SARFAESI ACT 2002

Introduction

SARFAESI ACT STANDS FOR “Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act”. Main aim of this act was to increase the capability of banks and non-banking organisations to liquidize the loan securities in case of non-repayment of loans. The act does so by two major steps , first, minimising the involvement of the court in such cases, prior to this act in case of non-repayment of loans a civil suit was filed this not only increased the time period for the liquidation sometimes also lead to complete failure. The second revolutionary step was by creating an entity called asset reconstruction company (ARCs) the aim of these companies was to take over the NPAs from the bank or non-banking organization (lender) and sell it to interested buyers hence assisting in the dissolution of NPAs.

According to a report by RBI, the NPAs of public sector banks increased from rupees 39584 cr in 1996 to rupees 53294 cr in  year 2000, which is more than a 130 % increase in just the span of 4 years. Now the question arises what are NPAs . NPA stands for non-performing assets . RBI defines NPA as an asset becomes non performing when it ceases to generate income for the bank, in respect to loans, interest and/or instalments of the principal remain overdue for a period of more than 90 days. Now these NPAs are a huge burden to the bank’s balance sheets as they not only reduce the cash flow but also reduce the capital available for future loans.

SARFAESI act was introduced on the recommendation of Narsimham committee II in 1998. After the liberalization in 1990, funds from IMF and world banks flowed but these didn’t result in the growth expected on a further evaluation it was observed that the banks in the nation were laden with NPAs which were a hurdle in any form of economics growth most of these NPAs were in fact created by the big industrialist borrowers. Initially Debt recovery tribunals (DRTs) were established but they needed to be strengthened hence this act was brought into existence.

SAFAESI Act 2002 , does its function by two routes

  1. Reducing the involvement of court in the recovery of loans- initially loan recovery was done by filing of a civil suit, which provided a 90-day buffer to the debtors, moreover delaying techniques were often used in other to prevent the repayment and/or recovery of the loan.

Now this act provides a new course of action in order to first declare a loan NPA and then to expedite  it.

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Sarfasi Act

The process is as follows

  • Identification of Default: this occurs when the borrower fails to pay the instalment , principle or interest on the agreed upon date or in the predecided time period.
  • 90 Days Overdue: as per the guidelines of RBI , a bank must wait for 90 days before declaring a loan as an NPA.
  • Asset Classification: Banks and financial institutions classify their assets based on the criteria mentioned in the RBI guidelines. The asset classification includes Standard Assets, Substandard Assets, Doubtful Assets, and Loss Assets.
  • Reporting to Credit Information Companies: Banks are required to report the borrower’s default information to credit information companies like CIBIL, which maintains credit records of individuals and entities.
  • Declaration as NPA: after the period of 90 days a loan is finally declared an NPA
  • Notice to Borrower: The Act does not provide giving notice to the borrower before initiating any action under this section. However, considering a Supreme Court ruling in the Swadeshi Cotton Mills vs Union of India (AIR 1981 SC 818), a hearing at pre-decisional stage must be given before resorting to any action. The said ruling is under a different law but on similar powers of taking over of the undertaking by the Central Government. The same principle laid down in the said case, will apply to these actions. Therefore, before taking action, notice to the borrower will be required to be given.
  • Response from borrower: the borrower is supposed to respond to the notice either by payment of instalment or object to the notice
  • Recovery of dues and balance the payments : the act provides the lender with the right to sell or transfer the property (security) for recovery of loan.

Although the act reduces the involvement of the court there are still certain conditions under with the court might get involved:

  1. The security is an agricultural land
  2. The security property has another legal dispute over it.
  3. Misreprentation by the borrower
  4. Absence of mortgage or pledge during the loan process.

2.Establishment of Asset reconstruction companies (ARC) :

described in the section 2 of sarfaesi act 2002 defines asset reconstruction companies as asset a company registered with reserve bank of India under section 3 in order to conduct asset reconstruction or securitisation or both while section 3 defines the entire workup and registration process of the same arcs are specialized monetary organization that purchases the bad loans the NPAs from the banks these can be state owned or private these companies let the banks focus on their primary works rather than focusing on the liquidation of the NPAs ARCs take away the NPAs and auction of the securities attached to the loans to interested buyers hence recovering the loan amounts these companies pay the bank the cash so that the bank can clear up its balance sheets and show the increased cash flow without going through the hassle of auctions arcs can only take up the loans that have gone through the entire process mentioned above and have been officially declared as an NPA a few of the existing arcs in India which are being monitors and governed by the reserve bank of india include asset reconstruction company india limited arcil asrec india limited reliance asset reconstruction company limited India some asset reconstruction company limited ISARC international asset reconstruction company private limited etc there are two conditions a company needs to fulfil in order to register under this act by the rbi a obtaining a certificate of registration granted by the rbi mentioned in section 3 b having net owned fund of at least two crore rupees if higher the reserve bank may specify this amount can vary in case of different types of arcs enactments that govern asset reconstruction companies are 1the companies act 1956 2013 2banking regulation act 1949 3 sarfaesi act 2002 4the small industries development bank of India act 1989 5 national housing bank act 1987 state financial corporations act 1951 recovery of debts due to banks and financial institutions act 1993 6 code of civil procedure 1908

Conclusion

Post liberalisation, Indian economy was trying to bloom but this wasn’t without hurdles. One of the hurdles was the non performing assents for different banking and non-banking institutions this problem was recognised by the Narsimham  committee and a debt recovery tribunal system was established. However, later on it was observed that the tribunal needed more power a better and stronger law as its backbone that’s when the SARFAESI Act of 2002 came into existence. This act helped the system by reducing court involvement and lowering the burden of the banks by creation of asset reconstruction companies.

Author: Saumya Singh, in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at  Khurana & Khurana, Advocates and IP Attorney.

References

  1. SARFAESI Act 2002 (bare act)
  2. https://m.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=3478
  3. https://www.indiacode.nic.in/handle/123456789/2006

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