SARFAESI | Bank Can Forfeit Entire 25% Deposit & Not Just The Extent Of Loss Due To Default By Auction Purchaser : Supreme Court

In a significant verdict, the Supreme Court held that the entire earnest money deposited by an auction purchaser would be forfeited as per Rule 9(5) of the Security Interest (Enforcement) Rules, 2002 (SARFAESI Rules) on the failure to deposit the remaining amount within the stipulated period.The Court rejected the view taken by the Madras High Court that the forfeiture of the earnest money deposit by the bank could only be to the extent of the loss suffered by it.The Supreme Court held that the High Court erred in law by holding that forfeiture of the entire deposit under Rule 9 sub-rule (5) of the SARFAESI Rules by the appellant bank after having already recovered its dues from the subsequent sale amounts to unjust enrichment."The consequence of forfeiture of 25% of the deposit under Rule 9(5) of the SARFAESI Rules is a legal consequence that has been statutorily provided in the event of default in payment of the balance amount. The consequence envisaged under Rule 9(5) follows irrespective of whether a subsequent sale takes place at a higher price or not, and this forfeiture is not subject to any recovery already made or to the extent of the debt owed. In such cases, no extent of equity can either substitute or dilute the statutory consequence of forfeiture of 25% of deposit under Rule 9(5) of the SARFAESI Rules," the Court stated.The Bench comprising Chief Justice of India D.Y. Chandrachud, Justices J.B. Pardiwala and Manoj Misra held that the secured creditor's right to forfeit the earnest deposit amount by the auction purchaser doesn't arise due to loss or damage suffered due to a breach of contract but under a statutory requirement mentioned under SARFAESI Rules.The Supreme Court held that the principle underlying Sections 73 and 74 of the Indian Contract Act 1872 - that the compensation payable due to a breach of contract is limited to the losses suffered by the other party due to the breach - did not apply to an auction purchase under the SARFAESI Act.The Court observed that the SARFAESI Act is a special legislation with an overriding effect on the general law more particularly the Indian Contract Act, 1872.“Being so, the underlying principle envisaged under Section(s) 73 & 74 of the 1872 Act which is a general law will have no application, when it comes to the SARFAESI Act more particularly the forfeiture of earnest-money deposit which has been statutorily provided under Rule 9(5) of the SARFAESI Rules as a consequence of the auction purchaser's failure to deposit the balance amount.”The auction purchaser could not claim back the earnest money deposited with the secured creditor in the event of non-payment of the remaining amount of the total value of the auction sale.“Once the afore-stated conditions are satisfied i.e., the auction purchaser after confirmation of sale fails to deposit the balance amount within the stipulated time, the secured creditor is required to forfeit the original auction purchaser's earnest money deposit and the secured assets have to be resold.”Rule 9(5) of the SARFAESI Rules puts a mandatory requirement on the successful auction purchaser to deposit a 25% amount after the sale is confirmed by the secured creditor in favor of the auction purchaser. Moreover, the Rule makes it clear that in default of payment of the remaining 75% amount by the auction purchaser within the period mentioned in Rule 9(4) i.e., 15 days, the deposit shall be forfeited by the secured creditor and the auction purchaser would not be entitled to receive the 25% deposited earnest money.Why banks should be entitled to forfeit entire amount?The Court explained that if Section(s) 73 and 74 respectively of the 1872 Act are interpreted so as to be made applicable to a breach in payment of balance amount by the successful auction purchaser, it would lead to a chilling effect in the following ways: -(i) First, it would be quite preposterous to suggest that in an auction which is a process meant for recovery of debt due to default of the borrower, the balance amount if not paid by the successful auction purchaser, another recovery proceeding would have to be initiated by the secured creditor in terms of Section(s) 73 and 74 of the 1872 Act to recoup the loss and expenditure occasioned to it by the defaulting successful auction purchaser.(ii) Secondly, such an interpretation would allow unscrupulous borrowers being hands-in-glove with the auction purchasers to use subversive methods to participate in an auction only to not pay the balance amount at the very end and escape relatively unscathed under the guise of Section(s) 73 and 74 of the 1872 Act, thereby gaming the entire auction process and leaving any possibility of recoveries under the SARFAESI Act at naught. The Court relied on its recent judgment of Authorized Officer State Bank of India v. C. Natarajan, to explain the purpose of providing an overriding effect to SARFAESI over the Indian Contract Act. “If indeed section 73 and section 74, which are...

SARFAESI | Bank Can Forfeit Entire 25% Deposit & Not Just The Extent Of Loss Due To Default By Auction Purchaser : Supreme Court

Yash Mittal

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