Supreme Court: Bank Can Forfeit Entire 25 Percent Deposit And Not The Extent Of Loss Due To Default By Auction Purchaser

Supreme Court: Bank Can Forfeit Entire 25 Percent Deposit And Not The Extent Of Loss Due To Default By Auction Purchaser

Cites its judgments under the SARFAESI Act in the previous cases

The Supreme Court has held that the entire earnest money deposited by an auction purchaser would be forfeited as per Rule 9(5) of the Security Interest (Enforcement) Rules, 2002 on the failure to deposit the remaining amount within the stipulated period.

The bench comprising Chief Justice of India DY Chandrachud, Justice JB Pardiwala, and Justice Manoj Misra overruled the judgment of the Madras High Court that the forfeiture of the earnest money deposit by the bank was restricted to the loss suffered by it.

The Apex Court held that the High Court erred in law by holding that forfeiture of the entire deposit under Rule 9 sub-rule (5) of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Rules by the appellant bank (after recovering the dues from the subsequent sale) amounted to unjust enrichment.

The bench stated, "The consequence of forfeiture of 25 percent of the deposit under Rule 9(5) of the SARFAESI Rules is a legal consequence statutorily provided in the event of default in payment of the balance amount. The consequence envisaged under Rule 9(5) follows irrespective of whether a subsequent sale takes place at a higher price or not. This forfeiture is not subject to any recovery already made or to the extent of the debt owed. In such cases, no extent of equity can either substitute or dilute the statutory consequence of forfeiture.”

The Court observed that the secured creditor's right to forfeit the earnest deposit amount by the auction purchaser did not arise due to loss or damage suffered because of a breach of contract but under the SARFAESI Rules statutory requirement.

The Top Court held that the principle underlying Sections 73 and 74 of the Indian Contract Act, 1872 stated that the compensation payable due to a breach of contract was limited to the losses suffered by the other party due to the breach. It did not apply to an auction purchase under the SARFAESI Act.

The judges noted that the SARFAESI Act was a special legislation with an overriding effect on the general law, particularly the Indian Contract Act.

The auction purchaser could not claim the earnest money deposited with the secured creditor in the event of non-payment of the remaining amount of the total value of the auction sale.

The Court held, “Once the afore-stated conditions are satisfied i.e., the auction purchaser after confirmation of sale fails to deposit the balance amount within the stipulated time, the secured creditor is required to forfeit the original auction purchaser's earnest money deposit and the secured assets have to be resold.”

Rule 9(5) of the SARFAESI Rules puts a mandatory requirement on the successful auction purchaser to deposit a 25 percent amount after the sale is confirmed by the secured creditor in favor of the auction purchaser. The Rule makes it clear that in default of payment of the remaining 75 percent amount by the auction purchaser within the period mentioned in Rule 9(4) i.e., 15 days, the deposit shall be forfeited by the secured creditor and the auction purchaser would not be entitled to receive the earnest money deposited.

On why the banks should be entitled to forfeit the entire amount, the Court explained that if Sections 73 and 74 were interpreted to be made applicable to a breach in payment of the balance amount by the successful auction purchaser, it would lead to a chilling effect.

It cited two points for clarification:

1. It would be quite preposterous to suggest that in an auction, a process meant for recovery of debt due to default of the borrower, the balance amount if not paid by the successful auction purchaser, another recovery proceeding would have to be initiated by the secured creditor in terms of Sections 73 and 74 to recoup the loss and expenditure occasioned to it by the defaulting successful auction purchaser.

2. The interpretation would allow unscrupulous borrowers being hands-in-glove with the auction purchasers to use subversive methods to participate in an auction only to not pay the balance amount till the very end and escape relatively unscathed under the guise of Sections 73 and 74, thereby gaming the entire process and leaving no possibility of recovery under the SARFAESI Act.

The bench cited its recent judgment in the Authorized Officer State Bank of India vs. C. Natarajan case to explain the purpose of providing an overriding effect to the SARFAESI Act over the Indian Contract Act.

It stated, “If Sections 73 & 74 were sufficient to cater to the remedy, the need to make sub-rule (5) of rule 9 as part of the Rules might not have arisen. Additionally, the insertion of sub-rule (5) with such specificity regarding forfeiture must not have been thought of only for reiterating what is already there. The lawmakers visualized the need to arrest cases of deceptive manipulation of prices at the instance of unscrupulous borrowers by thwarting the sale processes. This was the trigger for the insertion of such a provision with wide words conferring extensive powers of forfeiture.

It added, “The purpose of such insertion must have also been aimed at instilling a sense of discipline in the intending purchasers while they proceed to participate in the auction sale process. It must not be forgotten that the SARFAESI Act was enacted because the general laws were not found to be workable and efficient to ensure the liquidity of finances and flow of money essential for a healthy and growth-oriented economy.”

While referring to the Celir LLP. vs. Bafna Motors (Mumbai) Pvt. Ltd. & Ors case, the bench held that only the laws either enumerated in Section 37 of the SARFAESI Act or those that dealt with the same field, would be applicable in addition to the SARFAESI Act. The consequence of forfeiture was not a matter of breach of contract but an operation of the statutory provision.

The judges clarified, “The legislature has consciously provided only one consequence in the event of failure of the successful auction purchaser in depositing the balance amount i.e., forfeiture. It has not provided imposition of any other stipulation by the secured creditor in the event of a breach. This was done, keeping in mind the larger object of the SARFAESI Act. It is to facilitate recovery of debt in a time-bound manner by giving teeth to the measures enumerated within Section 13, particularly the sale of the secured asset in the event the borrower fails to repay the debt.”

The bench further stated, “The SARFAESI Act is a special legislation with an overriding effect on the general law, and only those legislations which are either specifically mentioned in Section 37 or deal with securitization will apply in addition to the SARFAESI Act. The underlying principle envisaged under Section(s) 73 & 74, which is a general law will have no application, when it comes to the SARFAESI Act, particularly the forfeiture of earnest-money deposit, which has been statutorily provided under Rule 9(5) of the SARFAESI Rules because the auction purchaser failed to deposit the balance amount."