SARFAESI Act, 2002 in Layman Words [Refer Text Book after reading this Chapter]

What is NPA?
Bank gives loan to a person.
Person fails to make regular payments.
Bank gives him notice to correct his behavior. But he doesnt.
Bank declares that loan as Non-Performing Asset (NPA) (=Bad Loan)
Currently Indian banks have NPAs worth more than Rs. 1 lakh crores.

Debt Recovery tribunals?

Prior to 90s, banks had very hard time recovering bad loans.
Because often, borrowers (loan takers) would file frivolous cases in civil courts, then taarikh pe taarikh, taarikh pe
taarikh.. proceeding would go on for years.
So 1993, Government established Debt Recovery Tribunals to deal with NPA matters.
Now borrower cannot approach civil court, theyve to go to special Debt Recovery Tribunal (DRT).
This led to some relief, but then DRTs clogged down by truckload of cases.

What is the SARFAESI Act and what is its basic mechanism?

Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002,
Suppose, Mr. PJ has opened factory with Rs.100 crores. He financed this, via mixture of Debt + equity in following way.

Equity (IPO->Shares)
Debt (loans, Bonds)

Total

Holder

Rupees in Cr.

PJ and his family

20

Juntaa (public)

30

Business loan from SBI

40

Bonds

10
100

Initially the company runs well and good.

But after some time then his company starts making losses and he fails to pay loan EMIs for many months.
SBI gives him 60 days notice to correct his behavior.
Still, he doesnt start paying money.
SBI declares this Rs. 40 crores loan NPA (Non-Performing Asset).
Once a loan is declared as non-performing asset, SBI can take actions under SARFAESI act, to recover the loan money.
Bank has following powers under SARFAESI Act:
1.
After sending 60 days notice to repay the loan if such notice remained un-responded, then Bank can take possession of Mr.
PJs assets without requiring court order (Commercial or residential, fixed or moving assets.)
2.
Auction / Sale them.
3.
Change the administration/ Management of those assets. [In case it had been PJ (P) Limited, then the expelled directors not
entitled to any compensation, Winding up petition cannot be filed without SBI permission]
4.
If Mr. PJ had sold away the mortgaged asset to third party Mr. X, bank can order Mr. X to surrender that Asset.
5.
If Mr. X owes money to Mr. PJ, then he can be ordered to pay money.
6.
If more than one Banks are the creditors, then action decided by 60% of value of creditors shall be taken
Appeal structure in SARFAESI Act?

The borrower (loan taker) has following options:

Get a stay order from Debt Recovery tribunal (DRT) against the auction/sale of his properties. (He cannot file case in Civil
courts.)

Fight the case in DRT.

If unhappy with DRT verdict, he can appeal to Debt Recovery Appellate Tribunal (DRAT).
Bank: Power to Auction

First SBI contacts the experts, gets valuation of Mr. PJs assets.
Expert says those assets are worth Rs.50 crores according to present market value of land/ building/ machinery whatever.
Then SBI will give advertisement in newspapers we are auctioning xyz land/ machinery/ building. Minimum bidding amount is
Rs. 50 crores. Whoever wishes to bid, send us application along with Rs.50,000 as deposit, and their other documents, etc.

Problem: sometimes, bidders do not take interest in buying such properties, factories etc.
To fix this problem, SARFESI has a provision: if no one else comes to bid in the auction, Bank itself can buy that property.

Here comes the new problem:

Suppose SBI attached a warehouse of Mr. PJ.

If the land was in good urban area, SBI could open a new branch office there (or housing for its employees).
But if plot/factory/house is in some remote area = useless for SBIs personal business.
Under the Banking regulation Act, a bank cannot keep such immovable property beyond 7 years, (max 12 years with RBIs
permission).
So ultimately SBI will have to auction it to someone.

What is ARC?
Asset reconstruction company (ARC).
They buy NPA (Bad loans) from Banks and try to extract maximum money out of it = profit.
Theyve to register with Reserve Bank of India.
Examples:
1.
ARCIL (Indias first and largest asset reconstruction company (ARC))
2.
Reliance Asset Reconstruction Company Limited by Anil Ambani

In our example, SBI has NPA worth Rs.40 crores.

ARC will buy the NPA file from SBI at a lower rate say 35 crores. (well, SBI is making loss, yes, but something is better than
nothing.)

Besides, banks have hundreds of bad loan cases, they donot have time or manpower to pursue individual case, sometimes no
bidders are interested in auction. In such cases, its better for bank to transfer NPA to ARC.

But that doesnt mean ARC will give 35 crores to the SBI from its own pocket!

Then how will the Asset reconstruction company (ARC) arrange for the money? = via Security Receipts.

What are Security Receipts (SR)?

In above example, ARC needs Rs.35 crores to buy a Non performing asset from SBI.
So ARC will issue security receipts (SR) worth Rs.35 crores.
Only Qualified Institutional buyers (QIB) can buy these security receipts (SR).
SR are not bonds, they donot carry fixed interest rate.
ARC will promise to pay money on SR, when it gets money the bad loan.
Although, ARC usually promise 9% profit on SR. If ARC fails then decision taken by atleast 75% of QIBs is binding on ARC.
Disputes arising in between in the parties involved to be solved as per Arbitration and Conciliation Act, 1996

Qualified institutional buyers (QIB) buy those security receipts (SR). So Rs.35 cr. cash goes from QIB -> ARC -> SBI.
ARCs aim = extract maximum money out of this investment. But how = ARC will have one or more of the following options:
1.
Auction the assets fully or partially (i.e. sell the machinery now, rent the building and wait for land prices to go up for two years
and then sell it)
2.
Sell the property in combination with other NPA properties of other defaulters (similar to buy one large pizza and get 20%
discount on any medium sized pizzas).
3.
Restructure the EMIs of Mr. PJ. For example, instead of 1 lakh per month, give us 75,000 per month.
4.
Change the Management of that asset, i.e., appoint its own directors/officers. [In case it had been PJ (P) Limited, then the
expelled directors not entitled to any compensation, Winding up petition cannot be filed without ARC permission]
5.
Order Mr. PJ to outsource or lease his business to another company.

Central Registry

Previously, borrowers used to forged property documents and get loans from multiple banks by giving them duplicate property
documents as security. So when borrower refuses to pay up loan, many banks would make claim for the same property!
To fix this problem, Reserve Bank of India (RBI) setup Central Registry in 2011, under SARFAESI.
This central registry has details of all properties against which loans have been taken.
Any person or bank can inspect records of this registry to make sure the mortgaged property is genuine.

Non applicability of the SARFAESI Act

Agricultural Land;
Amount Due < 20% [Principal (+) Interest thereon]
Other Specified Cases [Refer Text Book]