Position of guarantor under sarfaesi act
Deed of guarantee does not create any security interest. Sec.31(e) of the Act makes it further clear from the following words:
“any other contract in which no security interest has been created”.
SARFAESI Act deals with secured assets and not with the covenants in the contracts. This is because the guarantee deed needs adjudication for determination of guarantor’s liability. But adjudication process is avoided in SARFAESI Act in view of the recommendations of Andhyarujina Committee Report (which has discovered that adjudication process consumes more delay in recovery of bad debts). Therefore DRT is conferred with power of scrutinizing (u/s.17(2) of the Act) the action of secured creditor taken under the Act and not adjudication of claim amount. There is difference between scrutiny and adjudication. Scrutiny is nothing but legal audit of the action of the secured creditor under the Act. Adjudication is process of determination of claim or liability of borrower or guarantor. When DRT has no power to adjudicate on the quantum of the claim of secured creditor under the Act (FB :Madras High Court: in Laksmi Sankar Mills (P) Ltd. Vs. Authorised Officer, Indian Bank (2008(2)CTC 529), the question of adjudicating the guarantor’s liability does not arise under SARFAESI Act. However it is open to the borrower and or guarantor to challenge various issues such as legality of the action, illegal or excess loading of interest, compounding of penal interest, illegitimate charges etc.in the loan account, except seeking relief of determination of quantum of claim/liability.
Guarantor is entitled to service of all the statutory notices even if he has not created any security interest. This is clearly provided in Sub-Rule (4) of Rule 3 of Security Interest (Enforcement) Rules 2002 which reads thus:
“(4) Where there are more than one borrower, the demand notice shall be served on each borrower”.
Further, guarantor comes within the fold of the definition “borrower” under Sec.2(f) of SARFAESI Act which reads thus:
‘(f) "borrower" means any person who has been granted financial assistance by any bank or financial institution or who has given any guarantee or created any mortgage or pledge as security for the financial assistance granted by any bank or financial institution and includes a person who becomes borrower of a securitisation company or reconstruction company consequent upon acquisition by it of any rights or interest of any bank or financial institution in relation to such financial assistance’
Thus guarantor is also taken within the fold of definition of ‘borrower’ under Sec. 2(f) of SARFAESI Act. Therefore any action taken under the Act without serving statutory notices to guarantor (existing if any in loan transaction) is not known to law and the same shall stand vitiated.
Sub-Sec (2) of Sec. 2 of SARFAESI Act makes it further clear thus:
“(2) Words and expressions used and not defined in this Act but defined in the Indian Contract Act, 1872 (9 of 1872) or the Transfer of Property Act, 1882 (4 of 1882) or the Companies Act, 1956 (1 of 1956) or the Securities and Exchange Board of India Act, 1992 (15 of 1992) shall have the same meanings respectively assigned to them in those Acts”.
Therefore, even if the guarantor is defined in the SARFAESI Act as ‘borrower’ for the purpose of the Act, instead of calling him as ‘guarantor’ the position defined and expressed in Indian Contract Act, shall have the same meanings assigned. Guarantor can pay the entire debt demanded in which event he has right to fall back on the securities on paying the debt of the principal borrower and exercise his rights under Sec.141 and 145 of Indian Contract Act. For this reason also the guarantor is entitled to service of all the statutory notices even if he has not created security interest to support the loan of the principal borrower.
All the statutory notices under the Act have to be served to guarantor in the same manner as is evident from Sub-Rule 3 of Rule 3 of Security Interest (Enforcement) Rules 2002 which reads thus:
“(3) Any other notice in writing to be served on the borrower or his agent by authorised officer, shall be served in the same manner as provided in this rule”.
In cases where the guarantor has also has created security interest and if the secured creditor intends to enforce the security interest created by a guarantor first, before enforcing the security interest created by the principal borrower, it can do so and the guarantor cannot direct or dictate the secured creditor as to which security interest is to be enforced first.
The Hon’ble Supreme Court in Ahok Mahajan Vs. State of U.P.& Ors: 2007(2) D.R.T.C.696 (SC) held that action against guarantor cannot be taken until property of principal borrower is sold off in view of S-4(2)(b) of U.P. Public Moneys (Recovery of Dues) Act.
Distinguishing with the above judgment of Supreme Court, A.P. High Court in Ahok Sharada Vs. Small Industries Development Bank of India: 2007 (2) D.R.T.C 707(AP) held that, RDDB & FI Act and SARFAESI Act do not contain any provision analogous to S-4(2)(b) of U.P. Moneys (Recovery of Dues) Act 1972. Hence no such priority or preference can be given to guarantor's direction to secured creditor for taking action under the SARFAESI Act. It is secured creditors option to choose which security interest can be enforced first.
Any one please clarify if the above view is correct or not, giving reasons.