Supreme Court s Judgment on Securitization- A Balancing Act

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1 Supreme Court s Judgment on Securitization- A Balancing Act In a landmark judgment passed on , the Supreme Court has upheld the constitutional validity of the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest (SRAFESI) Act, 2002 except for the condition of deposit of 75% of the outstanding amount before approaching the Debt Recovery Tribunal. (DRT). This decision is reported as Mardia Chemicals Ltd. etc. vs. Union of India & Ors 1. PASSING OF THE ACT The main object in passing this act was to provide an effective legislation for speedy recovery of dues of Banks and Financial Institutions. Before passing of this Act the only remedy, which Banks and FIs had against defaulting borrowers, was to approach the Debt Recovery Tribunal (DRT) under the relevant provisions of Recovery of debts due to Banks and Financial Institutional Act. There was a perception, however, that working of these tribunals was unsatisfactory. Banks and FIs were facing considerable difficulties in recovery of their dues from the borrowers and enforcement of securities charged to them due to the delay in the legal processes. In addition to this, Banks and FIs also incurred substantial amount of expenditure by way of legal charges, which further added to their overheads. The blockage of a significant portion of the funds of banks and FIs in unproductive assets was a major concern to policymakers and stakeholders in, India s financial system. This step was thus taken towards securitisation of the debts and to evolve means for faster recovery of Non Performing Assets. The passing of this Act, however was accompanied by controversy that it was too harsh and draconian. Provisions of section 13 had armed the Banks and FIs with powers to take punitive action against the defaulters and also attachment and sell of their properties. Section 13 of the Act provides that- Enforcement of Security Interest- (1) any security interest created in favour of any secured creditor may be enforced, without the intervention of the court or tribunal, by such creditor in accordance with the provision of this Act. (2) Where any borrower, who is under a liability to a secured creditor under a security agreement, makes any default in repayment of secured debt or any instalment thereof, and his account in respect of such debt is classified by the secured creditor as non-performing asset, then, the secured creditor may require the borrower by in writing to discharge in full his liabilities to the secured creditor within sixty days from the date of notice failing which the secured creditor shall be entitled to exercise all or any of the rights under subsection (4). (3) The notice referred to in sub-section (2) shall given details of the amount payable by the borrower and the secured assets intended to be enforced by the secured creditor in the event of non-payment of secured debts by the borrower.(4) In case borrower fails to discharge his liabilities 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 1 (2004)4SCC311

2 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 realizing the secured asset (b) take over the management of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale (c) appoint any person to manage the secured assets the possession of which has been taken over by the secured creditor; A reading of Section 13 shows that Banks and FIs were empowered to initiate recovery proceeding without any intervention of court. Apart from this, provision of section 17(2) which was described as tiger tooth by the borrowers provides that- 17. Right to appeal- (1) Any person (including borrower), aggrieved by any of the measures referred to in sub-section (4) of section 13 taken by the secured creditor or his authorised officer may prefer an appeal to the Debt Recovery Tribunal having jurisdiction in the matter within forty five days from the date on which such measure had been taken.(2) Where an appeal is preferred by a borrower, such appeal shall not be entertained by the Debt Recovery Tribunal unless the borrower has deposited with the Debt Recovery Tribunal seventy-fie percent of the amount claimed in the notice referred to in sub-section (2) of section 13: provided that the Debt Recovery Tribunal may, for reasons to be recorded in writing, waive or reduce the amount to be deposited under this section This pre-condition of deposit of 75% of the outstanding amount under section 17(2) was so harsh that it was felt to have virtually made judicial recourse impossible for borrowers. CHALLENGES TO THE ACT The Act was initially challenged by the Mardia Chemicals against whom the ICICI Bank and other Financial Institutions had initiated legal proceedings under the Act. The main challenges to the Act can be summed up as under- the banks and financial institutions have been vested with arbitrary powers, without any guidelines for its exercise and also without providing any appropriate and adequate mechanism to decide the disputes relating to the correctness of the demand, its validity and actual amount of dues sought to be recovered from the borrower. The provisions of the Act has been made one sided affair while enforcing drastic measures of sale of the property or taking over the management; provision of Section 17(2) is unconstitutional as it virtually takes away borrowers right to resort to any legal recourse. This section makes it compulsory for defaulting companies to deposit 75% of the amount in dispute in case borrowers wish to appeal against an order under the Act.

3 SUPREME COURT S JUDGEMENT- A BALANCING ACT The Supreme Court in its judgment has upheld the constitutional validity of almost all provisions of the Act. It has, however, quashed section 17(2) of the Act by declaring it unconstitutional. The Supreme Court held as under- that after service of notice under sub-section (2) of section 13 it is incumbent upon secured creditor to serve 60 days notice before proceeding to take any of the measures as provided under sub-section (4) of section 13 of the Act. 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 mind and the reasons for not accepting the objections, howsoever brief they may be, must be communicated to the borrower. 2. if any measures are taken under sub-section (4) of section 13 and before the date of sale/auction of the property it would be open for the borrower to file an appeal (petition) under section 17of the Act before the Debt Recovery Tribunal. the tribunal in exercise of its ancillary powers shall have jurisdiction to pass any stay/ interim order subject to condition as it may deem fit and proper to impose. requirement of deposit of 75% of amount claimed before entertaining an appeal (petition) under section 17 of the Act is an oppressive, onerous and arbitrary condition against all the canons of reasonableness. Condition is invalid and struck down. The above stated Supreme Court verdict has not taken away the powers of lenders to initiate recovery proceeding but even borrowers have the right to resort to legal proceedings against such recovery without first complying with any pre-condition of deposit of 75% or any such part of outstanding amount. It is very difficult to say as to who has won the case- Lenders or Borrowers? As of now the court s verdict has brought cheer to both sides. It remains to be seen how successful the legislation will be in unlocking the blocked funds of Banks and FIs. PROS & CONS The main object of passing of this Act was to unlock on one estimate Rs. 100,000 crores of the non-performing assets in India s financial sector without getting into lengthy court processes. The Supreme Court in para 46 of its judgment holds view that we are holding that it is necessary to communicate the reasons for not accepting the objections raised by the borrower in reply to notice under section 13(2) of the Act more particularly for the reason that normally in the event of non-compliance with notice, the party giving the notice approaches the court to seek redressal but in the present case, in view of 2 This requirement has been read into the framework of section 13 even though it is not expressly so provided

4 section 13(1) of the Act the creditor is empowered to enforce the security himself without intervention of the court. Therefore, it goes with logic and reason that he may be checked to communicate the reason for not accepting the objections, if raised and before he takes the measures like taking over possession of the secured assets etc. With the above ruling each and every borrower will raise objections on frivolous grounds just to delay recovery proceedings. Dealing with these objections will need lot of managerial involvement. Apart from this Banks and FIs will also have to take help of attorneys in replying to objections raised by borrowers because even a minor fault may give them a ground to approach DRT. Section 17(2) of the Act was the only section which could prevent defaulting companies from approaching the court/ tribunal on frivolous grounds. However, after this judgment borrowers will have right to move the DRT without depositing 75% of the outstanding loans and the lending bank can only go ahead and sell the assets in the absence of any stay order from the tribunal. Now any one and everyone will file an appeal with DRT just to buy some time and passing of an interim order in favor of the borrower who may deplete the value of the assets further. It will also give a free hand to borrowers to tamper with assets. Historically the DRT has not been too successful in enforcing recovery of debts. There is large backlog of cases pending and adjudication is a time consuming process. It is most likely that the DRT may not be in a position to handle the expected deluge of such cases that are likely to be filed post the Supreme Court ruling and Bankers and FIs will again have to face the same and only too familiar difficulties. Though the Supreme Court has not fully met with expectations of lenders but still this verdict will be viewed positively. Before passing of this judgment there was much ambiguity about the true scope and implementation of the Act but now even lenders can negotiate with defaulters on a better balance. Atleast with the upholding of the Act, banks now have the right to seize and sell assets, where earlier they had to file a suit before the DRT even when they wanted to seize the assets. The Supreme Court ruling should aid the realizing of the objectives of the Act. It might happen that in the absence of section 17(2) the pace of recovery will be slower compared to what it would have been if this section was in force. But definitely recovery process would be still a lot faster than was possible before passing of this Act. Vasudha Mehta ALG India Law Offices The views are personal vasudha.mehta@algindia.com

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