SARFAESI: Companies, Registration, Priority and the Rest

In one line

Besides letting a bank seize its security, the Act creates companies that buy bad loans, a registry in which every charge is recorded, and a priority for registered secured creditors over Government dues.

In the wording a student can write in an exam: the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 provides in Chapter II for the registration and regulation of asset reconstruction companies and for the acquisition by them of financial assets; in Chapter IV for a Central Registry in which transactions of securitisation, reconstruction and creation of security interest are registered; by section 26E for the priority of registered secured creditors over all other debts and Government dues; and by section 31 for the transactions to which the Act does not apply.

The three subjects in the Act's name

Chapter 560 worked enforcement, which is the third and most examined. This chapter works the first two and the machinery that supports all three.

Securitisation is the conversion of a pool of loans into marketable securities. A bank sells a pool of receivables to a special purpose vehicle, which issues security receipts to investors, and the cash flow from the borrowers pays the investors. The bank gets its money now, and the risk moves to the investors.

Reconstruction of financial assets is the acquisition of a bank's bad loans by a specialist company, which then works them out: it may reschedule, settle, take over management, sell the security or convert debt to equity, with more time and more skill than the bank has.

Both rest on a single legal proposition, and it is the one chapter 60 established: a debt is an actionable claim, so a bank may sell it. Without that, neither business could exist.

The case that made the market possible

Facts. ICICI Bank Ltd. v. Official Liquidator of APS Star Industries Ltd., (2010) 10 SCC 1. A bank had assigned its debts to another bank. The assignment was challenged on the ground that a bank's business is defined by section 6 of the Banking Regulation Act, 1949, that dealing in debts is not among the listed forms of business, and that trading in debts would breach section 8, which forbids a banking company to deal in the buying or selling of goods.

Held. A bank may assign its debts to another bank. Such an assignment is within the business of banking and is not hit by the prohibition on trading in section 8, because the Explanation to that section defines goods as movable property other than actionable claims, and a debt is an actionable claim.

Why it matters. It is the legal foundation of the entire market in stressed assets, and therefore of the asset reconstruction companies this chapter describes. Chapter 60 works section 8 and its Explanation; this is where the consequence lands.