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

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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 DRT’s 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 3

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.

1 (2004) 4 SCC 3114

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.

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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?

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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 wisdom…A law made by the Parliament or State

legislature can be struck down on two grounds alone (1) lack of legislative competence,

(2)violation of any Constitutional rights”2

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-à-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

2 State of Andhra Pradesh v Mcdowell:AIR 1996 SC 1627 Para 45, 47A3 AIR 2002 SC 350

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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?

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

4 Raghubir Dayal v Union of India: AIR 1962 SC 2635 YA Marmade v Authority under Minimum Wages Act (1972) 2 SCC 1086 Krishan Kakkanth v Government of Kerala (1997) 9 SCC 495

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similar argument has been raised in a different context, namely statutes giving relief to

agricultural borrowers and it has been repeatedly rejected.

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, creditor’s

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

7 1951 SCR, 2928 1963(3) SCR, 19 1963 (Supp.)1 SCR p. 28210 1974(1) SCC p. 424.11 2001(5) SCC 54612 1977(2) SCC p. 670

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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.

15 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.

16 (1974) 2 SCC 393.17 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 provided 20 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.

19In 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 23 The Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Ordinance, 2004

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attachment of properties (of the debtor) before the judgement. Under section 17 of the Act the

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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