SARFAESI Act, 2002: Enforcement of security interest

It is observed that the general belief and perception of many of the legal luminaries, Court Judges, Chair persons of DRAT and Presiding Officers of DRT and also the secured creditors and their authorised officers, is that Section 13(2) of SARFAESI Act cannot be challenged and the borrower can challenge only actions initiated by the Authorised Officer under section 13(4) of the said Actand that too under section 17(1) of the Act when the borrower files his Securitisation Application (SA). As per the said Act, the borrower can approach DRT only when the Authorised Officer issues a notice of possession u/s 13(4) of SARFAESI Act.

But a perusal of the tenets of the SARFAESI Act shows the following aspects.

A secured creditor shall be entitled to exercise all of any of the rights under sub-section (4) of section 13 of SARFAESI Act without the intervention of the court only if the following actions are initiated by the secured creditor / authorised officer.

1. Security agreement should be executed between the secured creditor and the borrower.

2. Security interest should be created on the secured assets in favour of the secured creditor.

3. Debt of the borrower should be classified as Non-Performing Asset (NPA) for which the debt has to be crystallized.

4. Secured creditor has to issue a notice u/s 13(2) of SARFAESI Act demanding the dues from the borrower by giving all the details of the dues and securities to be enforced based on the definition of NPA as per RBI norms.

5. The borrower is required to make the payment as demanded by the secured creditor within 60 days from the date of the notice.

6. The borrower is entitled to make his representation and raise his objections to the notice.

7. The authorised officer has to give a reply to the representation made and objections raised by the borrower within 15 days giving valid reasons if he rejects the representation made and objections raised by the borrower.

Hence the question of serving of notice u/s 13(4) of the Act comes only when the bank and financial institution undertake the aforesaid actions upon which the borrower can file his Securitization Application (SA).

The first pertinent question is, can section 13(2) of SARFAESI Act be challenged? If so, on what grounds can it be challenged? The answer is “yes” if the notice issued u/s 13(2) of SARFAESI Act is not as per the provisions of SARFAESI Act and also if it violates RBI norms for classifying the account as NPA and if the bank and financial institution do not follow the RBI guidelines. In this connection Andhra High Court judgment in the matter of M/s Sravan Dall Mill P. Ltd. Vs. Central Bank of India pronounced on 11th September 2009 is worth recalling. The relevant portion of the said judgment is quoted hereunder. The judgment pertains to two important aspect of SARFAESI Act which as per the said judgmentare “(i) Whether the remedy under Article 226 is available to the petitioner challenging the notice under Section 13(2) of the SARFAESI Act? (ii) Whether the respondent bank has satisfied the requirement of asset classification under the Prudential Norms as framed under Master Circular of the RBI?”

“2. In normal course we would not have entertained this writ petition inasmuch as no measures under Section 13(4) of the SARFAESI Act have been taken by the first respondent bank but we have heard the writ petition at length after permitting the respondent to file a counter affidavit in view of the fact that the petitioner questions the classification of its account, by the first respondent bank, as a Non-Performing Asset (NPA). The foundation of the writ petition and the basic contention of the petitioner, therefore, is that the declaration of the petitioner's account as NPA is not justifiable and consequently the jurisdictional fact necessary for invocation of Section 13 of the SARFAESI Act is non-existent in this case.”It further states, "14. What was expected by this court was not as to whether the officers of the respondent-bank are aware of the circulars and the judgments, but what had been directed is to consider as to whether the account of the petitioner falls within the said category as defined in the circulars and such consideration should have come out in the form of a speaking consideration i.e., by assigning reasons as observed by the Hon'ble Supreme Court. Even the contents of para 5 does not disclose this aspect of the matter where it only says that the value of the security being more has no bearing towards classification without indicating what else was the method followed for classification. Thought the learned counsel for the respondents attempted to point out the circular of R.B.I., the same does not serve any purpose at this stage since neither the reply dated 25th May, 2005 nor the objection statement filed in this petition would refer to the details in this regard and what is required is not to notice the R.B.I guidelines alone but to indicate from the materials on record that the account in question falls within the guidelines. Only when that is done the respondents would be at liberty to proceed in accordance with law. Hence it requires reconsideration at the hands of the respondents themselves."And again the Hon’ble High Court points out, "37. Next we come to the question as to whether it is on whims and fancies of the financial institutions to classify the assets as non-performing assets, as canvassed before us. We find it not to be so”.

The judgment further says, “Thus, from the above, it is clear that the classification of an account as NPA must be in accordance with the directions or guidelines relating to asset classification issued by the RBI. The said aspect of classification of the account as NPA, therefore, assumes any amount of importance and is the first step that is necessary to be satisfied by the creditor bank for invoking the provisions of the SARFAESI Act.

It would, therefore, be open for the borrower to invoke the jurisdiction of this Court seeking judicial review of such decision of a creditor declaring his account as NPA, in view of the fact that such classification by itself leads to serious consequences of invocation of the SARFAESI Act against the borrower. Further, Section 13(3)(A) of the SARFAESI Act inserted by amendment consequent upon a decision of the Supreme Court in MARDIA CHEMICALS's case (2 supra) makes the position further clear that mere rejection of objections of the borrower to the notice of the creditor under Section 13(2) of the SARFAESI Act, would not give rise to cause of action to invoke jurisdiction of DRT under Section 17 of the SARFAESI Act, unless measures as envisaged under sub-clause (4) of Section 13 of the SARFAESI Act are taken by the creditor.” The most important aspect of the judgment is, “19. We are, however, not persuaded to accept the said submission of the learned counsel for the respondents for the reason that a serious civil consequence will flow against the borrower, the moment his account is classified as NPA and thereafter, the proceedings are taken demanding entire outstanding amount by issuing a notice under Section 13(2) of the SARFAESI Act. The appropriate adjudicatory internal mechanism as envisaged by the Supreme Court is not evolved as is evident from the present case. In fact, the only reply which the bank gave to the objections of the petitioner was that 'we would like to bring to you attention that the said account was classified as NPA on 31.05.2006 and bank has every right to take legal steps under the SARFAESI Act to recover its outstanding overdues from the said NPA account' (see reply of the bank dated 01.09.2006). There is no reference in the said reply as to when and how the account was classified as NPA, particularly, when the petitioner has asserted to the contrary and has sent detailed objections to the very classification of the said account based upon the prudential norms referred to above. The judicial review before this Court is, therefore, certainly available to the borrower in such circumstances. The first question whether the notice issued u/s 13(2) of SARFAESI Act can be challenged is accordingly answered.

Regarding the application of section 13(4) of SARFESI Act the judgment says, “21. The Supreme Court in MARDIA CHEMICALS's case (2 supra) in relevant paragraphs 45 and 46 has laid down as follows:

"45...The purpose of serving a notice upon the borrower under sub-section (2) of Section 13 of the Act is, that a reply may be submitted by the borrower explaining the reasons as to why measures may or may not be taken under sub- section (4) of Section 13 in case of noncompliance of notice within 60 days. The creditor must apply its mind to the objections raised in reply to such notice and an internal mechanism must be particularly evolved to consider such objections raised in the reply to the notice. There may be some meaningful consideration of the objections raised rather than to ritually reject them and proceed to take drastic measures under sub-section (4) of Section 13 of the Act. Once such a duty is envisaged on the part of the creditor it would only be conducive to the principles of fairness on the part of the banks and financial institutions in dealing with their borrowers to apprise them of the reason for not accepting the objections or points raised in reply to the notice served upon them before proceeding to take measures under sub-section (4) of Section 13. Such reasons, overruling the objections of the borrower, must also be communicated to the borrower by the secured creditor. It will only be in fulfillment of a requirement of reasonableness and fairness in the dealings of institutional financingwhich is so important from the point of view of the economy of the country and would serve the purpose in the growth of a healthy economy. It would certainly provide guidance to the secured debtors in general in conducting the affairs in a manner that they may not be found defaulting and being made liable for the unsavory steps contained under sub-section (4) of Section 13. At the same time, more importantly we must make it clear unequivocally that communication of the reasons not accepting the objections taken by the secured borrower may not be taken to give an occasion toresort to such proceedings which are not permissible under the provisions of the Act. But communication of reasons not to accept the objections of the borrower, would certainly be for the purpose of his knowledge which would be a step forward towards his right to know as to why his objections have not been accepted by the secured creditor who intends to resort to harsh steps of taking over the management/business of viz. secured assets without intervention of the court. Such a person in respect of whom steps under Section 13(4) of the Act are likely to be taken cannot be denied the right to know the reason of non-acceptance and of his objections..."

"46. We are holding that it is necessary to communicate the reasons for not accepting the objections raised by the borrower in reply to notice under Section 13(2) of the Act more particularly for the reason that normally in the event of noncompliance with notice, the party giving notice approaches the court to seek redressal but in the present case, in view of Section 13 (1) of the Act the creditor is empowered to enforce the security himself without intervention of the Court. Therefore, it goes with logic and reason that he may be checked to communicate the reason for not accepting the objections, if raised and before he takes the measures like taking over possession of the secured assets, etc.”It is apparent from the said sections of the Act that the SARFAESI Act comes into effect only if there is crystallized liability and that the account should be classified as NPA. Therefore, the judgment states, “23. The right of the borrower to have a due consideration of objections is, therefore, an important right of the borrower where the bank is bound to apply its mind and inform the borrower of its reasons as to why and how the account is classified as NPA, particularly, when the borrower raises specific objections in that regard. The reply of the bank must indicate application of mind by the bank that the decision of the bank in classifying the account as NPA was fully in conformity with the prudential norms of RBI. Non-consideration of the said objection by mere statements in the reply that the bank has considered the same cannot be said to be the fulfillment of the obligation of the bank under Sections 13(2) and 13(3)(A) of the SARFAESI Act.” Thus the second question also is clarified well.

Yet in another case of Madras High Court in the matter of W.P.No.15272 of 2009, Sheeba Philominal Merlin vs. The Repatriates Co-op Finance Bank on 10 August 2010, the judgment pronounced by the said High Court is worth recalling. The relevant portion is cited here with, “As per the Act, the first step would be to issue notice U/s. 13(2) by the authorised officer who is deemed to be armed with a money decree which attained finality. By the statute the authorised officer, is clothed with powers of trial court and execution court and the code of Civil Procedure which governs the civil proceedings is no more necessary. To put it otherwise, by the Special Act, the authorized officer acts like a Civil Court clothed with powers hitherto exercised by it.” The judgment continues, “The financial institutions, namely the lenders owe a duty to act fairly and in good faith. There has to be a fair dealing between the parties and the financing companies/institutions are not free to ignore performance of their obligation as a party to the contract. They cannot be free from it…………..It is incumbent upon such financial institutions to act fairly and in good faith complying with their part of obligations under the contract. This is also the basic principle of concept of lender's liability. It cannot be a one-sided affair shutting out all possible and reasonable remedies to the other party, namely, borrowers and assume all drastic powers for speedier recovery of NPAs. Possessing more drastic powers calls for exercise of higher degree of good faith and fair play. The borrowers cannot be left remediless in case they have been wronged against or subjected to unfair treatment violating the terms and conditions of the contract. They can always plead in defense deficiencies on the part of the banks and financial institutions.” Further, the judgment states, “5. The aforesaid Act clothes the authorized officer of the bank with enormous powers to deal with the secured assets to recover the outstanding amounts. Once the power is given, the Courts have held that the same has to be exercised in the way it is to be done and not otherwise. Here is a case where the first respondent/bank, contrary to the Act acted in whimsical and capricious manner and brought the property of the petitioners and sold the same to the fourth respondent in an ill-devised manner which is unknown to law.” But in practice the power vested with the Authorised Officer is abused and misused and it is not being exercised in the way it is to be done and not otherwise by the authorised officer of the bank or financial institution. The verdict further states, “The well-established precepts of public trust and public accountability are fully applicable to the functions which emerge from the public servants or even the persons holding public office.” And the judgment points out further, “82. Principle of public accountability is applicable to such officers/officials with all its vigour. Greater the power to decide higher is the responsibility to be just and fair. The dimensions of administrative law permit judicial intervention in decisions, though of administrative nature, but are ex facie discriminatory. The adverse impact of lack of probity in discharge of public duties can result in varied defects not only in the decision-making process but in the decision as well. Every public officer is accountable for its decision and actions to the public in the larger interest and to the State administration in its governance.” The judgment concludes with the final order, “47. For non-compliance of mandatory provisions of the Act, fraud, lack of fair play, bonafides etc., the entire proceedings initiated by respondent bank in favour of the fourth respondent gets vitiated and is hereby set aside.” And “48. There will be an order of exemplary cost of Rs.50,000/- (Rupees fifty Thousand only) payable by the respondents bank 1 to 3 to the petitioners within 15 days from the date of the receipt of a copy of this order. Consequently, connected M.P.No.1 of 2009 is closed”.

Section 17(7) OF SARFAESI Act states, “Save as otherwise provided in this Act, the Debts Recovery Tribunal shall, as far as may be, dispose of the application in accordance with the provisions of the Recovery of Debts Due to Banks and Financial Institutions Act,1993 (51 of 1993) and the rules there under.” Further Section 37 of the SARFAESI Act also states, “Application of other laws not barred” in which RDDB Act, 1993 is also included. Besides, SARFAESI ACT, 2002 states, under section 2- definitions(ha), “ { “Debt” shall have a meaning assigned to it in clause (g) of section 2 of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (51 of 1993)}.  Section 2 ((g) of DRT Act, 1993 which defines debt as, “ Debt” means any liability(inclusive of interest) which is claimed as due from any person by a bank or a financial institution or by a consortium of banks or financial institutions during the course of any business activity undertaken by the bank or the bank or financial institution or the consortium under any law for the time being in force, in cash or otherwise, whether secured or unsecured, or assigned , or otherwise, or whether payable under a decree or order of any civil court or any arbitration award or otherwise or under a mortgage and subsisting on, and legally recoverable on, the date of the application.” Such being the definition, it imperative and inevitable to ascertain whether the claim of the bank and financial institution pertains to legally recoverable debtor not for which first of all the debt has to be crystallised. Unless and until that is done, the bank and the financial institution cannot invoke SARFAESI Act and issue notice u/s 13(2) of the said Act and takefurther action u/s 13(4) of the said Act to take possession of the securities on which security interest has been created by them.The following two aspects are to be considered by the appropriate authorities when the bank and financial institution invoke SARFAESI Act.

- The secured creditor / authorised officer must ensure whether the demand made by them under section 13 (2) of SARFAESI Act is for the recovery of legally recoverable debt for which the debt has to be crystallized. Besides, the authorised Officer must also make certain that the representation made and objections raised by the borrower are understood properly by application of mind to the points brought out by the borrower to ascertain without any ambiguity and doubt that he is justified in rejecting the representation and objections of the borrower to realize the legally recoverable dues.

- The presiding officer of DRT also should ensure that the bank and the financial institution make certain that they have invoked section 13(4) of SARFAESI Act for the recovery of crystallised and legally recoverable debt only and that they sought the assistance of District Magistrate / Metropolitan Magistrate to take physical possession of the secured assets and that the District Magistrate / Metropolitan Magistrate also extend their assistance only after ascertaining the facts as true and correct as submitted in the affidavit by bank and financial institution for the recovery of legally recoverable debt only.In this connection the following judgment of Madras High Court is worth recalling. “In the matter of V. Noble Kumar vs Standard Chartered Bank, the Madras High Court (DB) vide citation 2011(1) Bankers’ Journal 178 decided on 27.07.10, declared that the proceedings mounted to arbitrary exercise of powers under Sec 14 and therefore the order of the CJM was set aside. The extract of the order is reproduced here below.

“19.A perusal of the said order shows that the Chief Judicial Magistrate had merely directed the appointment of a Commissioner for the purpose of taking possession of the schedule mentioned property and to hand over the same to the secured creditor. There is nothing to indicate as to the compliance of the provisions of section 13(2), 13(4) and Rule 8. As there is no reference to the compliance of the provisions by the secured creditor, it must be presumed that no materials were placed before the Chief Judicial Magistrate by the secured creditor in respect of the compliance. Further, the affidavit filed by the bank in support of the petition seeking for vacating interim order, nothing has been stated as to the compliance of the provisions of section1 3(2), 13(4) and particularly Rule 8. It does not also state that even after the advocate commissioner was directed to take possession, the above procedures have been followed. In that view of the matter, the impugned proceedings are unsustainable in the eye of law, as it would amount to arbitrary exercise of the powers conferred under section 14.

20. Accordingly, the impugned order of the learned Chief Judicial Magistrate, Chengalpattu, dated 14.12.2009 is set aside. The writ petition is allowed. No costs. Consequently, connected M.Ps. are closed.”

The pertinent question is what constitutes legally recoverable debt? Where as definition of debt is given, no where the definition of “legally recoverable” is given either in SARFAESI Act or under RDDB Act. Unless the definition of “legally recoverable” is resolved, it will be subjected to various interpretation and definition. (The author has given his interpretation of “legally recoverable debt in one his articles on the subject matter) Hence, it is apparent that section 13(2) can be challenged at any point of time during the process of adjudication or through the representation and objections submitted by the borrower or through his S.A andthe challenge of section 13(4) of SARFAESI Act need not be confined alone to the steps taken by the bank and financial institution under section 13(4) of SARFAESI Act. 

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