Supreme Court Rules on Mandatory Procedure under the SARFAESI Act

[Partha N. Mansukhani is a Fourth Year B.A. LL.B (Hons.) student at Symbiosis Law School, Pune]

The Supreme Court last month in a decision in ITC Limited v. Blue Coast Hotels Ltd. & Ors clarified that section 13(3A) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 (the “Act”) is not merely directory, but in fact mandatory in nature. The Court further stated that in the event a security interest has been created on agricultural land that is not intended to be used for the purpose of agriculture, then such security interest can be enforced by the creditor under the provisions of the Act.

Facts

In the present case, the Industrial Financial Corporation of India (“creditor”) entered into a corporate loan agreement with Blue Coast Hotels Ltd. (“debtor”) which included the creation of a special mortgage comprising of the debtor’s hotel property, including the agricultural land on which the debtor intended to develop villas. The debtor defaulted in repaying the loan amount and subsequently its account was classified as a non-performing asset (NPA). Notices issued calling for repayment went unheeded by the debtor, which prompted the creditor to issue a notice under section 13(2) of the Act. The debtor in reply presented a rescheduled plan for repaying the loan as provided under section 13(3A) of the Act; however, this never materialised and instead the debtor used a number of delaying tactics to prolong repayment of the outstanding amount. The creditor took symbolic possession of the property as permitted under section 13(4) of the Act and subsequently held a public auction, three of which failed to attract any bids, and the fourth auction led to the acquisition of the property by ITC Ltd.

Procedural History

Initially, the debtor approached the Debt Recovery Tribunal (“DRT”) against the creditor’s symbolic possession of the property and its subsequent intent to auction the same. After negotiations between the creditor and the debtor did not yield any positive results and the creditor issued a second notice of auction, the DRT passed an interim order directing the creditor to defer the acceptance of bids and not to take any further steps for the sale of the property. The creditor challenged this interim order passed by the DRT before the Debts Recovery Appellate Tribunal (“DRAT”) which in turn directed the DRT to dispose the second appeal within a month.

The DRT disposed off the second appeal and set aside the notice issued under section 13(2) on the grounds that the creditor did not comply with the provision laid down in section 13(3A) and issued a demand notice jointly for the mortgaged land comprising of the agricultural land, which is protected from the enforcement of security interest as provided under section 31(i) of the Act.

The creditor approached the DRAT which upheld the issuance of notice under section 13(2) of the Act and set aside the order passed by the DRT.

Subsequently, the debtor approached the Bombay High Court to set aside the order of the DRAT and challenged the order of handling possession of the secured assets to the creditor and its subsequent sale by way of auction.

The High Court in its ruling set aside the order of the DRAT, holding that the creditor failed to acknowledge the representations of the debtor and thus did not act in accordance with the provision contained in section 13(3A) of the Act. Also, going by the strict interpretation of the statute laid down in section 31(i), the High Court held that no security interest could be enforced on agricultural land which has been mortgaged. The High Court also held that it was incumbent on the creditor to take actual physical possession of the property before proceeding with the auction and that the said auction was vitiated due to fraud and collusion.

Aggrieved by the High Court’s ruling, ITC Limited, i.e. the auction purchaser, subsequently approached the Supreme Court in appeal.

Issues

The issues arising out of the facts in this case was (i) whether section 13(3A) of the Act was directory or mandatory in nature; (ii) whether a security interest can be enforced on agricultural land despite a statutory bar created by section 31(i) of the Act; and (iii) whether the creditor could maintain an application of possession under section 14 of the Act even though it only had symbolic possession before the sale of the property to the auction purchaser.

Analysis

In dealing with the first issue, it is important to revisit the Supreme Court’s decision in Mardia Chemicals Ltd. v. Union of India  wherein a three-judge bench clarified that, on receipt of a notice, the borrower can reply stating its objections and that the lender should reply to the borrower, giving its reasons so as to either accept or reject the objections that have been raised by the borrower. This directive of the Supreme Court was subsequently embedded in section 13(3A) of the Act which was inserted by Parliament by way of an amendment. It is critical to analyse the intent of the legislature in adding this provision. Section 13(3A) states that a borrower, on receipt of a notice issued under section 13(2) may raise an objection against the proposed measure or make a representation of any nature, explaining the circumstances revolving around its inability to repay the debt and propose rescheduling the repayment. The creditor must consider and, if not found acceptable, may reject the same after giving sufficient reasons for doing so before proceeding with action mandated under section 13(4) of the Act.

Initially, the Act did not provide for any representation on part of the borrower in the event a notice was issued under section 13(2). The amendment was brought about by Parliament following the decision of the Supreme Court in Mardia Chemicals. The intent of the legislature was clear to provide the borrower a chance to give its representations or objections to the demand notice issued by the creditor. The onus is then placed on the creditor to either accept or reject the contentions of the debtor by giving adequate reasons for its decision. The Supreme Court was of the view that in the event that any provision deals with providing reasons for consideration, then such provisions should be treated as mandatory and not merely directory.

Furthermore, the Supreme Court agreed with the view laid down in Transcore v. Union of India wherein it did not distinguish between actual or symbolic possession of the secured assets by the secured creditor in pursuance of enforcing security interest.

In the present case, whilst the creditor did not furnish any reasons for rejecting the debtor’s representations for rescheduling the repayment of the debt, it is key to note that communication between the two parties induced the creditor, through assurances and promises, not to take action against the debtor. Moreover, negotiations were even entered upon for settling the pending dues and the creditor even accepted six cheques in repayment (which were ultimately dishonoured) much after the notice issued under section 13(2) and a reply of the debtor’s representations. The creditor had given many opportunities to repay the debt; however, the debtor kept seeking more time. It is pertinent to note that the debtor even executed a ‘Letter of Undertaking’ acknowledging the right of the creditor to sell the assets in the event of default.

The intent of the legislature in enacting section 13(3A) was to remedy the lacuna in the law so as to ensure that the debtor is still given a chance to repay its debt on the contingency that its objections and representations are entertained (or not) by the creditor with sufficient reasons. However, given the facts of this case, the Supreme Court has gone beyond the plain reading of the statute and was of the view that despite being given several occasions for repaying the debt, the debtor has yet failed to do so, thus ruling in favour of the appellants.

On the second issue, the High Court went by the literal meaning of the law laid down under section 31(i) and held that the inclusion of agricultural land for the purpose of creating a security interest cannot be held to be valid. However, the Supreme Court elaborated the scope of this section beyond its literal meaning. The intention of Parliament to enact this provision was to protect agricultural land held by agriculturalists for the purpose of cultivation as well as protect their income and livelihood; hence the same was exempted from the provisions of the Act. In the present case, however, the debtor purchased several parcels of land, some of which were agricultural in nature with the intent of building a five-star hotel. Whilst the land purchased by the debtor directly from the agriculturalists were entered as agricultural lands in the revenue records, the debtor had applied to the revenue authorities for the conversion of the concerned land to non-agricultural land, which is yet pending approval.

In addition, whilst no security interest can be created on agricultural lands as explicitly stated under section 31(i) of the Act, and yet a mortgage was created showing that the parties never intended to treat the same as agricultural land. Also, it is pertinent to note that no substantial cultivation was taking place on the area and in fact the debtor had intended to develop villas on the agricultural land.

The debtors even went on to challenge to validity of Parliament’s legislative competence to enact this provision, considering the scope of  agricultural land falls within the ambit of the Entry 18 of List II of the Seventh Schedule of the Indian Constitution. However, the Supreme Court negated this contention by citing a precedent laid down in Union of India v. Delhi High Court Bar Association and Ors wherein it was held that this provision of the Act would wall within the scope of Entry 45 List I dealing with banking, which includes recovery of debts due to banks within its scope.

As far as the third issue is concerned, the Supreme Court did not agree with the High Court’s view that the Act did not contemplate the taking over of the symbolic possession and hence the creditors would be restrained from transferring the secured assets to the auction purchaser. It is important to highlight section 13(6) of the Act which states that any transfer of the secured asset after taking possession thereof or takeover of the management under sub-section (4) of section 13 by the secured creditor or by the manager of the secured creditor shall vest in the transferee all the rights as if the transfer had been made by the owner of the secured asset. Harmoniously constructing provisions of the Act along with section 8 of the Transfer of Property Act, 1882, the Supreme Court stated that the transfer of the secured asset cannot be construed as a complete transfer considering the creditor only had symbolic possession; however, the creditor nevertheless had a right to take actual possession of the secured assets and must therefore be held to be a secured creditor even after a limited transfer to the auction purchaser, as the creditor’s interest has not been entirely transferred, thus permitting the creditor to act in accordance with section 14 of the Act.

Conclusion

This ruling has now clarified the position with regards to section 13(3A) of the Act, with the Supreme Court holding that this provision is not directory but in fact, mandatory in nature. Furthermore, it also held that in the event a security interest is created over an agricultural land which is not intended to be used for agricultural purposes, then the creditor is not barred by section 31 (i) of the Act for enforcing the security interest that has been created on the asset. It is indeed remarkable that the Supreme Court has taken the effort to go beyond the literal meaning of the statute so as to ensure that the debtor does not evade its responsibility as far as repaying its debts are concerned.

– Partha N. Mansukhani

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