Introduction

Introduction of INSOLVENCY AND BANKRUPTCY CODE, 2016 has done away with
overlapping provisions contained in The Securitization and Reconstruction of Financial
Assets and Enforcement of Security Interest Act, (SARFAESI ACT) 2002. Let’s distinguish
between both Acts.

SARFAESI Act
The Securitisation and Reconstruction of Financial Assets and Enforcement of Securities
Interest Act, 2002 (also known as the SARFAESI Act) is an Indian law. It allows banks and
other financial institution to auction residential or commercial properties to recover loans. It
regulate securitization and reconstruction of financial assets and enforcement of security
interest and to provide for a central database of security interests created on property rights
and for matters connected therewith or incidental thereto. The SARFAESI Act deals with
Securitization, Asset reconstruction, Enforcement of security without intervention of the
court. The whole procedure is to be regulated by the RBI. The SARFAESI Act allows
secured creditors to take possession over collateral against which a loan had been provided
upon a default in repayment. This process is undertaken with assistance of the District
Magistrate, and does not require the intervention of courts or tribunals. This Act helps the
Banks and Financial Institutions who are the secured creditors to enforce securities held as
collaterals to loans disbursed by them, if such loans turn to be Non Performing Assets. If
borrower of financial assistance makes any default in repayment of loan or any installment
and his account is classified as Non performing Asset.

Under SARFAESI Act, secured creditors which include Banks and Financial institution
can refer the Non-Performing Asset (“NPA”) to any Asset Reconstruction Company,
established with the Reserve Bank of India under section 3 for the purposes of the Asset
Reconstruction or Securitization or both.

The provisions of this Act are applicable only for NPA loans with outstanding above Rs.
1,00,000/- (Rupees One Lakh). 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.

NPA should be backed by Securities charged to the bank by way of hypothecation or charge
or assignment.

The SARFAESI Act provides for the manner for enforcement of security interests by a
secured creditor without the intervention of a court or tribunal. If any borrower fails to
discharge his liability in repayment of any secured debt within 60 days from the date of
notice by the secured creditor, the secured creditor is conferred with powers under the
SARFAESI Act to:

a. take possession of the secured assets of the borrower, including transfer by way of lease,
assignment or sale, for realizing the secured assets

b. takeover of the management of the business of the borrower including the right to transfer
by way of lease, assignment or sale for realizing the secured assets,
c. appoint any person to manage the secured assets possession of which is taken by the
secured creditor, and

d. require any person, who has acquired any of the secured assets from the borrower and from
whom money is due to the borrower, to pay the secured creditor so much of the money as if
sufficient to pay the secured debt.  

Amendment in SARFAESI Act

The Securitization and Reconstruction of Financial Assets and Enforcement of Security

Interests Act, 2002 or SARFAESI Act Amendments have been made in 2016 because of
“Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions
(Amendment) Act, 2016”.

“Amendment Act, 2016”), provides for amendment in the Securitisation and

Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
(“SARFAESI Act”), the Recovery of Debts due to Banks and Financial Institutions Act, 1993
(“RDDBFI Act”), the Indian Stamp Act, 1899 and the Depositories Act, 1996

The rules pertaining to Security Enforcement, Debt Recovery Tribunal (Procedure) Rules,
1993, The Debt Recovery Appellate Tribunal (Procedure) Rules, 1994 have been amended to
that effect To DRT (Procedure) Rules, 2016 and DRT Appellate Tribunal (Procedure) Rules,
2016, respectively.

The act added new definitions to SARFAESI, widened the scope of debts and secured
creditors and bestowed upon RBI new powers in relation to making of policies.

The Amending Act provides that the requirement of classification of secured debt as
nonperforming asset shall not apply to a borrower who raised funds through issue of debt
securities but the provisions for enforcement of security interest shall apply to such borrower.

Further, in the event of default, the debenture trustee shall be entitled to enforce security
interest in the same manner as provided in section 13 with necessary modifications and in
accordance with the terms and conditions of security documents executed in favour of the
debenture trustee

The earlier prerequisite for ARC to hold fund not exceeding 15% of total financial asset
acquired or to be acquired by company is removed.

The earlier condition for sponsor not to be a holding company of ARC is replaced with a
sponsor, fit and proper in accordance with guidelines of RBI.

Mandatory to take RBI’s approval for appointment of director/managing director/chief

executive manager of ARC.

Exemption from stamp duty on documents given by banks to ARC for the purpose of
securitisation. Also, all rights and interest regarding the unpaid portion which was held by
bank earlier, will vest with ARC.
Measures to be taken for asset reconstructions are same. However, ARC will have to act
according to the directions and policies formulated by RBI. RBI to also release policies for
fee charged/incurred by ARC or transfer of security receipts issued to qualified buyers.

Enforcement of Security
1. Proviso added to section 13(2) – buyer need not classify NPA in case he has raised funds
through debt securities. Upon default, he can enforce under this section.

2. Section 13(8) – earlier dues could be paid till sale or transfer. Now it can be paid till the
date of auction/publication of notice. The time period for the borrower to make the payment
has been reduced considerably.

3. DM/CMM has to pass order for taking possession of the secured assets within 30 days. He
is allowed to extend the period by another 30 days but he will have to record reasons for the
same.

The RBI may carry out or caused to be carried out audit and inspection of an ARC from time
to time.

The Central Government may, by notification, delegate its powers and functions under this
Chapter, in relation to establishment, operations and regulation of the Central Registry to the
Reserve Bank, subject to such terms and conditions as may be prescribed

Insolvency And Bankruptcy Code, 2016

The Insolvency and Bankruptcy Code, 2016 (“Code”) offers a uniform comprehensive
insolvency legislation to Corporations, Firms and Individuals (other than financial firms).

One of the fundamental features of the Code is that it allows creditors to assess the viability
of a debtor as a business decision, and agree upon a plan for its revival or a speedy
liquidation.

The IBC creates a new institutional framework, consisting of a regulator, insolvency

professionals, information utilities and adjudicatory mechanisms, that will facilitate a formal
and time bound insolvency resolution process and liquidation.

To provide easy exit with a painless mechanism in cases of insolvency of individuals as well
as companies, the code has significant value for all stakeholders including various
Government Regulators. Introduction of this Code has done away with overlapping
provisions contained in various laws –

Sick Industrial Companies (Special Provisions) Act, 1985, The Recovery of Debts Due to
Banks and Financial Institutions Act, 1993, The Securitization and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002 and The Companies Act,
2013.

Applicability of the Code:-

The provisions of the Code shall apply for insolvency, liquidation, voluntary liquidation or
bankruptcy of the following entities:-

Any company incorporated under the Companies Act, 2013 or under any previous law. Any
other company governed by any special act for the time being in force, except in so far as the
said provision is inconsistent with the provisions of such Special Act. Any Limited Liability
Partnership under the LLP Act 2008.Any other body being incorporated under any other law
for the time being in force, as specified by the Central Government in this regard
Partnership firms and individuals. 

Code has differentiated liquidation and Insolvency process between Corporate Debtors
(which shall be dealt by the NCLT) and Individuals and firms liquidation process (which
shall be of the jurisdiction of DRT), the Corporate Debtors default should be at least INR
100,000 (USD 1495) (which limit may be increased up to INR 10,000,000 (USD 149,500) by
the Government).

(i) For the Corporate Debtors’ the Code proposes two independent stages:

 Insolvency Resolution Process: wherein the financial creditors assess the debtor’s

business and evaluate whether the business can be subjected to revival procedure and
evaluate options for its rescue and revival.
 Liquidation: if the insolvency resolution process fails or financial creditors decide to
wind down and distribute the assets of the debtor.

(ii) Insolvency Resolution Process for Individuals/Unlimited Partnerships:

 For individuals and unlimited partnerships, the Code applies in all cases where the
minimum default amount is INR 1000 (USD 15) and above (the Government may
later revise the minimum amount of default to a higher threshold). The Code
envisages two distinct processes in case of insolvencies: (i) automatic fresh start and
(ii) insolvency resolution.
 Under the automatic fresh start process, eligible debtors (basis gross income) can
apply to the Debt Recovery Tribunal (DRT) for discharge from certain debts not
exceeding a specified threshold, allowing them to start afresh.
 The insolvency resolution process consists of preparation of a repayment plan by the
debtor, for approval of creditors. If approved, the DRT passes an order binding the
debtor and creditors to the repayment plan. If the plan is rejected or fails, the debtor or
creditors may apply for a bankruptcy order.

Exceptions: There is an exception to the applicability of the Code that it shall not apply to
corporate persons who are regulated financial service providers like- Banks; Financial
Institutions; and Insurance companies. 

Objectives of the Code

A sound legal framework of bankruptcy law is required for achieving the following
objectives:-

Improved handling of conflicts between creditors and the debtor

It can provide procedural certainty about the process of negotiation, in such a way as to
reduce problems of common property and reduce information asymmetry for all economic
participants.

Set a limit between malfeasance and business failure

It can also provide flexibility for parties to arrive at the most efficient solution to maximize
value during negotiations. The bankruptcy law will create a platform for negotiation between
creditors and external financiers which can create the possibility of such rearrangements.

Macroeconomic downturns losses to be allocated

An infirm insolvency regime leads to the stereotype of “rich promoters of defaulting entities”
generating theories such as:

Misconduct is the reason for all the defaults made ultimately it is the promoters who should
personally and financially be held responsible for defaults of the firms which are under their
control.

Macroeconomic downturns losses to be allocated

Clear allocation of these losses is a result of a well-defined bankruptcy framework. Taxes,

inflation, currency depreciation, expropriation, or wage or consumption suppression are the
common practices of loss allocation. These could affect foreign creditors, small business
owners, savers, workers, owners of financial and non-financial assets, importers, exporters.

To consolidate and amend the laws relating to re-organization and insolvency resolution of
corporate persons, partnership firms, and individuals. To fix time periods for execution of the
law in a time-bound settlement of insolvency (i.e. 180 days).To maximize the value of assets
of interested persons. To promote entrepreneurship. To increase the availability of credit. To
balance all stakeholder’s interest (including alteration). Balance to be done in the order of
priority of payment of Government dues. To establish an Insolvency and Bankruptcy Board
of India as a regulatory body for insolvency and bankruptcy law. To establish higher levels of
debt financing across a wide variety of debt instruments. To deal with cross-border
insolvency .To resolve India’s bad debt problem by creating a database of defaulter list. 

SARFAESI Act V/s Insolvency and Bankruptcy Code,

2016.
 SARFAESI Act, 2002 provides a safety net to secured financial creditors (banks and
financial institutions) by empowering them to enforce their security interests without
the intervention of any court. On the other hand, under IBC, the rights and interests of
all types of creditors have been taken into consideration including that of secured
creditors
 Section 14(1)(c) of the Insolvency and Bankruptcy Code, 2016 clearly provides
that during the insolvency resolution process as defined in the Code, the Code
takes precedence over the DRT Act and SARFAESI Act.
 The Code is a welcome step in resolving issues faced in these archaic laws. Moreover,
it consolidates laws relating to insolvency and repeals the Presidency Towns
 Insolvency Act, 1909 and Provincial Insolvency Act, 1920. Other than that, the Code
also amends 11 laws, including the Companies Act, 2013, Recovery of Debts and
Bankruptcy Act, 1993 (DRT Act), and Securitization and Reconstruction of the
Financial Assets and Enforcement of the Securitization Act, 2002 (SARFAESI Act).
From the amendments, it is clear that all these 11 Acts are affected by the enactment
of the Code.
 Code has differentiated liquidation and Insolvency process between Corporate
Debtors (which shall be dealt by the NCLT) and Individuals and firms
liquidation process (which shall be of the jurisdiction of DRT), the Corporate
Debtors default should be at least INR 100,000 (USD 1495) (which limit may be
increased up to INR 10,000,000 (USD 149,500) by the Government). The Code
devises two separate processes for corporate insolvency matters and individual/
un-incorporated bankruptcy matter. Part II of the Code deals with corporate
insolvency mechanism pertaining to companies incorporated under the
Companies Act, 1956 and 2013 and limited liability partnership incorporated
under the Limited Liability Partnership Act, 2008; matters in this regard will be
dealt by the National Company Law Tribunal. Part III deals with the
bankruptcy process for individuals and partnership firms (unincorporated
entities) and is maintainable before the Debt Recovery Tribunal.

In the case, the NCLAT while referring to Supreme Court’s verdict in Innoventive case has
ruled that when two proceedings are initiated, one under the Insolvency and Bankruptcy
Code, 2016 (I&B Code) and the other under the SARFAESI Act, 2002, then the proceeding
under the I&B code shall prevail.

https://www.legaleraonline.com/articles/effect-of-
insolvency-and-bankruptcy-code-2016-on-sarfaesi-act-drt-
act .

The Insolvency and Bankruptcy Code, 2016 (“IBC”) was brought in to provide a single
unified framework to deal with bankruptcy and insolvency by persons other than financial
institutions. Prior to the introduction of IBC, the law of insolvency and bankruptcy was
spread across several statutes and fora, which rendered the process time consuming and
largely ineffective due to dissipation of value of assets. The IBC consolidated the law related
to insolvency by amending 11 laws, including the Companies Act, 2013, Recovery of Debts
and Bankruptcy Act, 1993 (DRT Act), and Securitization and Reconstruction of the Financial
Assets and Enforcement of the Securitization Act, 2002 (SARFAESI Act). It further repealed
the centuries-old laws of the Presidency Towns Insolvency Act, 1909 and Provincial
Insolvency Act, 1920 , which regulated insolvency resolution for individuals; and the Sick
Industrial Companies Act, 1985 which regulated insolvency resolution for sick companies
prior to the introduction of the IBC. This article seeks to trace the IBC in operation and
provide an overview of the interplay between IBC and some other statutes, and see how it
affects various stakeholders involved.
Statutory Framework of IBC

Overriding Clauses

The  Section 238 of IBC gives it an overriding effect over other laws. Section 245-255 of the
IBC deal with Amendments to various other statutes to the facilitate the afore-stated
overriding effect. With various other statutes already having “overriding” clauses, the three
years of IBC in operation and the lacunas in the Code left a lot of room for judicial
interpretation.

Moratorium:

The object of IBC is to expedite the insolvency process and to secure maximization of value
of assets of Corporate Debtor for distribution to all stake holders. The scheme under IBC
provides for a time bound resolution of insolvency. Once the application to initiate a
Corporate Insolvency Resolution Process (“CIRP”) by or against a corporate debtor is
accepted, the control of the corporate debtor goes in the hands of the Committee of Creditors
(CoC). This CoC is formed by and the initiation process is facilitated by an Interim
Resolution Professional (“IRP”), who assumes control of the operation of the corporate
debtor in the interim. The said IRP can be confirmed as the Resolution Professional (“RP”)
by the CoC or replaced by it by another RP. The CIRP process is a time bound process of 180
days, extendable to 270 days, after which the corporate entity is either revived (if a resolution
plan is approved) or it goes into liquidation.

In order to ensure that the assets of the corporate debtor are not eroded while the creditors
and resolution applicants negotiate resolution of insolvency during the CIRP, the IBC
provides for a “calm period” i.e. moratorium period. Moratorium is declared as soon as the
application for initiation of CIRP is admitted, during which time:

1. No legal proceedings can be initiated or continued against the corporate debtor; and
2. the corporate debtor’s property (even disputed property) cannot be disposed off in any
manner.

More specifically Moratorium under Section 14 of the IBC is applicable to

“(a) the institution of suits or continuation of pending suits or proceedings against the
corporate debtor including execution of any judgement, decree or order in any court of law,
tribunal, arbitration panel or other authority;

(b)transferring, encumbering, alienating or disposing off by the corporate debtor any of its
assets or any legal right or beneficial interest therein;

(c) any action to foreclose, recover or enforce any security interest created by the corporate
debtor in respect of its property including any action under the Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (54 of
2002);
 

(d)the recovery of any property by an owner or lessor where such property is occupied by or
in the possession of the corporate debtor.”

The same principle applies when a company goes into liquidation under IBC. Section 33
provides for a situation akin to moratorium during liquidation, which states that:

“Subject to section 52, when a liquidation order has been passed, no suit or other legal
proceeding shall be instituted by or against the corporate debtor:

Provided that a suit or other legal proceeding may be instituted by the liquidator, on behalf
of the corporate debtor, with the prior approval of the Adjudicating Authority”

In light of the scheme of IBC and its overriding nature, the subsequent sections will trace the
Interplay of IBC with some selected statutes.

IBC and SARFAESI:

Under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002 (‘SARFAESI Act”), banks and other financial institutions, in the capacity
of secured creditors are allowed to auction residential or commercial properties of borrowers
to recover loans, without approaching the courts. However, after the introduction of IBC, the
secured creditor’s interest in some sense has been compromised. Under the IBC, once a CIRP
is initiated, the Moratorium is applicable to  “any action to foreclose, recover or enforce any
security interest created by the corporate debtor in respect of its property including any
action under the Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002 (54 of 2002)”.  Therefore, financial institution or ARC seeking to
enforce  its security under SARFAESI has to be wary of any impeding proceedings under
IBC.

The case of J.M. Financial Asset Reconstruction Company Vs. Indus Finance Ltd.[1],
decided by NCLT at Bombay, throws light on the aforesaid position under law. In the said
matter, JM Financial Asset Reconstruction Company had initiated proceedings under the
SARFAESI Act against the erring corporate debtor. The sale process of the immovable assets
given as security had been initiated under Section 13 of the SARFAESI. Following the
auction sale process under Rule 9 of the Security Interest (Enforcement) Rules, 2002, the sale
had been confirmed in favour of a transferee, on payment of 25% of the sale price. However,
the Tribunal held that the sale had only been confirmed and not concluded and hence in light
of the moratorium, the auction sale was stayed. It was argued in this case, though
unsuccessfully, that the corporate debtor had acted in collusion with the financial creditor to
initiate CIRP against itself, in order to stall the SARFAESI proceedings.  Be that as it may, it
is conceivable that the borrowers may use IBC proceedings to stall recovery under
SARFAESI, especially in light of Section 10 of the IBC, which enables the corporate debtor
to file an application for initiation if CIRP against itself.

The IBC affects the rights of the secured creditor, inasmuch as during the CIRP process, the
“secured assets” form part of the common pool of assets. During moratorium, the secured
creditor cannot enforce its security outside the CIRP process. Its claim stands at par with
other creditors. At the CIRP stage, all the decision-making is controlled by committee of
creditors (“CoC”), including the decision to accept or reject a resolution plan. The CoC is
comprised of financial creditors. A resolution plan is approved for submission to the
adjudicating authority if it is passed by atleast 66% of the CoC. It is important to note that a
Resolution Plan may provide for:

 sale of secured asset [ Regulation 37(a)][2];

 satisfaction or modification of any security interest [Regulation 37(d)][3];
 reduction in the amount payable to the creditors [Regulation 37(f)][4]

Therefore, if the secured creditor is either not a financial creditor, or being a financial
creditors, its voting share in the CoC is less than 33%, the rest of the CoC may approve a
Resolution Plan that compromises such secured creditor’s security interest. Before 5 October
2018, regulation 38(1) of the IBBI CIRP Regulations, 2016, required that a resolution plan
provide for payment of liquidation value due to dissenting financial creditors (including
abstaining creditors) prior to any recoveries being made by the assenting financial creditors.
However, this protection has been done away with after the amendment to Regulation 38 on
05.10.2018.

During the liquidation process however, the secured creditors have been given an option to
enforce/ realise their security interest outside the liquidation process. Section 52 of the IBC
provides for treatment of secured creditor during liquidation. Section 33 of the IBC, which
stays any legal proceedings against the corporate debtor during liquidation, has been made
subject to Section 52. As a consequence, the secured creditors who seek to realise their
security interest outside of liquidation proceedings, are permitted to do so after proving their
security interest[5] and thereafter following the procedure under Regulation 37 of the
Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016.
However, secured creditors enforcing their security through SARFAESI proceedings, are not
required to follow this regulation.

No jurisdiction of civil courts under the code

Further section 63 of the Code stipulates that the civil court shall not have any jurisdiction to
entertain any suit or proceedings in respect of any matter on which the NCLT has
jurisdiction.

Choice of liquidation under the IBC

Once the company is under Corporate Insolvency Resolution Process, the existing laws on
insolvency have almost no interplay. If the resolution plan submitted by various resolution
applicants are accepted, the company has to follow it and all previous applications filed under
existing insolvency laws are back to square one.

If no resolution plan is approved, the company automatically goes into liquidation. The
creditors under Section 52 of the Code are given a choice of pursuing liquidation on their
own or as a part of collective liquidation proceedings. If the existing SARFAESI applications
are revived after CIRP, they have a later priority of payment as compared to Secured
financial creditors under the normal ‘waterfall mechanism’ prescribed under Section 53 of the
IBC.

The success of IBC

Burgeoning NPAs

 21 PSU banks had combined gross NPAs of Rs 7.3 lakh crore at the end of September 2017
quarter. This was a growth of 27% as compared to 2016 quarter.

Objectives of IBC

 Consolidate and amend all existing insolvency laws in India.

 To simplify and expedite the Insolvency and Bankruptcy Proceedings in India.
 To protect the interest of creditors including stakeholders in a company.
 To revive the company in a time-bound manner.
 To promote entrepreneurship.
 To get the necessary relief to the creditors and consequently increase the credit supply in
the economy.
 To work out a new and timely recovery procedure to be adopted by the banks, financial
institutions or individuals.
 To set up an Insolvency and Bankruptcy Board of India.
 Maximization of the value of assets of corporate persons.

The Insolvency and Bankruptcy Code ecosystem

 National Company Law Tribunal (NCLT) – The adjudicating authority (AA), has jurisdiction
over companies, other limited liability entities.
  Debt Recovery Tribunal (DRT) has jurisdiction over individuals and partnership firms other
than Limited Liability Partnerships.
 The Insolvency and Bankruptcy Board of India (IBBI) – apex body for promoting transparency
& governance in the administration of the IBC; will be involved in setting up the
infrastructure and accrediting IPs (Insolvency Professionals (IPs) & IUs (Information Utilities).
 It has 10 members from Ministry of Finance, Law, and RBI.
 Information Utilities (IUs) - a centralized repository of financial and credit information of
borrowers; would accept, store, authenticate and provide access to financial data provided
by creditors.
 IPs- persons enrolled with IPA (Insolvency professional agency (IPA) and regulated by Board
and IPA will conduct resolution process; it will act as Liquidator/ bankruptcy trustee; they
are appointed by creditors and override the powers of the board of directors.
 IPs have the power to furnish performance bonds equal to assets of the company under
insolvency resolutions
 Adjudicating authority (AA) - would be the NCLT for corporate insolvency; to entertain or
dispose of any insolvency application, approve/ reject resolution plans, decide in respect of
claims or matters of law/ facts thereof.

Key aspects of the Insolvency and Bankruptcy Code

 IBC proposes a paradigm shift from the existing 'Debtor in possession' to a 'Creditor in
control' regime.
 IBC aims at consolidating all existing insolvency related laws as well as amending multiple
legislation including the Companies Act.
 The code aims to resolve insolvencies in a strict time-bound manner - the evaluation and
viability determination must be completed within 180 days.
 Moratorium period of 180 days (extendable up to 270 days) for the Company. For startups
and small companies the resolution time period is 90 days which can be extended by 45
days.
 Introduce a qualified insolvency professional (IP) as intermediaries to oversee the Process
 Establishment of Insolvency and Bankruptcy board as an independent body for the
administration and governance of Insolvency & bankruptcy Law; and Information Utilities as
a depository of financial information.

DRT in IBC era a progressive redundancy

A closer look at the quasi-judicial authorities created under the Companies Act, 2013- NCLT
(National Company Law Tribunal) & the NCLAT (Appellate Tribunal) reveals their powers
to decide corporate disputes. It can pass orders to restitute parties, direct insolvency or
liquidation proceedings and even hold parties liable for punishments or costs. It may do so by
adhering to the principles of natural justice. The NCLAT holds the same powers of any other
appellate tribunal in reviewing the NCLT’s decisions. The final court of appeal under the
Court is the Supreme Court.

On the other hand, DRTs can be approached only by banks, financial institutions and their
customers. They were set up under the Recovery of Debts due to Banks and Financial
Institutions Act, 1993. Appeals can be heard by the DRAT (Appellate Tribunal). While the
government has increased the number of tribunals for speedy settlement of loan default cases,
juristic entities are beginning to eliminate it as an efficient forum for dispute resolution.

DRT v. NCLT: A Stark Contrast

The first basic point of difference between the two tribunals is that the NCLT is regulated by
the Companies Act and the Code while the DRT is regulated by its parent act and the
SARFAESI Act. Secondly, the very nature of the relief provided by these bodies is distinct-
the NCLT is a forum for resolution proceedings concerning liquidation, insolvency or
winding up due to bankruptcy. The DRT provides a recovery mechanism for debts of and
strictly confined to banks and other financial institutions.

Thirdly, the NCLT provides remedy sought to companies in case of default in payment of
debts that are both operational and financial. Therefore, banks and financial institutions are
also allowed to approach the NCLT for recovery of loan amount. Since operational debts
cover all commercial transactions entered into by businesses, companies choose the
convenient forum, the NCLT for initiation of insolvency resolution process instead of filing a
suit for breach of contract in the civil court. On the other hand, the DRT can only facilitate
recovery of amounts of a financial nature, that is, it resolves disputes between customers and
banks or financial institutions only. It does not have the subject-matter jurisdiction to
entertain any other cases.

Attributing Factors to the Popularity of the NCLT

There are several factors that can be attributed to the NCLT being viewed as the first and
most attractive forum to recover any form of debt by companies. It is significant to note that
Section 63 of the Code lays down that no civil court shall have any jurisdiction to entertain
any suit or proceedings in respect of any matter on which the NCLT has jurisdiction.
Therefore, this is pleaded to be an effective bar on institution of suit when in fact, the civil
court may still be approached for recovery of amounts under a contract.

Further, the Supreme Court in Madras Bar Association v. Union of India [i] upheld the
constitutional validity of NCLT & NCLAT, removing all doubts in the minds of legal officers
of companies who may have been hesitant to file applications. Section 14(1)(c) of the Code
explicitly states that when an insolvency resolution process is underway, the Code takes
precedence over not only the SARFAESI Act but also the DRT. This position is further
crystallized in the Supreme Court ruling in the infamous Innoventive case [ii] where it held
that when simultaneous proceedings are initiated under the Code and the SARFAESI Act, the
proceeding under the Code will prevail and its decision will be final.

The Allahabad High Court [iii] has also held that two proceedings cannot go on concurrently
before both forums when the liability of the parties is co-extensive and the cause of action is
the same. If the liability has not been adjudicated upon, the DRT proceeding cannot continue
and must be stayed until the NCLT approves a resolution plan or orders for liquidation.

Legislative Intent

The Code itself contains provisions that seem to clarify the legislative intent behind making
the NCLT appear more expedient to companies, and especially- banks and financial
institutions. Section 14 stays all other pending proceedings (before the DRT) between the
parties for a period of 180 days from the date of admission of application under Section 12
(corporate insolvency resolution process) before the NCLT. The NCLT may declare by order
that no fresh action would be allowed to be taken. The debtor is also prevented from
disposing of its asset during the moratorium period; this refers to the ‘cooling period’ wherein
the debtor and the creditor can deliberate the rehabilitation of the company (companies
incorporated under the Companies Act, 2013 and the Limited Liability Partnership Act,
2008). The same is applied to individuals and unincorporated entities under Section 85.
Therefore, the Code has laid down absolutely that the proceedings before the DRT (initiated
under the DRT Act and the SARFAESI Act) will be suspended without the limitation period
being affected for a period of 180 days. An order stating this is required to be passed.

On the other hand, the Code also attempts to bring harmony with other laws- a bankruptcy
proceeding may be maintained before the DRT. If an order is passed by the DRT, the creditor
is still entitled to realize his security interest in the same manner as he would have been
entitled to in the absence of such an order. In case a secured creditor is in conflict due to a
liquidation order directed towards a corporate debtor, he has two options. Firstly, he may
relinquish his security interest and become a party to the liquidation process and rank higher
in preference of distribution. Alternatively, he can stay out of the liquidation process and
enforce his security interest. Therefore, a favourable order passed by the DRT with respect to
bankruptcy is not diluted by any provision of the Code or the NCLT.

Conclusion

The contemporary litigation involving the Code still faces confusion as the presence of more
than one available forum is tested by the real implementation of the above law. The disposal
rate of DRTs is alarming. They are unable to reduce pendency of cases. It is recommended
that at the very first instance, if the proceeding can be held before the NCLT, the DRT choose
to direct an application for the same.

The existence of several company-related legislations with respect to recovery of debt

mandates interpretation. A delay in insolvency or liquidation proceedings due to overlapping
proceedings is worrisome. The interplay of rules of the Code, the SARFAESI Act and the
DRT Act remains unresolved. Simultaneous proceedings before the civil court, the DRT and
the NCLT for recovery of the same debt is contributing to an inefficient insolvency regime.
There is craving among experts for a settled position of law. Since almost any case before the
DRT can be resolved by the NCLT, the legislature as well as the judiciary must decide on the
chief question- has the Insolvency and Bankruptcy Code made Debt Recovery Tribunals
redundant

the Indian parliament has now passed the Enforcement of Security Interests and Recovery of
Debt Laws and Miscellaneous Provisions (Amendment) Act, 2016 to improve the efficacy of
Indian debt recovery laws.

The amendment act introduces a number of changes to the Securitization and Reconstruction
of Financial Assets and Enforcement of Security Interests Act, 2002 (SARFAESI Act) and
the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (DRT Act). These
changes will however come into effect as and when the government issues appropriate
notifications in the Official Gazette to implement the relevant provisions of the amendment.
KEY CHANGES INTRODUCED
A. Changes to the ARC Framework

(i) Ownership and Control of ARCs: Till now, ownership and control of an asset
reconstruction company (ARC) had to be diversified and no sponsor could hold a controlling
interest (more than 49%) in an ARC or appoint a majority of its board of directors. These
restrictions have been removed and sponsors are now allowed to hold up to 100% equity in
an ARC as well as exercise majority control over its board. Correspondingly, the Reserve
Bank of India (RBI) has also been given greater powers of oversight over an ARC's
operations including, the right to appoint RBI officers as observers to the board of directors
of an ARC and if required, change/ replace its directors.

(ii) Eligible Purchasers of Security Receipts: Until now, only 'qualified institution buyers'
(i.e. banks, financial institutions, insurance companies, state finance corporations, mutual
funds and foreign portfolio investors) were permitted to purchase security receipts issued by
ARCs. With the amendment, the scope of eligible investors has been widened to include non-
institutional investors as identified by RBI from time to time.

With non-performing assets (NPAs) and stressed assets of Indian banks exceeding INR 8
trillion (approx. USD 125 billion), these changes to the ARC framework could help remove
distressed assets from the balance sheets of Indian banks by developing a robust secondary
market for distressed debt in India. Removal of the sponsor ownership restrictions could
incentivize more players to set up ARCs and allow existing ARCs to raise necessary capital
to expand their portfolios. Further, the widening of the investor base for security receipts may
possibly generate more interest in these instruments and allow banks to off-load their NPAs
on an arms' length basis, as opposed to self-funding securitization transactions to restructure
their exposure.

B. Wider group of SARFAESI Eligible Lenders

Until recently, the benefits under the SARFAESI Act and the DRT Act were available to a
limited group of lenders – i.e. scheduled commercial banks, International Finance
Corporation, Asian Development Bank and identified Housing Finance Companies. The
government has made two significant additions to this group:

i. NBFCs: On 5 August, 2016, the Ministry of Finance has specifically notified and named those
non-banking financial companies (NBFCs) with an asset size of more than Rs. 500 crores, as
SARFAESI eligible lenders.
ii. Listed Debt Securities: The benefits of the SARFAESI Act and the DRT Act have been
extended to the listed bond market in India. Debenture trustees appointed in respect of
debt securities listed in accordance with applicable SEBI regulations have been specifically
included as 'secured creditors' under the SARFAESI Act, and corresponding changes have
been made to various provisions of both the SARFAESI Act and the DRT Act. These changes
potentially allow lenders that do not independently have rights under the SARFAESI Act or
the DRT Act (such as domestic funds, mutual funds, insurance companies, foreign portfolio
investors and other investors in the corporate debt market) to benefit from such rights when
acting through a debenture trustee in respect of listed bonds.
C.Central Registry for Security Interests

Once the amendments are notified, all secured creditors (including creditors who do not have
enforcement privileges under the SARFAESI Act) will be required to register their security
interests with the Central Registry of Securitization Asset Reconstruction and Security
Interests of India (Central Registry). This will facilitate implementation of the Bankruptcy
Code and will increase overall transparency in respect of security interests over a debtor's
assets.

D.Increasing efficacy of SARFAESI and DRT Proceedings

While the SARFAESI Act and DRT Act are intended to expedite recovery of secured debt,
there have been various procedural issues which have limited the efficacy of these
legislations. Accordingly, various modifications have been made to both the legislations to
deal with this problem. For instance:

i. timelines for various steps in the adjudication process before the debt recovery tribunals
such as filing of written statements, passing of orders, appeals, etc. have been reduced; and
ii. the cost on a borrower to delay recovery timelines through protracted appeals and
proceedings has been increased. Borrowers will now be required to deposit at least 25% of
the outstanding amounts with the debt recovery appellate tribunal (DRAT) under the DRT
Act to prefer an appeal. Previously, (a) this floor of 25% on the deposit obligation applied
only to appeals made under the SARFAESI Act, and (b) borrowers could request the DRAT for
a waiver of the entire deposit obligation under the DRT Act.

CONCLUSION

The amendments are perhaps the most significant set of changes to the SARFAESI Act since
its enactment in 2002. The Bankruptcy Code and the amendments to the SARFAESI Act
together reflect a clear legislative intent to shift the needle in a distressed situation towards
the creditors by plugging various loopholes available to borrowers.

DRT and Limitation Act

The Supreme Court has recently in its judgment dated 21 January 2020, in the case of
Standard Chartered Bank v MSTC Limited [SLP (C) No 20093 of 2019], provided clarity on
the interplay between the provisions of Recovery of Debts and Bankruptcy Act 1993 (RDB
Act) and Limitation Act 1963 (Limitation Act). Supreme Court has in doing so refused to
condone a delay of 28 days in filing of a review application by the government borrower
entity against a decree in favour of the bank.

BRIEF BACKGROUND:

 Standard Chartered Bank (SCB) filed an interim application (IA) seeking a decree on
admission against MSTC Limited (MSTC), in recovery proceedings pending before the Debts
Recovery Tribunal, Mumbai (DRT). The DRT passed an order allowing the IA and ordering
recovery of the outstanding due.
  MSTC preferred an Appeal against the Decree (Appeal) before the Debts Recovery Appellate
Tribunal (DRAT). During pendency of the appeal, MSTC also filed a review application against
the Decree before the DRT (Review Application).
 Rule 5A of the Debts Recovery Tribunal (Procedure) Rules 1993 (DRT Rules) prescribes a 30
day limitation period for filing of a review application and MSTC filed its Review Application
with a delay of 28 days. Subsequently, the Appeal was withdrawn by MSTC and MSTC
instituted an application to condone the delay in filing of the Review Application.
 DRT dismissed the application for condonation of delay holding that it did not have the
power to condone delay in filing of a review applications under the RDB Act. MSTC
challenged the Order of DRT by filing a writ petition before the Bombay High Court (High
Court), which was allowed on 3 May 2019. SCB challenged the High Court's decision before
the Supreme Court.

QUESTIONS OF LAW:

 Whether the DRT has the power to condone delay in filing of a review application?
 Whether a writ petition is maintainable against an Order of the DRT rejecting a review
application?

WHAT THE SUPREME COURT HELD:

 Supreme Court set aside the judgment of the High Court and held that the Tribunal does not
have the power to condone delay in filing of a review application. In arriving at this
conclusion Supreme Court analysed the provisions of the RDB Act, DRT Rules and the
Limitation Act:

o Rule 5-A provides that a review application is to be made within 30 days from the
date of the order (with no additional period prescribed thereunder). Supreme Court
observed that this period was in fact 60 days, which was cut short to 30 days by way
of an amendment with effect from 4 November 2016. This brings out the clear
legislative intent that review applications must be filed within a shorter period of
limitation. Supreme Court further held that the peremptory language of Rule 5A
makes it clear that beyond 30 days there is no power to condone delay.
o The Supreme Court further interpreted Section 5 of the Limitation Act, which
enables a Court to condone delay beyond the prescribed period read with Section 24
of the RDB Act, which extends the application of the Limitation Act to an
"application" made before the DRT. Supreme Court held that "application" is defined
under the RDB Act to only mean original applications filed under Section 19 and will
not include review applications which are filed under Section 22(2)(e) of the RDB Act
read with Rule 5A.
o The Supreme Court relied upon its judgment in International Asset Reconstruction
Company of India Limited v Official Liquidator of Aldrich Pharmaceuticals Limited
and Others [(2017) 16 SCC 137]  where it was held that the only application referred
to in section 24 is an application filed under Section 19 of the RDB Act.
 BHC had relied on Order XLVII Rule 7 of the Code of Civil Procedure 1908 (CPC) to hold that
there is a bar against filing of an appeal from an order rejecting a review application, and
hence the writ petition filed by MSTC against the order of DRT is maintainable. The Supreme
Court differed with the High Court's view and held that:

 o The High Court had failed to appreciate that Section 20 of the RDB Act makes all
orders passed by DRT subject to appeal; hence, a writ Petition is not maintainable
against an order of DRT rejecting a review application.
o RDB Act is a complete code and its provisions will have an overriding effect over CPC.

Applicability of Limitation Act on IBC

On 11 October 2018, the Supreme Court (Court) vide its judgment in B.K. Educational
Services Private Limited v Parag Gupta and Associates (Civil Appeal No. 23988 of 2017)
clarified the applicability of Limitation Act, 1963 (Limitation Act) to the Insolvency and
Bankruptcy Code, 2016 (Code).

Background

Parag Gupta and Associates, a financial creditor (Respondent) had filed an appeal before the
National Company Law Appellate Tribunal (NCLAT) against an order of the National
Company Law Tribunal (NCLT) whereby the Respondent's application for initiation of
insolvency proceedings under Section 7 of the Code was rejected because it was barred by
limitation. Vide its judgment dated 07 November .2017, the NCLAT held that the Limitation
Act would not be applicable to the initiation of Corporate Insolvency Resolution Process
(CIRP), and in cases where the financial and operational creditors are able to reasonably
justify their delays in filing applications, the same can be entertained. The decision of
NCLAT was challenged by B.K. Educational Services Private Limited, the corporate debtor
(Appellant) before the Court.

In the meantime, with effect from 06 June 2018, Section 238A was inserted in the Code vide
the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 (Amendment), which
provided that the provisions the Limitation Act shall, as far as may be, apply to the
proceedings or appeals before the Adjudicating Authority under the Code i.e. NCLT,
NCLAT, the Debt Recovery Tribunal; and the Debt Recovery Appellate Tribunal, as the case
may be.

In light of this background, the Court was faced with the issue of whether the Limitation Act
would apply to applications filed by financial and operational creditors for initiation of CIRP
before the Amendment.

Contentions of Parties

The Appellant contended that Limitation Act would apply to applications by creditors under
the Code as a time barred debt cannot be held to be 'debt due' so as to trigger the Code. The
Appellant further contended that the 'Adjudicating Authority' under the Code is the NCLT, as
established under the Companies Act, 2013 (Companies Act), and Limitation Act is
applicable to proceedings before NCLT as per Section 433 of Companies Act. Therefore,
Limitation Act would be applicable to proceedings under the Code before NCLT as well.

On the contrary, the Respondent contended that applying Section 433 of the Companies Act
to proceedings under the Code before the NCLT would lead to incongruous results, as
NCLAT is a common appellate forum under three statutes namely, Competition Act, 2002,
Companies Act, 2013 and the Code, and Limitation Act cannot be sweepingly applied to
proceedings before the NCLAT under all these statutes. The Respondent further contended
that Limitation Act only applies to courts and not tribunals, and accordingly, it would not
apply to proceedings before the NCLT under the Code. Another contention that was raised by
the Respondent was that the Code is a complete Code dealing with insolvency and not debt
recovery. It was submitted that while the definition of 'debt' under Section 3(11) of the Code
refers to claims that are 'due', 'default' under Section 3(12) of the Code means non-payment of
debt that is 'due and payable', which is different from debts 'due and recoverable'. Therefore,
even a time barred debt, which is due and payable but not due and recoverable can trigger
proceedings under the Code.

Findings of the Court

While rejecting the contentions of the Respondents, the Court made the following
observations:

 The Court relied on the Report of the Insolvency Law Committee (Committee) of March 2018
(Report) to cull out the intention of the Code and held that the intention of the Code could
not have been to give a new lease of life to stale and time-barred claims, but was solely to
clarify that Limitation Act is been applicable to the Code.
 The NCLT, which was established under the Companies Act is the 'Adjudicating Authority'
under the Code, and Section 433 of the Companies Act makes Limitation Act applicable to
the NCLT. Therefore, Limitation Act would be applicable to proceedings under the Code
before the NCLT as well.
 Section 238A of the Code is a clarification of the law and is procedural in nature, and
therefore, it is retrospective. The Court observed that the amendment of Section 238A
would not serve its object unless it is construed as being retrospective. Otherwise,
applications seeking to resurrect time-barred claims would have to be allowed, not being
governed by the law of limitation.
 The Court noticed that the expressions 'due' and 'due and payable' under Sections 3(11) and
3(12) refer to a default which is a non-payment of a debt that is due in law, i.e., such debt is
not barred by limitation, and even Sections 7 and 8 of the Code make it clear that CIRP can
be initiated by a financial or operational creditor in relation to debts which have not become
time-barred.
 Rejecting the argument that applying Limitation Act may lead to an anomalous situation, the
Court held that even though there is one appellate forum under three statutes, each appeal
would be decided keeping in mind the provisions of the particular Act in question.
 The Court also held that Section 60(6) of the Code, which provides for exclusion of period of
moratorium in computing the period of limitation for a suit or application against a
corporate debtor, would have been wholly unnecessary if the intention of the Legislature
was to exclude the application of Limitation Act from the Code.
 While examining section 433 of the Companies Act and Section 238A of the Code, the Court
observed that both these provisions make the Limitation Act applicable 'as far as may be',
and thus, in the event the Code specifically provides for certain limitation periods, the same
would override the Limitation Act.

In view of the above-mentioned reasons, the Court held that Limitation Act is applicable to
applications filed by financial and operational creditors under Section 7 and 9 of the Code,
from the inception of the Code. The right to sue accrues when a default occurs and if the
default occurs over three years prior to the date of filing of the application, the application
would be barred by limitation, except in those cases where delay can be condoned by
showing sufficient cause under section 5 of the Limitation Act.

Comment

The judgment has laid to rest the uncertainty regarding the time frame within which claims
could be brought by financial creditors and operational creditors. Further, the judgment will
restrict the number of stale claims made under the Code, especially by operational creditors,
where their ability to approach civil courts is restricted by the law of limitation.

The judgment further clarifies that where periods of limitation have been laid down in the
Code, the same would apply notwithstanding anything to the contrary contained in the
Limitation Act. Accordingly, Section 5 of the Limitation Act, may be invoked to condone
delays in filing applications under Section 7 and/or Section 9 of the Code, by showing
sufficient cause for the delay. However, Section 5 of the Limitation Act cannot be relied upon
to condone delays in filing of appeals under Section 61 of the Code, as a specific period of 30
days (extendable to 45 days) has been provided in the Code for filing of appeals.

Therefore, this judgment is likely to ease the burden on the already overloaded NCLTs and
the NCLAT as it would filter the time barred claims. 

ARCs and Insolvency Resolution Plans – The Enigma of Equity vs

Debt
September 19, 2020/0 Comments/in Insolvency and Bankruptcy, Resolution, SARFAESI /by Vinod
Kothari Consultants

– By Sikha Bansal (resolution@vinodkothari.com)

This article has also been published in IndiaCorpLaw Blog, the same can be viewed here

A regulatory framework for asset reconstruction companies (ARCs) was introduced in India
through the Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002 (SARFAESI Act). This intended to put in place a system for
clearing up non-performing assets (NPAs) from the books of banks and financial institutions.
Over a decade later, the Insolvency and Bankruptcy Code, 2016 (IBC) was introduced with
the objective of reorganisation and resolution of insolvent entities.

Although the common goal of both these legislation seems to be the cleaning or
reconstruction of bad loan portfolios, it is important to understand the difference between the
basic premises of these two laws: while the SARFAESI Act deals with ‘recovery’ and is
more of a ‘class’ remedy, the IBC is about ‘resolution’ and intended to constitute a collective
process. Given a common set of stakeholders involved under both these laws, there remains
an obvious possibility of overlaps or inconsistencies.
Recently, the rejection of a resolution plan pertaining to a telecom-sector entity by the
Reserve Bank of India (RBI) highlighted an important regulatory or interpretative gap.
According to publicly available information, the issue essentially revolves around investment
by an ARC in the equity of an insolvent entity. While the IBC has imbibed provisions for
submission of ‘resolution plans’ by financial entities (including an ARC), the SARFAESI Act
does not explicitly permit ARCs to ‘invest’ in or acquire equity in firms. Further, the
SARFAESI Act imposes a ban on ARCs from carrying on any business other than that of
asset reconstruction and/or securitisation. This has led to a conundrum as to the periphery
within which ARCs can operate.

This post intends to analyse the provisions of the SARFAESI Act and the IBC and consider if
there is in fact any gap as such, and whether there is any prejudice to the basic framework of
any of the laws applicable to the ARCs, if the ARCs become equityholders under resolution
plans.

Whether the SARFAESI Act bars equity infusion by ARCs

Going by the definition of “asset reconstruction company” under section 2(1)(ba) of the
SARFAESI Act, an ARC is formed for the purpose of “asset reconstruction” or
“reconstruction” or “both”. Here, “asset reconstruction” is the acquisition by an ARC of any
right or interest of any bank or financial institution in any financial assistance for the purpose
of realisation of such financial assistance, while ‘securitisation’ is the acquisition of financial
assets by an ARC from any originator, whether by the ARC raising funds from qualified
buyers by issue of security receipts representing undivided interest in such financial assets or
otherwise.

Barring these two “businesses”, an ARC would have to obtain RBI approval to commence or
carry on any other “business”. However, there are exceptions under clauses (a), (b), and (c) of
section 10(1), that is, where the ARC acts as a recovery agent, manager or receiver. Hence,
the law is clear that the ARCs are specialised business undertakings, expected to concentrate
on acquisition of financial assets, rights, or interests for the purpose of their realisation or
reconstruction.

Notably, with the inherent right to carry out the business of asset reconstruction, the ARCs
will have to be equipped with incidental rights that would facilitate the business. As such,
section 9 of the SARFAESI Act lists out the measures that the ARC can take “for the
purpose of asset reconstruction”, which includes the “proper management of the business of
the borrower, by change in, or takeover of, the management of the business of the borrower”
as well as “conversion of any portion of debt into shares of a borrower company”.

A connected provision is section 15(4) which states that the secured creditor (in this case, an
ARC) shall, on realisation of debt in full, “restore the management of the business of the
borrower to him”. This aspect was also pointed out by Bankruptcy Law Reform Committee
(BLRC) while assessing ARCs as possible tools for insolvency resolution [see, page 10 of the
Interim Report of the BLRC (2015)]:

“ . . . But given their powers to resort to several measures (which includes taking over the
management and conversion of debt into equity among others) for recovering the value
underlying those loans, ARCs can (at least in theory) also help in insolvency resolution of a
company. . . It may be noted that an ARC can takeover the management of the borrower only
for the purpose of ‘realization of dues’. The management of the company has to be
restored back to the borrower after realisation of the dues. Therefore, this mechanism is
largely seen as a debt recovery tool and not an insolvency resolution tool (i.e., it does not
facilitate rescue in practice).” [emphasis added]

Therefore, the BLRC drew a thin line between ‘realisation’ and ‘rescue’. As the intent and
objective of an ARC is to ‘realise the dues’ and reposition the borrower, it would not amount
to ‘rescue’ in its truest sense.

However, an important amendment was inserted in the SARFAESI Act by way of the
Amendment Act of 2016. A proviso to section 15(4) now provides that “if any secured
creditor jointly with other secured creditors or any asset reconstruction company or
financial institution or any other assignee has converted part of its debt into shares of a
borrower company and thereby acquired controlling interest in the borrower company, such
secured creditors shall not be liable to restore the management of the business to such
borrower.” [emphasis added} Therefore, there would be no obligation on the ARC to return
the business to the borrower where the ARC has already acquired a controlling interest in the
entity.

Therefore, it might appear that ARCs can undertake a permanent equity position in the
borrower entity. This however, in view of the author, comes with a rider, as imbibed in the
law itself. An ARC is only formed for the purpose of asset reconstruction and securitisation
and no other purpose. Any other business can only be undertaken with the prior approval of
the RBI. Hence, the author opines that the very act of being in the management of a borrower
cannot be in perpetuity: ultimately, the ARC will have to obtain an exit. At the same time, it
cannot be said that ARCs are completely debarred from infusing equity in the borrower.

On the question as to how the exit can occur, it is always possible for the ARCs to sell the
asset, which again, should be subject to overall provisions of the IBC, the SARFAESI Act as
well as directions issued by the RBI. For instance, the ARC will not be able to sell the asset
to a person ineligible under section 29A of the IBC: this has become all the more clear from
the Fair Practice Code for ARCs issued by RBI (see discussion here). As to the appropriate
time or stage for the exit, the ARC may have to take a commercial call on the same: the
objective, as is obvious, would be to recoup the investments made by the ARC in acquiring
the asset.

Besides the above, note that have explicit provisions for conversion of debt into equity.
Earlier, there was a cap of 26% of the total post-converted equity shareholding of an entity
upon conversion of debt into equity. However, the RBI removed the same through a
notification dated November 23, 2017. The 2017 notification also stated that ARCs shall
explore the possibility of preparing a panel of sector-specific management firms or
individuals having expertise in running firms or companies which could be considered for
managing the companies.

Although the notification deals with conversion of debt to equity, it gives the right to ARCs
to acquire equity of companies. Essentially, it should not matter whether the equity is
acquired against conversion of debt into equity or directly by infusion of equity into the
borrower.
Hence, in the view of the author, there is nothing in the SARFAESI Act that bars an ARC
from becoming an equity shareholder of the borrower company, subject to the rider that this
cannot be a permanent equity investment, as discussed above.

ARCs as resolution applicant under the IBC

Resolution applicants under the IBC can be any person who individually or jointly with any
other person submits a resolution plan. The person, however, should not be a person
ineligible under section 29A. The list is, therefore, a negative list: anyone who falls under that
list is not entitled to be a resolution applicant.

Here, one should refer to the first proviso to explanation I of section 29A. The same is
worded as: “Provided that nothing in clause (iii) of Explanation I shall apply to a resolution
applicant where such applicant is a financial entity and is not a related party of the
corporate debtor” [emphasis added]. According to explanation II, “financial entity” includes
an ARC registered under the SARFAESI Act.

The wordings of the law, as above, are amply clear that an ARC can be a resolution applicant
under the IBC. While the opening words of explanation II require such entities to meet such
criteria or conditions as the Central Government may notify, so far, however, no such
notification or criteria have been issued.

Now, the very task of a resolution applicant is to come up with a resolution plan. The
resolution plan, seeking the insolvency resolution of the corporate debtor as a going concern,
can contain a variety of measures, including varying kinds of restructuring options and
acquisition of shares. Therefore, whether the resolution happens by way of debt or by way of
equity should not be a matter of concern. As already established by way of landmark court
rulings[1], the IBC is a complete code in itself, having resolution and revival of insolvent
entities as a key objective. However, the resolution plan must not contravene provision of any
other law: see section 30(2)(e).

The author has noted above that there is nothing under the SARFAESI which prohibits
infusion of equity by an ARC in an entity. Therefore, there is arguably no inconsistency
between the provisions of the SARFAESI Act and the IBC and, as such, a plan that provides
for equity participation of an ARC cannot be said to be ultra vires the provisions of the
SARFAESI Act. This again is subject to the condition of impermanency of such relationship
between the ARC and the corporate debtor.

Global perspectives

Globally, the framework for asset management companies (AMCs) may follow either a
centralised approach or a decentralised approach, and may be either perennial or may be with
a sunset clause. See for instance, Danaharta (Malaysia), IBRA (Indonesia) and Thai Asset
Management Company (TAMC) were formed with specific sunset dates. However, no sunset
dates were specified while formation of AMCs in Japan, Korea and Taiwan.

In the Indian context, the activity of asset reconstruction has been encouraged as a ‘business’
activity, and ARCs have been promoted as a specialised business model, although of course,
with required regulatory overview. Therefore, it might be difficult to say that the ARCs
should be in the business of asset reconstruction, but with the prohibition that they should not
be allowed to acquire equity in the entity. This contention would be more irrational where
there already exists right with the ARC to take over the management of the borrower.

Conclusion

From the above discussion, there does not seem to be any bar on ARCs in being equity-
participants under resolution plans.  The only aspect that needs to be taken care of is that,
while ARCs take over the management of a company or the company itself, they shall run the
business only until the business is revived which, in turn, is a commercial decision .
Thereafter, the ARC must exit. In so far as any requirement for any amendment to the law is
concerned, given the perplexity surrounding the issue, it would be better if there is a
clarification under the SARFAESI Act or one issued by RBI on the same.

SARFAESI Act V/s Insolvency and Bankruptcy Code, 2016.

 SARFAESI Act, 2002 provides a safety net to secured financial creditors

(banks and financial institutions) by empowering them to enforce their
security interests without the intervention of any court. On the other hand,
under IBC, the rights and interests of all types of creditors have been taken
into consideration including that of secured creditors

 Section 14(1)(c) of the Insolvency and Bankruptcy Code, 2016 clearly

provides that during the insolvency resolution process as defined in the
Code, the Code takes precedence over the DRT Act and SARFAESI Act.

 The Code is a welcome step in resolving issues faced in these archaic laws.
Moreover, it consolidates laws relating to insolvency and repeals the
Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act,
1920. Other than that, the Code also amends 11 laws, including the
Companies Act, 2013, Recovery of Debts and Bankruptcy Act, 1993 (DRT
Act), and Securitization and Reconstruction of the Financial Assets and
Enforcement of the Securitization Act, 2002 (SARFAESI Act). From the
amendments, it is clear that all these 11 Acts are affected by the enactment
of the Code.

 Code has differentiated liquidation and Insolvency process between

Corporate Debtors (which shall be dealt by the NCLT) and Individuals and
firms liquidation process (which shall be of the jurisdiction of DRT), the
Corporate Debtors default should be at least INR 100,000 (USD 1495)
(which limit may be increased up to INR 10,000,000 (USD 149,500) by the
Government). The Code devises two separate processes for corporate
insolvency matters and individual/ un-incorporated bankruptcy matter. Part
II of the Code deals with corporate insolvency mechanism pertaining to
companies incorporated under the Companies Act, 1956 and 2013 and
limited liability partnership incorporated under the Limited Liability
 Partnership Act, 2008; matters in this regard will be dealt by the National
Company Law Tribunal. Part III deals with the bankruptcy process for
individuals and partnership firms (unincorporated entities) and is
maintainable before the Debt Recovery Tribunal.

The position in respect of individuals and unincorporated entities is different. In the event
that a bankruptcy order is passed by the Adjudicating Authority, which is the Debt Recovery
Tribunal, the bankruptcy order shall not affect the right of any secured creditor to realize or
otherwise deal with his/her security interest in the same manner as he would have been
entitled in case the bankruptcy order was not passed.

Though the legislature has made extensive efforts to bring harmony between these laws, it is
yet to stand the test of implementation. Some immediate concerns are as follows:

1. Time-bound insolvency resolution requires the establishment of several new entities.

Moreover, given the pendency and disposal rate of Debt Recovery Tribunals, their current
capacity may be inadequate to take up the additional role (As of December 2014, there were
62,000 cases pending with Debt Recovery Tribunals, and the disposal rate has been about
10,000 cases per year.).

2. Existence of multiple laws (the Code, DRT Act, and SARFAESI Act) and forums (NCLT
and Debt Recovery Tribunals) to deal with the debt recovery problems of secured creditors
will result in interpretation and harmonization of various laws, leading to delay in insolvency
proceedings.

3. Interplay of the Code with debt recovery laws such as the SARFAESI Act and DRT Act
has not been fully addressed, and there is an apparent tension between these statutes.
However, for an insolvency regime to function effectively, clear harmonization for the
interplay of the different laws will have to be done.

4. Additionally, the parties have the liberty to approach a forum dealing with Corporate Debt
Restructuring (CDR) and Joint Lenders Forum (JLF). Applicability of the CDR and JLF
proceedings on the Code will have to be addressed separately.