Introduction
Facts
Decision
Analysis


Introduction

The judiciary has often shown that it is by far the most mature of the three institutions that form the backbone of the Constitution. While it has been criticised for being conservative, the judiciary seeks to provide equilibrium in an otherwise imperfect world – no mean feat. Once again, the judiciary has stepped in to balance the equities in an unequal match.

The financial sector has been one of the key drivers of growth in India. Banks have relentlessly lent money to ensure that the wheels of business remain well oiled. However, lending money is at the heart of banks' business, not an act of charity. Thus, when money is borrowed, can default be far behind? It is this issue which banks found hard to tackle before the legislature stepped in apparently to correct the situation by enacting the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002. The act seeks to empower banks and financial institutions to ensure faster recoveries by allowing them to take possession of securities mortgaged to them and sell them without the intervention of courts. However, while the act gives unbridled power to banks, it leaves third parties in the lurch, with virtually no protection against repossession. In Harshad Govardhan Sondgar v International Assets Reconstruction Company Limited(1) the Supreme Court has set these inequities right, so that the match is now tied.

Facts

Certain premises were mortgaged to different banks as securities for loans advanced by banks to borrowers. When the borrowers defaulted on repaying their debts, the secured creditors classified their accounts as non-performing assets and issued notices under Section 13(2) of the act, putting the borrowers on notice of their intention to enforce the securities in the event of non-payment of the debts within 60 days.

The borrowers failed to repay the debts within 60 days and the secured creditors exercised their right under Section 13(4) of the act to take possession of the borrowers' secured assets. The secured creditors made a request under Section 14(1) of the act to the chief metropolitan magistrate of Mumbai to take possession of the premises and hand them over to the secured creditors.

However, the secured assets consisted of premises owned by persons who claimed to be the lawful tenants thereof. Threatened by eviction by the chief metropolitan magistrate under Section 14 of the act, these tenants approached the Bombay High Court, claiming that as lessees of the premises, they were entitled to remain in possession of the secured assets. In International Asset Reconstruction Co (P) Ltd v Union of India(2) the Bombay High Court followed a decision by the Division Bench of the Bombay High Court, which had held that when a secured creditor takes measures under Section 13(4) of the act and approaches the chief metropolitan magistrate for assistance in taking possession of secured assets – the liability of the borrower having crystallised – the magistrate cannot adjudicate the disputes, possession should be taken over by a non-adjudicatory process and there is no question of the magistrate noticing that the person being dispossessed was a tenant. The appellants filed special leave petitions under Article 136 of the Constitution before the Supreme Court.

Decision

The court found that, in a case where a borrower has created a lease on immovable property before the creation of the mortgage, the lessee would have the right to enjoy the property in accordance with the terms of the lease.

Further, a lease created by a borrower after the creation of a mortgage is valid and binding on the secured creditor if the lease satisfies the requirements of Section 65-A of the Transfer of Property Act 1882.(3)

A lease for a secured asset that was created by a borrower after receiving a notice under Section 13(2) from the secured creditor intending to enforce that secured asset is not valid.

According to the court, under the Transfer of Property Act, provided that a lease of an immovable property is not determined, the lessee has a right to enjoy the property; this right cannot be taken away without the authority of law. Section 13 of the act does not provide that a lease stands determined on proceedings once Section 13 is initiated. Without the determination of a valid lease, the possession of the lessee is lawful and courts and tribunals have to protect such lawful possession.

When a secured creditor requests assistance from the chief metropolitan magistrate or district magistrate under Section 14(1) in order to take possession of the secured asset, such secured creditor must file an affidavit stating that the secured asset is not in possession of a lessee under a valid lease.

Under the Security Interest (Enforcement) Rules 2002, a possession notice must be affixed at the property and published in two newspapers by an authorised officer. At this stage, the lessee will be notified that the secured creditor is making efforts to take possession of the secured asset and such lessee may surrender possession or resist the attempt to take the possession. The process is then as follows:

  • If the lessee surrenders possession, the lease (even if valid) is determined in accordance with the Transfer of Property Act.
  • If the lessee resists the attempt to take possession, the chief metropolitan magistrate or district magistrate will give the lessee and the secured creditor an opportunity to be heard.
  • If the chief metropolitan magistrate or district magistrate is satisfied that there is a valid lease, the chief metropolitan magistrate or district magistrate cannot grant possession of the secured asset to the secured creditor; in such cases, the secured creditor has the right to receive any money due or which may become due (including rent) from the lessee to the borrower under Section 13(4) of the act.
  • If the chief metropolitan magistrate or district magistrate concludes that there is no valid lease, it can grant the secured creditor possession of the secured asset.

While Section 14(3) of the act provides that no act of the chief metropolitan magistrate or district magistrate carried out under Section 14 can be questioned in court or before any authority, their decisions can be challenged before a high court under its writ jurisdiction.

The court also held that the lessee had no remedy under Section 17 of the act, as Section 17(3) of the act provides that the debt recovery tribunal has the power to restore possession of the secured asset only to the borrower, not a lessee.

Section 34 of the act provides that no injunction will be granted by any court or other authority in respect of any action taken or to be taken in pursuance of any power under the act. Thus, when action is sought under Sections 13 or 14 of the act, the court or authority mentioned in the relevant tenancy laws cannot grant the injunction to prevent such action.

Under Section 107 of the act, if an appellant claims to be entitled to possession of a secured asset for any term exceeding one year from the date of the lease, he or she must prove the execution of a registered instrument in his or her favour by the lessor. In the absence of a registered instrument, the chief metropolitan magistrate or district magistrate will conclude that such appellant is not entitled to the possession of the secured asset for more than a year from the date of the instrument or from the date of delivery of the possession in his or her favour by the landlord.

Analysis

The judgment answers the question posed by the lessee as to the validity of a lease on mortgaged property and his or her rights stemming from it. In addition, the Supreme Court resolved the issue regarding the time of creation of the lease. Where a lease was created before a mortgage, the lessee has the right to possess the property until determination of the lease. Where a lease is created after a mortgage, the borrower's right to mortgage the property is subject to Section 65-A of the Transfer of Property Act. Further, according to the Supreme Court, a lease created after receipt of a notice under Section 13(2) of the act is not valid.

The judgment shows an even-handed approach to the problem at hand. It balances the rights of a lawful lessee against the rights of the bank under the act. Moreover, while judicial pronouncements thus far have held that a chief metropolitan magistrate or district magistrate under Section 14 of the act is required to perform a non-adjudicatory function and is not required to give hearings to interested parties, the Supreme Court, keeping in mind the principles of natural justice, held that the chief metropolitan magistrate or district magistrate must allow the tenant to be heard. Only after the tenant is heard can the court decide whether the tenant should be dispossessed or whether the lease is valid.

On first blush, the decision may appear to defeat the purpose for which the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 was enacted (ie, the speedy recovery of dues by banks and financial institutions without court intervention). However, the court's emphasis on the "procedure established by law" (ie, that the actions should be just and fair and not arbitrary or oppressive) recognises that the rights of a bona fide lessee in lawful possession of property cannot be trampled. The judgment provides relief to tenants occupying properties that are mortgaged to banks and financial institutions, particularly in cases where large companies or multinationals have entered into leases for long durations and have spent time and resources in developing the property. Any interpretation of the act that would permit banks and financial institutions to dispossess bona fide lessees would be grossly unfair and would make businesses wary of plying their trade from leased properties.

Thanks to this decision, both banks and lessees are on the same playing field, with identical equipment and adequate protection.

For further information on this topic please contact Naresh Thacker or Rhia Marshall Banerjee at Economic Laws Practice by telephone (+91 22 6636 7000), fax (+91 22 6636 7172) or email (nareshthacker@elp-in.com or rhiamarshall@elp-in.com).

Endnotes

(1) (2014) 6 SCC 1.

(2) AIR 2011 Bom 163.

(3) Section 65A: mortgagor's power to lease:

"(1) Subject to the provisions of sub-section (2), a mortgagor, while lawfully in possession of the mortgaged property, shall have power to make leases thereof which shall be binding on the mortgagee.

(2)(a) Every such lease shall be such as would be made in the ordinary course of management of the property concerned, and in accordance with any local law, custom or usage,

(b) Every such lease shall reserve the best rent that can reasonably be obtained, and no premium shall be paid or promised and no rent shall be payable in advance,

(c) No such lease shall contain a covenant for renewal,

(d) Every such lease shall take effect from a date not later than six months from the date on which it is made,

(e) In the case of a lease of buildings, whether leased with or without the land on which they stand, the duration of the lease shall in no case exceed three years, and the lease shall contain a covenant for payment of the rent and a condition of re-entry on the rent not being paid with a time therein specified.

(3) The provisions of sub-section (1) apply only if and as far as a contrary intention is not expressed in the mortgage-deed; and the provisions of sub-section (2) may be varied or extended by the mortgage-deed and, as so varied and extended, shall, as far as may be, operate in like manner and with all like incidents, effects and consequences, as if such variations or extensions were contained in that sub-section."