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One of the important players in India's efforts to succeed in accelerating its economic development has been the finance industry. However, the legal structure governing business transactions has trailed behind in the changes that the financial industry and commercial transactions have encountered. Consequently, it increased the amount of nonperforming assets held by banks and other financial institutions and reduced the rate of recovery of defaulted loans thereby creating a void towards public money.

The Central Government, in view of the falling rate of recovery, established the Narasimham Committees I and II and the Andhyarujina Committee so as to evaluate banking sector reforms and determine whether the legal framework in these areas needs to be amended.

These committees, among others, proposed new legislation for securitization that would allow banks and financial organizations to seize securities and sell them without the need for judicial proceedings.

Application of The SARFAESI Act, 2002:

"An act to regulate securitization and reconstruction of financial assets and enforcement of security interests, as well as to provide for matters connected therewith or incidental thereto." 

The SARFAESI Act stands for Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act. The SARFAESI Act enables banks and other financial institutions to recoup loans from defaulting borrowers by selling commercial or residential assets at auction. Banks can thus use recovery and reconstruction measures to lower their non-performing assets owing to the SARFAESI Act, 2002.  Except for agricultural land, the Act allows banks and financial institutions to seize a borrower's property without having to go to court. Only the secured loans that were sanctioned by the banks/financial institutions can be enforced as underlying securities such as hypothecation, mortgage, pledge, etc. in accordance with the SARFAESI Act of 2002. Furthermore, unless the security is void or fraudulent, a court order is not necessary. Nevertheless, the bank/financial institution would have to appear in court and bring a civil lawsuit against the defaulters in an event wherein the assets were classified as unsecured.

Therefore, tThe biggest drawback of the Act is that it is not applicable to it disables unsecured creditors to recover their loan facilities. 

The purpose of the Act is to enable effective rapid recovery of non-performing assets (NPAs) from the banks/financial institutions by enabling the banks and financial institutions to auction properties  (commercial/residential) in an event the borrower fails to repay their loans.

The underlying purpose of the act was well iterated in a recent judgement by the Hon’ble Supreme Court in the matter of M/s R.D. Jain and Co.  V. Capital First Ltd. & Ors., Civil Appeal No.  175 Of 2022. The relevant para is as follows:

“7. Thus, the underlying purpose of the SARFAESI Act is to   empower   the   financial   institutions   in   India   to   have similar powers as enjoyed by their counterparts, namely, international banks in other countries. One such feature is to empower the financial institutions to take possession of securities and sell them. The same has been translated into provisions falling under Chapter III of the SARFAESI Act. Section 13 deals with enforcement of security interest. SubSection (4) thereof envisages that in the event a default is committed by the borrower in discharging his liability in full within the period specified in sub­section (2), the secured creditor may take recourse to one or more of the measures provided in sub­section (4). One of the measures is to take possession of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale for realizing the secured asset. That, they could do through their   “authorised   officer”   as   defined   in   Rule   2(a)   of   the Security Interest (Enforcement) Rules, 2002.”

Furthermore, it is pertinent to note that as per the Hon’ble Apex Court in Phoenix ARC Private Limited V. Vishwa Bharati Vidya Mandir & Ors, Civil Appeal Nos. 257-259 Of 2022, the Hon’ble Supreme Court set precedent that no Writ petition would maintainable against proceedings initiated under SARFAESI, Act. 

Hence, it is quite clear that the current legal framework in India has undoubtedly developed to empower banks and financial institutions to initiate legal proceedings under SARFAESI Act against the defaulting Borrowers.  

Types of Property covered under SARFAESI Act

The SARFAESI act applies to any asset, moveable or immovable, delivered as security through hypothecation, mortgage or the creation of a security interest in any other manner.However, it does not apply to those excluded under Section 31.

Are NBFCs (Non-Banking Financial Companies) covered under  SARFAESI Act?

The Ministry of Finance recently announced that NBFCs with assets at least Rs. 100 crores can now enforce security interests on debts totaling at least Rs. 50 lacs

What are the permissible recoveries under the SARFAESI Act?

The Act stipulates three ways to recover the Non-Performing Assets, which includes:

• Enforcement of security without interfering with court proceedings

The Act empowers banks and financial institutions to issue notices to individuals who have obtained a secured asset from the borrower for paying the due amount and claim to a borrower’s debtor to pay the sum due to the borrower.

• Securitisation

Securitisation is the process of issuing marketable securities backed by a pool of existing assets such as home or auto loans. An asset can be sold after it is converted into a marketable security. A securitisation or asset reconstruction company can raise funds from only the Qualified Institutional Buyers (QIBs) by forming schemes for acquiring financial assets.

• Reconstruction of assets

Asset reconstruction empowers asset reconstruction companies. It can be done by managing the borrower’s business by selling or acquiring it or by rescheduling payments of debt payable by the borrower as per the provisions of the Act.

What loans are exempted from the SARFAESI Act?

The SARFAESI Act does not apply to loans issued by Indian Contract Act or Sale of Goods Act (both 1930), because they are covered by other laws. Any unpaid wages or services rendered by the buyer after delivery of goods. It also does not cover real estate covered under Section 60 of the Code of Civil Procedure, which is not subject to attachment or sale.

The SARFAESI Act - do cooperative banks fall under it?

Yes, the SARFAESI Act, 2002 is applicable to cooperative banks and corporations created under State legislation, according to the Supreme Court's judgement.

The Supreme Court's ruling that allows co-op banks recourse to the SARFAESI Act will expedite the process of liquidation or resolution by making it easier for investors to recover their deposits. The law enables the bank to sell off assets in order to recover debts, which should bring a smile to your face. If you're a depositor in a co-op bank and your loan has gone bad, beware: if you don't repay your debt in 60 days, the bank can repossess whatever collateral is left on your mortgage; if this happens, expect to pay more than what you owed.

CONCLUSION:

In order to comply with the statute's requirements, the SARFAESI Act, 2002 has undergone significant revisions recently. In the past, the courts have contributed in preventing ambiguities over how to apply legislative requirements. As a consequence, the Supreme Court rightly upheld the significant expansion of the SARFAESI Act, 2002's purview in Karnataka State Financial Corporation v. N. Narasimahaiah, 2008, Appeal (civil)  610-612 of 2004 wherein the legitimacy of SARFAESI Act,2002 was challenged. The Hon’ble Supreme Court correctly emphasized the importance of the fundamental right to property. As a result, both creditors and lenders are guided as to the requirement of the asset mortgaged to the bank. The Supreme Court of India maintained the SARFAESI Act, 2002 as constitutionally legitimate, with the exception of the provisions under Section 17(2) of the Act, 2002, which was found to be in violation of Article 14 of the Indian Constitution. 

The SARFAESI Act, 2002 is a critical law for the development of the national economy, and expanding its purview is seen as an essential first step in fortifying the financial institutions of the nation.