When SARFAESI cannot be invoked: Statutory Bar Under Section 31(j)

Section 31(j) SARFAESI Bar and the 80% Discharge Rule

Summary: The article examines the statutory bar under Section 31(j) of the SARFAESI Act, 2002, where the amount due is less than 20% of the principal amount and interest thereon, described as the 80% discharge rule. It discusses Biju Mathew Abraham v. State Bank of Travancore (Writ Appeal No. 2186 of 2016, decided on 28.06.2021), which held that the provision concerns the balance liability after substantial discharge, and IFCI Factors Ltd. v. Patil Construction and Infrastructure Pvt. Ltd. & Ors. (Appeal No. 84/2022, Order dated 14.11.2023), where DRAT Mumbai held that the denominator includes principal and accrued interest under Clause (b) of the Explanation to the 5th Proviso to Section 13(9). The article further relies on Central Bank of India v. Ravindra & Ors. ((2002) 1 SCC 367), holding that penal interest cannot be capitalized and that RBI directives have statutory force, and Punjab National Bank v. Mithilanchal Industries Pvt. Ltd. (LPA No. 159 of 2020, decided on 17.08.2020), concerning itemised bifurcation of principal, interest, debits and credits in Section 13(2) notices. It concludes that Section 31(j) compliance requires considering aggregate contractual liability and excluding unauthorized penal interest or impermissible capitalization.

Statutory Protection Against Disproportionate SARFAESI Enforcement

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”) arms secured creditors with extraordinary, non-adjudicatory recovery mechanisms to enforce security interests without the prior intervention of a court or tribunal. To counterbalance these powers and safeguard borrowers from disproportionate enforcement, the legislature enacted statutory exemptions under Section 31.

Among these safeguards, Section 31(j) creates an express statutory bar against the invocation or continuation of SARFAESI measures in accounts where the outstanding debt has been substantially liquidated. However, the practical application of Section 31(j) frequently encounters judicial and procedural pitfalls—primarily arising from the erroneous computation of the statutory denominator and the improper segregation of lawful interest versus impermissible penal loading.

This article provides a comprehensive analysis of the statutory interplay between Section 31(j) and the Explanation under the 5th Proviso to Section 13(9), supported by landmark jurisprudence from the Supreme Court of India, High Courts, and the Debts Recovery Appellate Tribunal (DRAT).

1. The Statutory Framework: Section 31(j) and the 80% Discharge Rule

Section 31 of the SARFAESI Act outlines specific categories of transactions and claims where the provisions of the Act shall not apply. Specifically, Section 31(j) provides:

“31. Provisions of this Act not to apply in certain cases.—The provisions of this Act shall not apply to—

(j) any case in which the amount due is less than twenty per cent of the principal amount and interest thereon.”

The 80% Rule Established by Courts

A literal interpretation of Section 31(j) establishes that securitisation measures cannot be initiated or continued if the debtor has discharged 80% or more of the total liability.

In Biju Mathew Abraham v. State Bank of Travancore (Writ Appeal No. 2186 of 2016, decided on 28.06.2021), the Division Bench of the Hon’ble Kerala High Court held that the phrase “amount due is less than 20% of the principal amount and interest thereon” unambiguously signifies the balance amount due after the borrower has discharged the major portion of the contractual liability—namely, up to 80%. The Court observed that reading the clause otherwise would defeat the legislative scheme of enforcement under Sections 13(1) and 13(2).

2. Defining the denominator: The Interplay with Section 13(9) 5th Proviso

The core operational conflict in Section 31(j) litigation frequently centers on the calculation of the statutory denominator: Should the 20% threshold be computed against the bare original sanctioned principal, or against the cumulative principal and accrued contractual interest across the tenure of the facility?

Cross-Referencing Section 13(9)

To ascertain what constitutes “principal amount and interest thereon,” courts import the statutory definition of “amount outstanding” provided in Clause (b) of the Explanation under the 5th Proviso to Section 13(9) of the SARFAESI Act:

“Explanation: For the purposes of this sub-section,—

(b) ‘amount outstanding’ shall include principal, interest and any other dues payable by the borrower to the secured creditor in respect of secured asset as per the books of account of the secured creditor.”

The binding view of the DRAT Mumbai

This construction was authoritatively examined by the Hon’ble Debts Recovery Appellate Tribunal at Mumbai in IFCI Factors Ltd. v. Patil Construction and Infrastructure Pvt. Ltd. & Ors. (Appeal No. 84/2022, Order dated 14.11.2023).

The Ld. Chairperson, DRAT Mumbai, held:

“When determining whether an account falls within the exemption of Section 31(j), the “amount outstanding” must be reckoned by applying Clause (b) of the Explanation under the 5th Proviso to Section 13(9).”

“The total debt denominator encompasses the principal amount and the accrued interest as recorded in the books of account of the secured creditor.”

“A debtor who has discharged their liability up to 80% of this combined aggregate falls squarely within the statutory immunity of Section 31(j), barring the secured creditor from proceeding with SARFAESI measures.”

Comparing the outstanding balance solely against the original sanctioned principal, while ignoring cumulative accrued interest over the facility’s life is mathematically fallacious and runs contrary to the plain language of the statute.

3. Scrubbing the ledger: The prohibition on capitalizing penal interest

Section 13(9) refers to dues payable “as per the books of account of the secured creditor.” However, a financial institution cannot artificially inflate the claimed debt above the 20% threshold by introducing illegal compounding or unauthorized debits.

The Constitution Bench Ruling in Central Bank of India v. Ravindra

In the landmark decision of Central Bank of India v. Ravindra & Ors. (2002) 1 SCC 367 decided on 18^th October 2001, a 5-Judge Constitution Bench of the Supreme Court established critical guidelines governing banking interest and ledger entries:

1. Penal Interest cannot be capitalized: While ordinary contractual interest can be capitalized at agreed periodical rests, penal interest is a penalty founded on the doctrine of penal action. Compounding or capitalizing penal interest (charging interest on penal interest) is strictly opposed to public policy and prohibited.

2. Statutory force of RBI circulars: Directives and prudential norms issued by the Reserve Bank of India (RBI) under Sections 21 and 35A of the Banking Regulation Act, 1949 carry statutory force. Any interest charged or capitalized in contravention of RBI circulars must be disallowed, excluded from the capital sum, and pruned from the ledger.

3. Opportunity to pay & proof of accounting: Capitalization is predicated on a borrower’s default after having had the opportunity to pay. If a debit entry was not brought to the notice of the borrower or arose due to the bank’s operational omissions, capitalizing such amounts is impermissible.

Where a bank arbitrarily loads unapplied interest or capitalizes charges during periods where the borrower had sufficient funds or where earlier demand notices were fully satisfied, those debits must be excised from the ledger when computing Section 31(j) compliance.

4. Procedural safeguards: Mandatory bifurcation in Demand Notices (Section 13(3))

Beyond Section 31(j), the validity of enforcement measures rests on strict compliance with the statutory steps under Sections 13(2) and 13(3).

A. Under Section 13(3), a notice issued under Section 13(2) must specify the details of the amount payable as well as the secured assets intended to be enforced.

B. In Punjab National Bank v. Mithilanchal Industries Pvt. Ltd. (LPA No. 159 of 2020, decided on 17.08.2020), the Division Bench of the Hon’ble Gujarat High Court held that the Section 13(2) notice itself must contain a detailed break-up of the principal, interest, debits, and credits.

C. Supplying aggregate figures within the notice while leaving the borrower to infer calculations from extraneous or prior correspondence fails the mandatory requirement of Section 13(3). Non-compliance vitiates the demand notice and invalidates all subsequent measures (sublato fundamento cadit opus).

Summary of key precedents

Conclusion

The statutory bar enacted under Section 31(j) serves as a critical substantive defense against disproportionate SARFAESI enforcement. Correctly establishing this defense requires:

1. Constructing the statutory denominator using the aggregate contractual liability (principal plus accrued contractual interest under Section 13(9) 5th Proviso) rather than an isolated original principal;

2. Verifying that the remaining debt falls below the 20% mark (reflecting an 80%+ discharge); and

3. Auditing the creditor’s ledger under the principles of Central Bank of India v. Ravindra to exclude unauthorized penal interest and interest capitalised contrary to RBI directives.

Cases Discussed

• IFCI Factors Ltd. v. Patil Construction and Infrastructure Pvt. Ltd. & Ors. (DRAT Mumbai), Appeal No. 84/2022, Order dated 14.11.2023
• Biju Mathew Abraham v. State Bank of Travancore (Kerala High Court), Writ Appeal No. 2186 of 2016, decided on 28.06.2021
• Central Bank of India v. Ravindra & Ors. (Supreme Court of India), (2002) 1 SCC 367
• Punjab National Bank v. Mithilanchal Industries Pvt. Ltd. (Gujarat High Court), LPA No. 159 of 2020, decided on 17.08.2020

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Author Profile: Mihirkumar V. Patel is an independent Advocate practicing before the High Court of Gujarat, Debts Recovery Tribunal-1 and 2 at Ahmedabad, Debts Recovery Appellate Tribunal at Mumbai, and the City Civil Court at Ahmedabad. He specializes in Writ Petitions (Article 226), Direct and Indirect Tax Litigation, Commercial Litigation, Land disputes, RERA, Banking, SARFAESI Act, RDB Act, and Recovery Disputes.