SARFAESI ACT – What is legally recoverable debt?

The Recovery of Debts Due to Banks and Financial Institutions Act, 1993 and The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 were enacted by the Government to be exclusively used for the recovery of debts of Banks and Financial Institutions. These acts also envisage not the recovery of any amount that the banks and financial institutions declare as debts but they have to ensure that they recover only those amounts which are “legally recoverable” as debt. That raises a pertinent question as to what is legally recoverable debt.

SARFAESI ACT, 2002 states, under section 2- definitions(ha), “ { “Debt” shall have a meaning assigned to it in clause (g) of section 2 of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (51 of 1993)}.  Section 2 ((g) of DRT Act, 1993 defines debt as, {“ Debt” means any liability (inclusive of interest) which is claimed as due from any person by a bank or a financial institution or by a consortium of banks or financial institutions during the course of any business activity undertaken by the bank or the bank or financial institution or the consortium under any law for the time being in force, in cash or otherwise, whether secured or unsecured, or assigned , or otherwise, or whether payable under a decree or order of any civil court or any arbitration award or otherwise or under a mortgage and subsisting on, and legally recoverable on, the date of the application.}”

There are four aspects to the definition of debt as per the aforesaid ACT and the connected relationship among them should be understood in their correct perspectives. They are “DEBT”, “LIABILITY”, “Legally Recoverable” and “Date of Application”. The relevant question is whether ‘Debt ‘and ‘Liability’ are one and the same.  “A debt is a sum of money due by contract. It is most frequently due by a certain and express agreement, which fixes the amount, independent of extrinsic circumstances.” and it is also defined as, “A sum of money which is certainly and in all events payable is a debt, without regard to the fact whether it be payable now or at a future time.”. But “A sum payable upon a contingency, however, is not a debt, or does not become a debt until the contingency has happened” A liability is defined as “Any legal responsibility, duty or obligation. This liability may arise from contracts either express or implied or in consequence of torts committed.”

The words “debt” and “liability” are not synonymous. As applied to the pecuniary relations of parties, liability is a term of broader significance than debt. The legal acceptation of debt is a sum of money due by certain and expressed agreement. Liability is responsibility; the state of one who is bound in law and justice to do something which may be enforced by action. In other simple terms, “A debt is an amount of money borrowed by one party from another, and that must be paid back.” and a liability is defined as liabilities are a person’s or company’s legal debts or obligations that arise during the course of business operations. The principal differences are that an interest component is involved to a debt almost without exception, but interest may or may not be attached to a liability, depending on the form it takes. Yet another feature is that all debts are liabilities, but not all liabilities are debts. Considering the above mentioned features of debt and liability, the bank transactions under bank loan facilities also falls into either a debt or a liability. A bank debt is a loan sanctioned to a borrower and repayable with contractual rate of interest on demand or over a period of time as stipulated in the sanction along with other terms and conditions.  Besides, a sum payable upon contingency (like Letter of credit, bank guarantee etc) is not debt but when the contingency occurs and the sum is not paid, and then the sum becomes a debt.

The bank also charges fees and other charges by way of commission, incidental charges, penal interest, and transaction charges, service charge, inspection charges, commitment charges etc which do not come under the category of debt. These are liabilities to be paid as and when charged. These charges not being a debt do not attract any interest. Hence charging interest on such charges is against the accepted norms of banking and against the law. Therefore, arriving at the quantum of actual debt is very much important to invoke SARFAESI ACT.

A perusal of the statement of account may show that the bank and the financial institution not only debit the interest to the account but also levy other charges also to the loan account. Thus the balance arrived is the total of the principal debt and interest and all other charges and is generally called as the total liability or dues as on the particular date. The particular mention of “inclusive of interest” in the bracket is very significant in arriving at the legally recoverable debt because interest is charged either simple or compounded as per the terms of sanction by the banks and financial institutions only on loan amount and not on other charges. Normally the banks and financial institutions charge interest on a compound basis with specific rests as per the terms and conditions of sanction and charges simple interest on loans under exceptional circumstances like granting of agriculture loans. When interest is charged to a loan account, the pertinent question is the capitalisation of interest.

The balance of a loan is made up of two major components: the principal, which is the amount borrowed, and the interest, which accrues regularly on the principal. Loan capitalization is the point at which all of the unpaid interest that has accrued on the principal is added to the principal. In order for a loan to be capitalized, it must have interest that accrues during a time when the borrower is not making any payments. The significance of capitalisation of interest is that capitalizing interest on a loan increases the cost of repaying the loan. This is because the new principal balance is higher, and interest charges after capitalization are calculated based on the new principal balance. The borrower has to spend much of the monthly payment on not only paying off the higher balance after the capitalization, but also paying the extra interest on this higher balance.

If the interest on debt is capitalised, then the pertinent question is whether all other charges including penal interest can also be capitalised It may be noted that banks normally charge penal interest at 2% over the contracted rate depending on the terms of sanction. A perusal of the statement of account of the bank shows that the balance liability under any loan account is inclusive of interest and all other charges debited to the loan accounts which means not only the interest but also all other charges are capitalised on which further interest is charged as per the contracted rate and if not serviced penal interest is also charged. It is very important to understand that capitalisation of all other charges including penal interest by the bank and the financial institution and charging further interest on the capitalised amount is illegal and not tenable under the law and against banking principles. The total liability thus arrived at by the bank and the financial institution is not legally recoverable debt. The Supreme Court of India through their judgment dated 18^th October 2001(AIR 2001 SC 3095, 2002 (50) BLJR 207) in the matter of Central Bank of India vs. Ravindra and Ors which was sent to Constitutional bench for their views, has clearly established this aspect of capitalisation of interest. The relevant portion of the said judgment is quoted here with, “37. However ‘penal interest’ has to be distinguished from ‘interest’. Penal interest is an extraordinary liability incurred by a debtor on account of his being a wrong-doer by having committed the wrong of not making the payment when it should have been made, in favour of the person wronged and it is neither related with nor limited to the damages suffered. Thus, while liability to pay interest is founded on the doctrine of compensation, penal interest is a penalty founded on the doctrine of penal action. Penal interest can be charged only once for one period of default and therefore cannot be permitted to be capitalised.” Further “52. In conclusion this Court held that if bank was claiming interest in excess of that permitted by the circular/direction of the Reserve Bank, the Court could give relief to the aggrieved party notwithstanding Section 21A to the extent of interest charged in excess of the rate prescribed by the Reserve Bank of India. A distinction was drawn between Court’s power to interfere on the premise that the interest charged is excessive under the general law and courts interference on the premise that the interest charged is in contravention of the circulars/directions issued by the Reserve Bank of India. In the former case it would not be permissible in view of the bar enacted by Section 21A of the Banking Regulation Act while in the latter case it would be permissible because of the Reserve Bank’s circulars and directions having statutory force under Sections 21/35A of the Act having been violated. The question whether interest charged in excess of the minimum rate of interest appointed by the Reserve Bank without fixing a ceiling and levying higher rate to be charged at the discretion of each bank can be treated as excessive and unconscionable and whether in such situation Section 21A would debar the Court from reducing the rate of interest to a reasonable limit was left open and undecided as the same did not arise in the case before the Court. However it was made very clear that if the Reserve Bank has fixed the maximum rate of interest under Section 21/35A of the Act any transaction charging interest within the limit so appointed would not be treated as excessive.” and “54. (1) Though interest can be capitalised on the analogy that the interest falling due on the accrued date and remaining unpaid, partakes the character of amount advanced on that date, yet penal interest, which is charged by way of penalty for non-payment, cannot be capitalised. Further interest, i.e. interest on interest, whether simple, compound or penal, cannot be claimed on the amount of penal interest. Penal interest cannot be capitalised. It will be opposed to public policy.” RBI issues circulars on interest rates regularly and the charging interest by banks and financial institutions should confine to the instructions contained in the circulars. Similar is the case with other charges levied by the banks and financial institutions. Hence it is imperative that the borrowers should always keep their knowledge about the rate of interest charged by their banker / financial institution as per RBI circulars particularly with regard to charging excess interest.

Many banks adopt aggressive capitalisation policies and such capitalising and reporting as assets significant portions of expenditure, the realisation of which require unduly optimistic assumptions. Further, “Cost Capitalisation that stretches the flexibility within generally accepted accounting principles beyond its intended limits, resulting in reporting as assets items that more reasonably should have been expensed. The purpose of this activity is likely to alter financial results and financial position in order to create a potentially misleading impression of a firm’s business performance or financial position”. Hence, the borrower and his lawyer have to take congnisance of the above facts when dealing with Bank cases.

What “legally recoverable” means? It means that any legal initiative taken by the banks and financial institutions should confine to the tenets of the law. As far as SARFAESI ACT of 2002 and RDDB Act which are meant for the recovery of dues of banks and financial institutions and their later amendments are concerned, the primary legal aspects are the various provisions and rules of those acts and Reserve Bank of India guidelines and directives announced through their various circulars issued from time to time. Further, Section 37 of SARFAESI ACT states under “Application of other laws not barred: The provisions of this act or rules made thereunder shall be in addition to, and not in derogation of, the Companies Act 1956 (1 of 1956), the Securities Contracts (Regulation) Act, 1956(42 of 1956) the Securities and Exchange Board of India Act, 1992(15 of 1992) the Recovery of Debt Due to Banks and Financial Institutions Act, 1993(51 of 1993) or any other law for the time being in force.”  Similarly, RDDB Act also has incorporated the same under Section 34(2) of the said Act. But the experiences from the proceedings of DRT cases clearly indicate that in most of the cases the presiding officers (P.O) of DRT and DRAT are prejudiced having implicit bias against the borrowers and overlook all the provisions and rules of the act and deliver judgments against the borrowers which leave them to approach the Higher Courts to seek justice and that too at a very heavy cost which many time they cannot afford particularly the borrowers belonging to SME sector.

The last aspect is with regard to “date of application” as stated in the RDDB and FI Act. As per RDDB and FI Act, the date of application is the date on which the Bank files its O.A with DRT. But in the case of SARFAESI ACT, the Bank or F.I do not file any application but only declare the account as NPA. Hence, as far as SARFAESI Act is concerned, the date of application is the date on which the account is declared as NPA. Therefore, the notice should carry the dues as on the date of declaring the account as NPA and not as on any other date.

Yet another aspect as per Section 13(3) of the SARFAESI Act which states, “The notice referred to in sub-section (2) shall give details of the amount payable by the borrower and the secured assets intended to be enforced by the secured creditor in the event of non – payment of secured debts by the borrower.” Reserve Bank of India has issued their circular DBOD.No.BP.BC.12 /21.04.048/2011-12 dated July 1, 2011 to All Commercial Banks (excluding RRBs) on prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances which states under definition,

“2. DEFINITIONS

2.1 Non performing Assets

2.1.1 An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank.

2.1.2 A non performing asset (NPA) is a loan or an advance where;

i. interest and/ or instalment of principal remain overdue for a period of more than 90 days in respect of a term loan,

ii. The account remains ‘out of order’ as indicated at paragraph 2.2 below, in respect of an Overdraft/Cash Credit (OD/CC),

iii. The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted,

iv. The instalment of principal or interest thereon remains overdue for two crop seasons for short duration crops,

v. The instalment of principal or interest thereon remains overdue for one crop season for long duration crops,

vi. The amount of liquidity facility remains outstanding for more than 90 days, in respect of a securitisation transaction undertaken in terms of guidelines on securitisation dated February 1, 2006.

vii. in respect of derivative transactions, the overdue receivables representing positive mark-to-market value of a derivative contract, if these remain unpaid for a period of 90 days from the specified due date for payment.

2.1.3 Banks should, classify an account as NPA only if the interest due and charged during any quarter is not serviced fully within 90 days from the end of the quarter.”

Since the declaration of NPA is based on the overdue position of the liabilities, it is imperative that details of amount payable particularly that of the overdue amounts should be furnished without fail as under.

a. Total principal amount outstanding.

b. Overdue principal amount.

c. Total interest due.

d. Overdue interest due.

e. Total other charges due.

f. Overdue other charges.

g. Total penal interest due.

h. Overdue penal interest.

Considering the aforesaid aspects, the notice issued u/s 13(2) of SARFAESI ACT should contain the following details to commensurate with the provisions of SARFAESI ACT, RDDB ACT and RBI guidelines:

1. Date of declaration of the account as NPA.

2. The dues of the individual accounts as on the date of declaring the account as NPA.

3. The dues should not contain any capitalised amount of penal interest and other charges other than the interest charged and capitalised to the principal amount sanctioned by the Bank or FI.

4. The details of overdue position of individual account as enumerated above.

No contingent liability should be taken into account in the notice which has not been crystallised.

The borrowers and the lawyers can challenge the notice issued u/s 13(2) of SARFAESI ACT if the notice does not contain the above mentioned details since the total dues as shown in the notice is invariably not “legally recoverable debt”.

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