EPFO Vs Banks – The Priority in Payment of Debts – By Chidambaram Ramesh

EPFO Vs Banks – The Priority in Payment of Debts

– By Chidambaram Ramesh

(Author of The Law of Employees’ Provident Funds – A Case-law Perspective)

Recently, the Madras High Court in Axis Bank Ltd. Vs. The Assistant Provident Fund Commissioner & Recovery Officer (2022) ibclaw.in 464 HC ruled that the banks claiming as secured creditors under the SARFAESI Act cannot seek a ‘first charge’ over the lien on the money deposit because the lien is not covered under the SARFAESI Act as a security interest.  Two arguments support the ruling of the Madras High Court.  First, the term “lien” is notably omitted from Section 2(z)(f) of the SARFAESI Act.  Second, Section 31 of the SARFAESI Act specifies that the Act’s provisions do not apply to the lien.

History of the Case

M/s Dharani Offset Printers had borrowed money from M/s Axis Bank by creating a mortgage under a loan agreement. Due to its failure to repay the loan, the debts were classified as Non-Performing Assets.  Meanwhile, M/s Dharani Offset Printers obtained an Rs. 5 lakh bank-guarantee from M/s Axis Bank.  This bank guarantee was given in exchange for a fixed deposit with a 100% cash margin (against which the Bank created a lien).  Apart from that, M/s Dharani Offset Printers had failed to pay the statutory dues under the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952, prompting the Assistant Provident Fund Commission to issue a garnishee order in terms of Section 8F(3) of the EPF & MP Act, 1952 requiring the Bank to pay the EPF arrears of the defaulter from and out of the money held on behalf of the defaulter.  The Bank claimed that its obligation to honour the garnishee order is restricted to the money held on behalf of the defaulter over and above the dues owed to the Bank.  The Bank asserted its right to pursue its security interest as the secured creditor under Section 171 of the Indian Contract Act, 1872.[1] In other words, the Bank claimed that it not only had its right to lien but was also entitled to exercise the powers to acquire the security interests.  The bank guarantee issued to the borrowed was against the fixed deposit of an equivalent value, and a lien was marked against the fixed deposit of the borrower.  The Respondent PF Commissioner claimed that the Provident Fund arrears should be deemed to be the ‘first charge’ on the assets of the defaulter, notwithstanding anything contained in any other law for the time being in force, having priority over other debts, as provided under Section 11(2) of the EPF & MP Act, 1952.  The Ld.  Counsel for the PF Department relied on the Supreme Court’s decision in Central Bank of India vs State of Kerala and others.[2]  In that case, the Supreme Court ruled that the statutory first charge on the property would precede the rights made for secured creditors like banks and other financial institutions.

The High Court discussed the meaning of ‘secured creditor’ appearing in Sec. 2(1)(e) of the Provincial Insolvency Act and that of ‘Secured Creditor” under the SARFAESI Act.  “Secured Creditor” means a person holding a mortgage, charge or lien on the debtor’s property or any part thereof as a security for a debt due to him from the debtor.” Similarly, Section 2(1)(zf) of the SARFAESI Act defines ‘security interest’ as follows: “Security interest means right, title or interest of any kind, other than those specified in Section 31, upon property created in favour of any secured creditor and includes – (i) any mortgage, charge, hypothecation, assignment or any right, title or interest of any kind, on tangible asset retained by the secured creditor as an owner of the property, given on hire or financial lease or conditional sale or under any other contract which secures the obligation to pay any unpaid portion of the purchase price of the asset or an obligation incurred or credit provided to enable the borrower to acquire the tangible asset; or (ii) such right, title or interest in any intangible asset or assignment or licence of such tangible asset which secures the obligation to pay any unpaid portion of the purchase price of the intangible asset or the obligation incurred or any credit provided to enable the borrower to acquire the intangible asset or licence of intangible asset.

Thus, the meaning of the phrase ‘Security Interest’ is subject to the overriding clause contained in Section 31 of the SARFAESI Act.  Section 31 stipulates that the provisions of the SARFAESI Act will not apply to lien on any goods, money or security given by or under the Indian Contract Act, 1872 or the Sale of Goods Act, 1930 or any other law for the time being in force.  Given this, it is clear that the lien on any goods or money under the Indian Contract Act will not come as a ‘security interest,’ reasoned the High Court.

Difference between Lien and Mortgage

The word ‘lien’ is defined in Stroud’s Judicial Dictionary[3] as “the right to retain possession of a thing until a claim is satisfied, and it is either particular or general.” The mortgage and lien are distinct in purpose and large in nature.  Mortgage arises only on the intentional acts of the mortgager and the mortgagee.  Indeed, the lien is seen by many as indicating a security interest arising from the operation of law imposed on certain relationships, such as the unpaid vendor’s lien.  But just as certainly, liens may be created by contract and identical to a charge.  Whether or not it is will depend on the nature of the lien created.

Secured Creditors under the Provincial Insolvency Act

Section 2(e) of the Provincial Insolvency Act, 1920 defines the “Secured Creditor” as “a person holding a mortgage, charge or lien on the property of the debtor or any part thereof as a security for a debt due to him from the debtor”.

Two arguments support the ruling of the Madras High Court.  First, the term “lien” is notably omitted from Section 2(z)(f) of the SARFAESI Act.  Second, Section 31 of the SARFAESI Act specifies that the Act’s provisions do not apply to the lien.  Therefore, the Court ordered that the Bank claiming as a secured creditor under the SARFAESI Act cannot seek a ‘first charge’ over the lien on the deposit because the lien is not covered under the SARFAESI Act as a security interest.  The Court also said that a fixed deposit creates not a security interest but only a lien.  Since the SARFAESI Act does not consider a lien a secured interest, banks cannot claim to be the secured creditors.

Responsibilities in case of Sale of Attached Properties

The Recovery Officer of the Provident Fund Department is vested with the powers of attachment and sale of the defaulter’s property under Sec.  8-B of the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952.  The Recovery Officer of the EPFO can also attach a property mortgaged by the defaulter to a bank.  This being the case, situations may arise where the Authorised Officer of the Bank may have to proceed with the sale of the mortgaged property of the defaulter, and the same property was already attached by the Recovery Officer of EPFO and is encumbered.

Sub-Rule (7) to (10) of Rule 9 of the Security Interest (Enforcement) Rules, 2002, attempts to sort out the above issue. Sub-Rule (7) of Rule 9 provides, “where the immovable property sold is subject to any encumbrance, the authorised officer may, if he thinks fit, allow the purchaser to deposit with him the money required to discharge the encumbrances and any interest due thereon.  On such deposit of money for discharge of the encumbrances, the authorised officer may issue or cause the purchaser to issue notices to the persons interested in or entitled to the money deposited with him and take steps to make the payment accordingly.  If, after meeting the cost of removing encumbrances, there is any surplus available out of the money deposited by the purchaser, such surplus shall be paid to the purchaser within 15 days from the date of finalisation of the sale.  Rule 9(9) mandates that the Authorised Officer deliver the property to the purchaser free from encumbrances known to the secured creditor on deposit of money.  Likewise, Rule 9(10) stipulates that the certificate of sale issued by the Authorised Officer should mention whether the purchaser has purchased the immovable secured asset free from any encumbrances known to the secured creditor.  A combined reading of rules 9(9) and 9(10) reveals that the Authorized Officer of the Bank proceeds with the sale of the defaulter’s mortgaged property, which the EPFO’s Recovery Officer has already attached, is obligated to collect the arrears against which the EPFO attached the property, and after removing the encumbrance on the property, proceeds with the sale of the defaulter’s property (by paying the dues for which the EPFO attached the property).  Before issuing the Sale Certificate to the winning bidder/buyer, the property must be free of encumbrance.

 

Reference

[1] 171. General lien of bankers, factors, wharfingers, attorneys and policy-brokers. —Bankers, factors, wharfingers, attorneys of a High Court and policy-brokers may, in the absence of a contract to the contrary, retain as a security for a general balance of account, any goods bailed to them; but no other persons have a right to retain, as a security for such balance, goods bailed to them, unless there is an express contract to that effect. —Bankers, factors, wharfingers, attorneys of a High Court and policy-brokers may, in the absence of a contract to the contrary, retain as a security for a general balance of account, any goods bailed to them; but no other persons have a right to retain, as a security for such balance, goods bailed to them, unless there is an express contract to that effect.”

[2] (2017) ibclaw.in 73 SC

[3] 3rd Ed., pg.1644

 

Disclaimer: The Opinions expressed in this article are that of the author(s). The facts and opinions expressed here do not reflect the views of IBC Laws (http://www.ibclaw.in). The entire contents of this document have been prepared on the basis of the information existing at the time of the preparation. The author(s) and IBC Laws (http://www.ibclaw.in) do not take responsibility of the same. Postings on this blog are for informational purposes only. Nothing herein shall be deemed or construed to constitute legal or investment advice. Discussions on, or arising out of this, blog between contributors and other persons shall not create any attorney-client relationship.