Securitisation and Reconstruction of Financial Assets and

Enforcement of Security Interests (SARFAESI Act,2002)

IntroductionBanks and financial institutions lends money by obtaining security, except for the category of clean loans. The security obtained is to act as a protection for the money advanced and in case of need, the money can be realized by the sale of securities.Lender’s right over the securities, both moveable and immoveable, for the realization of the amount advanced, were limited and less effective since they were required to take help of the legal system which was taking unduly long time to complete prior to passing of the sarfaesi act,2002.

The Act is a major step in financial sector reforms.Securitisation of financial assetsReconstruction of financial assetsRecognition of any ‘interest’ created in the security for due repayment of a loan as a ‘security interest’.Power to enforce such a security for the realization of money due to banks and financial institutions in the events of a default, without the intervention of the courts.Central registry for the purpose of registration of transaction of securitisation, reconstruction and the creation of the security interest.

The acts extends to whole of India including the state of Jammu & Kashmir. It is effective from 21 june, 2002.The act is applicable also to housing finance companies.The provision of the act, relating to enforcement of the security interest, applies to cases in which security interests are created for due repayment of financial assistance.

DefinitionsAppellate tribunalany person aggrieved by the order passed by the ‘debt recovery tribunal’ can file an appeal to the authority called as the ‘appellate tribunal’.Constituted by the central government for the various states as per the provision of the recovery of debts due to banks and financial institution act,1993.Asset reconstructionTakeover of loans or advances from the banks or financial institutions for the purpose of recovery is called asset reconstruction.

All the banking companies, Nationalised bank, the State Bank of India as well as its subsidiary banks and cooperative banks are within the meaning of the word ‘bank’ for the purpose of this Act.The word ‘board’ is used in this act to mean the securities & exchange board of India.The borrower means, any person, who has been granted financial assistance by any bank, who has given any guarantee, who has created any mortgage or pledge as a security for the financial assistance granted by any bank, a person who becomes the borrower of a securitisation.

Central registryThe ‘registering office’, set up or caused to be set up by the central government.All the transaction of asset securitisation, reconstruction as well as transactions of creation of security interests, will have to be registered with the authority.First come will be first served.Debt recovery tribunalTo deal with the cases of recovery of debts above `10 lakhs due to the banks and financial institutions.

DefaultWhen the borrower does not pay any principal debt on the principle debt to the secured creditor(NPA).For security enforcement, there should be a default committed by the borrower. The creditor must also be a secured creditor. Any insecured creditor has no right of any nature in this act.In mardia chemicals case, bank can classify the account as NPA as per its decision. the supreme court rejected this argument and stated that it should be done as per RBI guidelines only. whenever a bank grants loan or advances or issues letter of credit , it is called as financial assistance.

Financial assetClaim to any debt or receivables whether secured or insecured,Any debt secured by mortgage of or change in immoveable property,Any right or interest in the security, whether full or part, securing debt,Any beneficial interest in any moveable or immoveable property or in debt, receivables, whether such an interest is existing, future, accruing, conditional or contingent,Any financial assistance

Financial institutionA public financial institution within the meaning of Companies Act,1956.Any institution specified by central government under the recovery of debts due to Bank Act,1958.The ‘international finance corporation’ established under the international finance corporation.Any other institution or NBF company as defined in the RBI Act,1934, which the central government may specify as a financial institution for the purpose of this Act.NPAAsset or a/c of borrower classified by bank as sub-standard, doubtful asset, in accordance with the direction relating to asset classification issued by the reserve bank.It should be done as per the RBI directives.

HypothecationA charge inExisting or futureCreated by a borrowerIn favour of a secured creditorBefore this act, hypothecation was not mentioned anywhere although it is an very common type of charge on a security for a bank lending.OriginatorOwner of the financial asset(i.e) acquired by securitisation company for the purpose of securitisation.When bank lends money against security, they are the originator.

ObligorPerson liableTo pay to the originator, whether under a contract or otherwiseTo discharge any obligation in respect of a financial asset, whether existing, future, conditional or contingent,Includes a borrowerReconstruction companyCompany formed for the purpose of asset reconstruction and registered under the Companies Act,1956.

PropertyImmoveable propertyMoveable propertyAny debt or rights to receive payment of moneyReceivables, whether existing or futureIntangible assets such as patents rights, trademarks, licence, franchise.Property has been much explained in this act. Due to this, now security interest can be created against these properties for raising loans from the banks and financial institutions.Property has been priorly explained in acts such as transfer of property act, registration act, etc…

Qualified institutional buyerSuch buyer means a financial institutions or an insurance company or a bank or a state financial corporation or state industrial development corporation, making an investment on behalf of a mutual fund or provident fund or foreign institutional investor, registered under the SEBI Act,1992.Company registered under the companies act, 1956 can’t be a QIB.To be a QIB, then the company has to get such a registration from SEBI.

SecuritisationMeans acquisition of financial asset by the securitisation or reconstruction company from the originator. Such an acquisition may be by raising funds by such a securitisation from the QIB by issue of security receipts represents undivided interest in the financial assetsProcess where non-liquidated financial assets are converted into marketable securities(sold to investors).Process of converting the receivables and other assets into securities(placed in market for trading).As per guidelines of 29 march,2004, the minimum capital requirement for securitisation is 2 crore at time of registration and these companies are required to maintain capital adequacy of 15% of total asset acquired or 100 crores

SchemeThe company can raise funds from QIB by formulating schemes.Funds so raised are required to be maintained in, separate and distinct accounts.Scheme invites subscription to security receipts proposed to be issued by such a company.Securitisation companyCompany registered under the companies act,1956 for the purpose of securitisation. The securitisation company also needs a registration from the rbi.Can set up separate trusts scheme wise and act as trustee for such schemes, as provided in securitisation companies and reconstruction companies guidelines and directions,2003.

Security agreementAn agreement, instrument or any other document or arrangement under which the security interest is created in favour of the secured creditor.Includes creation of mortgage by deposit of title deeds with the secured creditors.Secured assetProperty on which a security interest is created.If the borrower has any property over which no security interest is created, such property is outside the purview of enforcement powers under the act.Security debtMeans debt which is secured by any security interest.

Secured creditorAny bank in whose favour the security interest is created by the borrower for due repayment is called as secured creditor.Includes debenture trustee appointed by any bank or financial institution or reconstruction company.Also includes, any other trustee holding securities on behalf of a bank or financial institution.SponsorAn entity holding not less than 10% of the paid-up equity capital of securitisation or reconstruction company.

Security interestAny right, title and interest of any kind whatsoever upon the property created in favour of any secured creditor is called as security interest.Whenever any lender takes any security from the borrower, the lender gets interest in that security.The type of interest depends on the nature of charge created over the security.Any type of charge has come under one wide scoped definition, called the security interest.

Security receiptReceipt security issued by a securitisation company to any qualified institutional buyer pursuant to a scheme evidencing the purchase by the holder thereof an undivided right, in the financial asset involved in securitisation is called as security receipts.It evidences the purchase’s undivided right, title and interest in the security. These receipts are transferable in the market.