Prior SARFAESI security interests prevail over subsequent State charges on secured properties.

The State of Gujarat sanctioned a share-capital contribution of ₹20.56 crore in favour of Shri Mandvi Vibhag Sahkari Khand Udyog Mandli Limited, respondent no. 6, by Government Resolution dated 18 September 2014.

The District Registrar thereafter issued a communication dated 19 September 2018 directing creation of a charge over the society’s immovable properties to safeguard the State’s financial interest.

Pursuant to that communication, revenue entries nos. 1354 and 5167 recording a charge of ₹20.56 crore were made on 11 October 2018.

Before the State charge was recorded, respondent no. 6 had mortgaged the properties to a consortium of banks led by respondent no. 4 under a registered Memorandum of Agreement dated 29 March 2013.

Following default and issuance of a demand notice, the bank took possession under the SARFAESI Act and conducted an e-auction on 13 July 2023.

Petitioner no. 1 became the highest bidder for ₹22.38 crore, paid the entire sale consideration, and received a registered sale certificate-cum-conveyance deed stating that the property was sold free from other security interests, liens and encumbrances.

The petitioner discovered the State charge during a land-record search and filed the present petition seeking quashing of the District Registrar’s communication and removal of the charge.

Respondent no. 6 opposed the petition, contending that it had challenged the SARFAESI measures and auction in Securitisation Application No. 108 of 2023 pending before the DRT-II, Ahmedabad.

The State defended the charge on the ground that it had a financial interest in the society and was entitled to protect its contribution.

Whether the secured creditor’s prior mortgage and security interest had priority over the charge subsequently created by the State in respect of the society’s immovable properties?

Whether the State could sustain the charge created in 2018 despite the prior mortgage in favour of the bank and the subsequent SARFAESI auction in favour of the petitioner?

Whether relief could be granted to the auction purchaser while the borrower’s challenge to the SARFAESI auction remained pending before the DRT?

The Court applied Sections 26E and 35 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”). Section 26E gives a registered secured creditor priority in enforcement and recovery of secured debts over other debts, including State dues, while Section 35 gives the SARFAESI Act overriding effect over inconsistent laws.

The Court relied on Central Bank of India v. State of Kerala, (2009) 4 SCC 94, and Punjab National Bank v. Union of India, (2022) 7 SCC 260, for the principle that a secured creditor’s prior charge prevails over unsecured Crown or State debts.

It also followed Kotak Mahindra Bank Ltd. v. M/s Kailash Oil Cake Industries, M/s Nueva Mosaics LLP v. Department of Sales Tax, Hina Manubhai Panchal v. State of Gujarat, and Madhaviben J. Rupareliya v. State of Gujarat, which hold that an auction purchaser acquiring property from a secured creditor is entitled to receive it free from subsequent State encumbrances where the secured creditor’s mortgage and charge have priority.

The Court further noted that a State or Crown debt has priority only against ordinary or unsecured creditors, and cannot ordinarily override a prior mortgage or statutory secured interest.

The bank’s mortgage was created and registered in 2013, and its security interest was asserted to have been registered with CERSAI before the State charge was recorded in 2018.

Consequently, the bank held the prior and valid security interest. Applying Sections 26E and 35 of the SARFAESI Act and the cited precedents, the Court held that the State’s subsequent charge could not override the bank’s priority or prejudice the petitioner, who purchased the property through the bank’s SARFAESI auction and paid the full consideration.

The Court also observed that the Government Resolution dated 18 September 2014 did not itself authorise creation of a charge over the society’s immovable property.

The pending DRT proceedings did not justify maintaining the charge; however, to avoid conflicting orders and protect the interests of the borrower and the State, the petitioner was required to undertake that the removal of the charge and the confirmation of sale would remain subject to the final outcome of S.A. No. 108 of 2023, and that the High Court’s order would not create any equity in its favour.

The communication dated 19 September 2018 issued by the District Registrar and the consequential charge created over the properties were quashed and set aside.

The petition was allowed and Rule was made absolute, subject to the petitioner filing the prescribed undertaking before the High Court and the DRT within eight weeks, making the relief subject to the final decision in S.A. No. 108 of 2023 and acknowledging that the order would not create any equity in its favour.