Corporate Insolvency under SARFAESI

A reasonable person acquainted with the business world would concur with me if I say that it is almost impossible to conceive of a business that is completely insolvency-free. Laws relating to corporate insolvency and restructuring were enacted to serve several objectives, namely, to restore the debtor company to profitable trading where this is practicable; to maximize the return to creditors as a whole where the company itself cannot be saved; to establish a fair and equitable system for the ranking of claims and the distribution of assets among creditors, involving a redistribution of rights; and to provide a mechanism by which the causes of failure can be identified and those guilty of mismanagement brought to book, and where appropriate, deprived of the right to be involved in the management of other companies. The present article focuses solely on the SARFAESI act dealing with the rights of secured creditors, however there are many other stake holders like government agencies and employees whose are equally important and should be accorded due credence if not equal as compared to secured creditors[1].

Introduction

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (here-in-after referred to as The Securitisation Act) was  enacted with an intention to strengthen the rights of the creditors  through foreclosure and enforcement of securities by the banks and other financial institutions by referring on the creditors the right to acquire the secured asset and dispose of the same in order to recover dues promptly bypassing the expensive and very time consuming legal process through courts[2].

This Act transfers the powers on to the creditors themselves to move against a borrower whose assets are secured and has defaulted in some kind of payment. The Act is a non-obstante law which will take effect notwithstanding anything contrary contained in any other law. Thus, after satisfying the relevant statutory requirements the creditors can:

  • Take possession of the secured assets of the borrower even through means such as transfer by means of lease, assignment or sale.
  • Take control of the management of the secured asset
  • Appoint managerial personnel to look after the secured asset[3].

Scheme of the Act

The Securitisation Act contains 41 sections in 6 Chapters and a Schedule. Chapter 1 contains 2 sections dealing with the applicability of the Securitisation Act and the various definitions. Chapter 2 contains 10 sections dealing with regularization of securitisation and reconstruction of financial assets of banks and financial institutions, setting up of securitisation and reconstruction companies and matters related thereto. Chapter 3 contains 9 sections relating to enforcement of security interests and allied matters thereto. Chapter 4 contains 7 sections which provide for an establishment of a central registry, registration of securitization, reconstruction and security interest transactions and matters related thereto. Chapter 5 contains 5 sections containing offences, penalties and punishments. Chapter 6 contains 10 sections providing for routine legal issues.

Salient Provisions of the Act with respect to Insolvency

The act mandates that the liquidation and reconstruction of companies in distress be carried out through the mechanism of 2 special purpose vehicles namely Securitisation Company(SCO) and Reconstruction Company(RCO). These SPVs should be incorporated under the Companies Act and should possess owned funds of Rs. 2 crores and above.

Under this Act any creditor may move to enforce his security without the intervention of any court or tribunal if a right is created in his favour by the non-payment of certain sum which was due, even notwithstanding the provisions of the Transfer of Property Act.  Under Section 13(2) of the Act on non-payment of an amount due by the borrower the creditor can classify the amount as an non-performing asset(NPA) and provide a period of 60 days to pay the same. If such a payment does not take place owing to insolvency or any other contingency factor the secured creditor will be entitled to exercise any or all of the rights under sub- section 4 of the same section[4].

The section states:

(4). In case the borrower fails to discharge his liability in full within the period specified

in sub-section(2), the secured creditor may take recourse to one or more of the following

measures to recover his secured debt, namely:-

(a) take 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.

(b).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.

(c). appoint any person to manage the secured assets the possession of which has been taken over by the secured creditor.

(d). 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 any money is due or may become due to the borrower, to pay the secured creditor so much of the money as is sufficient to pay the secured debt.

According to section 2(o) of the Act means an asset or account of an borrower which has been classified as sub-standard, doubtful or loss asset by a bank or a financial institution:

a) In case such bank or financial institution is administered or regulated by any authority or body established, constituted or appointed by any law for the time being in force, in accordance with the directions or guidelines relating to the asset classifications issued by such authority or body;

b) In any other case, in accordance with the directions or guidelines relating to assets classifications issued by the Reserve Bank.

Exceptions to the Securitisation Act (Sec.31)

The provisions of this Act will not apply to–

(a) A lien on any goods, money or security given by or under the Indian Contract Act, 1872 (9 of 1872; or the Sale of Goods Act, 1930 (3 of 1930) or any other law for the time being in force;

(b) A pledge of movables within the meaning of section 172 of the Indian Contract Act, 1872 (9 of 1872);

(c) Creation of any security in any aircraft as defined in clause (1) of section 2 of the Aircraft Act, 1934 (24 of 1934);

(d) Creation of security interest in any vessel as defined in clause (55) of section 3 of the

Merchant Shipping Act, 1958 (44 of 1958);

(e) Any conditional sale, hire-purchase or lease or any other contract in which no security

interest has been created;

(f) Any rights of unpaid seller under section 47 of the Sale of Goods Act, 1930 (3 of 1930);

(g) Any properties not liable to attachment (excluding the properties specifically charged

with the debt recoverable under this Act) or sale under the first proviso to sub-section (1) of section 60 of the Code of Civil Procedure, 1908 (5 of 1908);

(h) Any security interest for securing repayment of any financial asset not exceeding one lakh rupees;

(i) Any security interest created in agricultural land;

(j) Any case in which the amount due is less than twenty per cent of the principal amount and interest thereon.

Conclusion

We have seen that genuine efforts have been made to formulate laws through recommendations, enactment etc. Yet, like any other branches of law, corporate insolvency and restructuring laws in India lacks teething. Authorities concerned need courage of conviction with clear mindset and will at heart in order to make the current laws more efficient and effective with an element of a definitive and predictable time frame. And the judicial process ought to take commercial approach towards revival of the sick companies. All supporting pillars i.e. accounting and auditing; statutory & legal framework; monitoring & enforcement; education & training; need to be strengthened and disciplined[5].

The corporate insolvency and restructuring laws should prescribe a flexible but transparent system for disposal of assets efficiently and at maximum value. Secured creditors™ claim should rank pari passu with workmen and government dues. The law should also provide for mechanism to recognize and record claims of unsecured creditors as well.

Finally, in the model of Public-Private-Partnerships (PPP) to facilitate corporate insolvency and restructuring, an Insolvency Fund with optional contributions by companies may be created with Government grants and incentives to encourage contributions by companies to the Fund. Companies which make contributions to the Fund should be allowed certain drawing rights in the event of insolvency. And since proposed Insolvency Fund shall have commercial element, the same may not be linked/credited to Consolidated Fund of India (or of a State).


[1] Robin Majumdar, Corporate Restructuring and Efficiency: In Search of Efficient Laws, Available At: http://www.legalserviceindia.com/article/l263-Corporate-Insolvency-&-Restructuring.html

[2]  Rakesh Mohan, Closing Business in India: Development in Legal and Regulatory Framework, Available At: http://www.oecd.org/daf/ca/corporategovernanceprinciples/44071177.pdf

[3] A Ramaiya, Ramaiya™s Gude to Company Law, Vol. III, Issue II( Lexis Nexis, Nagpur, pg. 2241, 2010)

[4] RBI Report on Trends and Progress in Banking, 2010

[5] M, Raghunath, Credit Risk and Credit Assessment in India, Vol.I, Issue III ( Deep and Deep Publishers, New Delhi, pg. 37, 2011)

Tags: Central bankCompanies ActCompany LawDebtorfinanceFinancial servicesIndian Contract Act 1872InsolvencyMerchant Shipping ActNon-performing assetReconstruction of Financial AssetsRestructuringSARFAESISecured creditorSecuritisationSecurity interestSpecial purpose entity

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About Alimpan Banerjee

Alimpan Banerjee | Student

IVth Year student at National Law University, Jodhpur

Corporate Law Referencer

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