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Flaws In The Current Security Regulation Framework And Its Affects On Project Financing For Companies

Project financing is essentially a type of secured lending. Any transaction in which there is security interest is called a "secured transaction". The presence of security is essential in any type of large loan agreement, specifically project financing. Security interest is essentially a legally enforceable legal claim on assets or collateral. The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 defines security interest.

As per the act, security interest is the right, title or interest of any kind that is created upon property created in favor of any secured creditor. A borrower will give the lender possession of certain assets during the making of the loan agreement as collateral along with giving the lender the right to repossess the assets if the borrower stops making loan payments.

This is done as security essentially so that the lender can sell large assets and pay off the loan instead of reporting default in the loan. Security interest lowers the risk of default of loan repayment for the lender, and because of the security created due to this collateral it also allows the lender to charge lower interest on the loan to the borrower. Borrowers in finance projects are usually special purpose vehicles created for the purpose of that specific project.

A Special Purpose Vehicle is a subsidiary company that is formed to undertake a specific task or business. These entities will not have credit history that the lender can refer to while making a loan agreement, and hence security interest provides confidence to the lender.

Various types of assets can be used as different types of security in a project, depending on the magnitude and nature of the project that is being financed. The question we analyze in this paper is whether the current regulatory frameworks for securitization of assets are working or whether they could be improved.

The Reserve Bank of India creates notifications on the methods of creation and registration of security interest. Over the years, the government has realized the importance of registering assets that are being used as collateral in an agreement for security interest reasons. The reason for the same can be simplified and explained through situations where an asset that has not been registered can then be used or even considered as collateral by another party as well.

It is often that lenders and companies are not always aware of whether the assets their borrowers are offering up to them as collateral are already tied up in another loan agreement, or even if those assets have been repossessed in case of immovable property. Several such logistical nightmares led to the government mandating that along with the creation of security interest for a loan agreement, the registration and perfection of that same security assets is essential. (Perfection of Security Interest, azb 2021)

Security interest can overall include various things and be of various types. Security interest can be in the form of any charge, mortgage, right, title or interest of any kind on a tangible asset, or similarly, the rights, title, license, or interest of any intangible asset. According to the Reserve Bank of India's mandate, the first step to creating security interest over any property is to create a security arrangement or a security agreement to secure any financial assistance that has been given by a secured creditor.

The lender is also known as the secured creditor. It is also important to think of factors such as a third party trying to claim the asset and charging a competing claim on the asset being used as security interest. To mitigate the risk of the above scenario, it is important to note that the mere creation of security interest is not enough. It is also essential to ensure that this charge or security over any asset is enforceable over third parties without having to file a competing claim on those assets.

Once the security interest is created, meaning the borrower has announced and told the lender the assets and types of security they will be given as collateral for the loan they are getting, we move on to the next step of perfection of security. Perfection of security is essentially when the secured party is required to give some form of public notice or register under certain government filings for the official and legally enforceable claim on that asset. This also tackles the earlier discussed problem of having to deal with competing creditor claims and, in a way, establishes priority of charge.

India has different legislations and requirements to register security under. Section 77 of the Companies Act, 2013 specifies mandates for all companies. These companies must, within thirty days of creation of a charge over its assets or undertaking, register the particulars of the charge with the Registrar of Companies (RoC). The reason this is done is because if this charge is not created and there falls an unfortunate event of insolvency or default, these charges that have not been registered will be considered by the liquidator. There are also penalties put in for security providers who fail to register the charge with the RoC. The security provider is liable to pay up to 5 lakh INR penalty according to the Companies Act, 2013.

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 (SARFAESI Act) is the legislation under which security interest is finally enforceable and used to cover assets and charges that are given as collateral for security interest.

Section 26 of the SARFAESI Act, 2002 states that unless a secured creditor has registered their security interest under the Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI), they will not be permitted to enforce the same security interest. The registration needs to be the borrower because he is the person in whose favor the security interest is being created. In an event in which there is subsequent security interest registered by some other creditor under the CERSAI and the original borrower has not registered the charge under CERSAI, precedence will be given to the subsequent creditor who has done the due registration.

Creation of security interest over several assets may require registration under different authorities. If we look at immovable properties that are being used to create security interest, it is usually done through the way of a mortgage deed that has to then be registered under the relevant jurisdictional sub-registrar of where the mortgaged land is situated. There may also be additional requirements to be fulfilled such as payment of registration fees that are specific to different states. (Perfection of Security Interest, azb 2021)

For example, if you look at mortgage deeds in the state of Maharashtra, even equitable mortgages are required to be registered under the sub-registrar of assurances. An equitable mortgage is a mortgage that is created through the depositing of title deeds. If a project encompasses aircrafts or other modes of civil aviation, the civil aviation requirements are also different.

The owners of the aircraft must provide documented proof that their aircraft is being used as security interest, and the document must be submitted with the directorate general of civil aviation. Once the certification of registrar is acquired by the owner, the directorate general of civil aviation then provides a beneficiary of hypothecation on the certificate.

This can then be used as evidence of security interest. In the event of insolvency and bankruptcy, it is also important to file assets with the Information Utilities as mentioned in the Insolvency and Bankruptcy Code, 2016. Section 215 of the Insolvency and Bankruptcy Code, 2016 state that financial creditors must file their financial information and information relating to assets with which they are creating security interest under to the Information Utilities.

This is essential because according to the National Company Law Tribunal mandates that in the event of insolvency, the default record already filed under the Information Utilities will only be used and no new charges or records or petitions will be entertained. Regulation 21 of the Insolvency and Bankruptcy Board of India Regulations specifically states that the records available in an information utility can be used by the secured creditor to prove the existence and charge of the security interests.

Intellectual property securitization has over the years grown and is in the form of things such as music royalty, trademark licensing receivable transactions or, most generally, patents. The owner of the intellectual property transfers the item for securitization and the investors provide a receipt of capital in the form of lump sum payments.

For intellectual property securitization the SPV receives the royalty stream, then capital market investors are issued securities based on this royalty stream by the SPV. The transfer is made to the SPV so that the original person whose intellectual property it is, can protect their IP assets from unsecured creditors.

This can be achieved by the SPV when they issue securities to institutional investors by placing the bonds privately instead of issuing them for the public. Section 67 and Section 69 of the Patents Act, 1970 talk about the regulatory framework. Section 69 states that any person who is entitled to use that patent as any form of interest must register their notice of interest in the patent register by applying to the controller of patents. Unregistered documents cannot be used as evidence in a court by a person to show their share of interest therein.

The main issue with using intellectual property as security is that neither the Securitization, Asset Reconstruction and Enforcement of Security Interest Act, 2002 nor the Patent Act, 1970 actually lay down explicit framework for the securitization of patents and other forms of intellectual property, yet they are widely used as finance in largescale projects and by companies. It isn't always clear what can be characterized as assets that can be securitized in terms of intellectual property. There are several other problems that also exist in the process of patent securitization.

The main issue with the lack of laid down framework for intellectual property securitization is the lack of reliability. Usually the process of securitization, as mentioned in the above methods for other forms of securitization, results in the asset being taken off a company's balance sheet and reduces pressures of capital adequacy and gives the issuer a protection of immediate liquidity.

The process of turning intellectual property into security involves several players and various loopholes in the current law that makes the entire process tedious and prone to error. Loopholes in the law that may allow for the securitization of patents are as follows; Section 2(1) of Securitization, Asset Reconstruction and Enforcement of Security Interest Act, 2002 uses the term 'property' when defining financial assets. (Kumar, 2006)

Overall, if we look at the process of creation and perfection of security interest, the most important part of security interest is the perfection. All the above-mentioned methods are the various ways in which security interest can be enforced so that third parties cannot claim those assets and charges for other projects.

These methods also help creditors and lenders look at the credit history of borrowers. Because the process for registration is branched and complicated, it is highly desirable that the process of filing for security interest and security registration frameworks become more streamlined. There exist many errant borrowers that benefit from companies or people that do not perfect security due to lack of streamlined security registration frameworks.

  • Kumar, J., 2006. [online] Available at: [Accessed 3 October 2022].
  • azb. 2021. Perfection of Security Interest - azb. [online] Available at: [Accessed 3 October 2022].

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