I. What is a Distressed Asset?

A loan classified as NPA for 90+ days, or a security where value has eroded. RBI classifies it as Sub-standard, Doubtful, Loss.

Regulation aims to solve 3 problems:

• How banks can clean their balance sheet
• Who can buy that bad loan
• How that buyer can recover / revive it without being a vulture fund

II. The Regulatory Framework

A. RBI Master Direction - Asset Reconstruction Companies Directions, 2024

This consolidated all prior circulars and came into effect 24 April 2024.

Key provisions:

• Entry barrier: To commence business of securitisation or asset reconstruction, minimum Net Owned Fund (NOF) Rs 300 crore and ongoing. Existing ARCs got glide path till Oct 2026.
• Registration: u/s 3 SARFAESI Act.
• Fit and Proper: Sponsor, directors need RBI approval. Sponsor shareholding >10% needs prior approval.
• Core Activities u/s 9 and 10 SARFAESI:
  • Acquisition of financial assets
  • Rescheduling debt, enforcement of security, settlement
  • Change or takeover of management u/s 9(a) - requires Board-approved policy
  • Sale/lease of business of borrower as going concern
• Funding structure: ARC issues Security Receipts (SRs) to Qualified Buyers. Minimum 15% cash to seller bank, 85% SRs. Now RBI mandates ARC must hold minimum 15% of SRs of each scheme it floated to ensure skin in the game.
• Tenure: Resolution to be within 8 years max. SRs to be rated and valued every 6 months.
• Prohibition on Assignment: ARC can assign debt only to another ARC, subject to Sec 9,10. Cannot sell to non-ARC except via NCLT or as per guidelines.
• New 2026 Prudential Norm: RBI banned sale of Specified Non-Financial Assets acquired on debt recovery back to defaulting borrower or related parties, effective Oct 1, 2026. Disposal must be via public auction per SARFAESI principles. This mirrors Section 29A IBC principle.

B. SARFAESI Act, 2002 - The Extra-Judicial Power

• Section 5: Allows banks/FIs to sell NPAs to ARC without borrower consent.
• Section 7: ARC can raise funds via SRs.
• Section 13: Secured creditor can take possession, sale, management without court intervention after 60-day notice. If dues > Rs 1 lakh and NPA.
• Section 14: CMM/DM to assist in physical possession.
• Section 35: Overriding effect over other laws.

C. IBC, 2016 - The Collective Resolution

When SARFAESI is individual action, IBC is collective.

• Section 7,9,10: Trigger CIRP.
• Section 14 Moratorium: Expressly prohibits any action to foreclose, recover or enforce any security interest, including action under SARFAESI Act during moratorium.
• Section 29A: Willful defaulters, promoters who caused NPA >1 year, disqualified from submitting resolution plan - now extended to buying back stressed assets under RBI norms.
• Section 53: Priority waterfall.

RBI in 2022 allowed ARCs with Rs 1000 cr net worth to act as Resolution Applicant under IBC.

III. Lifecycle: Bank -> ARC -> Resolution

1. Bank identifies NPA -> Calls for bids from ARCs (Swiss Challenge)
2. ARC acquires via Assignment Agreement - stamp duty exempt u/s 5(1A)
3. Trust is created - ARC is trustee, investors are SR holders
4. ARC works out: restructuring, OTS, sale of asset, change of management, CIRP filing under IBC
5. Recovery distributed to SR holders.

IV. Landmark Case Laws - You Must Know

1. Phoenix ARC Pvt Ltd v Vishwa Bharati Vidya Mandir (2022) - SC Civil Appeal Nos 257-259/2022
Held: Borrower aggrieved by SARFAESI action by bank/ARC must approach DRT under Section 17, writ petition under Article 226 not maintainable. This closed High Court forum shopping.

2. Pegasus Assets Reconstruction Pvt Ltd v Haryana Concast Ltd (2016) 4 SCC 47
Supremacy of SARFAESI. Company Court / Official Liquidator in winding up cannot interfere with sale of secured asset by secured creditor / ARC under SARFAESI.

3. Harshad Govardhan Sondagar v International Assets Reconstruction Co Ltd (2014) 6 SCC 357 + 2024 clarification
CMM/DM role u/s 14 SARFAESI is purely ministerial. Cannot adjudicate tenancy rights. Lessee must approach DRT. Stops misuse of Sec 14 as shortcut to bypass DRT.

4. Mardia Chemicals v Union of India (2004) 4 SCC 311
First constitutional challenge to SARFAESI. Upheld Act but struck down requirement of 75% deposit before DRT appeal, made it 50%, and provided borrower right to be heard post Section 13(4).

5. Alchemist ARC Case - NCLAT 15 May 2025
Reiterated RBI Master Direction 2024: Debt assigned to ARC can be assigned only to another ARC, not to non-ARC or individual investor. This kills private distressed debt trading.

6. IBC Moratorium Jurisprudence:

• ICICI Bank v Innoventive Industries (2017): Once moratorium declared, no court including High Court should proceed with action affecting corporate debtor's assets.
• P. Mohanraj v Shah Bros (2021): Moratorium does not extinguish claim, it only bars proceeding.
• Anand Rao Korada v Varsha Fabrics: Moratorium does not revive contracts already terminated before insolvency.
• Tejas J Shah v Various: Moratorium applies only to corporate debtor, not promoters, directors, personal guarantors.

7. Supreme Court Dismisses Plea that ARCs are not Banking Companies (2023-24)
Petitioner argued ARCs cannot use SARFAESI and RDB Acts as they are not banking companies. SC dismissed, holding ARCs are secured creditors under SARFAESI and financial institutions under RDB Act.

8. SARFAESI Can Be Invoked Despite Earlier DRT Decree - SC LiveLaw 2024
Section 35 overriding effect permits fresh SARFAESI action even if ex-parte decree already exists in DRT OA for same debt.

V. Current Regulatory Gaps & Reforms

1. NARCL (Bad Bank): Govt-backed ARC with 15:85 structure, takes large Rs 500cr+ NPAs.
2. SR Trading Platform: RBI pushing secondary market for SRs to improve price discovery.
3. Conduct Issues: LiveLaw study notes high-handedness, 2024 Master Direction introduced conduct rules, independent directors, audit committee.