Mirror of Justice

Mardia Chemicals V Idbi –case Study , Onset of Securitization in India

July 11th, 2009 at 06:21pm Under Appeals and Writs

 

Mardia Chemicals v IDBI case study

Facts of the case:

In a notice dated July 24, 2002 to Mardia Chemicals Ltd., the Industrial Development Bank of India (for short `the IDBI’) under Section 13 of the Ordinance, then in force, required it to pay the amount of arrears indicated in the notice within 60 days, failing which the IDBI as a secured creditor would be entitled to enforce the security interest without intervention of the court or Tribunal, taking recourse to all or any of the measures contained in sub-section (4) of Section 13 namely, by taking over possession and/or management of the secured assets. The petitioner was also required not to transfer by way of sale, lease or otherwise any of the secured assets. Similar notices were issued by other financial institutions and banks under the provisions of Section 13 of the Ordinance/Act to different parties who filed petitions in different High Courts.

This was joined with various writ petitions in various High Courts challenging the validity of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.

 

Issues

 

Issue 1: Whether it is open to challenge the statute on the ground that it was not necessary to enact it in the prevailing background particularly when another statute was already in operation

 

It was contended on behalf of the petitioners that the Recovery of Debts Due to Banks and Financial Institutions Act 1993 was enough to meet the challenge posed by NPAs and the present enactment was not necessary.

It is open to question in determining the Constitutional validity of a statute if it is at all necessary for the Court to enter into the necessity of a statute. The Supreme Court has held in the past that that

“The Parliament and Legislatures composed of as they are of the Representatives of the people are supposed to be aware of the needs of the people and what are good or bad for them. The Court cannot sit over the judgment of their wisdom…A law made by the Parliament or State legislature can be struck down on two grounds alone (1) lack of legislative competence,(2)violation of any Constitutional rights”[1]

The Court has recently held in BALCO Employees Union v Union of India[2]) that the proper forum for discussing a policy aspect is the parliament and not the Court.

So in view of the earlier pronouncements of the Court it is clear that the required enquiry is whether the statute is constitutional .Any discussion as to the whether a statute is necessary specially vis-avis another Act whose vires is not a issue in the present case was unnecessary. Therefore the Court refused to entertain the argument.

 

Issue II:

Whether the terms or existing rights under the contract entered into by two private parties could be amended by the provisions of law providing certain powers in one sided manner in favour of one of the parties to the contract

 

The argument raised on behalf of many petitioners was that existing rights of private parties under a contract cannot be interfered with, more particularly putting one party to an advantageous position over the other. For example, in the present case, in a matter of private contract between the borrower and the financing bank or institution through impugned legislation rights of the borrowers have been curtailed and enforcement of secured assets has been provided for without intervention of the court and above all depriving them the remedy available under the law by approaching to the civil court.

 

The Appellants are silent on where exactly are they locating the legal validity of their argument. It has been pointed out by the Honorable Supreme Court that unlike Art 1 s.10 of the US Constitution there is no bar to prospective invalidation of a contract in India and hence such a law is perfectly valid.[3]

Indeed the very right to property stand deleted from the Constitution as a fundamental right by the 44th amendment and exists merely as a Constitutional right. Indeed even when the right was existent in part III the Courts have held that absolute freedom of contract as expounded in the doctrine of leissez fare is obsolete.[4]

The Appellants also cannot locate the right under4 right to Art 19(1)(g) and Art 298 .The Supreme Court has held that these articles are subject to reasonable restrictions and that what is reasonable is to be interpreted from the point of view of public interest no matter how harsh it is on the interest of the person.[5]

In view of these case laws it is difficult to say where does the appellants locate their argument .The counsels for the respondents however has not entered into the position of freedom of contract or right to trade in the Constitution but has pointed out that similar argument has been raised in a different context, namely statutes giving relief to agricultural borrowers and it has been repeatedly rejected.

Some case laws may be mentioned here. ., Ramaswamy Aiyengar v. Kailasa[6] Thevar and Dahya Lala v. Rasul Mohd. Abdul Rahim,[7], validity of the Madras Agriculturalist’s Relief Act and Bombay Tenancy Act, 1939 were upheld respectively .Under these two statutes relief was given to the debtors who were agriculturists as a class, by sealing down their debts. The validity of the Act was upheld though it affected the individual interest of creditors.

Similar provisions were upheld in Swami Motor Transports Pvt. Ltd. v. Shri Sankraswamigal Mutt[8] and Raval & Co. v. K.G. Ramachandran[9],: Kanshi Ram v. Lachhman[10], Pathumma v. State of Kerala[11], Fatehchand Himmatlal v. State of Maharashtra[12] etc.

 

Issue III Whether Section 13 of the Act ultra vires of the Constitution

The first line of attack has been the Constitutionality of section 13 itself.

 

It has been argued that before applying the power u/s.13 certain determination of facts are necessary, namely, whether a person to whom notice is given is under a liability to pay as also the question of extent of the liability etc. Further the questions pertaining to law of limitation and bar under consortium agreements, claim of set off/counter claim, creditors defaults as bailee or its failure to disburse the credit in time, the chargeability of penal interest or compound interest or non-appropriation of amount already paid and so on and so forth, all these questions need to be decided. So it was argued with case laws that shall be discussed in the main project) that in such a case a lis exists and that power to decide a lis is a judicial or quasi-judicial power and not purely an administrative power. Therefore a suitable forum has to be provided to decide all such disputes at an appropriate stage.[13]

If such a forum is not provided then the statutory provision becomes arbitrary, procedurally and substantively unfair.

This is a factually faulty argument. S.13 do not exclude any judicial forum, but merely provides that a judicial remedy can be availed only after the secured creditor has exercised his powers under s.13 (4). This is perfectly valid. Many statutes has provisions under which a forum can be availed after the aggrieved party has engaged self help.

 

 

It was also pointed out that the provisions under s.13 create certain practical difficulties that might give rise to grave miscarriges of justice. For example Section 2(f) of the Act to indicate that the definition of the word `borrower’ covers even the guarantor. Under section 135 of the Contract Act a guarantor is discharged of his obligation under certain circumstances. Now suppose a discharged guaranteer received a notice under Section 13(2) of the Act in view of the bar of Section 34 to file a suit in the Civil Court, it is not possible for him to approach the Court to show and establish that he is a discharged guarantor. Hence notice under Section 13(2) is bad[14].

These concerns have been taken care of by s.35 of the Securitization Act that lays down that the provision of the Act overrides all other laws.

 

Finally it was pointed out that under s.13 read with s.34 the borrower has no access to Court before the lender exercises the powers u/s.13 (4) this exposes him to arbitrary even, fraudulent practices by the lender. In defense of this section it was pointed out that u/s 9 of the Rules the asset cannot be sold for 60 days, it is open to the borrower to approach the Tribunal within that period.

 

The Court partially accepted the argument of the plaintiffs and added two riders to s.13

Firstly it held that the lender is under a duty to disclose the reasons for the reason for not accepting the objections or points raised in reply to the notice served upon them before proceeding to take measures under sub-section (4) of Section 13.

Secondly the Court drew an analogy with English mortgage and pointed out that enforcement proceedings under an English mortgage can be challenged on the ground of fraud. Such provisions are applicable to this section as well.[15]

 

Another aspect the Court has ignored is that it is a general rule of statutory construction that a statute must be read in context and pari materia.[16]

S.13 of the present Act is Pari materia with s.29 of the State Financial Corporation Act 1951.

The Constitutional vires of this section has been repeatedly challenges Art 300A, 21, and 14 on substantially the same grounds namely that it gives no right to appeal. Though the case has never reached the Supreme Court a number of High Courts have deliberated on the issue. The Courts have persistently held that the statute itself discloses a definite policy and objective and the power conferred under s.29 is to achieve the policy namely speedy recovery of the dues.[17]

 

Issue IV: Whether the requirement of 75% of the amount due before appeal to the DRT is onerous and therefore Section 17 of the Act is ultra vires to the Constitution .

 

Section 17 of the Act s titled right to appeal. It requires that the borrower deposit 75% of the sum before approaching the DRT.This sum however may be waived by the DRT.

An appeal is defined by the Black’s Law Dictionary[18] as “ A proceeding undertaken to have a decision reconsidered by bringing it to a higher authority , esp the submission of a lower court court for review and possible reversal.” The BBC English Dictionary on the other hand defines an appeal to be “a serious and urgent request”.

The wording of section 17 is misleading because what it provides is a right to approach the Court at first instance and not merely as an appeal so it can be said to be an appeal in only very general sense.

Any aggrieved person including the borrower can prefer the Appeal. If it is the borrower who is making the Appeal then he has to deposit 75% of the borrowed to amount claimed in the notice under 13(2)before the DRT , otherwise the claim would not be entertained.

It was argued on behalf of the Appellants that the deposit of 75% of the amount makes the provision onerous and arbitrary.

The Respondents countered by citing two sets of case laws.

The first set lays down that right to Appeal is neither an absolute right nor an ingredient of natural justice which principles are to be followed in judicial and quasi-judicial proceedings. A right of appeal is a statutory right and it can be circumscribed by the conditions. [19] The other cases lay down that pre-deposit of amount is perfectly constitutional and not arbitrary[20].

The respondents also pointed out that as per RK Garg[21] as well as in other cases [22]after that

“there is always a presumption in favour of the constitutionality of a statute …. This rule is based on the assumption, judicially recognized and accepted, that the legislature understands and correctly appreciates the needs of its own people, its law are directed to problems made manifest by experience … Every legislation particularly in economic matters is essentially empiric and it is based on experimentation or what one may call trial and error method … There may be crudities and inequities in complicated experimental economic legislation but on that account alone it cannot be struck down as invalid.”

The Court however did not accept these arguments and struck down section 17(2) as ultra-virews to the Constitution being arbitrary.

The reasoning of the Court was the following

1. Under s.13 (2) the borrower does not get any pre decisional hearing

2. There should be no pre-supposition that the borrower is a willful defaulter.

In order to make the legislation fair the provision was held to be arbitrary and struck down.

 

Rest of the Act was upheld

 

Appraisal of the judgment

The Court upheld section 13. So it can be argued that the main structure of the statute has survived.

The judgment however suffers from a large number of deficiencies. These can be enumerated in terms of what the judgment does lay down and what the judgment does not discuss but should have done.

 

Relationship with winding up

There is a fundamental tension between the Act and Companies Act.

Under the Companies Act all the creditors and not merely the secured creditor can file a petition for winding up.(s.439 of the Co Act).This the creditors can do if a)the Company is indebted to a sum of more than 1lakh rupees and it has pay the sum or secure or compound for it to the reasonable satisfaction of the creditor within three weeks of the submission of demand ,b) if an execution of a decree remains unsatisfied ,c) it is proved to the satisfaction of the Tribunal that the Company is unable to pay its debts.(s.433).

However the right of the creditors to wind up a Company is limited by the case laws like Tata Iron Steel v Micro Forge (India)[23] that lays down that winding up is at the discretion of the Tribunal and a host of factors like whether the inability is temporary, the Company has grown consistently , there is a temporary cash crunch.etc.

But on the other hand u/s.13 of Securitization Act the Bank can straightaway enforce the security interest without regards to any of these criterion. Such enforcement in all probability shall force the Company to become insolvent.

So it seems there is a basic difference in philosophy behind the two statutes. While the Co Act strives to put the interest of the Company, and that of the economy in perpetuation of Corporations the other Act gives preference to the rights of the secured creditors above that of the Company.

The conflict is more than that of principle. Enforcement of security interests can actually reduce the value of other assets of the Company that is not with secured creditors. So the unsecured creditors and other persons who are to receive their dues had the Company being wound up stands to lose even more when a section 13 is brought into use. This is against the global trend has been to pay special attention to the interest of the unsecured creditors .The Enterprises Act of the UK engages in what is known as ring fencing that is keeping aside a certain amount of money for the benefit of the unsecured creditors.

On the basis of this can the Act be said to be arbitrary? The answer can be only guessed because the Court did not discuss this issue at all. This perhaps leaves a scope for the Act to be challenged in future on this ground.

 

The only duty that the secured creditor has is towards the workmen. Section 13(9) of the Act lays down that a secured creditor has the option of enforcing his security interests either under this Act or under s.529 of the Companies Act.

Incase he chooses to go by this Act he shall have to pay the workman’s dues as under s.529A of the Companies Act.

Then again unders.13 the secured creditor is not under a duty to pay not all the employees but only the workmen.

 

.

 

Under section 17 any person who is aggrieved by the measures taken by the lender can approach the DRT. Exactly who these aggrieved persons can be have not been defined under the Act. The Uniform Non-Judicial Foreclosure Act of the USA defines an “aggrieved party” as a party entitled to a remedy and includes the debtor, the secured creditor, a person having an interest in the real property that will be affected by 16 foreclosures, and a purchaser or prospective purchaser at a foreclosure.

 

It is submitted that the Indian law lacking that sort of precision leaves a space for intense and competitive litigation. The moment the banks make use of the provisions under s.13(4) there will be a flurry of litigation by the unsecured creditors, the workers and a host of other people with the active blessing of the management.

Indeed the process of litigation can go even further. Can “measures taken under s.13 (4) “ imply measures not taken under the said section when it should have been taken? This is not improbable in view of the fact that the Supreme Court has entertained a petition by Common Cause ( a NGO ) that has challenged a loan to S Kumar’s Shree Maheswar Hydro Power Corporation (SMHPCL) in Madhya Pradesh by LIC in spite of repeated default by the said Company.

It should be noted that the project has remained a point of contention between civil society groups and the Company. This controversial project has seen a pitched battle between the Narmada Bachao Andolan (NBA) and its promoters, ending with the NBA almost being gagged by the courts. It is not to accuse the Common Cause of any oblique motive but to point out that if somehow the Court system permits issues those are political to be settled by the Act.[24]

 

The Court can however be excused for not dealing with these issues as the Mardia Chemicals arguably did not raise them. But less easy is to accept certain innovations to the Act that the Court has done.

 

The addition of extra-statutory requirements

It has held that the lender is supposed to furnish the borrower the reason as to why his objections are not being acceded to and these reasons have to show an application of mind on part of the lender. It is difficult to understand the rationale form such action. After the entire lender is claiming the money after the fulfillment of certain conditions as a matter of right. Why an exercise of right must be accompanied by a rider?

The Court has added that this reason given shall not endow the borrower with the right to approach the DRT, at that stage. But can this be a ground for approaching the DRT at a later stage?. With approaching the DRT being made easier this extra statutory requirement imported by the Court shall only give another cause of action and more room for delay.

 

 

 

Wrong understanding of arbitrariness

The requirement of deposit of 75% u/s.17 of the Act was struck down because it was deemed to be onerous and arbitrary.The author considers this a failure on part of the respondents who did not point out why the Act should not be deemed to be arbitrary but instead harped on right to appeal and how economic legislations can afford to be a little inequitable.

This raises the question what is arbitray? It has ot been defined anywhere but it is probably safe to go by the definition provided by the Supreme Court in Srilekha Vidyarthi[25]..arbitrary is “something from which no discernible principle can be found.”

 

To see if one can find any discernible principle behind it one has to look into the provisions of the Act.

 

The powers unders.13 can be exercised under the following conditions

 

 

1. Before taking action under the Act the assets shall have to be classified as NPAs This is done under RBI guidelines.

2. Unders.s.13 (12) the aforesaid actions can be exercised only as per prescribed by the Union Government by Rule.

3. Under s.19 the banker is liable to pay compensation for wrongful possession

4. The debtor can file a writ under ART 226 if the bank is in Public sector( most of the major Banks are)

5. Detailed rules are laid down for giving notice, taking possession, ( the Court has also added to it)

6. As per RBI guidelines legal actions can be taken only in case of willful default.

7. The Court itself has empowered the borrower to approach the civil Court in case of any fraud in sale. Any way sale of assets under s.29 of the SFC Act is guided by the rules laid down in by the Supreme Court –s.13 of the Securitization Act is pari materia.

 

It is submitted that in view of all these safeguards it is highly unlikely that the powers unders.13 can be misused.

 

So why shall the borrower go to the DRT at all? Experience suggests that majority of the cases in the DRT challenge the loan document itself and often simply to delay the process rather than actually win the case. Under the Indian law the prohibition against unconscionable contracts have been imported by the Supreme Court[26]. This gives the borrower the chance to challenge the loan document as having signed under unequal bargaining power, having irrational clauses etc and prolong the judicial process..

There can be exceptions to this rule but then the DRT is empowered to waive the fees and if a probable case can be suggested then the DRT is most likely to do so. The presence of dilatory litigation is a well-known feature of the Indian legal system and it was precisely this defect that the legislature sought to remedy.[27] The Court by overturning the requirement of predeposit has more or less returned everything to square one.

Certain assumptions that the Court makes are also questionable. For example there has been a continuous stress on making the legislation balanced.

. In commercial arena there are many laws that are tilted to one party, mention may be made of the Consumer Protection Act, Rent Legislation, Industrial Disputes Act. These Acts are not arbitrary even when they are not equal benefit to both the parties, because there is no duty that legislation shall have to be balanced. The scrutiny is on a) public purpose, b) objective of the Act, c) legislative intent. The Court however was not directed to the end partly because of the faulty strategy of the respondents who insisted on cases that said pre-deposit is not arbitrary rather that this line of argument. This shall be elaborated in the project.

As pointed out in the cases involving s.29 of SFC Act that special privilege given to the Corporation is not arbitrary but for the purpose of achieving the objectives of the Act”. Here the object of the Act was very clear to avoid vexatious litigation. Striking down s.17 that object seems to have been defeated.

 

 

Conclusion -The way forward

It now seems certain that the Securitization Act is to be amended. This is in view of the fact that the Basel II provisions shall come into force by 2006, which would require the banks to make hefty provisions for credit risks apart from the market and operational risks Bankers feel that the credit risk in India is still high as per the global standards due to inadequate laws for recovery of the NPAs and lack of information sharing data base among bankers on the risk profile of the borrowers.

 

However it is not clear how the Government can go around the Supreme Court stricture on predeposit.

The Government can take two-pronged approach.

Firstly it can amend s.17. there are several options

It can reduce the amount, to say 25% of the amount due as recommended by the Bankers.[28]. It can make the debtor pay 75% of the pending amount rather than 75% of the interest rather than the whole loan as had been suggested by the Small Industries lobby some time ago.

The other way is to amend the DRT Act that makes putting a stay order against the enforcement of the security interest difficult, indeed impossible without the presence of a prima facie case. It seems this is the approach the Government is rather inclined to take.[29]

 

It is submitted the second approach is the most feasible one. The reason why the Court rejected the amount of predeposit was that the debtor may not be in a position to pay after the secured creditor has enforced his interest’s – a 25% predeposit may be held to be just as onerous by the Court .

 

The amendment should not only clear the air for the Banks but should also clear certain othyer ambiguities in the Act that has been mentioned like the broad definition of “. “aggrieved persons”, the locus standi of then Unions and the unsecured creditor before the DRT after the security interest under s.13 is enforced.

 

The judgment in this case has taken off the pressure that the laon defaulters, but the sake of the economy and development certain pressure has to exist .It remains to be seen how the Government brings some teeth into the Act without compromising on the fairness to the debtor.

 

[1] State of Andhra Pradesh v Mcdowell AIR 1996 SC 1627 Para 45, 47A

[2] AIR 2002 SC 350

[3] Raghubir Dayal v Union of India AIR 1962 SC 263

[4] YA Marmade v Authority under Minimum Wages Act (1972) 2 SCC 108

[5] Krishan Kakkanth v Government of Kerala (1997) 9 SCC 495

[6] 1951 SCR, 292

[7] 1963(3) SCR, 1

[8] 1963 (Supp.)1 SCR p. 282,

[9] 1974(1) SCC p. 424.

[10] 2001(5) SCC 546

[11] 1978(2) SCC 1

[12] 1977(2) SCC p. 670

[13] Kihoto Hollohan v. Zachillhu & Ors1992 Suppl. (2) SCC p. 651 and Associated Cement Companies Ltd v. P.N. Sharma(1965(2) SCR p. 366 at pages 386-87).

[14] Case laws support this view.See Mafatlal Industries Ltd. and Ors. v. Union of India and Ors. 1997(5) SCC p. 536 at page 735

[15] Adams v. Scott, (1859) 7 WR (Eng.) 213 (Z49)

[16] This logic has been accepted by the See RS Raghunath v State of Karnataka AIR 1992 SC 81, Union of India v Elphinstone Spinning and Weaving Co Ltd I 2001 (1) JT SC 536

[17] K Surendranathan v Kerala Financial Corporation AIR 1988 Ker 330

[18] 7th edn ,p 94

[19], Vijay Prakash D. Mehta and Anr. v. Collector of Customs (Preventive) Bombay 1988(4) SCC p. 402

[20] Shyam Kishore & Ors. v. Municipal Corporation of Delhi, 1993(1) SCC p. 22

[21]R.K. Garg v. Union of India (1981) 4 SCC p. 675

[22] Bhavesh D. Parish & Ors. v. Union of India & Anr., 2000(5) SCC 471 at 486 , also seeSrinivas Enterprises v. Union of India 1980(4) SCC p. 507 at 513-514, and Jalan Trading v. Union of India. 1967(1) SCR p. 15 at p. 36, the Collector of Customs, Madras v. Nathella Samapathu Chetty, 1962(3) SCR p. 786 at p. 829-30,

 

[23] CLC 20001669(Guj HC)

[24]Fine-tuning The SARFAESI Act www.fecolumnists.expressindia.com/full_column.php?content_id=42502 –> last visited 4.8.04

[25] Srilekha Vidyarthi v State of Uttar Pradesh (1991) 1SCC 912

[26] LIC v Consumer Education Research Center (1995) 5 SCC 482

[27] Even the Court System accepts the presence of delay tactics and over the years have taken a strong exception to it.

In Mahmad Manzoor Alam V. State of Bihar & Others {PLJR 2003(2), 148} the Hon’ble High Court of Patna has dismissed the petition with costs on the ground that the petitioner who defaulted in repayment of loan, resorted to legal engineering to avoid the liability of repayment. The court observed that the debts, if not pad, contribute to the deficit financing of the nation’s planned economy and affects the persons also who have nothing to do with these loans and who get lined up unconsciously for making up these bad debts by paying taxes, direct or indirect.

[28] IBA seeks deterrent to combat defaulters, www.ahmedabad.com/index/viewarticle/article/14480/sect last viewes 23.7.04

[29] Poornima Mohandas, Budget promise to amend Securitisation, DRT Acts — Banks breathe easy on NPAs, ,www.thehindubusinessline.com/bline/2004/07/10/stories/2004071000760800.htm –> last viewes 23.7.04