Securitisation Transactions in India – Legal Validity

May 18,2020

Pratish Kumar (Partner, Juris Corp)

Ankit Sinha (Principal Associate)

Garima Parakh (Associate)

1)        Background

Securitisation was introduced in India as part of the wave of financial reforms in 1999 to expand the funding capacity of banks and non-banking financial companies (“NBFCs”). With a volume of INR 1.57 lakh crore in December 2019[1], securitisation is a popular resource-raising mechanism, especially amongst NBFCs and housing finance companies (“HFCs”). This is also common in banks for meeting the priority sector lending requirements. The steady upward trend in securitisation transactions, from INR 1.44 lakh crore in the nine months preceding the financial year 2019 to INR 1.57 lakh crore in the nine months preceding the financial year 2020, is also reflective of the severe liquidity crunch faced by NBFCs and HFCs in recent times.[2]

Redistribution of risk can be achieved by way of sale of certain assets by banks or financial institutions, in any of the following manners –

(a)      Direct assignment: In a direct assignment transaction, assets owned by the originator bank or financial institution (“Originator”) are sold directly to the buyer(s). The said assets are reflected in the books of account of the buyer(s). A key principle in direct assignment transactions is that of true sale, which is required to be adhered to for a valid assignment of the standard assets. A direct assignment transaction is the most preferred mode of down selling standard assets.[3]

(b)      Securitisation: Securitisation is the process of pooling and repackaging of homogenous illiquid financial assets into marketable securities that can be sold to investors (“Investors”).[4] This involves sale of assets, along with its risks and any underlying assets, by an Originator to its Investors, through a special purpose vehicle (“SPV”). The assets move to the balance sheet of the SPV, which is set up for the specific purpose of pooling, sub-dividing, repackaging the assets as tradeable securities backed by such pooled assets, and sold to Investors either as pass through certificates (“PTCs”) or security receipts (“SRs”).[5] A flow chart delineating a simple securitisation transaction is set out below. There can be more complex charts depicting credit enhancement of PTCs / SRs and the role of credit rating agencies in rating these PTCs / SRs.

(c)       Listed transactions: The Securities and Exchange Board of India(“SEBI”) has notified the SEBI (Public Offer and Listing of Securitised Debt Instruments) Regulations, 2008 (“SDI Regulations”). These regulations, inter-alia specify disclosure requirements for public issuance and listing of securitised debt instruments (“SDIs”) (both publicly issued and privately placed) and obligations of the parties involved in the transaction. Under the SDI Regulations, a special-purpose distinct entity is a trust that acquires debt or receivables from funds mobilised by the entity, by issuing SDIs through one or more schemes. A certificate or instrument is issued to an Investor by the special purpose distinct entity, which possesses any debt or receivable, including mortgage debt assigned to such an entity by the Originator and the trustee. This certificate acknowledges the beneficial interest of the Investor in such debts or receivables.

Certain securitisation transactions which do not involve loan receivables (for example, lease receivables) are undertaken under the SDI Regulations. Securitisation of loan receivables may also be listed under the SDI Regulations. However, due to lack of an investor base, such transactions are not very common in India.

We have received many queries in relation to the legal validity of securitisation transactions. In specific, interested clients have raised questions as to whether Courts in India have upheld the validity of securitisation transactions (not Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 related provisions). While we have seen very few case laws on securitisation transactions in India, it is noteworthy to mention that all such judicial pronouncements indicate that the Courts in India have recognized and upheld the structure of securitisation transactions, their legality and feasibility.

The underlying basis of securitisation transactions is assignment of actionable claims. This forms part of laws relating to transfer of property. In this article, we are not dealing with case laws relating to ‘actionable claims’ and have restricted it to those relating to securitisation transactions.

2)        Case laws

Two landmark judgments, of the Hon’ble Supreme Court of India and Hon’ble High Court of Bombay recognise the role of Investors / buyers under securitisation and direct assignment transactions to be as creditors and further uphold the principles of true sale and bankruptcy remoteness.

(a)      ICICI Bank Limited v. Official Liquidator of APS Star[6]

The core question before the Hon’ble Supreme Court of India was whether assignment of debt is a permissible activity under the Banking Regulation Act, 1949 (“BR Act”). In this case, ICICI Bank Limited (“Assignor”) had, by way of deeds of assignment, assigned certain non-performing loans, including that availed by APS Star
Industries Ltd. (“Debtor”), to Kotak Mahindra Bank (“Assignee”). Winding-up proceedings were initiated against the Debtor, and the Assignee sought to substitute the Assignor in the winding-up petitions. The Hon’ble Supreme Court of India relied upon certain provisions of the BR Act and the Reserve Bank of India’s (“RBI”) Guidelines on Purchase / Sale of Non Performing Financial Assets Scope dated 13^th July 2005, to hold that banking companies can venture into new areas of business apart from their principle business of lending and accepting deposits, as long as they do not attract prohibitions and restrictions such as those contained in Sections 8 and 9 of the BR Act. In arriving at this conclusion, the Hon’ble Supreme Court of India relied upon Section 6(1)(a) read together with Section 6(1)(n) of the BR Act which permits banks to, inter se, deal in non-performing assets (“NPAs”). The Hon’ble Supreme Court of India concluded that, dealing in NPAs is a bona fide banking business and that assignment of NPAs is a well-recognised tool used in the interest of banking policy to resolve the issue of NPAs.

(b)      Interim applications in the Dewan Housing Finance Corporation Limited (DHFL) cases

A series of applications were filed by the assignees of DHFL against an ad-interim order of the High Court of Bombay dated 10^th October 2019 (“Order”), which had restrained DHFL from making any payments to its creditors, unless made to all secured creditors on a pro-rata basis from its current and future receivables. The applications sought a modification to the Order to allow payments to be made to the plaintiffs under securitisation and assignment agreements entered into with DHFL. The Hon’ble High Court of Bombay while accepting the contentions put forth by the plaintiffs, modified the Order to allow payments to be made to banks under such agreements. In doing so, the Hon’ble High Court of Bombay recognised the aspect of bankruptcy remoteness of such securitisation and direct assignment transactions.

3)        Securitisation Transactions: Legal Framework

(a)      The guidelines pertaining to securitisation and direct assignment of standard assets were issued by the RBI on 1^st February 2006. These guidelines were subsequently revised by the RBI on receipt of comments from concerned stakeholders and issued on 7^th May 2012 (the “Guidelines”). The Guidelines are organised in three Sections. Section A contains provisions relating to securitisation of assets. Section B contains stipulations regarding transfer of standard assets through direct assignment of cash flows. Section C enumerates the securitisation transactions which are currently not permissible in India.

(b)      Section A of the Guidelines deals with requirements to be met by the originating bank and the assets eligible for securitisation. The said Section of the Guidelines states that in a single securitisation transaction, the underlying assets should represent the debt obligations of a homogeneous pool of obligors. Section A of the Guidelines also specify the assets that cannot be transferred.

(c)       Section B of the Guidelines deals with the requirements to be met by the originating bank and the assets eligible to be transferred by way of direct assignment. The said Section of the Guidelines states that banks are permitted to transfer a single standard asset or a part of such asset or a portfolio of such assets to financial entities through an assignment deed. Section B of the Guidelines also specifies the assets which cannot be transferred. Specifically, assets purchased from other entities cannot be transferred by way of direct assignment.

(d)      The Guidelines also stipulate the minimum holding period and minimum retention requirement to be satisfied under Sections A and B, respectively and the true sale criteria which in effect requires immediate legal separation of the selling bank from the assets that are sold.

(e)      For securitisation under the SDI Regulations, please refer to paragraph 1) (c) above.

(f)        As regards stamp duty laws, stamp duty is applicable on such transaction documents at the time of execution. Many States (for example, Maharashtra, Karnataka and the National Capital Territory of Delhi) have provided certain relaxations on payment of stamp duty re assignment of debt. The quantum of stamp duty may be ascertained once the place of execution is finalised.

(g)      As regards registration of the transaction documents, the law in certain States (for example, the National Capital Territory of Delhi) require the document relating to the assignment of loan receivables to be mandatorily registered.