Wednesday, September 7, 2016

SARFAESI Amendment: A New Role for Debenture Trustees

[The following post is contributed by Vinod Kothari and Nidhi Bothra of Vinod Kothari & Co. The authors can be reached at and respectively]


The Enforcement of Security Interest and Recovery of Debt Laws and Miscellaneous Provisions (Amendment) Act, 2016[1] (Amendment Act) has introduced several amendments to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act), Recovery of Debts due to Banks and Financial Institutions Act, 1993 (RDDBFI Act) and other incidental laws. The amendments were introduced in an attempt to change the credit landscape and to augment ease of doing business. The objective was also to facilitate faster disposal of recovery applications which was the very intent with which the statutes were introduced in the first place.

The amendments introduced the Act focus on

(i) registration of creation, modification and satisfaction of security interest by all secured creditors and provision for integration of registration systems under different laws relating to property rights with the Central Registry so as to create Central database of security interest on property rights; (ii) conferment of powers upon the Reserve Bank of India to regulate asset reconstruction companies in a changing business environment; (iii) exemption from stamp duty on assignment of loans by banks and financial institutions in favour of asset reconstruction companies; (iv) enabling non-institutional investors to invest in security receipts; (v) debenture trustees as secured creditors; (vi) specific timeline for taking possession of secured assets; and (vii) priority to secured creditors in repayment of debts.

(Emphasis Ours)

The definition of secured creditors under section 2(1)(zd) in the SARFAESI Act was substituted to read as follows:

'(zd) "secured creditor” means—

(i)         any bank or financial institution or any consortium or group of banks or financial institutions holding any right, title or interest upon any tangible asset or intangible asset as specified in clause (l);

(ii)        debenture trustee appointed by any bank or financial institution; or

(iii)       an asset reconstruction company whether acting as such or managing a trust set up by such asset reconstruction company for the securitisation or reconstruction, as the case may be; or

(iv)       debenture trustee registered with the Board appointed by any company for secured debt securities; or

(v)        any other trustee holding securities on behalf of a bank or financial institution,
in whose favour security interest is created by any borrower for due repayment of any financial assistance.';

By virtue of the debenture trustee being included in the definition of secured creditors, the debenture trustee can take enforcement action under section 13 of the SARFAESI Act. To consider the provisions, section 13 (2) states:

(2) Where any borrower, who is under a liability to a secured creditor under a security agreement, makes any default in repayment of secured debt or any instalment thereof, and his account in respect of such debt is classified by the secured creditor as non-performing asset, then, the secured creditor may require the borrower by notice in writing to discharge in full his liabilities to the secured creditor within sixty days from the date of notice failing which the secured creditor shall be entitled to exercise all or any of the rights under subsection (4).

The Amendment Act introduces a proviso to section 13(2) in line with the amendment of the definition of secured creditors and is as follows:

"Provided that—

(i)         the requirement of classification of secured debt as non-performing asset under this sub-section shall not apply to a borrower who has raised funds through issue of debt securities; and

(ii)        in the event of default, the debenture trustee shall be entitled to enforce security interest in the same manner as provided under this section with such modifications as may be necessary and in accordance with the terms and conditions of security documents executed in favour of the debenture trustee;";

In essence, in case of debt securities, the requirement of the secured debt classifying as non-performing asset (NPA) shall not prevail and also that section 13(2) will be read with appropriate modifications in case the secured creditor is the debenture trustee. The debenture trustee can take action as provided under the security documents.

Further, the debenture trustee being a secured creditor can also take enforcement action once there is a default in repayment, where the debt is qualified as non-performing in nature.

The Amendment Act also substitutes the definition of default to read as follows:

(j) "default" means—

(i) non-payment of any debt or any other amount payable by the borrower to any secured creditor consequent upon which the account of such borrower is classified as non-performing asset in the books of account of the secured creditor; or

(ii) non-payment of any debt or any other amount payable by the borrower with respect to debt securities after notice of ninety days demanding payment of dues served upon such borrower by the debenture trustee or any other authority in whose favour security interest is created for the benefit of holders of such debt securities;

We now discuss the impact of the amendments with regard in case of debt securities.

Enforcement of security interests in case of debt securities

The significant points to be noted as regards enforcement of security interests in case of debt securities are as follows:

- Since the definition of “secured creditor”, as amended, includes a trustee for debt securities, the enforcement will be carried out by the trustee. In case of secured debentures, the trustee is the holder of security interests, which he holds in trust for the debenture holders.

- The debentures issued or invested in are not on the books of the trustee at all. Therefore, the question of such debentures or debt securities being an NPA in the books of the trustee does not arise. It is in this light that the proviso below sub-section (2) provides that the classification as an NPA in the books of the secured creditor will not be applicable.

- Clause (ii) of the proviso added by the Amending Act states that the trustee shall be entitled to exercise security interest in “accordance with the terms and conditions of security documents executed in favour of the debenture trustee”. It is quite obvious that the law merely provides a mechanism for self-help enforcement. That right of enforcement should come from the security agreement. This is the consistent view that the authors have had on the law, even as originally enacted. In view of the language of the law, going forward, the security agreements (mortgage, hypothecations or trust deeds) executed with debenture trustees may like to have specific clauses about enforcement of security interests.

Nature of secured assets and practical utility of the new provisions:

The market for corporate bonds in India is still a fledgling one; most debentures are issued by financial sector entities. Most of the debentures issued by financial sector entities, other than the bonds that are to qualify to be part of Tier IA or Tier II capital for regulatory purposes, are secured by floating charges on receivables. The floating charge is also typically on a common pool of receivables, shared by several series of debentures. That is to say, subject to a specific asset cover requirement, the issuer may continue issuing debentures, on the same common pool. Neither is there any ring-fencing, nor is there any identification.

Such a security interest is practically no different from the issuer’s obligation to pay. The issuer’s assets are fungible, unidentifiable pool of receivables, simply with the underlying asset cover. Most often, a common trustee holds security interest for several series of bonds or debentures. Assuming there is a default with respect to one of the series of debentures, there is no way the trustee may identify the receivables to any specific series of debentures. Therefore, unless the issuer was to default on all the bonds/debentures, there will be no way to enforce the section.

Assuming the unlikely situation where the issuer were to default on all the bonds, even then, unless the debenture trustee has a charge on all the assets of the issuer, enforcing security interest on the receivables may amount to collecting the money from the obligors – which is much worse than collecting the money from the issuer himself.

While the law does not help in such situations, a proper crafting of the security agreements may. For example, the security agreement may provide that that the trustee may, in the event of default, direct all receivables to be put into a separate bank account, from where the receivables will be used in a certain manner of waterfall.

Yet another difficulty in case of floating charges backing debentures will be overlapping security interest in favour of other lenders. Mostly, working capital lenders may also have floating charge over the receivables. If the trustee shares the security interest, on an unidentifiable portion of receivables, it may not be possible to use the security interests at all.

The whole device of floating charges backing the issue of debentures was visualized decades ago in the U.K., predominantly with the idea of permitting the debentureholders to appoint an administrative receiver, and to cause a change of management on a going concern basis. This was easy because the debentureholder had security interest on the entire enterprise of the issuer. However, the practice was abolished in the U.K. after the specific amendments brought by the Enterprise Act, 2002.

World over, corporate bonds are mostly unsecured obligations of the issuer. In India, debentures had to be secured because of the provisions pertaining to public deposits. Recent amendments in deposit rules have permitted companies to issue unsecured debentures – therefore, the whole concept of secured debentures may soon become obsolete.

Manner of enforcement by debenture trustee:

The manner of enforcement of security interest by a trustee will involve two notices, one, for constituting default, and the other, demanding payment in terms of section 13(2). The process will involve the following steps:

- First of all, there has to be a breach of scheduled payment, as per the terms of issue of the debentures. For example, a scheduled interest or principal payment is not made. Note that defaults other than payment defaults (for example, a default in meeting the obligation to maintain an asset cover, or a debt service reserve, etc.) may not constitute “default” as defined in section 2 (1) (j) at all.

- Once there is such breach of payment of obligation, the trustee has to serve a notice demanding payment. This is a 90-days’ notice, required in terms of section 2(1)(j) to constitute a case of default, equivalent to characterization of the asset as NPA in case of loans.

- If, after 90 days’ notice as above, the amounts demanded as above are not settled by the issuer, then the trustee may serve a notice in terms of section 13(2), demanding payment within 60 days of the notice. This notice is notice under section 13(2) – therefore, it has to satisfy all the requirements of the notice, including the details of the secured asset, etc. The notice under sec. 13 (2) may also be a recall or acceleration notice, demanding full repayment of the debentures, since, at this stage, the trustee may like to demand not just settlement of the defaulted amount, but a completely paydown of the entire debt security.

- If, after service of the second notice, issuer does not pay the amount demanded in the notice under section 13 (2), the trustee may take the measures mentioned in section 13 (4).


Debenture trustees hold the security interest for and on behalf of the debenture holders. With the insertions in the Amendment Act, the debenture trustees have a significant role in enforcement of security interests which goes beyond identifying such stress situations which may jeopardise the security interests they hold and taking timely and appropriate action in that regard. The security documents henceforth will have to have clauses detailing the role of the debenture trustee in case of default and the responsibilities thereof. Opening up SARFAESI action gives debenture trustees a strong hold on the enforcement possibilities and widens the scope the role. The debt investors’ community will certainly welcome the amendments introduced.

- Vinod Kothari & Nidhi Bothra  

[1] The Act received President’s assent on 12 August, 2016, although the enforcement notification has not yet been passed.

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