SARFAESI - Dues Of Secured Creditor Superior To Dues To State Govt Departments: Bombay High Court Full Bench Answers 7 Questions Of Law

A full bench consisting of Chief Justice Dipankar Datta, Justice M. S. Karnik and Justice N. J. Jamadar answered seven questions of law related to the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) and Recovery of Debts and Bankruptcy Act 1993 (RDDB Act).

The court passed the judgment in a batch of writ petitions filed by various banks and NBFCs, raising important questions of law relating to priority of charge, upon insertion of Chapter IV-A in the SARFAESI Act, and section 31B in the RDDB Act.

Jalgaon Janta Sahakari Bank Ltd. had filed a writ petition in 2018 seeking priority in respect of two flats mortgaged to it as a secured creditors over the Sales Tax Authorities. Similar petitions were filed over the years by ICICI, Bank of Baroda and other finance companies seeking priority to realize dues over various state authorities.

The court noted that common questions of law emerged in the petitions and decided to club the petitions and referred the petitions to a larger bench. The judgment, pronounce in court by Chief Justice Datta, decides 12 such writ petitions and answers seven questions of law regarding Chapter IV-A of the SARFAESI Act and section 31B of the RDDB Act inserted by Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016 (2016 Amending Act).

Questions (a) and (b)

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

(b) Whether despite section 26 E in the SARFAESI Act or section 31B of the RDDB Act being attracted in a given case, dues assumed to a government department should be repaired first as per state legislation giving such dues precedence over the dues of a secured creditor?

The petitioners who are secured creditors submitted that due to amendments in the RDDB Act and the SARFAESI Act, they are entitled to assert priority over claims of the State sales tax department under the MVAT Act. State legislations would yield to Central Acts creating first charge. The State submitted that section 26E merely provides for 'priority' of payment and doesn't create 'first charge' in favour of the secured creditors.

The court observed that the state legislature has specified if it intended a particular provision to be the dominant or subordinate to any other legislation in no uncertain terms. Even a 'first charge', by express statutory intendment, can be made subordinate to a paramount charge.

The court noted that both RDDB Act and SARFAESI Act provide that the dues of a secured creditor will take precedence over debts and revenues, taxes, cesses and other rates payable not only to State Government and local authority but also the Central Government. Thus, the rights of the first charge holders accorded by several State legislations would be subordinate to the right of the secured creditor. The court further stated that RDDB Act and SARFAESI Act being Central Acts, will prevail over state legislation in case any inconsistency between the Central Acts and state legislation cannot be reconciled.

The court held, "the dues of a secured creditor (subject of course to CERSAI registration) and subject to proceedings under the I & B code would rank superior to the dues of the relevant department of the state government".

Question (c) Are the provisions according priority in payment of dues to a secured creditor for imposing its security interest under the provisions of the SARFAESI Act prospective?

The court noted that the Government of India notified 24th January 2020 as the date on which section 18 of the 2016 Amending Act inserting Chapter IV-A into SARFAESI Act would come into force. Thus, Chapter IV-A giving priority in payment of dues to a secured creditor is prospective and will apply from the date it was brought into force, i.e., 24th January 2020.

Question (d) Whether section 31B of RDDB Act can be invoked for overcoming the disability of a secured creditor in enforcing its security interest under the SARFAESI Act due to failure to register the security interest?

The petitioners submitted that even if Section 26E of the SARFAESI Act is not applicable without CERSAI registration, the secured creditors are entitled to the statutory priority under section 31B of the RDDB Act.

The court rejected the contention and held, "a secured creditor, finding that it is disabled from obtaining the benefit of 'priority' in terms of section 26E of the SARFAESI Act for want of CERSAI registration, cannot fall back on section 31B of the RDDB Act to claim priority".

The court further said that a secured creditor cannot invoke section 31B of RDDB Act unless it has institutes proceedings under the Act and is successful in having an interim or final determination in its favor, that sum is due and payable.

Question (e) Whether the priority of interest under section 26 E could be claimed by a secured creditor without registration of the security interest with the Central Registry? Whether correct law has been laid down in ASREC (India) Limited v. State of Maharashtra and SBI v. State of Maharashtra?

The state contended that registration of the security interest is a pre-requisite for invoking section 26E of the SARFAESI Act. Section 26E does not come into effect without registration.

The court held, "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".

Observing that the it runs contrary to statutory mandate, the court overruled paragraph 21 of the division bench decision in ASREC (India) Limited v. State of Maharashtra. ASREC had rejected the contention that section 26E of the SARFAESI Act cannot be invoked unless the security interest were registered with the CERSAI.

The court also overruled the paragraph 35 of the division bench decision in SBI v. State of Maharashtra observing that the bench may not have considered sections 26D and 26E of the SARFAESI Act in great depth while holding that even if the secured creditor does not register the mortgage under section 26D of the SARFAESI Act, such non-registration would not affect the legal position on the issue of priority.

Question (f) When, and if at all, can it be said that the statutory first charge under the state legislations stands displaced having regard to Chapter IV-A in SARFAESI Act from 24 January 2020?

The court held that the priority under RDDB Act and SARFAESI Act wouldn't apply if the immovable property of the defaulter is attached and proclamation issued in accordance with law before Chapter IV-A of the SARFAESI Act or section 31B of the RDDB Act were enforced.

Question (g) 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, whatever there is basis"?

The court observed that Security Interest (Enforcement) Rules, 2002 provide that the the authorized officer while putting up the secured asset for sale has a duty to notify the details of the encumbrances. However, if the sale advertisement has "as is where is, whatever there is basis" clause, the highest bidder cannot insist upon issuance of sale certificate without clearing the other dues on the property unless he disproves constructive notice of the charge created on the property put up for auction sale.

Hence, the court held, "…notwithstanding the duty of the authorized officer to indicate in the sale advertisement inviting bids the encumbrance(s) attached to the immovable property, i.e., the secured asset, as known to the secured creditor, if at all any detail in regard to such encumbrance(s) 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 encumbrance(s)…."

Case no. – Writ Petition nos. 2935 of 2018, 3197 of 2019, 436 of 2021, 939 of 2020, 7999 of 2021, 2720 of 2021, 3553 of 2021, 2248 of 2021, 2251 of 2021, 2336 of 2021, 6297 of 2021, and 3120 of 2021

Case Title – Jalgaon Janta Sahakari Bank Ltd. & Anr. v. Joint Commissioner of Sales Tax & Anr. with 11 connected matters

Coram – Chief Justice Dipankar Datta, Justice M. S. Karnik & Justice N. J. Jamadar