Upon execution of a mortgage, a lender believes that a valid security is in place and could be enforced if the borrower defaults in repayment. The question lies – How enforceable is it when it comes to intervention from the enforcement directorate in respect of the mortgaged property which is a ‘Tainted Property'?

The Prevention of Money Laundering Act, 2002 (PMLA) came into force on July 1, 2005 and was enacted by the Central Government with the principal objective to prevent money-laundering and to provide for confiscation of property derived from, or involved in, money-laundering.

The scheme of PMLA is broadly two-fold in as much as it (a) allows for attachment of property if it is a proceed of crime to fulfil the ultimate objective of confiscation, upon adjudication; and (b) provides criminal sanction to the act of money laundering as a penal offence. The application of the PMLA finally results in confiscation of property, which takes away the right and title of its owner and vests it absolutely in the Central Government, free from all encumbrances.

Firstly let's understand what would constitute ‘Tainted Property'. Under the PMLA, Tainted Property would be property in respect of which there is prima facie evidence to show that the source of, or consideration for, its acquisition, directly or indirectly, is the product of specified crime.

The ultimate result of confiscation and vesting of the Tainted Property in the Central Government pits itself directly against the rights of secured lenders/ creditors (Secured Parties) having charge over such Tainted Property. Thus, the concern of a Secured Party is whether the mortgage property is really available as security for loans granted by the Secured Parties?

Since both the Central Government and the Secured Parties have legal rights to proceed against the Tainted Property, the conflict resolves itself into a question of the order of priority of such competing rights.

Though the Recovery of Debts and Bankruptcy Act, 1993 (RDBA), the Insolvency and Bankruptcy Code, 2016 (IBC) and the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (SARFAESI) have been enacted to secure the rights of the Secured Parties, the Delhi High Court (Court), in the case of The Deputy Director Directorate of Enforcement Delhi and Ors. vs. Axis Bank and Ors. (Axis Bank Case), has held that the objective of RDBA, SARFAESI and IBC are different from the PMLA and therefore, they would not prevail over the PMLA. All enactments are to be read harmoniously to determine the order of priority of claims.

An attachment order under the PMLA cannot, by itself, negate the right of Secured Parties in respect of a charge over a property deemed to be Tainted Property. The Secured Party is however required to have acted in a bona fide manner, which will be adjudicated considering the following:

  • The right of the Secured Party to the attached property deemed as a Tainted Property will not be declared void unless there is evidence available to show that security was created in collusion with the offender;
  • To be considered as “bona fide”, the Secured Party must show, by evidence, that the security in its favour was lawfully created for adequate consideration and that it has complied with the existing law including, if so required, by having said security interest registered;
  • If the property deemed as a Tainted Property was secured in favour of the Secured Party around or after the commission of the criminal activity, in order to establish a legitimate claim for its release from attachment, the Secured Party must additionally prove that it had taken “due diligence” (e.g. taking reasonable precautions and after due inquiry) to ensure that it was not a tainted asset. If the security was created prior to the criminal activity, then the claim of the Secured Party would have precedence; and
  • If the Secured Party is pursuing enforcement of the “security interest” held in respect of the property deemed as a Tainted Property sought to be attached, where such Secured Party has initiated action in accordance with law for such enforcement prior to the order of attachment under PMLA, the directions of such attachment shall be valid and operative subject to satisfaction of the charge or encumbrance of such Secured Party and restricted to such part of the value of the secured property as is in excess of the claim of the Secured Party against the secured property.

Therefore, it has turned extremely critical for Secured Parties to consider taking certain minimum safeguards in order to protect their rights in respect of secured properties deemed to be Tainted Properties. Such steps would include:

  • Adequate due diligence: The Secured Parties should conduct a due diligence to examine whether there are any prima facie deficiencies in respect of the manner in which the title to a property which may be deemed to be a Tainted Property was acquired by the security provider. The Secured Party should consider conducting a title diligence to examine the flow of title of the property in favour of the security provider as well as possibly trace the source of funds used to acquire the property, conduct a background check on both the current owner and the seller, etc.; and
  • The Secured Parties should ensure that all actions as required under law for creation of a valid mortgage are completed, including registration of the charge with the Central Registry of Securitisation Asset Reconstruction and Security Interest or the Registrar of Companies, without delay and by correctly capturing the description of the secured property.

The judgment in the Axis Bank Case has been appealed before the Supreme Court of India. However, the decision in the Axis Bank Case has been referred to and relied upon in subsequent judicial pronouncements as controlling law, which should act as a guiding principle for Secured Parties to stay away from transaction if, during the period of evaluation of the transaction, any facts do not meet the smell tests laid down in the Axis Bank Case.

Originally published by Phoenix Legal, September 2020

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.