IBC: Dues of a secured creditor rank higher than dues of government on sale of asset
IBC: Dues of a secured creditor rank higher than dues of government on sale of asset
In the High Court of Judicature at Bombay Ordinary Original Civil Jurisdiction
Writ Petition No. 2935 of 2018
Jalgaon Janta Sahakari Bank Ltd. & Anr. …. Petitioners
Vs
Joint Commissioner of Sales
Tax Nodal 9, Mumbai & Anr. …. Respondents
With 11 others
In the first week of September 2022, a full bench of the Bombay High Court held that dues of a secured creditor would rank in priority ahead of the dues/debts of government consequent to sale of asset of a company.
The full Bench was constituted to decide on important questions of law in a batch of similar petitions filed relating to Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (SARFAESI) and Recovery of Debts and Bankruptcy Act,1993 (RDDB).
The petitioners are secured creditors. The petitioners contend that:
- Section 26A and Chapter IVA (sections 26B to 26E) in SARFAESI Act and section 31B in the RDDB Act were amendments introduced in 2016 which contained provisions relating to priority of claims.
- priority created by amendment section 31B of the RDDB Act is also recognized by amendment section 26 of SARFAESI Act.
- such priority is not restricted to respective Acts but is recognized generally.
- Amendments in central enactments (such as SARFAESI & RDDB) entitle the petitioners to assert priority over state government departments.
A look at the questions of law (and the judgment) which arise consequent to amendments introduced:
1. Question of law (a) & (b):
Does a secured creditor as defined in SARFAESI and the RDDB have prior right over the relevant government department to claim amount realized by the sale of a secured asset?
Whether dues accruing to a government department ought to be repaid first by reason of first charge created over any property giving such dues precedence over dues of a secured creditor?
Analysis / Judgment:
Counsel for petitioners submitted that the amendment in SARFAESI Act and RDDB Act entitle them (as secured creditors) to get priority over amounts due to State government departments on the grounds that State legislations yield to central Act creating first charge.
Counsel for the State argued that the SARFAESI ACT and or the RDDB Act do not create a first charge on the assets of company. They only create a ‘priority’ of payment to secured creditors over others. Relying on the judgment passed in the Central Bank of India case (supra), it was contended that if the intention were so, then the provision of creating a ‘first charge’ would have been expressly incorporated in these Act like in other central legislations – Workmen’s compensation Act, Employees Provident Fund Act, Gift Tax Act etc. The court further observed that even a first charge created expressly in a statute can be subordinated to a paramount charge.
SARFAESI Act and RDDB Act expressly contained that the dues of a secured creditor will take priority over debts, revenue, taxes, cess, and others rates payable to state government or any local authority as well as central government that would have to stand in queue after the secured creditors for payment of dues.
The Court further observed that the RDDB Act and the SARFAESI Act are Central Acts. If any provision therein is inconsistent with any provision in a State legislation, reconciliation of the same ought to be attempted, failing which the Central Acts will prevail over the State legislations, pursuant to Article 254 of the Constitution.
The Court held that dues of a secured creditor (subject of course to CERSAI registration) and subject to proceedings under the IBC would rank superior to the dues of the relevant department of the State Government.
2. Question of law (c):
Are the provisions, inter alia, according ‘priority’ in payment of dues to a secured creditor for enforcing its security interest under the provisions of the SARFAESI Act prospective?
Analysis / Judgment
The Court observed that Chapter IV-A amendment in SARFAESI became effective by way of a notification issued by the Ministry of Finance w.e.f 24th January 2020. The court further observed that if the provisions of Chapter IV-A were to be applicable from a previous date, the notification would have expressly said so. The 2016 amendment was made applicable prospectively and not retrospectively. Hence the Court ruled that the applicability is prospective.
3. Question of law (d):
Whether section 31B of the RDDB Act will be applicable for overcoming the disability of secured creditor in enforcing its security interest under the SARFAESI Act upon such creditor’s failure to register the security interest in terms of the amendments introduced in the SARFAESI Act? (CERSAI)
Analysis / Judgment
The Court observed that both SARFAESI Act and RDDB Act are special laws which have been enacted for recovery of money. The process of recovery under both are different. Under RDDB Act, the recovery of money is through an elaborate procedure involving the Court. Under the SARFAESI Act, there is no court intervention for recovery of money.
Section 31B of the RDDB Act begins with a non obstante clause (a clause which removes ambiguity by giving overriding effect in the event of two contradictory legal provisions). Section 31B of the RDDB Act (which is court procedure driven) cannot be invoked in cases where a secured creditor seeks enforcement of security interest by taking recourse to the SARFAESI Act (which has no court intervention).
Thus, the Court held that a secured creditor who is disabled from claiming ‘priority’ u/s 26E of the SARFAESI Act (due to non-registration under CERSAI) cannot claim ‘priority’ under section 31B of the RDDB Act.
4. Question of law (e):
Whether the priority of interest contemplated by section 26E of the SARFAESI Act could be claimed by a secured creditor without registration of the security interest with the Central Registry? i.e, without registering under CERSAI.
Whether decision held in cases ASREC (India) Limited vs. State of Maharashtra and Ors. and State Bank of India vs. the State of Maharashtra and Ors that CERSAI registration is not mandatory is correct?
Analysis / Judgment
A non obstante clause (‘notwithstanding anything contained’) means that a section which contains such non obstante clause has an overriding effect on any other legal provision to the contrary under same or any other law. Section 26D of the SARFAESI Act begins with a non obstante clause. The section prohibits a secured creditor from exercising the rights for enforcement of security interest conferred by Chapter III, unless the secured interest created in its favour by the borrower has been registered with the CERSAI. Not only has it been made a mandatory pre-condition for invoking provisions of Chapter III, but provisions relating to debts that are due to any secured creditor being payable to such creditor in priority over all other debts and revenue, taxes etc. is available to be invoked only after the registration of security interest.
Therefore, the Court held that unless the security interest is registered, neither can the borrower seek enforcement invoking the provisions of Chapter III of the SARFAESI Act nor does the question of priority in payment would arise without such registration.
The decisions in ARSEC India (supra) and State Bank of India (supra) which held that CERSAI registration was not mandatory was overruled in this case.
5. Question of law (f):
When, and if at all, can it be said that the statutory first charge under the State legislation, viz. the BST Act, the MVAT Act and the MGST Act stands displaced having regard to introduction of Chapter IV-A in the SARFAESI Act from 24th January 2020?
(Simply put, it means whether section 31B of the RDDB Act would apply for cases already pending in court?)
Analysis /Judgment
The Court observed that unless the attachment of the defaulter’s immovable property is ordered in the manner ordained by a Code and its Rules and due proclamation thereof is made, even the creation of charge on such immovable property may not be of any real significance, unless there was constructive notice of the same.
If there has been an attachment and a proclamation thereof has been made according to law prior to January 2020 or 1st September 2016, i.e., the dates on which Chapter IV-A of The SARFAESI Act and section 31B of the RDDB Act, respectively, were enforced, the department may claim that its dues be paid first notwithstanding the secured dues of the secured creditors; but in the absence of an order of attachment being made public in a manner known to law, i.e., by a proclamation, once Chapter IV-A of the SARFAESI Act or section 31B, as the case may be, has been enforced, the dues of the secured creditor surely would have ‘priority’.
The Court held that if the immovable property of the defaulter is shown to have been attached in accordance with law prior to enforcement of Chapter IV- A of the SARFAESI Act or section 31B of the RDDB Act, such attachment is followed by a proclamation according to law, the ‘priority’ accorded by section 26E of the SARFAESI Act and section 31B of the RDDB Act would not get attracted.
6. Question of law (g):
Whether an auction purchaser of a secured asset would be liable to pay the dues of the department in order to obtain a clear and marketable title to the property having purchased the same on “as is where is and whatever there is basis”?
Analysis / Judgement
A reading of the Security Interest (Enforcement) Rules 2002 makes it clear that while putting up an immovable property (secured asset) for sale, the authorized officer is duty bound to notify details of encumbrances in respect of property to be sold. Such encumbrances are known to the secured creditor as well as to make the purchaser deposit money to discharge the encumbrances.
The Court observed that prior to enforcement of section 26B amendment of SRAFAESI Act, it may not have been possible for a potential purchaser to know all encumbrances on a secured asset. To be on the safer side, the authorized officer would insert an ‘as is where is, whatever there is’ clause in the sale advertisement. Consequently, the purchaser could not insist on sale certificate without clearing liability relating to such property. The purchaser cannot escape liability thereafter on grounds that he had no knowledge of certain charges.
Therefore, the Court held that notwithstanding the duty of the authorized officer to indicate in the sale advertisement inviting bids the encumbrance(s) attached to the immovable property, i.e., the secured asset, as known to the secured creditor, if at all any detail in regard to such encumbrance(s) is not indicated but the sale is expressly made on “as is where is, whatever there is basis”, the transferee shall be duty bound to deposit money for discharge of the encumbrance(s) provided, of course, that such liability may be overcome if he is in a position to disprove the claim of the department that he had no constructive notice of the charge, far less actual notice.
Conclusion
After expressly answering all substantial questions of law, the full bench proceeded to decide on other issues in individual cases. In all the cases, the questions of law (a) to (g) were expressly and unambiguously addressed.
Note: In this context, it is relevant to bring to the notice of the readers, judgement of the Supreme Court dated 6th September 2022 in Rainbow Papers Ltd (CA 1661/2020). The Supreme court reversed the decision of the NCLAT which held that the tax dues under the Gujarat VAT proceedings would not constitute a secured debt under the IBC law. Incidentally, the NCLAT also held that the claims were not to be considered as they were not preferred within the due time.
