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Legal Issues Relevant for Bankers – Important Acts Pertaining to

Banking Objectives
to list out few important Acts in the context of banking.
Need to know about the Acts
It is necessary for bankers to be aware of legal aspects pertaining to various
activities undertaken by them.
Over a period of time various legal issues pertaining to above Acts have been settled
in the court of law.
Relevant Acts
Some of the important Acts which are relevant for day to day functioning of Banks
are:
• The Indian Contract Act, 1872
• The Negotiable Instruments Act, 1881
• The Transfer of Property Act, 1882
• The Indian Stamp Act, 1899
• The Evidence Act, 1872
• The Indian Registration Act, 1908
• The Sale of Goods Act, 1930
• The Companies Act, 1956
• The Limitation Act, 1963
Few Relevant 19th Century Acts
Here are few acts passed between 1872 and 1899 that hold relevance for the
bankers.
Indian Contract Act: This Act defines as to what a contract is and the conditions it
must satisfy to qualify as a contract.
A contract is an agreement enforceable by law. Two important aspects for the
formation of a contract are:
1. An agreement
2. The agreement should be enforceable by law
Negotiable Instruments Act: This Act defines the law relating to promissory notes,
bills ofexchange and cheques and it also deals with ‘negotiation, noting and
protesting’ etc.
Transfer of Property Act: This Act defines the law relating to the transfer of
property by act of parties, sale, mortgage and lease of immovable property.
Indian Stamp Act: This Act relates to stamping of documents. It defines documents
chargeable with stamp duty and deals with mode of payment of stamp duty etc.
Indian Evidence Act: This act is concerned with evidence – oral/ documentary and
their admission/ rejection, relevancy of facts, witnesses etc.
Few Relevant 20th century Acts
Here are few Acts passed between 1908 and 1963 that hold relevance for the
bankers. Registration Act, 1908: This Act takes care of issues related to
‘registrable documents, place and time of registration, effects of registration and
non-registration, duties and powers of registering officers etc.
Sale of Goods Act, 1930: This Act deals with contract of sale, contract transfer of
property, performance of sale contract, rights of unpaid seller and suits for breach of
security etc.
Companies Act, 1956: This Act deals with all issues pertaining to companies.
Limitation Act, 1963: This Act pertains to limitation of suits, appeals &
applications, computation of period of limitation etc.
Legal Issues Relevant for Bankers – Legal Issues Pertaining to Guarantees
Objectives
To:
· Understand finer legal points related to Bank Guarantee
· Understand finer legal points related to Personal Guarantee

Bank Guarantee – Liability When Absolute


Let us start with Texmaco Limited vs. State Bank of India & Others, a case where the
bank had to make payment on demand. The bank guarantee, in this case, was for
performance of the contractual obligations of the party, for which the bank could not
oblige as the plaintiff filed a suit for injunction restraining the Bank from making any
payment pursuant to the bank guarantee.
But since the bank had undertaken to pay on demand and without contestation, demur or
protest, and without reference to such party, it was finally required to pay on demand.

The Case: The Bank issued a guarantee whereby it irrevocably and unconditionally
guaranteed due performance in an orderly manner of the contractual obligations of the
plaintiff and declared that in the event of default, the Bank would pay, on first demand,
the guaranteed amount without any contestation, demur or protest and/or without
reference to the plaintiff and/or without questioning the legal relationship subsisting
between the plaintiff and the beneficiary. The beneficiary having invoked the bank
guarantee, the plaintiff filed a suit for injunction restraining the Bank from making any
payment pursuant to the bank guarantee.

The Verdict:The High Court held that the plaintiff was not entitled to an injunction.
During the course of the judgment, the High Court observed: "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, 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 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 further stipulated that the Bank
should forthwith pay the amount due ‘notwithstanding any dispute between STC and
Texmaco'. In that context, the moment a demand is made without protest and
contestation, the Bank is obliged to pay irrespective of any dispute as to whether there
has been performance in an orderly manner of the contractual obligation by the party."

Elaboration of the Issue Involved


The law, at present, seems to be that an injunction restraining the bank from making
payment under a bank guarantee or letter of credit, cannot be issued if, under the terms of
the bank guarantee or the letter of credit, the bank has undertaken to make payment on
default and without proof or conditions, unless there is clear fraud of which the bank has
notice. Where the performance guarantee of the bank stipulated that the payment would
be made by the bank on demand and without proof, the performance guarantee would be
virtually a promissory note payable on demand. This was also brought out in the
following three cases.
Edward Owen Engineering Limited vs. Barclays Bank International Limited: Lord
Denning,
Master of Roils, in the case of Edward Owen Engineering Limited vs. Barclays Bank
International
Limited 1977 (3), Weekly Law Reports 764, observed:
“All this leads to the conclusion that the performance guarantee stands on a similar
footing to a letter of credit. A bank which gives a performance guarantee must honour
that guarantee according to its terms. It is not concerned in the least with the relations
between the supplier and the customer; nor with the question whether the supplier has
performed his contracted obligation or not; nor with the question whether the supplier is
in default or not. The bank must pay according to its guarantee, on demand, if so
stipulated, without proof or conditions. The only exception is when there is a clear fraud
of which the bank has notice."
Minerals and Metals Trading Corporation of India vs. Suryaballau Sheth: Where in a
bank guarantee there was no stipulation that irrespective of the dispute between the
parties, the bank would be obliged to pay, the Division Bench of the Calcutta High Court,
in the case of Minerals and Metals Trading Corporation of India vs. Suryaballau Sheth
(1970), 74 Calcutta Weekly Notes 991, upheld the order of injunction granted by the trial
Court.
SBI vs. Economic Trading Corporation Ltd.: The High Court distinguished the decision
of the Division Bench in the case of State Bank of India vs. Economic Trading
Corporation Limited, AIR 1975, Calcutta 145. In that case, the Division Bench had
upheld the order of injunction made by the trial Court restraining the State Bank from
making payment under the bank guarantee. Observing that the facts of the said case were
peculiar, the High Court pointed out that in that case there was already an order of
injunction against the foreign buyer and foreign banker and, therefore, that order should
not be allowed to be circumvented by allowing the State Bank to make payment.

Bank Guarantee – Liability to Pay on Demand -- Fraud has to be Pleaded and Proved
Presented is a case where there is a Liability to pay on Demand. The case of M/s.. Escorts
Limited (Plaintiff) vs. Modern Insulators and Another (Defendants) also held that Fraud
has to be pleaded and proved. Thus, where the Bank has agreed to pay on demand for any
shortfall in guaranteed performance of working of machinery and equipment, the Bank is
bound to pay and cannot be restrained by injunction on ground of fraud which has not
been pleaded and/or proved.

The Case
M/s. Escorts Limited (Plaintiff) agreed to supply a 1000 KVA Generating Set to the M/s.
Modern Insulators. For satisfactory performance of the Generating Set, the Plaintiff was
obliged to furnish a bank guarantee. Bank furnished the guarantee containing following
two material clauses:
(1) “We agree to indemnify and keep indemnified the purchaser against any loss or
damage caused to or suffered or would be caused or suffered by the purchaser to the
maximum extent of Rs. 2,24,700/- (Rupees two lacs twenty four thousand seven hundred
only) by reason of any shortfall in guaranteed performance of working of machinery and
equipment being supplied under the said contract.”
(2) “We undertake to pay the amount due and payable under guarantee without any
demur, on demand from purchaser stating that the amount claimed as due by way of loss
or damage caused to or would be caused to or suffered by purchaser by reason of any
shortfall in guaranteed performance, engineering and supply of machinery and equipment
in the said contract."

The Issue Involved


On 29th December 1988, the Generating Set was installed. Following its unsatisfactory
performance, the Defendant's Counsel wrote on 14th April 1987 to the Bank stating that
the Plaintiff had not carried out all the work and had not commissioned the Generating
Set successfully and that the Plaintiff had suffered heavy losses and demanded payment
of the guaranteed sum. The Bank did not make payment. In a suit filed by the Plaintiff for
issue of permanent injunction restraining the Defendant from recovering and the Bank
from making payment of the guaranteed sum, the Court, while granting adinterim
injunction, observed that the demand under the bank guarantee was not strictly in
accordance with the terms of the bank guarantee. Thereupon, the Defendant issued
another notice on 22nd June 1987 to the Bank demanding payment of the guaranteed sum
"towards the losses and damages already caused by reason of shortfall in the guaranteed
performance, engineering and supply of machinery and equipment.
The Bank still did not make payment.

The Suit
Counsel for the Plaintiff submitted that the Defendant had played fraud on the Bank
because: (a) the reasons given in the letter of demand dated 14th April 1987 was different
from the one pleaded in the subsequent notice dated 22nd June 1987
(b) the Defendant's own representative had signed the report about the satisfactory
installation and performance of the Generating Set and (c) the Defendant had concealed
from the Court the minutes of the discussions that took place between the representatives
of the Plaintiff and the Defendant on 21st February 1987, which recorded that the defects,
if any, were removed.

Observations by the Court


The Delhi High Court observed that the position in law with regard to the enforcement of
the bank guarantees and letters of credit is well settled. Referring to the latest decision of
the Supreme Court in U.P. Co-operative Federation Limited versus Singh Consultants &
Engineers (P) Ltd., (1987) 5 JT 406, the Court observed that the bank must pay according
to the guarantee except in case of fraud or irretrievable justice. The Supreme Court had
approved of the observations of Lord Diplock in the case of UCM (Investments) Ltd.
versus Royal Bank of Canada (1982) 2 All ER 720. Lord Diplock’s Observation: "…to
this general statement of principle as to the contractual obligation of the confirming bank
to the seller, there is one established exception, that is, where the seller, for the purpose of
drawing on the credit, fraudulently presents to the confirming bank documents that
contain, expressly or by implication material representation of fact that to his knowledge
are untrue... The exception for fraud on the part of the beneficiary seeking to avail
himself of the credit is a clear application to the maxim-ex turpi causa non oriture actio'
or if plain English is to be preferred, 'fraud unravels all', the Courts will not allow their
process to be used by a dishonest person to carry out a fraud."

Question of Fraud
The Court observed that firstly there were no clear averments of fraud in the pleading and
secondly, the fraud has to be pleaded and proved, which was not so in the present case.
Rejecting the contentions that the Defendant had deliberately and knowingly made false
averments to the bank, the Court held that the inconsistent statements in the letters dated
14th April 1987 and
22nd June 1987 would not amount to fraud.
Nor would it lead to the conclusion that the Defendant was seeking to play a fraud upon
the Court.
The Court felt that the Bank was perhaps right in not taking cognisance of the letter dated
14th April
1987 since the demand was not from the beneficiary himself and was not in terms of the
bank
guarantee. Furthermore, there was nothing to indicate that the statements made in the
letter dated
22nd June 1987 were knowingly false and were fraudulently made.
Screen title - The Verdict
The Court was of the view that merely because a certificate of satisfactory installation
was issued
on 28th December 1986 by the Defendant would not mean that after installation there
would be no
complaints. The Court observed that as the bank guarantee was a performance guarantee,
the
bank was under an obligation to indemnify for any loss or damage suffered by reason of
shortfall in
the guaranteed performance.
Screen title - Further Clarification
During the case, the Court in passing 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.
Hence it stands that, having undertaken absolute liability under the guarantee, the bank,
in case of doubts, should approach the Court for suitable directions.
Screen title - Personal Guarantee
Section 127 of the Indian Contract Act, 1872 provides that anything done, or any promise
made, for the benefit of the principal debtor, may be sufficient consideration to the surety
for giving the guarantee. By virtue of this section it is felt that guarantees obtained by
banks as security long after the loans was sanctioned and disbursed are treated as without
consideration and hence not valid.
The available case laws on the point do not make us any wiser. Therefore, banks take
additional care while taking guarantees long after they sanctioned loan and suitably word
the guarantee document to avoid enforceability problems. In that context the case of 270
Union Bank of India Vs Monin Enterprises decided by Karnataka High Court would be
useful to banks in designing their guarantee documents.
Screen title - The Facts
Union Bank of India (UBI) granted a Cash Credit Limit to one M/s Monin Enterprises in
the year 1981 and enhanced the limit from time to time, lastly to Rs. 45,000 on
8.12.1983. Further on 14.5.1984, a guarantee was obtained from a third party for the cash
credit granted to the borrower. The loans went bad and UBI sued the borrower and the
guarantor. The guarantor contended that the guarantee document was obtained long after
the loan was sanctioned and hence the requirement of Section 127 of the Indian Contract
Act, 1872 is not satisfied. Therefore, it is invalid for lack of consideration and thus he is
not liable. UBI refuted the said contention.
Screen title - Decision of the Court
After hearing the contentions of both the parties, the court held Per K.L.Manjunath that;
"When we look at Exhibit P.3 (deed of guarantee) the 2nd defendant (guarantor) has not
executed the deed of guarantee admitting the past consideration passed on to the 1st
defendant. Ex. P.3 is printed form.
Except filling the name of the 1st defendant and the amount, the rest of the document is
in printed form. Therefore, the plaintiff bank has made use of the printed form in its usual
course. Generally, such documents will be obtained along with the other loan forms to be
executed by the principal borrower. In the same fashion, Ex. P3 has come into existence"
It is not the case of the bank that defendant no. 1 (borrower) had undertaken to furnish a
guarantee or surety at a later date. Even according to P.W.I (bank's witness), the borrower
had not been called upon to furnish the guarantee. In the absence of proper pleadings (and
evidence to show the guarantee was for past consideration and pursuant to an undertaking
given by the borrower) I have to hold that Ex.P.3 has not been executed by the guarantor
acknowledging the past consideration passed on to the borrower. So, in the
circumstances, I find no merits in the case of the bank.
Screen title – Notes
Without going into, correctness or otherwise of the judgment, one can say that Union
Bank of India could not produce enough evidence to prove the case and thus lost the case
against the guarantor.
The judgment is a pointer to the perils of taking printed forms without considering its
suitability to the circumstances of the case. In the case UBI could have succeeded, if it
had obtained the printed form with suitable changes to prevent guarantor from raising
contentions of lack of consideration.
Screen title - Personal Guarantee
In the case of The Bank of Bihar Limited: (Appellant) vs. Damodar Prasad and Another
(Respondents)
AIR 1969 Supreme Court 297, the question whether a creditor is bound to exhaust his
remedy against the principal debtor before he can sue the surety, was settled.
Screen title - The Facts
The bank lent monies to respondent No.1 Damodar Prasad on the guarantee of respondent
No.2 Paras Nath Sinha. In terms of the guarantee bond executed by respondent No.2 on
15th June 1951, respondent No.2 agreed to pay and satisfy the liabilities' of respondent
No.1 up to Rs.12,000/ - and interest thereon, two days after demand. The bond further
provided that the bank would be at liberty to enforce and to recover upon, the guarantee,
notwithstanding any other guarantee security or remedy which the bank might hold or be
entitled to in respect of the amount secured. In spite of demands, the respondents did not
pay to the bank the sum of Rs.11,723.56 on account of principal and Rs.2,769.37 on
account of interest.
The bank filed a suit in the Court of the Subordinate Judge, 1st Court, Patna, which was
decreed in favour of the bank. The trial Court, however, directed that the "bank shall be at
liberty to enforce its dues in question against respondent No.2, only after having
exhausted its remedies against respondent No.1."
An appeal filed by the bank challenging the legality and propriety of the aforesaid
direction was dismissed by the High Court.
Screen title - Supreme Court’s Stance
The bank went in appeal to the Supreme Court. For the following reasons, the Supreme
Court allowed the appeal and directed the deletion of the trial Court's direction that the
bank should exhaust its remedies against respondent No.1, before it could proceed against
respondent No.2:
i. Under section 128 of the Indian Contract Act, save as provided in the contract, the
liability of the surety is co-extensive with that of the principal debtor. His liability is
immediate and cannot be deferred until the creditor has exhausted his remedies against
the principal debtor.
ii. A surety has no right, before making payment, to dictate terms to the creditor, and ask
him to pursue his remedies against the principal debtor in the first instance.
iii. A surety has no right, in the absence of some special equity, to restrain an action
against him by the creditor, on the ground that the principal debtor is solvent or that the
creditor may have relief against the principal debtor in some other proceedings. Likewise
where the creditor has obtained a decree against the surety and the principal debtor, the
surety has no right to restrain execution against himself until the creditor has exhausted
his remedies against the principal debtor.
iv. A guarantee taken by a bank is usually taken by it as collateral security. It will become
useless if the bank's right against the surety can be so easily cut down. It is the duty of the
surety to pay the decretal amount.

3. Legal Issues Relevant for Bankers – Secured Credit


Screen title – Objectives
On completion of this module, you will be able to:
• Understand various cases related to Mortgages
• Understand various cases related to Hypothecation
• Understand finer points relating to Secured Creditors
Screen title - Registration of Charge
Presented is a case involving the issue of secured creditor. The case under
consideration is
M/s. Reshma Estate Private limited Advance Commercial Company limited
{Petitioner} 78
Bombay Law' Reporter 654.
It is obligatory upon a secured creditor to make diligent enquiries to ascertain
whether the
charge created by a limited company in his favour has been registered with the
Registrar of
Companies in time, and if has not been so registered to obtain permission for
condonation of
delay.
Screen title - Facts of the Case
The petitioner granted a loan to the company, which was secured by an indenture of
mortgage,
duly executed and registered with the Registrar of Assurances, Bombay. The
company filed
with the Registrar of Companies an application in Form No.8, to have the said charge
registered in the records of the Registrar. The company did not file a copy of the said
indenture
of mortgage, even though the Registrar called upon the company to do so. After
considerable
delay, the company filed the copy of the indenture, whereupon the Registrar wrote to
the
company requiring it to obtain an order from the competent Court for condonation of
the delay.
A copy of the letter of the Registrar was sent to the petitioner. All that the petitioner
did was to
write two letters to the company, requiring it to obtain an appropriate order from the
Court and
to file a certified copy thereof with the Registrar of Companies. Nothing further was
done by the
petitioner, for getting the charge registered with the Registrar of Companies.
What Ensued …
The petitioner, in exercise of the powers as mortgagee, sought to put the mortgaged
property
for sale. A day prior to the date fixed for sale of the mortgaged property, an
unsecured creditor
of the company filed a petition for winding up the company and applied for
appointment of a
provisional liquidator. The present petition was filed by the petitioner seeking
condonation of
delay in filing the particulars of charge created by the company. Roughly, the delay
in seeking
from the Court the condonation of delay was about three years from the date of
execution of
the said indenture of mortgage. It was contended on behalf of the petitioner that the
petitioner
believed that the company would take appropriate action to have the said mortgage
registered.
After writing two letters, the company did not make any enquiries either from the
company or
the Registrar of Companies, with regard to the registration of the mortgage, and that
the
omission to register the charge was accidental or due to the inadvertence, and, in
any event,
was due to sufficient cause.
Observations by the High Court
The High Court rejected all these contentions and observed as follows:
(i) It is inconceivable that after having known the fact that the company was
negligent
in not complying with the requisitions, so as to have the charge registered with the
Registrar of Companies within time, a diligent secured creditor would have rested
on his oars, in the so-called belief that the company would take steps to obtain the
requisite order from the Court.
(ii) The plea appears to be a clumsy attempt to camouflage utter negligence on the
part of the petitioner, in not making any enquiry as to whether any order for
condonation was obtained to have the charge registered.
(iii) While it is true that the expression "sufficient cause" must be construed in favour
of
a person who invokes exemption from the rigours of law, a person who, on his own
showing, is unable to say as to what prevented him from adopting proceedings for
registration of the charge, is not entitled to get any relief.
(iv) The Courts do not lean to protect the negligent or those who lack bonafides.
(v) The winding up petition is for the benefit of all unsecured creditors and creates
contingent rights and legitimate expectation, in favour of all unsecured creditors,
which cannot be defeated at the hands of a negligent secured creditor.
Screen Title – The Verdict
While normally the Court would accede to an application to register a mortgage or
charge out of
time, provided the application is made bonafide and in good faith, an application of a
negligent
creditor cannot be said to be one made in good faith.
In the result the petition was dismissed with costs.
Screen title - Secured credit – Mortgages
The next case that concerns the issue of Mortgage By Joint Owner Rights Of
Mortgagee.
This is with regard to Debi Singh (Appellant) 1'5 Shim Singh and Others
(Respondents)
AIR 1971 Delhi 316.
Two questions came up for consideration in this appeal as to whether:
i. A joint owner could mortgage 'his share in the property”
ii. The other joint owner could defeat the rights of the mortgagee.
Screen title - The Facts
The facts, briefly stated, were that the appellant (Debi Singh) and his father, Khem
Ram, were
the joint owners of a land situated in village Ladpur, Delhi. Khem Ram obtained an
advance of
Rs. 2,OOO from the respondents, executed a mortgage agreement, claiming himself
to be the
sole owner of the land, and delivered possession of the land to the respondents. The
mortgage
agreement was not registered. The appellant (Debi Singh) alleged that the
respondents were
trespassers and filed a suit for possession of the land.
Screen title - Decree by the Trial Court
The trial Court decreed the suit on the ground that the respondents were in
possession of the
land as trespassers since the mortgage agreement was unregistered, and as Khem
Ram was
only a co-owner, he was not entitled to mortgage the whole land without the consent
of the
appellant.
On appeal, the Senior Sub-Judge held that the appellant (Debi Singh) could not be
permitted to
evict the respondents without the settlement of the dispute between Khem Ram and
the
respondents. The Senior Sub-Judge felt that the appellant had been put up merely to
dislodge
the respondents from the possession of the land, and since the appellant was not in
actual
possession, before the respondents were put in possession, he was not entitled to a
decree for
possession.
Screen title - The High Court’s Stance
Being aggrieved by, and dissatisfied with, the decision of the Senior Sub-Judge, the
appellant
preferred an appeal to the High Court.
The High Court dismissed the appeal and observed as follows:
• A co-owner was entitled to mortgage his share in the property (Refer Gulab Singh
us.
L. Him Lal, AIR 1954 All 314, Mt. Zura us. Mohd. Ayub, AIR 1943, page 17).
• The definition of the mortgage given in section 58 of the Transfer of Property Act
shows
that a mortgage is “a transfer of an interest in specific immovable property for the
purpose of securing the payment of money advanced or to be advanced by way of
loan." Therefore, it is clear that Khem Ram had mortgaged his interest in the land to
the
respondents, and since he had put the respondents in possession of the 'and, in view
of the provisions of section 53A of the Transfer of Property Act, he was debarred from
enforcing his right to possession.
• The appellant was also not entitled to get possession from the respondents on the
footing that they were trespassers since as against Khem Ram they could not be
considered "trespassers”.
• The suit was merely an attempt to avoid the mortgage through the instrumentality
of the
appellant. In order to succeed, the appellant had to show that he was the person
entitled to get possession before the alleged trespassers got possession. Inasmuch as
the appellant had not been dispossessed by the respondents, who were put into
possession by Khem Ram, the appellant had no better claim against the respondents
than he had against Khem Ram. The appellant could not have got possession from
his
father because they were the joint owners and, therefore, the appellant could not
dispossess the respondents who had the same rights as Khem Ram.
Screen title - Secured Credit – Mortgages
Here is another case under Mortgages, which concerned the issue of Equitable
Mortgages. The
case here is C. Assiamma (Appellant) Vs.
State Bank of Mysore and Others (Respondents).
AIR 1990 Kerala 157
Important questions relating to validity of equitable mortgage, retirement of partner
and
acknowledgement of liability arose for consideration in this appeal.
Screen title - Facts of the Case
The Bank had granted certain credit facilities to the partnership firm. The business of
the firm
was being carried by the Manager by virtue of a power of attorney executed by the
partners of
the firm.
One of the partners, Ms. A, deposited a registration copy of the Deed of Gift executed
in favour
of herself and other donees, with the Bank, with intent to create mortgage of her
share in the
immovable property gifted to her. The original Deed of Gift was with one other
donee, and,
therefore, was not available for deposit.
Another partner, Ms. B, deposited title deeds of her properties in favour of the Bank.
She also
executed a power of attorney in favour of the Bank authorising the Bank to sell the
mortgaged
properties and to reimburse themselves out of sale proceeds.
Following default in payment, the Bank filed the suit against the firm, Ms. A and Ms.
B, as
partners, the Manager, and the purchasers of the properties mortgaged to the Bank.
The suit was contested by the Defendants. Ms. A contended that she had retired as a
partner
and an agreement of dissolution was entered into by the partners. She had given
public notice
of retirement in the newspaper. After dissolution, the Manager had no authority, as
the power of
attorney had come to an end. She had not created any equitable mortgage. In any
case,
another partner, Ms. B, had undertaken to discharge the liabilities of the firm.
Ms. B contended that with the retirement of Ms. A the firm had ceased to exist, that
power of
attorney in favour of the Manager had come to an end and that no equitable
mortgage was
created by her. The other defendants adopted identical defenses.
The Trial Court rejected all the contentions and decreed the suit. However, it found
the
purchasers of the mortgaged properties, bonafide purchasers for value and directed
that the
mortgaged properties be sold only in the last instant.
An appeal to the High Court was preferred by Ms. A.
Screen title - The High Court’s Stance
Dealing with the question of creation of equitable mortgage, the High Court referred
to section
58 (f) of the Transfer of Property Act and observed that the original documents of
title are
required to be deposited for creation of equitable mortgage. Relying on the decision
of the
Division Bench in Syndicate Bank versus Modem Tile and Clay Works 1980 Ker. L.T.
550, the
High Court observed that title deeds would include registration copy of the document
where the
original is lost and the deposit of registration copy would create an equitable
mortgage. While a
revenue receipt or copy of the Transfer Deed will not be documents of title, where
the original is
lost and there are no chances of that document being made use of for any purpose, a
certified
copy, with safeguards, can be received as a document of title.
Screen title - Other Observations of the High Court
The High Court referred to the decision of the Full Bench of the Rangoon High Court
in K.LC.T.
Chidambaram Chettiyar vs. Aziz Meah, AIR 1938 Rang. 149 and the Division Bench
decision of
the Madras High Court in Angu Pillai vs. M.S.M. Kasivisnanathan Chettiar, AIR 1974
Mad. 16,
in which it was held that it was not necessary that the whole or even the most
material of the
documents of title to the property should be deposited, or that the documents
deposited should
show a complete or good title in the depositor and it is sufficient if the deeds
deposited
bonafide relate to the properties or are material evidence of title or are shown to
have been
deposited with the intention of creating a security thereon.
In this case, the original Deed of Gift was not available with the depositor as it is
impossible for
all donees to possess the original deed. The certified copy was deposited with the
Bank. Merely
because the Bank later on insisted on registered mortgage does not nullify the
deposit already
made with intent to create a mortgage.
As regards the question of retirement of Ms. A from partnership, the High Court, on
scrutiny of
evidence on record, found that there was no intimation given to the Bank of
retirement or
dissolution of partnership. Referring to Section 32(3) of the Partnership Act, the High
Court held
that the retiring partner will continue to be liable until public notice of retirement was
given. The
public notice is required to be given as per the provisions of Section 72 of the
Partnership Act.
Intimation has to be given to the Registrar of Firm. A notice is required to be given in
Official
Gazette and in at least one vernacular newspaper circulating in the district where the
firm has
its place of business. Mere giving of notice in vernacular" newspaper will not be
sufficient
compliance of Section 72 of the Partnership Act. Publication in Official Gazette or
proof of
notice to Registrar of Firms is necessary. It was, therefore, held by the High Court
that no
proper notice of retirement was given by Ms. A.
The High Court rejected the contention that the power of attorney stood revoked with
the
retirement of the partner on the ground that under Section 208 of the Contract Act,
the
termination of authority of an agent does not take place so far as regards third
persons before it
becomes known to them.
The High Court, therefore, held that the termination of authority of the manager
would not take
effect as against the Bank and all acts by the manager done on behalf of the firm will
be binding
on the firm and its partners.
As regards acknowledgement of liability signed by the manager, the High Court held
that in
view of very wide power given by the partners, which continued to remain operative
under
Section 208 of the Contract Act and the rights of the Bank were not affected by the
alleged
retirement or dissolution of the firm, the acknowledgement made by the manager
was binding
on the firm and the partners, and the suit was not barred by limitation. In any case,
since an
equitable mortgage was created by Ms. A, the period of limitation of 12 years had not
expired
and the suit cannot be considered as barred by limitation.
In the result the appeal was dismissed.
Screen title - Secured Credit – Hypothecation
Presented is the case of hypothecation under secured credit. The case, Canara Bank
(Petitioner) vs. Asst. Commissioner, (C. r.) Zone III Madras and Others
(Respondents)
AIR 1989 Madras 17 sought to resolve the issue of hypothecation of goods.
The question for consideration was whether debt secured by hypothecation of goods
can be
considered secured debt and would have priority over the sales tax dues of the
Government.
Screen title – The Facts and The Outcome
Briefly the facts were that the Bank had granted certain facilities in July 1974 to the
Borrower
firm on hypothecation of the stock-in-trade etc. The borrower firm was in arrears of
payment of
sales tax for the assessment year 1978-79 to 1980-81. The Assistant Commissioner,
therefore,
issued a restraint order demanding payment and on nonpayment attached the
movable
properties of the Borrower firm, which were already hypothecated in favour of the
Bank. Bank
requested for release of the hypothecated goods claiming first charge. Instead of
sending any
reply, the Assistant Commissioner issued notice of sale of hypothecated goods.
The High Court held that the hypothecation in favour of the Bank is not a secured
debt, which
could be treated in preference to the Government dues.
In the circumstances, the Petition filed by the Bank was dismissed.
Screen title - Points for Consideration
No reasons have been given as to why hypothecation of goods cannot be considered
as
creating a secured debt. In numerous decisions, it has been held that hypothecation
is only an
extended idea of a pledge, the creditor permitting the debtor to retain possession
either on
behalf or in trust for himself. The creditor was, therefore, entitled to retain possession
and also
to exercise right of private sale, which is permitted by the terms of hypothecation of
Agreement.
(See also AIR 1988 Andhra Pradesh 18). The decision requires consideration.
Screen title - Secured Debt – Hypothecation
The case of State Bank of India vs. M/ s. Victory Export Import Syndicate &
Others, AIR
1978 Jammu & Kashmir 76 dealt with the deed of hypothecation.
The stamp duty on a deed-of hypothecation containing a power of attorney clause
will be as on
an agreement and a power of attorney.
Screen title - Facts of the Case
As security for advances granted by the Bank, an agreement of hypothecation was
executed by
the borrower in favour of the Bank. Stamps of the value of Rs.11.50 (that is Rs.1.50
for
agreement and Rs.10 for power of attorney) were affixed to this agreement. An
objection was
taken that the agreement was not duly stamped and was therefore, inadmissible in
evidence.
Screen title - The High Court’s Stance
The High Court held that the agreement was sufficiently stamped. As delivery of
possession of
the goods was not given by the borrower to the Bank, it would be covered by Article
5(C) and
not by Article 6(2) of the First Schedule to the Stamp Act. In the course of his
judgment, LK.
Kotwal, J., said:
"A deed of an agreement not falling within the definition of a pawn or pledge would
not be
covered by Article 6(2) of Schedule 1 to the Stamp Act and consequently the stamp
payable on
such a document would not be governed by the schedule provided therein. The
crucial question
which, therefore, falls for the determination is whether or not in the instant case,
delivery of
possession of the goods hypothecated had also passed on the Bank at the time the
agreement
dated the 18th March 1970 came to be executed. In this score, there is no dispute
between the
parties, and rightly so, because even on a plain reading of clause 6 of the agreement,
it
transpires that the possession of the goods hypothecated was to remain with the
debtor itself.
That being so, this deed cannot be held-to be a deed of pawn or pledge so as to
attract the
mischief of Article 6(2) of Schedule 1 to the Stamp Act. A transaction of
hypothecation and a
transaction of pledge do have a common ingredient in as much as both of them
create a
security in the goods hypothecated or pledged for the repayment of the loan, the
ownership in
the goods remaining with the person hypothecating or pledging the same.
Nevertheless, there
is a distinction between these two transactions because unlike a pledge where the
possession
of the goods pledged must pass on to the pawnee, no such possession passes on to
the
creditor in the case of hypothecation."
Screen title - Other Issues
Article 5 of Schedule 1 of the Stamp Act prescribes stamp duty payable on an
agreement or
memorandum of agreement (a) if relating to sale of a bill of exchange; or (b) sale of
Government security or a share in an incorporated company, or other body
corporate; or (c) if
not otherwise provided for Article 6 prescribes stamp duty, inter alia, on an
agreement relating
to deposit of title deeds, pawn or pledge of movable property. If the agreement is not
pawn or
pledge, undoubtedly it will not fall under-Article 6. Section 172 of the Contract Act
defines
pledge to mean bailment of goods as security for payment of-debtor performance of
a promise,
Section 148 of the Contract Act defines bailment to mean delivery of goods by one
person to
another for some purpose upon a contract that they shall, when the purpose is
accomplished,
be returned or otherwise disposed of according to the directions of the person
delivering them.
Thus, one of the ingredients of a valid pledge is delivery of goods by the pawnor to
the pawnee.
On perusal of the agreement in question, the High Court found that it is specifically
stated
therein that the possession of the goods hypothecated was to remain with the
borrower. The
agreement was, therefore, rightly held to fall under Article 5 and not under Article 6
of Schedule
1 to the Stamp Act.
Screen title - Hypothecating Bank - Whether Liable For Accident
In the area of hypothecation, here is another case -- Bank of Baroda (Appellant)
vs. RabarJ
Bachubhai Hirabhai and Others (Respondents) AIR 1987 -Gujarat 1.
The question in this appeal was whether the Bank is vicariously liable for damages as
a result
of negligent driving of the motor truck hypothecated by the owner to the Bank.
The Motor Accident Claims Tribunal held that the hypothecating Bank steps into the
shoes of
the owner and is, therefore, vicariously liable. "
Being aggrieved, the Bank appealed to the High Court. Criticizing vehemently the
one-line
judgment of the Tribunal, the High Court said that the Tribunal has completely
ignored the jural
relationship between the owner of the motor truck and the hypothecating Bank.
Screen title - Facts of the Case
The motor truck met with an accident with a passenger bus due to collision causing
injuries to
some of the passengers of the bus. The Tribunal held both the drivers guilty of care
and caution
and apportioned the liability at 25 per cent for the bus driver and 75 per cent for the
truck driver.
The Tribunal held the owners of both the vehicles vicariously liable and also held the
hypothecating Bank vicariously liable.
Screen title - The High Court’s Stance
"When a property is hypothecated with the creditor, it is pledged (charged) as
security or
collateral for a debt without physical transfer thereof to the creditor. The title to the
property
does not pass to the creditor but the creditor has merely the right to sell the pawn
(security)
upon default. In other words, the hypothecation is a transaction where goods are
made
available as security for a debt without actual transfer of either the property or the
possession
thereof to the creditor. The owners are under an obligation to discharge the debt
within the
stipulated time and if they fail to do so, the creditor has the right of re-entry for the
limited
purpose of repayment of the loan. The title in the goods remains with the pledger,
the de jure
and de facto possession continues to remain with him and the pledgee/ creditor has
merely the
right to recover his dues, if need be by sale of the security. The owners have absolute
control of
the vehicle and at the relevant point of time when the accident occurred, the vehicle
was driven
by the driver employed by him. The hypothecating Bank, a creditor, had merely
advanced, a
loan against the security of that vehicle and had a specific right to recover its dues in
the event
of default by, if need be, the sale of the vehicle. It was not even in constructive
possession of
the vehicle."
Screen title – Held
In the circumstances, the High Court held that the Tribunal committed a gross error
in law in
holding that the hypothecating Bank had stepped into the shoes of the owner for
having
advanced a loan against the security of the vehicle.
Decision
The appeal was, therefore, allowed.
Screen title - Hypothecation - Can The Banker take possession of
Hypothecated Goods
without Court’s intervention
The State Bank Of India, Hyderbad Main Branch, Appellant Vs. S.B.Shah Ali
brought to
fore the issue as to whether the Banker can take possession of hypothecated goods
without
Court’s intervention.
Screen title - Facts of the Case
This Appeal has been preferred by the appellant Bank against the judgement of a
Learned
Single Judge in C.C.C.A. No: 98 of 1980 dated 26.08.1987. The appellant Bank filed a
mortgage suit O.S.No. 530 of 1973 for recovery of Rs. 46,987.62. The defendant
disputed the
nature of the loan advanced to him and mainly raised the contention that the
appellant Bank
has high-handedly seized his lorry bearing registration No. ADT 1520 which was
hypothecated
to the appellant Bank and thus caused damage and loss to him and for that purpose
he made a
counter claim for damages in the suit. The defendant filed a suit earlier to the suit
filed by the
appellant Bank seeking relief of declaration that the seizure of lorry is illegal and for
an
injunction restraining the appellant Bank from selling the lorry. Both these suits were
clubbed
and tried together. The main controversy is whether the seizure of lorry by the
appellant Bank is
legal and, if not, whether the appellant Bank is liable to pay compensation for the
illegal seizure
and for the damage caused to the defendant.
Screen title - Civil Court and High Court’s Stance
The Civil Court held that the appellant Bank’s seizure as clandestine and clause 10 of
the
hypothecation agreement as invalid and thereby the appellant Bank is liable to pay
compensation. Assailing the correctness of the said finding of the Learned Judge, the
appellant
Bank filed C.C.C.A No. 98 of 1980 in the Andhra Pradesh High Court. The learned
Single
Judge of the High Court with regard to the question whether the right of seizure and
sale of the
vehicle can be exercised without intervention of the Court has observed that:
“When the hypothecation creates only a charge, it is only a right in respect of the
property and
such a covenant in the contract can only be enforced through Court. The reason
being that in
the absence of d ejure or d efacto possession or transfer of title, a person cannot take
the law
into his own hands and take possession of the goods forcibly when the debtor
obstructs taking
of possession. The clause in the deed providing seizure and sale only enables the
creditor to
enforce through a Court of Law as it operates an equitable charge in favour of the
creditor.”
Applying this test to the case in question the learned Single Judge held that the
appellant Bank
does not have a right to seize the hypothecated goods forcibly, without intervention
of the
Court.
Screen title - Observations of Division Bench of High Court -- Pledge vs.
Hypothecation
Bank filed appeal against above decision before the Division Bench of Andhra
Pradesh High
Court.
One important question that was considered here was whether the hypothecatee
Bank has got
a right to take possession of the hypothecated goods and sell the same without
intervention of
the Court.
The concept of hypothecation is not provided under the Indian Contract Act.
Hypothecation is
not a statutory creation but it is in usage in mercantile field since times immemorial.
The
hypothecation is neither governed by any statute nor is there any law governing the
same
directly or indirectly. Therefore, Courts have to consider the cases involving
hypothecation
cases purely on general conditions of the contract as per the terms of the
hypothecation
agreement. The Bench has considered decisions of various High Courts in India and
the rulings
and Judgments of the foreign Courts.
Screen title - Observations of Division Bench of High Court Pledge vs.
Hypothecation
While drawing distinction between “pledge” and “hypothecation” the Division Bench
observed
that:
“In case of hypothecation, the hypothecator can be in possession of the goods
hypothecated
and enjoy the same without causing any damage to the rights of the hypothecatee,
whereas in
case of pledge the possession of movables will be transferred to the pawnee and he
will be in
possession and the pawnor will not be able to enjoy the same as the possession has
already
been parted with.”
Further, the Division Bench observed that in the case of movables actually covered
by the
hypothecation deeds, there can be no doubt that the Bank is entitled to retain
possession and
also to exercise the right of private sale as hypothecation is only extended idea of a
pledge, the
creditor permitting the debtor to retain possession either on behalf of or in trust for
himself (the
creditor). In the case of pledge, the special feature of property is to keep possession
of the
pledged goods with the pledgee and to dispose of them for the realisation of the debt
for which
they are held as security. In case of hypothecation, possession remains with the
hypothecator
but the hypothecatee has the right to take possession of the hypothecated property
and to sell
it for the realization of the debt secured by hypothecation. It is open to the Bank to
take
possession of the hypothecated property on its own or through Court as per the
terms of
hypothecation.
Screen title - The Decision
The Division Bench has allowed the appeal by setting aside the order of the learned
Single
Judge and the Trial Court. Upholding that “when there is any specific clause in
hypothecation
agreement empowering the hypothecatee to take possession of the goods and sell
the same, in
the event of default in payment, as per the said terms the hypothecatee can proceed
ahead
without intervention of the Court.”
Screen title - Machinery Installed on Land or Building Whether Movable or
Immovable
Property
Case: Bamodev Panisrald VB. Smt. Monorama Raj
AIR 1974 Andhra Pradesh 226,where above issue was dealt with..
In this appeal, the question which arose for consideration was whether machinery
embedded
and installed in the earth, by constructing foundations for the purpose, was movable
or
immovable property. The question was relevant for determining the period of
limitation for a suit
for declaration of title to, or for recovery of possession of an item of machinery. If the
machinery
was movable property, then such a suit was required to be filed within three years
from the date
of denial of the right to it, but if it was immovable property, then the suit could be
filed within a
period of twelve years from the date of denial of the right.
Screen title - Main Points for Considerations in the Case
The High Court, after considering the statutory definitions of the terms "movable
property" and
"immovable property", stated that movable property would become immovable
property if it was
attached' to the earth or permanently fastened to anything attached to the earth.
The enquiry
should be not whether the attachment was director indirect, but what the nature and
character
of the attachments, and the intention and object of such attachment, are.
After considering several English as well as Indian decided cases-on the subject, the
High
Court felt that the tests enunciated by these cases to determine the-character and
nature of the
property are:
• What is the intendment, object and purpose of installing the machinery - Whether it
is
for the beneficial enjoyment of the building, land or structure, or the enjoyment of
the
very machinery?
• The degree and manner of attachment or annexation of the machinery to the earth.
Screen title - The High Court’s Stance
As for determining the intendment, object and purpose of installing the machinery,
the High
Court observed: "Where the machinery and the building or land on which it is
installed, are
owned by one and the same person, normally it should be inferred, unless the
contrary is
proved, that the object and purpose of installing the machinery is to have beneficial
enjoyment
of the entire building or land, but not the sole enjoyment of the very machinery itself.
However,
where the machinery imbedded or installed and the building or land belong to two
different
persons, the intendment and object of the person, who is in possession and
enjoyment of the
property, in installing or annexing. The machinery, must normally be presumed, until
the
contrary is proved, to be to exploit the benefit of the machinery alone, as he is not
interested in
the building or the land."
Screen title – Verdict
It has to be held that the object and purpose of installation of the machinery by a
lessee or a
tenant in possession of a building, factory or land was for the beneficial enjoyment of
the very
machinery, during the period of lease or tenancy, and not for making any permanent
improvement of the building, factory or land, as the case may be. Again, where the
building in
which machinery has been installed was not a pucca and permanent one, but was
only a
temporary shed or tent, the" intention and purpose of the owner could only be the
beneficial
enjoyment of the very machinery, but not of the building.
Applying the above principles to the facts of the case, the High Court was of the firm
view that
"the intendment, object and purpose of installing the machinery (in this case, cinema
equipment
and diesel oil engine and their accessories) was only to have the beneficial
enjoyment of the
very machinery during the period of the lease and, therefore, the machinery was
movable
property.
Held
In the result, it was held by the High Court that the suit for recovery of possession of
the
machinery filed after a period of three years from the date of denial of the right was
barred by
limitation.

4.
Legal Issues Relevant for Bankers – Interest
Screen title – Objectives
On completion of this module, you will be able to:
· Understand some finer points related to Bank Interest, including Interest on Agricultural
Loans
Screen title - Loading of Interest with Tax Liability and Rounding Off
The first case pertaining to interest rates relates to Indian Banks' Association vs. Devkala
Consultancy (2004) 120 Compo Case 613 (SC).
The issue involved in this case was the Banking Regulation Act, 1949 - Section 35 as to
whether the loading of interest with tax liability and rounding off to next higher 0.25% is
valid.
Screen title - Principle Issue involved
It is not lawful for the credit institutions to load the interest payable by borrowers with
interest
tax of 3 per cent and then round off to the next higher 0.25 per cent (on account of
grossing up
involved in calculating the incidence of tax or otherwise). The purported demand of
Banks and
credit institutions from the borrowers for a higher amount of tax and consequently a
higher
amount of interest by way of rounding off is wholly illegal and without jurisdiction.
Screen title- Facts of the Case
In this Appeal against the judgment of the Karnataka High Court in a petition filed by
Association of Borrowers of Karnataka, the Supreme Court considered the question of
authority
of Bankers to round up the existing interest rates to 0.25% pursuant to section 26 C of the
Interest - Tax Act, 1974. The Interest-tax Act was enacted by Parliament with effect from
August 1, 1974, with the object of imposing tax on the total amount of interest received
by
scheduled Banks/credit institutions on loans and advances. The Act was withdrawn in
1978, but
re-introduced in 1980. Thereafter it was again withdrawn in 1985 and re-introduced with
effect
from October 1, 1991, by the Finance (No.2) Act, 1991. The Reserve Bank of India by its
circular letter dated September 2, 1991, advised all the scheduled commercial Banks that
the
incidence of interest tax should pro rata be passed on to the borrowers where for a
uniform
practice should be followed in consultation with the Indian Banks' Association (IBA), the
first
appellant.
In view of the foregoing IBA, with a view to formulating a structure of uniform interest
rate,
chargeable after including the interest tax payable, which was passed on to the borrower
by the
concerned Banks, advised them that the rate of interest be loaded with interest tax of 3
per cent
and rounded off to the next higher 0.25 per cent. This rounding off was considered
necessary
on account of grossing up involved in calculating the incidence of tax and had
purportedly the
approval of the Reserve Bank of India in terms of its letter dated April 22, 1993. Other
appellants herein followed the said purported policy. This action of the appellants was
questioned by the respondents in a public interest litigation filed before the Karnataka
High
Court, inter alia, on the ground that such rounding off is illegal and without jurisdiction
as
thereby the tax element came to be increased and as a result thereof, the Banks collected
an
additional sum of Rs. 723.79 crores annually.
Screen title - Observations of the Court
The Court observed that Section 26C of the Interest Tax Act, 1974, providing that "it
shall be
lawful" for credit institutions to increase the agreed rate of interest from borrowers to the
extent
of their interest-tax liability, is an enabling provision. This has to be understood having
regard to
the term "lawful" used therein. The section prevails over the agreement under which any
term
loan has been sanctioned by the credit institution to vary the agreement as regards rate of
interest for the purpose of recovering the amount of interest-tax payable by the credit
institution, but nothing over and above the same. The increase in the rate of interest
envisaged
is to the extent to which such institution is liable to pay the interest-tax in relation to the
amount
of interest on the term loan and, which is due to the credit institution.
Under Article 265 of the Constitution, read with Article 366 (28), nothing is realisable as
a tax or
by way of recovery of tax or any action akin thereto, which is not permitted by law. This
implies
that no amount can be realised by way of tax or a similar duty, which has not been
authorised
by Parliament. The increase in the rate of interest in terms of section 26C has a direct
nexus
with the statutory impost of interest-tax. But, the executive cannot levy tax or for that
purpose,
take recourse to the process of interpretation.
Screen Title –Verdict
The Court observed that although in the case of ambiguous statutory provisions,
contemporaneous construction placed thereon by the officers charged with its
enforcement and
administration of that statute might be required to be considered and given due weight,
the
Reserve Bank of India or the appellants, Indian Banks' Association who are not charged
with
administration or enforcement of Interest tax Act, are not competent to interpret the
provisions
of the Interest tax Act.
Decision
The appeal was dismissed accordingly.
Screen title - Creation of a Fund Pursuant to Court orders
The Supreme Court had found that the Banks had by misinterpretation of the statute
unjustly
enriched themselves. As it was not practicable to return the excess interest-tax recovered
from
the borrowers, the Court gave directions for the formation of a fund for the benefit of
disabled
persons covered by the Persons with Disabilities (Equal Opportunities, Protection of
Rights and
Full Participation) Act, 1995 with the excess tax recovered, irrespective of whether it is
deposited with the Union of India or lying with the concerned Banks.
Screen title - Interest – Compounding of Interest on Agricultural Loans
Presented is a case regarding Interests where the issue was that of Compounding of
interest
payable on agricultural loans at quarterly intervals and Charging of penal interest
(Banking
Regulation Act, 1949 - Section 21A).
The case being referred to is Punjab National Bank vs. Narain Dass
AIR 2003 HP 69
Screen title - Principle Issue Involved
It is not permissible for a Bank to charge compounding of interest with quarterly rests on
agricultural loans. However, Bank would be entitled to charge compounding of interest
with
annual rests if the loanee fails to pay the interest. Bank is also entitled to charge penal
interest
on default in payment of installments.
Screen title - Facts of the Case
The plaintiff Bank had granted a term loan of Rs.1, 64,000 for the purchase of a vehicle.
On
default in repayment of the loan by the borrower, a suit was filed by the Bank for
recovery of the
money with interest @ 17% per annum with quarterly rests from the date of the suit till
the date
of realisation of the amount. The case of the Bank was that the borrower had agreed to
pay
interest of 2.5% over and above the Reserve Bank of India rate with a minimum of 12.5
% per
annum with quarterly rests and interest was liable to be charged at the rate as may be
applicable from time to time. There was also a provision in the agreement for the
payment of
penal interest in the case of default in payment of instalments @ 2% over and above the
agreed rate.
Screen title - The Case
Accordingly, the plaintiff contended that the borrower and the guarantor had defaulted in
the
payment of instalments and the plaintiff was entitled to penal interest. The District Judge
found
that the plaintiff was entitled to an amount of Rs. 88,500/- as principal amount on the date
of
the decision and decreed the suit accordingly with simple interest @12.5% p.a.
Aggrieved by
the judgement, the plaintiff Bank filed this appeal contending that it was not permissible
for the
Trial Court to have reopened the question of interest.
Screen title - Observations of The Court
The Court observed that the loan in question was clearly an agricultural loan and not a
commercial loan. Accordingly, there cannot be any dispute that the Bank was entitled to a
simple interest @ 12.5 % p.a. and not compound interest. The Court referred to and relied
on
the decision of the Supreme Court in Corporation Bank vs. D.S. Gowda (1994) 5 SCC
213
wherein after referring to the provisions of Section 21A of the Banking Regulation Act
and the
various circulars and instructions issued by the Reserve Bank, the Court had taken the
view
that in the case of agricultural loan/ advances, the circulars of the Reserve Bank of India
do not
permit Banks to charge compound interest with quarterly rests and as such loans cannot
be
treated on par with the commercial loans insofar as the rate of interest was confirmed. At
best,
interest could be fixed with annual rests coinciding with the time that the farmer is fluid
and if
thereafter the farmer fails to pay the interest, it would be open to compound the interest
on the
loan on the term loan becoming due. However, the Bank would be entitled to compound
the
interest with annual rests if the loanee failed to pay the interest.
So far as the question of penal interest is concerned, the Court referred to the decision of
the
Constitution Bench of the Supreme Court in Central Bank of India vs. Ravindra AIR
2001 SC
3095 wherein it was held that penal interest is an extraordinary liability incurred by a
debtor for
not making the payment when it ought to have been made to the person who advanced
the
loan. Therefore, it was not limited to the damages suffered. Penal interest can be charged
only
once for one period and therefore, it cannot be permitted to be capitalised. The Court
accordingly came to the conclusion that the loan in question being an agricultural loan,
interest
was payable only @ 12.5 % p.a. and the Bank was entitled to capitalisation of penal
interest.
The Bank was not entitled to charge interest with quarterly rests and when default of
interest
was made in terms of the loan agreement, interest could only be capitalised annually.
Decision
The Court accordingly allowed the appeal partly.
Screen title - Conclusion
In the case of agricultural loans, Banks have to charge interest only at the permissible
rates as
observed by the Court and the rate of interest is not at the discretion of the Bank. The
compounding of interest can be done only on annual rests and penal interest cannot be
capitalised. If the Banks follow this established law as laid down by the Supreme Court,
unnecessary litigation can be avoided.
Screen title - AP Agricultural Relief Act–Whether debtor entitled for scaling down of
interest on agricultural loans
This case deals with the issue if the borrower is entitled to scaling down of interest on
agricultural loans under AP Agricultural Relief Act, 1938 – Sections 4 & 7.
The case involved Andhra Bank and Chittabathuni Sree Ramulu AIR 1999 AP 52.
Screen title - Principle Issue Involved
In case the Bank loan is obtained for agricultural purposes, then under AP Agricultural
Relief
Act, 1938 debtor is not entitled to any relief by way of scaling down of interest on
account of
the provisions of Section 21A of the Banking Regulation Act. However, interest can be
charged
only on basis of yearly rests.
Screen title - Facts of the Case
Andhra Bank had given certain loans for agricultural purposes. As the loan was not
repaid in
full, the Bank filed a suit for recovery. In defence, it was contended that the debtors being
agriculturists, and the debt having been incurred for agricultural purposes, they were
entitled to
benefit on the AP Agriculturist's Relief Act, 1938, and the interest is to be scaled down
accordingly. It was claimed that the interest charged was exorbitant, excessive, usurious
and
that the claim of penal interest was arbitrary and opposed to law. The Bank relied on the
provisions of Section 21A of the B.R Act to claim that scaling down was not permissible.
Bank
further submitted that the A.P. Agriculturist's Relief Act was not applicable to this case.
The
lower Court having decided the case in favour of the defendants, the plaintiff Bank filed
this
Appeal before the High Court.
Screen title – High Court’s Stance
The High Court observed that the decision of the lower Court was based on earlier
decisions of
the High Court which were overruled by either the Division Bench of the High Court or
by the
Supreme Court. The decision in M. Satyanarana Vs. Andhra Bank Ltd., 1984(2) APLJ
(SH) (21)
relied on by the Court was overruled by the Full Bench of the Court in State Bank of
Hyderabad
Vs. Advath Sakru (FB), AIR 1994 AP 170 (FE). The decision in Indian Bank Vs.
Muddana
Krishna Murthy, AIR 1983 AP 347 relied on by the Court was overruled by the Supreme
Court
in Bank of India Vs. M/s. Vijay Transport, AIR 1998, SC 151. Accordingly, although the
A.P. Act
provides for scaling down of interest on agricultural debts, this provision does not apply
to any
debt due to a Corporation formed pursuant to any special Indian Law or Royal Charter or
Letters Patent. This covers the law made by the Indian Legislature and also Corporations
constituted in pursuance of such law. Hence, a debtor would not be entitled for any
scaling
down in terms of the Debt Relief Act in view of Section 21A of the Banking Regulation
Act even
if the loan is for agricultural purposes.
The Court observed that according to the Supreme Court decision in Corporation Bank
Vs. G.
S. Gowda, AIR 1994, SCW 2721, it is clear that as far as the agricultural loan is
concerned,
Bank would not be justified in charging interest either on quarterly rest or on half yearly
rest,
since normally, farmers would be fluid only after they harvest the crops and thus, they get
income only once in a year. Hence, on Agricultural Loans, interest has to be charged only
on
yearly rests and on that basis, interest may be compounded if loan/installment becomes
overdue. Accordingly, the Court found it proper to modify the order of the lower Court
by
awarding interest at the rate of 14% on the basis of annual rests from the date of the loan
till
the date of realisation.
Decision
The appeal was partly allowed accordingly.

5.
Legal Issues Relevant for Bankers – Debt
Screen title – Objectives
On completion of this module, you will be able to:
• Understand the various issues relating to Debt Recovery Tribunals
Screen title - Jurisdiction of DRT/ Civil court in respect of Proceedings for
recovery of debt
The case C. J. Glenny VS. Catholic Syrian Bank (2003) 117 Comp Cas 227
brought out the
issue of jurisdiction of DRT/ Civil court in respect of proceedings for recovery of Debt.
This is
related to Recovery of Debt Due to Banks and Financial Institutions Act, 1993-
Sections 17-19,
22, 31 and 34- Civil Procedure 1908, Order 9, Rule 13. .
Screen title - Principle Issue involved
An application for setting aside an ex parte decree relating to recovery of debt by a
bank
constitutes 'proceedings' in relation to recovery of debt and when the amount in
dispute is in
excess of Rs. 10 lakhs, the Civil Court has no jurisdiction to deal with the matter as
these
proceedings lie within the' exclusive jurisdiction of the Tribunal. It is mandatory for
the Civil Court
to transfer the application to the Tribunal for lack of jurisdiction to decide the matter
and the civil
court is precluded from dealing with the application.
Screen title- Facts of the Case
The appellant, C. J. Glenny had taken a loan from the respondent bank which he
failed to repay.
The Bank thereupon filed a suit for recovery of Rs. 8, 61, 530 with interest. On 16th
June, 2000,
the Civil Court passed an ex parte decree for Rs. 11 lakhs allowing the claim of the
bank with
interest @ 18% from the date of the suit till realisation of the same. Later, the bank
filed an
application before the Debt Recovery Tribunal for recovering the amount under a
decree of the
Civil Court. After about six months, on 23rd March, 2001, the appellant filed an
application before
the Civil Court for setting aside the ex parte decree which the Trial Court dismissed
on the basis
that the Court had no jurisdiction in view of the provisions of Section 18, 22(g) and 31
of the
Recovery of Debt Due to Banks and Financial Institutions Act, 1993. Against these
orders of the
Trial Court, the appellant approached the High Court with this appeal.
Screen title - Observations of the High Court
The High Court observed, referring to the decision of the Patna High Court in Ram
Laxman Glass
(P) Ltd. vs. State of Bihar AIR 2000 Patna 210, that even an application for setting
aside an ex
parte decree constitutes proceedings in relation to recovery of debt by the bank and
these
proceedings lie within the exclusive jurisdiction of the Tribunal and not the Civil
Court. Further,
considering the fact that the amount in dispute was in excess of Rs. 10 lakhs the Civil
Court had
no jurisdiction to deal with the matter as already recorded by the Civil Court. Thus, it
was
mandatory for the Civil Court to transfer the matter also precluded the Civil Court
from dealing
with the application. The Court was, therefore, not correct in dismissing the
application.
Screen Title – Jurisdiction of Civil Court
When the Civil suit was filed in 1998, the suit was for recovery of Rs. 8, 61, 530/- with
interest and
the Civil Court was entitled to entertain. After the establishment of the Tribunal for
the State, the
Civil Court is not entitled to entertain a suit or any other proceeding relating to
recovery of debt of
Rs. 10 lakhs or more by a bank. By virtue of Section 18, the jurisdiction of Civil Court
has been
ousted and the provisions of the Debt Recovery Act being a special statute override
the
provisions of the general law. The application filed by the appellant under Order 9
Rule 13 should
have been returned to the applicant for presentation to the competent forum, which
is the
Tribunal. As the Civil Court had no jurisdiction, its order dismissing the application is
also liable to
be set aside and the application shall be returned to the appellant for presentation to
the Tribunal.
A decree passed by the Civil Court can be challenged by the aggrieved party before
the Appellate
Tribunal when the amount is Rs. 10 lakhs or more.
Screen title - Verdict
In view of the foregoing, the order passed by the Civil Court was set aside with
direction to return
the petition to the appellant for presentation to the Tribunal.
Comments
This judgment affirms the exclusive jurisdiction the Debt Recovery Tribunal in debt
recovery
proceeding of banks and financial institutions for amounts exceeding Rs. 10 lakhs,
which extends
even to setting aside an ex parte decree passed by a civil court.
Screen title - Debt Recovery Tribunal –Recovery of money owed under a
decree of foreign
court
We now move on to a case where it was held that the Debt Recovery Tribunal (DRT)
can
entertain an application for recovery of money owed under a decree of foreign court.
The case
under reference is AIR 2002 Born. 449 S.A. Bobde J Bank of India vs.
Harshadrai Odhavji.
Screen title - Facts of the Case
On 16th October, 1996 Bank of India obtained a decree before the High Court of
Justice, Queen's
Bench Division at England for a sum of Rs. 2,47,82,743.40. The Bank then put the
said decree in
execution before the High Court of Mumbai. On establishment of Debt Recovery
Tribunal,
Mumbai, when, the execution petition was being transferred, the defendant/
judgement debtor
moved the court by way of chamber summons requesting that the case should not be
transferred
to DRT, since the DRT will not have jurisdiction to decide the matter arising in the
case. The main
contention raised in support of the same was that money owed arises out of a decree
of foreign
court and therefore is not debt capable of being recovered through DRT. Further it
was
contended that execution petition was filed under Section 44-A of the Code of Civil
Procedure,
1908 and therefore can be executed only under the said provisions and not under the
provisions
of Recovery of Debts due to Banks and Financial Institutions Act, 1993 (ROB Act). The
said
contention was negatived by the Court.
Screen title - Decision of the Court
Hon'ble Justice Shri S.A. Bobde speaking for the court held "Section 44A of C.P.C.,
makes it
clear that foreign decree may be executed in India if it has been passed by the
District Court.
Thus, original character of a foreign decree is not of any consequence and the
amount 'payable'
under a decree or order of civil court may be treated as debt payable within the
meaning of
Section 2(g) of ROB Act". "The plea by the Judgement debtor that Section 44A of CPC
is special
law which governs the execution of a foreign decree and not the RDB Act of 1993
which is a
general law would not be tenable as the RDB Act is indeed a special law enacted
under Entry 45
of List I of Schedule 7 to the constitution of India for the purpose of enabling only the
banks and
financial institutions to recover debts due to them. Since both laws must be deemed
to be special
laws, the principle that the later must prevail should be applied as laid down by the
Supreme
Court on several occasions. Thus, Section 44A cannot in the circumstances be
allowed to prevail
over and in derogation of Section 17 and other related provisions of the RDB Act. The
harmony
could be best achieved by taking a view that an execution of foreign decree, where
the decree
holder is a bank or financial institution, must be entertained by the Tribunal under
the RDB Act
and while doing so the tribunal would be entitled to exercise all the powers which the
District
Court would have exercised under the Code of Civil Procedure, 1908."
Screen title - Significance of the Judgement
The judgement is very important from the' point of view of directly filing execution
applications for
recovery of monies owed under a foreign decree before the DRT under Section 31 A
of the RDB
Act. The reasoning of the court is very innovative. The court says relying on the
judgement of a
privy council in the case of East and Dwellings Co. Ltd. Vs. Finsbury Borough Council,-
(1952) PC
109 that since CPC directs that a decree of foreign court in the reciprocating territory
should be
treated as decree of District Court in India, it is legally permissible to assume that
decree of
foreign court is decree of civil court in India for bringing the same within the ambit of
the definition
of 'Debt" under Section 2(g) of RDB Act The judgement helps in avoiding the
rigmarole of filing a
fresh application in the DRT under Section 19 of the RDB Act and on that count, the
banks should
receive the judgement with cheers.
Screen title - DRT – Powers to Pass an Ex-Parte Interim Order
The next case concerns the Recovery of Debts Due to Banks and Financial
Institutions Act, 1993
- Sections 19 (6) and 22 (1) and (2)
And deals with the issue of the Authority of Debt Recovery Tribunal to pass ex-parte
Interim
Order.
This is the case involving ICICI Ltd. and. Grapco Industries Ltd (1999) 4 Scc
710.
Screen title - The Principle
The power of the Debt Recovery Tribunal under section 19 (6) of the Act to grant
interim order
infers the power to grant ex-parte interim order. Such order should be a reasoned
order putting
the applicant on terms and must be for a short period. High Court can go into merits
of such order
and correct it if made without justification.
Screen title - Facts of the Case
ICICI had filed an application under Section 19 of the Recovery of Debts Due to Banks
and
Financial Institutions Act claiming an amount of over Rupees 36.5 crores against
Respondents 1
and 2 jointly and severally. The Tribunal granted an order of injunction and restrained
the
respondents from transferring or alienating the properties hypothecated to ICICI and
further
appointing a Special Officer for making an inventory of the assets and properties
hypothecated
and mortgaged by the respondents in favour of ICICI. A show-cause notice was also
issued by
the Tribunal to the respondents calling upon them to show-cause within 15 days as to
why
temporary injunction should not be granted. The respondents then moved the
Calcutta High Court
under Article 227 of the Constitution praying for setting aside the ex-parte order of
the Tribunal.
The High Court holding that the Tribunal had no jurisdiction to grant ex-parte orders
under the
Act, set aside the order of the Tribunal. The High Court also held that on merit, the
grant of exparte
order of injunction was wrong. Further, according to the High Court, the order was
not
proper as, the Tribunal did not give any reasons, and it was an omnibus order and
that there was
no reference even to prayers in the application and that the prayers stood allowed "in
terms of
entire hog". On appeal by IClCI, the matter came up before the Supreme Court.
Screen title - Supreme Court’s Observations
The tribunal constituted under the Act, has jurisdiction to grant an ad interim ex-
parte order of
injunction or stay against the defendant on an application filed by a bank or financial
institution for
recovery of debt as defined under clause (g) of Section 2 of the Act. When Section 22
of the Act
says that the Tribunal shall not be bound by the procedure laid down by the Code of
Civil
Procedure, it does not mean that it will not have jurisdiction to exercise powers of a
court as
contained in the Code of Civil Procedure. Rather, the TribunaI can travel beyond the
Code of Civil
Procedure and the only fetter that is put on its powers is to observe the principles of
natural
justice. This meaning has to give to Section 22 of the Act, as here the Tribunal is
exercising
powers of a civil court while trying a money suit. Further, when power is given to the
Tribunal to
make an interim order by way of an injunction or a stay, it inheres in it the power to
grant that
order even ex-parte, if it is so in the interest of justice and as per the requirements as
spelt out in
the judgement of the Supreme Court in Morgan Stanley Mutual Fund v. Kartick Das
(1994) 4 SCC
225.
Although an ex-parte order is only for short duration and is granted to safeguard the
interest of
the applicant, it cannot be granted as a matter of course. A court or tribunal should
also consider
the consequences of such an order if ultimately the order is to be revoked after
hearing the
defendant. In such circumstances, the Tribunal must put the applicant on terms while
granting an
ex-parte order and compensate the defendant in case the ex-parte order was
obtained without
any justification and harm has been caused to the defendant. An ex-parte order can
also affect
the reputation of the person against whom it is issued and sometimes it may be
difficult to undo
the damage caused by an interim order. A Tribunal while granting an ex-parte order
of stay or
injunction must record reasons, at least briefly and not pass a stereotyped order in
terms of the
prayer made. An ex-parte order cannot be allowed to continue indefinitely and the
continuance of
an interim order has to be decided without undue delay when the defendant puts in
his
appearance. Sub section (8) of Section 19 of the Act lays stress if an interim order of
injunction or
stay granted ex-parte is to be continued or not. The High Court was not correct in
holding that a
Tribunal under the Act has no power to grant an ex-parte order of injunction of stay.
Screen title – Verdict
The High Court can examine the merits and even interfere with the interim orders of
the courts
and tribunals under Article 227 if the order is made without jurisdiction, but a highly
technical
approach should be avoided. When the facts of the case brought before the High
Court are such
that the High Court can itself correct the error, then it should pass appropriate orders
instead of
merely setting aside the impugned order of the Tribunal and leaving everything in a
vacuum.
The Court observed that the object with which the Tribunal passed the ex-parte order
appeared to
have been lost and therefore, the Court would not interfere with the impugned
judgement of the
High Court setting aside the order of the Tribunal. But that was only because of
passage of time
and because the stage of proceedings before the Tribunal on the application filed by
ICICI under
Section 19 (1) of the Act was not known. It was however, be open to the Tribunal to
pass an
interim order on the plea of ICICI if the matter was still pending before it.
Decision
In the circumstances, the Court did not interfere with the judgement of the High
Court.
Screen title - Applicability of Debt Recovery legislation to Co-operative
banks
In Shamrao Vithal Co-operative Bank Ltd. Vs Star Glass Works AIR 2003
BOM 205, the
question that arose was whether Debt Recovery legislation applies to Co-operative
banks in
terms of the provisions contained in Recovery of Debts due to Banks and Financial
Institutions
Act, 1993 and Banking Regulation Act, 1949
Screen title - The Principle
The expression "banking company" in Section 2(e) of the Recovery of Debt Due to
Banks and
Financial Institutions Act, 1993 has to be given the meaning assigned to it under the
Banking
Regulation Act, 1949 and includes a co-operative bank. In view of the provisions
contained
therein the Debt Recovery Legislation is applicable to the debts due to Cooperative
banks also.
Screen title - Facts of the Case
The Shamrao Vithal Co-operative Bank Ltd. had provided loan facility to M/s. Star
Glass Works, a
partnership firm, on the terms and conditions agreed upon vide the loan agreement
dated 17th
January, 1998. On the firm and its partners failing to pay the installment under the
agreement and
a sum exceeding Rs. 29 lakhs being outstanding which remained to be paid by the
respondent, in
April 2001, the bank filed an application before the Debt Recovery Tribunal at
Mumbai for
recovery of the outstanding amount from the respondents. The Tribunal, vide its
order dated 29th
November, 2001, held that the Debt Recovery Tribunal has no subject-wise
jurisdiction for the
matter as the petitioner bank is a co-operative bank and not a company under the
Companies
Act, 1956. Aggrieved by the said order, the petitioners preferred an appeal to the
Debt Recovery
Appellate Tribunal which was also dismissed. Consequently, the petitioners
approached the High
Court challenging the said order.
Screen title - Observations of the High Court
The Court observed that under the Act of 1993, bank means "banking company" and
banking
companies shall have the same meaning as assigned to it in clause (c) of Section 5 of
the
Banking Regulation Act, 1949. Under Section 5 of the BR Act, 1949, 'banking
company' means
any company transacting the business of banking in India. Under Section 56(a) of the
Banking
Regulation Act, references to a 'banking company' or a 'company' or 'such company'
in the
Banking Regulation Act shall be construed as references to a co-operative bank
unless the
context otherwise requires. Hence, a banking company under section 5(c) without
hesitation
would include a co-operative bank. The interest of the legislature can be discerned by
the fact
that Section 2(e) of the Act of 1993 has used the expression "meaning assigned to it
in clause (c)
of Section 5 of the Banking Regulation Act, 1949 "in contradistinction to the
expression" as
defined in clause (e) of Section 5 of the Banking Regulation Act, 1949." By virtue of
Section
56(a)(1) of the Banking Regulation Act, the meaning assigned to the word "banking
company" in
clause (e) of Section 5 of the BR Act would include a cooperative bank. For the
purposes of the
Act of 1993, the expression "banking company" has to be given the meaning
assigned to it in the
Banking Regulation Act which includes co-operative bank. Once it is held that under
section 7(e)
of the Act of 1993, "banking company" includes co-operative bank, as a necessary
corollary, cooperative
bank shall be covered under Section 56(d) (i) as there under bank means a banking
company.
Screen title - The Verdict
A careful reading of the Banking Regulation Act and the Act of 1993 and respective
preamble,
objectives and reasons would make it clear that co-operative banks were not at all
intended to be
excluded from the benefits of the machinery made available to the bank under the
Act of 1999 for
recovery of outstanding loans. The Parliament does not intend to discriminate
between cooperative
banks and banking companies for the purpose of the said Act. Even if the co-
operative
banks have a separate machinery under the Maharashtra Cooperative Societies Act,
there is no
reason why the cooperative banks should be excluded from the purview of the 1993
Act. In the
circumstances, the 1993 Act is applicable to co-operative banks for adjudication of
recovery of
debts due to them and for matters connected therewith or incidental thereto. The
impugned
orders passed by the Debt Recovery Tribunal and the Appellate Tribunal have to be
set aside.
Decision
Accordingly, the Court set aside the orders of the Debt Recovery Tribunal and the
Appellate
Tribunal.
Screen title - SARFAESI Act
This case pertains to Securitisation and Reconstruction of Financial Assets and
Enforcement of
Security Interest Act, 2002 The questions that came up were, whether:
• Whether provisions of the Act are legal and valid
• Whether Safeguards provided to borrowers such as appeal on precondition of
deposit of
75% of sum determined by creditor is sustainable
The case was to do with Mardia Chemicals Ltd. and Ors. vs. Union of India and
Ors.(2004)
120 Camp Case 373 (SC)
Screen title - The Principle
The condition of deposit of 75% of the amount in claim before approaching Debt
Recovery
Tribunal under section 17 (2) of the Securitization and Reconstruction of Financial
Assets and
Enforcement of Security Interest Act (SARFAESI), 2002 is bad as it is imposed while
approaching
the adjudicating authority of the first instance, not in appeal. Except for Section 17(2)
of the Act,
which is ultra vires of Article 14 of the Constitution, the rest of the Act is valid. In the
absence of
any legislation on lender's liability, it is incumbent upon the financial institutions to
act fairly and in
good faith complying with their part of obligations under the contract.
Screen title - Facts of the Case
A bunch of cases came up for hearing before the Supreme Court including writ
petitions
transferred from the High Courts challenging the validity of the SARFAESI, more
particularly, the
provisions in Sections 13, 15, 17 and 34. In one of the cases relating to Mardia
Chemicals Ltd.,
notice had been issued to the company by the Industrial Development Bank of India
(IDBI) under
Section 13 (of the Ordinance, then in force), requiring it to pay the amount of arrears
indicated in
the notice within 60 days, failing which the IDBI as a secured creditor would be
entitled to enforce
the security interest without intervention of the court or tribunal, taking recourse to
all or any of the
measures contained in sub-section (4) of Section 13 namely, by taking over
possession and/or
management of the secured assets. Similar notices were issued by other financial
institutions and
banks under the provisions of Section 13 of the Ordinance/Act to different parties
who filed
petitions in different High Courts. The main contention was that the banks and the
financial
institutions had been vested with arbitrary powers, without any guidelines for its
exercise and also
without providing any appropriate and adequate mechanism to decide the disputes
relating to the
correctness of the demand and the actual amount of dues, sought to be recovered
from the
borrowers. It was also alleged that the Act has been made a one sided affair,
enforcing drastic
measures of sale of the property or taking over the management or the possession of
the secured
assets without affording any opportunity to the borrower and further no provision has
been made
to take into account the lenders liability.
Screen title - Section 13: Observations of Supreme Court
The court observed that the normal process of recovery of debts through courts is
lengthy and the
time taken is not suited for recovery of such dues. Financial liquidity is essential for
rendering
financial assistance to the industries by the financial institutions arid a blockade of
large amounts
creates circumstances which retard the economic progress. The court further
observed that
although, the Recovery of Debts Due to Banks and Financial Institutions Act was
enacted in 1993
for improving recovery of debts, the figures show that it did not bring the desired
results. Hence,
the step taken towards securitisation of the debts and to evolve means for faster
recovery of the
NPAs was not uncalled for. As guidelines are given by the Reserve Bank of India
laying down the
terms and conditions and circumstances in which the debt is to be classified as non-
performing
asset as early as possible, the court found no substance in the submission made on
behalf of the
petitioners that there are no guidelines for treating the debt as a non-performing
asset.
Section 13
As regards recovery under the Act, Section 13 provides that when any borrower, who
is under a
liability to a secured creditor under a security agreement, makes any default in
repayment of
secured debt or any instalment thereof, and his account in respect of such debt is
classified by
the secured creditor as non-performing asset, then, the secured creditor may require
the
borrower by notice in writing to discharge in full his liabilities to the secured creditor
within sixty
days from the date of notice. If the borrower fails to discharge his liability in full
within that period,
the secured creditor may take recourse to any specified measures to recover his
secured debt,
including taking possession of the secured assets of the borrower. Although there is
no right of
hearing for the borrower at this stage, the court held that if after service of notice,
the borrower
raises any objection or places facts for consideration of the secured creditor, such
reply to the
notice must be considered with due application of mind and the reasons for not
accepting the
objections, howsoever brief they may be, must be communicated to the borrower.
The reasons so
communicated shall only be for the purposes of the information/knowledge of the
borrower
without giving rise to any right to approach the Debt Recovery Tribunal under Section
17 of the
Act, at that stage. On measures having been taken under sub-section (4) of Section
13 and
before the date of sale/auction of the property it would be open for the borrower to
file an appeal
(petition) under Section 17 of the Act before the Debt Recovery Tribunal. That the
Tribunal in
exercise of its ancillary powers shall have jurisdiction to pass any stay interim order
subject to the
condition as it may deem fit and proper to impose.
Screen title - Observations of Supreme Court
As regards appeal, the court observed that the right of appeal is a statutory right and
it can be
circumscribed by the conditions. However, there is a basic distinction between the
right of suit
and the right of appeal as there is an inherent right in every person to bring a suit of
civil nature
and unless one's choice. The condition of pre-deposit in the present case under
section 17 (2) is
bad rendering the remedy illusory on the grounds that (i) it is imposed while
approaching the
adjudicating authority of the first instance, not in appeal, (ii) there is no
determination of the
amount due as yet (iii) the secured assets or its management with transferable
interest is already
taken over and under control of the secured creditor (iv) no special reason for double
security in
respect of an amount yet to be determined and settled (v) 75% of the amount
claimed by no
means would be a meager amount (vi) it will leave the borrower in a position where it
would not
be possible for him to raise any funds to make deposit of 75 % of the undetermined
demand.
Such conditions are onerous and oppressive. On these grounds, the court held that
sub-section
(2) of Section 17 of the Act is unreasonable and violative of Article 14 of the
Constitution.
The court observed that the object of the Act is to achieve speedier recovery of the
dues declared
as NPAs and better availability of capital liquidity and resources to help in growth of
economy and
welfare of the people and therefore, it would subserve the public interest.
Accordingly, the whole
of the Act, excluding section 17(2) was upheld. As regards lender's liability, the court
observed
that even in absence of any court decisions or legislation, it is incumbent upon such
financial
institutions to act fairly and in good faith complying with their part of obligations
under the
contract.
Decision
Accordingly, the Court partly allowed the petitions.
This case brought forth few other noteworthy comments
Comments
As the Act, excluding section 17(2), has been upheld, it would be open to the banks
and financial
institutions to proceed with recovery under the Act. Although the lenders will be free
to make
appeals to the Debt Recovery Tribunal without making any pre -deposit, it will be in
the discretion
of the Tribunal whether to stay the proceedings or not depending on the facts of each
case. The
court saw the requirement of depositing 75% of the claimed amount at the first stage
of
approaching the adjudicatory authority as onerous.
To bring the provisions of the Act in conformity with the Judgement of the Hon'ble
Supreme Court
Order, to dissuade the borrower from indulging in dilatory tactics with a view to
postpone the
repayment of dues and to enable secured creditors to make speedy recovery by
enforcement of
securities, the Securitisation and Reconstruction of Financial Assets and Enforcement
of Security
Interest Act, 2002 has been amended. The salient amendments are as under:-
(i) The Secured Creditor will be able to take possession of the secured assets only
after reasons
for not accepting the objections of the borrower have been communicated to him in
writing. After
possession of the secured asset has been taken, the borrower can file an application
before the
DRT without any deposit. If the DRT does not dispose off the petition within 4 months,
the
borrower or the Secured Creditor can move the Debt Recovery Appellate Tribunal
(DRAT) for
directing the DRT for expeditious disposal of the application.
(ii) After the disposal of the case by the DRT the borrower, if aggrieved, can appeal to
the DRAT
with a deposit of 50% of the decreed amount or as determined by the DRT but not
lower than
25%.
Screen title - Role of Finance Corporations - Promoting Industries at Any
Cost?
“Promoting industries does not mean financial corporations should give
loans, write them
off and go out of business themselves” --- Supreme Court
State Financial Corporation Vs. M/S. Jagadamba Oil Mills
Screen title - Facts of the Case
Haryana Financial Corporation (HFC) granted a loan of Rs. 7,48,000 to M/s.
Jagadamba Oil Mills,
the borrower against mortgage of properties. The loan was repayable in 15 half
yearly
instalments. The borrower committed default in payment of instalments although
HFC
rescheduled payment several times. Finally HFC revoked Section 29 of State
Financial
Corporations Act, 1951 (SFC Act) and took possession of the unit of the borrower. The
borrowers
instituted a suit for permanent injunction in the Court of Civil Judge at Ambala against
HFC and
sought to restrain the sale of the unit. Unhappy with the unfavourable verdict, HFC
moved the
Supreme Court. The Apex Court reversed the Judgement of the lower courts. The
borrower
argued that HFC did not give a breathing time and initiated recovery proceedings
within one year
from the date of last instalment. It was argued that HFC is established under SFC Act
1951 and
in terms of the objects of the said statute (i) HFC and the borrower have a fiduciary
relationship
and are really partners in a business enterprise, (ii) HFC stands in the position of a
trustee and is
not expected to act like any other individual moneylender. Further, it was contended
that action
of HFC is contrary to the directions of the Supreme Court in Mahesh Chandra’s Case.
Screen title - Supreme Court Observations and Verdict
Rejecting the contentions of the borrower and overruling the Judgement in Mahesh
Chandra’s
case, the Supreme Court observed as follows:
“As was observed by this Court in Gem Cap’s case, the legislative intent in enacting
the statute
(SFC Act) was to promote industrialization of States by encouraging small and
medium industries
by giving financial assistance in the shape of loans and advances, repayable within a
stipulated
period. Though the Corporation is not like a moneylender or a bank which lends
money, there is
purpose in its lending i.e., to promote small and medium industries. The relationship
between the
Corporation and the borrower is that of Debtor and Creditor. That basic feature
cannot be lost
sight of. A Corporation is not supposed to give loan and then to write off as a bad
debt and
ultimately to go out of business. As noted above, it has to recover the amounts due
so that fresh
loans can be given. In that way industrialization, which is the intended object of the
SFC Act, can
be promoted. It certainly is not and cannot be called upon to pump in more money to
revive and
resurrect each and every industrial unit irrespective of the cost involved. That would
be throwing
good money after bad money.
The view in Mahesh Chandra’s case appears to have been too widely expressed
without taking
note of ground realities and intended objects of the statute. If the guidelines as
indicated in the
said case were to be strictly followed, it would give premium to a dishonest borrower.
It would not
further the interest of any Corporation and consequently of Industries.” In our view,
the
observations in the Mahesh Chandra’s case do not lay down correct law and the said
decision is
overruled.”
Screen title – Comments
The decision in the case of Mahesh Chandra Vs. Regional Manager, U.P. Financial
Corporation,
in which the Supreme Court gave directions as to the procedure to be followed by the
Financial
Corporations in their loan recovery efforts, dealt a body blow to the recovery
initiatives of the
Financial Corporations. The defaulting borrower was given primacy in liquidation of
the Unit.
Nothing could be done without notice to and consent of the borrower. As rightly
observed in the
instant case, the directions in Mahesh Chandra’s case resulted in putting premium on
dishonest
loan defaults. The reconsideration of the decision was long overdue and it is
heartening that
finally Mahesh Chandra’s Case has been overruled. The judgment has rightly set the
pace for a
change in the Judicial thinking on lending by state owned enterprises.
Screen title - Primacy of Recovery of Debts Due to the Banks and Financial
Institutions
Act, 1993 or Companies Act, 1956
Here is a case between ICICI Ltd.. and. Vanjinad Leathers Ltd. AIR 1997 Kerala 273
where the
issue was regarding recovery of loans advanced by financial institutions.
This is related to Recovery of Debts Due to the Banks and Financial Institutions Act,
1993 -
Sections 2, 31 & 34 and Companies Act, 1956 - Section 446.
Screen title - Principle
Where suits are filed for recovery of loan advanced by banks or financial institutions
after the
appointed day under the Recovery of Debts Due to Banks and Financial Institutions
Act, and
proceedings for winding up of the debtor company were started subsequently before
the
Company Court, the Company Court will not have jurisdiction with regard to such
suits or
applications. Hence, neither leave under Section 446 of the Companies Act is
necessary to
continue the suit nor the suit would be transferred by Company Court under Section
446 (2) of
that Act.
Screen title - Facts of the Case
lCICI and IDBI had filed suits for recovery of loan advanced to the respondent
company and had
filed these suits after the appointed day under the Recovery of Debts Due to the
Banks and
Financial Institutions Act, 1993 (1993 Act). Subsequently, the company was taken
into liquidation
and winding up proceedings were initiated before the Company Court. The
Companies Act, which
is a special law, provides for excluding all other laws with regard to pending suits in
which the
company in liquidation is a party. The 1993 Act also is a special law enacted by the
Parliament to
deal with the applications of banks and financial institutions for recovery of debts.
Applications
were filed before the Kerala High Court to decide whether suits filed by secured
creditors before
the Bombay High Court need be withdrawn to the Company Court and leave it
necessary to
continue the suits standing outside the winding up proceedings.
Screen title - Issue involved, Kerala High Court’s observations and Decision
Issue
The issue was whether the Company Court will have jurisdiction under Section 446 of
the
Companies Act with regard to suits or applications pending on or after the appointed
day as per
the Act.
Observations of the Court
The Court observed that both the Companies Act and the 1993 Act being special laws
enacted by
the Parliament. When the latter special law was enacted the Parliament would have
certainly in
mind the provisions in the earlier special law viz. the Companies Act, 1956. Hence, it
was
notwithstanding the special provisions contained in the Companies Act that Section
34 had been
enacted in the t 993 Act providing that the Act shall have effect notwithstanding
anything
inconsistent therewith contained in any other law for the time being in force. Hence,
the Company
Court's jurisdiction is excluded by Section 34 of the 1993 Act. The Company Court
would not
exercise jurisdiction as regards such suits and the leave of the Company Court is not
necessary
to continue the suit.
Decision
The applications were disposed accordingly.

6. Legal Issues Relevant for Bankers – Miscellaneous


Screen title – Objectives
On completion of this module, you will be able to:
• Have finer view point about a few miscellaneous legal aspects relevant to Bankers
Screen title - Consumer Protection Act - Deficiency in service
In a case Vimal Chandra Grover v Bank of India AIR 2000" SC 2181, the issue
came up as
to whether bank giving overdraft facility to its clients provides 'service' and client
getting such
facility is 'consumer’.
This was related to the Consumer Protection Act, 1986 – Section 2 (1) (0) and (d) and
Banking
Regulation Act, 1949 - Section 6 Deficiency in service.
Screen title - Principle
The bank providing overdraft facility is rendering 'service' and the customer availing
of such
facility is a consumer. Hence, the failure of the bank to sell pledged shares within
reasonable time
causing loss to the claimants might amount to deficiency in service.
Screen title- The Facts
The Bank of India had given an overdraft facility to the appellant against the pledge
of shares.
The appellant requested the bank through letter dated 23rd April, 1992 to arrange for
sale of 500
shares of Castro I Limited at the price indicated by him to clear the overdraft
account. The branch
maintaining the overdraft account sent a letter to the Head Office after 12 days of
client's request,
agreeing to the proposed sale. After 2 months however, the Head Office stating
having not
received the letter of the client and further that the shares were not in the Head
Office. About a
month thereafter, the branch informed the appellant that the Head Office was not
holding the
shares. However, it was found later that the shares were lying with the branch itself.
During this
time, the price of the share fell and the shares could not be sold at the price
indicated by the
appellant. Hence, he filed a claim for Rs. 29,56,264.76 towards loss, interest etc. with
the
National. Commission on 'the ground of deficiency in service.
Screen title - Bank’s Argument
The bank contested the claim stating that it was not obliged to sell the shares as
under the law
the bank is not bound to follow the instructions in view of the provisions regarding
pledge under
Sections 172 to, 177 of the Contract Act and also alleging that it was the appellant
who had
misled the bank by stating that the shares were lying at the Head Office of the Bank.
The National
Commission held that there was no negligence on the part of the bank and also that
the Bank
was not bound to dispose of the shares.
This appeal arises from this judgement and order of the National Consumer Disputes
Redressal
Commission.
Screen Title – Observations of the Court
The Court observed that when the bank is engaged in different types of business as
mentioned in
Section 6 of the Banking Regulation Act, it is apparent that in granting overdraft
facilities to its
client which is a customer, it is providing service to him. The overdraft limit
prescribed by the bank
is not without consideration. The bank is charging interest and other charges in
providing the
service. Hence, provision of overdraft facility is certainly a part of banking and is
service within the
meaning of clause (0) of Section 2 of the Consumer Protection Act. In ordinary
parlance banking
is a business transaction of a bank. As the Consumer Protection Act does not define
the term
'banking' as to what services a bank can provide, Section 6 of the BR Act can be
usefully referred
to. The client who hires such service of the bank for consideration by way of payment
of interest
is a consumer.
Screen title - Observations of the Court – Bank’s Negligence and the Verdict
The Court observed that there was negligence on the part of the bank and the
service rendered
by the bank was deficient. That the bank has a right under the law to retain the
pledged goods is
not in dispute. But, once the bank agreed to sell a part of the pledged goods; it could
not fall back
on those very provisions to raise 'a plea of its rights under the law to retain the
pledged goods.
The bank has agreed that the appellant has suffered a loss because of the delay in
disposing of
the shares as agreed to by the bank. The Court found fault with the bank in' merely
going on
corresponding with its customer and its own Head Office in these days of revolution
in information
technology. It is true that the bank is not expected to process the request of its
customer at once,
but it should do so within a reasonable time. Certainly, promptness and diligence is
required
which was lacking in this case. Any fault of the appellant like being not regular in his
account with
the bank, are merely afterthoughts in order to hide its own default and inefficiency'.
Once the bank agreed to sell a part of the shares at the appellant's request without
any preconditions,
it cannot fall back on other alleged defaults of the appellant in his dealings with the
bank. The bank's plea that it could dispose of the shares only through its broker was
not accepted
by the Court as it never apprised the appellant of this fact. Accordingly, the Court
concluded that
there was negligence on the part of the bank.
The appellant had stated that he had suffered a loss of Rs. 5,09,037.47 after
deducting the debit
balance, which he claimed with interest and other charges like damage for loss of
long-standing
business due to non-renewal of letter of credit; for non-releasing of securities; undue
and unjust
harassment thus making the total of Rs. 29,56,264.76. The Court found that apart
from the claim
for damages for loss in selling of shares, the other claims were too much overblown
to be
considered at all. The appellant was therefore found to be entitled to the award of Rs.
5,09,037.47 with interest at the rate of 11 % per annum from August 1992. The bank
was granted
four weeks' time to make payment and in case of default directed to pay interest at
the rate of
18% on the above amount from the date of judgement till payment.
Decision
The appeal was allowed accordingly.
Screen title - Non-payment of Insurance Premium by Bank - Liability to Pay
Compensation
In this case between Godavari Grammena Bank vs Teja Poultry Farm IV
(2003) CPJ 675
Andhra Pradesh State Consumer Disputes Redressal Commission,
Hyderabad F.A. No.
118, the issue pertained to Bank having debited loanee/borrower's account with
premium amount
did not remit it to Insurance Co. by due date leading to loss to the borrower.
This led to question regarding Liability to pay compensation under Consumer
Protection Act,
1986.
Screen title - Principle
Risk of insurance company commences only on receipt of premium by it and in case
where
insurance premium has been collected by Bank in time and Bank has not
paid/credited same as
agreed upon to Insurance Co. by due date, Bank is held liable to pay compensation.
Screen title - Facts of the Case
Bank sanctioned a loan of Rs. 11,30,000/- for running a poultry farm of 10,000 birds
and amount
of Rs. 6,00,648/50 was disbursed. A comprehensive insurance policy was taken to
cover the risk
of the sheds in which poultry farm is to be located and Bank undertook to pay
premium towards
live stock and sheds. Bank deducted premium for live stock and paid to insurance
company.
Thereafter further amount was debited towards premium for sheds, on 16th October,
and sheds
were damaged during cyclone that occurred on the night of 6th/7th November,
damaging live
stock and sheds completely. Claim for damage of live stock was settled and paid
away. Bank
estimated the damages to the sheds at Rs. 3,10,000/-. Bank and Insurance Co. had
entered into
Grameena Package Master Policy Agreement whereby upon disbursement of loan.
Bank was
required to debit loanee/ borrower's account with the premium amount and send
credit advice to
its Head Office for crediting same on date appearing on credit advice in account of
Insurance Co.
to avoid violation of Section 64 VB of Insurance Act requiring that risk may be
assumed not
earlier than the date on which the premium has been paid in cash or by cheque to
the insurer.
Screen title - Other facts of the Case
In this case, premium amount for sheds was debited 'to the account of borrower on
16/10; Bank
claims it sent on 4/11, while Insurance Co. says that it received it on 25/11 after the
cyclone.
Distt. Consumer Disputes Redressal Forum gave a finding that Bank interpolated
entries to
indicate that it sent on 4/11; and on appeal, State Commission agreed with the
opinion of District
Forum. On appreciation of evidence like copy of Bank's Dispatch Register (original
not produced)
and Statement of Account of Insurance Co. furnished by Bank, entire episode to show
payment of
premium on 4/11 before cyclone has been held to be suspicious by Consumer Forum.
Premium
in respect of sheds received after cyclone was refunded by Insurance Co. to Bank.
Screen title - Observations of State Consumer Disputes Redressal
Commission and
Decision
National Consumer Disputes Redressal Commission in a case involving Citibank,
where owner of
car paid premium for insurance of car for two years and gave it in time to Bank for
insuring the car
and car having met with an accident became a total loss and occupants of car
succumbed to the
injuries, had held Bank liable to pay compensation. In view of this decision it was held
that
Grammena Bank committed deficiency in service in not remitting premium amount in
terms of
Master Policy Agreement and thus liable to pay compensation for sheds damaged
during the
cyclone.
Decision:
Payment of Rs. 3,85,015/- with interest at 12% p.a. and also compensation of Rs.
10,000/-
together with subsequent interest at 12 % p.a. Also held there is no deficiency in
service on the
part of Insurance Co. This order of District Forum confirmed by State Commission and
appeal
dismissed with costs of Rs. 2,000/.
Screen title - Comments
In view of Sec. 64-VB of Insurance Act, 1938 the risk of the Insurance Company
commences only
on the payment of the premium either in cash or by cheque. In the present case, the
amount of
premium of Rs. 837/- for the sheds was debited to the account of borrower of Bank
on 16/10;
sheds were damaged during cyclone on 6/7 Nov. and it has been held by Consumer
Forum that
Insurance Co. received the premium after the cyclone, and, therefore. Insurance Co.
was found
not bound to pay the amount. Borrower had paid the insurance premium and as such
Bank held
liable to pay compensation. In such circumstances, Banks are bound to ensure that
premia is
paid by due date to Insurance Companies to avoid stepping into shoes of insurance
co. for
indemnifying borrowers from the funds of Bank.

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