Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (hereafter referred to as the SARFAESI Act) provide the banks the power of recovery of loans without knocking the doors of the court. The very intention of this act is to enable the Banks and Financial Institutions to recover credited amounts at the earliest. Further, it allows the Banks and Financial Institutions to auction the property mortgaged with them to recover such outstanding debt. The said property could be a residential or any commercial premises which has been mortgaged with the Bank. This way the concept of security reconstruction was developed by the SARFAESI Act.
Prior to the Act, the banks found it very difficult to resort to judicial forums in order to regain the loan amount from the companies which had availed loans from them. In the hands of these companies there was a huge amount that had been blocked because of the non-repayment of the loans availed from the banks before. Since the judicial proceedings took time, the securities that were provided as collaterals by the borrowers to the banks either degraded in value or disappeared and provided no relief to the banks. Hence, this Act was introduced in order to allow the banks to sell the collateral provided as soon as they stopped providing income.[i]
Prior to the SARFAESI Act, Section 69 of the Transfer of Property Act[ii] provided that the interference of the court was not required because the mortgagee can cause a private sale of the mortgaged property without the intervention of Court. But this section had a limited scope because it contained three conditional clauses which do not match the requirements of free India. The other remedies included Order XXXIV Rule 1 of the Civil Procedure Code, Section 19 of the Recovery of Debts due to Banks and Financial Institutions Act, 1993, or to file a money suit to recover the money lent or to file a summary suit under Order XXXVII Civil Procedure Code which however, required the intervention of the Court.
Therefore, two Committees were formed in order to address the issue. One of these was headed by Shri M. Narsimha and the other by Shri T. Tiwari where they recommended the formation of special tribunals for the recovery of debts for the banks and other financial institutions. In accordance with these recommendations, the Recovery of Debts Due to Bank and Financial Institutions Act, 1993 was passed. However, the banks still faced the problem of liquidity and asset liability mismatches because the financial institutions were not allowed to realize the securities made in collateral on the event of default by the borrower. To solve the problem, the SARFAESI Act was passed.
In the SARFAESI Act, whenever an asset is qualified as Non-Performing Asset (NPA), the bank can send a notice to the borrower of 60 days from the date of notice, within which he is directed to pay the debts. If the borrower fails to pay the dues within the stipulated time, the financial institution can go ahead and take possession of the security and realize the amount by selling it. The bank has also been allowed to take over the management of the borrower company’s business as provided under Section 9A of the SARFAESI Act.
The new concept of securitization is a mechanism where the assets that have been provided as collateral with the banks and are converted into securities for being traded in the markets as investments. Section 2 of the SARFAESI Act provides that this can be done with the help of any reconstruction company. Such an asset reconstruction company is registered by the Reserve Bank of India (RBI) under the Companies Act. Accordingly, the concepts of asset reconstruction and securitization are two different concepts. Under the reconstruction concept, the NPA is reconstructed so that it can survive. But under securitization the property is traded in the market.[iii]
The constitutional validity was questioned and upheld in the case of Mardia Chemicals v. Union of India[iv] where the Apex court interpreted the legal concept of “security interest”. It recognized, inter alia, that any security created over movable or immovable property for securing due payment of money advanced or to be advanced or for performance of any obligation undertaken by any bank or financial institution is treated as security interest. Therefore, the property provided as collateral, was treated as belonging to the lenders. However, the restriction is that the interest should be fair and reasonable as said in the case of Jagdamba Oil Mills v. Haryana SFC.[v]
THE INITIAL EXCLUSION OF COOPERATIVE BANKS
When the SARFAESI Act was passed in 2002, in its definition of “banking” the financial institution of cooperative banks was not included. In order to rectify this situation a notification was released by the Central Government in 2003 that allowed the cooperative banks to proceed under the SARFAESI Act as “banks”.[vi] However, in 2007 a case was filed befor a three-judge bench in the Supreme Court where the court held that the cooperative banks are established under different State Cooperative Societies Acts like Maharashtra Cooperative Societies Acts, Andhra Cooperative Societies Acts etc. and therefore, the transacting business of cooperative societies does not fall under the meaning of “banking company” as defined under Section 5(c) of the Banking Regulation Act.[vii]
Moreover, the Cooperative banks are regulated in two ways, firstly under the Banking Regulation (BR) Act, 1949 and the Cooperative Society Act, 1965. They are mainly controlled by their respective State Governments and the RBI has a negligible role in it. Further, List I Entry no. 45 of the Seventh Schedule to the Constitution, the subject of “Banking” is provided. Whereas List II Entry no. 32 covers the subject of “Cooperative Society”. Based on these reasons the three Judge Bench said that the Union Government cannot legislate and cannot release notifications to govern the “Cooperative Banks” that are per se under state list.[viii]
Against this, in 2013, the Union Government passed an amendment in order to include the cooperative banks as well. This brought in conflict of laws because on the one hand, cooperative banks were recognized in the SARFAESI Act and on the other hand, the Supreme Court Bench had held that laws relating to cooperative banks cannot be made by the Union Government. Also, various High Courts had decided contrarily. The Bombay High Court in the case of Narendra Kantilal Shah v. Joint Registrar, Co-operative Societies,[ix]said that the term “Banking Company” in the Section 2(d) of the RDB Act, 1993 includes “cooperative societies”. The effect of this inclusion was that the Maharashtra Co-operative Societies Act, 1960, would cease to have jurisdiction when a debt recovery tribunal was formed under the RDB Act, 1993. This decision was soon set aside in the case of Greater Bombay Coop. Bank Ltd v. United Yarn Tex (P) Ltd. [x]by the apex court on the grounds that the cooperative banks functioning under the Maharashtra Cooperative Societies Act, 1960 and Andhra Pradesh Co-operative Societies Act, 1964, do not come under the purview of “Banking Companies” in the Section 5(c) of the Banking Regulation Act, 1949. Moreover, the Gujarat High Court in the case of Neel Oil Industries v. Union of India[xi]opposed the constitutional validity of the 2013 amendment in the SARFAESI Act.
The long array of contrary judgement saw a standstill in 2020 through Pandurang Ganpati Chaugule v. Vishwasrao Patil Murgud Sahakari Bank Limited[xii]which decided on two issues:
- The legislative competence of the Union Government to amend laws related to List II entry 32 of “cooperative banks”.
- The constitutional validity of the 2013 amendment that included “cooperative banks” in the ambit of SARFAESI Act.
On the basis of the above, the following arguments were made by the appellant-
- The appellants cited the case of Rustom Cavasjee Cooper v. Union of India[xiii]where the court held that banking is an activity different from the bank and banker and has two essential functions; firstly, core banking business and secondly, any other business provided in the Section 6(1) of the BR Act, 1949. Further banking business for cooperative societies is only an incidental business and not a core business activity.
- The entry 43 of List I empowers the legislation to enact laws relating to “incorporation, regulation and winding up” of a banking corporation. However, the subject of “cooperative banks” has been explicitly added in the state lists.
Whereas, on behalf of the respondents-
- The Parliament has the right to legislate for “banking activities” under the List I entry 45, therefore has the right to legislate the “banking business” under the section 5(c) of the BR Act.
- The acceptance and grant of bank loans and deposits come under the banking operations. The Parliament has been empowered to make and amend laws related to management and conduct of banks. Moreover, recovering dues by a bank is an essential part of banking business without which the business cannot be furthered. The banking entity performing such functions, could be a statutory corporation, cooperative society or a company, for which the Parliament can make laws.
- The statement of reasons and objective of the SARFAESI Act provides that the Act is related to banking and incidental functions of banking. It provides the power to the financial institutions to take into account the security and sell it or trade it in the market to recover the dues without the intervention of courts.
The court upheld the constitutional validity of the 2013 Amendment of the Parliament to the SARFAESI Act. The court said that in order to judge the constitutional validity of the amendment the court has to look into the competence of the Parliament to legislate in that matter. The motive of the enactment is of no use to the court and the court did not go into the merits of the enactment. Further, the court held that the activity of banking of a cooperative bank is regulated by the law made under the List I entry 45, thus the Parliament has the competence to make laws for the speedy recovery of dues for the Cooperative banks as well
The Court also held that the Entry 43 of the List I explicitly excludes “Cooperative Banks” but the Entry 45 of List I only mentions “banking”. This led the court to the conclusion that banking activities of the cooperative banks fall within Entry 45 of List I and provides the Parliament the legislative competence to enact laws for the same. The court also said that the definition of “bank” under the SARFAESI Act in Section 2(1)(c) is given in the Act and the Section 2(1)(c)(v) empowers the Central Government to specify “such other banks” for the purposes of this Act.
Another fact cited by the Court was the 97th Amendment Act, 2011 where Article 43B was concerned with the functioning and promotion of the cooperative societies. The Article 243ZL (1) of the same amendment applied the BR Act, 1949 to the Cooperative banks. Further, it made applicable, the entry 45 List I “banking” to the Cooperative banks.
The Court also drew a distinction between the non-banking and banking functions of the cooperative societies where it provided that the former is dealt by the Entry 32 of the List II and the latter by Entry 45 of the List I. When the Parliament enacted the SARFAESI Act, it did not intend to deal with the non-banking aspects of the cooperative society. It only concerned itself with the recovery of dues, that forms an important part of banking activities and so, it in no way encroaches the right of the State governments to make laws for the cooperative societies.
CONCLUSION
Cooperative Banks function across India alongside commercial Banks and play a pertinent role in providing need-based finance particularly for people engaged in agriculture-based operations like milk, cattle, farming, personal finance etc., along with self-employment driven activities and small industries. In India, facing contract enforcement delays in courts denies the banks the value of the money that is their source of efficient banking.
According to the Financial Stability Report 2021, the NPAs are rising as bad loans continue to pile up. In her Union Budget Speech Finance Minister Nirmala Sitharaman proposed a bad bank system to reduce NPAs in the system. It would be an Asset Reconstruction Company that will look after the stressed assets of the banks like SBI, Bank of Baroda and Punjab National Bank. Prior to the 2020 Judgement of the Supreme Court, the loans taken by the creditors would fail or collapse and there was no positive way of reconstructing the money back. Although after this judgement a similar route can be established for the Cooperative Banks through which they can go to an Asset Reconstruction Company for the stressed and NPAs.
The Court by including the cooperative societies into the “banks” for the purpose of SARFAESI Act is a constructive interpretation of a beneficial piece of legislation. The main objective of this legislation was to induce speedy recovery of dues from the defaulters without going to the courts. Excluding cooperative banks which perform the similar function of lending and recovery from this benefit of speedy recovery would be injustice to the cooperative banks. By including cooperative banks into the SARFAESI Act, the Court has taken a step forward to improve the backlog of defaulters in the banking sectors. People, who are unable to repay the money borrowed from banks, wrongly try to delay the cases in order to escape the liability. By giving the reigns in the hands of the banks, recovering dues from these people will be easy.
[i] Reshma A., “ENFORCEMENT OF SECURITY UNDER THE SARFAESI ACT”, 4 NUALS L.J. 136 (2010).
[ii] The Transfer of Property Act, 1882; Section 69.
[iii] Aishwarya H. & Rahul Miranda, Role of Asset Reconstruction Companies in the Indian Economy, 7 NUALS L.J. 41 (2013).
[iv] AIR 2004 SC 2371.
[v] AIR 2002 SCW 500.
[vi] Notification No.105(E) dated 28.1.2003.
[vii] Greater Bombay co-operative bank v. United Yarn (2007) 6 SCC 236.
[viii] 7 AIR 2015 Gujarat 17.
[ix] AIR 2004 Bom 166.
[x] (2007) 6 SCC 236.
[xi] AIR 2015 Gujarat 171.
[xii] 2020 SCC OnLine SC 431.
[xiii] (1970) 1 SCC 248.
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