Recovery of debt by HFCs and initiation of SARFAESI action in case of a decided civil suit: Two significant rulings by High Courts

-Shrestha Banerjee & Archisman Bhattacharjee I finserv@vinodkothari.com

Introduction

The High Courts of Madhya Pradesh and Kerala recently rendered two judgments delving into crucial legal inquiries surrounding the recoverability and enforcement of security interests in instances of borrower default via initiation of SARFAESI proceedings by financial institutions.

The Madhya Pradesh High Court’s ruling specifically addresses the recoverability of Housing Finance Companies (HFCs) in relation to the initiation of SARFAESI actions following borrower default. Conversely, the Kerala High Court’s judgement examines the enforcement of security interests through SARFAESI actions, where the same has been initiated without placing consideration on any judgement delivered by the civil courts concerning such recovery.

In this article, we aim to analyse both judgments, shedding light on their implications and legal interpretations.

Jasmine K. v. State Bank of India and Ors. (Hon’ble High Court of Kerala)

Question of Law:

In the current case under discussion, the respondent bank initiated proceedings under the SARFAESI Act by taking action against the appellant under Section 13(2) of the Act. This action was taken without considering a civil court order that had dismissed an application filed by the respondent on the grounds that no dues were recoverable from the appellant.

The primary question of law addressed by the Kerala High Court was whether a secured creditor is entitled to continue with measures under the SARFAESI Act after a civil suit for recovery initiated by it has been dismissed by a civil court.

Ratio decidendi:

The Kerala High Court, in response to a writ petition filed by the borrower, answered in the negative towards the question of law as has been provided by us above. It held that while the initial option of enforcing security interests through SARFAESI action was indeed available to the financial institution, the pursuit of such action became redundant in the current context. This was due to the financial institution having already sought recourse through a common law action by filing a recovery suit before a civil court. When the civil court dismissed the institution’s suit on the grounds of non-existent debt payable by the borrower, the initiation of SARFAESI action lost its relevance.

In delivering its judgement, the Kerala High Court analysed the term “debt” as defined under section 2(ha) of the SARFAESI Act. 

“Debt shall have the 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) and includes—

 (i) unpaid portion of the purchase price of any tangible asset given on hire or financial lease or conditional sale or under any other contract;

 (ii) any right, title or interest on any intangible asset or licence or assignment of such intangible asset, which secures the obligation to pay any unpaid portion of the purchase price of such intangible asset or an obligation incurred or credit otherwise extended to enable any borrower to acquire the intangible asset or obtain licence of such asset;”

Further as per clause 2(g) of the Recovery of Debts and Bankruptcy Act,1993:

“debt means any liability (inclusive of interest) which is claimed as due from any person  or a pooled investment vehicle as defined in clause (da) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) 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 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 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 and includes any liability towards debt securities which remains unpaid in full or part after notice of ninety days served upon the borrower by the debenture trustee or any other authority in whose favour security interest is created for the benefit of holders of debt securities”

It concluded that this definition encompassed any decree or order issued by a civil court. Therefore, when a civil court determined that no debt was payable, the initiation of SARFAESI action became moot since there was no legally recoverable debt on the date of the SARFAESI application. 

Further, the court while delivering its judgement noted the well defined law held by the Supreme Court under Transcore v. Union of India, stating that the remedies under SARFAESI are in addition to the remedies a creditor might have under the Recovery of Debts and Bankruptcy Act,1993 hence a civil suit can continue side by side with a SARFAESI action. However, once such a civil suit is decided based on the merits and the civil court has arrived at the stance that there is no recoverable debt then the creditor cannot seek for remedies under SARFAESI, post such judgement delivered by the Civil Court.

Virendra Kumar Rathor v. Tehsildar, Dist. Mandsaur (Hon’ble High Court of Madhya Pradesh)

Question of law: 

Whether the Respondent Housing Finance Company (HFC) is justified in resorting to the provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) to recover the loan amount from the petitioner, even though the loan amount is less than ₹20 lakhs.

Position of law: 

A Housing finance company is a type of financial institution regulated by the National Housing Bank Act, 1987 (‘NHB Act’), which provides finance for housing as its primary transacting business. The NHB Act mandates HFIs to obtain a certificate of registration under section 29A, and possess a net owned fund of ten crore rupees or such amount as the RBI mandates. NHB Act is the principle legislation providing an institutional framework for HFIs at all levels and framing policy guidelines for working of all the agencies connected with housing finance.

As per the notification dated 12.01.2021, issued under Section 2(1)(m)(iv) of the SARFAESI Act, NBFCs are allowed to resort to the machinery of SARFAESI Act for loan recovery only when they have a minimum debt of Rs. 20 Lakhs or more. Hence the petitioner filed a writ, contending that the respondent HFC is a type of NBFC,  and cannot proceed under SARFAESI for recovery when the loan amount is less than the 20 lakh threshold given in the notification dated 12.01.2021.

Ratio Decidendi:

The Court held that the Respondent HFC is a separate financial institution, and a specific category of entity created under the NHB Act. To arrive at this conclusion, the court analysed the intersection of the statutory provisions of SARFAESI, the RBI Act, and the NHB Act. Firstly, the statutory definitions of ‘Financial Institutions’ under Section 2(1)(m) of the SARFAESI Act and ‘Non-banking Financial Company’ under Section 45-I (f) of the RBI Act categorises some classes of financial institutions separately from NBFCs.  The term ‘Housing Finance Institution’ (HFI) as defined under the NHB Act can thus be treated to be covered under the category of ‘any other institution’ under these legislations.

Secondly, the court recognised the NHB Act, 1987 as a special enactment created just for regulating HFIs, that lays down special criteria for obtaining a certificate of registration for the HFIs under Section-29A.

The Court relied on the principles of statutory interpretation, stating that the specific provisions of the NHB Act and SARFAESI Act should be harmoniously interpreted as a specialised regulatory regime for HFCs, overriding the general provisions of the RBI Act overriding. Hence, the provision of Chapter III-B r/w Section 45-(I)(f) of the RBI Act, or any notifications issued thereunder, would not apply to the HFIs, and the registration and creation of HFIs/HFCs would always be sourced from provisions of NHB Act. The basic intent of the Central Government in taking out two different sets of notifications for the purposes of SARFAESI proceedings: one specifically for HFI/HFCs under the NHB Act, and the other for NBFCs under the RBI Act, means that they are to be treated differently. The respondent HFC’s name never appeared on any notification by the RBI on the list of NBFCs to be treated as FIs. Rather, it found a place in the notification pertaining to HFCs dated 18.15.2015, vide Serial No. 34.

Analysis 

Kerala High Court 

In our view the judgement so delivered by the Kerala High Court aligns with the principles against forum shopping.

The underlying objective behind the introduction of the SARFAESI Act has been extensively analysed by the Supreme Court in the landmark case of Mardia Chemicals Limited v Union of India. The SARFAESI Act, 2002 was introduced to tackle the problem of the sluggish pace of recovery of defaulting loans and mounting levels of non-performing assets of Banks and FIs. It was brought into force to solve the problem of recovering large debts in NPAs without the need for judicial recourse. However, it is crucial to note that even in cases of borrower default, the common law remedy of approaching civil courts for recovery remains available alongside SARFAESI action. SARFAESI action essentially functions as an execution measure devoid of delving into the substantive merits of a recovery action pursued in any court. Ordinarily, both routes are available to a party, to proceed either by way of a civil suit or under SARFAESI. Nevertheless, once a financial institution executes the relief obtained through the common law route, and subsequently, a civil court dismisses the case on the grounds of non-recoverability due to full payment of dues, SARFAESI action becomes untenable. The civil court’s ruling essentially transforms the matter into an execution action, akin to SARFAESI proceedings, as there remains no outstanding debt at the time of SARFAESI application.

Alternatively, if both SARFAESI action and a civil suit are initiated concurrently by a financial institution, and the civil court declares that no debt is payable by the borrower, the SARFAESI action should likewise be dismissed. This ensures consistency and coherence in legal remedies pursued by financial institutions in cases of borrower default.

Madhya Pradesh High Court 

The recent ruling by the Madhya Pradesh High Court is significant as it establishes a clear distinction between HFCs and NBFCs. The court interpreted maxim ‘generalia specialibus non derogant’, to confer a special status to HFCs created under Section 29A of the NHB Act, for the purpose of interpretation of notifications issued under Section 2(1)(m)(iv) of the SARFAESI Act. The same would necessarily override the general provisions of the RBI Act that cater to all types of NBFCs in general. From our understanding of the judgement, although it pertains to the enforcement of SARFAESI actions by an HFC, the generality of the language used by the court in differentiating HFCs from NBFCs suggests that the distinction so created can also extend to the interpretation of any regulatory guidelines/notification/directions issued by the RBI.

Conclusion

To summarise, both the judgments highlighted the interplay between different laws and the applicability of the SARFAESI Act on NBFCs, and through two different approaches, contributed to the importance of harmonious interpretation between general and special laws. 

While the Kerala HC significantly restricts the bank’s ability to invoke the SARFAESI Act for recovery after an adverse decision in the related civil suit upholds the borrower’s rights; the Madhya Pradesh HC judgement sets a legal precedent that reinforces the importance of procedural compliance, strikes a balance between the rights of lenders to recover their dues and the rights of borrowers in loan recovery and enforcement of security interests under the SARFAESI Act.