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COMPARATIVE ANALYSIS OF THE INSOLVENCY CODE AND SARFAESI ACT

INTRODUCTION

India has a gathering of many insolvency laws that have been constantly in dispute with each other. The two acts that gradually gained momentum are The Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest Act (SARFAESI)[1] enacted in 2002 and is regulated by the Ministry of Finance and the Reserve Bank of India (RBI) and the other one is The Insolvency and Bankruptcy Code of India (IBC)[2] enacted in the year 2016 and is regulated by the Insolvency and Bankruptcy Board of India. The SARFAESI act contains guidelines for the creditor to recover bad loans or debt from the debtor if there is a default in repayment of loans and also provides methods to the banks and other financial institutions for the recovery of non-performing assets. It is done by auctioning the collateral and residential assets. On the other-hand IBC targets those companies which go under insolvency. Under this act, the insolvent company has to file insolvency or bankruptcy, and then the process of liquidation is done. IBC helped India in ease of doing business and it turned out to be the most effective and important legal framework for the companies which are under financial distress. It helped India to get momentum in the global economy and it became a potential investment destination.[3]

Difference between IBC and SARFAESI Act

Sometimes there is a conflict between the two acts as both the acts deals with the liquidation process, but in the case of Encore Asset Reconstruction Company Pvt Ltd v. Ms Charu Sandeep Desai,[4] the national company law tribunal held that section 238 of IBC provides a non-obstante clause that means that IBC will prevail its supremacy over any act enforced at a particular time. In another case Rakesh Kumar Gupta V. Mahesh Banshal[5] it was held that if any proceeding is pending under SARFAESI Act, then also a fresh proceeding under IBC can be accepted and no law can affect the creditor’s right to apply to IBC.

Key differences between both the acts are:

  • The SARFAESI act works without any involvement of the court and helps to protect the credit rights of the creditors, who are mostly banks and other financial institutions by auctioning off the assets of the debtors. But under IBC the court is involved in the liquidation process, the insolvent company has to file to the court for the liquidation of assets. The IBC includes not only banks but also secured and unsecured operational creditors.
  • The insolvency process under IBC is more efficient and simpler than SARFAESI Act. Individuals and corporate debtors are handled differently under the IBC, the jurisdiction of liquidation for corporate debtors falls under NCLT (National Company Law Tribunal) and the liquidation process for individual firms and companies is processed by DBT (Debt Recovery Tribunal). But the SARFAESI act does not provide such distinction.
  • The expenses for the recovery process under SARFAESI are relatively lesser than IBC. But where the burden of debt is high then the IBC resolution process is more effective and focused on the interest of the stakeholders and also supports the revival of the company, and use of the SARFAESI Act for large size cases can kill the business. SARFAESI Act includes ARC (Asset Reconstruction companies) which acts as a middle man. These companies help in the fast and easy recovery of bad loans from the debtors.

Example: XYZ is a company that has taken a Loan of 8 crores from a bank and has not paid it back, and the loan is now an NPA. So The bank will “sell” the NPA to the ARC (think of it as giving XYZ’s loan papers to ARC to take the headache of recovery while getting money from the ARC that’s going to take the said headache).[6] While on the other hand, IBC includes IP ( Insolvency Professional) to develop a plan for resolving the recovery process, and it submits a proposal for securitization and asset recovery, which helps in the company’s revival.

  • According to an article published in Business Standard[7], in the year 2018-19, the recovery rate under SARFAESI was 14.5% and under IBC it was 42.4% under IBC. Hence we can see that IBC is preferred over SARFAESI for speedy and efficient recovery.
  • The insolvency proceeding under IBC takes at least 180 to 270 days and it starts just after the company files for liquidation to NCLT. Under SARFAESI Act, proper disposal proceeding of a case after investigation can take 1-2 years.
  • Creditors both secured and unsecured have to undergo the proceeding as prescribed by IBC for the liquidation process, on the other hand, SARFAESI Act has no such restrictions. A promoter can make an effort to get his rights before the resolution.

When can a bank shift from SARFAESI to IBC?

It is up to the bank when it prefers to shift from SARFAESI to IBC. During a period of delay in the performance of a legal obligation or the payment of a debt, which is called a moratorium period[8] the SARFAESI gets suspended and banks transfer to IBC for liquidation or resolution in the case of M/S Unigreen Global Private Limited v. Punjab National Bank held that once a moratorium was imposed under IBC no proceedings under section 13(4) SARFAESI Act could take place. Under IBC the financial creditor has faced a defaulted debt of Rs 1 lakhs then without any delay it can move for insolvency proceedings, and does not need to wait for 90 days as it is necessary under the SARFAESI act. IBC is more beneficial and safe for the creditor. After the bank or financial creditor gives application to NCLT for IBC proceeding, then a resolution plan is made and if is passed then resolution proceedings start, and if the resolution is not accepted then liquidation process starts in which the company’s assets are sold, but the rights of the secured creditor are maintained by Section 52 of IBC.

Conclusion

The recovery process is more efficient under IBC than SARFAESI. Whenever a company applies for liquidation under IBC then it takes over DRT or SARFAESI. When a resolution plan of a company is submitted and accepted then all the creditors also have to accept it. Then IBC also gives preference to secured creditors in the ‘waterfall mechanism’ it means during the liquidation process at first the secured creditors must be paid the full extent of their admitted claims before any sale proceedings. SARFAESI could be better for smaller cases like housing loans where only the lender is involved. The resolution process under SARFAESI Act is delayed and there are many pending proceedings, so that is also a reason to prefer IBC over SARFAESI for a quick solution, reviving the company, and safeguarding the interest of stakeholders.

Author(s) Name: Dibakar Banerjee (Law College, Durgapur)

References:

[1] THE SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST ACT, (2002).

[2]  THE INSOLVENCY AND BANKRUPTCY CODE, (2016).

[3]Dipak Mondal,  ‘How IBC improved India ease of doing business’ Business Today  (New Delhi,

24 October 2019) <https://www.businesstoday.in/latest/economy-politics/story/how-ibc-helped-improve-india-ease-of-doing-business-rankings-235937-2019-10-24> accessed Feb 27, 2022.

[4] Encore Asset Reconstruction Company Pvt Ltd v. Ms Charu Sandeep Desai, Company Appeal (AT) (Insolvency) No. 719 [2018]

[5]  Rakesh Kumar Gupta V. Mahesh Bansal Company, Appeal (At) (Insolvency) No. 1408 of 2019.

[6] Akash Batra, ‘IBC v. SARFAESI Act – Interplay and Overlapping’ (TaxGuru, 18 Dec 2020) <https://taxguru.in/corporate-law/ibc-v-sarfaesi-act-interplay-overlapping.html> accessed Feb 27, 2022.

[7] Dipak Mondal,  ‘How IBC improved India ease of doing business’ Business Today  (New Delhi, 24 October 2019) <https://www.businesstoday.in/latest/economy-politics/story/how-ibc-helped-improve-india-ease-of-doing-business-rankings-235937-2019-10-24> accessed Feb 27, 2022.

[8] Annual National Law School of India ” Review Symposium on the Insolvency and Bankruptcy Code” (2018) PL 136