Securitisation and Reconstruction of

Financial Assets and Enforcement of

Security Interest Act, 2002
(SARFAESI Act)
RBI guidelines & SARFAESI proceedings?
It is very clear that the Banks should follow RBI guidelines on Asset-Classification
before classifying any loan account as Non-performing Asset (NPA). There were
judgments saying that it is mandatory for the Banks to follow RBI guidelines while
classifying an account as Non-Performing Asset (NPA) and any deviation in this
regard can vitiate the proceedings initiated under SARFAESI Act, 2002. While RBI
guidelines are detailed when it comes to Asset Classification and related issues; the
Bank officials or the Banks may have to make a subjective assessment of certain
issues. It is understood from the reading of RBI guidelines on Asset-Classification
that genuine borrowers facing temporary difficulties may be treated separately and
based on reasonable assurance of recovery. Guideline 4.2.4 of RBI guideline deals
with the issue of accounts with temporary deficiencies and narration of few of
the temporary deficiencies in the said guideline appear to be inclusive in nature
allowing the Bank to make certain subjective assessments on case-to-case basis.
Obviously, no creditor and especially secured creditor want to harass a genuine
borrower having a good track-record with the Bank for a considerable time. However,
with constant emphasis on the issue of reduction of NPAs, it seems that the Banks
are very strict while getting the accounts classified as NPAs. The most important
thing about the issue of recovery by the Bank is that they are allowed to proceed
against the borrower for default in any of the facilities availed by him when a
borrower avails multiple credit facilities. Banks are asked to initiate recovery
proceedings Borrower-Wise and not Facility-Wise and it is very clear in the RBI
guideline 4.2.7. Again, Banks are not supposed to lay complete focus on the value of
the security available with the Bank as such while initiating the recovery proceedings
and it is very clear in RBI guideline 4.2.3. The extract of the said RBI guidelines are
as follows:
4.2.7 Asset Classification to be borrower-wise and not facility-wise:
i) It is difficult to envisage a situation when only one facility to a borrower/one
investment in any of the securities issued by the borrower becomes a problem
credit/investment and not others. Therefore, all the facilities granted by a bank to a
borrower and investment in all the securities issued by the borrower will have to be
treated as NPA/NPI and not the particular facility/investment or part thereof which
has become irregular.
4.2.3 Availability of security / net worth of borrower/ guarantor:

The availability of security or net worth of borrower/ guarantor should not be taken
into account for the purpose of treating an advance as NPA or otherwise, except to
the extent provided in Para 4.2.9, as income recognition is based on record of
recovery.
Again, dealing with the issue of temporary deficiencies in adhering to the terms of
the loan agreement, RBI guideline 4.2.4 says as follows:
4.2.4 Accounts with temporary deficiencies:
The classification of an asset as NPA should be based on the record of recovery.
Bank should not classify an advance account as NPA merely due to the existence of
some deficiencies which are temporary in nature such as non-availability of
adequate drawing power based on the latest available stock statement, balance
outstanding exceeding the limit temporarily, non-submission of stock statements and
non-renewal of the limits on the due date, etc.
The problems for many borrowers or the Small Businessmen availing the loan
facilities from the Bank comes from the issue that the Banks are asked to initiate
recovery proceedings borrower-wise and not facility-wise. Borrowers availing
facilities from the Bank with the complex commercial arrangements and agreements
face problems with this discretion available with the Banks or the Bank Officials.
Many complain that there is no effective redressel mechanism to raise all these
issues even when the borrower has a very good case for restructuring or for
questioning the judgment of the Bank in classifying a particular account as a NonPerforming Asset. In most cases, the borrowers are driven either to approach the
High Court under Article 226 of Constitution of India challenging the classification of
an account as NPA or the borrower may have to inevitably file an Appeal before the
Debt Recovery Tribunal under section 17 of SARFAESI Act, 2002. Even-though
Banks can consider the proposal for restructuring of a loan account upon certain
conditions and re-negotiating the terms, Banks do exercise great discretion in this
regard. Coupled with this situation, as the Banks can argue that the value of security
has got nothing to do while classifying an account as NPA, genuine borrowers or
borrowers/small businessmen with temporary/genuine/understandable problems
face lot of pressure and problems. For example, an industry may have a very
valuable property lying with the Bank as a security and may be facing some
problems in its business with the obvious reasons which are beyond its control, and
in such cases also, if the Bank is not convinced, the borrower becomes remediless.
Emphasis has always been laid on the issue of recovery and establishing an
efficacious internal system by the Banks and Guideline 4.2.2 of RBI guidelines says
as follows:
4.2.2. Banks should establish appropriate internal systems to eliminate the tendency
to delay or postpone the identification of NPAs, especially in respect of high value
accounts. The banks may fix a minimum cut off point to decide what would constitute
a high value account depending upon their respective business levels. The cutoff
point should be valid for the entire accounting year. Responsibility and validation
levels for ensuring proper asset classification may be fixed by the banks. The system
should ensure that doubts in asset classification due to any reason are settled

through specified internal channels within one month from the date on which the
account would have been classified as NPA as per extant guidelines.
RBI guidelines on Asset Classification are well-balanced and the Banks are asked
to make many subjective decisions and RBI guidelines do focus on the issue of not
harassing genuine borrowers while emphasizing at the need of speedy and
efficacious recovery. Along with the provisions dealing with the restructuring of loans
or advances, RBI guidelines also deal with the issue of up-gradation of loan
accounts classified as NPAs and the relevant RBI guideline in this regard is as
follows:
4.2.5 Upgradation of loan accounts classified as NPAs:
If arrears of interest and principal are paid by the borrower in the case of loan
accounts classified as NPAs, the account should no longer be treated as
nonperforming and may be classified as standard accounts. With regard to
upgradation of a restructured/ rescheduled account which is classified as NPA
contents of paragraphs 11.2 and 14.2 in the Part B of this circular will be applicable.
On certain issues, RBI guidelines are very clear as to when an account should be
treated as NPA. But, with regard to providing relaxation or understanding the
temporary difficulties of the borrower while considering upgradation of loan account
or regularizing the loan account, Banks do exercise lot of discretion. If at all the
borrower feels that the Secured Creditor or the Banks are unfair in dealing with his
loan account or loan accounts, he can do nothing except approaching superior
officers, approaching Banking ombudsmen or approaching High Court under Article
226 of Constitution of India. Though, even the DRT (Debt Recovery Tribunal) can
consider all objections raised by the borrower while entertaining an Appeal under
section 17 of SARFAESI Act, 2002, DRT may not have power to analyze a particular
case in the light of RBI guidelines in its entirety though DRT can certainly look into
the guideline dealing with the criteria for classifying a particular loan account or
accounts as Non-performing Assets. Normally, Banks do not commit any mistakes
in classifying an Account as NPA applying the RBI guidelines strictly. Apart from the
criteria, the DRT can look into the issue of debt, objections regarding debt and the
correctness of the procedure followed by the Bank under SARFAESI Act, 2002.
Normally, Banks do not commit mistakes in the procedure and the borrower will have
objection to the classification on the basis that he is not a willful-defaulter and the
deficiency in making payment is temporary in nature. However, these things are not
considered by the DRT normally as I think and they may not have power to consider
all these issues in-spite of various judgments of the Constitutional Courts from time
to time emphasizing at the powers of the Tribunal under section 17. Only due to the
judgments of the Courts, the borrowers are allowed to question every measure
initiated by the Banks under SARFAESI Act, 2002 now and technicalities are
normally ignored while entertaining appeals under section 17. It is also clear that
they can look into all objections pertaining to the loan account or even raised by the
third-party if he is connected. The Civil Court may be having limited jurisdiction to
look into the issues connected to the SARFAESI proceedings and the jurisdiction of
the High Court under Article 226 of Constitution of India is largely dependent on the
facts of the case, and the discretion of the Court.

Now, if the Bank takes a decision to classify an account as NPA and rejects the
objections or the request by the borrower, then, apart from writ remedy, the remedy
available to the borrower is to file an appeal under section 17 of the SARFAESI Act,
2002. Based on the merits of the case, the DRT will grant interim relief and finally,
only when it is established that there is a procedural irregularity, the DRT will allow
the SARFAESI Appeal and can order the restoration of property if the physical
possession has already been taken by the Bank pursuant to steps taken under
section 13 (4) or by taking assistance of the police etc. using the mechanism
provided under section 14 of SARFAESI Act, 2002. In many cases, DRT can insist
on payment of some deposit while granting an interim-relief when the borrower
approaches the Tribunal under section 17 of the Act challenging the proceedings
initiated by the Bank under SARFAESI Act, 2002. If the Bank proceeds with the
proceedings even during the pendency of the Appeal under section 17, then, it
becomes further more complicated to the borrower and it is very often heard that the
borrower is asked to file another appeal literally instead of looking into all
developments in the pending Appeal itself by way of entertaining affidavits or
petitions in the pending Appeal. Filing an Appeal against the order of the DRT to the
DRAT under section 18 is another big process and many normally get discouraged to
do this in-view of pre-deposit condition. In each and every step, the borrower is
discouraged and made to run from pillar to post even in cases with some merit and it
is the view of many of the professionals or the borrowers facing SARFAESI
proceedings. There is no reason as to why Appeals cant be speeded-up, additional
Tribunals cant be set-up. If Appeals are speeded-up and if sufficient Tribunals and
Appellate Tribunals are constituted, then, at-least genuine borrowers seeking remedy
may feel protected and at-present, every case of so-called default is treated in a
same way.
The SARFAESI Act, 2002 (The Securitisation and Reconstruction of Financial Assets
& Enforcement of Security Interest Act, 2002) seems to be proceeding on the basis
that the Banks or the Bank officials do not commit any mistakes. It is quite possible
to ensure speedy recovery through special legislations like SARFAESI Act, 2002 and
also giving confidence to the borrower that he will be heard fairly especially when the
borrower has got a very good track-record and long standing relation with the Bank
along with having valuable and marketable security lying with the Bank. It is quite
possible. Now, it seems that there is an amendment or the provision allowing the
Authorized Officers to bid for the property when there were no bidders initially and
the reason given for this step is that it will allow the Banks to clean-up their balancesheets. But, this kind of provisions can harm the borrowers and already it has
become extremely difficult for the borrowers to establish or state his case and
coordinating with the Banks. If there is too much pressure from the Banks when the
businesses are not doing well for the reasons beyond their control, then, small
business may be suffering irreparable loss if the Bank doesnt understand their
concerns reasonably and sympathetically. Normally, at-times, taking note of industry
specific problems, the Finance Ministry may come-up with some kind of directions to
the Bank to be lenient or understandable while insisting on the speedy recovery inrespect of some specific industries and Banks also are asked at-times to post-phone
the recovery process also.
Instead of discouraging the borrower to get any remedy or forum to advocate his
problems, the legal frame-work governing recovery of secured loans can still be very

fair, few more Tribunals and Appellate Tribunals can be constituted and well-drafted
powers are to be conferred on the Tribunals to even give directions to the Bank when
needed and in-favour of the borrower. For example, if the loan to be recovered is
only 10 lakh and the security lying with the Bank is worth 50 lakh admittedly, and if
the borrower seeks for payment of outstanding loan amount with interest and
charges seeking regularization, then, DRT should be able to give direction to the
Bank to accept the proposal. Delays in adjudication can certainly be curtailed and
technicalities can be ignored while entertaining pleas from the Borrower.
Admittedly, on the issues of reduction of interest, acceptance of OTS etc., Banks will
have their own internal systems and DRT may have little role in this regard.
With many more stringent provisions like allowing the Banks to file Caveats before
Tribunals under SARFAESI Act, 2002, allowing the Banks to bid for the properties;
discretion of the Banks or the Bank officials has grown like anything and the
borrower increasingly feels that he can not state his case and get remedy.
RBI keeps updating or modifies the guidelines governing Asset Classification, but,
borrowers feel that it has become so difficult for them to establish or advocate their
case even when they are not clearly willful defaulters and even when a valuable and
marketable security is lying with the Bank.
Whether it is a Public Sector Bank or Private Sector Bank, borrowers should have a
forum providing speedy, effective and efficacious remedy.
SARFAESI Act & sorrows of Borrower?
There is every need for the Government to enable/assist the Banks in reducing their
NPAs (Non-performing Assets) and it is beyond doubt that the Banks are now well
assisted/equipped through the legal frame-work in recovering their dues. The
provisions of SARFAESI Act, 2002 (The Securitisation and Reconstruction of
Financial Assets & Enforcement of Security Interest Act, 2002), judicial
pronouncements from time to time and amendments to the SARFAESI Act, 2002
enable the Banks to recover their dues speedily. While there should be emphasis on
the need and urgency of the Banks in reducing their NPAs, the rights of the borrower
can never be ignored. It is to be commended that the judiciary has maintained a
great balance between the rights of the Banks on the one hand and rights of the
borrowers on the other hand while interpreting the provisions of SARFAESI Act,
2002. The Act talks of a right of appeal available to the borrower/guarantor/aggrieved
person against the possession notice issued by the Bank under section 13 (4) of the
Act. Time limit is prescribed to prefer an appeal. If the appeal provision is interpreted
in stricto senso, then, the borrower has to confine himself to the issue of demand
notice issued by the Bank under section 13 (2), the issue of classification of an
Account as NPA based on RBI guidelines, the issue of objections raised by the
Borrower, the reply given by the Bank if any etc. issues and nothing more than that.
If the provisions are seen strictly, then, the Bank may not even be questioned when it
fixes the reserve price and sells the property for a very low price affecting the
borrower and also the Bank at times. Addressing these concerns, the judiciary has
maintained that all actions initiated by the Bank under the provisions of SARFAESI

Act, 2002 can be challenged by the borrower in an Appeal under section 17 of

SARFAESI Act, 2002. Technically, if the borrower is silent in questioning the
possession notice issued by the Bank under section 13 (4) of the Act and chooses to
question the Sale Notice, then, the borrower has to confine himself to the procedure
followed by the Bank after the issuance of notice under section 13 (4) and the issues
pertaining to Sale of Secured Asset. When the borrower questions the sale notice
and did not question the notice under section 13 (4) within the prescribed period, the
borrower has to explain as to why he has failed to question the notice under section
13 (4) within the prescribed period. In the absence of satisfactory explanation as to
why the borrower has failed to question the possession notice under section 13 (4),
his position to raise all kinds of objections to the Banks demand becomes untenable.
However, the system has become liberal and courts have also liberally interpreted
the provisions dealing with the right of appeal provided to the borrower and the
borrower can question every action initiated by the Bank under the provisions of
SARFAESI Act, 2002. The borrower or any person aggrieved can approach the Civil
Court in a very limited situation where actually there is fraud or serious dispute with
regard to the title of the secured asset/property mortgaged. Though there can be no
bar on the jurisdiction of High Courts under Article 226 in dealing with the grievances
of the borrower against the Bank when the Bank initiates action, the High Courts do
desist in being alternative to the remedy available before the DRT normally. As such,
there is enough support to the Banks through legal-framework in recovering their
dues from the borrowers. It is true that in the absence of a special legislation like
SARFAESI Act, 2002, it would have been very difficult for the Banks in recovering
their dues and reducing their NPAs. From the borrowers point of view, the borrowers
allege that they do not have an effective remedy against the illegal action being
initiated by the Bank using the provisions of SARFAESI Act, 2002. The Courts have
held that the DRT can look into all allegations while entertaining an appeal under
section 17 of the Act and it includes the issue of disputes pertaining to the actual
debt. Then, it is also settled that the DRT can order re-possession of the secured
asset when it is found that the Bank has illegally taken the possession of the
secured asset. It is very important to look into various stages and issues when the
borrower prefers an appeal under section 17 of the SARFAESI Act, 2002 and those
are as follows:
1.
When the borrower prefers an Appeal under section 17 against the Bank, the
DRT can grant ex-parte stay of proceedings against the Bank if there is sufficient
ground to that affect from the averments in the Grounds of Appeal and also the
documents produced. If there is a caveat, then, the procedure differs. Normally, the
DRT orders notice to the Bank irrespective of the fact as to whether it grants stay or
not in-favour of the borrower. The DRT can also ask the borrower to make some
deposit while granting stay and it is also reasonable as the borrower has to make the
payments towards installments to the Bank in any case and there can be some time
lapse between the demand notice issued by the Bank under section 13 (2) and the
appeal.
2.
The Bank files its reply pursuant to the notice ordered by the DRT and they
normally justify their action and say that the action initiated by the Bank is legal and
the Appeal is liable to be dismissed. The Bank also can ask for vacating the interim

order and can pray for allowing the Bank to continue with the further proceedings
like Sale.
3.
If there is no interim order against the Bank while the Appeal is pending and
the Bank is allowed to proceed with the sale proceedings, the issue gets
complicated. The borrower should be allowed to raise any point and additional
grounds by way of additional affidavit in the pending Appeal and there is nothing
wrong in it and technicalities are to be ignored. For example, the borrower might
have chosen to challenge the possession notice issued by the Bank under section
13 (4) and during the pendency of Appeal, if the Bank initiates the Sale Proceedings,
the borrower should be allowed to question the Sale Proceedings in the same
Appeal instead of bringing technicalities and asking the borrower to challenge the
Sale proceedings separately.
4.
Obviously, during the pendency of SARFAESI Appeal, if the Bank proceeds
with the sale of Secured Asset, it is likely that the property may not fetch the actual
market value as the bidder discounts all the possible risks associated with the
bidding. If the Bank is able to raise the money and can get the entire debt recovered
through the sale consideration, then, the Bank is safe and appeal under section 17
literally becomes meaningless though it is usual to see an order where DRT says
that sale confirmation is subject to the final disposal of Appeal. Or DRT can allow
the Bank to proceed with the sale of Secured Asset and can say that the sale
confirmation is to be stayed until further orders. Instead of doing this, the DRT can
dispose of the SARFAESI Appeal itself as it can ascertain the facts so fast based on
the averments in the SARFAESI Appeal, the documents filed and the reply presented
by the Bank. Once the SARFAESI Appeal is finally disposed off then, it is not easy
to prefer an appeal against the final order of DRT as the borrower will have to make
pre-deposit with the DRAT which can vary from 50% to 75% depending upon the
discretion of the DRAT. Now, with the provision enabling the Banks/secured creditors
to bid for the property when the sale is post-phoned for want of bidders, it has
become much easy for the Banks to deal with the secured asset and claim
recovery.
5.
The proceedings before DRT can not be compared to the proceedings
before Civil Court and adjudication process before the DRT is simple and can be
fast. However, it is also true that DRT requires time to look into the facts and read the
documents apart from hearing the oral submissions from the Bank. Additional DRTs
and DRATs can be constituted if required rather allowing the borrower to suffer and
feel that the remedy before the DRT and DRAT is not effective.
6.
Again, the DRT can either allow the Appeal filed by the borrower under
section 17 or dismiss the same finally. If the DRT allows the Appeal filed by the
borrower under section 17, then, it can order re-possession of the secured asset if
the physical possession of the secured asset is already taken. The Appeal can be
allowed or dismissed either with costs or without costs. More than this, I dont think
that the DRT can do anything else or can give any direction to the Bank. For
example, the borrower may be entitled for getting his loan restructured at the given
point of time pursuant to some notification from the ministry of finance or RBI and the
Bank must have ignored it. Even then, the DRT can not direct the Bank to restructure

the loan of the borrower while disposing off the appeal. This is where the borrower
feels remediless at times. If the Bank is to be asked to do something as per law,
where can the borrower go?. The borrower can give a representation to the Bank
officials, can write to the superior authorities and may approach the High Court under
Article 226 of Constitution of India seeking direction. However, even the High Court
may direct the Banks to consider the representation and with all the might and
luxury, the Bank can make the borrower to run from pillar to post. This happens in
many cases though the factor of habitual litigants can not be ignored.
7.
Very rarely, the Appeal filed by the borrower gets allowed and even then, the
Bank will again be initiating the proceedings correcting the lacunae. For example,
during the pendency of Appeal under section 17, the borrower may say that he is
willing to regularize his account and abide by the loan terms and the market value of
the secured asset can be intact. In such cases, the Bank is in no way gets effected
by regularizing the loan as it collects the interest and also the legal expenses for
initiating the proceedings. However, the DRT can not give such a direction to the
Bank though it can orally ask the Banks to consider the proposal of the borrower.
Now with the recent amendments, the Secured Creditor is enabled with the right of
filing Caveat and it presents many difficulties to the borrower and it becomes now
literally impossible to get an ex-parte stay order against the Bank. And also, it has
become very easy for the Banks to sell the secured asset as there is no need of
following separate procedure of Sale if the Sale is postponed for want of bidders
etc.
It is quite possible to ensure a system or practice under the provisions of SARFAESI
Act, 2002 which is fair and also effective. If the secured asset is valuable, then,
there can not be any worry to the Bank at all as it can recover the dues with interest
and expenses. If the secured asset is not valuable in comparison to the dues
recoverable, then, the officials of the Bank are to be blamed as to how they have
sanctioned the loan in the first place.
Emphasis is always laid as to how to enable the Banks to speed-up their recovery,
but, little emphasis is laid as to how the borrower feels remediless in some cases.
Even while providing the best possible legal-framework enabling the Banks to
recover their dues, the concerns of the borrower can certainly be addressed and it is
very much possible. From the borrowers point of view, the following issues need to
be considered.
a.

The Appeal mechanism under the provisions of SARFAESI Act, 2002 can be liberal
and the borrower should be allowed to question every action initiated by the Bank
under SARFAESI Act, 2002 without raising any technicalities like condonation of
delay etc.

b.

It should be mandatory on the part of the Banks to mention marketability and

market price/price of the secured asset in its reply to the appeal of the borrower
under section 17 among other things.

c.

There should be time-limit for the Banks in filing their reply in an appeal under
section 17 of the Act and in the absence of filing the reply within the specific period,

the proceedings of the Bank under SARFAESI Act against the borrower should
automatically be stayed.
d.

Though there is a time-limit for disposing the Appeals under section 17 in the Act,
the disposal normally takes time. If work-load in the DRTs and DRATs is the main
cause for the delay, then, additional DRTs and DRATs can be constituted and so that,
Appeals under section 17 and under section 18 of the Act can be disposed of as
quickly as possible.

e.

The scope of powers of the presiding officer of DRT under section 17 should be
expanded further and it should include giving suitable directions to the Bank from
time to time keeping the need of recovery of dues in mind.
With the system aimed at speedy recovery and balanced heavily towards the Bank,
genuine borrowers who are not willful or habitual defaulters also get affected. The
borrowers feel remediless now and even if the remedy is provided, most of the
borrowers feel that the remedy provided is ineffective.
While it is important to improve the financial health of the Banks/Financial
Institutions, there is no justification for a completely one-sided draconian legal
system where the borrower is harassed like anything. Bank officials exercise great
discretion and the Bank officials must be extremely happy with the legal provisions
now governing the recovery of secured loans under SARFAESI Act, 2002. It has
become totally one-sided affair now and ordinary citizens & small businesses may
feel it better to approach the private money leaders for their financial needs rather
approaching Banks and Financial Institutions in this country.
I expect constitutional courts to entertain certain important issues under SARFAESI
Act, 2002 in public interest rather supporting every view of the government.
It is known that while some loan transactions with the Bank like Housing Loan,
Educational Loan etc. are very simple, some commercial loan transactions are very
complex in nature. The Bank may provide various loan facilities to the Borrower and
most of these commercial loans are complex to understand and these loans infact
involve many complexities. When a Businessmen or a Corporate gets various loan
facilities and if there is a default or allegation of default with regard to a particular
loan facility, the Bank proceeds against the borrower and claims for the settlement of
entire outstanding debt in respect of all facilities. The Banks use the provisions of
Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002 (SARFAESI Act) which appear to be draconian in some cases
while the Act is justified from another angle. Irrespective of the long standing relation
of creditor and borrower, in some cases, the Bank may be unreasonable towards a
borrower and may insist for recovery of the entire outstanding dues even if the
borrower commits a default in respect of only one facility among many other facilities
extended to the same borrower. The Bank may say that they will proceed borrowerwise in classifying any Account as Non-performing Asset and proceed with the
recovery process under the provisions of SARFAESI Act, 2002. Banks or the officers
concerned do exercise some discretion in this regard while the Bank or the officers
are left with no discretion in respect of few other cases. The Bank has to follow the
RBI guidelines and the RBI circulars having binding nature from to time. It is known

that the Banks should follow the guidelines of Asset Classification prescribed by the
Reserve Bank of India in classifying any loan account as Non-performing Asset.
The guidelines never intended to unnecessarily and unreasonably harass the
borrowers. The guidelines refers to the significance of looking at risk factor, the
value of security, track record of the borrower and even getting the loan Account
updated though Bank usually follows their internal guidelines.
In some cases, the borrowers do not want to litigate the issues with the Bank and
may try their level best to get the default rectified and may try to get the account
settled finally under One-time Settlement Scheme. The Bank or the officers
concerned in most of the cases maintain written or oral communication with the
borrowers when there is default. The borrowers, in-turn, explains their difficulties in
view of their long standing relationship with the Bank and may seek some relaxation
and may seek indulgence of the Bank to rectify the default in repayment. This
communication or negotiation happens before classifying any loan Account as Nonperforming Asset and even after the classification of account as NPA and before
initiating the proceedings under the provisions of SARFAESI Act, 2002. In some
cases, the borrowers negotiate with the Bank for rectifying the default or for a final
settlement even after the issuance of demand notice by the Bank under section 13
(2) of the Act. This is the reason as to why there is delay on the part of the Bank in
proceeding with the recovery under the provisions of SARFAESI Act, 2002 even after
the issuance of demand notice under section 13 (2). When a borrower intends to
avoid litigation, he may listen or act upon the oral understanding with the officials.
Sometimes, the understanding for rectification of default or settlement of loan can
be in writing also. While the rectification of default is oral in most of the cases, the
final settlement of the account is in writing normally.
Settlement of Default of Debt/Regularisation:
It is frequently alleged now-a-days by the borrowers that the Bank or the officers of
the Bank agrees for the settlement for rectification of default, receives the money
from the borrower and later-on, insists for the full settlement of the outstanding due.
Inspite of updating the loan account, the Bank may choose to proceed under the
provisions of SARFAESI Act, 2002 and may say that they are acting on the basis of
classification and they never agreed for regularizing the loan account. This happens
even after the demand notice issued under section 13 (2). Even after the demand
notice, the borrower can negotiate with the Bank and the Bank may receive some
substantial amount of money in-between and even then, suddenly may choose to
proceed with the issuance of notice under section 13 (4). These are the usual
allegations from the borrowers against the Bank when it comes to regularization of
loan accounts. The allegation in some cases is that the Banks goes back from their
promise and in some cases, the Bank is not co-operating for regularization as even
the RBI guidelines refer to the regularization if other factors like the track-record,
risk-factor, value of security etc. are justified. Another thing is that the intention
behind giving notice to the borrower under section 13 (2) of the Act is to invite
objections if any. Law mandates the Bank to give a reasoned reply to the objections
raised by the borrower under section 13 (3A). But, what happens is that the Banks
agree for some kind of settlement either orally or in writing even after the issuance of
notice under section 13 (2). Later on, after a gap of some one year and when the
borrower makes the substantial payment, the Bank acts upon the demand notice and

issues a possession notice under section 13 (4) of the Act. This is infact incorrect. If
something notable has taken place with regard to the recovery of loan after the
issuance of notice under section 13 (2) and if the Bank is silent in acting on section
13 (2) for a considerable time in view of the payments made by the borrower, then, it
is incumbent upon the Bank to issue the demand notice afresh taking note of
subsequent developments and this fresh demand notice under section 13 (2) of
SARFAESI Act can give an opportunity to the borrower to include his objections
afresh without taking a direct recourse to an appeal to Debt Recovery Tribunal (DRT)
or without having to approach the High Court seeking intervention at times. But, this
is not happening. In most of the cases, unless the Debt Recovery Tribunal sets the
SARFAESI proceedings aside, the Banks do not issue demand notice twice under
section 13 (2) and instead acts upon the demand notice issued earlier irrespective of
time gap or lapse. These are the usual problems being faced by the borrowers in
getting his or their account regularized or updated. The borrowers are infact left with
no remedy in these cases as the scope of powers of DRT under section 17 of the Act
does not include the power to give direction to the Banks to agree for regularization.
These kinds of cases mostly come to High Court and the High Courts usually issues
suitable directions noting the interests of the Bank and the rights and plight of the
borrower.
Settlement of Debt/One-time Settlements:
The second issue is with regard to final settlement of debts. In many cases, Banks
are going back from their promise of one-time settlement. The Banks agree for final
settlement of account with the borrower. The Banks may ask the borrower to give an
offer letter in a format and with some averments and then, the Banks will agree for
settlement. When the substantial amount is paid, the Banks may say and are saying
in most of the cases that the RBI guidelines do not allow them to get the account
settled under One-time Settlement. Again, the Banks may say that the borrower has
not disclosed all the facts with the Bank while coming forward with the One-time
Settlement Proposal. Once the settlement proposal is agreed, the Banks will be very
silent till the substantial amount is deposited with the Bank and finally, they can say
that they do not have right to go for settlement or can blame the borrower that he
has not disclosed the whole facts. These things do happen regularly now-a-days.
The DRT normally do not look into these issues and the DRT may at best, look at the
procedural irregularities if any and even the disputes pertaining to outstanding are
not entertained as such though the DRT can look into those issues. The DRT
normally goes with the stand taken by the Bank unless the Bank is apparently wrong
in their approach. Public Sector Banks should concentrate on the recovery of money
and at the same time, can not harass the borrowers who are willing to get their
accounts regularized or willing to get their account finally settled. Even, the RBI
guidelines hint at this. When there is security lying with the Bank and when original
documents are with the Bank, the Banks pressurize the borrowers with all kinds of
things and using the provisions of SARFAESI Act, 2002 to their advantage. The DRT
in these cases proves to be ineffective and the borrower is not entitled to approach
the Civil Court in these cases in view of the bar under section 34 of SARFAESI Act,
2002. Though there is a scope for the Civil Court to entertain even the SARFAESI
related matters in some cases in a limited sense pursuant to the Mardia Chemicals
case, it is very difficult to persuade the Civil Court with regard to its jurisdiction in

SARFAEI matters and this can be attributed to the lack of expertise on the part of the
Civil Courts with the Securitisation Law.

Provisions of the SARFAESI Act

The Act has made provisions for registration and regulation of
securitisation companies or reconstruction companies by the RBI,
facilitate securitisation of financial assets of banks, empower SCs/ARCs to
raise funds by issuing security receipts to qualified institutional buyers
(QIBs), empowering banks and FIs to take possession of securities given
for financial assistance and sell or lease the same to take over
management in the event of default.

The Act provides three alternative methods for recovery of NPAs,

namely:

Securitisation: It means issue of security by raising of receipts or

funds by SCs/ARCs. A securitisation company or reconstruction
company may raise funds from the QIBs by forming schemes for
acquiring financial assets. The SC/ARC shall keep and maintain
separate and distinct accounts in respect of each such scheme for
every financial asset acquired, out of investments made by a QIB
and ensure that realisations of such financial asset is held and
applied towards redemption of investments and payment of returns
assured on such investments under the relevant scheme.

Asset Reconstruction: The SCs/ARCs for the purpose of asset

reconstruction should provide for any one or more of the following
measures:
the proper management of the business of the borrower, by
change in, or take over of, the management of the business of the
borrower
the sale or lease of a part or whole of the business of the
borrower
rescheduling of payment of debts payable by the borrower
enforcement of security interest in accordance with the provisions
of this Act
settlement of dues payable by the borrower
taking possession of secured assets in accordance with the
provisions of this Act.

Exemption from registration of security receipt: The Act also

provides, notwithstanding anything contained in the Registration
Act, 1908, for enforcement of security without Court intervention:
(a) any security receipt issued by the SC or ARC, as the case may
be, under section 7 of the Act, and not creating, declaring,
assigning, limiting or extinguishing any right, title or interest to or
in immovable property except in so far as it entitles the holder of
the security receipt to an undivided interest afforded by a registered
instrument; or (b) any transfer of security receipts, shall not require
compulsory registration.

The Guidelines for SCs/ARCs registered with the RBI are:

act as an agent for any bank or FI for the purpose of recovering

their dues from the borrower on payment of such fees or charges

act as a manager between the parties, without raising a financial

liability for itself;

act as receiver if appointed by any court or tribunal.

Apart from above functions any SC/ARC cannot commence or carryout

other business without the prior approval of RBI.
The Securitisation Companies and Reconstruction Companies
(Reserve Bank) Guidelines and Directions, 2003
The Reserve Bank of India issued guidelines and directions relating to
registration, measures of ARCs, functions of the company, prudential
norms, acquisition of financial assets and related matters under the
powers conferred by the SARFAESI Act, 2002.
Defining NPAs: Non-performing Asset (NPA) means an asset for which:
Interest or principal (or instalment) is overdue for a period of 180
days or more from the date of acquisition or the due date as per
contract between the borrower and the originator, whichever is
later;
interest or principal (or instalment) is overdue for a period of 180
days or more from the date fixed for receipt thereof in the plan
formulated for realisation of the assets
interest or principal (or instalment) is overdue on expiry of the
planning period, where no plan is formulated for realisation of the
any other receivable, if it is overdue for a period of 180 days or
more in the books of the SC or ARC.
Provided that the Board of Directors of a SC or ARC may, on default by
the borrower, classify an asset as a NPA even earlier than the period
mentioned above.
Registration:
Every SC or ARC shall apply for registration and obtain a certificate
of registration from the RBI as provided in SARFAESI Act;
A Securitisation Company or Reconstruction Company, which has
obtained a certificate of registration issued by RBI can undertake
both securitisation and asset reconstruction activities;
Any entity not registered with RBI under SARFAESI Act may
conduct the business of securitisation or asset reconstruction
outside the purview of the Act.

Net worth of Securitisation Company or Reconstruction Company: Net

worth is aggregate of paid up equity capital, paid up preference capital,
reserves and surplus excluding revaluation reserve, as reduced by debit
balance on P&L account, miscellaneous expenditure (to the extent not
written off ), intangible assets, diminution in value of investments/short
provision against NPA and further reduced by shares acquired in SC/ARC
and deductions due to auditor qualifications. This is also called Owned
Fund. Every Securitisation Company or Reconstruction Company seeking
the RBIs registration under SARFAESI Act, shall have a minimum Owned
Fund of Rs 20 mn.
Permissible Business: A Securitisation Company or Reconstruction
Company shall commence/undertake only the securitisation and asset
reconstruction activities and the functions provided for in Section 10 of
the SARFAESI Act. It cannot raise deposits.
Some broad guidelines pertaining to Asset Reconstruction are as follows:
Acquisition of Financial Assets: With the approval of its Board of
Directors, every SC/ARC is required to frame, a Financial Asset
Acquisition Policy, within 90 days of grant of Certificate of
Registration, clearly laying down policies and guidelines which
define the; norms, type, profile and procedure for acquisition of
assets,
valuation procedure for assets having realisable value, which could
be reasonably estimated and independently valued;
plan for realisation of asset acquired for reconstruction
The Board has powers to approve policy changes and delegate powers to
committee for taking decisions on policy/proposals on asset acquisition.
Change or take over of Management/ Sale or Lease of Business of
the Borrower: No SC/ARC can takeover/ change the management
of business of the borrower or sale/lease part/whole of the
borrowers business until the RBI issues necessary guidelines in this
behalf.
Rescheduling of Debt/ Settlement of dues payable by borrower: A
policy for rescheduling the debt of borrowers should be framed
laying the broad parameters and with the approval of the Board of
Directors. The proposals should to be in line with the acceptable
business plan, projected earnings/ cash flows of the borrower, but
without affecting the asset liability management of the SC/ARC or
commitments given to investors. Similarly, there should be a policy
for settlement of dues with borrowers.

 Enforcement of Security Interest: For the sale of secured asset as

specified under the SARFAESI Act, a SC/ARC may itself acquire the
secured assets, either for its own use or for resale, only if the sale
is conducted through a public auction.
Realisation Plan: Within the planning period a realisation plan
should be formulated providing for one or more of the measures
including settlement/rescheduling of the debts payable by
borrower, enforcement of security interest, or change/takeover of
management or sale/lease of a part or entire business. The plan
should clearly define the steps for reconstruction of asset within a
specified time, which should not exceed five years from the date of
acquisition.
Broad guidelines with regards to Securitisation are as follows:
Issue of security receipts: A SC/ARC can set up trust(s), for issuing
security receipts to QIBs, as specified under SARFAESI Act. The
company shall transfer the assets to the trust at a price at which
the assets were acquired from the originator. The trusteeship
remains with the company and a policy is formulated for issue of
security receipts.
Deployment of funds: The company can sponsor or partner a JV for
another SC/ARC through investment in equity capital. The surplus
available can be deployed in G-Sec or deposits in SCBs.
Asset Classification: The assets of SC/ARC should be classified as
Standard or NPAs. The company shall also make provisions for
NPAs.
Issues under the SARFAESI
Right of Title
A securitisation receipt (SR) gives its holder a right of title or interest in
the financial assets included in securitisation. This definition holds good
for securitisation structures where the securities issued are referred to as
Pass through Securities. The same definition is not legally inadequate in
case of Pay through Securities with different tranches.
Thin Investor Base
The SARFAESI Act has been structured to enable security receipts (SR) to
be issued and held by Qualified Institutional Buyers (QIBs). It does not
include NBFC or other bodies unless specified by the Central Government
as a financial institution (FI). For expanding the market for SR, there is a

need for increasing the investor base. In order to deepen the market for
SR there is a need to include more buyer categories.
Investor Appetite
Demand for securities is restricted to short tenor papers and highest
ratings. Also, it has remained restricted to senior tranches carrying
highest ratings, while the junior tranches are retained by the originators
as unrated pieces. This can be attributed to the underdeveloped nature of
the Indian market and poor awareness as regards the process of
securitisation.
Risk Management in Securitisation
The various risks involved in securitisation are given below:
Credit Risk: The risk of non-payment of principal and/or interest to
investors can be at two levels: SPV and the underlying assets. Since the
SPV is normally structured to have no other activity apart from the asset
pool sold by the originator, the credit risk principally lies with the
underlying asset pool. A careful analysis of the underlying credit quality
of the obligors and the correlation between the obligors needs to be
carried out to ascertain the probability of default of the asset pool. A well
diversified asset portfolio can significantly reduce the simultaneous
occurrence of default.
Sovereign Risk: In case of cross-border securitisation transactions where
the assets and investors belong to different countries, there is a risk to
the investor in the form of non-payment or imposition of additional taxes
on the income repatriation. This risk can be mitigated by having a foreign
guarantor or by structuring the SPV in an offshore location or have an
neutral country of jurisdiction
Collateral deterioration Risk: Sometimes the collateral against which
credit is sanctioned to the obligor may undergo a severe deterioration.
When this coincides with a default by the obligor then there is a severe
risk of non-payment to the investors. A recent example of this is the subprime crisis in the US which is explained in detail in the following
sections.
Legal Risk: Securitisation transactions hinge on a very important principle
of bankruptcy remoteness of the SPV from the sponsor. Structuring the
asset transfer and the legal structure of the SPV are key points that
determine if the SPV can uphold its right over the underlying assets, if
the obligor declare bankruptcy or undergoes liquidation.
Prepayment Risk: Payments made in excess of the scheduled principal
payments are called prepayments. Prepayments occur due to a change in

the macro-economic or competitive industry situation. For example in

case of residential mortgages, when interest rates go down, individuals
may prefer to refinance their fixed rate mortgage at lower interest rates.
Competitors offering better terms could also be a reason for prepayment.
In a declining interest rate regime prepayment poses an interest rate risk
to the investors as they have to reinvest the proceedings at a lower
interest rate. This problem is more severe in case of investors holding
long term bonds. This can be mitigated by structuring the tranches such
that prepayments are used to pay off the principal and interest of shortterm bonds.
Servicer Performance Risk: The servicer performs important tasks of
collecting principal and interest, keeping a tab on delinquency, maintains
statistics of payment, disseminating the same to investors and other
administrative tasks. The failure of the servicer in carrying out its
function can seriously affect payments to the investors.
Swap Counterparty Risk: Some securitisation transactions are so
structured wherein the floating rate payments of obligors are converted
into fixed payments using swaps. Failure on the part of the swap
counterparty can affect the stability of cash flows of the investors.
Financial Guarantor Risk: Sometime external credit protection in the form
of insurance or guarantee is provided by an external agency. Guarantor
failure can adversely impact the stability of cash flows to the investors .