Introduction
The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) is an act “to regulate securitisation and reconstruction of financial assets and enforcement of security interest and to provide for a central database of security interests created on property rights, and for matters connected herewith or incidental thereto”. As per Section 13(2) of the SARFAESI Act, where any borrower, who is under a liability to a secured creditor makes any default in repayment of secured debt or any instalment thereof, and his account in respect of such debt is classified by the secured creditor as a non-performing asset, then the secured creditor may require the borrower by notice in writing to discharge in full his liabilities to the secured creditor within 60 (sixty) days from the date of the notice, failing which, the secured creditor shall be entitled to exercise all or any of the rights to take possession of the secured assets under Section 13(4) of the SARFAESI Act and sell the same without the intervention of the court.
With that background, we aim to analyse whether the auction-purchasers can purchase the secured asset from the secured creditors under SARFAESI Act and the Security Interest (Enforcement) Rules, 2002 (SARFAESI Rules) (collectively “SARFAESI”) free from encumbrance including those arising out of pending statutory dues.
Priority of dues: An analysis
With the introduction of the SARFAESI Act, several banks contended that given the non obstante clause in Section 35, the banks being the secured creditors will have priority over the State’s first charge. However, the Supreme Court in Central Bank of India v. State of Kerala[1] clarified that SARFAESI Act does not provide for first charge to the secured debts due to banks and State sales tax law which are creating first charge in favour of the State shall prevail. Further, the Supreme Court in Dena Bank v. Bhikhabhai Prabhudas Parekh & Co.[2] has held that the crown debts have priority over secured debts only if a statute gives such priority to its dues. Above stated, we understand that the position of law was that if State law provides for priority to statutory dues that shall prevail over secured debts of the banks.
However, with the insertion of Section 26-E via the Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016 (amending Act), the above discussed position underwent a change and now any security created and recorded with the Central Registry3 is accorded statutory priority in accordance with Section 26-E of the SARFAESI Act. The text of Section 26-E of the SARFAESI Act (Section 26-E) reads as under:
26-E. Priority to secured creditors.— Notwithstanding anything contained in any other law for the time being in force, after the registration of security interest, the debts due to any secured creditor shall be paid in priority over all other debts and all revenues, taxes, cesses and other rates payable to the Central Government or State Government or local authority.
Explanation.— For the purposes of this section, it is hereby clarified that on or after the commencement of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), in cases where insolvency or bankruptcy proceedings are pending in respect of secured assets of the borrower, priority to secured creditors in payment of debt shall be subject to the provisions of that Code.[3]
Various litigations came before different courts on the interpretation of Section 26-E and brought forth certain pressing common questions. To understand the current position, we shall be discussing certain important judgments below and presenting our analysis:
(i) If a State tax act also has a non -obstante clause, will Section 26-E prevail over it?
a) The Gujarat High Court in Kalupur Commercial Cooperative Bank Ltd State of Gujarat[4] (Kalupur) has dealt with the non obstante clause in detail while analysing whether Section 26-E which is a part of the central legislation would prevail over Section 48 of the Gujarat Value Added Tax Act, 2003 (GVAT), a State Act. It referred to the decisions of the Supreme Court in Kumaon Motor Owners’ Union Ltd v. State of U.P.[5] (Kumaon Motor) and Solidaire India Ltd. v. Fairgrowth Financial Services Ltd.[6] (Solidare).
The Supreme Court in Kumaon Motor[7] had discerned three principles in case of conflict between the provisions of two statutes viz:
- If there is a conflict between the provisions of two statutes and nothing is repugnant, the provisions in the later statute would prevail;.
- While resolving such conflict, the court must look into the object behind the two statutes. In other words, what is to be looked at is what necessitated the legislature to enact a particular provision later in point in time, which may be in conflict with the provisions of earlier statute.
- The court must look into the language of the provisions. If the language of a particular provision is found to be more emphatic, the same would be indicative of the intention of the legislature that the same shall prevail over other statutes.
The Supreme Court in Solidare[8] stated that the principles of law discernible are that, if there is a conflict between two special legislations, the later must prevail. The simple reasoning is that at the time of enactment of the later statute, the legislature could be said to be aware of the earlier legislation and its non obstante clause. If the legislature still confers the later enactment with a non obstante clause, it means that the legislature wanted that enactment to prevail.
Having discussed the above, the Gujarat High Court, in Kalupur[9], noted that Section 48 of GVAT “would come into play only when the liability is finally assessed and the amount becomes due and payable”. Basis the above, it came to the conclusion that priority shall be that of the bank under Section 26-E and not of the State.
(b) The Nagpur Bench of the Bombay High Court in Union Bank of India v. State of Maharashtra[10] analysed the language of Section 37(1) of the Maharashtra Value Added Tax Act, 2002 (reproduced below) and ruled that though it begins with a non obstante clause, it is made subject to any provisions of the central legislation dealing with the issue in question. Hence, Section 26-E shall prevail.
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- … Notwithstanding anything contained in any contract to the contrary, but subject to any provision regarding creation of first charge in any Central Act for the time being in force, any amount of tax, penalty, interest, sum forfeited, fine or any other sum payable by a dealer or any other person under this Act, shall be the first charge on the property of the dealer or, as the case may be, person.
Similar view was also recently taken by the Division Bench of the Bombay High Court in SBI v. State of Maharashtra[11] (SBI judgment).
We further note that recently in Punjab National Bank v. Union of India[12], Supreme Court while dealing with the issue of whether the dues of the Excise Department would have priority over the dues of the secured creditors under Section 11-E to the Central Excise Act (which provides for first charge on the property of the defaulter for recovery), held that since Section 35 of the SARFAESI Act gives it an overriding effect on all other laws, the property shall be subject to the SARFAESI Act. Thus, the right of a secured creditor cannot be hampered and the State’s right to recover debts would prevail over other creditors only in cases where such creditors are unsecured.
(ii) Is the auction-purchaser liable to pay off the statutory dues?
(a) The Andhra Pradesh High Court in SBI v. CTO[13] (CTO case) held that the debts advanced by banks/financial institutions have precedence over the statutory dues of the government authorities. Accordingly, any secured asset sold by such bank or financial institution to any purchaser cannot be denied registration due to pending statutory dues and the banks are not entitled to withhold the sale certificate pursuant to the auction held. Further, it was clarified that if any balance of sale consideration amount is available post satisfaction of dues towards the banks, it shall be adjusted towards the dues, if any, of the department concerned.
(b) Similarly, the Gujarat High Court in Kalupur[14] set aside the attachment orders passed under the Section 48 of GVAT and held that as per Section 26-E, the bank/financial institutions had first charge over the mortgaged property. It is pertinent to note that despite the existence of the attachment orders, the Gujarat High Court validated sale of the mortgaged properties conducted by the bank and categorically stated that:
- 78. It is further clarified that the excess, if any, shall be adjusted towards the dues of the State under the Value Added Tax, 2005 Act. It is further declared that the respondents cannot proceed against the purchasers of the properties sold under the SARFAESI Act.
Further, in CTO case[15], as discussed above, the Andhra Pradesh High Court has held that the secured asset sold to any purchaser cannot be denied registration due to pending statutory dues and the banks are not entitled to withhold the sale certificate pursuant to the auction held. In SBI v. State of A.P.[16] and Pridhvi Asset Reconstruction and Securitisation Co. Ltd. v. State of A.P.[17], orders similar to the CTO case[18] were passed.
In SBI v. State of Maharashtra[19], the Bombay High Court have taken a similar view with regard to the registration of the sale certificate as upheld in the CTO case[20] i.e. the registration of sale certificate cannot be denied on account of pending statutory dues. This case has also highlighted that a Registrar does not have a quasi-judicial power and is only expected to ensure that the documents to be registered is accompanied by supporting documents.
However, having discussed the above position, it is pertinent to look at the judgment recently passed by the Supreme Court of India in Kotak Mahindra Bank Ltd. v. District Industries Centre[21] (Kotak case), disposing of the special leave petition that arose out of the order passed by the Bombay High Court in Medineutrina (P) Ltd. v. District Industries Centre[22] (Medineutrina case). The position taken by the Supreme Court in this case goes contrary to what has been established till now and hence needs a detailed mention.
In Medineutrina case[23], the petitioner was the auction-purchaser of the immovable property which was attached and auctioned by Punjab National Bank (PNB), under the SARFAESI Act. However, as certain statutory dues were due to the Sales Tax Department, PNB was not transferring the property in favour of the petitioner until such payment. The petitioner thus came before the Bombay High Court challenging such non-transfer and additionally, relief was claimed against PNB to issue a no-objection certificate and to issue a fresh sale certificate, free from all encumbrances in favour of the petitioner. The petitioner also contended that there was the absence of notice, and it had no prior knowledge of such an encumbrance.
The Bombay High Court on the above set of facts dismissed the reliefs claimed by the petitioner and held that the petitioner was liable to pay the pending sale tax dues on the secured asset even if there was absence of any notice or prior knowledge of such encumbrance. It further ruled contrary to the principle established by the Supreme Court in the case of Ahmedabad Municipal Corpn. of the City of Ahmedabad v. Haji Abdulgafur Haji Hussenbhai[24] that a charge may not be enforced against a transferee if it had no notice of the same unless the requirement of such notice has been waived by law. This was held by following the reasoning that the above position would hold only when a charge is created under Section 100 of the Transfer of Property Act, 1882 in terms of which charge is not on the property. It further referred to AI Champdany Industries Ltd. v. Official Liquidator[25], wherein the Supreme Court had differentiated between an encumbrance as understood in the general parlance and an encumbrance which is a charge on the property and runs with the property.
In this regard, Bombay High Court observed that[26]:
- 34. … It goes without saying that when a statutory charge is created on the property, the same would go with the property and would follow the property, in whosoever’s hands the property goes.
- Thus the notice of such a statutory charge on the property, is always presumed in law, to one and all and none can claim ignorance of the same.
- As Section 37(1) of the Maharashtra Value Added Tax Act, 2002, creates a charge on the property, a successful auction-purchaser, thus would hold the property, upon which a statutory charge has been created, subject to such charge and the property would thus continue to be liable for any statutory charges created upon it, even in the hands of such auction-purchaser, though for non-disclosure of such charge by the secured creditor, the auction-purchaser may sue the secured creditor and have such redress, as may be permissible in law. This is more so for the reason that the priority given in Section 26-E of the SARFAESI Act, to the banks, which is a secured creditor, would only mean that it is first in que for recovery of its debts by sale of the property, which is a security interest, the other creditors being relegated to second place and so on, in the order of their preference as per law and contract, if any, as the case may be. Thus the dues under Section 37(1) of the MVAT Act, 2002, being a statutory charge on the property, would also be recoverable by sale of the property, and that puts a liability upon the auction-purchaser, who, in case he wants an encumbrance free title, will have to clear such dues.
Aggrieved by the same, the above decision in the Medineutrina case[27] was challenged before the Supreme Court of India.
The Supreme Court vide its order[28] dated 18-11-2021, disposed of the special leave petition, and upheld the decision of the Bombay High Court by noting that the agreement pursuant to which the auction-purchaser purchased the immovable property specifically stated that the auction-purchaser shall bear all statutory dues inter alia other dues and having agreed to these stipulations, auction-purchaser cannot shy away from the obligation. The specific portion of the agreement is reproduced below:
“It is not necessary for us to examine the other aspects dealt with by the High Court in the impugned judgment. For, the agreement executed by the petitioner pursuant to which the auction was concluded in favour of the petitioner reads thus:
- All statutory dues/attendant charges/other dues, including registration charges, stamp duty, taxes, any other known, unknown liability, expenses, property tax, any other dues of the Government or anybody in respect of properties/assets sold, shall have to be borne by the purchaser…. ”
Further, the fact that the State has the first charge on the property concerning statutory dues, the auction-purchaser cannot resile from the liability to discharge the same. Additionally, the Supreme Court acceded to the request that once such statutory dues have been paid, a fresh sale certificate shall be issued which shall note that the immovable property has been transferred free from all known encumbrances.
Conundrum around enforcement of Section 26-E
We further deem it necessary to discuss the conundrum around the enforcement of Section 26-E. We note that the amending Act did not come into force all at once but in parts. While certain sections including Section 31-B, Recovery of Debts and Bankruptcy Act, 1993 (RDB Act) (Section 31-B) came into force on 1-9-2016; Section 26-E was brought into force much later, from 24-1-2020 vide Notification No. 4133 dated 26-12-2019. However, we observe that various judgments viz, Union Bank of India v. State of Maharashtra[29] and Medineutrina case[30] have been ruled on the premise that Section 26-E came into force on 1-9-2016.
However, the Gujarat High Court in Kalupur[31] which was decided on 23-9-2019, took into consideration the fact that Section 26-E was not yet enforced and had observed the below:
- While it is true that the bank has taken over the possession of the assets of the defaulter under the SARFAESI Act and not under the RDB Act, Section 31-B of the RDB Act, being a substantive provision giving priority to the “secured creditors”, the same will be applicable irrespective of the procedure through which the recovery is sought to be made. This is particularly because Section 2(l-a) of the RDB Act defines the phrase “secured creditors” to have the same meaning as assigned to it under the SARFAESI Act. Moreover, Section 37 of the SARFAESI Act clearly provides that the provisions of the SARFAESI Act shall be in addition to and not in derogation of inter alia the RDB Act. As such, the SARFAESI Act was enacted only with the intention of allowing faster recovery of debts to the secured credits without intervention of the court. This is apparent from the Statement of Objects and Reasons of the SARFAESI Act. Thus, an interpretation that, while the secured creditors will have priority in case they proceed under the RDB Act they will not have such priority if they proceed under the SARFAESI Act, will lead to an absurd situation and, in fact, would frustrate the object of the SARFAESI Act which is to enable fast recovery to the secured creditors.
58 . The insertion of Section 31-B of the RDB Act will give priority to the secured creditors even over the subsisting charges under other laws on the date of the implementation of the new provision i.e. 1-9-2016. The Supreme Court, in State of M.P. v. State Bank of Indore[32], has held that a provision creating first charge over the property would operate over all charges that may be in force.
The text of Section 31-B is reproduced below for ease of reference:
31-B. Priority to secured creditors.— Notwithstanding anything contained in any other law for the time being in force, the rights of secured creditors to realise secured debts due and payable to them by sale of assets over which security interest is created, shall have priority and shall be paid in priority over all other debts and Government dues including revenues, taxes, cesses and rates due to the Central Government, State Government or local authority.
Following this reasoning given in Kalupur[33], Bombay High Court in SBI judgment[34] has recently ordered that even if Section 26-E was effective only prospectively from 24-1-2020 and thus not applicable to the facts at hand as they were prior in time, that would not make any difference; as Section 31-B itself would be sufficient to give priority to a secured creditor over the statutory dues.
Similarly, the Division Bench of the Bombay High Court in Axis Bank Ltd. v. State of Maharashtra[35] quashed and set aside the impugned notices issued by the Assistant Commissioner of Sales Tax after taking into consideration Section 529-A of the Companies Act, 1956 while also noting the statutory recognition of priority claim of the secured creditor in view of the amendment brought into effect by virtue of introduction of Section 26-E providing for priority to secured creditor over all other debts and all taxes, cess and other rates payable to Central Government or the State Government or the local authority while stating that the applicability of provisions of Section 31-B is pari materia to Section 26-E.
A similar view has been upheld by various High Courts in ASREC (India) Ltd. v. State of Maharashtra[36], GMG Engineers & Contractor (P) Ltd. v. State of Rajasthan[37], Bank of Baroda v. CST[38], and Commr. v. Indian Overseas Bank[39].
Analysis and conclusion
We understand from the above discussion that there is plethora of judgments that have dealt with subject-matter regarding priority of claims of secured creditor over the statutory dues. Post introduction of Section 26-E, it is now a settled position that the dues of the secured creditor will stand in priority.
We however note that, in terms of liability to pay statutory dues, the decision of the Supreme Court in the Kotak case[40] has caused ripples to an otherwise settled position that the statutory dues are to be paid from the excess of auction amount and that the sale certificate cannot be withheld on such statutory dues being pending. The Supreme Court in Kotak case[41] held that the auction-purchaser cannot resile from the liability to pay statutory dues and a sale certificate free from all encumbrances can be issued only once such dues have been cleared.
We, however, would like to point to the fact that the above decision seems to be very case specific as the auction-purchaser had specifically agreed to such payment liability under the auction agreement and cannot be seen as laying down the law that an auction-purchaser is liable to pay statutory dues in the absence of a contractual arrangement specifically stating so.
Further, we note that many judgments have been passed considering that Section 26-E came into force on 1-9-2016, which as discussed above is not the correct factual position. However, certain courts have rightly acknowledged the correct position and have reasoned priority of secured creditors in line with Kalupur[42] judgment, that is:
- Section 31-B came into force on 1-9-2016;
- Section 37 of the SARFAESI Act clearly provides that the provisions of the SARFAESI Act shall be in addition to, and not in derogation of inter alia the RDB Act and as such the SARFAESI Act was enacted only with the intention of allowing faster recovery of debts to secured creditors without the intervention of the court;
- The definition of secured creditors is the same in both RDB Act and SARFAESI Act; and
- An interpretation that, while the secured creditors will have priority in case they proceed under the RDB Act and that they will not have such priority if they proceed under the SARFAESI Act, will lead to an absurd situation and, in fact, would frustrate the object of the SARFAESI Act which is to enable fast recovery to the secured creditors.
Taking into consideration the above and ruling of Supreme Court in State of M.P. v. State Bank of Indore[43], we understand that the priority of secured creditors can be said to have been established from coming into force of Section 31-B.
† Partner, Khaitan & Co.
†† Associate, Khaitan & Co.
††† Associate, Khaitan & Co.
[3] Central Registry means the registry set up or cause to be set up under S. 20(1) of the SARFAESI Act.
[10] 2021 SCC OnLine Bom 6070.
[11] 2020 SCC OnLine Bom 4190.
[13] 2021 SCC OnLine AP 343 : AIR 2021 AP 87.
[16] 2021 SCC OnLine AP 168 : AIR 2021 AP 108.
[17] 2020 SCC OnLine AP 1936 : (2021) 3 ALT 104.
[19] 2021 SCC OnLine Bom 2568.
[21] SLP (C) Diary No. 8269 of 2021, order dated 18-11-2021 (SC).
[22] 2021 SCC OnLine Bom 222 : (2021) 5 Mah LJ 402.
[23] 2021 SCC OnLine Bom 222 : (2021) 5 Mah LJ 402.
[26] 2021 SCC OnLine Bom 222 : (2021) 5 Mah LJ 402.)
[27] 2021 SCC OnLine Bom 222 : (2021) 5 Mah LJ 402.
[28] SLP (C) Diary No. 8269 of 2021, order dated 18-11-2021 (SC).
[29] 2021 SCC OnLine Bom 6070.
[30] 2021 SCC OnLine Bom 222 : (2021) 5 Mah LJ 402.
[31] 2019 SCC OnLine Guj 1892 : (2019) 156 SCL 668.
[33] 2019 SCC OnLine Guj 1892 : (2019) 156 SCL 668.
[34] 2020 SCC OnLine Bom 4190.
[35] 2017 SCC OnLine Bom 274 : (2017) 3 AIR Bom R 305.
[36] 2019 SCC OnLine Bom 5480 : (2020) 6 AIR Bom R 561.
[37] S.B. Civil Writ Petition No. 6872 of 2017, decided on 5-7-2017.
[38] 2018 SCC OnLine MP 1667 : (2018) 55 GSTR 210.
[39] 2016 SCC OnLine Mad 10030 : (2017) 1 Mad LJ 769.
[40] SLP (C) Diary No. 8269 of 2021, order dated 18-11-2021.
[41] SLP (C) Diary No. 8269 of 2021, order dated 18-11-2021.
[42] 2019 SCC OnLine Guj 1892 : (2019) 156 SCL 668 .
Supreme court judgment in the matter of Kotak cannot be treated as ratio since supreme court did not deal with para no. 35 in Medineutrina judgment in which Bombay high court laid down a law that none can claim ignorance of pending statutory dues. other high court can disagree with said observations of the Bombay high court which is not sound principle of law.
in the end Auction purchaser is left to the mercy of the secured creditor. And there is no check and balance on creditor. Bombay high court has discouraged auction purchaser from participating in auction and so in the end creditor is the looser who is the beneficiary of S.31B of RDB Act and S. 26E of SARFAESI Act.
What is given by legislature by one hand has been taken away by Judiciary by another hand.