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Recovery of debt by HFCs and initiation of SARFAESI action in case of a decided civil suit: Two significant rulings by High Courts

-Shrestha Banerjee & Archisman Bhattacharjee I finserv@vinodkothari.com

Introduction

The High Courts of Madhya Pradesh and Kerala recently rendered two judgments delving into crucial legal inquiries surrounding the recoverability and enforcement of security interests in instances of borrower default via initiation of SARFAESI proceedings by financial institutions.

The Madhya Pradesh High Court’s ruling specifically addresses the recoverability of Housing Finance Companies (HFCs) in relation to the initiation of SARFAESI actions following borrower default. Conversely, the Kerala High Court’s judgement examines the enforcement of security interests through SARFAESI actions, where the same has been initiated without placing consideration on any judgement delivered by the civil courts concerning such recovery.

In this article, we aim to analyse both judgments, shedding light on their implications and legal interpretations.

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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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Clog on redemption of mortgage after publication of sale notice – SC reiterates word of law u/s 13(8)

– Team Resolution | resolution@vinodkothari.com

Introduction

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ( ‘SARFAESI Act’) provides methods that can be undertaken by a secured creditor to recover its dues in case of a default.

Section 13 of the SARFAESI Act being an important section contains provisions relating to ‘Enforcement of Security Interest’. Sub-section (2) and (4) of section 13 describes the manner and timeline within which the creditor can enforce its rights to recover the dues against a Non-Performing Asset (‘NPA’). While, on one hand, the creditor has a right to sell the secured asset; in juxtaposition is the right of the borrower to have the property released on repayment of dues. These rights are in conflict with each other and therefore, there is a need to have clarity around the point of time at which the borrower would lose the right of redemption and the lender’s right of sale becomes absolute.

At this stage, section 13(8) of the SARFAESI Act comes into picture. The present provision of section 13(8) states that where any default has been made by the borrower in terms of repayment of the dues, the amount outstanding if repaid by the borrower at any time before the date of publication of auction notice by the creditor, such a creditor shall not have any further right to transfer or to take any other step in relation to transfer of such secured asset. On a contrary, the earlier provision stated that the right of the borrower to redeem the mortgaged property shall be available till the date fixed for sale or transfer.

The provision of section 13(8) has often been debated upon wherein, several High Courts have held different views. However, a recent ruling of the Hon’ble Supreme Court in the matter of Celir Llp v Bafna Motors (Mumbai) Pvt. Ltd.[1] , has clarified the position and scope of section 13(8) before and after the amendment.

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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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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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