Creation and Operation of Tenancy Rights over Secured Assets under SARFAESI

[Samarth Saxena is a final year student at ILS Law College, Pune]

The advent of Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 (“SARFAESI”) ushered in a new era of reforms for the Indian banking regime. These reforms were primarily aimed at facilitating the speedy recovery of defaulting loans and thereby controlling the rising levels of non-performing assets. Although envisaged to be a complete code on management of security interests, SARFAESI yet failed to answer some important questions such as whether tenancy rights could be created over secured assets and, if so, under what circumstances. This post seeks to address such questions.

Whether valid tenancy rights can be created by a borrower over the mortgaged property under SARFAESI?

This question has been conclusively answered in Harshad Govardhan Sondgar v. International Asset Reconstruction ((2014) 6 SCC 1). In this case, while allowing the creation of tenancy rights both prior to and post mortgage, the Supreme Court classified the kinds of leases granted by the borrower over the property mortgaged under SARFAESI as follows:

(I)        Leases entered into prior to the creation of mortgage as secured asset;

(II)       Leases entered into after the creation of mortgage in accordance with section 65-A of the Transfer of Property Act, 1882 (“TP Act”) and the terms of the mortgage, but before the receipt of notice under section 13(2) of SARFAESI.

(III)     Leases created pursuant to section 65-A of the TP Act, but after the receipt of notice under section 13(2) of SARFAESI.

As far as leases under classes (I) and (II) were concerned, the same were held to be valid, while leases under class (III) were declared as invalid, except when made with the prior consent of the secured creditor.

What is the effect of a demand notice under section 13(2) SARFAESI over the tenancy rights of a tenant granted lease under Classes (I) or (II)?

The Supreme Court in Harshad Govardhan Sondgar further opined that leases under Classes (I) or (II) do not stand automatically determined upon an action being initiated under sections 13 or 14 of SARFAESI by the secured creditor. Such lessees in possession cannot be evicted by the secured creditor until and unless the lease is validly determined in accordance with section 111 of the TP Act. But, for such lessees to continue to be in possession in cases where a period of more than one year from the commencement of lease has elapsed, proof of execution of a registered deed will have to be produced according to the mandate of section 107 of the TP Act. This was subsequently overturned in Vishal Kalsaria v. Bank of India AIR 2016 SC 530, where the Supreme Court held that if two parties execute their rights and liabilities under a landlord-tenant relationship and if regular rent is paid and accepted, then the absence of registration or a written deed will not render the lease nugatory for the purposes of proving occupation as tenants in proceedings initiated under section 14 of SARFAESI. On the other hand, if a lease is of a nature as contemplated by Class (III) or is not a valid lease or has been validly determined, the lessee shall be liable for immediate eviction and delivery of possession to the secured creditor.

Whether SARFAESI overrides applicable rent control laws?

Vishal Kalsaria also laid down that provisions of SARFAESI cannot be applied arbitrarily to defeat the provisions of the relevant Rent Control Act (in this case, Maharashtra Rent Control Act, 1999) and, therefore, tenants cannot be evicted in contravention of the Rent Control Act.

What are the remedies available to a secured creditor unable to take possession of the secured asset due to existence of tenancy rights?

It is worth clarifying that the Supreme Court in Harshad Govardhan Sondgar has ruled that even in such cases where the secured creditor is unable to take possession of the secured asset after the expiry of 60 days from the notice to the borrower, informing him of the intention of the secured creditor to enforce the secured asset, the secured creditor will have the right to receive any money due or which may become due, including rent, from the lessee to the borrower. This is made clear from clause (d) of sub-section (4) of section 13 of SARFAESI.

What are the remedies available to a lessee or holder of tenancy right?

Harshad Govardhan Sondgar also listed the lessor’s right of hearing in front of the District Magistrate (“DM”) or Chief Metropolitan Magistrate (“CMM”) and a challenge to the DM/CMM’s order by petitions under Article 226/227 of the Constitution as the only remedies available to a lessee to retain possession when proceedings under section 13 or 14 of SARFAESI are initiated against the borrower or lessor. By virtue of the addition of section 17 (4A) to SARFAESI under The Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016, these remedies now stand modified since a lessee can now approach the Debt Recover Tribunal to adjudicate upon its tenancy rights. [[i]]

Conclusion

The ratio in the various decisions cited herein clearly lay down the principle to be followed: tenancy rights of an independent bona fide third party always take precedence over other rights. That being said, the practice of creation of tenancy rights for the purposes of defeating the interests of secured creditor has been looked down upon by the courts. The courts, thus being wary of the menace that such non-performing assets and slow recoveries create, have leaned in favour of interpreting SARFAESI and rent control laws as harmoniously as possible. It is also important to note that the various decisions cited above have been reaffirmed in subsequent cases of Aravindamma and Indian Bank v. M/s Nippon Enterprises South & Ors. [[ii]] and, therefore, the judicial intent clearly appears to be to uphold these precedents.

– Samarth Saxena

[i] See also Aravindamma v. K.S. Jayalakshmammanni, 2018 SCC OnLine Kar 530.

[ii] Supreme Court Civil Appeal Nos. 5610-5611 of 2011.