The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) authorise banks and other financial institutions to auction commercial or residential properties for the purpose of recovering loan. It permits the banks to auction the borrower’s properties when there is a failure on the part of the borrower to repay the loan amount. Thus, the SARFAESI Act, 2002 empowers the bank to decrease their non-performing assets by way of measures of reconstruction and recovery.

The SARFAESI Act which is also known as securitization act requires that the banks are authorized to seize the borrower’s property except for the agricultural land without moving to court. SARFAESI Act, 2002 is applicable only in the cases of secured loans where banks are in a position to enforce underlying securities such as hypothecation, mortgage, pledge etc. In all such cases, the court's order is not needed unless the security is invalid or fraudulent. On the other hand, the bank would have to move the court to file a civil case against the defaulters, in case of unsecured assets.

Working

Under the SARFAESI Act, 2002 the bank has the power to seize the property. Defaulting borrowers are provided with notice by the bank to discharge their liabilities within a duration of sixty days. If there is a failure on the part of the defaulting borrower to obey the notice sent by the bank then the SARFAESI Act requires for the following recourse to the bank -

1. Sale or lease or assign the right to the security;
2. Take possession of the security for the loan;
3. Manage the same or appoint any person to manage the same.

Under the SARFAESI Act, 2002, Establishment of Asset Reconstruction Companies is also provided. These companies are to be managed by the Reserve Bank of India (RBI) to obtain assets from the financial institutions and banks. The SARFAESI Act requires that the banks and financial institutions shall sell the financial assets to asset reconstruction companies. Guidelines have been issued to financial institutions and banks by the Reserve Bank Of India relating to the process to be observed for sales of financial assets to asset reconstruction companies.

Applicability

The provisions of this Act are applicable only for Non Performing Assets loans with outstanding above Rs. 1.00 lac. Non Performing Assets loan accounts where the sum is less than 20% of the principal and interest are not eligible to be dealt with under this Act. NPA means an asset for which principal or interest or instalment is overdue for a duration of ninety days or more from the date of accession or the due date as per the contract between the lender and the borrower, whichever is later. Non Performing Assets should be supported by securities charged to the Bank by way of mortgage or assignment or hypothecation. Security Interest by the method of pledge, Lien, lease and hire purchase not liable for attachment under Setion.60 of Civil Procedure Code, 1908 are not covered under this Act.

Non-Applicability

1. a lien on any goods, money or security given by or under the Indian Contract Act, 1872 or the Sale of Goods Act, 1930 or any other law for the time being in force;
2. a pledge of movable within the meaning of Section 172 of the Indian Contract Act, 1872;
3. creation of any security in any aircraft as defined in clause(1) of Section 2 of the Aircraft Act, 1934;
4. creation of a security interest in any vessel as defined in clause (55) of Section 3 of the Merchant Shipping Act, 1958;
5. any conditional sale, hire-purchase or lease or any other contract in which no security interest has been created;
6. any rights of the unpaid seller under Section 47 of the Sale of Goods Act, 1930;
7. any properties not liable to attachment or sale under Section 60 of the Code of Civil Procedure, 1908;
8. any security interest for securing the repayment of any financial asset not exceeding one lakh rupees;
9. any case in which the amount due is less than 20% of the principal amount and interest thereon.

Securitisation under SARFAESI Act, 2002

The securitization of the asset starts with a lending institution to be called as ‘Originator’ whose receivables and loans will be converted as securities either as Special Purpose Vehicle (SPV) or as a trust, through which the assets of the former will be liquefied. The pool of assets which are alike in nature to the balance sheet is selected by the originator and pass on them to Special Purpose Vehicle(SPV) through a pass-through agreement or transaction. It is then converted into marketable securities for investment. The resultant money flow will allow Originator to make further assets and periodical money flows from the underlying collaterals by the system of repayment of loans and interest payments will allow the Special Purpose Vehicle(SPV) to pay off its obligations of interest and principal to its debtors.

Methods Of Recovery

According to the SARFAESI Act, 2002 the Reserve Bank Of India is responsible for registration and regulation of the reconstruction or securitisation companies. The authorization has been furnished to these companies to raise funds by providing security receipts to a qualified institutional buyer. This has empowered the financial institutions and banks in taking ownership of securities which are given for monetary assistance and can lease or sell the same to take over the management in case there is some default. There are two principal methods provided in the SARFAESI Act for recovery of NPAs :

Securitisation:

Securitisation is the procedure of issuing marketable securities supported by a pool of existing assets like home or auto loans. After an asset is transformed into a marketable security, it is sold. A reconstruction company or securitisation company may raise funds from only the Qualified Institutional Buyers (QIB) by creating schemes for acquiring assets that are financial.

Asset Reconstruction:

Enacting SARFAESI Act has given birth to the Asset Reconstruction Companies in India. It can be done by either proper management of the borrower’s business, or by taking over its business or by making the sale of a part or whole of the business or by the rescheduling of payment of debts that is payable by the borrower according to the provisions of this Act.

The SARFAESI Act also provides an exception under the registration of security receipt. It means that when reconstruction company or securitization company issues receipts then the holder of the receipt is enabled to undivided interests in the financial assets and there is no requirement of registration unless and otherwise, it is required under the Registration Act 1908. However, in the following cases the registration of the security receipt is required which are as under :

1. When there is a transfer of receipt;
2. The security receipt is limiting, declaring, creating, assigning, and extinguishing any title, right, or interest in immovable property.

Notable Verdict

Mardia Chemicals Ltd. v. ICICI Bank :

In this case, the Supreme Court of India stated the Sarfaesi Act to be constitutionally valid. The Court said that a borrower may make an appeal against the lender in the DRT, without having to deposit 75% of the sum of the debt. If the tribunal does not stay the order, the lender may sell the assets. After this law passed on 27 November 2002, ICICI Bank took possession of Mardia Chemical plant in Vatva, Ahmedabad district, Gujarat. ICICI Bank was owed Rs. 300 crores, in all it owed Rs. 1,450 crores to 20 lenders.