Bombay High Court’s ASREC Ruling: Form v. Substance in SARFAESI Proceedings

[Sharanya Shivaraman  is an Advocate practicing in Mumbai and a graduate of ILS Law College, Pune]

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 was enacted over two decades ago to facilitate loan recovery and the securitisation of financial assets of banks and financial institutions. Under the framework of the Act, section 13 is a key provision dealing with the enforcement of security interest (i.e. any interest created over property in favour of the secured creditor and includes mortgage, charge, hypothecation etc.). Section 13 provides that when a borrower of a secured loan defaults in repayment thereof, and his account in respect of such debt is classified as a non-performing asset, then the secured creditor may require the borrower, by a notice in writing, to discharge his liability within sixty days of the notice, failing which the secured creditor will be at liberty to take steps for taking possession and sale of the secured asset. It is, therefore, evident that the notice under section 13(2) (“13(2) Notice”) is the foundation for taking any steps/proceedings by the secured creditor. In a recent ruling by the Bombay High Court in ASREC (India) v. Fastgrowth Hospitality, the court laid down important principles on the issue of form versus substance of the 13(2) Notice. In this post, I examine the implications of this ruling for security enforcement proceedings under SARFAESI.

Facts of the Case

IIFL Wealth Finance Limited had extended certain financial facilities to Fastgrowth. Fastgrowth defaulted on the repayment of the said financial facilities as per the terms agreed between the parties. IIFL therefore filed a Commercial Suit before the Bombay High Court for recovering the outstanding loan amount. Thereafter, IIFL issued the a 13(2) Notice calling upon Fastgrowth to repay the then outstanding amount along with interest. In the meanwhile, the account of Fastgrowth was assigned by IIFL to ASREC (India) Ltd.

In February 2022, ASREC filed an Application before the District Magistrate, Goa seeking assistance under section 14 of the Act to take physical possession of the secured assets situated in Goa. The District Magistrate allowed ASREC’s application. Pursuant to the District Magistrate’s Order, the Mamlatdar delegated the power to take possession to the ‘Head Clerk’ and scheduled a date for taking over the possession as well. Aggrieved by this, Fastgrowth preferred Securitisation Application No. 160 of 2022 before the Debt Recovery Tribunal (“DRT”), seeking interim and ad interim reliefs of injunction to restrain ASREC from taking any step in furtherance of the 13(2) Notice or the Order of the District Magistrate and the Mamlatdar.

The DRT allowed the application granting interim relief to Fastgrowth and restraining ASREC from taking any further steps under SARFAESI. Pertinently, the DRT founded the relief on the following key grounds:

First, that the Mamlatdar delegated the authority to take physical custody of the secured assets to the Head Clerk, which was legally impermissible; second, that the 13(2) Notice shows capitalization of penal interest; and third, that the 13(2) Notice does not provide a breakup of the principal interest, and penal interest sought to be recovered.

The Debt Recovery Appellate Tribunal (“DRAT”) upheld the order passed by the DRT, restraining ASREC from taking steps as per the Act. Aggrieved by the above orders passed by DRT and DRAT, ASREC preferred a Writ Petition before the Bombay High Court.

Interpretative Issues

The High Court, while allowing the Writ Petition, made observations having wide implications on the interpretation of section 13 of the Act.

At the outset, the DRT, DRAT and the High Court agreed that the power to take physical possession of the secured asset could not be sub-delegated by the Mamlatdar to the Head Clerk. However, the High Court disagreed with the decision of the DRT and DRAT to restrain ASREC on the sole ground that the Order of the Mamlatdar suffered from the abovementioned defect. The High Court held that if the sub-delegation was an impediment, the DRT could have passed appropriate orders cancelling sub-delegation or directed ASREC to do so. Interestingly, the High Court in paragraph 14 notes that “the Impugned Order does not record a finding that the Petitioner was instrumental in getting the sub-delegation done or had benefited from it”. By the said observation, the High Court has suggested that mere non-compliance with the provisions of the Act or the Rules framed thereunder, does not ipso facto render the entire order/proceeding unenforceable, and the DRT ought to not apply the mandate of the Act in a technical manner, but delve into whether the suggested illegality/non-compliance is intentionally caused or prejudices the parties in any manner whatsoever.

A similar approach is seen towards the issue of capitalisation of penal interest. On this aspect, the High Court, upon examining the 13(2) Notice as well as the pleadings in the Commercial Suit preferred by ASREC prior to sending the 13(2) Notice, came to the conclusion that, in fact, there was no capitalisation of interest in the 13(2) Notice. The Court further observed that in any case, the outstanding amounts mentioned in the Commercial Suit and the 13(2) Notice were identical (despite passage of time in the interregnum). Therefore, the High Court concluded as follows: “…… The DRT has proceeded as if the moment legal argument is made by the borrower, no enquiry was necessary for grant of injunction and even admitted amounts can be ignored. The Tribunal could have called upon the Respondents to address it on the admitted amounts and as to why the Respondents should not be directed to deposit the same or substantial part thereof as a condition to injunct the Petitioner from proceeding further.”

It is evident from the aforesaid paragraph that the High Court has added a layer of analysis and enquiry in the scheme of interim and ad interim proceedings. The High Court has indicated that mere departure from the statute may not be sufficient to tilt the equities in favour of the debtor. The High Court’s approach appears to emanate from the need to balance the interests of the creditor and the debtor. In the present case, as the debt or liability of the debtor was never disputed, the High Court was of the view that the debtor would not be entitled to unconditional protection from the Tribunal. Instead, the High Court indicated that the debtor’s interim protection from any action of the creditor, be made conditional, subject to the debtor making a deposit in the DRT. While there is no statutory requirement for a party to deposit any money, as a pre-condition to be entitled to interim relief, High Courts have often imposed such a condition on the petitioning party to balance the equities at the interim stage. The condition of pre-deposit is not alien to the SAFRAESI and debt recovery jurisprudence, with the Tribunals adopting the practice of the High Courts on a case to case basis. Albeit in a different context, Section 18 of the SARFAESI Act, requires parties to deposit 50% of the amount claimed by the secured creditor/determined by the DRT as a pre-condition to appeal against the order of the DRT.

Further, Fastgrowth raised an issue pertaining to the 13(2) Notice violating section 13(3) of the Act. As per section 13(3), the 13(2) Notice is required to provide the break-up of the principal and interest component of the outstanding dues mentioned therein. In the present case, the Notice admittedly did not provide for such breakup. The DRT, on the basis of the said non-compliance, granted relief to Fastgrowth. However, the High Court took an opposite view.

The Court based its finding on the fact that Fastgrowth was aware of the principal and interest breakup and the detailed particulars of the outstanding dues, as the same were mentioned in the Commercial Suit filed before the High Court. The High Court stated that the aforesaid infirmity in the 13(2) Notice does not warrant an unconditional interim relief. Interestingly, the High Court goes a step further and hypothesizes a case where necessary particulars of the outstanding dues are intimated to the debtor a day before the issuance of the 13(2) Notice. In these circumstances as well, according to the High Court, non-compliance with Section 13(3) would not have fatal consequences.

The High Court emphasised that the DRT ought to have examined the fact that the debt and liability were never disputed by the debtor. The High Court in paragraph 32, states that “before injuncting the Petitioner from proceeding as per law to recover the dues, the Tribunal was obliged to consider the implications of the arguments advanced by the Respondents on the final outcome of the application and whether it merited an unconditional interim order and in what manner equities could have been balanced.…...”

Challenges

Broadly, the approach of DRT and DRAT stem from two factors viz. (a) DRT and DRAT being statutory tribunals, are strictly informed by the Act and the Rules framed thereunder and (b) banks and financial institutions being sophisticated commercial institutions cannot be exempt from knowing or following the letter of the law strictly.

The significance of this judgment lies in the fact that the High Court has implored DRT and DRAT to travel beyond the strict mandate of the Act to examine the issues and equities at the interim stage. The High Court has clarified that mere non-compliance with a statutory mandate cannot entitle any party to relief if equities do not rest in their favour. However, the challenge in interpreting this judgment will perhaps arise due to the specialised nature of the Act. The Act provides for a specific procedure and strict timelines for any action taken in respect of a security interest. Departure from these procedures (for instance:- inadequacies in the notices intimating the debtor of take-over of possession/proposed auction of the secured assets etc.), invite judicial intervention to protect the interests of the debtor and ensure that no action is taken in respect of any property without due process of law. It is a well-established principle that if the law requires a thing to be done in particular way, it must be done in that way only.

Therefore it remains to be seen how the DRT and DRAT will balance the potential infirmities in the security enforcement process, the impact such infirmities have on the interests of the debtor and the nature of protection to be granted to the debtor.

– Sharanya Shivaraman