Does The SARFAESI Act Supersede the India Contract Act?

The question of applicability of provisions of the SARFAESI ACT, in supersession to the provisions under the Indian Contact Act has been recently settled by the Supreme Court in its verdict in the case of The Authorised Officer, Central Bank of India v. Shanmugavelu bearing Civil Appeal no 235-236 of 2024, with respect to the right of a secured creditor to forfeit earnest money paid by the buyer of the security interest in case of a failed transaction of sale. The underlying principle of law involved in the case on point is the applicability of a special piece of legislation which would have an overring effect over the general law.

General Vs Special Legislation – Understanding the Difference

The Indian Contract Act is a general piece of legislation that provides the governing principle for all contractual obligations, their validity and enforcement. However, this general law is supplemented with a plethora of specialised Acts that have been promulgated by the legislature to address, regulate and govern specific sectors keeping in mind the specific modalities involved in the subject matter and is applicable under certain circumstances whereas general laws have extensive applicability.

It is a settled principle of law that in the event of conflict between a general and special law, ordinarily the special law will prevail, subject to exceptions. Keeping in mind the interests of the banking sector and providing a streamlined set of law, the SARFAESI Act was enacted by the Legislature to expedite the resolution of financial debts owed to banking institutions by way of sale of the asset which is held by them as security against the said mortgage or loan.

The entire scheme of the SARFAESI Act is to provide a robust mechanism which allows Secured Creditors to recover their debts in an expeditious and effective manner by sale of the secured asset without intervention either from the Courts or the Debts Recovery Tribunal as per the procedure prescribed under the Act.

General Rule of Damages – Compensation Payable to The Extent of Injury Suffered

The Indian Contract Act, as a general law prescribes that compensation must not become payable as a way of penalty or fine towards any breach that has been made by a contracting party and rather must be strictly limited to the extent of the injury that has been suffered by the aggrieved party. Such damage or injury must be demonstrable and proved by the party having suffered it.

Section 74 of the Indian Contract Act does not recognise the concept of compensation in the absence of specific loss or injury resulting from any breach of contract.

Forfeiture of Earnest Money – Permissible Under SARFAESI in Case of A Failed Sale of Security Interest – Contract Act Not Applicable
The scheme of SARFAESI Act allows secured creditor to sell the immovable secured asset in case of default on the loan or mortgage subject to fulfilment of the requirements under the Act.  The SARFAESI Security Interest (Enforcement) Rules 2002 provide the way such sale may be undertaken.

Rule 9(5) of the said Rules permits the Secure Creditor/Bank to forfeit the deposit made by a prospective buyer for the property/secured interest in question towards earnest money in case it makes a default in making payment towards the balance outstanding amount. To put it simply, the SARFAESI Act provides an express right to the Secured Creditor/Bank to forfeit the earnest money in case a buyer fails to make the balance payment as per schedule, irrespective of any implication or annotation to penalty, etc and is rather couched in such language which flows as a consequential action upon failure to pay the outstanding balance.

The Supreme Court while analysing the implications of the above Rules and whether the same would amount to unjust enrichment of the Secured Creditor, was pleased to observe that the Act has an unequivocal provision for forfeiture of the deposit amount and as such is an express and clear departure from the general provision of law pertaining to damages, more particularly Section 74 of the Contract Act.

The SARFAESI Act by way of the Rules has specifically permitted the forfeiture of the deposit amount thereby rendering the scheme envisaged under the Indian Contract Act as inapplicable to the proceedings commenced under SARFAESI.

Forfeiture Under SARFAESI Cannot Be Understood as Breach of Obligation, but Couched as A Statutory Provision

One of the crucial clarifications and distinctions made by the Apex Court vide its judgment in The Authorised Officer, Central Bank of India (supra) is in the import of forfeiture under the SARFAESI, which though stems from a breach of obligation by the purchaser. However, it finds statutory force from the Rules that explicitly permit forfeiture, therefore, the question of applicability of the provisions under the Indian Contract Act does not arise.

Refund of Earnest Money Permissible Under Sarfaesi Under Exceptional Circumstances

While the recent judgment has accorded much required clarity over earnest money forfeitures being made by Secured Creditors/Banks against defaulting purchasers who fail to make the payment as per the scheme of under SARFAESI Act, it is not the case that refunds are not permissible for such deposits.

If a buyer can demonstrate extraneous and intervening circumstances as ground for the inability to make the balance payments with no imputation of fault on the purchaser, then such grounds can be pleaded for either grant of additional extension of time for making the balance payment, or refund of the amount deposited.