Rule 9(5) SARFAESI Rules Mandates Earnest Money Forfeiture on Auction Default; Contract Act Principles Not Applicable: Karnataka High Court Citing SC in Shanmugavelu - 2024-10-16

Karnataka HC Upholds Bank's Right to Forfeit Earnest Money on Auction Default, Cites SC's Shanmugavelu Ruling

Bengaluru, Karnataka: The Karnataka High Court, in a significant judgment, has overturned a Single Judge's order that directed Canara Bank to refund Rs. 3.25 crores forfeited from defaulting auction purchasers. Chief Justice N.V.Anjaria , delivering the judgment for the Division Bench, firmly established that Rule 9(5) of the Security Interest (Enforcement) Rules, 2002, under the SARFAESI Act, mandates the forfeiture of earnest money upon an auction purchaser's failure to pay the balance bid amount within the stipulated time.

The Bench heavily relied on the recent Supreme Court decision in * Authorised Officer, Central Bank of India v. Shanmugavelu (2024)*, emphasizing that such forfeiture is a statutory consequence and not a penalty, thereby rendering principles of the Indian Contract Act concerning damages inapplicable.

Case Background: Auction Default and Plea for Refund

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. The respondents (original petitioners) were successful bidders, paying Rs. 3.25 crores, which constituted 25% of the bid amount. They were required to pay the balance 75% (Rs. 9.75 crores) within 15 days.

Despite an extension granted by the Bank until February 10, 2022, the purchasers failed to remit the balance, citing ongoing loan processes. Consequently, the Bank cancelled the sale and forfeited the Rs. 3.25 crores. The purchasers filed a writ petition seeking a refund, which the Learned Single Judge allowed on January 12, 2024. The Single Judge observed that the Bank had not adequately proven the loss from a subsequent sale and had allegedly kept the petitioners in the dark about a One Time Settlement (OTS) with the original borrower.

Arguments Before the Division Bench

Canara Bank (Appellant) argued: * The writ petition was not maintainable as an alternative remedy before the Debt Recovery Tribunal (DRT) existed, citing Agarwal Tracom Pvt. Ltd. v. Punjab National Bank . * Rule 9(5) of the Security Interest (Enforcement) Rules, 2002, provides for mandatory forfeiture of the deposit upon default. * The Bank suffered a loss of Rs. 1.98 crores due to the property being sold in a subsequent auction on March 19, 2022, for Rs. 11.02 crores, which was less than the original bid.

Original Petitioners (Respondents) contended: * The Bank was statutorily obliged under Rule 9(4) to extend the payment time up to three months. * The Bank lacked transparency regarding the proceedings. * They cited various High Court judgments, including * P. Balaji Babu Vs. State Bank of India , where refunds were ordered, and the Supreme Court's decision in Alisha Khan Vs. Indian Bank*, where a refund was allowed due to the COVID-19 pandemic and no loss to the bank.

High Court's Reliance on Supreme Court Precedent

The Division Bench, led by Chief Justice Anjaria , meticulously analyzed Rule 9 of the Security Interest (Enforcement) Rules, 2002. Rule 9(4) allows for payment of the balance purchase price within fifteen days or an extended period not exceeding three months, as agreed in writing. Crucially, Rule 9(5) states: > "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 judgment extensively quoted the Supreme Court's findings in Shanmugavelu (supra) : > "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 60 to 63) > > "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... thereby gaming the entire auction process and leaving any possibility of recoveries under the SARFAESI Act at naught." (para 65) > > "Since Rule 9 sub-rule (5) of the 2002 Rules provides for the forfeiture of only the earnest money deposit of the successful auction-purchaser i.e. only 25% of the total amount, by no stretch of imagination can it be regarded as a penal clause and as such Sections 73 and 74 of the Contract Act will have no application." (Paras 72 and 80)

The Court noted that the Shanmugavelu judgment clarified that forfeiture under Rule 9(5) is a statutory mandate, distinct from penal provisions under the Contract Act, and is crucial for the time-bound debt recovery objective of the SARFAESI Act.

Decision and Implications

The High Court concluded that the Single Judge had disregarded the clear legal position, now unequivocally affirmed by the Supreme Court in Shanmugavelu . The earlier decisions relied upon by the respondents were deemed to have lost their "legal efficacy" in light of this Supreme Court ruling.

The Court stated: > "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..." > > "In the facts of the case, no special circumstance exists which would justify the demand for return of earnest money by the petitioner. There is no unjust enrichment on the part of the Bank. 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."

Consequently, the appeal filed by Canara Bank was allowed, and the judgment and order of the Learned Single Judge dated January 12, 2024, directing the refund, were set aside. This ruling reinforces the secured creditor's right to forfeit earnest money in SARFAESI auctions upon default by the purchaser, underscoring the mandatory nature of Rule 9(5) and its insulation from general contract law principles regarding damages.