Section 5 SARFAESI: Acquisition of Financial Assets by an ARC

Section 5 is the hinge that moves a bad loan from a bank to an ARC. It sets two ways to acquire a financial asset, and then, through a set of deeming provisions, makes the ARC the lender in the bank's place, carries every related instrument across, and keeps pending litigation alive in the ARC's hands. This note sets out the modes of acquisition, the deeming effects, and how acquisition leads on to the notice to the obligor and enforcement.

1. The Two Modes of Acquisition

Figure 1: By issuing a security or by agreement

• By issuing a security. The ARC may acquire a financial asset by issuing a debenture or bond, or any other security in the nature of a debenture, to the bank or financial institution for the agreed consideration.
• By agreement of transfer. Alternatively it may enter an agreement with the bank or financial institution for the transfer of the financial asset, on such terms and conditions as they agree.
• Either way a true acquisition. By both routes the asset moves from the bank to the ARC, which then holds the claim together with the security that travels with it (Topic 12)

2. The Deeming Effects

Figure 2: How the ARC steps into the bank's shoes

• Deemed lender, s.5(2). On acquisition the ARC is deemed to be the lender, and all the rights of the bank or financial institution in that financial asset vest in the ARC, so it holds the debt and the security as the bank did.
• Continuity of instruments, s.5(3). All contracts, deeds, bonds, agreements and powers of attorney relating to the asset continue in full force in favour of the ARC, so the security documents need not be redone.
• Pending proceedings continue. A suit, appeal or other proceeding pending by or against the bank in relation to the asset continues, with the ARC substituted as the party in place of the transferor, so litigation is not restarted.
• Stamp duty exemption, s.5(1A). Documents executed in favour of the ARC for the acquisition are exempt from stamp duty under the Indian Stamp Act, lowering the cost of moving assets to the ARC.

3. What Follows Acquisition

Figure 3: From acquisition to notice and enforcement

• The ARC becomes the creditor. Because it is the deemed lender with all rights vested, the ARC may now do everything the bank could: hold the security, take measures, and enforce.
• Notice to the obligor, s.6. The obligor is notified that the asset has been acquired and must thereafter pay the ARC, not the originating bank; payment to the old creditor after notice does not discharge the obligor (Topic 19)
• Reconstruction and enforcement. The ARC may then take the s.9 reconstruction measures or invoke the s.13 enforcement machinery, the acquisition being the gateway to both (Topics 18, 26)
• CERSAI registration. Transactions of securitisation and asset reconstruction are registered with CERSAI, giving public notice of the ARC's interest in the asset (Topic 3)

4. Frequently Asked Questions

How does an asset reconstruction company acquire a financial asset under Section 5?

Under Section 5, an asset reconstruction company may acquire a financial asset of a bank or financial institution in either of two ways: by issuing a debenture or bond or any other security in the nature of a debenture for the agreed consideration, or by entering into an agreement with the bank or financial institution for the transfer of the asset on agreed terms. On acquisition, Section 5(2) deems the ARC to be the lender, and all the rights of the bank in the financial asset vest in it. Section 5(3) keeps all related contracts, deeds and powers of attorney in force in the ARC's favour, pending proceedings continue with the ARC substituted, and Section 5(1A) exempts the acquisition documents from stamp duty.

What happens to a suit pending in the bank's name when the ARC acquires the loan?

The suit does not have to be restarted. On acquisition, the ARC is deemed to be the lender and all the bank's rights vest in it, and any suit, appeal or other proceeding pending in relation to the financial asset continues, with the asset reconstruction company substituted as the party in place of the originating bank or financial institution. The contracts, deeds and powers of attorney relating to the asset likewise continue in the ARC's favour, so the ARC prosecutes or defends the litigation from the point the bank had reached, rather than beginning afresh.

5. Related Topics

• Topic 19: Section 6 Notice to Obligor. The notice that follows acquisition.
• Topic 18: Section 9 Reconstruction Measures. What the ARC may do with the acquired asset.