THE SECURITIZATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST ACT, 2002

PRESENTED BYCHARU PUNDIR JAYANTI KUMARI APAR GUAR SHOMIC GUPTA ANIL VARMA VANDANAA BHARTI

INTRODUCTIONy GOI has taken several steps to improve the recovery of bad

debts of banks and financial institutions.y First step was the enactment of The Recovery Of Debts due

to Banks And Financial Institutions Act,1993.y Establishment of 29 Debt Recovery Tribunals(DRTs) and 5

DRATs , but failed.y Thus introduce Securitization And Reconstruction Of

Financial Assets And Enforcement Of Security Interest Act,2002.

SARFAESI ACT, 2002y Act extends to whole of India y Came into force on 21st June 2002 y The SARFAESI Act allowed the banks and financial institutions

to take possession of the collateral security given by the defaulting borrowers and sell these assets without having to go through protracted legal procedures. y Deals with basic 3 aspects: To provide legal framework for securitization of asset. Transfer of NPAs to asset reconstruction company, which can then dispose off the assets and realize the proceeds. Enforcement of security interest by secured creditor (banks/financial institutions)

WHAT IS SECURITIZATION ???Securitization is the process of conversion of existing assets or future cash flows into marketable securities. For the purpose of distinction, the conversion of existing assets into marketable securities is known as asset-backed securitization and the conversion of future cash flows into marketable securities is known as future-flows securitization.

y Act is divided into 6 chapters with 42 sections. Chapter 1:- Applicability of SARFAESI act definition of various

terms Chapter 2:- Regulations setting up of securitization and reconstruction companies Chapter 3:- Enforcement of security interest allied and incidental matters Chapter 4:- Establishment of central registry registration of securitization reconstruction and security interest transactions Chapter 5:- Offences, penalties and punishments Chapter 6:- Routine and legal issues.

Securitization and Asset Reconstructiony Securitization is to sell the secured NPA loans to investors

through a special purpose vehicle called securitization company(SC).y SC formulate a separate scheme for each set of assets and

invites QIBS for investment in the scheme.y SC realize the financial asset and pays the proceedings to QIB y Asset Reconstruction involves securitization and

enforcement of security interests.

y Securitizaton Company and Asset Reconstruction company is

to be registered with the RBI.y The purpose of asset reconstruction is Registration of securitization or reconstruction companies

with RBI. The effect of non-registration or rejection of application of such companies.y ARC acquires NPA loan from banks and financial institutions. y ARC formulates a scheme for each of financial assets taken

over .

AR involves any one or more of following measures Rescheduling of payment of dues payable by the borrower. Enforcement of security interest in accordance with the

provisions of the Act. Settlement of dues payable by the borrower. Taking possession of securities.

ELIGLIBILITY CRITERIA FOR SECURITIZATION COMPANY/ ASSET RECONSTRUCTION COMPANY (SECTION 3)

Obtaining a certificate of registration granted under the above

act. Owned funds- min 2 crore or max.15% of total financial assets

acquired or to be acquired. Reserve

Bank shall consider the application provided the company has: not incurred losses in any 3 preceding F.Ys. Adequate arrangements for realization of financial assets. Directors with adequate professional experience in matters related with finance etc. Nominee directors number should be equal to or less than half of the total strength of the directors ,and

Any of its directors should not been convicted of any offence

involving companys moral.y Sponsor(any person) of the company should not hold any

controlling interest in the company.y It should be compiled with one or more guidelines issued by the

Reserve Bank for the said purpose.y Prior approval of the RBI is necessary for any substantial change

in management or location of the company.y RBI may reject the application if not satisfied.

Process Of Enforcement under the Act

Debt realization using the Provisions of SARFAESI Act, 2002 Classify an account as NPA Bank issues notice under section 13(2) Borrower can reply to notice under section 13(2) & place his

objections. Bank to deal with these objections & send a reply. After this has been done Bank proceeds with taking possession of the secured asset under section 13(4). Borrower can file an appeal against notice & DRT can pass orders & ask the Bank not to proceed further.

Debt realization using the Provisions of SARFAESI Act, 2002 If no restraint from DRT, Bank can proceed by taking physical

possession of the property & proceed with auctioning the property If Bank could auction the property it will first realize the outstanding dues of the borrower & then the remaining amount is given to the borrower. If the amount realized through auction is not sufficient to meet the outstanding dues, then Bank proceeds further against the borrower.

ENFORCEMENT OF SECURITY INTERESTSecured NPA > than 1 lakh Default amt > than 20% of P&I Other than exempted categories under Sec 31 Bank empowered as secured creditor under the act Notice to Borrower Sec 13(2) 60 days time Objections answered

Rights of BORROWER Appeal to DRAT Deposit 50% of debt determined by DRT Within 30 days of DRT order Right to Appeal DRT Within 45 days DRT to dispose of within 60 days Max 4 months

Sec 13(4) Enforcement Proceedings Authorized officer District Magistrate Sec 34 bars civil proceedings

Sale Notice of 30 days Reserve Price fixation

Possession Lease Assignment

Management Takeover

Demand on Holder of Security

Exemptions from Enforcementy Lien y Pledge y Security in Air crafts / Shipping Vessels y Conditional Sale / Lease y Security interest in Agricultural land y Any financial asset:o Not exceeding Rs. 1 Lakh o Where amt due is < 20% of Principal Amount & Interst

Outcome of SARFAESI Act

NPA recovery was through SARFAESI Act Source: RBI, D&B Research

New Amendments in SARFAESIy Allow banks to have priority over tax authorities for

proceeds from sale of assets.y To set up central registry, which will have all the information

regarding mortgages in the current year, thereby avoiding duplication of mortgages.

CASE STUDY ON MARDIA CHEMICALS VS. ICICI BANK

Introductiony Rs. 1000 crore company y It is a flagship of Mardia group has facilities to manufacturing

a range of products like dyes, dye intermediates, basic chemicals and caustic soda.y It owed over Rs. 1450 crore (including a principle of Rs. 800

crores and unpaid interest forming the balance) to 22 lenders which were BOI, BOB, Corporation Bank, UBI ,IDBI ,LIC ,IFCI

Allegationsy MC had bought property worth Rs.34cr and converted them

into Co. guesthouse, but there was no information available on source of funds, there are allegations of diversion of funds against the co.y Also the Co. has not been responding to the notices severed by

the Registrar of Companies, Ahmedabady A notice was issued to MC by the bank requiring to pay the

amount due indicated in the notice within 60 days failing which the bank as a secured creditor would be entitled to enforce the security interest w/o intervention of court or DRT by way of sale, lease or otherwise any of its secured assets

Challenges To The Acty It claimed that any of the banks and FIs have been vested

with arbitrary powers, without any guidelines for its exercise and also providing any appropriate and adequate mechanism to decide the disputes relating to the correctness of the demand, its validity and actual amount of dues, sought to be recovered from the borrowery The offending provisions as contained under the act are such

that, it all has been made one sided affair while enforcing drastic measures of sale of the property or taking over of the management or the possession of the secured assets without affording any opportunity to the borrower

Challenges To The Acty In the year 1999 ICICI filed a suit before the HC at Mumbai

against MC ltd for recovery of amount totaling Rs 140 cr due from MCy ICICI bank issued a notice under securitisation act for

recoveries of Rs. 293 cr within 60 days of the notice been delivered and then acquired some assets from Mardia after which the latter filed a case against ICICI

Challenges To The Acty MC appealed to the SC that while the law permitted the bank

to attach assets ,they may not sell themy DRT of Mumbai issued an order to MC to pay up 25% of the

outstanding amount to ICICI bank by Oct 21 2003

Amendments To The Acty Under 2004 Act, a borrower may appeal a banks action

before the DRT w/o making a 75% deposit of the amount claimed. The DRT is required to dispose of such an application within 4 monthsy Any person aggrieved by a DRT order can file an appeal to

the Debt Recovery appellate Tribunal after depositing 50% of the debt due from it as claimed by the secured creditor or determined by the DRT, whichever is less.

FURTURE OUTLOOKy Securitization is expected to become more popular in the

near future in the banking sector. y Since, blocking too much capital in NPAs can reduce the capital adequacy of banks that is why banks go for two options raise more capital or to free capital tied up in NPAs and other loans through securitization. y Banks are expected to sell off a greater amount of NPAs to ARC

Thank you