Creditors may be allowed to exercise first right over assets

Written by Arun S | Gireesh Chandra Prasad | Gireesh Chandra Prasad | New Delhi | Updated: Aug 5 2014, 05:51am hrs
The government is planning legislative changes to enable secured creditors having first right over defaulters' assets to exercise the same, without being interrupted by the tax authorities. The idea is to make use of the overriding nature of the Sarfaesi Act to virtually ensure that a lender gets to recover dues from a defaulter before others.

According to the proposed change in the Sarfaesi Act, whoever registers their charge on an asset first with the designated central registry will get priority over others in recovering the dues by attaching the assets. Since lenders practically are the first to do such registration (at the time of giving the loan), this would in most cases lead to their lien getting precedence.

Currently, the out-of-the-court mechanism under Sarfaesi Act allows secured creditors to take possession of the assets of a firm under liquidation if their dues are not paid within two months of raising demand. However, in practice, tax authorities and municipal corporations often attach the assets of a defaulting company beforehand, which comes in the way of lenders recovering their dues.

The tax departments draw the powers to attach from their respective laws Income Tax Act, Central Excise Act and the like. As per the new proposal, the provisions of Sarfaesi Act of 2002, which is a relatively new law, will prevail over those of older statutes and will effectively protect the interest of lenders without any amendment to any other law.

According to sources, in this regard the Department of Financial Services in the finance ministry is considering incorporating in the Sarfaesi Act the principle of first to register a lien on the assets of defaulting companies. Sources said the move would not impinge on the taxman's right to recover dues by impounding defaulters' assets, despite lenders' lien getting priority.

The registration has to be with the Central Registry of Securitisation Asset Reconstruction and Security Interest of India (Cersai) set up to eliminate instances of multiple lending on the same property.

The proposed amendments also include a provision to classify central and state authorities handling income tax, excise and value added tax as well as municipal corporations as secured creditors, so that the moment a taxpayer defaults, the authorities would need to register their charge on the assets. However, if the company has already taken a loan, the lender would have already registered his charge on the assets, giving the tax authorities only second charge on the assets.

Currently, secured creditors include banks, financial institutions, debenture trustees appointed by banks, securitisation companies, asset reconstruction companies and any other trustee holding security. These changes to the Sarfaesi Act will be a huge leapfrog in terms of reforms in this area. States which agree to this provision may soon be perceived as more investor friendly and therefore would see greater lending by banks and financial institutions, said an expert in bankruptcy laws.

The changes are in line with international best practices followed by the UK, US, Australia and Canada.