Reinforcing Secured Creditors’ Rights: Insights from the Ronak Industries Case

[Shruti Srivastava is a 4^th year B.A., LL.B. (Hons.) student at National Law University and Judicial Academy, Assam]

In the ever-evolving landscape of financial regulations, the concept of a secured creditor has assumed significant importance. A momentous shift occurred with the introduction of section 26-E in The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act, 2002), endowing secured creditors with priority over their counterparts in the resolution of outstanding dues. Echoing the significance of this shift, the Bombay High Court, in the landmark case of Ronak Industries v. Assistant Commissioner Central Excise & Customs (28 June 2023), reaffirmed the priority of securing creditors in debt repayment. This post examines the implications of the Ronak Industries case, shedding light on the priority given to secured creditors under section 26-E of the SARFAESI Act, 2002.

Facts of the Case

On 14 December 2007, Mr. Prem Prakash Sarogi, acting as the guarantor for Goldstar Polymer Pvt. Ltd. (the borrower), mortgaged the secured asset to Bank of Baroda to secure facilities provided to the borrower. It is pertinent to note that this mortgage predated any attachment levied on the secured asset by the Assistant Commissioner Central Excise & Customs and the Assistant Commissioner CGST & Central Excise.

Following the prescribed legal procedures, Bank of Baroda duly registered its security interest over the secured asset with the Central Registry of Securitisation Asset Reconstruction and Security Interest (CERSAI) on the 24 February 2012. Subsequently, due to non-payment of dues owed to Bank of Baroda, they exercised their rights under the provisions of the SARFAESI Act, 2002, and proceeded to sell the secured asset to Ronak Industries, the petitioner in the present case. Following the sale, Bank of Baroda also issued a sale certificate in favor of Ronak Industries, further validating the transfer of ownership.

However, the problem arose when the Sub-Registrar refused to register the sale certificate issued to Ronak Industries. The refusal was based on the presence of a lien, charge, encumbrance, or mutation entry attributed to the Assistant Commissioner Central Excise & Customs and the Assistant Commissioner CGST & Central Excise in the records maintained by both the Sub Registrar and the Mamlatdar concerning the secured asset.

Considering these circumstances, Ronak Industries asked for the removal of any lien, charges, encumbrance, or mutation entry, if registered by the Assistant Commissioner Central Excise & Customs and the Assistant Commissioner CGST & Central Excise with the Mamlatdar. Additionally, Ronak Industries requested a directive from the Sub-Registrar to officially record and register the sale certificate/sale deed (issued by Bank of Baroda to Ronak Industries) under the provisions of the Registration Act, 1908, ensuring that it is free from any encumbrances attributed to the Assistant Commissioner Central Excise & Customs and the Assistant Commissioner CGST & Central Excise.

What do the Law and Precedents Say?

The priority of secured creditors has been spoken about in several legislations, but this case primarily deals with section 26-E of the SARFESI Act, 2002, and section 31B of the Recovery of Debt and Bankruptcy Act, 1993. Section 26-E states that once the security interest is registered, the debts due to the secured creditors will take priority over all other dues. Additionally, section 31B emphasizes the priority granted to secured creditors over any other forms of debt.

This is not the first instance where a court had been grappled with such a scenario; there have been numerous cases where the court had to discern whether the government or the secured creditor should be prioritized for repayment of unpaid dues. In Dena Bank v. Bhikhabhai Prabhudas Parekh & Co., the Supreme Court categorically ruled that crowned debts do not enjoy any preferential treatment over secured debts. The crown’s preferential right to recover debts is confined solely to ordinary or unsecured debts.

In Bank of Bihar v. State of Bihar, the Supreme Court established a vital principle regarding the rights of a pawnee. This principle affirms that the pawnee, who provides money to the pawnor against the security of goods, retains a valid claim over the goods. Even if the goods are lawfully seized to make funds available to other creditors of the pawnor, the rights of the pawnee cannot be extinguished until their claim is first fully satisfied. Moreover, in ICICI Bank Ltd. v. SIDCO Leathers Ltd., the Supreme Court unambiguously affirmed that secured creditors are granted preference and priority over government departments’ outstanding dues, provided that the proceedings of I&B and CERSAI registration are duly adhered to. These legal precedents solidify the position of secured creditors and highlight the importance of proper registration to provide the secured creditors their rightful priority in the event of debt recovery.

Bombay High Court’s Judgment

The Bombay High Court in Ronak Industries based its judgment on a comprehensive analysis of several relevant cases, including the precedent set by it in Jalgaon Janta Sahakari Bank Ltd. v. Joint Commissioner of Sales Tax Nodal 9, Mumbai. The full bench in that case held that if a secured creditor’s security interest has been duly registered with the CERSAI, the creditor is entitled to priority over the government in the settlement of dues. Furthermore, the Court ruled that following the enforcement of Chapter IV-A of the SARFAESI Act, 2002 any government department seeking to recover its dues must register such claims with CERSAI under sub-section (4) of section 26B. Additionally, sub-section (2) of section 26C states that any attachment order issued after the registration of the security interest with CERSAI shall be subject to the prior registered claim. Therefore government authorities must register their claims with CERSAI to assert their right to recover dues. In the present case, the Assistant Commissioner Central Excise & Customs and the Assistant Commissioner CGST & Central Excise failed to register their claim with CERSAI, resulting in their inability to claim their dues.

In Jalgaon Janta Sahakari Bank Ltd. the Bombay High Court also critically examined the term priority as defined under section 26-E of the SARFAESI Act, 2002. According to the Black’s Law Dictionary, priority denotes taking precedence over others. In the context of the legislation at hand, it signifies the right to enforce a claim ahead of other competing interests. To ensure clarity in the distribution of proceeds from the sale of a borrower’s properties, the Parliament wisely opted for the phrase priority over all other dues in the SARFAESI Act, 2002. This choice was made considering the prevalent use of the first charge in various legislations. Notably, the inclusion of non-obstante clauses in sections 31B and 26-E of the Act supports the reasonable notion that the secured creditor’s dues shall take precedence over all other obligations, including revenues, taxes, cesses, and rates payable to the Central Government, State Government, or local authority. This provision establishes a well-defined framework for the inter-se distribution of proceeds, ensuring that the secured creditor’s claims are prioritized above all other competing interests.

The Bombay High Court in Ronak Industries resolved the dispute regarding the settlement priority of dues between the secured creditor and the Central Government, State Government, or local authority under section 26-E of the SARFAESI Act, 2002 by stating that the secured creditor holds priority over all others in the settlement of dues. The Court also held that any lien, charges, encumbrance, or mutation entry registered by the Assistant Commissioner Central Excise & Customs or the Assistant Commissioner CGST & Central Excise with the Mamlatdar cannot be allowed. Moreover, the Court ruled that the Sub Registrar must register the sale certificate/sale deed following the provisions of the Registration Act, 1908, without any lien, charges, encumbrance, or mutation entry.

Conclusion

Rashbehary Ghose, in the book Law of Mortgage, said that in India, government debt does not hold precedence over secured debt. The practice of granting higher priority to secured creditors incentivizes lending by reducing the perceived risk associated with providing loans. This increases confidence among creditors fostering a greater willingness to extend credit to borrowers.

Furthermore, a significant number of secured creditors comprise institutional investors and individuals who have invested their savings in financial instruments such as bonds or securitized assets. Providing them priority protection ensures the safeguarding of their interests and promotes overall confidence in the stability of financial markets. Through a series of legal precedents and established principles, the stance on granting priority to secured creditors over others in settling dues has been unequivocally defined. This jurisprudential clarity aims to strike a delicate balance between encouraging lending and investment while upholding the interests of diverse secured creditors within the broader financial market. The principle of prioritizing secured creditors stands as an integral aspect of India’s legal framework, striving to foster a robust and well-functioning financial market that benefits both creditors and borrowers.

– Shruti Srivastava