The Enforcement of Security Interest and Recovery of Debt Laws and Miscellaneous Provisions (Amendment) Bill, 2016 (the “Bill”) was introduced in Lok Sabha in May this year to make the debt recovery and security enforcement process more effective. The Bill, when passed, will amend the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”), the Recovery of Debts due to Banks and Financial Institutions Act, 1993 (“RDBFI Act”), the Indian Stamp Act, 1899 and the Depositories Act, 1996.
The amendments proposed in the Bill are with a view to improve the ease of doing business by expediting adjudication of recovery applications and suggesting and facilitating matters connected therewith such as: (i) debenture trustees to be classified as secured creditors; (ii) providing specific timelines for taking possession of secured assets; (iii) priority to secured creditors in repayment of debts; (iv) creation of a centralized database for registration and satisfaction of security interest by all secured creditors under different laws relating to property rights; (v) empowerment of the Reserve Bank of India (“RBI”) to regulate asset reconstruction companies (“ARCs”); (vi) exemption from stamp duty on assignment of loans by banks and financial institutions in favour of ARCs; and (vii) enabling non-institutional investors to invest in security receipts.
The Bill was referred to the Joint Parliamentary Committee (“Committee”) for its recommendations - this was largely the same Parliamentary Committee (under the chairmanship of Shri Bhupender Yadav) which had reviewed and provided its recommendations on the Insolvency and Bankruptcy Bill, 2015. The aim of this exercise was to align the Bill with the Insolvency and Bankruptcy Code, 2016 (“Insolvency Code”) and harmonise their functioning. This newsletter highlights certain key amendments under the Bill and the recommendations of the Committee.
Key amendments proposed by the Bill
Widening the scope of borrowers and creditors under the SARFAESI Act
One of the significant features of the SARFAESI Act is that only banks and financial institutions were the beneficiaries of its prescribed security enforcement mechanism. The Bill seeks to change that.
Borrower: The Bill expands the definition of borrower to include any person who has raised funds through the issue of debt securities. Debt securities include non-convertibles debentures and bonds which are listed in accordance with the regulations framed by the Securities and Exchange Board of India (“SEBI”).
Secured creditors: In line with the aim of the Insolvency Code to create a level playing field for all secured creditors, the scope of secured creditors has been enhanced to include:
Debenture trustees who are registered with SEBI and appointed by companies for secured listed debt securities;
A bank or financial institution that has an interest in any asset given on hire or financial lease or conditional sale. This will have a positive impact on the hire purchase and financial leasing industry as the banks and financial institutions will be able to repossess the asset in case of a default without requiring any intervention of the courts. However, non-banking financial companies (“NBFCs”) which are not notified as financial institutions for the purpose of the SARFAESI Act will not benefit from this amendment; and
A bank or a financial institution that has a right to any intangible asset (such as intellectual property rights) or a license or assignment of such intangible asset.
Further, corresponding changes have been made in the definition of ‘default’ and ‘financial assistance’ to cover payment defaults in relation to debt securities and purchase of debentures/bonds (either by way of initial subscription or secondary market purchase of debentures/bonds), respectively.
Asset Reconstruction Company: The individual definitions of ‘securitisation company’ and ‘reconstruction company’ have been deleted and instead have been integrated into the definition of ‘asset reconstruction company’. This seems to be a change in the nomenclature instead of any concrete impact in relation to recovery of debt or security enforcement measures under the SARFAESI Act.
Qualified Institutional Buyers (“QIBs”): The scope of QIBs has been enhanced and RBI can now prescribe any other category of non-institutional investors to invest in security receipts. This is likely to promote investments by non-institutional buyers in security receipts and improve the liquidity and market for such security receipts.
Empowerment of RBI
Another important aspect of the amendments is the empowerment of the RBI to regulate the ARCs. As per the Bill:
RBI would be able to carry out audits and inspections of ARCs, and the ARC and its officers are duty bound to co-operate with RBI;
RBI would have the right to appoint officers as observers on the board of directors of the ARC;
RBI approval will be required for any substantial change in management of an ARC (including change in director or change in the sponsorship of the ARC);
RBI will have to prescribe directions and determine policy in relation to ARCs exercising the rights granted to them under the Bill (such as regulating the management of the business of the borrower, sale/lease of the business of the borrower or rescheduling any debt payments by the borrower); and
RBI may also prescribe rules on fees and other charges that can be charged or incurred for management of financial assets by an ARC, and on transfer of security receipts issued to QIBs.
Stamp duty exemption
The Bill exempts any transactions undertaken for transfer of financial assets (i.e. loans and security) in favour of ARCs from payment of any stamp duty.
Role of District Magistrate
The SARFAESI Act allows secured creditors to take possession over collateral, against which a loan had been provided, upon a default in repayment. This process is undertaken with the assistance of the District Magistrate, and does not require the intervention of courts or tribunals. The Bill:
provides that this process will have to be completed by the District Magistrate within 30 days of receiving the application; and
empowers the District Magistrate to assist those secured creditors (including ARCs) also who have converted their outstanding debt into equity shares, and consequently hold a stake of 51% or more in the company, in taking possession of the secured assets and documents. Further, the Bill provides that where secured creditors have converted their debt take majority control of the borrower, then on payment of their outstanding debt they are not liable to restore the business of the borrower.
The Bill provides for the creation of a central database for recording the rights created over any property and integration of records maintained with various databases, namely the registration records maintained under the Companies Act, 2013, the Registration Act, 1908, the Merchant Shipping Act, 1958, the Motor Vehicles Act, 1988, the Patents Act, 1970, the Designs Act, 2000, etc.
Further, a secured creditor shall be entitled to enforce its security under the provisions of the SARFAESI Act only if the creation or modification of charge on the assets is registered with the central registry. Otherwise, it will not get the benefit of the SARFAESI Act and will have to use other means for enforcement.
After registration of security interest, such secured creditors will have priority over any subsequent security interest created on the property. Further, any transfer, sale, lease, assignment or license of the property will be subject to such secured creditor’s claim. The Bill also provides that once a security interest of a secured creditor is registered with the central registry, the debts due to such secured creditor shall be paid in priority to all debts, revenues and taxes payable to the government.
Sponsor stake in ARC
The Bill has changed the criteria of sponsor of the ARC as “fit and proper” as against the current provision that sponsors cannot have majority stake in them. The Bill proposes to pave the way for a sponsor of an ARC to hold up to a 100% stake in the ARC.
Amendments to the RDBFI Act
Currently, banks and financial institutions have to file cases for recovery of loans only in tribunals that have jurisdiction over the defendant’s (i.e. the borrower or security provider’s) area of business or residence or where the cause of action may arise. The Bill enables banks and financial institutions to file cases even with tribunals that have jurisdiction over the place of the branch / office of the bank / financial institution where the debt is outstanding.
The Bill also provides for the electronic filing of pleadings, written statements and documents with the Debt Recovery Tribunals (“DRT”) and the Debt Recovery Appellate Tribunals.
Further, any appeal against an order of the recovery officer will be entertained by the DRT only if the appellant deposits 50% of the debt due to a bank or financial institution. This will ensure that frivolous appeals are not made against orders of the DRT and only genuine disputes are appealed.
Recommendations of the Joint Parliamentary Committee
The Committee has recommended certain drafting and clarificatory modifications to the Bill. We have provided a summary of the vital amendments suggested by the Committee below.
In furtherance of the removal of restrictions on the shareholding of an ARC by allowing a sponsor to hold 100% shareholding in an ARC, the Committee has proposed deletion of the provision which places restrictions on the number of directors to be appointed by a sponsor.
Stamp duty exemption
The Committee has clarified that the stamp duty exemption (as discussed above) will not be applicable in relation to any acquisitions by an ARC for purposes other than asset reconstruction or securitisation.
Therefore, going forward, ARCs will have to justify that the acquisition of the financial asset is indeed for these purposes, failing which they will have to pay full stamp duty on the transfer documents.
Audit and inspection by RBI
As discussed above, the RBI has been empowered to conduct audits and carry out inspections of ARCs. In this regard, the Committee has recommended enabling the RBI to delegate such powers to a specialised agency.
Payment of dues to the secured creditor
Section 13(8) of the SARFAESI Act provides that if the dues of a secured creditor (including all costs and expenses incurred by it) are paid to it prior to the date fixed for sale / transfer of the collateral, then such collateral should not be sold / transferred. The Bill further modifies this clause to state that if the dues of the secured creditor are paid prior to the date fixed for sale / lease / assignment of the secured assets, then such secured assets should not be so disposed off. As a clarificatory recommendation, the Committee, in light of Rule 8(5) of the Security Interest (Enforcement) Rules, 2002 (which provides for sale of secured assets through inter alia public auction, or inviting tenders from the public), has recommended that any payment of dues to the secured creditor should occur prior to the date of publication of notice for public auction or inviting quotations or tender from public or private treaty.
Taking possession/control of secured asset
The Bill proposes to insert a new provision wherein two or more banks (who have converted their outstanding debts into equity) or ARCs, holding more than 51% shareholding in a borrower can approach the District Magistrate for assistance in taking possession/control of any secured asset in relation to the balance debt owed to such persons.
The Committee clarified that such provision should be removed as the current provision of the SARFAESI Act is wide enough to cover the proposed amendment and because possession of assets of a company or conversion of debt into equity will require compliance with Companies Act, 2013, SEBI Act, 1992 and other applicable laws. In relation to secured creditors who have taken majority control of the borrower upon conversion of their debt, the Committee in its recommendation has clarified that it should be read as restoring the management of the borrower and not business of the borrower.
Harmonization of SARFAESI Act with the Insolvency Code
The Insolvency Code provides for moratorium (or standstill) during the insolvency resolution process which prohibits any person from taking action to recover or enforce any security interest in relation to the corporate debtor under the SARFAESI Act. If the insolvency resolution plan is not approved, the Insolvency Code provides for enforcement of security interest as per the applicable law.
On the aforesaid provisions, it seems that the Committee intends to harmonize the Insolvency Code with SARFAESI Act and for the sake of clarity, recommended that an explanation be inserted which would state that priority to secured creditors in payment of debt would be subject to the provisions of the Insolvency Code in cases where insolvency and bankruptcy proceedings are pending in respect of secured assets of the borrower.
With the Insolvency Code and the legislative amendments proposed under the Bill, the government seems to be putting in place critical building blocks of the infrastructure necessary for faster and more efficient recovery of debt and enforcement of security.
While the Bill and the Committee recommendations seek to bring some much needed changes in the Indian legal framework, the Bill still fails to address some critical issues regarding recovery of debt and enforcement of security which are being faced by the industry.
The definition of ‘debt securities’ does not include (i) bonds issued (unlisted or listed) overseas including ‘Masala Bonds’ and foreign currency convertible bonds (FCCBs) and (ii) unlisted non-convertible debentures and bonds.
NBFCs and lenders under the External Commercial Borrowing (“ECB”) guidelines issued by the RBI are still not included in the definition of ‘secured creditors’.
Therefore certain categories of bond holders (as specified in (a) above), NBFCs and ECB lenders continue to be on a non-level playing field vis-à-vis banks and financial institutions which have the right to speedier recovery and enforcement measures under the SARFAESI Act.
Enforcement of pledge created over securities continues to be outside the provisions of the SARFAESI Act and therefore, the enforcement process for pledge continues to be subject to the risk of protracted proceedings in Indian courts.
Further, under the Insolvency Code, the enforcement action can only be taken by a creditor under SARFAESI Act only when an asset is a non-performing asset. To aid effective implementation of the Insolvency Code, the Bill could have provided that if a secured creditor is standing outside liquidation process, then the benefit of SARFAESI Act will be available to such a creditor even if the debt has not become a non-performing asset.
The recommendations highlighted by the Committee suggest that the Bill will undergo further changes and deliberation in the Parliament before the amendments come into effect. Considering that the proposed amendments do not take into consideration any of the above issues, there is still scope for further improvement in the Indian debt recovery and security enforcement laws and ultimately the ease of doing business in India.