Secured Creditor Cannot Seek Removal Of Disclosed Encumbrances Without Settling Dues: Madras High Court

The Madras High Court has held that priority given to secured creditors over government dues under the SARFAESI Act does not allow a bank or auction purchaser to seek removal of known encumbrances without complying with Rules 9(6) to 9(10) of the Security Interest (Enforcement) Rules, 2002.

Rule 9(6) deals with confirmation of the sale and issuance of the sale certificate, while Rule 9(10) prescribes the contents/ form of the sale certificate, including the details of known encumbrances.

A coram of Justice Abdul Quddhose and Justice R Rajesh Vivekananthan held that an auction purchaser who knowingly purchases a property subject to disclosed encumbrances cannot seek removal of those encumbrances from the records without first discharging the dues payable towards them.

“If the prayer sought for by the appellant in the writ petition, namely the removal of the encumbrance reflected in the encumbrance certificate is granted, it will indirectly amount to setting aside the disclosures made in the sale notice as well as the sale certificate about the known encumbrances, which includes the encumbrance in favour of the first respondent. What the appellant or the fourth respondent could not have legally achieved directly, namely to sell the property free of encumbrances, they are attempting to craftily achieve the said objective by filing the writ petition and this writ appeal which is not legally permissible.” the Bench observed

Indian Overseas Bank had created a mortgage over Hi-Tech Minerals Industries Covai Private Limited's property in 2007. The Central Excise Department subsequently attached the property in 2014 towards statutory dues.

The bank initiated proceedings under the SARFAESI Act and auctioned the property, with the sale notice and sale certificate specifically disclosing the known encumbrances. SKM Animal Feeds and Foods India Private Limited purchased the property, and the sale certificate was registered.

The bank then approached the High Court seeking removal of the Central Excise Department's attachment from the encumbrance records.

The Single Judge dismissed the petition, holding that the auction purchaser was aware of the encumbrances and was required to discharge the corresponding dues.

Challenging this, the bank contended that Rule 9(9) of the SARFAESI Rules requires the secured creditor to deliver the property free from known encumbrances upon payment of the dues specified under Rule 9(7). It further argued that Sections 26E and 35 of the SARFAESI Act, read with Section 31B of the Recovery of Debts and Bankruptcy Act, give secured creditors priority over government dues and other statutory claims.

The auction purchaser supported the bank's case.

The Central Excise Department opposed the appeal, arguing that the purchaser had knowingly purchased the property subject to the encumbrances and that Section 26E, introduced in 2020, could not retrospectively override the 2014 attachment.

The Bench observed that a SARFAESI sale on an “as is where is”, “as is what is” and “whatever there is” basis does not give the secured creditor immunity from disclosing known liabilities or defects.

The Court also observed that Rule 9(7) provides for payment towards existing encumbrances, requiring the auction purchaser to deposit sufficient funds with the secured creditor to discharge the encumbrances, including applicable interest and related expenses.

“Therefore, it is clear that sale in favour of the successful auction purchaser is only subject to the known encumbrances as disclosed in the sale certificate.” it held

On the Bank's reliance on Sections 26E and 35 of the SARFAESI Act and Section 31B of the RDB Act, the Bench held:

“Even though the aforesaid sections grant priority to the secured creditors over government dues, taxes, cesses and other statutory claims, they do not stipulate that the registration department will have to remove the known encumbrances as reflected in the sale notice..”

The Court held that the Bank must first comply with Rules 9(6) to 9(10) of the SARFAESI Rules and settle the dues relating to the disclosed encumbrances before seeking their removal from the encumbrance certificate. Since the auction purchaser was aware of the encumbrance, its removal could not be directed without violating the Rules.

Observing that the auction purchaser had purchased the property with full knowledge of the encumbrance disclosed in the sale notice and sale certificate, but had not discharged the statutory dues, the Court held that the relief sought could not be granted.

The Court clarified that the proposition that secured creditors enjoy priority over government dues was well settled. However, it said that such priority could not be relied upon to bypass the mandatory procedure prescribed under the SARFAESI Rules.

It further noted that the bank had not recovered its entire dues and its recovery proceedings before the Debts Recovery Tribunal were still pending. It therefore rejected the argument that the bank had become functus officio after issuing and registering the sale certificate.

Accordingly, the Division Bench dismissed the appeal.

For Appellant: Advocate M.L Ganesh

For Respondents: Senior Advocate K. Umesh Rao, Advocates B Ambili, K. Maheshwaran and Sharath Chandran