Sale Of Property Under SARFAESI Will Not Extinguish Prior Existing Charge For Dues Under State Tax Laws : Kerala High Court

The Kerala High Court on Friday held that the statutory charge created under the provisions of the Kerala General Sales Tax Act, 1963 and the Kerala Value Added Tax Act, 2003, prior to any mortgage made, against the dealers would remain intact, even if the property is sold by the Bank, by the rights conferred under Section 26E of the SARFAESI Act, 2002, and Section 31B of the Recovery of Debts and Bankruptcy Act 1993 read with the Rules to it, until such encumbrances are cleared as per the provisions of the said enactments and the rules. 

The Division Bench comprising Chief Justice S. Manikumar and Justice Shaji P. Chaly, passed the above orders in a batch of writ appeals filed by the State challenging the Single Bench order which held that a secured creditor under Section 26E of the SARFAESI Act and Section 31B of the RDB Act obtains priority over the right claimed by the Revenue, both in proceeding against the properties in question, or in recovering the secured debt.

While allowing the writ appeals, the Division Bench observed:

"To put it otherwise, if and when any amounts have fallen due as per the provisions of the KGST Act, 1963 and the KVAT Act, 2003 and the proceedings start, consequent to which a charge is created on the properties of the assessee and the said charge created would continue to run with the property even if the Banks / financial institutions conduct the sale to recover the amounts due under the mortgage". 

It noted that,

"....if the mortgage is created after the amounts have fallen due as per the provisions of the KGST Act, 1963 and the KVAT Act, 2003 and accordingly, proceedings are initiated, such a mortgage can only be termed as subject to a statutory charge as per Sections 26B and 38 of Act 1963 and the Act 2003 respectively". 

The Court had perused the scheme of the SARFAESI Act and the RDB Act, and the parliamentary discussions to the amendments of the two legislations, and observed, 

"...from the discussions and deliberations what we could gather was only as to how the Bank has to be paid first the amounts due to it under a mortgage. Therefore under no circumstances it can be legally presumed that the parliament ever thought of realizing the amounts due under a mortgage giving an absolute go by to the statutory charge created by the Central and State enactments. That apart since Section 26E makes it clear that the Bank is entitled only for a priority in payment alone, it can never be said to be a charge created over the property against the statutory charge contained under the KGST Act, 1963 and the KVAT Act, 2003 or any Central enactment". 

Factual Matrix 

It is noted that amounts were due from various registered dealers, under the State laws, who had availed loans from various financial institutions. Proceedings were therefore initiated under various enactments such as the KGST Act, 1963, and the KVAT Act, 2003 to recover the amounts due. When steps were initiated to register the documents pertaining to the properties sold by the Banks under the provisions of the SARFAESI Act, 2002, and the RDB Act, 1993, the Registration department objected to the same and issued proceedings stating that since amounts were due to the State Government, as per the provisions of the various statutes, first charge is created over the properties and the documents cannot thus be registered. 

The banks and the final creditors claimed that they had a right as secured creditors to proceed against the properties in question in terms of the provisions of Section 26E of the SARFAESI Act, 2002 and Section 31B of the RDB Act, 1993, and the statutory charges as per the state acts no longer survive.

However, the Revenue and Financial Department of the State also claimed first charge over the properties under the provisions of Section 26B of the KGST Act, 1963 and Section 38 of the KVAT Act, 2003.

In light of the rival claims, the Court had to consider the issue as to which authority had the right to proceed against the property, and further, if the Bank had the sold any property, whether the first charge created under the statutes would continue to run with the properties sold.

Division Bench Ruling

The Division Bench perused Sections 26E, 26B, and 26C of the SARFAESI Act, as well as Section 31B of the RDB Act, and discerned that there were various modalities prescribed for registration of other attachments against the properties mortgaged by the loanees before the financial institutions.

"However, Section 26E only specifies that the 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", it noted. 

It also perused Rules 8 and 9 of the Security Interest (Enforcement) Rules, 2002 which had been brought to its notice by the State Government to buttress their argument that the said rules along with Section 26E provided a "clear-cut procedure to enforce the security interest and to remove the encumbrances in the property". 

The Court also took note of the provisions in KGST Act, 1963 and the KVAT Act, 2003, the Transfer of Property Act, 1882, as well as the decisions rendered in a plethora of judgments including Central Bank of India v. State of Kerala & Ors. (2009), and Medineutrina Pvt. Ltd. v. District Industries Centre (2021). 

It was on this basis that it finally ascertained that as per the present law, the State has the first charge over the property, and the charge runs with the property irrespective of the sale conducted by the financial institutions as per the provisions of the SARFAESI Act, 2002 and the RDB Act, 1993. It added that the debts were also to be arranged in priority. 

"True, the aforesaid acts being central legislations, and going by the rules in vogue, the financial institutions have the right to conduct sale of the secured assets in accordance with law and adjust the amounts due in priority to other debts, but the statutory charge under the state laws would continue to run with the property". 

It noted that Section 26E SARFAESI Act made it clear that the provision only creates a 'priority' in favour of the financial institutions with respect to the payment over all other debts and all revenues, taxes, cesses and other rates payable to the Central Government or the State Government or local authority.

"But the priority in payment is in no manner in conflict with the first charge created over the properties as per the provisions of the KGST Act, 1963, and the KVAT Act, 2003". 

The Court disagreed with the arguments of the Banks and financial institutions that the provisions of the Rules 2002 was in conflict with Section 26E, and found that the provisions of the Rules 2002 was only intended to "translate the true spirit of the SARFAESI Act, 2002", and to ensure that a purchaser intending to purchase a property offered by the Banks/financial institutions, make due inquiries concerning any encumbrance created over the property and thereby protect his interest. 

"In our view, this would be more clear from the explanation contained under Section 26E which states that ‘for the purpose of the said 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. The above is a clear indication that it cannot be said that merely because a priority in payment is available to the financial institutions, the statutory charge created under various enactments vanishes", it added. 

It thereby allowed the writ appeals.

Case Title: The Tahsildar (RR) & Ors. v. Nizamudeen S. & Ors. and other connected cases. 

Citation: 2023 LiveLaw (Ker) 17 

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