Objective:- SARFAESI Act enables and empowers the secured creditors to take possession of their Securities, to deal with them without the intervention of the court. The Act has made provisions for registration and regulation of securitization companies or reconstruction companies by the RBI facilitate securitization of financial assets of banks, empower SCO/RCO to raise funds by issuing security receipts to qualified institutional buyers (QIBs), empowering banks and FIs. It authorizes any Securitization or Reconstruction Company to take possession of securities given for financial assistance and sell or lease the same to take over management in the event of default.
- Incorporation of Special Purpose Vehicles viz. Securitization Company and Reconstruction Company.
- Securitization of Financial Assets
- Funding of securitization.
- Asset Reconstruction
- Enforcing security interest i.e. taking over the assets given as security for the loan.
- Establishment of Central Registry for regulating and registering securitization transactions.
- Offences & Penalties.
- Boiler – plate provisions.
- Dilution of provisions of SICA.
- Exempted transactions
The provisions of this Act are applicable only for NPA loans with outstanding above Rs. ONE Lakh. NPA loan accounts where the amount is less than 20% of the principal and interest are not eligible to be dealt with under this Act.SS
Non-performing Asset (NPA) means an asset for which Interest or principal (or installment) is overdue for a period of 90 days or more from the date of acquisition or the due date as per contract between the borrower and the lender, whichever is later. NPA should be backed by securities charged to the Bank by way of hypothecation or mortgage or assignment.
Special Purpose Companies
The Securitization Act proposes to securitize and reconstruct the financial assets through two special purpose vehicles viz. Securitization Company and Reconstruction Company. SCO and RCO ought to be a company incorporated under the Companies Act, having securitization and asset reconstruction respectively as main object. The SCO or RCO which has obtained the registration certificate under the Securitization Act shall be a Public Financial Institution within the meaning of Section 4A of the Companies Act.
A Securitization Company or Reconstruction Company shall commence/undertake only the securitization and asset reconstruction activities and the functions provided for in Section 10 of the SARFAESI Act. It cannot raise deposits.
- The Securitization Act requires compulsory registration of SCO and RCO under the Securitization Act before commencing its business.
- A minimum financial stability requirement is also provided by requiring SCO and RCO to possess owned fund of Rs. 2 Cr or up to 15% of the total financial assets acquired or to be acquired.
- The RBI has the power to specify the rate of owned fund from time to time. Different rates can be prescribed for different classes of SCO and RCO.
- Existing SCO and RCO are also required to get registered under the Securitization Act. The application for registration will have to be made to RBI.
Besides the core business of securitization and asset reconstruction, a SCO/RCO may perform the following functions:
- Acting as recovery agent on behalf of any bank or financial institution.
- Acting as manager to manage the secured assets the possession of which has been taken over by the secured creditor.
- Acting as receiver if appointed by any Court or Debt Recovery Tribunal.
- Apart from above functions any SCO/RCO cannot commence or carryout other business without the prior approval of RBI.
A SCO/RCO, which is carrying on any other business other than that of securitization or asset reconstruction before commencement of the Securitization Act, has to discontinue such other business within one year from the commencement of the Securitization Act.
Broad guidelines with regards to Securitization are as follows:
- Issue of security receipts: A SCO/RCO can set up trust(s), for issuing security receipts to QIBs, as specified under SARFAESI Act. The company shall transfer the assets to the trust at a price at which the assets were acquired from the originator. The trusteeship remains with the company and a policy is formulated for issue of security receipts.
- Deployment of funds: The Company can sponsor or partner a JV for another SCO/RCO through investment in equity capital. The surplus available can be deployed in G-Sec or deposits in SCBs.
- Asset Classification: The assets of SCO/RCO should be classified as Standard or NPAs. The company shall also make provisions for NPAs.
Broad guidelines pertaining to Asset Reconstruction are as follows:
- Acquisition of Financial Assets: With the approval of its Board of Directors, every SCO/RCO is required to frame, a ‘Financial Asset Acquisition Policy’, within 90 days of grant of Certificate of Registration, clearly laying down policies and guidelines which define the; norms, type, profile and procedure for acquisition of assets
- Valuation procedure for assets having realizable value, which could be reasonably estimated and independently valued
- Plan for realization of asset acquired for reconstruction
- The Board has powers to approve policy changes and delegate powers to committee for taking decisions on policy/proposals on asset acquisition.
- No SCO/RCO can takeover/ change the management of business of the borrower or sale/lease part/whole of the borrower’s business until the RBI issues necessary guidelines in this behalf
- A policy for rescheduling the debt of borrowers should be framed laying the broad parameters and with the approval of the Board of Directors. The proposals should to be in line with the acceptable business plan, projected earnings/ cash flows of the borrower, but without affecting the asset liability management of the SCO/RCO or commitments given to investors. Similarly, there should be a policy for settlement of dues with borrowers.
- For the sale of secured asset as specified under the SARFAESI Act, a SCO/RCO may itself acquire the secured assets, either for its own use or for resale, only if the sale is conducted through a public auction.
- Within the planning period a realization plan should be formulated providing for one or more of the measures including settlement/rescheduling of the debts payable by borrower, enforcement of security interest, or change/takeover of management or sale/lease of a part or entire business. The plan should clearly define the steps for reconstruction of asset within a specified time, which should not exceed five years from the date of acquisition.
Methods for recovery of non-performing assets: –
- Securitization– It means issue of security by raising of receipts or funds by SCO/RCO. A securitization company or reconstruction company may raise funds from the QIBs by forming schemes for acquiring financial assets. The SCO/RCO shall keep and maintain separate and distinct accounts in respect of each such scheme for every financial asset acquired, out of investments made by a QIB and ensure that realizations of such financial asset is held and applied towards redemption of investments and payment of returns assured on such investments under the relevant scheme
- Asset Reconstruction– The SCO/RCO for the purpose of asset reconstruction should provide for any one or more of the following measures:
- The proper management of the business of the borrower, by change in, or takeover of, the management of the business of the borrower
- The sale or lease of a part or whole of the business of the borrower
- Rescheduling of payment of debts payable by the borrower
- Enforcement of security interest in accordance with the provisions of this Act
- Settlement of dues payable by the borrower
- Taking possession of secured assets in accordance with the provisions of this Act
- Exemption from registration of security receipt: The Act also provides, notwithstanding anything contained in the Registration Act, 1908, for enforcement of security without Court intervention: (a) any security receipt issued by the SCO/RCO, as the case may be, under section 7 of the Act, and not creating, declaring, assigning, limiting or extinguishing any right, title or interest to or in immovable property except in so far as it entitles the holder of the security receipt to an undivided interest afforded by a registered instrument; or (b) any transfer of security receipts, shall not require compulsory registration.
- To issue demand notice to the defaulting borrower and guarantor, calling upon them to discharge their dues in full within 60 days from the date of the notice.
- To give notice to any person who has acquired any of the secured assets from the borrower to surrender the same to the Bank.
- To ask any debtor of the borrower to pay any sum due or becoming due to the borrower.
- Any Security Interest created over Agricultural Land cannot be proceeded with.
If on receipt of demand notice, the borrower makes any representation or raises any objection, Authorized Officer shall consider such representation or objection carefully and if he comes to the conclusion that such representation or objection is not acceptable or tenable, he shall communicate the reasons for non acceptance WITHIN ONE WEEK of receipt of such representation or objection.
A borrower / guarantor aggrieved by the action of the Bank can file an appeal with DRT and then with DRAT, but not with any civil court. The borrower / guarantor have to deposit 50% of the dues before an appeal with DRAT.
If the borrower fails to comply with the notice, the Bank may take recourse to one or more of the following measures:
- Take possession of the security
- Sale or lease or assign the right over the security
- Manage the same or appoint any person to manage the same
Issues under the SARFAESI
- Right of Title – A securitization receipt (SR) gives its holder a right of title or interest in the financial assets included in securitization. This definition holds good for securitization structures where the securities issued are referred to as ‘Pass through Securities’. The same definition is not legally inadequate in case of ‘Pay through Securities’ with different tranches.
- Thin Investor Base – The SARFAESI Act has been structured to enable security receipts (SR) to be issued and held by Qualified Institutional Buyers (QIBs). It does not include NBFC or other bodies unless specified by the Central Government as a financial institution (FI). For expanding the market for SR, there is a need for increasing the investor base. In order to deepen the market for SR there is a need to include more buyer categories.
- Investor Appetite – Demand for securities is restricted to short tenor papers and highest ratings. Also, it has remained restricted to senior tranches carrying highest ratings, while the junior tranches are retained by the originators as unrated pieces. This can be attributed to the underdeveloped nature of the Indian market and poor awareness as regards the process of securitization.
- Risk Management in Securitization – The various risks involved in securitization are given below:
- Credit Risk: The risk of non-payment of principal and/or interest to investors can be at two levels: SPV and the underlying assets. Since the SPV is normally structured to have no other activity apart from the asset pool sold by the originator, the credit risk principally lies with the underlying asset pool. A careful analysis of the underlying credit quality of the obligors and the correlation between the obligors needs to be carried out to ascertain the probability of default of the asset pool. A well diversified asset portfolio can significantly reduce the simultaneous occurrence of default
- Sovereign Risk: In case of cross-border securitization transactions where the assets and investors belong to different countries, there is a risk to the investor in the form of non-payment or imposition of additional taxes on the income repatriation. This risk can be mitigated by having a foreign guarantor or by structuring the SPV in an offshore location or have an neutral country of jurisdiction
- Collateral deterioration Risk: Sometimes the collateral against which credit is sanctioned to the obligor may undergo a severe deterioration. When this coincides with a default by the obligor then there is a severe risk of non-payment to the investors. A recent example of this is the sub-prime crisis in the US which is explained in detail in the following sections
- Legal Risk: Securitization transactions hinge on a very important principle of “bankruptcy remoteness” of the SPV from the sponsor. Structuring the asset transfer and the legal structure of the SPV are key points that determine if the SPV can uphold its right over the underlying assets, if the obligor declares bankruptcy or undergoes liquidation.
- Prepayment Risk: Payments made in excess of the scheduled principal payments are called prepayments. Prepayments occur due to a change in the macro-economic or competitive industry situation. For example in case of residential mortgages, when interest rates go down, individuals may prefer to refinance their fixed rate mortgage at lower interest rates. Competitors offering better terms could also be a reason for prepayment. In a declining interest rate regime prepayment poses an interest rate risk to the investors as they have to reinvest the proceedings at a lower interest rate. This problem is more severe in case of investors holding long term bonds. This can be mitigated by structuring the tranches such that prepayments are used to pay off the principal and interest of short-term bonds
- Servicer Performance Risk: The servicer performs important tasks of collecting principal and interest, keeping a tab on delinquency, maintains statistics of payment, disseminating the same to investors and other administrative tasks. The failure of the servicer in carrying out its function can seriously affect payments to the investors.
- Swap Counterparty Risk: Some securitization transactions are so structured wherein the floating rate payments of obligors are converted into fixed payments using swaps. Failure on the part of the swap counterparty can affect the stability of cash flows of the investors
- Financial Guarantor Risk: Sometime external credit protection in the form of insurance or guarantee is provided by an external agency. Guarantor failure can adversely impact the stability of cash flows to the investors.
Under the Securitization Act only banks and financial institutions can securitize their financial assets pertaining to NPAs with a securitization company. Securitization means, according to the Securitization Act, acquisition of financial assets by any Securitization company or Reconstruction Company from any financial institution or banks. The necessary funds for such acquisition may be raised from ‘qualified institutional buyers (‘QIB’), by issuing security receipts representing undivided interest in such financial assets or otherwise.
Financial assets are as under:
- A claim to any debt or receivables or part thereof, whether secured or unsecured.
- Any debt or receivables secured by, mortgage of, or charge on, immovable property.
- A mortgage, charge, hypothecation or pledge of movable property.
- Any right or interest in the security whether full or part underlying such debt or receivables.
- Any beneficial interest in property, whether movable or immovable, or in such debts, receivables, whether such interest is existing, future, accruing, conditional or contingent.
- Any financial assistance.
The much-needed legal framework for the securitization of financial assets has been made by the enactment of the Securitization Act. Securitization of financial assets is a financial tool for the lenders to securitize their future cash flows from the secured assets and thus to release their funds blocked in them. In the hands of the SCO and RCO the secured assets become “merchandise”, realization of which gives them their return. This aspect brings in the much-needed expertise in adept handling in realization of the secured assets. The legal impediments of normal civil law procedure to foreclose the mortgaged assets have thus been effectively removed by empowering the enforcement of the secured assets.
Securitization of financial assets may take some time to fructify as it requires sound accounting principles also for which standards to be prescribed. In other words there should be accounting framework, as well, besides legal framework.
This is the main part of securitization. Section 5 provides for the acquisition of rights or interests in financial assets of any bank or financial institution by SCO / RCO, notwithstanding anything contrary contained in any agreement or any other law for the time being in force, in either of the following manner:
- Issuing a debenture or bond or any other security in the nature of debenture, as consideration agreed upon by a SCO /RCO and bank/financial institution, incorporating therein the terms and conditions of issue.
- Entering into an agreement with bank/financial institution for the transfer of such financial assets on such terms and conditions as may be agreed upon.
Upon acquiring the financial assets from the bank/financial institution, the SCO/RCO steps into the shoes of the lender qua the borrower. The Securitization Act has provided for all necessary rights and powers for SCO/RCO to realize the financial assets from the borrower.
The SCO/RCO may raise the necessary funds, for the acquisition of financial assets, from the QIB by issuing a security receipt. Security receipt is exempted from compulsory registration under the Registration Act. Security receipts issued by any SCO or RCO shall be “securities” within the meaning of Section 2(h)(ic) of the Securities Contracts (Regulation) Act, 1956.
A Scheme of acquisition has to be formulated for every acquisition detailing therein the description of financial assets under acquisition, the quantum of investment, rate of return assured etc. Further separate and distinct accounts have to be maintained in respect of each scheme of acquisition. Realizations made from the financial assets have to be held and applied towards the redemption of investments and payment of assured returns.
In the event of non-realization of financial assets, the QIB holding not less than 75% of the total value of the security receipts issued, are entitled to call a meeting of all QIB and pass resolution and every such resolution is binding on the SCO/RCO.
A SCO or RCO may, according to the guidelines prescribed by RBI, carry out asset reconstruction in any one of the following manners:
- Taking over the management of the business of the borrower.
- Changing the management of the business of the borrower.
- Selling or leasing of a part or whole of the business of the borrower.
- Rescheduling of the payment schedule of the debt.
- Enforcing the security interest.
- Entering into settlement with the borrower for the payment of debt.
However, the above measures are subject to the provisions contained in any other law for the time being in force.
The second objective of the Securitization Act is to provide for the enforcement of security interest i.e. taking possession of the assets given as security for the loan. Section 13 of the Securitization Act contains elaborate provisions for a lender (referred to as ‘secured creditor’) to take possession of the security given by the borrower. The sum and substance of the provisions are as under:
- The Lender has to send a notice of demand, giving details of the amount payable and the secured assets intended to be enforced in the event of non-payment, to the defaulting borrower to discharge his liabilities.
- No borrower, after the receipt of the demand notice, shall transfer the secured assets in whatsoever manner without prior written consent from the lender.
- The Borrower has to discharge the liabilities within 60 days from the date of receipt of notice of demand.
- In the event of non-payment of demand by the borrower, the lender may take any one or more of the following measures:
- Taking possession and / or management of the secured assets of the borrower with a right to transfer the same by way of lease, assignment or sale for realizing the secured asset.
- Appointing any person as manager to manage the secured assets the possession of which has been taken over.
- Asking any person, who has acquired any of the secured assets from the borrower and owes money to the borrower, to pay so much of the money which is sufficient to pay the secured debt.
- Any transfer of secured assets made by the lender shall be deemed to be made by the owner of such secured asset.
- If the borrower pays all the dues together with all costs, charges and expenses incurred by the lender before the date fixed for the sale of the secured assets, the lender shall not transfer or sell the secured assets.
- When there is more than one lender or joint financing, the approval of lender(s) representing not less than 75% of the amount due is required to take any steps to enforce the security interest and such approval is binding on all the lenders.
- In the case of a corporate borrower under liquidation the sale proceeds from the secured assets shall be distributed as per Section 529A of the companies Act, 1956.
- In the event of lender opts to realize his security instead of relinquishing his security and proving his debt may retain the sale proceeds of his secured assets after depositing the workmen’s dues with the Liquidator.
- If the sale proceeds of the secured assets are not fully satisfying the debt due, the lender may file a claim before the DRT or before a competent court for the recovery of the shortfall.
- The lender also has an option to proceed against any of the guarantors or sell the pledged assets without taking any measures against the borrower.
- The lender can take the assistance of the Chief Metropolitan Magistrate or District Magistrate, as the case may be, in taking possession of the secured assets from the borrower.
- If any person, including the borrower, is aggrieved by any of the measures adopted by the lender, he may prefer an appeal to the DRT within 45 days by depositing at least 75% of the claim of the lender. The decision of the DRT is further appealable to an Appellate Tribunal.
- The lender can initiate any proceedings to enforce the security interest unless his claim of the financial asset is made within the period prescribed under the Limitation Act, 1963.
Establishment of a Central Registry
The functions relating to securitization, asset reconstruction and creation of security interest is sought to be administered and regulated by a Central Registry. Branch offices of the Central Registry may be established as and when the need is required. A Central Registrar shall head the Registry. The functions of the Central Registry are as under:
- Particulars relating to securitization of assets, reconstruction of financial assets and creation of security interest are entered in a record called Central Register.
- The records can be kept in electronic form also i.e. in floppies, diskettes etc.
- The particulars of every transaction of securitization, asset reconstruction or creation of security interest shall be filed within 30 days of the transaction by SCO, RCO or the lender as the case may be.
- Modifications made in the security interest registered with the Registry are to be filed within 30 days of such modification.
- Satisfaction of security interest is required to be filed with the Registry within 30 days of satisfaction.
- Records maintained at the Central Registry are open to inspection for any person on payment of the prescribed fee.
Important Rulings under SARFAESI
- Mardia chemicals Ltd Vs Union of India
- The Supreme Court had decided that the SARFAESI Act had the constitution validity.
- M/s. Dr. P.B’s Health & Glow Clinic Ltd. & Ors Vs Oriental Bank Of Commerce The High Court at Calcutta Civil Revisional Jurisdiction, held that notice issued under Section 13(2) of the 2002 Act was duly tendered to the Petitioners. When the persons under occupation of the premises/property refused the notice, the same was affixed on the conspicuous part of the said premises. Therefore, the notice was duly served in presence of the occupiers of the secured assets.
- Deepthi Trading Company Vs The Authorized Officer
- The High Court of Madras held that once the Tribunal found that it had no jurisdiction to entertain the SARFAESI Application, it is bound to return the papers and as such is not empowered to pass any order touching upon the merits of the case.
- The court further held that the period during which the case was before the Tribunal having no jurisdiction shall be excluded in view of Section 14 of the Limitation Act and also the Petitioner may seek adjustment of court fee paid in that Tribunal.
- Punjab National Bank Vs. Raju M. Thomas
- The guarantor is very much a ‘borrower’ as defined under Section2(f) of the Act
- Rule 8(6) of the Rules casts a duty on the Authorized Officer to serve a notice on the borrower about the proposed sale of the property at least 30 days ahead. Any failure to issue notice as stated above shall invalidate the sale.
- The DRT had no jurisdiction to interfere with the action taken by the secured creditor after the stage contemplated under S.13 (4) of the Act. On the other hand, the law is otherwise and it contemplates that the action taken by a secured creditor in terms of S.13 (4) is open to scrutiny and cannot only be set aside but even the status quo ante can be restored by the DRT
- Kundanben Jaynatilal Sanghvi Vs. State Bank of Sourashtra
- The High Court dismissed the Writ holding the contentions of the Petitioner as wrongly construed and directed the Respondent Bank to also issue a fresh 13(2) Notice to the Petitioner who was in possession of the secured asset and passed directions to the Petitioner to approach the DRT under Section 17 of the Act.
- Vijay Laghu Udyog Vs. Punjab National Bank
- Act have remedy before the Debt Recovery Tribunal not before High Court
- In case any defaulter is sincere and ready to pay back the amount, there would hardly be any objection from the Bank to accept it. The petitioners can make a prayer to the Bank to accept the amount either in lump sum or in such installments as may be fixed by it.
Offences & Penalties
Following are the offences prescribed under the Securitization Act:
- Default in filing particulars of transactions relating to asset securitization, asset reconstruction and creation of security interest.
- Default in filing particulars of modification.
- Default in giving intimation of particulars satisfaction.
- Non-compliance of RBI directives by SCO and RCO.
- Contravention, including attempt to contravene and abetting in contravention, of any of the provisions of the Securitization Act or any rules made there under.
Following are the penalties prescribed in the Securitization Act:
- For default in filing particulars of transactions mentioned above, every company and every officer of the company or every lender or officer of the lender shall be punished with a fine which may extend to Rs.5000/- for every day during which the default continues.
- For non-compliance of RBI directives every company and every officer of the company shall be punished with a fine which may extend to Rs.5, 00,000/-; and for continuing offence an additional fine of Rs.10, 000/- for every day during which the default continues.
- For contravention of any provisions of the Securitization Act, the punishment is imprisonment for a term which may extend to one year, or with a fine, or with both.
Only a Metropolitan Magistrate or Judicial magistrate of the First Class has powers to take cognizance and try an offence under the Securitization Act.
The following are the general provisions of the Securitization Act:
- The matters, over which DRT or Appellate Tribunal has jurisdiction under this Securitization Act, shall not be tried by any Civil Court.
- The provisions of the Securitization Act shall override the provisions of other laws or any instruments.
- However the provisions of the Securitization Act are in addition to and not in derogation of the following enactments:
- The Companies Act, 2013.
- The Securities Contracts (Regulation) Act, 1956.
- The Securities and Exchange Board of India Act, 1992.
- The Recovery of Debts due to Banks and Financial Institutions Act, 1993.
- The Central Government has powers to make rules for carrying out the provisions of the Securitization Act.
- Since the Central Registry is not yet established, the provisions relating to the Central Registry shall be applicable after the setting up of the Central Registry.
Dilution of provisions of SICA
The protective umbrella of registering with BIFR under Sick Industrial Companies (Special Provisions) Act 1985(SICA), which has hitherto encouraged industrial sickness, has been removed by inserting two provisos in Section 15 of the SICA. They are as under:
- After the commencement of the Securitization Act, where any SCO or RCO has acquired financial assets, no reference shall be made to BIFR.
- After the commencement of the Securitization Act, any pending reference before BIFR shall come to an end where secured creditors, representing not less than 75% of the value of the amount outstanding, have taken any measures to recover their secured debts under the provisions of the Securitization Act.
The following transactions are exempted from the provisions of the Securitization Act:
- Lien on any goods, money or securities given under the Contract Act, 1872.
- Pledge of movables under the Contract Act, 1872.
- Creation of security on aircraft.
- Creation of security interest on vessel.
- Conditional sale, hire-purchase or lease in which no security interest is created.
- Rights of unpaid seller under the Sale of Goods Act, 1930.
- Non attachable properties under the civil Procedure Code.
- Security interest on an amount less than or equal to Rs.1 Lakh.
- Security interest created on agricultural land.
- Amount due is less than 20% of the principal sum and interest thereon.