SARFAESI Act, 2002 | Chapter II

Section 7 of SARFAESI Act: Issue of Security Receipts and Raising Funds by Asset Reconstruction Companies

Section 7 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 governs how an asset reconstruction company (ARC) issues security receipts, raises funds from qualified buyers, administers asset acquisition schemes and responds to non-realisation of financial assets.

Meaning and scope of Section 7

An asset reconstruction company is a company registered with the Reserve Bank of India under Section 3 for the purposes of asset reconstruction. A security receipt, defined under Section 2(1)(zg), evidences a holder's undivided right, title or interest in financial assets involved in securitisation pursuant to a scheme. A qualified buyer is a person or entity falling within Section 2(1)(u) and applicable notifications. These statutory concepts should be read with the definitions in Section 2.

The power to issue security receipts under Section 7(1) follows acquisition of a financial asset under Section 5(1). It does not displace applicable company law, securities law, RBI directions or relevant SEBI requirements.

Section 7: Explanation of each sub-section

Section 7(1): Offering security receipts

After acquiring a financial asset under Section 5(1), an ARC may offer security receipts for subscription to qualified buyers, and to such other investor categories (including non-institutional investors) as the RBI may specify in consultation with SEBI. The offer remains subject to the applicable statutory and regulatory framework, including the securities legislation referred to in Section 7(1).

Section 7(2): Raising funds and separate accounts

An ARC may formulate schemes to raise funds from qualified buyers for acquiring financial assets. It must maintain separate and distinct accounts for each scheme and the financial assets acquired with investments under that scheme. Realisations must be held and applied towards redemption of investments and payment of returns provided under the relevant scheme.

Section 7(2A): Trust structure

A scheme for offering security receipts or raising funds may be constituted as a trust managed by the ARC. The ARC holds the assets acquired or funds raised in trust for the benefit of qualified buyers holding security receipts or contributing funds. The Indian Trusts Act, 1882 applies insofar as its provisions are not inconsistent with the SARFAESI Act.

Section 7(3): Rights on non-realisation

If financial assets are not realised under a scheme, qualified buyers holding security receipts representing at least 75% of the total value of the security receipts issued under that scheme are entitled to call a meeting of all qualified buyers. Resolutions passed at that meeting bind the ARC, subject to the applicable legal and regulatory framework. The 75% threshold concerns entitlement to convene the meeting; it should not be confused with an independently prescribed voting threshold for each resolution.

Section 7(4): Meeting procedure

Qualified buyers attending a meeting under Section 7(3) must follow, as nearly as possible, the procedure used at meetings of the ARC's board of directors.

Practical implications for ARCs and investors

Acquisition: Confirm that the underlying financial assets have been acquired in accordance with Section 5.
Investor eligibility: Verify the statutory definition of qualified buyers and any RBI or SEBI notifications governing additional investor categories.
Scheme administration: Maintain scheme-specific accounts and records of assets, realisations, redemptions and distributions.
Trust duties: Where a trust is used, apply the trust provisions together with the SARFAESI framework.
Non-realisation: Determine the relevant scheme's outstanding security receipt value before invoking the 75% meeting entitlement.

The RBI's directions governing ARCs may impose additional requirements concerning issuance and valuation of security receipts, disclosures, investment by ARCs, scheme administration and reporting. Section 7 must therefore be read together with the directions applicable on the transaction date.

Amendments and related legal provisions

The Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Act, 2004 inserted sub-section (2A) and amended the wording of sub-section (3). The Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016 replaced references to securitisation or reconstruction companies with asset reconstruction companies, substituted qualified buyers for qualified institutional buyers, and expanded the language concerning eligible investors. The original statutory reference to the Companies Act, 1956 appears in the section; relevant provisions must also be considered in light of the Companies Act, 2013 and applicable repeal and saving rules.

For comparison, Section 8 deals with exemption from registration of certain security receipts and transfers, while Section 9 covers measures for asset reconstruction.

Official legal and regulatory resources

This article explains the statutory framework and is not a substitute for checking the applicable Act, Gazette notifications and current regulatory directions in a particular transaction.