securitisation act in india

8/3/2019 Securitisation Act in India

1/42

Click to edit Master subtitle style

Corporate insolvency by Vinod Kothari

Securitisation Act(SARFAESI Act)Provisions on Asset Reconstruction andEnforcement of Security Interests

Vinod Kothari1012 Krishna224 AJC Bose RoadCalcutta 700 017

Phone 033-23233863/23233864/22811276/22817715/22813742Fax 91-33-23233863/22811276Email: [email protected]; [email protected]
mailto:[email protected]:[email protected]


2/42

Cor orate insolvenc bCor orate insolvenc b22

Copyright information

All rights reserved with VinodKothari.The presentation is to be used only for thepurpose of the training course/meeting/class forwhich it is intended and any use of any part of it,other than for distribution at such trainingcourse/meeting/class is unauthorized.

No rights of any kind have been transferred insoft copy of the presentation, meant only for thepurpose of printing. The soft copy should bepurged immediately after printing.

No copying or distribution of this presentation inany form is allowed except with the expresspermission of the author.


3/42



Provisions of SARFAESI Act onReconstruction Companies


4/42


Meaning of reconstruction and ARCs

l Reconstruction not definedl reconstruction company is a company formed

for reconstruction

l General commercial meaning to be adopted

l Essential provisions of law for securitisationcompanies and ARCs the same; purpose anddifferent to be observed in practice, not in law

l Single or multiple ARCs: in line with East Asian experience, Govt seems

inclined to opt for a consolidated ARC


5/42


Nature of ARCs

Originator

(s)

NPLs

owning

Reconstruct

ioncompany

Transfers at fairvalue

Securitisation

QIBs

debentures

Other means


6/42


Who can form ARCs

l

ARCs do not need to be government-sponsored; anyonewith the requisites can form an ARCl Private ARCs:

since sale of NPLs by ARCs not specifically provided for,private debt resolution companies wanting to buy NPLs mayhave to form their own ARCs

privileges of ARCs:l all powers of ARCs/ powers of enforcement of security interest

applicable to such ARCsl bankers may find it convenient to sell down NPLs to private

buyers with ARCs than to enforce/ restructure loans themselves

l

Requisites: similar to securitisation company no losses for 3 years condition for continued registration may

be difficult, since most ARCs do incur losses


7/42Cor orate insolvenc bCor orate insolvenc b77

Process of acquisition of assets

l

Acquisition of assets by ARCs to be by transferl Provision to issue debentures - as in case of RTC, USA; could be

zero coupon bond

l Transfer understandably at fair value

l transfer by agreement

l Legal impact of transfer the same as in case of securitisationcompanies: transfer of loans with securities

power of notification

fractional transfers liable to problems



Special legal powers of ARCs

l

Sec 9 provides distinctive legal powers change in or takeover of management sale or lease of a part or whole of business rescheduling enforcement of security interests and taking possession of

assets - same as permitted to any other lender power of settlement

l Power of takeover/ forcing sale of business is the onlydistinctive power

l Since secured creditor includes ARCs, powers under

sec 15 applicable to ARCs also compulsory change in directors or officers sec 15 (4) - secured creditor on realisation of his debt to

restore management;l debt could be the original debt or debt of the ARC



Funding of ARCs

l

Issuance of debentures and securitisation seem two alternativeroutes

l It does not sound logical to issue debentures and also securitise

l If debenture route adopted: whether secured or unsecured? Whether coupon or zero coupon

whether amortising, bullet payment, soft bullet?l If securitisation route adopted:

ability to give further funding limited post-securitisation restructuring of loans difficult substantial recourse to originating bank may put questions on true

sale

l Combination of the two: QIBs are senior investors on soft-bullet basis originating bank as a subordinated debentureholder



Stamp duty issues

l SARFAESI Act does not specifically answer the stampduty issue

l Stamp duty may be applicable on each of these: transfer of assets to the ARC

issue of debentures by ARC in return

issue of other security receipts by ARC

further transfer/ sale of the acquired assets by the ARC

decree for transfer of any charged assets in favour of the ARCor any one else

transfer of debentures by the holders transfer of security receipts by the holders



Manner of resolution and sales

l In order that ARC is not another BIFR, ARCs must begiven commercial discretion to sell down the NPLs

l SARFAESI Act provides for acquisition of financialassets by ARCs, not for sale of financial assets

l Sale is a crucial provision - in most countries, bad loans

have been sold by ARCs Korea Thailand and China

l Sale of NPLs by the ARC: no specific provisions in the SARFAESI Act procedure of sec 130 applicable

stamping issues, notification etc transfer of mortgages may further complicate sale



Impact on originator banks

l

Transfer of NPLs by originating banks to ARCs to giverise to: gain on sale

loss on sale

l If unprovided book value exceeds the fair value of the

loans, banks may have to write losses, affecting profits,capital adequacy

l Retention of subordinated interest by banks may beideal solution



SARC (RBI) Directions

l

RBI has promulgated SARC Guidelines and Directionsvide a 23rd April 2003 notification

l Policy-making: SARCs must make policies w.r.t acquisition of financial assets

change in management or takeovers: guidelines to be issued

by RBI. Rescheduling of assets

Acquisition of assets by enforcement of security interests: onlyif the assets are sold by public auction

Settlement

Plan for realisation issuance of security receipts



Issue of security receipts

l

Para 8 seems to have accepted the trust modeas a standard practice for SARCs: mistaken notion: transfer of assets to trusts. Appropriately SARC must acquire assets and hold

them as trustees. There is no transfer between the

SARC and the trust. Security receipts to be offered and be transferable to

only QIBss

l Disclosures for issuance of security receipts

laid down: initial disclosures quarterly disclosures



Capital adequacy requirements

l

15% capital adequacy ratio laid down forSARCs

l Para para 2, this is not applicable in case ofassets held in the name of trusts:

therefore, the requirement of capital adequacy isrendered nugatory.

l However, if the SARC continues to hold anyresidual interest in the trust or a first loss piece,

the trust could be said to be subsidiary of the



Asset classification by SARCs

l

During planning period, assets acquired forreconstruction to be treated as standard: planning period is a period of 12 months or until

reconstruction plan is made, whichever is earlier

l On rescheduling or renegotiation, assetssubstandard

l To be upgraded into standard after 12 monthsperformance

l provisioning requirements: on similar lines as

for banksl Requirements inapplicable in case of assets

held by trusts



Disclosures on the balance sheet

l

Names of transferring banks, and the value atwhich these assets were acquired: most unwarranted disclosure

l Dispersion of assets by industry and sponsor

l Migration of financial assets

l This is also inapplicable to assets held as atrustee



Directions to banks

l Only NPAs can be sold to SARCs

literally interpreted, this guideline proscribes any CLOs ofperforming assets

l Sale should qualify for off-balance sheet treatment, andthere should not be any known liability devolving on thetransferor:

vague statement:l representations and warranties commonl any credit enhancement is a known liability

does it imply non-recourse transfer only?

l Transfer price must be non-contingent. Deferred sale

proceeds not allowed. But banks may share the surplus: the surplus is nothing but non-contingent consideration. Only it

cannot be booked into profit immediately. Equivalent to 100% provisioning for the retained interest



Directions to banks ..2

l

On sale: the asset will be removed from books

gain/loss on sale will be written off

l In case the gain is by way of reversal of provisions, thesame shall be used to meet deficits on other assets.

l Securities issued by SARC: must not have a term of more than 6 years (legal final?)

carry at least a rate of Bank rate + 150 bpsl zero coupon bonds ruled out

the commitment to pay must be unconditional and not basedon realisation the SARC:l this would not be possible in case of transfer to trusts: in case of

any SPV, unconditional undertaking to pay has no meaning


20/42



Provisions of SARFAESI Act onEnforcement of Security Interests



Meaning of security interests

l Security interest under the law has 4 elements:

secured debt/ financial assistance

security interest

secured creditor

borrower

l Sec 2 (1) (zf) - right title and interest of any kind whatsoever, including mortgage,charge, hypothecation, assignment

l right title orinterest - obviously meaning those created for security

l Mortgage - sec 58 of TP Act is limited to immovable property. Generally, conferring anyright to a lender to sell property on default

l Hypothecation - sec. 2 (1) (n) - all charges except a pledge

l Charge - by itself, does not mean anything but security interest. Sec 100 of TP Act - asecurity interest not being a mortgage. Any interest in property defeasible or

destructible on repayment of a debt - Bond Worth Limited(1980) Chl Assignment - assignment by way of security, and not assignment by way of transfer



Ingredients of a charge

l

Meaning of security interest - a right to sell property torealise a debt. In Cossletts case, a right of a contractee to sell contractors

equipment was held to be a security interest

l Charge is related to debt. A charge secures a debt,does not create a debt.

l Ownership interest may also amount to a charge -conditional sale or reversible sale.

l Charge should be co-terminus with the debtl Property, present or future should be made available.

l Floating charges do not relate to any property unlessfixed: ruling in Brumark Investments and Cosslett

l Mere restraint on property is not a charge



Financial assistance

l Building block of relationship between a borrower and secured lender.l Loan advance granted

intends to include originated loans, not acquired loans

l debentures or bonds subscribed purchased debentures cannot be included

l guarantees given or letter of credit established

obviously, lead to a financial assistance only when principal debtor defaults

l any other credit facility - makes it an inclusive definition; other similarfacilities to be included

l Are these included? Discounting of bills of exchange any purchase or sale of securities

any lease or hire purchase transaction factoring transaction amounting to purchase of factored debt securitisation investments purchase of commercial paper



Secured creditor - sec 2 (1) (zd)

l Bankl financial institution:

Includes power to notify financial companies

l In case of debentures:

unsecured debentures do not seem to be covered (last lineof definition)

secured debentures - rights exercisable by trustees

l debenture trustee appointed by any bank or financialinstitution:

misnotion- debenture trustees are appointed by thecharge-creator and assented to by the beneficiary

could create confusion where debentures are held by non-banks as well

l securitisation company and reconstruction company

l any other trustee holding securities on behalf of a bank

"secured creditor" means any

bank or financial institution orany consortium or group ofbanks or financial institutionsand includes-

.debenture trustee appointedby any bank or financialinstitution; or

.securitisation company orreconstruction company; or

any other trustee holdingsecurities on behalf on a bank orfinancial institution, in whosefavour security interest is createdfor due repayment by anyborrower of any financial

assistance;


25/42


Borrower

l

Key word is financial assistancel Any person who has availed of financial assistance

l guarantor: guarantee as defined in sec.126 of Contracts Act does not include contracts of indemnity consent of the principal debtor important issue: can rights under the law be enforced against the guarantor as

principal obligor- apparently yes

l provider of security only mortgage and pledge included here usually security provider will also be a guarantor

l borrower of securitisation companyl makes no distinction between corporate and non-corporate

borrower

l Continued relation between lender and borrower important - afterassignment, lender cannot operate against the borrower


26/42


Secured asset

l

Meaning is important, as the rights under the lawexercisable against secured assetsl Sec 2 (1) (zc) - assets over which security interest

createdl Requisites:

the security interest must be specific to the asset the interest must be in the nature of security interest

l Floating charges: interest does not become specific untilreceivership/ winding up action

l Can the process of this law be taken as receivership?

The rights to take possession of the assets under this law areakin to rights of a debentureholder to appoint receivers u/s 123

The process under this law should amount to crystallisation ofthe charge

however sec 13 (13) may create difficulties


27/42


Exceptions under sec. 31

l Lien on goods, money or security under Contracts law or Sale of Goods Act:

a very confusion clause, as essentially, all security interests are liens and all such liens bycontract of parties are given under Contracts law

intent to exclude bailee lien u/s 170, bankers lien u/s 171

unpaid sellers lien u/s 47 of Sale of Goods Act

l pledge generic rights under Contracts law applicable

l creation of security in any aircraft

l creation of security in vessels

l conditional sale, hire purchase or lease or any other contract in which no securityinterest has been created exclusion of conditional sale unreasonable; conditional sales regarded as lending transactions

- Sundaram Finance v State of Kerala

l rights of unpaid seller

l

properties not liable for attachment under CPC: exclusions under sec. 60 of CPC; most include personal effects, LIP, public provident fund

l where financial assistance not exceeding Rs 1 lac

l where dues are less than 20% of principal and interest

l agricultural land

E f t f it / 13


28/42


Enforcement of security u/s 13

l Sec. 13 overrides sec. 69/ 69A of TP Act, not however, sec. 67 However, by sec 35, the SARFAESI Act overrides all laws in the country.

Sec. 67 (a) puts an important distinction between right of foreclosure and right of sale. Anormal charge holder has a right of sale, not right of possession

Remedies under this law are not to the exclusion of other rights - e.g., DRT proceedings,decree of Civil Courts

l Requisites for action u/s 13:

borrower, under liability to secured lender makes default in repaymentof a secured debt or instalment: any default of agreement

cannot trigger the power

account classified as NPA under RBI norms: bankers books to be evidence

creditor requires borrower in writing to discharge all his liability within 60 days of notice

notice to specify amounts due and the details of secured assets

effect of notice:freeze on sale lease or transfer u/s 13 (13)

freeze in case of floating charges? Details of secured assets?l Notice only demands payments. Does not amount to receivership.

l Rights under sec 13 (1): are rights to enforce security interest; do not confer any new rights not implied by the

agreement between parties. It is only the interest created which can be enforced.

principles of natural justice applicable

F l ti t t / 13 (13)


29/42


Freeze relating to assets u/s 13 (13)

l

Receipt of notice u/s 13 (2) would put a freeze on transfer ofsecured assets secured assets only subject to injunction

details whereof given in the notice u/s 13 (2)

l analogous provision - sec 19 (12) of RDB Act; order 39 rule 1 ofCPC

l Under CPC, a Court may order injunction - exercise of discretion.

l No discretion under this law - hence principles of balance ofconvenience etc have no place

l Floating charges saved - exception in case of sale in ordinary

course of businessl Restraint only against transfer - not against creation of further

charges; encumbrances: can be used for stone-walling


30/42


Measures to be taken

l Measures against the secured assets Taking possession of the secured assets of the borrower: does it include right to use

assets - No

transfer by way of lease, assignment or sale

take over the management of the secured assets - does not mean takeover ofmanagement of business

appoint a manager to manage the assets possession of which has been taken

require by notice a person who has bought the secured assets to pay for such asset to thelender - this envisages payment for secured assets subject fo fixed charge

l measures u/s 13 (4) limited and cannot be expanded - for example, no power toforce a sale without taking possession or management

l recover expenses for action u/s 13 (4) - sec 13 (7)

l proceeding against guarantors/ pledged assets - primary right u/s 13 (11)

l proceeding for balance due under DRTs or competent Court - as the case maybe implies RDB Act allocation

l Provisions in case of company under liquidation - sec. 529A of Companies Act tobe applicable

l Limitation Act applicable - debts barred by limitation cannot be enforced under thislaw


31/42


Taking possession u/s 13 (4)

l Purpose of the law is to enforce security interest, not to allow a lenderthe interest of an asset owner.

l Taking of possession does not amount to transfer of title

l Taking of possession is only for the purpose of realisation of security -

position similar to receiverships under Order 40, rule 1 of CPC

difference - Civil law receiverships are for preservation of subject matter; thislaw is for sale

l Use of reasonable force permitted for possession - Blade v. Higgs (1861)10 CBNS 713.

l Position of lender taking repossession and sale discussed in severalEnglish rulings: lender in possession is not a trustee for the borrower

l Sec 13 (4) to be read with sec 13 (7) - attempts of sale of the assetshould follow forthwith upon possession

l In respect of sale proceeds, the lender is accountable to borrower

l Lender not allowed to use the asset: all usufructs belong to the borrower


32/42


Taking over management of assets

l Right of taking over management also conditioned by the basicpurpose of the law - security interest

l However, sale of assets is not permissible u/s 13 (6) withouttaking over possession or management, either of the two is amust

l As the purpose of possession is to make a sale, banks may beinclined to avoid difficulties of possession by appointing amanager instead

l Nature of the functions of a manager - asset-specific


33/42


Injunction against confiscation action

l An important question is - can a borrower seek injunction against aconfiscation action u/s 13 (4) (a)

l Appeal lies against confiscation u/s 17 (1) within 45 days ofmeasures having been taken.

l May imply post-facto appeal, not stay of action

l Section 34 ousts jurisdiction of civil courts on a matter wherepowers conferred to DRTs

l Ouster is not total but specific

l By sec 9 of CPC, civil courts have jurisdiction on all matters exceptwhere barred

l Can it be implied that civil court jurisdiction remains for injunctionagainst an action?: No, SC in Mardia Chemicals

M f l t f f t


34/42


Manner of sale or transfer of assets

l Equity of redemption is an important right of a borrower and any clause putting aclog on equity is invalid.

l Present law gives to the borrower a right to pay within 60 days of notice

l in addition, at any time before sale or transfer, the borrower may clear his duesand prevent the asset from being sold - sec 13 (8) This implies the asset cannot be sold without notice to borrower

borrower has a pre-emptive right to purchase the asset himselfl 30 days notice required before sale: Security Interest Enforcement Rules

l Also by implication, the sale cannot be made at the back of the borrower: preferably a public sale

sale at best price as the borrower gets discharge to the extent of amount paid - sec. 13 (5)

borrowers right to moneys collected by the seller after appropriation - sec 13 (7)

l Transferee to get all the rights as if the owner of the assets has transferred thesame: subject to all the equities of the previous owner

l Can the lender sell the asset to himself - no as implicitly there is a trust betweenthe lender and the borrower; adversary title to beneficiary not permitted


35/42


Rules of natural justice

l In Mahesh Chandra vs. UP Finance Corporation 78 Comp Cas 1,SC set important rules of natural justice in repossession. Thetechnicalities implied by these rules have been overruled by theSC in Jagadamba Oil Mills case but the rules of natural justicecontinue to apply.

l The following are implicitly still applicable: Attempt must be made for best possible price - easiest indication is a

public auction.

Borrower must always be given a right of first refusal or improvingupon the price

The sale must not be made at the back of the borrower


36/42


Priorities and pari-passu interests

l In case of financing of a financial asset by more than one lender, 3/4th sanction invalue to be obtained before any or all right u/s 13 (4) is exercised. Wrong use - should be read as financing of the secured asset

financing of the secured asset cannot be limited to a case where the acquisition of the assetwas primarily funded by a lender

l Financing of the secured asset confusing:

proper meaning is, where security interest on a secured asset held by more than one lender consent of 3/4th of the lenders required before any action u/s 13 (4)

record date -meaning circular and inconclusive - the date is agreed upon at time when thedetermination of the date itself requires 3/4 th sanction

3/4th in value refers to amount outstandingl evidence of amount outstanding - books of the borrower made evidence

l stone-walling action possible:

l

creation of subordinate charges in favour of a friendly lender question of priorities not at all considered by the law - lenders having subordinate charges put

at par with other lenders

l If lenders take such action, their mutual prioritisation not laid down. Rules of sec. 529of Companies Act and insolvency laws [sec. 61 of Provincial Insolvency Act] to applyon priorities.

l Pari passu rule is an important rule of equity - contracting it out is against public

policy -McMillan and Lockwoord1992 NZ Court of Appeal

P i iti b t fi d d fl ti h


37/42


Priorities between fixed and floating charges

l As a trite law, fixed charges will have a priority over floatingcharges.

l Determination of multiple financiers on an asset has no betteranswer than charge-holder holding charges.

l The most practical view, therefore, is chargeholders holding fixed

charges on the asset need to take a decision (75% voting) onaction under sec. 13 (4).

l Floating chargeholders cannot be said to be holding a securityinterest in the asset until the charge crystallised.

l Will subordinate charge-holders rank equally for voting -

apparently yes


38/42


Overriding Preferential claims

l

Provisions relating to preferential claims made applicable onlywhere the company is in liquidation

l where the company is in liquidation, sec 28 (6) of ProvincialInsolvency Act saves the rights of the secured creditors.

l This law appropriately overrides. However, subject to preferentialclaims.

l Appropriately, the provisions should be applicable even where thecompany is not in liquidation: sec 123 (1) of the Companies Act requires any receiver to forthwith

pay the debts which are preferential claims in case of debentures, the provisions of sec 123 shall be applicable

notwithstanding the SARFAESI Act

Sec. 529A of the Companies Act also contains a notwithstandingclause

l Sec 529A - workers dues and dues of secured creditors takepriority over other debts

l Leave of Companies Court not required in case of companiesunder winding up -Allahabad BankvCanara Bank(SC)


39/42


Enforcement of possession -sec 14

l

For forcing possession of assets, possession by order ofCMM or DM of appropriate jurisdiction may berequested. Does not bar self-help possession.

Any action taken in good faith protected u/s 32

l CMM/ DM shall do the samel No court shall call to question the action of any CMM /

DM

l Principle of exclusive jurisdiction in case of DRTs has

been approved by the SC inAllahabad Bankv CanaraBank101 Comp Cas 64 (2001)


40/42


Takeover of management

l Sec. 15 talks of takeover of management of business while the power

under sec. 13 (4) (b) is only to take over management of assetsl Sec 15 clearly exceeds sec. 13 (4).

l Sec 15 also divergent from the scheme of the SARFAESI Act onenforcement of security: the powers granted under the law can be usedonly to enforce security and not to run businesses: Delhi High Court ruling in Micronix India 96 Comp Cas 950 - vestation of

proeprty in the SFC only for enforcing security interest

l Takeover of management only in case of ARCs and securitisationcompanies u/s 9.

l Takeover of assets u/s 13 (4) can only lead to sale of assets - not theirrunning by the lender. Essential rule of foreclosure versus sale

l Appointment of directors/ administrator to be appointed by the securedcreditors notice in newspapers

on publication of notice, existing directors shall vacate office creditor-directors shall take over the office/ assets

l sec 15 (3) overrides the Companies Act.

l Sec 15 (4) - restoration of management

A l DRT


41/42


Appeals to DRT

l Surprisingly, number of secured creditors may not come under

DRT jurisdiction, but appellate powers conferred on DRTs.l Appeal within 45 days of measures having been taken

l Jurisdiction - jurisdiction under sec. 19 (1) of DRT law is based onthe borrowers residence

l Cannot do away with powers of making an appeal even before themeasures are taken.

l Sec 19 (12) allows DRT to order injunction

l Deposit of 75% of the notice amount Struck down by Supreme Court in Mardia Chemicals

l Appeal to Appellate Tribunal within 30 days

l The appellate authorities may hold the possession unauthorised

and order compensation.

Unresolved issues on possession/ sale of assets


42/42

Unresolved issues on possession/ sale of assets

l Claims of the Government - rights of a secured creditor rank above the

claims of the government - Bank of Biharv State of Bihar(1971) SC andSitani Textiles 98 Comp Cas.(AP)

l whether involvement of liquidator necessary in case of companies underliquidation - divergent view: Kerala HC held liquidator s involvement required: Titus Daniel101 Comp Cas

117; Pennar Paterson - AP HC 106 Comp Cas 338 (power of advocatecommissioner appointed by DRT subject to leave of company court)

l Can a view be taken that of the two alternate remedies:

DRT proceedings

direct action under this law

this law should be resorted only as a remedy of last resort? A debatable issue

l Can sale be made after repossession by instalments? Can banker give

credit to new buyer? How does original borrower get credit?

securitisation act in india

Documents