CASE ANALYSIS: THE AUTHORISED OFFICER, CENTRAL BANK OF INDIA v. SHANMUGAVELU

Navjot Tyagi & Navtej Tyagi

Babu Banarasi Das University, Lucknow.

INTRODUCTION:

In this case analysis, we will understand the relationship between the Indian Contract Act, 1872 and the SARFAESI Rules regarding the EMD (Earnest Money Deposit) forfeiture in the situation when the successful auction purchaser defaults to pay the balance amount. The case questions if SARFAESI Rules made under a special enactment can supersede the Indian Contract Act. Further, we will discover whether the Bank can forfeit the EMD post-recovery of dues from a subsequent sale.

COURT	Hon’ble Supreme Court of India
CORAM	Chief Justice Dr. DY Chandrachud, Justice JB Padiawala, Justice Manoj Mishra
DATE	2nd February, 2024
APPELLANT	The Authorized Officer, Central Bank of India (CBI)
RESPONDENT	Shanmugavelu

FACTS:

The appellant bank provided a credit facility to ‘Best and Crompton Engineering Projects’ and took a land as a simple mortgage. However, the borrowers couldn’t repay, so it became a non-performing asset (NPA). The bank followed Section 13(4)[i] of the SARFAESI Act, took possession of the secured asset, and put it up for a public auction.

The e-auction notice mentioned the reserve price and the requirement of the Earnest Money Deposit (EMD). The successful bidder must pay 25% of the auction price excluding EMD within 24 hours of the bid being accepted and the remaining 75% by the 15th day or agreed extension[ii]. In case of default, the sum already paid will be forfeited, and the property will be re-auctioned.

After the e-auction, the respondent was declared the successful buyer and deposited 25%. The CBI confirmed the sale in his favor on 7th December, 2016.

Despite the grant of extension of 3 months for the payment of remaining amount, the respondent could not pay the balance amount.  The respondent requested a further extension, but the bank denied it and canceled the sale, forfeiting the deposited amount.

Even after this, the respondent addressed another letter to the CBI along with a cheque of Rs.50,00,000/-, asking for 90 day extension for the payment of the balance amount. CBI rejected, and the respondent made an application before the Debts Recovery Tribunal-II (DRT-II).

Meanwhile, CBI conducted a fresh auction and sold the secured asset at a higher price compared to the previous auction. DRT-II directed CBI to refund EMD after deducting rupees 5 lakh for the expenses incurred.

The appellant challenged this order before the Debt Recovery Appellate Tribunal, Chennai (DRAT), which increased the forfeiture amount to Rs. 55Lakhs. Distressed by this decision, both the appellant and the respondent went to the Hon’ble High Court.

The High Court set aside the DRAT’s order based on two reasons: firstly, Rule 9(5)[iii] of the SARFAESI Rules cannot override Section 73 of the Indian Contact Act, 1872,[iv] which implies that the secured creditor cannot take more than the loss or damage actually suffered by it, and secondly, the appellant keeping the entire EMD amounts to unjust enrichment, which is impermissible.

The Bank was not pleased with this order, and it filed an appeal before the Hon’ble Apex Court.

ISSUES RAISED:

I. Whether, the principle contained in Section 73 and section 74[v] of the Indian Contract Act, 1872 apply to the forfeiture of EMD under Rule 9(5) of the SARFAESI Rules? Or should the forfeiture only be for the actual loss or damage suffered by the appellant bank?

II. Whether, it is considered unjust enrichment if the entire EMD is forfeited under Rule 9(5) of the SARFAESI Rules? Should the forfeiture be limited to the amount of debt owed?

III. Whether, the exceptional circumstances exist to overturn the forfeiture of the EMD?

JUDGMENT AND ITS ANALYSIS:

I.WHETHER, THE PRINCIPLE CONTAINED IN SECTION 73 AND SECTION 74 OF THE INDIAN CONTRACT ACT, 1872 APPLY TO FORFEITURE OF EMD UNDER RULE 9(5) OF THE SARFAESI RULES? OR SHOULD THE FORFEITURE ONLY BE FOR THE ACTUAL LOSS OR DAMAGE SUFFERED BY THE APPELLANT BANK?

1. The Supreme Court in C. Natarajan,[vi] held that the SARFAESI Act is a special enactment which supersedes Section 73 & 74 of the Indian Contract Act in accordance with Section 35 and 37[vii] of the SARFAESI Act. SARFAESI Rules are a part of SARFAESI Act as they have been enacted as per section 38[viii] of this Act. Thus, the provisions of the Indian Contract Act cannot override Rule 9(5) of the SARFAESI Rules.

2. If we apply Section 73 & 74 of the Indian Contract Act to the failure to pay the balance amount in an auction, it would defeat the purpose of the SARFAESI Act and would make section 13[ix] of the SARFAESI Act ineffective, which is disastrous for India’s economic growth. It could lead to additional recovery proceedings and allow the borrowers to exploit the auction process and avoid consequences.

3. Moreover, it was observed in Kailash Nath[x] that section 74 of the Indian Contract Act will not be relevant in those cases of forfeiture of EMD that occurs in accordance with the terms of a public auction, but for all other cases of forfeiture, it will be applicable.

4. Even though Rule 9(5) of the SARFAESI Rules provides unconstrained power to the authorized officer, yet the aggrieved individual can stand against the order of forfeiture before DRT in line with section 17 of the Act[xi].

Thus, the provisions of the Indian Contract Act, being a general law, cannot set aside Rule 9(5) of the SARFAESI Rules, which makes provisions for the forfeiture of EMD in case the successful auction purchaser fails to pay the balance amount.

II.WHETHER, IT IS CONSIDERED UNJUST ENRICHMENT IF THE ENTIRE EMD IS FORFEITED UNDER RULE 9(5) OF THE SARFAESI RULES? SHOULD THE FORFEITURE BE LIMITED TO THE AMOUNT OF DEBT OWED?

1. Supreme Court observed that the forfeiture of EMD under Rule 9(5) of the SARFAESI Rules is a legal consequence for the default in the payment of balance amount. This consequence will apply regardless of the re-auction outcome. No equity can replace this statutory consequence as where the law is clear, the consequence must follow[xii].

2. Moreover, when an auction fails and a re-auction is needed, there is uncertainty about the future bids or whether or not the subsequent auction will be a success; therefore the High Court’s decision that no loss was caused to the appellant bank and EMD cannot be forfeited was wrong.

3. By forfeiting the EMD, the Bank wasn’t enriched. It has a power to enforce the security interest and safeguard public funds. The forfeiture was a statutory consequence in SARFAESI Rules. The respondent knew the risk of forfeiture when participating in the auction.

Thus, the decision of the High Court that the appellant bank cannot forfeit the EMD after recovering its dues from the subsequent sale; otherwise, it would amount to unjust enrichment, is legally incorrect.

III.WHETHER, THE EXCEPTIONAL CIRCUMSTANCES EXIST TO OVERTURN THE FORFEITURE OF THE EMD?

1.The Hon’ble Apex Court  in C. Natarajan[xiii] held that generally when the EMD is forfeited, the Courts should abstain from intervening in the matter unless and until the case involves circumstances exceptional[xiv] enough to warrant judicial scrutiny.  If, however, a bidder’s legitimate request for an extension is unreasonably denied, a Court review can be sought.

2.The respondent in the instant case claims that demonetization caused a delay in securing necessary finance. Also, the CBI failed to provide certain documents on time , resulting in the inability of the respondent to secure a term loan. But the Supreme Court observed that the demonetization happened before the e-auction. 

3.Moreover, the respondent requested the documents from the bank after the confirmation of sale, which the bank provided. The bank also gave a 3-month extension period to the respondent, but he failed to pay. The consequence of such default was clearly mentioned in the e-auction notice.

Thus, these circumstances can in no case be considered exceptional enough to set aside the forfeiture of EMD.

SAFEGUARDS FOR DEBTORS AGAINST UNJUST FORFEITURE PRACTICES-

1. Terms of the transaction must be properly notified- In order to promote transparency, debtors should be made aware of their obligations, rights, and potential outcomes in the event of default.

2. Access to Alternative dispute resolution mechanisms- ADR especially Mediation facilitates a situation fruitful for both the parties and curtails the probability of lose-lose scenario[xv]. The parties can negotiate and fulfill their claims without undergoing the time-consuming and expensive adjudication process.

Moreover, adjudication is based on the notion of ‘winner/lose’ principle leading to one of the parties losing the case[xvi]. This can damage commercial relations between the parties.

3. Creditors should provide notice to the debtor before forfeiture of assets- The notice must highlight the reason for seizure, the amount owed, and the legal basis for the action so that the debtors have the clear information to question the forfeiture.

CONCLUSION:

The Hon’ble Apex Court struck down the High Court’s judgment. The appeal of the bank was accepted, and the respondent’s application made before DRT-II was rejected and dismissed.

In a nut shell, the discussion on this case makes it clear that the provisions of the Indian Contract Act, 1872 cannot override the SARFAESI Rules that are created under the special legislation.

Thus, this case highlights the bank’s prerogative to enforce the SARFAESI Rules over the provisions of the Indian Contract Act, 1872. The bank can forfeit the EMD when a successful auction purchaser is not able to pay the required balance amount within the time fixed by the SARFAESI Act, that is, within a maximum of fifteen days of the sale confirmation by the Secured Creditor or within the agreed-upon time[xvii].

AUTHORS’ INSIGHTS:

In the opinion of the authors, the Hon’ble Supreme Court was correct in holding that the principle under Section 73 and section 74 of the Indian Contract Act cannot govern the SARFAESI Act or the Rules created under it.

As the maxim 'Expressio unius est exclusio alterius'[xviii] suggests, the specific provisions of the SARFAESI Act exclude the application of these sections.  This interpretation aligns with the basic idea behind the enactment of the SARFAESI Act, which was to empower the banks and financial institutions to take possession of the securities and sell them without the Court’s intervention so that the recovery of defaulting loans by banks gets easier.

This judgment paves the way for ensuring the economic growth of India and helps in realizing the true objective of the SARFAESI Act, which was to allow banks and financial institutions to unlock the value of their long-term assets and effectively deal with the liquidity issues and asset liability mismatches.

REFERENCES

[i]The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 §.13, cl.4, Act No. 54, Act of Parliament 2002(India).

[ii] Sub rule 4 of Rule 9 of The Security Interest (Enforcement) Rules, 2002 (India).

[iii] Sub rule 5 of Rule 9 of The Security Interest (Enforcement) Rules, 2002(India).

[iv] The Indian Contract Act, 1872 §.73, Act No. 9, Act of Parliament 1872(India).

[v] The Indian Contract Act, 1872 §.74, Act No. 9, Act of Parliament 1872(India).

[vi] Authorized Officer State Bank of India v. C. Natarajan, 2023 SCC OnLine SC 510

[vii] The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 §.37, Act No. 54, Act of Parliament 2002(India).

[viii] The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 §.38, Act No. 54, Act of Parliament 2002(India).

[ix] The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 §.13, Act No. 54, Act of Parliament 2002(India).

[x] Kailash Nath Associates v. Delhi Development Authority & Anr., (2015) 4 SCC 136

[xi] The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 §.17, Act No. 54, Act of Parliament 2002(India); Agarwal Tracom Private Limited v. Punjab National Bank & Ors. (2018) 1 SCC 626.

[xii] National Spot Exchange Ltd. v. Anil Kohli, Resolution Professional for Dunar Foods Ltd., (2022) 11 SCC 761

[xiii] Authorized Officer State Bank of India v. C. Natarajan, 2023 SCC OnLine SC 510

[xiv] One such exceptional circumstance was seen in the case of Alisha Khan v. Indian Bank (Allahabad Bank) [2021 SCC OnLine SC 3340], where the Court intervened and granted relief because the appellant had been unable to pay the balance amount due to complications arising from COVID

[xv] Edward J. Kelly and Natalija Kaminskienė, (2016), “Importance of emotional intelligence in negotiation and Mediation”, International Comparative Jurisprudence, Vol. 2

[xvi]Retrieved from https://ibbi.gov.in/uploads/resources/1acc8439aab101c013221a481fe108a6.pdf (last visited on Sept. 9, 2024)

[xvii] Sub rule 4 of Rule 9 of The Security Interest (Enforcement) Rules, 2002(India).

[xviii] This maxim means the expression of one thing is the exclusion of the other.