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In the era when debt securitisation became one of the trending techniques of the financial markets, the need was felt of a legislation implementing and regulating this latest technique of debt or asset securitization. Under the scheme of debt securitisation, financial institution creates a pool of loan and packages of individuals, creates securities against them then get them rated and sell them to the market investors.
Asset or Debt securitization thus is a process of stimulating assets into securities and securities into liquidity on an ongoing basis, increasing thereby turnover of business and profits, while also providing for flexibility in yield, pricing, pattern, size, risks, and marketability of instruments.
The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI). The SARFAESI Act allows banks and other financial institutions to auction residential or commercial properties for the purpose of recovering loan. It allows the banks to auction properties of the borrowers when they fail to repay their loan amount. Thus, the SARFAESI Act, 2002 enables the bank to reduce their non-performing assets by way of measures of recovery and reconstruction.
The SARFAESI Act also known as securitization act provides that the banks are allowed to seize the property of a borrower except for the agricultural land without going to the court. SARFAESI Act, 2002 is applicable only in the cases of secured loans where banks are in a position to enforce underlying securities such as mortgage, hypothecation, pledge etc. In all such cases, order from the court is not required unless the security is fraudulent or invalid. On the other hand, in case of unsecured assets the bank would have to move the court to file a civil case against the defaulters.
SARFAESI Act, 2002 provides power to the bank to seize the property. Defaulting borrowers are given notice by the bank to discharge their liabilities within a period of 60 days. If the defaulting borrower fails to comply with the notice sent by the bank then the SARFAESI Act provides for the following recourse to the bank -
Take possession of the security for the loan;
Sale or lease or assign the right to the security;
Manage the same or appoint any person to manage the same.
Establishment of Asset Reconstruction Companies is also provided in the SARFAESI Act, 2002. These companies are to be regulated by the Reserve Bank of India (RBI) to acquire assets from the banks and financial institutions. The SARFAESI Act provides that the banks and financial assets shall sell the financial assets to these asset reconstruction companies. Guidelines have been issued to banks and financial institutions by RBI regarding the process to be followed for sales of financial assets to asset reconstruction companies.
The securitization of asset initiates with a lending institution to be known as ‘Originator’ whose loans and receivables will be converted as securities either as a trust or Special Purpose Vehicle (SPV), through which the assets of former will be liquefied. The pool of assets which are similar in nature to the balance sheet is picked by the originator and pass on them to SPV through a pass-through transaction. It then converts it into marketable securities for investment. The resultant cash flow will enable Originator to create further assets and periodical cash flows from the underlying collaterals by the way of repayment of loans and interest payments will enable the SPV to pay off its obligations of principal and interest to its debtors.
SARFAESI Act has the following main features -
Procedural nature of SARFAESI Act - The act is procedural in nature and provides the procedure for providing the remedy of enforcement of security in secured assets without going to the court, directly through the secured creditor.
Retrospective nature of provisions of SARFAESI Act - The provisions of SARFAESI Act is retrospective in nature. The Act intends to cover up all the transactions of loan already entered into the subject to the provisions within the period of limitation and the defaults in making repayment and the debts already classified as non-performing assets and such future contingencies too.
Constitutional Validity of SARFAESI Act - Supreme court has upheld the validity of SARFAESI Act, 2002. In one of the case, there was default on the part of the borrower in repaying his debt in full and the bank sent the notice for 60 days to the defaulter as required under the SARFAESI Act. After the measures have been taken under section 13 (4) have been resorted to then the mechanism provided under Section 17 of the Act is for the borrower to approach Debt Recovery Tribunal (DRT). The Constitutional validity of the Act and its provision was upheld except Section 17(2) of Act, which was declared Ultra vires Article 14 of Constitution.
The action under SARFAESI Act during the pendency of Civil Suit - During the pendency of the bank’s civil suit, the bank can resort to simultaneous action under Section 13(4) of the Act
Writ Jurisdiction - The remedy of appeal is available under the Act against actions relating to recoveries of dues of banks and financial institutions. Hence, it is not necessary to resort to writ jurisdiction under Article 226 of the Constitution. Section 13(4)(d) gives power to a creditor to require the borrower to pay to the secured creditor a sum of money sufficient to discharge the secured debt such notice is given under Section 13(2). The action to be taken is contemplated under Section 13(4)(d) of the Act. The order passed by the DRT directing bank to proceed under the section during the pendency of the petition was upheld.
Can Co-operative Banks take action under SARFAESI Act - The provisions of this Act enabling co-operative banks to take resort to the Act cannot be challenged on the ground that members of co-operative banks are governed by the provisions of the bye-laws which inter-alia, provide for filing of suits before the Nominee, which cannot be nullified by the provisions of the present Act. The validity of Securitisation Act so far as inclusion of co-operative banks is concerned cannot be challenged on the ground that since provisions for recovery by a co-operative bank is already made under Gujarat Co-operative Societies Act and therefore remedy under any other law is excluded.
As per the SARFAESI Act, 2002 RBI is responsible for regulation and registration of the securitisation or reconstruction companies. Authorization has been provided to these companies to raise funds by issuing security receipts to a qualified institutional buyer. This has empowered the banks and financial institutions in taking the possession of securities which are given for financial assistance and can sell or lease the same to take over the management in case of a default. There are two main methods provided in the SARFAESI Act for recovery of non-performing assets :
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 securitisation 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 the rescheduling of payment of debts payable by the borrower enforcement of security interest in accordance with the provisions of this Act.
The SARFAESI Act further provides an exemption under the registration of security receipt. It means that when securitization company or reconstruction company issue 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, and extinguishing any right title or interest in an immovable property.
Appeals can be heard by the debt recovery tribunal against the banks and financial institutions where they have misused their powers. If a person is aggrieved by the order of Debt Recovery Tribunal then such person can file an appeal before the Appellate Tribunal within 30 days from the date of the order of Debt Recovery Tribunal.
The SARFAESI Act, 2002 allows High Court to entertain certain matters related to the implementation of the SARFAESI Act in the state of Jammu & Kashmir. However, High Courts have been entertaining writ petitions under article 226 (Power to issue writs) of the constitution of India.
The SARFAESI Act is not applicable to:
Regional Rural Banks
State Bank of India and their Associate banks
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