Supreme Court Orders Refund of Forfeited Amount in Auction Dispute: Mohd. Shariq vs. Punjab National Bank (2023)

Introduction

Date of the Judgment: 11 April 2023

Citation: (Not provided in the source)

Judges: Justice Ajay Rastogi and Justice Bela M. Trivedi

Can a bank forfeit the earnest money of a bidder who was unaware of ongoing legal proceedings affecting the auctioned property? The Supreme Court of India recently addressed this critical question in a case involving a property auction under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. The court examined whether the bank’s failure to disclose pending litigation impacted the fairness of the auction process and the rights of the bidder. The judgment was delivered by a two-judge bench comprising Justice Ajay Rastogi and Justice Bela M. Trivedi.

Case Background

The third respondent had taken a loan from Punjab National Bank (first respondent) and defaulted, leading to their account being classified as a Non-Performing Asset (NPA). The bank initiated proceedings under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act), taking possession of the borrower’s assets. An auction notice was published on June 18, 2013, with a reserve price of Rs. 1.19 crores.

The appellant, Mohd. Shariq, was the highest bidder at Rs. 2.01 crores. He deposited Rs. 11.19 lakhs as earnest money on July 22, 2013, and a further Rs. 38.35 lakhs (25% of the bid amount) on July 27, 2013.

Meanwhile, on July 25, 2013, the borrower (third respondent) filed an appeal before the Debt Recovery Tribunal (DRT), challenging the auction notice. The DRT passed an interim order on July 26, 2013, allowing the auction to proceed but keeping the confirmation of sale in abeyance. The appellant was unaware of this interim order when he deposited the 25% of the bid amount on July 27, 2013.

The DRT later vacated its interim order on October 14, 2013, due to non-prosecution, but the substantive proceedings remained pending. The bank informed the appellant on October 18, 2013, to pay the balance amount. The appellant agreed to pay the balance, provided the DRT matter was decided. The bank then threatened forfeiture of the earnest money if the balance was not paid.

Without any formal forfeiture order, the bank initiated re-auction proceedings on March 5, 2014. The appellant then approached the High Court seeking to halt the re-auction and for the sale deed to be executed in his favor, or alternatively, to refund his deposited amount. The High Court allowed the re-auction to proceed, subject to the outcome of the writ petition. The appellant deposited Rs. 1.77 crores as directed by the High Court. The re-auction was conducted on May 1, 2014, and the property was sold to a subsequent purchaser.

The Single Judge of the High Court set aside the re-auction and directed the bank to execute the sale deed in favor of the appellant. However, the Division Bench reversed this order, upholding the re-auction and directing the bank to return the appellant’s deposit of Rs. 1.77 crores, while allowing the appellant to seek remedy for the forfeited amount. This led to the appeal before the Supreme Court.

Timeline

Legal Framework

The case primarily revolves around the interpretation and application of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) and the Security Interest (Enforcement) Rules, 2002.

The SARFAESI Act allows banks and financial institutions to recover their dues by auctioning the mortgaged properties of defaulters.

Rule 9(5) of the Security Interest (Enforcement) Rules, 2002, deals with the consequences of a successful bidder failing to deposit the balance amount of the purchase price. It 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.”

Arguments

Appellant’s Arguments:

• The appellant argued that the Division Bench of the High Court erred in relegating him to pursue other legal remedies for the recovery of the forfeited amount.
• He contended that there was no dispute on the facts or law that he was entitled to a refund of the forfeited amount.
• The appellant emphasized that he was never informed about the pending proceedings before the DRT when the auction was held and when he deposited 25% of the bid amount.
• He argued that his offer to pay the balance amount was conditional on the DRT matter being resolved, indicating his bona fide intentions.

Respondent Bank’s Arguments:

• The bank argued that the forfeiture of the earnest money was justified under Rule 9(5) of the Security Interest (Enforcement) Rules, 2002, as the appellant failed to deposit the balance amount within the stipulated time.
• The bank contended that the appellant was responsible for the reduction in the property’s value during the re-auction.
• The bank argued that the decision to forfeit the money was in accordance with the terms and conditions of the auction notice.

Analysis of Arguments:

The appellant’s primary argument was that the bank’s failure to disclose the pending DRT proceedings was a material fact that should have been disclosed before the auction. This non-disclosure, according to the appellant, vitiated the fairness of the auction process and justified the refund of the forfeited amount. The bank, on the other hand, relied on the strict interpretation of Rule 9(5) of the Rules, 2002, which allows for forfeiture in case of default by the highest bidder.

The innovativeness of the appellant’s argument lies in highlighting the bank’s duty to disclose material information to the bidders, especially when such information could affect their decision to participate in the auction.

Issues Framed by the Supreme Court

The Supreme Court did not explicitly frame specific issues in a separate section. However, the core issue addressed by the court can be summarized as:

1. Whether the Division Bench of the High Court was justified in relegating the appellant to avail other legal remedies for the recovery of the forfeited amount, despite the undisputed facts of the case.

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Supreme Court considered the following legal authorities:

• Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act): The court examined the provisions of this Act, which empowers banks to auction mortgaged properties to recover dues.
• Rule 9(5) of the Security Interest (Enforcement) Rules, 2002: This rule was central to the bank’s argument for forfeiture of the earnest money. The court analyzed the rule in the context of the specific facts of the case.

The Court did not cite any case laws.

Judgment

How each authority was viewed by the Court?

• Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002: The Court acknowledged the bank’s power to auction under the Act but emphasized the need for fairness and transparency in the process.
• Rule 9(5) of the Security Interest (Enforcement) Rules, 2002: The Court noted that while the rule allows for forfeiture in case of default, it was not applicable in the present case due to the non-disclosure of material information by the bank.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following factors:

• Non-disclosure of Material Fact: The court emphasized that the bank’s failure to inform the appellant about the pending DRT proceedings was a critical factor. This non-disclosure deprived the appellant of the opportunity to make an informed decision about participating in the auction.
• Bona Fide Intention of the Appellant: The court noted that the appellant had shown a genuine intention to purchase the property by depositing the earnest money and 25% of the bid amount. His offer to pay the balance amount, conditional on the resolution of the DRT matter, further demonstrated his bona fides.
• Fairness and Transparency: The court highlighted the need for fairness and transparency in auction processes, particularly under the SARFAESI Act. The bank’s conduct was deemed to be lacking in these aspects.

Logical Reasoning:

The court considered the bank’s argument regarding Rule 9(5) of the Security Interest (Enforcement) Rules, 2002, but held that it was not applicable in the present case due to the non-disclosure of material information by the bank.

The court’s decision was based on the principle of fairness and transparency, emphasizing that the bank had a duty to disclose all relevant information to the bidders.

The Supreme Court stated:

“This fact has not been disputed that DRT passed an interim order on 26th July, 2013 and the fact that the proceedings had been initiated and pending on the date when the auction was held and the date on which 25% of the bid amount was deposited by the appellant, i.e., 27th July, 2013, was never brought to the notice of the appellant which would give him an option to revisit as to whether he may proceed with the auction or withdraw at that stage.”

“We are of the considered view that once there is no dispute on the facts came on record, there appears no reason for the appellant to be relegated to avail other remedial mechanisms for recovery of the undisputed amount and the Division Bench has committed a manifest error in the facts and circumstances in not exercising its power under Article 226 of the Constitution and instead of resolving the dispute, the Division Bench under the impugned judgment has kept the issue alive, permitting the parties to have a second innings in reference to the dispute which stands crystalized/settled.”

“But the instant case was not a case of simple default. The appellant has come with the bona fide defence that he was never informed on the date when the auction was held or day thereafter that the substantive proceedings are pending before the DRT instituted at the instance of the borrower.”

Key Takeaways

• Duty of Disclosure: Banks and financial institutions conducting auctions under the SARFAESI Act have a duty to disclose all material facts, including pending legal proceedings, to potential bidders.
• Fairness in Auction Process: The auction process must be fair and transparent, ensuring that bidders are not misled or disadvantaged due to non-disclosure of critical information.
• Protection of Bidders: Bidders are entitled to a refund of their earnest money if they were not informed about material facts that could have influenced their decision to participate in the auction.
• Limitations on Forfeiture: Rule 9(5) of the Security Interest (Enforcement) Rules, 2002, cannot be applied mechanically in cases where the bidder has a bona fide defense, such as non-disclosure of material facts.

Directions

The Supreme Court directed the first respondent (Punjab National Bank) to return the amount of Rs. 50.25 lakhs to the appellant, which was deposited in reference to the auction notice dated June 18, 2013, within a period of two months. The court also specified that if the bank fails to return the amount within two months, it shall carry interest at 12% per annum until the date it is paid to the appellant.

Development of Law

The ratio decidendi of this case is that a secured creditor (bank) must disclose all material facts, including pending legal proceedings, to potential bidders in an auction under the SARFAESI Act. The failure to do so entitles the bidder to a refund of the forfeited amount. This judgment reinforces the principles of fairness and transparency in auction processes.

The judgment clarifies that Rule 9(5) of the Security Interest (Enforcement) Rules, 2002, should not be applied in a mechanical manner, especially when there is a failure on the part of the secured creditor to disclose material facts. This is a departure from a strict interpretation of the rule, emphasizing the need to consider the specific circumstances of each case.

Conclusion

In the case of Mohd. Shariq vs. Punjab National Bank, the Supreme Court held that the bank was not justified in forfeiting the earnest money of the appellant because the bank failed to disclose the pending DRT proceedings. The court directed the bank to refund the forfeited amount, emphasizing the need for fairness and transparency in auction processes under the SARFAESI Act. This judgment reinforces the principle that bidders must be provided with all material information to make informed decisions and protects their interests in auction proceedings.