1. Verdict Corner: Sarfaesi trumps Sica

Verdict Corner: Sarfaesi trumps Sica

The SC ruling giving precedence to debt recovery over attempts to revive sick industries will help lessen banks' NPA burden

By: | Published: February 10, 2016 12:39 AM

In a judgment involving different high courts and debt recovery tribunals, the Supreme Court has laid down five guidelines on the interplay of debt recovery laws—the Sick Industrial Companies (Special Provisions) Act 1985 (Sica), the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (Sarfaesi Act) and Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (DRT Act).

While the purpose of Sica is to provide ameliorative measures for reconstruction of sick companies, the other two deal with speedy recovery of debts by banks and financial institutions (FIs).

Addressing the issue whether the public interest in recovering debts due to banks and financial institutions is to give way to the public interest in rehabilitation of sick units, the apex court has held that the new legislative scheme qua recovery of debts contained in the Sarfaesi Act has to be given precedence over the Sica. This means that the debt recovery from a sick unit will take precedence over any attempt to revive it.

In the matter of Madras Petrochemicals vs BIFR, it said that Sica will continue to apply in the case of unsecured creditors seeking to recover their debts from a sick unit. This, according to the apex court, is because Sica overrides the provisions of the DRT Act. A secured creditor of a sick unit can invoke Sarfaesi Act provisions notwithstanding the provisions of Sica.

Where at least 60% of the secured creditors don’t agree to exercise the right to realise their security under the Sarfaesi Act, then Sica will continue to have full play, the ruling stated. According to the top court, where secured creditors representing not less than 75% in value of the outstanding loan decide to enforce their security under the Sarfaesi Act, any reference pending under Sica cannot be proceeded with further and such proceedings will abate. These guidelines, meant to harmonise all the three legislations, will make it easy for secured creditors to regain their outstanding dues by selling the assets of a defunct company.

Expressing concern over mounting bad debts in the financial system, the apex court felt that though recoveries under the Sarfaesi Act had declined in FY12, it still accounted for 70% of the total. The recoveries under the DRT Act constituted only 28% of overall recoveries, it noted.

Even the Report on Trend and Progress of Banking in India 2011-2012 for the year ended June 30, 2012, submitted by RBI to the Centre, provided that the opening balance of NPAs in public sector banks for 2011-2012 was R746 billion, but the closing balance for the same period was R1,172 billion.

“All this would go to show that the amounts that public sector banks and FIs have to recover are in staggering figures and at long last at least one statutory measure has proved to be of some efficacy. This court would be loathe to give such an interpretation as would thwart the recovery process under the Securitisation Act which Act alone seems to have worked to some extent at least,” the court said.

Legal experts have also welcomed the SC decision. Says Sameer Parekh, managing partner, Parekh & Co, “Banks and financial institutions covered by the Sarfaesi Act would be able to sell the security despite the company being before BIFR. This is a landmark judgment, particularly when RBI is cracking the whip on banks to recover loans that have become non-performing assets (NPAs) and when the government is trying to repeal Sica and replace it by a Bankruptcy Code.”

While Sica was brought into force to help companies under stress to restructure and revive, it has been more misused than used. Sica has a provision for suspending rights of all creditors from pursuing legal remedies till such time as the company is before BIFR. Even though the Sarfaesi Act was enacted subsequently to Sica, the companies would take the benefit of Section 22 of Sica and prevent the secured and unsecured creditors from recovering their debts.

“In the Madras Petrochemicals matter, the company was referred to BIFR in 1989 and there were various failed attempts to revive the company. Even by 2016—27 years later—the creditors have not recovered any money,” he says.

This much-needed clarity will also streamline the existing procedures for revival and rehabilitation of potentially viable sick companies. Till the Bankruptcy Code is in place, these guidelines will aid the process of recovery of NPAs.


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