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RBI lessons ARCs on fairness

A discussion on the fair practice code issued for ARCs

-Sikha Bansal and Kanakprabha Jethani

Introduction

Asset Reconstruction Companies (ARCs) are companies specializing in the business on acquiring non-performing assets and stressed assets of the banks and financial institutions and reconstructing them.

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) accords the status of ‘financial institutions’ and ‘secured creditor’ to ARCs, such that an ARC acquiring bad loans is also able to exercise same rights and powers as the originator of the loan would have. This is explicitly stated in section 5 of SARFAESI.

Now, as they say, with great power, comes great responsibility; since, the business of ARCs involves frequent dealing with borrowers of loans, they must be guided by principles of fairness in their dealings with borrowers. Earlier, there were no guidelines with respect to fair practices of ARCs. However, after a gap of almost 20 years from the time the law was enacted, the Reserve Bank of India (RBI) through a notification dated 16.07.2020[1], issued a Fair Practices Code (FPC) for ARCs. It is noteworthy that in this span of 20 years, around 28 ARCs have been registered in India[2] and have an AUM of USD 14,583 million[3]. Further, the role and involvement of ARCs have increased multifold with IBC proceedings.

The FPC seeks to ensure fairness as well as transparency in the operations of ARCs, and calls upon the ARCs to put in place board approved FPC, grievance redressal mechanisms, code of conduct for recovery agents, etc. However, what is more important is that the FPC sets out principles for ARCs for sale and purchase of assets, as discussed below.

Acquisition of assets: follow arm’s length principle

While acquiring any asset, an ARC should maintain transparency and follow arms’ length principle and shall ensure there is no discrimination between sellers in the process of acquisition.

Notably, RBI has already prohibited ARCs to have bilateral acquisitions (that is, one to one transactions) from certain connected entities, e.g. sponsor banks/FIs, and group entities[4], irrespective of the consideration involved. However, auction purchases are allowed provided the auction is transparent, is on arms’ length and price is determined by market forces. This essentially entails that the auctions should be widely publicised, be open to all interested parties and be transparent in terms of bids submitted.

Sale of assets: be transparent

ARC should enable the participation of as many prospective buyers they can, so that actual market value can be determined of any asset. For that, the invitation shall be made public. The extant guidelines for conduct of ARCs[5] also require sale of assets through public auction only. Thus, this is just a reiteration of the existing guidelines.

Further, while finalising the terms and condition for sale of underlying assets, the ARCs shall consult the investors of security receipts (SRs).

Besides, a crucial provision in the FPC is the reference to section 29A of the Insolvency and Bankruptcy Code, 2016 (IBC), as discussed below.

The ‘spirit’ of section 29A

FPC mentions that the “spirit” of section 29A of IBC may be followed while dealing with prospective buyers”.

The reference to section 29A, most predictably, comes in the wake of rising involvement of ARCs in insolvency proceedings, either as sole or joint resolution applicants. Section 29A provides a list of persons who shall not be eligible to be a resolution applicant or a buyer of assets in case of a liquidation sale. The intent here seems to bar persons such as undischarged insolvents, wilful defaulters, a person whose accounts are classified as NPA, etc. from buying the assets. One concern with regard to section 29A is possible use of ARCs as devices to camouflage ineligible persons. Therefore, it is a logical and a positive step to add this restriction as a component of FPC for ARCs.

It is relevant to note that courts have held that the disability under section 29A is to be considered even where the sales are made by a secured creditor outside liquidation[6]. Say, what if the secured creditor assigns his rights and interest to an ARC? Will an ARC be debarred from selling the assets to a person hit by section 29A?

The issue has to be examined under two circumstances – first, where the borrower has been under insolvency proceedings of IBC and in case of liquidation, the secured creditor stands out of liquidation proceedings to sell the asset, and second, where there are no preceding IBC proceedings.

Considering the extant precedents surrounding section 29A, it can be contended that the contagion of section 29A might also hamper the freehand of ARCs in selling the assets whether or not the assets have been through IBC proceedings or not. However, one may note that the extant guidelines, on the contrary, permit the defaulting promoters to buy-back the assets from ARCs, provided the settlement is considered beneficial in certain respects[7].

Hence, ARCs would be required to take a balanced view on determining whether the sale is to be made to a prospective buyer or not. Notably, FPC does not impose section 29A, per se, on sales by ARCs, but advises the ARCs to follow the spirit of section 29A. The intent of section 29A has been to ensure that among others, persons responsible for insolvency of the corporate debtor do not participate in the resolution process[8].

Therefore, it may be contended that in case the assets are in or have passed through IBC proceedings, the provisions of section 29A will apply strictly, and in other cases, the ARCs should endeavour to abide by the intent of section 29A. The stance of the regulator may become clearer in due course of time.

Action points for ARCs

The following are actionables on the part of ARCs. We are of the view that, since the notification does not provide for any specific date of applicability, the same shall be immediately applicable. Hence, the FPC, incorporating the following, shall be formulated within reasonable time and may be adopted in the next board meeting.

Particulars Actionables
Measures to prevent harassment by recovery agents ·  Ensure that the staff and recovery agents are adequately trained to deal with customers and to handle their responsibilities with care and sensitivity, particularly in respect of aspects such as hours of calling, privacy of customer information

·  Adoption of code of conduct (as discussed above)

·  Ensure that the recovery agents and the staff of ARCs observe strict customer confidentiality.

·  Ensure that recovery agents do not induce adoption of uncivilized, unlawful and questionable behaviour or recovery process.

Charging of fees Put in place a board approved policy on management fee, expenses and incentives, if any, claimed from trusts under their management.
Outsourcing Put in place an outsourcing policy, approved by the Board, which incorporates, criteria for selection of activities to be outsourced as well as service providers, delegation of authority depending on risks and materiality and systems to monitor and review the operations of these activities/ service providers.
Grievance Redressal ·  Constitute a Grievance Redressal machinery which deals with the issue relating to services provided by the outsourced agency and recovery agents, if any.

·  Mention the name and contact number of designated grievance redressal officer of the ARC in communications with the borrowers.

Conclusion

As regards acquisition and realisation of assets, the extant directions provide for framing of acquisition policies and realisation plans. Further, as discussed, RBI from time to time, had been issuing directives regulating the sales by ARCs. The FPC, incorporating the provisions of section 29A, can be said to be an additional step in the same direction.

Insofar as conduct towards borrowers is concerned, before issue of the FPC for ARCs, there were no separate guidelines. However, this should not imply that ARCs were not required to act as such. As a matter of practice, the conduct of ARCs towards the borrowers should be guided by the behavioural principles and principles of fairness and equity.

The banks/financial institutions are anyway under the directions of RBI[9] to be fair in all respects in dealing with the borrowers. Therefore, it could not be said that an ARC which purchases loans from the banks/financial institutions could have all the powers of a secured lender but not the responsibilities. In the authors’ view, the responsibility to act fairly is tagged along with the right to enforce security. However, the FPC as issued now, concretises the concept of ‘fair practice’ for ARCs, and is a step in the right direction. With the FPC coming into force, practices of ARCs, which were earlier based on the market practice and varied largely, shall be unified.

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11937&Mode=0

[2] List of ARCs on the website of the RBI (As in February 2020)

[3] https://www2.deloitte.com/content/dam/Deloitte/in/Documents/tax/in-tax-asset-reconstruction-companies-tax-regulatory-framework-noexp.pdf

[4] https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=11749&Mod e=0

[5] https://www.rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9901

[6] NCLAT ruling- https://nclat.nic.in/Useradmin/upload/20572042075dd3e35176572.pdf

[7] See para 5 of the ARC Guidelines

[8] Swiss Ribbons Pvt. Ltd. vs Union Of India (https://indiankanoon.org/doc/17372683/)

[9] Guidelines on Fair Practices for lenders- https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=3315&Mode=0 and;

Fair Practice Code for NBFCs- https://rbidocs.rbi.org.in/rdocs/notification/PDFs/45MD01092016B52D6E12D49F411DB63F67F2344A4E09.PDF

EASE OF RECOVERY FOR NBFCS?

–  Ministry of Finance relaxes the criteria for NBFCs to be eligible for enforcing security interest under SARFAESI

-Richa Saraf (richa@vinodkothari.com)

 

The Ministry of Finance has, vide notification[1] dated 24.02.2020 (“Notification”), specified that non- banking financial companies (NBFCs), having assets worth Rs. 100 crore and above, shall be entitled for enforcement of security interest in secured debts of Rs. 50 lakhs and above, as financial institutions for the purposes of the said Act.

BACKGROUND:

RBI has, in its Financial Stability Report (FSR)[2], reported that the gross NPA ratio of the NBFC sector has increased from 6.1% as at end-March 2019 to 6.3% as at end September 2019, and has projected a further increase in NPAs till September 2020. The FSR further states that as at end September 2019, the CRAR of the NBFC sector stood at 19.5% (which is lower than 20% as at end-March 2019).

To ensure quicker recovery of dues and maintenance of liquidity, the Finance Minister had, in the Budget Speech, announced that the limit for NBFCs to be eligible for debt recovery under the SARFAESI is proposed to be reduced from Rs. 500 crores to asset size of Rs. 100 crores or loan size from existing Rs. 1 crore to Rs. 50 lakhs[3]. The Notification has been brought as a fall out of the Budget.

Our budget booklet can be accessed from the link below:

http://vinodkothari.com/wp-content/uploads/2020/02/Budget-Booklet-2020.pdf

ELIGIBILITY FOR INITIATING ACTION UNDER SARFAESI

To determine the test for eligible NBFCs, it is first pertinent to understand the terms used in the Notification.

The Notification provides that NBFCs shall be entitled for enforcement of security interest in “secured debts”. Now, the term “secured debt” has been defined under Section 2(ze) of SARFAESI to mean a debt which is secured by any security interest, and “debt” has been defined under Section 2(ha) as follows:

(ha) “debt” shall have the meaning assigned to it in clause (g) of section 2 of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (51 of 1993) and includes-

(i) unpaid portion of the purchase price of any tangible asset given on hire or financial lease or conditional sale or under any other contract;

(ii) any right, title or interest on any intangible asset or licence or assignment of such intangible asset, which secures the obligation to pay any unpaid portion of the purchase price of such intangible asset or an obligation incurred or credit otherwise extended to enable any borrower to acquire the intangible asset or obtain licence of such asset.

Further, Section 2(g) of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, provides that the term “debt” means “any liability (inclusive of interest) which is claimed as due from any person by a bank or a financial institution or by a consortium of banks or financial institutions during the course of any business activity undertaken by the bank or the financial institution or the consortium under any law for the time being in force, in cash or otherwise, whether secured or unsecured, or assigned, or whether payable under a decree or order of any civil court or any arbitration award or otherwise or under a mortgage and subsisting on, and legally recoverable on, the date of the application and includes any liability towards debt securities which remains unpaid in full or part after notice of ninety days served upon the borrower by the debenture trustee or any other authority in whose favour security interest is created for the benefit of holders of debt securities.”

Therefore, NBFCs having asset size of Rs. 100 crores and above as per their last audited balance sheet will have the right to proceed under SARFAESI if:

  • The debt (including principal and interest) amounts to Rs. 50 lakhs or more; and
  • The debt is secured by way of security interest[4].

EFFECT OF NOTIFICATION:

An article of Economic Times[5] dated 07.02.2020 states that:

“Not many non-bank lenders are expected to use the SARFAESI Act provisions to recover debt despite the Union budget making this route accessible to more such lenders due to time-consuming administrative hurdles as well as high loan ticket limit.”

As one may understand, SARFAESI is one of the many recourses available to the NBFCs, and with the commencement of the Insolvency and Bankruptcy Code, the NBFCs are either arriving at a compromise with the debtors or expecting recovery through insolvency/ liquidation proceedings of the debtor. The primary reasons are as follows:

  • SARFAESI provisions will apply only when there is a security interest;
  • NBFCs usually provide small ticket loans to a large number of borrowers, but even though their aggregate exposure, on which borrowers have defaulted, is substantially high, they will not able to find recourse under SARFAESI;
  • For using the SARFAESI option, the lender will have to wait for 90 days’ time for the debt to turn NPA. Then there is a mandatory 60 days’ notice before any repossession action and a mandatory 30 days’ time before sale. Also, the debtor may file an appeal before Debt Recovery Tribunal, and the lengthy court procedures further delay the recovery.

While the notification seems to include a larger chunk of NBFCs under SARFAESI, a significant question that arises here is whether NBFCs will actually utilise the SARFAESI route for recovery?

 

[1] http://egazette.nic.in/WriteReadData/2020/216392.pdf

[2] https://m.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=952

[3] https://www.indiabudget.gov.in/doc/Budget_Speech.pdf

[4] Section 2(zf) “security interest” means right, title or interest of any kind, other than those specified in section 31, upon property created in favour of any secured creditor and includes-

(i) any mortgage, charge, hypothecation, assignment or any right, title or interest of any kind, on tangible asset, retained by the secured creditor as an owner of the property, given on hire or financial lease or conditional sale or under any other contract which secures the obligation to pay any unpaid portion of the purchase price of the asset or an obligation incurred or credit provided to enable the borrower to acquire the tangible asset; or

(ii) such right, title or interest in any intangible asset or assignment or licence of such intangible asset which secures the obligation to pay any unpaid portion of the purchase price of the intangible asset or the obligation incurred or any credit provided to enable the borrower to acquire the intangible asset or licence of intangible asset.

[5] https://economictimes.indiatimes.com/industry/banking/finance/banking/not-many-nbfcs-may-use-sarfaesi-act-to-recover-loan/articleshow/74012648.cms