ASSET RECONSTRUCTION COMPANIES(Regulations)

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Operational Framework

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Legal FrameworkThe Act: SARFAESI (Securitisation and Reconstruction of Financial

Assets and Enforcement of Security Interest Act, 2002)

RBI Guidelines & Clarifications:

The Securitisation Companies and Reconstruction Companies (Reserve Bank)Guidelines and Directions, 2003

RBI Guidance Notes for Securitisation Companies and Reconstruction Companies

Sale of Financial Assets to Securitisation Company (SC)/ Reconstruction Company (RC) (Created under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002) and Related Issues

The Securitisation Companies/ Reconstruction Companies Prudential Norms (Reserve Bank) Directions, 2002 3

Need for an Act

NPAs block Bank/FI capital and have negative impact on financial sector. NPAs estimated at Rs 70,000 cr in 2002.

Legal reforms necessary to keep pace with changing industrial and financial scenario when law dodgers take protection under lenient provisions.

Overloaded Debt Recovery Tribunals (DRTs) and courts.

Urgent need to reign in willful and habitual defaulters.

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Scope & Objectives

Three objectives:

Securitization of financial assets.

Setting up of asset reconstruction companies.

Enforcement of security interest.

Earlier RBI had suggested:

To incorporate such companies for one-time operation with 7 years life, minimum paid-up capital of Rs 100 cr, and authorized capital of Rs 500 cr, with no function of securitization, taking over past NPAs of the banks at the time of incorporation and not the NPAs accruing subsequently.

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Scope & Objectives

However, GoI decided to:

Allow incorporation of such companies as ongoing entities, with power to securitize, and with initial capital of Rs 2 cr or 15% of financial assets to be acquired.

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Securitization & Securitization CompanySecuritization: Acquisition of financial asset by ARC from

Originator by raising funds from QIBs by issue of security receipts.

Financial Assets: Debt, Receivables, Claim etc.

Originator: Owner of financial asset acquired by ARC for the purpose of reconstruction or securitization.

Securitization Company: Formed under Companies Act for the purpose of securitization.

Non-corporate SPVs can securitize but can not use powers of this Act.

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Securitization & Securitization Company

QIB: Financial institution, insurance company, bank, AMC etc.

Security Receipts are offered to QIBs only, not general public.

Security Receipt: Undivided interest in the financial asset involved in securitization.

Distinct scheme is formulated by ARC for each group of security receipts issued.

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Asset Reconstruction & Asset Reconstruction CompanyAsset Reconstruction: Acquisition by ARC of interest of Bank/FI

in any financial assistance for the purpose of realization.

Only NPAs are eligible for acquistion.

Certain categories of borrowers are exempted.

Financial Institution: Includes Banks, FIs, and also the others eligible as per RBI Act.

Reconstruction Company: Company formed under Companies Act for the purpose of Asset Reconstruction.

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Borrower, Obliger & Default

Borrower: Person granted financial assistance.

Includes guarantors and co-obligants.

Obliger: Person liable to Originator.

Includes debtors of the Borrower too.

For ARC the Borrower is Obliger and the Bank/FI is Originator.

Default: Non-payment of principal or interest.

It is a necessary but not sufficient criteria to classify as NPA.

Default must have happened and account must been classified as NPA for any action under this Act.

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Security Interest

Security Interest: Right, title, and interest upon property created in favor of Secured Creditor.

Secured Debt: Debt secured by Security Interest.

Secured Asset: Property on which Security Interest is created.

Security Agreement: An agreement under which Security Interest is created in favor of Secured Creditor.

Secured Creditor: Bank/FI, Consortium, ARC, Debenture Trustee etc.

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Incorporation of ARC

Setup under Companies Act as Private or Public Ltd.

Can be setup as subsidiary of Bank/FI.

Can commence business if:

Owned funds of minimum Rs 2 cr.

Registered with RBI.

Existing ARC must register with RBI within six months and can continue business till then.

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Owned Funds

Minimum Rs 2 cr or 15% of total financial assets acquired or to be acquired.

RBI can notify different amounts of owned funds for different classes of securitization and reconstruction companies.

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Eligibility Criteria

No loss in previous three years.

Has made adequate arrangements to pay security receipt holders (QIBs).

Directors have professional experience in finance.

Sponsor must have less than 50% members in board.

Directors must not be convicted.

Sponsor can not have controlling stake in the ARC.

Compliance with prudential norms specified by RBI.

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Procedure for Registration

Application to RBI.

RBI due diligence of books of the company, and assessment as per the eligibility criteria.

RBI issues certificate of registration.

Approval of RBI required for any subsequent change in management, address, name etc.

RBI can cancel registration for violation of provisions. ARC can appeal to GoI within 60 days. ARC continues to be a SC/RC until it repays the investments held by it within the period stipulated by RBI.

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Registration of Transactions with Central RegistryAll transactions are recorded within 30 days in Central Register

by Central Registrar on intimation by ARC:

Securitization of financial assets.

Reconstruction of financial assets.

Creation of security interest.

ARC responsible to update Central Registrar for all the modifications.

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Exemptions from Purview of the Act

Securities given under the Indian Contract Act.

Conditional sale in which no security interest created.

Repayment not exceeding Rs 1 lakh.

Agricultural land.

Amount due is less than 20% of principal amount and interest thereon.

The Act covers only financial assets and that too by Banks and FIs.

If the security is easily saleable then Bank/FI can handle it themselves internally.

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Recovery Workflow

Step 1 - Physical Possession of Assets:

Bank/FI handles this directly. It prompts Borrower to repay.

Step 2 - Transfer Assets to ARC:

Value assets with mutual consent and as per RBI guidelines.

Step 3 - Securitization of Assets by ARC:

Formulate a scheme and issue Security Receipts equal to asset value to QIB to raise funds to pay Bank/FI.

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Recovery Workflow

Step 4 - Asset Reconstruction by ARC:

ARC uses powers given in the Act to ensure generation of recurring cash flows by managing business or through full/part sale of assets.

Step 5 - Redemption by QIB:

ARC utilizes cash flow generated to redeem Security Receipts issued to QIB.

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Notice to Obliger/Borrower

Bank/FI, if finds appropriate, may give notice of acquisition to Obliger.

If notice is given then Obliger will make payment directly to ARC.

If notice is not given then any payment subsequently received by Bank/FI is held in trust and delivered to ARC.

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Securitization of Assets

Not allowed to raise funds from Retail.

Funds raised from QIB by formulating a scheme.

ARC maintains separate account for each scheme.

ARC ensures realization of assets and pays returns to investors.

Issue of security exempted from registration of Security Receipt. Transfer also doesn’t require registration.

QIB holding >75% of value can call other QIBs for a resolution meeting in case of non-realization of assets.

Disputes resolved as per Arbitration & Conciliation Act.

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Powers of RBI

Can determine binding policies pertaining to:

Income recognition.

Accounting standards.

Provisions for bad & doubtful debts.

Capital adequacy based on risk weights.

Deployment of funds by ARC.

Type of assets that can be acquired.

Procedure for acquisition and valuation.

Aggregate value of assets that can be acquired.22

Measures for Asset Reconstruction

Acquisition of assets and raising funds are routine functions.

Asset reconstruction is the real business as it needs skills on the part of ARC promoters.

Success of asset reconstruction results in real turnaround of business and recycling of funds owned/raised by ARC. It enables ARC to pay for eventual redemption of securitized bonds by QIBs when they mature.

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Measures for Asset Reconstruction

ARC can take the following measures to ensure business turnaround:

Change/takeover of management of the business.

Sale/lease of part/whole of business.

Rescheduling of debt payments.

Settlement of dues payable.

Taking possession of secured assets.

Taking over Management of Business is a special power as it means taking over assets, establishment, including employees etc.

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Other Functions of ARC

ARC can perform these functions as service provider without any legal transfer of assets:

Act as Agent for Bank/FI for recovering dues.

Act as Manager of secured assets.

Act as Receiver if appointed by court or tribunal.

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Enforcement of Security Interest by Secured CreditorProve default to justify taking possession. Serve demand notice.

If repayment is not done in notice period then:

Take possession of secured assets.

Take over management of assets by appointing a person to manage the assets.

Send notice to debtors of the Borrower demanding direct payment of dues to secured creditor.

Recover expenses incurred on enforcement action.

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Enforcement of Security Interest by Secured CreditorEnforcement can be done without intervention of court or

tribunal. Civil courts have no jurisdiction to interfere.

Secured Creditor can exercise enforcement under the Act even for pending cases before civil courts/DRT by getting them transferred.

ARC comes into picture only after Secured Creditor has enforced Security Interest and taken possession.

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Notice to Borrower

Notice given to Borrower to discharge his full liabilities within 60 days of the notice. Two requirements when the notice can be issued:

Borrower must have defaulted on at least one installment.

Borrower’s loan account must have been subsequently categorized by Bank/FI and transferred to NPA.

Notice must specify the assets intended to be enforced by the Secured Creditor.

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Other Provisions

Sundry Debtors of Borrower:

Secured Creditor can pursue any debtors of the borrower.

Rights of Buyer of Secured Assets from Creditor:

All rights are transferred to the Buyer.

Claims for Expenses on Account of Action:

Recovered from Borrower.

Repayment After Possession by Secured Creditor:

If paid before the date fixed for sale/transfer the asset shall not be sold/transferred by Secured Creditor.

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Other Provisions

Consortium/Multiple Bank Financing:

Consensus of 75% by value needed to exercise rights.

Borrower Company Under Liquidation:

Sales proceeds distributed as per Companies Act.

Liability of Secured Creditor to Remit Workmen Dues:

Secured Creditor entitled to sale proceeds after depositing the workmen’s dues with the liquidator in accordance with Companies Act.

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Other Provisions

Recovery of Residual Dues after Exhausting Security Interest Enforcement:

If dues are not fully satisfied by sale of assets then Secured Creditor applies to DRT for recovery of balance amount from Borrower.

Action Against Guarantor & Assets Under Pledge:

Secured Creditor can proceed against Guarantors or sell the pledged assets.

Miscellaneous:

After receipt of notice secured asset can not be sold or transferred by Borrower without consent of Secured Creditor.

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Right to Appeal

Any person (including Borrower) can appeal to DRT within 45 days of the date when the measure was taken.

In case of Borrower, appeal will not be entertained by DRT unless Borrower deposits 75% of the amount in notice. DRT can waive or reduce this deposit amount.

Any person aggrieved by any order made by DRT can appeal to Appellate Tribunal (AT) within 30 days.

DRT/AT dispose of appeal in accordance with Recovery of Debts due to Bank/FI Act 1993.

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List of ARCs

Asset Reconstruction Company (India) Ltd, (ARCIL)

Assets Care Enterprise Ltd.,

ASREC (India) Ltd,

Pegasus Assets Reconstruction Pvt. Ltd.

Dhir & Dhir Asset Reconstruction & Securitisation Company Ltd.

International Asset Reconstruction Company Pvt. Ltd.

Reliance Asset Reconstruction Company Ltd.

Pridhvi Asset Reconstruction and Securitisation Company Ltd.

Phoenix ARC Pvt Ltd.

Invent Assets Securitisation & Reconstruction Private Limited

JM Financial Asset Reconstruction Company Limited

India SME Asset Reconstruction Company Limited (ISARC)

Edelweiss Asset Reconstruction Company Limited

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Thank You!

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