The Supreme Court has ruled that a bank can use the SARFAESI Act, 2002, to recover a secured loan that it has taken over from a Non-Banking Financial Company (NBFC), even if that NBFC was not covered by the SARFAESI Act when the loan was originally given.
The ruling settles an important question: Can a bank use the faster recovery process under the SARFAESI Act for a loan that was originally given by an NBFC that was not covered by the Act at that time?
The Supreme Court has answered yes.
What Happened in This Case?
The dispute involved loan accounts originally given by City Financial Consumer Finance Limited (CFCFL), an NBFC. At the time these loans were given, CFCFL was not included as a “financial institution” under Section 2(1)(m) of the SARFAESI Act.
Later, on August 27, 2018, CFCFL was notified as a financial institution covered under the Act.
Meanwhile, between 2012 and 2013, Kotak Mahindra Bank acquired three sets of loan accounts from CFCFL. These loans were secured by mortgages.
After taking over the loans, Kotak Mahindra Bank started recovery proceedings under the SARFAESI Act because the borrowers had failed to repay the outstanding amounts.
Why Did the Borrowers Object?
The borrowers challenged the bank’s action. Their argument was simple: when the loans were originally given by CFCFL, the NBFC was not covered by the SARFAESI Act. Therefore, they argued that the loans could not later become eligible for SARFAESI recovery simply because the loans were transferred to a bank.
In other words, the borrowers said that the loan’s legal status should be determined by the position at the time it was originally created.
They argued that Kotak Mahindra Bank therefore could not use the SARFAESI Act and would have to recover the money through the normal legal process.
What Did the Lower Courts Decide?
The borrowers initially succeeded before the Debt Recovery Tribunal (DRT) and the Debt Recovery Appellate Tribunal (DRAT). The Bombay High Court’s Division Bench also upheld this view.
The courts held that Kotak Mahindra Bank could not invoke the SARFAESI Act to recover the loans because CFCFL was not a notified financial institution under the Act when the loans were originally given.
Kotak Mahindra Bank then approached the Supreme Court.
What Did the Supreme Court Decide?
The Supreme Court disagreed with the Bombay High Court and the lower tribunals. A bench of Justice Sanjay Kumar and Justice Sanjeev Sachdeva held that once a non-performing secured loan is acquired by a bank to which the SARFAESI Act already applies, the loan becomes a “secured debt” covered by the Act.
The Court said that it does not matter that the original lender was not covered by the SARFAESI Act when the loan was created.
In simple terms, the fact that the loan originally came from an NBFC outside the SARFAESI framework does not prevent a bank from using the Act after it legally acquires that secured loan.
Why Did the Supreme Court Take This View?
The Court rejected the borrowers’ argument that the loan should remain outside the SARFAESI Act forever because of the status of the original lender.
The Court pointed out that accepting such an argument could create an unfair situation.
For example, borrowers who took loans from NBFCs not covered by the SARFAESI Act could potentially face only slower, ordinary civil recovery proceedings. In contrast, borrowers who took loans from institutions covered by the Act could face the faster recovery mechanism under SARFAESI.
The Supreme Court said that such a distinction would not make sense, particularly because loan defaults can have a wider impact on the financial system.
What Is SARFAESI Act?
The SARFAESI Act provides banks and certain financial institutions with a legal mechanism to recover secured debts without having to go through a lengthy civil court process in the usual manner.
When a borrower defaults on a secured loan, the Act can allow the lender to take steps against the secured asset, subject to the requirements of the law.
This is why whether a loan falls under the SARFAESI Act is important for both banks and borrowers.
What Did the Supreme Court Say About the Loan’s Status?
The Supreme Court made an important distinction. According to the Court, it is not necessary that both the original lender and the loan were covered by the SARFAESI Act from the beginning.
If the loan is a secured, non-performing loan and is later acquired by a bank that is already covered by the SARFAESI Act, the bank can use the Act for recovery.
The Court essentially held that the identity of the original lender does not prevent SARFAESI proceedings once the secured loan has been taken over by a bank covered by the Act.
Earlier Supreme Court Decisions
While reaching its decision, the Supreme Court relied on its earlier judgments in:
- M.D. Frozen Foods Exports Private Limited v. Hero Fincorp Limited (2017)
- Indiabulls Housing Finance Limited v. Deccan Chronicle Holdings Limited (2018)
The Court considered these earlier decisions while determining whether the status of the original lender could prevent SARFAESI proceedings after a secured loan was transferred to a bank.
What Is the Final Decision?
The Supreme Court allowed Kotak Mahindra Bank’s appeal and set aside the Bombay High Court’s decision. It directed that the bank’s securitisation application before the Debt Recovery Tribunal be restored.
This means Kotak Mahindra Bank can continue pursuing the recovery proceedings under the SARFAESI Act in accordance with the law.
Why Is This Ruling Important?
The judgment is important for banks because it confirms that they can use the SARFAESI recovery mechanism for eligible secured loans acquired from NBFCs, even where the original NBFC was not covered by the Act when the loan was created.
For borrowers, the ruling means that transferring a secured loan from an NBFC to a bank covered by the SARFAESI Act can make the loan subject to SARFAESI recovery proceedings.
In short, the Supreme Court has made it clear that the original lender’s status under the SARFAESI Act does not by itself prevent a bank from using the Act after taking over a secured non-performing loan.
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