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March 12, 2009
Is Secured Creditor Really Secured?
Highlight of the judgment
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| The Supreme Court of India has held
that the DRT Act and SARFAESI Act do not per se create
preceding charge in favour of banks, financial
institutions and other secured creditors and specific
statutory charge will prevail over rights of any other
secured creditor. The judgment lays down that the
provisions contained in State/ Central revenue
legislations providing priority of claim in favour of
State dues are not inconsistent with the provisions of
the DRT Act and SARFAESI Act. |
Introduction
It is a settled principle under common law, that the government
(“State”) has first charge over the priority of
debts. This principle is also known as the ‘doctrine of
priority of state debts’. This common law doctrine of
priority of State's debts has been recognised by the courts of
India, as being applicable to British India before 1950 and
hence the doctrine has been treated as "law in force" within the
meaning of Article 372(1) of Constitution. However, in the
recent past there have been conflicts between secured creditors
who have initiated credit recovery proceedings under the
provisions of the Recovery of Debts Due to Banks and Financial
Institutions Act, 1993 (“DRT Act”) or the
Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interests Act, 2002 (“SARFAESI
Act”) and the State with respect to priority of claim
on the debts due to them. It has been contended by the State
that by virtue of the doctrine of priority of state debt,
they have priority over the claim of secured creditors, while,
banks, financial institutions and other secured creditors, who
have initiated proceedings under the SARFAESI Act or DRT Act
have maintained that the non-obstante clause contained under the
SARFAESI Act and DRT Act has an overriding effect on the
provisions of any other legislation providing for recovery of
dues, including the debts due to the State.
In the recent judgment of the Supreme Court of India (“Supreme
Court”) dated February 27, 2009, in the matter of
Central Bank of India v. State of Kerala and Ors1
the Supreme Court dealt in detail with the issue relating to the
scope and extent of application of the SARFAESI Act and DRT Act
in light of the non-obstante clause contained under these two
Acts and also considered the circumstances for the applicability
of the ‘doctrine of priority of state debts’. After
detailed analysis of the SARFAESI Act and DRT Act and the
respective conflicting State Government revenue legislations
providing for creation of first charge in favour the State, the
Supreme Court laid down that the State Government revenue
legislations providing for recovery of dues from the seller as
arrears of land and the SARFAESI Act and DRT Act have different
domains of operation and there is no overlap or conflict in the
application of the laws. Thus, if there is any right over
property created by Statute, it would prevail over the rights of
the secured creditors.
Background of the case
In the present case the Supreme Court tagged various appeals
involving interpretation of the non-obstante clause under the
Section 35 of the SARFAESI Act and Section 34(1) of the DRT Act,
giving priority of claim to the debts due to banks, financial
institutions and other secured creditors.
The Supreme Court analyzed the aforesaid non-obstante clauses in
light of the non-obstante clauses contained under the State
Government revenue legislations, such as the Bombay Sales Act,
1959 (“Bombay Act”) and Kerala General Sales
Tax Act, 1963 (“Kerala Act”), which provides
for creation of first charge in favour of State Government over
the property of the assessee who has defaulted in payment of
State Government dues.
The non-obstante clauses contained under the SARFAESI Act, DRT
Act, Bombay Act and the Kerala Act are reproduced herein below:
SARFAESI Act
“Section 35 – The provisions of this Act to
override other laws: The provisions of this
Act shall have effect, notwithstanding anything inconsistent
therewith contained in any of the law for the time being in
force or any instrument having effect by virtue of any such law”.
DRT Act
“Section 34 – Act to have over-riding
effect: (1) Save as otherwise provided in
Sub-section (2), the provisions of this Act shall have effect
notwithstanding anything inconsistent therewith contained in any
other law for the time being in force or in any instrument
having effect by virtue of any law other than this Act.”
Bombay Act
“Section 38C - Liability Under this Act to be First
Charge - Notwithstanding anything contained in any
contract to the contrary but subject to any provision regarding
first charge in any Central Act for the time being in force,
any amount of tax, penalty, interest or
any other sum, payable by a dealer or any other person under
this Act shall be the first charge on the property of the
dealer, or, as the case may be, person.”
Kerala Act
“Section 26 - Tax payable to be first charge on the
property - Notwithstanding anything to the contrary
contained in any other law for the time being in force, any
amount of tax, penalty, interest and any
other amount, if any, payable by a dealer or any another person
under this Act, shall be the first charge on the property of the
dealer, or such person.”
The Supreme Court has held that, the DRT Act and SARFAESI Act
have been enacted by Central Government under Entry 45 in List I
in the Seventh Schedule whereas Bombay Act and Kerala Act have
been enacted by the concerned State Government under Entry 54 in
List II in the Seventh Schedule, implying that the, two sets of
legislations have been enacted with reference to entries in
different lists in the Seventh Schedule. The Supreme Court held
that, there is no conflict in the operation of the DRT Act and
SARFAESI Act vis-a-vis against the provisions of Bombay Act and
Kerala Act and there is no ostensible overlapping between two
sets of legislations. Therefore, the said State Government
legislation cannot be struck down as the same are not in
conflict with the mentioned two Central Government legislations.
Interestingly, the Supreme Court has observed that both DRT Act
and SARFAESI Act regulate the distribution of money received by
the secured creditor, and do not create a preceding charge in
favour of the secured creditor. The DRT Act and SARFAESI Act
provides a credit recovery mechanism to secured creditors and
ensures that priority is given to the claim of workers of a
company in liquidation under Section 529A of the Companies Act,
1956 vis-a-vis secured creditors like banks and financial
institutions is duly respected.
The Supreme Court further held that, it could have given effect
to the non-obstante clauses contained in Section 34(1) of the
DRT Act and Section 35 of the SARFAESI Act vis-a-vis Section 38C
of the Bombay Act and Section 26B of the Kerala Act and similar
other State legislations, only if there was a specific provision
in the two Central Government legislations creating first charge
in favour of the banks, financial institutions and other secured
creditors. As the Central Government has not made any such
provision in either of the enactments, the first charge created
by the State Government legislations on the property of the
dealer or any other person, liable to pay sales tax etc., cannot
be destroyed by implication or inference, notwithstanding the
fact that banks, financial institutions or other secured
creditors fall in the category of secured creditors.
Priority of Tax Dues
The question to be considered is whether the dues to the State
have priority over the claims of a secured creditor. It was held
in Collector of Aurangabad v. Bank of India2
that merely because sales tax arrears are to be recovered as
arrears of land revenue does not make the dues, have priority
over dues of secured creditors.
Similarly, in the year 2008, in Krishna Lifestyle
Technologies Ltd v. Union of India3,
the question arose before the Bombay High Court was, whether
recovery under provisions of the Central Excise Act, 1944 have
priority over the claim of secured creditors under the SARFAESI
Act in view of the proviso introduced by the Finance Act, 2004,
under which power was conferred on the revenue authorities to
recover the dues by sale of the excisable goods, material,
preparations, plant, machineries, vessels, utensils, implants
and articles in custody of the person to whom the transfer as
contemplated by the proviso is effected.
The Bombay High Court held that the dues owed to the State have
preference only over the dues of an ordinary creditor, not a
secured creditor. The Bombay High Court while considering the
language of Section 35 held that the provisions of SARFAESI Act
override the provisions of the Central Excise Act, 1944 and as
such the priority given to a secured creditor would override
State dues. A sale of the assets would be under the provisions
of SARFAESI Act and the proceeds thereof would be distributed in
the order of priority of the creditor.
However, the Bombay High Court observed that, it is open to the
State, to provide that its dues have priority of claims over the
dues of a secured creditor(s). This understanding has been
affirmed in the present case, where it has been laid down by the
Supreme Court that, the provisions of the Bombay Act and Kerala
Act, which provides for creation of first charge in favour of
State over the property of the assessee, has priority of claims
over the dues of secured creditors.
Conclusion
Though, the Supreme Court has recognized the fact that the DRT
Act and SARFAESI Act have been created for a benefit of a banks,
financial institutions and other secured creditors, it has been
clarified that these two Central legislations do not per se
create first charge in favour of the banks, financial
institutions and other secured creditors. Thus, it can be
concluded that the State would have priority of claim, if there
is a specific provisions giving priority to the State dues.
However, if the dues are recoverable merely as arrears of land
revenue based on a certificate issued by the recovery collector,
those debts cannot have priority of claim over the dues of a
secured creditor.
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1. Civil
Appeal Nos. 95 of 2005, 2811, 3549, 3973, 4174, 4909 of 2006,
1288/2007 and C.A. No. 1318 of 2009 (Arising out of S.L.P. (C)
No. 24767 of 2005)
2. AIR 1967 SC 1831
3. 2008(110)Bom.L.R.456
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Shikhar
Kacker &
Vyapak Desai
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