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A New Dimension to Debts Recovery Laws: The Securitisation Ordinance*
by Ashish Pathak**

Cite as : (2002) 5 SCC (Jour) 17


Spirited efforts of the Finance Ministry and financial sector players have finally borne fruit1 with the promulgation of the "Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Ordinance, 2002" ("the Ordinance") — a law permitting securitisation and reconstruction of financial assets, and providing for speedy enforcement of security interests is now a reality.

The prime propellant for the promulgation has been, of course, the worrisome state of the financial sector, where the snag of bad debt has almost snowballed into a crisis. The Ordinance, however, also aims to smoothen the debts recovery process by enabling secured creditors to resort to self-help in certain specified circumstances. The Ordinance is arguably the last in the set of measures that the Government has initiated over the past few years for curbing the evil of non-performing assets ("NPAs"). The beginning was made by the announcement of an amnesty scheme for settlement whereby the lenders agreed to offer huge discounts to borrowers for recovering at least a part of their investments locked in bad and doubtful assets. It did work out to a small extent, but failed to provide any comprehensive solutions. The second was the setting up of special Fast Track Courts in the form of Debts Recovery Tribunals ("DRTs") under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 ("the DRT Act"), which also proved to be only a placebo, reasons being the time-consuming legal process under the DRT Act and the woefully inadequate infrastructure made available to DRTs. The result? As on date, nationalized banks alone are estimated to have gross NPAs of over Rs 36,000 crores2


The Ordinance is expected to help banks and financial institutions ("FIs") inject liquidity in their investments in financial assets in the following ways3:

— Banks and FIs would now be able to convert their assets into securities through the contrivance of a securitisation company ("SCO"). Capable of being traded in smaller bundles, these securities would fetch immediate liquidity which can be utilized for productive endeavours, instead of waiting patiently for loan realization.

— The Ordinance would also facilitate setting up of reconstruction companies ("RCOs")4, special purpose vehicles, which would recover the bad assets of banks or FIs.

— It will help banks and FIs enforce their security interest in a smooth and efficient manner5


Registration of SCOs and RCOs

An SCO or RCO will be required to obtain a registration certificate6 and to have the minimum amount of Rs 2 crores of owned fund or such other amount not exceeding fifteen per cent of the total financial assets as specified by Reserve Bank of India ("RBI"), in order to commence or carry on the business of securitisation or asset reconstruction. Financial functions of securitisation or reconstruction can be performed as per the guidelines issued by RBI. RBI would also have the power, under specified circumstances, to cancel a certificate of registration granted to an SCO or RCO7

Acquisition of rights or interest in financial assets

An SCO or RCO may acquire financial assets of any bank or FI by issuing a debenture or bond or any other security in the nature of the debenture, for mutually agreed upon consideration8 In relation to any financial assets acquired by the SCO or the RCO, the acquirer would be deemed to be the lender and would be entitled to all the rights of the transferor bank or FI9 Moreover, on the date of acquisition of a financial asset, any pending suit, appeal or other proceeding relating to the financial asset by or against the bank or FI would not abate10 or be discontinued or in any way be prejudicially affected by reason of the acquisition by the SCO or RCO, but may be continued, prosecuted and enforced by or against the SCO or RCO11

Measures for assets reconstruction

An SCO or RCO may, subject to the provisions of existing laws and any guidelines framed by RBI, employ any one or more of the following measures for assets reconstruction12:

— ensure proper management of the business of the borrower, by change in, or takeover of, the management of the business;

— sale or lease of the business of the borrower, either in whole or in part;

— rescheduling of payment of debts payable by the borrower;

— enforcement of security interest by taking possession of secured assets as per the provisions of the Ordinance; or

— settlement of dues payable by the borrower.

Power of Reserve Bank to determine policy and issue directions

Under certain circumstances, RBI may determine the policy and give directions to all or any SCO or RCO in matters relating to income recognition, accounting standards, making provisions for bad and doubtful debts, capital adequacy based on risk weights for assets and also relating to deployment of funds by the SCO or RCO, as the case may be, and such company would be bound to follow the policy so determined and directions so issued13

RBI may give directions to any SCO or RCO generally or to a class of SCOs or RCOs or to any SCO or RCO in particular as to the type of financial assets of a bank or FI which can be acquired14, procedure for acquisition of such assets and valuation thereof, and the aggregate value of financial assets which may be acquired by any SCO or RCO.

Enforcement of security interest

All secured creditors have been empowered to enforce any security interest created in their favour, without the intervention of any court or tribunal, in accordance with the provisions of the Ordinance15

Where any borrower, under a liability to a secured creditor in a security agreement, makes any default in repayment of the secured debt or any instalment thereof, and his account in respect of such debt is classified by the secured creditor as an NPA, such secured creditor may require the borrower by notice16 in writing to discharge in full his liabilities within sixty days from the date of the notice, failing which the secured creditor would be entitled to exercise all or any of the following enforcement steps17:

— Take possession of the secured assets, including the right to transfer by way of lease, assignment or sale for realizing the secured asset.

— Take over the management of the secured assets including the right to transfer by way of lease, assignment or sale, and realize the secured asset.

— Appoint a manager for the secured assets, possession of which has been taken over by the secured creditor.

— Require at any time by notice in writing, any person who has acquired any of the secured assets from the borrower and from whom any money is due or may become due to the borrower, to pay the secured creditor, so much of the money as is sufficient to pay the secured debt18

Taking possession

Where the possession of secured assets is required to be taken by the secured creditor or if any of the secured assets is required to be sold or transferred by the secured creditor, such secured creditor may request the Chief Metropolitan Magistrate or the District Magistrate within whose jurisdiction the secured assets or other documents relating thereto may be situated or found, to take possession thereof and the latter would, on such request, take possession of the assets and documents relating thereto, and forward the same to the secured creditor19

For the purpose of securing compliance, the Magistrate concerned may take such steps and use such force as he may deem necessary. No such act of the above Magistrate(s) done in pursuance of this provision is to be called in question in any court or before any authority20

Right to appeal

Any person aggrieved by any of the above measures taken by the secured creditor, may prefer an appeal to the DRT of relevant jurisdiction within forty-five days from the date on which such measures are taken21 Where a borrower prefers an appeal, the DRT concerned is not to entertain such appeal unless the borrower deposits with the DRT seventy-five per cent of the amount claimed in the notice22 This amount may, however, be waived or reduced by the DRT for reasons to be recorded in writing. A person aggrieved by the order made by the DRT under the above provision may prefer a further appeal to an Appellate Tribunal within thirty days from the date of receipt of the order of DRT. Both the DRT and the Appellate Tribunal are required to dispose of the appeal in accordance with the provisions of the DRT Act and Rules made thereunder23

Central Registry

A registry to be known as the Central Registry having its own seal is proposed to be set up under the Ordinance, for the purposes of registration of transactions of securitisation and reconstruction of financial assets and creation of security interests. Provisions of the Ordinance pertaining to the Central Registry would be in addition to and not in derogation of any of the provisions of any other law requiring registration of charges and are not to affect the priority of charges or validity thereof under those Acts or laws24

Central Registrar

The Central Government would appoint a person, to be known as the Central Registrar, for the purpose of registration of transactions relating to securitisation and reconstruction of financial assets, and security interests created over properties25 The Central Government may also appoint other officers for the purpose of discharging, under the superintendence and direction of the Central Registrar, such functions of the Central Registrar under the Ordinance as he may authorize them to discharge26

Register of securitisation, reconstruction and security interest transactions

For the purposes of the Ordinance, a record called the Central Register would be kept at the head office of the Central Registry, under the control and management of the Central Registrar, for entering the particulars of the transactions relating to securitisation, reconstruction and creation of security interests27

Particulars of every transaction of securitisation, assets reconstruction or creation of security interest are to be filed with the Central Registrar within thirty days after the date of such transaction or creation of security28 The SCO or the RCO or the secured creditors are also under the duty to send the particulars of any modifications of any security interest registered under the Ordinance29, and of the payment or satisfaction in full, of any security interest requiring registration under the Ordinance, within thirty days from the date of such payment or satisfaction30

Right to inspect particulars of securitisation, reconstruction and security interest transactions

Particulars of securitisation or reconstruction or creation of security interest entered in the Central Register of such transactions would be open for inspection by any person on payment of a fee. The Central Register would also be maintained in electronic form, and any person would be able to inspect the same through electronic media on payment of a fee.

Provisions of the Ordinance not to apply in certain cases

The provisions of the Ordinance would not apply to the following31:

— a lien on any goods, money or security given by or under any existing law;

— a pledge of movables;

— creation of any security in any aircraft or in any vessel;

— any conditional sale, hire-purchase or lease or any other contract in which no security interest has been created;

— any rights of unpaid seller;

— properties not liable to attachment under the Code of Civil Procedure, 1908;

— any security interest in any financial asset having the value of less than Rs 1,00,000 (Rupees one lakh);

— any security interest created in agricultural land; and

— any case in which the amount due is less than twenty per cent of the principal amount and interest thereon.

Provisions of Ordinance to override other laws

Provisions of the Ordinance would have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law32

Application of other laws not barred

The provisions of the Ordinance or the Rules made thereunder are to be in addition to, and not in derogation of, the Companies Act, 1956, the Securities Contracts (Regulation) Act, 1956, the Securities and Exchange Board of India Act, 1992, the DRT Act or any other law for the time being in force33

Civil court not to have jurisdiction

No civil court would have jurisdiction to entertain any suit or proceeding in respect of any matter which a DRT or an Appellate Tribunal is empowered by or under the Ordinance to determine. Further, no injunctions are to be granted by any court or other authority in respect of any action taken or to be taken in pursuance of any power conferred by or under the Ordinance or under the DRT Act34


The Ordinance does not bring in any fundamental changes in the tenets of Indian insolvency laws, most of which have remained untouched. Instead, it may be regarded as being an extremely useful augmentation to the law of debts recovery, removing some of the regulatory bottlenecks tormenting the financial sector35 and opening speedier avenues for secured creditors to recover their debts.

The Ordinance holds the promise of reformulating the contours of assets management and of rectifying the imbalance between borrowers and lenders in India, a direct consequence of which has been the colossal accumulation of NPAs36 However, it is being said by certain industry associations that some of the provisions are draconian, and that no distinction has been made between wilful defaulters and borrower companies facing actual financial difficulties. Thirdly, there is the issue of moral hazard: that if banks or FIs know that their bad debts will be taken off the books, they would have no incentive to focus on good-loan appraisal and prompt recovery, and further that if someone has displayed bad judgment while making an investment decision, why should not he face the consequences?

Coming to the first two points, it is not the purpose of the Ordinance to penalize borrowers but to enable banks and FIs to realize their dues, this being the very substratum of banking business. One fails to understand how the corporate sector can object to these provisions addressing the fundamental concerns of the credit industry. As for wilful defaulters, they can of course be proceeded against in the criminal courts for remedies that have been available for decades now. It may be argued that promoters are worried that bankers may suddenly become trigger-happy, and sell charged assets at seeing the very first symptoms of impending default. There are also concerns about the stiff conditions laid down for making an appeal to the DRTs against actions taken under the Ordinance, most notable of them being that the borrower would have to deposit seventy-five per cent of the dues before an appeal is entertained. Even as there may be a case for diluting the conditions for appeal, examples abound where banks and FIs have been unable to dispose of and realize assets, despite being armed with the permission of a court. As it is, finding buyers for unviable units is a tough job and lenders have to often write off large amounts in order to effect a sale. As for the smaller units, many of these are utterly unviable, mainly because of their inability to compete in a liberalized and dereserved market. Put simply, the sale of business units is unlikely to be an easy decision for lenders who are, more likely than not, to respond favourably to any promoter coming up with a credible plan for repayment of dues.

Fears of these promoters, therefore, are largely unfounded. In fact, winding up sick and unviable units would help the healthy ones since, under the current dispensation37, they continue to operate without bothering to repay their debts and are, therefore, able to cut into the market prices commanded by healthy units.

As regards the issue of the moral hazard, the author supports the pragmatic and utilitarian spirit that the Ordinance embodies, and feels that moral wrangles would have to be kept on the back burner, at least for the time being. With the progressive liberalization of the financial sector, even government-controlled banks and FIs are now competing in the open market and have professional management, and there seem to be little chances of complacency creeping in. Moreover, at present, commercial banks alone have NPAs worth about Rs 70,000 to 1,00,000 crores. On an average, this could be anywhere between 10 and 25 per cent of their total assets, appalling statistics indeed, which certainly demanded manifestly strong measures. Furthermore, the Ordinance will bring down the risk premium involved in lending to the Indian corporate sector, thereby reducing the cost of funds and encouraging lending. For an economy slated to grow at the rate of eight per cent per annum, fundamental economic restructuring necessitated these short-term inconveniences which, the author feels, may be worth entertaining for a better tomorrow.

For all these reasons, the basic structure of the Ordinance must not be questioned or be tampered with, though a few changes, like making appeals easier, can be considered. In conclusion, it must be said that the Ordinance by empowering lenders to exercise their right of expeditious attachment and foreclosure for the enforcement of security has made a beginning in the right direction.

*   LLM (Cambridge), Kochhar & Co., S-454, Greater Kailash II, New Delhi 110 048, India. Return to Text

**   Based on the recommendations of Narasimham Committee I and II and Andhyarujina Committee reports, the Ordinance is a revolutionary piece of law addressing the core concerns raised by these Committees. Return to Text

  1. The total amount involved in NPAs is estimated to be anywhere between Rs 70,000 and 110,000 crores. The seriousness of the Government is, in fact, borne out by the Presidential promulgation under special constitutional powers, as Parliament was not in session. Return to Text
  2. Before the Ordinance, the option before lenders was either to take defaulters to DRTs or initiate winding-up proceedings in courts. In both the cases, prompt relief was not forthcoming. Since their inception till 30-9-2001, the 22 DRTs in the country decided only 9814 cases for Rs 6265 crores, with public sector banks recovering merely Rs 1864 crores. As on 30-9-2001 over 33,000 cases involving about Rs 43,000 crores were pending before various DRTs. Getting relief through courts in winding-up proceedings is tougher with the Companies Rules alone requiring over 100 sequential procedures to be followed. Clearly, a dramatic change in insolvency laws facilitating faster exits was needed to address the problem of NPAs. Return to Text
  3. RCOs may be described as external "bad banks". Armed with the Ordinance, the banks and FIs having large proportion of bad debts or NPAs would now be able to sell these to a legally separate RCO, which would then recover whatever it can through takeover, attachment, foreclosure or liquidation. The bank or FI would have the benefits of a relatively "clean" asset book, and if the transfer prices of the NPAs are low enough, the RCO would also end up making a profit. Return to Text
  4. That is, right to the security in case of default in payment by the borrower. Return to Text
  5. See Section 3 Return to Text
  6. Section 4 Return to Text
  7. See Section 5(1). This provision is music for the officials of government-controlled banks and FIs. The pricing issue of NPAs was an awkward one, which became significant in view of the Government's ownership of banks and FIs. There was an apprehension that the Government would initiate the setting up of RCOs to do a clean-up act. There can be only two ways an NPA can be priced, at book value or according to what the market offers. The former would be great for the bank or FI, but no RCO worth the name would be willing to take on bad debts at book value in the absence of arm-twisting by the Government, because this would only shift losses from the banks or FIs to the RCO. As regards transfer at realistic market prices, that is at a discount to book values, there was the Damocles' sword of being questioned by anti-corruption investigators. That being so, in the absence of this provision, there would have been little incentive for taking the risk by the already beleaguered officials of public sector banks and FIs. Return to Text
  8. Section 5(2). Return to Text
  9. Except as provided in the third proviso to sub-section (1) of Section 15 of the Sick Industrial Companies (Special Provisions) Act, 1985 ("SICA"), this proviso having been inserted by the Ordinance. It may be noted that proceedings before the Board of Industrial and Financial Reconstruction ("BIFR") have contributed to the accumulation of NPAs in the country to alarming levels because the provisions of SICA imposed a freeze on all legal proceedings for recovery of debts against companies referred to BIFR, a quasi-judicial body constituted under SICA. The Ordinance takes away the comfort enjoyed by BIFR companies and places them on a par with non-BIFR defaulting companies. With this proviso in place, even companies already under BIFR would not be spared and the reference to BIFR would abate if a majority of secured creditors start recovery proceedings. Next to scrapping BIFR, this is the best that the banks and FIs could have asked for. It may be further noted that amendments to the Companies Act, 1956 are pending whereby provisions have been made for scrapping BIFR by subsuming it into the proposed National Company Law Tribunal. This provision in the Ordinance is designed to address the problems of lenders in the interim period. Return to Text
  10. Section 5(4) Return to Text
  11. Section 9 Return to Text
  12. Section 12(1) Return to Text
  13. Section 12(2) Return to Text
  14. Section 13(1). This provision is to override Sections 69 and 69-A of the Transfer of Property Act, 1882 ("TPA"). TPA severely restricted the powers of the mortgagee to sell the mortgaged property. An archaic statute, TPA conferred the power of foreclosure only in cases of English mortgages, or where the mortgagee was the Government having such power of sale expressly conferred by the mortgage deed, or where the mortgaged property was situated in certain specified locations. TPA under Section 69 prescribed a prior notice of three months, and under Section 69-A restricted the rights of secured creditors to appoint a receiver. Moreover, the operation of TPA was limited to immovable property alone, which is not the case with the Ordinance that applies to all conceivable kinds of property. Return to Text
  15. The notice is to give details of the amount payable by the borrower and of the secured assets subject to the charge of the secured creditor etc. Section 13(13) prohibits the borrower, after receipt of notice, from transferring by way of sale, lease or otherwise (other than in the ordinary course of his business) any of his secured assets referred to in the notice, without prior written consent of the secured creditor. Return to Text
  16. Section 13(2). As per Section 13(11), secured creditors would be entitled to proceed against the guarantors or sell the pledged assets without first taking any of these measures, and this would be without prejudice to the rights conferred under this section. Return to Text
  17. Section 13(4) Return to Text
  18. Section 14 Return to Text
  19. Sections 14(2) and (3) Return to Text
  20. Section 17(1) Return to Text
  21. Section 17(2). This notice is the demand notice referred to in sub-section (2) of Section 13, supra note 18 Return to Text
  22. Sections 18(1) and (2) Return to Text
  23. Section 20(4) Return to Text
  24. Section 21(1) Return to Text
  25. Section 21(2) Return to Text
  26. Section 22 Return to Text
  27. Section 23 Return to Text
  28. Section 24 Return to Text
  29. Sections 25(1) and (2) Return to Text
  30. Section 31 Return to Text
  31. Section 35 Return to Text
  32. Section 37 Return to Text
  33. Section 34. This means that neither can the borrowers rush for protection to BIFR since the Ordinance empowers the creditors to prevent it, nor can injunctions be obtained from civil courts which would not have any powers in the matter. Return to Text
  34. For example, reference to BIFR by borrower companies. Return to Text
  35. Although this accumulation is not big enough to threaten the economy, by allowing banks and FIs to short-circuit the delays in justice and realize the secured assets without having to seek the permission of a court or tribunal, the Ordinance has laid the foundation of a fundamentally different debts recovery dispensation. Return to Text
  36. That is, BIFR Return to Text
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