Introduction

A company’s borrowings are typically secured by way of creation of a ‘security’ or ‘charge’ over its assets. However, mere creation of a contractual security interest is not sufficient to secure the interests of secured creditors in financing transactions. Creditors must ensure that any security interest is also enforceable against any third parties with a competing claim (including, without limitation, any other creditors of the company or the official liquidator). In order to mitigate this risk, the law usually requires the secured party to give some form of public notice and/ or make certain filings – this requirement of public notice is known as perfection of security. Perfection of security interest by making the required public filings is also important in instances of competing creditor claims and establishing priority of charge vis-à-vis other secured creditors.

In India, there are multiple requirements under different legislations to register the security interests. The following sections provide a brief overview of such requirements and also summarize the consequence of their non fulfillment:

1. Registration with the Registrar of Companies under Companies Act, 2013

Sub-section (1) of section 77 of the Companies Act, 2013 (“CA, 2013”) mandates every company creating a charge on its assets or any of its undertakings to register the particulars of the charge with the Registrar within thirty days of creation of such charge.[1] In the event of a delay in charge creation beyond the original 30 days’ time period, the company may seek extension by filing the charge form supported by a declaration that such belated filing shall not adversely affect the rights of any other intervening creditors of the company.[2]

Effect of Non-registration: Non-registration of charge with the Registrar of Companies (“RoC”) will not invalidate the charge created but the same will not be taken into account by a liquidator (in case of a winding up or insolvency resolution process) and other creditors of the security provider, as specified above. However, this does not prejudice any contract or obligation for the repayment of the money secured by such charge. Moreover, if the security provider fails to register the charge with RoC, it shall also be liable to pay a penalty of up to INR 5 lakhs and every officer of the company who is in default shall be liable to a penalty of fifty thousand rupees.

2.  CERSAI Filings under SARFAESI Act

Pursuant to certain amendments (which came into force from January 24, 2020) to Section 26D of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 (“SARFAESI Act”), no secured creditor[3] (as defined under the SARFAESI Act) shall be permitted to enforce any security interest under the SARFAESI Act unless the same has been registered with the Central Registry of Securitisation Asset Reconstruction and Security Interest of India (“CERSAI”). This registration must be done by the person in whose favour the security interest has been created – therefore, if the secured creditor has not completed CERSAI filing till now, they can still undertake the same to perfect their security interest.

Reserve Bank of India (“RBI”) has also advised all banks and financial institutions to register the transactions relating to securitization and reconstruction of financial assets and those relating to mortgage by deposit of title deeds with CERSAI.[4] Particulars of creation, modification or satisfaction of security interest (a) in immovable properties by way of mortgage; (b) in plant and machinery, stocks, debts including book debts or receivables, whether existing or future; (c) in intangible assets, (for example know how, patent, copyright, trademark, license, franchise or any other business or commercial right of similar nature); and (d) in any under construction residential or commercial properties or a part thereof by an agreement or instrument other than mortgage, are required to be registered under Section 23, 24 and 25 of the SARFAESI Act.

Effect of Non-registration: As specified above, if the secured creditor fails to register the security interest created in its favour by the borrower with CERSAI, then such creditor will not be able to enforce its interest in the secured assets under the provisions of SARFAESI Act and the rights of any other creditor with subsequent security interest registered with CERSAI will take precedence over rights of such creditor.

3. Filing with Information Utilities under the Insolvency and Bankruptcy Code, 2016

As per sub-section (2) of section 215 of the Insolvency and Bankruptcy Code, 2016 (“IBC”), Financial Creditors (as defined under IBC) are required to submit financial information of indebtedness availed and information relating to assets in relation to which any security interest has been created to Information Utilities (“IUs”). Chapter V of the Insolvency and Bankruptcy Board of India (Information Utilities) Regulations, 2017 (“IU Regulations”) specifies the form and manner in which financial creditors are to submit this information to IUs.

NCLT Kolkata had on May 12, 2020 passed an order (“Order”) directing that financial creditors moving to National Company Law Tribunal (“NCLT”) for initiation of insolvency process would have to henceforth mandatorily file ‘default record’ from IU and no new petition would be entertained without the record of default under Section 7 of the IBC. Even though the IBC mandates the filing of information relating to assets in relation to which security interest has been created, in the absence of any implications of non-compliance of the same, most of the creditors have not been filing the same with the IUs. Naturally, the Order created unrest among the creditors who now had an additional compliance to fulfill. The Order was set aside on appeal by Calcutta High Court in the case of in Univalue Projects Pvt. Ltd v. Union of India & Ors.[5], providing the relief to the Financial Creditors. Since then the NCLT had also updated the Order and removed the operative language of “No new petition shall be entertained without record of default under Section 7 of IBC, 2016” from the text of the Order.

Also, Regulation 21 of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016, specifically provides that the existence of a security interest may be proved by a secured creditor on the basis of (a) the records available in an information utility, if any; (b) certificate of registration of charge issued by the ROC; or (c) proof of registration of charge with the CERSAI. Therefore, the records available in an information utility are not the only way of proving the security interest under the IBC.

The RBI has also released a circular mandating all the Scheduled Commercial Banks (including RRBs), Small Finance Banks, Local Area Banks, Co-operative Banks, NBFCs and India Financial Institutions to adhere to the relevant provisions of IBC and IU Regulations in relation to submitting financial information and information relating to assets on which any security interest has been created, and immediately put in place appropriate systems and procedures to ensure compliance to the provisions of the IBC and IU Regulations.

Effect of Non-registration: Although, there is no adverse impact on the security interest created on non filing of information with IUs, Section 235A of IBC provides that if any person contravenes any of the provisions of IBC or the rules or regulations made thereunder for which no penalty or punishment is provided, such person shall be punishable with fine which shall not be less than one lakh rupees but which may extend to two crore rupees. There has not been any case of such penalty being imposed on the secured creditors for failing to file the relevant information with IUs yet, which is probably the reason why the filing with IUs have not become a norm with financial institutions, although it is advisable for secured creditors to avert such risk.

4.  Asset Specific Registration requirements

Apart from the registration and filings requirements as discussed in points 1 to 3 above, creation of security interest over several assets requires the registration with the relevant authority as specified below:

a) Immovable Properties: Creation of security interest over immovable property by way of an English or simple mortgage recorded under a mortgaged deed will have to be registered with the relevant jurisdictional sub-registrar of assurances within which the mortgaged land is situated, along with payment of state-specific registration fees, as applicable in the state of registration of such document. Further, equitable mortgages (i.e. mortgage by way of deposit of title deeds) in some states like Maharashtra are also required to be registered with the relevant sub-registrar of assurances.

b) Pledge Over Demat Shares: For the creation of a pledge, it is required that the pledge should have been recorded in the depository system with the depository participant holding the shares on behalf of the pledgor. The relevant depository shall thereupon mark an entry of such charge in its records evidencing pledge creation.

c) Aircrafts: Civil aviation requirements require the owner of the aircraft to provide a notarized copy of the security document which evidences the creation of charge which is to be submitted with the directorate general of civil aviation (“DGCA”). DGCA then endorses the beneficiary of hypothecation on the certificate of the registration which is accepted as prima facie evidence of lessor, lender or owner interest in the aircraft by the courts in India.

d)  Ships and Vessels: Section 47 of the Merchant Shipping Act, 1958 read with Merchant Shipping (Registration of Indian Ships) Rules, 1960 prescribes that any instrument creating security for a loan or other valuable consideration over a registered ship or vessel shall be produced before the registrar of the ship’s port of registry and the registrar shall record it in the register book. It is important to note that the rights of the mortgagor, mortgagee, and transfer of mortgage and priority of mortgages are also governed as per the terms of the Merchant Shipping Act, 1958.

e) Motor Vehicles: A charge created over motor vehicles by way of hypothecation also needs to be duly registered with the Regional Transport Office in terms of Section 51 of the Motor Vehicles Act, 1988. Post-registration, the name of the charge holder will appear on the registration certificate of the charged vehicle which will preclude the borrower to transfer the charged motor vehicle without the no-objection certificate of the charge holder.

f)  Intellectual Property (IP): As per Section 67 of the Patents Act, 1970, patent offices are required to maintain a register of patents, containing particulars of all such information which affects the validity or proprietorship of patents. Section 69 requires any person who becomes entitled as a mortgagee or to any other interest in a patent, to apply to the controller of patents for the registration of notice of his interest in the patent register. The controller of patents shall, upon its satisfaction, enter in the register the notice of interest of such person. No unregistered document will be admitted by the controller of patents or by any court as evidence of the title of any person to a patent or to a share or interest therein. Same is the case for the registration of security interest created over designs[6], under Section 30 of the Designs Act, 2000, where any such mortgage or interest created over the designs shall not be valid unless application for registration of title under the instrument creating such charge or interest is filed in the prescribed manner with the controller within six months from the execution of such instrument.

As part of the Government’s program to improve the ease of doing business in India, it would be desirable to streamline the labyrinth of security registration frameworks and have a single window for security filings (except for specific asset classes such as shares, immovable properties, aircrafts etc). This will avoid a major loophole that certain errant borrowers (and even competing creditors, in certain cases) seek to exploit in security enforcement situations. However, until such time, it is of utmost importance that the creditors ensure that the security created in their favour is fully perfected and all relevant filings are completed within the timelines prescribed under law.

Footnotes:

[1] Charge is defined as interest or lien created on the property or assets of a company or any of its undertakings or both as security and includes a mortgage.
[2] Rule 4 of Companies (Registration of Charges) Rules, 2014
[3] Any bank or financial institution holding any right, title or interest upon any tangible asset or intangible asset or a debenture trustee appointed by any bank or financial institution or appointed by any company for secured debt securities; or an asset reconstruction company; or any other trustee holding securities on behalf of a bank or financial institution in whose favour security interest is created by any borrower for due repayment of any financial assistance.
[4] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11439&Mode=0
[5] W. P. No. 5595 (W) of 2020
[6] As defined under Section 2(d) of the Designs Act, 2000.

Authors:
Nikunj Maheshwari, Partner
Dhruv Mairal, Senior Associate
Puru Bansal, Associate