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Who gets paid 1st when debt recovery happens or company goes bust; here’s what law says about secured creditors

Who gets paid 1st when debt recovery happens or company goes bust; here's what law says about secured creditors Who gets paid 1st when debt recovery happens or company goes bust; here’s what law says about secured creditors

By Radhika Sankaran

The Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act came into force on September 01, 2016 with an objective to streamline the process of debt recovery. This Act, amongst the other amendments, also amended the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act).

It introduced a non-obstante clause as Section 26E giving priority to payment of debts owed to the secured creditor over all other debts and all revenues, taxes, cesses and other rates payable to the Central Government or State Government or local authority.

This provision is in addition to the already existing non-obstante clause in Section 35 which gives overriding effect to the SARFAESI Act, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law.

The aforesaid provision seemingly gives priority to the payment of the debts of a secured creditor over every other debt in existence but this conferment of priority of payments has to be weighed-in against other dues of the debtor which might have been conferred with a first charge provision under other legislations.

For instance, Section 11(2) of the Employee’s Provident Fund and Miscellaneous Provisions Act, 1952 and Section 14 of the Employees Compensation Act, 1923 provides that the amount due from the employer towards the Provident Fund contribution or compensation shall be treated as the first charge on the assets of the establishment, and notwithstanding anything contained in any other law, such dues shall be paid in priority to all other debts.

Once would find such first charge provisions also in the sales tax regulations of various states such as the Rajasthan, Maharashtra and Kerala which states that notwithstanding anything contrary containing any other law for the time being in force, any amount of tax, penalty, interest and any other amount payable by a dealer or any other person shall be the first charge on the property of the dealer or such person.

The fact that Section 26E was introduced in 2016 may lead one to believe that the non-obstante clause under this section providing for a priority in payment to the secured creditor over all other dues under any statute, would have precedence in terms of enforceability, over all other provisions that existed prior to 2016, thereby giving an absolute right to the secured creditors to enforce its security.

However, one needs to analyse whether it shall be lawful for a secured creditor to enforce its security interest by selling or disposing-off the secured asset which happens to be encumbered with a first charge created vide a statute existing prior to 2016, and also about the legitimacy of the title over the asset so acquired by the transferee from the secured creditor.

Implications of a non-obstante clause have been interpreted by the courts in various cases wherein it  has been held that before enforcing a non-obstante clause, it is essential to find out the extent to which the legislature had intended to give one provision an overriding effect over another prevailing provision and this must be done, keeping in view the legislative policy underlying the prevailing enactments.

This is attributable to the principle that a subsequent law does not necessarily repeal an earlier law but might repeal a provision to the extent that it is conflicting with the later provision. A non-obstante provision comes into effect only in case there is a conflict between the existing provisions regarding the same subject matter.

Therefore, to be under the impression that Section 26E being a non-obstante clause will always have an overriding effect over all the existing provisions dealing with priority of payments could blindside the secured creditor, as the prevailing effect of a non-obstante clause shall have to be determined on a case to case basis in light of the ratio laid down by the courts.

It will always be beneficial for a secured creditor to take into account provisions of first charge provided in other laws and to be wary about any statutory encumbrances or the crystallization of any charge on the asset provided to it as a security, especially when the secured creditor is desirous of enforcing its security interest by relying on the priority conferred to it under Section 26E of the SARFAESI Act.  In this regard, a word of caution also to the person who seeks to acquire an asset from a secured creditor.

Radhika Sankaran is a Partner at Lakshmikumaran and Sridharan Attorneys. Views are her own.

Source: Financial Express