Position of a tenant when landlord becomes a defaulting debtor

The Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (the ‘SARFAESI Act’ or ‘the Act’)was enacted to help financial institutions secure assets in various ways. The objective of this Act is to remedy the problem of Non-Performing Assets (NPAs) or bad assets by different methods and mechanisms.  This article focuses on one such situation – the position of the tenant/lessee when the landlord is a debtor of a financial institution and the premises is the secured asset for such debt. The situation has a similar effect on the tenant/lessee as that of a child in the event of a  divorce between his parents.

To remedy this, on September 1, 2016, the Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provision (Amendment) Act, 2016 came into effect inter alia amending Section 17 of the SARFAESI Act by replacing the heading “Application against measures to recover secured debts” with  “Right to Appeal” and inserting a sub-Section (4-A) to Section 17. The amendment had the effect that if any person claims of tenancy in the secured asset then that person has to approach the Debts Recovery Tribunal (DRT) which has the jurisdiction to decide about the legitimacy of that lease or tenancy after examining the facts of the case and evidence.

In case the landlord borrows a loan from a bank/financial institution mortgaging the building as secured asset for the same and thereafter defaults the repayment of the interest and loan; the financial institution invokes the provisions of SARFAESI Act against the landlords/borrower by issuing a notice under Section 13(2) asking them to  fulfill their liability within 60 days, failing which the financial institution would initiate proceedings to acquire the secured asset to recover the outstanding loan amount. The financial institution also approaches the Magistrate under Section 14 of the Act, which gives him the authority to assist in acquiring the secured asset and to allow them to take over the possession of the secured asset which will be the building in this instance. Here,  if the Magistrate passes an order in favor of the financial institution directing it to take over the physical possession of the building to recover the outstanding loan amount, the tenants of the premises, who were oblivious to all the legal battles between the landlord and the financial institution, would suffer immeasurably. The only option left to the tenant/lessee would be to approach the higher courts to remedy the situation.

Situations like these were remedied previously by the Supreme Court and the various High Courts of the country in various cases. Some of the decisions were prior to the above-mentioned amendment and the amendment only emphasizes what the judicial precedents have observed.

In the case of Harshad Govardhan Sondagar v. International Assets Reconstruction Company Ltd and Ors., (2014) 6 SCC 1, the Supreme Court observed that the Magistrate would have to give notice and an opportunity of hearing to the person claiming to be the lessee of a secured creditor thereby following the Principles of Natural Justice. The Supreme Court also observed that only after examining the legitimacy of the lease/tenancy must the Magistrate pass the order in such cases.

In the case of Vishal N Kalsaria v. Bank of India and Ors., (2016) 3 SCC 762, the Supreme Court rightly pointed out that ‘if it is held that the provisions of SARFAESI Act will override the provisions of various Rent Control Acts, then to allow a Bank to evict a tenant from the tenanted premise, which was a secured asset of Bank, after the default on loan by the landlord and dispense with the procedure laid down under various Rent Control Acts and the law laid down by the courts, then the legislative powers of the State legislature are stripped and that would amount to subverting the law enacted by the State legislature.’

In Sanjivkumar Surajprakash Aggarwal v. State Bank of India and Ors., (2016) 14 SCC 532, the Supreme Court directed that the Magistrate was to conduct an enquiry under Section 14 of the Act involving the Appellant in that case, the tenants, and that it would be fit and fair to adjudicate based on the Principles of Natural Justice.

In the case of Swastyayan Agro Industries and Anr. v. Union of India and Ors., WP No. 379(W) of 2013, Calcutta High Court took the view that theDistrict Magistrate cannot direct the Bank to take over the possession of Secured Asset with Police aid under Section 14 of the Act and had stated that such an act was beyond the mandate of Section 14.

What is interesting to note is that the lower courts have the tendency to repeatedly oversee the precedents and still pass orders without considering the rights of the tenants. Some of the aggrieved tenants/lessees in Karnataka approached the High Court where a similar situation had arisen. In the case of M/s Remco Software Pvt Ltd and Ors. v. HDB Financial Services Ltd and Ors., WP No 35597-601/2017 and 35602-604/2017, decided by a Single Bench comprising of Vineet Kothari, J., the above-mentioned precedents were relied upon and a judgment was passed in favor of the tenant reiterating their rights. The Court made interesting observations and laid down precedents which are of high significance for those practicing in the courts of Karnataka –

1. Notice to a tenant is a must

While exercising power under Section 14 of the Act, the learned Magistrate has erred in saying that a  ‘notice need not be issued to the tenants’ and that Section 14 does not exclude the compliance of principles of Natural Justice. It further went on to say that irrespective of the proceedings under Section 13(4) of the Act, the Magistrate, if it is brought to notice that the secured asset is being occupied, has to issue notice while invoking Section 14 of the Act. It was also noted that it is the duty of the landlord to bring to the notice of the court about such occupancy.

2. Confirm the validity of lease/tenancy

The Court went on to also state a disclaimer of sorts, by saying that it also becomes apparent to examine if it is a valid lease/tenancy and if it was created before or after the creation of mortgage. Stating further, that the tenants cannot be evicted directly without DRT expressing its opinion about the bona fides of such tenancy. If proven that the tenancy is a way to contravene the proceedings under the Act, such occupants are to be rightfully evicted by DRT under Section 17(4) of the Act.

3. Tenants have the right to be heard

Justice Kothari had rightly relied upon the judicial precedents and stated that the Magistrate must refrain from acting only on the affidavit of the banks but has to consider the rights of the borrowers to controvert the affidavit and that of the tenants of the premises are to be heard. And that the Petitioners-tenants/lessees’ contention was right in pointing out that the Magistrate had erred by ordering to deliver the possession of the secured asset to the secured creditor straight away.

4. Transfer of tenancy

However, in that event the auction purchasers are the ones who would have to step into the shoes of the landlord and take this due process of law and that the tenant cannot object to such proceedings against the defaulting borrower. It was also opined that the attornment of tenancy in favor of auction purchaser would be automatic under the Act and DRT can direct payment of rental to the bank.

This judgment notably gave a disclaimer to avoid willfully defaulting borrowers/landlords getting into a system of avoiding acquisition of the secured assets by the financial institutions through the help of the amendment which was made to protect the tenants’ rights.

The ratio laid down by the Remco case was followed in a later decision by the same Court in the case of Mahadevaiah v. Karur Vysya Bank and Ors., WP no. 32864/2017, and in a recent decision of Smt. Aravindamma v. Smt. K.S. Jayalakshmammanni, 2018 SCC OnLine Kar 530, thereby reiterating the position of law that tenants have a right to approach DRT under Section 17 of the SARFAESI Act.

The situation which was ambiguous regarding the status of tenancy has been cleared due to the latest amendment and the clarification by the courts – no more do the tenant has to pay for the dues of the landlord. The clarification and check and balances introduced will be very helpful tenants who are stuck between the tiff of their landlord and the bank.

DISCLAIMER: The information provided in this article is for educational purposes only. The same cannot be construed as legal advice.