The financial sector has been one of the key drivers in India's efforts to achieve success in rapidly developing its economy. While the banking industry in India is progressively complying with the banking and financial prudential norms and accounting practices, therein Securitisation has emerged as an important tool in the flourishing of the current configuration of the financial sector. Banks all over the world are engaged in transforming loans and lending risks into capital market securities and selling the same. The economic logic for securitisation is so influential that the trend towards securitisation knows no limits. Capital markets are today a place where everything is traded: from claims over entities to claims over assets, to risks, and rewards. Thereby it can be said that it is a process of converting something, which is not a security in to a security
Considering the Indian scenario, the securitisation potential in India is huge. With increasing aspirations of Indian consumers, today credit growth is taking place at an unprecedented pace and the much slower pace of deposit mobilisation is inadequate to keep the growth momentum going. In such a situation, banks and non- banking finance companies strapped for funds need to identify alternate sustainable funding sources to supplement existing ones. Securitisation is an ideal option for originators allowing them to sustain growth, leverage existing capital and manage risks. Investors benefit by accessing a constant supply of highly rated instruments tailored to their requirements and offering better yields. The need for securitisation is significant and present day's financial markets would not have been what they are, unless some standard thing that market players could buy and sell, that is, financial securities, were available.
Keeping in mind the impact of Securitisation in the Indian markets and its potential prospects the project has been undertaken. The purpose of the study is to make in-depth analysis of the provisions related to securitisation prevalent in the Indian legal system and the Indian market. The study also aims at underlying the various causes and consequences related to the emergence of new trends pertaining to the provision. The main emphasis is to study the different avenue and suggest a workable analysis to the existing procedure. The study is primarily a legal exploration addressing itself to the trends and current analysis of the subject and provisions involved. Though the study is referring to a vast topic but then the prime concern is SARFAESI Act, 2002 and the provisions therein.
The project has been undertaken with the aim of appreciating the concept of securitisation and the main feature is to analyse the varied laws prevalent in the legal system for the advancement of securitisation in the Indian markets. In the project following legal questions have been put forth and have been attempted to be answered through the length of the project:-
I. Whether securitisation as a tool of structured finance is needed in the Indian markets ?
II. Whether the legal outline enables securitisation in an unsurpassed mode and the provisions are apposite and adequate in the present Indian scenario?
III. Whether the legal framework is free from lacunas and is efficient in enabling structured finance in the Indian market?
The project has been made using the doctrinal method of research methodology by using the discovery and development of legal doctrines based on published materials, such as legal texts, law journals, reported and unreported judgments; official documents, drafts and bills prepared by legal academicians as the project consists of a simple research directed at finding a specific statement of the law in depth analysis of legal reasoning therein.
II. CONCEPTUALISING SECURITISATION
Securitisation is one of the most prominent developments in the recent decade in the financial sector with its new-fangled gadgets of high finance. Apart from investments, assets of a bank include loans. The foremost distinguishing feature between the investment assets and the loan assets is the feature of transferability and being tradable. Investments assets have the advantage of liquidity which implies that they can be converted into cash quickly while the loan assets lack this feature in totality of being liquid in nature. Also maintaining adequate liquidity is one of the hallmarks of a healthy and throbbing banking system. So, the problem which comes up was how to make loan assets liquid in nature, thereby contributing to the liquidity. With this emerges the innovative and clever idea of transforming loans into securities imparting the feature of marketability. This process is called as Securitisation. It is a process of liquidizing assets appearing in the balance sheet of a Bank or financial institution which represent long term receivables by issuing marketable securities there against.
In financial terminologies, Securitisation is the process of taking group of loans and then splitting them into different classes of securities which in turn is sold to third party investors . It can further be elaborated by stating that it is a process through which illiquid assets are transferred into a more liquid form of assets and distributed to a broad range of investors through capital markets ; It is a form of structured financing where an entity seeks to pool together its interest in identifiable cash flows over time, transfer the same to investors either with or without the support of future collaterals, and achieve the purpose of financing. In plain words, it can be understood as a process of converting something, which is not a security in to a security. It involves a transfer of outstanding balances in loans and advances and packaging into transferable and tradable securities. The name securitization is derived from the fact that the form of financial instruments used to obtain funds from the investors is securities. All assets can be securitised so long as they are associated with cash flow. Hence, the securities which are the outcome of securitisation processes are termed asset-backed securities. From this perspective, securitisation could also be defined as a financial process leading to an issue of an Asset Backed Security.
Securitisation involves the raising of finance which is generally the debt by issuing securities in the market. The borrower will raise funds directly from the market investor as opposed to seeking finance from the banking system in the form of a bank loan or overdraft. This type of securitisation gradually leads to the erosion of the traditional role of banks as providers of loan capital; this form may be regarded as primary securitisation. The second and the more recent form of securitisation includes the pooling and repackaging of existing loan assets into securities which are then sold to market investors, removing the assets from the originators balance sheet. This form is called as secondary securitisation.
Securitisation occurs when an entity pools together its interest in identifiable cash flows over time, transfers the same to investors either with or without the support of further collaterals, and thereby achieve the purpose of financing. In other words, if multiple customers owe company money, securitisation allows that company to access the securities markest to get a loan secured by the aggregate value of these customer accounts.
A very basic illustration of the process of securitisation would be as follows: X Bank loans 10 people Rs100, 000 a piece, which they will use to buy homes. X Bank has invested in the success and failure of those 10 home buyers, if the buyers make their payments and pay off the loans, X Bank makes a profit. Also if we look at it in another way, X Bank has taken the risk that some borrowers won't repay the loan. In exchange for taking that risk, the borrowers pay X Bank interest on the money they borrow. From the perspective of X Bank, those loans are 10 different assets. They have value- one, if the loan fails, X Bank takes ownership of the house. Two, if the loan succeeds, X Bank gets their money back along with the interest they charge. X Bank can do two things with those loans. They can hold them for 20 years and, they would hope, make a profit on their investment. Or they could sell them to some other investor, and walk away. In doing this, they would make less profit than if they held onto them long term, but they would benefit in that they make some profit while also getting their original investment back. They give up some of the profit in exchange for not having face the risk. So X Bank decides they would rather have the cash now. They could sell those 10 loans to 10 investors. Each investor would be taking a risk in buying those loans, because if any loan defaults, that one investor loses.
The present-day meaning of securitisation is a blend of two forces that are critical in current world of finance: structured finance and capital markets. Securitisation leads to structured finance as the resulting security is not a generic risk in entity that securitises its assets but in specific assets or cashflows of such entity. Secondly, the idea of securitisation is to create a capital market product - that is, it results into creation of a "security" which is a marketable product. This meaning of securitisation can be further expressed in various words:-
' Securitisation is the process of commoditisation - The basic idea is to take the outcome of this process into the market, the capital market. Thus, the result of every securitisation process, whatever might be the area to which it is applied, is to create certain instruments which can be placed in the market.
' Securitisation is the process of integration and differentiation - The entity that securitises its assets first pools them together into a common hotchpots (assuming it is not one asset but several assets, as is normally the case). This is the process of integration. Then, the pool itself is broken into instruments of fixed denomination. This is the process of differentiation.
' Securitisation is the process of de-construction of an entity - If one envisages an entity's assets as being composed of claims to various cash flows, the process of securitisation would split apart these cash flows into different buckets, classify them, and sell these classified parts to different investors as per their needs. Thus, securitisation breaks the entity into various sub-sets.
GENESIS OF SECURITISATION
The first structured asset securitisation occurred in 1970 in the United States when the newly created Government National Mortgage Association began publicly trading in securities backed by a pool of mortgage loans. These securities, known as 'mortgage pass through securities', facilitated the investors to purchase a fractional undivided interest in a pool of mortgage loans be providing for a share in interest income and in the principal payments generated by the underlying mortgage. Increasing pools of mortgage, the lenders were careful to put together those assets with similar characteristics in regards to quality, term and interest rate. The pool of mortgages placed with a trust was actually sold in the form of certificates to investors, either directly or through private placement.
In recent years, more complex securitisation structures have been evolved to provide some classes of investors with an instrument that has more certain maturity, average life and more predictable average yield. New features have added complexity to asset securitisation, but have enhanced marketability of Mortgage-Based Securities (MBS) or Asset Backed Securities (ABS) in a big way.
In the U.S, asset securitisation has grown on a large scale since its beginning in 1970 and the annual issuance of securities backed by assets other than mortgage increased to almost $60 billion by the end of 2000.
The asset backed securities market in the U.S, however, is dominated by securities backed by automobile loans, credit card receivables, computer and automobile leases, mortgaged home receivables, insurance premium receivables, etc.
Securitisation is a more recent development in the United Kingdom compared to the U.S. the first mortgage securitisation issue arranged in London for the international market was MINI, a 50 million refinancing of certain Bank of America Finance Ltd. U.K. property mortgages launched in 1985. Thereafter, the business has taken off in both variety and forms.
NEED OF SECURITISATION
The generic need for securitisation is as mature as that for organised financial markets. A financial relation invariably needs the coming together and remaining together of two entities. Not that the two entities would necessarily come together of their own, or directly. They might involve a number of financial intermediaries in the process, but nevertheless, a relation involves a fixity over a certain time. Generally, financial relations are created to back another financial relation, such as a loan being taken to acquire an asset, and in that case, the needed fixed period of the relation hinges on the other which it seeks to back-up.
Financial markets have developed in response to the need to involve a large number of investors in the market place. As the number of investors keeps on increasing, the average size per investors keeps on coming down -this is a simple rule of the marketplace, because growing size means involvement of a wider base of investors. The small investor is not a professional investor: he is not as such in the business of investments. Hence, he needs an instrument which is easier to understand, and is liquid. These two needs set the stage for evolution of financial instruments which would convert financial claims into liquid, easy to understand and homogenous products, at times carrying certified quality labels (credit-ratings or security ) , which would be available in small denominations to suit every one's purse. Thus, securitisation in a generic sense is basic to the world of finance, and it is a truism to say that securitisation envelopes the entire range of financial instruments, and hence, the entire range of financial markets. Following reasons clearly elucidate as to why the world of finance prefers a securitised financial instrument to the underlying financial claim in its original form:-
Firstly the financial claims often involve sizeable sums of money, clearly outside the reach of the small investor. The initial response to this was the development of financial intermediation: an intermediary such as a bank would pool together the resources of the small investors and use the same for the larger investment need of the user.
Secondly the small investors are typically not in the business of investments, and hence, liquidity of investments is most critical for them. Underlying financial transactions need fixity of investments over a fixed time, ranging from a few months to may be a number of years. This problem could not even be sorted out by financial intermediation, since if the intermediary provided a fixed investment option to the seeker, and itself sought funds with an option for liquidity, it would get caught into serious problems of a mismatch. Hence, the answer was a marketable instrument.
Thirdly generally, instruments are easier understood than financial transactions. An instrument is homogenous, usually made in a standard form, and generally containing standard issuer obligations. Hence, it can be understood generically. Besides, an important part of investor information is the quality and price of the instrument, and both are far easier known in case of instruments than in case of underlying financial transactions.
In short, the need for securitisation is almost inescapable as it
it creates liquidity in the market against assets which are generally sleeping or dormant in character and even creates opportunities for investment to people who want to invest to augment income, assured securities having opportunity for encashment as and when required.
Moreover, securitisation transactions enable the borrower to match maturities of assets and liabilities, and to borrow at lower rates. It is most valuable when the cost of funds, reflected in the interest rate that is necessary to entice investors to purchase the securities issued, is less than the cost of the originator's other direct source of funds. The goal of securitisation, therefore, is to obtain low cost capital market funding by separating all or a portion of an originator's receivables from the risks associated with the originator.
So powerful is the economic logic for securitisation that the trend towards securitisation knows no limits. Capital markets are today a place where everything is traded: from claims over entities to claims over assets, to risks, and rewards. Therefore the call for securitisation as a tool of structured finance is inexorable as it harnesses the financial sector ultimately benefiting the economy at large.
Securitisation in its most basic form is a method of selling assets involving various parties performing varied functions at varied stages. ADVANTAGES OF SECURITSATION
1. Allows banks and FIs to keep loans (debts) off the balance sheets thereby reducing the need for additional capital
2. Providing banks and FIs with alternative prior of funding risk transfer, a new investor base, potential capital
3. Relief and Capital market development can reduce lending concentration, improve liquidity
4. Access the alternate source of funding for banks and FIs
5. Facilitating attainment of funding at lower costs as a result of isolating the assets from potential bankruptcy risk of the originator.
6. Facilitates better matching of assets and liabilities
7. Provides diversified port of uniform assets
8. Asset converts long non-liquid loans or assets which cannot be easily sold to third party investors into liquid assets or marketable securities
9. Leads to movement of investors from less efficient debt markets to more efficient capital markets.
ANATOMY OF SECURITISATION
The assets involved in the process of securitisation are one with stable cash flows like residential mortgages, credit cards, etc ; which have their payments due on a future date. Such assets are generally termed as receivables, as they have the payments due on a future date. The ARC needs to identify such assets which would generate predictable payment. Generally and largely the securitisable assets must bear characterisitics of having a predictable cash flows, low default experience, total amortization of principal maturity, demographically and geographically diverse obligors, underlying collateral with high liquidation values and utility to the obligors.
Players in the market
Securitisation as a scheme of financial management involves various players at different levels performing specialist functions ; by virtue of which the complex process of securitisation is undertaken. Essentially the core players involved are :-
1. The Originator/ Seller ' The originator is the chief carter of the deal of securitisation as it sets up the initial structure to accomplish the process of securisation. The core function involves the selling if the assets on its books and in turn receiving the funds for such sale. It is a cash meager enterprise having illiquid assets.
Under the SARFAESI Act , 'Originator' means the owner of a financial asset which is acquired by a securitisation company or reconstruction company for the purpose of securitisation or asset reconstruction.
2. Special Purpose Vehicle ' SPV is a low-capitalised unit which buys the assets from the originator. The principal concern of securitsation is to remove the assets from the balance sheet of the originator and this is done by the SPV. SPV holds the assets in the balance books and makes the upfront payment for them to the originator. Funds are raised by SPV by issuing binds or other debt instruments .
3. The Investors ' The investors buy a participating interest in the total pool of receiebavles and receive payments in form of interest and principal as per agreed patterns. They may be individuals or institutional investors. They buy a participating interest in the total pool of receivables and receive their payment in the form of interest and principal as per agreed pattern.
Besides the three primary dealers in the securitiation process, few others also play significant role. There are players like the obligor , the trustee , the Credit Rating Agency , the Regulators , the Structurer, the Specialist functionaries like legal & tax consultants, etc.
Modus operandi of Securitisation
The originator selects the receivables to be securitised; the receivables are to be homogenous in nature. Such selected receivables are then transferred to the special purpose conduit viz., the SPV. The SPV on such transfer of receivables becomes the owner. The SPV finances itself by issuing securities like debt securities similar to bonds/debentures, interest certificates. While the SPV holds the receivables, investors acquire either a beneficial right therein by either buying the beneficial interest certificates, or by buying the debt securities of the SPV. In either case, as the SPV is merely a shell consisting of the assets of the originator, the rights of the investors are collateralized by the assets transferred by the originator.
The difference between the weighted average cost of the securities issued by the SPV, and the yield transferred by the originator (depending upon the discounting rate employed for selling the receivables), is called excess spread. The excess spread is normally captured as the residual profit of the originator.
The transaction between SPV and the originator can assume the modes of pass through or pay through by the nature of the investors' interest in the underlying assets. In a pass through structure, the SPV issues 'Pass Through Certificates' which are in the nature of participation certificates that enable the investors to take a direct exposure on the performance of the securitised assets. Pay through structures permit de-synchronization of servicing of the securities from the underlying cash flows. In the pay through structure, the SPV is given discretion (albeit to a limited extent) to re-invest short term surpluses - a power that is not available to the SPV in the case of the pass through structure.
Under the pay through structure, on the other hand, gives investors only a charge against the securitised assets, while the assets themselves are owned by the SPV. The SPV issues regular secured debt instruments. In the pass through structure, investors are serviced as and when cash is actually generated by the underlying assets. Delay in cash flows is of course shielded to the extent of credit enhancement. Prepayments are, however, passed on to the investors who then have to tackle re-investment risk. A further advantage of the pay through structure is that different issues of securities can be ranked and hence priced differentially.
Based on theses, the SPV issues ABS in the form of debt, certificates of beneficial ownerships and other instruments. The securities issued may be with or without recourse. Here the word recourse refers to the original lender, and so, securitisation can be both with recourse and without recourse to the original lender. The expression 'without recourse' means that in case there is failure on part of the borrower to pay, the loser party is either the SC or the investors, because the amount has not been or cannot be recovered from the original lender. On the other hand, in case of securitisation with recourse, the SC or the investors can recover the principal along with inherent from the original lending institution in case of failure of the borrower to pay.
Interest and principal payments on the loans, leases and receivables in the underlying pool of assets are collected by the servicer and transmitted to the investors. Credit enhancement can add features to boost investor's confidence. This could be in the form of a provision of recourse, a guarantee requiring the originators to cover losses, a letter of credit from a bank, or overcollaterlisation.
III. DEMYSTIFYING THE SARFAESI ACT, 2002
SARFAESI Act is simply a procedural enactment simultaneously dealing with substantive aspects on the properties. It explicitly or by imp0lication overrides all earlier procedural laws for the recovery of NPAs.
The various salient features :-
1. Registration and regulataion of securitisation companies or reconstruction companies by the Reserve Bank of India.
2. Facilitating securitisation of financial assets of banks and FIs with or without the benefit of underlying securities.
3. Facilitating easy transferability of financial assets by the SC or RC to acquire financial assets or banks or FIs by issue of debentures or bonds or any other security in the nature of debentures.
4. Empoweing SC or RC to raise funds by issue of security receipts to qualified institutional buyers
5. Facilitating reconstruction of financial assets acquired by exercising powers of enforcement of securities or change of management or other powers which are proposed to be conferred on the banks and FIs.
6. Declaration of SC and RC registered with RBI as a public financial institution for the purpose of ??4A of the Companies Act, 1956.
7. Defining ' security interest' as any type of security including mortgage and charge in immovable properties given for due repayment of any financial assistance given by bank of FIs.
8. Empowering banks and FIs to take possession of the securities given for financial assistance and sell or lease the same or take over management in the event if default i.e. classification of the borrowers account as NPA in accordance with the directions given or guidelines issued by the RBI from time to time.
9. The rights of secured creditor to be exercised by one or more of its officers authorised in this behalf in accordance with the rules made by the Central Government.
10. An appeal against the action of any bank of FI to the concerned DRT and a second appeal to the appellate DRT.
11. Setting up pr causing to be set up a Central Registry by the Central Government for the purpose of registration of transactions relating to securitisation, asset reconstruction and creation of security interest.
REGULATION OF SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS OF THE BANKS AND FIs
Registration of SC or RC - ??3 (1) of the SARFAESI Act, 2000 proposes to securitise and reconstruct the financial assets through the SPV i.e. the SC and RC. They are the companies incorporated under the Companies Act, 1956 and have securitisation and reconstruction as the main object. The act mandates compulsory registration of the SC and RC before commencing its business. A SC or RC should own or acquire Rs. 2 crore or upto 15% of the total financial assets.
RBI has power to specify the rate of owned fund from time to time. Different rates can be prescribed for different classes of SC and RC. Also if any SC or RC existed before the commencement of the SARFAESI Act, such company to make application for registration to the RBI before the expiry of 6 months from the commencement of the Act. Meanwhile during such period of pendency of the application, the SC or RC can continue with the business of securitisation or asset reconstruction till certificate of registration is granted to it. In case the certificate is rejected the same needs to be communicated to the SC or RC.
Procedure for Registration - ??3(2) and ??3(3) deal with the process of registering the SC or RC. ??3(2) prescribe that every SC or RC to make an application for registration to the RBI in the manner prescribed by RBI.
??3(3) provide that RBI while considering application for registration of SC or RC to take consider the following:-
1. That the SC or RC has not incurred any losses in any of the three preceding financial years.
2. That such SC or RC has made adequate management for realisation of the financial asset acquired for the purpose of securitisation or asset reconstruction and should be able to pay periodical returns and redeem on respective due dates on the investments made in the company by the QIB or any other person.
3. That the directors of SC or RC have adequate professional expertise in matters related to finance, securitisation and reconstruction.
4. That the board of directors of such SC or RC does not consist of more than half of its total number of directors who are either nominees of any sponsor or associated in any manner with the sponsor or any of its subsidiaries.
5. That none of the directors have been convicted of any offence involving moral turpitude.
6. That a sponsor is not a holding company of the SC or RC as the case many be, or does not otherwise hold any controlling interest in such SC or RC.
7. That SC or RC has complied with or is in a position to comply with prudential norms specified by RBI.
8. That the Sc or RC has complied with one or more conditions specified in the guidelines by the RBI for the said purpose.
Grant of Certificate of Registration by RBI- ??3(4) provides that on the satisfaction of the RBI that all the conditions have been fulfilled by SC or RC, the RBI may grant a certificate of registration to SC or RC to commence or carry on the business of securitisation or asset reconstruction but subject to conditions imposed by it.
Rejection of Application by RBI- ??3(4) provides that RBI can reject the application if it does not fulfill the conditions specified. However, before rejecting the application a reasonable opportunity to be heard to be given to the applicant.
Prior approval of RBI for change of management - ??3(6) provides that every SC or RC to obtain prior approval of the RBI for any substantial change in the management or change of location of its registered office of change in its name. The decision of RBI is to be final with this concern.
Cancellation of Certificate of Registration- ?? 4 provides that RBI may cancel a certificate of registration granted to SC or RC if such a company :-
1. Ceases to carry on the business of securitisation or reconstruction
2. Ceases to receive or hold any investment from QIB
3. Failed to comply with any conditions subject to which the certificate of registration has been granted to it
4. At any times fails to fulfil any of the conditions under 3(3) (a)-(g)
5. Fails to
a. comply with any direction issued by the RBI under the provisions of the ordinance,
b. maintain accounts in accordance with the requirements of any law or any directions or order issued by the RBI under the provisions of this ordinance.
c. Submit or offer for inspection its books of accounts or other relevant documents when so demanded by the RBI.
d. Obtain prior approval of the RBI required under ??3(6) of the SARFAESI Act.
Opportunity of being heard before cancellation in Certain cases :- The proviso to ??4(1) provides opportunity of being heard before cancelling a certificate of registration on the ground that the SC or RC has failed to comply with the provisions of clause (c) or has failed to fulfill any of the conditions under clause (d) or sub- clause (iv) of clause (e), the RBI unless it is of the opinion that the delay in cancelling the certificate of registration granted under ??3(4) shall be prejudicial to public interest or the interests of the investors or the SC or RC, to be given opportunity on such terms as the RBI may specify for taking necessary steps to comply with such provision or fulfilment of such conditions.
Appeal against Order of Cancellation- ??4(2) prescribes that SC or RC aggrieved by the order of cancellation of certificate of registration may prefer an appeal within 30 days from the date of order of such cancellation to the Central Government.
Consequences of Rejection or Cancellation of certificate of Registration where the company is already holding investment- ??4(3) mentions that if certificate is cancelled in event the company holds investment of the QIB then in such circumstances, notwithstanding such rejection or cancellation be deemed to be SC or RC until it replays the entire investments held by it together with interests within the period specified by the RBI.
No intervention of the Court or Tribunal in the Enforcement of Security Interest- ?? 13(1) provides that security interest created in favour of the secured creditor may be enforced without intervention of the court or tribunal by the creditor as per the provision prescribed under the Act. This clause carries a non obstante clause which over rides the provisions under ??69 or ??69A of the Transfer of Property Act, 1882. This particular provision gives unencumbered powers to the Banks and FIs to take possession and effect sale of the secured assets.
Notice by Secured Creditor to Borrow to Discharge Liabilities within 60 days- ??13(2) empowers the bank that in event where any borrower who is under a liability to s secured creditor under a security agreement, makes any default in the repayment of the secured debt or any installment thereof, and the account of the person concerned with respect to such debt is classified by the secured creditor as NPA then the secured creditor may served the borrower with the notice in writing to discharge the liabilities in full to the secured creditor within 60 days from the date of notice failing which the secured creditor would be entitled to extend all or any of the rights as prescribed under ?? 13(4).
Thereby ??13(2) provides that it is incumbent upon the secured creditor to served with 60 days notice before the proceedings to take any measures under ??13(4) of the Act. After the notice is served, if the borrower raises any objection or places facts for consideration of the secured creditor such reply to the notice must be considered with due application of the secured creditors, the reasons for not accepting the objections must be communicated to the borrower. The reason so communicated shall be for the purpose of information of the borrower without giving rise to any right to approach DRT under ??17 of the Act. In Transcore v. UOI , the lender is not required to elect between taking action under SARFAESI Act and going before DRT. The bank can take action under SARFAESI Act as well as under DRT simultaneously.
The authorised officer of the Bank can take physical possession of the assets and not just symbolic. Fees payable for filing an application to DRT against notice under ??13(2) SARFAESI Act is as per DRT (Procedure) Rules.
Measures for Secured Creditor is case of default by the Borrower- ??13(4) of the ct provides that in case the borrower fails to discharge his liability in full within the period specified of 60 days , the secured creditor may take recourse to one or more of the following measures for the purpose of recovering the secured debt:-
' Possession of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale for releasing the secured asset.
' Take over the management of the assets of the borrower including the right to transfer by way of lease, assignment or sale for releasing the secured asset.
' Appoint any person to be the manage the secured assets the possession of which has been taken over by the secured creditor.
' Require at any time by notice in writing, any person who has acquired any of the secured assets from the borrower and from whom any money is due or may become due to the borrower, to pay the secured creditor as much of the money is sufficient to pay the secured debt.
Disclosures in the Notice :- ?? 13(3) provides that the notice under ??13(2) to give details of the amount payable by the borrower and the secured assets intended to be enforced by the secured creditor in case of non-payment of the secured debts by the borrower.
Borrower cannot apply to DRT- ??13(3A) was inserted in the Act by medium of an Ordinance in 2004 in tune with the Mardia Chemcials v. UOI. The section provides that if on receipt of the notice, the borrower makes any representation or objection and if the secured creditor comes to the conclusion that such representation or objection is not acceptable or tenable, the borrower to communicate within 15 days of receipt of such representation or objections noting the reasons for non-acceptance of the representation or objection to the borrower.
It is further provided that the reason so communicated or the likely action of secured creditor at the stage of communication of reasons shall not confer any right upon the borrower to prefer an application to the DRT uncer??17 of the Court of District Judge under ??17A.
Payment to Secured Creditor by an Acquirer of Secured Asset to give a Valid Discharge - ??13(5) provides that any payment by any person under ??13(4) (d) to the secured creditor shall give such person a valid discharge as if he has made payment to the borrower.
Section 13(5A), (5B) and (5C) have been added by the Enforcement of Security Interests and Recovery of Debt Laws (Amendment) Act, 2012 which came into effect on 31.03.2013 which also amended the SARFAESI Act, 2002. ??13(5A) where the sale of an immovable property, for which a reserve price has been specified, has been postponed for want of a bid of an amount not less that such reserve price, it shall be lawful for any officer of the secured creditor, if so authorised by the secured creditor in this behalf to bid for the immovable property on behalf of the secured creditor at ant subsequent sale. ??13 (5B) where the secured creditor is declared to be the purchaser of the immovable property at any subsequent sale, the amount of the purchase price shall be adjusted towards the amount of the claim of the secured creditor for which the auction of enforcement of security interest is taken by the secured creditor, under ??13(4). ??13(5C) makes applicability of ??9 of the Banking Regulation Act, 1949, so far as to applicable to immovable property acquired by the secured creditor under ??13(5A).
Effects of Transfer of Secured Asset by the Secured Creditor - ??13(6) provides that any transfer of the secured asset after taking possession thereof or take over of management under ??13(4), by the secured creditor or by the management on behalf of the secured creditor shall vest in the transferee all rights in or in relation to the secured asset transferred as if the transfer has been made by the owner of such secured asset.
Recovery of Costs by the Secured Creditor from the Borrower- ??13(7) provides that where any action has been taken against a borrower under the provision of ??13(4), all costs, charges and expenses which in the opinion of the secured creditor, have been properly incurred by him or any expenses incidental thereto, shall be recoverable from the borrower and the money which is received b the secured creditor shall, in the absence of any contract to contrary be held by him in trust, to be applied firstly in payment of such costs, charges and expenses and secondly, in discharge of the sues of the secured creditor and the residue of the money so received shall be paid to the person entitled therto in accordance with his rights and interest.
No sale of Secured Asset of all dues paid to Secured Creditor before the sate fixed for sale- ??13(8) provides that if the dues of the secured creditor together with all costs, charges and expenses incurred by him are tendered to the secured creditor at any time before the date fixed for sale or transfer, the secured asset shall not be sold or transferred by the secured creditor, and no further step shall be taken by him for transfer or sale of that secured asset.
Right of Action in case of Joint Financing of a Financial Asset- ??13(9) provides that in case of financing of a financial asset by more than one secured creditor or in case of joint financing of a financial asset by the secured creditor, no secured creditor to be entitled to exercise any of the rights conferred on him under ??13(4) unless and until the exercise of such right is agreed upon by the secured creditor representing not less than 60% in value of the amount outstanding as on record date and such action shall be binding on all the secured creditors.
It is also provided that in case of a company in liquidation, the amount realised from the sale of secured assets shall be distributed as per ??529A of the Companies Act, 1956.
Provided further that in case of a Company being wound up on or after commencement of this Act, the secured creditor of such company who opts to realise his security instead of relinquishing his security and proving his debt under ??529(1) of the Companies Act, 1956 may retain the sale proceeds of his secured assets after depositing the workmen's dues with the liquidator in accordance with the provisions of ??529 of the Act.
Provided that the liquidator in the second proviso to intimate the secured creditors the workmen's dues in accordance with the provision of ??529A of the Companies Act, 1956 and in case such workmen's dues cannot be ascertained, the liquidator shall intimate the estimated amount of the workmen's dues under that section to the secured creditor and in such case the secured creditor may retain the sale proceeds of the secured assets after depositing the amount such estimated dues with the liquidator:
Provided also that in case the secured creditor deposits the estimated amount of workmen's dues, such creditor shall be liable to pay the balance of the workmen's dues or entitled to receive the excess amount, if any, deposited by the secured creditor with the liquidator.
It is also provided that the secured creditor shall furnish an understanding to the liquidator to pay the balance of the workmen's dues, if any.
Recovery of Unsatisfied dues of Secured Creditor - ??13(10) provides that where dues of the secured creditor are not fully satisfied with the sale proceeds of the secured assets, the secured creditor may files an application in the form and manner as may be prescribed to the DRT having jurisdiction or a competent court, as the case may be for recovering the balance from the borrower.
Right of Action against the Guarantor or Pledged Assets - ??13(11) provides that the secured creditor to be entitled to proceed against the guarantors or sell the pledged assets without first taking any of the measures specified in clauses (a) to (d) of ??13(4) in relation to the secured assets under this Act.
Exercise of Rights of Secured creditor by Authorised officers -??13(12) provides that the rights of a secured creditor under this Act may be exercised by one or more of his officers authorised in this behalf in such manner as may be prescribed.
Borrower not to Sell, Lease or otherwise Transfer secured asset after receipt of notice- ??13(13) mentions that the borrower after the receipt of notice under ??13(2), transfer by way of sale, lease or otherwise any of the secured assets referred to in the notice, without prior written consent of the secured creditor.
CJM or DM to assist secured creditor in taking in possession of secured assets- ??14 provides that where the possession of any secured asset is required to be taken by the secured creditor or if any of the secured asset is required to be sold or transferred by the secured creditor under the provisions of this Act, the secured creditor may for the purpose of taking possession or control of any such secured asset, request in writing the CJM or the DM within whose jurisdiction any such secured asset or other documents relating thereto may be situated or found, to take possession thereof, and the CJM or the DM on such request made to him '
a) Take possession of such asset and document relating thereto
b) Forward such assets and documents to the secured creditor
Application to DRT against action taken by Secured Creditor- ??17(1) provides that any person including borrower aggrieved by any of the measures referred to in 13(4) taken by the secured creditor or his authorised officer, may make an application along with such fee as may be prescribed by DRT having jurisdiction in the matter within 45 days from the date on which such measures had been taken. For the purpose of removal of doubts, the communication of the reasons to the borrower by the secured creditor for not having accepted his representation or objection or the likely action of the secured creditor at the stage of communication of reasons to the borrower shall not entitle the person including the borrower to make an application to the DRT under ??17(1).
Decision on Application by DRT- ??17(2) provides that the DRT to consider whether any of the measures referred under ??13(4) taken by the secured creditor for enforcement of security are in accordance with the provisions of this Act and the rules made.
??17 has amended by the Enforcement of Security Interest and Recovery of Debt Laws (Amendement) Act, 2004
Rights of Borrowers
' On receipt of notice the borrower can raise objections and / or make representations about contents of the notice which the secured creditors must respond within 7 days about acceptance/non acceptance in writing.
' A borrower can object to the measures taken under this Act within 45 days without depositing any amount with DRT. [Section 17] However for making application at the second appeal stage with Debt Recovery Appellate Tribunal, 50% of the amount outstanding has to be deposited which can also be reduced to 25% at the discretion of the Appellate Tribunal ' [Section 18].
' If at appeal level, it can be established that the possession of secured assets by the secured creditor was wrongful then DRT/Appellate Tribunal will direct the secured creditor to return such secured assets to the concerned borrower. [Section 19]
' Limitation as prescribed under Limitation Act 1963 will be applicable even to this Act. [Section 36]
WHERE THE ACT NOT APPLICABLE ' Section 31
The Provision of this Act shall not apply to
' A lien on any goods. ' Indian contract Act, 1872
' A pledge of movables. - 1872
' Creation of any security in any aircraft/vessel shipping ' Aircraft Act 1934 / Merchant shipping Act 1958
' Any conditional sale, hire purchase or lease or any other contract in which no security interest has been created
' Any right of unpaid seller under section 47 of the sale of Goods. Act 1930
' Any security interest for securing repayment of any financial asset not exceeding one lakh rupees
' Any security interest created in agricultural land
' Any case in which the amount due is less than twenty percent of the principal amount and interest thereon
' The SARFAESI act have undergone sea change in 2013 wherein the multistate co-operative banks have been brought under the definition of bank. But what about the action taken by the multistate co-operative banks by invoking SARFAESI act before the new law in 2013(amendment act 2013)? Now the secured creditor can bid for the property in auction when there is no buyer for said property. also as per new legislation secured creditor has to decide the objection to demand notice within two weeks. there is also amendment in banking regulation act and no co-operative bank can do banking business in India without banking licence. There are co-operative banks doing banking business without banking licence. Now it will be stopped but early. The banking regulation act was amended in 2004 when multistate co-operative bank was defined but SARFAESI act came in 2002. For almost a decade no one realised what was going on as to multistate co-operative using SARFAESI act ? Is this banking reform?
' Banks and asset reconstruction companies (ARCs) will be allowed to convert any part of the debt of the defaulting company into equity. Such a conversion would imply that lenders or ARCs would tend to become an equity holder rather than being a creditor of the company.
' The amendments also allows banks to bid for any immovable property they have put out for auction themselves, if they do not receive any bids during the auction. In such a scenario, banks will be able to adjust the debt with the amount paid for this property. This enables the bank to secure the asset in part fulfillment of the defaulted loan. Banks can then sell this property to a new bidder at a later date to clear off the debt completely. However lenders will be able to carry this property on their books only for seven years, as per the Banking Regulation Act, 1949.
STAMP DUTY & REGISTRATION LAWS
Stamp Duty and Registration laws act as a stumbling block and thereby creating hurdles in a securitisation transactions.
Stamp duty is an important aspect that needs to be considered in an asset securitisation deal, as high stamp duty would make the transaction unviable. Stamp Duty is attracted on account of transfer of intangible assets viz receivables (which constitute actionable claims) through a written instrument. The written instrument is considered a 'conveyance' in law, which is an instrument liable to stamp duty. Thereby stamp duty is payable on any instrument which seeks to transfer any rights or receivables, whether by way of assignment or novation or by any other mode. Stamp duty is a tax on the instrument and not on the transaction . Normally, the duty is paid on the value of assets transferred by the instrument and the duty is limited to the value of the assets transferred by the instrument, irrespective of the transfers that will take place in the future. The instrument of transfer attracts stamp duty at an ad valorem rate, which ranges from 0.1% to 8% and this varies from state to state.
Registration requirements also, literally applied will come in the way of several securitisation transactions. A transfer of receivables backed by mortgage of immovable property is itself taken as a document transferring immovable property, and hence, requires registration. The instrument must be registered under the Indian Registration Act, 1908 which further imposes additional cost and bother. As a way out, in many cases, the mortgage interest is retained with the seller, who continues to hold the same as trustee for the buyer.
There are no specific provisions under the Income Tax Act , 1961 addressing the peculiarities of securitisation transactions. Tax is leviable at various stages on the participating entities depending on the transaction. It will normally depend on how the documents relating to the transaction are structured, the characterisation of the transaction by the income tax authorities and other issues. The tax implications of a securitisation transaction in respect of each of the entities would be involved, namely the originator (normally a company, whether a financial institution, bank or commercial corporation), the SPV and the investors and this part of the project attempts to discuss the taxability of the players of a securitisation transaction.
TAXABILITY OF THE ORIGINATOR
Tax liability of the originator would depend on:
' Whether the securitisation transaction results in the legal transfer of property (i.e. the assets being securitised); and
' Whether the gain or loss (in cases where there is a transfer of the property) is treated as a business gain/loss or a capital gain/loss by the tax authorities.
A) Taxability as capital gains
Where there is a legal transfer of property (a true sale) with respect to the assets to be securitised, the gain, if any, arising on the transfer may be taxed as a capital gain or as business income. Conversely, if such a transfer results in a loss, the same is allowed as a deduction in computing total taxable income for that year.
Under the provisions of ITA, ??45 provides that any profits or gains arising from the transfer of capital assets is chargeable to income tax under the head 'Capital Gains'. It may be noted that any profits or gains would also be chargeable as Capital Gains, where there is a conversion of an asset to stock-in-trade. If the tax authorities construe the securitisation transaction as a transfer of capital assets or as a conversion of the assets into stock-in-trade, Capital Gains tax would be applicable.
Further, Capital gains is categorised into long term capital gains and short-term capital gains. Long term capital gains would arise on transfer of the capital assets held by the holder of the asset for more than thirty six (36) months [twelve (12) months in the case of shares held in a company or any other listed security or a unit of the Unit Trust of India or of a specified mutual fund]. Gains on transfer of capital assets held by the holder of the asset for thirty six (36) months or less [twelve (12) months or less in case of shares held in a company or any other security listed in a recognised stock exchange in India, or a unit of the Unit Trust of India or of a specified mutual fund] immediately preceding the date of transfer, would be taxed as short term capital gains. The rate of tax on long-term capital gains is currently 20% for resident individuals and domestic or foreign companies (or as applicable under the income tax treaty between India and the foreign company's country of residence). The rate of tax for short-term capital gains is 35% for companies incorporated in India; foreign companies are taxed at a rate of 40%.
B) Taxability as business income
Where the profit or gain on a securitisation transaction is treated as a business profit or gain, it is chargeable to tax as "profits and gains of business". The term "business" has been defined to include any trade, commerce or manufacture, or any adventure or concern in the nature of trade, commerce or manufacture .
In a transaction where there is no legal transfer of property with respect to the assets to be securitised, the tax authorities may characterize the securitisation transaction as a method of financing (on the security of the receivables) and levy tax on the originator, on the gain. In such a situation, the discount charged by the SPV on the receivables is a tax-deductible finance expense. The net amount received by the originator is liable to tax as business income.
TAXABILITY OF THE SPV
There are three alternative approaches to taxing the SPV, viz:-
' First, the SPV may be regarded as a conduit between the originator and the ultimate investor. In such case, it receives income flows from the underlying assets and would use the same to service the instruments issued by it. Thus, it would not earn any income nor make any profits, and it would not be liable to tax.
' Second, the SPV, when organized as a trust, generally has a pass-through status and the trustee acts on behalf of the beneficiaries (i.e. the investors). In such cases, certain ITA provisions dealing with the concept of a 'representative assessee' may apply to the SPV. A trustee is regarded as an agent of the non-resident or the resident investor/beneficiary for tax purposes. Such an agent is regarded a representative assessee of the beneficiary. A representative assessee is subject to the same duties, responsibilities and liabilities as the beneficiaries, and the tax treatment of such person is the same as if the income received by the beneficiaries were the income received by or accruing to the representative assessee beneficially . Accordingly, the trustee may be taxed on the income received by it on behalf of the investors, and such tax is levied on the trustee in the same manner and to the same extent as it would be levied on the investors. However, if the SPV is held to carry on business, it is liable to tax at the maximum marginal rate applicable to individuals. As a representative assessee, the trustee would generally not bear the tax liability.
' Finally, the SPV may be treated as an independent taxable entity. Where the SPV is treated as an independent entity, any income received or deemed to be received by the SPV would be deemed to be its income. Interest income distributed by the SPV is a tax-deductible expense for the SPV and is income in the hands of the investors. The SPV is taxed on its net income at a rate of 35%. The SPV must withhold tax at source when paying interest to investors. The investor may be able to claim credit for this withholding tax against its own tax liability on the same income.
Where payments by the SPV represent a distribution of income, they would not be tax deductible expense. The SPV must withhold tax at source, in the case of both resident and nonresident investors. An applicable income tax treaty between India and the investor's country of residence may reduce the tax rate applicable to a non-resident.
TAXABILITY OF THE INVESTORS
Investors receiving income from an SPV, which is regarded as a pass-through entity, are liable to tax on the income earned in proportion to its investment. Where the SPV is characterized as a representative assessee and is accordingly taxed, the tax paid by the SPV is deemed to be paid by the investors. In this case the investors would again not be required to pay tax individually on the same income.
Where the SPV is characterized as an independent entity and it issues debt instruments to the investors, the investors are taxed on the income from such debt instruments. If the investors receive dividends from the SPV, the same are taxable as ordinary income in the hands of the investors. However, the investors may claim a credit for the taxes withheld at source by the SPV, to be applied against their tax liability on the dividend.
RESERVE BANK OF INDIA GUIDELINES ' The RBI acts in large public interest by regulating the scheme of securitisation in India. Various guidelines like the
The RBI in the interest of the public and for the purpose of enabling itself to regulate the financial system beneficial to the country and to prevent the affairs of Securitisation as carried on by the banks, SC or RC, FIs, etc from begin conducted in a manner detrimental to the interest of the investors, the RBI issues guidelines
THE SC AND RC (RBI) GUIDELINES AND DIRECTION, 2003
The RBI issued the SC and RC (RBI) Guidelines and Direction, 2003 for the purpose of regulation to registration, measures of asset reconstruction, functions of the company, prudential norms, acquisition of financial assets and matters related thereto, in exercise of the powers conferred by ??3, ??9, ??10 and ??12 of the SARFAESI Act, 2002. The salient features on the guidelines are:-
' The impugned guideline has made a significant departure from the definition of the NPA under the existing RBI guidelines. Receivables are to be treated as NPAs if the same remain overdue for a period of 180 days or more. While this is in accordance with existing RBI norms for classification of debts as NPAs, Regulation 3(vi) of the Guidelines also states that the board of directors of a SC / RC may, on default by the borrower, classify an asset as a non-performing asset even earlier that the said 180 days for the purposes of facilitating enforcement as provided for in ??13 of the SARFAESI Act. The Guidelines therefore permit a SC / RC to classify a debt as an NPA and proceed to give the aforesaid 60 day notice under the Act immediately upon default by the borrower, without having to wait for the aforesaid 180 day period.
' The Guidelines clarify that a SC / RC that has obtained a certificate of registration issued by the RBI under the Act can undertake both Securitisation and Reconstruction activities. The Guidelines also clarify that an entity that is not registered with the RBI may conduct the business of Securitisation or Asset Reconstruction outside the purview of the Act. This is a significant clarification as the Act is silent in this regard. In view of this clarification, banks and financial institutions that were engaged in securitisation activities prior to the Act can continue the same without having to obtain a certificate of registration under the Act. The benefits of the enhanced enforcement rights under the Act however, will not be available to them.
' Every SC /RC seeking the Bank's registration under ??3 of the SARFAESI Act, shall have a minimum Owned Fund of Rs. 2 crore.
' The guidelines prohibit a SC / RC from raising monies by way of deposit. A SC is permitted to raise funds from qualified institutional buyers by issuing security receipts to them. It has been clarified that the security receipts would be transferable/ assignable only in favour of other qualified institutional buyers.
' The Guidelines state that security receipts are to be issued thorough one or more trusts set up exclusively for the purpose. The trusteeship of such trusts is required to vest with the SC / RC. The SC/ RC are required to transfer the financial assets to the said trust at the price at which those were acquired. It is important to note that these transfers of assets will double the incidence of stamp duty, as stamp duty will have to be paid in respect of the transfer of the financial asset from the originator to the SC/ RC, and also for the transfer of the financial asset from the SC/RC to the trust.
' The Guidelines require that a SC / RC shall formulate policies for asset acquisition, including valuation procedure, rescheduling of debts of borrowers (to be supported by an acceptable business plans, projected earnings and cash flows of the borrower), settlement of debts due from borrower, and plans for realisation of assets.
' The Act allows lenders and SC to change or take over the management of the borrower and sell or lease the business of the borrower for the purpose of recovery of loans. However, the Guidelines state that no SC / RC shall take any measures for change or take over of management/sale or lease of the business of the borrower until the RBI issues necessary guidelines in this behalf.
' While taking recourse to the sale of secured assets, it has been clarified that a SC / RC may itself acquire the secured assets only if the sale is concluded through a public auction.
' The Guidelines impose restrictions upon the permissible modes of deployment of funds by SC / RC. A SC/ RC is permitted to invest in the equity share capital of another SC/ RC , as a sponsor and for the purpose of establishing a joint venture. They are allowed to deploy any available surplus in the government securities and deposits with scheduled commercial banks in accordance with a policy framed in this regard by its board of directors.
' No SC / RC are allowed to invest its owned funds in land and building. However, this restriction would not apply to funds borrowed as also to owned funds in excess of the minimum prescribed.
' The Guidelines also provide for provisioning requirements, income recognition norms , disclosures required to be made in balance sheets , etc.'
GUIDELINES TO BANKS/ FIS ON SALE OF FINANCIAL ASSETS TO SC/ RC AND RELATED ISSUES (SALE GUIDELINES)
These guidelines are applicable to the sale of financial assets by banks and FIs for asset reconstruction and securitisation under the Act.
' Financial assets which can be sold - As per the Sale Guidelines, the following classes of assets can be sold by banks / FIs to SC/RC :
' An NPA;
' A standard asset (i.e., an asset that is not an NPA) where:
o the asset is under consortium /multiple banking arrangements,
o at least 75% by value of the asset is classified as NPA in the books of other bank/FIs, and
o at least 75% by value of the banks/FIs who are under the consortium/multiple banking arrangement agree to the sale of the asset to the SC/ RC.
' The sale of financial assets from a bank/FI may be on a 'without recourse' basis, i.e., with the entire credit risk associated with the financial asset being transferred to the SC/ RC , as well as on a 'with recourse' basis, i.e., subject to the unrealized part of the asset reverting to the seller bank/FI. Banks/FIs are however, required to ensure that the effect of the sale of the financial assets should be such that the asset is taken off the books of the bank/FI and after the sale there should not be any known liability devolving on the bank/FI. It has also been clarified that under no circumstances can a transfer from the SC / RC be made at a contingent price whereby in the event of shortfall in the realization by the SC / RC , the banks/FIs would have to bear a part of the shortfall.
' Further, in the case of specific financial assets, where it is considered necessary, banks/FIs may enter into agreements with the SC/ RC to share, in agreed proportion, any surplus realised by the SC/ RC on the eventual realization of the concerned asset.
In the case of financial assets that cannot be revived, the Sale Guidelines recognize that a SC/RC may not take over these assets but act as an agent for recovery for which it will charge a fee. In such a case, the assets will not be removed from the books of the bank/FI but realizations as and when received will be credited to the asset account.
' The securities offered by the SC/ RC to the banks/FIs are required to satisfy the following conditions:-
' The securities must not have a term in excess of six years.
' The securities must carry a rate of interest which is not lower than 1.5% above the Bank rate in force at the time of issue.
' The securities must be secured by an appropriate charge on the assets transferred.
' The securities must provide for part or full prepayment in the event that the SC/ RC sells the asset securing the security before the maturity date of the security.
' The commitment of the SC/ RC to redeem the securities must be unconditional and not linked to the realisation of the assets.
' Wherever the security is transferred to any other party, notice of transfer should be issued to the SC / RC.
GUIDELINES ON SECURITISATION OF STANDARD ASSETS, 2006
The guideline covers securitisation of standard assets by banks, All India Term Lending and Refinancing Institutions, and Non Banking Financial Companies (including RNBCs). The reference to 'bank' in the guidelines would include all the above institutions. The Guidelines define securitisation as a two staged process involving, in the first stage, sale of asset(s) to a 'bankruptcy remote' SPV in return for an immediate cash payment and, in the second stage, repackaging and selling the security interests representing claims on incoming cash flows from the asset(s) to third party investors by issuance of tradable debt securities. The Salient features of these Guidelines are:-
' True Sale - The guidelines define the criteria for 'true sale'. The sale should result in immediate legal separation of the originator and SPV with effective transfer of risks/rewards and rights/obligations pertaining to the asset and the originator shall not hold any beneficial interest in the asset or shall not have any economic interest in the asset(s) after its sale to the SPV. A legal opinion should also be kept on record.
' Credit enhancements & Liquidity facility - According to RBI, the credit enhancements, extended to support the transaction, should be available to the SPV during the entire life of the securities issued by the SPV. The credit enhancements will now be classified as 'first loss' and 'second loss' credit enhancements. The first loss credit enhancement would represent the first level of financial support which brings the SPV to investment grade while a second loss credit enhancement would provide additional cover to the pool to provide for potential losses which are beyond those covered by first loss credit enhancement.
As per the RBI Guidelines, for the purpose of capital adequacy computation, the first loss credit enhancement should be deducted from capital funds, 50% from Tier I & 50% from Tier II, in the books of credit enhancement provider who could be the originator or third party. In case the first loss is provided by the originator, deduction shall be capped at the amount of capital that the bank would have been required to hold for the full value of the assets, had they not been securitized. According to the Guidelines, there is a differential capital treatment of second loss credit enhancement for originators and third parties. The second loss credit enhancement, if provided by the originator, should be deducted from capital funds.
However, if the second loss credit enhancement is provided by a third party, it should be treated as a direct credit substitute with a 100% credit conversion factor and a 100% risk weight covering the amount of the facility.
The guidelines also provide for a liquidity facility which is aimed at smoothening the timing differences faced by the SPV between the receipt of cash flows from the underlying assets and the payments to be made to investors. If the liquidity facility is provided by the originator, an independent third party should be brought in, within a period of three months from the securitization, to co-provide at least 25% of such a liquidity facility that shall be drawn and repaid on a pro-rata basis. The facility should remain drawn only for short periods of upto 90 days and amount outstanding beyond such a period should be classified as NPA and fully provided for. For computation of capital adequacy, the commitment to provide liquidity facility, to the extent not drawn would be an off balance sheet item and attract 100% credit conversion factor & 100% risk weight. If the second loss credit enhancement is placed with a third party, the securitization could provide capital relief to the originator provided the first loss credit enhancement along with capital required for liquidity facility is lower than capital required to be held for the full value of the assets, had they not been securitised.
' Underwriting - The guidelines also provide for a third party service provider to step in and underwrite the securities issued by the SPV, which is currently not very prevalent in the Indian scenario. Such an underwriter will be subjected to a risk weight of 100% for the purpose of capital adequacy computation. However, if the underwriter is a third party, below investment grade securities held over a period of three months would be deducted from capital funds.
' Servicer - A service provider (also known as servicing & paying agent), shall hold in trust, on behalf of the investors, the cash flows arising from the underlying asset and should avoid comingling of these cash flows with their own cash flows. In India, for most of the transactions, the service provider has been the originator.
' Investment in PTCs - Since the securities issued by SPVs would be in the nature of non-SLR securities, banks' investment in these securities would attract all prudential norms applicable to non-SLR investments prescribed by RBI from time to time. The originator may purchase, at market price, only senior securities issued by the SPV if these are at least 'investment grade', for investment purposes. Such purchase, along with the securities that may devolve on account of underwriting commitments, should not exceed 10% of the original amount of the issue.
' Accounting treatment- The Originator should account for any loss arising on sale to SPV and reflect the same in the Profit & Loss account for the period during which the sale is affected. Also, the entire expenses incurred on the transaction, say, legal fees, etc., should be expensed at the time of the transaction and should not be deferred. However, any profit/premium arising on account of sale should be amortised over the life of the securities issued or to be issued by the SPV. Thus, securitisation in the future, will not be driven by upfront profit motive.
RBI DRAFT GUIDELINES ON MINIMUM HOLDING AND MINIMUM RETENTION PERIOD, 2010
The RBI recently issued draft guidelines regarding the minimum holding period and minimum retention requirement for securitisation transactions. The aim behind the guidelines is to develop an orderly and healthy securitisation market, to ensure greater alignment of the interests of the originators and the investors, as also to encourage the development of the securitisation activity, said the RBI in its circular.
The circular says that originators should retain a portion of each securitisation originated, as a mechanism to better align incentives and ensure more effective screening of loans. In addition, the RBI has also recommended a minimum period of retention of loans prior to securitisation so as to give comfort to investors regarding the due diligence exercised by the originator. Salient features include:-
' Loans maturing in up to 24 months, the company would have to hold the asset on its books for at least nine months and retain 5 percent of the book value of the loans being securitised.
' Twelve months is the minimum holding period for loans maturing in more than 24 months and which have periodic repayment schedules, while 10 percent of the book value of securitised loans will have to be retained.
' No securitisation of loans with maturity exceeding 24 months and bullet repayment is envisaged.
' The RBI guidelines also list certain assets where banks are not permitted to undertake securitisation activities or assume securitisation exposures.
Securitisation is a process of converting assets/cash flows into marketable securities, which can be bought and sold in the securities markets and here comes the role of SEBI regulating the selling and buying of the securities in the market.
SEBI in June 2007 proposed the Draft Regulations for 'Public Offer and Listing of Securitised Debt Instruments'. The draft regulations provided for a system of special purpose distinct entities which could offer securitized debt instruments to the public or could seek listing of such instruments. The Draft document also elaborates on the permissible structure for the special purpose distinct entity, conditions for their assignment of debt or receivables from any originator, procedure for launching of schemes, obligation to redeem securitized debt instruments, credit enhancement and liquidity facilities which could be availed by the entity, conditions for appointing servicers, procedure to be followed for public offer of securitised debt instruments, their listing, rights of investors, inspection and disciplinary proceedings and action in case of default. And it was in May 2008, that the SEBI (Public Offer and Listing of Securitised Debt Instruments) Regulations, 2008 are notified in the Official Gazette dated May 26, 2008. SEBI has notified the guidelines taking into account the market needs, cost of the transactions, competition policy, the professional expertise of credit rating agencies, disclosures and obligations of the parties involved in the transaction and the interest of investors in such instruments.
The regulations apply only to public offers or listing of securitised debt instruments that are issued by a SPV that purchases securities through securitization. The new regulatory environment creates a market which has the following players: originator/obligor/sponsor, special purpose distinct entity , trustee, service provider, liquidity provider, and of course, investors. The main elements of these regulations relating to public offers of securitised debt instruments / listing if SDIs issued to public or any person on a recognized stock exchange are registration of trustees , constitution/management of SPDE , schemes of SPDE , public offer of SDIs , right of investors , listing of SDIs , inspection and disciplinary proceedings and action in case of default.
Under the regulation, debt or receivables have been broadly defined to mean and include any right that generates or results into cash flow. Any cash flow whether from mortgage, non-performing assets or even inventory receivables, could be an asset and converted into securities.
The originator transfers by way of sales the cash flows to an SPDE, which is a registered trust. The trust has trustees, who are duty bound to protect the interests of the investors. The trustees are registered with SEBI as recognised intermediaries. The contract assigning the cash flows is thus between the originator and the trustees. The trustees are also expected to sign contracts for various services on behalf of the investors. This would include a service agreement ensuring that the cash flows are properly received and distributed. This would include a liquidity provider, who steps in to correct liquidity shortfalls in the cash flow streams, and credit enhancer, who improves the credit of the asset pool. Salient features of the regulations are as follows:-
' The SPDE i.e. issuer shall be in the form of a trust, the trustees thereof will require registration from SEBI. The registration granted to a trustee shall be permanent subject to compliance with the provisions with the SCRR and the regulations and payment of appropriate fees.
' If a debenture trustee registered with SEBI or a SC or ARC registered with RBI or National Housing Bank or the NABARD is the trustee of the issuer no registration from SEBI to act as such shall be required.
' The securitised debt instruments issued to public or listed on recognized stock exchange shall acknowledge the beneficial interest of the investors in underlying debt or receivables assigned to the issuer. The regulations provide flexibility in terms of pay through / pass through structures and do not restrict any particular mode.
' The assignment of assets to the issuer shall be a true sale. The debt or receivables assigned to the issuer should be expected to generate identifiable cash flows for the purpose of servicing the instrument and the originator should have valid enforceable interests in the assets and in cash flow of assets prior to securitisation.
' The issuer shall be a bankruptcy remote from the originator. Originator shall be an independent entity from the issuer and its trustees and the originator and its associates shall not exercise any control over the issuer. However, the originator may be appointed as a servicer. The issuer may appoint any other person as servicer in respect of any it's schemes to co-ordinate with the obligors, manage the said pool and collection there from, administer the cash flows of asset pool, distribution to investors and reinvestments. The issuer shall not acquire any debt or receivables from any originator who is part of the same group or which is under the same management as the trustee. Regulations require strict segregation of assets of each scheme.
' The issuer may offer securitised debt instruments to public for subscription through an offer document containing disclosures of all relevant material facts.
' Rating from atleast two credit rating agencies is mandatory and all ratings including unaccepted ratings shall be disclosed in the offer documents. The rating rationale should include reference to the quality of the said pool and strengthen of cash flows, originator profile, payment structure, risks and concerns for investors, etc.
' The instrument shall be in dematerialised form.
' The draft offer document shall be filed with SEBI atleast 15 days before opening of the issue.
' In case of public issuances listing will be mandatory. The instruments issued on private placement basis may also be listed subject to the compliance of simplified provisions of the regulations. The securitised debt instruments issued to the public or listed on a recognized stock exchange in accordance with these regulations shall be freely transferable.
It has been proposed to introduce simplified and relaxed listing agreement. Listing of private placement is also permitted subject to the compliance of simplified provisions of the listing agreement and the regulations. The simplified listing agreement is under preparation.
After discussing the varied significant legal frameworks pertaining to securitisation, it can be said that although laws are in a way adequate but certain ambiguities rampant in the legal framework make the laws a bit inept. Therefore the need of the hour is that the laws to be tailored or amended as per the requirements of the market, so as to capitalise the benefits for the securitisation players and for the economy.
IV. CRITICAL CONCERNS UNDER SARFAESI ACT :ROLE OF JUDICIARY
Securitisation as mentioned many a times, is an emerging concept and is still in its nascent stage. Courts many a times have intervened so as to standardize the functioning and the performance of securitisation in the Indian markets. This chapter of the project attempts to discuss various milestone judgments concerning securitisation and its functioning in the Indian markets and the impact therein. As already mentioned that the model is in its nascent stage there are limited judicial examples to cite, as decided by the Hon'ble courts in India.
MARDIA CHEMICALS LTD V. UOI
The case laid down a strong foundation for the enforcement of SARFAESI. The Hon'ble SC upheld the validity of the Act, thereby putting an end to a large number of pending and expected litigation on the ultra vires of the Act throughout the country. Various issues considered by the Apex Court includes:-
' Constitutionality of ??13 - The Hon'ble Court considered the pivotal of the whole controversy namely ??13 of the SARFAESI Act. The petitioner contended that the sale of a secured asset for enforcement of secured interest is an exception to the common law principle. It was strongly argued by the petitioner that ??13 empowers the borrower with unchecked arbitrary power since 'before any action is taken under ??13, there is no forum or adjudication mechanism to resolve any dispute which may arise in respect of the alleged dues or the NPA.
The court observed that there is a need for modern enforcement laws and speedy enforcement laws and there has been shift in paradigm on the issue of enforcement laws which have increasingly becoming lender friendly. The court held 'in such a situation, there is a need for change in approach towards enforcement of the security interest law and the act cannot be held to be ultra vires merely because it allows the secured creditors to enforce their rights without the intervention of a judicial authority'. The Court also pointed out that any law which does not give the other party to represent his case would be struck down of Article 14 of the Constitution. Particularly there must be some internal mechanism which provides safeguards for a borrower, before a secured asset is classified as NPA. The Hon'ble SC observed that such an internal mechanism must be included in the Act by mandating that the creditor must apply its mind to the objections raised in reply to such notice and an internal mechanism must be particularly evolved to consider such objection raised in the reply to the notice. In accordance with the observation of the SC ?? 13(3A) of the Act was inserted by the 2004 Ordinance.
' Jurisdiction of Civil Courts - The Hon'ble court noted that civil Courts can be approached in a limited number of cases. The court illustrated that one of such event where the civil Court will have jurisdiction could be invoked is where 'the action of the secured creditor is alleged to be fraudulent or their claim may be so absurd and untenable which may not require any probe whatsoever or to say precisely to the extent the scope is permissible to bring an action in the civil court in the cases of English mortgages.' Another illustration of such an action could be cases where a notice has been served upon the guarantor and character of the guarantor itself is denied by the party on whom the notice is served.
' Deposit of Money Before 'Appeal' - The provisions of ??17(2) came under attack before the constitutional courts which provides the right to appeal. It requires that the borrower deposit 75% of the sum before approaching the DRT. This sum however may be waived by the DRT.
An 'appeal' is defined by the Black's Law Dictionary as 'A proceeding undertaken to have a decision reconsidered by bringing it to a higher authority, the submission of a lower court for review and possible reversal.'
The wording of ??17 is misleading because what it provides is a right to approach the Court at first instance and not merely as an appeal so it can be said to be an appeal in only very general sense. The Court pointed out in the case that the word 'appeal' has been inappropriate used in the statue. The secured creditor argued that the ?? was not an unreasonable condition because '
' The Act provides that the Tribunal can reduce or waive the amount based on the facts and circumstances of the case. Hence, the tribunal can use its discretion to reduce the deposit required in cases where the demand is unreasonable,
' The deposit is necessary requirement because the value of the secured asset which would be taken possession by the creditor may not be enough to cover the amount of loans advanced.
The Court rejected both the arguments and held that they are devoid of any merit. The Court held that the requirement of pre-depositing 75% of the money renders the remedy 'illusory'. The court summarized the reasons for holding so under-
' it is imposed while approaching the adjudicating authority of first instance, not in appeal,
' there is no determination of the amount due as yet, the secured assets or its, management with transferable interest is already taken over and under control of the secured creditor,
' no special reason for double security in respect of an amount yet to be determined and settled
' 75% of the amount claimed by no means would be a meager amount
' It will leave the borrower in a position where it would not be possible for him to raise any fund to make deposit of 75% of the undetermined demand.
For the above reasons the Court held ?? 17(2) of the Act is 'unreasonable, arbitrary and violative of Article 14 of the Constitution.'
' Public Interest v. Private Interest- The Hon'ble SC observed that though a loan transaction may have a character of private contract, yet the question of great importance behind such transactions, as a whole having far reaching effect on the economy of the country, cannot be ignored when financing is through banks and financial institutions, utilising the money of people in general. Therefore, where public interest is involved to such a large extent, and it may become necessary to achieve an object which serves the public purpose, individual rights may have to give way. Public interest has always been considered to be above the private interest. Even if few borrowers are affected by the enactment, it would not impinge upon validity of the Act, which otherwise serves larger interest.
The issue as to whether the bank can resort to exercise its rights under the NPA Act even after initiating a proceeding under DRT was considered. In other words whether simultaneously cases can be instituted by the banks and FIs under DRT Act, 1993 and SARFAESI Act, 2002. It was held by the Supreme Court that the object of SARFAESI and DRT Act is the same, namely recovery of debts. Conceptually, there is no inherent or implied inconsistency between the remedies provided under the two Acts and they are cumulative in nature for secured creditors. Secured creditors are given the right to choose one or more of them. Though the DRT Act is a complete code in itself for recovery of debts and provides for various modes of recovery, it does not provide for expeditious enforcement of security interest of a non-adjudicatory process as has been provided for under the SARFAESI in order to prevent asset-liability mismatch in the balance sheet of the lender. It is for this reason that SARFAESI is treated as an additional remedy, which is not inconsistent with the DRT Act. Both the acts collectively provide for one single remedy of enforcing security interest therefore the principle of election is not applicable. Banks and the FIs are allowed to take recourse to one Act notwithstanding the pendency of proceeding under the erstwhile Act.
The doctrine of election of remedies comes into play in the event when the two remedies are co-existent at the time of election and are repugnant or inconsistent with each other. In case of no such repugnancy or inconsistency the matter of election does not crop up and therefore lacks application. It was held that the SARFAESI Act is an additional remedy under ??37 and is not inconsistent with the DRT Act.
ICICI BANK v. SHANTI DEVI SHARMA
There were allegations of deployment of musclemen, which was held as illegal. The Court held that while acknowledging that banks have vast powers under the Act, the SC held that the banks also have equal responsibilities and banks/financial institutions cannot adopt unfair practices for repossession of secured assets. Unfair trade practices have no place in India, which is civilised society governed by the rule of law.
ATV PROJECTS INDIA LTD. v. STATE OF MAHARASHTRA
The Division Bench of Bombay HC held that statutory and equally efficacious remedies are available to a borrower under ?? 17 of the SARFAESI by filing application before the DRT against the action taken by secured creditor under ??13(4) of the Act. Therefore, a borrower cannot invoke extraordinary jurisdiction of the HC under article 226 to circumvent the legal process provided under special statute.
Questioning constitutionality of Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 - Whether seat of Parliament or Legislature of a State would be a relevant factor for determining territorial jurisdiction of a High Court to entertain a writ petition under Article 226 of the Constitution of India - Framing of a statute, statutory rule or issue of an executive order or instruction would not confer jurisdiction upon a court only because of situs of office of maker thereof unless a cause of action arises therefore. Whether the seat of the Parliament or the Legislature of a State would be a relevant factor for determining the territorial jurisdiction of a High Court to entertain a writ petition under Article 226 of the Constitution of India.
Unique Engineering Works v. UOI
The issue at hand was whether the SARFAESI Act has prospective or retrospective application and the Uttaranchal High Court distinguishing between retrospective and prospective legislation held that the Act is retroactive in nature. Prospective means forward looking, having reference to a state of things existing before the Act in question. While retrospective statute contemplates the past and gives to a previous transaction some different legal effect that which it had under the law when it occurred. The Court shall not presume retrospectivty if any substantive right is created by the statute. Ordinarily, the retrospecitivity must be found from the provisions of the Act itself. In case of acts provision procedure and machinery provisions, the statute have always been given retrospective effect.
In UBI v. Satyawathi Tondon , the Supreme Court considered the maintainability of proceeding under Article 226 when an alternative remedy is available. The court observed that the High Courts overlook the availability of the statutory remedies available under the DRT Act and SARFAESI Act and continue to enforce the rights by exercising jurisdiction under Article 226. This leads to adversely effecting the rights of the bankers and other FIs to recover the dues as per the extant provisions under the two statues. In case of Punjab National Bank Vs Imperial Gift House also the Hon'ble Supreme Court of Indian held that High Court was not justified in entertaining the writ petition when the notice was issued under ??13(2) of the SARFAESI Act and so the same to be quashed
In UBI v. Satyawathi Tanddon, in the same case the court also held that proceedings against the Guarantors property by issuing notice under ??13 (2) and ??13(4) and thereby filing an application under ??14 of the SARFAESI Act without exhausting action against the borrower for recovery of the dues is allowed.
Authorised Officer, IOB v. Ashok Saw Mills The main question which falls for determination in this appeal is whether the DRT would have jurisdiction to consider and adjudicate with regard to post 13(4) events or whether its scope in terms of S. 17 of the SARFAESI Act would be confined to the stage contemplated u/s. 13(4), as contended on behalf of the appellants.
In the Statement of Objects and Reasons of the amending Act reference has been made to the decision of this Court in Mardia Chemicals Ltd.'s case 2004 Indlaw SC 258 (supra). It has been mentioned therein that Sub-S. (2) of S. 17 had been declared ultra vires Art. 14 of the Constitution. It was also mentioned that it had become necessary to make amendments in Ss. 13 and 17 of the Act since it had been held that where a secured creditor had taken action under Sub-S. (4) of S. 13 of the Act, it would be open to the borrowers to file appeals u/s. 17 of the Act within the period of limitation as prescribed therefor. It is on such account that S. 13 of the principal Act was amended by inserting Sub-Section (3-A).
The intention of the legislature is, therefore, clear that while the Banks and Financial Institutions have been vested with stringent powers for recovery of their dues, safeguards have also been provided for rectifying any error or wrongful use of such powers by vesting the DRT with authority after conducting an adjudication into the matter to declare any such action invalid and also to restore possession even though possession may have been made over to the transferee. The consequences of the authority vested in DRT under Sub-S. (3) of S. 17 necessarily implies that the DRT is entitled to question the action taken by the secured creditor and the transactions entered into by virtue of S. 13(4) of the Act. The Legislature by including Sub-S. (3) in S. 17 has gone to the extent of vesting the DRT with authority to even set aside a transaction including sale and to restore possession to the borrower in appropriate cases. DRT has jurisdiction to interfere with the action taken by the secured creditor after the stage contemplated u/s. 13(4) of the Act.
Malhotra Tractors v. Chief Manager, SBI, Faizabad, the court held that the requirements of ??13 (3A) are mandatory and their non compliance will render the next steps unfructuous. In this case, the Allahabad High Court held that the Banks have no right to proceed with the recovery proceedings unless they decide the objections or representations of the borrower or the guarantor as the case may be. The provisions of this ?? has its roots in the fundamental principle of fair play and natural justice.
Kiran Devi Bansal v. D.G.M. Small Scale Industries Development Bank of India the High Court of Gujarat held that the statue has fixed that the time limit of one week under ??13(3A) with the intention to expedite the proceedings. Every prescription of a period within which an act must be done is not the prescription of a period of limitation, with painful consequences, if the act is not done within that period. The time limit prescribed is directory and its non compliance does not render the proceedings vitiated under ??13(4) provided that the reasons for rejection of the objection are communicated to the borrower, before taking any action under ??13(4) of the Act.
Indian Bank v. Blue Jaggers Estates Limited & Ors. held that the DRAT has power to insist for deposit of 50 % of debt without the determination of the debt. Further the rate of interest levied cannot be challenged at a later stage of default; the agreement was signed with open eyes and was agreed to stand by the terms and conditions on which the loan was given, Thereby the doctrine of unconscionable contract cannot be cited for frustrating the cause of action for the purpose of recovering the dues.
K.R. Chandrasekran v. UOI discusses the nature and extent of powers exercisable by the CMM/DM under the SARFAESI Act. The consequences of an order passed by CMM/DM under ??14 relating to force to be used for taking possession without giving an opportunity to the person is ostensibly draconian. The 20120 Amendment Act requires and affidavit to be filed by the secured creditor, duly affirmed by its authorised officer after confirming the aggregate amount of financial assistance granted, total claim existing as on the date of filing the application, details of the properties of the borrower, etc. The 2012 Amendment Act makes it clear that the CMM/DM to pass suitable orders for taking the possession of the property after being satisfied by the contents of the affidavit. The role of CMM/DM is no longer executionary or merely ministerial; verification of facts which are stated in the affidavit is essential, even if the matters are not under any dispute.
Mahavir Plantations Ltd. v. ICICI Bank Ltd. held that notice under ??13(2) is of mandatory nature. The word used is 'may' but the permissive word 'may' only indicate that if the secured lender chooses to enforce the remedies under SARFAESI Act, the secured lender must serve a notice as required under this ??. The DRAT held that ??13(2), (3), (3A) are necessary for the scheme of the self-enforcement provisions of SARFAESI Act and so they should be compiled with in letter and spirit. Also held that the notice to the guarantor is mandatory so as to allow the guarantor to either persuade the borrower to pay or to make arrangements for paying.
Also held that notice to give such details as the borrower has fair knowledge about what is due. It is sufficient to mention that the account has become NPA alongwith the quantum of loan i.e liability recalled.
Shikshak Sahakari Bank Ltd. v. IOCL- Held that bank to take symbolic possession of any property when such a property is mortgaged to the Bank leased out to a third party. Possession is subject to the lease hold rights of the lessee. Provision under ??65(a) of the TPA is not inconsistent with the provisions under ??13 of the SARFAESI Act.
SBI v. Heera Laxmi Contractors Pvt. Ltd.
The question which came for consideration was whether the provisions of the Arbitration and Conciliation Act to be applicable to proceedings initiated under the SARFAESI Act. It was held that the provisions of ??35 of the SARFAESI Act will have over ridding effect over ??8 of the Arbitration and Conciliation Act which was enacted earlier in point of time. The provisions of SARFAESI Act having been enacted later in point of time, definitely the legislature can be deemed to have been aware of the earlier enactment and if the legislature has intended that the mandatory provisions of ??8 of Arbitration and Conciliation Act were to prevail over the SARFAESI Act, the same would have been provided under the SARFAESI Act.
Central Bank of India v State of Kerala
Even though the Central and State legislations have not been enacted with reference to a particular entry in List III of the Seventh Schedule, whether it will attract Article 254 of the Constitution? It was held that Article 254 comes into picture only when both the Central and State legislations have been enacted on any of the matters which are enumerated in List III of the Seventh Schedule and there is conflict between them. DRT Act and the SARFAESI Act both of them have been enacted under Entry 45 in List I in the Seventh Schedule while the Sales Tax Acts of Bombay, Kerala etc are enacted by the State Legislators under Entry 54 in List II in the Seventh Schedule. So Article 254 is not attracted for the purpose of striking down the State legislations on the ground that it is in conflict with the Central Legislations.
Ram Murty Pyara Lal v. Central Bank of India
Held that the provisions of SARFAESI Act to prevail in event of any inconsistency of any provision with the provision of TPA and CPC.
Jay Engineering Works Ltd. v. Industry Facilitation Council held that ??22 of the SICA provides for protection to company when an inquiry is pending or any scheme is under preparation or consideration or a sanctioned scheme is under implementation, against any initiation or continuation of any winding up proceedings or execution of such proceedings or distress or any proceeding of like nature against the properties of the industrial company. There is no blanket ban on such proceedings, but such proceedings cannot be either initiated or proceeded against such industrial comoany except with the consent of BIFR or appellate authority, as the case may be. The question for consideration was whether such protection to a sick company would be available when a borrower has taken measures to recover their secured debt under the SARFAESI Act. It was held that the Sick company is entitled to protection under ??22 of the Act notwithstanding the SARFAESI Act. SICA has non obstante clause and is a special statute and a complete code by itself. ??22 of the SICA, 1985 provides for a safeguard against impediment that is likely to be caused in implementation of the scheme.
K. Raamaselvam & Others Vs. Indian Overseas Bank
The question which came for consideration was with respect to the rights of the borrowers in realizing the maximum possible price of the property in question when it is being auctioned by the Bank, along with the responsibility of the Bank. The Bank is under the obligation to mandatorily follow the procedure mentioned under the SARFAESI Act for the purpose of conducting the public auction, but it depends upon the facts and circumstances of the case and the intent is to get the best possible price of the property. In case the secured creditor finds that the highest bid offered does not reflect the true market value of the said property and there have been collusion between the bidders in such a case the secured creditor can refuse the highest bid, notwithstanding the fact that the highest bid is more than the price. The Court observed that the secured creditor acts as the trustee on behalf of the borrower apart from acting as the secured creditor. In such a scenario, by acting as the trustee the secured creditor is not only expected to realize the debts but can also if possible to generate highest possible amount which can be refunded to the borrower after the settlement of the accounts.
Dhulabhai Vs. State of MP
The Supreme Court discussed the principles relating to exclusion of jurisdiction of civil court, the provisions and the extent of such jurisdiction. The Apex Court summarized the principles relating to the exclusion of jurisdiction of civil courts:-
(a) Where the statute gives a finality to the orders of the special tribunals, the civil court's jurisdiction must be held to be excluded if there is adequate remedy to do what the civil courts would normally do in a suit. Such provision, however, does not exclude those cases where the provisions of the particular Act have not been complied with or the statutory tribunals has not acted in conformity with the fundamental principles of judicial procedure.
(b) Where there is an express bar of the jurisdiction of the court, an examination of the scheme of the particular Act to find the adequacy or the sufficiency of the remedies provided may be relevant but is not decisive to sustain the jurisdiction of the Civil Court. Where there is no express exclusion, the examination of the remedies and the scheme of the particular Act to find out the intendment becomes necessary and the result of the inquiry may be decisive. In the latter case, it is necessary to see if the statute creates a special right or a liability and provides for the determination of the right or liability and further lays down that all questions about the said right and liability shall be determined by the tribunals so constituted, and whether remedies normally associated with actions in Civil Courts are prescribed by the said statute or not.
An exclusion of the jurisdiction of the civil court is not readily to be inferred unless the conditions above set down apply.
However, there are certain cases which require the civil courts to extend their jurisdiction to adjudicate upon issues under the SARFAESI Act,2002 and the courts should not hesitate to do the same when the requirement of such a leap, despite the existence of section 34 , is apparent.
V. SHORTCOMINGS UNDER SARFAESI ACT, 2002
The provisions under the SARFAESI Act have been the subject matter of litigation as and when the same was enacted. The Supreme Court ruling in Mardia Chemicals v. UOI has cleared most of the doubts. Subsequent amendments made pursuant to the ruling were reckless as the rest of the drafting of the law. The draftsman's stronger urge to give whatever powers a bank may need to enforce security interest s may be seen in the 2004 amendments that gave drastic powers as the right to takeover the business of the borrower. Essentially this law provides only a means of non-judicial enforcement of the rights that were mutually agreed between the parties in the loan document; the law cannot give such powers to the lender that were never envisaged in the loan document. The provisions of this law suffer from multiple flaws of drafting like loose language, bad English, flawed conceptual understanding and lack of meticulousness.
Section 2 (1) (z) defines Securitsation . The foremost basic flaw lies in the fact that the definition mixes up the concept of 'securitisation' and 'asset reconstruction', the two being different concepts. Further the act of converting a financial asset into securities which are merely altered version of the assets is securitisation. The act of acquiring a financial asset is not securitisation. it is the act of transforming such assets into securities. However, this definition relates securitisation to the act of acquisition of financial assets by SC. So this definition cannot guide to the proper meaning of securitisation. On close reading of the definition of securitisation and SC, the two leads to nowhere. An acquisition of financial assets by a SC is securitisation and a SC is the one which acquires the financial assest for securitisation.
Another notable and co-related flaw in the definition of securitisation lies in the fact the Act stipulates the acquisition of financial assets by SC or RC from any originator. While under ??5, financial assets are transferred are means of acquisition by SC or RC of 'financial assets of any banks or FIs'. The essential part to be noted is that the by doing so the legislators have created another classification of 'any originator'; as a result of which the banks and FIs can only act as originators. Therefore on co joint reading of both the ?? it can be inferred that the Act contemplates that Banks and FIs are allowed to do the securitisation only.
Defined under ??2(1) (zf). The words 'right, title and interest of any kind whatsoever' are ambitious if left unrestrained. A title conferred in case of sale of property, cannot be covered by the above definition. The too-general and wide words 'right, title and interest of any kind whatsoever' will get coloured by the specific words following- mortgage, charge, hypothecation, assignment, etc. in other words, if a right, title or interest is similar to mortgage, hypothecation, charge, etc., it will be covered by security interest in the above definition. To cite another example, if a creditor has only a negative lien (i.e. merely in the form of a covenant barring the borrower from alienating or dealing with certain assets in a certain manner) over the assets of a borrower he can undertake enforcement action under the Act. This would also create a practical problem as any and every interest, which could qualify, as 'security interest' would also be required to be 'registered' under the Act.
No difference between SC and RC under the Act- The SARFAESI provides for registration of SC and RC which act as the SPV. The Act fails to make any difference between the two under ??2 (v) and (za) of the Act. Neither SC nor RC is restricted to the respective transactions of securitisation or asset reconstruction respectively. Securitization as commonly understood is a method of structured finance adopted by the companies / banks / financial institutions for the purposes of conversion of financial assets into marketable securities; raising cheaper funds; liquidity; access to new market; balance sheet management. Asset reconstruction, on the other hand, normally relates to Non Performing Assets of Banks and Financial Institutions, which are transferred to specialized entities (i.e. RC ) for the purposes of recovery of the NPA and better balance sheet management. Therefore, the Act has tried to relate the transactions of securitization and asset reconstruction, which by its nature and purpose is different from one another.
Overlapping legal mechanisms - There are diverse legal concerns like Stamp Duty, Registration Act, Tax law, RBI Regulations, SEBI rules which are not addressed in the Act properly and sufficiently. The synchronization between these statues is essential for the purpose of encouraging the securitization transactions in India. Therefore, the need is to harmonise and regularize the various regulatory frameworks. Apart from this domestic legal issue, it is important to have the law feasible and in coherence with the international standards, so that in future when the law on securitization widens its horizon, there will be no difficulty in its transition.
Classification of Account as NPA and the demand notice- ??13(2) of the SARFAESI Act prescribes that the Banks to classify a loan as NPA as per the guidelines issued by RBI. NPA is a credit facility with respect of which the interest or installment of the principal has remained past due for a specified period of time. In order to achieve international standards, the 90 days overdue norms for the purpose of identifying the NPAs have been adopted. There are instances wherein this power of classification of a loan account as NPA by the secured creditor is misused. There have been instances where the borrowers are harassed by the bank officials under the garb of SARFAESI Act which has given unencumbered powers to the banks and FIs for the purpose of realization of the debts. The secured creditors are under an obligation to follow the RBI guidelines but there have been instances of willful ignorance in the process of classification of the accounts as NPA. In the plethora of cases similar to those abovementioned indicate the lenient approach adopted by the courts in regularisation of the defaulting loan accounts. In spite of the judiciary playing a significant role by managing and controlling such unencumbered powers of banks and FIs, the borrower faces many hurdles.
Powers of DRT - ??17 of the SARFAESI Act empowers the DRT to entertain appeals in the event when the banks and FIs misuse the powers given to banks under ??13(4) of the Act. The first glaring lacuna exists in matter of terminology. Under ??17, the word used is appeal; which is wholly inapposite for a compliant against the wrongful measures adopted by s secured creditor. A secured creditor takes action on the authority of this law is only a party to the contract and under the guise of this law attempting to enforce the rights. The secured creditor is under no power of performing any judicial or quasi judicial functions. As appeal is the right to seek to redress for a higher judicial forum for an order or decision of a lower judicial or quasi-judicial forum. There is an order passed by an authority of law, against which an appeal lies. There is no existence of any authority of law to the secured creditor. The aggrieved party may file a complaint or application but definitely the word appeal is most inappropriately used under ??17 of the SARFAESI Act. In Marida Chemicals v. UOI, the Court held that ' We may like to observe that proceedings under ??17 of the Act, in fact are not appellate proceedings. It seems to be a misnomer. In fact it is the initial action that is brought before a forum as prescribed under the Ac, raising grievance against the action or measures taken by one of the parties to the contract'.
Further the aggrieved person has a right to file a complaint against wrongful measures adopted by the secured creditor, so the right to take the grievance to a forum cannot be exercised only after the measures have been taken. This section seem to suggest that the appeal before the DRT can be filed only after the measures under ??13 have been taken by the secured creditor.. if there is indeed anything wrong in the measures adopted by the secured creditor, the aggrieved party must be allowed to approach a judicial authority either before or after the measures have been taken.
The next fault under this section lies with respect to the powers of DRT. It does not spell out the powers of the DRT to redress the grievances. The next issue is that the provisions of this Act are extended by the RBI to financial companies, is the action appealable before the DRT? DRT does not exercise jurisdiction in matters relating to claims by financial companies. Even a trust constituted by the ARCs is deemed to be a lender under this law so the question of jurisdiction arises with respect to all such entities which re not clearly covered by the DRT Law. Like the provisions of the Act have been extended to housing finance companies, which are not otherwise not under the coverage of DRTs. So the propriety of such cases being dealt by the DRT needs to be examined.
Measures under Section 9(a) and (b) of the Securitization Act are too wide
The powers set forth under Section 9 of the Act in respect of asset reconstruction are in addition to the powers under Section 13 of the Act and therefore suffers from similar flaws as Section 13 of the Act.
Also, empowering the RBI to frame directions more particularly in respect of Section 9(a) and 9(b) could be prejudicial to the interests of the borrowers as the RBI may completely ignore the interest of the borrower. Thus, it is necessary to explicitly set out the guidelines to use the powers, which may be exercised in respect of asset reconstruction rather than allowing RBI to frame guidelines from time to time.
??13(9) ' The wordings of this section is extremely lousy. The intermixing of 'secured creditor' and 'financial asset' is one of the glaring blemishes it carries. Financial asset is the loan and the secured asset is the security that backs up the loan. This, the words 'financing of financial asset' appearing at the start of ??13(9) in the definition of 'amount outstanding' are both wrong, as 'financial asset' is actually the funding itself and the amount outstanding is in respect of a financial asset and not a secured asset.
The next incumbent issue relates to the sale of the assets under the SARFAESI Act. The banks have been sanctioned under the provisions of the SARFAESI Act to take possession of the secured assets and transfer by way of lease, assignment or sale of the secured asset. Once demand notice is served for repayment of secured debt or installment to the debtor and such the debtor fails to pay the sum , in such an event the secured creditor is permitted to enforce its right under ??13 (4) by taking possession of the secured assets of the borrower as well as the right to jurisdiction by way of lease, assignment or sale for realising the secured assets. The issues of concern is that the often borrowers are subjected to disadvantageous position by acting arbitrarily or exercising unauthorized powers by the banks and FIs for the purpose of selling the secured assets. Not only while taking possession of the secured assets, the banks use excessive discretion while the auctioning of the secured assets. This in turn acting positive for the banks and FIs becomes a draconian legislation for the borrowers leaving them into disadvantageous position.
Sale of assets of company in liquidation or being wound up- A perusal of ??13(9) of the SARFAESI Act shows that in case of a company in liquidation the sum realised from the sale of secured assets must be distributed as per the requirements of the provisions of ?? 529A of the Companies Act. The second proviso also postulates that in case of a company being wound up after the commencement of the SARFAESI Act, a secured creditor or a SC may retain the sale proceeds of his secured assets after depositing workmen's dues with the liquidator as per the requirements of Section 529A of the Act. However, in spite of laid down provisions, the banks tend to overlook these provisions extending beyond the scope of powers under the enactment. The company in liquidation or being wound up does not have adequate remedies except for approaching the DRT by way of appeal under ??17, where also the tribunals acting as agents to the banks fail to provide adequate justice to the borrowers. In view of the genuine grievances of the borrower depending upon case to case, it is essential that the banks provide adequate remedies to the borrowers in respect of auctioned properties by compliance with all the provisions under the law as well as ensuring the maximum price as benefits to them.
Limitations of the Act
' The legislation empowers one party to the dispute, i.e. the creditor to take action without due judicial process against the other party. The bank and FIs in their eagerness to recover NPAs may violate the fundamental rights of the borrowers. The borrowers can approach the DRTs in case of grievances, but it amounts to post corrective measure as the Act allows the banks and securitisation companies to initiate action.
' In case of enforcement of their claims by banks/FIs under this Act, they do not examine the validity of the charge nor are they empowered to do so. Therefore, in the rarest case of defective charge also the recovery shall take place.
' The main object of the Act is fast recovery of debts. But the Act provides for appeal over appeal, which is lengthy judicial process and leads to delay in execution proceedings.
' It will be difficult for banks to sell distressed assets as there are few takers for such assets.
' The Act empowers the banks to take over the management of defaulting companies. Banks are not skilled enough to run any business activity with guaranteed success.
' In case of enforcement of claims in consortium advances the creditors can enforce only on the consent of the other creditors having minimum 75% share in the loan whereas enforcement of claim though DRT/Civil Court can be initiated by a single creditor by adding other creditors as respondents in the case.
' In case of sale of seized assets, the seller and the beneficiary will be the same. The sale of secured assets by banks at a value enough to cover their dues would be adequately self serving, but it may appear to be unfair to the stakeholders.
' The Act provides to take help from the district administrative machinery for enforcement of security interest is an impractical stipulation. As our district administrative machinery is even unable to provide assistance even to the DRTs for the recovery work.
' Valuation of assets and binding process can trigger legal cases. There may be lack of unanimity among lenders, as all lenders holding at least 75% stake in outstanding dues are required to agree to sell the assets of defaulters.
' The appointment of a manager for the management of acquired assets, in consultation with the borrower, whose assets have been seized by the banks, is a utopian idea.
' Appeal can be admitted only after action is taken even if the demand raised is for wrong amount.
' At the time of disposal by secured creditors ' who will bear tax liability on account of capital gains arising from sale transfer of assets or eight therein? Will the recovery of dues by secured creditors still stand subordinated to the recovery of taxes by the state / government.
' Cheques issued as JDC ' After wards Take over of management of business of Company ' Cheques not being honored then action u/s 138 can be initiated against original signatories, who otherwise have lost control on the company.
' Notified Area Tax, water changes revenue cess if remained unpaid or demand arises in such areas, whether the new buyer will still get clear title, even in such cases is still subjective, even is such cases.
' Transfer charges of MIDC/GIDC/Collectors etc have to be paid off at the time of sale of securitized assets- All such conditions make disposal of assets taken under possession difficult.
' Where Conditional approval given by society/collector for creation of mortgage at initial stage who has to fulfill or release those charges or comply with the conditions?
' FIIs/NBFC's are not yet allowed protection under this act.
' The buyer/transferee gets the same title as owned by owner before creation of security interest. It however does not wash away pre-existing / part defects in the titles. For example, unauthorized construction done by builders and such properties are mortgaged in good faith, or where earlier agreements or documents are take / forged / created using questionable stamp paper or other methods, etc.
' No time limit set for secured creditors for taking action after expiry of 60 days time of notice. They can take action at any time before expiry of limitation.
' No time limit for disposal of second appeal at Appellate Tribunal.
' Mainly used against small & medium sized borrowers. Very few cases of application against large borrowers, where security/collateral cover is normally less and CDR mechanism is preferred there.
' Creation of charge becomes invalid when winding up petition is admitted and proceedings are started. No action u/s 13(4) will sustain.
' Recent judgments do not favour direct action of taking physical possession without intervention of District Magistrate, which again has resulted into delays in recoveries/settlement of dues.
Securitisation reflects innovation in the financial markets at its best. Pooling assets and using the cash flows to back securities allows originators to unlock the value of illiquid assets and provide consumers lower borrowing costs at the same time. The importance of securitisation for financial stability derives from the ability of the shadow banking system to increase total supply of credit to end-users. It has been a tremendous boon for banks/ FIs which are beleaguered by excess illiquid and non-performing assets. It has also significantly galvanised the financial market. For NBFCs, securitisations could be an avenue of low cost funding while for banks securitisation will continue to provide immediate liquidity.
Structural benefits from securitisation arise from the flexibility they provide in transforming cash flows and risks of the collateral pool into those of the securities issued on the pool. The traditional securitisation models have played an important role in strengthening the lending culture by providing the lenders with an avenue to free up the balance sheets in a cost-effective manner. Securitization can also improve balance sheet liquidity by converting long-term and illiquid receivables into funds that can be used for additional value-generating investments. Furthermore, securitisation enables end investors to obtain a more efficient market portfolio and thereby diversify their idiosyncratic risks. Globally, over the past two decades, banks have lost their traditional role as the dominant suppliers of credit in some countries, and securitisation has become a core component of the market-based supply of credit. While corporate bonds served as the main dis-intermediated financing tool for non-financial corporations, securitisation acted as the main capital market instrument for household finance, and to a lesser degree SMEs.
In the Indian context, securitisation can indeed play a positive role in financial intermediation provided there is genuine transfer of risk away from the banking system. Although the existing and proposed guidelines are in line with international practices but require certain modifications to suite the environment so that securitisation market develops for the right reasons. It is also necessary to promote standardisation to facilitate risk assessment and valuation and eventually enable the trading of these securities on the exchanges.
A lot depends on what has been put forth by the SRFAESI Act, 2002, and to discuss, or rather focus on the future of Securitisation (specifically in India), one has to analyse the clauses of so. Therefore, an attempt has been made to forecast about one of the most essential elements with the help of following:
Explaining and Understanding the Characteristics of Real-Property-Securitised Products:
In order to continuously promote effective real property securitisation, the investor's understanding of the characteristics of securitised products is essential. If only the higher return is emphasized and investment is made without full understanding of the risk factors, the investment in real-property-securitised products will not be repeated by investors when risks materialise and losses are experienced. To prevent such problems, written offers to invest in real-property-securitised products and oral presentations to potential investors must be well prepared and fully explain the products' characteristics, as well as the transaction prices of the subject properties and return-related information (e.g. tenant information, and other appropriate disclosures) etc.
Establishment of Better Environment for Promotion of Securitisation:
Rationalising the Rental Agreement: With regards the rental and leasing of properties , the 'normal rental system' used for residential properties is also used in the case of office and commercial properties (under the "normal rental system" the rights of landlords are to some degree regulated in order to protect the rights of residential tenants deemed to be in a relatively weak position). When landlords advise tenants of non-renewal or cancellation of rental agreements the so-called 'Due Cause' System limits the landlords' right to terminate them, even when such cancellation is stipulated in the agreement with three to six months notice. Landlords must show 'reasonable cause' for refusing to renew or cancel rental agreements: for example, the landlord may require the subject property for his/her own use. Supplementary lease provisions are also common. Usually it may be agreed that the tenant can terminate the rental agreement with one to six months prior notice. Under these conditions, the termination period of the rental agreement is unpredictable, and it is pointed out that the revenue streams from securitised property, which are essential to successful real property securitisation, are also unpredictable.
Property Evaluations Based On Income Stream:
In order to precisely reflect the risk/return potential of a subject property, it is important that during the process of implementing securitisation due diligence is conducted with respect to the physical attributes of the property including structure, building equipment and deferred maintenance; the legal matters such as the contents of rental agreements and the rights and interests of parties with respect to the subject property; and economic factors such as the rent-paying abilities of tenants and the prospects for development in surrounding areas. Also, it is important that property evaluations are based on income factors.
Securing Prime Properties for Securitisation:
In order to establish and offer attractive securitised products in which a wider group of investors are likely to become interested, it is necessary that many properties which have the high returns that investors require be secured for purchase at prices reflecting their risk/return profile. In relation to securitised products currently under development, it is noted that the number of properties that satisfy conditions regarding rental incomes and occupancy ratios is limited. In order to improve returns and reduce risk factors, it is necessary to increase the supply of prime properties by positively promoting the remodelling and reconstruction of existing properties. As real property securitisation takes off, new properties can be built specifically for this purpose. Problems related to the securitisation of projects under development are as: Firstly, it is difficult to project the return in advance, because of fluctuating development costs and development periods; and Secondly, there is a substantial time lag between the initial investment and the realization of income.
So, the risk stemming from the uncertainty of the return can be reduced by combining the securitisation of new developments with the securitisation of existing properties; and especially in the early stages of project development, projects could make practical use of public loans and guarantees through the government policy finance.
Keeping in mind, the above, the following should be noticed with a further observation:
?? Although the internal and external costs of a transaction are high, securitisation can raise significant amounts of funds. As a result, the costs are generally worth bearing (and when amortised, are not significant).
?? Securitisation appears to be complicated to the uninitiated. However, once the basic principles have been learned and an appropriate transaction structure designed, most clients wonder what the fuss was all about.
?? Transactions are generally easy to administer (and to repeat), provided they have been correctly structured. Most of the work from an originator's perspective is involved in: (i) setting up systems and procedures before transactions are launched, (ii) ensuring the legal and tax neutrality of the transaction and (iii) assisting in the delivery of a transaction which meets the originators commercial objectives.
The final issue that may arise from an SPV's unlicensed status is that in some jurisdictions, interest payments to non-banks are subject to a withholding tax. It is most unlikely that a corporate borrower would agree to a securitisation of its loan in circumstances where it becomes required to gross-up its interest payments. This would remain true despite the argument that the effect of a gross-up is not to increase the cost of borrowing, but is it rather a timing issue, since the person making the gross-up will eventually receive a tax credit.
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