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Wednesday, February 01, 2017

Distortions in the Indian land collateral market

by Bhargavi Zaveri.

In conventional finance theory, land is considered to be good collateral for three main reasons: it is easily traceable and cannot be siphoned off as easily as movables, it is easily re-usable, and unlike movables, it does not depreciate in value (at least in India). While the data on the size of the Indian land collateral market is not publicly available, the notion that land constitutes a significant proportion of the security against outstanding loans is generally accepted. However, the fragmented nature of the Indian land market has significantly increased the cost of enforcing land collateral in India (Krishnan and others (2016)).

In 2002, India enacted the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI), which amongst other things, allowed banks to re-possess and enforce their security without the intervention of the Court. SARFAESI was perceived to be a watershed moment in the history of secured creditors' rights in India.

In 2016, the Supreme Court delivered two important judgements in relation to land-collateral that have opposite outcomes for secured creditors under SARFAESI. One of these judgements holds that secured creditors' rights, under SARFAESI, over-ride State laws that restrict the transfer of land held by tribals to non-tribals. The other judgement holds that secured creditors' rights, under SARFAESI, do not over-ride State rent control laws that protect the rights of tenants. Effectively, this means that while banks can, under SARFAESI, sell tribal land governed by State laws without Court intervention, they cannot sell tenanted premises governed under State laws without Court intervention.

In this article, I argue that the inconsistent approach in these judgements (a) accentuates the prevailing uncertainty on secured creditors' rights in relation to land collateral in India; and (b) underscores the need to dispense with the fragmented legal regime governing the Indian land market since the 1960s and usher in the next generation of land reforms in India.

Secured creditors' rights do not over-ride State laws governing protected tenants

Rent control laws enacted by State legislatures confer certain protections on tenants of premises covered under such laws (hereafter, "protected tenancies" and "protected tenants"), such as capping rentals and restricting the grounds on which a protected tenancy can be terminated.

In January 2016, a case where the landlord of a protected tenancy had mortgaged the premises to a bank and had defaulted on the loan, reached the Supreme Court. In this case, the Supreme Court faced the question of whether the bank could, under SARFAESI, ask a protected tenant under the Maharashtra Rent Control Act, 1999 (Rent Control Act) to vacate the premises, which were mortgaged by the landlord to the secured creditor.

Ruling in favour of the protected tenants, the Court held that a secured creditor's rights under SARFAESI did not over-ride a protected tenant's rights under the Rent Control Act. A secured creditor could not enforce her security under SARFAESI without following the Court-driven process prescribed under the Rent Control Act. The Court reasoned that if the provisions of SARFAESI are allowed to over-ride the provisions of the rent control laws, it would render the entire scheme of all Rent Control Acts operating in the country as useless and nugatory. It observed that:

Tenants would be left wholly to the mercy of their landlords and in the fear that the landlord may use the tenanted premises as a security interest while taking a loan from a bank and subsequently default on it...Under no circumstances can this be permitted, more so in view of the statutory protections to the tenants under the Rent Control Act...

The judgement, thus, (a) was largely premised on the social policy underlying the Rent Control Act, that is, protection of protected tenants; and (b) made limited reference to the question of whether a Parliamentary law on the enforcement of a security over-rode the State law governing the rights of protected tenants.

Secured creditors' rights over-ride State laws governing occupants of tribal land

Several States have enacted laws that restrict tribals from transferring the land occupied by them to non-tribals.

In December 2016, another bench of the Supreme Court considered whether secured creditors' rights over-rode a State law that restricted the transfer of land occupied by tribals to non-tribals. Here, ruling in favour of secured creditors, the Apex Court held that secured creditors' rights over-rode the State laws which mandate that tribal land cannot be sold to non-tribals. To arrive at this conclusion, the Supreme Court relied on the constitutional doctrine of pith and substance, and held that since SARFAESI governed the entire field of secured creditors' rights in India, SARFAESI would prevail over the State laws governing land occupied by tribals. The principle underlying the judgement is re-produced below:

94. Although Parliament cannot legislate on any of the entries in the State List, it may do so incidentally while essentially legislating within the entries under the Union List. Conversely, the State Legislatures may encroach on the Union List, when such an encroachment is merely ancillary to an exercise of power intrinsically under the State List. The fact of encroachment does not affect the vires of the law even as regards the area of encroachment. ... This principle commonly known as the doctrine of pith and substance, does not amount to an extension of the legislative fields. Therefore, such incidental encroachment in either event does not deprive the State Legislature in the first case or Parliament in the second, of their exclusive powers under the entry so encroached upon. In the event the incidental encroachment conflicts with legislation actually enacted by the dominant power, the dominant legislation will prevail (emphasis supplied).

Thus, unlike the judgement of the Court in January 2016, this judgement (a) was largely based on questions of interpretation of Constitutional provisions governing the powers of the Union and State legislatures to make laws on field assigned to them; and (b) barely referred to the social policy underlying the restriction on transfer of tribal land.

Similar social policy, opposite judicial outcomes

The social policy underlying the laws which restrict (a) the grounds on which a protected tenant may be evicted from her premises, and (b) tribal land from being transferred to non-tribals, is similar: these laws were intended to protect a class of land occupants, who the State believed, need protection. In the judgement of December 2016, the Court referred to the judgement of January 2016 only in passing, and stated that the judgement of January 2016 "seemed" to support the principle of pith and substance that the Court was relying on. However, while the judgement of January 2016 takes the refuge of the underlying social policy to hold that secured creditors' rights do not over-ride the rights of protected tenants, the judgement of December 2016 ignores the social policy underlying the law, and instead relies on constitutional doctrine to conclude that SARFAESI occupies the entire field on secured creditors' rights.

State laws impose several similar restrictions on the transferability of land (examples). The abovementioned judgements leave open the question of whether secured creditors' rights under SARFAESI over-ride such restrictions generally. Since the cost of credit is intrinsically linked to the ease with which collateral can be liquidated, such uncertainty increases the cost of credit to the borrower. Ironically, landholders protected by State laws may end up borrowing at relatively higher rates owing to the protections conferred on them by State laws.

Next generation land reforms

Inconsistent judgements of this kind are only one adverse fall-out of the artificial restrictions created by law in the land market. In an earlier article on this blog, we had advocated dismantling the restrictions on transferability of land by demonstrating the working of the securities markets, where for listed entities, there are no regulatory barriers restricting the rights of security-holders to monetize their securities (by sale, pledge, etc.).

Most barriers on transfer of land are the product of reforms between the 1950s and 1970s, which were primarily motivated by concerns of social justice (eg. abolition of zamindari and security to the tiller of land) and central planning (eg. enhancing agricultural production). Artificial restrictions, created by law, on a land-holder to monetise her land when she needs it, are counter-productive to the beneficiaries of such reforms. Similarly, laws which require the permission of some authority for the owner to transfer her land, increase the bureaucratic overhang and indirectly tax transactions in land. For example, in the four States that have still not repealed the Urban Land Ceiling Act, 1976 (a law that imposes ceilings on the amount of vacant land that a person may hold in urban areas), stories of corruption by officers under the law are plentiful (example, example).

Conclusion: Political economy of land reforms

The popular discourse suggests that the States lack incentives to dismantle barriers to the transferability of land. However, the story of land reforms of the 1990s indicates otherwise. In 1976, 17 State Governments and three Union Territories adopted the Urban Land Ceiling Act, 1976 (ULCA), which imposed a ceiling on the amount of vacant land that people could hold in urban agglomerations. Nearly 20 years later, it was found that ULCA actually reduced the amount of land which became available for development in urban areas and vested excessive discretion in the State administration. In the late 1990s, the push towards urban development resulted in the Central Government nudging the States to repeal ULCA.A similar push is now required to dismantle other like restrictions which continue to distort the land market in India.


K.P. Krishnan, Venkatesh Panchapagesan and Madalasa Venkataraman, Distortions in Land Markets and Their Implications to Credit Generation in India, IGIDR Working Paper WP-2016-005, January 2016.

Bhargavi Zaveri is a researcher at the Indira Gandhi Institute of Development Research, Mumbai.

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