Unless the relevant law specifies the priority for debt repayment, banks cannot claim first charge.
The recent spate of appeals by banks and financial institutions seeking priority in debt recovery puts the Supreme Court in a somewhat similar situation as a security guard engaged in controlling a jostling queue. Default in payment seems to have become rampant, despite the coming into force of the Recovery of Debts Due to Banks and Financial Institutions Act 1993 and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002. Now that these laws have made the recovery faster, the line-up is for asserting priority in getting the money back.
Each creditor, and some taxmen too, a line in the Act proclaims, should be paid first, “notwithstanding” anything contained in any other law. However, the irony is that the one before him and the one after also carry a statute which declares that he has the first charge on the mortgaged property, “notwithstanding” anything contained in any other legislation. So it is for the Supreme Court to prevent the hopefuls from queue-crashing.
The latest batch of appeals by banks, Central Bank of India and others vs State of Kerala raised mainly two questions — whether sales tax arrears will take precedence over the dues owed to secured creditors, and whether the payment schedule should follow chronological order. The sales tax laws of Kerala, Maharashtra and several other states carry the ubiquitous word, “notwithstanding”. The debt recovery laws also have the same word, granting priority to secured creditors. Whereas the sales tax laws are legislated by the states, the debt recovery statutes are made by Parliament. Therefore, the question arises — will the central law prevail over the state laws?
The Supreme Court waded through all the laws which use the word “notwithstanding other Acts” and decided in favour of the states. This, despite Article 254 of the Constitution, which states that if there is inconsistency between laws made by Parliament and those made by the legislatures of states, the central law will prevail. The reason is that the debt recovery laws do not speak of “first charge” on the assets of a defaulter. On the other hand, the state legislations in this case specifically mention that the state dues will be the first charge on the property of the firms.
It is not that the two parliamentary laws inadvertently dropped the phrase. In fact, it is found in several central statutes like the Workmen’s Compensation Act, the EPF Act, the Mines and Minerals (Development and Regulation) Act and the Gift Tax. Section 529A of the Companies Act provides for “overriding preferential payments” to the workers and secured creditors in case of winding up. The debt recovery laws do not speak of ‘first charge’ to the dues of the secured creditors. Therefore, the latter must take a back seat when it comes to state revenue. The court also rejected the contention of the banks that a prior charge created in favour of a bank would prevail over the subsequent mortgage in favour of the state.
However, it all depends upon the way the provisions of law which governs the field are worded. Three months ago, the secured creditors won a decade-old battle asserting their priority in debt recovery over the state finance corporation (Union of India vs SIMCO Ltd). The firm borrowed money from the state financial agency by a mortgage, which it could not return. The state agency took over the mortgaged property. Meanwhile, the excise authorities also jumped in the fray and wanted to seize the property of the sinking firm. The Supreme Court said that “a debt which is secured or which by reason of the provisions of a statute becomes the first charge over the property must be held to prevail over government debt which is an unsecured one.”
One of the earliest cases in which the question of ‘first charge’ arose was in the context of income tax. In that case, Builders Supply Corporation vs Union of India (1965), the tax authorities argued that they had the first charge over the assets of the defaulting assessee. According to Section 46(2) of the Income Tax Act, the collector could proceed against an assessee to recover the arrears. However, this argument was rejected.
A year ago, a case arose where sugar was pledged with a bank by a company for securing a loan and it was not repaid (Bank of India vs Siriguppa Sugars & Chemicals). The goods were forcibly taken possession of at the instance of the revenue recovery authority from the custody of the bank. The bank approached the Supreme Court which stated that the Cane Commissioner and the workers of the mills stood only as unsecured creditors and their rights could not prevail over those of the bank.
