Provision of Law where Banks/Financial Institutions can Recover the Debt amount without Judicial Intervention
There are several laws and legislations in force that regulate the process of debt recovery. The creditors could approach the Adjudicating Authorities/other Judicial Forum through a civil suit or through legislations, not limited to the Companies Act, 2013, Recovery of Debt Due to Banks and Financial Institutions Act, 1993 (DRT Act), Sick Industrial Companies Act, 1985. Specialized Tribunals/ Adjudicatory Bodies have been created over the period for dispensing justice under the abovementioned Statutes.
However, the said enactments were not able to provide satisfactory results to the Creditors. The Banks & the Financial Institutions were unable to recuperate their debts for years before these tribunals as the adjudication process has been time consuming and the said circumstances have crippled the viability of strength of the Banks and the Financial Institutions. Further, the provision of appeal etc., led to delay in the process of recovery which ultimately caused huge losses to the banks resulting in decrease in the value of the mortgaged properties.
However, the other side of the coin reveals the existence of certain model/laws enacted and enforced in the country, where the creditors including private and government Financial Institutions without the intervention of courts are entitled to take over the assets of the debtor in case of default. The said legislations are iterated as under:
1. Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI)
The legislature with an intention to speed up the recovery process and convert the Non-Performing Assets (NPA) of Banks and Financial Institutions. The Government of India has enacted the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) which empowers the Banks / FI’s to recover their NPA without the intervention of the Court. SARFAESI Act has also been given a green flag by the Hon’ble Supreme Court of India in case titled “Mardia chemicals Ltd Vs Union of India  ibclaw.in 16 SC” upholding the constitutional validity of the act.
As per the provision of section 13 of the Act, a secured creditor can enforce his interest without the intervention of the court, in case of default by the borrower towards the repayment of his loan. The borrower who defaults in the repayment of the loan as a whole or in installments, the bank reserves a right to hold his account as a non-performing asset.
A secured creditor serves a notice to the borrower to discharge his liability within a period of 60 days. If the borrower fails to do so, the secured creditor has the following remedies in order to enforce his rights:-
- The creditor can take possession of such security and have the right to transfer such security by the way of sale, lease or assignment till the extent of debt recoverable.
- The creditor can take over the management of the business of the borrower till the extent of debt due and sell, lease or assign it.
- He can appoint a manager to manage the secured asset. In case where the secured asset is sold by the borrower to a third party, a notice should be given to such bank or financial institution that the responsibility to pay the due debt shall now lie with the third party.
- Further, the secured creditor or an officer authorized by him can sell the secured asset through auction.
The SARFAESI legislation was passed with the intent to avoid judicial intervention, however when the law was implemented it was found there were litigations before the Ld. DRTs etc. However, the success rate of recovery was far better in case if compared with the laws implement before the SARFAESI. The Act has been proved to be a success in a majority of the cases, however in certain cases where issues relating to possession arises, the banks may approach the Chief Judicial Magistrate for the resolution of the same.
2. The State Financial Corporations Act, 1951
In order to meet the financial needs of Micro, Small and Medium Enterprise (MSME) which are not governed by Industrial Finance Corporation, the Government of India passed the State Finance Corporation Act in 1951. As per section 29 of the Act, in case of default by the debtor, the Financial Corporation reserves a right to take over the management or possession or both as well as the right to transfer by way of lease or sale and realise the property pledged, mortgaged, hypothecated or assigned to the Financial Corporation without the intervention of Court/Judicial Forum.
The relevant part of the Section 29 of the State Financial Corporations Act, 1951 is quoted below:
“29. Rights of Financial Corporation in case of default. —
(1) Where any industrial concern, which is under a liability to the Financial Corporation under an agreement, makes any default in repayment of any loan or advance or any instalment thereof or in meeting its obligations in relation to any guarantee given by the Corporation or otherwise fails to comply with the terms of its agreement with the Financial Corporation, the Financial Corporation shall have the right to take over the management or possession or both of the industrial concerns, as well as the right to transfer by way of lease or sale and realise the property pledged, mortgaged, hypothecated or assigned to the Financial Corporation.”
The Act empowers and allows the borrower to make use of their right to get hold of the assets of Company.
Further, as per Section 3(1) of the said Act, the State Government may, by notification in the Official Gazette, establish a Financial Corporation for the State under such name as may be specified in the notification. In light of the said Section, various sates in India had passed the law in their respective states and had similar provision (Section 29) in the state act.
3. Transfer of Property Act 1882 – English Mortgage
In general terms, a mortgage is a loan sanctioned against an immovable asset, such as a house or a commercial property. It helps the borrower unlock the otherwise locked liquidity. While understanding the terms of mortgage, we may come across its various types, one of which is English Mortgage.
English mortgage, as defined under Section 58 (e) of the Transfer of Property Act, 1882, is a scheme; wherein, the lender is entitled to take the possession of the mortgaged property in case the buyer defaults on payment. Moreover, the lender may also proceed to sell the property, sans any judicial intervention. Considered to be the safest form of mortgage, an English mortgage is usually preferred by banks and other financial institutions.
“Section 58(e) in The Transfer of Property Act, 1882 is quoted below:
(e) English mortgage. —Where the mortgagor binds himself to repay the mortgage-money on a certain date, and transfers the mortgaged property absolutely to the mortgagee, but subject to a proviso that he will re-transfer it to the mortgagor upon payment of the mortgage-money as agreed, the transaction is called an English mortgage.”
4. Indian Contract Act, 1872 – Pledge
As per section 172 of Indian Contract Act 1872 – The bailment of goods as security for payment of a debt or performance of a promise is called “pledge”. The person who delivers the goods as security is case called “pledgor/ pawnor”. The person to whom the goods are delivered is called the “pledgee /pawnee”. However, in pledge, there is no change in ownership of the property.
As per section 176 of the Contract Act: If the Pledgor makes default in payment of the debt, or performance, at the stipulated time of the promise, in respect of which the goods were pledged, the pawnee/ pledgee may bring a suit against the pledgor /pawnor upon the debt or promise, and retain the goods pledged as a collateral security; or he may sell the goods pledged on giving the pledgor /pawnor a reasonable notice of the sale. If the proceeds of such sale are less than the amount due in respect of the debt or promise, the pledgor /pawnor will still be held liable to pay the balance amount. If the proceeds of the sale are greater than the amount so due, the pawnee/ pledgee shall pay over the surplus to the pledgor /pawnor.
5. Bank Guarantees
In general terms, a Bank Guarantee is a promise made by the bank to any third party to undertake the payment risk on behalf of its customers. A bank guarantee is given on a contractual obligation between the bank and its customers. Such guarantees are widely used in business and personal transactions to protect the third party from financial losses. This guarantee helps a company to enter into transactions that it ordinarily cannot, thus helping the Companies to grow their business and promote entrepreneurial activity. However, the banks take into account the Company’s performance in the preceding financial year while providing a bank guarantee. The Banks charge some commission while providing for such guarantee which is again subject to the guidelines as set and laid down by the banks and approval from the sanctioning authority. Further, it has been laid down by the Government that with effect from July 01, 2017, GST @ rate of 18% p.a. will be levied on banking services and products. The Bank Guarantees are issued against some margin money or at 100% margin which is keep in the form of FDR.
Enforcement of Bank Guarantee and its encashment does not involve the intervention of court/Judicial authority. As soon as it is established that the party in whose favour the Bank Guarantee has been issued is satisfied and default has been occurred, the bank can enforce the Bank Guarantee and collect the money. It is pertinent to mention that the Bank Guarantees are issued against some margin money or at 100% margin or some collateral security which is kept in the form of FDR.
The above mentioned legislations interpret that the Banks and the Financial Institutions undergo huge losses while attempting to recover the debts due to them before the Adjudicating Authorities. The whole legal/litigation process is a time-consuming mechanism and by the time the Banks and the Financial Institutions attains justice, the delay in the entire procedure causes decline in the value of the assets kept with the banks. Thus, for the avoidance of the losses/damages incurred by the Banks on account of recovery of debt, the legislature has enacted several legislations which provides for several recourse opportunities in order to enable the banks to recover their dues without the intervention of the Judicial Authorities subject that the creditor falls under the above-mentioned legislation
The said legislations have been enacted to empower the Banks and the Financial Institutions to recoup their dues making correct use of the powers/rights bestowed upon them. Now, the Banks and the Financial Institutions do not only have to rely upon the Judicial Forums/Adjudicating Authorities in order to get the justice with respect to the money invested by them. These enactments have been enabled to serve justice to the banks in a favourable manner, without causing undue delay which results in insufferable loss or damage.
The Banks and the Financial Institutions grant loans pursuant to the proper documentation and hypothecation or mortgage of asset or security if any, to the Companies. Early step for the enforcement of security will facilitate better recovery with very less litigation. At the end approaching the Adjudicating Authorities for the recovery of the loan amount and/or the damages incurred by them during the period is inevitable.
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