How a company acquires a loan under the SARFAESI Act, how it resolves the asset and what borrowers and other creditors should know.
Asset reconstruction companies buy non-performing loans from banks and financial institutions and seek to recover them. They are regulated entities with powers that an ordinary assignee of a debt does not have. For a lender selling a loan, for a borrower whose loan has been sold and for a creditor dealing with such a company, it is useful to understand how they operate. This note describes the framework under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. It is general information, not advice on a particular transaction.
What an asset reconstruction company is
Under Section 3, a company must be registered with the Reserve Bank of India, and meet the requirements of capital and conduct that the Reserve Bank prescribes, before it may carry on the business of asset reconstruction or securitisation. The Reserve Bank supervises the companies under directions it issues, including those on the acquisition of financial assets, the resolution of acquired assets and the investment the company must itself make.
Acquisition of a loan
Section 5 allows a bank or financial institution to sell financial assets to a company under an agreement. On acquisition, the right or interest of the seller in the asset vests in the company as if it were the original lender, and the security goes with it. If proceedings are pending in a court or tribunal, the company is substituted as a party. The company does not need to obtain the borrower's consent, and the borrower is informed by notice. A company acquires the assets from lenders in several ways, including by a bilateral sale or a competitive process in which it bids for a portfolio. Such sales are usually made on the basis of a valuation, and the lender takes the price in cash, in security receipts, or in a combination of the two.
Security receipts
A company usually raises funds from qualified investors by issuing security receipts, which represent an undivided interest in the financial assets held in a trust, under Section 7. The receipts are redeemed as the assets are recovered. The Reserve Bank's directions require the company to hold a minimum proportion of the receipts it issues in each scheme, so that it shares the risk with the investors.
Powers for resolving the asset
Section 9 lists the measures a company may take for asset reconstruction. They include the proper management of the business of the borrower, by taking over or changing its management, the sale or lease of the business, the rescheduling of payment of the debt, the enforcement of security interest and the settlement of dues. The company can enforce security under Section 13, as a secured creditor would. It may also apply to the Debts Recovery Tribunal and may join in or begin proceedings under the Insolvency and Bankruptcy Code as a financial creditor.
What this means for borrowers and other creditors
- A borrower can still negotiate, and a company may agree a settlement at a figure lower than the original debt, since it may have acquired the loan at a discount.
- The borrower's defences remain. A dispute about the amount or the validity of the original loan is available against the company as it was against the bank.
- Other creditors of the borrower may find that the company is now the principal secured creditor and takes the lead in enforcement or in the committee of creditors.
- The borrower should look for the notice of assignment, since the company's rights depend on a valid transfer.
For a lender considering a sale
- Prepare the file: the loan and security documents, the statements of account, the notices, and the status of each proceeding.
- Follow the Reserve Bank's guidelines on the sale of stressed assets, including the stated requirements for how the sale is conducted and priced.
- Make clear in the agreement what representations the lender gives about the asset, and the remedies if they are wrong.
- Inform the borrower and guarantors, and update the registers, including the Central Registry.
The framework is meant to allow lenders to clear their books and to place recovery in the hands of specialists. It operates within the borrower's rights, which the law preserves.
This note is general information on the law at the date of publication. It is not legal advice, and it should not be relied on without advice on the facts of a particular matter.
