Court denies assignee bank benefit of SARFAESI Act

By Babu Sivaprakasam, Deep Roy and Megha Agarwal, Economic Laws Practice
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The assignment of debt by banks and other financial institutions has become quite common. Bombay High Court recently adjudicated upon an interesting aspect of law in relation to one such assignment in the case of Kotak Mahindra Bank Ltd v Trupti Sanjay Mehta and Others.

Facts of the case

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Babu Sivaprakasam

In this case, a non-banking financial company (NBFC) had sanctioned a loan to an entity that defaulted in meeting its payment obligations in relation to the loan. Upon the default, the NBFC invoked the arbitration clause in the financing document and the arbitral tribunal ordered the borrower to repay the loan to the NBFC in accordance with the terms stipulated. The NBFC subsequently assigned the debt to a bank via a deed of assignment. The assignee invoked the provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act), to recover the outstanding amount and took possession of the flat which was provided as security for the loan.

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Deep Roy

The borrower filed an application before the Debt Recovery Tribunal, claiming that since the original lender (i.e. the NBFC) was not entitled to invoke the provisions of the SARFAESI Act, the assignee bank was also not entitled to take action under the act. The tribunal allowed the application and directed the bank to hand over possession of the flat. The bank filed an application before the Debt Recovery Appellate Tribunal, which was dismissed. Accordingly, the bank filed a writ petition before Bombay High Court.

Court’s findings

While considering the issue, the court delved deeply into the circumstances in which the SARFAESI Act was passed and the problem that it sought to remedy. The court observed that the statement of objects and reasons of the SARFAESI Act clearly disclose that the mechanism under the act is designed only for the benefit of banks, and financial institutions (as notified under the act), to enable faster recovery of non-performing assets.

Interpreting the definitions of “debt” and “borrower” under the SARFAESI Act, the court observed that the definition of “borrower” only includes debts assigned from banks to financial institutions or vice versa and specifically excludes entities such as NBFCs. It was contended before the court that the term “debt” would mean any debt assigned to a bank or financial institution, regardless of the nature of the assignor.

The court held that the term “assigned” in the definition of “debt” would be restricted to assignments of debt between entities to which the SARFAESI Act applies. Further, the court observed that only acquisitions by securitization or reconstruction companies of the rights or interest of a bank or financial institution are covered under the term “borrower”. In light of the scheme and provisions of the SARFAESI Act considered by the court, the court took the view that a debt assigned by an NBFC to a bank or financial institution is not covered within the definition of the term “borrower”. The court held that the assignee bank could not enforce such a debt under section 13 of the SARFAESI Act.

Analysis

The Bombay High Court division bench has interpreted the definition of the term “borrower” strictly in this judgment. Not only are NBFCs denied the benefit of the SARFAESI Act, even banks purchasing loan accounts from NBFCs, by virtue of this judgment, cannot enforce under the SARFAESI Act. It’s a rare scenario of a judgment in favour of the borrower, which has not only defaulted in meeting its payment obligations under the loan but has also not adhered to the arbitral order passed against it.

The impact of the judgment may be short-lived if NBFCs are permitted access to the provisions of the SARFAESI Act, as was proposed by the finance minister in his budget speech for this financial year.

In the event that NBFCs with a certain asset size are notified as “financial institutions” under the SARFAESI Act by the government, as was proposed in the speech, the judgment may not pose a challenge. However, any other way of making the SARFAESI Act available to NBFCs would have to be carefully worded, keeping in mind the scenario of this case.

The intent of the SARFAESI Act was to aid banks and financial institutions in recovery of loans, thereby reducing non-performing assets. In order to achieve the desired intent, it would be ideal if banks which have been assigned a debt from an NBFC are permitted to resort to action under the SARFAESI Act.

In the interim, banks, financial institutions and NBFCs will have to keep this decision of Bombay High Court in mind while considering transactions regarding assignment of debt.

Babu Sivaprakasam is a partner, Deep Roy is an associate partner and Megha Agarwal is an associate at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.

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