Will SC judgment on securitisation help bad loan recovery?

Help for secured lenders

Ashwani Puri
Financial Services Advisory Leader, PwC

The Supreme Court's judgment on the Securitisation Act upholds the constitutional validity of key provisions of the Act. It allows for exercise of security enforcement as a remedy under a private contractual arrangement without the need to seek court intervention if done in accordance with loan documentation and the Act's provisions.

The court has noted that banks and institutions are saddled with large amounts as non performing assets (NPAs) and the normal processes available for recovery of debt through the court route are lengthy and cumbersome.

It has recognised the need for speedier recovery mechanisms and acknowledges that today's circumstances make provisions of the Transfer of Property Act (1882), requiring court intervention for security enforcement, outdated.

It accepts that the issue of notice under the Act does not attract the application of principles of natural justice. This rejects borrowers' call for explaining why the contractually provided remedy is being sought to be enforced instead of any alternatives.

While lenders are required to give serious consideration to the borrowers' response, if any, to such a notice, no hearing can be demanded from the creditor at this stage nor can court or debt recovery tribunal (DRT) intervention be sought, except where the claim is alleged to be fraudulent or absurd.

By settling the uncertainty regarding the Act, the judgment, along with the repeal of SICA (under Section 22 of which, borrowers got automatic protection from action by secured lenders) significantly strengthens the hands of secured lenders.

Also, as lenders would have control over secured assets even before the appeal to DRT, it would check the possibility of erosion in security value during the litigation as happens in the BIFR cases.

While it is true that security enforcement is a measure of last resort to be exercised only if all else fails, its importance cannot be underestimated.

While such pressure is desirable and needed, and while accepting that DRT is the only permitted forum for addressing borrowers' grievances against such action (which remedy can be sought only after the lender enforces security), the court has seen the requirement to deposit 75 per cent of the outstanding amount before moving DRT as excessive and struck it down.

It might be worth noting that the requirement for pre-deposit of 75 per cent of the amount prior to appeal against the DRT's decision as contained in the DRT Act is unchanged by this ruling. The striking down of the 75 per cent requirement at the first stage upholds the principles of fair play and should check lenders acting without sufficient caution. However, it may result in a large number of petitions being filed with DRTs and consequent delays.

Nevertheless, enhancing the capacity of DRTs needs urgent attention. Besides additional benches, there may be a need for procedures for summary examination of petitions and for distinguishing between petitions on the basis of the kinds of treatment required. Segregation of benches on the basis of amounts may also help ensure that a flood of small cases does not retard the disposal of larger cases.

A cleanser for the system

Rajendra Kakker
MD & CEO,
Asset Reconstruction Company

The Supreme Court, keeping in view public interest and the economic growth of the country, upheld the constitutional validity of the Securitisation Act.

It also observed that certain provisions of the Act may be a bit harsh for some borrowers but cannot be said to be unconstitutional for the very fact that the object of the legislation is to achieve speedy recovery of non performing assets (NPAs).

The banking industry has been keeping pace with international prudential norms and accounting standards. In certain areas like recovery of dues, however, it has not had a level playing field with borrowers, unlike in international markets.

The enactment of the Securitisation Act is a step towards improving the legal framework in accordance with changing commercial practices and financial sector reforms world over. The court's decision upholding the Act has vindicated aforesaid legislative intent.

This enactment can be broadly classified into two parts. The first part relates to the laws governing securitisation and reconstruction of financial assets by asset reconstruction companies (ARCs) and the other part concerns enforcement of security interests without the intervention of the court.

The Indian model of ARCs is unique as there is no bailout money to be made available by the government unlike in some other countries in the region. The empowerment of ARCs and the banking sector through the Securitisation Act is, therefore, critical for resolution of NPAs. Thus, the upholding of the securitisation is a landmark event for cleaning the system.

The recent action of the Reserve Bank of India (RBI) to increase the 'net owned fund' of ARCs to an amount not less than 15 per cent of the total financial assets acquired or to be acquired or on an aggregate of Rs 100 crore "" whichever is lower "" would pave the way for orderly growth of asset reconstruction business.

At present, Arcil is the only ARC which has been operational. The setting up of more ARCs would encourage competition and fairness in the field. Arcil has positioned itself as an entity equidistant from the sellers as well as potential investors (mostly FIIs at present) for market making and price discovery.

The hands of ARCs would be strengthened upon issuance of necessary guidelines by the RBI for operationalisation in terms of Section 9 (a) and (b) of the Securitisation Act.

As regards enforcement of security interests, although the Supreme Court has struck down Section 17 (2) of the Act which requires pre-deposit of 75 per cent of the amount claimed by the secured creditor, it has actually transposed these powers to debt recovery tribunals (DRTs) who could impose conditions as they deem fit.

In other words, DRTs can play a significant role in helping to build a healthy economy by disciplining willful defaulters by specifically requiring them to furnish security.

As such, the Supreme Court decision of striking down Section 17 (2) would in no way dilute the legislative intent in disciplining defaulters.

Overall, the objective of the legislation could be achieved if utmost diligence is ensured by secured creditors at each stage of action.