[sbinews] Securitisation Act ? Lender's right and liability (Businessline)
- From: "Rajendra S. Pai" <rspai9@xxxxxxxxx>
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- Date: Thu, 6 May 2004 20:14:48 -0700 (PDT)
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Securitisation Act ? Lender's right and liability
(Businessline)
Dharmalingam Venugopal
THE recent judgment of the Supreme Court in the Mardia
Chemicals case upholding the Securitisation and
Reconstruction of Financial Assets and Enforcement of
Security Interests (Sarfaesi) Act, 2002, seems to have
received more brickbats than bouquets from bankers and
analysts.
The ruling, some feel, has put the clock back to the
pre-Sarfaesi days. Others say there is more smoke than
fire in the judgment. However, a careful reading shows
that the judgment is well-reasoned and pragmatic,
striking a balance between a lender's right and his
liability.
Lender's right
The main contention of the defaulters was that the
Sarfaesi Act was one-sided and had vested the banks
and the financial institutions with arbitrary powers
in dealing with defaulters; that the Act did not take
into account lender's liability and provide safeguards
against irresponsible action by the lenders; and that
the conditions under which an appeal was allowed were
too stiff and unfair.
Nevertheless, while giving due consideration to the
defaulters' objections, the Supreme Court upheld the
validity of the Sarfaesi Act based on the broader
national objective being sought to be served by it.
Having accepted the path of globalisation and
liberalisation to spur economic growth, the country
had to first bring its economic policies, rules, laws,
practices and institutions in line with global
standards. The balance of payments crisis of the early
1990s came as a blessing in disguise as it provided a
major fillip to push through such reforms.
The thrust of the reforms focussed on the financial
sector, in general, and banks, in particular, as these
were fundamental to any reforms in the economy.
After many high-level committees and much
deliberations, the Narasimham Committee laid down a
roadmap for reforms in the banking and financial
sectors. It stands to the credit of the financial
system that it adapted itself to the changes in a
remarkable manner in quick time.
However, while the banking industry was progressively
complying with the international prudential norms and
accounting practices, it was lagging in certain
crucial areas. There was, in particular, no effective
way to deal with bad debts or non-performing assets
which were already at much higher than globally
accepted levels.
As the court observed, the existing legal framework
relating to commercial transactions had not kept pace
with the changing commercial practices and financial
sector reforms.
Debt Recovery Tribunals were set up under the Recovery
of Debts Due to Banks and Financial Institutions Act
1993 but were plagued by their own problems so much so
that they could hardly cut down on legal delays. There
was, therefore, an imperative need for a faster
procedure empowering the banks to recover their dues.
More specifically, as in the case of international
banks, Indian banks needed to be vested with the power
to take possession of the securities given by the
defaulters and sell them to realise their dues. This
practice of securitisation of debts is in vogue all
over the world.
It was in these circumstances that the Sarfaesi Act
was enacted, duly recommended by the Narasimham
Committee and then the Andhyarujina Committee.
Explaining that the intention of the Act was not to
interfere with an individual's right, the Supreme
court held that "wherever public interest to such a
large extent is involved, individual rights may have
to give way... Even if a few borrowers are affected
here and there, that would not impinge upon the
validity of the Act which otherwise serves the larger
interest".
Lender's liability
At the same time, while upholding the Sarfaesi Act,
the court held that the process of implementing the
law must be fair and reasonable. The apex court
underlined the need for action under the Act to be in
keeping with the concept of right to know and lender's
liability, which are part of international best
practices in banking. In fact, there was a move to
introduce a Bill to legislate on lender's liability
but it was deferred as it was later felt that the
provisions of the Act might be more misused than used.
Nevertheless, a Fair Practices Code with regard to
lender's liability has since been introduced.
Stressing further the case for upholding the
principles of lender's liability, the court felt that
the Act cannot be a one-sided affair shutting out all
possible and reasonable remedies to the borrowers. It
has, therefore, struck down the contentious condition
of the Act which required the defaulters to deposit 75
per cent of the disputed amount before going on
appeal.
The court described the condition as "one example of
hitting below the belt''. The Supreme Court has also
empowered the DRT to grant stays on sale of assets in
deserving cases.
Guidelines
The apex court summed up its judgment by laying down
certain general guidelines to be followed by banks and
financial institutions while taking recourse to the
Sarfaesi Act.
First, it is incumbent upon the banks to serve 60 days
notice before proceeding to take any of the measures
as provided in the Act. After service of notice, if
the borrower raises any objection or places facts for
consideration of the banks, such reply to the notice
must be considered with due application of mind and
the reasons for not accepting the objections,
howsoever brief they may be, must be communicated to
the borrower. An internal mechanism must be
particularly evolved to consider such objections
raised in the reply to the notice.
However, the reasons so communicated shall only be for
the purposes of the information/knowledge of the
borrower without giving rise to any right to approach
the Debt Recovery Tribunal under Section 17 of the
Act, at that stage.
Second, after taking possession of the securities it
would be open for the defaulter, before the date of
sale/auction of the property, to file an appeal before
the Debt Recovery Tribunal.
The Tribunal can stay the sale or auction or pass an
interim order subject to conditions it may deem fit
and proper to impose. The defaulter need not deposit
any amount before preferring the appeal. In addition,
the aggrieved party can, under certain limited
grounds, take recourse to a civil suit if the matter
relates to an English mortgage enforceable without
intervention of the court.
Impact
What will be the net impact of the judgment on banks'
NPA levels is the big question now. In the last two
years of its existence, Sarfaesi has had a salutary
effect on NPA management in banks. Banks have issued
over 15,000 legal notices on defaulting companies to
recover bad loans worth about Rs 20,000 crore.
Besides, the Act has paved the way for several
out-of-court settlements. It has also generally helped
inculcate a repayment discipline among borrowers.
The judgment does not appear to have diluted the power
of "seize and sell'' originally vested with the banks
under the Act. There is also not much scope for
defaulters to misuse the relaxations allowed by the
recent judgment and flood the courts with such cases.
The appeal allowed under the Act is at best only an
indemnity on the part of the banks in case they act
wrongly. Besides, stay of the sale or auction of
assets cannot be expected as a matter of routine.
According to estimates, the judgment is expected to
reduce the gross non-performing assets (NPAs) of banks
and FIs by about 20 per cent from the present level of
around Rs 1,00,000 crore within a year.
The net impact of the Act must be viewed in the
context of the progress of the overall banking
reforms. Indian banking is in the second phase of
reforms when more stringent prudential norms are
likely to be introduced.
India has also agreed to adopt the Basle-II norms in
stages. The loan impairment period has been reduced
from 180 days to 90 days, meaning a loan will be
declared non-performing at the end of the third month
itself if the dues are not paid. This together with
the stricter inspection and auditing practices, which
have been introduced as part of the reforms, would
keep the potential defaulters under scrutiny from the
beginning.
In the circumstances, it will be in the interest of
the banks as well as the borrowers to avoid defaults
and take timely remedial action in the first place.
Where defaults are unavoidable, the banks will be left
with no option but to resort to Sarfaesi. The
defaulters will have little to gain by challenging the
action unless they have a definite case of malafide
action by the banks.
At the same time, it may not be in the interest of
banks to use the Sarfaesi Act as a matter of routine.
There is severe competition among banks and the
avenues of credit deployment by banks have narrowed
down significantly.
In such a situation, banks cannot afford to scare away
potential borrowers with Acts like Sarfaesi. It is for
the bankers to determine where to draw the line.
=====
R.S.Pai, Web Address: http://rspai.tripod.com
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