Publication of defaulting borrowers' photos in SARFAESI notices

Publication of photographs of home loan borrowers in SARFAESI notices: Are we doing the right thing?

The title puts a question, and it is easy to imagine a counter question too – is the borrower defaulting on the bank’s money is doing the right thing? This article examines the wrong involved in defaulting on loan commitments,  but puts a bigger question before the society : are we rightly reacting to the borrower’s default? The article is particularly focused on home loans.

Before we get into the question – let us be aware of what is happening around us. The SARFAESI Act was enacted in 2002 presumably on the lines of the article 9 of US Uniform Commercial Code. The Act is, actually, nowhere even close to that Code. In fact, UCC deals with personal property and not real estate, and therefore, home loans are not at all covered by US UCC article 9. The Act was recommended before the Parliament as one which help reduce the burden of bank NPAs. The picture one got was those so-called “wilful” defaulters who habitually over-borrow from banks, siphon off money possibly even before the  loan repayment starts, and enjoy life at the cost of banks. In other words, the objective was to be stern against promoters of companies that go sick while promoters enjoy the pink of their own health. Little did the Parliamentarians who passed the law realise that the law will be used, as it is being done, vehemently to drag home loan borrowers out of their homes.

No one contends that a borrower should be allowed to go scot free after having borrowed money from a bank or housing finance company, even if it was purchase of a residential house. But is a default of a home loan a case of wilful default that was in the minds of the lawmakers when the SARFAESI Act was enacted? Is it difficult to envisage that there may be zillion reasons for which a borrower may be forced to default on loan EMIs? Once again, financial discipline is important, and it is a settled fact that home borrowers who are unable to pay their EMIs have to suffer foreclosure at some stage. There are hundreds of  thousands of such homes under foreclosure action today in the USA, and therefore, no one should shed tears if borrowers have to face a mortgage foreclosure on account of default of a home loan.

But then, the SARFAESI Act puts a non-judicial route to mortgage foreclosures. The way the section is worded, a  home borrower will first have to lose the roof over his head before he can run to his lawyer to take an action in a DRT. One just needs to take a practical stock of the situation – a person having a salary income of Rs 30000 pm takes a loan that has an EMI of Rs 10000 per month. The ratio works perfectly fine since a debt to income ratio of 33% is one of the best a lender can expect. Also, given that a household can easily manage living costs within a range of 10-15k per month, there is sufficient scope for the individual to pay his home loan without default. Now, say, he loses his job. It obviously will take a few months before he can get a replacement job, particularly in a market as the present one. So, 3 EMIs missing, and the bank classifies the loan as an NPA. The bank sends a loan recall notice, demanding not just 3 EMIs, but the whole of the loan. And in the meantime, the bank starts adding penal interest, which is much higher than the loan interest rate.

The  issue is, where does the individual, out of job and facing his own worries in life trying to find a new job, get the money from, to pay the bank? Not just the EMIs, but the lethal penal interest rate too. So, as would always happen – debt begets debt. He would possibly run to a usurious lender, and borrow at excessive interests to pay the bank off, but sooner or later, will get into a default at both the places.

Here comes the bank with a SARFSAESI notice – pay off the entire loan, along with penal interest and all other charges within 60 days, or face repossession.

The tragedy is, the individual can run to no one for rescue. He would often run with pleading face to the branch manager, but the manager would say – the matter is out of control now.

Now think of remedies available. Is it unlikely that the borrower may have questioned the very claim of the bank? Is it unlikely that the bank might have added wrongful costs or charges which the individual may be disputing? Thanks to the Supreme Court ruling in Mardia Chemicals, the law gives the borrower a right of representation, but the right of representation is a mere lipservice, as the representation goes to the very bank or bank manager with whom the borrower has an issue. The law does not even require the borrower’s grievance to be handled by a senior office who can examine the matter dispassionately. Invariably, if at all the borrower makes a representation, the answer from the bank is going to be mechanical – turning down the representation with a stereotyped rebuttal of whatever the borrower might have said.

So, can the borrower approach his lawyer and seek a redressal? Unfortunately, as the law seems to say, the borrower must first allow the bank to take action (read, take away the borrower’ house),  and go for redressal before a DRT. DRT action may stretch for months altogether. To add to the injury, the DRT may also pass an order for pre-deposit of a large part of the amount demanded by the bank before the application can proceed. Irony is – if the borrower had the money to pre-deposit, why would he let the loan default anyways? But law is merciless, regardless, and concern-less.

Banks are adding insult to the injury by publishing the borrowers’ photographs in the newspapers. This is simply outrageous. The matter was discussed in a Madras High Court ruling  where the High court affirmed of the practice, but the issue was mainly on the grounds of borrowers’ privacy rights, bank secrecy laws, and so on. Our Courts have still not got rid of the mindset that when a borrower defaults, he is not necessarily defaulting because he is not wanting to pay, but because he is unable to pay. Also, over the decades of the way the banking system has worked, courts are simply unable to appreciate the miseries of retail borrower failing to pay a  consumer loan. Therefore, it is a little surprise that the Hon. Judge in the Madras High court above said: “If borrowers could find newer and newer methods to avoid repayment of the loans, the Banks are also entitled to invent novel methods to recover their dues.” This indicates that the publication of the photo of the borrower is also a recovery device, whereas, it was not pointed out before the court that the photo is published only after the recovery action has been taken.

Repossession action having been taken, the question is – why would a bank at all want to do a further damage to the borrower by publishing his photograph too? Surely enough, it is  not the photo of an India’s-most-wanted terrorist to caution the public. If the idea is to caution other lenders, that is taken care of by CIBIL as the financial system is anyway entitled to CIBIL’s database. In any case, other lenders don’t lend by looking at the photo of the borrower. One would understand if default of a loan was a criminal offence, but first, a loan default is a civil wrong and not a criminal wrong, second, no one could hold a person liable of having done a crime other than a criminal court, let alone a commercial bank, and third,  even in criminal wrongs, for the most heinous crimes, courts do not go all out to publish photographs.

Irrespective of legality involved in such publication, what is happening currently is outright wrong. Our brethren who have fallen victims of bad times and are anyway deprived of the roof over their head are being further driven into ignominy by putting their photographs in papers. This is so very cruel, so very inhuman, at least in case of residential mortgage loans. RBI and NHB should put an end to this practice immediately.

Foreign investments in ARCs and security receipts

I have commented, several times, that the ARC model in India in unique and has nothing to do with similar models elsewhere in the world, in more senses than one. Special statutory powers have been conferred in India on ARCs, while ARCs in India are profit-driven shareholder companies unlike state-promoted special purpose vehicles in other countries. In India, the ARCs are nothing but a surrogate route to a special situations fund or a distressed debt fund, coupled with special powers of recoveries.

The special powers granted under the SARFAESI Act and under the Sick Industrial Companies Act are drastic, and at least in cases, seem to be exceeding the boundaries of well-settled public policies. For example, one of the provisions of the Sick Industrial Companies Act, recently interpreted by the Bombay High court , says that if any loan taken by a sick company is acquired by an ARC, then the reference of the sick company before the BIFR shall abate. Seemingly, the only purpose of constituting the BIFR is that entities which may be revived are sent to the nursing home and not the crematorium. But if any loan, irrespective of the amount of the loan, taken by such sick company, is acquired by an ARC, and that causes the reference before the BIFR to cede, the very philosophy of the revival of sick companies gets negated.

Same are the provisions in sec 9 of the SARFAESI Act about takeover of management. An ARC that has bought a loan taken by a defaulting borrower has the right to takeover the management of the business of the borrower. Notably, the loan was originally given by a bank, and the bank never had any such right of takeover of management. The ARC that buys the loan from the bank cannot have a better right than that of the bank. The bank had a security interest; security interest cannot imply the right of takeover of business.

There are also issues concerning workers’ interest which have not been properly appreciated: workers’ claims are recognised under SARFAESI proceedings only where the company is in liquidation. Sadly enough, the very repossession of assets by an ARC may leave the borrower with no substratum at all, and therefore, with no option but to go for liquidation. But by this time, as the core assets of the borrower would have been taken away by the secured lender, the question is – where do the workers get paid from?

These are generic concerns about the whole scheme of ARCs , which seem to have been pushed into legislation without a holistic approach to resolution of bankruptcies in the country.

However, the present policy about FDI in ARCs and the security receipts (SRs) issued by the ARCs may also be reviewed.

Currently, non-residents are allowed to invest in capital of ARCs, but FIIs are not allowed. As regards investments in SRs, FIIs are allowed to invest upto 49% of a single tranche of SRs, with a limit of 10% per FII.

As regards ARCs themselves, the 49% cap was perhaps devised to ensure ARCs may end up owning bad loans, and bad loans may (a) pertain to borrowers from sectors where there are current restrictions on foreign investments; and (b) be backed by real estate whereby foreign investors may end up owning immovable properties, which may be against the extant FDI policy.

These concerns may, however, be misplaced. First of all, most ARCs do not invest in bad loans themselves – they do it mostly by issuing SRs in the trust mode. Therefore, as long as there are prudent restrictions on investment in SRs, the restriction on equity capital of ARCs may not be necessary. Secondly, even if an ARC with, say, majority foreign ownership, ends up buying bad loans of a borrower where there are sectoral caps, this does not lead to creation of equity stakes in such sector. The acquisition of an NPL does not mean acquisition of equity or ownership of the business of the borrower. True, ARCs have the power to cause change of management or takeover the management as well, but the so-called takeover of management under SARFSAESI Act is not buyout of a business. The law says that the takeover shall be only for the purpose of realisation of the loans, and once the loans have  been realised, the business will be handed back to the original owners. Takeover of management of business is a rarity – ARCs have caused management change, but have never so far taken over management themselves.

It is to be noted that SRs are essentially in the nature of equity – since the returns on the SRs depend on the money realised on recovery of the underlying loans. Though the RBI’s directions to ARCs put a maximum time frame for realisation of loans acquired by ARCs, practically, the repayment of the SRs depends on the realisation of the underlying loans. Hence, investment in SRs is more like an FDI than ECB. However, it is an FDI into the loans, and not FDI into the business from where the loan emanates – thus, not conflicting with the current FDI policy.

How would investment in SRs help Indian economy? Currently, given the restriction of 49% on investment in SRs, most SRs are being subscribed either by the banks that sell the NPLs themselves, or domestic NBFCs that qualify as “qualified institutional buyers.” Internationally, distressed debt has attracted international investors – this is particularly true for China. SRs in India make more sense than distressed debt in China, as ARCs in India are vested with special powers.

Therefore, there is a strong case for relaxing the limit of 49% in case of SRs. Is this likely to attract lot of money into the country? Given the soaring amount of NPLs and loans undergoing restructuring, the amount of NPLs in India will rise sharply in time to come. This may be the right time to attract international investors.

If any ARC acquires an asset of a sick company, does reference before BIFR abate?

Yes, says the Bombay High court. 

In Paper Prints (India) Pvt. Ltd vs Phoenix Arc Pvt. Ltd http://indiankanoon.org/doc/57289971/ , a Division Bench of the Bombay High court interpreted the second proviso to section 15 (1) of the SICA to suggest that where any financial assets have been acquired by an ARC. The ruling says that the second proviso and third proviso to sec 15 (1) are independent, and there is no presumption as to taking of action by any particular percentage of secured creditors under the second proviso. Under the second proviso, once the “financial assets” have been acquired by an ARC, reference shall not be made at all.

Our comments: So, the SICA becomes completely irrelevant! If there is any philosophy at all behind the SICA, that purpose or philosophy is completely rendered redundant. The drafting of the second and third provisos to sec 15 (1) is as bad as the whole of the SARFAESI Act itself, but with the interpretation placed by the Hon’ble Court, just because any loan or facility extended to a borrower have been acquired  by an ARC, the very process of rehabilitation gets negated. This seems like saying – move over rehabilitation, realisation takes over!

In fact, the onus of making reference under section 15 (1) is on the borrower, that is, the sick company. The board of directors of the sick company needs to make a reference, if the entity has become sick. The reference e has a wholesome purpose, which has been discussed by lots of authorities in lots of cases. If entities become sick, it does not serve the cause of economic development if such entities are allowed to fall dead freely. If a person becomes sick, humanity cannot allow him to die. Death of economic entities is even more serious than death of persons – as livelihoods of lots of families depends upon an economic entity.

The transfer of a financial asset is a transaction between a lender and the ARC. The sick company is not a party to it at all.  In many cases, the sick company may not have been notified, or may be notified much later.

With the interpretation placed by  the Hon’ble High court, a sick company shall not make a reference, if financial assets have been sold by a creditor to an ARC. The law does not specify, which financial assets, or how much financial assets? Sure enough, the “financial asset” in question cannot be the asset of the sick company. In any event, the proviso is an exception to the mandatory requirement under section 15 (1) on making of a reference. Unlike third proviso, the second proviso does not say that a reference already made shall abate.

The correct interpretation of second proviso should have been – if all loans/financial assets pertaining to a sick company have been sold to an ARC, then there is no role of the BIFR in such a case, as a secured creditor under the SARFAESI Act has the right to proceed with repossession even in case of sick companies. But if what is sold is just a one of the many loans, there is no reason whatsoever as to the hope of revival of the company fading away. It is not at all proper to allow the wholesome process of revival of entities to be overshadowed by the self-centric provisions of SARFAESI Act.