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What is the primary objective of ARC formation in India?
In India, the level of non-performing assets with banks and financial institutions was considerably high on account of a number of factors including a lethargic legal system and lack of focus on NPA management by banks and financial institutions . A need was, therefore, perceived for setting up specialised agencies, in the form of ARCs to unlock the value of such assets in a timely and effective manner and allow the banks to focus on their core banking activities.
How are financial assets transferred from Banks/ Financial Institutions to an ARC?
Any SC or RC may acquire financial assets of any bank or financial institution –
By issuing debentures/ bonds or any other security in the nature of debenture
By entering into an agreement with such bank of financial institution for the transfer of such financial assets on such terms and conditions as may be agreed upon between them

The purchase consideration for effecting such a transfer includes:
Cash – in such cases the selling bank/ FI ceases to hold any interest in the financial asset post sale to ARC.
S2.    Security Receipts (refer detailed note in FAQ no.5), or other bonds/ debentures issued by SC/RC. In such cases, the pricing is linked to Recoveries and the selling bank/FI continues to hold interest in the financial asset. Such securities will be classified as investments in the books of banks/ financial institutions.
Banks/financial institutions may enter into an agreement with SC/RC to share, in an agreed proportion, any surplus realised by SC/RC o on resolution of the concerned asset.
What is the process followed by an ARC to acquire the assets from a bank/FI?
ARCs can acquire assets either through participation in auctions of NPAs conducted by the banks/financial institutions or through bilateral negotiations.

In case of auctions, the following process is commonly adopted
  • Submission of expression of interest for acquisition of NPAs
  • Due Diligence of the financial asset to be acquired ,
  • Submission of bids
  • Negotiation with the selling bank/FI and finalisation of purchase consideration
  • Declaration of Trust – A trust is constituted for acquiring the financial asset wherein the ARC acts as a sole trustee. The Trust raises funds from qualified investors through issue of Security Receipts for financing the acquisition. SRs are issued pursuant to an Offer Document specifying the details of the acquisition. The SC/RC is required to invest an amount of at least 5% of the purchase consideration. The Trustee is the legal owner of the financial asset acquired under the trust while subscribers to the SRs become the beneficial owners of the financial asset. ARC acts as a trustee and the manager of the trust and uses its powers available under the SARFAESI Act to recover the dues from the Borrower.
  • Payment of Purchase consideration and simultaneous Execution of Assignment Agreement between selling bank/FI (Assignor) & ARC (Assignee).
  • Collection of all the relevant files & documents of the borrowers whose assets are acquired by ARC from selling bank/FI for resolution.
  • Substitute ARC in all recovery proceedings
What is an Asset Reconstruction Company?

An ARC means a Securitisation company(SC) or Reconstruction company(RC) registered under the Companies Act, 1956 and which has obtained certificate of registration from Reserve Bank of India to commence or carry on the business of securitisation or assets reconstruction under section 3 of the SARFAESI Act, 2002 (Act). A SC or RC can undertake only securitisation and reconstruction activities and the following functions provided under section 10 of the Act;

  1. act as an agent for any bank or financial institution for the purpose of recovering their dues from the borrower on payment of such fees or charges
  2. act as a manager between the parties, without raising a financial liability for itself;
       c.     act as receiver if appointed by any court or tribunal.
What is Securitisation?
The term securitisation is defined under section 2(z) of the SARFAESI Act 2002 as "means of acquisition of financial assets by any securitisation company from any originator, whether by raising funds by such securitisation company or reconstruction company from qualified institutional buyers by issue of security receipts representing undivided interest in such financial assets or otherwise."

What is Security Receipt?
Under the SARFAESI Act the term “ security receipt” is defined to 'mean a receipt or other security, issued by a securitisation company or reconstruction company to any qualified institutional buyer pursuant to a scheme, evidencing the purchase or acquisition by the holder thereof, of an undivided right, title or interest in the financial asset involved in the securitisation.'

SARFAESI Act provides for issue of Security Receipts (SRs) to Qualified Institutional Buyers (QIBs) for raising funds for acquisition of any financial asset. The RBI has issued detailed guidelines regarding Security Receipts.
Special features of SRs
The SRs issued by SCs/RCs are predominantly backed by impaired assets.

These SRs have the following unique features
  • SRs cannot be strictly characterized as debt instruments since they combine the features of both equity and debt. However, these are recognized as securities under Securities Contracts (Regulation) Act, 1956.
  • The cash flows from the underlying assets cannot be predicted in terms of value and intervals.
  • The investment in SRs is restricted to QIBs only.
  • These instruments are generally privately placed and can be listed. SRs are freely transferable to any QIB.
  • RBI prescribes rating of SR by a recognised credit rating agency within a year from the date of its issue or after finalisation of Resolution policy whichever is earlier
  • Net Asset Value (NAV) of the SRs issued will be declared twice a year
In the event of non-realisation of the financial assets, the SR holders representing 75% of the total value of SRs issued by the SC/RC can call for a meeting of all the SR holders in a particular scheme and every resolution passed in such meeting shall be binding on the SC or RC.
What is the tenor of a SR issued by SC/RC?
The tenor of a SR has been specified to be a maximum of 5 years from the date of acquisition of asset in accordance with the Securitisation Companies and Reconstruction Companies (Reserve Bank) Guidelines and Directions, 2003. However, RBI, vide circular dated 24th April 2009 accorded permission to give an extension of 2 more years for resolution of assets in respect of SRs issued by SCs/RCs which have already completed 5 years.
What is a QIB?
QIB stands for Qualified Institutional Buyer which includes the following:
  • Financial Institution
  • Insurance Company
  • Bank
  • State Financial Corporation
  • State Industrial Development Corporation
  • Trustee or any asset management company making investment on behalf of mutual fund or provident fund or gratuity fund or pension fund
  • Foreign Institutional Investor registered under the Securities and Exchange Board of India Act, 1992 (15 of 1992) or regulations made thereunder, or
  • Any other body corporate as may be specified by SEBI
Will Non-banking Financial Companies (NBFCs) qualify as a QIB?
In accordance with the powers extended to Securities & Exchange Board of India, the SEBI specified that NBFC registered under Sec 45-IA of the Reserve Bank of India Act, 1934 and satisfying the following conditions shall be qualified as QIBs for the purposes of SARFAESI Act:
  • systemically important non-deposit taking NBFCs with asset size of one hundred crore rupees and above; and
  • other non-deposit taking NBFCs which have asset size of fifty crore rupees and above and “Capital to Risk – weighted Assets Ratio” (CRAR) of 10% as applicable to non-deposit taking NBFCs as per the last audited balance sheet.
Is there any restriction on the investment by FIIs in SRs?
As per Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 the total holding by a single FII in each tranche of scheme of SRs should not exceed 10% of the issue and the total holdings of all FIIs put together should not exceed 49% of the paid up value of each tranche of scheme of SRs issued by the ARC.
Can ARC buy standard assets?
Financial assets which can be bought by SC/RC from any bank or FI where the asset is
  • A NPA, including non performing Bond or Debenture
  • A Standard Asset where :

    • The asset is under consortium/ multiple banking arrangement
    • At least 75% by value of the asset is classified as non-performing asset in the books of other banks/ financial institutions, and
    • At least 75% (by value) of the banks / financial institutions who are under the consortium / multiple banking arrangements agree to the sale of asset to SC/RC
Thus an asset reconstruction company can buy standard assets as well. However enforcement of security interest cannot be applied against the standard assets.
What assets are covered under SARFAESI action?
Any asset movable or immovable, given as a security whether by way of creating a mortgage, hypothecation or creating a security interest in any other form are covered under the SARFAESI action. However, provisions of the act are not applicable in certain cases as specified under section 31 of the Act.
Can security interest be enforced against a sick company registered with BIFR?
Yes, SARFAESI action can be initiated against any sick company registered with the BIFR provided at least 75% of the secured creditors agree for this. Upon the secured lenders taking action under SARFAESI, the proceedings before BIFR abate.
Can ARC take over the Management of a borrower company as part of restructuring?
In accordance with the provisions of the SARFAESI Act, an ARC, for the purpose of asset reconstruction, can ensure proper management of the business of the borrower, by change in, or takeover of, the management of the business of the borrower as per guidelines issued by RB.
When can the creditor take possession of the assets?
After sending demand notice u/s 13(2) if outstanding dues are not paid within 60 days, the secured creditor can take possession u/s 13(4) of the Act, provided consent of the secured lenders holding at least 75% of the secured debt has been obtained.
When can secured creditor dispose of the secured assets?
If the borrowers fails to discharge his liability within the period of 60 days from the date of notice issued u/s 13(2) the secured creditor may take a recourse u/s 13(4) by taking possession of secured assets with a right to transfer by way of lease, assign or sale for realising the secured asset. In case of joint financing of a financial asset or where there are more than one secured creditor at least 75% in value of the outstanding creditor should agree for such an action.

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