Sucheta Dalal :Fine-tuning The SARFAESI Act (22 Sep 03)
Sucheta Dalal

Click here for FREE MEMBERSHIP to Moneylife Foundation which entitles you to:
• Access to information on investment issues

• Invitations to attend free workshops on financial literacy
• Grievance redressal


You are here: Home » Column Topics » Financial Express » Fine-tuning The SARFAESI Act (22 Sep 03)
                       Previous           Next

Fine-tuning The SARFAESI Act (22 Sep 03)  

The Supreme Court has already indicated that the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) Act, 2002 will need to be cured of ‘serious defects’ that render it one-sided. And Attorney General Soli Sorabjee’s Sept 15 deposition seemed to accept this contention when he suggested modifications to bring in natural justice and fair play. The apex court’s verdict in the Mardia Chemicals case will determine how the ends of ‘natural justice’ will be served by the Act and whether a reluctant Reserve Bank of India would be forced to frame lenders liability rules and level the playing field between borrowers and lenders.

But before it does that, the Supreme Court may end up considering a few other issues as well. For starters, the fact that the playing field is not limited to lenders and borrowers, although they are the key players. Equity investors, depositors and other service providers are also stakeholders of borrower companies and the SARFAESI Act has unfairly shut them out of the debate and killed their chances of recovering their investments. These stakeholders were forced to watch from the sidelines while lending institutions deliberately created bad loans by conniving with borrowers or under political pressure. They were also helpless when the government repeatedly diverted public money to bail out loss-making financial institutions through payouts from the exchequer.

Now the courts have permitted two NGOs a foot in the door to the debating room by admitting two separate writ petitions. The first of these was filed by the renowned activist HD Shourie of Common Cause in the Maheshwar Dam case.

Common Cause’s petition before the Supreme Court says that the Union government directed Life Insurance Corporation of India (LIC) to advance a loan of Rs 100 crore to S Kumar’s Shree Maheswar Hydro Power Corporation (SMHPCL) in Madhya Pradesh despite a default. This controversial project has seen a pitched battle between the Narmada Bachao Andolan (NBA) and its promoters, ending with the NBA almost being gagged by the courts.

However, Common Cause has focussed on the fact that the Maheshwar project was being sanctioned fresh funds by LIC despite having defaulted on various other borrowings from banks and institutions. The petition argues that the loan violates the Reserve Bank guidelines, which ask lenders not to advance loans to entities facing payment problems. Specifically, the petition says that the central government and its minister of state for finance asked LIC to “pro-actively” participate in the project by subscribing to convertible debentures of Rs 100 crore. LIC officials were quoted as saying that a conditional sanction has been given to the loan and nearly Rs 30 crore has already been disbursed. The sanction was apparently based on a AAA credit rating by Crisil. But the rating itself was not based on project fundamentals, but a mere existence of a guarantee from a power finance agency, also controlled by the government, in effect a sovereign guarantee.

Common Cause has prayed that the SARFAESI Act should incorporate provisions to deal with such violations by lending institutions. A bench headed by Chief Justice VN Khare and comprising Justices Ashok Bhan and SB Sinha has asked the government to respond to Common Cause’s allegations. If Common Cause has attacked the motivated or behest lending that is largely responsible for creating the humungous non-performing assets in banks and institutions, the second litigation takes a slightly different tack.

Midas Touch Investors Association has filed a writ petition before the Lucknow Bench of the Allahabad High Court arguing that the SARFAESI Act has no provision for effective recovery of money looted from lending institutions or to prevent further siphoning of funds in connivance with lending officials. The petition, attacks the staggering NPAs of Rs 1,10,000 crore (Soli Sorabjee puts it at Rs 91,000 crore) accumulated by Indian banks and institutions and prays that instead of merely attaching the security pledged against the loans, borrowers should be asked to list assets acquired out of diverted funds and forced to bring it back. It also seeks the attachment of assets of promoters and directors during whose tenure the money was diverted.

Justice Pradeep Kant, while issuing notices to the central government, Reserve Bank and the Board for Industrial and Financial Restructuring, observed that the petition raises several larger issues of significance. Virendra Jain of Midas Touch says that his petition has focussed only on those cases where more than Rs five crore have been siphoned off and not on companies that may have turned sick due to business failure. The litigation quotes extensively from articles published by this newspaper under the “Loot and Scoot” series and questions raised in Parliament. The examples it has quoted include Modern Wollen, Parasrampuria, Mukand Group, SPIC, Sanghi Polyester, Essar Gujarat, JK Synthetics, Lloyds Finance, JCT, Dunlop etc.

Both petitions, either directly or indirectly, have attacked weaknesses in the SARFAESI Act that allow only the lenders to benefit and both suggest that although the general public fully supports the provisions that give greater teeth for lending institutions to recover loans, they cannot have unbridled powers with no accountability either to the public, the borrowers or their investors. As one defaulter told me, a loan agreement is a contract between a lender and a borrower. But the SARFAESI Act allows the lender to also be the judge, which is against the principles of natural justice.

The NGOs support this contention and pray that lenders should not only be liable for timely disbursal of loans, but for flaws in the project appraisal as well. The SARFAESI Act, they say, does not attack the root cause of bad loans, which is political pressure, lack of diligence on the part of lenders and their connivance with borrowers. They want lenders to be held accountable for malafide decisions and regulators for lax supervision.

The Midas petition also cites instances where lenders allowed false profit numbers to determine project viability even after the fraud was brought to their attention. It cites examples where industrialists have not been asked to return the funds diverted to their private coffers even when the amount ran into several hundred crores of rupees.

If companies are not forced to disgorge diverted money, only a part of the loans can be recovered by encashing the security of assets and this would always leave investors, depositors and other stakeholders out in the cold. They are hoping that the apex court will restore the balance and protect their rights.

-- Sucheta Dalal