Forfeiture of Earnest Money Deposit by Bank is Not Limited to Extent of Damage Suffered

The Hon’ble Supreme Court of India, in the case of Authorised Officer, Central Bank of India v. Shanmugavelu, [2024 INSC 80] held on February 2, 2024, that banks can cause the forfeiture of the entire amount of the earnest money deposit and not restrict it to the extent of the damage or loss suffered by it due to a default on repayment of the loan by the borrower. The court observed that the mere harshness of a provision of law cannot cause it to be ‘read down’ by the court when the provision is clear and unambiguous. The court also held that sections 73 and 74 of the Indian Contract Act, 1872, do not apply to Rule 9(5) of the Security Interest (Enforcement) Rules, 2002 (hereinafter referred to as the “SARFAESI Rules, 2002”).

The Central Bank of India, the Appellant in the present case, had extended credit facilities to a borrower against a parcel of land held as security interest. When the borrower failed to meet their obligations of repayment, the loan was categorized as a Non-Performing Asset (NPA), and the bank invoked the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (the “SARFAESI Act, 2002”), to take possession of and auction the parcel of land that was the secured asset. The Respondent, who was the winning bidder in this auction, deposited 25% of the bid amount as earnest money, upon which the Appellant verified the sale and issued a confirmation letter in this behalf in favour of the Respondent. The Appellant also clearly specified via the confirmation letter that in the event of default in payment of the balance amount by the Respondent within 15 days from the date of receipt of the confirmation letter, the sale was liable to be cancelled and the earnest money was liable to be forfeited. The Respondent made a request to the Appellant for an extension of three-months which was approved in accordance with Rule 9(5) of the SARFAESI Rules, 2002. The letter of approval for the extension also clearly stated that there was no possibility of a further extension. Unable to pay the balance amount within the extended period, the Respondent made a request for a further extension of 15 days. This was denied, resulting in the cancellation of the sale and forfeiture of the earnest money deposited.

The Respondent contested the forfeiture before the Debt Recovery Tribunal (DRT), which instructed the bank to reimburse the earnest money while deducting Rs. 5 lakhs for costs. During the proceedings in the DRT, the Appellant bank conducted a fresh auction, with a completed sale receiving Rs. 14.76 crore. On appeal to the Debt Recovery Appellate Tribunal (DRAT), the forfeiture amount was raised to Rs. 55 lakhs, however, a refund of the remaining amount was directed. On further appeal to the High Court, the DRAT order was overturned, emphasizing that theorfeitture of earnest money should not be in excess of the loss or damages suffered by the Appellant Bank, in line with sections 73 and 74 of the Indian Contract Act, 1872, even though it was permitted by the SARFAESI Rules, 2002. Aggrieved by the order, the present case was brought before the Apex Court.

The main issues for consideration before the Supreme Court were;

(i) Whether the forfeiture of entire earnest money under Rule 9(5) is restricted to the extent of the loss and damages incurred as per Sections 73 and 74 of the Contract Act?

(ii)  Whether the quantum of forfeiture under the SARFAESI Rule is limited to the extent of debt owed?

(iii) Whether there existed ‘exceptionable circumstances’ to set aside the order of forfeiture of the earnest money deposit?

On considering the contentions of both parties, the Supreme Court observed that sections 73 and 74 of the Indian Contract Act, 1872 have no application to the forfeiture of money according to the SARFAESI Rules, 2002. The objective of the SARFAESI Act, 2002 and the SARFAESI Rules, 2002 is to depart from the general provisions of the law for speedy debt recovery from the borrower in the event of default in the repayment of loans. Relying on well settled precedents on the matter, the court further stated that if the provisions of the Indian Contract Act, 1872 were to apply to Rule 9(5) of the SARFAESI Rules, 2002 then the purpose of the auction process would be defeated, allowing every devious borrower to make sham bids and default in the payment of the balance amount at the last minute without facing any consequences for the same. The court also noted that the SARFASEI Act, 2002 being a special legislation has an overriding effect on general statutes unless the provisions explicitly state otherwise and therefore the court held that sections 73 and 74 of the Indian Contract Act, 1872 have no application on the SARFAESI Act or Rules and by extension, to the forfeiture of earnest money.

As regards the ‘reading down’ of a provision due to the harshness of its consequences, the court noted that the reading down of a provision is done with the objective of preventing constitutional or legal issues from arising on its plain reading, only where a narrow reading of the provision in question was required to uphold its constitutionality. Holding that the mere harshness of a provision’s applicability on its plain reading does not justify altering its clear and legally valid meaning, the Supreme Court dismissed the High Court’s view on reading down Rule 9(5) of the SARFAESI Rules, 2002.

The court further disagreed with the High Court’s observation that forfeiture of the entire amount of deposit by the Appellant bank when the subsequent sale of the Secured Asset was at a much higher price than the previous auction amounted to ‘unjust enrichment’. The court observed that there looms a degree of uncertainty as to the extent of bids that may be received in the future auction or whether the fresh auction would even be successful or not. Also, with the efflux of time, the value of the Secured Asset erodes. In such a case it would be preposterous to tie or limit the forfeiture under Rule 9(5) of the SARFAESI Rules on an eventuality or a contingency of a subsequent sale of the secured asset if any. The court stated that no extent of equity can either substitute for or dilute the statutory consequence of forfeiture of 25% of the deposit under Rule 9(5) of the SARFAESI Rules.