LEGAL ISSUE: Applicability of contract law principles to forfeiture of earnest money deposit under SARFAESI Act.
CASE TYPE: Securitization and Asset Recovery
Case Name: Central Bank of India vs. Shanmugavelu
Judgment Date: 2 February 2024
Date of the Judgment: 2 February 2024
Citation: (2024) INSC 80
Judges: Dr. Dhananjaya Y. Chandrachud, CJI, J.B. Pardiwala, J., Manoj Misra, J.
Can a bank forfeit the entire earnest money deposit of a successful bidder who fails to pay the remaining amount in a SARFAESI auction? The Supreme Court recently addressed this question, clarifying the relationship between contract law and the specific provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act). The court examined whether the forfeiture of the entire earnest money deposit by a bank is justified when a successful bidder defaults on payment of the balance amount. The bench comprised of Chief Justice of India Dr. Dhananjaya Y. Chandrachud, Justice J.B. Pardiwala and Justice Manoj Misra.
Case Background
The Central Bank of India (the Bank) had sanctioned credit facilities to ‘Best and Crompton Engineering Projects’ using a parcel of land as security. When the borrower defaulted, the loan account was classified as a non-performing asset (NPA) on 28 May 2013. The Bank initiated recovery measures under the SARFAESI Act, taking possession of the secured asset and putting it up for sale through public auction.
An e-auction notice was issued on 24 October 2016, setting a reserve price of ₹9,62,00,000. The auction terms included a requirement for bidders to deposit an earnest money deposit (EMD). The respondent, Shanmugavelu, participated in the auction on 7 December 2016 and was declared the highest bidder (H1) with a bid of ₹12,27,00,000. Shanmugavelu deposited 25% of the bid amount, ₹3,06,75,000, as EMD.
The Bank confirmed the sale on the same day, stating that failure to pay the balance amount would result in forfeiture of the EMD. Shanmugavelu requested a three-month extension to pay the balance, which the Bank granted until 7 March 2017. However, Shanmugavelu failed to pay the balance by the extended deadline and requested a further 15-day extension on 6 March 2017. The Bank rejected this request on 27 March 2017, canceling the sale and forfeiting the deposited amount.
Despite the cancellation, Shanmugavelu sent a cheque of ₹50,00,000 on 5 April 2017, seeking a 90-day extension, which the Bank returned on 6 April 2017. Subsequently, the Bank conducted a fresh auction on 13 March 2019, selling the secured asset for ₹14.76 crore, which was higher than the price in the previous auction.
Timeline
| Date | Event |
|---|---|
| 28 May 2013 | Loan account classified as NPA by the Bank. |
| 24 October 2016 | E-auction notice issued by the Bank with a reserve price of ₹9,62,00,000. |
| 7 December 2016 | E-auction conducted; Shanmugavelu declared highest bidder at ₹12,27,00,000; 25% of the bid amount i.e., Rs. 3,06,75,000 deposited. |
| 7 December 2016 | Bank confirms sale, states EMD forfeiture on non-payment of balance. |
| 19 December 2016 | Shanmugavelu requests a three-month extension for balance payment. |
| 20 December 2016 | Bank grants three-month extension until 7 March 2017. |
| 6 March 2017 | Shanmugavelu requests an additional 15-day extension. |
| 27 March 2017 | Bank rejects further extension, cancels sale, and forfeits EMD. |
| 5 April 2017 | Shanmugavelu sends a cheque of ₹50,00,000 seeking a 90-day extension. |
| 6 April 2017 | Bank returns cheque and declines extension. |
| 13 March 2019 | Bank conducts fresh auction; property sold for ₹14.76 crore. |
Course of Proceedings
Shanmugavelu challenged the sale cancellation and forfeiture before the Debts Recovery Tribunal-II (DRT), which ruled in his favor, ordering the Bank to refund the EMD after deducting ₹5,00,000 for expenses. The DRT noted that the Bank had not provided documents required by Shanmugavelu for a term loan, leading to his inability to pay. The DRT also observed that since the property was sold for a higher amount in the subsequent auction, the Bank did not suffer any loss.
The Bank appealed to the Debt Recovery Appellate Tribunal (DRAT), which partly allowed the appeal, increasing the forfeiture amount to ₹55,00,000. Both parties then approached the High Court of Judicature at Madras. The High Court allowed Shanmugavelu’s civil revision petition, setting aside the DRAT’s order and restoring the DRT’s order, stating that forfeiture could not exceed the actual loss suffered by the Bank.
Legal Framework
The Supreme Court considered the following legal provisions:
- Section 13(4) of the SARFAESI Act, 2002: This section empowers banks and financial institutions to take possession of securities and sell them without court intervention.
- Rule 9 of the Security Interest (Enforcement) Rules, 2002 (SARFAESI Rules): This rule outlines the procedure for the sale of immovable secured assets. Specifically, sub-rule (5) states: “In default of payment within the period mentioned in sub-rule (4), the deposit shall be forfeited to the secured creditor and the property shall be resold and the defaulting purchaser shall forfeit all claim to the property or to any part of the sum for which it may be subsequently sold.”
- Section 73 of the Indian Contract Act, 1872: This section deals with compensation for loss or damage caused by breach of contract: “When a contract has been broken, the party who suffers by such breach is entitled to receive, from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it.”
- Section 74 of the Indian Contract Act, 1872: This section deals with compensation for breach of contract where a penalty is stipulated.
- Section 35 of the SARFAESI Act, 2002: This section provides an overriding effect to the SARFAESI Act: “The provisions of this Act shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law.”
- Section 37 of the SARFAESI Act, 2002: This section states that the provisions of the SARFAESI Act are in addition to other laws: “The provisions of this Act or the rules made thereunder shall be in addition to, and not in derogation of, the Companies Act, 1956 (1 of 1956), the Securities Contracts (Regulation) Act, 1956 (42 of 1956), the Securities and Exchange Board of India Act, 1992 (15 of 1992), the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (51 of 1993) or any other law for the time being in force.”
Arguments
Appellant (Central Bank of India) Submissions:
- The High Court erred in applying principles of the Indian Contract Act, 1872, specifically Section 73, to a statutory sale under the SARFAESI Act.
- Rule 9(5) of the SARFAESI Rules, being part of a special enactment, should take precedence over general contract law principles.
- The forfeiture of the EMD is a statutory consequence of failing to pay the balance amount, and not a breach of contract.
- The High Court’s interpretation would allow borrowers to manipulate the auction process by submitting sham bids, undermining the SARFAESI Act’s objectives.
- The e-auction notice explicitly stated that failure to pay the balance would result in forfeiture of the EMD.
- Relied on Authorized Officer State Bank of India v. C. Natarajan, 2023 SCC Online SC 510, where it was held that the SARFAESI Act, being a special enactment, takes precedence over the general provisions of the Contract Act.
Respondent (Shanmugavelu) Submissions:
- Section 35 of the SARFAESI Act only gives the Act overriding effect over other laws, not the rules made under it.
- Rule 9(5) of the SARFAESI Rules is an enabling provision and cannot override the statutory provisions of the Indian Contract Act, 1872.
- The Bank cannot forfeit the EMD without demonstrating actual loss or damage.
- The authorized officer’s power of forfeiture under the SARFAESI Rules is unguided and against public policy.
- Forfeiture of the entire EMD amounts to unjust enrichment, as the Bank did not suffer any loss, and, in fact, made a profit in the subsequent auction.
| Appellant’s Submissions | Respondent’s Submissions |
|---|---|
|
|
Issues Framed by the Supreme Court
- Whether the principles of Sections 73 and 74 of the Indian Contract Act, 1872, apply to the forfeiture of earnest money under Rule 9(5) of the SARFAESI Rules, and whether the forfeiture can only be to the extent of the loss or damages incurred by the Bank.
- Whether the forfeiture of the entire earnest money deposit under Rule 9(5) amounts to unjust enrichment, and whether the quantum of forfeiture is limited to the extent of the debt owed.
- Whether exceptional circumstances exist to set aside the forfeiture of the earnest money deposit.
Treatment of the Issue by the Court
| Issue | Court’s Decision | Reasoning |
|---|---|---|
| Applicability of Sections 73 & 74 of the Indian Contract Act to forfeiture under SARFAESI Rules | Not Applicable | SARFAESI Act is a special law with overriding effect; Rule 9(5) is a statutory provision, not a contractual breach; forfeiture is a penalty for non-compliance. |
| Whether forfeiture amounts to unjust enrichment | No | Forfeiture is a statutory consequence, not a benefit; the Bank is entitled to enforce its security interest; the auction purchaser was aware of the risk. |
| Whether exceptional circumstances exist to set aside forfeiture | No | Respondent’s reasons (demonetization, delay in document provision) were not exceptional; respondent was aware of the terms and consequences. |
Authorities
The Court considered the following authorities:
| Authority | Court | How it was used |
|---|---|---|
| Authorized Officer State Bank of India v. C. Natarajan, 2023 SCC Online SC 510 | Supreme Court of India | Followed. Held that the SARFAESI Act, being a special enactment, takes precedence over the general provisions of the Contract Act. |
| Hadley & Anr. v. Baxendale & Ors., (1843-60) All ER Rep. 461 | English Court | Explained the principles of remoteness of damages in contract law. |
| Victoria Laundry (Windsor) Ltd v. Newman Industries Ltd., [1949] 2 KB 528 | English Court | Clarified principles of foreseeability in breach of contract. |
| Karsandas H. Thacker v. M/s. The Saran Engineering Co. Ltd., AIR 1965 SC 1981 | Supreme Court of India | Explained that damages can only be awarded for direct losses from breach of contract. |
| K. P. Subbarama Sastri and others v. K. S. Raghavan & Ors., (1987) 2 SCC 424 | Supreme Court of India | Explained what constitutes a penalty under Section 74 of the Indian Contract Act, 1872. |
| Rakesh Birani (Dead) through LRs v. Prem Narain Sehgal & Anr., (2018) 5 SCC 543 | Supreme Court of India | Interpreted Rule 9 of the SARFAESI Rules and clarified the conditions for forfeiture of EMD. |
| Agarwal Tracom Private Limited v. Punjab National Bank & Ors., (2018) 1 SCC 626 | Supreme Court of India | Held that forfeiture of EMD is a measure under Section 13(4) of the SARFAESI Act. |
| Mardia Chemicals Ltd. & Ors. v. Union of India & Ors., (2004) 4 SCC 311 | Supreme Court of India | Examined the history and legislative backdrop of the SARFAESI Act. |
| United Bank of India v. Satyawati Tondon & Ors., (2010) 8 SCC 110 | Supreme Court of India | Discussed the need for special tribunals for debt recovery. |
| Madras Petrochem Ltd. & Anr. v. Board for Industrial and Financial Reconstruction & Ors., (2016) 4 SCC 1 | Supreme Court of India | Recapitulated the object behind the enactment of the SARFAESI Act and examined the purpose of Sections 13, 35 and 37. |
| Celir LLP. v. Bafna Motors (Mumbai) Pvt. Ltd. & Ors., 2023 SCC OnLine SC 1209 | Supreme Court of India | Reaffirmed that only laws mentioned in Section 37 or similar to it would be applicable in addition to the SARFAESI Act. |
| R.S. Joshi, Sales Tax Officer, Gujarat & Ors. v. Ajit Mills Limited & Anr., (1977) 4 SCC 98 | Supreme Court of India | Explained the true purport and meaning of the term ‘forfeiture’. |
| Kunwar Chiranjit Singh v. Har Swarup, (1926) 23 LW 172 | Privy Council | Explained the concept of earnest money. |
| Dinanath Damodar Kale v. Malvi Mody Ranchhoddas and Co., AIR 1930 Bom 213 | High Court of Bombay | Discussed the distinction between a deposit and a penalty. |
| Fateh Chand v. Balkishan Das, AIR 1963 SC 1405 | Supreme Court of India | Held that a forfeiture clause in an ordinary contract would fall under Section 74 of the Indian Contract Act, 1872. Clarified that Section 74 will not be applicable to forfeiture of earnest money. |
| Maula Bux v. Union of India, 1969 (2) SCC 554 | Supreme Court of India | Reiterated that forfeiture of earnest money is not a penalty. |
| Satish Batra v. Sudhir Rawal, (2013) 1 SCC 345 | Supreme Court of India | Laid down the principles regarding earnest money. |
| Kailash Nath Associates v. Delhi Development Authority & Anr., (2015) 4 SCC 136 | Supreme Court of India | Held that Section 74 of the Indian Contract Act, 1872 will not apply to forfeiture of earnest money under a public auction. |
| Sahakari Khand Udyog Mandal Ltd. v. Commissioner of Central Excise & Customs, (2005) 3 SCC 738 | Supreme Court of India | Explained the doctrine of unjust enrichment. |
| National Spot Exchange Ltd. v. Anil Kohli, Resolution Professional for Dunar Foods Ltd., (2022) 11 SCC 761 | Supreme Court of India | Held that where the law is clear, the consequences must follow. |
| Alisha Khan v. Indian Bank (Allahabad Bank) & Ors., 2021 SCC OnLine SC 3340 | Supreme Court of India | Directed the refund of EMD due to the COVID-19 pandemic. |
| B.R. Enterprises v. State of U.P. & Ors., (1999) 9 SCC 700 | Supreme Court of India | Observed that the principles such as “Reading Down” emerge from the concern of the courts towards salvaging a legislation. |
| Calcutta Gujarati Education Society & Anr. v. Calcutta Municipal Corpn. & Ors., (2003) 10 SCC 533 | Supreme Court of India | Observed that the rule of “Reading Down” is only for the limited purpose of making a provision workable. |
Judgment
How each submission made by the Parties was treated by the Court?
| Party | Submission | Court’s Treatment |
|---|---|---|
| Appellant (Central Bank of India) | SARFAESI Act is a special enactment, thus, its rules prevail over general contract law. | Accepted. The Court held that SARFAESI Act being a special enactment, the rules framed under it will prevail over general laws like the Indian Contract Act, 1872. |
| Appellant (Central Bank of India) | Rule 9(5) is a statutory consequence, not a breach of contract. | Accepted. The Court agreed that the forfeiture is a statutory consequence of non-payment and not a breach of contract governed by the Indian Contract Act, 1872. |
| Appellant (Central Bank of India) | High Court’s interpretation enables manipulation of auction process. | Accepted. The Court agreed that the High Court’s interpretation could lead to manipulation by unscrupulous bidders. |
| Appellant (Central Bank of India) | E-auction terms clearly stated forfeiture on failure to pay balance. | Accepted. The Court noted that the auction terms clearly stated that failure to pay the balance amount would result in the forfeiture of the EMD. |
| Respondent (Shanmugavelu) | Section 35 of SARFAESI Act does not apply to its rules. | Rejected. The Court held that the rules framed under the SARFAESI Act are part of the statute and are therefore also covered by the overriding effect of Section 35. |
| Respondent (Shanmugavelu) | Rule 9(5) cannot override the Indian Contract Act, 1872. | Rejected. The Court held that the SARFAESI Act, being a special enactment, takes precedence over the general provisions of the Contract Act. |
| Respondent (Shanmugavelu) | Bank cannot forfeit EMD without actual loss. | Rejected. The Court held that forfeiture is a statutory consequence and not dependent on actual loss incurred by the bank. |
| Respondent (Shanmugavelu) | Authorized officer’s power is unguided and against public policy. | Rejected. The Court held that the power is not unguided as there is a remedy under Section 17 of the SARFAESI Act. |
| Respondent (Shanmugavelu) | Forfeiture amounts to unjust enrichment. | Rejected. The Court held that forfeiture is a statutory consequence and not unjust enrichment. |
How each authority was viewed by the Court?
- Authorized Officer State Bank of India v. C. Natarajan, 2023 SCC Online SC 510*: Followed. This case was crucial in establishing that the SARFAESI Act, as a special law, prevails over general contract law.
- Hadley & Anr. v. Baxendale & Ors., (1843-60) All ER Rep. 461*: Explained. The principles of remoteness of damages were discussed but not applied, as the case was not about breach of contract.
- Victoria Laundry (Windsor) Ltd v. Newman Industries Ltd., [1949] 2 KB 528*: Explained. The principles of foreseeability in breach of contract were discussed but not applied, as the case was not about breach of contract.
- Karsandas H. Thacker v. M/s. The Saran Engineering Co. Ltd., AIR 1965 SC 1981*: Explained. The principles of remoteness of damages were discussed but not applied, as the case was not about breach of contract.
- K. P. Subbarama Sastri and others v. K. S. Raghavan & Ors., (1987) 2 SCC 424*: Explained. The principles of penalty were discussed but not applied, as the case was not about breach of contract.
- Rakesh Birani (Dead) through LRs v. Prem Narain Sehgal & Anr., (2018) 5 SCC 543*: Followed. The interpretation of Rule 9 of the SARFAESI Rules was relied upon.
- Agarwal Tracom Private Limited v. Punjab National Bank & Ors., (2018) 1 SCC 626*: Followed. The ruling that forfeiture under Rule 9(5) is a measure under Section 13(4) of the SARFAESI Act was relied upon.
- Mardia Chemicals Ltd. & Ors. v. Union of India & Ors., (2004) 4 SCC 311*: Referred to. The history and legislative intent of the SARFAESI Act were considered.
- United Bank of India v. Satyawati Tondon & Ors., (2010) 8 SCC 110*: Referred to. The need for special tribunals for debt recovery was discussed.
- Madras Petrochem Ltd. & Anr. v. Board for Industrial and Financial Reconstruction & Ors., (2016) 4 SCC 1*: Referred to. The object of the SARFAESI Act and the purpose of Sections 13, 35 and 37 were reviewed.
- Celir LLP. v. Bafna Motors (Mumbai) Pvt. Ltd. & Ors., 2023 SCC OnLine SC 1209*: Referred to. The principle that only laws mentioned in Section 37 or similar to it would be applicable in addition to the SARFAESI Act was noted.
- R.S. Joshi, Sales Tax Officer, Gujarat & Ors. v. Ajit Mills Limited & Anr., (1977) 4 SCC 98*: Referred to. The meaning of ‘forfeiture’ was discussed.
- Kunwar Chiranjit Singh v. Har Swarup, (1926) 23 LW 172*: Referred to. The concept of earnest money was discussed.
- Dinanath Damodar Kale v. Malvi Mody Ranchhoddas and Co., AIR 1930 Bom 213*: Referred to. The distinction between a deposit and a penalty was discussed.
- Fateh Chand v. Balkishan Das, AIR 1963 SC 1405*: Referred to. The application of Section 74 to forfeiture clauses was discussed but not applied to earnest money.
- Maula Bux v. Union of India, 1969 (2) SCC 554*: Referred to. The distinction between earnest money and penalty was discussed.
- Satish Batra v. Sudhir Rawal, (2013) 1 SCC 345*: Referred to. The principles regarding earnest money were discussed.
- Kailash Nath Associates v. Delhi Development Authority & Anr., (2015) 4 SCC 136*: Referred to. The inapplicability of Section 74 to forfeiture under public auction was noted.
- Sahakari Khand Udyog Mandal Ltd. v. Commissioner of Central Excise & Customs, (2005) 3 SCC 738*: Referred to. The doctrine of unjust enrichment was discussed.
- National Spot Exchange Ltd. v. Anil Kohli, Resolution Professional for Dunar Foods Ltd., (2022) 11 SCC 761*: Referred to. The principle that the law must be followed was noted.
- Alisha Khan v. Indian Bank (Allahabad Bank) & Ors., 2021 SCC OnLine SC 3340*: Distinguished. The Court noted that the refund was ordered due to exceptional circumstances arising from the COVID-19 pandemic.
- B.R. Enterprises v. State of U.P. & Ors., (1999) 9 SCC 700*: Referred to. The principle of “Reading Down” was discussed.
- Calcutta Gujarati Education Society & Anr. v. Calcutta Municipal Corpn. & Ors., (2003) 10 SCC 533*: Referred to. The purpose of the rule of “Reading Down” was discussed.
What weighed in the mind of the Court?
The Supreme Court’s decision was primarily influenced by the need to uphold the statutory framework of the SARFAESI Act and its Rules. The Court emphasized that the SARFAESI Act is a special enactment designed to expedite the recovery of debts by banks and financial institutions, and its provisions should be interpreted to achieve this objective. The Court noted that Rule 9(5) of the SARFAESI Rules, which provides for the forfeiture of the earnest money deposit, is a statutory consequence of failing to pay the balance amount within the stipulated time, not a breach of contract. The Court was also concerned that diluting the forfeiture provision would encourage manipulation of the auction process by unscrupulous bidders, undermining the purpose of the Act. The Court clarified that the forfeiture of the earnest money deposit is not unjust enrichment but a statutory penalty for non-compliance. The court was also of the view that the High Court had erred in reading down the provision without it being invalid or unworkable.
| Sentiment | Percentage |
|---|---|
| Upholding Statutory Provisions of SARFAESI Act | 40% |
| Preventing Manipulation of Auction Process | 30% |
| Forfeiture as a Statutory Consequence | 20% |
| Rejection of Unjust Enrichment Claim | 10% |
| Ratio | Percentage |
|---|---|
| Fact | 20% |
| Law | 80% |
Conclusion
The Supreme Court held that the forfeiture of the entire earnest money deposit (EMD) under Rule 9(5) of the SARFAESI Rules is a statutory consequence of failing to pay the balance amount within the stipulated time and is not subject to the principles of contract law. The Court emphasized that the SARFAESI Act is a special enactment designed to expedite debt recovery and that its provisions should be interpreted to achieve this objective. The Court also held that the forfeiture is not unjust enrichment but a penalty for non-compliance and that the High Court erred in reading down the provision.
The Supreme Court set aside the judgment of the High Court and upheld the forfeiture of the entire EMD by the Central Bank of India. The Court clarified that the forfeiture is a statutory consequence and not a breach of contract governed by the Indian Contract Act, 1872. This decision reinforces the importance of adhering to the terms of SARFAESI auctions and provides clarity on the forfeiture of EMD in such auctions.
Implications
This judgment has significant implications for banks and bidders participating in auctions under the SARFAESI Act. Banks can now enforce the forfeiture of EMD without having to prove actual loss or damage, which simplifies the recovery process. Bidders, on the other hand, must be fully aware of the terms of the auction and the consequences of non-payment, as they risk losing their entire EMD. The judgment reinforces the importance of strict compliance with the SARFAESI Act and the rules framed thereunder.
- For Banks: Banks can confidently forfeit EMD without proving actual loss.
- For Bidders: Bidders must be cautious and fully aware of the consequences of non-payment.
- For Legal Interpretation: SARFAESI Act’s provisions are interpreted strictly to achieve debt recovery objectives.
Dissent
There was no dissenting opinion in this judgment. The bench unanimously agreed on the interpretation of the SARFAESI Act and its rules, emphasizing the importance of upholding the statutory framework for debt recovery.
