The Supreme Court has ruled that a bank governed by the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, can invoke the Act to recover a secured debt acquired from a non-banking financial company that was not covered by the legislation when the loan was originally granted.
A Bench comprising Justice Sanjay Kumar and Justice Sanjeev Sachdeva held that once a bank covered by the SARFAESI Act acquires a live, outstanding and secured loan account from an entity outside the Act, the loan immediately acquires the attributes of a “secured debt” enforceable under the statute.
The principal question before the Supreme Court was whether a bank, as defined under Section 2(1)(c) of the SARFAESI Act, could use the recovery machinery provided under the Act for a debt assigned to it by a financial entity that was not governed by the SARFAESI Act when the debt was created.
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The loans involved in the appeals had originally been advanced by Citi Financial Consumer Finance Limited, an NBFC. At the relevant time, the company had not been notified as a “financial institution” under Section 2(1)(m) of the SARFAESI Act.
Kotak Mahindra Bank subsequently acquired the loan accounts from the NBFC through deeds of assignment and initiated recovery proceedings under Sections 13 and 14 of the SARFAESI Act.
The borrowers and other affected parties questioned the bank’s jurisdiction, contending that a debt not covered by the SARFAESI Act at its inception could not subsequently become enforceable under the statute merely because it had been assigned to a bank.
In the lead appeal, a borrower had availed a home loan of ₹69.60 lakh from the NBFC to purchase a residential flat from two individuals. A sum of ₹66.72 lakh was stated to have been transferred to the sellers.
After the borrower defaulted, an arbitral tribunal directed him to pay ₹75.30 lakh, along with interest, to the NBFC through an award dated July 31, 2010.
Kotak Mahindra Bank took over the loan account on July 13, 2012. It subsequently issued a demand notice under Section 13(2) of the SARFAESI Act on July 3, 2013, claiming approximately ₹1.10 crore, together with interest.
The bank also obtained an order from the Chief Metropolitan Magistrate, Mumbai, permitting it to take physical possession of the secured residential property. The bank claimed that the original sellers continued to occupy the flat despite having agreed to sell it to the borrower.
The sellers approached the Debt Recovery Tribunal and argued that the bank could not invoke the SARFAESI Act because the original lender was not covered by the legislation when the loan was granted.
The DRT accepted the objection, invalidated the bank’s action and directed restoration of possession. The Debt Recovery Appellate Tribunal and, subsequently, the Bombay High Court affirmed that decision.
The bank then approached the Supreme Court.
The second appeal concerned two housing loans of ₹28.50 lakh and ₹13.36 lakh obtained from the same NBFC in February 2009. After defaults and an arbitral award of ₹43.57 lakh, Kotak Mahindra Bank acquired the accounts in April 2013 and initiated SARFAESI proceedings.
In that case, the borrowers’ securitisation application was dismissed on the ground of delay. The bank later obtained an order under Section 14 for taking possession of the secured property.
The third matter involved a loan of ₹2.98 crore advanced by the NBFC to a car rental and logistics company and its directors. The loan became a non-performing asset in 2009 and was assigned to Kotak Mahindra Bank in July 2012.
The Bombay High Court upheld the bank’s SARFAESI action, holding that the controversy stood covered by the Supreme Court’s earlier decisions in M.D. Frozen Foods Exports Private Limited v. Hero Fincorp Limited and Indiabulls Housing Finance Limited v. Deccan Chronicle Holdings Limited.
The secured property involved in that case was eventually sold in 2023.
The borrowers argued that banks and financial institutions governed by the SARFAESI Act could not acquire non-performing assets from entities outside the statute and then enforce those assets through the Act’s stringent recovery mechanism.
They contended that a loan which did not qualify as a secured debt under the SARFAESI Act at the time of its creation could not acquire that character merely upon assignment.
It was further argued that the Act permits enforcement of security interests without prior judicial intervention and, therefore, its provisions must be applied strictly. According to the borrowers, allowing banks to acquire non-performing assets from unnotified NBFCs and then invoke the Act would expand the statutory mechanism beyond its intended scope.
Reliance was also placed on the definitions of “borrower,” “non-performing asset,” “secured creditor,” “security arrangement” and “security interest” under Section 2 of the Act.
The Reserve Bank of India told the Supreme Court that it had no objection to banks purchasing non-performing assets from financial institutions and NBFCs.
The RBI referred to its regulatory guidelines permitting the purchase and sale of non-performing assets. It asserted that enabling banks to enforce security interests attached to acquired assets would serve the interests of the financial system.
A restrictive interpretation, the RBI submitted, would create a situation where an assignee bank could validly acquire a loan account but would be unable to use the statutory mechanism available to it for enforcing the related security.
The RBI also maintained that assignment did not prejudice a borrower’s contractual rights or liabilities. A borrower remains liable to repay the secured debt irrespective of the identity of the entity that subsequently acquires the loan account.
Rejecting the borrowers’ arguments, the Supreme Court observed that the SARFAESI Act was enacted to facilitate the liquidation of non-performing assets and bad debts held by banks and financial institutions.
The Court acknowledged that the legislation provides stringent recovery measures and considerably limits judicial intervention. However, it said the object and purpose of the enactment could not be ignored while interpreting its provisions.
The Court observed that accepting the borrowers’ argument would effectively give persons who borrowed from unnotified NBFCs greater freedom to default than persons who obtained loans from financial institutions covered by the SARFAESI Act.
Loans granted by an entity outside the Act could otherwise be recovered only through ordinary and time-consuming civil proceedings, even after their valid assignment to a bank governed by the legislation.
“Every borrower is bound to honour his commitment and repay his loan along with the interest payable thereon,” the Court observed, adding that there could be no deviation from this legal and moral obligation merely because of the recovery mechanism applicable to the original lender.
The Bench held that the borrowers’ attempt to escape the operation of the SARFAESI Act on this ground lacked a legal foundation.
The Supreme Court explained that the controversy was not merely about the identity of the original lender. It also concerned whether the legal status of a loan could change after its assignment to an institution governed by the SARFAESI Act.
The Court relied on M.D. Frozen Foods, where it had held that the SARFAESI Act applies to all existing loan agreements once it becomes applicable to the concerned financial institution, irrespective of whether that institution was notified when the agreement was executed.
The relevant consideration is whether the debt remains “owing and live” when the Act becomes applicable. The date on which the account was classified as a non-performing asset is not decisive.
The Bench also referred to Indiabulls Housing Finance, where a notified financial institution was permitted to invoke the SARFAESI Act for loans inherited through a merger, even though the original lender was not covered by the legislation.
Those decisions, the Court said, established that a successor-in-interest could use the SARFAESI mechanism even when the original lender was not a financial institution covered by the Act.
Applying the same principle, the Supreme Court held that when a bank already governed by the SARFAESI Act acquires a non-performing secured loan account from an entity outside the Act, the loan account is immediately clothed with the attributes of a secured debt under the legislation.
The Court declared that it makes no legal difference whether the lender and the debt subsequently come within the SARFAESI framework together, or whether only the debt enters the statutory framework because it has been acquired by a bank already governed by the Act.
In both situations, the recovery provisions of the SARFAESI Act become available.
The Bench also rejected the attempt to separately dissect the definitions contained in Section 2 of the Act. It held that the purposive interpretation already adopted in its earlier judgments foreclosed such definitional objections.
The Supreme Court consequently set aside the Bombay High Court judgment dated July 16, 2015, which had held that Kotak Mahindra Bank could not invoke the SARFAESI Act in the lead matter. The underlying orders passed by the DRT and DRAT were also set aside.
However, the Court noted that the sellers’ other factual and legal objections had not been examined because the tribunals had decided the case against the bank at the jurisdictional stage itself.
The Court, therefore, restored their securitisation application for adjudication of the remaining issues on their merits. It allowed the sellers to pursue those objections after depositing an additional ₹25 lakh with the bank within eight weeks. The deposit will be without prejudice to their rights and will remain subject to the final outcome of the securitisation proceedings.
The sellers had earlier deposited ₹40 lakh under an interim arrangement directed by the Supreme Court and had consequently recovered possession of the flat.
The Supreme Court held that the bank was legally entitled to invoke Section 14 of the SARFAESI Act to obtain physical possession of the secured property.
Since the borrowers’ securitisation application had already been dismissed because of delay, the Court said they could pursue appropriate legal remedies if a fresh cause of action arose.
The Court upheld the Bombay High Court’s conclusion that the matter was covered by the rulings in M.D. Frozen Foods and Indiabulls Housing Finance. It also took note of the fact that the secured property had already been sold in 2023.
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