CREATION OF CHARGES - CONFLICTING PRIORITIES BETWEEN STATUTORY PAYMENTS & SECURED LENDERS - A CRITIQUE

CREATION OF CHARGES - CONFLICTING PRIORITIES BETWEEN STATUTORY PAYMENTS & SECURED LENDERS - A CRITIQUE

By K P C Rao., LLB.,  FCMA., FCS

Practicing Company Secretary

kpcrao.india@gmail.com

Registration of Charges  

Part V of the Companies Act 1956 contains provisions related to Registration of the charges (Section 142 to 145). These contain provision of charge including mortgage, date of notice of charge, registration of charges, registration in case of debentures, certificate of registration, register of charges, inspection, penalties, etc.  

These provisions prescribe for the registration of charges with the Registrar of the Companies and also provide a list of assets and separate them from the unencumbered assets. Registration of charge acts as protection to the lenders and creditors, banks and liquidators. Register of charges is to be maintained by Registrar of Companies as well as the companies concerned. 

Consequences of Non-registration  

Non-registration would not prejudice any contract or obligation for payment of money secured by the charge and where the charge becomes void for registration, the debt secured becomes immediately payable. Also a charge on becoming void, no right if lien can be claimed on the documents of title as they were only ancillary to the charge and were delivered in pursuant to the charge. 

If a registerable charge is not registered, the transaction does not become void or debt does not become irrecoverable but the security created by the charge or mortgage becomes void against liquidator and creditors. 

It is mandatory for a company to file the particulars of charge and failure to do so or contravene the provisions of section 125 are punishable under Section 142 with  fine extending up to rupees Five Thousand  for every day of default.   

Conflicting Priorities 

There has not been any concerted, cohesive effort either to think or to codify the law of priorities over last several decades. Therefore, there are fragments of laws scattered over different enactments, each of which seems to assert its own preponderance disregarding other claims or interests. It is rather unfortunate that such a significant area on secured lending is left to be settled by case law rather than by well-knit policy of the government. Law-making in this very serious area has been sporadic and ad-hoc – just limited to achieving a limited result, rather than comprehensive review of the matter. 

There are several enactments currently competing for super-priority – Sec. 529A of the Companies Act creates a pari passu interest between secured lenders and workmen. Sec 11 of Employees' Provident Funds and Miscellaneous Provisions Act, 1952, provides that in case of insolvency of the employer or winding up of the company, the amount so due from the employer shall be deemed to be the first charge on the assets and shall be paid in

priority to other debts. Sales tax laws of most states, for instance, Sec 38C of Bombay Sales Tax Act, 1959, provides that subject to the provisions regarding first charge in any Central Act, any sum of money due under this Act shall be the first charge on the property. Likewise Sec 14A of Workmen’s Compensation Act, 1923 provides that any liability accrued with respect of any compensation to be paid by the employer shall have first charge on the assets, on the other hand, Sec 11 of the Central Excise Act, 1944 read with Sec142 of the Customs Act 1962 says that the amount of duty may be recovered by attachment and sale of excisable goods. 

While these are the different laws that provide for stacking order of priorities, there are several “special recovery” laws enacted from time to time, such as Recovery of Debt due to Banks and Financial Institutions Act, 1993, SARFAESI Act, SFC Acts, IDBI Act, IFCI Act, etc. These special recovery laws either provide the secured lender direct right to sell (for instance, SARFAESI Act, SFC Acts, IDBI Act, IFCI Act, SIDBI Act), or empower a DRT to order the sale of assets to meet the claims of the secured lender. 

The question of priority order of different claims will arise (a) in the event of distribution of liquidation proceeds in liquidation proceedings; (b) on recovery orders of a body like DRT; (c) self-help repossession and sale of assets by secured lenders under SARFAESI Act, IFCI Act, and SFC Act etc. 

Ruling in Central Bank of India vs. State of Kerala 

In the case of Central Bank of India vs. State of Kerala & others[1], the Supreme Court in its judgment dated February 27, 2009, in the matter of priorities between statutory first charges and secured lenders makes the landscape of conflicting priorities of charges over assets even more complex. 

In this case, the Supreme Court was concerned with the significant question whether the statutory first charges created by various central and state laws will prevail over the claims of the secured lender even while disposing of assets under the DRT law or the SARFAESI Act. After considering a series of rulings given in the past, such as Bank of Bihar vs. State of Bihar[2], Dena Bank vs. Bhikhabhai Prabhudas Parekh & Co. andothers[3], Central Bank of India vs. Siriguppa Sugars & Chemicals Ltd[4], State Bank of Bikaner & Jaipur vs. National Iron & Steel Rolling Corporation and others [5], the Supreme Court came to the conclusion that the primacy of statutory first charges prevails even in case of recovery under the DRT law and the SARFAESI Act.  

Some important principles to decide the stacking order of priorities that emerge out of the SC ruling are as follows: 

a)     Central Law prevails over a State Law – Hence, if a Central Law provides for a statutory first charge, it has to gain primacy over a conflicting State Law. Sec 38C of the Bombay Sales Tax Act, clearly states that;

“…if any Central Act provides for first charge, the charge created under Section 38C of Bombay Sales Tax Act is overridden”

b)     As usual, the doctrine that a later law prevails over an earlier law applies here too. So, if there are several central laws providing for priority, the later law will prevail over the earlier one.

c)     Unless the law clearly provides for a “first charge”, a mere provision for attachment or recovery as land revenue does not by itself create a first charge. Based on analysis of the provisions of the Central Excise Act, in the case of SICOM vs. Union of India[6] the Supreme Court came to a conclusion that the Excise dues rank only above the claims of ordinary creditors, and not secured creditors.

d)     If the law creates a first charge, the date of creation of the charge is irrelevant - that is, the normal rule of priorities based on the date of creation of the charge is not relevant in case of statutory first charges.  

Position of unpaid Government dues under SARFAESI Act 

An important provision of the SARFAESI Act [Sec 13 (9)] is that in case there are multiple security interests on an asset, no secured lender may take an action against such asset without the consent, in writing, of at least 75% of the secured lenders. As per the principles of statutory first charges, obviously, the government becomes a security interest holder over an asset to the extent of unpaid taxes. This is automatic, and without any need for registration of charges or any similar act of creation or perfection of security

interests. The question is, if such a security interest exists, is a bank or financial institution, as secured lender, entitled to take action against an asset without consulting the government as a security interest holder? The word “secured creditor” is defined in sec 2 (zd) of the Act to mean only such persons who have extended financial facility against an asset. An unpaid Government is certainly a security interest holder, but not a secured lender. Hence, sec. 13 (9) does not seem applicable to need the consent of the government before taking of any action under sec 13 (4). However, surely enough, in light of the statutory first charge, the distribution of assets upon sale by the secured lender will have to be first towards the statutory first charge holders, and thereafter, to other secured lenders. 

Illustration 

Assuming the value of assets of an entity is ` 10 crores, and the entity has the following out standings:

o   Dues to banks, holding charges over the assets: Rs. 15 crores

o   Excise dues:Rs.1 crore

o   Sales-tax duesRs.1 crore

o   EPF dues Rs.1 crore

o   Workmen’s Compensation dues Rs.1 crore

o   Workmen’s dues Rs.3 crore

Assuming the company is not under liquidation, the order of priorities will run as follows:

1.      Workmen’s Compensation Dues – Rs.1 crores

2.      Sales Tax Dues –Rs.1 crores

3.      Dues to Banks – Rs. 8 crores 

Assuming the company is under liquidation, the order of priorities will run as follows:

1.      EPF dues –Rs. 1 crores

2.      Workmen’s Compensation Dues – Rs.1 crores

3.      Sales Tax Dues – Rs.1 crores

4.      Dues to Banks (pari passu with Workmen’s Dues) – Rs.5.83 crores

5.      Workmen’s Dues (pari passu with Bank Dues) –Rs.1.17 crores 

Ruling in EPF Commissioner Vs Official Liquidator  

In another significant judgment (November 8, 2011) in the case of Employees Provident Fund Commissioner Vs. O.L. of Esskay Pharmaceuticals Limited[7],  the Supreme Court while allowing the applications filed by the appellant held that  in terms of Section 530(1), all revenues, taxes, cesses and rates due from the company to the Central or State Government or to a local authority, all wages or salary or any employee, in respect of the services rendered to the company and due for a period not exceeding 4 months all accrued holiday remuneration etc. and all sums due to any employee from provident fund, a pension fund, a gratuity fund or any other fund for the welfare of the employees maintained by the company are payable in priority to all other debts. The court also directed the Official Liquidator appointed by the High Court shall deposit the dues of provident fund payable by the employer within a period of 3 months. 

An interesting question was resolved by the Supreme Court in this case. This sprang up a rather unusual situation where the Court was required to decide between non obstante clauses contained in two different legislations that ran somewhat contrary to each other.  

Section 529-A of the Companies Act provides that “notwithstanding anything contained in any other provision of this Act or any other law for the time being in force”, in case of a winding up, the workmen’s dues and debts due to secured creditors shall be paid in priority to all debts. On the other hand, section 11(2) of the Employees Provident Fund and Miscellaneous Provisions Act, 1952 (EPF Act) provides that amounts due under that Act from an insolvent employer shall be deemed to be a first charge and be paid in priority to all other debts “notwithstanding anything contained in any other law for the time being in force”. The argument made by the company was that since section 529-A was introduced by an amendment to the Companies Act and was later in point of time, that should prevail. However, the court refused to accept that contention. 

Of course, after the amount due from an employer under the EPF Act is paid, the other dues of the workers will be treated at par with the debts due to secured creditors and payment thereof will be regulated by the provisions contained in Section 529(1) read with Section 529(3), 529A and 530 of the Companies Act. 

The Supreme Court’s reasoning was based on principles of statutory interpretation, and the court was also persuaded by the fact that the EPF Act is a welfare legislation that must be given importance.

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[1] Central Bank of India vs. State of Kerala & others ; (2009)4 SCC 94

[2] Bank of Bihar vs. State of Bihar; [(1972) 3 SCC 196]

[3] Dena Bank vs. Bhikhabhai Prabhudas Parekh & Co. and others; [(2000) 5 SCC 694]

[4] Central Bank of India vs. Siriguppa Sugars & Chemicals Ltd; [(2007) 8 SCC 353]

[5] State Bank of Bikaner & Jaipur vs. National Iron & Steel Rolling Corporation and others;[(1995) 2 SCC 19]

[6] SICOM vs Union of India; Bom 1, I (2007) BC 82; 2006 (6) Bom CR 159

[7] Employees Provident Fund Commissioner Vs. O.L. of Esskay Pharmaceuticals Limited; (2011) 10 SCC 727