Security Receipts and Qualified Buyers under SARFAESI

Securitisation needs funding, and the Act supplies both the instrument and the investor. The security receipt is the instrument an ARC issues against the financial assets it acquires; the qualified buyer is the institutional investor allowed to hold it. Section 7 lets the ARC raise funds by offering these receipts under schemes, and gives the holders of a large majority real control over how a scheme is run. This note sets out the instrument, the investor, the fund-raising mechanism, and the control the holders hold.

1. The Instrument and the Investor

Figure 1: Security receipt and qualified buyer

• Security receipt, s.2(1)(zg). A receipt issued by an ARC to a qualified buyer evidencing the buyer's undivided right, title or interest in the financial asset acquired, so the holder shares in the realisation of the pool (Topic 14)
• Qualified buyer, s.2(1)(u). The eligible investor who may hold security receipts: a bank, financial institution, insurer, or other notified entity, so SRs are an institutional instrument, not a retail one.
• The link. The SR is the instrument, the qualified buyer is the holder, and together they supply the funding that lets the ARC acquire the bad loans.

2. Raising Funds under Section 7

Figure 2: Schemes, separate accounts, and no public offer

• Offer to qualified buyers only, s.7(1). An ARC may offer security receipts to qualified buyers and not by an offer to the public, keeping the instrument within the institutional circle the Act contemplates.
• Funds by schemes, s.7(2). It raises funds by formulating schemes for acquiring financial assets, and must keep and maintain a separate account in respect of each scheme.
• Each scheme ring-fenced. Because each scheme is accounted for separately, the assets and realisations of one scheme are kept apart, and a holder's return tracks the scheme invested in.
• Exemption from registration, s.8. A security receipt is exempt from registration under the Registration Act, unless it creates, declares or assigns a right or interest in immovable property, easing its issue and transfer.

3. Control by the Qualified Buyers

Figure 3: The 75 per cent holders steer the scheme

• The 75 per cent threshold, s.7(3). Qualified buyers holding not less than seventy-five per cent of the total value of the security receipts of a scheme may call a meeting of all the holders.
• Binding resolutions. Resolutions passed at such a meeting by the requisite majority are binding on the ARC in managing the scheme, giving the investors real say over the workout.
• Board-like procedure, s.7(4). Such meetings are conducted following a procedure as near as possible to that of a meeting of a board of directors, lending the process a settled form.
• Why the control. Because the holders carry the recovery risk, the Act lets a strong majority steer the scheme, aligning control with the money at stake.

4. Frequently Asked Questions

Who can hold a security receipt and how does an ARC raise funds under Section 7?

Only a qualified buyer may hold a security receipt. Under Section 2(1)(u) a qualified buyer is an institutional investor such as a bank, financial institution, insurance company or other notified entity, so security receipts are not offered to the public. Under Section 7, an asset reconstruction company raises funds by offering security receipts to qualified buyers and by formulating schemes for acquiring financial assets, keeping a separate account for each scheme so that the assets and realisations of one scheme are ring-fenced from another. A security receipt evidences the holder's undivided interest in the financial assets acquired under that scheme.

What control do security receipt holders have over a scheme?

Section 7(3) gives qualified buyers holding not less than seventy-five per cent of the total value of the security receipts of a scheme the right to call a meeting of all the holders, and resolutions passed by that majority are binding on the asset reconstruction company in managing the scheme. Section 7(4) provides that such meetings follow a procedure as near as possible to that of a meeting of a board of directors. The scheme of control reflects that the holders bear the recovery risk, so a strong majority is allowed to direct how the scheme is run.

5. Related Topics

• Topic 14: Securitisation and Security Receipt Defined. The instrument and the two routes.
• Topic 21: RBI Powers and Dispute Resolution. Oversight and disputes among the parties.