Tax dues subservient to dues of secured creditors under SARFAESI Act and RDDB Act

Neha Sinha, Executive, Vinod Kothari & Company

corplaw@vinodkothari.com

Introduction

SARFAESI Act and RDDB Act are specific laws for recovery of debts.  Both these laws provide that  the secured creditors can claim priority for the realisation of dues. On the other hand, State and Central tax authorities can also enforce the payment of tax dues under tax statutes, which often create a statutory first charge in favour of the authorities. This may give rise to situations wherein the secured creditors are competing with the tax authorities in respect of payment of dues. Such competing claims have to be resolved in case of insolvency/deficiency.

A similar situation arose in the case of Jalgaon Janta Sahakari v. Joint Commissioner of Sales.^[1] The Division Bench of the Bombay High Court decided on the issue of the conflict between  SARFAESI Act and RDDB Act, and State tax statutes, in respect of priority of claims. The primary that arose in this case was whether State tax authorities can claim priority, by virtue of first charge created under State tax statutes, over a secured creditor for liquidation of their respective dues.

Chapter IV-A of the SARFAESI deals with registration of charges by secured creditors and. Pursuant to section 26D therein,  a secured creditor who has not registered the charge loses his right to enforce the security under SARFAESI. Section 26E, which has a non-obstante clause, accords priority to the secured creditor who has registered the charge in the CERSAI, over “all other debts and all revenue, taxes, cesses and other rates payable to the Central Government or State Government or local authority.” Similarly, section 31B of the RDDB Act gives states that “notwithstanding anything contained in any other law….rights of secured creditors shall have priority and shall be paid in priority over all other debts and Government dues including revenues, taxes, cesses and rates due to the Central Government, State Government or local authority.” Pertinently, the aforesaid provisions in both Acts have a non-obstante clause, having the effect of overriding any other law inconsistent with it.

In the instant case, by virtue of relevant State tax statutes, a first charge was created in favour of State tax authorities. This brings forth the conflict as to who shall have priority in terms of payment-  that State tax authorities with first charge or the secured creditors with the registration of charge in CERSAI?

Key Takeaways

The key takeaways from the judgement in respect of this issue are as follows:

Priority to secured creditors

Both the SARFAESI Act and RDDB Act bestow priority upon secured creditors over all other debts and Government taxes and levies.

The State tax authorities have the first charge created in their favour by virtue of the State tax statutes. On the other hand, the primacy to the secured creditor is by virtue of Central legislations, i.e., SARFAESI Act and RDDB Act. In accordance with the doctrine of repugnancy, in the event there is a conflict between a State legislation and a Central legislation, the latter will override the former. Therefore, SARFAESI Act and RDDB Act will prevail over State tax statutes.

First charge holders subordinate to secured creditors

The Bombay High Court also deliberated on the Supreme Court’s decision in the Central Bank of India v. State of Kerala^[2] judgement in the year 2009. In the Central Bank matter,  the question arose as to whether the provisions in State tax statutes creating a first charge in its favour are in conflict with enforcement of security and recovery of debt under SARFAESI Act and RDBFI Act respectively. The Supreme Court had held that SARFAESI Act and RDBFI Act did not contain provisions which gave priority to secured creditors over the first charge holders wherein the first charge is created under State legislations. Hence, first charge holders were held to be superior to secured creditors.

However, this judgement was prior to the 2016 Amendment which introduced Chapter IV-A in SARFAESI Act (which contains section 26E giving priority to secured creditors) and  the 2016 Amendment in RDDB Act which introduced section 31B therein giving priority to secured creditors. The Kerala High Court in State Bank of India v. State of Kerala^[3] had held that in view of section 31B of RDDB Act and section 26E of SARFAESI Act, first charge created in favour often banks and financial institutions is created for recovery of their dues in priority to the dues of a department of the Government.

Hence, the Bombay HC held that the Supreme Court’s dictum in the Central Bank is no longer relevant with the introduction of Chapter IV-A in SARFAESI Act. Further, the Court held that even “a first charge can be made subservient to a paramount charge,” and as such, ‘priority’ of secured creditors will have precedence over ‘first charge’ created by State legislations.

Mandatory registration with CERSAI

The Bombay High Court further delved into the necessity of registering the charge with the CERSAI in order to avail of the right to enforce security under Chapter III of SARFAESI Act. Section 26D of SARFAESI Act lays down that “no secured creditor shall be entitled to exercise the rights of enforcement of securities under Chapter III unless the security interest created in its favour by the borrower has been registered with the Central Registry.” Hence, registration of charge with CERSAI is a condition precedent to enjoying the rights of enforcement of security.

Therefore, if a secured creditor has not registered the charge with CERSAI, he shall lose the right to enforce the security. A secured creditor will have priority over all other debts and taxes and levies only if the charge is registered with CERSAI. Hence, secured creditors are can invoke the enforcement proceedings under SARFAESI Act and seek priority in terms of section 26E only after the security is registered with CERSAI

In a case where a creditor has registered the charge in the record of rights with the Land Revenue Department vide a Mutation Entry (as was the case in the Writ Petition No. 2336 of 2021 under appeal before Bombay High Court in this case), such a party can still not claim priority over a secured creditor who has the charge registered with CERSAI. Hence, in order to compete with a secured creditor, the charge has to be registered with CERSAI. It is pertinent to note that taxes are Crown debts. Crown debts do not enjoy priority over secured debts as was held in Dena Bank v. Bhikhabhai Prabhudas Parekh & Co.^[4] The Court further went on to adjudge that taxes and levies, in the nature of Crown debts, shall always be subordinate to the claims of secured creditors.

Disability of secured creditor under SARFAESI Act precludes them from invoking priority under RDDB Act

The Court analysed the issue of whether a secured creditor, who cannot claim priority under section 26E of SARFAESI Act due to non-registration charge, can subsequently resort to recovery under RDDB Act pursuant to section 31B.

Answering in negative, the Court  observed that while the outcome of proceedings under SARFAESI Act and RDDB Act are the same, i.e., recovery of due amount, the process of recovery is different. Recovery under SARFAESI Act does not require court intervention, whereas under RDDB, the recovery process is court driven. By virtue of section 31B of RDDB Act, a secured creditor can claim priority. The Court, in respect of the issue, held the following:

“…in such cases only, where the proceedings originate in the DRT under the RDDB Act, would the non-obstante clause in section 31B override all other provisions whereunder interest in respect of the same property may have been created in favour of other persons or authorities and the rights of the secured creditor to realize secured debts shall have priority and be paid in priority. Thus, such provision (section 31B) cannot be invoked or applied to a sale under the SARFAESI Act, which is a sale by the secured creditor without court intervention….section 31B of the RDDB Act being a substantive provision, it cannot be invoked by a secured creditor faced with the disability posed by section 26E of the SARFAESI Act; and without recourse having been taken to the procedure envisaged in the RDDB Act for recovery of its dues and without there being a determination of its claim by the DRT to the effect that any sum due from the borrower is payable to it, a secured creditor is not entitled to invoke the provisions of section 31B.”

The right to be paid in priority will accrue only upon the determination by DRT that the debts are due and payable.

Conclusion

This decision lays down the principle that secured creditors under SARFAESI Act and RDDB Act shall have priority over tax authorities in terms of payment and realisation of dues;  a secured creditor can enforce under SARFAESI Act only if the charge is registered with CERSAI; and a secured creditor under SARFAESI Act and RDDB Act shall rank superior to tax authorities.

Here, the author notes sections 26B and 26C of SARFAESI Act. Section 26B also allows tax authorities to file particulars of attachment orders with the Central registry. Further, pursuant to section 26C (2), priority of a claim (with respect to security interest or even an attachment order) shall be determined on the basis of the sequence of registration.  Therefore, say if the tax authorities file and register attachment orders prior to registration of security interest by a secured creditor, the claim of tax authorities will have precedence over the claim of the secured creditor.

[1] Writ Petition No. 2935 of 2018.

[2] (2009) 4 SCC 94, https://indiankanoon.org/doc/857240/

[3] (2019) SCC OnLine Ker 2890.

[4] (2000) 5 SCC 694.