Strengthening rights of banks as secured creditors

A secured creditor is defined as a creditor in whose favour a security interest is created under section 3(30) of the Insolvency and Bankruptcy Code, 2016 (IBC). Under section 3(31) of the Code, the phrase "Security Interest" is also defined. It refers to a claim to property created in favour of, or provided for, a secured creditor as a result of a transaction that secures payment or performance of an obligation, and includes a mortgage, charge, hypothecation, assignment, and encumbrance, as well as any other agreement or arrangement securing payment or performance of any person's obligation. The word "Security Interest" does not include performance security, according to the proviso to section 3(31).

The moratorium clause in section 14 of the IBC prevents a secured creditor from enforcing its security interest against a corporate debtor during the Corporate Insolvency Resolution Process (CIRP). On the insolvency beginning date, the Adjudicating Authority shall impose a moratorium by order banning any action to foreclose, collect, or enforce any security interest created by the corporate debtor in respect of property, including any action under the SARFAESI Act, 2002. Only after the beginning of liquidation proceedings against the corporate debtor under Section 33 of the Code are secured creditors' rights restored. A secured creditor can pursue any of the following remedies to recover its debt once liquidation procedures have begun:

• Secured creditor can either relinquish its security interest to the liquidation estate under section 52(1)(a) or

• The secured creditor can realize the security interest in the manner specified under section 52(1)(b)

SARFAESI ACT

Securitisation And Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (SARFAESI ACT) is an acronym for Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002. The Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Act 2004 altered the Act. The SARFAESI Act allows for the enforcement of security interests for the recovery of debts without the involvement of courts or tribunals, and it is considered one of the most effective methods for recovering NPAs under existing legislation.

The registration process, the power of enforcement of securities, and secured creditors' priority are all addressed in the 2019 Amendment to the SARFAESI Act, 2002. In the exercise of its powers under the SARFAESI Act, 2002 (as amended by the SARFAESI Act, 2016), the Finance Ministry of the Government of India notified on 5 August 2016, that 196 NBFCs are included in the definition of Financial Institutions under the aforementioned Act. It was a significant move in bringing NBFCs up to speed with banks, focusing on how the NBFCs handled recovery operations previous to the notification. NBFCs registered as Public Financial Institutions by the Central Government were also brought under the SARFAESI Act to exercise their powers, in addition to the 196 NBFCs covered by the Act.

As per the 2019 Amendment to SARFAESI Act, 2002, the implication for banks regarding rights of secured creditors is that Debt owed to a secured creditor such as banks will have priority over all other claims, including other debt and all revenue, taxes, cesses, and dues payable to the Central and state governments and local authorities, following the passage of a new amendment to the SARFAESI legislation. Tax or government authorities, or other parties, cannot claim priority over the amount in respect of pending SARFAESI proceedings initiated by the banks, or the amounts already recovered by the bank by sale of secured properties of the borrower/ guarantor if the charge is created on the borrower/ property’s guarantors through mortgage/ hypothecation in favour of the bank and is registered and filed with CERSAI.

RIGHTS OF BANKS AS SECURED CREDITORS

Only debt designated as NPA under RBI guidelines gives secured creditors (banks) the power to enforce this action. The Government of India published the Security Interest (Enforcement) Rules 2002 on September 20, 2002. The rules also provide for the Authorised Officer to exercise the secured creditor's rights under the Act. The Security Interest (Enforcement) Rules 2002, Rule 2a. The term "Authorised Officer" refers to an officer who has been designated by the Board of Directors to execute the rights of a secured creditor and is not less than a Chief Manager of a public sector bank or equivalent. Only the bank's Authorised Officer has the authority to exercise the authorities to activate implement and operate as a Secured Creditor.

When an account is classed as non-performing, the bank will send a demand notice to the defaulting borrower and guarantor(s) under section 13 of the SARFAESI Act, 2002 (rule 2). The notice in writing issued by a secured creditor or authorised officer, as the case may be, to any borrower according to section 13(2) of the Act is referred to as a ‘Demand Notice' (rule 2b). The notification specifies the debts owed to them and instructs them to pay the bank within 60 days of receiving the notice. If the borrower raises any objections after receiving the notification, the bank must respond within fifteen days (earlier it was one week). The reason for the non-acceptance of the objection or representation must be disclosed in the message. In the event that the borrower fails to discharge the bank's liability as stipulated under section 13(2), the Secured Creditor may pursue one or more of the following remedies under section 13(4).

Section 13(4)(a) allows to take possession of the secured asset of the borrower including the right to transfer by way of lease, assignment or sale. Section 13(4)(b) allows takeover the management of the secured asset, provided a substantial part of the business is held as security and or the business is severable, takeover whole or part of such business which is relatable to the security for the debt. Section 13(4)(c) allows to appoint any person to manage the secured assets, the possession of which has been taken over by the secured creditor and under section 13(4)(d). He/ She may require at any time by notice in writing to any person who has secured assets from the borrower and from whom any money is due or become due to the borrower to pay it to the secured creditor.” (Powers under section.13(4)(d) cannot be exercised until notice under section13(2) has been issued and the sixty days period has expired).

PROCEDURE GIVEN BY THE SARFAESI ACT

When a sale is conducted by requesting public tenders or holding a public auction, the SARFAESI Act specifies the procedure for issuing a sale notice:

• The sale notice shall be published in two leading newspapers one in the vernacular language having sufficient circulation in the locality by setting out the terms of sale.

• Every notice of sale is affixed on a conspicuous part of the immovable property and may if the authorised officer deems it fit, put on the website of the secured creditor on the internet.

According to the Ministry of Finance's directive, all public sector banks and financial institutions must post all SARFAESI auction notices on the government's official website, "tender.gov.in" to ensure a wider audience and a better response.

A brief notice about possession of the property should be painted on the outer door/compound walls in the event of immovable properties. If real possession of the secured property cannot be obtained, the bank must file an application for a possession order with the Chief Metropolitan Magistrate/ District Magistrate. If the amount recovered after taking enforcement action under the SARFAESI Act is insufficient to cover the whole debt, the bank may submit an application with the DRT/ Court within the loan documents' limitation period. The mailing of a 30-day sale notice copy to the borrower/ mortgagor after 20 days of possession allows the aggrieved party (as a right) to file an application for a stay of sale transaction of the secured property within 45 days before DRT.

The Rajasthan High Court held in GMG Engineers & Contractor Private Ltd. v. State of Rajasthan (S.B. Civil Writ Petition No.6872/2017), that while section 26E of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 gives priority to secured creditors, it cannot be construed to nullify the statutory first charge.

A landmark judgment was given by the Bombay High Court, Nagpur Bench, in the case of Medineutrina Private Ltd. v. District Industries Centre (D.I.C.), Udyog Bhavan, Nagpur & Others, REED 2021 Bom 02243, concurring with the earlier decisions of the Courts that secured creditors have priority over Government dues held that—

• The dues of the Bank as a secured creditor, in light of the language of Section 26E of the SARFAESI Act will have priority, but that does not have the effect of wiping out the dues payable under any Central/ State/ Local Act, where, for the recovery of such dues, a first charge has been created 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.

• 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. 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

• The priority given in Section 26E of the SARFAESI Act, to the Banks, which is a secured creditor, would only mean that it is first in queue for recovery of its debts by sale of the property, the other creditors being relegated to second place and so on in the order of their preferences, as per law and contract, if any, as the case may be.

• The dues under Section 37(1) of the MVAT Act, 2002 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. Thus, the purchase of the property holds it with all its rights, obligations and liabilities, whatsoever they may be, which would include, all dues, impositions, restrictions as may have been imposed upon the same and consequent to acquiring title to the property.

• Its duty of the auction purchaser, before bidding for the same, to make inquiries about the impositions upon the property, so that he can have it free of any encumbrances. After acquiring title to the property, the auction purchaser cannot be heard to say that he will have the rights associated with the property and not the liabilities.

• The obligation to make reasonable enquiries about the encumbrances and liabilities and to include such liabilities in the notice inviting the bids, is on secured creditor or if that is not done, to include the tax liabilities in the reserve price, fixed for sale of the security interest, so that the encumbrances can be taken care of.

• The bank is bound to disclose such encumbrances in advertisement inviting bids. The secured creditor is also bound to make enquires about any encumbrances attached to the property under sale and disclose to prospective buyer.

CONCLUSION

Hence, as on today, though the secured creditor being bank can appropriate sale proceeds first in priority, the obligation to discharge tax dues under respective Acts shall survive and it will for the auction purchaser or secured creditors who will be responsible for such discharge of tax dues. To summarise the legal position as derived from statutory provisions and judicial pronouncements, Secured Creditors, which are banks, shall have priority over Government tax dues in terms of recovery under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, however, tax liability will be discharged by the auction purchaser. There is a ruling under the Recovery of Debts and Bankruptcy Act, 1993, that the statutory charge persists and the subject remains open until then.