The Supreme Court has ruled that a minor shortfall in the earnest money deposit (EMD) stipulated in a SARFAESI auction notice would not, by itself, invalidate the successful bidder’s offer where the condition was non-statutory, the statutory requirement of depositing 25% of the sale price was subsequently fulfilled, and no prejudice was caused to the borrower or competing bidder.
The bench of Justice Pamidighantam Sri Narasimha and Justice Alok Aradhe directed the concerned bank to refund a surplus amount of ₹1,33,94,054 to the borrower with interest at 7% per annum, observing that the bank ought to have kept the surplus sale proceeds in an interest-bearing account.
The dispute arose after a borrower had availed a cash-credit facility from United Bank of India. The borrower failed to repay the outstanding dues, which stood at approximately ₹88.53 lakh as on July 31, 2008, against a sanctioned limit of ₹85 lakh. The account was consequently classified as a Non-Performing Asset.
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The bank issued a demand notice under Section 13(2) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act), requiring payment of the outstanding amount within 60 days. The secured property was a parcel of land measuring approximately 4,900 square feet along with a building comprising ground and first floors at McNichols Road, Chetpet, Chennai.
After earlier litigation concerning the auction notice, the bank issued a fresh possession-cum-sale notice on March 18, 2009, fixing April 24, 2009 as the auction date. The notice required prospective bidders to submit an EMD of ₹21.50 lakh, expressly stating that an offer without the EMD would be rejected.
The auction purchasers submitted their bid along with an EMD of ₹21.15 lakh, resulting in a shortfall of ₹35,000 from the ₹21.50 lakh stipulated in the auction notice.
Despite the shortfall, the bank entertained the bid. At the auction, the purchasers offered ₹2.17 crore, which was the highest bid, and they were declared successful bidders.
Importantly, the other bidder had also deposited the same amount of ₹21.15 lakh rather than the stipulated ₹21.50 lakh. The Supreme Court therefore examined whether the EMD condition was an essential eligibility requirement whose breach necessarily rendered the bid invalid, or whether it was an ancillary condition capable of being relaxed where no prejudice was demonstrated.
The litigation travelled through several rounds before the Debts Recovery Tribunal (DRT), Debts Recovery Appellate Tribunal (DRAT) and the Madras High Court.
The DRT initially dismissed the borrower’s challenge and held that the relevant statutory notices had been issued in compliance with the SARFAESI Act. However, the DRAT subsequently held that the auction was not compliant with Rule 8(5) of the Security Interest (Enforcement) Rules, 2002 and that the terms of the auction notice had not been followed. It consequently directed restoration of possession of the secured asset to the borrower.
The High Court initially remitted the matter because the alleged non-compliance relied upon by the DRAT had not been raised in the memorandum of appeal. On reconsideration, however, the DRAT reaffirmed its earlier conclusion. The High Court ultimately dismissed the writ petitions, leading to the appeals before the Supreme Court.
The central legal question before the Supreme Court was whether the failure to deposit the entire EMD stipulated in the auction notice invalidated the bid.
The Court noted the established distinction between essential conditions of eligibility and conditions that are merely ancillary or subsidiary. While essential eligibility conditions ordinarily require strict compliance, the Court observed that authorities may, in appropriate circumstances, refrain from insisting upon literal compliance with subsidiary conditions, particularly where relaxation does not cause substantial prejudice or injustice.
Applying these principles, the Court held that the EMD requirement in the present case was non-statutory. It had been incorporated into the possession-cum-sale notice principally to filter out non-serious bidders.
The Court also took note of the fact that both bidders had deposited exactly ₹21.15 lakh. The bank had accepted and considered both bids, and there was no indication that the shortfall gave the successful bidder an unfair advantage over the competing bidder.
A significant factor in the Supreme Court’s reasoning was the subsequent compliance with Rule 9(3) of the Security Interest (Enforcement) Rules, 2002.
The successful auction purchasers deposited 25% of the sale price, inclusive of the EMD, on the date of the auction. Since the bid amount was ₹2.17 crore, the required 25% came to ₹54.35 lakh, and the purchasers deposited that amount.
The Court held that the purchasers were statutorily required to reach the 25% threshold and had in fact done so. Consequently, the earlier ₹35,000 shortfall in the EMD stipulated by the auction notice lost significance once the statutory 25% requirement had been fulfilled.
The Court therefore rejected the borrower’s contention that the EMD requirement constituted an essential eligibility condition.
The Supreme Court placed considerable emphasis on the absence of prejudice.
The Court found that the EMD shortfall had not caused injustice either to the borrower or to the other bidder. Both bidders had deposited the same amount, and the successful bidder subsequently complied with the statutory requirement of depositing 25% of the sale consideration.
The Court concluded that the non-conformity relating to the EMD did not affect the validity of the auction bid.
The borrower had also argued that the auction purchasers failed to pay the remaining 75% of the sale consideration within the stipulated 15-day period.
The Supreme Court rejected this argument after examining the circumstances in which the balance payment was made.
The auction notice itself permitted the authorised officer to extend the period for payment. The record showed that the auction purchasers had approached the bank to pay the balance amount, but the bank informed them that, because court proceedings were pending, the date for payment would be communicated later.
After the borrower’s appeal was dismissed by the Tribunal on October 1, 2009, the auction purchasers paid the balance amount almost immediately, on October 5, 2009. The Court therefore concluded that the bank had effectively extended the period for payment and that the borrower’s contention could not be accepted.
While upholding the validity of the auction, the Supreme Court found fault with the manner in which the bank handled the surplus sale proceeds.
After appropriation of the amount due to the bank, a surplus of ₹1,33,94,054 remained. The bank had offered this amount to the borrower by demand draft, but the borrower declined to accept it, apparently because litigation was pending.
The Supreme Court held that the bank nevertheless ought to have kept the surplus amount in an interest-bearing account. Its failure to do so could not operate to the detriment of the borrower.
The Court consequently directed the bank to refund the entire surplus amount together with interest at 7% per annum from March 23, 2010 until the date of payment.
The Supreme Court quashed and set aside the Madras High Court’s judgment dated March 22, 2013 as well as the DRAT’s order dated June 20, 2011.
The Court allowed the appeals filed by the auction purchasers and the bank, while disposing of the connected appeals filed by the borrower. It also directed the bank to refund the surplus amount with interest at 7% per annum. There was no order as to costs.
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