Declaration of account as NPA without detailed consideration and without assigning reasons is arbitrary and illegal

KARNATAKA HIGH COURT

Before :- A. S. Bopanna, J.

W.P. No. 16694 of 2005. D/d. 6.3.2008.

M/s. Raja Associates and Ors. - Petitioner Versus Union of India and Ors.- Respondent

For the Petitioner :- X. M. Joseph, Advocate.
For the Respondent :- T. N. Raghupathy, M/s. Rao Associates.

A. Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, Section 13(3-A) (as inserted by Act 30 of 2004) - Account classified as NPA (Non-Performing Asset) - Held - When in objection/representation details are furnished by the borrower to indicate that classification of account of borrower NPA is contrary to the legal position enunciated by Supreme Court and also not in accordance with the RBI guidelines, it is incumbent on Bank/Financial Institutions to consider this aspect in detail and clarify to the borrower the entire details which went into consideration before classifying the account as NPA and such consideration should be indicated to be in conformity with the RBI guidelines and the decision rendered by Supreme Court - Declaration of account as NPA without detailed consideration and without assigning reasons is arbitrary and illegal.
[Paras 12, 13 and 14]
B. Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, Section 13(3-A) (as inserted by Act 30 of 2004) - Constitution of India, 1950, Article 14 - Section 13(3-A) whether constitutionally valid - Held - Said provision has been introduced for the benefit of the borrowers - Introduction of sub-section (3A) is an opportunity to compel the bank/financial institutions to disclose reasons for treating the account of the borrower as NPA - Thus, in any event, said provision cannot be said to be either arbitrary or unconstitutional.
[Para 5]
C. Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, Section 13(2) - Recovery of Debts Due to Banks and Financial Institutions Act, 1993, Section 19 - Security transaction - Recovery of Debt - Debt Recovery Tribunal - Doctrine of Election - Respondent/Bank can invoke the provisions of Securitisation Act when they have resorted to the remedy available under the DRT Act - Doctrine of Election is not applicable.
[Paras 6 and 7]

ORDER

A.S. Bopanna, J. - The petitioner No. 1 herein is a registered partnership firm who took over the running business of wholesale distribution of pharmaceuticals. The earlier owner of the said business had banking transactions with Karnataka Bank Limited and on taking over the said business, the petitioner approached the respondents-bank to take over the existing liability of the said wholesale pharmaceuticals business from Karnataka Bank Limited. Accordingly, the respondents took over the liabilities by sanctioning to petitioner No. 1 the cash credit facility of Rs. 35,00,000/- in two different accounts against hypothecation of stock in trade and on assignment of book debts on certain terms and conditions. The petitioner alleges that when this was the position, there was a fire accident in the godown belonging to the petitioner on 4-7-2003 and according to the petitioner since the insurance policy stood in the name of the bank, the bank should have sought for the insurance claim and the same should have been credited to their account. Since the respondents have failed to do so, the petitioner has taken steps in this regard and the matter is pending before the Karnataka State Consumer Dispute Redressal Commission.
2. The grievance of the petitioner at this juncture is however with regard to the notice issued by the respondents under Section 13(2) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (hereinafter referred to as the 'Securitisation Act'). The petitioner was before this Court with the said grievance at the first instance in W. P. Nos. 33886-33887/2004. With regard to the fire accident and the manner of insurance claim, this Court has already reissued the contention put forth by the petitioner and as such the reasons assigned by the respondents in such of those paragraphs to reject the contention of the petitioner on to reject the contention of the petitioner on that aspect in their reply dated 25-5-2005 are justified. However, this Court by its order dated 24-2-2005 has not expressed its opinion with regard to the other contentions which had been raised regarding the improper manner in which the petitioner's account was treated as Non-Performing Asset (hereinafter referred to as the 'NPA'). But this Court had held that it would be open for the petitioner to raise the said issue either by way of representation or objection to the notice under Section 13(2) of the Act, as the amended provision of the Act as contained in Section 13(3A) of the Act had come into force, the same being inserted after the judgment of the Hon'ble Supreme Court. In this regard, the decision in the case of Mardia Chemicals Ltd. etc. etc. v. Union of India and others etc. etc., reported in AIR 2004 SC 2371 was also noticed by this Court. Ultimately while disposing of the writ petition, such liberty was granted to the petitioner to file detailed representation/objection to the notice under Section 13(2) of the Securitisation Act and the respondents were directed to consider the representation in the light of the aforesaid judgment of the Hon'ble Supreme Court and pass appropriate orders in accordance with law. The petitioner has thereafter filed a detailed objection/representation dated 10-3-2005. The respondents have disposed of the representation by their communication dated 25-5-2005. The petitioner claiming to be aggrieved by the rejection of the objection/representation dated 10-3-2005 is once again before this Court in this petition.
3. I have heard Sri. X. M. Joseph, learned counsel for the petitioners and Sri. T. N. Raghupathy, learned counsel appearing on behalf of M/s. Rao and Rao Associates for the respondents.
4. Having heard the respective learned counsel, I have perused the writ papers, objection statement and also the decisions in the case of Mardia Chemicals, (2004 AIR-Kant HCR 1677) and in the case of M/s. Transcore v. Union of India and another, reported in 2007 AIR SCW 389 : (AIR 2007 SC 712).
5. In the background of the contentions urged by the learned counsel, the prayer made in the writ petition are to be considered. Insofar as the first prayer made by the petitioner seeking for a declaration that Section 13(3A) of the Securitisation Act inserted with effect from 11-11-2004 is arbitrary and unconstitutional insofar as petitioners are concerned, the same need not detain this Court for long. The said provision had already come into force when the earlier petition in W. P. Nos. 33886-33887/04 was filed by the petitioner and this Court on noticing the said provision had reserved liberty in favour of the petitioner to make an appropriate objection/representation in terms of the said provision and the same has been utilised by the petitioner. Therefore, at the outset, it cannot lie in the mouth of the petitioner to question the very same provision. Even otherwise, the validity of the Securitisation Act itself has been upheld by the Hon'ble Supreme Court in the case of Mardia Chemicals and it is pursuant to certain observations made in the said decision by the Hon'ble Supreme Court, the said amendment by way of introduction of subsection (3A) to Section 13 has been made. The said provision has been introduced for the benefit of the borrowers. Though it is contended by the learned counsel for the petitioners that the decision being rendered by the respondents themselves is contrary to law and against principles of natural justice, the fact that the Hon'ble Supreme Court had upheld the Act when it was even more stringent without the additional opportunity would indicate that the introduction of sub-section (3A) is an opportunity to compel the bank/financial institutions to disclose reasons for treating the account of the borrower as NPA. Therefore, in any event, the said provision cannot be said to be either arbitrary or unconstitutional.
6. With regard to the second prayer made by the petitioners to declare that the respondent-Bank cannot simultaneously invoke the remedy available under the Securitisation Act and the one available under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, the fact of the matter is that both the learned counsel for the petitioners as well as the learned counsel for the respondents have placed reliance on the decision of the Hon'ble Supreme Court in the case of M/s. Transcore, wherein this aspect of the matter has been considered. The Hon'ble Supreme Court after discussing the matter threadbare has stated as follows :

"For the above reasons, we hold that withdrawal of the O. A. pending before the DRT under the DRT Act is not a pre-condition for taking recourse to NPA Act. It is for the Bank/FI to exercise its discretion as to cases in which it may apply for leave and in cases where they may not apply for leave to withdraw. We do not wish to spell out those circumstances because the said first proviso to Section 19(1) is an enabling provision, which provision may deal with myriad circumstances which we do not wish to spell out herein."

7. While arriving at the said decision, the Hon'ble Supreme Court has come to the conclusion that the said two acts are complementary to one another and as such the NPA Act is an additional remedy to DRT Act and they together constitute one remedy. That being so, the Doctrine of Election does not apply. This would make it clear that the Hon'ble Supreme Court has set at rest the said controversy and as such it would not be open for the petitioner to contend that the respondent-Bank cannot invoke the provisions of the Securitisation Act when they have resorted to the remedy available under the DRT Act. Even otherwise in the instant case, the respondent-Bank had classified the account of the petitioner as NPA on 31-3-2004 and the notice under Section 13(2) of the Securitisation Act was issued on 29-7-2004. Admittedly, the DRT proceedings were initiated thereafter on 7-2-2005 and therefore, in any event, the said argument would not be open for the petitioner in the facts and circumstances of this case.
8. The next prayer made by the petitioners is to declare that without classification of the account or asset of the petitioner with respondent-Bank as "sub-standard, doubtful or loss assets", the respondent-Bank cannot invoke the Securitisation Act. While considering this prayer, the contentions urged in the earlier petition and the liberty granted by this Court and the manner of consideration of the objection/representation by the respondents also requires consideration. Insofar as declaring the account belonging to the petitioner as NPA, the respondent-Bank has furnished the summary of NPA accounts for the period ending 31-3-2004 before this Court. The said summary only indicates the name of the borrower account, the date when it was first classified as NPA and also the total outstanding and the present realisable value. The name of the petitioner-firm is indicated at Sl. No. 1 and the date of classification as NPA is indicated as 31-3-2004. Against the column No. 1 total outstanding figure of 6538 is indicated while against the present realisable value of the security 7100 is indicated. The category of NPA and Part is indicated as No. 2. Therefore, insofar as treating the account belonging to the petitioner as NPA, the Bank has indicated the date as 31-3-2004 and thereafter the notice under Section 13(2) has been issued on 29-7-2004. But the strenuous contention of Sri X. M. Joseph, learned counsel for the petitioners is that the account has been treated as NPA at the whims and fancies of the respondent-Bank without following the RBI guidelines in this regard nor following the methodology indicated by the Hon'ble Supreme Court both in the case of Mardia Chemicals Limited and M/s. Transcore. It is contended by the learned counsel that even though there may be default in payment, the account cannot be treated as NPA so as to take benefit of the Securitisation Act. The learned counsel would refer to the guidelines enclosed along with the Master Circular Prudential Norms which is produced at Annexure-L to the petition to contend that the RBI vide Clause (3) has stated the method of asset classification and as such the sub-standard assets could be classified only as per the guidelines laid down therein. The learned counsel also contends that despite this Court directing the respondent-Bank to consider the objection/representation keeping in view the RBI guidelines and the decisions rendered by the Hon'ble Supreme Court, the respondents have failed to even indicate the manner in which the account of the petitioner has been classified as NPA.
9. On the contrary, Sri T. N. Raghupathy, learned counsel for the respondents sought to justify the action of the respondents. The learned counsel would contend that on the petitioner making a representation in terms of the liberty granted in the earlier writ petition, the respondent-Bank has considered the same in detail by its reply dated 25-5-2005. With regard to the circulars regarding treating an account as NPA, the same has been considered at paras 4 and 5 of the reply and as such the petitioners cannot make out any grievance. The learned counsel would also contend that the account of the petitioner has been treated as NPA as per the guidelines of the RBI and in this regard it is contended that the Master Circular dated 2-12-2004 relied on by the petitioner is not the relevant one since the same relates to Primary Urban Co-operative Banks. The learned counsel therefore relied on the Prudential Norms of Income Recognition, Asset Classification and Provisioning Master Circular issued by the RBI on 22-8-2003. Referring to the said circular the learned counsel would state that the asset classification is indicated in para 4 and the sub-standard assets is indicated in para 4.1.1. Since the account was thereafter classified as NPA on 31-3-2004, the notice as contemplated under Section 13(2) has been issued subsequently and therefore the action initiated by the respondents is in accordance with law.
10. Insofar as the circulars relied on, prima facie it appears to me that the circular relied on by the petitioners is in respect of Urban Co-operative Banks issued by the Reserve Bank of India. Hence, the relevant circular appears to be the circular relied on by the respondent-Bank dated 22-8-2003. Thereafter the learned counsel for the petitioner has also produced a compilation of five circulars from the year 2003 to 2007. Be that as it may. The question is whether the respondents have considered the objection/representation made by the petitioner pursuant to the liberty granted and direction issued by this Court in W. P. Nos. 33886-33887/04 in its correct perspective.' As already noticed, this Court had taken note of Section 13(3A) of the Securitisation Act regarding the procedure provided thereunder to the borrower to make out a grievance that the declaration of his account as NPA is arbitrary, illegal and contrary to the RBI Regulations and that the same could be pointed out by the borrower to the bank/ financial institutions. This Court has also made specific observation that the bank is expected to consider the said objections in accordance with law and in the light of the Supreme Court judgment referred to in the course of the said judgment viz., the judgment rendered in the case of Mardia Chemicals and give its opinion. It is thereafter this Court granted the liberty and directed the respondents to consider the same in the said manner.
11. Further, the Hon'ble Supreme Court in the case of M/s. Transcore has made the relevant observations in paras 23 and 24 of the judgment, which reads as hereunder :

"After classification of an account as NPA, a last opportunity is given to the borrower of sixty days to repay the debt, Section 13(3-A) inserted by Amending Act 30 of 2004 after the judgment of this Court in Mardia Chemicals (supra), whereby the borrower is permitted to make representation/objection to the secured creditor against classification of his account as NPA. He can also object to the amount due if so advised. Under Section 13(3-A), if the Bank/FI comes to the conclusion that such objection is not acceptable, it shall communicate within one week the reasons for non-acceptance of the representation/objection. A proviso is added to Section 13(3-A) which states that the reasons so communicated shall not confer any right upon the borrower to file an application to the DRT under Section 17. The scheme of sub-sections (2), (3) and (3-A) of Section 13 of NPA Act shows that the notice under Section 13(2) is not merely a show cause notice, it is a notice of demand. That notice of demand is based on the footing that the debtor is under a liability and that his account in respect of such liability has become sub-standard, doubtful or loss. The identification of debt and the classification of the account as NPA is done in accordance with the guidelines issued by RBI. Such notice of demand, therefore, constitutes an action taken under the provisions of NPA Act and such notice of demand cannot be compared to a show cause notice. In fact, because it is a notice of demand which constitutes an action, Section 13(3-A) provides for an opportunity to the borrower to make representation to the secured creditor. Section 13(2) is a condition precedent to the invocation of Section 13(4) of NPA Act by the Bank/FI. Once the two conditions under Section 13(2) are fulfilled, the next step which the Bank or FI is entitled to take is either to take possession of the secured assets of the borrower or to take over management of the business of the borrower or to appoint any manager to manage the secured assets or require any person, who has acquired any of the secured assets from the borrower, to pay the secured creditor towards liquidation of the secured debt."

"Reading the scheme of Section 13(2) with Section 13(4), it is clear that the notice under Section 13(2) is not a mere show cause notice and it constitutes an action taken by the Bank/FI for the purposes of the NPA Act.

Section 13(6) inter alia provides that any transfer of secured asset after taking possession or after taking ever of management of the business, under Section 13(4), by the Bank/FI shall vest in the transferee all rights in relation to the secured assets as if the transfer has been made by the owner of such secured asset."

12. The observation of the Hon'ble Supreme Court would clearly indicate that Section 13(3A) has been inserted in view of the observations made by the Hon'ble Supreme Court in Mardia Chemicals case and also that the notice issued under Section 13(2) of the Securitisation Act is not a mere show cause notice but would constitute an action taken by the Bank/Financial Institutions for the purpose of NPA Act. These aspects would indicate that the consideration of an objection/representation filed after issue of Section 13(2) notice in terms sub-section (3A) requires detailed consideration by the Bank and the reasons for non-acceptability of objection is to be assigned. Therefore, in such objection/representation, when details are furnished by the borrower to indicate that the classification of the account of the borrower NPA is contrary to the legal position enunciated by the Hon'ble Supreme Court and also not in accordance with the RBI guidelines, it is incumbent on the Bank/Financial Institutions to consider this aspect in detail and clarify to the borrower the entire details which went into consideration before classifying the account as NPA and such consideration should be indicated to be in conformity with the RBI guidelines and the decision rendered by the Hon'ble Supreme Court. In the instant case, this had in fact been particularly directed by this Court in the earlier writ petition. Despite this, the reasons assigned by the respondent-Bank in their reply dated 25-5-2005 on this aspect of the matter in paras 4 and 5 would not only indicate lack of reasons due to non-application of mind, but also arbitrariness is writ large. I am also constrained to say that it reflects a shade of arrogance on the part of the respondents.
13. I am compelled to say so due to the fact that, though this Court in the earlier writ petition had directed the respondents to consider whether the petitioner's account has been declared as NPA in terms of the circulars and the judgment of this Court, the respondents have the temerity of stating as follows in reply to the representation -

"The Bank is well aware of the circulars regarding NPA and also all the judgments of the various Hon'ble Courts, also the Hon'ble Supreme Court. The account has been declared as NPA after considering all the aspects/Circulars/Directives of RBI issued from time to time and there cannot be any change in the same."

14. What was expected by this Court was not as to whether the officers of the respondent-Bank are aware of the circulars and the Judgments, but what had been directed is to consider as to whether the account of the petitioner falls within the said category as defined in the circulars and such consideration should have come out in the form of a speaking consideration i.e., by assigning reasons as observed by the Hon'ble Supreme Court. Even the contents of para 5 does not disclose this aspect of the matter where it only says that the value of the security being more has no bearing towards classification without indicating what else was the method followed for classification. Though the learned counsel for the respondents attempted to point out the circular of RBI, the same does not serve any purpose at this stage since neither the reply dated 25-5-2005 nor the objection statement filed in this petition would refer to the details in this regard and what is required is not to notice the RBI guidelines alone but to indicate from the materials on record that the account in question falls within the guidelines. Only when that is done the respondents would be at liberty to proceed in accordance with law. Hence it requires re-consideration at the hands of the respondents themselves.
15. Before parting, it is also necessary to notice that even though the petitioner has produced a letter dated 2-3-2005 at Annexure-P to the petition, wherein he has alleged about certain loose statements made by the Recovery Officer of UCO Bank and the Branch Manager of the UCO Bank, the same cannot be accepted on its face value, but the reading of the reason assigned in para 4 of the communication dated 25-5-2005 in reply to the objection/representation would give an impression that all is not well with the attitude of the officers of the respondent-Bank. It is necessary to caution that the officers should realise that they are the employees of a bank which is an "other authority" as defined in Article 12 of the Constitution of India being a Government of India Undertaking. As such they cannot afford to behave like private money-lenders but would be accountable to judicial scrutiny and review and all actions should indicate that the same is taken after proper application of mind and should indicate lack of arbitrariness. Mere being aware of the regulations and the decision being taken in the mind is not sufficient but should be exhibited in the records and the orders/communications issued by them. It is needless to mention that the law is well settled that in the matter of Judicial review under Article 226 of the Constitution of India, this Court is empowered to consider the correctness or otherwise of the procedure adapted by the officers of a public authority in arriving at the decision though not so much with the decision itself. Hence, while reconsidering the matter, the respondents shall bear this in mind and shall pass appropriate orders in accordance with law.
16. For all the abovesaid reasons, the following,
ORDER

i) W. P. No. 16694/05 is allowed in part and rule made absolute to that extent.

ii) Consequently, the reason assigned in paras 4 and 5 of the communication dated 25-5-2005 which is impugned at Annexure-S to the petition is quashed to that extent and the respondents are directed to reconsider the objection/representation dated 10-3-2005 on that aspect of the matter and pass appropriate orders in accordance with the RBI guidelines and the judgments rendered by the Hon'ble Supreme Court referred to supra.

iii) Until such re-consideration, the further proceedings pursuant to the notice dated 29-7-2004 issued under Section 13(2) of the Securitisation Act shall remain suspended. It is, however, made clear that there shall be no impediment for the respondent-Bank to take action pursuant to the recovery certificate issued under DRT Act dated 4-4-2007 if the same has attained finality and if the respondents desire to execute the same.

iv) In the peculiar facts and circumstances of this case, the parties shall bear their own costs.

Order accordingly.