1. Legal Framework of OTS in India

RBI Master Framework: RBI June 2023 Master Framework and RBI - Resolution of Stressed Assets Directions, 2025 defines OTS as "Compromise Settlement".

• OTS is available for NPA accounts only, including written-off accounts; standard assets cannot be compromised.
• OTS is non-discretionary and non-discriminatory but also not a matter of right. Supreme Court in Bijnor Urban Cooperative Bank vs Meenal Agarwal held High Court cannot issue writ of mandamus compelling bank to give OTS.
• Banks usually require upfront payment of 10 to 25 percent of settlement amount to approve OTS.
• OTS sanctioned is valid for 90 days i.e. 3 months. If payment exceeds 3 months, it is treated as restructuring.
• OTS deed is a binding contract - default allows bank to resume all enforcement proceedings and invoke Revival Clause. Any amount paid during OTS negotiation is usually treated as part-payment towards total debt.

Core Legal Question: When borrower defaults, can bank forfeit the down payment as earnest money / penalty, or must it adjust it against total dues and refund balance?

Answer depends on wording of OTS letter.

2. Two Types of Forfeiture Clauses

Type A - Adjustment Clause (Most PSU Banks):

"In case of failure to pay within stipulated time, OTS shall stand cancelled and amount already paid shall be appropriated towards outstanding dues and balance recovery proceedings shall revive."

In this case, no forfeiture, only appropriation. This is legally safest for banks.

Type B - Forfeiture Clause (Private Banks / ARCs / SARFAESI Auctions):

"In case of default, the upfront amount of Rs. X paid as earnest shall stand forfeited and OTS shall stand cancelled."

This is where litigation happens. Validity tested under Section 74 of Indian Contract Act, 1872.

3. Case Laws - Detailed

A. Supreme Court on SARFAESI Auction Forfeiture - The Landmark 2024 Ruling

Case: Auth. Officer, Indian Bank vs. M/s. Kone Elevator + SLP (C) No. 17553/2022 - Supreme Court Judgment dated 2024, Bench of CJI D.Y. Chandrachud, J.B. Pardiwala, Manoj Misra

Facts: Auction purchaser deposited 25% under Rule 9(4) but failed to pay balance within 15 days. Bank forfeited entire 25% and resold property at higher price. Madras High Court held forfeiture to extent of loss only, otherwise unjust enrichment.

Supreme Court Held:

The consequence of forfeiture of 25% of the deposit under Rule 9(5) is a legal consequence statutorily provided in event of default in payment of balance amount. The consequence follows irrespective of whether subsequent sale takes place at higher price or not, and forfeiture is not subject to any recovery already made or extent of debt owed.

And:

Entire 25% deposit forfeited in SARFAESI cases is statutory consequence triggered by failure to pay balance, unaffected by subsequent sale prices.

Principles of Sections 73 and 74 of Indian Contract Act limiting compensation to actual losses do not apply to SARFAESI auctions.

Ratio: Rule 9(5) forfeiture is statutory forfeiture, not contractual penalty. Therefore Section 74 does not apply.

This is now the governing law for all OTS-linked auctions.

B. Delhi High Court on OTS Default

Case: Delhi High Court, Subramonium Prasad & Harish Vaidyanathan Shankar JJ - 2024

Borrower who defaults on OTS and fails to challenge SARFAESI proceedings timely cannot seek judicial relief against lawfully conducted auction sale.

Principle: OTS is a concession. Once borrower breaches, revival clause is automatic.

C. Allahabad High Court on Re-initiation of SARFAESI

Allahabad HC 2023:

Rule 9(5) is legal consequence statutorily provided. Re-initiation of SARFAESI action by bank upon borrower not paying is not exceptional circumstance to dilute forfeiture.

D. Supreme Court on Earnest Money Forfeiture - General Law Applicable to OTS

OTS down payment is legally treated as earnest money. General law:

1. Godrej Projects Development Ltd v. Anil Karlekar & Ors. Civil Appeal No. 3334 of 2023 - Supreme Court Judgment 3 Feb 2025

Forfeiting 20% of flat's cost as earnest money upon cancellation is excessive. Forfeiture of 20% earnest money excessive and arbitrary.

Supreme Court limited forfeiture to 10% of Basic Sale Price, holding that one-sided, excessive forfeiture clauses are "unfair trade practice" under Consumer Protection Act.

Earnest money forfeited upon flat booking cancellation must be reasonable and not excessive enough to be considered penalty under Section 74.

Application to OTS: If OTS letter does not clearly define upfront as earnest money and provides for forfeiture of more than 10-15%, courts will strike down as penalty under Section 74.

2. Kailash Nath Associates vs DDA (2015) 4 SCC 136 - The Bible for Forfeiture:

Supreme Court laid down:

• Earnest money must be specified as such in contract. Advance payment is not earnest unless explicitly called.
• Forfeiture of earnest money is permissible without proof of actual loss.
• Forfeiture of non-earnest (advance/part payment) requires proof of loss under Section 74.

Therefore, drafting is critical. Bank must write: "Rs. X paid as earnest money deposit for due performance of OTS".

3. Satyam Construction vs. Surinder Singh - 2023 Supreme Court

When both buyer and seller were at fault, forfeiture of earnest money impermissible as it would unjustly enrich seller.

If bank itself delays in giving NOC or disbursing OTS closure, it cannot forfeit.

4. When Can Bank Legally Forfeit Down Payment in OTS?

Bank can forfeit IF all conditions satisfied:

1. Clear Contract: OTS sanction letter explicitly states amount is "Earnest Money / Security Deposit for performance" and "shall be forfeited on default".
2. Reasonable Percentage: 10-25% is reasonable. 100% of outstanding as forfeiture is penalty.
3. Default is Solely Borrower's: Bank has not contributed to breach.
4. Statutory Auction: Under SARFAESI Rule 9(5), 25% forfeiture is automatic statutory right, no need to prove loss.

If OTS letter says "amount will be adjusted", bank cannot forfeit, must adjust against dues under Section 60-61 Contract Act.

5. Practical Defenses for Borrowers Against Forfeiture

1. Section 74 Challenge: Forfeiture clause is in nature of penalty, not genuine pre-estimate. Cite Godrej v Anil Karlekar.
2. No concluded contract: OTS is still under negotiation - advance is not earnest unless contract signed.
3. Unjust Enrichment: Bank already recovered full dues from subsequent sale, forfeiture would be double recovery - argument rejected by Supreme Court in SARFAESI cases but still valid in pure contractual OTS.
4. Force Majeure / Bank's breach: Bank delayed documentation.

Current Legal Position in 2026:
After 2024 Supreme Court ruling, Banks have full right to forfeit 25% in SARFAESI-linked OTS auctions. In pure contractual OTS (non-auction), forfeiture is limited to reasonable earnest (10-25%) and only if contract explicitly says so. Excessive forfeiture will be struck down as unfair trade practice.