The government during June 2002 promulgated the "The Securitisation And Reconstruction of Financial Assets And Enforcement Of Security Interest Ordinance, 2002" for setting up asset reconstruction companies and for securitisation by these companies of NPAs of banks/FIs taken over by them. The measure is intended to facilitate banks and financial institutions to utilise the services of ARCs/SCs for speedily recovering dues from defaulters and to reduce their non-performing assets, now estimated at over Rs.70,000 Crores. The Ordinance contains provisions that would make it possible for ARCs/SCs to directly take possession of the secured assets and/or the management of the defaulting borrower companies without having to resort to time consuming process of litigation and without allowing borrowers to take shelter under provisions of SICA/BIFR. The ordinance is based on the suggestions of Narasimham and Andhyarujina committees.
An ordinance can be promulgated by the President under advice of the Council of Ministers to meet urgent contingencies, when parliament is not in session. Needless to point out that the Government attaches top most priority to finding ways of liquidating the huge NPA burden of Banks and FIs and made commitment to set up ARCS in the current year budget speech of the Finance Minister.
The Need for the Ordinance
Quite a few pressing factors urged the need for enacting the Ordinance to set up ARCs/SCs?
First concern is the impact of the burden of ballooning Non-performing Assets on the health of the financial sector, estimated exceeding Rs.70,000 Crores at present.
There is also urgent need for legal reforms to keep pace with the changing industrial and financial scenario of the times. Several laws in the country have turned archaic and out of times, having been legislated over a century back. The present legal structure in the country enables criminals and law dodgers to take protection under its too lenient and cumbersome provisions, and to delay or defeat punitive action against them. This prevents effecting positive remedial measures without undue delay
Piling up of large overload of cases with DRTs & Law Courts resulting in slower processing in the Debt Recovery Tribunals (DRTs) and the courts.
An urgent need to take tougher measures to reign in the exploding problem of Non-performing Assets especially for tackling willful defaulters, who have learnt to perfect the art of defaulting/dodging repayment with a habitual recurrence.
Scope & Objectives of the Ordinance
The object clause of the Ordinance describes the legal measure as "An Ordinance to regulate securitisation and reconstruction of financial assets and enforcement of security interest and for matters connected therewith or incidental thereto". The Ordinance allows setting up of ARC/SC companies to be registered with and regulated by RBI. Under the Ordinance identical powers and functions are prescribed for both types of companies, Securitisation Companies and Asset Reconstruction Companies.
Scope of the Ordinance
As per an official release of Government of India from New Delhi, "The ordinance deals with three distinct actions in respect of financial assets held by banks and FIs in the form of securitisation of financial assets, setting up of asset reconstruction companies and enforcement of security interest." These three actions are in fact not seen as distinct, but inter-connected. Securitisation as a co-function helps ARC/SC companies to operate with minimum capital under a sort of self-generated source of funding, while enforcement of security interest helps ARC/SC companies to take possession, to securitise and later to realise the financial assets, more quickly and easily without approaching DRTs or Law Courts.
During January 2002, the Reserve Bank of India, while forwarding its recommendation to the Government for setting up of Asset Reconstruction Companies, had suggested such companies for one time operation with a maximum life-span of seven years and a minimum initial paid-up capital of Rs 100-crore. The suggestion places the authorised capital of ARCs at Rs 500 crore. RBI had then contemplated ARC companies as distinct entities, without the function of securitisation of assets. They would only take over past NPAs of the bank at the time of their incorporation and not NPAs accruing subsequently. However the Government of India by combining and empowering the functions of Asset Reconstruction and securitisation to be exercised by a single entity, has enabled ARC/SC companies to be incorporated with an initial capital of Rs.2 Crores (minimum) or 15% of the financial assets to be acquired (maximum). RBI is vested with powers, under the Ordinance, to stipulate the quantum of capital to be owned by ARC/SC companies within this range, and for regulating the functioning of these companies after registration.
Definition of Important Legal Terms Used in the Ordinance
Understanding the legal definitions of the words and terms is important for the proper interpretation of the provisions of the ordinance. It is also provided that "Words and expressions used and not defined in this Ordinance but defined in the Indian Contract Act, 1872 or the Transfer of Property Act, 1882 or the Companies Act, 1956 or the Securities and Exchange Board of India Act, 1992 shall have the same meanings respectively assigned to them in those Acts."[Section 2(2)].
Securitisation & Securitisation Company
The Ordinance defines securitisation as per Clause 2(1)(z) as under -
"securitisation" means acquisition of financial assets by any securitisation company or reconstruction company from any originator, whether by raising of funds by such securitisation company or reconstruction company from qualified institutional buyers by issue of security receipts representing undivided interest in such financial assets or otherwise;[Section 2(1)(z)]
The term "financial assets" has been defined in Clause 2(1)(l) as under:
"financial asset" means debt or receivables and includes--
a claim to any debt or receivables or part thereof, whether secured or unsecured; or
any debt or receivables secured by, mortgage of, or charge on, immovable property; or
a mortgage, charge, hypothecation or pledge of movable property; or
any right or interest in the security, whether full or part underlying such debt or receivables; or
any beneficial interest in property, whether movable or immovable, or in such debt, receivables, whether such interest is existing, future, accruing, conditional or contingent; or
any financial assistance;
"originator" means the owner of a financial asset which is acquired by a securitisation company or reconstruction company for the purpose of securitisation or asset reconstruction;[Section 2(1)(r)]
The ordinance defines "securitisation company" as any company formed and registered under the Companies Act, 1956 for the purpose of securitisation.[(Section 2(1)(za)]. It thus precludes such companies registered under the Indian Trusts Act and engaging exclusively in the function of securitisation of assets . There is no bar on securitisation through non-corporate Special Purpose Vehicles (SPVs) outside the law, but such entities cannot exercise powers under this Ordinance. The ordinance therefore may be considered as not to be legislating on "securitisation" as such but on this function to be exercised specifically by ARC companies for asset reconstruction of NPAs of banks/FIs exclusively.
"qualified institutional buyer"
is defined as "a financial institution, insurance company, bank, state financial corporation, state industrial development corporation, trustee or any asset management company making investment on behalf of mutual fund or provident fund or gratuity fund or pension fund or a foreign institutional investor registered under the Securities and Exchange Board of India Act, 1992 or regulations made thereunder, or any other body corporate as may be specified by the Board."[Section 2(1)(u)]
As per this definition 'securitisation' implies acquisition of the financial asset by the ARC/SC from the bank or financial institution (referred as originator). Acquisition can be normally by raising funds by securitisation of financial assets taken over by issue of security receipts. The security Receipt are backed by a charge on the financial assets and the eventual cash flow to be generated from that asset by sale, lease or by managing such assets. The security receipt are to be offered to the QIB i.e. qualified institutional buyers only and not to the general public.
"Security Receipt"
is defined vide Section 2(1)(zg) as " a receipt or other security, issued by a securitisation company or reconstruction company to any qualified institutional buyer pursuant to a scheme, evidencing the purchase or acquisition by the holder thereof, of an undivided right, title or interest in the financial asset involved in securitisation. A distinct scheme is to be formulated by the ARC/SC for each group of security receipts issued by them to QIBs.
Asset Reconstruction & Asset Reconstruction Company
"asset reconstruction" means acquisition by any securitisation company or reconstruction company of any right or interest of any bank or financial institution in any financial assistance for the purpose of realisation of such financial assistance;[ Section 2(1)(b) ]
The ordinance as explicitly stated in the above definition applies only to securitisation of financial assets of banks and financial institution. In particular only NPAs can be handled by the ARC/SC companies formed under the Ordinance. NPAs relating to certain categories of borrowers are exempted under the provisions of the Ordinance.
However under Section 2(1)(m) a wide definition is given to the term "financial institution" to include not only banks and Term Lending Institutions, but also "any other institution or non-banking financial company as defined in clause (f) of section 45-I of the Reserve Bank of India Act, 1934, which the Central Government may, by notification, specify as financial institution for the purposes of this Ordinance;"
"reconstruction company" means a company formed and registered under the Companies Act, 1956 for the purpose of asset reconstruction; [(Section 2(1)(v)]
"Borrower", "Obliger" & "Default"
"Borrower" means any person who has been granted financial assistance by any bank or financial institution or who has given any guarantee or created any mortgage or pledge as security for the financial assistance granted by any bank or financial institution and includes a person who becomes borrower of securitisation company or reconstruction company consequent upon acquisition by it of any rights or interest of any bank or financial institution in relation to such financial assistance;
The definition of the term borrower under the ordinance is wider and covers not only borrowers, but also guarantors and all types of co-obligants.
"obligor" means a person liable to the originator, whether under a contract or otherwise, to pay a financial asset or to discharge any obligation in respect of a financial asset, whether existing, future, conditional or contingent and includes the borrower;[Section 2(1)(q)].
The term "obliger" includes in addition to the "borrower" as defined above, 3rd parties, who have taken on credit part or all of the secured assets, but have not paid for the same. In other words debtors of the borrower on the date of take over of the secured assets under the Ordinance.
It may be clarified that the borrower is referred as "obliger" and "Bank/FI" as "originator" respectively in relation to the ARC/SC. For the ARC/SC the borrower is not a borrower, but an "obliger" and the bank/FI, the "originator".
"default" means non-payment of any principal debt or interest thereon or any other amount payable by a borrower to any secured creditor consequent upon which the account of such borrower is classified as non-performing asset in the books of account of the secured creditor in accordance with the directions or guidelines issued by the Reserve Bank;[Section 2(1)(j)]
There should be "default" by the "borrower"(as defined in the Ordinance) for the process under the Ordinance to be initiated. Default implies failure to repay plus as a consequent classification of the borrower's account as a non-performing asset. Thus if the account of the borrower is not transferred as NPA, action under the ordinance is not possible even if there is default.
Security Interest & allied terms
"security interest" means right, title and interest of any kind whatsoever upon property, created in favour of any secured creditor and includes any mortgage, charge, hypothecation, assignment other than those specified in section 31;[ section 2(1)(zf)]
It is important to understand correct meaning of this term, as the Ordinance deals extensively with "enforcement of security interest"
"secured debt" means a debt which is secured by any security interest;[Section 2(1)(ze)]
"secured asset"
means the property on which security interest is created;[Section 2(1)(zc)
"security agreement" means an agreement, instrument or any other document or arrangement under which security interest is created in favour of the secured creditor including the creation of mortgage by deposit of title deeds with the secured creditor; [Section 2(1)zb)]
"secured creditor" means any bank or financial institution or any consortium or group of banks or financial institutions and includes--
debenture trustee appointed by any bank or financial institution; or
securitisation company or reconstruction company; or
any other trustee holding securities on behalf of a bank or financial institution, in whose favour security interest is created for due repayment by any borrower of any financial assistance;[Section 2(1)(zd)]
