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Mohan R. Lavi

Mohan R. Lavi on a case that discussed the constitutional validity of the new securitisation law

ISSUES under Section 13(9) of the Securitisation and Reconstruction of Financial Assets Act 2002 (SARFAESI) came up before the Allahabad High Court in Garlon Polyfab Industries vs SBI (Allahabad 2003 133 Taxman 493).

Garlon had borrowed from both the UP State Financial Corporation (UPSFC) and the State Bank of India (SBI). The exposure of UPSFC was higher than that of SBI. Disputes about the clean bills limit sanctioned to Garlon arose between SBI and the company.

The company became eligible to go to the BIFR, wherein BIFR permitted SBI to approach the Debts Recovery Tribunal for settlement of its dues. On the enactment of the SARFAESI Act, SBI saw an opportunity and issued a notice under Section 13(4) of the Act.

Garlon saw red and claimed that SBI has violated Section 13(9) of the Act, which stipulates that 75 per cent of the secured creditors have to agree to issue a notice under the Act in case of consortium or multiple lenders. Since Garlon had decided to proceed legally in any case, they also questioned the constitutional validity of the Act and claimed that it cannot override the provisions of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993.

The Allahabad High Court ruled that Section 13 is a drastic provision but it appears to have been enacted in view of the grave financial position in the country that huge amounts of loans are outstanding. It was not correct that Garlon did not get any opportunity of being heard as contemplated under Section 13(2).

Once a notice is given it amounts to compliance with the principles of natural justice. The obvious purpose of enacting the impugned Act was that the loans of banks and financial institutions were not being recovered promptly and that was adversely affecting the financial health of the nation.

Unless loans are repaid promptly money will not remain in circulation, and the banks and financial institutions may get into trouble. In fact, already many banks and financial institutions are in financial difficulty. However, it cannot be said that Section 13 is constitutionally invalid. Rather it serves a statutory purpose.

Also, the court ruled that where there are more than one secured creditors, no secured creditor can exercise the right under Section 13(4) unless secured creditors representing not less than three-fourths of the outstanding amount agree. Action under Section 13(4) cannot be taken in violation of Section 13(9).

It is common for banks to enter into consortium advances for large projects. In many instances, the State Financial Corporation sanctions the term loan and the working capital is funded by banks. Typically, the entire assets of the company are hypothecated pari passu to all lenders.

In a few cases, certain creditors have first charge over the assets while the others hold second charge. In case differences arise amongst the banks with regard to the methodology to be employed to recover the dues, creditors who have a first charge over the assets would be short-changed in case the others refuse for drastic action as contemplated by the Act.

Borrowers too can be good to bankers who lend them facilities, such as working capital, and so on, but stubborn with bankers who have sanctioned one-time facilities such as term loans, and so on. Prior to the enactment of SARFAESI, all bankers were uniformly approaching the Debts Recovery Tribunal for redressal of their grievances.

The Government could consider fine-tuning the Act to enable all creditors proceed independently under the Act without however sacrificing the interests of the other creditors.

A workable mechanism needs to be introduced to make the provisions effective. After a decision in the Mardia Chemicals case, one can expect a lot of action from banks and FIs. It would be prudent to be prepared on all counts now than getting battle-scarred later.

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