Rule 9(5) SARFAESI Rules: Forfeiture of Auction Deposit is Mandatory Statutory Consequence, Not Penal; Sections 73 & 74 Contract Act Inapplicable: Karnataka High Court - 2024-10-16

Karnataka High Court Upholds Canara Bank's Forfeiture of Rs 3.25 Crore Auction Deposit, Cites Mandatory Nature of SARFAESI Rules

Bengaluru: The Karnataka High Court, in a significant ruling, has upheld Canara Bank's decision to forfeit an earnest money deposit of Rs 3.25 crores from auction purchasers who failed to pay the balance bid amount within the stipulated time. The Division Bench, comprising Chief Justice N.V. Anjaria and Justice K.V. Aravind , set aside a Single Judge's order that had directed the bank to refund the amount.

The judgment, delivered on October 16, 2024, in Writ Appeal No.349 of 2024, heavily relied on the Supreme Court's pronouncements, particularly in Authorised Officer, Central Bank of India v. Shanmugavelu , emphasizing that the forfeiture under Rule 9(5) of the Security Interest (Enforcement) Rules, 2002 (SARFAESI Rules) is a mandatory statutory consequence and not a penal provision.

Background of the Dispute

The case originated from an e-auction conducted by Canara Bank on November 29, 2021, for a property in Wilson Garden, Bengaluru, under the SARFAESI Act to recover outstanding dues. The respondents, Mr. Subramanya Rao K and Mrs. H.N. Nagarathna , were the successful bidders, and they paid Rs 3.25 crores, representing 25% of the total bid amount.

The balance 75%, amounting to Rs 9.75 crores, was due within 15 days. Despite an extension granted by the bank until February 10, 2022, the respondents failed to remit the balance, citing ongoing loan processes. Consequently, the bank forfeited the Rs 3.25 crore deposit and proceeded with a fresh sale of the property on March 19, 2022, for Rs 11.02 crores.

The respondents challenged the forfeiture by filing a writ petition, seeking a refund. The Single Judge, in an order dated January 12, 2024, allowed the petition in part, directing the bank to refund the Rs 3.25 crores. The Single Judge reasoned that the bank had not adequately proven the loss it claimed from the resale and criticized the bank's conduct, particularly concerning a One-Time Settlement (OTS) with the original borrower.

Arguments Presented

Canara Bank (Appellant), represented by Sri Shetty Vignesh Shivaram , argued: * The writ petition should not have been entertained as an alternate remedy was available before the Debt Recovery Tribunal (DRT), citing Agarwal Tracom Pvt. Ltd. v. Punjab National Bank . * The respondents defaulted on payment, making the forfeiture under Rule 9(5) of the SARFAESI Rules mandatory. * The bank suffered a loss of Rs 1.98 crores in the subsequent sale and incurred additional interest losses.

The Original Petitioners (Respondents), represented by Senior Advocate Sri Aditya Sondhi, contended: * The bank was statutorily obliged under Rule 9(4) of the SARFAESI Rules to grant an extension of up to three months. * They claimed the bank did not provide proper clarifications and kept them in the dark about certain proceedings. * They cited several High Court and Supreme Court decisions ( P.Balaji Babu , S.L. Ispat Private limited , Syed Hidayathulla , Alisha Khan ) where refunds were ordered under varying circumstances, including instances where banks suffered no loss or where OTS was reached with the borrower.

High Court's Reasoning: Emphasis on Shanmugavelu

The Division Bench meticulously examined Rule 9 of the SARFAESI Rules, 2002, which governs the sale of immovable property by secured creditors. The crux of the decision hinged on the interpretation and application of Rule 9(5), which states:

> "(5) In default of payment within the period mentioned in sub-rule (4), the deposit shall be forfeited [to the secured creditor] and the property shall be resold and the defaulting purchaser shall forfeit all claim to the property or to any part of the sum for which it may be subsequently sold."

The High Court decisively leaned on the Supreme Court's recent judgment in Authorised Officer, Central Bank of India v. Shanmugavelu [(2024) 6 SCC 641] . The Bench noted that Shanmugavelu clarified the law extensively, holding that: * Rule 9(5) is mandatory and not a penal provision. * Therefore, Sections 73 and 74 of the Indian Contract Act, 1872 (dealing with damages for breach of contract and compensation for penalty) have no application to the forfeiture of an earnest money deposit under this rule. * The forfeiture is a statutory consequence of the auction purchaser's failure to deposit the balance consideration within the statutory period. * This legislative intent supports the SARFAESI Act's objective of time-bound debt recovery.

The High Court observed: > "The Supreme Court held, ‘Legislature through Rule 9(5) of the 2002 Rules, has made a conscious departure from the general law by statutorily providing for the forfeiture of earnest money deposit of the successful auction-purchaser for its failure in depositing the balance consideration within the statutory period...’" (Para 5.5.4 of the judgment, quoting Shanmugavelu )

And further: > "If Sections 73 and 74, respectively of the Contract Act are interpreted so as to be made applicable to a breach in payment of balance amount by the successful auction-purchaser, it would lead to a chilling effect..." (Para 5.5.6 of the judgment, quoting Shanmugavelu )

The Division Bench concluded that the Single Judge had erred by disregarding this binding precedent: > "In view of the decision in Shanmugavelu (Supra) which is latest in point of time, all the earlier decisions referred to by learned Single Judge or relied on by learned advocate could be said to have denuded of its legal efficacy." (Para 6)

The Court found no special circumstances justifying the demand for the return of the earnest money, stating: > "In light of the law laid down by the Supreme Court in Shanmugavelu (supra) , there is no escape from the position of law that Rule 9(5) of the Rules, 2002 providing for forfeiture of the earnest money has mandatory application once the auction purchaser is unable to pay the balance amount of sale consideration within statutory time limit contemplated for the purpose." (Para 6.1) > > "When the petitioner-bidder failed to deposit the balance amount within the statutory period despite having been granted extension, the forfeiture of his earnest money deposit was a statutory consequence." (Para 6.2)

Final Decision and Implications

Allowing Canara Bank's appeal, the High Court set aside the Single Judge's order directing the refund. The judgment reinforces the strict application of Rule 9(5) of the SARFAESI Rules. It serves as a clear reminder to auction purchasers participating in SARFAESI auctions about the critical importance of adhering to payment timelines. Failure to do so will almost invariably lead to the forfeiture of the 25% earnest money deposit, as this is a statutory consequence, independent of whether the bank can prove a specific quantum of loss from a subsequent resale or whether the provisions of the Indian Contract Act concerning penalties might otherwise apply.