Debtor’s Unwillingness to Pay Debts without Proof of his Inability to Pay

Can Proceedings Commence in such a situation?

Yes. Proceedings under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act“) can definitely commence even without proof of the debtor’s inability to pay. Section 13 of the SARFAESI Act does not mandate that the debtor’s must be unable to pay its debts. All this section requires is default in repayment of secured debt or any installment thereof (resulting in declaration of the debtor’s account as NPA, i.e. Non- performing Asset) and failure of the debtor in discharging its full liabilities within sixty days of the notice from the creditor for whatsoever the reason. Inability to pay the debt can be just one of the reasons and hence need not be proved as a pre-condition or requirement of a proceeding under the SARFAESI Act. Debtor’s inability to pay the debt is a mandatory requirement under the Companies Act for the purpose of winding-up proceedings. Winding up proceeding is initiated with the intention of declaring a particular company as commercially insolvent and to see that such insolvent company is wound up in the interest of the general public whereas the very intention of commencing a proceeding under SARFAESI Act is recovery of the debt. A debtor, being unwilling to pay the debt for any reason or even without reason, if defaults in discharging its full liabilities within sixty days of the notice from the secured creditor, it gives a valid ground for the secured creditor to move under the Section 13 of the SARFAESI Act to recover their money.

The term ‘”default” is defined in clause (j) as:

“default” means non-payment of any principal debt or interest thereon or any other amount payable by a borrower to any secured creditor consequent upon which the account of such borrower is classified as non-performing asset in the books of account of the secured creditor in accordance with the directions or guidelines issued by the Reserve Bank”

It can be observed from this definition that it does not talk about the ‘reason’ for the non-payment. The reasons can be anything including the ‘inability to pay the debt’ in which case the secured creditor will be having a further option of proceeding under Section 433(e) of the Companies Act too, for the winding-up of the company, apart from the usual remedy of recovering money under the SARFAESI Act. Several essential factors as public interest, justice and convenience enter into the consideration before declaring a debtor company insolvent. However, no such consideration is required for a proceeding under the SARFAESI Act. All it (SARFAESI Act) seeks to achieve is repayment of the debt without getting into the more complex issue of the debtor’s inability to pay the debt and consequent winding-up. The Act itself was enacted to curb the menace of growing non-performing assets (NPAs).

The question of commencing a proceeding under the SARFAESI Act was vehemently debated in Mardia Chemicals Ltd. Etc. v. Union of India (UOI) and Ors.[1] In this case it was argued that it is on whims and fancies of the financial institutions to classify the assets as non-performing assets and commence a proceeding under the SARFAESI Act. This submission can be remodeled to argue in the present case that if proof of ‘inability to pay the debt’ is not made a pre-condition for commencing a proceeding under the SARFAESI Act, it would be on whims and fancies of the secured creditor to declare any asset as NPA and invoke section 13 of the SARFAESI Act. The Supreme Court in Mardia Chemicals categorically denied this kind of argument by saying that “policy has been laid down by the Reserve Bank of India providing guidelines in the matter for declaring an asset to be a non-performing asset known as “RBI’s prudential norms on income recognition, asset classification and provisioning – pertaining to advances.” Therefore, in line with the Supreme Court’s stand here, excluding proof of ‘inability to pay the debt’ as a pre-requisite for commencing a proceeding under the SARFAESI Act, cannot be said to be arbitrary and giving the secured creditor leeway to abuse remedy under the SARFAESI Act. If a situation meets the criteria under the RBI guideline, nothing can stop a secured creditor to commence a proceeding under the SARFAESI Act regardless of the fact whether debtor is actually unable to pay its debt or not. Debtor’s inability to pay the debt is a separate question which is significant only for the purpose of winding-up.

Would a cessation of payment by the debtor need to be proved?

No, even the cessation of payment need not be proved to commence a proceeding. The moment a debtor fails to discharge its full liabilities within sixty days of the notice from the creditor, the secured creditor can start a proceeding under the SARFAESI Act without intervention of the Court. Proceedings under this Act bars the jurisdiction of Civil Court and the gives the creditor power to commence a proceeding for the recovery of the debt without having a need to prove the cessation of the payment. In fact, this was one of the main contentions of Kapil Sibal for Mardia Chemicals[2] against the Creditors. With regard to the entire SARFAESI Act, he had submitted that-

there was no occasion to enact such a draconian legislation to find a short-cut to realize the dues without their ascertainment but which the secured creditor considered to be the dues and declare the same as non-performing assets (NPAs).”   

 Such submission shows that there is hardly any criterion, including the criterion of proving cessation of payment, to prove before commencement of a proceeding under the SARFAESI Act by the secured creditor. The only restriction to commence a proceeding under the SARFAESI Act is the RBI guidelines in the matter for declaring an asset to be a non-performing asset as mentioned before with reference to Mardia Chemical Case[3].

Author: Vivek Kumar Verma

[1] AIR2004SC2371

[2] Mardia Chemicals Ltd. Etc. v. Union of India (UOI) and Ors. AIR2004SC2371

[3]Ibid. 

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