Impact of Crown Debts/Sovereign Debts on secured creditor

“Crown Debt” is common law doctrine.  This is recognized by Indian High Courts prior to 1950.  This law continues to be in force within the meaning of Article 372(1) of Indian Constitution. Government takes precedence and priority over the citizens for recovery of the statutory dues i.e., citizens are bound to pay the statutory dues first before they pay their dues to the creditors. This is a Royal prerogative. According to Yajnavalkya (YÄjñavalkya of Mithila was a legendary sage of Vedic India, credited with the authorship of the Shatapatha Brahmana (including the Brihadaranyaka Upanishad ...), a debtor shall be forced to pay the dues to the King and priest first as forced by his creditors. Even Mohammedan Sovereigns have not abandoned or waived this important prerogative.  Supreme Court in Builders Supply Corporation’s case (Builder Supply Corporation vs. Union of India represented by the commissioner of Income Tax, West Bengal & others AIR 1965 SC 1061) held that recovery of tax due from citizen must take precedence and priority over the unsecured debts from the said citizen to his other private creditors.

In Bank of Bihar Vs. State of Bihar & others (AIR 1971 SC 1210) for Sugar cess, the sugar cane was confiscated.  Supreme Court held that the cane commissioner couldn’t lay his hand on the goods, as he is an unsecured creditor and the bank as pledgee has priority. In State Vs. Andhra Bank (AIR 1988 AP 18) AP High Court held that the bank has a preferential right compared to Tahsildar who has attached the hypothecated sugar towards purchase tax.

In Indian Bank Vs. State of AP &others (1993 STC Page 548) it was held that land revenue is different from public revenue.  Hence sales tax arrears cannot be treated as land revenue, and hence not soverign debt, and cannot have priority. In Satyam Vs. Krishna Murthy &others (AIR 1969 AP 237) it was held that income tax arrears subsequent to mortgage couldn’t have priority.  In Sitari Textiles & Fabrics (p) Ltd Vs. Asst. Collector of Customs & C.E. Hyderabad (1999 –(106) ELT – 0296- AP.  In this case, M/s Dakshin Fabrics availed loan from APIDC.  On account of default in repayment of the loan APIDC brought, the unit for sale.  The supdt. of C.E. detained the plant and machinery. The High Court held that right of the Pawnee (Pledgee) couldn’t be extinguished by subsequent attachment or seizure of the goods under any other law.  A mortgagee has preferential right over unsecured creditor. But this concept and thought is changed in Dena Bank Vs. Bhikkmbhai Prabhudas Parekh & Co and others (2000 AIR SCW 4237) Supreme Court held that the statutory dues will  have priority over the dues of a secured  creditor if there is provision in that particular statute. In the absence of such provision, the statutory dues will not have priority over the dues of the secured creditor. Supreme Court, in State of M.P. & others vs. State Bank of Indore & others (STC Volume 126, 2002) following its earlier judgment in Dena Bank Vs. Bhikkam Bhai Prabhudas Parekh & Co. held that Sales Tax Dept. has preference over the bank’s dues. This is because the State of M.P. inserted section 33–C in M.P. Sales Tax Act, 1958  to operate as statutory first charge in respect of the sales tax arrears and thus have preference over the bank’s charge on the plant & Machinery.  Now it is settled law that, “Crown debts” shall have priority over secured creditors.

If Central or State law provides that, such dues will have priority over the secured creditors it is binding on the secured creditor even if it is First Charge holder. The secured creditor has to satisfy first the crown debts if any out of the sale proceeds.  This is legal position in relation to the hypothecated movable properties and mortgage of immovable properties.

But position of a pledgee is different (see Bank of Bihar Vs. State of Bihar & others AIR 1971 SC 1210). In this case, for ‘sugar cess’, the sugar cane was confiscated by the cane commissioner. Supreme Court held that the cane commissioner couldn’t lay his hand on the goods, as he has no priority but the bank as pledgee has priority. In Indian Bank Vs. State of AP & others (1993 STC Page 548) it was held that land revenue is different from public revenue.  In Satyam Vs. Krishna Murthy & others (AIR 1969 AP 237) it was held that income tax arrears subsequent to mortgage could not have priority.  The High Court of AP in Sitari Textiles & Fabrics (p) Ltd Vs. Asst. Collector of Customs & C.E. Hyderabad (1999 –(106) ELT – 0296- AP held that right of a Pawnee (Pledgee) couldn’t be extinguished by subsequent attachment or seizure of the goods under any other law.  A mortgagee has preferential right over unsecured creditor.

Priority charge is different from pari passu charge. Dues of a workmen of a company under liquidation will have pari passu charge. If the borrower company is in liquidation it is necessary and mandatory that the dues of the workmen are ascertained from the official liquidator and paid. To meet the deficit amount if any the Official Liquidator may obtain indemnity from the secured creditor. However dues of workmen of a company which is a going concern cannot claim any pari passu charge. Section 529A applies only when the company is under liquidation and a Provincial Official Liquidator is appointed. If the company is not in liquidation but is a going concern the question of paying the workmen dues by the secured creditor does not arise (Andhra Bank Vs. Official Liquidator and Anr.: 2005 (II) BC 425).  

Co-lenders (secured creditors) in joint finance will have pari passu charge in proportion to their debts due as per their sharing pattern. However the multiple financiers with or without consent can claim charge only after satisfaction of the first charge holders.

Non- Priority Charges: Electricity dues have no priority(Ahmedabad Electricity Board Vs. Gujarat Inns Pvt. Ltd.: 2004(3) ALD 33 (SC)).;(Isha Marbles Vs. Bihar State Electricity Board : 1 (1995) BC 529; Swan Industries Ltd. Vs. Ajmer Vidhyut Vitaran Nigam Ltd).: 1 (2005) bc 286 (Raj.) Madras High Court (Full bench) in (UTI Bank Ltd. Vs. Commissioner of Central Excise) [2007]135 Comp. Cas. 329. held that the Custom & Excise dues are not crown debts and have no priority over secured creditor.

In the absence of any specific provisions in SARFAESI Act creating any first charge in favour of the Bank, Sec 281 (b) of the Income Tax Act r/w Rule 16 of the Second Schedule of the IT Act will have overriding effect. The provisional attachment under IT Act being prior to the creation of the security interest in favour of the bank, the subsequent action of the Bank under SARFAESI Act cannot sustain, the notice issued by Tax Recovery Officer to UCO Bank demanding the sale proceeds in respect of property is held to be legal: UCO Bank Vs Union of India 2009 [2009]182 Taxman 26 (Guj).

Sec 11(2) of the E.P.F Act has priority over banks dues (Bank of India Vs Assistant Provident Commissioner:2006(2) DRTC 282 (Ker.)(DB).

In view of the enactment of special laws by the State giving priority to the dues of arrears of tax over security interest created, the rights of the secured creditors have been eroded and diluted.  It is not clear whether the State laws giving priority to tax dues over secured creditors have been enacted after obtaining President’s assent and are valid laws under Article 254 of the Constitution in spite of the inconsistency with Central Law.  The above issue was not raised before the Supreme Court and it has been held that such laws are constitutionally valid. Possibility of more such enactments by the other State Government cannot be ruled out and therefore, uncertainty prevails in regard to rights of secured creditors in the absence of specific provisions spelling out priority over others.

State Finance Corporation (SFC) Act 1951 is combination of substantive law and procedural law. There is specific provision in SFC Act for claiming priority of dues over the crown debts. State Finance Corporation Act has statutory right which will have priority over other laws as can be seen from the non-obstante clause contained in Sec.46B of State Finance Corporations Act. It not only prevails over the contract but also on other laws. Central Excise Rules have no priority over right of State Finance Corporation (Union of India & Ors. Vs. SICOM Ltd. & Anr. 2009(1)DRTC 297 SC) 

RDDB & FI Act 1993 and SARFAESI Act 2002 are not substantive laws. They are only procedural laws. Substantive law governs rights and obligations of those who are subject to it and defines the legal relationship of people with other people or between them and the state. Procedural law deals with the method and means by which substantive law is administered. There are no specific provisions in the RDDB & FI Act 1993 or SARFAESI Act 2002 which enable the Bank to claim priority of charge over crown debts. State Bank of India Act 1955 or Banking Companies (Acquisition) Act 1970 /1980 being substantive laws are silent in this regard and have no provisions claiming priority of charge over Crown debts. In the absence of provisions the banks have to forego the sale proceeds realised after exercise of the powers for recovery of the debt in full. Hence the concerned Ministry should think about the urgent need of incorporating such law to safeguard interest of banks.