MARDIA CASE AND ITS IMPLICATIONS ON SARFAESI ACT

SUBJECT: BANKING AND FINANCE

SUBMITTED BY VIVEKANANDA SWAROOP ROLL NO: 2009-70

SUBMITTED TO: DR. K. VIDYULATTHA REDDY

IV YEAR VII SEMESTER

NALSAR UNIVERSITY OF LAW

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TABLE OF CONTENTS
Introduction ................................................................................................................................... 3 Research Methodology ............................................................................................................... 4 Facts in Brief ................................................................................................................................. 5 Issues .............................................................................................................................................. 6 Judgement ...................................................................................................................................... 7 Issue I .......................................................................................................................................... 7 Issue II......................................................................................................................................... 7 Issue III. ...................................................................................................................................... 9 Issue IV ..................................................................................................................................... 10 Implications on sarfaesi act and Post-mardia developments .................................................. 14 Amendments ............................................................................................................................. 14 Committees ............................................................................................................................... 14 Section 13 Is Valid .................................................................................................................... 15 Is Section 17 Really Different from Code of Civil Procedure? ................................................ 15 Conclusion ................................................................................................................................... 17 Bibliography ................................................................................................................................ 18

INTRODUCTION

After the Nationalisation of Banks in 1969 and 1980, as the local money lenders faced a great set back, the banking sectors emerged as a viable option for the common man for the much needed loans and other depository facilities. The legislators thought, in the view of national development, the interest of the common man is to be given more prominence and thus it provided him with lenient terms for availing loans and in addition the recovery process for the bank loans were made complex so as to protect the common man from the harassment of banks. However it turned out that the banking sectors were exploited to a much greater point due to the lack of efficient recovery means. Though there was quantitative efficiency on the part of the banks, the failure of the legislature to foresee this condition put the banks in a very hard time and the banks suffered financial losses year after year due to low efficiency, productivity, bad portfolio performance and eroded profitability. The Bank suffered in the hands of unscrupulous borrowers and the prolonged civil proceedings made it a privilege for them and the hypothecated movable security assets vanished and the advances were defaulted and the non productive assets remained as unproductive assets in the books of the bank. Some Banks also faced Credit Crunches when some others had to borrow from RBI. The condition being so, the Narasimham Committee was formed to bring in reforms in Banking Sector, for which it is popularly called Banking Sector Reforms (BSR) Committee which submitted 2 reports, one in 1992 and the second in 1998, stressed greatly about the need for the reconstruction of financial assets and the need for a separate tribunal to facilitate speedy recovery of debts owing to the banks. On the first report of the committee, the parliament passed the Recovery of Debt Due to Banks and Financial Institutions Act, 1993, which provided for a Debt Recovery Tribunal (DRT). But the DRTs performance was shackled by various impediments and the speedy trial was not at all achieved. Then again in the second report of the committee, the same was stressed
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One of the main issues that always bothered the policy makers in India is that of the Non Performing Assets (NPA) of commercial banks. It greatly affected the smooth credit flow, and thus an immediate need of reforms in legal framework, particularly for speedy recovery of debts of banks and financial institutions were suggested. Thus a comprehensive Act combining all the aspects was passed in 2002 by the Parliament called SARFAESI Act 2002 very often called as Securitization Act. The constitution validity of this act came to be questioned before the Supreme Court in the renowned case of Mardia Chemicals Ltd v Union of India,1 which the researcher ventures to discuss through the present project.

Research Methodology
The researcher has adopted the doctrinal form of research in making this project. Primary as well as secondary sources of information have been used from the NALSAR Law Library. The above category of material and its topic on the case related were largely available online and latest books on it were not up to date hence the researcher has resorted to majorly base his research from Manupatra and other journals.

(2004) 4 SCC 311

FACTS IN BRIEF

In a notice dated July 24, 2002 to Mardia Chemicals Ltd., the Industrial Development Bank of India (for short `the IDBI') under Section 13 of the Ordinance, then in force, required it to pay the amount of arrears indicated in the notice within 60 days, failing which the IDBI as a secured creditor would be entitled to enforce the security interest without intervention of the court or Tribunal, taking recourse to all or any of the measures contained in sub-section (4) of Section 13 namely, by taking over possession and/or management of the secured assets. The petitioner was also required not to transfer by way of sale, lease or otherwise any of the secured assets. Similar notices were issued by other financial institutions and banks under the provisions of Section 13 of the Ordinance/Act to different parties who filed petitions in different High Courts. The Mardia chemicals raised the main contention challenging the vires of certain provisions of the Act through which the banks and the financial institutions had been vested with arbitrary powers, without any guidelines for its exercise and also without providing any appropriate and adequate mechanism to decide the disputes relating to the correctness of the demand, its validity and the actual amount of dues, sought to be recovered from the borrowers. Thus the Petitioners challenged the validity of the offending provisions as contained under the Act, are such that, it all had been made one sided affair while enforcing drastic measures of sale of the property or taking over the management or the possession of the secured assets without affording any opportunity to the borrower. The dispute being so, it was joined with various writ petitions in various High Courts challenging the validity of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.

ISSUES
Though the court listed out 7 questions for its consideration, in essence the court answered mainly 4 significant issues through the case. These issues are as Follows:

Issue I.

Whether it is open to challenge the statute on the ground that it was not necessary to enact it in the prevailing background particularly when another statute was already in operation?

Issue II.

Whether the terms or existing rights under the contract entered into by two private parties could be amended by the provisions of law providing certain powers in one sided manner in favour of one of the parties to the contract?

Issue III.

Whether Section 13 of the Act ultra vires of the Constitution?

Issue IV.

Whether the requirement of 75% of the amount due before appeal to the DRT is onerous and therefore Section 17 of the Act is ultra vires to the Constitution?

JUDGEMENT
Issue I
Whether it is open to challenge the statute on the ground that it was not necessary to enact it in the prevailing background particularly when another statute was already in operation? The Petitioner claimed that the Recovery of Debts due to Banks and Financial Institutions Act, 1993 was already in effect dealing with challenges posed by the NPAs and hence there was no need for another Securitization Act as the present Act which is being challenged. In its contention related to the necessity of the statute, the Court pointed out the holding of the Supreme Court in the past which said, The Parliament and Legislatures composed of as they are of the Representatives of the people are supposed to be aware of the needs of the people and what are good or bad for them. The Court cannot sit over the judgment of their wisdomA law made by the Parliament or State legislature can be struck down on two grounds
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alone

(1)

lack

of

legislative

competence,(2)violation of any Constitutional rights

The Court also cited the then recent case BALCO Employees Union v Union of India3 where the Court itself had held that the proper forum for discussing a policy aspect is the parliament and not the Court. So in view of the earlier pronouncements of the Court the court said it was very clear that the required enquiry is whether the statute is constitutional or not. No discussion as to the whether a statute is necessary specially vis--vis another Act whose vires is not a issue in the present case could not be allowed. Therefore the Court refused to entertain the argument.

Issue II
Whether the terms or existing rights under the contract entered into by two private parties could be amended by the provisions of law providing certain powers in one sided manner in favour of one of the parties to the contract?
2 3

State of Andhra Pradesh v Mcdowell:AIR 1996 SC 1627 Para 45, 47A AIR 2002 SC 350

One of the main arguments raised on behalf of many petitioners was that existing rights of private parties under a contract cannot be interfered with, more particularly putting one party to an advantageous position over the other. For example, in the present case, in a matter of private contract between the borrower and the financing bank or institution through impugned legislation rights of the borrowers have been curtailed and enforcement of secured assets has been provided for without intervention of the court and above all depriving them the remedy available under the law by approaching to the civil court. But the Court observed that the Appellants were silent on where exactly were they locating the legal validity of their argument. It had been pointed out by the Honorable Supreme Court that unlike Art 1 s.10 of the US Constitution there was no bar to prospective invalidation of a contract in India and hence such a law is perfectly valid.4 The Court said, indeed the very right to property stands deleted from the Constitution as a fundamental right by the 44th amendment and existed merely as a Constitutional right. Indeed even when the right was existent in part III the Courts have held that absolute freedom of contract as expounded in the doctrine of laissez faire is obsolete.5 Further, the Court observed that the Appellants also could not locate any right under Article 19(1)(g) or Article 298. It observed that the Supreme Court has held that these articles are subject to reasonable restrictions and that what is reasonable is to be interpreted from the point of view of public interest no matter how harsh it is on the interest of the person.6 In view of these case laws, the court said it was difficult to say where does the appellants locate their argument .The counsels for the respondents however had not even entered into the position of freedom of contract or right to trade in the Constitution but had pointed out that similar argument has been raised in a different context, namely statutes giving relief to agricultural borrowers and it has been repeatedly rejected.

4 5

Raghubir Dayal v Union of India: AIR 1962 SC 263 YA Marmade v Authority under Minimum Wages Act (1972) 2 SCC 108 6 Krishan Kakkanth v Government of Kerala (1997) 9 SCC 495

The Court mentioned Some case laws Ramaswamy Aiyengar v. Kailasa Thevar7 and Dahya Lala v. Rasul Mohd. Abdul Rahim,8where the validity of the Madras Agriculturalist's Relief Act and Bombay Tenancy Act, 1939 were upheld respectively. Under these two statutes relief was given to the debtors who were agriculturists as a class, by sealing down their debts. The validity of the Act was upheld though it affected the individual interest of creditors. Similar provisions were upheld in Swami Motor Transports Pvt. Ltd. v. Shri Sankraswamigal Mutt9 and Raval & Co. v. K.G. Ramachandran,10 Kanshi Ram v. Lachhman,11 Fatehchand Himmatlal v. State of Maharashtra12 etc. Thus the Court completely rejected the said contention raised by the petitioners.

Issue III.
Whether Section 13 of the Act ultra vires of the Constitution? The first line of attack in the instant case has been the Constitutionality of section 13 itself. It had been argued that before applying the power u/s.13 certain determination of facts are necessary, namely, whether a person to whom notice is given is under a liability to pay as also the question of extent of the liability etc. Further the questions pertaining to law of limitation and bar under consortium agreements, claim of set off/counter claim, creditors defaults as bailee or its failure to disburse the credit in time, the chargeability of penal interest or compound interest or non-appropriation of amount already paid and so on and so forth, all these questions needed to be decided. So it was argued with case laws that in such a case a lis exists and that power to decide a lis is a judicial or quasi-judicial power and not purely an administrative power. Therefore an argument was made that a suitable forum had to be provided

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1951 SCR, 292 1963(3) SCR, 1 9 1963 (Supp.)1 SCR p. 282 10 1974(1) SCC p. 424. 11 2001(5) SCC 546 12 1977(2) SCC p. 670

to decide all such disputes at an appropriate stage.13 If such a forum is not provided then the statutory provision becomes arbitrary, procedurally and substantively unfair. The Court said that it was a factually faulty argument. S.13 does not exclude any judicial forum, but merely provides that a judicial remedy can be availed only after the secured creditor has exercised his powers under s.13 (4). This is perfectly valid. Many statutes have provisions under which a forum can be availed after the aggrieved party has engaged self help. It was also pointed out that the provisions under s.13 create certain practical difficulties that might give rise to grave miscarriages of justice. Any concerns that have arisen or might arise have been taken care of by s.35 of the Securitization Act that lays down that the provision of the Act overrides all other laws. Finally it was pointed out that under s.13 read with s.34 the borrower has no access to Court before the lender exercises the powers u/s.13 (4) this exposes him to arbitrary even, fraudulent practices by the lender. In defense of this section it was pointed out that u/s 9 of the Rules the asset cannot be sold for 60 days, it is open to the borrower to approach the Tribunal within that period. But most significant part was that the Court partially accepted the argument of the plaintiffs and added two riders to s.13 Firstly, it held that the lender is under a duty to disclose the reasons for not accepting the objections or points raised in reply to the notice served upon them before proceeding to take measures under sub-section (4) of Section 13. Secondly, the Court drew an analogy with English mortgage and pointed out that enforcement proceedings under an English mortgage can be challenged on the ground of fraud. Such provisions are applicable to this section as well.14

Issue IV

13

Kihoto Hollohan v. Zachillhu & Ors1992 Suppl. (2) SCC p. 651 and Associated Cement Companies Ltd v. P.N. Sharma(1965(2) SCR p. 366 at pages 386-87) 14 Adams v. Scott, (1859) 7 WR (Eng.) 213 (Z49)

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Whether the requirement of 75% of the amount due before appeal to the DRT is onerous and therefore Section 17 of the Act is ultra vires to the Constitution? The Main Grounds of Challenge of Validity of Section 17 are as follows: (i) The remedy before the Tribunal under section 17 of the Act is illusory, as it is burdened with the onerous and oppressive condition of deposit of 75% of the amount of demand, before the Tribunal can entertain the appeal. (ii) That provision impedes access to the Tribunal which is meant for redressal of the grievance of a borrower. (iii) Where the possession of the secured assets or the management of the secured assets of the borrower, including the right to transfer the same has already been taken over, it is not at all necessary to burden the borrower doubly with deposit of 75% of the demand amount. (iv) It would not be possible for a borrower to raise funds to deposit the huge amount of 75% of the demand, once he is deprived of the possession/management of the secured assets. The Above Challenges were answered by the Respondent as under: The said challenge was sought to be met on the following grounds. (i) The condition of pre-deposit has been held to be valid by the Supreme Court in many cases.15 (ii) Under the proviso to subsection (2) of section 17, the Tribunal has the power to waive or reduce the amount. The Tribunal, which is presided over by a Member of the Higher Judicial Service, would exercise its discretion and may waive or reduce, in deserving cases, the amount required to be deposited. (iii) The secured assets, which may be taken possession of or sold, may fall short of the dues. (iv) The right of appeal is a statutory right and it can be circumscribed by the conditions.
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Seth Nandial v. State of Haryana, 1980 (Supp.) SCC 574, Anant Mills Co. Ltd. v. State of Gujarat, 1975 (2) SCC 175 at p. 202, Vijay Prakash D. Mehta and Anr. v. Collector of Customs (Preventive) Bombay, 1988(4) SCC p. 402.

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Considering the above arguments, the Court observed that the reference to the remedy provided under section 17 of the Act as an appeal is a misnomer. It is the initial action, which is brought before a forum as provided under the Act for raising grievance against the action or measures taken by one of the parties to the contract. It is the stage of initial proceeding like filing a suit. The requirement of pre-deposit at the stage of initiation of proceedings does not stand on the same footing as the requirement of pre-deposit at the stage of filing appeal. The Supreme Court quoted with approval the observations made by it in Smt. Ganga Bai & Others v.Vijay Kumar and others16 regarding the distinction between the right of suit and the right of appeal. There is an inherent right in every person to bring a suit of civil nature. A suit for its maintainability requires no authority of law and it is enough that no statute bars a suit. The position in regard to appeals is quite the opposite. An appeal for its maintainability must have the clear authority of law. The requirement of predeposit at the stage of initiation of proceedings impedes the inherent right of a party to approach a judicial forum for redressing his grievances. If the law provides that an appeal can be filed only upon depositing a portion of the amount in dispute, such a law is valid as it conferred on the party (though subject to predeposit), a right to appeal that was not there, but for such law. The decisions17 relied upon by the respondents relate to appeals. In suits, under the Code of Civil Procedure, it is permissible to attach18 the property before the judgement is passed or to appoint receivers and to make provision by way of interim measure in respect of the property, before decree. For obtaining such orders, a case has to be made out in accordance with the relevant provisions of the Code of Civil Procedure. There is no such provision in the Act. In view of all the arguments, the Court concluded that the condition of pre-deposit is bad, rendering the remedy illusory. It is imposed while approaching the adjudicating authority of the first instance, not an appeal.
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(1974) 2 SCC 393. Seth Nandial v. State of Haryana, 1980 (Supp.) SCC 574, Anant Mills Co. Ltd. v. State of Gujarat, 1975 (2) SCC 175 at p. 202, Vijay Prakash D. Mehta and Anr. v. Collector of Customs (Preventive) Bombay, 1988(4) SCC p. 402. 18 Order XXXVIII rules 5 and 6 of the Code of Civil Procedure, 1908.

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There is no determination of the amount due as yet. The secured assets or its management with transferable interest is already taken over and is under the control of the secured creditor. There is no special reason for requiring double security in respect of amount due yet to be determined and settled. 75% of the amount claimed by no means would be a meagre amount. It would leave the borrower in a position where it would not be possible for him to raise the funds to make deposit of 75% of the undetermined demand. Such conditions are not only onerous and oppressive but also unreasonable and arbitrary.

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IMPLICATIONS ON SARFAESI ACT AND POST-MARDIA DEVELOPMENTS

Amendments
By the Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Ordinance, 2004 , Section 17 has since been amended.19 The petition to the Tribunal under that Section is now being referred to as an application and not as an appeal. It is now provided20 that the Appellate Tribunal shall not entertain the appeal of the borrower unless the borrower deposits 50% of the amount of debt due from him or the amount determined by the Debts Recovery Tribunal, whichever is less. It may be expected that since the requirement of pre-deposit is now at the appellate stage and the amount to be deposited is also reduced to 50% which may further be reduced to 25% by the Appellate Tribunal, the amended provisions would be held as constitutionally valid.

Committees
The Courts have noted that the question of non-recoverable or delayed recovery of debts advanced by banks and financial institutions had been attracting the attention of Government of India and RBI and that the matter was considered in-depth by the committee21 consisting of experts in the field specially constituted. The Court rightly upheld the validity of the Act, which was passed after taking into consideration the recommendations of various committees22 of experts and considering the totality of circumstances and the financial climate in the country.

19

In section 17 of the principal Act,-(a) in sub-section (1),(i) for the words "may prefer an appeal", the words "may make an application along with such fee, as may be prescribed," shall be substituted and shall be deemed to have been substituted with effect from the 21 st day of June, 2002;" 20 "Provided further that no appeal shall be entertained unless the borrower has deposited with the Appellate Tribunal fifty per cent. of the amount of debt due from him, as claimed by the secured creditors or determined by the Debts Recovery Tribunal, whichever is less: Provided also that the Appellate Tribunal may, for the reasons to be recorded in writing, reduce the amount to not less than twenty-five per cent. of debt referred to in the second proviso." 21 Andhyarujina Committee. 22 Narasimham Committee I and II and Andhyarujina Committee constituted by the Central Government for the purpose of examining banking sector reforms.

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Section 13 Is Valid
Even though the text of section 13 does not contemplate the communication of reasons for not accepting the objections of the borrower, the Court said that it goes with logical reason that before the secured creditor takes the measures like taking over possession of the secured assets, he communicates to borrower, the reasons for not accepting his objections. The Court rightly held that it is necessary to communicate the reasons for not accepting the objections raised by the borrower in reply to the notice issued to him under subsection (2) of section 13 of the Act. The Court rightly noted that the requirement to communicate the reasons to the borrower is in keeping with the concept of right to know and lenders' liability. Such a measure, the court felt, caters to the cause of transparency and is conducive to building up of confidence in the commercial practices. The Court had no hesitation in holding that such a safeguard was inherent under section 13 of the Act. The Court has in fact read down the provisions of section 13 by requiring the secured creditor to give reasons and thereby made the provisions of that section logical and reasonable. Section 13 has since been amended23 and the secured creditor is now required13 to communicate the reasons to the borrower for not accepting his objections. The second proviso to subsection (3A) of section 13 clearly states that the borrower does not get the right to make an application to the Tribunal on the secured creditor communicating the reasons for not accepting the objections. The explanation added to Section 17 is also to the same effect and makes it clear that the borrower cannot approach the Tribunal immediately after the communication of the reasons and thwart the recovery process.

Is Section 17 Really Different from Code of Civil Procedure?

The discretion vested in the Tribunal to waive or reduce the amount required to be deposited is similar to the power conferred on a civil court to attach properties before decree. Under the Code of Civil Procedure, the creditor has to satisfy the Court to obtain an order for attachment of properties (of the debtor) before the judgement. Under section 17 of the Act the
23

The Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Ordinance, 2004

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debtor has to satisfy the Tribunal that there are grounds for waiving or reducing the amount to be deposited. The difference between the two provisions is only in respect of the burden of proof. It may be appreciated that the borrowers invariably apply for waiving or reducing the amount to be deposited under section 17. The borrowers would deposit the amount only after the Tribunal rejects their application for waiving or reducing the amount to be deposited. In practical terms therefore, the borrowers would be required to deposit the amount only after the Tribunal which is presided over by a Member of the Higher Judicial Service passes an order on the application for waiving or reducing the amount to deposited. There is no doubt that the Supreme Court could have laid down as to what are the relevant factors to be taken into consideration by Tribunal before exercising the discretion conferred on it under the statute. The requirement to deposit 75% of the claim was obviously a step calculated to improve recovery by banks and financial institutions for recycling the funds in the interest of the economy. The quashing of the said provision seriously affects recovery by banks and financial institutions.

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CONCLUSION
The amendments since carried out in the Act remedy the defects pointed out by the Supreme Court in the above judgement. The said amendments provide a reasonable protection to the borrowers. Though the amount required to be deposited is postponed to the stage of appeal and the amount required to be deposited is reduced to 50% as against 75% at the initial stage before the Tribunal itself (under the erstwhile provisions), the amendments may be expected to help recovery as there is sufficient disincentive to the borrowers to file appeals to avoid or postpone recovery. The amendment may be regarded as a balanced step in the right direction. The amendment should not only clear the air for the Banks but should also clear certain other ambiguities in the Act that has been mentioned like the broad definition of "aggrieved persons", the locus standi of then Unions and the unsecured creditor before the DRT after the security interest under s.13 is enforced. The judgment in this case has taken off the pressure that the laon defaulters, but the sake of the economy and development certain pressure has to exist .It remains to be seen how the Government brings some teeth into the Act without compromising on the fairness to the debtor.

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BIBLIOGRAPHY

Website 1. www.Manupatra.com 2. www.indiafinace.org. 3. www.indiatimes.com. 4. www.economictimes.indiatimes.com. 5. www.jstor.com

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