Author: Nishica Srivastava, a student at Amity University
INTRODUCTION
Debt recovery refers to the process where the creditor retrieves the money lent to the debtor which may be in various forms including loans, bonds, instruments and which may be secured or unsecured.
The legal mechanism for debt recovery by financial institutions and banks after independence was flawed and required a lot of amendments. Financial institutions did not possess any power recover loans and often had to take recourse to the legal route against the defaulters. The time wasted in obtaining decrees against the defaulters and then execution of the same squandered a substantial amount of time. Consequently, the banks and financial institutions were heavily burdened by the sheer volume of bad loans and non-performing assets. A sizable portion of their funds was obstructed by unproductive assets, which were often depreciating in nature.
The situation was detrimental to the growth of the Indian economy and could not afford to see a stagnation. The government, taking cognizance of the situation, appointed various committees to study the situation to identity the problem areas and recommend measures to rectify and improve the then-existing framework.
In 1981, a committee was constituted under Shri T. Tiwari to examine the difficulties faced by financial institutions. The Committee, inter alia, had suggested remedial legal changes and additionally, the setting up of Tribunals to deal with suits for recovery of debts due to financial. This point was reiterated in the report of the Narasimham Committee or the Committee on the Financial System (1991) which under the chairmanship of Shri M Narasimham had recommended the establishment of specialized Tribunals for adjudication of such matters and fast recovery of the dues. Eventually, the Recovery of Debts due to Banks and Financial Institutions Act, 1993 was enacted which provided for the setting up of Debt Recovery Tribunal and Debt Recovery Appellate Tribunal. However, this specialized system did not prove to be of much use as it, too, was soon overburdened by the huge number of cases referred to them.
Then the Central Government constituted the Narasimham Committee II and the Andhyarujina Committee to evaluate the situation and suggest measures to alleviate the issues and difficulties faced by the banks and financial institutions. Both Committees in their respective reports suggested the need for a radical legislation which would empower banks to take possession of the securities and sell them without the intervention of the judiciary. In 2002, the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests (SARFAESI) Act was enacted in accordance with the suggested reforms.
The primary object of this statute was to provide financial institutions with the power to recover non-performing assets themselves by seizing possession and selling off or auctioning the concerned asset, without the need to approach the courts. The main object is to facilitate the timely recovery of debts and to reduce the level of non-performing assets in the banking sector, thereby improving the overall health and stability of the financial institutions. The constitutionality of the SARFAESI Act was challenged in the case of Mardia Chemicals Ltd v Union of India (AIR 2004). The Apex Court in this case ruled that the Act certainly put one party in a favourable position, however that could not solely operate as the ground for unconstitutionality.
The Act removes the fetters on the rights of banks and financial institutions to recover debts and provides for securitization, asset reconstruction and enforcement of security interests. Under this Act, the secured creditors, i.e, banks and financial institutions can avail of two methods to recover their dues.
- Securitization
- Reconstruction Method
- Recovery Method
SECURITIZATION
As per Section 2(1)(z) of the SARFAESI Act, securitization refers to the process of acquisition of financial assets by an asset reconstruction company from any originator, either by raising funds from qualified buyers by issuing security receipts, in exchange, representing an undivided interest in the financial assets or any other method. In other words, securitization is the process whereby the loss-making financial assets of any financial institution or secured creditor is acquired by an asset reconstruction company (ARC). The funds for such acquisition may be raised through qualified buyers which include other banks, financial companies, insurance companies etc. by issuing security receipts in return which signifies that the buyer holds an undivided interest over the concerned asset.
Thus, securitization is essentially a method through which assets are converted into investable securities. This process is very beneficial as it enables non-performing assets to become useful assets which generate profit. The qualified buyers can be said to the investors in the asset. Through this process, the originator or financial institutions can sell off the asset to asset reconstruction companies and can remove the bad debt from their books, thereby improving their records. The asset reconstruction companies raise funds to purchase such bad assets from originators from qualified institutional buyers or investors who in turn receive an undivided interest in the asset. Section 5 of the Act provides for the acquisition of interest in financial assets. It states that such interest may be acquired either:
(a) through the issue of a debenture, bond or any other security similar in nature to a debenture, for a consideration agreed upon between the asset reconstruction company and originator
(b) through an agreement with the originator for the transfer of such financial assets to the asset reconstruction company on agreed terms and conditions.
This section also provides for the substitution of the asset reconstruction company in the place of the originator in connection with the rights and obligations towards the financial assets of the debtor. On acquisition it shall be assumed that all rights, duties, interests, obligations, instruments like power of attorney shall be in force in favour or against the asset reconstruction company, instead of the originator as though it had been issued against it in the first place.
RECONSTRUCTION METHOD
As per Section 2(1)(b) of the Act, asset reconstruction means acquisition by any asset reconstruction company of any right or interest of any bank or financial institution in any financial asset for the purpose of realisation of such financial asset. The asset reconstruction company acquires the possession of the asset and employs any of the methods provided under section 9 of the Act for the purpose of reconstruction which are as follows:-
(a) proper management of the business of the debtor by either changing the management or taking over the same.
(b) sale or lease of the whole or part of the business of the debtor
(c) rescheduling the payment of debts payable by the debtor
(d) enforcement of security interest
(e) settling dues payable by the debtor
(f) taking possession of secured assets
(g) conversion into shares of a borrower company of any portion of the debt
RECOVERY METHOD
Recovery method entails the enforcement of security interest by the secured creditor itself. Section 13 of the Act governs enforcement of security interest. It allows the banks and financial institutions to issue a notice to the defaulter, whose account has been classified as non-performing assets to repay his full liability within 60 days from date of receipt. If he fails to do so, the secured creditor shall be entitled to exercise any or all of the rights mentioned under Section 13(4). The rights available under Section 13(4) are:
a) acquiring possession of the debtor’s secured assets
(b) taking over the management of the debtor’s business
(c) appointing a person for the management of the secured assets the possession of which has been seized by the secured creditor
(d) require any person, through a notice in writing, who has acquired possession of any secured assets from the borrower and from whom any money is due to the borrower, to pay the secured creditor an amount which would be sufficient to repay the debt
This method allows banks and financial institutions to take the necessary steps to recover loans due to them. It is a significant shift from the earlier system where only courts had the power and authority to do so.
However, if even after selling off the asset, the dues of the secured creditor have not been met, Section 13(10) provides that an application for fulfilment of the same can be filed before the appropriate Debt Recovery Tribunal.
CONCLUSION
The SARFAESI Act has undoubtedly brought about a much-needed change in the debt recovery mechanism prevailing in India. The unique and diverse methods of recovery of dues by financial institutions is provided with the intention of expediting the entire process of recovery and enabling assets to generate profits again instead of lying stagnant.
Understanding the various methods of recovery is imperative for both creditors as well as debtors as the Act not only provides the framework for recovery but also demarcates the rights and remedies available to the borrowers. Thus, SARFAESI contributes heavily to the improvement of the banking sector and creates a more transparent and accountable debt recovery mechanism in India.
