ARC rights to use SARFAESI for debts assigned by non-SARFAESI entities

– Archana Kejriwal

Asset reconstruction companies, formed under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (‘SARFAESI Act’/‘the Act’) are an important part of the country’s ecosystem to tackle non-performing loans. ARCs buy and resolve non-performing loans by acquiring them from the financial system.

ARCs were traditionally focusing on acquiring large corporate loan exposures. However, recently, there is increasing participation of the ARCs in retail loans. When ARCs buy retail loans, it is quite likely that the lender or the loan does not qualify for SARFAESI right when the loan was with the lender. This may be either because of the nature of the lender (NBFCs having assets of less than Rs 100 crores) or the size of outstanding (less than Rs 20 lakhs). In such cases, once the ARC acquires the loans, will it have the rights under the SARFAESI Act?

The question becomes important, because in case of corporate loans, the advantage that ARCs had over the original lender was one of aggregation, that is, ARCs acquiring loans given to the same borrower by various lenders, and thus getting significant strength in relation to the borrower. This cannot be the case, obviously, with retail loans. Hence, if the acquiring ARC is no better than the outgoing NBFC, in what way does the transfer of the loans help to accelerate the recovery?

In this article, we discuss this important question.

Explicit rights extended to ARCs under the SARFAESI Act

As per the definition of “asset reconstruction company” under section 2(1)(ba) of the SARFAESI Act, an ARC is formed for the purpose of “asset reconstruction” or “reconstruction” or “both”. The secured creditor often undertakes to assign its defaulted debts to an ARC. The SARFAESI Act provides the formation of ARCs to acquire loans from secured lenders and take actions extended to it. Section 9 of the Act lists down the measure exclusive extended to the ARCs for the purposes of asset reconstruction and reads as-

“9. Measures for assets reconstruction.—(1)Without prejudice to the provisions contained in any other law for the time being in force, an asset reconstruction company may, for the purposes of asset reconstruction, provide for any one or more of the following measures, namely:—

(a) the proper management of the business of the borrower, by change in, or take over of, the management of the business of the borrower;

(b) the sale or lease of a part or whole of the business of the borrower;

(c) rescheduling of payment of debts payable by the borrower;

(d) enforcement of security interest in accordance with the provisions of this Act;

(e) settlement of dues payable by the borrower;

(f) taking possession of secured assets in accordance with the provisions of this Act;

(g) conversion of any portion of debt into shares of a borrower company ….”

RBI’s stand on ARC rights

Controversies have arisen for quite a long period of time. The RBI, in its Report of the Committee to Review the Working of Asset Reconstruction Companies,, [para-F.4.1 of pg. 66-67] raised the concern with respect to right of ARC to enforce security interest irrespective of availability of enforcement rights with the assignor and proposed the following:

Recommendation: ‘In the interest of efficient recovery of debt by creditors, the Act may be amended to ensure that enforcement rights under Section 13 of the Act would be available to an ARC to which a secured financial asset is assigned, irrespective of the availability of enforcement rights with the assignor under Section 13 of the Act. For this purpose, the definition of “secured creditor” under Act may be modified by amending the closing clause in Section 2(1)(zd)(vi) as follows : “in whose favour security interest is created by any borrower for due repayment of any financial assistance or transferred pursuant to assignment, transfer, transmission, etc. of any financial assistance.’ Although no such clarification has been brought to deal with this question, the issue continues to grow and entangle with the other circumstantial aspects.

Being a crucial mechanism for securitisation and asset reconstruction, the ARCs have been contending the right to take over the assets of the borrower even if assigned to it by an entity ineligible under SARFAESI Act. However over the years, this issue has been a matter of concern  which is yet to receive an appropriate elucidation.

Judicial Pronouncements

In the case of Poorti Rent a Car and Logistics Pvt. Ltd. & ors. v Kotak Mahindra Bank Ltd. & ors., the petitioner (‘borrower’) obtained financial assistance from a Non-Banking Financial Company (‘lender’). The lender assigned the debt to a bank (‘respondent’) who, on default in repayment, issued a notice to the borrower under section 13(2) of the SARFAESI Act. The borrower argued against such notice contending that the lender was not being a “financial institution” within the meaning of section 2(m) of the Act is not a “secured creditor” within the meaning of section 2(zd)thus is ineligible to take actions under the Act. As a result, the respondent bank will also not have authority to take action against the borrower under the Act. Aggrieved by the action, the borrower filed the writ petition before this court.

The Bombay High Court, held the action taken by the assignor(respondent) is legal and valid. It further upheld the decision laid in the case of M. D. Frozen Foods Exports Pvt. Ltd v. Hero Fincorp Ltd., holding the application of SARFAESI on the point of retrospectivity and retroactivity and was firmly of the view that the SARFAESI Act being brought into force to solve the problem of recovery of large debts, would apply to all claims which are alive at the time when it was brought into force.

In Indiabulls Housing Finance Limited v Deccan Chronicle Holdings Limited and others, the original lender, being a ‘financial institution’/ ‘secured creditor’ ineligible to take actions under SARFAESI, merged with the appellant, eligible under SARFAESI, was granted the right to take actions against the borrower under the SARFAESI Act. Here the court held-

“We find that all such parameters in the present case are fulfilled with the result that initiation of action under Chapter III of the SARFAESI Act by the respondent no.1, being a “secured creditor” within the meaning of section 2(zd) thereof for the purpose of enforcing the security interest that was created earlier, is legally permissible. That the respondent no. 1 is the successor-in-interest of the respondent no.2, which was not a “financial institution” at the material time would make no difference insofar as consequence in law is concerned.”

An opposite view altogether was held in Kotak Mahindra Bank Ltd. v Trupti Sanjay Mehta and others, dealing with a similar issue wherein the petitioner (assignor) contended that regardless of the status of the assignor, if the assignee of a debt along with its underlying security is a bank or financial institution, it is open to such assignor to adopt steps under the SARFAESI Act. However, the court held that the term ‘secured creditor’ being restricted to any bank or financial institution or any consortium or group of banks or financial institutions but does not include a NBFC, thus no rights under SARFAESI gets transferred. The same was however overruled by the Bombay High Court in the Poorti Rent a Car and Logistics Pvt. Ltd.

ARCs as assignors under IBC

In a recent case of Naresh Kumar Aggarwal v Cfm Asset Reconstruction Pvt Ltd, a question relating to validity of assignment of debt was acknowledged by the NCLAT. It was further held that the action taken under section 7 of Insolvency and Bankruptcy Coded(‘IBC’) is valid and legal. It held-

“When acquisition of assets by Asset Reconstruction Company is made as per Section 5(1), deeming provision contained in Sub-section (2) of Section 5 shall come into play and the Asset Reconstruction Company shall be deemed to be Lender for all purposes.”

On a conjoint reading of IBC and SARFAESI, the common goal of both these legislation is to clean and resolve  bad loan portfolios. A common set of stakeholders involved under both these laws, sets out a well established connection between them. It is often seen how the provisions of these legislations are dealt harmonically giving way to both to the extent possible. Taking the basis of the judgment in Naresh Kumar Aggarwal, it can be contended that the assignment of debt being valid under IBC may be held to be at par with SARFAESI Act.

Conclusion

The opposing viewpoints and methods on this vital subject opened up a bag of worms. Some judgments are indicative of conferring the right on ARCs whereas others are not.

From the cited judgments, it seems like the view has been kept limited to the provisions of section 13 of the Act without considering the provisions of section 9 of the Act. This point is pertinent to be highlighted because even if we keep aside the actions under section 13 for once, section 9(f) of the Act clearly holds the validity of taking possession of secured assets in accordance with the provisions of this Act.” Therefore, ignoring the specific provision under section 9, while paving way for the general provisions leads to questioning the purpose of the ARCs in relation to transfer of retail loans as a whole.

From the above discussions and provisions of section 9 of the Act, there seems no point to bar the ARCs from taking possession of the secured asset even if its rights come from an ineligible assignor. Concerning the given perplexity surrounding the issue, it would be better if there is a clarification in this context.