ISSUE XIII : Secured creditors vis-a-vis doctrine of priority of state debts

SECURED CREDITORS VIS-À-VIS DOCTRINE OF PRIORITY OF STATE DEBTS

Background

“Doctrine of Priority of State Debts” is a well-settled principle under common law as per which the government has the first charge over priority of debts. The courts in India have time and again reinforced this doctrine, and it is treated as “law in force” as per the Indian Constitution.1 The Supreme Court of India in its various judicial pronouncements2 has also upheld government’s priority and precedence over other private claims. However, in the recent past there have been numerous conflicts between secured creditors who initiate recovery proceedings under revenue legislations like the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (“DRT Act”) and/or the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”) and the government with respect to priority of claim on the debts.

In 2012, the Andhra Pradesh High Court in the case of Industrial Development Bank of India Ltd. and others v. The Deputy Commissioner (Arrears Recovery Cell), Central Excise and Customs, O/o Chief Commissioner of Customs & Central Excise, Basheerbagh, Hyderabad and others3 decided on a similar question on the rights of banks/financial institutions to recover their loans vis-à- vis government- custom and excise department(s) dues.

1. Brief Facts of the Case

The matter arose mainly out of four writ petitions filed with the Hyderabad bench of the Andhra Pradesh High Court with regard to conflict of claims between arrears on excise duty payable to the department of Customs, Central Excise and Service Tax (“Excise Department”) and recovery of loans due to public sector banks.

1.1 First Writ Petition

Industrial Development Bank of India Limited (“IDBI”) had advanced a loan of INR 32.5 million (650,000 US$ approx4) to an incorporated company in return of which land was offered as collateral security. IDBI instituted a suit against the company under the DRT Act for recovery of its loan before the Debts Recovery Tribunal, Hyderabad who decreed in favour of IDBI for INR 38.6 million (772,000 US$ approx) with interest. At the same time excise duty was due to the company, and the Excise Department proceeded against it, auctioning off its land, a part of which was also mortgaged to IDBI

1.2Second Writ Petition

Indian Bank had sanctioned a loan to another incorporated company, which failed to repay the amount. Through the provisions of the SARFAESI Act, the bank took possession of the property and issued a notice which stated its intention to sell the property. On coming to know of this, the Superintendent of the Excise Department initiated proceedings as the company owed excise duty on its excisable goods. The Superintendent ruled that all the excisable goods including plant, machinery etc. which are part of the property shall be sold to recover the dues of the Commissioner of Central Excise.

  1. 3 Third and Fourth Writ Petition

These were against two group companies who had defaulted in repayment of loans availed from the Andhra Bank. The bank had proceeded under the SARFAESI Act and invited bids for auction. The Commissioner of Central Excise filed writ petitions before the court for stay of the auction proceedings since excise duty was due on the goods produced by the group concerns and sale of the property by the bank would result in a loss of revenue to the Central Government.

2.Issues

The main issue under all the writ petitions arose out of conflict of laws. On one hand, the Central Excise Act, 1944 (“Excise Act”) gave power to the Excise Department to attach and sell property, and on the other, the DRT and SARFAESI Act allowed banks to take possession and sell properties when creditors have defaulted in repayment. The court had to decide on the preference of one over the other at the time of recovery/winding up.

3.Modes of recovery available to the Excise Department

The Excise Department has two modes of recovery for the outstanding money. One is through the Excise Act and the other through the Customs Act, 1962.5

3.1 Excise Act

Section 11 provides three options of recovery (i) deduction of the arrear from any money payable to the defaulter; (ii) sale of the excisable goods and (iii) preparation of a certificate for the due amount which shall be sent to the District Collector, who shall recover the amount as an arrear of land revenue.

3.2 Customs Act

Section 142(1)(c)(ii) gives the power to the Excise Department to seize and then sell the movable or immovable property of the defaulter.

The difference between Section 11 and Section 142(1)(c)(ii) is that in the former, the Excise Department can only recover dues by sale of the excisable goods whereas in the latter it can seize the property possessed by the defaulter and realize its recovery through its sale.

4.Mode of recovery available to the banks

The banks can recover their debts under the following two legislations:

4.1 DRT Act

Section 34 of the DRT Act is a non-obstanate clause i.e. it provides that the provisions of the legislation will have an overriding effect notwithstanding anything contained in any other law in force. This means that if there is a conflict between the provisions of the DRT Act and any other statue, provisions of the DRT Act will prevail unless and until the other statue specifically contains a clause overriding it.

The court concluded that the provisions of the DRT Act, overrides the Excise and Customs Act(s). The Commissioner of Central Excise does not have a right of precedence over the bank or the secured creditor.

4.2 SARFAESI Act

After reading the Custom, Excise and the SARFAESI Act(s) together, the court opined that there was no overriding effect in these revenue legislations over the SARFAESI Act. The court held that under common law, it is the government who always had the first right over recovery of debts, however this principle is subject to statutory provisions enacted by the government itself.

In Union of India v SICOM Ltd6 the apex court had held that the “doctrine of priority of state debts” is subject to the statutory provisions of our country. In a welfare State, the government indeed has a right to enforce its writ and collect due taxes, but this inherent power of the State has to yield to the statutory provisions of the State. Based on the same principle, in the present case, the government had brought into force a statute which gave banks the first right to recovery over the Excise Department.

5.Amendments to Customs and Excise Act

The Finance Bill of 2011 had brought certain amendments to these revenue legislations. The Excise Act has been amended to give the first right over the property of a defaulter/assessee to the Excise Department. A similar clause has also been inserted under the Customs Act.

However, these amendments are also subject to DRT Act and the SARFAESI Act. The amendment has expressly excluded from its operational field the application of the said legislations. Therefore, only after the banks, does the Central Government have a right over the property.

6.First right of the State

Though the Andhra Pradesh High Court judgment upheld the preference of bank dues but there are also instances where the State has a better right. In Central Bank of India v. State 0f Kerala,7 the Supreme Court ruled on the provisions under the state government revenue legislations, including the Bombay Sales Act, 1959 and the Kerala General Sales Tax Act, 1963 which provided for creation of first charge in favour of state government over the property of the assessee who has defaulted in payment of state government dues. The Supreme Court noted that the non-obstante provisions contained under the SARFAESI Act and DRT Act merely gives an overriding effect to the credit recovery proceedings initiated under the said two legislations. Further, the said Acts regulate the distribution of money received by the secured creditor, and do not per se create a preceding charge in favour of the secured creditor. Thus, the State would have priority of claim, if there is a specific provision giving priority to the State dues.

The proviso to the non-obstanate clause of the DRT Act also lists a few legislations over which it does not have an overriding effect. They include the Industrial Finance Corporation Act, 1948, the State Financial Corporations Act, 1951, the Unit Trust of India Act, 1963, the Industrial Reconstruction Bank of India Act 1984 and the Sick Industrial Companies (special provisions) Act, 1985.

Conclusion

The courts in India have recognized the fact that the DRT Act and SARFAESI Act have been created for benefit of banks, financial institutions and other secured creditors. The overriding effect of these legislations over other enactments along with the amendments to the Customs and Excise Act(s) has clearly given banks a preference in recovery of debts. However it should be noted that the State would have priority of claim, if there is a specific provision in its favour. To conclude, the trend of the judiciary along with the enabling provisions of the DRT and SARFAESI Act(s) has gone a long way in dealing with the festering problem of bad debts in the banking system of our country.

Authored by: Ankush Goyal

1 Article 372(1) of Constitution of India, 1950
2 Builders Supply Corp. v Union of India, AIR 1965 SC 1061 and Dena Bank v. Bhikhabhai Prabhudas Parekh& Co., (2000) 5 SCC 694
3 1012 (4) ALD 517
4 1 US$ = INR 50 approx
5 Made applicable through notification number 68/63- C.E. dated May 4, 1963 passed by the Ministry of Finance, Government of India

 

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