2025 (4) TMI 1593 - HC - VAT / Sales Tax

Recovery of arrears of sales tax - priority of claims of secured creditor bank s equitable mortgage created in 1991 over the claims of the Commercial Taxes Department arising from sales tax arrears under the Tamil Nadu General Sales Tax Act 1959 - interpretation and applicability of Section 26E of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (SARFAESI Act) - HELD THAT - The records make it clear that this arrangement has been on-going since December 1991. The impugned notices/communications have been issued only in December 2002 and hence the arrangement between the bank and the defaulters was already in place for more than a decade when the impugned notices were received. On a careful perusal of the records of the Commercial tax Department as well as DRT/DRAT it is concluded that the available documents establish the legitimacy of the factual position of the bank in these writ petitions. As far as the question of priority is concerned Section 26E of the SARFAESI Act is a specific provision which states that notwithstanding anything contained in any other law for the time being in force and after the registration of security interest it is the debts due to the secured creditor that shall have priority over all other debts and revenues including those payable to the Central or State Government or local authority. Hence as far as SARFAESI Act is concerned and with respect to the question of priority it is Section 26E which is a specialized section that would apply. The provisions of Section 34 of the RDB Act are by contrast general in nature - in the juxtaposition of Section 26E of the SARFAESI Act with Section 34 of the RDB Act it is Section 26E of the SARFAESI Act that will provide the necessary impetus for determining the priority of a charge of security interest in favour of the Financial Institution as Section 34 of the RDB Act is by comparison only a general provision. It is very clear that it is the provisions of Section 26E of the SARFAESI Act and Section 34 of the RDB Act would prevail over the provisions of Section 24 of the TNGST Act. Additionally this is a case where security interest has been created by the bank as early as in 1991 prior to the charge imposed by the Sales tax Department. Section 24 of the TNGST Act does not provide for priority by creation of a first charge in respect of the demands raised under that Act. Hence Section 26E of the SARFAESI Act and Section 34 of RDB Act would prevail in public interest. Conclusion - Section 26E of the SARFAESI Act and Section 34 of the RDB Act would prevail over the provisions of Section 24 of the TNGST Act in public interest. The impugned notices and communications are quashed and both writ petitions are allowed.

The core legal questions considered in the judgment include:

1. Whether the secured creditor bank's equitable mortgage created in 1991 over the property has priority over the claims of the Commercial Taxes Department arising from sales tax arrears under the Tamil Nadu General Sales Tax Act, 1959 (TNGST Act).

2. The interpretation and applicability of Section 26E of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) regarding priority of secured creditors over government dues.

3. The effect of Section 24 of the TNGST Act, which creates a charge on the properties of a person liable to pay tax arrears, and whether this charge amounts to a first charge with priority over secured creditors.

4. The interplay between the SARFAESI Act, the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (RDB Act), and the TNGST Act, particularly in relation to priority of claims and overriding effect of statutes.

5. The legitimacy and effect of the lease arrangement between the bank and the defaulting assessee, whereby lease rentals were adjusted towards the loan dues.

6. The relevance of precedent authorities on the priority of secured creditors vis-`a-vis government dues, including the principle of Crown debts and statutory first charges.

7. Whether the impugned notices issued by the Commercial Taxes Department under Form B-6 and show cause notices demanding payment from the bank are valid in light of the bank's secured creditor status.

Issue-wise Detailed Analysis:

1. Priority of Secured Creditor's Charge vs. Government's Charge under TNGST Act

The legal framework involves Section 26E of the SARFAESI Act which provides that after registration of security interest, debts due to secured creditors have priority over all other debts and revenues payable to government authorities. Conversely, Section 24 of the TNGST Act creates a charge on the property of a person liable for tax arrears, which the Commercial Taxes Department contended gives it priority.

The Court examined the chronology of events: the bank sanctioned loans in 1990 and the equitable mortgage was created and confirmed in January 1991, well before the issuance of the impugned tax demand notices in December 2001. The bank had been in possession of the property and had a lease arrangement with the assessee since 1992, with lease rentals credited towards the loan dues.

The Court found the arrangement legitimate and ongoing for over a decade before the tax department's notices. It held that the bank, as a secured creditor with a registered charge, holds priority over the government's charge under the TNGST Act, which does not create a statutory first charge but merely a charge subject to prior charges.

Precedents such as Punjab National Bank v. Union of India and Others and Union of India v. SICOM Limited were relied upon, which establish that Crown debts (government dues) generally have priority over unsecured debts but not over secured creditors with statutory charges. The Court emphasized that only a specific statutory provision creating a "first charge" can override a secured creditor's charge.

2. Interpretation and Application of Section 26E of the SARFAESI Act and Section 34 of the RDB Act

Section 26E of the SARFAESI Act contains a non-obstante clause giving secured creditors priority over all other debts and revenues, including government dues, once the security interest is registered. The Court noted that Section 34 of the RDB Act has a general overriding effect over other laws but is not as specific as Section 26E of SARFAESI Act.

The Court held that the specific provision of Section 26E of SARFAESI Act governs the priority question and overrides the general provisions of the RDB Act and the TNGST Act. It also noted that Section 37 of the SARFAESI Act clarifies that the Act is in addition to and not in derogation of other laws, indicating concurrent application but with priority given to registered secured creditors.

3. Legitimacy of Lease Arrangement and Adjustment of Rent Towards Loan Dues

The bank was a tenant of the property under a lease deed executed in 1992. The defaulting assessee had authorized the bank to adjust lease rentals against the loan dues. The Court examined documents, including the lease deed and communications, and the records of the Debt Recovery Tribunal and Appellate Tribunal, confirming the arrangement was bona fide and longstanding.

This arrangement demonstrated the bank's secured interest in the property and the ongoing adjustment of dues, reinforcing the bank's priority claim.

4. Treatment of Competing Arguments and Precedents

The Commercial Taxes Department argued that their charge under Section 24 of the TNGST Act gave them priority. The Court distinguished this from statutory first charges under other Acts (e.g., Bombay Sales Tax Act), which create explicit first charges with priority over secured creditors.

The Court reviewed various precedents and held that the TNGST Act's charge is not a first charge and does not override prior registered secured interests. It also discussed the principle of Crown debts, clarifying that it applies to unsecured debts, not secured creditors with statutory charges.

The Court further analyzed the Supreme Court's decision in Rainbow Papers, which involved a statutory first charge under the Gujarat VAT Act and the Insolvency and Bankruptcy Code, noting that the facts and statutory provisions differ from the present case.

5. Application of Law to the Facts and Final Conclusions

Given the equitable mortgage was created and registered in 1991 and the bank's possession and lease arrangement predated the tax arrears demand notices by over a decade, the bank's secured charge has priority over the Commercial Taxes Department's charge.

The impugned B-6 notices and show cause notices demanding payment from the bank were quashed as they conflicted with the bank's priority secured creditor status under the SARFAESI Act and RDB Act.

The Court also noted that the bank had purchased the property in auction and was occupying it as owner, further reinforcing its rights.

Significant Holdings:

"Notwithstanding anything contained in any other law for the time being in force, after the registration of security interest, the debts due to any secured creditor shall be paid in priority over all other debts and all revenues, taxes, cases and other rates payable to the Central Government or State Government or local authority." (Section 26E, SARFAESI Act)

"The Crown's preferential right to recovery of debts over other creditors is confined to ordinary or unsecured creditors. The common law ... do not accord the Crown a preferential right of recovery of its debts over a mortgage or pledge of goods or a secured creditor." (Extract from Punjab National Bank v. Union of India)

"Section 24 of the TNGST Act does not provide for priority by creation of a first charge in respect of the demands raised under that Act."

"Section 26E of the SARFAESI Act and Section 34 of the RDB Act would prevail over the provisions of Section 24 of the TNGST Act, in public interest."

"The impugned notices and communications issued by the Commercial Taxes Department under Form B-6 and show cause notices are quashed as they are inconsistent with the bank's priority secured charge."

"The arrangement between the bank and the defaulting assessee for adjustment of lease rentals towards loan dues is legitimate and ongoing since 1991, establishing the bank's secured interest."

The Court's final determination was to allow the writ petitions filed by the bank, quash the impugned tax demand notices and show cause notices, and uphold the priority of the bank's secured charge created in 1991 over the claims of the Commercial Taxes Department under the TNGST Act.

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