Unit-8-

Advances secured by collateral securities and law relating to

debt recovery
Introduction
 The flow of credit relies on the sanctity of the debt contract. A
debt contract is one where a borrower raises money with the
promise to repay interest and principal according to a specified
schedule. If the borrower cannot meet his promise, he is in
default.
 In the standard debt contract through the course of history
and across the world, default means the borrower has to make
substantial sacrifices, else he would have no incentive to repay.
For instance, a defaulting banker in Barcelona in mediaeval
times was given time to repay his debts, during which he was
put on a diet of bread and water. At the end of the period, if he
could not pay he was beheaded. Punishments became less
harsh over time. If you defaulted in Victorian England, you went
to debtor’s prison. Today, the borrower typically only forfeits
the assets that have been financed, and sometimes personal
property too if he is not protected by limited liability, unless he
has acted fraudulently.
 The sanctity of the debt contract has been continuously eroded
in India in recent years, not by small borrower but by the large
borrower. And this has to change if we are to get banks to
finance the enormous infrastructure needs and industrial
growth that this country aims to attain.
 In much of the globe, when a large borrower defaults, he is
desperate to show that the lender should continue to trust him
with management of the enterprise. In India, too many large
 borrowers insist on their divine right to stay in control despite
their unwillingness to put in new money.
 The Debts Recovery Tribunals (DRTs) were set up under the
Recovery of Debts Due to Banks and Financial Institutions
(RDDBFI) Act, 1993 to help banks and financial institutions
recover their dues speedily without being subject to the
lengthy procedures of usual civil courts.
 The Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interests (SARFAESI) Act, 2002 went a
step further by enabling banks and some financial institutions
to enforce their security interest and recover dues even
without approaching the DRTs. Yet the amount banks recover
from defaulted debt is both meagre and long delayed.
 The rationale behind bringing a new legislation is contained in
the Tiwari Committee Report, which stated: " The civil courts
are burdened with diverse types of cases. Recovery of dues due
to banks & financial institutions is not given any priority by the
civil courts. The banks and financial institutions like any other
litigants have to go through a process of pursuing the cases for
recovery through civil courts for unduly long periods."
 They suggested to set up quasi-judicial bodies to deal
exclusively with the recovery process of the financial sector.
The Committee on financial system chaired by Shri Narasimham
in its report to the Ministry of Finance, Government of India in
November 1991, endorsed the views of the Tiwari Committee
for setting up special legislation and special tribunals to
expedite the recovery process in the financial sector. Thus the
Recovery of Debts Due to Banks and Financial Institutions Act,
1993 was passed.
 The preamble of the Recovery of Debts Due to Banks &
Financial Institutions Act 1993.(RDB Act, DRT Act) –An Act to
 provide for the establishment of Tribunals for expeditious
adjudication & recovery of debts due to banks & financial
institutions & for matters connected therewith or incidental
thereto.
 Amendment of the Act in 2000- the legality & validity of this
was challenged in the Delhi High Court Bar Association v. UOI
Debt Recovery Tribunals
 Debt Recovery tribunals were constituted with the objective of
providing a faster & more efficient mode of recovery of debts
for banks & financial institutions.
 In almost all cases the suit instituted by banks and financial
institutions, there was delay in disposal of the cases in the
court often not due to the fault of the banks or financial
institutions.
DRT’s -Reason for failure
 The amount recovered from cases decided in 2013-14 under
DRTs was Rs. 30590 crore while the outstanding value of debt
sought to be recovered was a huge Rs. 2,36,600 crore. Thus
recovery was only 13% of the amount at stake.
 Even though the law indicates that cases before the DRT should
be disposed off in 6 months, only about a fourth of the cases
pending at the beginning of the year are disposed off during
the year – suggesting a four year wait even if the tribunals
focus only on old cases.
 However, in 2013- 3 14, the number of new cases filed during
the year was about one and a half times the cases disposed off
during the year. Thus backlogs and delays were growing, not
coming down.
 The judgments of the DRTs can be appealed to Debt Recovery
Appellate Tribunals, and while there are 33 of the former, there
are only five of the latter.
 And even though section 18 of the RDDBFI Act is intended to
prevent higher constitutional courts from intervening routinely
in DRT and DRAT judgments, the honorable Supreme Court
recently lamented that “It is a matter of serious concern that
despite the pronouncements of this Court, the High Courts
continue to ignore the availability of statutory remedies under
the RDDBFI Act and SARFAESI Act and exercise jurisdiction
under Article 226 for passing orders which have serious adverse
impact on the right of banks and other financial institutions to
recover their dues.”
 The consequences of the delays in obtaining judgements
because of repeated appeals implies that when recovery
actually takes place, the enterprise has usually been stripped
clean of value.
 The depreciated value of what the bank can hope to recover is
a pittance. This skews bargaining power towards the borrower
who can command the finest legal brains to work for him in
repeated appeals, or the borrower who has the influence to
obtain stays from local courts – typically the large borrower.
Faced with this asymmetry of power, banks are tempted to
cave in and take the unfair deal the borrower offers.
 The total write-offs of loans made by the commercial banks in
the last five years is 161018 crore, which is 1.27% of GDP. Of
course, some of this amount will be recovered, but given the
size of stressed assets in the system, there will be more write-
offs to come.
 (To put these amounts in perspective – thousands of crore
often become meaningless to the lay person – 1.27% of GDP
 would have allowed 1.5 million of the poorest children to get a
full university degree from the top private universities in the
country, all expenses paid.)
 What we need is a more balanced system, one that forces the
large borrower to share more pain, while being a little more
friendly to the small borrower. The system should shut down
businesses that have no hope of creating value, while reviving
and preserving those that can add value.
 And the system should preserve the priority of contracts, giving
creditors a greater share and greater control when the
enterprise is unable to pay, while requiring promoters to give
up more.
Banking Industry-Overview
• Indian banking Industry has emerged into a complex multi-tier
structure with big, small and financial institutions operating in
the financial sector.
• The need to form state sponsored institutions to increase flow
of credit to the rural areas led to the formation of State Bank of
India in 1955.
• Social control on banks led to the emergence of nationalization
& 1969 saw the nationalization of 14 major banks.
• 1990’s saw major reforms of moving towards international
norms and major changes in banks with a more liberalized
approach of lending.
• With growth came the severe problem of NPA’s.
• Non Performing loans also referred as non performing assets
are loans that are in risk of default. An asset becomes non
performing when it ceases to generate income for the bank.
• Banks classify an account as NPA only if the interest due &
charged on that account during any quarter is not serviced fully
within 90 days from the end of the quarter.
• In March 2018, non-performing assets (NPAs) at commercial
banks amounted to ₹10.3 trillion.
• Public sector banks (PSBs) accounted for ₹8.9 trillion, or 86%, of
the total NPAs
• These are levels typically associated with a banking crisis.
• The answer lies partly in the credit boom of the years 2004 to
2006.
• In that period, commercial credit doubled. It was a period in
which the world economy as well as the Indian economy were
booming. Indian firms borrowed furiously in order to avail of
the growth opportunities they saw coming.
• Most of the investment went into infrastructure and related
areas — telecom, power, roads, aviation, steel.
• Businessmen were overcome with exuberance and they
believed, as many others did, that India had entered an era of
9% growth.
• But soon after, as the Economic Survey of 2016-17 notes, many
things began to go wrong.
• There were problems in acquiring land and getting
environmental clearances and several projects got stalled.
Project costs soared.
• At the same time, with the onset of the global financial crisis in
2007-08 and the slowdown in growth after 2011-12, revenues
fell well short of forecasts.
• As a result, financing costs rose as policy rates were tightened
in India in response to the crisis.
• Further, the depreciation of the rupee meant higher outflows
for companies that had borrowed in foreign currency.
High levels of NPA & the problems associated with it.
• Decline of assets in the financial sector and increase of
operating expenses.
• Diversion of management and financial resources to NPA
problems and drifting away from more productive business
problems/functions.
• The illiquid nature of NPA and loss of depositor and interbank
confidence often rise to funding problems.
• Banks become averse to risk and lending/credit takes a
backseat resulting in a credit crunch that slows down economy.
• Real estate properties tied up as collateral to defaulted loans
create stagnant property markets with excess capacity.
• Unavoidable government costs of resolving NPA problems
affects budgets and divert resources away from important
government programs.
• Govt response to NPA over the last 35 years
• Sick Industrial Companies Act 1985
• RBI set up the Tiwari Committee in 1981 to examine the
reasons for the high sickness in the industry and suggest
measures to deal with the problem of industrial sickness. The
Committee suggested the need for a special legislation to
provide for speedy revival of sick industries in the lines of US
chapter 11 proceedings and winding up of unviable units.
• This led to the enactment of SICA in 1985 –the main objective
of the Act was to provide for timely detection of sickness in
industrial companies & of expeditious determination by a body
of experts the BIFR( the Board for Industrial and Financial
Reconstruction) and adoption of preventive, reconstructive,
remedial and other suitable measures.
• RDDBFI Act 1993
• The Committee on financial system chaired by Shri Narasimhan
in its report to the Ministry of Finance, in November 1991,
endorsed the views of the Tiwari Committee for setting up
special legislation and special tribunals to expedite the recovery
process in the financial sector. (at that time more than ₹5622
crores was owed to Public sector banks and ₹391 crores to
other financial institutions).
• Thus the Recovery of Debts Due to Banks and Financial
Institutions Act, 1993 was passed.
• Debt Recovery tribunals were constituted with the objective of
providing a faster & more efficient mode of recovery of debts
for banks & financial institutions.
• However in almost all cases the suit instituted by banks and
financial institutions, there was delay in disposal of the cases
often not due to the fault of the banks or financial institutions.
• The total number of cases filed in DRT’s by scheduled
commercial banks amounted to 1,50,503 of which ₹2601
billions was the amount involved. Only 427 billions(16.43%)
were recovered till March 2014. Within less than a decade it
became clear that the DRT’s failed to serve their purpose.
• SARFAESI Act 2002
• There were several loopholes in the RDDBFI Act and these
loopholes were mis-used by the borrowers, which led the
 government to introspect the Act and another committee
under Mr. Andhyarujna was appointed to examine banking
sector reforms and changes in law relating to debt recovery.
• This led to the passing of SARFAESI Act in 2002. The
Securitization & Reconstruction of Financial Assets and
Enforcement of Security Interest Act allows banks and other
financial institution to auction residential or commercial
properties to recover loans when borrowers fail to repay their
loans.
• It enables banks to reduce their non-performing assets(NPA’s)
by adopting measures for recovery or reconstruction.
• SARFAESI Act (2002) provides a three way procedure for
recovery of dues due to Banks and FIs. Firstly, it provides a legal
framework for securitization of assets in India, secondly it
enables sale or transfer of NPA accounts to ARCs and clean up
the balance sheet and thirdly, it gives power to the banks and
FIs to takeover immovable properties charged to the bank and
enforce security by way of auction or private treaty and adjust
the proceeds towards the dues without the intervention of
courts.
• Under SARFAESI also there is recourse for the respondents with
DRTs if they are affected by the action of banks.
• However, if the asset in question is an unsecured asset, the
bank would have to move the court to file civil case against the
defaulters.
• The procedure is as follows:
•
1. The Bank or Financial Institution gives a notice under
section 13 (2) to the defaulting borrower whose account was
categorized as “NPA” (default of 90 days)
 2. The borrower who receives the notice under section 13 (2),
can send his objections to the Bank’s claim within the time
limit.
• 3. The Bank shall consider the objections and however, it need
not pass any order after considering the objections. This
enables the Bank to correct itself if it is wrong in the process of
adjudication.
• 4. When the Bank feels that the objections are not tenable,
then, the Bank can take possession of the secured asset by
issuing a notice under section 13 (4).
• 5.Steps under section 13 (4), gives the borrower a right to file
an appeal to the Debt Recovery Tribunal under section 17 and
further appeal to the Debt Recovery Appellate Tribunal under
section 18.
• 6. Not only the borrower, any person who is aggrieved by the
action taken by the Bank under section 13 of the Act, can
approach the Tribunal in accordance with the procedure.
• Conditions- The Act stipulates four conditions for enforcing the
rights by a creditor(bank/nbfc)
• The debt is secured;
• The debt has been classified as an NPA by the banks,
• The outstanding dues are one lakh and above and more than
20% of the principal loan amount and interest there on;
• The security to be enforced is not an Agricultural land.
• The SARFAESI Act also provided for the establishment of Asset
Reconstruction Companies regulated by RBI to acquire assets
from banks and financial institutions.
• It provides for sale of financial assets by banks and financial
institutions to Asset Reconstruction Companies.
• RBI has issued guidelines to banks on the process to be
followed for sales of financial assets to Asset Reconstruction
Companies.
DRT vs. SARFAESI
• DRT- DRT’s are for recovery of outstanding amount against
borrower’s with or without secured asset.
• Tribunal for recovery of outstanding loans.
• SARFAESI- Is for attachment of secured asset for non payment
of loan amount of banks and NBFC’s without going to DRT’s.
• Mechanism for attachment of secured assets by banks without
intervention of any one.
RDDBFI v. SARFAESI
RDDBFI- The RDDBFI Act enables the Bank to approach the
Tribunals when the debt exceeds the prescribed limit.
• Under RDDBI Act, the Debt Recovery Tribunal will adjudicate
the amount that is due and passes the final award.
SARFAESI- SAFAESI Act, provides a procedure wherein the Bank
or Public Financial Institution itself will adjudicate the debt.
Only after adjudication by the Bank, the borrower is given right
to prefer an appeal to the Tribunal under SARFAESI Act, 2002.
• The Banks or Financial Institutions can invoke the provisions of
SAFAESI Act, 2002 only in respect of secured assets and not all.
Thus, under SARFAESI Act, 2002, the Banks are given powers
under section 13 to carry out the adjudication exercise.
• Asset Reconstruction Companies-ARC’s purchases bad assets
or NPAs from banks at a negotiable price and helps banks to
clean up their balance sheets (by removing the NPAs).
• ARCs are in the business of buying bad loans from banks.
• ARCs clean up the balance sheets of banks when the latter sells
these to the ARCs. This helps banks to concentrate in normal
banking activities. Banks rather than going after the defaulters
(wasting their time and effort), can sell the bad assets to the
ARCs at a mutually agreed value.
Out of Court Restructuring Framework
• -RBI introduced a scheme for out of court restructuring of
corporate loans in 2001.
• CDR ( Corporate Debt Restructuring Scheme) is a non-
statutory, voluntary and contractual arrangement based on the
debtor-creditor agreements.
• The agreements are legally binding but their enforceability has
been low.
• Foreign lenders are not part of the CDR system and it focused
more on financial restructuring than operational restructuring,
lenders were interested in recovering money rather than
encouraging business restructuring.
• In 2014 RBI set up the Joint lending forum (JLF) to provide a
more flexible mechanism to restructure debt.
• In 2015, RBI formulated the SDR (Strategic Debt Restructuring
Scheme) to enable banks to convert loan into equity.
• In 2016 a scheme for S4A (Sustainable Structuring of Stressed
Assets) was also introduced in 2016 to ensure more stake of
promoters of distressed enterprises in reviving the company
 and provide banks enhanced capabilities to change ownership
of debtor companies.
• RBI issued a number of One Time Schemes for settlement of
dues between lenders & borrowers. But most of them failed as
writing off loans often brought investigating bodies who
questioned the merits of such waiver. (This also brought illicit
associations between some banks & promoters.)

Insolvency & Bankruptcy Code, 2016

• In 2004 Irani Committee was constituted and the committee
proposed significant legislative changes to make the
restructuring & liquidation process speedy, efficient and
effective.
• The government later introduced a Bill in Parliament to
implement reforms & the proposed law allowed debtor to
continue in possession with an independent oversight of
insolvency practitioner over the debtor.
• The provision for setting up of creditor committee was also
introduced.
• Moratorium could be granted only on determination of
sickness of companies which was moved to default test from
balance sheet test provided under SICA.
• NCLT was to empowered to function as a bankruptcy court &
timelines were also provided for each stage of proceedings.
• After nearly two decades of work by various committees the
Bankruptcy Law Reform Committee was constituted by the
department of Economic Affairs, Ministry of finance under the
chairmanship of T.K Viswanathan in Aug 2014.
• The mandate of the committee was to study the corporate
bankruptcy legal framework in India & submit a report to the
government for reforming the system.
• The committee approached the framing of code in a two
phased manner-
- (a) to examine the existing legal framework for corporate
insolvency & suggest immediate reforms (for which the
committee submitted an interim report)
- (b) to develop an ‘Insolvency Code’ for India covering all the
aspects of personal and business insolvency (C submitted its
report in Nov 2015 in two volumes- Vol.1(Rationale & Design)
Vol.II (Draft Code)
- IBC was introduced in Lok Sabha on 21 Dec 2015 & was then
referred to a joint committee of both houses of the parliament.
- It was passed in the Lok Sabha on 5 May 2016, Rajya Sabha
passed it on 11 May 2016 & the President’s assent was granted
on 28 May 2016.
- The Insolvency and Bankruptcy Code was implemented in 2016
to facilitate
-timely resolution of insolvency and bankruptcy cases,
-provide maximization of value of assets,
-reorganization of business of corporate debtors,
-facilitate credit market,
-encourage entrepreneurship in India and to balance the
interest of all stake holders.
The Insolvency and Bankruptcy Code proposes two stages for
effective debt recovery-
• The first stage involves insolvency resolution negotiation;
whereby the viability of running the enterprise and protecting
the rights of creditors is assessed and
• second stage when negotiation to run the entity fails,
liquidation of the corporate entity is proposed.
• The code proposes to conclude both processes in a time bound
manner.