More institutions to enjoy powers to enforce security

“Banks and financial institutions at present face considerable difficulties in recovery of dues from the clients and enforcement of security charged to them due to the delays in the legal processes.”

Taking into account the above observation of the Narasimham Committee, the legislature enacted the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (RDDB Act), providing for the establishment of tribunals for expeditious adjudication and recovery of debts. However, banks and financial institutions still did not have the power to take possession of secured assets and sell them. Observing that this lack of power resulted in a slow pace of recovery of defaulting loans, the legislature enacted the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act).

Scope of SARFAESI Act

The SARFAESI Act enables banks and certain financial institutions to take possession of the secured assets of the borrower, take over the management of the borrower’s business and appoint persons to manage the borrower’s secured assets thereby providing them with an effective means for enforcement of security without the intervention of courts.

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While the intent and the provisions of the SARFAESI Act are sensible, the SARFAESI Act initially applied to only banks and certain specified financial institutions. This led to non-banking financial companies (NBFCs) falling out of the ambit of the SARFAESI Act, unless the NBFC was: (i) a public financial institution within the meaning of section 4 of the Companies Act, 1956; or (ii) an institution notified by the central government under section 2(h)(ii) of the RDDB Act; or (iii) an NBFC notified as a “financial institution” for the purposes of the SARFAESI Act.

Difficulties faced

As a result of the above provisions, many NBFCs were unable to enjoy the benefits under the SARFAESI Act. With a view to seek speedy enforcement of security, NBFCs usually adopt arbitration as a means of dispute resolution. However, this would not help much since the Supreme Court clearly laid down in the case of Booz Allen and Hamilton Inc v SBI Home Finance Ltd and Others that a suit for sale, foreclosure or redemption of a mortgaged property, being the enforcement of a right in rem, can only be tried by a public forum and not by an arbitral tribunal.

The other problems faced by NBFCs are: (i) difficulties in selling down their loans; (ii) difficulties in buying bank loans, since arbitration provisions would have to be inserted in the loan documents, which would be vehemently opposed by banks; and (iii) general issues in enforcement. Not being on the same footing as banks adversely affected NBFCs in the corporate debt restructuring or joint lenders’ forum mechanisms.

Taking the above issues into consideration, the Working Group on the Issues and Concerns in the NBFC Sector suggested that NBFCs could be given the benefits under the SARFAESI Act, considering that their clients (borrowers) may be similar to those of banks.

Recent developments

Almost four years after the report of the working group, the minister of finance in his recent budget speech announced that NBFCs registered with the Reserve Bank of India and having an asset size of ₹5 billion (US$80 million) and above would be considered for notification as a “financial institution” under section 2(m)(iv) of the SARFAESI Act. This proposed notification would give NBFCs with the specified asset size the much needed teeth to enforce security. However, one would need to wait to see how the proposed notification would be implemented.

The key issue would be whether the notified NBFCs could resort to the SARFAESI Act for loans advanced before the enforcement of the proposed notification. Andhra Pradesh High Court in the case of Deccan Chronicles Holdings Ltd and Ors v Union of India observed that the SARFAESI Act could not be permitted to govern transactions which were outside its purview when they were made. However, Orissa High Court in the case of Sarthak Builders Private Limited v Orissa Rural Development Corporation Limited and others said that as soon as a financial institution is notified for purposes of section 2(m) of the SARFAESI Act, the SARFAESI Act’s machinery would become available to recover any outstanding and legally recoverable debt even if the loan was advanced earlier.

Access to the SARFAESI Act has been an effective tool for recovery of loans and would help NBFCs in maintaining their accounts as standard. In the long run, this move could play a major role in curbing the rise of bad loans in the Indian economy.

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Babu Sivaprakasam is a partner, Deep Roy is an associate partner and Megha Agarwal is an associate at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.