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.

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Display of information on repossession under SARFAESI

– Eliza Bahrainwala, Executive, finserv@vinodkothari.com

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Vehicle financiers must follow SARFAESI process for repossession: Patna High Court

Ruling holds self-help repossession as a breach of the borrower’s fundamental rights of livelihood and dignity

– Vinod Kothari, finserv@vinodkothari.com

Repossession of vehicles (from two-wheelers to four-wheelers), in case of borrowers’ defaults, has been done almost entirely using common law process, on the strength of the provisions of the hypothecation agreement. The roughly Rs 500000 crores auto finance market in India, including financing of passenger vehicles and commercial vehicles, rarely makes use of the process of SARFAESI Act for repossession of vehicles from defaulting borrowers, even though most of the NBFCs and all of the banks are authorised to make use of the process.

However, a recent Patna High Court, from a single judge of the Court[1], holds that since hypothecation is a “security interest” on the vehicle, the use of the process of the SARFAESI Act is mandatory, and any repossession action not adhering to the process of that Act is illegal. The Court has gone to the extent of ordaining all banks and NBFCs in the State to return the repossessed vehicles which are either not sold or are traceable to the borrowers on payment of 30% of the due amount, and in case of those vehicles which are not traceable or returnable, it permits the petitioners to seek compensation. It has simultaneously directed the Police to investigate and register cases of use of force or illegal tactics in repossession.

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Security Interest: Meaning, forms, registration, enforcement, and effects of non-registration

-Team Vinod Kothari and Company | resolution@vinodkothari.com

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National financial information repository: One more or one for all?

– Lovish Jain, Executive | lovish@vinodkothari.com

Some days ago, Mr. Vinod Kothari had commented on a LinkedIn post :

“Do we realise how many places does a lender (NBFC, Bank) register information about a loan? There are 4 credit information companies (such as CIBIL) where the credit data, including performance history, is uploaded. If the exposure is Rs 5 crores or above, in the aggregate over the banking system, information goes on CRILC too.

RBI has recently written to NBFCs reminding them of the obligation to register details with NeSL, an information utility under IBC, irrespective of whether the provisions of Code apply (for example in case of individuals), or whether the lender in question is at all contemplating resorting to IBC as a remedy (for example, consumer loans).

If the loan is a secured loan, the details need to be filed with CERSAI. If the secured loan borrower is a company, details need to be filed with RoC too. If the security interest is on immovable property, one needs to file particulars with land registry. If the security interest is on motor vehicles, the hypothecation is registered with Vahan portal too.

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Registration of Security Interest and Rights of Secured Creditors under IBC

– Sikha Bansal, Partner & Neha Malu, Senior Executive | resolution@vinodkothari.com

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Read our writeups on the topic –

  1. CERSAI beyond SARFAESI – The multi-faceted effects of security interest registration
  2. Fragmented framework for perfection of security interest

CERSAI beyond SARFAESI – The multi-faceted effects of security interest registration

– Sikha Bansal and Anirudh Grover | finserv@vinodkothari.com

Introduction

The rights of secured creditors are spread across various laws: common law, Companies Act, Insolvency and Bankruptcy Code (IBC) and the SARFAESI Act. In equal measure, the preconditions which are requisite to assert these rights are also spread over those very laws. 

It is lamentable that the security interest registration regime in India is fragmented, without any obvious sense of purpose or direction. This was discussed in our previous article Fragmented Framework for Perfection of Security Interest[1].

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Tax dues subservient to dues of secured creditors under SARFAESI Act and RDDB Act

Neha Sinha, Executive, Vinod Kothari & Company

corplaw@vinodkothari.com

Introduction

SARFAESI Act and RDDB Act are specific laws for recovery of debts.  Both these laws provide that  the secured creditors can claim priority for the realisation of dues. On the other hand, State and Central tax authorities can also enforce the payment of tax dues under tax statutes, which often create a statutory first charge in favour of the authorities. This may give rise to situations wherein the secured creditors are competing with the tax authorities in respect of payment of dues. Such competing claims have to be resolved in case of insolvency/deficiency.

A similar situation arose in the case of Jalgaon Janta Sahakari v. Joint Commissioner of Sales.[1] The Division Bench of the Bombay High Court decided on the issue of the conflict between  SARFAESI Act and RDDB Act, and State tax statutes, in respect of priority of claims. The primary that arose in this case was whether State tax authorities can claim priority, by virtue of first charge created under State tax statutes, over a secured creditor for liquidation of their respective dues.

Chapter IV-A of the SARFAESI deals with registration of charges by secured creditors and. Pursuant to section 26D therein,  a secured creditor who has not registered the charge loses his right to enforce the security under SARFAESI. Section 26E, which has a non-obstante clause, accords priority to the secured creditor who has registered the charge in the CERSAI, over “all other debts and all revenue, taxes, cesses and other rates payable to the Central Government or State Government or local authority.” Similarly, section 31B of the RDDB Act gives states that “notwithstanding anything contained in any other law….rights of secured creditors shall have priority and shall be paid in priority over all other debts and Government dues including revenues, taxes, cesses and rates due to the Central Government, State Government or local authority.” Pertinently, the aforesaid provisions in both Acts have a non-obstante clause, having the effect of overriding any other law inconsistent with it.

In the instant case, by virtue of relevant State tax statutes, a first charge was created in favour of State tax authorities. This brings forth the conflict as to who shall have priority in terms of payment-  that State tax authorities with first charge or the secured creditors with the registration of charge in CERSAI?

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Mortgage on movable property –  whether another lucrative option for lenders?

– Sikha Bansal, Partner & Shraddha Shivani, Executive | corplaw@vinodkothari.com

Introduction

Pledge[1], hypothecation, mortgage – these are all forms of security interest[2], albeit with different features. Although the common objective of any form of security interest is to create a right in rem[3] (rather than in personam[4]) in favour of the lender, the effectiveness of the security interest would depend on the extent of overarching rights created by such security interest in favour of the lender. In another article[5], we have drawn a quick snapshot of the characteristics of each form of security interest. For instance, in hypothecation, the lender does not have any right of possession or any beneficial interest in the property, and the lender’s rights are limited to cause a sale on default; on the other hand, a mortgage (depending upon the type) may have far better rights – including the right to have the title, beneficial interest, etc. In fact, as we discuss elaborately in this article, a mortgage has several motivations for the lender.

However, a conventional notion around mortgages has been that the concept of ‘mortgage’ is only applicable to immovable property. This common view arises in view of explicit provisions under the Transfer of Property Act, 1882 (‘TP Act’). On the other hand, there are no written/codified provisions on mortgage of movable property. It is not that the Courts have not discussed and debated on the same. There have been ample opportunities before the Courts (as this article highlights), wherein Courts have upheld mortgages of movable properties as well. As such, it  cannot be said that there has not been any decisive jurisprudence around the subject, however, the recent ruling of Supreme Court in PTC India Financial Services Limited v. Venkateshwar Kari and Another strongly revives the discussion and reinforces the argument that ‘mortgage of movables’ is perfectly possible, although not exactly in terms of the Contract Act; however, under common law principles of equity and natural justice. In fact, in his book Securitisation, Asset Reconstruction and Enforcement of Security Interests, Vinod Kothari, has discussed about ‘chattel mortgages’.

Here, it is important to understand the relevance of this discussion. As we discuss below, a mortgage is seen as the strongest form of security interest – a pledge or a hypothecation create much lesser rights in favour of the secured lender. Hence, from a lender’s perspective, it is always beneficial to have ‘better’ rights in terms of beneficial interest and control. Also, mortgages can be of various kinds (as discussed below), hence, the parties may have the flexibility to structure and opt for a suitable form of security interest.

The article thus, studies the jurisprudence around mortgage of movable property, and the principles which must be followed in order to effect the same. The article also studies how the PTC India ruling has revived the discussion around mortgage of movables.  However, before we do so, it would be extremely important to understand the features of a mortgage and how a mortgage can be used as a superior tool of security interest.

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Special Situation Funds: Funds into asset reconstruction business

Aanchal Kaur Nagpal (Assistant Manager) | Parth Ved (Executive)

finserv@vinodkothari.com

Introduction

The intent behind asset reconstruction is not merely concerned with realisation of bad loans but also ‘reconstruction’, that is, to try and resurrect bad loans or bad borrowers into good ones. This almost always leads us to one name i.e. Asset Reconstruction Companies (‘ARCs’). Today, financial institutions are eager to sell their non-performing assets to clean-up their books while stressed companies find ways to get access to capital to anchor themselves. The Indian financial sector is known to be laden financial entities struggling to survive with their mammoth stressed assets. The COVID-19 pandemic has only added fuel to the fire. As at September, 2021, GNPA of banks was at INR 4,53,145 crore and that of the top 30 NBFCs, including HFCs stood at around INR 84,000 crore. Out of these loans, In 2019-20, the amount recovered as per cent of the amount involved under IBC was 45.5 per cent, followed by 26.7 per cent for ARCs. While the amount recovered through ARCs as per cent of amount involved was significantly higher in the initial years of their inception, in the recent years, it has dipped below 30 per cent except for a spurt in 2017-18.

Securities and Exchange Board of India (‘SEBI’) on January 24, 2022[1] along with its circular dated January 27, 2022[2], has further widened the NPA market to a specifically dedicated class of AIFs called Special Situation Funds (‘SSFs’), that shall exclusively invest in the distressed asset market. The intent behind the same is to use these cash-filled alternative funds to supplement ARCs in acquiring such stressed assets and aid banks and other financial institutions to release critical money choked up in such assets. AIFs are currently already permitted to invest in security receipts of ARCs and/ or invest in securities of distressed companies, however, SSFs will be additionally permitted to even acquire stressed loans. These SSFs also have been granted additional exemptions/ benefits over and above regular AIFs to facilitate stressed asset resolution.

This article attempts to cover the adoption of the concept of SSF from the global markets, and the characteristics of this peculiar kind of investing. Read more