How are Laws from the Nineteenth
Century Still Valid Today?
A Look into India’s
Secured Transaction System
Law of Nation Building Seminar
In July of 2005, India officially became the world’s tenth largest economy landing it just behind other leading global economies of Span, Canada and China. India’s 2004 real GDP growth rate was estimated at 6.2% and the country has been averaging more than 6% economic growth over the past decade. The country has a labor force of over 480 million people from a population just over one billion growing at 1.4% annually. In times when the world’s top seven economies in 2005 were the same top seven in 2003, India’s fast-rising economy is threatening to shake up the status quo.
There are many factors attributed to India’s long-term economic boom. Among them, massive industrial growth, a hard-working labor pool (a good percentage of which speak English), and changing economic policies. An important result of this latter factor, is the continued increase of Foreign Direct Investment (FDI). Even recently, large western corporations such as Microsoft, Intel and Cisco Systems have announced planned investments in India of over one billion dollars each over the next few years.
In today’s global economy however, every country, developing and developed, is competing for investments from abroad. Consequently, India needs to continue to progress in becoming the target of these inflows of capital. One sure way India can do this is to continue to improve the commercial environment better. This includes not only its financial and banking systems but also the legal system. Specifically, India needs to provide the creditors and the debtors more options, clarity and security in order for them to better structure transactions between them. A start to this should be s a restructuring of its out-dated and incomplete secured transaction system. Although this improvement may be on a much smaller, micro-economic level, a new and improved secured transaction can ultimately give more confidence to foreign companies looking to find a home for their investment dollars (and Euros, Yen,, etc.).
Part I of this paper will provide a brief economic history of India and the policies which have paved the way for its unbridled economic growth. Part II describes some of the components and benefits of FDI within a growing economy and also the advantages of a sound secured transaction system in place within the legal system. Part III is a comparison of some of key secured transaction provisions of India’s commercial statutes and Article 9 of the U.C.C. Finally, Part IV will more thoroughly analyze these comparisons and notes some significant lapses of India’s secured transaction regime.
PART I: An Economic History of India
Since India’s emergence from British reign in 1947 it has progressed through decades of varying economic policy. The Industrial Policy Resolution of 1948 gave the Indian government a monopoly in such industries as armaments, atomic energy, and railroads as well as exclusive rights to develop minerals, the iron and steel industries, aircraft and ship manufacturing and manufacturing of telephone equipment. In 1956, the government passed the Industry Policy Resolution, which greatly extended its prevalence in the Indian economy. Under this Resolution, the private sector was regulated primarily to the production of consumer goods. However, despite the public sector’s extensive influence throughout the economy, the value by assets held was still minute compared to the private sector.
With regards to macro-economic and fiscal policy, the government, by the late 1950’s, had instituted pervasive controls that regulated private investment in industry, prices of many commodities, imports and exports, and the flow of foreign exchange. Additionally, it had in place a pervasive licensing system that was creating imbalances and structural problems in many parts of the economy and was meant to decrease the concentration of private economic power. In 1970, The Monopolies and Restrictive Practices Act was designed to provide the government with additional information on the structure and investments of all firms of a certain size.
It wasn’t until 1985 when the government abolished some of its licensing requirements that India’s economic reforms began. Here, in the mid-80’s, the private sector reversed its contraction and the pace of liberalization increased. By the mid-90’s, a number of sectors previously reserved for public ownership were slashed open and private-sector investment was encouraged in certain key industrial areas including energy, steel and oil and also certain consumer sectors such as air transportation and telecommunications.
One of the most important aspects of these reforms was India’s view of its role within the global economy, especially India’s ability to export goods and services and foreign direct investment. Foreign exchange regulations were liberalized and many import regulations were greatly simplified. For example, the average import-weighted tariff was reduced from 87% in 1991 to 33% in 1994.
The environment for foreign investors started to change in the early 1990’s as the government continued to allow foreign investors greater control and influence over its investments in India. 1991, in particular, was a key year foreign investors because for the first time, foreign owners were allowed to have a 40% or greater stake in their Indian subsidiaries or businesses.
PART II: FDI and the Secured Transaction Framework
FDI – Elements and Benefits
FDI is defined as investment of foreign assets into domestic structures, equipment, and organizations. FDI includes investment in partnership or proprietorship concerns, investment in and formation of new companies, investment in shares and securities in the capital market, deposits with companies, and portfolio investments by foreign institutional investors in either the primary or the secondary markets.
Foreign ownership has been found to have a positive and significant influence on various dimensions of firm performance, but only so when it crosses a certain threshold. Where property rights do not clearly transfer to the foreign shareholders, there may be a disinclination to provide superior performance-enhancing capabilities to the firm in which there is an ownership stake.
Benefits of a Sound Secured Transaction System
Allowing foreign investors greater control in their investments ultimately leads to better performance of these firms against firms in which foreign owners did not exercise similar control. One study has even found that such concentrated foreign ownership is more important than concentrated domestic ownership.
An effective secured transactions regime has a fundamental role to play in a financial system. It can ensure enhanced access to credit by various sectors of the economy that have previously been excluded or have had only limited access to credit by expanding the pool of assets that can be used as collateral. A secured transactions regime can also contribute to improved transparency in determining the creditworthiness of debtors and increased certainty in determining claimants to collateral both of which promote access to credit and allow credit to be extended on better terms. Further more, a secured transactions regime can facilitate diversification of credit risk and financial intermediation by encouraging non-financial creditors like merchants, dealers, traders, and manufacturers and a more competitive credit market. Finally, a modern secured transactions regime also supports reduction of transaction costs and improved access to credit by fostering efficient out-of-court creditor-initiated enforcement.
A sound secured transactions regime is important to rural and urban, small and medium sized enterprises, microfinance institutions and “new economy” start-ups, all of which can make a potentially key contribution to economic growth in India.
Moving to Improve the Current Regime
Many of the important commercial laws in India were enacted in the late nineteenth century and for the most part, they have stood the test of time and formed the foundation for more recent commercial laws. There has been criticism though that no major changes in the laws have been made to meet the demands of globalization and a market-oriented economy. Currently, there is a need to modify the commercial laws to reduce the legal barriers faced by individuals operating in the market on their own terms to produce wealth.
Based on the recommendations of Joint Parliamentary Committee (JPC) the Reserve Bank of India advised the Indian Banks’ Association (IBA) to set up a working group to review and suggest changes in India’s secured transaction framework. In October 2003, the IBA formed a working group under the direction of the CEO of one of India’s major banks. Some of the goals outlined by the working group include reviewing the various methods of creating a security interest available to and the rights of secured creditors, to review the registration requirement and publicity aspects relating to various types of security interest, to examine creditors’ mechanisms for enforcement of security interests, to examine the priority rules amongst various creditors and suggesting measures to protect the rights of secured creditors and finally to suggest measures for enhancing the value and acceptability of the collateral.
India is not the only rising superstar in the world; a few of its own neighbors are becoming global players as well. China, Malaysia and Thailand are all seeing year over year growth and increasing FDI demand. With an improved secured transactions system, India can better compete for foreign investments. Foreign investors that are familiar and confident with the laws that would govern their investment in India are more likely to invest and pump money into the Indian economy.
Comparing Current Indian and American Law
The Secured Transaction Framework
The paradigmatic “secured transaction” has certain indispensable characteristics. It describes a legal relationship between two or more people that is defined by a contract, known as a financing agreement. This agreement involves a piece of property, referred to as collateral, that is either movable or immovable, and the agreement transfers some aspects of title in the property from the debtor to the creditor.
Definitions of Property that are Subject to Security Interests
The expression “property” is defined in various laws in India, the latest being in §2(1)(t) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (“SARFAESI”) which defines it as “(i) immovable property, (ii) movable property, (iii) any debt or any right to receive payment of money whether secured or unsecured, (iv) receivables, whether existing or future, and (iv) intangible assets, being know-how, patent, copyright, trade mark, license, franchise or any other business or commercial right of similar nature.”
The U.C.C. defines the term collateral as the “property subject to a security interest and includes accounts and chattel paper which have been sold.” The numerous types of property aren’t specifically mentioned in this definition, however they are clearly defined elsewhere throughout the U.C.C. For example, the definition of goods, one category of collateral, “includes all things which are movable at the time the security interest attaches or which are fixtures” and lists some exceptions and specific inclusions. Also, there is a definition for important terms used as collateral such as chattel paper, deposit account, instrument, inventory.
The Financing Agreement
The financing agreement, as mentioned above, is the basic agreement defining the security interest. Under the U.C.C. a financing agreement must contain the names of both the secured creditor and the debtor, be signed by the debtor, provide an address of the secured creditor and debtor and most importantly, give a description of the collateral. The description of the collateral within the financing agreement needs to be specific enough for any potential creditors to identify which assets are covered by that security interest. For example, the terms “all inventory including that acquired in the future” have enough specificity for a creditor to know which inventory is covered.
SARFAESI does not, within the act itself, describe the particulars required for the financing agreement.
(a) Amending the Financing Agreement
Under Article 9, In order for a debtor or secured creditor to amend a financing agreement, a writing signed by both parties needs to be filed. Although an amendment cannot extend the period of effectiveness of the financing agreement, it may add collateral to the security interest. The amended financing agreement however, is only effective as to collateral added after the filing of the amendment. 
SARFAESI also provides for modifications of the original financing agreement. The Act allows either the secured creditor or the debtor to file such a statement and merely states that such modification is governed by the provisions of the Act in the same manner as the original agreement.
After the financing agreement is drafted, the next step within the secured transaction framework is to file the agreement with the appropriate governmental office. SARFAESI requires that the details of every transaction of securitisation or creation of security interest be filed with the Central Registrar within thirty days after the date of the transaction or creation of interest by the secured creditor.
Under Article 9, filing a security interest falls under one of the methods of a secured debtor’s ability to perfect a security interest. For most movable collateral, the financing agreement is required to be filed either in the office of the secretary of state where the debtor or the property is located.
Satisfaction of the debt
After the debtor has made all his payments due under the financing agreement, he will have satisfied his obligations. The security interest placed on his collateral will need to be removed to reflect this satisfaction.
SARFAESI requires that the secured creditor give notice to the Central Registrar of payment and satisfaction in full of a security interest. Notice must be given within thirty days from the date of the satisfaction. The Act requires that the Registrar send notice to the secured creditor of receipt of the satisfaction and allow the secured creditor fourteen days to show cause as to why the satisfaction should not be recorded.
Article 9 provides that within one month after there is no longer an outstanding secured obligation, the secured creditor must file with each party with whom a financing agreement was filed a termination statement. This statement must state that the secured creditor no longer has claims to the security interest under the financing agreement. If the secured party does not on his own file the termination statement, the debtor may request him to do so in writing. From that point, the debtor has within ten days to file the termination statement before Article 9’s penalty provisions kick in.
Measures facing and into Default
When the debtor fails to make a payment under the financing agreement or breaches any other terms of the agreement, he may be in default of the secured transaction. Both Article 9 and SARFAESI offer the secured creditor a variety of means of enforcing the security interest, some judicial and some non-judicial. Among the non-judicial means of enforcing a security interest, both Article 9 and SARFAESI provide for acceleration of the debt prior to default and self-help and judicial means in default.
Under SARFAESI, the secured creditor can accelerate any amounts due under the financing agreement upon any failure to make payment by the debtor. The secured creditor must give the debtor notice in writing to discharge the liabilities within sixty days from the date of the notice. The notice shall give details of the amount payable by the debtor and the assets intended to be enforced by the secured creditor if failure to make payment. If the debtor fails to comply with this acceleration request, the secured creditor can take advantage of recovery privileges in default.
Facing default, the U.C.C. allows the secured party to accelerate the debt and payments due under the financing agreement or alternatively require additional collateral in certain conditions. Terms within the financing agreement allow the secured creditor to demand acceleration of the debt “at will” or “when he deems himself insecure” or use other similar terms. The U.C.C. provides that such terms of the financing agreement shall be construed to mean that the secured creditor shall have power to exercise his powers only if he in “good faith believes that the prospect of payment or performance is impaired.” The burden of establishing lack of good faith is on the party against whom the power has been exercised, usually the debtor. Such a provision must be specifically provided for under the financing agreement as the right is not given to the secured creditor by any statute, contrary to how such powers are provided for under SARFAESI.
Upon actual default by the debtor, one method of enforcing the security interest is self-help. SARFAESI allows the secured creditor to take possession of the secured assets of the debtor including the right to transfer by way of lease, assignment or sale. Similarly, under Article 9, default allows the secured creditor the ability to take possession of the collateral, if he may do so without breaching the peace.
(c) Judicial Means
If possession of collateral is required by the secured creditor or if any of the collateral is to be sold or transferred by him, SARFAESI provides that he may request in writing the Chief Metropolitan Magistrate or the District Magistrate to take possession of the collateral. Likewise, under Article 9, after the secured creditor proceeds with judicial action and obtains judgment, he can have a sheriff assist in taking possession of the property.
Costs Related to Disposition
If the secured creditor is forced to sell the collateral in order to recover his initial investment to the debtor, he will be entitled to also recover any costs related to the disposition of the collateral. SARFAESI allows the secured creditor to recover all costs, charges and expenses that have been properly incurred incidental to any action after default from the debtor. Any money that is received by the secured creditor shall be held in trust to be applied to the payment of such costs with the remaining funds proceeding to the debt.
Article 9 requires
that the secured creditor, upon disposition of the collateral, to apply the
proceeds of such disposition first to “the reasonable expenses of retaking,
holding, preparing for sale or lease, selling, leasing and the like” and to
some extent, attorneys’ fees.
This allows the secured party to recoup any costs related to the disposition
before succumbing the proceeds to the rights of any creditors, including his
own, are asserted.
Under SARFAESI, both the debtor and secured creditor one potentially liable for certain non-compliance with the act for a fine of up to 5,000 rupees (USD109.26) for every day during which the default continues. Either party is liable for violations of the filing and amendment provisions of the Act and also any violations relating to rules of notice of satisfaction.
However, Article 9 doesn’t provide any explicit penalties for the secured creditor in case of non-compliance with the statute. The secured creditor’s course of action in a situation of non-compliance is to move forward with default proceedings and recover any expenses may face from the proceeds of the disposition of the assets.
SARFAESI not Applicable to Certain Agreements
The provisions of SARFAESI do not apply to all security interests, there are some exceptions. For example, possessory security interests are governed by the Indian Contract, 1872. Possessory securities in U.S. law however, are still governed by Article 9.
Precedence over Other Laws
While SARFAESI takes precedence over other laws, Article 9 is subject to any statute of the United States. Therefore, in the United States, if a creditor other than a secured creditor has a lien that would ordinarily fall subsequent to that of the secured creditor, that creditor might still be able to assert its rights before the secured creditor, if provided by valid state statute. In India however, the secured creditor’s rights will prevail over those of any conflicting creditors.
The key objective of a secured transaction system is to allow businesses to utilize the full value inherent in their assets to obtain credit in a broad array of credit transactions.
For the most part, where Indian Law makes provisions within the same areas covered by Article 9, the two governing bodies are very similar and in some places, almost identical. However, Article 9 is very detailed and explicit on debtors’ and creditors’ rights, giving clarity to both parties in almost any possible situation. Indian law, on the other hand, is incomplete and does not provide the parties with as much lucidity. The recent enactment of SARFAESI has filled in many of the gaps once existing in India’s secured transaction framework but it is just a starting point in this effort.
One blatant deficiency of SARFAESI is that it does not dictate the specific information essential to a financing agreement. The financing agreement is the most basic and fundamental element of the secured transaction. Whereas Article 9 spells out to the parties exactly what provisions are necessary for a valid financing agreement, SARFAESI is completely silent. How can a system that does not provide guidelines for this basic underlying agreement be even close to complete? In establishing the new secured transaction framework, Indian law needs to properly define and set out the elements of a financing agreement. This is an essential start for the new regime.
SARFAESI has provided the Indian government with the authority to create a registration system for security interests on whatever level they may choose, however, neither the national, state or local governments have created this system. A registration system is essential to provide potential creditors with clarity as to the credit situation of their potential debtors. Increased transparency is one way to bolster creditor-debtor transactions and the different levels of government within India should take advantage of SARFAESI’s provisions and create a current and easy-to-use registry system for security interests.
There is another important element of a sound secured transaction framework that was not properly remedied by SARFAESI. Although SARFAESI’s definition of property does make the concept very wide, the various types of movable properties are not specifically covered by the definition. It is true that by using the expression “movable property” in this definition, any asset which is movable will be covered, but for the purpose of clearly defining rights and obligations upon creation of security over such property it needs to be considered whether the definition of property should be made more specific. For example, the U.C.C. acknowledges different categories of movable property such as dividing all goods into consumer goods, equipment, farm products and inventory. A definition of collateral that is broad enough to include many different kinds of assets will provide flexibility to the debtor in its ability to provide a variety of assets as collateral to secure capital. However, the definition also needs to be specific enough to classify and differentiate between the many different types of assets used as collateral. For example, the Working Group suggested that movable property be classified as under: intangible property, investment property, inventory, consumer goods, agricultural produce, receivables, equipments and machinery, fixed assets, document of title to goods, consumer good and certificate of title. If the categorization of various movable properties is done, the group suggests, it will facilitate making provision for rights and obligations of different parties having interest in such properties. Such categorization would also provide more transparency to the secured transaction system because any persons dealing with such properties, whether it be debtors or creditors, will be in a position to ascertain exactly which property is subject to the encumbrance of a certain financing agreement. Ultimately in a system that provides, and perhaps even requires, specific terms to be used in the categorization of assets as collateral, both secured creditors and debtors will be more certain as to the extent of the debtor’s assets covered by a security interest.
Indian law offers creditors and debtors other arrangements aside from security interests with which they can structure a transaction. Hire-purchase agreements, an arrangement similar to security interests, provide the parties with many of the same benefits of the security interest, but differ structurally in only minor ways. Such agreements however, are governed under an entirely different act. The result of these similar agreements with differing governing bodies could lead to major confusion between debtors and creditors when it comes down to interpreting and enforcing their interests within these agreements. If India created a reliable and sophisticated secured transaction system that would provide debtors and creditors benefits over other antiquated agreements, it might encourage them to use security interests in structuring a transaction. As a result, security interests could become the benchmark of the debtor-creditor relationship. The prevalence of security interests within commercial law would continue to strengthen their regulation, give debtors and creditors more confidence in their use and stability and ultimately facilitate more transactions, thereby generating more capital for the Indian economy.
Limitations of This Paper
This paper is an attempt to compare the existing frameworks of Indian and American secured transaction law. That being said, there are some important limitations to the analysis. First, this paper only dealt with laws relating to movable property and there is still an important portion of secured transaction law relating to immovable property. This paper was meant to focus on the more common aspects of secured transaction law and in reality, immovable property is more often the collateral used in secured transactions for businesses seeking capital because it provides more flexibility for the debtor and the secured creditor in structuring the transaction. Another important limitation is that the entire Indian law was not available for this comparison. This study used a limited base of Indian law, primarily major statutes, which are easily accessible to the public over such forums as the internet. Indian case law, except any that might have been discussed in another paper or committee report, was not readily available as a point of analysis.
The report issued by the working group that was set up by the Indian Banks’ Association clearly outlines the government’s recognition of the problems of the current secured transaction system and it was an attempt to outline a plan to ameliorate the situation. The comparisons presented in this paper of India’s current laws to Article 9 demonstrate some of the gaps and weaknesses of India’s current system and further illustrates the need to reform its laws.
A transformation of the secured transaction system will infuse India with new momentum to continue its extraordinary rate of growth. A sound secured transaction framework will first, provide creditors and debtors with more liquidity and confidence in their transactions. This added certainty will spark more transactions within the Indian economy coming from both domestic, but especially foreign sources. Ultimately, these continued inflows of FDI will foster a greater number of transactions, thus injecting more capital into the Indian economy. This capital is the fuel India will need to continue its unprecedented decades of growth, propelling its economy closer to the top five in the world. As Hernando De Soto once wrote, “capital is the force that raises the productivity of labor and creates the wealth of nations. It is the lifeblood of the capitalist system, the foundation of progress.”
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 CIA world fact book, <http://www.cia.gov/cia/publications/factbook/geos/in.html> (last visited September 22, 2005).
 India Booms into World’s Top 10 Economies
 Microsoft to Invest $1.7 Billion in India, December 7, 2005, <http://www.eweek.com/article2/0,1759,1897184,00.asp?kc=EWNKT0209KTX1K0100440> (last visited December 20, 2005).
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 Pradeep Chhibber & Sumit Majumdar, Foreign Ownership and Profitability: Property Rights, Control, and the Performance of Firms in Indian Industry, 42 J.L. & Econ. 209, 213 (1999). [hereinafter Foreign Ownership and Profitability].
 Definition of FDI / Foreign Direct Investment, <http://%20economics.about.com/cs/economicsglossary/g/fdi.htm> (last visited October 20, 2005). See Colleen Klanchnik, United States-European Union Dispute on Foreign Source Income, Export Activity, and the Extraterritorial Income Exclusion Act, 33 Hofstra L. Rev. 331, FN13 (2004).
 Ravinder Singhania, Setting Up a Business in India, I.C.C.L.R. 1995, 6(6), SUPP I-IV pg ii (1995).
 Foreign Ownership and Profitability: Property Rights, pg. 213.
 Id. at 227.
 Asian Development Bank, Technical Assistance to India for Secured Transactions Reform, pg. 1 (2002). [hereinafter Asian Development Bank Report].
 Joint Parliamentary Committee - Working Group’s paper on Secured Transaction, pg. 6 (2005). [hereinafter Working Group’s Paper].
 Id. at pg. 3.
 Alan Kitchin, John McClenahan & Ashurst Crisp, Doing business in Asia: Focus on Japan, India and Vietnam, C942 ALI-ABA 177, 177 (1994).
 Previously referred to as a chattel mortgage in American Law.
 Referred to as a security agreement in Indian law.
 Referred to as secured assets in Indian law.
 For the purposes of this paper, analysis will be devoted solely to movable properties..
 Referred to in Indian law as borrower to the secured debtor.
 U.C.C. Article 9 §105(c).
 U.C.C. Article 9 §105(h).
 U.C.C. Article 9 §402.
 Id. at §402(4).
 A financing agreement is only good for five years from the date of filing, Id. at §403(2).
 Id. at §402(4).
 The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002, s.4(24). [hereinafter SARFAESI].
 Id. at s.4(23).
 Perfection is a concept within American Law primarily used to determine priority amongst secured creditors.
 U.C.C. Article 9 §313.
 Id. at §401(1)(f).
 SARFAESI at s.4(25).
 U.C.C. Article 9 §404(1).
 SARFAESI at s.13(2).
 Id. at s.13(3).
 Id. at s.13(2).
 810 ILCS 5/1-208.
 SARFAESI at s.13(4).
 U.C.C. Article 9 §503.
 SARFAESI at s.13(7).
 U.C.C. Article 9 §504.
Currency conversion with rate on Nov. 18, 2005 of .02815 Rupees per dollar.
 SARFAESI at s.4(27).
 Id. at s.4(31).
 Referred to as bailments of pledges in Indian Law.
 Id. at s.31(2).
 Id. at s.35.
 U.C.C. Article 9 §104(a).
 Working Group’s Paper, pg 17.
 Id., pg. 18.
 U.C.C. Article 9 §109.
 Working Group’s Paper, pg. 18.
 The Hire-Purchase Act 1972.
 The Mystery of Capital, pg. 5 (2000).