Documentation – CS Professional Study Material

Chapter 14 Documentation – CS Professional Banking Law and Practice Notes is designed strictly as per the latest syllabus and exam pattern.

Documentation – CS Professional Banking Law and Practice Study Material

Question 1.
Attempt the following:
State the objectives of loan documentation. (Dec 2007, 5 marks)
Answer:
Objectives of Loan Documentation:
The ultimate objective of documentation is to serve as primary evidence for enforcing the banks right to recover the contracted debt, in the event of all other resources proving to be of no avail, through Court of law as the final resort. Documentation will succeed in fulfilling this objective only when the following requirements are met:

(a) The owing of debt to the Bank by the borrower is established by documents.
(b) The charge created on the borrower’s amount as security for the debt is maintained intact; and
(c) The bank’s right to enforce the recovery of the debt through court of law is not allowed to be time barred under the law of limitation.

Documentation - CS Professional Study Material

Question 2.
Attempt the following:
Briefly explain the process of ‘securitisation’. (Dec 2007, 5 marks)
Answer:
Securitization : Securitization in the process of liquidating the assets appearing in balance sheets of Banks/Financial Institutions, Corporates which represents long-term receivables by issuing marketable securities against them. This involves conversion of an illiquid, non-negotiable and high valued financial asset into securities of small value which are tradable and transferable.

The assets generally securitized by Financial Institutions are term loans to high rated companies, receivables from Government companies, credit card receivables, vehicle loans, mortgage loans, lease finance etc.

Company sells receivables to Special Purpose Vehicles (SPVs) and takes cash.

SPVs convert the assets into securities and sell to investors in the market in marketable lots.

The repayment of loan installments is diverted by the company to the account of SPV/Reserve Account.

SPV pays the amount to the investors by way of returns from this amount. Any shortfall in case of non-recovery of installments is to be borne by the company for this purpose, a separate account is opened with funds which are utilized in case of any short-fall.

Documentation - CS Professional Study Material

Question 3.
What are the basic principles on which bank claims can be settled through Lok Adalats? (Dec 2008, 5 marks)
Answer:
Keeping in view the utility of Lok Adalats, for reducing NPAs, Indian Banks Association has issued guidelines for settlement of claims through Lok Adalats. At present, only cases having any monetary claim can be settled through Lok Adalats. While agreeing for settlement through Lok Adalats, interest from the date of filing suit till date of realization, may be agreed upon as may be proposed by the Lok Adalats.

When facilities of installments are agreed upon, repayment should not extend beyond 3 years. Efforts should be made to obtain some down payment at the time of settlement/decree. When there was no exemption in court fee the expenses on court fee may be borne by the borrower and the bank equally.

Documentation - CS Professional Study Material

Question 4.
The increasing non-performing assets (NPAs) and the time consuming legal process of loan recovery prompted enactment of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. Describe the important provisions of this Act having a bearing on NPAs. Is it justified to use the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 as a tool in management of NPAs ? Has this Act helped in quicker recovery of loan and reducing NPAs ? (June 2014, 15 marks)
Answer:
The Securitization and Reconstruction of Financial Assets and Enforcement of Securities Act, 2002 [SARFAESI] Act, 2002 was enacted to regulate securitization and reconstruction of financial assets and enforcement of security interest and for matters connected therewith or incidental thereto.

Provisions of SARFAESI related to NPA
The right of the banks/financial institutions to resort to the provisions of the SARFAESI arises only in the event where any borrower, who is under liability to a secured creditor under a security agreement, makes any default in payment of a secured debt or any installment thereof and his account in respect of such debt is classified by the secured creditor as non-performing asset.

Documentation - CS Professional Study Material

Therefore, classification of account as an NPA is a sine qua non and, the following eventualities can be called out for recovery under the provisions of SARFAESI, that is:

  • there must be a debt by a borrower from a secured creditor under a security agreement;
  • there must be a default in repayment of secured debt or any installment thereof by the borrower;
  • the borrower’s account in respect of such debt is classified by the secured creditor as ‘nonperforming asset’;
  • a notice in writing should be issued by the secured creditor to the borrower to discharge in full his liabilities within sixty days from the date of the notice;
  • in terms of sub-section (3) of Section 13, the notice shall also give details of the amount payable by tbe borrower and the secured assets intended to be enforced by the secured creditor.

It is mandatory by the Banks to follow the RBI guidelines on asset classification before any account can be classified as an NPA and any irregularity in this regard can be fatal and can nullify the proceedings initiated under the SARFAESI Act. Normally Bankers are giving enough opportunity & sufficient time like:

  1. Following up for 90 days;
  2. Examining restructuring option for viable unit.

Bank voluntarily taking the action to save the account from NPA. The process runs nearly 6 to 9 months from date of surface of overdue. And only after exhausting all options to help the borrower & to save the economic value of assets, lenders resort to go for SARFAESI Action as last resort for recovery action. Hence we are of view that borrower are given enough opportunity voluntarily to take out account from NPA before SARFAESI Action.

Under this act, the secured creditor may take recourse to one or more of the following measures to recover his secured debt, namely:
(a) take possession of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale for realizing the secured asset;

(b) substitution of management of the business of the borrower including the right to transfer by way of lease, assignment or sale for realizing the secured asset;

Documentation - CS Professional Study Material

(c) appoint any person (hereafter referred to as the manager), to manage the secured assets the possession of which has been taken over by the secured creditor;

(d) require at any time by notice in writing, any person who has acquired any of the secured assets from the borrower and from whom any money is due or may become due to the borrower, to pay the secured creditor, so much of the money as is sufficient to pay the secured debt.

Further the provisions of this Act shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law.

In view of the above, we may say that SARFAESI can be used as tool in management of NPAs.

The promulgation of the SARFAESI Act has been a benchmark reform in the Indian banking sector. The progress under this Act had been significant, as evidenced by the fact that during 2002-03 when the Act came into effect, there was an overall reduction of non-performing loans to 9.4 per cent of gross advances from 14.0 percent in 1999-2001.

Currently, three legal options are available to banks for resolution of NPAs the SARFAESI Act, Dept Recovery Tribunals and Lok Adalats. The SARFAESI Act has been the most important means for recovery of NPAs. For example: Banks have referred as many as 78,366 loan default cases for the year 2010 under the SARFAESI Act involving a loan amount of ₹ 14,249 crores. Against this, banks managed to recover ₹ 4,269 crores representing 30% of the loans.

The ‘Report of the Working Group on the Issues and Concerns in the NBFC Sector’ laid out recommendations to extend the coverage of SARFAESI to NBFCs as well. This move will benefit NBFCs, ensuring quicker recovery of their non-performing assets.

Documentation - CS Professional Study Material

Question 5.
Discuss the implication of the Limitation Act, 1963 on the rights of bankers and remedy available to a banker when limitation sets in. (June 2015, 5 mark)
Answer:
The Limitation Act, 1963 with the intention of protecting borrowers and preventing lenders from misusing their position and acquiring assets of the borrower after a very long period of silence.

The Act specifies that if debt is not acknowledged within a time prescribed under the Act, it gets time barred. The provisions of the Limitation Act are also applicable to the Banking transactions and thus, the Banker has to ensure that the documents remain valid and are not time Barred. The limitation period for different type of documents as prescribed under Limitation Act are given under:

S. N. Type of Document Limitation Period
1. Demand promissory Note 3 years from the date of the note
2. Bill of exchange payable at site or on presentation 3 years from the date of presentation
3. Usance Bill of exchange 3 years from the due date
4. Clean loans 3 years from the date of the loan
5. Guarantee 3 years from the date of invocation of the guarantee
6. Mortgage-Payment 12 years from the date the money sued becomes due
7. Mortgage-foreclosure 12 years from the money secured by the mortgage becomes due
8. Mortgage-Possession of immoveable property 30 years when the mortgagee becomes entitled for possession
9. Letter of credit 3 years from the date of payment of the amount of bills under the letter of credit.

In the above, it is clear that the banker should recover the due amount within the limitation period. In case, they are unable to do so they should file a suit for recovery within the period. Banks are expected to hold valid legal documents as per the provisions of the Limitation Act. If the limitation period expires, then the bank should arrange to obtain fresh set of documents. A limitation period can be extended in the following manners.

(a) Acknowledgment of debt
(b) Part payment
(c) Fresh set of documents

Documentation - CS Professional Study Material

Question 6.
Briefly explain what is SARFAESI Act? What are the safeguards one should bear in mind While enforcing the security under the SARFAESI Act or Securitization Act to recover the banks’ dues? (June 2017, 5 +10 =15 marks)
Answer:
Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI), popularly known as Securitisation Act empowers the banks and Financial Institutions to recover their dues in Non-Performing Assets (NPA) accounts classified as Sub-standard, Doubtful or as Loss Asset as per the RBI guidelines.

The Act empowers the Banks and Financial Institutions to issue notice for recovery from the defaulting borrowers and guarantors, calling upon them to discharge the dues in full within 60 days. The special feature of the Act is that the security interest can be enforced without the intervention of the Courts, subject to certain procedure to be followed, like 60 days notice has to be served by the Bank on the borrower with a request to discharge the loan liability. In case the borrower and/or guarantor fails to comply with, the bank and/or Financial Institution can:

(a) Take the possession or the management of secured assets of the borrower, and also can transfer the same by way of lease, assignment or sale for realizing the secured assets without the intervention of a court/Debt Recovery Tribunal;
Documentation - CS Professional Study Material

(b) Appoint any person to manage the secured assets which have been taken over by the secured creditor (Bank);

(c) Also instruct at any time by a notice in writing to a person

  1. who holds secured assets of the borrowers;
  2. from whom any money due or becoming due to the borrower;
  3. to pay such money to the secured creditor (Bank).

No civil Court has any jurisdiction under this Act. The Indian Limitation Act, 1963 is applicable to this Act.

While taking possession of the assets various precautions are required to be taken and if required the help of the Chief Metropolitan Magistrate (CMM) or District Magistrate (DM) can be taken by the Bank and/or Financial Institution.

It is to be noted that the provision of the Act shall not apply in case of:
(a) a lien on any goods, money or security;
(b) a pledge of movables;
(c) creation of any security interest in any aircraft;
(d) creation of security interest in any vessel;
(e) any conditional sale, hire-purchase or lease or any other contract in which no security interest has been created;
(f) any right of unpaid seller;
(g) any properties not liable to attachment or sale;
(h) any security interest for securing payment of any financial asset not exceeding one lakh rupees;
(i) any security interest created in agricultural land;
(j) any case in which the amount due is less than twenty five percent of the principal amount and interest thereon.

Documentation - CS Professional Study Material

Question 7.
“The Documents taken by Banks for a Credit Facility do not have perpetual life”. Explain the statement in detail and what are the various modes to revive the Loan documents. (Aug 2021, 6 marks)
Answer:
Limitation period is the time limit within which the parties to a legal agreement, can take action in a Court of law to enforce their legal rights. A suit cannot be filed for recovery on the strength of a time barred document. Hence, if the documents are time barred, the bank’s right of legal remedy is lost (expiry of limitation period does not take away the right of recovery of the debt, as it bars only the remedy of filing a suit).

There are certain rights like lien, set-off, selling the securities which are pledged where remedy through Court is not required. As such there is no limitation period for these rights. In computing limitation for any suit, the date from which such period is to be reckoned, shall be excluded. The suit can be filed on the ‘anniversary day’. The limitation period can not be shortened or lengthened by mutual agreement.

A limitation period can be extended (to revive the loan documents) in following ways.
(i) Acknowledgement of Debt : It is an acceptance of liability by the party liable by Letter of Acknowledgement of Debt (LAD), balance confirmation letter or even ordinary letter. It can be in form of signing of a balance sheet by authorized person. It has to be before expiry of limitation period.

(ii) Part Payment : A credit entry by itself will not save limitation. If a debtor makes a part payment before expiry of limitation period, himself or if it is made by his authorized agent a fresh limitation period starts from the date of such payment. The pay in-slip has to be filled in by the debtor himself or signed by him or his agent. It cannot be signed by any other person including employee of the debtor.

(iii) Obtaining fresh set of documents: When the bank obtains the fresh set of documents, fresh period of limitation starts from the date of execution of the fresh documents. A time barred debt can be revived under Section 25(3) of Indian Contract Act, 1872 only by fresh promise in writing and signed by the borrower or his authorized agent. A promissory note / fresh documents executed for the old or a barred debt will give rise to a fresh cause of action and a fresh limitation period will start from the date of such documents.

Documentation - CS Professional Study Material

Question 8.
How the ‘acknowledgement of debt by borrower’ helps banks in enforcing money suits while the document is Time-barred? (June 2022, 3 marks)

Question 9.
Attempt the following:
Hotch-Potch Ltd. is under the winding-up process. Whether the High Court permission is required by a bank to proceed against it before Debt Recovery Tribunal (DRT)? . (Dec 2007, 2 marks)
Answer:
No. The Debts Recovery Tribunal Act being a special Act, its provisions have an overriding effect over other laws. [Viral Filaments V. Industrial Bank 33 SCL 132 (Bombay High Court)].

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