who shall quote more than the base price. If anyone bids more than that then the auction ends there. But suppose if no one bids more than the price that the officer bids, the officer shall buy that property. Now the officer shall become the owner of such property and purchase price would be reduced from the claim/ loan amount. Not only this the borrower shall also be liable for all the expenses incurred in this process. 

I will explain this in detail, in the same example. Mr. Ram had to pay 2crore to the bank, out of which he paid 20 lakhs by way of instalments. So, he is left to pay 1crore 80 lakhs along with 4% interest. He is unable to pay the same. So, the loan becomes a non-performing asset to the bank. The bank has complied with the procedure and has placed his property for auction. The base price of the auction is 1crore rupees, and none of the bidder quoted price above 1crore. So, there is a subsequent bid, where Mr. Roy has been appointed as the officer, he bids 1crore 10 lakhs and buys the property. So, in this case, Mr. Ram is discharged up to 1crore. 10 lakhs rupees but is still liable to pay the 70 lakhs rupees. Now, the bank/ financial institution has incurred XXX cost towards sale/ transfer of such security asset. All the expenses incurred shall also be born by Mr. Ram. 

In case if all this was done in compliance with law, then DRT/ court shall have no say in this. Section 13(1).

In this section, the guarantor shall also be liable to the extent of loan amount not recoverable from the borrower. 

Section 17: Appeal 

The party who is aggrieved by the action taken by a bank/ financial institution under section 13 will appeal: 

As discussed earlier, if the bank/ financial institution follows enforcement procedure as described under section 13 then the court/ DRT shall have no say.  WHO SHALL FILE A SUIT? The borrower or any interested person can file a suit. They must pay some fees as prescribed to institute a suit. Possible outcomes may be:  

1. If the DRT finds that the legal/ statutory provisions are met by the bank/ financial institutions then it shall pass an order in favour of the security creditor to have recourse to the action they are taking. 
2. If the DRT finds the banks/ financial institutions have exercised its power beyond the provisions of law then it shall pass an order to stop the bank/ financial institution from taking such action. The DRT shall direct the bank to restore the borrower in his original place.
3. Such suits shall be filed within 45 days. 

This section lays down that the suit shall be disposed of within 60 days and can be extended to a maximum of 4 months and beyond that. In case the suit is not disposed within 60 days then the aggrieved party can file the same before the Appellate Tribunal under section 18. 

Conclusion

The enforcement mechanism provided under the act would curb the interference of the courts. Otherwise, the tireless litigation process would procure results much later, now banks are given independence to enforce their assets within the legal framework. This would encourage the banker towards more loans as their assets would be secured. 

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