Applicability of SARFAESI to Assignment of Loan by an NBFC

[Siddharth Tandon is a BB.A. LL.B student at National Law University, Jodhpur]

The primary objective of enacting the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (or the SARFAESI Act) was to empower the financial institutions by identifying and remedying the problem of non-performing assets (NPA) by providing efficient solutions such as recovery of NPA without intervention of courts. Although from the time of its enactment the Act did recognise non-banking financial companies (NBFCs) as coming under the ambit of ‘financial institutions’, it required the Central Government to pass a notification stating the same. The need for such a notification was felt by the Central Government almost thirteen years after the Act came into force, when it was stated by the then Finance Minister of India, Mr. Arun Jaitley, in his 2015 budget speech.

After almost eighteen months, the Central Government passed a notification recognizing and listing a total of 196 substantially important NBFCs, which were allowed to take benefit of the provisions of the SARFAESI Act. The notification also listed certain conditions to be fulfilled by the NBFCs to come under the purview of the Act. The NBFCs should be:

  • Covered under clause (f) of section 45-I of the Reserve Bank of India Act ( or the RBI Act), 1934, which defines ‘NBFCs’
  • Registered with RBI;
  • Having assets worth rupees five hundred crore and above as per their last audited balance sheet.

In addition to this, the notification also highlighted that only those NBFCs with “such security interest which is obtained for securing repayment of secured debt with principal amount of rupees one crore and above” will be allowed to make use of sections 13 to 19 of the SARFAESI Act, which are of utmost importance when it comes to recovery of loan arrears.

This is where the notification leads to a problem. Only NBFCs which have given secured loans having a principal amount of rupees one crore or more are allowed to make use of sections 13 to 19 of the Act for recovery of the loan, while the other financial institutions have a reduced threshold of rupees one lakh. Hence, an issue arises during the assignment of loan by an NBFC to any other financial institution, where the principal amount is less than rupees one crore. Will such financial institution, which otherwise would have been allowed to use the provisions of the Act, be allowed in this situation where it is an assignee of a loan from an NBFC not coming under the purview of the Act.

Analysis

The word “assignment” can be defined as “a transfer or setting over of property, or of some right or interest therein, from one person to another; the term denoting not only the act of transfer, but also the instrument by which it is effected”.[i] As has previously been held in multiple cases, ‘assignment of loan or debt’ is permissible under the provisions of the Transfer of Property Act.

The law of assignment is based on the principle of “nemo dat quad non habet”, meaning that ‘the assignee cannot have better rights than that of the assignor’. This maxim forms the basis of the issue that if an NBFC itself does not have the right to make use of provisions of recovery of loan arrears of SARFAESI Act, how the assignee financial institution can do the same.

This question was dealt by the Bombay High Court in 2015 in Kotak Mahindra Bank Ltd v Trupti Sanjay Mehta and Others. In this case, an NBFC had sanctioned a loan to an institution which had defaulted in paying back the loan. The debt was subsequently assigned to a bank, which invoked the SARFAESI Act for recovery of the amount. The borrower filed an application with the Debt Recovery Tribunal (DRT) stating that as the original lender did not possess the right to enforce the Act, the assignee should not be allowed to do the same. Aggrieved by the judgment of the DRT which was pronounced against the bank, it filed a petition in the Bombay High Court.

The High Court delved into the definition of ‘borrower’ as defined in the SARFAESI Act to hold: “The third part [of the definition of ‘borrower’] … clearly restricts the definition to a ‘borrower’ of a Bank or Financial Institution who acquires any right or interest and specifically excludes any other type of Institution”. It went on to state that “by virtue of the restrictive definition, only debts which are assigned to a Bank from another Financial Institution (or vice versa), such debts alone are covered under the term “borrower”. If the legislature intended to expand the scope of “borrower” to mean any debt assigned to a Bank or Financial Institution by a Non-Banking Financial Institution or any other private person, it would not have excluded a Non- Banking Financial Institution or any other person in the last part of the definition.” It finally held: “The Objects and Reasons of the SARFAESI Act … clearly disclose that this mechanism has … been designed only for the benefit of Banks and Financial Institutions and not for other categories such as Non-banking Financial Institutions etc.”

The Court read the Act restrictively by not allowing ‘NBFCs’ to be interpreted into the provisions. But to place reliance on this case for answering the issue in contention would not be correct. This is because the Bombay High Court gave this judgment during the time when the Central Government had not come up with the notification identifying various NBFCs coming under the purview of the Act. Though it cannot be said that the notification overruled the judgment, it can definitely be stated that it changed the legal environment in which this issue exists. After the notification, the reasoning of the Bombay High Court holds little water.

Another case, which indirectly deals with this issue, is Indiabulls Housing Finance Limited v. Deccan Chronicles Holdings Limited. The Supreme Court in this case held: “No doubt, till the respondent (an NBFC) was not a ‘financial institution’ within the meaning of Section 2(1)(m)(iv) of the Act, it was not a ‘secured creditor’ as defined under Section 2(1)(zd) of the Act and, thus, could not invoke the provisions of the Act. However, the right to proceed under the Act accrued once the Notification was issued.” It further held: “… the definition clauses dealing with ‘debt securities’, ‘financial assistance’, ‘financial assets’, etc., clearly convey the legislative intent that the Act applies to all existing agreements irrespective of the fact whether the lender was a notified ‘financial institution’ on the date of the execution of the agreement with the borrower or not.”

This case, though relevant in the sense that it portrays the inclusive nature of the statute, does not directly give us the answer to the present issue.

Conclusion

An analysis of the present legal regime, including the cases of various courts as well as statutes have not been able to correctly provide us with a clear answer. The case of Trupti Sanjay Mehta, though directly dealing with the question, cannot be relied upon as the judgment came before the notification was passed. Similarly, the IBFSL judgment cannot be relied upon, as it is less about assignment of loan and more about whether an NBFC is allowed to make use of provisions of the Act even if the loan was given out before the notification was passed.

Therefore, according to the author, in order to arrive at an answer, a different and a more inclusive viewpoint needs to be taken. The right to make use of the provisions of SARFAESI Act cannot be considered as a contractual right, which can be transferred or taken away by way of contract. Thus, the fact that an assignee cannot have better rights than that of assignor is not applicable as the rule is in relation to contractual rights, and not in respect to legal rights. At this point, reliance can be placed on the case of ICICI Bank Limited v. Official Liquidator of APS Star Industries Ltd., where it was held: “In assigning the debts with underlying security, the bank [a financial institution] is only transferring its asset and is not acquiring any rights of its client(s)…The High Court(s) has erred in not appreciating that the assignor bank is only transferring its rights under a contract and its own asset, namely, the debt … without in any manner affecting the rights of the borrower(s) in the assets.”

Thus, as long as there is no interference with the right of the borrower, the assignment of loan should be held to be rightful, along with the assignee having full discretion to make use of the Act for recovery of loan.

Siddharth Tandon

[i] Alexander M. Burrill, A Treatise on the Law and Practice of Voluntary Assignments for the Benefit of Creditors §1, at 1 (James Avery Webb ed., 6th ed. 1894).

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