Supreme Court Upholds Auction Sale of Hotel, Clarifies Section 13(3A) of SARFAESI Act: ITC vs. Blue Coast Hotels (2018)

Date of the Judgment: 19 March 2018

Citation: (2018) INSC 215

Judges: S. A. Bobde, J., L. Nageswara Rao, J.

Can a secured creditor’s failure to respond to a borrower’s representation under Section 13(3A) of the SARFAESI Act invalidate an auction sale? The Supreme Court of India addressed this crucial question in a case involving the sale of a luxury hotel. The core issue revolved around whether the creditor’s non-compliance with the requirement to respond to the borrower’s representation and provide reasons for non-acceptance rendered the subsequent auction sale illegal. This judgment clarifies the scope and mandatory nature of Section 13(3A) of the SARFAESI Act.

The bench comprised of Justice S. A. Bobde and Justice L. Nageswara Rao, with the judgment authored by Justice S. A. Bobde.

Case Background

The case originated from a loan agreement between Industrial Financial Corporation of India (IFCI), the creditor, and Blue Coast Hotels Ltd., the debtor. The debtor defaulted on a loan of Rs. 150 crores, leading to the classification of the account as a Non-Performing Asset (NPA) on 30 September 2012. The loan was secured by a mortgage on the debtor’s hotel property, including agricultural land intended for villa development.

Following the default, IFCI sent several notices to the debtor, demanding repayment of the outstanding amount of Rs. 133.18 crores. A notice under Section 13(2) of the SARFAESI Act was issued on 26 March 2013, requiring the debtor to pay within 60 days. The debtor responded with a proposal for an extension of time. IFCI then took symbolic possession of the hotel property on 18 June 2013, and initiated auction proceedings. Multiple auction notices were issued, and the property was eventually sold to ITC Ltd. on 25 February 2015, after a fourth auction notice.

The debtor challenged the auction sale, leading to a series of legal proceedings, culminating in the present appeals before the Supreme Court.

Timeline:

Course of Proceedings

The Debts Recovery Tribunal (DRT) initially set aside the notice issued under Section 13(2) of the SARFAESI Act, citing non-compliance with Section 13(3A) and the inclusion of agricultural land in the notice. However, the Debts Recovery Appellate Tribunal (DRAT) overturned the DRT’s decision and upheld the validity of the notice under Section 13(2). The debtor then filed writ petitions in the High Court.

The High Court of Judicature at Bombay set aside the DRAT’s judgment, holding that the entire recovery and sale proceedings were illegal. The High Court’s decision was primarily based on the creditor’s failure to respond to the debtor’s representation under Section 13(3A), the inclusion of agricultural land in the security interest, and the lack of physical possession before the sale. The High Court also concluded that the auction was vitiated by fraud and collusion.

Legal Framework

The core of this case revolves around the interpretation of Section 13 of the SARFAESI Act, which deals with the enforcement of security interest. Specifically, Section 13(2) allows a secured creditor to demand repayment from a borrower who defaults. Section 13(3A), introduced following the Supreme Court’s observations in Mardia Chemicals Ltd. v. Union of India [(2004) 4 SCC 311], mandates that if the borrower makes a representation or raises objections to the notice under Section 13(2), the secured creditor must consider such representation or objection and communicate the reasons for non-acceptance within fifteen days.

The Act also provides for the Security Interest (Enforcement) Rules, 2002, which elaborate on the procedure for dealing with the borrower’s representation. Section 13(4) enables the creditor to take possession of the secured assets if the borrower fails to discharge the liability. Further, Section 31(i) of the SARFAESI Act states that the provisions of the Act shall not apply to any security interest created in agricultural land.

The relevant provisions are as follows:

• Section 13(2) of the SARFAESI Act: “Where any borrower, who is under a liability to a secured creditor under a security agreement, makes any default in repayment of secured debt or any instalment thereof, and his account in respect of such debt is classified by the secured creditor as non-performing asset, then, the secured creditor may require the borrower by notice in writing to discharge in full his liabilities to the secured creditor within sixty days from the date of notice failing which the secured creditor shall be entitled to exercise all or any of the rights under sub-section (4).”
• Section 13(3A) of the SARFAESI Act: “If, on receipt of the notice under sub-section (2), the borrower makes any representation or raises any objection, the secured creditor shall consider such representation or objection and if the secured creditor comes to the conclusion that such representation or objection is not acceptable or tenable, he shall communicate within fifteen days of receipt of such representation or objection the reasons for non-acceptance of the representation or objection to the borrower…”
• Section 31(i) of the SARFAESI Act: “Provisions of this Act not to apply in certain cases-The provision of this Act shall not apply to- (i) any security interest created in agricultural land;”

Arguments

Arguments of the Debtor (Blue Coast Hotels Ltd.):

• The creditor failed to comply with Section 13(3A) of the SARFAESI Act by not responding to the debtor’s representation and not providing reasons for non-acceptance. The High Court correctly held that this non-compliance invalidated the subsequent actions.
• The inclusion of agricultural land in the security interest was illegal under Section 31(i) of the SARFAESI Act. The High Court correctly held that the creditor could not have recovered the land.
• The creditor was not entitled to initiate proceedings under Section 14 of the SARFAESI Act, as it was no longer a secured creditor after the sale of the property.
• The creditor did not take physical possession of the property before the auction sale, which is a violation of the SARFAESI Act.
• The auction sale was vitiated by fraud and collusion between the creditor and the auction purchaser.
• The letter of undertaking given by the debtor was “without prejudice” and cannot be used as an evidence of acknowledgment of liability.

Arguments of the Auction Purchaser (ITC Ltd.) and the Creditor (IFCI):

• The creditor substantially complied with Section 13(3A) by considering the debtor’s representation and granting multiple opportunities for repayment. The failure to provide a formal written response should not invalidate the entire process.
• The land in question was not agricultural land but part of the hotel property and was mortgaged as such. The debtor’s application for conversion of the land into non-agricultural land shows that it was not treated as agricultural land.
• The creditor had the right to apply for possession under Section 14 of the SARFAESI Act, even after the sale of the property, as the creditor remained a secured creditor until the entire debt was recovered, and the transfer was not a complete transfer.
• Taking symbolic possession is a valid practice under the law.
• There was no fraud or collusion in the auction sale. The sale was conducted transparently, and the auction purchaser was a bona fide purchaser.
• The words “without prejudice” in the letter of undertaking have no significance and the debtor clearly acknowledged the debt.

The innovativeness of the argument by the auction purchaser and the creditor was that even though the creditor did not reply to the representation of the debtor, the creditor had considered the representation and had given the debtor multiple opportunities to repay the debt. Further, the creditor continued to be a secured creditor even after the transfer of the property to the auction purchaser.

Issues Framed by the Supreme Court

The Supreme Court framed the following issues for consideration:

1. Whether the failure to reply to the representation of the borrower under Section 13(3A) of the SARFAESI Act invalidates the subsequent actions of the secured creditor?
2. Whether the inclusion of agricultural land as security interest in the notice of recovery was illegal under Section 31(i) of the SARFAESI Act?
3. Whether the creditor could maintain an application for possession under Section 14 of the SARFAESI Act after the sale of the property to the auction purchaser?
4. Whether the High Court was correct in finding fraud and collusion between the creditor and the auction purchaser?

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

Judgment

The Supreme Court allowed the appeals filed by ITC Ltd. and set aside the judgment of the High Court. The Supreme Court held that the creditor’s failure to furnish a reply to the debtor’s representation under Section 13(3A) of the SARFAESI Act did not invalidate the subsequent actions, given that the creditor had considered the representation and granted multiple opportunities for repayment. The Court also held that the land in question was not agricultural land and the creditor could maintain an application for possession under Section 14 of the SARFAESI Act. The Court found no fraud or collusion in the auction sale.

How each authority was viewed by the Court:

• Mardia Chemicals Ltd. v. Union of India [(2004) 4 SCC 311]: The Court affirmed the need for a reasoned order but held that in the present case, the creditor had substantially complied with the spirit of the provision.
• Transcore v. Union of India [(2008) 1 SCC 125] and Keshavlal Khemchand & Sons (P) Ltd. v. Union of India [(2015) 4 SCC 770]: The Court reiterated the interpretation of Section 13 of the SARFAESI Act.
• Other authorities were cited to support the interpretation of the relevant provisions of the SARFAESI Act, the meaning of agricultural land, and the principles for exercising discretionary relief.

What weighed in the mind of the Court?

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

• Substantial Compliance: The Court emphasized that while a formal written reply to the borrower’s representation is required under Section 13(3A), the creditor had substantially complied with the spirit of the provision by considering the representation and granting multiple opportunities for repayment.
• Debtor’s Conduct: The Court noted that the debtor’s conduct was primarily aimed at seeking time for repayment without any concrete action to clear the debt. The debtor had induced the creditor to enter into negotiations and had given multiple assurances that were not fulfilled.
• Nature of the Land: The Court determined that the land in question was not agricultural land but was part of the hotel property and mortgaged as such. The debtor’s own actions, such as applying for conversion of the land, indicated that it was not treated as agricultural land.
• Validity of Symbolic Possession: The Court affirmed that taking symbolic possession is a valid practice under the law.
• No Evidence of Fraud: The Court found no evidence of fraud or collusion in the auction sale.
• Letter of Undertaking: The Court held that the words “without prejudice” in the letter of undertaking have no significance and the debtor clearly acknowledged the debt.

Flowchart of the Case

Conclusion

The Supreme Court’s judgment in ITC Limited vs. Blue Coast Hotels Ltd. & Ors. clarifies the scope and mandatory nature of Section 13(3A) of the SARFAESI Act. The Court held that while a formal written reply to the borrower’s representation is required, substantial compliance is sufficient if the creditor has considered the representation and provided opportunities for repayment. The Court also clarified that the inclusion of agricultural land as security is not illegal if the land is part of a larger property and not treated as agricultural land. The judgment reinforces the validity of symbolic possession and the rights of a bona fide auction purchaser.

Final Decision: The Supreme Court allowed the appeals filed by ITC Ltd., setting aside the judgment of the High Court and upholding the auction sale of the hotel property.