Objective
The main objective behind the introduction of this act was the speedy and swift recovery of debts which are significant for the growing economy and matching the international standards determining the Banking sector though the introduction of Asset Reconstruction in the Indian Markets. The importance for the introduction of this act was necessitated with the huge backlog of cases that were already clogged in the system and inability of the preceding acts through which, institutions and creditors were unable to recover their assets and advanced loans. This act had indeed met the expectations devised from it and was successful in strengthening the Indian financial sector and improving debt recovery in India.
The Act also provided with the Right for the Enforcement of Security Interest on the secured asset by the creditor against the borrower. Security Interest is defined under Section 2 (1) (zf) of the SARFAESI Act, 2002 as an interest upon the property of the borrower created in the favor of the creditor for the facilitation of the loan or advances.
Asset Reconstruction Company
Asset Reconstruction Company (ARC) are the financial institutions which deals in the business of reconstructing and securitization of bad assets and loans of banks and other financial institutions.[1] Basically, they deal in the business of liquifying bad loans through the reconstruction of bad loans and assets. The intention behind the introduction of ARC through the SARFAESI Act was the facilitation of going concern so that the companies are not wound up rather are revived through the actions of these ARC’s. Suppose, a company is declared NPA and is unable to pay off its debt. Rather than wounding up the company to recover debt, ARC facilitate the sale of the secured assets to the company have greater value for them to recover bad debts.
RDDBFI Act, 1993
RDDBFI refers to Recovery of Debts Due to Banks and Financial Institutions Act, 1993, which was introduced with the intention of forming special courts for the recovery of debts in India. In 1991, the Narashmam committee suggested the formation of special tribunal for debt recovery which was based upon the recommendation of the Tiwray committee, 1981.
The enactment of this Act led to the formation of Debt Recovery Tribunal (DRT) which are specialized for adjudicating upon matters relating to recovery of debts. Before the advent of this act, the matters relating to recovery of Debts were tried before the civil courts, which were very slow and adjudication of matters before these courts were subjected to very long delays leading to increase institutional costs. Yet, this act failed to deliver an effective outcome on such issue where the disposal rate of the DRT was very alarming for which SARFAESI Act was brought into force in the year 2002.
The RDDBFI Act had its differences from SARFAESI Act, where only banks and financial institutions could approach the DRT for getting their matter adjudicated while any other secured and unsecured creditors could approach under the SARFESI act. Another astonishing provision under RDDBFI Act dealt with the pecuniary jurisdiction for matters approachable before the DRT in India. This pecuniary limit was subjected to Rs. 10,00,000 or more. Such limit was ineffective and not in line with the objects of the Act where the RBI had reported that roughly 4% of loans comprising about 75% of outstanding bank credit were potentially affected by such reform.[2] This limited the scope of the act from reaching its full potential.
Reasons for the introduction of SARFAESI Act, 2002
The banks were generating huge losses and the main reason behind these losses were the growing numbers of Non-Performing Assets (NPA) in their balance sheets. NPA could be defined as a loan or and advance to the borrower which are in default or in arrears where the reason for such default being the non-payment or failure to discharge the liabilities or installments of the loan or advance which has become outstanding for a period of 90 days or more after the date of repayment or installment.
Trends in Net NPAs before the SARFAESI Act, 2002.[3]
It is the basic understanding that NPAs are the smoking gun which are directly intimidating the very stability of the Indian banks and economy. NPAs not only destroy a bank’s profitability through a loss of interest income but also, is responsible for writing-off of the principal loan amount itself thereby, eroding their very own capital.[4] These NPA results into bad loans which are one among the many reasons for the collapse and downfall of the Yes Bank which had advanced loans to companies like DHFL, Reliance Group led by Anil Ambani, Essel group and many such companies that are in ruin or have declared themselves as bankrupt.
In Fatehchand Himmatlal, where debts of the agriculturists were wiped off, the Court observed:
“44. Every cause claims its martyr and if the law, necessitated by practical considerations, makes generalizations which hurt a few, it cannot be helped by the Court. Otherwise, the enforcement of the Debt Relief Act will turn into an enquiry into scrupulous and unscrupulous creditors, frustrating through endless litigation, the instant relief to the indebted which is the promise of the legislature.”[5]
The tribunal and courts adjudicating upon the matters for the recovery of debts were in serious condition which were clogged to their brim with the case and matters thereby delaying them to an indefinite period, while the creditors like banks and financial institutions were facing huge losses because of the growing number of NPA, were also getting saddled with these new costs for recovery of debts. In 1997, around 3.2 million original civil cases were pending at the district-level civil courts, of which more than 30% of these cases had been in process for longer than three years. What more could have said about the situation of the court in India where Disputes about asset liquidation appears to take even longer. In 1988, the Government of India had reported that more than 40% of the liquidation cases in 1985 had been pending longer than 8 years.[6]
Supreme court rulings
The Supreme Court in the Mardia Chemicals Ltd. Etc. Etc vs Union of India, 2004 the Act was challenged as being arbitrary and suffering from the vice of unreasonableness imposed due to the harsh steps taken against the borrower under sub-section (4) of Section 13, without providing any adequate remedy to the borrower. The court was of the view that certain provisions of the said act might be harsh but upholding the constitutional validity of this act is inescapable because of its growing necessity in the development of the country.[7]
In Apex Electricals v. ICICI Bank Limited, the court has upheld the validity of the SARFAESI Act.[8] Provision extending this Act to Cooperative Banks was also upheld. However, it was also held that the Banks should follow the principles of natural justice while following the procedure laid down under the SARFAESI Act and should allow the borrowers to submit their replies after receipt of notice demanding the borrowers to discharge their liabilities. Bank should also be considerate of the replies before taking any further action on possession and control of secured assets. This led to the insertion of Section 13(3A) which provides that the creditor must consider any representation or objection made by the borrower against the notice demanding the discharge of liabilities.
In Collector of Customs v. Nathella Sampathu Chetty, it is submitted that the intent of Parliament shall not be defeated merely for the reason that it may operate a bit harshly on a small section of public where it may be necessary to make such provisions of achieving the desired objectives to ensure that the nefarious activities of smuggling, etc. had to be necessarily curbed.[9]
The controversial provision of the SARFAESI Act
The major controversial provision brought by this act was Section 13(1) which provides with the right to Enforce Security Interest. Under this act, any security interest created in favor of any secured creditor, may be enforced, without the intervention of courts or tribunals. Basic pretext of this provision empowers the creditor in taking possession or control over the secured assets of the borrower without the intervention of the court or tribunal which could only be initiated after the loan had been termed as a non-performing asset by the bank. When the borrower who has taken a loan from a creditor, secured or unsecured, fails to repay such loan or part installment for consecutively 90 days, the creditor could term such borrower as a non-performing asset (NPA). Section 13(2) empowers the creditor to demand the discharge of liabilities by the borrower and the right to Enforce Security Interest. After the creditor declares the borrower as NPA, they can issue a notice to the borrower for discharging his liabilities in full within 60 days from the date of receipt of notice. Failing this notice, the creditor becomes entitled to exercise his rights provided under Section 13(4).
In the case of KMC Company V. Irving Trust Company, the court was of the view that the liquidity of finances is essential for the growth of the economy yet, the law should never be in derogation of rights conferred by the constitution.[10] Say, the debt is backed by a house property where the borrower resides. Taking possession over such property by the creditor could result in a clash against the Right to Life enshrined under Article 21 of the Constitution.
Conclusion
In conclusion, the SARFAESI Act of 2002 has emerged as a pivotal instrument for the growing Indian financial landscape, aimed at not only expediting the recovery of debts but, is also instrumental in bolstering the Indian banking sector. The Act has addressed a pressing need for an efficient mechanism which was required to handle the incessant problem of Non-Performing Assets (NPAs) that had been plaguing the Indian banks, resulting in substantial losses for them resulting into an adverse effect on the overall economic stability.
One of the Act’s significant achievements through the Act was the establishment of Asset Reconstruction Companies (ARCs), which has played a crucial role in the resolution of bad debts. By facilitating the reconstruction and securitization of assets, ARC had provided an alternative to the winding up of companies, contributing to the revival of businesses facing financial distress to the businesses that could effectively use such assets.
The introduction of SARFAESI Act was prompted by the limitations of its predecessor, the RDDBFI Act of 1993, which had struggled to deliver effective outcomes. While the Debt Recovery Tribunal (DRT) created under RDDBFI Act faced challenges such as slow disposal rates and limited jurisdiction, SARFAESI Act widened the scope by allowing both secured and unsecured creditors to seek remedies. The Act recognized the need for a more inclusive approach to address the diverse challenges faced by financial institutions.
However, the SARFAESI Act did not come without controversy, particularly with its provision under Section 13(1) granting creditors the right to enforce security interest without court intervention. This provision raised concerns about potential clashes with the fundamental rights, as taking a precedent from the of KMC Company v. Irving Trust Company. Because of this, the Act was challenged before the court based on its constitutional validity. The delicate balance between the imperative of financial liquidity and the protection of individual rights underscored the ongoing debates surrounding the Act. This led to an irrelevant delay in its enforcement.
In essence, the SARFAESI Act stands as a crucial legislative intervention that has significantly contributed to the restructuring of India’s financial landscape. Its provisions have not only empowered creditors but also necessitated a careful balance between economic imperatives and individual rights.
As the financial sector continues to evolve, the Act remains a cornerstone in the ongoing dialogue between economic progress and legal safeguards.
SUBMITTED BY: SOHAM BANSAL, 3RD YEAR LAW, SYMBIOSIS LAW SCHOOL, NAGPUR
[1] Arshit Kapoor and Srilagna Dash, Asset Reconstruction Companies as Resolution Applicants: Revisiting the SARFAESI’s Limitations, 2023, IndiaCorpLaw, https://indiacorplaw.in/2023/01/asset-reconstruction-companies-as-resolution-applicants-revisiting-the-sarfaesis-limitations.html#:~:text=Asset%20Reconstruction%20Companies%20(%E2%80%9CARCs%E2%80%9D,2002%20(%E2%80%9CSARFAESI%E2%80%9D).
[2] Reserve Bank of India, Report of the Working Group to Review the Functioning of Debts Recovery Tribunals, 1998.
[3] Anupam Panigrahi, Kalyan Suman & Suman Chaudhary, The Impact of Sarfaesi Act 2002 in Reducing Non-Performing Assets of Indian Scheduled Commercial Banks, Asia Pacific Journal of Research, 2017, https://www.researchgate.net/publication/340809636_THE_IMPACT_OF_SARFAESI_ACT_2002_IN_REDUCING_NON-PERFORMING_ASSETS_OF_INDIAN_SCHEDULED_COMMERCIAL_BANKS.
[4] SN Bidani, Managing Nonperforming Assets in Banks, Vision Book Private Ltd., New Delhi, 2002.
[5] (1977) 2 SCC 670.
[6] Government of India, Analysis of Institution, Disposal and Pendency of Civil and Criminal Cases in District and Subordinate Courts in the States and Union Territories for 1997, 2000 No. 13011/34/99-Jus(M).
[7] (2004) 4 SCC 311.
[8] (2003) 46 SCL 592.
[9] (1962) 3 SCR 786.
[10] 757 F 2d 752 (6th Cir 1985).
DUCTUS EDGE 