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What Happens To The Tenancy Right (Long Term License) If The Property Owner Is Declared NPA And The Property Is Auctioned?

The banking system of India achieved another milestone with the emergence of Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 (SARFAESI). This act imparts power to the banks to take possession and sell the secured asset without taking recourse to filing cases in Courts or the Debt Recovery Tribunal.

Reforms under this act primarily aim at fostering the speedy recovery of defaulting loans and thus regulating the rising number of Non-Performing Assets (NPA). It was initially formulated to cater to the management of security interests; however, the act failed to answer some important questions such as those pertaining to the establishment of tenancy rights in cases of secured assets and so on.[1] This paper seeks to answer such questions.

Background
Section 2(zc) of the SARFAESI Act[2] defines secured asset' as the property on which security interest is created'. With respect to an immovable property, a secured interest is effectuated in a secured asset by way of a mortgage in the interest of the secured creditor. However, there may be circumstances wherein the borrower had already leased out the property in favor of a lessee either as the owner or someone who is competent to make the said transfer, before the mortgage is created by virtue of Section 7 of Transfer of Property Act (TOPA)[3].

In such cases, the lessee will have the right to enjoy the said property in compliance with the terms and conditions of the lease agreement irrespective of whether the mortgagee of the said property has knowledge about the lease as per Section 8, TOPA[4].

Section 65A, TOPA[5] governs the rights of the borrower to lease a mortgaged immovable property after it has been mortgaged in favor of a secured creditor. As per Section 65A(1) of the act, the mortgagor being in lawful possession of the mortgaged property has all the rights to lease it, subject to the conditions mentioned under Section 65A(2), TOPA. Also, the mortgagee is bound by the lease, until and unless a contrary intention is expressed in the mortgage deed. Thus, as long as the mortgage deed does not forbid a mortgagor from making a lease of the mortgaged property, it will be valid and binding on the secured creditor.

Section 13 of the SARFAESI Act[6], bestows a statutory right on the secured creditor to take possession over the secured asset for the realisation of the secured debt. Section 13(4) of the act states that the secured creditor may take recourse to any of the measures mentioned in this section to recover his debt, in case the borrower is unable to discharge his liability in full within the sixty days period from the date of notice as mentioned under Section 13(2); one of them being to take possession of the secured assets of the borrower as well as his right to transfer by way of lease.

However, in cases where the lawful possession of the secured asset is with a lessee under a valid lease agreement and not with the borrower, the secured creditor cannot take over possession until the lawful position of the lessee gets identified.

Taking into account Sections 105 and 111, TOPA[7], the lessee has an unfettered right to enjoy the property which cannot be taken away until and unless there is a lawful explanation for the same as mentioned in Article 300-A of the Constitution, as long as the lease of that immovable property remains undetermined.

Section 13(13) of the SARFAESI Act[8] states that after the receipt of the notice, no borrower shall lease any of his secured assets mentioned in the notice, without taking the prior written consent of the secured creditor.

This provision of the SARFAESI Act is at loggerheads with the provisions of TOPA which permit the borrower to make a lease after he has entered into a mortgage. Therefore, Section 13(13), SARFAESI Act will have an overriding effect on the provisions of Section 65A, TOPA as a result of Section 35, SARFAESI Act to this extent, and a lease of a secured asset made by the borrower after he has received the notice (Section 13(2), SARFAESI Act) from the secured creditor will be an invalid lease.

Rights Of The Secured Creditor Under The Sarfaesi Act Against Tenanted Secured Asset

A recent Supreme Court judgment in Harshad Govardhan Sondagar v. International Assets Reconstruction Company Ltd.[9] has provided a boost to the banks towards enabling the speedy recovery of their dues by opening the door for banks to secure rapid vacant possession of the property even by evicting certain types of tenants.

The court held that the Bank in its own capacity could vacate:
  1. Tenants whose leases have expired or stood determined
  2. Tenants whose leases are: a) inconsistent with the provisions of Section 65A, TOPA; b) inconsistent to the conditions of the mortgage;
  3. created after notice of default under Section 13(2), SARFAESI Act has been issued[10]
The judgment was rendered at a time when the SARFAESI Act was facing a lot of criticism, due to defaulters trying to take undue advantage of the loopholes in the act, causing a prejudice to the banks.

Analysis Of The Judgment And Its Implication On Banks

Tenants of secured assets were classified into three categories to understand the significance of the judgment.[11]
  1. A tenant who was inducted into the property before it was mortgaged to the bank
  2. A tenant who was inducted into the property after it was mortgaged to the bank but before the issuance of notice of default under Section 13(2), SARFAESI Act by the bank.
  3. A tenant who was inducted into the property after the bank has issued a notice of default and demands payment under Section 13(2), SARFAESI Act
Category 1: With respect to the 1st category, the Supreme Court has held that such tenancy would be binding on the secured creditor i.e. the bank. Rights of the bank covered under the SARFAESI act cannot supersede the rights of the tenants under TOPA. In case the lease is valid and in force and has not expired at the time bank seeks to take possession of the property, then in that case the tenants cannot be asked to dispossess the property until their lease expires or stands terminated as per law. However, the option with respect to the sale of the property still remains with the bank, subject to the rights of the tenants. In this case, the bank would not be able to hand over the possession of the vacant property to the buyer.

Within this category itself, there could be cases where there are tenants whose lease may have begun before the mortgage but may have expired/terminated at the time when bank seeks to take possession. In such cases, the tenant could be removed after receiving an order from the Magistrate, who is required to give a proper notice and an opportunity of being heard to the parties.
It is not necessary that the lease should have been terminated by the landlord himself in case it has not expired.

After the expiry of the 60 days period as mentioned under Section 13(2), SARFAESI Act, the bank may take over the landlord's ownership rights and thus even if the lease was created before the mortgage and has not yet expired; in case the terms of the lease allow the landlord to terminate the lease under certain circumstances such as default on payment of rent etc., and if those circumstances exist, the bank of its own accord has an option to issue a notice for terminating the lease as per the conditions mentioned therein, then subsequently applying to the Magistrate and obtaining eviction orders of the tenant once he has been given an opportunity of being heard.

Nevertheless, even in the aforementioned case, if the tenancy is covered under any Rent Control Act and that act permits for the recovery of possession only by a special tribunal/court and only under special conditions, it would follow that the tenant cannot be evicted by the Magistrate at the request of the bank and that such sale would be subject to the tenant's rights and privileges. The bank would not be in a condition to hand over the possession of a vacant property to the buyer.

Category 2: With respect to the 2nd category, a further classification of this lease can be created:
  1. A lease that complies with the provisions of Section 65A, TOPA and is not in contravention with the terms and conditions of the mortgage.
  2. A lease that is in contravention with the provisions of Section 65A, TOPA.
  3. A lease that is in contravention to the terms of the mortgage, forbidding the mortgagor from creating any leasing of the property.

With regard to sub-category (a), the Supreme Court has held that these tenants cannot be deprived from enjoying their property by the banks, until and unless their leases have expired or have been terminated in accordance with the terms of the lease.

In case the Bank wants to sell the property, it will have to do so keeping in mind the terms of the lease and the tenant's rights of possession. The court also noted that tenants would have to produce a registered lease deed if they were to claim a lease for a period of more than one year according to the provisions of Section 107, TOPA, as that can only be created by a registered document.

However, this was subsequently overturned in the case of Vishal Kalsaria v. Bank of India[12], wherein the Supreme Court held that if two parties perform their rights and duties under a landlord-tenant relationship and all the requirements of the rent are being met, then in that case the absence of a written lease deed will not render the lease insignificant for the purposes of claiming occupation as tenants in the proceedings.

Also, in this case, the bank was allowed to take over the rights of the landlord and terminate the lease and subsequently apply to the magistrate for further actions. Had the lease fallen under any Rent Control Act, then this wouldn't have been possible. Since it didn't, this meant that the lease could be terminated under the conditions mentioned in the contract. If the conditions were violated, then after the 60 days period as under the SARFAESI Act, the bank's powers kicked in.

With regard to sub-category (b), wherein a lease is created after the mortgage but in contravention to the terms of Section 65A, TOPA, the Supreme Court has held it to be invalid, thus allowing the bank to recover the possession of the vacant property by approaching the Magistrate. For example: a lease of a property for a term of more than three years or for lesser than market rent would be held invalid. If the Magistrate is convinced that the lease is not in compliance with the requirements of Section 65A, TOPA, he can order the Police authorities to assist the bank for taking possession of the land.

Nevertheless, even in such situations, it is possible that the tenants may contend that although their leases were initially invalid as being in contravention to Section 65A, TOPA; however because of the acceptance of rent by the landlord, a monthly lease has been established. In order to deal with such claims, it would be desirable for the banks to give a notice to the tenants after taking over the ownership rights under the SARFAESI Act, ceasing the alleged lease that can be asserted with a 15 days prior notice being without prejudice to the bank's assertion that there is no legitimate lease at all.

With regard to sub-category (c), the banks have an option to directly approach the Magistrate to seek recovery by evicting the alleged tenants from the property as their tenancies are also void. The bank need not file a suit before the Civil court for vacating the tenants.

Category 3: With respect to the 3rd category, the Supreme Court has held that such leases would be void as the SARFAESI Act itself prohibits any creation of encumbrance without prior consent after a notice has been issued by the bank pursuant to Section 13(13) of the act. Thus, even in such situations, banks don't need to get the tenants evicted by filing a lawsuit in a civil court, nor can they be compelled to sell the property with such tenants in possession. The bank can simply get the tenants evicted and recover the possession of the vacant property by directly approaching the magistrate.

Leases Covered Under Rent Control Act[13]

In the cases pertaining to leases created before the property was put up for mortgage, if they are covered under a Rent Control act, banks may not be able to evict the tenants under the provisions of the SARFAESI Act, unless those leases have terminated as per the Rent Control Act. In order to refrain from such a situation, banks should ensure that the terms of the mortgage forbid the initiation of any such lease.

The lease would be void and may not be covered under the Rent Control act, in case it is created after the property is put up for mortgage since it would be in contravention to the terms of Section 65A, TOPA.

The lease would also be void in cases where it is created after the notice has been issued under Section 13(2) of the SARFAESI Act and as a result would not be covered under the safeguarding provisions of the Rent Control Acts.

The Supreme Court has held that all these questions pertaining to which category a tenant would fall under and with regards to his rights; it's the Magistrate whose decision will be binding upon the parties under the provisions of the SARFAESI Act. The only way by which it can be challenged is through filing a writ petition.

Tenants do not have an option of approaching the Debts Recovery Tribunal. However, in the latter case of Vishal Kalsaria[14], the Supreme Court laid down that the provisions under the SARFAESI Act cannot be arbitrarily applied to render the provisions of the Rent Control act futile, which would mean that the tenants cannot be vacated in contravention of the Rent Control Act.

Conclusion[15]
The ratio of the various cases cited herein, clearly lays down the fundamental rationale to be followed: an independent third party's tenancy rights always prevail over other rights of the borrower or the secured creditor.

Nevertheless, the courts have looked down upon the practice of creating tenancy rights for the sole purpose of defeating the interests of the secured creditor. Thus, the courts being aware of the consequences that such non-performing assets and slow recoveries result in, have resorted to interpreting both the SARFAESI Act and the Rent Control act as harmoniously as possible. It is significant to note that the above mentioned cases have been upheld in various High Court and Supreme Court judgments which clearly points out that the judicial intent is clear on this aspect.

End-Notes:
  1. https://www.taxmann.com. (2019). What is SARFAESI Act?. [online] Available at: https://www.taxmann.com/blogpost/2000000381/what-is-sarfaesi-act.aspx [Accessed 27 Oct. 2019].
  2. Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002
  3. Indiacode.nic.in. (2019). Transfer of Property Act, 1882. [online] Available at: https://indiacode.nic.in/handle/123456789/2338?view_type=browse&sam_handle=123456789/1362 [Accessed 27 Oct. 2019].
  4. Ibid.
  5. Ibid.
  6. Indiankanoon.org. (2019). Section 13 in The Securitisation And Reconstruction Of Financial Assets And enforcement Of Security Interest Act, 2002. [online] Available at: https://indiankanoon.org/doc/1089596/ [Accessed 27 Oct. 2019].
  7. Indiacode.nic.in. (2019). Transfer of Property Act, 1882. [online] Available at: https://indiacode.nic.in/handle/123456789/2338?view_type=browse&sam_handle=123456789/1362 [Accessed 27 Oct. 2019].
  8. Indiankanoon.org. (2019). Section 13 in The Securitisation And Reconstruction Of Financial Assets And enforcement Of Security Interest Act, 2002. [online] Available at: https://indiankanoon.org/doc/1089596/ [Accessed 27 Oct. 2019].
  9. Harshad Govardhan Sondagar v. International Assets Reconstruction Company Ltd., (2014) 6 SCC 1
  10. Supremecourtcases.com. (2019). [online] Available at: http://www.supremecourtcases.com/index2.php?option=com_content&itemid=99999999&do_pdf=1&id=45822 [Accessed 27 Oct. 2019].
  11. Harshad Govardhan Sondagar v. International Assets Reconstruction Company Ltd., (2014) 6 SCC 1
  12. Vishal Kalsaria v. Bank of India AIR 2016 SC 530
  13. Anon, (2019). [online] Available at: http://spsharmaassociates.co.in/links/DRT_Judgement.pdf [Accessed 27 Oct. 2019].
  14. Vishal Kalsaria v. Bank of India AIR 2016 SC 530
  15. IndiaCorpLaw. (2019). Creation and Operation of Tenancy Rights over Secured Assets under SARFAESI - IndiaCorpLaw. [online] Available at: https://indiacorplaw.in/2018/12/creation-operation-tenancy-rights-secured-assets-sarfaesi.html [Accessed 27 Oct. 2019].

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