Supreme Court: In appeals filed by a Nationalised Bank against the judgment and order passed by the Madras High Court, wherein the Court held that the forfeiture of the earnest money deposit by the bank could only be to the extent of the loss suffered by it, the Three Judge Bench of Dr. Dhananjaya Y. Chandrachud, CJI, JB Pardiwala*, and Manoj Misra, JJ. while setting aside the impugned judgment and order, has held that the entire earnest money deposited by an auction purchaser would be forfeited as per Rule 9(5) of the Security Interest (Enforcement) Rules, 2002 (SARFAESI Rules) on the failure to deposit the remaining amount within the stipulated period.
Background
The Central bank of India (‘Bank’) had sanctioned credit facilities to ‘Best and Crompton Engineering Projects’ against a parcel of land with superstructures, as security interest in the form of a simple mortgage in lieu of the sanctioned credit. Thereafter, the said borrowers defaulted, and the loan account was classified as a non-performing asset (‘NPA’) by the bank. To recover its dues, the bank took measures under Section 13(4) of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”), by taking over the possession of the Secured Asset and putting the same for sale by way of public auction. Accordingly, an e-auction notice for the sale of Secured Asset at a reserve price was issued by the bank.
Pursuant to the same, the e-auction was conducted, and four bids were received, where the respondent also participated and submitted its highest bid, and he was declared the successful auction purchaser. Thereafter, the respondent on the same day deposited 25% of the bid amount as the earnest money deposit upon which, the bank confirmed the sale of the secured asset in favour of the respondent vide its letter which stipulated that in the event of default in payment of the balance amount, the sale shall be liable to be cancelled and the earnest money would be forfeited. The respondent, being unable to pay the balance amount within the extended period, sought an additional 15 days to make the balance payment. However, the bank turned down the said request for further extension and intimated the respondent that due to its failure in remitting the balance amount within the stipulated time, the sale is cancelled, and the amount already deposited stands forfeited.
High Court’s Order:
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Rule 9(5) of the SARFAESI Rules is merely an enabling provision that permits forfeiture in principle. It cannot override the underlying ethos of Section 73 of the Contract Act, 1872 (‘1872 Act’). It should yield to the principle recognised in Section 73 of the 1872 Act or must be read down accordingly.
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By virtue of the delegated legislation as in the SARFAESI Rules, the basic principle in the 1872 Act should not be diluted or disregarded.
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Rule 9(5) of the SARFAESI Rules if not read along with the principle recognised in Section 73 of the 1872 Act, the same may result in a secured creditor unjustly enriching itself which is not permissible.
Issues and Analysis:
1. Whether the underlying principle of Section(s) 73 & 74 of the 1872 Act is applicable to forfeiture of earnest-money deposit under Rule 9(5) of the SARFAESI Rules?
The Court took note of the legislative history and scheme of the SARFAESI Act and the applicability of Sections 73 & 74 of the 1872 act to forfeiture under the SARFAESI Rules.
The Court said that it appears that the High Court whilst passing the impugned order was of the view that the legislature had provided for forfeiture under the SARFAESI Rules as a relief to the secured creditor for the breach of obligation by the auction purchaser. Thus, as per the High Court, Section 73 of the 1872 Act will be applicable to forfeiture under Rule 9(5) of the SARFAESI Rules and any forfeiture will only be allowed to the extent of the loss or damage suffered by the secured creditor.
Forfeiture under the SARFAESI Rules
The Court referred to Madras Petrochem Ltd. v. BIFR, (2016) 4 SCC 1, wherein it was observed that Sections 35 and 37 of the SARFAESI Act form a unique scheme of overriding provisions, however the scope and ambit of Section 37 is restricted only to securities law.
The Court said that the legislature through Rule 9(5) of the SARFAESI Rules, has made a conscious departure from the general law by statutorily providing for the forfeiture of earnest-money deposit of the successful auction purchaser for its failure in depositing the balance consideration within the statutory period. The forfeiture is a result of a breach of obligation, but the consequence of forfeiture in such case is taking place not because of the breach, but because of operation of the statutory provision providing for forfeiture that is attracted because of the breach.
After referring to SBI v. C. Natarajan, 2023 SCC OnLine SC 510 it added that if the consequence of forfeiture was purely a matter of breach of contract, then there would have been no occasion for the legislature to specifically provide for forfeiture through the statutory provisions, and it would have simpliciter relegated the consequences of such breach to already existing general law under Sections 73 and 74 of the 1872 Act.
The Court further said that the legislature has consciously provided for only one consequence in the event of failure of the successful auction purchaser in depositing the balance amount i.e., forfeiture and has not provided for imposition of any other stipulation by the secured creditor in the event of a breach, by keeping in mind the larger object of the SARFAESI Act, which is to facilitate recovery of debt in a time-bound manner by giving teeth to the measures enumerated within Section 13 of the SARFAESI Act, more particularly sale of the secured asset in the event the borrower fails to repay the debt. If Sections 73 and 74 of the 1872 Act are interpreted to be made applicable to a breach in payment of balance amount by the successful auction purchaser, it would lead to a chilling effect. Thus, it said that such an interpretation would completely defeat the very purpose and object of the SARFAESI Act and would reduce the measures provided under Section 13 of the SARFAESI Act to a farce and thereby undermining the country’s economic interest.
Further, the Bench said that SARFAESI Act is a special legislation with an overriding effect on the general law, and only those legislations which are either specifically mentioned in Section 37 or deal with securitization will apply in addition to the SARFAESI Act. Thus, the underlying principle envisaged under Sections 73 and 74 of the 1872 Act which is a general law will have no application, when it comes to the SARFAESI Act, more particularly the forfeiture of earnest-money deposit which has been statutorily provided under Rule 9(5) of the SARFAESI Rules as a consequence of the auction purchaser’s failure to deposit the balance amount.
Concept of Earnest-Money & Law on Forfeiture of Earnest-Money Deposit:
The Court examined the true purport and meaning of the term ‘forfeiture’. Further, by referring to Fateh Chand v. Balkishan Dass, 1963 SCC OnLine SC 49; Maula Bux v. Union of India, (1969) 2 SCC 554 and Satish Batra v. Sudhir Rawal, (2013) 1 SCC 345, it said that there lies a difference between ‘forfeiture of any amount’ and ‘forfeiture of earnest money’ with the former being a penal clause and the latter a general forfeiture clause. A clause providing for forfeiture of an amount could fundamentally be in the nature of a penalty clause or a forfeiture clause in the strict sense or even both, and the same has to be determined in the facts of every case keeping in mind the nature of contract and the nature of consequence envisaged by it. Thus, as Rule 9 (5) provides for the forfeiture of only the earnest money deposit of the successful auction purchaser i.e. only 25% of the total amount, it cannot be regarded as a penal clause.
The Court reiterated the difference between an earnest deposit and an advance part payment of price, that the practice of giving earnest is current in the present-day commercial contracts. An advance is made and accepted by way of deposit or guarantee for the due performance of the contract.
Thus, it said that forfeiture can be justified, if the terms of the contract are clear and explicit. If it is found that the earnest money was paid in accordance with the terms of the tender for the due performance of the contract by the Promisee, the same can be forfeited in case of non-performance by him or her.
Placing reliance on Kailash Nath Associates v. DDA, (2015) 4 SCC 136, wherein it was held that Section 74 of the 1872 Act will be applicable to cases of forfeiture of earnest-money deposit, however, where such forfeiture takes place under the terms and conditions of a public auction, Section 74 will have no application, it was held that Sections 73 and 74 of the 1872 Act will have no application when it comes to forfeiture of the earnest-money deposit under Rule 9 (5) of the SARFAESI Rules.
Concerning the view of the High Court that Rule 9(5) of the SARFAESI Rules must be read down so as to yield to the underlying principle recognized in Sections 73 & 74 of the 1872 Act, the Court explained the principle of “reading down” a provision, as a legal interpretation approach, where a court, while examining the validity of a statute, attempts to give a narrowed or restricted meaning to a particular provision to uphold its constitutionality. This principle is rooted in the idea that courts should make every effort to preserve the validity of legislation and should only declare a law invalid as a last resort.
The Court noted that the High Court has resorted to reading down Rule 9(5) of the SARFAESI Rules not because its plain meaning would result in the provision being rendered invalid or unworkable or the statute’s objective being defeated, but because it would result in the same harsh consequence of forfeiture of the entire earnest-money deposit irrespective of the extent of default in payment of balance amount.
Further, it said that harshness of a provision is no reason to read down the same, if its plain meaning is unambiguous and perfectly valid. A law/rule should be beneficial in the sense that it should suppress the mischief and advance the remedy. The harsh consequence of forfeiture of the entire earnest-money deposit has been consciously incorporated by the legislature in Rule 9(5) of the SARFAESI Rules to sub-serve the larger object of the SARFAESI Act of timely resolving the bad debts of the country, and the idea behind prescribing such a harsh consequence is not illusory, it is for attaching a legal sanctity to an auction process once conducted under the SARFAESI Act from ultimately getting concluded.
Thus, it was held that the High Court committed an egregious error by proceeding to read down Rule 9(5) of the SARFAESI Rules in the absence of the said provision being otherwise invalid or unworkable in terms of its plain and ordinary meaning without appreciating the purpose and object of the said provision.
2. Whether the forfeiture of the entire amount towards the earnest-money deposit under Rule 9(5) of the Rules amounts to unjust enrichment?
The Court said that when an auction fails, and a fresh auction is required to be conducted in respect of the Secured Asset, there looms a degree of uncertainty as to the extent of bids that may be received in the future auction or whether the fresh auction would even be successful or not. Often, with the efflux of time, the value of the Secured Asset erodes. In such a case it would be preposterous to tie or limit the forfeiture under Rule 9(5) of the SARFAESI Rules on an eventuality or a contingency of a subsequent sale of the secured asset if any.
While examining the meaning of ‘unjust enrichment’, the Court said that it is clear that the concept of ‘unjust enrichment’ is a by-product of the doctrine of equity, and equity cannot supplant the law, equity has to follow the law if the law is clear and unambiguous
Thus, it said that the consequence of forfeiture of 25% of the deposit under Rule 9(5) of the SARFAESI Rules is a legal consequence that has been statutorily provided in the event of default in payment of the balance amount. The consequence envisaged under Rule 9(5) follows irrespective of whether a subsequent sale takes place at a higher price or not, and this forfeiture is not subject to any recovery already made or to the extent of the debt owed. In such cases, no extent of equity can either substitute or dilute the statutory consequence of forfeiture of 25% of deposit under Rule 9(5) of the SARFAESI Rules.
Thus, it was held that the High Court erred in law by holding that forfeiture of the entire deposit under Rule 9 (5) of the SARFAESI Rules by the bank after having already recovered its dues from the subsequent sale amounts to unjust enrichment.
3. Whether a case of exceptionable circumstances could be said to have been made out by the respondent to set aside the order of forfeiture of the earnest money deposit?
After taking note of Alisha Khan v. Indian Bank (Allahabad Bank), 2021 SCC OnLine SC 3340, wherein it was held that where extraneous conditions exist that might have led to the inability of the successful auction purchaser despite best efforts from depositing the balance amount to no fault of its own, in such cases the earnest-money deposited by such innocent successful auction purchaser could certainly be asked to be refunded.
The Court noted that it is the respondent’s case that he was unable to make the balance payment owing to the advent of the demonetisation. The same led to a delay in raising the necessary finance. It has been pleaded by the respondent that the bank failed to provide certain documents to him in time because of which he was not able to secure a term loan. However, it said that this not an exceptional circumstance warranting judicial interference as demonetization had occurred much before the e-auction was conducted by the bank. Further, the respondent was granted an extension of 90 days time period to make the balance payment and was specifically reminded that no further extension would be granted, in spite of this he failed to make the balance payment.
Thus, it said that the respondent, being aware of his financial capacity, willingly participated in the e-auction and offered his bid fully knowing the reserve price of the Secured Asset and the consequences of its failure in depositing the balance amount.
[Authorised Officer, Central Bank of India v. Shanmugavelu, 2024 SCC OnLine SC 92, decided on 02-02-2024]
*Judgment Authored by: Justice JB Pardiwala
