Secured credit law being redrawn

Govt for UN model on security interest.

The finance ministry is working on a new law for secured credit that will help banks and financial institutions to realise dues from companies dealing in intangible assets like software. The new law may override the provisions of the Transfer of Property Act, 1882, and the Contract Act, 1872.

For example, cash flow is the only collateral when a bank funds a software firm. The new law will redefine intangible properties like software.

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaesi) Act, 2002, allows lenders to sell financial assets to securitisation and reconstruction companies.

Banks and institutions can seize the assets of any defaulter after serving a 60-day notice and are at liberty to sell the assets in order to recover the dues.

"However, there are a lot of grey areas. While the Sarefaesi Act focuses on creation and enforcement of securities, it does not address the issue of prioritisation of various claims on assets," said a government source.

The move has been triggered by a decision of the United Nations Commission on International Trade Law (Uncitral) to have uniform commercial laws in member countries. Financial Sector Secretary N S Sisodia recently attended an Uncitral meeting in New York. Two Uncitral working groups are now studying security interest and insolvency provisions.

The Transfer of Property Act and the Contract Act do not address such issues. Even hypothecation laws do not specify the rights and obligations of the parties involved.

Uncitral wants to develop an efficient legal regime for security rights in goods involved in a commercial activity, including inventory.

The decision to work on a model law for secured credit was prompted by the need for an efficient legal regime that will remove legal obstacles to secured credit. This, in turn, will influence the availability and the cost of credit.

"In the longer term, a flexible and effective legal framework for security rights could serve as a useful tool to increase economic growth," an Uncitral document said.

Why the law is needed

• Cash flow is now the only collateral when a bank funds a software firm. There is no provision for intangible property like software.
• The securitisation law does not address the issue of prioritising various claims on assets.
• Hypothecation laws do not specify the rights and obligations of the parties involved.
• The new law may override the provisions of the Transfer of Property Act and the Contract Act.