ANDHYARUJINA much substance in the submission made on

ANDHYARUJINA COMMITTEE

This
was a committee on Legal Reforms. This Committee, being a ten-member Committee
under the Chairmanship of Shri. T.R. Andhyarujina, former Solicitor General of
India, had been set-up in February, 1999 to formulate specific proposals for
giving effect to the suggestions as made by the Narasimham Committee. The
report of this Committee was submitted in May, 2000 and as regards legal
reforms in banking sector, had highlighted the following points as regards
bringing about the present Securitisation and Reconstruction of Financial
Assets and Enforcement of Security Interest Act:

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i)       
Banks must be
vested with power of taking possession and sale of securities without
intervention of court as regards mortgaged properties;

                 
ii)       
The existing
Recovery of Debts Due to Banks and Financial Institutions Act, 1993 should be
amended to make its provisions more effective; and

               
iii)       
Amendment should
also be made in the Contract Act, 1872, by making provision of giving more time
to Banks and Financial Institutions to enforce their claims under Guarantee.

In
view of what has been stated above, there is not much substance in the
submission made on behalf of the petitioners that while the Recovery of Debts
Due to Banks and Financial Institutions Act was in operation, it was uncalled
for to have yet another legislation for the recovery of the mounting dues.
Considering the totality of circumstances and the financial climate world over,
if it was thought as a matter of policy to have yet speedier legal method to
recover the dues, such a policy decision cannot be faulted with nor is it a
matter to be gone into by the courts to test the legitimacy of such a measure
relating to financial policy1.

In
1999, the Reserve Bank of India had also set-up a Working Group on Development
of the Market for Asset Securitisation which had submitted its report in
December, 1999, identifying several impediments in the matter of securitization
and making certain suggestions. This Working Group was followed by its
successor which virtually prepared a draft Bill on Securitisation, and the same
was submitted to the Government for its consideration.

Other
policy decisions taken conterminously by the Reserve Bank of India include-

     
i)       
One Time Settlement Scheme- This Scheme was introduced in 1999; and in pursuance
of this Scheme, mainly covering small borrowers, the Public Sector Banks had
recovered a total sum of Rs. 2,192 crores pertaining to 5.23 lakh accounts as
on 30.06.2001. Although the Scheme was not extended yet  banks had the liberty to frame their own
policies both for recovery and for writing off, including compromise and
negotiated settlements conforming to Reserve Bank Guidelines issued in 1995,
and a Scheme in the name of Mid-term Monetary and Credit Policy had been
further announced on 22.10.2001, by Dr. Bimal Jalan, Governor of the Reserve
Bank of India.

 

   
ii)       
Corporate Debt Reconstruction Scheme- This Scheme was announced in the year 2001 and had its
application only to multi-banking accounts having an outstanding exposure of
Rs. 20 crore and above with banks and financial institutions.

 

  iii)       
Policy Norms for Non-Performing Assets- Stricter norms had been adopted in this policy and the
Reserve Bank of India, through its matter circular of 4.7.2000, revised its
prudential norms on Asset classification.

 

  iv)       
Monetary and Credit Policy for 2002-03- This Policy was announced by Dr. Bimal Jalan, Governor
of the Reserve Bank of India on 29.4.2002, stating that-

    “Consistent with the recommendations of
Narasimham Committee II, and with a view to moving closer to international best
practices, it is proposed that with effect from March 31, 2005, an asset would
be classified as doubtful if it remained in the sub-standard category for 12
months. Banks are permitted to phase the consequent additional provisioning
over a four-year period with a minimum of 20% each year.”

 

Subsequently a mid-term
review of this policy was announced on 29.10.2002, stating that-

     “There has been some improvement with
regard to NPAs, operating expenses and cost of funds of commercial banks. Gross
NPAs of public sector banks as a percentage of gross advances declined from
12.4% in March 2001 to 11.1% in March 2002. The net NPAs as a percentage of
advances also declined from 6.7% to 5.8% during the same period. With a view to
moving towards international best practices and to ensure greater transparency,
commercial banks were advised to adopt 90 days norm for recognition of loan
impairment from the year ending March 31, 2004. The 90 days norm has also been
made applicable to Urban Co-operative Banks and regional rural banks, w.e.f.
March 31, 2004. In order to facilitate adoption of 90 days norm for negotiation
of loan impairment from the year ending March 31, 2004, banks were advised to
switch to charging interest on advances at monthly rests with effect from April
1, 2002.”

 

Hithertofore, Section 69
of the Transfer of Property Act permitted a mortgagee to take possession of
mortgaged property and sell the same without intervention of court only in case
of English Mortgage, which is a transaction where the mortgagor binds himself
to repay the mortgage money on a certain day and transfers the mortgaged
property, absolutely to the mortgagee but subject to proviso that he will
retransfer it to the mortgagor upon payment of the mortgage money as agreed2.

 

   That apart, the mortgagee could take
possession of mortgaged property where there existed specific provision in the
mortgage deed and the mortgaged property were situated in specified towns like
Kolkata, Chennai or Mumbai, but in other cases possession of property could be
taken only by intervention of court.

 

    Taking possession of the mortgaged property
through intervention of courts for enforcement of the security interest of the
mortgagee was, of course, a slow process with the result that by the time the
secured creditor could in any case get possession of the asset, the asset had
either withered away or become of no value. There was, however, no provision
either in the Contract Act or in the law relating to hypothecation, with regard
to hypothecated asset which is equally a major security interest created in
favour of the secured creditor.

 

    The predominant suggestions made,
therefore, in the Reports of the Narasimham Committee was to empower the banks
and financial institutions to take possession of the securities and to sell
them or their part without the intervention of courts; and this recommendation
was given effect to in the text of section 13 of the Draft Bill which opened
with a non-obstante clause, thereby giving this section an overriding effect
over anything contained in section 69 or 69A of the Transfer of Property Act,
1882.

 

     The
Government on its part, consolidated, the reports of the aforesaid Narasimham
Committee as also the draft bill prepared and proposed by the Andhyarujina
Committee; and without losing time, an Ordinance with the title as that of the
Act, was promulgated by the President, in exercise of his powers under Article
123(1) of the Constitution of India, since the Parliament was not then in
session and the President was satisfied that circumstances did exist rendering
it necessary for him to take immediate action.

 

    The Ordinance being Ordinance 2 of 2002,
was thus, promulgated on June 21, 2002 and had come into force at once.

 

    With a view to replacing the Ordinance by
an Act of the same name, a Bill was introduced, on July 9, 2002, but the same
could not be passed in the Monsoon Session of the Parliament in August 2002.
Normally, therefore, the life of the Ordinance had to be extended by a fresh
Ordinance, issued again, in August, 2002, so as to replace the former
Ordinance. Finally, the Ordinance came to culminate into an Act in the winter
session of the Parliament in December, 2002 which was deemed to have come into
force on the 21st of June, 2002 i.e., the date of promulgation of
the first Ordinance.

 

    The Bill as such having been passed by both
Houses of Parliament received the assent of the President on 17th
December, 2002 and came on the statute Book with its name as the Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002 (54 of
2002).

 

   Taking cue from certain implications of the
Supreme Court judgement in Mardia
Chemicals Ltd. v Union of India3,
the Act came to be amended through the Enforcement of Security Interest and
Recovery of Debts Laws (Amendment) Ordinance, 2004 (5 of 2004), which was
enacted by the Parliament as Enforcement of Security Interest and Recovery of
Debts Laws (Amendment) Act, 2004 (30 of 2004).

 

Statement of Objects and Reasons of
the Principal Act (54 of 2002)

The financial sector has
been one of the key drivers in India`s efforts to achieve success in rapidly
developing its economy. While the banking industry in India is progressively
complying with the international prudential norms and accounting practices,
there are certain areas in which the banking and financial sectors do not have
a level playing field as compared to other participants in the financial
markets in the world. There is no legal provision for facilitating
securitization of financial assets of banks and financial institutions.
Further, unlike international banks, the banks and financial institutions in
India do not have power to take possession of securities and sell them. Our
existing legal framework relating to commercial transactions has not kept pace
with the changing commercial practices and financial sector reforms. This has
resulted in slow pace of recovery of defaulting loans and mounting levels of
non-performing assets of banks and financial institutions. Narasimham Committee
I and II and Andhyarujina Committee constituted by the Central Government for
the purpose of examining banking sector reforms have considered the need for
changes in the legal system in respect of these areas. These Committees, inter
alia, have suggested enactment of a new legislation for securitization and
empowering banks and financial institutions to take possession of the
securities and to sell them without the intervention of the court. Acting on
these suggestions, the Securitisation and Reconstruction of Financial Assets
and Enforcement of Security Interest Ordinance, 2002, was promulgated on the 21st
June, 2002, to regulate securitisation and reconstruction of financial assets
and enforcement of security interest and for matters connected therewith or
incidental thereto. The provisions of the Ordinance would enable banks and
financial institutions to realise long-term assets, manage problem of
liquidity, asset liability mismatches and improve recovery by exercising powers
to take possession of securities, sell them and reduce non-performing assets by
adopting measures for recovery or reconstruction.

     It is now proposed to replace the
Ordinance by a Bill, which, inter alia, contains provisions of the Ordinance to
provide for-

 

a) 
Registration and
regulation of securitisation companies or reconstruction companies by the
Reserve Bank of India;

 

b)
Facilitating
securitisation of financial assets of banks and financial institutions with or
without the benefit of underlying securities;

 

 

c) 
Facilitating easy
transferability of financial assets by the securitisation company or
reconstruction company to acquire financial assets of banks and financial
institutions by issue of debentures or bonds or any other security in the name
of a debenture;

 

d)
Empowering
securitisation companies or reconstruction companies  to raise funds by issue of security receipts
to qualified institutional buyers;

 

 

e) 
Facilitating
reconstruction of financial assets acquired by exercising powers of enforcement
of securities or change of management or other powers which are proposed to be
conferred on the banks and financial institutions;

 

f)  
Declaration of any
securitization company or reconstruction company registered with the Reserve
Bank of India as a public financial institution for the purpose of section 4A
of the Companies Act, 19564;

 

 

g)
Defining ‘security
interest’ as any type of security including mortgage and charge on immovable
properties given for due repayment of any financial assistance given by any
bank or financial institution;

 

h)
Empowering banks
and financial institutions to take possession of securities given for financial
assistance and sell or lease the same or take over management in the event of
default, i.e., classification of the borrower`s account as non-performing asset
in accordance with the directions given or guidelines issued by the Reserve
Bank of India from time to time;

 

 

i)   
The right of a
secured creditor to be exercised by one or more of its officers authorised in
this behalf in accordance with the rules made by the Central Government;

 

j)  
An appeal against
the action of any bank or financial institution to the concerned Debts Recovery
Tribunal and a second appeal to the Appellate Debts Recovery Tribunal;

 

k) 
Setting up or
causing to be set up a Central Registry by the Central Government for the
purpose of registration of transactions relating to securitisation, asset
reconstruction and creation of security interest;

 

 

l)   
Application of the
proposed legislation initially to banks and financial institutions and
empowerment of the Central Government to extend the application of the proposed
legislation to non-banking financial companies and other entities;

 

m)          
Non-application of
the proposed legislation to security interest in agricultural lands, loans not
exceeding rupees one lakh and cases where eighty percent of the loans are repaid
by the borrower.

 

 

 

Constitutional Validity Of Act

The
constitutional validity of the act was challenged but upheld in M.R. Utensils v Union of India5,
as also in Unique Enterprises Works v
Union of India6.

   However, in Mardia Chemicals Ltd. v Union of India7,
the Supreme Court struck down sub-section (2) of section 17 of the Act as
arbitrary and unreasonable though the rest of the Act was declared to be
constitutionally valid8.

   A DB of the Delhi High Court9
also upheld the validity of the Act and its provisions except the provisions
contained in section 17(2) of the Act which have already been held ultra vires
by the Supreme Court in Mardia Chemical`s case supra.

 

Amendments In Other Acts Brought About
By The Act Of 2002

The
Act in hand has amended certain other Acts which are:

   
i)       
The Companies Act,
1956 by insertion of new sub-section (viia) of section 4A10;

 

 
ii)       
The Securities
Contracts (Regulation) Act, 1956 by insertion of new clause (h), after clause
(ib), of section 2; and

iii)       
The Sick Industrial
Companies (Special Provisions) Act,1985 by insertion of second and third
provisos after the proviso to sub-section (1) of section 15.

 

Impact of amendments in the Securities Contracts
(Regulation) Act, 1956 and the Sick Industrial Companies (Special Provisions)
Act, 1985 is being dealt with in the succeeding paragraphs.

 

 

Need for the Act

 

The petitioners argued that there was “no occasion to
enact such a draconian legislation to find a short-cut to realize the dues
without their ascertainment but which the secured creditor considered to be the
dues and declare the same as non-performing assests (NPA’s)”. The petitioners
further submitted-

 

(a)      
More than 50% of
the projected NPA’s are concentrated in the priority sector. They further
showed that majority of the dues are against borrowers who have dues ranging
from Rs. 25,000 and Rs. 10 Lakhs. Therefore, a special legislation aimed
primarily to recover dues from the industrial and corporate bodies does not
address the NPA problem and a knee jerk reaction.

 

(b)     
There is already a
legislation namely the Recovery of Debts Due to Banks and Financial
Institutions Act on the same issue of recovery of debts and providing an
expeditious recovery procedure through the Debts Recovery Tribunals.

(c)      
The NPA problem in
India is sexed up by certain commentators. The petitioners argued that “the
percentage of NPA of as against the GDP is only 6% in India which is much less
as compared to China, Malaysia, Thailand, Japan, South Korea and other
countries. Therefore, it is evident that resort has been taken to a drastic
legislation, under misapprehension that other ways and means have failed to
recover the dues from the borrowers.”

 

At the  very outset, the Supreme Court rejected the
argument that NPA’s due from industrial units is not a serious issue. While the
Court accepted that the Recovery of Debts Due to Banks and Financial
Institutions Act deals essentially with the same subject-matter, the Court
stated that it is a widely accepted fact that the legislation has not been very
successful in dealing with the problem of NPA’s. The Court observed-

 

“…it is to be noted that
things in the concerned spheres are desired to move faster. In the present day
global economy, it may be difficult to stick to old and conventional methods of
financing and recovery of dues. Hence, in our view, it cannot be said that a
step taken towards securitisation of the debts and to evolve means for faster
recovery of the NPA’s was not called for or that it was superimposition of
undesired law since one legislation was already operating in the field namely,
the Recovery of Debts Due to Banks and Financial Institutions Act”.

 

The Court further observed
that the NPA problem is an important issue retarding the growth of the economy
in general and the financial sector in particular. The Court pointed out that
the fact that the NPA’s have reached an alarming proportion was noted by
several committees and institutions dealing with the financial sector. The Narasimham
Committee which was constituted in 1991 in “Under Chapter V of the Report under
the heading ‘Capital Adequacy, Accounting Policies and other Related Matters’,
it opined that a proper system of income recognition and provisioning is
fundamental to the preservation of the strength and stability of banking
system. It was also observed that the assets are required to be classified; it
also takes note of the fact that the Reserve Bank of India had classified the
advances of a bank, one category of which was bad debts/doubtful debts”. The
Court also noted that the committee also recommended the setting up of a “a
separate institution by the Government of India to be known as ‘Assets
Reconstruction Fund’ (ARF) with the express purpose of taking over such assets
from banks and financial institutions and subsequently following up on the
recovery of dues owed to them from the primary borrowers”. The Court further
noted that similar concerns were raised by the Second Narasimham Committee, the
Andhyarujina Committee, and the Reserve Bank of India.

 

Against
this backdrop of rich literature, the Court rejected the contention of the
petitioners that there was no rationale for the enactment of a special
legislation to address the concern of the growing NPA’s in banks. The Court
also pointed out whether to draft a particular legislation or not is a matter
of legislative policy and “such a policy decision cannot be faulted with, nor
it is a matter to be gone into by the Courts to test the legitimacy of such a
measure relating to financial policy.” However, the Court also cautioned: “But
certainly, what must be kept in mind is that the law should not be in
derogation of the rights which are guaranteed to the people under the
Constitution. The procedure should also be fair, reasonable and valid, though
it may vary looking to the different situations needed to be tackled and object
sought to be achieved.” Hence, the Court proceeded to consider the Constitutionality
of the various provisions of the Act.

1
Mardia Chemicals Ltd. v Union of India, AIR 2004 SC 2371

2
Section 58(c) of the Transfer of Property Act, 1882

3
Mardia Chemicals Ltd. v UOI, AIR 2004 SC 2371

4
Now section 2(72) of the Companies Act, 2013, w.e.f. 12.9.2013.

5
M.R. Utensils v Union of India, (2002) 40 SEBI & Corporate Laws 360 (Guj.)
(DB).

6
Unique Enterprises Works v Union of India, 2004 (2) BC 241 (Uttaranchal) (DB).

7
Mardia Chemicals Ltd. v Union of India, AIR 2004 SC 2371

8 As
a sequel to the observations of the Supreme Court in Mardia Chemical`s case the
Act was amended by the Enforcement of Security Interest and Recovery of Debts
Laws (Amendment) Act, 2004, since brought on the statute book by Act 30 of
2004.

9
GABS (Group Apparel Business Services v Union of India, 2004 (20) AIC 304
(Del.) (DB).

10
Section 4A(viia) of the Companies Act, 1956, which was inserted by the SARFAESI
Act, 2002, has been omitted by the Enforcement of Security Interest and
Recovery of Debts Laws (Amendment) Act, 2004, w.e.f. 11.11.2004.