Introduction:
The Hon’ble Supreme Court in Authorised Officer, Central Bank of India v. Shanmugavelu[1]adjudicated, inter alia, upon (i) whether the forfeiture of the earnest-money deposit under Rule 9(5)[2] of the SARFAESI Security Interest (Enforcement) Rules (“SARFAESI Rules”) can be only to the extent of loss or damages incurred by the Bank/secured creditor, in consonance with the underlying ethos of Sections 73 and 74 of the Indian Contract Act, 1872 (“Contract Act”)? In other words, whether, the forfeiture of the entire earnest money deposit under the SARFAESI Rules amounts to unjust enrichment?; and (ii) whether the principle of “reading down” of a provision should be employed even in situations where the provision, in its plain meaning, is unambiguous and valid, but results in an allegedly ‘harsh’ consequence.
The Apex Court categorically held that (i) Sections 73 and 74 of the Contract Act have no application to the forfeiture of earnest money under the SARFAESI Act; and (ii) a statutory provision cannot be read down if its plain meaning is unambiguous and valid. Accordingly, the Supreme Court set aside the impugned judgment of the High Court of Judicature at Madras[3] (“HC”) vide which inter alia Rule 9(5) of SARFAESI Rules was read down, as it prescribed the forfeiture of the entirety of the earnest money deposited irrespective of the actual default or damage suffered.
Relevant Facts:
The Central Bank of India (“Appellant Bank”) extended credit facilities to an entity/ borrower against the mortgage of a parcel of land (“Secured Asset”). Upon the borrower’s default in payment, the loan amount was classified as a Non-Performing Asset (“NPA”) and the Appellant Bank took measures under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”) to take possession of and auction the Secured Asset.
One Shanmugavelu (“Respondent”) was declared the successful e-auction purchaser, having bid INR 12.27 crore, the highest amount. Upon the Respondent depositing 25% of the bid amount, i.e. INR 3.06 crore as earnest money, the Appellant Bank confirmed the sale of the Secured Asset in favour of the Respondent vide a confirmation letter. Such letter inter-alia stipulated that in the event of a default in payment of the balance amount within a period of fifteen (15) days from the date of the said letter, the sale shall be liable to be cancelled and the earnest money deposited by the Respondent shall be forfeited. Thereafter, upon the Respondent’s request on December 19, 2016, the payment timeline for remitting the balance amount was extended by the Appellant Bank up to a period of three (3) months, in consonance with Rule 9(5) of the SARFAESI Rules, and on the condition that no further extension of time shall be granted to the Respondent. However, as the payment deadline approached, the Respondent’s request for further extra time of fifteen (15) days was rejected; the Appellant Bank cancelled the sale; and the earnest money deposited by the Respondent stood forfeited.
The Respondent inter alia challenged the forfeiture of the entirety of the earnest money deposit before the Debt Recovery Tribunal (“DRT”). Pertinently, during the pendency of the challenge before the DRT, the Appellant Bank conducted a fresh auction of the Secured Asset, pursuant to which the same was sold to a third party at an enhanced price of INR 14.76 crore. Accordingly, it was argued by the Respondent before the DRT, that given the subsequent sale of the secured asset at a higher price, the Appellant Bank had not incurred any loss and thus the earnest money deposited by the Respondent ought not to be forfeited. The DRT allowed the Respondent’s application and directed the Appellant Bank to refund the earnest money deposited by the Respondent, after deducting INR 5 Lakh towards any expenses incurred. The Appellant Bank appealed to the Debt Recovery Appellate Tribunal (“DRAT”), which partly allowed the appeal; by increasing the forfeiture amount from INR 5 Lakh to INR 55 Lakh, whilst directing the Appellant Bank to refund the remainder of the earnest money deposit.
Aggrieved, the Appellant Bank and the Respondent challenged the aforementioned order before the HC. The HC allowed the Respondent’s petition and set aside the order of the DRAT on the ground inter alia that the forfeiture of earnest money under SARFAESI Rules cannot be more than the loss or damage suffered by the Appellant Bank, based on the underlying principles of Section 73 of Contract Act. Thus, while Rule 9(5) of the SARFAESI Rules provides for forfeiture in principle, it cannot override the principles of Section 73, and accordingly must be read down. Hence, the Appellant Bank sought an appeal before the Hon’ble Supreme Court, impugning the judgment passed by the HC.
Contention of the Parties
The counsel for the Appellant Bank primarily contended that the HC had erred in reading down Rule 9(5) and subjecting it to the principles under Section 73 of Contract Act, regardless of the wide words used in Rule 9(5). The counsel further buttressed his submissions basis the Hon’ble Supreme Court’s judgment in State Bank of India v. C. Natarajan (C. Nataraja),wherein it was held inter alia that Rule 9(5) of the SARFAESI Rules emanates from a special statute and would accordingly take precedence over the general nature of Sections 73 and 74 of the Contract Act.
On the other hand, the counsel for the Respondent contended inter alia that Rule 9(5) of the SARFAESI Rules being delegated legislation is only an enabling provision and cannot override the statutory principles of the Contract Act. It was further submitted that the SARFAESI Rules provide the authorised officer with unguided power of forfeiture, which is against public policy and would lead to unjust enrichment, and thus Rule 9(5) should be struck down as being unconstitutional.
Findings of the Hon’ble Supreme Court
- Re: The applicability of Sections 73 and 74 of the Contract Act to forfeiture of earnest money under the SARFAESI Rules: The Hon’ble SC categorically rejected the argument that Sections 73 and 74 of the Contract Act are applicable to forfeiture of earnest money under the SARFAESI Rules. It observed that the “legislature through Rule 9(5) of the SARFAESI Rules, has made a conscious departure from the general law by statutorily providing for the forfeiture of earnest-money deposit of the successful auction purchaser for its failure in depositing the balance consideration within the statutory period.”[4] Hence, the consequences of forfeiture is not only a matter of breach of contract, but is in keeping with the larger object of the SARFAESI Act, which is to provide for debt recovery in a time-bound manner and give teeth to its provisions in the event a borrower fails to repay its debt. Further, the Hon’ble SC, relying on C. Nataraja, held that in case the aforementioned provisions of the Contract Act are held to be applicable to Rule 9(5) of the SARFAESI Rules, it may facilitate unscrupulous borrowers to “participate in an auction only to not pay the balance amount at the very end and escape relatively unscathed under the guise of Section(s) 73 and 74 of the 1872 Act, thereby gaming the entire auction process and leaving any possibility of recoveries under the SARFAESI Act at naught.”[5] Additionally, it was held that the SARFAESI Act being a legislation, has an overriding effect on general law, except those statutes that have been specifically mentioned in Section 37[6] and whose applicability has not been barred explicitly. Thus, the underlying ethos of Sections 73 and 74 of the Contract Act, which are general in nature, shall have no application qua the SARFAESI Act and more specifically qua the forfeiture of earnest money under the SARFAESI Rules.
- Re: The law on ‘Reading Down’ a provision: The Hon’ble SC observed that the principle of ‘reading down’ a provision whilst examining the validity of a statute, is an interpretive approach utilised by courts to extrapolate a narrow meaning of a particular provision in order to uphold its constitutionality. Such a principle “is rooted in the idea that courts should make every effort to preserve the validity of legislation and should only declare a law invalid as a last resort.”[7] Hence, a provision is ‘read down’ only if, when construing the same literally, it can pose constitutional or legal challenges. In such cases, the court interprets the language of the provision in a way that limits its scope, thereby aligning it with constitutional or legal principles. The Hon’ble SC accordingly rejected the rationale advanced by the Hon’ble HC vide the impugned judgment that Rule 9(5) of the SARFAESI Rules ought to be read down because it would result in an allegedly ‘harsh consequence’ of forfeiture of the entire earnest-money deposited regardless of the extent of default that has occurred. It was categorically held that “harshness of a provision is no reason to read down the same, if its plain meaning is unambiguous and perfectly valid. A law/rule should be beneficial in the sense that it should suppress the mischief and advance the remedy.”[8]
Conclusion
The present decision of the SC assumes great significance as it, not only clarifies the ambit of the SARFAESI Act as a special legislation vis-à-vis general contractual principles, it emboldens the statutory framework designed to facilitate time-bound debt recovery, and reinforces the legislative intent behind the SARFAESI Act.
By categorically holding that banks have a statutory right to the forfeiture of the entirety of earnest money deposits, regardless of the perceived ‘harshness’ of such a provision, the SC has not only settled any interpretive ambiguity regarding ‘reading down’ Rule 9(5) of the SARFAESI Rules, it has also provided a powerful deterrent to unscrupulous borrowers and auction participants who may be incentivised to conduct sham bids.
For further information, please contact:
Vikash Kumar Jha, Partner, Cyril Amarchand Mangaldas
vikashkumar.jha@cyrilshroff.com
[1] Judgment Dated February 02, 2024, in Civil Appeal No(s). 235-236 of 2024
[2] Rule 9(4) & (5): Time of sale, Issue of sale certificate and delivery of possession, etc.-
4) The balance amount of purchase price payable shall be paid by the purchaser to the authorised officer on or before the fifteenth day of confirmation of sale of the immovable property or such extended period 32[as may be agreed upon in writing between the purchaser and the secured creditor, in any case not exceeding three months].
(5) In default of payment within the period mentioned in sub-rule (4), the deposit shall be forfeited 33[to the secured creditor] and the property shall be resold and the defaulting purchaser shall forfeit all claim to the property or to any part of the sum for which it may be subsequently sold.
[3] Shanmagavelu v. Authorised Officer, Central Bank, 2021 SCC OnLine Mad 5639
[4] Para 61
[5] Para 64(ii)
[6] Section 37: Application of other laws not barred: The provisions of this Act or the rules made thereunder shall be in addition to, and not in derogation of, the Companies Act, 1956 (1 of 1956), the Securities Contracts (Regulation) Act, 1956 (42 of 1956), the Securities and Exchange Board of India Act, 1992 (15 of 1992), the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (51 of 1993) or any other law for the time being in force.
[7] Para 93
[8] Para 101
