The SARFARESI Act does not fulfill the purpose of registration of security interests. For, the Central Registry does not guarantee reliability. Therefore, the law as it stands is a futile and very costly exercise
After nine years in hibernation, the provisions of the SARFAESI Act pertaining to the Central Registry have been brought to life. The Central Registry was constituted by a notification on 31 March 2011. And in a separate notification on the same date, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Central Registry) Rules, 2011 (Central Registry Rules) were also notified.
The SARFAESI Act has been criticised as shabbily drafted and thoughtlessly promulgated and was collecting dust for over nine years. It is also called the Securitisation Act, but it doesn’t deal with securitisation transactions at all. It has of course made a difference in the manner in which non-performing assets (NPAs) are handled in the country, but it has resulted in an inconsistency with the laws that deal with insolvency and revival of sick companies. The benign concept of reconstruction of NPAs, for which models exist in several other countries, has been used in India to create a model to buy NPAs. Overall, the SARFAESI Act is a unique Indian model; it was designed in line with Article 9 of the UCC of the United States, but has strayed completely.
One of the key principles of Article 9 of the UCC was registration of security interests, and providing priority to security interests based on the date of registration. According to common law principles underlying the Companies Act, a security interest (aka charge) is effective from the date of its creation, unless it is an unregistered charge. However, in the US system, it is not the date of creation, but the date of filing of the charge that determines priority.
It is for this reason that the concept of registration of security interests was enshrined in the SARFAESI Act. However, while the Act did provide for mandatory registration, it nowhere mentioned that priority of security interests will be based on the date of registration. On the contrary, section 20(4) of the Act states that the provisions of the Act shall NOT affect the priority or validity of charges registered/required to be registered either under the Companies Act or under the Registration Act, or other similar laws pertaining to registration of security interests. That is to say that even if the security interest is not registered as required by Central Registry Rules, the only implication will be the penal consequences of the law, and there will be no impact on the validity or priority of the security interest. There is, however, a provision for payment of a penalty of Rs5,000 per day of the default(1) .
The Rules have currently been implemented only in case of equitable mortgages. It is difficult to understand as to why equitable mortgages had to be distinguished. An RBI Press Release of 21 April (2) says that this has been done to prevent frauds. In fact, the chances of frauds are minimal in case of equitable mortgages, as the title deeds are physically with the lender. If the title deeds are indeed fabricated, then the Central Registry does not help at all, because registration of such mortgage does not validate what is actually invalid.
Unimaginable magnitude of the rules
The ambit of coverage of the Rules is vast, as described in Section 23 of the SARFAESI Act. In fact, neither the draftsmen nor the banks/financial institutions supposed to abide by the provisions of Section 23 may have imagined what the implications of are. But before we get into the implications, here are some important points to note.
> In the Companies Act, the obligation is on the borrower to register a charge; under Section 23 of the SARFAESI Act, the obligation is on the secured creditor, that is, the bank.
> Under the Companies Act, the obligation is only for registration of security interests created by a company. Under the SARFAESI Act, all security interests, no matter by whom created (except, of course, for the exceptions given in Section 31, but that will take out only where the loan amount is Rs1 lakh or less) can be registered.
Now, with this, the magnitude of the burden being thrown on the banks may be imagined, once the provisions of Section 23 are fully enforced. On any given trading day, one would imagine an average bank in the country would get some thousand security interests, in respect of corporate loans, car loans, home loans, property loans, trade loans, or any loan for that matter, irrespective of whom it is given to, as long as the loan amount exceeds Rs 1 lakh.
On any given business day, lots of these security interests may be modified, either because of extension of the limit or modification of the terms, etc. Hundreds may get satisfied. All of these need to be registered by the bank with the Central Registry. Failure to do so will attract a fine of upto Rs5,000 every day, obviously for every offence to so register. Of course, the validity of the charge is not affected, but would banks either be able to handle the magnitude, or will they be in a position to pay the penal charges. Note that Section 23 leaves no option with the bank–all creation of security interests, modifications and satisfactions are registrable mandatorily.
Every transfer of a receivable, where there is a security interest, is also a case of modification of security interest. Hence, every transfer of receivable also becomes a registrable transaction.
Note that the registration of security interests under Section 23 would be in addition to registration under the Companies Act, Motor Vehicles Act, and so on. This would mean several registries of a single charge. For example, if there is a hypothecation of a motor vehicle by a company in favour of a bank, it requires registration under the Motor Vehicles Act, and under the Companies Act, and under the SARFAESI Act. The same is the case with land mortgages.
Registration of securitisation/asset reconstruction transactions
While every bank in the country would, therefore, face tremendous strain complying with the mandatory provisions of Section 23, asset reconstruction companies would be lost in the confusing words of the section. The section says, every transaction of securitisation and asset reconstruction, and every satisfaction of such transaction, is registrable. First of all, as we have mentioned above, the real-life financial transactions of securitisation do not come within the ambit of this law because of the flawed definition of a “securitisation company”. The only securitisation companies in the country are the reconstruction companies. The transactions of securitisation of receivables, for example, a housing finance company or a microfinance company securitising a portfolio of receivables, do not come under this law as they are sales to either SPVs or to other financial entities.
However, let us understand the applicability of the Rules to an asset reconstruction company. Most of the transactions of sale of NPAs in India take place between banks and ARCs, with the latter acting as trustees of a trust. It may be contended that such a sale of NPAs is not a sale to the ARC, but a sale to the trust, and hence, the transaction is not covered by Section 23. However, as practically almost all transactions take place through the trust route, taking this interpretation would make Section 23 almost redundant for reconstruction transactions.
On the contrary, if Section 23 is taken as applicable, the biggest enigma would be, what exactly is the transaction of “asset reconstruction” that is required to be registered, the transfer of the NPA itself, or its refinancing by issuing security receipts? Going by the purpose of registration requirements, it should be the transfer of the NPA to a reconstruction company.
Section 23 has further strange words: satisfaction of an asset reconstruction. One understands satisfaction of a charge, but satisfaction of “asset reconstruction” is a term difficult to understand. Since the repayment of security receipts is contingent upon realisation of cash from the NPA, full redemption of the security receipts may either never happen, or may happen after a substantial number of years. Hence, if satisfaction of asset reconstruction is taken to mean the redemption of security receipts, the registration would be required at that uncertain future date.
Not that clarity is a great attribute of the rest of the SARFAESI Act, but the complete confusion underlying a mandatory administrative compliance section that Section 23 is, would make its implementation extremely difficult.
And what does the country gain by this?
Assuming that banks all over the country incur massive compliance costs and register all transactions in security interests, and all transfers of security interests, and all transfers to asset reconstruction companies, etc, what does the country gain out of this massive exercise? We mentioned earlier that registration of security interests is not unique to India. Several countries have adopted the US UCC model to require central filing of security interests. The perceived benefit of central registration is to enable searching of security interests, so that a lender, wanting to give a loan against an asset, may search whether a security interest already exists. If a security interest is not registered on an asset, a lender may presume the asset is free from security interests, because, as was mentioned earlier, the priority of security interests is based on the date of registry.
This benefit of searching, and drawing a presumption about the existence or otherwise of a security interest, does not apply to India. As we have said earlier, Indian law, exactly contrary to the very spirit of international laws, says that the non-filing of security interest will not affect priority. This would mean, a lender may have obtained security interest, and not filed it, and yet claim priority over a second lender who would have searched the Central Registry, not found the charge, and hence, went ahead and sanctioned a loan on the same asset. If the fact of non-registration does not affect the validity or priority of a security interest, then the very reliability of the searching process gets negated. And if the search of the Central Registry does not have an unquestionable reliability, one wonders why it exists at all? After all, the Central Registry is not a library of security interests, displaying its proud possessions!
The drafting of the Act has killed the very purpose of registration of security interests. As it stands, it would be a futile, and yet very costly, exercise.
(1) For a detailed incisive commentary on the relevant provisions of SARFAESI Act, see 'Vinod Kothari: Securitisation, Asset Reconstruction and Enforcement of Security Interests', Butterworths Lexis Nexis, 2010
(2) DBOD. Leg. No. BC. 86/09.08.011 /2010-11
(Vinod Kothari is a chartered accountant, trainer and author. He is an expert in such specialised areas of finance as securitisation, asset-based finance, credit derivatives, accounting for derivatives and financial instruments and microfinance. He can be contacted at [email protected] Visit his financial services website at www.vinodkothari.com.)
The Nifty has to breach the 5,800 mark for an upmove
The market closed the week with a loss of 2%, in contrast to the gains in the previous week. Overall for April, the Sensex was down 2% and the Nifty 1% compared to gains of 9% in March. A revival of inflation and concerns over lower revenue forecasts by corporates weighed on investors.
The Sensex closed the week down 466 points at 19,136 and the Nifty was 135 points lower at 5,750. The market will see an upward movement only if the Nifty is able to cross 5,800.
The market is finding it difficult to maintain the upward momentum and is expected to find further direction after the Reserve Bank of India’s policy meeting on Tuesday.
ONGC (up 2%), Sterlite Industries, Maruti Suzuki, ITC, and Bharti Airtel (up 1% each) were the top gainers in the Sensex space, whereas DLF (down 10%), Jaiprakash Associates (down 9%), Larsen & Toubro, Reliance Communications and Jindal Steel & Power (down 6% each) were the main losers on the benchmark.
Among the sectoral indices, BSE Healthcare and BSE Fast Moving Consumer Goods, up 1% each were the gainers, whereas BSE Realty (down 8%) and BSE Capital Goods (down 4%) were laggards.
The indices closed in the red through the week, with the losses expanding in the latter half. While results of banking companies were mostly in line with expectations, IT companies disappointed. Among auto companies, Maruti Suzuki reported a marginal rise in Q4 net, and two-wheeler maker TVS Motors reported a two-fold jump in profit. Other auto firms are yet to announce their numbers.
Food inflation inched up marginally to 8.76% for the week ended 16th April from 8.74% in the previous week. This is the second consecutive week that the rate of price rise of food items has gone up, after a period of moderation in February and March. Earlier this month, prime minister Manmohan Singh expressed concern about rising prices, especially of food items, and said the country needs to do more to ensure food security of its citizens.
The RBI, which will announce its monetary policy for 2011-12 next week, is expected to hike key policy rates by at least 25 basis points. The central bank has already increased the short-term lending (repo) and borrowing (reverse repo) rates eight times since March last year to suck out excess liquidity from the system and tame demand to fight inflation.
But headline inflation has stubbornly stayed above 8% since January 2010. It was 8.98% in March this year, way above the government’s target level of 7%.
In other news in the past week, the Central Bureau of Investigation filed its second charge-sheet in the second generation (2G) spectrum allocation case, naming Tamil Nadu chief minister M Karunanidhi’s daughter and MP Kanimozhi and four others—Sharad Kumar, managing director, Kalaignar TV, Asif Balwa, cousin of Shahid Usman Balwa, promoter of Swan Telecom, Rajeev Agarwal, director of Kusegaon Fruits and Vegetables, and Karim Murani of Cineyug Films.
The Supreme Court quashed the levy of Airport Development Fee (ADF) by private airport developers in Delhi and Mumbai, on international and domestic travellers. The court passed the order on a petition filed by an NGO, Consumer Online Foundation, which contended that the fee was illegal, as it was not approved by the Airports Economic Regulatory Authority of India (AERA).
In international news, South Korea’s economy expanded at a faster pace in the first quarter of 2011 compared to the previous quarter. GDP expanded by 1.4% during the January-March quarter, up from the previous quarter, when it advanced 0.5%.
Industrial output in Japan fell by 15.3% in March, higher than analysts’ forecasts of an 11% fall and exceeding the previous record decline during the 2009 Lehman crisis. Household spending fell to a record 8.5% in March, from that a year earlier, indicating the worsening sentiment since the earthquake.
HSBC’s China Purchasing Managers’ Index (PMI) stood at 51.8 in April, unchanged from the previous month, even as the government hiked interest rates, pointing to a steady growth in the country’s manufacturing sector.
The US Federal Reserve left its benchmark interest rate in a range of zero to 0.25% and reiterated to keep it “exceptionally low” for an “extended period.” Fed chairman Ben Bernanke said that the central bank will maintain its record monetary stimulus, even after ending large-scale bond purchases in June.
Inflation in the 17-nation euro region rose to 2.8% in April from 2.7%, the European Union’s statistics office in Luxembourg said. Analysts expect the European Central Bank would go in for another round of rate hikes soon.
SEBI had introduced the ASBA facility for public offers first in September 2008, when retail investors were allowed to use it. The facility eliminates any delays related to refunds for the unallotted shares
Mumbai: All non-retail investors will have to use the Application Supported by Blocked Amount (ASBA) facility—where money is debited from investor’s account only after share allotment—from 2nd May to apply for share sale offers in the capital market, the Securities and Exchange Board of India (SEBI) said on Friday, reports PTI.
Under the ASBA facility, the application money of investors remains blocked in his bank account until the process of allotment of shares is completed.
“It has been decided that non-retail investors i.e. qualified institutional buyers (QIBs) and non-institutional investors, making application in public or rights issue shall mandatorily make use of the ASBA facility,” SEBI said.
SEBI had introduced the ASBA facility for public offers first in September 2008, when retail investors were allowed to use it. The facility eliminates any delays related to refunds for the unallotted shares. Initially, it was offered to retail investors only and was given to other investors in 2009.
“The circular shall be applicable for Red herring Prospectus/Letter of Offer filed with Registrar of Companies or stock exchanges on or after 2 May 2011,” SEBI added.
The market regulator, however, did not make it mandatory for retail investors to use the ASBA facility.