The Enforcement of Security Interest and Recovery of Debt Laws and Miscellaneous Provisions (Amendment) Act, 2016 (the Act) received assent of the President on August 12, 2016 and was  published in the Gazette on August 16, 2016. It will come into effect from such date(s) as may be notified by the Central Government. The Act makes far reaching changes to the way securitisation and reconstruction companies are regulated, as well as the category of financial assets and the secured creditors to whom non- judicial remedies and access to debt recovery tribunals are available. We try to examine this through this short post.

Listed Debt Securities

The Act extends the benefit of remedies under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) and the Recovery of Debts due to the Banks and Financial Institutions Act, 1993 (DRT Act) to debt securities listed on Indian stock exchanges. It also revises the definition of financial assets to include, among others, hire purchase, financial lease and conditional sale within its ambit.

Under the Act, the debenture trustee can enforce its security with respect to listed debt securities under SARFAESI in the event of non-payment of debt after 90 days notice of default has been served on the borrower. For this provision to apply, such debt is not required to be classified as a non-performing asset (NPA).

The stated objective of the Act is to facilitate ease of doing business. Admittedly there is a need to deepen the bond market as well as the market for distressed assets – the extension of the SARFAESI remedy to listed bondholders may help in achieving both of these.

However, the inclusion of only listed debt securities and the non-application of the NPA requirement in respect of listed debt securities create certain anamolies. Firstly, the remedies under the SARFAESI Act are not available to other lenders such as those providing external commercial borrowing (ECB) or investing in unlisted debt securities such as alternative investment funds. It is likely that such lenders would seek treatment at par at least with listed bondholders.

Secondly, the Act still retains the requirement that an account should be classified as an NPA before banks and financial institutions enforce their security under the SARFAESI Act. Currently different periods have been prescribed for NPA classification by different regulators (e.g., for certain financial institutions the period is six months) and corresponding provisioning requirements. Although such differences among the banks and financial institutions have been accepted by the Supreme Court in Keshavlal Khemchand  case, it may lead to a scenario where a default in respect of all debts by a borrower will entitle some secured creditors to invoke SARFAESI Act provisions earlier than others .

Non-banking financial companies

The Act does not make any reference to non-banking financial companies (NBFCs) but financial assets such as financial leases and conditional sales are primarily dealt with by NBFCs. In exercise of the powers conferred under the SARFAESI Act, the Central Government has notified certain NBFCs, having assets of rupees five hundred crores and above as per the last audited balance sheet, as financial institutions to which the provisions of the SARFAESI Act apply except that provisions of Sections 13 to 19 (relating to private enforcement of security) only apply for security interest where the principal amount of secured debt equals or exceeds Rs. 1 crore (notification dated August 5, 2016). It may be noted that the remedies under the DRT Act are still not available to the NBFCs. It may also be noted that under the current RBI regulations, asset reconstruction companies (ARCs) cannot acquire financial assets from NBFCs.

Registration Requirements

Registration of security interest with the Central Registry will be mandatory for enforcement of security under the SARFAESI Act and will act as public notice. In order to create a central database for security interest over property rights, the Act also envisages integration of registry systems under different laws with the Central Registry.

Asset Reconstruction Companies

The Act also confers wide powers on the RBI to regulate ARCs including the right to audit, inspect, approve appointment of and, in certain cases, appoint and remove directors. Stiff penalties have been prescribed for non-compliance by ARCs  of RBI directions. Any document executed in favour of an ARC by a bank or financial institution for acquisition of financial assets for the purposes of asset reconstruction or securitisation will be exempt from stamp duty. Besides qualified institutional buyers the ARCs can also offer the security receipts to other institutional investors as specified by the RBI. This will enhance the ability of ARCs to provide working capital to distressed borrowers.

Given the high levy of registration fees  in certain states, a similar exemption from registration fees might have been considered.

Changes to the DRT Act

The most notable amendment in the DRT Act is the requirement of deposit for stay and appeal. Stay on recovery under a recovery certificate (RC) will be granted only if the borrower pays 25 per cent of the debt upfront and gives an unconditional undertaking to pay the balance within a reasonable time. 50 percent of the debt under the RC will need to be deposited for making an appeal against the order of the Recovery Officer. The Act provides that the DRT will make every effort to complete the proceedings in two hearings and shall issue the recovery certificate within 30 days of completion of hearing. When an application is filed for recovery of debt, the Tribunal shall issue summons to the defendant directing it to disclose the properties other than those identified by the applicant. The defendant is restrained from transferring assets except in the ordinary course of business without the prior approval of the Tribunal over which security has been created in favour of the applicant or where the value of the secured assets in not sufficient to satisfy the debt, other assets specified by the applicant or such other assets as disclosed to the Tribunal.

The Act also empowers the Central Government to provide by rules e-filing of applications and written statements, service of summons and notices through electronic form and display of interim and final orders of on the website of the Tribunal and Appellate Tribunal. In view of pendency of cases the Act also provides that the Presiding Officers shall be eligible for reappointment and has increased their age of retirement from sixty two to sixty five years.

The Act is a welcome step towards streamlining procedures and will help in expeditious disposal of recovery cases under the DRT Act. However, in view of the pendency of cases (over 70,000 cases are pending) before DRTs and the likely increase on account of bankruptcy jurisdiction being conferred under the Insolvency and Bankruptcy Code, substantial investment and capacity building will be required at DRTs to achieve the objectives.

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Photo of Dhananjay Kumar Dhananjay Kumar

Partner in the Projects and Projects Finance Team at the Mumbai office of Cyril Amarchand Mangaldas. Dhananjay specialises in project and project finance and focuses mainly on oil & gas, telecom and port sectors. He advises both lenders and developers in the infrastructure sector and has acted for many key players in this space. Dhananjay is also a member of the Bankruptcy Practice of the Firm. He can be reached at dhananjay.kumar@cyrilshroff.com

Photo of Piyush Mishra Piyush Mishra

Partner in the Projects and Projects Finance Team at the Delhi office of Cyril Amarchand Mangaldas. Piyush has been recognised as leading infrastructure lawyer and handles complex project finance and structured deals. He can be reached at piyush.mishra@cyrilshroff.com