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SARFAESI Act, 2002: Understanding Applicability, Objectives, Process, and Documentation

Nov 20 2023
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Introduction

In the dynamic landscape of India's financial boom, the financial sector plays a pivotal role. However, the prison framework governing commercial transactions struggled to maintain pace with evolving practices and financial quarter reforms, impeding the recovery of defaulting loans and main to a boom in nonperforming assets (NPAs) of banks and financial establishments. Committees such as Narasimham I and II, along with the Andhyarujina Committee, were established by the Central Government to evaluate banking sector reforms and propose necessary changes to the legal system.

Among these committees, recommendations were made to enact new legislation focusing on securitization, allowing banks and financial institutions greater control over seized assets without court intervention. This led to the formulation of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act).

What is the SARFAESI Act, of 2002?

The SARFAESI Act, short for "Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act," empowers banks and financial institutions to auction commercial or residential properties to recover loans when borrowers fail to meet repayment obligations. By doing so, the SARFAESI Act aids in reducing Non-Performing Assets (NPAs) through effective recovery methods and reconstruction.

Applicability of SARFAESI Act, 2002

The SARFAESI Act is applicable in cases of secured loans, allowing banks to enforce underlying securities like hypothecation, mortgage, and pledge. Court intervention is unnecessary unless the security is invalid or fraudulent. Unsecured assets, however, require the bank to file a civil case against defaulters in court. The Act does not apply to security interests in agricultural lands, loans less than one lakh rupees, and cases where 80% of the loan has been repaid by the borrower.

Objectives of SARFAESI Act, 2002

The SARFAESI Act has two primary objectives:

  • Efficient and rapid recovery of non-performing assets (NPAs) of banks and financial institutions.
  • Empowering banks and financial institutions to auction properties, both commercial and residential, in cases of borrower default.

How SARFAESI Act, of 2002 work?

The SARFAESI Act grants banks and financial institutions the authority to seize the property of defaulting borrowers without court involvement, except for agricultural land. If a borrower defaults on loan repayment, the financial institution can classify the account as a Non-Performing Asset (NPA) and issue notices to the defaulting borrower. The borrower has 60 days to discharge their liabilities. If the borrower fails to comply, the bank has the following options:

  • Take possession of the loan security.
  • The right to the security can be leased, sold, or assigned.
  • Manage the security or appoint someone else to manage it.
  • The Act also facilitates the establishment of Asset Reconstruction Companies (ARCs), regulated by the Reserve Bank of India (RBI), to acquire assets from banks and other financial institutions.

Formation of SARFAESI Act, 2002

The SARFAESI Act was formulated to regulate the securitization and reconstruction of financial assets, enforce security interests, and address related matters. It applies across India and has undergone amendments through the Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Act, 2016.

Amendments to the SARFAESI Act, 2002

The 2016 amendment to the SARFAESI Act introduced several changes, including:

  • Empowering banks and Asset Reconstruction Companies (ARCs) to transfer part of the debt of defaulting companies into equity.
  • Granting banks the ability to request immovable properties set for auction if no bids are received, allowing them to adjust the debt with the amount paid for the property.
  • Providing the option for banks to sell the property to a new buyer, who can remit the debts over time?

Right of Borrower under SARFAESI Act, 2002

Borrowers under the SARFAESI Act have specific rights:

They can remit dues to avoid losing their securities before the sale concludes.

They are entitled to compensation for defaults by authorized officers.

Section 17 of the SARFAESI Act allows borrowers to approach the Debt Recovery Tribunal to address grievances against creditors or authorized officers.

Methods of Recovery under SARFAESI Act, 2002

The SARFAESI Act outlines three methods for recovering Non-Performing Assets (NPAs):

Securitization: The process of issuing marketable securities backed by a pool of existing assets, which can be sold after conversion into a marketable security.

Asset Reconstruction: Empowers Asset Reconstruction Companies to manage the borrower's business, sell or acquire it, or reschedule debt payments as per the Act.

Enforcement of Security without Court Interruption: Enables banks and financial institutions to issue notices for payment to individuals who acquired secured assets from the borrower.

Assets Not Covered Under SARFAESI Act, 2002

Certain assets are not covered by the SARFAESI Act, including:

  • Money or security is given following the Sale of Goods Act of 1930 or the Indian Contract Act of 1872.
  • Leases, hire-purchase, conditional sale, or other contracts without created security interest.
  • Unpaid sellers' rights under Section 47 of the Sale of Goods Act of 1930.
  • Properties are not liable for sale or attachment under Section 60 of the Code of Civil Procedure, 1908.

Conclusion

The SARFAESI Act, of 2002, stands as a crucial piece of legislation facilitating the efficient recovery of non-performing assets and empowering banks and financial institutions to take necessary actions without prolonged court procedures. Through a systematic approach, the Act aims to strike a balance between the rights of creditors and borrowers while contributing to the overall health and stability of the financial sector in India

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