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INSOLVENCY AND BANKRUPTCY CODE, 2016 AND SECURITIZATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST ACT, 2002 (SARFAESI); APPLICABILITY ON BANKS.

  1. INSOLVENCY AND BANKRUPTCY CODE, 2016

    The Insolvency and Bankruptcy Code, 2016 (“Code”) offers a uniform comprehensive insolvency legislation to Corporations, Firms and Individuals (other than financial firms).

    One of the fundamental features of the Code is that it allows creditors to assess the viability of a debtor as a business decision, and agree upon a plan for its revival or a speedy liquidation.

    The IBC creates a new institutional framework, consisting of a regulator, insolvency professionals, information utilities and adjudicatory mechanisms, that will facilitate a formal and time bound insolvency resolution process and liquidation.

    Code has differentiated liquidation and Insolvency process between Corporate Debtors (which shall be dealt by the NCLT) and Individuals and firms liquidation process (which shall be of the jurisdiction of DRT), the Corporate Debtors default should be at least INR 100,000 (USD 1495) (which limit may be increased up to INR 10,000,000 (USD 149,500) by the Government).

    (i) For the Corporate Debtors’ the Code proposes two independent stages:

    • Insolvency Resolution Process: wherein the financial creditors assess the debtor’s business and evaluate whether the business can be subjected to revival procedure and evaluate options for its rescue and revival.

      The Code does not elaborate on the types of revival plans that may be adopted, which may include fresh finance, sale of assets, haircuts, change of management etc.

    • Liquidation: if the insolvency resolution process fails or financial creditors decide to wind down and distribute the assets of the debtor.

    (ii) Insolvency Resolution Process for Individuals/Unlimited Partnerships:

    For individuals and unlimited partnerships, the Code applies in all cases where the minimum default amount is INR 1000 (USD 15) and above (the Government may later revise the minimum amount of default to a higher threshold). The Code envisages two distinct processes in case of insolvencies: (i) automatic fresh start and (ii) insolvency resolution.

    Under the automatic fresh start process, eligible debtors (basis gross income) can apply to the Debt Recovery Tribunal (DRT) for discharge from certain debts not exceeding a specified threshold, allowing them to start afresh.

    The insolvency resolution process consists of preparation of a repayment plan by the debtor, for approval of creditors. If approved, the DRT passes an order binding the debtor and creditors to the repayment plan. If the plan is rejected or fails, the debtor or creditors may apply for a bankruptcy order.

  2. SECURITIZATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST ACT, 2002

    SARFAESI Act: An act to regulate securitization and reconstruction of financial assets and enforcement of security interest and to provide for a central database of security interests created on property rights and for matters connected therewith or incidental thereto.

    Under SARFAESI Act, secured creditors which include Banks and Financial institution can refer the Non-Performing Asset (“NPA”) to any Asset Reconstruction Company, established with the Reserve Bank of India under section 3 for the purposes of the Asset Reconstruction or Securitization or both.

    The provisions of this Act are applicable only for NPA loans with outstanding above Rs. 1,00,000/- (Rupees One Lakh). NPA loan accounts where the amount is less than 20% of the principal and interest are not eligible to be dealt with under this Act.

    NPA should be backed by Securities charged to the bank by way of hypothecation or charge or assignment.

    The SARFAESI Act provides for the manner for enforcement of security interests by a secured creditor without the intervention of a court or tribunal. If any borrower fails to discharge his liability in repayment of any secured debt within 60 days from the date of notice by the secured creditor, the secured creditor is conferred with powers under the SARFAESI Act to:

    1. take possession of the secured assets of the borrower, including transfer by way of lease, assignment or sale, for realizing the secured assets

    2. takeover of the management of the business of the borrower including the right to transfer by way of lease, assignment or sale for realizing the secured assets,

    3. appoint any person to manage the secured assets possession of which is taken by the secured creditor, and

    4. require any person, who has acquired any of the secured assets from the borrower and from whom money is due to the borrower, to pay the secured creditor so much of the money as if sufficient to pay the secured debt.

    The Central Government has prescribed Security Interest (Enforcement) Rules, 2002 pursuant to the powers conferred on it under the SARFAESI Act. The foregoing enforcement measures must be exercised by a secured creditor in accordance with the Enforcement Rules and are further subject to guidelines issued by the RBI.

    The SARFAESI Act deals with Securitization, Asset reconstruction, Enforcement of security without intervention of the court.

    The Measures for Asset reconstruction have been amended and the same to that effect can be found in Section 9 of the ACT.

    The rules pertaining to Security Enforcement, Debt Recovery Tribunal (Procedure) Rules, 1993, The Debt Recovery Appellate Tribunal (Procedure) Rules, 1994 have been amended to that effect To DRT (Procedure) Rules, 2016 and DRT Appellate Tribunal (Procedure) Rules, 2016, respectively.

  3. CONCLUSION:

    Banks which are considered as one of the creditors in both the cases can approach NCLT for the Corporate Debtors or the DRT in case of Individuals/Firms opting for the Liquidation and Bankruptcy wherein the Insolvency Professional shall be appointed to evaluate the financial position and weigh the options available for if possible any recovery or rescue of the Debtor.

    The Code pertains to a debt not satisfied, thus, in such cases an Insolvency Resolution Process (IRP) can be initiated by any of the creditors to the company, not necessarily being a Bank or Financial Institution. The Code thereby guarantees fair process wherein the options pertaining to liquidation or otherwise, as in if the creditors’ committee cannot agree on a plan to keep the company as a going concern, it would automatically go into liquidation. The Resolution Professional (RP) would rarely make a mistake through which the auction fails, because his/her earnings are proportional to the value of recovery.

    Where as in the case of the SARFAESI Act, the liquidation and insolvency are not the prima facie options rather a certain Asset reconstruction Firm would take up the financial assets from the Bank or the financial institution and try to reconstruct that particular NPA to revive and make it a performing Asset. The whole procedure is to be regulated by the RBI.

    The SARFAESI Act allows secured creditors to take possession over collateral against which a loan had been provided upon a default in repayment. This process is undertaken with assistance of the District Magistrate, and does not require the intervention of courts or tribunals and it is prescribed by bill that this process has to be completed in 30 days.

    The Magistrate is empowered by the bill to assist the banks in taking over the management of the company, in case the company is unable to repay the loans. This will be done in case the banks convert their outstanding debt into equity shares and consequently hold a stake of 5% of the company.

    This Act helps the Banks and Financial Institutions who are the secured creditors to enforce securities held as collaterals to loans disbursed by them, if such loans turn to be Non Performing Assets. The SARFAESI act as mentioned is applicable to the NPA which involves a willful defaulter. SARFAESI Amendment Act prescribes time limit for the proceedings.

    RBI’s timelines are as follows:

    If the account does not reflect credits, 90 days preceding the date of balance sheet of the firm and for temporary deficiencies like late/ non-submission of stock statements or balance outstanding exceeding the drawing power, non-renewal of limits it should not get categorized as NPA.

    If the borrower does not pay three installments continuously after 90 days but up to 12 months the account becomes sub-standard and NPA. Section 13 (2) empowers the Bank/ FI to serve a notice to the borrower for taking possession of the assets held as security for the money lent by it. But there is a precursor to this action: the Bank/FI shall serve notice to the borrower to discharge his full liabilities within 60 days from the date of notice that should also detail out the legal consequences and penal provisions.

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