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January 28, 2009
Court disallows trading in NPAs by Banks
The Hon’ble High Court of Gujarat (“Court”) in
a recent decision in an appeal filed by Kotak Mahindra Bank
Limited (“Appellant”) v. Official Liquidators
of M/s. APS Star Industries Limited & Others decided on January
12, 2009 that banks cannot trade, transfer or purchase a pool of
Non Performing Assets1
(“NPA’s”), or more commonly called “bad debts”.
Background and Submissions
ICICI Bank Limited (“Assignor Bank”) executed a
Deed of Assignment (“Deed”) in favour of the
Kotak Mahindra Bank Limited (“Appellant” or
“Assignee Bank”) by which a basket of NPAs of
the Assignor Bank along with underlying security interest, if
any, were assigned/transferred on “as is where is” basis to the
Assignee Bank at a defined purchase price.
The single judge of the Company Court in an application made by
the Assignee Bank held with respect to the Company - APS Star
(in liquidation) that the Deed was not a valid document and
rejected the request for substitution of the Assignee Bank in
place of Assignor Bank. The present decision is passed in an
appeal filed by the Assignee Bank against the said order. The
Official Liquidator on behalf of the Company alongwith the
Company’s workmen union raised a preliminary objection resisting
the application for substitution made by the Assignee Bank.
Judgement
The Court after hearing the submissions held that the Deed,
executed between the Assignor Bank and the Assignee Bank, was
not valid on several grounds. The Court reasoned that the Deed
essentially has been executed for the purpose of transferring
NPAs from the Assignor Bank to the Assignee Bank, which is
nothing but trading in debts. It further said that the concept
of trading in debts is, by its very nature, abhorrent to the
concept of banking in any form, either the form of primary
business of banking or the additional activities envisaged under
Section 62
of the Banking Regulation Act, 1949 (the “Act”).
The court further noted that the act of securitization itself is
‘necessary concomitant to the activity of lending. Such an
activity cannot also be part of any policy of sound economic
growth because it only means, if one may use the expression,
clearing the debris from one balance-sheet and dumping the same
in another balance-sheet’. The Court further noted that
under the provision SARFESI Act, a banking company cannot
function as a securitization or a reconstruction company which
have separate powers for enforcing their security interest.
The Court observed that the activities envisaged under Section
6(1) (a) of the Act make it clear that concept of buying and
selling is available as part of additional business only for
certain specified categories of activities and that trading in
debts in no measure falls with the ambit of these activities.
The Court further said that recovery of a loan can only be from
the borrower while in the instant case there is a transfer of
NPAs and thus the consideration received for transfer of assets
cannot be termed to be towards recovery of outstanding loan.
Further the court observed that since customer is an essential
element of negotiation of any public or private loan, and
therefore, the Deed would be invalid since the creditor is not
made party to the Deed. In this context, Court rejected the
contention of the Appellant that buying and selling of debt was
permitted under the Transfer of Property Act, 1882 as not
applicable in this case, as such activities were not permitted
under the Act which is a special enactment and therefore
Appellants are not allowed to take recourse to a general law
when a special law is in place.
The Court has raised a strong objection against such
substitution of a creditor by way of assignment, since this
exercise adversely affects the right of the debtor. The Court
has relied on the findings of Hon’ble Supreme Court in the case
C.B. Gautam v/s Union of India & Ors [1993] 199 ITR 530 and said
that ‘notice granting an opportunity of hearing is a must,
even in absence of a provision’ and therefore debt must not
be assigned without giving meaningful and reasonable opportunity
to the borrower to be heard.
The Court also held that the execution of Deed involves not only
assignment but also the concept of novation and further as the
law stands, transfer of obligations are not permitted and the
terms of the original contract as the terms of the Deed have
been varied to that extent and therefore unless and until the
creditor is a party with the Assignee Bank, it would have no
liability.
The Court has further observed that the benefit of a pari
passu charge created on assets of the company as per
Section 529A3
of Companies Act is available only to the first charge holder
and the second charge holder and as such the Assignee Bank does
not fit the category of either of the two and therefore cannot
be substituted for the Assignor Bank in the instant case.
Since the Court held the very execution of the Deed to be
invalid, the Court did not adjudicate the other various issues
related to the Bombay Stamp Act, 1958 and the Registration Act,
1908.
Analysis
The very purpose of the SARFAESI Act was to enable
securitization and reconstruction of financial assets and
enforcement of security interest which would help banks recover
NPAs and enforce security interest in an expeditious manner. We
believe that the instant case has raised an important and
contentious issue where the Court has questioned the means
through which banks could deal with NPAs, which in the present
case was done by transferring them to another bank for a
consideration.
This judgment would have a ramification and implication on the
banking industry and the manner in which the securitization of
debts, more particularly the NPAs, are dealt with.
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Litigation & Dispute
Resolution Team
You can direct your queries or comments to the authors
__________________________
1 Section
2 (1) (o), Securitisation and Reconstruction of Financial Assets
And Enforcement Of Security Interest Act, 2002 (“SARFAESI Act”)
defines a "non-performing asset" as 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 such bank or financial institution is administered or
regulated by an authority or body established, constituted or
appointed by any law for the time being in force, in accordance
with the directions or guidelines relating to assets
classifications issued by such authority or body;(b) in any
other case, in accordance with the directions or guidelines
relating to assets classifications issued by the Reserve Bank.
2 Section 6 - Forms of business in which
banking companies may engage (1) In addition to the business of
banking, a banking company may engage in any one or more of the
following forms of business, namely:
(a) the borrowing, raising, or taking up of money; the lending
or advancing of money either upon or without security; the
drawing, making, accepting, discounting, buying, selling,
collecting and dealing in bills of exchange, hoondees,
promissory notes, coupons, drafts, bills of lading, railway
receipts, warrants, debentures, certificates, scrips and other
instruments and securities whether transferable or negotiable or
not; the granting and issuing of letters of credit, traveller's
cheques and circular notes; the buying, selling and dealing
inbullion and specie; the buying and selling of foreign exchange
including foreign bank notes; the acquiring, holding, issuing on
commission, underwriting and dealing in stock, funds, shares,
debentures, debenture stock, bonds, obligations, securities and
investments of all kinds; the purchasing and selling of bonds,
scrips or other forms of securities on behalf of constituents or
others, the negotiating of loans and advances; the receiving of
all kinds of bonds, scrips or valuables on deposit or for safe
custody or otherwise; the providing of safe deposit vaults; the
collecting and transmitting of money and securities.
3 [529A. Overriding preferential payment
(1) Notwithstanding anything contained in any other provision of
this Act or any other law for the time being in force, in the
winding up of a company-
(a) workmen's dues; and
(b) debts due to secured creditors to the extent such debts rank
under clause (c) of the proviso to sub-section (1) of section
529 pari passu with such dues,
shall be paid in priority to all other debts.
(2) The debts payable under clause (a) and clause (b) of
sub-section (1) shall be paid in full, unless the assets are
insufficient to meet them, in which case they shall abate in
equal proportions.]
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