196 NBFCs notified under the SARFAESI Act

Niddhi Parmar

parmar@vinodkothari.com

Vinod Kothari & Company

Corporate Law Services Group

corplaw@vinodkothari.com

August 10, 2016

Article

Check at: http://india-financing.com/staff-publications.html for more write ups.

Copyright: This write up is the property of Vinod Kothari & Company and no part of it can be copied, reproduced or distributed in any manner. Disclaimer: This write up is intended to initiate academic debate on a pertinent question. It is not intended to be a professional advice and should not be relied upon for real life facts.

196 NBFCs notified under the SARFAESI Act

Article

This year seems to bring much needed regulatory reforms for the financial entities. First, enactment of the Insolvency and bankruptcy Code, 2016, second, enactment of the Constitution (One Hundred and Twenty-second Amendment) Act, 2016, third, enactment of the Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Bill, 2016 and finally, a time-honoured recognition under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (hereinafter referred to as “SARFAESI Act”) becomes a reality. The Finance Minister in his budget speech 2015-16 presented on February 28, 20151 said, “To bring parity in regulation of NBFCs with other financial institutions in matters relates to recovery. It is proposed that NBFCs registered with RBI and having asset size of Rs.500 crore and above will be considered for notifications as ‘financial institution’ in terms of the SARFAESI Act, 2002.” The term “Financial institution” has been defined in section 2 (1) (m) of the SARFAESI Act, in the following manner –

(i) a public financial institution within the meaning of section 4A of the Companies Act, 1956 (1 of 1956); (ii) any institution specified by the Central Government under sub-clause (ii) of clause (h) of section 2 of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (51 of 1993); (iii) the International Finance Corporation established under the International Finance Corporation (Status, Immunities and Privileges) Act, 1958 (42 of 1958); (iv) 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 (2 of 1934), which the Central Government may, by notification, specify as financial institution for the purposes of this Act;

After a lapse of almost 1.5 years from the date of budget speech, the Central Government issued a notification dated August 5, 2016 notifying 196 NBFCs2 to be recognised under the term “financial institution”.

1 See. http://indiabudget.nic.in/budget2015-2016/ub2015-16/bs/bs.pdf 2 Notification No. F. No. 6/1/2014-Recovery; See. http://egazette.nic.in/WriteReadData/2016/171157.pdf

196 NBFCs notified under the SARFAESI Act

Article

NBFCs having asset size of Rs. 500 crores or more The criteria for determining the applicability of the SARFAESI Act does not seems to be distinguishing between an NBFC holding a deposit accepting licence or a non-deposit accepting licence. The criteria are – 1. the company shall be an NBFC covered under clause (f) of section 45-I of the Reserve Bank of India Act, 1934; 2. registed with RBI and 3. having asset of Rs. 500 crore and above as per their last audited balance sheet. Further, the notification states that all the provisions of the SARFAESI Act shall apply to the notified NBFCs except “the provisions of section 13 to 19, which shall apply only to such security interest which is obtained for securing repayment of secured debt with principal amount of rupees one crore and above.” Chapter III dealing with enforcement of security interest. The term “security interest” has been defined under section 2 (1) (zf)3 to mean “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.” Any security interest created in favour of secured creditor for due repayment by any borrower of any financial assistance shall not be less than Rs. 1 crore. On careful reading of the exception, one may notice that the word used is “principal amount of rupees one crore and above”, which infers that if the secured debt (i.e. security + amount of debt) is less than Rs. 1 crore then the provisions shall not apply. Therefore, both the amount of debt and the value of security created in favour of secured creditor for the amount of debt shall not be less than Rs. 1 crore.

NBFCs notified under section 4A (1) of the Companies Act, 1956 Pursuant to the circular issued by the Ministry of Corporate Affairs dated June 2, 2011 for declaring the financial institutions as PFIs, various NBFCs upon getting the status of PFIs found an indirect way of being recognised for the purpose of SARFAESI Act. This circular was further amended by the Central Government vide its notification dated June 10, 2011 permitting

3 This definition has undergone changes pursuant to the Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Bill, 2016. Since, the final text of the Act was not available as on August 10, 2016, the author has quoted the text of the SARFAESI Act, 2002.

196 NBFCs notified under the SARFAESI Act

Article

private companies, principally engaged in infrastructure funding, to be categorized as PFIs. However, by virtue of, notification dated August 5, 2016; NBFCs with asset size of Rs. 500 crores or more are recognised under the provisions of SARFAESI Act.

Enforcement of Security Interest and Recovery of Debts Laws and

Miscellaneous Provisions (Amendment) Bill, 2016 The Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Bill, 20164 (hereinafter referred to as “Amendment Bill, 2016”) bring various major changes to the SARFAESI Act5. The scope of the term “financial institutions” has become wider to include debenture trustee registered with the Board and appointed for debt securities or by asset reconstruction company. Under the SARFAESI Act, only those debenture trustees, appointed by banks and FIs were treated as secured creditor; however, the Amendment Bill, 2016 also recognises debenture trustees appointed by companies for issue of debt securities are also covered under the term secured creditor. The Amendment Bill, 2016 provides for insertion of new chapter, i.e., Chapter IVA dealing with registration by secured creditors and other secured creditors. Section 26B propose to provide for extending the provision of registration to all creditors other than secured creditor as defined under the SARFAESI Act, for creation, modification or satisfaction of any security interest over any property of the borrower for the purpose of securing due repayment of any financial assistance granted by such creditor to the borrower. Notably, sub-clause (2) provides that any creditor including the secured creditor “may” file particulars of transactions of creation, modification or satisfaction of any security interest with the Central Registry in such form and manner as may be prescribed. The word used is “may” which implies that even if the Central Government issues notification requiring the creditors to file particulars of transaction, the creditors may or may not file such particulars. However, clause 26D of the Amendment Bill, 2016 provides that a secured creditor shall be entitled to enforce securities only if it is registered with Central Registry. Further, pursuant to clause 26E the debts due to secured creditor shall rank in priority over all other debts. One may note that this clause is a non-

4 Please note that the text of the final Act was not available as on August 10, 2016, therefore, the author has commented on the changes as per the draft Bill. 5 See clause by clause analyses at: http://www.india-financing.com/images/Articles/Comparison_-_SARFAESI_Act__Amendment_Bill_2016.pdf by Niddhi Parmar.

196 NBFCs notified under the SARFAESI Act

Article

obstante clause; therefore, once this clause is notified it shall override any other section of any law which is in force.

Registration of all transactions with CERSAI

Prior to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Central Registry) Amendment Rules, 20166 (hereinafter referred as “Amendment Rules, 2016”), the secured creditor were required to file only equitable mortgages with Central Registry of Securitisation Asset Reconstruction and Security Interest of India (“CERSAI”). However, post Amendment Rules, 2016, the secured creditors were not only required to register equitable mortgages with CERSAI but were also required to register the particulars of transactions as specified under Rule 4 (2A) to (2D)7. The Amendment Bill, 2016 further provides for insertion of new sections pertaining to integration of registration systems with Central Registry. In order to create a centralised system and avoid multiple registration system, the Central Government has been vested with the powers to create a Central Registry for recording rights over any property of creation, modification or satisfaction of any security interest on such property. Non-Banking Financial Companies (‘NBFCs’) irrespective of class or asset size were advised to file and register the records of all equitable mortgages created in their favour on or after 31st March 2011 with the CERSAI as and when equitable mortgages are created in their favour vide its circular no. RBI/2013-14/369 DNBS.(PD).CC.No.360 /03.10.001/2013-14 dated November 12, 20138. Subsequently, NBFCs were advised to register all types of mortgages with CERSAI9. With the Amendment Rules, 2016 coming into picture, various NBFCs held the view that the same shall also apply to them and the transactions stated in the said Rules were required to be registered with CERSAI. This buzz was due to an unnoticed proviso which was inserted in the Amendment Rules, 2016. Proviso to sub-rule (b) of rule 2 of the Amendment Rules, 2016 clearly stated that particulars of all subsisting transactions under sub-rule (2A) to (2D) of rule 4 shall be filed by the secured creditors with the Central Registry. The term ‘secured creditor’ as defined under section 2 (zd) of the SARFAESI Act did not include NBFCs, since, they were not notified by that time. However, due to recognition of the NBFC pursuant to notification issued by the

6 See. http://egazette.nic.in/WriteReadData/2016/167743.pdf 7 Read more at: http://www.india-financing.com/images/Articles/Second_leg_of_SARFAESI_-_all_transactions_to_be_registered_with_CERSAI.pdf by Niddhi Parmar. 8 See. https://www.rbi.org.in/scripts/BS_CircularIndexDisplay.aspx?Id=8571 9 See. https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=8782&Mode=0

196 NBFCs notified under the SARFAESI Act

Article

Ministry of Finance, now, the notified NBFCs will have to register the particulars of transactions referred under sub-rule (2A) to (2D) with CERSAI.

Conclusion The gross NPA in case of banks is much higher as compared to NBFCs. The Indian Credit Rating Agency has projected an increase in banks’ gross NPA in the range of 8-8.5 per cent by March 201710 and the India Ratings and Research has estimated an overall increase in NBFCs gross NPA to 7.8 per cent by March 201711. Further, 1.5-1.7 per cent of the increase in NBFCs gross NPA is expected pursuant to the shift to 120-day NPL recognition norm in financial year 2016-17 from 150-days at financial year 2015-16. Pursuant to recognition under the SARFAESI Act, NBFCs have been empowered to recover their NPAs without court intervention and gradually, one may expect a reduction in the ratio by virtue of this power.

10

Read more at: http://economictimes.indiatimes.com/articleshow/53212958.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst 11 Read more at: http://articles.economictimes.indiatimes.com/2016-02-07/news/70421125_1_retail-focused-nbfcs-npl-sarfaesi

Read articles on: 1. SARFAESI Act extended to NBFCs: Systematically important companies get the power to use self-help

repossession of secured assets can be viewed at: http://www.india-

financing.com/images/Articles/SARFAESI_Act_extended_to_NBFCs.pdf

2. Book on SARFAESI authored by Mr. Vinod Kothari can be viewed at: http://vinodkothari.com/secbook/

3. Our various workshops can be viewed at: http://vinodkothari.com/secwork/

4. Our various write-ups on NBFCs can be viewed at: https://www.india-financing.com/staff-publications-nbfc.html

5. Our various write-ups on Bankruptcy Code can be viewed at: http://www.india-

financing.com/component/content/article/325.html

6. Read other articles on Companies Act, 2013 at: http://www.india-

financing.com/component/content/article/281.html