SEMINAR ON CORPORATE RESCUE & INSOLVENCY

SARFAESI Act, 2002 & Role of Asset Reconstruction

10th September, 2010
NEED FOR ASSET RECONSTRUCTION & ENACTMENT OF SARFAESI ACT, 2002 Though the SARAFAESI Act was enacted in 2002 but its need was recognized for the first time in 1991 in the First Narasimham Committee Report on Financial Sector Reforms in 1991. Since then 3 Committee Reports in total have highlighted the need of Asset Reconstruction and the mechanism to implement their suggestions. The brief overview of committee recommendation has been given below: 1) Committee on Financial Sector Reforms: - Asset Reconstruction was mentioned for the

first time in the Committee on the Financial Sector Reforms (Narasimham Committee 1991). The committee first proposed an Asset Reconstruction Fund (ARF) that would purchase the NPAs of banking institutions, as a means of tackling the burgeoning bad and doubtful accounts of financial institutions in India, viz., banking institutions as well as development finance institutions. However, for various reasons, at the time when the recommendation was processed, it was felt that an ARF could pose problems, such as who would fund it, how will the assets of the banks be valued, who would provide the money for buying out the assets at discounted value, and who would handle the recovery of those loans. Hence, the recommendation could not be implemented.
2) Committee on Banking Sector Reforms: - The second Narasimham Committee on

Banking Sector Reforms (1998) reiterated its proposal but this time in the form of ARCs, inasmuch as banking institutions had already carried out recapitalization to some extent. It was proposed that ARCs would take over the NPAs of weak public sector banks by issuing and swapping their own bonds. The Government accepted the idea and in the union budget for 1998/99 encouraged a few banks with high levels of NPAs to undertake ARCs on an experimental basis. The Government set up a task force in July 1998 to study the possible modalities and to prepare an operating plan for establishing ARCs in India.1
1 Asian Development Bank Report, Developing the enabling environment for and structuring Asset Reconstruction Companies in India, 2002, http://www.adb.org/Documents/TARs/IND/tar_ind36062.pdf, Visited on 17.08.2010. 1|Page

3) The Verma Committee (1999): - It looked at the restructuring of weak public sector

banks and also proposed the disposal of NPAs as a critical component in the restructuring of weak public sector banks. However, The Committee report suggested another alternative structure comprising a financial restructuring authority, an ARF, and an asset management company (AMC). The financial restructuring authority was to be an independent government agency owning the ARF and appointing the AMC, and would approve and monitor specific bank restructurings. The ARF would acquire the NPAs of weak public sector banks and the AMCproposed to be a private sector companywould manage and dispose of the acquired NPAs for a fee. The nonperforming loans of banks and financial institutions in India as of March 2001 had reached approximately Rs548 billion (about $11.2 billion) for public sector banks and roughly Rs240 billion (about $5 billion) for other financial institutions. The high level of nonperforming loans has impaired the financial position of a number of public sector banks, weakened the financial capacity of other financial institutions, and has emerged as a major concern. 2 To facilitate the early resolution of nonperforming assets (NPAs) of banks and financial institutions, the Government enacted SARFAESI Act, 2002 for the extensive use of ARCs in India.

2 Ibid.

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BRIEF OVERVIEW OF THE SARFAESI ACT, 2002

The SARFAESI Act is a significant legislative initiative to address the malaise of mounting NPAs. The Act addresses the interests of secured creditors. Its purpose is to promote the setting up of asset reconstruction/securitization companies to take over the NPAs accumulated with the banks and public financial institutions. The Supreme Court, in its judgment in the case of Mardia Chemicals Ltd. and Others vs. Union of India and Others 3 upheld the constitutional validity of SARFAESI Act. The Act provides three alternative methods for recovery of NPAs, namely: (i) Securitisation; (ii) Asset Reconstruction; and (iii) Enforcement of Security without the intervention of the Court. OBJECTIVES OF THE ACT
It has laid down the legal framework for securitization in India The transfer of NPAs to asset reconstruction companies for the disposal of the assets

and the realization of the proceeds.

To enforce the security interest without the Courts intervention To empower the banks and financial institutions to take over the immovable property

that is hypothecated or charged to enforce the recovery of debt by seizing the property.

SOME KEY CONCEPTS

1. Securitization4

Securitisation is the process of polling and repackaging of homogenous illiquid financial assets into marketable securities that can be sold to investors. In other words asset securitisation is the process of converting receivable and other assets into securities that can be placed and traded in capital markets. In terms of definitions of actionable claim under section 130 of the transfer of Property Act, 1882, a claim secured by any mortgage, pledge, hypothecation or other charge is not covered by the definition. Thus, there is no provision in our law relating to transfer of claims which are secured by any security. Reading the definition of securitisation
3 (2004 (4) CTC 759; 2004 (4) SCC 311).

4 M. R. Umarji, Law & Practice relating to SARFAESI, (TaxMann, 4th Ed., New Delhi), p. 91

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with the definition of financial asset, it is clear that a loan secured by mortgage or other charge is made transferable. Securitisation process consists of following transactions on the part of a securitisation company or reconstruction company:
i. ii.

Acquisition of financial assets from any originator, and Raising of funds from qualified institutional buyers by issue of security receipts for acquiring the financial assets or

iii. iv.

Raising of funds by any other manner, and Since definition of financial asset includes any right or interest in the securities such as mortgage, chard, hypothecation or pledge, acquisition of financial asset may be coupled with acquisition of right or interest in underlying securities also.

While the definition treats acquisition of assets and raising of funds for such acquisition by issue of security receipts as securitisation, the mode of acquisition, consequences of such acquisition and rights of investors in such assets are provided by section 5, 6, 7 and 8 of the SARFAESI Act, 2002. Any financial asset which has a reasonably predictable cash flow can be securitized. The definition of financial asset contained in section 2(1) (l) of the SARFAESI Act is in wide terms to include any dept or receivable whether present or further but the substantive provision in section 5 enabling securitisation of such assets restricts it to financial assets of banks and financial institutions only.
2. Asset Reconstruction

The word "asset reconstruction" in India owes its origin to Narsimham I which envisaged the setting up of a central Asset Reconstruction Fund with money contributed by the Central Government, which was to be used by banks to shore up their balance sheets to clean up their non-performing loans. This idea never worked: so Narsimham II thought of asset reconstruction companies, the likes of which had already been successful in Malaysia, Korea and several other countries in the World. To keep the tune the same as the original idea of asset reconstruction fund, as also to give an impression that ARCs are not merely concerned with realization of bad loans but they are going to do "reconstruction", that is, try and resurrect bad loans into good ones, the word ARC has been used in India.

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The term asset reconstruction has been defined under S. 2(1) (b) of the Act to mean acquisition by any securitization company or reconstruction company of any right or interest of any bank or financial institution in any financial assistance for the purpose of realization of such financial assistance. A Securitization Company or Reconstruction Company may, for the purposes of Asset Reconstruction, having regard to the Guidelines framed by RBI, for provide one or more of the following measures laid down in Section 9 of the Act: a) the proper management of the business of the borrower, by change in, or takeover of,

the management of the business of the borrower;

b) the sale or lease of a part or whole of the business of the borrower; c) rescheduling of payment of debts payable by the borrower; d) enforcement of security interest in accordance with the provisions of this Act; e) settlement of dues payable by the borrower; f) taking possession of secured assets in accordance with the provisions of this Act. 3. Enforcement of security interest

The Act empowers the lender, in the event of default by a borrower, to issue demand notice to the defaulting borrower and guarantor, calling upon them to discharge their dues in full within 60 days from the date of the notice. If the borrower fails to comply with the notice, the bank or the financial institution may take recourse to one or more of the following measures:
a) Take possession of the security; b) Sale or lease or assign the right over the security; c) Appoint Manager to manage the security; d) Ask any debtors of the borrower to pay any sum due to the borrower.

If there are more than one secured creditors, the decision to make provisions of this Act will be made applicable only when 75% of them are agreeable.

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FRAMEWORK OF ARCs UNDER SARFAESI ACT, 2002

THE INDIAN LEGAL FRAMEWORK The SRFAESI Act enacted in December 2002 provides the formal legal basis for setting up ARCs in India. The RBI, the designated regulatory authority has issued following to govern ARCs and securitization companies (hereinafter referred to as SCs):
The Securitization Companies and Reconstruction Companies (Reserve Bank)

Guidelines and Directions, 2003 (hereinafter referred to as the Directions);

Guidance Notes for Securitization Companies and Reconstruction Companies

(hereinafter referred to as the Guidance Notes) and

Guidelines to banks / FIs on sale of Financial Assets to Securitization Company (SC) /

Reconstruction Company (RC) (created under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002) and related issues (hereinafter referred to as the Guidelines to Banks) The Central Government has issued the Security Interest (Enforcement) Rules, 2002 (hereinafter referred to as the Enforcement Rules) to govern the enforcement remedies granted to secured creditors under the Act. STRUCTURAL FRAMEWORK The existing ARC framework and the Directions envisage non government supported multiple ARCs, which may be set up by the lenders, NPA investors or corporates. The Act recognizes any person holding not less than 10% of the paid-up equity capital of the ARC as a sponsor and places restrictions on any sponsor holding a controlling interest or being the holding company of the ARC or controlling its management. This may act as a disincentive for independent NPA investors who typically like to have complete control over their investments. Involvement of independent NPA investors is critical not only for cleaning up of the banks balance sheets; they bring a combination of skills, experience, objectivity and commercialism to the resolution process. CAPITAL AND FUNDING
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The Act permits the ARC to commence operations with a minimum net-owned fund of Rs. 20 million and the Directions require an ARC to maintain a capital adequacy ratio of 15% of its risk weighted assets. The Directions clarify that financial assets held in trusts shall not be subject to capital adequacy requirements. An ARC may issue bonds and debentures for meeting its funding needs. However, the Directions do not permit it to mobilize deposits. An ARC may also issue security receipts to the Qualified Institutional Buyers (QIBs) in respect of various schemes managed by it. The Directions clarify that these security receipts can only be issued by the trusts set up by the ARCs. ASSET ACQUISITION AND VALUATION The Act permits the ARCs to acquire financial assets either by way of a simple agreement assigning the assets to the ARC on the terms and contained therein or by an issue of bonds and debentures to the originating lenders. Though there is no restriction on ARCs acquiring financial assets on their balance sheet, in view of capital adequacy and ringfencing requirements, asset acquisition is likely to be effected through a trust structure, under respective schemes. The Guidance Notes suggest that NPAs shall be acquired at a fair price in an informed market in an arms length transaction. These notes also suggest that ARCs should value the acquired assets in an objective manner and use uniform process for all assets of the same profile. In India, stamp duty is a state subject and the rate of stamp duty payable in respect of an assignment of financial assets varies from state to state, ranging from a cap of Rs. 0.1 million to 14% of either the consideration paid or the market value of the financial assets being assigned. Consequently, the stamp duty payable in respect of the assignment of the financial assets would substantially impact the transaction costs. Though an attempt has been made to address this issue in the Act by providing for the acquisition of the financial assets through an issue of debentures and bonds by the ARC, it is not clear whether legal title to the underlying assets would get vested in the ARC under this route. Further, it is not free from doubt whether the bonds or debentures issued by the ARC would attract stamp duty as an assignment / conveyance owing to the nature of the transaction, impeding commercial efficacy of the Act. RESOLUTION STRATEGIES The Directions lay down a maximum resolution time frame of five years (including a one-year planning period) from the date of acquisition of the assets. The Act stipulates several measures
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that can be undertaken by ARCs for asset reconstruction. These include a) enforcement of security interest b) taking over or changing the management of the business of the borrower, c) the sale or lease of the business of the borrower d) entering into settlements and e) restructuring or rescheduling of debt. ARCs and the secured creditors cannot enforce the security interest under SRFAESI unless at least 75% by value of the secured creditors agree to the exercise of this right. OTHER FUNCTIONS OF ARCS ARCs are permitted to act as a manager of collateral assets taken over by the lenders under security enforcement rights available to them or as a recovery agent for any bank or financial institution and to receive a fee for the discharge of these functions. They can also be appointed to act as a receiver, if appointed by any Court or DRT. REGULATIONS APPLICABLE TO BANKS/ FIS Banks/FIs are required to ensure that the sale of the assets to the ARC is a true sale transaction and there should be no known liability devolving on them after assets are taken off from the banks balance sheets. Although the Guidelines to Banks do not permit contingent sales where banks/FIs are required to bear the shortfall in realisation, they allow the sharing of the surplus of realisation of certain specific financial assets between the ARC and the banks/FIs. Further, banks/ FIs should charge any loss on transfer of their NPAs to their profit and loss account in the year of transfer only. Banks/ FIs may receive bonds/ debentures as consideration for NPAs transferred to the ARCs. These bonds/ debentures can have a maximum maturity of six years and must carry a rate of interest at least 1.5% above the bank rate, among other conditions. Additionally, banks / FIs, as QIBs, may invest in the security receipts issued by various trusts managed by an ARC and repayment of these security receipts would, inter-alia, be linked to actual realisation from the acquired NPAs. Further, though there is no restriction on ARCs acquiring assets, which are not considered revivable, the Guidelines to Banks state that ARCs will not normally takeover assets which cannot be revived and will act as an agent for recovery on a fee basis for these assets.

ENFORCEMENT OF SECURITY INTEREST

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The Act permits the secured creditors (if secured creditors hold 75% or more of the amount outstanding) to enforce their security interest in relation to the underlying asset without reference to the Court after giving 60 day notice to the defaulting borrower upon classification of the corresponding loan as a non performing asset. The Act permits the secured creditors to take over possession/management of secured assets, appoint any person as a manager of the secured asset and recover receivables of the borrower in respect of any secured asset which has been transferred. After taking over possession of the secured assets, the secured creditors are required to obtain valuation of the assets. These secured assets may be sold by obtaining quotations from persons dealing in such assets, by inviting tenders from the public, by holding public auctions or by private treaty. In case of immovable property, the secured creditors are required to fix a reserve price and no sale can be made in case the bid price is less than the reserve price unless the borrower and the secured creditors agree. Though, reserve price fixation is not mandatory in cases of moveable assets, it is not clear whether consultation with the borrower would be required for effecting a sale below reserve price in case a reserve price is fixed. CENTRAL REGISTRY The Act requires all particulars of transactions relating to securitization, asset reconstruction, creation of security interest and any modification thereof to be filed with a Central Registry within 30 days of such transaction, creation or modification. The obligation to file such particulars has been imposed on the SC, ARC or secured creditor, as may be relevant. In addition there is an obligation on secured creditors to file details of any release of charge. However, the central registry, as proposed does not either provide notice of particulars filed therein or determine the priority of any security interests filed therein. Further, Central Registry has not been set up yet. The Rakesh Mohan Committee on Financial Sector Assessment in its report submitted to Reserve Bank of India in 2009, in its report has quoted as 5: 5 Rakes Mohan Committee Report on Financial Sector Assessment, p. 81 of the Executive Summary has given its suggestions (mentioned) in relation to the Central Registry provided for under SARFAESI Act, 2002. The document is available at http://www.rbi.org.in/scripts/PublicationReportDetails.aspx? UrlPage=&ID=543

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The lack of a registry, which keeps a record of the security interests created in respect of movable properties, is another lacuna in the system of registration of security interest. The Central Registry, which is provided for under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act (SARFAESI) Act, and which could take care of a major part of the transactions of banks and financial institutions, is yet to be set up. The Central Registry should be set up urgently to have a central and reliable record of all security interests created by banks and financial institutions. The Central Registry should also be allowed to register all transactions creating security interests (both in movable as well as immovable property) by entities/individuals in addition to those of banks/financial institutions. For this purpose, it may be appropriate to bring in a separate legislation in respect of the Central Registry. In the course of time, the Central Registry (with an adequate number of branches all over the country) should be the sole registry for registration of all security interests over properties, and the registries under various statutes should be wound up with suitable amendments to the respective Acts dealing with registration of security interests. The Central Registry should be constituted to provide a good database and reliable record on the creation of security interests/charges under the SARFAESI Act. On the basis of the review of the international best practices, we have identified the following critical success factors for the effective functioning of private ARCs in India 6: Requirement of a strong legal framework for facilitating resolution of NPAs Regulatory support and incentives to facilitate the transfer of NPAs by banks/financial

institutions to ARCs
Establishment of clear valuation guidelines and acceptance of NPA valuation

methodology
Availability of requisite funding and involvement of independent NPA investors, i.e.

parties other than originating banks and financial institutions

Flexibility to ARC in determination of resolution strategies Availability of special legal powers for the achievement of specific objectives 6 Developing the enabling environment for and Structuring asset reconstruction companies in India: Volume I - Recommendations for changes in the existing ARC framework. The entire report is available at http://finmin.nic.in/downloads/reports/ta3943ind.pdf

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 Elimination/Minimisation of taxes and costs relating to NPA transfers. Rationalisation of the tax regime incentivising investments in NPAs Use of professional management teams with expertise in financial restructuring.

ISSUES UNDER SARFAESI ACT, 20027

Some of the issues under SARFAESI Act, 2002 that require immediate attention for the better and efficient functioning of the ARCs and SCs are as follows: 7 The issues under SARFAESI Act, 2002 which need to be addressed have been taken from materials provided by Mr. Rajeev Ranjan, President & CEO, Reliance ARC Ltd.

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1. Notifying ARC as a Financial Institution under SARFAESI Act, 2002

Under Section 41 of SARFAESI Act, 2002, ARC had been notified as a financial institution. This was given effect to by inserting clause (vii) under Section 4-A (1) of Companies Act, 1956. Subsequently, the Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Act, 2004 de-notified ARC as a financial institution by omitting this clause. Presumably, this was done so as to block the possibility of a group of ARCs indulging in a ponzi operation by going on transferring an asset from one to another, in a circular way, without making much recovery. Such circular transfers from one ARC to another would defeat the very purpose for which ARCs were set up which was to realize value from the NPAs acquired from banks, within a period of 5 years. But the remedy de-notifying ARC as a financial institution so that an ARC can acquire NPAs from a bank or financial institution but not from another ARC has turned out to be worse than the disease. For, it has blocked the transfer of assets between one ARC and another even for a legitimate purpose. In a rehabilitation/ revival case, for instance, after acquiring the NPA from a bank/ banks, an ARC needs to infuse fresh funds for turning the company around. Before committing such extra funds, however, an ARC would like to acquire at least 75% of the debt so that it has powers of SARFAESI action against the borrower, in case things go wrong. If another ARC holds debt of 26% or more, the ARC implementing rehabilitation/ revival must be allowed to acquire the same from the former. However, under current provisions the law, this is ruled out. Incidentally, banks do not, normally, infuse fresh funds in NPA cases; they only restructure loans. Hence the dire necessity to address this issue in potentially revivable cases. 8 But merely notifying ARC as a financial institution is not the solution because it will open the floodgates, again, for the ponzi transfer of assets among ARCs in a circular way, without any real resolution or recovery.
8 The inter-se transfer of funds between different ARCs may be allowed though for a limited purpose only but overall banning the entire transaction is irrational.

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Therefore besides notifying ARC as a financial institution under SARFAESI, there may be a need to introduce a new section in the Act disallowing sale of asset by one ARC to another, except in certain special circumstances (such as for debt aggregation purposes in case of rehabilitation/ revival or take-over of management, etc.), and with prior approval of RBI.
2. Permitting ARCs to Acquire Assets Directly in the Name of Trusts

This is necessary so as to ensure an ARC is not required to pay stamp duty on assignment of the same debt twice, first time at the time it acquires the debt in its books on behalf of its trust and a second time when it is transferred by it to the ARC trust. This is the procedure laid down in SARFAESI Act [Sections 7 (1) & 7 (2-A)] and the RBI (SARFAESI) Guidelines and Direction, 2003 (paragraph 8).
3. Permitting ARCs to Convert Debt into Equity subject to RBI Guidelines :

ARCs also need to convert debt into equity in cases of business restructuring/ rehabilitation/ revival and under Sections 9 (a) (proper management of the borrower companys business by effecting a change in, or take-over of, its management) and 9 (c) (rescheduling of payment of debts payable by the borrower company) of the SARFAESI Act. Under the provisions of Companies Act, 1956, shareholders approval for such debt-to-equity conversion is a must. In a case where an ARC is proposing to infuse fresh funds for rehabilitation which may be either with or without take-over of management of a borrower companys business shareholders may or may not give such approval. Therefore, in special cases such as rehabilitation/ revival, or where action for take-over of management has been initiated, an ARC should be exempted from the provision of Section 81(1) of the Companies Act (under clause (b) of the proviso to sub-section 3 of Section 81), on the lines of exemptions already granted to certain other financial institutions.

4. Estoppel of Precipitate Action by Statutory Authorities:

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Section 15 (3) (c) lays down that once take-over of management of the business by an ARC under Section 9 (a), or by a secured creditor under Section 13 (4) (b), has been notified, no proceeding for winding up of such company or for appointment of a receiver shall lie in any court, except with the consent of the secured creditor. The provision under Section 15 (3) (c) referred to above, however, may not cover actions by statutory authorities. In cases of rehabilitation/ revival or take-over of management under Section 9(a) of SARFAESI Act, an ARC would invariably need to infuse fresh funds in the company. If, after fresh funds have been infused, a statutory authority serves an order on the borrower company impounding all or a part of the cash available (which may have either been generated from operations or resulted from fresh infusion of funds by way of debt and/ or equity by the ARC) or attaching its assets in order to realize any past dues, it would not only jeopardize the companys revival but would also put at risk the new funding arranged by the ARC. Therefore, it is imperative to lay down that, over the entire five-year period mandated for the ARCs operation under this section, the borrower companys management can be held responsible for making payment of statutory dues only prospectively and not retrospectively, and any precipitate action by authorities in respect of past statutory dues is precluded by estoppel.
5. Enlarging the Scope of Business for ARCs:

Under the SARFAESI Act, an ARC must acquire a non-performing asset from a bank, first, before it can work on any kind of resolution whether through a one-time settlement with the borrower, or sale of physical assets, or rehabilitation/ revival. In 2002, when the Act was passed, the All Banks Gross NPA Ratio was 10.4% and solving the NPA problem of banks was the primary concern of the government. The Gross NPA Ratio is about one-fifth of that now, and it is time the scope of ARCs operations is enlarged. The most glaring paradox the industry faces, today, is the following. A company in distress needs funds for reviving itself but, as a matter of policy, banks do not infuse fresh funds in an NPA case. An ARC can, and wants to, but is not allowed to do so unless it acquires at least a part of the NPA first (which is not feasible if banks do not want to sell) even though entities

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like Private Equity Fund are allowed to do so. As a result, ARCs cannot make what could potentially be their most important contribution to the economy reviving distressed cases. In order to address the issue, SARFAESI Act needs to be amended by inserting a sub-section (a) to Section 5 (2) which may be worded as follows: In case of non-performing assets or restructured loans in the books of a bank/ financial institution, a securitization company/ reconstruction company may acquire interest in the financial assets of the borrower company by infusing fresh funds either by way of debt, or equity, or both. Such debt shall rank pari passu with the mortgages and other charges created by the borrower in favor of existing secured creditors.

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ANNEXURE - I Its time to clear the asset recast logjam

The Economic Times, 19 May 2010, 0017 hrs IST By Rajiv Ranjan (http://economictimes.indiatimes.com/articleshow/5946712.cms)

OUR asset reconstruction structure is unique; no other country operates a model of tightly regulated private sector companies engaged in the business of unlocking value from nonperforming assets (NPAs) like we do. Yet, the industry scenario is grim. Why such a denouement for a unique dispensation like ours, then? Because, a flawed implementation of the asset reconstruction company (ARC) model has resulted in the focus being shifted from unlocking value to solving banks NPA problem. The key issue for ARCs is not the asset base but recovery and the time-frame within which it is made. The performance on this front is agonizing; at the end of six years of operation, the combined recovery of all ARCs works out to 31.9% of the acquisition price paid. Clearly, this points to a systemic logjam that needs to be tackled. The logjam is on account of legal infirmities, legacy issues and certain bank practices but the more fundamental question that we need to ask is: Is ARC operation unlocking value for the economy the way it can and should? The simple answer to that question is no. Garbage disposal cannot be the main role for ARCs; enforcement agents can do that as well, if not better. The real value from NPAs will get unlocked only if ARCs do two things: one, tackle recalcitrant borrowers (thats what Sarfaesi, or The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002,was supposed to be all about) in order to make good recovery from NPAs that still have value; and two, rehabilitate revivable sick cases. ARCs have not resolved too many cases of the first variety and, as far as the second is concerned, they have not even scratched the surface. There is confusion galore as two sets of RBI guidelines prescribe two different standards for determining the price at which banks should sell their NPAs: one for sale to ARCs (reasonably estimated realisable value, or current market value: 2003 Guidelines for Sale to ARCs) and another for sale to banks (economic value of estimated cash flows, or present value of expected cash realisations in future: 2005 Guidelines for Sale to Banks in Cash).The 2003 guidelines
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ignored time value of money perhaps because, at that time, it was expedient to let banks solve their provisioning problem by selling their NPAs to ARCs at a price higher than warranted against issue of security receipts (SRs). In the absence of fair practices guidelines, officials in the PSU banks-dominated banking system view sale of NPAs to ARC as a huge risk fraught with the dangers of a vigilance probe. The logjam is complete: an ARC can submit cash bid matching the banks reserve price only if it is willing to book a loss. In order to break the logjam, following steps need to be taken. First and foremost, we must put in place a mechanism so that banks are forced to get rid of their NPAs after a certain holding period of, say, two years. Second, Sarfaesi Act must be amended to confer extra powers on ARCs so as to instill responsible behaviour on the part of recalcitrant borrowers. Third, RBI should issue guidelines covering one-on-one deals between banks & ARCs for OTS and rehabilitation cases, auction and due diligence process (so that a one-sided application of market mechanism is avoided), fair value (stipulating that reserve price be computed based on: one, valuation of physical assets on strip sale, rather than going concern, basis; and two, present value of expected future realisations), inter-se transfer of debt (allowing such transfer for rehabilitation / revival and debt aggregation purposes), OTS payment by an ARC, on borrowers behalf, as an investor, etc. Finally, the proposed Financial Sector Legislative Reforms Commission should be charged with the responsibility of mediating between ARCs, banks and the regulator in order to reform and reinvent asset reconstruction. There is a unique opportunity for partnership between PE funds and ARCs, since the former have expertise in handling equity and the latter in handling debt. Investing funds together in a rehabilitation case would make sense because an ARC can also add value as a rehab expert and a debt aggregator with Sarfaesi powers, including the power to take over management of the borrowers business. The author is the president and CEO of Reliance ARC. Views are personal.

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