Tamal Bandyopadhyay: Reading between the lines

On April 8, the Supreme Court upheld the Constitutional validity of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaesi) Act 2002, but struck down a provision in the Act that required borrowers to deposit 75 per cent of the amount claimed by lenders before they could file appeals with debt recovery tribunals (DRTs).

Finance sector commentators feel the Sarfaesi Act has now become a paper tiger "" it roars, but cannot bite. But bankers are reacting differently. They believe that the power to seize is half the battle won.

Rarely has a court judgement evoked smiles from both sides. Rasik Lal Mardia, chairman and managing director of Mardia Chemicals, which challenged the constitutional validity of the Act after ICICI Bank slapped a claim of Rs 1,400 crore on his company, rushed to Tirupati to pay homage after the "victory".

"We have got more than we asked for," Mardia had said immediately after a Supreme Court Bench comprising Chief Justice V N Khare, Justice Brijesh Kumar and Justice Arun Kumar delivered the judgement.

In Mumbai, ICICI Bank's Deputy Managing Director Kalpana Morparia said: "It's a positive move for banks because it will help speed up our recoveries."

So, who actually won and who lost? Or is it a win-win for both the borrower and the lender? Before answering these questions, take a close look at the judgement and the Act.

The Sarfaesi Act inter alia provides for the enforcement of security interest for realisation of dues without the intervention of courts or tribunals.

The Act provides for the sale of financial assets by banks and financial institutions to securitisation and reconstruction companies.

Under this Act, banks and institutions can seize the assets of any defaulter after serving a 60-day notice period, and sell the assets to recover the dues. If a defaulter wants to file an appeal at a DRT against the lender's move, under Section 17 (2) of the Act, it needs to deposit 75 per cent of the claim by the lenders with the DRT.

Mardia Chemicals and other companies had moved court against notices sent to them by banks and institutions, arguing that Section 17 (2) of the Act was blocking their ability to take legal recourse against seizure notices. Mardia, in fact, made a counter-claim of Rs 5,600 crore against ICICI Bank.

For over a year, banks could only seize defaulters' assets but not sell them pending the judgement of the Mardia Chemicals vs ICICI Bank case in the Supreme Court.

Now, the court has paved the way for sale of assets after the seizure. But this may not be a cakewalk for banks because of a likelihood of a spate of appeals (or "petitions" as the Supreme Court says) at the DRTs against the action of the lenders.

The point to note here is that appeals can be made at DRTs only after the assets have been seized by the lenders. In other words, the Supreme Court judgement does not curb the lenders' power to seize.

As a result of this, the lenders will have control over secured assets even before the case is heard at a DRT. This will ensure safe upkeep of the assets and prevent erosion in security value during the litigation as it happens in the case of those companies that are referred to the Board for Industrial and Financial Reconstruction (BIFR).

Section 69 of the Transfer of Property Act, 1882, and Section 29 of State Financial Corporation Act, 1951, also give similar powers to the borrowers.

In an earlier case in 1984 (Mahesh Chandra), the Supreme Court had said that the borrower must be involved at every stage "" from the seizure of an asset to its sale.

But in 2002, another Supreme Court judgement (Jagdamba Oil Mill) laid down only two basic principles for the lenders in such cases "" they must follow the law and they must be fair and reasonable. This has certainly made the job easy for the lenders.

But what has made it tough for them is the court's striking down of Section 17 (B) of the Sarfaesi Act. This will allow borrowers to make a beeline for the DRTs.

At the moment, 29 DRTs are working across the country. They were set up under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993.

As on June 30 last year, out of 57,915 cases (involving Rs 82,266 crore) filed by banks to the DRTs, 22,163 cases (involving Rs 19,633 crore) have been adjudicated and the amount recovered stood at Rs 5,787 crore.

Until now, only those cases where the money involved is Rs 10 lakh and above could go to the DRTs; other cases involving smaller amounts were tackled at the civil court level. Post-Sarfaesi Act, the smaller cases were directly handled by banks and institutions.

So, now one will see two types of cases being referred to the DRTs "" loans worth Rs 10 lakh and above (which are dealt by the DRTs in the normal course) and loans worth Rs 1 lakh and above (where borrowers file a "petition" against the lenders' action).

There will, however, be a difference in the treatment of the cases. For the first lot, the DRT will directly sit in judgement for the recovery proceedings, while in the second lot, it will judge the action of the lenders in seizing the assets and wanting to sell them.

It can either give a go-ahead to the lenders or direct them to return the assets to the borrowers. It can even force the borrowers to give compensation to the lenders (under Section 19 of the Act) for wrongful possession.

Now, can a lender proceed under the Sarfaesi Act for cases that are already pending with the DRT? The answer is both yes and no. The law is silent on this. The lenders are required to seek permission of the DRTs to move under the Act at a parallel level and the DRTs can say no if they feel there is a conflict between the two processes.

The recovery process can get delayed further since a borrower can move the appellate authority (Debt Recovery Appellate Tribunal, or DRAT) if he finds the DRT decision not palatable. For that, he does not need to deposit any amount. This is an anomalous situation.

A borrower who challenges a lender's action under the Sarfaesi Act at a DRT can move to the DRAT smoothly, but in those cases where a lender has moved the DRT to recover dues (under the DRT Act for loans worth Rs 10 lakh and over), a borrower needs to deposit 75 per cent of the claim to go to the DRAT.

Finally, the DRAT does not necessarily draw the curtain on a case. Even after the DRAT's decision, a borrower can file a writ petition at the high court level. This is despite the fact that the Sarfaesi Act does not allow any lender to move a civil court.

There is a reason for this: About 80 per cent of the banking industry is in the public sector and all public sector banks and financial institutions are described as "authorities" under Article 12 of the Indian Constitution in the chapter (III) on fundamental rights.

The action of the "authorities" should be in accordance with the provisions of fundamental rights laid down in the chapter. If the "authorities" are not acting properly, Indian citizens have the right to file writ petitions under Section 226 of the Indian Constitution. The borrowers can exercise this right and move a high court since no law can take away the constitutional rights.

A high court, however, may not give relief to the borrowers in such cases since, going by the norms, whenever the existing law provides a remedy, the writ petition route may not be considered as a remedial measure.

In this case, Section 17 of the Sarfaesi Act allows borrowers to move the DRTs and, hence, there is already an existing law to provide remedy.

However, the legal paraphernalia can delay the entire recovery process and defeat the purpose of the Sarfaesi Act. Ideally, a DRT is expected to take about six months to clear a case. But experience says that these tribunals take at least two years for each case. It may take another year to clear the hurdle of the DRAT and yet another six months at a high court.

So, by a conservative estimate, a borrower can drag a case and postpone sale of an asset even after its seizure, by three-and-a-half years. Are the banks and institutions equipped to preserve the value of the assets for such a long time?

Finally, the writ petition route can only be taken by the borrower when the lender is a public-sector entity. No borrower can move against a private bank to protect its fundamental rights because private entities are not "authorities" as defined by the Indian Constitution!

The only way to remove the anomaly is to change the public-sector character of banks. This can be done by divesting the government's stake in nationalised banks.

A Bill amending the Banking Regulation Act and bringing down the government's stake in these banks to a minimum of 33 per cent (from 51 per cent now) has been hanging fire for years. The government is willing to bring down its stake but preserve the "public-sector character" of the banks. But that is a separate story altogether.