Explained: SARFAESI Act

Reading time: 8-10 minutes.

 “The object of the law of insolvency is to seize the property of an insolvent before he can squander it and distribute it amongst his creditors. It is however not every debtor who has borrowed beyond his assets or even one whose property is attached in execution of his debts, who can be subjected to such control. The jurisdiction of the court commences when certain acts take place which are known as acts of insolvency and which can give a right to his creditor to apply to the court for his adjudication as an investment.”

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) is a piece of one such legislation that focuses on strengthening the rights of the secured creditors against the defaulting debtors. It was enacted after the recommendations of Narashiman Committee-I and introspecting Committee under Andhyarujna, in replacement of the existing Recovery of Debts due to Banks and Financial Institution Act, 1993.

Supreme Court, in the matter of Mardia Chemicals Ltd. Vs. Union of India, declared the notable verdict of the constitutional validity of the SARFAESI Act, 2002 and allowed the borrowers to appeal against the lenders in the Debt Recovery Tribunal (DRT), without depositing 75% of the debt amount and if the tribunal does not issue a stay order, the lender may sell the assets.

Moving a step ahead, a five judge constitution bench of the Supreme Court of India comprising of Justice Indira Banerjee, Justice Vineet Saran, Justice MR Shah, Justice Aniruddha Bose and headed by Justice Arun Mishra, in Pandurang Ganpati Chaugule and Others v. Vishwarao Patil Murgud Sahakari Bank Ltd., 0had recently effectuated that the Cooperative Banks established by the Cooperative societies to be recognised as Banks under the SARFAESI Act, 2002.

Significance of the development:

“When we apply the provisions of section 5(c) to the co-operative Banks, we have to read the co-operative banks as part and parcel of said definition as mandated statutorily. In case a company is not taken as a reference to the co-operative societies/banks in section 5(c), several problems as to the interpretation of section 56 would arise. It would have become necessary to amend all the provisions whenever words ‘banking company’ occur in the Banking Regulation Act, 1949 in the application to co-operative banks.”

This judgement has caused the state and multi- state co-operative banks to seize and sell the assets of the defaulters to recover their dues, like any other banks under the SARFAESI Act, 2002. The main motive of the Apex Court is to remove the delays caused to the banks established by the Cooperative societies due to the intervention of courts or summary procedures under the Cooperative Societies Act as the process of recovery of loans due is an essential part of any banking system.

Salient features of the Act:

Under the SARFAESI Act, 2002 the creditors are conferred with the right to seize the secured asset and sell off the same in order to recover dues promptly by passing the costly and very time-consuming legal process through courts.

This procedural law and retrospective in effect, established the concept of Asset Reconstruction Company (ARC), letting the banks to sell their Non- Performing Assets (NPA) to the ARC. The first Asset Reconstruction Company of India, ARCIL, was set up under this Act. The Act is an effective tool for the recovery of NPA and is effective and against the secured loans.

Mentioned below are the salient features of the Act, which tries to:

  • securitise the financial assets (securitisation)
  • Fund the securitisation
  • Incorporate companies as SCO (Securitisation Company) and RCO (Reconstruction Company)
  • Enforce Security interest by the secured creditor (without court intervention)
  • Act as an agent of banks
  • Reconstruct the financial assets
  • Establish Central Registry
  • Prescribe penalties for offences/ non- compliance of rules

Unlike many legislations, the SARFAESI Act, 2002 provides the bank the right to resort to action under section 13(4) of the Act during the pendency of the civil suit. The Act further renders remedy of appeal against the actions relating to recovery of loans dues.

Objective and purpose of the Act:

One key factor that has rapidly progressed India’s economy is the efforts of Financial sector. Despite the Indian banks and financial institutions keeping pace with the international practices and norms, there was lacunae persisting in certain areas. The areas of concern included the lack of power with Financial institutions to recover the defaulting loans.

Thus, the SARFAESI Act, 2002 was enacted after detailed perusal, enabling the banks and financial institutions to overcome the problems over liquidity, long term assets, increasing NPAs and delay in recovery of loans (reconstruction).

Critical analysis:

The whole purpose of enactment of the SARFAESI Act was to remove the time delay caused to the Banks for the recovery of loans. It is considered as an essential function of the banking system and an improper delay caused to such actions cannot be encouraged. Thus, the banks wished to reduce their NPAs through faster recovery. Since the previously enacted law namely the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, failed to satisfy the agenda of the enactment leading to a replacement. Hence the SARFAESI Act, 2002 came into existence.

Though, initially few apprehensions over the utility of this legislation prevailed, various judicial pronouncements have influenced a better understanding over the same.

  • The Supreme Court, in the case of Karnataka State Financial Corporation vs. N. Narasimahaiah, has rightly highlighted the significance of the constitutional right to property. Thereby, guiding both the creditors and lenders on the necessity of the property mortgaged to the bank.
  • The Supreme Court of India upheld the SARFAESI Act, 2002 to be constitutionally valid except for the provision under section 17(2) of the Act, 2002, as it was Ultra vires the Article 14 of the Indian Constitution.
  • The Ministry of Finance vide notification dated 24.02.2020 considered Non – Banking Financial Companies (NBFCs) having assets worth Rs. 100 Crore and above, to be entitled for enforcement of security interest in secured debts of Rs. 50 Lakhs and above, similar to that of financial institutions for the purposes of the SARFAESI Act, 2002.
  • The various Crisis faced by the Co-operative Banks of Punjab, Maharastra and other co-operative banks exposed the vulnerable nature of the Co-operative Banks. With regard to this, in the matters of Pandurang Ganapathi Chaugule vs. Vishwasrao Patil Murugud Sahakari Bank Limited the Supreme Court of India has established the following outcomes:
  • Co-operative Banks established under both the state and multi- state level co-operative societies are recognised under section 2(1)(c) of SARFAESI Act, 2002, thus allowing the secured creditors to take possession of assets of defaulting borrower(s) within 60 days from demand for repayment, as per section 13 of the Act, 2002.
  • Co-operative Banks are bound by the provisions of legislations that are relatable to Entry 45 of List I of the Seventh Schedule such as the Banking Regulation Act, 1949 and other legislations that the banks are generally governed as under the Reserve Bank of India Act. Thus, the co-operative banks are considered under the definition of ‘banking’.
  • The Activities of Co-operative Banks are explained in Entries 45 and 38 of List I of the seventh schedule and are covered within the meaning of ‘banking company’ defined u/s 5(c) read with section 56(a) of the Banking Regulation Act, 1949 for the purpose of determining the activities of such banks.
  • The process of ‘incorporation, regulation and winding up’ of the co-operative banks are also dealt under the Entry 32 of List II of the Seventh Schedule.
  • The power of Parliament to enact law, in order to provide the Banks with the recovery procedures for speedy recovery of dues without the court’s intervention, is upheld.
  • Thereby, the Apex court upheld the 2003 Government notification, which allowed the banks to recover the dues from the defaulters through the prescribed recovery procedures u/s 13 of the SARFAESI Act, 2002 without the intervention of court/ tribunal.

Conclusion:

Various developments in SARFAESI Act, 2002 is witnessed in the recent years to fulfil the criteria of the legislation. The Judiciary has always helped to keep the doubts away from interpretation of legislative provisions. Thus, the new development in the scope SARFAESI Act, 2002 is the necessity that has been rightly upheld by the Supreme Court. The SARFAESI Act, 2002 being an important Act for the betterment of country’s economy, widening its scope is felt to be an essential step to strengthen the financial institutions of the country.

Author: T.K.Vaishnavvi from School Of Excellence In Law, TNDALU, Chennai.

Editor: Dhawal Srivastava from Rajiv Gandhi National University of Law, Patiala.

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