The primacy of homebuyers over financial institutions: the RERA and SARFAESI conundrum

The Supreme Court's decision to consider banks as promoters for the purpose of the RERA Act will lead to a conundrum in the execution of the three legislations namely, the RERA, the SARFAESI Act, and the IBC.

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ON February 14, the division bench of the Supreme Court consisting Justices M.R Shah and B.V Nagarathna upheld the judgment of the Rajasthan High court, passed in December 2021, in Union Bank of India v. Rajasthan Real Estate Regulatory Authority & Ors., which has caused a conflict, in this regard, between the provisions of the Real Estate (Regulation and Development) Act, 2016 ('RERA Act') and the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ('SARFAESI Act'). 

The Supreme Court's decision extends the jurisdiction of RERA authority in the cases where a complaint is lodged by an aggrieved person against the bank as a secured creditor in the event the bank takes recourse to any of the provisions under Section 13(4) of the SARFAESI.

Section 13(4) reads as follows:

"4) In case the borrower fails to discharge his liability in full within the period specified in sub-section (2), the secured creditor may take recourse to one or more of the following measures to recover his secured debt, namely:—

(a) take possession of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale for realising the secured asset;

(b) take over the management of the business of the borrower including the right to transfer by way of lease, assignment or sale for realising the secured asset:

Provided that the right to transfer by way of lease, assignment or sale shall be exercised only where the substantial part of the business of the borrower is held as security for the debt: Provided further that where the management of whole of the business or part of the business is severable, the secured creditor shall take over the management of such business of the borrower which is relatable to the security for the debt.

(c) appoint any person (hereafter referred to as the manager), to manage the secured assets the possession of which has been taken over by the secured creditor;

(d) require at any time by notice in writing, any person who has acquired any of the secured assets from the borrower and from whom any money is due or may become due to the borrower, to pay the secured creditor, so much of the money as is sufficient to pay the secured debt."

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The objective of RERA legislation was to protect the interests of home-buyers against the influence of promoters in the real estate market, and that of SARFAESI was to protect the banks against the defaults committed by the promoters of real estate projects in repaying the debt. Due to the inconsistencies created by the judgment, the law has become even more complicated, causing a conundrum in the execution of three statutes: the RERA Act of 2016, the SARFAESI Act of 2002, and the Insolvency and Bankruptcy Code, 2016. This has been explained below. 

RERA to prevail over SARFAESI

The Supreme Court upheld the Rajasthan High Court's decision on three significant issues of contention between the two legislations:

1. Whether RERA has the authority to hear allottee complaints against a secured creditor?
2. Which legislation will survive in case of a conflict between RERA and SARFAESI?
3. Whether the RERA Act would apply retrospectively to financial institutions in whose favour security interests were created prior to the Act's enactment?

On the first contention, the Supreme Court's bench observed that banks will be considered promoters for the purposes of the RERA Act, and if the bank uses any measures under Section 13(4) of the SARFAESI Act, it triggers a statutory assignment of the borrower's right to the secured creditor, providing jurisdiction to RERA authority to hear a complaint filed by an aggrieved person. This means that a lender cannot recoup its debts from a developer by selling the property but must instead assume the role of a promoter or developer. However, the court made it clear, in this regard, that the RERA will have the jurisdiction only when the homebuyers approach the authority to protect their interests. 

On the second, the Rajasthan High Court relied on Bikram Chatterji versus Union of India and Ors(2019), in which the Supreme Court had declared that in case of a conflict between the two acts, provisions of RERA would prevail. This was reiterated.

Lastly, the Supreme Court concluded that RERA would not apply retrospectively unless the security interest was created by fraud or collusion.

Impact on financial institutions

As the financial institutions are now considered "promoters," they will have to comply with responsibilities for promoters enshrined under RERA Act. Furthermore, financial institutions will now be subject to RERA's jurisdiction, meaning they will have to adhere to RERA's notice and will have to represent themselves if allottees make a complaint. Also, due to the possibility of several complaints being submitted by allottees, the process of enforcing security interests by financial institutions as per section 13(4) of the SARFEASI Act will not be a smooth process. 

Previously, financial institutions could bring a case as per Section 13(4) of the SARFAESI Act without the involvement of tribunals/courts. However, if the promoter fails to pay the dues, the proceedings may be delayed due to the RERA Authority's involvement. Finally, if a developer defaults on a loan and the financial institution considers selling the mortgaged property by auction, the financial institution will have to obtain prior written consent from the RERA authority.

More importantly, putting lenders in the shoes of a promoter or his assignee under Section 2 (zk)(i) of RERA goes against the financial institutions' core duty. The role of providing funding for house building is assigned to banks and financial entities regulated by the National Housing Bank. It is not legally tenable to impose the obligation on financial institutions to step into the shoes of a promoter in real estate activities because none of these regulations provides for allocating such duty to lenders. 

It can also be claimed that putting the lender in the borrower's shoes may result in an absurd situation in which the lenders are perceived to be engaging in any and all activities that they finance. The part of the order which requires banks to get RERA's clearance before transferring a secured asset violates legal standards because the statute itself is silent on the method for transferring property under the Act. 

Also, applying the principles of subrogation and guarantee under the present conflict can lead to unfounded conclusions. If the real estate project is delayed or becomes a non-performing asset, the promoters have a legal and statutory obligation to settle their debts to the lenders first. However, as per the decision of this case, the lender itself is asked to protect the rights of home-buyers first, creating a legal gap between the requirements of the SARFAESI Act and the RERA Act because the latter infringes on the former's purview of executing recovery powers, which are solely vested with the Debts Recovery Tribunals ('DRTs').

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Hence, the Supreme Court's decision will impact the rights of financial organisations that offer credit to real estate businesses in relation to the rights of project allottees. It raises doubts about RERA's authority to evaluate the validity or invalidity of a mortgage generated by a registered instrument, or to completely overturn the bank or financial institution's actions, given that RERA's jurisdiction in such circumstances is clearly limited by Section 34 of the SARFAESI Act. Also, under Section 17 of the SARFAESI, any person (including an aggrieved flat purchaser) who is aggrieved by a secured creditor's actions under the SARFAESI Act has the right to file a statutory appeal. 

The RERA may not have the authority to set aside, alter, or modify a registered mortgage or charge made in favour of the bank/financial institutions, or to adjudicate the question of fraud, as these matters will fall under the jurisdiction of the DRT/civil courts, as applicable. Under Section 14 of the SARFAESI Act, the authority also lacks the ability to hear appeals or set aside physical possession orders. The sole option is to file a complaint with the DRT under Section 17 of the SARFEASI Act.

Further, unlike the IBC, no moratorium is mandated under the SARFAESI Act. As a result, house-buyers will be able to register complaints with RERA Authorities. Such claims can be filed as soon as any bank or financial institution takes enforcement action under Section 13(4) of the SARFAESI Act.