Interface Between SARFAESI Act and IBC: A Legal Analysis

Introduction

The Indian financial landscape underwent a transformative shift with the introduction of the Insolvency and Bankruptcy Code, 2016. This legislation emerged as a response to the fragmented legal framework that previously governed insolvency proceedings in India. Before its enactment, creditors had to navigate through multiple statutes, each with its own procedural complexities and timelines, often leading to prolonged litigation and diminished asset values. The Code sought to address these inefficiencies by creating a unified, time-bound mechanism for resolving insolvency and maximizing asset value for all stakeholders. Alongside the Insolvency and Bankruptcy Code, the Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002, commonly known as the SARFAESI Act, continues to play a significant role in debt recovery mechanisms in India. The interface between SARFAESI Act and IBC has become increasingly important, as this legislation was specifically designed to empower secured creditors, particularly banks and financial institutions, to enforce their security interests without court intervention. The Act provided these institutions with the authority to take possession of secured assets and sell them to recover outstanding debts, thereby streamlining the recovery process and reducing the burden on already overcrowded debt recovery tribunals.

However, the coexistence of these two robust legislative frameworks has inevitably led to situations where their provisions intersect and sometimes appear to conflict. When both statutes address similar objectives—namely, the recovery of debts from defaulting borrowers—questions naturally arise about which law should take precedence. This article examines the interface between these two important pieces of legislation, analyzing the legal principles that govern their interaction, the judicial interpretations that have shaped their application, and the practical implications for creditors, debtors, and other stakeholders in insolvency proceedings.

The Legislative Framework: Understanding Both Statutes

The Insolvency and Bankruptcy Code, 2016

The Insolvency and Bankruptcy Code represents a paradigm shift in how India addresses corporate distress and insolvency. The Code consolidated and amended the provisions of eleven different statutes that previously governed insolvency proceedings, including the Companies Act, 1956, the Sick Industrial Companies Act, 1985, and various provisions relating to partnership firms and individuals. Its primary objective is to facilitate the timely resolution of insolvency in a manner that maximizes the value of assets and promotes entrepreneurship by providing a fresh start to failed businesses.

The Code establishes a comprehensive framework that balances the interests of all stakeholders—secured creditors, unsecured creditors, operational creditors, employees, and shareholders. It introduces time-bound processes, with the Corporate Insolvency Resolution Process typically required to be completed within 180 days, extendable by another 90 days in exceptional circumstances. This temporal discipline was designed to prevent the deterioration of asset values that often occurred under previous regimes where insolvency proceedings dragged on for years.

One of the most significant features of the Code is its waterfall mechanism for distribution of proceeds, which ensures that different classes of creditors are paid in a specified order of priority. The Code also establishes specialized institutions, including the Insolvency and Bankruptcy Board of India, which regulates insolvency professionals and information utilities, and the National Company Law Tribunal, which serves as the adjudicating authority for corporate insolvency matters.

The SARFAESI Act, 2002

The SARFAESI Act was enacted to address the mounting problem of non-performing assets in the Indian banking sector. Prior to its introduction, secured creditors had to approach courts or debt recovery tribunals to enforce their security interests, a process that was both time-consuming and expensive. The Act fundamentally changed this by enabling secured creditors to bypass judicial processes and directly take possession of secured assets upon a borrower’s default.

Under the SARFAESI Act, when a borrower’s account is classified as a non-performing asset, the secured creditor can issue a notice demanding payment within sixty days. If the borrower fails to comply, the creditor has the power to take various measures, including taking possession of the secured assets, appointing a manager to manage the secured assets, or selling the assets to recover the outstanding debt. This self-help mechanism significantly reduced the time and cost involved in debt recovery.

The Act applies to banks, financial institutions, and asset reconstruction companies, but notably excludes certain categories of loans, such as agricultural land and those secured against amounts less than specified thresholds. It also provides borrowers with the right to approach the Debt Recovery Tribunal if they are aggrieved by the measures taken by secured creditors, thereby ensuring a basic level of procedural fairness while maintaining the efficiency of the recovery process.

The Non-Obstante Clause: Section 238 of the Insolvency and Bankruptcy Code

The key to understanding the Interface between the Insolvency and Bankruptcy Code and the SARFAESI Act lies in Section 238 of the Code. This provision contains what is known as a non-obstante clause, which is a legislative device used to indicate that the provisions of a particular statute should prevail over conflicting provisions in other laws. Section 238 states: “The provisions of this Code shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law.”

This provision establishes the supremacy of the Insolvency and Bankruptcy Code over all other laws that may contain inconsistent provisions. The use of the phrase “notwithstanding anything inconsistent therewith contained in any other law” clearly indicates legislative intent that the Code should override conflicting provisions in statutes enacted either before or after it. This is particularly significant because the SARFAESI Act was enacted fourteen years before the Insolvency and Bankruptcy Code, and its provisions were not originally designed to interact with a comprehensive insolvency framework.

The non-obstante clause in Section 238 operates on the principle that when Parliament enacts a comprehensive statute to address a particular subject matter, it intends for that statute to provide a complete code on the subject. This principle is especially important in the context of insolvency proceedings, where multiple creditors may have competing claims on a debtor’s assets. The Code’s non-obstante clause ensures that once insolvency proceedings commence, all creditors are treated equally according to the waterfall mechanism established by the Code, rather than allowing individual creditors to pursue their own remedies under other statutes.[1]

Judicial Interpretation: Key Precedents

The Encore Asset Reconstruction Company Judgment

The Interface between the SARFAESI Act and the Insolvency and Bankruptcy Code (IBC) was extensively examined by the National Company Law Appellate Tribunal in the case of Encore Asset Reconstruction Company Private Limited versus Ms. Charu Sandeep Desai. This case arose from a situation where a secured creditor had already taken possession of mortgaged property under the SARFAESI Act before insolvency proceedings were initiated against the corporate debtor under the Code.

The facts of the case involved a loan taken by Calyx Chemicals and Pharmaceuticals Limited from Dena Bank in 2011, with property pledged as security. When the borrower defaulted, Dena Bank initiated proceedings under the SARFAESI Act and took possession of the secured property in 2017. Subsequently, in October 2017, the State Bank of India filed an application under Section 7 of the Code against the same corporate debtor before the National Company Law Tribunal. After the application was admitted in February 2018, an Interim Resolution Professional was appointed and a moratorium was declared under Section 14 of the Code.

Dena Bank approached the Tribunal seeking an interim order to prevent the Interim Resolution Professional from taking custody of the property, arguing that since they had already taken possession under the SARFAESI Act, they had acquired all rights relating to the property. The bank relied on the Supreme Court’s judgment in Transcore versus Union of India, which had held that once a bank or financial institution takes possession of a secured asset under the SARFAESI Act, it can deal with the asset as if it were the owner.

The National Company Law Tribunal analyzed the Transcore judgment carefully and concluded that the use of the words “as if” in that judgment indicated deemed ownership rather than actual ownership. The Tribunal observed that the property continued to appear on the balance sheet of the corporate debtor, and therefore, under Section 18 of the Code, the Interim Resolution Professional was obligated to take control and custody of the asset.[2]

When Dena Bank appealed to the National Company Law Appellate Tribunal, the Appellate Tribunal upheld the lower tribunal’s decision. The Appellate Tribunal emphasized that Section 18 of the Code imposes a mandatory obligation on the Interim Resolution Professional to take control and custody of any asset over which the corporate debtor has ownership rights. The tribunal noted that although possession had been transferred to Dena Bank, ownership remained with the corporate debtor. Neither had the title been transferred nor had the asset been sold under Section 13(4) of the SARFAESI Act.

Most significantly, the Appellate Tribunal observed that the Transcore judgment was delivered in 2008, several years before the Insolvency and Bankruptcy Code came into existence. The tribunal held that the non-obstante clause in Section 238 of the Code unambiguously establishes its primacy over the SARFAESI Act in cases of conflict. This judgment effectively settled the question of which statute prevails when secured creditors have taken action under the SARFAESI Act before insolvency proceedings commence.[3]

The Moratorium Provision: Section 14 of the Code

Another critical aspect of the interface between the SARFAESI Act and IBC involves Section 14 of the Insolvency and Bankruptcy Code, which provides for a moratorium period during insolvency proceedings. When a moratorium is declared, it prohibits the institution of suits or continuation of pending suits or proceedings against the corporate debtor, the transfer of any asset by the corporate debtor, and any action to foreclose, recover, or enforce security interest created by the corporate debtor.

The moratorium provision is designed to create a breathing space during which the corporate debtor’s business can continue as a going concern while a resolution plan is being formulated. This standstill period prevents individual creditors from taking actions that could dismember the corporate debtor’s assets and destroy its value as a continuing enterprise. Courts have consistently held that once a moratorium is imposed under the Code, any proceedings under Section 13(4) of the SARFAESI Act must cease immediately.

This interpretation was first established in M/S Unigreen Global Private Limited versus Punjab National Bank, where the National Company Law Appellate Tribunal held that the Insolvency and Bankruptcy Code is superior to the SARFAESI Act. The tribunal observed that even a pending proceeding under the SARFAESI Act cannot prevent a creditor from filing a new proceeding under the Code, and once insolvency proceedings are admitted and a moratorium is declared, all SARFAESI proceedings must be suspended.[4]

Duties of the Interim Resolution Professional Under Section 18

Section 18 of the Insolvency and Bankruptcy Code delineates the duties of the Interim Resolution Professional, and these duties are central to understanding why the Code prevails over the SARFAESI Act when both statutes come into conflict. Specifically, clause (f) of Section 18 requires the Interim Resolution Professional to “take control and custody of any asset over which the corporate debtor has ownership rights as recorded in the balance sheet of the corporate debtor, or with information utility or the depository of securities or any other registry that records the ownership of assets.”

This provision encompasses a wide range of assets, including assets over which the corporate debtor has ownership rights that may be located in a foreign country, assets that may or may not be in possession of the corporate debtor, tangible assets whether movable or immovable, intangible assets including intellectual property, securities including shares held in any subsidiary of the corporate debtor, and assets subject to the determination of ownership by a court or authority.

The key phrase in this provision is “ownership rights.” The courts have consistently held that what matters for the purposes of Section 18 is not physical possession but ownership rights. Even if a secured creditor has taken possession of an asset under the SARFAESI Act, if the corporate debtor retains ownership rights over that asset, the Interim Resolution Professional is obligated to take control and custody of it. This interpretation flows naturally from the Code’s objective of maximizing asset value for the benefit of all creditors collectively, rather than allowing individual creditors to sequester assets for their exclusive benefit.

Distinguishing Between Both Legislative Frameworks

Scope of Creditor Protection

One of the fundamental differences between the SARFAESI Act and the Insolvency and Bankruptcy Code lies in the scope of creditor protection each statute provides. The SARFAESI Act was designed specifically to protect secured creditors, particularly banks and financial institutions. It empowers these creditors to enforce their security interests without court intervention, giving them significant leverage in debt recovery situations. The Act essentially provides a self-help remedy to secured creditors, allowing them to realize their security quickly and efficiently.

In contrast, the Insolvency and Bankruptcy Code adopts a more inclusive approach by safeguarding the rights of all types of creditors. The Code explicitly recognizes different classes of creditors, including financial creditors, operational creditors, secured creditors, and unsecured creditors, and establishes mechanisms to ensure that each class receives appropriate consideration in insolvency proceedings. The Code’s committee of creditors, which plays a crucial role in approving resolution plans, is composed of financial creditors, but operational creditors and other stakeholders also have the right to participate in the process and have their claims adjudicated.

This difference in scope reflects the different objectives of the two statutes. The SARFAESI Act is primarily a debt recovery mechanism that prioritizes the interests of secured creditors who have lent money against collateral. The Insolvency and Bankruptcy Code, however, is designed to address the broader question of corporate distress and to find solutions that maximize value for all stakeholders while attempting to preserve the corporate debtor as a going concern wherever possible.

Procedural Differences and Effectiveness

The procedural frameworks established by the two statutes differ significantly in their complexity and effectiveness depending on the circumstances of the case. Under the SARFAESI Act, the process is relatively straightforward: the secured creditor issues a notice under Section 13(2), gives the borrower sixty days to pay, and if payment is not made, proceeds to take possession and sell the secured assets under Section 13(4). This process does not require court approval, although borrowers can challenge the action before the Debt Recovery Tribunal.

The Insolvency and Bankruptcy Code, on the other hand, involves a more elaborate process. After an application is filed and admitted by the National Company Law Tribunal, an Interim Resolution Professional is appointed, a moratorium is declared, and a Corporate Insolvency Resolution Process commences. During this process, claims are invited and verified, a committee of creditors is formed, and a resolution professional works with the committee to invite and evaluate resolution plans. This process, while more complex, is designed to examine the corporate debtor’s financial situation holistically and to find a solution that preserves value and addresses the interests of all stakeholders.

The effectiveness of each statute varies depending on the nature of the debt and the debtor’s circumstances. In cases where there is no viable business to save—where there are no revenue streams, no potential for revival, and no significant assets beyond the collateral—an action under the SARFAESI Act typically results in quicker recovery through the sale of secured assets. The costs involved in SARFAESI proceedings are generally lower than those associated with the Corporate Insolvency Resolution Process under the Code, which involves the appointment of professionals and various administrative expenses.[5]

However, in large cases involving significant debt burdens and complex business structures, the SARFAESI Act has proven less effective. Taking physical possession of assets in such cases often kills the business and leaves little scope for revival, resulting in reduced overall recovery for creditors. The Insolvency and Bankruptcy Code, with its focus on resolution plans that aim to revive the business as a going concern, has shown greater effectiveness in such situations. Resolution plans under the Code typically secure better outcomes for all stakeholders by preserving the business, maintaining employment, and maximizing the overall value of the corporate debtor’s assets.[6]

Application to Different Categories of Debtors

Another significant difference between the two statutes concerns their application to different categories of debtors. The SARFAESI Act applies broadly to secured debts owed to banks, financial institutions, and asset reconstruction companies, without making distinctions based on whether the debtor is a corporation, partnership, or individual. The Act’s focus is on the nature of the debt and the security interest, rather than on the legal form of the debtor.

The Insolvency and Bankruptcy Code, however, explicitly differentiates between corporate debtors and individuals or partnership firms. The Code establishes separate processes for corporate insolvency resolution and liquidation, which are adjudicated by the National Company Law Tribunal, and for insolvency resolution and bankruptcy of individuals and partnership firms, which fall under the jurisdiction of the Debt Recovery Tribunal. This distinction reflects the different considerations that apply to corporate insolvency, where the focus is often on preserving going concern value and maintaining employment, versus individual insolvency, where issues of fresh start and personal rehabilitation are more prominent.

Practical Implications for Stakeholders

Impact on Secured Creditors

For secured creditors, particularly banks and financial institutions, the interplay between the SARFAESI Act and the Insolvency and Bankruptcy Code has significant practical implications. Prior to the Code’s enactment, secured creditors could confidently rely on the SARFAESI Act to enforce their security interests without worrying about other proceedings. They could take possession of secured assets and proceed to sell them without needing approval from any court or tribunal.

The Code has changed this calculus considerably. Secured creditors must now be aware that if insolvency proceedings are initiated against a corporate debtor, any actions they have taken under the SARFAESI Act may be stayed by the moratorium imposed under Section 14 of the Code. Even if they have already taken possession of secured assets, they may be required to hand over control and custody to the Interim Resolution Professional if the corporate debtor retains ownership rights over those assets.

This does not mean that secured creditors are left unprotected under the Code. They remain part of the committee of creditors and have significant influence over the Corporate Insolvency Resolution Process. The Code’s waterfall mechanism also ensures that secured creditors are paid ahead of most other creditors in the event of liquidation. However, secured creditors can no longer act unilaterally to enforce their security interests once insolvency proceedings have commenced.

Strategic Considerations for Creditors

The existence of parallel frameworks under the SARFAESI Act and the Insolvency and Bankruptcy Code creates important strategic considerations for creditors. When a borrower defaults, creditors must carefully evaluate which remedy to pursue based on the specific circumstances of the case. If the primary objective is quick recovery and the value of the collateral is sufficient to cover the debt, proceeding under the SARFAESI Act may be appropriate, provided there is no risk of insolvency proceedings being initiated by other creditors.

However, if the debtor has multiple creditors and there is a possibility of competing claims, initiating insolvency proceedings under the Code may be the more prudent course. The Code provides a collective mechanism for dealing with all creditor claims simultaneously and ensures that no individual creditor can gain an unfair advantage by racing to enforce their security first. This is particularly important in cases involving large corporate debtors with complex capital structures and multiple layers of debt.

Creditors must also consider the potential for the corporate debtor to be revived through a resolution plan under the Code. In cases where the business has intrinsic value and the financial distress is temporary or the result of factors that can be addressed through restructuring, a resolution plan may yield better returns than liquidating the secured assets. This is especially true in industries where the business’s value as a going concern significantly exceeds its liquidation value.

Implications for Corporate Debtors

From the perspective of corporate debtors facing financial distress, the interface between the SARFAESI Act and the Insolvency and Bankruptcy Code presents both challenges and opportunities. On one hand, the threat of action under the SARFAESI Act, which can result in loss of physical possession of crucial assets, creates significant pressure on defaulting borrowers. The Act provides creditors with powerful leverage that can be used to compel payment or negotiation.

On the other hand, the Insolvency and Bankruptcy Code provides corporate debtors with a potential lifeline through the Corporate Insolvency Resolution Process. Once insolvency proceedings are initiated and a moratorium is declared, the corporate debtor gets breathing space during which no creditor can take individual action to enforce their claims. This moratorium period allows for a holistic assessment of the business and the formulation of a resolution plan that may enable the business to continue as a going concern.

For corporate debtors, timing becomes crucial. If a creditor has already taken possession of critical assets under the SARFAESI Act, the debtor may find itself in a weakened position even if insolvency proceedings are subsequently initiated. While the Interim Resolution Professional will be entitled to take custody of assets over which the debtor retains ownership rights, the disruption caused by the creditor’s actions may have already damaged the business. Therefore, corporate debtors facing multiple creditor claims may find it advantageous to proactively initiate insolvency proceedings before individual creditors can take action under the SARFAESI Act.

Harmonization Challenges and Legislative Gaps

Despite the clear supremacy of the Insolvency and Bankruptcy Code established by Section 238, practical challenges persist in harmonizing the application of these two statutes. One persistent issue is the timing of when SARFAESI proceedings should be stayed after insolvency proceedings are initiated. While the law is clear that the moratorium under Section 14 of the Code prevents the continuation of SARFAESI proceedings, disputes can arise regarding actions taken by secured creditors in the period between when an insolvency application is filed and when it is admitted and a moratorium is declared.

Another challenge arises from the different institutional frameworks governing the two statutes. The SARFAESI Act falls primarily within the regulatory domain of the Reserve Bank of India, while the Insolvency and Bankruptcy Code is overseen by the Insolvency and Bankruptcy Board of India. The National Company Law Tribunal adjudicates corporate insolvency matters under the Code, while challenges to SARFAESI actions are heard by Debt Recovery Tribunals. This institutional fragmentation can lead to coordination problems and, in some cases, conflicting interpretations of how the statutes should interact.

The existence of multiple debt recovery mechanisms—the SARFAESI Act, the Recovery of Debts Due to Banks and Financial Institutions Act, and now the Insolvency and Bankruptcy Code—creates complexity for all stakeholders. While the Code’s non-obstante clause theoretically resolves conflicts in favor of the Code, the practical application of this principle requires creditors, debtors, and adjudicators to navigate through overlapping provisions and determine which statute applies in any given situation.

There is also the question of secured creditors who have completed the sale of assets under the SARFAESI Act before insolvency proceedings are initiated. In such cases, the transfer of ownership has occurred, and the question arises whether the Interim Resolution Professional can still claim those assets or whether the creditor is entitled to retain the proceeds of the sale. The Code does not explicitly address this situation, and judicial interpretation has been required to resolve such disputes.

The Path Forward: Recommendations for Reform

To further streamline the interface between the SARFAESI Act and the IBC, certain legislative and regulatory reforms would be beneficial. First, explicit provisions could be added to the Code to address the treatment of SARFAESI proceedings that have advanced to various stages before insolvency proceedings are initiated. Clear rules regarding the point at which SARFAESI actions become irreversible would reduce litigation and provide greater certainty to all stakeholders.

Second, enhanced coordination between the regulatory bodies overseeing these statutes would improve implementation. The Reserve Bank of India, the Insolvency and Bankruptcy Board of India, and the National Company Law Tribunal could develop joint guidelines clarifying how secured creditors should proceed when a borrower faces financial distress and multiple debt recovery avenues are available. Such guidelines could establish best practices for creditors to avoid conflicting proceedings and reduce the burden on adjudicating authorities.

Third, the training and capacity building of insolvency professionals should include specific modules on handling assets where secured creditors have taken action under the SARFAESI Act. Insolvency professionals need clear guidance on how to take control and custody of such assets and how to deal with creditors who may resist handing over possession based on their SARFAESI actions.

Finally, there may be merit in consolidating all debt recovery legislation into a single comprehensive statute or establishing clearer hierarchies and transition rules between different statutes. While the Insolvency and Bankruptcy Code made significant strides in consolidating insolvency law, the continued parallel existence of the SARFAESI Act and the Recovery of Debts Due to Banks and Financial Institutions Act creates complexity that could be reduced through further legislative rationalization.

Conclusion

The interface between the SARFAESI Act and the Insolvency and Bankruptcy Code (IBC) represents one of the most important areas of commercial law in contemporary India. Both statutes serve crucial roles in the financial ecosystem: the SARFAESI Act provides secured creditors with efficient mechanisms for debt recovery, while the Insolvency and Bankruptcy Code offers a comprehensive framework for addressing corporate distress that balances the interests of all stakeholders.

Through judicial interpretation, particularly in cases like Encore Asset Reconstruction Company Private Limited versus Ms. Charu Sandeep Desai, Indian courts have established that the Insolvency and Bankruptcy Code prevails over the SARFAESI Act when the two statutes come into conflict. This supremacy flows from the Code’s non-obstante clause in Section 238 and from the legislative intent to create a unified, comprehensive framework for insolvency that supersedes earlier piecemeal approaches to debt recovery.

However, the coexistence of these two powerful statutes continues to present practical challenges for creditors, debtors, and insolvency professionals. Understanding when to pursue remedies under the SARFAESI Act versus initiating insolvency proceedings under the Code requires careful analysis of the debtor’s circumstances, the nature and extent of the debt, and the potential for business revival. The choice between these frameworks can have profound implications for the ultimate recovery obtained by creditors and for the fate of the corporate debtor.

As India’s insolvency regime continues to mature, further harmonization between these statutes will be essential. Clear legislative guidance, regulatory coordination, and continued judicial clarification will help reduce conflicts and ensure that both statutes can operate effectively to achieve their respective objectives. The ultimate goal must be to create a legal framework that facilitates efficient debt recovery while preserving viable businesses and maximizing value for all stakeholders in the economy.

References

[1] Blog iPleaders. “Landmark decisions on Section 238 of the IBC and non-obstante clauses.” Available at: https://blog.ipleaders.in/landmark-decisions-section-238-ibc-non-obstante-clauses/ 

[2] Indian Kanoon. “Encore Asset Reconstruction Company vs Charu Sandeep Desai & Ors on 14 May, 2019.” Available at: https://indiankanoon.org/doc/50336951/ 

[3] IBC Laws. “Encore Asset Reconstruction Company Pvt. Ltd. Vs. Ms. Charu Sandeep Desai & Ors.” Available at: https://ibclaw.in/case-name/encore-asset-reconstruction-company-pvt-ltd-vs-ms-charu-sandeep-desai-ors/ 

[4] India Corp Law. “Battle for Claiming Secured Assets: Insolvency Code vs SARFAESI Act.” Available at: https://indiacorplaw.in/2019/06/16/battle-claiming-secured-assets-insolvency-code-vs-sarfaesi-act/ 

[5] Mondaq. “Lender In Physical Possession Of Its Security Under SARFAESI Cannot Retain Possession On Commencement Of CIRP.” Available at: https://www.mondaq.com/india/insolvencybankruptcy/813292/lender-in-physical-possession-of-its-security-under-sarfaesi-cannot-retain-possession-on-commencement-of-cirp 

[6] Clove Legal. “Fate of Secured Creditor(s): IBC v. SARFAESI Act.” Available at: https://clovelegal.com/2022/11/11/fate-of-secured-creditors-ibc-v-sarfaesi-act/