By TIOL News Service

CHENNAI, DEC 27, 2006 : THE myth of crown's debts is once again shattered!

The question before the larger bench of the Madras High Court was, Whether the Crown's debts, for which there is no priority or charge is created under the statute, should have precedence over the secured creditors?

The facts:-

The petitioner, UTI Bank has approached the High Court to issue a Writ of Mandamus forbearing the first respondent - Deputy Commissioner of Central Excise, Chennai II Division and the second respondent - Secretary, Ministry of Finance, Government of India from bringing the property situated at Plot No.55, Ambattur Industrial Estate, Ambattur, Chennai 600 058 into auction for any alleged dues payable by the debtor company, namely M/s Sumeet Research and Holdings Private Limited, since the said property has already been taken possession by the petitioner in pursuance to its statutory rights under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (Act 54 of 2002) (in short 'SARFAESI Act').

M/s.Sumeet Research and Holdings Private Limited, the borrower took a loan of about 7.85 Crores from the petitioner UTI Bank and created a mortgage by deposit of title deeds, in respect of various properties, including the factory land and building situate at Plot Nos.54 and 55, Ambattur Industrial Estate, Ambattur, Chennai-58

On failure of the borrower to repay the loan, the petitioner UTI Bank took took constructive possession of the secured assets on 8.2.2005 as contemplated under the SARFAESI Act, and also took physical possession of the same on 29.3.2005.

In the meanwhile, the Deputy Commissioner of Central Excise addressed a letter dated 28.3.2005 to the petitioner Bank informing that a sum of Rs.41,17,246/- was due and payable by the borrower company to the Department of Central Excise, and requested the writ petitioner to hold the money or property with it, as dues to the Department. The borrower company sold Plot No.54, and repaid a part of the amount due to the petitioner Bank and the property now available as secured asset, is the Unit at Plot No.55.

Even though the Central Excise department does not have any statutory first charge over the property secured by the petitioner Bank, the department is trying to sell the property under the control of the bank and so the bank is in writ petition before the High Court.,

As the High Court had earlier taken different views on the same subject, the matter was referred to a larger bench, which is the present case.

The Larger Bench observed that

•  What we have to see is, as per the provisions of SARFAESI Act, after issuance of proper notice, when the petitioner Bank took possession of the secured asset, viz., Plot No.55, whether the same can be set at naught by way of Section 142(C) of Customs Act, 1962.

The Bank's plea is that:-

•  the SARFAESI Act is a special enactment and the same is applicable notwithstanding the fact that other enactments are in force or not and in other words, the general power of recovery under the Customs Act, Central Excise Act, is subject to the proceedings under SARFAESI Act.

•  the SARFAESI Act is a complete code by itself and it provides for all contingencies for recovery of debt due from a defaulter.

•  if the debtor is an unsecured creditor like the Central Excise Deputy Commissioner , then it has to make a claim under Section 13(7) of the SARFAESI Act.

•  since the SARFAESI Act has already been invoked, the first respondent(Deputy Commissioner, Central Excise) will not have jurisdiction to proceed under Section 142 or any other provision of the Customs Act, but it must take a claim under Section 13(7) of the SARFAESI Act.

•  any action taken by the first respondent(Deputy Commissioner) is totally without jurisdiction.

•  since a statutory first charge is created in favour of the petitioner Bank by the provisions of SARFAESI Act, the same will prevail over all other subsequent charges.

•  the first respondent, viz., Department of Central Excise does not have a first charge over the property.

The High Court noted that the Supreme Court had considered these issues and observed,

•  This common law doctrine of priority of State's debts has been recognised by the High Courts of India as applicable in British India before 1950 and hence the doctrine has been treated as "law in force" within the meaning of Article 372 (1) of Constitution.

•  The principle of priority of Government debts is founded on the rule of necessity and of public policy.

•  The basic justification for the claim for priority of State debts rests on the well recognised principle that the State is entitled to raise money by taxation because unless adequate revenue is received by the State, it would not be able to function as a sovereign government at all.

•  It is essential that as a sovereign, the State should be able to discharge its primary governmental functions and in order to be able to discharge such functions efficiently, it must be in possession of necessary funds and this consideration emphasises the necessity and the wisdom of conceding to the State, the right to claim priority in respect of its tax dues.

•  On the very principle on which the rule is founded, the priority would be available only to such debts as are incurred by the subjects of the Crown by reference to the State's sovereign power of compulsory exaction and would not extend to charges for commercial services or obligation incurred by the subjects to the State pursuant to commercial transactions.

The High Court noted that the law is summed up as follows:-

•  There is a consensus of judicial opinion that the arrears of tax due to the State can claim priority over private debts.

•  The common law doctrine about priority of crown debts which was recongnised by the Indian High Courts prior to 1950 constitutes "law in force" within the meaning of Article 372 (1) and continues to be in force.

•  The basic justification for the claim for priority of State debts is the rule of necessity and the wisdom of conceding to the State the right to claim priority in respect of its tax dues.

•  The doctrine may not apply in respect of debts due to the State if they are contracted by citizens in relation to commercial activities which may be undertaken by the State for achieving socio-economic good. In other words, where the welfare State enters into commercial fields which cannot be regarded as an essential and integral part of the basic government functions of the State and seeks to recover debts from its debtors arising out of such commercial activities the applicability of the doctrine of priority shall be open for consideration.

After referring to a number of decided cases, the High Court concluded,

•  Generally, the dues to Government, i.e., tax, duties, etc. (Crown's debts) get priority over ordinary debts.

•  Only when there is a specific provision in the statute claiming "first charge" over the property, the Crown's debt is entitled to have priority over the claim of others.

•  Since there is no specific provision claiming "first charge" in the Central Excise Act and the Customs Act, the claim of the Central Excise Department cannot have precedence over the claim of secured creditor, viz., the petitioner Bank.

•  In the absence of such specific provision in the Central Excise Act as well as in Customs Act, we hold that the claim of secured creditor will prevail over Crown's debts.

So the High Court held that the petitioner UTI Bank, being a secured creditor is entitled to have preference over the claim of the Deputy Commissioner of Central Excise, first respondent.

The High Court made it clear that the petitioner Bank being a secured creditor, the first respondent, the Deputy Commissioner of Central Excise Department is not entitled to bring the property viz., Plot No.55, Ambattur Industrial Estate, Ambattur, Chennai 600 058 into auction for their dues payable by the borrower company, viz., M/s. Sumeet Research and Holdings Private Limited.

(See 2006-TIOL-404-HC-MAD-CX-LB in 'Excise' + 2006-TIOL-404-HC-MAD-CX-LB in 'Legal Corner')