Basics of SARFAESI Act A Complete Study

Financial Assistance - Definition

In this session let's analyze the definition of financial assistance.

already in the definition of the borrower, we have seen a borrower is a person who has been granted financial assistance by any bank or financial institution

so in that context definition of financial assistance gains its importance

the definition goes like this

whenever any bank or financial institution grants a loan or advance or makes a subscription of debenture or bonds or gives a guarantee or issues a letter of credit or extends other credit facilities then it is called financial assistance

So as per this definition financial assistance can be given by a bank or it can also be given by financial institution point number one

number 2 this financial assistance can be in the form of a loan

it can be in the form of an advance

it can be in the form of subscription of debenture - that is bank subscribing to the debenture of a company - so here bank by subscribing to the debenture of the issuer it is actually giving them a financial assistance

next, it can be in the form of bonds - so here also bank by subscribing to the bonds of the issuer it is actually giving them a financial assistance

In all the 4 forms we have discussed, that is loan, advance, subscription to debenture, and subscription to bonds there is going to be a cash outflow from the Bankside.

but it is not necessary that financial assistance should be only in the form of cash outflow.

if a bank is going to give a guarantee or if it is going to issue a letter of credit or if it is going to give some other credit facility, then that will also be called financial assistance.

Financial Asset - Definition

In this session let's analyze the definition of financial assets as per SARFAESI Act.

let me read out the definition and then we’ll analyze

financial asset means debt or receivables and includes

1. a claim to any debt or receivables or part thereof whether secured or unsecured or

2. any debt or receivable secured by mortgage off or charge in immovable property or

3. a mortgage charge, hypothecation, or pledge of movable property or

4. any right or interest in the security, whether full or part, securing debt or

5. any beneficial interest in any movable or immovable property or in debt, receivables whether such interest is existing, future, accruing, conditional or contingent or

6. any financial assistance

The first sentence of the definition says financial asset means debt or receivables. so banks basically give debt and it is a financial asset for them.

receivables are something which arises out of credit sales - So what is more relevant here from the banker point of you is debt.

and the definition is not just limited to debt or receivables - rather it includes various other elements into the understanding of financial assets.

the first point says

“claim to any debt or receivables or part thereof whether secured or unsecured”

What we can understand from this? already we know that if there is a debt or receivable it is a financial asset - but from this what we can infer is if you are having a claim on any debt or if you are having a claim on any receivable - whether full or part of it -if you have a claim on it then it is also a financial asset whether that is secured or unsecured.

next, let's move on to the second point

the second point says

“any debt or receivable secured by mortgage of or charge in immovable property”

So the messages if the debt or receivable is secured that is also financial asset only - This security can be by way of mortgage of immovable property or by having a charge on that immovable property.

let's move to the 3rd point

3rd point says

“a mortgage charge, hypothecation or pledge of movable property”

So what we can infer from this point is, if there's a mortgage charge or hypothecation or pledge on a movable property then that will also be considered as a financial asset

moving on to the 4th point

4th point says

“any right or interest in the security, whether full or part, securing debt”

so if the bank or financial institution is having any right or interest in the security, In order to secure a debt then that right or interest in the security will be considered as a financial asset whether it is full or part of it

next, let's move on to the 5th point

“any beneficial interest in any movable or immovable property or in debt, receivables whether such interest is existing, future, accruing, conditional or contingent “

As per this point if the bank or financial institution is having any beneficial interest, let it be movable property or immovable property, let it be debt, let it be receivable - it will be called a financial asset - Whether that interest is existing as of now, or it's going to be in future only, or it's already accruing, or it's conditional in nature, or it is contingent in nature.

And the final point says any financial assistance is a financial asset.

so if a bank has given financial assistance to a borrower then all those financial assistance can be called financial assets.

Hypothecation - Definition

In this session let's analyze the definition of hypothecation

let me read out the definition first and then will move into analysis

hypothecation means

a charge in or upon any movable property

existing or future

created by borrower

in favour of a secured creditor

without delivery of possession of the moveable 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.

so from this definition, it is clear that hypothecation is a charge.

on which kind of property hypothecation will be created?

it will be created only on movable property.

Whether that movable property should be in existence as on the date of creation of hypothecation?

It is not necessary that movable property should be in existence as on date - because the definition says movable property existing or future - it means even the moveable property which is about to be created in future can be covered under hypothecation.

okay?

So who will create hypothecation?

it will be created by the borrower!

in whose favor hypothecation should be created?

it should be created in favor of a secured creditor.

okay - weather hypothecation involves the delivery of possession of the property?

no hypothecation is without delivery of possession of the property - which property? it is a movable property.

And why hypothecation is created in favor of secured creditors?

it's basically to give that moveable property as security for the financial assistance availed from the secured creditor

Wait wait – there was something very important in the last part of the definition – it said, hypothecation includes floating charge and crystallization of such charge into fixed charge on moveable property.

So floating charge is hypothecation and if that floating charge crystallizes into a fixed charge on a mobile property then that is also hypothecation only.

to understand this better, now we need clarity on what is a floating charge and what is a fixed charge.

First, let me take you through floating charge

floating charge as the name implies it's going to be floating in nature

that is the bank will be having a charge on those secured assets, but floating charge gives scope for the company to sell, transfer or dispose of those assets without getting approval from the bank.

so if you look at it from the lender's point of view it actually leaves them exposed whereas for borrowers it gives more freedom for their business.

generally, we will be seeing floating charges on assets like stock, receivables, movable plant and machinery, movable furniture fixtures.

so that's about the floating charge.

then what is the fixed charge?

fixed charges generally attached to a particular asset and it can be easily identified.

a fixed charge would generally protect the lender because here the borrower cannot dispose of the asset where fixed charges were created without the prior approval of the bank.

So I think with this we have made a complete analysis of the definition of hypothecation.

one interesting item to note here is - it is only the SARFAESI Act that has defined hypothecation for the first time.

Prior to that, no Indian law has defined the term hypothecation despite hypothecation being a very common type of charge in bank lending.

Definition of Property

In this session, let's look at the definition of property

property means

1) immovable property

2) movable property

3) any debt or any right to receive payment of money whether secured or unsecured

4) receivables whether existing or future

5) intangible assets such as

• know-how

• Patents

• copyright

• trademarks

• license

• franchise or

any other business or commercial right of similar nature

In Sarfaesi Act a wider meaning has been given for the term property

even other acts like the Transfer of Property Act, Registration Act have defined property

but this definition has included 3 additional items under the property

That is item number 3

any debt or any right to receive payment of money whether secured or not

that is now considered as property

receivables whether it is existing or future that is also considered as property

and specifically, intangible assets are also included under the definition of property

with this security, interest can now be created on these items as well and they can be used for raising loans from banks and Financial Institutions.

Definition of Security Interest

Let's move on to the definition of security interest

I'll read out the definition

Any right, title, and interest of any kind, whatsoever, upon the property, created in favour of, any secured creditor is called a security interest. It includes any mortgage charge, hypothecation, assignment other than those specified in Sec 31 of the SARFAESI Act.

So what can we infer from the definition?

if a lender is taking any security from the borrower, he is getting interested in that security.

do not confuse interest on security with interest on the loan.

so what kind of interest he is getting on that security actually depends upon the nature of charge that is created over the security.

until the enactment of the Sarfaesi Act, the interest of the lender on the security was not defined in any law.

so we can say, A for the first time surface acts as a defined security interest.

if the lender is having any type of charge, or he is having any type of security e then that comes under the wide scope definition of security interest.

Definition of Secured Creditor

Let's move on to the definition of the secured creditor.

any bank or financial institution or any Consortium or group of banks or Financial Institutions in whose favour the security interest is created by the borrower for due repayment is called a secured creditor.

Now let's analyse this

who can be called as a creditor as per this definition

Bank

financial institution

Consortium

group of banks

group of Financial Institutions

when they can be called as a secured creditor

they can be called a secured creditor when the security interest is created in their favour

who should create a security interest in favour of a secured creditor?

obvious it's by the borrower

and of course, the borrower will be given the security for having taken the financial assistance.

The definition also goes further and includes certain other persons also under secured creditor.

they are

debenture trustee appointed by any bank or financial institution or securitisation company or reconstruction company

It also includes,

any other Trustee holding securities on behalf of a bank or financial institution.

Introduction to Enforcement of Security Interest

In this section, we are going to talk about the enforcement of security interests.

Now we have a picture as to why this SARFAESI Act was enacted?

I'll just repeat for clarity's sake.

If a bank has taken movable or immovable property as security for a loan and if that borrower has defaulted on the loan, then for recovering that loan amount, the bank or that financial institution has to sell that movable or immovable property and for that, it requires the intervention of the court.

This resulted in an enormous delay.

So, it was felt necessary to give powers to the lenders to enforce the security without going through the court intervention process, and hence came this SARFAESI Act.

we can say

SARFAESI Act gives power to banks and Financial Institutions to enforce the securities in the event of default by the borrower and This enforcement can happen without the intervention of the Civil Court for debt recovery Tribunal.

The powers that are available under this act have an overriding effect on other laws on the security enforcement matter.

So here the secured creditor has been given the option to select the right course of action in the event of defaulted loans.

Let's talk more about enforcement in the coming sessions.