The non-banking financial company (NBFC) sector in the country crossed a new milestone, as the Finance Ministry redeemed a promise made long time back in Budget 2015. A total of 196 systematically important NBFCs, with assets of Rs500 crore or more as per their last balance sheets have been notified as ‘secured lenders’ under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act). As such, these NBFCs may now enforce security interests on assets charged to them, without having to resort to either judicial or arbitral authorities.
The SARFAESI Act is due for a major strengthening, as Parliament recently passed an amending Bill 2016, which gives further strength to its provisions. The Bill has been passed by the both the Houses, and awaits the assent of the President, after which it may be given effect by a notification of the Ministry.
The extension of SARFAESI Act to NBFCs brings a much-needed level-playing field between NBFCs and banks. NBFCs did better than many banks in terms of debt recoveries, despite not having statutory powers; how, armed with powers of repossession, there will hopefully be more debt discipline and better recoveries than ever. Eventually, one may expect the cost of credit to come down.
SARFAESI powers for facilities above Rs1 crore:
The Notification dated 5 August 2015, names 196 NBFCs, including most of the larger asset finance companies, and factoring companies. Several of the infrastructure finance companies had earlier been defined as ‘public financial institutions’ using section 4A of the Companies Act 1956.
While the whole of the SARFAESI Act has been extended to the notified NBFCs, the Notification clearly provides that sections 13 to 19 of the Act can be used only in respect of ‘such security interest which is obtained for securing repayment of secured debt with principal amount of rupees one crore and above’.
As may be expected, there may be lot of confusion about the interpretation of this clause in the Notification. While the intent is clear – that new-begotten powers are not used for consumer loans, retail lending etc., the computation of the limit of Rs1 crore may be subject to questions. In the opinion of the author, the threshold limit of Rs1 crore refers to the facility, that is, the original amount of lending, which is secured. There may, for instance, be various interpretations:
1. Original secured debt Rs1 crore, current amount outstanding Rs60 lakh
2. Original facility amount Rs1 crore, amount of drawdown, Rs80 lakh, current outstanding Rs60 lakh
3. Original facility amount Rs80 lakh, value of security Rs1.20 crore, current outstanding Rs60 lakh
4. Original facility amount Rs80 lakh, value of security Rs1.20 crore, current outstanding Rs1.10 crore
5. Original facility amount Rs1 crore, under which several assets (say, cars) were financed. Original principle value of all facilities adds to Rs1 crore, but individually, none of them reach that threshold.
Based on the above, No 1 and No 5 will be covered by the Notification.
Will the notification apply to existing facilities?
A question may arise whether the Notification is applicable only for facilities, which are granted on or after the notification date, or will it apply to existing facilities. This question arose when the SARFAESI was first implemented in 2012. There have been rulings, such as the Supreme Court ruling in the case of Mardia Chemicals, that the Act is merely a device of enforcement. It is not a new power; it is simply a new method of enforcing an existing power.
Therefore, the notification will cover existing facilities as well.
A question may also arise – does the Notification cover existing cases pending at different stages – for example, arbitration, and civil proceedings? Generally speaking, if there is a change of law, and a party finds a better way of enforcing one’s claims, one may withdraw from an existing proceeding by seeking the leave of the forum, and then, use SARFAESI process for enforcement.
Question also arises, what about cases, which are not covered by the Notification? This includes two types of cases:
NBFCs not covered by the Notification at all
NBFCs covered by the Notification, but the funding is not covered by virtue of the threshold amount
In both the cases, civil law or arbitral remedies will still exist.
Bankruptcy Code and the SARFAESI Act:
How does the SARFAESI process work in a case which is referred under the Bankruptcy Code? There is a moratorium during the period when an insolvency resolution process is going on, both in case of individuals and in case of corporate debtors, under the Bankruptcy Code. The maximum period for the insolvency resolution process is 180 days (extendible by another 90 days) in case of corporate persons. There is no overall maximum limit in case of non-corporate entities, but there are timelines for each sub-step.
However, once the insolvency resolution period ends, the entity will be either put on revival, or put under liquidation. In case of revival orders, the eligibility of the lender to exercise SARFAESI powers will depend on what agreement has been struck between the lenders for revival. In case of bankruptcy, the power of the lender to use SARFAESI survives, of course, after proving for security interest before the liquidator.
SARFAESI Amendment Bill
The 2016 Amendment Bill brings several significant changes to the SARFAESI Act. Importantly, secured corporate debentures are brought under the purview of the Act. A new necessity and invincibility is sought to be granted to registration of security interests with Central Registry of Securitisation Asset Reconstruction and Security Interest (CERSAI), with a provision stating that unregistered security interests will not be enforceable at all. At the same time, if there is a registered security interest, it will gain supremacy over all other conflicting or overlapping claims, including those of the government.
(CA Vinod Kothari is an author, trainer and consultant on specialised financial subjects like housing finance, securitisation, credit derivatives, accounting for financial instruments, structured finance and banking regulations. Mr Kothari through his firm Vinod Kothari and Company is also engaged in practice of corporate laws for over 25 years.)