RBI Guidelines: NPA classification/SARFAESI Act – discretion of Bank/Secured Creditor?

The Banks or Secured Creditors do feel comfortable in recovering their dues using the provisions of SARFAESI Act, 2002. The object of the enactment, as everybody knows, is to enable the Banks/Secured Creditors to reduce the level of ‘Non-performing Assets (NPA)’. In the absence of a special legislation like ‘Recovery of Debts due to Banks and Financial Institutions Act, 1993’ and “Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002”, it is infact very difficult for the Banks to recover debts approaching Civil Courts. The observation of Hon’ble Madras High Court in The Repatriates Co-op Finance & Development Bank Ltd., Chennai & Others, 2010 (4) LW 497, 2010 (5) CTC 449, 2010 (7) MLJ 882, on the plight of Banks in recovering their dues from the borrower through Civil Courts, is as follows:

“3. For getting a decree in usual course before a Civil Court litigant including Banks have to file the suit before a Civil Court. After service of notice, written statement and trial, the suit would be decided by passing a decree. The decree would possibly be challenged by way of appeal upto Supreme Court and it would take about 5 to 15 years to attain finality. There would be possibility of dismissal of suit on various grounds. After the decree is passed by the competent civil court, the same would be put to execution by filing E.P. The Execution Court after service of notice would bring the property of the debtor/guarantor for sale through auction. To reach this stage, lot of money, especially very long time has to be spent. The above process is dispensed with by the Special Act "SARFAESI ACT" which is meant only for the financial institutions. As per the Act, the first step would be to issue notice U/s. 13(2) by the authorised officer who is deemed to be armed with a money decree which attained finality. By the statute the authorised officer, is clothed with powers of trial court and execution court and the code of Civil Procedure which governs the civil proceedings is no more necessary. To put it otherwise, by the Special Act, the authorized officer acts like a Civil Court clothed with powers hitherto exercised by it.”

The primary objective of the Banks/Secured Creditor should be to deal with the defaulters and not to harass the borrowers using the provisions of SARFAESI Act, 2002. The borrower very often raises a grievance that they are not willful defaulters and the Bank or Bank Officials are harassing them.But, the Bank says that they follow the guidelines issued by the Reserve Bank of India and in many cases, they follow the guidelines very strictly and mechanically. The borrower, in many cases now, may not be able to convince the Bank that he can not be construed as a defaulter and he will pay the loan amount if the Bank is liberal. It is true that the borrower gets a right to question the action initiated by the Bank if the Bank is incorrect in classifying an account as ‘NPA”. The borrower can certainly insist the Bank to follow the guidelines issued by the Reserve Bank of India and the courts have held that the guidelines are mandatory from the borrower point of view. The Bank or the Secured Creditor, though is entitled to classify an account as ‘NPA” based on the guidelines issued by the Reserve Bank of India, the borrower can certainly question the issue of classification if he can establish that the Bank has acted unreasonably or the classification is perverse on the face of it. It may be really difficult for the borrower to question the classification of Account by the Bank, but, in some cases, the borrower may have a case to show that the Bank has acted unreasonably. On the issue of classification of Account by the bank as “NPA”, the Hon’ble Madras High Court in

M/s. Signal Apparels Pvt. Ltd. & Another Vs. Canara Bank P.N. Road Branch, Tirupur & Another, 2010 (5) CTC 337, 2010 (8) MLJ 967,was pleased to observe as follows:

“16. To put it precisely, for invocation of provision of Section 13(2) of the Act, the declaration of an asset or account to be a non-performing asset is a condition precedent. In the event such declaration is not in accordance with the R.B.I. guidelines and the account of a borrower is a performing account, Section 13(2) may not be pressed into service; as such account cannot be brought under Section 2(o) of the Act. Equally, going by the scheme of the Act, the discretion conferred on the bank to declare an asset to be a non-performing asset is in order to tackle the issue of increase of non-performing asset to high level. That is why; the legislature had left the discretion to the bank while declaring a debt as a non-performing asset, qualifying such bank to follow the directions or guidelines issued by the Reserve Bank of India while classifying the assets to be sub-standard, doubtful or loss assets to be known as non-performing assets. This discretion is on national policy and all that requires for the secured creditor is to exercise the discretion judicially. In the wake of the right of the secured creditor to declare a debt as a non-performing asset, to show the application of mind for such declaration, it may indicate the reasons thereof in the notice under Section 13(2) and the Section does not contemplate that in all cases such reasons should be indicated in the notice. The application of mind could be culled out from the materials that were existed on the date of such declaration.”

On the same issue of classification of Account as ‘NPA’ by the Bank before proceeding against the borrower under the provisions of SARFAESI Act, 2002, the Hon’ble Andhra Pradesh High Court, in M/s. Sri Srinivasa Rice and Floor Mill Vs. The Authorised Officer, State Bank of India (2007 (4) ALT 317, 2007 (4) ALD 649, 2007 AIR (AP) 252), was pleased to observe as follows:

“There is, as considered earlier in the judgment no statutory format, express or by necessary implication, that requires the respondent bank to follow a particular or formal procedure or requires a formal declaration as a condition precedent to classification of debt as NPA. From the scheme of the Act in general and the provisions of Sec.13 (2) in particular, the conclusion is compelling that the legislature has consecrated the power, authority and discretion (to classify a debt as a NPA) to the secured creditor within the generic guidelines to be ascertained from the definition of a non performing asset [Sec.2 (o)]. A wide margin of discretion is available to the respondent bank as the secured creditor, within the legislative presents of the Act, to assess and classify a debt but within the legislative framework. This Court is not constituted an appellate authority over the bank’s exercise of discretion in this area. The respondent bank, as legislatively recognized is an institution having the requisite expertise to form a commercial judgment on known principles of banking practices and procedures fertilized by R.B.I directions and guidelines to assess and classify a debt as NPA. From the wealth of material pleaded in the counter-affidavit the bank had assessed the debt as non-performing asset. On facts, the petitioners have miserably failed to establish that such assessment by the bank is perverse or irrational to a degree warranting oversight and correction in judicial review.”

Conclusion: The issue is really complicated. If it is a case where the Bank has ignored the guidelines issued by the Reserve Bank of India, then, the borrower can question the illegal action of the Bank and can definitely succeed. However, if the issue is about reasonableness in classifying an Account as “NPA” though the Bank has followed the guidelines issued by the Reserve Bank of India strictly, then, the borrower has to establish a strong case about his track-record and intention when it comes to repayment of the outstanding-due; and also as how the Bank acts unreasonably.

Note: the views expressed are my personal and a view point only.