Bombay High Court
Case BriefsHigh Courts

   

Bombay High Court: The issue before the Court in the instant matter was that between a secured creditor (defined in SARFAESI Act and Recovery of Debt and Bankruptcy Act), and the revenue departments of the Central/State Governments, who can legally claim priority for liquidation of their respective dues qua the borrower/dealer upon enforcement of the ‘security interest' and consequent sale of the ‘secured asset'. The 3 Judge Bench of Dipankar Datta, CJ., and M.S. Karnik and N.J. Jamadar, JJ., while deliberating upon the question went on to frame and answer seven substantial questions of law on the issue.

Background: Prior to 1993, for effecting recovery of debts, the lenders were required to institute suits regulated by the provisions of the CPC. However, the lengthy processes and other problems led to ‘retardation of economic growth'. It is at this point that the Parliament enacted the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, which was instrumental in establishing the Debt Recovery Tribunals in various States for expeditious adjudication and recovery of debts due to the lenders and other connected matters.

In due course of time, even the creation of DRTs fell short of achieving the desired results and after many deliberations, the SARFAESI Act came into being, which aimed at evolving means for faster recovery of dues without judicial intervention. The afore-stated legislations were deliberated by the Supreme Court in Central Bank of India v. State of Kerala, (2009) 4 SCC 94, wherein it was held that these legislations do not create first charge in favour of banks, financial institutions and other secured creditors over the first charge created under State legislations because Parliament did not intend to give priority to the dues of private creditors over sovereign debt of the State.

Later in 2016, via an amendment, the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 was rechristened as Recovery of Debt and Bankruptcy Act and Section 31-B- ‘Priority to the Secured Creditors' was incorporated. Even SARFAESI underwent an amendment in 2016 and Chapter IV-A- ‘Registration by Secured Creditors and Other Creditors', was added. These amendments resulted in another slew of decisions by several High Courts wherein it was observed that the amendments have tilted the scales in favour of the secured creditors and being a pre-2016 Amendment decision, the Central Bank of India case is no longer relevant.

Given the broad questions of law involved in the issue, the Division Bench of this Court comprising of Dipankar Datta, CJ., and M.S. Karnik, J., referred the matter to a larger Bench for consideration, therefore leading to the present writ petition

Primary Contentions: The secured creditors submitted that the priority created by Section 31-B of RDDB Act is not restricted to enforcement under this Act itself as the provision recognizes priority in a general manner. It was further submitted that the SARFAESI Act also recognises priority. It was contended that in view of amendments brought in both the Central enactments, they are entitled to assert priority over claims of the State sales tax department under the Maharashtra Value Added Tax Act.

The creditors also submitted that there is no dispute that the Central Acts and the State legislations operate in different fields and there is no apparent repugnancy; on the contrary, the State legislations are clear to this extent that the same would yield to Central Acts creating first charge.

Per contra, the State Government and its departments argued that Section 26-E as inserted in the SARFAESI Act does not create first charge in favour of the secured creditors; it only provides priority of payment to secured creditors over other creditors. Placing their interpretation of the newly added provisions, the counsels contended that that ‘priority' as inserted by the 2016 Amendment Act shall not displace the ‘first charge' of the State wherever the respective enactments provide so. The secured creditors shall have ‘priority' over Government dues only in cases where dues arising out of an enactment did not provide for the ‘first charge'.

Seven Questions of Law framed by the Court

  1. Does a secured creditor have a prior right over the relevant department of the Government to appropriate the amount realized by the sale of a secured asset?

  2. Despite Section 26-E in the SARFAESI Act or Section 31-B of the RDDB Act being attracted in a given case, whether dues accruing to a department of the Government ought to be repaid first by reason of ‘first charge' created over any property by operation of law (viz. the legislation in force in Maharashtra) giving such dues precedence over the dues of a secured creditor?

  3. Are the provisions in the SARFAESI Act according ‘priority' in payment of dues to a secured creditor for enforcing its security interest, prospective in nature?

  4. Whether Section 31-B of the RDDB Act can be pressed into service for overcoming the disability that visits a secured creditor in enforcing its security interest under the SARFAESI Act, upon such creditor's failure to register the security interest in terms of the amendments introduced in the SARFAESI Act?

  5. Whether the priority of interest contemplated by section 26-E of SARFAESI Act could be claimed by a secured creditor without registration of the security interest with the Central Registry?

  6. When, (if at all) can it be said that the statutory first charge under the State legislations (MVAT Act, MGST Act) stands displaced having regard to introduction of Chapter IV-A in the SARFAESI Act from 24-01- 2020?

  7. Whether an auction purchaser of a secured asset would be liable to pay the dues of the department in order to obtain a clear and marketable title to the property having purchased the same on “as is where is and whatever there is basis”?

The Answers

Questions 1 and 2: The Court perused the newly added provisions in the SARFAESI Act via the 2016 Amendment and noted that the object that the Parliament had in mind while incorporating Chapter IV-A in the SARFAESI Act seems crystal clear. “The dominant theme of the additions in the statute were intended to emphasize upon the need to register transactions of securitisation, reconstruction and creation of security interest with the Central registry (CERSAI)”. It was observed that Parliament designed Chapter IV-A in such a manner so as to include provisions which on the one hand, would disable any secured creditor to exercise the right of enforcing security interest under Chapter III of the SARFAESI without the CERSAI registration, and on the other enable the secured creditor, if it has the CERSAI registration, to claim priority over all other debts and all revenues, taxes, etc., in the matter of payment of the debts due to it. The Parliament used the word ‘priority over all other dues' in the SARFAESI Act to obviate any confusion as to inter-se distribution of proceeds received from sale of properties of the borrower/dealer.

Bare perusal of the 2016 Amending Act would show that the dues of the Central/State Governments were in the specific contemplation of the Parliament while it amended the RDDB Act and the SARFAESI Act, both of which make specific reference to debts and all revenues, taxes, cesses and other rates payable to the Central Government or State Government or local authority and ordains that the dues of a secured creditor will have ‘priority', i.e., take precedence.

It was stated the SARFAESI and RDDB Act being Central legislations, will prevail over State legislations as per the principle enshrined in Art. 254 of the Constitution. “Subject to compliance of the terms of Chapter IV-A, Section 26-E of the SARFAESI Act would thus override any provision in the MGST Act and the BST Act in case of a conflict with the SARFAESI Act”.

We have no hesitation to hold that the dues of a secured creditor (subject of course to CERSAI registration) and subject to proceedings under the IBC, would rank superior to the dues of the relevant department of the State Government”.

Question 3: Answering the question in affirmative, the Court once delved into the intention of the Legislature into bringing the 2016 Amendments in SARFAESI Act and RDDB Act via its Statement of Objects and Reasons. It was observed that the amendment was proposed to bring about a substantive change in the law and these changes were introduced for the first time “to suit changing credit landscape and augment ease of doing business”, as appears from the Statement for the amendment. These substantial changes, remedial in nature, having been brought in force for the first time, amount to substantive law and cannot be given retrospective effect. It was further noted that express provision in Section 26-D regulating the exercise of power by secured creditors, by barring them to take recourse to Chapter III of the SARFAESI Act without the CERSAI registration, there could be little doubt as to the fact that Section 26-E of the SARFAESI Act would apply prospectively from the date it was brought into force, i.e., 24-01- 2020.

Question 4: Answering this question negative, the Court observed that a statute has to be construed after ascertaining the legislative intent and in the context and scheme of the enactment. It was further stated that the end result of the RDDB Act and the SARFAESI Act is recovery of money, however, the process of recovery under the RDDB Act is largely court driven; and the process of recovery under the SARFAESI Act is essentially without court intervention. The nature of the two proceedings is, therefore, completely different.

The non-obstante clause in Section 31-B of RDDB Act makes it inescapably clear that the provision cannot be pressed into service in all cases where a secured creditor seeks enforcement of a security interest by taking recourse to the SARFAESI Act. Meanwhile, Sections 26-D and 26-E of SARFAESI Act, when read together, provides a special manner in which a secured creditor may enforce its security interest in supersession of others, without the intervention of courts. Enforcement of security interest under the SARFAESI Act by any other method is (if not expressly) impliedly barred.

Thus, Section 31-B of RDDB Act cannot be invoked to undo the disability that is expressly imposed by Section 26-D of the SARFAESI Act, more so when both these provisions have been brought on the respective statute books by the same 2016 Amending Act (notwithstanding that the two sections were made operative on different dates).

“A secured creditor, finding that it is disabled from obtaining the benefit of ‘priority' in terms of Section 26-E of the SARFAESI Act for want of CERSAI registration, cannot fall back on Section 31-B of the RDDB Act to claim ‘priority'”

Question 5: It was noted that the drastic power made available to a secured creditor by provisions contained the SARFAESI Act to dispossess the borrower/guarantor from the secured asset without intervention of Courts (but necessarily upon compliance with the procedural safeguards laid down therefor) has seemingly been arrested to a limited extent by incorporation of Section 26-D by the 2016 Amending Act. “Section 26-D, which also opens with a non-obstante clause, prohibits a secured creditor from exercising the rights for enforcement of security interest conferred by Chapter III, unless the secured interest created in its favour by the borrower has been registered with the CERSAI”. Not only registration with the CERSAI has been made a mandatory pre-condition for invocation of the provisions contained in Chapter III of the SARFAESI Act, the provisions relating to debts that are due to any secured creditor is available to be invoked only after the registration of security interest.

“This leads to the irresistible and inevitable conclusion that unless the security interest is registered, neither can the borrower seek enforcement invoking the provisions of Chapter III of the SARFAESI Act nor does the question of priority in payment would arise without such registration”.

Question 6: The Court opined if there has been an attachment and a proclamation thereof has been made according to a law prior to 24-01-2020 or 01-09-2016, i.e., the dates on which Chapter IV-A of the SARFAESI Act and Section 31-B of the RDDB Act, respectively, were enforced, the department may claim that its dues be paid first notwithstanding the secured dues of the secured creditors. However, in the absence of an order of attachment being made public in a manner known to law, once Chapter IV-A of the SARFAESI Act or Section 31-B has been enforced; the dues of the secured creditor surely would have ‘priority'.

In other words, if the immovable property of the defaulter is shown to have been attached in accordance with any law being enforced prior to Chapter IV-A of the SARFAESI Act, or Section 31-B of the RDDB Act and such attachment is followed by a proclamation according to law, the ‘priority' accorded by Section 26E of SARFAESI and Section 31-B of RDDB Act would not get attracted.

Question 7: It was observed that, notwithstanding the duty of the authorized officer to indicate the encumbrances attached to the secured asset in the sale advertisement inviting bids; if any detail in regard to such encumbrances is not indicated but the sale is expressly made on “as is where is, whatever there is basis”, the transferee shall be duty bound to deposit money for discharge of the encumbrances provided. However, such liability may be overcome if he is in a position to disprove the claim of the department that he had no constructive notice of the charge.

[Jalgaon Janta Sahakari Bank Ltd. v. Joint Commissioner of Sales Tax, 2022 SCC OnLine Bom 1767, decided on 30-08-2022]


Advocates who appeared in this case :

Rajiv Narula a/w Mehek Choudhary i/b. Jhangiani Narula and Associates for the petitioners in WP/2935/2018.


*Sucheta Sarkar, Editorial Assistant has prepared this brief.

Bombay High Court
Case BriefsHigh Courts

Bombay High Court: While deciding the instantwrit petition wherein the issue was regarding transgression of Additional District Magistrate’s jurisdiction under Section 14 of the SARFAESI Act; the Division Bench of A.S. Doctor and K.R. Shriram, JJ., observed that the jurisdiction of the Designated Authority under Section 14 of the SARFAESI Act is purely ministerial and limited only to assisting secured creditors in taking possession of secured assets and nothing more. “Section 14 of the SARFAESI Act does not contemplate much less empower the DA to even consider much less adjudicate upon any objections raised by Borrower or anybody else”.

Brief Facts– In September 2014, the borrowers approached one Religare Finvest Limited for Rs.6 crore loan and the same was issued by the Religare on 30-09-2014. Subsequently, borrowers committed defaults in repayment of the said loan and hence, Religare declared the borrowers’ account as a Non-Performing Asset. Thereafter, they issued a notice on 31-03-2018 under Section 13(2) of the SARFAESI Act, entreating borrowers to pay the amount within sixty days.

Later, in September 2018, Religare assigned all its rights to Phoenix ARC (P) Ltd., (the petitioner) by a deed of assignment .A second SARFAESI notice was sent to the borrowers, however, the borrowers in reply denied their liability.

Petitioner filed an application under Section 14 of SARFAESI Act seeking the assistance of the Additional District Magistrate, Nashik for taking the physical possession of the secured assets. On 10-08-2020, the second respondent who was a tenant at secured asset premises of the company, intervened the proceedings. The ADM via his Order dated 27-08-2021, declined to assist the petitioner and ordered that further orders regarding possession and mortage would be decided after the termination of tenancy rights of the second respondent. .

Aggrieved with the afore-stated Order, the petitioner approached the High Court.

Contentions: The Petitioner contended that the ADM’s order was in excess of jurisdiction under Section 14 of the SARFAESI Act. It was sumbitted that Section 14 was only limited to assisting the secured creditors to obtain the secured assets and nothing more.

  • Observations: The Court strictly observed that the impugned Order is yet another instance of the Designated Authorities under Section 14 of the SARFAESI Act not only failing and/or neglecting to exercise their jurisdiction but instead, and regrettably acting in excess of and contrary to the jurisdiction vested in them under Section 14. “Such conduct on the part of the DA is now common place and is being impugned repeatedly before this Court. This is despite the fact that the scope of Section 14 as also the jurisdiction of the DA thereunder is not only clear from a plain reading of Section 14 but has since been emphasized in several judgements of the Supreme Court as well as this Court”.

  • It was observed that jurisdiction of the CMM/DM under Section 14 of the SARFAESI Act is purely ministerial and limited only to assisting secured creditors in taking possession of secured assets. The Court pointed out that it is implicit in Chapter III of the SARFAESI Act that the DA on finding that the secured creditor has complied with Section 14 must act promptly and with due dispatch in ensuring that possession of the secured asset is recovered as quickly as possible.

  • The Court highlighted the objective of SARFAESI Act which is to enable secured creditors to enforce their security interest without the intervention of the Court or Tribunal.

  • The Bench expressed their shock at the observations made by the ADM. Where on one hand the ADM held the petitioner’s application under Section 14, SARFAESI to be legally valid, but in the same vein, denied relief to the petitioner, thereby derailing the objective of the SARFAESI Act.

“We find that the DA under Section 14 of the SARFAESI Act claim powers which they do not have under Section 14 and proceeds to pass orders which are completely contrary to the provisions of Section 14 and the very object and purpose of Chapter III of the SARFAESI Act. We find that the conclusion reached by ADM in the impugned order is a prime example of this very worrying trend”.

Decision: With the afore-stated observations, The Court held that the impugned Order passed by the ADM is patently illegal and contrary to Section 14.

It was alsoheld that the ADM had transgressed the jurisdiction vested in him under Section 14 . Thus the impugned order was quashed and set aside. [Phoenix ARC Pvt. Ltd. v. The State of Maharashtra, 2022 SCC OnLine Bom 1710, decided on 03-08-2022]


Advocates who appeared in this case :

Petitioner- Prathmesh Kamat along with Jyoti Sanap, I/by V. Deshpande & Company

Respondents: S.D. Vyas, GP, ‘B’ Panel for Respondent No.1-State;

Durgesh Rege, for the Respondent Nos.2(a) to 2(d);

Mayank Bagla i/by Jainish Jain, for the Respondent Nos.3 to 9.


*Sucheta Sarkar, Editorial Assistant has reported this brief.

Case BriefsSupreme Court

Supreme Court: The bench of L. Nageswara Rao and BR Gavai*, JJ has held that the proceedings under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) cannot continue once the CIRP has been initiated and the moratorium has been ordered as per the Section 14(1)(c) of the Insolvency and Bankruptcy Code, 2016 (IBC).

The Indian Oversees Bank had extended certain credit facilities to the Corporate Debtor. When the Corporate Debtor failed to repay the dues and the loan account became irregular, it came to be classified as “Non¬Performing Asset” (NPA).

The Bank issued a Demand Notice under Section 13(2) of the SARFAESI Act, calling upon the Corporate Debtor and its guarantors to repay the outstanding amount due. Upon failure to do so, the Bank, under Section 13(4) of the SARFAESI Act, took symbolic possession of two secured assets of the Corporate Debtor and Corporate Guarantor, mortgaged exclusively with it. E-auctions were also held to recover the public money availed by the Corporate Debtor.

Later, NCLT, passed an order under Section 10 of the IBC, after which the Corporate Insolvency Resolution Process (CIRP) of the Corporate Debtor commenced. A moratorium under Section 14 of the IBC was notified and an Interim Resolution Professional (the IRP) was also appointed.

It is important to note, that 75% of the sale consideration from E-Auctions was received before initiation of the CIRP. The remaining 25% was recovered subsequently. Hence, it was argued that merely because a part of the sale consideration was received subsequently, it could not affect the sale. It was also argued before the Court that the CIRP was initiated only to stall the SARFAESI proceedings.

It was submitted before the Court that Section 14(1)(c) of the IBC interdicts any action to foreclose, recover or enforce any security interest including any action under SARFAESI. However, it does not undo actions which have already stood completed.

The Court, however, noticed that, in the case at hand, the balance amount was accepted by the Bank on 8th March 2019. The sale stood completed only on 8th  March 2019. Admittedly, this date falls much after 3rd January 2019, i.e., on which date CIRP commenced and moratorium was ordered.  Hence, the Court refused to accept the argument of the Bank that the sale was complete upon receipt of the part payment.

The Court explained that under Section 14(1)(c) of the IBC, which has overriding effect over any other law, any action to foreclose, recover or enforce any security interest created by the Corporate Debtor in respect of its property including any action under the SARFAESI Act is prohibited.

Considering that IBC is a special Code, its provisions have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law.

It is thus clear that after the CIRP is initiated, there is moratorium for any action to foreclose, recover or enforce any security interest created by the Corporate Debtor in respect of its property including any action under the SARFAESI Act. It is clear that once the CIRP is commenced, there is complete prohibition for any action to foreclose, recover or enforce any security interest created by the Corporate Debtor in respect of its property. The words “including any action under the SARFAESI Act” are significant.  The legislative intent is clear that after the CIRP is initiated, all actions including any action under the SARFAESI Act to foreclose, recover or enforce any security interest are prohibited.

[Indian Overseas Bank v. RCM Infrastructure ltd., 2022 SCC OnLine SC 634, decided on 18.05.2022]


*Judgment by: Justice BR Gavai


For Bank: Senior Advocate Tushar Mehta

For aution purchasers: Senior Advocate C.S. Vidyanathan

For Respondents: Senior Advocate K.V. Viswanathan and Advocate Aditya   Verma

Case BriefsSupreme Court

Supreme Court: The Division Bench of L. Nageswara Rao and Vineet Saran*, JJ., quashed the confiscation order of Customs and Central Excise Commission confiscating land, building, plant and machinery of Rathi Ispat Ltd. for lacking statutory backing. The Bench observed that the existing law only permit confiscation of goods and no land, building can be confiscated under the Central Excise Rules, 2017.

Chronology of Events

  • The Commissioner, Customs and Central Excise, Ghaziabad (Commissioner) had imposed a penalty of Rs.7,98,03,000 and confiscated the land, building, plant and machinery of Rathi Ispat Ltd. (RIL) under Rule 173Q(2) of the Central Excise Rules, 1944 on 25-11-1997.
  • However, the said order was set aside by the Customs, Excise & Gold (Control) Appellate Tribunal (now CESTAT) for being contrary to principles of natural justice, and the matter was remanded back for de novo proceedings.
  • Subsequently, subrule 2 of Rule 173Q of the Central Excise Rules, 1944, came to be omitted by a notification dated 12-05-2000.
  • In 2005, RIL availed credit from the consortium of banks with the Appellant/Punjab National Bank being the lead bank, and mortgaged all its movable and immovable properties for securing the loan.
  • By the order dated 26-03-2007, the Commissioner confirmed the demand of excise duty of Rs.7,98,02,226 and a penalty of Rs.7,98,03,000 on RIL. The Commissioner also ordered, under rule 173Q(2) of the 1944 Rules, for the confiscation of all the land, building, plant, machinery and materials used in connection with manufacture and storage.
  • Similarly, the Central Excise Commissioner, vide order dated 29-03-2007, confirmed a demand of central excise duty amounting to Rs.2,67,00,348 and Rs.74,24,332 from RIL and also imposed a penalty of Rs.3,41,24,68 and further, under rule 173Q(2) of the 1944 Rules, ordered confiscation of land, building, plant, machinery, material, conveyance etc.

RIL’s Default in Clearing the Loan

Since RIL defaulted in clearing the loan amount and had failed to liquidate outstanding dues, the Appellant bank issued notice to RIL under section 13(2) of the SARFAESI Act, 2002, however, Commissioner, Customs and Central Excise had already confiscated the property by virtue of Rule 173Q(2) of Rules, 1944. Aggrieved, the appellant bank approached the Allahabad High Court with its grievances, however dismissing the petition, the High Court held that if any property has been confiscated it vests in the state and no person can claim any right, title, or interest over it, further the High Court opined that the bank had no locus standi to challenge the order as RIL had already preferred an appeal against confiscation.

Question of Law

  1. Whether the Commissioner could have invoked the powers under Rule 173(Q)(2) of Central Excise Rules, 1944 on 26-03-2007 and 29-03-2007 when on such date, the rule 173Q(2) was not on the Statue Book having been omitted w.e.f. 17-05-2000?
  2. Whether in the absence of any provisions providing for First Charge in relation to Central Excise dues in the Central Excise Act, 1944, the dues of the Excise department would have priority over the dues of the Secured Creditors or not?

Validity of Confiscation Order

The Bench noted that in the impugned order, the High Court had not considered that on the date of the confiscation orders Rule 173Q(2) stood omitted from the statute books. Rejecting the contention of the respondent that notwithstanding the omission of Section 173Q(2) from the 1944 Rules the proceedings were entitled to continue on account of Section 38A(c) and Section 38A(e) of the Central Excise Act, 1944, read along with Section 6 of the General Clauses Act, 1897 as misplaced and lacking statutory backing, the Bench opined that the proceedings initiated under the erstwhile Rule 173Q(2) would come to an end on the repeal of the said Rule 173Q(2).

The Bench followed the decision of Kolhapur Canesugar Works Ltd. v. Union of India, (2000) 2 SCC 536, wherein it had been held that Section 6 of the General Clauses Act, 1897 is applicable where any Central Act or Regulation made after commencement of the General Clauses Act repeals any enactment. It is not applicable in the case of omission of a “Rule”. Secondly, Section 38A(c) and 38A(e) of the Central Excise Act, 1944, are attracted only when “unless a different intention appears”.

Noticeably, in the instant case the legislature had clarified its intent to not restore/revive the power of confiscation of any land, building, plant machinery etc., after omission of the provisions which could be inferred from the fact that power to confiscate any land, building, plant, machinery etc. after omission had not been introduced in the subsequent Central Excise Rules, 2001, Central Excise Rules, 2002 and Central Excise Rules, 2017.

Additionally, this intent was also fortified by the fact that the newly enacted Rule 28 of the Rules of 2001, Rule 28 of the Rules of 2002 and Rule 28 of the Rules of 2017, did not provide for confiscation of any land, building, plant, machinery etc. and their consequent vesting in the Central Government, as Rule 28 only provided for vesting in the Central Government of the “Goods” confiscated by the Central Excise Authorities under the Excise Act, 1944.

Whether the dues of the Excise department create a First Charge?

In UTI Bank Ltd. v. Commissioner Central Excise, 2006 SCC Online Madras 1182, it had been held that since there is no specific provision claiming “first charge” in the Central Excise Act and the Customs Act, the claim of the Central Excise Department cannot have precedence over the claim of secured creditor, viz., the petitioner Bank. Similarly, in Union of India v. SICOM Ltd., (2009) 2 SCC 121, it was observed that prior to insertion of Section 11E in the Central Excise Act, 1944 w.e.f. 08-04-2011, there was no provision in the Act inter alia, providing for First Charge on the property of the assessee or any person under the Act of 1944.

Further, section 35 of the SARFAESI Act, 2002 inter alia, provides that the provisions of the SARFAESI Act shall have overriding effect on all other laws. Therefore, the provisions of Section 11E of the Central Excise Act, 1944 are subject to the provisions contained in the SARFAESI Act, 2002. Therefore, the Bench held that the Secured Creditor-Bank would have a First Charge on the Secured Assets.

Verdict

In the light of above, the Bench concluded that the Commissioner of Customs and Central Excise could not have invoked the powers under Rule 173Q(2) of the Central Excise Rules, 1944 on 26-03-2007 and 29-03-2007 for confiscation of land, buildings etc., when on such date, the said Rule 173Q(2) was not in the Statute books, having been omitted by a notification dated 12-05-2000. Secondly, the dues of the secured creditor, i.e. the bank, would have priority over the dues of the Central Excise Department. Accordingly, the appeal was allowed and the confiscation orders were quashed.

[Punjab National Bank v. Union of India, 2022 SCC OnLine SC 227, decided on 24-02-2022]


*Judgment by: Justice Vineet Saran 


Appearance by:

For the Appellant: Dhruv Mehta, Senior Counsel

For Union of India: K.M. Nataraj, Additional Solicitor General


Kamini Sharma, Editorial Assistant has put this report together

Experts CornerKhaitan & Co

Introduction

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) is an act “to regulate securitisation and reconstruction of financial assets and enforcement of security interest and to provide for a central database of security interests created on property rights, and for matters connected herewith or incidental thereto”. As per Section 13(2) of the SARFAESI Act, where any borrower, who is under a liability to a secured creditor makes any default in repayment of secured debt or any instalment thereof, and his account in respect of such debt is classified by the secured creditor as a non-performing asset, then the secured creditor may require the borrower by notice in writing to discharge in full his liabilities to the secured creditor within 60 (sixty) days from the date of the notice, failing which, the secured creditor shall be entitled to exercise all or any of the rights to take possession of the secured assets under Section 13(4) of the SARFAESI Act and sell the same without the intervention of the court.

 

With that background, we aim to analyse whether the auction-purchasers can purchase the secured asset from the secured creditors under SARFAESI Act and the Security Interest (Enforcement) Rules, 2002 (SARFAESI Rules) (collectively “SARFAESI”) free from encumbrance including those arising out of pending statutory dues.

 

Priority of dues: An analysis

 

With the introduction of the SARFAESI Act, several banks contended that given the non obstante clause in Section 35, the banks being the secured creditors will have priority over the State’s first charge. However, the Supreme Court in Central Bank of India v. State of Kerala[1] clarified that SARFAESI Act does not provide for first charge to the secured debts due to banks and State sales tax law which are creating first charge in favour of the State shall prevail. Further, the Supreme Court in Dena Bank v. Bhikhabhai Prabhudas Parekh & Co.[2] has held that the crown debts have priority over secured debts only if a statute gives such priority to its dues. Above stated, we understand that the position of law was that if State law provides for priority to statutory dues that shall prevail over secured debts of the banks.

 

However, with the insertion of Section 26-E via the Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016 (amending Act), the above discussed position underwent a change and now any security created and recorded with the Central Registry3 is accorded statutory priority in accordance with Section 26-E of the SARFAESI Act. The text of Section 26-E of the SARFAESI Act (Section 26-E) reads as under:

 

26-E. Priority to secured creditors.— Notwithstanding anything contained in any other law for the time being in force, after the registration of security interest, the debts due to any secured creditor shall be paid in priority over all other debts and all revenues, taxes, cesses and other rates payable to the Central Government or State Government or local authority.

Explanation.— For the purposes of this section, it is hereby clarified that on or after the commencement of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), in cases where insolvency or bankruptcy proceedings are pending in respect of secured assets of the borrower, priority to secured creditors in payment of debt shall be subject to the provisions of that Code.[3]

Various litigations came before different courts on the interpretation of Section 26-E and brought forth certain pressing common questions. To understand the current position, we shall be discussing certain important judgments below and presenting our analysis:

(i) If a State tax act also has a non -obstante clause, will Section 26-E prevail over it?

a) The Gujarat High Court in Kalupur Commercial Cooperative Bank Ltd State of Gujarat[4] (Kalupur) has dealt with the non obstante clause in detail while analysing whether Section 26-E which is a part of the central legislation would prevail over Section 48 of the Gujarat Value Added Tax Act, 2003 (GVAT), a State Act. It referred to the decisions of the Supreme Court in Kumaon Motor Owners’ Union Ltd v. State of U.P.[5] (Kumaon Motor) and Solidaire India Ltd. v. Fairgrowth Financial Services Ltd.[6] (Solidare).

 

The Supreme Court in Kumaon Motor[7] had discerned three principles in case of conflict between the provisions of two statutes viz:

  • If there is a conflict between the provisions of two statutes and nothing is repugnant, the provisions in the later statute would prevail;.
  • While resolving such conflict, the court must look into the object behind the two statutes. In other words, what is to be looked at is what necessitated the legislature to enact a particular provision later in point in time, which may be in conflict with the provisions of earlier statute.
  • The court must look into the language of the provisions. If the language of a particular provision is found to be more emphatic, the same would be indicative of the intention of the legislature that the same shall prevail over other statutes.

 

The Supreme Court in Solidare[8] stated that the principles of law discernible are that, if there is a conflict between two special legislations, the later must prevail. The simple reasoning is that at the time of enactment of the later statute, the legislature could be said to be aware of the earlier legislation and its non obstante clause. If the legislature still confers the later enactment with a non obstante clause, it means that the legislature wanted that enactment to prevail.

 

Having discussed the above, the Gujarat High Court, in Kalupur[9], noted that Section 48 of GVAT “would come into play only when the liability is finally assessed and the amount becomes due and payable”. Basis the above, it came to the conclusion that priority shall be that of the bank under Section 26-E and not of the State.

(b) The Nagpur Bench of the Bombay High Court in Union Bank of India v. State of Maharashtra[10] analysed the language of Section 37(1) of the Maharashtra Value Added Tax Act, 2002 (reproduced below) and ruled that though it begins with a non obstante clause, it is made subject to any provisions of the central legislation dealing with the issue in question. Hence, Section 26-E shall prevail.

    1. Notwithstanding anything contained in any contract to the contrary, but subject to any provision regarding creation of first charge in any Central Act for the time being in force, any amount of tax, penalty, interest, sum forfeited, fine or any other sum payable by a dealer or any other person under this Act, shall be the first charge on the property of the dealer or, as the case may be, person.

 

Similar view was also recently taken by the Division Bench of the Bombay High Court in SBI v. State of Maharashtra[11] (SBI judgment).

 

We further note that recently in Punjab National Bank v. Union of India[12], Supreme Court while dealing with the issue of whether the dues of the Excise Department would have priority over the dues of the secured creditors under Section 11-E to the Central Excise Act (which provides for first charge on the property of the defaulter for recovery), held that since Section 35 of the SARFAESI Act gives it an overriding effect on all other laws, the property shall be subject to the SARFAESI Act. Thus, the right of a secured creditor cannot be hampered and the State’s right to recover debts would prevail over other creditors only in cases where such creditors are unsecured.

 

(ii) Is the auction-purchaser liable to pay off the statutory dues?

(a) The Andhra Pradesh High Court in SBI v. CTO[13] (CTO case) held that the debts advanced by banks/financial institutions have precedence over the statutory dues of the government authorities. Accordingly, any secured asset sold by such bank or financial institution to any purchaser cannot be denied registration due to pending statutory dues and the banks are not entitled to withhold the sale certificate pursuant to the auction held. Further, it was clarified that if any balance of sale consideration amount is available post satisfaction of dues towards the banks, it shall be adjusted towards the dues, if any, of the department concerned.

(b) Similarly, the Gujarat High Court in Kalupur[14] set aside the attachment orders passed under the Section 48 of GVAT and held that as per Section 26-E, the bank/financial institutions had first charge over the mortgaged property. It is pertinent to note that despite the existence of the attachment orders, the Gujarat High Court validated sale of the mortgaged properties conducted by the bank and categorically stated that:

 

  1. 78. It is further clarified that the excess, if any, shall be adjusted towards the dues of the State under the Value Added Tax, 2005 Act. It is further declared that the respondents cannot proceed against the purchasers of the properties sold under the SARFAESI Act.

 

Further, in CTO case[15], as discussed above, the Andhra Pradesh High Court has held that the secured asset sold to any purchaser cannot be denied registration due to pending statutory dues and the banks are not entitled to withhold the sale certificate pursuant to the auction held. In SBI v. State of A.P.[16] and Pridhvi Asset Reconstruction and Securitisation Co. Ltd. v. State of A.P.[17], orders similar to the CTO case[18] were passed.

 

In SBI v. State of Maharashtra[19], the Bombay High Court have taken a similar view with regard to the registration of the sale certificate as upheld in the CTO case[20] i.e. the registration of sale certificate cannot be denied on account of pending statutory dues. This case has also highlighted that a Registrar does not have a quasi-judicial power and is only expected to ensure that the documents to be registered is accompanied by supporting documents.

 

However, having discussed the above position, it is pertinent to look at the judgment recently passed by the Supreme Court of India in Kotak Mahindra Bank Ltd. v. District Industries Centre[21] (Kotak case), disposing of the special leave petition that arose out of the order passed by the Bombay High Court in Medineutrina (P) Ltd. v. District Industries Centre[22] (Medineutrina case). The position taken by the Supreme Court in this case goes contrary to what has been established till now and hence needs a detailed mention.

 

In Medineutrina case[23], the petitioner was the auction-purchaser of the immovable property which was attached and auctioned by Punjab National Bank (PNB), under the SARFAESI Act. However, as certain statutory dues were due to the Sales Tax Department, PNB was not transferring the property in favour of the petitioner until such payment.  The petitioner thus came before the Bombay High Court challenging such non-transfer and additionally, relief was claimed against PNB to issue a no-objection certificate and to issue a fresh sale certificate, free from all encumbrances in favour of the petitioner. The petitioner also contended that there was the absence of notice, and it had no prior knowledge of such an encumbrance.

 

The Bombay High Court on the above set of facts dismissed the reliefs claimed by the petitioner and held that the petitioner was liable to pay the pending sale tax dues on the secured asset even if there was absence of any notice or prior knowledge of such encumbrance. It further ruled contrary to the principle established by the Supreme Court in the case of Ahmedabad Municipal Corpn. of the City of Ahmedabad v. Haji Abdulgafur Haji Hussenbhai[24] that a charge may not be enforced against a transferee if it had no notice of the same unless the requirement of such notice has been waived by law. This was held by following the reasoning that the above position would hold only when a charge is created under Section 100 of the Transfer of Property Act, 1882 in terms of which charge is not on the property. It further referred to AI Champdany Industries Ltd. v. Official Liquidator[25], wherein the Supreme Court had differentiated between an encumbrance as understood in the general parlance and an encumbrance which is a charge on the property and runs with the property.

 

In this regard, Bombay High Court observed that[26]:

  1. 34. … It goes without saying that when a statutory charge is created on the property, the same would go with the property and would follow the property, in whosoever’s hands the property goes.
  1. Thus the notice of such a statutory charge on the property, is always presumed in law, to one and all and none can claim ignorance of the same.
  1. As Section 37(1) of the Maharashtra Value Added Tax Act, 2002, creates a charge on the property, a successful auction-purchaser, thus would hold the property, upon which a statutory charge has been created, subject to such charge and the property would thus continue to be liable for any statutory charges created upon it, even in the hands of such auction-purchaser, though for non-disclosure of such charge by the secured creditor, the auction-purchaser may sue the secured creditor and have such redress, as may be permissible in law. This is more so for the reason that the priority given in Section 26-E of the SARFAESI Act, to the banks, which is a secured creditor, would only mean that it is first in que for recovery of its debts by sale of the property, which is a security interest, the other creditors being relegated to second place and so on, in the order of their preference as per law and contract, if any, as the case may be. Thus the dues under Section 37(1) of the MVAT Act, 2002, being a statutory charge on the property, would also be recoverable by sale of the property, and that puts a liability upon the auction-purchaser, who, in case he wants an encumbrance free title, will have to clear such dues.

 

Aggrieved by the same, the above decision in the Medineutrina case[27] was challenged before the Supreme Court of India.

 

The Supreme Court vide its order[28] dated 18-11-2021, disposed of the special leave petition, and upheld the decision of the Bombay High Court by noting that the agreement pursuant to which the auction-purchaser purchased the immovable property specifically stated that the auction-purchaser shall bear all statutory dues inter alia other dues and having agreed to these stipulations, auction-purchaser cannot shy away from the obligation. The specific portion of the agreement is reproduced below:

“It is not necessary for us to examine the other aspects dealt with by the High Court in the impugned judgment. For, the agreement executed by the petitioner pursuant to which the auction was concluded in favour of the petitioner reads thus:

  1. All statutory dues/attendant charges/other dues, including registration charges, stamp duty, taxes, any other known, unknown liability, expenses, property tax, any other dues of the Government or anybody in respect of properties/assets sold, shall have to be borne by the purchaser…. ”

 

Further, the fact that the State has the first charge on the property concerning statutory dues, the auction-purchaser cannot resile from the liability to discharge the same. Additionally, the Supreme Court acceded to the request that once such statutory dues have been paid, a fresh sale certificate shall be issued which shall note that the immovable property has been transferred free from all known encumbrances.

 

Conundrum around enforcement of Section 26-E

 

We further deem it necessary to discuss the conundrum around the enforcement of Section 26-E. We note that the amending Act did not come into force all at once but in parts. While certain sections including Section 31-B, Recovery of Debts and Bankruptcy Act, 1993 (RDB Act) (Section 31-B) came into force on 1-9-2016; Section 26-E was brought into force much later, from 24-1-2020 vide Notification No. 4133 dated 26-12-2019. However, we observe that various judgments viz, Union Bank of India v. State of Maharashtra[29] and Medineutrina case[30] have been ruled on the premise that Section 26-E came into force on 1-9-2016.

 

However, the Gujarat High Court in Kalupur[31] which was decided on 23-9-2019, took into consideration the fact that Section 26-E was not yet enforced and had observed the below:

  1. While it is true that the bank has taken over the possession of the assets of the defaulter under the SARFAESI Act and not under the RDB Act, Section 31-B of the RDB Act, being a substantive provision giving priority to the “secured creditors”, the same will be applicable irrespective of the procedure through which the recovery is sought to be made. This is particularly because Section 2(l-a) of the RDB Act defines the phrase “secured creditors” to have the same meaning as assigned to it under the SARFAESI Act. Moreover, Section 37 of the SARFAESI Act clearly provides that the provisions of the SARFAESI Act shall be in addition to and not in derogation of inter alia the RDB Act. As such, the SARFAESI Act was enacted only with the intention of allowing faster recovery of debts to the secured credits without intervention of the court. This is apparent from the Statement of Objects and Reasons of the SARFAESI Act. Thus, an interpretation that, while the secured creditors will have priority in case they proceed under the RDB Act they will not have such priority if they proceed under the SARFAESI Act, will lead to an absurd situation and, in fact, would frustrate the object of the SARFAESI Act which is to enable fast recovery to the secured creditors.

 

58 . The insertion of Section 31-B of the RDB Act will give priority to the secured creditors even over the subsisting charges under other laws on the date of the implementation of the new provision i.e. 1-9-2016. The Supreme Court, in State of M.P. v. State Bank of Indore[32], has held that a provision creating first charge over the property would operate over all charges that may be in force.

 

The text of Section 31-B is reproduced below for ease of reference:

31-B. Priority to secured creditors.— Notwithstanding anything contained in any other law for the time being in force, the rights of secured creditors to realise secured debts due and payable to them by sale of assets over which security interest is created, shall have priority and shall be paid in priority over all other debts and Government dues including revenues, taxes, cesses and rates due to the Central Government, State Government or local authority.

 

Following this reasoning given in Kalupur[33], Bombay High Court in SBI judgment[34] has recently ordered that even if Section 26-E was effective only prospectively from 24-1-2020 and thus not applicable to the facts at hand as they were prior in time, that would not make any difference; as Section 31-B itself would be sufficient to give priority to a secured creditor over the statutory dues.

 

Similarly, the Division Bench of the Bombay High Court in Axis Bank Ltd. v. State of Maharashtra[35] quashed and set aside the impugned notices issued by the Assistant Commissioner of Sales Tax after taking into consideration Section 529-A of the Companies Act, 1956 while also noting the statutory recognition of priority claim of the secured creditor in view of the amendment brought into effect by virtue of introduction of Section 26-E providing for priority to secured creditor over all other debts and all taxes, cess and other rates payable to Central Government or the State Government or the local authority while stating that the applicability of provisions of Section 31-B is pari materia to Section 26-E.

A similar view has been upheld by various High Courts in ASREC (India) Ltd. v. State of Maharashtra[36], GMG Engineers & Contractor (P) Ltd. v. State of Rajasthan[37], Bank of Baroda v. CST[38], and Commr. v. Indian Overseas Bank[39].

 

Analysis and conclusion

We understand from the above discussion that there is plethora of judgments that have dealt with subject-matter regarding priority of claims of secured creditor over the statutory dues. Post introduction of Section 26-E, it is now a settled position that the dues of the secured creditor will stand in priority.

 

We however note that, in terms of liability to pay statutory dues, the decision of the Supreme Court in the Kotak case[40] has caused ripples to an otherwise settled position that the statutory dues are to be paid from the excess of auction amount and that the sale certificate cannot be withheld on such statutory dues being pending. The Supreme Court in Kotak case[41] held that the auction-purchaser cannot resile from the liability to pay statutory dues and a sale certificate free from all encumbrances can be issued only once such dues have been cleared.

 

We, however, would like to point to the fact that the above decision seems to be very case specific as the auction-purchaser had specifically agreed to such payment liability under the auction agreement and cannot be seen as laying down the law that an auction-purchaser is liable to pay statutory dues in the absence of a contractual arrangement specifically stating so.

 

Further, we note that many judgments have been passed considering that Section 26-E came into force on 1-9-2016, which as discussed above is not the correct factual position. However, certain courts have rightly acknowledged the correct position and have reasoned priority of secured creditors in line with Kalupur[42] judgment, that is:

  • Section 31-B came into force on 1-9-2016;
  • Section 37 of the SARFAESI Act clearly provides that the provisions of the SARFAESI Act shall be in addition to, and not in derogation of inter alia the RDB Act and as such the SARFAESI Act was enacted only with the intention of allowing faster recovery of debts to secured creditors without the intervention of the court;
  • The definition of secured creditors is the same in both RDB Act and SARFAESI Act; and
  • An interpretation that, while the secured creditors will have priority in case they proceed under the RDB Act and that they will not have such priority if they proceed under the SARFAESI Act, will lead to an absurd situation and, in fact, would frustrate the object of the SARFAESI Act which is to enable fast recovery to the secured creditors.

 

Taking into consideration the above and ruling of Supreme Court in State of M.P. v. State Bank of Indore[43], we understand that the priority of secured creditors can be said to have been established from coming into force of Section 31-B.


† Partner, Khaitan & Co.

††  Associate, Khaitan & Co.

††† Associate, Khaitan & Co.

[1] (2009) 4 SCC 94.

[2] (2000) 5 SCC 694.

[3] Central Registry means the registry set up or cause to be set up under S. 20(1) of the SARFAESI Act.

[4] 2019 SCC OnLine Guj 1892

[5] AIR 1966 SC 785.

[6] (2001) 3 SCC 71.

[7] AIR 1966 SC 785.

[8] (2001) 3 SCC 71.

[9] 2019 SCC OnLine Guj 1892

[10] 2021 SCC OnLine Bom 6070.

[11] 2020 SCC OnLine Bom 4190.

[12] 2022 SCC OnLine SC 227.

[13] 2021 SCC OnLine AP 343 : AIR 2021 AP 87.

[14] 2019 SCC OnLine Guj 1892

[15] 2022 SCC OnLine SC 227.

[16] 2021 SCC OnLine AP 168 : AIR 2021 AP 108.

[17] 2020 SCC OnLine AP 1936 : (2021) 3 ALT 104.

[18] 2022 SCC OnLine SC 227.

[19] 2021 SCC OnLine Bom 2568.

[20] 2022 SCC OnLine SC 227.

[21] SLP (C) Diary No. 8269 of 2021, order dated 18-11-2021 (SC).

[22] 2021 SCC OnLine Bom 222 : (2021) 5 Mah LJ 402.

[23] 2021 SCC OnLine Bom 222 : (2021) 5 Mah LJ 402.

[24] (1971) 1 SCC 757.

[25] (2009) 4 SCC 486.

[26] 2021 SCC OnLine Bom 222 : (2021) 5 Mah LJ 402.)

[27] 2021 SCC OnLine Bom 222 : (2021) 5 Mah LJ 402.

[28] SLP (C) Diary No. 8269 of 2021, order dated 18-11-2021 (SC).

[29] 2021 SCC OnLine Bom 6070.

[30] 2021 SCC OnLine Bom 222 : (2021) 5 Mah LJ 402.

[31] 2019 SCC OnLine Guj 1892 : (2019) 156 SCL 668.

[32] (2002) 10 SCC 441

[33] 2019 SCC OnLine Guj 1892 : (2019) 156 SCL 668.

[34] 2020 SCC OnLine Bom 4190.

[35] 2017 SCC OnLine Bom 274 : (2017) 3 AIR Bom R 305.

[36] 2019 SCC OnLine Bom 5480 : (2020) 6 AIR Bom R 561.

[37] S.B. Civil Writ Petition No. 6872 of 2017, decided on 5-7-2017.

[38] 2018 SCC OnLine MP 1667 : (2018) 55 GSTR 210.

[39] 2016 SCC OnLine Mad 10030 : (2017) 1 Mad LJ 769.

[40] SLP (C) Diary No. 8269 of 2021, order dated 18-11-2021.

[41] SLP (C) Diary No. 8269 of 2021, order dated 18-11-2021.

[42] 2019 SCC OnLine Guj 1892 : (2019) 156 SCL 668 .

[43] (2002) 10 SCC 441.

Case BriefsSupreme Court

Supreme Court: Holding Advocates to be officers of the Court, the bench of AM Khanwilkar* and CT Ravikumar, JJ t has held that it would be open to the Chief Metropolitan Magistrate (CMM)/District Magistrate (DM) to appoint an advocate commissioner to assist him/her in execution of the order passed under Section 14(1) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.

The Court was hearing the appeal against the Bombay High Court judgment wherein it was held that that Section 14(1A) of the 2002 Act does not permit the CMM/DM to authorise an advocate. The language used in the provision is amply clear. Such delegation could be done only to an officer subordinate and none else. The High Court rejected the argument that the overburdened CMM/DM had inadequate subordinate staff and it would be difficult, if not virtually impossible for the secured creditor to take possession of and realise the outstanding dues by disposing the secured asset. The High Court was not impressed with that argument and preferred to strictly construe the stated provision.

This issue arose because of the expression used in the said provision, “may authorise any officer subordinate to him”.

Section 14 of the 2002 Act predicates that if the secured creditor intends to take possession of the secured assets, must approach the CMM/DM by way of an application, in writing, and on receipt of such request, the CMM/DM must move into action in right earnest. After passing an order thereon, he/she (CMM/DM) must proceed to take possession of the secured assets and documents relating thereto for being forwarded to the secured creditor in terms of Section 14(1) read with Section 14(2) of the 2002 Act. Section 14(2) is an enabling provision and permits the CMM/DM to take such steps and use force, as may, in his opinion, be necessary. This position obtained even before the amendment of 2013 i.e., insertion of sub-Section (1A) and continues to this date.

Incidentally, along with insertion of sub-Section (1A), a proviso has also been inserted in sub-Section (1) of Section 14 of the 2002 Act whereby the secured creditor (Bank/Financial Institution) is now required to comply certain conditions and to disclose that by way of an application 28 accompanied by affidavit duly affirmed by its authorised officer in that regard. Sub-Section (1A) is in the nature of an explanatory provision and it merely restates the implicit power of the CMM/DM in taking services of any officer subordinate to him. The insertion of sub-Section (1A) is not to invest a new power for the first time in the CMM/DM as such.

Thus, the question to be decided before the Supreme Court was whether the past practice followed by most of the courts across the country in recognising the power of the CMM/DM to appoint an advocate as a commissioner to assist him in merely taking possession of the secured assets and documents relating thereto and to forward the same to the secured creditor, needs to be discontinued as being prohibited owing to insertion of sub-Section (1A)?

At the outset the Court observed that the construct of the provision must depend on the context of the legislative intent and the purpose for which such dispensation has been envisaged. The setting in which the expression has been used in the concerned section of the Act would assume significance.

The Court observed that the statutory obligation enjoined upon the CMM/DM is to immediately move into action after receipt of a written application under Section 14(1) of the 2002 Act from the secured creditor for that purpose. As soon as such application is received, the CMM/DM is expected to pass an order after verification of compliance of all formalities by the secured creditor referred to in the proviso in Section 14(1) of the 2002 Act and after being satisfied in that regard, to take possession of the secured assets and documents relating thereto and to forward the same to the secured creditor at the earliest opportunity. The latter is a ministerial act. It cannot brook delay. Time is of the essence. This is the spirit of the special enactment. However, it is common knowledge that the CMM/DM are provided with limited resources. That inevitably makes it difficult, if not impossible, for the CMM/DM to fulfil his/her obligations with utmost dispatch to uphold the spirit of the special legislation.

“It is common knowledge that in the respective jurisdictions, there is only one CMM/DM. If he is expected to reach at every location himself for taking possession, in some jurisdictions it would be impracticable, if not impossible, for him to do so owing to large number of applications in the given jurisdiction being a commercial city.”

Hence, strict construct would defeat the legislative intent and purpose for enacting the 2002 Act. Indeed, logistical problems of the Office of the CMM/DM cannot be the basis to overlook the statutory provision. However, an advocate is and must be regarded as an officer of the court and subordinate to the CMM/DM for the purposes of Section 14(1A) of the 2002 Act.

The Court, further, held that the Advocate Commissioner is not a new concept. The advocates are appointed as Court Commissioner to perform diverse administrative and ministerial work as per the provisions of Code of Civil Procedure and Code of Criminal Procedure. An advocate is an officer of the court.

“It is well established that an advocate is a guardian of constitutional morality and justice equally with the Judge. He has an important duty as that of a Judge. He bears responsibility towards the society and is expected to act with utmost sincerity and commitment to the cause of justice. He has a duty to the court first. As an officer of the court, he owes allegiance to a higher cause and cannot indulge in consciously misstating the facts or for that matter conceal any material fact within his knowledge.”

The Court, hence, observed that sub-Section (1A) of Section 14 of the 2002 Act is no impediment for the CMM/DM to engage services of an advocate (an officer of the court) — only for taking possession of secured assets and documents relating thereto and to forward the same to the secured creditor in furtherance of the orders passed by the CMM/DM under Section 14(1) of the 2002 Act in that regard.

The Court made clear that it does not follow that the advocate so appointed needs to be on the rolls in the Office of the CMM/DM or in public service. There is intrinsic de jure functional subordinate relationship between the CMM/DM and the advocate being an officer of the court. The apprehension of the borrowers about improper execution of orders of the CMM/DM passed under Section 14(1) of the 2002 Act by the Advocate Commissioner, is plainly misplaced. Further, being an officer of the court and appointed by the CMM/DM, the acts done by the Advocate Commissioner would receive immunity under Section 14(3) of the 2002 Act — as an officer authorised by the CMM/DM.

“There is no reason to assume that the advocate so appointed by the CMM/DM would misuse the task entrusted to him/her and that will not be carried out strictly as per law or it would be a case of abuse of power. Rather, going by the institutional faith or trust reposed on advocates being officers of the court, there must be a presumption that if an advocate is appointed as commissioner for execution of the orders passed by the CMM/DM under Section 14(1) of the 2002 Act, that responsibility and duty will be discharged honestly and in accordance with rules of law.”

[NKGSB Cooperative Bank Limited v. Subir Chakravarty, 2022 SCC OnLine SC 239, decided on 25.02.2022]


*Judgment by: Justice AM Khanwilkar


Counsels

For Banks: Senior Advocate Rana Mukherjee, and Advocates Viraj Kadam, Manish Shanker Srivastava, Devendra Kumar Singh and M.L. Ganesh,

For Borrowers: Advocate B. Raghunath,

For State of Maharashtra: Advocate Rahul Chitnis

Case BriefsSupreme Court

Supreme Court: In a major relief to Banks, the bench of MR Shah* and BV Nagarathna, JJ has held that no borrower can, as a matter of right, pray for grant of benefit of One Time Settlement Scheme (OTS Scheme) as,

“If it is held that the borrower can still, as a matter of right, pray for benefit under the OTS Scheme, in that case, it would be giving a premium to a dishonest borrower, who, despite the fact that he is able to make the payment and the fact that the bank is able to recover the entire loan amount even by selling the mortgaged/secured properties, either from the borrower and/or guarantor. This is because under the OTS Scheme a debtor has to pay a lesser amount than the actual amount due and payable under the loan account. Such cannot be the intention of the bank while offering OTS Scheme and that cannot be purpose of the Scheme which may encourage such a dishonesty.”

Factual Background

The original writ petitioner had obtained credit facility from the bank of about Rs. 1 crore. The said loan account with the Bank was categorised as “Non-Performing Asset, (NPA)”. The Bank also initiated proceedings under the provisions of the SARFAESI Act. These proceedings have remained pending for seven years.

There were two other loan accounts also which were being regularly serviced by the original writ petitioner, meaning thereby that the payment was regularised insofar as two other loan accounts are concerned. However, so far as the NPA is concerned, not a single amount was paid till an application for extending the benefit of OTS was submitted.

The Allahabad High Court had directed the Bank to positively consider the original writ petitioner’s application for OTS.

While passing the impugned judgment and order, the High Court, in response to the submissions on behalf of the Bank that, there are all possibilities of recovery of the loan amount and the efforts are being made to recover the amount by initiating proceedings under the SARFAESI Act and that the properties mortgaged can be auctioned, had observed that the proceedings under the SARFAESI Act have remained pending for seven years and the Bank has been unable to recover its dues and therefore the hope of recovery is illusory.

The bank had, hence, moved the Supreme Court.

Analysis

RBI Guidelines on OTS Scheme

As per the RBI guidelines, the grant of benefit of OTS Scheme cannot be prayed as a matter of right and the same is subject to fulfilling the eligibility criteria mentioned in the scheme. A wilful defaulter in repayment of loan and a person who has not paid even a single installment after taking the loan and will not be able to pay the loan will be considered in the category of “defaulter” and shall not be eligible for grant of benefit under the OTS Scheme. Similarly, a person whose account is declared as “NPA” shall also not be eligible.

Further, if there is possibility of recovery of the amount, either by initiating appropriate proceedings or by auctioning the property mortgaged and/or the properties given as a security either by the borrower and/or by guarantor, the application submitted by the borrower for grant of benefit under the OTS Scheme can be rejected.

Benefit of OTS Scheme not a right

No borrower can, as a matter of right, pray for grant of benefit of One Time Settlement Scheme.

In a given case, it may happen that a person would borrow a huge amount, for example Rs. 100 crores. After availing the loan, he may deliberately not pay any amount towards installments, though able to make the payment. He would wait for the OTS Scheme and then pray for grant of benefit under the OTS Scheme under which, always a lesser amount than the amount due and payable under the loan account will have to be paid.

No bank can be compelled to accept a lesser amount under the OTS Scheme despite the fact that the Bank is able to recover the entire loan amount by auctioning the secured property/mortgaged property. When the loan is disbursed by the bank and the outstanding amount is due and payable to the bank, it will always take a conscious decision in the interest of the bank and in its commercial wisdom.

Issue a writ of mandamus directing the Bank to positively consider the grant of benefit under the OTS Scheme

No writ of mandamus can be issued by the High Court in exercise of powers under Article 226 of the Constitution of India, directing a financial institution/bank to positively grant the benefit of OTS to a borrower. The grant of benefit under the OTS is always subject to the eligibility criteria mentioned under the OTS Scheme and the guidelines issued from time to time. If the bank/financial institution is of the opinion that the loanee has the capacity to make the payment and/or that the bank/financial institution is able to recover the entire loan amount even by auctioning the mortgaged property/secured property, either from the loanee and/or guarantor, the bank would be justified in refusing to grant the benefit under the OTS Scheme. Ultimately, such a decision should be left to the commercial wisdom of the bank whose amount is involved and it is always to be presumed that the financial institution/bank shall take a prudent decision whether to grant the benefit or not under the OTS Scheme, having regard to the public interest involved and having regard to the factors which are narrated hereinabove.

“If a prayer is entertained on the part of the defaulting unit/person to compel or direct the financial corporation/bank to enter into a one-time settlement on the terms proposed by it/him, then every defaulting unit/person which/who is capable of paying its/his dues as per the terms of the agreement entered into by it/him would like to get one time settlement in its/his favour. Who would not like to get his liability reduced and pay lesser amount than the amount he/she is liable to pay under the loan account?”

Ruling on facts

The original writ petitioner and her husband were making the payments regularly in two other loan accounts and those accounts are regularised. Despite having the capacity to make the payment even with respect to the present loan account, not a single amount/installment had been paid in the present loan account for which original petitioner was praying for the benefit under the OTS Scheme.

Further, merely because the proceedings under the SARFAESI Act have remained pending for seven years, the Bank cannot be held responsible for the same. No fault of the bank can be found. What was required to be considered is a conscious decision by the Bank that the Bank will be able to recover the entire loan amount by auctioning the mortgaged property and a due application of mind by the Bank that there are all possibilities to recover the entire loan amount, instead of granting the benefit under the OTS Scheme and to recover a lesser amount.

Hence, the High Court, had materially erred and had exceeded in its jurisdiction in issuing a writ of mandamus in exercise of its powers under Article 226 of the Constitution of India by directing the appellant-Bank to positively consider/grant the benefit of OTS to the original writ petitioner who was not just an NPA account holder but also a willful defaulter.

[Bijnor Urban Cooperative Bank Limited v. Meenal Agarwal, 2021 SCC OnLine SC 1255, decided on 15.12.2021]


Counsels

For Bank: Senior Advocate Meenakshi Arora,

For original writ petitioner: Senior Advocate V.K. Shukla


*Judgment by: Justice MR Shah

Know Thy Judge | Justice M. R. Shah

Op EdsOP. ED.

Introduction

Non-performing assets (NPA)

The Indian economy and the banking system, in particular, have been weighed down by a sizeable NPA portfolio for a long time now. NPA is an acronym for a non-performing asset and it is used to classify loans or advances that are in default or arrears. Pursuant to Section 2(o) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 20021 (hereinafter SARFAESI), NPA is an asset or account of a borrower which has been classified by a bank or financial institution as a sub-standard, doubtful or loss asset. According to the Master Circular of Reserve Bank of India (RBI), an asset becomes non-performing when it ceases to generate income for the bank.2

Simply put, when a debtor is unable to honour his obligations with respect to payment of principal or interest as per the loan agreement for a specified period of time, such a loan is classified as an NPA. Due to NPAs, banks find themselves in a position where they do not have adequate funds for promoting other financial activities in the economy. The banks then try to recover their loss by restructuring the loan or liquidating the assets or selling the loans to asset reconstruction companies at steep discounts.

Asset reconstruction company (ARC)

As per Section 2(b) of the SARFAESI Act, 20023, “asset reconstruction” means acquisition by any securitisation or reconstruction company of any right or interest of any bank/financial institution in any financial assistance for the purpose of its realisation. A reconstruction company has further been defined under Section 2(v) of the Act4 as a company formed and registered under the Companies Act, 19565 for the purpose of asset reconstruction.

Asset reconstruction companies (ARCs) are specialised financial institutions that buy NPAs from banks and financial institutions and aid them in cleaning up their balance sheets. This saves the time and effort of banks in going after defaulters and thus allows them to focus on normal banking activities. They function under the regulatory oversight of the Reserve Bank of India.

The ARCs undertake various resolution strategies like:

  1. taking over/changing the management of the business of the borrower;
  2. the sale/lease of the business of the borrower;
  3. entering into settlements;
  4. restructuring or rescheduling of debt; and
  5. enforcement of security interest.6

Among the different entities operating in India, the oldest is Asset Reconstruction Company (India) Limited (ARCIL), owned by several financial institutions including SBI, IDBI Bank, ICICI Bank, PNB and Avenue India Resurgence Pte Limited. It has resolved approximately Rs 78,000 crore NPAs acquired from Indian bank and financial institutions.

Bad bank

The concept of a bad bank originated at the Pittsburgh headquartered Mellon Bank in 1988. The idea and discussions over bad bank are not nascent in India rather have been in place since 2015 when former RBI Governor Raghuram Rajan started a debate on bad bank as a possible solution to the problem of NPAs. Afterwards, former Interim Finance Minister Piyush Goyal put forth the idea of National ARC on a recommendation of the Committee headed by Sunil Mehta. The Economic Survey 2017 also propounded to create a Public Sector Asset Rehabilitation Agency (PARA).

A bad bank is a corporate structure that isolates illiquid and high-risk assets or non-performing loans held by a bank or a financial organisation, or perhaps a group of banks or financial organisations.7 It is also referred to as Asset Management Company (AMC).

Considering the actual as well as an expected increase in NPAs due to the global pandemic in 2020, the Government came up with the model of bad bank to manage the surge of NPAs across the Indian banking sector. Recently announced in the Budget 2021-2022, it is set up by State-owned and private sector banks with no direct equity contribution from the Government. Hence, there will be no direct intervention by the Central Government.

It is aimed at easing the burden of banks holding a pile of stressed assets and allowing them to lend more actively. It generally does not have a primary purpose of generating profits. It will mainly focus on resolving and restructuring Rs 2-2.5 lakh crores of around 70 large accounts.

It works by demarcating assets into good assets (that are repaid within time) and toxic or bad assets (defaulted loans). Such toxic assets are meant to be transferred from the books of banks to bad bank at a price below their book value, for the sole purpose of recovery of risky assets.

It is supposed to have a two-tiered structure. Tier 1 will be a government-backed ARC, offering 15% of net book value upfront in cash and 85% in security receipts. Hence, it is called the 15:85 structure. Tier 2, on the other hand, will be an AMC run by public and private bodies and turnaround professionals.

The Indian Banks Association (IBA) had applied for a licence to RBI to set up Rs 6000 crore National Asset Reconstruction Company Ltd.(NARCL), India’s first-ever Bad Bank, on 22-8-2021, and RBI has recently granted the same on 4-10-2021 under the SARFAESI Act 2002. NARCL is incorporated in Mumbai as a “Union Government Company” with an authorised capital of Rs 100 crore on 7-7-2021. On 15-9-2021, the Cabinet has cleared a Rs 30,600 crore five-year guarantee programme to NARCL for taking over and resolving NPAs to the tune of Rs 2 lakh crores. If the bad bank is unable to sell the bad loan or has to sell it at a loss, then the government guarantee will be invoked. NARCL has received Rs 5000-6000 crores towards the 15% obligation from around 16 public and private sector banks including Canara Bank, State Bank of India (SBI), Union Bank of India, Bank of India (BoI), Bank of Baroda (BoB), Bank of Maharashtra, Punjab National Bank (PNB) and Indian Bank. In NARCL, State-owned banks will hold a 51% stake, while public financial institutions (PFIs) or debt management companies will hold 49%.

Key persons on the Board of NARCL include industry experts like Padmakumar Madhavan Nair, a stressed assets expert from State Bank of India (SBI), as the Managing Director (MD), and Sunil Mehta (IBA’s Chief Executive), Salee Sukumaran Nair (SBI’s Deputy MD) and Ajit Krishnan Nair (Canara Bank’s representative) as Directors.

To manage assets with the help of market professionals and turnaround experts, the Government will also set up India Debt Resolution Company Ltd. (IDRCL) along with NARCL. The IDRCL is a service company or an operational entity wherein public sector banks (PSBs) and PFIs will hold a maximum of 49% stake and the rest will be with private-sector lenders. When the assets are sold, with the help of IDRCL, the commercial banks will be paid back the rest.8

Stumbling blocks of existing alternatives

There are other options of getting rid of bad debts to clean up books, like insolvency resolution under the Insolvency and Bankruptcy Code, 20169 (IBC, 2016) and ARCs in the SARFAESI Act, 2002. However, unlike its initial success in terms of recovering debts over 50%, lately, haircuts have increased and lenders are able to recover hardly 5-6% of debts. Besides, the disproportionate number of National Company Law Tribunal (NCLT) Judges when compared to instituted cases, causes resolutions to take more time than specified under IBC, 2016.

Concerning ARCs under the SARFAESI Act, asset reconstruction has slowed down due to capital issues and downgraded ratings for security receipts. Consequently, ARCs are also reluctant to take up NPAs unless offered very steep discounts.

Difference between bad bank and asset reconstruction companies

  1. Essential character 

While ARCs are primarily of private nature, bad bank will be public in nature.

  1. Majority ownership

Concerning ARCs, the majority ownership is with privately-owned banks. On other hand, it is with State-owned banks in the case of bad bank.

  1. Ability to do cash deals

ARCs are generally small in size and hence, have less ability to do cash deals concerning big accounts, forcing banks to move to NCLT where chances of resolution are relatively less and time-consuming. On other hand, being government-backed, bad bank will have deep pockets to buy out big accounts and thus freeing up banks more readily. Owing to this, RBI might also extend it more relaxation for the applicable rules.

  1. Valuation

ARCs typically take steep discounts on the acquisition of stressed assets. On other hand, owing to acquisition at net book value, valuation hurdles might be eased, and thus banks will be more willing to get their balance sheets cleared in favour of the bad bank.

  1. Costs and delays

ARCs suffer from unnecessary delays and cost overruns as for matters concerning consortium loans, ARCs have to wait for approval from multiple lenders before a deal is concluded. With bad bank, the industry’s bad loans will be consolidated into one entity, and thus the existing ARCs can negotiate deals with the bad bank more effectively.10

  1. Funds

Funds in ARC are brought in by investors at every stage in lieu of security receipts. In the case of bad bank, funds are to be originally brought in by banks and later by investors; hence it puts the initial burden on banks.

  1. Management fee

Apart from exchanging NPAs either for cash or a mix of cash and security receipts redeemable on recovery of the loan by ARC, ARCs charge an asset management fee of 1.5-2 per cent of the asset every year. However, NARCL will charge a managing fee from lenders in lieu of managing their NPAs. The management fee is yet to be finalised but it will depend on the quantum of guarantee the NARCL gets from the Government.

Why bad bank? 

  1. Quicker resolution via consolidation under a single head

It can help aggregate or consolidate all bad loans of banks under a single exclusivity. This helps easier and quicker resolution due to effective management.

  1. Frees management bandwidth

Owing to resolution by experts, it will make them financially healthy via cleaning up bank’s balance sheets and allow banks to focus on its core activity of lending.

  1. Plugs in loopholes in ARC model with its domain expertise

Private-run ARCs have not seen much success in resolving bad debts. The bad bank aims to overcome the shortcomings of ARCs, utilising its domain expertise and public character.

  1. Better price discovery

A bad bank is opined to have the ability to fix the better and appropriate prices. The transferring bank could make additional provisions in case the discovered cost is less than the book value and the Bank wants to retain the asset on its books.

Concerns hovering over bad bank

  1. One of the key concerns is that there must be a sunset clause to this resolution process. The bad bank should not go on in perpetuity and so a definite time period of its existence should be decided upon.11 The intent should clearly be a faster resolution. Therefore, it is quintessential to develop time-bound strategies for the resolution of assets, or else the bad bank will be reduced to a mere parking space of bad loans.
  2. A major criticism is that public sector banks (PSBs) are themselves holding substantial stakes in the NARCL which implies that PSBs are paying to buy their own bad loans.12 This mingling of roles, as PSBs are both investors and customers of NARCL, can blur the objective of this institution and impact decision-making.
  3. A major challenge is the development of a clear resolution strategy. The bad bank is not a panacea in itself and so it remains to be seen whether the bad bank has the requisite resources and operational framework to accomplish its purpose. It is necessary to develop a detailed recovery plan based on reliable data analysis. Prudent management of resources in restructuring and recovery of advances is one of the ways to address this challenge.
  4. A sudden rise in the availability of assets for sale can cause price distortion.13 Such an effect could adversely impact the recovery value of assets.
  5. NARCL will be purchasing assets at net book value (NBV) whereas ARCs purchase NPAs on an arm’s length basis at market-determined prices. This variance in RBI regulations might lead to ambiguity and regulatory uncertainty with reference to the validity of such transfers.
  6. It is required to have a suitable mechanism in place that can facilitate funding for maintaining the quality of assets till their resolution.

Global experience with bad bank

The idea of a bad bank has been previously adopted in countries like the United States, Germany, Japan, Malaysia, Thailand, Korea, Indonesia, China and others. It has been successfully implemented in the European countries post-2007 financial crisis. A few experiences, relevant to India, are illustrated below:

  1. Malaysia – Danaharta-Danamodal

In 1998, it was established with a public AMC regime, in wake of the Asian crisis. With cohesive efforts, it was able to curtail non-performing loans and brought the banking system back on track. Currently, it is inactive.

  1. Indonesia – Indonesian Bank Restructuring Agency (IBRA) 

In 2004, it was established with a public AMC regime. Although it performed well as a bank resolution agency, it was comparatively less successful with respect to maximising recovery through loan restructuring and shareholders’ settlements. It is now inactive.

  1. Ireland –National Asset Management Agency (NAMA)

In 2009, NAMA was established with a mixed but predominantly public regime. It adopted a consensual approach with the debtors and provided funding on a commercial basis to complete existing projects and commence new projects. Consequently, it performed well in the initial years. However, after six years, it faced challenges with respect to the retention of its staff, because unlike before it was not able to remunerate its staff at par with the private sector. Moreover, it could not clean up the bad assets of the banking as it extended beyond land and development loans.14

Concluding remarks

The pandemic has hit the economy hard and has exposed the vulnerabilities of our banking system.  RBI noted in its recent Financial Stability Report that the gross NPAs of the banking sector are predicted to rise to 9.80% by March 2022 from 7.48% in March 2021, under a baseline scenario.15Although a move to manage the surge in NPAs was well timed, however, the concerns and loopholes raised over bad bank (NARCL) make it imperative to clearly lay down a mechanism to set its accountability and to ensure its independence. It must be ensured that bureaucratic delays do not occur in NARCL, unlike other similar entities. Global experiences portray that it must be made flexible as per the needs of the country.


*First-year law student, Campus Law Centre, Faculty of Law, University of Delhi. Author can be reached at deepanshigupta228@gmail.com

**Fifth-year law student, Institute of Law, Nirma University, Ahmedabad. Author can be reached at aadeshshinde666@gmail.com

1 Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002.

2Reserve Bank of India, Master Circular, 1-7-2009, <https://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=5154#2>.

3http://www.scconline.com/DocumentLink/68w57S9L.

4http://www.scconline.com/DocumentLink/68w57S9L.

5http://www.scconline.com/DocumentLink/pm3Rt2A0.

6Reserve Bank of India, Report of the Task Force on the Development of a Secondary Market for Corporate Loans,3-9-2019, <https://m.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=940>.

7Gabriel Brenna, Thomas Poppensieker and Sebastian Schneider, Understanding the Bad Bank, McKinsey & Company, December 2009, <https://web.archive.org/web/20160107005934/http:/www.mckinsey.com/insights/financial_services/understanding_the_bad_bank>.

8Sheersh Kapoor, What are NARCL and IDRCL? How do they Work and What is the Plan?, BFSI, 17-9-2021, <https://bfsi.economictimes.indiatimes.com/news/banking/what-are-narcl-and-idrcl-how-do-they-work-and-what-is-the-plan/86282175>.

9http://www.scconline.com/DocumentLink/86F742km.

10Dinesh Unnikrishnan, How is the Proposed “Bad Bank” Different from Existing ARC?, 2-2-2021, <https://www.moneycontrol.com/news/business/how-is-the-proposed-bad-bank-different-from-existing-arc-6436601.html>.

11Pratik Dutta, Lessons from China on Bad Banks, The Indian Express, 25-6-2021, <https://indianexpress.com/article/opinion/columns/india-bad-bank-national-asset-reconstruction-company-china-7374608/>.

12Anand Adhikari,  Shaping India’s Bad Bank, Business Today, 25-7-2021, <https://www.businesstoday.in/magazine/finance/story/shaping-indias-bad-bank-300658-2021-07-08>.

13Deepti George and Madhu Srinivas, How to get the Bad Bank off to a Good Start, Money Control, 3-8-2021, <https://www.moneycontrol.com/news/opinion/how-to-get-the-bad-bank-off-to-a-good-start-7267211.html>.

14Bad Banks in India, Deloitte, November 2020, <https://www2.deloitte.com/content/dam/Deloitte/in/Documents/finance/in-fa-bad-bank-note-noexp.pdf>.

15Reserve Bank of India, The Financial Stability Report, 1-7-2021, <https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=51832>.

Experts CornerShardul Amarchand Mangaldas


Introduction


The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) was enacted with the objective to enable banks and financial institutions to realise long-term assets, to improve recovery of debts and reduce non-performing assets by taking possession and selling such assets, in the manner and as per the procedure as provided therein and read with the Security Interest (Enforcement) Rules, 2002 (Rules).

 

The SARFAESI read with the Rules, meticulously sets out the step-by-step procedure which is to be adhered to by the banks/financial institutions i.e. the secured creditors, for taking possession and ultimately effecting the transfer of a non-performing asset. Non-adherence to any single procedural step or even non-compliance of a time period stipulated therein by the secured creditor, has lead to a plethora of litigation.

 

A third-party purchaser, being interested in acquiring the secured asset must primarily ensure that the secured creditor has taken all the necessary steps and checked all the boxes as spelt out under the SARFAESI read with the Rules, prior to acquisition of the secured asset.

 


Sale on “As is where is basis”


The sale of secured assets under SARFAESI in most cases takes place on “as is where is basis” which means that the purchaser would be acquiring the asset with all its existing rights, obligations and liabilities. Auction notices which are issued by the secured creditors usually state that “the property is free from all encumbrances known to the secured creditor” and thereby shifting the onus onto the purchaser to make its own independent enquiry. However, the Bombay High Court, Nagpur Bench, in its recent judgment dated 18-2-2021 in Medineutrina (P) Ltd. v. District Industries Centre[1] held that, when a property is sold on “as is where is basis”, though it would be upon the purchaser to make reasonable enquiries about the encumbrances affecting the property, the mere mention of “as is where is basis” or any such phrase should not absolve the secured creditor of its obligation to make proper enquiries about other dues/encumbrances affecting the property, to obtain information about which the secured creditor has the means and which information should be disclosed in the auction notice so that the purchaser can make a conscious decision and not raise a plea of not having been informed. Insofar as encumbrances on account of statutory/government/municipal/ revenue dues are concerned, the responsibility of obtaining the details thereof is of the secured creditor. In spite of the aforesaid directions laid down in the judgment, the Court further held that an encumbrance affecting the secured asset, prior to the issuance of the auction notice, would be the liability of the purchaser in order to obtain a clear and marketable title to the property having purchased the same on “as is where is basis”.

 

Even though the aforesaid judgment directs secured creditors to make a disclosure of statutory encumbrances in the auction notice, it is still to be seen if the directions laid down therein will become a reality and will protect a third-party purchaser who is acquiring the secured asset on “as is where is basis”. It is prudent for the purchaser to make its own independent enquiry with respect to outstanding dues and encumbrances affecting the property, so as to factor in such cost as such additional cost will not form part of the consideration payable to the secured creditor for acquisition of the asset. As per Section 31-B of SARFAESI [as amended by the Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016], any debt due to a secured creditor by sale of assets over which security interest is created, shall take priority over any debt due to the Central Government, State Government or local authority. Accordingly, any other dues/encumbrances affecting the property, will have to be cleared in addition to the consideration payable to the secured creditor so as to enable the purchaser to obtain a clear and marketable title to the secured asset.

 


Borrowers right to foreclose and redeem the mortgage


As per Section 60 of the Transfer of Property Act, 1882, the mortgagor/borrower has a right to redeem the mortgage on payment of the entire mortgage money to the secured creditor. It has been the contention of borrowers that the right of redemption only stands extinguished on the date of registration of the sale certificate in favour of the purchaser. This point on redemption has been analysed by the Supreme Court of India in its judgment dated 20-8-2019 in Shakeena v. Bank of India[2] wherein it was held that the borrower has a right of redemption only before the time the mortgage is foreclosed or the estate is sold. It was further held that issuance of a sale certificate as per Rule 9(7) of the Rules is a complete and absolute sale for the purpose of SARFAESI and the sale certificate need not be registered, as Section 17(2)(xii) of the Registration Act, 1908 provides that a sale certificate issued by a Civil or Revenue Officer in respect of property sold in a public auction does not require registration. Accordingly, the right to redemption stands obliterated from the date of issuance of the sale certificate as registration of the sale certificate is not mandatory.

 


Borrowers right to prevent transfer of secured assets


In addition to what is stated hereinabove and as per the amended Section 13(8) of the SARFAESI which has come into force with effect from 1-9-2016,  which amended section states that, where the amount of dues of the secured creditor together with all costs, charges and expenses incurred by the secured creditor are tendered by the borrower to the secured creditor prior to the date of publication of notice for public auction or inviting quotations or tender from public or private treaty for transfer of the secured asset, the secured asset shall not be transferred by the secured creditor. The Supreme Court of India in its judgment dated 10-2-2014 in Mathew Varghese v. M. Amritha Kumar[3] held that by virtue of the provisions of Section 13(8) of the SARFAESI, any sale or transfer of a secured asset cannot take place without duly informing the borrower of the time and date of such sale or transfer in order to enable the borrower to tender the dues of the secured creditor and any such sale or transfer effected without complying with the said statutory requirement would be a constitutional violation and nullify the ultimate sale.

 


Conclusion


In light of what is stated hereinabove, acquisition of a secured asset under SARFAESI requires the purchaser to do thorough due diligence to ensure there are no outstanding dues and encumbrances affecting the property and to ensure strict compliance of the procedure along with the time periods as stipulated in SARFAESI read with the Rules. The thorough due diligence will enable the purchaser to obtain a clear and marketable title to the secured asset which is free from all encumbrances and by carrying out such due diligence, the purchaser will ultimately be saved from knocking on the doors of the court to enforce its right to the secured asset.

 


† Partner, Shardul Amarchand Mangaldas

†† Associate, Shardul Amarchand Mangaldas.

[1] 2021 SCC OnLine Bom 222.

[2] 2019 SCC OnLine SC 1059.

[3] (2014) 5 SCC 610.

Kerala High Court
Case BriefsHigh Courts

Kerala High Court: A.M. Badar, J., while dismissing the present petition, reiterated the observations of the Supreme Court in the words, “In cases relating to recovery of the dues of banks, financial institutions and secured creditors, stay granted by the High Court would have a serious adverse impact on the financial health of such bodies/institutions, which (sic will) ultimately prove detrimental to the economy of the nation. Therefore, the High Court should be extremely careful and circumspect in exercising its discretion to grant stay in such matters.”

 Background

The petitioner who happens to be the Managing Director of one Heera Construction Company; a corporate debtor, is challenging orders namely, P3, P4 and P4(a) and is seeking further direction against the respondent 1 to keep in abeyance all further proceedings pursuant to Ext P3, P4 and P4(a) till the disposal of CP(IB) 4447/2018. It is to be noted that Ext P3 is a notice of sale under Rule 8(6) of Security Interest (Enforcement) Rules, 2002, Ext P4 is a further notice under the said Rules for sale of secured assets and Ext P4 (a) is e-auction sale notice issued in terms of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002.

 Observations

On the contention that parallel proceedings under SARFAESI is impermissible

“… argument advanced by the learned counsel for the petitioner that because of pendency of proceedings before the NCLT, parallel proceedings under the SARFAESI Act are not maintainable, needs to be rejected. Even otherwise Section 7 of the Insolvency and Bankruptcy Code has application against the corporate debtor. It cannot be said that there is bar for proceedings against the guarantor under the SARFAESI Act because of pendency of corporate insolvency resolution process against the corporate debtor.”

 On interference of Court under Article 226 if an alternative statutory remedy is available

Court placed reliance on the case of, Authorized Officer, State Bank of Travancore v. Mathew K.C., 2018 (1) KLT 784; “…the discretionary jurisdiction under Article 226 is not absolute but has to be exercised judiciously in the given facts of a case and in accordance with law. The normal rule is that a writ petition under Article 226 of the Constitution ought not to be entertained if alternate statutory remedies are available, except in cases falling within the well defined exceptions…”

Further reference was made to the alternate remedy available under DRT Act through, Punjab National Bank v. O.C. Krishnan, (2001) 6 SCC 569; “The Act has been enacted with a view to provide a special procedure for recovery of debts due to the banks and the financial institutions. There is a hierarchy of appeal provided in the Act, namely, filing of an appeal under Section 20 and this fast-track procedure cannot be allowed to be derailed either by taking recourse to proceedings under Articles 226 and 227 of the Constitution or by filing a civil suit, which is expressly barred. Even though a provision under an Act cannot expressly oust the jurisdiction of the court under Articles 226 and 227 of the Constitution, nevertheless, when there is an alternative remedy available, judicial prudence demands that the Court refrains from exercising its jurisdiction under the said constitutional provisions”

 Decision

Dismissing the present petition, the Court said, “Loans by financial institutions are granted from public money generated at the tax payers expense. Such loan does not become the property of the person taking the loan, but retains its character of public money given in a fiduciary capacity as entrustment by the public. Timely repayment also ensures liquidity to facilitate loan to another in need, by circulation of the money and cannot be permitted to be blocked by frivolous litigation by those who can afford the luxury of the same.”[Dr Abdul Rasheed v. IFCI Limited, 2020 SCC OnLine Ker 8293, decided on 03-12-2020]


Sakshi Shuka, Editorial Assistant has put this story together

Case BriefsSupreme Court Roundups

Did you know? In the year 2020,

    • All the Constitution bench verdicts were unanimous with no dissenting opinion.
    • 9 out of 11 Constitution bench judgments were delivered by benches consisting of Justices Arun Mishra, Indira Banerjee, Vineet Saran and M.R. Shah, followed by Justices Aniruddha Bose and S. Ravindra Bhat who were part of Constitution benches in 5 and 4 cases, respectively.

As we look forward to the new year of 2021, here is a quick recap of the Constitution bench verdicts delivered by the Supreme Court of India in 2020.

1. Questions of law can be referred to larger bench while hearing a review petition

9-judge bench: SA Bobde, CJ and R Banumathi, Ashok Bhushan, L Nageswara Rao, M M Shantanagoudar, S A Nazeer, R Subhash Reddy, B R Gavai and Surya Kant, JJ

After renowned jurist and senior advocate Fali Nariman objected to the manner in which the Supreme Court turned a review of the Sabarimala case into an opportunity to set up a nine-judge Bench and examine whether certain essential religious practices of various faiths, including Islam and Zoroastrianism, should be constitutionally protected, the 9-judge bench held that the Supreme Court can refer questions of law to a larger bench while exercising its review jurisdiction.

The Court had in November last year, suggested that the Sabarimala issue along with other related issues, be heard by a larger bench of at least 7-judges. [Read: Sabarimala Review Petitions Not Referred To A Larger Bench, But Kept Pending. Here’s What Supreme Court Has Actually Held]

Read more…

[Kantaru Rajeevaru v. Indian Young Lawyers Assn, (2020) 3 SCC 52]


2. Pleas challenging the abrogation of Article 370 not referred to a larger bench

5-judge bench: NV Ramana, SK Kaul, R. Subhash Reddy, BR Gavai and Surya Kant, JJ

The bench refused to refer the petitions challenging the constitutional validity of the Centre’s move to abrogate Article 370 to a larger bench. Holding that there is no conflict between the judgments in the Prem Nath Kaul case and the Sampat Prakash casethe bench said that judgments cannot be interpreted in a vacuum, separate from their facts and context. Observations made in a judgment cannot be selectively picked in order to give them a particular meaning. It noted,

the Constitution Bench in the Prem Nath Kaul case did not discuss the continuation or cessation of the operation of Article 370 of the Constitution after the dissolution of the Constituent Assembly of the State. This was not an issue in question before the Court, unlike in the Sampat Prakash case where the contention was specifically made before, and refuted by, the Court. This Court sees no reason to read into the Prem Nath Kaul case an interpretation which results in it being in conflict with the subsequent judgments of this Court, particularly when an ordinary reading of the judgment does not result in such an interpretation.”

Read more…

[Dr. Shah Faesal v. Union of India, (2020) 4 SCC 1]


3. No time limit could be fixed while granting anticipatory bail

5-judge bench: Arun Mishra, Indira Banerjee, Vineet Saran, MR Shah, and S. Ravindra Bhat, JJ

The bench unanimously ruled that the protection granted to a person under Section 438 Cr.PC should not invariably be limited to a fixed period; it should inure in favour of the accused without any restriction on time.

Read more…

[Sushila Aggarwal v. State of NCT of Delhi,  (2020) 5 SCC 1]


4. No lapse of acquisition proceedings if government has ‘paid’ compensation

5-judge bench: Arun Mishra, Indira Banerjee, Vineet Saran, MR Shah, and S. Ravindra Bhat, JJ

The bench unanimously held that the land owners who had refused to accept compensation or who sought reference for higher compensation, cannot claim that the acquisition proceedings had lapsed under Section 24(2) of the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013

Last year, Justice Arun Mishra, heading the Bench, had refused to recuse himself from hearing the case and had said,

“I would be committing a grave blunder by recusal in the circumstances, on the grounds prayed for, and posterity will not forgive me down the line for setting a bad precedent. It is only for the interest of the judiciary (which is supreme) and the system (which is nulli secundus) that has compelled me not to recuse.”

Justice Mishra’s recusal was sought on the ground that he was heading a Bench meant to re-examine a judgment that he had himself given in 2018 in in Indore Development Authority v. Shailendra, (2018) 3 SCC 412. 

Read more…

[Indore Development Authority v. Manohar Lal Sharma, (2020) 8 SCC 129]


5. States, and not MCI, have power to make reservation for in-service candidates in Post Graduate Medical Course 

5-judge bench: Arun Mishra, Indira Banerjee, Vineet Saran, MR Shah and Aniruddha Bose, JJ

The bench unanimously held that States have the legislative competence and/or authority to provide for a separate source of entry for in-service candidates seeking admission to postgraduate degree/diploma courses, in exercise of powers under Entry 25, List III.

“…policy must provide that subsequent to obtaining the postgraduate degree by the concerned in-service doctors obtaining entry  in degree courses through such separate channel serve the State in the rural, tribal and hilly areas at least for five years after obtaining the degree/diploma and for that they will execute bonds for  such  sum the   respective  States  may   consider   fit  and  proper”

 The Court, however, specifically observed and clarified that the present decision shall operate prospectively, and any admissions given earlier taking a contrary view shall not be affected by this judgment.

Read more…

[TN Medical Officers Association v. Union of India, 2020 SCC OnLine SC 699]


6. Sub-classification of Scheduled Castes| E.V. Chinnaiah decision to be revisited; Matter referred to larger bench

5-judge bench: Arun Mishra, Indira Banerjee, Vineet Saran, MR Shah and Aniruddha Bose, JJ

After noticing that a 5-Judge Bench in E.V. Chinnaiah v. State of A.P., (2005) 1 SCC 394, is required to be revisited, the bench referred the matter to a larger bench and said,

“Reservation was not contemplated for all the time by the framers of the Constitution.  On the one hand, there is no exclusion of those who have come up, on the other hand, if sub¬classification is denied, it would defeat right to equality by treating unequal as equal.”

Read more…

[State of Punjab v. Davinder Singh, (2020) 8 SCC 1]


7. SARFAESI Act applicable to Co­operative Banks

5-judge bench of Arun Mishra, Indira Banerjee, Vineet Saran, MR Shah and Aniruddha Bose, JJ

The bench unanimously held that banking’ relating to co­operatives can be included within the purview of Entry 45 of List I, and it cannot be said to be over inclusion to cover provisions of recovery by co­operative banks in the SARFAESI Act.

Holding that Co­operative bank’s entire operation and activity of banking are governed by a law enacted under Entry 45 of List I, i.e., the BR Act, 1949, and the RBI Act under Entry 38 of List I, the bench said,

“recovery of dues would be an essential function of any banking institution and the Parliament can enact a law under Entry 45 of List I as the activity of banking done by co­operative banks is within the purview of Entry 45 of List I. Obviously, it is open to the Parliament to provide the remedy for recovery under Section 13 of the SARFAESI Act.”

Read more…  

[Pandurang Ganpati Chaugale v. Vishwasrao Patil Murgud Sahakari Bank Ltd,  (2020) 9 SCC 215]


8. Andhra Pradesh’s 100% reservation for Scheduled Tribe candidates for the post of teachers without rhyme or reason

5-judge bench: Arun Mishra, Indira Banerjee, Vineet Saran, MR Shah and Aniruddha Bose, JJ 

Holding the Government Office Ms. No.3 dated 10.1.2000 issued by the erstwhile State of Andhra Pradesh providing 100% reservation to the Scheduled Tribe candidates out of whom 33.1/3% shall be women for the post of teachers in the schools in the scheduled areas in the State of Andhra Pradesh, unconstitutional, the bench said that there was no rhyme or reason with the State Government to resort to 100% reservation.

“It was least expected from the functionary like Government to act in aforesaid manner as they were bound by the dictum laid down by this Court in Indra Sawhney and other decisions holding that the limit of reservation not to exceed 50%.”

Read more…

[Chebrolu Leela Prasad Rao v. State of Andhra Pradesh, 2020 SCC OnLine SC 383]


9. District Forum can’t extend limitation period of 45 days for filing response under Section 13 of Consumer Protection Act

5-judge bench: Arun Mishra, Indira Banerjee, Vineet Saran, MR Shah and S. Ravindra Bhat, JJ

The bench unanimously held that the District Forum has no power to extend the time for filing the response to the complaint beyond the period of 15 days in addition to 30 days as is envisaged under Section 13 of the Consumer Protection Act, 1986.

The bench was answering the reference relating to the grant of time for filing response to a complaint under the provisions of the Consumer Protection Act, 1986 wherein the answers to the following questions were sought:

  • whether Section 13(2) (a) of the Consumer Protection Act, which provides for the respondent/opposite party filing its response to the complaint within 30 days or such extended period, not exceeding 15 days, should be read as mandatory or directory; i.e., whether the District Forum has power to extend the time for filing the response beyond the period of 15 days, in addition to 30 days.
  • what would be the commencing point of limitation of 30 days stipulated under the aforesaid Section.

Read more…

[New India Assurance v. Hilli Multipurpose Cold Storage Pvt. Ltd., (2020) 5 SCC 757]


10. Accused under NDPS Act not entitled to acquittal as a blanket rule merely because the complainant is the investigating officer

5-judge bench: Arun Mishra, Indira Banerjee, Vineet Saran, MR Shah and S. Ravindra Bhat, JJ

The bench unanimously held that the accused under the Narcotic Drugs and Psychotropic Substances Act, 1985 (NDPS Act) is not entitled to an acquittal as a blanket rule merely because the complainant is the investigating officer.

“… merely because the informant is the investigator, by that itself the investigation would not suffer the vice of unfairness or bias and therefore on the sole ground that informant is the investigator, the accused is not entitled to acquittal. The matter has to be decided on a case to case basis.”

Read more…

[Mukesh v. State (Narcotic Branch of Delhi), (2020) 10 SCC 120]


11. State Government cannot fix the “minimum price” of sugarcane once Centre has already fixed it

5-judge bench: Arun Mishra, Indira Banerjee and Vineet Saran, M.R. Shah and Aniruddha Bose, JJ,

The bench unanimously held that once the Central Government having exercised the power under Entries 33 and 34 List III of seventh Schedule and fixed the “minimum price”, the State Government cannot fix the “minimum price” of sugarcane.

By virtue of Entries 33 and 34 List III of seventh Schedule, both the Central Government as well as the State Government have the power to fix the price of sugarcane. The Court, however, clarified that

“it is always open for the State Government to fix the “advised price” which is always higher than the “minimum price”, in view of the relevant provisions of the Sugarcane (Control) Order, 1966, which has been issued in exercise of powers under Section 16 of the U.P. Sugarcane (Regulation of Supply and Purchase) Act, 1953.”

Read more…

[West UP Sugar Mills Association v. State of Uttar Pradesh, (2020) 9 SCC 548]


Also read:

Supreme Court year-end roundup| From important judgments to unmissable facts and stories, here’s a comprehensive roundup of all that happened in 2020

Case BriefsSupreme Court

Supreme Court: The 3-judge bench of L. Nageswara Rao, Hemant Gupta* and Ajay Rastogi, JJ has upheld Kerala High Court’s decision holding that Section 14 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) mandating the District Magistrate to deliver possession of a secured asset within 30 days, extendable to an aggregate of 60 days upon reasons recorded in writing, is a directory provision.

Object of SARFAESI Act

It was noticed that the SARFAESI Act was enacted to provide a machinery for empowering banks and financial institutions, so that they may have the power to take possession of secured assets and to sell them. This was done after Recovery of Debts due to Banks and Financial Institutions Act, 1993, which was first enacted to streamline the recovery of public dues, did not give desirous results.

Does inability to take possession of secured assets within time limit renders the District Magistrate Functus Officio?

Taking note of this objective of the SARFAESI Act in mind, the Court noticed that the time limit to take action by the District Magistrate has been fixed to impress upon the authority to take possession of the secured assets. However, inability to take possession within time limit does not render the District Magistrate Functus Officio.

Interpreting Section 14 of the SARFAESI Act, the Court said that

“… the secured creditor has no control over the District Magistrate who is exercising jurisdiction under Section 14 of the Act for public good to facilitate recovery of public dues. Therefore, Section 14 of the Act is not to be interpreted literally without considering the object and purpose of the Act. If any other interpretation is placed upon the language of Section 14, it would be contrary to the purpose of the Act.”

The Court noticed that the time limit is to instill a confidence in creditors that the District Magistrate will make an attempt to deliver possession as well as to impose a duty on the District Magistrate to make an earnest effort to comply with the mandate of the statute to deliver the possession within 30 days and for reasons to be recorded within 60 days. Hence, the remedy under Section 14 of the Act is not rendered redundant if the District Magistrate is unable to handover the possession. The District Magistrate will still be enjoined upon, the duty to facilitate delivery of possession at the earliest.

Limitations on power of High Courts to pass interim orders

On the issue of borrowers and other aggrieved persons invoking the jurisdiction of the High Court under Articles 226 or 227 of the Constitution of India without availing the alternative statutory remedy, the Court said that though the High Courts are well aware of the limitations in exercising their jurisdiction when affective alternative remedies are available, but a word of caution would still be necessary for the High Courts that

“… interim orders should generally not be passed without hearing the secured creditor as interim orders defeat the very purpose of expeditious recovery of public money.”

[C. Bright v. District Collector, 2020 SCC OnLine SC 909, decided on 05.11.2020]


*Justice Hemant Gupta has penned this judgment

Case BriefsHigh Courts

Delhi High Court: A Division Bench of Hima Kohli and Subramonium Prasad, JJ., considered the following question:

Whether a bank/financial institution can institute or continue with proceedings against a guarantor under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act), when proceedings under the Insolvency and Bankruptcy Code 2016 (IB Code) have been initiated against the principal borrower and the same are pending adjudication?

Respondent 4 was the principal borrower in the present case who had obtained loans from the State Bank of India. Guarantor was the wife of the promoter of the principal borrower. Further, it has been stated that the bank filed an insolvency petition against the principal borrower under the provisions of the IB Code before the NCLT, Delhi.

At the time of pendency of the insolvency proceedings against the principal borrower, bank issued a notice under Section 13(2) of the SARFAESI Act to the petitioner and another notice under Section 13(4) of the SARFAESI Act was also issued. Both the notices were challenged by the petitioner.

The above-stated notices were challenged before Debts Recovery Tribunal but were later withdrawn in light of negotiation talks between the Bank and the Principal Borrower.

Petitioner alleged that without issuing a Notice under Section 1(4) of SARFAESI Act, the Bank issued  Sale Notice under Rule 8 (6) of Security Interest (Enforcement) Rules for sale of her residential house.

In the instant matter, the prime question for consideration was confined to the action of the Bank of initiating proceedings against the petitioner under the SARFAESI Act when insolvency proceedings have been initiated against the Principal Borrower under the IB Code and the same are pending before the NCLT.

Analysis & Decision

Bench referred to the relevant provisions, Sections 14 and 31 of the IB Code and Section 128 of the Contract Act.

Section 14 of the IB code related to Moratorium, Section 31 of the IB Code refers to the approval of the resolution plan and Section 128 of the Contract Act provides the Surety’s liability.

Section 128 of the Contract Act provides that the liability of a Guarantor is coextensive with that of the Principal Debtor.

Bench cited the decision of Industrial Investment Bank of India Ltd. v. Biswanath Jhunjhunwala, (2009) 9 SCC 478.

Court held that since the liability of a guarantor is co-extensive with that of the principal debtor and not in the alternative, it cannot be said that proceedings in the NCLT against the principal debtor can be a bar to institution or continuation of proceedings against the guarantor under the SARFAESI Act.

Bench stated that the question raised with regard to whether the bank can proceed against a guarantor even after initiation of proceedings under the IB Code also stands settled and is squarely covered by the Supreme Court’s decision in SBI v. V. Ramakrishan, (2018) 17 SCC 394.

The above-cited decision holds that Sections 14 and 31 of the IB Code do not bar initiation and continuation of the SARFAESI proceedings against the Guarantor.

View of the Supreme Court amply demonstrated that neither Section 14 nor Section 31 of the IB Code place any fetters on banks/Financial Institutions from initiation and continuation of the proceedings against the guarantor for recovering their dues.

Therefore, Court held that,

“…petitioner cannot escape her liability qua the respondent/Bank in such a manner. The liability of the principal borrower and the Guarantor remain co-extensive and the respondent/Bank is well entitled to initiate proceedings against the petitioner under the SARFESI Act during the continuation of the Insolvency Resolution Process against the Principal Borrower.”

In view of the above, no merit was found in the petition and hence was dismissed. [Kiran Gupta v. State Bank of India, 2020 SCC OnLine Del 1390, decided on 02-11-2020]

Op EdsOP. ED.

When we study the origins and functioning of the Indian credit recovery infrastructure, it can be seen that originally the only remedy was suits under the provisions of CPC[1] which was long and cumbersome. Here, the process had two parts i.e. debt adjudication which end in a judgment/decree followed by execution proceedings under Order 21 CPC for recovery of decreed amount. Later, with the enactment of the RDBFI Act, 1993[2], DRTs[3] were established as exclusive forums for speedy adjudication and recovery of debts due to Banks and Financial Institutions (FIs). As per the RDBFI Act, DRTs had the power to issue a Recovery Certificate certifying the amount payable by the debtor after debt adjudication in a summary procedure. This amount was thereafter recovered by the Recovery Officer attached to DRT as per the procedure of recovery of tax under Schedule II of the Income Tax Act, 1961. So, the design was to speed up the recovery once the debt adjudication by DRTs. Although, the RDDBFI Act gave 180 days for disposal of recovery applications, cases have been pending for many years due to prolonged hearings. Almost 70,000 cases involving more than Rupees 5 lakh crore were pending in DRTs as of April 2016[4]. Majority of the delay is at the debt adjudication stage with long drawn processes and adjournments in DRTs. It was for overcoming this hurdle and to further speed up recovery that the SARFAESI Act[5] was enacted. This Act give the Banks and FIs the power to recover their debts classified as non-performing assets by various modes including taking possession and sale of the security, without approaching any Court or Tribunal. Interestingly, the SARFEASI Act dispenses the requirement of debt adjudication and the debt amount stated by the creditor in their demand notice issued under Section 13(2) is conferred sanctity to trigger recovery actions under the Act. When we read through the provisions of the aforesaid Acts and the procedure laid down by them for recovery, it is clear that one of the major causes for delay in securing recovery was the time taken for ascertaining the debt amount payable[6].

Most of the litigation in money recovery laws are in the nature of disputes on the amount claimed for recovery by the creditors. This kind of litigation and resultant delay in recovery can be avoided if there is a mechanism for collection, collation, authentication and dissemination of information regarding debts/defaults by independent third parties that are reliable as evidence of debt/default.

The law-makers of the country seem to have appreciated this point while enacting the Insolvency and Bankruptcy Code, 2016 (IBC) which in its Chapter V under Part IV talks about ‘Information Utilities’ (IUs) which is a first of its kind in the world. In this regard, it is significant to note the following statements in the Report of the Bankruptcy Law Reforms Committee[7]:

“Under the present arrangements, considerable time can be lost before all parties obtain this information. Disputes about these facts can take up years to resolve in court. Hence, the Committee envisions a competitive industry of information utilities who hold an array of information about all firms at all times. When the IRP commences, within less than a day, undisputed and complete information would become available to all persons involved in the IRP and thus address this source of delay.”

This article attempts to understand the concept and working of IUs as contemplated under the IBC regime and its utilities in securing the objectives of IBC.

What is ‘Information Utility’?

IUs are entities that would act as data repositories of financial information which would receive, authenticate, maintain and deliver financial information pertaining to a debtor with a view to facilitate the insolvency resolution process in a time-bound manner. IU maintains an information network which would store financial data like borrowings, default and security interests among others of debtors for providing such information to businesses, financial institutions, adjudicating authorities, insolvency professionals and other stakeholders.

As per Section 3(21) of IBC, ‘Information Utility’ is defined as a person registered with the IBBI[8] under Section 210. Furthermore, as per Section 209 of IBC, a person shall be eligible to carry on business as IU only if a certificate of registration is obtained from the IBBI. As per Section 210 of IBC, a certificate of registration shall be issued to an entity to function as IU if all the technical formalities are completed as prescribed by the IBBI.

Historical perspective of ‘Information Utilities’

The setting up of IUs was preceded by a regime of Credit Information Companies (CICs) and Central Registry of Securitisation Asset Reconstruction and Security Interest (CERSAI) that provided credit-related information services including details of security interests.

In his Budget speech made in  Parliament on 28th February 1994, the then Finance Minister of India announced that Reserve Bank of India (RBI) would put in place arrangements for circulating names of defaulting borrowers among the Banks and FIs. The purpose of the same was to alert them and to put them on guard against the borrowers who have defaulted in their dues to other lending institutions. Pursuant to the above announcement, a Working Group was set up under the Chairmanship of Mr N.H. Siddiqui (Chief General Manager, RBI) which submitted its Report in 1999 recommending the establishment of CICs[9]. Accordingly, Credit Information Bureau (India) Ltd. (CIBIL) was incorporated in August 2000. Later, pursuant to the enactment of the Credit Information Companies (Regulation) Act, 2005[10], three other CICs have also been set up in India[11]. Further, in 2013, RBI constituted another Committee under the Chairmanship of Mr Aditya Puri (Managing Director, HDFC Bank) to examine the reporting formats used by CICs and other related issues. This Committees’ report led to the standardisation of data formats for reporting corporate, consumer and MFI[12] data by all credit institutions and streamlining the process of data submission by credit institutions to CICs[13]. In 2015, all credit institutions were directed by RBI to become members of all the CICs and submit current and historical data about specified borrower to them and to update it regularly.

Later, in the year 2011 the then Finance Minister declared in his budget speech about creation of a central registry of equitable mortgages. Pursuant to the same, the Central Registry of Securitisation Asset Reconstruction and Security Interest (CERSAI) was established to maintain and operate a registration system for the purpose of registration of transactions of securitisation, asset reconstruction of financial assets and creation of security interest over property, as contemplated under the SARFAESI Act. CERSAI is providing a platform for filing registrations by the Banks and FIs with an option for other lenders and the public to search its database.

The idea to establish IUs appears to be an outcome of the research and efforts to set up a hybrid model unique to India by incorporating the best features of CICs, CERSAI and other similar agencies across the world that are engaged in financial information services.

How an ‘Information Utility’ can be created under IBC?

As per Section 196 of IBC, IBBI is entrusted with the power to grant, renew, withdraw, suspend or cancel registration to IUs. This provision further empowers IBBI to make regulations for registration and matters connected therewith. In exercise of the said power, IBBI has notified the Insolvency and Bankruptcy Board of India (Information Utilities) Regulations, 2017[14] (“the IU Regulations”) which provide detailed regulations for registration and working of IUs.

As per Regulation 3 of the IU Regulations, registration can be applied by any public company having a minimum net worth of fifty crore rupees and; (a) whose sole object is to provide core services and other services under the IU Regulations, and discharge such functions as may be necessary for providing these services; (b) its shareholding and governance is in accordance with Chapter III of the IU Regulations; (c) its bye-laws are in accordance with Chapter IV of the IU Regulations; (d) its promoters, directors, key managerial personnel, and persons  holding more than 5%, directly or indirectly, of its paid-up equity share capital or its total voting power, are fit and proper persons[15].

A person eligible for registration as aforesaid may make an application to IBBI in Form A of the Schedule to the IU Regulations, along with a non-refundable application fee of five lakh rupees. After due enquiry as contemplated under the IU Regulations, IBBI shall issue a Certificate of Registration in Form B of the Schedule within sixty days of receipt of the application excluding the time taken for removal of difficulties and for obtaining additional documents, if any. Such certificate of registration is valid for a period of five years from the date of issue and it may be renewed by filing an application for renewal at least six months before the expiry of its registration along with the renewal fees of five lakh rupees. IUs are also required to pay annual fee of fifty lakh rupees to IBBI, within fifteen days from commencement of the financial year. However, no annual fee shall be payable in the financial year in which an IU is granted registration or renewal[16].

The shareholding pattern and governance of IUs should be in compliance to the requirements under Chapter III of the IU Regulations. Furthermore, all changes in the shareholding and voting power of IUs are to be reported to the IBBI. As per Regulation 8 of the IU Regulations, no person shall at any time, directly or indirectly, either by itself or together with persons acting in concert, acquire or hold more than 10% of the paid-up equity share capital or total voting power of an IU. However, there are certain exemptions to the said restriction as follows:

  • None of the restrictions on shareholding are applicable to the holding of shares or voting power by the Central Government or a State Government[17].
  • A government company, stock exchange, depository, bank, insurance company and public financial institution either by themselves or together in concert, acquire or hold up to 25% of the paid-up equity share capital or total voting power of an IU[18].
  • Holding up to 51% of paid-up equity share capital or total voting power of an IU by a person directly or indirectly, either by itself or together with persons acting in concert, is allowed up to 3 years from the date of its registration[19], if the IU is registered before 30th September, 2018.
  • Indian companies (i) which are listed on a recognised stock exchange in India, or (ii) where no individual, directly or indirectly, either by himself or together with persons acting in concert, holds more than 10% of the paid-up equity share capital, may hold up to 100% of the paid-up equity share capital or total voting power of an information utility up to three years from the date of its registration[20], if such IU is registered before 30th September, 2018.

Importance and Utility of Information Utilities

The Bankruptcy Law Reforms Committee (BLRC) led by Mr T. K. Viswanathan which designed the IBC, visualised four pillars of supporting institutional infrastructure to make the processes under IBC to work efficiently. They are:  (1) a private industry of IUs, (2) a private industry of Insolvency Professionals (IPs) with oversight by private insolvency professional agencies (IPAs), (3) adjudication infrastructure at the National Company Law Tribunal (NCLT) and DRT, and (4) a regulator i.e.  IBBI[21]. As noted rightly by the BLRC, IU is a very significant institution for the successful operation of the processes under IBC.

IBC was enacted with a view to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time-bound manner for maximisation of the value of assets of such persons[22]. Section 12 of IBC thus mandates that the Corporate Insolvency Resolution Process (CIRP) of a corporate debtor (CD) must conclude within 330 days[23] from the insolvency commencement date which includes (a) normal CIRP period of 180 days, (b) one-time extension, if any, up to 90 days of such CIRP period granted by the adjudicating authority, and (c) the time taken in legal proceedings in relation to the CIRP of the corporate debtor. This ambitious time-limit prescribed for concluding CIRP appears to be based on an assumption that information relevant for the process will be easily accessible to the parties involved viz. creditors, adjudicating authorities, insolvency resolution professionals, etc. This assumption appears to be based on the confidence of the framers of the law in the idea of IUs envisaged under IBC. As the timelines specified by IBC are strict, they can be met only if the IUs stand ready to provide all relevant information quickly.

The relevant financial information in this stage includes the details of the default, disputes on the same, other financial information of debtors such as records of its debt, liabilities at the time of solvency, assets over which the security interest is created by debtor, timely records of its default and its financial statements of preceding years. Furthermore, it is quintessential for the adjudicating authority to ascertain the existence of default as claimed by the applicant and such existence would decide the fate of the application for CIRP.

As per the scheme of IBC, once CIRP gets initiated against any  corporate debtor, the management of its affairs vest in the Interim Resolution Professional (IRP) and thereupon all the powers of its Board of Directors stands suspended and the same is exercised by the IRP. During such phase, there is every possibility for the Resolution Professionals to face non-cooperation from the management and the suspended Board of the  corporate debtor in disseminating relevant financial information. In these circumstances, an independent and reliable third party which is a repository of validated information regarding debt/default that is capable of providing the same quickly can add significant value to the process.

IBBI has now strengthened the role of IUs by allowing it to access the data of MCA-21[24] database and CERSAI portals to speed up the process of debtor default authentication[25]. By ensuring access of MCA-21 and CERSAI portal data to an IU, IBBI is also providing the mechanism for quick and reliable data for all the stake-holders in the processes under IBC. It may also be noted that RBI has directed all the Scheduled Commercial Banks (Including RRBs), small finance banks, local area banks, non-banking financial companies and all the co-operative banks of the country to put in place appropriate systems and procedures for submission of financial information to IUs[26].

Functions of ‘Information Utility’ as contemplated under the IBC

As per Section 213 of IBC, IUs shall provide services which include core services to any person, if such person complies with the terms and conditions of the IU Regulations. Furthermore, as per Section 3(9) of IBC, “core  services” means – (a) accepting electronic submission of financial information; (b) safe and accurate recording of financial information; (c) authenticating and verifying financial information submitted by person; and (d) providing access to information stored with IUs to persons as may be specified.

As per Section 3(13) of IBC, “financial information”, in relation to a person, means one or more of the following categories of information, namely:  (a) records of the debt of the person; (b) records of liabilities when the person is solvent; (c) records of assets of person over which security interest has been created; (d) records, if any, of instances of default by the person against any debt; (e) records of the balance sheet and cash-flow statements of the person; and (f) such other information as may be specified.

Section 214 of the IBC elaborate the functions to be performed by IUs for the purpose of providing core services. The major obligations of IUs as per Section 214 can be summarised as follows:

  • Acceptance of financial information in electronic form from persons who are under obligation to submit the same under IBC and also from other persons who intend to submit the same. This acceptance is to be in such form and manner as specified under the IU Regulations.
  • Authentication of the financial information so received by all the parties concerned.
  • Storage of the financial information received as aforesaid in a universally accessible format after the same is duly authentication by all the parties concerned.
  • Providing the financial information stored by it as aforesaid to any person who intend to access such information in such manner as may be specified by the IU Regulations.
  • Publication of such statistical information as may be specified by the IU Regulations.

While performing aforesaid obligations, IUs are required to meet such minimum service quality standards as may be specified by IBBI and they are also required to ensure systems to facilitate inter-operatability with other IUs[27]. As per Section 215 of IBC, while it is mandatory for the financial creditors[28] to submit financial information and information relating to assets in relation to which any security interest has been created; submission of information is optional for the operational creditors[29]. Insolvency professionals also may submit reports, registers and minutes in respect of any insolvency resolution, liquidation or bankruptcy proceedings to an IU for storage[30].

Significance of Information Utility in the operation of processes under IBC

As per the scheme of IBC, a CIRP can be triggered by the corporate debtor itself or by the financial or operational creditors of such corporate debtor[31]. Application for CIRP by a financial creditor is governed by Section 7 of the IBC read with Rule 4 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016[32].  The application is to be filed as per Form 1 of the said Rules along with the record of the default recorded with the IU or such other record or evidence of default as may be specified. As per Part V of the said Form 1, record of default with IU is listed among the documents acceptable as evidence of default. Upon submission of application, NCLT is required to ascertain the existence of default from the records of an IU or on the basis of other evidence furnished by the financial creditor. It is significant to note that this activity is to be completed by NCLT within fourteen days of the receipt of application. This timeline can be met only if such ascertainment can be done from the records of an IU. Furthermore, upon initiation of CIRP when public announcement is made by the IRP calling for claims, financial creditors may submit their claims along with sufficient proof of such claims. In this regard, it may be noted that the records available with an IU is accepted as a proof of existence of debt due[33].

Whereas, application for CIRP by operational creditors is governed by Section 9 of the IBC read with Rules 5 & 6 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016. On the occurrence of a default, operational creditors are required to deliver either a demand notice of the unpaid debt to the debtor as per Form 3 of the said Rules or a copy of an invoice attached with a notice in Form 4. On receipt of notice, the debtor may, within 10 days, bring to the notice of the creditor about any pre-existing dispute on such debt and get out of the clutches of IBC. On expiry of 10 days from the said notice, if the payment is not done by the defaulter, the operational creditor can file application for CIRP in Form 5 of the aforesaid Rules. As per the aforesaid Forms 3 and 5, record of default with IU is listed as one of the documents to prove the debt. Furthermore, upon initiation of CIRP when the public announcement is made by the IRP calling for claims, operational creditors may submit their claims along with records available with IU which are acceptable as proof for the debt.

Similarly, in an application for CIRP by corporate applicants and in the claims submitted by the other categories of claimants/creditors including workmen, records with IU is accepted as proof of such debt/default. Furthermore, as per IBC and the Rules, the records with IUs can be accessed and relied by the adjudicating authority as evidence for the default/debt in their proceedings. Hence, IUs play a very significant role in enabling timely completion of the processes under IBC.

Operating Procedure of ‘Information Utility’ under IBC

IBC provides little guidance on how IUs are to function, leaving the details to subordinate regulation. Section 240 of IBC empowers the IBBI to make regulations by notification with regard to the registration of IUs, their functioning and on matters connected thereto. The IU Regulations were notified in exercise of this power in order to prescribe the details on how IUs shall operate to meet their objectives as contemplated under IBC.

As per the IU Regulations, a person shall register itself with an IU for submitting information to; or for accessing information stored with any of the IUs. Upon such registration, IU shall verify the identity of the applicant and assign him with a unique identifier and intimate the same to him. A person registered once with an IU shall not register itself with any IU again. A registered user may submit information to any IU and not only to the IU with which he is registered. Different parties to the same transaction may use different IUs to submit, or access information in respect of the same transaction and a user may access information stored with an IU through any IU[34].

A user can submit information of debts or defaults to the IU[35] and on receipt of the same, IU is to assign a unique identifier to the information and intimate the same to the user along with an acknowledgement. In the case of information of default, IU is to expeditiously undertake the process of authentication and verification of the information of default. For this purpose, IU is to deliver the information of default to the debtor seeking confirmation of the same within the specified time. If the debtor fails to respond, IU is to send three reminders giving 3 days’ time in each case for the debtor to respond. If the debtor do not respond even after three reminders as aforesaid, the information is deemed to be authenticated[36]. In case if the debtor confirms the information of default, the information is treated as authenticated and green colour is assigned to the status. If the debtor disputes the information of default the information is treated as disputed and red colour is assigned to the status. Whereas, in cases where the debtor does not respond even after three reminders, the information is‘Deemed to be authenticated’ and yellow colour is assigned to the status. After recording the status of information of default, IU is to communicate the status of authentication in physical or electronic form of the relevant colour, as aforesaid, to the registered users who are- (a) creditors of the debtor who has defaulted; (b) parties and sureties, if any, to the debt in respect of which the information of default has been received[37].

IUs are required to store the information received by it in their facilities located in India and they shall allow the following persons to access the information stored with it- (a) the user which has submitted the information; (b) all the parties to the debt and the host bank[38], if any, if the information is regarding record of debts or assets or instances of default by a person against any debt; (c) the corporate person and its auditor, if the information is of liabilities of a person during solvency or balance sheet and cash-flow statements of the person; (d) the insolvency professional; (e) the adjudicating authority; (f) the IBBI; (g) any person authorised to access the information under any other law; and (h) any other person who the persons referred to in (a), (b) or (c) have consented to share the information.

Provisions to ensure protection of the data with Information Utilities

As per the provisions of IBC, data entrusted with the IUs by the users are to be held as a custodian and hence they shall not have ownership over the data available with them. As such, it is one of the most important duties of the IUs to ensure safety of the data and its protection from unauthorised interferences and data theft. To ensure safety of the data, the IU Regulations prescribe the following to be complied by the IUs:

  • Establish adequate procedures and facilities to ensure that its records are protected against loss or destruction and adopt secure systems for information flows.
  • Storage of all information in a facility located in India shall be governed by the laws of India.
  • Not to outsource the provision of core services to a third-party service provider.
  • Not to use the information stored with it for any purpose other than providing services under these Regulations, without the prior approval of the Board.
  • Not to seek data/details of users except as required for the provision of services under IBC[39].
  • Adequate arrangements, including insurance is to be made for indemnifying the users for losses that may be caused to them by any wrongful act, negligence or default of the IU, its employees or any other person whose services are used for the services[40].
  • Appoint external auditor having relevant qualifications to audit its information technology framework, interface and data processing systems every year. The auditor’s report along with the comments of the Governing Board of IU is to be submitted to the IBBI within one month from the receipt of the same[41].
  • Establish an appropriate risk management framework in line with the Technical Standards[42].
  • Declare a Preservation Policy providing for the form, manner and duration of preservation of information stored with it; and details of the transactions of the IU with each user in respect of the information stored with it[43].
  • Inspection by the IBBI with such periodicity as may be considered necessary[44]. Disciplinary actions can be taken by IBBI including imposition of penalty under Section 220(3) of IBC.

Evidentiary Value of Information with Information Utilities

Authenticated information stored by IUs with regard to a debt or its default amounts to admission of such debt and default thereto by and between the parties to such debt or default. In the light of this fact, evidentiary value of information with IUs can be appreciated by referring to certain provisions of the Evidence Act, 1872. As per Section 65-B of the Evidence Act, information contained in any electronic record shall be deemed to be a document and shall be admissible in the court of law. Furthermore, Section 31 of the Evidence Act state that admissions are not conclusive proof of the matters admitted, but they may operate as estoppels under the provisions hereinafter contained.  In the context of information with IUs, Section 115 of the Evidence Act is significant, which state as follows:  “When one person has, by his declaration, act or omission, intentionally caused or permitted another person to believe a thing to be true and to act upon such belief, neither he nor his representative shall be allowed, in any suit or proceeding between himself and such person or his representative, to deny the truth of that thing.”

When we examine the provisions of IBC with regard to IUs as explained in the preceding paragraphs of this article, it can be noted that the adjudicating authorities are given the option to accept records with IUs as proof/evidence of debts and defaults. This is on the basis of estoppel which would operate against the parties as per the aforesaid provisions of the Evidence Act. In Swiss Ribbons Pvt. Ltd. v. Union of India[45], constitutional validity of the various provisions of IBC was considered by the Supreme Court of India. One of the arguments in the matter was that IBC provides for private information utilities not only to collect financial data, but also to check whether a default has occurred or not. It was also argued that certification of debt/default by IUs is in the nature of a preliminary decree issued without any hearing and without any process of adjudication. On this ground along with others, the constitutional validity of IBC was challenged in this matter. However, the  Supreme Court of India upheld the constitutional validity of IBC and on the basis of statements made by the then Attorney General of India, declared at para 57 of the judgment that the record of default with IU is only a prima facie evidence of default, which is rebuttable by the  corporate debtor. So, the records with IUs are not conclusive proof and they are only a prima facie evidence of default, which is rebuttable by the corporate debtor.

Conclusion

It can be concluded that creation of IU is definitely a step towards ensuring an information-rich environment for the working of IBC. IUs certainly provide an infrastructure which ensure relevant financial information of debtors easily accessible at anytime from anywhere. This infrastructure undoubtedly empower the creditors and lenders to make informed choices and also provide essential financial information enabling time-bound insolvency resolution process. While, the purpose of setting up the above regime of IUs was to reduce information asymmetry; IUs not only reduce information asymmetry, but it is also enable the processes of IBC to meet the strict timelines prescribed. It can also be seen that the IUs are significant as they provide for improved credit risk assessment and improve the recovery processes. Though there is no doubt about the significance of the IUs; it may take a while before they become relevant as expected. As the first step, IBBI has registered National E-Governance Services Limited (a Union Government company) as the first IU of the country on September 25, 2017. Being sanguine about the developments thus far, we can expect that the data available with the IUs will grow in terms of quantity and quality over a period of time making them an important pillar in the overall resolution process.


* BA LLB (Hons.), LLM, currently working as Manager-Legal with Hindustan Petroleum Corporation Limited at Zonal Administrative Office, Chennai.

[1] Civil Procedure Code, 1908 (Act  5 of 1908).

[2] Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (Act  51 of 1993).

[3] Debts Recovery Tribunal.

[4]Indu Bhan, “Long Due – Banks can now confiscate security in case of a loan default”, Financial Express, August 19, 2016, available at https://www.financialexpress.com/opinion/long-due/351486/, last visited on 15.05.2020.

[5]Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (Act  54 of 2002).

[6] Prasanth V. Regy and Shubho Roy, “Understanding Judicial Delays in Debt Tribunals”, Paper No. 195 in the Working Paper Series of National Institute of Public Finance and Policy at New Delhi, May 2, 2017, available at https://www.nipfp.org.in/media/medialibrary/2017/05/WP_2017_195.pdf, last visited on 15.05.2020.

[7] Government of India, “Report of the Bankruptcy Law Reforms Committee” (Ministry of Finance, November 2015).

[8] Insolvency and Bankruptcy Board of India established under Section 188 of the Insolvency and Bankruptcy Code, 2016 (Act 31 of 2016).

[9]Reserve Bank of India, “Report of the Working Group to explore the possibilities of setting up a Credit Information Bureau in India” (Department of Banking Operations and Development, October 1999)

[10] Credit Information Companies (Regulation) Act, 2005 

[11] Equifax Credit Information Services Private Limited, Experian Credit Information Company of India Private Limited and CRIF High Mark Credit Information Services Private Limited have been granted Certificate of Registration by RBI.

[12]Monetary Financial Institutions.

[13]Reserve Bank of India, “Report of the Committee to Recommend Data Format for Furnishing of Credit Information to Credit Information Companies”, (Department of Banking Operations and Development, January 2014)

[14] Insolvency and Bankruptcy Board of India (Information Utilities) Regulations, 2017

[15]As per Explanation to Regn. 3 of Insolvency and Bankruptcy Board of India (Information Utilities) Regulations, 2017, a person is considered as fit and proper, if he (a) is having integrity, reputation, character and financial solvency (b) has never been convicted by a Court for an offence or sentenced to imprisonment for a period less than 6 months, and (c) has not suffered any restraint order issued by financial sector regulator or adjudicating authority.

[16] IBBI (Information Utilities) Regulations, 2017, Regns. 5 and 6.

[17]Id, Regn.  8(3).

[18]Id,  proviso to Regn. 8(1)

[19]Id, Regn. 8(2)(a).

[20]Id,  Regn. 8(2)(b).

[21]Supra Note 7.

[22]Government of India, “Report of the Working Group on Information Utilities” (Ministry of Corporate Affairs, January 2017).

[23] This cap of 330 days was brought by the Insolvency and Bankruptcy Code (Amendment) Act, 2019 (w.e.f. 16-8-2019).

[24]MCA-21 is an e-Governance initiative of Ministry of Company Affairs (MCA), Government of India that enables an easy and secure access of the MCA services to the corporate entities, professionals and citizens of India. It is designed to fully automate all processes related to the enforcement and compliance of the legal requirements under the Companies Act, 1956, the New Companies Act, 2013 and the Limited Liability Partnership Act, 2008. Its database will contain the master data and the charges registered on companies and LLP.

[25]Insolvency and Bankruptcy Board of India, Circular No. IBBI/IU/025/2019 dated 07-09-2019.

[26] Notification No: DBR.No.Leg.BC.98/09.08.019/2017-18 dated December 19, 2017 issued by Reserve Bank of India, available at https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11189&Mode=0, last accessed on 16.05.2020.

[27] Insolvency and Bankruptcy Code, 2016 (31 of 2016), Ss. 214(d) and (h).

[28] As per Section 5(7) of IBC, “financial creditor” means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred. Eg. – Banks and financial lenders.

[29] As per Section 5(20) of IBC, “operational creditor” means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred. Eg. – Suppliers and vendors.

[30]Insolvency and Bankruptcy Board of India (Information Utilities) Regulations, 2017, Regn. 38.

[31] Insolvency and Bankruptcy Code, 2016 (31 of 2016), S.6.

[32] Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016

[33]Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, Regn. 8(2)(a)

[34]Insolvency and Bankruptcy Board of India (Information Utilities) Regulations, 2017, Chapter V (Regns.17 to 27).

[35]Id, Form C of the Schedule.

[36]Deemed authentication was inserted by Notification No. IBBI/2019-20/GN/REG046 dated 25/07/ 2019. Prior to this, there was no option for deemed authentication when debtor do not respond to notice for authentication.

[37] Insolvency and Bankruptcy Board of India (Information Utilities) Regulations, 2017, Regn. 21.

[38] Host bank means the financial institution hosting the repayment account.

[39] Insolvency and Bankruptcy Board of India (Information Utilities) Regulations, 2017, Regn. 30.

[40]Id, Regn. 31.

[41]Insolvency and Bankruptcy Board of India (Information Utilities) Regulations, 2017, Regn 34.

[42]Id,  Regn. 33.

[43]Id, Regn. 35.

[44]Id,  Regn.37.

[45] 2019 SCC OnLine SC 73.

Case BriefsHigh Courts

Karnataka High Court: P.S. Dinesh Kumar, J., rejects the petition seeking the writ of certiorari against the order of NCLT imposing heavy costs.

Facts

The petitioner company availed a loan from the Bank of Maharashtra towards its infrastructure development and various other works. Upon delay in payment of interest, the bank issued a notice under Section 13(2) of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. Sale notice and public notice were subsequently published. By an interim order passed by the present court, the Bank was allowed to proceed with the auction provided it shall not confirm the sale.

Subsequently, the respondent also moved to the NCLT under Section 7 of the Insolvency and the Bankruptcy Code, 2016 wherein the tribunal appointed an Insolvency Resolution Professional (IRP) to facilitate the process. Noticeably, while the case was before NCLT, the petitioner sought time for settling the issue and submitting its objections on several occasions through as many as thirteen adjournment orders.

Petitioner’s Contentions

It was submitted by the counsel for the petitioner, Vivek Holla, that despite sincere attempts, the interest amount could not be deposited either before the NCLT or the present Court. Further, no adequate opportunity of filing the counter was provided at the hearing before NCLT. Lastly, the tribunal was devoid of any jurisdiction upon the instant matter as on the date of application under Section 7, the debt was time-barred.

 Respondent’s Contentions

The counsel for the respondent, M. Jagadeesh submitted that the petition by an erstwhile Director of the Company is not maintainable and further the conduct of the petitioner also disentitles him from any other discretionary relief. The counsel relying on the case of Innoventive Industries Ltd. v. ICICI Bank, (2018) 1 SCC 407, contended that once IRP is appointed, the erstwhile directors who are no longer in management cannot stand in appeal.

Court’s Observation

The Court rejected the present petition recognizing several reasons. Firstly, the petitioner company is represented by its erstwhile director, secondly, the petitioner company has willfully defaulted on several occasions, giving false assurances with regards to the settlement before the NCLT and thirdly, the impugned order is an appealable order. With respect to the court order and an undertaking, the court remarked, ‘An assurance is a promise and stands on a higher footing than an order passed by Tribunals or Courts because promises or undertakings are given voluntarily whereas orders are imposed by an authority.’ Further relying on the judgment of Prestige Lights Ltd. v. State Bank of India, (2007) 8 SCC 449, it was held that an order passed by a competent court, interim or final, has to be obeyed without reservation.[Alpine Wineries (P) Ltd. v. Pridhvi Asset Reconstruction Company, WP No. 1631 of 2020, decided on 04-09-2020]

Reserve Bank of India
COVID 19Op EdsOP. ED.

The current articles deals with RBI’s announcement on 27.03.2020 and 22.05.2020 regarding moratorium on term loans up to 31.08.2020. It points to certain areas of concern and provides pointers for further consideration by RBI and policy-makers. 

The outbreak of the COVID-19 pandemic has brought the economic activity in the country to a grinding halt. An already debilitated banking environment now faces the new challenges for maintaining liquidity and servicing borrowers many of whom are facing a near collapse on both demand and supply side. The problem will be more acute for SME, MME and small entrepreneurs who may not possess the staying power to tide over the present phase of uncertainty.

Reserve Bank of India in the immediate aftermath of the outbreak and lockdown came out with a press statement on 27.03.2020 regarding moratorium on term loan and working capital loan. The objective it appears is to provide some immediate relief to the borrowers facing liquidity crunch. The relevant portion of the statement was:

“STATEMENT ON DEVELOPMENT AND REGULATORY POLICIES

II. Regulation and Supervision

    *                                 *                                               *

5. Moratorium on Term Loans

All commercial banks (including regional rural banks, small finance banks and local area banks), co-operative banks, all-India financial institutions, and NBFCs (including housing finance companies and micro-finance institutions) (“lending institutions”) are being permitted to allow a moratorium of three months on payment of instalments in respect of all term loans outstanding as on March 1, 2020. Accordingly, the repayment schedule and all subsequent due dates, as also the tenor for such loans, may be shifted across the board by three months.

6. Deferment of Interest on Working Capital Facilities

In respect of working capital facilities sanctioned in the form of cash credit/overdraft, lending institutions are being permitted to allow a deferment of three months on payment of interest in respect of all such facilities outstanding as on March 1, 2020. The accumulated interest for the period will be paid after the expiry of the deferment period.

In respect of Paras 5 and 6 above, the moratorium/deferment is being provided specifically to enable the borrowers to tide over the economic fallout from COVID-19. Hence, the same will not be treated as change in terms and conditions of loan agreements due to financial difficulty of the borrowers and, consequently, will not result in asset classification downgrade. The lending institutions may accordingly put in place a Board approved policy in this regard.

7. Easing of Working Capital Financing

In respect of working capital facilities sanctioned in the form of cash credit/overdraft, lending institutions may recalculate drawing power by reducing margins and/or by reassessing the working capital cycle for the borrowers. Such changes in credit terms permitted to the borrowers to specifically tide over the economic fallout from COVID-19 will not be treated as concessions granted due to financial difficulties of the borrower, and consequently, will not result in asset classification downgrade.

In respect of Paras 5, 6 and 7, the rescheduling of payments will not qualify as a default for the purposes of supervisory reporting and reporting to credit information companies (CICs) by the lending institutions. CICs shall ensure that the actions taken by lending institutions pursuant to the above announcements do not adversely impact the credit history of the beneficiaries.”

This “moratorium” now stands extended for a further 3 month period announced by RBI on 22.05.2020, RBI Statement on “Development and Regulatory Policy”. The new statement provides extension of export credit from 1 year to 15 months, permits banks to allow deferment on working capital payment up to 31.08.2020, conversion of the accumulated interest on working capital loans up to the extension period up to 31.08.2020 into a interest term loan repayable by the end of the financial year and extends the previous moratorium on payment of EMIs on term loans up to 31.08.2020.

The previous press statement was necessary to provide immediate succor, in the background of the sudden pandemic and announcement of a pan India lockdown. The subsequent announcement on 22.05.2020 merely extends the same.

RBI now may additionally consider a more medium to long term objective of facilitating the sector/business wise revival of the economy. The salient points of concern are as follows:

              1. While the moratorium announced on 27.03.2020 was ostensibly for a three month period, most borrowers would have paid their EMI for the month of March, 2020 before the statement.

There is no reduction in repayment liability as interest and principal will have to be serviced but after the three month moratorium period up to 31.08.2020.

              2. Interest will continue to be charged for the moratorium period and hence, one’s outstanding EMI payment will be higher after the moratorium period than had one paid on a monthly basis. This is likely to be a cause of immediate stress for many borrowers.

              3. While RBI expects borrowers to tide over the liquidity problem, it is unlikely that the same can be overcome by most borrowers as there is still uncertainty surrounding how the lockdown will actually be rolled back. Consumer demand is expected to remain very low and cautious even post lockdown and hence the expectation of prompt revival of demand close to previous levels is unlikely.

            4. In most sectors the supply chain or/and labour force have been disrupted. Any revival in production and ergo liquidity will therefore necessary have to await restoration of the same post lockdown. Only such revival will help enterprises in servicing their credit facilities.

            5. The Government of India has issued an advisory asking all public and private enterprises to ensure that their workers are not retrenched on the pretext of the pandemic and are paid full wages for the period of the lockdown. The Supreme Court in Alakh Alok Srivastava v. Union of India[1], in the context of the Disaster Management Act, stated in its order dated 31.03.2020:

Disobedience to an order promulgated by a public servant would result in punishment under Section 188 of the Penal Code. An advisory which is in the nature of an order made by the public authority attracts Section 188 of the Penal Code.

The Government advisory will be very difficult to enforce, however if the same is strictly enforced it will be another factor of stress that will affect liquidity.

           6. It may be prudent that the banks assess the situation borrower wise/sector wise. This aspect would require RBI’s earnest consideration.

            7. A separate framework may also be formulated for bona fide borrowers with transient default/minor defaults or undergoing a reschedulement of their credit facilities who were servicing their credit facilities but have been hampered by the lockdown and pandemic.

Thus while summarising the above it is clear that while RBI press statement was aimed to be a limited immediate step further flexibility ought to be allowed to the banks that would help them make a clear and detailed assessment of both demand, production and supply side factors borrower/segment wise to assist in revival of the bona fide borrowers. 

Many enterprises in the present face peculiar problems. The credit facilities were availed envisaging a certain level of demand and supply. Currently there is a lack of availability of raw materials, labour, transport incapacitating production and distribution. The current near collapse of demand in many sectors has lead to the absence of potential to service the credit facilities. It may also lead to perishing of final goods and atrophy of stocks and assets.

A grim but very likely consequence is that many enterprises may not be able to bear the burden of near collapse of projected demand even post 31.08.2020. They will not be able to service their outstanding EMIs and in a few months thereafter will fall into the NPA category. This will further bar trade for many in terms of their contractual stipulations that require them to be solvent. It many cases it will create stress on their stock value and adversely affect investor confidence.  It will affect the credit ratings of the borrowers. In such a scenario the inevitable legal proceedings under the Insolvency Code, SARFAESI and for debt recovery, will lead to collapse of numerous industries that may have a chance at revival, if they given the necessary helping hand. It will overburden an already overloaded judicial system. The same will have ramifying effects on ancillary units and ultimately the health of the economy.

Further increase in NPAs, costly legal proceedings will also impact the profit and loss statement of the banks and their market perception.

With an objective to revive the borrower out of the current imbroglio I suggest that RBI may consider to formulate a more detailed medium to long term plan focusing on revival of the borrower after taking inputs from industry and banks. The following points may be kept in mind while framing its response for borrowers who were servicing their credit facilities but for the pandemic or those who even while servicing their EMIs are in need of easing repayment schedules:

  1. While the complete lockdown may be ended, lockdown may continue in certain areas or industrial sectors and therefore a flexible approach needs to adopted by RBI and banks;
  2. Allow banks greater flexibility to assess the default borrower /sector wise taking into account factors both on the supply side and demand side  and the bona fides of the borrower;
  3. Allow banks upon assessment to shape and support and if necessary reschedule loans synchronised with the pace of revival of economic activity;
  4. The benefit of the recent reduction in REPO rate and CRR granted by RBI to banks should be passed on to the ultimate consumer/borrower;
  5. RBI may consider to review and consider relaxation of norms for provisioning and classification of accounts as NPA, allowing banks greater window to work with the borrower for standardisation of the account without any stress on the assets available with the banks;
  6. RBI may also formulate a plan for borrowers with minor or transient defaults, or whose credit facilities were reschedule immediately prior to the lockdown to avail the necessary support from the lending bank;
  7. Assist banks to work together on the above mentioned lines in cases of consortium loans.

* Author is a graduate from National Law School of India University and has been practicing before the Supreme Court for past 17 years. He works in area of Banking and taxation laws.

[1] 2020 SCC OnLine SC 345  

Kerala High Court
Case BriefsHigh Courts

Kerala High Court: Raja Vijayaraghavan V., J., disposed of this writ petition filed under Article 226 of the Constitution of India.

The petitioner here is the accused in the suit filed under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. The petitioner took a loan from the Co-operative Urban Bank Ltd (Respondent 1). The petitioner committed some default in the re-payment, hence the initial suit was filed under SARFAESI. The present petition is against the measures initiated under SARFAESI for recovery of the loan amount by the Bank. This Act enables the secured creditors to take possession of the securities of the defaulters, without any intervention of the Court and also alternatively to authorize any Securitization or Reconstruction Company to acquire financial assets of any Bank or Financial Institutions. 

The counsel for the petitioner, K.V. Anil Kumar, contended that default was committed because of some reasons beyond the control of the petitioner. The only prayer of the petitioner is that some time may be granted so that he can clear all the arrears and regularize his account in the bank.

The counsel for the respondent, Deepa Arun V., contended that the bank is only interested in realizing the arrears amounting to Rs 9,23,000, expeditiously. 

The Court referred to the judgments of the Supreme Court- Union Bank of India v. Stayawati Tandon, (2010) 8 SCC 110 and State Bank of Travancore v. Mathew K.C., 2018 (1) KLT 784. The judgment in the above-mentioned case was that, where any alternate remedy is available, the petition under Article 226  should not be entertained by the High Court. Section 17 of the SARFAESI Act provides for the right to appeal. It enumerates that any person who is aggrieved by the measures referred in Section 13(4) of the Act shall make an application to the Debt Recovery Tribunal within 45 days from the date on which measures have been taken. Though the rule of exhaustion of alternate remedy is a rule of discretion and not one of compulsion.

The Court held that it will be indulging for the last and final time as the respondents are also agreeable for an opportunity to salvage the property of the petitioner. Further, the Court directed the petitioner to deposit the total arrears in easy installments divided into 10 equal and monthly installments starting from 15-01-2020. Only after compliance with the said order, the bank account was supposed to be regularized. It was directed that the petitioner has to simultaneously pay regular EMIs without any default. In case of non- compliance on behalf of the petitioner, the benefit granted by this Court would stand vacated and the Bank will be entitled to proceed to recover the loan amount through the procedure stated in the SARFAESI Act. [Abdul Salam v. General Manager, Co-operative Urban Bank Ltd., 2019 SCC OnLine Ker 5762, decided on 27-12-2019]

Case BriefsSupreme Court

Supreme Court: A Bench comprising of CJ Ranjan Gogoi and Navin Sinha and K.M. Joseph, JJ. dismissed an appeal filed against the appellate order whereby interference in the order of Company Judge was declined.

The appellant was an assignee of debt by Industrial Finance Corpn. of India Ltd. for the outstandings of Mahendra Petrochemical Ltd. Earlier, a company petition was filed for winding up of MPL. Subsequently, after assignment of debt by IFCI in its favour, the appellant filed another company appeal for substitution of its name in place of IFCI as a secured creditor. The Company Judge rejected the application holding that the appellant was neither a bank or a banking company or a financial institution or a securitisation company or a reconstruction company, and therefore could not be substituted in place of IFCI as a secured creditor for the purpose of Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (SARFAESI). It was also held that in the nature of the relief sought under the SARFAESI Act, the appellant could not draw any benefit from Section 130 of the Transfer of Property Act. The review application filed to the Company Court under Section 9 of the Companies (Court) Rules, 1959 was rejected. The appellant submitted that it never sought substitution as a secured creditor, but simply desired substitution as a transferee of an actionable claim under Section 130 of Transfer of Property Act.

The Supreme Court, after considering the submissions and perusing the record, was of the view that the submissions made before the Company Judge left no room for doubt that as an assignee of debt from IFCI, the appellant essentially sought substitution as a secured creditor under SARFAESI Act and for that purpose sought to draw sustenance from Section 130 of Transfer of Property Act. After the claim of the appellant of being a secured creditor was rejected, it realised the unsustainability of its claim and made a complete volte face from its earlier stand contrary to its own pleadings. The contention of the appellant was belied from its own recitals before the Company Court. Referring to Amar Singh v. Union of India, (2011) 7 SCC 69 and Joint Action Committee for Airline Pilots’ Assn. of India v. Director General of Civil Aviation, (2011) 5 SCC 435, the Supreme Court held that a litigant can different stands at different times but cannot take contrary stands in the same cases. A party cannot be permitted to approbate and reprobate on the same facts and take inconsistent shifting stands. [Suzuki Parasrampuria Suitings (P) Ltd. v. Official Liquidator of Mahendra Petrochemicals Ltd.,2018 SCC OnLine SC 1798, dated 08-10-2018]

Case BriefsHigh Courts

Bombay High Court: A Single Judge Bench comprising of A.S. Chandurkar, J. allowed a civil revision application filed by the tenant — Dena Bank, against the order of the trial court whereby its application under Order 7 Rule 11(d) CPC for rejection of the plaint filed by the landlord for its eviction was dismissed.

The Bank filed the abovesaid application stating that in the light of provisions of Section 17(4-A) read with Section 13(4) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Act, 2002 (SARFAESI), the civil court had no jurisdiction in the suit. However, the application was rejected. Aggrieved thus, the Bank approached the High Court.

The High Court noted that according to Section 17(4-A), any person who is aggrieved by any of the measures referred to in Section 13(4) of  SARFAESI being taken by a secured creditor can approach Debts Recovery Tribunal and can raise a grievance. A person claiming tenancy or leasehold is also entitled to make such application under Section 17. As per Section 34, a civil court has no jurisdiction to entertain any suit or proceeding with regard to any matter which the DRT is empowered to adjudicate under SARFAESI. The High Court, on the basis of the above, held that the trial court rejected the application of the Bank without having regard to Section 17(4-A) and therefore committed a jurisdictional error. Hence, the order impugned was quashed and set aside. The application filed by the Bank under Order 7 Rule 11(d) was allowed. However, it was open to the landlord to take such other steps as permitted under law. The civil revision was accordingly allowed. [Dena Bank v. Pravin Vithalrao Dorkhande,2018 SCC OnLine Bom 2800, decided on 26-09-2018]

Case BriefsSupreme Court

Supreme Court: Dealing with a matter under Section 13(4) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act), the bench of RF Nariman and Navin Sinha, JJ said:

“In financial matters grant of ex-parte interim orders can have a deleterious effect and it is not sufficient to say that the aggrieved has the remedy to move for vacating the interim order.”

The Court said that it is the solemn duty of the Court to apply the correct law without waiting for an objection to be raised by a party, especially when the law stands well settled. Any departure, if permissible, has to be for reasons discussed, of the case falling under a defined exception, duly discussed after noticing the relevant law.

Explaining the concept of loans by financial institutions, the Court said that these loans are granted from public money generated at the tax payers expense. It was observed:

“Such loan does not become the property of the person taking the loan but retains its character of public money given in a fiduciary capacity as entrustment by the public. Timely repayment also ensures liquidity to facilitate loan to another in need, by circulation of the money and cannot be permitted to be blocked by frivolous litigation by those who can afford the luxury of the same.”

It was said that the writ petition ought not to have been entertained and the interim order granted for the mere asking without assigning special reasons, and that too without even granting opportunity to the Appellant to contest the maintainability of the writ petition and failure to notice the subsequent developments in the interregnum. The opinion of the Division Bench that the counter affidavit having subsequently been filed, stay/modification could be sought of the interim order cannot be considered sufficient justification to have declined interference.

The Court was hearing appeal arising out of interim orders in the the writ petition under Article 226 of the Constitution, staying further proceedings at the stage of Section 13(4) of SARFAESI Act on deposit of Rs.3,50,000/-within two weeks. An appeal against the same was also dismissed by the Division Bench observing that counter affidavit having been filed, it would be open for the Appellant Bank to seek clarification/modification/variation of the interim order. [Authorized Officer, State Bank of Travancore v. Mathew KC, 2018 SCC OnLine SC 55, decided on 30.01.2018]