Banking Law

Framework of ARCs and real-world case studies in SARFAESI Act 2002


A brief report on important aspects of the SARFAESI Act.



Saumya Parmarthi

Symbiosis Law School, Noida






SARFAESI Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest
NPA Non-Performing Assets
ARC Asset Reconstruction Company
SCs Securitization Companies
Sec. Section
RBI Reserve Bank of India
QIB Qualified Institutional Buyer
SC/RC Securitization Company or Reconstruction Company




Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest – SARFAESI, 2002
The SCs and Reconstruction Companies (Reserve Bank) Guidelines and Directions, 2003 – DIRECTIONS
Guidance Notes for Securitization Companies and Reconstruction Companies – GUIDANCE NOTES
Guidelines to banks / FIs on sale of Financial Assets to Securitization Company (SC)/ Reconstruction Company (RC) (created under SARFAESI, 2002) – GUIDELINES TO BANKS
Security Interest (Enforcement) Rules, 2002 – ENFORCEMENT RULES

  • The Enactment of SARFAESI Act was done to facilitate the early resolution of NPAs of banks & other financial institutions and for the extensive use of ARCs in India. The high level of non-performing loans had impaired the financial position of a number of public sector banks, weakened the financial capacity of other financial institutions and had emerged as a major concern. The non-performing loans of banks and financial institutions in India as of March 2001 had reached approximately Rs. 548 billion for public sector banks and roughly Rs. 240 billion for other financial institutions.
  • Need for Asset Reconstruction was recognized for the first time in 1991 in the Ist Narasimha Committee Report on Financial Sector Reform and since then three more Committee Reports have highlighted the same the mechanism to implement their suggestions.

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. vs. Union of India[1] upheld the constitutional validity of SARFAESI Act.

The Act provides three alternative methods for recovery of NPAs, namely:

  • Securitization;
  • Asset Reconstruction; and
  • Enforcement of Security (without the intervention of the Court)
  • Objectives Of the Act
  • To lay 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 Court’s 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. Securitization[2] 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 securitization is the process of converting receivable and other assets into securities that can be placed and traded in capital markets.

Securitization process consists of following transactions on the part of a securitization company or reconstruction company:

  1. Acquisition of financial assets from any originator, and
  2. Raising of funds from qualified institutional buyers by issue of security receipts for acquiring the financial assets or
  3. Raising of funds by any other manner, and
  4. 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 & raising of funds for such acquisition by issue of security receipts as securitization, the mode of acquisition, consequences of such acquisition and rights of investors in such assets are provided in Sec. 5-8 of the SARFAESI Act.  Any financial asset which has a reasonably predictable cash flow can be securitized. The definition of financial asset[3] include any debt or receivable whether present or further but the substantive provision in Sec. 5 enabling securitization of such assets restricts it to financial assets of banks and financial institutions only.

A SC/RC may raise funds from only the QIB by forming schemes for acquiring financial assets.

  1. Asset Reconstruction[4] means, by any SC/RC 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 SC/RC for the purposes of Asset Reconstruction may provide one or more of the following measures[5] laid down in Sec. 9[6]:

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

e) Settlement of dues payable by the borrower

f) Taking possession of secured assets

  1. 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.



The Act was 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 & SCs

  • Directions
  • Guidance Notes; and
  • Guidelines to Banks

The Central Government has also issued the Enforcement Rules[7]. 

  • 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 corporate. 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 who 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 but they also bring a combination of skills, experience, objectivity & commercialism to the resolution process.
  • Capital And Funding – 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 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 & 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 ring fencing requirements, asset acquisition is likely to be effected through a trust structure, under respective schemes.
  • 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 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 & the secured creditors cannot enforce the security interest under SARFAESI 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/ FI’s- 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 realization, they allow the sharing of the surplus of realization of certain specific financial assets between the ARC and the banks/FIs.
  • Enforcement Of Security Interest The Act permits the secured creditors[8] 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.
  • 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.


Critical success factors for the effective functioning of private ARCs in India[9]:

  • 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
  • Elimination/Minimization of taxes and costs relating to NPA transfers.
  • Rationalization of the tax regime incentivizing investments in NPAs
  • Use of professional management teams with expertise in financial restructuring.


  1. Kingfisher Airlines Ltd. vs. State Bank of India & Ors[10]


FACTS: The said Application was filed contending that by invoking the jurisdiction of the this Court for winding up, the Banks are deemed to have relinquished and surrendered all security interest and therefore seeking to invoke Sec. 14 of the SARFAESI Act after filing the Petition for winding up is wholly illegal and without jurisdiction. Further the proceedings under SARFAESI may jeopardize the interests of a large number of creditors, employees, shareholders and the company as well.


QUESTIONS: The following points were considered in this Judgment[11]

  1. Whether there is a bar on jurisdiction of the High Court as a Company Court to grant relief in the light of Sec. 34 & 35 of the SARFAESI Act?
  2. Whether the Banks could choose to stand outside the winding up, in seeking to enforce the security assets and simultaneously prefer a Company Petition seeking for winding up of the Company in respect of the balance debt not covered by such security?
  3. Whether the Company Court could exercise jurisdiction over the secured assets whether before or after a winding up order is passed when possession of the property is sought to be taken by recourse to SARFASEI Act in the capacity of a secured creditor?

After applying Sec. 34 & 35 of the Act with Sec. 446 (2)[12] it was held that the Karnataka High Court as a Company Court did not have jurisdiction to interfere.

The Single Judge held that a secured creditor can choose to stand outside the winding up and yet simultaneously prefer a company petition and also that the Company Court could not exercise jurisdiction over the property when recourse is sought to be taken against the secured asset by a secured creditor under SARFAESI Act. The Court held that the Company Court could not exercise jurisdiction over the secured assets whether before or after the winding up order is passed when the secured creditor has taken recourse under SARFAESI Act. This so because the secured creditor does not need to relinquish his secured asset if he files petition for a winding up. When the stage of proving his debt does arise, he will only have to prove the balance due to him after he has realized the secured assets. Thus secured creditor may pursue the remedies available to him irrespective of the winding up.


  1. Punjab National Bank vs. Raju M. Thomas[13]

The judgment threw light on few below mentioned questions:

  1. Whether guarantor can be construed as “borrower” under section 2 of the SARFAESI Act, 2002? The guarantor is very much a ‘borrower’ as defined under Section2(f) of the Act which states: “borrower means any person who has been granted financial assistance by any bank or financial institution or who has given a guarantee or created any mortgage or pledge as security for the financial assistance granted by any bank or financial institution and includes a person who becomes borrower of a securitization company or reconstruction company consequent upon acquisition by it of any rights or interest of any bank or financial institution in relation to such financial assistance”.
  2. Whether Authorized officer has an obligation to serve notice to the guarantor too under the Act? Rule 8(6) of the Rules casts a duty on the Authorized Officer to serve a notice on the borrower about the proposed sale of the property at least 30 days ahead. That such a notice has to be served on each of the borrower is evident from Rule 3(3) and Rule 3(4) of the Rules. Any failure to issue notice as stated above shall invalidate the sale.

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. It is the SARFAESI Act that brought a greater change in the debt recovery scenario in the country. One of the important changes that SARFAESI has brought is that it allowed the banks to take over possession from the defaulter, without going through the stringent court procedure, once the loan account has been categorized as a Non- Performing Asset.



  • R. Umarji, Law & Practice relating to SARFAESI, (Taxmann, 4th Ed., New Delhi),



  • Mardia Chemicals Ltd. and Others vs. Union of India and Others (2004 (4) SCC 311).
  • Kingfisher Airlines Ltd. V. State Bank Of India And Ors Karnataka High Court Company Application No. 2214/2013 in Company Petition No. 164/2013


[1]  2004 (4) SCC 311

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

[3] section 2(1) (l) of the SARFAESI Act

[4] defined under S. 2(1) (b) of the SARFAESI Act

[5] having regard to the Guidelines framed by RBI

[6] SARFAESI Act, 2002

[7] To govern the enforcement remedies granted to secured creditors under the Act.

[8] if secured creditors hold 75% or more of the amount outstanding

[9] 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 <;

[10] Karnataka High Court Company Application No. 2214/2013 in Company Petition No. 164/2013

[11] Retrieved from


[12] The Companies Act, 1956

[13] O.P.(DRT).No.1390 OF 2012 and O.P.(DRT).No.2835 OF 2012


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s