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LEGAL AND REGULATORY ASPECTS OF BANKING 2nd
Edition
INDIAN INSTITUTE OF BANKING & FINANCE
MACMILLAN 'THE ARCADE', WORLD TRADE CENTRE, CUFFE
PARADE MUMBAI400005
Established on 30th April 1928
MISSION
• To develop professionally qualified and competent bankers and financial
professionals primarily through a process of education, training, examination,
consultancy/counselling and continuing professional development programs.
VISION
• To be the premier Institute for developing and nurturing competent
professionals in banking and finance field.
OBJECTIVES
• To facilitate study of theory and practice of banking and finance.
• To test and certify attainment of competence in the profession of
banking and finance.
• To collect, analyse and provide information needed by professionals in
banking and finance.
• To promote continuous professional development.
• To promote and undertake research relating to Operations, Products,
Instruments, Processes, etc., in banking and finance and to encourage innovation
and creativity among finance professionals so that they could face competition
and succeed.
COMMITTED TO PROFESSIONAL EXCELLENCE Website: www.iibf.org.in
LEGAL & REGULATORY ASPECTS OF BANKING
(For JAIIB/Diploma in Banking & Finance Examination)
2nd Edition
Indian Institute of Banking & Finance
MACMILLAN
© INDIAN INSTITUTE OF BANKING & FINANCE, MUMBAI, 2005, 2008
(This book has been published by Indian Institute of Banking & Finance.
Permission of the Institute is essential for reproduction of any portion of this
book. The views expressed herein are not necessarily the views of the Institute.)
All rights reserved. No part of this publication may be reproduced or
transmitted, in any form or by any means, without permission. Any person who
does any unauthorised act in relation to this publication may be liable to criminal
prosecution and civil claims for damages.
J-'im t'tlitiim. 2005 Second edition, 2008 Reprinted, 2008 2009 (twice)
MACMILLAN PUBLISHERS INDIA LIMITED
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Printed by S.M. YOGAN at Macmillan India Press, Chennai 600 041.
LEGAL & REGULATORY ASPECTS OF BANKING
Originally prepared by K.D. Zacharias (Module A), C.P. Ravindranath (Module
B), P.R. Kulkarni (Module C), B. Gopalakrishnan (Module D) under the
guidance of M.L. Chandak, Advocate, High Court, Mumbai.
Revised and updated by K.D. Zacharias, Legal Adviser, RBI (Module A), G.M.
Ramamurthy, Legal Adviser, IDBI Ltd. (Modules B, C and D)
This book is meant for educational and learning purposes. The author(s) of the
book has/have taken all reasonable care to ensure that the contents of the book
do not violate any existing copyright or other intellectual property rights of any
person in any manner whatsoever. Jn the event the author(s) has/have been
unable to track any source and if any copyright has been inadvertently infringed,
please notify the publisher in writing for corrective action.
FOREWORD
The world of banking and finance is changing very fast and banks are leveraging
knowledge and technology in offering newer services to the customers. Banks
and technology are evolving so rapidly that bank staff must continually seek new
skills that enable them not only to respond to change, but also to build
competence in handling various queries raised by customers. Therefore, there is
a need for today's bank employees to keep themselves updated with a new set of
skills and knowledge.
The Institute, being the main provider of banking education, reviews the syllabus
for its associate examinations viz. JAIIB/CAIIB and various other examinations
with the help of Expert Groups from time to time to make the contents relevant
and contemporary in nature. The latest revision has been done by an expert
group under the Chairmanship of Prof. Y.K. Bhushan. This book and the other
two books mentioned below are the courseware for JAIIB which aims to impart
up-to-date knowledge in the field of banking and finance and equip the bankers
to face the emerging challenges of today and tomorrow.
As there is a growing demand for qualified manpower in the banking sector with
accent on banking knowledge and skills, together with technology-familiarity,
customer-orientation and hands-on application skills - which will substantially
reduce the training intervention at the bank level before/immediately after they
are employed - the institute has launched the Diploma in Banking & Finance in
2007 for graduation-plus level candidates. Candidates to the course will get
extensive and detailed knowledge on banking & finance and details of banking
operations. The Diploma is offered in the distance learning mode with a mix of
educational support services like provision of study kits, contact classes, etc. The
key features of the Diploma is that it aims at exposing students to real-life
banking environment and that it is equivalent to JAIIB.
The JAIIB and the Diploma in Banking & Finance has three papers viz.
1. Principles & Practices of Banking
2. Accounting & Finance for Bankers
3. Legal & Regulatory Aspects of Banking
This book, the courseware for the third paper on Legal & Regulatory Aspects of
Banking, deals with legal and regulatory aspects that have a bearing on banking
operations, and are woven in to the units/chapters to make their relevance easily
understandable. Banking and business laws insofar as they relate to day-to-day
banking operations, have also been covered at appropriate places. Case laws are
included, wherever appropriate. There are various newly enacted laws like Anti-
money Laundering Act, Right to Information Act, Information Technology Act,
etc., which have significantly changed the way banking operations are done, and
these laws are explained in simple terms as needed to be understood by a
practicing banker.
The Institute had constituted teams consisting of eminent bankers and
academicians to prepare the reading material for all the subjects as self-
instructional study kits obviating the need for the intervention of a teacher. This
book represents the outcome of this endeavour to bring out self-contained
comprehensive courseware/book on the subject. The Institute acknowledges with
gratitude the valuable services rendered by the authors in preparing the
courseware in a short period of time.
VI
The team, who developed the book, has made all efforts to cover the entire
syllabus prescribed for the subject. However, the candidates could still refer to a
few standard textbooks to supplement this material which we are sure, will
enhance the professional competence of the candidates to still a higher degree.
We have no doubt that the study material will be found useful and will meet the
needs of the candidates to prepare adequately for the examinations. In addition,
we are sure that these books will also be useful to practitioners, academicians,
and other interested readers.
We welcome suggestions for improvement of the book.
Mumbai 3-7-2008
R. Bhaskaran
Chief Executive Officer
RECOMMENDED READING
The Institute has prepared comprehensive courseware in the form of study kits to
facilitate preparation for the examination without intervention of the teacher. An
attempt has been made to cover fully the syllabus prescribed for each
module/subject and the presentation of topics may not always be in the same
sequence as given in the syllabus.
Candidates are also expected to take note of all the latest developments relating
to the subject covered in the syllabus by referring to Financial Papers, Economic
Journals, Latest Books and Publications in the subjects concerned.
PAPER 3-
LEGAL®ULATORY ASPECTS OF BANKING
Objectives: The candidates would be able to acquire knowledge in:
• The legal & regulatory framework of the banking system and
• The various laws and enactments affecting day-to-day banking
operations
MODULE, A.-REGULATIONS &COMPLIANCE
• The questions in this section will be with reference to legal issues and
problems.
A. Provisions of RBI Act 1935, Banking Regulation Act 1949, Banking
Companies [Acquisition and Transfer of Undertakings Act 1970 & 1980].
B. Government and RBIs Powers:
- Opening of New Banks and Branch Licensing
- Constitution of Board of Directors and their Rights
- Banks Shareholders and their Rights
- CRR/SLR Concepts
- Cash/Currency Management
• Winding Up - Amalgamation and Mergers
• Powers to Control Advances - Selective Credit Control - Monetary and
Credit Policy
• Audit and Inspection
• Supervision and Control-Board for Financial Supervision - Its Scope and
Role
• Disclosure of Accounts and Balance Sheets
• Submission of Returns to RBI, etc.
• Corporate Governance
MODULE B - LEGAL ASPECTS OF BANKING OPERATIONS
• Case Laws on Responsibility of Paying/Collecting Banker
• Indemnities/Guarantees
- Scope and Application
- Obligations of a Banker
- Precautions and Rights
• Laws Relating to Bill Finance, LC and Deferred Payments
• Laws Relating to Securities
• Valuation of Securities - Modes of Charging Securities - Lien, Pledge,
Mortgage, Hypothecation,
etc.
• Registration of Firms/Companies
• Creation of Charge and Satisfaction of Charge
MODULE C - BANKING RELATED LAWS
• Law of Limitation
• Provisions of Bankers Book Evidence Act
• Special Features of Recovery of Debts Due to Banks and Financial
Institutions Act, 1993
• TDS and Service Tax
• Banking Cash Transaction Tax
• Asset Reconstruction Companies
• The Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest
Act, 2002
• The Consumer Protection Act, 1986
• Banking Ombudsman 2006
• LokAdalats
• Lender's Liability Act
MODULE D - COMMERCIAL LAWS WITH REFERENCE TO BANKING
OPERATIONS
• Indian Contract Act, 1872 (Indemnity, Guarantee, Bailment, Pledge and
Agency, etc.)
• The Sale of Goods Act, 1930 (Sale and Agreement to Sell, Definitions,
Conditions and Warranties,
Express and Implied, Right of Unpaid Seller, etc.)
• The Companies Act, 1956, Definition, Features of Company, Types of
Companies, Memorandum,
Articles of Association, Doctrines of Ultra Vires, Indoor Management and
Constructive Notice,
Membership of Company - Acquisition - Cessation, Rights and Duties of
Members and Register of
Members, Prospectus and Directors.
• Indian Partnership Act, 1932, Definition and Types of Partnership,
Relation of Partners to One
Another-Relation of Partners to Third Parties, Minor Admitted to the Benefits of
Partnership,
Dissolution of Firm, Effect of Non-Registration
• The Transfer of Property Act
• Foreign Exchange Management Act, 2000
• Prevention of Money Laundering Act, 2002
• Right to Information Act, 2005
• Information Technology Act, 2000
CONTENTS
Foreword v
MODULE A - REGULATIONS AND COMPLIANCE
1. Legal Framework of Regulation of Banks 3
2. Control Over Organisation of Banks 15
3. Regulation of Banking Business 31
4. Returns, Inspection, Winding Up 49
5. Public Sector Banks and Co-operative Banks 65
MODULE B - LEGAL ASPECTS OF BANKING OPERATIONS
6. Case Laws on Responsibility of Paying Bank 83
7. Case Laws on Responsibility of Collecting Bank 93
8. Indemnities 101
9. Bank Guarantees 107
10. Letters of Credit 119
11. Deferred Payment Guarantee 131
12. Laws Relating to Bill Finance 135
13. Various Types of Securities 143
14. Law Relating to Securities and Modes of Charging -1
• 155
15. Law Relating to Securities and Modes of Charging - II 163
16. Different Types of Borrowers 173
17. Types of Credit Facilities 181
18. Secured and Unsecured Loans, Registration of Firms, Incorporation of
Companies 187
19. Registration and Satisfaction of Charges 197
MODULE C - BANKING RELATED LAWS
SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS
AND ENFORCEMENT OF SECURITY INTEREST, 2002
(SARFAESI ACT)
20. Introduction to SARFAESI Act, 2002 205
21. Definitions at SARFAESI Act, 2002 209
22. Regulation of Securitisation and Reconstruction of Financial Assets of
Banks and Financial Institutions 219
xii
23. Enforcement of Security Interest
24. Central Registry
25. Offences and Penalties
26. Miscellaneous Provisions
THE BANKING OMBUDSMAN SCHEME, 2006
27. Purpose, Extent, Definitions, Establishment and Powers
28. Procedure for Redressal of Grievances
RECOVERY OF DEBTS DUE TO BANKS AND FINANCIAL
INSTITUTIONS ACT, 1993 (DRTACT)
29. Preliminary
30. Establishment of Tribunal and Appellate Tribunal
31. Jurisdiction, Powers and Authority of Tribunals
32. Procedure of Tribunals
33. Recovery of Debts Determined by Tribunal and Miscellaneous
Provisions
THE BANKERS' BOOKS EVIDENCE ACT, 1891
34. The Bankers' Books Evidence Act, 1891
THE LEGAL SERVICES AUTHORITIES ACT, 1987
35. LokAdalats
THE CONSUMER PROTECTION ACT, 1987
36. Preliminary, Extent and Definitions
37. Consumer Protection Councils
38. Consumer Disputes Redressal Agencies
THE LAW OF LIMITATION
39. Limitations of Suits, Appeals and Applications
TAX LAWS
40. Income Tax, Banking Cash, Transaction Tax, Fringe Benefit Tax and
Service Tax
231 241 245 249
255 259
267 271 275 279 285
293 299
303 311 315
327 331
MODULE D - COMMERCIAL LAWS WITH REFERENCE TO BANKING
OPERATIONS
41. Meaning and Essentials of a Contract
42. Contracts of Indemnity
43. Contracts of Guarantee
44. Contract of Bailment
45. Contract of Pledge
46. Contract of Agency
47. Meaning and Essentials of a Contract of Sale
48. Conditions and Warranties
341 345 347 353 357 359 365 369
XIII
49. Unpaid Seller
50. Definition, Meaning and Nature of Partnership
51. Relations of Partners to One Another
52. Relations of Partners to Third Parties
53. Minor Admitted to the Benefits of Partnership
54. Dissolution of a Firm
55. Effect of Non-Registration
56. Definition and Features of a Company
57. Types of Companies
58. Memorandum of Association and Articles of Association
59. Doctrines of Ultra Vires/Constructive Notice/Indoor Management
60. Membership
61. Prospectus
62. Directors
63. Foreign Exchange Management Act, 1999
64. Transfer of Property Act, 1882
65. The Right to Information Act, 2005
66. Right to Information and Obligations of Public Authorities
67. The Prevention of Money Laundering Act, 2002
68. Information Technology Act, 2000
Bibliography
373 377 381 385 389 393 397 399 405 411 415 419 425 429 437 443 453 457
463 469 475
MODULE-A REGULATIONS AND COMPLIANCE
Unit 1. Legal Framework of Regulation of Banks
Unit 2. Control over Organisation of Banks
Unit 3. Regulation of Banking Business
Unit 4. Returns, Inspection, Winding Up
Unit 5. Public Sector Banks and Co-operative Banks
Unit 1 LEGAL FRAMEWORK OF REGULATION OF BANKS
STRUCTURE
1.0 Objectives
1.1 Introduction
1.2 Business of Banking
1.3 Constitution of Banks
1.4 Reserve Bank of India Act, 1934
1.5 Banking Regulation Act, 1949
1.6 Reserve Bank as Central Bank and Regulator of Banks
1.7 Government as a Regulator of Banks
1.8 Control Over Co-operative Banks
1.9 Regulation by Other Authorities
\1.10 Let Us Sum Up
1.11 Keywords
1.12 Check Your Progress
1.13 Answer to 'Check Your Progress'
1.14 Terminal Questions
1.0 OBJECTIVES
The objectives of this Unit are to understand:
• the definition and nature of the business of banking;
• the constitution of different types of banks;
• the regulatory scheme of the RBI Act and the BR Act;
• the role of the Reserve Bank and the Central Government as regulators;
and
• the special position of public sector banks and co-operative banks.
1.1 INTRODUCTION
Banking in India is mainly governed by the Banking Regulation Act, 1949 and
the Reserve Bank of India Act, 1934. The Reserve Bank of India and the
Government of India exercise control over banks from the opening of banks to
their winding up by virtue of the powers conferred under these statutes.
All the regulatory provisions are not uniformly applicable to all banks. The
applicability of the provisions of these Acts to a bank depends on its
constitution; that is, whether it is a statutory corporation, a banking company or
a co-operative society. In this unit, we look at the definition of banking, the
constitution of different types of banks and applicability of regulatory laws, the
general framework of the regulatory laws and the role of regulators namely, the
Reserve Bank of India and the government.
1.2 BUSINESS OF BANKING
i. Definition of Banking: Banking is defined in Section 5(b) of the Banking
Regulation Act as the acceptance of deposits of money from the public for the
purpose of lending or investment. Such deposits may be repayable on demand or
otherwise and withdrawable by cheque, draft, order or otherwise. Thus, a bank
must perform two essential functions: i) acceptance of public deposits, and ii)
lending or investment of such deposits. The deposits may be repayable on
demand or for a period of time as agreed by the banker and the customer. In
terms of the definition, the banker can accept "deposits" of money and not
anything else. Further, accepting deposits from the "public" implies that a banker
accepts deposits from anyone who offers money for such purpose. However, a
banker can refuse to open account for undesirable persons and further, the
opening of accounts is subject to certain conditions like proper introduction and
identification.
The "Know Your Customer" guidelines issued by the Reserve Bank require
banks to follow certain customer identification procedure for opening of
accounts for protecting the banks from frauds, etc., and also for monitoring
transactions of a suspicious nature for the purpose of reporting to appropriate
authorities for taking anti-money laundering measurers and combating financing
of terrorism.
There is no exhaustive definition of "banking" in Common Law of England.
However, the usual characteristics of banking as identified by Lord Denning MR
in United Dominions Trust Ltd. vs Kirkwood ([1966] 1 All ER 968 at 975) are:
(a) the conduct of current accounts;
(b) the payment of cheques; and
(c) the collection of cheques for customers.
These characteristics are not equivalent to a definition, and these are also not the
only characteristics. (See, Paget's Law of Banking, 12th Edn., pp. 107 to 109)
ii. Deposits Withdrawable by Cheque: Under Section 49A of the Banking
Regulation Act, no organisation other than a bank is authorised to accept
deposits withdrawable by cheque. The Savings Bank
Scheme run by the government, a Primary credit society and any other person or
firm notified by the government are exempted from this prohibition.
iii. Acceptance of Deposits by Non-banking Entities: There are also non-banking
companies, firms and other unincorporated associations of persons and
individuals who accept deposits from the public. Acceptance of deposits by non-
banking financial companies is regulated by the Reserve Bank under the Non-
Banking Financial Companies Acceptance of Public Deposits (Reserve Bank)
Directions, 1998 and other directions issued by it under Chapter IIIB of the
Reserve Bank of India Act. Other companies are regulated by the Central
Government under the Companies (Acceptance of Deposit) Rules, 1975 issued
under Section 58A of the Companies Act, 1956. Individuals, firms and other
unincorporated associations of persons whose business includes the business of a
financial institution or whose principal business is acceptance of deposits, is
prohibited under Section 45S of the RBI Act (as amended in 1997) from
accepting deposits from the public, except relatives. This prohibition does not
apply to acceptance of deposits by those who are mainly engaged in
manufacturing or trading.
iv. Licence for Banking: In India, it is necessary to have a licence from the
Reserve Bank under Section 22 of the Banking Regulation Act for commencing
or carrying on the business of banking. Every banking company has to use the
word "bank" as part of its name (See, Section 7 of the Act) and no company
other than a banking company can use the words "bank", "banker", "banking" as
part of its name. Further, no firm, individual or group of individuals is permitted
to use the words "bank", "banking" or "banking company" as a part of the name
or for the purpose of business. Subsidiaries of banks and association of banks in
certain cases as also Primary Credit Societies are exempted from this restriction.
v. Permitted Business: Although, traditionally, the main business of banks is
acceptance of deposits and lending, the banks have now spread their wings far
and wide into many allied and even unrelated activities. The forms of business
permissible under Section 6(1) of the Banking Regulation Act, apart from
banking business, are summarised below:
(a) (i) Borrowing, raising or taking up of money;
(ii) Lending or advancing of money either upon security or without security;
(iii) Drawing, making, accepting, discounting, buying, selling, collecting and
dealing in bills of exchange, hundis, promissory notes, coupons, drafts, bills of
lading, railway receipts, warrants, debentures, certificates, scrips and other
instruments and securities whether transferable or negotiable or not;
(iv) Granting and issuing of letters of credit, travellers' cheques and circular
notes;
(v) Buying, selling and dealing in bullion and specie;
(vi) Buying and selling of foreign exchange including foreign bank notes;
(vii) Acquiring, holding, issuing on commission, underwriting and dealing in
stock, funds, shares, debentures, debenture stock, bonds, obligations, securities
and investments of all kinds;
(viii) Purchasing and selling of bonds, scrips and other forms of securities on
behalf of constituents or others;
(ix) Negotiating of loans and advances;
(x) Receiving of all kinds of bonds, scrips or valuables on deposit or for safe
custody or otherwise;
(xi) Providing of safe deposit vaults; and
(xii) Collecting and transmitting of money and securities.
(c) Contracting for public and private loans and negotiating and issuing the
same.
(d) Insure, guarantee, underwrite, participate in managing and carrying out
any issue of state, municipal or other loans or of shares, stock, debentures or
debenture stock of companies and lend money for the purpose of any such issue.
(e) Carry on and transact every kind of guarantee and indemnity business.
(f) Manage, sell and realise any property which may come into its
possession in satisfaction of any of its claims.
(g) Acquire, hold and deal with any property or any right, title or interest in
any such property which may form the security for any loan or advance.
(h) Undertake and execute trusts.
(i) Undertake the administration of estates as executor, trustee or otherwise.
(j) Establish, support and aid associations, institutions, funds, trusts, etc., for
the benefit of its present or ex-employees; grant money for charitable purposes,
(k) Acquire, construct and maintain any building for its own purpose.
(L) Sell, improve, manage, develop, exchange, lease, mortgage, dispose of or
turn into account or otherwise deal with all or any part of the business of any
person or company, when such business is of a nature described in Section 6.
(m) Acquire and undertake the whole or any part of the business of any person
or company, when such business is of a nature described in Section 6.
(n) Do all such things which are incidental or conducive to the promotion or
advancement of the business of the company,
(o) Do any other business specified by the Central Government as the lawful
business of a banking company. The Central Government has accordingly
specified leasing and factoring as permissible business for banks.
vi. Prohibited Business: Section 8 of the Banking Regulation Act prohibits a
banking company from engaging directly or indirectly in trading activities and
undertaking trading risks. Buying or selling or bartering of goods directly or
indirectly is prohibited. However, this is without prejudice to the business
permitted under Section 6(1) of the Act. Accordingly, a bank can realise the
securities given to it or held by it for a loan, if need arises for the realisation of
the amount lent. It can also buy or sell or barter for others in connection with: (i)
bills of exchange received for collection or negotiation, and (ii) undertaking the
administration of estates as executor, trustee, etc. Goods for the purpose of this
Section means every kind of moveable property, other than actionable claims,
stocks, shares, money, bullion and specie and all instruments referred to in
Clause (a) of sub-Section (1) of Section 6.
As regards immoveable properties, Section 9 prohibits a banking company from
holding such property, howsoever acquired, except as is required for its own use,
for a period exceeding seven years from the acquisition of the property. The
Reserve Bank may extend this period by another five years, if it is satisfied that
such extension would be in the interest of the depositors of the banking
company. The banking company shall be required to dispose of such property
within the permitted period.
1.3 CONSTITUTION OF BANKS
i. Banks in India fall under one of the following categories:
(a) Body corporate constituted under a special statute;
(b) Company registered under the Companies Act, 1956 or a foreign
company;
(c) Co-operative society registered under a central or state enactment on co-
operative societies.
ii. Public Sector Banks: The public sector banks including nationalised banks,
State Bank of India and its associates (subsidiaries) and the Regional Rural
Banks fall in the first category. By the Banking Companies (Acquisition and
Transfer of Undertakings) Act, 1970 and the Banking Companies (Acquisition
and Transfer of Undertakings) Act, 1980 the Central Government nationalised
(took over the business undertakings) of certain banking companies and vested
them in newly created statutory bodies (corresponding new banks) constituted
under Section 3 of the 1970/1980 Act. The State Bank of India was constituted
under the State Bank of India Act, 1955 and the six associate/subsidiary banks
were constituted under the State Bank (Subsidiary Banks) Act, 1959 or other
statutes (See Para 5.2.6). The regional rural banks are constituted under the
Regional Rural Banks Act, 1976. These banks are governed by the statutes
creating them as also some of the provisions of the Banking Regulation Act and
the Reserve Bank of India Act. The details are discussed in Unit 5.
iii. Banking Companies: A banking company, as defined in Section 5(c) of the
Banking Regulation Act is a company which transacts the business of banking.
Such company may be a company constituted under Section 3 of the Companies
Act or a foreign company within the meaning of Section 591 of that Act. All the
private sector banks are banking companies. These banks are governed by the
Companies Act, 1956 in respect of their constitution and by the Banking
Regulation Act and the RBI Act with regard to their business of banking.
iv. Co-operative Banks: A co-operative bank is a co-operative society registered
or deemed to have been registered under any Central Act for the time being in
force relating to the multi-state co-operative societies, or any other central or
state law relating to co-operative societies for the time being in force. If a co-
operative bank is operating in more than one state, the Central Act applies. In
other cases, the state laws apply. The Banking Laws (Application to Co-
operative Societies) Act, 1965 extended certain provisions of the Banking
Regulation Act and the Reserve Bank of India Act to the co-operative banking
sector. After the Supreme Court held in Apex Co¬operative Bank's case (AI R
2004 SC 141) that multi-state co-operative societies cannot be licensed as co-
operative banks, the Banking Regulation (Amendment) and Miscellaneous
Provisions Act, 2004 was enacted to permit licensing of multi-state co-operative
banks. A "multi-state co¬operative bank" under this Act means a multi-state co-
operative society which is a primary co-operative bank.
1.4 RESERVE BANK OF INDIA ACT, 1934
i. The Reserve Bank of India Act, 1934 was enacted to constitute the Reserve
Bank of India: (i) to regulate the issue of bank notes, (ii) for keeping reserves for
securing monetary stability in India, and (iii) to operate the currency and credit
system of the country to its advantage. The Act came into force on 6th March
1934. The Act has been amended from time to time to meet the demands of
changing times. The last amendment to the Act was effected by the RBI
(Amendment) Act, 2006.
ii. The Act deals with the constitution, powers and functions of the Reserve
Bank. It does not directly deal with regulation of the banking system except for
Section 42, which provides for cash reserves of scheduled banks to be kept with
the Reserve Bank, with a view to regulating the credit system and ensuring
monetary stability. Further, Section 18 of the Act provides for direct discount of
bills of exchange and promissory notes when a special occasion arises, making it
necessary or expedient for the purpose of regulating credit in the interests of
trade, industry and agriculture. The Act, in short, deals with:
(i) incorporation, capital, management and business of the bank:
(ii) the central banking functions like issue of bank notes, monetary control,
acting as banker to government and banks, lender of last resort;
(iii) collection and furnishing of credit information;
(iv) acceptance of deposits by non-banking financial institutions;
(v) general provisions regarding reserve fund, credit funds, publication of bank
rate, audit and accounts; and
(vi) penalties for violation of the provisions of the Act or the directions issued
thereunder.
1.5 BANKING REGULATION ACT, 1949
i. The Banking Regulation Act, 1949 was enacted to consolidate and amend the
law relating to banking and to provide for a suitable framework for regulating
the banking companies. Initially, the Act provided for regulation of banking
companies only, but in 1965 the Act was amended to cover co-operative banks
as well with certain modifications (See, Section 56). However, the Act, as
provided in Section 3, does not apply to primary agricultural credit societies and
co-operative land mortgage banks. The provisions of the Act are applicable to
banking companies in addition to other laws which are applicable to such
companies, unless otherwise specifically provided in the Act. Thus, Companies
Act, 1956 which deals with the incorporation and working of companies is
applicable to banking companies except where special provisions are made in
the Banking Regulation Act in that regard.
ii. The Act regulates entry into banking business by licensing as provided in
Section 22 thereof. The Act also puts restrictions on the shareholding,
directorship, voting rights and other aspects of banking companies. There are
several provisions in the Act regulating the business of banking such as
restriction on loans and advances, rates of interest to be charged, requirement as
to cash reserve and maintenance of percentage of assets, etc. There are
provisions regarding audit and inspection and submission of balance sheets and
accounts. The Act provides for control over the management of banking
companies and also deals with the procedure for winding up of the business of
the banks and penalties for violation of its provisions. In short, the Act deals
with:
(a) regulation business of banking companies;
(b) control over the management of banking companies;
(c) suspension and winding up of banking business; and
(d) penalties for violation of the provisions of the Act.
1.6 RESERVE BANK AS CENTRAL BANK AND REGULATOR OF
BANKS
i. The Reserve Bank was constituted under Section 3 of the Reserve Bank of
India Act, 1934 for taking over the management of currency from the Central
Government and carrying on the business of banking in accordance with the
provisions of the Act. Originally, under the RBI Act, the Bank had the
responsibility of:
(a) regulating the issue of bank notes;
(b) keeping of reserves for ensuring monetary stability; and
(c) generally to operate the currency and credit system of the country to its
advantage.
ii. The Reserve Bank is a body corporate having perpetual succession and
common seal and shall sue and be sued in its name. The whole capital of the
bank is held by the Central Government. The Bank has its central office in
Mumbai and offices in Mumbai, Kolkata, Delhi and Chennai, and branches at
most of the state capitals and some other cities.
iii. The bank functions under the general superintendence and directions of the
Central Board of
Directors. The bank has to abide by the directions given by the Central
Government in public interest after consultation with the Governor of the bank.
The board shall consist of a Governor and not more than four Deputy Governors
to be appointed by Central Government and other directors nominated by the
Central Government. Apart from the Central Board, the bank has also local
boards situated at Mumbai, Kolkata, Delhi and Chennai, which perform any duty
delegated to them by the Central Board. The Governor has the power of general
superintendence and direction of the affairs of the bank and exercise all powers
of the bank unless otherwise provided in the regulations made by the Central
Board. The Deputy Governors, Executive Directors and other officers in
different grades assist the Governor in the discharge of the Bank's functions.
iv. The Reserve Bank is the sole authority for issue and management of currency
in India under Section 22 of the RBI Act. The bank may issue notes of different
denominations from Rs. 2 to Rs. 10,000 as the Central Government may decide
on the recommendations of the Central Board of the bank. Such notes shall be
legal tender at any place in India.
v. The bank is the banker to the Central Government under Section 20 of the
Act, and accordingly it is obligatory to undertake banking business for the
Central Government. In the case of state governments, their banking business is
undertaken by the bank based on agreements as provided in Section 21 A. Bank
provides ways and means of advances to the Central and state governments.
These are temporary advances to meet immediate needs when there is interval
between expenditure and flow of revenue.
vi. The role of the bank as regulator of banking sector is mainly by virtue of the
provisions of the Banking Regulation Act, 1949. In exercise of the powers under
that Act the bank regulates the entry into banking business by licensing,
exercises control over shareholding and voting rights of shareholders, exercises
controls over the managerial persons, and regulates the business of banks. The
bank also inspects banks and exercises supervisory powers, and may issue
directions from time to time in public interest and in the interest of the banking
system with respect to interest rates, lending limits, investments and various
other matters.
vii. The major powers of the Reserve Bank in the different roles as regulator and
supervisor can be summed up as under:
(a) power to licence;
(b) power of appointment and removal of banking boards/personnel;
(c) power to regulate the business of banks;
(d) power to give directions;
(e) power to inspect and supervise banks;
(f) power regarding audit of banks;
(g) power to collect, collate and furnish credit information;
(h) power relating to moratorium, amalgamation and winding up; and (i)
power to impose penalties.
1.7 GOVERNMENT AS A REGULATOR OF BANKS
i. The Reserve Bank is the primary regulator of banks. But the Central
Government has also been conferred extensive powers under the RBI Act and
BR Act either directly or indirectly over the banks.
ii. The government holds the entire capital of the Reserve Bank and appoints the
Governor and the
mr.mhe.rs nf the Central Rmrd nnri Vns the power to remove them. The
government has also the
- - • j i
10
necessary in public interest after consultation with the Governor. Thus, the
government can exercise control over banks by influencing decision-making by
the Reserve Bank and has also got appellate authority in respect of several
matters in which the Reserve Bank has been conferred the power to decide at the
first instance. Thus, under the Banking Regulation Act appeal lies with the
Central Government on removal of managerial personnel under Sections 10B
and 36AA of the BR Act. Similarly, there are also provisions for appeal in
respect of cancellation of banking licence (under Section 22) and refusal of
certificate regarding floating charge on assets (Section 14A).
iii. The government has the power to suspend the operations of the Banking
Regulation Act or to give exemption from any of the provisions of the Act on the
representation/recommendation of the Reserve Bank under Sections 4 and 53 of
the Act, respectively. The government has also the power to notify other forms
of business which a bank may undertake under Section 6(1 )(o) of the Act. Rule-
making powers under Sections 52 and 45Y are vested in the Central
Government. There are also other provisions under which the Central
Government exercises powers as under:
(a) Approval for formation of subsidiary for certain business under Section
19;
(b) Notification with reference to accounts and balance sheet under Section
29;
(c) Issue of direction for inspection of banks under Section 35;
(d) Power to acquire undertakings of banks (Section 36AE);
(e) Appointment of court liquidator;
(f) Suspension of business and amalgamation of banks under Section 45.
The above provisions confer wide powers on the Central Government to regulate
banks. These are in addition to the powers conferred on the government as
majority shareholder or full owner of public sector banks under the statutes
constituting them.
1.8 CONTROL OVER CO-OPERATIVE BANKS
i. A co-operative bank is a co-operative society engaged in the business of
banking and may be a primary Co-operative bank, a district central co-operative
bank or a state co-operative bank. Co¬operative banks operating in one state
only are registered under the State co-operative Societies Act concerned. The
formation of such banks as well as their management and control over personnel
is regulated by the co-operative law of the state. The Registrar of co-operative
societies under the Co-operative Societies Act exercises a wide range of powers
on co-operative societies from registration to winding up.
ii. In the case of co-operative banks operating in more than one state, the Multi-
State Co-operative Societies Act, 2002 is applicable. In that case, the Registrar
appointed by the Central Government takes the place of the Registrar appointed
by the State Government in other cases.
iii. With the introduction of Section 56 in the Banking Regulation Act, 1949
with effect from 1965, co¬operative banks have come under the regulatory
purview of the Reserve Bank. While the formation and management of co-
operative societies operating in one state only (including those conducting
banking business) are under the control of the State Government, licensing and
regulation of banking business rests with the Reserve Bank. Thus, there is dual
control of State Governments and the Reserve Bank over these banks.
IV. In the case of co-operative banks which are registered under the Deposit
Insurance and Credit Guarantee Corporation Act, the Reserve Bank has the
power to order their winding up. The circumstances in which Reserve Bank may
require winding up are mentioned in Section 13D of the Act.
11
1.9 REGULATION BY OTHER AUTHORITIES
i. Banks may be subject to the control of other regulatory agencies in the conduct
of their business. For instance, a banking company will be subject to the control
of the authorities under the Companies Act in respect of company matters.
Similarly, a bank is answerable to labour authorities in respect of the terms and
conditions of service of its workmen, opening and closing of its premises,
engagement of contract labour, etc. Banks are also liable to pay income tax like
cash transaction tax, service tax, etc., and other taxes and have to follow the
rules and regulations in that regard.
ii. As provided in Section 6 of the Banking Regulation Act, banks may
undertake certain non-banking business in addition to the business of banking. In
that regard also, banks may be subject to the regulatory control of other
agencies. For instance, in the case of dealings in securities like shares and
debentures, banks are subject to regulation by the Securities Exchange Board of
India under the Securities Contract (Regulation) Act, 1956 read with the
Securities and Exchange Board of India Act, 1992. If the Bank desires to raise
capital through public issue, it has to comply with SEBI guidelines. In case of
Insurance Business - by IRDA and in case of Mutual Fund Business -RBI, SEBI.
The study herein is, however, largely confined to the regulation of banks by the
Reserve Bank and the Central Government under the Reserve Bank of India Act
and the Banking Regulation Act.
1.10 LET US SUM UP
1. Banking means acceptance of deposits of money from the public for
lending or investment. Such
deposits may be repayable on demand or may be for a period of time as agreed
to, by the banker
and the customer, and may be repayable by cheque, draft or otherwise. Apart
from banking, banks
are authorised to carry on other business as specified in Section 6 of the Banking
Regulation Act.
Banks are, however, prohibited from undertaking any trading activities.
2. Banks are constituted as companies registered under the Companies Act,
1956, statutory corporations
constituted under Special Statutes or Co-operative societies registered under the
Central or State
Co-operative Societies Acts. The extent of applicability of the regulatory
provisions under the
Banking Regulation Act and the Reserve Bank of India Act to a bank depends
on the constitution of
the bank.
3. Reserve Bank of India is the central bank of the country and the primary
regulator for the banking
sector. The government has direct and indirect control over banks. It can
exercise indirect control
through the Reserve Bank and also act directly in appeals arising from decisions
of the Reserve
Bank under the various provisions of the Banking Regulation Act. In public
sector banks like the
State Bank of India and its subsidiaries, nationalised banks and the regional rural
banks, 50% or
more of their shares are held by the Central Government. Central Government
has substantial
control over the management of these banks. Only certain provisions of the BR
Act are applicable
to these banks as indicated in that Act. Co-operative banks operating in one state
only are registered
under the State Co-operative Societies Act and are subject to the control of the
State Government
as also the Reserve Bank. In the case of non-banking business of the banks, they
are subject to
control by other regulatory agencies.
1.11 KEYWORDS
Banking; Banking Company; Body Corporate; Co-operative Bank; Nationalised
Bank; Regional Rural Bank; Public Sector Bank.
12
1.12 CHECK YOUR PROGRESS
A. 1. State whether the following statements are True or False.
(i) A public sector bank is a body corporate created under a special statute.
(ii) A banking company is registered under the Banking Regulation Act.
(iii) Co-operative banks are registered under the Multi-State Co-operative
Societies Act or a
State Co-operative Societies Act.
(iv) Subsidiaries of the State Bank are companies registered under the
Companies Act. (v) Accepting deposits for safe custody would fall within the
definition of "banking".
2. Fill in the gaps choosing the answers from the brackets.
(i) Reserve Bank was constituted under (BR Act, RBI Act, Companies Act)
(ii) A Regional Rural Bank is (a body corporate created under a special
statute, a co¬
operative society, a company)
(Reserve Bank, Registrar of Companies,
(iii) Banking companies are licensed by
Company Law Board)
(iv) Business which a banking company may undertake other than banking is as
stipulated by
(Reserve Bank, BR Act, RBI Act)
(v) BR Act was enacted for (regulating banking companies, creating
Reserve Bank,
regulating acceptance of deposits from public)
B. 1
State whether the following statements are True or False, (i) Central
Government can give direction to the Reserve Bank, (ii) All kinds of business of
banks is regulated only by the Reserve Bank, (iii) Central Government is the
primary regulator of banks, (iv) State governments have no control over co-
operative banks. (v) On cancellation of licence of any bank, an appeal lies with
Central Government.
Fill in the gaps choosing the answers from the brackets.
(State Co¬
operative Societies Act, Multi-State Co-operative Societies Act, RBI Act)
Government can exempt a bank from the provisions of BR Act (on the
recommendation of RBI, whenever the government is satisfied, if requested by a
bank)
exercises the central banking function in India. (State Bank, Central
Bank of
(ii) (iii)
(i) Co-operative banks operating in different states are registered under
(Reserve Bank,
India, Reserve Bank)
(iv) Company matters of a banking company are regulated by
(Controller
Authorities under the Companies Act, SEBI) (v) Trading in shares and securities
by banks is subject to regulation by .
of Capital Issues, SEBI, Company Law Board)
1.13 ANSWERS TO 'CHECK YOUR PROGRESS'
A. 1. (i) True; (ii) False; (iii) True; (iv) False; (v) False.
2. (i) RBI Act (ii) a body corporate created under a special statute
(iii) Reserve Bank (iv) BRAct
(v) for regulating banking companies.
B. 1. (i) True; (ii) False; (iii) False; (iv) False; (v) True.
2. (i) Multi-State Co-operative Societies Act
(ii) On recommendation of RBI (iii) Reserve Bank
13
(iv) Authorities under the Companies Act (v) SEBI.
1.14 TERMINAL QUESTIONS
Fill in the gaps choosing the answers from the brackets. 1. One of the essential
characteristics of banking is _
(lending to traders; investment in
_. (body corporate
securities; acceptance of deposits from the public) 2. Banking companies
operating in India are constituted in the form of.
constituted under a special statute; company registered under the Companies
Act, 1956 or a foreign company; society registered under the Societies
Registration Act)
3. Companies Act applies to banking companies _. (notwithstanding the
provisions of the
Banking Regulation Act; insofar as its provisions are not inconsistent with the
provisions of the Banking Regulation Act; only in relation to registration and
winding up)
4. Under the Reserve Bank of India Act, Reserve Bank regulates
acceptance of deposits by
(all companies; non-banking financial companies; non-banking non-
financial
companies)
_. (to the extent as provided in the state laws
5. BR Act is applicable to co-operative banks
on co-operative societies; in a modified form as provided in Section 56 thereof;
at par with commercial banks)
6. "Corresponding new banks" means (new banks [nationalised
banks] constituted under
the Banking Companies [Acquisition and Transfer of Undertakings] Act, 1970
and the Banking Companies [Acquisition and Transfer of Undertakings] Act,
1980; new generation banking companies registered under the Companies Act; a
new bank formed by amalgamation of two banking companies)
7. Central Government may give directions to the Reserve Bank when
considered necessary in
public interest only after consulting (the Governor of Reserve Bank; the
Central
Board of the Reserve Bank; the Finance Commission)
8. A co-operative society registered under the Multi-State Co-operative
Societies Act (is
prohibited from undertaking banking business; can be declared as a state co-
operative bank; can undertake banking business as a primary co-operative bank)
9. A multi-state co-operative bank means a multi-state co-operative society
which is a
(primary co-operative bank; central co-operative bank; state co-operative bank)
10. For the purposes of the BR Act, a "co-operative society" means a society
registered or deemed to
have been registered under (any Central Act for the time being in force
relating to the
multi-state co-operative societies only; any state law relating to co-operative
societies for the time being in force only; any Central Act for the time being in
force relating to the multi-state co¬operative societies or any other central or
state law relating to co-operative societies for the time being in force)
UNIT
2
CONTROL OVER ORGANISATION OF BANKS
STRUCTURE
2.0 Objectives
2.1 Introduction
2.2 Licensing of Banking Companies
2.3 Branch Licensing
2.4 Paid-up Capital and Reserves
2.5 Shareholding in Banking Companies
2.6 Subsidiaries of Banking Companies
2.7 Board of Directors
2.8 Chairman of Banking Company
2.9 Appointment of Additional Directors
2.10 Restrictions on Employment
2.11 Control Over Management
2.12 Corporate Governance
2.13 Directors and Corporate Governance
2.14 Let Us Sum Up
2.15 Keywords
2.16 Check Your Progress
2.17 Answers to 'Check Your Progress'
2.18 Terminal Questions
16
2.0 OBJECTIVES
The objectives of this unit are to understand the laws that govern banking
companies, in respect of:
• Licensing and branch licensing
• Paid up capital and reserves
• Shareholding and rights of shareholders
• Formation of subsidiaries and holding of shares of other companies
• Constitution and regulation of board of directors
• Exercise of control by the Reserve Bank and the Government over the
appointment and removal of
chairmen, managerial and other personnel
• Corporate governance
2.1 INTRODUCTION
The Banking Regulation Act provides for regulation of the organisation of
banking companies. To start with, there are restrictions at the entry point, by
way of licensing and then the requirement of permission for opening or shifting
of branches. There are further regulations over the paid-up capital and reserves,
shareholder's rights, constitution of the board of directors, appointment of
chairman and formation of subsidiaries. Apart from the above, there are also
controls over the managerial and other personnel, including the power to remove
unsuitable persons and to appoint suitable persons. In this unit, we study various
provisions of the Banking Regulation Act, providing for controls over the
organisation and management of banking companies.
2.2 LICENSING OF BANKING COMPANIES
i. License Requirement from RBI: To commence or carry on, the banking
business in India, a company requires a licence from the Reserve Bank under
Section 22 of the Banking Regulation Act, 1949. Commencing or carrying on a
banking business without a licence is prohibited. When the Act came into force,
the banking companies, which were then in existence were required to apply for
licence within six months from the commencement of the Act. But, such
banking companies were permitted to continue business, unless and until their
applications for licence were rejected by the Reserve Bank. The requirement of
licence was meant to ensure the continuance of only those banks, which were
established and operating on sound lines and to prevent indiscriminate formation
of banking companies.
ii. Discretion of Reserve Bank: The granting of licence by the Reserve Bank
may be subject to such conditions as the RBI may think fit in each case. As held
by the Gujarat High Court in Shivabhai vs RBI, Ahmedabad (AIR 1986 Guj 19),
Reserve Bank has the discretion to grant or refuse the licence and when such
decision based on relevant, material and germane considerations, the decision
cannot be assailed. Only if the decision is based on extraneous considerations or
is perverse, the court will intervene.
It is open to the RBI to consider the defects or improvements revealed in an
inspection held under Section 35 of the BR Act while disposing of an application
for licence. (See, Sajjan Bank Pvt. Ltd. vs RBI, AI R 1961 Mad 8). The refusal
of licence to a company would make it ineligible to undertake banking business,
but it would still be open to the company to carry on other business like money
lending.
iii. Conditions to be Satisfied: Before granting a licence under Section 22,
Reserve Bank may have to be satisfied by an inspection of the books of the
banking company or otherwise in respect of the
fnllnwintr matters-
17
(a) Whether the company is or will be in a position to pay its present and
future depositors in full
as their claims accrue;
(b) Whether the affairs of the company are being conducted or likely to be
conducted in a manner
detrimental to the interests of its present and future depositors;
(c) Whether the general character of proposed management of the company
will not be prejudicial
to public interest or the interest of depositors;
(d) Whether the company has an adequate capital structure and earning
prospects;
(e) Whether public interest will be served by grant of licence to the
company;
(f) Whether considering the banking facilities available in the proposed area
of operation, the
potential scope for expansion of business by banks already in existence in that
area and
other relevant factors, the grant of licence would be prejudicial to the operation
and consolidation
of banking system, consistent with monetary stability and economic growth;
(g) The fulfilment of any other condition which the Reserve Bank considers
relevant in public
interest or in the interest of depositors.
Although Section 11 of BR Act specifies the minimum capital and reserves
requirements of a banking company, the Reserve Bank can stipulate a higher
requirement of capital for licensing a banking company as under Section 22 the
Reserve Bank has to be satisfied that the company has an adequate capital
structure and earning prospects.
iv. Foreign Banks: In the case of companies incorporated outside India applying
for a licence, apart from the conditions specified in the case of domestic
companies, three additional conditions have been stipulated for consideration by
the Reserve Bank. These are:
(a) Whether carrying on of banking business by the company in India will
be in public interest;
(b) Whether the government or the law of the country, in which the
company is incorporated
discriminates in any way against banking companies registered in India;
(c) Whether the company complies with provisions of the BR Act, as
applicable to foreign
companies.
v. Local Area Banks: The Reserve Bank has recognised the concept of local area
banks and licensed a few(four) such banks. These are banking companies
operating only in a limited geographical area. The licence issued to these banks
would restrict their operations to the specified local area to ensure adequate
banking services in that area.
vi. Cancellation of Licence: Sub-Section (4) of Section 22 of the Banking
Regulation Act authorises the Reserve Bank to cancel the licence granted to any
banking company. The cancellation of licence may be on any one or more of the
following grounds:
(a) The company ceases to carry on banking business in India;
(b) The company at any time fails to comply with any of the conditions
imposed under the sub-
Section (1) of Section 22 of Banking Regulation Act;
(c) The company does not fulfil at any time, any of the conditions referred
to in the sub-Section(3)
or 3(A) of Section 22 of Banking Regulation Act.
Before cancellation of a licence for non-compliance with any of the conditions
as above, the company has to be given an opportunity for taking necessary steps
for complying with or fulfilling the conditions. However, in cases where the
Reserve Bank is of the opinion that delay will be prejudicial to the interests of
depositors or the public, the requirement of opportunity can be dispensed with.
As observed by the Madras High Court in Sajjan Bank Pyt. Ltd. vs RBI (AIR
1961 Mad. 8), the Reserve Bank has a wide range of administrative discretion
under the Act, which it is competent to exercise, and it cannot be said that there
is an excessive delegation of power. A banking company, whose licence is
cancelled, can appeal to the Central Government within a
; i _ r
t/\ J r-.
18
2.3 BRANCH LICENSING
i. Apart from the requirement of licence for commencing or carrying on banking
business, banks have to obtain the prior permission of Reserve Bank for opening
a new place of business or changing location of the existing place of business.
Under Section 23 of the Banking Regulation Act, 'Place of business' for this
purpose includes any sub-office, pay office, sub-pay office or any place at which
deposits are received, cheques cashed or moneys lent. However, changing the
location of an existing place of business within the same city, town or village
would not need such permission. These restrictions also apply to foreign
branches of banking companies incorporated in India. Opening of a temporary
place of business up to one month for purpose of affording banking facilities for
any exhibition, mela, conference or like occasion is exempt. However, the
temporary branch has to be within the limits of the city; town or village where
there is an existing branch or in the environs thereof. The present guidelines
from RBI provide that Banks should submit their request for new branches,
administrative offices, ATMs once in a year for consideration of RBI as against
the earlier practice of making individual applications for each and every branch.
When approved, the permission would be valid for a period of one year before
which the branches/ offices should be operationalised.
ii. For granting permission under Section 23, the Reserve Bank may require to
be satisfied of the following:
(a) Financial condition and history of the bank;
(b) General character of its management;
(c) Adequacy of capital structure and earning prospects;
(d) Public interest.
This may be done by an inspection of the bank under Section 35 or otherwise.
While granting permission for opening or shifting a branch, the Reserve Bank
may impose any conditions which it thinks fit necessary. If any bank fails to
comply with such conditions, the permission may be revoked after giving an
opportunity to the bank to show cause.
iii. In the case of regional rural banks, the applications for permission have to be
routed through the National Bank (NABARD), and the national bank has to offer
its comments on merits to the Reserve Bank.
2.4 PAID-UP CAPITAL AND RESERVES
Section 11 of the Banking Regulation Act provides for certain minimum
requirements as to paid-up capital and reserves of banking companies. Any
company wanting to commence banking business has to comply with these
requirements. The amounts stipulated have reference to the places of business.
'Place of business' for this purpose means any office, sub-office, sub-pay office
and any place at which deposits are received, cheques cashed or moneys lent. In
the case of any dispute regarding computation of paid-up capital and reserves of
any banking company, the decision of the Reserve Bank shall be final.
i. Foreign Banks: Under the sub-Section (2) of Section 11 of the BR Act, a
foreign bank (banking company incorporated outside India) operating in India,
has to deposit and keep deposited with the Reserve Bank, an amount of Rs.15
lacs and if it has a place of business in Mumbai or Kolkata or both, Rs. 20 lacs.
The amount has to be kept in cash, unencumbered approved securities or partly
in both. Apart from this, an amount of twenty per cent of the profit for each year
in respect of business transacted through the branches in India as disclosed in the
profit and loss account has to be deposited with the Reserve Bank. The securities
deposited can be replaced by other unencumbered
19
approved securities or cash deposited can be similarly replaced by securities.
The Central Government can exempt any foreign bank from this requirement on
the recommendation of the Reserve Bank for a specified period if the amounts
deposited already by it are considered adequate. On the cessation of business by
any foreign bank for any reason, these deposits shall form the assets of the
company on which the creditors in India shall have the first charge.
ii. Indian Banks: In case of banking companies incorporated in India, the
requirements of minimum paid-up capital and reserves under Section 11 (3) are
as follows:
(a) If it has a place of business in more than one state, Rs. 5 lac and if such
places of business
include Mumbai, Kolkata or both, Rs. 10 lac.
(b) If the place of business is in only one state and does not include Mumbai
or Kolkata, Rupees 1
lac for its principal place of business, plus Rs. 10,000 for other places of
business, in the same
district in which the principal place of business is situated, plus an additional Rs.
20,000, for
each place of business elsewhere; in total not exceeding Rs. 5 lacs. If the bank
has only one
place of business, the amount is limited to Rs. 50,000.
For banking companies commencing business after the commencement of the
Act, paid-up capital is stipulated as Rs 5 lac.
(c) If places of business are in one state only, but one or more of them is in
Mumbai or Kolkata,
Rs. 5 lac, plus Rs. 25,000 for each place of business outside these cities and the
aggregate not
exceeding Rs. 10 lac.
During 2005, RBI stipulated the minimum capital requirement for a new Private
Bank at Rs 300 crore as a part of Corporate Governance guidelines and as a
policy of Foreign Direct Investment.
iii. Paid-up Capital, Subscribed Capital and Authorised Capital: Apart from the
above, Section 12(1) of the Banking Regulation Act stipulates that the
subscribed capital of a banking company shall not be less than half of its
authorised capital; and the paid-up capital shall not be less than half of its
subscribed capital. If capital is increased, this requirement has to be complied
within a period not exceeding two years as allowed by the Reserve Bank.
Banking companies are permitted to have only ordinary or equity shares.
However, preference shares issued before 1 July 1944 are exempt. Further, the
provisions of Section 12(1) are not applicable to banks incorporated before 15
January 1937. Now preference shares and other capital instruments are also
allowed. Since 2005, Banks have been permitted by RBI to raise capital even in
the from of innovative debt instruments which are perpetual and perpetual non-
cumulative preference shares in addition to the equity capital.
2.5 SHAREHOLDING IN BANKING COMPANIES
i. Voting rights of shareholders: There is no specified ceiling on a person's
holding of shares in a banking company under the Banking Regulation Act or
any other law. However, Section 12(2) of the Act puts certain restrictions on
voting rights of shareholders. Accordingly, no shareholder can exercise voting
rights in respect of the shares held by him/her in excess of ten per cent of the
total voting rights of all the shareholders of the banking company. This provision
does not in any way affect the transfer of shares or the registration of such
transfers. It only puts a limit on voting rights. However, Section 12(3) bars suits
or other proceedings against registered shareholders by any other person
claiming title except by a transferee of shares, in accordance with the law or on
behalf of minors or lunatics for whom the registered shareholder holds the
shares. The provisions of the Companies Act also govern transfer of shares of
banking companies.
ii. Acknowledgement by Reserve Bank: Reserve Bank has instructed banking
companies that when
20
they receive more than the specified percentage of their shares for transfer to one
party, the bank's board must refer the matter to the Reserve Bank. The banks
shall not transfer the shares without receiving Reserve Bank's acknowledgement.
This is with a view to ensure that the controlling interest in a banking company
does not change hands without the knowledge and approval of the Reserve
Bank.
iii. Reports on shareholding: A report regarding the particulars of shareholding
of the chairman, managing director or chief executive officer, by whatever name
called, of every banking company, requires submission to the Reserve Bank.
Such report should contain the full particulars and extent of value of shares held
directly or indirectly and of any change in the extent of holding or of any
variation in the rights attaching thereto. The Reserve Bank may also order for
any other information relating to those shares.
iv. Commission, brokerage, discount: Section 13 of the Banking Regulation Act
imposes a ceiling on the commission, brokerage, discount or remuneration on
the sale of shares of banking companies. Accordingly, the payments on this
account in any form should not exceed two-and-a-half per cent of the paid-up
value of the shares.
v. Dividend: There are also certain restrictions on the payment of dividend to the
shareholders of banking companies. Thus, under Section 15 of the Banking
Regulation Act, no dividend is payable until all capitalised expenses are
completely written off. Such expenses include preliminary expenses,
organisation expenses, share-selling commission, brokerage, loss incurred and
any other item, of expenditure not represented by tangible assets. However,
dividends are payable without writing off depreciation, bad debt etc., as under:
(a) Depreciation in value of approved securities, which is not capitalised or
accounted for as a
loss.
(b) Depreciation in investment of shares, bonds or debentures, other than
the approved securities
for which adequate provision has been made.
(c) Bad debts for which an adequate provision is provided.
RBI has given detailed eligibility criteria for declaration of dividend by banks
and also guidelines on the quantum of dividend that can be declared by banks.
The eligibility criteria require a minimum 9 % of CAR and Net NPAs not
exceeding 1%. The quantum of dividend that can be declared is based on the
levels of net NPAs and in a graded level (Maximum 40% pay out ratio) and can
be paid out of only current year's profits.
2.6 SUBSIDIARIES OF BANKING COMPANIES
i. Formation of Subsidiaries: There are certain restrictions under Section 19 of
the Banking Regulation Act on the formation of subsidiaries by banking
companies. This is for purpose of preventing banks from carrying on trading
activities by acquiring a controlling interest in non-banking companies.
Accordingly, subsidiaries are permissible only for the following purposes:
(i) Undertaking any business which is permissible for banking companies under
Section 6(1) clauses (a) to (o).
(ii) Carrying on the business of banking exclusively outside India. Prior
permission of the Reserve Bank is a must for this banking business.
(iii) Undertaking any other business which Reserve Bank with prior approval of
the Central Government permits. Reserve Bank may permit only such other
business which it considers conducive to the spread of banking in India or
otherwise useful or necessary in the public interest. The undertaking of any
business by a subsidiary will not be deemed to amount to the bank itself taking
up that business directly or indirectly for the purpose of Section 8.
21
ii. Shareholding in other companies: Apart from the restriction on subsidiaries,
there is also a ceiling [Section 19(2)] on shareholding in companies other than
subsidiaries. Thus, the holding of shares by a banking company in any company
as pledgee, mortgagee or absolute owner shall not be exceeding thirty per cent of
the paid-up share capital of that company or the paid-up share capital and
reserves of the banking company. Further, holding of shares in any company in
which the managing director or manager of a banking company is interested in
or concerned with in any manner, is prohibited except in the case of subsidiaries.
2.7 BOARD OF DIRECTORS
i. Qualifications: Section lOAofthe Banking RegulationAct stipulates certain
qualifications fordirectors of banking companies. Accordingly at least fifty-one
per cent of the total number of directors shall be persons, who have special
knowledge or practical experience, with respect of accountancy, agriculture and
rural economy, banking, cooperation, economics, finance, law, small scale
industry or any other matter, the special knowledge or practical experience
which is useful to the banking company, in the opinion of the Reserve Bank.
Further, at least two of the directors should have special knowledge or practical
experience in agriculture and rural economy or co-operation or small scale
industry.
ii. Substantial interest: The directors of a banking company shall not have a
substantial interest in or be connected with as employee, manager or managing
agent in a company or firm which carries on trade, commerce or industry as per
Section 10A (2)(b) of the BR Act. However, companies registered under Section
25 of the Companies Act and small scale industrial concerns are not included for
the purpose. The proprietors of trading, commercial or industrial concerns other
than small scale industrial concerns are also disqualified for directorship.
'Substantial interest' for this purpose is defined in Section 2 of the Banking
Regulation Act. Accordingly, holding of beneficial interest by any individual or
his spouse or minor child, whether singly or taken together in the shares of a
company exceeding Rs. 5 lacs or ten per cent of the paid-up capital of the
company amounts to substantial interest. In the case of firms, such holding of
beneficial interest exceeding ten per cent of the total capital of the firm amounts
to substantial interest.
iii. Period of office: The directors of a banking company shall not hold office for
more than eight years continuously. However, this provision is not applicable to
the chairman or a whole-time director. When the chairman or a whole-time
director of a bank is removed from office, he/she ceases to be a director of the
bank and shall not be eligible for further appointment as director of that banking
company for a period of four years.
iv. Reconstitution of Board: When the board of a banking company is not
constituted in accordance with the requirements of Section 10A of the BR Act,
the board has to be reconstituted, to comply with the provisions. If any director
has to be retired for such a reconstitution, this may be done by lots, in the
prescribed manner and such decision shall be binding on every director of the
board. If the Reserve Bank is of the opinion that the board of any banking
company does not fulfil the requirements, it may order such a bank to
reconstitute the board after giving reasonable opportunity of being heard. If,
within two months' time, the bank does not fulfil the order of the Reserve Bank,
the Bank may then remove any director (determined by lots drawn in the
prescribed manner) and such a person shall cease to hold office. The Reserve
Bank may also appoint a new director in the place of the person removed and
he/she shall continue in office until the date up to which his predecessor would
have held office. However, any proceedings of a banking company will not be
invalid only because of any defect in the composition of the board.
22
2.8 CHAIRMAN OF BANKING COMPANY
i. Whole-time Chairman/Managing Director: Section 1 OB of the Banking
Regulation Act provides that every banking company should have a full-time or
part-time chairman, appointed from among its directors. The chairman, if
appointed on a whole-time basis is entrusted with the management of the entire
affairs of the bank. The chairman on a part-time basis has to be appointed with
the prior approval of the Reserve Bank and such an appointment shall be subject
to any conditions that may be imposed by the Reserve Bank while granting
approval. In the absence of a chairman, the management of the whole of the
affairs of the banking company shall be entrusted to a managing director. The
exercise of powers by the whole-time chairman or managing director is subject
to the superintendence, control and directions of the board of directors. The
whole-time chairman and a managing director shall hold office for a period not
exceeding five years as the board may fix and is also eligible for reelection or
reappointment. Although the chairman is in full-time employment of the bank,
he may be a director of a subsidiary of the bank or of a company registered
under Section 25 of the Companies Act. The Reserve Bank may also permit the
whole-time chairman or the managing director to undertake part-time honorary
work not likely to interfere with the duties of the chairman or the managing
director.
The whole-time chairman or the managing director of a banking company may
continue in office at the end of the term of the office until his/her successor
assumes office, subject to the approval of the Reserve Bank.
ii. Qualifications of Whole-time Chairman/Managing Director: The whole-time
chairman or the managing director of a banking company should have special
knowledge or practical experience of the working of a banking company or the
State Bank or a subsidiary bank or a financial institution or financial, economic
or business administration. The whole-time chairman or the managing director
will be disqualified under the following circumstances:
(a) if he/she is director of a company other than a subsidiary of the banking
company or a charitable
company (registered under Section 25 of the Companies Act);
(b) if he/she is a partner of any firm which carries on trade, business or
industry;
(c) if he/she has substantial interest in any other company or firm or is
director, manager, managing
agent, partner or proprietor of any trading, commercial or industrial concern; or
(d) if he/she is engaged in any other business or vocation.
iii. Removal of Wholetime Chairman/Managing Director: If the Reserve Bank is
of the opinion that the person elected to be the chairman of the board of directors
and appointed on a whole time basis or the managing director is not a fit and
proper person to hold such office, the Reserve Bank may require the banking
company to remove such a chairman or the managing director and appoint a
suitable person. However, before taking such an action, the Reserve Bank has to
give such a person, as also the banking company, a reasonable opportunity of
being heard. If the banking company does not comply with the order within two
months, the Reserve Bank may remove the person from the office and appoint a
suitable person in his/her place. Such a chairman or managing director would
continue in office, for the residual period of office of the person removed from
office.
The banking company or the person affected by the Reserve Bank's order may
appeal to the Central Government within thirty days. The order of the
Government where an appeal is filed and the order of the Reserve Bank, where
no appeal is filed shall be final and not liable to be challenged before any civil
court.
vi. Temporary vacancies: In cases where the wholetime chairman or the
managing director dies or
23
he/she resigns or is not capable of discharging his/her functions due to illness,
temporary arrangements can be made to carry out the duties of the chairman or
the managing director for a period not exceeding four months. However, this has
to be done with the approval of the Reserve Bank.
v. Power of Reserve Bank to appoint Chairman: In certain cases, the office of
the whole-time chairman or the managing director of a banking company may
fall vacant and may not be filled up by the bank immediately. This may
adversely affect the interests of the banking company. If the Reserve Bank is of
the opinion that continuation of such vacancy is likely to be against the interests
of the banking company, it may appoint an eligible person to fill such vacancy
under Section 10BB of the Banking Regulation Act. If the chairman or the
managing director so appointed is not a director of the banking company, he/she
shall be deemed to be a director of the banking company. Such appointment may
be for a period not exceeding three years. There is also a provision for
reappointment after the initial period. The chairman or the managing director so
appointed may be removed from office only by the Reserve Bank and shall draw
pay and allowances from the banking company, as determined by the Reserve
Bank.
vi. Qualification shares: The whole-time chairman or the managing director of a
banking company is exempted under Section IOC of the Banking Regulation Act
from the requirement of holding qualification shares. Similar exemption is also
available to a director of a banking company appointed by Reserve Bank under
Section 10A of the Act.
vii. Overriding provisions: The provisions of Section 10A, Section 10B and
Section 10BB of the Banking Regulation Act regarding the appointment and
removal of a director, managing director or the chairman shall have overriding
effect over all other laws, contracts, etc. Any person affected by any action taken
under these provisions is not entitled to any compensation for any loss or for
termination of office.
2.9 APPOINTMENT OF ADDITIONAL DIRECTORS
i. The Reserve Bank has the power to appoint additional directors on the boards
of banking companies under Section 36AB of the Banking Regulation Act. One
or more additional directors may be so appointed when the bank is of the
opinion that it is necessary to do so in the interest of:
(a) banking policy (b) public
(c) banking company (d) depositors of the banking company.
ii. The directors so appointed shall not require any qualification shares. They
hold office during the pleasure of the Reserve Bank. Subject to this, appointment
may be for a period not exceeding three years or further extended periods not
exceeding three years at a time as specified by the Reserve Bank. The additional
directors are protected from any liability or obligation for executing their
functions in good faith. The provisions of Section 36AB have overriding effect
over other laws.
2.10 RESTRICTIONS ON EMPLOYMENT
i. The Banking Regulation Act (Section 10) prohibits employment of managing
agents and imposes restrictions on employment of certain type of persons,
namely —
(a) a person who is or has been adjudicated insolvent or has suspended payment
or has compounded
with his/her creditors;
a nprtnn
\\\r 9 r*riminQl rrmrt r\f 'An
invnivina mortal
24
(c) a person whose remuneration or part thereof is by way of commission or
share in the profits
of the company;
(d) a person whose remuneration is excessive in the opinion of the Reserve
Bank. Before forming
an opinion regarding the remuneration, the Reserve Bank has to consider the
financial condition
and history of the banking company, its area of operation, resources, volume of
business and
the trend of its earning capacity, number of its branches, qualifications, age and
experience of
the person concerned, remuneration of other personnel in the bank or persons
holding similar
positions in other banks and the interest of depositors.
The above restrictions are applicable to workmen as well as management
personnel, as held by the Supreme Court in Central Bank of India vs Their
Workmen (AIR 1960 SC 12). However, the restriction on remuneration does not
affect payment of bonus according to a settlement or award or in accordance
with a scheme framed by the bank or in accordance with the prevailing practice
in banking business. Commission paid to brokers, auctioneers, forwarding
agents, etc., who are not regular members of the bank's staff, is also not covered
by these provisions.
ii. Persons who are directors of any company other than a subsidiary of a
banking company or company registered under Section 25 of the Companies Act
are also prohibited from managing a banking company. However, this
prohibition shall not apply to a director for a temporary period of three months,
or a further period not exceeding nine months, if allowed by the Reserve Bank.
Apart from this, persons engaged in any other, business or vocation or whose
term of office as a person managing the company is for a period exceeding five
years also fall in the prohibited category. However, the period of office can be
renewed or extended for further periods not exceeding five years at a time.
2.11 CONTROLS OVER MANAGEMENT
i. Power to remove Management and other personnel: The Reserve Bank is
empowered under Section 36AA of the Banking Regulation Act to remove any
chairman, director, chief executive officer (by whatever name called), or other
officer or employee of a banking company. For this purpose, the bank has to be
satisfied that it is necessary to do so. The bank (RBI) has the discretionary power
to remove management and other personnel in the following circumstances:
(a) Public interest
(b) Preventing the affairs of the banking company being conducted in a
manner detrimental to the
interest of depositors
(c) Securing proper management of the banking company.
The Reserve Bank has to pass such an order recording the reasons in writing.
Before passing the order, the affected person has to be given a reasonable
opportunity of making a representation against the proposed order. Where an
urgent action is required and delay would be against the interests of the company
or its depositors, the Reserve Bank is empowered to direct by order, at the time
of giving opportunity of making a representation that the person concerned shall
not act in his/her official capacity or directly or indirectly take part in the
management of the bank from the date of such order, pending consideration of
the representation. The person so removed shall not be entitled to any
compensation for loss of office notwithstanding anything contained in any law,
the memorandum, articles or any contract to the contrary as the provisions of
Section 36AA have overriding effect.
ii. Appeal: An appeal against the order of removal lies with the Central
Government. Such an appeal has to be filed within thirty days from the date of
communication of the order. The appellate decision of the Central Government,
and subject thereto the order of the Reserve Bank, shall be final and not liable to
challenge in any Civil Court.
25
iii. Effect of the order of removal: On the Reserve Bank passing a removal order,
the person concerned ceases to hold office which he/she was holding till then.
Further, he/she is prohibited, from directly or indirectly taking part in the
management of any banking company for a period not exceeding five years as
may be specified in the order. Contravention of the order is punishable with a
fine of Rs. 250 for each day during which the contravention continues.
iv. Appointment of a suitable person: When any chairman, director, chief
executive officer, other officer or employee is removed by the Reserve Bank
under Section 36AA as above, the Reserve Bank may appoint a suitable person
in his place. Such person shall hold office at the pleasure of the Reserve Bank.
Subject to this, the appointment may be for a period not exceeding three years
and is extendable for further periods not exceeding three years at a time. Such
appointee shall not incur any obligation or liability for action taken in good faith
in the execution of the duties of his office.
2.12 CORPORATE GOVERNANCE
i. The Concept: Corporate governance is a dynamic concept involving promotion
of corporate fairness, transparency and accountability in the interest of
shareholders, employees, customers and other stakeholders. It is a concept of
recent origin. However, there is considerable divergence in the understanding
and practice of corporate governance across different jurisdictions. The concept
has evolved since the first major study by the Cadbury Committee in 1992. The
DECO principles of corporate governance published in 1999, the first
international code of good corporate governance approved by governments, was
revised in 2004. Corporate governance can be seen as 'the way in which boards
oversee the running of a company by its managers, and how board members are
in turn accountable to shareholders and the company' and it has implications for
company behaviour towards employees, shareholders, customers, banks and
other stakeholders. Further, good corporate governance plays a vital role in
ensuring the integrity and efficiency of financial markets and the lack of it can
pave the way for financial difficulties and sometimes even fraud.
ii. OECD Principles of Corporate Governance, 2004: The OECD principles of
corporate governance, 2004 stipulate what the corporate governance framework
should ensure, which is briefly as under:
(a) Ensuring the basis for an effective corporate governance framework: To
promote transparent
and efficient markets which are consistent with the rule of law. Also, to
articulate clearly the
division of responsibilities among the different supervisory, regulatory and
enforcement
authorities.
(b) The rights of shareholders and key ownership functions: To protect and
facilitate the exercise
of shareholders' rights.
(c) The equitable treatment of shareholders: In the equitable treatment of
shareholders are included
the minority and foreign shareholders. Further, all shareholders should have the
opportunity to
obtain an effective redress for violation of their rights.
(d) The role of stakeholders in corporate governance: To recognise the
rights of stakeholders,
established by law or through mutual agreements and encourage active
cooperation between
the corporations and stakeholders in creating wealth, jobs, and the sustainability
of financially
sound enterprises.
(e) Disclosure and transparency: Timely and accurate disclosures made on
all material matters,
regarding the corporation, including the financial situation, performance,
ownership, and
governance of the company.
(f) The responsibilities of the board: Strategic guidance of the company,
effective monitoring of
management by the board and the board's accountability to the company and the
shareholders
are the important aspects. These principles are applicable to all types of
companies including
banks.
26
iii. Corporate Governance and Banks: Banks hold a special position in corporate
governance as they accept and deploy large amounts of public funds in fiduciary
capacity and also leverage such funds through credit creation. The position of
banks is also important for the smooth functioning of the payment system.
Accordingly, legal prescriptions for ownership and governance of banks laid
down in the statutes are supplemented by regulatory prescriptions. The Basel
Committee on Banking Supervision has issued guidance (February 2006) for
promoting the adoption of sound practices of corporate governance by banking
institutions. This guidance, entitled Enhancing Corporate Governance for
Banking Organisations, highlights the importance of:
• the roles of boards of directors (with a focus on the role of independent
directors) and senior
management
• effective management of conflicts of interest
• the roles of internal and external auditors, as well as internal control
functionaries
• governing in a transparent manner, especially where a bank operates in
jurisdictions, or through
structures, that may impede transparency
• the role of supervisors in promoting and assessing sound corporate
governance practices.(See,
http://www.bis.org/press/pO6O213.htni).
Apart from the fiduciary role of banks, their cross-border operations add a
special dimension. This provides an added impetus for convergence in standards
internationally. In almost all countries, the policy framework with regard to
corporate governance involves a multiplicity of agencies. In India, the
Department of Company Affairs, Securities and Exchange Board of India (in
respect of listed entities) are involved apart from the Reserve Bank in respect of
banks.
iv. Reserve Bank's approach: Following the formal policy announcement in
regard to corporate governance, in the mid term Review of the Monetary and
Credit Policy, in October, 2001, the Reserve bank constituted a Consultative
Group in November, 2001 under the chairmanship of Dr. A.S. Ganguly with a
view to strengthen the internal supervisory role of the boards of banks. The
report of the group was transmitted to all the banks for their consideration in
June, 2002 and simultaneously to the Government of India for consideration.
Earlier, an advisory group on corporate governance under the chairmanship of
Dr. R.H. Patil had submitted its report in March, 2001 which examined the
issues relating to corporate governance in banks in India, including the public
sector banks and made recommendations to bring the governance standards in
India on par with the best international standards. There were also some relevant
observations by the advisory group on banking supervision under the
chairmanship of Shri M.S. Verma which submitted its report in January, 2003.
Keeping all these recommendations in view and the cross-country experience,
the Reserve Bank initiated several measures to strengthen the corporate
governance in the Indian banking sector, including the concept of 'fit and proper'
criteria for directors of banks which included the process of collecting
information, exercising due diligence and constitution of a nomination
committee of the board to scrutinise the declarations made by the bank directors.
The RBI guidelines on ownership and governance in the private sector banks
released on February 28, 2005 (Paras 5 and 6) provide as under:
Shareholding
(i) The RBI guidelines on acknowledgement for acquisition or transfer of shares
issued on 3 February, 2004 will be applicable for any acquisition of shares of
five per cent and above of the paid-up capital of the private sector bank.
(ii) In the interest of diversified ownership of banks, the objective will be to
ensure that no single entity or group of related entities has shareholding or
control, directly or indirectly, in any bank in excess of ten per cent of the paid-up
capital of the private sector bank. Any higher level of
27
acquisition will be with the prior approval of RBI and in accordance with the
guidelines of 3 February, 2004 for grant of acknowledgement for acquisition of
shares.
(iii) Where ownership is that of a corporate entity, the objective will be to ensure
that no single individual/entity has ownership and control in excess of ten per
cent of that entity. Where the ownership is that of a financial entity the objective
will be to ensure that it is a well-established regulated entity, widely held,
publicly listed and enjoys good standing in the financial community.
(iv) Banks (including foreign banks having a branch presence in India)/FIs
should not acquire any fresh stake in a bank's equity shares, if by such
acquisition, the investing bank's/FI's holding exceeds five per cent of the
investee bank's equity capital as indicated in RBI circular dated 6 July, 2004.
(v) As per the existing policy, large industrial houses will be allowed to acquire,
by way of strategic investment, shares not exceeding ten per cent of the paid-up
capital of the bank, subject to RBI's prior approval. Furthermore, such a
limitation will also be considered, if appropriate, in regard to important
shareholders with other commercial affiliations.
(vi) In case of a restructuring of the problem/weak banks or in the interest of
consolidation in the banking sector, RBI may permit a higher level of
shareholding, including by a bank.
2.13 DIRECTORS AND CORPORATE GOVERNANCE
(i) The board of directors should ensure that the responsibilities of directors are
well defined and the banks should arrange need based training for the directors
in this regard. While the respective entities should perform the roles envisaged
for them, private sector banks will be required to ensure that the directors on
their boards representing specific sectors, as provided under the B.R. Act, are
indeed representatives of those sectors in a demonstrable fashion, they fulfil the
criteria under corporate governance norms provided by the Ganguly Committee
and they also fulfil the criteria applicable for determining 'fit and proper' status
of important shareholders (i.e., shareholding of five per cent and above) as laid
down in RBI circular dated 25 June, 2004.
(ii) As a matter of desirable practice, not more than one member of a family or a
close relative (as defined under Section 6 of the Companies Act, 1956) or an
associate (partner, employee, director, etc.) should be on the board of a bank.
(iii) Guidelines have been provided in respect of 'fit and proper' criteria for
directors of banks by the RBI circular dated 25 June, 2004 in accordance with
the recommendations of the Ganguly Committee on corporate governance. For
this purpose a declaration and undertaking is required from the
proposed/existing directors.
(iv) Being a director, the CEO should satisfy the requirements of the 'fit and
proper' criteria applicable for directors. In addition, RBI may apply any
additional requirements for the chairman and CEO. The banks will be required
to provide all information that may be required while making an application to
RBI for approval of appointment of chairman/CEO.
With regard to public sector banks, the principles of corporate governance have
been statutorily recognised as per Banking Companies (Acquisition and Transfer
of Undertakings) Financial Institutions Laws (Amendment) Act, 2006. The Act
as amended provides for shareholder directors to be a person having 'fit and
proper' status and the Reserve Bank has to notify the 'Fit and Proper' criteria
[Section 9(2)].
28
2.14 LET US SUM UP
A company wanting to commence banking business requires prior licence from
the Reserve Bank. The Reserve Bank has the discretion to reject licence or
approve the licence on such conditions as it thinks fit. Before granting licence,
Reserve Bank has to be satisfied by inspection or otherwise of the suitability of
the company for licence. A licence once given may also be cancelled after
giving the bank an opportunity to be heard. Further, for opening new branches or
shifting branches outside a city, town or village, permission of the Reserve Bank
is required. Banking companies have to have minimum capital and reserves as
specified in the Banking Regulation Act. The shareholders of a banking
company are entitled to dividends only after all the capitalised expenses are
written off. The commission or brokerage payable on selling shares is restricted
to two and half per cent of the paid-up value of the shares. The board of directors
of a bank has to be constituted with persons having special knowledge or
experience in accountancy, banking, economics, law, etc., as stipulated. The
directors should not have substantial interest in other companies or firms. The
maximum period of office is limited to eight years continuously. The Reserve
Bank is empowered to reconstitute the board, if the board is not properly
constituted. Every banking company should have a full-time chairman (or a full-
time managing director, if there is no full-time chairman) with the specified
qualifications. The Reserve Bank has powers to remove the chairman and
appoint a suitable person in his place in certain cases. The Reserve Bank also has
powers to remove the directors or managerial personnel or other employees of
banking companies. The principles of corporate governance including the 'fit
and proper' criteria for directors apply to banking companies as well as public
sector banks.
2.15 KEYWORDS
Additional Director; Authorised Capital; Overriding Provisions; Paid-up Capital;
Place of Business; Substantial Interest; Subscribed Capital; Subsidiary.
2.16 CHECK YOUR PROGRESS
1. Fill in the gaps choosing the answers from the brackets.
(i) A company has to obtain a from the Reserve Bank to commence banking
business
in terms of Section 22 of the BR Act. (registration; licence; commencement
certificate)
(ii) Shifting of a bank's branch in the same does not require Reserve
Bank's permission
arising out
under Section 23. (district; state, city, town or village) (iii) Foreign banks are
required under Section 11 of the BR Act to deposit
of their business in India with the Reserve Bank, (twenty per cent of profit for
each year; thirty
per cent of profit for each year; twenty per cent of the deposits collected each
year)
(iv) Banks may float subsidiaries for carrying on the business specified in
. (their
Memorandum of Association; Section 6(1 )(a) to (o) of the BR Act; their
Articles of Association)
(v) A shareholder of a banking company can exercise voting rights up to of the
total
voting rights of all shareholders, (one per cent; ten per cent; hundred per cent)
(vi) Banking companies are not permitted to give dividend until all are
written off.
(bad debts, expenses, capitalised expenses)
2.
Say whether True or False, (i) A temporary branch for less than thirty days in a
town where a bank has an existing branch
does not require permission from Reserve Bank. (ii) A company whose banking
licence is rejected can undertake business as a moneylender or
undertake other business, (iii) The decision of Reserve Bank to revoke licence is
final and no appeal lies from it.
29
(iv) Banking companies are permitted to give brokerage up to two-and-half per
cent of the paid-up
value of shares.
(v) No person can hold the shares of banks beyond ceiling specified under the
BR Act. (vi) A banking company cannot hold shares in any other company other
than a subsidiary.
3. Fill in the gaps choosing the answer from the brackets.
(i) A director of a banking company should not have in any other company,
(beneficial
interest, any interest, substantial interest)
(ii) At least of the directors should have the qualifications prescribed under
Section
10A(2) of the BR Act. (50 per cent, 75 per cent, 51 per cent) (iii) When the
board of a banking company is ordered to be reconstituted under Section 10A of
the
BR Act, directors will be removed for the purpose of reconstitution. (by
rotation,
by lots, by majority decision)
(iv) Before removing the chairman of a bank from office, Reserve Bank has to
. (give
compensation for loss of office, give opportunity of being heard, give an option
to continue as
director) (v) The provisions of Section 36AA of the BR Act regarding removal
of managerial personnel have
over other laws, (no effect, overriding effect, persuasive effect)
(vi) Reserve Bank is authorised to appoint under Section 36AB of the BR
Act. (directors,
additional directors, managing director)
(vii) The (Central Government; RBI; SEBI) has stipulated the 'fit and
proper' criteria
for directors of banking companies.
4. Say whether True or False.
(i) The maximum period of office that may be held continuously by an ordinary
director in a
banking company is eight years, (ii) The decisions of the board of directors,
during the period when the board's constitution is
defective shall be void.
(iii) The post of chairman of a banking company may be on part-time basis, (iv)
The chairman of a banking company can hold office only for a maximum period
of eight
years, (v) From the order removing chairman of a banking company, appeal lies
to the Central Government
within thirty days of the order. (vi) Reserve Bank has the power to remove any
officer or other staff of a banking company under
Section 36M of the BR Act.' (vii) The concept of 'fit and proper' criteria for
directors is not applicable to public sector banks.
2.17 ANSWERS TO CHECK YOUR PROGRESS'
1. (i) licence; (ii) same city, town or village; (iii) 20 per cent of profit for
each year; (iv) Section
6(l)(a) to (o) of BR Act; (v) 10 per cent; (vi) capitalised expenses.
2. (i) True; (ii) True; (iii) False; (iv) True; (v) False; (vi) False.
3. (i) substantial interest; (ii) 51 per cent; (iii) by lots; (iv) give opportunity
of being heard; (v) over¬
riding effect; (vi) additional directors; (vii) RBI
4. (i) True; (ii) False; (iii) True; (iv) False; (v) True; (vi) True; (vii) False
2.18 TERMINAL QUESTIONS
Fill in the gaps choosing answers from the brackets.
30
. (such conditions as the Central Government may specify; such
conditions as the
Reserve Bank may think fit to impose; confirmation by the Central
Government).
2. Reserve Bank is not empowered to cancel the licence granted to a
banking company on the
ground that . (the company ceases to carry on any of its business; the
company
changes its registered office from one state to another state; the company is not
in a position to pay its depositors in full as their claims accrue).
3. A bank requires permission of the Reserve Bank for opening a new
branch or shifting an existing
branch . (to any new location from where it is situated; otherwise than within
the
same city, town or village; otherwise than in the same building).
4. In addition to the requirements as to minimum capital and reserves
under Section 11 of the BR
Act, Reserve Bank . (cannot look into the capital structure of a banking
company;
has to satisfy itself under Section 22(3) of the BR Act as to adequacy of capital
structure and earning prospects; has to consult the Central Government as to the
adequacy of the capital structure of a banking company before licensing).
5. In the case of a banking company, a shareholder cannot exercise voting
rights on poll .
(in excess of ten per cent of the total voting rights of all the shareholders of the
company; in excess of two per cent of the total voting rights of all the
shareholders of the company; in excess of ten per cent of the total voting rights
of all the shareholders except with prior permission of the Reserve Bank).
Choose the correct statements from the following.
6. (i) There are no restrictions in the BR Act on payment of dividend by
banking companies,
(ii) Before payment of dividend by a banking company, all its capitalised
expenses, unless
specifically exempted under the BR Act, have to be completely written off. (iii)
Banking companies are not permitted to pay dividend above ten per cent of net
profits.
7. (i) There are no specific qualifications required for the directors of a
banking company.
(ii) At least fifty-one per cent of the directors of a banking company should
consist of persons
with professional or other experience as provided in the BR Act. (iii) At least
fifty-one per cent of the directors of a banking company should be chartered
accounts
or experts in finance.
8. (i) There is no provision for maintenance of reserves by a banking
company under the BR Act.
(ii) Every banking company has to maintain a reserve fund and transfer before
declaring dividend,
not less than twenty per cent of the profit to the reserve fund, (iii) The
maintenance of a reserve fund is optional for a bank.
9. (i) The chairman of a banking company has to be always on whole-time
basis and should be
entrusted with the management of the whole of the affairs of the banking
company, (ii) The chairman of a banking company can be on part-time basis and
a managing director can
be appointed on whole-time basis who shall be entrusted with the whole of the
affairs of the
banking company, (iii) The chairman of a banking company can be on part-time
basis and the whole of the affairs
of the banking company shall be entrusted to a committee of the board of
directors. 10. (i) A banking company can form subsidiaries for undertaking
any business approved by its
board of directors, (ii) A banking company can form subsidiaries for undertaking
any business mentioned in Section
6(1) (a) to (o) of the BR Act, which is permissible for a banking company to
undertake, (iii) A banking company does not require the permission of the
Reserve Bank to form a subsidiary
for doing banking business exclusively outside India.
UNIT
3
REGULATION OF BANKING BUSINESS
STRUCTURE
3.0 Objectives
3.1 Introduction
3.2 Power to Issue Directions
3.3 Acceptance of Deposits
3.4 Nomination
3.5 Loans and Advances
3.6 Regulation of Interest Rate
3.7 Regulation of Payment Systems
3.8 Internet Banking Guidelines
3.9 Regulation of Money Market Instruments
3.10 Banking Ombudsman
3.11 Reserve Funds
3.12 Maintenance of Cash Reserve
3.13 Maintenance of Liquid Assets
3.14 Assets in India
3.15 Let Us Sum Up
3.16 Keywords
3.17 Check Your Progress
3.18 Answers to 'Check Your Progress'
3.19 Terminal Questions
32
3.0 OBJECTIVES
The objectives of this unit are to understand the law, in particular the provisions
of the Banking Regulation Act, relating to:
• issue of directions by Reserve Bank to banks
• regulation of acceptance of deposits by banks
• regulation of loans and advances
• regulation of interest rates of banks on deposits and borrowing
• maintenance of reserve fund
• maintenance of cash reserve by scheduled banks and other banks
• maintenance of liquid assets
• maintenance of assets in India
3.1 INTRODUCTION
The Banking Regulation Act provides for regulation of the business activities of
banking companies. Accordingly, the Act empowers the Reserve Bank to issue
directions for regulating terms and conditions of making of loans and advances
and other matters including acceptance of deposits. The Banking Regulation Act
also imposes certain restrictions on loans and advances to the directors of
banking companies, and companies and firms in which they are interested. The
Act contains provisions for creation of a reserve fund and transfer of a
percentage of profits to that fund. There are also provisions for maintenance of
cash reserve, liquid assets and assets in India. In this unit, we look at the relevant
provisions of law in this regard.
3.2 POWER TO ISSUE DIRECTIONS
i. The Banking Regulation: Act authorises the Reserve Bank to issue directions
to banks under Sections 21 and 35Aof the Act. While Section 21 gives the power
to regulate advances by banking companies, Section 35A gives wide powers
generally to regulate banking companies. The Reserve Bank has been issuing
directions from time to time under Section 21 (read with Section 35A) regulating
rates of interest and other terms and conditions of acceptance of deposits and
making of loans and advances. Regulation of deposits and loans and advances
are discussed below (See, Paras 3.4 and 3.5, respectively).
ii. Nature of Directions: The directions issued by the Reserve Bank in exercise
of powers under Sections 21 and 35A of the BR Act, being statutory directions,
are binding on the banks. The circulars of the Reserve Bank giving instructions
to banks where it has statutory powers to give such instructions are also binding
on the banks, even if they do not specifically refer to any statutory provisions.
However, as held by the Supreme Court in State Bank of India vs. CIT (AIR
1986 SC 757), non-statutory circulars of the Reserve Bank cannot affect legal
rights. The Reserve Bank's powers to issue directions are over the banks. Hence,
the directions are addressed to banks only and not to customers or the public.
The effect of violation of Reserve Bank's directions/ instructions which are
binding on banks, has been considered by the Supreme Court in BOI Finance
Ltd. vs. The Custodian (AIR 1997 SC 1952) in the context of some banks
entering into certain repo transactions against the circulars of the Reserve Bank
prohibiting such transactions. The court found that the action of the banks
violated the Reserve Bank's instructions and held that the violations would not
invalidate the contracts with third parties but would render the banks liable to
prosecution. The effect of directions will be prospective and not retrospective in
the absence of any statutory provisions providing for retrospective operation of
directions.
33
iii. Bonafides: The powers of the Reserve Bank to issue directions have to be
exercised with bonafide intentions, as held by the Gujarat High Court in RBI vs
Harisidh Co-op. Bank Ltd. (AIR 1988 Guj 107). In that case the Court
considered the power of the Reserve Bank to issue directions for superseding the
board of a co-operative bank for securing its proper management and upheld the
action taken by the Reserve Bank on the finding that it was without mala fide.
iv. Caution and Advice: Apart from giving directions, the Reserve Bank may
also caution or give advice to banking companies. Section 36 of the Banking
Regulation Act provides that the Reserve Bank may caution or prohibit banking
companies generally or any banking company in particular against any
transaction or class of transactions. Further, the Reserve Bank may generally
give advice to any banking company.
3.3 ACCEPTANCE OF DEPOSITS
i. As discussed in unit I, the essence of banking business is the acceptance of
deposits from the public withdrawable by cheque. [See also the judgement of
Madras High Court in Sajjan Bank Pvt. Ltd. vs RBI (AIR 1961 Mad 8)]. The
definition of "banking" in Section 5(b) of the Banking Regulation Act
acknowledges this position.
ii. Types of Deposits: Banks accept different types of deposits, both time and
demand deposits, from the public. While time deposits, like fixed deposits or
recurring deposits are repayable after an agreed period, demand deposits, like
deposits in current account and savings bank accounts, are repayable on demand,
subject to the terms and conditions of the deposits. The period of the deposit and
rate of interest applicable to the deposit are matters to be agreed between the
depositor and the bank under the terms of the deposit, subject to any directions
given by the Reserve Bank in this regard.
iii. Regulation of acceptance of deposits: The Banking Regulation Act does not
contain any specific provisions for regulation of acceptance of deposits of banks.
However, Section 35 A which authorises the Reserve Bank to give directions is
wide enough to cover acceptance of deposits. Accordingly, acceptance of
deposits may be regulated in the public interest or in the interest of banking
policy or in the interests of depositors by issuing directions. The Reserve Bank
issues directions from time to time regulating the rates of interest applicable to
deposits. The directions may either fix the rates or specify the minimum and/or
maximum rate of interest on savings deposits and time deposits for various
periods as also for special categories of deposits like senior citizen, NRI
deposits. If only minimum and/or maximum rates are specified or no rates are
specified, the banks are free to decide their rates accordingly. The directions
issued by the Reserve Bank may also stipulate conditions regarding minimum or
maximum periods for which deposits may be accepted, reduction of interest
payable on premature withdrawal and payment of interest on renewal of overdue
deposits.
However, currently RBI prescribes the minimum and maximum period for
which deposits can be accepted and prescribes interest rates only in respect of
Savings Deposits and NRI deposits leaving others for the individual banks.
iv. Returns on unclaimed deposits: Banks have to file a return every year on their
unclaimed deposits under Section 26 of the Banking Regulation Act. The return
has to be filed within thirty days of the end of each calendar year in the form and
manner prescribed and should cover all deposits not operated for ten years. In
the case of fixed deposits the period of ten years starts from the expiry of the
period of the deposit.
34
3.4 NOMINATION
i. Repayment of Deposits: Section 45ZA of the Banking Regulation Act
provides that a depositor or depositors of a banking company (including co-
operative banks) may nominate one person in the prescribed manner as nominee
to whom the deposit may be returned in the event of death of the sole depositor
or depositors. Unless the nomination is varied or cancelled, the nominee is
entitled to all the rights of the depositor/s in the event of death of the depositor/s.
In the case of minor nominees, there is also a provision to appoint a person to
receive the deposit on behalf of the minor. Payment by a bank in accordance
with these provisions gives a valid discharge to the bank, but this does not affect
the right or claim a person may have against the nominee in respect of the
amount received by him. Rule 2 of the Banking Companies (Nomination) Rules,
1985 provides for the procedure and forms for making nomination in respect of
deposits with commercial banks. In the case of Co-operative banks, similar
provisions are incorporated in the Co-operative Banks (Nomination) Rules,
1985.
ii. Articles in Safe Custody and Safety Lockers: There are also provisions in the
Banking Regulation Act for nomination in respect of articles kept in safe
custody with banks and safety lockers. Sections 45ZC and 45ZE provide that
any person who leaves any article in safe custody and in safety lockers
respectively with a banking company, may nominate one person as nominee to
receive the article in the event of death of that person. The nomination has to be
in the prescribed manner and on return of articles kept in safe custody or
removal of contents of locker by nominees as provided, the bank gets a valid
discharge. Rules 3 and 4 of the Banking Companies (Nomination) Rules, 1985,
and also the Rules 3 and 4 of the Co-operative Banks (Nomination) Rules, 1985
deal with the form and procedure applicable to articles in safe custody and safety
lockers respectively in the case of banking companies and co-operative banks.
3.5 LOANS AND ADVANCES
i. The definition of 'banking' in Section 5(b) of the Banking Regulation Act
indicates that acceptance of deposits may be for lending or investment. Thus,
lending or making of loans and advances is a core business of a banking
company. Lending may be for short term or long term, on secured or unsecured
basis and for different purposes.
ii. Regulation of Loans and Advances
(a) The Reserve Bank is empowered under Section 21 of the Banking
Regulation Act to issue
directions to control advances by banking companies. Such directions may be
issued to banking
companies generally or to any particular banking company. The Reserve Bank
may determine
the policy in relation to advances and issue directions when it is satisfied that it
is necessary to
give directions:
(i) In public interest (ii) In the interests of depositors
(iii) In the interests of banking policy.
(b) The directions given by the Reserve Bank are binding on banking
companies, and may be on
one or more of the following matters:
(i) Purpose for which advances may or may not be made.
(ii) Margins, to be maintained in respect of secured advances.
(iii) Maximum amount of advances or other financial accommodation which
may be made to any company, firm, association of persons or individual. The
policy on these matters may be specified having regard to the paid-up capital,
reserves and deposits of the banking company and other relevant considerations.
35
(iv) Maximum amount up to which guarantees may be given by a banking
company on behalf of any company, firm, association of persons or individual.
In this case, also the paid-up capital, reserves, deposits and other relevant
considerations have to be taken into account for determining the maximum
amount.
(v) Rate of interest and other terms and conditions on which advances and other
financial accommodation may be made or guarantees may be given.
The Reserve Bank issues directions from time to time regulating the lending
operations of banking companies in exercise of these powers vested under
Section 21. Apart from this, the general powers to give directions under Section
35A are also available for regulation of loans and advances.
iii. Selective Credit Control
(a) Purpose: Banks have been traditionally financing trade and commerce
and against items they
deal in even before the country started industrializing. To ensure that prices of
essential
commodities like food grains, pulses, edible oils, sugar, jaggery and cotton and
textiles are not
increased by certain sections of the business community with a motive of profit
maximisation
by hoarding with the help of bank finance, these restrictions have been put in
place. These
cover the quantum of credit that can be extended and also the rate at which it can
be extended.
With self-sufficiency achieved by our country over the years in almost all of the
above, RBI
had taken them out of the purview of selective credit control and currently
restrictions are
there only in case of levy sugar.
(b) Methods and tools: Selective credit control seeks to influence the
demand for credit by
(i) making borrowing more costly for certain purposes which are considered
relatively inessen¬tial, or
(ii) by imposing stringent conditions on lending for such purposes, or (iii) by
giving concessions for certain desired types of activities.
The tools employed for exercising selective credit control are:
(i) minimum margins for lending against selected commodities; •
(ii) ceilings on the levels of credit; and
(iii) charging of minimum rate of interest on advances against specified
commodities.
The quantum and cost of credit are regulated by operating these tools of control.
iv. Price control: In India, selective credit control has been generally used for
preventing speculative hoarding of essential commodities and basic raw
materials using bank credit. This is with a view to check the undue rise of prices
of such sensitive commodities.
v. Restrictions on loans and advances: Section 20 of the Banking Regulation Act
imposes certain restrictions on loans and advances. Accordingly, no banking
company shall grant loans or advances on the security of its own shares. Further,
a banking company, is prohibited from entering into any commitment for
granting any loans or advances to or on behalf of any of its directors. The
prohibition also applies to loans and advances to:
(a) firms in which any director is interested as a partner, manager, employee
or guarantor, and
(b) any company (other than a company registered under Section 25 of the
Companies Act) in
which a director of the banking company holds substantial interest as defined in
Section 5(ne)
of the Act or of which he is director, manager, managing agent, employee or
guarantor.
If the director of a banking company is a partner or guarantor of any individual,
loans and advances to such individual are also barred. 'Director' includes a
member of any board for managing or
36
advising the bank regarding management of all or any of its affairs. It is open to
the Reserve Bank to specify any transaction as not being a loan or advance for
this purpose by a general or special order. In so doing the bank has to consider
the nature of the transaction, period, manner and circumstances in which the
amount is likely to be realised, the interest of depositors and other relevant
considerations. If there is any doubt or dispute as to whether a transaction is a
loan or advance, the decision of the Reserve Bank in the matter shall be final.
vi. Restrictions on power to remit debt: For remitting any debt to its directors, a
banking company requires prior permission of the Reserve Bank under Section
20A of the Banking Regulation Act. Permission is also required for remission of
loans to:
(a) any firm or company in which a director is interested as director,
partner, managing agent, or
(b) any individual for whom a director is partner or guarantor. Any
remission made in contravention
of Section 20 is void and will have no effect.
3.6 REGULATION OF INTEREST RATE
The Reserve Bank is authorised to regulate interest rates under Section 21 (read
with Section 35A) of the Banking Regulation Act. This includes rates of interest
for loans and advances as well as deposits. While giving directions on interest
rates, there should not be any discrimination against any class of depositors or
loanees or banks. Any differential treatment should be justifiable in law as not
being against the principles of equality. In Harjit Singh vs Union of India (AIR
1994 SC 1433), the Supreme Court held in the context of reduction of rate of
interest on bank loans to riot victims that the concession should be extended to
loanees from financial institutions also, as there was no basis for discrimination
between loanees from banks and loanees from financial institutions.
i. Interest on deposits: The rates of interest on deposits were not regulated by the
Reserve Bank until 1964. Hence, it was open to the banks to decide their deposit
rates freely. Thereafter the Reserve Bank has been issuing directions from time
to time regulating rates of interest applicable to different types of deposits.
Accordingly, payment of interest on current account was prohibited. As the
directions are issued by virtue of the powers vested in the Reserve Bank under
Section 35A of the Banking Regulation Act, before issuing the directions the
Bank has to be satisfied that the directions are necessary in public interest or in
the interest of depositors or of banking policy. Reserve Bank may permit higher
rate of interest in favour of certain categories of depositors like former/existing
employees or depositors of certain classes of banks like co-operative banks. Of
late, the movement has been in the direction of liberalisation of interest rates,
thereby giving increased freedom to banks to decide the rates themselves.
ii. Interest rate on loans and advances: Interest rate on loans and advances is
subject to regulation specifically under Section 21(2)(e) of the Banking
Regulation Act apart from the general provisions of Section 35A. The Reserve
Bank has been issuing directions from time to time under Section 21 (read with
Section 35A) of the Act regulating different aspects of lending including lending
rates. Accordingly, different rates are permissible for different sectors like small-
scale industries, agriculture, large-scale industries, etc., and of late, much
freedom has been given to banks to decide the rates themselves. Further, the rate
of interest may vary on the basis of the period of the loan. The Reserve Bank
tightens the regulations or gives relaxations thereby permitting banks to decide
the rates on their own, depending on the position of money supply in the public
interest or in the interest of depositors or of banking policy. Currently the
directions of RBI regarding interest rates of advances cover only finance to
exporters and small loans with limits up to Rs 2 lac and DRI loans.
37
iii. Usurious loans Act, 1918: The Usurious Loans Act, 1918 prohibits lending at
exorbitant rates. The law has been made to protect the weaker borrowers from
the powerful moneylenders. Similarly, debt relief legislation in different states
attempts to protect the agriculturists and other weaker sections from
unscrupulous lenders, by remitting debts or giving other concessions. Although
the lending rates of banks are regulated by the Reserve Bank, borrowers often
used to resort to these laws for remitting loans or reducing rates of interest in
respect of loans taken by them from banks. This was coming in the way of the
monetary policy decided by the central bank. Accordingly, Section 21A was
inserted in the Banking Regulation Act to make the rates of interest charged by
banking companies beyond the scrutiny of courts.
iv. Protection to interest rate: Section 21A of the Banking Regulation Act
provides that a transaction between a banking company and its debtor cannot be
reopened by any court on the ground that the rate of interest charged is
excessive. This provision is given an overriding effect over the provisions of the
Usurious Loans Act, 1918 or any other law relating to indebtedness in force in
any state.
Section 21A was held to be valid and not ultra vires the Constitution by the
Supreme Court. In Corporation Bank vs D. S. Gowda [(1994) 5 SCC 213], the
Supreme Court held that banks can compound interest on annual rates and not
half yearly rates in view of the express directives of the Reserve Bank. The court
further held that where the Reserve Bank fixes both minimum and maximum
rates of interest, courts would not interfere in the matter of interest rate, if the
rate charged by the bank is not in violation of the Reserve Bank directive.
However, the court did not express any opinion on the question whether Section
21A would debar the courts from interfering if the circulars or directives of the
Reserve Bank do not fix the maximum and leave it to the discretion of the banks
to fix the rate above the minimum.
3.7 REGULATION OF PAYMENT SYSTEMS
The Reserve Bank of India Act, until recently, did not contain any provision for
regulation of payment systems. Section 58 empowers the Bank to make
regulations for giving effect to the provisions of the Act and Clause (g) of the
sub-Section (2) thereof, provides for making provisions for regulation of
clearing houses for the banks including post office saving banks. (The clearing
houses are now functioning under the uniform clearing house rules and
regulations framed by the mutual consent of members and no statutory rules or
regulations have been framed.) However, the regulation of payment systems has
become important in the context of electronic payment systems becoming
popular and the probability of complications in the absence of a suitable
regulatory framework with statutory backing. In the absence of specific powers
under the Act, the Bank has not been able to frame any regulations relating to
payment systems. Hence, the Information Technology Act, 2000 has amended
the Reserve Bank of India Act, inserting the Clause (pp) in Section 58 (2)
empowering the Reserve Bank to frame regulations for payment systems of
banks and financial institutions. Financial institution for this purpose will have
the same meaning as provided in the Clause (c) of Section 45 of the Reserve
Bank of India Act. Accordingly, the Central Board of the Reserve Bank has
framed the Reserve Bank of India (Board for Regulation and Supervision of
Payment and Settlement Systems) Regulations, 2005. Further, RBI is in the
process of finalising the guidelines under the Payment and Settlement Systems
Act, 2007.
i. Board for regulation and supervision of Payment and Settlement Systems: The
Reserve Bank, in terms of the RBI (Board for Regulation and Supervision of
Payment and Settlement Systems) Regulations, 2005, has constituted a Board for
Regulation and Supervision of Payment and Settlement Systems (BPSS) as a
committee of its Central board. The Board has the Governor of the Bank as its
chairman and its functions include prescribing policies relating to the regulation
and supervision of all types of payment and settlement systems, setting standards
for existing and future systems,
38
authorising the payment and settlement systems, determining criteria for
membership to these systems including continuation, termination and rejection
of membership.
3.8 INTERNET BANKING GUIDELINES
The Reserve Bank has issued guidelines in respect of internet banking. These
guidelines cover:
(i) technology and security issues; (ii) legal issues;
(iii) regulatory and supervisory issues.
These guidelines apply, in addition to Internet banking, to other forms of
electronic banking to the extent relevant. All banks offering internet banking
have to make a review of their systems in the light of these guidelines and report
to the Reserve Bank the types of services offered, extent of their compliance
with the recommendations, deviations, if any and their proposal indicating a
timeframe for compliance.
3.9 REGULATION OF MONEY MARKET INSTRUMENTS
The Reserve Bank of India (Amendment) Act, 2006 (Section 45W) empowers
the Bank, in public interest or to regulate the financial system of the country to
its advantage, to determine the policy relating to interest rates or interest rate
products and give directions in that behalf to all agencies or any of them, dealing
in securities, money market instruments, foreign exchange, derivatives, or other
instruments of like nature as the Bank may specify from time to time. Further,
the Bank may, for the purpose of enabling it to regulate these agencies call for
any information, statement or other particulars from them, or cause an inspection
of such agencies to be made. However, the directions issued by the Bank in this
behalf shall not relate to the procedure for execution or settlement of the trades
in respect of the transactions on the recognised Stock Exchanges. Every director
or member or other body for the time being vested with the management of the
affairs of the agencies falling under Section 45 W has to comply with the
directions given by the Reserve Bank and submit the information or statement or
particulars as required.
3.10 BANKING OMBUDSMAN
Ombudsman is generally an authority (official) appointed to receive and
investigate on the public grievances against the Government or any other
authority or institution or organisation and redress such grievances as a non-
adversarial adjudicator, or an alternative to the adversary system for resolution
of disputes. The position is that of an independent and non-partisan officer who
deals with specific complaints from the public against administrative injustice
and maladministration. The banking ombudsman is an authority originally
established under the Banking Ombudsman Scheme, 1995 by the Reserve Bank
of India in exercise of the powers vested in it under Section 35A of the Banking
Regulation Act. The scheme aimed at resolution and settlement of complaints of
the banking public against the commercial banks (excluding RRBs) and the
scheduled primary co-operative banks without resorting to courts. It was
modified by the Banking Ombudsman Scheme, 2002 and later by the Banking
Ombudsman Scheme, 2006 to enlarge the extent and scope of the authority and
functions of banking ombudsman for 'redressal of grievances against deficiency
in banking services, concerning loans and advances and other specified matters'.
All commercial banks, regional rural banks and scheduled primary co-operative
banks are required to comply with the modified scheme.
1. Object of the scheme: The object of the scheme is to enable resolution of
complaints relating to
specified services rendered by the banks and to facilitate the satisfaction or
settlement of such
complaints.
2. Grounds of complaint: The grounds on which complaints may be made
to the banking ombudsman
are:
39
3.
(i) Deficiency in banking or other services in respect of:
(a) non-payment or inordinate delay in the payment or collection of
cheques, drafts, bills, etc.;
(b) non-acceptance, without sufficient cause, of small denomination notes
tendered for any
purpose, and for charging of commission in respect thereof;
(c) non-acceptance, without sufficient cause, of coins tendered and for
charging of commission
in respect thereof;
(d) non-payment or delay in payment of inward remittances;
(e) failure to issue or delay in issue of drafts, pay orders or bankers'
cheques;
(f) non-adherence to prescribed working hours;
(g) failure to honour guarantee or letter of credit commitments;
(h) failure to provide or delay in providing a banking facility (other than loans
and advances)
promised in writing by a bank or its direct selling agents;
(i) delays, non-credit of proceeds to parties' accounts, non-payment of deposit or
non-observance of the Reserve Bank directives, if any, applicable to rate of
interest on deposits
in any savings, current or other account maintained with a bank; (j) delays in
receipt of export proceeds, handling of export bills, collection of bills, etc., for
exporters provided the said complaints pertain to the bank's operations in India;
(k) complaints from Non Resident Indians having accounts in India in relation to
their remittances
from abroad, deposits and other bank-related matters; (1) refusal to open deposit
accounts without any valid reason; (m) levying of charges without adequate
prior notice to the customer; (n) non-adherence by the bank or its subsidiaries to
the instructions of Reserve Bank on ATM/
Debit card operations or credit card operations; (o) non-disbursement or delay in
disbursement of pension (to the extent the grievance can be
attributed to the action on the part of the bank concerned, but not with regard to
its
employees); (p) refusal to accept or delay in accepting payment towards taxes, as
required by Reserve
Bank/Government; (q) refusal to issue or delay in issuing, or failure to service or
delay in servicing or redemption
of Government securities;
(r) forced closure of deposit accounts without due notice or without sufficient
reason; (s) refusal to close or delay in closing the accounts; (t) non-adherence to
the fair practices code as adopted by the bank; (u) any other matter relating to
the violation of the directives issued by the Reserve Bank in
relation to banking services.
(ii) Deficiency in banking service in respect of loans and advances pertaining to:
(a) non-observance of Reserve Bank Directives on interest rates;
(b) delays in sanction, disbursement or non-observance of prescribed time
schedule for disposal
of loan applications but not declining credit;
(c) non-acceptance of application for loans without furnishing valid reasons
to the applicant;
(d) non-observance of any other direction or instruction of the Reserve
Bank as may be
specified by the Reserve Bank for this purpose from time to time;
(iii) Such other matters as may be specified by the Reserve Bank from time to
time in this behalf.
Jurisdiction and Procedure: The location and the territorial jurisdiction of the
ombudsman are as specified by the Reserve Bank. A complaint may be made in
writing by a person himself or through an authorised representative. No
complaint to the banking ombudsman shall lie unless,
40
(a) the complainant had, before making a complaint to the banking
ombudsman, made a written
representation to the concerned bank and the bank had rejected the complaint or
the complainant
had not received any reply within a period of one month after the bank received
his representation
or the complainant is not satisfied with the reply given to him by the bank;
(b) the complaint is made not later than one year after the complainant has
received the reply of the
bank to his representation or, where no reply is received, not later than one year
and one month
after the date of the representation to the bank;
(c) the complaint is not in respect of the same subject matter which was
settled or dealt with on
merits by any previous banking ombudsman proceedings whether or not
received from the
same complainant or along with one or more complainants or one or more of the
parties
concerned with the subject matter;
(d) the complaint does not pertain to the same subject matter for which any
proceedings before
any court, tribunal or arbitrator or any other forum is pending or a decree or
award or order
has been passed by any such court, tribunal, arbitrator or forum;
(e) the complaint is not frivolous or vexatious in nature;
(f) the complaint is made before the expiry of the period of limitation
prescribed under the Indian
Limitation Act, 1963 for such claims.
The Supreme Court has in a recent case, M/s Durga Hotel Complex vs. Reserve
Bank of India and Ors. [Appeal (civil) 1389 of 2007], observed that a banking
ombudsman, though might have initially jurisdiction to entertain a complaint on
the basis that it has a legal foundation, in terms of the scheme, he may be
divested of that jurisdiction, or the foundation in law might be lost, on either of
the parties, approaching the Court, the arbitrator or the debts recovery tribunal in
respect of the same subject matter. This is on the basis that the complaint must
continue to have a foundation in law at the time the ombudsman takes up the
claim for his consideration and renders his decision or award and that foundation
would be lost when the complaint is taken to a Court, Arbitrator, Tribunal or any
other competent forum. The ombudsman being an authority or tribunal of
limited jurisdiction conferred by the scheme, the exercise of jurisdiction or
power by the ombudsman would depend on his having jurisdiction, not only to
entertain a claim but also to end it. Accordingly, once he/she is deprived of his
jurisdiction or gets deprived of his jurisdiction over the subject matter, he/she
could no more proceed with a complaint which was earlier filed and therefore, a
complaint goes out of his/her purview when the subject matter of it is taken to a
court, arbitrator, tribunal or forum. Moreover, the relief that can be granted by
the ombudsman may not conflict with a more comprehensive adjudication by a
court, arbitrator, tribunal or forum with wider powers.
In short, when the ombudsman is about to pronounce his award, he finds that the
subject matter of the dispute has been taken to the debts recovery tribunal or a
civil court or an arbitrator or to any other competent forum, the ombudsman will
have to decline jurisdiction to pass any order or award on the complaint to bring
about a resolution of the complaint by way of a non adversarial adjudication.
The ombudsman may call for information from the bank concerned and make
endeavour to promote a settlement with the bank. The ombudsman is free to
follow the procedure considered appropriate. Where a complaint is not settled by
agreement within a period of one month from the date,of receipt of the
complaint or such further period as the banking ombudsman may consider
necessary, he may pass an award after affording the parties reasonable
opportunity to present their case. He shall be guided by the evidence placed
before him by the parties, the principles of banking law and practice, directions,
instructions and guidelines issued by the Reserve Bank from time to time and
such other factors which in his/her opinion are necessary in the interest of
justice. An award shall not be binding on a bank against which it is passed
unless the complainant furnishes a letter of
41
acceptance of the award in full and final settlement of his claim within a period
of fifteen days from the date of receipt of copy of the award. If the complainant
fails to furnish his/her letter of acceptance within this time or within extended
time of fifteen days, the award will lapse. However, on a written request for
extension of time, the banking ombudsman may grant extension of time up to a
further period of fifteen days for such compliance. Within one month from the
date of receipt by the bank of the acceptance in writing of the award by the
complainant (or within such time not exceeding a period of fifteen days that may
be granted by the banking ombudsman), the bank has to comply with the award.
However, if the bank or the complainant is aggrieved by the award, it/ he can
make an appeal to the appellate authority (Deputy Governor, Reserve Bank)
under the scheme.
4. Banking Ombudsman and Reserve Bank Directions: The legal position
of banking ombudsman vis¬
a-vis the Reserve Bank has been considered by the Supreme Court in Canara
Bank vs P.R.N.
Upadhyaya (AIR 1998 SC 3000). The court observed that since an ombudsman
is appointed by
virtue of the scheme framed under S 35A of the Banking Regulation Act, 1949,
he/she is obliged to
comply with the directions/circulars and notifications issued by the Reserve
Bank under Section
35A or 21 of the Act. He/She is also required to issue directions to banks based
on the Reserve
Bank directions/circulars and ensure their compliance. The ombudsman cannot
ignore these circulars
and directions while dealing with the complaints filed by customers of banks.
The impugned award
having been made, ignoring various circulars/directions issued by the Reserve
Bank, the same was
held to be not sustainable. The court, therefore, set aside the impugned award
and remitted the
complaint to the ombudsman for its fresh disposal in the light of the
circulars/directions issued by
the Reserve Bank with regard to charging of rate of interest from the landlord
loanees, whose
buildings were taken on lease/rent by the concerned bank and calculating the
interest rate at quarterly
rests.
5. Banking Ombudsman and Debt Recovery Tribunals: As regards the
position of banking ombudsman
vis-a-vis the debt recovery tribunal, the Allahabad High Court in M/s Hindustan
Ferro and Industries
Ltd. vs Debt Recovery Tribunal (AIR 2001 All 155) observed that while the
object of the scheme
is to enable resolution of complaints relating to provision of banking services
and the satisfaction
or settlement of such complaints, the purpose of the Act is to provide for the
establishment of
tribunals for expeditious adjudication and recovery of debts due to banks and
financial institutions
and for matters connected therewith or incidental thereto. The procedure
prevailing prior to the
enactment of the Act for recovery of debts due to the banks and financial
institutions has blocked
a significant portion of their funds in unproductive assets, the value of which
deteriorated with the
passage of time. It was for this compelling reason and to obviate the difficulties
in recovering debts
due to the banks and financial Institutions that the Act was enacted. The scheme
has nothing to do
with the proceedings of recovery of debts due to the banks and financial
institutions. The scheme
formulated by the Reserve Bank under the Banking Regulation Act, 1949 cannot
override the
provisions of the Act.
3.11 RESERVE FUNDS
i. Creation of Reserve Fund: Every banking company incorporated in India has
to create a reserve fund under Section 17(1) of the BR Act out of the profits as
shown in the profits and loss account prepared under Section 29 of the Act.
Every year, a sum equivalent to not less than twenty per cent of such profits has
to be transferred to the reserve fund. Such transfer of profits to reserve fund has
to be made before any dividend is declared.
ii. Exemption from Contribution: If any banking company has an adequate paid-
up capital and reserves
42
in relation to its deposit liabilities, the Reserve Bank may recommend to the
Government of India for exemption from the requirement of transfer of profits to
reserve fund. Thereupon, the Government may pass an order in writing,
exempting the banking company from Section 17(1) for such period as may be
specified in the order. No such order shall be made unless the amount already in
the reserve fund together with the amount in the share premium account is not
less than the paid-up capital of the banking company.
iii. Appropriation from Reserve Fund/Share Premium Account: Appropriation of
any amount from the reserve fund or the share premium account has to be
reported to the Reserve Bank within twenty-one days of such appropriation. The
banking company has also to explain the circumstances in which such
appropriation was made. It is open to the Reserve Bank in any particular case to
extend the period for submitting the report or to condone the delay in making the
report.
iv. Foreign Banks: The provisions of Section 17(1) of the Banking Regulation
Act for creating a reserve fund do not apply to foreign banks operating in India.
In their case, instead of creating a reserve fund under Section 17(1), Section
11(2) of the Act requires them to deposit and keep deposited with the Reserve
Bank an amount calculated at twenty per cent of the profit for each year in
respect of all the business transacted through their branches in India. The amount
may be deposited in cash or unencumbered approved securities or partly in cash
and partly in unencumbered approved securities. Section 11 (2A) also provides
for exemption by Central Government on the recommendation of the Reserve
Bank, where the deposits already made are considered adequate in relation to the
deposit liabilities of the banking company.
3.12 MAINTENANCE OF CASH RESERVE
Every banking company which is a scheduled bank has a duty to maintain
certain cash reserve with the Reserve Bank under Section 42 of the Reserve
Bank of India Act. In the case of non-scheduled banks, Section 18 of the
Banking Regulation Act provides for the maintenance of cash reserve.
i. Scheduled Banks: A scheduled bank is a bank included in the second schedule
of the Reserve Bank of India Act. Under Section 42(6) of the Act, the Reserve
Bank may include any bank in the second schedule if it satisfies the following
requirements -
(a) it has a paid-up capital and reserves of an aggregate value of not less
than Rs. 5 lac;
(b) it satisfies the Reserve Bank that its affairs are not conducted in a
manner detrimental to the
interests of depositors;
(c) it is:
(i) a state co-operative bank, or
(ii) a company as defined in Section 3 of the Companies Act, or
(iii) an institution notified by the Central Government in this behalf, or
(iv) a corporation or a company incorporated outside India under the foreign
laws.
Thus, a banking company which has the requisite capital and reserves of Rs. 5
lac and the affairs of which are not conducted in a manner detrimental to the
interests of depositors is eligible to be included in the second schedule. The
Reserve Bank, may exclude any bank from the second schedule, if the aggregate
value of its paid-up capital falls below Rs. 5 lac, or its affairs are found to be
conducted in a manner detrimental to the interests of depositors on an inspection
under Section 35 of the Banking Regulation Act, or if it goes into liquidation, or
otherwise ceases to carry on banking business.
ii. Quantum of Cash Reserve: The cash reserve required to be maintained by a
scheduled bank with the Reserve Bank under Section 42(1) of the Reserve Bank
of India Act (as amended in 2006) is an
43
average daily balance, being 'such per cent of the total of the demand and time
liabilities in India of that bank as shown in the return referred to in the sub-
Section (2), as the Reserve Bank may from time to time, having regard to the
needs of securing the monetary stability in the country, notify in the Gazette of
India'. Thus, under the amended statute, the Reserve Bank can, in order to secure
monetary stability in the country, determine the CRR for scheduled banks
without any ceiling or floor rate (as against a statutory minimum of three per
cent earlier). 'Average daily balance' for this purpose means the average of the
balances held at the close of business of each day for a fortnight. The liabilities,
for this purpose do not include paid-up capital and reserves and any credit
balance in the profit and loss account.
Further, the amounts borrowed from the Reserve Bank, IDBI, Exim Bank, IIBI,
National Housing Bank and National Bank for Agriculture and Rural
Development, are also excluded. Apart from this, in case of a scheduled bank,
other than a state co-operative bank, the aggregate of liabilities of the scheduled
bank to the State Bank, subsidiary banks, Nationalised banks, banking
companies, co¬operative banks and any financial institutions notified by the
Government in this behalf, shall be reduced by the aggregate of liabilities of
these banks and institutions to that scheduled bank. Further, the Reserve Bank is
empowered under the sub-Section (1C) of Section 42 to specify, from time to
time whether any transaction shall be regarded as liability in India of a scheduled
bank.
iii. Interest: Until the amendment to the RBI Act in 2006, the Reserve Bank was
authorised under the Act [Section 42(1 B)] to pay interest to a scheduled bank
when it maintained reserves above the statutory minimum as required under the
Reserve Bank's notification under the erstwhile proviso to the sub-Section (1) or
under the sub-Section (1A) of Section 42. As the sub-Section (IB) providing for
interest has been omitted now, the Reserve Bank cannot pay interest on any
portion of the CRR balances of banks.
iv. Returns: Every scheduled bank has to submit a return to the Reserve Bank
showing its demand and time liabilities and borrowings from banks in India,
classifying them into demand and time liabilities and giving other details
required under Section 42(2) of the Reserve Bank of India Act. The return has to
be as at the close of business on each alternate Friday and has to be sent not later
than seven days after the date to which it relates. In some cases, it may be
impracticable to furnish fortnightly returns by reason of the geographical
position of the banks and its branches. If so, the Reserve Bank may permit
presentation of a provisional return fortnightly, to be followed by a final return
within twenty days after the date to which it relates. Alternatively, such a bank
may be permitted to file a monthly return within twenty days after the end of the
month. In addition to the above, where the last Friday of the month is not an
alternate Friday for the purpose of return, a special return as at the close of
business on that day has to be submitted within seven days. Where the relevant
Friday is a holiday under the Negotiable Instruments Act, the return has to be
prepared as at the close of the preceding working day.
v. Penalties: When the balance maintained by any scheduled bank falls below
the stipulated minimum, such a bank shall be liable to pay a penal interest to the
Reserve Bank. During the first fortnight, when such shortage occurs, the penal
interest shall be three per cent above the bank rate and if the shortage continues
in the next fortnight, the penal interest shall increase to five per cent above the
bank rate. Where the shortfall still persists in the third fortnight, every director,
manager or secretary of the bank who is a wilful party thereto shall be
punishable with a fine. In that case, the Reserve Bank may also prohibit the bank
from accepting fresh deposits. Contravention of the order of prohibition is also
punishable with a fine. Failure to file the return as required, also attracts a
penalty under Section 45(4) of the Act. Where Reserve Bank is satisfied that a
bank had sufficient reason for committing the default, either in maintaining
reserves or in filing return, the penalty may be
44
waived. When penalty is imposed for a default, the amount has to be paid within
fourteen days of the notice demanding payment. On failure to pay accordingly,
Reserve Bank may obtain a direction from the Principal Civil Court for levying
the penalty and obtain a certificate for the amount which may be enforced like a
decree of a civil court.
vi. Cash Reserves of Non-Scheduled Banks: In the case of banking companies,
which are not scheduled banks under Section 18 of the Banking Regulation Act,
the cash reserve need not be maintained with the Reserve Bank. It may be with
the bank itself, or in a current account with the Reserve Bank or by way of net
balance in current accounts or in one or more of these ways. The balance
maintained should not be less than three per cent of the demand and time
liabilities as on the last Friday of the second preceding fortnight. The bank has
also to submit a return to the Reserve Bank before the twentieth day of every
month showing the amount so held on alternate Fridays during the month, along
with particulars of its demand and time liabilities in India on such Fridays. If the
Fridays concerned fall on holidays under the Negotiable Instruments Act, the
returns have to be filed as on the preceding working day.
3.13 MAINTENANCE OF LIQUID ASSETS
Every banking company has a duty to maintain a certain percentage of their
assets in India under Section 24 of the Banking Regulation Act in the form and
manner specified by the Reserve Bank by notification in the official gazette.
Recently, the Banking Regulation (Amendment) Ordinance, 2007 amended the
provisions of Section 24, omitting the sub-Sections (1) and (2) of Section 24
which provided for a statutory minimum requirement of 25 per cent. Under the
sub-Section (2A), as modified by the Ordinance, a scheduled bank, in addition to
the average daily balance which it is, or may be required to maintain under
Section 42 of the Reserve Bank of India Act, 1934 shall maintain in India,
assets, the value of which shall not be less than such percentage not exceeding
40 per cent of the total of its demand and time liabilities in India as on the last
Friday of the second preceding fortnight. Banking companies other than
scheduled banks have also to maintain such assets in addition to the cash
reserve, which they are required to maintain under Section 18 of the BR Act.
i. Returns: For ensuring compliance with the above provisions, a monthly return
has to be submitted to the Reserve Bank by every banking company. The return
has to be submitted not later than twenty days from the end of the month to
which it relates, in the prescribed form and manner and giving particulars of
assets and demand and time liabilities at the close of business of each alternate
Friday. If such a Friday is a public holiday, the return has to be prepared as at the
close of the preceding working day. Without prejudice to the above, the Reserve
Bank is also empowered to require a banking company to furnish a return
showing particulars of the assets and demand and time liabilities as at the close
of each day of a month.
ii. Penalty for Default: If the balance on any alternate Friday (or the preceding
working day, when such Friday is a holiday) falls below the minimum
requirement, the banking company is liable to pay to the Reserve Bank penal
interest at the rate of three per cent above bank rate on the shortfall for the day.
If the default recurs on the succeeding alternate Friday, the penal interest is
raised to five per cent above the bank rate on the shortfall. If the default occurs
on the next succeeding Friday, then every director, manager and secretary of the
banking company is punishable with a fine. The Reserve Bank is also
empowered to impose a similar penal interest for shortfall in the assets on any
day and if shortfall continues on the succeeding working day, the higher penal
interest is payable as above. If the Reserve Bank is satisfied on the application of
a banking company that it had sufficient cause not to comply with the provisions
as to maintenance of assets, penal interest may be waived.
45
3.14 ASSETS IN INDIA
i. Quarterly position of assets: Every banking company has to maintain in India
certain amount of assets as required under Section 25 of the Banking Regulation
Act. Accordingly, at the close of business on the last Friday of every quarter,
such assets shall not be less than seventy five per cent of the demand and time
liabilities of the banking company in India. If the last Friday is a holiday under
the Negotiable Instruments Act, the assets are based upon as at the close of
business on the preceding working day. 'Quarter' for this purpose means the
period of three months ending on the last day of March, June, September and
December. This provision is meant to ensure that the resources mobilised by
banks operating in India, especially the foreign banks, are largely invested
within the country. The assets may be in cash, gold or unencumbered approved
securities. 'Assets in India' also include export bills drawn in and import bills
drawn on and payable in India and expressed in currencies approved by the
Reserve Bank for this purpose. Such bills and securities approved by the Reserve
Bank in this behalf are treated as assets in India even if these assets were held
outside India. The paid-up capital, reserves and any credit balance in the profit
and loss account of a banking company shall not be treated as 'liabilities in India'
for this purpose.
ii. Returns: A return regarding the assets maintained in India under Section 25(1)
of the Banking Regulation Act has to be submitted to the Reserve Bank within
one month from the end of every quarter. Such return has to be filed in the form
and manner prescribed by the rules made under the Act.
3.15 LET US SUM UP
i. The Banking Regulation Act empowers the Reserve Bank to issue directions to
banking companies in public interest, in the interest of banking policy and in the
interest of depositors. Section 21 provides for the issue of directions to regulate
loans and advances by banking companies. This may be done by regulating the
purposes of lending, margins in respect of secured loans, rate of interest and
terms and conditions of lending. Section 35A gives wide general powers to issue
directions. The Reserve Bank issues directions from time to time under Section
21 (read with Section 35 A) regulating acceptance of deposits and lending.
Under Section 21A of the Act, the rate of interest on loans and advances
contracted between a bank and its customer is not liable to be reopened by a
court of law. Section 20 of the Act imposes restrictions on loans and advances to
directors, and companies and firms in which directors are interested as director,
partner, etc.
ii. A banking company which is a scheduled bank has to maintain a certain
percentage of the time and demand liabilities as cash reserve with the Reserve
Bank under Section 42 of the Reserve Bank of India Act, as notified by the
Reserve Bank from time to time. Failure to do so renders the banking company
liable to penalty. For non-scheduled banking companies, Section 18 of the BR
Act provides for cash reserve. Banking companies have also to maintain a
certain percentage of their demand and time liabilities in liquid assets as
stipulated under Section 24 of the BR Act. These assets may be maintained to
the extent and in the form and manner as notified by the Reserve Bank. Apart
from this, banking companies are required to maintain such assets in India at not
less than seventy five per cent of demand and time liabilities as at the close of
business of the last Friday of every quarter. Banking companies also have to
transfer to the reserve fund twenty per cent of their annual profits as disclosed in
the profit and loss account.
3.16 KEYWORDS
Bank Rate; Demand Liabilities; Scheduled Bank; Selective Credit Control; Time
Liabilities; Usurious Loans.
46
3.17 CHECK YOUR PROGRESS
1. Fill in the gaps choosing the answers from the brackets.
(i) Reserve Bank may issue directions to banking companies under Section 21 of
BR Act on
. (audit, loans and advances, capital structure)
(ii) may regulate acceptance of deposits including rate of interest on
deposits by
(iii) (iv)
(v)
(vi)
2. Say
(i)
(ii) (iii)
(iv) (v) (vi)
3. Fill
(i)
(ii) (iii)
(iv) (v) (vi)
4. Say
(i)
(ii)
banking companies under Section 35A of the BR Act. (Government, Reserve
Bank, Board of Directors)
The banking ombudsman can settle a dispute between . (a bank and its
customer/
s, two or more customers, a bank and the Government)
Directions can be issued to banking companies on loans and advances . (in
strict
confidence, in public interest, in the interest of borrowers)
The purpose of is to make credit available to essential sectors of the economy
according to national priorities, (selective credit control, maintenance of cash
reserve, reserve fund)
Act prohibits lending at exorbitant rates and empowers reopening of
such contracts.
(BR Act, RBI Act, Usurious Loans Act)
whether the following statements are true or false.
Reserve Bank can issue directions on loans and advances under Section 21 of the
Banking
Regulation Act.
Regulation of credit to different sectors of the economy is known as selective
credit control.
Banks are free to lend to their directors.
Banks have to file a return to Reserve Bank regarding unclaimed deposits under
Section 26 of
the BR Act.
Directions may be issued under RBI Act to banks in respect of loans and
advances in the
interest of depositors.
The directions issued by Reserve Bank under Section 35 A of the BR Act may
be either generally
to banks or to a particular bank.
in the gaps choosing the answers from the brackets.
The amount transferable to the reserve fund by the banks incorporated in India is
of the profit for each year. (25 per cent, 20 per cent, 10 per cent)
Every banking company has to maintain certain amount of assets under Section
25 of the
Banking Regulation Act as at the (last Friday of every fortnight, last
Friday of
every month, last Friday of every quarter)
The penalty which is payable by a banking company which is a scheduled bank
for failure to
maintain the cash reserve in any week for the first time is(3 per cent, 3 per cent
over the bank rate, 5 per cent over the bank rate)
have to maintain cash reserve under Section 18 of the BR Act.
(Cooperative
banks, Banking companies which are not scheduled banks, Nationalised banks)
The liquid assets to be maintained under Section 24(2A) of BR Act are
of the
balances maintained under Section 42 of the RBI Act. (inclusive, not inclusive,
partly inclusive)
The payment of penalty under Section 24 of BR Act can be enforced by making
an application
before (the Government, civil court, high court)
whether the following statements are true or false.
Only scheduled banks have a duty to maintain cash reserve under Section 42 of
the Reserve
Bank of India Act.
Every banking company has to maintain the liquid assets as required under
Section 24 of the
Banking Regulation Act.
47
(hi) The share capital and reserves of a banking company form part of its
demand and time liabilities
for the purpose of Section 42 of the RBI Act. (iv) The cash reserve required
under Section 42(1) of the RBI Act will be a minimum of three per
cent of the demand and time liabilities, (v) Interest is payable to scheduled banks
on the cash reserve maintained as required under Section
42(1) of the RBI Act. (vi) No banking company incorporated in India is required
to maintain reserve fund under Section
17(1) of the BR Act.
3.18 ANSWERS TO 'CHECK YOUR PROGRESS'
(ii) Reserve Bank (iv) in Public Interest (vi) Usurious Loans Act
1.
2. 3.
4.
(i) Loans and Advances (iii) a bank and its customer/s (v) Selective Credit
Control
(i) True; (ii) True; (iii) False; (iv) True; (v) False; (vi) True
(i) 20 per cent
(ii) last Friday of every quarter (iii) 3 per cent over bank rate
(iv) banking companies which are not scheduled banks (v) not inclusive (vi)
civil court
(i) True; (ii) True; (iii) False; (iv) False; (v) False; (vi) False
3.19 TERMINAL QUESTIONS
Fill in the gaps choosing answers from the brackets.
1. The directions of the Reserve Bank issued to the banking companies
under Section 35A of the
Banking Regulation Act are . (binding on them only; not binding on them
and are in
the nature of guidelines; binding on the banks and the public)
2. A contract if entered into by a banking company with any party in
contravention of a direction
issued by the Reserve Bank . (shall be invalid; shall render the banking
company
liable to prosecution for violation of directions; shall render the bank and any
other party to the contract liable to prosecution for violation of directions)
3. Liquid assets are required to be maintained in India under Section 24 of
the BR Act, may be held
in the form of . (cash only; cash and gold only; cash, gold or unencumbered
approved
securities)
4. For the purpose of maintenance of liquid assets under Section 24 of the
BR Act, unencumbered
approved securities shall be valued at . (face value; current market price;
average of
market price for previous six months)
5. The penal interest chargeable on a banking company under Section
24(4) of the BR Act for not
maintaining liquid assets as specified under Section 24(2A) of the Act . (may
be
waived by the Reserve Bank if it is satisfied that the bank had sufficient cause
for the failure; has to be charged in all cases and the Reserve Bank has no option
but to waive penal interest; can be reduced by the Reserve Bank, but, not
completely waived).
Choose the correct statements from the following:
6. (i) There are no restrictions on a banking company against grant of loans
or advances on the
security of its own shares.
48
(ii) (iii)
7. (i)
(ii)
(iii)
8. (i)
00
(iii)
9. (i) (ii)
(iii)
10. (i)
(ii)
(iii)
A banking company can lend to any firm in which its director is a partner. A
banking company is prohibited from entering into any commitment for granting
loans or advances to or on behalf of any individual in respect of whom any of its
directors is a partner or guarantor.
The power of the Reserve Bank to control advances extends to specifying the
purposes for
which advances may or may not be made.
A direction, regarding advances may be issued by Reserve Bank to banking
companies
generally and not to any banking company in particular.
A direction regarding advance can be issued by the Reserve Bank only in the
interest of
banking policy and on no other grounds.
The depositor of a banking company can make a nomination in the form
prescribed under
the Banking Companies (Nomination) Rules, 1985.
There is no form prescribed for nomination by depositors under Banking
Companies
(Nomination) Rules, 1985.
The nominee is entitled to receive the proceeds of the deposit on maturity of the
deposit
during the lifetime of the depositor or later.
Banking ombudsman is appointed by the Government under the Banking
Regulation Act. Banking ombudsman is appointed by the Reserve Bank under
the Banking Ombudsman Scheme, 2006 framed in the nature of directions under
the Banking Regulation Act, 1949. Banking ombudsman is appointed by the
Reserve Bank under the Reserve Bank of India Act.
For maintenance of cash reserve under Section 42 of the RBI Act, 'demand and
time liabilities'
do not include paid-up capital of the banking company.
Loan taken from the Reserve Bank and Exim Bank are included in 'demand and
time liabilities'
under Section 42 of the RBI Act.
Any loan taken by a regional rural bank from its sponsor, forms part of its
demand and time
liabilities for the purpose of cash reserve under Section 42 of the RBI Act.
UNIT
4
RETURNS, INSPECTION, WINDING UP
STRUCTURE
4.0 Objectives
4.1 Introduction
4.2 Annual Accounts and Balance Sheet
4.3 Audit and Auditors
4.4 Submission of Returns
4.5 Preservation of Records and Return of Paid Instruments
4.6 Inspection and Scrutiny
4.7 Board for Financial Supervision
4.8 Acquisition of Undertakings
4.9 Amalgamation of Banks
4.10 Winding up of Banks
4.11 Penalties for Offences
4.12 Let Us Sum Up
4.13 Keywords
4.14 Check Your Progress
4.15 Answers to 'Check Your Progress'
4.16 Terminal Questions
50
4.0 OBJECTIVES
The objectives of this unit are to understand the laws applicable to banking
companies in respect of
• preparation of accounts and balance sheet
• audit of accounts
• filing of returns
• inspection and scrutiny
• acquisition of assets by the Central Government
• amalgamation with other banks
• winding up
• penalties for default or contravention
4.1 INTRODUCTION
Banking companies have to prepare their balance sheet and accounts annually as
provided in the Banking Regulation Act. The accounts have to be audited by
duly qualified auditors as stipulated in the Act. The audited balance sheet and
accounts have to be submitted as returns to the Reserve Bank and copies thereof
have to be submitted to the Registrar of Companies. Banking companies have to
file many other returns to the Reserve Bank. The Banking Regulation Act also
provides for inspection and scrutiny of the books and accounts of banking
companies. The board for financial supervision has been set up for this purpose.
The Central Government is authorised to acquire the assets of banking
companies and order the amalgamation of any banking company with another
banking company. The Reserve Bank has the power to apply to the High Court
for the winding up of banking companies. Non-compliance with the provisions
of the Reserve Bank of India Act, the Banking Regulation Act and the orders,
rules, regulations, or directions issued under them is punishable under these acts.
In this chapter, we examine the law relating to the above matters.
4.2 ANNUAL ACCOUNTS AND BALANCE SHEET
i. All Banks whose shares are listed with Stock Exchanges are required to
publish their unaudited quarterly results as per proforma prescribed by the SEBI.
Every banking company has to prepare its balance sheet and profit and loss
account as stipulated in Section 29 of the Banking Regulation Act. The balance
sheet and profit and loss account, has to be prepared at the end of each calendar
year or on expiry of the twelve months period, ending with any other date which
the Central Government may notify in the official gazette in this behalf, as on
the last working day of the year or the period, as the case may be. For this
purpose, banking companies incorporated in India, have to cover their entire
business and in the case of foreign banks operating in India, the business
transacted through all their branches in India. While preparing the accounts, the
banking company has to comply with the directions and instructions issued by
the Reserve Bank in respect of income recognition, asset classification,
provisioning, etc., from time to time.
ii. The balance sheet and profit and loss account of a banking company
incorporated in India has to be signed by the manager or principal officer of the
company and at least three directors if there are more than three directors and by
all directors if there are not more than three directors. In the case of foreign
banks, the manager or the agent of its principal office in India can sign.
iii. The balance sheet and profit and loss account have to be prepared in the
forms set out in the III Schedule to the BR Act or as near thereto as
circumstances permit. The Companies Act requires every company to prepare its
balance sheet and profit and loss account in the forms set out in the part I of
schedule VI to that Act. However, the respective provisions of the Banking
Regulation Act have overriding effect in respect of banking companies. Hence,
the provisions of the Companies
!
51
Act that are inconsistent with the provisions of the Banking Regulation Act are
not applicable to banking companies. However, those provisions of the
Companies Act that are consistent with the Banking Regulation Act are
applicable. The forms specified in the third schedule of the Banking Regulation
Act may be modified by the Central Government from time to time by
notification in the official gazette.
iv. In the case of banking companies, the profit and loss account, which has to be
placed before the annual general meeting should relate to the period ending with
the last working day of the year immediately preceding the year in which the
annual general meeting is held. The provisions of Section 210 of the Companies
Act, in this behalf have been specifically made inapplicable to banking
companies by Section 2y^3A) of the Banking Regulation Aci.
v.
Publication of Accounts and Balance Sheet: The accounts and balance sheet
prepared under Section 29 of the Banking Regulation Act along with the
auditors' report have to be published, as provided in Section 31 thereof read with
Rule 15 of the Banking Regulation (Companies) Rules, 1949. Accordingly, the
publication has to be made in a newspaper, which is in circulation at the place
where the banking company has its principal office, within a period of six
months from the end of the period to which the account and balance sheet relate.
For this purpose, 'newspaper' means any newspaper or journal published at least
once a week but does not include a journal other than a banking, commercial,
financial or economic journal. As per current guidelines, Banks whose shares are
listed in the capital market are required to publish their unaudited quarterly
results as per proforma prescribed by SEBI.
VI
Submission to Reserve Bank: Every banking company has to submit three copies
of its balance sheet and profit and loss account to the Reserve Bank within three
months from the end of the period to which they relate. This period may be
extended by the Reserve Bank by a further period not exceeding three months.
vu
Furnishing of Accounts and Balance Sheet to Registrar: Section 220 of the
Companies Act provides for submission by companies of copies of accounts and
balance sheet along with the auditor's report to the Registrar of Companies.
However, in the case of banking companies, Section 32 of the Banking
Regulation Act provides for furnishing to the registrar three copies of the
accounts, balance sheet and auditor's report submitted to the Reserve Bank under
Section 31 of the Act, which would be dealt with in all respects, as if these were
submitted under Section 220 of the Companies Act. When any company submits
additional information relating to balance sheet and profit and loss account to the
Reserve Bank under Section 27(2) of the Banking Regulation Act, the company
has to send a copy thereof to the Registrar as well.
viii. Display of Balance Sheet and Accounts: Foreign banks (banking companies
incorporated outside India) operating in India have to display in a conspicuous
place, in their principal office a copy of the last audited balance sheet and profit
and loss account. This has to be done not later than the first Monday in August
of any year in which it carries on business. The accounts and balance sheet have
to be kept displayed until replaced by a copy of the subsequent balance sheet and
profit and loss account. Similarly, foreign banks have also to display copies of
their complete audited balance sheet and profit and loss account relating to their
banking business as soon as these are available and keep displayed till the
subsequent accounts are available.
4.3 AUDIT AND AUDITORS
The balance sheet and profit and loss account of a banking company have to be
audited, as stipulated under Section 30 of the Banking Regulation Act.
Accordingly, a person duly qualified under any law for the time being to be an
auditor of companies is eligible to be the auditor of a banking company.
52
i. Powers and Functions of Auditors: The powers, functions and duties of the
auditors and the liabilities and penalties to which they are subjected to under
Section 227 of the Companies Act are applicable to auditors of banking
companies. In addition to the above, the auditor of a banking company has to
give certain additional information in his audit report. In the case of banks
incorporated in India, the additional matters are as under:
(a) Whether or not information and explanation, required by him were
found to be satisfactory;
(b) Whether or not the transactions of the company, as noticed by him were
within the powers of
the company;
(c) Whether or not returns from branches were adequate for the audit;
(d) Whether or not profit and loss account shows a true picture of the profit
and loss for the
period covered;
(e) Any other matter, which the auditor considers necessary to bring to the
notice of the shareholders
of the company.
In dealing with bank accounts, the responsibility of the auditor is not confined to
safeguarding the interests of the proprietors. The auditor will be reasonably
blamed, if after signing the usual auditor's report on an apparently sound balance
sheet, the bank is afterwards found insolvent (See the judgment of the Kerala
High Court in Institute of Chartered Accountants vs. Srinivasa, AIR 1960
Kerala. 309 at 311 and the judgment of Madras High Court in Registrar of
Companies vs. RM. Hegde, AIR 1954 Madras 1080 at 1084).
ii. Special Audit: Reserve Bank is empowered under Section 30( IB) of the
Banking Regulation Act to order a special audit of the accounts of any banking
company. Such an order may be passed when the Reserve Bank is of the opinion
that special audit is necessary in the public interest or in the interest of the
banking company or its depositors. An order, on special audit may relate to any
transaction or class of transactions or such period or periods as the Reserve Bank
may specify in the order. The bank may by the same order or by a different order
appoint a duly qualified auditor for this purpose or may direct the auditor of the
banking company himself to conduct such a special audit. The Reserve Bank's
directions are binding on the auditor of the banking company and the auditor has
to make a report of such an audit to the Reserve Bank and also give a copy
thereof to the banking company. The expenses in relation to the special audit
have to be borne by the banking company.
4.4 SUBMISSION OF RETURNS
Every banking company has to furnish several returns to the Reserve Bank under
various provisions of the Banking Regulation Act and under the Reserve Bank
of India Act. The details of these returns are discussed below.
i. Return on Liquid Assets: Every banking company has to submit a return of its
liquid assets under Section 24(3) of the Banking Regulation Act. The return has
to be submitted within twenty days from the end of the month to which it relates.
The return has to be in the form prescribed under Rule 13A of the Banking
Regulation (Companies) Rules, 1949. The return should contain particulars of
assets and the demand and time liabilities, as at the close of business of each
alternate Friday or when such a Friday is a holiday, as at the close of business of
the preceding working day. The Reserve Bank is also empowered to require a
banking company to furnish returns showing particulars of assets and demand
and time liabilities as at the close of each day of the month.
ii. Monthly Returns: Every month, a banking company has to submit to the
Reserve Bank a return under Section 27 of the BR Act, showing its assets and
liabilities in India as at the close of business
53
on the last Friday of the previous month. Such a return has to be submitted
before the close of the month succeeding to which it relates. The return has to be
in the form prescribed under Rule 14A of the Banking Regulation (Companies)
Rules, 1949. Apart from this, the Reserve Bank may also call for statements and
information relating to the business or affairs of a banking company at any time.
The bank may direct the banking company to submit such statement or
information within such time as it may direct. The Bank may also call for
information every half year regarding investments of a banking company or the
classification of its advances in respect of industry, commerce or agriculture.
iii. Accounts and Balance Sheet: The annual accounts and balance sheet have to
be submitted to the Reserve Bank within three months from the end of the period
to which they relate. The Reserve Bank may extend the time by a further period
of three months.
iv. Return of Assets in India: A banking company has to submit to Reserve Bank
under Section 25(1) of the Banking Regulation Act, a quarterly return regarding
its assets in India. The return has to be submitted within one month of the end of
the quarter. The return has to be filed in the form specified in the Rule 14A of
the Banking Regulation (Companies) Rules.
v. Return of Unclaimed Deposits: Under Section 26 of the BR Act, a banking
company has to file within thirty days of the close of each calendar year a return
on unclaimed deposits (not operated for ten years). This has to be submitted as
specified in the Rule 14B of the Banking Regulation (Companies) Rules.
vi. Return of Cash Reserve of Non-Scheduled Banks: Every banking company,
not being a scheduled bank, has to furnish a return to the Reserve Bank under
Section 18(1) of the BR Act relating to cash reserve. The return has to be
submitted before the twentieth day of every month showing the amounts held on
the alternate Fridays during a month along with the particulars of demand and
time liabilities in the form stipulated in the Rule 13A of the BR (Companies)
Rules.
vii. Return by Scheduled Banks: Under Section 42 of the RBI Act, scheduled
banks have to submit returns to the Reserve Bank of their demand and time
liabilities as specified in the sub-Section (2) thereof.
4.5 PRESERVATION OF RECORDS AND RETURN OF PAID
INSTRUMENTS
i. Preservation of Records: The Central Government is empowered under
Section 45 Y of the Banking Regulation Act to make rules specifying the periods
of preservation of books, accounts and other documents by banks and the
periods of preservation of different instruments paid by banks. Accordingly, the
Government has notified the Banking Companies (Preservation of Records)
Rules, 1985 and the Cooperative Banks (Period of Preservation of Records)
Rules, 1985. These rules specify the period of preservation of different types of
ledgers and registers, and records other than ledgers and registers. The rules
further provide that, notwithstanding this, the Reserve Bank may, having regard
to the factors specified in Section 35A(1) of the BR Act, direct any bank by an
order in writing for preserving any books, accounts or registers for a longer
period than the period specified under the rules.
ii. Return of Paid Instruments: Under Section 45Z of the Banking Regulation
Act, a bank is authorised to return paid instruments to their customers even
before the end of the period of preservation specified under the Act. However, in
that case, the bank shall not return the instrument without making and keeping in
its possession a true copy of all relevant parts of the instruments by a mechanical
or another process ensuring accuracy of the copy. Banks are not entitled to
charge the customers (including Government departments and corporations) for
giving such copies of instruments.
54
4.6 INSPECTION AND SCRUTINY
i. Inspection: The Reserve Bank is empowered under Section 35 of the Banking
Regulation Act to conduct an inspection of any banking company. The bank may
conduct such an inspection at any time. The Central Government may also direct
the Reserve Bank to conduct inspection of any bank and in that case, the Reserve
Bank is bound to comply with such a direction. After inspection of the books
and accounts of the banking company, a copy of the inspection report has to be
given to the banking company. The directors and officers of a banking company
are bound to produce for inspection all books, accounts and other documents in
their custody. The inspecting team may also require the bank to furnish any
statements or information relating to the affairs of the banking company within
the time specified by them. The inspecting officer is authorised to examine any
director or officer of a banking company on oath.
ii. Powers of the Government: A copy of the report of inspection has to be sent
to the Central Government in all cases where inspections have been conducted
as directed by the Central Government. In other cases, it is optional for the
Reserve Bank to send copies of inspection to the Government. On consideration
of the report, if the Central Government is of the opinion that the affairs of a
banking company are being conducted to the detriment of the interests of the
depositors, the Government may -
(a) Prohibit the banking company from receiving fresh deposits.
(b) Direct the Reserve Bank to apply for winding up of the banking
company under Section 38 of
the BR Act.
However, before taking such action, the Government has to give an opportunity
to the banking company to make a representation in respect of the report. The
Central Government is authorised to defer the passing of such an order or to
cancel or modify such an order subject to any terms and conditions imposed by
it. It is also open to the Central Government to publish an inspection report or a
portion thereof after giving the banking company a reasonable notice.
iii. Scrutiny: Apart from making regular inspections, Reserve Bank is also
empowered to conduct a scrutiny of the affairs and the books and accounts of
any banking company under the sub-Section (1 A) of Section 35 of the Banking
Regulation Act. One or more officers of the Reserve Bank may conduct such a
scrutiny. A copy of the report has to be furnished to the banking company, if it
makes a request for the same or if adverse action is contemplated against the
banking company, based on the scrutiny. Otherwise, unlike in the case of
inspection, it is not mandatory to give a copy of the report to the banking
company. The powers of the Reserve Bank to call for books, accounts and
documents or statements and information as for examination of any director or
officer of the banking company on oath extend to scrutiny as well.
4.7 BOARD FOR FINANCIAL SUPERVISION
i. Constitution of the Board: The Board for Financial Supervision (Board) is a
committee established under Regulation 4 of the Reserve Bank of India (Board
for Financial Supervision) Regulations, 1994. These regulations were framed by
the Reserve Bank under Section 58 of the Reserve Bank of India Act, 1934 with
the previous sanction cfthe Central Government. The Board has jurisdiction over
the banking companies, Nationalised banks, State Bank and its subsidiaries.
ii. Composition of the Board: The Board consists of the following members:
(a) Governor of the Reserve Bank of India, (S)he is the chairperson of the
board.
(b) Deputy Governors of the Reserve Bank of India, one of the deputy
Governors shall be nominated
by the Governor as the full time vice chairman.
(c) Four directors from the central board of the Reserve Bank nominated by
the Governor as
55
members, the Governor has to make the nominations to the board in consultation
with the central board of the Reserve Bank (Central Board) for a specified
period,
iii. Functions and Powers: The board performs the functions and exercises the
powers of supervision and inspection under the Reserve Bank of India Act and
the Banking Regulation Act, in relation to different sectors of the financial
system, including banking companies. The board shall also perform any other
function as may be notified by the central board of the Reserve Bank. The board
is assisted by the department of supervision in the Reserve Bank and may also
draw personnel from outside. The chairman, vice-chairman and members can
jointly and severally exercise the powers vested in the board, as may be
specified by the central board from time to time. The board can also authorise
senior officers of the department of supervision with prior approval of the
central board to carry out certain functions. The board has to report to the central
board on a half yearly timeline.
iv. Meetings of the Board: The board meets at least once in a month. Three
members, of whom, one shall be the chairman or the vice chairman shall form a
quorum for the meeting. A member who absents himself/herself without leave of
the chairman for three consecutive meetings of the board, would cease to hold
office.
v. Executive Committee: The board has the power to constitute sub-committees.
One such sub¬committee is the executive committee. The vice chairman of the
Board, is the ex-officio chairman of the committee and there shall also be not
less than two members of the board in that committee. The committee meets as
often as necessary.
vi. Advisory Council: Governor may constitute an advisory council to tender
advice from time to time to the board. This council will have not less than five
members having special knowledge of accountancy, law, economics, banking,
finance and management. The Governor presides over the meetings of the
council and the vice-chairman and other members are members of the council.
4.8 ACQUISITION OF UNDERTAKINGS
The Central Government can acquire the undertakings of banking companies in
certain cases as mentioned in Section 36AE of the Banking Regulation Act.
'Undertaking' means the entire organisation (See the judgement of the Supreme
Court in R.C. Cooper vs Union of India, AIR 1970 SC 564). Acquisition may be
made if on receipt of a report from the Reserve Bank, the Government is
satisfied that it is necessary to acquire any undertaking on certain grounds.
Before passing the order, the Central Government may make such consultation
with the Reserve Bank as it thinks fit. The grounds for acquisition are as under:
• Banking company has failed on more than one occasion to comply with
the Reserve Bank's directions
under Section 21 or 35A of the Banking Regulation Act.
• Banking company is managed in a manner detrimental to the interests of
depositors and it is
necessary to acquire its undertaking in the interests of depositors or in the
interests of banking
policy or for better provision of credit generally or to any particular section of
the community or
any particular area.
Before acquiring the assets of a banking company, it has to be given a
reasonable opportunity of showing cause against the proposal.
i. On acquisition of the undertaking all the assets and liabilities of the acquired
bank stand transferred to and vests in the Central Government. It is also open to
the Central Government to order the vesting of the undertaking of the acquired
bank in a company or corporation instead of vesting in the Government. In that
case, the transferee bank takes over all the acquired assets and liabilities of the
transferer bank.
56
ii. Power to make scheme: The Central Government is empowered under Section
36AF to make a scheme for any acquired bank. Such a scheme is framed in
consultation with the Reserve Bank. The scheme may provide for all matters
relating to property, assets, liabilities, board of management, service of
employees and their terms and conditions, payment of compensation to
shareholders of acquired bank and other matters. The Central Government may
modify or vary any such scheme after consulting the Reserve Bank. The scheme
and any subsequent modification thereof is published in the official gazette and
laid down before the Parliament. The provisions of part IIC of the Act providing
for acquisition of undertakings of banks by the Government and of any scheme
framed there under shall have an overriding effect on other laws. The scheme
shall have binding effect on the Government, the acquired bank, members,
creditors and depositors of the acquired bank and all other persons having any
rights or liabilities in respect of the acquired bank.
iii. Compensation to shareholders: The shareholders of an acquired bank have a
right to get compensation under Section 36AG of the Banking Regulation Act.
The amount thereof will be determined as provided in the fifth schedule to the
Act, after consultation with the Reserve Bank. There is also a provision (Section
36AH) for a reference to a tribunal for hearing claims relating to compensation.
If the compensation offered by the Government or the transferee bank is not
acceptable to any person to whom such compensation is payable, he may request
the Central Government to refer the matter to the tribunal, and a reference has to
be made to the tribunal, subject to the satisfaction of certain conditions. In the
case of acquisition of the undertaking of a foreign bank in India, a reference has
to be made to the tribunal, if requested by the foreign bank.
4.9 AMALGAMATION OF BANKS
i. Voluntary Amalgamation: A banking company may be amalgamated with
another banking company under Section 44A of the Banking Regulation Act.
For this purpose, a scheme has to be prepared, containing the terms of such an
amalgamation in a draft and placed before the shareholders of the two
companies separately. The scheme has to be approved by a resolution passed by
majority of members representing two-thirds in value of the shareholders of each
company present in person or by proxy. Notice has to be given to every
shareholder in this behalf. A share holder who votes against such scheme or
dissents to the scheme and gives notice as stipulated, may claim the value of his
shares from the banking company, in the event of sanction of the scheme by the
Reserve Bank. After the scheme is approved by the requisite majority, the
scheme has to be submitted to the Reserve Bank for sanction. On sanction by
Reserve Bank, the assets and liabilities of the amalgamated company pass to the
banking company, with which it is to be amalgamated. The Reserve Bank may
also direct that the amalgamated company will stand dissolved from any
specified date and intimate the Registrar of Companies accordingly. The order of
sanction of amalgamation by Reserve Bank will be the conclusive evidence of
amalgamation.
ii. Amalgamation by Government: The Central Government is empowered to
order amalgamation of two banking companies under Section 396 of the
Companies Act. However, such power has to be exercised only after
consultation with the Reserve Bank.
iii. Moratorium and Amalgamation: The Reserve Bank is authorised under
Section 45 of the Banking Regulation Act to apply to the Central Government
for an order of moratorium in respect of any banking company where it appears
to it that there is good reason to do so. After considering the application, the
Central Government may pass an order of moratorium staying the
commencement or continuation of any action or proceedings against the banking
company for a fixed period. This may be on such terms and conditions as the
Government thinks fit and prefers to impose. The
57
period of moratorium is extendable from time to time. However, the total period
of moratorium shall not exceed six months. During the period of moratorium,
the banking company shall not make any payment to depositors or discharge any
liabilities or obligations to any other creditors unless otherwise directed by the
Central Government in the order of moratorium or at any time thereafter.
iv. Scheme of Amalgamation:
(a) During the period of moratorium, Reserve Bank may prepare a scheme
either for reconstruction
of the banking company, or for amalgamation of the banking company with any
other banking
institution. Such a scheme may be prepared if the Reserve Bank is satisfied that
it is necessary
to do so:
(i) in the public interest;
(ii) in the interests of the depositors;
(iii) for securing the proper management of the banking company;
(iv) in the interest of the banking system of the country as a whole.
(b) The scheme of amalgamation or reconstruction may contain provisions
for all or any of the
matters specified in the clauses (a) to (I) of the sub-Section (5) of Section 45.
These include:
(i) constitution, name, registered office, capital assets, powers, rights, duties and
obligations
of the banking company after reconstruction of the transferee company; (ii)
transfer of assets from transferrer bank to transferee bank, and terms and
conditions
thereof in the case of amalgamation; (iii) change in or appointment of board of
directors; (iv) alteration in memorandum and articles; (v) continuation of action
by or against the banking company after amalgamation or
reconstruction; (vi) reduction of the interest or rights of members, depositors or
other creditors considered
necessary in public interest or in the interest of members, depositors or creditors
or for
maintenance of the business of banking company; (vii) payment in cash or
otherwise to creditors and other depositors; (viii) allotment of shares of the
transferrer bank to the shareholders of transferrer bank for
shares held by them in the transferrer bank; (ix) continuance of service of
employees after reconstruction or amalgamation.
The scheme has to provide for the continuance of all workmen and other staff
(excepting those specifically excluded by name in terms of the scheme) on the
same terms and conditions of service as before. The scheme should also provide
that within three years, these employees have to be given the same pay and terms
and conditions as are applicable to the other employees of the transferee bank of
corresponding rank or status of equivalent qualifications and experience. See the
judgements of the Supreme Court in State Bank of Travancore vs Elias (1970)2
SCC 761 and also K.I. Shepherd and others vs Union of India and others AIR
1988 SC 686. In the case of any dispute regarding rank, status, etc., of
employees in this regard, the decision of the Reserve Bank shall be final.
Scheme has also to provide for payment of terminal benefits to workers who
have opted not to continue in service on amalgamation or reconstruction and
other employees, who have been specifically mentioned in the scheme for
exclusion from service. The scheme may contain other terms and conditions of
amalgamation or reconstruction and also incidental matters.
(c) Sanction of Scheme by Government: A copy of the draft of the scheme
prepared by the
Reserve Bank has to be sent to the Government and also to the banking
company, transferee
58
bank and any other banking company concerned in the amalgamation, for their
suggestions and objections, if any. The Reserve Bank may specify the period for
receipt of such suggestions and objections. In the light of any suggestions and
objections received, modification may be made in the draft, as considered
necessary by the Reserve Bank. Thereafter, the scheme, may be placed before
the Central Government for sanction. The Government may sanction the scheme
with such modifications as it may consider necessary. The scheme shall come
into force from the date of the sanction.
(d) Effect of Sanction: On the Central Government sanctioning the scheme, it
becomes binding on the banking company, transferee bank and the members,
depositors and other creditors, employees and any person having any right or
liability in relation to the banking company. The sanction by the Central
Government is the conclusive evidence that the amalgamation or reconstruction
has been done in compliance with the provisions of Section 45 of the Act. The
assets and properties of the banking company shall stand transferred to and vest
in, and liabilities shall stand transferred and become liabilities of the transferee
bank as provided in the scheme.
If any difficulty arises in implementing the scheme, the Central Government
may pass the necessary orders for removing the difficulties. A copy of the
scheme and any orders passed for removing difficulties has to be placed before
the Parliament.
Consequent to amalgamation, the transferee bank has to carry on the business of
the banking company acquired by the transferee bank, according to the law
governing the transferee bank. The Central Government may give necessary
exemptions and modifications in this behalf on the recommendation of the
Reserve Bank. However, such modification or exemption should not last for
more than seven years.
A single scheme of amalgamation can be made in respect of several banking
companies under moratorium. The provision of Section 45 and the scheme
sanctioned there under shall have overriding effect on other laws, agreements,
awards or instruments.
4.10 WINDING UP OF BANKS
i. Suspension of Business and Winding Up: A banking company which is
temporarily unable to meet its obligations may apply to the High Court under
Section 37 of the Banking Regulation Act for staying the commencement or
continuance of any proceedings against it. Such stay will be for a fixed period
and subject to any terms and conditions imposed by the High Court as it may
think fit. The total period of such moratorium shall not exceed six months. An
application for moratorium shall be supported by a report of the Reserve Bank
indicating that the banking company will be able to pay its debts if the
application is allowed. The Court, for sufficient reasons, may grant the relief,
even if the application is not supported by the Reserve Bank's report. In that
case, a report will be called for and the order, may be modified or rescinded
based on the report. On passing of moratorium order the court may appoint a
special officer to take custody and control of the assets, books, etc., of the
banking company in the interests of the depositors.
If the Reserve Bank is satisfied that the affairs of a banking company under
moratorium as above, are being conducted in a manner detrimental to the
interests of the depositors, it may apply to the High Court for winding up of the
company. Thereafter, the High Court shall not extend the period of moratorium.
ii. Winding Up by High Court:
(a) The High Court shall order the winding up of a banking company in the
circumstances mentioned in Section 38 of the Banking Regulation Act. They
are:
59
(i) The banking company is unable to pay its debts;
(ii) An application for winding up has been made by the Reserve Bank under
Section 37 or Section 38 of the Act.
(b) The Reserve Bank is bound to make an application for winding up under
Section 38, if directed
by the Central Government under Section 35(4) of the Banking Regulation Act.
The Central
Government may issue such direction under Section 35(4) when, on
consideration of the
report of inspection or scrutiny made by the Reserve Bank at the direction of the
Central
Government, it is of opinion that the affairs of the bank are being conducted to
the detriment
of the interests of the depositors. However, before giving such direction, the
banking company
has to be given an opportunity to make a representation in connection with the
report of
inspection or scrutiny.
(c) It is open to the Reserve Bank to apply for winding up of a banking
company in certain other
cases as follows:
(i) failure to comply with the requirements of Section 11 regarding minimum
paid-up capital
and reserves; (ii) bank being not entitled to carry on banking business in India
under Section 22 of the BR
Act by reason of rejection or cancellation of licence; (iii) prohibition to accept
fresh deposits under Section 35(4) of the BR Act or Section 42
(3A)(b) of the Reserve Bank of India Act; (iv) failure to comply with the
requirements of the BR Act other than Section 11 and
continuance of such failure or contravention beyond the period or periods
specified by
the Reserve Bank in this behalf and after notice in writing of such failure or
contravention.
In addition to the above, the Reserve Bank may apply for winding up of a
banking
company if it is of the opinion that:
(a) a compromise or arrangement sanctioned for a banking company cannot
be worked
satisfactorily with or without modification; or
(b) the returns, statements and information given by the bank under the Act
show that
it cannot pay its debts; or
(c) the continuance of the banking company is prejudicial to the interests of
the
depositors.
A banking company shall be deemed to be unable to pay its debts if it has
refused to meet any lawful demand made at any of its offices or branches within
the stipulated time and the Reserve Bank certifies in writing that the banking
company is unable to pay its debts. If the demand is made at a place where the
Reserve Bank has an office, branch or agency, the time limit is two days and in
other cases five days. When the Reserve Bank makes an application for winding
up, the court is bound to allow the application. As held by the Supreme Court in
the Palai Central Bank case (AIR 1962 SC 1371 at 1383), as between the Court
and the Reserve Bank, the momentous decision to wind up in the interests of
depositors may reasonably be left to the Reserve Bank.
iii. Official Liquidator: Section 38A of the BR Act provides for a liquidator to be
appointed by the Central Government, attached to respective High Court, for
conducting the winding up proceedings relating to banking companies. Such a
liquidator need not be appointed where enough cases of winding up of banking
companies are not available in any High Court.
iv. Reserve Bank as Liquidator: Although there is a provision for an official
liquidator as above, if the Reserve Bank applies to the Court under Section 39 of
the Act, the Reserve Bank, State Bank or any other bank notified by the Central
Government in this behalf or any individual stated in the application may be
appointed as the official liquidator. The remuneration of the liquidator and other
costs and expenditure of winding up shall be borne by the banking company. All
provisions of the Companies
60
Act, which are not inconsistent with the Banking Regulation Act shall be
applicable to such a liquidator. The liquidator has to make a preliminary report
to the High Court within two months of the winding up order on the availability
of assets for making preferential payments under Section 530 of the Companies
Act and for discharging liabilities to depositors and other creditors. Within
fifteen days of the winding up order, the liquidator has to give notice calling for
claims for preferential payment and other claims from every secured and
unsecured creditor. Under Section 43 of the Act, the depositors need not make
claims. The claims of every depositor of a banking company is deemed to have
filed for the amount as shown in the books of the banking company standing to
his credit.
v. Preferential Payment: In the winding up proceedings, the liquidator of a
banking company has to make certain preferential payments under Section 43 A
of the Banking Regulation Act. Accordingly, the preferential payments referred
to in Section 530 of the Companies Act, in respect of which, claims have been
made within one month of service of notice, get the first preference. After that,
depositors in savings bank account up to Rs. 250 and then other depositors up to
Rs. 250 get priority over all other creditors. After making these payments, the
balance available will be utilised for payment to general creditors and then for
payment of further amounts due to the depositors. The provision for preferential
payment by liquidator will not apply to depositors covered by the DICGC Act.
vi. Voluntary Winding Up: Apart from the provision for compulsory winding up
as above, Section 44 provides for voluntary winding up by banking companies.
However, no such winding up will be permissible unless the Reserve Bank
certifies that the bank will not be able to pay in full all its debts as they accrue. It
is open to the High Court to order during voluntary winding up of a banking
company that it shall continue, subject to the supervision of the Court. The High
Court may also order winding up by Court either on its own motion or on the
application by the Reserve Bank, if during voluntary winding up it becomes
clear that the company is not able to meet its debts as they accrue or if
continuing voluntary winding up or winding up under supervision of the court
may be detrimental to the interests of depositors.
4.11 PENALTIES FOR OFFENCES
A banking company has to abide by the requirements of the Reserve Bank of
India Act and the Banking Regulation Act and the subordinate legislation there
under, namely statutory rules, directions, etc., issued under these Acts. Failure to
do so invites penalties.
i. Penalties Under the RBI Act: Chapter V of the Reserve Bank of India Act
deals with penalty for violation of the Act. Banking companies have to make
applications and furnish returns, statements, etc., under different provision of the
Act, regulations, orders, directions, etc. While doing so, the making of any
statement which is false in any particular material, knowing it to be false or
wilfully omitting to make any material statement, is punishable with
imprisonment up to a period of three years and also a fine.
Failure to produce any books, accounts or other documents or statements, or
information which a person is duty bound to make under the Act, or any order,
regulation or direction is punishable with fine up to Rs. 2,000 for each offence.
For continuing offences, there is a provision for fine of Rs. 100 for each day
when the offence continues. There are penalties under the sub-Section (3) to
(5B) of Section 58B for contravention of specific provisions of the Act or orders,
direction, etc., made there under. Apart from this, for contravention of any other
provisions or not complying with any requirements under the Act, order,
regulation or direction, the guilty shall be punishable with fine up to Rs. 2,000,
and further Rs. 100 every day for continuing the offence.
In the case of offences by companies, every person who was in charge of or
responsible for conduct of the company's business shall be deemed guilty of the
contravention or default unless he proves that the offence was committed
without his knowledge or that he had exercised due diligence to prevent the
61
offence. The court will not take cognizance of an offence under the Act (except
offences relating to acceptance of deposits under the Chapter IIIC) otherwise
than on a complaint by an officer of the bank generally or specially authorised in
writing in this behalf by the Bank. A metropolitan magistrate or magistrate of
the first class or court superior thereto shall try the offences.
ii. Penalties under the BR Act: The provisions of the Banking Regulation Act,
relating to penalties, are provided in Section 46 thereof. Accordingly, making
wilfully any false statement in any return, balance sheet or other document or
information given under the Act is punishable. Similarly, wilful omission to
make any material statement is also punishable. In both cases, punishment is up
to three years imprisonment and fine.
Failure to produce any book, account or other document or to furnish a statement
or information that is obligatory to be produced under Section 35(2), during
inspection or scrutiny is punishable with fine up to Rs. 2,000. Similarly, failure
to answer any question relating to the business of the banking company during
inspection is also punishable. Continuance of the offence is punishable with fine
of Rs. 100 for every day during which the offence continues. Acceptance of
deposits against an order prohibiting acceptance of deposits under Section 35(4)
is punishable with a fine up to twice the amount of deposits accepted. Every
director or officer is punishable in this case, unless he proves that the
contravention was without his knowledge or that he had exercised all diligence
to prevent it. Any contravention of other provisions of the Act, or any rule, order
or direction made or condition imposed, is punishable with fine up to Rs. 50,000
or twice the amount involved in the contravention. In the case of continuing
offences, a fine up to Rs. 2,500 for each day may be imposed. In the case of
offences by companies, every person who was in charge of the company at the
time of commission of the offence is punishable unless he proves that the
offence was committed without his knowledge or in spite of his exercising due
diligence to prevent it.
Under Section 47, the offences are cognizable only by a metropolitan magistrate,
judicial first class or a court superior thereto on a complaint by an officer of the
Reserve Bank and in some cases by the National Bank.
Under Section 47A, the Reserve Bank is empowered to impose a penalty for
default or contravention. If the Reserve Bank exercises that power, no complaint
shall be filed in a Court in respect of the same contravention or default.
4.12 LET US SUM UP
Every banking company has to prepare its balance sheet and profit and loss
account annually as at the end of the calendar year or at the end of twelve
months as on a date notified by the Central Government. The accounts have to
be audited by auditors duly qualified to be auditors of companies. Three copies
of the balance sheet, profit and loss account and the auditor's report have to be
submitted as returns to the Reserve Bank and to the Registrar of Companies.
Banking companies have also to furnish other returns like return on maintenance
of cash reserve, maintenance of liquid assets, etc. The Reserve Bank is
authorised to inspect or conduct, scrutiny of banking companies, their books and
accounts. The Board for Financial Supervision set up by the Reserve Bank by
statutory regulations framed under the Reserve Bank of India Act supervises the
affairs of banking companies. The Government may acquire the undertakings of
banking companies in certain circumstances based on a report from the Reserve
Bank. The Central Government may also order moratorium on banking
companies on the application of the Reserve Bank. During moratorium, the
Reserve Bank may prepare a scheme for amalgamation, which may be
sanctioned by the Central Government. Such an amalgamation scheme will have
overriding effect on any laws, agreements, etc. The Reserve Bank may also
apply to the High Court for winding up of a banking company when it is not able
to pay its debts and also in certain other circumstances. The Reserve Bank of
India Act and the Banking Regulation Act impose certain penalties for
contravention or default committed by banking companies or other persons.
62
4.13 KEYWORDS
Amalgamation; Board for Financial Supervision; Continuing Offence;
Inspection; Moratorium; Scrutiny; Winding up.
4.14 CHECK YOUR PROGRESS
1. Fill in the gaps choosing answers from the brackets.
(i) A banking company has to prepare profit and loss accounts and balance sheet
as at the
or at the expiration of twelve months ending with such date as notified
by the
Central Government, (end of calendar year, end of March, end of June) (ii) The
balance sheet and profit and loss account shall be audited by a person duly
qualified to
be . (a certified financial analyst, auditor of companies, auditor of
cooperative
societies)
(iii) Three copies of the balance sheet and accounts along with the auditor's
report of a banking company sent to the Reserve Bank under Section 31 of the
BR Act, have also to be sent to
. (the Central Government, Registrar of Companies, Company Law
Board)
(iv) Reserve Bank is empowered to conduct of a banking company under
Section
35(1) of the BR Act. (inspection, special audit, audit)
(v) A copy of the inspection report, relating to a banking company, to that
banking
company, (should be given, need not be given, should be given at request)
(vi) The board for Financial Supervision is constituted by . (the
Government, Reserve
Bank, Indian Banks Association) (vii) Under Section 35(4) of the BR Act,
Central Government can prohibit a banking company
from accepting fresh deposits if the business of the banking company is
conducted
. (not profitably, not in compliance with the Act, to the detriment of
interest of
its depositors)
2.
Say whether true or false:
(i) Foreign banks have to prepare accounts and balance sheet in respect of all
business transacted
by them in India, (ii) Reserve Bank requires the permission of the Central
Government for ordering special audit
of a banking company, (iii) Three copies of the balance sheet, profit and loss
account, and auditor's report of a banking
company have to be submitted to the Reserve Bank as returns, (iv) A copy of
scrutiny report has to be given to the banking company whether requested by it
or not. (v) The Board for Financial Supervision is set up under the regulations
framed by the Reserve
Bank under Section 58 of the Banking Regulation Act. (vi) The Central
Government is not empowered to order Reserve Bank for inspection of a
banking company, (vii) Central Government has to give notice to the banking
company before publishing its
inspection report or any part of it.
3.
Fill in the gaps choosing answers from the brackets.
(i) The undertaking of a banking company may be acquired by the Central
Government if it is satisfied on a report from the Reserve Bank that the banking
company has failed on more
than one occasion to comply with the . (directions of the Government,
directions
under Sections 21 and 35A of BR Act, provisions of the Companies Act)
(ii) The Central Government may make a after consultation with the
Reserve Bank
63
for carrying out the purposes of part IIC of the BR Act, in relation to an acquired
bank.
(scheme, plan, memorandum)
may apply to the High Court for winding up of a banking company
under
(iii)
Section 38 of the BR Act. (Registrar of Companies, Reserve Bank, Central
Government) (iv) The High Court shall order winding up of a banking company
if the banking company is
unable to (pay its debts, file returns in time, eliminate non-performing
assets)
(v) In a winding up proceeding the depositors shall for the amounts shown
in the
books of the bank standing to their credit, (be deemed to have filed claim, have
to file claim,
have no claim)
(vi) The may apply to the Central Government for an order of
moratorium in
respect of a banking company, (banking company, Registrar of Companies,
Reserve Bank) (vii) The provisions of a scheme of amalgamation sanctioned by
the Central Government under
Section 45 of the BR Act will the provisions of other laws, (not affect, have
overriding effect on, will be subject to).
4. Say whether true or false
(i) Central Government can acquire the undertaking of a banking company under
Section
36AE of the Banking Regulation Act in the interest of banking policy without
any report
from the Reserve Bank on the affairs of the banking company, (ii) The
undertaking of an acquired bank may vest in the Central Government or in any
company
or corporation as directed by the Central Government, (iii) On the application of
Reserve Bank, the High Court may stay the commencement or
continuance of proceedings against any banking company for any period, (iv)
The Reserve Bank or State Bank or another person as specified by the Reserve
Bank in its
application before the High Court may be appointed as liquidator of a banking
company, (v) On winding up of a banking company, all the depositors as a class
get the first preference
for payment, (vi) The Reserve Bank may prepare a scheme for reconstruction or
amalgamation of a banking
company under moratorium under Section 45 of the BR Act. (vii) Making any
false statement in a return or other document submitted under the provisions of
the BR Act is punishable with imprisonment and fine also.
4.15 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (i) end of calendar year (ii) auditor of companies
(iii) Registrar of Companies (iv) Inspection
(v) should be given (vi) Reserve Bank
(vii) to the detriment of interest of the depositors
2. (i) True; (ii) False; (iii) True; (iv) False; (v) False; (vi) False; (vii)
True
3. (i) directions under Sections 21 and 35A of the BR Act
(ii) Scheme (iii) Reserve Bank
(iv) Pay its debts (v) be deemed to have filed claim
(vi) Reserve Bank (vii) have overriding effect on
4. (i) False; (ii) True; (iii) False; (iv) True; (v) False; (vi) True;
(vii) True
4.16 TERMINAL QUESTIONS
Fill in the blanks choosing answers from brackets —1 A banking mmpany has
tn prepare its annual accounts in the forms
_. (decided by the
64
board of the banking company and approved in general meeting; specified by the
Department of Company Affairs; in the form set out in the Third Schedule to the
BR Act or as near thereto as circumstances admit)
2. A banking company has to submit three copies of its accounts and
balance sheet together with
auditors' report . (to the Reserve Bank and also to the Registrar of Companies;
only
to the Reserve Bank; only to the Registrar of Companies).
3. The expenses incidental to a special audit under Section 3O(1B) of the
BR Act shall be borne by
. (the Reserve Bank of India; the banking company; the Government of
India)
4. The balance sheet and profit and loss account of a banking company,
have to be audited, as
stipulated under Section 30 of the Banking Regulation Act, by . (a person duly
qualified
under any law for the time being in force to be an auditor of companies; Reserve
Bank; Registrar of Companies).
5. Reserve Bank shall cause an inspection of a banking company, by one or
more of its officers
. (if so required by shareholders representing at least ten per cent of the
shares of the
bank; if so required by the Central Government; if so required by the Registrar
of Companies.)
Choose the correct statements from the following:
6. (i) Reserve Bank may publish, if they consider in the public interest to
do so, any information
obtained by them under the BR Act in such consolidated form as it thinks fit. (ii)
Reserve Bank may not publish any information in whatever form collected from
a banking
company in exercise of the powers under the BR Act. (iii) Reserve Bank may
not publish information obtained during inspection of a banking company
even in a consolidated form.
7. (i) Board of Financial Supervision is a body established by the
Government under the provisions
of the BR Act. (ii) Board of Financial Supervision is a body established under
the Reserve Bank of India Act for
the supervision of banks and financial companies, (iii) Board of Financial
Supervision is a body established by the Government for supervising the
securities market.
8. (i) The Reserve Bank may order moratorium in respect of a banking
company when it is satisfied
that there is good reason to do so. (ii) The Central Government may order
moratorium on its own motion when it is satisfied that
the financial position of the banking company is not satisfactory, (iii) The
Central Government may after considering the application made by the Reserve
Bank
for an order of moratorium in respect of a banking company, order moratorium
staying the
commencement and continuance of all actions and proceedings against the
banking company.
9. (i) The High Court shall under Section 38 of the BR Act order winding
up of a banking company
if it is unable to pay its debts, (ii) The High Court shall under Section 38 of the
BR Act order winding up of a banking company
if the Government makes an application therefore under Section 37 of the BR
Act. (iii) The High Court shall under Section 38 of the BR Act order winding up
of a banking company
if the continuance of the banking company is prejudicial to the interests of its
shareholders
and the Reserve Bank applies to the court on that ground. 10. (i) No provisions
of the Companies Act apply to the liquidator in the winding up of a banking
company, (ii) All provisions of the Companies Act apply to the liquidator in the
winding up of a banking
company, (iii) All provisions of the Companies Act relating to liquidator, insofar
as they are consistent with
BR Act, apply to a liquidator of a banking company.
UNIT
5
PUBLIC SECTOR BANKS AND CO-OPERATIVE BANKS
STRUCTURE
5.0 Objectives
5.1 Introduction
5.2 State Bank and Its Subsidiaries
5.3 Regional Rural Banks
5.4 Nationalised Banks
5.5 Application of Banking Regulation Act to Public Sector Banks
5.6 Disinvestment of Shares by Government
5.7 Co-operative Banks
5.8 Let Us Sum Up
5.9 Keywords
5.10 Check Your Progress
5.11 Answers to 'Check Your Progress'
5.12 Terminal Questions
66
5.0 OBJECTIVES
The objectives of this unit are to understand:
• the special laws governing the public sector banks, namely, State Bank
and its subsidiaries,
Nationalised banks, and regional rural banks;
• the applicability of Banking Regulation Act and the Reserve Bank of
India Act to these banks;
• laws governing the co-operative banks, in particular applicability of
Banking Regulation Act to co¬
operative banks;
• extent of legal control of state governments over co-operative banks.
5.1 INTRODUCTION
i. The public sector banks, namely, the State Bank of India and its subsidiaries,
Nationalised banks and regional rural banks are established by special statutes.
These statutes and the rules, regulations and/or schemes framed thereunder
provide the powers, functions and management of these banks. The Banking
Regulation Act is applicable to these banks only in a limited way, as some of the
provisions are not applicable.
ii. In the case of co-operative banks, these banks being created and governed by
the laws relating to co-operative societies, if they operate only in one state, the
State Act and if they operate in different states, the Central Act applies. The
Banking Regulation Act is applicable to co-operative banks in a modified
manner as provided in Section 56 of the Act.
iii. In this unit, we study the special laws applicable to the public sector banks
and co-operative banks as also the Banking Regulation Act and Reserve Bank of
India Act as they apply to these banks.
5.2 STATE BANK AND ITS SUBSIDIARIES
i. Establishment of State Bank: State Bank of India was established under
Section 3 of the State Bank of India Act, 1955 for taking over the undertaking of
the Imperial Bank and to carry on the business of banking and other business in
accordance with that Act. It is a body corporate, with perpetual succession and
common seal and shall sue and be sued in its name. The majority of ; shares are
held by the GOI. Further, no shareholder other than the GOI can exercise voting
right above ten per cent, unless otherwise specified by the Central Government
in consultation with the Reserve Bank. Now the complete holding of RBI is
acquired by the central government.
ii. Management: The State Bank has its central office in Mumbai and local head
offices at Mumbai, Kolkata, Chennai and other places as decided by its Central
Board in consultation with the Central Government. The superintendence and
direction of the affairs of the bank is vested in the Central Board, which has to
function according to the business principles having regard to public interest.
The Central Government can give directions to the bank on matters of policy
involving public interest in consultation with the Governor of the Reserve Bank
and the Chairman of the State Bank. The directions have to be given through the
Reserve Bank. The board is empowered to make regulations for carrying out the
purposes of the Act in consultation with the Reserve Bank and with the previous
sanction of the Central Government.
iii. Composition of the Board: The Board shall consist of Chairman, Vice-
Chairman, not more than two Managing Directors appointed by the Central
Government, presidents of local boards and other directors. There are directors
falling in different categories, namely, appointed by the Government to represent
workmen and officers, nominated by the Central Government in consultation
with the Reserve Bank from among persons with special knowledge of co-
operatives and rural
67
economy, nominated by Reserve Bank, nominated by Central Government and
elected by shareholders other than Reserve Bank.
The chairman and managing directors are appointed for a period not exceeding
five years and are eligible for reappointment. Their services can be terminated
by the Central Government by giving a three month's notice or notice pay in lieu
thereof, after consultation with the Reserve Bank.
Local boards are set up at each place where there is a local head office to
exercise all powers and to perform the functions and duties of the bank delegated
under Section 2 IB of the Act. The local board consists of the chairman and
other elected and nominated members as specified in Section 21 of the Act.
iv. Business of State Bank: The State Bank shall act as an agent of the Reserve
Bank at the places where it has a branch and where Reserve Bank has no branch,
if so required, by the Reserve Bank, for transacting Government business and
other business entrusted to it by the Reserve Bank. The terms and conditions
thereof shall be as agreed between the Reserve Bank and the State Bank. If
agreement is not reached, the terms shall be decided by the Central Government.
The State Bank may transact the work through its subsidiaries or an agent
approved by the Reserve Bank. Apart from this, the State Bank may carry on the
business of banking as defined in Section 5(b) of the Banking Regulation Act
and other business specified in Section 6(1) of that Act. The bank is permitted to
acquire business of other banks with the sanction of the Central Government or
if so directed by the Central Government in consultation with the Reserve Bank.
v. Accounts and Audit: The State Bank has to close its books and balance
accounts each year as on 31 March or such other date as may be specified by the
Central Government. Within three months of the closing date, it has to furnish to
the Central Government and the Reserve Bank its balance sheet and profit and
loss account together with auditors' report and a report by the Central Board on
the working and activities of the bank. The audit may be conducted by any
person duly qualified to be auditors of companies under Section 226 of the
Companies Act. No Director, member of local board, local committee or an
officer of the State Bank shall be eligible to be the auditor. The appointment of
auditors is done by the Reserve Bank in consultation with the Central
Government. The auditors' report and report of the Central Board have to be
placed before the Parliament. The State Bank has also to transmit to the Central
Government and the Reserve Bank within two months of the date of annual
closing of accounts, the particulars of its shareholders as on that date. The
balance sheet and profit and loss account, auditor's report and report of the
Central Board shall be open for discussion by the shareholders at the annual
general meeting. The annual general meeting has to be held within six weeks of
the date of sending the balance sheet, etc., to the Central Government and the
Reserve Bank.
vi. Subsidiary Banks: The subsidiary banks of the State Bank of India were
established by different special statutes. The State Bank of Hyderabad was
constituted as Hyderabad State Bank under the Hyderabad State Bank Act and
later renamed as State Bank of Hyderabad under the State Bank of Hyderabad
Act, 1956. The State Bank of Saurashtra was constituted under the Saurashtra
State Banks (Amalgamation) Ordinance, 1950. The other banks were established
under Section 3 of the State Bank of India (Subsidiary Banks) Act, 1959. Every
subsidiary bank is a body corporate with perpetual succession and common seal
and shall sue and be sued in its own name. The majority of the issued share
capital of the subsidiary banks is held by the State Bank. The shares of the
subsidiary banks are freely transferable as provided in Section 18 of the Act.
However, the State Bank is not entitled to transfer the shares if such transfer
would result in reducing its shareholding to less than fifty per cent of the issued
capital.
vii. Management of Suhsidiarv Ranlrs- Tht* opnprai cimonnton/fon^ ^~A ~
,,-,+ ,-v-f-* f*4?£nZ-~r* rt-C ~ . 1-. — 1 .31
68
bank vests in its board of directors and the board may exercise all the powers
and carry out all functions with the assistance of the managing director, subject
to the directions and instructions given by the State Bank from time to time.
The board consists of the chairman (State Bank Chairman, ex-officio), managing
director and other directors. The directors are nominated or appointed by the
Central Government, Reserve Bank or the State Bank except for the directors to
be elected by the shareholders other than the State Bank. The State Bank
appoints the managing director after consulting the board of the subsidiary bank
and with the approval of the Reserve Bank. The day-to-day administration vests
in the managing director. The State Bank may, with the approval of the Reserve
Bank and after giving opportunity to show cause, remove the managing director
from office. The Act provides for an executive committee, consisting of
directors, which may deal with any matter within the competence of the board
subject to any regulations made under the Act.
viii. Business of Subsidiary Banks: A subsidiary bank has to act as agent of the
State Bank under Section 36 of the (SBI Subsidiary Banks) Act, at any place as
required by the State Bank to receive, collect and remit money, bullion and
Government securities on behalf of the Government of India, and undertake
other business which the Reserve Bank may entrust the State Bank from time to
time, with the approval of the Reserve Bank. Under Section 36A, a subsidiary
bank has also act as an agent of the Reserve Bank if required by it, to undertake
Government work or other work entrusted by the Reserve Bank. The terms and
conditions of agency with the Reserve Bank will be as agreed between the
Reserve Bank and the subsidiary bank and if no agreement is reached or dispute
arises, the decision of the Central Government shall be final. A subsidiary bank
shall also transact the business of banking as defined in Section 5(b) of the
Banking Regulation Act and any other business specified in Section 6(1) of that
Act.
The Central Government may after consultation with the State Bank and Reserve
Bank, by order in writing authorise a subsidiary bank to undertake other form of
business or prohibit it from carrying on any business, which is otherwise lawful
for it to engage in. It is open to a subsidiary bank to acquire the business of other
banks with the approval of State Bank. The Reserve Bank may direct the bank in
consultation with State Bank to acquire the business of any bank.
ix. Accounts and Audit: Subsidiary banks have to close and balance their
accounts annually as on 31 March or such other date as may be specified by the
Central Government by notification in the official gazette. After providing for
bad and doubtful debts and other matters specified in Section 40 of the SBI (sub-
Banks) Act, a subsidiary bank may declare a dividend out of its profits.
The audit of accounts has to be done by a qualified auditor of companies as
specified under Section 226 of the companies Act who shall be appointed by the
State Bank in consultation with the Reserve Bank.
The balance sheet and profit and loss account together with auditors' report and
report of the board on the working and activities of the bank have to be
submitted as returns to the State Bank, Reserve Bank and the Central
Government within three months of the date of closing accounts. The Reserve
Bank may extend the period by further three months in consultation with the
State Bank.
A general meeting of shareholders shall be held annually as required under
Section 44 of the Act within six weeks of sending the accounts, etc., to the State
Bank and others. The shareholders are entitled to discuss the balance sheet,
profit and loss account, auditor's report and the board's report at such meeting.
The State Bank is empowered under Section 47 to inspect the subsidiary banks.
69
x. Rules and Regulations: The Central Government is empowered to make rules
under Section 62 of the Act for giving effect to the purposes of the Act. The
State Bank is also empowered to make regulations under Section 63 with the
approval of the Reserve Bank for giving effect to the purposes of the Act.
5.3 REGIONAL RURAL BANKS
The Regional Rural Banks (RRBs) are public sector institutions, regionally
based, rural oriented and engaged in commercial banking. They were first set up
in 1975 under the Regional Rural Banks Ordinance, 1975. The ordinance was
later replaced by the Regional Rural Banks Act, 1976. The formation of these
banks was the result of the growing realisation that the ethos and attitude of the
existing public sector banks were not fully conducive to meet the credit needs of
the rural people. As stated in the preamble to the Act, the object of setting up
regional rural banks is to develop rural economy by providing credit and other
facilities for the purpose of development of agriculture, trade, commerce,
industry and other productive activities in rural areas, particularly to small and
marginal farmers, agricultural labourers, artisans and small entrepreneurs.
i. Establishment of RRBs: Section 3 of the Act authorises the Central
Government to establish regional rural banks by notification in the official
gazette at the request of a sponsor bank to operate within specified local limits.
'Sponsor Bank' is a bank by which a regional rural bank is sponsored and it holds
35 per cent of the issued capital of the RRB, while the Central Government
holds 50 per cent and the State Government holds the remaining fifteen per cent
of the issued capital. Every RRB is a body corporate with perpetual succession
and common seal with power to acquire, hold and dispose of property and to sue
and be sued in its name. Generally, a regional rural bank is allotted a compact
area of operation comprising a few districts with homogeneous agro-climatic
conditions and rural clientele: These banks may accept all types of deposits from
the public and engage in the business of 'banking' as defined in Section 5(b) of
the Banking Regulation Act.
ii. Management of the Affairs of an RRB: The management of RRB vests in the
board of directors. The board has to function on business principles with due
regard to public interest. The board is empowered to make regulations for giving
effect to the provisions of the Act in consultation with the sponsor bank and with
previous approval of the Central Government. The Central Government is
empowered to give directions to RRBs on matters of policy involving public
interest.
The board consists of a chairman appointed by the sponsor bank from among its
officers in consultation with the National Bank, or otherwise in consultation with
the Central Government. The chairman holds office on whole-time basis and is
removable by the sponsor bank, where the chairman is an officer of the sponsor
bank, in consultation with the National Bank and in other cases in consultation
with the Central Government.
A person who is adjudged insolvent or is convicted of an offence involving
moral turpitude is disqualified to be a director and has to vacate office. Absence
from three meetings consecutively without leave of the board also results in
vacation of office.
iii. Business of Regional Rural Banks: Regional rural banks may transact the
business of banking as defined in Section 5(b) of the Banking Regulation Act
and any other business permissible for a bank to undertake under Section 6(1) of
that Act. However, the main thrust of the business would be granting of loans
and advances to small and marginal farmers, agricultural labourers, agricultural
marketing societies, farmers' service societies, artisans, small entrepreneurs, etc.,
within the notified area of operation.
70
other date as the Central Government may specify. The auditors have to be
appointed with the approval of the Central Government. A person qualified to
act as an auditor of companies under Section 226 of the Companies Act is
qualified to be an auditor of a regional rural bank. The auditor's report and report
on the working of the bank has to be laid before the Parliament. The sponsor
bank is empowered to monitor the progress of the RRBs by inspection, internal
audit and scrutiny and suggest corrective measures.
v. Amalgamation: Two or more RRBs may be amalgamated by the Central
Government by notification in the official gazette. Such notification shall
provide for all terms and conditions of amalgamation including continuation of
service of employees and shall be binding on the banks and all other parties
concerned.
5.4 NATIONALISED BANKS
The Bank Nationalisation Acts [Banking Companies (Acquisition and Transfer
of Undertakings) Act, 1970 and Banking Companies (Acquisition and Transfer
of Undertakings) Act, isfeO] transferred the undertakings of then existing private
banks to the corresponding new banks established under these Acts. These
corresponding new banks, are popularly known as Nationalised banks.
Originally, the entire paid-up capital (equity shares), of the Nationalised banks
were held by the Central Government. Some of these banks have recently made
public issues of shares, but the Central Government still holds the majority of
shares in all these banks. The Banking Companies (Acquisition and Transfer of
Undertakings) and Financial Institutions Laws (Amendment) Act, 2006 enables
these banks to raise capital by way of public issue or preferential allotment or
private placement of equity shares or preference shares. The Central
Government shall, however, at all times hold not less than fifty one per cent of
the equity of these banks. The shares other than those held by the Central
Government are freely transferable. The guidelines for issue of preference shares
(including those on the classes of preference shares) shall be issued by the
Reserve Bank. No equity shareholder other than the Central Government can
exercise voting rights in excess of one per cent of the total voting rights of all the
shareholders. In the case of the preference shareholders, they shall have a right
to vote in respect of those shares only on resolutions which directly affect the
rights attached to the preference shares. Further, no preference shareholder shall
be entitled to exercise voting rights in respect of the preference shares held by
him in excess of one per cent of the total voting rights of all the shareholders
holding preference share capital only.
Every Nationalised bank is a body corporate having perpetual succession and
common seal and power to acquire, hold and dispose of property and enter into
contracts and to sue and be sued in its name. These banks may carry on the
business of banking as defined in Section 5(b) of the Banking Regulation Act
and other forms of business specified in Section 6(1) of that Act. The
Nationalised banks have also to act as agents of the Reserve Bank, if so required
by the Reserve Bank to undertake the banking business of Central Government
and any other business entrusted by the Reserve Bank.
a. Management: The general superintendence, direction and management of the
affairs of a Nationalised bank vests in the board of directors. The board can
exercise all the powers and functions of the bank and shall be entitled to discuss,
approve and adopt the annual accounts. The Central Government is empowered
to issue directions to the bank in the discharge of its functions on matters of
policy involving public interest after consultation with the Governor of the
Reserve Bank, to supersede the board on the recommendation of the Reserve
Bank and also to appoint an administrator. Further, under Section 9 of both the
Nationalisation Acts, the Central Government has the power to make a scheme
for carrying out the provisions of the Act after consultation with the Reserve
Bank. The
71
Government may also amend or vary the scheme in consultation with the
Reserve Bank. Such a scheme has to be laid before Parliament and is binding on
the bank and any person having any right or liability in relation to the bank.
b. Directors: The directors of Nationalised banks are nominated by the
Central Government or elected
from the shareholders. The nomination of directors is as under:
(i) not more than four whole-time directors (as against two earlier);
(ii) one director who is an official of the Central Government to be nominated by
the Central
Government; (iii) one director, possessing necessary expertise and 'experience in
matters relating to regulation
or supervision of commercial banks, to be nominated by the Central Government
on the
recommendation of the Reserve Bank; (iv) a director representing workmen
employees of the bank; (v) a director representing officers of the bank; (vi) one
chartered accountant with not less than fifteen years experience nominated in
consultation
with Reserve Bank; (vii) not more than six directors to be nominated by Central
Government.
The other shareholders can elect up to a maximum of three directors to the
board. No person shall be eligible to be elected as director, unless he is a person
having fit and proper status based upon track record, integrity and such other
criteria as the Reserve Bank may notify from time to time in this regard. The
Reserve Bank may also specify in the notification, the authority to determine the
fit and proper status, the manner of such determination, the procedure to be
followed for such determination and such other matters as may be considered
necessary or incidental thereto.
The directors nominated under Item (vii) and the elected directors should have
special knowledge or practical experience of agriculture and rural economy,
banking, cooperation, economics, finance, law, small scale industry or other
knowledge or experience useful to the bank in the opinion of the Reserve Bank
or must represent the interest of depositors or farmers or workers and artisans.
An elected director, who in the Reserve Bank's opinion does not qualify the
requirements, can be removed by the Reserve Bank after giving an opportunity
of being heard. The board can co-opt any other qualified persons in his place
who will continue until another director, is duly elected in the next annual
general meeting. Apart from the direction and management of affairs of the
bank, the board has also the power to frame regulations under Section 19 for
giving effect to the provisions of the Act. This has to be done in consultation
with the Reserve Bank and with the sanction of the Central Government.
c. Additional directors: The Reserve Bank may appoint one or more
additional directors on the board
of a Nationalised bank, if it is of the opinion that in the interest of banking policy
or in the public
interest or in the interests of the bank or its depositors, it is necessary to do so.
The appointment
may be made from time to time, by order in writing, with effect from such date,
as may be
specified in the order and the additional directors shall hold office during the
pleasure of the
Reserve Bank and subject thereto, for a period not exceeding three years or such
further periods
not exceeding three years at a time as the Reserve Bank may specify. They shall
not incur any
obligation or liability by reason only of being a director or for anything done or
omitted to be done
in good faith in the execution of the duties of this office or in relation thereto.
d. Accounts and Audit: Every Nationalised bank has to close its account as
on 31 March or such
other date specified by the Central Government by notification in the official
gazette as provided in
Section 10 of the Act. The auditor shall be a person duly qualified to be an
auditor of a company
under Section 226 of the Companies Act. The auditor shall make a report to the
Central Government
72
upon the balance sheet as stipulated in Section 10 of the Act. The auditor shall
send copies of the report to the bank and the Reserve Bank. The bank has to
furnish copies of the balance sheet, profit and loss account and auditor's report
along with the report of the board of directors on the working and activities of
the bank to the Central Government and the Reserve Bank. The auditor's report
and report of the board have to be laid before the Parliament. Without prejudice
to the above, the Centra] Government is also empowered to appoint auditors as it
thinks fit at any time to examine and report on the accounts of a Nationalised
bank.
A Nationalised bank may pay dividends out of profits after making the necessary
provisions under the law or as usually provided by banking companies. An
annual general meeting of shareholders has to be held within six weeks of the
date of forwarding the balance sheet, etc., to the Central Government. In such
meeting, the shareholders will be free to discuss the balance sheet, accounts,
auditors' report and report of the board. For the purpose of Income Tax Act, a
Nationalised bank is treated as an Indian company.
e. Schemes of Management: In exercise of the powers under Section 9 of the
Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 and
Section 9 of the Banking Companies (Acquisition and Transfer of Undertakings)
Act, 1980, the Central Government has framed two schemes, namely:
(i) Nationalised Banks (Management and Miscellaneous Provisions) Scheme,
1970. (ii) Nationalised Banks (Management and Miscellaneous Provisions)
Scheme, 1980.
These schemes provide in detail for constitution of board of directors,
appointment of chairman and managing director, term of office of whole-time
director including managing director, term of office of other directors,
disqualifications of directors and vacation of office, meetings of board and
committees of the board (management committee and advisory committee),
regional consultative committees, increase in paid-up capital and other
miscellaneous matters.
5.5 APPLICATION OF BANKING REGULATION ACT TO PUBLIC
SECTOR BANKS
Section 51 of the Banking Regulation Act provides that certain provisions of the
Act would apply to State Bank and its subsidiaries, Nationalised banks and
Regional Rural Banks as they apply to banking companies. The applicable
provisions are Sections 10, 13 to 15, 17, 19 to 21 A, 23 to 28, 29 [excluding the
sub-Section (3)], the sub-Sections (IB), (1C) and (2) of Sections 30, 31, 34, 35,
35A, 36 [excluding clause (d) of the sub-Section (1)], 45Y to 45ZF, 46 to 48, 50,
52 and 53. The proviso to Section 51 also gives certain exemptions from the
applicable provisions regarding holding of office in approved institutions under
Section 10(l)(c), to the chairman and the managing director of State Bank,
granting of loan, etc., under Section 20(l)(b)(iii) to all banks and nominee
directors in respect of Sections 46 and 47A.
The provisions which are not made applicable, are mainly the preliminary
provisions up to Section 9, provisions relating to capital (Sections 11 and 12),
prohibition of common directors (Section 16), licensing (Section 22) audit
except special audit (Section 30), control over management [Part IIA (Sections
36AA to 36AD)], acquisition of undertaking in Part C (Sections 36AE to 36AJ)
and winding up in Part III and Part IIIA (Sections 36B to 45X).
i. Public Sector Banks as Scheduled Banks: All the public sector banks are
scheduled banks under Section 42 of the Reserve Bank of India Act and have to
comply with the requirements of maintaining cash reserve as provided therein.
5.6 DISINVESTMENT OF SHARES BY GOVERNMENT
In the context of the Government policy to dilute the holdings in public sector
banks, certain amendments
72
upon the balance sheet as stipulated in Section 10 of the Act. The auditor shall
send copies of the report to the bank and the Reserve Bank. The bank has to
furnish copies of the balance sheet, profit and loss account and auditor's report
along with the report of the board of directors on the working and activities of
the bank to the Central Government and the Reserve Bank. The auditor's report
and report of the board have to be laid before the Parliament. Without prejudice
to the above, the Central Government is also empowered to appoint auditors as it
thinks fit at any time to examine and report on the accounts of a Nationalised
bank.
A Nationalised bank may pay dividends out of profits after making the necessary
provisions under the law or as usually provided by banking companies. An
annual general meeting of shareholders has to be held within six weeks of the
date of forwarding the balance sheet, etc., to the Central Government. In such
meeting, the shareholders will be free to discuss the balance sheet, accounts,
auditors' report and report of the board. For the purpose of Income Tax Act, a
Nationalised bank is treated as an Indian company.
e. Schemes of Management: In exercise of the powers under Section 9 of the
Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 and
Section 9 of the Banking Companies (Acquisition and Transfer of Undertakings)
Act, 1980, the Central Government has framed two schemes, namely:
(i) Nationalised Banks (Management and Miscellaneous Provisions) Scheme,
1970. (ii) Nationalised Banks (Management and Miscellaneous Provisions)
Scheme, 1980.
These schemes provide in detail for constitution of board of directors,
appointment of chairman and managing director, term of office of whole-time
director including managing director, term of office of other directors,
disqualifications of directors and vacation of office, meetings of board and
committees of the board (management committee and advisory committee),
regional consultative committees, increase in paid-up capital and other
miscellaneous matters.
5.5 APPLICATION OF BANKING REGULATION ACT TO PUBLIC
SECTOR BANKS
Section 51 of the Banking Regulation Act provides that certain provisions of the
Act would apply to State Bank and its subsidiaries, Nationalised banks and
Regional Rural Banks as they apply to banking companies. The applicable
provisions are Sections 10, 13 to 15, 17, 19 to 21 A, 23 to 28, 29 [excluding the
sub-Section (3)], the sub-Sections (IB), (1C) and (2) of Sections 30, 31, 34, 35,
35A, 36 [excluding clause (d) of the sub-Section (1)], 45Y to 45ZF, 46 to 48, 50,
52 and 53. The proviso to Section 51 also gives certain exemptions from the
applicable provisions regarding holding of office in approved institutions under
Section 10(l)(c), to the chairman and the managing director of State Bank,
granting of loan, etc., under Section 20(l)(b)(iii) to all banks and nominee
directors in respect of Sections 46 and 47A.
The provisions which are not made applicable, are mainly the preliminary
provisions up to Section 9, provisions relating to capital (Sections 11 and 12),
prohibition of common directors (Section 16), licensing (Section 22) audit
except special audit (Section 30), control over management [Part IIA (Sections
36AA to 36AD)], acquisition of undertaking in Part C (Sections 36AE to 36AJ)
and winding up in Part III and Part IIIA (Sections 36B to 45X).
i. Public Sector Banks as Scheduled Banks: All the public sector banks are
scheduled banks under Section 42 of the Reserve Bank of India Act and have to
comply with the requirements of maintaining cash reserve as provided therein.
5.6 DISINVESTMENT OF SHARES BY GOVERNMENT
In the context of the Government policy to dilute the holdings in public sector
banks, certain amendments
were made in the statutes governing public sector banks. The State Bank of India
Act, was amended by the State Bank of India (Amendment) Act, 1993. Section 4
was modified to divide capital into shares of Rs. 10 each instead of Rs. 100. The
restriction on voting rights (which existed under Section 11, being up to two
hundred shares only) was modified as up to ten per cent of the issued capital and
restriction on dividends was deleted.
The Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970
(and also the 1980 Act) were modified by Amendment Acts of 1994 and 1995,
for facilitating public holding of shares. Section 3 was amended to provide for
an authorised capital of Rs. 1,500 crore, divided into shares of Rs. 10 each, to
increase or reduce the authorised capital between Rs. 1,500 crore and Rs. 3,000
crore, for transferability of shares, other than those held by the Government,
raising of capital through public issue, voting rights of shareholders (limited to
one per cent per shareholder) and keeping register of shareholders including in
floppies. Section 10A was amended to declare dividends, as earlier balance of
profits was to be transferred to the Central Government..
5.7 CO-OPERATIVE BANKS
i. Applicability of BR Act:
(a) Co-operative banks are registered either under the state laws governing
co-operatives or under
the multi-state Co-operative Societies Act. If a co-operative bank operates only
in one state,
the state law applies and in the case of co-operative banks operating in more
than one state, the
Central Act applies. While the state law/Central law governs the constitution and
related matters,
the business of banking is regulated by the Banking Regulation Act as applicable
to co-operative
societies.
(b) The Banking Regulation Act is applicable to co-operative societies
subject to the modifications
stipulated in Part V (Section 56) of the Act. The Act was made applicable to co-
operative
societies by the Banking Laws (Application to Co-operative Societies) Act,
1965. As defined in
Section 5 (cci) of the BR Act (as applicable to co-operative societies), a co-
operative bank
means a state co-operative bank, a central co-operative bank and a primary co-
operative bank.
A primary co-operative bank is a co-operative society other than a primary
agricultural credit
society, which satisfies the following criteria;
(i) The primary object or principal business is the transaction of banking
business, (ii) The paid-up share capital and reserves are not less than Rs. 1 lac.
(iii) The byelaws do not permit admission of any other co-operative society as a
member (except the membership of a co-operative bank by subscribing to the
share capital of the society out of the funds provided by the state Government).
(c) A state co-operative bank is the principal co-operative society in a state
with the primary
objective of financing other societies. A central co-operative bank is the
principal co-operative
society in a district with the primary objective of funding other co-operative
societies in the
district
The reference to banking company in the Act shall be construed as a reference to
co-operative banks unless the context otherwise requires.
ii. Bank, Banker, Banking: No co-operative society other than a co-operative
bank is permitted to use as part of its name or in connection with the business,
the words 'bank', 'banker' and 'banking'. Further, a co-operative society carrying
on banking business has to use at least one of such words as part of its name.
However, certain categories of co-operative societies are exempt from these
provisions as follows:
(a) a primary credit society;
74
(b) a co-operative society formed for the protection of the mutual interest of
co-operative banks
or co-operative land development banks;
(c) a co-operative society other than a primary credit society formed by
employees of the State
Bank, a subsidiary bank, a Nationalised bank or a co-operative bank, a primary
credit society,
or a co-operative land development bank.
iii. Paid-up Capital and Reserves: The minimum paid-up capital and reserves
required to commence or carry on banking business by a co-operative bank is
not less than Rs. 1 lakh under Section 11 (as applicable to co-operative banks).
However, this provision is not applicable to a primary credit society, which
becomes a primary co-operative bank after the commencement of the Act, for a
period of two years from the date it becomes a primary co-operative bank. The
Reserve Bank may give a further period of one year in the interests of depositors
of the primary co-operative bank in any particular case. For calculating the value
of paid-up capital and reserves, the real and exchangeable value and not the
nominal value would be considered. In the case of a dispute regarding the value
of paid-up capital and reserves, Reserve Bank's decision shall be final.
iv. Cash Reserve: Co-operative banks other than scheduled Co-operative Banks
and scheduled state co-operative banks have to maintain in India by way of cash
reserve with itself or by way of balance in current account with the Reserve
Bank or the state co-operative bank of the state concerned or district Co-
operative Bank or by way of net balance in current accounts or any one or more
of these ways a sum equivalent to at least three per cent of its total demand and
time liabilities in India. In the case of a primary co-operative bank the balance in
current accounts with the central co-operative bank of the district concerned may
also be taken into account. The balance has to be reckoned as on the last Friday
of the second preceding fortnight. The co-operative bank has to submit a return
every month showing such amount held by it on alternate Fridays during a
month along with the particulars of its demand and time liabilities in India on
such Fridays. When the relevant Friday is a holiday under the Negotiable
Instruments Act, the return shall be required as at the close of business on the
preceding working day. The demand and time liabilities have to be calculated as
stipulated in Section 18 (as applicable to co-operative societies). For scheduled
Primary Co-operative Banks and State co-operative Banks, CRR has to be
maintained as per Section 42 of RBI Act.
v. Restrictions on Loans and Advances:
(a) Section 20 of the Banking Regulation Act (as applicable to co-operative
societies) lays down certain restrictions on loans and advances by co-operative
banks. Accordingly, a co-operative bank shall not grant loans and advances as
under:
(i) loans and advances on the security of its own shares; (ii) unsecured loans or
advances to any of its directors;
(iii) unsecured loans or advances to firms or private companies in which any of
its directors are interested as partner, managing agent or guarantor, or to
individuals in cases where any of its directors is a guarantor for the loans or
advances;
(iv) unsecured loans or advances to any company in which the chairman of the
co-operative bank is interested as managing agent or chairman or managing
director.
However, these restrictions do not apply to unsecured loans or advances made
by a co¬operative bank against bills for supplies or services made to
Government or bills of exchange arising out of bona fide, commercial or trade
transactions. Further, unsecured loans or advances in respect of which trust
receipts are furnished to the co-operative bank and loans to directors or any other
persons within the limits and on terms and conditions approved by the Reserve
Bank are also exempted.
i
I i
ij
75
(b) Every co-operative bank has to submit a return in the prescribed form
showing the unsecured loans and advances granted by it to companies in which
its directors are interested as director, managing agent, or guarantor. Such
returns have to be filed before the close of the month succeeding to which the
return relates. If it appears to the Reserve Bank on examination of any return that
the loans or advances were granted to the detriment of the interest of depositors,
Reserve Bank may prohibit granting of such further loans or advances. The
Reserve Bank may also impose other restrictions on the grant of such loans and
direct the co-operative bank to secure the repayment of the loan or advance
within a stipulated time.
Note: It must be noted here that RBI with effect from 1 October 2003, has
prohibited co-operative banks from providing, renewing secured or unsecured
loans and advances or any other funded or non-funded financial accommodation
to their directors or their relatives and firm/companies in which their relatives
are interested.
vi. Licensing of Co-operative Banks:
(a) Every co-operative society requires a licence from the Reserve Bank
under Section 22
of the Banking Regulation Act (as applicable to co-operative societies) to carry
on
banking business in India. However, primary credit societies are exempt from
the requirement.
The Reserve Bank may impose such conditions as it may deem fit while granting
licence
to a co-operative bank. Co-operative societies carrying on banking business at
the commence¬
ment of the Banking Laws (Application to Co-operative Societies) Act, 1965
were given
exemption for a period of one year. Every co-operative society carrying on
banking
business at the commencement of the Act had to apply for a licence within three
months
from such commencement and every primary co-operative society, which
becomes a
primary co-operative bank after such commencement has to apply for a licence
before
three months from the date of it becoming a primary co-operative bank. After
applying
for licence the co-operative bank can continue to carry on banking business
unless its
licence is rejected.
(b) A co-operative bank requires the prior permission of the Reserve Bank
for opening a new place
of business or changing an existing place of business otherwise within the same
city, town or
village where it has an existing place of business. However, opening of
temporary branches for
a period not exceeding one month within the city, town or village where it has a
place of
business, on the occasion of an exhibition, conference, mela or any like occasion
is permissible.
The opening or changing of location of branches by a central co-operative bank
within its area
of operation is also exempt. The application of a co-operative bank for
permission to open a
branch, other than of a primary co-operative bank, has to be routed through the
National Bank.
However, an advance copy of the application has to be sent directly to Reserve
Bank.
vii. Liquid Assets: Co-operative banks have to maintain liquid assets as provided
in Section 24(1) of the Banking Regulation Act. In computing the amount of
liquid assets any balances maintained by a co¬operative bank in current account
with the Reserve Bank or by way of net balances in current accounts would be
taken into account. In the case of state co-operative banks, which are scheduled
banks, the balances required under Section 42 of the RBI Act will also be
accounted. In the case of the Central co-operative banks, balances maintained
with the state co-operative bank concerned and in the case of primary co-
operative banks the balances maintained with Central co-operative banks or the
state co-operative bank concerned shall be accounted. The co-operative banks
have also to maintain as specified in Section 24(2A) liquid assets being not less
than 25 per cent or such other percentage not exceeding forty per cent as the
Reserve Bank may stipulate by notification in the Gazette. The amount has to be
maintained as at the close of business on any day. For this
76
purpose, any balance maintained by a scheduled private co-operative banks and
state co-operative bank with the Reserve Bank in excess of the balance required
under Section 42 of the RBI Act shall be accounted. Similarly, cash or balances
maintained in India by a non-scheduled co-operative bank with itself or with the
state co-operative bank or in current account with Reserve Bank or net balance
in current accounts in excess of the requirement of Section 18 would be
accounted. In the case of primary co-operative banks, such balances maintained
with the Central co-operative bank of the district concerned will also be taken
into account.
The co-operative banks have to file a return with the Reserve Bank and every
co-operative bank, other than a primary co-operative bank has also to furnish a
copy thereof to the National Bank.
viii. Accounts and Audit: Every co-operative bank has to prepare a balance sheet
and profit and loss account of its business as on the last working day of the year.
The balance sheet and accounts have to be prepared in the forms set out in the
third schedule to the Act or as near thereto as circumstances admit. Three copies
of such balance sheet and accounts, along with statutory auditor's report has to
be submitted to the Reserve Bank within six months. A state co-operative bank
and a central co¬operative bank have to submit such return to the National Bank
also.
ix. Inspection: The provisions of Section 35 relating to inspection are applicable
to co-operative banks with minor modifications. It is also open to Reserve Bank
to call for inspection of a primary co¬operative bank by one or more officers of
the state co-operative bank in the state where the primary co-operative bank is
registered. The Reserve Bank may supply a copy of the report on any inspection
or scrutiny to the state co-operative bank or the Registrar of Co-operative
Societies concerned.
x. Insured Co-operative Banks:
(a) Registration with DICGC: The Deposit Insurance and Credit Guarantee
Corporation Act, 1961,
which provides for insuring deposits of banks, is applicable to co-operative
banks also.
Accordingly, under Section 13C of the Act, co-operative banks have to be
registered with the
corporation for this purpose. The registration of a co-operative bank may be
cancelled if:
(i) it is prohibited from accepting deposits;
(ii) its licence is cancelled;
(iii) it has been ordered to be wound up;
(iv) it has ceased to be a co-operative bank under the sub-Section (2) of Section
36A of the
BRAct;
(v) it has converted into a non-banking co-operative society; (vi) it has been
amalgamated with any other co-operative society; (vii) it has transferred its
deposit liabilities to any other institute or; (viii) it ceases to be an eligible co-
operative bank.
(b) Eligible Co-operative Bank: An eligible co-operative bank is defined in
Section 2(gg) of the Act.
Accordingly, for a co-operative bank to become an eligible co-operative bank,
the law governing
that co-operative bank should have the following provisions:
(i) An order for the winding up, or an order sanctioning a scheme of compromise
or arrangement or of amalgamation or reconstruction of the bank, may be made
only with the previous sanction in writing of the Reserve Bank.
(ii) An order for the winding up of the bank shall be made, if so required by the
Reserve Bank in the circumstances referred to in Section 130.
(iii) An order shall be made for the supersession of the committee of
management or other managing body of the bank and the appointment of an
administrator therefore for such period or periods not exceeding five years in the
aggregate as may be specified by the
77
Reserve Bank if so required by the Reserve Bank in the public interest or for
preventing the affairs of the bank being conducted in a manner detrimental to the
interests of the depositors or for securing the proper management of the bank.
(iv) An order for the winding up of the bank, or an order sanctioning a scheme of
compromise or arrangement or of amalgamation or reconstruction or an order for
the supercession of the committee of management or other managing body of the
bank and the appointment of an administrator therefore made with the previous
sanction in writing or on the requisition of the Reserve Bank shall not be liable
to be called in question in any manner.
(v) The liquidator or the insured bank or the transferee bank, as the case may be,
shall be under an obligation to repay the corporation as provided in Section 21 of
the Act.
(c) Requisition by Reserve Bank for Winding Up: Section 130 of the DICGC
Act mentions the circumstances in which Reserve Bank may require winding up
of a co-operative bank. Such circumstances are that:
(i) the co-operative bank has failed to comply with the requirements as to
minimum paid-up
capital and reserves specified in Section 1 ] of the Banking Regulation Act; (ii)
the co-operative bank has under Section 22 of the Act (dealing with licence)
become disentitled to carry on banking business in India;
(iii) the co-operative bank has been prohibited from receiving fresh deposits by
an order under Section 35(4) of the Act or under Section 42(3A)(b) of the
Reserve Bank of India Act;
(iv) the co-operative bank having failed to comply with any requirement of the
Banking Regulation Act, 1949, other than the requirements laid down in Section
11 thereof, has continued such failure or having contravened any provisions of
the Act, has continued such contravention beyond such period or periods as may
be specified by the Reserve Bank, after notice in writing of such failure or
contravention has been conveyed to the co-operative bank;
(v) the co-operative bank is unable to pay its debts;
(vi) in the opinion of the Reserve Bank, a compromise or arrangement
sanctioned by a competent authority in respect of the co-operative bank cannot
be worked satisfactorily with or without modification, or the continuance of the
co-operative bank is prejudicial to the interests of its depositors.
A co-operative bank, shall be deemed to be unable to pay its debts if, (i) on the
basis of the returns, statements or information furnished to the Reserve Bank
under or in pursuance of the provisions of the Banking Regulation Act, the
Reserve Bank is of opinion that the co-operative bank is unable to pay its debts,
(ii) if the co-operative bank has refused to meet any lawful demand made at any
of its offices or branches within two working days, if such demand is made at a
place where there is an office, branch or agency of the Reserve Bank, or within
five working days if such demand is made elsewhere and, in either case, the
Reserve Bank certifies in writing that the co-operative bank is unable to pay its
debts
5.8 LET US SUM UP
1. The public sector banks, namely, State Bank and its subsidiaries, the
Nationalised banks and the regional rural banks are statutory corporations (or
body corporate) established under special statutes. State Bank and its
subsidiaries, as Nationalised banks, are commercial banks engaged in the
business of banking and other forms of business permissible for banking
companies. The regional rural banks are also commercial banks but operating in
limited local areas to cater to rural industries,
71
trade, farmers, artisans, etc. The State Bank and its subsidiaries and the
Nationalised banks also act as agents of the Reserve Bank to transact the
banking business of the Central Government. All public sector banks are
governed by their respective, statutes and the rules, regulations or schemes made
under these statutes. In addition to this, these banks are also governed by certain
provisions of the Banking Regulation Act as stipulated in Section 51 of that Act.
The provisions of the Reserve Bank of India Act are also applicable to them.
2. The co-operative banks, functioning in one state only are registered under the
state laws on co-operative societies. The co-operative banks operating in more
than one state, are registered under the multi-state Co-operative Societies Act.
The Banking Regulation Act is applicable to co-operative banks as provided in
Section 56 of that Act with certain modifications. For this purpose, a co-
operative bank means a state co-operative bank, Central co-operative bank and a
primary co-operative bank. While, the constitution of the bank is governed by
the co¬operative laws, the business of banking undertaken by them is regulated
by the Reserve Bank under the BR Act.
5.9 KEYWORDS
Nationalised Bank; Subsidiary Bank; Primary Co-operative Bank; Regional
Rural Bank; Sponsor Bank; Co-operative Bank; Central Co-operative Bank;
State Co-operative Bank; Co-operative Credit Society.
5.10 CHECK YOUR PROGRESS
1. Fill up the blanks choosing answers from the brackets.
(i) The State Bank of India is a
constituted under the State Bank of India Act.
(ii) (iii)
in consultation with the Reserve
(banking company, body corporate, society) The Chairman of the State Bank is
appointed by.
Bank, (the Central Board, Banking Service Recruitment Board, Central
Government)
State Bank has to act as and carry out Central Government business and other
business entrusted by the Reserve Bank, (agent of Reserve Bank, agent of
Central Government,
advisor to the Central Government)
(iv) The provisions of the are applicable to State Bank as stipulated in
Section 51 of
_. (Reserve Bank, Central
the BR Act. (RBI Act, Banking Regulation Act, Companies Act)
(v) The majority of shares of subsidiary banks are held by
Government, State Bank)
(vi) Regional rural banks operate in . (a notified area, the whole of a state,
only a
district)
(vii) The management of the affairs of a regional rural bank vests in . (the
Sponsor
Bank, its board of directors, the National Bank)
2.
Say whether true or false
(i) The State Bank can make statutory regulations for carrying out the purposes
of the State
Bank of India Act, in consultation with Reserve Bank and with previous
approval of the
Central Government, (ii) The Central Government is not authorised to give any
directions to the State Bank in matters
of policy involving public interest, (iii) The provisions of Section 42 of the
Reserve Bank of India Act relating to cash reserve apply
to State Bank.
(iv) Subsidiary banks do not have to maintain liquid assets under Section 24 of
the BR Act. (v) Regional rural banks may transact the business of banking as
defined in Section 5(b) of the
BR Act and also other business specified in Section 6(1) of that Act.
2. 3.
79
3.
4.
(vi) Two regional rural banks may be amalgamated by the Reserve Bank by
notification in the
gazette, (vii) The management of Nationalised Banks is governed by the
Nationalised Banks (Management
and Miscellaneous Provisions) Schemes of 1970 and 1980.
Fill in the gaps choosing answers from the brackets.
in the Banking
(i) Unless the context otherwise requires, the reference to a
Regulation Act shall be construed as reference to a co-operative bank, (co-
operative society,
banking company, body corporate)
(ii) in relation to a co-operative society, for the purpose of BR Act, includes
a
member of any committee or body for the time being vested with the
management of the
affairs of that society. (Director, Member, Manager) (iii) The requirement of
minimum paid-up capital and reserves for a co-operative bank to
commence or carry on banking business is . (Rs. 1 crore, Rs. 1 lakh, Rs. 10
lakh)
(iv) There are restrictions on co-operative banks on in other co-operative
societies
under Section 19 of the BR Act. (holding of shares, keeping deposits, acquiring
any interest) (v) Central and state co-operative banks have to submit their returns
under Section 31 of BR
Act to . (Reserve Bank and National Bank, National Bank only, Reserve Bank
only)
(vi) Under Section 23 of the BR Act, without the permission of Reserve Bank, a
can open a new place of business within the area of its operation, (central co-
operative
bank, state co-operative bank, primary co-operative bank) (vii) Co-operative
banks have to prepare their balance sheet and profit and loss account in the
forms set out in the Third Schedule to . (Banking Regulation Act, Reserve
Bank
of India Act, State Co-operative Societies Act)
Say whether true or false.
(i) Banking Regulation Act was made applicable to co-operative banks by the
Banking Laws
(Application to Co-operative Societies) Act, 1965. (ii) A primary co-operative
bank does not require licence from the Reserve Bank to carry on
banking business, (iii) The provisions of the Banking Regulation Act as
provided in Section 56 of the Act apply to
co-operative banks, (iv) A 'Co-operative Bank' means a primary co-operative
bank, central co-operative bank and a
state co-operative bank, (v) There are no restrictions under the BR Act on
lending by co-operative banks to their directors
or firms in which they are interested, (vi) A scheduled co-operative bank has to
maintain cash reserve as stipulated in Section 42 of
the Reserve Bank of India Act (as applicable to co-operative societies).
(vii) Inspection of co-operative banks is done by the state Government under the
Co-operative Socie¬ties Act and the Reserve Bank has no power to inspect
under the Banking Regulation Act.
5.11 ANSWERS TO CHECK YOUR PROGRESS'
Central Government
BRAct
notified area
1. (i) body corporate (ii)
(iii) Agent of Reserve Bank (iv)
(v) SBI (vi)
(vii) its board of directors
2. (i) True; (ii) False; (iii) True; (iv) False; (v) True; (vi) False; (vii)
True
3. (i) Banking company (ii) Director
(iii) Rs. 1 lakh (iv) Holding of shares
(vi) Central co-operative bank (vii) Bunking Regulation Act 4. (i) True; (ii)
False; (iii) True; (iv) True; (v) False; (vi) True; (vii) False
5.12 TERMINAL QUESTIONS
Fill in the blanks choosing answers from brackets. 1. State Bank may act as
agent of the Reserve Bank
. (for transacting only Government
business; for transacting Government business and other business entrusted by
the Reserve
Bank; only for collection of taxes)
2.
shall be the ex-officio chairman of the subsidiary banks. (Chairman of
State Bank;
Finance Secretary to Central Government; Managing Director of the State Bank)
3. The thrust of business of regional rural banks is to make loans and
advances available 'in rural
areas' (only to farmers; only to small enterprises; small and marginal formers,
agricultural labourers,
artisans and small entrepreneurs in particular).
4. Nationalised banks can undertake (only such business as
permitted by the
Government from time to time; only such business as permitted by the Reserve
Bank in consultation with Central Government; banking business and any other
business permissible for banks under Section 6(1) of the BR Act.
5. The auditor of a Nationalised bank has to be (an officer of the
Central Government
under the C&AG; an officer of the Reserve Bank; a person duly qualified to be
an auditor of a company under Section 226 of the Companies Act.
Choose the correct statements from the following:
6. (i) The provisions relating to licensing under Section 22 of the BR Act
are applicable to Nationalised
banks, (ii) The provisions of Section 22 of the BR Act relating to licensing are
not applicable to Nationalised
banks, (iii) The provisions relating to cancellation of licence under Section 22 of
the BR Act are applicable
to Nationalised banks.
7. (i) All public sector banks are scheduled banks.
(ii) All regional rural banks are not scheduled banks, (iii) Some public sector
banks are not scheduled banks.
8. (i) BR Act is not applicable to primary agricultural credit societies.
(ii) Primary credit societies are required to hold a licence under the BR Act. (iii)
BR Act is applicable to co-operative land development banks (Agricultural and
Rural Development Banks)
9. (i) A co-operative bank is not eligible for insurance under the DICGC
Act.
(ii) An eligible co-operative bank under Section 2(gg) of the DICGC Act has to
be registered with the DICGC for insurance.
(iii) The registration of a co-operative bank for insurance with DICGC cannot be
cancelled even
if it converts into a non-banking co-operative society.
10. (i) Reserve Bank can direct the Registrar of co-operative societies to wind
up an insured co¬operative bank if it is unable to pay its debts.
(ii) Reserve Bank can suo moto wind up a co-operative bank if the bank is
unable to pay its debts.
(iii) The Registrar can suo moto wind up a co-operative bank in the
circumstances mentioned in Section 13D of the DICGC Act.
MODULE -B
LEGAL ASPECTS OF BANKING OPERATIONS
Unit 6. Case Laws on Responsibility of Paying Bank
Unit 7. Case Laws on Responsibility of Collecting Bank
Unit 8. Indemnities
Unit 9. Bank Guarantees
Unit 10. Letters of Credit
Unit 11. Deferred Payment Guarantee
Unit 12. Laws Relating to Bill Finance
Unit 13. Various Types of Securities
Unit 14. Law Relating to Securities and Modes of Charging -1
Unit 15. Law Relating to Securities and Modes of Charging - II
Unit 16. Different Types of Borrowers
Unit 17. Types of Credit Facilities
Unit 18. Secured and Unsecured Loans, Registration of Firms,
Incorporation of Companies
Unit 19. Registration and Satisfaction of Charges
CASE LAWS ON RESPONSIBILITY OF PAYING BANK
STRUCTURE
6.0 Objectives
6.1 Introduction
6.2 Negotiable Instruments Act and Paying Banks
6.3 Liability of Paying Banker when Customer's Signature on Cheque is
Forged
6.4 Payment to be in Due Course for Bank to Seek Protection
6.5 Payment in Good Faith, without Negligence of an Instrument on which
Alteration is not
Apparent
6.6 Payment by Bank Under Mistake Whether Recoverable
6.7 Let Us Sum Up
6.8 Keywords
6.9 Check Your Progress
6.10 Answers to 'Check Your Progress'
' L.K.A.D-7
84
6.0 OBJECTIVES
After studying this unit, you should be able to:
• explain the various laws applicable to a paying bank;
• explain the responsibilities of a paying bank based on case laws;
• explain the protection given under law to a paying bank as decided by
Courts.
6.1 INTRODUCTION
The Negotiable Instruments Act, 1881 lays down the law relating to payment of
a customer's cheque by a banker and the protection available to a banker. The
relationship between a banker and customer being debtor-creditor relationship
the banker is bound to pay the cheques drawn by his customer. This duty on the
part of the banker, to honour his customers' mandate, is laid down in Section 31
of the Negotiable Instruments Act.
Sections 10, 85, 85A, 89 and 128 of the Negotiable Instruments Act, 1881, grant
protection to a paying banker. We shall in detail, examine individually these
sections and with the help of case laws apply the provisions of these sections to a
given set of facts.
6.2 NEGOTIABLE INSTRUMENTS ACT AND PAYING BANKS
As stated in Part 1.1 of this unit, the customer who has deposited money with a
bank being a creditor has the right to ask back the money from the banker who is
a debtor. The duty on the part of the banker to pay has been laid down in Section
31 of the Negotiable Instruments Act, 1881 in the following terms:
'The drawee of a cheque having sufficient funds of the drawer in his hands
properly applicable to the payment of such cheque must pay the cheque when
duly required to do so, and, in default of such payment, must compensate the
drawer for any loss or damage caused by such default.'
The following points are important to note:
i. Section 31 Applies Only to Bankers: This is because as per Section 6 of the
Negotiable Instruments
Act, 1881 'cheque' has been defined as a "bill of exchange drawn on a specified
banker and not
expressed to be payable otherwise than on demand'", ii. Sufficient Funds: The
banker should have sufficient funds of the drawer, i.e. there should be
sufficient credit balance in the customer's account, iii. Properly Available: The
funds available in the customer's account should also be properly available
for the payment of the cheque. The funds may not be available to pay the cheque
if:
(a) the banker has exercised his right of set off for amounts due from the
customer, or
(b) there is an order passed by a Court, competent authority or other lawful
authority restraining
the bank from making payment.
iv. When Duly Required to Do So: The banker is duty bound to pay the cheque
only when he is duly required to do so. It means that the cheque must be
properly drawn and signed by the drawer.
v. Compensate the Drawer: In case the banker refuses payment wrongfully, then
he is liable only to the drawer of the cheque and not to any endorsee or holder,
except when
(a) the bank is wound up, in which case the holder becomes a creditor
entitled to make a claim;
(b) the banker pays a cheque disregarding the crossing, wherein the true
owner can hold the
banker liable.
vi. Loss or Damage Caused by Default: A banker is liable to the drawer for any
loss or damage, which may have occurred to the drawer due to the wrongful
dishonour of the customer's cheque.
85
Protection to paying banker: For a paying banker to claim protection under the
Negotiable Instruments Act, one of the criteria he has to satisfy, is that the
payment is in due course. As to what is, payment in due course has been stated
in Section 10, which reads as follows:
Payment in due course: 'Payment in due course' means payment in accordance
with the apparent tenor of the instrument in good faith and without negligence to
any person in possession thereof under circumstances which does not afford a
reasonable ground for believing that he is not entitled to receive payment of the
amount therein mentioned.
From the above definition, it can be seen that payment in due course requires the
payment to be made
(a) in accordance with the apparent tenor of the instrument;
(b) in good faith;
(c) without negligence;
(d) to the person in possession of the instrument; and
(e) while making payment the banker should not have reasons to 'believe'
that the person in possession
of the instrument is not entitled to receive payment of the amount mentioned in
the instrument.
Section 85 of the Negotiable Instruments Act, 1881 grants protection to a banker
on his making payment of a cheque. Though this principle may sound as a
simple logic, it is to be noted that the protection granted as per Section 85 is not
absolute.
Section 85 of the Negotiable Instruments Act, 1881 can be explained as follows:
1. Where a cheque payable to order purports to be endorsed by or on behalf
of the payee, the drawee
is discharged by payment in due course.
2. Where a cheque is originally expressed to be payable to bearer, the
drawee is discharged by payment
in due course to the bearer thereof, notwithstanding any endorsement whether in
full or in blank
appearing thereon, and notwithstanding that any such endorsement purports to
restrict or exclude
further negotiation.
Section 89 of the Negotiable Instruments Act states the effect of making
payment on instrument on which alteration is not apparent and reads as follows:
Section 89
Payment of instrument on which alteration is not apparent: Where a promissory
note, bill of exchange or a cheque has been materially altered but does not
appear to have been so altered, or where a cheque is presented for payment
which does not at the time of presentation appear to be crossed or to have had a
crossing which has been obliterated, payment thereof by a person or banker
liable to pay, and paying the sum according to the apparent tenor thereof at the
time of payment and otherwise in due course, shall discharge such person or
banker from all liability thereon, and such payment shall not be questioned by
reason of the instrument having been altered or the cheque crossed.
6.3 LIABILITY OF PAYING BANKER WHEN CUSTOMER'S
SIGNATURE ON THE CHEQUE IS FORGED
Section 128
Where the banker on whom a crossed cheque is drawn has paid the same in due
course, the banker paying cheque, and in case such cheque has come to the
hands of the payee the drawer thereof, shall respectively be entitled to the same
rights, and be placed in the same position in all respects as they would
respectively be entitled to and placed in if the amount of the cheque, has heen
pair! tn and received by the true owner thereof.
i. When the customer's signature on the cheque is forged there is no mandate to
the hank tn
86
pay. As such a banker is not entitled to debit the customer's account on such
forged cheque: Canara Bank vs Canara Sales Corporation and Others [(1987) 2
Supreme Court Cases 666]: The company had a current account with the bank
which was operated by the company's Managing Director. The Company's
accountant in whose custody the cheque book was, forged the signature of the
Managing Director in forty-two cheques totalling Rs. 3,26,047.92 over a period
of time. This was detected by another accountant. The company immediately on
detection of the fraud demanded the amount from the bank. The bank refused
payment and therefore the company filed a suit against the bank. The bank lost
the suit and took the matter up to the Supreme Court. The Supreme Court
dismissed the appeal of the bank and held that:
"Since, the relationship between the customer and the bank is that of a creditor
and debtor, the bank had no authority to make payment of a cheque containing a
forged signature. The bank would be acting against the law in debiting the
customer with the amount of the forged cheque, as there would be no mandate
on the bank to pay. The Supreme Court pointed out that the document in the
cheque form on which the customer's name as drawer was forged was a mere
nullity. The bank would succeed only when it would establish adoption or
estoppel."
In deciding the case, the Supreme Court relied on its earlier judgement in Bihta
Co-operative Development and Cane Marketing Union Ltd. vs Bank of Bihar
(AIR 1967 Supreme Court 389).
ii. In a joint account if one of the signatures is forged then there is no mandate
and banker cannot make payment: The case law in this case is of Bihta Co-
operative Development and Cane Marketing Union Ltd. vs Bank of Bihar: The
Co-operative Marketing Union had an account with the bank, which was
authorised to be operated by the joint secretary and treasurer of the Co-operative
Marketing Union. On 16 April 1948, the bank made payment of Rs. 11,000 on a
loose leaf cheque and not on a cheque from the cheque book issued to the
Society. Though the two signatures appeared on the cheque, one of them, the
signature of the Joint Secretary was forged. The bank made payment, whereupon
the Co-operative Marketing Union sued the bank for recovery of the money.
Though the bank admitted negligence on its part, it argued that the employees of
the Co-operative Marketing Union were dishonest in the discharge of their duties
and as such it cannot succeed. The matter went up to the Supreme Court and the
Supreme Court, while allowing the case of the Co-operative Marketing Union
held that 'one of the signatures was forged so that there never was any mandate
by the customer at all to the banker and the question of negligence of the
customer in between the signature and the presentation of the cheque never
arose.'
6.4 PAYMENT TO BE IN DUE COURSE FOR BANK TO SEEK
PROTECTION
i. The Supreme Court in Bank of Bihar vs Mahabir Lai (AIR 1964 Supreme
Court 397) held that a banker can seek protection under Section 85 only where
payment has been made to the holder, his servant or agent, i.e. payment must be
made in due course.
In this case, the bank had agreed to grant the firm a cash credit facility against
the pledge of cloth bales, on the firm fulfilling certain conditions, one of which,
was that the money for purchasing the cloth would not be directly given to the
firm, but instead, the supplier would be paid the amount by the bank and the
cloth bales would be kept by the bank as pledge for the loan. The firm thereafter
was required to draw a cheque on itself which was handed over to the bank. The
bank instead of handing over cash to the firm's partner to be paid over to the
wholesalers, entrusted it with one of the bank's employees (Potdar) who
accompanied the partner to the wholesalers. However, before the rnoney could
be paid to the wholesalers the Potdar absconded. The bank
87
sought repayment of the money, which was refused by the firm. The bank
therefore sued the firm for the money relying on Sections 85 and 118 of the
Negotiable Instruments Act, 1881. The matter reached the Supreme Court and it
was held that, before the provisions of Section 85 can assist the bank it had to be
established that payment had in fact, been made to the firm or to a person on
behalf of the firm. Payment to a person who had nothing to do with the firm or a
payment to an agent of the bank would not be a payment to the firm.
ii. The Calcutta High Court had occasion to consider as to whether a bank had
made payment in due course or not in the case of Bhutoria Trading Company
(BTC) vs Allahabad Bank (AIR 1977 Cal. 363) the facts of which are as follows:
BTC, a limited company, had sold some jute to WFD another limited company,
for payment of which WFD issued an un-crossed cheque payable to BTC or
order which was delivered to one of the officials of BTC. The official using the
company's seal endorsed the cheque as manager and encashed it over the
counter. BTC later sued the bank for recovery of the money on the grounds of
damages or in the alternative on the grounds of money had and received by the
bank. The Court held that:
'The Expression payment in due course has been defined in Section 10 of the
Negotiable Instruments Act to mean payment in accordance with the apparent
tenor of the instrument in good faith and without negligence to any person in
possession thereof, under circumstances which do not afford reasonable ground
for believing that he is not entitled to receive payment of the amount therein
mentioned. It can hardly be questioned that the payment by the defendant bank
of the cheque in question has been made by the defendant bank in accordance
with its apparent tenor. The cheque is an un-crossed cheque payable to the
plaintiff or order. The cheque was endorsed by the plaintiff through its Manager.
The fact that Jethmall is the Manager is borne out by the seal of the company
which is unquestionably an authentic seal. The seal of the Manager is also
equally authentic. That the payment was made in good faith has not been
disputed for all practical purposes. There is not a grain of evidence before the
Court from which it remotely appears that the payment was not made in good
faith. Now that the entire evidence is before the Court, the question of onus to
prove good faith loses much of its importance. No negligence has been proved
against the bank. The defendant bank insisted on identification of Jethmall and
Jethmall was, in fact, identified by Kishanlal Maheswari, a constituent of the
bank, the defendant No. 3. The defendant bank therefore took all reasonable
precautions even though the circumstances in which the cheque was presented
for payment did not afford any reasonable ground for believing that Jethmall
was not entitled to receive payment of the amount mentioned therein. The
plaintiff having failed to prove the trade practice which he alleged and the bank
having paid the cheque, in accordance with the apparent tenor of the instrument,
in good faith, and without negligence, to Jethmall who was in possession
thereof, the defendant is entitled to succeed. There were no circumstances which
afforded any reasonable ground for believing that he was not entitled to receive
payment of the cheque. It must be held that the bank made the payment in due
course. The learned Judge, in our opinion has rightly pointed out that payment in
due course is necessarily payment in the ordinary course.
iii. Whether payment made by a bank was payment in due course would depend
on the facts of a given case. In Madras Provincial Co-operative Bank Ltd. vs
Official Liquidator, South Indian Match Factory Ltd. (AIR 1945 Mad 30) the
Court held that payment to a liquidator against the cheque presented across the
counter was not a payment in due course and the bank was not entitled to seek
protection under Section 85 of the Negotiable Instruments Act.
In this case the Official Liquidator of the Company had sold certain properties of
the company, for which payment was made by the purchaser by giving a cheque
in favour of the liquidator. The liquidator presented the cheque over the counter
and obtained payment in cash which he
88
! !
misappropriated. He was later prosecuted and convicted and removed from
office. His successor proceeded against the bank for recovery of the amount on
the ground that the bank was negligent and the amount was wrongly paid. The
Court held that under Section 244A of the Indian Companies Act, 1913, an
official liquidator was required to open an account with a bank and pay therein
moneys received by him in the course of the liquidation. Rule 66 of the Rules
framed by the Madras High Court under the Act required that all bills and other
securities payable to the company or to the liquidator should, unless the judge
otherwise directs, shall as soon as they came into the hands of the liquidator, be
deposited by him in the bank. From the cheque itself the bank had noticed that it
was payable to the liquidator in his official capacity. That the bank realised this
in full was shown by the fact that it called for the order of his appointment. The
learned judge therefore concluded:
We have no doubt that the officers of the bank did not realise, as they should
have done, that the bank was doing something improper, but in the
circumstances there was negligence. They knew or must have deemed to have
known that this money could only be collected by the payee through his own
bank and therefore it was most improper on his part to ask for payment over the
drawee's counter. In our judgement there was a clear breach of a statutory duty
placed upon the bank and the learned judge was right in holding the bank liable.
6.5 PAYMENT IN GOOD FAITH WITHOUT NEGLIGENCE OF AN
INSTRUMENT ON WHICH ALTERATION IS NOT APPARENT
i. The effect of Sections 10 and 89, and Section 31 was considered by the
Supreme Court in Bank of Maharashtra vs M/s Automotive Engineering Co.
(1993) 2 SCC 97.
The question, which arose for consideration in this appeal, was whether the
paying bank was bound to keep an ultraviolet ray lamp and to scrutinise the
cheque under the said lamp even if no infirmity on the face of the said cheque on
visual scrutiny was found.
Briefly stated, the respondent, a partnership firm, opened a current account with
the Wagle Industrial Estate branch of the appellant bank. The said branch was in
the industrial area on the outskirts of City of Bombay, where forgery of cheques
were rampant and although other branches of the appellant bank were provided
with ultraviolet ray lamps, the said branch was not provided with such lamp. On
26 May 1967, one Shri Shah, as a proprietor of Messrs Imperial Tube and
Hardware Mart, opened an account, in the name of his firm, with a branch of the
Union Bank of India.
Shri Shah presented a cheque dated 29 May 1967 for Rs. 6,500 in favour of his
firm to Union Bank of India. On presentation of the cheque through clearing, the
appellant bank passed the cheque and debited the amount to the account of the
respondent. Later on, on receipt of the objection from the respondent-defendant,
the said cheque was examined under the ultraviolet ray lamp when it transpired
that the original cheque was issued in favour of Shri G.R. Pardawala and the
amount of the said cheque was Rs. 95.98. The writing on the cheque was
chemically altered with regard to date, the name of the payee and also the
amount. The respondent made demands to the appellant bank to credit the
amount to its account.
The appellant bank filed a suit in which the agent of the appellant bank was
examined, who stated that before passing the said cheque for payment he had
checked the serial number and date of the cheque and had compared the
signature of the respondent with the specimen signature and that from visual
appearance of the cheque no infirmity was noted by him and from the tenor of
the cheque it appeared to be a genuine one.
The Trial Court dismissed the suit on the ground that by not providing the
facility of ultraviolet ray lamp, the appellant bank had failed to discharge proper
care and, therefore, did not pass the said cheque with the due diligence.
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On appeal, the District Judge, while agreeing that no abnormal features to
suspect the genuineness of the cheque could be found on visual inspection of the
cheque, was of the view that the appellant bank was not entitled to protection for
the lapse in subjecting the said cheque for scrutiny under the ultraviolet ray
lamp.
On further appeal, the High Court of Bombay, while accepting the finding that
the cheque in question apparently did not show any sign of alteration, held that
the appellant bank did not act with proper care and caution in not providing
necessary device for detecting forged cheques. Since the absence of such a lamp
amounted to negligence on the part of the appellant bank, no protection was
available because payment was not made in due course.
The appellant bank preferred this appeal to the Supreme Court. The Supreme
Court allowed the appeal of the bank on the following grounds:
(i) Section 89 of the Negotiable Instruments Act gives protection to the paying
banker of a cheque which has been materially altered but does not appear to
have been so altered, if payment was made according to the apparent tenor
thereof at the time of payment and otherwise in due course.
(ii) Section 10 of the said Act defines payment in due course to mean payment in
accordance with the apparent tenor of the instrument in good faith and without
negligence to any person in possession thereof under circumstances which do
not afford a reasonable ground for believing that he is not entitled to receive
payment of the amount therein mentioned.
(iii) Section 31 of the said Act obliges the drawee bank having sufficient funds
of the drawer in its hands properly applicable to the payment of such cheque to
make payment of the cheque when duly required to do so.
(iv) On analysing the evidence, the Courts below have held that on visual
examination no sign of forgery or tampering with the writings on the cheque
could be detected. It was found that the agent of the appellant bank had verified
the serial number and signature on the cheque and had compared the signature
on the cheque with the specimen signature of the respondent and on scrutiny of
the cheque visually, no defects could be detected by him. There were sufficient
funds of the drawer with the appellant bank, which had no occasion to doubt
about the genuineness of the cheque from the apparent tenor of the instrument.
There was no evidence to hold that, the payment was not made in good faith.
Simply, because the ultraviolet ray lamp was not kept in the branch and the said
cheque was not subjected to such lamp would not be sufficient to hold the
appellant bank guilty of negligence, more so when it has not been established on
evidence that the other branches of the appellant bank or the other commercial
banks had been following a practice of scrutinising each and every cheque or
cheques involving a particular amount under such lamp by way of extra
precaution.
(v) In such circumstances, it is not a correct legal proposition that the bank, in
order to get absolved from the liability of negligence, was under an obligation to
verify the cheque for further scrutiny under advanced technology or for that
matter, under ultraviolet ray lamp, apart from visual scrutiny even though the
cost of such scrutiny was only nominal and it might be desirable to keep such
lamp at the branch to take aid in appropriate case.
(vi) The Courts below were not justified in holding that the bank had failed to
take reasonable care in passing the cheque for payment without subjecting it to
further scrutiny under ultraviolet ray lamp because the branch was in the
industrial area where such forgery was rampant and other branches of the
appellant bank were provided with such lamp.
The appeal was, therefore, allowed and the Suit of the appellant bank was
decreed only for the principal amount without any interest on the same.
ii. The protection granted to a banker under Section 89 had come up for
consideration before the Calcutta High Court in Brahma Shumshere Jung
Bahadur vs Chartered Bank of India, Australia and China (AIR 1956 Cal. 399):
90
In this case B who was a member of the royal family of Nepal had an overdraft
account with the bank, for which certain securities were deposited with the bank.
The overdraft limit was not a fixed limit and fluctuated depending on the
securities deposited. In April 1946, B requested the bank to enhance the
overdraft limit which however, was not agreed to by the bank and the limit was
Rs. 70,000. In July 1946, B sent a cheque by post, drawn on the overdraft
account which was intercepted in the mail and the amount was raised from Rs.
256 to Rs 2,34,081. The cheque was put for collection in another bank which
was paid by B's bank. B on coming to know about the forgery, sued both the
paying and collecting bank, contending that though the cheque was signed by
him it was written out by some other person and as such it should have aroused
the suspicion of the bank. The Court, however, held that since no alteration or
obliteration was visible at the time of payment, the payment was made according
to the apparent tenor at the cheque. Further since B had on other occasions also
issued cheque signed by him and written by others, the bank's suspicion could
not have aroused. The Court also held that the words 'liable to pay' appearing in
the third paragraph of Section 89 included a liability to pay under an overdraft
agreement as much as it applied to an ordinary deposit account.
As regards exceeding the overdraft limit, the Court held that no definite limit
was fixed at any time and it fluctuated according to the securities deposited by
B. In this case the collecting bank was liable for other reasons for which we shall
see in the next unit.
iii. In the case of Tanjore Permanent Bank vs S.R. Rangachari (AIR 1959
Madras 119) the High Court was called upon to decide a case in which cheque
was materially altered and the bank sought protection under Section 89. In this
case R had an overdraft account with the bank and requested the Manager to
advance him Rs. 16,000 to the debit of his account. The Manager asked R to
send him three blank cheques signed.
R accordingly did the same. However, of the three cheques only one was utilised
for the payment of Rs. 16,000. The other two cheques were alleged to have been
filled by the accountant of the bank for Rs. 7,600 and Rs. 4,200 and the names of
two clerks were written as the payees. In both the cheques the alterations were
apparent and visible but the bank paid these cheques. On R not clearing the debit
because of his overdraft account, the bank sued him. R contended that the two
debit entries for Rs. 7,600 and 4,200 were made by the bank wrongly and as
such he cannot be held liable.
The Court held that since the material alteration on both the cheques were visible
and since they were not authenticated by the drawer's initials, the payment made
by the bank was not according to the apparent tenor of the instrument and as
such the bank cannot claim protection under Section 89 of the Negotiable
Instruments Act. The Court in coming to the above conclusion relied on the
following paragraph of Bhashyam and Adiga's Negotiable Instruments Act:
The bank has also to see whether there are any alterations in the cheque and
whether they have been properly authenticated. Therefore, where an alteration in
a cheque is initialled not by all the drawers but only some of them, the bank will
be paying the amount on the said cheque at its own risk. In this connection it is
necessary to notice that under Section 89 protection is afforded to the bank
paying a cheque where the alteration is not apparent.
It is to be noted that as per Section 89, the bank can seek protection only if there
is no material alteration in the cheque and does not appear to have been altered.
This, however, does not protect a banker in case the signature of the customer is
forged. As stated earlier a forged cheque is no mandate of the customer and as
such the bank cannot make payment on a cheque where the signature of the
customer is forged. The question whether a signature is forged or not depends on
the evidence and the court in coming to a conclusion that the signature is forged
would look into the facts and circumstances that led to the payment of the
cheque.
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iv. Bareilly Bank Ltd. vs Naval Kishore (AIR 1964 All 78): N opened an
account with the bank by making a cash deposit of Rs. 19,900. N was issued a
cheque book containing 25 cheques. 17 months after the opening of the account
N drew a cheque for the first time for Rs. 5,900 which was dishonoured by the
bank. On enquiries N was informed that 11 months back three cheques
aggregating Rs. 19,500 were paid by the bank and the present balance in the
account was a mere Rs. 437. N denied issuing of the cheques and sued the bank.
In evidence it came out that 3 cheques used to withdraw the amounts were not
from the cheque book issued to N and were from a different cheque book.
Though bank was not in a position to explain this lapse, they made an attempt to
counter the contentions of N by producing his specimen signature which
appeared to be similar to the ones on the cheques. N however denied that the
specimen signature was his and the Court concluded that the alleged specimen
signature were totally different from N's regular signature. Evidence also was led
to show that the bank's own employees were involved in the forgery since the
ledger page of N's account showed that certain erasures and scorings were made
and the signature of N missing in the cheque book issue register.
Therefore the Court refused to accept the bank's contention.
6.6 PAYMENT BY BANK UNDER MISTAKE WHETHER RECOVERABLE
The question whether a bank paying a forged cheque can recover the same from
the payee was considered by the Calcutta High Court in United Bank of India vs
AT Ali Hussain & Co. (AIR 1978 Calcutta 169).
In this case, a cheque for Rs. 5,000, purportedly drawn by a company was
presented by the collecting bank to the paying bank, and was paid. The signature
as well as all other writings on the cheque were forged. The forgery was so
perfect that it was not possible even for a trained eye to detect it. The paying
bank, having subsequently come to know of the forgery, filed a suit against the
collecting bank and the payee of the cheque, for recovery of the amount paid, on
the ground of payment under mistake. Defending the suit, the collecting bank
contended that it received the cheque in the ordinary course of its business, and
presented the same for encashment in good faith. The payee contended, that he
received the cheque from some persons claiming to be representatives of a
company, in the ordinary course of business, towards payment of the price of the
goods to be supplied by him, that he acted in good faith, having no reason to
suspect that the cheque was forged, and that he parted with the goods only on
receipt of intimation from the collecting bank that the cheque had been
encashed.
The Trial Court having dismissed the suit on the ground that the paying bank
had no cause of action, an appeal was preferred to the High Court.
Decision: The High Court dismissed the appeal and held that both from the point
of view of equitable principles and the doctrine of estoppel, the paying bank was
disentitled to recover the money either from the collecting bank or the payee. In
the course of his judgement, M.M. Dutt. J. said:
The evidence on record supports the findings of the learned Judge that the
forgery was so accurate that it was not possible even to a trained eye to detect
the same. In these circumstances, it is difficult to hold that the plaintiff bank had
acted carelessly or negligently. The encashment was made by the plaintiff bank
on the mistaken belief that the cheque was a genuine one. The defendant United
Bank had nothing to do with the question as to whether the cheque was genuine
or forged. In due course of business, it presented the cheque to the plaintiff bank
for collection and after the cheque was encashed, intimation was given by it to
its constituent, namely, the defendant No.l, and the latter, in its turn, sold goods
to the persons who came with the forged cheque as the representatives of the
Metal Alloy Co. Thus, it appears that the parties in the suit acted in good faith in
due course of business. It was due to
92
the mistake that was committed by the plaintiff bank that it had to suffer the loss
of the said sum of Rs. 5,200. Upon the consideration of the principles of law as
noticed above, it seems to us that so long as the status quo is maintained and the
payee has not changed his position to his detriment, he must repay the money
back to the payer. If, however, there has been a change in the position of the
payee who, acting in good faith, parts with money to another without any benefit
to himself before the mistake is detected, he cannot be held liable. Equity
disfavours unjust enrichment. When there is no question of unjust enrichment of
the payee by reaping the benefit of an accidental windfall he should not be made
to suffer, for he would be as innocent as the payer who paid the money acting
under a mistake.
6.7 LET US SUM UP
The Negotiable Instruments Act, 1881 lays down the law relating to the payment
of a customer's cheque and the protection that is available to a banker making
payment of a cheque in due course. Sections 10, 85, 85A, 89 and 128 of the Act
deal with the protection available to a banker whereas Section 31 lays down the
condition as to when a bank has to make payment on a cheque drawn by the
customer. The banker on making the payment in due course is entitled to seek
protection provided the cheque has not been altered or the alteration, if altered, is
not apparent. However, the banker does not get protection, if signature of the
customer is forged
6.8 KEYWORDS
Apparent Tenor of the Instrument; Material Alteration.
6.9 CHECK YOUR PROGRESS
1. State whether true or false.
(i) The law relating to the payment of cheques and protection to a banker is
contained in the
Indian Contract Act. (ii) The responsibility of a banker to pay back the money of
the customer specifically stated in
the Negotiable Instruments Act, 1881.
(iii) Section 31 of the Negotiable Instruments Act applies only to the banker, (iv)
The banker is first bound to honour a customer cheque and only thereafter
exercise his
right of set off.
(v) A forged signature is no mandate of the customer, (vi) A customer is bound
to inform the bank about lost cheque leaves, (vii) In a joint account if one of the
signatures is forged, the bank and the customer are equally
liable, (viii) Payment to be made in due course need not always be made to
holder but can be made to
his agent or servant, (ix) In case bank makes payment by mistake it can recover
the same even if the payee has
changed his position, (x) If a bank makes payment without checking the
instrument under an ultraviolet lamp, it can
be held liable on the grounds of negligence.
6.10 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (i) False; (ii) True; (iii) True; (iv) False; (v) True; (vi) False; (vii) False; (viii)
True; (ix) False; (x) False
I
Rs.
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:is of ide
UNIT
7
CASE LAWS ON RESPONSIBILITY OF COLLECTING BANK
r's se. ;as he he
lOt
STRUCTURE
7.0 Objectives
7.1 Introduction
7.2 Statutory Protection to Collecting Bank
7.3 Duties of the Collecting Bank
7.4 Let Us Sum Up
7.5 Keywords
7.6 Check Your Progress
7.7 Answers to 'Check Your Progress'
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7.0 OBJECTIVES
After studying this unit you should be able to understand:
• the duties of a collecting banker when opening an account and collecting
cheques in the account;
• the protection granted under the Negotiable Instruments Act to a banker
collecting a cheque.
7.1 INTRODUCTION
In the earlier unit, we had studied the duties imposed on a paying banker under
the Negotiable Instruments Act and the protection granted to him. In this unit,
we will be studying the duties of a collecting banker that has been imposed,
more by the practice adopted by bankers over a period rather than by law. We
shall also be studying the protection available to a collecting banker which is
granted by certain provisions under the Negotiable Instruments Act. Before we
delve into the subject, it would be worth trying to understand who a collecting
bank is by an illustration.
Illustration
Ram has an account with Ideal Bank Ltd. The bank has issued a cheque book to
Ram to withdraw money from the account. Ram owes Rs. 400 to Shyam and to
repay this amount, Ram draws (issues) a cheque in favour of Shyam. Shyam has
two ways to obtain payment of the cheque. He can go straight to the Ram's bank
(Ideal Bank Ltd.) and collect cash against the cheque if it is not crossed or he can
deposit the cheque in his account with his banker, who would send the same to
Ram's banker (Ideal Bank Ltd.) and collect the amount. Here, Shyam's banker is
the collecting bank and Ram's bank, i.e. Ideal Bank Ltd. is the paying bank. If in
the above illustration, Ram were to post the cheque to Shyam and the same were
stolen by X in transit and X were to open an account in the name of Shyam and
collect the cheque, the bank that opened the account of X to collect the proceeds
of the cheque would be the collecting bank.
7.2 STATUTORY PROTECTION TO COLLECTING BANK
Section 131 of the Negotiable Instruments Act grants protection to a collecting
banker and reads as follows:
Section 131
i. Non-liability of a Banker Receiving Payment of Cheque: A banker, who has,
in good faith and without negligence, received payment for a customer of a
cheque crossed generally or specially to himself shall not, in case the title to the
cheque proves defective, incur any liability to the true owner of the cheque by
reason only of having received such payment.
Explanation: A banker receives payment of a crossed cheque for a customer
within the meaning of this section notwithstanding that he credits his customer's
account with the amount of the cheque before receiving payment thereof.
The provisions of the above section has been applied to drafts as per Section
131A of the Negotiable Instruments Act.
ii. Conditions for Protection: Though Section 131 grants protection to a
collecting banker, the protection is conditional. For the collecting banker to
claim the protection under Section 131 he has to comply with certain conditions
and they are:
1. The collecting banker should have acted in good faith.
2. He should have acted without negligence.
3. He should receive payment for a customer.
4. The cheque should be crossed generally or specially to himself.
I
95
7.3 DUTIES OF THE COLLECTING BANK
Since no specific enactment has been laid down prescribing the nature of duties
a banker will have to observe while acting as a collecting banker, Section 131 of
the Negotiable Instruments Act, which affords protection to the collecting bank
requires amongst other conditions that the bank should not have been negligent.
To show that the bank has not been negligent the bank will have to prove that it
has taken all precautions that would be required of a prudent banker in collecting
a cheque. Over the years based on practice and judicial pronouncements, these
precautions have been laid down as duties imposed on bankers, the non-
compliance of which can make the bank liable on the grounds of negligence. We
shall now individually examine these duties.
i. Duty to Open the Account with References and Sufficient Documentary Proof:
The duty to open an account only after the new account holder has been properly
introduced is too well ingrained in the today's banker's mind that it would be
impossible to find an account without introduction. The necessity to obtain
introduction of a good customer is to keep off crooks and fraudsters who may
open accounts to collect forged cheques or other instruments. As an added
precaution, RBI has insisted that while opening accounts photograph of the
customer and sufficient documentary proofs for constitution and address be
obtained under the applicable KYC norms.
In this regard, the English Decision Ladbroke vs Todd (1914) 30 TLR 433 can
be referred to. In this case, a thief stole a cheque in transit and collected the same
through a bank, where he had opened an account without reference and by
posing himself as the payee whose signature the thief forged. After collection of
the cheque, the thief withdrew the amount. The bank was held liable to make
good the amount since it acted negligently while opening the account inasmuch
as it had not obtained any reference.
In Syndicate Bank vs Jaishree Industries and Others AIR 1994 Karnataka 315,
the appellant opened an account in the name of M/s Axle Conductor Industries
Ltd. by the Proprietor, R.K. Vyas. A person Mr Nanjunde Gowda, who was
having a small shop at the address given by the account holder, gave the
introduction. The address of the account holder, given by the account holder,
was just opposite the appellant bank. In the account opening form, the name of
the account holder was given as M/s Axle Conductor Industries by the Proprietor
R.K. Vyas. No information was sought or inquiry neither held as to the
incorporation of the account holder nor was the memorandum of association,
resolution, etc., scrutinised. On 3 January 1979, partners of Firm 'A' purchased a
draft for Rs. 2,51,125 from State Bank of India, Ahmednagar, in favour of M/s
Axle Conductor Industries Ltd. The draft was deposited in the account with the
appellant on 5 October 1979 and the amount was collected by the appellant and
credited to the account on 9 October 1979. On 10 October 1979, the monies
were withdrawn from the account. The partners of 'A filed a suit against the
appellant and State Bank of India for recovery of Rs. 2,51,125 wrongly collected
by appellant and paid by State Bank of India.
The High Court held that there was failure to follow the proper procedure for
opening account in the name of a limited company, that the account was opened
as if it was a proprietary concern, the staff of the appellant bank did not bestow
sufficient care even to notice the word 'Ltd.' on several occasions, such as, at the
time of opening of the account or withdrawal of amounts from the account. The
High Court felt that having accepted the application as if it was an application by
a proprietary concern, strangely the appellant bank allowed the account to
operate in the name of the limited concern. There was, therefore, lack of care on
the part of the appellant bank in the entire transaction.
The conditions to be satisfied for claiming protection under Section 131 of the
Negotiable Instruments Act are:
(a) that the banker should act in good faith and without negligence in receiving
payment, i.e. in the process of collection;
96
(b) that the banker should receive payment for a customer, i.e. act as mere
agent in the collection of
the cheque, and not on his account as holder;
(c) that the person for whom the banker acts must be his customer;
(d) that the cheque should be one crossed generally or specially to himself.
The High Court stated that if the draft was drawn in favour of a fictitious person,
it could not be said that the ownership stood transferred to a non-existent person
for the purpose of examining the question whether the bank as a collecting
banker acted negligently or not. The ownership would pass to the true owner.
The High Court did not consider it necessary to decide as to what extent a person
obtaining a draft in favour of a fictitious person would lose the ownership in
favour of a bona fide 'holder in due course'.
In view of the aforesaid, the appellant bank was held to have acted without
taking any care, and was found negligent throughout and was not entitled to the
protection under Section 131 of the Negotiable Instruments Act.
In Indian Bank vs Catholic Syrian Bank AIR 1981 Mad 129, the Madras High
Court had occasion to consider negligence of the collecting banker, which had
opened an account after proper introduction.
Briefly, the facts were that one D had opened an account with Salem branch of
bank 'A'. A customer of that branch had taken D to the said branch and had
informed the manager that D was a man from Indore and that .he wanted to open
a bank account to enable him to purchase carpets from Salem. Although the
bank A had claimed that the customer, who had introduced D, was a well-known
customer of the bank A and was a leading merchant of Salem and had a large
volume of business, it was found in the evidence recorded by the Court that
these claims were not true. The introducer had an account and had some fixed
deposits with the bank A. The transactions were for paltry amounts and the
amount standing to the credit of the introducer at the relevant time, was only Rs.
192.57.
On 12 June 1969, M obtained a demand draft for Rs. 20 from the branch at
Singanallur of the bank B. The draft was drawn on the branch office of bank B
in favour of D and company. By means of a clever forgery, the draft was altered
for Rs. 29,000 drawn in favour of D. D presented the draft on 13 June 1969 for
credit to his account opened with Salem branch of bank A and the amount was
collected by bank A from bank B and credited to the account of D.
On 14 June 1969, the Salem branch of bank B came to know from its
Singanallur branch that the draft issued for Rs. 20 and was drawn in favour of D
and company, payable at Cochin and that no draft for a sum of Rs. 29,000 had
been issued. At once the Salem branch of bank A was contacted and was
informed of the fraud, but unfortunately by then bank A had already paid a large
part of the draft amount to D under a self cheque.
Bank B (Paying banker) filed the suit against bank A (collecting banker) for
recovery of Rs. 29,000 on the ground that the collecting banker had been
negligent while opening an account in the name of D and by reason of its
negligence and want of good faith, the forged draft got to be wrongly converted.
The High Court observed that the collecting banker had opened the account in
the name of D on a mere introduction of one of its account holders, knowing
fully well that the said account holder was not a well known leading merchant
and had no large business with it at the relevant time. Further, the collecting
banker had not independently questioned D about his business and his
creditworthiness before allowing him to open an account. When D stated that he
had come from Indore, the manager of the collecting banker did not even care to
find out his permanent address, more so, when in the application for opening
account filed by D, the address given was of that of the introducer. Moreover,
97
when D told the manager of collecting banker that he had not until then opened
any account although he had come from Indore to Salem to do business, the
collecting banker, before opening the account, should have been more alert.
ii. Duty to Confirm the Reference where the Referee is not known or has given
Reference in Absentia: However, as a matter of practice, bankers in India require
introduction by an existing customer of the bank, this may not always be
possible especially when the branch is newly opened. In such cases, the
customers are required to get references from known persons in the locality or
from the existing bankers. In such case, the banker is required to make enquiries
with the referee to confirm that the person whose account is newly opened is a
genuine person. Under the current KYC norms, the authenticity of the customer
is required to be verified by calling for a direct identification document like a
copy of passport, PAN number issued by IT department, Identity certificate
issued by Election authorities or identification issued by the employer if the
company is a prominent one. The address can be authenticated by obtaining a
copy of a electricity or Telephone bill, or copy of ration card, or copy of any
bank statement where the customer has already an account. Only in the case of
very small customers, this requirement is waived and a third party introduction is
accepted.
In Harding vs London Joint Stock Bank [1914] 3 Legal Decision Affecting
Bankers 81, an account was opened for a new customer after complying with the
necessary formalities. The account was not opened by deposit of cash, as is the
usual practice but was opened by paying in a third party cheque. The bankers in
the case made enquiries with the customer who thereupon produced a forged
letter issued by his employer giving him power to deal with the cheque. It was
thereafter found that the cheque was stolen by the customer and credited to his
account. The bank was held negligent for failure to make necessary enquiries
from the employer as to whether the customer who was an employee had, in
fact, the necessary power to deal with the cheque.
iii. Duty to Ensure Crossing and Special Crossing: It is the duty of the banker to
ensure that the cheque is crossed specifically to himself and if the cheque is
crossed to some other banker they should refuse to collect it. Similarly, where
the cheque is crossed to a specific account then crediting the same to another
account without necessary enquiries would make him liable on the grounds of
negligence. In case of 'non-negotiable' crossing a banker cannot be held
negligent merely because of collection of such instruments. In the case of
Crumpling vs London Joint Stock Bank Ltd. [1911-13] All England Rep 647. It
was held that a non-negotiable crossing is only one of the factors amongst others
to be considered to decide about the bankers, negligence and that the mere
taking of a non-negotiable cheque cannot be held to be evidence of negligence
on the part of the bankers.
iv. Duty to Verify the Instruments or any Apparent Defect in the Instruments:
Sometimes the instrument, which is presented for collection would convey to the
banker a warning that a customer who has presented the instrument for
collection either is committing a breach of trust or is misappropriating the
money belonging to some other. In case the banker does not heed the warning,
which is required of a prudent banker, then he could be held liable on the
grounds of negligence as can be seen from the following cases:
(a) In Underwood Ltd. vs Bank of Liverpool Martin Ltd. [1924] 1 KB 775,
the Managing Director
of a company paid into his private account large number of cheques which were
to be paid into
the company's account and the bank was held negligent since it did not make
enquiries as to
whether the managing director was, in fact, entitled to the amounts represented
by these
cheques.
(b) In Savory Company vs Llyods Bank [1932] 2 KB 122, the cheques
which were payable to the
employer was collected by the employee in a private account opened by him and
the bank was
98
held liable for negligence. In this case, two dishonest clerks of a stock broker
stole bearer cheques belonging to their employer which were collected in an
account maintained by one of the clerks and in another account in his wife's
name. It was held that the bank had been negligent in opening the clerk's account
inasmuch as they had not obtained his employer's name while opening the
account and that in the case of his wife's account the bank was negligent
inasmuch as it had not obtained the husband's occupation and his employer's
name while opening the account.
(c) In the case of Australia and New Zealand Bank vs Ateliers de
Constructions Electriques de
Cherleroi [1967] 1 AC 86 PC, an agent paid his principal's cheque into his
personal account
and the bank was charged with conversion. However, the bank defended the
same because
there was implied authority from the principal to his agent to use his private
account for such
purpose. Though the banker was negligent in dealing with the cheques without
specific authority
the bank escaped liability since it was found that the principal had, in fact,
authorised his agent
to use his private account.
(d) In Morrison vs London County and Westminster Bank Ltd. [1914-5] All
ER Rep 853, the
manager of the plaintiff was permitted to draw cheques per pro his employer and
he drew
some cheques payable to himself which he collected into his private account.
The bank was
held negligent for collecting such cheques without making necessary enquiries
even though
there was a clear indication that the manager was signing as an agent of the firm.
v. Duty to take into Account the State of Customer's Account: The collecting
banker is required to take into account the status of the customer and the various
transactions that have taken place in the customer's account to know the
circumstances and the standard of living of the customer. If for example, a
person is an employee and the nature of his employment is that of a clerk, his
salary would be approximately known to the bank and any substantial credits by
way of collection of cheques would be suspected and it would be the duty of the
banker to take necessary precautions while collecting such cheques.
In Nu-Stilo Footwear Ltd. vs Lloyds Bank Ltd. [1956] 7 Legal Decisions
Affecting Bankers P. 121, the plaintiffs who were manufacturers of ladies
footwear were defrauded by their secretary and works accountant who converted
nine cheques payable to the plaintiffs into his account. The secretary opened the
accounts in the defendant's bank in a false name and as reference gave his real
name. The bank thereupon called the reference and got a satisfactory reply,
which included the fact that the account holder had recently come down from
Oxford and intended setting up a business of his own. The secretary thereupon
presented nine cheques totally aggregating to £ 4855. Since these cheques were
drawn on the plaintiffs, they sued the defendant bank who had collected the
cheques. The Court held that the collecting bank was negligent inasmuch as the
collecting bank did not take necessary precautions because the amounts
collected were inconsistent with the business of the account holder and therefore
necessary enquires should have been made by the bank.
vi. Negligence of Collecting Bank in Collecting Cheques Payable to Third
Parties: The collecting bank has to make necessary enquiries before any third
party cheques, are collected on behalf of its customer. In Ross vs London
County Westminster and Parrs Bank Ltd. [1919] 1 KB 678, cheques payable to
'the Officer in charge, Estate Office, Canadian Overseas Military Force' were
used by an individual to payoff his debts. There was an instruction in all the
cheques that it was negotiable by the concerned officer. However, it was held
that the fact that the cheques were drawn in favour of the officer in charge
should have put the banker on enquiry and since no such enquiry was made by
the banker the bank is liable on the grounds of negligence.
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7.4 LET US SUM UP
However, the Negotiable Instruments Act does not specifically lay down the
duties of a collecting banker while collecting cheque, it gives protection to a
collecting banker under Section 131. From Section 131, it can be deduced that a
banker to claim protection should comply with certain basic duties failing which
he will not be entitled to seek protection under Section 131. These duties are:
1. The collecting banker should have acted in good faith.
2. He should have acted without negligence.
3. He should receive payment for a customer.
4. The cheque should be crossed generally or specially to himself.
In concluding whether the bank had been negligent or not the following matters
would be relevant and if the banker has failed to carry out any of the following
duties then he can be liable on the grounds of negligence. These duties are:
(i) To open the account with proper references and documentary proof.
(ii) To confirm the reference, where the referee is not known and or does
not come personally.
(iii) To ensure crossing and special crossing.
(iv) To verify the instruments or any apparent defect in the instruments.
(v) To take into account the state of customer's account.
(vi) To make enquiries by the collecting bank in collecting cheques payable
to third parties.
7.5 KEYWORDS
Conversion; Non-negotiable crossing.
7.6 CHECK YOUR PROGRESS
1. State whether true or false.
(i) The statutory protection to a collecting banker is as per Section 6 of the
Indian Contract Act. (ii) Section 131A of the Negotiable Instruments Act
extends the protection granted to a banker
while receiving payment of a cheque, and drafts, (iii) The duties of collecting
bank to claim protection has been laid down under the Indian Contract
Act and Banking Regulation Act.
(iv) In the absence of proper reference the banker can be held liable on the
grounds of negligence, (v) It is necessary for the banker to make enquiries
regarding the reference given by the customer.
7.7 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (i) False; (ii) True; (iii) False; (iv) True; (v) True
L.K.A.B.8
INDEMNITIES
STRUCTURE
8.0 Objectives
8.1 Introduction
8.2 Contract of Indemnity Defined
8.3 Distinctive Features of Indemnity Contract and Guarantee
8.4 Scope and Application of Indemnity Contracts to banks
8.5 Rights of an Indemnity Holder
8.6 Let Us Sum Up
8.7 Keywords
8.8 Check Your Progress
8.9 Answers to 'Check Your Progress'
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8.0 OBJECTIVES
After studying this unit, you should be able to understand:
• the definition and concept of indemnity;
• distinctive features of an Indemnity Contract and how it differs from a
guarantee;
• when and why bankers take indemnities;
• know the rights of an indemnity holder;
• know the liabilities of the indemnifier.
8.1 INTRODUCTION
The word indemnity means 'to save from loss'. This loss could be either due to
the act of the party giving the indemnity or due to the act of a third party. The
law regarding indemnity as laid down in Sections 124 and 125 of the Indian
Contract Acts, is not exhaustive. The law of indemnity is much wider than as
stated in the Contract Act, since Courts applying the principles of equity have
developed it. A Contract of Indemnity is a contingent contract, i.e. its
performance is made dependent upon the happening or non-happening of some
event.
8.2 CONTRACT OF INDEMNITY DEFINED
Section 124 of the Indian Contract Act, 1872 defines contract of indemnity as
follows:
Sectionl24. 'Contract of Indemnity' defined: A contract by which one party
promises to save the other from loss caused to him by the conduct of the
promisor himself or by the conduct of any other person, is called a 'Contract of
Indemnity'.
Section also gives an illustration of a Contract of Indemnity as follows:
A contract to Indemnify B against the consequences of any proceedings which C
may take against B in respect of a certain sum of Rs. 200, is called a contract of
Indemnity.
In the above definition, the person giving the promise is called the indemnifier
and the person to whom the promise is made is called the indemnified or the
indemnity holder. As stated, earlier the contract of indemnity as defined in the
contract is narrow and not exhaustive and the law regarding indemnity is much
wider than that as defined in the Contract Act. For example, all insurance
contracts come within the ambit of a contract of indemnity, but are not dealt with
under Section 124 of the Contract Act. Section 124 deals only with one
particular type of indemnity, viz., where a person gives a promise to save
another person from loss caused by either the conduct of the person giving the
promise or by the conduct of any other person. Over and above the kind of
indemnity stated in Section 124, there are cases where the Courts applying the
principles of general law have held a person liable to indemnify, though the
person never did undertake such a liability. The decision of the Privy Council in
Secretary of State vs Bank of India Ltd. (AIR 1938 PC 191) best illustrates this
point. In this case, Ms. G was the holder of a Government promissory note
which she had handed over to Mr. A, her broker. Mr. A forged Ms. G's signature
and endorsed it in his favour. Mr. A then endorsed it for value to the bank. The
bank in good faith applied to the Government Public Debt Office to have the
note exchanged in their name, which was done. Ms. G on being aware that she
has been defrauded, sued the Government and recovered the appropriate
damages. The Government in turn sued the bank to indemnify the Government
against the loss suffered by them. The Court held the bank to be liable because
under common law covering right of indemnity, the bank is responsible for an
injury to a third party's rights.
A contract of indemnity, though similar to a contract of guarantee differs on
various counts. To know the difference between these two types of contracts we
shall examine their respective features one by one in the next part.
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8.3 DISTINCTIVE FEATURES OF INDEMNITY CONTRACT AND
GUARANTEE
i. Number of Parties to the Contract of Indemnity: In a contract of indemnity
there are two parties, viz., the indemnifier and the indemnified whereas in a
contract of guarantee there are three parties, viz., the debtor (the person on
whose behalf the guarantee is given), the creditor (the beneficiary, the person to
whom the guarantee is given) and the surety (the person who gives the
guarantee).
ii. Contingent Risk: In an indemnity, the risk is contingent whereas in a
guarantee the liability is
subsisting. ,
iii. Nature of Liability: In a contract of indemnity, the indemnifier is required to
make good the loss as soon as it occurs and he cannot rely on the fact that the
person on whose behalf the indemnity is given has not made good the loss,
whereas in a contract of guarantee, the surety's liability is secondary and the
principal debtor is primarily liable.
iv. Number of Contracts: There are only two parties to a contract of indemnity
and as such only one contract. However, in a contract of guarantee there are at
least three contracts: one between the debtor and creditor, the other between the
creditor and the surety and the third between the surety and the debtor.
v. Purpose of Contract: An indemnity is for the reimbursement of a loss whereas
a guarantee is for the security of the creditor.
8.4 SCOPE AND APPLICATION OF INDEMNITY CONTRACTS TO
BANKS
As far as a banker is concerned, the law relating to indemnities is of great
importance. Customers of the bank who have lost a demand draft or travellers'
cheque are required to give an indemnity before the issuance of a fresh
instrument in lieu of the lost one. These indemnities are required since the bank
has to protect itself from any subsequent claim made by a person who may have
for value received these instruments. In some cases over and above the
indemnity, banks ask for surety. This is usually done in cases where the amount
involved is quite substantial or the banker does not know the customer well
enough, since the customer must have had only one or two dealings with the
banker. Indemnity bonds are also insisted by bankers while issuing duplicate
FDRs, settling death claims to heirs or while issuing duplicate pay orders
(bankers' cheque), etc.
In the indemnity taken by the bank the customer undertakes to protect the bank
from any loss or damage and for costs incurred. In most states, these indemnities
are stamped as an agreement. However, if they are witnessed, they would be
treated as an indemnity bond thereby being liable for payment of ad valorem
stamp duty.
8.5 RIGHTS OF AN INDEMNITY HOLDER
Section 125 of the Contract Act lays down the rights of an indemnity holder.
125. 'Rights of indemnity holder when sued: The promisee in a contract of
indemnity, acting within the scope of his authority, is entitled to recover from
the promisor the following:
i. All damages which he may be compelled to pay in any suit in respect of any
matter to which the
promise to indemnify applies, ii. All costs which he may be compelled to pay in
any such suit if, in bringing or defending it, he did
not contravene the orders of the promisor, and acted as it would have been
prudent for him to act
in the absence of any contract of indemnity, or, if the promisor authorised him to
compromise the
suit, iii. All sums which he may have paid under the terms of any compromise of
any such suit, if the
compromise was not contrary to the orders of the promisor, and was one, which
it would have
104
been prudent for the promisee to make in the absence of any contract of
indemnity, or, if the promisor authorised him to compromise the suit.
A reading of the above Section shows that the rights of an indemnity holder are
subject to:
(a) his acting within the scope of his authority;
(b) he does not contravene the specific directions of the promisor.
In case the indemnity holder does not violate the above two conditions, he is
then entitled to be indemnified by the indemnifier to the extent of:
(a) the damages paid by him;
(b) the costs required either to file the suit or defend it;
(c) any amounts paid by him pursuant to a compromise in the suit provided
that the compromise
was not contrary to any of the order or directions of the indemnifier and the
compromise was
such that it was an act of prudence in the absence of a contract of indemnity.
1. Damages: As regards damages, it is to be noted that High Courts have
differed in the views as to
when the indemnifier's liability commences. Some High Courts have held that
the liability commences
only from the time the indemnity holder actually incurs loss, whereas some
others have held that an
indemnity holder can compel the indemnifier to put him in a position to meet the
liability. The
former view is to be preferred.
2. Costs: As regards costs, costs paid to solicitors, travelling expenses and
also costs reasonably
incurred in resisting or reducing or ascertaining the claim, may be recovered.
The general principle
in computing the costs is that it should be such as, would a reasonable man think
if necessary to
incur.
3. Sums paid on Compromise: As per Section 125, if the indemnity holder
acts within the scope of his
authority, then he is entitled to recover from the indemnifier all the sums that he
may have paid
pursuant to a compromise in a suit, provided however that
(a) such compromise was not contrary to the orders of the indemnifier;
(b) such compromise was prudent to be made by the indemnity holder in
the absence of any
contract of indemnity;
(c) the indemnifier had authorised the indemnity holder to compromise the
suit.
The Madras High Court in Venkataramana vs Mangamma AIR 1944 Mad. 457,
has held that even in the absence of a notice to the indemnifier (promisor), the
compromise would bind him, if not contrary to the orders of the promisor, and is
entered bona fide and without any collusion and is not imprudent.
8.6 LET US SUM UP
Sections 124 and 125 of the Indian Contract Act respectively, lays down the
laws of indemnity and the rights of indemnity holder. These sections are not
exhaustive and the general law of indemnity, which is wider, has been applied in
cases not covered by Sections 124 and 125. The indemnifier has to compensate
the indemnity holder who is entitled to the damages suffered, costs incurred and
to recover any sums paid in a compromise of any suit. Bankers obtain
indemnities to protect themselves from any loss that they may incur while
issuing duplicate of instruments like demand drafts or travellers' cheques, FDRS,
pay-orders, etc.
8.7 KEYWORDS
Indemnity; Indemnifier; Indemnity holder.
105
8.8 CHECK YOUR PROGRESS
A. 1. Fill in the blanks,
(i) Section
of the Indian Contract Act defines an indemnity.
(ii) A person promising to save another from loss is called
(iii) is a person who is promised to be saved from loss.
2. State whether the statements are true or false.
(i) Contract of Indemnity as defined in the Contract Act is exhaustive, (ii)
Insurance Contracts are not contracts of indemnity.
B. 1. Fill in the blanks.
(i) There are parties to a contract of indemnity.
(ii) Indemnifiers liability in a contract of indemnity is .
2. State whether the following statements are true or false.
(i) There are three parties to a contract of indemnity, the indemnifier, the
indemnity holder and
the person on whose behalf the indemnity is given, (ii) Indemnifter's liability
occurs only if the indemnity holder suffers loss.
C. 1. State whether the statements are true or false.
(i) Customers as a matter of right and without an indemnity can obtain duplicate
of demand
drafts or travellers' cheques.
(ii) Indemnities are required by banks purely as a formality and does not serve
any other purpose, (iii) The indemnity obtained by banker only protects him
from the actual value of the instrument.
D. 1. What are the two conditions that an indemnity holder is bound to
comply before being indemnified
for a loss?
2. To what extent is the indemnity holder entitled to be indemnified?
3. In case of compromise the indemnity holder has to satisfy certain
conditions before recovering
the loss from the indemnifier, what are these conditions?
4. State whether the statements are true or false.
(i) An indemnity holder can act beyond his authority.
(ii) An indemnity holder can be compensated only for damages and not for the
costs incurred
by him. (iii) An indemnity holder is entitled to compromise a suit as thought fit
by him though contrary
to the orders of the indemnifier.
8.9 ANSWERS TO 'CHECK YOUR PROGRESS'
A. 1. (i) 124; (ii) Indemnifier; (iii) Indemnity holder
2. (i) False; (ii) False
B. 1. (i) 2; (ii) Primary
2. (i) False; (ii) True
C. 1. (i) False; (ii) False; (iii) False.
D. 1. (i) He should act within the scope of his authority and should not
contravene any directions
of the indemnifier.
2. To the extent of the damages suffered, costs incurred and sums paid for
compromise of any
suit.
3. (i) The compromise was not contrary to the orders of the indemnifier.
(ii) Such compromise was prudent.
(iii) the indemnifier had authorised the indemnity holder to compromise the suit.
4. (i) False; (ii) False; (iii) False
BANK GUARANTEES
STRUCTURE
9.0 Objectives
9.1 Introduction
9.2 Bank Guarantees
9.3 Various Ttypes of Bank Guarantees
9.4 Banker's Duty to Honour Guarantee
9.5 Issuance of Bank Guarantee - Precautions to be taken
9.6 Payment Under Bank Guarantee - Precautions to be taken
9.7 Let Us Sum Up
9.8 Keywords
9.9 Check Your Progress
9.10 Answers to 'Check Your Progress'
108
9.0 OBJECTIVES
After studying this unit, you should be able to understand:
• various kinds of bank guarantees, their nature and scope;
• the precautions to be taken while issuing a bank guarantee;
• the precautions to be taken on invocation of a bank guarantee.
9.1 INTRODUCTION
In commercial transactions, bank's customers are sometimes required to give a
bank guarantee. This is mostly as an alternative to keep cash as a security
deposit. The third party who seeks the guarantee, not being aware of the
customer's financial standing, prefers a bank guarantee. In turn, the bank, which
very well understands the financial standing of the customer, undertakes to
guarantee the customer's financial commitments or the performance of contracts
by him. The bank charges a commission for this service which depends on the
security available and the financial stability of the customer. In this Chapter, you
will learn what exactly is a bank guarantee, the various types of bank guarantees,
the precautions to be taken while issuing a bank guarantee and on making
payment on a bank guarantee the distinction between a bank guarantee and an
ordinary guarantee, why in a bank guarantee the banker's duty to honour the
guarantee is of prime importance and the limit to which this duty can be
extended.
9.2 BANK GUARANTEES
The term 'bank guarantee' briefly stated means:
a guarantee given by a bank to a third person, to pay him a certain sum on behalf
of the bank's customer, on the customer failing to fulfil any contractual or legal
obligations towards the third person.
From the above, it can be seen that there should first be a commitment on the
part of the customer to fulfil certain obligations to a third party. This could be
contractual or legal, i.e. imposed by law. This commitment of the customer is
guaranteed by a bank and if the customer fails to honour his commitment the
banker pays the amount, it has promised to pay. Once the bank gives a
guarantee, then its commitment to honour the guarantee is onerous and as such,
it is prudent that a banker before issuing a guarantee on behalf of his customer
takes appropriate security and understands his rights and duties. Before we
embark on a study of the banker's duty to honour guarantees and the onerous
obligation he undertakes on behalf of the customer when he issues a guarantee, it
would be necessary to understand the various kinds of guarantees that a banker
usually issues.
9.3 VARIOUS TYPES OF BANK GUARANTEES
Though under law, bank guarantees have not been classified by the nature of the
underlying contract entered into by the customer, in practice such classification
has been made. Though there are various types of guarantees, the important
ones, which a banker would be regularly required to issue in the course of his
business are as follows:
i. Financial Guarantee: These are guarantees issued by banks on behalf of the
customers, in lieu of the customer's requirement to deposit a cash security or
earnest money. These kinds of guarantees are mostly issued on behalf of
customers/contractors dealing with Government departments. Such guarantees
are also issued in situations where a party is required to deposit cash as a part of
contract. Most Government departments insist that before the contract is
awarded to contractor he should show that he is willing to perform the contract
and to ensure that now frivulous tenders
109
are mad, insist on an Earnest Money Deposit. However in lieu of the earnest
money government departments are generally willing to accept a bank
guarantee. This also helps the contractor who can utilise the funds for fulfilling
his obligations under the contract. In case the contractor does not take up
contract of awarded then the Government departments invoke the guarantee and
collect the money from the banks.
ii. Performance Guarantee: These are guarantees issued by the bank on behalf of
its customer whereby the bank assures a third party, that the customer will
perform the contract entered into by the customer as per the condition stipulated
in the contract, failing which the bank will compensate the third party up to the
amount specified in the guarantee. These types of guarantees are usually issued
by bankers on behalf of their customers, who have entered into contracts to do
certain things on or before a given date. Though the bank assures, that the
conditions as stipulated in the contract will be complied with by the customer in
practice, the banks on being served a notice of default by the third party pays
over the amount guaranteed without going into the technicality of the contract.
This is because, after a guarantee is issued, the contract of guarantee is
independent of underlying commercial transaction and any claim as per terms of
guarantee is required to be honoured. Though, in certain performance guarantees
a clause is inserted, that proof of default of the customer is necessary, most bank
guarantees do not insist on such proof. A mere demand from the beneficiary that
there has been a default by the bank's customer is sufficient for the bank to make
payment. This is so, since banks by the nature of their expertise prefer to deal
with documents and they would not like to go beyond the contract and verify
whether there has been a breach of the contract or not. This is because, generally
the guarantee document makes it obligatory on the part of the issuing bank to
honour their guarantee without going into the points of differences between the
beneficiary and the principal on whose behalf he had issued the guarantee.
iii. Deferred Payment Guarantee: Under this type of guarantee, the banker
guarantees payment of instalments spread over a period. This type of guarantee
is required, when goods or machinery are purchased by a customer on long-term
credit and the payment is to be made in instalments on specified dates spread
over more than a year. In terms of the contract of sale, the seller draws drafts
(bills of exchange) of different maturities on the customer which are to be
accepted by the customer. The banker guarantees due payment of these drafts. A
deferred payment guarantee constitutes an undertaking on the part of the bank to
make payments of deferred instalments to the seller (beneficiary) on the due
dates, in the event of default by the customer (buyer). While issuing a deferred
payment guarantee, the banker has to assess the ability and sources of funds of
the customer to honour the payment of instalments on due dates.
9.4 BANKER'S DUTY TO HONOUR GUARANTEE
Bank guarantees are called 'the life blood of national and international
commerce' and even though they are an offshoot of a primary contract between
the debtor and creditor, these guarantees are independent commitments taken by
bank on the behalf of their customers. In most bank guarantees, banks undertake
to make payment merely on demand by the beneficiary. It is therefore absolutely
necessary that irrespective of the underlying contract and any dispute between
the parties to the contract, the bank makes payment, if the guarantee has been
invoked properly. We shall now examine this duty of the banker to honour his
commitment under a guarantee and the grounds on which payments can be
refused.
i. Bank's Obligation to Pay Primary
(a) The obligation of a banker, to honour his commitment on a guarantee given
by him being primary, casts a duty on the bank to honour it irrespective of the
disputes between the beneficiary
110
and the debtor. The first of the cases wherein the bank's commitment to honour
its guarantee was discussed was the English case of R.D. Harbottle Ltd. vs
National Westminster Bank Ltd. (1978) OB 146, wherein Justice Kerr held as
follows:
Such guarantees even though having their genesis in the primary contract
between the parties are nevertheless autonomous and independent contracts and
a bank, which has given a performance guarantee must honour that guarantee
according to its terms. It is not concerned in the least with relations, between the
supplier and the customer, nor with the question whether the supplier has
performed his contracted obligations or not, nor with the question whether the
supplier is in default or not and the only exception is when there is a clear fraud,
of which the bank has notice.
(b) The above principle has been accepted by Courts in India and they have
refused to grant injunctions against banks from making payment under the
guarantee except in cases of fraud or special equities in favour of the person on
whose behalf the guarantee has been issued. The decision of the Calcutta High
Court in Texmaco Ltd. vs State Bank of India AIR (1979) Cal 44, the first
among the Indian cases illustrates the duty imposed on a bank to honour its
guarantee. In this case, the bank had issued a guarantee to STC on behalf of M/s
Texmaco Ltd., wherein the bank irrevocably and unconditionally guaranteed the
due performance of the contractual obligations of M/s Texmaco and in case of
default by Texmaco, the bank, on first demand by STC, guaranteed payment of
the amount without any contestation, demur or protest and/or without reference
to Texmaco and/or without questioning the legal relationship subsisting between
Texmaco and STC. The guarantee was invoked by STC upon which Texmaco
filed a suit for injunction to restrain the bank from making any payment. The
High Court held that:
In the absence of such special equities and in the absence of any clear fraud, the
bank must pay on demand, if so stipulated, and whether the terms are such must
have to be found out from the performance guarantees as such. Here though the
guarantee was given for the performance by Texmaco in an orderly manner their
contractual obligation, the obligation was taken by the bank to repay the amount
on 'first demand' and 'without contestation, demur or protest and without
reference to Texmaco and without questioning the legal relationship subsisting
between STC and Texmaco'. It further stipulated, as I have mentioned before,
that the decision of STC as to the liability of the bank under the guarantee and
the amounts payable thereunder shall be final and binding on the bank. It has
further stipulated that the bank should forthwith pay the amount due
'notwithstanding any dispute between STC and Texmaco'. In that context, in my
opinion the moment, a demand is made without protest and contestation, the
bank has obliged itself to pay irrespective of any dispute as to whether there has
been performance in an orderly manner of the contractual obligation by the
party.
The Supreme Court has also considered the liability of a banker on a guarantee
and after referring to the various English decisions and the decisions of various
High Courts held in UP Co-operative Federation vs Singh Consultant [1988 (1)
SCC 174] that commitments of banks must be honoured free from interference
by the Courts. Otherwise, trust in commerce, internal and international, would be
irreparably damaged. It is only in exceptional cases, that is to say, in case of
fraud or in case of irretrievable injustice be done, the Court should interfere.
LIABILITY OF BANK UNDER A GUARANTEE GIVEN ON BEHALF OF A
COMPANY ORDERED TO BE WOUND UP
In Maharashtra Electricity Board, Bombay vs Official Liquidator, High Court of
Ernakulam and Another (AIR 1982 SC. 1497), the Supreme Court had occasion
to consider the liability of a bank on a guarantee
111
given by it on behalf of a company that was being wound up, the facts of which;
in a nutshell are as follows:
The Cochin Malleable Private Limited (Company) entered into a contract with
Maharashtra State Electricity Board, Bombay (Board) for supply of goods from
time to time. As per the terms of the contract, the company furnished a bank
guarantee for Rs. 50,000 as earnest money deposit. As per the guarantee given
by Canara Bank Limited (Bank), the bank agreed unequivocally and
unconditionally to pay within forty-eight hours on demand in writing from the
board a sum not exceeding Rs. 50,000. On 30 July 1973, a petition for winding
up of the company was presented and the High Court, Kerala, on 16 September
1974, ordered the company to be wound up. On 27 August 1973, the board
called upon the bank to pay the guarantee amount of Rs. 50,000 followed by
several reminders and final demand was made on 23 July 1974.
On 4 November 1974, the Bank wrote to the official liquidator stating that the
company was liable to the bank for payment of Rs. 1,64,353.12 which included
the guaranteed amount. Thereupon, the official liquidator filed an application
before the company Judge, praying for an order restraining the board from
realising the amount covered by the bank guarantee on the ground that since the
company was ordered to be wound up, the board could not claim payment under
the bank guarantee.
The learned company Judge upheld the plea of the official liquidator and issued
an order restraining the board from realising the amount from the bank. The
board filed an appeal to the Division Bench of the High Court, which was also
dismissed. The board thereupon approached the Supreme Court. The Supreme
Court held that:
Where under a letter of guarantee the bank has undertaken to pay any amount
not exceeding Rs. 50,000 to the board, within forty-eight hours of the demand
and the payment of the amount guaranteed by the bank was not made dependent
on the proof of any default on the part of the company in liquidation, the bank
was bound to make payment to the board. The board was not concerned with
what the bank did in order to reimburse itself after making the payment under
the bank guarantee. It was the responsibility of the bank to deal with the
securities held by it in accordance with law. The Supreme Court observed that
under Section 128 of the Contract Act, the liability of the surety is co-extensive
with that of the principal debtor, unless, it is otherwise provided in the contract.
Further, a surety is discharged under Section 134 by any contract between the
creditor and the principal debtor by which the principal debtor is released or by
any act or omission of the creditor, the legal consequence of which is the
discharge of the principal debtor. But a discharge which a principal debtor may
secure by operation of law in bankruptcy (or in liquidation proceedings in the
case of a company) would not absolve the bank from its liability under the bank
guarantee.
LIABILITY OF BANKS UNDER A GUARANTEE WHEN THE MAIN
CONTRACT IS SUSPENDED
The question whether the bank is absolved of its liability under a guarantee
issued by it when the main contract is suspended by a statute was considered by
the Bombay High Court in Messrs SCII (India) Limited vs Indian Bank and
Another (AIR 1992 Bom. 121). The facts of the case are as follows:
For carrying out erection, testing and commissioning of IP pipe works, the
company engaged the services of a contractor. At the request of the contractor,
the bank furnished a performance guarantee where under the bank undertook to
pay to the company on demand 'any and all monies payable by the contractor to
the extent of Rs. 10,72,806 at any time up to 30 June, 1989 without demur,
reservation, contest, recourse of protest and/or without reference to the
contractor'.
The Government of West Bengal had issued a notification under which the
contractor was declared as an unemnlovment relief undertaking under the West
Bengal Act, 1972, and had suspended all contracts
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On invocation of the guarantee the contractor, therefore, submitted that the
contract of erection, etc., entered into by the contractor with the company stood
suspended.
On behalf of the company, it was submitted that the bank guarantee was an
independent contract between the bank and the company and was not affected or
suspended by operation of the above referred to Act or the notification.
The High Court observed that the company had not invoked the guarantee
fraudulently or mala fide. The High Court pointed out that according to the
decision of the Bombay High Court and Supreme Court, the contract of bank
guarantee is an independent and separate contract. The High Court noted, that in
several Supreme Court decisions, particularly in M.S.E.B. Bombay vs Official
Liquidator, AIR 1982, S.C. 1497, and in State Bank of India vs Messrs Saksaria
Sugar Mills Limited, AIR 1986, S.C. 868, it was held that the liability of the
guarantor to pay was not affected by suspension of liability of the principal
debtor under some statutory provisions. In the result, the High Court refused to
grant any injunction restraining the bank from making payment under the bank
guarantee more so when there was no special equity in favour of the contractor.
From the above decisions, it can be seen that the liability of the bank is not
dependent on the underlying contract but is an independent contract which the
Courts would enforce except in case of fraud.
ii. Exceptions
(a) Cases of fraud: The Supreme Court in United Commercial Bank vs Bank of
India AIR 1981 SC 1426 observed as follows:
Except possibly in clear case of fraud of which the banks have notice, the Courts
will leave the merchants to settle their disputes under the contracts by utilisation
or arbitration as available to them or as stipulated in the contracts.
Fraud, has been held to be one of the exceptions to the general rule regarding the
contracts of guarantee. A banker, who has knowledge of fraud, can therefore
refuse payment of the amount guaranteed. The question however, would arise as
to how a banker can decide as to whether a fraud has been committed or not. In
such cases, it is advisable that the banks inform their customer about the
invocation of the guarantee by the creditors and the banks intention to pay within
a given time if the unless restrained by an injunction order of a court. This would
relieve the bank of the task of judging as to whether a fraud has been committed
or not. On this point the observations of Supreme Court in UP Co-operative
Federation vs Singh Consultants 1988 (1) Section 174 is worth noting, whether
it is a traditional letter of a credit or a new device like performance bond or
performance guarantee, the obligation of banks appears to be the same. If the
documentary credits are irrevocable and independent, the banks must pay when
demands are made. Since the bank pledges its own credit involving its
reputation, it has no defence except in the case of fraud. The bank's obligations,
of course should not be extended to protect the unscrupulous seller, that is, the
seller who is responsible for the fraud. However, the banker must be sure of his
ground before declining to pay. The nature of the fraud that the Courts talk
about, is fraud of an 'egregious nature as to vitiate the entire underlying
transaction'. It is fraud of the beneficiary, not the fraud of somebody else. If the
bank detects, with a minimal investigation, the fraudulent action of the seller the
payment could be refused. The bank cannot be compelled to honour the credit in
such cases. However, it may be very difficult for the bank to take a decision on
the alleged fraudulent action. In such cases, it would be proper for the bank to
ask the buyer to approach the court for an injunction. M/s Escorts Limited vs
Messrs Modern insulators and Another AIR 1988 Delhi 345 also illustrates the
point that banks in case of doubt should seek appropriate direction from the
Court. In this case, the
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Escorts supplied generator sets to Modern Insulators the performance of which
were guaranteed by the bank. Modern invoked the guarantee, whereupon Escorts
moved the Court to restrain Modern from recovering the amount and the bank
from making payment of the guaranteed sum. The Court granted injunction since
the guarantee was not invoked properly. Thereafter Modern invoked the
guarantee once again but the bank did not pay. The matter came before the High
Court and Escorts pleaded that Modern had played a fraud and hence were not
entitled to the guaranteed amount. The High Court held that averments of fraud
have to be pleaded and proved, which was not done by Escorts. Of importance in
this judgement is the Court's remark as regards the conduct of the bank. The
Court remarked that the bank should have approached the Court for appropriate
directions if it had any doubts. Merely because an application for injunction was
made, would not be a ground for the bank not to honour its commitment under
the bank guarantee.
It is therefore important to ensure that a clear cut case of fraud is established
before a bank can refuse payment.
(b) Special equity in favour of debtor: If there is a possibility of an irretrievable
harm or injustice to one of the parties concerned, the Courts would adjunct the
bank from making payment. As an illustration to the exception the Supreme
Court cited and approved the decision of the US Court in Itek Corp. vs First
National Bank of Boston (566 Fed. Supp 1210). In this case, an exporter in USA
entered into an agreement with the Imperial Government of Iran and sought an
order terminating its liability on stand by letters of credit issued by an American
Bank in favour of an Iranian Bank as part of the contract. The relief was sought
because of the situation created after the Iranian revolution when the American
Government cancelled the export licences in relation to Iran and the Iranian
Government had forcibly taken 52 American citizens as hostages. The US
Government had blocked all Iranian assets under the jurisdiction of the United
States and had cancelled the export contract. The Court upheld the contention of
the exporter that any claim for damages against the purchaser if decreed by the
American Courts would not be executable in Iran under these circumstances and
realisation of the bank guarantee/letters of credit would cause irreparable harm
to the Plaintiff. This contention was upheld. To avail of this exception, therefore,
exceptional circumstances, which make it impossible for the guarantor to
reimburse himself if he ultimately succeeds, will have to be decisively
established. Clearly, a mere apprehension that the other party will not be able to
pay, is not enough. In the Itek case there was a certainty on this issue. Secondly,
there was good reason, in that case for the Court to be prima facie satisfied that
the guarantors, i.e. the bank and its customer would be found entitled to receive
the amount paid under the guarantee.
9.5 ISSUANCE OF BANK GUARANTEE - PRECAUTIONS TO BE TAKEN
The liability of a bank under a guarantee depends on two fundamental criteria,
viz., the amount guaranteed and the period of the guarantee. These two factors
have to be specifically stated since in the absence of any one or both of these
factors, the bank's liability could be unlimited either in the amount guaranteed or
the period during guarantee. The banker should also obtain a counter guarantee
from his customer on whose behalf he has given the guarantee, so that in case he
is required to pay the guarantee he can fall back on the counter guarantee to
claim the amount paid by him. We shall study these aspects in detail since in
your day-to-day practice as a banker you will come across these aspects quite
frequently.
i. Amount Guaranteed: When the bank issues a guarantee, the first and foremost
consideration that should weigh in a banker's mind is the amount of the
guarantee he is called upon to issue. In the guarantee agreement, the amount has
to be specifically stated, both in figures and words. While
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stating the amount, that the bank would guarantee to pay, care should be taken to
state whether or not the amount is inclusive of all interests, charges, taxes and
other levies. This is important to avoid unnecessary disputes regarding the
liability of the bank. On invocation, the bank is liable to pay the whole amount
of the guarantee unless as stated earlier a case of fraud has been brought to its
notice.
ii. Period of Guarantee: Banks always specify the period for which their
guarantee subsists and an additional period during which a claim has to be made
on the bank to make payment. The former period during which the guarantee
subsists, is called the validity period and the latter, the claim period. If any
default has been committed by the debtor (i.e. the bank's customer) it should be
within the validity period. The claim period is only to facilitate the beneficiary to
prepare and lodge claim, if any, under the guarantee. It is thus, necessary as a
matter of great caution that this period be specified to the exact date, for
example, 'this guarantee is valid up to 31 December 2007.'
Once this outer limit for the bank to guarantee a default of the debtor is fixed,
then the creditor can make a claim only if the default has occurred within this
period, and for any default beyond this date the bank cannot be held liable. Once
a default is made then the beneficiary has to make a claim on the bank to make
good the loss within the claim period.
Claim period in a guarantee: In a guarantee, it is necessary to provide for a
period slightly longer than the validity period for the beneficiary to make a
claim. The claim period is usually a few months more than the validity period of
the guarantee. Since if the debtor were to commit a default on the last day of the
validity period, then the beneficiary, at the earnest, invoke the same only on the
next day. Taking into account the time to communicate the invocation, etc., the
claim period should at least be fifteen to thirty days after the validity period. For
example, if the validity period of the guarantee is up to 31 December 2007, then
the claim period would normally be up to 31 January 2008.
Amendment to Section 28 of Indian Contract Act and its effect on Bank
Guarantee: Prior to the amendment of Section 28 of the Indian Contract Act,
1872 most bank guarantees had a standard clause at the end of their guarantee
agreements. As per this clause, the beneficiary was required to enforce his
claims within a period of three to six months, failing which, the bank's liability
was extinguished and hence the rights of the beneficiary. The above clause was
necessitated due to the fact that in the absence of it, Government departments
and municipal bodies can file a suit against the bank under a bank guarantee
within a period of thirty years after making a claim. The banks would therefore
be required to carry forward this liability for a long period and thereby required
to make provisions for the same in their balance sheets. Added to this, the
customers cash margin and security would have to be retained either until the
guarantee is returned by the beneficiary or until the expiration of the period of
limitation. However, this clause, had been challenged before various High
Courts and the High Courts have held that such clauses in the bank guarantees to
be valid, and not violative of Section 28 of the Contract Act.
However, from 1 January 1997, Section 28 of the Indian Contract Act has been
amended due to which the standard limitation clauses in the bank guarantees by
which the bank extinguished their liability as been declared illegal. As such, at
present if a beneficiary were to invoke the guarantee within the claim period, for
a default committed by the debtor during the validity period then in case the
bank did not make payment, the beneficiary can sue the bank within the normal
period as provided in the Limitation Act, 1963. This period under the Limitation
Act is thirty years in case the beneficiary is Government department or
municipal body and three years in all other cases.
As such it is prudent to insist that the bank guarantee be returned after the claim
period duly cancelled by the beneficiary or a certificate be obtained from the
beneficiary that there are no claims under the
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guarantee, and until such time the cash margin and the security of the debtor
(customer) has to be retained.
iii. Counter Guarantee and Other Security: Though a bank guarantee is a
contingent liability, it is always prudent for a banker to secure this contingent
liability to cover himself in case it is enforced. This can be done by obtaining a
counter guarantee-cum-indemnity executed by the customer in favour of the
bank. The counter guarantee-cum-indemnity, should be carefully drafted to
ensure, that in case the bank were to make payment on behalf of the customer,
then the customer in turn 1 should not only make good the amounts paid by the
bank to the creditor but also any expenses connected therewith including costs of
attorney, any interest on delayed payment, taxes and other levies. It is to take
care of all the above payments that the counter guarantee also includes an
indemnity aspect. The counter guarantee should also include a clause that it
would remain in force until the guarantee given by the bank subsists, viz., until
the bank is duly discharged by the beneficiary or a certificate to this effect is
issued by the beneficiary.
Though a counter guarantee-cum-indemnity is taken as a security for every
guarantee issued by the bank, its value would depend on the financial standing
of the person/company giving the counter guarantee. As such, it is preferable
that keeping in mind the financial worth of the counter guarantor necessary
security in the form of tangible securities like fixed deposits, other paper
securities or immovable properties, etc., are obtained or the existing charge of
the debtor be also extended to cover the guarantee.
9.6 PAYMENT UNDER BANK GUARANTEE - PRECAUTIONS TO BE
TAKEN
Before making payment, a banker has to ensure that the invocation of the
guarantee has been properly made; failing which he may not have any recourse
against the debtor. The banker should also see that no order of injunction has
been passed by any Court of law prohibiting the bank from making payment. In
case, a banker makes payment ii1 spite of there being an order by a competent
Court in which the bank is a party, then the bank will be answerable for
Contempt of Court.
i. Proper Invocation of Guarantee: The bank while making payment on its
guarantee has to be careful and ensure that the invocation has been properly
made. There are divergent views as regards the proper manner in which a bank
guarantee should be invoked. The Delhi High Court, in M/s Harprashad and Co.
Ltd. vs Sudarshan Steel Mills, AIR 1980, Delhil74, had occasion to consider this
question. In this case, the High Court took the view that:
The duty of the beneficiary in making the demand on the bank is like the duty of
the plaintiff to disclose the cause of action in the plaint. Just as a plaint is liable
to be rejected for non-disclosure of the cause of action, a demand by the
beneficiary of the bank guarantee is liable to be rejected by the bank if it does
not state the facts showing that the conditions of the bank guarantee have been
fulfilled.
However, in contrast to the above views of the Delhi High Court, the Calcutta
High Court in Road Machines (India) Pvt. Ltd. vs The Project and Equipment
Corporation of India Ltd. and Another (AIR 1983 Cal91) held that:
It is not necessary that a bank guarantee should be invoked in an exact and
punctilious manner setting out the entire case of the beneficiary under the
guarantee in the same way as setting out a cause of action in a plaint. A bank
guarantee is a commercial document and is neither a statutory notice nor a
pleading in a legal proceeding. A bank guarantee may be invoked in a
commercial manner. The invocation would be sufficient and proper if the bank
concerned understands, that the guarantee is being invoked by the beneficiary, in
terms of the guarantee.
As a banker, it would be prudent to verify that the invocation made is proper and
in deciding whether the invocation made is proper the banker has to see among
other things that the following requirements are satisfied:
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1. The invocation is within validity period.
2. The invocation amount is not more than the guaranteed amount. In case
it is more then only the
maximum amount stipulated in the guarantee need be paid.
3. The authority invoking the guarantee is competent or empowered to
invoke the guarantee. In
guarantees issued to Government departments the authority to invoke is usually
designated by the
post, so as to avoid any later problems by change in the person holding the post.
The banker has to
ensure that the person invoking has the powers to do so.
The Supreme Court in its decision in Hindustan Construction Co. Ltd. vs State
of Bihar (1999) 8 SCC436 has held that where as per the terms of the guarantee
the invocation was to be done by the chief engineer, the invocation by the
executive engineer was wholly wrong and the refusal of the bank to make
payment was valid.
ii. No Injunction Prohibiting Payment: Though Courts are reluctant to interfere
with the bank guarantee, there have been instances where Courts have granted
injunction restraining the banks from making payment under a guarantee. In one
such case that came up before the Calcutta High Court injunction was granted.
The facts of the case in Messrs G.S. Atwal Co. Engineers Pvt. Ltd. vs Hindustan
Works Construction Limited (AIR 1989 Cal 184) is as follows:
Under the terms of the contract entered into between the HWC Ltd. and the GSA
Co, the Petitioner was to furnish a bank guarantee for mobilisation advance
made by the Respondent to the Petitioner for Rs. 32.50 lakh. The contract did
not require the Petitioner to give any bank guarantee for the due performance of
the contract. The Petitioner requested the bank to issue a guarantee for Rs. 32.50
lakh to cover the mobilisation advance received by the Petitioner from the
Respondent. The bank made use of its standard format of guarantee and did not
delete certain clauses therein because of which the guarantee issued by it became
a mobilisation advance-cum-performance guarantee. Since the bank and the
Respondent, as beneficiaries, were the only parties to the bank guarantee, the
Petitioner never knew of the mistake on the part of the bank. The Respondent
took advantage of the mistake and although the mobilisation advance was
recovered in full, it invoked the bank guarantee for recovery of its claim for
damages for loss suffered, as a result of non-performance of the contract by the
Petitioner and demanded payment from the bank. On the bank showing its
willingness to make payment of the amount guaranteed by it, the Petitioner
approached the High Court for an order restraining the bank from making
payment.
The High Court held that: The Respondent was aware of the mistake on the part
of the bank and with ulterior motive took advantage of the mistake by
demanding payment in respect of its claim for damages for non-performance and
not in respect of any amount due for mobilisation advance given to the
Petitioner.
The bank has no right to saddle its customer with any additional liability under
the guarantee by issuing the same contrary to the instructions by its customer.
The Respondent has invoked the guarantee for recovery of loss and damages,
alleged to have been suffered due to alleged breach of contract by the Petitioner.
Though the general principle of non-interference by the Court in cases of bank
guarantee and letter of credit is for the smooth functioning of international trade
and commerce, this principle would not apply where the bank has acted
negligently and issued bank guarantee contrary to the customer's instructions.
Whether the invocation of the bank guarantee was in terms of the guarantee or
not will depend upon the terms of the guarantee and the letter of invocation. The
bank cannot act arbitrarily or whimsically in deciding whether the invocation
was in terms of the guarantee when in fact it was not.
In the instant case, the bank guarantee" was for mobilisation advance and not for
performance of the contract and the invocation of the bank guarantee was
admittedly for recovery of damages for the
alleged non-performance of the contract. The High Court, therefore, held that
there was special equity in favour of the Petitioner and he can prevent the
beneficiary from enforcing the bank guarantee.
It is, therefore, absolutely necessary for the bank to confirm that no injunction
order has been issued restraining the bank from making payment.
9.7 LET US SUM UP
A bank guarantee is a contract by which the bank guarantees a certain sum to a
person/entity on the customer failing to fulfil any contractual or legal obligation
to the said person/entity. Guarantee issued by banks mainly are financial
guarantees, performance guarantees, deferred payment guarantees and statutory
guarantees. Bank under a contract of guarantee is bound to honour its guarantee
and its obligations to pay is primary and independent of the underlying contract
between the customer on whose behalf the guarantee is given and the
beneficiary. This has been settled by the various decisions of the Courts. The
only exception for a bank not to make payment under a guarantee is when a
fraud exists, which must be proved beyond doubt or special equity is in favour of
the debtor.
While issuing a guarantee a bank has to ensure that, the amount guaranteed and
the period of the guarantee is specifically stated in the guarantee. Pursuant to the
amendment to Section 28 of the Indian Contract Act, the limitation period on a
contract of guarantee cannot be restricted to less than the period provided under
the Limitation Act. As such, if the guarantee is invoked in time then the
beneficiary can sue the bank within thirty years in case the beneficiary is a
Government or municipal body or three years in all other cases. The bank while
making payment under a guarantee has to ensure that the invocation is proper
and that the person invoking the guarantee has the authority to invoke the
guarantee. The bank while issuing a guarantee has to obtain a counter guarantee
from its customer and if necessary, additional security to protect the bank in case
it is required to pay under the guarantee.
9.8 KEYWORDS
Bank guarantee; Beneficiary; Counter guarantee; Debtor; Surety.
9.9 CHECK YOUR PROGRESS
1. State briefly what is a bank guarantee?
2. What purpose does a bank guarantee serve?
3. List the various types of bank guarantees and explain in brief their
specific nature.
4. Explain in brief- 'On a bank guarantee the banks duty to pay is primary.'
5. There are two exceptions to the general rule that banks must pay on a
guarantee. What are these
two exceptions? Explain in brief.
6. Choose the right answer from the choices given:
(i) In bank guarantees the bank makes payment on:
(a) being convinced that the beneficiary has incurred loss;
(b) on being sued by the beneficiary;
(c) on the guarantee being invoked and after seeking concurrence of the
debtor;
(d) merely on demand by the beneficiary.
(ii) In case of bank guarantees on behalf of company that is in liquidation the
bank on invocation of the guarantee by the beneficiary:
(a) must pay the amount to the Liquidator and not the beneficiary;
(b) must deposit the amount in the court to avoid any controversy;
(c) must pay the beneficiary;
(d) need not pay, since the bank guarantee lapses on the company being
liquidated.
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7. State in brief the precautions to be taken while issuing a bank guarantee.
8. While issuing a guarantee the bank omits to mention the amount and the
period of the guarantee.
Can the bank still be held liable? What would be the extent of the liability?
9. What is a validity period and claim period in a bank guarantee?
10. Can the bank in a guarantee issued by it restrict the claim period so as to
avoid its liability?
11. What is a counter guarantee and when is it obtained?
9.10 ANSWERS TO 'CHECK YOUR PROGRESS'
6. (i) d; (ii) c.
LETTERS OF CREDIT
STRUCTURE
10.0 Objectives
10.1 Introduction
10.2 Letters of Credit - General Consideration
10.3 Parties to a Letter of Credit
10.4 Types of Letters of Credit
10.5 Documents Under a Letter of Credit
10.6 Uniform Customs and Practice for Documentary Credits - UCPDC 600
10.7 Payment Under Letter of Credit - Banks Obligation Primary
10.8 Let Us Sum Up
10.9 Keywords
10.10 Check Your Progress
10.11 Answers to 'Check Your Progress'
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10.0 OBJECTIVES
After studying this unit, you should be able to understand:
• what is a letter of credit and its purpose;
• the parties involved in a letter of credit transaction;
• the various types of letters of credits;
• the various documents involved in a letter of credit transaction;
• the law as laid down in UCP 600.
10.1 INTRODUCTION
The simplest form of payment in a business transaction is payment by cash, and
then comes payment by cheques, drafts, travellers cheques, etc. However, all
these modes of payment require proximity between the buyer and seller and the
element of trust between them. In international trade, the buyer and seller are
miles apart, having different legal systems and each unaware of the other's
financial position. In such cases, it would be preferable that both parties deal
through their bankers. This is done when the documents covering the goods
traded re-routed through the bankers. However, in this method the seller should
have confidence that the buyer would pay for the goods as and when the same is
due either immediately or after the agreed period of credit. In case the seller is
not fully satisfied about this he may ask for an assurance from a banker that the
terms of trade would be complied with and his interest would be protected. One
of the methods of achieving this assurance more in international trade is by
completing the transaction through the system of a letter of credit. Due of the
devices used by the bankers to effect payment for goods supplied or services
provided is called Banker's Commercial Credit or Letter of Credit (LC for
brevity). Though this device for payment is the creation of the British merchants,
it has now become a universally accepted method of payment. As a banker, you
will at some point of time in your career, be required to deal with letters of
credit. As such, it is necessary that you understand the various provisions
relating to LC and the legal aspects involved therein.
In this chapter, unless specifically stated so, the term letters of credit is used
interchangeably as LC or credits and should not be mistaken as a different term.
10.2 LETTERS OF CREDIT - GENERAL CONSIDERATION
An LC can be compared to a guarantee given by a bank on behalf of its customer
to the effect that the bank would make payment to the beneficiary when the
beneficiary presents the documents as is required in the LC. They are not
negotiable instruments.
To understand better a LC transaction, let us consider a practical situation.
M/s Bharath & Co. in India want to import certain machinery, which they know
is manufactured by M/s Edward & Co. in England. They enter into a contract for
purchase of the machinery, payments for which are required to be made by a LC.
Since neither party knows the other, they are not sure whether the other will
fulfil his part of the obligation. In such a situation, M/s Bharath & Co. will
approach its banker, Bank of India and make a request by an application for
opening a letter of credit (LC) in favour of M/s Edward & Company. Bank of
India, after opening a letter of credit LC in favour of M/s Edward & Co., informs
another bank in England, the UK bank with whom Bank of India has an
arrangement, to forward the letter of credit LC to M/s Edward & Co. The UK
bank (say Barclays Bank) after verifying the authenticity of the LC (letter of
credit) and finding it as genuineness forwards the same to M/s Edward & Co.
After verifying that the LC has been drawn according to the sale contract M/s
Edward & Co. ships the machinery to M/s Bharath & Co. M/s Edward & Co.
now collect the bills of lading handed over by the shipping Co. and other
documents required as per the LC and draws a bill of
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exchange (Bills) under the LC and presents it to its bankers, the Barclays Bank,
for negotiating the bill and to obtain the payment. Barclays Bank, on their part,
receive the bill and the documents from M/s Edward & Co. and checks that they
are as per the terms of the LC. On finding them to be in order, Barclays Bank
negotiates the bill and makes payment to M/s Edward & Co. Barclays Bank
thereafter sends the bill and documents to Bank of India. Bank of India on its
part verifies the bill and documents and if found in order sends the bill to M/s
Bharath & Co. for payment. M/s Bharath & Co. on receiving the bills checks the
documents or pays the bill. On M/s Bharath & Co. making payment, Bank of
India will release the shipping document so that M/s Bharath & Co. can collect
the goods from the shipping company.
The above illustrates the simplest form of payment under a letter of credit. The
terms of an LC are sometimes complicated and various kinds of LCs have been
devised since the concept of LC was introduced, which requires a banker to be
very well versed in this aspect of financing.
Before we proceed to understand the parties to a letter of credit and the various
types of letters of credit, it would be worthwhile to examine the advantages of a
letter of credit (LC). As regards the Buyer, i.e. M/s Bharath & Co. in the above
illustration the major advantages are as follows:
(a) No payment has to be made in advance to the seller.
(b) The buyer can induce the seller to give credit from his supplier, which
he may not be otherwise
willing to give, since there is a guarantee from a banker regarding payment on
due date.
(c) In most cases the bills are payable over a period of time (called usance
bills) thereby giving additional
credit to the buyer.
(d) The buyer can, while opening the LC insist that the quality of goods are
certified by an independent
body and such certificate be sent along with the bill for negotiation, thereby
assuring himself that
the goods meet with the required quality as specified. In case the seller does not
enclose such a
document then the banks will not make payment on the Bills. He can also
stipulate other terms and
conditions to protect his interests and which are also acceptable to the seller.
As regards the seller, i.e. M/s Edward & Co. in the illustration the advantages
are as follows:
(a) The seller is assured that he will receive payment on his complying with
the terms of the LC.
(b) On shipment of the goods the seller can draw and negotiate the bills
thereby getting immediate
payment in his country, which payment otherwise would be made only after the
goods are received
by the buyer, which would cause delay in payment.
(c) The seller need not bother himself about the import regulations of the
buyer's country since this is
the responsibility of the buyer.
(d) The seller also need not bother about the fluctuations in currency since
this will be the responsibility
of the buyer.
10.3 PARTIES TO A LETTER OF CREDIT
You have learnt by now that in a letter of credit transaction various parties are
involved. Various terms, have been coined to identify these parties, which you,
as a banker, will be required to know since, in all transactions involving letters
of credit, the terminology used to identify parties will be on these lines. To help
us better understand the parties we shall be making use of the illustration given
in Para 10.2.
(i) Applicant-Buyer-Importer-Opener: He is the person who applies to the bank
to open a letter of credit, since he would be either purchasing goods or availing
services for which payment has to be made. In the illustration - M/s Bharath &
Co.
(ii) Issuing Bank: The bank which opens the letter of credit LC on the request of
the applicant/ buyer. Also called the opening bank or importers bank. In the
illustration - Bank of India.
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(iii) Beneficiary-Exporter-Seller: Is the person who is entitled to receive the
benefit under a LC (letter of credit), i.e. the right to receive payment or to draw
bills and receive payment as per the terms of the LC. In the illustration - M/s
Edward & Co..
(iv) Advising Bank: The bank in the beneficiary/exporters country through
which the letter of credit is advised to the beneficiary. The advising bank only
forwards the LC to the beneficiary, thereby enabling the beneficiary to rely on
its authenticity and genuineness. The advising bank is also sometimes termed as
the Notifying Bank. In the illustration - The UK Bank.
(v) Negotiating Bank: The bank in the beneficiary/exporters country which
negotiates the bills (i.e. makes payment on the bills drawn by the seller and
accepts the documents). If the LC specifies a bank then that bank is the
negotiating bank and is also called the nominated bank or paying bank. If the LC
however does not specify a bank, then any bank can be the negotiating bank,
since the issuing banks open invitation contained in the credit is an offer, which
is accepted as soon as the negotiating bank negotiates the bills and accepts the
documents. In the illustration, Barclays Bank would be the negotiating bank. If
Barclays Bank was also specifically mentioned in the credit as the negotiating
bank, then Barclays Bank will also be the nominated Bank.
(vi) Confirming Bank: The advising bank is only required to advise the credit to
the beneficiary. If the seller is not conversant with the issuing bank or not
satisfied with his financial position, he may ask for an additional
assurance/guarantee from another bank located in his country/place and the
second guarantee is called confirming the LC. The seller would look to the
confirming bank to pay the amount covered by the bill if drawn as per terms of
the LC. If however in addition to' advising the credit the advising bank were to
confirm it, then the advising bank will also be the confirming bank. In such case,
the confirming bank is deemed to undertake on its part the liabilities of the credit
vis-a-vis the beneficiary or the Negotiating bank.
(vii) Reimbursing Bank: It is the bank, which is appointed by the Issuing bank to
make reimbursement to the negotiating, paying or confirming bank.
10.4 TYPES OF LETTERS OF CREDIT
i. Acceptance Credit: Ordinary letters of credit are usually sight credits, i.e.
immediate payment should be made of the bills drawn by the beneficiary.
However, sometimes as per the terms of the letter of credit (LC) the bills will be
payable after an agreed period of time (such bills being called usance bills).
Such an LC under which usance bills can be drawn is an acceptance credit or
time credit. The bills drawn on the various dates, will be honoured on their
maturity. This is one of the methods by which, a buyer can obtain credit from the
seller. The seller can either wait until the date of maturity to receive money or he
can discount the bills and obtain immediate value for the goods supplied.
ii. Irrevocable Credit: An irrevocable credit is a credit, that can neither be
amended nor cancelled without the consent of the beneficiary. The
issuing/opening bank is bound by the commitments given in the credit. As per
the latest uniform customs and practice for documentary credits 600, all credits
are irrevocable.
iii. Confirmed Credit: If a bank advising the credit to the beneficiary adds its
own confirmation to the credit, then the credit would be called a confirmed
credit. Only irrevocable letters of credit can be confirmed, since in a revocable
credit the issuing bank can amend or cancel the credit without notice, and as
such if an advising bank were to confirm it, it would be liable without having
any recourse to the 'issuing bank'. Confirmation here means that the confirming
bank would fulfil the obligation under the letter of credit if the beneficiary
complies with the terms contained therein. A confirming bank accepts this
responsibility only on instructions by the issuing bank and as such, if
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any of the terms in the LC have to be changed then the concurrence of all the
parties would be necessary.
iv. With Recourse and Without Recourse Credits: When a beneficiary draws a
bill under a letter of credit, he is generally liable to any negotiating LC bank if
the drawee fails to make payment under the Negotiable Instruments Act. In other
words, his liability is extinguished only on the drawee making payment. LC
calling for these kinds of bills is with recourse LCs. However, the beneficiary
can exclude this liability by adding to the bill the following words 'without
recourse', which means that the right (recourse) against the drawer under the bill
is not available to any endorsee of the bill of exchange. This defence however is
available to the beneficiary only on the bills drawn by him. In case there is any
discrepancy in the documents submitted then the beneficiary cannot avail any
protection on a bill with the endorsement 'without recourse'. However, as per the
current guidelines from RBI, banks are not supposed to accept any inland bill
drawn 'without recourse' for negotiation.
v. Transferable Credits: As stated earlier, a letter of credit is not a negotiable
instrument, though the bills of exchange drawn under it are negotiable. As such,
the rights under an LC cannot be transferred and is vested in the beneficiary. A
transferable credit is one under which the beneficiary can transfer his rights to
third parties (secured beneficiaries). Unless specifically stated an LC is not
transferable.
vi. Back-to-Back Credits: This a credit which is an offshoot of the credit issued
to the beneficiary. In a back-to-back credit, the beneficiary in whose favour an
LC is issued uses the same to open another credit from his (beneficiary's) bank
in favour of his supplier. There are thus three banks involved in a back-to-back
credit. First, the bank issuing the original credit to the beneficiary, the second,
the advising bank through which the credit has been advised to the beneficiary
and the third the bank, which issues an ancillary credit against the security of the
original credit, vii. Anticipatory Letter of Credit:
(i) Red Clause letter of credit: In a usual LC transaction, the beneficiary will be
entitled to receive payment only on his handing over the documents and the bills
drawn under the LC to the negotiating bank. However, in certain credits the
beneficiary will be entitled to get an advance of the price. These credits contain a
'red clause' (because the clause is printed in red) which authorises an
intermediary bank to make an advance to the beneficiary before shipment. Red
Clause LCs are however dying out.
(ii) Green Clause letter of credits: This is a refinement of the 'Red Clause'. This
type of LC not only permits pre shipment advance but also permits advances to
the exporter to cover storage at the port of shipment. The red clause and green
clause credit are called anticipatory credits since payment of an advance is
provided for in anticipation of the seller making shipment.
ix. Revolving Letter of Credit: In a regular LC transaction, once the bills are
negotiated the entire transaction comes to an end. If fresh shipment is to be
made, another LC will have to be drawn. This procedure becomes time
consuming especially when there is regular trade between the same parties. In
such cases, it is preferable to open a revolving letter of credit. In this type of
credit though the amount is fixed, it can be renewed as soon as the earlier bills
have been paid.
10.5 DOCUMENTS UNDER A LETTER OF CREDIT
One of the two basic doctrines that underlie the letter of credit transaction is the
principle of strict compliance. The other being the independent nature of the
letter of credit transaction.
As per the strict compliance doctrine all the parties to a letter of credit
transaction should strictly observe the terms and conditions under which the
credit is issued and on failure to do so, the defaulting party would be either liable
to the others or have no cause of action to recover any payment if made by the
defaulting party.
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Within the sweep of the strict compliance doctrine comes the duty of a banker to
"ensure that the documents tendered are strictly those specified in the letter of
credit. In this regard it would be worth noting the observation given more than
half a century back by LORD SUMNER in Equitable Trust Co. vs Dawson
Partners (27 Lloyds Law Reports 49).
There is no room for documents which are almost the same or which will do just
as well.
In this case, the credit required inter alia a certificate testifying to the quality of
the purchase that was to be signed by (experts). However, due to a decoding
error, the message received by the advising bank required only a certificate
signed by 'an expert'. The beneficiary therefore, while presenting the documents
submitted a certificate signed by a single expert, which was honoured by the
advising bank and accepted by the issuing bank. However, since the goods were
defective, the applicant refused to reimburse the issuing bank, which was upheld
by the Courts.
The issuing bank owes a duty to its customer to ensure that the documents
tendered by the beneficiary under the credit comply with the instructions given
by its customer. Any default, on the part of issuing bank would forbid the bank
from claiming reimbursement from its customer with the added disadvantage
that it would not be entitled to claim any remuneration for the transaction. The
matter of strict compliance as far as a bank is concerned has been emphasised by
Courts of Law all over the world. A bank is not compelled to honour the credit
unless the beneficiary pursues and conforms in every material particular to the
authority conferred therein. Due to the prime importance given to documents
under a letter of credit transaction, it is necessary for a banker to understand the
documents that accompany a letter of credit.
i. Bill of Exchange: This is a financial document. Payment is made on this
document. This for brevity sake is called 'bill' and is sometimes referred to as
'draft' (to be distinguished from a 'demand draft'). In a letter of credit transaction
the right to draw a bill is conferred only on the beneficiary. The bill amount
should be within the limit fixed in the letter of credit. The tenor, endorsement
and the drawee should be the same as given in the letter of credit. This document
should be distinguished from 'bills of lading', which is a transport document and
is discussed later on in this chapter. Bills or drafts can be payable on
presentation (sight bills) or on a certain date (usance bill).
ii. Invoice: This is the basic commercial document. This document gives details
of the sale. It should be made in the name of the opener/importer unless required
otherwise in the letter of credit. All the details mentioned in the invoice must
tally with those mentioned in the letter of credit, failing which it may amount to
a discrepancy, making the documents liable for rejection. Where the quantities
are specified in a letter of credit, the form in which they are specified should be
adhered to. For example, if the letter of credit calls for 100 kg of tea, the invoice
should be made accordingly and converting the measure to equivalent pounds or
quintals would make it liable to be rejected. A further problem posed is whether
it would be in order, whereas per the credit the value of the shipment is Rs. 15
lakh and the goods shipped is worth Rs. 20 lakh, with a request that Rs. 15 lakh
be paid and excess Rs. 5 lakh collected to be repaid later. This would not comply
with the credit terms and the opener/buyer/importer would be legally entitled to
reject the documents.
iii. Transport Documents: The mode of despatch of goods or the transporting of
goods would depend on the terms of contract between the buyer and the seller
and the same is incorporated in the letter of credit. The two main modes of
transport of goods are either by sea or by air. In case the goods are shipped, the
document evidencing the shipment of the goods is called the 'Bill of Lading'. In
case the goods are transported by air, the documents evidencing receipt of goods
would be the 'Airway Bill' in case the goods are directly handed over to an
Airline or its agent. In case goods are transported through postal system or
courier service, the document evidencing receipt of goods would be either the
'Post Parcel Receipt' or the 'Courier Receipts'.
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iv. Bills of Lading: Bills of Lading are of two types - one, the traditional ship bill
of lading and the other, the 'Combined Transport Bill': a creation of modern age
containerisation of shipments which permits more than one means of carriage
and is also known as 'Multimodal Transport'. Bill of lading is a document to title
to goods, i.e. they are representatives of the goods and holder of the same is
entitled to get possession of the goods. A bill of lading, to a certain extent is
negotiable inasmuch as a bona fide transfer of the same by endorsement entitles
the transferee the right to the goods. A bill of lading is issued in sets of 2, 3, or 4
and all are termed as originals. A banker should see that all the originals are
received. Unless otherwise specified in the letter of credit, a bill of lading must
be a 'shipped' bill of lading and a 'received for shipment' or 'transportation' bill of
lading or a 'charter party' bill of lading is not acceptable. This is because the
shipped bill indicates that the goods have been taken on board of a specified ship
and the journey has commenced while in the case of received for shipment bill
though the goods have been delivered to the transporter the journey is yet to
commence.
v. Airway Bill: This is a document, which evidences that the goods have been
received by an airline company or its agent. Unlike a bill of lading an airway bill
does not carry with it the right to the goods, i.e., it is not a document of title to
the goods. If however the letter of credit terms permit acceptance of an airway
bill then the banker is within his rights to accept it.
vi. Post Parcel Receipt and Courier Receipts: When the goods to be sent are
small in quantity, then they can be sent through post or courier. The document
issued by the postal department or the courier are similar in nature to the airway
bill. They are not title to goods and only evidence that the goods have been
entrusted for transportation to either the postal department or the courier
company and most often than not the goods are addressed directly to the buyer.
vii. Insurance Documents: The goods shipped, if required to be insured under the
terms of the letter of credit should be so insured and the insurance document as
required in the letter of credit should be enclosed with the other documents.
Either an insurance company or underwriter or their agents should sign it. The
type of insurance cover should be the same as specified in the credit. The
requirements of the buyer regarding the amount of the policy, the currency, the
risk to be covered and the place of payment in case of claim are to be strictly
complied with.
viii. Other documents: Over and above, the major documents discussed above
which are required in all letters of credit transaction, the letter of credit may also
call for certain other documents among which include certificate of origin,
certificate of weight or quality or analysis, Health authorities certificate, etc.
Such documents/enclosures are mandatory with the other documents, failing
which payment can be refused. In interpreting these documents too, the Courts
have applied the principle of strict interpretation.
10.6 UNIFORM CUSTOMS AND PRACTICE FOR DOCUMENTARY
CREDITS - UCPDC 600
The ICC Banking Commission, approved the UCP 600, ICC's new rules on
documentary credits, on 25 October 2006. UCP 600, which came into effect on 1
July 2007, contains significant changes, including:
• A reduction in the number of articles from 49 of UCP 500 to 39.
• New articles on 'Definitions' and 'Interpretations' to provide more clarity
and precision in the
rules.
• The replacement of the phrase 'reasonable time' for acceptance or refusal
of documents by a
definite period of five banking days.
• New provisions which allow for the discounting of deferred payment
credits.
• A definitive description of negotiation as 'purchase' of drafts of
documents.
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The new UCP 600 also contains within the text the 12 Articles of the eUCP,
ICC's supplement to the UCP governing presentation of documents in electronic
or part-electronic form.
10.7 PAYMENT UNDER LETTER OF CREDIT - BANKS OBLIGATION
PRIMARY
We had earlier while studying the various aspects pertaining to bank guarantees,
noted that under a bank guarantee the liability of the bank to make payment is
primary and unless a case of fraud is made out or there are special equities in
favour of the debtor, Courts would not adjunct a bank from making payment
under a guarantee. The same analogy applies to payment by banks under a letter
of credit. The Supreme Court had occasion to consider this aspect in various
cases and in all these cases, the Court has held that the obligation of a bank to
pay under a letter of credit is primary, irrespective of the underlying contract.
We shall now refer to some of the decisions of Supreme Court, which have been
the touch stone for later judgements of the Supreme Court and also the High
Courts.
I. Tarapore and Company, Madras vs Messrs v/o Taractor.expert, Moscow,
Another (AIR 1970 Supreme Court 891)
(i) Facts of the case: The Indian firm opened in favour of the Russian firm a
confirmed, irrevocable and divisible letter of credit with the Bank of India for
the entire value of the machinery. Under the letter of credit, the bank was
required to pay to the Russian firm twenty-five per cent on presentation of
documents specified therein and the balance of seventy-five per cent on the
expiry of one year from the date of first payment. The Russian firm supplied,
and the Indian firm took possession of, the entire machinery to be supplied under
the contract. After using the machinery for some time, the Indian firm
complained that the performance of the machinery was not satisfactory and was
causing considerable loss. With a view to preventing the Russian firm from
realising the balance of the amount payable under the letter of credit, the Indian
firm filed a suit against the Russian firm, but the same was withdrawn on an
agreement having been arrived at between the parties. In pursuance of the said
agreement, it was agreed that the Russian firm would instruct its bankers not to
make a demand for further payment against the letter of credit for a period of six
months from the due dates of the drafts and that, during this period the parties
would do their best to reach an amicable settlement. It would appear that the
parties did not amicably settle the dispute and when the extended time was about
to come to a close, the Indian firm instituted another suit praying that the
Russian firm and the Bank of India be restrained from taking any further steps in
pursuance of the letter of credit opened by the Indian firm in favour of the
Russian firm.
(ii) Decision: Rejecting the contention of the Indian firm that the Russian firm
should not be allowed to take away the money secured by the letter of credit,
since the Russian firm had no assets in India and the Indian firm might not be
able to enforce its claims under any decree that might be passed in its favour, the
Supreme Court observed:
'An irrevocable letter of credit has a definite implication. It is a mechanism of
great importance in international trade. Any interference with that mechanism is
bound to have serious repercussions on the international trade of this country.
Except, under exceptional circumstances, the Court should not interfere with that
mechanism.'
The Supreme Court considered some of the important decisions of the Courts in
England and America and observed:
'A letter of credit is independent of an unqualified contract of sale or underlying
transaction. The autonomy of an irrevocable letter of credit is entitled to
protection. As a rule, Courts refrain from interfering with that autonomy.'
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II. In United Commercial Bank vs Bank of India (AIR 1981 SC 1426)
(i) Facts of the case: The question, considered by the Supreme Court in this
appeal was whether the Court should grant injunction at the instance of the
beneficiary of an irrevocable letter of credit, restraining the issuing bank from
recalling the amount paid under reserve from the negotiating bank, acting on
behalf of the beneficiary, against a document of guarantee/indemnity at the
instance of the beneficiary.
Facts were rather complicated, but briefly, the relevant facts were that G agreed
to supply to B 1000 metric tonnes of 'Sizola Brand Pure Mustard Oil'. A letter of
credit was opened in favour of G by the appellant bank. The goods were
supplied in two lots. When the documents were presented by G for payment of
the amount against first lot, the appellant bank refused to make payment except
under reserve on the ground of discrepancies in the documents presented to it.
The main discrepancy was that the goods were described in the railway receipts
as 'Sizola Brand Pure Mustard Oil "Unrefined"'. Bank of India, under
instructions of G, accepted payment under reserve. Regarding the second lot,
also payment was made and accepted under guarantee in favour of United
Commercial Bank, whereby the Bank of India unconditionally agreed to hold the
United Commercial Bank harmless and indemnified for all consequences of non-
acceptance and/or non-payment of bills due to the discrepancies in the
documents. The goods despatched, were not accepted by B. The United
Commercial Bank, therefore, made a demand upon the Bank of India, to refund
the amounts paid under reserve. Thereupon G approached the High Court for
interim injunction restraining Bank of India from making payment. The single
Judge of the High Court made absolute the temporary injunction granted earlier,
until the disposal of the suit on the ground that the United Commercial Bank, in
terms of the credit, could not unilaterally impose the condition of payment
'under reserve' or refuse to pay against the documents tendered by G merely
because of alleged discrepancies.
The matter on further appeals finally reached the Supreme Court. After
considering the case law on the subject, the Supreme Court allowed the appeal
for the following reasons:
(a) A letter of credit constitutes the sole contract with the banker and the
bank issuing the letter of
credit has no concern with any question that may arise between the seller and the
purchaser of
goods. The judicial authority lays down the necessity of strict compliance both
by the seller with
the letter of credit and by the banker with his customer's instructions.
(b) As pointed out by Halsbury's Laws of England, the documents must be
those called for, and not
documents which are almost the same or which will do just as well.
(c) The banker is not called upon to know or interpret trade customs and
terms.
(d) In Paget's Law of Banking, 8th Edn. p. 648, it has been stated thus -
Unless documents tendered
under a credit are in accordance with those for which the credit calls and which
are embodied in
the promise of the issuing banker, the beneficiary cannot claim against him and
it is the banker's
duty to refuse payment.
(e) The well established rule is that a bank issuing or confirming a letter of
credit is not concerned with
the underlying contract between the buyer and seller. Duties of a bank under a
letter of credit are
created by the documents itself, but in any case, it has the power and is subject
to the limitations
which are given or imposed by it, in absence of the appropriate provisions in the
letter of credit.
(f) The Courts usually refrain from granting injunction to restrain the
performance of a contractual
obligation arising out of a letter of credit or a bank guarantee between one bank
and another. The
whole banking system would fail if the banker making payment under reserve
were restrained by
injunction from recalling the amount.
(g) Buyer-customer cannot instruct the banker not to pay in view of banker's
obligations to pay under
irrevocable letter of credit. Confirmed letter of credit imposes an absolute
obligation to the banker
to pay.
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(h) A bank giving a performance guarantee must honour that guarantee
according to its terms.
(i) It is in exceptional cases that the Court would interfere with the machinery
of irrevocable obligations
assumed by the banks, such as, clear cases of fraud of which the banks have
notice, (j) The payments were made 'under reserve' and against the indemnity
or guarantee of Bank of India.
Therefore, when the bills of exchange were dishonoured, on being presented, the
amount became
immediately, payable on demand.
10.8 LET US SUM UP
A letter of credit (LC) otherwise called a banker's commercial credit is a device
used for effecting payment by bankers for goods supplied or services provided
between two parties and is mostly used in foreign trade. It is similar to a bank
guarantee, inasmuch as the bank, issuing the LC, guarantees payment to the
seller, in case the terms as required under the LC are complied with. There are
various parties to a letter of credit transaction. The opener of the letter of credit
otherwise called the Buyer or Importer. The bank, which issues the LC called the
Issuing Bank or the Opening Bank or Importer's Bank. The person in whose
favour the LC is issued - the Beneficiary, also called the Exporter or Seller. The
Advising Bank that advises the LC to the beneficiary, also called the Notifying
Bank. The Negotiating Bank,.i.e. the bank that makes payment on the bills
drawn by the seller also called the Nominated Bank or Paying Bank. The
Confirming Bank, which is the advising bank when it also confirms the credit.
The Reimbursing Bank, which reimburses, the negotiating/paying/confirming
bank. Letter of credit are classified based on the various terms and conditions
they contain. Main among them, are the following Acceptance Credit, where the
payment is made after a certain period; Revocable Credit, where the credit terms
can be unilaterally altered or cancelled by the issuing bank in contrast to an
Irrevocable Credit where any alteration of terms or cancellation requires the
concurrence of beneficiary; Confirmed Credit, where the advising bank adds its
own confirmation to the credit while advising the beneficiary; With Recourse
Credits - where the beneficiary is liable on a bill drawn by him under an LC in
contrast to a Without Recourse, where the beneficiary is not liable; Transferable
Credits, where rights under an LC can be transferred to third parties; Back-to-
Back Credits, where on the basis of LC in favour of the beneficiary, his bank
opens another LC in favour of the beneficiary's supplier. Red Clause Credits,
where the beneficiary is entitled to advance payment before production of
documents; Green Clause Credits wherein addition to advance, the beneficiary is
entitled to payment of storage/warehousing charges; Revolving Credits, where
the amount is fixed but can be utilised repeatedly as and when the earlier bills
drawn are paid. There are two basic principles that underline every LC
transaction the first one being that in every transaction strict compliance of terms
is required and the other being the independent nature of LC transaction. As
such, it is necessary to ensure strict compliance of the documents required under
an LC. The documents include bill of exchange (drafts, bills), invoice, transport
documents, insurance documents are primary for most transactions. Over and
above these documents the credit terms, which may require various certificates
and/or other documents. The rights and liabilities of all parties to an LC have
been laid down in the UCP 600 a document published by the International
Chamber of Commerce. The UCP 600 though not enforceable as law, is
incorporated as a part of the credit terms and as such is enforceable as a
contractual term.
A letter of credit being similar to a bank guarantee, the liability to make payment
by a bank under an LC is primary and the Supreme Court has endorsed this view
in various decisions.
10.9 KEYWORDS
Acceptance Credit; Advising Bank; Airway Bill; Applicant; Back-to-Back
Credit; Bankers Commercial
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Credit; Beneficiary; Bill of Exchange; Bill of Lading; Confirmed Credit;
Confirming Bank; Green Clause Credit; Invoice; Issuing Bank; Negotiating
Bank; Red Clause Credit; Reimbursing Bank; Revocable Credit; Revolving
Credit; Transferable Credit; UCP 600; With Recourse Credit; Without Recourse
Credit;
10.10 CHECK YOUR PROGRESS
1. State whether true or false.
(i) A letter of credit is a form of guarantee given by banks on behalf of its
customer. (ii) Letters of credit are bills of exchange drawn by a seller or a buyer,
(iii) LCs are negotiable instruments.
2. Choose the right answer.
(a) The letter of credit is opened on the request of
(ii) Applicant (iv) Confirming bank
(i) Issuing bank (iii) Beneficiary
(b) The LC issuing bank is also called
(i) the importers bank or the opening bank
(ii) the advising bank or the confirming bank (iii) the negotiating bank or the
nominated bank (iv) the reimbursement bank
(c) The right to receive payment under a letter of credit or the right to draw
bills on a letter of
credit is vested in
(i) the opener of the LC (ii) the issuing bank only
(iii) the seller only (iv) all the three parties
(d) The advising bank's responsibility is
(i) to inform the issuing bank as to whom to issue the letter of credit (ii) to
advise the buyer the despatch of documents by the seller (iii) to inform the
beneficiary/seller about the letter of credit (iv) none of the above
(e) The advising bank is also called the
(i) Confirming bank (ii) Notifying bank
(iii) Reimbursing bank (iv) None of the above
(f) Negotiating bank is the bank which
(i) negotiates the preliminary contract of sale between the buyer and the seller
(ii) makes payment of the bills drawn by the seller and accepts the documents
(iii) guarantees payment by the issuing bank
(iv) none of the above
(g) When the LC specifies the bank that is to negotiate the bills drawn under
the LC then the
bank is also called
(i) Confirming bank (ii) Reimbursing bank
(iii) Nominated bank (iv) None of the above
(h) The confirming bank is
(i) the issuing bank when it confirms the issue of the LC (ii) the negotiating bank
when it confirms the negotiation of the bills (iii) the advising bank when it
confirms the LC (iv) none of the above
(i) When the confirming bank confirm the credit it (i) does not take any liability
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(ii) undertakes on its part the liability under the LC
(iii) undertakes to make timely delivery of the documents and bills to the
buyer or his bank
(iv) none of the above
(j) Reimbursing bank is the bank
(i) that reimburses the seller
(ii) that reimburses the negotiating/paying or confirmingbank
(iii) that reimburse the buyer on the goods being found defective
(iv) none of the above
3. Fill in the blanks.
(a) Ordinary letters of credit are usually , i.e. the bills drawn hereunder
have to be
paid immediately.
(b) Letter of credit under which usance bills can be drawn is called an
.
(c) In a revocable LC the credit can be amended or cancelled by the .
(d) Only letters of credit can be confirmed.
(e) Credit in which the beneficiary is not liable for the bills drawn
thereunder is
credit.
(f) A back-to-back credit would involve at least bank, viz., the bank,
the
bank and the bank.
4. State whether true or false.
(a) All parties to a letter of credit transaction need to comply with the terms
only as far as
practical and not strictly.
(b) In case the documents submitted by seller do not comply with the terms
of letter of credit
then the same can be accepted and sent for confirmation of buyer.
(c) A bill of exchange is a document to title to goods.
(d) A bill of exchange is also called a 'bill' or a 'draft'.
(e) Invoice in a letter of credit transaction is a document similar to a
quotation based on which
the buyer places his order.
(f) A bill of lading on a bona fide transfer confers on the transferee a right
to the goods.
(g) An airway bill is also a document evidencing title to goods.
10.11 ANSWERS TO CHECK YOUR PROGRESS'
1. (i) True; (ii) False; (iii) False
2. (a) ii; (b) i; (c) iii; (d) iii; (e) ii; (f) ii; (g) iii; (h) iii; (i)ii;j)ii
3. (a) Sight credits; (b) Acceptance credits; (c) Issuing bank; (d)
Irrevocable; (e) without recourse;
(f) Three; issuing, advising, third
4. (a) False; (b) False; (c) False; (d) True; (e) False; (f) True; (g) False
DEFERRED PAYMENT GUARANTEE
STRUCTURE
11.0 Objectives
11.1 Introduction
11.2 Purpose of Deferred Payment Guarantee
11.3 Method of Payment
11.4 Let Us Sum Up
11.5 Keywords
11.6 Check Your Progress
11.7 Answers to 'Check Your Progress'
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11.0 OBJECTIVES
After studying this unit, you should be able to understand:
• a deferred payment guarantee,
• purpose of a deferred payment guarantee,
• various methods of payment under a deferred payment guarantee.
11.1 INTRODUCTION
Though we had touched this type of guarantee while studying bank guarantees,
we shall deal with it here in more detail, since this type of a guarantee is
regularly issued by banks. 'Deferred Payment Guarantee' as the name itself
suggests, is a guarantee that indicates that deferred (postponed) payments.
Suppose a bank's customer were to import capital goods on a deferred payment
credit where the price is to be paid in instalments spread over a five year period,
the exporter will have to wait for each instalment to mature until the whole
amount is paid. In the meantime, the chances of the importer going bankrupt or
failing to pay may arise. To avoid such a situation the exporter can request the
importer to obtain a guarantee that the payment in instalments will be made. The
importer would therefore, approach his banker to guarantee the payments in
instalments. This guarantee of the bank, assuring the exporter of the timely
payment of the instalments, is in short, called 'Deferred Payment Guarantee' in
brevity referred to as DPG.
11.2 PURPOSE OF DEFERRED PAYMENT GUARANTEE
When import or export of raw materials or consumer goods are made the
payment is done either immediately or within 360 days. This period is called
short term. However, in the case of capital goods the amount involved being
quite substantial, short-term credit would not be of much help to the buyer,
unless he has made arrangements to get a term loan. Added to this, the
requirement of substantial amount of foreign exchange, may place the buyer at a
great disadvantage. To overcome this payment problem, since the fifties the
concept of deferred payment was introduced in India. As stated earlier, in a
deferred payment arrangement, the buyer/importer is not required to make the
entire payment of the goods at one time, instead the price of the goods is paid in
instalments over a period of time as per terms mutually agreed to with the seller.
In a deferred payment guarantee, a third party, mostly banks and financial
institutions, guarantee the payment of the instalments. This guarantee ensures
timely payment of the instalments to the seller/ exporter, failing which, the
guarantee can be invoked and payment received. To understand better the
deferred payment guarantee, it is necessary to understand how a payment is
made in a deferred payment contract and how the same is guaranteed by a bank.
11.3 METHOD OF PAYMENT
In a contract for import of goods on deferred payment terms, the importer is
required to make payments in instalments over a period of time which may range
from one to seven years, in a normal deferred payment contract. The payment, is
usually done on the following terms:
1. Advance payment of ten per cent to fifteen per cent of the price of the goods
is made by the buyer. 3. Another ten per cent to fifteen per cent on receipt of
documents under letter of credit. 3. The balance amount, is paid in instalments
spread over a period of one to seven years, which is secured by a 'Deferred
Payment Guarantee'.
In a deferred payment guarantee, which as stated earlier, issued by banks and
financial institutions,
iED PAYMENT GUA
133
what is guaranteed, is the timely payment of instalments and interest if provided.
This is done by issuing a deferred payment guarantee in which the following
terms are mandatory:
1. the supply of goods by the seller to the buyer and the seller agreeing to
postpone the payment of the
price, this being the consideration of the guarantee;
2. the payment schedule of both the instalment and the interest;
3. the unconditional and irrevocable assurance of the bank that it would
make payments on the
invocation of the guarantee.
As regards the supply of goods by the seller, it is to be remembered, that banks
do not take the respon¬sibility to ensure that the goods shipped are what is
required by the buyer/importer. Since the guarantee, is mostly given prior to
shipment of the goods, if the documents are, as required under the letter of
credit, and are valid, then the guarantee of the bank subsists and the buyer
cannot after receipt of the goods, request the bank to stop payment on a deferred
payment guarantee on the grounds of defective goods.
As regards the payment schedule, it is to be noted that the payment schedule is
usually incorporated in the main contract between the buyer/importer and the
seller/exporter and the bank guarantees the payment as stipulated in the
schedule. Some banks as a matter of abundant caution or to have better clarity of
the payment schedule incorporate the same in the guarantee issued by them,
though it is, for all purpose a verbatim reproduction of the payment schedule
from the main contract. In certain cases the seller/exporter would draw bills on
the buyer/importer for the amounts of the deferred instalments including interest,
which are usance bills (being payable on a particular date and not immediately)
and payment of these bills are guaranteed by the bank. The advantage of this
method is that the seller/ exporter can discount these bills with his banker and
get immediate finance.
In a deferred payment guarantee, like all other bank guarantees, the banks
undertake to make payment without any demur or protest, since as per the
guarantee, the bank has given an unconditional and irrevocable assurance to the
seller/exporter. It is on such assurance that the seller/exporter has sold the goods.
It is therefore, of prime importance that the bank honours its commitment. We
have studied earlier while dealing with the bank guarantees, that the bank's
liability in a bank guarantee is primary and independent of the underlying
contract between the buyer/importer and the seller/exporter. These principles
apply in toto to a DPG also.
11.4 LET US SUM UP
A deferred payment guarantee (DPG) is an unconditional and irrevocable
guarantee given by a bank to a seller/exporter that on his supplying goods to the
buyer/importer (who is the bank's customer) on instalment basis the bank would
ensure payment on the due dates. DPGs are usually insisted upon, when capital
goods are imported and the seller/exporter requires an additional assurance that
the instalment payment allowed by him to the buyer/importer is met. In a DPG
the bank guarantees either the payment of the instalments and the interest on the
due dates or the payment of the bills drawn on various dates by the
seller/exporter. A DPG being a guarantee given by a bank, its commitment to
honour the same is absolute unless there exists a case of fraud.
11.5 KEYWORDS
Deferred Payment; Deferred Payment Guarantee.
11.6 CHECK YOUR PROGRESS
1. Say whether true or false.
(i) In a deferred payment guarantee, the guarantee is to ensure delivery of eoods.
134
(ii) A deferred payment guarantee is mostly based on a primary contract between
the buyer and
the seller, (iii) A deferred payment guarantee differs from other kinds of
guarantee issued by banks as
regards payment liability of the bank on invocation, (iv) In a deferred payment
guarantee the banks liability comes into existence only if all the
instalments are not paid and not on the non-payment of any one instalment by
the customer.
11.7 ANSWERS TO CHECK YOUR PROGRESS
1. (i) False; (ii) True; (iii) False; (iv) False.
er and nks as
ill the tomer.
LAWS RELATING TO BILL FINANCE
STRUCTURE
12.0 Objectives
12.1 Introduction
12.2 Class of Bills and Law Governing Bills
12.3 Classification of Bills
12.4 Various Categories of Bill Finance
12.5 Bill Finance and Legal Position of a Banker
12.6 Let Us Sum Up
12.7 Check Your Progress
12.8 Answers to 'Check Your Progress'
136
BEGUL/
12.0 OBJECTIVES
After studying this unit, you should be able to understand:
• basic law relating to bill finance;
• legal position of banker in case of bill finance.
12.1 INTRODUCTION
Bill finance is one of the modes of lending by a banker. As compared to other
modes of financing, Bill finance offers a banker an easy mode of lending. From
the banker's point of view, bill finance has many advantages. Bill finance
involves discounting or purchase of commercial bills arising out of sale of
goods. Bill finance, as compared to cash credit and overdraft, has the following
advantages:
(a) The underlying transactions are easily identifiable
(b) There is definite date of repayment
(c) The bill will carry more than one signature if it is on usance basis
(d) It represents an easily transferable asset and in case of need the same can
be rediscounted to
improve the liquidity of the bank.
12.2 CLASS OF BILLS AND LAW GOVERNING BILLS
(a) Bills Discounted by banks belong to one of the following categories
(i) Clean bills (ii) Documentary bills
(iii) Bills drawn under credit
(b) Laws Governing Bills: The law on bills deals with the liabilities and
rights of parties to a bill is
governed by the Negotiable Instruments Act, 1881.
(i) What is a BUI? The term 'Bill' is the short form of 'Bill of Exchange'. Section
5 of Negotiable Instruments Act, 1881 defines bill of exchange as 'instruments in
writing containing an unconditional order signed by maker, directing a certain
person to pay certain sum of money only, to or to the order of a certain person or
to the bearer of the instrument.'
(ii) 'Drawer', 'Drawee', 'Payee': Section 7 of the Act provides that amaker of 'Bill
of Exchange' is called 'Drawer' and the person who is directed to pay is called
'Drawee' and the person entitled to receive payment of amount represented by
'Bill' is called 'Payee', (iii) Relationship of Parties to a Bill: 'Drawer' of bill is a
creditor/seller and the 'Drawee' of a bill is the debtor/buyer. If the bill is assigned
to third parties, then such assignees will become creditors and drawer would be
liable for such assignees in case of default by drawee.
(c) A Glimpse of some important provisions of Negotiable Instruments Act
relating to Bills: It
will have to be noted that a 'Bill' is a negotiable instrument. Any person to whom
the bill is transferred in accordance with the provisions of the Act, would
become entitled to receive the amounts represented by the bill. We shall now
examine certain important provisions of the Act.
Section 8 'Holder': Section 8 of the Negotiable Instruments Act defines the word
'Holder'. A Holder of bill of exchange means a person entitled in his own name
to possess the bill and recover the amount represented by bill.
Section 9 'Holder in Due Course': 'Holder in due course' means any person who
for consideration became the possessor of the bill (that is a person to whom the
bill is transferred).
Section 10 'Payment in Due Course': 'Payment in due course' means payment in
accordance with
137
the apparent tenor of bill of exchange to the holder or holder in due course in
good faith and without negligence.
Section 14 'Negotiation': When a bill is transferred for considerations to any
person so as to entitle him to claim the amount represented by bill, then such
transfer is called 'Negotiation'.
Section 15 'Endorsement': If the holder of instrument signs the bill of exchange
for the purpose of transferring it, such signing is called 'Endorsement'.
Section 30 'Liability of Drawer': The drawer of a bill of exchange or cheque is
bound in the case of dishonour (failure to pay) by the drawee or acceptor thereof,
to compensate the holder, provided due notice of dishonour has been given to, or
received by, the drawer.
Section 32 'Liability of Acceptor/Drawee of Bill': An acceptor of bill of
exchange is bound to pay the amount thereof at maturity according to apparent
tenor of the acceptance.
Section 35 'Liability of Endorser': In the absence of contract to the contrary,
whoever endorses and delivers a negotiable instrument is bound thereby to every
subsequent holder in the case of dishonour unless his liability is excluded.
Section 79 'Interest rate Specified': When interest at a specified rate is expressly
made payable on a bill of exchange, then interest shall be calculated at such rates
specified and payable.
Section 80 'Interest when no rate is specified': When no rate of interest is
specified in the instrument, interest due thereon shall be calculated at the rate of
eighteen per cent p.a.
12.3 CLASSIFICATION OF BILLS
'Bills' used under bill finance can be classified depending upon the place where
drawn, period and their nature as under:
Place
Inland bills
Period
3. Demand bills
4. Usance bills
Nature
1.
5. Clean bills
2. Foreign bills 4. Usance bills 6. Documentary bills
1. Inland Bills: Bills drawn or made in India and made payable in or drawn
upon any person resident
in India are inland bills. The necessary requisites of inland bills are:
(a) it must be drawn and made payable in India; (or)
(b) it must be drawn in India upon some person resident in India, though it
may be made
payable in a foreign country.
Inland instruments are defined in Section 11 of Negotiable Instruments Act, as
under - Inland Instrument:
"A promissory note, bill of exchange or cheque drawn or made in India and
made payable in or drawn upon any person resident in India shall be deemed to
be an inland instrument."
2. Foreign Bills: As per Section 12 of the Negotiable Instruments Act,
Foreign Bills are:
(a) Bills, drawn outside India and made payable in or drawn upon any
person, resident in any
country outside India;
(b) Bills drawn outside India and made payable in or drawn upon any
person, resident in India.
3. Demand Bills: Section 19 of the Negotiable Instruments Act, defines
'Demand Bill': It is an instrument
payable on demand and no time for payment is specified therein. 'Demand Bill'
is otherwise called
'sight bill'. In these bills, the payee is entitled to the value of the bill on demand
and on presentation.
4. Usance Bills: A usance bill is a bill payable otherwise than on demand.
It specifies nnrmaiiv <. *;~~
138
li
for payment of the value it represents. 'Usance Bills' are otherwise called 'Bills
payable after sight'. In these kinds of bills, the drawer draws a bill of exchange
and specifies a time within which the payment shall be made and presents the
same to drawee for acceptance. Once the drawee accepts the bill, the drawer at
the time or date specified on bill for payment can present the same to drawee and
demand payment. The date specified for payment is otherwise called
'maturity/due date'.
5. Clean Bills: A clean bill is a bill of exchange drawn as per the
requirements of the Negotiable
Instruments Act and is not supported by documents of title to goods. Clean bills
are drawn normally
to effect discharge of a debt or claim. Clean bills also arise when the goods
covered by the bill are
directly sent to the buyer due to mutual consent e.g. local bills and supply bills.
6. Documentary Bills: A bill of exchange accompanying documents of title
to goods, is called
'Documentary Bill'. These bills, are drawn to claim price of goods supplied.
(i) Bills drawn with an instruction to deliver against payment: (or) D.P. Bills: In
a transaction for supply of goods, a seller draws a bill on the buyer and sends the
same to his banker along with document of title to goods like bill of lading, or
railway receipt or lorry receipt. The seller instructs the banker to deliver the bill
and documents of title to goods only when the buyer pays the price of goods.
These types of bills are D.P. bills in other words 'Delivery against Payment
Bills'.
(ii) Bills drawn with instruction to deliver against acceptance or DA. Bills: An
usance bill supported by documents of title to goods bearing an instruction that
the documents can be delivered, if the buyer accepts the bill of exchange drawn
on him. These are called D.A. Bills or 'Delivery against Acceptance Bills'.
Besides the above, when the government department is supplied goods or raw
materials a bill is drawn on them for the price of goods supplied. These are
called supply bills. They do not squarely fall within the ambit of Negotiable
Instruments Act. However, principle underlying to bills is also applied to
'Supply Bills'.
12.4 VARIOUS TYPES OF BILL FINANCE
Basically, a banker offers following types of bill finance.
1. Bill Purchase (B.P.) 2. Bill Discount (B.D.)
3. Advance against Bills for Collection (A.B.C.)
1. Bills Purchased: When the bank negotiates bills payable on demand,
whether clean or documentary,
the facility is known as bill purchase. The face value of the bill, is immediately
paid to the holder.
The bank, after purchasing the bill, becomes the holder in due course of the bill
and acquires all the
rights of ownership over the instrument. Bill purchase facility is extended
generally in the case of
bills payable on demand. However, in the case of usance bills also this is
extended when the due
date of the bill is not readily known at the time of extending this facility. Such a
situation arises
when the bill is drawn payable after some days after sight. The due date of such
a bill is known
when the bill is presented to the drawee and the period of usance commences
from the date of
presentation.
2. Bills Discounting: This facility is extended by banker when the bills of
exchange are payable after
a particular period, that is bills payable otherwise on demand. For example, 'A'
draws a bill on 'B'
payable after three months and 'B' on presentation accepts the same and agrees
to pay after three
months. Such a bill is called a bill payable, otherwise on demand or usance bill.
In this type of
facility a banker pays the face value of the bill less discount, becomes holder in
due course, and
acquires all the rights under the bill.
139
3. Advance Against Bills for Collection: When the bank advances against the
bills, which are in course of collection, the facility is known as advance against
bills for collection. Under this facility, a prescribed margin is kept by the bank
and the amount, in consideration of this is allowed to the customer. The bill
thereafter is sent for collection.
In all these cases, the legal effect is that the banker, who lends money, becomes
holder in due course for the bill.
12.5 BILL FINANCE AND LEGAL POSITION OF A BANKER
Bill Discounting and Rights of a Banker: In the case of bills discounting or bills
purchase the bill of exchange drawn by the borrower on third parties is presented
to banker. Then the banker pays the value of the bill of exchange to the borrower
after charging a commission or after a discount and gets the bill transferred to
his name. By such transfer, which is made by endorsement by the borrower, the
banker becomes the 'Holder in due course' and would be entitled to receive the
amounts from the acceptor of the bill. Hence, it is imperative that a banker
acquaints himself with the legal aspects of lending through 'Bills discounting'.
Legal Relationship in the Case of Bills Discounting: In 'Bills discounting'
transactions a banker becomes a lawful holder of the bill by taking a proper
endorsement of the bill in his favour. The banker becomes 'payee' of the bill and
is entitled to recover the amount represented by the bill. We will study some
cases in respect of bills discounting facilities that have been decided by courts.
(i) Irinjalakuda Bank Ltd. vs Pourthussery Panchayat (1970) 40 Compo Cases.
767: In this case a document in the form of cheque issued by a Panchayat on a
Government treasury payable to 'self or order' was discounted by a bank. It was
dishonoured by the treasury, since Panchayat Inspector countermanded the
payment. The Court held that the banker is a holder in due course and hence can
recover the amount from the Panchayat.
(ii) Shambumal Gangaram and Another vs State Bank of Mysore (AIR 1971
Mys. 156): In this case, legal action was initiated by the bank for the recovery of
dues from the customer because of the bill discounting facility granted to the
customer. The bank was providing 'Local Bill Discounting' (LBD) facility to its
customer by discounting the bills drawn by customer and endorsed by the
customer in bank's favour. The drawees of the bills generally paid the amounts
of bills. However, several bills remained unpaid and bank filed a suit for
recovery from the customer. The customer contended that bank should have
filed suit against the drawees of bill of exchange. The Court rejected the
argument of the customer and directed him to pay the amount to bank holding
that customer being drawee is liable to bank who are holders in due course.
Discounting of Documentary Bills
A banker provides discounting of 'Documentary Bills', as a credit facility to his
customer.
What is a Documentary Bill?
'Documentary Bill' is a bill which is supported or accompanied by a document of
title to goods.
A lorry receipt or railway receipt, warehouse receipt, bill of lading, etc., are
some of the examples of documents of title to goods.
Law relating to Documents of Title to Goods
Sale of Goods Act and Bill of Lading Act: Government documents of title to
goods. Under these Acts, 'documents of title to goods' is one in which ownership
in goods can be transferred by endorsement and delivery. Therefore, a banker as
an endorsee of a lorry receipt, railway receipt or bill of lading becomes the
owner of goods on transfer of said documents in his name.
140
In the case of Morvi Merchantile Bank Ltd. vs Union of India (1965) 35 Compo
Cases 629, a Bombay firm, sent by rail (to self) six boxes stated to contain
menthol crystals from Thana to Okhla. The railway receipts were endorsed by
the firm to a bank against an advance of Rs. 20,000. The boxes were not
delivered at Okhla and the bank sued the railway claiming damages amounting
to Rs. 35,000 which was stated to be the value of the consignments. The Trial
Court dismissed the suit. On appeal by the bank, the Bombay High Court held
that the bank as an endorsee of railway receipts was entitled to receive the
amount. The Supreme Court confirmed the order of High Court.
Drawee Bills Acceptance and Bill Co-acceptance Facilities
In 'Drawee Bills Acceptance Facility', the bank agrees to pay the drawer the
amount of bills drawn on the borrower on presentation and recovers from the
drawee on the respective due dates. This credit facility is normally extended to
borrowers who have been granted working capital facilities. This is an
alternative to cash credit or overdraft. The amounts of bills accepted by the bank
are debited to 'drawee bills' discounting account and the borrower reimburses the
bank the amounts paid by bank with interest on the respective due dates. These
advances, are also governed by the principles of law under the Negotiable
Instruments Act. The bank would be entitled to sue the borrower and recover
from him the amount due on bills. The bank will have also an additional
advantage of suing the drawer in event of dishonour of bill.
In the case of 'Bills Co-acceptance Facility', the banker accepts the bills along
with the borrower. Under this facility banker undertakes a joint liability along
with the borrower and enters into agreement with the borrower for
reimbursement.
12.6 LET US SUM UP
1. Law relating to bills is provided in the Negotiable Act, 1881.
2. Categories of bills financed by banker are:
(i) Clean bills (ii) Documentary bills
(iii) Bills drawn under credit
3. Maker of bill of exchange is called drawer.
4. Drawee of a bill of exchange is a person who is directed to pay the value
of bill, and in the case
of usance bill of exchange, the drawee is called acceptor.
5. In the case of bills relationships between the parties are:
(i) The drawer of the bill is creditor, (ii) The drawee of a bill is the debtor.
6. Holder in due course means any person who for consideration became
the possessor of the bill
and is entitled to all the rights of holder of the bill.
7. Payment in due course means payment in accordance the tenor of bill to
the holder in due course
or to the holder of the bill, in due course and in good faith and without
negligence.
8. Endorsement means signing the bill of exchange for the purpose of
transfer.
9. Depending upon the place where the bills are made, they can be
classified into
(i) Inland Bills (ii) Foreign Bills
10. Documentary bill means a bill accompanying documents of title to goods.
12.7 CHECK YOUR PROGRESS
1. Bill of exchange means a unconditional direction to the drawer to pay
the moneys. (True/False)
2. The maker of the bill is called .
-^ rtrr? ATIM.
3. Bill purchase facility is granted in the case of demand bills. (True /False)
4. facility is granted in the case of usance bills.
5. of the bill is bound in case of dishonour of bill.
6. Ownership of goods can be transferred by endorsement and delivery of
.
7. In bills co-acceptance facility the banker becomes a surety for the value
of bill. (True/False)
/
12.8 ANSWERS TO 'CHECK YOUR PROGRESS'
1. True; 2. Drawer; 3. True; 4. Bill Discounting; 5. Drawer; 6. Document of title
to goods; 7. True.
VARIOUS TYPES OF SECURITIES
STRUCTURE
13.0 Objectives
13.1 Introduction
13.2 Various Kinds of Securities
13.3 Let Us Sum Up
13.4 Keywords
13.5 Check Your Progress
13.6 Answers to 'Check Your Progress'
144
13.0 OBJECTIVES
After studying this unit, you should be able to understand:
• various kinds of securities;
• advantages and disadvantages of the various securities.
13.1 INTRODUCTION
An advance made by a banker may be secured by a collateral security. The
effectiveness of a security would largely depend on the nature of the security.
The effectiveness of the securities can be broadly classified on two aspects, the
first being the economic aspect, that is the marketability, valuation and other
economic factors that has a bearing on the value of the security. The other the
legal aspect is the validity and enforceability of the security. The requisites of a
good and acceptable security are as follows:
1. The borrower should have a good title to the security.
2. It should be easily and freely transferable.
3. It should not have any encumbrance or liability for, e.g., partly paid
shares.
4. It should be easily marketable.
5. It should not be liable to wide price fluctuations.
6. Its value should be easily ascertainable.
7. Its storing should not be difficult.
8. It should be durable.
9. It should be easily transportable.
We shall now study the various kinds of securities in the light of above
requisites and understand their advantages and disadvantages.
13.2 VARIOUS KINDS OF SECURITIES
1. Land/Real Estate: Bankers in the olden days were very much averse to accept
land and building as a security, but this prejudice has over a period of time
changed and land and building as a security has become an acceptable collateral
in most advances, more particularly to corporate customers. The advantages and
disadvantages of this form of security cannot be universally applied to all lands
and it depends on the nature of the land offered. We shall now discuss both the
advantages and disadvantages.
Advantages
(i) The advantage that land has over other types of securities is that its value
generally increases with time. With every fall in the value of money, the value of
land goes up and due to its scarce availability in developing areas its value is
bound to increase.
(ii) It cannot be shifted, a fact which sometimes is also a disadvantage.
Disadvantages
(i) Valuation is at-times difficult: The value of a building depends on several
factors such as location, size of property, state of repair, amenities, etc., and in
the case of factories and industrial buildings, the machinery, nature of industry,
etc. This makes the valuation very difficult. Buildings and the materials used in
the buildings are not alike. In fact, buildings must be valued on a conservative
basis because of limited market in the event of sale.
(ii) Ascertaining the title of the owner: The banker cannot obtain a proper title
unless the borrower himself has title to the property to be mortgaged. In India,
the laws of succession
145
a security >e broadly lation and >ect is the ty are as
d their
ngas :urity ners. ands and
ises its
as id
particularly those relating to Hindus and Muslims being very complicated, it is
difficult to ascertain whether a person has a perfect title to the property or not.
The banker would therefore have to consult solicitors and obtain their opinion
before accepting it as a security, which in many cases delays lending. Title
verification, must also be done to know whether the property was encumbered.
This has to be done by verifying record with the Registrar's office, which
involves expense and time. In the case of agricultural land, with the introduction
of land ceiling legislation, legislation protecting the tenants' rights, absence of
up-to-date and proper land records, it has become less valuable as a security.
Added to this there have been a number of legislations in different states giving
debt relief to the farmers and prohibiting transfer of land to persons other than
agriculturists.
(iii) Difficult to realise the security: Land is not easily and quickly realisable due
to lack of ready market. It may take months to sell and some times if the market
is not favourable, it may fetch a lower price than what was anticipated.
(iv) Creating a charge is costly: The security can be charged either by way of
legal mortgage or by way of an equitable mortgage. An equitable mortgage may
be created by a simple deposit of title deeds with or without a memorandum.
Although equitable mortgage is less expensive, a banker always prefers legal
mortgage to an equitable mortgage, since the remedies under a legal mortgage
are better than those under an equitable mortgage. However, completing a legal
mortgage involves expenses including stamp duty and lot of formalities.
(v) Difficulty on account of Rent Control Act: In the case of buildings, which
come within the purview of the Rent Control Act, it would be difficult to sell the
building, particularly when a tenant has been occupying it for a long time. This
reduces the marketability and value.
Precautions to be taken by the banker
(i) Financial soundness of borrower: The banker should place more reliance on
the financial soundness of the borrower.
(ii) Borrower's title: The banker should get a solicitor to verify the title to the
property and the right of the borrower to mortgage.
(iii) Enquiry regarding prior charges: The borrower should produce a certificate
from the Registrar's office listing the charges over the property over a period of
time (generally 30 years) that the property is free from encumbrances. This is
commonly understood as non-encumbrance certificate. If any prior charges exist
the banker's right will be subject to such prior charges.
(iv) Freehold or leasehold: A freeholder is the absolute owner of his land and is
able to deal with it as he likes. A leasehold property is one which is taken on
lease for a period and a leaseholder derives a legal status for a term of years
from the freeholder and is free to deal with the land when acting within the terms
of the lease and within the law during that period. When the lease expires, the
land reverts to the freeholder. In the case of leasehold property, the unexpired
period of the lease is an important consideration. The longer the unexpired
period of the lease, greater is the value of the security. The bank should also
ensure by verifying a copy of lease deed that there are no onerous covenants
such as the necessity of taking the freeholder's consent before mortgaging the
property. The banker should also obtain the last ground receipt to ensure that the
lease is active.
(v) Valuation of the property: Valuation can be done in anyone of the following
ways:
(a) By utilising the services of recognised valuers who would be engineers
or architects.
(b) Making enquiries with local real estate agents.
(c) By local authorities.
146
(d) Latest sale transaction of neighbouring properties.
(e) Calculations based on the annual rental value.
(vi) Registration: Where the principal money secured is Rs. 100 or more, a
mortgage charge
is required to be registered unless the charge is an equitable mortgage, (vii)
Documentations: The mortgage deed must be drafted carefully considering all
the legal
stipulations. It should be witnessed by at least two persons. In case of simple
mortgage it
attracts ad-valorum stamp duty, (viii) Verification of Tax Receipts: The banker
should request the borrower to produce latest
property tax receipts since any arrears of tax constitute a preferential charge on
property, (ix) Insurance of the property: To avoid loss of security by fire, natural
calamities, it is prudent
that in case of buildings the banker insist on insurance of the property for its full
value at the
borrower's expense.
2. Stocks and Shares
Shares: These may be classified into preference shares (which enjoy preference
both with regards the payment of dividend and repayment of capital) and equity
shares, i.e., shares which are not preference shares. Banks accept only quoted
shares as security.
Advantages
(i) Value of the security can be ascertained without any difficulty.
(ii) In normal times, stocks and shares enjoy stability of value and are not subject
to wide
fluctuations.
(iii) Stocks and shares require very little formalities for taking them as security,
(iv) It is easier compared to real estate to ascertain the title, more so with the
advent of depositories. (v) Creating a charge of this is less expensive than real
estate, (vi) They yield intermittent income by way of dividends, which can be
appropriated towards the
loan account.
(vii) Being a tangible form of securities they are more reliable, (viii) The release
of such securities involves very little expense and formality.
Disadvantages
(i) Being easy to realise, they are fraud prone and as such they must be properly
secured, (ii) In the case of partly paid shares, the following demerits are there:
(a) The banker may have to pay the calls.
(b) Partly paid shares are subject to violent price fluctuations.
(c) They are not easily realisable because of the restricted market for such
shares.
Precautions while taking stocks and shares as security: Banker must take the
following precautions while advancing against stocks and shares:
(i) In the case of partly paid shares (a) the banker should never register them in
his name.
(b) He must ensure that pending calls are paid.
(c) Sufficient margin should be taken to avoid any future loss or change in
the value of
the security.
(d) The banker should verify share certificate and ensure that the calls are
paid properly
and entered in the space provided for the same.
Other precautions
(i) Update the list of shares which the particular bank is willing to lend against
on a regular basis.
I
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(ii) Updating the amount that can be lent against a particular share which is
called the card limit
at regular intervals, (iii) Yearly review of the portfolio or more frequent review
depending upon the volatility in the
capital market.
3. Debentures: Debenture is a document issued by a company acknowledging its
indebtedness to the bearer or a registered holder. A fixed rate of interest is
payable at stated periods on such debentures. In the case of mortgage
debentures, a charge is created on the assets of the company issuing such
debentures in favour of a trustee who is responsible to take care of the interest of
individual investors.
Advantages
(i) Easy to sell.
(ii) Not subject to violent price fluctuations.
(iii) They can be transferred at minimum cost.
(iv) Bearer debentures are fully negotiable.
(v) They rank in priority to shares and mostly secured by a charge on the
company's property.
Disadvantages
(i) If interest is not paid regularly on the debentures, it would affect its price and
marketability, (ii) If the charge on property of company is not registered, the
subsequent charges will get a
priority, (iii) Debentures may be issued by companies having no power to
borrow money.
Precautions to be taken while taking debentures as security
(i) The nature of the debentures must be ascertained, i.e., whether they are
unsecured or
secured, the later being preferred, (ii) The borrowing powers of the company
issuing the debentures must be ascertained and to
verify that the same has not been exceeded.
(iii) Deposit of the debentures plus a memorandum of deposit is necessary, (iv)
The nature and value of the assets charged must be examined frequently. (v) The
banker must find out whether there are any uncancelled redeemed debentures.
4. Goods: Though, earlier, bankers were not forthcoming to advance against
goods or documents of title to goods, now more and more secured advances of
the scheduled banks in India are against goods.
Merits of this Security
(i) Goods have a ready market and as such can be easily sold unlike other kinds
of security.
(ii) Valuation of the goods can be easily done.
(iii) The banker gets a tangible form of security compared to unsecured
advances, which in
case of default by the borrower, can be realised by sale of pledged goods, (iv)
Advances against goods are normally given for short periods and therefore the
risk of the
banker is considerably reduced, (v) Barring a few states where the stamp duty is
heavy, creating a charge on the security is less
costly and involves minimum formalities, (vi) Banker acquires a good title to the
goods when dealing with customers of repute and
standing.
Demerits of this Security
(i) Certain goods are liable to perish or deteriorate in quality over a period of
time, thus resulting in reduction of the value of the banker's security.
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(ii) There are possible risks of fraud or dishonesty on the part of the borrower.
For example, when 10,000 tins of cashew nuts are shown in the godown as
security for an advance, it is not possible for the banker to verify the quality and
quantity in every tin. It is not even possible to verify whether all the 10,000 tins
contain cashew nuts. A fraudulent borrower may not store the full stocks as
declared in the godown.
(iii) The value of the security in certain cases more particularly electronic
consumer goods are subject to wide fluctuations. Therefore, the valuation of
such goods is difficult. Even in the case of necessaries, there being several
varieties, unless the banker has expert knowledge, the valuation may be
misleading. Disposing of large quantities of goods within a short time may be
difficult and may not fetch the expected / declared price.
(iv) The banker may find it difficult to store the goods.
(v) Transporting the goods from the borrower's premises to the banker's
premises and thereafter to the market in case of sale is a considerably costly and
time-consuming affair.
(vi) When the banker releases goods for sale on the execution of trust receipts,
the money realised by the sale of such goods may not be deposited with the
banker and the borrowers may default to the bankers.
(vii) If the goods are warehoused, the warehouse keeper enjoys a lien over the
goods for any unpaid charges. The banker therefore, has to ensure periodically
that all charges are duly paid.
Valuation of Goods
(i) Advances are given based on the stocks and their value declared in monthly
stock/statements.
The stock/goods are to be inspected at regular intervals and prices verified and
tallied with
purchase invoices.
(ii) By visiting factory/godown by officials and valuers like cost accountants,
(iii) Follow up of account ensuring payment to creditors for stock and collection
of debtors
thus avoiding diversion/misuse of funds.
Precautions to be taken
(i) Advances against goods should be restricted to genuine traders and not to
speculators, (ii) Loans must be given for short periods, since the quality and
thereby the value of the security
is likely to diminish, (iii) The banker must have a working knowledge and gather
information of the different types
of goods regarding their character, price movements, storage value, etc. (iv) The
banker should confirm the state of goods, (v) The goods should be insured
against loss by theft or fire, (vi) The banker should verify and confirm the title of
the borrower to the goods by inspecting
the invoices or cash memos. (vii) The banker as a Pawnee is liable, if reasonable
care is not taken of the goods pledged. He
should therefore, take proper care for their storage and also take reasonable steps
to protect
them from damage and pilferage.
(viii) The price of the goods must be accurately ascertained, (ix) Necessary
margin must be taken by the banker to protect him against fluctuations in the
price of goods.
(x) The banker must obtain absolute or constructive possession of the goods, (xi)
In the case of hypothecated goods, the bank should obtain from the borrower a
written
undertaking that the goods are not charged to any bank or creditor and will not
be so
charged as long as the borrower is indebted to the bank. The banker should
obtain at regular
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periods certificates regarding the quantity and valuation of the goods, which
should be physically verified by the banker.
Documents of Title to Goods: What are Documents of Title to Goods?
As per the Section 2(4) of the Sale of Goods Act, 1930, a document of title to
goods is 'a document used in the ordinary course of business as a proof of
possession or control of goods authorising or purporting to authorise either, by
endorsement or delivery, the possessor of the documents to transfer or receive
the goods thereby represented.' Thus, the essential requisites of a document of
title to goods are:
(i) The mere possession of the documents creates a right either by virtue of law
or trade usage,
to possess the goods represented by the documents, (ii) Goods represented by the
documents can be transferred by endorsement and/or delivery of
the documents.
(iii) The transferee of the documents can take delivery of the goods in his own
right, (iv) Although they appear to be negotiable instruments, documents of title
to goods are not negotiable instruments. The title of bona fide transferee for
value can be affected by defects in the title of transferor. They may be called
quasi-negotiable instruments.
Examples of documents of title to goods are bills of lading, dock warrant,
warehouse-keeper's certificate, railway receipts, delivery orders, etc. Documents
of title to goods must be distinguished from other documents like the warehouse-
keeper's non-transferable receipts, which are mere acknowledgement of the
goods. Documents of title to goods are preferred by bankers because under
Section 52(2)(e) of the Presidency Towns Insolvency Act, 1909, and Section
28(3) of the Provincial Insolvency Act, 1920, possession of goods represented
by such instruments duly endorsed in his favour are taken out of the order and
disposition of the insolvent. The significance of this is that in case the borrower
becomes insolvent, the Official Receiver or Official Assignee as the case may
be, cannot include such goods in the assets of the insolvent.
Merits of this Security
(i) By mere pledge of the instruments the goods are pledged and serve as a good
security, (ii) The person in possession of the document can transfer the goods by
endorsement and/or
delivery. The transferee thereafter is entitled to take delivery of the goods in his
own right, (iii) The documents are easily transferable, and the formalities
involved are less compared to
mortgage or assignment.
Demerits of this Security
(i) Possibility for fraud and dishonesty: Since the bill of lading or a railway
receipt or a warehouse-keeper's certificate does not certify or guarantee the
correctness of the contents of the bags or packages, the banker will have no
remedy against the carrier or warehouse-keeper, if they turn out to be containing
worthless goods.
(ii) Forged and altered documents: The documents might be forged ones, or even
if genuine,
the quantity may be altered.
(iii) Not Negotiable documents: The document being "Not Negotiable", the
transferee of such documents will not get a better title than that of the transferor.
Therefore, if the person who pledged the documents has a defective title, the
banker will not acquire a better title, (iv) Unpaid vendor's right of stoppage in
transit: Under the Sale of Goods Act, 1930, an unpaid vendor has the 'right of
stoppage in transit' and he is entitled to direct the carrier that the goods need not
be delivered, if not already done. If this right is exercised by the unpaid vendor,
the banker cannot obtain the goods and his security is of no value.
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(v) In the case of lost documents, delivery of the goods is allowed on the
execution of an indemnity bond, this option may be misused by the borrower by
selling the goods to some other customer who may take delivery of the goods
declaring that he had lost/misplace the document and indemnifying the carrier.
To avoid such a contingency, the banker can give notice to the carrier regarding
his interest and the pledge.
Precautions to be taken by the banker
(i) The documents must be examined thoroughly to ensure that they are genuine
and of recent origin. In the case of bills of lading, they are prepared generally in
triplicate and as such all the copies must be obtained by the banker. Otherwise,
the carrier is released from his obligation by delivering the goods on the
presentation of any one copy containing ostensibly regular endorsements.
(ii) The banker should ensure that the documents do not contain any onerous
clauses or prejudicial remarks about the condition of goods received.
(iii) Banker should ensure that the goods are adequately covered by insurance
for full value against risks of theft, fire, damage in transit, etc., and in the case of
goods shipped by sea, all the marine risks should be covered.
(iv) Banker should ensure to get consignee copy and banks name being entered
as consignee, so that endorsement/transfer of title is specific.
Trust Receipt
Whenever the bank releases documents of title to goods to the borrower without
payment being made, then a 'Letter of Trust' should be taken. So also in the case
of goods hypothecated to the bank. The reasons are as follows:
(i) The borrower on sale of the goods has to hold proceeds in trust for the
banker. (ii) The goods taken under such trust receipts or the sale proceeds
thereof, are not available to the official receiver in case the borrower becomes
insolvent.
A Trust letter incorporates the following clauses
(i) Borrower's recognition, of bank's rights in the goods as security and in case of
sale, the
proceeds, thereof.
(ii) Borrower's, undertaking to hold the goods or sale proceeds thereof, in trust
for the banker, (iii) Borrower's undertaking, to ensure proper storage and
insurance, at his cost. (iv) Borrower's undertaking to direct the buyer to pay the
monies directly to the banker, if so
required by the banker, (v) Borrower's undertaking to return unsold goods on
banker's request or dispose of the same
as directed by the banker.
5. Life Policies: Purpose of Life Policy: A life policy is taken for two purposes:
(i) It is a source of income for the dependents of the assured in case of his death,
(ii) It is an ideal form of saving since along with income tax deduction on the
premium, paid loans can be raised on the policies in times of need.
Advantages
(i) Life insurance business being highly regulated and permitted only to
companies having sound financial health, the banker need not doubt the
realisation of the policies, which will be done without any difficulty, if the
policy and the claim are in order.
(ii) The assignment of the policy in favour of the banker requires very little
formalities and the banker obtains a perfect title.
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6.
(iii) The longer the period for which the policy has been in force, the greater the
surrender value. It is also useful as an additional security because, in the event of
the borrower's death, the debt is easily liquidated from the proceeds of the
policy.
(iv) The security can be realised immediately on the borrower's default of
payment by surrendering the policy to the insurance company.
(v) The policy is a tangible security and is in the custody of the bank. The banker
only has to ensure that regular payment of premiums is made.
Disadvantages
(i) If the premium is not paid regularly, the policy lapses and reviving the policy
is complicated.
(ii) Insurance contracts being contracts of utmost good faith, any
misrepresentation or non¬disclosure of any particulars by the assured would
make the policy void and enable the insurer to avoid the contract.
(iii) The person (proposer) who has obtained the policy must have an insurable
interest in the life of the assured or the contract is void.
(iv) The policy may contain special clauses, which may restrict the liability of
the insurer.
(v) When the banker accepts a policy coming under Married Women Property
Act he must ensure that all the parties sign in the bank's form of assignment.
(vi) There is facility to obtain the duplicate policy if the original is lost. This can
be misused by persons by obtaining duplicate policies. Banker should, therefore,
verify that no duplicate policy has been issued and there are no encumbrances on
the policy.
Advantages
(i) The policy must be assigned in favour of the bank and should be sent directly
to the insurance company for registration and ensured that only authorised office
of Insurance Company has noted assignment.
(ii) The bank should see that the age of the assured is admitted.
(iii) The banker should ensure the regular payment of premium.
Book Debts: Borrowers can take advances by assigning book debts in favour of
the bank. Section 130 of the Transfer of Property Act permits assignment of
actionable claim and the procedure to be followed is:
(i) The assignment must be in writing and signed by the transferor or his duly
authorised
agent.
(ii) Notice of the assignment in writing must be given to the debtor; and. (iii)
The assignment may be absolute or by way of charge.
Legal implication of assignment
(i) The assignee can sue in his/their own name and can give a valid discharge.
(ii) The debtor can exercise any right of set off against the assignee, which but
for such
transfer, he could have exercised against assignor, (iii) As an actionable claim
includes future debts, there can be a valid assignment of future debts
as well.
Precautions to be taken
(i) The value of the security depends on the solvency of the debtor and his right
of set off, if
any. The banker must enquire into both aspects, (ii) The instrument of
assignment must be in writing and duly signed in the presence of the
banker, signed by the assignor or his duly authorised agent.
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(iii) The banker must serve notices of assignment on debtors, who must be asked
to acknowledge its receipt and confirm:
(a) The amount of the debt.
(b) His right of set off, if any, and
(c) Whether he has received notice of prior assignments, if any.
(iv) An undertaking from the borrower should be taken that the amount of debts
collected directly if any by him will be passed on to the banker, towards the loan
account and operations in account be controlled to ensure this compliance.
(v) Where the book debts are as assigned by a joint stock company, the charge
must be registered with the Registrar of Joint Stock Companies.
7. Fixed Deposit: When money deposited by a customer is not repayable
on demand and is payable on
the expiry of a specified period from the date of deposit such a deposit is called a
'Fixed Deposit'.
The banker evidences a deposit by issuing a receipt known as fixed deposit
receipt. Interest is paid
at regular intervals at a specified rate on such deposits. Banks usually permit
depositors to borrow
against the deposit. This security is certainly the most valuable, as the money
represented by the
receipt is already with the bank and there is no problem of valuation or enquiring
the title, or the
problem of storage and costs associated with storage.
Precautions
(i) The banker should grant the advance only to the person in whose name the
money is deposited. Banker should not advance against fixed deposit receipts of
other banks. This is because the banker who has received the deposit will have a
general lien over such monies. Even if the lending bank gives notice to the bank,
which has received the deposit, the latter may even refuse to register the lien in
favour of the lending bank.
(ii) If the deposit is in joint names the request for loan must come from all of
them.
(iii) When the deposit receipt is taken as security, the banker should ensure that
all the depositors duly discharge it on the back of the instrument after affixing
the appropriate revenue stamp. In addition to this, the banker should obtain a
letter of appropriation which authorises the banker to appropriate the amount of
the deposit on maturity or earlier towards the loan amount.
(iv) After granting the advance, the banker must note his lien in the fixed deposit
register to avoid payment by mistake and the lien, must also be noted on the
receipt itself.
(v) Advance should preferably not be made against fixed deposit receipt in the
name of a minor, unless a declaration is taken from guardian, that loan will be
utilised for benefit of the minor.
(vi) Where the money is being advanced against the fixed deposit receipt issued
by another branch, the FDR duly discharged must be sent to the branch where
such money is deposited for the following purposes:
(a) To verify the specimen signature of the depositor
(b) To ensure that no prior lien exists on the fixed deposit receipt
(c) To mark lien on the FDR and the FDR register, in favour of branch
advancing money.
(vii) Sometimes a person may approach for advances by offering the fixed
deposit receipts held by third parties as security. In such a case, the fixed deposit
receipt must be duly discharged by the third party, i.e., FD holder and he should
declare in writing the bank's right to hold the deposit receipt as security, and also
to adjust the deposit amount towards the loan account on maturity or on default
in repayment of instalment if any.
8. Supply Bills: Supply bills arise in relation to transactions with the
Government and public sector
undertakings. A party might have taken a contract for execution, and he is
entitled to progressive
153
payments based on work done, for which he has to submit bills in accordance
with the terms and conditions of the contract. Similarly, parties who have
accepted tenders for supply of goods over a period are entitled to payments on
the supply of goods, for which they submit bills in accordance with the terms of
the contract. These bills are known as supply bills.
Procedure followed in respect of supply bills
(i) The supplier delivers the goods supported by a delivery challan and produces
the documents. The appropriate authority of the government department inspects
these goods and accepts for payment on due date and the supplier obtains an
inspection note. In the case of contracts, an engineer's certificate regarding work
done is obtained.
(ii) The supplier or the contractor as the case may be, prepares the bill for
obtaining payment. Government departments take quite some time to verify the
bills and pass them for payment. Therefore, the supplier or contractor submits
these bills together with the accepted delivery challan and inspection note or the
engineer's certificates to the appropriate Government department through the
banker and requests the banker to advance against such bills.
These bills do not enjoy the status of negotiable instruments. They are in the
nature of debts and are assigned, in favour of the banker for payment, after
affixing a revenue stamp for having received the amount. The bank should also
obtain a letter from the supplier or contractor, requesting the appropriate
department to make the payment directly to the banker.
Risks involved in advancing against supply bills
(i) Although the advance is self-liquidating in nature, in certain cases it can take
quite some
time before the advance is realised because of administrative and other
Governmental
procedures, (ii) It is virtually a clean advance and the bank may not realise the
full amount, because of the
possibility of counter claim or the right of set off by the Government, as the
charge is only
by way of assignment, (iii) Sometimes, the Government may not pass the bills
for full payment because of the
unsatisfactory quality of goods or defective work done by the contractor or
delays in the
completion of work.
Precautions to be taken by the banker
(i) Advances against supply bills should be made only to borrowers who have
sufficient
experience in Government business and Government regulations. (ii) The
contract between the supplier and the Government department should be
scrutinised
by the banker, to know the volume of transaction, period of supply, rates agreed
upon and
various other terms and conditions. The Government will not pass the bills
unless there is
faithful adherence to the terms and conditions by the supplier, (iii) The banker
should obtain a power of attorney from the supplier authorising him to receive
the money. The same should be registered with the appropriate Government
department, (iv) The banker should obtain the inspection note or the engineer's
certificates along with the
bills. There should be no adverse remarks in the inspection report regarding the
quality and
quantity of goods supplied, (v) There are two types of bills that are submitted by
the suppliers. They are:
(a) Interim bills against which Government pays eighty to eighty-five per
cent of the
amount.
(b) Final Bills for the balance of twenty to fifteen per cent which will be
paid only after
complete verification of goods at the point of destination. Because of the delay
involved
154
in the settlement of final bills, banks should prefer the interim bills for
advancing and final bills only for collection. Keep sufficient margin to cover
advance with interest thereon from proceeds to be received.
(vi) Banker must reserve the right of demanding the repayment of advance, if the
bills remain unpaid for a specified period. The banker, in other words, treats the
bills as only items for collection and the advances are recovered.
13.3 LET US SUM UP
The effectiveness of a security offered to a banker would largely depend on the
nature of the security, which includes its marketability, valuation and other
economic factors and certain legal aspects, like the borrower's title, existing
encumbrance or liability attached to the security. The various kinds of normally
acceptable securities include land/real estate, stocks and shares, debentures,
goods, life policies, book debts, fixed deposit receipts and supply bills.
The securities depending on their nature have various advantages and
disadvantages. The banker however, has to verify the worth of the security and
its readability, before accepting it. Of all the kinds of security, fixed deposit
receipt of the bank is the best and most reliable compared to other forms of
security. The security of goods can be created either by pledging the goods
directly or by pledging the title to goods, which in turn is a pledge of the goods
or by charge by way of hypothecation.
13.4 KEYWORDS
Preference Shares; Equity Share; Debenture; Documents of Title to Goods; Life
Policy; Trust Receipt.
13.5 CHECK YOUR PROGRESS
1. State whether true or false.
(a) If money lent is more than Rs 100 on the security of land, then the
mortgaged (simple)
requires registration.
(b) A mortgage deed need not be witnessed.
(c) Permission from Income Tax Authorities under the Section 230 to create
mortgage is required
only if the land belongs to a company.
(d) Arrears of tax constitute a preferential charge on the property.
(e) There are three types of shares - ordinary, equity and preference.
(f) Debenture is a kind of share issued by a company and has no voting
rights.
(g) Borrower can create a valid pledge with documents of title to goods.
(h) Bills of lading, dock warrants, warehouse-keeper's certificate, etc., are some
examples of documents of title to goods.
(i) Documents of title to goods are negotiable instruments.
(j) Only Life Insurance Companies can issue life policies, (k) Insurance
contracts are contracts of absolute good faith.
(1) An assignee of a life policy can sue in his/her own name, (m) For a loan
against fixed deposit receipt, the stamp duty is very high, (n) Supply bills are
bills of exchange.
13.6 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (a) True; (b) False; (c) False; (d) True; (e) False; (f) False; (g) True; (h) True;
(i) False; (j) True; (k) True; (I) True; (m) False; (n) False.
LAW RELATING TO SECURITIES AND MODES OF CHARGING - I
STRUCTURE
14.0 Objectives
14.1 Introduction
14.2 Mortgage
14.3 Let Us Sum Up
14.4 Check Your Progress
14.5 Answers to 'Check Your Progress'
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14.0 OBJECTIVES
After studying this unit, you should be able to understand:
• various types of mortgages and law relating thereto;
• essential features of various types of mortgages.
14.1 INTRODUCTION
When land/building is offered as a security, it is charged to the bank by a
mortgage. Mortgages are of six kinds, though as a banker you would be dealing
in only three of them. The law, relating to mortgages is dealt with in the Transfer
of Property Act, 1882. and more particularly in Sections 58 to 99 and 102 to
104. We shall now study these provisions and see how they affect us, as bankers
in our business of lending.
14.2 MORTGAGE
Section 58(a) of the Transfer of Property Act, 1882 defines a mortgage as
follows:
'A mortgage is the transfer of interest in specific immoveable property, for the
purpose of securing the payment of money advanced or to be advanced by way
of loan, on existing or future debt or the performance of an engagement which
may give rise to a pecuniary liability.'
The transferor is called the 'mortgagor' and the transferee a 'mortgagee' the
principal money and interest of which payment is secured is called mortgage
money and the instrument by which the transfer is effected is called the
'mortgage deed'.
1. Ingredients of Mortgage: From the above definition of mortgage, the
following are the requirements
of a mortgage:
(i) There should be transfer of interest in the property by the mortgagor (the
owner or lessor), (ii) The transfer should be to secure the money paid or to be
paid by way of loan.
2. Mortgage of Land - Various Types: The Transfer of Property Act
contemplates six different kinds
of mortgages. They are:
(i) Simple mortgage (ii) Mortgage by conditional sale
(iii) Usufructuary mortgage (iv) English mortgage
(v) Mortgage by deposit of title deeds (Equitable mortgage)
(vi) Anomalous mortgage
Simple mortgage
According to Section 58(b) of the Transfer of Property Act, a simple mortgage is
a transaction whereby, 'without delivering possession of the mortgaged property,
the mortgagor binds himself personally to pay the mortgage money and agrees,
expressly or impliedly, that in the event of his failing to pay according to his
contract, the mortgagee shall have a right to cause the mortgaged property to be
sold by a decree of the Court in a suit and the proceeds of the sale to be applied
so far as may be necessary in payment of the mortgage money.'
Features of simple mortgage
(i) The mortgagee has no power to sell the property without the intervention of
the Court.
In case there is shortfall in the amount recovered even after sale of the
mortgaged property the
mortgagor continues to be personally liable for the shortfall, (ii) The mortgagee
has no right to get any payments out of the rents and produce of the mortgaged
property.
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02 of
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id
157
(iii) The mortgagee is not put in possession of the property.
(iv) Registration is mandatory if the principal amount secured is Rs. 100 and
above.
Mortgage by way of conditional sale
As per Section 58(c) of the Transfer of Property Act, a mortgage by way of a
conditional sale of the property is a transaction whereby the mortgagor
ostensibly sells the mortgaged property on the condition that:
(a) on default of payment of the mortgage money on a certain date, the sale
shall become absolute, or
(b) on such payment being made the sale shall become void; or
(c) on such payment being made, the buyer shall transfer the property to the
seller.
No such transaction shall be deemed to be a mortgage of conditional sale, unless
the condition is embodied in the document, which effects or purports to effect
the sale.
Essential features
(i) The sale is ostensible and not real.
(ii) If the money is not repaid on the agreed date, the ostensible sale will become
absolute upon the
mortgagor applying to the Court and getting a decree in his favour. The
mortgagor in such a case
loses his right to redeem his property, (iii) The mortgagee can sue for
foreclosure, but not for sale of the property. Foreclosure, means the
loss of the right possessed by the mortgagor to redeem the mortgaged property,
(iv) There is no personal covenant for repayment of the debt and therefore
bankers do not prefer this
type of mortgage. The mortgagee cannot look to the other properties of the
mortgagor in case the
mortgaged property proves insufficient.
Usufructuary mortgage
According to Section 58(d) of the Transfer of Property Act, 'a Usufructuary
mortgage is a transaction in which
(a) the mortgagor delivers possession expressly, or by implication and binds
himself to deliver
possession of the mortgaged property to the mortgagee; and
(b) authorises the mortgagee to retain such possession until payment of the
mortgage money and to
receive the rents and profits accruing from the property or any part of such rents
and profits and
to appropriate the same in lieu of interest, or in payment of the mortgage money,
or partly in lieu
of interest and partly in payment of the mortgage money.
Essential features
(i) The mortgagee is put in possession of the mortgaged property. Here, by
possession it is meant, the legal possession and not the physical possession. For
example, the mortgagor may continue to enjoy the physical possession as the
lessee of the mortgagee or the mortgagor may be the caretaker of the property
directing the tenants to pay rent to the mortgagee. However, the deed must
contain a clause providing for the delivery of the property to the mortgagee and
authorising him to retain such possession.
(ii) The mortgagee has the right to receive the rents and profits accruing from the
property. Such rents and profits or part thereof, may be appropriated in lieu, of
interest or in payment of the mortgage money or partly for both.
(iii) Unless there is a personal covenant for the repayment of the mortgage
money, there is no personal liability for the mortgagor. Therefore, the mortgagee
cannot sue the mortgagor for repayment of the mortgage debt; nor can he sue
mortgagor for the sale or foreclosure of the mortgaged property.
(iv) There is no time limit specified and the mortgagee remains in possession of
the property until the debt is repaid. The only remedy for the mortgagee is to
remain in possession of the mortgaged property and pay themselves out of the
rents and or profits of the mortgaged property. If the
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mortgagor fails to sue for redemption within thirty years, the mortgagee
becomes the absolute owner of the property.
Bankers do not prefer this form of mortgage for the following reasons:
(i) There is no personal covenant to repay the debt.
(ii) As the mortgaged money can be recovered only by the appropriation of rents
and/or profits, it will take a very long time to recover money through this
process.
English Mortgage
According to Section 58(e) of the Transfer of Property Act, an 'English
Mortgage' is a transaction in which, the mortgagor binds himself 'to repay the
mortgage money on a certain date and transfers the mortgaged property
absolutely to the mortgagee, but subject to the provision that he will retransfer it
to the mortgagor upon payment of the mortgage money as agreed'.
Essential features
(i) It provides for a personal covenant to pay on a specified date notwithstanding
the absolute
transfer of the property to the mortgagee, (ii) There is an absolute transfer of the
property in favour of the mortgagee.
However, such absolute transfer is subject to a provision that the property shall
be re-conveyed to
the mortgagor in the event of the repayment of mortgage money, (iii) The
mortgagee can sue the mortgagor for the recovery of the money and can obtain a
decree for
sale.
Equitable mortgage or mortgage by deposit of title deeds
According to Section 58(f) of the Transfer of Property Act, 'Where a person in
any of the following towns - namely, the towns of Kolkata, Chennai and
Mumbai and in any other town which the State Government concerned may, by
notification in the official gazette, specify in this behalf - delivers to a creditor or
his agent documents of title to immoveable property, with intent to create a
security thereon, the transaction is called a mortgage by deposit of title deeds.'
Documents of title
Documents of title or title deed in case of mortgage by deposit of title deeds,
shall be documents or instruments which relate to ownership of the mortgagor
over the property. In other words, by virtue of a document or instrument, if a
person has a right to peaceful possession and enjoyment of the immoveable
property, then such a document or instrument is called the title deed. In the case
of Syndicate Bank vs Modern Tile and City Works (1980 KL T 550); it was
explained by the learned Judges that documents of title or deed means the legal
instrument which proves the right of a person in a particular property.
Essential features
(i) Such a mortgage can be affected only in the towns notified by the State
Government. However, the territorial restriction refers to the place where the
title deeds are delivered and not to the situation of the property mortgaged.
(ii) To create this mortgage, there must be three ingredients i.e. a debt, a deposit
of title deeds and an intention that the deeds shall be act as security for the debt.
Anomalous mortgage
According to Section 58(g) of the Transfer of Property Act, 'a mortgage which is
not a simple mortgage, a mortgage by conditional sale and usufructuary
mortgage and English mortgage or a mortgage by deposit of title deeds within
the meaning of this Section, is called an 'Anomalous Mortgage.'
Essential features
(i) It must be a mortgage as defined by Section 58 of the Transfer of Property
Act. (ii) It is negatively defined and should not be anyone of the mortgages listed
above.
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(iii) Anomalous mortgages are usually a combination of two mortgages.
Examples of such mortgages are:
(a) a simple and usufructuary mortgage, and
(b) an usufructuary mortgage accompanied by conditional sale. There may
be other forms,
moulded by custom and local usage.
3. Merits and Demerits of an Equitable Mortgage
Merits
(i) The borrower saves the stamp duty on the mortgage deed and the registration
charges. It
involves minimum formalities, (ii) It involves less time and can be conveniently
created.
It can be done without much publicity and therefore, the customer's position is
not exposed to public gaze.
Demerits
(i) In case of default, the remedy is to obtain a decree for sale of the property.
Since, this involves going to the Court, it is expensive and time consuming. This
shortcoming, can be overcome by inserting a covenant by which the mortgagee
is given the power of sale. In that case, the mortgage deed must be properly
stamped and registered and the mortgage loses the advantage of being simple in
procedure and less expensive.
(ii) Where the borrower is holding the title deeds in his capacity as a trustee and
equitable mortgage of the same is effected, the claim of the beneficiary, under
trust will prevail over any equitable mortgage. Therefore, the banker has to make
a proper scrutiny of the title deeds before accepting them as a security.
(iii) The borrower may create a subsequent legal mortgage in favour of another
party. However, this possibility is not there, if the equitable mortgagee holds the
original title deeds. In India, there is no difference between the two types of
mortgages. According to Section 48 of the Registration Act, 1908, a mortgage
by deposit of title deeds prevails against any subsequent mortgage relating to the
same property. Similarly, the title of the equitable mortgagee, is not defeated by
any subsequent sale without notice. However, to avoid any risk of this type, the
equitable mortgage should be accepted only after obtaining the original title
deeds.
The law in England is slightly different. As between equitable mortgage and
legal (simple) mortgage, the latter prevails even though it is effected
subsequently. The law, regarding this is, as between law and equity, law
prevails. As between the equities, the prior in time prevails.
4. Difference between Equitable Mortgage and Pledge
Table 14.1: Difference between Equitable Mortgage and Pledge
Pledge Mortgage
Pledgee acquires only a limited interest in the property and ownership remains
with the right of pledger.
The Pawnee has 'special property' in the goods pledged and can sell the same in
the event of default by the pledger of course, after giving reasonable notice.
Pawnee has no right of foreclosure. He can only sell the property to realise his
dues. Here the legal ownership passes to mortgagee, of course, subject to the
mortgagor to redeem the property. The mortgagee as a rule takes decree of a
Court of Law before having recourse against the property mortgaged. In certain
cases, the mortgagee can foreclose the property.
5. Priority of Mortgages: Indian Law of Priorities is provided in Section 48 of
the Transfer of Property Act. The rule is based on maxim 'He has a better title
who was first in point of time.' It lays the
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general rule regarding priority of rights created by transfer by a person at
different times in or over the same immoveable property and provides that, as
between such rights, each later created right is subject to the rights previously
created. We may further see, as how the rule of priorities operate in respect of
different instruments creating mortgages.
(a) Priority among registered instruments: Section 47 of the Registration
Act, 1908 provides
that a registered document operates, not from the date of its registration, but
from the time
of its execution. Thus, a document executed earlier, though registered later than
another,
has priority over the documents executed later.
(b) Priority between registered and unregistered instruments: Let us now
deal with the exceptions
to the rule that priority is determined by order of time which either have been
created by
statute or owe their origin to the ancient rule of Hindu Law, which required
delivery of
possession in the case of a security of land. There are also some exceptions
recognised in
the Indian system founded upon those general principles of justice and equity,
which in the
absence of any express enactment, Indian judges are bound to administer, and
which have
been mostly borrowed from the English Law.
The first exception is that contained in Section 50 of the Registration Act which
under certain circumstances allows a registered mortgage priority over
unregistered mortgage. However, it may be noted that prior mortgage by deposit
of title deeds is not affected by subsequent registered mort¬gage as the same
need not be registered. This is provided in Section 48 of Indian Registration Act.
6. Limitation Period in Mortgages: Article 62 of the Indian Limitation Act, 1963
provides limitation period for filing of suit for recovery of mortgaged debt and
sale of mortgaged property in the event of non-payment of the mortgaged debt.
Article 63(a) of the said Act provides a limitation period, in case of foreclosure
of the mortgaged property. The limitation period for filing a suit for sale of
mortgaged property is TWELVE YEARS, from the date the mortgage debt
becomes due. The limitation period for filing suit for foreclosure is THIRTY
YEARS from the date the money secured by mortgage becomes due.
Enforcement of Mortgage - Some Important Aspects
We will now learn some important aspects as to enforcement of mortgage. It
may be noted that a banker, secures moneys advanced by creating one of the
various types of mortgages mentioned above. Popular types of mortgages
obtained by a banker are:
(i) Mortgage by deposit of title deeds (ii) Simple mortgage and in some cases
(iii) English mortgage.
Enforcement of all these types of mortgages is by way of filing a suit for sale of
mortgaged properties. The procedure for filing a suit for a sale is provided for in
the Code of Civil Procedure, 1908. The Section 16(c) of the Civil Procedure
provides that a suit for sale of mortgaged property shall be filed in the Court
within whose jurisdiction the mortgaged property is situated. Order 34 of the
Code provides for various things to be adhered to while filing suit for sale of
mortgaged property. When a suit for sale is filed, the Court after hearing the
parties passes a preliminary decree. Through the preliminary decree it directs the
mortgagor to pay the mortgage debt within a certain period and in the event of
his failure to pay the money due under the mortgage, the Court orders for sale of
mortgaged properties by passing a final decree. After passing of the final decree,
the mortgagee with the help of the Court gets the mortgaged property sold in
execution of the mortgage decree.
14.3 LET US SUM UP
1. Mortgage is a transfer of interest in immoveable property to secure an
advanced loan, or an existing debt or a future debt or performance of an
obligation.
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2. Transfer of Property Act, contemplates six types of mortgages, they are:
(a) Simple mortgage (b) Mortgage by conditional sale
(c) Usufructuary mortgage (d) English mortgage
(e) Mortgage by deposit of title deeds (f) Anomalous mortgage
3. In Simple mortgage, the mortgage is by deposit of title deeds and in
English mortgage, the
possession of the mortgaged properties is not given to the mortgagee.
4. In usufructuary mortgage and in mortgage by conditional sale,
possession of mortgaged properties
is normally given to the mortgagee.
5. In the case of simple mortgage and mortgage by deposit of title deeds,
the mortgagee has a right
to proceed against the property mortgaged and also personally against the
mortgagor.
6. Mortgage is to be created by way of deed and requires to be registered
under the Registration Act.
7. Mortgage by deposit of title deeds, is not required to be created by way
of a deed and does not
require registration.
8. The rule of priority in case of successive mortgages is in the order of
time they are created.
9. Limitation period for filing a suit for sale of mortgaged property is
twelve years from the date
mortgage debt becomes due.
10. Limitation period for filing a suit for foreclosure is thirty years from the
date mortgage debt
becomes due.
11. Enforcement of mortgage is governed by the Code of Civil Procedure,
1908. Suit for sale of
mortgaged properties are to be filed in the Court, within whose jurisdiction the
mortgage property
is situated.
12. In a suit for sale, of mortgaged properties, the Court first passes a
preliminary decree and thereafter
a final decree.
14.4 CHECK YOUR PROGRESS
1. Mortgage is
in the immoveable property.
2. Simple mortgage is created by an instrument in writing. (True/False)
3. Mortgage by deposit of title deeds is required to be registered.
(True/False)
4. In the case of usufructuary mortgage the possession of the properties is
given. (True/False)
5. In mortgage by way of conditional sale the property is sold with a
condition for re-conveyance.
(True/False)
6. All successive mortgages created will rank equally and no mortgage will
have a greater priority
over the other. (True/False)
7. To decide as to which mortgage will have priority over the other in the
case of two or more
mortgages on the same immoveable property, the date of mortgage is pertinent.
8. Limitation period for filing a suit for sale of mortgaged properties is
years from the
date the mortgage debt becomes due.
9. Mortgage suits are filed in the Court within whose jurisdiction the
mortgagee resides. (True/
False)
14.5 ANSWERS TO CHECK YOUR PROGRESS'
!• transfer of interest; 2. True; 3. False; 4. True; 5. True; 6. False; 7. execution
of; 8. twelve; 9. False
LAW RELATING TO SECURITIES AND MODES OF CHARGING - II
STRUCTURE
15.0 Objectives
15.1 Introduction
15.2 Pledge
15.3 Hypothecation
15.4 Let Us Sum Up
15.5 Check Your Progress
15.6 Answers to 'Check Your Progress'
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15.0 OBJECTIVES
After studying this unit, you should be able to understand:
• the law relating to security of pledge and hypothecation;
• basic features of pledge and hypothecation.
15.1 INTRODUCTION
A banker, in his business of lending takes security of pledge and hypothecation
of moveable goods to secure cash credit and overdraft. These are popular
securities obtained by a banker. In this unit, we will learn about the law relating
to security of pledge and hypothecation.
15.2 PLEDGE
'Pledge means bailment of goods for purpose of providing security for payment
of debt or performance of promise' (as per the Section 172 of Contract Act
1872).
As per the above definition to constitute a valid pledge, three requirements are to
be satisfied:
1. There must be bailment of goods (bailment means delivery of goods);
2. The bailment must be, by or on behalf of the debtor; and
3. The bailment, must be for the purpose of providing security for the
payment of a debt or performance
of promise.
The person, whose goods are bailed is called the Pawnor, the person who takes
the goods as security is called the Pawnee.
1. Legal Implications of a Pledge: The following are the legal implications of a
pledge:
(a) The ownership of the property is retained by the pawnor, which is
subject only to the
qualified interest which passes to the pawnee by the bailment.
(b) One of the main and most essential requirements of a pledge is the
actual or constructive
delivery of the goods to the pawnee. By constructive delivery, it is meant that
there need be
no physical transfer of goods from the custody of the pledger/pawnor to the
pawnee. All
that is required is, that the goods, must be placed in the possession of the pawnee
or of any
person authorised to hold them on his behalf.
Goods, may be delivered by one of the following ways (as mentioned in the Sale
of Goods Act):
(i) By handing over the key of the godown in which the goods are kept.
(ii) By attornment, i.e. if goods are in public warehouse, the warehouseman
acknowledges to the pawnee that he will hold the goods thereafter on behalf of
the pawnee.
(iii) Handing over the document of title to goods, such as railway receipt, bill of
lading, warehouse receipts, etc.
(iv) Even if the goods are in possession of the pawnor, he may acknowledge that
he holds them thereafter for and on behalf of the pawnee. This is again similar to
attornment. Thus, delivery may be physical, when goods are physically
transferred or symbolic as in the case of handing over the key to the godown,
where the goods are stored so as to be out of the control of the pawnor or
constructive as in the case of an attornment.
In the case of Co-operative Hindustan Bank Ltd. vs Surendar Nath Dey AIR
1932 Cal 524, it was observed that it is essential in a transaction of pledge that
there must be a delivery of goods to the pawnee and he must keep the goods.
The delivery need not be simultaneous with lending of money. It may be actual
delivery or symbolic delivery, e.g. by delivery of
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key of the warehouse where the goods are stored or something may be done
which is equivalent to delivery that is keeping of goods without any actual
delivery, as if the pawnee has the possession or effect of possession.
(c) Pledge can be created only in the case of existing goods which are in the
possession of the
pawnor himself. There can be no pledge of future goods or goods which the
pawnor is
likely to get into his possession subsequently. Since delivery is involved, goods
must be
specific and identified.
(d) Possession of goods is the most important characteristic of pledge and
therefore, pledge is
lost when possession of the goods is lost.
However, the pawnee may release the goods after obtaining a letter of trust from
the pawnor. Such a letter of trust is known as the trust receipt. It is an instrument
by which the borrower receives the goods or documents of title to goods and
undertakes to hold them or the proceeds thereof, in trust for the lender. Because
of the trust receipt, the bankers, rights as a pawnee remains unaffected. Even if
the borrower becomes insolvent, the Official Receiver cannot claim the goods.
(e) An agreement of pledge may be implied from the nature of the
transaction or the
circumstances of the case. However, an agreement in writing clearly laying
down the terms
and conditions leaves no ambiguity.
2. Who can create a Pledge?
The following persons can make a valid pledge:
(a) Owner of the goods
(b) A mercantile agent, provided the following conditions are satisfied
(i) He should be in possession of the goods, or the documents of title to goods
with the
consent of the owner.
(ii) The goods must have been entrusted to him in his capacity as a mercantile
agent, (iii) The mercantile agent should create the pledge in the ordinary course
of his business
as such agent, (iv) The pawnee acts in good faith and has no notice at the time of
pledge that the pawnor
has no authority to pledge (as per Section 178 of Contract Act).
(c) Persons in possession of goods under a voidable contract, provided the
contract, has not
been rescinded at the time of pledge
(d) Seller of the goods, who continues to be in possession of the goods even
after sale, can create
a valid pledge. The pawnee must act in good faith and without notice of the
previous sale.
A pawnee can repledge the goods, but it is valid only to the extent of his interest
in such goods. When the original pawnor repays the debt to the first pawnee, he
is entitled to the return of the goods although they may be in the hands of the
second pawnee to whom the first pawnee has not repaid the debt.
3. Rights of Pawnee
(a) Right of retainer: As per Section 173 of the Contract Act, the pawnee
can keep the goods
pledged not only for the non-payment of the debt or non-performance of the
promise, but
also for the interest on the debt and for all expenses properly and necessarily
incurred for
the preservation of the goods pledged. This is similar to the rights of the bailee.
(b) Right to claim extraordinary expenses: In respect of such expenditure
incurred for
taking care of the pledged goods, he cannot claim lien over the goods but can
only sue to
recover the goods.
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4.
(c) No right to retain in respect of the other debts: In the absence of a
contract to the
contrary, the pawnee cannot retain the goods for a debt or a promise, other than
the promise
or debt for which they are pledged. However, in the case of subsequent advances
made,
such a contract is presumed, in the absence of anything, to the contrary.
(d) Rights against third parties: A pawnee has the same remedies against
third persons, as
the owner himself would have, if he is deprived of his goods. (Morvi Mercantile
Bank Ltd.
vs Union of India AIR 1965 Supreme Court 1954.)
(e) Pawnee's right where Pawnor makes default in payment: In case where
the pawnor
makes default, the pawnee has three rights:
(i) He may sue the pawnor upon the debt or promise; (ii) He may retain the
pawned goods as collateral security; or (iii) He may sell it after giving the
pawnor reasonable notice of the sale.
The right to retain the pawn(pawned goods) and the right to sell it are alternative
and not concurrent rights. While the pawnor retains, he does not sell and when
he sells he does not retain. However, the pawnee has the right to sue on the debt
or the promise concurrently with his right to retain the pawn or sell it. The
retention of the pawn does not exclude this right of suit, since the pawn is a
collateral security only.
In Nanak Chand Ramkrishandas vs Lalchand Ganeshilal AIR 1958 Punj. 222, it
was held that a pawnee may keep the goods as security for the debt due to him
from the pawnor and although he has got the right to sell after notice to the
pawnor, he is not bound to sell at any particular time. The mere fact that the
pawnee gave a notice that he would sell the goods cannot possibly be a
compelling factor for sale to be effected. If the goods are sold, by the pawnee
without a notice, as provided by this Section, they will be deemed to have been
converted and an action for conversion of the same would lie against the
pawnee; but damages would be assessed, by taking into consideration the market
rate of the goods in question as on the date of conversion, which ordinarily,
would be the date on which the goods were wrongfully sold. In case of an
improper sale, the pawnee is liable for conversion, but the sale cannot be set
aside.
Whether two notices must be given
It was held in A. Srinivasalu vs Gajaraj Mehta & Sons 1990 (II) MLJR 188, that
a sale notice is only an intimation of the proposed sale by the pawnee and it is
not necessary that such notice must be proceeded by another notice informing
the pawnor that on his not making payment the goods would be sold. The sale
notice also need not be signed by the pawnee or the amount due be mentioned.
If the goods are sold by the pawnee after giving reasonable notice, the pawnor is
entitled to receive from him any surplus over and above the debt amount.
The pawnor has a right to redeem the goods even though the time stipulated for
payment is over, provided the goods have not been sold by the pawnee.
Duties of Pawnor:
(a) He must disclose to the pawnee any material faults or extra ordinary
risks in the goods to
which the pawnee may be exposed. Failure to disclose makes him responsible
for damages
for any loss caused to the pawnee.
(b) The pawnor must reimburse the pawnee for any expenses incurred for
the preservation of
the goods.
(c) In the case of forced sale, if the amount realised is less than the debt due
from the pawnor,
he is liable to make good the balance.
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5.
6.
(d) When the goods are pledged, there is the implied condition that the pawnor
has title to the goods pledged. However, in practice the banker obtains the
pawnor's signature to a document known as an agreement of pledge. The
following are the important points usually covered in the document:
(i) The pledge is in respect of all the goods delivered and upon all documents of
title to
goods deposited by the pawnor (ii) A declaration that the securities deposited
would cover the existing and future debt,
interest and expenses (iii) The letter stipulates that it will be a continuing
security without the operation of the
rule in Clayton's case, (iv) Pawnors title to the security is clear, that the goods
will be insured adequately at his
expense and that sufficient margin will be maintained as agreed upon, (v) A
promise to pay all the money secured by the pledge on demand, and in the case
of
default in repayment, the bank to have the right of sale, (vi) Where the pawnor
fails to insure the goods, the banker reserves the right to effect
such insurance and debit the premium and other charges to the account of the
customer, (vii) A declaration by the pawnor not to hold the bank responsible for
the default of any
broker employed to sell the goods. The pawnor undertakes to pay the rent and
other
charges incidental to warehousing, (viii) The banker reserves the right of general
lien and nothing in the agreement, shall be
construed as excluding such right, (ix) The pawnor undertakes to submit
periodical statements of stocks and to allow inspection
of the goods and records by the bank, all at his cost.
Advantages of Pledge:
(a) The goods are in the custody of the pawnee and, therefore, it is easy to
sell in case of
default. If the banker takes proper precautions, through periodical inspections, it
will not be
possible for the pawnor to create subsequent charges against the same goods.
(b) Because of close supervision, it will not be possible for the pawnor to
manipulate the
stocks.
(c) Even if the goods are lost, the banker can recover the amount under the
insurance policy.
(d) The formalities connected with the pledge are simpler than in the case of
mortgage.
Precautions to be taken:
(a) To ensure that the pawnor has the title to goods.
(b) To ensure that the contract of pledge is complete in all respects and
incorporates the already
referred to usual clauses.
(c) To exercise full and effective control over all the goods pledged.
(d) To put up a signboard at the godown prominently displaying, that the
goods are pledged to
the banker.
(e) To take reasonable care of the goods as a man of ordinary prudence
would under similar
circumstances take of his own goods of the same bulk quantity and value of the
goods
pledged. Any loss arising to the goods due to failure to take such care must is to
be
compensated to the pawnor. In his own interest also, the banker must take such
care so that
the value of security is not eroded.
(f) Banker must make periodical inspections to verify the quality, quantity,
value, etc., of the goods
and ensure the maintenance of reasonable margin throughout the period until the
debt is repaid.
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7. Cases Relating to Pledge
(a) Morvi Mercantile Bank Ltd. vs Union of India AIR 1965 SC 1954. In
this case M/s Harshadrai
Mohanlal & Co., a firm, entrusted on 4 Octobe, 1949 to GIP Railway, 4 boxes of
menthol
crystals belonging to the firm for transport from Thane to Okhla near Delhi.
Further, on 11
October 1949 the firm sent two more boxes to Okhla from Thane through the
railways. The
firm was issued railway receipts. The firm endorsed the railway receipts in
favour of Morvi
Mercantile Bank. On failure of railways to deliver the goods, the bank, claiming
as an endorsee
of the railway receipts for valuable consideration, filed a suit against railways for
recovery of
the value of the goods.
The Supreme Court delivering a judgement in appeal, decided that the bank was
entitled to recover the value of goods for the following reasons:
(i) Valid pledge can be created by endorsement of railway receipts.
(ii) For a valid pledge, actual delivery is not necessary and constructive delivery
is sufficient, (iii) By endorsing the railway receipts, the firm created a valid
pledge in bank's favour, (iv) Pledge being the bailment of goods, the bank as a
pledgor will have all the rights of owner
of goods, (v) Hence, the bank is entitled to recover value of goods from the
railway as a pledge.
(b) Lallan Prasad vs Rahmat Ali and Another AIR 1967 SC 1322. The
question decided in this
case was whether a pawnee can file a suit for recovery of debt due to him if the
pawnee lost
the goods pledged to him. In this case, on 10 January 1946, Lallan Prasad gave a
loan of Rs
20,000 to Rahmat Ali. Lallan Prasad also obtained a pledge of 147 tonnes of
aero-scraps from
Rahmat Ali. On failure to repay the loan, Lallan Prasad filed a suit against
Rahmat Ali for
recovery. Rahmat Ali argued that Lallan Prasad is not in a position to deliver the
goods
pledged and he should not be granted a decree for recovery of money.
Supreme Court after analysing the facts of the case rendered a judgement that a
pawnee under the Contract Act is entitled to retain the goods pledged and file a
suit for recovery of the money. However, this right of pawnee can be
countenanced only when pawnee is in a position to return the goods pledged,
when pawnor repays the debt. A pawnee cannot be allowed to have a decree for
recovery, if he is not willing to return the goods pledged.
(c) Bank of Bihar vs State of Bihar AIR 1971 SC 1210. In this case the
rights of pawnee came up
for consideration of the Court. In this case, Bank of Bihar lent moneys and took
security by
way of pledge of different varieties of sugar. Government of Bihar seized the
bags of sugar
from the borrower and sold them to recover Government dues. The bank filed a
suit for
recovery of moneys due to it against Government of India.
The Supreme Court deciding the case, held that right of bank as a pawnee cannot
be taken away by government and hence, the Government of Bihar shall pay the
amount due to the bank.
(d) Standard Chartered Bank vs Custodian AIR 2000 SC 1488. In this case,
the Supreme Court
held that, if during the pledge there is an increase in value of the goods pledged,
the pawnee
is entitled to the increase, as an integral part of his security. In this case, the
shares and
debentures were pledged with the bank and these shares and debentures were
entitled to
bonus, dividend and interest. The Supreme Court held, that these accretions
formed part of
the pledged property and as such the pawnee is required to return the same only
when the
pledged goods were returned and in case of pawnor's default in payment of debt,
the pawnee
has the right to sell the pledged property along with the accretions after giving
reasonable
notice to the borrower.
169
15.3 HYPOTHECATION
Until recently there was no legislative definition of the term 'hypothecation'.
This term came to be defined in the S ARFAESI Act, 2002. As per the definition
contained in the Act, the term 'Hypothecation' means a charge in or upon any
moveable property, existing or future, created by a borrower in favour of a
secured creditor, without delivery of possession of the moveable property to
such creditor, as a security for financial assistance and includes floating charge
and crystallisation of such charge into fixed charge on moveable property.
The mortgage of moveable property is called 'Hypothecation'. It may be
described as 'a transaction whereby money is borrowed by the debtor (owner of
the goods) on the security of the moveable property without transferring either
the property or the possession to the creditor'. Hart describes hypothecation as 'a
charge against property for an amount of debt where neither ownership nor
possession is passed to the creditor'. Hypothecation differs from pledge because
goods remain in the possession of the borrower and are equitably charged in
favour of the creditor under documents signed by the borrower. However, the
document provides for a covenant, whereby the borrower agrees to give
possession of the goods when called upon to do so by the creditor. Once the
possession is given up, the charge becomes transformed into pledge.
Hypothecation differs from mortgage in two respects. Firstly, mortgage relates
to immoveable property whereas hypothecation relates to moveables. Secondly,
in a mortgage, there is transfer of interest in the property to the creditor but in
hypothecation there is only obligation to repay money and no transfer of interest.
Facility limited to respectable customers
Law permits hypothecation of assets as a security by sole proprietorships,
partnerships, joint stock companies and even individuals. However, the charge
being only equitable without possession, the facility is normally granted to
customers of undoubted integrity. There is less risk when such a facility is
granted to a joint stock company because of the registration of such a charge
with the Registrar of Companies. Such a registration constitutes a constructive
notice to the world at large, but such a facility is not available in the case of
other forms of business.
Hypothecation is resorted to in the following cases:
(a) When loan is to be raised against work-in-progress, the only way of
creating a charge is
hypothecation.
(b) It is also done in respect of goods which require constant handling in a
factory, e.g. rice mills, oil
expellers, etc.
(c) This charge is also convenient, where lending is to be done against
goods in a shop or showroom
which are required in day-to-day business.
1. Drawbacks of Hypothecation
(a) The fundamental difficulty about this charge is that goods remain in the
possession of the
borrower and therefore the creditor's control over such goods is almost nil. This
may give
rise to fraudulent dealings in such goods by the borrower.
(b) The borrower may realise stocks hypothecated and pay to other
creditors. He may even sell
marketable stocks and keep only obsolete and slow moving stocks for the banker
to realise.
Thus erosion of security can take place.
(c) The borrower may hypothecate the same stock with more than one
banker or having
previously hypothecated, the goods may subsequently be pledged to another
creditor.
(d) The realisation of the assets in case of default of payment is a difficult,
prolonged and costly
affair. As stated earlier, the banker may find only obsolete and slow-moving
items.
170
(e) According to Section 534 of the Companies Act, 1956, any floating charge
on the undertaking or property of the company created within a period of twelve
months preceding the commencement of the winding up, becomes invalid under
certain circumstances.
2. Precautions to be taken in the case of Hypothecation: Although these
disadvantages seriously limit the value of hypothecation as a security, the banker
can take certain precautions and avoid at least some of the disadvantages. The
following precautions usually are taken by banks:
(a) Banks ensure that the borrower is not enjoying hypothecation facilities
from other banks and is
confining his borrowings to only one bank. An undertaking to this effect is
obtained from the
borrower in writing. Banks also ensure that boards are prominently displayed on
the premises
where the goods are stored stating that the goods are hypothecated to the bank.
(b) In the case the borrower is a company registered under the Companies
Act, the charge by
way of hypothecation must be registered within a period of thirty days of its
creation or a
further period of thirty days on payment of fine. If this is not done, the charge
would be
void against the liquidator or any other creditor of the company.
(c) The banker must obtain periodical statements of stocks with a
declaration regarding the
borrower's clear title to the goods and the correctness of the quality, quantity and
valuation.
Banks should not merely be content with the receipt of the stock statements, but
should also
effectively supervise the goods hypothecated and the financial position of the
borrower from
time to time. Banks should verify in such an inspection that there is no
depreciation in the value
of the security or any adverse change in the borrower's financial position. If an
inspection
discloses such a state of affairs, the banker should take appropriate action
immediately.
Deed of Hypothecation: While lending against hypothecation of goods, bankers
obtain a letter of hypothecation which serves as the hypothecation agreement
and contains several clauses to protect the banker's interest under all
contingencies. It is a very comprehensive document and contains the following
important clauses:
(a) The request made by the borrower for the grant of accommodation in the
form of loan or
cash credit on the hypothecation of goods, resulting in the agreement.
(b) The description of the goods in a separate statement giving the
particulars, quality, rate,
quantity, market value and an undertaking that the particulars are true and that
the borrowers
are the absolute owners of the property and with authority to hypothecate. The
statement
also declares that the goods are not subject to any lien, claim or charge of any
sort.
(c) An undertaking that no further charge or encumbrance will be created on
the goods and that
all money realised by way of sale proceeds or realisation of insurance claims,
will be held
exclusively as the bank's property and such money will be paid in, to the
satisfaction of the
balance due and owing on the account kept by the bank in respect of such
accommodation.
(d) The borrower, whenever required by the bank, must give full particulars
of all his assets
and of the hypothecated goods. He must, at all times allow the bank or its
authorised agent
to inspect the hypothecated goods and all records of the borrower. All costs,
charges and
expenses incurred by the bank in respect of such an inspection are to be paid to
the bank on
demand, failing which, the amount and interest thereof will be a charge upon the
hypothecated
goods.
(e) The borrower undertakes to insure the goods against risks specified by
the banker at his
cost. The policy so taken is to be endorsed and assigned in favour of the bank.
(f) The borrower undertakes to maintain the agreed,margin of security at all
times during the
continuance of the security.
(g) The borrower undertakes to pay all rents, taxes, payments and outgoings
in respect of the
immoveable property, in which the hypothecated goods are kept.
171
(h) The bank reserves the right to call upon the borrower to pay to the bank the
loan amount together with interest and other charges at any time. In the event of
default, the bank reserves the right to dispose the hypothecated stocks and apply
the proceeds in satisfaction of the loan amount. If the proceeds are insufficient, it
reserves the right to recover the balance from the borrower.
(i) The borrower undertakes not to dispute the correctness of any sum due to the
banker as stated in the demand made by the banker under the hypothecation
agreement.
(j) A clause stating that the security shall be a continuing security for the balance
due to the bank from time to time. Where by any chance, the cash credit results
in a credit balance, it is not to be considered to be closed for the purpose of the
security. In other words, the security is not treated as exhausted simply because
the cash credit showed a credit balance at any time.
15.4 LET US SUM UP
1. Pledge means bailment of goods for the purpose of securing a payment
of debt or an obligation.
2. Pawnee has special property rights in the goods pledged.
3. A valid pledge can be created by owner of goods or a mercantile agent.
4. A constructive pledge involves only delivery of keys of the warehouse.
5. Under the contract of pledge, the pawnee can sell the goods pledged
after notice or retain the
goods and file a suit for recovery of debt.
6. Mortgage of moveable property is called Hypothecation.
15.5 CHECK YOUR PROGRESS
1. Pledge means of goods for purpose of securing a payment of debt or
performance
of promise, (fill with appropriate words)
2. The most important characteristic of pledge is of goods, (fill with
appropriate words)
3. Owner of goods cannot make a pledge. (True/False)
4. Hypothecation is an implied pledge in cases where constructive
possession of goods is given.
(True/False)
5. Hypothecation letter gives a banker right to possession of goods in the
event of default.
(True/False)
15.6 ANSWERS TO 'CHECK YOUR PROGRESS'
1. bailment; 2. possession; 3. False; 4. True; 5. True.
DIFFERENT TYPES OF BORROWERS
STRUCTURE
16.0 Objectives
16.1 Introduction
16.2 T^pes of Borrowers
16.3 Let Us Sum Up
16.4 Keywords
16.5 Check Your Progress
16.6 Answers to 'Check Your Progress'
174
16.0 OBJECTIVES
After studying this unit, you should be able to understand:
• the legal aspects pertaining to different borrowers;
• the laws governing various types of borrowers.
16.1 INTRODUCTION
One of the prime functions of a banker is lending money. In its business of
lending money, a banker shall acquaint himself with various laws governing
different types of borrowers. The borrowers of a bank may be Individuals,
partnership firms, Hindu Undivided Family, Companies' and other Corporate
entities. This unit deals with various laws that banker should acquaint himself in
his business of lending.
16.2 TYPES OF BORROWERS
Types of borrowers, for the convenience of our study, can be classified as
follows:
1. Individual 2. Partnership Firm
3. Hindu Undivided Family 4. Companies
5. Statutory Corporations 6. Trusts and Co-operative Societies
1. Individual: An Individual borrower is one of the constituents of a bank in its
business of lending. When a banker lends to an individual, he should verify
certain facts, so that the bank's lending is not affected.
One of the essential elements of a contract is the capacity of the parties to
contract. The bank, while lending to an individual should ensure that he is
competent to enter into contract. Money lent to an individual who is not
competent to contract cannot be recovered in the following circumstances:
(i) If an individual is a. minor: A person who has not attained the age of eighteen
years under Indian Majority Act and twenty-one years if he is a ward, under the
Guardians and Wards Act, is considered a 'Minor' in the eyes of law. Under the
law a 'minor' is not competent to contract. Therefore, if a banker lends money to
a minor, then the same, cannot be recovered, if the minor fails to repay.
Exceptions:
The only exception recognised in a contract with a minor is of supply of
necessities to him. If a bank lends money to a minor to meet the expenses for
purchasing necessities of life, then bank can recover the money from the estate
of the minor.
(ii) If an individual is not of sound mind: If a person is not of a sound mind, then
he is incompetent to enter into a contract. The Contract Act says that a person
will be considered not of sound mind if, at the time when he makes the contract,
he is not capable of understanding it and of forming a rational judgement as to
its effect upon his interests.
Notice that a contract entered, would be invalid if proof is shown that the
borrower at the time of entering into contract was not in sound state of mind and
could not understand what he was doing and could not understand the
implications of entering into contract.
(iii) Disqualified persons: There may be statutory disqualifications imposed on
certain persons in respect of their capacity to contract. For example, a person,
declared as insolvent under the Insolvency Law. As long as the person continues
to be a non-discharged insolvent, he cannot enter into contract. The contracts
entered into by such a person are not enforceable.
175
In our country there are various businesses and economic activities conducted by
a single person which are called sole proprietary concerns. In the eyes of the law
there is no distinction between the assets and liabilities of the person and the
business conducted in the name of the sole proprietor.
2. Partnership Firm: 'Partnership Firm' is another entity with which a banker
deals within the course of his business. The Indian Partnership Act, 1932
governs the 'Partnership Firm'. Section 4 of the Act says, that a partnership is the
relation between persons who have agreed to share the profits of a business,
carried on by all or any of them acting for all. The relationship between the
partners is governed by partnership deed.
Legal position of a partnership
A partnership is not distinct from its partners. Under the law, the name of a
partnership firm, is regarded as an abbreviation of the names of partners. The
Indian Partnership Act, 1932, provides for registration of a partnership and it is
necessary that a banker dealing with a partnership firm should verify as to
whether the firm is registered or not. This would help him know all the names of
partners and their relationship.
Authority of the partners
Section 19 of the Indian Partnership Act, 1932 deals with the implied authority
of a partner as an agent of the firm and Section 22 deals with the mode of doing
acts to bind the firm. In view of the provisions of Sections 19 and 22, it should
be noted that the acts of a partner shall be binding on the firm if they are done:
1. in the usual business of the partnership,
2. in the usual way of the business, and
3. as a partner, i.e. on behalf of the firm and not solely on his own behalf.
Business of partnership firm; How is it done?
In the case of a partnership firm, rights and duties of the partners are determined
by the deed of partnership. It provides for opening of bank accounts, borrowing
powers, signing of cheques, etc. Generally, there may be a managing partner
who conducts the business on behalf of the other partners. A banker dealing with
a partnership firm, should ensure that the business is conducted as per the
partnership deed. If the managing partner does not have the powers to conduct
certain transactions then, it should be ensured, that consent of all partners are
obtained.
Partnership firm and transactions in immoveable property
Section 19 of the Indian Partnership Act, 1932 states that a partner cannot affect
the transfer of immoveable property of the firm unless expressly authorised. A
banker taking a mortgage security of firm's immoveable property should ensure
that the partner who is creating the mortgage is expressly authorised to create the
mortgage. If the partner, has no authority to create the mortgage, then the banker
should ensure that all the partners jointly create the mortgage.
Insolvency of the firm
The banker, on receiving notice of insolvency of the firm, must immediately
stop any further transactions in the account irrespective of the fact that the
account is in credit or debit. In case there is a credit balance, and the banker does
not intend to set off the same against the dues in any other account, then the
balance has to be handed over to the official receiver appointed by the Court or
as directed by the Court. In case the account is in debit then the banker would be
required to prove his debt before the Court and thereafter will be entitled to
receive the same from the Official Receiver either in full or as per the dividend
declared by the Courts.
176
Insolvency of the partner
If at the time of insolvency of one of the partners, the firm's account is in credit
then the other partners can operate the same, but the banker should obtain a fresh
mandate and all previous cheques issued by the insolvent partner may be paid
provided the other partners confirm the same. In case, the account is in debit
then further transactions in the account should be stopped so that the rule in
Clayton's case does not apply.
Death of a partner
In case of death, the principles as stated in Insolvency of a partner applies. Since
the death of a partner dissolves the partnership firm, upon receipt of such
information, banks are required to stop the transactions of the firm in a running
credit facility like cash credit, overdraft to crystllise the liability of the deceased
partner and make his/her estate liable for its dues. Banks allow the transactions
in a separate account so that the business of the firm is not adversely affected.
3. Hindu Undivided Family: 'Hindu Undivided Family' otherwise known as
'Joint Hindu Family' is a creature of Customary Law among Hindus and is
governed by personal laws. In Bengal and other parts of erstwhile Bengal
province, a Hindu Undivided Family is governed by Dayabhag Law. In other
parts of India, it is governed by Mitakshara Law.
Constitution of a Joint Hindu Family
A joint Hindu Family consists of male members descended lineally from a
common male ancestor, together with their mothers, wives or widows and
unmarried daughters bound together by the fundamental principle of family
relationship which is the essence and distinguishing feature of institution. The
Joint Hindu Family, is purely a creature of law and cannot be created by an act
of parties.
Law governing Joint Hindu Family
Joint Hindu Family is governed basically by two schools of thought. They are
Dayabhag and Mitakshara schools.
The law governing Joint Hindu Family is codified under Hindu Code and now,
succession among Hindus is governed by the Hindu Succession Act, 1956.
Though Hindu Code changed the law applicable to Hindus substantially, the
spirit of joint family concept is retained; Women are also made members of the
Family as its male members. It is to be noted that a woman member also inherits
properties at par with a male member and is treated as co-parceners.
Management of business of a Joint Hindu Family
In a Joint Hindu Family, for as long as members remain undivided, the senior
most male member of the family is entitled to manage the family properties. He
is called 'Manager' or 'Karta' of the joint family.
In a Hindu Family, the 'Karta' or Manager, occupies a position superior to that of
the other members insofar as he manages the family property or business or
looks after the family interests on behalf of the other members. The managership
of the joint family property comes to a person by birth and he does not owe his
position as manager on the consent of other co-parceners. The liability of the
'Karta' is unlirftited, whereas the liability of the co-parceners is limited to their
shares in the joint family estate.
Powers and duties of the manager
A manager or 'Karta' of a joint family has the following powers and duties:
177
Powers
(a) Right to possession and management of the joint family property
(b) Right to income from the joint family property
(c) Right to represent the joint family
(d) Right to sell the joint family property for family purpose.
Duties
(a) Duty to run the family business and manage the property for the benefit
of the family
(b) Duty to account for the income from the joint family business and
property.
Banker and his dealings with joint family
(a) A banker dealing with a Hindu Undivided Family, should know the
'Karta' of the family.
(b) Banker should ensure that 'Karta' of the joint family deals with the bank
and borrows only for
the benefit of joint family business.
(c) The application to open an account must be signed by all the members
and all adult members
should be made jointly and severally liable for any borrowings or if the account
gets overdrawn.
4. Companies: A company is another type of borrower, which a banker deals
with in his business of lending. A company is a juristic person created by law,
having a perpetual succession and Common seal distinct from its members. A
company, depending upon its constitution is governed by various laws.
Basic laws governing company
In India, companies are governed by the Companies Act, 1956. Companies as
per the Companies Act, 1956 are required to be registered under the Act. Section
11 of the Companies Act provides that an association or partnership consisting
of more than ten in the case of banking business and more than twenty in the
case of other business, shall be registered under the Companies Act. If not
registered, the said association or partnership will be illegal.
Incorporation of company
Section 12 of the Companies Act, 1956 provides that any seven or more persons
or where a company formed is a private company, any two or more persons can
form a company, by subscribing their names to the Memorandum of
Association.
Requirements of forming a company
The business and objects of a company and the rules and regulations governing
its management are known by two important documents called 'Memorandum of
Association' and 'Articles of Association'. Therefore, for the formation of a
company these documents are essential. What is Memorandum of Association?
The memorandum of association is the charter of the company. Its purpose is to
enable the shareholders, creditors and those dealing with the company to know
its permitted range of business.
Memorandum of Association of a company contains the following details among
others:
(a) Name of the company
(b) State in which the registered office of the company is to be situated
(c) Objects of the company
(d) Liability of the members and
(e) Share capital and its division.
What is Articles of Association?
Articles of Association are rules and regulations governing the internal
management of the company.
178
They define the powers of the officers of the company. Articles of Association
are subordinate to Memorandum of Association and it contains the following
details among other things:
(a) Number of directors of the company
(b) Procedure for conducting meetings of the shareholders, board of
directors, etc.
(c) Procedure for transfer and transmission of shares
(d) Borrowing powers of the company
(e) Officers of the company and other details.
Types of companies
(a) Private company: According to the Section 3(1) (iii) a private company
is one which contains
following provisions in its Articles of Association:
(i) Restrictions on the right to transfer its shares
(ii) Limitation on number of members to fifty, excluding the people, who are
employees
and ex-employees of the company (iii) Prohibition as to participation by general
public in its capital requirements.
(b) Public company: A public company is one, which is not a private
company. That is, a
public company does not have any restrictions of the private company and its
main features
are as follows:
(i) Shares are freely transferable
(ii) No restriction on number of members
(iii) Public at large can participate in its share capital.
The public companies can be further classified as:
(i) Limited liability company (ii) Unlimited liability company (iii) Limited
by guarantee.
It can be seen from the classification itself that in a limited liability company,
liability of the members is limited to their contribution of capital. In the case of
unlimited liability company, the liability of the members is unlimited. In the case
of guarantee companies, the liability of members is not limited to the extent of
the amount guaranteed by them.
(c) Government company: A company in which Central Government or
State Government or
both has not less than fifty-one per cent of the share capital, is called
Government Company.
(d) Other companies: Besides the above, Companies Act, 1956 classifies
companies on the
basis of time, place of incorporation and nature of working of share capital into
the following
categories:
(i) Existing company (ii) Foreign company
(iii) Holding company (iv) Subsidiary company, etc.
(i) Existing Company: A company, already existing before the coming into force
of the
Companies Act, 1956.
(ii) Foreign Company: A company registered in a foreign country, (iii) Holding
Company: A company owning more than fifty per cent of share capital in
another company or a company, which can appoint the majority of directors in
another
company, (iv) Subsidiary Company: It can be seen that when there is a holding
company, the other
company is called a subsidiary company.
We will study in detail in other chapters about incorporation of companies and
the precautions a banker should take while lending to a company.
179
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5. Statutory Corporations: Besides companies registered under the
Companies Act, 1956, there may
be corporations established by an Act of Parliament. These are called 'Statutory
Corporations'. For
example State Bank of India is established under State Bank of India Act, 1955.
Nationalised banks
are established under the Banking Companies (Acquisition and Transfer of
Undertakings) Act,
1970.
These statutory corporations are governed by the Acts under which they were
established. These Acts provide for making rules and regulations by the
Government for the corporation. The Act, rules and regulations define the scope,
objects and range of business of the corporations.
6. Trusts and Co-operative Societies, etc.
(i) Clubs, societies, schools and other non-trading associations: Such bodies, if
not incorporated under the laws governing them, cannot enter into any
transactions. These bodies are usually governed by the Companies Act or the
Co-operative Societies Act and function within the ambit of those laws. For
example clubs can be registered either under the Companies Act, 1956 or under
the Societies Registration Act or the Co-operative Societies Act. In the case of
lending to these bodies, a banker should study the bye-laws, rules and
regulations applicable to them and ascertain the legality of lending to them, (ii)
Trusts: These are governed by the Indian Trusts Act, 1882, if they are private
trusts and by Public Trusts Act if they are public trust, or Religious and
Charitable Endowments Act, if they are trusts of Hindus and in the case of
Muslims they are governed by Wakf Act. A banker dealing with trusts should
acquaint himself with the respective laws applicable to them and should ensure
that his lending is within the ambit of those laws, (iii) Trustee: Trustees manage
trusts. The powers and duties of the trustees are provided in trust deed and are
also regulated by the respective laws applicable to such trusts. For example, in
the case of public trusts, Charity commissioners, or commissioner of
endowments appointed by the Government, have the power to supervise the
activities of the trusts. The trustee of the Muslim Wakf is called Mutawali and
his conduct and functions are regulated by the Wakf Board. Therefore, a banker
dealing with a trust should ensure that all the permission required for taking a
loan is obtained from respective Government authorities.
16.3 LET US SUM UP
As a banker, it is necessary to be aware of the various types of borrowers and the
laws applicable along with the precautions to be taken while dealing with them.
Borrowers can be broadly classified in the following categories: individuals,
partnership firms, Hindu Undivided Family, companies, statutory corporations,
trusts and co-operative societies. The laws applicable to all these different kinds
of borrowers are different. Individuals are governed by the Indian Contract Act,
partnership firms by the Indian Partnership Act, Hindu Undivided Family by the
customary law pertaining to Hindus, companies by the Companies Act, statutory
corporations by the Acts that created them, trusts by the Indian Trusts Act,
Public Trusts Act, Religious and Charitable Endowments Act, Wakf Act and co-
operative societies by the Co-operative Societies Act or the Societies
Registration Act. .
16.4 KEYWORDS
Memorandum of Association; Articles of Association; Company; Hindu
Undivided Family (HUF); Partnership; Trustee.
ms
L.R.A.B-13
180
16.5 CHECK YOUR PROGRESS
1. Fill in the blanks.
(a) (b) (c) (d)
(e) (f) (g) (h)
(i)
Individual borrowers are governed by the Act.
In a Hindu undivided family the business of the family is managed by
A company is and from its members.
number of members and a maximum
A Private Limited Company has minimum
of numbers of members.
transferable.
A Public Limited Company shares are
Statutory corporations are established by Acts of
Private trusts are governed by the Act.
Act. Act.
Trusts of Hindus are governed by the _ Trusts of Muslims are governed by the
16.6 ANSWERS TO CHECK YOUR PROGRESS'
1. (a) Indian Contract; (b) Karta; (c) separate and distinct; (d) 2, 50; (e) freely;
(f) Parliament; (g) Indian Trusts Act; (h) Religious and Charitable Endowments
Act; (i) Wakf.
um
TYPES OF CREDIT FACILITIES
:nt;
STRUCTURE
17.0 Objectives
17.1 Introduction
17.2 Types of Credit Facilities
17.3 Cash Credit and Overdraft
17.4 Term/Demand Loans
17.5 Bill Finance
17.6 Let Us Sum Up
17.7 Check Your Progress
17.8 Answers to 'Check Your Progress'
182
17.0 OBJECTIVES
After studying this unit, you should be able to understand:
• various types of credit facilities and the laws governing them;
• laws affecting credit facilities granted by the bank.
17.1 INTRODUCTION
Lending is a principal activity of a bank. The advances portfolio of a bank
indicates its dynamic perso¬nality. A banker to grow in the business of banking
should have a thorough knowledge of the requirements of his customer and
should be in a position to cater to the needs of the customer. It is common
know¬ledge that a bank's existence depends on its customer's need to borrow. A
banker should be in a posi¬tion to identify the needs of the customer for funds
and mould the lending tool, according to the requirements of the customer
conforming to the laws of the land. Therefore, a banker for his success as a
lender is required to acquaint himself with various types of credit facilities that
are presently in vogue in business of lending and shall understand the legal
relationship existing under different credit facilities. In this unit, we will study
different types of credit facilities and their legal aspects.
17.2 TYPES OF CREDIT FACILITIES
We have seen earlier that the primary business of a bank is lending. The business
of lending is carried on by the bank by offering various credit facilities to its
customers. We can classify the credit facilities into 'Fund' based credit facilities
and 'Non-Fund' based credit facilities and customised credit facilities in the case
of special constituents. We know that Nationalisation of Banks ushered in a new
concept in bank's lending and added a dimension of social banking to business
of lending by banks. Basically various credit facilities offered by banks are
generally repayable on demand. That being the case, a banker, to ensure proper
recovery of funds lent by him, should acquaint himself with the nature of legal
remedies open to him and law affecting the credit facilities provided by him.
Credit facilities are broadly classified into two types based on funds outflow;
they are:
1. Fund based credit facilities
2. Non-fund based credit facilities
1. Fund Based Credit Facilities: Fund based credit facilities involve the
outflow of funds meaning
thereby, the money of the banker is lent to the customer. They can be generally
of following types:
(a) Cash credits/overdrafts (b) Term loans/Demand loans
(c) Bill finance
2. Non-Fund Based Credit Facilities: In this type of credit facility the
bank's funds are not directly
lent to the customer and they include:
(a) Bank guarantee (b) Letter of credit facility
(c) Acceptance facility
These have already been dealt with elaborately in other units and hence, are only
outlined here.
17.3 CASH CREDIT AND OVERDRAFT
A cash credit or overdraft is an arrangement by which a banker allows his
customer to borrow money up to a certain limit. This is the most popular mode
of borrowing by the large commercial and industrial concerns in India, on
account of the inherent advantage. A customer need not borrow at once, the
183
whole of the amount up to the limit as the same may not required from day one,
but can draw such amounts as and when required.
Cash credit/overdraft is a contract of a loan between a bank and its borrower.
The contract of cash credit or overdraft can be express or implied.
In the case of Bank of Maharashtra vs United Construction Co. & Others
(1986),[ 60 Compo Cases 163 (Bom).] a customer overdrew his account. There
was no written contract for an overdraft. The bank demanded repayment of the
moneys overdrawn with interest. The customer refused to pay interest. The bank
therefore, filed a suit for recovery of the monies overdrawn with interest. The
Bombay High Court held that there is no need for express contract for an
overdraft and directed the borrower to repay the moneys with interest as there is
an implied contract of an overdraft.
Rule in Clayton's Case
The credit facility, given in the form of a cash credit/overdraft is operated
normally, through a running account opened and kept by the customer.
Whenever a customer withdraws money, the account being debited for the
amount and whenever the customer pays, the account being credited. Under the
law, each item of debit forms a separate loan and each credit as a repayment of
the earliest debits. This aspect of discharge of the debit items by subsequent
credits was first enunciated in a case, called the Clayton's case. In that case, the
Courts held that the first sum of money paid into the account, is deemed to repay
the first item recorded on the debit side of the account. For example, if there are
two items on the debit side of the customer's current account. A debit of Rs.
1,000 on 3 March and Rs 500 on 6 March, in a year and the borrower pays Rs.
750 on 12 March; the sum will be appropriated first, by reducing the earlier debit
of Rs. 1,000 rather than discreating a charge the later debt of Rs. 500. This
creates problems for recovery for the bank. Hence, the bankers, to avoid the rule
in the Clayton's case agree on the method of appropriation and treat all debits as
one debt.
Bank not to Terminate Overdraft Facility without Notice
Once a bank grants an overdraft facility, then there is a contract between the
bank and the customer that is not be cancellable unilaterally. The Gujarat High
Court vs Indian Overseas Bank considered this in M/s Narain Prasad Govindlal
Patel (AIR 1980 Guj 158). In this case, a firm was enjoying temporary overdraft
facility to a limit of Rs. 5,000 with the bank, for a period of four years. No
document was executed nor was any security furnished. The bank unilaterally,
without notice, terminated the facility with the result that a cheque drawn by the
firm was dishonoured by the bank on the ground that there was insufficient
balance in the account. The firm claimed damages for wrongful dishonour of the
cheque. Both the Trial Court and the Appellate Court allowed the claim of the
firm. A further appeal by the bank to the High Court was dismissed, in which the
High Court observed:
The bank grants overdraft facility in order to earn interest. Its constituents enjoy
the overdraft facility in order to develop their business. Therefore, both are
deeply interested in such an arrangement. Such an arrangement - euphemistically
called by Mr Chhatrapati as a facility - is nothing but a contract. The contract, if
it is well settled, can be inferred from the conduct of the parties. The enjoyment
of overdraft facility for a period of four years unfailingly points to the conduct of
the bank.
A temporary overdraft facility is not one, which can be terminated unilaterally at
the sweet will of the bank without giving its constituent a notice thereof. It is
temporary because, it is not intended to be a permanent and everlasting
arrangement. Sometimes, a constituent is required to square up his account at the
end of every half financial year - 30 June and 31 December. Merely because, the
overdraft is called temporary overdraft, it does not militate against the plaintiff
drawing a cheque upon the bank in favour of its constituent and in getting it
honoured by the bank.
184
11
17.4 TERM/DEMAND LOANS
Term/Demand loans are granted to customers generally for meeting the capital
expenditure needs of the business. Term loans are granted in one lump sum and
are allowed to be repaid over a period in instalments the schedule of which is
specified in the agreement itself. Demand loans are those which are repayable on
demand through a repayment schedule is agreed upon by the bank. Term loans
on the basis of period of repayment are further classified into:
(i) Short-term Loans, (ii) Medium-term Loans, (iii) Long-term Loans.
Short-term loans are loans that are repayable within one year, medium-term
loans within two to seven years and long-term loans above seven years periods.
Banks normally grant the short-term and medium-term loans. The development
financial institutions usually grant long-term loans. Banks in certain cases like
housing loans sanction long-term loans which are repayable over longer period
of 20-25 years.
Law relating to term loans
Term loans are governed by the agreement entered into between the parties. The
loan agreement provides for various eventualities and contains details of the
loan, repayment or amortisation schedule and other obligations of the borrower
like payment of interests, costs and expenses, etc. We will now consider a case
decided by High Court in respect of term loans.
(i) Acceleration of Repayment: P.K. Achuthan vs State Bank of Travancore
1974 K.L.T. 806
(FB): A question that came for a decision in this case was, whether a provision
in the hypothecation bond to the effect that on a default of the borrower in
paying any of the instalments, the lender would be entitled to recover the whole
of the debt due, inclusive of the future instalments in one lump sum is legal. The
Kerala High Court held that where the contract provides for repayment of money
in instalments and also contains a stipulation that on a default being committed
in paying any of the instalments, the whole sum shall become payable, then the
lender would be entitled to recover the whole sum inclusive of future
instalments.
(ii) Time within which a suit for recovery shall be filed: We have seen earlier
that in the case of term loans, periodical repayment in instalments is allowed. In
the event of a default in payment of instalments, the bank can institute a suit for
recovery of the unpaid instalment. Besides, the bank is entitled to wait until the
due date of the last instalment and then institute a suit for recovery of whole
amount. The limitation period for filing a suit in the case of term loans is three
years from the date of default of a particular/specific instalment. However, if by
doing so the time limit gets over in case of some earlier defaulted instalments,
bank looses its right against such unpaid instalments. In the case of a demand
loan the time limit is three years from the date of default.
17.5 BILL FINANCE
Bill finance is also one of the important facets of lending by banks. Generally,
the bill finance is conducted through discounting of bills of exchange drawn by
the borrower or third persons on the customers of borrower. The methods of bill
finance, depending upon payment obligations incurred by the bank, can be
classified into:
(i) Bill discounting and bills purchase; (ii) Drawee bill acceptance;
(iii) Bills co-acceptance.
In all these cases, the banker undertakes an obligation and depending on the
nature of bill finance, the first two are fund-based facilities and the last is a non-
fund based facility.
This subject has been dealt with in more detail in the chapter of 'Law Relating to
Bill Finance'.
185
Non-Fund Based Facilities
In the business of lending, a banker also extends non-fund based facilities. Non-
fund based facilities do not involve an immediate outflow of funds. The banker
undertakes a risk to pay the amounts on happening of a contingency. Non-fund
based facilities can be of following types among other:
(a) Guarantee facility; (b) Letter of credit facility;
(c) Underwriting and credit guarantee.
(a) Guarantee facility: The banker in his business of lending extends various
facilities to its constituents.
Under this facility, the bank undertakes to discharge the liability of the borrower
to third parties.
The nature of guarantees includes; performance guarantees, deferred payment
guarantees, advance
payment guarantees, guarantees to Government departments, etc.
(b) Letter of credit facility: Letter of credit or documentary credit facility is
another non-fund based
facility extended by the bankers to their constituents. Under this facility the
banker undertakes to
pay on presentation of documents of title to goods. The banks generally adopt
the Uniform
Customs and Practices relating to Documentary Credits 600 (UCPDC 600)
framed by International
Chamber of Commerce which defines the obligations and rights of the parties
w.e.f. 1 July 2007.
(c) Underwriting and credit guarantee: Besides the above non-fund based
facilities, some banks also
do underwriting and credit guarantee business. The risk under this activity
involves the obligation
of the banker to provide funds or pay, in the event of the failure of the borrower
to raise moneys,
or to repay moneys. After the advent of merchant banking, this type of lending
by commercial
banks is on the decline.
(d) Derivative products: In addition to the above traditional non-fund
facilities, banks are now
increasingly offering the derivative products to their clients to enable them to
hedge their currency
and interest rate risks.
Other credit facilities
A banker besides extending fund based and non-fund based credit facilities, also
extends various other miscellaneous credit facilities depending upon the
constitution of the borrower. For example, in the case of individual borrowers,
many of the banks are extending, personal loans for purchase of a house, car,
and other consumer durables. This type of lending, otherwise called 'Consumer
Credit' has become very popular these days and contributes significantly to the
profitability of the bank's business.
17.6 LET US SUM UP
1. Credit facilities are mainly classified into:
(i) Fund based facilities (ii) Non-fund based facilities
2. Fund based facilities, among other things, include:
(i) Cash credits/Overdrafts (ii) Term loans
(iii) Bill finance
3. Non-fund based facilities, among other things, include:
(i) Bank guarantee (ii) Letter of credit facility
4. Under customary law of bankers, interest can be charged on the
temporary overdrafts granted.
5. As per rule, in the Clayton's case each credit discharges the earliest of
the debit entries.
6. Term loans based on period of repayment are classified into:
(i) Short-term loan (ii) Medium-term loan
(iii) Long-term loan
186
17.7 CHECK YOUR PROGRESS
1. Cash Credit facility is a
2. Bills co-acceptance facility is a .
3. Banker is entitled to charge interest on temporary overdraft under
.
4. Limitation period for filing a suit in term loans isyears from the date of
default of
instalment.
5. Period of repayment in the case of medium-term loan is .
17.8 ANSWERS TO 'CHECK YOUR PROGRESS'
1. Fund based facility; 2. Non-Fund based facility; 3. Banking custom; 4. 3
(Three); 5. 5-7 years.
SECURED AND UNSECURED LOANS, REGISTRATION OF FIRMS,
INCORPORATION OF COMPANIES
STRUCTURE
18.0 Objectives
18.1 Introduction
18.2 What are 'Unsecured Loans' and 'Secured Loans'?
18.3 Why a Secured Loan?
18.4 Registration of Firms
18.5 Consequences of Non-registration of Firm
18.6 Incorporation of a Company
18.7 Let Us Sum Up
18.8 Check Your Progress
18.9 Answers to 'Check Your Progress'
188
18.0 OBJECTIVES
After studying this unit, you should be able to understand:
• what is a secured and unsecured loan;
• the law governing bankers' securities;
• the procedure for registration of firms and incorporation of companies.
18.1 INTRODUCTION
In the earlier units, we have studied about type of borrowers, credit facilities and
the laws governing them. In this unit, we will endeavour to understand the
securities for bank's lending business, legal status of a banker in the case of
unsecured loans, and more about law relating to partnership firms and
companies, their registration and incorporation.
18.2 WHAT ARE 'UNSECURED LOANS' AND 'SECURED LOANS'?
Unsecured Loans
Most of the loans granted by banks in India are generally secured by tangible
security being assets purchased out of the bank funds and/or some valuable
collateral such as bonds, shares and merchandise deposited either in the bank's
godowns or in the godowns of the borrowers under agreement of hypothecation,
and immoveable property, but occasionally loans are granted even without any
security.
An unsecured loan is one for which the banker has to rely upon the personal
integrity of the borrower. The chief basis of such transactions is the personal
credit or credit worthiness of the customer. In other words, 'creditworthiness' is
the confidence of a banker on the future solvency of a person or his future
financial strength, which enables him to take a loan at present and pay it in
future. All unsecured loans, otherwise called clean loans are dependent on the
borrower's financial strength to pay in future.
Secured Loans
Secured loans are the antithesis to unsecured loans. These loans are given by a
banker not merely based on his confidence on the borrower's future financial
strength but also based on his present net worth that he is able to give a banker to
rely upon and recover the moneys lent in the event of his failure to repay the
loan in the ordinary course. We will elaborate it a little further. In the case of
secured loans, a banker besides verifying the future solvency of the borrower
asks for the charge over property of the borrower so that in the event of failure
by the borrower to repay, the banker can sell the property of the borrower
charged to him and recover the moneys.
18.3 WHY A SECURED LOAN?
We have seen the difference between an unsecured loan and a secured loan. It
would be relevant to know why a 'secured loan' is preferred over 'unsecured
loan'. It is common knowledge that lending by a banker is generally for the
economic activity of the borrower and recovery of loans given by a banker is
mostly dependent on the economic success of the borrower. Success or failure of
an economic activity depends on various macro and micro economic factors. A
banker lending to a customer can assess only the existing macro and micro
economic factors and can only predict success or failure of the borrower's
activity in the future reasonably. A banker cannot be absolutely certain about the
recovery of the amounts lent, if he solely relies on the economic success of the
borrower. Therefore, a banker asks for further security in form of a charge on
property of the borrower. The charge created over the property of the borrower
acts as cushion to absorb the shocks of economic failure of the borrower as the
banker can safely sell the properties charged to him and recover the moneys lent.
This is the primary reason for preference of secured loans over unsecured loans.
18.4 REGISTRATION OF FIRMS
We have in an earlier unit, dealt with borrowers who are 'Partnership Firms' and
governed by the Indian Partnership Act, 1932. In this unit, we shall study the law
relating to registration of partnership firms.
Registration
It is in the interest of the partners themselves to have their firms registered under
the Partnership Act. The procedure for the registration of firms and other
incidental matters has been dealt in Sections 56 to 68 of the Unit VII of Indian
Partnership Act, 1932.
For registration, an application is to be submitted to the Registrar of Firms of the
area in which any place of business of the firm is conducted, with a statement in
the prescribed form and accompanied by the prescribed fee, stating
(a) name of the firm,
(b) place or principal place of business of the firm,
(c) names of any other place where the firm carries on business,
(d) date of joining of each of the partners,
(e) names in full and permanent addresses of the partners,
(f) duration of the firm-length of time for which the firm wants/proposes to
conduct the business.
We have to note that the Act contemplates registration of firms, not the
registration of partnership deed. The registration of the firm is optional and not
compulsory. So a mere non-registration would not affect the carrying on
business and giving effect to partnership deed.
When the Registrar is satisfied that the provision of Section 58 has been duly
complied with, he will record an entry of the statement in the register called the
Register of Firms. In addition to making the necessary entries in the Register of
Firms, he is required to file the original of every statement submitted to him. The
original statement and all subsequent statements and notices will be filed
together so that all original papers relating to any firm will be conveniently
found together in one file. Note that the registration of the firm takes place only
when the Registrar makes the necessary entries in the Register of Firms under-
Section 59. In other words, a firm is deemed to be registered only when the
certificate of registration is granted.
Alterations
Rules relating to alterations are provided in Section 60 which reads:
1. When alteration is made in the firm's name or in the location of the
principal place of business of a
registered firm a statement may be sent to the Registrar accompanied by the
prescribed fee,
specifying the alteration and signed and verified in the manner required under
Section 58.
2. When the Registrar is satisfied that the provisions of the sub-Section (1)
of the Section 60 has been
complied with, he shall amend the entry relating to the firm in the Registrar of
Firms in accordance
with the statement and shall file it along with the statement filed under the
Section 59. There is no
time limit fixed as to when notices of alterations have to be given.
Section 61 provides that when a registered firm discontinues business in any
place or begins to carry on business at any place, such a place, not being its
principal place of business, any partner or agent of the firm, may send an
intimation thereof 'to the Registrar', who shall make a note of such an intimation
in the entry relating to firms in the Registrar of Firms and shall file the
intimation along with the statement relating to firm filed under Section 59.
Similarly, when any partner in a registered firm, alters his name or permanent
address, an intimation of the alteration may be sent by any partner or agent or
firm to the Registrar, and he shall deal with it in the manner nrnv
;« c—
I
ib'U
Section 63 provides for the recording of a change in and the dissolution of a firm
and also the recording of withdrawal of a minor.
There is no particular form of notice. If substantial compliance has been made
with the provision that would be sufficient for the purpose of the section.
Rectification of Mistake
The Registrar has power at all times to rectify any mistake so as to bring the
entry in the Register of firms relating to any firm in conformity with the
documents relating to that firm already filed with him.
The Registrar may also rectify any mistake on the application made by the
parties who had signed the document. However, this power is not a general
power, but limited to rectifying the mistakes to bring the entry in conformity
with the document filed by the partners or their agents. If there is an omission in
the mention of one of the places of business of the firm, the omission is capable
of rectification under this provision. Moreover, this omission does not affect the
registration; similarly, if certain persons are wrongly noted in the Register, this
is a mistake which can be rectified under this provision.
Amendment of Register by Court's Order
Provision is made for a Court deciding any matter relating to a registered firm
may direct the Registrar to make any amendment in the entry in the Register of
Firms relating to such firms which is consequential upon its decision, and the
Registrar shall amend the entry accordingly.
Inspection
The Register of Firms, the statements, notices and intimations filed with the
Registrar are open to inspection by any person on payment of a prescribed fee.
Copies
Similarly, any person can obtain a copy of any entry or portion in the Register of
Firms by making an application to the Registrar and paying prescribed fee.
Evidentiary Value
Section 68(1) provides, any statement, intimation or notice recorded or noted in
the Register of Firms shall, as against any person by whom or on whose behalf
such statement, intimation or notice was signed is conclusive proof of any fact
stated therein.
Penalty
Section 70 provides that any person who signs any statement, amending
statement, notice or intimation under the Unit VII of the Partnership Act
containing any particulars, which he knows to be false or does not believe to be
true or containing particulars which he knows to be incomplete or does not
believe to be complete, shall be punishable with imprisonment which may
extend to three month, or with fine or both.
18.5 CONSEQUENCES OF NON-REGISTRATION OF A FIRM
Section 69 of Indian Partnership Act, 1932 sets out the effect of non-registration
of firm and may be conveniently studied under the following four heads:
(i) suits by partners inter se (ii) suits by a firm against third parties
(iii) exceptions (iv) non-application of provisions to certain suits,
(i) Suits by Partners Inter se: If a firm is not registered under the Indian
Partnership Act, then no suit to enforce a right, arising from a contract or
conferred by the Partnership Act, shall be
)rding n that
ter of i him.
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191
instituted in any Court, by or on behalf of any person suing as a partner in a firm
against the firm or against any other partner of the firm. This prohibition applies
to the claim of set off or other proceeding to enforce a right arising from a
contract.
The Supreme Court in the case of Loon Karan Sethia (AIR 1977 SC 336) has
held that this provision for registration is mandatory in character and its effect is
to render a suit by the plaintiff in respect of a right vested in him or required by
him under contract, which he entered into as a partner of a unregistered firm,
whether existing, or dissolved as void. In other words, a partner of an erstwhile
un-registered partnership firm cannot bring a suit to enforce a right arising out of
a contract falling within the ambit of Section 69 and simply by making an
application for registration before instituting a suit is also not sufficient.
(ii) Suit by a Firm Against Third Parties: No suit to enforce a right arising from a
contract can be instituted in any Court, by or on behalf of a firm against any
third party, unless the firm is registered and the persons suing or have been
shown in the Register of Firms as partners in the firm. This provision also
applies to a claim of set off or other proceeding to enforce a right arising from a
contract.
Before the bar of the Section 69 can be invoked there should be clear evidence
that the plaintiffs were partners as defined in the Section 4 of the Act and the
loose use of the term 'partnership' on a firm would not by itself establish that the
plaintiffs were partners in the true sense of the term. Moreover, the burden of
proof would be on the defendant.
The bar under this section applies to rights arising out of a contract only and not
in respect of other rights as the sub-Section (i) above. Some of the illustrations
of such rights are: the right to enforce a contract embodied in a negotiable
instrument, right to eject a landlord, right to determine the liability of the
landlord, etc.
Section 69(2) requires that the person serving must have been shown in the
Register of Firms as a partner, but the mode of proof of that fact is not in
anyway restricted.
(iii) Exceptions: Sub-Section (3) of the Section 69 provides for two exceptions:
(a) The enforcement of right to sue for dissolution of a firm, or for accounts
of a dissolved firm
or any right or power to realise the property of the dissolved firm.
(b) The powers of an official assignee receiver or Court, under the
Presidency Towns Insolvency
Act, 1909 to realise the property of an insolvent partner.
(iv) Non-application of Section 69: Certain Suits: Sub-Section (4) of Section 69
provides that the Section 69 shall not apply
(a) to firms to which the Act extends or whose places of business in the said
territories are
situated in areas to which, by notification under the Section 56 Unit VII of the
Partnership
Act does not apply; or
(b) to any suit or claim of set off not exceeding Rs. 100 in value which,
according to the
Presidency Towns is not of a kind specified in the Section 19 of the Presidency
Small Cause
Courts Act, 1882, or outside the presidency towns, is not of the kind specified in
the second
Schedule to the Provincial Small Cause Courts Act, 1887, or to any proceedings
in execution
or other proceeding incidental to or arising from any such suit or claim.
The bar does not apply to suits of Small Cause nature, value of which not
exceeding Rs. 100. But when a suit or cross-objection is not cognisable either by
the Presidency Court of Small Causes or by the Small Causes Court, the Section
69(4)(b) will not apply even though the relief for accounts may be value at Rs.
100.
192
18.6 INCORPORATION OF A COMPANY
We have seen in the earlier units that among others 'company' is also one of the
borrowers of a banker. We have also studied briefly the law governing
companies. In this unit, we will study the law relating to companies and their
incorporation.
1. Company - Meaning and Characteristics: A company is an artificial person,
since it is created by law. It is clothed with many of the rights, liabilities, powers
and duties prescribed by law. Among the two most important characteristics of a
company, one is its separate individuality and the other is perpetuity within the
limits prescribed by law. It can do all acts as a natural person may do.
A company has a 'Corporate Personality' separate from all the members who
have formed it unlike a partnership firm. Because of this, a company incurs all
the liabilities and possesses all rights of a natural person subject to the regulation
of law. The classical judgement of the House of Lords in Salomon vs. Salomon
& Co. Ltd. (1897) AC 22 lays down the principle of 'corporate personality'.
The facts of this case are that one Mr. Salomon who was individually carrying
on the business of boot and shoe manufacture, incorporated a company named
'Salomon & Co. Ltd.' which consisted of seven of his family members. This
company took over the personal business assets of Mr. Salomon for 38,782
pounds and in turn Mr. Salomon took 20,000 shares of one pound each and
debentures worth 10,000 pounds, for which there was a charge on the company's
assets and balance in cash.
All his family members took one share of a pound each. The company later went
into liquidation and various unsecured creditors contended that Mr. Salomon
could not be treated as a secured creditor of the company in respect of
debentures held by him. The House of Lords after hearing the arguments held
that:
The company is by law a different person altogether from its shareholders and
though it may be that after incorporation, the business is precisely the same as it
was before and the same persons are managers and the same hands receive the
profits; the company is not in law the agent of the shareholders or trustees for
them. Nor are the shareholders liable in any shape or form except to extent and
the manner provided in the Act.
The Salomon Case for the first time authoritatively and clearly established the
fact that a company has its own existence or personality, which is separate and
distinct from its members and as a result a shareholder cannot be held liable for
the acts of the company, even though he holds virtually the entire share capital.
The case also recognised and accepted the concept of limited liability. The legal
status and position of a company has been aptly described by Supreme Court in
Tata Engineering and Locomotive Company Ltd. vs State of Bihar AIR 1965 SC
40 in the following words:
The corporation in law is equal to a natural person and has a legal entity of its
own. The entity of the corporation is entirely separate from that of its
shareholders; it bears its own name and has a seal of its own; its assets are
separate and distinct from those of its members and it can sue and be sued
exclusively for its own purpose; its creditors cannot obtain satisfaction from the
asset of its members; the liability of the members or the shareholder is limited to
the capital invested by them. Similarly, the creditors of the members have no
right to the assets of the corporation.
The main characteristics of a company are summed up as under:
(i) Company is a voluntary association of persons who have come together to
carry on some business
for profit, (ii) It has a perpetual existence and though members may come and
members may go, the company
continues forever. Change in its members or in their identity does not affect the
legal existence or
its identity. Only law can dissolve it, since it is a creation of law.
193
(iii) The shares of joint stock companies are freely transferable and in the case of
a private limited company, the Companies Act has put certain restrictions on the
transferability of shares. Every member who owns fully paid-up shares is free to
dispose of his shares according to his choice but subject to any regulation of the
company. Any absolute bar or restriction on the right to transfer shares is void.
(iv) The member's/shareholder's liability in a company is limited to the extent of
the nominal value of the shares held by them. Under no circumstance, is a
member/shareholder directed to pay anything more than the unpaid value of his
shares. As regards a company limited by guarantee, the members are liable only
to the extent of the amount guaranteed by them and not beyond and that too only
when the company goes into liquidation.
(v) As a corporate person, a company is entitled to own and hold property in its
own name.
(vi) A company being a body corporate can sue and be sued in its own name.
In brief, the most striking features of a company are its distinct legal personality,
the easy transferability of its shares, and the limited liability of its members.
Incorporation of a Company
We shall now in brief understand the various steps to be taken and as to how a
company comes into existence. It is to be noted that at the time of formation of
the company the promoters have to amongst other things decide the following
aspects:
(a) Type of company: Under the Companies Act, 1956 only two types of
companies can be registered,
viz.,
(i) Public companies (ii) Private companies.
These companies may further be classified as follows:
(i) Companies limited by shares
(ii) Companies limited by guarantee with or without share capital and (iii)
Unlimited companies with or without share capital.
(b) Name of company: A company is identified by the name under which it
is registered. According
to Section 13 of the Act, the Memorandum of Association of a company should
state the name of
the company. To avoid delay and to afford flexibility to the Registrar to decide
the availability of
names the promoters are required to submit at least three suitable names in the
order of preference.
The name of a company must necessarily end with the word 'limited' in the case
of a public
company and the words 'private limited' in case the company is a private
company. In case of a
Section 25 Company, the inclusion of the word 'limited' can be dispensed with
by obtaining a
licence from the Regional Director. Section 20 prohibits the registration of a
company, the name
of which is undesirable or which is identical with or too nearly resembles the
name of an existing
company. A company will not be permitted to use a name which is prohibited
under the Emblems
and Names (Prevention of Improper Use) Act, 1950.
The Registrar is required by law to make preliminary enquiries so as to ensure
that the name permitted by him will not be misleading or is not intended to
deceive with reference to its objects clause.
(c) Memorandum of Association: The memorandum of association is the
constitution of a company
and amongst other things, defines the area withiirwhich the company can act. It
is, therefore,
necessary to state the object for which the company has been formed, the various
businesses that
it can undertake, the liability of its members, etc. For a banker it is absolutely
essential to verify
the memorandum and ensure that the business undertaken by the company is
within its objects,
if not, any loan made to the company would not be recoverable.
194
(d) Articles of Association: The other important document of a company is
the articles of association,
which contains the rules and regulations relating to the internal management of a
company.
Section 15 of the Companies Act stipulates that every memorandum should be
signed by each
subscriber who should add his address, description and occupation, if any, in the
presence of at
least one witness who shall attest the signature and shall likewise add his
address, description and
occupation, if any. As regards companies having a share capital the subscribers
to the memorandum
should at least take one share each and they have to state clearly the number and
nature of the
shares taken by them.
The articles of association should similarly be signed separately by persons
subscribing to the same. The signatures of the subscribers in the Articles of
Association are also to be attested by a witness.
(e) Preparation of other documents: The promoters forming the company
are also required to submit
various other forms and documents prescribed under Companies (Central
Governments' General
Rules and Forms) Act, 1959.
(f) Payment of registration fees: The fee prescribed for registration of a
company is required to be
paid the quantum of which depends on the nominal capital of the company to be
incorporated in
the case of companies having share capital.
(g) Certificate of Incorporation: Once all the formalities as detailed above
are satisfied, the promoters
are entitled to get from the Registrar of Companies the certificate of
Incorporation. Section 33(3)
of the Companies Act states that if the Registrar is satisfied that all the
requirements, as stated
above have been complied with by the company and that it is authorised to be
registered under the
Act, he shall retain and register the memorandum, articles, if any. On the
registration of the
memorandum of a company the Registrar shall certify under his hand that the
company is
incorporated and, in the case of a limited company that the company is limited.
From the date of
incorporation mentioned in the certificate of incorporation, such of the
subscribers of the
memorandum and other persons, as may from time to time be members of the
company, shall be
a body corporate by the name contained in the memorandum, capable forthwith
of exercising all
the functions of an incorporated company and having perpetual succession and a
common seal,
but with such liability on the part of the members to contribute to assets of the
company in the
event of its being wound up as mentioned in the Act (Section 34).
Certificate of Incorporation: Conclusive Evidence
Section 35 of the Act states that a certificate of incorporation given by the
Registrar in respect of any association shall be conclusive evidence that all the
requirements of the Act have been complied with in respect of registration and
matters precedent and incidental thereto, and that the association is a company
authorised to be registered and duly registered under the Act. The certificate of
incorporation is conclusive evidence that everything is in order as regards
registration and that the company has come into existence from the earliest
moment of the day of incorporation stated therein with rights and liabilities of a
natural person, competent to contracts. Once a certificate of incorporation has
been issued its validity cannot be impeached. In the case of Moosa vs Ebrahim
[ILR (1913)40 Cal.l (PC.)] the memorandum of association of a company was
signed by two adults and by a guardian of the other five members, who
happened to be minors. The Registrar, however, registered the company and
issued under his hand a certificate of incorporation. It was contended that the
certificate of incorporation should be declared to be void. Lord Macnaughten
deciding the case said:
Their Lordships will assume that the conditions of registration prescribed by the
Indian Companies Act were not duly complied with; that there were no seven
subscribers to the memorandum and that the Registrar ought not to have granted
the certificate. But the certificate is conclusive for all purpose. Thus, the
certificate prevents anyone alleging that the company does not exist.
195
Though the certificate of incorporation makes the existence of a company legally
valid, it does not mean that the certificate legalises an illegal object mentioned in
the memorandum. In fact, it is for the purpose of incorporation only that the
certificate is made conclusive by law.
(h) Certificate of Commencement of Business: Once a certificate of
incorporation has been issued, a company becomes forthwith capable of
exercising all the functions of an incorporated company. This however applies
only to private companies and a company having no share capital. In the case of
companies other than a private company and a company having no share capital,
a further requirement is to be complied with, namely, obtaining a certificate of
commencement of business before commencing any business. Thus, whereas a
private company and a company having no share capital can commence business
right from the date of its incorporation, a public company is required to file
either a prospectus or a statement, in lieu of prospectus and the declaration of
statutory compliances, as prescribed under Section 149 with the Registrar of
Companies of the State where the company is situated and obtain from the
Registrar a certificate of commencement of business before the company
commences business.
Documents to be filed with the Registrar (Section 33)
After taking the above steps, the following documents are required to be filed
with the Registrar of Companies of the state in which the registered office of the
company is to be situated:
(i) The memorandum of association duly signed by the prescribed minimum
number of
subscribers, duly stamped and signed by witness.
(ii) The articles of association should also be similarly signed, stamped and
witnessed, (iii) Any agreement which the company proposes to enter into with
any individual for appointment
as its managing or whole time director or manager, (iv) Any other agreement, if
referred to in the memorandum and articles of association, in case,
it will form part of the memorandum and articles, (v) Letter of authority
(stamped as a specific power of attorney) signed by the subscribers
authorising a representative to make amendments and/or alterations in the
memorandum
and articles of association, (vi) A copy of the letter received from the Registrar
of Companies intimating the availability of
the proposed name, (vii) A statutory declaration in the prescribed form by an
advocate, an attorney or pleader entitled
to appear in a High Court or a secretary or a chartered accountant practising in
India, who
is engaged in the formation of the company, or by a person who is named as a
director or
manager or secretary of the company stating that all requirements of the Act and
the Rules
thereunder have been complied with in respect of registration and matters
precedent and
incidental thereto (Section 33). (viii) In case the first directors are appointed by
the articles, or named in the prospectus or
statement in lieu of prospectus:
• a written consent of each director to act as such, signed by him or by an
agent duly
authorised in writing in prescribed form; and
• an undertaking in the same form as referred above in writing, agreeing
to take from the
company and pay for his qualification shares, if any, or sign the memorandum
for
shares not being less than his qualification shares (Section 266). In case, a
prospectus
is issued in relation to the intended company and proposed directors are named
therein,
then the consent and undertaking must be filed before the publication of the
prospectus.
(i) Payment of the requisite fee for registration
Procedure for the incorporation of a company limited by guarantee: Though the
procedure involved for the incorporation of a company limited by guarantee is
the same as that of the public
196
company or a private company, as described above, following must however be
noted in this regard:
• In the memorandum of association of such a company, a clause stating
the amount of guarantee
will have to be added in addition to the other necessary clauses to this effect.
• A guarantee company may be a company with the share capital or
without the share capital.
• A company formed with no intention to generate profit is usually formed
as a guarantee
company.
• A company limited by guarantee can either be a private or a public
company.
18.7 LET US SUM UP
1. An insecured loan is one for which the banker has to rely upon the
personal security of the
borrower.
2. Secured loans are antithesis to insecured loans.
3. Various methods of securing a loan are pledge, hypothecation, mortgage
and assignment of debts
of the borrower.
4. If two or more persons come together and agree to share profits of a
business, it is called a
partnership.
5. A partnership firm can be registered under the Section 58 of Partnership
Act, 1932.
6. If a firm is not registered, then a partner cannot sue the other partners or
third parties to enforce
contractual rights.
7. A company is an artificial person created by law.
8. There are only two types of companies that are registered under the
Companies Act. They are:
(a) Public Limited Company (b) Private Limited Company
9. Certificate of incorporation is the conclusive evidence of coming into
existence of the company.
10. Certificate of commencement of business is required for a public company to
start business.
18.8 CHECK YOUR PROGRESS
loans.
1. Only personal security of the borrower is available in the case of.
2. Secured loans are normally secured by .
3. Pledge is of goods as a security for debt.
4. Hypothecation is treated as pledge.
5. Personal obligation of mortgagor is a distinct feature of
6. Section 58 of Partnership Act, 1932 provides for .
7. A partner on behalf of firm cannot institute a suit on contract, if the firm
is registered.
(True/False)
8. Shares of public limited company are freely transferable. (True/False)
9. Certificate of incorporation is a document evidencing existence of
company. (True/False)
10. Certificate of commencement of business is required for private limited
company to start business. (True/False)
18.10 ANSWERS TO 'CHECK YOUR PROGRESS'
1. Insecured; 2. pledge, hypothecation, mortgage or assignment of debts; 3.
bailment; 4. constructive; 5. mortgage by deposit of title deeds; 6. registration of
partnership; 7. False; 8. True; 9. True; 10. False.
REGISTRATION AND SATISFACTION OF CHARGES
STRUCTURE
19.0 Objectives
19.1 Introduction
19.2 What is a Charge?
19.3 Procedure for Registration of Charge
19.4 Effect of Non-registration of Charges
19.5 Provisions of Law Relating to Registration of Charges
19.6 Let Us Sum Up
19.7 Check Your Progress
19.8 Answers to 'Check Your Progress'
198
19.0 OBJECTIVES
After studying this unit, you should be able to briefly understand:
• the creation of charge over the properties, registration of charges under
different enactments;
• registration of charges with the various authorities.
19.1 INTRODUCTION
We have seen in earlier units, the types of loans granted by a banker and
methods of securing a loan. In this unit, we will focus on the meaning of 'charge'
under the Companies Act and registration of charges.
19.2 WHAT IS A CHARGE?
1. Before studying the meaning of word 'charge' and provisions relating to the
registration of charges, we will learn the general meaning of the word 'charge'.
It may be noted that the word 'charge' is used to mean any form of security for
debt, unless the word is used otherwise. We have seen in the earlier chapters,
that a banker accepts different types of securities to secure a loan granted to
borrowers. Section 125(4) of the Companies Act, 1956 provides, that for the
purpose of registration under the said Act, it includes all the following charges:
(a) A charge for the purpose of securing debentures
(b) A charge on uncalled capital of the company
(c) A charge on any immoveable property, wherever situated, or any
interest therein
(d) A charge on any book debts of the company
(e) A charge, not being a pledge, on any moveable property of the company
(f) A floating charge on the undertaking or any property of the company
including stock-in-
trade
(g) A charge on calls made but not paid
(h) A charge on a ship or any share in a ship
(i) A charge on goodwill, on a patent or a licence under a patent, or a trademark,
or on a
copyright or a licence under a copyright
2. Types of Charges: 'Charges' registered under the Companies Act can be
classified into the two types:
(i) Fixed charge (ii) Floating charge
(i) Fixed charge- 'Fixed charge' is also called 'specific charge'. It extends over a
specific property or properties of the company. In other words, when a particular
or a specific property of the company is given as a security for loan, then a 'fixed
charge' is said to be created over the property. It may be noted, that charges
specified in Section 125(4)(b) ot the Companies Act, 1956, created in
conformity with the provisions of the said Act over a specific property gives
right to the creditor so secured, to sell the said property and claim the proceeds
towards the dues payable by the company.
(ii) Floating Charge: A 'floating charge' means a 'charge' that is general and not
specific. It can be said to be a charge
(a) that floats over the present and future property of the company subject
thereto, that
means it does not fasten on or attach to any particular or specific property;
(b) that does not restrict the company from assigning the property, subject
to charge to
third persons, whether by way of sale or security;
(c) that on happening of an event or contingency, crystallises as a fixed
charge.
199
From the above, it can be noted that when the charge is floating, the company
may, in the ordinary course of business, deal with the property in any manner
until the charge attaches. In other words, a floating charge is an equitable charge
which does not fasten on any specific property but covers the whole of the
company's property whether it is or is not subject to fixed charge.
When floating charge becomes fixed or crystallised/attaches
When the debtor company ceases to carry on business or goes into liquidation or
the debenture holder or creditor, in whose favour charge is created, intervenes by
getting a receiver appointed or doing some other act which affects the powers of
the company to dispose the assets charged. A floating charge may also
crystallise on the happening of an event specified in the creating a charge deed.
Effect of floating charge becoming fixed or crystallised
When a floating security upon all the property or assets of the company becomes
fixed, it constitutes a charge upon all the property or assets then belonging to the
company. It has priority over the subsequent equitable charges and over
insecured creditors and over money advanced to the liquidator.
19.3 PROCEDURE FOR REGISTRATION OF CHARGE
Companies Act, 1956 under Section 125(1) provides that all the particulars of a
charge created by the company shall be filed with the Registrar of Companies
together with an instrument, creating charge, for registration within thirty days
of the creation of charge. The time limit of thirty days within which the charge
shall be registered can be extended by Registrar of Companies by further thirty
days.
The procedure for registration is provided under the Rule 6 of the Companies
(Central Government's) General Rules and Forms:
(a) It provides that for the registration of charge, the company shall file the
prescribed particulars for
creation, modification or satisfaction of the charge in the Form 8, or Form 13 or
Form 17 in
triplicate. The forms are prescribed under the rules.
(b) A copy of every instrument evidencing any charge or modification of
charge is required to be filed
with the registrar duly verified and certified.
(c) The fee prescribed for registration shall be paid.
Recently Government of India has introduced electronic filing of returns. This is
a centralized registry and all companies are required to file all returns which they
were filing with ROC earlier are required to file them with this new registry.
Even banks and other charge holders are required to file the particulars of the
charges created in their favour by the companies under this method. This is to
ensure reduction in delays and one point availability of information about any
company.
19.4 EFFECT OF NON-REGISTRATION OF CHARGES
Section 125 of the Companies Act provides that the charge created by the
company over the properties, if not registered, would not be valid against the
liquidator and any creditor of the company.
It has been held in various cases by the Courts that non-registration of charge
under Section 125 would not render the security invalid automatically. The only
consequence of non-registration is that the charge would not be valid against the
liquidator and other creditors of the company in the event of winding up.
It must be noted that, as against the company itself, so long as the company does
not go into liquidation, the mortgage or charge is good and maybe enforced.
200
19.5 PROVISIONS OF LAW RELATING TO REGISTRATION OF
CHARGES
Sections 124 to 145 of the Companies Act, 1956 provides for the registration of
charges. They can be stated briefly as follows:
Section 124: This Section provides that 'charge' means and includes mortgage
over any or all properties of the company.
Section 125: This Section provides that the charge created over the properties of
the company shall be registered with the Registrar of Companies within thirty
days of creation of charge. It also provides that if the charge is not registered
then the charge created would be invalid as against the liquidator and other
creditor of the company in its winding up.
Section 126: This Section provides that after registration of charge created, any
other person acquiring such property charged or any party thereof, shall be
deemed to have notice of the charge registered and shall take the property
subject to such charge.
Section 127: This Section provides that if a company acquires a property
charged under Section 125, then the company shall declare the same by filing
the particulars of the property, so acquired, subject to charge.
Section 128: This Section provides that provision for registration charges is also
applicable for securing debentures issued by the company. The registration of
charge for securing debentures shall be carried out by filing particulars of the
amount of debentures, the date of the resolutions authorising the issue of the
series of debentures, general description of property charged, and the names of
the trustees.
Section 129: This Section provides that the particulars filed for creating the
charge for securing deben¬tures shall also contain any commission, allowance
or discount paid directly or indirectly by the company to any person in
consideration of his subscribing or agreeing to subscribe or procuring
subscriptions.
Section 130: It is provided under this Section that Registrar of Companies shall
keep a register of charges containing particulars of all charges requiring
registration. This Section further provides that a copy of particulars contained in
the register of charges can be obtained by any person on payment of fee.
Section 131: This Section provides that Registrar of Companies shall maintain
an index of register of charges.
Section 132: This Section provides that the Registrar shall give a certificate
under his hand of the registra¬tion of any charge registered, stating the amounts
thereby secured; and the certificate shall be a conclusive evidence of that the
requirements of Companies Act as to registration has been complied with.
Section 133: This Section directs that the company, in the case of secured
debentures, shall cause a copy of every certificate of registration given under
Section 132 to be endorsed on every debenture or certificate of debenture stock.
Section 134: This Section imposes duty on a company to register a charge
required to be registered under the Act. It also provides that any person
interested in registration of charge can also apply for registration.
Section 135: This Section provides that the procedure and law of registration of
charges is equally applicable to modification of charges.
Section 136: This Section requires the company that a copy of an instrument or
document creating the charge shall be kept at the registered office of the
company.
Section 137: Under this Section any person appointed as receiver or manager of
the property charged, shall give notice to Registrar of Companies within 30 days
of his appointment.
201
Section 138: Under this Section, the company shall give intimation to the
Registrar of the payment or satisfaction in full, of any charge, relating to the
company and requiring registration under this part, within thirty days from the
date of such payment or satisfaction. Thereafter the Registrar of Companies shall
record such satisfaction of charge.
Section 139: Under this Section, Registrar of Companies that on evidence being
given to his satisfaction with respect to any registered charge:
(a) that the debt for which the charge was given has been paid or satisfied in
whole or in part; or
(b) that part of the property or undertaking charged has been released from
the charge, or has ceased
to form part of the company's property or undertaking can record the fact that
charge is satisfied
or property is released.
Section 140: This Section provides that the Registrar after entering
memorandum of satisfaction in whole or in part, in pursuance of Section 138 or
139, he shall furnish the company with a copy of memorandum.
Section 141: Under this Section the Company Law Board can order for the
creation of charge or modification or satisfaction of the charge, if the company
due to inadvertence or by accident, omitted filing charges under those
provisions.
Section 142: This Section empowers Registrar to impose a penalty on the
company, if it fails to comply with the provisions of law relating to registration
of charges.
Section 143: This Section enjoins upon a company to keep at its registered office
a register of charges and enter therein all the charges specifically affecting the
property of the company.
Section 144: This Section provides that any creditor or member of company can
inspect the books relating to charges created by the company and it is the duty of
the company to keep the register of charges open to inspection.
19.6 LET US SUM UP
1. The word 'charge' means any form of security for debt, unless the word
is used otherwise.
2. All charges created by a company are required to be registered with
Registrar of Companies
under Section 125 of the Companies Act, 1956.
3. Charges can be fixed or floating.
4. Charge will have to be registered within thirty days of creation of the
charge.
5. If the charge created is not registered, then the same is invalid against
liquidator and other
creditors on winding up of the company.
6. Sections 124 to 145 of the Companies Act deal with Registration of
Charges.
19.7 CHECK YOUR PROGRESS
for
(a) Charge means any form of
(b) Charges created by company shall be registered with .
(c) Under Companies Act a charge includes .
(d) Charge, if not registered is not enforceable against company. True/False
(e) Charge shall be registered within days from the date of creation
of charge.
19.8 ANSWERS TO 'CHECK YOUR PROGRESS'
(a) Security, debt; (b) Registrar of Companies; (c) Mortgage; (d) False; (e) 30
MODULE -C
BANKING RELATED LAWS
r
SECURITISATION AND RECONSTRUCTION OF
FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY
INTEREST, 2002 (SARFAESI ACT, 2002)
Unit 20. Introduction to Securitisation and Reconstruction of Financial Assets
and Enforcement of Security Interest, 2002 (SARFAESI Act, 2002)
Unit 21. Definitions of SARFAESI Act, 2002
Unit 22. Regulation of Securitisation and Reconstruction of Financial Assets of
Banks and Financial Institutions
Unit 23. Enforcement of Security Interest
Unit 24. Central Registry
Unit 25. Offences and Penalties
Unit 26. Miscellaneous Provisions
THE BANKING OMBUDSMAN SCHEME, 2006
Unit 27. The Banking Ombudsman Scheme, 2006: Purpose, Extent, Definitions,
Establishment and Powers
Unit 28. Procedure for Redressal of Grievance
RECOVERY OF DEBTS DUE TO BANKS AND FINANCIAL
INSTITUTIONS ACT, 1993 (DRT ACT)
Unit 29. Recovery of Debts Due to Banks and Financial Institutions Act, 1993
(DRT Act) Preliminary
Unit 30. Establishment of Tribunal and Appellate Tribunal
Unit 31. Jurisdiction, Powers and Authority of Tribunals
Unit 32. Procedure of Tribunals
Unit 33. Recovery of Debts Determined by Tribunal and Miscellaneous
Provisions
THE BANKERS' BOOKS EVIDENCE ACT, 1891 Unit 34. The Bankers'
Books Evidence Act, 1891
THE LEGAL SERVICES AUTHORITIES ACT, 1987 Unit 35. The Legal
Services Authorities Act, 1987: Lok Adalats
204
THE CONSUMER PROTECTION ACT, 1986
Unit 36. The Consumer Protection Act, 1986: Preamble, Extent and Definitions
Unit 37. Ponsumer Protection Councils Unit 38. Consumer Disputes Redressal
Agencies
THE LAW OF LIMITATION Unit 39. Limitation of Filing Suits, Appeals and
Applications
TAXLAWS Unit 40. Income Tax, Banking Cash, Transaction Tax, Fringe
Benefit Tax and Service Tax
INTRODUCTION TO SECURITISATION AND RECONSTRUCTION OF
FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST,
2002 (SARFAESI ACT, 2002)
STRUCTURE
20.0 Objectives
20.1 Introduction
20.2 Constitutional Validity of the Act
20.3 Let Us Sum Up
20.4 Keywords
20.5 Check Your Progress
20.6 Answers to 'Check Your Progress'
20.7 Multiple Choice Terminal Questions
206
20.0 OBJECTIVE
The objective, of this unit is to see why there was a need for the new legislation,
viz., Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest, 2002 (SARFAESI Act 2002) and why it was enacted. The Act
has created a new legal framework, new concepts about security and new
procedures for recovery of dues by banks and financial institutions.
20.1 INTRODUCTION
1. Banks and Financial institutions lend money by obtaining security,
except for the category of clean
loans. The security obtained is to act as a protection for the money advanced and
in the case of
need, the money can be realised by the sale of securities.
2. The lender's rights over the securities, both moveable and immoveable,
for realisation of the
amount advanced, were limited and less effective since they were required to
take help of the legal
system which was taking unduly long time to complete prior to the passing of
the SARFAESI Act,
2002. This Act introduced major changes in the legal framework for the
recovery of dues by laying
hands on the securities.
3. The Act is a major step in financial sector reforms. It has brought a legal
framework for the
following important activities in the credit market:
(a) Securitisation of financial assets.
(b) Reconstruction of financial assets.
(c) Recognition of any 'interest' created in the security for due repayment of
a loan as a 'security
interest', irrespective of its form and nature but when it is not in the possession
of the creditor.
(d) Power to enforce such a security for the realisation of money due to
banks and the financial
institutes in the event of a default, without the intervention of the Courts.
(e) Enabling provisions for the setting up a central registry for the purpose
of registration of
transactions of securitisation, reconstruction and the creation of the security
interest.
4. The Act extends to whole of India including the State of Jammu &
Kashmir. It is effective from 21
June, 2002. The Act is applicable also to housing finance companies whose
names are notified by
the Central Government for such applicability.
5. The provisions of the Act, relating to enforcement of the security
interest, applies to cases in
which the security interests are created for due repayment of financial assistance.
The Act has
presupposed a simple thing, that there is an obligation on the part of the
borrowers to repay loans
and if they are unable to repay, then the securities for the loans are liable to be
sold for the recovery
of loans. The Act has retrospective application, i.e., it applies for loans and
securities created prior
to the Act coming into operation of the Act.
20.2 CONSTITUTIONAL VALIDITY OF THE ACT
1. In Mardia Chemicals vs Union of India (2004) 21 ILD 521 SC, a three
member bench of the Supreme Court has declared this Act as constitutionally
valid, except a part of the Section 17(2). The Section 17(2) had laid down that
when the lender intends to take action of taking possession of the security asset,
the borrower can file an appeal to the DRT only after depositing seventy-five per
cent of the amount claimed by the lender. The Supreme Court has declared this
condition of the deposit of seventy five per cent of the claim amount as
unreasonable, oppressive, arbitrary and violative of the Article 14 of the
Constitution.
After the Supreme Court decision in the Mardia case and its fall out on the very
intention of the legislation giving importance for recovery and prevent long legal
battles that borrowers create without
207
any payment, the Government of India has issued a notification amending the
Section 17(2) of the SARFAESI Act. The amendment now stipulates payment of
fifty per cent amount instead of seventy five per cent as originally enacted. An
aggrieved person has now a right to refer the matter to DRT and then to the
Appellate Tribunal by depositing fifty per cent of the claimed amount.
20.3 LET US SUM UP
In this unit, we have seen how new changes are brought in by the Act. The
comfort available for the lender for his money to come back will give him a
confidence for lending.
20.4 KEYWORDS
Security in Possession; Remedy with and/or without Court Intervention;
Prudential Norms; Security Interest; Financial Assets; Securitisation of Financial
Asset; Reconstruction of Financial Asset; Enforcement of Security; Possession
and Sale of Asset.
20.5 CHECK YOUR PROGRESS
1. Banks obtain security while lending, so that in the case of need, the
money can be of
securities.
2. The SARFAESI Act is applicable to the housing finance companies
whose names are notified by
the Central Government. (True or False)
3. In Mardia Chemical Case the Supreme Court decided that the condition
of deposit of amount is
fully invalid. (True or False)
4. After Mardia Chemical Case, the amendment made in the SARFAESI
Act stipulates deposit of
amount before preferring the appeal to DRT (Appellate Tribunal).
20.6 ANSWERS TO CHECK YOUR PROGRESS'
1. realised by sale; 2. True; 3. True; 4. 50 per cent.
20.7 MULTIPLE CHOICE TERMINAL QUESTIONS
1. Whether moveable securities in possession of the bank can be sold by
the bank without the
intervention of the Court?
(a) Now, a Court order is required to sale the security.
(b) Yes, bank can sell as provided in the Contract Act, 1872.
(c) Yes, as the SARFAESI Act, 2002 has made provisions to that effect.
(d) No, until the account is not declared as NPA by the bank.
2. As per the laws existing today, the mortgaged security cannot be sold
without a Court intervention.
Is this correct?
(a) Yes, Court intervention is required as per the provisions of the Transfer
of Properties Act.
(b) No, SARFAESI Act, 2002 has now made enabling provisions.
(c) Yes, since the Contract Act has made no provisions about any Court
intervention.
(d) No, due to the recent amendments in the Transfer of Property Act no
Court intervention is
required.
rto-wmxrrseeurifies?
(a) Any moveable or immoveable security charged to the bank or financial
institution.
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(b) To mortgage securities only.
(c) Where the security interests are created for repayment of financial
assistance given by the
bank or a financial institution.
(d) To the properties owned by the defaulter borrower, but those that are not
charged to the
bank.
4. In the Mardia case what did the Supreme Court declared as invalid?
(a) Entire SARFAESI Act, 2002.
(b) Creation of security interest.
(c) Formation of Reconstruction Companies.
(d) Condition to pay seventy-five per cent of the amounts as pre-condition
while preferring
appeal to the DRT.
Ans. I. (b); 2. (b); 3. (c); 4. (d).
UNIT
21
DEFINITIONS OF SARFAESI ACT, 2002
STRUCTURE
21.0 Objective
21.1 Introduction
21.2 Preamble
21.3 Appellate Tribunal
21.4 Asset Reconstruction
21.5 Bank
21.6 Board
21.7 Borrower
21.8 Central Registry
21.9 Debt Recovery Tribunal
21.10 Default
21.11 Financial Assistance
21.12 Financial Asset
21.13 Financial Institution
21.14 Hypothecation
21.15 Non-performing Asset
21.16 Originator
21.17 Obligor
21.18 Property
21.19 Qualified Institutional Buyer
21.20 Reconstruction Company
21.21 Scheme
21.22 Securitisation
21.23 Securitisation Company
21.24 Security Agreement
21.25 Secured Asset
21.26 Secured Creditor
21.27 Secured Debt
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21.28 Security Interest
21.29 Security Receipt
21.30 Sponsor
21.31 Keywords
21.32 Check Your Progress
21.33 Answers to 'Check Your Progress'
21.34 Multiple Choice Terminal Questions
211
r
21.0 OBJECTIVE
The objectives of this unit, are to understand:
• The purpose of enacting the Act;
• Important definitions given in the SARFAESI Act, 2002.
21.1 INTRODUCTION
For any Act, different concepts and effects revolve mainly around certain
defined words. The Act also takes some definitions from some other Acts, to the
extent it is relevant and applicable. The preamble to the Act gives in a nutshell,
the purpose of the enactment.
21.2 PREAMBLE
The preamble indicates the purpose of the enactment. For the SARFAESI Act,
the preamble states 'An Act to regulate securitisation and reconstruction of
financial assets and the enforcement of security interest and for the matters
connected therewith or incidental thereto.'
21.3 APPELLATE TRIBUNAL
Any person aggrieved by the order passed by the 'Debt Recovery Tribunal' can
file an appeal to the authority called as the 'Appellate Tribunal', subject to the
maintainability of the appeal. These tribunals are constituted by the Central
Government for the various States as per the provisions of the Recovery of
Debts due to Bank and Financial Institutions Act, 1993.
21.4 ASSET RECONSTRUCTION
Acquisition of any right or interest, of any bank or financial institution, in any
financial assistance, by any securitisation company or reconstruction company,
for the purpose of realisation of such financial assistance, is called as asset
reconstruction. In simple words, it is the takeover of loans or advances from the
bank or financial institution for the purpose of recovery.
21.5 BANK
All the banking companies, Nationalised banks, the State Bank of India as well
as its subsidiary banks and co-operative banks are within the meaning of the
word bank for the purpose of this Act. This definition has excluded the regional
rural banks. So the SARFAESI Act is not applicable to RRBs.
21.6 BOARD
The word 'Board' is used in the Act to mean the Securities and Exchange Board
of India (SEBI). It is established under the Securities and Exchange Board of
India Act, 1992.
21.7 BORROWER
The borrower means,
(i) any person, who has been granted financial assistance by any bank or
financial institution, or (ii) who has given any guarantee, or
(iii) who has created any mortgage or pledge as a security for the financial
assistance granted by any bank or financial institution, or
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(iv) a person who becomes the borrower of a securitisation company or
reconstruction company, consequent upon acquisition by it of any right or
interest of any bank or financial institution, in relation to such financial
assistance.
21.8 CENTRAL REGISTRY
Under this Act, 'Central Registry' means the registering office, set up or caused
to be set up by the Central Government. With this proposed set up, all the
transactions of asset securitisation, reconstruction as well as transactions of
creation of security interests, will have to be registered with this authority. The
registration system will operate on a priority of registration basis, i.e., first in
time to register gets priority over the person doing registration at a later time.
The registry will also serve the purpose of maintaining credit information for the
lenders.
21.9 DEBT RECOVERY TRIBUNAL
These tribunals were established under the Recovery of Debts Due to Banks and
Financial Institutions Act, 1993, to deal with the cases of recovery of debts
above Rs. 10 lakh due to the banks and financial institutions.
21.10 DEFAULT
1. When the borrower does not pay any principal debt or any interest on
the principle debt or any
other amount payable to the secured creditor and due to such non-payment the
account of such
a borrower is classified as a non-performing asset (NPA) in the books of
accounts of the secured
creditor, as per the RBI guidelines, it is called default.
2. For getting the right of security enforcement, under this Act, there
should be a default committed
by the borrower. The creditor must also be a secured creditor. Any insecured
creditor has no
right of any nature in this Act.
3. In the Mardia Chemicals case, it was argued before the Supreme Court
by the bank, that bank can
classify the account as NPA as per its decision. The Supreme Court rejected this
argument and
stated that it should be done as per RBI guidelines only.
21.11 FINANCIAL ASSISTANCE
Whenever any bank or financial institution grants a loan or advance or makes
subscription of debenture or bonds or gives guarantee or issues letters of credit
or extends other credit facility, it is called financial assistance.
21.12 FINANCIAL ASSET
Financial asset means debt or receivables and includes:
(i) a claim to any debt or receivables or part thereof whether secured or
insecured, or
(ii) any debt or receivable secured by mortgage of or charge in immoveable
property, or
(iii) a mortgage charge, hypothecation or pledge of moveable property, or
(iv) any right or interest in the security, whether full or part, securing debt,
or
(v) any beneficial interest in any moveable or immoveable property or in
debt, receivables, whether
such an interest is existing, future, accruing, conditional or contingent, or
(vi) any financial assistance.
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21.13 FINANCIAL INSTITUTION
The financial institution means:
(i) A public financial institution within the meaning of the Companies Act, 1956.
(ii) Any institution specified by the Central Government under the Recovery of
Debts due to Bank
and Financial Institutions Act, 1993. (iii) The 'International Finance
Corporation', established under the International Finance Corporation
(Status, Immunities and Privileges) Act, 1958. (iv) Any other institution or non-
banking financial company as defined in the Reserve Bank of India
Act, 1934, which the Central Government may specify as a financial institution
for the purpose
of this Act.
21.14 HYPOTHECATION
1. Hypothecation means:
• a charge in or upon any moveable property
• existing or future
• created by a borrower
• in favour of a secured creditor
• without delivery of possession of the moveable property to such creditor
as a security for
financial assistance and includes floating charge and crystallisation of such
charge into fixed
charge on moveable property.
2. Prior to this Act no Indian Law has defined the term hypothecation
though hypothecation is a very
common type of charge on a security for a banks' lending.
21.15 NON-PERFORMING ASSET
It is an asset or account of a borrower classified by a bank or financial institution
as sub-standard, doubtful or a loss asset, in accordance with the directions or
under guidelines relating to asset classification issued by the Reserve Bank. For
classification of any account as NPA it is important that the classification is done
as per the RBI directives.
\
21.16 ORIGINATOR
Originator is the owner of a financial asset that is acquired by a securitisation
company or reconstruction company for the purpose of securitisation or asset
reconstruction. In plain meaning, when the bank or financial institution lends
money against security they are the originator.
21.17 OBLIGOR
Obligor means a person liable,
(i) To pay to the originator, whether under a contract or otherwise, or
(ii) To discharge any obligation in respect of a financial asset, whether existing,
future, conditional
or contingent, or
(iii) and includes a borrower.
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21.18 PROPERTY
1. Property means:
(i) Immoveable property, (ii) Moveable property,
(iii) Any debt or any right to receive payment of money whether secured or
insecured, (iv) Receivables, whether existing or future,
(v) Intangible assets such as; know-how, patents, copyright, trademarks, licence,
franchise or any other business or commercial right of a similar nature.
2. Definition of property is made much wider by this Act. Prior to this Act,
property has been defined
under various Acts such as Transfer of Property Act, Registration Act, etc. By
this Act, the addition
of properties stated at sub-clauses (iii), (iv) and (v) here above is made. Due to
this, now security
interest can be created against these properties for raising loans from the banks
and financial
institutions.
21.19 QUALIFIED INSTITUTIONAL BUYER
1. Such buyer means a financial institution or an insurance company or a
bank or a state financial
corporation or state industrial development corporation or trustee or any asset
management company,
making an investment on behalf of a mutual fund or provident fund or gratuity
fund or pension
fund or a foreign institutional investor, registered under the SEBI Act, 1992 or
any other body
corporate as may be specified by SEBI.
2. This definition covers several categories of institutional investors but
does not include a company
registered under the Companies Act, 1956. If any company wants to become a
qualified institutional
buyer then it will have to get such a registration from SEBI.
21.20 RECONSTRUCTION COMPANY
A company formed for the purpose of asset reconstruction and registered under
the Companies Act, 1956 is called Reconstruction Company.
21.21 SCHEME
The securitisation company or the reconstruction company can raise funds from
qualified institutional buyers by formulating schemes. Funds so raised are
required to be maintained in, separate and distinct accounts scheme-wise,. The
scheme invites subscription to security receipts proposed to be issued by such a
company.
21.22 SECURITISATION
1. Securitisation means acquisition of financial asset by the securitisation
or reconstruction company
from the originator. Such an acquisition may be by raising of funds by such a
securitisation or
reconstruction company from the qualified institutional buyers by issue of
security receipts
representing undivided interest in the financial assets or otherwise.
2. The concept and modality of securitisation defined here is new for the
Indian laws as well as for
the markets. This is a process where non-liquidated financial assets are
converted into marketable
securities, i.e., security receipts that can be sold to the investors. It is also a
process of converting
the receivables and other assets into securities, i.e., security receipts that can be
placed in the
market for trading. In Indian laws, there is no provision for transfer of claims
that are secured by
215
any security. Now SARFAESI Act has made the loans secured by mortgage or
other charges transferable.
On acquisition of a financial asset, the securitisation or reconstruction company
becomes the owner of the financial asset and steps into the shoes of the lender
bank or financial institution. This acquisition can also be said to be, as a sale of
asset without recourse to the bank or financial institution. RBI is the regulatory
authority for all securitisation or reconstruction companies.
3. As per present guidelines of 29 March, 2004, the minimum capital
requirement for the securitisation or reconstruction company is Rs. 2.00 crore at
the time of registration and these companies are required to maintain capital
adequacy of fifteen per cent of total asset acquired or Rs. 100 crore whichever is
less.
21.23 SECURITISATION COMPANY
It is a company registered under the Companies Act, 1956 for the purpose of
securitisation. The securitisation company also needs a registration from the RBI
as per the SARFAESI Act. The securitisation company can set up separate trusts
scheme wise and act as trustee for such schemes, as provided in the
Securitisation Companies and Reconstruction Companies (Reserve Bank)
Guidelines and Directions, 2003. The investors in the securitisation company are
the beneficiaries of such trusts.
21.24 SECURITY AGREEMENT
Security agreement means an agreement, instrument or any other document or
arrangement under which security interest is created in favour of the secured
creditor. This includes creation of mortgage by deposit of title deeds with the
secured creditors.
21.25 SECURED ASSET
Secured asset means the property on which a security interest is created. The
powers given by SARFAESI Act for the enforcement of securities are against
the secured assets only. If the borrower has any property over which no security
interest is created, such a property is outside the purview of enforcement powers
under the SARFAESI Act.
21.26 SECURED CREDITOR
Any bank or financial institution or any consortium or group of banks or
financial institutions in whose favour the security interest is created by the
borrower for due repayment is called a secured creditor. It includes debenture
trustee appointed by any bank or financial institution or securitisation company
or reconstruction company. It also includes, any other trustee holding securities
on behalf of a bank or financial institution.
21.27 SECURED DEBT
Secured debt means a debt which is secured by any security interest.
21.28 SECURITY INTEREST
1. Any right, title and interest of any kind whatsoever upon the property
created in favour of any
secured creditor is called as security interest. It includes any mortgage charge,
hypothecation,
assignment other than those specified in Section 31 of the SARFAESI Act.
2. Whenever any lender takes any security from the borrower, the lender
pets i
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The type of interest depends on the nature of charge created over the security.
Until now, such interest of the lender in the security was not defined in any law.
SARFAESI Act has, for the first time defined this. Now, any type of charge or
any type of security has come under one wide scoped definition, called the
security interest.
21.29 SECURITY RECEIPT
1. A receipt or another security issued by a securitisation company or
reconstruction company to any
qualified institutional buyer pursuant to a scheme evidencing the purchase or
acquisition by the
holder thereof of an undivided right, title or interest in the financial asset
involved in securitisation
is called the security receipt.
2. The security receipt evidences the purchaser's undivided right, title and
interest in the security.
These receipts are transferable in the market. By this Act, a new type of
transaction in the financial
market has been created for transfer of the security interest.
21.30 SPONSOR
Sponsor is an entity holding not less than ten per cent of the paid-up equity
capital of securitisation or reconstruction company.
21.31 KEYWORDS
Appellate Tribunal; Asset Reconstruction; Central Registry; Debt Recovery
Tribunal; Non-performing Asset; Notification; Obligor; Originator; Qualified
Institutional Borrower; Reconstruction Company; Securitisation; Securitisation
Company; Security Agreement; Secured Asset; Security Interest; Security
Receipt; Sponsor.
21.32 CHECK YOUR PROGRESS
1. The SARFAESI Act is applicable for pledged securities also. (True or
False)
2. For the enforcement of a mortgage security, court intervention is
required even for actions under
the SARFAESI Act. (True or False)
3. Banks and financial institutions can issue notice for enforcement over
security under SARFAESI
Act only if these securities are not creditor and only when the account is
classified
as .
4. If the borrower does not pay within ' days after notice by the
secured creditor the
creditor can . of the security.
5. After receipt of notice from the secured creditor for repayment of dues
by the borrower, the
borrower is legally prevented from transferring his property in any way. (True or
False)
6. On request of the secured creditor the District Magistrate or the Chief
Judicial Magistrate can
take possession of the security for handing over it to the creditor. (True or False)
7. When the management of the company is taken over by the secured
creditor, the directors of
such company are entitled to compensation for loss of office. (True or False)
In this unit we have studied various definitions given in the SARFAESI Act,
2002. Some definitions are creating new notions. Definitions for asset
reconstruction, borrower, default, financial assistance, hypothecation, property,
securitisation, security interest and security receipt are some of the important
definitions to clear the concepts of the Act.
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21.33 ANSWERS TO 'CHECK YOUR PROGRESS'
1. False; 2. False; 3. in possession, NPA; 4. Sixty, take possession; 5. True; 6.
True; 7. False.
21.34 MULTIPLE CHOICE TERMINAL QUESTIONS
1. When any bank or financial institution obtains a charge against property,
with which authority
will the transaction have to be registered under the SARFAESI Act, 2002?
(a) With the Central Registry.
(b) With the ROC.
(c) With the Registrar of Assurances within whose jurisdiction the property
lies.
(d) With the Reserve Bank of India.
2. When can the provisions of SARFAESI Act, 2002 be invoked for
proceeding against the charged
property?
(a) When the bank feels that it is necessary for the recovery at any time.
(b) When the RBI directs to do so.
(c) When there is default in repayment by the borrower.
(d) When there is default in repayment and the bank declares the account as
NPA.
3. Whether existing or future receivables are property?
(a) Yes.
(b) No.
(c) Yes, but if and when charged to the lender.
(d) No, if hypothecated to the lender.
4. From the following which function is of a securitisation company?
(a) Acquisition of loan transaction from the lender.
(b) Help the lender in recovery by sale of charged property.
(c) Take legal steps against the defaulter borrower on behalf of the lender.
(d) Acquisition of financial asset from the originator.
Ans. 1. (a); 2. (d); 3. (a); 4. (d)
REGULATION OF SECURITISATION AND RECONSTRUCTION OF
FINANCIAL ASSETS OF BANKS AND FINANCIAL INSTITUTIONS
STRUCTURE
22.0 Objectives
22.1 Introduction
22.2 Registration of Securitisation Company or Reconstruction Company
22.3 Cancellation of Certificate of Registration
22.4 Acquisition of Rights or Interest in Financial Assets
22.5 Notices to Obligor and Discharge of Obligation of Such Obligor
22.6 Issue of Security Receipts and Raising of Funds by Securitisation
Company or
Reconstruction Company
22.7 Exemption from Registration of Security Receipt
22.8 Measures of Assets Reconstruction
22.9 Other Functions of Securitisation Company or Reconstruction Company
22.10 Resolution of Dispute
22.11 Power of Reserve Bank to Determine Policy and Issue Directions
22.12 Let Us Sum Up
22.13 Keywords
22.14 Check Your Progress
22.15 Answers to 'Check Your Progress'
22.16 Multiple Choice Terminal Questions
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22.0 OBJECTIVE
The objective of this unit is to understand the regulatory framework, in which
the securitisation and reconstruction companies are required to work, how they
have to raise the funds, acquisition of assets and other such functional
modalities.
22.1 INTRODUCTION
The SARFAESI Act has streamlined the functions of the securitisation and
reconstruction companies for dealing with financial assets of banks and financial
institutions. For this purpose, procedures as well and regulatory control
measures were required. In this unit we will consider these aspects.
22.2 REGISTRATION OFSECURITISATION COMPANY
OR RECONSTRUCTION COMPANY
1. The securitisation or reconstruction company can commence or carry
business, only after complying
the following two conditions:
(i) It obtains certification of registration from the Reserve Bank of India by
applying in prescribed
format; and (ii) It has the owned funds at the time of registration not less than
Rs. 2 crore or such other
amount not exceeding fifteen per cent of the total financial assets acquired or to
be acquired
as the RBI may specify.
2. As per the SARFAESI Act the securitisation of an asset or
reconstruction of an asset, are treated as
similar activities and the provisions relating to the registration of these
companies are same. Such
registered companies can raise money for their acquisition activities by issue of
security receipts
for formulating schemes. This Act has provided the legal framework for this
activity.
3. Depending on the nature of security asset the Reserve Bank of India has
the powers to specify
different amounts of owned funds for different class or classes of securitisation
companies or
reconstruction companies. The Reserve Bank of India may impose such other
conditions as it
deems fit on the company.
4. If any securitisation or reconstruction company wants to make any
substantial change in its
management or a change in the registered address or change in the name, then
that needs prior
approval of the Reserve Bank of India.
5. The scheme of the Act and the guidelines published by the Reserve
Bank of India under the Act,
gives a business pattern of the securitisation or reconstruction company as under.
(i) The company can formulate separate schemes for the acquisition of a
financial asset.
(ii) Create separate trusts for each scheme and maintain separate and distinct
records and
accounts in respect of each scheme and issue security receipts to the investors,
(iii) The securitisation company or reconstruction company can act as trustees
for such trusts
and manage the assets held in trust.
(iv) As the assets acquired in trust are scheme-wise, the risk of non-realisation of
assets will be impacting the investors who are the beneficiaries under the trust.
As such there should not be loss to the company. These companies do the
activity in such a way that they make arrangements for realisation of money
from the asset acquired. They do not invest their own funds in the acquisition of
asset but utilise the money invested on risk assessment and act on careful
considerations for asset acquisition decision. The risk factors are required to be
assessed, anticipated and also disclosed to the investors.
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22.3 CANCELLATION OF CERTIFICATE OF REGISTRATION
1. The registration granted to the securitisation or the reconstruction
company by the Reserve Bank
of India is cancellable on following grounds:
(i) The company ceases to carry on the business of securitisation or asset
reconstruction, or (ii) The company ceases to receive or hold any investment
from a qualified institutional buyer,
or (iii) The company fails to comply with any of the conditions subject to which
the certificate of
registration was granted, or (iv) The company fails to,
(a) comply with any of the directions issued by the Reserve Bank, or
(b) maintain accounts in accordance with the requirements of any law or
any direction or
order issued by the Reserve Bank of India, or
(c) submit or offer for inspection its books of accounts or other relevant
documents
when so demanded by the Reserve Bank of India, or
(d) obtain prior approval of the Reserve Bank of India for change in
management or
change in registered office or change of name.
2. The Act has provided that the cancellation of registration may be of two
categories. In the first
category the cancellation of registration is without giving any opportunity to the
company if the
company does any of the following:
(i) Ceases to carry on the business of securitisation or reconstruction, or
(ii) Ceases to carry or hold any investment from a qualified institutional buyer,
or
(iii) Fails to comply with RBI directions, or
(iv) Fails to maintain accounts in accordance with directions issued by RBI, or
(v) Fails to give accounts and documents to RBI for inspection.
The second category of cancellation is done with an opportunity to comply with
the defaults other than the above. However, even in this second category, the
RBI has powers and discretion, to deny opportunity, if the RBI feels that a delay
in the cancellation of registration shall be prejudicial to the public interest or the
interests of the investors of the company. It is required that the order is with
reasons recording the reasons as to why the company has been denied the
opportunity.
3. The securitisation or reconstruction company whose registration is
cancelled can prefer an appeal
within thirty days from the date of communication of order, to the Central
Government. The
company is required to be given a hearing before rejecting the appeal.
4. Even if the application for registration is rejected or the already existing
registration is cancelled,
the company shall be deemed as registered, until the company pays the dues of
the investors along
with interest within the period as the RBI may specify.
22.4 ACQUISITION OF RIGHTS OF INTEREST IN FINANCIAL ASSETS
1. The securitisation company or the reconstruction company can acquire the
financial asset of any bank or financial institution by any of the following ways:
(i) By issuing a debenture or bond or any other security in the nature of
debenture for the agreed consideration and agreed terms and conditions between
the bank/financial institution and the securitisation company/reconstruction
company as the case may be,
(ii) By entering into an agreement with such bank or financial institution for the
transfer of financial asset to such company on terms and conditions as may be
agreed between them.
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2. The securitisation or the reconstruction company can acquire financial
assets without execution of
any deed of assignment or transfer in its favour by the concerned bank or the
financial institution.
Assignment is complete on the acquiring company issuing a debenture or bond
and incorporating
therein the terms and conditions of acquisition. There is no need for execution of
any other
document. The document to be executed requires payment of stamp duty as per
the Indian Stamp
Act, which is an Act of the Union of India. The said document is not required to
be stamped as per
the State Stamp Duty laws.
3. As stated earlier, the securitisation transaction involves two stages. The
first is acquisition of
financial assets and undivided interest therein. The second is issue of security
receipts in favour of
the investors for the purpose of raising money from investors.
4. If the bank or financial institution is a 'lender' in relation to any financial
asset acquired by the
securitisation or a reconstruction company, then such a company is deemed as
lender in context
with the acquired property. Therefore, all the rights of such bank or financial
institution in the
security vest in the company which acquired the assets.
5. The statutory provisions say that acquiring company shall be vested with
all the rights of such
bank or financial institution. The provisions have excluded the liabilities. Thus,
if there is any
liability or commitment to be discharged from the side of bank or financial
institution, it will not
pass on to the securitisation or reconstruction company. Even if there is any
commitment to lend
further to the borrower, such commitment will not pass on to the asset acquiring
company. On this
issue, the Reserve Bank of India in the guidance note for securitisation
companies and reconstruction
companies has provided recommendatory guidance as under:
(i) Acquisition of funded assets, should not include takeover of outstanding
commitments, if
any, of any bank or financial institution to lend further, (ii) Terms of acquisition
of the security interest in non-fund-based transactions should provide
for the relative commitments to continue with bank or financial institute until
demand for
further funding arises.
6. In relation to the financial asset all contracts, deeds, bonds, agreements,
power of attorney, grants
of legal representations, permissions, approvals, consents or no objections under
any law or otherwise
to which the bank or financial institution is a party or which are in favour of the
bank or financial
institution are fully enforceable upon in place of bank or financial institution by
and in favour of
securitisation company or reconstruction company.
7. If at the time of acquisition of an asset by the securitisation company or
reconstruction company,
any suit, appeal or other proceeding of whatever nature related to the asset is
pending by or against
the bank or financial institution it does not get discontinued or abated or get in
any way prejudicially
affected because of the acquisition of asset. In such an event the suit, appeal or
other proceeding
can be continued, prosecuted and enforced by or against the securitisation or
reconstruction
company, as the case may be. If a securitisation company or reconstruction
company acquires the
assets of more than one bank or financial institution, where cases before
different Debt Recovery
Tribunals are pending, the securitisation company or reconstruction company
can file an application
to any of the Appellate Tribunal under which, such DRT come for transfer of all
applications to
anyone of the DRT as the Appellate Tribunal may decide.
8. Following documents are involved in a securitisation transaction.
(i) Offer document: The Reserve Bank of India in its guidelines of 2003 has
mentioned details about the form of offer and details to be incorporated therein.
By and large the full details and particulars about the financial asset, loan details
of bank, trustees' details, etc., are included. Some quarterly details are also
required to be disclosed. These include details
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about profit-loss, prepayments, expenses, defaults, collection, etc., and also any
other material thing affecting the securitisation arrangement.
(ii) Debenture: A debenture, for the payment of consideration, is to be paid to
the bank or the financial institution for the acquisition of financial asset from it.
As per the extant guidelines from RBI, the rate of interest offered in the
debenture cannot be less than one and half per cent above the Bank Rate as on
the date of issue of the debentures and the period of redemption of debenture
cannot exceed six years.
(iii) An agreement: It is with the originator to continue to service the assets of
the securitisation.
(iv) Security receipt: It is in favour of the investors.
22.5 NOTICES TO OBLIGOR AND DISCHARGE OF
OBLIGATION OF SUCH OBLIGOR
1. When the bank or financial institution decides, that the financial asset be
now acquired by the
securitisation or reconstruction company, a notice may be given about such an
acquisition to the
obligor, i.e., borrower or any other person liable to repay to the bank or financial
institution. Giving
of such notice is optional and not compulsory under the Act. In case, the obligor
is a company and
creation of charge has been registered, then also the giving of notice to the
respective registrar is
optional. Thus, there is no need of modification of charge with the Registrar of
Companies. However,
if the bank or financial institution decides to give notice to the obligor, then
notice to the ROC is
required to be given when the obligor is a company.
2. If notice of acquisition as said above is given to the obligor, it is
necessary that the obligor should
make payments to the concerned securitisation or reconstruction company. Such
payments amount
to a valid discharge of liability of the obligor making the payment.
If notice of acquisition, as said above is not given, the money or property
received by the bank or financial institution from the obligor shall be held by
such bank or financial institution in trust and shall be handed over to the
concerned securitisation company or reconstruction company.
22.6 ISSUE OF SECURITY RECEIPTS AND RAISING OF FUNDS BY
SECURITISATION OR RECONSTRUCTION COMPANY
1. The securitisation or reconstruction company raises funds for acquisition
of an asset by issue of
security receipts. Only the qualified institutional buyers can buy these security
receipts. The security
receipts are not issued to the public. The investment and financial market in this
field is very
complex and much risk assessment is required to be done by the investor. The
individual investor
does not possess such expertise. Therefore, the Act has debarred individuals
from making an
investment in securitisation or reconstruction company.
2. When the securitisation or reconstruction company decides to raise
funds from qualified institutional
investors following conditions apply:
(i) For each financial asset acquired or to be acquired there should be a separate
scheme.
(ii) Scheme-wise and asset-wise separate distinct accounts should be maintained.
(iii) Realisation of the asset is held and applied towards redemption, i.e.,
repayment of investments as assured while issuing the security receipt.
(iv) In case there is no realisation and repayment as said above, the qualified
institutional buyers, holding not less than seventy-five per cent of the total value
of the security receipts issued are entitled to call a meeting of all qualified
institutional buyers making investments in that scheme and the resolutions
passed in such a meeting are binding on the concerned securitisation or
reconstruction company.
(v) When the qualified institutional investors call the meeting, as said above, to
decide the further course of action due to non-realisation of the asset, they have
to follow the same procedure, as nearly as possible as is followed at meetings of
the board of directors of the securitisation company or reconstruction company,
as the case may be.
(vi) The funds raised or assets acquired out of the raised funds by the
securitisation or reconstruction company shall be held by such company in trust
for the investors.
3. When separate schemes are made and funds are raised by the securitisation or
reconstruction company, the provisions of SARFAESI Act do not directly
provide for setting up of trusts for each scheme. However, in totality the legal
effect is that there are resultant trusts in respect of each scheme. The investors in
such schemes become the beneficiaries under the trust and the company framing
the scheme is the trustee, managing the trust. The Reserve Bank of India
guidelines for securitisation also provide for such an arrangement. Due to such
trust arrangement the money held by the company are held in trust and do not
form the assets of the company. Due to this, in the eventuality of liquidation of
such a company the money does not pass on to liquidator and the beneficiaries
get the money on priority and distinctly.
22.7 EXEMPTION FROM REGISTRATION OF SECURITY RECEIPT
1. When the securitisation company or reconstruction company issues
security receipts the holder of
the security receipts is entitled to an undivided interest in the financial assets. In
such an event the
security receipt does not require registration that is otherwise compulsory under
the Registration
Act, 1908.
2. However registration of the security receipt is required in following
cases or eventualities,
(i) There is a transfer of the security receipt.
(ii) If the security receipt is creating, declaring, assigning, limiting or
extinguishing any right, title or interest to or in an immoveable property.
22.8 MEASURES OF ASSET RECONSTRUCTION
1. Asset reconstruction means the acquisition of any right or interest of any
bank of financial institution
in any financial asset for the purpose of realisation. Powers to take various
measures for asset
reconstruction are given without prejudice to the provisions contained in any
other law. Thus, the
powers given under the SARFAESI Act are subject to the provisions of all the
other existing laws.
2. The measures for asset reconstruction are as under :
(i) To change or takeover of the management of the business of the borrower for
proper management of business of the borrower.
Until now, the recovery actions against the defaulting borrowers were taken as a
last stage and as a last resort when the unit is closed and has incurred losses.
Such legal actions at the last stage when unit is unable to function do not give
desired recovery. With these new provisions under SARFAESI Act, a borrowal
unit that has been classified as NPA as per the applicable norms of ninety days
default, but is still functioning, can be treated differently by banks and financial
institutions. If the cause of default in such a unit is any mismanagement or lack
of expertise on the part of the existing management, the securitisation company
or reconstruction company has the powers to takeover the management or
change the management. This power can be exercised even when there is no
default. On realisation of the secured debt in full the management of the business
can be restored back to the borrower. When the lender lends money against a
security asset and creates charge over the assets, the ownership of the asset still
remains with the borrower who has
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created the charge. The lender has charge and the only objective is to have a
secured
lending and getting repayment by realising the asset, (ii) To sell or lease of a part
or whole of the business of the borrower, (iii) Rescheduling of payment of debts
payable by the borrower.
(iv) Enforcement of security interest in accordance with the provisions of the
SARFAESI Act. (v) Settlement of dues payable by the borrower, (vi) Taking
possession of secured asset in accordance with the provisions of the SARFAESI
Act.
3. In respect of these powers for asset securitisation, the following important
operative points need to be kept in mind.
(i) The power is not linked with any default by the borrower. Even without there
being any
default these powers can be exercised, (ii) The exercise of powers is subject to
existing laws.
(iii) There is no provision for having an overriding effect on the loan agreements
between the bank/financial institution and the borrower.
(iv) There is no civil appeal provided for against any action under this section.
(v) The SARFAESI Act is silent about the grounds or reasons based on which
the action of acquisition can be taken. Therefore, loan agreements between the
bank/financial institution and the borrower are required to be taken into account
as provisions of this section do not have an overriding effect on existing
contracts and laws.
(vi) The Act does not provide giving notice to the borrower before initiating any
action under this section. However, considering a Supreme Court ruling in the
Swadeshi Cotton Mills vs Union of India AIR 1981 SC 818, a hearing at pre-
decisional stage must be given before resorting to any action. The said ruling is
under a different law but on similar powers of taking over of the undertaking by
the Central Government. The same principle laid down in the said case, will
apply to these actions. Therefore, before taking action, notice to the borrower
will be required to be given.
(vii) The provisions contained in the SARFAESI Act for taking forcible
possession of the assets
are applicable to the secured assets only and not to other assets.
(viii) Since the actions can be taken in accordance with the loan agreements, it is
necessary that defaults as contemplated in such agreements have occurred.
(ix) If the contractual power arising out of the loan agreements to takeover or
change the management or to sale or to lease the business of the borrower
becomes exercisable, the same must be exercised under the provisions of the
SARFAESI Act.
(x) There are cases that the controlling shares of the promoter directors are
pledged with the bank/financial institution with power to transfer and sale of
such shares in case of default. In such cases, the power to change or takeover the
management or sale of business of the borrower can be done by sale of such
shares in accordance with the powers derived under loan agreements and the
provisions of the Indian Contract Act. Provisions of SARFAESI Act will not
apply to such cases because pledge and enforcement of pledge are kept outside
the purview of SARFAESI Act. For such transfer and sale of shares, compliance
of SEBI regulations regarding the takeover code and other applicable laws and
regulations will have to be done.
(xi) The acquisition powers under the SARFAESI Act are exercisable subject to
guidelines framed by Reserve Bank of India. This provision is incorporated in
the Act itself.
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22.9 OTHER FUNCTIONS OF THE SECURITISATION COMPANY
OR RECONSTRUCTION COMPANY
1. Any securitisation company or reconstruction company registered under
the SARFAESI Act may,
(i) Act as an agent for any bank or financial institution for the purpose of
recovering their dues from the borrower on payment of fees or charges as may
be mutually agreed upon between them.
(ii) Act as a manager for the secured assets, of which the possession is taken by
any bank or financial institution for such bank or financial institution on fees as
may be mutually agreed upon between the parties. However, if acting such as
manager gives rise to any pecuniary liability on the securitisation or
reconstruction company, then no such acting as manager can be done.
(iii) Act as receiver if appointed by any Court or Tribunal.
2. The securitisation company or reconstruction company can act as stated
above without the prior
approval of the Reserve Bank of India. For any other acts as well as business
other than securitisation
or asset reconstruction prior approval of the Reserve Bank of India is required.
For the purposes of above said provisions the 'securitisation company' or
'reconstruction company' does not include its subsidiary.
22.10 RESOLUTION OF DISPUTE
1. Any dispute between the bank or financial institution and the
securitisation or reconstruction company
as well as with or by qualified institutional buyer relating to securitisation or
reconstruction or
non-payment of any amount due or interest, is required to be settled by
conciliation or arbitration
as provided in the Arbitration and Conciliation Act, 1996. The dispute may be
amongst any of the
three parties stated above. The Act provides that settlement of dispute through
arbitration and
conciliation shall be as if the concerned parties have consented in writing for
such a settlement and
the provisions of Arbitration and Conciliation Act, 1996 shall apply.
2. Here it should be noted that only the said three parties are mentioned in
the provision made in the
Act. Obligor or borrower is not mentioned. Therefore, the provisions of
mandatory arbitration and
conciliation are not applicable to the dispute by or against the borrower.
22.11 POWER OF RESERVE BANK TO DETERMINE POLICY
AND ISSUE DIRECTIONS
1. If the Reserve Bank of India is satisfied that it is necessary or expedient
so to do, it may determine
the policy and give directions,
(i) In the public interest, or
(ii) To regulate financial system of the country to its advantage, or
(iii) To prevent the affairs of any securitisation company or reconstruction
company from
being conducted in a manner prejudicial to the interest of such securitisation
company or
reconstruction company.
2. The Reserve Bank of India directions are given to or policies are framed,
in respect of the
securitisation company or reconstruction company in matters related to,
(i) Income recognition,
(ii) Accounting standards,
(iii) Making provisions for bad and doubtful debts,
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(iv) Capital adequacy based on risk weights for the assets,
(v) Deployment of funds by the said companies.
Whenever, the Reserve Bank of India decides the policy, and issues directions,
the securitisation company or the reconstruction company is bound to follow the
same as it has a statutory effect.
3. In addition to the above stated powers vested with the RBI for making
policy or giving directions
generally, the RBI has the powers to make policy or issue directions to any
particular securitisation
or reconstruction company or a class of such companies or all such companies.
In such cases, in
addition to the aspects given above, on which the policy can be framed or
directions can be issued,
the RBI may do so on the following aspects also:
(i) The type of financial asset of a bank or financial institution which can be
acquired and procedure for such an acquisition of such assets and valuation
thereof.
(ii) The aggregate value of financial asset which may be acquired by any
securitisation company or reconstruction company.
4. Some important points from the guidelines issued until October 2004 by
the RBI are as under:
(i) On the acquisition of a financial asset that has been classified by the bank or
financial
institution as a non-performing asset, the securitisation company or the
reconstruction
company has to formulate a plan for realisation of such an asset within twelve
months.
During such a planning period, the asset can be classified as a Standard Asset,
(ii) Definition of a non-performing asset, has been linked to an overdue period,
which is now
ninety days, (iii) Any entity not registered with the Reserve Bank of India under
the SARFAESI Act, may
conduct the business of securitisation or asset reconstruction outside the purview
of
SARFAESI Act. (i v) The securitisation company or reconstruction company
can undertake activities and functions
as given in the SARFAESI Act and no other business.
(v) A securitisation company or reconstruction company cannot raise money by
way of deposits, (vi) At the time of enforcing securities as per provisions of the
SARFAESI Act, the securitisation
company or reconstruction company may itself acquire secured assets for use or
resale if
such resale is through a public auction, (vii) When the asset is acquired for
reconstruction there is a limit of five years for such
reconstruction, (viii) The securitisation company or reconstruction company is
permitted to set up trusts that
can issue security receipts. Trusteeship of such trusts vests in the concerned
securitisation
or reconstruction company, (ix) While issuing security receipts, detailed
disclosures are required to be made by the concerned
securitisation or reconstruction company, (x) The balance sheet of the asset
acquiring company should disclose names and addresses of
the banks/financial institutions from whom the assets are acquired with values
thereof,
industry-wise and sponsor-wise dispersion of assets and related party
disclosures, (xi) Maintaining of the capital adequacy of fifteen per cent of total
assets acquired or the capital
of Rs. 100 crore, whichever is less.
5. The RBI has powers to call for statements and information at any time
from the securitisation or
reconstruction company, relating to the business and affairs of these companies
as the RBI may
consider necessary.
L.R.A.D-16
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22.12 LET US SUM UP
In this unit, we have seen about the functional part of the securitisation and
reconstruction company. It includes the registration of these companies, their
functional freedom and the RBI restrictions thereon. There are some stipulations
for capital requirements and for raising the same. The existing companies
require registration. There are various conditions based on which the registration
is considered by the RBI. We have seen when registration of the company can be
cancelled and reasons thereof. How financial assets are acquired is important
and it involves detailed procedure. The effect of contracts, deeds, suits by or
against involving the security asset is also seen. There are specific documents
involved and the procedure for securitisation transaction. The acquisition of
asset involves the proper notice and procedure. There are conditions for raising
funds from the qualified institutional investors. Issuance of security receipts and
conditions/exemptions for the same is also seen. The asset reconstruction
company can take various measures for realisation from the asset. The Act
provides for dispute settlement between the securitisation/reconstruction
company and the investor by arbitration. RBI has powers to issue various
guidelines under the Act.
22.13 KEYWORDS
Securitisation Company and Reconstruction Company; Experienced
Professional Directors; Nominees of Sponsor Restrictions; No Conviction; No
Controlling Interest; Prudential Norms; Notice of Acquisition; Contents and
Procedure; Funds from Institutional Investors; Scheme-wise Trust; Security
Receipt; Arbitration.
22.14 CHECK YOUR PROGRESS
1. A securitisation or reconstruction company needs registration from the
RBI for commencement
of business. (True or False)
2. Right of acquisition of a financial asset by the securitisation or
reconstruction company is subject
to the prior agreements or contracts about the asset. (True or False)
3. Acquisition of a financial asset by the securitisation company or
reconstruction company is with
the liability also over such an asset. (True or False)
4. Which are the four documents involved in the securitisation transaction?
5. For each asset acquired or to be acquired, by the securitisation company
or the reconstruction
company there should be scheme.
6. When the securitisation company or reconstruction company issues
security receipts, the holder
thereof, is entitled to a in the financial asset.
7. The security receipt issued by the securitisation or reconstruction
company requires registration.
(True or False)
8. Any direction issued by the RBI under the SARFAESI Act has effect
and is
on the parties concerned.
22.15 ANSWERS TO 'CHECK YOUR PROGRESS'
1. True; 2. False; 3. False; 4. offer document, debenture, agreement and security
receipt; 5. separate; 6. undivided interest; 7. False; 8. statutory, binding.
22.16 MULTIPLE CHOICE TERMINAL QUESTIONS
1. After application of the SARFAESI Act what have the existing companies to
do about registration with RBI?
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(a) They are automatically deemed to be registered.
(b) They are required to stop functioning.
(c) Existing companies do not require registration
(d) They have to get registered within six months from the commencement
of the Act.
2. Which, from amongst the following, is a reason for the cancellation of
registration of the securitisation company and reconstruction company without
giving a hearing opportunity?
(a) The company does not keep accounts as per the RBI norms.
(b) The company ceases to carry on the business of securitisation or
reconstruction.
(c) The company fails to hold investment from the qualified investor.
(d) The company does not fulfil any of the conditions imposed at the time of
registration.
Ans. 1. (d); 2. (b).
UNIT
23
ENFORCEMENT OF SECURITY INTEREST
STRUCTURE
23.0 Objectives
23.1 Introduction
23.2 Enforcement of Security Interest
23.3 Chief Metropolitan Magistrate or District Magistrate's Assistance for
Taking Possession
of Secured Asset
23.4 Manner and Effect of Take Over of Management
23.5 No Compensation to Directors for Loss of Office
23.6 Right to Prefer Application to DRT
23.7 Appeals to Appellate Authority
23.8 Right of Borrower for Compensation and Costs
23.9 Let Us Sum Up
23.10 Keywords
23.11 Check Your Progress
23.12 Answers to 'Check Your Progress'
23.13 Multiple Choice Terminal Questions
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23.0 OBJECTIVES
We know that when immoveable property is obtained as security by way of
mortgage for its sale and realisation of money, Court intervention is required.
Similarly, in the case of moveable property also, except for the pledged security,
Court intervention is required for sale of property and realisation of money. Now
with the provision of this Act, there are changes in the procedures for sale of
securities. The creditor can also take the help of the District Magistrate or the
Chief Metropolitan Magistrate. We will see all these provisions in this unit.
23.1 INTRODUCTION
With introduction of NPA norms and its higher levels on one side and delay in
realisation of money by sale of properties through Court intervention on the
other side, giving powers to the lender to enforce security was essential, by the
introduction of new suitable enactment.
The SARFAESI Act empowers banks and financial institutions to enforce
securities in the event of default by the borrower without the intervention of
either, the Civil Court or the Debt Recovery Tribunal. The powers so given by
this Act, have an overriding effect on other laws in this respect. The powers are
also over and above other remedies available for recovery, by filling appropriate
proceeding either in a Civil Court or Debt Recovery Tribunal. The secured
creditor has been given the option to decide which course of action should be
adopted in respect of defaulted loans.
From the angle of banks and financial institutions this unit is very important. In
this unit, see about the powers to enforce the securities obtained, while lending
money and realise money therefrom. These powers can be exercised by the
creditor, i.e. lender without intervention of the Court.
23.2 ENFORCEMENT OF SECURITY INTEREST
1. Under the SARFAESI Act a secured creditor can enforce the security
interest created in his favour
without the intervention of the Court or Tribunal. This power given to the
secured creditor, has an
overriding effect over the provisions related to mortgage in the Transfer of
Property Act, 1882, as
in that Act Court intervention is required.
2. Section 13(2) of the SARFAESI Act speaks about the notice to be given
by the secured creditors to
the borrower, who has defaulted in making the repayment and whose account is
classified as
NPA. The precondition to get the right to serve this notice is that the notice
should be given asking
the borrower to discharge in full his liabilities to the secured creditors within the
sixty days from
the date of notice. Failing to do so by the borrower, the secured creditor gets
further rights as
detailed in the Act, that we will see later herein below.
3. The notice referred to above, should give the details of the amount
payable by the borrower and the
secured asset intended to be enforced by the secured creditor in the event of non-
payment of
secured debt by the borrower.
Though the Act contemplates giving of only two particulars, viz., details of
amount payable and details of securities, in the notice said above, it is more
proper to give the details of defaults, overdue period and the date from which the
account is classified as NPA, facility-wise securities provided for the loans and
particulars of security documents executed.by the borrower. The Act or the rules
made there under, have not prescribed any format of notice to be given.
However, this notice is a statutory notice having consequence, that the borrower
is prohibited from transferring the property mentioned in the notice in any way.
Any contravention of these legal consequences, if made, by the borrower is
punishable under the SARFAESI Act. So it is advisable that the notice mentions
about the legal consequences and the penal provisions.
233
4. The Act does not Contemplate a reply from the borrower to the notice.
But the borrower may reply
or make representation to the notice, so received by him. The Supreme Court in
Mardia Chemicals
Ltd. case, has laid down certain guidelines about what the bank or the financial
institution should
do when the borrower submits any reply or representation to the said notice.
These guidelines
broadly are as under:
(i) The secured creditor must apply his mind to the objection raised by the
borrower in reply or representation to the notice served on him by the secured
creditor.
(ii) An internal mechanism must be particularly evolved to consider the reply of
the borrower.
(iii) There may be some meaningful consideration in the objection raised by the
borrower and the rejection of the points raised by the borrower should not be
ritually followed by execution of drastic action under the Act.
(iv) The reasons for overriding the objections of the borrower must be
communicated to him by the secured creditor.
(v) While directing that the reasons for the rejection must be conveyed to the
borrower, the Supreme Court has clarified that the communication to the
borrower giving the reasons for not accepting the objections of the borrower
does not give an occasion to resort to any proceedings, such as a stay
application, injunction, any other type of suit to restrain the creditor's actions.
After this ruling, there has been an amendment to the Act. Now, Section 13(3A)
says that if the borrower on receipt of the notice under Section 13(2) from the
secured creditor makes any representation or raises any objection, the secured
creditor has to consider the representation or the objection and, if it is not tenable
or acceptable it has to be communicated within one week to the borrower. The
borrower has to be communicated the reasons for non-acceptance of the
representation or the objections. However, such communication or reasons
mentioned therein by the secured creditor or the likely action as contemplated
does not confer any right upon the borrower to prefer an appeal to the DRT or to
any Civil Court.
5. If the borrower does not pay in full as per the notice such non-payment
by the borrower gives the
secured creditor right to take recourse to one or more of the following measures
to recover his
secured debt:
(i) Take possession of the secured assets of the borrower including the right to
transfer by way of lease, assignment or sale for the realisation of money from the
secured asset. This right can be exercised only when a substantial part of the
business of the borrower is held as security for the debt.
(ii) Takeover the management of the secured asset of the borrower including the
right to transfer by way of lease, assignment or sale and realise the secured asset.
(iii) Appoint any person as manager to manage the security assets the possession
of which has been taken over by the secured creditor.
(iv) Require at any time, by giving a notice in writing, any person who has
acquired the secured asset from the borrower and from whom any money is due
or may become due to the borrower, to pay to the secured creditor. Such
demands from the other person will be to the extent of secured debt. If such
other person pays any amount to the secured creditor the person so paying gets a
valid discharge as if he has made payment to the borrower.
6. Any transfer of secured asset effected by the secured creditor as
provided under this Act, shall
vest in the transferee all rights in, or in relation to, the secured asset as if the
transfer has been
made by the owner of such a secured asset.
7. When sale of the secured asset is made the appropriation of sale
proceeds realised are required to
be made in the following order:
234
(i) Firstly, towards costs, charges and expenses incidental towards preservation
and protection of securities, insurance premiums, etc., that are recoverable from
the borrower.
(ii) Secondly, towards the due of the secured creditors.
(iii) Thirdly, if there is any surplus it will be paid to the person entitled thereto,
in accordance with the right and interests.
The above stated order of payment thus gives the right of secured creditors to
realise their securities in preference to all other creditors and even the other
preferential payments like the dues payable to the Government labour, etc.
8. If the borrower pays the entire dues, costs charges and expenses incurred
by the creditor at any
time before the date fixed for sale or transfer, the secured creditor shall not sell
or transfer the
secured asset and no further steps shall be taken for sale or transfer. In cases of
joint finance or
consortium finance by two or more secured creditors no secured creditor can
take any action of
taking possession of secured asset, unless exercise of such right is agreed upon
by the secured
creditors representing not less than three-fourths in value of the outstanding dues
on the record
date. The 'outstanding amount' shall include principal, interest and any other
dues payable by the
borrower to the secured creditors in respect of secured asset as per the books of
account of the
secured creditors. The 'record date' means the date agreed upon by the secured
creditors representing
not less than three-fourths in value, of the amount outstanding on such date. Any
decision taken by
such creditors is then binding on all other remaining creditors.
9. In case the borrower is a company under winding up process, the dues
payable to the workmen
have pari passu charge with the secured creditors as provided in Sections 529
and 529A of the
Companies Act. This is the exception for the priorities the secured creditor
otherwise gets when he
initiates recovery actions under the SARFAESI Act. The dues of the workmen
are required to be
deposited from the realised amount with the liquidator. In case the dues are not
ascertained or
ascertainable at such a time, then the liquidator has to give an estimated amount
to be deposited.
The liabilities of the secured creditor to payout of the realised amount from the
secured asset is not
finished due to the payment of the estimated amount but the balance amount on
finalisation is
required to be paid.
If after the sale of the secured asset the entire dues of the secured creditors are
not recovered and still there is due balance then the secured creditor can file an
application before DRT or a civil suit in a competent Civil Court. Depending on
the amount to be recovered the pecuniary jurisdiction will be decided.
10. Apart from the security assets, many times the secured creditor may be
holding security by way of
pledge of any moveable or guarantee of any person for the due repayment of the
loan amount. In
such cases, secured creditors are entitled to sell the pledged goods or proceed
against the guarantor
to recover the defaulted loan without initiating any actions against the security
asset. Thus, the
right against security under the SARFAESI Act and the one against the pledged
security and
proceeding against guarantor are kept separate and distinct.
11. The SARFAESI Act has given different rights to the secured creditor.
The rights of a secured
creditor under the Act may be exercised by one or more of its officers authorised
in this behalf in
such manner as may be prescribed. As the powers of enforcing securities need to
be exercised
prudently, fairly, and with due care and caution the Rules framed under the
SARFAESI Act provide
that the authorised officer should be of the level equivalent to a Chief Manager
of a public sector
bank or equivalent or any other authorised person exercising powers of
superintendence, direction
,s and control of the business or affairs of the creditors, as the case may be.
235
12. When the borrower receives the notice from the creditor under Section
13(2), the borrower shall
not transfer by way of sale, lease or otherwise, other than in the ordinary course
of business, any
of his secured assets referred to in the notice without prior written consent of the
secured creditor.
Non-compliance with this provision attracts penal provisions under the
SARFAESI Act that provide
for punishment of imprisonment of one year or fine or both.
13. The provision of Section 13 at different sub-sections gives power to the
secured creditor for
taking the security into possession and then sell the same. This entire process
involves several
factors of fairness and technicalities. Therefore, the Rules framed under the
SARFAESI Act, have
laid down certain procedural aspects in this connection. Some broad procedures
and precautions
as per the Rules are as under:
(i) Inventory of the property taken into possession be made and the property
must be entrusted
to any person authorised or appointed by the secured creditor, (ii) The secured
creditor shall take care of the property under his possession as an owner of
ordinary prudence, preserve and protect the secured assets and insure the same if
necessary
until they are sold, (iii) If the property is subject to speedy or natural decay or
the expense of keeping such property
in custody is likely to exceed its value, then the authorised officer can sell it at
once, (iv) For taking of possession and then sale of immoveable property, the
secured creditor is
required to serve a possession notice as nearly as possible as given in Appendix
IV to the
Rules on the borrower and by affixing the possession notice on the outer door or
at a
conspicuous place at the property, (v) The authorised officer is required to obtain
a valuation of the immoveable property before
sale, fix the reserve price after consulting the secured creditor and sell it by
methods permitted
under Rule 8. (vi) The authorised officer is required to publish the possession
notice in two leading newspapers,
one of which should be in the local vernacular language, (vii) Thirty days before
sale of the immoveable property, the borrower should be given a notice
about the sale. If the sale is by public auction or by inviting tenders from the
public, notice
is required to be published in two leading newspapers, one of which should be in
the local
vernacular language, detailing the terms of sale, (viii) If the price for the secured
asset is coming to less than the reserve price, the authorised
officer can sell the asset at a lower price with the consent of the borrower and
secured
creditor, (ix) When the offer of sale of property is accepted by the purchaser and
the secured creditor
accepting the offer confirms the sale, the purchaser has to deposit twenty-five
per cent of
the offer price, (x) In case of immoveable property, the purchaser has to deposit
the amount required to clear
the encumbrance. The authorised officer then has to pay and remove the
encumbrance
after giving notice to the concerned parties.
14. The authorised officer is authorised to issue the sale certificate. Such a
certificate is conveyance of
immoveable property and requires stamping, as may be required under the
relevant State laws.
23.3 CHIEF METROPOLITAN MAGISTRATE OR DISTRICT
MAGISTRATE'S ASSISTANCE FOR TAKING POSSESSION OF SECURED
ASSET
1. When the secured creditor is required to take possession or control of the
secured asset or when the secured asset is required to be sold or transferred
under the provisions of the SARFAESI Act,
236
the secured creditor can take the help of the Chief Metropolitan Magistrate or the
District Magistrate. For seeking such help the secured creditor has to make a
request in writing to the said authority within whose jurisdiction the secured
asset or documents related to it are situated.
2. On such request being made the Chief Metropolitan Magistrate or the
District Magistrate, as the case may be, shall take possession of the security asset
and documents relating thereto.
For compliance of the provisions of the Act as stated above, the Metropolitan
Magistrate or the District Magistrate may take or cause to be taken such steps
and use or cause to be used such force as may be in his opinion necessary. Any
act of the Metropolitan Magistrate or the District Magistrate for and while taking
possession of the security shall not be called in question in any Court or before
any authority.
A very important aspect of these provisions is that the powers of taking
possession, or causing the same, are given to the judicial authority, who will take
the possession and hand it over to the secured creditor.
23.4 MANNER AND EFFECT OF TAKE OVER OF MANAGEMENT
1. When the secured creditor takes over the management of business of a
borrower, he may publish
a notice in a newspaper published in the English language and in a newspaper
published in an Indian
language in circulation in the place where the principal office of the borrower is
situated, for
appointment of:
(i) If the borrower is a company as defined in the Companies Act, 1956, to be
the directors of
such company, or (ii) In any other case, to be the administrator of the business of
borrower.
2. On publication of such a notice, the directors of the company, in case the
borrower is a company
and in other cases, the person holding any office having power of
superintendence, direction and
control of the business of the borrower immediately before the publication of the
notice, shall be
deemed to have vacated their offices. As an effect of this, any management
contract between the
borrower and any directors or manager thereof shall be deemed to be terminated.
3. On publication of the above said notice and then after the appointments
of directors or the
administrators as stated above, all the property and effects of the business of
borrower are deemed
to be in the custody of the directors or the administrators so appointed, as the
case may be. All the
directors or the administrators are empowered to take such steps as may be
necessary to take into
their custody or under their control all the property, effect and actionable claims
to which the
borrower is entitled. Thereafter, the directors or the administrators are alone
entitled to exercise all
the powers of superintendence, direction and control of the business of the
borrower. Such powers
are derived as if from the memorandum or articles of association of the company
or from any
other source whatsoever.
4. Where the management of the business of a borrower which is a
company as defined in the Companies
Act, 1956, is taken ever by the secured creditor, then, notwithstanding anything
contained in the
Companies Act, 1956 or the memorandum or in the articles of association
following effects apply:
(i) The shareholders of the company can lawfully appoint any person to be a
director of the
company, (ii) No resolution passed by the shareholders of the company shall be
given effect to, unless
approved by the secured creditor, (iii) No proceeding for the winding up of such
company or for the appointment of a receiver for
the company shall lie in any Court, except with the consent of the secured
creditor.
237
5. Where the management of the business of a borrower has been taken over by
'the secured creditor', on realisation of the debt in full the secured creditor shall
restore the management of the business of the borrower to him.
23.5 NO COMPENSATION TO DIRECTORS FOR LOSS OF OFFICE
No managing director or director or any person in charge of management of the
business of the borrower shall be entitled to any compensation for the loss of
office or for premature termination of any contract of management, entered into
by him with the borrower. This provision has an overriding effect over any other
laws or contract.
However, if any director or any other person controlling the management has to
recover any amount from borrower, it can be recovered.
23.6 RIGHT TO PREFER APPLICATION TO DRT
1. Any person, including the borrower, aggrieved by any of the measures
taken by the secured
creditor or his authorised officer for taking possession of the security may make
an application
along with the prescribed fees, to the Debts Recovery Tribunal having
jurisdiction within forty-
five days from the date on which such measures are taken. There can be different
prescribed fees
for the borrower's application and the application from other than the borrower.
The right to file an
application is provided not only to the borrower but also to any person aggrieved
by the action
taken by the secured creditor.
2. The Debts Recovery Tribunal has to dispose of the application, in
accordance with the provisions
of the recovery of debts due to Banks and Financial Institutions Act, 1993 and
the Rules made
thereunder. The application has to be disposed as early as possible, but within
sixty days. If for any
reason it is not possible to so dispose the application, the Tribunal has to record
the reasons for
delay, but such delay should not be beyond four months from the date of filing
of the application.
If any such application is not disposed within four months, the aggrieved party
can prefer an
application to the Appellate Tribunal for seeking directions for the early disposal
of the application.
23.7 APPEAL TO APPELLATE AUTHORITY
Any person aggrieved by any order made by the debts recovery tribunal can
prefer an appeal along with the prescribed fees to the Appellate Tribunal within
thirty days from the date of receipt of the order of debts recovery tribunal. There
can be different fees prescribed for the borrower's appeal and an appeal by
anyone other than the borrower. The amendments to the Act made in November
2004 have now stipulated that no appeal can lie unless the borrower deposits
fifty per cent of the debt claimed by the secured creditor. The tribunal has
powers for reasons to be recorded, to reduce this amount to twenty-five per cent
of the claim amount.
23.8 RIGHT OF THE BORROWER FOR COMPENSATION AND COSTS
1. If the debt recovery tribunal or the appellate tribunal, as the case may be
(i) holds that the possession of secured asset by the secured creditor is not in
accordance with
the provisions of the Acts or Rules framed thereunder and (ii) directs the secured
creditor to return the secured asset to the borrower, then such borrower
shall be entitled to payment of such compensation and costs as may be
determined by the
tribunal or the appellate tribunal.
238
2. No pecuniary limit is fixed by the Act for the appellate jurisdiction. The
jurisdiction of the DRT is Rs. 10 lakh and above under the Recovery of Debts
due to Banks and Financial Institutions Act, 1993. However, the SARFAESI Act
does not provide any pecuniary limit. Therefore, appeal before the DRT against
the actions initiated by the secured creditors in cases even below Rs. 10 lakh
would lie.
23.9 LET US SUM UP
In this chapter, we have seen the details about enforcement of securities by
banks and financial institutions and the procedural requirements thereof. We
have discussed how, on default being committed by the borrower, the creditor
can enforce the securities as per provisions of the Act. For this no Court
intervention is required as earlier. The service of notice calling for payment and
on failing to pay, the creditor can invoke the provisions for the take over of the
asset/management. After the notice, transfer by the borrower is prohibited. The
reply to the notice needs consideration on lines with Supreme Court directions as
in Mardia case. Creditor can also call for payment due to the borrower from a
third party. For the remaining dues after sale of assets, the remedy at Civil Court
or DRT are open as per jurisdiction. For initiating various actions under the Act
there is need of an authorised person. While taking possession of the asset,
various precautions are required to be taken. For talcing possession, help of the
Chief Metropolitan Magistrate or District Magistrate can be taken. In such an
event the possession is taken by such authorities and handed over to the creditor.
Against the possession notice, appeal can be made but on payment of the amount
as prescribed. If possession is wrongfully taken, the creditor has to pay
compensation to the borrower. For appeal to the tribunal fifty per cent of the
debt amount is required to be deposited.
23.10 KEYWORDS
Enforcement of Security; Notice for Default; Contents; Take Over Management;
Payment in Hands of Third Party; Consortium/Joint Finance; Payment of
Labour; Pari Passu; Independent Remedy.
23.11 CHECK YOUR PROGRESS
1. Asset reconstruction means
by any securitisation company or reconstruction
company of any right or interest of the creditor in any
2. SARFAESI Act is applicable to the Regional Rural Banks. (True/False)
3. Mortgage or asset backed debt instruments can be issued by the
securitisation company or
reconstruction company to the general public. (True/False)
4. A guarantor to the loan is within the meaning of the word borrower
under SARFAESI Act.
(True/False)
5. SARFAESI Act is applicable only when there is security. (True/False)
6. Has SARFAESI Act defined hypothecation and whether the Act is
applicable to hypothecation
security? (True/False)
23.12 ANSWERS TO CHECK YOUR PROGRESS'
1. acquisition, financial assistance; 2. False; 3. False; 4. True; 5. True; 6. True
23.13 MULTIPLE CHOICE TERMINAL QUESTIONS
1. On giving of a default notice by the creditor, the borrower gives a reply to it.
What should the creditor do?
239
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(a) Ignore the notice as the law does not provide for any reply option to the
bank.
(b) Wait until the borrower initiates any legal action based on his reply.
(c) Give due consideration to the reply as per the guidelines issued in the
Mardia Chemical case
by the Supreme Court and reply to it.
(d) Take the matter before DRT for resolving issues raised in the reply.
2. On sale of the security asset, the sale proceeds are appropriated firstly.
(a) Towards the satisfaction of dues of secured creditor.
(b) Towards the payment of dues of labour.
(c) Towards payment of cost, charges and expenses for the preservation and
protection of
securities, insurance premiums, etc.
(d) Towards payment of legal costs incurred by the creditor for taking
possession and for
effecting sale.
Ans. 1. (c); 2. (c).
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CENTRAL REGISTRY
STRUCTURE
24.0 Objectives
24.1 Introduction
24.2 Central Registry
24.3 Central Registrar
24.4 Register of Securitisation, Reconstruction and Security Interest
Transactions
24.5 Filing of Transactions of Securitisation, Reconstruction and Creation of
Security Interest
24.6 Modification of Security Interest Registered
24.7 Satisfaction of Security Interest
24.8 Right to Inspect Particulars of Securitisation, Reconstruction of Security
Interest
Transactions
24.9 Let Us Sum Up
24.10 Keyword
24.11 Check Your Progress
24.12 Answers to 'Check Your Progress'
24.13 Multiple Choice Terminal Questions
242
24.0 OBJECTIVES
The SARFAESI Act has brought in a new concept of security and the
enforcement of security. For a proper noting and registering of the charges
created in favour of the secured creditors against the properties that would
eventually be enforced, the charges created need to be noted with authority. It is
like the charges noted with the Registrar of Companies in case of charges
created against the property of the Company. This unit deals with the central
registry created under the SARFAESI Act.
24.1 INTRODUCTION
The creation of a security interest in property has gained importance and
significance with the provisions of the SARFAESI Act. It has given various
powers to the creditor. The securitisation and reconstruction companies will be
carrying on transactions of a different nature in accordance with the provisions
of the Act. Therefore, both of these need an authentic registration. In this unit,
we will see about the central registry with whom the transactions above and the
creation of charges over security will be required to be registered. In this unit,
we will see the provisions about the same.
24.2 CENTRAL REGISTRY
1. The Central Government is authorised to set up or cause to be set up a
'Central Registry' by issue
of notification from such date as may be specified in the notification for the
purpose of registration
of following transactions:
(i) Securitisation and reconstruction of financial assets (ii) Creation of security
interest under the SARFAESI Act.
Maintaining the records of the 'Registry' on computers is permissible under the
Act. The Government can also establish branch offices at other places. The
Government has the authority to decide the territorial jurisdiction of these offices
for the purpose of registration.
2. There are some other Acts which require registration of certain things
and charges. These Acts are:
(i) Registration Act, 1908 (ii) Companies Act, 1956
(iii) Merchant Shipping Act, 1958 (iv) Patents Act, 1970
(v) Designs Act, 2000 (vi) Motor Vehicles Act, 1988
The registration contemplated before the central registry is in addition to the
respective registrations contemplated under the above stated six Acts or any
other Act. Thus, the registration under SARFAESI Act is not in substitution of
the other registrations required under different laws. This is obvious because the
purpose and effect and consequence of registration are different under different
respective Acts. The registration under different laws will have priority of
charge depending on the provisions of respective registration laws.
24.3 CENTRAL REGISTRAR
The Central Government has to appoint by notification a person as central
registrar for the purpose of registration contemplated under the Act. The Central
Government is also empowered to appoint such other officers with such
designations as it thinks fit for the purpose of discharging various duties for
registrations under the Act.
24.4 REGISTER OF SECURITISATION, RECONSTRUCTION AND
SECURITY INTEREST TRANSACTIONS
A record shall be maintained at the central registrar at the head office of the
central registrar in which transactions relating to
243
(i) Securitisation of financial assets,
(ii) Reconstruction of financial assets,
(iii) Creation of security interests shall be maintained.
The record of central registrar can be kept fully or partly on computer, floppies,
diskettes, or any other electronic form. Any entry made with the central registrar
shall be a reference to any such transaction. The central registrar shall have the
control and management of the central register.
24.5 FILING OF TRANSACTIONS OF SECURITISATIQN,
RECONSTRUCTION AND CREATION OF SECURITY INTEREST
Under the SARFAESI Act, now filing of details of transactions of securitisation,
reconstruction and the creation of security interest is required to be filed with the
central registrar. The period of filing such details in proper form as may be
prescribed, is thirty days after the date of transaction or the creation of security.
The central registrar has to prescribe fees for such filing. The particulars are
required to be filed as stated above by the securitisation company or the
reconstruction company or the secured creditor, as the case may be. The delay in
filing the said particulars can be condoned by the central registrar for a period of
next thirty days after the first thirty days prescribed, on payment of fees not
more than ten times of the prescribed fees.
24.6 MODIFICATION OF SECURITY INTEREST REGISTERED
Whenever any security interest is registered with the central registrar is
modified, the modification is required to be filed before central registrar. It is the
duty of the securitisation or the reconstruction company or the secured creditor
to file the modification. For filing the modification same provisions as are made
for registration of charge apply. This means, modification will have to be filed
within thirty days in the prescribed forms with prescribed fees. Delay
condonation will be for a period of next thirty days on payment of fees not more
than ten times of the prescribed fees.
24.7 SATISFACTION OF SECURITY INTEREST
1. The security interest registered with the central registrar is required to be
satisfied on the payment
of full amount by the borrower. The duty to report satisfaction is on the
securitisation or
reconstruction company or the secured creditor, as the case may be. The
reporting is required to
be done within thirty days of payment in full or satisfaction of the charge.
2. On receipt of the satisfaction of the charge the central registrar is
required to cause a notice to be issued
to the securitisation or reconstruction company or the secured creditor, calling
upon to show cause
within a time not exceeding fourteen days as to why the payment or satisfaction
should not be recorded
as intimated. If no cause is shown then the central registrar has to order that a
memorandum of
satisfaction shall be entered in the central register. If any cause is shown the
central registrar shall record
a note to that effect in the central register and shall inform to the borrower about
it.
24.8 RIGHT TO INSPECT PARTICULARS OF SECURITISATION,
RECONSTRUCTION OF SECURITY INTEREST TRANSACTIONS
The particulars of securitisation or reconstruction or security interest entered in
the central register are open for inspection by any person during office hours on
payment of fees as may be prescribed. Same is applicable if the data is kept in
the electronic form at the office of the central registrar.
L.K.A.B-17
244
24.9 LET US SUM UP
Central Government has to set up or cause to set up central registry for
registration of securitisation and reconstruction transaction and creation of
security interest. Registration under other applicable laws will continue. All
transactions and creation of security interest needs to be noted. Modification and
satisfaction also needs noting in prescribed form with payment of fees.
24.10 KEYWORD
Central Registry.
24.11 CHECK YOUR PROGRESS
1. After coming into operation, the provisions relating to central registry
the banks and financial
institutes will have to register all security interests created in the asset.
(True/False)
2. The period stipulated in the Act for filing details of security interest is
days.
3. Duty to report satisfaction of charge to the central registrar is on creditor
or on the borrower?
24.12 ANSWERS TO 'CHECK YOUR PROGRESS'
1. True; 2. 30; 3. Creditor.
24.13 MULTIPLE CHOICE TERMINAL QUESTIONS
1. Besides the SARFAESI Act, some other laws require some registration of
charge created in the property. Is such double registration avoidable?
(a) Yes, the creditor can choose under which law he needs registration.
(b) No, registration under the SARFAESI Act as well as any other
applicable law will have to be
made as the SARFAESI Act is not substitution of any other law.
(c) Yes, if one charge noting is by a registered document.
(d) No, as the Civil Courts and DRT still have jurisdiction against the
properties both registrations
are required.
Ans. 1. (b)
tion ible and
OFFENCES AND PENALTIES
rial
the
)be
STRUCTURE
25.0 Objectives
25.1 Introduction
25.2 Penalties
25.3 Penalties for Non-compliance of Directions of Reserve Bank of India
25.4 Offences
25.5 Cognisance of Offences
25.6 Let Us Sum Up
25.7 Keyword
25.8 Check Your Progress
25.9 Answers to 'Check Your Progress'
25.10 Multiple Choice Terminal Questions
ons
246
25.0 OBJECTIVE
The objective of this unit is to know the penal provision of the Act. For effective
implementation of the law and as a deterrent step to prevent improper actions by
parties concerned penal provisions are kept in laws.
25.1 INTRODUCTION
The Act has given many statutory obligations. If anything said in the law is not
acted upon or is not followed there is a breach of the legal provisions. So there
are penalties provided in the Act. In this chapter, we will see about the offences
and penalties. It also gives details about which Court should be dealt with for
imposition of penalty for breach of provisions of the Act.
25.2 PENALTIES
Section 23 of the Act provides for filing of the particulars of charge created.
Section 24 has provides for modification of the charge filed and the Section 25
has provides that the satisfaction of the charge has to be intimated to the central
registrar. If the securitisation or reconstruction company or the secured creditor
fails to perform any of the duties as stated above, the company and the officers
concerned for the default, as per provisions of this section, are punishable with a
fine that may extend to five thousand rupees for each day during which the
default continues.
25.3 PENALTIES FOR NON-COMPLIANCE OF
DIRECTIONS OF RESERVE BANK OF INDIA
Under the Section 12 of the SARFAESI Act, the Reserve Bank of India is
statutorily empowered to issue directions to the securitisation or reconstruction
company. If any such company fails to comply with any of the directions issued
by the Reserve Bank of India, then such company is punishable with a fine not
exceeding Rs. 5 lakh for the default. In case of further continuation of the
offence, an additional fine up to Rs. 10,000 per day of the default can be
imposed.
25.4 OFFENCES
If any person:
1. contravenes, or
2. attempts to contravene, or
3. abets the contravention of the provisions of the SARFAESI Act or rules
made thereunder, he shall
be punishable with imprisonment for a term, which may extend to one year or
with a fine or both.
The Act has made various provisions where duties are cast on the borrower, the
secured creditor, the securitisation and the reconstruction company. Any
contravention of these provisions is punishable as stated above under the
provisions of this section.
25.5 COGNISANCE OF OFFENCES
Section 30 provides that cognisance of the offence under the SARFAESI Act
shall be taken by the Metropolitan Magistrate or the Judicial Magistrate of First
Class only. No Court below rank than this can take cognisance of such offences.
25.6 LET US SUM UP
If the charges created, modified and satisfied are not intimated to the central
registrar it is an offence. The securitisation company or the reconstruction
company is required to perform various duties under the Act. Breach thereof is
also an offence. The punishments are up to Rs. 5,000 for each day of default.
Breach of RBI directives is also punishable by a fine up to Rs. 5 lakh and Rs.
10,000 for continuation per day. Any general infringement of provisions of
SARFAESI Act is punishable with imprisonment for one year or fine or both.
25.7 KEYWORDS
Offences for Breach.
25.8 CHECK YOUR PROGRESS
1. Is there any punishment provided in the Act for not following RBI
directions? (Yes/No)
2. Can the Honorary Magistrate take cognisance of offence under the
SARFAESI Act?
25.9 ANSWERS TO 'CHECK YOUR PROGRESS'
1. Yes; 2. No
25.10 MULTIPLE CHOICE TERMINAL QUESTIONS
1. Whether breach of RBI directives is punishable offence and to what extent?
(a) Yes, a fine up to Rs. 5 lakh and for continuation of offence a fine of up
to Rs. 10,000 per
day.
(b) Yes, by cancellation of licences of the company.
(c) No, these are the administrative directions.
(d) No, the Act has not provided for any punishment in specific.
Ans. 1. (a)
MISCELLANEOUS PROVISIONS
STRUCTURE
26.0 Objective
26.1 Introduction
26.2 Non-Applicability of the Provisions of the SARFAESI Act in Certain
Cases
26.3 Protection of Action Taken in Good Faith
26.4 Offences by Companies
26.5 Civil Court not to have Jurisdiction
26.6 Overriding Effect on Other Laws
26.7 Limitation
26.8 Power of the Central Government to Make Rules
26.9 Certain Provisions of the Act to Apply after Central Registry is Set Up
or Cause
to be Set Up
26.10 Amendments to Certain Other Enactments
26.11 Let Us Sum Up
26.12 Check Your Progress
26.13 Answers to 'Check Your Progress'
26.14 Multiple Choice Terminal Questions
250
26.0 OBJECTIVE
The objective of this unit is to understand the exceptions of securities to which
this Act is not applicable. At the same time, the person or the organisation
utilising the provisions and powers given under this Act should know about the
legal protections the Act has given when it is implemented properly and in good
faith. At the same time, if any of the provisions are not followed, then it has
penal provisions also.
26.1 INTRODUCTION
In this unit, we will see some miscellaneous provisions about implementation of
the Act. Section 31 gives some exclusions of securities to which the Act is not
applicable. For creditor it is important to note these exclusions. The Act has
given many strict powers to take possession of security, change of management,
etc. These require some hard steps to be taken. So the person exercising the
rights under the Act needs a legal protection. Section 32 gives such protection
for action taken in good faith under the Act. Similarly, to curb the tendency of
the borrowers to go to Civil Court or any other authority and bring injunctions,
stay, orders for status quo, etc., the Act has barred the jurisdiction of Civil Court
as well as other authorities for the matters covered by this Act. The unit also
deals with offences, limitation period for actions, overriding effect on other
laws, Central Government powers to make rules and some such provisions for
effective implementation of the Act.
26.2 NON-APPLICABILITY OF THE PROVISIONS OF
THE SARFAESI ACT IN CERTAIN CASES
The object of the SARFAESI Act is to give powers to the banks and financial
institutions to enforce the securities given to the loans and advances by the
borrowers without the intervention of the Court. It should be noted that the
securities not in possession of the bank or financial institution are only covered
by this Act. The securities in possession of the secured creditors are not covered
by this Act and provisions of the Act are not applicable to them.
Therefore, the Section 31 gives the exclusions for securities that can be taken
possession of and to some other specific securities to which the Act is not
applicable. These exclusions, to which the provisions of the Act are not
applicable, are
(i) A lien, on any goods, money or security given by or under the Indian
Contract Act, 1872 or the
Sale of Goods Act, 1930 or any other law for the time being in force.
(ii) A pledge of movable, within the meaning of Section 172 of the Indian
Contract Act, 1872. (iii) Creation of security interest in any vessel as defined
within the meaning of Section 3(55) of the
Merchant Shipping Act, 1958.
(iv) Creation of security in any aircraft as defined in Section 2 of Aircraft Act
1934. (v) Any conditional sale, hire-purchase or lease or any other contract in
which no security interest
has been created.
(vi) Any rights of unpaid seller under Section 47 of the Sale of Goods Act, 1930.
(vii) Any properties not liable for attachment or sale under the first proviso to
Section 60(1) of the
Civil Procedure Code, 1908.
(viii) Any security interest for securing repayment of any financial asset not
exceeding one lakh rupees, (ix) Any security interest created in agricultural land,
(x) Any case, in which the amount due is less than twenty per cent of the
principal amount and
interest thereunder.
26.3 PROTECTION OF ACTION TAKEN IN GOOD FAITH
The secured creditors and their officers are protected for actions taken in good
faith by the provisions made in the Act. For initiating actions under the Act no
suit, prosecution or any other legal proceeding
251
can be taken against the secured creditor or his officers. This protection is given
so that actions contemplated and authorised under SARFAESI Act, can be taken
without fear of counteraction from the borrower or any other person having
interest in the property.
26.4 OFFENCES BY COMPANIES
1. If a company and its officers commit any offence under the provisions
of the SARFAESI Act the
same is punishable. There are provisions in the Act that cast some statutory
obligations. If these
statutory obligations are not observed then there is contravention of the Act
which amounts to
offence. If any offence is committed under the provisions of this Act by a
company, such company,
as well as any person who is in charge of the business of the company, are
deemed to be guilty of
the offence and they are liable to be prosecuted and punished. It is permissible
for a person acting
for the company to prove that the offence was committed without his knowledge
or that he had
exercised due diligence to prevent the commission of such offence. In such cases
and on proving
his stand the person concerned shall not be punishable. If such offence is
committed with the
consent or connivance of any director or officer of the company, such director or
officer shall be
deemed to be guilty for the offences along with the company.
2. The penal provisions are applicable to all categories of borrowers such
as individuals, partnership
firms, companies incorporated under the Companies Act or any other association
of individuals.
The Act has clarified, that company includes a partnership firm or other
association of individuals
and the expression director includes a partner of a firm.
26.5 CIVIL COURT NOT TO HAVE JURISDICTION
1. The SARFAESI Act has conferred jurisdiction on many matters to the debts
recovery tribunal or the appellate tribunal. Therefore, for any such matters where
empowerment and jurisdiction is to the debts recovery tribunal or the appellate
tribunal, no Civil Court shall have jurisdiction to entertain any suit or
proceedings. Similarly, any Court or authority cannot grant injunction in such
matters and actions taken, or to be taken, under this Act as well as under
Recovery of Debts Due to Banks and Financial Institutions Act, 1993. Due to
such provisions the implementation of the Act becomes effective.
26.6 OVERRIDING EFFECT ON OTHER LAWS
The provision of this Act has overriding effect on any other laws if the
provisions in the other law are inconsistence with this Act. If for any particular
point, the provisions of this Act and in some other Act are inconsistent with each
other, a question will come as to which provisions are to be followed, when both
such Acts are applicable to that particular point. The Act, therefore, provides that
the provisions of the SARFAESI Act will have overriding effect on the other
Act. Mainly, such inconsistencies are in the Transfer of Property Act and the
Registration Act. The provisions the SARFAESI Act will apply, overriding the
provisions in those Acts.
26.7 LIMITATION
The actions that secured creditor can take against the security under the
SARFAESI Act are required to be taken within the limitation as per Section 36
of the Limitation Act. That means, the action has to be taken within three years
from the date on which the cause of action arose.
Due to the provisions of this section, all secured creditors are required to take
measures such as taking possession of the securities, provided their claim is
within the period of limitation. It will be necessary
252
for the banks and financial institutions to comply with the limitation aspect. If
after sale of securities the claim is not fully satisfied and still there are any dues
to be recovered from the borrower, the creditor is required to file civil suit before
the Civil Court or a claim before the debt recovery tribunal within the limitation
period. Therefore, the secured creditor will have to make an assessment, before
taking possession of the security, whether it would be possible to sell the
security and make an eventual claim for shortfall within the limitation period.
26.8 POWER OF CENTRAL GOVERNMENT TO MAKE RULES
1. For carrying out the provisions of this Act, the Central Government can
frame rules and notify
them in the Official Gazette. The Act also allows the Government to notify the
rules in the Electronic
Gazette as defined in the Information Technology Act, 2000, i.e. on the website
of the Government.
2. Whenever the Government makes a rule under the Act, the rule is so
required to be kept before
each House of Parliament, while in session for a total period of thirty days. Both
the Houses should
agree to the rules as framed and they can make modifications therein or decide
not to make the
rules. The rule gets the validity in the manner as decided by both the Houses. If
already made rules
are modified or cancelled, then any act done under the then existing rule does
not get vitiated or
modified in any way.
26.9 CERTAIN PROVISIONS OF THE ACT TO APPLY AFTER
CENTRAL REGISTRY IS SET UP OR CAUSE TO BE SET UP
The provisions contained in sub-Sections (2) to (4) of Sections 20 and 21 to 27
that provide for registration of the security interest created, satisfaction of
charge, etc., are applicable only after the central registry is set up or caused to be
set up by the Central Government.
26.10 AMENDMENTS TO CERTAIN OTHER ENACTMENTS
For effective purpose of this Act, it has amended some related provisions of the
Companies Act, 1956, The Securities Contracts (Regulation) Act, 1956 and The
Sick Industrial Companies (Special Provisions) Act, 1985.
The amendments are as under:
1. Section 4A of the Companies Act, 1956 is amended for the purpose of
declaring any securitisation
company or reconstruction company registered with the Reserve Bank of India
as a Public Financial
Institution within the meaning of Section 4A of the Companies Act, 1956.
2. The Securities Contracts (Regulation) Act, 1956 is amended at Clause
(h) of Section (2 )for
including security receipt as defined in Clause (zg) of Section 2 of the
SARFAESI Act.
3. Amendment to The Sick Industrial Companies (Special Provisions) Act,
1985 is made to provide
that
(i) no reference to the Board for Industrial and Financial Reconstruction (BIFR)
shall lie, where financial assets are acquired by any securitisation company or
reconstruction company under sub-Section 5 of the SARFAESI Act, and
(ii) for the purpose of providing that a reference pending before BIFR shall abate
if the secured creditors, representing not less than three-fourths in value of the
amount outstanding, take any measures to recover their secured debt under sub-
Section (4) of Section 13 of SARFAESI Act.
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26.11 LET US SUM UP
The Act is applicable to securities not in possession of the creditors. We have
seen a list of securities to which the Act is not applicable. Contravention of the
provisions of the Act is punishable. Act has dealt with the situations for offences
committed by individuals, partnerships and a company. By debarring Civil Court
or any other authority for jurisdiction for giving injunction, etc., the
implementation of the Act is made effective by removing legal hindrance, which
otherwise the borrower can bring. We have also seen how and when the Act has
an overriding effect. The Act has provided that the provisions of the Limitation
Act are applicable for the actions under this Act also. The Central Government
has powers to make rules for procedural implementation of the Act. The central
registry is not yet formed and the provisions relating to the registrations required
under Sections 21 to 27 are not yet made applicable. The chapter also has dealt
with the powers of the Central Government to remove difficulties that may arise
while giving effect to the provisions of the Act and about the amendments made
in the other Acts by this Act.
26.12 CHECK YOUR PROGRESS
1. For challenging an action initiated by secured creditor against the
defaulting borrower under the
SARFAESI Act, the borrower can go to the Civil Court for an injunction.
(True/False)
2. Can the bank take action under SARFAESI Act against a deposit under
lien with it? (Yes/No)
3. Are hire-purchase and lease contracts covered under SARFAESI Act?
(Yes/No)
4. After the bank's notice a defaulting borrower has paid within sixty days
a substantial amount and
the present dues are Rs. fifteen lakh which is fifteen per cent of the claimed
amount. Can bank
proceed to take possession of the security? (Yes/No)
5. If on some point the provisions of the Transfer of Property Act and the
SARFAESI Act are
different, which Act will prevail?
6. Can a bank proceed to take possession of the security after four years of
cause of action?
(Yes/No)
26.13 ANSWERS TO 'CHECK YOUR PROGRESS'
1. False; 2. No; 3. No; 4. No; 5. SARFAESI Act; 6. No
26.14 MULTIPLE CHOICE TERMINAL QUESTIONS
1. Provisions of the SARFAESI Act are applicable to which of the
following?
(a) Pledged goods.
(b) Only mortgaged properties.
(c) Securities that are not otherwise charged to the creditors.
(d) Securities charged to creditors and not in possession of the creditor.
2. When the rules, framed by the Central Government, under the Act get
validity?
(a) After the appellate tribunal of DRT approves them.
(b) On Supreme Court approving the same.
(c) Immediately on framing of the rules by the Government and notifying
the same.
(d) When both the Houses of Parliament approve the Rule so framed.
Ans. 1. (d); 2. (d)
THE BANKING OMBUDSMAN SCHEME, 2006: PURPOSE, EXTENT,
DEFINITIONS, ESTABLISHMENT AND POWERS
STRUCTURE
27.0 Objective
27.1 Introduction
27.2 Object of Scheme and Extent
27.3 Definitions
27.4 Appointment and tenure
27.5 Territorial Jurisdiction and Location of Office
27.6 Secretariat
27.7 General Powers of Banking Ombudsman
27.8 LetUsSumUp
27.9 Keywords
27.10 Check Your Progress
27.11 Answers to 'Check Your Progress'
27.12 Multiple Choice Terminal Questions
256
27.0 OBJECTIVE
The objective of this unit is to understand the purpose of introduction of the
scheme, viz., 'The Banking Ombudsman Scheme 2006, various words and the
terms used in the scheme and how the appointment of banking ombudsman is
done, its establishment and powers.
27.1 INTRODUCTION
In this unit, we will see the definitions of the words used in the scheme. The
definitions are important, as they have an assigned meaning in the scheme and
these words are used in the scheme in the context of definitions. If the
definitions are well mastered, it is easy to understand the scheme. We will also
see the provisions relating to establishment of office of banking ombudsman.
The RBI decides his appointment and other terms of office, his secretariat, his
powers, etc. The RBI also decides the territorial jurisdiction of the banking
ombudsman. The scheme has come in force with effect from 1 January 2006.
27.2 OBJECT OF SCHEME AND EXTENT
1. The scheme was introduced with the following objectives:
(i) To resolve complaints relating to banking services and to facilitate the
satisfaction or settlement
of such complaints, (ii) Resolve disputes between a bank and its constituents as
well as amongst banks, through the
process of conciliation, meditation and arbitration.
2. The scheme extends to the whole of India. It is applicable to the banks in
India. The Reserve Bank
has the authority to suspend the operation of the scheme fully or partly for such
period as may be
specified in the order. Such suspension, may be general or in relation to any
specified bank. The
period of suspension can be extended if deemed fit by the Reserve Bank.
27.3 DEFINITIONS
1. 'Award' means an award passed by the banking ombudsman in
accordance with this scheme.
2. 'Appellate Authority' means the Deputy Governor in charge of the
department of the RBI
implementing the scheme.
3. 'Authorised Representative' means a person duly appointed and
authorised by a complainant to
act on his behalf and represent him before a banking ombudsman, for
consideration of his complaint.
4. 'Banking Ombudsman' means any person appointed under Clause No. 4
of the scheme.
5. 'Bank' means,
• a banking company,
• and includes a corresponding new bank,
• a Regional Rural Bank,
• State Bank of India and its Subsidiary banks as defined in Part I of the
Banking Regulation Act,
1949,
• and also includes a scheduled primary co-operative bank and included in
the second Schedule
to the RBI Act, 1934 having a place of business in India.
6. 'Complaint' means a representation in writing or through ELECTRONIC
MEANS containing a
grievance, alleging deficiency in banking service.
7. 'Settlement' means an agreement reached by the parties either by
conciliation or mediation under
the Scheme.
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27.4 APPOINTMENT AND TENURE
The Reserve Bank may appoint one or more of its officers in the rank of Chief
General Manager or General Manager to be known as the banking ombudsmen
to carry out the functions entrusted to them by or under the scheme. This
appointment may be made for a period not exceeding three years at a time.
27.5 TERRITORIAL JURISDICTION AND LOCATION OF OFFICE
1. The Reserve Bank shall specify the territorial limits to which the
authority of each of the banking
ombudsman shall extend.
2. The office of the banking ombudsman will be located at such places as
may be specified by the
Reserve Bank.
3. The banking ombudsman may hold sittings at such places within his
area of jurisdiction as may be
considered necessary and proper by him, in respect of a complaint or reference
before him.
27.6 SECRETARIAT
(i) The Reserve Bank shall depute such number of its officers and other staff to
the office of the banking ombudsman as considered necessary to function as the
secretariat of the banking ombudsman.
(ii) The cost of the secretariat will be borne by the Reserve Bank.
27.7 GENERAL POWERS OF BANKING OMBUDSMAN
The banking ombudsman shall have the following powers and duties:
(a) to receive complaints relating to banking services
(b) to consider such complaints relating to the deficiencies in the banking
and other services and
facilitate their satisfaction or settlement by agreement through conciliation and
mediation between
the bank and the aggrieved parties or by passing an award in accordance with the
scheme.
27.8 LET US SUM UP
The object of the scheme makes clear the purpose behind introduction of the
scheme. We have seen the definitions of different words used in the scheme. The
definition of words have importance as they are used in a particular context in
the scheme. We have seen the provisions about appointment and tenure of
banking ombudsman. The RBI is the authority for appointment and deciding
terms of appointment, etc. RBI also decides the territorial jurisdiction of the
banking ombudsman. We have seen about his powers and duties and how he has
to deal with the complaint.
27.9 KEYWORDS
Conciliation; Meditation.
27.10 CHECK YOUR PROGRESS
1. Disputes amongst two banks can be taken up before the banking
ombudsman. (True/False)
2. Co-operative banks are not covered by the banking ombudsman scheme.
(True/False)
3. Banking ombudsman is appointed by a committee of Supreme Court
Judges. (True/False)
4. It is not within the powers of banking ombudsman to deal with the
complaint unless both parties
agree for his intervention. (True/False)
258
27.11 ANSWERS TO CHECK YOUR PROGRESS'
1. True; 2. False; 3. False; 4. False
27.12 MULTIPLE CHOICE TERMINAL QUESTIONS
1. What is the object of introducing the banking ombudsman scheme,
2006?
(a) For effective monitoring of the NPA accounts in the banks.
(b) It is the RBI agency to regulate the disputes amongst the banks.
(c) To enable resolution of complaints relating to banking services.
(d) For executing the orders passed by the DRT.
2. Complaints relating to non-acceptance of small denomination notes by a
bank, can be made to a
banking ombudsman:
(a) Such small denomination notes and coins to be deposited with the
Reserve Bank.
(b) They may be deposited with a bank having a currency chest facility.
(c) Banking ombudsman can deal with the complaints under the scheme.
(d) The complainant can seek no remedy at all through banking
ombudsman, but has to approach
the consumer disputes redressal machinery.
3. Complaints can be made against promises made by sales agents but not
fulfilled by the bank
represented by them under the banking ombudsman Scheme 2006?
(a) No complaint is admissible as he is not the employee of the bank.
(b) The sales agent has no authority to make any promise and hence the
bank is not bound to
fulfil them.
(c) The banking ombudsman can entertain the complaint under the scheme.
(d) Agency functions are outside the purview of the banking ombudsman
scheme.
Ans. 1. (c); 2. (c); 3. (c)
PROCEDURE FOR REDRESSAL OF GRIEVANCE
STRUCTURE
28.0 Objective
28.1 Introduction
28.2 Grounds of Complaint
28.3 Procedure of Filing Complaint
28.4 Power to Call for Information
28.5 Settlement of Complaint by Agreement
28.6 Award by the Banking Ombudsman
28.7 Rejection of the Complaint
28.8 Proceeding Before the Review Authority
28.9 Banks to Display Salient Features of the Scheme for Common
Knowledge of Public
28.10 Let Us Sum Up
28.11 Keywords
28.12 Check Your Progress
28.13 Answers to 'Check Your Progress'
28.14 Multiple Choice Terminal Questions
260
28.0 OBJECTIVE
The objective of this unit is to understand the procedure adopted by the banking
ombudsman for dealing with the grievance of the complainant. A banker must
know, on what issues and matters complaint can be filed.
28.1 INTRODUCTION
From procedural point of filing a complaint and the manner of dealing with it,
this unit is very important. The aspects on which a complaint can be filed are
exhaustive and cover all of the services the bank offers to its customers. The
grounds include some matters related to loans and advances also. Though there
cannot be a complaint for not sanctioning a loan, it can be for non-observance of
RBI directives, delay in decision, interest rate directives and non-acceptance of a
loan application. In a broader sense, the aspects also cover what the customers
expect from the bank about its declared services. For effectively dealing with the
complaint the banking ombudsman has powers to call for information from the
parties concerned. The complaint needs to be in writing and supported by
documents and declarations as given in the scheme. The limitation period for
filing a complaint is one year.
28.2 GROUNDS OF COMPLAINT
A complaint on any of the following grounds alleging deficiency in banking
service may be filed with the banking ombudsman having jurisdiction:
(i) non-payment/inordinate delay in the payment or collection of cheques, drafts,
bills, etc; (ii) non-acceptance, without sufficient cause, of small denomination
notes or coins tendered
for any purpose, and for creating a charge of commission in respect thereof; (iii)
non-payment or delay in payment of inward remittances; (iv) failure to issue or
delay in issue of drafts, pay orders or bankers cheques; (v) failure to honour a
guarantee or letter of credit commitments; (vi) failure to provide or delay in
providing a banking facility (other than loans and advances)
promised in writing by a bank or its direct selling agents;
(vii) delays, non-credit of proceeds to parties accounts, non-payment of deposit
or non-observance of the Reserve Bank directives, if any, applicable to rate of
interest on deposits in any savings, current and other account maintained with a
bank; (viii) delay in receipt of export proceeds, handling of export bills,
collection of bills etc., for
exporters provided that the said complaints pertain to the bank's operations in
India; (ix) complaints form non-resident Indians having accounts in India in
relation to their remittances
from abroad, deposits and other bank related matters; (x) refusal to open deposit
accounts without any valid reason for refusal; (xi) levying of charges without
adequate prior notice to the customer; (xii) non-adherence by the bank or its
subsidiaries to the instructions of Reserve Bank on ATM/
Debit card operations or credit card operations;
(xiii) non-disbursement or delay in disbursement of pension (to the extent the
grievance can be attributed to the action on the part of the bank concerned, but
not with regard to its employees); (xiv) refusal to accept or delay in accepting
payment towards taxes, as required by Reserve
Bank/Government; (xv) refusal to issue or delay in issuing, or failure to service
or delay in servicing or redemption
of Government securities; (xvi) forced closure of deposit accounts without due
notice or without sufficient reason;
261
(xvii) refusal to close or delay in closing the accounts; (xviii) non-adherence to
the fair practices code as adopted by the bank;
(xix) any other matter relating to the violation of the directives issued by the
Reserve Bank of India in relation to banking services.
2. Complaints concerning loans and advances may also be filed, only in so
far as they relate to the
following:
(i) non-observance of Reserve Bank of India directives on interest rates.
(ii) delays in sanction, disbursement or non-observance of prescribed time
schedule for disposal
of loan applications.
(iii) non-acceptance of application for loans without furnishing valid reasons to
the applicant, (iv) non-observance of any other directions or instructions of the
Reserve Bank of India, as may be specified by it from time to time.
3. The banking ombudsman may also deal with such other matter as may
be specified by the Reserve
Bank of India from time to time in this behalf.
28.3 PROCEDURE FOR FILING COMPLAINT
1. Any person who has a grievance against a bank relating to the banking
services for reasons as
detailed above, may himself or through his authorised representative other than
an advocate make
a complaint to the banking ombudsman within whose jurisdiction the branch or
office of the bank
complained against is located. Complaints arising out of the operation of credit
cards shall be filed
before the banking ombudsman within whose jurisdiction the billing address of
the complainant is
located.
2. The complaint shall be in writing, duly signed by the complainant or his
authorised representative.
The complaint shall be in a form specified in Annexure - A of the scheme and
shall state clearly
following particulars:
(i) The name and address of the complainant
(ii) The name and address of the branch or office of the bank against which the
complaint is
made
(iii) The facts giving rise to the complaint (iv) The nature and extent of the loss
caused to the complainant (v) The relief sought from the banking ombudsman
3. No complaint to the banking ombudsman shall lie unless
(a) the complainant had before making a complaint to the banking
ombudsman made a written
representation to the bank and either the bank had rejected the complaint or the
complainant
had not received any reply within a period of one month after the bank
concerned received
his representation or the complainant is not satisfied with the reply given to him
by the bank;
(b) the complaint is made not later than one year after the cause of action
has arisen as per
Clause (a) above;
(c) the complaint is not in respect of the same subject matter which was
settled through the
office of the banking ombudsman in any previous proceedings;
(d) the complaint does not pertain to the same subject matter, for which any
proceedings
before any court, tribunal or arbitrator or any other forum is pending or a decree
or award
or a final order has already been passed by any such competent court, tribunal,
arbitrator or
forum;
(e) the complaint is not frivolous or vexatious in nature;
262
(f) It is made before the expiry of the period of limitation prescribed under the
Indian Limitation Act 1963 for such claims.
28.4 POWER TO CALL FOR INFORMATION
1. The banking ombudsman may require the bank named in the complaint
or any other related bank to
provide any information or furnish certified copies of any document relating to
the subject matter
of the complaint that is or is alleged to be in the possession of such bank. In the
event of the failure
of a bank to comply the requisition without any sufficient cause, the banking
ombudsman may
draw the inference that the information, if provided or copies if furnished, would
be unfavourable
to such bank.
2. The banking ombudsman shall not disclose any information or
document to any person except
with the consent of the person furnishing such information or document.
However, the banking
ombudsman may disclose information or document furnished by a party in
complaint to the opposite
side of the complaint, to the extent considered by him to be reasonably required
to comply with the
principles of natural justice and fair play in the proceedings.
28.5 SETTLEMENT OF COMPLAINT BY AGREEMENT
1. The banking ombudsman has to serve a notice of the receipt of
complaint along with a copy of the
complaint to the branch or office of the bank named in the complaint. He has to
attempt for a
settlement of the complaint by an agreement between the complainant and the
bank through
conciliation or mediation.
2. For the purpose of promoting a settlement of the complaint, the banking
ombudsman may follow
such procedures as he may consider appropriate and he shall not be bound by
any legal rule of
evidence.
3. The proceedings before the banking ombudsman shall be summary in
nature.
28.6 AWARD BY THE BANKING OMBUDSMAN
1. If a complaint is not settled by agreement within a period of one month
from the date of receipt of
the complaint or such further period as the banking ombudsman may consider
necessary, he may
pass an award after affording the parties a reasonable opportunity to present their
case. He shall be
guided by the evidence placed before him by the parties, the principles of
banking law and practice,
directions, instructions and guidelines issued by the Reserve Bank of India from
time to time and
such other factors which in his opinion are necessary in the interest of justice.
2. The award passed under the sub-clause above shall state the direction(s),
if any, to the bank for
specific performance of its obligations in addition to the amount to be paid by
the bank to the
complainant by way of compensation for the loss suffered by him and may
contain any direction
to the bank.
The banking ombudsman shall not give any direction(s) in the award under sub-
clause above regarding payment of compensation in excess of that which is
necessary to cover the loss, suffered by the complainant, as a direct consequence
of the commission or omission of the bank, or for an amount exceeding Rs. 10
lakh whichever is lower.
3. In case of complaints relating to credit card operations, the banking
ombudsman shall take into
account the loss of complainant's time, expenses incurred by the complainant,
financial loss,
harassment and mental anguish suffered by the complainant, while determining
the amount of
compensation. ;
263
4. A copy of the award shall be sent to the complainant and the bank
named in the complaint. An
award shall not be binding on a bank against which it is passed unless the
complainant furnishes to
it within a period of fifteen days from the date of receipt of copy of the award, a
letter of acceptance
of the award in full and final settlement of his claim in the matter. If the
complainant does not
accept the award passed by the banking ombudsman and fails to furnish his letter
of acceptance
within such time, without making any request for extension of time to comply
with such
requirements, the award shall lapse and be of no effect.
5. The bank shall within one month from the date of receipt by it, of the
acceptance in writing of the
award by the complainant comply with the award and intimate the compliance to
the banking
ombudsman.
28.7 REJECTION OF THE COMPLAINT
1. The banking ombudsman may reject the complaint at any stage if it
appears to him that the complaint
made is:
(i) frivolous, vexatious, mala-fide; or (ii) without any sufficient cause; or
(iii) that it is not pursued by the complainant with reasonable diligence; or ! (iv)
prima facie, there is no loss or damage or inconvenience caused to the
complainant; or (v) beyond the pecuniary jurisdiction of the banking
ombudsman under the scheme
2. The banking ombudsman may reject a complaint at any stage, if after
consideration of the complaint
and evidence produced before him the banking ombudsman is of the opinion that
the complicated
nature of the complaint requires consideration of elaborate documentary and oral
evidence and the
proceedings before the banking ombudsman are not appropriate for adjudication
of such a complaint.
The decision of the banking ombudsman in this regard shall be final and binding
on the complainant
of the bank.
28.8 PROCEEDING BEFORE THE APPELLATE AUTHORITY
1. Any person aggrieved by the award has the right to prefer an appeal
against the award before the
appellate authority within forty-five days form the date of receipt of the award.
The appellate
authority is empowered to allow a further period not exceeding thirty days on his
being satisfied
that the appellant had sufficient cause for not preferring the appeal in time. In
case the appeal is by
the bank, the filing of appeal should have been with the previous sanction of the
Chairman or in his
absence the Managing Director or Executive Director or the Chief Executive
Officer or any other
officer of equal rank.
2. The appellate authority after giving the parties a reasonable opportunity
of being heard, may pass
the following orders:
(a) dismiss the appeal; or
(b) allow the appeal and set aside the award; or
(c) remand the matter to the banking ombudsman for fresh disposal in
accordance with such
directions as the appellate authority may consider necessary or proper; or
(d) modify the award and pass such directions as may be necessary to give
effect to the award
so modified; or
(e) pass any other order as it may deem fit.
The order of the appellate authority has also the same effect as that of the award
of the banking ombudsman.
264
28.9 BANKS TO DISPLAY SALIENT FEATURES OF
THE SCHEME FOR COMMON KNOWLEDGE OF THE PUBLIC
1. The banks covered by the scheme shall ensure that the purpose of the
scheme and the name and
address of the banking ombudsman to whom the complaints are to be made by
the aggrieved party
are displayed in all the branch/office premises.
2. The banks covered by the scheme are required to ensure that a copy of
the scheme is made
available with the designated officer of the bank for perusal in the office
premises of the bank.
There should be a notice displayed at each office of the bank about the
availability of the copy of
the scheme with such a designated officer.
The banks covered by the scheme are required to appoint nodal officers at their
Regional/Zonal offices and inform the respective office of the banking
ombudsman. The nodal officer appointed shall be responsible for representing
the bank and furnishing information to the banking ombudsman in respect of
complaints filed against the bank.
28.10 LET US SUM UP
We saw the grounds on which a complaint can be filed. It touches all aspects of
banking services. It relates to some issues about loans and advances also. The
procedural part of filing and dealing with the complaint is material and needs to
be well noted. We have seen how the information required by the banking
ombudsman can be called and how he deals with the complaint. How an award
is passed. For awareness of the public, a notice about the scheme is required to
be displayed at each office along with copy of the scheme.
28.11 KEYWORDS
Banking Ombudsman.
28.12 CHECK YOUR PROGRESS
1. Bank can refuse acceptance of small denomination notes from the
customer and therefore, on
this ground there cannot be a complaint to banking ombudsman. (True/False)
2. On valid grounds bank can refuse the opening of a new account, but on
this ground, complaint
before the banking ombudsman is maintainable. (True/False)
3. Can a prospective borrower go before the banking ombudsman for non-
sanction of his loan by
the bank? (Yes/No)
4. Banking ombudsman has powers to call for any information and
certified copies from bank when
he is dealing with the complaint.
5. For settling the complaint the banking ombudsman is bound by legal
rules of evidence.
(True/False)
6. What is the maximum amount the banking ombudsman can award as
compensation? (No limit /
10 lakh)
7. Limitation period for filing of the review application against the award
given by the banking
ombudsman is days. (60/45 days)
28.13 ANSWERS TO CHECK YOUR PROGRESS'
1. False; 2. False; 3. No; 4. Yes; 5. False; 6. Rs 10 lakh; 7.45
265
e and party
made bank, pyof
tonal inted sman
ss. It hthe Mhe . For with
28.14 MULTIPLE CHOICE TERMINAL QUESTIONS
1. Can a customer from whose account someone fraudulently has
withdrawn money make a complaint
before the banking ombudsman?
(a) No, as the offence committed, is of criminal nature, FIR with police has
to be filed.
(b) Yes, but if the police authorities who have received the FIR permit filing
of the complaint
with ombudsman.
(c) Yes, as this aspect comes under the powers of the banking ombudsman.
(d) No, as the loss caused to the customer is of a civil nature for recovery,
civil suit is required
to be filed.
2. Reserve Bank and the Central Government may forward a complaint to
the banking ombudsman?
(a) The right to complaint is given to the complainant only.
(b) Neither the Reserve Bank nor the Central Government has the right to
refer the matter to the
banking ombudsman under the scheme.
(c) Reserve Bank and the Central Government are empowered to send the
complaint received
by them to the banking ombudsman.
(d) Only an individual's complaint can be sent by the Reserve Bank and the
Central Government.
3. Can the complaint be filed through an advocate as the authorised
representative of the complainant?
(a) Advocates are not allowed to act as authorised representatives of the
complainants under
the scheme.
(b) Advocates can file the complaint, provided he has been given the
vakalatnama by the party.
(c) Advocates can appear for the parties as they can present the case well
before the banking
ombudsman.
(d) Advocates are allowed to appear only if the party does not stay within
the jurisdiction of the
banking ombudsman.
Ans: 1. (c); 2. (c) and 3. (a).
!, on laint a by rhen ice. nit/ ting
UNIT
29
RECOVERY OF DEBTS DUE TO BANKS AND FINANCIAL
INSTITUTIONS ACT, 1993 (DRT ACT) PRELIMINARY
STRUCTURE
29.0 Objective
29.1 Introduction
29.2 Constitutional Validity of the Act
29.3 Preamble, Extent, Commencement, Application and Definitions
29.4 Let Us Sum Up
29.5 Keywords
29.6 Check Your Progress
29.7 Answers to 'Check Your Progress'
29.8 Multiple Choice Terminal Questions
268
29.0 OBJECTIVE
The objective of this unit is to understand the purpose of this specific legislation
viz., Recovery of Debts due to Banks and Financial Institutions Act, 1993 (DRT
Act 1993). This is an Act enacted to cope up with the much felt requirement of
time. The Act is quite procedural in nature.
29.1 INTRODUCTION
Recovery of the dues from the borrowers through courts was a major cause of
concern for the banks and financial institutions due to huge back log of pending
cases with various courts. Even in recovery of decreed debts, considerable
difficulties were faced by them prior to the passing of this Act in 1993 it was
observed and felt that the existing laws are not adequate to solve the issues faced
by the banks and financial institutions, and huge assets were blocked as
unproductive assets. Besides, in this process of recovery considerable manpower
of the banks and financial institutions gets involved wasting their productivity.
Because of delays involved in finalising of cases the industrial assets were
getting damaged and deteriorating in value in 1991, the Recovery of Debts due
to Banks and Financial Institutions Act, 1993 (DRT Act, as commonly known or
called) was passed and it came into operation from 24 June 1993. This Act
constituted the special, 'Debt Recovery Tribunals' for speedy recovery.
In this unit, we will see how the Act received legal challenges and subsequent
declaration of the Act as constitutionally valid by the Supreme Court. We will
also see the definitions of different words used in the Act.
29.2 CONSTITUTIONAL VALIDITY OF THE ACT
The constitutional validity of the Act was challenged by the Delhi High Court
Bar Association before the Delhi High Court. The Delhi High Court decided the
law to be unconstitutional, void and hit by Article 14 of the Constitution. The
High Court held that the Civil Courts who are directly under control and
superintendence of the High Court have been deprived of their jurisdiction and,
therefore, it is against the theme of the Constitution and independence of the
judiciary.
However, on appeal in Union of India vs Delhi High Court Bar Association
(2002)4 SCC 274, the Supreme Court decided in favour of the constitutional
validity of the DRT Act. The Supreme Court observed that the Parliament alone
can enact law in regard to banking business which includes recovery of bank's
dues and for that purpose setting up adjudicatory body like the Banking Tribunal
is valid.
A question of applicability was referred to the Supreme Court regarding the
applicability of this Act to co-operative banks. However, it was decided that
DRT mechanism is not applicable to dues of Co¬operative banks since the
recovery mechanism in those banks is separate and if working satisfactorily.
29.3 PREAMBLE, EXTENT, COMMENCEMENT, APPLICATION AND
DEFINITIONS
1. The preamble to the DRT Act describes the Act as, 'An Act to provide
the establishment of tribunals
for expeditious adjudication and recovery of debts due to banks and financial
institutions and for
matters connected therewith or incidental thereto.'
2. The Act is applicable to the whole of India except the State of Jammu &
Kashmir. The Act is made
applicable from 24 June 1993, through the DRTs were established progressively
across the country.
The Act is applicable for the debt due to any bank or financial institution or a
consortium of them, when the debt is above Rupees ten lakh. The Central
Government may, by notification make the Act applicable to such other amount
of debt not less than rupees one lakh. At present there is no notification from the
Government about any other amount of debt less than Rupees ten lakh.
Therefore, the jurisdiction of the DRT Act is to the debt above Rupees ten lakh.
269
3. Some important definitions as per this Act are as under:
(i) 'Appellate Tribunal'It is a body established for the purpose of preferring an
appeal against the order passed by the tribunal. It is established under the sub-
Section (1) of Section 8 of the Act. (ii) 'Application' means an application made
to a tribunal for recovery of the debt, under section
19. (iii) 'Appointed day' in relation to a tribunal or an appellate tribunal, means
the date on which such
tribunal is established.
(iv) 'Bank' means, a banking company, a corresponding new bank, i.e., bank
commonly known as Nationalised Bank established with the Act that
Nationalised them, State Bank of India and its subsidiary bank or a Regional
Rural Bank.
(v) 'Chairperson' means a chairperson of an appellate tribunal appointed under
Section 9. (vi) The important definition is about the 'debt'. As the purpose of the
Act is to have faster recovery of debts due to banks and financial institutions, it
is important to define the debt to decide the jurisdiction of the tribunal under
DRT Act As per the definition given at Section 2(g) the expres¬sion 'debt' shall
cover following categories of debts of the banks and financial institutions: (i)
any liability inclusive of interest, whether secured, (ii) any liability inclusive of
interest, whether insecured, or (iii) any liability payable under a decree or order
of any Civil Court or any arbitration award
or otherwise, or (iv) any liability payable under a mortgage and subsisting on
and legally recoverable on the
date of application.
What constitutes debt has been interpreted by different courts in many cases. In
G.V. Films vs UTI [2000] 100 Compo Cases 257 (Mad) (HC), it was held that
payment made by the bank by mistake is a debt. In the State Bank of India vs
S.S. Engineering Corporation [1998] 1 BC 702 (Mad), it was held, that money
overdrawn from a bank account without any overdraft facility is a debt
recoverable under the DRT Act.
The Supreme Court in United Bank of India vs DRT [1999] 4 SCC 69, held that
if the bank had alleged in the suit that the amounts were due to it from
respondents as the liability of the respondents had arisen during the course of
their business activity and the same was still subsisting, it is sufficient to bring
such amount within the scope of definition of debt under the DRT Act and is
recoverable under that Act.
However, if an employee commits fraud and misappropriation of money, the
amount recoverable from him is not a debt within the meaning of DRT Act,
Bank of India vs Vijay Ramniklal AIR 1997 Guj. 75.
(vii) 'Financial institution' means a public financial institution within the
meaning of Section 4A of the Companies Act, 1956 and securitisation and
reconstruction company and such other institutions as the Central Government
may, by notification, specify, (viii) 'Presiding Officer' means the presiding
officer of the Debts Recovery Tribunal appointed
under sub-Section (1) of Section 4.
(ix) 'Recovery Officer' means a recovery officer appointed by the Central
Government for each tribunal under the sub-Section (1) of Section 7. These
officers are appointed under the Act for implementing the recovery orders
passed by the Tribunal.
29.4 LET US SUM UP
There was need to have an effective law for recovery. Prior to this Act, the
recovery laws were found inadequate. Huge assets of the banks' were involved
in recovery because of huge pendency with
270
various courts. Introduction of the NPA norms aggravated the problems. This
affected the financial sector. The Act was introduced in 1993. Initially, Delhi
High Court decided the Act as constitutionally invalid. Supreme Court then
decided the Act as valid. Applicability to co-operative banks was decided only
recently by Supreme Court. Preamble to Act states that Act is for expeditious
adjudication and recovery of debts. The Act is applicable from 24 June 1993 and
is applicable to debts above Rs 10 lakh. In this chapter we have seen the
definition of words which are very important and used in the context of this Act.
29.5 KEYWORDS
Unproductive Assets; DRT Act; Presiding Officer; Recovery Officer.
29.6 CHECK YOUR PROGRESS
1. DRT Act is applicable only if the debt recoverable is above Rs.
_.(Rs. 151akh/Rs. 10 lakh)
2. The debt recoverable through DRT may be secured or insecured.
(True/False)
3. Overdrawn amount in an account is not a debt recoverable under DRT
Act. (True/False)
4. If a Civil Court has passed a decree it has to be executed through that
court only and cannot come
to recovery tribunal. (True/False)
29.7 ANSWERS TO 'CHECK YOUR PROGRESS'
1. Rs. 10 lakh; 2. True; 3. False; 4. False.
29.8 MULTIPLE CHOICE TERMINAL QUESTIONS
1. A bank has allowed a current A/c holder an ad hoc overdraft of Rs. 15 lakh.
The amount is due. Whether this is recoverable under provisions of DRT Act?
(a) No, as it is not a regular loan.
(b) No, as only secured loans can be recovered under the DRT Act.
(c) Yes, as it is a legally recoverable amount by the bank.
(d) Yes, but if the tribunal grants special permission to lodge the case.
Ans. 1. (c)
incial nally ;ided i and lakh, itext
ESTABLISHMENT OF TRIBUNAL AND APPELLATE TRIBUNAL
kh)
me
e.
STRUCTURE
30.0 Objective
30.1 Introduction
30.2 Establishment of Tribunal
30.3 Composition of Tribunal
30.4 Qualification for Appointment as Presiding Officer and Term of Office
30.5 Staff of Tribunal
30.6 Establishment and Composition of Appellate Tribunal
30.7 Qualification for Appointment as Chairperson of the Appellate Tribunal
and
Term of Office
30.8 Filling up of Vacancies at Tribunal and Appellate Tribunal
30.9 Finality of Orders Constituting Tribunal or an Appellate Tribunal
30.10 Let Us Sum Up
30.11 Keywords
30.12 Check Your Progress
30.12 Answers to 'Check Your Progress'
30.13 Multiple Choice Terminal Questions
272
30.0 OBJECTIVE
The objective of this unit is to understand about the appointment of the tribunals,
appellate tribunals and their powers.
30.1 INTRODUCTION
For implementation of the Act, establishment of the authorities and conferring
on them required powers is essential. Their jurisdiction is also to be decided. All
these powers are with the Central Government. Appellate authorities are also
required to be set up. All the authorities need the appropriate staff. In this unit
we will see about all these establishment aspects.
30.2 ESTABLISHMENT OF TRIBUNAL
The Central Government is empowered to establish one or more tribunal to be
known as debt recovery tribunal to exercise the jurisdiction, powers and
authority conferred on such tribunal by or under this Act. The section also
empowers the Central Government to decide and specify the areas within which
the tribunal may exercise jurisdiction for entertaining and deciding the
applications filed before it. When the Government exercises these powers and
takes such decisions they are notified in the Official Gazette of the Government.
30.3 COMPOSITION OF TRIBUNAL
The tribunal is made up of only one person called presiding officer and the
appointment is done by the Central Government by issuing a notification.
The Central Government by notification has the powers to authorise the
presiding officer of one tribunal to discharge also the functions of the presiding
officer of another tribunal.
30.4 QUALIFICATION FOR APPOINTMENT AS
PRESIDING OFFICER AND TERM OF OFFICE
1. A person is qualified for appointment as presiding officer of a tribunal if
he is, or has been, or is
qualified to be appointed as a District Judge.
2. The presiding officer of a tribunal holds office for a term of five years
from the date on which he
enters upon his office or until he attains the age of sixty-two years, whichever is
earlier.
30.5 STAFF OF TRIBUNAL
The Central Government shall provide the tribunal with one or more recovery
officer and such other officers and employees as the Government may think fit.
The staff so appointed shall work under the general superintendence of the
presiding officer.
30.6 ESTABLISHMENT AND COMPOSITION OF APPELLATE
TRIBUNAL
1. The Central Government is empowered to establish one or more appellate
tribunals, to be known as debt recovery appellate tribunal to exercise the
jurisdiction, powers and authority conferred on such tribunal by or under this
Act. The Central Government is also empowered to decide and specify the areas
within which the tribunal may exercise jurisdiction for entertaining and deciding
the applications filed before it. The person occupying the office of the appellate
tribunal is called as the chairperson, appointed by the Central Government.
273
2.
For administrative convenience, the Central Government has the powers to
authorise the chairperson of one appellate tribunal to discharge also the functions
of the chairperson of another appellate tribunal. As said earlier the Government
decisions are required to be notified in the Official Gazette. Appellate tribunal
consists of only one person called as Chairperson and the appointment shall be
done by the Central Government.
30.7 QUALIFICATIONS FOR APPOINTMENT AS CHAIRPERSON OF
THE APPELLATE TRIBUNAL AND TERM OF OFFICE
1. A person shall not be qualified for appointment as the chairperson of an
appellate tribunal unless he
(i) is, or has been, or is qualified to be a Judge of a High Court;
(ii) has been a member of the Indian legal service and has held a post in grade I
of that service
for at least three years; or (iii) has held office as the presiding officer of a
tribunal for at least three years.
2. The chairperson of an appellate tribunal shall hold office for a term of
five years from the date on
which he enters upon his office or until he attains the age of sixty-five years,
whichever is earlier.
30.8 FILLING UP OF VACANCIES AT TRIBUNAL AND APPELLATE
TRIBUNAL
If there occurs any vacancy at tribunal or appellate tribunal, that is not of a
temporary nature, the Central Government may fill up such vacancy in
accordance with the provisions of the Act. When such appointments are made
the proceedings going on and continued before the earlier presiding officer of
the tribunal and chairperson of the appellate tribunal continue further from the
stage where they were.
30.9 FINALITY OF ORDERS CONSTITUTING TRIBUNAL
OR AN APPELLATE TRIBUNAL
No order of the Central Government appointing any person as the presiding
officer of the tribunal or the chairperson of the appellate tribunal shall be called
in question in any manner. Similarly, no act or proceeding before the tribunal or
the appellate tribunal can be questioned in any manner on the ground, merely of
any defect in the constitution of a tribunal or the appellate tribunal.
Presiding officer or chairperson can by a three months written notices, resign his
office. They cannot be removed, unless by an order of the Central Government
on ground of proved misbehaviour or incapacity after inquiry.
30.10 LET US SUM UP
Debt recovery tribunals were established by the Central Government. The
Government also decides their jurisdiction. The Tribunal consists one member
called as presiding officer appointed by the Central Government. Eligibility for
appointment as presiding officer is a minimum of a district Judge. The term is
five years or sixty-two years. One or more recovery officers are provided to the
tribunal by the Central Government. For filing an appeal the Central
Government appoints the appellate recovery tribunal and a person heading it is
called chairperson. Qualification of chairperson must be a minimum High Court
Judge or presiding officer of tribunal for minimum three years. The appointment
is for five years or age of sixty-five years. The unit also includes the provisions
about filling up of vacancies. The presiding officer and the chairperson can
resign from the office. The authorities cannot be removed from the office unless
proven misbehaviour or incapacity after enquiry.
274
30.11 KEYWORDS
Jurisdiction of Tribunal; Appellate Tribunal; Chairperson.
30.12 CHECK YOUR PROGRESS
1. Debt recovery tribunals are established by
2. Debt recovery tribunals consist benches of three persons. (True/False)
3. Jurisdiction of appellate tribunal is with the respective High Courts.
(True/False)
30.13 ANSWERS TO 'CHECK YOUR PROGRESS'
1. Central Government; 2. False; 3. False.
30.14 MULTIPLE CHOICE TERMINAL QUESTIONS
1. Can the order of Central Government in the appointment of the presiding
officer of the tribunal be challenged in any Court?
(a) Yes, before the appellate tribunal.
(b) No.
(c) No, unless the High Court permits for it.
(d) Yes, under Constitution Article 226 before the High Court.
Ans. 1. (b)
UNIT
31
JURISDICTION, POWERS AND AUTHORITY OF TRIBUNALS
STRUCTURE
31.0 Objective
31.1 Introduction
31.2 Jurisdiction, Powers and Authority of Tribunals
31.3 Bar of Jurisdiction of Civil Courts
31.4 Let Us Sum Up
31.5 Keywords
31.6 Check Your Progress
L.R.A.B-19
276
31.0 OBJECTIVE I
i
The objective of this unit is to know the jurisdiction, powers and authority of the
Tribunal and Appellate Tribunal.
31.1 INTRODUCTION
In any Act the jurisdiction, powers and authority of the judicial authorities is
well defined. In this unit, we will see these points related to Tribunal and
Appellate Tribunal. Very important provision is that for the matters where DRT
has jurisdiction the Civil Courts are debarred from entertaining any case.
31.2 JURISDICTION, POWERS AND AUTHORITY OF TRIBUNALS
1. Whenever the Tribunal or the Appellate Tribunal is established from its
appointed day, i.e., date
from which they function is declared in the notification, they exercise
jurisdiction, powers and
authority to entertain and decide applications or appeals, as the case may be,
from the banks and
financial institutions for and about recovery of debts due to them.
As already seen to have jurisdiction of Tribunal the claim for recovery of the
debt must be above Rupees ten lakh, including principal and interest.
In Bank of India vs Harshadrai Odhavji Mody [2002] 40 SCL 20, Bombay High
Court has held that an application for execution of the decree of foreign court
can be entertained by the Debt Recovery Tribunal.
2. Chairperson of Appellate Tribunal is given general power of
superintendence and control over the
Tribunals under his jurisdiction. The chairperson can transfer any application
from any Presiding
Officer within his jurisdiction to any other Presiding Officer within his
jurisdiction, on receiving
application for transfer of case or even on his own motion. However before such
transfer, he has
to give notice to the parties and hear them. He also has power of appraising work
of presiding
officers, under his control.
31.3 BAR OF JURISDICTION OF CIVIL COURTS
1. From the date of establishing the Tribunal, i.e., the appointed day, no
court or other authority shall
have any jurisdiction, powers or authority to deal within any way in recovery
cases above Rupees
ten lakh. Thus the Civil Courts or any other authority will loose and will not
have the jurisdiction
for cases where due amount recoverable is above Rupees ten lakh by banks and
financial institutions.
However, this is not applicable to High Courts and Supreme Courts exercising
jurisdiction under
Articles 226 and 227 of the Constitution.
2. The relevant date of bar of jurisdiction by the court or other authority is
not the date when this Act
came into application. The date is since when the Tribunal is established having
jurisdiction in that
particular area. In Bhanu Construction Company Ltd. vs Andhra Bank [2002] 37
SCL 769, a
question came whether the order passed by a Civil Court after coming into force
of the DRT Act
but before establishing the Tribunal is valid on jurisdiction point or not. The
Supreme Court held
that order passed by the Civil Court prior to establishment of a Tribunal but after
commencement
of DRT Act was well within the jurisdiction of the Civil Court.
31.4 LET US SUM UP
The Tribunal and Appellate Tribunal function from the appointed day, which is
declared in notification. Their powers, duties and jurisdiction is well declared
and defined. High Courts and Supreme Courts, however, have jurisdiction under
Constitution Articles 226 and 227.
277
31.5 KEYWORDS
Tribunal; Appointed Day; Jurisdiction; Powers; Authority; High Court; Spreme
Court; Jurisdiction.
31.6 CHECK YOUR PROGRESS
1. A decree passed by the foreign court can be executed by the Tribunal.
(True or False)
2. For reasons the Chairperson of the Appellate Tribunal can transfer any
case from one Tribunal to
other Tribunal within his jurisdiction. (True or False)
3. For the matters for which the Tribunals are empowered the Civil Courts
have no jurisdiction.
(True or False)
PROCEDURE OF TRIBUNALS
STRUCTURE
32.0 Objective
32.1 Introduction
32.2 Application to the Tribunal
32.3 Appeal to the Appellate Tribunal
32.4 Deposit of Amount of Debt Due, for Filing Appeal
32.5 Procedure and Powers of the Tribunal and the Appellate Tribunal
32.6 Limitation
32.7 Let Us Sum Up
32.8 Keywords
32.9 Check Your Progress
32.10 Answers to 'Check Your Progress'
32.11 Multiple Choice Terminal Questions
280
32.0 OBJECTIVE
The objective of this unit is to know the procedure followed at the Tribunals for
dealing with the cases before them.
32.1 INTRODUCTION
Filing of the application before DRT and its dealing with application involves
procedural aspects. The procedure has various stages and requirements that need
to be followed very strictly. This unit gives such procedure.
32.2 APPLICATION TO THE TRIBUNAL
1. The purpose for filing application is for recovery of the debt due to
them. The procedure has to be
followed properly and the interim relief and remedies are required to be properly
prayed for.
2. When a bank or a financial institution has to recover any debt from any
person/entity, it may make
an application to the Tribunal [Section 19(1)] within the local limits of whose
jurisdiction,
(i) the defendant at the time of making application for loan reside or carry on
business or
personally works for gain; or (ii) any of the defendant, where there are more than
one defendant, reside at the time of making
application for loan or carry on business or personally works for gain; or (iii) the
cause of action, wholly or in part, arises.
3. Where a bank or a financial institution has filed application under
Section 19(1) before the Tribunal
for recovery of its debt and if from the same person another bank or financial
institution has also
to recover any debt, then such later bank or financial institution may join the
applicant bank or
financial institution in already filed application at any stage of the proceedings
before the final order
is passed [Section 19(2)] by making an application.
4. Every application to be filed before the Tribunal under Section 19(1) or
19(2) shall be in such form
and accompanied by such documents or other evidence and by such fee as may
be prescribed.
However, when the Civil Suit already filed is transferred to the Tribunal as
provided in Section 31
(1) of the DRT Act no fees is required to be paid. This is because the plaintiff
had already paid court-
fees while filing the civil suit and the transfer of cases is due to statutory changes
[Section 19(3)].
5. On receipt of application under sub-Section (1) or (2) the Tribunal has to
issue summons to the
defendant requiring him to show cause within thirty days of the service of
summons as to why the
relief prayed for should not be granted [Section 19(4)].
6. The defendant has to present a written statement on or before the first
hearing or within such time
as the Tribunal may permit [Section 19(5)].
7. If the defendant claims any amount from the applicant and to have a set
off against the applicant's
demand with ascertained sum of money legally recoverable by him from such
applicant, the defendant
on the first date should make such claim in the written statement. If the claim is
not made on the
first hearing at the time of filing of written statement then it can be made only if
permitted by the
Tribunal [Section 19(6)].
8. When the written statement contains claim and set-off the written
statement has the same effect as
a plaint in a cross-suit so as to enable the Tribunal to pass a final order in respect
of both the
original claim and on set off [Section 19(7)].
9. A defendant in his application, in addition to his right of pleading a set
off under sub-Section (6)
may set up a counter claim against the claim of the applicant. Such counter-
claim can be for any
right 6r claim in respect of cause of action accruing to the defendant against
applicant. But such
281
or dealing with the cases
procedural aspects. The strictly. This unit gives
he procedure has to be perly prayed for. )n/entity, it may make se jurisdiction,
carry on business or
it the time of making ;or
' before the Tribunal institution has also ; applicant bank or :fore the final order
all be in such form
ay be prescribed.
:dedin Section 31
Ireadypaidcourt-
s [Section 19(3)].
summons to the
HIS as to why the
vithin such time
!the applicant's it, the defendant ot made on the emitted by the
same effect as ct of both the
:b-Section (6) in be for any int. But such
cause must be accruing either before or after the filing of the application by the
applicant but before the defendant submitting his defence in given time. The
counter-claim can be for damages also [Section 19(8)J.
10. A counter-claim filed under sub-Section (8) has the same effect as a
complaint in a cross-suit so as
to enable the tribunal to pass a final order in respect of both the original claim
and on counter-claim
[Section 19(9)].
11. The applicant is at liberty to file a written statement to the counter-claim
of the defendant within
such period as may be fixed by the tribunal [Section 19(10)].
12. If the applicant wants to contend that the counter-claim made by the
defendant ought not to be
disposed as a counter-claim but be disposed in an independent action, he should
make application
to that effect before the tribunal before the issues are settled. The tribunal on
hearing such application,
may pass such order as it deems fit [Section 19(11)].
13. The tribunal may pass an interim order against the defendant to debar
him from transferring,
alienating or otherwise dealing with or disposing of any property or assets
belonging to him without
the permission of the tribunal. Such an order may be by way of injunction or
stay or attachment
[Section 19(12)].
14. If at any stage of the proceeding the tribunal is satisfied by the affidavit
or otherwise that the
defendant, with intent to obstruct or delay or frustrate the execution of any order,
for the recovery
of debt that may be passed against him [Section 19(13A and 8)],
(i) is about to dispose of the whole or any part of his property, or
(ii) is about to remove the whole or any part of the property from the local limits
of the
jurisdiction of the tribunal, or
(iii) is likely to cause any damage or mischief to the property or affect its value
by misuse or creating third party interest the tribunal may direct the defendant to
furnish security of the value of the property or to place said property at the
disposal of tribunal or value of the same, sufficient to satisfy the debt or to
appear before the tribunal and show cause why he should not furnish security.
If the defendant fails to show cause why he should not furnish security or fails to
furnish security required, the tribunal may pass order for attachment of the
whole or part of the property offered as security to the applicant or other
property owned by the defendant, sufficient for recovery of debt.
15. When the applicant wants that the properties of the defendant should be
attached, he is required to
specify the property required to be attached and the estimated value thereof
[Section 19(14)J.
16. The tribunal can pass a conditional attachment order, of whole or part of
the property as the case
may be and as required [Section 19(15)].
17. Sub-Section (13) has contemplated that the attachment order can be
passed on satisfying the
tribunal on the points mentioned in that sub-Section by affidavit or otherwise. If
any attachment
order is passed without complying the requirements of sub-Section (13), then
such order is void
[Section 19(16)].
18. The tribunal has power to pass interim orders, attachment orders, etc.,
under sub-Sections (12),
(13) and (18). If there is any breach of the orders so passed by the tribunal, the
tribunal may order
that the properties of the person guilty of the breach of the order be attached and
the person be
detained in civil prison for a term not exceeding three months [Section 19(17)].
19. If the tribunal finds it just and convenient, it may by order [Section
19(18)]
(i) appoint a receiver of any property, whether before or after grant of certificate
for recovery
of debt;
(ii) remove any person from the custody or possession of the property; (iii) give
possession, custody or management of the property to the receiver;
282
(iv) confer powers to the receiver in respect of the property given in his
possession for bringing suits or defend it, file applications, collection of rents
and profits, preservation, realisation, management, protection, execution of
documents, etc., and as the tribunal may deem fit;
(v) appoint a commissioner for preparation of an inventory of the properties of
the defendant or for sale thereof.
20. If the recovery certificate is granted against a company registered under
the Companies Act, 1956,
the tribunal may order that the sale proceeds of such company be distributed
among its secured
creditors as provided in Section 529A of the Companies Act, 1956 and surplus,
if any, be paid to
the company [Section 19(19)].
21. The tribunal may, on giving opportunity to both the sides of being heard,
pass interim or final order
for payment of amount including interest thereon [Section 19(20)].
22. The tribunal is required to send a copy of every order passed by it to the
applicant and the defendant
[Section 19(21)].
23. The presiding officer of the tribunal has to issue a certificate under his
signature to the recovery
officer for recovery of the amount of debt specified in the certificate [Section
19(22)].
24. When the property of the defendant against whom the certificate of
recovery is issued is situated
in the local limits of jurisdiction of more than one tribunal, the tribunal issuing
the recovery certificate
will send copies of the recovery certificate to such other tribunal in whose
jurisdiction the property
is situated. If the tribunal which receives such certificate finds that it has no
jurisdiction to comply
with the certificate of recovery, it shall be returned back to the tribunal who has
issued the same
[Section 19(23)].
25. The sub-Section provides that the application received by the tribunal
for recovery of debt shall be
dealt with as expeditiously as possible and it should be attempted that the
application is disposed of
finally within 180 days from date of receipt of application [Section 19(24)].
26. The tribunal may make such orders and give such directions as may be
necessary or expedient to
give effect to its orders as well as to prevent abuse of its process or to secure the
ends of justice
[Section 19(25)].
In S. Ravindran vs DRT [1999] 95 Compo Cas. 825, the Karnataka High Court
has held that the purpose of the Act is to ensure expeditious disposal of
application, long and liberal adjournments should not be granted.
27. The DRT (Procedure) Rules at Rule 12(6) provide that DRT can order
that any fact may be proved
by affidavit and once affidavit is submitted tribunal will allow cross-examination
of the witness
only, if in the opinion of the tribunal it is necessary to do so. In the event of
witness not appearing
then the affidavit shall not be taken as evidence. Even prior to this rule coming
into operation, due
to amendment in the case of Union of India vs Delhi High Court Bar Association
AIR 2002SC 1479,
the Supreme Court has held, that if evidence is taken by way of an affidavit, it is
not mandatory for
the tribunal to require production of witness for cross-examination. The Supreme
Court also
observed that when the Supreme Court and High Courts decide the matters on
the basis of documents
and affidavits, there is no reason why the Tribunal should not decide likewise.
In Keshrimal Jivji Shah and another vs Bank of Maharashtra [2004 (2) D.R.T.C.
682] the Bombay High Court has held that if any transfer of property is made in
violation of the injunction order issued by the Court of Law it is no transfer at all
as it confers no right, title or interest in transferee and the transfer is void.
32.3 APPEAL TO THE APPELLATE TRIBUNAL
1. Any person aggrieved by the order passed by the Tribunal or deemed to have
been passed by the Tribunal under DRT Act, may prefer an appeal to an
Appellate Tribunal having jurisdiction in the
283
matter. However, if the order was made by the Tribunal with the consent of the
parties no appeal shall lie.
2. The appeal is required to be filed within forty-five days from the date on
which copy of the order
is received. At the time of filing the appeal as per Section 21 of the DRT Act,
50% of the amount
(Max.) shown as due in the order passed by the Tribunal is required to be
deposited by the
appellant. The appeal is required to be in the form prescribed and along with the
prescribed fees.
The appeal filed after forty-five days may be entertained by the Appellate
Tribunal if it is satisfied
about the cause for not filing the appeal in time.
3. On receipt of the appeal the Appellate Tribunal after giving hearing to
both the parties pass such
orders as it thinks fit either confirming or modifying or setting aside the order
passed by the
Tribunal. Every order made by the Appellate Tribunal is sent to the parties to the
appeal and to the
Tribunal concerned.
4. The appeal filed before the Appellate Tribunal shall be dealt with as
expeditiously as possible and it
should be attempted that the appeal is disposed of finally within six months from
date of receipt of
appeal.
In Anamika vs DRT [2001] 104 Compo Cas. 273 (Kar) (HC) (DB) it was held
that when once the case is transferred from the Civil Court to the Tribunal
appeal shall lie with the Appellate Tribunal only and the contention of the party
that he still continues to be governed by Civil Procedure Code and can file
appeal accordingly is not tenable.
5. There is no provision in the Act for further appeal against the order
passed by the Appellate Tribunal.
However writ jurisdiction of High Court under Article 226 and supervisory
jurisdiction of High
Court as well as Special Leave Petition before the Supreme Court are not barred.
32.4 DEPOSIT OF AMOUNT OF DEBT DUE FOR FILING APPEAL
1. When the defendant against whom the Debt Recovery Tribunal has
passed recovery order wants
to prefer appeal to the Appellate Tribunal, he is required to deposit 75 per cent
of the amount
determined by the Tribunal. Without such payment no appeal can be filed.
However, the Tribunal
has right to reduce or waive such payment for the reasons to be recorded in
writing.
2. As the purpose of the Act is to have a fast track remedy for recovery of
loans given by banks and
financial institutions, the condition of deposit of 50% of the amount found due
by the Tribunal is in
accordance with the purpose of the Act. Otherwise the remedy of the appeal will
be routinely used
by the borrowers to delay the recovery procedure and actual recovery.
32.5 PROCEDURE AND POWERS OF THE TRIBUNAL
AND THE APPELLATE TRIBUNAL
1. The Tribunal and the Appellate Tribunal are not be bound by the
procedure laid down by the Civil
Procedure Code, 1908. It further provides that they shall be guided by the
principles of natural
justice and subject to the provisions of this Act and Rules there under, shall have
powers to regulate
their own procedure.
2. The Tribunal and the Appellate Tribunal are for the purpose of
discharging their functions under
the Act, have the same powers as are vested in a Civil Court under the Code of
Civil Procedure,
1908 while trying a suit. Such powers are in respect of summoning and
enforcing the attendance
of any person and examining him on oath, requiring the discovery and
production of documents,
receiving evidence of affidavits, issuing commissions for the examination of
witnesses or documents,
reviewing its decisions, dismissing an application for default or deciding it ex-
parte, setting aside
any order of dismissal of any application for default or any order passed by it ex-
parte any other
matter which may be prescribed.
284
3. The Tribunal and the Appellate Tribunal are deemed to be a Civil Court for all
purposes of Section 195 and Chapter XXVI of the Code of Criminal Procedure,
1973. Any proceeding before Tribunal and the Appellate Tribunal is deemed to
be a judicial proceeding.
32.6 LIMITATION
For application to be filed before the Tribunal the Limitation Act, 1963 apply.
This means that the application must be filed by the bank or the financial
institution within three years from cause of action.
32.7 LET US SUM UP
Bank has to file application for recovery of loan taking into consideration
jurisdiction and cause of action. Other bank or financial institution can join the
application. Application has to be with fees, documents and evidence. For
transfer from Civil Court to Tribunal no fresh fee is required as transfer is due to
effect of law. The section has given elaborate provisions for summons and
hearing. Tribunal can pass interim orders to prevent defendant from transferring
his property. The section also gives the procedure for issuing recovery
certificate. There are provisions for appeal to Appellate Tribunal. However for
preferring appeal 50% of the amount determined by the Tribunal is required to
be deposited. The Limitation Act applies for the DRT cases which means bank
has to file the recovery application within three of the cause of the action.
32.8 KEYWORDS
Application for Recovery; Cause of Action; set off Claim at First Date; Counter-
claim; Interim Order; Injunction; Attachment of Property; Receiver; Recovery
Certificate.
32.9 CHECK YOUR PROGRESS
1. DRT jurisdiction for a bank is where the head office of the bank is
located. (True/False)
2. If a bank has filed recovery application, other bank can join the
application if the defendants are
same. (True/False)
3. When a case get transferred from Civil Court to tribunal fresh court fee
is required to be paid.
(True/False)
4. A counterclaim field before DRT has the same effect as a .
5. Since DRT is not a Civil Court it cannot pass interim orders such as
attachment, injunction,
receiver, etc. (True/False)
6. A person who has to file appeal before the Appellate Tribunal has to pay
.
32.10 ANSWERS TO CHECK YOUR PROGRESS'
1. False; 2. True; 3. False; 4. plaint in cross-suit; 5. False; 6. 75 per cent of the
debt ordered by the Tribunal.
32.11 MULTIPLE CHOICE TERMINAL QUESTIONS
1. While filing appeal before the appellate tribunal if any amount is required to
be deposited?
(a) No, amount is required to be deposited until the appellate tribunal
decides.
(b) Yes, Court-fee on the appeal amount is required to be paid.
(c) Yes, 75 per cent of the amount determined by the tribunal is required to
be deposited at the
timing of filing of the appeal.
(d) Yes, after admission of the appeal 75 per cent of the amount determined
by the tribunal is
required to be deposited.
Ans. 1. (c)
1
m
RECOVERY OF DEBTS DETERMINED BY TRIBUNAL AND
MISCELLANEOUS PROVISIONS
33.0 Objective
33.1 Introduction
33.2 Modes of Recovery of Debts
33.3 Validity of Recovery Certificate and Amendment Thereof
33.4 Stay and Amendment for Recovery Proceeding and Certificate
33.5 Other Modes of Recovery
33.6 Application of Certain Provisions of the Income Tax Act
33.7 Appeal Against the Order of Recovery Officer
33.8 Transfer of Pending Cases
33.9 Power of Tribunal to Issue Certificate of Recovery in Case of Decree or
Order
33.10 Chairperson, Presiding Officer and Staff of Appellate Tribunal and
Tribunal Public Servants
33.11 Protection of Action Taken in Good Faith
33.12 Overriding Effect of the Act
33.13 Doctrine of Election
33.14 Powers to Make Rule
33.15 Let Us Sum Up
33.16 Keywords
33.17 Check Your Progress
33.18 Answers to 'Check Your Progress'
33.19 Multiple Choice Terminal Questions
286
33.0 OBJECTIVE
The objective of this unit is to understand the recovery procedure through the
recovery officers appointed under the Act.
33.1 INTRODUCTION
The tribunal issues Recovery Certificate to the applicant. There are recovery
officers appointed under the Act and attached to the tribunal. They are given
adequate powers to recover the amount awarded. These provisions and
procedures are required otherwise the award will as mere paper award. This
chapter gives provisions and procedure for recovery. There are provisions for
transfer of cases from Civil Court to Tribunal established under DRT Act,
powers of Tribunal to issue recovery certificate where decree is already passed
by a Civil Court and other miscellaneous powers of Tribunal for implementation
of the Act. A legal protection is given to the authorities for immunity of any
action done in good faith.
33.2 MODES OF RECOVERY OF DEBTS
1. On receipt of the copy of the recovery certificate issued under Section
19(22), the Recovery
Officer has to proceed to recover the amount specified in the certificate by one
or more of the
following modes:
(i) attachment and sale of movable and immovable property of the defendants;
(ii) arrest of the defendant and his detention in prison; (iii) appointment of a
receiver for the management of the movable and immovable properties of the
defendant.
2. The Recovery Officer can sell any of the property owned by the
defendant. The provision for
arrest of the defendant though appears in the Act, its use will have to be made
keeping in view the
Supreme Court decision in case of George Verghese vs Bank of Cochin AIR
1980 SC 470. In this
case the Court has observed that putting a person in prison for his poverty and
consequential
inability to pay the contractual liability is too much violative of Article 21 of the
Constitution, unless
there is minimal fair proof of the wilful failure to pay in spite of his sufficient
means.
33.3 VALIDITY OF RECOVERY CERTIFICATE AND AMENDMENT
THEREOF
1. The defendant is debarred from raising any dispute before the Recovery
Officer about the correctness
of the amount specified in the recovery certificate issued by the Tribunal. The
Recovery Officer
also cannot entertain any objection raised by the defendant on any other ground
against the certificate.
2. The Presiding Officer of the Tribunal who had issued the recovery
certificate is authorised to
withdraw the certificate or correct any clerical or arithmetical mistake in the
certificate.
3. One of the Rules framed under the Act (5A) says that when any party
wants to have a review of the
order passed by the Tribunal or the recoyery certificate issued by the Tribunal on
the ground that
error is apparent on the face of the record, he can make application for review
within sixty days of
passing the order or issuing the certificate. Such application needs to be
supported by affidavit
verifying the contents. It is also required that the opposite party is given notice
and hearing before
the application is granted.
33.4 STAY AND AMENDMENT FOR RECOVERY
PROCEEDING AND CERTIFICATE
1. Even though a certificate has been issued to the recovery officer, the
Presiding Officer may grant
287
time for the payment of the amount. If such time is granted, the recovery officer
has to stay the proceedings until expiry of the time granted.
2. If after recovery certificate is issued there is any payment by the
defendant or any time is granted
for payment, the Presiding Officer has to keep the recovery officer informed.
3. If the order passed by the Presiding Officer of the Tribunal is modified
in appeal by the Appellate
Tribunal and the amount of recovery certificate is changed, the Presiding Officer
who has issued
the recovery certificate, has to amend or withdraw the recovery certificate
accordingly.
33.5 OTHER MODES OF RECOVERY
1. In addition to the modes of recovery given at Section 25, Section 28 of
this Act has given additional
modes that can be adopted by the Recovery Officer. These powers are similar to
the powers given
to the Tax Recovery Officer under Section 226 of the Income Tax Act, 1961.
These powers are
also similar to passing of garnishee orders in respect of debt, share and other
property not in
possession of the judgement debtor under Order XXI, Rules 46 and 46A to 461
of the Code of Civil
Procedure, 1908.
2. If any amount is due from any person to the defendant the Recovery
Officer may ask such person
by giving a notice in writing to pay the amount to the Recovery Officer and not
to the defendant.
It is then obligatory on that person to pay the amount to the Recovery Officer.
However for this
provision the exemption of the amount from attachment as provided is Section
60 of the Code of
Civil Procedure, 1908 applies.
3. When such notice is issued to a bank, post office, financial institution or
as insurer, it shall not be
necessary to produce any passbook, deposit receipt, policy or any other
document for any purpose
like entry or endorsement, etc., before making the payment. Even if there is any
practice, rule or
requirement that before payment any of the said document is required the
provisions of this Act
have overriding effect on it.
4. When the notice said above is issued in relation to any property, any
claim made against that
property subsequent to the notice is void.
5. These provisions also apply to any person who is holding any money for
or on account of the
defendant. In cases if there is joint-holding, then the equal shares of the joint-
holders are presumed
unless contrary is proved. A copy of notice will be sent to the defendant, as also
to all joint holders.
6. If any person receiving the notice from the Recovery Officer is not
liable to pay to or is not holding
anything for or on behalf of the defendant then he has to object the notice stating
such statement
on oath. However, if it is found that the statement is false then the person is
personally liable to the
Recovery Officer to the extent of amount payable or held by him or the liability
of the defendant,
whichever is less. If any court holds money belonging to the defendant,
Recovery Officer may
apply to the court for payment to him the money to discharge the amount of debt
due.
7. When the person pays to the Recovery Officer in accordance with the
notice served on him by the
Recovery Officer, he shall be given receipt for payment. The person is then not
liable and is
discharged from liability to the defendant to the extent of amount paid to the
Recovery Officer.
8. If the person after receipt of the notice fails to pay to the Recovery
Officer, he is deemed to be
defendant in default in respect to the amount mentioned in the notice.
9. The Recovery Officer has powers to order at any stage of the execution
of the recovery certificate
to require any person against whom the recovery certificate issued, to declare on
affidavit the
particulars of his assets. If the defendant is a company such order will be issued
to its any of the
officer to so declare the assets of the company.
10. The Recovery Officer has also powers to sale the movable property by
distraint and recover the
amount in the same manner as laid down in I the Third Schedule to the Income
Tax Act, 1961.
288
33.6 APPLICATION OF CERTAIN PROVISIONS OF THE INCOME TAX
ACT
1. Provisions of Section 29 of this Act, are linked to certain sections of the
Income Tax Act, 1961. For its effective purpose and to avoid its repetition in this
Act, it is stated that these provisions will apply as if provided in this Act and
Rules framed there under. This also makes it possible that any amendment made
in the Income Tax Act to those provisions will automatically become applicable
for this Act without there being requirement to amend this Act.
The section says that the provisions of the Second Schedule and Third Schedule
to the Income Tax Act, 1961 and the Income Tax (Certificate Proceedings) Rule,
1962, as in force from time to time shall, as far as possible, apply with necessary
modifications as if those provisions and rules refer to debt due under this Act.
Due to this provision the debt due from the defendant to the bank or financial
institution is treated on par with Income Tax arrears and can be recovered like
the arrears under the income tax.
33.7 APPEAL AGAINST THE ORDER OF RECOVERY OFFICER
The Recovery Officer is given powers under Sections 25 and 28 to recover the
amount mentioned in the recovery certificate. As per Section 26, the defendant
cannot question or dispute before the Recovery Officer about the correctness of
the amount mentioned in the recovery certificate. When the Recovery Officer
attaches and sells the property it is possible that the third party having any
interest in such property may get affected. Therefore, Section 30 provides that
any person aggrieved by the order of Recovery Officer may appeal within thirty
days to the Tribunal. The period of thirty days is to be counted from the receipt
of the copy of the order by such person. On receipt of the appeal, the Tribunal
has to hear the appellant and make enquiries as it deems fit. Thereafter the order
of the Recovery Officer may be either confirmed or modified or set aside.
In R. Advaiah vs Union of India [2000] 102 Compo Cas. (AP) (HC) it was held
that since there is remedy of appeal available by way of Section 30 of the Act,
no writ can be entertained against the order of the Recovery Officer.
33.8 TRANSFER OF PENDING CASES
1. As the Act is specific one for recovery of dues of banks and financial
institutions, it was necessary
that the recovery cases to which DRT Act applies should be brought under one
forum. Therefore
all the suits or other proceedings pending before the Civil Court, where the
Tribunal has jurisdiction
since establishment of the Tribunal, stand transferred to the Tribunal. Since the
establishment of
the Tribunal no Civil Court has the jurisdiction on the matters where Tribunal is
conferred with the
jurisdiction. Such cases stand transferred to the Tribunal from the Civil Court.
The Tribunal on
receipt of the record has to deal with the suit or proceeding as if it is an
application filed under
Section 19 of the Act. The Tribunal may deal with it from the stage where it had
reached in Civil
Court. No de-novo, i.e new from the start, proceedings start after the transfer of
case from Civil
Court to the Tribunal. The section has used the word suits and proceeding that
get transferred
from Civil Court to DRT. Proceeding will include execution petitions and they
also get transferred
to DRT.
2. In Punjab National Bank vs Chajju Ram [2000] 102 Compo Cas. 41, the
Supreme Court has held
that execution is a proceeding before the Civil Court and hence on coming into
operation of the
DRT Act, the execution will stand transferred to the DRT.
289
33.9 POWER OF TRIBUNAL TO ISSUE CERTIFICATE OF
RECOVERY IN CASE OF DECREE OR ORDER
1. If there is a decree or order passed by any court before coming into operation
the DRT Act and the decree or order is not yet executed, the decree-holder may
apply to the Tribunal for issue of recovery certificate. There is fresh hearing or
trial, etc., in such cases and the tribunal has to directly issue the recovery
certificate based on the decree of the Civil Court.
33.10 CHAIRPERSON, PRESIDING OFFICER AND STAFF OF
APPELLATE TRIBUNAL AND TRIBUNAL PUBLIC SERVANTS
The Chairperson of an Appellate Tribunal, the Presiding Officer of a tribunal,
the Recovery Officer and other officers of the Appellate Tribunal and Tribunal
are deemed public servants within the meaning of Section 21 of the Indian Penal
Code.
33.11 PROTECTION OF ACTION TAKEN IN GOOD FAITH
When anything is done in good faith under this Act or is intended to be so done,
no suit, prosecution or other proceeding shall lie against the Central
Government, the Chairperson, Presiding Officer or the Recovery Officer. This
protection is given so that the authorities can function without fear as well as
hindrances that the borrower otherwise can put while the authorities discharge
their duties.
33.12 OVERRIDING EFFECT OF THE ACT
The provisions of this Act have overriding effect when there is inconsistency
with any other law or in any instrument by virtue of any other law for the time
being in force.
In Allahabad Bank vs Canara Bank AIR 2000 SC 1535, it is held that this Act is
a special Act for recovery of debt due to banks and financial institutions. It has
overriding effect over the provisions of Companies Act, 1956 and, therefore,
leave of the company court is not necessary even if the company is under
winding up proceedings.
In Viral Filaments vs Industrial Bank 33 SCL 132, the Bombay High Court has
held that a petition for winding up a company against which recovery
proceedings are pending in the Debt Recovery Tribunal is admissible, since
jurisdiction to wind up a company is wholly not available in the DRT Act.
Allahabad Bank vs Canra Bank 2000 AIR sew 1347
In this case one of the issues before the court was whether permission of
Company Court is required for filing case before the Debt Recovery Tribunal
when winding up proceedings are pending before the Company Court. The
Honourable Supreme Court after examining the Company Law and Recovery of
Debts Due to banks and financial Institutions Act (DRT Act) held that:
(A) Adjudication under DRT Act is exclusive and jurisdiction of Civil Court
and Company Court is
ousted.
(B) DRT proceedings cannot be stayed by Company Court nor proceedings
can be transferred to
Company Court.
(C) DRT Act overrides the Companies Act.
(D) In respect of moneys realised under DRT Act out of the assets not
charged, distribution between
Bank/FIs and other creditors, when no winding up order passed against the
company, the priorities
have to be decided subject to principles underlying Section 73 of CPC and
principles of natural
justice, ( Section 73 of CPC mentions about ratable distribution of sale proceeds
of execution
among decree holders).
290
(E) Moneys realised under DRT Act, distribution between bank and other
secured creditors, when
winding up proceedings pending in company court, priority of secured creditors
is subject to
provisions of 529A of Companies Act (the said section mentions about priority
of secured creditors
and workman over other dues and distribution inter se between secured creditors
and workmen
should be pari-pasu).
(F) DRT is a special law; it overrides Companies Act. Leave of Company or
Court u/s 446 is neither
necessary nor the recovery application needs to be transferred to the Company
Court.
33.13 DOCTRINE OF ELECTION
By amending Act 30 of 2004, on 11-11-2004, the following provisos were
inserted in section 19(1) of the DRT Act, 1993.
'Provided that the bank or financial institution may, with the permission of the
Debts Recovery Tribunal, on an application made by it, withdraw the
application, whether made before or after the Enforcement of Security interest
and Recovery of Debts Laws (Amendment) Act, 2004 for the purpose of taking
action under the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002, if no such action had been taken
earlier under that Act;
'Provided further that any application made under the first proviso for seeking
permission from the Debt Recovery Tribunal to withdraw the application made
under sub-Section (1) shall be dealt with by it as expeditiously as possible and
disposed of within thirty days from the date of such application;
'Provided also that in case the Debts Recovery Tribunal refuses to grant
permission for withdrawal of the application filed under this sub-Section, it shall
pass such orders after recording the reasons thereof
The question whether withdrawal of the Original Application in terms of the first
proviso to the Section 19(1) of the DRT Act, 1993 is condition precedent to
taking recourse to the SARFAESI Act, 2002 was decided by the Supreme Court
in M/s Transcore vs Union of India and Another (decided on 29-2-2006). The
Supreme Court observed that there are three elements of election, namely,
existence of two or more remedies; inconsistencies between such remedies and a
choice of one of them. If anyone of the three elements is not there, the doctrine
will not apply. There is no repugnancy nor inconsistency between the two
remedies and therefore, the doctrine of election does not apply. The SARFAESI
Act is enacted to enforce the interest in the financial assets which belongs to the
bank/FI by virtue of the contract between the parties or by operation of common
law principles or by law. Essentially the Act deals with the right of the secured
creditor. DRT is tribunal, a creature of the statue. It has no inherent power which
exists in the civil courts. The object behind introducing the first proviso and the
third proviso to Section 19(1) of the DRT Act is to align the provisions of the
DRT Act, the SARFAESI Act and Order XXIII of the Code of Civil Procedure,
1908. Order XXIII CPC is an exception to the common law principle of non-
suit; hence the proviso to Section 19 (1) became a necessity. Withdrawal of the
Original Application before the DRT under the DRT Act is not a pre-condition
for taking recourse to the SARFAESI Act. It is for banks/Fls to exercise its
discretion as to cases in which it may apply for leave and in cases where they
may not apply for leave to withdraw. First proviso to Section 19(1) is an
enabling provision.
In view of the above judgement of the supreme court, the controversy as to
whether simultaneous actions under the DRT Act and SARFAESI Act will lie,
has been set at rest.
33.14 POWERS TO MAKE RULE
The Central Government has the power to frame rules under the Act to carry out
the provisions of the Act. These rules are required to be notified and placed
before both the Houses of Parliament. The Parliament may accept the rules or
may modify the same.
291
33.15 LET US SUM UP
On receiving recovery certificate the recovery officer has to proceed for the
recovery by attachment and sale of movable and immovable property of
defendant, arrest and detention in prison of defendant and appointment of
receiver. Defendant is debarred from disputing the correctness of the amount
given in recovery certificate. The presiding officer can correct the clerical or
arithmetical errors. The section has given wide enabling provisions to call
money from third party in whose hands defendants money are lying. When
amount of defendant is in the hands of third party and recovery officer issues
notice calling money the third party failing to pay is deemed as defendant.
Orders of recovery officer applicable within thirty days to the Tribunal. If there
is already a decree passed by the Civil Court, the DRT can issue recovery
certificate thereon. The chairperson, presiding officer and staff of both Tribunals
are deemed public servants. They are also protected from any action for their
acts done in good faith. The act has overriding effect when there is inconsistency
with any other law.
33.16 KEYWORDS
Recovery Officer; Deemed Defendant; Recovery as Income Tax Dues as per
Provisions of Income Tax Act.
33.17 CHECK YOUR PROGRESS
1. Recovery Officers appointed under DRT Act can attach and sell
movable as well as immovable
property of the person against whom order is passed even if the property is not
charged to the
creditor. (True/False)
2. The defendant can raise a plea before the Recovery Officer about
correctness of the amount
ordered to be paid. (True/False)
3. If the recovery certificate has clerical or arithmetical mistake can
correct the same.
4. For recovery the Recovery Officer can adopt the same methods as
adopted for recovery of
income tax under the Income Tax Act. (True/False)
5. Recovery Officer can ask the defendant to furnish by affidavit
particulars of his asset.
(True/False)
33.18 ANSWERS TO 'CHECK YOUR PROGRESS'
1. True; 2. False; 3. Presiding Officer of the Tribunal; 4. True; 5. True.
33.19 MULTIPLE CHOICE TERMINAL QUESTIONS
1. A company is under winding up process. Whether High Court
permission is required to a bank to
proceed against it before DRT?
(a)No, as the DRT Act being a special Law having overriding effect over other
laws.
(b)Yes, as Companies Act specially provides to that effect. t
(c)Depends on the stage of winding up process.
(d) No permission but concurrence of High Court required.
2. Doctrine of election will come into play
(a) when there exixts two or more remedies;
(b) when there are inconsistencies between the remedies;
(c) when there is choice available to the party to opt for on e of them;
(d) when all the aforesaid elements are to be present in a case.
Ans: 1. (a); 2. (d).
\
L.R.A.U-20
THE BANKERS' BOOKS EVIDENCE ACT, 1891
STRUCTURE
34.0 Objective
34.1 Introduction
34.2 Applicability and Definitions
34.3 Conditions in the Printout
34.4 Mode of Proof of Certain Entries in Bankers' Books
34.5 Case in which Officer of Bank not Compellable to Produce Books
34.6 Inspection of Books by Order of Court or Judge
34.7 Costs of Application
34.8 Let Us Sum Up
34.9 Keywords
34.10 Check Your Progress
34.11 Answers to 'Check Your Progress'
34.12 Multiple Choice Terminal Questions
(I::
294
II!
34.0 OBJECTIVE
The objective of this unit is to understand the special provisions made for giving
evidentiary value to the extracts of the books of bankers while producing any
evidence in the courts for proving or establishing anything the original evidence
is relied upon.
34.1 INTRODUCTION
Banks keep their accounting and its details in various ledgers, registers, etc.
When any claim of the bank is required to be established or proved in the Courts
of Law or any other such forums, these books are required to be produced in
original. It is difficult to do so. Therefore, its extracts and statement of accounts
are produced. To facilitate the production of such evidence in easy way and to
have evidentiary value to the extracts and copies, 'The Bankers' Books Evidence
Act, 1891 was enacted to amend the Law of Evidence with respect to bankers'
books.
34.2 APPLICABILITY AND DEFINITIONS
1. The Act extends to the whole of India except the State of Jammu &
Kashmir.
2. 'Company' means a company as defined in Section 3 of the Companies
Act, 1956 and includes a
foreign company within the meaning of that Act. The Companies Act, 1956
gives elaborately the
requirements for getting the company registered. It has several prerequisites.
3. 'Corporation' means any body corporate established by any law and
includes the Reserve Bank of
India, the State Bank of India and any subsidiary bank of the State Bank of
India.
4. 'Bank' and 'banker' means
(i) any company or corporation carrying on business of banking.
(ii) any partnership or individual to whose books, provisions of this Act are
made applicable.
(iii) any post office saving bank or money order office.
5. 'Bankers' books' include ledgers, day books, cash books, account books
and all other records
used in the ordinary business of a bank. These records may be kept in written
form or stored in a
micro-film, magnetic tape or any other form of mechanical or electronic data
retrieval mechanism.
Such record can be either on site or at any off site location and includes a back-
up or disaster
recovery site.
6. 'Legal proceeding' means
(i) any proceeding or inquiry in which evidence is or may be given;
(ii) an arbitration; and
(iii) any investigation or inquiry under the Code of Criminal Procedure, 1973 or
under any other law for the time being in force for the collection of evidence,
conducted by a police officer or any other person authorised for the purpose by
the magistrate or by any law. Such other person to be authorised should not be a
magistrate.
This definition of the word legal proceeding is very wide and covers different
types of inquiries, proceedings and investigations.
7. 'Court' means the person or persons before whom a legal proceeding is
held or taken.
8. 'Judge' means a judge of a High Court.
9. 'Trial' means any hearing before the Court at which evidence is taken.
For this definition also, if the earlier definitions of legal proceeding and Court
are considered together, the scope of word 'trial' is much wider.
10. 'Certified copy' means when the books of a bank;
295
(i) if maintained in the written form, a copy of any entry in such books together
with a certificate written at the foot of such copy mentioning that
(a) it is a true copy of such entry
(b) that such entry is contained in one of the ordinary books of the bank
(c) that such entry was made in the ordinary course of business
(d) that such book is still in the custody of the bank
(e) and if the copy was obtained by a mechanical or other process that in
itself ensures
the accuracy of the copy, a further certificate to that effect.
If after taking out the copy from the books of the bank, the original books are
destroyed in usual course of the bank's business a further certificate to that effect
of having destroyed the book is necessary.
Each certificate mentioned above shall bear date and should be signed by the
principal accountant or manager of the bank with his name and official title, (ii)
if maintained in the electronic form
(a) consists of printouts of data stored in a floppy, disc, tape or any other
electromagnetic
data storage device, or
(b) a copy of such printout; and it should contain the certificate having all
the applicable
contents detailed above at sub-Para (i).
(iii) if maintained mechanical form
(a) a printout of any entry in the books of a bank stored in a microfilm,
magnetic tape, or
(b) any other form of mechanical or electronic data retrieval mechanism
obtained by a
mechanical or other process, and it should contain the certificate having all the
applicable
contents detailed above in sub-Para (i).
34.3 CONDITIONS IN THE PRINTOUT
1. When the books of the bank are not written in the handwritten and
copies are taken by way of
printout the copy must accompany following:
(i) a certificate by the principal accountant or the manager to the effect that it is a
printout of
such entry or a copy of such printout; and (ii) a certificate by a person in charge
of computer system containing a brief description of the
computer system and the particulars thereof,
(a) the safeguards adopted by the system to ensure that data is entered or
any other
operation performed is only by authorised person;
(b) the safeguards adopted to prevent and detect unauthorised change of
data;
(c) the safeguards available to retrieve data that is lost due to systemic
failure or any other
reasons;
(d) the manner in which the data is transferred from the system to
removable media like
floppies, discs, tapes or other electromagnetic data storage devices;
(e) the mode of verification in order to ensure that data has been accurately
transferred to
such removable media;
(f) the mode of identification of such data storage device;
(g) the arrangement for the storage and custody of such storage devices;
(h) the safeguards to prevent and detect any tampering with the system; and
(i) any other factor which will vouch for the integrity and accuracy of the
system.
2. In addition to the above, a further certificate required is from the person
in charge of the computer
system to the effect that to the best of his knowledge and belief, such computer
system is operated
296
properly at the material time, he was provided with all the relevant data and the
printout in question represents correctly and is appropriately derived from the
relevant data.
34.4 MODE OF PROOF OF CERTAIN ENTRIES IN BANKERS' BOOKS
A certified copy of any entry in a bankers' book shall in all legal proceedings be
received as prima facie evidence of the existence of such entry. Further it shall
be admissible as evidence of all the matters, transactions and accounts therein
recorded in every case as the original entry itself.
In Chandrahdar Goswami vs Gauhati Bank Ltd. AIR 1967 SC 1058, the
Supreme Court has held that to make a person liable mere entries in books of
account are not sufficient even though the books of account are kept in regular
course of business. There has to be further evidence to prove payment of the
money by the bank which appear in the books of account to make the person
liable, except where the person accepts the correctness of the books of account.
34.5 CASE IN WHICH OFFICER OF BANK NOT
COMPELLABLE TO PRODUCE BOOKS
In any proceeding where the bank is not a party, no officer of a bank shall be
compellable to produce any bankers' book contents of which can be proved
under this Act by production of certified copies. Similarly no officer of the bank
shall be called as witness to prove the matters, transactions and accounts
recorded in the certified copies. However, the Court may order otherwise for
special cause.
34.6 INSPECTION OF BOOKS BY ORDER OF COURT OR JUDGE
1. On application by any party to the legal proceeding, the Court or a Judge
may order that,
(i) such party be at liberty to inspect and take copies of any entries in a banker's
book for any of the purposes of the proceeding; or
(ii) the bank to prepare and produce, within time specified in the order, certified
copies of all such entries, accompanied by a further certificate that no other
entries are to be found in the books of the bank relevant to the matters in issue in
such proceeding. This further certificate also should be dated and signed as
required for certified copy stated above.
2. An order that bank officer should either produce the books of account or
appear as witness can be
made by the Court or Judge with or without summoning the bank. The order so
passed shall be
served on the bank at least three clear working days before the same is to be
obeyed. The bank may
at any time before the time limited for compliance of any such order either offer
to produce their
books at the trial or give notice of their intention to show cause against the order.
If the bank
chooses to give show cause against the order then the order passed by the Court
or Judge cannot
be enforced without further order.
34.7 COSTS OF APPLICATION
1. The costs of any application to the court
(i) under or for the purpose of this Act; and
(ii) the costs of anything done or to be done under an order of the court for the
purpose of this Act, shall be in the discretion of the court. The court may further
order such costs or part thereof to be paid by the bank to the party, if they have
been incurred in consequence of any fault or improper delay on the part of the
bank.
2. Any order made under this section for payment of cost to or by a bank
may be enforced as if the
bank were a party to the proceeding.
297
3. Any order passed under this section awarding costs may on application to any
Court of Civil Judicature be executed by such court as if the order is a decree for
money passed by itself. However, the court who passed the order can also have
the powers to enforce of its own orders with respect to the payment of costs.
34.8 LET US SUM UP
The definition clause gives the meaning of different words in the context of the
Act. The certified copy needs a certificate giving some declarations. When the
books of bank are taken in printout form they need a further certificate as
detailed in the Section. When data is stored in computer form a certificate from
person in charge of the computer system is required. Certified copy is a prima
facie evidence and admissible in evidence as if original is produced. On
production of certified copy no further evidence is required. In any proceeding
where bank is not a party and certified copies are produced bank's officer cannot
be called as witness as copy is admissible evidence. Court can order inspection
of books of accounts. The orders for inspection of books must give three clear
days for the bank to arrange for inspection. Court has discretion to award costs
for any application under the Act.
34.9 KEYWORDS
Certified Copy.
34.10 CHECK YOUR PROGRESS
1. If the books of the bank are maintained in the electronic form, does all
the provisions of this Act
are applicable to it. (Yes/No)
2. Does this Act apply to any investigation or inquiry under the Criminal
Procedure Code? (Yes/No)
3. A certified copy of any entry in a bankers' Book is received in legal
proceeding as
evidence for existence of such entry.
4. Unless the Court otherwise directs, bank officer cannot be compelled to
produce to
prove any banker's book's contents when copy is produced.
34.11 ANSWERS TO 'CHECK YOUR PROGRESS'
1. Yes; 2. Yes; 3. prima facie; 4. original books.
34.12 MULTIPLE CHOICE TERMINAL QUESTIONS
1. In a civil suit, to which bank is not a party, one of the parties has produced
certified copy of books of account. One party to the suit wants to call bank
officer as witness to prove the contents of copy. Can it be done?
(a) Yes, as it is the right of the party to get it reaffirmed in evidence.
(b) No, as the certified copy is a prima facie evidence that is admissible in
evidence.
(c) No, unless the bank volunteers to do so.
(d) Yes, but if Court allows the application to call the witness.
Ans. 1. (b) No
THE LEGAL SERVICES AUTHORITIES ACT, 1987: LOK ADALATS
STRUCTURE
35.0 Objective
35.1 Introduction
35.2 Organisation of Lok Adalats
35.3 Jurisdiction of Lok Adalats
35.4 Cognisance of Cases by Lok Adalats
35.5 Disposal of Cases by Lok Adalats
35.6 Nature of Award of the Lok Adalats
35.7 Let Us Sum Up
35.8 Check Your Progress
35.9 Answers to 'Check Your Progress'
300
35.0 OBJECTIVE
The objective of this unit is to familiarise the readers with the system of Lok
Adalats organised under the Legal Services Authorities Act, 1987 for
compromise or settlement of disputes between parties.
35.1 INTRODUCTION
The functioning of Lok Adalats, their jurisdiction, the manner in which Lok
Adalats take cognisance of cases, the types of disposal of the cases or matters
referred to the Lok Adalats and the nature of award that may be passed by the
Lok Adalats are discussed in this unit.
35.2 ORGANISATION OF LOK ADALATS
Lok Adalat are organised by the State Authority, District Authority or the
Supreme Court Legal Services Committee or High Court Legal Services
Committee or Taluk Legal Services Committee at such intervals and places for
exercising jurisdiction and for such areas as it thinks fit.
35.3 JURISDICTION OF LOK ADALATS
A Lok Adalats shall have jurisdiction to determine and arrive at a compromise or
settlement between the parties to a dispute. The dispute should be either a
pending case before any court for which the Lok Adalat is organised or a matter
which is falling within the jurisdiction but not pending in any court. The
offences, which are compoundable under any law cannot be brought within the
purview of the Lok Adalats. The monetary ceiling of amounts regarding which
civil disputes can be settled under this mechanism is presently Rs 20 lakh.
35.4 COGNISANCE OF CASES BY LOK ADALATS
Lok Adalats shall deal with the following types of cases or matters, viz.,
(a) the disputes the parties agree to refer;
(b) the disputes where one of the parties makes an application to the court to
refer to Lok Adalat and
the court is satisfied that there are chances of settlement. In this case the court
shall give an
opportunity to the other party before deciding the case to be referred to the Lok
Adalat;
(c) the dispute which, in the opinion of the Court, it is appropriate to be
taken cognisance by the Lok
Adalat.
(d) Where in respect of a potential dispute, the authority or committee
organising Lok Adalat on
receipt of an application from anyone of the parties is of the opinion that the
matter needs to be
determined by the Lok Adalat, may refer such matter to the Lok Adalat for
determination.
35.5 DISPOSAL OF CASES BY LOK ADALATS
The Lok Adalats shall arrive at a compromise or settlement between the parties.
They shall act with utmost expedition to arrive at a compromise or settlement
between the parties and shall be guided by the principles of justice, equity, fair
play and other legal principles. Where no compromise or settlement could be
arrived at between the parties, the records of the case shall be returned to the
court from which the reference was received. The court shall proceed with the
matter from the stage it had reached before making a reference to the Lok
Adalat. In respect of disputes which were not before the court, in the absence of
compromise or settlement between the parties to seek remedy in a court.
301
35.6 NATURE OF AWARD
The award of Lok Adalat shall be deemed to be a decree of a civil court or an
order of any other court. In case of compromise or settlement arrived at by a Lok
Adalat the court fee paid in the case shall be refunded in the manner provided
under the Court fees Act, 1870. Every award shall be binding on all the parties to
the dispute. No appeal shall lie to any court against the award.
35.7 LET US SUM UP
Lok Adalats are organised under the Legal Services Authorities Act, 1987.
They are intended to bring about a compromise or settlement in respect of any
dispute or potential dispute. Lok Adalats derive jurisdiction by consent of parties
or on an application made to the court by one of the parties to the dispute or the
court is satisfied that the dispute between the parties could be settled by Lok
Adalat. In respect of a potential dispute, any party may request the Authority or
Committee organising Lok Adalat to refer the dispute for determination. Lok
Adalats shall be guided by the principles of justice, equity, fair play and other
legal principles. In case of settlement, the Award shall be binding on the parties
to the dispute. No appeal shall lie in any court against the Award. If no
settlement, the case shall be remitted back to the court which referred the matter
to the Lok Adalat. In case of potential court case, the Lok Adalat shall advise the
parties to seek remedy in court.
35.8 CHECK YOUR PROGRESS
1. Lok Adalats are organised under the Lok Adalats Act. (True/False)
2. Lok Adalats are organised to settle only the existing disputes between
the parties. (True/False)
3. If one party intends to refer the dispute to Lok Adalat, the consent of the
other is not required.
(True/False)
4. Lok Adalats shall strive at arriving a compromise or settlement between
the parties. (True/False)
5. There shall be no appeal against the award of the Lok Adalat.
(True/False)
35.9 ANSWERS TO CHECK YOUR PROGRESS'
1. False; 2. False; 3. False; 4. True; 5. True.
UNIT
36
THE CONSUMER PROTECTION ACT, 1986: PREAMBLE, EXTENT AND
DEFINITIONS
STRUCTURE
36.0 Objective
36.1 Introduction
36.2 Purpose of the Act, Preamble and Extent
36.3 Definitions
36.4 Act not Overriding on any Other Law
36.5 Let Us Sum Up
36.6 Keywords
36.7 Check Your Progress
36.8 Answers to 'Check Your Progress'
36.9 Multiple Choice Terminal Questions
304
36.0 OBJECTIVE
The objective of this unit is to get the knowledge of the purpose of this special
enactment, viz., The Consumer Protection Act, 1986 and the particular word
defined for appropriate use therein.
36.1 INTRODUCTION
To protect the interests of the consumers, 'The Consumer Protection Act was
enacted.' The word consumer and services has been defined in the Act very
elaborately. In this unit, we will see the purpose of enacting the Act and various
definitions of words used in the context of this Act.
36.2 PURPOSE OF THE ACT, PREAMBLE AND EXTENT
1. The Act was enacted with the objective, 'for better protection of the
interests of consumers".
Different authorities were established for the settlement of consumers' disputes.
The Act is social
welfare benefit oriented legislation for the consumer providing self-contained
quasi-judicial machinery
to provide speedy and simple redressal to consumer disputes. The said quasi-
judicial machinery is
established at the district, state and central levels. They observe the principles of
natural justice and
are empowered to give relief of specific nature and, if required, award
compensation to the
consumers. The Act also provides penalties for non-compliance of the orders
given by these
authorities.
2. In the preamble, it is made clear about the purpose of the Act. It says
that the Act is for,
(i) better protection of the interests of the consumers and for that purpose to
make provision for the establishment of consumer councils and other authorities
for the settlement of consumers' disputes.
3. The Act extends to the whole of India except the State of Jammu &
Kashmir.
4. The Act applies to all goods and services, excluding goods for resale or
for commercial purpose
and services rendered free of charge and under a contract for personal service.
36.3 DEFINITIONS
1. 'Appropriate laboratory' means a laboratory or organisation recognised
by the Central Government
or by the state government, or any such laboratory or organisation established by
or under any law
for carrying out analysis or test of any goods with a view to determining whether
such goods
suffer from any defect.
2. 'Branch office' means any establishment described as a branch by the
party or any establishment
carrying on either the same or substantially the same activity as that carried on
by the head office
of the establishment.
3. 'Complainant' means
(i) a consumer, or
(ii) any voluntary consumer association registered under the Companies Act,
1956 or under
any law for the time being in force, or
(iii) the Central Government or a state government, who or which makes the
complaint, or (iv) one or more consumers, where there are numerous consumers
having the same interest,
and (v) in case of death of a consumer, his legal heirs or representative.
4. 'Complaint' means any allegation in writing made by a complainant with
a view to obtaining any
relief provided by or under this Act that,
305
he
rd
lal
ry is id
tie se
of
se
nt w
ds
nt
:e
er
(i) an unfair trade practice or a restrictive trade practice has been adopted by any
trader or
service provider;
(ii) the goods brought by him or agreed to be brought by him suffer from one or
more defects; (hi) the services hired or availed of or agreed to be hired or availed
of by him suffer from
deficiency in any respect;
(iv) a trader or the service provider has charged for the goods or for the services
mentioned in the complaint, at a price in excess of the price
(a) fixed by or under any law, or
(b) displayed on the goods or any package containing such goods, or
(c) displayed on the pricelist exhibited by him by or under any law, or
(d) agreed between the parties.
(v) the goods which will be hazardous to life and safety when used, are being
offered for sale to the public
(a) in contravention of any standard relating to safety of such goods as
required to be
complied with, by or under any law,
(b) if the trader could have known with due diligence that the goods so
offered are unsafe
to the public,
(vi) the services which are hazardous or likely to be hazardous to life and safety
of the public when used, are being offered by the service provider which such
person could have known with due diligence to be injurious to life and safety.
5. 'Consumer' means any person who
A. (i) buys any goods for a consideration which has been paid or promised
to be paid or partly
paid and partly promised, or (ii) under any system of deferred payment, and (iii)
includes any user of such goods other than who buys the goods in the manner as
said
above, or (iv) buys the goods under any system of deferred payment when such
use is made with the
approval of such person,
However, the definition does not include a person who obtains such goods for
re-sale or for
any commercial purpose.
B. (i) hires or avails of any services for a consideration which has been paid
or promised or partly
paid and partly promised, or (ii) under any system of deferred payment, and (iii)
includes any beneficiary of such services other than who hires or avails of the
services in
the manner as said above, or (iv) avails the services under any system of
deferred payment when such services are availed of
with the approval of such person.
However, the definition does not include a person who avails of such services
for any commercial purpose.
The word 'commercial purpose' herein above does not include use by a person of
goods bought and used by him and services availed by him exclusively for the
purpose of earning his livelihood, by means of self-employment.
The definition of consumer is thus very elaborate and inclusive of many aspects.
6. 'Consumer dispute' means a dispute where the person against whom
complaint has been made,
denies or disputes the allegations contained in the complaint.
306
7. 'Defect' means any fault, imperfection, shortcoming in the quality,
quantity, potency, purity or
standard which is required to be maintained by or under any law or under any
contract, express or
implied or as is claimed by the trader in any manner whatsoever in relation to
any goods.
8. 'Deficiency' means any fault, imperfection, shortcoming or inadequacy
in the quality, nature and
manner of performance which is required to be maintained by any law or has
been undertaken to
be performed by a person in pursuance of a contract or otherwise in relation to
any service.
In Jagannath Meher vs Branch Manager, State Bank of India (1993) II CPJ 146,
it was held that where a loan was sanctioned by the bank but the complaint that
the loan was inadequate to start the industry is not tenable. It was held that the
Consumer Forum cannot override the decision taken by the bank as that was a
power of discretion of the bank and there was no reason that the bank acted
otherwise than in good faith.
9. 'District Forum' means a Consumer Dispute Redressal Forum
established under Clause (a) of
Section 9 under this Act.
10. 'Goods' means goods as defined in the Sale of Goods Act, 1930. The
said Act has stated that goods
means every kind of moveable property other than actionable claims and money.
However, it does
not include stocks and shares, growing crops, grass and things attached to or
forming part of the
land which are agreed to be served before sale or under contract of sale.
11. 'Manufacturer' means a person who
(i) makes or manufactures any goods or parts thereof; or
(ii) does not make or manufacture any goods but assembles parts thereof made
or manufactured
by others; or (iii) puts or causes to be put his own marks on any goods made or
manufactured by any other
manufacturers.
12. 'National Commission' means the National Consumer Disputes
Redressal Commission established
under Clause (c) of Section 9.
13. 'Notification' means a notification published in Official Gazette by the
State or Central Government.
14. 'Person' includes
(i) a firm whether registered or not; (ii) a Hindu undivided family; (iii) a co-
operative society;
(iv) every other association of persons whether registered under the Societies
Registration Act, 1860 or not.
15. 'Prescribed' means prescribed by the State or Central Government, as the
case may be, under this
Act.
16. 'Regulation' means the regulations made by the National Commission
under this Act.
17. 'Restrictive trade practice' means
(i) a trade practice which tends to bring about manipulation of price, or (ii) its
conditions of delivery, or
(iii) to affect flow of supplies in the market relating to goods or services in such
a manner to impose on the consumers unjustified costs or restrictions and
include,
(a) delay beyond the period agreed to by a trader on supply of such goods or
in providing
the services which has led or is likely to lead to rise in the price, and
(b) any trade practice which requires a consumer to buy, hire or avail of any
goods or
services as condition precedent to buying, hiring or availing of other goods or
services.
307
18. 'Service' means
(i) service of any description which is made available to potential users and
includes, but not limited to, the provision of facilities in connection with
banking, financing, insurance, transport, processing, supply of electrical or any
other energy, boarding or lodging or both, housing construction, entertainment,
amusement or the surveying of news or other information. However, this does
not include the rendering of any service free of charge or under a contract of
personal service.
The definition gives elaborately what amounts service from various sectors and
lines. It has specifically included the services rendered by the bank.
19. 'Spurious goods and services' means such goods and services which are
claimed to be genuine but
they are actually not so.
20. 'State Commission' means a Consumer Disputes Redressal Commission
established in a state
under Clause (b) of Section 9 of the Act.
21. 'Trader' in relation to any goods means a person who sells or distributes
any goods for sale and
includes the manufacturer thereof, and where such goods are sold or distributed
in package form,
includes the packer thereof.
22. 'Unfair trade practice' means a trade practice which, for the purpose of
promoting the sale, use or
supply of any goods or for the provision of any service, adopts any unfair
method or unfair or
deceptive practice. Such unfair practices include:
A. the practice of making any statement orally or in writing or visible
representation which
(i) falsely represents that the goods are of a particular standard, quality, quantity,
grade,
composition, style or model;
(ii) falsely represents that the services are of a particular standard, quality or
grade; (iii) falsely represents any rebuilt, second-hand, renovated, reconditioned
or old goods as new
goods; (iv) represents that the goods or services have sponsorship, approval,
performance,
characteristic, accessories, uses or benefits which such goods or services do not
have; (v) represents that the seller or the supplier has a sponsorship or approval
or affiliation which
such seller or supplier does not have; (vi) makes a false or misleading
representation concerning the need for or the usefulness of
any goods or services; (vii) gives to the public any warranty or guarantee of the
performance, efficacy, or length of
life of a product or of any goods that is not based on an adequate or proper test
thereof; (viii) makes to the public a representation in a form that purports to be,
(a) a warranty or guarantee of a product or of any goods or services; or
(b) a promise to replace, maintain or repair an article or any part thereof or
to repeat or
continue a service until it has achieved a specified result, if such purported
warranty
or guarantee or promise is materially misleading or if there is no reasonable
prospect
that such warranty, guarantee or promise will be carried out;
(ix) materially misleads the public concerning the price at which a product like
products of goods or services, have been or are, ordinarily sold or provided and
for this purpose, a representation as to price shall be deemed to refer to the price
at which the product, goods or services are sold or provided;
(x) gives false or misleading facts disparaging the goods, services or trade off
another person.
For the purpose of Clause (1) above, a statement that is:
(i) expressed on an article offered or displayed for sale or on it wrapper or
container; or
308
(ii) expressed on anything attached to, inserted in or accompanying as an article
offered or displayed for sale or on anything on which the article is mounted for
display or sale; or
(iii) contained in or on anything that is sold, sent, delivered, transmitted or in any
other manner made available to the public, is deemed to be a statement made to
the public by the person who has caused the statement to be so expressed, made
or contained.
B. Permits the publication of any advertisement for sale of goods or supply
of service in the
newspaper or otherwise at a bargain price that are in fact not at bargain price.
Bargain price
means a price stated to be a bargain price by reference to an ordinary price or a
price at which
the product is ordinarily sold or otherwise.
C. Permits
(i) offering of gifts, prizes or other items with the intention of not providing
them as offered or creating impression that something is being given or offered
free of charge when actually it is not so;
(ii) the conduct of any contest, lottery, game of chance or skill for the purpose of
promoting the sale, use or supply of any product or business interest.
D. Withholding of any participants of any scheme offering gifts, prizes or
other items free of
charge and informing the final results on the closure of the scheme.
E. Permits the sale or supply of goods intended to be used by consumers
knowing or having
reason to believe that the goods do not comply with the standards prescribed by
competent
authority relating to performance, composition, contents, design, construction,
finishing or
packaging as are necessary to prevent or reduce the risk of injury to the person
using the
goods.
F. Permits the hoarding or destruction of goods, or refuses to sell the goods
or to make them
available for sale or to provide any service if such hoarding or destruction or
refusal tends to
raise the cost of goods or services.
G. Manufacture of spurious goods or offering such goods for sale or
adopting deceptive practices
in the provision of services.
The definition of 'unfair trade practice' is very exhaustive. Due to different unfair
practices adopted in sale of goods or offering services the definition is required
to be done all inclusive and covering various possibilities that amount unfair
practice. The fundamental concept underlying the word 'fair' is that the
transaction has nothing underhand in it, is honest, just, equitable and upright and
that the other party to the contract has not taken any undue advantage. If the
transaction lacks any of the contents out of this, it can be termed as 'unfair'.
36.4 ACT NOT OVERRIDING ON ANY OTHER LAW
The provisions of this Act are in addition to other applicable laws and not
overriding on any other law, i.e. the provisions of this Act do not supercede any
specific provision in other Act. The Act provides additional means of obtaining
remedy by a consumer but if the remedy prayed is barred under any other Act,
then the Forums constituted under this Act cannot grant such remedy.
36.5 LET US SUM UP
The Act has been enacted for the settlement of consumer disputes. The Act is
social welfare benefit oriented legislation. It is for speedy disposal of the
redressal of consumer disputes. Deciding the consumer types and protections
required the Act was made for better protection of the interests of the
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consumers establishing the consumer councils and authorities. The provisions of
the Act are not overriding on any other law.
36.6 KEYWORDS
Quasi-judicial Authorities; Appropriate Laboratory; District Forum; State
Commission; National Commission; Restrictive Trade Practice.
36.7 CHECK YOUR PROGRESS
1. Consumer Protection Act is enacted to protect the manufacturing
conditions of the Industries.
(True/False)
2. The agencies appointed under Consumer Protection Act are quasi-
judicial in nature. (True/False)
3. Can a voluntary consumer association file a complaint on behalf of
consumer? (Yes/No)
4. A consumer has purchased goods for resale. Can he file complaint?
(Yes/No)
36.8 ANSWERS TO 'CHECK YOUR PROGRESS'
1. False; 2. True; 3. Yes; 4. No.
36.9 MULTIPLE CHOICE TERMINAL QUESTIONS
1. 'N. has purchased a draft from a bank favouring 'B'. The draft is lost in transit
and for duplicate draft in lieu of first bank need some formalities to be
completed by 'N'. Can 'B' file a consumer case against the formalities as it is
delaying payment to him.
(a) No, as he is not consumer of the bank and is not taking any service from
the bank.
(b) No, as he has not paid the demand draft commission.
(c) Yes, as because of bank, his payment is getting delayed.
(d) Yes, his money is lying in the bank, he is deemed as account holder of
the bank.
Ans. 1. (a)
UNIT
37
CONSUMER PROTECTION COUNCILS
STRUCTURE
37.0 Objective
37.1 Introduction
37.2 Central Consumer Protection Council
37.3 Procedure for Meeting of the Central Council
37.4 Objects of the Councils
37.5 State Consumer Protection Council
37.6 District Consumer Protection Council
37.7 Let Us Sum Up
37.8 Check Your Progress
37.9 Answers to 'Check Your Progress'
37.10 Multiple Choice Terminal Questions
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37.0 OBJECTIVE
The objective of this unit is to understand the appointment and functions of the
consumer councils appointed. They have to discharge the functions and use their
power keeping in mind the purpose of the enactment to protect the rights of the
consumers.
37.1 INTRODUCTION
To promote and protect the right of the consumer councils are established. Their
scope is not regarding directly dealing with the consumer complaints at initial or
appellate scope but to promote and protect the rights of consumer. The function
is more of promoting the rights and spreading awareness by education. The
highest council is the Central Council who has the jurisdiction for the entire
country. Then below it is the State Council for each state. Below that is the
District Council for each district. This unit gives the provisions for establishment
of these councils, their objects and procedure for their meetings.
37.2 CENTRAL CONSUMER PROTECTION COUNCIL
The Central Government has established a council known as the Central
Consumer Protection Council, called as Central Council.
The Central Council shall consist of the following:
(i) The Minister-in-Charge of the Consumer Affairs in the Central Government,
who shall be the
Chairman of the Council, and (ii) Such number of other official or non-official
members representing such interests as may be
prescribed.
37.3 PROCEDURE FOR MEETING OF THE CENTRAL COUNCIL
The Central Council shall meet as and when necessary but at least once in a
year. For transacting the business of the meeting the procedure shall be as may
be prescribed.
37.4 OBJECTS OF THE COUNCILS
The objects of the Council shall be to promote and protect the rights of the
consumers such as
(i) the right to be protected against the marketing of goods and services which
are hazardous to life
and property; (ii) the right to be informed about the quality, quantity, potency,
purity, standard and price of goods
or services so as to protect the consumer against" unfair trade practices; (iii) the
right to be assured wherever possible for access to a variety of goods and
services at competitive
price; (iv) the right to be heard and to be assured that consumers' interests will
receive due consideration at
appropriate forums; (v) the right to seek redressal against unfair trade practices
or restrictive trade practices or unscrupulous
exploitation of consumers; and (vi) the right to consumer education.
37.5 STATE CONSUMER PROTECTION COUNCIL
The State Government shall establish Consumer Protection Councillor the State
Council by issuing a notification. The State Council shall consist of following
members:
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(i) the Minister-in-Charge of the Consumer Affairs in the State Government who
shall be the Chairman
of the Council, (ii) such number of official and non-official members
representing such interests as may be prescribed
by the State Government, (iii) such number of other official and non-official
members not exceeding ten, as may be nominated
by the Central Government.
The State Council shall meet as and when necessary. There has to be at least two
meeting every year. For transacting the business of the meeting the procedure
shall be as may be prescribed by the State Government.
37.6 DISTRICT CONSUMER PROTECTION COUNCIL
1. For every district the State Government establishes the District
Consumer Protection Council
called as District Council.
The District Council shall consist of following members:
(i) the Collector of the district who shall be the Chairman of the Council, (ii)
such number of other official and non-official members representing such
interests as may be prescribed by the State Government.
2. The District Council shall meet as and when necessary. There has to be
at least two meeting every
year. For transacting the business of the meeting the procedure shall be as may
be prescribed by
the State Government.
37.7 LET US SUM UP
Central Government has to establish Central Council and notify the same. It
consists Minister-in-Charge of the Consumer Affairs in the Central Government
and such other persons as the government may prescribe. In similar way State
Government has to establish State Council and District Council. Compositions
of State Council and District Council are different and as laid down in the
section.
37.8 CHECK YOUR PROGRESS
1. Central Consumer Protection Council is the apex council having all
India jurisdiction. (True/
False)
2. Minister-in-Charge of consumer affairs in the Central Government is the
Chairman of Central
Consumer Protection Council. (True/False)
3. State Consumer Protection Council is appointed by Central Government.
(True/False)
4. State Consumer Protection Council has to meet at least in a year.
37.9 ANSWERS TO "CHECK YOUR PROGRESS'
1. True; 2. True; 3. False; 4. Twice.
37.10 MULTIPLE CHOICE TERMINAL QUESTIONS
1. Who is the Chairman of the Central Consumer Protection Council?
(a) Chief Justice of the Supreme Court.
(b) Judge of the Supreme Court appointed by the Chief Justice of the
Supreme Court.
(c) Minister-in-Charge of Law and Judiciary in the Central Government.
(d) Minister-in-Charge of Consumer Affairs in the Central Government.
Ans. 1. (d)
CONSUMER DISPUTES REDRESSAL AGENCIES
STRUCTURE
38.0 Objective
38.1 Introduction
38.2 Establishment of Consumer Disputes Redressal Agencies
38.3 Composition of District Forum
38.4 Jurisdiction of District Forum
38.5 Form of Complaint
38.6 Procedure on Admission of Complaint
38.7 Finding of the District Forum
38.8 Appeal
38.9 Composition of the State Commission
38.10 Jurisdiction and Procedure of State Commission
38.11 Transfer of Cases
38.12 Appeals
38.13 Composition of the National Commission
38.14 Jurisdiction and Powers of National Commission
38.15 TVansfer of Cases
38.16 Finality of Order if no Appeal is Preferred
38.17 Limitation Period
38.18 Enforcement of Orders
38.19 Dismissal of Frivolous or Vexatious Complaints
38.20 Penalties and Protections
38.21 Service of Notice
38.22 Let Us Sum Up
38.23 Check Your Progress
38.24 Answers to 'Check Your Progress'
38.25 Multiple Choice Terminal Questions
316
38.0 OBJECTIVE
In this unit we are looking at different agencies that function for redressal of the
complaints of the consumers. The purpose of the Act itself is the protection of
the consumer interest. Therefore the functions of these agencies have much
significance.
38.1 INTRODUCTION
For resolving and dealing with the consumer complaints different fora are
established at district level, state level and national level. These forums have
different laid down composition. They have to work and deal with the
complaints in the prescribed manner. Their jurisdiction and powers are decided.
All these aspects are laid down in the Act in detail giving full procedural
particulars. In this unit, we will see these issues. They are on various aspects and
with minute details.
38.2 ESTABLISHMENT OF CONSUMER DISPUTES REDRESSAL
AGENCIES
1. For the purposes of this Act, there shall be following agencies established by
the state government or the Central Government, as the case may be.
(i) District Forum established by the state government at each district. The
government may
establish more than one District Council for any district, (ii) State Commission
established by the state government for the state, (iii) National Commission
established by the Central Government.
38.3 COMPOSITION OF DISTRICT FORUM
1. Each District Forum shall consist of following:
A. A person who shall be or has been qualified to be a District Judge, who
shall be the President
of the District Forum.
B. Two other members, one of whom shall be a woman having
qualifications as under:
(i) be not less than thirty-five years of age,
(ii) possess a bachelor's degree from a recognised university,
(iii) be person of ability, integrity and standing, and have adequate knowledge
and experience
of at least ten years in dealing with problems relating to economics, law,
commerce,
accountancy, industry, public affairs or administration.
2. Every appointment as member of the District Forum has to be made by
the state government on
the recommendations of the selection committee consisting of the following:
(i) the President of the State Commission, who shall be the Chairman of
Selection Committee, (ii) Secretary, Law Department of the state, who shall be
the member of Selection Committee, (iii) Secretary-in-Charge of the department
dealing with Consumer Affairs in the state, who shall be the member of
Selection Committee.
If for any reason the President of the State Commission is absent or otherwise,
the state government may refer the matter to the Chief Justice of the High Court
for nominating a sitting Judge of that High Court to act as Chairman.
3. Every member of the District Forum shall hold office for a term of five
years or up to the age of
sixty-five years, which ever is earlier. If the member fulfils the qualifications of
appointment, he
may be reappointed on expiry of initial term of five years. A member may resign
from his office in
writing under his hand addressed to the state government.
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4. The salary or honorarium and other allowance payable to, and other terms and
conditions of service of the member, of the District Forum shall be such as may
be prescribed by the state government.
38.4 JURISDICTION OF DISTRICT FORUM
1. Subject to the other provisions of the Act, the District Forum has
jurisdiction to entertain complaints
where the value of the goods or services and the compensation, if any, claimed
does not exceed
Rs. 20 lakh.
2. A complaint has to be instituted in a District Forum within the local
limits of whose jurisdiction
(i) the opposite party actually and voluntarily resides or carries on business or
has a branch
office or personally works for gain, or (ii) the cause of action, wholly or in part
arises.
Anyone of opposite parties reside provided District Forum gives permission or
party not residing acquiesce in such institution.
38.5 FORM OF COMPLAINT
1. A person aggrieved by any service or whereas consumer his interests are
not observed or followed,
he can file a complaint. The details about filing such complaint for which the
complaint can be filed
are as under:
1. A complaint in relation to,
(i) any goods sold or delivered; or
(ii) agreed to be sold or delivered; or
(iii) any service provided; or
(iv) any service agreed to be provided may be filed with the District Forum by,
(a) the consumer to whom any goods sold or delivered or agreed to be sold
or delivered or
any service 'provided or any service agreed to be provided;
(b) any recognised consumer association whether the consumer to whom
any goods sold
or delivered or agreed to be sold or delivered or any service provided or any
service
agreed to be provided is a member of such association or not;
(c) one or more of the consumers where there are numerous consumers
having same
interest, with the permission of the District Forum, on behalf of or for the benefit
of all
consumers so interested; or
(d) the Central Government or the state government, as the case may be,
either in its
individual capacity or as representative of interests of the consumers in general.
2. The recognised consumer association said above means any voluntary
consumer association
registered under the Companies Act, 1956 or any other law.
3. The complaint should be accompanied with the prescribed fee.
4. The District Foram has to ordinarily decide within twenty-one days from
the date of receipt of the
complaint about its admissibility. The complaint cannot be rejected without
hearing the complainant.
5. Once the complaint is admitted by the District Foram it cannot be
transferred to any other Court or
Tribunal or any authority set up under any law.
38.6 PROCEDURE ON ADMISSION OF COMPLAINT
1. If the complaint admitted by the District Foram relates to any goods, the said
Foram shall
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(i) Refer a copy of complaint within twenty-one days from the date of admission
to the opposite party to give his version of the case. The opposite party is
required to give his version within thirty days or extended period of not more
than fifteen days.
(ii) If the opposite party denies or disputes the allegation contained in the
complaint or fails to submit any of his version, then the consumer dispute is
dealt with further as provided herein.
(iii) Where the complaint alleges a defect in the goods that cannot be determined
without proper analysis or test of the goods, the District Forum shall obtain a
sample of the goods from the complainant and refer the sample in sealed
condition to the appropriate laboratory for analysis or test. The report of the
laboratory is required to be received within forty-five days or extended period, if
and as, allowed by the District Forum. The sample to be sent to the laboratory
has to be sealed and authenticated by the District Forum as prescribed.
(iv) Before the sample of the goods is sent to the laboratory for analysis or test
the complainant is required to deposit the fees as may be specified for payment
to the laboratory for analysis or test.
(v) On receipt of the report from the laboratory about the analysis or test of the
goods, copy of the laboratory report along with such remarks as the District
Forum may feel appropriate are required to be sent to the opposite party.
(vi) If any of the party to the complaint dispute in any way the report received
from the laboratory about the analysis or test of the goods such party has to
submit in writing his objections about the report.
(vii) The District Forum after giving reasonable opportunity to both the parties
to the complaint for giving their say on the report and the objections has to make
appropriate orders thereon.
2. If the complaint relates to services or about the goods for which
procedure given above cannot be
followed, the District Forum shall refer a copy of the complaint to the opposite
party to give his
version of the case. The opposite party is required to give his version within
thirty days or extended
period of not more than 15 days.
If the opposite party denies or disputes the allegation contained in the complaint
or fails to submit any of his version, then the consumer dispute is settled:
(a) on the basis of evidence brought to its notice by the complainant and the
opposite party; or
(b) ex parte on the basis of the evidence brought to its notice by the
complainant where the
opposite party has not appeared.
(c) If the complainant fails to appear on the date of hearing the District
Forum may either dismiss
the complaint for default or decide it on merits.
3. No proceedings stated above can be called in question in any Court on
the ground that the principles
of natural justice have not been complied with.
4. Every complaint has to be heard as expeditiously as possible and there
has to be attempt that the
complaint is decided within three months from the date of receipt of notice by
the opposite party.
If the goods under reference to the complaint are required to be analysed or
tested then the complaint
should be decided within five months. Unless sufficient cause is shown for
adjournment and noted
in writing, adjournment is ordinarily not granted in proceedings under this Act.
The District Forum
has to impose cost for the adjournment on the party concerned. If the time limits
prescribed above
for disposal of any dispute is not observed and the dispute is decided beyond the
stipulated time
then the District Forum has to mention the reasons for delay while disposing the
case.
5. If the District Forum feels appropriate, it can pass suitable necessary
interim orders during tendency
of any proceedings.
6. For the purposes of this section, the District Forum shall have the same
powers as are vested in a
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7.
Civil Court under the Code of Civil Procedure, 1908 while trying a civil suit in
respect of the following matters:
(i) the summoning and enforcing attendance of any defendant or witness and
examining the
witness on oath;
(ii) the discovery and production of any document or other material object
producible as evidence; (iii) the reception of evidence on affidavits; (iv) the
requisitioning of the report of the analysis or test concerned from the appropriate
laboratory
or from any other relevant source;
(v) issuing of any commission for the examination of any witness; and (vi) any
other matter that may be prescribed.
Every proceeding before the District Forum shall be deemed to be a judicial
proceeding within the meaning of Sections 193 and 228 of the Indian Penal
Code and the District Forum shall be deemed to be a Civil Court for the
purposes of 195 and chapter 26 of the Code of Criminal Procedure.
38.7 FINDING OF THE DISTRICT FORUM
1. If after the proceedings under Section 113 are conducted and, the
District Forum is satisfied that,
(i) the goods complained against suffer from any of the defects specified in the
complaint, or (ii) any of the allegations made in the complaint about the service
are proved;
it shall issue an order to the opposite party directing him to do one or more of the
following things to:
1. remove the defect pointed out by the laboratory from the goods in
question;
2. replace the goods with new goods of similar description which shall be
free from any defect;
3. return to the complainant the price or the charges paid by the
complainant, as the case may
be;
4. pay such amount as may be awarded by it as compensation to the
consumer for any loss or
injury suffered by the consumer due to the negligence of the opposite party and
if deemed fit
grant punitive damages;
5. remove defects in goods or deficiencies in the services in question;
6. discontinue the unfair trade practice or restrictive trade practice or not to
repeat them;
7. refraining from offering hazardous goods for sale;
8. withdraw hazardous goods from being offered for sale;
9. cease manufacturing hazardous goods and to desist from offering
services that are hazardous
in nature;
10. pay such sum, which shall not be less than 5 per cent of the value of
such goods sold or
services provided as may be determined if loss or injury has been suffered by a
large number
of consumers who are not identifiable conveniently and pay to such consumer
and utilise
such sum so obtained as may be prescribed;
11. issue corrective advertisement to neutralise the effect of misleading
advertisement at the cost
of the opposite party responsible for issuing such misleading advertisement;
12. provide for adequate costs to the parties.
2. Every proceeding as said above has to be conducted by the President of
the District Forum and at
least one member of the Forum.
3. Every order made under this section has to be signed by the President
and the member or members
who conducted the proceedings. If the President and one member conduct the
proceeding and
they differ on any point, the point of difference has to be referred to the other
member for hearing
on such point and thereafter the opinion of majority shall be the order of the
District Forum.
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4. The procedure relating to the conduct of the meetings of the District Forum,
its sittings and other matters shall be as may be prescribed by the state
government.
In Narsuns Battery Manufacturing Company vs General Manager, Andhra Bank
1992 CPC 707 (NC), the National Commission has passed an order that bank
asking from a small-scale industry main as well as collateral security four times
the values of loan was within the bank's power of advancing money and asking
for adequate security. The contention of the applicant-borrower that excessive
security was asked and asking collateral security from a small-scale industry was
against the guidelines of the IBA was not accepted by the National Commission.
38.8 APPEAL
Any person aggrieved by the order passed by the District Forum may prefer as
appeal to the State Commission within a period of thirty days from the date of
order, in the form and manner as may be prescribed. The State Commission has
the powers to condone delay in preferring an appeal on getting satisfied about
the cause of delay. If the order of the District Forum involves payment of any
amount by the person preferring the appeal, the appeal cannot be filed without
payment of 50 per cent or the amount ordered to be paid or Rs. 25,000,
whichever is less.
38.9 COMPOSITION OF THE STATE COMMISSION
1. Each State Commission shall consist of following:
A. A person who is or has been Judge of a High Court, who shall be its
President. His appointment
has to be made only after consultation with the Chief Justice of the High Court.
B. Not less than two other members and not more than such number of
members as may be
prescribed, one of whom shall be a woman having qualifications as under,
(i) be not less than thirty-five years of age;
(ii) possess a bachelor's degree from a recognised university; and
(iii) be person of ability, integrity and standing, and have adequate knowledge
and experience
of at least ten years in dealing with problems relating to economics, law,
commerce,
accountancy, industry, public affairs or administration.
However, not more than 50 per cent of the members shall be from amongst
persons having a judicial background, i.e. minimum ten years knowledge and
experience as presiding officer of District Court, Tribunal or equivalent level.
2. Every appointment as member of the State Commission has to be made
by the state government on
the recommendations of the Selection Committee consisting of the following:
(i) the President of the State Commission, who shall be the Chairman of
Selection Committee, (ii) Secretary, Law Department of the state, who shall be
the member of Selection Committee, (iii) Secretary-in-Charge of the department
dealing with Consumer Affairs in the state, who shall be the member of
Selection Committee.
If for any reason the President of the State Commission is absent or otherwise,
the state government may refer the matter to the Chief Justice of the High Court
for nominating a sitting Judge of that High Court to act as Chairman.
3. The jurisdiction, powers and authority of the State Commission may be
exercised by Benches
thereof.
If the Members of the Bench differ on any point, the point has to be decided by
majority. If there
321
is equality in differing members, then the point of difference has to be referred to
the President. The President may hear the point of difference himself or refer it
to some other member for hearing. The point of difference has to be then
decided by majority of the members who heard the case initially and after
reference of difference.
4. Every member of the State Commission shall hold office for a term of five
years or up to the age of sixty-seven years, which ever is earlier. But he will be
eligible for appointment for another term of five years or up to the age of 67
years whichever is earlier. A member may resign from his office under his hand
addressed to the state government.
38.10 JURISDICTION AND PROCEDURE OF STATE COMMISSION
1. Subject to the other provision of the Act the State Commission has
jurisdiction
(a) to entertain complaints where the value of the goods or services and
compensation, if any,
claimed exceeds Rs. 20 lakh but does not exceed Rs. 1 crore and appeals against
the orders
of any District Forum within the state, and
(b) to call for the records and pass appropriate orders in any consumer
dispute that is pending
before or has been decided by any District Forum within the state where the
State Commission
is of the opinion that the District Forum has acted without jurisdiction or with
material
irregularity.
2. A complaint has to be instituted in a State Commission within the local
limits of whose jurisdiction,
(i) the opposite party actually and voluntarily resides or carries on business or
has a branch office or personally works for gain, at the time of the institution of
the complaint, or
(ii) when one of opposite parties, do not reside or carry business then either with
permission of State Commission or acquiescence of such party,
(iii) the cause of action, wholly or in part arises.
3. For disposal of disputes by the State Commission same procedure, with
necessary modifications,
is applicable as given at Sections 12, 13 and 14 for District Forum.
38.11 TRANSFER OF CASES
On the application of a complainant or on its own motion the State Commission
may transfer any proceeding at any stage from one District Forum to another
District Forum if in the interest of justice it so requires.
38.12 APPEALS
1. Any person aggrieved by the order passed by the State Commission may
prefer as appeal to the
National Commission within a period of thirty days from the date of order, in the
form and manner
as may be prescribed. The National Commission has the powers to condone
delay in preferring an
appeal on getting satisfied about the cause of delay. If the order of the State
Commission involves
payment of any amount by the person preferring the appeal, the appeal cannot be
filed without
payment of 50 per cent or the amount ordered to be paid or Rs. thirty-five
thousand, whichever is
less.
2. An appeal filed before the State Commission or the National
Commission has to be heard as
expeditiously as possible. There has to be an attempt to dispose appeal finally
within a period of
ninety days of its admission.
Ordinarily no adjournment is granted. However the State Commission or the
National Commission
322
may grant adjournment on sufficient cause shown by the party seeking
adjournment and the
reasons are recorded.
The State Commission or the National Commission can make orders for the
imposition of costs
occasioned by the adjournment.
If any appeal is disposed by the State Commission or the National Commission,
as the case may be,
beyond the specified period of ninety days the Commission has to give the
reasons for delay while
passing final order disposing the appeal.
3. Any person aggrieved by an order made by the National Commission in
exercise of powers under Section 21 of the Act may prefer an appeal against
such order to the Supreme Court within a period of thirty days from the date of
such order.
The Supreme Court may entertain an appeal after expiry of the specified period
of thirty days on getting satisfied that there was sufficient cause for not filing the
appeal in time. If the order against which appeal is to be preferred involves
payment of any amount by the person preferring the appeal, the appeal cannot be
filed without payment of 50 per cent of the amount ordered to be paid or Rs. 50
thousand, whichever is less.
38.13 COMPOSITION OF THE NATIONAL COMMISSION
1. Each National Commission shall consist of following:
A. A person who is or has been Judge of the Supreme Court, who shall be
its President. His
appointment has to be made by the Central Government only after consultation
with the Chief
Justice of India.
B. Not less than four other members and not more than such number of
members as may be
prescribed, one of whom shall be a woman having qualifications as under,
(i) be not less than thirty-five years of age.
(ii) possess a bachelor's degree from a recognised university.
(iii) be person of ability, integrity and standing, and have adequate knowledge
and experience
of at least ten years in dealing with problems relating to economics, law,
commerce,
accountancy, industry, public affairs or administration.
However, not more than 50 per cent of the members shall be from amongst
persons having a judicial background. For this section the expression judicial
background means knowledge and experience for at least ten years as a
presiding officer at the district level Court or any tribunal at equivalent level.
2. Every appointment as member of the National Commission has to be
made by the Central Government
on the recommendations of the Selection Committee consisting of the following:
(i) a person who is a Judge of the Supreme Court, to be nominated by the Chief
Justice of
India, who shall be the Chairman of Selection Committee, (ii) Secretary, in the
Department of Legal Affairs in the Government of India, who shall be the
member of Selection Committee, (iii) Secretary of the Department dealing with
Consumer Affairs in the Government of India,
who shall be the member of Selection Committee.
3. The jurisdiction, powers and authority of the National Commission may
be exercised by Benches
thereof. If the President and one member conduct the proceeding and they differ
on any point, the
point of difference has to be referred to the other member for hearing on such
point and thereafter
the opinion of majority may be exercised by Benches thereof. A Bench may be
constituted by the
President with one or more members, as the President may deem fit.
4.
5.
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If the Members of the Bench differ on any point, the point has to be decided by
majority. If there is equality in differing members, then the point of difference
has to be referred to the President. The President may hear the point of
difference himself or refer it to some other member for hearing. The point of
difference has to be then decided by majority of the members who heard the case
initially and after reference of difference.
Every member of the National Commission shall hold office for a term of five
years or up to the age of seventy years, which ever is earlier. Member will be
eligible for reappointment for another term of 5 years or up to age of 70 years. A
member may resign from his office under his hand addressed to the Central
Government.
The salary or honorarium and other allowance payable to, and other terms and
conditions of service of the member of the National Commission shall be such as
may be prescribed by the Central Government.
38.14 JURISDICTION AND POWERS OF NATIONAL COMMISSION
1. Subject to the other provision of the Act the National Commission has
jurisdiction,
(a) to entertain complaints where the value of the goods or services and
compensation, if any,
claimed exceeds Rs. 1 crore and appeals against the orders of any State
Commission, and
(b) to call for the records and pass appropriate orders in any consumer
dispute that is pending
before or has been decided by any State Commission where the National
Commission is of
the opinion that the State Commission has acted without jurisdiction or with
material irregularity.
2. For disposal of disputes by the National Commission same procedure,
with necessary modifications,
is applicable as given at Sections 12, 13 and 14 for District Forum.
The National Commission has also powers to review any order made by it when
there is error apparent on the face of record.
3. If the National Commission passes any ex parte order against the
opposite party or the complainant,
the aggrieved party may apply to the Commission to set aside the ex parte order
in the interest of
justice.
38.15 TRANSFER OF CASES
In the interest of justice the National Commission may transfer, on the
application of the complainant or on its own motion, any proceeding at any stage
from one District Forum of one state to a District Forum of another state and
from one State Commission to another State Commission.
38.16 FINALITY OF ORDER IF NO APPEAL IS PREFERRED
Every order of a District Forum, State Commission or of the National
Commission is final if no appeal is preferred against such order under the
provisions of the Act.
38.17 LIMITATION PERIOD
For filing any complaint before a District Forum, State Commission or the
National Commission the limitation period is two years from the date of cause of
action.
The District Forum, State Commission or National Commission may entertain a
complaint after the specified period of two years if sufficient cause is shown for
the delay and the Forum or Commission, as the case may be, records the reasons
for condoning the delay.
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38.18 ENFORCEMENT OF ORDERS
1. If any interim order passed under this Act by the District Forum, State
Commission or National
Commission, as the case may be, is not complied with the District Forum, State
Commission or
National Commission may order that the property of the person who is not
complying the order be
attached.
2. If within three months of attachment of the property as stated above, the
person does not comply
with the order, the attached property is sold. From the sale proceedings of the
property the District
Forum, State Commission or National Commission, as the case may be, may
order payment of
compensation to the complainant. The balance amount, if any, out of sale
proceeds after payment
of compensation is paid to the party entitled thereto.
3. Where any amount is due from any person under an order made by the
District Forum, State
Commission or National Commission, as the case may be, the person entitled to
the amount has
to make an application to the respective authority that has passed the order. On
the application
such authority has to issue a certificate for the said amount to the Collector of
the district. The
Collector has to then proceed to recover the amount mentioned in the certificate
as arrears of
land revenue.
38.19 DISMISSAL OF FRIVOLOUS OR VEXATIOUS COMPLAINTS
If the District Forum, State Commission or National Commission, as the case
may be, finds that the complaint instituted before it is frivolous or vexatious, it
shall dismiss the complaint after recording in writing the reasons. The order shall
also be for the cost, not exceeding Rs. ten thousand, that the complainant should
pay to the opposite party.
38.20 PENALTIES AND PROTECTIONS
1. Where a trader or a person against whom a complaint is made or the
complainant fails or omits to
comply with any order made by the District Forum, State Commission or
National Commission, as
the case may be, such trader or person or complainant shall be punishable with
imprisonment for
a term of not less than one month but which may extend to three years, or with
fine of minimum
Rs. 2,000 that may extend to Rs. ten thousand or with both.
2. For the trial of offences under this Act the District Forum, State
Commission or National Commission,
as the case may be, is deemed as and is conferred with powers of the First Class
Judicial Magistrate.
3. All offences under this Act are tried summarily by the District Forum,
State Commission or National
Commission, as the case may be.
4. No suit, prosecution or other legal proceedings lie against the members
of the District Forum,
State Commission or National Commission or any officer or person acting under
the direction of
the District Forum, State Commission or National Commission for execution of
any order made by
it. Similarly no action can lie for anything done in good faith or intended to be
done in good faith by
such member, officer or person under this Act or rules made there under.
38.21 SERVICE OF NOTICE
1. The service of notice may be made by delivering a copy thereof by
registered post acknowledgement
due addressed to the party against whom complaint is filed or to the
complainant. It can also be
sent by speed post or through the courier service approved by the District
Forum, State or National
Commission, as the case may be, or by fax.
2. The District Forum, State Commission or National Commission, as the
case may be shall declare
that the notice had been duly served to the addressee in following circumstances:
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3.
(i) when an acknowledgement or any other receipt purported to be signed by the
addressee is
received; or (ii) the communication sent in any manner as stated above is
received back with the remarks
made by postal employee or the authorised person of the courier agency that the
addressee
has refused to accept the delivery; or
(iii) the addressee has refused to take delivery of the notice sent by any other
means, and (iv) in case the notice was properly addressed, prepaid and duly sent
by registered post
acknowledgement due the declaration of service of notice can be made within
thirty days
from the date of posting of the notice even if the acknowledgement receipt has
not been
received back or lost or not found.
All notices required to be served on the opposite party are deemed to be
sufficiently served if addressed to the place where business or profession is
carried by him.
38.22 LET US SUM UP
For dealing with complaints by consumer there are District Forum, State and
National Commission. First two are established by the state government,
National Commission established by Central Government. Jurisdiction
respectively the district, the state and the entire country. District forum has
powers to deal with cases up to Rs. 20 lakh. Complaints have to be in prescribed
manner. Complaint should be made with full details, evidence and prescribed
fee. Supporting affidavit is required. Admissibility of complaint needs to be
decided within twenty-one days. The District Forum after conducting the case if
finds that complaint is true, can award compensation, replacement of goods etc.
Against the order of District Forum appeal within 30 days to State Commission.
If order involves payment to other party then at the time of appeal 50 per cent
amount is required to be deposited. National Commission has powers to make
regulations not inconsistent with Act and Rules.
38.23 CHECK YOUR PROGRESS
1. To appoint a person as President of District Forum, he must be qualified
to be a District Judge.
(True/False)
2. Appointment of District Forum is made by the High Court. (True/False)
3. Can few consumers file a representative complaint on behalf of general
consumers at large?
4. As the agencies appointed for under the Act are quasi-judicial, they do
not have powers of Civil
Court while conducting the case. (True/False)
38.24 ANSWERS TO 'CHECK YOUR PROGRESS'
1. True; 2. False; 3. Yes, but with permission of District Forum; 4. False.
38.25 MULTIPLE CHOICE TERMINAL QUESTIONS
1. District Forum has passed order to pay compensation. How recovery of the
ordered amount is made?
(a) By filing execution in Civil Court.
(b) By filing execution before District Forum.
(c) By filing Civil Suit.
(d) By referring the order to collector for making recovery as if it is land
revenue recovery.
Ans. 1. (d)
THE LAW OF LIMITATION
STRUCTURE
39.0 Objective
39.1 Introduction
39.2 Definition
39.3 Limitation and its Computation
39.4 Acts Giving Rise to Fresh Period of Limitation
39.5 Certain Important Provisions in Schedule to the Limitation Act
39.6 Let Us Sum Up
39.7 Check Your Progress
39.8 Answers to 'Check Your Progress'
m
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39.0 OBJECTIVE
The objective of this unit is to familiarise the aspects relating to the Limitation
Act, 1963 in so far as they are relevant to the banks and financial institutions.
39.1 INTRODUCTION
The Limitation Act, 1963 has significant application to the banks and financial
institutions. These entities provide financial assistance to borrowers and in
default by the borrowers; they are required to take appropriate action for the
recovery of the money lent. The Recovery of Debts due to Banks and financial
institutions Act, 1993 and the Securitisation and Reconstruction of Financial
Assets and Enforcement of Security Interest Act, 2002 specifically state that
actions under those Acts are permissible only if the claim is within the period of
limitation. The Limitation Act, 1963 is an Act to consolidate and amend the law
for the limitation of suits and other proceedings.
39.2 DEFINITION
Period of limitation is always in relation to a document which entitles the
beneficiary to take action in a court of law. Period of limitation means the period
of limitation prescribed for any suit, appeal or application by the Schedule,
andprescribedperiod means the period of limitation computed in accordance with
the provisions of this Act.
Suit does not include an appeal or an application.
39.3 LIMITATION AND ITS COMPUTATION
It is absolutely necessary that every suit or application or appeal shall have to be
made within the period of limitation. Section 3 of the Limitation Act declares
that every suit instituted, appeal preferred, and application made after the
prescribed period shall be dismissed although limitation has not been set up as a
defence. A suit is instituted when the plaint is presented to the proper officer in
the court. In the case of set off or counterclaim, they shall be treated as a
separate suit and shall be deemed to have been instituted:
(a) in the case of a set off, on the same date as the suit in which the set off is
pleaded;
(b) in the case of a counterclaim, on the date on which the counter-claim is
made in court.
Computation of the period of limitation
(a) When the period of limitation expires on a day when the court is closed,
the suit, appeal or
application may be instituted, preferred or made on the day when the court
reopens.
(b) Any appeal or any application other than execution petitions may be
admitted after the prescribed
period, if the appellant or applicant makes out sufficient cause for not preferring
the appeal or
application within the period of limitation.
(c) In computing the period of limitation, the day from which such period is
to be reckoned, shall be
excluded. The computation of the period of limitation for filing appeal shall
exclude the day on
which the judgment complained was pronounced and the time taken for
obtaining a copy of the
decree, sentence or order appealed. Time required for obtaining a copy of the
order or award
shall be excluded while computing the time limit for filing revision or review
application or an
application to set aside the award.
(d) For an application for execution of decree, the period during which the
institution or execution
has been stayed by injunction or order, the day on which the order was issued or
made and the
day on which it was withdrawn shall be excluded.
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(e) For filing any suit of which notice has to be given, or for which the
previous consent or sanction
of the Government or any other authority is required, in accordance with the
requirements of any
law for the time being in force, the period of such notice, or the time required for
obtaining such
consent or sanction shall be excluded.
(f) In computing the period of limitation for any suit, the time during which
the defendant has been
absent from India and from the territories outside India under the administration
of the Central
Government shall be excluded.
39.4 ACTS GIVING RISE TO FRESH PERIOD OF LIMITATION
There are two instances which will give rise to fresh period of limitation. In
these cases the period of limitation will be computed as if the starting point is the
happening of the instances.
1. Where before the expiration of the prescribed period for a suit or
application in respect of any
property or right, an acknowledgement of liability in respect of such property or
right has been
made in writing signed by the party against whom such property or right is
claimed, or by any
person through whom he derives his title or liability, a fresh period of limitation
shall be computed
from the time when the acknowledgement was so signed.
2. Where payment on account of a debt or of interest on a legacy is made
before expiration of the
prescribed period by the person liable to pay the debt or legacy or by his agent
duly authorised in
this behalf, a fresh period of limitation shall be computed from the time when
the payment was
made. In this case 'debt' does not include money payable under a decree or order
of a court.
39.5 CERTAIN IMPORTANT PROVISIONS IN SCHEDULE TO THE
LIMITATION ACT
Some of the important aspects that are required to be noted for filing suits of
different types are given below:
Description of Suits Period of Limitation Time from which Period begins
to Run
For money payable for money lent Three years When the loan is made
For money lent under an agreement that it shall be payable on demand Three
years When loan is made
On a bill of exchange payable at sight, or after sight, but not at a fixed time
Three years When the bill is presented
On a bill of exchange or promissory note payable at a fixed time after sight or
after demand Three years When the fixed time expires
On a promissory note or bond payable by instalments Three years The
expiration of the first term of payment as to the part then payable; and for the
other parts, the expiration of the respective terms of payment
For arrears of rent Three years When the arrears become due.
For specific performance of a contract Twelve years The date fixed for the
performance, or if no such date is fixed, when the plaintiff has noticed that
performance is refused
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To enforce payment of money secured by a mortgage or otherwise charged upon
immovable property Thirty years When the money sued for becomes due
By a mortgagee (a) for foreclosure Twelve years When the money
secured by the mortgage become due
(b) for possession of immovable property Thirty years When the
mortgagee become entitled to possession
Any suit (except a suit before the Supreme Court in the exercise of its original
jurisdiction) by or on behalf of the Central Government or any State
Government, including the Government of the State of Jammu and Kashmir
Three years When the period of limitation would begin to run under
this Act against a like suit by a private person
Any suit for which no period of limitation is provided elsewhere in this Schedule
Thirty years When the right to sue accrues
39.6 LET US SUM UP
The Law of Limitation plays an important role in filing a suit, appeal or
application in court. The suit, appeal or application instituted, preferred or made
after the prescribed period shall be dismissed although limitation has not been
set up as a defence. The Act provides exclusion of certain period while
computing the period of limitation. Acknowledgement in writing and payment
on account of a debt give rise to a fresh period of limitation from the time when
the acknowledgement was signed or the payment made, as the case may be
Schedule to the Act provides the limitation period and the time from which it is
to be computed.
39.7 CHECK YOUR PROGRESS
1. In the Limitation Act, the definition of 'suit' does not include appeal or
application. (True/False)
2. The defendant is required to set up the plea of limitation if he has to
succeed in a suit instituted
beyond the period of limitation. (True/False)
3. A suit is said to be instituted when the plaint is presented before the
proper officer. (True/False)
4. Acknowledgement in writing gives rise to fresh period of limitation.
(True/False)
5. Part payment of a debt within the period of limitation entails the plaintiff
to compute fresh period
of limitation from the date of payment. (True/False)
6. Limitation for a mortgage suit is three years from the date when the
mortgage money becomes
due. (True/False)
7. A suit on demand promissory note can be filed within three years from
the date on which the
demand was made. (True/False)
39.9 ANSWERS TO 'CHECK YOUR PROGRESS'
1. True; 2. False; 3. True; 4. True; 5. True; 6. False; 7. False
TAX LAWS
STRUCTURE
40.0 Objective
40.1 Introduction
40.2 Income Tax
40.3 Fringe Benefit Tax
40.4 Banking Cash Transaction Tax
40.5 Service Tax
40.6 Let Us Sum Up
40.7 Check Your Progress
40.8 Answers to 'Check Your Progress'
40.9 Multiple Choice Questions
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40.0 OBJECTIVE
This unit is intended to provide an outline on the basic aspects of the laws
relating to Income tax, fringe benefit tax, banking cash transaction tax and
service tax limiting the discussions on the applicability of the above tax laws to
banks and financial institutions.
40.1 INTRODUCTION
The banks and financial institutions are required to implement the provisions of
the tax laws by deducting taxes at source, crediting the tax deducted at source to
the income tax authorities and also have regard to the provisions relating to
Banking Cash Transaction Tax, Service Tax, etc., in their day to day operations.
40.2 INCOME TAX
The law relating to taxation of income is governed by Income Tax Act 1961.
This Act envisages taxation of income of an assessee on the basis of his
(a) Residence; (b) Place of source of income.
Meaning of Income
The definition of 'income' is inclusive and not exhaustive in nature. Thus no
precise definition as to what constitutes income.
Assessee and Assessment year
The income accruing, or arising, to a person (called 'Assessee') is taxed on the
basis of 'Assessment Year'. The term Assessment Year represents the period of
12 months beginning from 1st April every year. The income arising in the
'previous year' is taxed in the assessment year. Previous year is the financial year
immediately preceding the assessment year of an assessee.
Residential status
The residential status of an assessee is determined on the basis of the number of
days an assessee was present in India during the previous year. In the case of
corporates, it is determined on the basis of location of control and management
of the company and also the place of registration. When a company is an Indian
company, that is a company registered under Companies Act of India or a body
corporate set up by statute or a company whose control and management of a
company is based in India, such a company is treated as resident in India.
There is also a third category called resident but not ordinarily resident which is
relevant only for assessees who are individuals and Hindu undivided families.
The income declared by the resident assessee from anywhere in the world is
taxable under Income Tax Act in India. As against this in the case of non-
resident and persons who are not ordinarily resident in India, any income derived
abroad is not taxable and only income accruing or arising in India is liable to tax
in India. Heads of income
Under IT Act - Other applications are:
(a) Quoting PAN for opening a/c, purchase of DD, Term Deposit above Rs.
20,000.
(b) Declaration in Form 60 and 61.
(c) Repayment of T. Deposit above Rs. 20,000 by pay-order
(d) Reporting high value transactions - above Rs. 1 lakh
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Income Tax Act, 1961 envisages taxation of income under following heads:
1. Salaries 2. Income from house property
3. Profits and gains from business or profession 4. Capital gains 5. Income
from other sources
Computation of income
Computation of Taxable income involves the following steps. Income arising
under various heads to income is computed separately as per the relevant
sections covering such incomes. After having computed the income under each
head separately, the 'gross total income' representing the sum of above amounts
computed under such heads is arrived at. Chapter VIA of the Income Tax Act
provides for various deductions allowable from the gross total income. The
taxable income of the assessee is arrived at after deducting such amounts
covered under Chapter VIA of the Income Tax Act.
Income exempt from tax
Certain categories of income are exempt from tax and such income is not taken
into account in the computation of income. They are excluded from the
computation at the beginning.
Assessment Proceedings
Every person whose total income in a previous year exceeds the maximum
amount which is not liable to tax is required to file his return by the due date
prescribed in section 139. A company or partnership firm has to file its return of
income.
A corporate assessee is required to file its return of income in the prescribed
Form No 1. Corporate assesses are required to file the return of income in
computer media (e-filing). The due date for filing of this return is presently
October 31 of the Assessment year.
A return of income can be revised to correct any mistake in computation of
income in the original return by filing another return within one year from the
end of the assessment year or before completion of assessment whichever is
earlier. A return declaring loss should be filed before the due date and any delay
in filing of such return declaring loss will result in denial of the benefit of carry
forward of such loss and set off in future years.
The returns filed by an assessee is assessed by an officer duly designated for this
purpose (Assessing Officer - AO). The assessment could be in the nature of
summary assessment where the return of income is accepted u/s 143(1) by AO
without any further enquiry. The AO may also scrutinise the return furnished by
the issuing a notice u/s 143 (2) of the Act and complete the assessment under
Section 143(3) which is commonly called as 'Scrutiny Assessment'.
The AO determines the total income and issues an assessment order along with
the notice of demand. The demand if any, raised after scrutiny assessment is
payable within 30 days of the service of the assessment order and the demand
notice on the assessee.
When a person fails to file his return of income as prescribed in the Act, the AO
can issue a notice under section 142 calling him to file a return and proceed to
assess the income. AO can also reopen and reassess the income under prescribed
circumstances.
Payment of Taxes
Advance tax is payable as per the provisions of section 210 of the Income Tax
Act. Advance tax arises from the concept of 'pay as you earn'. In the case of
corporate assessees, advance tax is payable in four instalments as given below:
(a) By June 15-15 per cent
(b) By September 15-30 per cent
334
(c) By December 15-60 per cent
(d) By March 15-100 per cent of the advance tax payable.
The advance tax which is paid by an assessee on the basis of estimation of
income may at times fall short of the tax payable as per the return of income.
Such a shortfall if any shall be paid by way of 'self-assessment tax' under Section
140A of the Income Tax Act.
Deduction/collection of tax source
Members of Co-operative bank are exempted from TDS. Apart from advance
taxes and self-assessment, income tax is also payable through other modes, viz..
Deduction of Tax at Source (TDS) and Collection of Tax at Source (TCS).
The provisions relating to TDS are important in the normal day-to-day business
activities of a bank and are relevant when payments of specific nature are made.
The following payments generally occur during the course of business activities
of a bank and are covered under TDS under the Income Tax Act, 1961.
(i) Salaries - Section 192
(ii) Interest on securities - Section 193
(iii) Payment of interest, other than interest of securities - Section 194A (iv)
Payment to contractors or sub-contractors - 194C (v) Payment of brokerage and
commission - Section 194H (vi) Payment by way of rent - Section 1941 (vii)
Payment of professional and technical fees - Section 194J (viii) Payment to non-
resident - Section 195
The compliance with regard to provisions of the Act relating to TDS requires
special attention as it casts an onerous responsibility on the person paying such
amounts.
Firstly, the person deducting tax at source is required to obtain Tax Deduction
Account Number (TAN) by filing an application in Form 49B. Tax shall be
deducted at source as per the rates given in the Finance Act of the respective
years. The tax deducted at source is required be deposited in the Government
account, generally within one week from the end of the month in which tax is
deducted at source. It should be noted that whenever the amount payable by way
of interest, professional fees, rent, etc., are credited into the account of payee in
the books of the payer without actually making payment to the person
concerned, it is deemed to be a payment and there is an obligation to deduct tax
at source.
Frequently payments are requirement to be made to non-residents. It should be
noted that the relevant
section 195 covers payment interest and any other sum not being salaries. The
rate of deduction of tax
on payments made to non-residents under Section 195 is also given in the
Finance Act of the relevant
year. The Government of India enters into agreements for avoidance of double
taxation of income both
on the basis of residence and source with other countries. The rate given in the
Double Taxation
Avoidable Agreement (DTAA) with the respective country where the recipient
is resident will have to
be taken into account. The rates applicable as per the DTAA will have to be
applied for the purposes of
TDS, when it is lower than the rates given in the Finance Act. '
A person deducting tax at source is required to file quarterly return of TDS in
prescribed form for salaries, other than salaries and payments to non-residents.
These returns are also required to be filed in computer media.
It should be noted that as per the provision of Section 40(a) of the Act, any
failure to deduct tax at source or payment of TDS into Government account,
results in disallowance of the relevant expenditure in computation of income of
the bank, e.g. a payment of Rs. 1 lakh is to be made by a bank to a contractor on
which tax has not been deducted at source, then entire amount of Rs. 1 lakh will
be
335
added back and treated as income of the bank in the computation of income and
the bank will be liable to pay tax on the same. Besides, improper or non-
compliance with regard to TDS also attracts levy of interest, penalty and
prosecution.
Non-compliance with provisions relating to TDS attracts
1. Levy of interest @ 12 per cent p.a. on the amount on tax payable at
source from the date on which
it is deductible until the date of payment.
2. Recovery of tax deductible at source from the person responsible for
deduction.
3. Non-payment of tax deducted at source into Government a/c attracts
prosecution proceedings
under Section 276B of the Income Tax Act.
4. Any failure to file returns/statements in this regard attracts penalty @ of
Rs. 100 per day for the
period of default.
40.3 FRINGE BENEFIT TAX
Fringe Benefit Tax [FBT] was introduced by Finance Act 2005 and is applicable
for the previous year beginning 1.4.2005 (i.e. For AY 2006-2007 onwards).
FBT intends to tax fringe benefits, which are provided or deemed to have been
provided, by an employer to its employee during the previous year. It is in the
nature of a presumptive tax levied on an employer in respect of various expenses
incurred by the employer on behalf of its employee.
FBT is payable at the rates applicable to the assessee on the 'Value' of such
fringe benefit, this tax is payable by an employer in addition to the income tax.
The definition of the term fringe benefit is contained in Section 115(w)(b) of the
Income Tax Act. There are two parts in the definition. First part defines three
categories of benefit, which are specifically taken to mean 'Fringe Benefit'. The
second part treats certain benefits or expenditure incurred by the employer as
'Deemed Fringe Benefit'.
The value 'Deemed Fringe Benefit' as defined in Section 115(w)(b) is to be
calculated at the rates specified on the total expenditure incurred. In other words,
only part of the expenditure and not the entire amount expended is taken into
account as 'value of fringe benefit' for the purpose of payment of FBT.
The Act also envisages payment of FBT in advance on the basis of expenses
incurred at the end of every quarter. FBT by way of advance tax is payable on or
before 15th day of the month following each quarter. However, for the quarter
ending 31st March of the financial year, it shall be paid before 15th March of the
same financial year.
Return of FBT is also required to be filed before due date for filing of return
under the Income Tax Act. In practice, presently there is no separate return but it
is made as a separate section of the Income tax return.
40.4 BANKING CASH TRANSACTION TAX
Banking Cash Transaction Tax [BCTT] was introduced with effect from
01/06/2005 to cover certain specific transactions involving withdrawal of cash
from accounts maintained by branches of the scheduled banks. This tax is
payable @ 0.1 per cent of the value of every taxable banking transaction.
'Taxable Banking Transaction' is defined in Clause 8 of Section of 94 of the
Finance Act 2005 to mean,
(a) A transaction, being withdrawal of cash (by whatever mode) on any single
day from an account (other than a saving bank account) maintained with any
scheduled bank, exceeding:
336
(i) Fifty thousand rupees, in cash such withdrawal is from the account
maintained by any
individual or Hindu undivided family (ii) One lakh rupees, in case such
withdrawal is from the account maintained by a person other
than any individual or Hindu undivided family or
(b) A transaction, being receipt of cash from any scheduled bank on any single
day on encashment of one or more term deposits, whether on maturity or
otherwise, from that bank, exceeding-(i) Fifty thousand rupees, in case such term
deposit or deposits are in the name of any individual
or Hindu undivided family; (ii) One lakh rupees, in case such term deposit or
deposits are by any person other than an
individual or Hindu undivided family.
The tax collected by way of BCTT is payable to the credit of Central
Government by 15th day of the month immediately following the month in
which such tax is collected. A branch of the bank is required to maintain a
statement prepared in Form No.l, A monthly statement in Form No. 2 is also to
be filed by the following month. A return in Form No. 3 is to be filed in
computer media by 31 st July in respect of the year ending 31st March.
Any default in payment of BCTT attracts interest @ 1 per cent for every month
or part thereof for the period of delay. The relevant legislation also contains the
procedure for assessment, rectification, appeals and levy of penalty for non-
compliance with aforesaid law relating to BCTT.
40.5 SERVICE TAX
Service Tax was introduced by Finance Act, 1994. Initially it covered just 3
services, viz., telephone, general insurance and stock broking. No Separate Act
exists for Service Tax. Over the years, amendments have been made to the
Finance Act and various other services were brought within the ambit of service
tax. There will be no service tax if the turnover does not exceed Rs. 8 lakh. If the
turnover exceeds this limit, the person providing the services covered will have
to pay service tax.
Among the services covered, the service tax is leviable on banking and financial
service w.e.f. 16/7/ 2001. The term banking and financial services covers various
kinds of business activities of the bank. It has also been extended to lending
related activities of the banks, fees, commission, etc. It is not payable on interest
income of the bank. Various services like merchant banking activities, securities
and foreign exchange brokerage, advisory services, safe deposit locker service,
etc., are covered.
Besides the above, there are some other services on which service tax is payable,
e.g. credit and debit card services, business auxiliary services, etc. In the event
of an obligation arising under any category of service, the service provider will
have to obtain separate registration for each such service.
The service tax registration can be obtained by filing Form ST-1 with the service
tax authorities. With the introduction of centralised accounting system in various
banks there is also scope to obtain centralised registration for all the branches.
Centralised Registration can be obtained from the Commissioner of Service Tax
at the location which the accounting activities are centralised.
Service tax is at present payable @ 12 per cent along with education cess 3 per
cent thereon (total 12.36 per cent) on the fee income received. Obligation to pay
service tax is on the person providing service and is payable on actual receipt of
fee income. The law also provides that in the event of service tax is not collected
separately by the service provider, the amount received by way of value for the
service provided can be bifurcated into fee, income and service tax component
by reverse arithmetical calculation. E.g. if the amount received is x, service tax
can be worked out as follows:
X/112.4 multiplied by 12.4
The amount so arrived at can be paid as service tax and the balance can be
reported as value for services rendered. Service tax is payable to the credit of the
Government by 5th of the month following
___„_.._-__„__„__ 337
I:
the month in which the income is received [except in the month of March when
it is required within the same month]. The return in Form ST-3 is required to be
filed half yearly on April 25 and October 25 and every year covering half period
ending 31st March and 30th September respectively.
Cenvat Credit
If service tax paid is by an assessee for input services, the same can be set off to
the extent of 20 per cent of the liability on output services. Such set off to the
extent of 20 per cent of the service tax liability is across all input services. Rule
6[l][iii] of Cenvat credit rules, also provides for set off to the extent of 100 per
cent of service tax liability in respect of service tax paid on certain specified
input services. In other words, service tax paid on input service includes specific
category of service, the limit of 20 per cent mentioned above can be breached
and credit for the entire amount paid for input service can be taken against the
liability on output service.
Export and Import of Services
Service tax is not applicable when service are rendered outside India or
exported. Conversely service tax is leviable when services are imported. The
relevant rules regarding service tax chargeable in respect of imported services is
contained in Import of Service Rules, 2006.
Whenever service tax is payable on import of services, the liability to pay such
service tax is on the person importing such services. Such a person is required to
obtain registration for each category of service imported.
Any delay in payment of service tax to Government account attracts levy of
interest at a specified rate (presently 13 per cent p.a.) which is required to be
paid along with the service tax. Non-compliance with the law relating to the
service tax also attracts penalty equivalent to the amount of Service Tax payable.
40.6 LET US SUM UP
As a business entity, banks are required to comply with various tax laws. Income
is computed under separate heads and the gross total income is calculated.
Taxable Income is arrived at after deduction allowable under Chapter VIA.
Fringe benefit Tax and Banking Cash Transactions tax also require independent
compliances. Income Tax and Fringe Benefit Tax are payable in instalments by
way of advance tax. Tax is deductible at source at the specified rates on making
certain types of payment. There are separate compliance requirement in respect
of TDS.
Service Tax is payable on various services rendered by banks and which are
mainly covered under 'Banking and Financial services'. However, Compliance
may be required to be made through separate registration for other services.
Cenvat credit is available on service tax payable on the basis of service tax on
input services.
40.7 CHECK YOUR PROGRESS
1. Liability to pay income tax arises on account of residential status and
place of the source of
income. (True/False)
2. Assessment year represents the period of 12 months beginning from 1st
April each year.
l(True/False)
3. Previous year is the financial year immediately preceding the assessment
year (True/False)
4. Income is taxed only on salaries. (True/False)
5. Income exempt from tax is to be deducted out of taxable income before
computation of tax
(True/False)
338
6. Assessment is of two types (a) summary assessment and (b) scrutiny
assessment (True/False)
7. Partnership firm, if it has no income, need not file a tax return.
(True/False)
8. Tax assessed by AO shall be paid within days. (30/45)
9. Entire advance tax is to be paid by 15th March. (True/False)
10. Tax deduction is to be made before making payment to non-residents.
(True/False)
11. Tax deducted at source is to be deposited within one week from the end
of the month in which it
is to be deducted. (True/False)
12. Person deducting tax at source is required to file a quarterly return of
TDS. (True/False)
13. FBT consists of specific items and certain benefits or expenditure
incurred by the employer as
deemed fringe benefit. (True/False)
14. For FBT a separate return has to be filed. (True/False)
15. Service Tax Act deals with levy of tax on services. (True/False)
16. Cenvat credit can be availed of in respect of tax paid on certain specified
input services.
(True/False)
40.8 ANSWERS TO CHECK YOUR PROGRESS1
HI
1. True; 2. True; 3. True; 4. False; 5. False; 6. True; 7. False; 8. 30; 9. True; 10.
True; 11. True; 12. True; 13. True; 14. False; 15. False; 16. True.
40.9 MULTIPLE CHOICE QUESTIONS
1. Failure to deduct tax at source will result in
(a) disallowance of expenditure;
(b) only tax with interest shall be payable
(c) tax will be collected from the person receiving payment;
(d) no effect on the person making payment.
2. Banking Cash Transaction Tax is payable if withdrawal by an individual
exceeds
(a) Rs. 10,000; (b) Rs. 10,000 in a week;
(c) Rs. 50,000 in a day; (d) Rs. 25,000 in a day.
3. Banking Cash Transaction Tax is payable to the credit of the Central
Government by
(a) 15th day of the next month; (b) 7th day of the next month;
(c) last day of the current month; (d) 10th day of the next month
Ans: 1. (a); 2. (c); 3. (a)
MODULE -D
COMMERCIAL LAWS WITH REFERENCE TO BANKING OPERATIONS
Unit 41. Meaning and Essentials of a Contract
Unit 42. Contracts of Indemnity
Unit 43. Contracts of Guarantee
Unit 44. Contract of Bailment
Unit 45. Contract of Pledge
Unit 46. Contract of Agency
Unit 47. Meaning and Essentials of a Contract of Sale
Unit 48. Conditions and Warranties
Unit 49. Unpaid Seller
Unit 50. Definition, Meaning and Nature of Partnership
Unit 51. Relations of Partners to One Another
Unit 52. Relations of Partners to Third Parties
Unit 53. Minor Admitted to the Benefits of Partnership
Unit 54. Dissolution of a Firm
Unit 55. Effect of Non-Registration
Unit 56. Definition and Features of a Company
Unit 57. Types of Companies
Unit 58. Memorandum of Association and Articles of Association
Unit 59. Doctrines of Ultra Vires/Constructive Notice/Indoor Management
Unit 60. Membership
Unit 61. Prospectus
Unit 62. Directors
Unit 63. Foreign Exchange Management Act, 1999
Unit 64. Transfer of Property Act, 1882
Unit 65. The Right to Information Act, 2005
Unit 66. Right to Information and Obligations of Public Authorities
Unit 67. The Prevention of Money Laundering Act, 2002
Unit 68. Information Technology Act, 2000
L.R.A.B-23
UNIT
41
MEANING AND ESSENTIALS OF A CONTRACT
STRUCTURE
41.0 Objective
41.1 Introduction
41.2 Meaning of Contract
41.3 Key Components to Form a Contract
41.4 Essentials of a Valid Contract
41.5 Let Us Sum Up
41.6 Keywords
41.7 Check Your Progress
41.8 Answers to 'Check Your Progress'
342
41.0 OBJECTIVE
The objective of this unit, is to enable the candidates to have a broad
understanding of the essential elements of a contract.
41.1 INTRODUCTION
The law of contract constitutes the most important branch of commercial law. It
affects the entire trade, commerce and industry in the country. In India, the law
relating to contracts is governed by the Indian Contract Act, 1872. The Act is
broadly divisible into two parts. Part one describes the general principles of a
contract which are applicable to all types of contracts. The second part deals
with special types of contracts, namely indemnities, guarantees, etc.
41.2 MEANING OF CONTRACT
Contract means an agreement enforceable by law. It has two major constituents:
1. An agreement between two persons or more.
2. The agreement must be enforceable by law (i.e. the rights and
obligations arising out of it).
41.3 KEY COMPONENTS TO FORM A CONTRACT
When one person signifies to another person, his willingness to do or not to do
something, with a view to obtaining the consent of that other person, he is said to
make a proposal.
When a person to whom the proposal is made, signifies his assent (consent), the
proposal is said to be accepted.
A proposal becomes a promise when it is accepted. The person making the
proposal is called the 'promisor'. The person accepting the proposal is called
'promisee'.
41.4 ESSENTIALS OF A VALID CONTRACT
Proposal and Acceptance
There must be a lawful proposal by one party and the other party must accept the
proposal. Illustration
A proposes by a letter to B to sell his car for Rs. 10,000. This is known as a
proposal. A is the promisor. If B accepts the proposal then he becomes the
promisee. This results into a contract.
An Agreement may be Oral or Written
While valid cnntwte ^^ w» ^J^ uiax agreements, under certain laws an
agreement is required to be in writing only and is also required to be registered
and attested. If such formalities are not complied with, then the agreement
cannot be enforced before a court of law. This applies for example, in the case of
sale or mortgage of immoveable property, lease, etc.
Consideration
There must be a lawful consideration for both the parties to enter into an
agreement. Consideration here means 'something in return'. Hence, when both
(or more) parties to an agreement give something to one another and get
something in return, then the agreement becomes enforceable at law.
343
The Contract Act defines consideration as under.
When, at the desire of the promisor, the promisee or any other person
• has done or abstained from doing, or
• does or abstains from doing, or
• promises to do or to abstain from doing something.
such act or abstinence or promise is called a consideration for the promise.
(abstains means refrains/avoids)
Illustration
A agrees to sell his car to B provided that B gives Rs 1 lakh to A. Here, As
promise to sell the car is a consideration for B's promise to pay the money and
B's promise to pay the money is a consideration for A's promise to sell the car.
These are lawful considerations and the contract is enforceable at law.
It has always to be remembered that an agreement without consideration is void.
(Void means, it is of no legal effect and is not enforceable by law.) However, in
the following cases an agreement without consideration is valid:
• An agreement made out of natural love and affection.
• Between parties standing in near relation to each other.
• Which is in writing and registered.
Illustration
Mr A out of his natural love and affection, promises to give to his son B, a sum
of Rs. 1000. A puts his promise in writing and registers it. This is a valid
contract even though there is no consideration from B.
A promise to compensate a person, who has already done something voluntarily
for the promisor (or done something voluntarily, that the promisor was legally
bound to do) is enforceable at law.
Illustration
A finds B's watch and gives it to him. B promises to give A a sum of Rs. 100.
This is a contract.
The agreement must be entered for lawful objects, e.g. it should not be forbidden
by law or must not be fraudulent (i.e. to commit a fraud/must not be
immoral/must not be opposed to public policy, etc.).
Free Consent
Free consent of the parties to a contract is required. A consent is said to be free
when the parties agree to the same thing in the same sense.
Capacity to Contract
The parties to an agreement must be legally competent to enter into a contract.
Section 11 of the Contract Act lays down that every person is competent to enter
into a contract if,
• he has attained the age of majority, and
• he is of sound mind, and
• he is not disqualified from entering into an contract by any law to which
he is subject.
Minor's Contracts
An agreement made by minor is void ab initio. The principle behind this is that a
minor is not supposed to have a mature judgement and hence, he cannot decide
what is good or bad for him. A minor is hence, not liable to perform any promise
made by him under any agreement.
This leading case of Mohiri Bibi vs Dharmodas Ghose (1903) 30 Cal539: 39IA
114 (PC) settled this law.
344
In this case a minor borrowed a certain sum and as a security to repay it, he gave
a mortgage of certain immoveable property. Later on, the minor sued for setting
aside the mortgage. The mortgagee demanded the return of the money given by
him to the minor. The Court held that the agreement made by the minor was
void ab initio and there was no question of refunding the money.
41.5 LET US SUM UP
Contract means an agreement enforceable by law. There must be a lawful
proposal by one party and the other party must accept the proposal to enter into a
contract. An agreement may be oral or written. There must be a lawful
consideration for both the parties to enter into an agreement. The parties to an
agreement must be legally competent to enter into a contract. An agreement
made by minor is void ab initio.
41.6 KEYWORDS
Void Agreement; Enforceable by Law; Suit; Voidable Agreement; Person of
Sound Mind; Ab Initio; Sue; Sued; Registration/Registered Agreement, etc.;
Damages.
41.7 CHECK YOUR PROGRESS
1. Fill in the blanks from the alternatives provided.
(i) A is free when the parties to the contract agree to the same thing in the
same
sense, (consent/contract/agreement)
(ii) A contract without is void, (cash/consideration/indemnity/guarantee)
(iii) A person who makes a proposal is known as (promisor/principal
debtor/surety/
guarantor)
(iv) A person is said to be competent to contract if (he is a major/he is of
sound
mind/he is a major and of sound mind)
2. Identify whether the following statements are True or False.
(i) A enters into an agreement with B to rob C and share the money. B runs away
with all the
money. A can file a suit against B to recover the money.
(ii) Mr. X (aged 17) can enter into an agreement with Mr. Y (aged 25) to buy a
car. (iii) A contract is concluded only when the party to whom the proposal is
made, accepts the
proposal.
41.8 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (i) consent; (ii) consideration; (iii) promisor; (iv) He is a major and of
sound mind.
2. (i) False; (ii) False; (iii) True.
CONTRACTS OF INDEMNITY
un
ed
he UNIT
42
ind
en. an
ab STRUCTURE
ue;
42.0 Objectives
42.1 Introduction
42.2 Rights of Indemnity Holder
42.3 Let Us Sum Up
42.4 Check Your Progress
42.5 Answers to 'Check Your Progress'
me
ay/ ind
the
the
3.46
42.0 OBJECTIVES
The objective of this unit is to enable the candidates to understand:
• What can be construed as a Contract of Indemnity?
• What are the rights and liabilities of the indemnity holder and the
indemnifier?
42.1 INTRODUCTION
A Contract of Indemnity is a contract by which one party promises to save the
other from loss likely to be caused to him. This loss can be, either by the conduct
of the promisor himself or by the conduct of any other person.
42.2 RIGHTS OF INDEMNITY HOLDER
The indemnity holder (i.e. the promisee or the person who is indemnified) has
the following rights when sued (i.e. when a legal action is taken against the
person who has indemnified).
The promisee is entitled to recover from the promisor, in respect of the matter to
which the promise to indemnify applies:
1. All damages which he may be compelled to pay in any suit.
2. All costs which he may be compelled to pay in any suit.
3. All sums paid in compromise, not contrary to indemnity.
Illustration
Mr A contracts with C, that B will not sue C in respect of Rs. 1,00,000, which C
owes to B. If B sues C, any consequences of such a suit will be borne by A
according to the contract. Is such a contract valid?
The Contract Act specifically provides that such a contract can be entered into.
These are known as Contracts of indemnity. Here, A is said to indemnify C for a
certain loss, which he may suffer.
All insurance contracts are examples of contracts of indemnity because all
insurance contracts are contracts, which indemnify a person from certain losses,
which he may suffer, e.g. under a fire insurance policy taken by a shopkeeper for
his godown, the insurance company undertakes to pay a certain amount to the
policy holder (i.e. the shopkeeper) in the event of fire in the godown, subject to
the conditions of the policy and payment of premium by the shopkeeper (policy
holder).
42.3 LET US SUM UP
A Contract of Indemnity is entered into when a party apprehends a loss in a
particular contract and wants itself to be covered from the losses it may incur.
42.4 CHECK YOUR PROGRESS
1. Fill in the blanks from the alternatives provided.
-. (guarantee /pledge/
(i) Insurance policies are contracts which are in the nature of
bailment/indemnity)
(ii) There are parties in a contract of indemnity. (2/3/4/5)
2. Identify whether the statement is True or False.
(i) A person who is indemnified can recover damages as well as costs for
claiming the damages.
42.5 ANSWERS TO CHECK YOUR PROGRESS'
1. (i) indemnity, (ii) 2; 2. (i) True.
CONTRACTS OF GUARANTEE
STRUCTURE
43.0 Objective
43.1 Introduction
43.2 Parties to the Contract
43.3 Basic Principles of Contract to be Complied
43.4 Consideration
43.5 The Liability of the Surety
43.6 Continuing Guarantee
43.7 Death of Surety
43.8 Variance in the Terms of a Contract
43.9 Discharge of Principal Debtor
43.10 Forbearance to Sue
43.11 Release of One Co-surety does not Discharge Other
43.12 Surety can Claim His Dues from the Principal Debtor
43.13 Security
43.14 Misrepresentation Made by the Creditor
43.15 Implied Promise by the Principal Debtor to Indemnify the Surety
43.16 Co-sureties for the Same Debt
43.17 Let Us Sum Up
43.18 Keywords-
43.19 Check Your Progress
43.20 Answers to 'Check Your Progress'
348
43.0 OBJECTIVE
The objective of this unit is to impart knowledge of the basic elements of a
Contract of Guarantee and the role and obligations of the guarantor in various
contracts and discharge of his obligations in various
contingencies/circumstances.
43.1 INTRODUCTION
A 'Contract of Guarantee' is a contract to perform the promise, or discharge the
liability, of a third person in case of latter's default. A guarantee may be either
oral or written. The question whether a particular contract is a contract of
indemnity or guarantee has to be decided by examining the language of the
documents entered into between the parties and the nature of transaction.
43.2 PARTIES TO THE CONTRACT
The person who gives the guarantee is called the 'surety'.
The person in respect of whose default the guarantee is given is called the
'principal debtor'.
The person to whom the guarantee is given is called the 'creditor/beneficiary'.
Illustration
'A' wants to take a loan of Rs. 10,000 from B, but B does not know 'A' very well
and fears that A may not return the money. C is a good friend of A. C tells B that
if A does not return the money to B, C will personally, pay it to B. Under this
assurance by C to B, B lends the money to A. On the date on which the money
was to be returned, A fails to pay back Rs. 10,000. Can B now, demand this
money from C?
Yes, he can. The contract, described above is called a Contract of Guarantee.
This contract involves three persons. Under the above illustration, A is the
principal debtor. B is the creditor. C is the surety. Therefore, in the above
scenario, C shall pay to B Rs. 10,000.
However, it is important to note that the contract does not end here. B can, after
he has paid the amount to C, claim the same amount from A. This is the unique
feature of a Contract of Guarantee. There are actually two separate agreements
each between two of the parties. The first is an express contract between the
person standing guarantee (surety) and the person to whom the guarantee is
made (creditor). The second agreement is between the person who is being
guaranteed (principal debtor) and the surety and this is an implied contract
(discussed later).
43.3 BASIC PRINCIPLES OF CONTRACT TO BE COMPLIED
All the principles and rules, which apply to other contracts, like what can form
consideration, or what would be a valid contract, also apply to a Contract of
Guarantee.
43.4 CONSIDERATION
Anything done, or any promise made, for the benefit of the principal debtor, is a
sufficient consideration to the surety for giving the guarantee. This is explained
by the following illustrations:
Illustration
(a) B requests A to sell and deliver to him goods on credit. A agrees to do so,
provided C will give gua¬rantee the payment of the price of the goods. C
promises to guarantee the payment in consideration of A's promise to deliver the
goods. This is a sufficient consideration for C's promise.
349
(b) A sells and delivers goods to B. C afterwards requests A to forbear to
sue B for the debt for a year
(i.e. not to take legal action for recovery) and promises that if he does so C will
pay for them in
case of default by B. A agrees to forbear as requested. This is a sufficient
consideration for C's
promise.
(c) A sells and delivers goods to B. C afterwards, out of nothing and
without any request or promise
to him by any party, agrees to pay for the goods in default of B. This is a void
(invalid) contract
as there is no consideration for C's promise.
43.5 THE LIABILITY OF THE SURETY
The liability of the surety is co-extensive with that of the principal debtor. This
means that once, if the principal debtor is unable to pay the debt, the surety takes
the place of the principal debtor. Therefore, any sum of money owed by the
principal debtor becomes payable by the surety. This includes, even the interest
that the principal debtor may owe to the creditor. Again, once the surety has paid
the debt, he then occupies the place of the original creditor. He can then claim
from the principal debtor, the entire sum he has paid to the original creditor.
Illustration
'A' guarantees to B the payment of a bill of exchange by C, the acceptor. The bill
is dishonoured by C. A is liable not only for the amount of the bill, but also for
any interest and charges which may have become due on it.
43.6 CONTINUING GUARANTEE
A guarantee which extends to a series of transactions, is called, a 'continuing
guarantee'. This type of guarantee is not limited to only one transaction but to
many transactions.
Illustration
Mr. A contracts with Mr. B, a shopkeeper to allow Mrs. A to take whatever
goods she may need from his shop, up to the amount of Rs. 20,000. Mr. A will
be liable for the debts incurred by Mrs. A up to the given amount.
A continuing guarantee may at any time be revoked by the surety, as to future
transactions, by notice to the creditor.
Say Mr. A and his wife are now living separately; Mr. A may inform Mr. B that
the guarantee stands revoked from that point on. Then, any debts incurred by
Mrs. A after such a revocation would not be payable by Mr. A.
43.7 DEATH OF SURETY
Normally, when the surety dies, the guarantee ends from that date. However, this
is not true in all cases. It depends upon the terms of the contract and the intention
of the parties as regards future transactions.
Generally all guarantees obtained by banks are continuing guarantees and in the
case of death of a surety, the guarantee would stand revoked for future
transactions. The is the precise reason when the information of a guarantor's
death is received, banks prefer to break the running accounts of a borrower.
43.8 VARIANCE IN TERMS OF THE CONTRACT
Any variance (change/modification) made without the surety's consent, in the
'terms of contract'
II:
350
guaranteed by him, between the principal debtor and the creditor discharges the
surety as to transactions subsequent to the variance.
In a Contract of Guarantee, the surety gives his guarantee on his own terms. If
the principal debtor and the creditor change the terms of the guarantee without
the consent of the surety, obviously, this would not be fair to the surety.
Therefore, if there is any variance in the terms of the guarantee, the surety will
be discharged from liability for any future debts, incurred after any such
variance.
Illustration
Let us assume that in the above example, the surety that Mr. A had given strict
instructions to the shopkeeper not to allow his wife to buy any cosmetics on
credit. If the shopkeeper allows Mrs. A to buy these items, the terms of the
guarantee are changed and therefore, Mr. A would not be liable to pay to the
shopkeeper for any future transactions from that point onwards.
43.9 DISCHARGE OF PRINCIPAL DEBTOR
The surety is discharged if the principal debtor is released by the creditor.
Illustration
A gives a guarantee to C for goods to be supplied by C to B. C supplies goods to
B and afterwards B contracts with his creditors (including C) to assign/sell them
certain properties of his, in consideration of all the creditors, releasing B from all
their demands. Here B is now, after the settlement, not a debtor to C. A is
therefore discharged from his surety-ship to C.
The consent/permission of the surety must be obtained by the creditor and the
principal debtor, before making any settlement which would affect the liability
of the principal debtor and consequently, the liability of the surety. Otherwise,
the surety would be discharged from his liability.
43.10 FORBEARANCE TO SUE
Further, mere forbearance on the part of the creditor to sue the principal debtor
or to enforce any other remedy against him, does not discharge the surety unless
the parties had agreed for such discharge.
Illustration
B owes to C a debt guaranteed by A. The debt becomes payable. However, C
does not sue B for a year after the debt has become payable. Despite this
forbearance A is not discharged from his surety-ship.
43.11 RELEASE OF ONE CO-SURETY DOES NOT DISCHARGE OTHER
Where there are co-sureties, a release by the creditor of one of them does not
discharge the others. Also, the surety released does not become free from his
responsibility to the other sureties.
43.12 SURETY CAN CLAIM HIS DUES FROM THE PRINCIPAL
DEBTOR
Once the surety makes the payment or performs the act which the principal
debt6r*bM'failed to pay/ perform, the surety steps into the shoes of the creditor
and he can claim his dues from the principal debtor.
43.13 SECURITY
A surety is entitled to the benefit of every security which the creditor has against
the principal debtor at the time when the contract of surety-ship is made,
whether the surety knows of the existence of such
351
security or not. If the creditor loses such security, then the surety is discharged to
the extent of the value of the security.
Illustration
A, as a surety for B, makes a bond to C, to secure a loan from C to B.
Afterwards, C obtains from B a further security for the same debt. Subsequently,
C gives up the security. A is not discharged in this case because the security was
not in existence at the time when the contract of surety-ship was entered into
(i.e. when the bond was made). If the security was taken simultaneously at the
time of getting the surety or prior to that, then A would have been discharged
from his surety-ship to the extent of the value of security.
43.14 MISREPRESENTATION MADE BY THE CREDITOR
Any guarantee obtained by means of misrepresentation made by the creditor is
invalid. Any guarantee which the creditor has obtained by means of keeping
silent as to the material circumstance is also invalid.
Illustration
A engages B as a clerk to collect money for him. B fails to account for some
receipts and A calls upon him to furnish a security for his due accounting. C
gives his guarantee for B's due accounting. A does not inform C of B's previous
misconduct. B afterwards makes default. The guarantee is invalid.
43.15 IMPLIED PROMISE BY THE PRINCIPAL DEBTOR
TO INDEMNIFY THE SURETY
In every Contract of Guarantee there is an implied promise by the principal
debtor to indemnify the surety. The surety is entitled to recover from the
principal debtor whatever sum he has rightfully paid under the guarantee (but no
sums which he has paid wrongfully).
Illustration
(a) B is indebted to C and A is surety for the debt. C demands payment
from A and on his refusal sues
him for the amount. A defends the suit, having reasonable grounds for doing so,
but he is compelled
to pay the amount of debt with costs. He can recover from B the amount paid by
him for costs as
well as the principal debt.
(b) A guarantees to C to the extent of Rs. 20,000 as payment for rice to be
supplied by C to B. C
supplies to B, rice to a lesser amount than Rs. 20,000 but obtains from A, a
payment of Rs.
20,000 in respect of the rice supplied. A cannot recover from B more than the
price of the rice
actually supplied.
43.16 CO-SURETIES FOR THE SAME DEBT
Where two or more persons are sureties for the same debt, whether with or
without the knowledge of each other, the co sureties are liable to pay an equal
share of the whole debt, or of that part of it which remains unpaid by the
principal debtor.
Illustration
A, B and C are sureties to D for the sum of Rs. 30,000 lent to E. E makes a
default in payment. All of A, B and C are liable between themselves to pay Rs.
10,000 each.
In the case of guarantees obtained by banks in our country, the creditor bank has
the full liberty to choose to proceed against among the principal debtor, various
sureties so long as there is legal recourse available with him to proceed against
the principal debtor.
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43.17 LET US SUM UP
A Contract of Guarantee is a contract to perform the promise, or discharge the
liability, of a third person in case of his default.
43.18 KEYWORDS
Discharge; Express; Implied; To Revoke; To forbear; Mere; Misrepresentation;
Co-Surety;
43.19 CHECK YOUR PROGRESS
1. Identify whether the following statements are True or False.
(i) In a Contract of Indemnity the indemnifier is primarily liable.
(ii) In a Contract of Guarantee the liability of the surety is secondary.
(iii) Anything done for the benefit of the principal debtor is a sufficient
consideration to the surety
for giving the guarantee, (iv) Where there are co-sureties, a release by the
creditor of one of them does not discharge the
others, (v) Principal debtor need not pay the surety after the surety has paid the
amount to the creditor.
2. Fill in the blanks from the available alternatives.
(i) Surety is also known as the (indemnifier/bailor/guarantee or/bailee)
(ii) Liability of the surety is that of the principal debtor, (co-extensive
with/primary
to/secondary to)
(iii) A guarantee which extends to a series of transactions is known as a
guarantee.
(continuing /invalid/ irrevocable/ general)
(iv) Surety is if the principal debtor is released by the creditor,
(discharged/liable)
(v) Guarantee obtained by is invalid,
(misrepresentation/consent/agreement/contract)
43.20 ANSWERS TO CHECK YOUR PROGRESS'
1. (i) True; (ii) True; (iii) True; (iv) True; (v) False.
2. (i) Guarantor; (ii) Co-extensive with; (iii) Continuing; (iv) Discharged;
(v) Misrepresentation.
CONTRACT OF BAILMENT
STRUCTURE
44.0 Objective
44.1 Introduction
44.2 Meaning of Bailment
44.3 Bailor Bound to Disclose to the Bailee
44.4 Bailee to Take Care of Goods
44.5 Effects of Mixing of Goods; Miscellaneous Expenses
44.6 Duties of the Bailee with Return the Goods
44.7 Bailee's Lien
44.8 Let Us Sum Up
44.9 Check Your Progress
44.10 Answers to 'Check Your Progress'
354
44.0 OBJECTIVE
The objective of this unit, is to make the candidates aware as to when a contract
of bailment arises and what constitutes a bailment and the rights and duties of
the bailor and the bailee.
44.1 INTRODUCTION
A 'bailment' is the delivery of goods by one person to another for some purpose.
When the purpose is accomplished, the goods are to be returned or otherwise
disposed of according to the direction of the person delivering them.
The person delivering the goods is called the 'bailor'.
The person to whom they are delivered is called the 'bailee'.
We come across the applicability of this law in case of pledge facilities granted
to borrowers including pledge of jewellery articles and also when we take over
the assets of a defaulting borrower in our efforts to recover the bank's dues.
44.2 MEANING OF BAILMENT
When one person delivers to another, certain goods to be used for a certain
purpose, the contract is known as a contract of bailment. Here, the contract will
specify the time for which the goods will remain with the person taking them.
Also, the person who gives the goods can direct the other either to return the
goods after the requisite time has expired or, direct him to dispose off the goods
in a particular manner.
44.3 BAILOR BOUND TO DISCLOSE TO BAILEE
The bailor is bound to disclose to the bailee faults in the goods bailed
(a) of which the bailor is aware,
(b) and which materially interfere with the use of them,
(c) or expose the bailee to extraordinary risk;
and if he does not make such disclosure, he is responsible for damage arising to
the bailee directly from such faults. If the goods are bailed for hire, the bailor is
responsible for any damage whether he was aware of the existence of such faults
in the goods bailed or not.
Illustrations
(a) A lends a horse, which he knows to be vicious, to B. He does not
disclose the fact that the horse is
vicious. The horse runs away. B is thrown and injured. A is responsible to B for
damage sustained.
(b) A hires a carriage of B. The carriage is unsafe, though B is not aware of
it and A is injured. B is
responsible to A for the injury.
44.4 BAILEE TO TAKE CARE OF GOODS
In all cases of bailment, the bailee is bound to take care of the goods bailed to
him as he would do for his own goods. The bailee (in the absence of any special
contract) is not responsible for the loss, destruction or deterioration of the thing
bailed if he takes such care.
On the other hand, if the bailee does anything different or inconsistent with what
was supposed to be done with the goods, the bailor can demand that the bailee
must pay the damage suffered as a result of these acts.
355
A contract of Bailment is voidable at the option of the bailor, if the bailee does
any act with regard to the goods bailed, inconsistent with the conditions of the
bailment.
If the bailee makes any use of the goods bailed, which is not according to the
conditions of the bailment, he is liable to make compensation to the bailor for
any damage arising to the goods from or during such use of them.
Illustrations
(a) A lends a horse to B for his own riding only. B allows C, a member of
his family, to ride the horse.
C rides with care but the horse accidentally falls and the horse is injured. B is
liable to make
compensation to A for the injury done to the horse.
(b) A hires a horse in Mumbai from B to go to Lonavla. A rides with due
care but marches to Khandala
instead. The horse accidentally falls and is injured. A is liable to make
compensation to B for the
injury to the horse.
44.5 EFFECTS OF MIXING OF GOODS AND EXPENSES
(a) If the bailee (with the consent of the bailor), mixes the goods of the
bailor with his own goods, the
bailor and the bailee shall have an interest, in proportion to their respective
shares, in the mixture
thus produced.
(b) If the bailee, without the consent of the bailor, mixes the goods of the
bailor with his own goods
and the goods can be separated or divided, the property in the goods remain with
the parties
respectively. The bailee is bound to bear the expense of separation or division,
and any damage
arising from the mixture.
Illustration
A bails 100 sacks of cotton marked with a particular mark to B. B without A's
consent mixes the 100 sacks with other sacks of his own bearing a different
mark. A is entitled to have his 100 sacks returned and B is bound to bear all the
expenses incurred in the separation of the sacks and any other incidental
damage.
(c) If the bailee, without the consent of the bailor, mixes the goods of the
bailor with his own goods
in such a manner that it is impossible to separate the goods bailed from the other
goods, and
deliver them back, the bailor is entitled to be compensated by the bailee for the
loss of the goods.
Illustration
A bails a bag of flour worth Rs. 100 a bag to B. B without A's consent mixes the
flour with another flour worth Rs. 75 a bag. B must compensate A for the loss in
value of his flour.
44.6 DUTIES OF THE BAILEE WITH REGARD TO GOODS
(a) It is the duty of the bailee to return the goods bailed as soon as the time
for which they were
bailed has expired or the purpose for which they were bailed has been
accomplished.
(b) The bailee is responsible to the bailor for any loss, destruction or
deterioration of the goods if the
goods are not returned on time.
(c) In the absence of any contract to the contrary, the bailee is bound to
deliver to the bailor any
increase or profit which may have arisen from the goods bailed.
Illustration
A leaves a cow in the custody of B. B agrees to take care of the cow. The cow
delivers a calf. B is bound to deliver the calf as well as the cow to A.
356
Rights of Bailee with Regard to Goods
(a) The bailor is responsible to the bailee for any loss which the bailee may
sustain because of the
reason that the bailor was not entitled to make the bailment or to receive back
the goods.
(b) If the bailor has no title to the goods and the bailee, in good faith
delivers them to the bailor or
according the directions of the bailor, the bailee is not responsible to the owner
in respect of such
delivery.
(c) If the goods are to be kept or to be carried, or to have work done upon
them by the bailee for the
bailor, and the bailee is to receive no remuneration, the bailor shall repay to the
bailee the necessary
expenses incurred by him for the purpose of the bailment.
44.7 BAILEE'S LIEN
If the bailee has rendered any service involving the exercise of labour or skill in
respect of the goods bailed to him, he has a right to retain such goods until he
receives due remuneration for the services he has rendered.
Illustrations
(a) A delivers a rough diamond to B, a jeweller, to be cut and polished
which is accordingly done. B is
entitled to retain the stone till he is paid for the services he has rendered.
(b) A gives some cloth to B, a tailor, to make into a coat. B promises to
deliver the coat as soon as it is finished
and to give a three months credit for the price. B is not entitled to retain the coat
till he is paid.
Bankers, factors (financiers who purchase receivables and also offer related
services), Attorneys of a High Court and policy brokers can, in the absence of a
contract to the contrary, retain any goods bailed to them as a security for a
general balance of account. Others do not enjoy such right unless there is
express contract to that effect.
44.8 LET US SUM UP
A bailment is the delivery of goods by one person to another for some purpose.
When the purpose is accomplished, the goods are to be returned or otherwise
disposed of according to the direction of the person delivering them.
44.9 CHECK YOUR PROGRESS
1. Identify whether the following statements are True or False.
(i) Bailor is a person who delivers his goods to the surety to enable him to give a
guarantee, (ii) Bailee can use the goods given by the bailor, in the manner as he
likes, (iii) The bailee can keep the goods bailed to him and he need not return the
same to the bailor, (iv) Giving a product on rent for use to another person is a
contract of bailment, (v) If ornaments kept in the safe locker of bank are stolen,
in spite of due care by the bank, the
bank is liable to the depositor of ornaments.
(vi) It is the obligation of the bailee to keep his goods separate from the goods of
the bailor, (vii) The bailor is liable for any loss to the bailee if the goods bailed
are defective and the bailor
knowingly does not disclose this fact to the bailee.
(viii) If the bailee has rendered any service involving the exercise of labour or
skill in respect of the goods bailed to him, he has a right to retain such goods
until he receives due remuneration for the services he has rendered.
44.10 ANSWERS TO CHECK YOUR PROGRESS
1. (i) False; (ii) False; (iii) False; (iv) True; (v) False; (vi) True; (vii) True; (viii)
True.
CONTRACT OF PLEDGE
STRUCTURE
45.0 Objective
45.1 Introduction
45.2 Nature of Pledge
45.3 Let Us Sum Up
45.4 Check Your Progress
45.5 Answers to 'Check Your Progress'
358
45.0 OBJECTIVE
The objective of this unit is to highlight a particular form of bailment known as
pledge and the purpose of such a contract.
45.1 INTRODUCTION
The bailment of goods as security for payment of a debt or performance of a
promise is called 'pledge'. The bailor is in this case called 'pawnor'. The bailee is
called 'pawnee'.
45.2 NATURE OF PLEDGE
(a) If the pawnor makes default in payment of the debt in respect of which
the goods were pledged,
the pawnee may bring a suit against the pawnor and retain the goods pledged as
a security (or) he
may sell the goods pledged, after giving notice of the sale to the pawnor.
(b) If the proceeds of such sale are less than the amount due, in respect of
the debt, the pawnor is still
liable to pay the balance. If the proceeds of the sale are greater than the amount
so due, the pawnee
shall pay over the surplus to the pawnor.
For example, say A takes a loan of Rs. 20,000 from B. As an assurance that he
will pay this money back, A keeps his car, as security, with B.
Thus, if after the fixed date, if A is unable to pay the money back to B, B can
either bring a suit for this purpose while he retains the car, or he can sell the car
for the purpose of recovering his dues. If B chooses to sell the car, the two
possibilities are as follows: He may receive less than the amount due, in which
case, A will still have to pay him the balance, or he may receive more than the
amount due, in which case he must return the excess amount to A.
(c) It is important to note, that in all contracts of bailment, the bailee, while
he is in possession of the
goods, steps into the shoes of the owner for the purpose of legal remedy. Thus, if
any person were
to deprive the bailee of the goods - by way of theft, etc. - the bailee, himself,
would have the right
to file a suit against such other person. If, any damages are received from such a
suit, it would be
split between the bailor and the bailee, according to the proportion of their losses
or damages.
(d) The pawnee can retain the goods pledged, not only for payment of the
debt/interest on the debt but
also for all necessary expenses incurred by him in preservation of the goods
pledged.
The pawnee is entitled to receive from the pawnor, extraordinary expenses
incurred by him for the preservation of the goods pledged.
45.3 LET US SUM UP
The bailment of goods as security for payment of a debt or performance of a
promise is called pledge.
45.4 CHECK YOUR PROGRESS
Identify whether the following statements are True or False.
(i) In a pledge, the goods are delivered to be kept as security for a debt or for
performance of a promise.
(ii) The pawnee can sell the goods, if the pawnor fails to pay.
(iii) The pawnee can sell the goods without giving notice to the pawnor.
(iv) The pawnee can keep the goods even after the pawnor has paid the dues.
45.5 ANSWERS TO CHECK YOUR PROGRESS
fi) True; (ii) True; (iii) False; (iv) False.
CONTRACT OF AGENCY
STRUCTURE
46.0 Objective
46.1 Introduction
46.2 Meaning of Agency
46.3 Normal Rules of Contract
46.4 Persons to be Majors and of Sound Mind
46.5 Consideration \
46.6 Authority of an Agent
46.7 Extent of Agent's Authority
46.8 Agent's Authority in an Emergency
46.9 When Agent cannot Delegate
46.10 Right of Person as to Acts Done for Him Without His Authority - Effect
of Ratification
46.11 Termination of Agency
46.12 Agent's Duty in Conducting Principal's Business
46.13 Agent's Accounts
46.14 Right of Principal when Agent Deals, on His own Account, in Business
of Agency Without
Principal's Consent
46.15 When Agent's Remuneration Becomes Due
46.16 Agent not Entitled to Remuneration for Business if He is Guilty of
Misconduct
46.17 Agent's Lien on Principal's Property
46.18 Agent to be Indemnified Against Consequences of Lawful Acts
46.19 Agent to be Indemnified Against Consequences of Acts Done in Good
Faith
46.20 Let Us Sum Up
46.21 Keywords
46.22 Check Your Progress
46.23 Answers to 'Check Your Progress'
360
46.0 OBJECTIVE
The objective of this unit is to understand:
• The concept of entering into contracts through agents
• The parties involved in such contracts
• The role, duties and liabilities of the principal and the agent
46.1 INTRODUCTION
To understand contracts of an agency, it is first necessary to understand what the
terms 'agent' and 'principal' mean.
An agent, is a person employed to do any act for another person or to represent
another person in dealings with some third person.
The person for whom such act is done (or who is represented) is called the
principal.
When banks collect various financial instruments for their customers, this law
would come into force. The authority of the agent is restricted to what is
explicitly mentioned by the principal and the agent cannot construe some
additional authority.
46.2 MEANING OF AGENCY
The actual test of agency is as follows:
The person should be authorised to do an act for a person in such a manner, as to
bind that person, i.e. to make him answerable for such acts done on his behalf.
The agent creates contractual relations between two separate persons when he
enters into a contract on behalf of one of the parties.
46.3 NORMAL RULES OF CONTRACT
The contract between the principal and his agent is a contract in itself and that is
also governed by the normal rules of contract.
46.4 PERSONS TO BE MAJORS AND OF SOUND MIND
Any person who is a major according to the law of which he is subject, and who
is of sound mind, may employ an agent. Any person can become an agent, if he
is a major and of sound mind.
46.5 CONSIDERATION
No consideration is necessary to create an agency.
46.6 AUTHORITY OF AN AGENT
The authority of an agent may be expressed or implied. An authority is said to be
expressed, when it is given by words spoken or written. An authority is said to
be implied when it is to be inferred from the circumstances of the case.
Illustration
A owns a shop in Mumbai and he lives in New Delhi and visits the shop
occasionally. The shop is managed by B and he is in the habit of ordering goods
from C in the name of A for the shop and makes payments from A's funds. B has
an implied authority from A to order goods from C in the name of A for the
purposes of the shop.
361
46.7 EXTENT OF AGENT'S AUTHORITY
An agent having an authority to do an act, has authority to do every lawful thing
which is necessary; in order to do such act. An agent having an authority to carry
on a business has authority to do every lawful thing necessary to conduct such
business.
Illustration
A is employed by B (residing in London) to recover at Mumbai a debt due to B.
A may adopt any legal process necessary for the purpose of recovering the debt
and may give a valid discharge for the same.
46.8 AGENT'S AUTHORITY IN AN EMERGENCY
In an emergency, an agent has authority to do all acts to protect his principal
from loss as would be done by a person in his own case.
Illustration
A consigns goods (say eatables) to B at Mumbai with directions to send them
immediately to C at Ahmedabad. B may sell the goods at Mumbai if they will
not bear the journey to Ahmedabad without getting spoiled.
46.9 WHEN AGENT CANNOT DELEGATE
An agent cannot employ another to perform acts which he has undertaken to
perform personally. A sub-agent may be employed if the custom of trade or the
nature or agency so requires. A 'sub-agent' is a person employed by and acting
under the control of the original agent. The agent is responsible to the principal
for the acts of the sub-agent. The sub-agent is responsible for his acts to the
agent, but not to the principal, except in case of fraud or wilful wrong.
46.10 RIGHT OF PERSON AS TO ACTS DONE FOR HIM WITHOUT HIS
AUTHORITY - EFFECT OF RATIFICATION
If acts are done by an agent on behalf of the principal without his knowledge or
authority, the principal may elect to ratify or to disown such acts. If he ratifies
them, the same effects will follow as if they had been performed with his
authority. Ratification may be express or implied in the conduct of the person on
whose behalf the acts are done.
Illustrations
(a) A, without authority, buys goods for B. Afterwards B sells them to C on
his own account. B's
conduct implies a ratification of the purchase made for him by A.
(b) A, without B's authority, lends B's money to C. Afterwards B accepts
interest on the money from
C. B's conduct implies a ratification of the loan.
46.11 TERMINATION OF AGENCY
An agency can be terminated by
(i) principal revoking his authority or
(ii) agent renouncing (giving up) the business of the agency; or
(iii) business of the agency being completed; or
(iv) either the principal or agent dying or becoming of unsound mind; or
(v) the principal being adjudicated an insolvent.
362
46.12 AGENT'S DUTY IN CONDUCTING PRINCIPAL'S BUSINESS
An agent is bound to conduct the business of his principal according to the
directions given by the principal. In the absence of any such directions, conduct
business according to the customs, which prevails in doing business of the same
kind at the place where the agent conducts such business. If the agent, acts
otherwise and if any loss be sustained, he has to make it good to his principal
and if any profit accrues, he must account for it.
Illustrations
(a) A, an agent, engaged in carrying on for B, a business, in which, it is the
custom to invest from
time to time at interest the money which may be in hand, makes such an
investment. A must make
good to B the interest usually obtained by such investments.
(b) B, a broker in whose business it is not the custom to sell on credit sells
goods of A on credit to C,
whose credit at the time was very high. C, before payment, becomes insolvent. B
must make
good the loss to A.
46.13 AGENT'S ACCOUNTS
An agent is bound to render proper accounts to his principal on demand.
46.14 RIGHT OF PRINCIPAL WHEN AGENT DEALS ON HIS OWN
ACCOUNT
IN BUSINESS OF AGENCY WITHOUT PRINCIPAL'S CONSENT
If an agent deals on his own account in the business of the agency without the
consent of the principal, the principal may repudiate the transaction, if any
material fact has been dishonestly concealed from him by the agent, or the
dealings of the agent have been disadvantageous to him.
Illustrations
(a) A directs B to sell A's estate. B buys the estate for himself in the name
of C. A, on discovering that
B has bought the estate for himself, may repudiate the sale, if he can show that B
has dishonestly
concealed any material fact, or that the sale has been disadvantageous to him.
(b) A directs B to sell A's estate. B, on looking over the estate before selling
it, finds a mine on the
estate which is unknown to A. B informs A that he wishes to buy the estate for
himself but
conceals the discovery of the mine. A allows B to buy, in ignorance of the
existence of the mine.
A, on discovering that B knew of the mine at the time he bought the estate, may
either repudiate
or adopt the sale at his option.
46.15 WHEN AGENT'S REMUNERATION BECOMES DUE
An agent can detain money received by him on account of goods sold, even if all
the goods consigned to him for sale are not sold.
46.16 AGENT NOT ENTITLED TO REMUNERATION FOR
BUSINESS IF HE IS GUILTY OF MISCONDUCT
An agent who is guilty of misconduct is not entitled to any remuneration in
respect of that part of the business which he has not conducted properly.
Illustrations
(a) A employs B to recover Rs. 1,00,000 from C, and to lay it out on good
security. B recovers the Rs. 1, 00,000 and lays out Rs. 90,000 on a good
security, but lays out Rs. 10,000 on security
r
363
(b)
which he ought to have known to be bad, whereby A loses Rs. 2,000. B is
entitled to remuneration for recovering the Rs. 1, 00,000 and for investing the
Rs. 90,000. He is not entitled to any remuneration for investing the Rs. 10,000,
and he must make good the Rs. 2,000 to B. A employs B to recover Rs. 1,000
from C. Through B's misconduct the money is not recovered. B is entitled to no
remuneration for his services and must make good the loss.
46.17 AGENT'S LIEN ON PRINCIPAL'S PROPERTY
In the absence of anything contrary in the contract, an agent is entitled to retain
goods, papers, and other property of the principal which is received by him, until
the amount due to the agent for commission, disbursements and services in
respect of the same has been paid or accounted for to him.
46.18 AGENT TO BE INDEMNIFIED AGAINST
CONSEQUENCES OF LAWFUL ACTS
The principal is bound to indemnify the agent against the consequences of all
lawful acts done by the agent in exercise of the authority conferred upon him.
Illustrations
(a) B, at Singapore under instructions from A of Calcutta, contracts with C
to deliver certain goods
to him. A does not send the goods to B, and C sues B for breach of contract. B
informs A of the
suit, and A authorises him to defend the suit. B defends the suit, and is
compelled to pay damages
and costs, and incurs expenses. A is liable to B for such damages, costs and
expenses.
(b) B, a broker at Calcutta, by the orders of A, a merchant there, contracts
with C for the purchase
of ten casks of oil for A. Afterwards A refuses to receive the oil, and C sues B. B
informs A, who
repudiates the contract altogether. B defends, but unsuccessfully, and has to pay
damages and
costs and incurs expenses. A is liable to B for such damages, costs and expenses.
46.19 AGENT TO BE INDEMNIFIED AGAINST CONSEQUENCES
OF ACTS DONE IN GOOD FAITH
The principal is liable to indemnify the agent against the consequences of acts
done by him in good faith, though it may cause an injury to the rights of third
person.
Illustrations
(a) A, a decree-holder and entitled to execution of B's goods requires the
officer of the Court to seize
certain goods, representing them to be the goods of B. The officer seizes the
goods, and is sued
by C, the true owner of the goods. A is liable to indemnify the officer for the
sum which he is
compelled to pay to C, in consequence of obeying his directions.
(b) B, at the request of A, sells goods in the possession of A, but which, A
had no right to dispose of.
B does not know this, and hands over the proceeds of the sale to A. Afterwards
C, the true owner
of the goods, sues B and recovers the value of the goods and costs. A is liable to
indemnify B for
what he has been compelled to pay to C, and for B's own expenses.
46.20 LET US SUM UP
Agent is a person employed to do any act for another person or to represent
another person in dealing with some other person. Unlike other contracts, no
consideration is essential for a contract of agency. It is agent's duty to perform as
per the principal's lawful direction and get paid for services and be indemnified
against consequences.
364
46.21 KEYWORDS
Adjudicated; Insolvent; To repudiate; To consign goods; Lien.
46.22 CHECK YOUR PROGRESS
1. Fill in the blanks from the available alternatives.
(i) Agent can be appointed by (express appointment/implication of
law/ratification
_. (power of attorney/indemnity
by principal/any of the three modes)
(ii) The usual form of contract of agency is by way of a
bond/guarantee bond) (iii) When a person by his words or conduct appoints
someone as his agent it is known as agency
by (estoppel/promise/conduct/action)
2. Identify whether the following statements are True or False.
(i) Consideration is the most essential element in any contract of agency.
(ii) A contract of agency is terminated if the agent does not wish to continue as
agent any more.
(iii) An agent can have a lien on the goods of the principal for the dues payable
by the principal to
the agent.
(iv) Minor can be a principal or an agent, (v) The principal has to indemnify the
agent for all the lawful acts done by the agent in the course
of his duties.
46.23 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (i) Any of the three modes; (ii) Power of attorney; (iii) Estoppel.
2. (i) False; (ii) True; (iii) True; (iv) False; (v) True.
UNIT
47
MEANING AND ESSENTIALS OF A CONTRACT OF SALE
STRUCTURE
47.0 Objective
47.1 Introduction
47.2 Meaning of Some of the Important Terms Defined Under the Sale of
Goods Act
47.3 Meaning of Contract of Sale of Goods
47.4 Features of Contract of Sale of Goods
47.5 Sale and Agreement to Sell
47.6 Distinction between a Sale and an Agreement to Sell
47.7 Let Us Sum Up
47.8 Keywords
47.9 Check Your Progress
47.10 Answers to 'Check Your Progress'
366
47.0 OBJECTIVE
The objective of this unit on the Sale of Goods Act, is to provide a basic level
knowledge and understanding to the candidates about the contractual rights and
liabilities of the seller and the buyer in a contract for sale of goods. These rights
and liabilities are in addition to the rights and liabilities of the parties to a
contract as laid down in the Contract Act.
47.1 INTRODUCTION
The Contract Act covers the aspects of general principles and essentials of
contracts made in the commercial world. A contract for the sale of goods is also
governed by the general principles and essentials as stated in the Contract Act.
However, the Sale of Goods Act is specially enacted to lay down the law relating
to the sale and purchase of moveable goods in the country. The provisions of the
Sale of Goods Act spell out the contractual rights and liabilities of the seller and
buyer in detail.
47.2 MEANING OF SOME OF THE IMPORTANT TERMS DEFINED
UNDER THE SALE OF GOODS ACT, 1930
'Goods' means every kind of moveable property (other than actionable claims
and money) and includes
• stock and shares
• growing crops, grass
• things attached to or forming part of the land which are agreed to be
severed before sale or under
the contract of sale.
'Buyer' means a person who buys or agrees to buy goods.
'Seller' means a person who sells or agrees to sell goods.
'Price' means the money consideration for a sale of goods.
'Delivery' means voluntary transfer of possession from one person to another.
'Document of title to goods' includes bill of lading, dock-warrant, warehouse-
keeper's certificate, wharfingers' certificate, railway receipt, multimodal
transport document, warrant or order for the delivery of goods and any other
document used in the ordinary course of business as proof of the possession or
control of goods authorised by endorsement or delivery to transfer or receive
goods as possessor of document.
'Future goods' means goods to be manufactured or produced or acquired by the
seller after making of the contract of sale.
'Specific goods' means goods identified and agreed upon at the time a contract of
sale is made.
'Mercantile agent' means an agent having authority either to sell goods, or to
consign goods for the purposes of sale, or to buy goods, or to raise money on the
security of goods.
47.3 MEANING OF CONTRACT OF SALE OF GOODS
A contract of sale of goods is a contract under which the seller transfers or
agrees to transfer the property in goods to the buyer for a price. When the
property in the goods is transferred from the seller to the buyer, the contract is
called a sale.
47.4 FEATURES OF CONTRACT OF SALE OF GOODS
(a) Bilateral: contract: A sale involves two persons - The buyer and the
seller.
(b) Money consideration: The consideration for a sale of goods must be
money, called the price
payable for the transfer of goods. It cannot be a barter, where goods are
exchanged for goods.
(c) Moveable property: The Sale of Goods Act covers only the sale of
moveable goods and not
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immoveable property like land and building. The contracts relating to transfer of
immoveable property are governed by the Transfer of Property Act and not Sale
of Goods Act. (d) No particular form: The Sale of Goods Act does not make it
mandatory to enter into written contracts for the sale of goods. However, if any
particular law provides for sale of certain types of goods to be done by a contract
in writing, then that law has to be complied and the contract has to be in writing.
The contract may be oral or written or can be implied by the conduct of the
parties. A contract of sale is made by an offer to buy or sell goods for a price and
the acceptance of such offer.
The contract may provide for:
• Immediate delivery of the goods immediate payment of the price.
• For the delivery or payment by instalments.
• Postponement of delivery or payment.
47.5 SALE AND AGREEMENT TO SELL
A contract of sale may be absolute or conditional. In an absolute contract for sale
of goods, there are no conditions to be fulfilled by the seller or the buyer for the
sale and purchase of the goods. In a conditional sale, the parties to the contract
(seller and buyer) agree that the sale of goods shall be regarded as final only on
the fulfilment of certain conditions either before or after the conclusion of the
contract for sale of goods.
When the transfer of the property in the goods is to take place at a future time or
subject to some condition, thereafter to be fulfilled, the contract is called an
agreement to sell.
An agreement to sell becomes a sale when the time elapses or the conditions are
fulfilled, subject to which the property in the goods is to be transferred. Thus,
when an agreement to sell provides that the property in goods (the ownership)
shall pass on a certain date, then the agreement to sell becomes a sale on that
date. Further, if an agreement to sell provides that the ownership in goods shall
pass only on the fulfilment of such and such conditions by the seller and such
and such conditions by the buyer, the agreement to sell becomes a sale, only on
the fulfilment of such conditions as agreed to between the parties.
47.6 DISTINCTION BETWEEN A SALE AND AN AGREEMENT TO
SELL
Table 47.1 Difference in Sale and Agreement to Sell
Sale
1. A sale is a contract in which the parties have
already performed their part.
2. In a sale the ownership of goods have already
passed, irrespective of whether the goods are
delivered or not.
3. The risk in goods is with the buyer.
4. In a sale, if the seller does not deliver the goods,
the buyer can file a suit and demand specific
performance and delivery of the goods.
5. If the buyer does not pay for the goods the
seller can claim file a suit and demand the price.
He also has the right to stop the deliver of goods
p onnds
>: Agreement to Sell
An agreement to sell an act in which the parties are yet
to perform their mutual promises.
In an agreement to sell the ownership of goods is yet
to pass from the seller to the buyer at a later date after
the fulfilment of certain conditions, as agreed upon by
the seller and the buyer.
The risk in goods is still with the seller and passes to the
buyer only after the agreement to sell becomes a sale.
In an agreement to sell, if the seller does not deliver
the goods, the buyer can only claim damages in a suit
and cannot demand the delivery as the sale is not yet
concluded.
In an agreement to sell the seller may not part with the
goods until he is paid the price. In case he parts with
the possession, he can sue for return of goods or
Davment of price.
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47.7 LET US SUM UP
A sale involves two persons, the buyer and the seller. A contract of sale of goods
is a contract under which the seller transfers the goods to the buyer for a price.
When the property in the goods is transferred from the seller to the buyer, the
contract is called a sale. The consideration for a sale of goods is the money
payable for the transfer of goods. The Sale of Goods Act covers only the sale of
moveable goods and not immoveable property.
When the transfer of the property in the goods is to take place at a future time or
subject to some condition thereafter to be fulfilled, the contract is called an
agreement to sell. An agreement to sell becomes a sale when the time elapses or
the conditions are fulfilled, subject to which the property in the goods is to be
transferred.
47.8 KEYWORDS
Breach; Encumbrance.
47.9 CHECK YOUR PROGRESS
1. Fill in the gaps from the available options given in the brackets.
(i) means the consideration for a sale of goods. (Price/Lien
Delivery/Shares)
(ii) Goods as defined under Sale of Goods Act do not include . (actionable
claims/
shares/stock/grass)
(iii) goods are to be manufactured/produced/acquired by the seller after
making of
the contract of sale. (Future/Specific/Moveable/Immoveable)
(iv) goods means goods identified and agreed upon at the time a contract of
sale is
made. (Future/Specific/Moveable/Tmmoveable)
(v) means voluntary transfer of possession from one person to another.
(Delivery/
Lien/Indemnity/Suit) (vi) When the transfer of the property in the goods is to
take place at a future time or subject to
some conditions thereafter to be fulfilled, the contract is called . (agreement to
sell/contract of sale/contract of future goods/contract of specific goods)
(vii) In the ownership of goods is yet to pass from the seller to the buyer,
(agreement
to sell/contract of sale/contract of future goods/contract of specific goods)
2. Identify whether the following statements are True or False.
(i) Shares are goods within the meaning of the Sale of Goods Act.
(ii) Fixtures can be regarded as moveable goods only if they are intended to be
severed and sold separately.
47.10 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (i) price; (ii) actionable claim; (iii) future; (iv) specific; (v) delivery; (vi)
agreement to sell;
(vii) agreement to sell.
2. (i) True; (ii) True.
CONDITIONS AND WARRANTIES
STRUCTURE
48.0 Objective
48.1 Introduction
48.2 Meaning of Condition and Warranty
48.3 Implied Conditions and Warranties
48.4 Let Us Sum Up
48.5 Keywords
48.6 Check Your Progress
48.7 Answers to 'Check Your Progress'
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48.0 OBJECTIVE
The objective of this unit is to give an understanding of the concepts of
warranties and its implications.
48.1 INTRODUCTION
Every contract of sale of goods has certain stipulations, terms and conditions
regarding the nature, quality, quantity of the goods, etc. There are also many
obligations under the contract for sale of goods. However, the importance of
every such term, stipulation and obligation is not equal.
48.2 MEANING OF CONDITION AND WARRANTY
Under the Sale of Goods Act, the stipulations in a contract of sale with reference
to goods are classified based on their importance as condition or a warranty.
If the stipulation agreed to between the parties is essential to the main purpose of
the contract and is of such a nature that if the stipulation is breached (i.e.
violated/not complied) then a party to the agreement would have a right to treat
the contract as repudiated (cancelled) then such a stipulation is known as a
condition.
On the other hand, a warranty is a stipulation collateral to the main purpose of
the contract. The breach of such a stipulation gives rise to a claim for damages
only. The parties cannot reject the goods and treat the contract as repudiated.
Whether a stipulation in a contract of sale is a condition or a warranty depends
on the type of contract. Even if the parties have agreed that a stipulation is a
warranty, in fact, it may be a condition if it is the basis of the contract.
If a contract of sale is subject to any condition to be fulfilled by the seller and the
seller does not fulfil it, the buyer, can waive the fulfilment of the condition or he
can treat it as non-fulfilment of a warranty. This is left to the buyer. However, if
the buyer has accepted the goods, then such a choice is not available to the buyer
and the buyer has to treat the non-fulfilment of condition by the seller as a
breach of warranty only, unless there is express or implied term of contract.
48.3 IMPLIED CONDITIONS AND WARRANTIES
In a contract of sale of goods conditions and warranties may be either expressed
or implied. Expressed conditions and warranties are those, which are expressly
stated in the contract. Implied conditions and warranties are those, which the law
implies into every contract of sale of goods. However, such implied conditions
and warranties can be excluded by the parties to the contract if they agree
expressly on these issues.
A. Title of the seller
There is an implied condition on the part of the seller that,
• he has a right to sell the goods (in the case of a sale), or
• he will have a right to sell the goods at the time when the ownership is
to pass to the buyer (in the
case of an agreement to sell).
Illustration
A buys a second-hand car from B and pays him. Police takes away the car, as it
was a stolen one. A can recover the price paid, from B, as he has violated the
implied condition above.
CONDI
371
B. Sale of goods by description
In the sale of goods by description, there is an implied condition that the goods
shall correspond with the description.
Illustration
A sells certain curtains to B by describing them to be of seventeenth century.
Later on B discovers, that the curtains are not of the seventeenth century. A can
reject the goods and claim back the price.
C. Sale by sample
In case of a sale by sample there is an implied condition that the
(a) bulk shall correspond with the sample in quality;
(b) buyer shall have an opportunity to compare the bulk with the sample;
(c) goods shall be free from any defect, rendering them unmerchantable,
which would not be apparent
on reasonable examination of the sample.
Illustration
A wants to buy rubber material of a certain length and width. B shows a sample
to A. A approves the sample but B delivers the same material with a variation in
the length of the rubber. A can reject the goods as the goods did not correspond
with the sample in quality.
D. Sale is by sample as well as by description
If the sale is by sample as well as by description, the goods must correspond not
only to the sample but also to the description given.
Illustration
A sells to B, 'foreign rape-seed refined oil'. He even shows a sample to B.
Afterwards the oil according to the sample is delivered to B. When the oil is
delivered to B, he discovers that there is some 'hemp oil' also mixed in it. B can
reject the goods because he was delivered as per the sample but the sample and
oil itself were not 'foreign rape-seed refined oil' as described by A.
£. Quiet possession
There is an implied warranty that the buyer shall have and enjoy quiet
possession of the goods. F. Goods are free from any charge or encumbrance
There is an implied warranty that the goods shall be free from any charge or
encumbrance in favour of any third party not declared or known to the buyer
before or at the time when the contract is made. This means that the buyer can
assume that the goods that are being sold to him would be his absolute property
and no one would claim any right over the goods in future once he pays the price
and purchases then from the seller.
G Quality or fitness of goods for any particular purpose
There is no implied warranty or condition as to the quality or fitness of goods for
any particular purpose except in the following case:
If the buyer discloses to the seller the purpose for which he wants the goods and
he relies on the seller's skill/judgement and if the goods are in the course of the
seller's business to supply then in such case, there is an implied condition that
the goods shall be reasonably fit for such purpose.
Illustration
A buys a hot water bottle from B (a retail chemist). A asked B whether it would
hold hot water. B says it is meant to hold hot water only. As wife is injured as
the hot water bottle bursts. B was held liable for breach of implied condition as
to the quality or fitness of the hot water bottle.
L.R.A.B-25
372
• If goods are bought by description from a seller who deals in goods of
that description, there is an
implied condition that the goods shall be of merchantable quality. However, if
the buyer has examined
the goods, there is no implied condition as regards defects which can be revealed
by examination.
• The usage of trade may give an implied warranty or condition as to
quality or fitness of goods for
any particular purpose.
It is to be noted that an express warranty or condition given by any party is
always in addition to the implied warranties or conditions as explained above.
H. Caveat Emptor (Buyer beware)
Caveat means a warning, a caution. According to the doctrine of caveat emptor,
the person who buys goods must keep his eyes open, his mind active and be
cautious while buying the goods. In other words, the buyer must examine the
goods thoroughly. Later on, if the goods do not serve his purpose or he depends
upon his own judgement and he makes a bad choice, he cannot blame the seller
for selling him such goods. The Sale of Goods Act also enshrines doctrine by
stating that 'There is - ( implied warranty or condition as to the quality or fitness
of goods for any particular purpose' except in cases specifically explained above.
48.4 LET US SUM UP
If a stipulation agreed to between the parties is essential to the main purpose of
the contract it is known as a condition. On the other hand, a warranty is a
stipulation collateral to the main purpose of the contract.
48.5 KEYWORDS
Warranty: Caveat Emptor.
48.6 CHECK YOUR PROGRESS
1. Fill in the gaps from the available options given in the brackets.
(i) If the stipulation agreed to between the parties is essential to the main
purpose of the contract
then such a stipulation is known as a . (condition/warranty/implied condition/
guarantee)
(ii) A is a stipulation, collateral to the main purpose of the contract, (condition/
warranty/implied condition/guarantee)
(iii) There is an implied condition on the part of the seller that he has a right to
the
goods, (use/sell/retain/resell)
(iv) If the sale of goods is by there is an implied condition that the goods
shall
correspond with the description, (description/sample/oral agreement/written
contract)
2. Identify whether the following statements are True or False.
(i) In every contract of sale it is implied that the seller has got the right to sell the
goods, (ii) An implied warranty as to quality or fitness for particular purpose
may be annexed by the usage of trade.
48.7 ANSWERS TO CHECK YOUR PROGRESS'
1. (i) condition; (ii) warranty; (iii) sell; (iv) description.
2. (i) True; (ii) True.
UNPAID SELLER
STRUCTURE
49.0 Objective
49.1 Introduction
49.2 Rights of an Unpaid Seller
49.3 Let Us Sum Up
49.4 Check Your Progress
49.5 Answers to 'Check Your Progress'
374
49.0 OBJECTIVE
The objective of this unit is to impart knowledge on the meaning of an 'Unpaid
Seller' in a contract of sale and the rights of such a person.
49.1 INTRODUCTION
The seller of goods is deemed to be an 'unpaid seller',
(a) When the whole of the price has not been paid or tendered;
(b) When the payment for the goods is received in the form of a cheque or
other negotiable instrument
and the same is dishonoured for financial or other reasons
Here, the term 'seller' includes any person who is in the position of a seller, e.g.,
an agent of the seller, to whom the bill of lading has been endorsed, or a
consignor or agent who has paid for goods to the seller.
49.2 RIGHTS OF AN UNPAID SELLER
Table 49.1 Rights of Unpaid Seller Against Goods and the Buyer
^^^^^^^^Rights against the goods Rights against the
buyer ^^HB
personality
®* Where the property in the goods have passed Where the property in
the goods have not passed Suit for price Suit for damages
Repud¬iation contr¬act Suit for interest I
Lien Stoppage in transit Resale delivery Withholding in transit
Stoppage
Unpaid seller's rights against the goods
The following rights are available to the unpaid seller, whether the property in
the goods has passed to the buyer or not
(a) a lien on the goods for the price while he is in possession of them;
(b) in case of insolvency of the buyer, a right of stopping the goods in
transit after he has parted with
the possession of them;
(c) a right of resale.
If the property in goods has not passed to the buyer, the unpaid seller also has a
right of withholding delivery of the goods.
Unpaid seller's lien
The unpaid seller of goods (who is in possession of them), is entitled to retain
possession of them until payment of the price is made in the following cases:
(a) if the goods have been sold without any stipulation as to credit;
(b) if the goods have been sold on credit, but the term of credit has expired;
(c) if the buyer becomes insolvent.
Where an unpaid seller has made part delivery of the goods, he may exercise his
right of lien on the balance goods, unless he makes part delivery under
circumstances to show that he would waive the
375
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right to lien on all goods. The seller may exercise the right of lien
notwithstanding that he is in possession of the goods as an agent or bailee for the
buyer.
Termination of lien
The unpaid seller of goods loses his lien thereon:
(a) when he delivers the goods to a carrier or other bailee for the purpose of
transmission to the
buyer without reserving the right of disposal of the goods;
(b) when the buyer or his agent lawfully obtains possession of the goods;
(c) by waiver of lien.
However, the lien is not lost just because the seller obtains a decree for the price
of the goods. Right of stoppage in transit
When the buyer becomes insolvent, the unpaid seller who has parted with the
possession of the goods has the right of stopping them in transit. He may retain
them until payment of the price.
Duration of transit
Goods are deemed to be in course of transit from the time when they are
delivered to a carrier or other bailee for the purpose of transmission to the buyer
and the transit ends, when the buyer or his agent takes delivery of them from
such carrier or other bailee.
How stoppage in transit is affected?
The unpaid seller may exercise his right of stoppage in transit either by taking
actual possession of the goods, or by giving notice of his claim to the carrier or
other bailee in whose possession the goods are.
Effect of sub-sale or pledge by buyer
The unpaid seller's right of lien or stoppage in transit is not affected by a further
sale or by other disposition of the goods, which the buyer may have made
(unless the seller has given his permission). Exception to this is when any person
in good faith and for consideration takes documents of title to goods from a
buyer; or transfer of goods is by way of pledge, where right of unpaid seller may
get defeated.
If the goods are of a perishable nature, or if the unpaid seller, who has exercised
his right of lien or stoppage in transit gives notice to the buyer of his intention to
re-sell, the unpaid seller may, if the buyer does not within a reasonable time pay
the price, resell the goods.
He can also recover from the original buyer, damages for any loss occasioned by
his breach of contract. The buyer is not entitled to any profit which may occur
on the resale.
If the unpaid seller does not give, a prior notice of sale to the buyer, then the
unpaid seller is not entitled to recover damages from the buyer. On the contrary,
the buyer becomes entitled to the profit on a resale.
If the unpaid seller who has exercised his right of lien or stoppage in transit re-
sells the goods, the, 'new' buyer acquires a good title to the goods as against the
original buyer, even if no notice of the resale was given to the original buyer.
Unpaid seller's rights against the buyer personally
These rights arise out of breach of contract and the seller can file a suit to claim
damages, claim the price of goods with interest and he can also repudiate the
contract.
49.3 LET US SUM UP
An unpaid seller has the following rights:
(a) a lien on the goods for the price while he is in possession of them;
376
(b) in case of insolvency of the buyer, a right of stopping the goods in
transit after he has parted with
the possession of them;
(c) a right of resale;
(d) right to withhold delivery of goods.
49.4 CHECK YOUR PROGRESS
GO (iii)
1.
2.
Fill in the gaps from the available options given in the brackets.
has not been paid
(i) The seller of goods is deemed to be an unpaid seller when the
(price/interest/damages/penalty)
There is no as to the quality or fitness of goods for any particular purpose.
(implied condition/implied warranty/express condition/express warranty)
When the is in possession of goods, a lien can be exercised,
(seller/buyer/agent
of the buyer/carrier)
is terminated when the buyer gets the possession of the goods.
(Lien/Agreement/
(iv)
Condition/Warranty)
Identify whether the following statements are True or False. (i) When property
in the goods has not passed to the buyer and the buyer becomes insolvent
before the price is paid, the seller can withhold the delivery of goods.
(ii) A seller who has accepted a negotiable security as an absolute payment is no
longer an unpaid seller.
5 5
51
49.5 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (i) price; (ii) implied condition; (iii) seller; (iv) lien.
2. (i) True; (ii) True.
UNIT
50
DEFINITION, MEANING AND NATURE OF PARTNERSHIP
1
STRUCTURE
50.0 Objective
50.1 Introduction
50.2 Meaning and Nature of Partnership
50.3 types of Partnership
50.4 Let Us Sum Up
50.5 Check Your Progress
50.6 Answers to 'Check Your Progress'
378
50.0 OBJECTIVE
The objective of this unit is to give the candidates a broad view of the legal
aspects involved in a partnership business and the determination of the rights
and liabilities arising out of partnership business.
50.1 INTRODUCTION
The Partnership Act lays down the important provisions relating to partnership
contracts. However, the general principles of the Contract Act also continue to
apply to the partnership contracts. A business can be carried on by a single
individual by using his own funds or by two or more persons together in which
case some of them would bring in money and some of them would use their
business skills. These persons agree to share the profits and losses of their
venture and it amounts to a contract. The rights and liabilities arising out of such
a mode of carrying on business are governed by the Partnership Act.
50.2 MEANING AND NATURE OF PARTNERSHIP
Partnership is the relation between persons who have agreed to share the profits
of a business carried on by all or any of them acting for all. Persons, who have
entered into partnership with one another are called individually 'partners' and
collectively a 'firm' and the name under which their business is carried on is
called the firm's name.
It must always be remembered that a partnership is not a separate legal entity
like a company formed under the Companies Act, 1956. Let us try to understand
the concept of a 'separate legal entity' little more clearly which is very important
as this forms the basis for the difference between a company and a partnership.
In the case of a company formed by the members, who contribute the capital and
start the business of the company, the wrongful acts of the company are not the
wrongful acts of the individual members of the company. A person who is
cheated by the company cannot file a case against each and every mem¬ber or
even a single member of the company saying that the members of the company
have cheated him. A company has its own separate existence and the person who
is cheated can claim damages from the funds of the company and not from the
pockets of the members forming the company.
A partnership is formed by the persons who have come together to carry on a
business and share profits. However, if a particular partner cheats a customer
and runs away with, say Rs. 1 lakh, then the other partners have to pay for his
misdeed (and in fact the customer can catch any single partner and demand him
to shell out the entire funds). If the partnership firm is left with no funds, the
individual partners will have to pay the funds from their own pockets.
Hence, from the above it can be seen that there is a difference between the
company and the members forming the company, while the partnership is seen
clearly to be a group of persons who have joined together to do business. The
partnership firm and the partners are not separate from each other.
The sharing of profits or returns arising from property by persons holding a
common interest in that property does not mean that the persons have formed a
partnership firm to carry on such business.
If a payment to a person is dependent upon the earning of profits or varying with
the profits earned by a business, or he is given a share of the profits of the
business then simply this fact does not make the person receiving such payment
as a partner in the business.
Example: The receipt of a payment or share in profits of the business by a
servant or agent as remuneration. Hence, to summarise the essentials of a
partnership.
Partnership is the result of an agreement between the persons joining together to
do some lawful business.
379
• The contract between the partners may be oral or written.
• The partnership must be formed to carry on some lawful business.
• The business must be carried on to earn and share the profits and returns
of the business.
• There must be a mutual relation of 'agency' between the partners. This
means that any partner can
by his acts bind all the partners of the firm. This is the meaning of 'business
carried on by all or any
of them acting for all' in the definition of partnership.
Illustrations
(a) A and B buy ten boxes of mangoes agreeing to equally share the
mangoes for personal consumption
and pay the purchase price thereof. This is not a partnership. However, if they
further agree to
sell some mangoes and share the profits from the sale, it is a partnership.
(b) A and B are joint owners of a car. It is not a partnership. However, if
they decide to give it on hire
and share the rentals it is a partnership between the two.
50.3 TYPES OF PARTNERSHIP
1. Partnership at will
Where no provision is made by a contract between the partners for the duration
of their partnership or for the determination (i.e. the termination or end) of the
partnership - the partnership is known as 'partnership at will'. A partnership at
will can be dissolved by any partner by giving notice in writing to all the other
partners of his intention to dissolve the firm. The firm gets dissolved from the
date mentioned in the notice as the date of dissolution and if no date is
mentioned, the/firm gets dissolved from the date of the commencement of the
notice.
2. Partnership for a fixed period
When two or more persons enter into a partnership agreement for a fixed period
of time, it is known as a partnership for a fixed term. In such a case, when the
fixed period of partnership is over, it comes to an end. However, the partners can
continue to carry on the business after the fixed period. In that case, the mutual
rights and duties remain absolutely unaffected and the partnership is
automatically transformed into a partnership at will.
3. Particular partnership
Such partnership is entered into, for completing a particular job or assignment
taken up by two or more persons jointly and to share the profits arising there
from. Hence, a person may become a partner with another person in particular
adventures or undertakings.
50.4 LET US SUM UP
Partnership is the relation between persons who have agreed to share the profits
of a lawful business, carried on by all or any of them acting for all. There is a
mutual relation of 'agency' between the partners. Any partner can, by his acts,
bind all the partners of the firm. This is the meaning of 'business carried on by
all or any of them acting for all'. The three different types of partnership are:
partnership at will, partnership for a fixed period and particular partnership.
50.5 CHECK YOUR PROGRESS
1. Indicate whether the following statements are True or False.
(i) If one partner cheats a customer of the partnership firm then all the partners
of the partnership firm are liable to compensate the customer.
HI:
380
(ii) Registration of firms is compulsory under the Partnership Act. (iii) It is
compulsory to enter into a partnership deed, (iv) The partners are free to decide
their mutual rights and liabilities.
(v) A partnership deed can even provide that a particular partner would not take
part in the day-to-day business decisions of the partnership firm, (vi) Consent of
all the partners is necessary to change the nature of business carried on by the
firm, (vii) A partnership at will can be dissolved by notice.
50.6 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (i) True; (ii) False; (iii) False; (iv) True; (v) True; (vi) True; (vii) True.
.11:
RELATIONS OF PARTNERS TO ONE ANOTHER
STRUCTURE
51.0 Objective
51.1 Introduction
51.2 General Duties of Partners
51.3 Duty to Indemnify the Loss caused by Fraud
51.4 Determination of Rights and Duties of Partners by Contract between the
Partners
51.5 The Conduct of the Business
51.6 Mutual Rights and Liabilities
51.7 The Property of the Firm
51.8 Profits Earned by Partners
51.9 Rights and Duties of Partners
51.10 Let Us Sum Up
51.11 Check Your Progress
51.12 Answers to 'Check Your Progress'
382
I
51.0 OBJECTIVE
The objective of this unit is to understand the relationship of partners amongst
themselves and their mutual rights and duties.
51.1 INTRODUCTION
Partners are bound to carry on the business of the firm to the greatest common
advantage. The partners are responsible to each other for the conduct of the
business of the firm.
51.2 GENERAL DUTIES OF PARTNERS
The partners should not make secret profits. They have to be just and faithful to
each other. They must render true accounts of the business and full information
of all things affecting the firm to all the partners or their legal representatives.
51.3 DUTY TO INDEMNIFY THE LOSS CAUSED BY FRAUD
Every partner is bound to indemnify the firm for any loss caused to the
partnership firm by his fraud, in the conduct of the business of the firm. For
example, if a partner commits a fraud upon a customer of the partnership firm
for which the firm is held liable then the partnership firm, is entitled to recover
from the partner the damages that the firm is required to pay. This liability of the
partner cannot be waived off by the partners as it would be opposed to public
policy in the sense that it would amount to exempting a person from his own
frauds.
51.4
DETERMINATION OF RIGHTS AND DUTIES OF PARTNERS BY
CONTRACT BETWEEN THE PARTNERS
The partners of a firm can decide their mutual rights and duties and change them
from time to time with the consent of all the partners. This may be implied (i.e.
understood by the dealings between them/ with outsiders) or may be expressed
(i.e. specifically discussed and made clear). These should however, be not
against the provisions of the Partnership Act. Such contracts (defining their
rights and duties) may even provide that a partner shall not carry on any business
other than that of the firm while he is a partner.
51.5 THE CONDUCT OF THE BUSINESS
Subject to a contract between the partners (i.e. the agreement and understanding
arrived between themselves)
(a) every partner has a right to take part in the conduct of the business;
(b) every partner is bound to attend diligently to his duties in the conduct of
the business;
(c) any difference arising as to ordinary matters connected with the business
can be decided by a
majority of the partners and every partner has a right to express his opinion
before the matter is decided. However, no change can be made in the nature of
the business without the consent of all the partners.
(d) every partner has a right to have access to and to inspect and copy any of
the books of the firm.
The above rights may be given to some partners only and the others may not be
allowed to have a say in the day-to-day management of the business or even in
critical decisions. The bifurcation of powers can be decided by the partners
themselves based on the agreement and understanding arrived between
383
themselves (except in cases where consent of all partners is required as stated
above). However, if they have no specific understanding on these matters, the
above applies to them.
51.6 MUTUAL RIGHTS AND LIABILITIES
Subject to a contract between the partners (i.e., the agreement and understanding
arrived between themselves),
(a) a partner is not entitled to receive remuneration for taking part in the
conduct of the business;
(b) the partners are entitled to share equally in the profits earned and liable
to contribute equally to the
losses made by the firm;
(c) where a partner is entitled to interest on the capital subscribed by him
such interest is to be paid
only out of profits of the firm;
(d) Interest at 6 per cent on extra amount paid by the partner;
(e) the firm has to indemnify a partner in respect of payments made and
liabilities incurred by him:
(i) in the ordinary and proper conduct of the business, and
(ii) in doing such act in an emergency, for the purpose of protecting the firm
from loss;
(f) similarly, a partner has to indemnify the firm for any loss caused to it by
his wilful neglect in the
conduct of the business of the firm.
On the matters stated above, the partners are free to have an understanding other
than in the manner stated above, e.g. all or some of the partners may be allowed
remuneration by way of salary in addition to share profits. Further, the share in
profits may not be equal and the options can decide that a particular partner
would get more share in the profits than the others. However, if they have no
specific understanding on these matters, the above applies to them.
51.7 THE PROPERTY OF THE FIRM
The property of the firm includes all property/rights in property originally
brought into the firm or later on acquired (by purchase, etc.) by the firm for the
purpose of business of the firm and includes also the goodwill of the business.
The property acquired by the partners from the funds of the partnership business
is deemed to be the property of the firm (unless, e.g. say the partners had
decided to purchase a particular property from the partnership funds and give it
to a partner towards his long due remuneration). The property of the firm has to
be held and used by the partners exclusively for the purposes of the business.
However, the partners can decide the use of the property by mutual consent.
51.8 PROFITS EARNED BY PARTNERS
If a partner derives any profit for himself from any transaction of the firm or
from the use of the property/business connection of the firm/the firm name he is
bound to pay it to the firm. Also, if a partner carries on any business competing
with the firm he is bound to pay to the firm all profits made by him in that
business. On the matters stated above, the partners are free to have an
understanding other than in the manner stated above. However, if they have no
specific understanding on these matters, the above applies to them.
51.9 RIGHTS AND DUTIES OF PARTNERS
(a) After a change in the partners of a firm the mutual rights and duties of
the partners in the
reconstituted firm remain the same as they were immediately before the change.
(b) Similarly, after the expiry of the term of the firm, if a firm constituted
for a fixed term, continues
to carry on business, the mutual rights and duties of the partners remain the same
as they were
before the expiry.
384
(c) Mutual rights and duties remain same for additional
undertaking/adventure carried out.
(d) On the matters stated above, the partners are free to have an
understanding other than in the
manner stated above. However, if they have no specific understanding on these
matters, the
above applies to them.
51.10 LET US SUM UP
Every partner is bound to indemnify the firm for any loss caused to the
partnership firm by his fraud in the conduct of the business of the firm. The
partners of a firm can decide their mutual rights and duties and change them
from time to time with the consent of all the partners. The property of the firm
has to be held and used by the partners exclusively for the purposes of the
business. The partners can decide the use of the property by mutual consent.
51.11 CHECK YOUR PROGRESS
1. State whether the following statements are True or False, (i) Every partner
has a right to receive remuneration, (ii) It is necessary that all the partners in the
partnership firm must receive equal share of profits in
the partnership firm, (iii) No partner is entitled to use the partnership property
for his private purposes.
51.12 ANSWERS TO CHECK YOUR PROGRESS'
1. (i) False; (ii) False; (iii) True.
RELATIONS OF PARTNERS TO THIRD PARTIES
STRUCTURE
52.0 Objective
52.1 Introduction
52.2 Partner is an Agent of the Firm
52.3 Implied Authority of Partner as Agent of the Firm
52.4 Extension and Restriction of Partner's Implied Authority
52.5 Partner's Authority in an Emergency
52.6 Mode of Doing Act to Bind Firm
52.7 Liability of a Partner for Acts of the Firm
52.8 Liability of the Firm for Wrongful Acts of a Partner
52.9 Liability of Firm for Misapplication by Partners
52.10 Holding Out
52.11 Rights of Transferee or a Partner's Interest
52.12 Let Us Sum Up
52.13 Check Your Progress
52.14 Answers to 'Check Your Progress'
386
52.0 OBJECTIVE
The objective of this unit is to understand the rights and liabilities of the partners
with respect to contracts entered into with third parties.
52.1 INTRODUCTION
A partner is the agent of the firm for the purpose of the business of the firm.
Every partner plays a dual role in a partnership. One is the role of a principal, i.e.
on his own behalf and the other the role of an agent for every other partner. It
must be noted that every partner is an agent of every other partner only in the
business of the firm.
52.2 PARTNER IS AN AGENT OF THE FIRM
A partner can make the firm liable by his acts, if done in the name of the firm
and in the ordinary course of business of the firm. A partner, who contracts in
his own name, incurs only a personal liability and not the collective liability of
the firm.
52.3 IMPLIED AUTHORITY OF PARTNER AS AGENT OF THE FIRM
An act done by a partner to carry on the kind of business done by the firm (in the
usual way) binds the firm. This authority of a partner to bind the firm is called
his 'implied authority'.
The implied authority of a partner does not empower him to
(a) submit a dispute relating to the business of the firm to arbitration (i.e. for
settlement by an
independent person other than the parties to the dispute);
(b) open a banking account on behalf of the firm in his own name;
(c) compromise or relinquish (give up) any claim by the firm;
(d) withdraw a suit or proceeding filed on behalf of the firm;
(e) admit (accept) any liability in a suit or proceeding against the firm;
(f) acquire immoveable property on behalf of the firm;
(g) transfer immoveable property belonging to the firm; or
(h) enter into partnership on behalf of the firm.
52.4 EXTENSION AND RESTRICTION OF PARTNER'S IMPLIED
AUTHORITY
The partners in a firm may by mutual agreement amongst themselves, extend or
restrict the implied authority of any partner. Any act done by a partner on behalf
of the firm within his implied authority binds the firm unless the person with
whom he is dealing knows the restriction.
52.5 PARTNER'S AUTHORITY IN AN EMERGENCY
Whatever may be the powers given to a particular partner, in case of an
emergency, a partner has authority to do all acts to protect the firm from loss, as
would be done by a person of ordinary prudence in his own case. The firm is
bound by such acts.
52.6 MODE OF ACTION TO BIND FIRM
In order to bind a firm, the partner must do the activities in the name of the firm
and execute the documents on behalf of the firm or in any other manner
expressing or implying an intention to bind the firm. A person cannot simply
sign an agreement in his own name to purchase goods for the firm and
387
say that since he is the partner in a firm XYZ it is implied that the partners are
bound to pay for the goods. For example, he should sign as 'For and on behalf of
XYZ'.
52.7 LIABILITY OF A PARTNER FOR ACTS OF THE FIRM
Every partner is liable jointly with all the other partners and also severally for all
acts of the firm done while he is a partner. This is a core principle of partnership
business.
52.8 LIABILITY OF THE FIRM FOR WRONGFUL ACTS OF A
PARTNER
If a partner commits some wrongful act or omits doing of something in the
ordinary course of the business of the firm with or without the authority of other
partners and consequently a loss or injury is caused to any third party, the firm is
liable thereof to the same extent as the partner.
52.9 LIABILITY OF FIRM FOR MISAPPLICATION BY PARTNERS
The firm is liable to make good the loss of money or property from a third party
in the following cases:
If any partner had received the funds within his obvious and clear authority but
had misapplied the funds.
The firm received the funds in the course of its business and the same was
misapplied by any of the partners while it is in the custody of the firm.
52.10 HOLDING OUT
Anyone who by words spoken or written or by conduct represents himself or
knowingly permits himself to be represented to be a partner in a firm is as liable
as a partner in that firm to any who has on the faith of any such representation
given credit to the firm whether the person representing himself or represented
to be a partner does or does not know that the representation has reached the
person so giving credit.
This is known as doctrine of holding out. This means that when a person who is
not at all a partner in a firm, either represents himself, or knowingly permits
himself to be represented, as a partner in a firm and as a result of this, he induces
others to give credit to the firm then he is known as a partner holding out. Such a
stranger is liable individually and personally for the debts of the firm as if he
was a partner in the firm on the principle of holding out. However, legal heirs or
estate of the deceased partner is not liable to the firm, who uses his name, after
his death.
52.11 RIGHTS OF TRANSFEREE OR A PARTNER'S INTEREST
A transfer by a partner of his interest in the firm does not entitle the person to
whom the interest is transferred (transferee) to interfere in the conduct of the
business but entitles the transferee only to receive the share of profits of the
transferring partner and the transferee has to accept the account of profits agreed
to by the partners. On dissolution of firm or cessation of the partner, the
transferee is entitled to a share in assets of the firm and verification of accounts
to ascertain his share.
52.12 LET US SUM UP
In order to bind a firm, the partner must do the activities under the name of the
firm and execute the documents on behalf of the firm or in any other manner
expressing or implying an intention to bind the firm. Every partner is liable
jointly with all other partners and also severally for all acts of the firm done
while he is a partner. This is a core principle of partnership business.
L.R.A.B-26
388
52.13 CHECK YOUR PROGRESS
1. State whether the following statements are True or False.
(i) A single partner can be authorised to carry on business and sign documents
on behalf of the
firm.
(ii) Every partner is liable jointly with all other partners and also severally for all
acts of the firm done while he is a partner.
52.14 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (i) True; (ii) True.
MINOR ADMITTED TO THE BENEFITS OF PARTNERSHIP
STRUCTURE
53.0 Objective
53.1 Introduction
53.2 A Minor cannot be a Partner
53.3 Legal Position after the Minor Attains Majority
53.4 Retirement of a Partner
53.5 Insolvency of a Partner
53.6 Let Us Sum Up
53.7 Check Your Progress
53.8 Answers to 'Check Your Progress'
390
I
53.0 OBJECTIVE
The objective of this unit is to understand whether or not a minor can be a
partner in a partnership firm and what are his rights and liabilities in a firm.
Further the consequences of retirement of a partner and adjudication of a partner
as insolvent are also discussed.
53.1 INTRODUCTION
As mentioned in the Indian Contract Act, 1872 a minor is not competent to enter
into a contract. Hence, he is not eligible to enter into a contract of partnership. A
person who is a minor cannot be a partner in a firm but with the consent of all
the partners, he may be admitted to the benefits of partnership. In no
circumstances, the minor can be made a party to the liabilities of the firm.
53.2 A MINOR CANNOT BE A PARTNER
The minor has a right to share the property and profits of the firm as may be
agreed upon by the partners and the minor can have access to the accounts of the
firm.
As explained earlier, the partners of the firm are personally liable for all the
liabilities of the firm. However, only the minor's share is liable for the acts of the
firm but the minor is not personally liable for the acts of the firm and the
liabilities arising there from.
The minor may or may not take legal action (by filing suit) against the partners
for payment of his share of the property or profits of the firm except when
severing (ending) his connection with the firm.
However, all the partners acting together or any partner who is entitled to
dissolve the firm by notice to other partners can elect (choose) in such a suit
filed by the minor to dissolve the firm. Thereafter, the court proceeds with the
suit as a suit for dissolution and for settling accounts between the partners. The
share of the minor is then determined along with the shares of the other partners.
53.3 LEGAL POSITION AFTER THE MINOR ATTAINS MAJORITY
At any time within six months of his attaining majority, or of his obtaining
knowledge that he had been admitted to the benefits of partnership (whichever
date is later) the person may give public notice to the effect whether he has
elected to become a partner or not. This notice determines his position as regards
the firm. However, if he fails to give such notice, he shall become a partner in
the firm on the expiry of the said six months.
Where such a person becomes a partner (either because he elected to do so or
because he failed to take a decision and six months have elapsed since he
attained majority):
(a) his rights and liabilities as a minor continue up to the date on which he
becomes a partner but he
also becomes personally liable to third parties for all acts of the firm done since
he was admitted
to the benefits of partnership, and
(b) his share in the property and profits of the firm shall be the share to
which he was entitled as a
minor.
If such person elects not to become a partner:
(a) his rights and liabilities shall continue to be those of a minor up to the
date on which he given
public notice that he does not want to become a partner;
(b) his share shall not be liable for any acts of the firm done after the date of
the notice; and
(c) he shall be entitled to sue the partners for his share of the property and
profits.
391
53.4 RETIREMENT OF A PARTNER
A partner may retire
(a) with the consent of all other partners
(b) in accordance with an express agreement by the partners, or
(c) where the partnership is at will, by giving notice in writing to all the
other partners of his intention
to retire.
The retiring partners and other partners shall be liable as partners to third parties
for any act done by any of them which would have been an act of the firm if
done before retirement until the public notice is given of the retirement. The
public notice may be given by the retiring partner or the remaining partners of
the reconstituted firm. A retiring partner is discharged of his liability to a third
party for acts of the firm before his retirement if there is an agreement between
the third party, the retiring partner and the remaining partners of the
reconstituted firm.
A partner can also be expelled from the firm by any majority of the partners if
done in exercise of good faith of powers conferred by contract between the
parties. The expelled partner is in the same position as that of the retiring
partner.
53.5 INSOLVENCY OF PARTNER
If partner of a firm is adjudicated as an insolvent, he ceases to be partner from
the date on which the order of adjudication is made. An order of adjudication of
a partner may or may not dissolve the firm. If the firm is not dissolved pursuant
to a contract upon adjudication of a partner, the estate of a partner so adjudicated
is not liable for any act of the firm and firm is not liable for any act of the
insolvent, done after the date on which the order of adjudication is made.
53.6 LET US SUM UP
A minor cannot be a partner but he can be admitted to the benefits of the
partnership.
53.7 CHECK YOUR PROGRESS
1. State whether the following statements are True or False, (i) A minor can be
a partner in a partnership firm, (ii) A minor can be admitted to the benefits of a
partnership firm, (iii) A minor is personally liable like other partners to pay the
debts of the firm, (iv) A minor who is admitted to the benefits of a partnership
firm, has a choice when he attains majority as to whether he wants to continue as
a partner or not.
53.8 ANSWERS TO CHECK YOUR PROGRESS'
1. (i) False; (ii) True; (iii) False; (iv) True.
UNIT
54
DISSOLUTION OF A FIRM
STRUCTURE
54.0 Objective
54.1 Introduction
54.2 Dissolution by Agreement
54.3 Compulsory Dissolution
54.4 Dissolution on the Happening of Certain Contingencies
54.5 Dissolution by the Court
54.6 Liability for Acts of Partners Done after Dissolution
54.7 Let Us Sum Up
54.8 Check Your Progress
54.9 Answers to 'Check Your Progress'
394
54.0 OBJECTIVE
To understand as to when and how a partnership firm may be dissolved and if
so, what are the rights and liabilities of partners on the dissolution of the firm.
54.1 INTRODUCTION
A partnership firm can be dissolved. This means that the partners can decide to
stop carrying on the business for which it is formed and the partners can decide
their share in the profits or losses as on the date of dissolution after payment of
debts and liabilities. This unit discusses the various modes of dissolution of a
partnership firm.
54.2 DISSOLUTION BY AGREEMENT
A firm can be dissolved with the consent of all the partners or in accordance
with a contract between the partners.
54.3 COMPULSORY DISSOLUTION
A firm is dissolved:
(a) if all the partners (except one) are adjudicated insolvent; or
(b) by the happening of any event which makes it unlawful for the business
itself to be carried on or
the event makes the business unlawful if it carried on in partnership.
However, if the partnership firm is carrying on more than one separate
businesses, the illegality of one or more does not cause the dissolution of the
firm. The firm can continue to carry on its lawful adventures and undertakings.
54.4 DISSOLUTION ON THE HAPPENING OF CERTAIN
CONTINGENCIES
A firm is dissolved in the following circumstances. To avoid dissolution in these
cases, the partners should expressly agree that the firm shall not be dissolved in
these circumstances:
(a) if the partnership is constituted for a fixed term, then by the expiry of
that term;
(b) if the partnership is constituted to carry out one or more adventures or
undertaking, then by the
completion thereof;
(c) by the death of a partner; and
(d) by the adjudication of a partner as an insolvent.
54.5 DISSOLUTION BY THE COURT
At the suit of a partner the court may dissolve a firm on any of the following
grounds:
(a) that a partner has become of unsound mind;
(b) that a partner (other than the partner suing for dissolution) has become
permanently incapable of
performing his duties as partner;
(c) that a partner (other than the partner suing) is guilty of conduct which is
likely to affect prejudicially
the carrying on of the business;
(d) that a partner (other than the partner suing) wilfully or persistently
commits breach of agreements
in relation to the management of the affairs of the firm or the conduct of its
business or it is not
reasonably practicable for the other partners to carry on the business in
partnership with him
I because of his conduct with respect to the business;
395
(e) that a partner (other than the partner suing) has transferred the whole of
his interest in the firm to
a third party;
(f) that the business of the firm cannot be carried on except at a loss; or
(g) on any other ground which renders it just and equitable that the firm
should be dissolved.
54.6 LIABILITY FOR ACTS OF PARTNERS DONE AFTER
DISSOLUTION
Any partner of the firm must give a public notice to the effect that the firm is
dissolved. This is because even after the dissolution of a firm, the partners
continue to be liable to third parties for any act done by any of them, until such
public notice is given.
54.7 LET US SUM UP
A firm can be dissolved by agreement between the partners or by the court or it
gets compulsorily dissolved in certain cases.
54.8 CHECK YOUR PROGRESS
1. State whether the following statements are True or False, (i) The partners can
mutually agree and dissolve the firm, (ii) On the death of a partner the
partnership firm is compulsorily dissolved.
54.9 ANSWERS TO CHECK YOUR PROGRESS'
1. (i) True; (ii) False
EFFECT OF NON-REGISTRATION
STRUCTURE
55.0 Objective
55.1 Introduction
55.2 Registration
55.3 Check Your Progress
55.4 Answers to 'Check Your Progress'
398
55.0 OBJECTIVE
The objective of this unit, is to understand as to whether a partnership firm is
required to be registered with any governmental authorities and what are the
benefits of registration and the consequences of non-registration of a partnership
firm.
55.1 INTRODUCTION
A company is compulsorily required to be incorporated and registered with the
Registrar of Companies under the Companies Act, 1956. However, a partnership
firm is not required to be compulsorily registered with the Registrar of
Partnership Firms.
55.2 REGISTRATION
The partner's may or may not enter into a partnership deed and may decide to
have an oral partnership if they have a strong understanding amongst
themselves. Further, even if a partnership deed is entered into by the partners
they may not opt for registration of the partnership firm. However, the
Partnership Act casts certain disabilities on a partnership firm that is not
registered with the Registrar of Partnership Firms. Due to this provision which is
stated in the Section 69, a majority of the partnership firms decide to register the
firm to avoid future hassles and complexities on solving issues amongst the
partners as well as with third parties. The provisions of the Section 69 are briefly
stated hereunder:
A partner of an unregistered firm cannot enforce by way of a suit, any right
available to him under the Partnership Act or a right conferred by a contract
amongst the partners against the partnership firm or any partner thereof.
Similarly an unregistered firm cannot enforce by way of a suit, any right arising
by a contract against any third party.
However the enforcement of any right to sue, for matters relating to the
dissolution of a firm is not affected and can be brought before the Court of Law.
55.3 CHECK YOUR PROGRESS
1. State whether the following statement is True or False.
(i) A partner of an unregistered firm can file a suit against other partners to get
his share of profits.
55.4 ANSWERS TO CHECK YOUR PROGRESS'
1. (i) False.
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UNIT
56
DEFINITION AND FEATURES OF A COMPANY
:s :d
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tie or
STRUCTURE
56.0 Objective
56.1 Introduction
56.2 Definition of a Company
56.3 Features of a Company
56.4 Distinction between a Company and Partnership
56.5 Let Us Sum Up
56.6 Check Your Progress
56.7 Answers to 'Check Your Progress'
ist
lOt
ts.
400
56.0 OBJECTIVE
In this unit, an attempt is made to explain the nature of a company and the
fundamental legal aspects of the form of organisation of a company as evolved
by courts and as enshrined under the Companies Act, 1956.
56.1 INTRODUCTION
In today's trade world, companies are the rivers of commercial prosperity of the
country. The form of organisation of a company is relatively more advantageous
than other forms of business organisations. The features of limited liability,
perpetual existence and separate entity serve as advantages to set up a company.
56.2 DEFINITION OF A COMPANY
Section 3 of the Companies Act, 1956 defines a company as 'a company formed
and registered under this Act, or an existing company'. An existing company
means a company formed and registered under any of the former Companies
Acts.
56.3 FEATURES OF A COMPANY
(a) Registration
A company has to be compulsorily registered under the Companies Act, 1956.
(b) Artificial Legal Person
A company is an artificial legal person which is created by law and can be
dissolved by the law alone. It is invisible, intangible and exists only in the eyes
of the law. It enjoys many rights of a natural person. A company may enter into
contracts in its own name, and it can acquire and dispose property and can be
fined under the provisions of the law for violation of law. However a company is
not a natural citizen like an individual and courts have held that neither the
provisions of the Constitution of India nor the provisions of the Citizenship Act
apply to a company. Thus, even though a company has a nationality and
domicile it has no citizenship.
(c) Independent corporate personality
A partnership firm has no legal existence apart from its members. In other
words, a partnership firm is nothing but the aggregate of the partners. A
company on the other hand, after incorporation is in law a single person, it has a
distinct legal personality. By incorporation under the Companies Act, 1956 the
company is vested with a corporate personality which is independent of and
different from the members who compose it.
The decision of House of Lords in England in the case of Salomon vs A.
Salomon and Company Limited (1897) AC 22 at 57: (1895-9) All ER Rep 33 is
the leading case as the bedrock of the existence of a company.
Salomon, an individual was a boot and shoe manufacturer. He incorporated a
company named Salomon and Company Limited and the company took over and
carried on his personal business. The seven subscribers to the memorandum of
association were Salomon himself, his wife, four sons and a daughter each
taking one share. The company's board of directors was composed of Salomon
as the managing director and his four sons. Through this board, the personal
business of Salomon was transferred to the company for 40,000 pounds. In
payment thereof Salomon was allotted 20,050 shares of one pound each and
debentures worth 10,000 pounds. These debentures certified that the
401
company owed Salomon 10,000 pounds and created a charge on the company's
assets. One share was given to each remaining member of the family. Within a
year, the company went into liquidation and the state of affairs was broadly like
this - assets 6,000 pounds liabilities - Salomon's debentures at 10,000 pounds
and ordinary insecured creditors at 7,000 pounds. Thus, after paying off the
debenture holder (Salomon) nothing would be left for the insecured creditors.
The insecured creditors filed a case against the company and contended that
though incorporated under the Companies Act, 1956 the company never had an
independent existence at all. It was Salomon himself trading under another name
and that he cannot pay off himself first for the debentures from his own funds by
creating a charge on the assets. The insecured creditors should be paid first. The
House of Lords held that Salomon and the company were different and the
company had a separate existence of its own.
(d) Limited liability
Limitation of liability is an advantage of incorporation of a company. Since
under company law, the existence of a company is different from its own
members and directors and a company leads its own business existence and
since it is itself the owner of its assets and has its own liabilities, the members of
the company are not bound to contribute anything more than the nominal value
of the shares held by them and their liability ends there even though there may
be creditors who may be claiming crore of rupees from the company In a
partnership firm, on the other hand, the liability of the partners for the debts of
the firm is unlimited and the partners are required to meet all the liabilities of the
partnership firm from their own pocket.
(e) Perpetual succession
An incorporated company never dies. It is a legal entity with perpetual
succession. The insolvency or death of members does not affect the continued
existence of the company. In spite of a total change in the members of the
company, the company will remain the same entity. Members may come and
members may go but the company goes on forever.
(f) Separate property
On incorporation the company becomes the owner of its capital and assets. The
company is capable of holding property in its own name.
(g) Transfer of shares
The Companies Act, 1956 states that shares or other interest of any member in a
company shall be moveable property, transferable in the manner provided by the
articles of association. A shareholder may sell his shares in the open market and
get back his money without changing the capital of the company.
(h) Common Seal
As a company is an artificial legal person, it is not capable of signing documents
for itself. It acts through natural persons who are the directors appointed by the
shareholders of the company. However since it is a legal person it can be held
responsible for only those documents that bear its signature. Hence the law
provides for a common seal with the name of the company engraved on it as a
substitute for its signature. Any document bearing the common seal of the
company is legally binding on the company. However a common seal cannot be
affixed by any director. It has to be affixed in the manner stated in the articles of
association, e.g., in the presence of two directors who shall sign on the document
where the common seal is affixed in their presence.
(i) Corporate veil
Although a company is a separate legal entity distinct from shareholders in
reality it is an association of persons who are the beneficial owners of all the
corporate property. Hence it may sometime become
402
necessary to look at the persons who are behind the corporate veil. The corporate
veil is said to be lifted or pierced when the Court ignores the separate entity of
the company and directly concerns itself with the members or directors of the
company. There is no specific law as to when this should be done. The Court
decides this as applicable on a case to case basis.
56.4 DISTINCTION BETWEEN A COMPANY AND PARTNERSHIP
(a) Registration
Registration of a company is compulsory under the Companies Act, 1956.
Registration of a partnership is not compulsory under the Indian Partnership Act,
1932.
(b) Number of members/partners
Minimum of two and maximum of fifty in case of a private company and a
minimum of seven and no limit on maximum number of members in case of
public company.
Minimum number of two persons is required to form a partnership. The
maximum number is ten for banking business and twenty for any other business.
(c) Legal status
A company has a legal existence separate from its own members and is viewed
as a separate legal person from its members. A firm does not have, a separate
legal existence different from its own partners.
(d) Ownership of property
The property of the company is owned by the company itself and not its
members as the company has a separate legal existence. The property of the firm
is owned by the partners themselves and not by the firm as a firm does not have
a separate legal existence different from its own partners.
(e) Management
The company is managed by a board of directors elected by the shareholders. A
partnership is managed by the partners except the dormant and sleeping partners.
(f) Perpetual existence
A company has a perpetual existence.
A partnership does not have a perpetual existence.
(g) Contracts
A member of the company can contract with the company. A partner cannot
contract with the partnership firm.
(h) Liability
Except in case of a company with unlimited liability, the liability of the
members of the company is limited. The liability of partners in a partnership is
unlimited.
(i) Transfer
A transferee of shares in a company becomes a member of the company and the
consent of all members is not required to become a member. A person can
become a partner in a partnership firm with the consent of all the partners.
0) Death
The death of any or all members of the company does not determine (end) the
existence of the company. Death of a partner dissolves the partnership unless the
partnership deed provides otherwise.
403
(k) Agency
The members of a company are not the agents of each other or of the company.
Every partner of a firm is an agent of the other.
56.5 LET US SUM UP
A company is an artificial legal person which is created by law and can be
dissolved by law alone. It is invisible, intangible and exists only in the eyes of
law. A company can enter into contracts in its own name, and it can acquire and
dispose property and can be fined under the provisions of the law for a violation
of the law. It is a distinct entity from the members forming it. Since a company
is a distinct legal person, it has its own signature, i.e., a common seal with the
name of the company engraved in it.
56.6 CHECK YOUR PROGRESS
1. Indicate whether the following statements are True or False, (i) Directors are
the actual owners of a company.
(ii) A company has to be compulsorily registered under the Companies Act,
1956. (iii) A company cannot enter into contracts in its own name, (iv) If all the
members of a company die, then the company has to be wound up (i.e.,
dissolved).
56.7 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (i) False; (ii) True; (iii) False; (iv) False.
UNIT
57
TYPES OF COMPANIES
STRUCTURE
57.0 Objective
57.1 Introduction
57.2 Classifications of Companies on the Basis of Mode of Incorporation
57.3 Classifications of Companies on the Basis of Liability
57.4 Classifications of Companies on the Basis of Public Interest
57.5 Holding and Subsidiary Companies
57.6 Let Us Sum Up
57.7 Check Your Progress
57.8 Answers to 'Check Your Progress'
406
57.0 OBJECTIVE
The objective of this unit is to enable the candidates to understand the various
types of companies that can be formed under the Companies Act, 1956 and their
peculiar features.
57.1 INTRODUCTION
There are various types of companies that can be formed under the Companies
Act, 1956 and they can be classified as per the mode of incorporation, on the
basis of liability, on the basis of public interest, as holding and subsidiary
companies, etc. This unit examines these in brief.
57.2 CLASSIFICATIONS OF COMPANIES
THE BASIS MODE OF INCORPORATION
1. Statutory Company
2. Registered under the Companies Act, 1956
57.2.1 Statutory Company
A statutory company is created or incorporated by a special Act passed by either
the Central or the State Legislature. It enjoys powers, rights and privileges as
laid down in the Act. Hence, the statutory companies are not required to have
Memorandum of Association. Although each statutory company is governed by
the provisions of the special Act, the Companies Act, 1956 is also applicable to
them insofar as the provisions of the Companies Act, 1956 are not inconsistent
with the provisions of the special Act under which the company is incorporated.
Examples of statutory companies - Reserve Bank of India incorporated under the
Reserve Bank of India Act, 1934; Food Corporation of India.
57.2.2 Registered under the Companies Act, 1956
Such companies are incorporated and registered under the prevailing Companies
Act, e.g. Tata Iron and Steel Company Limited is incorporated and registered
under the Companies Act prevailing before the enactment of the Companies Act,
1956, i.e. the Companies Act, 1913.
57.3 CLASSIFICATIONS OF COMPANIES ON THE BASIS OF LIABILITY
1. Company limited by shares
3. Company with unlimited liability
2. Company limited by guarantee
Company Limited by Shares
In such companies there is a share capital and each share has a fixed nominal
value also known as the face value which the shareholder is bound to pay either
at a time or in instalments. The member is not bound to pay anything more than
the fixed amount on the share, whatever may be the liabilities of the Company.
In other words, the liability of the members of such a company is limited to the
extent of amount unpaid on the shares. It may be a private company or a public
company. Such companies are the most commonly found companies.
Company Limited by Guarantee
Where the liability of the members of the company is limited by the
memorandum of association to such an amount as the members undertake to
contribute to the assets of the company in the event of the liquidation of the
company, the company is known as a company limited by guarantee. In other
words, in such a company each member promises to pay a fixed sum of money
in case of its winding up. The amount is called the guarantee. A guarantee
company may or may not have a share capital. A guarantee company must have
articles of association. If such a company has a share capital then each
40/
member is required to pay the amount of the fixed share capital as in the case of
a company limited by shares in addition to the guarantee. Thus the liability is
restricted to the amount of the share capital plus the amount of guarantee. Such a
company may also be a private company or a public company.
57.3.3 Company with Unlimited Liability
Where the liability of the members of a company is unlimited it is known as an
unlimited company. Every member of such a company is liable without any limit
for its debts as in the case of a partnership firm in proportion to his interest in the
company. If such a company has a share capital, it may be a public company or
private company. An unlimited company must have articles of association and it
must state the number of members and the share capital (if any) with which it is
proposed to be registered.
57.4 CLASSIFICATIONS OF COMPANIES ON THE BASIS OF PUBLIC
INTEREST
On the basis of public interest companies can be classified as under:
1. Private company 2. Public company
3. Government company 4. Foreign company
Private Company
A private company is defined under the Section 3 of the Companies Act, 1956 as
a company which under its articles of association contains the following
restrictions:
(a) Transfer of Shares
If a private company has a share capital it imposes restriction on the right to
transfer shares in a manner which restricts the number of members to fifty.
(b) Restricts the number of members to fifty
The maximum number of members of a private company is limited to fifty
excluding the members who were past employees or are the present employees
of the company.
(c) Issue of Prospectus
A private company cannot issue a prospectus and cannot invite the public to
subscribe for any shares or debentures of the company.
(d) Deposits
A private company prohibits any invitation or acceptance of deposits from
persons other than its members, directors or their relatives.
A private company should have a minimum paid-up capital of Rs. 1 lakh.
Public Company
A public company is one which is not a private company. In a public company
the number of its members is unlimited. Any seven or more persons can form a
public company. Generally the shares of a public company are listed on the
stock exchange and therefore the marketability of the shares is more. A public
company should have a minimum paid-up capital of Rs. 5 lakh.
There are certain provisions under the Companies Act, 1956 which are
applicable only to a public company and not to a private company and by which
a private company is benefited. However, if a private company defaults in
complying with the aforesaid four restrictions then it shall cease to enjoy these
exemptions and all these provisions shall apply as if it is a public company.
Some of the advantages of a private company over a public company
(exemptions and benefits to a private company under the Companies Act, 1956).
This also forms a distinction between a private
408
(i) A private company can have only two members and two directors. A public
company has to
have a minimum of seven members and three directors, (ii) A private company
need not obtain a certificate of commencement of business from the Registrar
of Companies which a public company has to obtain and it has to only get the
certificate of
incorporation, (iii) A private company need not hold a statutory meeting and
submit a statutory report to the
Registrar of Companies while a public company has to do so. (iv) Certain
provisions of the Companies Act, 1956 with respect to requirements of
appointment and
remuneration payable to the directors applicable to a public company are not
applicable to a
private company, (v) Certain provisions of the Companies Act, 1956 with
respect to general meetings of a company
are not applicable to a private company, (vi) Restrictions on the powers of the
Board of Directors under the Section 293 of the Companies
Act, 1956 which stipulate that certain powers cannot be exercised by the Board
of Directors
except without the consent of the company in a general meeting are not
applicable to a private
company.
Government Company
The Companies Act, 1956 defines a government company as any company in
which not less than fifty-one per cent of the paid-up share capital is held by
• the Central Government or
• by any State Government or Governments or
• partly by the Central Government and partly by one or more of State
Governments
and includes a company which is subsidiary of a government company, e.g.
Bharat Heavy Electricals Limited, Bokaro Steel Limited, etc.
Foreign Company
The Companies Act, 1956 defines a foreign company as a company which is
incorporated outside India but has a place of business in India.
57.5 HOLDING AND SUBSIDIARY COMPANIES
A company is deemed to be a subsidiary of another if:
• That other company controls the majority composition of its board of
directors with the sole object
of controlling its management.
• That other company holds the majority of its shares.
• The holding company's subsidiary has its own subsidiary; it becomes the
subsidiary of the first
mentioned company (i.e. the first holding company). Thus, for example,
company B is a subsidiary
of company A and company C is a subsidiary of company B then company C is
a subsidiary of
company A.
57.6 LET US SUM UP
There are various types of companies that can be incorporated, e.g. statutory
company, company limited by shares, company limited by guarantee, company
with unlimited liability, private company, public company, etc. A private
company enjoys certain relaxations of legal compliance under the Companies
Act, 1956 as compared to a public company.
409
57.7 CHECK YOUR PROGRESS
1. State whether the following statements are True or False.
(i) In case of a company limited by shares the creditors of the company can
recover the money
from the members if the company is not making profits, (ii) A member cannot
transfer shares in a public company without the consent of other members.
2. Fill in the blanks from the options given in the brackets.
(i) The minimum number of members required in a private company is .
(3/7/12/2)
(ii) The minimum number of members required in a public company is
(3/7/12/2)
(iii) The maximum number of members in a private company can be
(7/12/50/2)
(iv) The maximum number of members in a public company can be . (any
number/
12/50/15)
(v) A private company should have a minimum paid-up capital of Rupees
. (five
crore/five lakh/one crore/one lakh)
(vi) A public company should have a minimum paid-up capital of Rupees
. (five
crore/five lakh/one crore/one lakh)
(vii) In a government company the government holds at least per cent of the
paid-up
capital. (12/15/50/51)
57.8 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (i) False; (ii) False.
2. (i) 2; (ii) 7; (iii) 50; (iv) any number; (v) one lakh; (vi) five lakh; (vii)
51.
UNIT
58
MEMORANDUM OF ASSOCIATION AND ARTICLES OF ASSOCIATION
STRUCTURE
58.0 Objective
58.1 Introduction
58.2 Memorandum of Association
58.3 Articles of Association
58.4 Distinction between the Memorandum of Association
and Articles of Association
58.5 Let Us Sum Up
58.6 Check Your Progress
58.7 Answer to 'Check Your Progress'
412
58.0 OBJECTIVE
To understand the concept and importance of the constitutional documents
which form the basis of incorporation and administration of a company.
58.1 INTRODUCTION
The basic documents that are necessary to incorporate a company are the
'Memorandum of Association' and the "Articles of Association'. The business of
the company is carried on the basis of the objectives laid down in the
memorandum of association while the internal management and procedures are
regulated by the articles of association.
58.2 MEMORANDUM OF ASSOCIATION
The first step in the formation of a company is the preparation of the
memorandum of association. It is a document of great significance as it
embodies the fundamental rules regarding the constitution and scope of activities
of a company. The purpose of memorandum of association among others is to
enable the member's creditors and those who deal with the company to know the
permitted scope of its activities.
Contents of the various clauses of the memorandum of association are stated
herein together with a brief of a provision pertaining to that clause.
A. Name clause
A company is a legal person and hence it must have a name to be identified. A
company cannot have a name which in the opinion of Central Government is
undesirable. A name is undesirable when it is identical with or too nearly
resembles the name of another company.
If the company is with limited liability the last word of the name should be
limited and in case of a private company the last words should be private
limited. However, the Central Government has powers to permit by licence a
company not to use the words private limited or limited as the case may be, if
the company is formed for promotion of arts, commerce, science, religion,
charity or any other useful objective and the company intends to apply its
income, if any, in promoting its objects and to prohibit the payment of any
dividend to its members.
B. Registered office clause
This clause must mention the name of the state in which the registered office of
the company is situated. It is to be noted that the address of the registered office
is not to be mentioned. Only the name of the state is required to be mentioned. A
company shall from the date on which it commences business or within thirty
days after the date of incorporation, whichever is earlier, have a registered office
to which all the communications and notices may be addressed. Notice of the
situation of the registered office and of every change therein is to be given
within thirty days after the date of incorporation of the company or after the date
of the change as the case may be to the registrar of companies who shall record
the same.
C. Objectives Clause
This is a very important clause and must be drafted very carefully and it should
clearly state the objectives for which the company is established (incorporated)
and the nature of business it can undertake/carry on. Choice of the objectives is
left with the subscribers to the memorandum of association who incorporate the
company. Although the ownership of the corporate capital is vested in the
company itself, in reality the capital is contributed by the shareholders. It is
therefore very essential that the objectives of the proposed company must be
intimated to the shareholders so that they can decide in
I
413
which business areas they want to invest their mo.iey. A company can have any
lawful objectives. This means that a company cannot have objectives contrary to
law to carry on activities prohibited under the law.
The objectives clause, of the memorandum of association of a company are to be
classified and stated under two sub-clauses as 'main clause' and 'other
objectives'.
The Main Objectives clause must contain the main objectives which are to be
pursued by the company immediately on incorporation and objectives which are
incidental or ancillary to the attainment of the main objectives of the company.
The Other Objectives clause must contain other objectives which are not
included in the above clause.
D. Liability clause
If the company is to be incorporated with limited liability the liability clause
must state that the liability of the members shall be limited by the unpaid amount
on shares.
E. Capital clause
In case of companies having a share capital this clause must state that the
amount of share capital which the company will be authorised to raise and the
number and the value of shares into which it is divided.
F. Association or subscription clause
The memorandum of association concludes with a declaration of the
subscription that the persons who have subscribed their signatures intend to form
themselves into an association in accordance with the Memorandum of
Association.
58.3 ARTICLES OF ASSOCIATION
Articles of Association is the second important document of a company. It
consists of a set of rules/ regulations and bye laws made by the company for
internal management of the company and for carrying out the objects of the
company embodied in its memorandum of association.
The Companies Act, 1956 requires that the articles of association must be filed
together with the memorandum of association by the following kind of
companies:
• Unlimited company • Company limited by guarantee
• Private company limited by shares
Schedule I of the Companies Act, 1956 sets out the tables or model forms of
articles of association for different companies. Table A is applicable to public
companies limited by shares. Hence a public company limited by shares may
either frame its own articles of association or adopt the regulations contained in
Table A which will then automatically apply to the extent to which it is not
excluded.
The main advantage of adopting Table A lies in the fact that its provisions are
legally beyond all doubt.
In the case of an unlimited company the articles of association must state the
number of members with which the company is to be registered and the amount
of share capital of the company (if the company has a share capital).
In the case of a company limited by guarantee the articles of association must
state the number of members with which the company is to be registered.
In the case of a private company the articles of association must contain the
restrictive conditions peculiar to a private company (i.e. with respect to
prospectus, deposits, number of members and transfer of shares).
414
58.4 DISTINCTION BETWEEN THE MEMORANDUM OF
ASSOCIATION AND
ARTICLES OF ASSOCIATION
The memorandum of association contains the fundamental conditions (objects)
upon which the company is incorporated. The conditions are introduced for the
benefit of the creditors, the shareholders, and the outside public.
The articles of association are the internal regulations of the company and they
provide the manner in which the proceedings of the company are to be carried
on.
The memorandum of association is a dominant instrument as it states the
purposes of the company and the reasons for which it has come into existence.
The articles of association are always held to be subordinate to the memorandum
of association because the articles of association are merely the internal
regulations of the company while the memorandum of association states the
objects of the company beyond which the company cannot go.
Clauses in the memorandum of association (e.g. change of registered office in
another state or the objects clause) can be altered only by a special resolution
passed by the company and with the sanction of the Company Law Board.
Any terms of the articles of association can be altered by a special resolution and
no approvals are required from the Company Law Board or any other authority.
If a company commits an act in contravention of the memorandum of
association (e.g. a company having objects only to manufacture biscuits starts
activities of bottling of milk without proper amendments in the objects clause)
then the acts done and liabilities arising there from are not binding on the
company and the same cannot be ratified by the company.
If a company does something in contravention of the provisions of its articles of
association, it is only a procedural irregularity and the same can be ratified by
the shareholders at a general meeting and thus rectified.
58.5 LET US SUM UP
The memorandum of association and articles of association are the basic
constitutional documents of the company, which define the ambit of the
operations of the company.
58.6 CHECK YOUR PROGRESS
1. Indicate whether the following statement is True or False.
(i) In case of conflict between the memorandum of association and articles of
association, the articles of association prevail.
58.7 ANSWER TO CHECK YOUR PROGRESS'
1. (i) False.
UNIT
59
DOCTRINES OF ULTRA VIRES/ CONSTRUCTIVE NOTICE/INDOOR
MANAGEMENT
STRUCTURE
59.0 Objective
59.1 Introduction
59.2 Doctrine of Ultra Vires
59.3 Effects of Ultra Vires Transaction
59.4 Constructive Notice of Memorandum of Association and Articles of
Association
59.5 Effect of the Doctrine of Constructive Notice
59.6 Doctrine of Indoor Management
59.7 Let Us Sum Up
59.8 Check Your Progress
59.9 Answers to 'Check Your Progress' s
416
59.0 OBJECTIVE
The objective of this unit is to understand the implications of the doctrines of
ultra vires/constructive notice/indoor management which govern the
interpretation of the memorandum and articles of association.
59.1 INTRODUCTION
These three doctrines deal with the rights and duties of the company with respect
to the members, amongst the members, and of the company with the outsiders.
We now dwell upon the doctrines in detail as under:
59.2 DOCTRINE OF ULTRA VIRES
When a company exercises its powers to promote and/or realise any of its
objectives stated in the memorandum of association, it is intra;vires (i.e. within
the powers of) the company. However, any other act of the company which is
outside the scope of the objects clause of the memorandum of association is
known as ultra vires (i.e. beyond the powers of) the company.
The rule of law on the question of the doctrine of ultra vires has been clearly and
emphatically laid down by House of Lords in Ashbury Railway Carriage and
Iron Company vs Riche (1875) LR 7 HL 653, 671. The facts of the case are as
under:
Ashbury Company was incorporated with the objectives to manufacture and sell
railway carriages, etc., and to act as mechanical engineers and general
contractors. The directors of the company had contracted with Riche to finance
the construction of railway line in Belgium. Subsequently, the directors
repudiated the contract on the ground that it was ultra vires to the company and
Riche brought an action for damages for breach of contract.
The House of Lords held that the contract was ultra vires and therefore null and
void. It was laid down that the company came into existence for the achievement
of the objectives as stated in the objectives clause. These objectives
affirmatively state the activities that the company can undertake/carry and its
states negatively that nothing shall be done beyond the ambit of the objectives
for which the company is established. The term general contractors was meant to
be read as making such type of contracts generally that are connected with the
business of mechanical engineers and if it is not so interpreted then it would
authorise the making of contracts of every nature and description. Hence, it was
entirely beyond the powers of the company to enter into the contract.
59.3 EFFECTS OF ULTRA VIRES TRANSACTION
An ultra vires transaction is void ab initio and therefore cannot become intra
vires by reason of ratification. No company can be held liable for obligations
arising out of such a contact. If lending done by the company is ultra vires then
the company is entitled to recover the money from the debtors because the
debtors cannot say that the company had no power to lend. If the rendering of a
particular service by the company is ultra vires the company is entitled to
recover the charges for such services. If the property of the company is delivered
to an outsider through an ultra vires act, the company can get back the property
if such property can be traced.
Effects of Ultra Vires Acquired Property
If a company's money has been spent ultra vires in purchasing any property the
company is entitled to the ownership of such a property because that asset
though wrongly acquired represents the capital of the company.
417
Personal Liability of Directors
If a director of a company makes an ultra vires payment he is personally liable to
the company and he can be compelled to refund the money. In the case of
deliberate misapplication, criminal action can also be taken for fraud.
Breach of Authority
Directors are the agents of the company. Hence, they must act within the limits
of the powers of the company. If they induce (however innocently) an outsider
to contract with the company in a matter in which the company does not have
power to act, they will be personally liable to such an outsider for his loss
provided that the outsider had no knowledge of the fact that the act was ultra
vires the company.
59.4 CONSTRUCTIVE NOTICE OF MEMORANDUM ASSOCIATION
AND
ARTICLES OF ASSOCIATION
What is meant by constructive notice of the memorandum of association and
articles of association? The memorandum of association and articles of
association of a company are registered with the registrar of companies at the
time of incorporation. As the office of the registrar of companies is a public
office, the memorandum of association and articles of association become public
documents. Hence, the act expressly guarantees the right of inspection of these
documents to all. It is therefore the duty of every person who deals with a
company to inspect its public documents, i.e. its memorandum of association
and articles of association and make sure that his contract is in accordance with
their provisions. However, whether a person has actually read them or not he
shall be in the same position as if he had read them.
In other words, he will be presumed to have knowledge of the contents of these
documents and to have understood them according to their proper meaning. This
kind of presumed notice is known as constructive notice. This is known as the
doctrine of constructive notice.
59.5 EFFECT OF THE DOCTRINE OF CONSTRUCTIVE NOTICE
The following are the practical effects of the doctrine of constructive notice:
(a) He who deals with the company is deemed to have notice of the public
documents whether he has
actually seen them or not.
(b) Another effect is that a person dealing with the company is not only
deemed to have notice but is
also presumed to have read those documents and to have understood not only the
company's
powers but also of its officers.
(c) The doctrine of constructive notice is of a negative nature in the sense
that it stops a person from
contending (arguing) that he had no notice of the contents of the documents.
59.6 DOCTRINE OF INDOOR MANAGEMENT
The principle of constructive notice seeks to protect the company against the
outsiders whereas the doctrine of indoor management seeks to protect outsiders
against the company. The doctrine of indoor management may be stated briefly
as under:
A person who deals with the company is deemed to have read and understood
the registered public documents such as the memorandum of association and
articles of association, etc., to see that his contract with the company is not
inconsistent with them. But he is not bound to inquire into the regularity of the
company's internal functioning or the internal management of the company.
Hence if his contract is consistent with the public documents, the company is
bound. He will not be affected by
418
any irregularity in the internal management of the company. This is known as
the doctrine of indoor management.
The doctrine of indoor management was first illustrated in the case of Royal
British Bank vs Turquand
(1856) 6 E & B 327: (1843-60) All ER Rep 435. The facts of the case are as
under:
The directors of a company (Royal British Bank) borrowed a sum of money
from Turquand, and issued a bond to him. The articles of association of the
company provided that the directors might borrow on bonds such sums as may
be from time to time be expressly authorised by the resolution of the
shareholders. The shareholders claimed that there had been no such resolution
authorising the loan.
The company, however, was held bound by the loan because Turquand had the
right to assume that the necessary resolution must have been passed.
Exception
The doctrine of indoor management has the following exception:
Knowledge of internal irregularity
Where a person dealing with the company has actual knowledge of the internal
irregularity of the company he is not entitled to claim protection of this doctrine
because he could have taken measures for self-protection.
Acts outside apparent authority of an officer of company
Finally, if an officer of the company makes a contract with an outsider and if the
act of the officer falls outside the apparent authority of an officer, then the
company is not bound by such a contract.
59.7 LET US SUM UP
Doctrine of ultra vires lays down that a company cannot carry on the objects not
permitted by its memorandum of association. Doctrine of constructive notice
states that every outsider is assumed to have read the memorandum of
association and articles of association. Doctrine of indoor management lays
down that the outsiders are not required to see the compliance of internal
regulations of the company.
59.8 CHECK YOUR PROGRESS
1. State whether the following statements are True or False.
(i) Doctrine of ultra vires lays down that every outsider is assumed to have read
the memorandum
of association and articles of association, (ii) Doctrine of constructive notice
states that the outsiders are not required to see the compliance
of internal regulations of the company.
(iii) Doctrine of indoor management lays down that a company cannot carry on
the objects not permitted by its memorandum of association.
59.9 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (i) False; (ii) False; (iii) False.
MEMBERSHIP
STRUCTURE
60.0 Objective
60.1 Introduction
60.2 Who is a Member of a Company?
60.3 Various Modes of Becoming Member of a Company
60.4 Who can be Members of a Company?
60.5 Cessation of Membership in a Company
60.6 Register of Members
60.7 Place of Keeping and Inspection of Register of Members
60.8 Rights and Duties (Liabilities) of Members of a Company
60.9 Rights of Embers
60.10 Let Us Sum Up
60.11 Check Your Progress
60.12 Answers to 'Check Your Progress'
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60.0 OBJECTIVE
The objectives of this unit, are to understand the concept of membership in a
company, who can be a member in a company and what are the rights of a
member of a company.
60.1 INTRODUCTION
The words member and shareholder have been used interchangeably in the
Companies Act, 1956 and generally speaking, except for a few cases they are
synonymous, e.g. in the case of companies having no share capital there are
members but not shareholders.
60.2 WHO IS A MEMBER OF A COMPANY?
According to the Companies Act, 1956 the term member of a company means:
• The subscribers of the memorandum of association.
• Every other person who agrees in writing to become a member of a
company and whose name is
entered in its register of members.
• Every person holding equity share capital of a company and whose
name is entered as beneficial
owner in the records of the depository shall be deemed to be a member of the
concerned company.
60.3 VARIOUS MODES OF BECOMING A MEMBER OF A COMPANY
(a) By Subscribing to Memorandum of Association: The Companies Act,
1956 provides that a
subscriber of the memorandum of association shall be deemed to have agreed to
become a member
of the company. Hence on registration of the company he shall be entered as
member of the
company in its register of members. It may noted that a subscriber of the
memorandum of association
is deemed to have agreed to become a member of the company and neither
application form nor
allotment of shares is necessary.
(b) Membership by Allotment of Shares: A person may become a
shareholder if he agrees to take
shares in the company by allotment. What is allotment? Broadly speaking the
term allotment means
an appropriation by directors of shares to a particular person.
(c) Transfer of Shares: If a person buys shares of a company in the open
market and then applies to
the company to register him as a member he becomes a member on registration
of his name.
(d) Transmission of Shares: On a death of a member, if the member has not
made a nomination for
the shares then the surviving joint holder (if any) or his legal representatives
have the right to
register themselves as members.
(e) Membership by Acquiescence: A person is deemed to become a member
of a company if he
allows his name to be put on the register of the members or otherwise holds
himself out as a
member even if there is no agreement to become a member.
(f) Joint Membership: When two or more persons hold shares in a company
in their joint names, it
is called a joint membership. In such a case the name of the member appearing
first is considered
to be the main member for the purpose of sending notices, dividend, etc.
However, they all shall be
treated as a single member.
60.4 WHO CAN BE MEMBERS OF A COMPANY?
(a) Any Person competent to contract: The Companies Act, 1956 has not
prescribed any qualifications for acquiring membership of a company. Hence,
every person who is competent to contract can become a member of a company.
It therefore follows that a person who is incapable of entering into a contract
cannot be a member.
—_„ 421
(b) Minor and persons of unsound mind: Under the Indian Contract Act,
1872 minors and persons
of unsound mind are incompetent at law to contract. Hence such persons cannot
become members
of a company.
A minor therefore cannot apply for and be a member of a company. However, if
a minor has by mistake been recorded as a member of the company, the
company and the minor have a right to rescind the transaction and remove the
name from the register of members. However, if a minor has been allotted shares
and his name is entered into the register of members he incurs no liability during
minority.
(c) Company as a member: As a company is a legal person it can become a
member of another
company provided it is so authorised by its memorandum of association. A
company cannot buy
its own shares and become a member of itself.
(d) Partnership firm: Since a partnership firm is not a legal person it cannot
buy any shares in its
own name and thus become a member of a company. The shares have to bought
only in the name
of the individual partners of the partnership firm even though such shares
constitute a part of the
assets of the partnership firm.
(e) Registered society: A society registered under the Societies Registration
Act, 1860 can hold
shares in a company.
(f) Non-residents: A non-resident cannot become a member of a company
without complying with
the requirements of the Foreign Exchange Management Act, 1999 and the
regulations made there
under that inter-alia stipulate the permission of the Reserve Bank of India.
(g) Fictitious Persons: The Companies Act, 1956 provides that any person
who:
(a) makes in a fictitious name an application to a company for acquiring or
subscribing shares
therein, or
(b) otherwise induces a company to allot, or register any transfer of shares
to him or any other
person in a fictitious name, shall be punishable with imprisonment for a term
which may
extend to five years.
60.5 CESSATION OF MEMBERSHIP IN A COMPANY
The membership in a company ceases in case of any of the following:
1. If a member transfers his shares to another person.
2. If a member's shares are forfeited.
3. If the shares are sold pursuant to a decree of a Court.
4. If the member surrenders his shares to the company where such
surrender is permitted.
5. If he rescinds the contract to take the shares, e.g. on the ground of
misrepresentation in the
prospectus.
6. If a member is adjudicated insolvent (shares and other properties of an
insolvent vest in the Official
Receiver or Assignee).
7. On the death of a member: However, the estate of the deceased member,
remains liable until the
shares are registered in the name of his legal representative.
8. If redeemable preference shares are redeemed.
9. If the company is being wound up. In such a case a member remains
liable as a contributor and is
also entitled to share in the surplus assets, if any.
60.6 REGISTER OF MEMBERS
The Companies Act, 1956 provides that every company shall keep a register of
its members and enter
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(a) the name and address, and the occupation, if any, of each member;
(b) in the case of a company having a share capital, the shares held by each
member, distinguishing
each share by its number except where such shares are held with a depository
and the amount
paid or agreed to be considered as paid on those shares;
(c) the date at which each person was entered in the register as a member;
and
(d) the date at which any person ceased to be a member.
A company may, after giving not less than seven days previous notice by
advertisement in some newspaper circulating in the district in which the
registered office of the company is situated, close the register of members or the
register of debenture holders for any period not exceeding in the aggregate forty-
five days in each year, but not exceeding thirty days at any one time.
60.7 PLACE OF KEEPING AND INSPECTION OF REGISTER OF
MEMBERS
The register of members is to be kept at the registered office of the company. It
may be kept at any other place within the city, town or village in which the
registered office is situated, if
(i) such other place has been approved for this purpose by a special resolution
passed by the
company in general meeting, and (ii) the Registrar of Companies has been given
in advance a copy of the proposed special resolution.
The registers are to be open during business hours to the inspection of any
member or debenture
holder without fee. Any other person has to pay a fee. Any such member,
debenture holder or
other person may make extracts from any register.
60.8 RIGHTS AND DUTIES (LIABILITIES) OF MEMBERS OF A
COMPANY
The liability of a member of a company depends upon the nature of the
company.
(a) Unlimited Liability Company: The member is liable in full for all the
debts of the company
contracted during the period of his membership.
(b) Company Limited by Guarantee: The member is liable to contribute a
sum of money agreed
and specified in the liability clause of memorandum of association in the event
of being wound up.
(c) Company Limited by Shares: The member is liable to pay the full
nominal value of the shares
and the liability of the member ends there. However, if the member has paid
only a part of the
amount of the shares then his liability is limited to the unpaid amount on the
shares in respect of
which he is a member.
60.9 RIGHTS OF MEMBERS
(a) Statutory Rights: These are the rights conferred by the Companies Act, 1956.
These rights cannot be taken away or modified by the memorandum of
association or the articles of association. Some of the statutory rights available to
members under the Companies Act, 1956 are as under:
1. Priority to have new shares offered, in case the company proposes to
increase capital.
2. To receive notice of meetings, attend and vote at meetings.
3. Transfer shares.
4. Receive copies of annual accounts of the company.
5. To inspect the register of members, register of debenture holders and
copies of annual returns.
6. To apply to the CLB to call annual general meeting if the board of
directors fails to call such a
meeting.
7. To convene an extraordinary general meeting of the company.
8. Appoint the directors and auditors at the general meetings of the
company.
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9. To approach the CLB to order an investigation into the affairs of the
company. 10. To file a petition to the High Court to order the winding up of the
company.
(b) Documentary Rights: These rights are conferred upon the members by
the memorandum of
association and the articles of association of the company.
(c) Proprietary Rights:
(a) To be registered as a member in the company's register of members,
(subject to a valid
membership obtained by transfer, allotment, etc.)
(b) No personal liability of a company's debts.
(c) To receive dividends (if declared by the board of directors and approved
by the members at
AGM).
(d) To participate in the distribution of assets in case of liquidation of the
company.
60.10 LET US SUM UP
Any person competent to contract can be a member of a company. There are
various modes by which a person can acquire membership in a company.
60.10 CHECK YOUR PROGRESS
1. Indicate whether the following statements are True or False.
(i) A minor can be a member of a private company but not of a public company,
(ii) A member can inspect the register of members.
60.11 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (i) False; (ii) True.
PROSPECTUS
L
STRUCTURE
61.0 Objective
61.1 Introduction
61.2 What is a Prospectus?
61.3 Compliance with Respect to Prospectus
61.4 Misstatements in a Prospectus and Remedies
61.5 Let Us Sum Up
61.6 Check Your Progress
61.7 Answers to 'Check Your Progress'
426
61.0 OBJECTIVE
The objective of this unit is to understand the meaning and implications of
misstatements in the prospectus and the liabilities of the company, the promoters
and the directors for such misstatements.
61.1 INTRODUCTION
As explained in the previous units, a public company can raise funds for its
business from the public by issuing a document known as the prospectus. This
document has to contain all the material disclosures as required under the
Companies Act, 1956.
61.2 WHAT IS A PROSPECTUS?
The Companies Act, 1956 defines a prospectus as any document described or
issued as a prospectus and includes any notice, circular, advertisement or other
document inviting deposits from the public or inviting offers from the public for
the subscription or purchase of any shares in, or debentures of a body corporate.
Hence, put in plain words, prospectus means a document by which a company
solicits funds from the public for its capital either by way of shares, debentures
or deposits.
It is very clear that private companies cannot issue a prospectus to raise funds
from the public. It is prohibited under the articles of association of the company.
It is necessarily the public companies who issue the prospectus.
In the following cases even though shares are offered to the public, issue of
prospectus is not required:
(a) When a person is invited to enter into an underwriting
agreement/arrangement to purchase/subscribe
the shares.
(b) When the shares are offered only to the existing shareholders or
debenture-holders of the company.
(c) When the shares or debentures offered are in all respect uniform with
the shares or debentures
previously issued and listed on a recognised stock exchange.
61.3 COMPLIANCE WITH RESPECT TO PROSPECTUS
(a) Time of issue of Prospectus: A prospectus can be issued only after the
incorporation of the
company.
(b) Contents of the Prospectus: Section 56 read with Schedule II of the
Companies Act, 1956
stipulates the mandatory provisions that are to be stated in the prospectus.
(c) Date of publication: Section 55 states that a prospectus must be dated
and this ensures a prima
facie evidence of the date of its publication.
(d) Signature of every director on the Prospectus: A prospectus must be
signed by every person
mentioned therein as a director or proposed to be a director.
(d) Application form with a Prospectus: Every application form for shares must
be accompanied by a copy of the prospectus except for the application forms
issued to underwriters and existing shareholders and debenture holders.
(f) Statements by expert in Prospectus: A prospectus including a statement
purporting to be made by an expert cannot be issued unless he has given his
written consent to the issue thereof and he has not withdrawn such consent
before the delivery of a copy of the prospectus for registration to the Registrar of
Companies and a statement that he has given and has not withdrawn his consent
as aforesaid appears in the prospectus. The expert must not be engaged or
interested in the formation, promotion or in the management of the company.
)
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(g) Registration of the Prospectus: Before the issue of a prospectus the same
must be delivered to the Registrar of Companies for registration with the
documents which are stipulated under the Companies Act, 1956, e.g. the consent
of the expert, copy of contracts relating to appointment and remuneration of the
managerial personnel, etc.
61.4 MISSTATEMENTS IN A PROSPECTUS AND REMEDIES
A person who has been induced to subscribe for shares or debentures on the faith
of a statement in a prospectus which is untrue has a two fold remedy:
1. Remedy against the company
2. Remedy against the promoters and experts who were responsible for (or
associated with) the issue
of the prospectus. The liability can be civil or criminal.
Civil Liability
Remedies against the Company
If there are untrue statements or mis-statements or omissions in a prospectus
which have induced any shareholder or debenture holder to buy shares or
debentures respectively, the person has two fold remedies:
1. rescind the contract
2. claim damages from the company whether the statement is a fraudulent
one or innocent one.
Remedies against the promoters and experts, who were responsible for or
associated with the issue of the prospectus.
A suit for damages can be filed for misstatements in the prospectus against the
promoters and experts who were responsible for or associated with the issue of
the prospectus.
Criminal Liability
Section 56 requires certain matters and reports must be stated in the prospectus.
Failure to do so will render the director or any other person responsible for the
issue of such prospectus to be punished with fine.
Section 63 provides that if prospectus contains an untrue statement, every person
who is responsible for the untrue statement in the prospectus shall be punishable
with a fine or imprisonment or with both.
61.5 LET US SUM UP
A public company raises funds from the public by issuing a prospectus. The
company, the promoters and the directors of the company have certain liabilities
for any wrongful statements that may be included in the prospectus on the basis
of which the public invests funds into the company by way of subscribing to the
shares and/or debentures of the company.
61.6 CHECK YOUR PROGRESS
1. Indicate whether the following statement is True or False.
(i) There are no remedies available for misstatements in prospectus by directors.
61.7 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (i) False
UNIT
62
DIRECTORS
STRUCTURE
62.0 Objective
62.1 Introduction
62.2 Minimum Number of Directors
62.3 Subscribers of Memorandum Deemed to be Directors
62.4 Appointment of Directors and Proportion of Those who are to Retire by
Rotation
62.5 Ascertainment of Directors Retiring by Rotation and Filing of Vacancies
62.6 Right of Persons Other than Retiring Directors to Stand for Directorship
62.7 Maximum Number of Directors
62.8 Additional Directors
62.9 Filling of Casual Vacancies among Directors
62.10 Separate Resolutions are required to Appoint Every Director in a
Meeting
62.11 Consent to the Company
62.12 Consent to Registrar of Companies
62.13 Whole-time Director
62.14 Qualification Shares
62.15 Maximum Number of Directorships
62.16 Vacation of Office by Directors
62.17 Certain Powers can be exercised Only at Meetings of the Board
62.18 Restrictions on Powers of Board
62.19 Loan to Director
62.20 Contracts in which Directors are Interested
62.21 Alternate Director
62.22 Compensation for Loss of Office
62.23 Let Us Sum Up
62.24 Keywords
62.25 Check Your Progress
62.26 Answers to 'Check Your Progress'
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62.0 OBJECTIVE
To have an overview of the legal provisions of the Companies Act, 1956 relating
to the requirement, appointment and removal of directors in a company.
62.1 INTRODUCTION
The ownership of a company is with the shareholders who are scattered all over
and due to free transferability of shares, the shareholders keep on changing quite
frequently. In such a scenario, the management of the company needs to be
entrusted with a professional body, i.e., the board of directors. The ownership
and management of the company is thus bifurcated. The board of directors
control the day-to-day working and management of the company as well the
long-term strategic planning of the company. No body corporate, association or
firm can be appointed as director of a company, and only an individual can be
appointed. The important provisions of the Companies Act, 1956 pertaining to
directors are discussed hereunder.
62.2 MINIMUM NUMBER OF DIRECTORS
Every public company must have at least three directors. A public company
having
(a) a paid-up capital of Rs. 5 crore or more;
(b) one thousand or more small shareholders can elect a director from small
shareholders. Small
shareholders mean a shareholder holding shares of nominal value of Rs. twenty
thousand rupees
or less. A private company must have at least two directors. As per the latest
directives of SEBI,
all listed companies should have at least 50 per cent of their Directors as
independent directors.
Further the boards should follow the criteria of 'fit and proper' while appointing
the Directors.
62.3 SUBSCRIBERS OF MEMORANDUM DEEMED TO BE
DIRECTORS
Subscribers of the memorandum, who are individuals, are deemed to be the
directors of the company, until the directors are duly appointed in accordance
with the Act.
62.4 APPOINTMENT OF DIRECTORS AND PROPORTION OF THOSE
WHO
ARE TO RETIRE BY ROTATION
Unless the articles provide for the retirement of all directors at every annual
general meeting, at least two-thirds of the total number of directors of a public
company, or of a private company which is a subsidiary of a public company,
have to be
(a) Persons whose period of office is liable to determination by retirement
by rotation;
(b) Appointment by the company in general meeting.
The remaining directors are to be appointed in the general meeting subject to the
provisions of the articles of association.
62.5 ASCERTAINMENT OF DIRECTORS RETIRING BY ROTATION
AND
FILLING OF VACANCIES
The directors who are to retire by rotation at every annual general meeting are
those who have been longest in office since their last appointment, but as
between persons who became directors on the same day, those who are to retire
is to be determined by lots (unless there is an agreement between them that who
would retire). The retiring director can also be reappointed.
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62.6 RIGHT OF PERSONS OTHER THAN FOR DIRECTORSHIP
RETIRING DIRECTORS TO STAND
Any person is eligible for appointment to the office of director at any general
meeting, if not less than fourteen days before the meeting he himself or some
other member intends to propose that person as a director gives a signed notice
in writing to the company signifying that person's candidature for the office of
director along with a deposit of Rs. five hundred.
The deposit is refunded to such a person or to the member (whoever had given
the notice and paid the deposit) if that person is elected as a director.
62.7 MAXIMUM NUMBER OF DIRECTORS
A company can have a maximum number of twelve directors and to increase this
number, the approval of Central Government is required.
62.8 ADDITIONAL DIRECTORS
The board of directors can appoint directors by passing a resolution if such a
power exists in the articles. Such directors are known as additional directors and
they hold office only up to the date of the next annual general meeting of the
company.
62.9 FILLING OF CASUAL VACANCIES AMONG DIRECTORS
In the case of a public company or a private company, which is a subsidiary of a
public company, if there arises any vacancy in office of any director (other than
by expiry of term of office) then subject to the articles, the board of directors can
fill the vacancy at a meeting of the board. Such a director can hold office only up
to the date up to which the director in whose place he is appointed would have
held office if he had continued as a director.
62.10 SEPARATE RESOLUTIONS ARE REQUIRED TO APPOINT
EVERY
DIRECTOR IN A MEETING
One single resolution can appoint one director only and not two or more, e.g., to
appoint as directors A and B in the same meeting, two different resolutions are
to be passed.
62.11 CONSENT TO THE COMPANY
In case of every public company and every private company which is subsidiary
company of a public company.
Every person proposed as a candidate for the office of a director must sign, and
furnish to the company, his consent in writing to act as a director. This does not
apply to a director retiring by rotation or otherwise or a person who has left at
the office of the company a notice under Section 257 signifying his candidature
for the office of a director.
62.12 CONSENT TO REGISTRAR OF COMPANIES
A person cannot act as a director unless he/she, within thirty days of his
appointment, signs and files with the Registrar his consent to act as a director.
This does not apply to the following directors:
(a) A director reappointed (after retirement by rotation) or (immediately on the
expiry of his term of office).
432
(b) An additional or alternate director, or a person filling a casual vacancy
reappointed as director, on
the expiry of his term of office).
(c) A person named as a director of the company under its articles as first
registered.
62.13 WHOLE-TIME DIRECTOR
Every public company, or a private company which is a subsidiary of a public
company, having a paid-up share capital of Rupees five crore must have a
Managing or Whole-time Director or a Manager, (under the entire Companies
Act, 1956 the term manager does not mean a manager as we understand it
normally like assistant manager/deputy manager/senior manager/chief manager).
Manager under the Companies Act, 1956 means a person having substantial
powers of the management of the company and one who is in control of the
entire affairs of the company under the supervision of the board.
62.14 QUALIFICATION SHARES
A director is required to hold certain shares as qualification shares if such
requirement is there in the articles of association of the company. This
requirement is not applicable to a private company, unless it is a subsidiary of a
public company.
There are certain disqualifications under which a person shall not be capable of
being appointed director of a company; e.g., he has been found to be of unsound
mind by a Court or he is an undischarged insolvent or he has been convicted by
a Court of any offence involving moral turpitude and sentenced in respect
thereof to imprisonment, he has not paid the call money on his shares.
62.15 MAXIMUM NUMBER OF DIRECTORSHIPS
A person cannot be a director of more than fifteen companies (excluding a
private company, an unlimited company, an association not carrying on business
for profit or which prohibits the payment of a dividend, alternate directorships).
62.16 VACATION OF OFFICE BY DIRECTORS
The office of a director becomes automatically vacant (i.e., his directorship
ceases) if
(a) he fails to obtain qualification shares within six months of his becoming
a director in the Company,
if qualification shares were essential as per the articles of association.
(b) he is found to be of unsound mind by a Court;
(c) he applies to be adjudicated an insolvent;
(d) he is adjudged an insolvent;
(e) he is convicted by a Court of any offence involving moral turpitude and
sentenced to imprisonment;
(f) he fails to pay any call in respect of shares;
(g) he absents himself from three consecutive meetings of the board of
directors, or from all meetings
of the board for a continuous period of three months, whichever is longer,
without obtaining leave
of absence from the board;
(h) he acts in contravention of Section 295 (loan to directors) or Section 299
(disclosures of interest
by directors); (i) he is removed by the shareholders by resolution passed in a
general meeting.
A company can remove a director even before the expiry of his period of office
(not being a director appointed by the Central Government) by passing ordinary
resolution.
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62.17 CERTAIN POWERS CAN BE EXERCISED ONLY AT
MEETINGS OF THE BOARD
The board of directors have the general powers to do all the acts on behalf of the
company but certain powers can be exercised only at meetings of the board and
not by circulating papers amongst the directors and passing the resolution by
such circulation. These are some significant matters which need deliberations
and discussions. These are the powers to
(a) make calls on shareholders in respect of money unpaid on their shares;
(b) issue debentures;
(c) borrow moneys otherwise than on debentures;
(d) invest the funds of the company;
(e) make loans; and
(f) authorise a particular buyback as stated in Section 77 A.
62.18 RESTRICTIONS ON POWERS OF BOARD
The board of directors of a public company, or of a private company which is a
subsidiary of a public company can exercise the following powers only after a
resolution is passed to that effect by the shareholders of the company in general
meeting:
(a) dispose of any undertaking of the company;
(b) remit, or give time for the repayment of, any debt due by a director
(except in the case of renewal
or continuance of an advance made by a banking company to its director in the
ordinary course of
business);
(c) invest, otherwise than in trust securities, the amount of compensation
received by the company in
respect of the compulsory acquisition;
(d) borrow moneys in excess of aggregate of the paid-up capital of the
company and its free reserves;
(e) contribute to charitable and other funds not directly relating to the
business of the company or the
welfare of its employees an amount more than Rs. fifty thousand or five per cent
of its average net
profits during the three immediately preceding, financial years whichever is
greater.
62.19 LOAN TO DIRECTOR
A public company requires the previous approval of the Central Government to
give any loan to its director (and certain other related partnership firms and
private companies) or to give any guarantee or security to any person for any
loan given to the director or the related parties. This is to ensure that the board of
directors of a public company does not misuse the funds of the company for the
benefit of its directors.
62.20 CONTRACTS IN WHICH DIRECTORS ARE INTERESTED
Also when any company enters into contracts relating to the business of the
company with the directors (or) private companies in which the directors are
members/directors (or) partnership firms in which the directors are partners, the
consent of the board of directors is required by way of a resolution. If the paid-
up capital of the company is Rs. one crore or more then the approval of Central
Government is also required. Every director of a company who is interested in a
contract to be entered into by the company has to disclose the nature of his
concern or interest at a meeting of the board of directors. Interest means say for
example that the company is going to purchase its raw materials from a
partnership firm in which he is a partner. Hence he becomes interested in the
contract as a director of the company
434
and he can influence the price to be paid to the partnership firm. Such interested
director cannot participate or vote for decision by resolution and in the
discussions on such matters in which he is interested.
62.21 ALTERNATE DIRECTOR
The board of directors can appoint an alternate director to act for a director ('the
original director') during the original director's absence for a period of not less
than three months from the state in which meetings of the board are ordinarily
held if the articles or a shareholders resolution have authorised the directors to
make such appointments. The alternate director vacates the office when the
original director returns or when the term of office of the original director
expires (whichever is earlier).
62.22 COMPENSATION FOR LOSS OF OFFICE
Managing or whole-time directors or directors who are managers and eligible for
compensation for loss of office if they are removed from directorships except in
cases like when they were guilty of fraud, etc., or the removal is consequent to
some amalgamations of the company, etc. No compensation is payable on a take
over of management under the Securitisation Act. Similarly there is no
compensation under Section 10A of Banking Regulation Act.
For the academic interests of the students, we have summarised a case law,
which highlights the jurisdiction of a Company Law Court vis-a-vis a Debt
Recovery Tribunal (DRT).
A. Adjudication under the DRT Act is exclusive and jurisdiction of Civil
Court and Company Court is
ousted.
B. DRT proceedings cannot be stayed by the Company Court nor
proceedings can be transferred to
the Company Court.
C. DRT Act overrides the Company act.
D. In respect of money realised under DRT Act for distribution between
Bank/FIs and other creditors,
when no winding up order is passed against the company, priorities to be
decided subject to the
principles underlying the Section 73 of CPC and principles of natural justice.
(Section 73 of CPC
mentions about the rateable distribution of sale proceeds of execution among the
decree holders.)
E. Moneys realised under the DRT Act, distribution between bank and
other secured creditors, when
winding up proceedings are pending in the Company Court, priority of secured
creditors is subject
to provisions of the Section 529A of Companies Act (the said section mentions
about the priority
of secured creditors and workman over other dues and distribution inter se
between secured
creditors and workman should be pari passu).
F. DRT is a special law, it overrides the Company Law. Levee of Company
Court under the Section
446 is not necessary nor could the suit be transferred to the Company Court
under the Section
446.
62.23 LET US SUM UP
The ownership of a company is diversified from the management of the
company. The ownership of a company is with the members of the company.
The management of the company is with the board of directors elected by the
members of the company.
62.24 KEYWORDS >
Liquidation; Perpetual; Ultra Vires; Intra Vires; Ratification; Approval of the
Underwriter; Underwriting Agreement, —
435
10t : is
r') ch he or
or of m >n
62.25 CHECK YOUR PROGRESS
1. Fill in the blanks from the options given in the brackets.
_. (3/7/12/15)
. (3/7/12/15)
_. (3/7/12/2)
(3/7/12/2)
(i) The maximum number of directors in a private company can be (ii) The
maximum number of directors in a public company can be _
(iii) The minimum number of directors required in a public company is
(iv) The minimum number of directors required in a private company is
(v) At least of the total number of directors of a public company are to be
persons
whose period of office is liable to determination by retirement by rotation.
(2/3/7/two-third) (vi) Every public company, or a private company which is a
subsidiary of a public company,
having a paid-up share capital of Rupees must have a managing or whole-time
director or a manager, (five crore/five lakh/one crore/one lakh)
(vii) Additional directors are appointed by the (board of directors/promoters/
underwriters/shareholders)
(viii) Alternate directors are appointed by the (board of directors/promoters/
underwriters/shareholders)
(ix) Casual vacancies in the board of directors is filled in by the (board of
directors/
promoters/underwriters/shareholders)
62.26 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (i) 12; (ii) 12; (iii) 3; (iv) 2; (v) two-third; (vi) five crore; (vii) board of
directors; (viii) board of directors; (ix) board of directors
FOREIGN EXCHANGE MANAGEMENT ACT, 1999
STRUCTURE
63.0 Objective
63.1 Introduction
63.2 Meaning of Certain Important Terms Used in FEMA
63.3 Regulation and Management of Foreign Exchange
63.4 Powers of RBI with Respect to Authorised Persons
63.5 Contravention, Penalties, Adjudication and Appeals
63.6 Directorate of Enforcement
63.7 Check Your Progress
63.8 Answers to 'Check Your Progress'
438
63.0 OBJECTIVE
This unit aims to show the broad structure of the Foreign Exchange Management
Act, 1999 which is enacted to regulate foreign exchange transactions in India.
By a reading of this unit, it would be clear that the FEMA does not specify the
details of each and every procedure and matter concerning the regulation of
foreign exchange. The RBI and the Central Government frame various rules,
regulations and issue directions and orders under the FEMA for the actual
implementation of the check on foreign exchange transactions.
63.1 INTRODUCTION
The main objective of the Foreign Exchange Regulation Act, 1973 (FERA), was
to consolidate and amend the law; regulate certain payments; dealings in foreign
exchange and securities; transactions, indirectly affecting foreign exchange; the
import and export of currency, for the conservation of the foreign exchange
resources of the country; and finally, the proper utilisation of this foreign
exchange so as to promote the economic development of the country. The FERA
has since been repealed.
The object of enacting the Foreign Exchange Management Act, 1999 (FEMA) is
to consolidate and amend the law relating to foreign exchange with the objective
of facilitating external trade and payments and for promoting the orderly
development and maintenance of foreign exchange market in India.
The provisions of the FEMA extends to all over India and also applies to all
branches, offices and agencies outside India owned or controlled by a person
resident in India and also to any contravention committed outside India by any
such person to whom this Act applies.
63.2 MEANING OF CERTAIN IMPORTANT TERMS USED IN FEMA
'Authorised person' means any bank or other person including authorised money
changer or dealer, authorised under the FEMA to deal in foreign exchange or
securities.
'Capital account transaction' means a transaction by which there may be a
change (either an increase or decrease) in the assets or liabilities outside India of
persons resident in India or assets or liabilities in India of persons resident
outside India.
'Current account transaction' means a transaction other than a capital account
transaction. For example,
(i) payments due with respect to the foreign trade done, other business, services,
and short-term
banking and credit facilities in the ordinary course of business; (ii) payments due
as interest on loans and as income from investments; (iii) remittances for living
expenses of parents, spouse and children residing abroad; and (iv) expenses in
connection with foreign travel, education and medical care of parents, spouse
and children.
'Currency' is defined under the FEMA not only to include all currency notes but
also postal notes, postal orders, money orders, cheques, drafts, travellers'
cheques, letters of credit, bills of exchange and promissory notes, credit cards or
such other similar instruments as may be notified by the RBI.
'Foreign currency' is defined to mean any currency other than Indian currency.
•The term 'foreign exchange' is much wider than the term foreign currency. In
addition to the foreign currency, it includes the following:
(i) amounts payable in any foreign currency;
(ii) drafts, travellers' cheques, letters of credit or bills of exchange, expressed or
drawn in Indian currency but payable in any foreign currency;
439
(iii) drafts, travellers cheques, letters of credit or bills of exchange drawn by
banks, institutions or persons outside India, but payable in Indian currency.
Under the FEMA 'security' is defined to include shares, stocks, bonds and
debentures, Government securities, savings certificates, deposit receipts and
units of any mutual fund etc. However, it does not include bills of exchange or
promissory notes other than Government promissory notes or any other
instruments which may be notified by the RBI.
Under the FEMA, the term 'foreign security' means any security as stated above.
Under the FEMA a 'person' is defined to include the following entities:
(i) an individual;
(ii) a Hindu Undivided Family;
(iii) a company;
(iv) a firm;
(v) an association of persons or a body of individuals, whether incorporated
or not;
(vi) every artificial juridical person; and
(vii) any agency, office or branch owned or controlled by such person.
'Person resident in India' means the following:
(i) a person residing in India for more than one hundred and eighty-two days in
the preceding financial year but does not include
(A) a person who has gone out of India or who stays outside India:
(a) for taking up employment outside India, or
(b) for carrying on a business or vocation outside India, or
(c) for any other purpose, in such circumstances as would indicate his
intention to stay
outside India for an uncertain period;
(B) a person who has come to India or stay in India, otherwise than:
(a) for taking up employment in India, or
(b) for carrying on a business or vocation in India; or
(c) for any other purpose, in such circumstances as would indicate his
intention to stay in
India for an uncertain period;
(ii) any person or body corporate registered or incorporated in India;
(iii) an office, branch or agency in India owned or controlled by a person
resident outside India;
(iv) an office, branch or agency outside India owned or controlled by a person
resident in India.
Accordingly, a 'person resident outside India' means a person who is not resident
in India as above.
'Repatriate to India' means bringing into India, foreign exchange and selling it to
an authorised person in India in exchange for rupees.
63.3 REGULATION AND MANAGEMENT OF FOREIGN EXCHANGE
Any person who wants to carry out the following activities has to do so in
accordance with the provisions of the FEMA. At times if the FEMA prescribes
approval of the RBI, it has to be obtained.
(a) deal/transfer any foreign exchange or foreign security to any person
other than an authorised
person;
(b) make any payment to any person resident outside India;
(c) receive (otherwise through an authorised person) any payment on behalf
of any person resident
outside India.
(d) enter into any financial transaction in India in relation to a right to
acquire any asset outside India
by any person.
440
A person resident in India can hold, own, transfer or invest in foreign currency,
foreign security or any immoveable property situated outside India if it was
acquired, held or owned by such person when he was resident outside India,
There is no bar on a person resident outside India to hold, own, transfer or invest
in foreign currency, foreign security or any immoveable property situated
outside India.
Every exporter of goods and services has to furnish the necessary data by way of
a declaration to the RBI. Such export proceeds cannot be held in foreign
countries and has to be repatriated to India. Non-repatriation is a violation of the
provisions of the FEMA.
63.4 POWERS OF RBI WITH RESPECT TO AUTHORISED PERSONS
RBI has the following powers under FEMA:
1. To appoint authorised persons: The said authorised persons are
authorised to deal in foreign
exchange. The person so appointed shall work under the direction of the RBI
and shall have to
comply with the rules and regulations so framed or formulated by the RBI from
time to time for
this purpose.
2. To inspect the authorised persons: So appointed to ensure that the said
person complies with all
the rules and regulations so formulated by the RBI from time to time.
63.5 CONTRAVENTION, PENALTIES, ADJUDICATION AND
APPEALS
Under the FEMA any violation of the provisions of the said Act will attract
penal provisions including the right of arrest and detention.
Like any other statutes there exists the right of appeal. The first of such appeals
shall be with the special director (Appeals). Thereafter if someone is aggrieved
by the said appellate order they can prefer an appeal against the order before the
appellate tribunals established for this purpose. Wherein questions of law are
involved and need to be interpreted, an appeal lies to the High Court. Only
questions of law are referred to the High Courts and thereafter to the Supreme
Court.
Penalty can be levied up to thrice the sum involved in such contravention where
such amount is quantifiable, or up to Rs. two lakh where the amount is not
quantifiable, and where such contravention is a continuing one, further penalty
which may extend to Rs. five thousand for every day after the first day during
which the contravention continues.
63.6 DIRECTORATE OF ENFORCEMENT
The Central Government establishes a directorate of enforcement with a director
and other officers, called officers of enforcement.
Power of Search, Seizure, etc.
The director of enforcement and other officers of enforcement, not below the
rank of an assistant director can investigate contraventions.
The Central Government can also authorise any class of officers in the Central
Government, State Government or the RBI to investigate contraventions.
Empowering Other Officers
The Central Government can (subject to conditions and limitations), authorise
any customs officer/ central excise officer/any police officer/any other officer of
the Central Government or a State
441
Government to exercise the powers and discharge the duties of the director of
enforcement or any other officer of enforcement.
63.7 CHECK YOUR PROGRESS
1. State whether the following statements are True or False.
(i) Authorised person is an individual appointed by the RBI to deal in foreign
exchange.
(ii) A current account transaction alters the assets or liabilities outside India of
persons resident
in India, (iii) A capital account transaction includes payments due in connection
with foreign trade in the
ordinary course of business, (iv) Foreign exchange includes traveller's cheques,
(v) RBI can revoke any authorisation given to an authorised person, (vi) Civil
Court has the jurisdiction to entertain any suit or proceeding in respect of any
matter
under the FEMA.
63.8 ANSWERS TO CHECK YOUR PROGRESS'
1. (i) False; (ii) False; (iii) False; (iv) True; (v) True; (vi) False;
UNIT
64
TRANSFER OF PROPERTY ACT, 1882
STRUCTURE
64.0 Objective
64.1 Introduction
64.2 Sale of Immoveable Property
64.3 Mortgage of Immoveable Property
64.4 Types of Mortgage
64.5 Sale without Court Intervention
64.6 Enforcement of Mortgages through Court
64.7 Leases of Immoveable Property
64.8 Enforcement of Mortgages through Court
64.9 Actionable Claims
64.10 Check Your Progress
64.11 Answers to 'Check Your Progress'
444
IKING
64.0 OBJECTIVE
We have seen that the transactions relating to moveable goods and the rights and
liabilities of the parties in a contract for the sale of moveable goods are stated in
the Sale of Goods Act. Sale of Goods Act does not cover transactions of
immoveable property. The objective of this unit is to learn briefly the aspects of
the transactions of immoveable property as contained in the Transfer of Property
Act which concerns a banker, i.e., sale, mortgage, lease and actionable claims.
64.1 INTRODUCTION
Transfer of property means an act by which a living person conveys property, in
present or in future, to one or more other living persons, or to himself and one or
more other living persons. (Living person includes a company or any such
association whether incorporated or not.)
Every person competent to contract and entitled to transferable property is
competent to transfer property.
64.2 SALE OF IMMOVEABLE PROPERTY
Sale is a transfer of ownership in exchange for a price paid or promised or part-
paid and part-promised. The sale of tangible immoveable property for a
consideration exceeding Rs. 100/- can be made only by a registered instrument.
Delivery of tangible immoveable property takes place when the seller places the
buyer (or such person as directed by the buyer) in possession of the property.
64.3 MORTGAGE OF IMMOVEABLE PROPERTY
A mortgage is the transfer of an interest in specific immoveable property to
secure the payment of money given by way of loan or to secure the performance
of an engagement which may give rise to a pecuniary (monetary) liability.
The transferor is called a mortgagor. The transferee is called a mortgagee. The
principal money and interest secured is called the mortgage-money. The
instrument (if any) by which the transfer is effected is called a mortgage-deed.
Mortgagor can be
(i) An absolute owner of property (including ownership by purchase or by
partition or inheritance or by gift or by lease)
(ii) One of two or more co-owners; (iii) KartaofHUF;
(iv) Guardian of minor's property with sanction of Court under the Guardians
and Wards Act, 1890; (v) Executor or administrator.
Mortgage is a transfer of an interest in specific immoveable property as a
security for the repayment of a monetary liability. This liability could be arising
out of money already advanced or to be advanced; it could be a future debt or it
could be pecuniary liability arising out of the non-performance of any
engagement.
The mortgage referred in the Transfer of Property Act, 1882 is a mortgage of
immoveable property and it has no application to moveable property. Security
by way of moveable property is called hypothecation or pledge or pawn.
445
64.4 TYPES OF MORTGAGE
(A) Essentials of a simple mortgage:
(i) The mortgagor does not deliver possession of the mortgaged property to the
mortgagee, (ii) The mortgagor binds himself personally to pay the mortgage-
money, (iii) The mortgagor agrees that in the event of his failing to pay
according to his contract, the mortgagee shall have a right to get the mortgaged
property sold and recover his dues.
(B) Essentials of a mortgage by conditional sale:
(i) the mortgagor apparently sells the mortgaged property to the mortgagee; (ii)
the condition of sale is that on default of payment of the mortgage-money on a
certain date
the sale shall become absolute; or (iii) on such payment being made the sale
shall become void, or the buyer (mortgagee) shall
transfer the property to the seller (mortgagor).
(C) Essentials of a usufructuary mortgage:
(i) The mortgagor delivers possession of the mortgaged property to the
mortgagee, (ii) The mortgagor authorises the mortgagee to retain such
possession until payment of the
mortgage-money.
(iii) To receive the rents and profits arising from the property, (iv) Appropriate
the same towards the payment of interest or mortgage-money or both.
(D) Essentials of an English mortgage:
(i) The mortgagor binds himself to repay the mortgage-money on a certain date,
and transfers
the mortgaged property absolutely to the mortgagee, (ii) subject to a condition
that he will re-transfer it to the mortgagor upon payment of the
mortgage-money.
(E) Essentials of a mortgage by deposit of title deeds (Equitable Mortgage):
(i) The mortgagor delivers to a creditor or his agent documents of title to
immoveable property,
(ii) With intent to create a security thereon.
(iii) The delivery of documents of title is done in a town specified by the
State Government,
(iv) The property given as a mortgage may or may not be situated in the
notified towns.
A mortgage other than a mortgage by deposit of title deeds can be effected only
in terms of a mortgage deed duly signed by the mortgagor and attested by at
least two witnesses.
A mortgage by deposit of title deeds does not require any writing. As such a
mortgage by deposit of title deeds being an oral transaction is not affected by the
law of registration. All other mortgages in writing must be registered.
In simple words, the procedure followed in banks for the creation of an equitable
mortgage is as under:
(i) Title clearance certificate is to be obtained from an advocate that the property
proposed to be mortgaged is free from all encumbrances and readily marketable
and a search of the land records should be taken for at least thirty years prior to
the date of certificate.
(ii) There shall be a deposit of the original title deeds in the notified towns
personally by the true and legal owner of the immoveable property or his/its duly
authorised agent.
(iii) A record of equitable mortgage popularly called as memorandum of entry is
to be prepared by the concerned branch. The stamp duty is payable on the said
memorandum of entry as per local laws of the state and no registration is
required. It is a sort of evidence/record to file in the Court if required for the
recovery of the bank dues.
446
(iv) In the case of limited companies, the company has to pass a resolution
authorising the director/ officer to deposit the deeds for raising a loan and after
memorandum of entry is recorded, charge is required to be filed with registrar of
charges.
64.5 SALE WITHOUT COURT INTERVENTION
One of the important provision of the Transfer of Property Act, which permits
the mortgagee (i.e., the lender) to sell the mortgaged property without the
intervention of the Court is as explained hereunder.
Section 69 of the Transfer of Property Act is as under-Power of sale when valid
1. A mortgagee or any person acting on his behalf has power to sell the
mortgaged property or any
part thereof, in default of payment of the mortgage-money, without the
intervention of the Court,
in the following cases namely
(a) where the mortgage is an English mortgage, and neither the mortgagor
nor the mortgagee is a
Hindu, Mohammedan or Buddhist or a member of any other race, sect, tribe or
class from
time to time specified in this behalf by the State Government, in the official
gazette;
(b) where a power of sale without the intervention of the Court is expressly
conferred on the
mortgagee by the mortgage-deed and the mortgagee is the Government;
(c) where a power of sale without the intervention of the Court is expressly
conferred on the
mortgagee by the mortgage-deed and the mortgaged property or any part thereof
was, on the
date of the execution of the mortgage-deed, situated within the towns of Kolkata,
Chennai,
Mumbai, or in any other town or area which the State Government may, by
notification in the
official gazette, specify in this behalf.
2. No such power shall be exercised unless and until
(a) notice in writing requiring payment of the principal money has been
served on the mortgagor,
or on one of several mortgagors, and default has been made in payment of the
principal
money, or of part thereof, for three months after such service; or
(b) some interest under the mortgage amounting at least to Rs. five hundred
is in arrear and
unpaid for three months after becoming due.
3. When a sale has been made in the professed exercise of such a power,
the title of the purchaser
shall not be impeachable on the ground that no case had arisen to authorise the
sale, or that due
notice was not given, or that the power was otherwise improperly or irregularly
exercised; but any
person indemnified by an unauthorised or improper or irregular exercise of the
power shall have his
remedy in damages against the person exercising the power.
4. The money which is received by the mortgagee, arising from the sale,
after discharge of prior
encumbrances, if any, to which the sale is not made subject, or after payment
into the Court under
the Section 57 of a sum to meet any prior encumbrance, shall, in the absence of a
contract to the
contrary, be held by him in trust to be applied by him, first, in payment of all
costs, charges and
expenses properly incurred by him as incident to the sale or any attempted sale;
and, secondly, in
discharge of the mortgage-money and costs and other money, if any, due under
the mortgage; and
the residue of the money so received shall be paid to the person entitled to the
mortgaged property,
or authorised to give receipts for the proceeds of the sale thereof.
64.6 ENFORCEMENT OF MORTGAGES THROUGH COURT
After the enactment of the Recovery of Debts due to Banks and Financial
Institutions Act, 1993, recovery of debts due to banks and financial institutions
in excess of Rs. ten lakh only can be commenced
447
in the Debts Recovery Tribunals. Since the banks and financial institutions
advance loans/facility below Rs. ten lakh, and if they were secured by a
mortgage on the borrower's immovable properties, the lender has to file a civil
suit for the recovery of his dues by enforcement of the mortgage. While filing
the civil suit the following aspects may have to be kept in view:-
1. The suit shall be instituted in the court of the lowest jurisdiction where it
can lie.
2. The suit shall be instituted in the jurisdiction of the court where the
mortgaged properties are
situated.
3. All puisne mortgagees (subsequent mortgagees) shall be impleaded as
defendants.
4. If there is more than one mortgage in favour of the lender filing the suit,
he shall sue on all debts
unless a leave of the court is obtained for filing separate suits.
5. If personal covenant of the mortgage is to be enforced, it must be
ensured that the claim is within
limitation.
6. In Civil Courts the decree on mortgage is two fold; namely a
preliminary decree and a final decree.
The preliminary decree sets out a time limit for the mortgagor to pay the decretal
amount. If the
mortgagor fails to pay the decretal amount by the time stipulated in the
preliminary decree, the
mortgagee is entitled to make an application to the Court for passing the final
decree. The execution
proceedings shall be commenced only after the final decree is passed in the
mortgage suit.
7. While executing the mortgage decree, the decree holder can bring the
properties mortgaged to sale
without first seeking an order of attachment from the Court.
64.7 LEASES OF IMMOVEABLE PROPERTY
A lease is a transfer of a right to enjoy the property for a certain time (express or
implied) or in perpetuity (that is forever), in consideration of a price paid or
promised or any other thing of value, to be given periodically to the transferor by
the transferee. The transferor is called 'the lessor', the transferee is called the
'lessee', the price is called the premium, and the money or any other thing to be
given is called the rent.
A sale is an absolute transfer of property. A lease is a partial or limited transfer
of property. In a lease, there is a transfer of the right to enjoy such property.
Thus, in case of a lease, there is a separation between ownership and possession.
Duration of Certain Leases in Absence of Written Contract or Local Usage: A
lease for an agricultural or manufacturing purpose is deemed to be a lease from
year to year. It can be terminated by the lessor or lessee by giving six months
notice to one another.
A lease for any other purpose is deemed to be a lease from month to month. It
can be terminated by the lessor or lessee by giving fifteen days notice to one
another.
Important Case Law
Chapsibhai Dhanjibhai Danad, Appellant vs. Purushottam, Respondent AIR
1971 SC 1878
(1883): The facts of the case in brief are as under:
By a deed of Jqase, dated 5 May 1906, the predecessor-in-title of the respondent
let out to the appellant's father an open portion of land measuring 26 ft x 225 ft
out of a larger plot. The lease was for constructing buildings arid for a period of
thirty years certain at the annual rate of Rs. 130. The lease contained, inter alia,
the following: ,
'Even after the prescribed time-limit, I shall have a right to keep my structure on
the leased-out land, so long as I like, and I shall be paying to you the rent every
year as stated above. You will have no right to increase the rent and I shall also
not pay it, myself and my heirs shall use this land in whatever manner
Afff»r fhp IPUCP n(*rir\r\
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1—11 J-—
448
vacate your land. In case we remove our structure before the stipulated period,
we shall be liable to pay to you, the rent for all the 30 years, as agreed to above.
... In case I were to sell away the buildings, which I shall be constructing on the
above land, to anyone else, then, the purchaser shall be bound by all the terms in
this lease-deed.'
The trouble between the parties started when the respondent commenced
construction on the rest of the land in a fashion so as to be in close vicinity to the
western boundary of the leased land to house an industry, called Sudha
Industries.
The appellant filed the suit in 1958, out of which this appeal arises, urging that
the said lease was a permanent lease. The Trial Court partially decreed the
appellant's suit.
The District Court dismissed the appellant's appeal and allowed the cross-
objections with the result that the appellant's suit was dismissed. A second
appeal filed by the appellant in the High Court was heard by a single Judge who
held that the said lease was a permanent lease.
Aggrieved by the judgement and decree passed by the learned single Judge, the
respondent filed a letters patent appeal wherein the principal question was
canvassed whether the said lease was a permanent lease or not. The Letters
Patent Bench answered the question against the appellant holding that the said
lease being a lease for building purposes and transferable, was a lease for an
indefinite period.
On appeal the Supreme Court held that the lease was undoubtedly for an
indefinite period which only means that it was to ensure for the lessee's lifetime.
The lease in question was held to be of the former class and not inheritable and
permanent.
On arriving at such a decision the Supreme Court relied on the following
principles:
Whether a lease was permanent or for the lifetime only of the lessee, even where
it was for building structures and was transferable, depended upon the terms of
the lease and the Court must, therefore, look at the substance of it to ascertain
whether the parties intended it to be a permanent lease. The mere fact, however,
that a lease provides for the interests there under to pass on to the heirs of the
lessee would not always mean that it is a permanent lease. Such a provision can
be made in two ways resulting in two different consequences. A lease may
provide a fixed period and then include a provision that in the event of the lessee
dying before the expiry of such period, his heirs would be entitled to have the
benefit of the lease for the remainder of the period. In such a case, although the
lease may provide for the heirs to succeed to the interests in the leased land, it
would only mean that such heirs succeed to the rights up to the expiry of the
lease period. If the lease, on the other- hand, were for an indefinite period, and
contains a provision for the rights there under being inheritable, then, such a
lease, though ordinarily for the lifetime of the lessee, would be construed as
permanent. The lease in question was held to be of the former class and not
inheritable and permanent. If any accession is made to the leased property during
the continuance of a lease, such accession is deemed to be comprised in the
lease. If the accession is by encroachment by the lessee, and the lessee acquires
title thereto by prescription, he must surrender such accession together with the
leased land to the lessor at the expiry of the term. The presumption is that the
land so encroached upon is added to the tenure and forms part thereof for the
benefit of the tenant so long as the lease continues and afterwards for the benefit
of the landlord.
How are leases made?
A lease from year to year or for any term exceeding one year can be made only
by a registered instrument. All other leases can be made either by a registered
instrument or by oral agreement accompanied by delivery of possession.
The practical procedure followed for mortgage of lease hold rights is: (i)
Original lease agreement can constitute the title deeds if the lease is perpetual.
449
(ii) The Lease agreement should be duly stamped and registered.
(iii) The unexpired lease period must be sufficiently longer and must cover, the
period allowed for repayment for bank's advance.
(iv) A tripartite agreement may also be entered into between the lender bank, the
lessor and the lessee (the borrower).
(v) The lease deed must contain a clause permitting/authorising the lessee to
create mortgage, or alternatively the lessor should give a specific letter of
authority-cum-no-objection authorising the lessee to create the mortgage in
favour of the lender bank and undertaking not to exercise the right of forfeiture
of the lease so long as lender bank's dues are outstanding.
64.8 ENFORCEMENT OF MORTGAGES THROUGH COURT
After the enactment of the Recovery of Debts due to Banks and Financial
Institutions Act, 1993, recovery of debts due to banks and financial institutions
in excess of Rs. ten lakh only can be commenced in the Debt Recovery
Tribunals. Since banks and financial institutions advance loans/facility below
Rs. ten lakh, and if they were secured by a mortgage on the borrower's
immovable properties, the lender has to fi-le a civil suit for the recovery of his
dues by enforcement of the mortgage. While filing the civil suit the following
aspects may have to be kept in view:-
1. The suit shall be instituted in the court of the lowest jurisdiction where it
can lie.
2. The suit shall be instituted in the jurisdiction of the court where the
mortgaged properties are
situated.
3. All puisne mortgagees (subsequent mortgagees) shall be impleaded as
defendants.
4. If there is more than one mortgage in favour of the lender filing the suit,
he shall sue on all debts
unless leave of the court is obtained for filing separate suits.
5. If a personal covenant of the mortgagor is to be enforced, it must be
ensured that the claim is
within limitation.
6. In Civil Courts the decree on mortgage is two-fold, namely a
preliminary decree and a final decree.
The preliminary decree sets out a time limit for the mortgagor to pay the decretal
amount. If the
mortgagor fails to pay the decretal amount by the time stipulated in the
preliminary decree, the
mortgagee is entitled to make an application to the court for passing the final
decree. The execution
proceedings shall be commenced only after the final decree is passed in the
mortgage suit.
7. While executing the mortgage decree, the decree-holder can bring the
properties mortgaged to sale
without first seeking an order of attachment from the court.
64.9 ACTIONABLE CLAIMS
'Actionable claim' means a claim to any debt (other than a debt secured by
mortgage, hypothecation or pledge).
Transfer of actionable claim
The transfer of an actionable claim whether with or without consideration, can
be done only by the execution of an instrument in writing signed by the
transferrer. There is no mandatory requirement of giving notice to the debtor
before the transfer of the actionable claim. The transferee of an actionable claim
can sue the debtor in his own name without obtaining the transferrer's consent
and without making him a party to the suit.
Illustration
(i) A owes money to B. B transfers the debt to C. A is not aware of the same. B
then demands the debt from A. A pays B. The payment is valid, and C cannot
sue A for the debt.
.-^"■"T.1*:-^,"*:.;-1
For the academic interests of the students, a summary of a couple of case laws
are stated hereunder: Dena Bank vs Bhikhabhai Prabhudas Parekh and Co. and
others 2000 AIR (SC) 3654
This judgement is regarding issue of priority of dues of Government vis-a-vis
the bank dues. The Honourable Supreme Court held that crown debts gets
priority over others debts. In this case the Court has examined the various
provisions of the Sales Tax Act, the Land Revenue Act and the precedents
prevailing in India as well as in England and finally come to the conclusion that
the debts of the crown (Government) prevail over the others provided there are
statutory provisions to that effect in the respective statutes.
Sirpur Paper Mills Ltd v/s The Collector of Central Excise. AIR 1998 SC 1489.
In this case the Honourable Supreme Court held that just because plant and
machinery had to be installed in earth for better functioning it does not
automatically become immoveable property. Property liable to excise duty. In
this case, the issue was whether plant and machinery installed in the earth can be
treated as immoveable property whereby the tax burden (excise duty) on such
plant and machinery may be avoided. The Court examined the definition of the
word immoveable property in the Transfer of Property Act and the other Acts
and accordingly gave such verdict.
64.10 CHECK YOUR PROGRESS
1. Indicate whether the following statements are True or False.
(i) Transfer of Property Act basically contains provisions relating to transfer of
moveable
property and goods, (ii) Mortgage is a transfer of an interest in specific
immoveable property to secure the payment
of money given by way of loan, (iii) In a simple mortgage the mortgagor does
not deliver possession of the mortgaged property
to the mortgagee, (iv) In a mortgage by conditional sale the property is
transferred the condition of sale is that on
default of payment of the mortgage-money on a certain date the sale shall
become absolute. (v) In a usufructuary mortgage the mortgagor delivers
possession of the mortgaged property
to the mortgagee, (vi) In an English mortgage the property is transferred
absolutely by the mortgagor to the
mortgagee with a condition for retransfer. (vii) In a mortgage by deposit of title-
deeds the property given as a mortgage has to be situated
in notified towns, (viii) A lease of from year to year or for any term exceeding
one year can be made by transfer of
possession, (ix) The debtor has to be given a notice of transfer of actionable
claim.
2. Fill in the blanks from the options given in the brackets.
(i) A lease for agricultural or manufacturing purpose can be terminated by the
lessor or lessee
by giving notice to one another, (six months/15 days)
(ii) A memorandum recording mortgage by deposit of title deeds does not
require
(registration/stamping)
(iii) The essentials of valid equitable mortgage are debt, deposit of title deeds
and
(intention as security/intention of safe deposit) (iv) In case of accession to the
mortgaged property, where the mortgagee is in possession of
the mortgaged property, the mortgagee is of the accession, (entitled/not
entitled)
(v) A mortgagor, while lawfully in possession of the mortgaged property, shall
have
to make leases thereof, (power/no power)
451
3. Multiple Choice Questions. Select the alternative as applicable.
(i) The power of sale without intervention of the Court is given to the mortgagee
in the case of:
(a) Equitable mortgage (b) English mortgage
(c) Simple mortgage (d) Usufructuary mortgage
(ii) A lease for an agricultural or manufacturing purpose is deemed to be a lease
for:
(a) year to year (b) month to month
(c) week to week (d) with infinite period
64.11 ANSWERS TO 'CHECK YOUR PROGRESS'
1. (i) False; (ii) True; (iii) True; (iv) True; (v) True; (vi) True; (vii) False;
(viii) False; (ix) False.
2. (i) 6 months; (ii) registration; (iii) intention of security; (iv) entitled; (v)
power
3. (i) English mortgage; (ii) year to year
UNIT
65
THE RIGHT TO INFORMATION ACT, 2005
STRUCTURE
65.0 Objective
65.1 Introduction
65.2 Applicability
65.3 Definitions
65.4 Let Us Sum Up
65.5 Keywords
65.6 Check Your Progress
65.7 Answers to 'Check Your Progress'
65.8 Multiple Choice Terminal Questions
454
65.0 OBJECTIVE
The objective of this unit is to provide salient features of the Right to
Information Act, 2005. The Act has application to most of the banks and
financial institutions that will come under the purview of public authority as
defined in the Act.
65.1 INTRODUCTION
The Right to Information Act, 2005 was enacted with intent to provide for
setting out the practical regime of right to information for citizens to secure
access to information under the control of public authorities, in order to promote
transparency and accountability in the working of every public authority. The
Act aims at containing corruption and holding the Governments and their
instrumentalities accountable to the governed by providing access to
information. The Act also creates machinery for ensuring effective
implementation of the Act.
65.2 APPLICABILITY
This Act extends to whole of India except the State of Jammu & Kashmir. While
the provisions of the Act relating to the obligations of public authorities,
designation of public information officers and assistant public information
officers, constitution of Central information commission, constitution of State
information commission, non applicability of the Act to certain organisations
and power to make rules came into force on 15 June 2005, the remaining
provisions were made effective 120 days after the aforesaid date. They came into
force on 12 October 2005. On coming into force of this Act (i.e., 12.10.2005) the
Freedom of Information Act, 2002 has been repealed.
65.3 DEFINITIONS
It is relevant to understand the meaning of some of the terms defined in the Act
for the proper understanding of the Act. These are discussed below:
The term 'Appropriate Government' has to be understood in the context of the
definition of public authority. It can be either the Central Government or the
State Government. Central Government is the appropriate authority if the
concerned public authority is established, constituted, owned, controlled or
substantially financed by funds provided directly or indirectly by that
Government or the Union Territory Administration. It is the State Government,
if the concerned public authority is established, constituted, owned, controlled or
substantially financed by funds provided directly or indirectly by that
Government.
'Central Information Commission' means the Central Information Commission
constituted by the Central Government.
'Central Public Information Officer' means the Central Public Information
Officer designated by the public authority and includes a Central Assistant
Public Information Officer.
'Information' means any material in any form, including records, documents,
memos, e-mails, opinions, advices, press releases, circulars, orders, logbooks,
contracts, reports, papers, samples, models, data material held in any electronic
form and information relating to any private body which can be accessed by a
public authority under any law for the time being in force.
'Public authority' means any authority or body or institution of self Government
established:
(a) by or under the Constitution;
(b) by any other law made by Parliament;
(c) by any other law made by the State Legislature;
I
455
(d) by notification issued or order made by the appropriate Government and
includes any (i) body owned, controlled or substantially financed; (ii) non-
Government organisation substantially financed, directly or indirectly by funds
provided
by the appropriate Government.
'Right to information' has been defined in an inclusive manner. It means the right
to information accessible under this Act which is held by or under the control of
any public authority and includes the right to:
(i) inspection of work, documents, records;
(ii) taking notes, extracts or certified copies of documents or records; (iii) taking
certified samples of material; (iv) obtaining information in the form of diskettes,
floppies, tapes, video cassettes or in any other
electronic mode or through printouts where such information is stored in
computers or in
other device.
'State Information Commission' means the State Information Commission
constituted by the State Government under this Act.
65.4 LET US SUM UP
The Right to Information Act, 2005 secures access to information under the
control of public authorities to the citizens. The Act aims at promoting
transparency and accountability in the working of every public authority and
containing corruption. The Act was brought in to force in stages on 15 June 2005
and 12 October 2005. The chief public information officers and Central assistant
public information officers are appointed by the public authorities. The Central
Government constitutes the Central Information Commission and the State
Government, the State information commission.
65.5 KEYWORDS
Appropriate Governtnent; Central Information Commission; Central Public
Information Officer; Central Assistant Public Information Officer; information;
Right to Information; State Information Commission.
65.6 CHECK YOUR PROGRESS
1. The Right to Information Act, 2005 was enacted to contain corruption.
(True or False)
2. The Right to Information Act, 2005 came into force on October 12,
2005. (True or False)
3. The Right to Information Act, 2005 repealed the Freedom of
Information Act, 2002. (True or
False)
4. The Right to Information Act, 2005 applies to all organisations. (True or
False)
5. Central Public Information Officers are appointed by the Central
Government. (True or False)
65.7 ANSWERS TO 'CHECK YOUR PROGRESS'
1. True; 2. False; 3. True; 4. False; 5. False.
65.8 MULTIPLE CHOICE TERMINAL QUESTIONS
1. Public authority means
(a) an authority established by the Government;
(b) an authority established by law;
(c) a non Government organisation;
(d) any authority or body or institution of self government established or
constituted by or under the Constitution, by any other law made by Parliament;
by any other law made by State Legislature; by notification issued or order made
by the appropriate Government. 2. Right to Information means the right to
(a) inspection of work, documents and records;
(b) taking notes, extracts, or certified copies of documents or records;
(c) taking certified samples of materials;
(d) all the above and obtaining information in the form of diskettes,
floppies, etc., of information
stored in a computer or in any other device.
Ans: 1. (d); 2. (d).
RIGHT TO INFORMATION AND OBLIGATIONS OF PUBLIC
AUTHORITIES
STRUCTURE
66.0 Objective
66.1 Introduction
66.2 Obligations of Public Authorities
66.3 Procedure for Obtaining Information
66.4 Disposal of Request
66.5 Appeal
66.6 Orders in Appeal
66.7 Penalties
66.8 Let Us Sum Up
66.9 Check Your Progress
66.10 Answers to 'Check Your Progress'
458
66.0 OBJECTIVE
This unit explains the obligations of public authorities, the procedure for
obtaining information and the information exempt from disclosure etc.
66.1 INTRODUCTION
Every public authority shall maintain all its records duly catalogued and indexed
which facilitates the right to information and ensure that all records that are
appropriate to be computerised are, within a reasonable time and subject to
availability of resources, computerised and connected through a network all over
the country on different systems so that access to such records is facilitated.
66.2 OBLIGATIONS OF PUBLIC AUTHORITIES
PIOs (Public Information Officers) are officers designated by the public
authorities in all administrative units or offices under it to provide information to
the citizens that request for information under the Act. Any officer, whose
assistance has been sought by the PIO for the proper discharge of his or her
duties, shall render all assistance, whenever demanded.
66.3 PROCEDURE FOR OBTAINING INFORMATION
PIO shall deal with requests from persons seeking information and where the
request cannot be made in writing, to render reasonable assistance to the person
to reduce the same in writing.
If the information requested for is held by or its subject matter is closely
connected with the function of another public authority, the PIO shall transfer,
within five days, the request to that other public authority and inform the
applicant immediately.
PIO may seek the assistance of any other officer for the proper discharge of
his/her duties.
PIO, on receipt of a request, shall as expeditiously as possible, and in any case
within thirty days of the receipt of the request, either provide the information on
payment of such fee as may be prescribed or reject the request for any of the
reasons specified in 8.8 or 8.9 of the Act.
Where the information requested for concerns the life or liberty of a person, the
same shall be provided within forty-eight hours of the receipt of the request.
66.4 DISPOSAL OF REQUEST
(a) If the PIO fails to give a decision on the request within the period specified,
he shall be deemed to have refused the request.
Where a request has been rejected, the PIO shall communicate to the requester -
(i) the reasons for such rejection,
(ii) the period within which an appeal against such rejection may be preferred,
(iii) the particulars of the appellate authority.
PIO shall provide the information in the form in which it is sought unless it
would disproportionately divert the resources of the public authority or would be
detrimental to the safety or preservation of the record in question.
If allowing partial access, the PIO shall give a notice to the applicant, informing:
(a) that only part of the record requested, after severance of the record
containing information which is exempt from disclosure, is being provided;
f
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459
(b) the reasons for the decision, including any findings on any material
question of fact, referring
to the material on which those findings were based;
(c) the name and designation of the person giving the decision;
(d) the details of the fees calculated by him or her and the amount of fee
which the applicant is
required to deposit; and
(e) his or her rights with respect to review of the decision regarding non-
disclosure of part of the
information, the amount of fee charged or the form of access provided.
If information sought has been supplied by a third party or is treated as
confidential by that third party, the PIO shall give a written notice to the third
party within five days from the receipt of the request and take its representation
into consideration.
Third party must be given a chance to make a representation before the PIO
within ten days from the date of receipt of such notice.
(b) Payment of fees
As per the Right to Information (Regulation of Fee and Cost) Rules, 2005, the
application shall be accompanied by a fee of rupees ten. It may be paid in cash
against proper receipt or by demand draft or a banker's cheque or by Indian
Postal Order. The instrument is payable to the accounts officer of the public
authority.
(c) Disposal of the request
Where the application is received by another public authority or the information
is more closely connected with the functions of another public authority, the
application shall be transferred to that other public authority within five days
from the date of the receipt of the application and inform the applicant about the
transfer.
If the application relates to the public authority receiving it, the information shall
be provided as expeditiously as possible but within thirty days.
If the information sought concerns the life or liberty of a person, the same shall
be provided within forty-eight hours of the receipt of the request.
The applicant is required to pay the charges for providing the information. The
rules prescribe the charges for computing the cost. The charges are computed at
the following rates:
(a) rupees two for each page in A-4 or A-3 size paper created or copied;
(b) actual charge or cost price of a copy in larger size paper;
(c) actual cost or price for samples or models; and
(d) for inspection of records, no fee for the first hour and a fee of rupees
five for each fifteen
minutes or fraction thereof thereafter.
The period intervening between the dispatch of the intimation for payment of fee
and actual
payment shall be excluded for reckoning the period of thirty days.
The information requested should ordinarily be provided in the form in which it
is sought unless
it would disproportionately divert the resources of the public authority or would
be detrimental to
the safety or preservation of the record in question.
If the Central Public Information officer fails to give decision on the request for
information
within the period of thirty or thirty-five days, the request shall be deemed to
have been refused.
(d) Third Party information
Third party means a person other thanJhe citizen making a request for
information and includes a public authority. Where a Central Public Information
Officer intends to disclose any informatiorT or record or part thereof which
relates to or has been supplied by a third party and has been
460
treated as confidential by that third party, the Central Public Information Officer
shall within five days from the date of receipt of the request give a written notice
to such third party that he intends to disclose the information. The third party
may make his submissions in writing or orally within ten days from the date of
receipt of such notice, which shall be taken in to account by the Central Public
Information Officer.
Except in the case of trade or commercial secrets protected by law, disclosure of
third party information may be allowed if the public interest in disclosure
outweighs in importance any possible harm or injury to the interests of such
third party.
The notice given to the third party must state that the third party is entitled to
prefer an appeal against the decision to disclose the information.
(e) Rejection of the request
The request for Information may be rejected where such a request for providing
access would involve an infringement of copyright subsisting in a person other
than the State.
Where a request has been rejected, the Central Public Information Officer shall
communicate to the person making the request the reasons for such rejection, the
particulars of the appellate authority and the period within which an appeal
against such rejection may be preferred.
(f) Information exempt from disclosure
The Act lists certain categories of information that is exempt from disclosure.
These include:
(a) information, the disclosure of which would prejudicially affect the
sovereignty and integrity
of India;
(b) disclosure of information expressly forbidden by law or may constitute
contempt of court;
(c) disclosure of which would cause a breach of privilege of Parliament or
of the State Legislature;
(d) information relating to commercial confidence, trade secrets or
intellectual property;
(e) information available to a person in his fiduciary relationship;
(f) information received in confidence from foreign government;
(g) information, the disclosure of which would endanger the life or physical
safety of any person;
(h) information which would impede the process of investigation or
apprehension or prosecution
of offenders;
(i) cabinet papers including records of deliberations of the Council of
Ministers, Secretaries and other officers.
In respect of items listed at (a), (c), and (i), the information if relating to any
event which occurred or happened twenty years before the date on which the
request is made shall be provided to the person making a request.
66.5 APPEAL
The Central Government has the powers to constitute a body known as the
Central information commission. The State Governments have the power to
constitute for the State a body known as the State Information Commission to
administer the provisions of the Act where the State Government is the
appropriate authority.
The Central Information Commission (also the State Information Commission
wherever it has the jurisdiction) has been empowered to receive and inquire into
a complaint from any person-
(a) who has been unable tojmbmiLarequesUaaCentral Public Information
Officer; or his application for information or appeal was refused to be received
by the Central Assistant Public Information Officer;
461
(b) who has been refused access to any information requested under this
Act;
(c) who has not been given a response to a request for information;
(d) who has been required to pay a fee which he considers unreasonable;
(e) who believes he has been given incomplete, misleading or false
information; and
(f) in respect of any other matter under this Act.
Any person who does not receive a decision within the time specified (normally
thirty days) or is aggrieved by a decision of the Central Public Information
Officer may within thirty days from the expiry of such period or from the receipt
of such decision, prefer an appeal to the officer who is senior in rank to the
Central Public Information Officer in each public authority. The appellate
authority has the power to condone the delay in filing the appeal if he is satisfied
that the appellant was prevented by sufficient reasons from filing the appeal in
time.
If the appeal is against the third party information, the appeal by the concerned
third party shall be made within thirty days from the date of the order.
A second appeal will lie against the decision of the appellate authority before the
Central Information Commission (or the State Information Commission) and the
same shall have to be preferred within ninety days from the date on which the
decision should have been made or was actually received.
The appeal shall be disposed of within thirty days of the receipt of the appeal or
within such extended time not exceeding a total of forty-five days from the date
of filing thereof. The decision of the Central Information Commission is binding
on the parties.
66.6 ORDERS IN APPEAL
In deciding the appeal, the Central Information Commission may pass the
following orders:
(a) require the public authority to take any steps necessary to secure
compliance with the provisions
of this Act including -
(i) by providing access to information in a particular form; (ii) by appointing a
Central Public Information Officer; etc.;
(b) require the public authority to compensate the complainant for any loss
or other detriment suffered;
(c) impose any of the penalties provided under this Act;
(d) reject the appeal.
66.7 PENALTIES
The Central Information Commission has the power to impose a penalty of two
hundred and fifty rupees for each day till the information is furnished subject to
a maximum of twenty-five thousand rupees. The Commission shall give an
opportunity to the parties of being heard before imposing any penalty. The
Commission has the power to recommend taking disciplinary action against the
Central Public Information Officer under the service rules applicable to him
when he is satisfied that the Central Public Information Officer
(i) without reasonable cause persistently failed to receive an application for
information; or
(ii) has not furnished the information within the time specified; or
(iii) with malafied intent denied the request for information; or
(iv) knowingly given incorrect, incomplete or misleading information; or
(v) destroyed information which was the subject of request; or
(vi) obstructed in furnishing the information.
462
66.8 LET US SUM UP
The Right to Information Act, 2005 gives right to every citizen to seek
information from any public authority under the Act. He need not give reasons
for requesting the information. Every public authority is required to display
specified information about the organisation, its employees, etc., and continue to
update the information periodically. Every public authority is required to
designate one or more of its officials as Central public information officer and at
branch, district levels Central assistant Public Information Officers. The central
assistant public information officers are required to receive the request for
information and forward the same to the Central Public Information Officer
within five days of its receipt. Fees has been prescribed both for the application
and for the cost of furnishing information. Information has to be furnished
within thirty days. Where the request involves disclosure of information
furnished by a third party and the Central Public Information Officer intends to
disclose it, he shall within five days of the receipt of the request communicate in
writing to the third party of his intention to disclose. The third party has a right
to make representation. The Act provides a right of appeal to the officer senior in
rank to that of the Central Public Information Officer against the non disclosure
or the decision to disclose the third party information. Further appeal lies to the
Central Information Commission. The appeal has to be filed within ninety days.
The Act prescribes penalties for various offences under the Act.
66.9 CHECK YOUR PROGRESS
1. Every citizen is entitled to seek information under the Right to
Information Act from a public
authority. (True/False)
2. Every public authority is required to display information about their
organisation, employees, etc.,
and update them periodically. (True/False)
3. Central Government appoints Central Public Information Officer in
every public authority. (True/
False)
4. A person seeking information has to disclose the reason for seeking
information. (True/False)
5. Central Assistant Public Information Officer has to forward the request
for information to the
concerned public authority within five days of the receipt of the request if it does
not relate to his
organisation. (True/False)
6. The request for information has to be disposed of ordinarily within thirty
days. (True/False)
7. No third party information can be sought from a public authority.
(True/False)
8. If information requested is not provided it will be treated as a deemed
refusal. (True/False)
9. There is no redressal if the Central Public Information Officer refuses to
provide information.
(True/False)
10. Central information commission can recommend taking disciplinary
action against the Central
Public Information Officer if the latter failed to furnish information within the
specified time.
(True/False).
66.10 ANSWERS TO CHECK YOUR PROGRESS'
1. True; 2. True; 3. False; 4. False; 5. True; 6. True; 7. False; 8. True; 9. False;
10. True.
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UNIT
67
THE PREVENTION OF MONEY LAUNDERING ACT, 2002
STRUCTURE
67.0 Objective
67.1 Introduction
67.2 Offence of Money Laundering
67.3 Punishment for Money Laundering
67.4 Obligations of Banking Companies, Financial Institutions and
Intermediaries
67.5 Rules Framed
67.6 Records to be Maintained
67.7 Information Contained in the Records
67.8 Procedure for Maintaining Information
67.9 Procedure for Furnishing Information
67.10 Verification of Records of the Identity of Clients
67.11 Maintenance of Records of Identity of Clients
67.12 Let Us Sum Up
67.13 Check Your Progress
67.14 Answers to 'Check Your Progress'
464
67.0 OBJECTIVE
The objective of this unit is to familiarise the students with the requirements of
the Prevention of Money Laundering Act, 2002 and the rules made there under
in so far as the banking transactions are concerned.
67.1 INTRODUCTION
The Prevention of Money Laundering Act, 2002 was enacted to prevent money
laundering and to provide for the confiscation of property derived from, or
involved in, money laundering. The banking machinery has been used by the
persons indulging in money laundering. In order to prevent the misuse of the
banking machinery, a separate Chapter, viz., Chapter IV dealing with
Obligations of Banking Companies, Financial Institutions and Intermediaries has
been included in the Act. The Central Government in consultation with the
Reserve Bank of India has framed the rules, viz., The Prevention of Money
Laundering, Maintenance of Records of the Nature and Value of Transactions
etc., Rules, 2004.
67.2 OFFENCE OF MONEY LAUNDERING
There is no definition of money laundering in the Act. However, the Section 3 of
the Act states that whosoever directly or indirectly attempts to indulge or
knowingly assists or knowingly is a party or is actually involved in any process
or activity connected with the proceeds of crime and projecting it as untainted
property shall be guilty of offence of money laundering.
67.3 PUNISHMENT FOR MONEY LAUNDERING
Whosoever commits the offence of money laundering shall be punishable with
rigorous imprisonment for a term which shall not be less than three years but
may extend to seven years and also be liable to a fine which may extend to five
lakh rupees. If the offence relates to offences under the Narcotic Drugs and
Psychotropic Substances Act, 1985 the maximum punishment could extend to
imprisonment for ten years.
67.4 OBLIGATIONS OF BANKING COMPANIES,
FINANCIAL INSTITUTIONS AND INTERMEDIARIES
Every banking company, financial institution and intermediary is required to
(a) maintain a record of all transactions, of the nature and value specified in
the rules whether such
transactions comprise of a single transaction or a series of transactions integrally
connected to
each other, and where such a series of transactions take place within a month;
(b) furnish information of the transactions to the director within the
prescribed time;
(c) verify and maintain records of the identity of all its clients.
The records shall be maintained for ten years from the date of cessation of the
transactions between the clients and the banking company, financial institution
or intermediary. The director appointed by the Central Government, has the right
to call for the records and make such inquiry or cause an enquiry to be made. If
he finds that the banking company, financial institution or intermediary has not
complied with the requirements he may impose a fine on the banking company
which shall not be less than ten thousand rupees but may extend to one lakh
rupees. The Act also specifically provides that the banking companies and their
officers shall not be liable to any civil proceedings against them for furnishing
information.
465
67.5 RULES FRAMED
The Central Government in consultation with the Reserve Bank of India has
framed 'The Prevention of Money Laundering Maintenance of Records of the
Nature and Value of Transactions, the Procedure and Manner of Maintaining
and Time for Furnishing Information and Verification and Maintenance of
Records of the Identity of the Clients of the Banking Companies, Financial
Institutions and Intermediaries Rules, 2004'.
67.6 RECORDS TO BE MAINTAINED
The Act envisages the following records shall be maintained by every banking
company, financial institution or intermediary, namely:
(A) all cash transactions of the value of more than rupees ten lakh or its
equivalent in foreign currency;
(B) all series of cash transactions integrally connected to each other which
have been valued below
rupees ten lakh or its equivalent in foreign currency where such series of
transactions have taken
place within a month;
(C) all cash transactions where forged or counterfeit currency notes or bank
notes have been used as
genuine and where any forgery of a valuable security has taken place,
(D) all suspicious transactions, whether or not made in cash and by way of:
(i) deposits and credits, withdrawals into or from any accounts in whatsoever
name they are referred to in any currency maintained by way of:
(a) cheques including third party cheques, pay orders, demand drafts,
cashiers cheques or
any other instruments or payment of money including electronic receipts or
credits and
electronic payments or debits; or
(b) travellers cheque; or
(c) transfer from one account within the same banking company, financial
institution and
intermediary, as the case may be, including from or to Nostro and Vostro
accounts; or
(d) any other mode in whatsoever name it is referred to;
(ii) credits or debits into or from any non-monetary accounts such as a demat
account, security
account in any currency maintained by the banking company, financial
institution and
intermediary, as the case may be; (iii) money transfer or remittances in favour of
own clients or non-clients from India or abroad
and to third party beneficiaries in India or abroad including transactions on its
own account
in any currency by any of the following:
(a) payment orders, or
(b) cashier cheques; or
(c) demand drafts; or
(d) telegraphic or wire transfer or electronic remittances or transfer; or
(e) interest transfers; or
(f) automated clearing house remittances; or
(g) lock box driven transfers or remittances; or
(h) remittances for credit or loading to electronic cards; or (i) any other mode
of money transfer by whatsoever name it is called;
(iv) loans and advances including credit or loan substitutes, investments and
contingent liability by way of:
(a) subscription to debt instruments such as commercial paper, certificate of
deposits
preferential shares, debentures, securitised participation, inter-bank participation
or any
other investments in securities or the like whatever form and name it is referred
to; or
(b) purchase and negotiation of bills, cheques and other instruments; or
466
(c.) foreign exchange contracts, currency, interest rate and commodity and any
other derivative
instrument in whatsoever name it is called; or (d) letters of credit, standby letters
of credit, guarantees, comfort letters, solvency certificates
and any other instruments for settlement and/or credit support.
(v) collection service in any currency by way of collection of bills, cheques,
instruments or any other mode of collection in whatsoever name it is referred to.
67.7 INFORMATION CONTAINED IN THE RECORDS
The record shall contain the following information:
(a) the nature of the transaction
(b) the amount of the transaction and the currency in which it was
denominated
(c) the date on which the transaction was conducted; and
(d) the parties to the transaction.
67.8 PROCEDURE FOR MAINTAINING INFORMATION
The information as to the transactions shall be maintained in hard and soft copies
in accordance with the procedure and manner as may be specified by the RBI or
SEBI.
Banking company shall have to evolve a mechanism for maintaining such
information in such form and at such intervals as may be specified by the RBI or
SEBI.
It is the duty of the banking company to observe the procedure and manner of
maintaining the information as specified by the RBI or SEBI.
67.9 PROCEDURE FOR FURNISHING INFORMATION
The principal officer of a banking company shall furnish the information in
respect of the transaction every month to the director by the seventh day of the
succeeding month. If the transactions relate to
(a) forged or counterfeit currency notes or bank notes or forgery of valuable
security or (b) all suspicious transactions, whether or not made in cash shall be
promptly furnished in writing or by way of fax or electronic mail to the director
not later than three working days from the date of occurrence of such
transactions.
67.10 VERIFICATION OF RECORDS OF THE IDENTITY OF CLIENTS
The rules prescribe the type of records to be obtained or verified in respect of
various types of clients. The rules mandate that every banking company shall at
the time of opening an account or executing any transaction with it, verify and
maintain the record of identity and current address or addresses including
permanent address of the client, the nature of business of the client and his
financial status. If it is not possible to verify the identity at the time of opening
the account or executing the transaction, the banking company shall verify the
identity of the client within a reasonable time after the account has been opened
or the transaction has been executed.
The documents required to be taken for verification of the identity of clients
differ from the type of client. They are listed below:
(a) Individual
One certified copy of an officially valid document containing details of his
permanent address, current address including in respect of the nature of business
and financial status.
(b) Company
1. Certificate of incorporation
467
2. Memorandum and articles of association
3. Board resolution or the power of attorney
4. Officially valid document in respect of the person, operating the account
(c) Partnership firm
1. Registration certificate;
2. Partnership deed;
3. Officially valid document in respect of the person acting in the
transaction.
(d) Trust
1. Registration certificate;
2. Trust deed; and
3. Officially valid document in respect of the person acting in the
transaction.
(e) Unincorporated association
1. Resolution of the managing body
2. Power of attorney granted to the person conducting the transaction; and
3. Information as may be required by the banking company to establish the
legal existence of
the association or body of individuals.
67.11 MAINTENANCE OF RECORDS OF IDENTITY OF CLIENTS
The records relating to the identity of clients shall be maintained for a period
often years from the date of cessation of the transactions between the client and
the banking company.
67.12 LET US SUM UP
The Prevention of Money Laundering Act, 2002 was enacted to prevent money
laundering. The Act provides rigorous punishment for the offence of money
laundering. Certain obligations have been cast on banking companies, financial
institutions and intermediaries to maintain record of transactions, identity of
clients, etc. A director appointed by the Central Government has the right to call
for records and impose penalties if he finds that the banking company has failed
to comply with the requirement of the Act. Central Government has, in
consultation with the RBI, framed rules. The rules prescribe what records are to
be maintained, retention of records, verification of the identity of client and
furnishing information in respect of the transactions to the director, etc.
67.13 CHECK YOUR PROGRESS
1. The Prevention of Money Laundering Act, 2002 does not apply to
banking transactions. (True/
False)
2. The term money laundering has been defined in the Prevention of
Money Laundering Act, 2002.
(True/False)
3. Director under the Act is appointed by the Reserve Bank of India.
(True/False)
4. Record of transactions specified under the Act is to be maintained for
ten years (True/False)
5. RBI and SEBI can prescribe the nature of records to be maintained by a
banking company (True/
False)
6. Documents to be verified depend upon the type of the client.
(True/False)
7. Bank is not required to enquire the financial status of the client.
(True/False)
8. All cash transactions of the value of more than ten lakhs or its equivalent
in foreign currency are
covered by the Act (True/False)
67.14 ANSWERS TO 'CHECK YOUR PROGRESS'
1. False; 2. False; 3. False; 4. True; 5. True; 6. True; 7. False; 8. True.
L.R.A.B-31
INFORMATION TECHNOLOGY ACT, 2000
STRUCTURE
68.1 Introduction
68.2 Definitions
68.3 Electronic Governance
68.4 Certifying Authorities
68.5 Digital Signature Certificates
68.6 Penalties
68.7 Appeal
68.8 Investigations
68.9 Let Us Sum Up
68.10 Keywords
68.11 Check Your Progress
68.12 Answers to 'Check Your Progress'
470
68.1 INTRODUCTION
The General Assembly of the United Nations by the resolution A/RES/51/162,
dated 30 January, 1997 has adopted the Model Law on Electronic Commerce
adopted by the United Nations Commission on International Trade Law. The
said resolution recommends inter alia that all States give favourable
consideration to the said Model Law when they enact or revise their laws, in
view of the need for uniformity of the law applicable to alternatives to paper-
cased methods of communication and storage of information. It is considered
necessary to give effect to the said resolution and to promote efficient delivery
of Government services by means of reliable electronic records.
Therefore in May 2000, both the houses of the Indian Parliament passed the
Information Technology Bill. The Bill received the assent of the President in
August 2000 and came to be known as the Information Technology Act, 2000.
Cyber laws are contained in the IT Act, 2000.
This Act aims to provide the legal infrastructure for e-commerce in India which
involves the use of alternatives to paper based methods of communication and
storage of information and also to facilitate electronic filing of documents of
Government agencies. Therefore the Act facilitated the amendments to Indian
Penal Code, the Indian Evidence Act, 1872, the Bankers' Books Evidence Act,
1891 and the Reserve Bank of India Act, 1934 and for matters connected
therewith or incidental thereto. And the cyber laws have a major impact for e-
businesses and the new economy in India. So, it is important to understand what
the various perspectives of the IT Act, 2000 are and what does it offer.
The Information Technology Act, 2000 also aims to provide the legal framework
so that legal sanctity is accorded to all electronic records and other activities
carried out by electronic means. The Act states that unless otherwise agreed, an
acceptance of contract may be expressed by electronic means of communication
and the same shall have legal validity and enforceability. Some highlights of the
Act are listed below.
68.2 DEFINITIONS
In this Act, unless the context otherwise requires,
1. 'access' with its grammatical variations and cognate expressions means
gaining entry into,
instructing or communicating with the logical, arithmetical, or memory function
resources of a
computer, computer system or computer network;
2. 'addressee' means a person who is intended by the originator to receive
the electronic record but
does not include any intermediary;
3. 'adjudicating officer' means an adjudicating officer appointed under sub-
Section (1) of Section
46;
4. 'affixing digital signature' with its grammatical variations and cognate
expressions means adoption
of any methodology or procedure by a person for the purpose of authenticating
an electronic
record by means of digital signature;
5. 'appropriate Government' means as respects any matter, -
(i) enumerated in List II of the Seventh Schedule to the Constitution;
(ii) relating to any State law enacted under List III of the Seventh Schedule to
the Constitution, the State Government and in any other case, the Central
Government;
6. 'asymmetric crypto system' means a system of a secure key pair
consisting of a private key for
creating a digital signature and a public key to verify the digital signature;
7. 'certifying authority' means a person who has been granted a licence to
issue a Digital Signature
Certificate under Section 24;
8. 'certification practice statement' means a statement issued by a
Certifying Authority to specify
the practices that the Certifying Authority employs in issuing Digital Signature
Certificates;
471
9. 'computer' means any electronic magnetic, optical or other high-speed data
processing device or system which performs logical, arithmetic, and memory
functions by manipulations of electronic, magnetic or optical impulses, and
includes all input, output, processing, storage, computer software, or
communication facilities which are connected or related to the computer in a
computer system or computer network;
10. 'computer network' means the interconnection of one or more computers
through -
(i) the use of satellite, microwave, terrestrial line or other communication media;
and (ii) terminals or a complex consisting of two or more interconnected
computers whether or not the interconnection is continuously maintained;
11. 'computer resource' means computer, computer system, computer
network, data, computer
data base or software;
12. 'computer system' means a device or collection of devices, including
input and output support
devices and excluding calculators which are not programmable and capable of
being used in
conjunction with external files, which contain computer programmes, electronic
instructions,
input data and output data, that performs logic, arithmetic, data storage and
retrieval, communication
control and other functions;
13. 'controller' means the Controller of Certifying Authorities appointed
under the sub-Section (1) of
Section 17;
14. 'Cyber Appellate Tribunal' means the Cyber Regulations Appellate
Tribunal established under the
sub-Section (1) of Section 48;
15. 'data' means a representation of information, knowledge, facts, concepts
or instructions which
are being prepared or have been prepared in a formalised manner, and is
intended to be processed,
is being processed or has been, processed in a computer system or computer
network, and may
be in any form (including computer printouts magnetic or optical storage media,
punched cards,
punched tapes) or stored internally in the memory of the computer;
16. 'digital signature' means authentication of any electronic record by a
subscriber by means of an
electronic method or procedure in accordance with the provisions of section 3;
17. 'Digital Signature Certificate' means a Digital Signature Certificate
issued under the sub-Section
(4) of Section 35;
18. 'electronic form' with reference to information means any information
generated, sent, received
or stored in media, magnetic, optical, computer memory, micro film, computer
generated micro
fiche or similar device;
19. 'Electronic Gazette' means the Official Gazette published in the
electronic form;
20. 'electronic record' means data, record or data generated, image or sound
stored, received or sent
in an electronic form or micro film or computer generated micro fiche;
21. 'function', in relation to a computer, includes logic, control arithmetical
process, deletion, storage
and retrieval and communication or telecommunication from or within a
computer;
22. 'information' includes data, text, images, sound, voice, codes, computer
programmes, software
and databases or micro film or computer generated micro fiche;
23. 'intermediary' with respect to any particular electronic message means
any person who on behalf
of another person receives, stores or transmits that message or provides any
service with respect
to that message;
24. 'key pair', in an asymmetric crypto system, means a private key and its
mathematically related
public key, which are so related that the public key can verify a digital signature
created by the
private key;
25. 'law' includes any Act of Parliament or of a State Legislature,
Ordinances promulgated by the
President or a Governor, as the case may be. Regulations made by the President
under the article
472
240, Bills enacted as President's Act under the sub-Clause (a) of Clause (1) of
the Article 357 of the Constitution and includes rules, regulations, bye laws and
orders issued or made there under;
26. 'licence' means a licence granted to a Certifying Authority under the
Section 24;
27. 'originator' means a person who sends, generates, stores or transmits any
electronic message or
causes any electronic message to be sent, generated, stored or transmitted to any
other person
but does not include an intermediary;
28. 'prescribed' means prescribed by the rules made under this Act;
29. 'private key' means the key of a key pair used to create a digital
signature;
30. 'public key' means the key of a key pair used to verify a digital signature
and listed in the Digital
Signature Certificate;
31. 'secure system' means computer hardware, software, and procedure that
(a) are reasonably secure from unauthorised access and misuse;
(b) provide a reasonable level of reliability and correct operation;
(c) are reasonably suited to performing the intended functions; and
(d) adhere to generally accepted security procedures;
32. 'security procedure' means the security procedure prescribed under the
Section 16 by the Central
Government;
33. 'subscriber' means a person in whose name the Digital Signature
Certificate is issued;
34. 'verify' in relation to a digital signature, electronic record or public key,
with its grammatical
variations and cognate expressions means to determine whether —
(a) the initial electronic record was affixed with the digital signature by the
use of a private key
corresponding to the public key of the subscriber;
(b) the initial electronic record is retained intact or has been altered since
such an electronic
record was so affixed with the digital signature.
68.3 ELECTRONIC GOVERNANCE
Chapter III of the Act deals with electronic governance and provides that
information or any other matter shall be in writing or in the typewritten or
printed form, then notwithstanding anything contained in such law, such
requirement shall be deemed to have been satisfied if such information or matter
is -
(a) rendered or made available in an electronic form; and
(b) accessible so as to be usable for a subsequent reference. The said chapter
also details recognition
of Digital signatures.
The said chapter also details the legal recognition of Digital Signatures.
68.4 CERTIFYING AUTHORITIES
Chapter IV of the said Act gives a scheme for Regulation of Certifying
Authorities. The Act envisages a Controller of Certifying Authorities who shall
perform the function of exercising supervision over the activities of certifying
authorities as also laying down standards and conditions governing the certifying
authorities as also specifying the various forms and content of Digital Signature
Certificates. The Act recognises the need for recognising foreign certifying
authorities and it further details the various provisions for the issue of license to
issue Digital Signature Certificates.
68.5 DIGITAL SIGNATURE CERTIFICATES
Chapter VII of the Act deals with the scheme of things relating to Digital
Signature Certificates. The duties of subscribers are also enshrined in the said
Act.
473
68.6 PENALTIES
Chapter IX of the said Act talks about penalties and adjudication for various
offences. The penalties for damage to computers, computer system, etc., has
been fixed as damages by way of compensation not exceeding Rs. 1 crore to
affected persons. The Act talks of appointment of any officers not below the
rank of a director to the Government of India or an equivalent officer who shall
adjudicate whether any person has made a contravention of any of the provisions
of the Act or rules framed there under. The said adjudicating officer has been
given the powers of a Civil Court.
68.7 APPEAL
Chapter X of the Act talks about the establishment of the Cyber Regulations
Appellate Tribunal which shall be an appellate body where appeals against the
orders passed by Adjudicating Officers will be preferred.
68.8 INVESTIGATION
Chapter XI of the Act talks about various offences and the said offences will be
investigated by the Police Officer not below the rank of Dy. Superintendent of
Police. These offences include the tampering with computer source documents,
publishing of information, which is obscene in electronic form and hacking.
The Act also provides for the constitution of the Cyber Regulation Advisory
Committee which shall advise the Government as regards any rules or for any
other purpose connected with the said Act. The said Act also proposes to amend
the Indian Penal Code 1860, The Indian Evidence Act 1872, The Bankers Book
Evidence Act 1891, The Reserve Bank of India Act 1934, to make them in tune
with the provisions of the IT Act.
68.9 LET US SUM UP
This Act is very important in the electronic age, where documents are
transmitted through electronic means. Students should be aware of its relevance
and provisions, when e-commerce and e-transactions are on the rise.
68.10 KEYWORDS
Digital Signature; Asymmetric Crypto System; Computer data; Digital
Signature; Information Originator; Secure System; Electronic Commerce
68.11 CHECK YOUR PROGRESS
1. The IT Act was introduced on account of the initiatives of
(A) IT industry of India (B) Indian Parliament
(C) Reserve Bank of India (D) None of the above
68.12 ANSWER TO 'CHECK YOUR PROGRESS'
1. (D) None of the above - United Nations Commission on International Trade
Law.
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