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Parate Suspension: Sri Lanka’s debt recovery dilemma
Parate execution
‘Parate’ is a Dutch term which means immediate. It’s a non-court procedure.
In this process, banks can take possession of borrowers’ properties but cannot own them. If the properties aren’t sold, the bank gets them at a nominal price (usually at Rs.1,000.00), but they must sell them again to cover debts and refund any excess money to borrowers.
It has been reported that on February 26, 2024, the Cabinet of Ministers in Sri Lanka, at a meeting chaired by President Ranil Wickremesinghe, agreed to suspend the controversial Parate action, based on a proposal put forward by Justice Minister Dr. Wijeyadasa Rajapakshe.
Recovery laws
Banks, financial institutions, and lenders were forced to follow lengthy legal processes to recover funds they had lent. Thus, in 1990, legislatures introduced the Debt Recovery (Special Provisions) Act, the Recovery of Loans by Banks Act and Mortgage Act to streamline and speed up the debt recovery process. These laws not only define legal rules but also outline the required steps for legal actions. Additionally, the Civil Procedure Code guides the debt recovery process.
In some cases, borrowers might seek court injunctions to halt auctions initiated through Parate actions. The Act outlines a specific procedure (sections 5 to 15) that banks must follow to recover debts, known as “Parate execution.”
The Parate Action Procedure starts with a demand letter to the borrower, followed by a Parate Notice. The board of directors of the firm reviews and approves necessary documents, including translations into languages like Sinhala and Tamil. Notices about property auctions are published in newspapers and in the Gazette. Auctions follow and depending on the property’s status (vacant or occupied), actions like serving quit notices are taken to ensure compliance.
Loss of reputation of borrowers
When a “Parate Action” notice is published in the newspapers, it damages the borrower’s reputation, marking them as a defaulter. Banks use this powerful tool for loan recovery. SME owners and borrowers believe Parate action should be the last option, only chosen after all other recovery efforts fail.
However, according to a person called Selvarajah Thumilan, representing ‘Micro, Small and Medium Enterprises Chamber of Sri Lanka,’ banks were unwilling to engage in negotiations with borrowers for loan restructuring or rescheduling. Instead, they allowed loans to reach the Non-Performing Loan (NPL) level, enabling them to use Parate rights for quicker loan recovery.
On the other hand, from the Banks’ point of view, they turn to Parate action to protect the interests of their depositors when other methods prove ineffective. They argue that banks should be driven in the direction of economic development, safeguard public deposit and confidence, more flow of money without stagnating in the process of litigation in the recovery of their debts.
A banker pointed out Justice Nawaz’s recent decision in the Sunpack vs. DFCC case, which expands the scope of Parate execution. It includes not just director-mortgagors but also individuals who, though not directors, have used their property as loan security for the borrowing company. This broader interpretation of “borrower” is a modern and accommodating approach rather than a restrictive one.
Non-performing loans (NPLs)
Banks have a system for managing loan recoveries. Loans with arrears up to 30 days fall into Stage 1, those with arrears up to 60 days fall into Stage 2, and loans with arrears up to 90 days and beyond are categorized as Stage 3. When loans go unpaid for 90 days, banks must address the issue by first suspending accruing interest and then making provisions for doubtful debt. This process affects the profitability of the bank.
At this point banks use the authority, through a Board Resolution, to sell mortgaged property at public auction to recover the outstanding loan amount, interest, and associated costs. However, an amendment in 2011 specifies that no action shall be initiated for loans less than five million rupees. During default calculation, interest and penalties are not considered.
Third party properties
In November 2023, the Supreme Court made a significant ruling. It stated that properties pledged to a bank, not just by the borrower but also by a third party for the borrower’s loan, could be sold at an auction to recover the unpaid loan and interest under the Parate law.
This marks a departure from the Supreme Court’s previous stance that third-party mortgages are exempt from Parate execution, as seen in the case of Chelliah Ramachandran vs. Hatton National Bank (2006). However, the court made a distinction in Hatton National Bank Ltd vs. Samathapala Jayawardena (2007), emphasising that directors serving as guarantors for a company’s loan can be held liable, regardless of their status as principal borrowers.
The intentions of Parate law
A seasoned attorney, who has effectively overseen the recovery units of two prominent commercial banks, brings to light a critical perspective on the efficacy of Parate Execution. The intended purpose of introducing Parate Execution, as explained by the legal expert, is to circumvent potential liquidity challenges that banks might encounter when dealing with bad loans. This is particularly pertinent given the protracted nature of recovery through court proceedings.
Conversely, some contend that the introduction of the Parate law aimed to facilitate easier borrowing for small and medium-sized businesses in Sri Lanka. This perspective views it to streamline the loan recovery process for banks, which were initially reluctant to provide loans due to challenges in recovering them. Dr. Nandalal Weerasinghe, the Governor of the Central Bank, supports this argument, asserting that without the ability to employ Parate laws, banks might be hesitant to extend loans, potentially causing significant economic repercussions.
The reality of Parate law
However, the reality, as pointed out by the banker-lawyer, is that over 95% instances, banks have to acquire properties and this approach fails to generate cash inflow, rendering the intended solution to liquidity issues ineffective.
The issue is compounded when it comes to auctioning properties that are occupied. Potential bidders are discouraged from participating due to the additional legal complexities involved in evicting occupants. As a result, the selling bank is left with the property at a nominal price of Rs. 1,000.00, exacerbating the liquidity challenge.
The legal-banking expert also asserts that a blanket suspension of Parate Execution is not warranted across all sectors. Instead, he argues for a more targeted approach, emphasizing that only small and medium enterprises in the commercial and industrial sectors require such relief. The rationale behind this targeted relief is clear – the failure of these economic units has a cascading effect on employment and the supply of goods. Therefore, maintaining their operational continuity is crucial for overall economic stability.
Similarly, the lawyer advises against incorporating personal loans in the suspension of Parate Execution. Doing so would impede the recovery process from the crisis, introducing complexities that might obstruct the overall resolution. Essentially, a nuanced and strategic approach is necessary for the suspension of Parate Execution, ensuring it aligns with the specific needs of businesses and industries vital for economic health, without enabling certain personal borrowers to unduly exploit it.
The impact of Parate suspension
Selvarajah Thumilan has emphasised that in 2023, banks applied the Parate law in 1,140 cases, contradicting the figure of 557 cases reported by the Central Bank, which says about 38 billion were claimed from 557 people using Parate laws in the year 2023 and that account for only about 0.4 percent of total loans. He has said there were about Rs 1.4 trillion worth of non-performing loans (NPLs) and only 1.7 percent of those loans were subjected to Parate laws.
This implies that a significant portion of Non-Performing Loans (NPLs) lacks property collateral that can be sold within the current legal framework for recovery. These loans are typically disposed of with political influence, and over time, banks often must write them off.
(The writer, a senior Chartered Accountant and professional banker, is Professor at SLIIT University, Malabe. He is also the author of the “Doing Social Research and Publishing Results”, a Springer publication (Singapore), and “Samaja Gaveshakaya (in Sinhala). The views and opinions expressed in this article are solely those of the author and do not necessarily reflect the official policy or position of the institution he works for. He can be contacted at saliya.a@sliit.lk and www.researcher.com)