Company Law Board & SARFAESI proceedings?

Company Law Board exercises very important functions under section 397/398 of the Companies Act, 1956 providing relief to the shareholders against ‘oppression and mis-management’ in the Company. When a group of shareholders are oppressed in any company or the company is mis-managed causing loss to the interests of the shareholders, shareholders very frequently exercise the option of approaching the Company Law Board under section 397/398 of the Companies Act, 1956 if they are qualified to do so under section 399. The shareholders have the option and can even approach the High Court seeking to wind-up the Company on ‘just and equitable cause’. In appropriate cases, the shareholders do approach even the Civil Courts seeking some relief against the Company though there always remains a confusion about the jurisdiction of Civil Court in dealing with the cases of ‘oppression and mis-management’ and also there is a strong belief that it is extremely difficult to get speedy relief from a Civil Court. In the cases of ‘oppression and mis-management’, the affected shareholders expect immediate relief in order to get their interests in the Company protected and this is the reason why the shareholders approach the Company Law Board under section 397/398 of the Companies Act, 1956 where the CLB is supposed to ignore technicalities and is supposed to ‘put an end to the matters complained of’.

In the process of adjudication under section 397/398 of the Companies Act, 1956 and where mis-management in the Company is alleged, the applicant shareholders can even make many other group companies or third parties etc., as parties to the petition and can be seeking to get certain transactions cancelled. This happens when the majority group in the Company or the directors in actual control of the Company, deal with the properties and funds of the company in an illegal manner and with the ultimate intention of siphoning off funds of the Company. These things are very frequently alleged in respect of ‘closely-held companies’ and rarely seen in-respect of ‘Listed Public Limited Companies’ in view of the shareholding-pattern and the authority of the SEBI to look into certain issues and the authority of the stock-exchanges where the shares are listed if it is a listed Company. 

In appropriate cases, the Company Law Board can be passing suitable orders under section 397/398 of the Companies Act read-with section 402 of the Act and these orders can affect even the third parties including Banks at times in my opinion.

Competency of Company Law Board to interfere with SARFAESI proceedings:

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) is meant to enable the Banks to speedily recover their ‘secured dues’ without approaching any Court or Tribunal and even when there exists a grievance to any person affected, he can only file an appeal under section 17 of SARFAESI Act, 2002. It is settled that when a Bank initiates proceedings against a Company under SARFAESI Act, 2002, the aggrieved party can give their objections to the Bank, can seek mandatory reply from the Bank under section 13 (3A) and if they are not satisfied at the reply given by the Bank, the aggrieved party can file an appeal under section 17 of the SARFAESI Act, 2002. There is a specific provision under section 34 of SARFAESI Act, 2002 that no Civil Court can interfere with SARFAESI proceedings and even the High Court exercises caution in interfering SARFAESI proceedings though there can never be a complete bar on the jurisdiction of High Court under section 226 and 227 of Constitution of India with regard to the proceedings initiated by Public Sector Banks or Banks. However, in view of the perceived failure of the Debt Recovery Tribunals in providing speedy and effective relief, High Courts can entertain challenge to the SARFAESI proceedings in appropriate cases as otherwise; there will not be any relief to the aggrieved even when the Bank proceeds illegally and unreasonably. Though, Civil Court’s jurisdiction is not completely barred in respect of SARFAESI proceedings in view of the scope established with Mardia Chemicals Case and other subsequent cases, it is highly difficult to convince any Civil Court and get the relief against the Bank. Again, aggrieved are often afraid to approach the Civil Courts in view of the lack of expertise on the part of Civil Courts in dealing with SARFAESI issues, the technicalities, the expenses and the delay involved.

As such, though section 34 of the SARFAESI Act, 2002 specifically deals with the jurisdiction of Civil Court, it is implied that no court or the forum can interfere with the proceedings initiated by the Bank under SARFAESI Act, 2002. This is established even when the liquidation proceedings are pending against a Company and the Bank will be proceeding against the ‘Secured Assets’ even when the liquidation proceedings are taking place against the Company.

Under these circumstances, it would be interesting to look into the jurisdiction of Company Law Board to pass any order or orders under section 397/398 of the Companies Act, 1956 affecting the proceedings initiated by the Bank against the Company. Two things are very important in this regard and those are as follows:

a.                           One is that the power of the Company Law Board to pass orders section 402 of the Companies Act, 1956 affecting the third party transactions and agreements.

b.                           Second is that the relief provided to the affected person under section 17 of the SARFAESI Act, 2002.

Though it is frequently referred that the Debt Recovery Tribunal can look into all issues under section 17 of the Companies Act, 1956, the Tribunal may not be able to effectively look into certain issues. For example, there is a precedent now that the rights of Tenants under the Tenancy Laws made by the State Governments will prevail over the rights of the Bank under SARFAESI Act, 1002; and if the Bank wants to get any tenant vacated from the premises; it has to mandatorily approach the Rent Control Tribunals. Same is the case, where the Bank can not claim the complete ownership of the ‘Secured Asset’ and these issues arise when the property mortgaged is a ‘Joint Family Property’ and the Bank was negligent in accepting the property as a security. In these cases, the appropriate authority to look into the rights of the members of a family in the property is the Civil Court and the Debt Recovery Tribunal may not be competent enough to look into partition and related property issues. These are the complications with which there was a precedent initially with regard to SARFAESI proceedings that the Debt Recovery Tribunal is supposed to only look into the fact as whether the Bank has followed the procedure under SARFAESI Act, 2002 or not. But, this precedent now has changed and the authority of the Debt Recovery Tribunal under section 17 of the Act is expanded at-least as a matter of principle irrespective of practical issues and difficulties.

Like-wise, a group of shareholders in a Company may allege mis-management in the Company and can oppose any proceedings initiated by the Bank against the Company under the provisions of SARFAESI Act, 2002. If it is established that the Bank is negligent and is also at fault while sanctioning the loan to the Company, the minority shareholders can definitely be opposing the proceedings initiated by the Bank against the Company. For example, if the Bank grants loan to the Company upon certain terms without bothering at the regulations under Companies Act, 1956 and without looking into the fact as to whether the people processed the loan transaction with the Company are authorized to do so or not, then, certainly, the minority shareholders would even be questioning the Bank and the Bank can not say that they are not supposed to look into any rules and regulations; and they will only look into the security provided. This argument may not be accepted always. There may be a contention here that even the minority shareholders or a shareholder of a Company can approach the Debt Recovery Tribunal under section 17 of the Companies Act, 1956 and as such, Company Law Board can do nothing with regard to the proceedings initiated by the Bank against the Company under SARFAESI Act, 2002. It is true that the shareholders can approach the Debt Recovery Tribunal under section 17 of the SARFAESI Act, 2002 according to me if they could establish that their interests in the Company are affected and the Bank is wrong in sanctioning the loan without looking into the required issues. However, the Debt Recovery Tribunal may not be competent enough to look into the corporate rights of the shareholders and the Company Law principles. The Debt Recovery Tribunal can say that the affected shareholders can only proceed against the Company or the management and they can approach the High Court seeking winding-up and can approach the Company Law Board alleging mis-management. The Debt Recovery Tribunal may be right in its contention and it’s a very complicated issue and I don’t think that these issues would arise frequently, but, there is a possibility.

The issues of Bank negligently sanctioning loans to the Company and the interests of the shareholders, is very important when the Bank intends to proceed against the Company beyond the security provided.  Even when the Company gives security, if it is wrongful on the face of it and if the minority group or the shareholders are affected because of it, then, the minority group or the shareholders can definitely be questioning even the loan transactions with the Bank. 

If any individual guarantees the repayment of loan given to the Company and individual properties were mortgaged, then, the mortgagor may have no option if he feels aggrieved, except to approach the Debt Recovery Tribunal or the High Court in appropriate cases seeking relief. The issue is when the Bank proceeds against the Company assets and the Company and the interests of the shareholders in the Company are affected. This is certainly a very complicated issue to deal-with.

Few important points to be noted:

1.     It can not be said that the Company Law Board can not pass orders under section 397. 398 and 402 of Companies Act affecting the SARFAESI proceedings initiated against the Company. 

2.     Even if there is a mis-management in the Company, if the Bank has taken due and reasonable care while sanctioning the loan to the Company, then, the CLB may hesitate to interfere with any SARFAESI proceedings initiated by the Bank against the Company.

3.     Though the Debt Recovery Tribunal can look into all objections under section 17 of the SARFAESI Act, 2002, it may not be competent enough to deal with the issues of ‘oppression & mis-management’ requiring expertise and there can be a clear link at times between the SARFAESI proceedings against the Company and the interests of the minority group as protected under Companies Act, 1956.

4.     Though every shareholder is entitled for certain rights in the Company and for the relief at times, it is certainly complicated to say that the shareholder/s not qualified to approach High Court seeking liquidation etc. and shareholders not qualified under section 397/398 of the Companies Act, 1956, can approach the Debt Recovery Tribunal under section 17 of the SARFAESI Act, 2002. It is important in the light of a single shareholder alleging that his interests in the Company are affected with the Bank proceeding against the Company.

5.     If the Bank’s sanction of loan to the Company is clear and independent of other issues in the Company, then, the allegations of mis-management in the Company may not affect the rights of the Bank in proceeding against the Company or the security provided.

6.     The Bank’s interests can in no way be affected by any orders of the Company Law Board when the loan sanctioned to the Company is guaranteed with the sufficient assets of individuals and the CLB in those cases, may hesitate to interfere with the SARFAESI proceedings initiated by the Bank.

7.     Except the issues of fraud, gross negligence and the interests of the minority group in the Company, no other issues can be raised against the Bank if Bank is involved in a proceeding under section 397, 398 and 402 of Companies Act, 1956.

8.     There are no established precedents so far on these issues, but, these issues are very significant and real with the routine commercial transactions between the Banks and Companies.

Note: the views expressed are my personal only. 

NPA classification/SARFAESI Act – discretion of Bank/Secured Creditor?

The Banks or Secured Creditors do feel comfortable in recovering their dues using the provisions of SARFAESI Act, 2002. The object of the enactment, as everybody knows, is to enable the Banks/Secured Creditors to reduce the level of ‘Non-performing Assets (NPA)’. In the absence of a special legislation like ‘Recovery of Debts due to Banks and Financial Institutions Act, 1993’ and “Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002”, it is infact very difficult for the Banks to recover debts approaching Civil Courts. The observation of Hon’ble Madras High Court in The Repatriates Co-op Finance & Development Bank Ltd., Chennai & Others, 2010 (4) LW 497, 2010 (5) CTC 449, 2010 (7) MLJ 882, on the plight of Banks in recovering their dues from the borrower through Civil Courts, is as follows:

“3. For getting a decree in usual course before a Civil Court litigant including Banks have to file the suit before a Civil Court. After service of notice, written statement and trial, the suit would be decided by passing a decree. The decree would possibly be challenged by way of appeal upto Supreme Court and it would take about 5 to 15 years to attain finality. There would be possibility of dismissal of suit on various grounds. After the decree is passed by the competent civil court, the same would be put to execution by filing E.P. The Execution Court after service of notice would bring the property of the debtor/guarantor for sale through auction. To reach this stage, lot of money, especially very long time has to be spent. The above process is dispensed with by the Special Act "SARFAESI ACT" which is meant only for the financial institutions. As per the Act, the first step would be to issue notice U/s. 13(2) by the authorised officer who is deemed to be armed with a money decree which attained finality. By the statute the authorised officer, is clothed with powers of trial court and execution court and the code of Civil Procedure which governs the civil proceedings is no more necessary. To put it otherwise, by the Special Act, the authorized officer acts like a Civil Court clothed with powers hitherto exercised by it.”

The primary objective of the Banks/Secured Creditor should be to deal with the defaulters and not to harass the borrowers using the provisions of SARFAESI Act, 2002. The borrower very often raises a grievance that they are not willful defaulters and the Bank or Bank Officials are harassing them. But, the Bank says that they follow the guidelines issued by the Reserve Bank of India and in many cases, they follow the guidelines very strictly and mechanically. The borrower, in many cases now, may not be able to convince the Bank that he can not be construed as a defaulter and he will pay the loan amount if the Bank is liberal. It is true that the borrower gets a right to question the action initiated by the Bank if the Bank is incorrect in classifying an account as ‘NPA”. The borrower can certainly insist the Bank to follow the guidelines issued by the Reserve Bank of India and the courts have held that the guidelines are mandatory from the borrower point of view. The Bank or the Secured Creditor, though is entitled to classify an account as ‘NPA” based on the guidelines issued by the Reserve Bank of India, the borrower can certainly question the issue of classification if he can establish that the Bank has acted unreasonably or the classification is perverse on the face of it. It may be really difficult for the borrower to question the classification of Account by the Bank, but, in some cases, the borrower may have a case to show that the Bank has acted unreasonably. On the issue of classification of Account by the bank as “NPA”, the Hon’ble Madras High Court in

M/s. Signal Apparels Pvt. Ltd. & Another Vs. Canara Bank P.N. Road Branch, Tirupur & Another, 2010 (5) CTC 337, 2010 (8) MLJ 967, was pleased to observe as follows:

“16. To put it precisely, for invocation of provision of Section 13(2) of the Act, the declaration of an asset or account to be a non-performing asset is a condition precedent. In the event such declaration is not in accordance with the R.B.I. guidelines and the account of a borrower is a performing account, Section 13(2) may not be pressed into service; as such account cannot be brought under Section 2(o) of the Act. Equally, going by the scheme of the Act, the discretion conferred on the bank to declare an asset to be a non-performing asset is in order to tackle the issue of increase of non-performing asset to high level. That is why; the legislature had left the discretion to the bank while declaring a debt as a non-performing asset, qualifying such bank to follow the directions or guidelines issued by the Reserve Bank of India while classifying the assets to be sub-standard, doubtful or loss assets to be known as non-performing assets. This discretion is on national policy and all that requires for the secured creditor is to exercise the discretion judicially. In the wake of the right of the secured creditor to declare a debt as a non-performing asset, to show the application of mind for such declaration, it may indicate the reasons thereof in the notice under Section 13(2) and the Section does not contemplate that in all cases such reasons should be indicated in the notice. The application of mind could be culled out from the materials that were existed on the date of such declaration.”

On the same issue of classification of Account as ‘NPA’ by the Bank before proceeding against the borrower under the provisions of SARFAESI Act, 2002, the Hon’ble Andhra Pradesh High Court, in M/s. Sri Srinivasa Rice and Floor Mill Vs. The Authorised Officer, State Bank of India (2007 (4) ALT 317, 2007 (4) ALD 649, 2007 AIR (AP) 252), was pleased to observe as follows:

“There is, as considered earlier in the judgment no statutory format, express or by necessary implication, that requires the respondent bank to follow a particular or formal procedure or requires a formal declaration as a condition precedent to classification of debt as NPA. From the scheme of the Act in general and the provisions of Sec.13 (2) in particular, the conclusion is compelling that the legislature has consecrated the power, authority and discretion (to classify a debt as a NPA) to the secured creditor within the generic guidelines to be ascertained from the definition of a non performing asset [Sec.2 (o)]. A wide margin of discretion is available to the respondent bank as the secured creditor, within the legislative presents of the Act, to assess and classify a debt but within the legislative framework. This Court is not constituted an appellate authority over the bank’s exercise of discretion in this area. The respondent bank, as legislatively recognized is an institution having the requisite expertise to form a commercial judgment on known principles of banking practices and procedures fertilized by R.B.I directions and guidelines to assess and classify a debt as NPA. From the wealth of material pleaded in the counter-affidavit the bank had assessed the debt as non-performing asset. On facts, the petitioners have miserably failed to establish that such assessment by the bank is perverse or irrational to a degree warranting oversight and correction in judicial review.”

Conclusion: The issue is really complicated. If it is a case where the Bank has ignored the guidelines issued by the Reserve Bank of India, then, the borrower can question the illegal action of the Bank and can definitely succeed. However, if the issue is about reasonableness in classifying an Account as “NPA” though the Bank has followed the guidelines issued by the Reserve Bank of India strictly, then, the borrower has to establish a strong case about his track-record and intention when it comes to repayment of the outstanding-due; and also as how the Bank acts unreasonably.

Note: the views expressed are my personal and a view point only.

Is it correct to say that "once NPA is always NPA" under SARFAESI Act, 2002?

It true that the Banks suffer a lot in recovering the outstanding dues from the borrowers in the absence of special enactment like SARFAESI Act and the object of the enactment is really laudable. It is a procedural change basically to enable the Banks to recover the loans speedily and in my opinion, it is not the intention of the legislature to put the borrower remediless if they are really aggrieved at the action initiated by the Banks under SARFAESI Act, 2002. The validity of the enactment was challenged before the Constitutional Courts and the validity is upheld. Many issues like the jurisdiction of the High Court to interfere at the stage of issuance of notice under section 13 (2), the powers of Debt Recovery Tribunal, the grounds on which the action initiated by the Bank can be agitated, the approach to be adopted by the Banks while entertaining objections from the borrower to the notice issued under section 13 (2) etc, were discussed by the Courts from time to time and many issues are now settled though there still exist ambiguity and complication on certain issues.

If we keep other complicated issues in the course of proceeding against the borrowers under SARFAESI Act apart, it is indeed interesting to deal with the issue of ‘NPA’, classifying an account as ‘NPA’, the procedure to be followed to classify an account as NPA and the approach to be adopted by the Bank when an account is classified as ‘NPA’ technically by applying the guidelines prescribed by the Reserve Bank of India. Even the Courts refer to the guidelines prescribed by the Reserve Bank of India in this regard. The problem with the classification of an account as NPA is that once the Bank classifies an account as NPA, then, it will proceed with taking action against the borrower under the provisions of the SARFAESI Act, 2002 when there is ‘secured asset’. Though, it is emphasized again and again that the Bank is supposed to give a considered reply to the objections raised by the borrowers in response to the notice under section 13 (2) of the SARFAESI Act, 2002, in many cases the reply by the Bank is based on technicalities. In my opinion, the stand of the borrower that his account can not be classified as NPA by strictly applying the guidelines issued by the Reserve Bank of India requires special consideration by the Bank both before contemplating action under SARFAESI Act and even after initiating steps under the Act by issuing notice under section 13 (2) of the Act. This approach will be fair to the borrowers and, the Bank, in no way gets prejudiced by listening to the borrower when he claims that his account can not be classified as ‘NPA’ and he is willing to remit all the pending installments with interest etc. This is a very important issue in the course before contemplating action against the borrowers under the provisions of the SARFAESI Act, 2002. I have recently read of a judgment of the High Court of Andhra Pradesh between M/s. Sravan Dall Mill P. Limited, Rep. by its Managing Director Vs. Central Bank of India reported in 2010 (1) ALT 321 (DB), 2010 AIR(AP) 35, 2009 (6) ALD 615 which has observed as follows:

“The right of the borrower to have a due consideration of objections is, therefore, an important right of the borrower where the bank is bound to apply its mind and inform the borrower of its reasons as to why and how the account is classified as NPA, particularly, when the borrower raises specific objections in that regard. The reply of the bank must indicate application of mind by the bank that the decision of the bank in classifying the account as NPA was fully in conformity with the prudential norms of RBI. Non-consideration of the said objection by mere statements in the reply that the bank has considered the same cannot be said to be the fulfillment of the obligation of the bank under Sections 13(2) and 13(3)(A) of the SARFAESI Act. It also cannot be disputed that even assuming that particular account had become NPA, the subsequent payments by the borrower entitles a borrower to upgrade the said account and may come out of the said classification of his account as NPA. Therefore, it is incorrect to presume that once an NPA is always an NPA and it is precisely for the said reason that the clause 4.2.4 of the prudential norms specifically states that if interest and principal are paid by the borrower in case of loans classified as NPA, the said account should no longer be treated as NPA and may be classified as sub-standard account. Consequently, therefore, the action under the SARFAESI Act with regard to the said account would not be tenable, as jurisdictional fact under Section 13(2) of the SARFAESI Act would remain unsatisfied”.

Note: I am not dealing with the binding law on the issue and I have just exposed a point of view.