BANKING LAW AND PRACTICE

Question 1: Explain whether SARFAESI Act 2002 is applicable to all NBFCs or not. Is there
a threshold for applicability of SARFAESI Act on NBFCs? Also state whether the NBFCs can
avoid SARFAESI Act and enforce security interest under common law principles.

Answer: No, All NBFC’s are not covered Under SARFAESI ACT 2002 As Explained:

The primary objective of enacting the Securitization and Reconstruction of Financial Assets and
Enforcement of Securities Interest Act, 2002 (or the SARFAESI Act) was to empower the
financial institutions by identifying and remedying the problem of non-performing assets
(NPA) by providing efficient solutions such as recovery of NPA without intervention of courts.
Although from the time of its enactment the Act did recognize non-banking financial companies
(NBFCs) as coming under the ambit of ‘financial institutions’, it required the Central
Government to pass a notification stating the same. The need for such a notification was felt by
the Central Government almost thirteen years after the Act came into force, when it was stated
by the then Finance Minister of India, Mr. Arun Jaitley, in his 2015 budget speech.

 This announcement comes after the budget announcement in the year 2015-16; it has allowed the
applicability of SARFAESI to certain NBFC’s SARFAESI Act is a legislation that helps financial
institutions to ensure asset quality in many ways. It mainly helps in addressing the problem of Non-
performing assets.

 SARFAESI act gives power to banks and financial institutions to take over the immovable property
that is hypothecated or charged to enforce the recovery of debt.

 SARFAESI act declares Loan as a non-paying asset (NPA) only when the installment on principle is
due for more than 90 days or more. SARFAESI act is applicable on loans greater than ten lakhs
only.

The Ministry of Finance vide its notification dated 24th February, 2020, in exercise of its
powers under section 2(1)(m)(iv) of the SARFAESI Act, notified NBFCs having asset size of Rs.
100 crores or more (‘eligible NBFCs’) as financial institution for the purpose of SARFAESI Act,
for enforcement of security interest on debts amounting to at least Rs. 50 lacs.
 In this regard, following are the cases of applicability/inapplicability of SARFAESI Act to
NBFCs.

NBFC’s which are covered by the SARFAESI Act are:

 196 NBFCs which are notified by The Ministry of Finance on 5th August 2016
 An NBFC having asset size of Rs. 100 crores or more, and the amount of debt less
than Rs. 50 lacs: The NBFC is eligible to be considered as a financial institution under
SARFAESI Act. However, security interest on the particular debt which amounts to less
than Rs. 50 lacs, cannot be enforced. Further, security interest on other debts of the same
NBFC, which amount to Rs. 50 lacs or more, may be enforced.
 An NBFC having an asset size of less than Rs. 100 crores and the amount of debt is
more than Rs. 50 lacs: The NBFC is not eligible to be classified as a financial institution
under the SARFAESI Act. Thus, security interest on any of the debts of such NBFC
cannot be enforced, irrespective of the amount of debt.
 An NBFC having an asset size of Rs. 100 crores or more and the amount of debt is
more than Rs. 50 lacs: The NBFC is a financial institution under SARFAESI Act and
the amount of debt is above the benchmark of Rs. 50 lacs. Thus, the NBFC can enforce
security interest on such debt.

Power of NBFC’s and Banks under SARFAESI act

 Take possession of the assets which are hypothecated.

 to sell the assets which have been hypothecated; If the borrower has already sold
the asset to a third party, the third party can be ordered to surrender the asset.

With the significant changes that favor SARFESI act by 2016 amendment bill, the NBFC companies are
also brought up to the power of banks. These changes have been implemented to 196 companies in total,
which are systematically important Non-Banking Financial Company.

After almost eighteen months, the Central Government passed a notification recognizing and
listing a total of 196 substantially important NBFCs, which were allowed to take benefit of the
provisions of the SARFAESI Act. The notification also listed certain conditions to be fulfilled by
the NBFCs to come under the purview of the Act. The NBFCs should be:
 Covered under clause (f) of section 45-I of the Reserve Bank of India Act (or the RBI Act),
1934, which defines ‘NBFCs’
 Registered with RBI;
 Having assets worth rupees five hundred crore and above as per their last audited balance
sheet.

In addition to this, the notification also highlighted that only those NBFCs with “such security
interest which is obtained for securing repayment of secured debt with principal amount of
rupees one crore and above” will be allowed to make use of sections 13 to 19 of the SARFAESI
Act, which are of utmost importance when it comes to recovery of loan arrears.

Threshold Criteria for Coverage of NBFCs under the SARFAESI

Act :
The SARFAESI Act does not examine the NBFCs for being covered, on the basis of Deposit
taking and Non-Deposit taking. Rather, it looks into the following points of concern:

1. The NBFCs shall possess a valid Certificate of Registration (CoR) under Section 45-I of
the Reserve Bank of India Act, 1934;
2. The concerned NBFC shall have net assets of INR 500 crores or more as per the latest
Audited Balance Sheet.
3. The amount of debt and the value of security created in favor of NBFCs for the amount
of debt shall not be less than INR 1 crore.

The threshold for the applicability of SARFAESI Act on NBFCs

 As per the notification, the covered NBFCs are allowed to enforce their security interest only
in the cases where the interest in the security has been cast to secure financial assistance
having a value of INR 1 crore or more. On the contrary, apart from the NBFCs, the limit
prescribed for another category of secured creditors is only INR 1 lac.
 The rights under the SARFAESI Act is available even if the lender has initiated recovery
proceedings through other methods. Moreover, under any scenario, the Act does not bind the
lender to take resort only through the SARFAESI Act, when it seems easier for the lender to
use other frameworks for the recovery proceedings. For instance, for movable properties, it is
convenient for the NBFCs to take possession of the property rather than taking a resort under
the SARFAESI Act.
 On the other hand, it is a cumbersome process for the concerned NBFCs to take possession
of immovable properties under the common law. In this case, they can look out for protection
under the SARFAESI Act.
Yes, NBFCs can avoid SARFAESI Act and enforce security interest under common law
principles:
SARFAESI Act only provides a mode of enforcement of security interest and does not bind the
secured creditor to use nothing but SARFAESI Act. Therefore, NBFCs can avoid using
SARFAESI Act and enforce security interests under common law principles.
 For instance, it will be easier for the NBFCs to take possession of movable properties under
common law principles, hence, they can avoid taking the SARFAESI route in this regard.
 Again, enforcement of mortgages on immovable properties are cumbersome under the
common law principles, therefore, in this case powers of SARFAESI Act will be
comparatively beneficial for the NBFCs.

The term “security interest” has been defined in section 2(if) of the SARFAESI Act, 2002, as
amended by the Enforcement of Security Interest and Recovery of Debts Laws and
Miscellaneous Provisions (Amendment) Act, 2016 (Amendment Act). Broadly, it includes the
following:
(a) Where the property is tangible in nature:
i. Right, title or interest created on any property;
ii. Mortgage created under section 58 of the Transfer of Property Act, 1881 conferring the right
to the lender to sell the property on default;
iii. Charge created on immovable property under section 100 of the Transfer of Property Act,
1881;
iv. Hypothecation created on movable property – defined in section 2(1)(n) of the SARFAESI
Act, 2002 and includes all forms of security interest created on movable properties except by
virtue of which the possession is taken by the creditor, i.e., pledge;
v. Assignment of rights created for the purpose of creating a security and not for the purpose of
transferring.
vi. Right or interest created by way of financial lease, hire purchase or conditional sale – Though
from legal point of view, these are ownership interests, however, for the purpose of SARFAESI
Act, these have been recognized as security interests
(b) Where the property is intangible in nature:
i. Right, title or interest created on any property as security;
ii. Assignment of rights created for the purpose of creating a security and not for the purpose of
transferring;
iii. License created on any intangible property for security.
Question 2: What are the powers provided to the bank under the Securitisation
and Reconstruction of Financial Assets and Enforcement of Security Interest Act,
2002?
ANSWER: The Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002 (SARFAESI) empowers Banks / Financial Institutions to recover
their non-performing assets without the intervention of the Court. The Act provides three
alternative methods for recovery of non-performing assets, namely: -

 Securitisation
 Asset Reconstruction
 Enforcement of Security without the intervention of the Court

The provisions of this Act are applicable only for NPA loans with outstanding above Rs. 1.00
lac. NPA loan accounts where the amount is less than 20% of the principal and interest are not
eligible to be dealt with under this Act.

Non-performing assets should be backed by securities charged to the Bank by way of

hypothecation or mortgage or assignment. Security Interest by way of Lien, pledge, hire
purchase and lease not liable for attachment under sec.60 of CPC, are not covered under this Act

The Act empowers the Bank:

 To issue demand notice to the defaulting borrower and guarantor, calling upon them to
discharge their dues in full within 60 days from the date of the notice.
 To give notice to any person who has acquired any of the secured assets from the
borrower to surrender the same to the Bank.
 To ask any debtor of the borrower to pay any sum due or becoming due to the borrower.

Any Security Interest created over Agricultural Land cannot be proceeded with.

If on receipt of demand notice, the borrower makes any representation or raises any objection,
Authorised Officer shall consider such representation or objection carefully and if he comes to
the conclusion that such representation or objection is not acceptable or tenable, he shall
communicate the reasons for non-acceptance WITHIN ONE WEEK of receipt of such
representation or objection.
 A borrower / guarantor aggrieved by the action of the Bank can file an appeal with DRT and then
with DRAT, but not with any civil court. The borrower / guarantor has to deposit 50% of the
dues before an appeal with DRAT.
If the borrower fails to comply with the notice, the Bank may take recourse to one or more of the
following measures:

 Take possession of the security

 Sale or lease or assign the right over the security
 Manage the same or appoint any person to manage the same
 Rights of Borrowers
The above observations make it clear that the SAFAESI act was able to provide the effective
measures to the secured creditors to recover their long-standing dues from the Non-performing
assets, yet the rights of the borrowers could not be ignored, and have been duly incorporated in
the law.
 The borrowers can at any time before the sale is concluded, remit the dues and avoid
loosing the security.
 In case any unhealthy/illegal act is done by the Authorised Officer, he will be liable for
penal consequences.
 The borrowers will be entitled to get compensation for such acts.
 For redressing the grievances, the borrowers can approach firstly the DRT and thereafter
the DRAT in appeal. The limitation period is 45 days and 30 days respectively.

 Pre-conditions

The Act stipulates four conditions for enforcing the rights by a creditor.
 The debt is secured.
 The debt has been classified as an NPA by the banks.
 The outstanding dues are one lakh and above and more than 20% of the principal loan
amount and interest there on.
 The security to be enforced is not an Agricultural land.

 Methods of Recovery
According to this act, the registration and regulation of securitization companies or
reconstruction companies is done by RBI. These companies are authorized to raise funds by
issuing security receipts to qualified institutional buyers (QIBs), empowering banks and Fls to
take possession of securities given for financial assistance and sell or lease the same to take over
management in the event of default.
 This act makes provisions for two main methods of recovery of the NPAs as follows:

 Securitisation: Securitisation is the process of issuing marketable securities backed by a

pool of existing assets such as auto or home loans. After an asset is converted into a marketable
security, it is sold. A securitization company or reconstruction company may raise funds from
only the QIB (Qualified Institutional Buyers) by forming schemes for acquiring financial assets.
 Asset Reconstruction: Enacting SARFAESI Act has given birth to the Asset
Reconstruction Companies in India. It can be done by either proper management of the business
of the borrower, or by taking over it or by selling a part or whole of the business or by
rescheduling of payment of debts payable by the borrower enforcement of security interest in
accordance with the provisions of this Act.
Further, the act provides Exemption from the registration of security receipt. This means that
when the securitization company or reconstruction company issues receipts, the holder of the
receipts is entitled to undivided interests in the financial assets and there is no need of
registration unless and otherwise it is compulsory under the Registration Act 1908.

However, the registration of the security receipt is required in the following cases:

 There is a transfer of receipt

 The security receipt is creating, declaring, assigning, limiting, extinguishing any right
title or interest in an immovable property.

The Sarfaesi act covers any asset, movable or immovable, given as security whether by way of
mortgage, hypothecation or creation of a security interest. There are some exceptions in the act
such as personal belongings. However, only that property given as security can be proceeded
under the provisions of SARFAESI Act. If the property of the borrower is his own mortgaged
residential house, it is also NOT exempted from the Sarfaesi act.

 Powers of Debt Recovery Tribunal

The debt Recovery Tribunals have been empowered to entertain appeals against the misuse of
powers given to banks. Any person aggrieved, by any order made by the Debts Recovery
Tribunal may go to the Appellate Tribunal within thirty days from the date of receipt of the order
of Debts Recovery Tribunal.
 Proposed amendments to the Act

The government had approved bill to amend the act. The Enforcement of Security Interest and
Recovery of Debts Laws (Amendment) Bill, 2011, amends two Acts — Sarfaesi Act 2002, and
Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (DRT Act). Via these
amendments:
 Banks and asset reconstruction companies (ARCs) will be allowed to convert any part of
the debt of the defaulting company into equity. Such a conversion would imply that lenders or
ARCs would tend to become an equity holder rather than being a creditor of the company.
 The amendments also allow banks to bid for any immovable property they have put out
for auction themselves, if they do not receive any bids during the auction. In such a scenario,
banks will be able to adjust the debt with the amount paid for this property. This enables the
bank to secure the asset in part fulfillment of the defaulted loan.
 Banks can then sell this property to a new bidder at a later date to clear off the debt
completely.
However, lenders will be able to carry this property on their books only for seven years, as per
the Banking Regulation Act, 1949.