The Interplay between the Insolvency & Bankruptcy Code, 2016, and SARFAESI Act, 2002

By Aarya Dubey [Student at MNLU, Aurangabad (Batch of 2027)]

Image Source: https://pixabay.com/illustrations/man-figure-toy-pokes-fun-at-shovel-76196/

Introduction

The primary purpose behind the introduction of the Insolvency and Bankruptcy Code, 2016, (henceforth, IBC) was to safeguard the interests of both creditors and stakeholders of the corporate debtor.[1] This consolidated framework has been introduced to streamline the previously scattered laws concerning this subject, which were dispersed across various statutes. The success of IBC is beyond any doubt, as evidenced by the enhanced ranking of India in the Ease of Doing Business Index issued by the World Bank. This improvement is attributable to the increased efficiency in addressing insolvency, which is in fact one of the seven indicators employed in the Index calculation.[2]

The Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (henceforth, SARFAESI Act) primarily centers on the securitization of capital resources and the imposition of security interest, all with no requirement of a court or tribunal involvement.[3] The Act basically enables financial institutions to retrieve loans by auctioning off properties owned by the borrower who has defaulted. The Reserve Bank of India (henceforth, RBI) oversees the entire procedure, and in the event of repayment default, empowers secured creditors to assume control of the collateral against which the loan was extended.[4]  

SARFAESI Act, 2002 & IBC, 2016- The Dissension

The IBC and the SARFAESI Act share a common goal: recovery of unpaid debts by identifying and directing the debtor’s assets toward debt repayment. Consequently, it was evident that these two legislations would intersect at some juncture. The National Company Law Appellate Tribunal (henceforth, NCLAT) however, clarified the applicability of certain overlapping provisions in Encore Asset Reconstruction Company Pvt. Ltd. v. Ms. Charu Sandeep Desai.[5] Section 18 of the IBC outlines “duties of interim professionals,” and sub-clauses (f) and (f)(i) authorize the interim resolution professional to assume both “control” and “custody” of the corporate defaulter’s assets.[6] Conversely, under Section 13(4) of the SARFAESI Act, once a corporate debtor defaults on repaying a bank loan, the bank can submit an application to legally take physical possession of the debtor’s property.[7] The inconsistency arises because the IBC allows the resolution professional to potentially take physical possession of the defaulter’s assets, while the SARFAESI Act authorizes the bank to do so in case of any default.

In the Encore case, the NCLAT decided that the creditor who has already got hold of the mortgaged property before the institution of proceedings must transfer its possession to the Interim Resolution Professional. This decision was based on the understanding that Section 18 of the IBC precedes Section 13(4) of the SARFAESI Act. It was clarified that in cases of any discrepancy, the provisions of the IBC will override those of the SARFAESI Act. However, even in the judgment of the Encore Case, issues concerning concurrent proceedings under the two laws lacked clarity. In Punjab National Bank v. M/s Vindhya Cereals Pvt. Ltd.[8], the NCLAT ruled in the affirmative and held that financial creditors have the right to pursue simultaneous actions under both the SARFAESI Act and the IBC. Section 238 of the IBC states that “the provisions of this code shall have an effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by the virtue of any such law“,[9] which means that the non-obstante clause of the IBC precedes over any other law applicable at that time.

IBC & SARFAESI Act- A Comparison

IBC and the SARFAESI Act are the two significant pieces of legislation in India pertaining to the financial sector. Although both these legal frameworks play crucial roles in addressing issues related to debt recovery and financial distress, they are often found at crossheads with each other.

While the SARFAESI Act operates independently of any court involvement, instead authorizing the financial institutions, to exercise their credit rights by conducting auctions of the debtor’s assets, the IBC, requires a company to initiate liquidation proceedings in a court, which are overseen by the Insolvency Board. However, the IBC has a broader scope as it encompasses a wider range of creditors, encompassing not just banks, both secured and unsecured in nature. The insolvency procedure is significantly more efficient under the IBC compared to the SARFAESI Act. The former outlines distinct venues for liquidation based on the type of entity involved. For instance, the National Company Law Tribunal (henceforth, NCLTs) handles corporate debtors, while individual firms are dealt with by the Debt Recovery Tribunals (henceforth, DRTs). Additionally, the IBC sets a minimum default amount of $1,495 for corporate debtors, which, in contrast, is not provided under the SARFAESI Act. Further, the latter incorporates a provision for the setting up of Asset Reconstruction Companies (henceforth, ARCs). ARCs are entities specialized in acquiring bad loans from debtors and employing specific mechanisms to recover those debts. However, the Act does not permit these ARCs to participate in the resolution process, which is indeed a limitation as this can impede the expeditious and straightforward recovery of debts. In contrast, the former allows ARCs to propose a resolution plan and actively engage in the subsequent proceedings.

Because of the more expedited recovery and cost-effective resolution under the IBC than the SARFAESI Act, the preference of the former over the latter is clearly evident in the article published in the Business Standard.[10]

Conclusion

The dominating proviso in the IBC, along with fixing of suspension on actions taken under other statutes, has increased the chances of creditors achieving the objective of maximizing the assets of the debtor during the resolution process and ensuring timely resolution of insolvency. In instances of smaller loans, like house loans, the SARFAESI Act may still be a preferable option, especially when there is just a single creditor involved. Nonetheless, some high-value matters may be transferred from DRTs to the NCLT, as even banks are encountering challenges due to delays in DRT resolutions, which contribute to their non-performing assets. Consequently, despite the amendments aimed at streamlining the SARFAESI Act’s process, lenders often find that the IBC is a more secure way for recovery, particularly when multiple creditors are engaged or when dealing with substantial accounts. The IBC continues to attract more lenders, particularly now that it has been established that secured financial creditors hold precedence and concerns regarding asset attachment have been addressed.

---

[1] The Insolvency and Bankruptcy Code, 2016, No. 31, Acts of Parliament, 2016 (India).

[2] Dipak Mondal, How IBC helped improve India’s ease of doing business rankings, BIZ. TODAY. (Sep. 21, 2023, 10:15 AM), https://www.businesstoday.in/latest/economy-politics/story/how-ibc-helped-improve-india-ease-of-doing-business-rankings-235937-2019-10-24#:%7E:text=India%E2%80%99s%20ranking%20in%20the%20World.

[3] The Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002, No. 54, Acts of Parliament, 2002 (India). 

[4] CS Ishrat Siddiqui, Synopsis on Sarfaesi Act Vs Insolvency and Bankruptcy code, 2016, TAX GURU (Sep. 21,

2023, 10:23 AM), https://taxguru.in/corporate-law/synopsis-sarfaesi-act-insolvency-bankruptcy-code-2016.html.

[5] Encore Asset Reconstruction Company Pvt. Ltd. v. Ms. Charu Sandeep Desai, Company Appeal (AT) (Insolvency) 719 of 2018.

[6] The Insolvency and Bankruptcy Code, 2016, § 18, No. 31, Acts of Parliament, 2016 (India).

[7] The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, § 13, No. 54, Acts of Parliament, 2002 (India).

[8] Punjab National Bank v. M/s Vindhya Cereals Pvt. Ltd., Company Appeal (AT) (Insolvency), 854 of 2019.

[9] The Insolvency and Bankruptcy Code, 2016, § 238, No. 31, Acts of Parliament, 2016 (India).

[10] BUSINESS STANDARD, https://www.business-standard.com/article/economy-policy/explained-why-lenders-prefer-ibc-over-sarfaesi-act-for-recovery-of-dues-120011900913_1.html (last visited Sep. 21, 2023).