Sunday, March 8, 2009

Securitisation and Debt Recovery – A Centre-States Conflict?

The Constitution has devised an elaborate scheme of distribution of legislative powers, and the competence of a legislature to enact a law has normally been challenged by a private citizen to whom the law applies. The latest battleground looks to be the fairly recent structure of securitization, debt recovery and other FI-friendly legislation. The first major decision of the Supreme Court on this point – Central Bank of India v. State of Kerala (C.A. No. 95/2005, decided on 27 February 2009) does not entirely settle the issue.

The issue before the Court was whether recovery mechanisms prescribed in legislations like the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (“RDB Act”), the Securitisation Act, 2002 etc. have primacy over State legislations which provide that the State shall have first charge over assets to enforce any dues that it may be owed. For example, the Bombay Sales Tax Act, 1959 provides that any sum payable to the State under the Act shall be the first charge on the property of the dealer, subject to any provision contained in any Central law regarding first charge. Other State legislations are to the same effect without the rule that it is subject to a provision in a Central law regarding first charge (Kerala General Sales Tax Act, 1963, § 26B). In addition, there are also some Central laws that prescribe first charge independently – the Workmen’s Compensation Act, 1923 (§ 14A), the Employees Provident Fund and Miscellaneous Provisions Act, 1952 (§ 11), the Estate Duty Act, 1953 (§ 74(1)), Mines and Minerals (Development and Regulation) Act, 1957 (§ 25(2)), Companies Act (§ 529A) and so on.

However, the RDB Act (§ 34(1) provides that the provisions of that Act will have effect notwithstanding anything inconsistent contained in any other law. The Securitisation Act contains a similar provision (§ 35). Relying on this, Central Bank of India argued that the Recovery Certificate it had obtained from the DRT in respect of a loan it had granted took precedence over sales tax arrears that the borrower owed to the State Government, and that the first charge provisions of the State legislation were overridden by the Central Acts. The Court examined the contention from three angles. First, it concluded that the doctrine of repugnance had no application, as Article 254 of the Constitution applies only when there are two legislations under the same entry in the Concurrent List. In other words, the Court concluded that the State legislation did not become invalid to the extent it was inconsistent with the Central Act merely because of Art. 254.

Secondly, and more importantly, the Court analysed the scope of the non-obstante clause in the RDB Act and the Securitisation Act. This is likely to be of great importance for future disputes. The Court noted that the provision that the RDB Act and the Securitisation Act would operate notwithstanding anything contained in any other law had to be interpreted in accordance with legislative intent, and that if the legislature intended it to have a limited scope, that had to be given effect to. In determining what the legislature in fact intended with these provisions, the Court observed that the State has for a long time been accorded priority in its debts and first charge over assets. The Court concluded that Parliament, when it enacted the RDB Act and the Securitisation Act, was deemed to be aware of this rule and must be presumed not to have altered it unless it did so specifically. No such specific provision exists in the RDB Act or the Securitisation Act, which allowed the Court to conclude that these legislations operate in a different field, and that there is in fact no conflict between these legislations and the State legislations mentioned above. Such specific provisions exist in Section 529 of the Companies Act, or Section 11(2) of the EPF Act, which prescribe that the creditors secured by those provisions have priority over the first charge that the State traditionally enjoys. The Court observed, “[h]owever, the fact of the matter is that no such provision has been incorporated in either of these enactments despite conferment of extraordinary power upon the secured creditors to take possession and dispose of the secured assets without the intervention of the Court or Tribunal…”. Thirdly, and consequently, the Court held that the sales tax and other arrears owed t the State Government had priority over the decree/Recovery Certificate issued by the DRT in respect of banking debts.

This judgment is likely to be of enormous significance in what is surely going to be the most contentious arena of State-Centre legislative power disputes, with the rapidly increasing number of State legislations that create first charge. For example, ET reports that SEBI has challenged the validity of a Gujarat legislation – Sardar Sarovar Narmada Nigam (Conferment of Power to Redeem Bonds) Act, 2008, claiming that it conflicts with the Companies Act. With the growing penchant for States to enact depositor-protection or other such legislations, this trend looks set to continue in the near future.


Mandar Kagade said...

The Supreme Court is clearly wrong in inferring that "crown debts" have priority over the dues of the secured creditors.

May I take liberty to point out the "Transcore" litigation where the Suprme Court analysed both the RDB Act and the Securitistion law and concluded that once the secured Creditor takes possession under the Securitisatio law, it takes possession "qua owner".

Section 13 also clearly provides for the preferential treatment of the secured creditor, which read along with the non obstante Section 35 clearly leads to an inference that the doctrine of the Crown as preferred creditor is repealed by the prescriptions. Indeed, the celebrated debates between Shri Sibbal and Shri Jaithley in the course of enactment of the Securitisation law clearly indicate that the law makers intent was to confer all the powers of the owner on tyhe secured creditor on his obtaining possession. (A fact corroborated by the Supreme Court itself in Transcore).

One might conclude symmetrically on a purposive construction of the debt recovery precsriptions. The easy flush out of NPAs.

From a Chicago school approach too, the Court seems to be out of touch with the market realities. It is clear that ex post impedence to banks and FIs in debt recovery that the doctrine of according priority to crown debts will lead to, will affect their ex ante (credit supply)behaviour. They will be more conservative than optimum which will exarcerberate demand destruction that the regulators are fighting to tackle.

We have had the Gujrath HC declaring that the OTC NPA sale market is beyond the competence of Banks under the relevant provisions of BR Act recently.

Clearly the judiciary in this country should be given some elementary lessons in the L&E school. That way, they can assimilate the economic impact of their old school insistence of construing law in social vacuum.


Bharat Bhushan said...

The enactment of Securitisaton Act is definetely a way forward in liquidating the NPA's of the Banking Industry. however, the provisions of this Act are being manipulated to a great exent. Many Banks are misusing this Act and The Gujarat High Court has rightly ruled against the Sale Of NPA. Recently the Allahabad High Cour in case titled " Arunachalam Muthu Vs State Bank of India" have again ruled gainst the sale of NPA in he Garb of Securitisation and have even gone to the extent of impounding the Assignment Deed and also allowing the State Govt to imposea heavy Stamp Duty and Pealty against the Bank indulging in these practices. The law should not be allowed to be misused by some smart private banks workig as Recovery Agents in the the name of Securitisation.