Enforcement of Security Interest by Banks under SARFAESI Act

Enforcement of Security Interest under the SARFAESI Act refers to the legal process by which a secured creditor (such as a bank or financial institution) recovers its dues from a borrower without the intervention of courts or tribunals, by taking possession and/or selling the secured asset, as permitted under Section 13 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act).

Table of Contents

1. Bank Can Recover Loans by Enforcing Security Interest
2. Meaning of ‘Security Interest’
3. Who is ‘Secured Creditor’
4. When an Action for Enforcement of Security Can Be Initiated

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1. Bank Can Recover Loans by Enforcing Security Interest

Bank/FI almost always grant loans/credit facilities on basis of security. The security may be in form of mortgage, hypothecation, pledge etc. In addition, personal guarantees of directors/partners/group companies are obtained. Thus, on paper, the lending by Bank/FI appears to be very secured. However, when the time comes, it is found that the security for advance/loan is only on paper and is of no use in recovering the bad debts.

SARFAESI Act will be useful in such cases.

1.1 When Security Can Be Enforced

Section 13(1) of SARFAESI Act provides that, notwithstanding anything contained in section 69 or 69A of Transfer of Property Act, any security interest can be enforced by secured creditor without intervention of Court or Tribunal in accordance with provisions of the Act.

[Under sections 69 and 69A of Transfer of Property Act, Bank can take possession of mortgaged property without intervention of Court only in case of English Mortgage. Now, under SARFAESI Act, such action is permissible in any mortgage].

As per section 13(2) of SARFAESI Act, such action can be taken only if there is default in repayment of instalment of debt and the account is classified as NPA (Non-Performing Asset) by the secured creditor.

If funds were raised through debt securities, then action can be initiated even if secured debt was not classified as NPA – proviso (i) to section 13(2) of SARFAESI Act.

No action in certain specified cases – No action for enforcement of security interest can be taken if:

(a) Agricultural land

(b) when amount due is less than Rs. one lakh

(c) when amount due is less than 20% of the principal amount and interest thereon, i.e. if borrower has repaid more than 80% of the principal amount and interest

(d) lien under Act

(e) pledge of movable

(f) security over aircraft or vessel

(g) properties which cannot be attached – section 31 of Sarfaesi Act.

SARFAESI provisions not applicable to security interest in agricultural land – SARFAESI Act provisions are not applicable in respect of any security interest created in agricultural land – Narendra v. State of Madhya Pradesh (2020) 161 SCL 317 = 117 taxmann.com 91 (MP HC DB) * Sundaram Home Finance v. Rahul Jayvantrao Kaulavkar (2021) 164 SCL 150 = 119 taxmann.com 427 (Bom HC).

However, properties in question will not be exempt from SARFAESI Act u/s 31(i) merely because they are shown as agricultural lands in revenue records. They will be so exempt only if they are actually used as agricultural lands at the time the security interest is created for the purpose of attracting exemption u/s 31(i). Where except the revenue records, the borrowers did not file any evidence to show that the agricultural work was being done in the said properties, and on the contrary, the secured creditor produced the photographs to show that there was no agricultural activities being done and no agricultural activity was going on, the scheduled properties in question will not be exempted from the provisions of SARFAESI Act in view of section 31(i) of the SARFAESI Act – K. Sreedhar v. Raus Constructions (P.) Ltd. [2023] 146 taxmann.com 123 (SC).

No action if debt time barred – No action can be taken under SARFAESI Act, if the debt is time barred under Limitation Act. [Section 36 of SARFAESI Act].

Debenture trustees can initiate action for enforcement of security if there is default – Debenture trustees can initiate action under section 13(2) of SARFAESI Act to enforce security interest in the same manner in accordance with terms and conditions of documents executed in favour of debenture trustees – proviso (ii) to section 13(2) of SARFAESI Act inserted w.e.f. 1-9-2016.

1.2 Meaning of ‘Debt’

As per section 2(1)(ha) of SARFAESI Act, ‘debt’ shall have the meaning assigned to it in section 2(g) of RDB Act, 1993 and includes:

(i) unpaid portion of purchase price of any tangible asset given on hire or financial lease or conditional sale or any other manner

(ii) any right, title or interest on any intangible asset or licence or assignment of such intangible asset, which secures the obligation to pay any unpaid portion of the purchase price of such intangible asset or an obligation incurred or credit otherwise extended to enable any borrower to acquire the intangible asset or obtain licence of such asset.

1.3 Financial Lease

“Financial lease” means a lease under any lease agreement of tangible asset, other than negotiable instrument or negotiable document, for transfer of lessor’s right therein to the lessee for a certain time in consideration of payment of agreed amount periodically and where the lessee becomes the owner of the such assets at the expiry of the term of lease or on payment of the agreed residual amount, as the case may be – section 2(1)(ma) of SARFAESI Act.

Negotiable Document – “Negotiable document” means a document, which embodies a right to delivery of tangible assets and satisfies the requirements for negotiability under any law for the time being in force including warehouse receipt and bill of lading – section 2(1)(na) of SARFAESI Act.

2. Meaning of ‘Security Interest’

‘Security interest’ means right, title or interest of any kind, other than those specified in section 31 of SARFAESI Act, upon property created in favour of any secured creditor and includes:

(i) any mortgage, charge, hypothecation, assignment or any right, title or interest of any kind, on tangible asset, retained by the secured creditor as an owner of the property, given on hire or financial lease or conditional sale or under any other contract which secures the obligation to pay any unpaid portion of the purchase price of the asset or an obligation incurred or credit provided to enable the borrower to acquire the tangible asset; or

(ii) such right, title or interest in any intangible asset or assignment or licence of such intangible asset which secures the obligation to pay any unpaid portion of the purchase price of the intangible asset or the obligation incurred or any credit provided to enable the borrower to acquire the intangible asset or licence of intangible asset – section 2(1)(zf) of SARFAESI Act.

Section 31 of SARFAESI Act provides that the provision of the Act shall not apply to lien of goods, pledge of movables, security interest less than Rs. one lakh, amount due is less than 20% of principal amount etc.

2.1 Meaning of ‘Property’

‘Property’ means:

(i) Immovable property

(ii) Movable Property

(iii) Any debt or any right to receive payment of money, whether secured or unsecured

(iv) Receivables, whether existing or future

(v) Intangible assets, being know-how, patent, trade mark, licence, franchise or any other business or commercial right of similar nature, as may be prescribed by Central Government in consultation with RBI. [Section 2(1)(t) of SARFAESI Act].

2.2 Hypothecation

‘Hypothecation’ means a charge in or upon any movable property, existing or future, created by a borrower in favour of a secured creditor without delivery of possession of the movable property to such creditor, as a security for financial assistance, and includes floating charge and crystallization of such charge into fixed charge on movable property [section 2(1)(n) of SARFAESI Act].

Hypothecation is a sub-species of pledge and has same legal value – Infrastructure Leasing and Financial Services Ltd. v. BPL Ltd. (2015) 3 SCC 363 = 120 SCL 534 = 53 taxmann.com 234 (SC).

It can be seen that the term ‘security interest’ as defined in the Act is very wide. It includes interest of any kind not only in movable and immovable assets, but also in claims, debts, receivables, beneficial interest etc. It also includes interest in intangible assets. Such interest includes mortgage, charge, hypothecation and assignment.

2.3 Exclusions from ‘Security Interest’

As per section 31 of SARFAESI Act, provisions of the Act shall not apply to the following:

(a) A lien on any goods, money or security given by or under the Indian Contract Act, 1872 or the Sale of Goods Act, 1930 or any other law for the time being in force.

(b) A pledge of movables within the meaning of section 172 of Indian Contract Act, 1972.

(c) Creation of any security in any aircraft as defined under section 2(1) of Aircraft Act, 1934.

(d) Creation of security interest in any vessel as defined in section 3(35) of Merchant Shipping Act, 1958.

(e) Omitted w.e.f. 1-9-2016 [Earlier, the entry was as follows – Any conditional sale, hire-purchase or lease or any other contract in which no security interest has been created]

(f) Any right of unpaid seller under section 47 of Sale of Goods Act, 1930.

(g) Any properties not liable to attachment or sale (excluding the properties specifically charged with the debt recoverable under Securitisation Act) or sale under first proviso to section 60(1) of Code of Civil Procedure, 1908.

(h) Any security interest for securing repayment of any financial asset not exceeding one lakh Rupees.

(i) Any security interest created in agricultural land.

(j) Any case in which the amount due is less than 20% of the principal amount and interest thereon [i.e. where borrower has repaid more than 80% of principal amount and interest].

Residential property mortgaged can be attached – In Joseph George v. Joint Registrar (2006) 65 SCL 239 (Ker HC), it was held that section 31(g) specifically excludes properties charged with debt. Hence, a residential property which is mortgaged as security for debt, is not exempt from attachment or sale under the Securitisation Act.

Lien under Contract Act – A bailee has lien on goods for remuneration for the services rendered by him in respect of goods bailed. [section 170 of Contract Act]. Banks, factors, wharfingers, attorneys and policy brokers have general lien on goods bailed to him for a general balance of account. [Section 171 of Contract Act]. Thus, a lien, if created legally, will have priority over security interest.

Pledge of movable – Bailment of goods as security for payment of debt or performance of a promise is called ‘pledge’. The bailor in this case is called ‘pawnor’. The bailee is called ‘pawnee’. [Section 172 of Contract Act]. A pawnee has right to retain goods pledged to him. [section 173 of Contract Act]. In such case, security interest cannot be enforced, as bailee i.e. pawnee already has physical possession of goods. Of course, bailee can retain goods only to recover his debt and nothing more.

Right of unpaid seller – Unpaid seller has lien in respect of goods in his possession and retain the goods till payment is received. [Section 47 of Sale of Goods Act, 1930]. He can stop goods in transit. [Section 50 of Sale of Goods Act].

Lease – In lease, property in goods remains with owner and he only ‘leases’ the goods for use to another for certain charges. After the lease period is over, the owner can take back the goods.

Hire purchase – In ‘hire purchase’, possession of goods is delivered by owner to hirer on condition of payment of agreed number of instalments. Hirer has option to purchase the goods as per terms of agreement. (usually, a nominal payment is provided at the end of hire period). Property in goods is passed on to the hirer after all terms of agreement are fulfilled. If the hirer does not fulfil the conditions of hire-purchase (e.g. does not pay instalments on due dates) possession of goods can be taken back by owner giving goods on hire purchase. The hirer is not owner of goods. The financing company continues to be owner.

In Charanjit Singh Chadha v. Sudhir Mehra 2001 AIR SCW 3487, it was observed, ‘Hire purchase agreements are executory contracts under which goods are let on hire and hirer has option to purchase in accordance with terms of the agreement. Under hire purchase agreement, the hirer is simply paying for the use of goods and for option to purchase them. If the hirer makes default by not paying instalments, the owner can take possession of goods, if agreement provides for such repossession. This cannot be considered as theft by the owner. It can at the most be a civil dispute and not criminal case’.

In K L Johar  v. Dy CTO AIR 1965 SC 1082 = (1965) 2 SCR 112 = (1965) 16 STC 213 (SC), it was held that in hire purchase agreement, ‘sale’ takes place only when purchaser exercises the option of purchase and fulfils the terms of agreement. Till then, it is a ‘bailment’. In Marikar Motors Ltd. v. STO 101 STC 377 = (1996) 3 SCC 263 (SC), it has been held that in case of hire purchase, ‘sale’ takes place only when the purchaser exercises the option to purchase after fully paying the agreed amount. It does not automatically (willy nilly) takes place at the end of period mentioned in the hire purchase agreement. Similar views in Damodar Valley Corpn. v. State of Bihar AIR 1961 SC 440, where it was held that mere contract for hiring is a contract of bailment, which does not create a title in the bailee. If hirer has reserved right to return the goods at any time during the contract, then clearly there is no contract of sale.

Exclusion of pledge etc. for all purposes? – Section 31 of SARFAESI Act provides that the provision of the Act shall not apply to lien of goods, pledge of movables, security interest less than Rs. one lakhs, amount due is less than 20% of principal amount etc. Really, this exclusion is meant for Chapter III i.e. enforcement of security interest only. However, as per present wording, the provision will apply even in respect of Securitisation also.

Thus, securitisation of such borrowings will not be possible. This does not seem to be and cannot be the intention and it should be clarified that section 31 of SARFAESI Act applies only to Chapter III.

2.4 Meaning of ‘Financial Asset’

‘Financial Asset’ means debt or receivables and includes –

(i) A claim to any debt or receivables or part thereof, whether secured or unsecured or

(ii) any debt or receivables secured by mortgage of or charge on immovable property or

(iii) A mortgage, charge, hypothecation or pledge of movable property or

(iv) any right or interest in the security, whether full or part underlying such debt or receivables or

(v) any beneficial interest in property, whether movable or immovable, or in such debt, receivables, whether such interest is existing, future, conditional or contingent (va) any beneficial right, title or interest in any tangible asset given on hire or financial lease or conditional sale or under any other contract which secures the obligation to pay any unpaid portion of the purchase price of such asset or an obligation incurred or credit otherwise provided to enable the borrower to acquire such tangible asset; or (vb) any right, title or interest on any intangible asset or licence or assignment of such intangible asset, which secures the obligation to pay any unpaid portion of the purchase price of such intangible asset or an obligation incurred or credit otherwise extended to enable the borrower to acquire such intangible asset or obtain licence of the intangible asset; or

(vi) any financial assistance [section 2(1)(l) of SARFAESI Act Words in italics have been inserted w.e.f. 1-9-2016].

2.5 Financial Assistance – Meaning

‘Financial Assistance’ means any loan or advance granted or any debentures or bonds subscribed or any guarantee given or letter of credit established or any other facility extended by any bank or financial institution, including funds provided for the purpose of acquisition of any tangible asset on hire or financial lease or conditional sale or under any other contract or obtaining assignment or licence of any intangible asset or purchase of debt securities [Section 2(1)(k) of SARFAESI Act. Words in italics have been added w.e.f. 1-9-2016].

3. Who is ‘Secured Creditor’

“Secured creditor” means—

(i) any bank or financial institution or any consortium or group of banks or financial institutions holding any right, title or interest upon any tangible asset or intangible asset as specified in clause (l);

(ii) debenture trustee appointed by any bank or financial institution; or

(iii) an asset reconstruction company whether acting as such or managing a trust set up by such asset reconstruction company for the securitisation or reconstruction, as the case may be; or

(iv) debenture trustee registered with the Board and appointed for secured debt securities; or [drafting mistake corrected w.e.f. 1-4-2021]

(v) any other trustee holding securities on behalf of a bank or financial institution,

in whose favour security interest is created by any borrower for due repayment of any financial assistance – section 2(1)(zd) of SARFAESI Act replaced w.e.f. 1-9-2016.

Asset Reconstruction company – Asset Reconstruction Company (ARC) means a company registered with RBI for purpose of carrying on business of asset reconstruction or securitization or both – section 2(1)(ba) of SARFAESI Act inserted w.e.f. 1-9-2016.

3.1 Meaning of ‘Bank’

‘Bank’ means banking company, corresponding new bank (i.e. nationalised banks), State Bank of India, subsidiary of SBI, a Multi-State Cooperative Bank or such other Bank as may be notified by Central Government. [section 2(1)(c) of SARFAESI Act].

‘Banking Company’ has the meaning assigned to it in section 5(c) of the Banking Regulation Act, 1949. [section 2(1)(d) of SARFAESI Act].

As per this section, ‘banking company’ means any company which transacts the business of banking in India. As per section 5(b) of Banking Regulation Act, ‘banking’ means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise.

As per section 5(d) of Banking Regulation Act, ‘company’ means any company as defined under section 3 of Companies Act, 1956 and includes a foreign company within meaning of section 591 of Companies Act.

Since the word used is ‘company’, it is obvious that cooperative banks are not covered in the definition, as they are not ‘companies’.

Sarfaesi Act applies to cooperative banks and regional rural banks – The Sarfaesi Act has been extended to cooperative banks vide Notification No. SO 105(E) dated 28-1-2003.

The SARFAESI Act has been extended to Regional Rural Banks vide Notification No. SO 772(E) dated 17-5-2007.

Cooperative Banks eligible as secured creditor – Cooperative Banks and Multi-State Cooperative Banks are covered under SARFAESI Act – Pandurang Ganpati Chaugule v. Vishwasrao Patil Murgud Sahakari Bank (2020) 9 SCC 215 = 116 taxmann.com 414 (SC 5 member bench).

3.2 Financial Institution

‘Financial Institution’ means * Public Financial Institution within meaning of section 4A of Companies Act (now section 2(72) of Companies Act, 2013) * International Finance Corporation * Any Institution notified under section 2(h)(ii) of Recovery of Debts and Bankruptcy Act, 1993* Debenture trustee registered with SEBI and appointed for secured debt securities * Asset Reconstruction Company whether acting as such or managing a trust for purpose of securitization or asset reconstruction * Any other institution or NBFC as defined in section 45-I(f) of RBI Act, as may be notified by Central government [section 2(1)(m) of SARFAESI Act – words in italics inserted w.e.f. 1-9-2016].

Secured debt – ‘Secured debt’ means a debt which is secured by any security interest. [section 2(1)(ze) of SARFAESI Act].

3.3 Public Financial Institution

“Public financial institution” means:

(i) the Life Insurance Corporation of India, established under section 3 of the Life Insurance Corporation Act, 1956

(ii) the Infrastructure Development Finance Company Limited, referred to in of section 4A(1)(vi) of the 1956 Act (which is repealed under section 461 of the 2013 Act)

(iii) specified company referred to in the Unit Trust of India (Transfer of Undertaking and Repeal) Act, 2002

(iv) institutions notified by the Central Government under section 4A(2) of the 1956 Act (which is now repealed under section 465 of the 2013 Act)

(v) such other institution as may be notified by the Central Government in consultation with the Reserve Bank of India [section 2(72) of Companies Act, 2013].

SFC can take action under the SARFAESI Act – State Financial Corporations have recovery powers under the SFC Act, 1951. However, they can also resort to SARFAESI Act, 2002 for recovery action, since provisions of 2002 Act are in addition to other Acts – Golden Wvg. Mills v. Tamil Nadu Industrial Investment Corpn. Ltd. (2011) 105 SCL 172 (Mad HC DB).

4. When an Action for Enforcement of Security Can Be Initiated

As per section 13(2) of SARFAESI Act, action for enforcement of security interest can be initiated when any borrower, who is under a liability of secured creditor under a security agreement, makes any default in repayment of secured debt or any instalment thereof, and his account is classified by the secured creditor as non-performing asset, the secured creditor may require the borrower by notice in writing to discharge the liabilities in full within 60 days from date of notice, failing which the secured creditor shall be entitled to exercise all or any of the rights specified in section 13(4) of SARFAESI Act.

Thus, action can be initiated only when:

(a) Borrower

(b) who is under a liability of secured creditor

(c) under a security agreement

(d) makes default

(e) in repayment of secured debt or instalment thereof and

(f) his account is classified as NPA by secured creditor.

Unless all these conditions are fulfilled, no action can be initiated.

4.1 Who is ‘Borrower’

‘Borrower’ mans any person who, or a pooled investment vehicle as defined in section 2(da) of SCRA which has been granted financial assistance by any Bank/FI or who has given any guarantee or created any mortgage or pledge as security for the financial assistance granted by any Bank/FI, and includes a person who, or a pooled investment vehicle which becomes borrower of an Asset Reconstruction Company consequent upon acquisition by it of any rights or interest of any Bank/FI in relation to such financial assistance or who has raised funds through issue of debt securities. [section 2(1)(f) of SARFAESI Act]. The words in italics inserted w.e.f. 1-4-2021, vide Finance Act, 2021.

4.2 Security Agreement

‘Security agreement’ means an agreement, instrument or any other document or arrangement under which the security interest is created in favour of the secured creditor, including the creation of mortgage by deposit of title deed with the secured creditor. [section 2(1)(zb) of SARFAESI Act].

4.3 Meaning of ‘Default’

“Default” means:

(i) non-payment of any debt or any other amount payable by the borrower to any secured creditor consequent upon which the account of such borrower is classified as non-performing asset in the books of account of the secured creditor; or

(ii) non-payment of any debt or any other amount payable by the borrower with respect to debt securities after notice of 90 days demanding payment of dues served upon such borrower by the debenture trustee or any other authority in whose favour security interest is created for the benefit of holders of such debt securities – section 2(1)(j) of SARFAESI Act as amended w.e.f. 1-9-2016.

4.4 Secured Debt

‘Secured debt’ means a debt which is secured by any security interest. [section 2(1)(ze) of SARFAESI Act].

4.5 Foreclosure of Loan

Though the Sarfaesi Act does not use the word ‘foreclosure’, practically, it is foreclosure. ‘Foreclose’ means stop (a mortgage) from being redeemable or (a mortgager) from redeeming, especially as a result of defaults in payment. [Concise Oxford Dictionary]. The term is loosely applied to any of various methods, statutory or otherwise, of enforcing payment of debt secured by a mortgage, by taking and selling the mortgaged estate. [Law Lexicon – Wadhwa & Co.].

Once a secured creditor decides to foreclose a loan, the entire amount borrowed along with interest becomes due, including instalments which are not due. Thus, notice should be of the entire loan along with interest payable upto date of notice and even future interest till loan is repaid.

4.6 Meaning of Non-Performing Asset

Action for enforcement of security interest can be initiated only if the secured asset is classified as ‘Non-Performing Asset’ (NPA).

‘Non-Performing Asset’ means an asset or account of a borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset –

(a) In case of bank, FI administered or regulated by any authority, in accordance with directions or guidelines of such authority and

(b) in other cases, in accordance with the directions or guidelines relating to asset classification issued by RBI. [section 2(1)(o) of SARFAESI Act].

Such classification between two types of financial institutions has been held valid in Keshavlal Khemchand v. UOI (2015) 4 SCC 770 = 129 SCL 780 = 53 taxmann.com 470 (SC).