Supreme Court Prioritizes Employee Dues over Secured Creditor in SARFAESI Act Case: Maharashtra State Co-operative Bank Ltd. vs. Babulal Lade (2019)

Introduction

Date of the Judgment: 4 December 2019
Citation: (2019) INSC 1234
Judges: Mohan M. Shantanagoudar, J. and Krishna Murari, J.

When a company faces financial difficulties, who gets paid first – the bank that lent money or the employees who are owed their salaries? The Supreme Court of India recently tackled this complex issue, examining whether employee dues should be given priority over a secured creditor’s claim under the SARFAESI Act. This case clarifies the interplay between labour laws, banking regulations, and the rights of secured creditors.

The two-judge bench, comprising Justice Mohan M. Shantanagoudar and Justice Krishna Murari, delivered the judgment. Justice Mohan M. Shantanagoudar authored the opinion for the bench.

Case Background

The case revolves around Vainganga Sahakari Sakhar Karkhana Ltd. (hereafter ‘Karkhana’), a cooperative society that obtained credit facilities from the Maharashtra State Co-operative Bank Ltd. (hereafter ‘Appellant-Bank’). The Karkhana mortgaged its properties to the Appellant-Bank as security. When the Karkhana defaulted on its loan repayments, the Appellant-Bank initiated recovery proceedings under the SARFAESI Act.

On 10.02.2005, the Appellant-Bank issued a notice under Section 13(2) of the SARFAESI Act. Subsequently, on 13.06.2005, the Appellant-Bank took physical possession of the Karkhana’s mortgaged properties under Section 13(4) of the SARFAESI Act. Due to its poor financial condition, the Karkhana issued a notice on 24.01.2006, directing its employees to proceed on leave without salary from 24.02.2006.

The Karkhana employees (Respondent Nos. 1 to 3) challenged this notice, filing a complaint under the Maharashtra Recognition of Trade Unions and Prevention of Unfair Labour Practices Act, 1971 (MRTU & PULP Act). The Industrial Court ruled in favor of the employees, declaring the notice an unfair labor practice and ordering the Karkhana to pay the unpaid salaries of employees since July 2003.

The employees then sought a recovery certificate against the Karkhana, its Managing Director, and the Appellant-Bank under Section 50 of the MRTU & PULP Act. The Industrial Court initially refused to issue a recovery certificate against the Appellant-Bank. However, the High Court of Bombay directed the issuance of a recovery certificate against the Karkhana and its Managing Director.

In the interim, the Appellant-Bank auctioned one of the Karkhana’s properties on 26.08.2010 to Purti Power and Sugar Ltd. (Respondent No. 5). The sale agreement stipulated that the purchaser would accept all encumbrances on the property. The Appellant-Bank used the sale proceeds to offset the Karkhana’s debt.

The employees then filed a writ petition seeking a recovery certificate against the Appellant-Bank. During the pendency of this petition, the Karkhana was ordered to be liquidated on 19.01.2013. The High Court ruled that the Appellant-Bank held the sale proceeds in trust and that employee dues should have priority over other claims. This order was challenged in the current appeal before the Supreme Court.

Timeline:

Course of Proceedings

The Industrial Court initially ruled in favor of the employees, declaring the Karkhana’s notice of leave without pay an unfair labor practice. The Industrial Court also directed the Karkhana to pay the unpaid salaries of the employees. However, the Industrial Court refused to issue a recovery certificate against the Appellant-Bank.

The High Court of Bombay, in its first ruling, held that recovery could only be made against the Karkhana and not the Appellant-Bank, as there was no employer-employee relationship between the Bank and the employees. The High Court also directed the Industrial Court to issue a recovery certificate against the Karkhana and its Managing Director.

Subsequently, the High Court modified the Industrial Court’s order, holding that the Appellant-Bank held the proceeds from the sale of the Karkhana’s property in trust. It further held that the employee dues should have priority over other claims, including that of the secured creditor. This order was challenged in the appeal before the Supreme Court.

Legal Framework

The judgment discusses several key legal provisions:

• Section 167 of the Maharashtra Co-operative Societies Act, 1960: This provision explicitly states that the provisions of the Companies Act, 1956, do not apply to societies registered under the Maharashtra Co-operative Societies Act. The Court noted:
  
  “167. Companies Act not to apply – For the removal of doubt, it is hereby declared that the provisions of the Companies Act, 1956 shall not apply to societies registered or deemed to be registered; under this Act.”
• Section 13 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act): This section outlines the process for secured creditors to enforce their security interest. Specifically, Section 13(7) dictates how the proceeds from the sale of secured assets are to be distributed.
  
  “13. Enforcement of security interest – (4) In case the borrower fails to discharge his liability in full within the period specified in sub -section (2), the secured creditor may take recourse to one or more of the following measures to recover his secured debt, namely: — (a) take possession of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale for realising the secured asset…
  (7) Where any action has been taken against a borrower under the provisions of sub -section (4), all costs, charges and expenses which, in the opinion of the secured creditor, have been properly incurred by him or any expenses incidental thereto, shall be recoverable from the borrower and the money which is received by the secured creditor shall, in the absence of any contract to the contrary, be held by him in trust, to be applied, firstly, in payment of such costs, charges and expenses and secondly, in discharge of the dues of the secured creditor and the residue of the money so received shall be paid to the person entitled thereto in accordance with his rights and interests.”
• Section 50 of the Maharashtra Recognition of Trade Unions and Prevention of Unfair Labour Practices Act, 1971 (MRTU & PULP Act): This provision allows for the recovery of money due to an employee from an employer, and it stipulates that such dues can be recovered as arrears of land revenue.
  
  “50. Recovery of money due from employer – Where any money is due to an employee from an employer under an order passed by the Court under Chapter VI, the employee himself or any other person authorized by him in writing in this behalf, or in the case of death of the employee, his assignee or heirs may, without prejudice to any other mode of recovery, make an application to the Court for the recovery of money due to him, and if the Court is satisfied that money is so due, it shall issue a certificate for the amount to the Collector, who shall, proceed to recover the same in the same manner as an arrear of land revenue …”
• Section 169 of the Maharashtra Land Revenue Code, 1966: This section deals with the priority of government claims on land. Sub-section (1) makes arrears of land revenue a paramount charge on the land, while sub-section (2) gives priority to other government dues recoverable as land revenue, but only over unsecured claims.
  
  “169. Claims of State Government to have precedence over all others – (1) The arrears of land revenue due on account of land shall be a paramount charge on the land and on every part thereof and shall have precedence over any other debt, demand or claim whatsoever, whether in respect of mortgage, judgement -decree, execution or attachment, or otherwise howsoever, against any land or the holder thereof.
  (2) The claim of the State Government to any monies other than arrears of land revenue, but recoverable as a revenue demand under the provisions of this Chapter, shall have priority over all unsecured claims against any land or holder thereof.”

Arguments

The Appellant-Bank argued that the High Court erred in applying Section 529A of the Companies Act, 1956, to a cooperative society, which is barred by Section 167 of the Maharashtra Co-operative Societies Act, 1960. Further, the Appellant contended that Section 529A requires the company to be in liquidation at the time of the sale of assets, which was not the case here. The Appellant-Bank also argued that it, as a secured creditor, should have priority over the sale proceeds under Section 13(7) of the SARFAESI Act and that there was no employer-employee relationship between the Bank and the employees, so the claim for unpaid salaries should not lie against it.

The Respondent employees argued that Section 50 of the MRTU & PULP Act makes employees’ dues recoverable as arrears of land revenue. They further argued that Section 169(1) of the Maharashtra Land Revenue Code, 1966, makes arrears of land revenue a paramount charge on the land. Therefore, the employees’ dues should have primacy over the Appellant-Bank’s claim. The employees also relied on the sale letter which stated that the Appellant-Bank would take responsibility for the employees’ dues.

Respondent No. 8, Vainganga Sahakari Sakhar Karkhana Mazdoor Sangh, also relied on the sale letter dated 08.03.2010, which stated that the Appellant-Bank would take responsibility for employees’ dues. Respondent No. 5, the subsequent purchaser of the property, similarly relied on this letter to argue that the liability for the payment of employees’ dues must be placed on the Appellant.

Issues Framed by the Supreme Court

The Supreme Court framed the following issue for consideration:

1. Whether, in the facts of this case, employees’ dues can take precedence over the claim of the secured creditor in respect of the proceeds from the sale of secured assets of the Karkhana under the SARFAESI Act.

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 authorities:

Judgment

The Court analyzed the submissions of both parties and the relevant legal provisions.

The Court also analyzed the authorities cited:

• SICOM Ltd. v. State of Maharashtra & Anr. [CITATION]*: The Court followed this case to distinguish between arrears of land revenue and amounts recoverable as arrears of land revenue.
• Builders Supply Corporation v. Union of India [CITATION]*: The Court relied on this case to clarify that only actual arrears of land revenue create a paramount charge, not other dues recoverable as such.
• Central Bank of India v. State of Kerala [CITATION]*: The Court followed this case to hold that only expressly created statutory first charges have priority over secured creditors under the SARFAESI Act.

What weighed in the mind of the Court?

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

• Contractual Obligation: The Court emphasized the contractual obligation arising from the sale letter dated 08.03.2010, where the Appellant-Bank had agreed to take responsibility for the employees’ dues.
• Statutory Interpretation: The Court interpreted Section 169 of the Maharashtra Land Revenue Code to mean that while employee dues are recoverable as arrears of land revenue, they do not have a paramount charge over secured creditors.
• Scheme of SARFAESI Act: The Court found that the SARFAESI Act does not automatically create a paramount charge in favor of secured creditors, especially when a contract to the contrary exists.

The sentiment analysis of the Supreme Court’s reasoning reveals a strong emphasis on contractual obligations and statutory interpretations. The court’s reasoning is primarily focused on the legal aspects of the case, with a secondary focus on the factual aspects of the case.

The court’s reasoning is primarily focused on the legal aspects of the case, with a secondary focus on the factual aspects of the case.

The Court considered alternative interpretations, such as the Appellant-Bank’s claim that its liability was limited to provident fund dues. However, the Court rejected this interpretation, noting that the sale letter was clear about the Bank’s responsibility for all employees’ dues. The Court also rejected the argument that the employees’ dues should be treated as a paramount charge under Section 169(1) of the Maharashtra Land Revenue Code.

The court concluded that the Appellant-Bank was liable to satisfy the employees’ dues as per its undertaking in the sale letter dated 08.03.2010. The court also ruled that the recovery certificate issued by the Industrial Court could be executed against the Appellant-Bank to this extent.

The court observed:

• “It is important to bear in mind that at the time of entering into this sale, the Appellant-Bank was well aware of the unpaid salaries due to the employees of the Karkhana in view of the orders of the Industrial Court dated 24.08.2006 and 27.04.2007.”
• “Thus, on facts, we find that in terms of Section 13(7) of the SARFAESI Act, the distribution of money received by the Appellant-Bank should be done as per the sale contract with Respondent No. 5.”
• “In other words, the Appellant-Bank is liable to satisfy the employees’ dues as per its undertaking in the sale letter dated 08.03.2010.”

Key Takeaways

The key takeaways from this judgment are:

• Employee dues do not automatically have a paramount charge over secured creditors’ claims simply because they are recoverable as arrears of land revenue.
• The SARFAESI Act does not automatically create a paramount charge in favor of secured creditors.
• Contractual obligations, such as those in a sale letter, can override the default distribution of sale proceeds under Section 13(7) of the SARFAESI Act.
• Banks and secured creditors must be aware of their contractual obligations and cannot escape liabilities by claiming a limited interpretation of the contract.

This judgment has potential implications for future cases involving the interplay between labour laws and banking regulations. It emphasizes the importance of clear contractual terms and the need for secured creditors to honor their commitments.

Directions

The Supreme Court gave the following directions:

• The recovery certificate issued by the Industrial Court on 08.08.2011 may be executed against the Appellant-Bank to the extent of the employees’ dues.
• The Collector shall make the recovery within six months from the date of the order.
• All other dues in respect of the secured property, including any unpaid statutory dues in relation to employees (provident fund, gratuity, bonus, etc.) shall be paid by Respondent No.5 within a period of six months from the date of this order.

Development of Law

The ratio decidendi of this case is that contractual obligations can override the default distribution of sale proceeds under Section 13(7) of the SARFAESI Act. Thisruling has clarified that while the SARFAESI Act provides a framework for secured creditors, it does not grant them an automatic paramount charge, especially when contractual obligations exist. It also clarifies that while employee dues are recoverable as arrears of land revenue, they do not automatically constitute a paramount charge over secured creditors.

This case builds on the precedent set by cases like Central Bank of India v. State of Kerala, which established that only expressly created statutory first charges can take precedence over secured creditors under the SARFAESI Act. However, this case goes further by highlighting that contractual obligations can also alter the priority of claims.

The judgment has significant implications for future cases involving the interplay between labour laws, banking regulations, and the rights of secured creditors. It underscores the importance of clear and unambiguous contractual terms and the need for secured creditors to honor their commitments, even when enforcing security interests under the SARFAESI Act.