Mardia Chemicals Ltd. v. Union of India (2004)

This is the case on the SARFAESI Act. It is the constitutional challenge to enforcement of security without the intervention of a court, and it produced the one provision of that Act to be struck down.

Three things make it indispensable to Module 3.

First, it explains why the statute exists, in language that also explains the recovery legislation of 1993 and every later reform.

Second, it is the leading authority on how far a legislature may strip a debtor of forum and remedy in the name of speedy recovery, and where the line runs. The Court's technique is the part to learn: it read the ouster of civil jurisdiction widely, and then made the statute survive by reading protections into it.

Third, it settles the borrower's position at the demand-notice stage — the point at which almost every real SARFAESI dispute begins.

A batch of writ petitions and transferred cases challenged the validity of the securitisation statute of 2002, more particularly the provisions contained in ss. 13, 15, 17 and 34.

The facts of the lead case are simple. On 24 July 2002 the Industrial Development Bank of India served a notice on Mardia Chemicals Ltd. under s. 13, requiring payment of arrears within sixty days, failing which the bank as a secured creditor would be entitled to enforce the security interest without the intervention of a court or tribunal, taking recourse to the measures in s. 13(4) — by taking over possession or management of the secured assets. The borrower was also forbidden to transfer the secured assets by sale, lease or otherwise. Similar notices had gone out from other banks and institutions to other borrowers, who petitioned in other High Courts.

The attack was that banks and financial institutions had been vested with arbitrary powers, without guidelines for their exercise and without any appropriate and adequate mechanism to decide disputes about the correctness of the demand, its validity and the actual amount due. The whole scheme, it was said, had been made a one-sided affair, enforcing drastic measures of sale of property or taking over of management or possession of the secured assets without affording the borrower any opportunity.

The vocabulary the Court set out

| Term | The definition in the statute | |---|---| | default | Non-payment of any principal debt or interest or other amount payable by a borrower to a secured creditor, consequent on which the borrower's account is classified as a non-performing asset | | non-performing asset | An asset or account classified by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance with the regulator's directions | | secured creditor | Any bank or financial institution, or any consortium or group of them, and among others a debenture trustee, a securitisation or reconstruction company, or a trustee holding securities on their behalf | | secured asset | The property on which security interest is created | | security interest | Right, title and interest of any kind whatsoever upon property, created in favour of a secured creditor, including any mortgage, charge, hypothecation or assignment other than those specified in s. 31 |

Notice what default does. It is tied to the regulatory classification of the account as a non-performing asset. The remedy is therefore available only to a bank or financial institution whose own books have classified the account, and not to a creditor at large.

1. Is a borrower left without any remedy before measures are taken under s. 13(4), given the non-obstante clause in s. 13(1) and the ouster of civil jurisdiction in s. 34?
2. Is the borrower entitled to a hearing before a notice under s. 13(2) issues?
3. Does enforcement without the intervention of a court destroy the mortgagor's right of redemption?
4. Is the condition of depositing seventy-five per cent of the amount claimed, before the Debts Recovery Tribunal will entertain a petition under s. 17, valid?

The Act and its provisions were upheld, except the pre-deposit condition, which was declared ultra vires Art. 14.

Why the statute existed

The Court explained the non-obstante clause historically. The position that prevailed in 1882, when the Transfer of Property Act was enacted, has undergone a sea change; the functions of banking and financial institutions have changed; and a new economic and fiscal environment exists more than a hundred years after that enactment. It relied on a committee report to the effect that the necessity for suitable safeguards to banks and other financing institutions is now rightly stressed, and that a legal framework essentially conceived to deal with unscrupulous moneylenders is no longer appropriate to deal with credit given by banks and other financing institutions.

That is the same reasoning which produced the recovery legislation of 1993 before it and the insolvency legislation of 2016 after it. A candidate who can trace that line is answering the background question with something better than a list of dates.

The width of the ouster

On the first issue the Court rejected the comforting reading of s. 34. A full reading of the section shows that the jurisdiction of the civil court is barred in respect of matters which a Debts Recovery Tribunal or the Appellate Tribunal is empowered to determine in respect of any action taken, or to be taken, in pursuance of any power conferred under the Act.

The consequence is wide. The prohibition covers even matters of which the Tribunal could take cognizance though no measure in that direction has yet been taken under s. 13(4). In respect of any matter on which an action may be taken even later, the civil court has no jurisdiction to entertain any proceeding.

The narrow residual jurisdiction

Civil jurisdiction survives to a very limited extent — for example, where the action of the secured creditor is alleged to be fraudulent, or its claim so absurd and untenable as to require no probe whatever. The measure is the scope permitted in the case of an English mortgage. The Court adopted the older High Court statement of the mortgagor's remedies: he may come to the court before sale with an injunction to stay the sale if there are materials to show that the power of sale is being exercised in a fraudulent or improper manner contrary to the terms of the mortgage, but the pleadings must clearly disclose a fraud or irregularity on the basis of which relief is sought.

Redemption survives

On the third issue the right of redemption is preserved. Where a borrower tenders the amount due with costs and expenses, no further steps for sale are to take place, and a mortgagor may exercise his right of redemption at any time until the final sale of the property by execution of a conveyance. A dispute about the amount does not destroy the right; the question of a difference in the amount may be kept open and decided before sale.

This is the judicial counterpart of s. 13(8), under which tender of the dues with costs, charges and expenses at any time before the date fixed for sale stops the sale.

The duty to consider objections

This is the passage that decides most real disputes.

The Court accepted that no hearing can be claimed before the demand notice issues: up to the stage of the making of the demand and notice under s. 13(2), no hearing can be claimed by the borrower.

But given the stringent nature of the measures to be taken without the intervention of a court, with a bar on approaching any court or forum at that stage, it becomes only reasonable that the secured creditor must bear in mind the borrower's say before the process of recovery is initiated. The obligation was then stated as a rule: the reply must be considered with due application of mind, and the reasons for not accepting the objections, however brief, must be communicated to the borrower.

The Court grounded the rule in commercial good sense as well as fairness. It is in keeping with the concept of the right to know and the lender's liability of fairness to keep the borrower informed; it caters to the cause of transparency and not secrecy; and it is conducive to building an atmosphere of confidence and healthy commercial practice.

Crucially, it limited the consequence. The communicated reasons are only for the information and knowledge of the borrower, and give rise to no right to approach the Debts Recovery Tribunal under s. 17 at that stage. The borrower gets reasons, not a fresh round of litigation.

The pre-deposit struck down

The condition that no petition under s. 17 be entertained unless the borrower deposited seventy-five per cent of the amount claimed was held bad. The Court gave six reasons, and the discipline of the list is what makes the holding usable:

1. the deposit was imposed while approaching the adjudicating authority of the first instance, not in appeal;
2. there is no determination of the amount due as yet;
3. the secured assets, or their management with transferable interest, are already taken over and under the control of the secured creditor;
4. there is no special reason for double security in respect of an amount yet to be determined and settled;
5. seventy-five per cent of the amount claimed is by no means a meagre amount;
6. it leaves the borrower in a position where it would not be possible for him to raise funds to make the deposit of an undetermined demand.

Such conditions are not alone onerous and oppressive but also unreasonable and arbitrary, and the sub-section was therefore unreasonable, arbitrary and violative of Art. 14.

The Court also dealt sharply with the argument that defaulters deserve no hearing. That argument presupposes admission of liability by the borrowers and that all of them are chronic defaulters; it would only be pre-judging an issue.

The five conclusions

| | Conclusion | |---|---| | I | Sixty days' notice is mandatory before any s. 13(4) measure; objections must be considered with due application of mind and brief reasons communicated, but that gives no right to move the Tribunal at that stage | | II | After measures are taken and before sale, the borrower may move the Debts Recovery Tribunal | | III | The Tribunal, in exercise of its ancillary powers, has jurisdiction to pass any stay or interim order subject to such conditions as it may deem fit and proper to impose | | IV | The requirement of a seventy-five per cent deposit is an oppressive, onerous and arbitrary condition against all the canons of reasonableness, and is struck down | | V | A civil suit remains maintainable within the narrow scope and on the limited grounds on which suits are permissible in matters relating to an English mortgage enforceable without the intervention of the court |

Why the rest survived

The effect of some of the provisions may be a bit harsh for some borrowers, but on that ground the provisions cannot be said to be unconstitutional, in view of the object of the Act: speedier recovery of dues declared as non-performing assets, and better availability of capital liquidity and resources to help the growth of the economy and the welfare of the people in general, which subserves the public interest.

Enforcement of a security interest by a secured creditor without the intervention of a court is constitutionally valid, and the bar on civil jurisdiction is to be read widely; but before measures under s. 13(4) are taken the creditor must consider the borrower's objections with due application of mind and communicate brief reasons for rejecting them, without thereby conferring a right of recourse to the Tribunal at that stage; the right of redemption survives until the final sale by conveyance; and a condition requiring the borrower to deposit seventy-five per cent of the amount claimed before his application to the Tribunal of first instance will be entertained is unreasonable, arbitrary and void under Art. 14.

Two points of statutory history must be kept straight, and examiners test them.

• The seventy-five per cent pre-deposit was in s. 17(2) as originally enacted, in a section then headed as a right to appeal. It is that sub-section which this case struck down. A student who quotes the original s. 17(2) as the present law has quoted a provision that no longer stands.
• The duty to consider the borrower's representation and to reply was a judicial creation in this case before it became statutory. When you state the demand-notice procedure, say where each element comes from: the sixty-day notice and the particulars from s. 13(2) and (3); the duty to consider objections and give reasons from this judgment.