assignment of loans to arc

RBI's Framework for Transfer of Loan Assets

Aditya Bhardwaj

ARTICLE 28 September 2021

As an anticipated measure for the banking and financial sector, the Reserve Bank of India (RBI) has, towards the close of past week, issued the comprehensive framework for the sale or transfer of loan assets. Taking immediate effect from the date of its issuance, the framework titled ‘ Master Directions - Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 ’ issued vide circular DOR.STR.REC.52/21.04.048/2021-22 dated September 24, 2021 (the ‘ Master Directions ’) is being seen as a pivotal move by the Regulator towards introducing an efficient secondary market for loans and ensuring proper credit-risk pricing, besides improving transparency in the identification of embryonic stress in the banking system as well as resolution of stressed loan exposures.

The Master Directions owes its genesis to the ‘ Draft Framework for Sale of Loan Exposures ’ which was released by RBI in course of the first COVID-19 induced lockdown in the Country. The draft had taken into consideration the recommendations of the ‘ Task Force on Development of Secondary Market for Corporate Loans ’ constituted by RBI under the chairmanship of Mr. T.N. Manoharan in May, 2019 and comments from the stakeholders were invited. One of the key components of the Task Force’s recommendation was to separate the regulatory guidelines for direct assignment transactions from the securitisation guidelines and treat it as a sale of loan exposure. The RBI had, accordingly, reviewed the recommendations and thought it prudent to comprehensively revisit the guidelines for sale of loan exposures, both standard as well as stressed, which were earlier spread across various circulars. The erstwhile guidelines or circulars on sale of loan exposures were particular to the asset classification of the loan exposure being transferred and / or the nature of the entity to which such loan exposure is transferred as well as the mode of transfer of the loan exposures. The need for a review also stemmed from the necessity to dovetail the guidelines on sale of loan exposures with the Insolvency and Bankruptcy Code, 2016 (‘ IBC ’) and the Prudential Framework for Resolution of Stressed Assets dated June 7, 2019 (“ Prudential Framework ”), which has witnessed substantial traction and developments towards building a robust resolution paradigm in India in the recent past.

The consolidation by RBI of a self-contained, comprehensive, and independent set of regulatory guidelines on transfer/sale of loan exposures is being seen as a laudable step in the direction of putting together a ‘ robust secondary market in loans which can be an important mechanism for management of credit exposures by lending institutions and also create additional avenues for raising liquidity ’. This write-up attempts to briefly summarize some key components of the Master Directions.

The Master Directions whilst superseding a host of existing circulars/directions (or a portion thereof) in relation of transfer of loan exposures (Chapter VI), has put forth a unified and singular framework for the sale of loan exposures by banks and other financial institutions. The exhaustive breadth of the framework is quite evident from the Chapters under the Master Directions which not only provide for ‘ General Conditions applicable to all Loan transfers ’ (Chapter II), but also cater specifically to transfer of loan exposures of standard assets (Chapter III) as well as stressed loan exposures (Chapter IV), including their respective and intrinsic modalities. The framework concludes with the imperative of ‘ Disclosures and Reporting ’ (Chapter V) and stipulates the mechanism for the stakeholders in that regard.

Applicability

On expected lines, nearly all constituents of the Financial sector regulated by RBI are mandated to ensure compliance to the Master Directions, both as a transferor as well as transferee of the loan exposures – Scheduled Commercial Banks, all NBFCs (including HFCs), Regional Rural Banks, Co-operative Banks, All India Financial Institutions and Small Finance Banks. In addition, the Master Directions also permits asset reconstruction companies (ARCs) and companies (save a financial service provider) to be ‘transferees’ of the loan exposures only if the same is pursuant to the resolution plan under the Prudential Framework and if they are permitted to take on loan exposures in terms of a statutory provision or under the regulations issued by a financial sector regulator.

It would be pertinent to take note that though all lenders permitted to acquire loans are required to ensure compliance to the extant Master Directions; yet, the acquisition of loans pursuant to securitisation are required to be independently dealt under the provisions of RBI’s ‘ Master Directions – RBI (Securitisation of Standard Assets) Directions, 2021 ’ dated September 24, 2021 (the ‘Securitisation Guidelines’). The coverage of the Master Directions includes transfer of loan exposures through novation, assignment, or risk participation. In cases of loan transfers other than loan participation, legal ownership of the loan shall be mandatorily transferred to the Transferee to the extent of economic interest transferred under the loan exposures.

For the Transferees which are financial sector entities (not falling under clause 3 of the Master Directions) and the ARCs, the prudential norms (asset classification, provisioning norms etc) of their respective sectoral regulators (SEBI, IRDA, PFRDA etc) shall be applicable post-acquisition of loan exposure under the Master Directions.

Basic Ingredients

Before venturing into the other nuances, it is an imperative that one accounts for the understanding of some key ‘constructs’ which cut across the Master Directions:

Transfer : Quite apparently, the expression denotes the process of transfer of the economic interest in a loan exposure by the transferor and acquisition of the same by the transferee. The subject matter of transfer being the ‘ economic interest ’ of the transferor in the loan exposure, it is important that the risks and rewards associated with loans are clearly demarcated and separated in favour of the transferee; especially when some portion of the economic interest in the loan exposure is retained by the transferor.
Transferor : Often referred as ‘assignor’ (in assignment transactions) or ‘grantor’ (for risk participation), transferor under the Master Directions would include Clause 3 entities which transfer their economic interest in the loan exposures.
Transferees : These refer to entities in whose favour the economic interest in the loans are transferred and would include Clause 3 entities as well as the ARCs/companies to the extent permitted under the Master Directions. It is clarified that the transferee should neither be a person disqualified under the IBC nor, in cases of loan exposures where frauds have been identified, belong to an existing promoter group of the borrower or its subsidiary / associate / related party etc. (domestic as well as overseas).
Minimum Holding Period (MHP) : As the expression suggests, the MHP refers to a threshold period for which the transferor should hold the loan exposures, along with its risks and rewards, before the economic interest in respect thereto is transferred. The intent of having a MHP is to ensure that the loan has been seasoned in the books of the originator (or the transferor) for a certain specified time period. The MHP for loans with tenor upto 2 years and more than 2 years, as per the Master Directions, have been capped at 3 months and 6 months, respectively.
Permitted Transferees : These include (i) Scheduled Commercial Banks, (ii) NBFCs (including HFCs), (iii) All India Financial Institutions and (iv) Small Finance Banks. The significance of carving out the foregoing financial sector entities from Clause 3 of the Master Directions lies in the fact that the transferor is permitted to transfer its loans (which are not in default) to permitted transferees only through novation, assignment, or loan participation. For the stressed exposures, the transfer is mandated only to such permitted transferees and ARCs and singularly through assignment or novation of such loan exposures.

Underlying Elements

The finer nuances of the Master Directions would certainly surface once the provisions have been widely given effect to by the stakeholders; however, as it stands, the framework undoubtedly promises to streamline the procedures and requirements for the stakeholders considering transfer of their loan exposures – standard as well as stressed. Some fundamental provisions of the Master Directions have been summarized as below:

Overarching Transfer conditions : Quite categorically, the Master Directions stresses on the necessity of delineation of Transferor’s ‘risks and rewards’ associated with the loan exposures to the extent of the transfer. In fact, it is stated that not only should the transferee have the unrestrained and unconditional entitlement to transfer or dispose of the loans to the extent of economic interest acquired by it, but also in the event of any economic interest in the loan exposure is retained by the transferor, the loan transfer agreement should demarcate the distribution of the principal and interest income from the transferred loan between the transferor and the transferee. The Master Directions also caution against any modification of terms of the underlying financing agreement and require that any change, in course of such transfer, should withstand the test of not being categorised as ‘Restructuring’ under the Prudential Framework. It would be significant to take note that the transfer of loan exposures under the Master Directions not only should be without recourse to the Transferor, but also the transferor or transferee should not be constrained to obtain consent from the transferee/ transferor, as the case may be, in the event of resolution or recovery in respect of the beneficial economic interest retained by or transferred to the respective entity. In addition to the foregoing, the Master Directions also prescribe for the enumerated conditions applicable to all transfers of loan exposures:
The Transferor shall have no obligation to re-acquire or fund the re-payment of the loans or any part of it or substitute loans held by the Transferee or provide additional loans at any time;
If the security interest is held by the Transferor in trust with the Transferee as the beneficiaries, the Transferee shall ensure that a mutually agreed and binding mechanism for timely invocation of such security interest is put in place;
Any rescheduling, restructuring or re-negotiation of the terms of the underlying agreement attempted by Permitted Transferee, after the transfer of assets to the transferee, shall be as per the Prudential Framework;
The Clause 3 entities, regardless of whether they are transferors or otherwise, should not offer credit enhancements or liquidity facilities in any form in the case of loan transfers.
Board-approved Policy : The Transferors are mandated to put in place a comprehensive Board-approved policy for transfer and acquisition of loan exposures under the Master Directions. These guidelines must, inter alia , lay down the minimum quantitative and qualitative standards relating to due diligence, valuation, requisite IT systems for capture, storage and management of data, risk management, periodic Board level oversight, etc. Further, the policy must also ensure the independence of functioning and reporting responsibilities of the units and personnel involved in the transfer/acquisition of loans from that of personnel involved in originating the loans.
Transfer of Standard Assets : The transfer of loan exposures classified as ‘standard’ can be undertaken through the mechanisms of assignment or novation or a loan participation. The transfer of such loan exposures should be only on a cash basis to be received at the time of transfer of loans; besides, the requirement of the transfer consideration being arrived at in a transparent manner on an arm's length basis. The Master Directions require the Transferees to monitor, on an ongoing basis and in a timely manner, the performance information on the loans acquired, including through conducting periodic stress tests and sensitivity analyses, and take appropriate action required, if any. Further, the Transferor’s retention of economic interest, if any, in the loans transferred should be supported by legally valid documentation supported by a legal opinion.

The requirements of Chapter III of the Master Directions are, however, not applicable to certain identified loan transfers, as below:

transfer of loan accounts of borrowers by a lender to other lenders, at the request/instance of borrower;
inter-bank participations as per the RBI’s circulars;
sale of entire portfolio of loans consequent upon a decision to exit the line of business completely;
sale of stressed loans; and
any other arrangement/transactions, specifically exempted by the RBI.
Minimum Risk Retention : The Master Directions are explicit in their requirement of the requisite due diligence in respect of the loans exposures and mention that the said exercise cannot be outsourced or delegated by the Transferee. In order to ensure a systemic departure from the conventional practice of placing solitary reliance on the due diligence of the originator (or the Transferor), the Master Directions mandate the Transferee to undertake the due diligence of the loan exposures through its own staff, at the level of each loan, and as per the same policies as would have been done had the Transferee been the originator of the loan. In case the due diligence of entire portfolio is undertaken by the Transferee, the requirement of a minimum retention requirement (MRR) of the Transferor can be dispensed with.

However, in case of loans proposed to be acquired as a portfolio, if a transferee is unable to perform due diligence at the individual loan level for the entire portfolio, the Transferor shall retain at least 10% of economic interest in the transferred loans as MRR. In such a case as well, the Transferee is required to undertake due diligence at the individual loan level for not less than one-third (1/3 rd ) of the portfolio by value and number of loans in the portfolio. As per the Master Directions, in case of multiple Transferees, the MRR would still be on the entire amount of transferred loan, even if any one of the transferee is unable to perform the due diligence at an individual level.

Transfer of Stressed Assets : Chapter IV of the Master Directions deals specifically with the transfer of stressed loan exposures to ARCs and other Permitted Transferees. It is specifically stated that the mechanism for transfer of such stressed accounts can be consummated only through assignment or novation. Besides the requirement of a Board-approved policy for transfer as well as acquisition of stressed loan exposures and the parameters thereof, the Master Directions mandate such transfers to ARCs and other Permitted Transferees only. Importantly, the Transferor is necessarily required to undertake an auction through a ‘ Swiss Challenge method ’ both in cases where (i) the aggregate loan exposure to be transferred is Rs. 100 crore or more after bilateral negotiations; and even under (ii) a transfer pursuant to the Resolution Plan approved in terms of the Prudential Framework (irrespective of the monetary threshold).
Accounting : In the event the transfer of loan exposures results in loss or profit, which is realised, the same should be accounted for and, accordingly, reflected in the P&L account of the Transferor for the accounting period during which the Transfer is consummated. However, the unrealised profits (if any) arising out of such Transfers, shall be deducted from the Common Equity Tier 1 (CET 1) capital or net owned funds of the Transferor for meeting regulatory capital adequacy requirements till the maturity of such transferred exposures. The Master Directions prescribe maintenance of borrower-specific accounts both by the Transferor as well as the Transferee of the retained and transferred loan exposures, respectively. It has been further clarified that the extant requirements of RBI for ‘income recognition, asset classification, and provisioning’ shall, accordingly, be ensured by the transferor and the transferee with respect to their respective shares of holding in the underlying loan exposures.

Though it would be quite nascent to present an analysis of the Master Directions even before it has been actually implemented, yet there are indeed some crucial aspects which underline the significance of the Master Directions issued by RBI which can be summarized as follows:

Identification and Resolution of Stressed Exposures : Though quite a premature assessment, yet it is felt that the framework under Master Directions could facilitate the development of a robust distressed asset ecosystem and speed-up the resolution of various stressed exposures, which could be driven by the ensuing characteristics of the Master Directions:
Early Identification and Resolution of Stressed Exposures : The framework has expanded the definition of stressed exposures (‘stressed loans’) to include both non-performing assets (NPAs) and special mention accounts (SMAs). Also, the deregulation of the price discovery process will enable faster and more efficient pricing of exposures – especially when coupled with a wider range of eligible investors.
Enhanced Viability of Stressed Asset Takeover Structures : More importantly, the Master Directions allow investors in stressed assets to classify the exposure as standard, although subject to any other exposure to the same entity on the investor’s books not being sub-standard on the date of the acquisition of the asset. This could significantly lower capital charge and provisioning requirements for the acquirer/investor of the stressed assets. Given that most stressed assets are restructured as well – often including a complete management overhaul, the rationalisation of the capital charge and provisions could make such assets more attractive to prospective acquirers.
Impetus to Long-Term Funding structures : The Indian credit markets have for long been bereft of avenues for mobilising capital through long-term debt instruments. As a result, liability structures for corporate borrowers in sectors such as power generation and roads front load cash outflows during the project life. This, at least in part, reflects the non-availability of long-dated liabilities for the financial sector. Therefore, an ecosystem which allows lenders to off-load long-dated exposures after a certain time period with reasonable foresightedness could enable borrowers to raise long-term debt instruments from the financial system in a cost-efficient manner.
Independent Credit Evaluations Could Prove Critical : The Master Directions mentions that transferees may have the loan pools rated before acquisition so as to have a third-party view of their credit quality in addition to their own due diligence; though, the latter is a mandatory requirement and cannot substitute for the due diligence that the transferee(s) are required to perform. Also, in case of transfer of stressed assets, it becomes critical to ensure that the valuation of the exposure and associated risk capital allocation are based on an assessment of the asset to meet its contractual debt obligations. Even restructured accounts have subsequently come under stress in some cases due to fundamental weaknesses in the business profile, heightened management risk/weak governance structures and unsustainable debt levels even after restructuring. Though not prescribed as a mandatory requirement under the Master Directions, yet a third-party evaluation by a credit rating agency could provide an added layer of assessment and valuations for such exposures along with subsequent capital charge and provisioning norms could be linked to the outcome of such evaluation.

The contents of this article are for general information and discussion only and is not intended for any solicitation of work. This article should not be relied upon as a legal advice or opinion.

ARC rights to use SARFAESI for debts assigned by non-SARFAESI entities

– Archana Kejriwal

Asset reconstruction companies, formed under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (‘SARFAESI Act’/‘the Act’) are an important part of the country’s ecosystem to tackle non-performing loans. ARCs buy and resolve non-performing loans by acquiring them from the financial system.

ARCs were traditionally focusing on acquiring large corporate loan exposures. However, recently, there is increasing participation of the ARCs in retail loans. When ARCs buy retail loans, it is quite likely that the lender or the loan does not qualify for SARFAESI right when the loan was with the lender. This may be either because of the nature of the lender (NBFCs having assets of less than Rs 100 crores) or the size of outstanding (less than Rs 20 lakhs). In such cases, once the ARC acquires the loans, will it have the rights under the SARFAESI Act?

The question becomes important, because in case of corporate loans, the advantage that ARCs had over the original lender was one of aggregation, that is, ARCs acquiring loans given to the same borrower by various lenders, and thus getting significant strength in relation to the borrower. This cannot be the case, obviously, with retail loans. Hence, if the acquiring ARC is no better than the outgoing NBFC, in what way does the transfer of the loans help to accelerate the recovery?

In this article, we discuss this important question.

Explicit rights extended to ARCs under the SARFAESI Act

As per the definition of “asset reconstruction company” under section 2(1)(ba) of the SARFAESI Act, an ARC is formed for the purpose of “asset reconstruction” or “reconstruction” or “both”. The secured creditor often undertakes to assign its defaulted debts to an ARC. The SARFAESI Act provides the formation of ARCs to acquire loans from secured lenders and take actions extended to it. Section 9 of the Act lists down the measure exclusive extended to the ARCs for the purposes of asset reconstruction and reads as-

“9. Measures for assets reconstruction.—(1)Without prejudice to the provisions contained in any other law for the time being in force, an asset reconstruction company may, for the purposes of asset reconstruction, provide for any one or more of the following measures, namely:—

(a) the proper management of the business of the borrower, by change in, or take over of, the management of the business of the borrower;

(b) the sale or lease of a part or whole of the business of the borrower;

(d) enforcement of security interest in accordance with the provisions of this Act;

(e) settlement of dues payable by the borrower;

(f) taking possession of secured assets in accordance with the provisions of this Act;

(g) conversion of any portion of debt into shares of a borrower company ….”

RBI’s stand on ARC rights

Controversies have arisen for quite a long period of time. The RBI, in its Report of the Committee to Review the Working of Asset Reconstruction Companies ,, [para-F.4.1 of pg. 66-67] raised the concern with respect to right of ARC to enforce security interest irrespective of availability of enforcement rights with the assignor and proposed the following:

Recommendation : ‘In the interest of efficient recovery of debt by creditors, the Act may be amended to ensure that enforcement rights under Section 13 of the Act would be available to an ARC to which a secured financial asset is assigned, irrespective of the availability of enforcement rights with the assignor under Section 13 of the Act. For this purpose, the definition of “secured creditor” under Act may be modified by amending the closing clause in Section 2(1)(zd)(vi) as follows : “in whose favour security interest is created by any borrower for due repayment of any financial assistance or transferred pursuant to assignment, transfer, transmission, etc. of any financial assistance.’ Although no such clarification has been brought to deal with this question, the issue continues to grow and entangle with the other circumstantial aspects.

Being a crucial mechanism for securitisation and asset reconstruction, the ARCs have been contending the right to take over the assets of the borrower even if assigned to it by an entity ineligible under SARFAESI Act. However over the years, this issue has been a matter of concern which is yet to receive an appropriate elucidation.

Judicial Pronouncements

In the case of Poorti Rent a Car and Logistics Pvt. Ltd. & ors. v Kotak Mahindra Bank Ltd. & ors ., the petitioner (‘borrower’) obtained financial assistance from a Non-Banking Financial Company (‘lender’). The lender assigned the debt to a bank (‘respondent’) who, on default in repayment, issued a notice to the borrower under section 13(2) of the SARFAESI Act. The borrower argued against such notice contending that the lender was not being a “financial institution” within the meaning of section 2(m) of the Act is not a “secured creditor” within the meaning of section 2(zd)thus is ineligible to take actions under the Act. As a result, the respondent bank will also not have authority to take action against the borrower under the Act. Aggrieved by the action, the borrower filed the writ petition before this court.

The Bombay High Court, held the action taken by the assignor(respondent) is legal and valid. It further upheld the decision laid in the case of M. D. Frozen Foods Exports Pvt. Ltd v. Hero Fincorp Ltd. , holding the application of SARFAESI on the point of retrospectivity and retroactivity and was firmly of the view that the SARFAESI Act being brought into force to solve the problem of recovery of large debts, would apply to all claims which are alive at the time when it was brought into force.

In Indiabulls Housing Finance Limited v Deccan Chronicle Holdings Limited and others , the original lender, being a ‘financial institution’/ ‘secured creditor’ ineligible to take actions under SARFAESI, merged with the appellant, eligible under SARFAESI, was granted the right to take actions against the borrower under the SARFAESI Act. Here the court held-

“We find that all such parameters in the present case are fulfilled with the result that initiation of action under Chapter III of the SARFAESI Act by the respondent no.1, being a “secured creditor” within the meaning of section 2(zd) thereof for the purpose of enforcing the security interest that was created earlier, is legally permissible. That the respondent no. 1 is the successor-in-interest of the respondent no.2, which was not a “financial institution” at the material time would make no difference insofar as consequence in law is concerned.”

An opposite view altogether was held in Kotak Mahindra Bank Ltd. v Trupti Sanjay Mehta and others , dealing with a similar issue wherein the petitioner (assignor) contended that regardless of the status of the assignor, if the assignee of a debt along with its underlying security is a bank or financial institution, it is open to such assignor to adopt steps under the SARFAESI Act. However, the court held that the term ‘secured creditor’ being restricted to any bank or financial institution or any consortium or group of banks or financial institutions but does not include a NBFC, thus no rights under SARFAESI gets transferred. The same was however overruled by the Bombay High Court in the Poorti Rent a Car and Logistics Pvt. Ltd .

ARCs as assignors under IBC

In a recent case of Naresh Kumar Aggarwal v Cfm Asset Reconstruction Pvt Ltd , a question relating to validity of assignment of debt was acknowledged by the NCLAT. It was further held that the action taken under section 7 of Insolvency and Bankruptcy Coded(‘IBC’) is valid and legal. It held-

“When acquisition of assets by Asset Reconstruction Company is made as per Section 5(1), deeming provision contained in Sub-section (2) of Section 5 shall come into play and the Asset Reconstruction Company shall be deemed to be Lender for all purposes.”

On a conjoint reading of IBC and SARFAESI, the common goal of both these legislation is to clean and resolve bad loan portfolios. A common set of stakeholders involved under both these laws, sets out a well established connection between them. It is often seen how the provisions of these legislations are dealt harmonically giving way to both to the extent possible. Taking the basis of the judgment in Naresh Kumar Aggarwal, it can be contended that the assignment of debt being valid under IBC may be held to be at par with SARFAESI Act.

The opposing viewpoints and methods on this vital subject opened up a bag of worms. Some judgments are indicative of conferring the right on ARCs whereas others are not.

From the cited judgments, it seems like the view has been kept limited to the provisions of section 13 of the Act without considering the provisions of section 9 of the Act. This point is pertinent to be highlighted because even if we keep aside the actions under section 13 for once, section 9(f) of the Act clearly holds the validity of taking possession of secured assets in accordance with the provisions of this Act. ” Therefore, ignoring the specific provision under section 9, while paving way for the general provisions leads to questioning the purpose of the ARCs in relation to transfer of retail loans as a whole.

From the above discussions and provisions of section 9 of the Act, there seems no point to bar the ARCs from taking possession of the secured asset even if its rights come from an ineligible assignor. Concerning the given perplexity surrounding the issue, it would be better if there is a clarification in this context.

Without considering the facts of the case, in our view, the same should not be allowed.

Sir can nbfc assign to ARC company when stay of alienation is there against nbfc by court

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Decoded: RBI committee report on working of Asset Reconstruction Companies

Let bad assets move to ARCs, to enable banks to focus on credit growth and core banking

Hari Hara Mishra | November 8, 2021

An RBI appointed committee to review the working of Asset Reconstruction Companies (ARCs) recently submitted a report containing a set of 42 recommendations. The recommendations have been made to ensure the flow of NPAs to ARCs gather speed and momentum, so that bankers can focus on core banking activities like lending, leaving stressed asset management to specialised regulated institutional framework like ARCs. A few of these are discussed below, which have potential to deepen and broad-base the distressed loan sales market substantially. The enabling suggestions can be clubbed in three categories: 1. Introduction of new players into distressed debt space 2. Factors facilitating / forcing banks to sell NPAs 3. Factors facilitating ARCs with greater capacity to acquire ARCs raise funds from investors for investment through Security Receipts (SRs), a typical promissory note type instrument issued by ARCs in lieu of cash and accepted by seller banks of the Non-Performing Assets (NPAs). The investors eligible to invest in these instruments are banks, Financial institutions, Foreign Portfolio Investors (FPIs), and some other specified entities like NBFCs, HFCs with a threshold level of asset size. Now the report recommends inclusion of several entities like High Net-worth Individuals (HNIs) (investment> ₹1 crore), corporates (Net worth>₹10 crore), all NBFCs, HFCs, Trusts, Family office, Distressed asset fund, pension funds etc. This change will greatly facilitate ARCs raise resources, while making a separate asset class, viz. Security Receipts, being made available in the market for investment and trading. Apart from banks extending credit facilities, there are many other players in the broader financial system like Mutual Funds and AIFs who have exposure to various debts. But so far only banks, FIs, NBFCs could sell their loans to ARCs. For a comprehensive solution of distressed debt, the report suggests inclusion of AMCs, AIFs, FPIs as eligible entities to sale credit facilities to ARC. So far, generally ARC sale used to be the last resort by banks after exploring all other means of resolution. In the process, the demographic composition of NPAs sold was ageing with minimal chance of a turnaround and ARCs did not have much choice other than asset sale, settlement etc, and there was not much of turnaround and reconstruction. The committee acknowledges the systemic importance NPA sale to ARC, and that too at an early date, so that lenders can focus on their core business. The committee has made recommendations as below which will have significant impact: • For all NPAs above ₹100 crore, the resolution must include evaluation of sale to ARC • For all NPAs above 2 years, with no active resolution, reason for not selling to ARC to be recorded • Allowing early sale of NPAs, even less than 60 days. It can be sold on date of default itself • Amortisation of loss on sale of NPAs over a period of 2 years • If 66% lenders agree to ARC sale, offer will be binding on all others, else they have to make 100% provision on total loan • Relaxation in provisioning norms for banks for loans sold by banks, if 51% of SRs held by non-lenders • All financial entities (not only banks) to prepare a list of NPAs to be sold at beginning of year and circulate it to all ARCs. • Fraud accounts (now estimated around ₹4 trillion ) permitted to be sold The acquisition capabilities of ARCs will go up, as its margin/ contribution to acquire is now proposed at only 2.5% against 15% now, if they are able to co-opt a SR investor and give cash exit to seller banks. For other cases, it will be only 15% of lenders’ investment or 2.5%, whichever is higher. ARCs’ scope of functioning and empowerment also are proposed to be enhanced as follows: • Permitted to float AIF as supporting platform for resolution • SARFAESI right available for debts acquired from even those which were not having the power as assignor • If ARC acquires 66% debt, 2-year moratorium on even Govt dues • ARCs can become resolution applicant under IBC, subject to capping it at the level of SRs acquired in its usual Non-IBC acquisitions • Can buy equity from banks • Can acquire loans to domestic borrowers by overseas regulated entities The Committee has made a host of other recommendations including standardisation of process and documents, online trading platform etc. One Important recommendation is fixation of reserve price, which will be done at a higher level, that has the power to write off the amount. So far, one of the bottlenecks was valuation expectation mismatch between banks and ARCs. Hopefully, with application of mind at higher management, price fixation will be more realistic. Incidentally, all assets above ₹500 crore will now have two valuers. The focus of ARCs now will be market making an investor class of HNIs, Corporates etc with risk capital and appetite to invest in distressed papers. The challenge lies in convincing the attractiveness of business proposition from a risk-reward perspective. Incidentally, very rightly, the RBI Committee recommends for disclosure of 10 years performance track record of ARCs in the offer document to be issued to the investors. Mishra is a policy analyst and columnist.

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Submission Guidelines

Applicability of SARFAESI to Assignment of Loan by an NBFC

[ Siddharth Tandon is a BB.A. LL.B student at National Law University, Jodhpur]

The primary objective of enacting the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (or the SARFAESI Act) was to empower the financial institutions by identifying and remedying the problem of non-performing assets (NPA) by providing efficient solutions such as recovery of NPA without intervention of courts. Although from the time of its enactment the Act did recognise non-banking financial companies (NBFCs) as coming under the ambit of ‘ financial institutions ’, it required the Central Government to pass a notification stating the same. The need for such a notification was felt by the Central Government almost thirteen years after the Act came into force, when it was stated by the then Finance Minister of India, Mr. Arun Jaitley, in his 2015 budget speech.

After almost eighteen months, the Central Government passed a notification recognizing and listing a total of 196 substantially important NBFCs, which were allowed to take benefit of the provisions of the SARFAESI Act. The notification also listed certain conditions to be fulfilled by the NBFCs to come under the purview of the Act. The NBFCs should be:

Covered under clause (f) of section 45-I of the Reserve Bank of India Act ( or the RBI Act), 1934, which defines ‘NBFCs’
Registered with RBI;
Having assets worth rupees five hundred crore and above as per their last audited balance sheet.

In addition to this, the notification also highlighted that only those NBFCs with “such security interest which is obtained for securing repayment of secured debt with principal amount of rupees one crore and above” will be allowed to make use of sections 13 to 19 of the SARFAESI Act, which are of utmost importance when it comes to recovery of loan arrears.

This is where the notification leads to a problem. Only NBFCs which have given secured loans having a principal amount of rupees one crore or more are allowed to make use of sections 13 to 19 of the Act for recovery of the loan, while the other financial institutions have a reduced threshold of rupees one lakh. Hence, an issue arises during the assignment of loan by an NBFC to any other financial institution, where the principal amount is less than rupees one crore. Will such financial institution, which otherwise would have been allowed to use the provisions of the Act, be allowed in this situation where it is an assignee of a loan from an NBFC not coming under the purview of the Act.

The word “assignment” can be defined as “a transfer or setting over of property, or of some right or interest therein, from one person to another; the term denoting not only the act of transfer, but also the instrument by which it is effected”. [i] As has previously been held in multiple cases , ‘assignment of loan or debt’ is permissible under the provisions of the Transfer of Property Act.

The law of assignment is based on the principle of “nemo dat quad non habet” , meaning that ‘the assignee cannot have better rights than that of the assignor’. This maxim forms the basis of the issue that if an NBFC itself does not have the right to make use of provisions of recovery of loan arrears of SARFAESI Act, how the assignee financial institution can do the same.

This question was dealt by the Bombay High Court in 2015 in Kotak Mahindra Bank Ltd v Trupti Sanjay Mehta and Others . In this case, an NBFC had sanctioned a loan to an institution which had defaulted in paying back the loan. The debt was subsequently assigned to a bank, which invoked the SARFAESI Act for recovery of the amount. The borrower filed an application with the Debt Recovery Tribunal (DRT) stating that as the original lender did not possess the right to enforce the Act, the assignee should not be allowed to do the same. Aggrieved by the judgment of the DRT which was pronounced against the bank, it filed a petition in the Bombay High Court.

The High Court delved into the definition of ‘borrower’ as defined in the SARFAESI Act to hold: “The third part [of the definition of ‘borrower’] … clearly restricts the definition to a ‘borrower’ of a Bank or Financial Institution who acquires any right or interest and specifically excludes any other type of Institution”. It went on to state that “by virtue of the restrictive definition, only debts which are assigned to a Bank from another Financial Institution (or vice versa), such debts alone are covered under the term “borrower”. If the legislature intended to expand the scope of “borrower” to mean any debt assigned to a Bank or Financial Institution by a Non-Banking Financial Institution or any other private person, it would not have excluded a Non- Banking Financial Institution or any other person in the last part of the definition.” It finally held: “The Objects and Reasons of the SARFAESI Act … clearly disclose that this mechanism has … been designed only for the benefit of Banks and Financial Institutions and not for other categories such as Non-banking Financial Institutions etc.”

The Court read the Act restrictively by not allowing ‘NBFCs’ to be interpreted into the provisions. But to place reliance on this case for answering the issue in contention would not be correct. This is because the Bombay High Court gave this judgment during the time when the Central Government had not come up with the notification identifying various NBFCs coming under the purview of the Act. Though it cannot be said that the notification overruled the judgment, it can definitely be stated that it changed the legal environment in which this issue exists. After the notification, the reasoning of the Bombay High Court holds little water.

Another case, which indirectly deals with this issue, is Indiabulls Housing Finance Limited v. Deccan Chronicles Holdings Limited . The Supreme Court in this case held: “No doubt, till the respondent (an NBFC) was not a ‘financial institution’ within the meaning of Section 2(1)(m)(iv) of the Act, it was not a ‘secured creditor’ as defined under Section 2(1)(zd) of the Act and, thus, could not invoke the provisions of the Act. However, the right to proceed under the Act accrued once the Notification was issued.” It further held: “… the definition clauses dealing with ‘debt securities’, ‘financial assistance’, ‘financial assets’, etc., clearly convey the legislative intent that the Act applies to all existing agreements irrespective of the fact whether the lender was a notified ‘financial institution’ on the date of the execution of the agreement with the borrower or not.”

This case, though relevant in the sense that it portrays the inclusive nature of the statute, does not directly give us the answer to the present issue.

An analysis of the present legal regime, including the cases of various courts as well as statutes have not been able to correctly provide us with a clear answer. The case of Trupti Sanjay Mehta , though directly dealing with the question, cannot be relied upon as the judgment came before the notification was passed. Similarly, the IBFSL judgment cannot be relied upon, as it is less about assignment of loan and more about whether an NBFC is allowed to make use of provisions of the Act even if the loan was given out before the notification was passed.

Therefore, according to the author, in order to arrive at an answer, a different and a more inclusive viewpoint needs to be taken. The right to make use of the provisions of SARFAESI Act cannot be considered as a contractual right, which can be transferred or taken away by way of contract. Thus, the fact that an assignee cannot have better rights than that of assignor is not applicable as the rule is in relation to contractual rights, and not in respect to legal rights. At this point, reliance can be placed on the case of ICICI Bank Limited v. Official Liquidator of APS Star Industries Ltd. , where it was held: “In assigning the debts with underlying security, the bank [a financial institution] is only transferring its asset and is not acquiring any rights of its client(s)…The High Court(s) has erred in not appreciating that the assignor bank is only transferring its rights under a contract and its own asset, namely, the debt … without in any manner affecting the rights of the borrower(s) in the assets.”

Thus, as long as there is no interference with the right of the borrower, the assignment of loan should be held to be rightful, along with the assignee having full discretion to make use of the Act for recovery of loan.

– Siddharth Tandon

[i] Alexander M. Burrill, A Treatise on the Law and Practice of Voluntary Assignments for the Benefit of Creditors §1, at 1 (James Avery Webb ed., 6 th ed. 1894).

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Stressed assets. RBI allows banks to sell ‘fraud loans’ to ARCs

Stressed loans, which are in default for more than 60 days or classified as non-performing assets (npa), can be transferred to arcs.

By Our Bureau

Close-up Of Businessperson Hands Checking Invoice With Magnifying Glass At Desk

The Reserve Bank of India on Friday allowed loan exposures classified as fraud to be transferred to Asset Reconstruction Companies (ARCs). This comes in the wake of banks reporting frauds aggregating ₹3.95-lakh crore between FY19 and FY21.

Stressed loans, which are in default for more than 60 days or classified as non-performing assets (NPA), can be transferred to ARCs. This shall include loan exposures classified as fraud as on the date of transfer.

Issuing the guidelines for transfer of loan exposure, including stressed loans, the central bank said the transfer of such loans to an ARC, however, does not absolve the transferor from fixing the staff accountability as required under the extant instructions on frauds.

Until now, when an account is declared fraud, banks had to set aside 100 per cent of the outstanding loan as provision. Under the new rules, banks can hope to recover a part of the loan. For ARCs, this will allow them to buy debt cheaper than regular loan accounts.

Swiss Challenge method

The RBI also said the transfer of stressed loans above ₹100 crore negotiated on a bilateral basis between lenders and permitted acquirers, including ARCs, must necessarily be followed by an auction through the Swiss Challenge method. Under the Swiss Challenge auction, the price bilaterally negotiated for the sale of a stressed asset becomes the floor price for inviting counter-proposals from other interested buyers.

Loan transfers are usually resorted to by lending institutions for multiple reasons ranging from liquidity management, rebalancing of exposure or strategic sales. “A robust secondary market in loans can be an important mechanism for management of credit exposures by lending institutions and also create additional avenues for raising liquidity,” the RBI said in a circular to lenders.

New guidelines

Under the new guidelines, loans can be transferred only after a minimum holding period (MHP) of three months in case of loans with tenor up to 2 years, and six months fior those with tenor of more than 2 years. In case of loans where the security does not exist or cannot be registered, the MHP shall be calculated from the date of first repayment of the loan.

The stamp duty payable during assignation of debt by Asset Reconstruction Companies – By Adv. Haaris Moosa

In Phoenix Arc Private Limited, Mumbai Vs. M/S. Cherupushpam Films Pvt Limited, Ernakulam (2023) ibclaw.in 48 NCLT (hereafter Phoenix ARC) the question raised before the NCLT, Kochi Bench was whether stamp duty has to be paid on a deed assigning debt to an Asset Reconstruction Company (ARC). The NCLT Kochi Bench has held that the ARC is bound to pay the appropriate stamp duty as per the relevant state legislation, in this case the Kerala Stamp Act, 1959 (KSA, 1959

The stamp duty payable during assignation of debt by Asset Reconstruction Companies

Adv. Haaris Moosa

Stamping has been used by litigators as a deus ex machina for long. Insufficient stamping determines the fate of a case quite independent of its facts or merits. The interplay of the stamping legislations with the Insolvency and Bankruptcy Code, 2016 (IB Code, 2016), has not been adequately analysed by either courts or tribunals. Stamping in India is regulated by both Union and State legislations since it is covered by Entry 91 of the Union List and Entry 63 of the State List. The Union legislation is the Indian Stamp Act, 1899 (ISA, 1899) 1 and almost all the States have their own stamping statutes. The stamping legislations of old vintage have stood their ground even with the coming of avant garde legislations meant to streamline commercial transactions like the Arbitration and Conciliation Act, 1996, SARFAESI Act, 2002, Companies Act, 2013 and now the IB Code,2016.

In Phoenix ARC Private Limited, Mumbai Vs. M/S. Cherupushpam Films Pvt Limited, Ernakulam (2023) ibclaw.in 48 NCLT (hereafter Phoenix ARC ) the question raised before the NCLT, Kochi Bench was whether stamp duty has to be paid on a deed assigning debt to an Asset Reconstruction Company (ARC). The NCLT Kochi Bench has held that the ARC is bound to pay the appropriate stamp duty as per the relevant state legislation, in this case the Kerala Stamp Act, 1959 (KSA, 1959) 2 . The Hon’ble NCLT held that the applicability of KSA 1959 2 is not ruled out by the prescription under Section 8F of the Indian Stamp Act, 1899 (ISA, 1899) which exempts ARCs from paying any stamp duty on “ any agreement or other document for transfer or assignment of rights or interest in financial assets of banks or financial institution s” covered under section 5 of the SARFAESI Act, 2002.

KSA, 1959 in section 25, declares the assignment of a debt to be a conveyance, and the duty payable has been pegged at 8%. In the instant case, the Tribunal found that the assignment deed was to be stamped at 8% as per Section 25 of KSA, 1959 since the agreement was made in Kerala. Interestingly in the instant case, the stamp duty as per KSA, 1959 comes to Rs. 6,33,99,500/- while the assignment deed was found to be made on a non-judicial stamp paper of Rs. 500/-. Consequently, the Tribunal found the assignment deed to be unenforceable for insufficient stamping. Phoenix ARC breaks new ground in holding that the assignment of a debt to an Asset Reconstruction Company is liable to be stamped as per the concerned state stamping legislation.

In Essar Steel India Ltd. Committee of Creditors v. Satish Kumar Gupta [2019] ibclaw.in 07 SC (hereafter Essar Steel ) the supreme court confirmed the decision of the NCLAT, [2019] ibclaw.in 109 NCLAT in affirming the decision of the NCLT in rejecting an application that suffered from insufficient stamping. And held that “Further, the submission of the Appellants that they have now paid the requisite stamp duty, after the impugned NCLAT judgment, would not assist the case of the Appellants at this belated stage. These appeals are therefore dismissed.” 3 Quite to the contrary, in Praful Nanji Satra v. Vistra ITCL (India) Ltd. (2022) ibclaw.in 550 NCLAT , the NCLAT went on to reject an argument for dismissal of an application for insufficient stamping, holding that the only issue that the NCLT in IBC proceedings can look at is whether there has been a default, and nothing further. It was also held that insufficient stamping is a curable defect. The effect of insufficient stamping has attracted contradictory judgments from the NCLAT and the Supreme Court. However, Phoenix ARC follows the correct law laid down by the Supreme Court in Essar Steel .

It is to be noted that proceedings under Code are non-adversarial. Any applicant seeking to initiate corporate insolvency proceedings is required to produce documents that satisfy the Adjudicating Authority (the NCLT) proving the default committed by the corporate debtor. Such an applicant is also required to ensure that the financial contracts on which they rely are legally sound and are not truncated. While structuring true sale transactions for assignment of debt (standard assets or NPA), compliance under the applicable stamping legislations must be ensured to avoid legal complications.

Disclaimer: The Opinions expressed in this article are that of the author(s). The facts and opinions expressed here do not reflect the views of IBC Laws ( http://www.ibclaw.in ). The entire contents of this document have been prepared on the basis of the information existing at the time of the preparation. The author(s) and IBC Laws ( http://www.ibclaw.in ) do not take responsibility of the same. Postings on this blog are for informational purposes only. Nothing herein shall be deemed or construed to constitute legal or investment advice. Discussions on, or arising out of this, blog between contributors and other persons shall not create any attorney-client relationship.

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< https://legislative.gov.in/sites/default/files/A1899-2.pdf > [ ↩ ]
< https://keralaregistration.gov.in/fileUploads/The%20Kerala%20Stamp%20Act.pdf > [ ↩ ][ ↩ ]
[2019] ibclaw.in 07 SC , para 99 [ ↩ ]

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RBI Guideline

Association of ARCs in India is a Representative Body of Asset Reconstruction Companies registered with Reserve Bank of India.

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RBI Circular | Acquisition of financial assets by an ARC from another ARC

03rd Jul, 2019

On June 28, 2019, the Reserve Bank of India (“ RBI ”) issued a circular on ‘Permission to acquire financial asset from other Asset Reconstruction Companies (ARCs)’ (“ Circular ”).

Vide the Circular, the RBI has set out the following conditions for an asset reconstruction company (“ ARC ”) to acquire financial asset(s) from another ARC:

1. The transaction is settled on cash basis.

2. Price discovery for such transaction is not prejudicial to the interest of security receipt holders.

3. The selling ARC will utilize the proceeds so received for the redemption of underlying security receipts.

4. The date of redemption of underlying security receipts and total period of realisation shall not extend beyond 8 (eight) years from the date of acquisition of the financial asset by the first ARC.

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RBI'S Framework For Transfer Of Loan Assets

Contributor.

As an anticipated measure for the banking and financial sector, the Reserve Bank of India (RBI) has, towards the close of past week, issued the comprehensive framework for the sale or transfer of loan assets. Taking immediate effect from the date of its issuance, the framework titled ' Master Directions - Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 ' issued vide circular DOR.STR.REC.52/21.04.048/2021-22 dated September 24, 2021 (the ' Master Directions ') is being seen as a pivotal move by the Regulator towards introducing an efficient secondary market for loans and ensuring proper credit-risk pricing, besides improving transparency in the identification of embryonic stress in the banking system as well as resolution of stressed loan exposures.

The Master Directions owes its genesis to the ' Draft Framework for Sale of Loan Exposures ' which was released by RBI in course of the first COVID-19 induced lockdown in the Country. The draft had taken into consideration the recommendations of the ' Task Force on Development of Secondary Market for Corporate Loans ' constituted by RBI under the chairmanship of Mr. T.N. Manoharan in May, 2019 and comments from the stakeholders were invited. One of the key components of the Task Force's recommendation was to separate the regulatory guidelines for direct assignment transactions from the securitisation guidelines and treat it as a sale of loan exposure. The RBI had, accordingly, reviewed the recommendations and thought it prudent to comprehensively revisit the guidelines for sale of loan exposures, both standard as well as stressed, which were earlier spread across various circulars. The erstwhile guidelines or circulars on sale of loan exposures were particular to the asset classification of the loan exposure being transferred and / or the nature of the entity to which such loan exposure is transferred as well as the mode of transfer of the loan exposures. The need for a review also stemmed from the necessity to dovetail the guidelines on sale of loan exposures with the Insolvency and Bankruptcy Code, 2016 (' IBC ') and the Prudential Framework for Resolution of Stressed Assets dated June 7, 2019 (" Prudential Framework "), which has witnessed substantial traction and developments towards building a robust resolution paradigm in India in the recent past.

The consolidation by RBI of a self-contained, comprehensive, and independent set of regulatory guidelines on transfer/sale of loan exposures is being seen as a laudable step in the direction of putting together a ' robust secondary market in loans which can be an important mechanism for management of credit exposures by lending institutions and also create additional avenues for raising liquidity '. This write-up attempts to briefly summarize some key components of the Master Directions.

The Master Directions whilst superseding a host of existing circulars/directions (or a portion thereof) in relation of transfer of loan exposures (Chapter VI), has put forth a unified and singular framework for the sale of loan exposures by banks and other financial institutions. The exhaustive breadth of the framework is quite evident from the Chapters under the Master Directions which not only provide for ' General Conditions applicable to all Loan transfers ' (Chapter II), but also cater specifically to transfer of loan exposures of standard assets (Chapter III) as well as stressed loan exposures (Chapter IV), including their respective and intrinsic modalities. The framework concludes with the imperative of ' Disclosures and Reporting ' (Chapter V) and stipulates the mechanism for the stakeholders in that regard.

Applicability

On expected lines, nearly all constituents of the Financial sector regulated by RBI are mandated to ensure compliance to the Master Directions, both as a transferor as well as transferee of the loan exposures – Scheduled Commercial Banks, all NBFCs (including HFCs), Regional Rural Banks, Co-operative Banks, All India Financial Institutions and Small Finance Banks. In addition, the Master Directions also permits asset reconstruction companies (ARCs) 1 and companies 2 (save a financial service provider 3 ) to be 'transferees' of the loan exposures only if the same is pursuant to the resolution plan under the Prudential Framework and if they are permitted to take on loan exposures in terms of a statutory provision or under the regulations issued by a financial sector regulator.

It would be pertinent to take note that though all lenders permitted to acquire loans are required to ensure compliance to the extant Master Directions; yet, the acquisition of loans pursuant to securitisation are required to be independently dealt under the provisions of RBI's ' Master Directions – RBI (Securitisation of Standard Assets) Directions, 2021 ' dated September 24, 2021 (the 'Securitisation Guidelines'). The coverage of the Master Directions includes transfer of loan exposures through novation, assignment, or risk participation. In cases of loan transfers other than loan participation, legal ownership of the loan shall be mandatorily transferred to the Transferee to the extent of economic interest transferred under the loan exposures.

Basic Ingredients

Before venturing into the other nuances, it is an imperative that one accounts for the understanding of some key 'constructs' which cut across the Master Directions:

Transfer : Quite apparently, the expression denotes the process of transfer of the economic interest in a loan exposure by the transferor and acquisition of the same by the transferee. The subject matter of transfer being the ' economic interest ' of the transferor in the loan exposure, it is important that the risks and rewards associated with loans are clearly demarcated and separated in favour of the transferee; especially when some portion of the economic interest in the loan exposure is retained by the transferor.

It is significant to take note that the transfer of the said economic interest can be with or without the transfer of underlying contract. Essentially, even loan participation transaction have also been recognised under the Master Directions (for transfer of standard loans) wherein the transferor transfers all or part of its economic interest in a loan exposure to transferee without the actual transfer of the loan contract, and the transferee(s) fund the transferor to the extent of the economic interest transferred which may be equal to the principal, interest, fees and other payments, if any, under the transfer agreement.

Transferor : Often referred as 'assignor' (in assignment transactions) or 'grantor' (for risk participation), transferor under the Master Directions would include Clause 3 entities which transfer their economic interest in the loan exposures.
Transferees : These refer to entities in whose favour the economic interest in the loans are transferred and would include Clause 3 entities as well as the ARCs/companies to the extent permitted under the Master Directions. It is clarified that the transferee should neither be a person disqualified under the IBC 4 nor, in cases of loan exposures where frauds have been identified, belong to an existing promoter group 5 of the borrower or its subsidiary / associate / related party 6 (domestic as well as overseas).
Minimum Holding Period (MHP) : As the expression suggests, the MHP refers to a threshold period for which the transferor should hold the loan exposures, along with its risks and rewards, before the economic interest in respect thereto is transferred. The intent of having a MHP is to ensure that the loan has been seasoned in the books of the originator (or the transferor) for a certain specified time period. The MHP for loans with tenor upto 2 years and more than 2 years, as per the Master Directions, have been capped at 3 months and 6 months, respectively.

The holding period for the Transferor, in case of secured exposures, is to be computed from the date of registration of the underlying security interests; unless, of course, the loan is unsecured in which case the MHP runs from the date of first repayment under such unsecured exposure. However, in case of project loans, the foregoing months of MHP is required to be calculated from the date of commencement of commercial operations of the project being financed. Besides, the loans acquired by the Transferor itself are required to have a MHP of atleast 6 months from the date of acquisition of the loan on the books of the Transferor, irrespective of the tenor of the loan exposures.

It would be of significance to note that the MHP criteria prescribed under the Master Directions do not apply for loans transferred by an arranging bank under a syndication arrangement.

Permitted Transferees : These include (i) Scheduled Commercial Banks, (ii) NBFCs (including HFCs), (iii) All India Financial Institutions and (iv) Small Finance Banks. The significance of carving out the foregoing financial sector entities from Clause 3 of the Master Directions lies in the fact that the transferor is permitted to transfer its loans (which are not in default) to permitted transferees only through novation, assignment, or loan participation. For the stressed exposures, the transfer is mandated only to such permitted transferees and ARCs and singularly through assignment or novation of such loan exposures.

Underlying Elements

Overarching Transfer conditions : Quite categorically, the Master Directions stresses on the necessity of delineation of Transferor's 'risks and rewards' associated with the loan exposures to the extent of the transfer. In fact, it is stated that not only should the transferee have the unrestrained and unconditional entitlement to transfer or dispose of the loans to the extent of economic interest acquired by it, but also in the event of any economic interest in the loan exposure is retained by the transferor, the loan transfer agreement should demarcate the distribution of the principal and interest income from the transferred loan between the transferor and the transferee. The Master Directions also caution against any modification of terms of the underlying financing agreement and require that any change, in course of such transfer, should withstand the test of not being categorised as 'Restructuring' under the Prudential Framework. It would be significant to take note that the transfer of loan exposures under the Master Directions not only should be without recourse to the Transferor, but also the transferor or transferee should not be constrained to obtain consent from the transferee/ transferor, as the case may be, in the event of resolution or recovery in respect of the beneficial economic interest retained by or transferred to the respective entity. In addition to the foregoing, the Master Directions also prescribe for the enumerated conditions applicable to all transfers of loan exposures:
The Transferor shall have no obligation to re-acquire or fund the re-payment of the loans or any part of it or substitute loans held by the Transferee or provide additional loans at any time;
If the security interest is held by the Transferor in trust with the Transferee as the beneficiaries, the Transferee shall ensure that a mutually agreed and binding mechanism for timely invocation of such security interest is put in place;
Any rescheduling, restructuring or re-negotiation of the terms of the underlying agreement attempted by Permitted Transferee, after the transfer of assets to the transferee, shall be as per the Prudential Framework;
The Clause 3 entities, regardless of whether they are transferors or otherwise, should not offer credit enhancements or liquidity facilities in any form in the case of loan transfers.

In case the transfer of loan exposures which are not compliant with the requirements mentioned in the Master Directions, the onus is on the Transferee to maintain capital charge equal to the actual exposure acquired and the Transferor is required to treat the transferred loan in its entirety, as if it was not transferred at all in the first place, and the consideration received by it shall be recognised as an advance.

Board-approved Policy : The Transferors are mandated to put in place a comprehensive Board-approved policy for transfer and acquisition of loan exposures under the Master Directions. These guidelines must, inter alia , lay down the minimum quantitative and qualitative standards relating to due diligence, valuation, requisite IT systems for capture, storage and management of data, risk management, periodic Board level oversight, etc. Further, the policy must also ensure the independence of functioning and reporting responsibilities of the units and personnel involved in the transfer/acquisition of loans from that of personnel involved in originating the loans.
Transfer of Standard Assets : The transfer of loan exposures classified as 'standard' can be undertaken through the mechanisms of assignment or novation or a loan participation. The transfer of such loan exposures should be only on a cash basis to be received at the time of transfer of loans; besides, the requirement of the transfer consideration being arrived at in a transparent manner on an arm's length basis. The Master Directions require the Transferees to monitor, on an ongoing basis and in a timely manner, the performance information on the loans acquired, including through conducting periodic stress tests and sensitivity analyses, and take appropriate action required, if any. Further, the Transferor's retention of economic interest, if any, in the loans transferred should be supported by legally valid documentation supported by a legal opinion.

The requirements of Chapter III of the Master Directions are, however, not applicable to certain identified loan transfers, as below:

transfer of loan accounts of borrowers by a lender to other lenders, at the request/instance of borrower;
inter-bank participations as per the RBI's circulars;
sale of entire portfolio of loans consequent upon a decision to exit the line of business completely;
sale of stressed loans; and
any other arrangement/transactions, specifically exempted by the RBI.
Minimum Risk Retention : The Master Directions are explicit in their requirement of the requisite due diligence in respect of the loans exposures and mention that the said exercise cannot be outsourced or delegated by the Transferee. In order to ensure a systemic departure from the conventional practice of placing solitary reliance on the due diligence of the originator (or the Transferor), the Master Directions mandate the Transferee to undertake the due diligence of the loan exposures through its own staff, at the level of each loan, and as per the same policies as would have been done had the Transferee been the originator of the loan. In case the due diligence of entire portfolio is undertaken by the Transferee, the requirement of a minimum retention requirement (MRR) of the Transferor can be dispensed with.

Transfer of Stressed Assets : Chapter IV of the Master Directions deals specifically with the transfer of stressed loan exposures to ARCs and other Permitted Transferees. It is specifically stated that the mechanism for transfer of such stressed accounts can be consummated only through assignment or novation. Besides the requirement of a Board-approved policy for transfer as well as acquisition of stressed loan exposures and the parameters thereof, the Master Directions mandate such transfers to ARCs and other Permitted Transferees only. Importantly, the Transferor is necessarily required to undertake an auction through a ' Swiss Challenge method ' both in cases where (i) the aggregate loan exposure to be transferred is Rs. 100 crore or more after bilateral negotiations; and even under (ii) a transfer pursuant to the Resolution Plan approved in terms of the Prudential Framework (irrespective of the monetary threshold).

The transfer of such stressed loan exposures, as per the Master Directions, should be bereft of any operational, legal or any other type of risks relating to the transferred loans including additional funding or commitments to the borrower / transferee. In fact, it is specifically required for the transferor to ensure that no transfer of a stressed loan is made at a contingent price whereby in the event of shortfall in the realization of the agreed price, the Transferor would have to bear a part of the shortfall.

In addition, the Transferor is required transfer the stressed loans to transferee(s) other than ARCs only on cash basis and the entire transfer consideration should be received not later than at the time of transfer of loans. The stressed exposure can be taken out of the books of the Transferor only on receipt of the entire transfer consideration.

Quite significantly, the Master Directions prescribed that if the Transferee of such stressed loan exposure (except ARCs) have no existing exposure to the borrower whose stressed loan account is acquired, the acquired stressed loan shall be classified as "Standard" by the transferee. However, in case the Transferee has an existing exposure to such borrower, the asset classification of the acquired exposure shall be the same as the existing asset classification of the borrower with the Transferee, irrespective of whether such acquisition is pursuant to the transferee being a successful resolution applicant under the IBC.

Further, the Master Directions require the Transferee to hold the acquired stressed loans in their books for a period of at least 6 months before transferring to other lenders; however, such holding period is not applicable in case the transfer of stressed loan exposure is to an ARC or is pursuant to a resolution plan approved in terms of the Prudential Framework.

As regards the mandate of undertaking the 'Swiss Challenge method' is concerned, the Master Directions require the lenders put in place a Board-approved policy which should, interalia , specify the minimum mark-up over the base-bid required for the challenger bid to be considered by the lender(s), which in any case, shall not be less than 5% and shall not be more than 15%. However, for transfer of stressed exposure under the Prudential Framework, the minimum mark-up over the base-bid required for the challenger bid is to be decided with the approval of signatories to the ICA representing 75% by value of total outstanding credit facilities and 60% of signatories by number.

Additionally, the Master Directions provide for sharing of surplus between the ARC and the Transferor, in case of specific stressed loans; though, the clarity in respect of such specific stressed loans is not mentioned. The repurchase of stressed loan exposures is also stipulated from the ARCs in cases where the resolution plan has been successfully implemented

Accounting : In the event the transfer of loan exposures results in loss or profit, which is realised, the same should be accounted for and, accordingly, reflected in the P&L account of the Transferor for the accounting period during which the Transfer is consummated. However, the unrealised profits (if any) arising out of such Transfers, shall be deducted from the Common Equity Tier 1 (CET 1) capital or net owned funds of the Transferor for meeting regulatory capital adequacy requirements till the maturity of such transferred exposures. The Master Directions prescribe maintenance of borrower-specific accounts both by the Transferor as well as the Transferee of the retained and transferred loan exposures, respectively. It has been further clarified that the extant requirements of RBI for 'income recognition, asset classification, and provisioning' shall, accordingly, be ensured by the transferor and the transferee with respect to their respective shares of holding in the underlying loan exposures.

Identification and Resolution of Stressed Exposures : Though quite a premature assessment, yet it is felt that the framework under Master Directions could facilitate the development of a robust distressed asset ecosystem and speed-up the resolution of various stressed exposures, which could be driven by the ensuing characteristics of the Master Directions:
Early Identification and Resolution of Stressed Exposures : The framework has expanded the definition of stressed exposures ('stressed loans') to include both non-performing assets (NPAs) and special mention accounts (SMAs). Also, the deregulation of the price discovery process will enable faster and more efficient pricing of exposures – especially when coupled with a wider range of eligible investors.
Enhanced Viability of Stressed Asset Takeover Structures :More importantly, the Master Directions allow investors in stressed assets to classify the exposure as standard, although subject to any other exposure to the same entity on the investor's books not being sub-standard on the date of the acquisition of the asset. This could significantly lower capital charge and provisioning requirements for the acquirer/investor of the stressed assets. Given that most stressed assets are restructured as well – often including a complete management overhaul, the rationalisation of the capital charge and provisions could make such assets more attractive to prospective acquirers.
Impetus to Long-Term Funding structures : The Indian credit markets have for long been bereft of avenues for mobilising capital through long-term debt instruments. As a result, liability structures for corporate borrowers in sectors such as power generation and roads front load cash outflows during the project life. This, at least in part, reflects the non-availability of long-dated liabilities for the financial sector. Therefore, an ecosystem which allows lenders to off-load long-dated exposures after a certain time period with reasonable foresightedness could enable borrowers to raise long-term debt instruments from the financial system in a cost-efficient manner.
Independent Credit Evaluations Could Prove Critical : The Master Directions mentions that transferees may have the loan pools rated before acquisition so as to have a third-party view of their credit quality in addition to their own due diligence; though, the latter is a mandatory requirement and cannot substitute for the due diligence that the transferee(s) are required to perform. Also, in case of transfer of stressed assets, it becomes critical to ensure that the valuation of the exposure and associated risk capital allocation are based on an assessment of the asset to meet its contractual debt obligations. Even restructured accounts have subsequently come under stress in some cases due to fundamental weaknesses in the business profile, heightened management risk/weak governance structures and unsustainable debt levels even after restructuring. Though not prescribed as a mandatory requirement under the Master Directions, yet a third-party evaluation by a credit rating agency could provide an added layer of assessment and valuations for such exposures along with subsequent capital charge and provisioning norms could be linked to the outcome of such evaluation.

1. Registered with the Reserve Bank of India under Section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002

2. Sub-section (20) of Section 2 of the Companies Act, 2013

3. Sub-section (17) of Section 3 of the Insolvency and Bankruptcy Code, 2016

4. Section 29A of the Insolvency and Bankruptcy Code, 2016

5. As defined under SEBI (ICDR) Regulations, 2018

6. As defined under the Insolvency and Bankruptcy Code, 2016

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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