Introduction:

In a recent judgement, the High Court of Karnataka (High Court), in Deputy Director, Directorate of Enforcement v. Asadullah Khan & Others[1], examined the intersection between the Prevention of Money Laundering Act, 2002 (PMLA) and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI). The Appeals filed under Section 42 of the PMLA, assailed an order of the Appellate Tribunal, PMLA whereby attachment orders passed by the ED were set aside. The ruling of the High Court provides crucial clarity on the rights of secured creditors and the scope of attachment under the PMLA, particularly when bank funds, not illicit proceeds, form the source of property acquisition.

The main issue was whether properties mortgaged to a bank, which had itself suffered losses due to fraudulent loan disbursals, could be subjected to attachment under the PMLA & consequently, whether the immovable properties mortgaged to a bank as a security for loans, could be treated as “proceeds of crime” under Section 2(u) of the PMLA.

Brief facts of the case:

The Central Bureau of Investigation (CBI) initiated a criminal investigation in 2009, against the officials of the Syndicate Bank and certain borrowers for offences under Section 120B, 409, 420, 467 and 471 of the Indian Penal Code and under Section 13(2) read with Section 13(1)(d) of the Prevention of Corruption Act, 1988 (PC Act). The allegations related to irregular sanctioning of loans in violation of banking norms, causing a loss of over Rs. 12,63,65,120/- to the Bank. Based on the predicate offence, the Enforcement Directorate registered a case under the PMLA and provisionally attached seven properties mortgaged to the Bank as security.

The Appellate Tribunal (PMLA), New Delhi, by order dated 18.09.2017, set aside the attachment, holding that the mortgaged properties were not proceeds of crime. The ED thereafter preferred four Miscellaneous Second Appeals before the Karnataka High Court under Section 42 of the PMLA.

Background about ‘Proceeds of Crime’ (PoC):

The concept of “PoC” is central to PMLA. Under Section 2(1)(u) of PMLA, it refers to any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offence.

Section 5(1) of the PMLA empowers the ED to attach such properties and Section 8 of the PMLA prescribes the adjudication process, requiring the Adjudicating Authority to issue notice to the persons claiming interest in the property. Pertinently, the provisos to Section 8(1) and 8(2) mandate that any person holding interest in the attached property must heard before the confirmation of attachment.

On the other hand, under the SARFAESI Act, a secured creditor, is empowered under Sections 13(2) and 13(4) to enforce its security interest without the intervention of courts. The statute ensures priority of repayment of debts out of secured assets. Both PMLA & SARFAESI aim to protect the financial system, by preventing money laundering, and by enabling recovery of legitimate loans, respectively.

The High Court made it clear that the properties mortgaged as security for the loans were part of legitimate banking transactions and were not acquired out of any PoC. Even though the securities were insufficient to cover the losses, they did not qualify as “PoC” under Section 2(u) of PMLA. Therefore, ED had no authority to treat these mortgaged assets as tainted property or to confiscate them under the Act.

The PMLA targets property derived from tainted sources, not property obtained from lawful funds that are misused later. Where the origin of money is traceable to legal banking channels, such as loans from regulated financial institutions, the property created therefrom does not lose its legitimate character unless it can be shown that the loan itself was obtained as part of the criminal conspiracy. This distinction becomes particularly significant in situations where loans were sanctioned in an improper manner, even though the money advanced came from the bank’s legitimate resources.

Findings of the Court:

The High Court held that the mortgaged properties could not be treated as PoC since the loans advanced by the Bank were sourced from legitimate funds of the Bank. The Court emphasised that the Bank was the victim of the fraud perpetrated by its officials and borrowers and not a participant in the criminal conspiracy. Therefore, the assets mortgaged to it could not be said to have been “derived or obtained” from any criminal activity.

The Court further noted that the Adjudicating Authority had failed to comply with the mandatory requirement of issuing notice to the Bank, despite being aware that the properties in question were mortgaged to it. This omission according to the Court violated the principles of natural justice as well as the express provisions of the PMLA.

Further, the Court observed that allowing attachment to continue would effectively defeat the Bank’s right as a secured creditor to recover dues under the SARFAESI Act. The purpose of the PMLA is to trace and confiscate illicit proceeds, not to impede lawful recovery of public funds. Since the Bank had already taken possession of the properties and initiated SARFAESI proceedings, the ED’s attachment could not override those rights.

A similar view was taken by the Delhi High Court in The Deputy Director, Directorate of Enforcement v. Axis Bank & Ors[2]. The Court made it clear that properties acquired through ordinary banking channels cannot be labelled as “proceeds of crime” merely because the borrower or certain bank officials later faced allegations in a scheduled offence. It also emphasised that the rights of secured creditors under the SARFAESI Act cannot be pushed aside by an attachment under the PMLA unless there is a definite and proven connection between the attached property and the alleged criminal activity. This approach mirrors the position adopted in the present case, reinforcing the principle that assets funded through legitimate loans remain lawful unless the loan itself is shown to be part of the wrongdoing.

Accordingly, the Court held that the Appellate Tribunal’s order confirming the order of Adjudicating Authority was legally sound. The appeals filed by the ED were accordingly, dismissed.

Conclusion:

According to the authors the High court has rightly found the balance between the powers of the enforcement authorities and the rights of financial institutions. The law (PMLA) serves a national purpose, but it must be restricted to (a) property intricately connected with crime and or (b) property which is acquired by PoC. To extend coverage to any assets acquired with the benefit of any credit transaction would stretch the definition of the term “proceeds of crime” too far and erode public confidence in the banking system.

The reasoning of the Court was that in such cases the banks, who are trustees of public money and are victims of cheating in their credit business, should not be penalized especially when that have proceeded to recover their dues under the SARFAESI Act. This decision will reinforce the principle that anti-money laundering tools should be used proportionately, fairly and with respect for the letter and spirit of the statutory framework. The judgment is a step further in the articulation of the idea that justice in financial crime is not achieved by the widest use of power, but by its most disciplined and reasoned application.

Authors: Mr. Ishwar Ahuja (Partner)

Shilpa Gireesha (Associate)

[1] MSA No. 78, 87, 88, 89 of 2020

[2] (2019) 3 SC C 571

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