SARFAESI Amendment 2004 Unconstitutional: Gujarat HC

The Gujarat High Court delivered an important judgment, wherein it held unconstitutional an amendment in securitization laws and restored the Reserve Bank of India (RBI) as the watchdog of banks and non-banking financial institutes across the country as far as their non-performing assets (NPA) period was concerned. A division bench of Chief Justice Bhaskar Bhattachrya and Justice J B Pardiwala has ruled that a 2004 amendment in the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests (Sarfaesi) Act, 2002 was illegal, unconstitutional and contrary to the object of the Act. It, thus took away powers to decide whether asset was NPA or not and the period of non-payment that would make an asset NPA from all regulators except the RBI. A petition moved by a borrower through advocate Vishwas Shah and Masoom Shah had challenged the amendment, which defined NPA under section 2(1)(O) classified different institutions (60 in total) under two groups, those under the purview of the RBI and those controlled by other agencies.

Several defaulters questioned the amendment made in November 2004 in the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002. Before this amendment in Section 2(1)(o) of the Act, the RBI was the controller for banking, non-banking firms and securitization agencies for deciding the period after which the loans could be treated as NPAs. Earlier, the NPA period for all such finance institutions, banks, NBFCs and other agencies, were 180 days. Later in 2004, the NPA period for banks were kept at 90 days by the RBI and 180 days for NBFCs. However, with the amendment in the law, the finance institutions were at the liberty to have their own regulators, and the RBI stopped to be the regulator for the purpose. With this, all finance firms decided the NPA period separately, which varied in each of the cases.

Some defaulters of banks and NBFCs who were aggrieved with the inconsistency approached the High Court questioning the reason for the difference of NPA periods among finance firms. The contention of their counsel Vishwas and Masoom Shah was that the difference was in violation of the right to equality as guaranteed by the Constitution. This argument was upheld by the High Court, which declared the amendment as unconstitutional. It observed that the Parliament was incorrect in taking away the power from the RBI to set NPA guidelines.

However, the petitioners prayer by which they questioned the guideline set by the RBI putting 90 days' NPA period for banks and 180 days for the NBFCs and other agencies, was rejected by the High Court. The petitioner has prayed that all borrowers should be treated equally and one should not get less number of days compared with other borrower of NBFC. The court has ruled that the guidelines were dealt with in the 2004 judgment of the apex court. The court observed that for the purpose of enforcing a statute like the Securitization Act, which deviates from the ordinary laws of the land relating to attachment, sale and recovery of possession of the secured asset, the fate of a borrower couldn’t be left in the hands of the regulators of those financiers. With the judgment, RBI can decide classification of NPAs by banks and various types of financial institutions – NBFCs, LIC, and state finance companies among others.

Currently, banks classify a borrower's (consumer or corporate) account as NPA after continuous non-payment of principal and interest for 90 days and make necessary provision for the same. However, NBFC, state finance companies (SFCs promoted by state governments) and other companies get a different period to fix whether the asset is NPA or not. Certain housing finance companies, SFCs and companies like Power Finance Corporation are not under the regulation of RBI for NPA classification they are managed by respective laws and regulators.