SARFAESI: Uncertain landscape for auction purchasers & asymmetric information

Presently lenders have SARFAESI as one of the main recovery channels. Govt inserted Section 26E “Notwithstanding anything, debts of secured creditor shall be in priority over all other debt, taxes…payable to Govt”, which is superb for Lenders. However, issues bothering potential Auction Purchasers (AP) and limiting effectiveness of SARFAESI are:

1. Who will pay the statutory dues, how such dues are determined & known in advance to potential Auction Purchasers
2. Reserve Price (RP) is mostly basis a Valuation exercise without considering such statutory dues/ taxes

Case specific ruling of Supreme Court in Medineutrina and Kotak Mahindra Bank Vs DIC is that “agreement under which AP purchased property specifically says that Auction Purchasers shall bear all statutory dues and hence AP cannot resile from these obligations”. Standard Agreement for such auctions state “All statutory dues/ charges including registration, stamp, taxes, any other known, unknown liability…shall be borne by AP”.

Hon’ble SC further observed :

· AO/ Bank undertaking Auction not responsible for any other charge, lien…to the Govt/ anyone. Auction Purchasers should make all the enquiries regarding such dues.
· Argument that the charge is not in respect of the property as such, but is the consequence of the statutory dues, makes no difference.

RBI Statistics indicate an extremely erratic trend in recovery from SARFAESI. After recording a peak loan of Rs.2.59 lakh Cr in 2018-19 referred under SARFAESI, Scheduled Commercial Banks (SCBs) recorded a decline of 24% and 66% during the next two years to reach Rs.67,510 Cr in 2020-21. However, during 2021-22, SCBs again referred Rs.1.22 lakh crore, an increase of 80%. Recovery percentage has been very volatile between 15% to rare 41%

Fair Competition vs what’s ailing SARFAESI : Better results are achieved when competition is fair and landscape very wide. The above judicial developments indicate any potential AP has to carry due diligence and also ready to take risk of uncertain future claims (Govt due limitation 30 years). Hence any third unrelated party would be very vary of participation and leaving the field open to people with knowledge/ connection (Related Party) and thus defeating the very purpose of such auction. Presently a property goes through multiple auctions with further & further discounts and ultimately AP is one who can leverage his knowledge of the property ( beneficiary of Asymmetric Information). Hence auctions under SARFAESI do not interest investor who can pay the actual economic value of the property, but have limited access to full information.

Way Forward:

1. Declaring/ making potential Auction Purchasers aware of all the dues other than auctioning Lenders.
2. Also, these dues should be considered for Valuation while fixing RP.
3. Further just like IBC, APs should not be exposed to uncertainities of unknown future liabilities.

This is an opinion column by Subash Chandra, former Chief Operating Officer (COO) & Head-Asset & Structured Finance, IL&FS Financial Services. The article first appeared in Mondaq.

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