On Failure of the Highest Bidder, Property Must Be Re-Auctioned, Private Negotiation Impermissible: Karnataka High Court

In a significant judgment Karnataka High Court quashed the order of the Debt Recovery Appellate Tribunal (DRAT), Chennai, which had upheld a negotiated sale in favor of the second-highest bidder instead of conducting a fresh auction. The Court ruled that such private negotiations violate Rule 9(3) of the Security Interest (Enforcement) Rules, 2002, and thereby invalidated the sale certificate issued in favor of the respondents.

A Division Bench comprising Justice Krishna S. Dixit and Justice G. Basavaraja held: "On the failure of the highest bidder to comply with the auction conditions, the bank must conduct a fresh auction, as mandated by Rule 9(3) of the Security Interest (Enforcement) Rules, 2002. Private negotiation with the second-highest bidder is impermissible and illegal."

Challenge to Auction Sale Under SARFAESI Act
The case arose from a loan default by the principal borrower (Respondent No. 4), secured by a mortgage of the petitioners' property. The Bank of India initiated recovery proceedings under the SARFAESI Act, 2002, and issued a sale notice for the auction of the petitioners’ mortgaged property on December 5, 2015.

An e-auction was conducted on January 12, 2016, where the highest bidder failed to comply with the auction terms. Instead of re-auctioning the property, the bank negotiated a sale with the second-highest bidder (Respondents No. 1 & 2) and issued a sale certificate on August 17, 2020.

The petitioners, being guarantors, challenged the sale before the Debt Recovery Tribunal (DRT-II), Bangalore, which nullified the sale certificate. However, the DRAT, Chennai, reversed this order, reinstating the auction sale. Aggrieved, the petitioners approached the Karnataka High Court.

Violation of Rule 9(3) of SARFAESI Rules
The Court emphasized that the SARFAESI Act, 2002, is designed for swift recovery of non-performing assets (NPAs), but its enforcement must adhere to due process and fair auction principles. Referring to Rule 9(3) of the Security Interest (Enforcement) Rules, 2002, the Court held: “The rule mandates that if the highest bidder fails to pay the deposit, the property shall be sold again. The phrase ‘sold again’ does not mean that the property can be sold to the second-highest bidder through private negotiation; rather, a fresh auction must be conducted.”

The Court reinforced this by citing the Orissa High Court’s ruling in Ullash Chandra Sahoo v. Bank of India (2007 (1) Bankers’ Journal 54), which held:

“If the highest bidder fails to deposit 25% of the sale price, the entire process of sale by public auction must be restarted, and the property cannot be sold to the second-highest bidder.”

Denial of Natural Justice: Guarantors Not Notified of Private Negotiation
The petitioners contended that they were not properly notified about the bank's decision to negotiate with the second-highest bidder instead of re-auctioning the property. The Court found merit in this argument, holding: “The bank’s failure to provide due notice and conduct a transparent re-auction violates the principles of natural justice. The borrowers and guarantors must be informed about any deviation from standard auction procedures, failing which the sale is invalid.”

One-Time Settlement (OTS): Higher Recovery for the Bank Justified Setting Aside the Sale
During the proceedings, the petitioners presented a One-Time Settlement (OTS) proposal, offering to repay ₹21 crore, significantly higher than the ₹11 crore auction price. The bank accepted the OTS offer, subject to the remaining amount being paid within 30 days.

The Court observed that the OTS arrangement secured a better financial outcome for the bank, and therefore, allowing the petitioners to retain their property was justified.

"Courts must balance equities—if a higher sum is recoverable through a lawful OTS arrangement, it serves both the interests of the secured creditor and the borrower, without compromising auction integrity."

Compensation to Auction Purchasers: ₹1 Crore Solatium Ordered
To balance equities, the petitioners voluntarily offered ₹1 crore as compensation to the auction purchasers. Accepting this, the Court held: “While setting aside the sale certificate, the Court acknowledges the position of the auction purchasers and directs the petitioners to pay ₹1 crore to them within three weeks as solatium, ensuring a fair outcome for all parties.”

Sale Certificate Quashed, Petitioners Allowed to Retain Property
The Karnataka High Court allowed the writ petition, quashing the impugned orders of the DRAT and DRT-II, Bangalore. The petitioners were directed to:

•    Pay ₹6 crore under the OTS arrangement within four weeks, with 18% interest on any delayed payment.
•    Pay ₹1 crore to Respondents No. 1 & 2 (auction purchasers) within three weeks.
•    Failure to comply would result in the automatic dismissal of the petition, and the DRAT order would stand enforced.
Justice Krishna S. Dixit, writing for the Bench, concluded: "The Court cannot turn away deserving litigants by quoting legal doctrines at the cost of justice. Courts must ensure fairness in auction sales under SARFAESI while upholding the legitimate interests of all stakeholders, including borrowers, guarantors, and secured creditors."

Date of Decision: February 3, 2025