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Debt recovery is a critical function for Non-Banking Financial Companies (NBFCs), which play an integral role in providing credit to sectors often underserved by traditional banks. However, NBFCs face unique challenges when it comes to recovering bad debts due to the nature of their lending operations. A strong understanding of the legal framework and regulatory guidelines that govern the NBFC loan recovery process to manage non-performing assets (NPAs) effectively and safeguard their financial stability.

In this blog, we’ll explore the regulatory framework, key legal mechanisms, and laws that NBFCs can leverage for debt recovery.

1. RBI Guidelines on NBFC Debt Recovery

The Reserve Bank of India (RBI) is the primary regulatory authority for NBFCs, issuing guidelines and compliance standards that NBFCs must adhere to, including those related to debt recovery. In recent years, the RBI has tightened its grip on the functioning of NBFCs to ensure transparency and accountability, especially regarding loan disbursement and recovery practices.

Key RBI guidelines include:

• Fair Practices Code: NBFCs are required to adopt a Fair Practices Code (FPC) that outlines transparent and fair recovery practices. Harassment or coercion of borrowers is strictly prohibited, and debt recovery agents must be adequately trained.
• NPA Recognition: NBFCs are mandated to classify loans as NPAs if repayments are overdue for more than 90 days. Once a loan is recognized as a Non-Performing Asset, the recovery process must be initiated promptly.
• Asset Classification and Provisioning: RBI guidelines require NBFCs to classify assets based on the period of non-repayment and maintain provisions against bad loans, ensuring they remain financially solvent despite delinquent debts.

While these guidelines provide a framework for fair and ethical recovery practices, NBFCs must also navigate specific legal channels to enforce debt recovery.

2. NBFC Debt Recovery under the SARFAESI Act

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI Act) of 2002 is a cornerstone of the debt recovery mechanism in India, applicable to both banks and NBFCs. The SARFAESI Act empowers lenders to recover secured debts by enforcing the security interest without needing to go through lengthy court procedures.

How NBFCs benefit under SARFAESI:

• Enforcement of Security Interest: If an NBFC has extended a loan secured by collateral (such as real estate, vehicles, or other assets), it can seize and sell the collateral to recover the outstanding amount if the borrower defaults.
• Fast-Track Recovery: The SARFAESI Act allows NBFCs to take possession of mortgaged assets and auction them without court intervention, reducing recovery time.
• Applicability to Larger NBFCs: NBFCs with an asset size of ₹100 crore or more are eligible to invoke the provisions of the SARFAESI Act. However, this law cannot be used for recovering unsecured loans or smaller debt amounts (below ₹1 lakh or where the unpaid amount is less than 20% of the loan).

3. The Role of Debt Recovery Tribunals (DRTs)

The Debt Recovery Tribunals (DRTs) were established under the Recovery of Debts and Bankruptcy Act, of 1993, to help financial institutions recover bad loans through a streamlined judicial process. For NBFCs, DRTs provide a vital mechanism for recovering debts in cases where secured assets are insufficient or unavailable.

Key features of DRTs for NBFCs:

• Filing of Claims: NBFCs can approach DRTs to recover debts exceeding ₹20 lakhs, streamlining the recovery process by avoiding lengthy civil court procedures.
• Fast-Track Judgments: DRTs are designed to handle debt recovery cases quickly, often delivering judgments within 6-9 months, compared to regular courts, which may take years.
• Appeals Process: In case a borrower disputes the decision, NBFCs can escalate cases to the Debt Recovery Appellate Tribunal (DRAT).

DRTs have become a crucial tool for NBFCs, especially when dealing with larger corporate or SME loans that fall into default.

4. Insolvency and Bankruptcy Code (IBC) and Its Impact on NBFCs

The introduction of the Insolvency and Bankruptcy Code (IBC) in 2016 brought sweeping changes to how debt recovery is handled in India, including for NBFCs. The IBC is primarily focused on resolving insolvency cases, but it also offers NBFCs a structured legal process for recovering debts from corporate and individual borrowers.

Key aspects of IBC relevant to NBFCs:

• Corporate Insolvency Resolution Process (CIRP): When a corporate borrower defaults on a loan, NBFCs can initiate the CIRP under the IBC to recover dues. This process allows for restructuring the borrower's debt or liquidation if restructuring is not feasible.
• Cross-Sector Recovery: The IBC framework also extends to individual and personal guarantors in certain cases, providing a broader scope for NBFCs to recover unsecured loans.
• Time-Bound Process: The IBC mandates a time-bound resolution process (typically 180 days), providing NBFCs with a faster resolution mechanism than traditional litigation.

The IBC has proven particularly useful for NBFCs in dealing with corporate defaults and large-scale NPAs, offering a robust framework for recovery and resolution.

5. Other Legal Provisions and Recovery Avenues

In addition to the SARFAESI Act, DRTs, and the IBC, NBFCs can leverage other legal tools to recover outstanding dues:

• Negotiable Instruments Act, 1881: NBFCs can initiate legal proceedings under this act in case of cheque bounce or dishonour of promissory notes, which often accompanies defaults.
• Civil Suits: NBFCs can file civil suits for debt recovery in cases where the SARFAESI Act or other special laws do not apply, although this process tends to be lengthier.
• Lok Adalats and Arbitration: Alternative dispute resolution mechanisms like Lok Adalats and arbitration can provide quicker and more cost-effective debt recovery solutions, especially for smaller loans or disputed amounts.

Conclusion

For NBFCs, debt recovery is not only about reclaiming funds but also about maintaining a healthy balance sheet and ensuring continued growth. By understanding and utilizing the legal framework, including RBI guidelines, the SARFAESI Act, DRTs, and the IBC, NBFCs can streamline their recovery processes and mitigate losses. However, it’s crucial to adopt recovery practices that align with legal norms and ethical guidelines to avoid disputes and ensure long-term sustainability.