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LEGAL.

v REGULATORY ASPECTS OF BANKING


2
ind

Edition

INDIAN INSTITUTE OF BANKING & FINANCE

MACMILLAN

LEGAL & REGULATORY ASPECTS OF BANKING

INDIAN INSTITUTE OF BANKING & FINANCE


'THE ARCADE', WORLD TRADE CENTRE, CUFFE PARADE MUMBAI400005

Established on 30th April 1928

MISSION To develop professionally qualified and competent bankers and financial professionals primarily through a process of education, training, examination, consultancy/counselling and continuing professional development programs.

VISION To be the premier Institute for developing and nurturing competent professionals in banking and finance field.

OBJECTIVES To facilitate study of theory and practice of banking and finance. To test and certify attainment of competence in the profession of banking and finance. To collect, analyse and provide information needed by professionals in banking and finance. To promote continuous professional development. To promote and undertake research relating to Operations, Products, Instruments, Processes, etc., in banking and finance and to encourage innovation and creativity among finance professionals so that they could face competition and succeed. COMMITTED TO PROFESSIONAL EXCELLENCE Website: www.iibf.org.in

LEGAL & REGULATORY ASPECTS OF BANKING


(For JAIIB/Diploma in Banking & Finance Examination) 2nd Edition

Indian Institute of Banking & Finance

MACMILLAN

ij

INDIAN INSTITUTE OF BANKING & FINANCE, MUMBAI, 2005, 2008 (This book has been published by Indian Institute of Banking & Finance. Permission of the Institute is essential for reproduction of any portion of this book. The views expressed herein are not necessarily the views of the Institute.)

All rights reserved. No part of this publication may be reproduced or transmitted, in any form or by any means, without permission. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. J-'im t'tlitiim. 2005 Second edition, 2008 Reprinted, 2008 2009 (twice) MACMILLAN PUBLISHERS INDIA LIMITED Delhi Bangalore Chennai Kolkata Mumbai Ahmedabad Bhopal Chandigarh Coimbatore Cuttack Guwahati Hubli Hyderabad Jaipur Lucknow Madurai Nagpur Patna Pune Thiruvananthapuram Visakhapatnam Companies and representatives throughout the world ISBN 10:0230-63610-1 ISBN 13:978-0230-63610-1 Published by Rajiv Beri for Macmillan Publishers India Limited, 2/10 Ansari Road, Daryaganj, New Delhi 110 002 Printed by S.M. YOGAN at Macmillan India Press, Chennai 600 041.

LEGAL & REGULATORY ASPECTS OF BANKING Originally prepared by K.D. Zacharias (Module A), C.P. Ravindranath (Module B), P.R. Kulkarni (Module C), B. Gopalakrishnan (Module D) under the guidance of M.L. Chandak, Advocate, High Court, Mumbai. Revised and updated by K.D. Zacharias, Legal Adviser, RBI (Module A), G.M. Ramamurthy, Legal Adviser, IDBI Ltd. (Modules B, C and D)

This book is meant for educational and learning purposes. The author(s) of the book has/have taken all reasonable care to ensure that the contents of the book do not violate any existing copyright or other intellectual property rights of any person in any manner whatsoever. Jn the event the author(s) has/have been unable to track any source and if any copyright has been inadvertently infringed, please notify the publisher in writing for corrective action.

FOREWORD

The world of banking and finance is changing very fast and banks are leveraging knowledge and technology in offering newer services to the customers. Banks and technology are evolving so rapidly that bank staff must continually seek new skills that enable them not only to respond to change, but also to build competence in handling various queries raised by customers. Therefore, there is a need for today's bank employees to keep themselves updated with a new set of skills and knowledge. The Institute, being the main provider of banking education, reviews the syllabus for its associate examinations viz. JAIIB/CAIIB and various other examinations with the help of Expert Groups from time to time to make the contents relevant and contemporary in nature. The latest revision has been done by an expert group under the Chairmanship of Prof. Y.K. Bhushan. This book and the other two books mentioned below are the courseware for JAIIB which aims to impart up-to-date knowledge in the field of banking and finance and equip the bankers to face the emerging challenges of today and tomorrow. As there is a growing demand for qualified manpower in the banking sector with accent on banking knowledge and skills, together with technology-familiarity, customer-orientation and hands-on application skills - which will substantially reduce the training intervention at the bank level before/immediately after they are employed - the institute has launched the Diploma in Banking & Finance in 2007 for graduation-plus level candidates. Candidates to the course will get extensive and detailed knowledge on banking & finance and details of banking operations. The Diploma is offered in the distance learning mode with a mix of educational support services like provision of study kits, contact classes, etc. The key features of the Diploma is that it aims at exposing students to real-life banking environment and that it is equivalent to JAIIB. The JAIIB and the Diploma in Banking & Finance has three papers viz. 1. Principles & Practices of Banking 2. Accounting & Finance for Bankers 3. Legal & Regulatory Aspects of Banking This book, the courseware for the third paper on Legal & Regulatory Aspects of Banking, deals with legal and regulatory aspects that have a bearing on banking operations, and are woven in to the units/chapters to make their relevance easily understandable. Banking and business laws insofar as they relate to day-to-day banking operations, have also been covered at appropriate places. Case laws are included, wherever appropriate. There are various newly enacted laws like Anti-money Laundering Act, Right to Information Act, Information Technology Act, etc., which have significantly changed the way banking operations are done, and these laws are explained in simple terms as needed to be understood by a practicing banker. The Institute had constituted teams consisting of eminent bankers and academicians to prepare the reading material for all the subjects as self-instructional study kits obviating the need for the intervention of a teacher. This book represents the outcome of this endeavour to bring out self-contained comprehensive courseware/book on the subject. The Institute acknowledges with gratitude the valuable services rendered by the authors in preparing the courseware in a short period of time.

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The team, who developed the book, has made all efforts to cover the entire syllabus prescribed for the subject. However, the candidates could still refer to a few standard textbooks to supplement this material which we are sure, will enhance the professional competence of the candidates to still a higher degree. We have no doubt that the study material will be found useful and will meet the needs of the candidates to prepare adequately for the examinations. In addition, we are sure that these books will also be useful to practitioners, academicians, and other interested readers. We welcome suggestions for improvement of the book. Mumbai 3-7-2008 R. Bhaskaran Chief Executive Officer

RECOMMENDED READING The Institute has prepared comprehensive courseware in the form of study kits to facilitate preparation for the examination without intervention of the teacher. An attempt has been made to cover fully the syllabus prescribed for each module/subject and the presentation of topics may not always be in the same sequence as given in the syllabus. Candidates are also expected to take note of all the latest developments relating to the subject covered in the syllabus by referring to Financial Papers, Economic Journals, Latest Books and Publications in the subjects concerned.

PAPER 3 - LEGAL & REGULATORY ASPECTS OF BANKING

Objectives: The candidates would be able to acquire knowledge in: The legal & regulatory framework of the banking system and The various laws and enactments affecting day-to-day banking operations

MODULE A - REGULATIONS AND COMPLIANCE


The questions in this section will be with reference to legal issues and problems. A. Provisions of RBI Act 1935, Banking Regulation Act 1949, Banking Companies [Acquisition and Transfer of Undertakings Act 1970 & 1980]. B. Government and RBFs Powers: - Opening of New Banks and Branch Licensing - Constitution of Board of Directors and their Rights - Banks Shareholders and their Rights - CRR/SLR Concepts - Cash/Currency Management Winding Up - Amalgamation and Mergers Powers to Control Advances - Selective Credit Control - Monetary and Credit Policy Audit and Inspection Supervision and Control-Board for Financial Supervision - Its Scope and Role Disclosure of Accounts and Balance Sheets Submission of Returns to RBI, etc. Corporate Governance

MODULE B - LEGAL ASPECTS OF BANKING OPERATIONS


Case Laws on Responsibility of Paying/Collecting Banker Indemnities/Guarantees - Scope and Application - Obligations of a Banker - Precautions and Rights Laws Relating to Bill Finance, LC and Deferred Payments Laws Relating to Securities Valuation of Securities - Modes of Charging Securities - Lien, Pledge, Mortgage, Hypothecation, etc. Registration of Firms/Companies Creation of Charge and Satisfaction of Charge

MODULE C - BANKING RELATED LAWS Law of Limitation Provisions of Bankers Book Evidence Act Special Features of Recovery of Debts Due to Banks and Financial Institutions Act, 1993 TDS and Service Tax Banking Cash Transaction Tax Asset Reconstruction Companies The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 The Consumer Protection Act, 1986 Banking Ombudsman 2006 LokAdalats Lender's Liability Act

MODULE D - COMMERCIAL LAWS WITH REFERENCE TO BANKING OPERATIONS Indian Contract Act, 1872 (Indemnity, Guarantee, Bailment, Pledge and Agency, etc.) The Sale of Goods Act, 1930 (Sale and Agreement to Sell, Definitions, Conditions and Warranties, Express and Implied, Right of Unpaid Seller, etc.) The Companies Act, 1956, Definition, Features of Company, Types of Companies, Memorandum, Articles of Association, Doctrines of Ultra Vires, Indoor Management and Constructive Notice, Membership of Company - Acquisition - Cessation, Rights and Duties of Members and Register of Members, Prospectus and Directors. Indian Partnership Act, 1932, Definition and Types of Partnership, Relation of Partners to One Another-Relation of Partners to Third Parties, Minor Admitted to the Benefits of Partnership, Dissolution of Firm, Effect of Non-Registration The Transfer of Property Act Foreign Exchange Management Act, 2000 Prevention of Money Laundering Act, 2002 Right to Information Act, 2005 Information Technology Act, 2000

CONTENTS
Foreword v

MODULE A - REGULATIONS AND COMPLIANCE 1. Legal Framework of Regulation of Banks 2. Control Over Organisation of Banks 3. Regulation of Banking Business 4. Returns, Inspection, Winding Up 5. Public Sector Banks and Co-operative Banks MODULE B - LEGAL ASPECTS OF BANKING OPERATIONS 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. Case Laws on Responsibility of Paying Bank Case Laws on Responsibility of Collecting Bank Indemnities Bank Guarantees Letters of Credit Deferred Payment Guarantee Laws Relating to Bill Finance Various Types of Securities Law Relating to Securities and Modes of Charging -1 Law Relating to Securities and Modes of Charging - II Different Types of Borrowers Types of Credit Facilities Secured and Unsecured Loans, Registration of Firms, Incorporation of Companies Registration and Satisfaction of Charges 83 93 101 107 119 131 135 143 155 163 173 181 187 197 3 15 31 49 65

MODULE C - BANKING RELATED LAWS SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST, 2002 (SARFAESI ACT) 20. Introduction to SARFAESI Act, 2002 21. Definitions at SARFAESI Act, 2002 22. Regulation of Securitisation and Reconstruction of Financial Assets of Banks and Financial Institutions

205 209 219

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23. 24. 25. 26. 27. 28. Enforcement of Security Interest Central Registry Offences and Penalties Miscellaneous Provisions THE BANKING OMBUDSMAN SCHEME, 2006 Purpose, Extent, Definitions, Establishment and Powers Procedure for Redressal of Grievances RECOVERY OF DEBTS DUE TO BANKS AND FINANCIAL INSTITUTIONS ACT, 1993 (DRTACT) Preliminary Establishment of Tribunal and Appellate Tribunal Jurisdiction, Powers and Authority of Tribunals Procedure of Tribunals Recovery of Debts Determined by Tribunal and Miscellaneous Provisions THE BANKERS' BOOKS EVIDENCE ACT, 1891 The Bankers' Books Evidence Act, 1891 THE LEGAL SERVICES AUTHORITIES ACT, 1987 LokAdalats THE CONSUMER PROTECTION ACT, 1987 Preliminary, Extent and Definitions Consumer Protection Councils Consumer Disputes Redressal Agencies THE LAW OF LIMITATION Limitations of Suits, Appeals and Applications TAX LAWS Income Tax, Banking Cash, Transaction Tax, Fringe Benefit Tax and Service Tax

231 241 245 249 255 259

29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40.

267 271 275 279 285 293 299 30 3 311 315 327 331

MODULE D - COMMERCIAL LAWS WITH REFERENCE TO BANKING OPERATIONS 41. 42. 43. 44. 45. 46. 47. 48. Meaning and Essentials of a Contract Contracts of Indemnity Contracts of Guarantee Contract of Bailment Contract of Pledge Contract of Agency Meaning and Essentials of a Contract of Sale Conditions and Warranties

341 345 347 353 357 359 365 369

XIII 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. Unpaid Seller Definition, Meaning and Nature of Partnership Relations of Partners to One Another Relations of Partners to Third Parties Minor Admitted to the Benefits of Partnership Dissolution of a Firm Effect of Non-Registration Definition and Features of a Company Types of Companies Memorandum of Association and Articles of Association Doctrines of Ultra Vires/Constructive Notice/Indoor Management Membership Prospectus Directors Foreign Exchange Management Act, 1999 Transfer of Property Act, 1882 The Right to Information Act, 2005 Right to Information and Obligations of Public Authorities The Prevention of Money Laundering Act, 2002 Information Technology Act, 2000 Bibliography

373 377 381 385 389 393 397 399 405 411 415 419 425 429 437 443 453 457 463 469 475

MODULE-A
REGULATIONS AND COMPLIANCE
Unit 1. Legal Framework of Regulation of Banks Unit 2. Control over Organisation of Banks Unit 3. Regulation of Banking Business Unit 4. Returns, Inspection, Winding Up Unit 5. Public Sector Banks and Co-operative Banks

LEGAL FRAMEWORK OF REGULATION OF BANKS

STRUCTURE 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 1.10 1.11 1.12 1.13 1.14 Objectives Introduction Business of Banking Constitution of Banks Reserve Bank of India Act, 1934 Banking Regulation Act, 1949 Reserve Bank as Central Bank and Regulator of Banks Government as a Regulator of Banks Control Over Co-operative Banks Regulation by Other Authorities Let Us Sum Up Keywords Check Your Progress Answer to 'Check Your Progress' Terminal Questions

1.0 OBJECTIVES
The objectives of this Unit are to understand: the definition and nature of the business of banking; the constitution of different types of banks; the regulatory scheme of the RBI Act and the BR Act; the role of the Reserve Bank and the Central Government as regulators; and the special position of public sector banks and co-operative banks.

1.1 INTRODUCTION
Banking in India is mainly governed by the Banking Regulation Act, 1949 and the Reserve Bank of India Act, 1934. The Reserve Bank of India and the Government of India exercise control over banks from the opening of banks to their winding up by virtue of the powers conferred under these statutes. All the regulatory provisions are not uniformly applicable to all banks. The applicability of the provisions of these Acts to a bank depends on its constitution; that is, whether it is a statutory corporation, a banking company or a co-operative society. In this unit, we look at the definition of banking, the constitution of different types of banks and applicability of regulatory laws, the general framework of the regulatory laws and the role of regulators namely, the Reserve Bank of India and the government.

1.2 BUSINESS OF BANKING


i. Definition of Banking: Banking is defined in Section 5(b) of the Banking Regulation Act as the acceptance of deposits of money from the public for the purpose of lending or investment. Such deposits may be repayable on demand or otherwise and withdrawable by cheque, draft, order or otherwise. Thus, a bank must perform two essential functions: (i) acceptance of public deposits, and (ii) lending or investment of such deposits. The deposits may be repayable on demand or for a period of time as agreed by the banker and the customer. In terms of the definition, the banker can accept "deposits" of money and not anything else. Further, accepting deposits from the "public" implies that a banker accepts deposits from anyone who offers money for such purpose. However, a banker can refuse to open account for undesirable persons and further, the opening of accounts is subject to certain conditions like proper introduction and identification. The "Know Your Customer" guidelines issued by the Reserve Bank require banks to follow certain customer identification procedure for opening of accounts for protecting the banks from frauds, etc., and also for monitoring transactions of a suspicious nature for the purpose of reporting to appropriate authorities for taking anti-money laundering measurers and combating financing of terrorism. There is no exhaustive definition of "banking" in Common Law of England. However, the usual characteristics of banking as identified by Lord Denning MR in United Dominions Trust Ltd. vs Kirkwood ([1966] 1 All ER 968 at 975) are: (a) the conduct of current accounts; (b) the payment of cheques; and (c) the collection of cheques for customers. These characteristics are not equivalent to a definition, and these are also not the only characteristics. (See, Paget's Law of Banking, 12th Edn., pp. 107 to 109) ii. Deposits Withdrawable by Cheque: Under Section 49A of the Banking Regulation Act, no organisation other than a bank is authorised to accept deposits withdrawable by cheque. The Savings Bank

Scheme run by the government, a Primary credit society and any other person or firm notified by the government are exempted from this prohibition. iii. Acceptance of Deposits by Non-banking Entities: There are also non-banking companies, firms and other unincorporated associations of persons and individuals who accept deposits from the public. Acceptance of deposits by non-banking financial companies is regulated by the Reserve Bank under the Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998 and other directions issued by it under Chapter IIIB of the Reserve Bank of India Act. Other companies are regulated by the Central Government under the Companies (Acceptance of Deposit) Rules, 1975 issued under Section 58A of the Companies Act, 1956. Individuals, firms and other unincorporated associations of persons whose business includes the business of a financial institution or whose principal business is acceptance of deposits, is prohibited under Section 45S of the RBI Act (as amended in 1997) from accepting deposits from the public, except relatives. This prohibition does not apply to acceptance of deposits by those who are mainly engaged in manufacturing or trading. iv. Licence for Banking: In India, it is necessary to have a licence from the Reserve Bank under Section 22 of the Banking Regulation Act for commencing or carrying on the business of banking. Every banking company has to use the word "bank" as part of its name (See, Section 7 of the Act) and no company other than a banking company can use the words "bank", "banker", "banking" as part of its name. Further, no firm, individual or group of individuals is permitted to use the words "bank", "banking" or "banking company" as a part of the name or for the purpose of business. Subsidiaries of banks and association of banks in certain cases as also Primary Credit Societies are exempted from this restriction. v. Permitted Business: Although, traditionally, the main business of banks is acceptance of deposits and lending, the banks have now spread their wings far and wide into many allied and even unrelated activities. The forms of business permissible under Section 6(1) of the Banking Regulation Act, apart from banking business, are summarised below: (a) (i) Borrowing, raising or taking up of money; (ii) Lending or advancing of money either upon security or without security; (iii) Drawing, making, accepting, discounting, buying, selling, collecting and dealing in bills of exchange, hundis, promissory notes, coupons, drafts, bills of lading, railway receipts, warrants, debentures, certificates, scrips and other instruments and securities whether transferable or negotiable or not; (iv) Granting and issuing of letters of credit, travellers' cheques and circular notes; (v) Buying, selling and dealing in bullion and specie; (vi) Buying and selling of foreign exchange including foreign bank notes; (vii) Acquiring, holding, issuing on commission, underwriting and dealing in stock, funds, shares, debentures, debenture stock, bonds, obligations, securities and investments of all kinds; (viii) Purchasing and selling of bonds, scrips and other forms of securities on behalf of constituents or others; (ix) Negotiating of loans and advances; (x) Receiving of all kinds of bonds, scrips or valuables on deposit or for safe custody or otherwise; (xi) Providing of safe deposit vaults; and (xii) Collecting and transmitting of money and securities.

(c) Contracting for public and private loans and negotiating and issuing the same. (d) Insure, guarantee, underwrite, participate in managing and carrying out any issue of state, municipal or other loans or of shares, stock, debentures or debenture stock of companies and lend money for the purpose of any such issue. (e) Carry on and transact every kind of guarantee and indemnity business. (f) Manage, sell and realise any property which may come into its possession in satisfaction of any of its claims. (g) Acquire, hold and deal with any property or any right, title or interest in any such property which may form the security for any loan or advance. (h) Undertake and execute trusts. (i) Undertake the administration of estates as executor, trustee or otherwise. (j) Establish, support and aid associations, institutions, funds, trusts, etc., for the benefit of its present or ex-employees; grant money for charitable purposes, (k) Acquire, construct and maintain any building for its own purpose. (1) Sell, improve, manage, develop, exchange, lease, mortgage, dispose of or turn into account or otherwise deal with all or any part of the business of any person or company, when such business is of a nature described in Section 6. (m) Acquire and undertake the whole or any part of the business of any person or company, when such business is of a nature described in Section 6. (n) Do all such things which are incidental or conducive to the promotion or advancement of the business of the company, (o) Do any other business specified by the Central Government as the lawful business of a banking company. The Central Government has accordingly specified leasing and factoring as permissible business for banks. vi. Prohibited Business: Section 8 of the Banking Regulation Act prohibits a banking company from engaging directly or indirectly in trading activities and undertaking trading risks. Buying or selling or bartering of goods directly or indirectly is prohibited. However, this is without prejudice to the business permitted under Section 6(1) of the Act. Accordingly, a bank can realise the securities given to it or held by it for a loan, if need arises for the realisation of the amount lent. It can also buy or sell or barter for others in connection with: (i) bills of exchange received for collection or negotiation, and (ii) undertaking the administration of estates as executor, trustee, etc. Goods for the purpose of this Section means every kind of moveable property, other than actionable claims, stocks, shares, money, bullion and specie and all instruments referred to in Clause (a) of subSection (1) of Section 6. As regards immoveable properties, Section 9 prohibits a banking company from holding such property, howsoever acquired, except as is required for its own use, for a period exceeding seven years from the acquisition of the property. The Reserve Bank may extend this period by another five years, if it is satisfied that such extension would be in the interest of the depositors of the banking company. The banking company shall be required to dispose of such property within the permitted period. 1.3 CONSTITUTION OF BANKS i. Banks in India fall under one of the following categories: (a) Body corporate constituted under a special statute; (b) Company registered under the Companies Act, 1956 or a foreign company; (c) Co-operative society registered under a central or state enactment on co-operative societies.

ii. Public Sector Banks: The public sector banks including nationalised banks, State Bank of India and its associates (subsidiaries) and the Regional Rural Banks fall in the first category. By the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 and the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 the Central Government nationalised (took over the business undertakings) of certain banking companies and vested them in newly created statutory bodies (corresponding new banks) constituted under Section 3 of the 1970/1980 Act. The State Bank of India was constituted under the State Bank of India Act, 1955 and the six associate/subsidiary banks were constituted under the State Bank (Subsidiary Banks) Act, 1959 or other statutes (See Para 5.2.6). The regional rural banks are constituted under the Regional Rural Banks Act, 1976. These banks are governed by the statutes creating them as also some of the provisions of the Banking Regulation Act and the Reserve Bank of India Act. The details are discussed in Unit 5. iii. Banking Companies: A banking company, as defined in Section 5(c) of the Banking Regulation Act is a company which transacts the business of banking. Such company may be a company constituted under Section 3 of the Companies Act or a foreign company within the meaning of Section 591 of that Act. All the private sector banks are banking companies. These banks are governed by the Companies Act, 1956 in respect of their constitution and by the Banking Regulation Act and the RBI Act with regard to their business of banking. iv. Co-operative Banks: A co-operative bank is a co-operative society registered or deemed to have been registered under any Central Act for the time being in force relating to the multi-state co-operative societies, or any other central or state law relating to co-operative societies for the time being in force. If a co-operative bank is operating in more than one state, the Central Act applies. In other cases, the state laws apply. The Banking Laws (Application to Co-operative Societies) Act, 1965 extended certain provisions of the Banking Regulation Act and the Reserve Bank of India Act to the co-operative banking sector. After the Supreme Court held in Apex Cooperative Bank's case (AI R 2004 SC 141) that multi-state co-operative societies cannot be licensed as co-operative banks, the Banking Regulation (Amendment) and Miscellaneous Provisions Act, 2004 was enacted to permit licensing of multi-state co-operative banks. A "multi-state cooperative bank" under this Act means a multi-state co-operative society which is a primary cooperative bank. 1.4 RESERVE BANK OF INDIA ACT, 1934 i. The Reserve Bank of India Act, 1934 was enacted to constitute the Reserve Bank of India: (i) to regulate the issue of bank notes, (ii) for keeping reserves for securing monetary stability in India, and (iii) to operate the currency and credit system of the country to its advantage. The Act came into force on 6th March 1934. The Act has been amended from time to time to meet the demands of changing times. The last amendment to the Act was effected by the RBI (Amendment) Act, 2006. ii. The Act deals with the constitution, powers and functions of the Reserve Bank. It does not directly deal with regulation of the banking system except for Section 42, which provides for cash reserves of scheduled banks to be kept with the Reserve Bank, with a view to regulating the credit system and ensuring monetary stability. Further, Section 18 of the Act provides for direct discount of bills of exchange and promissory notes when a special occasion arises, making it necessary or expedient for the purpose of regulating credit in the interests of trade, industry and agriculture. The Act, in short, deals with: (i) incorporation, capital, management and business of the bank:

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(ii) the central banking functions like issue of bank notes, monetary control, acting as banker to government and banks, lender of last resort; (iii) collection and furnishing of credit information; (iv) acceptance of deposits by non-banking financial institutions; (v) general provisions regarding reserve fund, credit funds, publication of bank rate, audit and accounts; and (vi) penalties for violation of the provisions of the Act or the directions issued thereunder. 1.5 BANKING REGULATION ACT, 1949 i. The Banking Regulation Act, 1949 was enacted to consolidate and amend the law relating to banking and to provide for a suitable framework for regulating the banking companies. Initially, the Act provided for regulation of banking companies only, but in 1965 the Act was amended to cover co-operative banks as well with certain modifications (See, Section 56). However, the Act, as provided in Section 3, does not apply to primary agricultural credit societies and co-operative land mortgage banks. The provisions of the Act are applicable to banking companies in addition to other laws which are applicable to such companies, unless otherwise specifically provided in the Act. Thus, Companies Act, 1956 which deals with the incorporation and working of companies is applicable to banking companies except where special provisions are made in the Banking Regulation Act in that regard. ii. The Act regulates entry into banking business by licensing as provided in Section 22 thereof. The Act also puts restrictions on the shareholding, directorship, voting rights and other aspects of banking companies. There are several provisions in the Act regulating the business of banking such as restriction on loans and advances, rates of interest to be charged, requirement as to cash reserve and maintenance of percentage of assets, etc. There are provisions regarding audit and inspection and submission of balance sheets and accounts. The Act provides for control over the management of banking companies and also deals with the procedure for winding up of the business of the banks and penalties for violation of its provisions. In short, the Act deals with: (a) regulation business of banking companies; (b) control over the management of banking companies; (c) suspension and winding up of banking business; and (d) penalties for violation of the provisions of the Act.

1 . 6 RESERVE BANK AS CENTRAL BANK AND REGULATOR OF BANKS


i. The Reserve Bank was constituted under Section 3 of the Reserve Bank of India Act, 1934 for taking over the management of currency from the Central Government and carrying on the business of banking in accordance with the provisions of the Act. Originally, under the RBI Act, the Bank had the responsibility of: (a) regulating the issue of bank notes; (b) keeping of reserves for ensuring monetary stability; and (c) generally to operate the currency and credit system of the country to its advantage. ii. The Reserve Bank is a body corporate having perpetual succession and common seal and shall sue and be sued in its name. The whole capital of the bank is held by the Central Government. The Bank has its central office in Mumbai and offices in Mumbai, Kolkata, Delhi and Chennai, and branches at most of the state capitals and some other cities. iii. The bank functions under the general superintendence and directions of the Central Board of

Directors. The bank has to abide by the directions given by the Central Government in public interest after consultation with the Governor of the bank. The board shall consist of a Governor and not more than four Deputy Governors to be appointed by Central Government and other directors nominated by the Central Government. Apart from the Central Board, the bank has also local boards situated at Mumbai, Kolkata, Delhi and Chennai, which perform any duty delegated to them by the Central Board. The Governor has the power of general superintendence and direction of the affairs of the bank and exercise all powers of the bank unless otherwise provided in the regulations made by the Central Board. The Deputy Governors, Executive Directors and other officers in different grades assist the Governor in the discharge of the Bank's functions. iv. The Reserve Bank is the sole authority for issue and management of currency in India under Section 22 of the RBI Act. The bank may issue notes of different denominations from Rs. 2 to Rs. 10,000 as the Central Government may decide on the recommendations of the Central Board of the bank. Such notes shall be legal tender at any place in India. v. The bank is the banker to the Central Government under Section 20 of the Act, and accordingly it is obligatory to undertake banking business for the Central Government. In the case of state governments, their banking business is undertaken by the bank based on agreements as provided in Section 21 A. Bank provides ways and means of advances to the Central and state governments. These are temporary advances to meet immediate needs when there is interval between expenditure and flow of revenue. vi. The role of the bank as regulator of banking sector is mainly by virtue of the provisions of the Banking Regulation Act, 1949. In exercise of the powers under that Act the bank regulates the entry into banking business by licensing, exercises control over shareholding and voting rights of shareholders, exercises controls over the managerial persons, and regulates the business of banks. The bank also inspects banks and exercises supervisory powers, and may issue directions from time to time in public interest and in the interest of the banking system with respect to interest rates, lending limits, investments and various other matters. vii. The major powers of the Reserve Bank in the different roles as regulator and supervisor can be summed up as under: (a) power to licence; (b) power of appointment and removal of banking boards/personnel; (c) power to regulate the business of banks; (d) power to give directions; (e) power to inspect and supervise banks; (f) power regarding audit of banks; (g) power to collect, collate and furnish credit information; (h) power relating to moratorium, amalgamation and winding up; and (i) power to impose penalties.

1.7 GOVERNMENT AS A REGULATOR OF BANKS


i. The Reserve Bank is the primary regulator of banks. But the Central Government has also been conferred extensive powers under the RBI Act and BR Act either directly or indirectly over the banks. ii. The government holds the entire capital of the Reserve Bank and appoints the Governor and the -----mr.mhe.rs nf the Central Rmrd nnri Vns the power to remove them. The government has also the
--j _______ i

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necessary in public interest after consultation with the Governor. Thus, the government can exercise control over banks by influencing decision-making by the Reserve Bank and has also got appellate authority in respect of several matters in which the Reserve Bank has been conferred the power to decide at the first instance. Thus, under the Banking Regulation Act appeal lies with the Central Government on removal of managerial personnel under Sections 10B and 36AA of the BR Act. Similarly, there are also provisions for appeal in respect of cancellation of banking licence (under Section 22) and refusal of certificate regarding floating charge on assets (Section 14A). iii. The government has the power to suspend the operations of the Banking Regulation Act or to give exemption from any of the provisions of the Act on the representation/recommendation of the Reserve Bank under Sections 4 and 53 of the Act, respectively. The government has also the power to notify other forms of business which a bank may undertake under Section 6(1 )(o) of the Act. Rule-making powers under Sections 52 and 45Y are vested in the Central Government. There are also other provisions under which the Central Government exercises powers as under: (a) Approval for formation of subsidiary for certain business under Section 19; (b) Notification with reference to accounts and balance sheet under Section 29; (c) Issue of direction for inspection of banks under Section 35; (d) Power to acquire undertakings of banks (Section 36AE); (e) Appointment of court liquidator; (f) Suspension of business and amalgamation of banks under Section 45. The above provisions confer wide powers on the Central Government to regulate banks. These are in addition to the powers conferred on the government as majority shareholder or full owner of public sector banks under the statutes constituting them. 1.8 CONTROL OVER CO-OPERATIVE BANKS i. A co-operative bank is a co-operative society engaged in the business of banking and may be a primary Co-operative bank, a district central co-operative bank or a state co-operative bank. Cooperative banks operating in one state only are registered under the State co-operative Societies Act concerned. The formation of such banks as well as their management and control over personnel is regulated by the co-operative law of the state. The Registrar of co-operative societies under the Co-operative Societies Act exercises a wide range of powers on co-operative societies from registration to winding up. ii. In the case of co-operative banks operating in more than one state, the Multi-State Co-operative Societies Act, 2002 is applicable. In that case, the Registrar appointed by the Central Government takes the place of the Registrar appointed by the State Government in other cases. iii. With the introduction of Section 56 in the Banking Regulation Act, 1949 with effect from 1965, cooperative banks have come under the regulatory purview of the Reserve Bank. While the formation and management of co-operative societies operating in one state only (including those conducting banking business) are under the control of the State Government, licensing and regulation of banking business rests with the Reserve Bank. Thus, there is dual control of State Governments and the Reserve Bank over these banks. IV. In the case of co-operative banks which are registered under the Deposit Insurance and Credit Guarantee Corporation Act, the Reserve Bank has the power to order their winding up. The circumstances in which Reserve Bank may require winding up are mentioned in Section 13D of the Act.

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1.9 REGULATION BY OTHER AUTHORITIES
i. Banks may be subject to the control of other regulatory agencies in the conduct of their business. For instance, a banking company will be subject to the control of the authorities under the Companies Act in respect of company matters. Similarly, a bank is answerable to labour authorities in respect of the terms and conditions of service of its workmen, opening and closing of its premises, engagement of contract labour, etc. Banks are also liable to pay income tax like cash transaction tax, service tax, etc., and other taxes and have to follow the rules and regulations in that regard. ii. As provided in Section 6 of the Banking Regulation Act, banks may undertake certain non-banking business in addition to the business of banking. In that regard also, banks may be subject to the regulatory control of other agencies. For instance, in the case of dealings in securities like shares and debentures, banks are subject to regulation by the Securities Exchange Board of India under the Securities Contract (Regulation) Act, 1956 read with the Securities and Exchange Board of India Act, 1992. If the Bank desires to raise capital through public issue, it has to comply with SEBI guidelines. In case of Insurance Business - by IRDA and in case of Mutual Fund Business RBI, SEBI. The study herein is, however, largely confined to the regulation of banks by the Reserve Bank and the Central Government under the Reserve Bank of India Act and the Banking Regulation Act.

1.10 LET US SUM UP


1. Banking means acceptance of deposits of money from the public for lending or investment. Such deposits may be repayable on demand or may be for a period of time as agreed to, by the banker and the customer, and may be repayable by cheque, draft or otherwise. Apart from banking, banks are authorised to carry on other business as specified in Section 6 of the Banking Regulation Act. Banks are, however, prohibited from undertaking any trading activities. Banks are constituted as companies registered under the Companies Act, 1956, statutory corporations constituted under Special Statutes or Co-operative societies registered under the Central or State Co-operative Societies Acts. The extent of applicability of the regulatory provisions under the Banking Regulation Act and the Reserve Bank of India Act to a bank depends on the constitution of the bank. Reserve Bank of India is the central bank of the country and the primary regulator for the banking sector. The government has direct and indirect control over banks. It can exercise indirect control through the Reserve Bank and also act directly in appeals arising from decisions of the Reserve Bank under the various provisions of the Banking Regulation Act. In public sector banks like the State Bank of India and its subsidiaries, nationalised banks and the regional rural banks, 50% or more of their shares are held by the Central Government. Central Government has substantial control over the management of these banks. Only certain provisions of the BR Act are applicable to these banks as indicated in that Act. Co-operative banks operating in one state only are registered under the State Co-operative Societies Act and are subject to the control of the State Government as also the Reserve Bank. In the case of non-banking business of the banks, they are subject to control by other regulatory agencies.

2.

3.

1.11 KEYWORDS
Banking; Banking Company; Body Corporate; Co-operative Bank; Nationalised Bank; Regional Rural Bank; Public Sector Bank.

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1.12 CHECK YOUR PROGRESS A. 1. State whether the following statements are True or False. (i) A public sector bank is a body corporate created under a special statute. (ii) A banking company is registered under the Banking Regulation Act. (iii) Co-operative banks are registered under the Multi-State Co-operative Societies Act or a State Co-operative Societies Act. (iv) Subsidiaries of the State Bank are companies registered under the Companies Act. (v) Accepting deposits for safe custody would fall within the definition of "banking". 2. Fill in the gaps choosing the answers from the brackets. (i) Reserve Bank was constituted under ________ (BR Act, RBI Act, Companies Act) (ii) A Regional Rural Bank is ________ (a body corporate created under a special statute, a co operative society, a company) (Reserve Bank, Registrar of Companies, (iii) Banking companies are licensed by _____ Company Law Board) (iv) Business which a banking company may undertake other than banking is as stipulated by _______ (Reserve Bank, BR Act, RBI Act) (v) BR Act was enacted for ________ (regulating banking companies, creating Reserve Bank, regulating acceptance of deposits from public) B. 1 State whether the following statements are True or False, (i) Central Government can give direction to the Reserve Bank, (ii) All kinds of business of banks is regulated only by the Reserve Bank, (iii) Central Government is the primary regulator of banks, (iv) State governments have no control over co-operative banks. (v) On cancellation of licence of any bank, an appeal lies with Central Government. Fill in the gaps choosing the answers from the brackets. _____ (State Co operative Societies Act, Multi-State Co-operative Societies Act, RBI Act) Government can exempt a bank from the provisions of BR Act ________ (on the recommendation of RBI, whenever the government is satisfied, if requested by a bank) _______ exercises the central banking function in India. (State Bank, Central Bank of (i) Co-operative banks operating in different states are registered under India, Reserve Bank) (Reserve Bank, (ii) (iv) Company matters of a banking company are regulated by _________ Authorities under the Companies Act, SEBI) (v) Trading in shares and (Controller (iii) securities by banks is subject to regulation by . of Capital Issues, SEBI, Company Law Board)

1.13 ANSWERS TO 'CHECK YOUR PROGRESS'


A. 1. (i) True; (ii) False; (iii) True; (iv) False; (v) False. 2. (i) RBI Act (ii) a body corporate created under a special statute (iii) Reserve Bank (iv) BRAct (v) for regulating banking companies. B. 1. (i) True; (ii) False; (iii) False; (iv) False; (v) True. 2. (i) Multi-State Co-operative Societies Act (ii) On recommendation of RBI (iii) Reserve Bank

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(iv) Authorities under the Companies Act (v) SEBI. 1.14 TERMINAL QUESTIONS Fill in the gaps choosing the answers from the brackets. 1. One of the essential characteristics of banking is _ (lending to traders; investment in securities; acceptance of deposits from the public) 2. Banking companies _. (body corporate operating in India are constituted in the form of. constituted under a special statute; company registered under the Companies Act, 1956 or a foreign company; society registered under the Societies Registration Act) 3. Companies Act applies to banking companies ________. (notwithstanding the provisions of the Banking Regulation Act; insofar as its provisions are not inconsistent with the provisions of the Banking Regulation Act; only in relation to registration and winding up) 4. Under the Reserve Bank of India Act, Reserve Bank regulates acceptance of deposits by ___________ (all companies; non-banking financial companies; non-banking non-financial companies) _. (to the extent as provided in the state laws 5. BR Act is applicable to co-operative banks _____ on co-operative societies; in a modified form as provided in Section 56 thereof; at par with commercial banks) 6. "Corresponding new banks" means ________ (new banks [nationalised banks] constituted under the Banking Companies [Acquisition and Transfer of Undertakings] Act, 1970 and the Banking Companies [Acquisition and Transfer of Undertakings] Act, 1980; new generation banking companies registered under the Companies Act; a new bank formed by amalgamation of two banking companies) 7. Central Government may give directions to the Reserve Bank when considered necessary in public interest only after consulting ________ (the Governor of Reserve Bank; the Central Board of the Reserve Bank; the Finance Commission) 8. A co-operative society registered under the Multi-State Co-operative Societies Act _________ (is prohibited from undertaking banking business; can be declared as a state co-operative bank; can undertake banking business as a primary co-operative bank) 9. A multi-state co-operative bank means a multi-state co-operative society which is a ________ (primary co-operative bank; central co-operative bank; state co-operative bank) 10. For the purposes of the BR Act, a "co-operative society" means a society registered or deemed to have been registered under ________ (any Central Act for the time being in force relating to the multi-state co-operative societies only; any state law relating to co-operative societies for the time being in force only; any Central Act for the time being in force relating to the multi-state cooperative societies or any other central or state law relating to co-operative societies for the time being in force)

UNIT

2
STRUCTURE 2.0 Objectives

CONTROL OVER ORGANISATION OF BANKS

2.1 Introduction 2.2 Licensing of Banking Companies 2.3 Branch Licensing 2.4 Paid-up Capital and Reserves 2.5 Shareholding in Banking Companies 2.6 Subsidiaries of Banking Companies 2.7 Board of Directors 2.8 Chairman of Banking Company 2.9 Appointment of Additional Directors 2.10 Restrictions on Employment 2.11 Control Over Management 2.12 Corporate Governance 2.13 Directors and Corporate Governance 2.14 Let Us Sum Up 2.15 Keywords 2.16 Check Your Progress 2.17 Answers to 'Check Your Progress' 2.18 Terminal Questions

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2.0 OBJECTIVES
The objectives of this unit are to understand the laws that govern banking companies, in respect of: Licensing and branch licensing Paid up capital and reserves Shareholding and rights of shareholders Formation of subsidiaries and holding of shares of other companies Constitution and regulation of board of directors Exercise of control by the Reserve Bank and the Government over the appointment and removal of chairmen, managerial and other personnel Corporate governance

2.1 INTRODUCTION
The Banking Regulation Act provides for regulation of the organisation of banking companies. To start with, there are restrictions at the entry point, by way of licensing and then the requirement of permission for opening or shifting of branches. There are further regulations over the paid-up capital and reserves, shareholder's rights, constitution of the board of directors, appointment of chairman and formation of subsidiaries. Apart from the above, there are also controls over the managerial and other personnel, including the power to remove unsuitable persons and to appoint suitable persons. In this unit, we study various provisions of the Banking Regulation Act, providing for controls over the organisation and management of banking companies.

2.2 LICENSING OF BANKING COMPANIES


i. License Requirement from RBI: To commence or carry on, the banking business in India, a company requires a licence from the Reserve Bank under Section 22 of the Banking Regulation Act, 1949. Commencing or carrying on a banking business without a licence is prohibited. When the Act came into force, the banking companies, which were then in existence were required to apply for licence within six months from the commencement of the Act. But, such banking companies were permitted to continue business, unless and until their applications for licence were rejected by the Reserve Bank. The requirement of licence was meant to ensure the continuance of only those banks, which were established and operating on sound lines and to prevent indiscriminate formation of banking companies. ii. Discretion of Reserve Bank: The granting of licence by the Reserve Bank may be subject to such conditions as the RBI may think fit in each case. As held by the Gujarat High Court in Shivabhai vs RBI, Ahmedabad (AIR 1986 Guj 19), Reserve Bank has the discretion to grant or refuse the licence and when such decision based on relevant, material and germane considerations, the decision cannot be assailed. Only if the decision is based on extraneous considerations or is perverse, the court will intervene. It is open to the RBI to consider the defects or improvements revealed in an inspection held under Section 35 of the BR Act while disposing of an application for licence. (See, Sajjan Bank Pvt. Ltd. vs RBI, AI R 1961 Mad 8). The refusal of licence to a company would make it ineligible to undertake banking business, but it would still be open to the company to carry on other business like money lending. iii. Conditions to be Satisfied: Before granting a licence under Section 22, Reserve Bank may have to be satisfied by an inspection of the books of the banking company or otherwise in respect of the
fnllnwintr matters-

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(a) Whether the company is or will be in a position to pay its present and future depositors in full as their claims accrue; (b) Whether the affairs of the company are being conducted or likely to be conducted in a manner detrimental to the interests of its present and future depositors; (c) Whether the general character of proposed management of the company will not be prejudicial to public interest or the interest of depositors; (d) Whether the company has an adequate capital structure and earning prospects; (e) Whether public interest will be served by grant of licence to the company; (f) Whether considering the banking facilities available in the proposed area of operation, the potential scope for expansion of business by banks already in existence in that area and other relevant factors, the grant of licence would be prejudicial to the operation and consolidation of banking system, consistent with monetary stability and economic growth; (g) The fulfilment of any other condition which the Reserve Bank considers relevant in public interest or in the interest of depositors. Although Section 11 of BR Act specifies the minimum capital and reserves requirements of a banking company, the Reserve Bank can stipulate a higher requirement of capital for licensing a banking company as under Section 22 the Reserve Bank has to be satisfied that the company has an adequate capital structure and earning prospects. iv. Foreign Banks: In the case of companies incorporated outside India applying for a licence, apart from the conditions specified in the case of domestic companies, three additional conditions have been stipulated for consideration by the Reserve Bank. These are: (a) Whether carrying on of banking business by the company in India will be in public interest; (b) Whether the government or the law of the country, in which the company is incorporated discriminates in any way against banking companies registered in India; (c) Whether the company complies with provisions of the BR Act, as applicable to foreign companies. v. Local Area Banks: The Reserve Bank has recognised the concept of local area banks and licensed a few(four) such banks. These are banking companies operating only in a limited geographical area. The licence issued to these banks would restrict their operations to the specified local area to ensure adequate banking services in that area. vi. Cancellation of Licence: Sub-Section (4) of Section 22 of the Banking Regulation Act authorises the Reserve Bank to cancel the licence granted to any banking company. The cancellation of licence may be on any one or more of the following grounds: (a) The company ceases to carry on banking business in India; (b) The company at any time fails to comply with any of the conditions imposed under the subSection (1) of Section 22 of Banking Regulation Act; (c) The company does not fulfil at any time, any of the conditions referred to in the sub-Section(3) or 3(A) of Section 22 of Banking Regulation Act. Before cancellation of a licence for non-compliance with any of the conditions as above, the company has to be given an opportunity for taking necessary steps for complying with or fulfilling the conditions. However, in cases where the Reserve Bank is of the opinion that delay will be prejudicial to the interests of depositors or the public, the requirement of opportunity can be dispensed with. As observed by the Madras High Court in Sajjan Bank Pyt. Ltd. vs RBI (AIR 1961 Mad. 8), the Reserve Bank has a wide range of administrative discretion under the Act, which it is competent to exercise, and it cannot be said that there is an excessive delegation of power. A banking company, whose licence is cancelled, can appeal to the Central Government __ ; __ i _ r within a
t/\
J _____ r-.

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2.3 BRANCH LICENSING i. Apart from the requirement of licence for commencing or carrying on banking business, banks have to obtain the prior permission of Reserve Bank for opening a new place of business or changing location of the existing place of business. Under Section 23 of the Banking Regulation Act, 'Place of business' for this purpose includes any sub-office, pay office, sub-pay office or any place at which deposits are received, cheques cashed or moneys lent. However, changing the location of an existing place of business within the same city, town or village would not need such permission. These restrictions also apply to foreign branches of banking companies incorporated in India. Opening of a temporary place of business up to one month for purpose of affording banking facilities for any exhibition, mela, conference or like occasion is exempt. However, the temporary branch has to be within the limits of the city; town or village where there is an existing branch or in the environs thereof. The present guidelines from RBI provide that Banks should submit their request for new branches, administrative offices, ATMs once in a year for consideration of RBI as against the earlier practice of making individual applications for each and every branch. When approved, the permission would be valid for a period of one year before which the branches/ offices should be operationalised. ii. For granting permission under Section 23, the Reserve Bank may require to be satisfied of the following: (a) Financial condition and history of the bank; (b) General character of its management; (c) Adequacy of capital structure and earning prospects; (d) Public interest. This may be done by an inspection of the bank under Section 35 or otherwise. While granting permission for opening or shifting a branch, the Reserve Bank may impose any conditions which it thinks fit necessary. If any bank fails to comply with such conditions, the permission may be revoked after giving an opportunity to the bank to show cause. iii. In the case of regional rural banks, the applications for permission have to be routed through the National Bank (NABARD), and the national bank has to offer its comments on merits to the Reserve Bank. 2.4 PAID-UP CAPITAL AND RESERVES Section 11 of the Banking Regulation Act provides for certain minimum requirements as to paid-up capital and reserves of banking companies. Any company wanting to commence banking business has to comply with these requirements. The amounts stipulated have reference to the places of business. 'Place of business' for this purpose means any office, sub-office, sub-pay office and any place at which deposits are received, cheques cashed or moneys lent. In the case of any dispute regarding computation of paid-up capital and reserves of any banking company, the decision of the Reserve Bank shall be final. i. Foreign Banks: Under the sub-Section (2) of Section 11 of the BR Act, a foreign bank (banking company incorporated outside India) operating in India, has to deposit and keep deposited with the Reserve Bank, an amount of Rs.15 lacs and if it has a place of business in Mumbai or Kolkata or both, Rs. 20 lacs. The amount has to be kept in cash, unencumbered approved securities or partly in both. Apart from this, an amount of twenty per cent of the profit for each year in respect of business transacted through the branches in India as disclosed in the profit and loss account has to be deposited with the Reserve Bank. The securities deposited can be replaced by other unencumbered

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approved securities or cash deposited can be similarly replaced by securities. The Central Government can exempt any foreign bank from this requirement on the recommendation of the Reserve Bank for a specified period if the amounts deposited already by it are considered adequate. On the cessation of business by any foreign bank for any reason, these deposits shall form the assets of the company on which the creditors in India shall have the first charge. ii. Indian Banks: In case of banking companies incorporated in India, the requirements of minimum paid-up capital and reserves under Section 11 (3) are as follows: (a) If it has a place of business in more than one state, Rs. 5 lac and if such places of business include Mumbai, Kolkata or both, Rs. 10 lac. (b) If the place of business is in only one state and does not include Mumbai or Kolkata, Rupees 1 lac for its principal place of business, plus Rs. 10,000 for other places of business, in the same district in which the principal place of business is situated, plus an additional Rs. 20,000, for each place of business elsewhere; in total not exceeding Rs. 5 lacs. If the bank has only one place of business, the amount is limited to Rs. 50,000. For banking companies commencing business after the commencement of the Act, paid-up capital is stipulated as Rs 5 lac. (c) If places of business are in one state only, but one or more of them is in Mumbai or Kolkata, Rs. 5 lac, plus Rs. 25,000 for each place of business outside these cities and the aggregate not exceeding Rs. 10 lac. During 2005, RBI stipulated the minimum capital requirement for a new Private Bank at Rs 300 crore as a part of Corporate Governance guidelines and as a policy of Foreign Direct Investment. iii. Paid-up Capital, Subscribed Capital and Authorised Capital: Apart from the above, Section 12(1) of the Banking Regulation Act stipulates that the subscribed capital of a banking company shall not be less than half of its authorised capital; and the paid-up capital shall not be less than half of its subscribed capital. If capital is increased, this requirement has to be complied within a period not exceeding two years as allowed by the Reserve Bank. Banking companies are permitted to have only ordinary or equity shares. However, preference shares issued before 1 July 1944 are exempt. Further, the provisions of Section 12(1) are not applicable to banks incorporated before 15 January 1937. Now preference shares and other capital instruments are also allowed. Since 2005, Banks have been permitted by RBI to raise capital even in the from of innovative debt instruments which are perpetual and perpetual non-cumulative preference shares in addition to the equity capital.

2.5 SHAREHOLDING IN BANKING COMPANIES


i. Voting rights of shareholders: There is no specified ceiling on a person's holding of shares in a banking company under the Banking Regulation Act or any other law. However, Section 12(2) of the Act puts certain restrictions on voting rights of shareholders. Accordingly, no shareholder can exercise voting rights in respect of the shares held by him/her in excess of ten per cent of the total voting rights of all the shareholders of the banking company. This provision does not in any way affect the transfer of shares or the registration of such transfers. It only puts a limit on voting rights. However, Section 12(3) bars suits or other proceedings against registered shareholders by any other person claiming title except by a transferee of shares, in accordance with the law or on behalf of minors or lunatics for whom the registered shareholder holds the shares. The provisions of the Companies Act also govern transfer of shares of banking companies. ii. Acknowledgement by Reserve Bank: Reserve Bank has instructed banking companies that when

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they receive more than the specified percentage of their shares for transfer to one party, the bank's board must refer the matter to the Reserve Bank. The banks shall not transfer the shares without receiving Reserve Bank's acknowledgement. This is with a view to ensure that the controlling interest in a banking company does not change hands without the knowledge and approval of the Reserve Bank. iii. Reports on shareholding: A report regarding the particulars of shareholding of the chairman, managing director or chief executive officer, by whatever name called, of every banking company, requires submission to the Reserve Bank. Such report should contain the full particulars and extent of value of shares held directly or indirectly and of any change in the extent of holding or of any variation in the rights attaching thereto. The Reserve Bank may also order for any other information relating to those shares. iv. Commission, brokerage, discount: Section 13 of the Banking Regulation Act imposes a ceiling on the commission, brokerage, discount or remuneration on the sale of shares of banking companies. Accordingly, the payments on this account in any form should not exceed two-and-a-half per cent of the paid-up value of the shares. v. Dividend: There are also certain restrictions on the payment of dividend to the shareholders of banking companies. Thus, under Section 15 of the Banking Regulation Act, no dividend is payable until all capitalised expenses are completely written off. Such expenses include preliminary expenses, organisation expenses, share-selling commission, brokerage, loss incurred and any other item, of expenditure not represented by tangible assets. However, dividends are payable without writing off depreciation, bad debt etc., as under: (a) Depreciation in value of approved securities, which is not capitalised or accounted for as a loss. (b) Depreciation in investment of shares, bonds or debentures, other than the approved securities for which adequate provision has been made. (c) Bad debts for which an adequate provision is provided. RBI has given detailed eligibility criteria for declaration of dividend by banks and also guidelines on the quantum of dividend that can be declared by banks. The eligibility criteria require a minimum 9 % of CAR and Net NPAs not exceeding 1%. The quantum of dividend that can be declared is based on the levels of net NPAs and in a graded level (Maximum 40% pay out ratio) and can be paid out of only current year's profits. 2.6 SUBSIDIARIES OF BANKING COMPANIES i. Formation of Subsidiaries: There are certain restrictions under Section 19 of the Banking Regulation Act on the formation of subsidiaries by banking companies. This is for purpose of preventing banks from carrying on trading activities by acquiring a controlling interest in non-banking companies. Accordingly, subsidiaries are permissible only for the following purposes: (i) Undertaking any business which is permissible for banking companies under Section 6(1) clauses (a) to (o). (ii) Carrying on the business of banking exclusively outside India. Prior permission of the Reserve Bank is a must for this banking business. (iii) Undertaking any other business which Reserve Bank with prior approval of the Central Government permits. Reserve Bank may permit only such other business which it considers conducive to the spread of banking in India or otherwise useful or necessary in the public interest. The undertaking of any business by a subsidiary will not be deemed to amount to the bank itself taking up that business directly or indirectly for the purpose of Section 8.

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ii. Shareholding in other companies: Apart from the restriction on subsidiaries, there is also a ceiling [Section 19(2)] on shareholding in companies other than subsidiaries. Thus, the holding of shares by a banking company in any company as pledgee, mortgagee or absolute owner shall not be exceeding thirty per cent of the paid-up share capital of that company or the paid-up share capital and reserves of the banking company. Further, holding of shares in any company in which the managing director or manager of a banking company is interested in or concerned with in any manner, is prohibited except in the case of subsidiaries.

2.7 BOARD OF DIRECTORS


i. Qualifications: Section lOAofthe Banking RegulationAct stipulates certain qualifications fordirectors of banking companies. Accordingly at least fifty-one per cent of the total number of directors shall be persons, who have special knowledge or practical experience, with respect of accountancy, agriculture and rural economy, banking, cooperation, economics, finance, law, small scale industry or any other matter, the special knowledge or practical experience which is useful to the banking company, in the opinion of the Reserve Bank. Further, at least two of the directors should have special knowledge or practical experience in agriculture and rural economy or co-operation or small scale industry. ii. Substantial interest: The directors of a banking company shall not have a substantial interest in or be connected with as employee, manager or managing agent in a company or firm which carries on trade, commerce or industry as per Section 10A (2)(b) of the BR Act. However, companies registered under Section 25 of the Companies Act and small scale industrial concerns are not included for the purpose. The proprietors of trading, commercial or industrial concerns other than small scale industrial concerns are also disqualified for directorship. 'Substantial interest' for this purpose is defined in Section 2 of the Banking Regulation Act. Accordingly, holding of beneficial interest by any individual or his spouse or minor child, whether singly or taken together in the shares of a company exceeding Rs. 5 lacs or ten per cent of the paid-up capital of the company amounts to substantial interest. In the case of firms, such holding of beneficial interest exceeding ten per cent of the total capital of the firm amounts to substantial interest. iii. Period of office: The directors of a banking company shall not hold office for more than eight years continuously. However, this provision is not applicable to the chairman or a whole-time director. When the chairman or a whole-time director of a bank is removed from office, he/she ceases to be a director of the bank and shall not be eligible for further appointment as director of that banking company for a period of four years. iv. Reconstitution of Board: When the board of a banking company is not constituted in accordance with the requirements of Section 10A of the BR Act, the board has to be reconstituted, to comply with the provisions. If any director has to be retired for such a reconstitution, this may be done by lots, in the prescribed manner and such decision shall be binding on every director of the board. If the Reserve Bank is of the opinion that the board of any banking company does not fulfil the requirements, it may order such a bank to reconstitute the board after giving reasonable opportunity of being heard. If, within two months' time, the bank does not fulfil the order of the Reserve Bank, the Bank may then remove any director (determined by lots drawn in the prescribed manner) and such a person shall cease to hold office. The Reserve Bank may also appoint a new director in the place of the person removed and he/she shall continue in office until the date up to which his predecessor would have held office. However, any proceedings of a banking company will not be invalid only because of any defect in the composition of the board.

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2.8 CHAIRMAN OF BANKING COMPANY i. Whole-time Chairman/Managing Director: Section 1 OB of the Banking Regulation Act provides that every banking company should have a full-time or part-time chairman, appointed from among its directors. The chairman, if appointed on a whole-time basis is entrusted with the management of the entire affairs of the bank. The chairman on a part-time basis has to be appointed with the prior approval of the Reserve Bank and such an appointment shall be subject to any conditions that may be imposed by the Reserve Bank while granting approval. In the absence of a chairman, the management of the whole of the affairs of the banking company shall be entrusted to a managing director. The exercise of powers by the whole-time chairman or managing director is subject to the superintendence, control and directions of the board of directors. The whole-time chairman and a managing director shall hold office for a period not exceeding five years as the board may fix and is also eligible for reelection or reappointment. Although the chairman is in full-time employment of the bank, he may be a director of a subsidiary of the bank or of a company registered under Section 25 of the Companies Act. The Reserve Bank may also permit the whole-time chairman or the managing director to undertake part-time honorary work not likely to interfere with the duties of the chairman or the managing director. The whole-time chairman or the managing director of a banking company may continue in office at the end of the term of the office until his/her successor assumes office, subject to the approval of the Reserve Bank. ii. Qualifications of Whole-time Chairman/Managing Director: The whole-time chairman or the managing director of a banking company should have special knowledge or practical experience of the working of a banking company or the State Bank or a subsidiary bank or a financial institution or financial, economic or business administration. The whole-time chairman or the managing director will be disqualified under the following circumstances: (a) if he/she is director of a company other than a subsidiary of the banking company or a charitable company (registered under Section 25 of the Companies Act); (b) if he/she is a partner of any firm which carries on trade, business or industry; (c) if he/she has substantial interest in any other company or firm or is director, manager, managing agent, partner or proprietor of any trading, commercial or industrial concern; or (d) if he/she is engaged in any other business or vocation. iii. Removal of Wholetime Chairman/Managing Director: If the Reserve Bank is of the opinion that the person elected to be the chairman of the board of directors and appointed on a whole time basis or the managing director is not a fit and proper person to hold such office, the Reserve Bank may require the banking company to remove such a chairman or the managing director and appoint a suitable person. However, before taking such an action, the Reserve Bank has to give such a person, as also the banking company, a reasonable opportunity of being heard. If the banking company does not comply with the order within two months, the Reserve Bank may remove the person from the office and appoint a suitable person in his/her place. Such a chairman or managing director would continue in office, for the residual period of office of the person removed from office. The banking company or the person affected by the Reserve Bank's order may appeal to the Central Government within thirty days. The order of the Government where an appeal is filed and the order of the Reserve Bank, where no appeal is filed shall be final and not liable to be challenged before any civil court. vi. Temporary vacancies: In cases where the wholetime chairman or the managing director dies or

23
he/she resigns or is not capable of discharging his/her functions due to illness, temporary arrangements can be made to carry out the duties of the chairman or the managing director for a period not exceeding four months. However, this has to be done with the approval of the Reserve Bank. v. Power of Reserve Bank to appoint Chairman: In certain cases, the office of the whole-time chairman or the managing director of a banking company may fall vacant and may not be filled up by the bank immediately. This may adversely affect the interests of the banking company. If the Reserve Bank is of the opinion that continuation of such vacancy is likely to be against the interests of the banking company, it may appoint an eligible person to fill such vacancy under Section 10BB of the Banking Regulation Act. If the chairman or the managing director so appointed is not a director of the banking company, he/she shall be deemed to be a director of the banking company. Such appointment may be for a period not exceeding three years. There is also a provision for reappointment after the initial period. The chairman or the managing director so appointed may be removed from office only by the Reserve Bank and shall draw pay and allowances from the banking company, as determined by the Reserve Bank. vi. Qualification shares: The whole-time chairman or the managing director of a banking company is exempted under Section IOC of the Banking Regulation Act from the requirement of holding qualification shares. Similar exemption is also available to a director of a banking company appointed by Reserve Bank under Section 10A of the Act. vii. Overriding provisions: The provisions of Section 10A, Section 10B and Section 10BB of the Banking Regulation Act regarding the appointment and removal of a director, managing director or the chairman shall have overriding effect over all other laws, contracts, etc. Any person affected by any action taken under these provisions is not entitled to any compensation for any loss or for termination of office.

2.9 APPOINTMENT OF ADDITIONAL DIRECTORS


i. The Reserve Bank has the power to appoint additional directors on the boards of banking companies under Section 36AB of the Banking Regulation Act. One or more additional directors may be so appointed when the bank is of the opinion that it is necessary to do so in the interest of: (a) banking policy (c) banking company (b) public (d) depositors of the banking company.

ii. The directors so appointed shall not require any qualification shares. They hold office during the pleasure of the Reserve Bank. Subject to this, appointment may be for a period not exceeding three years or further extended periods not exceeding three years at a time as specified by the Reserve Bank. The additional directors are protected from any liability or obligation for executing their functions in good faith. The provisions of Section 36AB have overriding effect over other laws.

2.10 RESTRICTIONS ON EMPLOYMENT


i. The Banking Regulation Act (Section 10) prohibits employment of managing agents and imposes restrictions on employment of certain type of persons, namely (a) a person who is or has been adjudicated insolvent or has suspended payment or has compounded with his/her creditors;
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(c) a person whose remuneration or part thereof is by way of commission or share in the profits of the company; (d) a person whose remuneration is excessive in the opinion of the Reserve Bank. Before forming an opinion regarding the remuneration, the Reserve Bank has to consider the financial condition and history of the banking company, its area of operation, resources, volume of business and the trend of its earning capacity, number of its branches, qualifications, age and experience of the person concerned, remuneration of other personnel in the bank or persons holding similar positions in other banks and the interest of depositors. The above restrictions are applicable to workmen as well as management personnel, as held by the Supreme Court in Central Bank of India vs Their Workmen (AIR 1960 SC 12). However, the restriction on remuneration does not affect payment of bonus according to a settlement or award or in accordance with a scheme framed by the bank or in accordance with the prevailing practice in banking business. Commission paid to brokers, auctioneers, forwarding agents, etc., who are not regular members of the bank's staff, is also not covered by these provisions. ii. Persons who are directors of any company other than a subsidiary of a banking company or company registered under Section 25 of the Companies Act are also prohibited from managing a banking company. However, this prohibition shall not apply to a director for a temporary period of three months, or a further period not exceeding nine months, if allowed by the Reserve Bank. Apart from this, persons engaged in any other, business or vocation or whose term of office as a person managing the company is for a period exceeding five years also fall in the prohibited category. However, the period of office can be renewed or extended for further periods not exceeding five years at a time.

2.11 CONTROLS OVER MANAGEMENT


i. Power to remove Management and other personnel: The Reserve Bank is empowered under Section 36AA of the Banking Regulation Act to remove any chairman, director, chief executive officer (by whatever name called), or other officer or employee of a banking company. For this purpose, the bank has to be satisfied that it is necessary to do so. The bank (RBI) has the discretionary power to remove management and other personnel in the following circumstances: (a) Public interest (b) Preventing the affairs of the banking company being conducted in a manner detrimental to the interest of depositors (c) Securing proper management of the banking company. The Reserve Bank has to pass such an order recording the reasons in writing. Before passing the order, the affected person has to be given a reasonable opportunity of making a representation against the proposed order. Where an urgent action is required and delay would be against the interests of the company or its depositors, the Reserve Bank is empowered to direct by order, at the time of giving opportunity of making a representation that the person concerned shall not act in his/her official capacity or directly or indirectly take part in the management of the bank from the date of such order, pending consideration of the representation. The person so removed shall not be entitled to any compensation for loss of office notwithstanding anything contained in any law, the memorandum, articles or any contract to the contrary as the provisions of Section 36AA have overriding effect. ii. Appeal: An appeal against the order of removal lies with the Central Government. Such an appeal has to be filed within thirty days from the date of communication of the order. The appellate decision of the Central Government, and subject thereto the order of the Reserve Bank, shall be final and not liable to challenge in any Civil Court.

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iii. Effect of the order of removal: On the Reserve Bank passing a removal order, the person concerned ceases to hold office which he/she was holding till then. Further, he/she is prohibited, from directly or indirectly taking part in the management of any banking company for a period not exceeding five years as may be specified in the order. Contravention of the order is punishable with a fine of Rs. 250 for each day during which the contravention continues. iv. Appointment of a suitable person: When any chairman, director, chief executive officer, other officer or employee is removed by the Reserve Bank under Section 36AA as above, the Reserve Bank may appoint a suitable person in his place. Such person shall hold office at the pleasure of the Reserve Bank. Subject to this, the appointment may be for a period not exceeding three years and is extendable for further periods not exceeding three years at a time. Such appointee shall not incur any obligation or liability for action taken in good faith in the execution of the duties of his office.

2.12 CORPORATE GOVERNANCE


i. The Concept: Corporate governance is a dynamic concept involving promotion of corporate fairness, transparency and accountability in the interest of shareholders, employees, customers and other stakeholders. It is a concept of recent origin. However, there is considerable divergence in the understanding and practice of corporate governance across different jurisdictions. The concept has evolved since the first major study by the Cadbury Committee in 1992. The DECO principles of corporate governance published in 1999, the first international code of good corporate governance approved by governments, was revised in 2004. Corporate governance can be seen as 'the way in which boards oversee the running of a company by its managers, and how board members are in turn accountable to shareholders and the company' and it has implications for company behaviour towards employees, shareholders, customers, banks and other stakeholders. Further, good corporate governance plays a vital role in ensuring the integrity and efficiency of financial markets and the lack of it can pave the way for financial difficulties and sometimes even fraud. ii. OECD Principles of Corporate Governance, 2004: The OECD principles of corporate governance, 2004 stipulate what the corporate governance framework should ensure, which is briefly as under: (a) Ensuring the basis for an effective corporate governance framework: To promote transparent and efficient markets which are consistent with the rule of law. Also, to articulate clearly the division of responsibilities among the different supervisory, regulatory and enforcement authorities. (b) The rights of shareholders and key ownership functions: To protect and facilitate the exercise of shareholders' rights. (c) The equitable treatment of shareholders: In the equitable treatment of shareholders are included the minority and foreign shareholders. Further, all shareholders should have the opportunity to obtain an effective redress for violation of their rights. (d) The role of stakeholders in corporate governance: To recognise the rights of stakeholders, established by law or through mutual agreements and encourage active cooperation between the corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises. (e) Disclosure and transparency: Timely and accurate disclosures made on all material matters, regarding the corporation, including the financial situation, performance, ownership, and governance of the company. (f) The responsibilities of the board: Strategic guidance of the company, effective monitoring of management by the board and the board's accountability to the company and the shareholders are the important aspects. These principles are applicable to all types of companies including banks.

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iii. Corporate Governance and Banks: Banks hold a special position in corporate governance as they accept and deploy large amounts of public funds in fiduciary capacity and also leverage such funds through credit creation. The position of banks is also important for the smooth functioning of the payment system. Accordingly, legal prescriptions for ownership and governance of banks laid down in the statutes are supplemented by regulatory prescriptions. The Basel Committee on Banking Supervision has issued guidance (February 2006) for promoting the adoption of sound practices of corporate governance by banking institutions. This guidance, entitled Enhancing Corporate Governance for Banking Organisations, highlights the importance of: the roles of boards of directors (with a focus on the role of independent directors) and senior management effective management of conflicts of interest the roles of internal and external auditors, as well as internal control functionaries governing in a transparent manner, especially where a bank operates in jurisdictions, or through structures, that may impede transparency the role of supervisors in promoting and assessing sound corporate governance practices.(See, http://www.bis.org/press/pO6O213.htni). Apart from the fiduciary role of banks, their cross-border operations add a special dimension. This provides an added impetus for convergence in standards internationally. In almost all countries, the policy framework with regard to corporate governance involves a multiplicity of agencies. In India, the Department of Company Affairs, Securities and Exchange Board of India (in respect of listed entities) are involved apart from the Reserve Bank in respect of banks. iv. Reserve Bank's approach: Following the formal policy announcement in regard to corporate governance, in the mid term Review of the Monetary and Credit Policy, in October, 2001, the Reserve bank constituted a Consultative Group in November, 2001 under the chairmanship of Dr. A.S. Ganguly with a view to strengthen the internal supervisory role of the boards of banks. The report of the group was transmitted to all the banks for their consideration in June, 2002 and simultaneously to the Government of India for consideration. Earlier, an advisory group on corporate governance under the chairmanship of Dr. R.H. Patil had submitted its report in March, 2001 which examined the issues relating to corporate governance in banks in India, including the public sector banks and made recommendations to bring the governance standards in India on par with the best international standards. There were also some relevant observations by the advisory group on banking supervision under the chairmanship of Shri M.S. Verma which submitted its report in January, 2003. Keeping all these recommendations in view and the cross-country experience, the Reserve Bank initiated several measures to strengthen the corporate governance in the Indian banking sector, including the concept of 'fit and proper' criteria for directors of banks which included the process of collecting information, exercising due diligence and constitution of a nomination committee of the board to scrutinise the declarations made by the bank directors. The RBI guidelines on ownership and governance in the private sector banks released on February 28, 2005 (Paras 5 and 6) provide as under:
Shareholding

(i) The RBI guidelines on acknowledgement for acquisition or transfer of shares issued on 3 February, 2004 will be applicable for any acquisition of shares of five per cent and above of the paid-up capital of the private sector bank. (ii) In the interest of diversified ownership of banks, the objective will be to ensure that no single entity or group of related entities has shareholding or control, directly or indirectly, in any bank in excess of ten per cent of the paid-up capital of the private sector bank. Any higher level of

27
acquisition will be with the prior approval of RBI and in accordance with the guidelines of 3 February, 2004 for grant of acknowledgement for acquisition of shares. (iii) Where ownership is that of a corporate entity, the objective will be to ensure that no single individual/entity has ownership and control in excess of ten per cent of that entity. Where the ownership is that of a financial entity the objective will be to ensure that it is a well-established regulated entity, widely held, publicly listed and enjoys good standing in the financial community. (iv) Banks (including foreign banks having a branch presence in India)/FIs should not acquire any fresh stake in a bank's equity shares, if by such acquisition, the investing bank's/FI's holding exceeds five per cent of the investee bank's equity capital as indicated in RBI circular dated 6 July, 2004. (v) As per the existing policy, large industrial houses will be allowed to acquire, by way of strategic investment, shares not exceeding ten per cent of the paid-up capital of the bank, subject to RBI's prior approval. Furthermore, such a limitation will also be considered, if appropriate, in regard to important shareholders with other commercial affiliations. (vi) In case of a restructuring of the problem/weak banks or in the interest of consolidation in the banking sector, RBI may permit a higher level of shareholding, including by a bank. 2.13 DIRECTORS AND CORPORATE GOVERNANCE (i) The board of directors should ensure that the responsibilities of directors are well defined and the banks should arrange need based training for the directors in this regard. While the respective entities should perform the roles envisaged for them, private sector banks will be required to ensure that the directors on their boards representing specific sectors, as provided under the B.R. Act, are indeed representatives of those sectors in a demonstrable fashion, they fulfil the criteria under corporate governance norms provided by the Ganguly Committee and they also fulfil the criteria applicable for determining 'fit and proper' status of important shareholders (i.e., shareholding of five per cent and above) as laid down in RBI circular dated 25 June, 2004. (ii) As a matter of desirable practice, not more than one member of a family or a close relative (as defined under Section 6 of the Companies Act, 1956) or an associate (partner, employee, director, etc.) should be on the board of a bank. (iii) Guidelines have been provided in respect of 'fit and proper' criteria for directors of banks by the RBI circular dated 25 June, 2004 in accordance with the recommendations of the Ganguly Committee on corporate governance. For this purpose a declaration and undertaking is required from the proposed/existing directors. (iv) Being a director, the CEO should satisfy the requirements of the 'fit and proper' criteria applicable for directors. In addition, RBI may apply any additional requirements for the chairman and CEO. The banks will be required to provide all information that may be required while making an application to RBI for approval of appointment of chairman/CEO. With regard to public sector banks, the principles of corporate governance have been statutorily recognised as per Banking Companies (Acquisition and Transfer of Undertakings) Financial Institutions Laws (Amendment) Act, 2006. The Act as amended provides for shareholder directors to be a person having 'fit and proper' status and the Reserve Bank has to notify the 'Fit and Proper' criteria [Section 9(2)].

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2.14 LET US SUM UP A company wanting to commence banking business requires prior licence from the Reserve Bank. The Reserve Bank has the discretion to reject licence or approve the licence on such conditions as it thinks fit. Before granting licence, Reserve Bank has to be satisfied by inspection or otherwise of the suitability of the company for licence. A licence once given may also be cancelled after giving the bank an opportunity to be heard. Further, for opening new branches or shifting branches outside a city, town or village, permission of the Reserve Bank is required. Banking companies have to have minimum capital and reserves as specified in the Banking Regulation Act. The shareholders of a banking company are entitled to dividends only after all the capitalised expenses are written off. The commission or brokerage payable on selling shares is restricted to two and half per cent of the paid-up value of the shares. The board of directors of a bank has to be constituted with persons having special knowledge or experience in accountancy, banking, economics, law, etc., as stipulated. The directors should not have substantial interest in other companies or firms. The maximum period of office is limited to eight years continuously. The Reserve Bank is empowered to reconstitute the board, if the board is not properly constituted. Every banking company should have a full-time chairman (or a full-time managing director, if there is no full-time chairman) with the specified qualifications. The Reserve Bank has powers to remove the chairman and appoint a suitable person in his place in certain cases. The Reserve Bank also has powers to remove the directors or managerial personnel or other employees of banking companies. The principles of corporate governance including the 'fit and proper' criteria for directors apply to banking companies as well as public sector banks. 2.15 KEYWORDS Additional Director; Authorised Capital; Overriding Provisions; Paid-up Capital; Place of Business; Substantial Interest; Subscribed Capital; Subsidiary. 2.16 CHECK YOUR PROGRESS 1. Fill in the gaps choosing the answers from the brackets. (i) A company has to obtain a _________ from the Reserve Bank to commence banking business in terms of Section 22 of the BR Act. (registration; licence; commencement certificate) (ii) Shifting of a bank's branch in the same __________does not require Reserve Bank's permission under Section 23. (district; state, city, town or village) (iii) Foreign banks are arising out required under Section 11 of the BR Act to deposit of their business in India with the Reserve Bank, (twenty per cent of profit for each year; thirty per cent of profit for each year; twenty per cent of the deposits collected each year) (iv) Banks may float subsidiaries for carrying on the business specified in __________ . (their Memorandum of Association; Section 6(1 )(a) to (o) of the BR Act; their Articles of Association) (v) A shareholder of a banking company can exercise voting rights up to __________ of the total voting rights of all shareholders, (one per cent; ten per cent; hundred per cent) (vi) Banking companies are not permitted to give dividend until all __________ are written off. (bad debts, expenses, capitalised expenses) 2. Say whether True or False, (i) A temporary branch for less than thirty days in a town where a bank has an existing branch does not require permission from Reserve Bank. (ii) A company whose banking licence is rejected can undertake business as a moneylender or undertake other business, (iii) The decision of Reserve Bank to revoke licence is final and no appeal lies from it.

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(iv) Banking companies are permitted to give brokerage up to two-and-half per cent of the paid-up value of shares. (v) No person can hold the shares of banks beyond ceiling specified under the BR Act. (vi) A banking company cannot hold shares in any other company other than a subsidiary. 3. Fill in the gaps choosing the answer from the brackets. (i) A director of a banking company should not have _________ in any other company, (beneficial interest, any interest, substantial interest) (ii) At least _________ of the directors should have the qualifications prescribed under Section 10A(2) of the BR Act. (50 per cent, 75 per cent, 51 per cent) (iii) When the board of a banking company is ordered to be reconstituted under Section 10A of the BR Act, directors will be removed _________ for the purpose of reconstitution. (by rotation, by lots, by majority decision) (iv) Before removing the chairman of a bank from office, Reserve Bank has to__________ . (give compensation for loss of office, give opportunity of being heard, give an option to continue as director) (v) The provisions of Section 36AA of the BR Act regarding removal of managerial personnel have _________ over other laws, (no effect, overriding effect, persuasive effect) (vi) Reserve Bank is authorised to appoint ________ under Section 36AB of the BR Act. (directors, additional directors, managing director) (vii) The _________ (Central Government; RBI; SEBI) has stipulated the 'fit and proper' criteria for directors of banking companies. 4. Say whether True or False. (i) The maximum period of office that may be held continuously by an ordinary director in a banking company is eight years, (ii) The decisions of the board of directors, during the period when the board's constitution is defective shall be void. (iii) The post of chairman of a banking company may be on part-time basis, (iv) The chairman of a banking company can hold office only for a maximum period of eight years, (v) From the order removing chairman of a banking company, appeal lies to the Central Government within thirty days of the order. (vi) Reserve Bank has the power to remove any officer or other staff of a banking company under Section 36M of the BR Act.' (vii) The concept of 'fit and proper' criteria for directors is not applicable to public sector banks.

2.17 ANSWERS TO CHECK YOUR PROGRESS'


1. (i) licence; (ii) same city, town or village; (iii) 20 per cent of profit for each year; (iv) Section 6(l)(a) to (o) of BR Act; (v) 10 per cent; (vi) capitalised expenses. 2. (i) True; (ii) True; (iii) False; (iv) True; (v) False; (vi) False. 3. (i) substantial interest; (ii) 51 per cent; (iii) by lots; (iv) give opportunity of being heard; (v) over riding effect; (vi) additional directors; (vii) RBI 4. (i) True; (ii) False; (iii) True; (iv) False; (v) True; (vi) True; (vii) False 2.18 TERMINAL QUESTIONS Fill in the gaps choosing answers from the brackets.

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_________ . (such conditions as the Central Government may specify; such conditions as the Reserve Bank may think fit to impose; confirmation by the Central Government). Reserve Bank is not empowered to cancel the licence granted to a banking company on the ground that __________ . (the company ceases to carry on any of its business; the company changes its registered office from one state to another state; the company is not in a position to pay its depositors in full as their claims accrue). A bank requires permission of the Reserve Bank for opening a new branch or shifting an existing branch ___________ . (to any new location from where it is situated; otherwise than within the same city, town or village; otherwise than in the same building). In addition to the requirements as to minimum capital and reserves under Section 11 of the BR Act, Reserve Bank __________ . (cannot look into the capital structure of a banking company; has to satisfy itself under Section 22(3) of the BR Act as to adequacy of capital structure and earning prospects; has to consult the Central Government as to the adequacy of the capital structure of a banking company before licensing). In the case of a banking company, a shareholder cannot exercise voting rights on poll . (in excess of ten per cent of the total voting rights of all the shareholders of the company; in excess of two per cent of the total voting rights of all the shareholders of the company; in excess of ten per cent of the total voting rights of all the shareholders except with prior permission of the Reserve Bank).

2.

3.

4.

5.

Choose the correct statements from the following. 6. (i) There are no restrictions in the BR Act on payment of dividend by banking companies, (ii) Before payment of dividend by a banking company, all its capitalised expenses, unless specifically exempted under the BR Act, have to be completely written off. (iii) Banking companies are not permitted to pay dividend above ten per cent of net profits. 7. (i) There are no specific qualifications required for the directors of a banking company. (ii) At least fifty-one per cent of the directors of a banking company should consist of persons with professional or other experience as provided in the BR Act. (iii) At least fifty-one per cent of the directors of a banking company should be chartered accounts or experts in finance. 8. (i) There is no provision for maintenance of reserves by a banking company under the BR Act. (ii) Every banking company has to maintain a reserve fund and transfer before declaring dividend, not less than twenty per cent of the profit to the reserve fund, (iii) The maintenance of a reserve fund is optional for a bank. 9. (i) The chairman of a banking company has to be always on whole-time basis and should be entrusted with the management of the whole of the affairs of the banking company, (ii) The chairman of a banking company can be on part-time basis and a managing director can be appointed on whole-time basis who shall be entrusted with the whole of the affairs of the banking company, (iii) The chairman of a banking company can be on part-time basis and the whole of the affairs of the banking company shall be entrusted to a committee of the board of directors. 10. (i) A banking company can form subsidiaries for undertaking any business approved by its board of directors, (ii) A banking company can form subsidiaries for undertaking any business mentioned in Section 6(1) (a) to (o) of the BR Act, which is permissible for a banking company to undertake, (iii) A banking company does not require the permission of the Reserve Bank to form a subsidiary for doing banking business exclusively outside India.

UNIT

3
STRUCTURE 3.0 Objectives

REGULATION OF BANKING BUSINESS

3.1 Introduction 3.2 Power to Issue Directions 3.3 Acceptance of Deposits 3.4 Nomination 3.5 Loans and Advances 3.6 Regulation of Interest Rate 3.7 Regulation of Payment Systems 3.8 Internet Banking Guidelines 3.9 Regulation of Money Market Instruments 3.10 3.11 3.12 3.13 Banking Ombudsman Reserve Funds Maintenance of Cash Reserve Maintenance of Liquid Assets

3.14 Assets in India 3.15 Let Us Sum Up 3.16 Keywords 3.17 Check Your Progress 3.18 Answers to 'Check Your Progress' 3.19 Terminal Questions

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3.0 OBJECTIVES The objectives of this unit are to understand the law, in particular the provisions of the Banking Regulation Act, relating to: issue of directions by Reserve Bank to banks regulation of acceptance of deposits by banks regulation of loans and advances regulation of interest rates of banks on deposits and borrowing maintenance of reserve fund maintenance of cash reserve by scheduled banks and other banks maintenance of liquid assets maintenance of assets in India

3.1 INTRODUCTION The Banking Regulation Act provides for regulation of the business activities of banking companies. Accordingly, the Act empowers the Reserve Bank to issue directions for regulating terms and conditions of making of loans and advances and other matters including acceptance of deposits. The Banking Regulation Act also imposes certain restrictions on loans and advances to the directors of banking companies, and companies and firms in which they are interested. The Act contains provisions for creation of a reserve fund and transfer of a percentage of profits to that fund. There are also provisions for maintenance of cash reserve, liquid assets and assets in India. In this unit, we look at the relevant provisions of law in this regard. 3.2 POWER TO ISSUE DIRECTIONS i. The Banking Regulation: Act authorises the Reserve Bank to issue directions to banks under Sections 21 and 35Aof the Act. While Section 21 gives the power to regulate advances by banking companies, Section 35A gives wide powers generally to regulate banking companies. The Reserve Bank has been issuing directions from time to time under Section 21 (read with Section 35A) regulating rates of interest and other terms and conditions of acceptance of deposits and making of loans and advances. Regulation of deposits and loans and advances are discussed below (See, Paras 3.4 and 3.5, respectively). ii. Nature of Directions: The directions issued by the Reserve Bank in exercise of powers under Sections 21 and 35A of the BR Act, being statutory directions, are binding on the banks. The circulars of the Reserve Bank giving instructions to banks where it has statutory powers to give such instructions are also binding on the banks, even if they do not specifically refer to any statutory provisions. However, as held by the Supreme Court in State Bank of India vs. CIT (AIR 1986 SC 757), non-statutory circulars of the Reserve Bank cannot affect legal rights. The Reserve Bank's powers to issue directions are over the banks. Hence, the directions are addressed to banks only and not to customers or the public. The effect of violation of Reserve Bank's directions/ instructions which are binding on banks, has been considered by the Supreme Court in BOI Finance Ltd. vs. The Custodian (AIR 1997 SC 1952) in the context of some banks entering into certain repo transactions against the circulars of the Reserve Bank prohibiting such transactions. The court found that the action of the banks violated the Reserve Bank's instructions and held that the violations would not invalidate the contracts with third parties but would render the banks liable to prosecution. The effect of directions will be prospective and not retrospective in the absence of any statutory provisions providing for retrospective operation of directions.

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iii. Bonafides: The powers of the Reserve Bank to issue directions have to be exercised with bonafide intentions, as held by the Gujarat High Court in RBI vs Harisidh Co-op. Bank Ltd. (AIR 1988 Guj 107). In that case the Court considered the power of the Reserve Bank to issue directions for superseding the board of a co-operative bank for securing its proper management and upheld the action taken by the Reserve Bank on the finding that it was without mala fide. iv. Caution and Advice: Apart from giving directions, the Reserve Bank may also caution or give advice to banking companies. Section 36 of the Banking Regulation Act provides that the Reserve Bank may caution or prohibit banking companies generally or any banking company in particular against any transaction or class of transactions. Further, the Reserve Bank may generally give advice to any banking company.

3.3 ACCEPTANCE OF DEPOSITS


i. As discussed in unit I, the essence of banking business is the acceptance of deposits from the public withdrawable by cheque. [See also the judgement of Madras High Court in Sajjan Bank Pvt. Ltd. vs RBI (AIR 1961 Mad 8)]. The definition of "banking" in Section 5(b) of the Banking Regulation Act acknowledges this position. ii. Types of Deposits: Banks accept different types of deposits, both time and demand deposits, from the public. While time deposits, like fixed deposits or recurring deposits are repayable after an agreed period, demand deposits, like deposits in current account and savings bank accounts, are repayable on demand, subject to the terms and conditions of the deposits. The period of the deposit and rate of interest applicable to the deposit are matters to be agreed between the depositor and the bank under the terms of the deposit, subject to any directions given by the Reserve Bank in this regard. iii. Regulation of acceptance of deposits: The Banking Regulation Act does not contain any specific provisions for regulation of acceptance of deposits of banks. However, Section 35 A which authorises the Reserve Bank to give directions is wide enough to cover acceptance of deposits. Accordingly, acceptance of deposits may be regulated in the public interest or in the interest of banking policy or in the interests of depositors by issuing directions. The Reserve Bank issues directions from time to time regulating the rates of interest applicable to deposits. The directions may either fix the rates or specify the minimum and/or maximum rate of interest on savings deposits and time deposits for various periods as also for special categories of deposits like senior citizen, NRI deposits. If only minimum and/or maximum rates are specified or no rates are specified, the banks are free to decide their rates accordingly. The directions issued by the Reserve Bank may also stipulate conditions regarding minimum or maximum periods for which deposits may be accepted, reduction of interest payable on premature withdrawal and payment of interest on renewal of overdue deposits. However, currently RBI prescribes the minimum and maximum period for which deposits can be accepted and prescribes interest rates only in respect of Savings Deposits and NRI deposits leaving others for the individual banks. iv. Returns on unclaimed deposits: Banks have to file a return every year on their unclaimed deposits under Section 26 of the Banking Regulation Act. The return has to be filed within thirty days of the end of each calendar year in the form and manner prescribed and should cover all deposits not operated for ten years. In the case of fixed deposits the period of ten years starts from the expiry of the period of the deposit.

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3.4 NOMINATION i. Repayment of Deposits: Section 45ZA of the Banking Regulation Act provides that a depositor or depositors of a banking company (including co-operative banks) may nominate one person in the prescribed manner as nominee to whom the deposit may be returned in the event of death of the sole depositor or depositors. Unless the nomination is varied or cancelled, the nominee is entitled to all the rights of the depositor/s in the event of death of the depositor/s. In the case of minor nominees, there is also a provision to appoint a person to receive the deposit on behalf of the minor. Payment by a bank in accordance with these provisions gives a valid discharge to the bank, but this does not affect the right or claim a person may have against the nominee in respect of the amount received by him. Rule 2 of the Banking Companies (Nomination) Rules, 1985 provides for the procedure and forms for making nomination in respect of deposits with commercial banks. In the case of Co-operative banks, similar provisions are incorporated in the Co-operative Banks (Nomination) Rules, 1985. ii. Articles in Safe Custody and Safety Lockers: There are also provisions in the Banking Regulation Act for nomination in respect of articles kept in safe custody with banks and safety lockers. Sections 45ZC and 45ZE provide that any person who leaves any article in safe custody and in safety lockers respectively with a banking company, may nominate one person as nominee to receive the article in the event of death of that person. The nomination has to be in the prescribed manner and on return of articles kept in safe custody or removal of contents of locker by nominees as provided, the bank gets a valid discharge. Rules 3 and 4 of the Banking Companies (Nomination) Rules, 1985, and also the Rules 3 and 4 of the Co-operative Banks (Nomination) Rules, 1985 deal with the form and procedure applicable to articles in safe custody and safety lockers respectively in the case of banking companies and co-operative banks. 3.5 LOANS AND ADVANCES i. The definition of 'banking' in Section 5(b) of the Banking Regulation Act indicates that acceptance of deposits may be for lending or investment. Thus, lending or making of loans and advances is a core business of a banking company. Lending may be for short term or long term, on secured or unsecured basis and for different purposes. ii. Regulation of Loans and Advances (a) The Reserve Bank is empowered under Section 21 of the Banking Regulation Act to issue directions to control advances by banking companies. Such directions may be issued to banking companies generally or to any particular banking company. The Reserve Bank may determine the policy in relation to advances and issue directions when it is satisfied that it is necessary to give directions: (i) In public interest (ii) In the interests of depositors (iii) In the interests of banking policy. (b) The directions given by the Reserve Bank are binding on banking companies, and may be on one or more of the following matters: (i) Purpose for which advances may or may not be made. (ii) Margins, to be maintained in respect of secured advances. (iii) Maximum amount of advances or other financial accommodation which may be made to any company, firm, association of persons or individual. The policy on these matters may be specified having regard to the paid-up capital, reserves and deposits of the banking company and other relevant considerations.

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(iv) Maximum amount up to which guarantees may be given by a banking company on behalf of any company, firm, association of persons or individual. In this case, also the paid-up capital, reserves, deposits and other relevant considerations have to be taken into account for determining the maximum amount. (v) Rate of interest and other terms and conditions on which advances and other financial accommodation may be made or guarantees may be given. The Reserve Bank issues directions from time to time regulating the lending operations of banking companies in exercise of these powers vested under Section 21. Apart from this, the general powers to give directions under Section 35A are also available for regulation of loans and advances. iii. Selective Credit Control (a) Purpose: Banks have been traditionally financing trade and commerce and against items they deal in even before the country started industrializing. To ensure that prices of essential commodities like food grains, pulses, edible oils, sugar, jaggery and cotton and textiles are not increased by certain sections of the business community with a motive of profit maximisation by hoarding with the help of bank finance, these restrictions have been put in place. These cover the quantum of credit that can be extended and also the rate at which it can be extended. With self-sufficiency achieved by our country over the years in almost all of the above, RBI had taken them out of the purview of selective credit control and currently restrictions are there only in case of levy sugar. (b) Methods and tools: Selective credit control seeks to influence the demand for credit by (i) making borrowing more costly for certain purposes which are considered relatively inessential, or (ii) by imposing stringent conditions on lending for such purposes, or (iii) by giving concessions for certain desired types of activities. The tools employed for exercising selective credit control are: (i) minimum margins for lending against selected commodities; (ii) ceilings on the levels of credit; and (iii) charging of minimum rate of interest on advances against specified commodities. The quantum and cost of credit are regulated by operating these tools of control. iv. Price control: In India, selective credit control has been generally used for preventing speculative hoarding of essential commodities and basic raw materials using bank credit. This is with a view to check the undue rise of prices of such sensitive commodities. v. Restrictions on loans and advances: Section 20 of the Banking Regulation Act imposes certain restrictions on loans and advances. Accordingly, no banking company shall grant loans or advances on the security of its own shares. Further, a banking company, is prohibited from entering into any commitment for granting any loans or advances to or on behalf of any of its directors. The prohibition also applies to loans and advances to: (a) firms in which any director is interested as a partner, manager, employee or guarantor, and (b) any company (other than a company registered under Section 25 of the Companies Act) in which a director of the banking company holds substantial interest as defined in Section 5(ne) of the Act or of which he is director, manager, managing agent, employee or guarantor. If the director of a banking company is a partner or guarantor of any individual, loans and advances to such individual are also barred. 'Director' includes a member of any board for managing or

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advising the bank regarding management of all or any of its affairs. It is open to the Reserve Bank to specify any transaction as not being a loan or advance for this purpose by a general or special order. In so doing the bank has to consider the nature of the transaction, period, manner and circumstances in which the amount is likely to be realised, the interest of depositors and other relevant considerations. If there is any doubt or dispute as to whether a transaction is a loan or advance, the decision of the Reserve Bank in the matter shall be final. vi. Restrictions on power to remit debt: For remitting any debt to its directors, a banking company requires prior permission of the Reserve Bank under Section 20A of the Banking Regulation Act. Permission is also required for remission of loans to: (a) any firm or company in which a director is interested as director, partner, managing agent, or (b) any individual for whom a director is partner or guarantor. Any remission made in contravention of Section 20 is void and will have no effect.

3.6 REGULATION OF INTEREST RATE


The Reserve Bank is authorised to regulate interest rates under Section 21 (read with Section 35A) of the Banking Regulation Act. This includes rates of interest for loans and advances as well as deposits. While giving directions on interest rates, there should not be any discrimination against any class of depositors or loanees or banks. Any differential treatment should be justifiable in law as not being against the principles of equality. In Harjit Singh vs Union of India (AIR 1994 SC 1433), the Supreme Court held in the context of reduction of rate of interest on bank loans to riot victims that the concession should be extended to loanees from financial institutions also, as there was no basis for discrimination between loanees from banks and loanees from financial institutions. i. Interest on deposits: The rates of interest on deposits were not regulated by the Reserve Bank until 1964. Hence, it was open to the banks to decide their deposit rates freely. Thereafter the Reserve Bank has been issuing directions from time to time regulating rates of interest applicable to different types of deposits. Accordingly, payment of interest on current account was prohibited. As the directions are issued by virtue of the powers vested in the Reserve Bank under Section 35A of the Banking Regulation Act, before issuing the directions the Bank has to be satisfied that the directions are necessary in public interest or in the interest of depositors or of banking policy. Reserve Bank may permit higher rate of interest in favour of certain categories of depositors like former/existing employees or depositors of certain classes of banks like co-operative banks. Of late, the movement has been in the direction of liberalisation of interest rates, thereby giving increased freedom to banks to decide the rates themselves. ii. Interest rate on loans and advances: Interest rate on loans and advances is subject to regulation specifically under Section 21(2)(e) of the Banking Regulation Act apart from the general provisions of Section 35A. The Reserve Bank has been issuing directions from time to time under Section 21 (read with Section 35A) of the Act regulating different aspects of lending including lending rates. Accordingly, different rates are permissible for different sectors like small-scale industries, agriculture, large-scale industries, etc., and of late, much freedom has been given to banks to decide the rates themselves. Further, the rate of interest may vary on the basis of the period of the loan. The Reserve Bank tightens the regulations or gives relaxations thereby permitting banks to decide the rates on their own, depending on the position of money supply in the public interest or in the interest of depositors or of banking policy. Currently the directions of RBI regarding interest rates of advances cover only finance to exporters and small loans with limits up to Rs 2 lac and DRI loans.

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iii. Usurious loans Act, 1918: The Usurious Loans Act, 1918 prohibits lending at exorbitant rates. The law has been made to protect the weaker borrowers from the powerful moneylenders. Similarly, debt relief legislation in different states attempts to protect the agriculturists and other weaker sections from unscrupulous lenders, by remitting debts or giving other concessions. Although the lending rates of banks are regulated by the Reserve Bank, borrowers often used to resort to these laws for remitting loans or reducing rates of interest in respect of loans taken by them from banks. This was coming in the way of the monetary policy decided by the central bank. Accordingly, Section 21A was inserted in the Banking Regulation Act to make the rates of interest charged by banking companies beyond the scrutiny of courts. iv. Protection to interest rate: Section 21A of the Banking Regulation Act provides that a transaction between a banking company and its debtor cannot be reopened by any court on the ground that the rate of interest charged is excessive. This provision is given an overriding effect over the provisions of the Usurious Loans Act, 1918 or any other law relating to indebtedness in force in any state. Section 21A was held to be valid and not ultra vires the Constitution by the Supreme Court. In Corporation Bank vs D. S. Gowda [(1994) 5 SCC 213], the Supreme Court held that banks can compound interest on annual rates and not half yearly rates in view of the express directives of the Reserve Bank. The court further held that where the Reserve Bank fixes both minimum and maximum rates of interest, courts would not interfere in the matter of interest rate, if the rate charged by the bank is not in violation of the Reserve Bank directive. However, the court did not express any opinion on the question whether Section 21A would debar the courts from interfering if the circulars or directives of the Reserve Bank do not fix the maximum and leave it to the discretion of the banks to fix the rate above the minimum.

3.7 REGULATION OF PAYMENT SYSTEMS


The Reserve Bank of India Act, until recently, did not contain any provision for regulation of payment systems. Section 58 empowers the Bank to make regulations for giving effect to the provisions of the Act and Clause (g) of the sub-Section (2) thereof, provides for making provisions for regulation of clearing houses for the banks including post office saving banks. (The clearing houses are now functioning under the uniform clearing house rules and regulations framed by the mutual consent of members and no statutory rules or regulations have been framed.) However, the regulation of payment systems has become important in the context of electronic payment systems becoming popular and the probability of complications in the absence of a suitable regulatory framework with statutory backing. In the absence of specific powers under the Act, the Bank has not been able to frame any regulations relating to payment systems. Hence, the Information Technology Act, 2000 has amended the Reserve Bank of India Act, inserting the Clause (pp) in Section 58 (2) empowering the Reserve Bank to frame regulations for payment systems of banks and financial institutions. Financial institution for this purpose will have the same meaning as provided in the Clause (c) of Section 45 of the Reserve Bank of India Act. Accordingly, the Central Board of the Reserve Bank has framed the Reserve Bank of India (Board for Regulation and Supervision of Payment and Settlement Systems) Regulations, 2005. Further, RBI is in the process of finalising the guidelines under the Payment and Settlement Systems Act, 2007. i. Board for regulation and supervision of Payment and Settlement Systems: The Reserve Bank, in terms of the RBI (Board for Regulation and Supervision of Payment and Settlement Systems) Regulations, 2005, has constituted a Board for Regulation and Supervision of Payment and Settlement Systems (BPSS) as a committee of its Central board. The Board has the Governor of the Bank as its chairman and its functions include prescribing policies relating to the regulation and supervision of all types of payment and settlement systems, setting standards for existing and future systems,

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authorising the payment and settlement systems, determining criteria for membership to these systems including continuation, termination and rejection of membership. 3.8 INTERNET BANKING GUIDELINES The Reserve Bank has issued guidelines in respect of internet banking. These guidelines cover: (i) technology and security issues; (ii) legal issues; (iii) regulatory and supervisory issues. These guidelines apply, in addition to Internet banking, to other forms of electronic banking to the extent relevant. All banks offering internet banking have to make a review of their systems in the light of these guidelines and report to the Reserve Bank the types of services offered, extent of their compliance with the recommendations, deviations, if any and their proposal indicating a timeframe for compliance. 3.9 REGULATION OF MONEY MARKET INSTRUMENTS The Reserve Bank of India (Amendment) Act, 2006 (Section 45W) empowers the Bank, in public interest or to regulate the financial system of the country to its advantage, to determine the policy relating to interest rates or interest rate products and give directions in that behalf to all agencies or any of them, dealing in securities, money market instruments, foreign exchange, derivatives, or other instruments of like nature as the Bank may specify from time to time. Further, the Bank may, for the purpose of enabling it to regulate these agencies call for any information, statement or other particulars from them, or cause an inspection of such agencies to be made. However, the directions issued by the Bank in this behalf shall not relate to the procedure for execution or settlement of the trades in respect of the transactions on the recognised Stock Exchanges. Every director or member or other body for the time being vested with the management of the affairs of the agencies falling under Section 45 W has to comply with the directions given by the Reserve Bank and submit the information or statement or particulars as required. 3.10 BANKING OMBUDSMAN Ombudsman is generally an authority (official) appointed to receive and investigate on the public grievances against the Government or any other authority or institution or organisation and redress such grievances as a non-adversarial adjudicator, or an alternative to the adversary system for resolution of disputes. The position is that of an independent and non-partisan officer who deals with specific complaints from the public against administrative injustice and maladministration. The banking ombudsman is an authority originally established under the Banking Ombudsman Scheme, 1995 by the Reserve Bank of India in exercise of the powers vested in it under Section 35A of the Banking Regulation Act. The scheme aimed at resolution and settlement of complaints of the banking public against the commercial banks (excluding RRBs) and the scheduled primary co-operative banks without resorting to courts. It was modified by the Banking Ombudsman Scheme, 2002 and later by the Banking Ombudsman Scheme, 2006 to enlarge the extent and scope of the authority and functions of banking ombudsman for 'redressal of grievances against deficiency in banking services, concerning loans and advances and other specified matters'. All commercial banks, regional rural banks and scheduled primary co-operative banks are required to comply with the modified scheme. 1. Object of the scheme: The object of the scheme is to enable resolution of complaints relating to specified services rendered by the banks and to facilitate the satisfaction or settlement of such complaints. 2. Grounds of complaint: The grounds on which complaints may be made to the banking ombudsman are:

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(i) Deficiency in banking or other services in respect of: (a) non-payment or inordinate delay in the payment or collection of cheques, drafts, bills, etc.; (b) non-acceptance, without sufficient cause, of small denomination notes tendered for any purpose, and for charging of commission in respect thereof; (c) non-acceptance, without sufficient cause, of coins tendered and for charging of commission in respect thereof; (d) non-payment or delay in payment of inward remittances; (e) failure to issue or delay in issue of drafts, pay orders or bankers' cheques; (f) non-adherence to prescribed working hours; (g) failure to honour guarantee or letter of credit commitments; (h) failure to provide or delay in providing a banking facility (other than loans and advances) promised in writing by a bank or its direct selling agents; (i) delays, non-credit of proceeds to parties' accounts, non-payment of deposit or nonobservance of the Reserve Bank directives, if any, applicable to rate of interest on deposits in any savings, current or other account maintained with a bank; (j) delays in receipt of export proceeds, handling of export bills, collection of bills, etc., for exporters provided the said complaints pertain to the bank's operations in India; (k) complaints from Non Resident Indians having accounts in India in relation to their remittances from abroad, deposits and other bank-related matters; (1) refusal to open deposit accounts without any valid reason; (m) levying of charges without adequate prior notice to the customer; (n) non-adherence by the bank or its subsidiaries to the instructions of Reserve Bank on ATM/ Debit card operations or credit card operations; (o) non-disbursement or delay in disbursement of pension (to the extent the grievance can be attributed to the action on the part of the bank concerned, but not with regard to its employees); (p) refusal to accept or delay in accepting payment towards taxes, as required by Reserve Bank/Government; (q) refusal to issue or delay in issuing, or failure to service or delay in servicing or redemption of Government securities; (r) forced closure of deposit accounts without due notice or without sufficient reason; (s) refusal to close or delay in closing the accounts; (t) non-adherence to the fair practices code as adopted by the bank; (u) any other matter relating to the violation of the directives issued by the Reserve Bank in relation to banking services. (ii) Deficiency in banking service in respect of loans and advances pertaining to: (a) non-observance of Reserve Bank Directives on interest rates; (b) delays in sanction, disbursement or non-observance of prescribed time schedule for disposal of loan applications but not declining credit; (c) non-acceptance of application for loans without furnishing valid reasons to the applicant; (d) non-observance of any other direction or instruction of the Reserve Bank as may be specified by the Reserve Bank for this purpose from time to time; (iii) Such other matters as may be specified by the Reserve Bank from time to time in this behalf. Jurisdiction and Procedure: The location and the territorial jurisdiction of the ombudsman are as specified by the Reserve Bank. A complaint may be made in writing by a person himself or through an authorised representative. No complaint to the banking ombudsman shall lie unless,

3.

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(a) the complainant had, before making a complaint to the banking ombudsman, made a written representation to the concerned bank and the bank had rejected the complaint or the complainant had not received any reply within a period of one month after the bank received his representation or the complainant is not satisfied with the reply given to him by the bank; (b) the complaint is made not later than one year after the complainant has received the reply of the bank to his representation or, where no reply is received, not later than one year and one month after the date of the representation to the bank; (c) the complaint is not in respect of the same subject matter which was settled or dealt with on merits by any previous banking ombudsman proceedings whether or not received from the same complainant or along with one or more complainants or one or more of the parties concerned with the subject matter; (d) the complaint does not pertain to the same subject matter for which any proceedings before any court, tribunal or arbitrator or any other forum is pending or a decree or award or order has been passed by any such court, tribunal, arbitrator or forum; (e) the complaint is not frivolous or vexatious in nature; (f) the complaint is made before the expiry of the period of limitation prescribed under the Indian Limitation Act, 1963 for such claims. The Supreme Court has in a recent case, M/s Durga Hotel Complex vs. Reserve Bank of India and Ors. [Appeal (civil) 1389 of 2007], observed that a banking ombudsman, though might have initially jurisdiction to entertain a complaint on the basis that it has a legal foundation, in terms of the scheme, he may be divested of that jurisdiction, or the foundation in law might be lost, on either of the parties, approaching the Court, the arbitrator or the debts recovery tribunal in respect of the same subject matter. This is on the basis that the complaint must continue to have a foundation in law at the time the ombudsman takes up the claim for his consideration and renders his decision or award and that foundation would be lost when the complaint is taken to a Court, Arbitrator, Tribunal or any other competent forum. The ombudsman being an authority or tribunal of limited jurisdiction conferred by the scheme, the exercise of jurisdiction or power by the ombudsman would depend on his having jurisdiction, not only to entertain a claim but also to end it. Accordingly, once he/she is deprived of his jurisdiction or gets deprived of his jurisdiction over the subject matter, he/she could no more proceed with a complaint which was earlier filed and therefore, a complaint goes out of his/her purview when the subject matter of it is taken to a court, arbitrator, tribunal or forum. Moreover, the relief that can be granted by the ombudsman may not conflict with a more comprehensive adjudication by a court, arbitrator, tribunal or forum with wider powers. In short, when the ombudsman is about to pronounce his award, he finds that the subject matter of the dispute has been taken to the debts recovery tribunal or a civil court or an arbitrator or to any other competent forum, the ombudsman will have to decline jurisdiction to pass any order or award on the complaint to bring about a resolution of the complaint by way of a non adversarial adjudication. The ombudsman may call for information from the bank concerned and make endeavour to promote a settlement with the bank. The ombudsman is free to follow the procedure considered appropriate. Where a complaint is not settled by agreement within a period of one month from the date,of receipt of the complaint or such further period as the banking ombudsman may consider necessary, he may pass an award after affording the parties reasonable opportunity to present their case. He shall be guided by the evidence placed before him by the parties, the principles of banking law and practice, directions, instructions and guidelines issued by the Reserve Bank from time to time and such other factors which in his/her opinion are necessary in the interest of justice. An award shall not be binding on a bank against which it is passed unless the complainant furnishes a letter of

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acceptance of the award in full and final settlement of his claim within a period of fifteen days from the date of receipt of copy of the award. If the complainant fails to furnish his/her letter of acceptance within this time or within extended time of fifteen days, the award will lapse. However, on a written request for extension of time, the banking ombudsman may grant extension of time up to a further period of fifteen days for such compliance. Within one month from the date of receipt by the bank of the acceptance in writing of the award by the complainant (or within such time not exceeding a period of fifteen days that may be granted by the banking ombudsman), the bank has to comply with the award. However, if the bank or the complainant is aggrieved by the award, it/ he can make an appeal to the appellate authority (Deputy Governor, Reserve Bank) under the scheme. 4. Banking Ombudsman and Reserve Bank Directions: The legal position of banking ombudsman vis a-vis the Reserve Bank has been considered by the Supreme Court in Canara Bank vs P.R.N. Upadhyaya (AIR 1998 SC 3000). The court observed that since an ombudsman is appointed by virtue of the scheme framed under S 35A of the Banking Regulation Act, 1949, he/she is obliged to comply with the directions/circulars and notifications issued by the Reserve Bank under Section 35A or 21 of the Act. He/She is also required to issue directions to banks based on the Reserve Bank directions/circulars and ensure their compliance. The ombudsman cannot ignore these circulars and directions while dealing with the complaints filed by customers of banks. The impugned award having been made, ignoring various circulars/directions issued by the Reserve Bank, the same was held to be not sustainable. The court, therefore, set aside the impugned award and remitted the complaint to the ombudsman for its fresh disposal in the light of the circulars/directions issued by the Reserve Bank with regard to charging of rate of interest from the landlord loanees, whose buildings were taken on lease/rent by the concerned bank and calculating the interest rate at quarterly rests. 5. Banking Ombudsman and Debt Recovery Tribunals: As regards the position of banking ombudsman vis-a-vis the debt recovery tribunal, the Allahabad High Court in M/s Hindustan Ferro and Industries Ltd. vs Debt Recovery Tribunal (AIR 2001 All 155) observed that while the object of the scheme is to enable resolution of complaints relating to provision of banking services and the satisfaction or settlement of such complaints, the purpose of the Act is to provide for the establishment of tribunals for expeditious adjudication and recovery of debts due to banks and financial institutions and for matters connected therewith or incidental thereto. The procedure prevailing prior to the enactment of the Act for recovery of debts due to the banks and financial institutions has blocked a significant portion of their funds in unproductive assets, the value of which deteriorated with the passage of time. It was for this compelling reason and to obviate the difficulties in recovering debts due to the banks and financial Institutions that the Act was enacted. The scheme has nothing to do with the proceedings of recovery of debts due to the banks and financial institutions. The scheme formulated by the Reserve Bank under the Banking Regulation Act, 1949 cannot override the provisions of the Act.

3.11 RESERVE FUNDS


i. Creation of Reserve Fund: Every banking company incorporated in India has to create a reserve fund under Section 17(1) of the BR Act out of the profits as shown in the profits and loss account prepared under Section 29 of the Act. Every year, a sum equivalent to not less than twenty per cent of such profits has to be transferred to the reserve fund. Such transfer of profits to reserve fund has to be made before any dividend is declared. ii. Exemption from Contribution: If any banking company has an adequate paid-up capital and reserves

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in relation to its deposit liabilities, the Reserve Bank may recommend to the Government of India for exemption from the requirement of transfer of profits to reserve fund. Thereupon, the Government may pass an order in writing, exempting the banking company from Section 17(1) for such period as may be specified in the order. No such order shall be made unless the amount already in the reserve fund together with the amount in the share premium account is not less than the paid-up capital of the banking company. iii. Appropriation from Reserve Fund/Share Premium Account: Appropriation of any amount from the reserve fund or the share premium account has to be reported to the Reserve Bank within twentyone days of such appropriation. The banking company has also to explain the circumstances in which such appropriation was made. It is open to the Reserve Bank in any particular case to extend the period for submitting the report or to condone the delay in making the report. iv. Foreign Banks: The provisions of Section 17(1) of the Banking Regulation Act for creating a reserve fund do not apply to foreign banks operating in India. In their case, instead of creating a reserve fund under Section 17(1), Section 11(2) of the Act requires them to deposit and keep deposited with the Reserve Bank an amount calculated at twenty per cent of the profit for each year in respect of all the business transacted through their branches in India. The amount may be deposited in cash or unencumbered approved securities or partly in cash and partly in unencumbered approved securities. Section 11 (2A) also provides for exemption by Central Government on the recommendation of the Reserve Bank, where the deposits already made are considered adequate in relation to the deposit liabilities of the banking company. 3.12 MAINTENANCE OF CASH RESERVE Every banking company which is a scheduled bank has a duty to maintain certain cash reserve with the Reserve Bank under Section 42 of the Reserve Bank of India Act. In the case of non-scheduled banks, Section 18 of the Banking Regulation Act provides for the maintenance of cash reserve. i. Scheduled Banks: A scheduled bank is a bank included in the second schedule of the Reserve Bank of India Act. Under Section 42(6) of the Act, the Reserve Bank may include any bank in the second schedule if it satisfies the following requirements (a) it has a paid-up capital and reserves of an aggregate value of not less than Rs. 5 lac; (b) it satisfies the Reserve Bank that its affairs are not conducted in a manner detrimental to the interests of depositors; (c) it is: (i) a state co-operative bank, or (ii) a company as defined in Section 3 of the Companies Act, or (iii) an institution notified by the Central Government in this behalf, or (iv) a corporation or a company incorporated outside India under the foreign laws. Thus, a banking company which has the requisite capital and reserves of Rs. 5 lac and the affairs of which are not conducted in a manner detrimental to the interests of depositors is eligible to be included in the second schedule. The Reserve Bank, may exclude any bank from the second schedule, if the aggregate value of its paid-up capital falls below Rs. 5 lac, or its affairs are found to be conducted in a manner detrimental to the interests of depositors on an inspection under Section 35 of the Banking Regulation Act, or if it goes into liquidation, or otherwise ceases to carry on banking business. ii. Quantum of Cash Reserve: The cash reserve required to be maintained by a scheduled bank with the Reserve Bank under Section 42(1) of the Reserve Bank of India Act (as amended in 2006) is an

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average daily balance, being 'such per cent of the total of the demand and time liabilities in India of that bank as shown in the return referred to in the sub-Section (2), as the Reserve Bank may from time to time, having regard to the needs of securing the monetary stability in the country, notify in the Gazette of India'. Thus, under the amended statute, the Reserve Bank can, in order to secure monetary stability in the country, determine the CRR for scheduled banks without any ceiling or floor rate (as against a statutory minimum of three per cent earlier). 'Average daily balance' for this purpose means the average of the balances held at the close of business of each day for a fortnight. The liabilities, for this purpose do not include paid-up capital and reserves and any credit balance in the profit and loss account. Further, the amounts borrowed from the Reserve Bank, IDBI, Exim Bank, IIBI, National Housing Bank and National Bank for Agriculture and Rural Development, are also excluded. Apart from this, in case of a scheduled bank, other than a state co-operative bank, the aggregate of liabilities of the scheduled bank to the State Bank, subsidiary banks, Nationalised banks, banking companies, cooperative banks and any financial institutions notified by the Government in this behalf, shall be reduced by the aggregate of liabilities of these banks and institutions to that scheduled bank. Further, the Reserve Bank is empowered under the sub-Section (1C) of Section 42 to specify, from time to time whether any transaction shall be regarded as liability in India of a scheduled bank. iii. Interest: Until the amendment to the RBI Act in 2006, the Reserve Bank was authorised under the Act [Section 42(1 B)] to pay interest to a scheduled bank when it maintained reserves above the statutory minimum as required under the Reserve Bank's notification under the erstwhile proviso to the sub-Section (1) or under the sub-Section (1A) of Section 42. As the sub-Section ( I B ) providing for interest has been omitted now, the Reserve Bank cannot pay interest on any portion of the CRR balances of banks. iv. Returns: Every scheduled bank has to submit a return to the Reserve Bank showing its demand and time liabilities and borrowings from banks in India, classifying them into demand and time liabilities and giving other details required under Section 42(2) of the Reserve Bank of India Act. The return has to be as at the close of business on each alternate Friday and has to be sent not later than seven days after the date to which it relates. In some cases, it may be impracticable to furnish fortnightly returns by reason of the geographical position of the banks and its branches. If so, the Reserve Bank may permit presentation of a provisional return fortnightly, to be followed by a final return within twenty days after the date to which it relates. Alternatively, such a bank may be permitted to file a monthly return within twenty days after the end of the month. In addition to the above, where the last Friday of the month is not an alternate Friday for the purpose of return, a special return as at the close of business on that day has to be submitted within seven days. Where the relevant Friday is a holiday under the Negotiable Instruments Act, the return has to be prepared as at the close of the preceding working day. v. Penalties: When the balance maintained by any scheduled bank falls below the stipulated minimum, such a bank shall be liable to pay a penal interest to the Reserve Bank. During the first fortnight, when such shortage occurs, the penal interest shall be three per cent above the bank rate and if the shortage continues in the next fortnight, the penal interest shall increase to five per cent above the bank rate. Where the shortfall still persists in the third fortnight, every director, manager or secretary of the bank who is a wilful party thereto shall be punishable with a fine. In that case, the Reserve Bank may also prohibit the bank from accepting fresh deposits. Contravention of the order of prohibition is also punishable with a fine. Failure to file the return as required, also attracts a penalty under Section 45(4) of the Act. Where Reserve Bank is satisfied that a bank had sufficient reason for committing the default, either in maintaining reserves or in filing return, the penalty may be

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waived. When penalty is imposed for a default, the amount has to be paid within fourteen days of the notice demanding payment. On failure to pay accordingly, Reserve Bank may obtain a direction from the Principal Civil Court for levying the penalty and obtain a certificate for the amount which may be enforced like a decree of a civil court. vi. Cash Reserves of Non-Scheduled Banks: In the case of banking companies, which are not scheduled banks under Section 18 of the Banking Regulation Act, the cash reserve need not be maintained with the Reserve Bank. It may be with the bank itself, or in a current account with the Reserve Bank or by way of net balance in current accounts or in one or more of these ways. The balance maintained should not be less than three per cent of the demand and time liabilities as on the last Friday of the second preceding fortnight. The bank has also to submit a return to the Reserve Bank before the twentieth day of every month showing the amount so held on alternate Fridays during the month, along with particulars of its demand and time liabilities in India on such Fridays. If the Fridays concerned fall on holidays under the Negotiable Instruments Act, the returns have to be filed as on the preceding working day. 3.13 MAINTENANCE OF LIQUID ASSETS Every banking company has a duty to maintain a certain percentage of their assets in India under Section 24 of the Banking Regulation Act in the form and manner specified by the Reserve Bank by notification in the official gazette. Recently, the Banking Regulation (Amendment) Ordinance, 2007 amended the provisions of Section 24, omitting the sub-Sections (1) and (2) of Section 24 which provided for a statutory minimum requirement of 25 per cent. Under the sub-Section (2A), as modified by the Ordinance, a scheduled bank, in addition to the average daily balance which it is, or may be required to maintain under Section 42 of the Reserve Bank of India Act, 1934 shall maintain in India, assets, the value of which shall not be less than such percentage not exceeding 40 per cent of the total of its demand and time liabilities in India as on the last Friday of the second preceding fortnight. Banking companies other than scheduled banks have also to maintain such assets in addition to the cash reserve, which they are required to maintain under Section 18 of the BR Act. i. Returns: For ensuring compliance with the above provisions, a monthly return has to be submitted to the Reserve Bank by every banking company. The return has to be submitted not later than twenty days from the end of the month to which it relates, in the prescribed form and manner and giving particulars of assets and demand and time liabilities at the close of business of each alternate Friday. If such a Friday is a public holiday, the return has to be prepared as at the close of the preceding working day. Without prejudice to the above, the Reserve Bank is also empowered to require a banking company to furnish a return showing particulars of the assets and demand and time liabilities as at the close of each day of a month. ii. Penalty for Default: If the balance on any alternate Friday (or the preceding working day, when such Friday is a holiday) falls below the minimum requirement, the banking company is liable to pay to the Reserve Bank penal interest at the rate of three per cent above bank rate on the shortfall for the day. If the default recurs on the succeeding alternate Friday, the penal interest is raised to five per cent above the bank rate on the shortfall. If the default occurs on the next succeeding Friday, then every director, manager and secretary of the banking company is punishable with a fine. The Reserve Bank is also empowered to impose a similar penal interest for shortfall in the assets on any day and if shortfall continues on the succeeding working day, the higher penal interest is payable as above. If the Reserve Bank is satisfied on the application of a banking company that it had sufficient cause not to comply with the provisions as to maintenance of assets, penal interest may be waived.

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3.14 ASSETS IN INDIA i. Quarterly position of assets: Every banking company has to maintain in India certain amount of assets as required under Section 25 of the Banking Regulation Act. Accordingly, at the close of business on the last Friday of every quarter, such assets shall not be less than seventy five per cent of the demand and time liabilities of the banking company in India. If the last Friday is a holiday under the Negotiable Instruments Act, the assets are based upon as at the close of business on the preceding working day. 'Quarter' for this purpose means the period of three months ending on the last day of March, June, September and December. This provision is meant to ensure that the resources mobilised by banks operating in India, especially the foreign banks, are largely invested within the country. The assets may be in cash, gold or unencumbered approved securities. 'Assets in India' also include export bills drawn in and import bills drawn on and payable in India and expressed in currencies approved by the Reserve Bank for this purpose. Such bills and securities approved by the Reserve Bank in this behalf are treated as assets in India even if these assets were held outside India. The paid-up capital, reserves and any credit balance in the profit and loss account of a banking company shall not be treated as 'liabilities in India' for this purpose. ii. Returns: A return regarding the assets maintained in India under Section 25(1) of the Banking Regulation Act has to be submitted to the Reserve Bank within one month from the end of every quarter. Such return has to be filed in the form and manner prescribed by the rules made under the Act. 3.15 LET US SUM UP i. The Banking Regulation Act empowers the Reserve Bank to issue directions to banking companies in public interest, in the interest of banking policy and in the interest of depositors. Section 21 provides for the issue of directions to regulate loans and advances by banking companies. This may be done by regulating the purposes of lending, margins in respect of secured loans, rate of interest and terms and conditions of lending. Section 35A gives wide general powers to issue directions. The Reserve Bank issues directions from time to time under Section 21 (read with Section 35 A) regulating acceptance of deposits and lending. Under Section 21A of the Act, the rate of interest on loans and advances contracted between a bank and its customer is not liable to be reopened by a court of law. Section 20 of the Act imposes restrictions on loans and advances to directors, and companies and firms in which directors are interested as director, partner, etc. ii. A banking company which is a scheduled bank has to maintain a certain percentage of the time and demand liabilities as cash reserve with the Reserve Bank under Section 42 of the Reserve Bank of India Act, as notified by the Reserve Bank from time to time. Failure to do so renders the banking company liable to penalty. For non-scheduled banking companies, Section 18 of the BR Act provides for cash reserve. Banking companies have also to maintain a certain percentage of their demand and time liabilities in liquid assets as stipulated under Section 24 of the BR Act. These assets may be maintained to the extent and in the form and manner as notified by the Reserve Bank. Apart from this, banking companies are required to maintain such assets in India at not less than seventy five per cent of demand and time liabilities as at the close of business of the last Friday of every quarter. Banking companies also have to transfer to the reserve fund twenty per cent of their annual profits as disclosed in the profit and loss account. 3.16 KEYWORDS Bank Rate; Demand Liabilities; Scheduled Bank; Selective Credit Control; Time Liabilities; Usurious Loans.

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3.17 CHECK YOUR PROGRESS 1. Fill in the gaps choosing the answers from the brackets. (i) Reserve Bank may issue directions to banking companies under Section 21 of BR Act on __________ . (audit, loans and advances, capital structure) (ii) _________ may regulate acceptance of deposits including rate of interest on deposits by banking companies under Section 35A of the BR Act. (Government, Reserve Bank, Board of Directors) (iii) The banking ombudsman can settle a dispute between ________________ . (a bank and its customer/ (iv) s, two or more customers, a bank and the Government) Directions can be issued to banking companies on loans and advances ________________ . (v) (in strict confidence, in public interest, in the interest of borrowers) The purpose of ________________ is to make credit available to essential sectors of the (vi) economy according to national priorities, (selective credit control, maintenance of cash reserve, reserve 2. Say fund) (i) _________________ Act prohibits lending at exorbitant rates and empowers reopening of such contracts. (ii) (BR Act, RBI Act, Usurious Loans Act) (iii) whether the following statements are true or false. Reserve Bank can issue directions on loans and advances under Section 21 of the Banking (iv) Regulation Act. Regulation of credit to different sectors of the economy is known as selective credit control. (v) Banks are free to lend to their directors. Banks have to file a return to Reserve Bank regarding unclaimed deposits under Section 26 of (vi) the BR Act. Directions may be issued under RBI Act to banks in respect of loans and advances in the 3. Fill interest of depositors. (i) The directions issued by Reserve Bank under Section 35 A of the BR Act may be either generally to banks or to a particular bank. (ii) in the gaps choosing the answers from the brackets. The amount transferable to the reserve fund by the banks incorporated in India is ________________ of the profit for each year. (25 per cent, 20 per cent, 10 per cent) (iii) Every banking company has to maintain certain amount of assets under Section 25 of the Banking Regulation Act as at the ________________ (last Friday of every fortnight, last Friday of (iv) every month, last Friday of every quarter) The penalty which is payable by a banking company which is a scheduled bank for failure to (v) maintain the cash reserve in any week for the first time is ________________ (3 per cent, 3 per cent (vi) over the bank rate, 5 per cent over the bank rate) _________________ have to maintain cash reserve under Section 18 of the BR Act. (Cooperative 4. Say (i) banks, Banking companies which are not scheduled banks, Nationalised banks) The liquid assets to be maintained under Section 24(2A) of BR Act are _____________ _______________________________________________________________________________ of the balances maintained under Section 42 of the RBI Act. (inclusive, not inclusive, partly inclusive) The payment of penalty under Section 24 of BR Act can be enforced by making an application before _________ (the Government, civil court, high court) whether the following statements are true or false. Only scheduled banks have a duty to maintain cash reserve under Section 42 of the Reserve

Bank of India Act. Every banking company has to maintain the liquid assets as required under Section 24 of the Banking Regulation Act.

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(hi) The share capital and reserves of a banking company form part of its demand and time liabilities for the purpose of Section 42 of the RBI Act. (iv) The cash reserve required under Section 42(1) of the RBI Act will be a minimum of three per cent of the demand and time liabilities, (v) Interest is payable to scheduled banks on the cash reserve maintained as required under Section 42(1) of the RBI Act. (vi) No banking company incorporated in India is required to maintain reserve fund under Section 17(1) of the BR Act.

3.18 ANSWERS TO 'CHECK YOUR PROGRESS'


1. (i) Loans and Advances (iii) a (ii) Reserve Bank (iv) bank and its customer/s (v) in Public Interest (vi) Usurious Loans Act Selective Credit Control (i) True; (ii) True; (iii) False; (iv) True; (v) False; (vi) True (i) 20 per cent (ii) last Friday of every quarter (iii) 3 per cent over bank rate (iv) banking companies which are not scheduled banks (v) not inclusive (vi) civil court (i) True; (ii) True; (iii) False; (iv) False; (v) False; (vi) False

2. 3.

4.

3.19 TERMINAL QUESTIONS Fill in the gaps choosing answers from the brackets. 1. The directions of the Reserve Bank issued to the banking companies under Section 35A of the Banking Regulation Act are _________ . (binding on them only; not binding on them and are in the nature of guidelines; binding on the banks and the public) 2. A contract if entered into by a banking company with any party in contravention of a direction issued by the Reserve Bank _________ . (shall be invalid; shall render the banking company liable to prosecution for violation of directions; shall render the bank and any other party to the contract liable to prosecution for violation of directions) 3. Liquid assets are required to be maintained in India under Section 24 of the BR Act, may be held in the form of _________ . (cash only; cash and gold only; cash, gold or unencumbered approved securities) 4. For the purpose of maintenance of liquid assets under Section 24 of the BR Act, unencumbered approved securities shall be valued at _________ . (face value; current market price; average of market price for previous six months) 5. The penal interest chargeable on a banking company under Section 24(4) of the BR Act for not maintaining liquid assets as specified under Section 24(2A) of the Act __________ . (may be waived by the Reserve Bank if it is satisfied that the bank had sufficient cause for the failure; has to be charged in all cases and the Reserve Bank has no option but to waive penal interest; can be reduced by the Reserve Bank, but, not completely waived). Choose the correct statements from the following: 6. (i) There are no restrictions on a banking company against grant of loans or advances on the security of its own shares.

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(ii) A banking company can lend to any firm in which its director is a partner. A banking

7.

8.

9.

10 .

(iii) company is prohibited from entering into any commitment for granting loans or advances to or on behalf of any individual in respect of whom any of its directors is a partner or (i) guarantor. The power of the Reserve Bank to control advances extends to specifying the purposes for which advances may or may not be made. (ii) A direction, regarding advances may be issued by Reserve Bank to banking companies generally and not to any banking company in particular. (iii) A direction regarding advance can be issued by the Reserve Bank only in the interest of banking policy and on no other grounds. (i) The depositor of a banking company can make a nomination in the form prescribed under the Banking Companies (Nomination) Rules, 1985. 00 There is no form prescribed for nomination by depositors under Banking Companies (Nomination) Rules, 1985. (iii) The nominee is entitled to receive the proceeds of the deposit on maturity of the deposit during the lifetime of the depositor or later. (i) (ii) Banking ombudsman is appointed by the Government under the Banking Regulation Act. Banking ombudsman is appointed by the Reserve Bank under the Banking Ombudsman Scheme, 2006 framed in the nature of directions under the Banking Regulation Act, 1949. (iii) Banking ombudsman is appointed by the Reserve Bank under the Reserve Bank of India Act. (i) For maintenance of cash reserve under Section 42 of the RBI Act, 'demand and time liabilities' do not include paid-up capital of the banking company. (ii) Loan taken from the Reserve Bank and Exim Bank are included in 'demand and time liabilities' under Section 42 of the RBI Act. (iii) Any loan taken by a regional rural bank from its sponsor, forms part of its demand and time liabilities for the purpose of cash reserve under Section 42 of the RBI Act.

UNIT

4
STRUCTURE
4.0 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11 Objectives Introduction

RETURNS, INSPECTION, WINDING UP

Annual Accounts and Balance Sheet Audit and Auditors Submission of Returns Preservation of Records and Return of Paid Instruments Inspection and Scrutiny Board for Financial Supervision Acquisition of Undertakings Amalgamation of Banks Winding up of Banks Penalties for Offences

4.12 Let Us Sum Up 4.13 Keywords 4.14 4.15 4.16 Check Your Progress Answers to 'Check Your Progress' Terminal Questions

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4.0 OBJECTIVES
The objectives of this unit are to understand the laws applicable to banking companies in respect of preparation of accounts and balance sheet audit of accounts filing of returns inspection and scrutiny acquisition of assets by the Central Government amalgamation with other banks winding up penalties for default or contravention

4.1 INTRODUCTION
Banking companies have to prepare their balance sheet and accounts annually as provided in the Banking Regulation Act. The accounts have to be audited by duly qualified auditors as stipulated in the Act. The audited balance sheet and accounts have to be submitted as returns to the Reserve Bank and copies thereof have to be submitted to the Registrar of Companies. Banking companies have to file many other returns to the Reserve Bank. The Banking Regulation Act also provides for inspection and scrutiny of the books and accounts of banking companies. The board for financial supervision has been set up for this purpose. The Central Government is authorised to acquire the assets of banking companies and order the amalgamation of any banking company with another banking company. The Reserve Bank has the power to apply to the High Court for the winding up of banking companies. Non-compliance with the provisions of the Reserve Bank of India Act, the Banking Regulation Act and the orders, rules, regulations, or directions issued under them is punishable under these acts. In this chapter, we examine the law relating to the above matters. 4.2 ANNUAL ACCOUNTS AND BALANCE SHEET i. All Banks whose shares are listed with Stock Exchanges are required to publish their unaudited quarterly results as per proforma prescribed by the SEBI. Every banking company has to prepare its balance sheet and profit and loss account as stipulated in Section 29 of the Banking Regulation Act. The balance sheet and profit and loss account, has to be prepared at the end of each calendar year or on expiry of the twelve months period, ending with any other date which the Central Government may notify in the official gazette in this behalf, as on the last working day of the year or the period, as the case may be. For this purpose, banking companies incorporated in India, have to cover their entire business and in the case of foreign banks operating in India, the business transacted through all their branches in India. While preparing the accounts, the banking company has to comply with the directions and instructions issued by the Reserve Bank in respect of income recognition, asset classification, provisioning, etc., from time to time. ii. The balance sheet and profit and loss account of a banking company incorporated in India has to be signed by the manager or principal officer of the company and at least three directors if there are more than three directors and by all directors if there are not more than three directors. In the case of foreign banks, the manager or the agent of its principal office in India can sign. iii. The balance sheet and profit and loss account have to be prepared in the forms set out in the III Schedule to the BR Act or as near thereto as circumstances permit. The Companies Act requires every company to prepare its balance sheet and profit and loss account in the forms set out in the part I of schedule VI to that Act. However, the respective provisions of the Banking Regulation Act have overriding effect in respect of banking companies. Hence, the provisions of the Companies

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Act that are inconsistent with the provisions of the Banking Regulation Act are not applicable to banking companies. However, those provisions of the Companies Act that are consistent with the Banking Regulation Act are applicable. The forms specified in the third schedule of the Banking Regulation Act may be modified by the Central Government from time to time by notification in the official gazette. iv. In the case of banking companies, the profit and loss account, which has to be placed before the annual general meeting should relate to the period ending with the last working day of the year immediately preceding the year in which the annual general meeting is held. The provisions of Section 210 of the Companies Act, in this behalf have been specifically made inapplicable to banking companies by Section 2y^3A) of the Banking Regulation Aci. v. Publication of Accounts and Balance Sheet: The accounts and balance sheet prepared under Section 29 of the Banking Regulation Act along with the auditors' report have to be published, as provided in Section 31 thereof read with Rule 15 of the Banking Regulation (Companies) Rules, 1949. Accordingly, the publication has to be made in a newspaper, which is in circulation at the place where the banking company has its principal office, within a period of six months from the end of the period to which the account and balance sheet relate. For this purpose, 'newspaper' means any newspaper or journal published at least once a week but does not include a journal other than a banking, commercial, financial or economic journal. As per current guidelines, Banks whose shares are listed in the capital market are required to publish their unaudited quarterly results as per proforma prescribed by SEBI. VI Submission to Reserve Bank: Every banking company has to submit three copies of its balance sheet and profit and loss account to the Reserve Bank within three months from the end of the period to which they relate. This period may be extended by the Reserve Bank by a further period not exceeding three months. vu Furnishing of Accounts and Balance Sheet to Registrar: Section 220 of the Companies Act provides for submission by companies of copies of accounts and balance sheet along with the auditor's report to the Registrar of Companies. However, in the case of banking companies, Section 32 of the Banking Regulation Act provides for furnishing to the registrar three copies of the accounts, balance sheet and auditor's report submitted to the Reserve Bank under Section 31 of the Act, which would be dealt with in all respects, as if these were submitted under Section 220 of the Companies Act. When any company submits additional information relating to balance sheet and profit and loss account to the Reserve Bank under Section 27(2) of the Banking Regulation Act, the company has to send a copy thereof to the Registrar as well. viii. Display of Balance Sheet and Accounts: Foreign banks (banking companies incorporated outside India) operating in India have to display in a conspicuous place, in their principal office a copy of the last audited balance sheet and profit and loss account. This has to be done not later than the first Monday in August of any year in which it carries on business. The accounts and balance sheet have to be kept displayed until replaced by a copy of the subsequent balance sheet and profit and loss account. Similarly, foreign banks have also to display copies of their complete audited balance sheet and profit and loss account relating to their banking business as soon as these are available and keep displayed till the subsequent accounts are available.

4.3 AUDIT AND AUDITORS


The balance sheet and profit and loss account of a banking company have to be audited, as stipulated under Section 30 of the Banking Regulation Act. Accordingly, a person duly qualified under any law for the time being to be an auditor of companies is eligible to be the auditor of a banking company.

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i. Powers and Functions of Auditors: The powers, functions and duties of the auditors and the liabilities and penalties to which they are subjected to under Section 227 of the Companies Act are applicable to auditors of banking companies. In addition to the above, the auditor of a banking company has to give certain additional information in his audit report. In the case of banks incorporated in India, the additional matters are as under: (a) Whether or not information and explanation, required by him were found to be satisfactory; (b) Whether or not the transactions of the company, as noticed by him were within the powers of the company; (c) Whether or not returns from branches were adequate for the audit; (d) Whether or not profit and loss account shows a true picture of the profit and loss for the period covered; (e) Any other matter, which the auditor considers necessary to bring to the notice of the shareholders of the company. In dealing with bank accounts, the responsibility of the auditor is not confined to safeguarding the interests of the proprietors. The auditor will be reasonably blamed, if after signing the usual auditor's report on an apparently sound balance sheet, the bank is afterwards found insolvent (See the judgment of the Kerala High Court in Institute of Chartered Accountants vs. Srinivasa, AIR 1960 Kerala. 309 at 311 and the judgment of Madras High Court in Registrar of Companies vs. RM. Hegde, AIR 1954 Madras 1080 at 1084). ii. Special Audit: Reserve Bank is empowered under Section 30( IB) of the Banking Regulation Act to order a special audit of the accounts of any banking company. Such an order may be passed when the Reserve Bank is of the opinion that special audit is necessary in the public interest or in the interest of the banking company or its depositors. An order, on special audit may relate to any transaction or class of transactions or such period or periods as the Reserve Bank may specify in the order. The bank may by the same order or by a different order appoint a duly qualified auditor for this purpose or may direct the auditor of the banking company himself to conduct such a special audit. The Reserve Bank's directions are binding on the auditor of the banking company and the auditor has to make a report of such an audit to the Reserve Bank and also give a copy thereof to the banking company. The expenses in relation to the special audit have to be borne by the banking company. 4.4 SUBMISSION OF RETURNS Every banking company has to furnish several returns to the Reserve Bank under various provisions of the Banking Regulation Act and under the Reserve Bank of India Act. The details of these returns are discussed below. i. Return on Liquid Assets: Every banking company has to submit a return of its liquid assets under Section 24(3) of the Banking Regulation Act. The return has to be submitted within twenty days from the end of the month to which it relates. The return has to be in the form prescribed under Rule 13A of the Banking Regulation (Companies) Rules, 1949. The return should contain particulars of assets and the demand and time liabilities, as at the close of business of each alternate Friday or when such a Friday is a holiday, as at the close of business of the preceding working day. The Reserve Bank is also empowered to require a banking company to furnish returns showing particulars of assets and demand and time liabilities as at the close of each day of the month. ii. Monthly Returns: Every month, a banking company has to submit to the Reserve Bank a return under Section 27 of the BR Act, showing its assets and liabilities in India as at the close of business

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on the last Friday of the previous month. Such a return has to be submitted before the close of the month succeeding to which it relates. The return has to be in the form prescribed under Rule 14A of the Banking Regulation (Companies) Rules, 1949. Apart from this, the Reserve Bank may also call for statements and information relating to the business or affairs of a banking company at any time. The bank may direct the banking company to submit such statement or information within such time as it may direct. The Bank may also call for information every half year regarding investments of a banking company or the classification of its advances in respect of industry, commerce or agriculture. iii. Accounts and Balance Sheet: The annual accounts and balance sheet have to be submitted to the Reserve Bank within three months from the end of the period to which they relate. The Reserve Bank may extend the time by a further period of three months. iv. Return of Assets in India: A banking company has to submit to Reserve Bank under Section 25(1) of the Banking Regulation Act, a quarterly return regarding its assets in India. The return has to be submitted within one month of the end of the quarter. The return has to be filed in the form specified in the Rule 14A of the Banking Regulation (Companies) Rules. v. Return of Unclaimed Deposits: Under Section 26 of the BR Act, a banking company has to file within thirty days of the close of each calendar year a return on unclaimed deposits (not operated for ten years). This has to be submitted as specified in the Rule 14B of the Banking Regulation (Companies) Rules. vi. Return of Cash Reserve of Non-Scheduled Banks: Every banking company, not being a scheduled bank, has to furnish a return to the Reserve Bank under Section 18(1) of the BR Act relating to cash reserve. The return has to be submitted before the twentieth day of every month showing the amounts held on the alternate Fridays during a month along with the particulars of demand and time liabilities in the form stipulated in the Rule 13A of the BR (Companies) Rules. vii. Return by Scheduled Banks: Under Section 42 of the RBI Act, scheduled banks have to submit returns to the Reserve Bank of their demand and time liabilities as specified in the sub-Section (2) thereof. 4.5 PRESERVATION OF RECORDS AND RETURN OF PAID INSTRUMENTS i. Preservation of Records: The Central Government is empowered under Section 45 Y of the Banking Regulation Act to make rules specifying the periods of preservation of books, accounts and other documents by banks and the periods of preservation of different instruments paid by banks. Accordingly, the Government has notified the Banking Companies (Preservation of Records) Rules, 1985 and the Cooperative Banks (Period of Preservation of Records) Rules, 1985. These rules specify the period of preservation of different types of ledgers and registers, and records other than ledgers and registers. The rules further provide that, notwithstanding this, the Reserve Bank may, having regard to the factors specified in Section 35A(1) of the BR Act, direct any bank by an order in writing for preserving any books, accounts or registers for a longer period than the period specified under the rules. ii. Return of Paid Instruments: Under Section 45Z of the Banking Regulation Act, a bank is authorised to return paid instruments to their customers even before the end of the period of preservation specified under the Act. However, in that case, the bank shall not return the instrument without making and keeping in its possession a true copy of all relevant parts of the instruments by a mechanical or another process ensuring accuracy of the copy. Banks are not entitled to charge the customers (including Government departments and corporations) for giving such copies of instruments.

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4.6 INSPECTION AND SCRUTINY i. Inspection: The Reserve Bank is empowered under Section 35 of the Banking Regulation Act to conduct an inspection of any banking company. The bank may conduct such an inspection at any time. The Central Government may also direct the Reserve Bank to conduct inspection of any bank and in that case, the Reserve Bank is bound to comply with such a direction. After inspection of the books and accounts of the banking company, a copy of the inspection report has to be given to the banking company. The directors and officers of a banking company are bound to produce for inspection all books, accounts and other documents in their custody. The inspecting team may also require the bank to furnish any statements or information relating to the affairs of the banking company within the time specified by them. The inspecting officer is authorised to examine any director or officer of a banking company on oath. ii. Powers of the Government: A copy of the report of inspection has to be sent to the Central Government in all cases where inspections have been conducted as directed by the Central Government. In other cases, it is optional for the Reserve Bank to send copies of inspection to the Government. On consideration of the report, if the Central Government is of the opinion that the affairs of a banking company are being conducted to the detriment of the interests of the depositors, the Government may (a) Prohibit the banking company from receiving fresh deposits. (b) Direct the Reserve Bank to apply for winding up of the banking company under Section 38 of the BR Act. However, before taking such action, the Government has to give an opportunity to the banking company to make a representation in respect of the report. The Central Government is authorised to defer the passing of such an order or to cancel or modify such an order subject to any terms and conditions imposed by it. It is also open to the Central Government to publish an inspection report or a portion thereof after giving the banking company a reasonable notice. iii. Scrutiny: Apart from making regular inspections, Reserve Bank is also empowered to conduct a scrutiny of the affairs and the books and accounts of any banking company under the sub-Section (1 A) of Section 35 of the Banking Regulation Act. One or more officers of the Reserve Bank may conduct such a scrutiny. A copy of the report has to be furnished to the banking company, if it makes a request for the same or if adverse action is contemplated against the banking company, based on the scrutiny. Otherwise, unlike in the case of inspection, it is not mandatory to give a copy of the report to the banking company. The powers of the Reserve Bank to call for books, accounts and documents or statements and information as for examination of any director or officer of the banking company on oath extend to scrutiny as well. 4.7 BOARD FOR FINANCIAL SUPERVISION i. Constitution of the Board: The Board for Financial Supervision (Board) is a committee established under Regulation 4 of the Reserve Bank of India (Board for Financial Supervision) Regulations, 1994. These regulations were framed by the Reserve Bank under Section 58 of the Reserve Bank of India Act, 1934 with the previous sanction cfthe Central Government. The Board has jurisdiction over the banking companies, Nationalised banks, State Bank and its subsidiaries. ii. Composition of the Board: The Board consists of the following members: (a) Governor of the Reserve Bank of India, (S)he is the chairperson of the board. (b) Deputy Governors of the Reserve Bank of India, one of the deputy Governors shall be nominated by the Governor as the full time vice chairman. (c) Four directors from the central board of the Reserve Bank nominated by the Governor as

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members, the Governor has to make the nominations to the board in consultation with the central board of the Reserve Bank (Central Board) for a specified period, iii. Functions and Powers: The board performs the functions and exercises the powers of supervision and inspection under the Reserve Bank of India Act and the Banking Regulation Act, in relation to different sectors of the financial system, including banking companies. The board shall also perform any other function as may be notified by the central board of the Reserve Bank. The board is assisted by the department of supervision in the Reserve Bank and may also draw personnel from outside. The chairman, vice-chairman and members can jointly and severally exercise the powers vested in the board, as may be specified by the central board from time to time. The board can also authorise senior officers of the department of supervision with prior approval of the central board to carry out certain functions. The board has to report to the central board on a half yearly timeline. iv. Meetings of the Board: The board meets at least once in a month. Three members, of whom, one shall be the chairman or the vice chairman shall form a quorum for the meeting. A member who absents himself/herself without leave of the chairman for three consecutive meetings of the board, would cease to hold office. v. Executive Committee: The board has the power to constitute sub-committees. One such subcommittee is the executive committee. The vice chairman of the Board, is the ex-officio chairman of the committee and there shall also be not less than two members of the board in that committee. The committee meets as often as necessary. vi. Advisory Council: Governor may constitute an advisory council to tender advice from time to time to the board. This council will have not less than five members having special knowledge of accountancy, law, economics, banking, finance and management. The Governor presides over the meetings of the council and the vice-chairman and other members are members of the council. 4.8 ACQUISITION OF UNDERTAKINGS The Central Government can acquire the undertakings of banking companies in certain cases as mentioned in Section 36AE of the Banking Regulation Act. 'Undertaking' means the entire organisation (See the judgement of the Supreme Court in R.C. Cooper vs Union of India, AIR 1970 SC 564). Acquisition may be made if on receipt of a report from the Reserve Bank, the Government is satisfied that it is necessary to acquire any undertaking on certain grounds. Before passing the order, the Central Government may make such consultation with the Reserve Bank as it thinks fit. The grounds for acquisition are as under: Banking company has failed on more than one occasion to comply with the Reserve Bank's directions under Section 21 or 35A of the Banking Regulation Act. Banking company is managed in a manner detrimental to the interests of depositors and it is necessary to acquire its undertaking in the interests of depositors or in the interests of banking policy or for better provision of credit generally or to any particular section of the community or any particular area. Before acquiring the assets of a banking company, it has to be given a reasonable opportunity of showing cause against the proposal. i. On acquisition of the undertaking all the assets and liabilities of the acquired bank stand transferred to and vests in the Central Government. It is also open to the Central Government to order the vesting of the undertaking of the acquired bank in a company or corporation instead of vesting in the Government. In that case, the transferee bank takes over all the acquired assets and liabilities of the transferer bank.

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ii. Power to make scheme: The Central Government is empowered under Section 36AF to make a scheme for any acquired bank. Such a scheme is framed in consultation with the Reserve Bank. The scheme may provide for all matters relating to property, assets, liabilities, board of management, service of employees and their terms and conditions, payment of compensation to shareholders of acquired bank and other matters. The Central Government may modify or vary any such scheme after consulting the Reserve Bank. The scheme and any subsequent modification thereof is published in the official gazette and laid down before the Parliament. The provisions of part IIC of the Act providing for acquisition of undertakings of banks by the Government and of any scheme framed there under shall have an overriding effect on other laws. The scheme shall have binding effect on the Government, the acquired bank, members, creditors and depositors of the acquired bank and all other persons having any rights or liabilities in respect of the acquired bank. iii. Compensation to shareholders: The shareholders of an acquired bank have a right to get compensation under Section 36AG of the Banking Regulation Act. The amount thereof will be determined as provided in the fifth schedule to the Act, after consultation with the Reserve Bank. There is also a provision (Section 36AH) for a reference to a tribunal for hearing claims relating to compensation. If the compensation offered by the Government or the transferee bank is not acceptable to any person to whom such compensation is payable, he may request the Central Government to refer the matter to the tribunal, and a reference has to be made to the tribunal, subject to the satisfaction of certain conditions. In the case of acquisition of the undertaking of a foreign bank in India, a reference has to be made to the tribunal, if requested by the foreign bank. 4.9 AMALGAMATION OF BANKS i. Voluntary Amalgamation: A banking company may be amalgamated with another banking company under Section 44A of the Banking Regulation Act. For this purpose, a scheme has to be prepared, containing the terms of such an amalgamation in a draft and placed before the shareholders of the two companies separately. The scheme has to be approved by a resolution passed by majority of members representing two-thirds in value of the shareholders of each company present in person or by proxy. Notice has to be given to every shareholder in this behalf. A share holder who votes against such scheme or dissents to the scheme and gives notice as stipulated, may claim the value of his shares from the banking company, in the event of sanction of the scheme by the Reserve Bank. After the scheme is approved by the requisite majority, the scheme has to be submitted to the Reserve Bank for sanction. On sanction by Reserve Bank, the assets and liabilities of the amalgamated company pass to the banking company, with which it is to be amalgamated. The Reserve Bank may also direct that the amalgamated company will stand dissolved from any specified date and intimate the Registrar of Companies accordingly. The order of sanction of amalgamation by Reserve Bank will be the conclusive evidence of amalgamation. ii. Amalgamation by Government: The Central Government is empowered to order amalgamation of two banking companies under Section 396 of the Companies Act. However, such power has to be exercised only after consultation with the Reserve Bank. iii. Moratorium and Amalgamation: The Reserve Bank is authorised under Section 45 of the Banking Regulation Act to apply to the Central Government for an order of moratorium in respect of any banking company where it appears to it that there is good reason to do so. After considering the application, the Central Government may pass an order of moratorium staying the commencement or continuation of any action or proceedings against the banking company for a fixed period. This may be on such terms and conditions as the Government thinks fit and prefers to impose. The

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period of moratorium is extendable from time to time. However, the total period of moratorium shall not exceed six months. During the period of moratorium, the banking company shall not make any payment to depositors or discharge any liabilities or obligations to any other creditors unless otherwise directed by the Central Government in the order of moratorium or at any time thereafter. iv. Scheme of Amalgamation: (a) During the period of moratorium, Reserve Bank may prepare a scheme either for reconstruction of the banking company, or for amalgamation of the banking company with any other banking institution. Such a scheme may be prepared if the Reserve Bank is satisfied that it is necessary to do so: (i) in the public interest; (ii) in the interests of the depositors; (iii) for securing the proper management of the banking company; (iv) in the interest of the banking system of the country as a whole. (b) The scheme of amalgamation or reconstruction may contain provisions for all or any of the matters specified in the clauses (a) to (I) of the sub-Section (5) of Section 45. These include: (i) constitution, name, registered office, capital assets, powers, rights, duties and obligations of the banking company after reconstruction of the transferee company; (ii) transfer of assets from transferrer bank to transferee bank, and terms and conditions thereof in the case of amalgamation; (iii) change in or appointment of board of directors; (iv) alteration in memorandum and articles; (v) continuation of action by or against the banking company after amalgamation or reconstruction; (vi) reduction of the interest or rights of members, depositors or other creditors considered necessary in public interest or in the interest of members, depositors or creditors or for maintenance of the business of banking company; (vii) payment in cash or otherwise to creditors and other depositors; (viii) allotment of shares of the transferrer bank to the shareholders of transferrer bank for shares held by them in the transferrer bank; (ix) continuance of service of employees after reconstruction or amalgamation. The scheme has to provide for the continuance of all workmen and other staff (excepting those specifically excluded by name in terms of the scheme) on the same terms and conditions of service as before. The scheme should also provide that within three years, these employees have to be given the same pay and terms and conditions as are applicable to the other employees of the transferee bank of corresponding rank or status of equivalent qualifications and experience. See the judgements of the Supreme Court in State Bank of Travancore vs Elias (1970)2 SCC 761 and also K.I. Shepherd and others vs Union of India and others AIR 1988 SC 686. In the case of any dispute regarding rank, status, etc., of employees in this regard, the decision of the Reserve Bank shall be final. Scheme has also to provide for payment of terminal benefits to workers who have opted not to continue in service on amalgamation or reconstruction and other employees, who have been specifically mentioned in the scheme for exclusion from service. The scheme may contain other terms and conditions of amalgamation or reconstruction and also incidental matters. (c) Sanction of Scheme by Government: A copy of the draft of the scheme prepared by the Reserve Bank has to be sent to the Government and also to the banking company, transferee

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bank and any other banking company concerned in the amalgamation, for their suggestions and objections, if any. The Reserve Bank may specify the period for receipt of such suggestions and objections. In the light of any suggestions and objections received, modification may be made in the draft, as considered necessary by the Reserve Bank. Thereafter, the scheme, may be placed before the Central Government for sanction. The Government may sanction the scheme with such modifications as it may consider necessary. The scheme shall come into force from the date of the sanction. (d) Effect of Sanction: On the Central Government sanctioning the scheme, it becomes binding on the banking company, transferee bank and the members, depositors and other creditors, employees and any person having any right or liability in relation to the banking company. The sanction by the Central Government is the conclusive evidence that the amalgamation or reconstruction has been done in compliance with the provisions of Section 45 of the Act. The assets and properties of the banking company shall stand transferred to and vest in, and liabilities shall stand transferred and become liabilities of the transferee bank as provided in the scheme. If any difficulty arises in implementing the scheme, the Central Government may pass the necessary orders for removing the difficulties. A copy of the scheme and any orders passed for removing difficulties has to be placed before the Parliament. Consequent to amalgamation, the transferee bank has to carry on the business of the banking company acquired by the transferee bank, according to the law governing the transferee bank. The Central Government may give necessary exemptions and modifications in this behalf on the recommendation of the Reserve Bank. However, such modification or exemption should not last for more than seven years. A single scheme of amalgamation can be made in respect of several banking companies under moratorium. The provision of Section 45 and the scheme sanctioned there under shall have overriding effect on other laws, agreements, awards or instruments. 4.10 WINDING UP OF BANKS i. Suspension of Business and Winding Up: A banking company which is temporarily unable to meet its obligations may apply to the High Court under Section 37 of the Banking Regulation Act for staying the commencement or continuance of any proceedings against it. Such stay will be for a fixed period and subject to any terms and conditions imposed by the High Court as it may think fit. The total period of such moratorium shall not exceed six months. An application for moratorium shall be supported by a report of the Reserve Bank indicating that the banking company will be able to pay its debts if the application is allowed. The Court, for sufficient reasons, may grant the relief, even if the application is not supported by the Reserve Bank's report. In that case, a report will be called for and the order, may be modified or rescinded based on the report. On passing of moratorium order the court may appoint a special officer to take custody and control of the assets, books, etc., of the banking company in the interests of the depositors. If the Reserve Bank is satisfied that the affairs of a banking company under moratorium as above, are being conducted in a manner detrimental to the interests of the depositors, it may apply to the High Court for winding up of the company. Thereafter, the High Court shall not extend the period of moratorium. ii. Winding Up by High Court: (a) The High Court shall order the winding up of a banking company in the circumstances mentioned in Section 38 of the Banking Regulation Act. They are:

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(i) The banking company is unable to pay its debts; (ii) An application for winding up has been made by the Reserve Bank under Section 37 or Section 38 of the Act. (b) The Reserve Bank is bound to make an application for winding up under Section 38, if directed by the Central Government under Section 35(4) of the Banking Regulation Act. The Central Government may issue such direction under Section 35(4) when, on consideration of the report of inspection or scrutiny made by the Reserve Bank at the direction of the Central Government, it is of opinion that the affairs of the bank are being conducted to the detriment of the interests of the depositors. However, before giving such direction, the banking company has to be given an opportunity to make a representation in connection with the report of inspection or scrutiny. (c) It is open to the Reserve Bank to apply for winding up of a banking company in certain other cases as follows: (i) failure to comply with the requirements of Section 11 regarding minimum paid-up capital and reserves; (ii) bank being not entitled to carry on banking business in India under Section 22 of the BR Act by reason of rejection or cancellation of licence; (iii) prohibition to accept fresh deposits under Section 35(4) of the BR Act or Section 42 (3A)(b) of the Reserve Bank of India Act; (iv) failure to comply with the requirements of the BR Act other than Section 11 and continuance of such failure or contravention beyond the period or periods specified by the Reserve Bank in this behalf and after notice in writing of such failure or contravention. In addition to the above, the Reserve Bank may apply for winding up of a banking company if it is of the opinion that: (a) a compromise or arrangement sanctioned for a banking company cannot be worked satisfactorily with or without modification; or (b) the returns, statements and information given by the bank under the Act show that it cannot pay its debts; or (c) the continuance of the banking company is prejudicial to the interests of the depositors. A banking company shall be deemed to be unable to pay its debts if it has refused to meet any lawful demand made at any of its offices or branches within the stipulated time and the Reserve Bank certifies in writing that the banking company is unable to pay its debts. If the demand is made at a place where the Reserve Bank has an office, branch or agency, the time limit is two days and in other cases five days. When the Reserve Bank makes an application for winding up, the court is bound to allow the application. As held by the Supreme Court in the Palai Central Bank case (AIR 1962 SC 1371 at 1383), as between the Court and the Reserve Bank, the momentous decision to wind up in the interests of depositors may reasonably be left to the Reserve Bank. iii. Official Liquidator: Section 38A of the BR Act provides for a liquidator to be appointed by the Central Government, attached to respective High Court, for conducting the winding up proceedings relating to banking companies. Such a liquidator need not be appointed where enough cases of winding up of banking companies are not available in any High Court. iv. Reserve Bank as Liquidator: Although there is a provision for an official liquidator as above, if the Reserve Bank applies to the Court under Section 39 of the Act, the Reserve Bank, State Bank or any other bank notified by the Central Government in this behalf or any individual stated in the application may be appointed as the official liquidator. The remuneration of the liquidator and other costs and expenditure of winding up shall be borne by the banking company. All provisions of the Companies

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Act, which are not inconsistent with the Banking Regulation Act shall be applicable to such a liquidator. The liquidator has to make a preliminary report to the High Court within two months of the winding up order on the availability of assets for making preferential payments under Section 530 of the Companies Act and for discharging liabilities to depositors and other creditors. Within fifteen days of the winding up order, the liquidator has to give notice calling for claims for preferential payment and other claims from every secured and unsecured creditor. Under Section 43 of the Act, the depositors need not make claims. The claims of every depositor of a banking company is deemed to have filed for the amount as shown in the books of the banking company standing to his credit. v. Preferential Payment: In the winding up proceedings, the liquidator of a banking company has to make certain preferential payments under Section 43 A of the Banking Regulation Act. Accordingly, the preferential payments referred to in Section 530 of the Companies Act, in respect of which, claims have been made within one month of service of notice, get the first preference. After that, depositors in savings bank account up to Rs. 250 and then other depositors up to Rs. 250 get priority over all other creditors. After making these payments, the balance available will be utilised for payment to general creditors and then for payment of further amounts due to the depositors. The provision for preferential payment by liquidator will not apply to depositors covered by the DICGC Act. vi. Voluntary Winding Up: Apart from the provision for compulsory winding up as above, Section 44 provides for voluntary winding up by banking companies. However, no such winding up will be permissible unless the Reserve Bank certifies that the bank will not be able to pay in full all its debts as they accrue. It is open to the High Court to order during voluntary winding up of a banking company that it shall continue, subject to the supervision of the Court. The High Court may also order winding up by Court either on its own motion or on the application by the Reserve Bank, if during voluntary winding up it becomes clear that the company is not able to meet its debts as they accrue or if continuing voluntary winding up or winding up under supervision of the court may be detrimental to the interests of depositors. 4.11 PENALTIES FOR OFFENCES A banking company has to abide by the requirements of the Reserve Bank of India Act and the Banking Regulation Act and the subordinate legislation there under, namely statutory rules, directions, etc., issued under these Acts. Failure to do so invites penalties. i. Penalties Under the RBI Act: Chapter V of the Reserve Bank of India Act deals with penalty for violation of the Act. Banking companies have to make applications and furnish returns, statements, etc., under different provision of the Act, regulations, orders, directions, etc. While doing so, the making of any statement which is false in any particular material, knowing it to be false or wilfully omitting to make any material statement, is punishable with imprisonment up to a period of three years and also a fine. Failure to produce any books, accounts or other documents or statements, or information which a person is duty bound to make under the Act, or any order, regulation or direction is punishable with fine up to Rs. 2,000 for each offence. For continuing offences, there is a provision for fine of Rs. 100 for each day when the offence continues. There are penalties under the sub-Section (3) to (5B) of Section 58B for contravention of specific provisions of the Act or orders, direction, etc., made there under. Apart from this, for contravention of any other provisions or not complying with any requirements under the Act, order, regulation or direction, the guilty shall be punishable with fine up to Rs. 2,000, and further Rs. 100 every day for continuing the offence. In the case of offences by companies, every person who was in charge of or responsible for conduct of the company's business shall be deemed guilty of the contravention or default unless he proves that the offence was committed without his knowledge or that he had exercised due diligence to prevent the

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offence. The court will not take cognizance of an offence under the Act (except offences relating to acceptance of deposits under the Chapter IIIC) otherwise than on a complaint by an officer of the bank generally or specially authorised in writing in this behalf by the Bank. A metropolitan magistrate or magistrate of the first class or court superior thereto shall try the offences. ii. Penalties under the BR Act: The provisions of the Banking Regulation Act, relating to penalties, are provided in Section 46 thereof. Accordingly, making wilfully any false statement in any return, balance sheet or other document or information given under the Act is punishable. Similarly, wilful omission to make any material statement is also punishable. In both cases, punishment is up to three years imprisonment and fine. Failure to produce any book, account or other document or to furnish a statement or information that is obligatory to be produced under Section 35(2), during inspection or scrutiny is punishable with fine up to Rs. 2,000. Similarly, failure to answer any question relating to the business of the banking company during inspection is also punishable. Continuance of the offence is punishable with fine of Rs. 100 for every day during which the offence continues. Acceptance of deposits against an order prohibiting acceptance of deposits under Section 35(4) is punishable with a fine up to twice the amount of deposits accepted. Every director or officer is punishable in this case, unless he proves that the contravention was without his knowledge or that he had exercised all diligence to prevent it. Any contravention of other provisions of the Act, or any rule, order or direction made or condition imposed, is punishable with fine up to Rs. 50,000 or twice the amount involved in the contravention. In the case of continuing offences, a fine up to Rs. 2,500 for each day may be imposed. In the case of offences by companies, every person who was in charge of the company at the time of commission of the offence is punishable unless he proves that the offence was committed without his knowledge or in spite of his exercising due diligence to prevent it. Under Section 47, the offences are cognizable only by a metropolitan magistrate, judicial first class or a court superior thereto on a complaint by an officer of the Reserve Bank and in some cases by the National Bank. Under Section 47A, the Reserve Bank is empowered to impose a penalty for default or contravention. If the Reserve Bank exercises that power, no complaint shall be filed in a Court in respect of the same contravention or default.

4.12 LET US SUM UP


Every banking company has to prepare its balance sheet and profit and loss account annually as at the end of the calendar year or at the end of twelve months as on a date notified by the Central Government. The accounts have to be audited by auditors duly qualified to be auditors of companies. Three copies of the balance sheet, profit and loss account and the auditor's report have to be submitted as returns to the Reserve Bank and to the Registrar of Companies. Banking companies have also to furnish other returns like return on maintenance of cash reserve, maintenance of liquid assets, etc. The Reserve Bank is authorised to inspect or conduct, scrutiny of banking companies, their books and accounts. The Board for Financial Supervision set up by the Reserve Bank by statutory regulations framed under the Reserve Bank of India Act supervises the affairs of banking companies. The Government may acquire the undertakings of banking companies in certain circumstances based on a report from the Reserve Bank. The Central Government may also order moratorium on banking companies on the application of the Reserve Bank. During moratorium, the Reserve Bank may prepare a scheme for amalgamation, which may be sanctioned by the Central Government. Such an amalgamation scheme will have overriding effect on any laws, agreements, etc. The Reserve Bank may also apply to the High Court for winding up of a banking company when it is not able to pay its debts and also in certain other circumstances. The Reserve Bank of India Act and the Banking Regulation Act impose certain penalties for contravention or default committed by banking companies or other persons.

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4.13 KEYWORDS Amalgamation; Board for Financial Supervision; Continuing Offence; Inspection; Moratorium; Scrutiny; Winding up. 4.14 CHECK YOUR PROGRESS 1. Fill in the gaps choosing answers from the brackets. (i) A banking company has to prepare profit and loss accounts and balance sheet as at the _________ or at the expiration of twelve months ending with such date as notified by the Central Government, (end of calendar year, end of March, end of June) (ii) The balance sheet and profit and loss account shall be audited by a person duly qualified to be_________ . (a certified financial analyst, auditor of companies, auditor of cooperative societies) (iii) Three copies of the balance sheet and accounts along with the auditor's report of a banking company sent to the Reserve Bank under Section 31 of the BR Act, have also to be sent to _________ . (the Central Government, Registrar of Companies, Company Law Board) (iv) Reserve Bank is empowered to conduct _________ of a banking company under Section 35(1) of the BR Act. (inspection, special audit, audit) (v) A copy of the inspection report, relating to a banking company, _________ to that banking company, (should be given, need not be given, should be given at request) (vi) The board for Financial Supervision is constituted by _________ . (the Government, Reserve Bank, Indian Banks Association) (vii) Under Section 35(4) of the BR Act, Central Government can prohibit a banking company from accepting fresh deposits if the business of the banking company is conducted _________ . (not profitably, not in compliance with the Act, to the detriment of interest of its depositors) 2. Say whether true or false: (i) Foreign banks have to prepare accounts and balance sheet in respect of all business transacted by them in India, (ii) Reserve Bank requires the permission of the Central Government for ordering special audit of a banking company, (iii) Three copies of the balance sheet, profit and loss account, and auditor's report of a banking company have to be submitted to the Reserve Bank as returns, (iv) A copy of scrutiny report has to be given to the banking company whether requested by it or not. (v) The Board for Financial Supervision is set up under the regulations framed by the Reserve Bank under Section 58 of the Banking Regulation Act. (vi) The Central Government is not empowered to order Reserve Bank for inspection of a banking company, (vii) Central Government has to give notice to the banking company before publishing its inspection report or any part of it. 3. Fill in the gaps choosing answers from the brackets. (i) The undertaking of a banking company may be acquired by the Central Government if it is satisfied on a report from the Reserve Bank that the banking company has failed on more than one occasion to comply with the _________ . (directions of the Government, directions under Sections 21 and 35A of BR Act, provisions of the Companies Act) (ii) The Central Government may make a _________ after consultation with the Reserve Bank

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for carrying out the purposes of part IIC of the BR Act, in relation to an acquired bank. (scheme, plan, memorandum) _________ may apply to the High Court for winding up of a banking company under
(iii)

Section 38 of the BR Act. (Registrar of Companies, Reserve Bank, Central Government) (iv) The High Court shall order winding up of a banking company if the banking company is unable to _________ (pay its debts, file returns in time, eliminate non-performing assets) (v) In a winding up proceeding the depositors shall _________ for the amounts shown in the books of the bank standing to their credit, (be deemed to have filed claim, have to file claim, have no claim) (vi) The _________ may apply to the Central Government for an order of moratorium in respect of a banking company, (banking company, Registrar of Companies, Reserve Bank) (vii) The provisions of a scheme of amalgamation sanctioned by the Central Government under Section 45 of the BR Act will _________ the provisions of other laws, (not affect, have overriding effect on, will be subject to). 4. Say whether true or false (i) Central Government can acquire the undertaking of a banking company under Section 36AE of the Banking Regulation Act in the interest of banking policy without any report from the Reserve Bank on the affairs of the banking company, (ii) The undertaking of an acquired bank may vest in the Central Government or in any company or corporation as directed by the Central Government, (iii) On the application of Reserve Bank, the High Court may stay the commencement or continuance of proceedings against any banking company for any period, (iv) The Reserve Bank or State Bank or another person as specified by the Reserve Bank in its application before the High Court may be appointed as liquidator of a banking company, (v) On winding up of a banking company, all the depositors as a class get the first preference for payment, (vi) The Reserve Bank may prepare a scheme for reconstruction or amalgamation of a banking company under moratorium under Section 45 of the BR Act. (vii) Making any false statement in a return or other document submitted under the provisions of the BR Act is punishable with imprisonment and fine also.

4.15 ANSWERS TO 'CHECK YOUR PROGRESS'


1. (i) end of calendar year (ii) auditor of companies (iii) Registrar of Companies (iv) Inspection (v) should be given (vi) Reserve Bank (vii) to the detriment of interest of the depositors 2. (i) True; (ii) False; (iii) True; (iv) False; (v) False; (vi) False; (vii) True 3. (i) directions under Sections 21 and 35A of the BR Act (ii) Scheme (iii) Reserve Bank (iv) Pay its debts (v) be deemed to have filed claim (vi) Reserve Bank (vii) have overriding effect on 4. (i) False; (ii) True; (iii) False; (iv) True; (v) False; (vi) True; (vii) True 4.16 TERMINAL QUESTIONS Fill in the blanks choosing answers from brackets 1 A banking mmpany has tn prepare its annual accounts in the forms _. (decided by the

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board of the banking company and approved in general meeting; specified by the Department of Company Affairs; in the form set out in the Third Schedule to the BR Act or as near thereto as circumstances admit) 2. A banking company has to submit three copies of its accounts and balance sheet together with auditors' report _________ . (to the Reserve Bank and also to the Registrar of Companies; only to the Reserve Bank; only to the Registrar of Companies). 3. The expenses incidental to a special audit under Section 3O(1B) of the BR Act shall be borne by _________ . (the Reserve Bank of India; the banking company; the Government of India) 4. The balance sheet and profit and loss account of a banking company, have to be audited, as stipulated under Section 30 of the Banking Regulation Act, by _________ . (a person duly qualified under any law for the time being in force to be an auditor of companies; Reserve Bank; Registrar of Companies). 5. Reserve Bank shall cause an inspection of a banking company, by one or more of its officers __________ . (if so required by shareholders representing at least ten per cent of the shares of the bank; if so required by the Central Government; if so required by the Registrar of Companies.) Choose the correct statements from the following: 6. (i) Reserve Bank may publish, if they consider in the public interest to do so, any information obtained by them under the BR Act in such consolidated form as it thinks fit. (ii) Reserve Bank may not publish any information in whatever form collected from a banking company in exercise of the powers under the BR Act. (iii) Reserve Bank may not publish information obtained during inspection of a banking company even in a consolidated form. 7. (i) Board of Financial Supervision is a body established by the Government under the provisions of the BR Act. (ii) Board of Financial Supervision is a body established under the Reserve Bank of India Act for the supervision of banks and financial companies, (iii) Board of Financial Supervision is a body established by the Government for supervising the securities market. 8. (i) The Reserve Bank may order moratorium in respect of a banking company when it is satisfied that there is good reason to do so. (ii) The Central Government may order moratorium on its own motion when it is satisfied that the financial position of the banking company is not satisfactory, (iii) The Central Government may after considering the application made by the Reserve Bank for an order of moratorium in respect of a banking company, order moratorium staying the commencement and continuance of all actions and proceedings against the banking company. 9. (i) The High Court shall under Section 38 of the BR Act order winding up of a banking company if it is unable to pay its debts, (ii) The High Court shall under Section 38 of the BR Act order winding up of a banking company if the Government makes an application therefore under Section 37 of the BR Act. (iii) The High Court shall under Section 38 of the BR Act order winding up of a banking company if the continuance of the banking company is prejudicial to the interests of its shareholders and the Reserve Bank applies to the court on that ground. 10. (i) No provisions of the Companies Act apply to the liquidator in the winding up of a banking company, (ii) All provisions of the Companies Act apply to the liquidator in the winding up of a banking company, (iii) All provisions of the Companies Act relating to liquidator, insofar as they are consistent with BR Act, apply to a liquidator of a banking company.

UNIT

5
STRUCTURE
5.0 Objectives

PUBLIC SECTOR BANKS AND CO-OPERATIVE BANKS

5.1 Introduction 5.2 State Bank and Its Subsidiaries 5.3 Regional Rural Banks 5.4 Nationalised Banks 5.5 Application of Banking Regulation Act to Public Sector Banks 5.6 Disinvestment of Shares by Government 5.7 Co-operative Banks 5.8 Let Us Sum Up 5.9 Keywords 5.10 Check Your Progress 5.11 Answers to 'Check Your Progress' 5.12 Terminal Questions

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5.0 OBJECTIVES
The objectives of this unit are to understand: the special laws governing the public sector banks, namely, State Bank and its subsidiaries, Nationalised banks, and regional rural banks; the applicability of Banking Regulation Act and the Reserve Bank of India Act to these banks; laws governing the co-operative banks, in particular applicability of Banking Regulation Act to co operative banks; extent of legal control of state governments over co-operative banks.

5.1 INTRODUCTION
i. The public sector banks, namely, the State Bank of India and its subsidiaries, Nationalised banks and regional rural banks are established by special statutes. These statutes and the rules, regulations and/or schemes framed thereunder provide the powers, functions and management of these banks. The Banking Regulation Act is applicable to these banks only in a limited way, as some of the provisions are not applicable. ii. In the case of co-operative banks, these banks being created and governed by the laws relating to co-operative societies, if they operate only in one state, the State Act and if they operate in different states, the Central Act applies. The Banking Regulation Act is applicable to co-operative banks in a modified manner as provided in Section 56 of the Act. iii. In this unit, we study the special laws applicable to the public sector banks and co-operative banks as also the Banking Regulation Act and Reserve Bank of India Act as they apply to these banks.

5.2 STATE BANK AND ITS SUBSIDIARIES


i. Establishment of State Bank: State Bank of India was established under Section 3 of the State Bank of India Act, 1955 for taking over the undertaking of the Imperial Bank and to carry on the business of banking and other business in accordance with that Act. It is a body corporate, with perpetual succession and common seal and shall sue and be sued in its name. The majority of ; shares are held by the GOI. Further, no shareholder other than the GOI can exercise voting right above ten per cent, unless otherwise specified by the Central Government in consultation with the Reserve Bank. Now the complete holding of RBI is acquired by the central government. ii. Management: The State Bank has its central office in Mumbai and local head offices at Mumbai, Kolkata, Chennai and other places as decided by its Central Board in consultation with the Central Government. The superintendence and direction of the affairs of the bank is vested in the Central Board, which has to function according to the business principles having regard to public interest. The Central Government can give directions to the bank on matters of policy involving public interest in consultation with the Governor of the Reserve Bank and the Chairman of the State Bank. The directions have to be given through the Reserve Bank. The board is empowered to make regulations for carrying out the purposes of the Act in consultation with the Reserve Bank and with the previous sanction of the Central Government. iii. Composition of the Board: The Board shall consist of Chairman, Vice-Chairman, not more than two Managing Directors appointed by the Central Government, presidents of local boards and other directors. There are directors falling in different categories, namely, appointed by the Government to represent workmen and officers, nominated by the Central Government in consultation with the Reserve Bank from among persons with special knowledge of co-operatives and rural

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economy, nominated by Reserve Bank, nominated by Central Government and elected by shareholders other than Reserve Bank. The chairman and managing directors are appointed for a period not exceeding five years and are eligible for reappointment. Their services can be terminated by the Central Government by giving a three month's notice or notice pay in lieu thereof, after consultation with the Reserve Bank. Local boards are set up at each place where there is a local head office to exercise all powers and to perform the functions and duties of the bank delegated under Section 2 IB of the Act. The local board consists of the chairman and other elected and nominated members as specified in Section 21 of the Act. iv. Business of State Bank: The State Bank shall act as an agent of the Reserve Bank at the places where it has a branch and where Reserve Bank has no branch, if so required, by the Reserve Bank, for transacting Government business and other business entrusted to it by the Reserve Bank. The terms and conditions thereof shall be as agreed between the Reserve Bank and the State Bank. If agreement is not reached, the terms shall be decided by the Central Government. The State Bank may transact the work through its subsidiaries or an agent approved by the Reserve Bank. Apart from this, the State Bank may carry on the business of banking as defined in Section 5(b) of the Banking Regulation Act and other business specified in Section 6(1) of that Act. The bank is permitted to acquire business of other banks with the sanction of the Central Government or if so directed by the Central Government in consultation with the Reserve Bank. v. Accounts and Audit: The State Bank has to close its books and balance accounts each year as on 31 March or such other date as may be specified by the Central Government. Within three months of the closing date, it has to furnish to the Central Government and the Reserve Bank its balance sheet and profit and loss account together with auditors' report and a report by the Central Board on the working and activities of the bank. The audit may be conducted by any person duly qualified to be auditors of companies under Section 226 of the Companies Act. No Director, member of local board, local committee or an officer of the State Bank shall be eligible to be the auditor. The appointment of auditors is done by the Reserve Bank in consultation with the Central Government. The auditors' report and report of the Central Board have to be placed before the Parliament. The State Bank has also to transmit to the Central Government and the Reserve Bank within two months of the date of annual closing of accounts, the particulars of its shareholders as on that date. The balance sheet and profit and loss account, auditor's report and report of the Central Board shall be open for discussion by the shareholders at the annual general meeting. The annual general meeting has to be held within six weeks of the date of sending the balance sheet, etc., to the Central Government and the Reserve Bank. vi. Subsidiary Banks: The subsidiary banks of the State Bank of India were established by different special statutes. The State Bank of Hyderabad was constituted as Hyderabad State Bank under the Hyderabad State Bank Act and later renamed as State Bank of Hyderabad under the State Bank of Hyderabad Act, 1956. The State Bank of Saurashtra was constituted under the Saurashtra State Banks (Amalgamation) Ordinance, 1950. The other banks were established under Section 3 of the State Bank of India (Subsidiary Banks) Act, 1959. Every subsidiary bank is a body corporate with perpetual succession and common seal and shall sue and be sued in its own name. The majority of the issued share capital of the subsidiary banks is held by the State Bank. The shares of the subsidiary banks are freely transferable as provided in Section 18 of the Act. However, the State Bank is not entitled to transfer the shares if such transfer would result in reducing its shareholding to less than fifty per cent of the issued capital.
vii. Management of Suhsidiarv Ranlrs- Tht* opnprai cimonnton/fon^ ^~ A ~
,,-,+ ,-v-f-* f*4?nZ-~r* rt-C ~ . ___1-. 1 .31 _____

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bank vests in its board of directors and the board may exercise all the powers and carry out all functions with the assistance of the managing director, subject to the directions and instructions given by the State Bank from time to time. The board consists of the chairman (State Bank Chairman, ex-officio), managing director and other directors. The directors are nominated or appointed by the Central Government, Reserve Bank or the State Bank except for the directors to be elected by the shareholders other than the State Bank. The State Bank appoints the managing director after consulting the board of the subsidiary bank and with the approval of the Reserve Bank. The day-to-day administration vests in the managing director. The State Bank may, with the approval of the Reserve Bank and after giving opportunity to show cause, remove the managing director from office. The Act provides for an executive committee, consisting of directors, which may deal with any matter within the competence of the board subject to any regulations made under the Act. viii. Business of Subsidiary Banks: A subsidiary bank has to act as agent of the State Bank under Section 36 of the (SBI Subsidiary Banks) Act, at any place as required by the State Bank to receive, collect and remit money, bullion and Government securities on behalf of the Government of India, and undertake other business which the Reserve Bank may entrust the State Bank from time to time, with the approval of the Reserve Bank. Under Section 36A, a subsidiary bank has also act as an agent of the Reserve Bank if required by it, to undertake Government work or other work entrusted by the Reserve Bank. The terms and conditions of agency with the Reserve Bank will be as agreed between the Reserve Bank and the subsidiary bank and if no agreement is reached or dispute arises, the decision of the Central Government shall be final. A subsidiary bank shall also transact the business of banking as defined in Section 5(b) of the Banking Regulation Act and any other business specified in Section 6(1) of that Act. The Central Government may after consultation with the State Bank and Reserve Bank, by order in writing authorise a subsidiary bank to undertake other form of business or prohibit it from carrying on any business, which is otherwise lawful for it to engage in. It is open to a subsidiary bank to acquire the business of other banks with the approval of State Bank. The Reserve Bank may direct the bank in consultation with State Bank to acquire the business of any bank. ix. Accounts and Audit: Subsidiary banks have to close and balance their accounts annually as on 31 March or such other date as may be specified by the Central Government by notification in the official gazette. After providing for bad and doubtful debts and other matters specified in Section 40 of the SBI (sub-Banks) Act, a subsidiary bank may declare a dividend out of its profits. The audit of accounts has to be done by a qualified auditor of companies as specified under Section 226 of the companies Act who shall be appointed by the State Bank in consultation with the Reserve Bank. The balance sheet and profit and loss account together with auditors' report and report of the board on the working and activities of the bank have to be submitted as returns to the State Bank, Reserve Bank and the Central Government within three months of the date of closing accounts. The Reserve Bank may extend the period by further three months in consultation with the State Bank. A general meeting of shareholders shall be held annually as required under Section 44 of the Act within six weeks of sending the accounts, etc., to the State Bank and others. The shareholders are entitled to discuss the balance sheet, profit and loss account, auditor's report and the board's report at such meeting. The State Bank is empowered under Section 47 to inspect the subsidiary banks.

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x. Rules and Regulations: The Central Government is empowered to make rules under Section 62 of the Act for giving effect to the purposes of the Act. The State Bank is also empowered to make regulations under Section 63 with the approval of the Reserve Bank for giving effect to the purposes of the Act.

5.3 REGIONAL RURAL BANKS


The Regional Rural Banks (RRBs) are public sector institutions, regionally based, rural oriented and engaged in commercial banking. They were first set up in 1975 under the Regional Rural Banks Ordinance, 1975. The ordinance was later replaced by the Regional Rural Banks Act, 1976. The formation of these banks was the result of the growing realisation that the ethos and attitude of the existing public sector banks were not fully conducive to meet the credit needs of the rural people. As stated in the preamble to the Act, the object of setting up regional rural banks is to develop rural economy by providing credit and other facilities for the purpose of development of agriculture, trade, commerce, industry and other productive activities in rural areas, particularly to small and marginal farmers, agricultural labourers, artisans and small entrepreneurs. i. Establishment of RRBs: Section 3 of the Act authorises the Central Government to establish regional rural banks by notification in the official gazette at the request of a sponsor bank to operate within specified local limits. 'Sponsor Bank' is a bank by which a regional rural bank is sponsored and it holds 35 per cent of the issued capital of the RRB, while the Central Government holds 50 per cent and the State Government holds the remaining fifteen per cent of the issued capital. Every RRB is a body corporate with perpetual succession and common seal with power to acquire, hold and dispose of property and to sue and be sued in its name. Generally, a regional rural bank is allotted a compact area of operation comprising a few districts with homogeneous agro-climatic conditions and rural clientele: These banks may accept all types of deposits from the public and engage in the business of 'banking' as defined in Section 5(b) of the Banking Regulation Act. ii. Management of the Affairs of an RRB: The management of RRB vests in the board of directors. The board has to function on business principles with due regard to public interest. The board is empowered to make regulations for giving effect to the provisions of the Act in consultation with the sponsor bank and with previous approval of the Central Government. The Central Government is empowered to give directions to RRBs on matters of policy involving public interest. The board consists of a chairman appointed by the sponsor bank from among its officers in consultation with the National Bank, or otherwise in consultation with the Central Government. The chairman holds office on whole-time basis and is removable by the sponsor bank, where the chairman is an officer of the sponsor bank, in consultation with the National Bank and in other cases in consultation with the Central Government. A person who is adjudged insolvent or is convicted of an offence involving moral turpitude is disqualified to be a director and has to vacate office. Absence from three meetings consecutively without leave of the board also results in vacation of office. iii. Business of Regional Rural Banks: Regional rural banks may transact the business of banking as defined in Section 5(b) of the Banking Regulation Act and any other business permissible for a bank to undertake under Section 6(1) of that Act. However, the main thrust of the business would be granting of loans and advances to small and marginal farmers, agricultural labourers, agricultural marketing societies, farmers' service societies, artisans, small entrepreneurs, etc., within the notified area of operation.

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other date as the Central Government may specify. The auditors have to be appointed with the approval of the Central Government. A person qualified to act as an auditor of companies under Section 226 of the Companies Act is qualified to be an auditor of a regional rural bank. The auditor's report and report on the working of the bank has to be laid before the Parliament. The sponsor bank is empowered to monitor the progress of the RRBs by inspection, internal audit and scrutiny and suggest corrective measures. v. Amalgamation: Two or more RRBs may be amalgamated by the Central Government by notification in the official gazette. Such notification shall provide for all terms and conditions of amalgamation including continuation of service of employees and shall be binding on the banks and all other parties concerned. 5.4 NATIONALISED BANKS The Bank Nationalisation Acts [Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 and Banking Companies (Acquisition and Transfer of Undertakings) Act, isfeO] transferred the undertakings of then existing private banks to the corresponding new banks established under these Acts. These corresponding new banks, are popularly known as Nationalised banks. Originally, the entire paid-up capital (equity shares), of the Nationalised banks were held by the Central Government. Some of these banks have recently made public issues of shares, but the Central Government still holds the majority of shares in all these banks. The Banking Companies (Acquisition and Transfer of Undertakings) and Financial Institutions Laws (Amendment) Act, 2006 enables these banks to raise capital by way of public issue or preferential allotment or private placement of equity shares or preference shares. The Central Government shall, however, at all times hold not less than fifty one per cent of the equity of these banks. The shares other than those held by the Central Government are freely transferable. The guidelines for issue of preference shares (including those on the classes of preference shares) shall be issued by the Reserve Bank. No equity shareholder other than the Central Government can exercise voting rights in excess of one per cent of the total voting rights of all the shareholders. In the case of the preference shareholders, they shall have a right to vote in respect of those shares only on resolutions which directly affect the rights attached to the preference shares. Further, no preference shareholder shall be entitled to exercise voting rights in respect of the preference shares held by him in excess of one per cent of the total voting rights of all the shareholders holding preference share capital only. Every Nationalised bank is a body corporate having perpetual succession and common seal and power to acquire, hold and dispose of property and enter into contracts and to sue and be sued in its name. These banks may carry on the business of banking as defined in Section 5(b) of the Banking Regulation Act and other forms of business specified in Section 6(1) of that Act. The Nationalised banks have also to act as agents of the Reserve Bank, if so required by the Reserve Bank to undertake the banking business of Central Government and any other business entrusted by the Reserve Bank. a. Management: The general superintendence, direction and management of the affairs of a Nationalised bank vests in the board of directors. The board can exercise all the powers and functions of the bank and shall be entitled to discuss, approve and adopt the annual accounts. The Central Government is empowered to issue directions to the bank in the discharge of its functions on matters of policy involving public interest after consultation with the Governor of the Reserve Bank, to supersede the board on the recommendation of the Reserve Bank and also to appoint an administrator. Further, under Section 9 of both the Nationalisation Acts, the Central Government has the power to make a scheme for carrying out the provisions of the Act after consultation with the Reserve Bank. The

71
Government may also amend or vary the scheme in consultation with the Reserve Bank. Such a scheme has to be laid before Parliament and is binding on the bank and any person having any right or liability in relation to the bank. b. Directors: The directors of Nationalised banks are nominated by the Central Government or elected from the shareholders. The nomination of directors is as under: (i) not more than four whole-time directors (as against two earlier); (ii) one director who is an official of the Central Government to be nominated by the Central Government; (iii) one director, possessing necessary expertise and 'experience in matters relating to regulation or supervision of commercial banks, to be nominated by the Central Government on the recommendation of the Reserve Bank; (iv) a director representing workmen employees of the bank; (v) a director representing officers of the bank; (vi) one chartered accountant with not less than fifteen years experience nominated in consultation with Reserve Bank; (vii) not more than six directors to be nominated by Central Government. The other shareholders can elect up to a maximum of three directors to the board. No person shall be eligible to be elected as director, unless he is a person having fit and proper status based upon track record, integrity and such other criteria as the Reserve Bank may notify from time to time in this regard. The Reserve Bank may also specify in the notification, the authority to determine the fit and proper status, the manner of such determination, the procedure to be followed for such determination and such other matters as may be considered necessary or incidental thereto. The directors nominated under Item (vii) and the elected directors should have special knowledge or practical experience of agriculture and rural economy, banking, cooperation, economics, finance, law, small scale industry or other knowledge or experience useful to the bank in the opinion of the Reserve Bank or must represent the interest of depositors or farmers or workers and artisans. An elected director, who in the Reserve Bank's opinion does not qualify the requirements, can be removed by the Reserve Bank after giving an opportunity of being heard. The board can co-opt any other qualified persons in his place who will continue until another director, is duly elected in the next annual general meeting. Apart from the direction and management of affairs of the bank, the board has also the power to frame regulations under Section 19 for giving effect to the provisions of the Act. This has to be done in consultation with the Reserve Bank and with the sanction of the Central Government. c. Additional directors: The Reserve Bank may appoint one or more additional directors on the board of a Nationalised bank, if it is of the opinion that in the interest of banking policy or in the public interest or in the interests of the bank or its depositors, it is necessary to do so. The appointment may be made from time to time, by order in writing, with effect from such date, as may be specified in the order and the additional directors shall hold office during the pleasure of the Reserve Bank and subject thereto, for a period not exceeding three years or such further periods not exceeding three years at a time as the Reserve Bank may specify. They shall not incur any obligation or liability by reason only of being a director or for anything done or omitted to be done in good faith in the execution of the duties of this office or in relation thereto. d. Accounts and Audit: Every Nationalised bank has to close its account as on 31 March or such other date specified by the Central Government by notification in the official gazette as provided in Section 10 of the Act. The auditor shall be a person duly qualified to be an auditor of a company under Section 226 of the Companies Act. The auditor shall make a report to the Central Government

72
upon the balance sheet as stipulated in Section 10 of the Act. The auditor shall send copies of the report to the bank and the Reserve Bank. The bank has to furnish copies of the balance sheet, profit and loss account and auditor's report along with the report of the board of directors on the working and activities of the bank to the Central Government and the Reserve Bank. The auditor's report and report of the board have to be laid before the Parliament. Without prejudice to the above, the Centra] Government is also empowered to appoint auditors as it thinks fit at any time to examine and report on the accounts of a Nationalised bank. A Nationalised bank may pay dividends out of profits after making the necessary provisions under the law or as usually provided by banking companies. An annual general meeting of shareholders has to be held within six weeks of the date of forwarding the balance sheet, etc., to the Central Government. In such meeting, the shareholders will be free to discuss the balance sheet, accounts, auditors' report and report of the board. For the purpose of Income Tax Act, a Nationalised bank is treated as an Indian company. e. Schemes of Management: In exercise of the powers under Section 9 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 and Section 9 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980, the Central Government has framed two schemes, namely: (i) Nationalised Banks (Management and Miscellaneous Provisions) Scheme, 1970. (ii) Nationalised Banks (Management and Miscellaneous Provisions) Scheme, 1980. These schemes provide in detail for constitution of board of directors, appointment of chairman and managing director, term of office of whole-time director including managing director, term of office of other directors, disqualifications of directors and vacation of office, meetings of board and committees of the board (management committee and advisory committee), regional consultative committees, increase in paid-up capital and other miscellaneous matters.

5.5 APPLICATION OF BANKING REGULATION ACT TO PUBLIC SECTOR BANKS


Section 51 of the Banking Regulation Act provides that certain provisions of the Act would apply to State Bank and its subsidiaries, Nationalised banks and Regional Rural Banks as they apply to banking companies. The applicable provisions are Sections 10, 13 to 15, 17, 19 to 21 A, 23 to 28, 29 [excluding the sub-Section (3)], the sub-Sections (IB), (1C) and (2) of Sections 30, 31, 34, 35, 35A, 36 [excluding clause (d) of the sub-Section (1)], 45Y to 45ZF, 46 to 48, 50, 52 and 53. The proviso to Section 51 also gives certain exemptions from the applicable provisions regarding holding of office in approved institutions under Section 10(l)(c), to the chairman and the managing director of State Bank, granting of loan, etc., under Section 20(l)(b)(iii) to all banks and nominee directors in respect of Sections 46 and 47A. The provisions which are not made applicable, are mainly the preliminary provisions up to Section 9, provisions relating to capital (Sections 11 and 12), prohibition of common directors (Section 16), licensing (Section 22) audit except special audit (Section 30), control over management [Part IIA (Sections 36AA to 36AD)], acquisition of undertaking in Part C (Sections 36AE to 36AJ) and winding up in Part III and Part IIIA (Sections 36B to 45X). i. Public Sector Banks as Scheduled Banks: All the public sector banks are scheduled banks under Section 42 of the Reserve Bank of India Act and have to comply with the requirements of maintaining cash reserve as provided therein.

5.6 DISINVESTMENT OF SHARES BY GOVERNMENT


In the context of the Government policy to dilute the holdings in public sector banks, certain amendments

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upon the balance sheet as stipulated in Section 10 of the Act. The auditor shall send copies of the report to the bank and the Reserve Bank. The bank has to furnish copies of the balance sheet, profit and loss account and auditor's report along with the report of the board of directors on the working and activities of the bank to the Central Government and the Reserve Bank. The auditor's report and report of the board have to be laid before the Parliament. Without prejudice to the above, the Central Government is also empowered to appoint auditors as it thinks fit at any time to examine and report on the accounts of a Nationalised bank. A Nationalised bank may pay dividends out of profits after making the necessary provisions under the law or as usually provided by banking companies. An annual general meeting of shareholders has to be held within six weeks of the date of forwarding the balance sheet, etc., to the Central Government. In such meeting, the shareholders will be free to discuss the balance sheet, accounts, auditors' report and report of the board. For the purpose of Income Tax Act, a Nationalised bank is treated as an Indian company. e. Schemes of Management: In exercise of the powers under Section 9 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 and Section 9 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980, the Central Government has framed two schemes, namely: (i) Nationalised Banks (Management and Miscellaneous Provisions) Scheme, 1970. (ii) Nationalised Banks (Management and Miscellaneous Provisions) Scheme, 1980. These schemes provide in detail for constitution of board of directors, appointment of chairman and managing director, term of office of whole-time director including managing director, term of office of other directors, disqualifications of directors and vacation of office, meetings of board and committees of the board (management committee and advisory committee), regional consultative committees, increase in paid-up capital and other miscellaneous matters. 5.5 APPLICATION OF BANKING REGULATION ACT TO PUBLIC SECTOR BANKS Section 51 of the Banking Regulation Act provides that certain provisions of the Act would apply to State Bank and its subsidiaries, Nationalised banks and Regional Rural Banks as they apply to banking companies. The applicable provisions are Sections 10, 13 to 15, 17, 19 to 21 A, 23 to 28, 29 [excluding the sub-Section (3)], the sub-Sections (IB), (1C) and (2) of Sections 30, 31, 34, 35, 35A, 36 [excluding clause (d) of the sub-Section (1)], 45Y to 45ZF, 46 to 48, 50, 52 and 53. The proviso to Section 51 also gives certain exemptions from the applicable provisions regarding holding of office in approved institutions under Section 10(l)(c), to the chairman and the managing director of State Bank, granting of loan, etc., under Section 20(l)(b)(iii) to all banks and nominee directors in respect of Sections 46 and 47A. The provisions which are not made applicable, are mainly the preliminary provisions up to Section 9, provisions relating to capital (Sections 11 and 12), prohibition of common directors (Section 16), licensing (Section 22) audit except special audit (Section 30), control over management [Part IIA (Sections 36AA to 36AD)], acquisition of undertaking in Part C (Sections 36AE to 36AJ) and winding up in Part III and Part IIIA (Sections 36B to 45X). i. Public Sector Banks as Scheduled Banks: All the public sector banks are scheduled banks under Section 42 of the Reserve Bank of India Act and have to comply with the requirements of maintaining cash reserve as provided therein. 5.6 DISINVESTMENT OF SHARES BY GOVERNMENT In the context of the Government policy to dilute the holdings in public sector banks, certain amendments

were made in the statutes governing public sector banks. The State Bank of India Act, was amended by the State Bank of India (Amendment) Act, 1993. Section 4 was modified to divide capital into shares of Rs. 10 each instead of Rs. 100. The restriction on voting rights (which existed under Section 11, being up to two hundred shares only) was modified as up to ten per cent of the issued capital and restriction on dividends was deleted. The Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 (and also the 1980 Act) were modified by Amendment Acts of 1994 and 1995, for facilitating public holding of shares. Section 3 was amended to provide for an authorised capital of Rs. 1,500 crore, divided into shares of Rs. 10 each, to increase or reduce the authorised capital between Rs. 1,500 crore and Rs. 3,000 crore, for transferability of shares, other than those held by the Government, raising of capital through public issue, voting rights of shareholders (limited to one per cent per shareholder) and keeping register of shareholders including in floppies. Section 10A was amended to declare dividends, as earlier balance of profits was to be transferred to the Central Government..

5.7 CO-OPERATIVE BANKS


i. Applicability of BR Act: (a) Co-operative banks are registered either under the state laws governing co-operatives or under the multi-state Co-operative Societies Act. If a co-operative bank operates only in one state, the state law applies and in the case of co-operative banks operating in more than one state, the Central Act applies. While the state law/Central law governs the constitution and related matters, the business of banking is regulated by the Banking Regulation Act as applicable to co-operative societies. (b) The Banking Regulation Act is applicable to co-operative societies subject to the modifications stipulated in Part V (Section 56) of the Act. The Act was made applicable to co-operative societies by the Banking Laws (Application to Co-operative Societies) Act, 1965. As defined in Section 5 (cci) of the BR Act (as applicable to co-operative societies), a co-operative bank means a state co-operative bank, a central co-operative bank and a primary co-operative bank. A primary co-operative bank is a co-operative society other than a primary agricultural credit society, which satisfies the following criteria; (i) The primary object or principal business is the transaction of banking business, (ii) The paid-up share capital and reserves are not less than Rs. 1 lac. (iii) The byelaws do not permit admission of any other co-operative society as a member (except the membership of a co-operative bank by subscribing to the share capital of the society out of the funds provided by the state Government). (c) A state co-operative bank is the principal co-operative society in a state with the primary objective of financing other societies. A central co-operative bank is the principal co-operative society in a district with the primary objective of funding other co-operative societies in the district The reference to banking company in the Act shall be construed as a reference to co-operative banks unless the context otherwise requires. ii. Bank, Banker, Banking: No co-operative society other than a co-operative bank is permitted to use as part of its name or in connection with the business, the words 'bank', 'banker' and 'banking'. Further, a co-operative society carrying on banking business has to use at least one of such words as part of its name. However, certain categories of co-operative societies are exempt from these provisions as follows: (a) a primary credit society;

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(b) a co-operative society formed for the protection of the mutual interest of co-operative banks or co-operative land development banks; (c) a co-operative society other than a primary credit society formed by employees of the State Bank, a subsidiary bank, a Nationalised bank or a co-operative bank, a primary credit society, or a co-operative land development bank. iii. Paid-up Capital and Reserves: The minimum paid-up capital and reserves required to commence or carry on banking business by a co-operative bank is not less than Rs. 1 lakh under Section 11 (as applicable to co-operative banks). However, this provision is not applicable to a primary credit society, which becomes a primary co-operative bank after the commencement of the Act, for a period of two years from the date it becomes a primary co-operative bank. The Reserve Bank may give a further period of one year in the interests of depositors of the primary co-operative bank in any particular case. For calculating the value of paid-up capital and reserves, the real and exchangeable value and not the nominal value would be considered. In the case of a dispute regarding the value of paid-up capital and reserves, Reserve Bank's decision shall be final. iv. Cash Reserve: Co-operative banks other than scheduled Co-operative Banks and scheduled state co-operative banks have to maintain in India by way of cash reserve with itself or by way of balance in current account with the Reserve Bank or the state co-operative bank of the state concerned or district Co-operative Bank or by way of net balance in current accounts or any one or more of these ways a sum equivalent to at least three per cent of its total demand and time liabilities in India. In the case of a primary co-operative bank the balance in current accounts with the central co-operative bank of the district concerned may also be taken into account. The balance has to be reckoned as on the last Friday of the second preceding fortnight. The co-operative bank has to submit a return every month showing such amount held by it on alternate Fridays during a month along with the particulars of its demand and time liabilities in India on such Fridays. When the relevant Friday is a holiday under the Negotiable Instruments Act, the return shall be required as at the close of business on the preceding working day. The demand and time liabilities have to be calculated as stipulated in Section 18 (as applicable to co-operative societies). For scheduled Primary Co-operative Banks and State co-operative Banks, CRR has to be maintained as per Section 42 of RBI Act. v. Restrictions on Loans and Advances: (a) Section 20 of the Banking Regulation Act (as applicable to co-operative societies) lays down certain restrictions on loans and advances by co-operative banks. Accordingly, a co-operative bank shall not grant loans and advances as under: (i) loans and advances on the security of its own shares; (ii) unsecured loans or advances to any of its directors; (iii) unsecured loans or advances to firms or private companies in which any of its directors are interested as partner, managing agent or guarantor, or to individuals in cases where any of its directors is a guarantor for the loans or advances; (iv) unsecured loans or advances to any company in which the chairman of the co-operative bank is interested as managing agent or chairman or managing director. However, these restrictions do not apply to unsecured loans or advances made by a cooperative bank against bills for supplies or services made to Government or bills of exchange arising out of bona fide, commercial or trade transactions. Further, unsecured loans or advances in respect of which trust receipts are furnished to the co-operative bank and loans to directors or any other persons within the limits and on terms and conditions approved by the Reserve Bank are also exempted.

i
Ii

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(b) Every co-operative bank has to submit a return in the prescribed form showing the unsecured loans and advances granted by it to companies in which its directors are interested as director, managing agent, or guarantor. Such returns have to be filed before the close of the month succeeding to which the return relates. If it appears to the Reserve Bank on examination of any return that the loans or advances were granted to the detriment of the interest of depositors, Reserve Bank may prohibit granting of such further loans or advances. The Reserve Bank may also impose other restrictions on the grant of such loans and direct the co-operative bank to secure the repayment of the loan or advance within a stipulated time. Note: It must be noted here that RBI with effect from 1 October 2003, has prohibited co-operative banks from providing, renewing secured or unsecured loans and advances or any other funded or nonfunded financial accommodation to their directors or their relatives and firm/companies in which their relatives are interested. vi. Licensing of Co-operative Banks: (a) Every co-operative society requires a licence from the Reserve Bank under Section 22 of the Banking Regulation Act (as applicable to co-operative societies) to carry on banking business in India. However, primary credit societies are exempt from the requirement. The Reserve Bank may impose such conditions as it may deem fit while granting licence to a co-operative bank. Co-operative societies carrying on banking business at the commence ment of the Banking Laws (Application to Co-operative Societies) Act, 1965 were given exemption for a period of one year. Every co-operative society carrying on banking business at the commencement of the Act had to apply for a licence within three months from such commencement and every primary co-operative society, which becomes a primary co-operative bank after such commencement has to apply for a licence before three months from the date of it becoming a primary co-operative bank. After applying for licence the co-operative bank can continue to carry on banking business unless its licence is rejected. (b) A co-operative bank requires the prior permission of the Reserve Bank for opening a new place of business or changing an existing place of business otherwise within the same city, town or village where it has an existing place of business. However, opening of temporary branches for a period not exceeding one month within the city, town or village where it has a place of business, on the occasion of an exhibition, conference, mela or any like occasion is permissible. The opening or changing of location of branches by a central co-operative bank within its area of operation is also exempt. The application of a co-operative bank for permission to open a branch, other than of a primary co-operative bank, has to be routed through the National Bank. However, an advance copy of the application has to be sent directly to Reserve Bank. vii. Liquid Assets: Co-operative banks have to maintain liquid assets as provided in Section 24(1) of the Banking Regulation Act. In computing the amount of liquid assets any balances maintained by a cooperative bank in current account with the Reserve Bank or by way of net balances in current accounts would be taken into account. In the case of state co-operative banks, which are scheduled banks, the balances required under Section 42 of the RBI Act will also be accounted. In the case of the Central co-operative banks, balances maintained with the state co-operative bank concerned and in the case of primary co-operative banks the balances maintained with Central co-operative banks or the state co-operative bank concerned shall be accounted. The co-operative banks have also to maintain as specified in Section 24(2A) liquid assets being not less than 25 per cent or such other percentage not exceeding forty per cent as the Reserve Bank may stipulate by notification in the Gazette. The amount has to be maintained as at the close of business on any day. For this

ij

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purpose, any balance maintained by a scheduled private co-operative banks and state co-operative bank with the Reserve Bank in excess of the balance required under Section 42 of the RBI Act shall be accounted. Similarly, cash or balances maintained in India by a non-scheduled co-operative bank with itself or with the state co-operative bank or in current account with Reserve Bank or net balance in current accounts in excess of the requirement of Section 18 would be accounted. In the case of primary co-operative banks, such balances maintained with the Central co-operative bank of the district concerned will also be taken into account. The co-operative banks have to file a return with the Reserve Bank and every co-operative bank, other than a primary co-operative bank has also to furnish a copy thereof to the National Bank. viii. Accounts and Audit: Every co-operative bank has to prepare a balance sheet and profit and loss account of its business as on the last working day of the year. The balance sheet and accounts have to be prepared in the forms set out in the third schedule to the Act or as near thereto as circumstances admit. Three copies of such balance sheet and accounts, along with statutory auditor's report has to be submitted to the Reserve Bank within six months. A state co-operative bank and a central cooperative bank have to submit such return to the National Bank also. ix. Inspection: The provisions of Section 35 relating to inspection are applicable to co-operative banks with minor modifications. It is also open to Reserve Bank to call for inspection of a primary cooperative bank by one or more officers of the state co-operative bank in the state where the primary co-operative bank is registered. The Reserve Bank may supply a copy of the report on any inspection or scrutiny to the state co-operative bank or the Registrar of Co-operative Societies concerned. x. Insured Co-operative Banks: (a) Registration with DICGC: The Deposit Insurance and Credit Guarantee Corporation Act, 1961, which provides for insuring deposits of banks, is applicable to co-operative banks also. Accordingly, under Section 13C of the Act, co-operative banks have to be registered with the corporation for this purpose. The registration of a co-operative bank may be cancelled if: (i) it is prohibited from accepting deposits; (ii) its licence is cancelled; (iii) it has been ordered to be wound up; (iv) it has ceased to be a co-operative bank under the sub-Section (2) of Section 36A of the BRAct; (v) it has converted into a non-banking co-operative society; (vi) it has been amalgamated with any other co-operative society; (vii) it has transferred its deposit liabilities to any other institute or; (viii) it ceases to be an eligible co-operative bank. (b) Eligible Co-operative Bank: An eligible co-operative bank is defined in Section 2(gg) of the Act. Accordingly, for a co-operative bank to become an eligible co-operative bank, the law governing that co-operative bank should have the following provisions: (i) An order for the winding up, or an order sanctioning a scheme of compromise or arrangement or of amalgamation or reconstruction of the bank, may be made only with the previous sanction in writing of the Reserve Bank. (ii) An order for the winding up of the bank shall be made, if so required by the Reserve Bank in the circumstances referred to in Section 130. (iii) An order shall be made for the supersession of the committee of management or other managing body of the bank and the appointment of an administrator therefore for such period or periods not exceeding five years in the aggregate as may be specified by the

77
Reserve Bank if so required by the Reserve Bank in the public interest or for preventing the affairs of the bank being conducted in a manner detrimental to the interests of the depositors or for securing the proper management of the bank. (iv) An order for the winding up of the bank, or an order sanctioning a scheme of compromise or arrangement or of amalgamation or reconstruction or an order for the supercession of the committee of management or other managing body of the bank and the appointment of an administrator therefore made with the previous sanction in writing or on the requisition of the Reserve Bank shall not be liable to be called in question in any manner. (v) The liquidator or the insured bank or the transferee bank, as the case may be, shall be under an obligation to repay the corporation as provided in Section 21 of the Act. (c) Requisition by Reserve Bank for Winding Up: Section 130 of the DICGC Act mentions the circumstances in which Reserve Bank may require winding up of a co-operative bank. Such circumstances are that: (i) the co-operative bank has failed to comply with the requirements as to minimum paid-up capital and reserves specified in Section 1 ] of the Banking Regulation Act; (ii) the cooperative bank has under Section 22 of the Act (dealing with licence) become disentitled to carry on banking business in India; (iii) the co-operative bank has been prohibited from receiving fresh deposits by an order under Section 35(4) of the Act or under Section 42(3A)(b) of the Reserve Bank of India Act; (iv) the co-operative bank having failed to comply with any requirement of the Banking Regulation Act, 1949, other than the requirements laid down in Section 11 thereof, has continued such failure or having contravened any provisions of the Act, has continued such contravention beyond such period or periods as may be specified by the Reserve Bank, after notice in writing of such failure or contravention has been conveyed to the co-operative bank; (v) the co-operative bank is unable to pay its debts; (vi) in the opinion of the Reserve Bank, a compromise or arrangement sanctioned by a competent authority in respect of the co-operative bank cannot be worked satisfactorily with or without modification, or the continuance of the co-operative bank is prejudicial to the interests of its depositors. A co-operative bank, shall be deemed to be unable to pay its debts if, (i) on the basis of the returns, statements or information furnished to the Reserve Bank under or in pursuance of the provisions of the Banking Regulation Act, the Reserve Bank is of opinion that the co-operative bank is unable to pay its debts, (ii) if the co-operative bank has refused to meet any lawful demand made at any of its offices or branches within two working days, if such demand is made at a place where there is an office, branch or agency of the Reserve Bank, or within five working days if such demand is made elsewhere and, in either case, the Reserve Bank certifies in writing that the co-operative bank is unable to pay its debts

5.8 LET US SUM UP


1. The public sector banks, namely, State Bank and its subsidiaries, the Nationalised banks and the regional rural banks are statutory corporations (or body corporate) established under special statutes. State Bank and its subsidiaries, as Nationalised banks, are commercial banks engaged in the business of banking and other forms of business permissible for banking companies. The regional rural banks are also commercial banks but operating in limited local areas to cater to rural industries,

71
trade, farmers, artisans, etc. The State Bank and its subsidiaries and the Nationalised banks also act as agents of the Reserve Bank to transact the banking business of the Central Government. All public sector banks are governed by their respective, statutes and the rules, regulations or schemes made under these statutes. In addition to this, these banks are also governed by certain provisions of the Banking Regulation Act as stipulated in Section 51 of that Act. The provisions of the Reserve Bank of India Act are also applicable to them. 2. The co-operative banks, functioning in one state only are registered under the state laws on cooperative societies. The co-operative banks operating in more than one state, are registered under the multi-state Co-operative Societies Act. The Banking Regulation Act is applicable to co-operative banks as provided in Section 56 of that Act with certain modifications. For this purpose, a co-operative bank means a state co-operative bank, Central co-operative bank and a primary co-operative bank. While, the constitution of the bank is governed by the cooperative laws, the business of banking undertaken by them is regulated by the Reserve Bank under the BR Act. 5.9 KEYWORDS Nationalised Bank; Subsidiary Bank; Primary Co-operative Bank; Regional Rural Bank; Sponsor Bank; Cooperative Bank; Central Co-operative Bank; State Co-operative Bank; Co-operative Credit Society. 5.10 CHECK YOUR PROGRESS 1. Fill up the blanks choosing answers from the brackets. (i) The State Bank of India is a constituted under the State Bank of India Act. (banking company, body corporate, society) The Chairman in consultation with the Reserve (ii) of the State Bank is appointed by. Bank, (the Central Board, Banking Service Recruitment Board, Central Government) (iii) State Bank has to act as __________________ and carry out Central Government business and other business entrusted by the Reserve Bank, (agent of Reserve Bank, agent of Central Government, advisor to the Central Government) (iv) The provisions of the__________ are applicable to State Bank as stipulated in Section 51 of the BR Act. (RBI Act, Banking Regulation Act, Companies Act) (v) The majority of shares of subsidiary banks are held by ________ _. (Reserve Bank, Central Government, State Bank) (vi) Regional rural banks operate in _________ . (a notified area, the whole of a state, only a district) (vii) The management of the affairs of a regional rural bank vests in _________ . (the Sponsor Bank, its board of directors, the National Bank) 2. Say whether true or false (i) The State Bank can make statutory regulations for carrying out the purposes of the State Bank of India Act, in consultation with Reserve Bank and with previous approval of the Central Government, (ii) The Central Government is not authorised to give any directions to the State Bank in matters of policy involving public interest, (iii) The provisions of Section 42 of the Reserve Bank of India Act relating to cash reserve apply to State Bank. (iv) Subsidiary banks do not have to maintain liquid assets under Section 24 of the BR Act. (v) Regional rural banks may transact the business of banking as defined in Section 5(b) of the BR Act and also other business specified in Section 6(1) of that Act.

2. 3.

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(vi) Two regional rural banks may be amalgamated by the Reserve Bank by notification in the gazette, (vii) The management of Nationalised Banks is governed by the Nationalised Banks (Management and Miscellaneous Provisions) Schemes of 1970 and 1980. Fill in the gaps choosing answers from the brackets. in the Banking (i) Unless the context otherwise requires, the reference to a Regulation Act shall be construed as reference to a co-operative bank, (co-operative society, banking company, body corporate) (ii) _________ in relation to a co-operative society, for the purpose of BR Act, includes a member of any committee or body for the time being vested with the management of the affairs of that society. (Director, Member, Manager) (iii) The requirement of minimum paid-up capital and reserves for a co-operative bank to commence or carry on banking business is _______ . (Rs. 1 crore, Rs. 1 lakh, Rs. 10 lakh) (iv) There are restrictions on co-operative banks on __________ in other co-operative societies under Section 19 of the BR Act. (holding of shares, keeping deposits, acquiring any interest) (v) Central and state co-operative banks have to submit their returns under Section 31 of BR Act to ______ . (Reserve Bank and National Bank, National Bank only, Reserve Bank only) (vi) Under Section 23 of the BR Act, without the permission of Reserve Bank, a __________ can open a new place of business within the area of its operation, (central co-operative bank, state co-operative bank, primary co-operative bank) (vii) Co-operative banks have to prepare their balance sheet and profit and loss account in the forms set out in the Third Schedule to _________ . (Banking Regulation Act, Reserve Bank of India Act, State Co-operative Societies Act) Say whether true or false. (i) Banking Regulation Act was made applicable to co-operative banks by the Banking Laws (Application to Co-operative Societies) Act, 1965. (ii) A primary co-operative bank does not require licence from the Reserve Bank to carry on banking business, (iii) The provisions of the Banking Regulation Act as provided in Section 56 of the Act apply to co-operative banks, (iv) A 'Co-operative Bank' means a primary co-operative bank, central co-operative bank and a state co-operative bank, (v) There are no restrictions under the BR Act on lending by cooperative banks to their directors or firms in which they are interested, (vi) A scheduled co-operative bank has to maintain cash reserve as stipulated in Section 42 of the Reserve Bank of India Act (as applicable to co-operative societies). (vii) Inspection of co-operative banks is done by the state Government under the Co-operative Societies Act and the Reserve Bank has no power to inspect under the Banking Regulation Act.

3.

4.

5.11 ANSWERS TO CHECK YOUR PROGRESS'


1. (i) body corporate (ii) Central Government (iii) Agent of Reserve Bank (iv) BRAct (v) SBI (vi) notified area (vii) its board of directors 2. (i) True; (ii) False; (iii) True; (iv) False; (v) True; (vi) False; (vii) True 3. (i) Banking company (ii) Director (iii) Rs. 1 lakh (iv) Holding of shares

(vi) Central co-operative bank (vii) Bunking Regulation Act 4. False; (iii) True; (iv) True; (v) False; (vi) True; (vii) False 5.12 TERMINAL QUESTIONS Fill in the blanks choosing answers from brackets. 1. State Bank may act as agent of the Reserve Bank

(i) True; (ii)

. (for transacting only Government business; for transacting Government business and other business entrusted by the Reserve Bank; only for collection of taxes) 2. ______________ shall be the ex-officio chairman of the subsidiary banks. (Chairman of State Bank; Finance Secretary to Central Government; Managing Director of the State Bank) 3. The thrust of business of regional rural banks is to make loans and advances available 'in rural areas' (only to farmers; only to small enterprises; small and marginal formers, agricultural labourers, artisans and small entrepreneurs in particular). 4. Nationalised banks can undertake __________ (only such business as permitted by the Government from time to time; only such business as permitted by the Reserve Bank in consultation with Central Government; banking business and any other business permissible for banks under Section 6(1) of the BR Act. 5. The auditor of a Nationalised bank has to be _________ (an officer of the Central Government under the C&AG; an officer of the Reserve Bank; a person duly qualified to be an auditor of a company under Section 226 of the Companies Act. Choose the correct statements from the following: 6. (i) The provisions relating to licensing under Section 22 of the BR Act are applicable to Nationalised banks, (ii) The provisions of Section 22 of the BR Act relating to licensing are not applicable to Nationalised banks, (iii) The provisions relating to cancellation of licence under Section 22 of the BR Act are applicable to Nationalised banks. 7. (i) All public sector banks are scheduled banks. (ii) All regional rural banks are not scheduled banks, (iii) Some public sector banks are not scheduled banks. 8. (i) BR Act is not applicable to primary agricultural credit societies. (ii) Primary credit societies are required to hold a licence under the BR Act. (iii) BR Act is applicable to co-operative land development banks (Agricultural and Rural Development Banks) 9. (i) A co-operative bank is not eligible for insurance under the DICGC Act. (ii) An eligible co-operative bank under Section 2(gg) of the DICGC Act has to be registered with the DICGC for insurance. (iii) The registration of a co-operative bank for insurance with DICGC cannot be cancelled even if it converts into a non-banking co-operative society. 10. (i) Reserve Bank can direct the Registrar of co-operative societies to wind up an insured cooperative bank if it is unable to pay its debts. (ii) Reserve Bank can suo moto wind up a co-operative bank if the bank is unable to pay its debts. (iii) The Registrar can suo moto wind up a co-operative bank in the circumstances mentioned in Section 13D of the DICGC Act.

MODULE -B
LEGAL ASPECTS OF BANKING OPERATIONS
Unit 6. Unit 7. Unit 8. Unit 9. Unit 10. Unit 11. Unit 12. Unit 13. Unit 14. Unit 15. Unit 16. Unit 17. Unit 18. Case Laws on Responsibility of Paying Bank Case Laws on Responsibility of Collecting Bank Indemnities Bank Guarantees Letters of Credit Deferred Payment Guarantee Laws Relating to Bill Finance Various Types of Securities Law Relating to Securities and Modes of Charging -1 Law Relating to Securities and Modes of Charging - II Different Types of Borrowers Types of Credit Facilities Secured and Unsecured Loans, Registration of Firms, Incorporation of Companies

Unit 19. Registration and Satisfaction of Charges

CASE LAWS ON RESPONSIBILITY OF PAYING BANK

STRUCTURE
6.0 6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8 6.9 6.10 Objectives Introduction Negotiable Instruments Act and Paying Banks Liability of Paying Banker when Customer's Signature on Cheque is Forged Payment to be in Due Course for Bank to Seek Protection Payment in Good Faith, without Negligence of an Instrument on which Alteration is not Apparent Payment by Bank Under Mistake Whether Recoverable Let Us Sum Up Keywords Check Your Progress Answers to 'Check Your Progress'

' L.K.A.D-7

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6.0 OBJECTIVES
After studying this unit, you should be able to: explain the various laws applicable to a paying bank; explain the responsibilities of a paying bank based on case laws; explain the protection given under law to a paying bank as decided by Courts.

6.1 INTRODUCTION
The Negotiable Instruments Act, 1881 lays down the law relating to payment of a customer's cheque by a banker and the protection available to a banker. The relationship between a banker and customer being debtor-creditor relationship the banker is bound to pay the cheques drawn by his customer. This duty on the part of the banker, to honour his customers' mandate, is laid down in Section 31 of the Negotiable Instruments Act. Sections 10, 85, 85A, 89 and 128 of the Negotiable Instruments Act, 1881, grant protection to a paying banker. We shall in detail, examine individually these sections and with the help of case laws apply the provisions of these sections to a given set of facts. 6.2 NEGOTIABLE INSTRUMENTS ACT AND PAYING BANKS As stated in Part 1.1 of this unit, the customer who has deposited money with a bank being a creditor has the right to ask back the money from the banker who is a debtor. The duty on the part of the banker to pay has been laid down in Section 31 of the Negotiable Instruments Act, 1881 in the following terms: 'The drawee of a cheque having sufficient funds of the drawer in his hands properly applicable to the payment of such cheque must pay the cheque when duly required to do so, and, in default of such payment, must compensate the drawer for any loss or damage caused by such default.' The following points are important to note: i. Section 31 Applies Only to Bankers: This is because as per Section 6 of the Negotiable Instruments Act, 1881 'cheque' has been defined as a "bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand'", ii. Sufficient Funds: The banker should have sufficient funds of the drawer, i.e. there should be sufficient credit balance in the customer's account, iii. Properly Available: The funds available in the customer's account should also be properly available for the payment of the cheque. The funds may not be available to pay the cheque if: (a) the banker has exercised his right of set off for amounts due from the customer, or (b) there is an order passed by a Court, competent authority or other lawful authority restraining the bank from making payment. iv. When Duly Required to Do So: The banker is duty bound to pay the cheque only when he is duly required to do so. It means that the cheque must be properly drawn and signed by the drawer. v. Compensate the Drawer: In case the banker refuses payment wrongfully, then he is liable only to the drawer of the cheque and not to any endorsee or holder, except when (a) the bank is wound up, in which case the holder becomes a creditor entitled to make a claim; (b) the banker pays a cheque disregarding the crossing, wherein the true owner can hold the banker liable. vi. Loss or Damage Caused by Default: A banker is liable to the drawer for any loss or damage, which may have occurred to the drawer due to the wrongful dishonour of the customer's cheque.

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Protection to paying banker: For a paying banker to claim protection under the Negotiable Instruments Act, one of the criteria he has to satisfy, is that the payment is in due course. As to what is, payment in due course has been stated in Section 10, which reads as follows: Payment in due course: 'Payment in due course' means payment in accordance with the apparent tenor of the instrument in good faith and without negligence to any person in possession thereof under circumstances which does not afford a reasonable ground for believing that he is not entitled to receive payment of the amount therein mentioned. From the above definition, it can be seen that payment in due course requires the payment to be made (a) (b) (c) (d) (e) in accordance with the apparent tenor of the instrument; in good faith; without negligence; to the person in possession of the instrument; and while making payment the banker should not have reasons to 'believe' that the person in possession of the instrument is not entitled to receive payment of the amount mentioned in the instrument.

Section 85 of the Negotiable Instruments Act, 1881 grants protection to a banker on his making payment of a cheque. Though this principle may sound as a simple logic, it is to be noted that the protection granted as per Section 85 is not absolute. Section 85 of the Negotiable Instruments Act, 1881 can be explained as follows: 1. 2. Where a cheque payable to order purports to be endorsed by or on behalf of the payee, the drawee is discharged by payment in due course. Where a cheque is originally expressed to be payable to bearer, the drawee is discharged by payment in due course to the bearer thereof, notwithstanding any endorsement whether in full or in blank appearing thereon, and notwithstanding that any such endorsement purports to restrict or exclude further negotiation.

Section 89 of the Negotiable Instruments Act states the effect of making payment on instrument on which alteration is not apparent and reads as follows: Section 89 Payment of instrument on which alteration is not apparent: Where a promissory note, bill of exchange or a cheque has been materially altered but does not appear to have been so altered, or where a cheque is presented for payment which does not at the time of presentation appear to be crossed or to have had a crossing which has been obliterated, payment thereof by a person or banker liable to pay, and paying the sum according to the apparent tenor thereof at the time of payment and otherwise in due course, shall discharge such person or banker from all liability thereon, and such payment shall not be questioned by reason of the instrument having been altered or the cheque crossed.

6.3

LIABILITY OF PAYING BANKER WHEN CUSTOMER'S SIGNATURE ON THE CHEQUE IS FORGED

Section 128 Where the banker on whom a crossed cheque is drawn has paid the same in due course, the banker paying cheque, and in case such cheque has come to the hands of the payee the drawer thereof, shall respectively be entitled to the same rights, and be placed in the same position in all respects as they would respectively be entitled to and placed in if the amount of the cheque, has heen pair! tn and received by the true owner thereof. i. When the customer's signature on the cheque is forged there is no mandate to the hank tn

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pay. As such a banker is not entitled to debit the customer's account on such forged cheque: Canara Bank vs Canara Sales Corporation and Others [(1987) 2 Supreme Court Cases 666]: The company had a current account with the bank which was operated by the company's Managing Director. The Company's accountant in whose custody the cheque book was, forged the signature of the Managing Director in forty-two cheques totalling Rs. 3,26,047.92 over a period of time. This was detected by another accountant. The company immediately on detection of the fraud demanded the amount from the bank. The bank refused payment and therefore the company filed a suit against the bank. The bank lost the suit and took the matter up to the Supreme Court. The Supreme Court dismissed the appeal of the bank and held that: "Since, the relationship between the customer and the bank is that of a creditor and debtor, the bank had no authority to make payment of a cheque containing a forged signature. The bank would be acting against the law in debiting the customer with the amount of the forged cheque, as there would be no mandate on the bank to pay. The Supreme Court pointed out that the document in the cheque form on which the customer's name as drawer was forged was a mere nullity. The bank would succeed only when it would establish adoption or estoppel." In deciding the case, the Supreme Court relied on its earlier judgement in Bihta Co-operative Development and Cane Marketing Union Ltd. vs Bank of Bihar (AIR 1967 Supreme Court 389). ii. In a joint account if one of the signatures is forged then there is no mandate and banker cannot make payment: The case law in this case is of Bihta Co-operative Development and Cane Marketing Union Ltd. vs Bank of Bihar: The Co-operative Marketing Union had an account with the bank, which was authorised to be operated by the joint secretary and treasurer of the Co-operative Marketing Union. On 16 April 1948, the bank made payment of Rs. 11,000 on a loose leaf cheque and not on a cheque from the cheque book issued to the Society. Though the two signatures appeared on the cheque, one of them, the signature of the Joint Secretary was forged. The bank made payment, whereupon the Co-operative Marketing Union sued the bank for recovery of the money. Though the bank admitted negligence on its part, it argued that the employees of the Co-operative Marketing Union were dishonest in the discharge of their duties and as such it cannot succeed. The matter went up to the Supreme Court and the Supreme Court, while allowing the case of the Co-operative Marketing Union held that 'one of the signatures was forged so that there never was any mandate by the customer at all to the banker and the question of negligence of the customer in between the signature and the presentation of the cheque never arose.' 6.4 PAYMENT TO BE IN DUE COURSE FOR BANK TO SEEK PROTECTION i. The Supreme Court in Bank of Bihar vs Mahabir Lai (AIR 1964 Supreme Court 397) held that a banker can seek protection under Section 85 only where payment has been made to the holder, his servant or agent, i.e. payment must be made in due course. In this case, the bank had agreed to grant the firm a cash credit facility against the pledge of cloth bales, on the firm fulfilling certain conditions, one of which, was that the money for purchasing the cloth would not be directly given to the firm, but instead, the supplier would be paid the amount by the bank and the cloth bales would be kept by the bank as pledge for the loan. The firm thereafter was required to draw a cheque on itself which was handed over to the bank. The bank instead of handing over cash to the firm's partner to be paid over to the wholesalers, entrusted it with one of the bank's employees (Potdar) who accompanied the partner to the wholesalers. However, before the rnoney could be paid to the wholesalers the Potdar absconded. The bank

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sought repayment of the money, which was refused by the firm. The bank therefore sued the firm for the money relying on Sections 85 and 118 of the Negotiable Instruments Act, 1881. The matter reached the Supreme Court and it was held that, before the provisions of Section 85 can assist the bank it had to be established that payment had in fact, been made to the firm or to a person on behalf of the firm. Payment to a person who had nothing to do with the firm or a payment to an agent of the bank would not be a payment to the firm. ii. The Calcutta High Court had occasion to consider as to whether a bank had made payment in due course or not in the case of Bhutoria Trading Company (BTC) vs Allahabad Bank (AIR 1977 Cal. 363) the facts of which are as follows: BTC, a limited company, had sold some jute to WFD another limited company, for payment of which WFD issued an un-crossed cheque payable to BTC or order which was delivered to one of the officials of BTC. The official using the company's seal endorsed the cheque as manager and encashed it over the counter. BTC later sued the bank for recovery of the money on the grounds of damages or in the alternative on the grounds of money had and received by the bank. The Court held that: 'The Expression payment in due course has been defined in Section 10 of the Negotiable Instruments Act to mean payment in accordance with the apparent tenor of the instrument in good faith and without negligence to any person in possession thereof, under circumstances which do not afford reasonable ground for believing that he is not entitled to receive payment of the amount therein mentioned. It can hardly be questioned that the payment by the defendant bank of the cheque in question has been made by the defendant bank in accordance with its apparent tenor. The cheque is an un-crossed cheque payable to the plaintiff or order. The cheque was endorsed by the plaintiff through its Manager. The fact that Jethmall is the Manager is borne out by the seal of the company which is unquestionably an authentic seal. The seal of the Manager is also equally authentic. That the payment was made in good faith has not been disputed for all practical purposes. There is not a grain of evidence before the Court from which it remotely appears that the payment was not made in good faith. Now that the entire evidence is before the Court, the question of onus to prove good faith loses much of its importance. No negligence has been proved against the bank. The defendant bank insisted on identification of Jethmall and Jethmall was, in fact, identified by Kishanlal Maheswari, a constituent of the bank, the defendant No. 3. The defendant bank therefore took all reasonable precautions even though the circumstances in which the cheque was presented for payment did not afford any reasonable ground for believing that Jethmall was not entitled to receive payment of the amount mentioned therein. The plaintiff having failed to prove the trade practice which he alleged and the bank having paid the cheque, in accordance with the apparent tenor of the instrument, in good faith, and without negligence, to Jethmall who was in possession thereof, the defendant is entitled to succeed. There were no circumstances which afforded any reasonable ground for believing that he was not entitled to receive payment of the cheque. It must be held that the bank made the payment in due course. The learned Judge, in our opinion has rightly pointed out that payment in due course is necessarily payment in the ordinary course. iii. Whether payment made by a bank was payment in due course would depend on the facts of a given case. In Madras Provincial Co-operative Bank Ltd. vs Official Liquidator, South Indian Match Factory Ltd. (AIR 1945 Mad 30) the Court held that payment to a liquidator against the cheque presented across the counter was not a payment in due course and the bank was not entitled to seek protection under Section 85 of the Negotiable Instruments Act. In this case the Official Liquidator of the Company had sold certain properties of the company, for which payment was made by the purchaser by giving a cheque in favour of the liquidator. The liquidator presented the cheque over the counter and obtained payment in cash which he

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misappropriated. He was later prosecuted and convicted and removed from office. His successor proceeded against the bank for recovery of the amount on the ground that the bank was negligent and the amount was wrongly paid. The Court held that under Section 244A of the Indian Companies Act, 1913, an official liquidator was required to open an account with a bank and pay therein moneys received by him in the course of the liquidation. Rule 66 of the Rules framed by the Madras High Court under the Act required that all bills and other securities payable to the company or to the liquidator should, unless the judge otherwise directs, shall as soon as they came into the hands of the liquidator, be deposited by him in the bank. From the cheque itself the bank had noticed that it was payable to the liquidator in his official capacity. That the bank realised this in full was shown by the fact that it called for the order of his appointment. The learned judge therefore concluded: We have no doubt that the officers of the bank did not realise, as they should have done, that the bank was doing something improper, but in the circumstances there was negligence. They knew or must have deemed to have known that this money could only be collected by the payee through his own bank and therefore it was most improper on his part to ask for payment over the drawee's counter. In our judgement there was a clear breach of a statutory duty placed upon the bank and the learned judge was right in holding the bank liable.

!!

6.5

PAYMENT IN GOOD FAITH WITHOUT NEGLIGENCE OF AN INSTRUMENT ON WHICH ALTERATION IS NOT APPARENT

i. The effect of Sections 10 and 89, and Section 31 was considered by the Supreme Court in Bank of Maharashtra vs M/s Automotive Engineering Co. (1993) 2 SCC 97. The question, which arose for consideration in this appeal, was whether the paying bank was bound to keep an ultraviolet ray lamp and to scrutinise the cheque under the said lamp even if no infirmity on the face of the said cheque on visual scrutiny was found. Briefly stated, the respondent, a partnership firm, opened a current account with the Wagle Industrial Estate branch of the appellant bank. The said branch was in the industrial area on the outskirts of City of Bombay, where forgery of cheques were rampant and although other branches of the appellant bank were provided with ultraviolet ray lamps, the said branch was not provided with such lamp. On 26 May 1967, one Shri Shah, as a proprietor of Messrs Imperial Tube and Hardware Mart, opened an account, in the name of his firm, with a branch of the Union Bank of India. Shri Shah presented a cheque dated 29 May 1967 for Rs. 6,500 in favour of his firm to Union Bank of India. On presentation of the cheque through clearing, the appellant bank passed the cheque and debited the amount to the account of the respondent. Later on, on receipt of the objection from the respondent-defendant, the said cheque was examined under the ultraviolet ray lamp when it transpired that the original cheque was issued in favour of Shri G.R. Pardawala and the amount of the said cheque was Rs. 95.98. The writing on the cheque was chemically altered with regard to date, the name of the payee and also the amount. The respondent made demands to the appellant bank to credit the amount to its account. The appellant bank filed a suit in which the agent of the appellant bank was examined, who stated that before passing the said cheque for payment he had checked the serial number and date of the cheque and had compared the signature of the respondent with the specimen signature and that from visual appearance of the cheque no infirmity was noted by him and from the tenor of the cheque it appeared to be a genuine one. The Trial Court dismissed the suit on the ground that by not providing the facility of ultraviolet ray lamp, the appellant bank had failed to discharge proper care and, therefore, did not pass the said cheque with the due diligence.

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On appeal, the District Judge, while agreeing that no abnormal features to suspect the genuineness of the cheque could be found on visual inspection of the cheque, was of the view that the appellant bank was not entitled to protection for the lapse in subjecting the said cheque for scrutiny under the ultraviolet ray lamp. On further appeal, the High Court of Bombay, while accepting the finding that the cheque in question apparently did not show any sign of alteration, held that the appellant bank did not act with proper care and caution in not providing necessary device for detecting forged cheques. Since the absence of such a lamp amounted to negligence on the part of the appellant bank, no protection was available because payment was not made in due course. The appellant bank preferred this appeal to the Supreme Court. The Supreme Court allowed the appeal of the bank on the following grounds: (i) Section 89 of the Negotiable Instruments Act gives protection to the paying banker of a cheque which has been materially altered but does not appear to have been so altered, if payment was made according to the apparent tenor thereof at the time of payment and otherwise in due course. (ii) Section 10 of the said Act defines payment in due course to mean payment in accordance with the apparent tenor of the instrument in good faith and without negligence to any person in possession thereof under circumstances which do not afford a reasonable ground for believing that he is not entitled to receive payment of the amount therein mentioned. (iii) Section 31 of the said Act obliges the drawee bank having sufficient funds of the drawer in its hands properly applicable to the payment of such cheque to make payment of the cheque when duly required to do so. (iv) On analysing the evidence, the Courts below have held that on visual examination no sign of forgery or tampering with the writings on the cheque could be detected. It was found that the agent of the appellant bank had verified the serial number and signature on the cheque and had compared the signature on the cheque with the specimen signature of the respondent and on scrutiny of the cheque visually, no defects could be detected by him. There were sufficient funds of the drawer with the appellant bank, which had no occasion to doubt about the genuineness of the cheque from the apparent tenor of the instrument. There was no evidence to hold that, the payment was not made in good faith. Simply, because the ultraviolet ray lamp was not kept in the branch and the said cheque was not subjected to such lamp would not be sufficient to hold the appellant bank guilty of negligence, more so when it has not been established on evidence that the other branches of the appellant bank or the other commercial banks had been following a practice of scrutinising each and every cheque or cheques involving a particular amount under such lamp by way of extra precaution. (v) In such circumstances, it is not a correct legal proposition that the bank, in order to get absolved from the liability of negligence, was under an obligation to verify the cheque for further scrutiny under advanced technology or for that matter, under ultraviolet ray lamp, apart from visual scrutiny even though the cost of such scrutiny was only nominal and it might be desirable to keep such lamp at the branch to take aid in appropriate case. (vi) The Courts below were not justified in holding that the bank had failed to take reasonable care in passing the cheque for payment without subjecting it to further scrutiny under ultraviolet ray lamp because the branch was in the industrial area where such forgery was rampant and other branches of the appellant bank were provided with such lamp. The appeal was, therefore, allowed and the Suit of the appellant bank was decreed only for the principal amount without any interest on the same. ii. The protection granted to a banker under Section 89 had come up for consideration before the Calcutta High Court in Brahma Shumshere Jung Bahadur vs Chartered Bank of India, Australia and China (AIR 1956 Cal. 399):

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In this case B who was a member of the royal family of Nepal had an overdraft account with the bank, for which certain securities were deposited with the bank. The overdraft limit was not a fixed limit and fluctuated depending on the securities deposited. In April 1946, B requested the bank to enhance the overdraft limit which however, was not agreed to by the bank and the limit was Rs. 70,000. In July 1946, B sent a cheque by post, drawn on the overdraft account which was intercepted in the mail and the amount was raised from Rs. 256 to Rs 2,34,081. The cheque was put for collection in another bank which was paid by B's bank. B on coming to know about the forgery, sued both the paying and collecting bank, contending that though the cheque was signed by him it was written out by some other person and as such it should have aroused the suspicion of the bank. The Court, however, held that since no alteration or obliteration was visible at the time of payment, the payment was made according to the apparent tenor at the cheque. Further since B had on other occasions also issued cheque signed by him and written by others, the bank's suspicion could not have aroused. The Court also held that the words 'liable to pay' appearing in the third paragraph of Section 89 included a liability to pay under an overdraft agreement as much as it applied to an ordinary deposit account. As regards exceeding the overdraft limit, the Court held that no definite limit was fixed at any time and it fluctuated according to the securities deposited by B. In this case the collecting bank was liable for other reasons for which we shall see in the next unit. iii. In the case of Tanjore Permanent Bank vs S.R. Rangachari (AIR 1959 Madras 119) the High Court was called upon to decide a case in which cheque was materially altered and the bank sought protection under Section 89. In this case R had an overdraft account with the bank and requested the Manager to advance him Rs. 16,000 to the debit of his account. The Manager asked R to send him three blank cheques signed. R accordingly did the same. However, of the three cheques only one was utilised for the payment of Rs. 16,000. The other two cheques were alleged to have been filled by the accountant of the bank for Rs. 7,600 and Rs. 4,200 and the names of two clerks were written as the payees. In both the cheques the alterations were apparent and visible but the bank paid these cheques. On R not clearing the debit because of his overdraft account, the bank sued him. R contended that the two debit entries for Rs. 7,600 and 4,200 were made by the bank wrongly and as such he cannot be held liable. The Court held that since the material alteration on both the cheques were visible and since they were not authenticated by the drawer's initials, the payment made by the bank was not according to the apparent tenor of the instrument and as such the bank cannot claim protection under Section 89 of the Negotiable Instruments Act. The Court in coming to the above conclusion relied on the following paragraph of Bhashyam and Adiga's Negotiable Instruments Act: The bank has also to see whether there are any alterations in the cheque and whether they have been properly authenticated. Therefore, where an alteration in a cheque is initialled not by all the drawers but only some of them, the bank will be paying the amount on the said cheque at its own risk. In this connection it is necessary to notice that under Section 89 protection is afforded to the bank paying a cheque where the alteration is not apparent. It is to be noted that as per Section 89, the bank can seek protection only if there is no material alteration in the cheque and does not appear to have been altered. This, however, does not protect a banker in case the signature of the customer is forged. As stated earlier a forged cheque is no mandate of the customer and as such the bank cannot make payment on a cheque where the signature of the customer is forged. The question whether a signature is forged or not depends on the evidence and the court in coming to a conclusion that the signature is forged would look into the facts and circumstances that led to the payment of the cheque.

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iv. Bareilly Bank Ltd. vs Naval Kishore (AIR 1964 All 78): N opened an account with the bank by making a cash deposit of Rs. 19,900. N was issued a cheque book containing 25 cheques. 17 months after the opening of the account N drew a cheque for the first time for Rs. 5,900 which was dishonoured by the bank. On enquiries N was informed that 11 months back three cheques aggregating Rs. 19,500 were paid by the bank and the present balance in the account was a mere Rs. 437. N denied issuing of the cheques and sued the bank. In evidence it came out that 3 cheques used to withdraw the amounts were not from the cheque book issued to N and were from a different cheque book. Though bank was not in a position to explain this lapse, they made an attempt to counter the contentions of N by producing his specimen signature which appeared to be similar to the ones on the cheques. N however denied that the specimen signature was his and the Court concluded that the alleged specimen signature were totally different from N's regular signature. Evidence also was led to show that the bank's own employees were involved in the forgery since the ledger page of N's account showed that certain erasures and scorings were made and the signature of N missing in the cheque book issue register. Therefore the Court refused to accept the bank's contention. 6.6 PAYMENT BY BANK UNDER MISTAKE WHETHER RECOVERABLE The question whether a bank paying a forged cheque can recover the same from the payee was considered by the Calcutta High Court in United Bank of India vs AT Ali Hussain & Co. (AIR 1978 Calcutta 169). In this case, a cheque for Rs. 5,000, purportedly drawn by a company was presented by the collecting bank to the paying bank, and was paid. The signature as well as all other writings on the cheque were forged. The forgery was so perfect that it was not possible even for a trained eye to detect it. The paying bank, having subsequently come to know of the forgery, filed a suit against the collecting bank and the payee of the cheque, for recovery of the amount paid, on the ground of payment under mistake. Defending the suit, the collecting bank contended that it received the cheque in the ordinary course of its business, and presented the same for encashment in good faith. The payee contended, that he received the cheque from some persons claiming to be representatives of a company, in the ordinary course of business, towards payment of the price of the goods to be supplied by him, that he acted in good faith, having no reason to suspect that the cheque was forged, and that he parted with the goods only on receipt of intimation from the collecting bank that the cheque had been encashed. The Trial Court having dismissed the suit on the ground that the paying bank had no cause of action, an appeal was preferred to the High Court. Decision: The High Court dismissed the appeal and held that both from the point of view of equitable principles and the doctrine of estoppel, the paying bank was disentitled to recover the money either from the collecting bank or the payee. In the course of his judgement, M.M. Dutt. J. said: The evidence on record supports the findings of the learned Judge that the forgery was so accurate that it was not possible even to a trained eye to detect the same. In these circumstances, it is difficult to hold that the plaintiff bank had acted carelessly or negligently. The encashment was made by the plaintiff bank on the mistaken belief that the cheque was a genuine one. The defendant United Bank had nothing to do with the question as to whether the cheque was genuine or forged. In due course of business, it presented the cheque to the plaintiff bank for collection and after the cheque was encashed, intimation was given by it to its constituent, namely, the defendant No.l, and the latter, in its turn, sold goods to the persons who came with the forged cheque as the representatives of the Metal Alloy Co. Thus, it appears that the parties in the suit acted in good faith in due course of business. It was due to

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the mistake that was committed by the plaintiff bank that it had to suffer the loss of the said sum of Rs. 5,200. Upon the consideration of the principles of law as noticed above, it seems to us that so long as the status quo is maintained and the payee has not changed his position to his detriment, he must repay the money back to the payer. If, however, there has been a change in the position of the payee who, acting in good faith, parts with money to another without any benefit to himself before the mistake is detected, he cannot be held liable. Equity disfavours unjust enrichment. When there is no question of unjust enrichment of the payee by reaping the benefit of an accidental windfall he should not be made to suffer, for he would be as innocent as the payer who paid the money acting under a mistake.

6.7 LET US SUM UP


The Negotiable Instruments Act, 1881 lays down the law relating to the payment of a customer's cheque and the protection that is available to a banker making payment of a cheque in due course. Sections 10, 85, 85A, 89 and 128 of the Act deal with the protection available to a banker whereas Section 31 lays down the condition as to when a bank has to make payment on a cheque drawn by the customer. The banker on making the payment in due course is entitled to seek protection provided the cheque has not been altered or the alteration, if altered, is not apparent. However, the banker does not get protection, if signature of the customer is forged

6.8 KEYWORDS
Apparent Tenor of the Instrument; Material Alteration.

6.9 CHECK YOUR PROGRESS


1. State whether true or false. (i) The law relating to the payment of cheques and protection to a banker is contained in the Indian Contract Act. (ii) The responsibility of a banker to pay back the money of the customer specifically stated in the Negotiable Instruments Act, 1881. (iii) Section 31 of the Negotiable Instruments Act applies only to the banker, (iv) The banker is first bound to honour a customer cheque and only thereafter exercise his right of set off. (v) A forged signature is no mandate of the customer, (vi) A customer is bound to inform the bank about lost cheque leaves, (vii) In a joint account if one of the signatures is forged, the bank and the customer are equally liable, (viii) Payment to be made in due course need not always be made to holder but can be made to his agent or servant, (ix) In case bank makes payment by mistake it can recover the same even if the payee has changed his position, (x) If a bank makes payment without checking the instrument under an ultraviolet lamp, it can be held liable on the grounds of negligence.

6.10 ANSWERS TO 'CHECK YOUR PROGRESS'


1. (i) False; (ii) True; (iii) True; (iv) False; (v) True; (vi) False; (vii) False; (viii) True; (ix) False; (x) False

I
Rs.

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UNIT

7
STRUCTURE 7.0 Objectives

CASE LAWS ON RESPONSIBILITY OF COLLECTING BANK

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7.1 Introduction 7.2 Statutory Protection to Collecting Bank 7.3 Duties of the Collecting Bank 7.4 Let Us Sum Up 7.5 Keywords 7.6 Check Your Progress 7.7 Answers to 'Check Your Progress'

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7.0 OBJECTIVES
After studying this unit you should be able to understand: the duties of a collecting banker when opening an account and collecting cheques in the account; the protection granted under the Negotiable Instruments Act to a banker collecting a cheque.

7.1 INTRODUCTION
In the earlier unit, we had studied the duties imposed on a paying banker under the Negotiable Instruments Act and the protection granted to him. In this unit, we will be studying the duties of a collecting banker that has been imposed, more by the practice adopted by bankers over a period rather than by law. We shall also be studying the protection available to a collecting banker which is granted by certain provisions under the Negotiable Instruments Act. Before we delve into the subject, it would be worth trying to understand who a collecting bank is by an illustration. Illustration Ram has an account with Ideal Bank Ltd. The bank has issued a cheque book to Ram to withdraw money from the account. Ram owes Rs. 400 to Shyam and to repay this amount, Ram draws (issues) a cheque in favour of Shyam. Shyam has two ways to obtain payment of the cheque. He can go straight to the Ram's bank (Ideal Bank Ltd.) and collect cash against the cheque if it is not crossed or he can deposit the cheque in his account with his banker, who would send the same to Ram's banker (Ideal Bank Ltd.) and collect the amount. Here, Shyam's banker is the collecting bank and Ram's bank, i.e. Ideal Bank Ltd. is the paying bank. If in the above illustration, Ram were to post the cheque to Shyam and the same were stolen by X in transit and X were to open an account in the name of Shyam and collect the cheque, the bank that opened the account of X to collect the proceeds of the cheque would be the collecting bank.

7.2 STATUTORY PROTECTION TO COLLECTING BANK


Section 131 of the Negotiable Instruments Act grants protection to a collecting banker and reads as follows: Section 131 i. Non-liability of a Banker Receiving Payment of Cheque: A banker, who has, in good faith and without negligence, received payment for a customer of a cheque crossed generally or specially to himself shall not, in case the title to the cheque proves defective, incur any liability to the true owner of the cheque by reason only of having received such payment. Explanation: A banker receives payment of a crossed cheque for a customer within the meaning of this section notwithstanding that he credits his customer's account with the amount of the cheque before receiving payment thereof. The provisions of the above section has been applied to drafts as per Section 131A of the Negotiable Instruments Act. ii. Conditions for Protection: Though Section 131 grants protection to a collecting banker, the protection is conditional. For the collecting banker to claim the protection under Section 131 he has to comply with certain conditions and they are: 1. 2. 3. 4. The collecting banker should have acted in good faith. He should have acted without negligence. He should receive payment for a customer. The cheque should be crossed generally or specially to himself.

95 7.3 DUTIES OF THE COLLECTING BANK


Since no specific enactment has been laid down prescribing the nature of duties a banker will have to observe while acting as a collecting banker, Section 131 of the Negotiable Instruments Act, which affords protection to the collecting bank requires amongst other conditions that the bank should not have been negligent. To show that the bank has not been negligent the bank will have to prove that it has taken all precautions that would be required of a prudent banker in collecting a cheque. Over the years based on practice and judicial pronouncements, these precautions have been laid down as duties imposed on bankers, the non-compliance of which can make the bank liable on the grounds of negligence. We shall now individually examine these duties. i. Duty to Open the Account with References and Sufficient Documentary Proof: The duty to open an account only after the new account holder has been properly introduced is too well ingrained in the today's banker's mind that it would be impossible to find an account without introduction. The necessity to obtain introduction of a good customer is to keep off crooks and fraudsters who may open accounts to collect forged cheques or other instruments. As an added precaution, RBI has insisted that while opening accounts photograph of the customer and sufficient documentary proofs for constitution and address be obtained under the applicable KYC norms. In this regard, the English Decision Ladbroke vs Todd (1914) 30 TLR 433 can be referred to. In this case, a thief stole a cheque in transit and collected the same through a bank, where he had opened an account without reference and by posing himself as the payee whose signature the thief forged. After collection of the cheque, the thief withdrew the amount. The bank was held liable to make good the amount since it acted negligently while opening the account inasmuch as it had not obtained any reference. In Syndicate Bank vs Jaishree Industries and Others AIR 1994 Karnataka 315, the appellant opened an account in the name of M/s Axle Conductor Industries Ltd. by the Proprietor, R.K. Vyas. A person Mr Nanjunde Gowda, who was having a small shop at the address given by the account holder, gave the introduction. The address of the account holder, given by the account holder, was just opposite the appellant bank. In the account opening form, the name of the account holder was given as M/s Axle Conductor Industries by the Proprietor R.K. Vyas. No information was sought or inquiry neither held as to the incorporation of the account holder nor was the memorandum of association, resolution, etc., scrutinised. On 3 January 1979, partners of Firm 'A' purchased a draft for Rs. 2,51,125 from State Bank of India, Ahmednagar, in favour of M/s Axle Conductor Industries Ltd. The draft was deposited in the account with the appellant on 5 October 1979 and the amount was collected by the appellant and credited to the account on 9 October 1979. On 10 October 1979, the monies were withdrawn from the account. The partners of 'A filed a suit against the appellant and State Bank of India for recovery of Rs. 2,51,125 wrongly collected by appellant and paid by State Bank of India. The High Court held that there was failure to follow the proper procedure for opening account in the name of a limited company, that the account was opened as if it was a proprietary concern, the staff of the appellant bank did not bestow sufficient care even to notice the word 'Ltd.' on several occasions, such as, at the time of opening of the account or withdrawal of amounts from the account. The High Court felt that having accepted the application as if it was an application by a proprietary concern, strangely the appellant bank allowed the account to operate in the name of the limited concern. There was, therefore, lack of care on the part of the appellant bank in the entire transaction. The conditions to be satisfied for claiming protection under Section 131 of the Negotiable Instruments Act are: (a) that the banker should act in good faith and without negligence in receiving payment, i.e. in the process of collection;

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(b) that the banker should receive payment for a customer, i.e. act as mere agent in the collection of the cheque, and not on his account as holder; (c) that the person for whom the banker acts must be his customer; (d) that the cheque should be one crossed generally or specially to himself. The High Court stated that if the draft was drawn in favour of a fictitious person, it could not be said that the ownership stood transferred to a non-existent person for the purpose of examining the question whether the bank as a collecting banker acted negligently or not. The ownership would pass to the true owner. The High Court did not consider it necessary to decide as to what extent a person obtaining a draft in favour of a fictitious person would lose the ownership in favour of a bona fide 'holder in due course'. In view of the aforesaid, the appellant bank was held to have acted without taking any care, and was found negligent throughout and was not entitled to the protection under Section 131 of the Negotiable Instruments Act. In Indian Bank vs Catholic Syrian Bank AIR 1981 Mad 129, the Madras High Court had occasion to consider negligence of the collecting banker, which had opened an account after proper introduction. Briefly, the facts were that one D had opened an account with Salem branch of bank 'A'. A customer of that branch had taken D to the said branch and had informed the manager that D was a man from Indore and that .he wanted to open a bank account to enable him to purchase carpets from Salem. Although the bank A had claimed that the customer, who had introduced D, was a well-known customer of the bank A and was a leading merchant of Salem and had a large volume of business, it was found in the evidence recorded by the Court that these claims were not true. The introducer had an account and had some fixed deposits with the bank A. The transactions were for paltry amounts and the amount standing to the credit of the introducer at the relevant time, was only Rs. 192.57. On 12 June 1969, M obtained a demand draft for Rs. 20 from the branch at Singanallur of the bank B. The draft was drawn on the branch office of bank B in favour of D and company. By means of a clever forgery, the draft was altered for Rs. 29,000 drawn in favour of D. D presented the draft on 13 June 1969 for credit to his account opened with Salem branch of bank A and the amount was collected by bank A from bank B and credited to the account of D. On 14 June 1969, the Salem branch of bank B came to know from its Singanallur branch that the draft issued for Rs. 20 and was drawn in favour of D and company, payable at Cochin and that no draft for a sum of Rs. 29,000 had been issued. At once the Salem branch of bank A was contacted and was informed of the fraud, but unfortunately by then bank A had already paid a large part of the draft amount to D under a self cheque. Bank B (Paying banker) filed the suit against bank A (collecting banker) for recovery of Rs. 29,000 on the ground that the collecting banker had been negligent while opening an account in the name of D and by reason of its negligence and want of good faith, the forged draft got to be wrongly converted. The High Court observed that the collecting banker had opened the account in the name of D on a mere introduction of one of its account holders, knowing fully well that the said account holder was not a well known leading merchant and had no large business with it at the relevant time. Further, the collecting banker had not independently questioned D about his business and his creditworthiness before allowing him to open an account. When D stated that he had come from Indore, the manager of the collecting banker did not even care to find out his permanent address, more so, when in the application for opening account filed by D, the address given was of that of the introducer. Moreover,

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when D told the manager of collecting banker that he had not until then opened any account although he had come from Indore to Salem to do business, the collecting banker, before opening the account, should have been more alert. ii. Duty to Confirm the Reference where the Referee is not known or has given Reference in Absentia: However, as a matter of practice, bankers in India require introduction by an existing customer of the bank, this may not always be possible especially when the branch is newly opened. In such cases, the customers are required to get references from known persons in the locality or from the existing bankers. In such case, the banker is required to make enquiries with the referee to confirm that the person whose account is newly opened is a genuine person. Under the current KYC norms, the authenticity of the customer is required to be verified by calling for a direct identification document like a copy of passport, PAN number issued by IT department, Identity certificate issued by Election authorities or identification issued by the employer if the company is a prominent one. The address can be authenticated by obtaining a copy of a electricity or Telephone bill, or copy of ration card, or copy of any bank statement where the customer has already an account. Only in the case of very small customers, this requirement is waived and a third party introduction is accepted. In Harding vs London Joint Stock Bank [1914] 3 Legal Decision Affecting Bankers 81, an account was opened for a new customer after complying with the necessary formalities. The account was not opened by deposit of cash, as is the usual practice but was opened by paying in a third party cheque. The bankers in the case made enquiries with the customer who thereupon produced a forged letter issued by his employer giving him power to deal with the cheque. It was thereafter found that the cheque was stolen by the customer and credited to his account. The bank was held negligent for failure to make necessary enquiries from the employer as to whether the customer who was an employee had, in fact, the necessary power to deal with the cheque. iii. Duty to Ensure Crossing and Special Crossing: It is the duty of the banker to ensure that the cheque is crossed specifically to himself and if the cheque is crossed to some other banker they should refuse to collect it. Similarly, where the cheque is crossed to a specific account then crediting the same to another account without necessary enquiries would make him liable on the grounds of negligence. In case of 'non-negotiable' crossing a banker cannot be held negligent merely because of collection of such instruments. In the case of Crumpling vs London Joint Stock Bank Ltd. [1911-13] All England Rep 647. It was held that a non-negotiable crossing is only one of the factors amongst others to be considered to decide about the bankers, negligence and that the mere taking of a non-negotiable cheque cannot be held to be evidence of negligence on the part of the bankers. iv. Duty to Verify the Instruments or any Apparent Defect in the Instruments: Sometimes the instrument, which is presented for collection would convey to the banker a warning that a customer who has presented the instrument for collection either is committing a breach of trust or is misappropriating the money belonging to some other. In case the banker does not heed the warning, which is required of a prudent banker, then he could be held liable on the grounds of negligence as can be seen from the following cases: (a) In Underwood Ltd. vs Bank of Liverpool Martin Ltd. [1924] 1 KB 775, the Managing Director of a company paid into his private account large number of cheques which were to be paid into the company's account and the bank was held negligent since it did not make enquiries as to whether the managing director was, in fact, entitled to the amounts represented by these cheques. (b) In Savory Company vs Llyods Bank [1932] 2 KB 122, the cheques which were payable to the employer was collected by the employee in a private account opened by him and the bank was

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held liable for negligence. In this case, two dishonest clerks of a stock broker stole bearer cheques belonging to their employer which were collected in an account maintained by one of the clerks and in another account in his wife's name. It was held that the bank had been negligent in opening the clerk's account inasmuch as they had not obtained his employer's name while opening the account and that in the case of his wife's account the bank was negligent inasmuch as it had not obtained the husband's occupation and his employer's name while opening the account. (c) In the case of Australia and New Zealand Bank vs Ateliers de Constructions Electriques de Cherleroi [1967] 1 AC 86 PC, an agent paid his principal's cheque into his personal account and the bank was charged with conversion. However, the bank defended the same because there was implied authority from the principal to his agent to use his private account for such purpose. Though the banker was negligent in dealing with the cheques without specific authority the bank escaped liability since it was found that the principal had, in fact, authorised his agent to use his private account. (d) In Morrison vs London County and Westminster Bank Ltd. [1914-5] All ER Rep 853, the manager of the plaintiff was permitted to draw cheques per pro his employer and he drew some cheques payable to himself which he collected into his private account. The bank was held negligent for collecting such cheques without making necessary enquiries even though there was a clear indication that the manager was signing as an agent of the firm. v. Duty to take into Account the State of Customer's Account: The collecting banker is required to take into account the status of the customer and the various transactions that have taken place in the customer's account to know the circumstances and the standard of living of the customer. If for example, a person is an employee and the nature of his employment is that of a clerk, his salary would be approximately known to the bank and any substantial credits by way of collection of cheques would be suspected and it would be the duty of the banker to take necessary precautions while collecting such cheques. In Nu-Stilo Footwear Ltd. vs Lloyds Bank Ltd. [1956] 7 Legal Decisions Affecting Bankers P. 121, the plaintiffs who were manufacturers of ladies footwear were defrauded by their secretary and works accountant who converted nine cheques payable to the plaintiffs into his account. The secretary opened the accounts in the defendant's bank in a false name and as reference gave his real name. The bank thereupon called the reference and got a satisfactory reply, which included the fact that the account holder had recently come down from Oxford and intended setting up a business of his own. The secretary thereupon presented nine cheques totally aggregating to 4855. Since these cheques were drawn on the plaintiffs, they sued the defendant bank who had collected the cheques. The Court held that the collecting bank was negligent inasmuch as the collecting bank did not take necessary precautions because the amounts collected were inconsistent with the business of the account holder and therefore necessary enquires should have been made by the bank. vi. Negligence of Collecting Bank in Collecting Cheques Payable to Third Parties: The collecting bank has to make necessary enquiries before any third party cheques, are collected on behalf of its customer. In Ross vs London County Westminster and Parrs Bank Ltd. [1919] 1 KB 678, cheques payable to 'the Officer in charge, Estate Office, Canadian Overseas Military Force' were used by an individual to payoff his debts. There was an instruction in all the cheques that it was negotiable by the concerned officer. However, it was held that the fact that the cheques were drawn in favour of the officer in charge should have put the banker on enquiry and since no such enquiry was made by the banker the bank is liable on the grounds of negligence.

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7.4 LET US SUM UP However, the Negotiable Instruments Act does not specifically lay down the duties of a collecting banker while collecting cheque, it gives protection to a collecting banker under Section 131. From Section 131, it can be deduced that a banker to claim protection should comply with certain basic duties failing which he will not be entitled to seek protection under Section 131. These duties are: 1. The collecting banker should have acted in good faith. 2. He should have acted without negligence. 3. He should receive payment for a customer. 4. The cheque should be crossed generally or specially to himself. In concluding whether the bank had been negligent or not the following matters would be relevant and if the banker has failed to carry out any of the following duties then he can be liable on the grounds of negligence. These duties are: (i) To open the account with proper references and documentary proof. (ii) To confirm the reference, where the referee is not known and or does not come personally. (iii) To ensure crossing and special crossing. (iv) To verify the instruments or any apparent defect in the instruments. (v) To take into account the state of customer's account. (vi) To make enquiries by the collecting bank in collecting cheques payable to third parties. 7.5 KEYWORDS Conversion; Non-negotiable crossing. 7.6 CHECK YOUR PROGRESS 1. State whether true or false. (i) The statutory protection to a collecting banker is as per Section 6 of the Indian Contract Act. (ii) Section 131A of the Negotiable Instruments Act extends the protection granted to a banker while receiving payment of a cheque, and drafts, (iii) The duties of collecting bank to claim protection has been laid down under the Indian Contract Act and Banking Regulation Act. (iv) In the absence of proper reference the banker can be held liable on the grounds of negligence, (v) It is necessary for the banker to make enquiries regarding the reference given by the customer.

7.7 ANSWERS TO 'CHECK YOUR PROGRESS'


1. (i) False; (ii) True; (iii) False; (iv) True; (v) True

L.K.A.B.8

INDEMNITIES

STRUCTURE 8.0 8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8 8.9 Objectives Introduction Contract of Indemnity Defined Distinctive Features of Indemnity Contract and Guarantee Scope and Application of Indemnity Contracts to banks Rights of an Indemnity Holder Let Us Sum Up Keywords Check Your Progress Answers to 'Check Your Progress'

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8.0 OBJECTIVES After studying this unit, you should be able to understand: the definition and concept of indemnity; distinctive features of an Indemnity Contract and how it differs from a guarantee; when and why bankers take indemnities; know the rights of an indemnity holder; know the liabilities of the indemnifier. 8.1 INTRODUCTION The word indemnity means 'to save from loss'. This loss could be either due to the act of the party giving the indemnity or due to the act of a third party. The law regarding indemnity as laid down in Sections 124 and 125 of the Indian Contract Acts, is not exhaustive. The law of indemnity is much wider than as stated in the Contract Act, since Courts applying the principles of equity have developed it. A Contract of Indemnity is a contingent contract, i.e. its performance is made dependent upon the happening or non-happening of some event. 8.2 CONTRACT OF INDEMNITY DEFINED Section 124 of the Indian Contract Act, 1872 defines contract of indemnity as follows: Sectionl24. 'Contract of Indemnity' defined: A contract by which one party promises to save the other from loss caused to him by the conduct of the promisor himself or by the conduct of any other person, is called a 'Contract of Indemnity'. Section also gives an illustration of a Contract of Indemnity as follows: A contract to Indemnify B against the consequences of any proceedings which C may take against B in respect of a certain sum of Rs. 200, is called a contract of Indemnity. In the above definition, the person giving the promise is called the indemnifier and the person to whom the promise is made is called the indemnified or the indemnity holder. As stated, earlier the contract of indemnity as defined in the contract is narrow and not exhaustive and the law regarding indemnity is much wider than that as defined in the Contract Act. For example, all insurance contracts come within the ambit of a contract of indemnity, but are not dealt with under Section 124 of the Contract Act. Section 124 deals only with one particular type of indemnity, viz., where a person gives a promise to save another person from loss caused by either the conduct of the person giving the promise or by the conduct of any other person. Over and above the kind of indemnity stated in Section 124, there are cases where the Courts applying the principles of general law have held a person liable to indemnify, though the person never did undertake such a liability. The decision of the Privy Council in Secretary of State vs Bank of India Ltd. (AIR 1938 PC 191) best illustrates this point. In this case, Ms. G was the holder of a Government promissory note which she had handed over to Mr. A, her broker. Mr. A forged Ms. G's signature and endorsed it in his favour. Mr. A then endorsed it for value to the bank. The bank in good faith applied to the Government Public Debt Office to have the note exchanged in their name, which was done. Ms. G on being aware that she has been defrauded, sued the Government and recovered the appropriate damages. The Government in turn sued the bank to indemnify the Government against the loss suffered by them. The Court held the bank to be liable because under common law covering right of indemnity, the bank is responsible for an injury to a third party's rights. A contract of indemnity, though similar to a contract of guarantee differs on various counts. To know the difference between these two types of contracts we shall examine their respective features one by one in the next part.

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8.3 DISTINCTIVE FEATURES OF INDEMNITY CONTRACT AND GUARANTEE i. Number of Parties to the Contract of Indemnity: In a contract of indemnity there are two parties, viz., the indemnifier and the indemnified whereas in a contract of guarantee there are three parties, viz., the debtor (the person on whose behalf the guarantee is given), the creditor (the beneficiary, the person to whom the guarantee is given) and the surety (the person who gives the guarantee). ii. Contingent Risk: In an indemnity, the risk is contingent whereas in a guarantee the liability is subsisting. , iii. Nature of Liability: In a contract of indemnity, the indemnifier is required to make good the loss as soon as it occurs and he cannot rely on the fact that the person on whose behalf the indemnity is given has not made good the loss, whereas in a contract of guarantee, the surety's liability is secondary and the principal debtor is primarily liable. iv. Number of Contracts: There are only two parties to a contract of indemnity and as such only one contract. However, in a contract of guarantee there are at least three contracts: one between the debtor and creditor, the other between the creditor and the surety and the third between the surety and the debtor. v. Purpose of Contract: An indemnity is for the reimbursement of a loss whereas a guarantee is for the security of the creditor. 8.4 SCOPE AND APPLICATION OF INDEMNITY CONTRACTS TO BANKS As far as a banker is concerned, the law relating to indemnities is of great importance. Customers of the bank who have lost a demand draft or travellers' cheque are required to give an indemnity before the issuance of a fresh instrument in lieu of the lost one. These indemnities are required since the bank has to protect itself from any subsequent claim made by a person who may have for value received these instruments. In some cases over and above the indemnity, banks ask for surety. This is usually done in cases where the amount involved is quite substantial or the banker does not know the customer well enough, since the customer must have had only one or two dealings with the banker. Indemnity bonds are also insisted by bankers while issuing duplicate FDRs, settling death claims to heirs or while issuing duplicate pay orders (bankers' cheque), etc. In the indemnity taken by the bank the customer undertakes to protect the bank from any loss or damage and for costs incurred. In most states, these indemnities are stamped as an agreement. However, if they are witnessed, they would be treated as an indemnity bond thereby being liable for payment of ad valorem stamp duty. 8.5 RIGHTS OF AN INDEMNITY HOLDER Section 125 of the Contract Act lays down the rights of an indemnity holder. 125. 'Rights of indemnity holder when sued: The promisee in a contract of indemnity, acting within the scope of his authority, is entitled to recover from the promisor the following: i. All damages which he may be compelled to pay in any suit in respect of any matter to which the promise to indemnify applies, ii. All costs which he may be compelled to pay in any such suit if, in bringing or defending it, he did not contravene the orders of the promisor, and acted as it would have been prudent for him to act in the absence of any contract of indemnity, or, if the promisor authorised him to compromise the suit, iii. All sums which he may have paid under the terms of any compromise of any such suit, if the compromise was not contrary to the orders of the promisor, and was one, which it would have

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been prudent for the promisee to make in the absence of any contract of indemnity, or, if the promisor authorised him to compromise the suit. A reading of the above Section shows that the rights of an indemnity holder are subject to: (a) his acting within the scope of his authority; (b) he does not contravene the specific directions of the promisor. In case the indemnity holder does not violate the above two conditions, he is then entitled to be indemnified by the indemnifier to the extent of: (a) the damages paid by him; (b) the costs required either to file the suit or defend it; (c) any amounts paid by him pursuant to a compromise in the suit provided that the compromise was not contrary to any of the order or directions of the indemnifier and the compromise was such that it was an act of prudence in the absence of a contract of indemnity. 1. Damages: As regards damages, it is to be noted that High Courts have differed in the views as to when the indemnifier's liability commences. Some High Courts have held that the liability commences only from the time the indemnity holder actually incurs loss, whereas some others have held that an indemnity holder can compel the indemnifier to put him in a position to meet the liability. The former view is to be preferred. 2. Costs: As regards costs, costs paid to solicitors, travelling expenses and also costs reasonably incurred in resisting or reducing or ascertaining the claim, may be recovered. The general principle in computing the costs is that it should be such as, would a reasonable man think if necessary to incur. 3. Sums paid on Compromise: As per Section 125, if the indemnity holder acts within the scope of his authority, then he is entitled to recover from the indemnifier all the sums that he may have paid pursuant to a compromise in a suit, provided however that (a) such compromise was not contrary to the orders of the indemnifier; (b) such compromise was prudent to be made by the indemnity holder in the absence of any contract of indemnity; (c) the indemnifier had authorised the indemnity holder to compromise the suit. The Madras High Court in Venkataramana vs Mangamma AIR 1944 Mad. 457, has held that even in the absence of a notice to the indemnifier (promisor), the compromise would bind him, if not contrary to the orders of the promisor, and is entered bona fide and without any collusion and is not imprudent. 8.6 LET US SUM UP Sections 124 and 125 of the Indian Contract Act respectively, lays down the laws of indemnity and the rights of indemnity holder. These sections are not exhaustive and the general law of indemnity, which is wider, has been applied in cases not covered by Sections 124 and 125. The indemnifier has to compensate the indemnity holder who is entitled to the damages suffered, costs incurred and to recover any sums paid in a compromise of any suit. Bankers obtain indemnities to protect themselves from any loss that they may incur while issuing duplicate of instruments like demand drafts or travellers' cheques, FDRS, pay-orders, etc. 8.7 KEYWORDS Indemnity; Indemnifier; Indemnity holder.

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8.8 CHECK YOUR PROGRESS A. 1. Fill in the blanks, (i) Section ____ of the Indian Contract Act defines an indemnity. (ii) A person promising to save another from loss is called (iii) _________ is a person who is promised to be saved from loss. 2. State whether the statements are true or false. (i) Contract of Indemnity as defined in the Contract Act is exhaustive, (ii) Insurance Contracts are not contracts of indemnity. B. 1. Fill in the blanks. (i) There are__________ parties to a contract of indemnity. (ii) Indemnifiers liability in a contract of indemnity is _________ . 2. State whether the following statements are true or false. (i) There are three parties to a contract of indemnity, the indemnifier, the indemnity holder and the person on whose behalf the indemnity is given, (ii) Indemnifter's liability occurs only if the indemnity holder suffers loss. C. 1. State whether the statements are true or false. (i) Customers as a matter of right and without an indemnity can obtain duplicate of demand drafts or travellers' cheques. (ii) Indemnities are required by banks purely as a formality and does not serve any other purpose, (iii) The indemnity obtained by banker only protects him from the actual value of the instrument. D. 1. What are the two conditions that an indemnity holder is bound to comply before being indemnified for a loss? 2. To what extent is the indemnity holder entitled to be indemnified? 3. In case of compromise the indemnity holder has to satisfy certain conditions before recovering the loss from the indemnifier, what are these conditions? 4. State whether the statements are true or false. (i) An indemnity holder can act beyond his authority. (ii) An indemnity holder can be compensated only for damages and not for the costs incurred by him. (iii) An indemnity holder is entitled to compromise a suit as thought fit by him though contrary to the orders of the indemnifier.

8.9 ANSWERS TO 'CHECK YOUR PROGRESS'


A. B. C. D. 1. (i) 124; (ii) Indemnifier; (iii) Indemnity holder 2. (i) False; (ii) False 1. (i) 2; (ii) Primary 2. (i) False; (ii) True 1. (i) False; (ii) False; (iii) False. 1. (i) He should act within the scope of his authority and should not contravene any directions of the indemnifier. 2. To the extent of the damages suffered, costs incurred and sums paid for compromise of any suit. 3. (i) The compromise was not contrary to the orders of the indemnifier. (ii) Such compromise was prudent. (iii) the indemnifier had authorised the indemnity holder to compromise the suit. 4. (i) False; (ii) False; (iii) False

BANK GUARANTEES

STRUCTURE 9.0 9.1 9.2 9.3 9.4 9.5 9.6 9.7 9.8 9.9 9.10 Objectives Introduction Bank Guarantees Various Ttypes of Bank Guarantees Banker's Duty to Honour Guarantee Issuance of Bank Guarantee - Precautions to be taken Payment Under Bank Guarantee - Precautions to be taken Let Us Sum Up Keywords Check Your Progress Answers to 'Check Your Progress'

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9.0 OBJECTIVES After studying this unit, you should be able to understand: various kinds of bank guarantees, their nature and scope; the precautions to be taken while issuing a bank guarantee; the precautions to be taken on invocation of a bank guarantee.

9.1 INTRODUCTION In commercial transactions, bank's customers are sometimes required to give a bank guarantee. This is mostly as an alternative to keep cash as a security deposit. The third party who seeks the guarantee, not being aware of the customer's financial standing, prefers a bank guarantee. In turn, the bank, which very well understands the financial standing of the customer, undertakes to guarantee the customer's financial commitments or the performance of contracts by him. The bank charges a commission for this service which depends on the security available and the financial stability of the customer. In this Chapter, you will learn what exactly is a bank guarantee, the various types of bank guarantees, the precautions to be taken while issuing a bank guarantee and on making payment on a bank guarantee the distinction between a bank guarantee and an ordinary guarantee, why in a bank guarantee the banker's duty to honour the guarantee is of prime importance and the limit to which this duty can be extended. 9.2 BANK GUARANTEES The term 'bank guarantee' briefly stated means: a guarantee given by a bank to a third person, to pay him a certain sum on behalf of the bank's customer, on the customer failing to fulfil any contractual or legal obligations towards the third person. From the above, it can be seen that there should first be a commitment on the part of the customer to fulfil certain obligations to a third party. This could be contractual or legal, i.e. imposed by law. This commitment of the customer is guaranteed by a bank and if the customer fails to honour his commitment the banker pays the amount, it has promised to pay. Once the bank gives a guarantee, then its commitment to honour the guarantee is onerous and as such, it is prudent that a banker before issuing a guarantee on behalf of his customer takes appropriate security and understands his rights and duties. Before we embark on a study of the banker's duty to honour guarantees and the onerous obligation he undertakes on behalf of the customer when he issues a guarantee, it would be necessary to understand the various kinds of guarantees that a banker usually issues. 9.3 VARIOUS TYPES OF BANK GUARANTEES Though under law, bank guarantees have not been classified by the nature of the underlying contract entered into by the customer, in practice such classification has been made. Though there are various types of guarantees, the important ones, which a banker would be regularly required to issue in the course of his business are as follows: i. Financial Guarantee: These are guarantees issued by banks on behalf of the customers, in lieu of the customer's requirement to deposit a cash security or earnest money. These kinds of guarantees are mostly issued on behalf of customers/contractors dealing with Government departments. Such guarantees are also issued in situations where a party is required to deposit cash as a part of contract. Most Government departments insist that before the contract is awarded to contractor he should show that he is willing to perform the contract and to ensure that now frivulous tenders

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are mad, insist on an Earnest Money Deposit. However in lieu of the earnest money government departments are generally willing to accept a bank guarantee. This also helps the contractor who can utilise the funds for fulfilling his obligations under the contract. In case the contractor does not take up contract of awarded then the Government departments invoke the guarantee and collect the money from the banks. ii. Performance Guarantee: These are guarantees issued by the bank on behalf of its customer whereby the bank assures a third party, that the customer will perform the contract entered into by the customer as per the condition stipulated in the contract, failing which the bank will compensate the third party up to the amount specified in the guarantee. These types of guarantees are usually issued by bankers on behalf of their customers, who have entered into contracts to do certain things on or before a given date. Though the bank assures, that the conditions as stipulated in the contract will be complied with by the customer in practice, the banks on being served a notice of default by the third party pays over the amount guaranteed without going into the technicality of the contract. This is because, after a guarantee is issued, the contract of guarantee is independent of underlying commercial transaction and any claim as per terms of guarantee is required to be honoured. Though, in certain performance guarantees a clause is inserted, that proof of default of the customer is necessary, most bank guarantees do not insist on such proof. A mere demand from the beneficiary that there has been a default by the bank's customer is sufficient for the bank to make payment. This is so, since banks by the nature of their expertise prefer to deal with documents and they would not like to go beyond the contract and verify whether there has been a breach of the contract or not. This is because, generally the guarantee document makes it obligatory on the part of the issuing bank to honour their guarantee without going into the points of differences between the beneficiary and the principal on whose behalf he had issued the guarantee. iii. Deferred Payment Guarantee: Under this type of guarantee, the banker guarantees payment of instalments spread over a period. This type of guarantee is required, when goods or machinery are purchased by a customer on long-term credit and the payment is to be made in instalments on specified dates spread over more than a year. In terms of the contract of sale, the seller draws drafts (bills of exchange) of different maturities on the customer which are to be accepted by the customer. The banker guarantees due payment of these drafts. A deferred payment guarantee constitutes an undertaking on the part of the bank to make payments of deferred instalments to the seller (beneficiary) on the due dates, in the event of default by the customer (buyer). While issuing a deferred payment guarantee, the banker has to assess the ability and sources of funds of the customer to honour the payment of instalments on due dates.

9.4 BANKER'S DUTY TO HONOUR GUARANTEE


Bank guarantees are called 'the life blood of national and international commerce' and even though they are an offshoot of a primary contract between the debtor and creditor, these guarantees are independent commitments taken by bank on the behalf of their customers. In most bank guarantees, banks undertake to make payment merely on demand by the beneficiary. It is therefore absolutely necessary that irrespective of the underlying contract and any dispute between the parties to the contract, the bank makes payment, if the guarantee has been invoked properly. We shall now examine this duty of the banker to honour his commitment under a guarantee and the grounds on which payments can be refused. i. Bank's Obligation to Pay Primary (a) The obligation of a banker, to honour his commitment on a guarantee given by him being primary, casts a duty on the bank to honour it irrespective of the disputes between the beneficiary

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and the debtor. The first of the cases wherein the bank's commitment to honour its guarantee was discussed was the English case of R.D. Harbottle Ltd. vs National Westminster Bank Ltd. (1978) OB 146, wherein Justice Kerr held as follows: Such guarantees even though having their genesis in the primary contract between the parties are nevertheless autonomous and independent contracts and a bank, which has given a performance guarantee must honour that guarantee according to its terms. It is not concerned in the least with relations, between the supplier and the customer, nor with the question whether the supplier has performed his contracted obligations or not, nor with the question whether the supplier is in default or not and the only exception is when there is a clear fraud, of which the bank has notice. (b) The above principle has been accepted by Courts in India and they have refused to grant injunctions against banks from making payment under the guarantee except in cases of fraud or special equities in favour of the person on whose behalf the guarantee has been issued. The decision of the Calcutta High Court in Texmaco Ltd. vs State Bank of India AIR (1979) Cal 44, the first among the Indian cases illustrates the duty imposed on a bank to honour its guarantee. In this case, the bank had issued a guarantee to STC on behalf of M/s Texmaco Ltd., wherein the bank irrevocably and unconditionally guaranteed the due performance of the contractual obligations of M/s Texmaco and in case of default by Texmaco, the bank, on first demand by STC, guaranteed payment of the amount without any contestation, demur or protest and/or without reference to Texmaco and/or without questioning the legal relationship subsisting between Texmaco and STC. The guarantee was invoked by STC upon which Texmaco filed a suit for injunction to restrain the bank from making any payment. The High Court held that: In the absence of such special equities and in the absence of any clear fraud, the bank must pay on demand, if so stipulated, and whether the terms are such must have to be found out from the performance guarantees as such. Here though the guarantee was given for the performance by Texmaco in an orderly manner their contractual obligation, the obligation was taken by the bank to repay the amount on 'first demand' and 'without contestation, demur or protest and without reference to Texmaco and without questioning the legal relationship subsisting between STC and Texmaco'. It further stipulated, as I have mentioned before, that the decision of STC as to the liability of the bank under the guarantee and the amounts payable thereunder shall be final and binding on the bank. It has further stipulated that the bank should forthwith pay the amount due 'notwithstanding any dispute between STC and Texmaco'. In that context, in my opinion the moment, a demand is made without protest and contestation, the bank has obliged itself to pay irrespective of any dispute as to whether there has been performance in an orderly manner of the contractual obligation by the party. The Supreme Court has also considered the liability of a banker on a guarantee and after referring to the various English decisions and the decisions of various High Courts held in UP Co-operative Federation vs Singh Consultant [1988 (1) SCC 174] that commitments of banks must be honoured free from interference by the Courts. Otherwise, trust in commerce, internal and international, would be irreparably damaged. It is only in exceptional cases, that is to say, in case of fraud or in case of irretrievable injustice be done, the Court should interfere. LIABILITY OF BANK UNDER A GUARANTEE GIVEN ON BEHALF OF A COMPANY ORDERED TO BE WOUND UP In Maharashtra Electricity Board, Bombay vs Official Liquidator, High Court of Ernakulam and Another (AIR 1982 SC. 1497), the Supreme Court had occasion to consider the liability of a bank on a guarantee

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given by it on behalf of a company that was being wound up, the facts of which; in a nutshell are as follows: The Cochin Malleable Private Limited (Company) entered into a contract with Maharashtra State Electricity Board, Bombay (Board) for supply of goods from time to time. As per the terms of the contract, the company furnished a bank guarantee for Rs. 50,000 as earnest money deposit. As per the guarantee given by Canara Bank Limited (Bank), the bank agreed unequivocally and unconditionally to pay within forty-eight hours on demand in writing from the board a sum not exceeding Rs. 50,000. On 30 July 1973, a petition for winding up of the company was presented and the High Court, Kerala, on 16 September 1974, ordered the company to be wound up. On 27 August 1973, the board called upon the bank to pay the guarantee amount of Rs. 50,000 followed by several reminders and final demand was made on 23 July 1974. On 4 November 1974, the Bank wrote to the official liquidator stating that the company was liable to the bank for payment of Rs. 1,64,353.12 which included the guaranteed amount. Thereupon, the official liquidator filed an application before the company Judge, praying for an order restraining the board from realising the amount covered by the bank guarantee on the ground that since the company was ordered to be wound up, the board could not claim payment under the bank guarantee. The learned company Judge upheld the plea of the official liquidator and issued an order restraining the board from realising the amount from the bank. The board filed an appeal to the Division Bench of the High Court, which was also dismissed. The board thereupon approached the Supreme Court. The Supreme Court held that: Where under a letter of guarantee the bank has undertaken to pay any amount not exceeding Rs. 50,000 to the board, within forty-eight hours of the demand and the payment of the amount guaranteed by the bank was not made dependent on the proof of any default on the part of the company in liquidation, the bank was bound to make payment to the board. The board was not concerned with what the bank did in order to reimburse itself after making the payment under the bank guarantee. It was the responsibility of the bank to deal with the securities held by it in accordance with law. The Supreme Court observed that under Section 128 of the Contract Act, the liability of the surety is co-extensive with that of the principal debtor, unless, it is otherwise provided in the contract. Further, a surety is discharged under Section 134 by any contract between the creditor and the principal debtor by which the principal debtor is released or by any act or omission of the creditor, the legal consequence of which is the discharge of the principal debtor. But a discharge which a principal debtor may secure by operation of law in bankruptcy (or in liquidation proceedings in the case of a company) would not absolve the bank from its liability under the bank guarantee.

LIABILITY OF BANKS UNDER A GUARANTEE WHEN THE MAIN CONTRACT IS SUSPENDED The question whether the bank is absolved of its liability under a guarantee issued by it when the main contract is suspended by a statute was considered by the Bombay High Court in Messrs SCII (India) Limited vs Indian Bank and Another (AIR 1992 Bom. 121). The facts of the case are as follows: For carrying out erection, testing and commissioning of IP pipe works, the company engaged the services of a contractor. At the request of the contractor, the bank furnished a performance guarantee where under the bank undertook to pay to the company on demand 'any and all monies payable by the contractor to the extent of Rs. 10,72,806 at any time up to 30 June, 1989 without demur, reservation, contest, recourse of protest and/or without reference to the contractor'. The Government of West Bengal had issued a notification under which the contractor was declared as an unemnlovment relief undertaking under the West Bengal Act, 1972, and had suspended all contracts

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On invocation of the guarantee the contractor, therefore, submitted that the contract of erection, etc., entered into by the contractor with the company stood suspended. On behalf of the company, it was submitted that the bank guarantee was an independent contract between the bank and the company and was not affected or suspended by operation of the above referred to Act or the notification. The High Court observed that the company had not invoked the guarantee fraudulently or mala fide. The High Court pointed out that according to the decision of the Bombay High Court and Supreme Court, the contract of bank guarantee is an independent and separate contract. The High Court noted, that in several Supreme Court decisions, particularly in M.S.E.B. Bombay vs Official Liquidator, AIR 1982, S.C. 1497, and in State Bank of India vs Messrs Saksaria Sugar Mills Limited, AIR 1986, S.C. 868, it was held that the liability of the guarantor to pay was not affected by suspension of liability of the principal debtor under some statutory provisions. In the result, the High Court refused to grant any injunction restraining the bank from making payment under the bank guarantee more so when there was no special equity in favour of the contractor. From the above decisions, it can be seen that the liability of the bank is not dependent on the underlying contract but is an independent contract which the Courts would enforce except in case of fraud. ii. Exceptions (a) Cases of fraud: The Supreme Court in United Commercial Bank vs Bank of India AIR 1981 SC 1426 observed as follows: Except possibly in clear case of fraud of which the banks have notice, the Courts will leave the merchants to settle their disputes under the contracts by utilisation or arbitration as available to them or as stipulated in the contracts. Fraud, has been held to be one of the exceptions to the general rule regarding the contracts of guarantee. A banker, who has knowledge of fraud, can therefore refuse payment of the amount guaranteed. The question however, would arise as to how a banker can decide as to whether a fraud has been committed or not. In such cases, it is advisable that the banks inform their customer about the invocation of the guarantee by the creditors and the banks intention to pay within a given time if the unless restrained by an injunction order of a court. This would relieve the bank of the task of judging as to whether a fraud has been committed or not. On this point the observations of Supreme Court in UP Co-operative Federation vs Singh Consultants 1988 (1) Section 174 is worth noting, whether it is a traditional letter of a credit or a new device like performance bond or performance guarantee, the obligation of banks appears to be the same. If the documentary credits are irrevocable and independent, the banks must pay when demands are made. Since the bank pledges its own credit involving its reputation, it has no defence except in the case of fraud. The bank's obligations, of course should not be extended to protect the unscrupulous seller, that is, the seller who is responsible for the fraud. However, the banker must be sure of his ground before declining to pay. The nature of the fraud that the Courts talk about, is fraud of an 'egregious nature as to vitiate the entire underlying transaction'. It is fraud of the beneficiary, not the fraud of somebody else. If the bank detects, with a minimal investigation, the fraudulent action of the seller the payment could be refused. The bank cannot be compelled to honour the credit in such cases. However, it may be very difficult for the bank to take a decision on the alleged fraudulent action. In such cases, it would be proper for the bank to ask the buyer to approach the court for an injunction. M/s Escorts Limited vs Messrs Modern insulators and Another AIR 1988 Delhi 345 also illustrates the point that banks in case of doubt should seek appropriate direction from the Court. In this case, the

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Escorts supplied generator sets to Modern Insulators the performance of which were guaranteed by the bank. Modern invoked the guarantee, whereupon Escorts moved the Court to restrain Modern from recovering the amount and the bank from making payment of the guaranteed sum. The Court granted injunction since the guarantee was not invoked properly. Thereafter Modern invoked the guarantee once again but the bank did not pay. The matter came before the High Court and Escorts pleaded that Modern had played a fraud and hence were not entitled to the guaranteed amount. The High Court held that averments of fraud have to be pleaded and proved, which was not done by Escorts. Of importance in this judgement is the Court's remark as regards the conduct of the bank. The Court remarked that the bank should have approached the Court for appropriate directions if it had any doubts. Merely because an application for injunction was made, would not be a ground for the bank not to honour its commitment under the bank guarantee. It is therefore important to ensure that a clear cut case of fraud is established before a bank can refuse payment. (b) Special equity in favour of debtor: If there is a possibility of an irretrievable harm or injustice to one of the parties concerned, the Courts would adjunct the bank from making payment. As an illustration to the exception the Supreme Court cited and approved the decision of the US Court in Itek Corp. vs First National Bank of Boston (566 Fed. Supp 1210). In this case, an exporter in USA entered into an agreement with the Imperial Government of Iran and sought an order terminating its liability on stand by letters of credit issued by an American Bank in favour of an Iranian Bank as part of the contract. The relief was sought because of the situation created after the Iranian revolution when the American Government cancelled the export licences in relation to Iran and the Iranian Government had forcibly taken 52 American citizens as hostages. The US Government had blocked all Iranian assets under the jurisdiction of the United States and had cancelled the export contract. The Court upheld the contention of the exporter that any claim for damages against the purchaser if decreed by the American Courts would not be executable in Iran under these circumstances and realisation of the bank guarantee/letters of credit would cause irreparable harm to the Plaintiff. This contention was upheld. To avail of this exception, therefore, exceptional circumstances, which make it impossible for the guarantor to reimburse himself if he ultimately succeeds, will have to be decisively established. Clearly, a mere apprehension that the other party will not be able to pay, is not enough. In the Itek case there was a certainty on this issue. Secondly, there was good reason, in that case for the Court to be prima facie satisfied that the guarantors, i.e. the bank and its customer would be found entitled to receive the amount paid under the guarantee. 9.5 ISSUANCE OF BANK GUARANTEE - PRECAUTIONS TO BE TAKEN The liability of a bank under a guarantee depends on two fundamental criteria, viz., the amount guaranteed and the period of the guarantee. These two factors have to be specifically stated since in the absence of any one or both of these factors, the bank's liability could be unlimited either in the amount guaranteed or the period during guarantee. The banker should also obtain a counter guarantee from his customer on whose behalf he has given the guarantee, so that in case he is required to pay the guarantee he can fall back on the counter guarantee to claim the amount paid by him. We shall study these aspects in detail since in your day-to-day practice as a banker you will come across these aspects quite frequently. i. Amount Guaranteed: When the bank issues a guarantee, the first and foremost consideration that should weigh in a banker's mind is the amount of the guarantee he is called upon to issue. In the guarantee agreement, the amount has to be specifically stated, both in figures and words. While

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stating the amount, that the bank would guarantee to pay, care should be taken to state whether or not the amount is inclusive of all interests, charges, taxes and other levies. This is important to avoid unnecessary disputes regarding the liability of the bank. On invocation, the bank is liable to pay the whole amount of the guarantee unless as stated earlier a case of fraud has been brought to its notice. ii. Period of Guarantee: Banks always specify the period for which their guarantee subsists and an additional period during which a claim has to be made on the bank to make payment. The former period during which the guarantee subsists, is called the validity period and the latter, the claim period. If any default has been committed by the debtor (i.e. the bank's customer) it should be within the validity period. The claim period is only to facilitate the beneficiary to prepare and lodge claim, if any, under the guarantee. It is thus, necessary as a matter of great caution that this period be specified to the exact date, for example, 'this guarantee is valid up to 31 December 2007.' Once this outer limit for the bank to guarantee a default of the debtor is fixed, then the creditor can make a claim only if the default has occurred within this period, and for any default beyond this date the bank cannot be held liable. Once a default is made then the beneficiary has to make a claim on the bank to make good the loss within the claim period. Claim period in a guarantee: In a guarantee, it is necessary to provide for a period slightly longer than the validity period for the beneficiary to make a claim. The claim period is usually a few months more than the validity period of the guarantee. Since if the debtor were to commit a default on the last day of the validity period, then the beneficiary, at the earnest, invoke the same only on the next day. Taking into account the time to communicate the invocation, etc., the claim period should at least be fifteen to thirty days after the validity period. For example, if the validity period of the guarantee is up to 31 December 2007, then the claim period would normally be up to 31 January 2008. Amendment to Section 28 of Indian Contract Act and its effect on Bank Guarantee: Prior to the amendment of Section 28 of the Indian Contract Act, 1872 most bank guarantees had a standard clause at the end of their guarantee agreements. As per this clause, the beneficiary was required to enforce his claims within a period of three to six months, failing which, the bank's liability was extinguished and hence the rights of the beneficiary. The above clause was necessitated due to the fact that in the absence of it, Government departments and municipal bodies can file a suit against the bank under a bank guarantee within a period of thirty years after making a claim. The banks would therefore be required to carry forward this liability for a long period and thereby required to make provisions for the same in their balance sheets. Added to this, the customers cash margin and security would have to be retained either until the guarantee is returned by the beneficiary or until the expiration of the period of limitation. However, this clause, had been challenged before various High Courts and the High Courts have held that such clauses in the bank guarantees to be valid, and not violative of Section 28 of the Contract Act. However, from 1 January 1997, Section 28 of the Indian Contract Act has been amended due to which the standard limitation clauses in the bank guarantees by which the bank extinguished their liability as been declared illegal. As such, at present if a beneficiary were to invoke the guarantee within the claim period, for a default committed by the debtor during the validity period then in case the bank did not make payment, the beneficiary can sue the bank within the normal period as provided in the Limitation Act, 1963. This period under the Limitation Act is thirty years in case the beneficiary is Government department or municipal body and three years in all other cases. As such it is prudent to insist that the bank guarantee be returned after the claim period duly cancelled by the beneficiary or a certificate be obtained from the beneficiary that there are no claims under the

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guarantee, and until such time the cash margin and the security of the debtor (customer) has to be retained. iii. Counter Guarantee and Other Security: Though a bank guarantee is a contingent liability, it is always prudent for a banker to secure this contingent liability to cover himself in case it is enforced. This can be done by obtaining a counter guarantee-cum-indemnity executed by the customer in favour of the bank. The counter guarantee-cum-indemnity, should be carefully drafted to ensure, that in case the bank were to make payment on behalf of the customer, then the customer in turn 1 should not only make good the amounts paid by the bank to the creditor but also any expenses connected therewith including costs of attorney, any interest on delayed payment, taxes and other levies. It is to take care of all the above payments that the counter guarantee also includes an indemnity aspect. The counter guarantee should also include a clause that it would remain in force until the guarantee given by the bank subsists, viz., until the bank is duly discharged by the beneficiary or a certificate to this effect is issued by the beneficiary. Though a counter guarantee-cum-indemnity is taken as a security for every guarantee issued by the bank, its value would depend on the financial standing of the person/company giving the counter guarantee. As such, it is preferable that keeping in mind the financial worth of the counter guarantor necessary security in the form of tangible securities like fixed deposits, other paper securities or immovable properties, etc., are obtained or the existing charge of the debtor be also extended to cover the guarantee.

9.6 PAYMENT UNDER BANK GUARANTEE - PRECAUTIONS TO BE TAKEN


Before making payment, a banker has to ensure that the invocation of the guarantee has been properly made; failing which he may not have any recourse against the debtor. The banker should also see that no order of injunction has been passed by any Court of law prohibiting the bank from making payment. In case, a banker makes payment ii1 spite of there being an order by a competent Court in which the bank is a party, then the bank will be answerable for Contempt of Court. i. Proper Invocation of Guarantee: The bank while making payment on its guarantee has to be careful and ensure that the invocation has been properly made. There are divergent views as regards the proper manner in which a bank guarantee should be invoked. The Delhi High Court, in M/s Harprashad and Co. Ltd. vs Sudarshan Steel Mills, AIR 1980, Delhil74, had occasion to consider this question. In this case, the High Court took the view that:
The duty of the beneficiary in making the demand on the bank is like the duty of the plaintiff to disclose the cause of action in the plaint. Just as a plaint is liable to be rejected for non-disclosure of the cause of action, a demand by the beneficiary of the bank guarantee is liable to be rejected by the bank if it does not state the facts showing that the conditions of the bank guarantee have been fulfilled.

However, in contrast to the above views of the Delhi High Court, the Calcutta High Court in Road Machines (India) Pvt. Ltd. vs The Project and Equipment Corporation of India Ltd. and Another (AIR 1983 Cal91) held that: It is not necessary that a bank guarantee should be invoked in an exact and punctilious manner setting out the entire case of the beneficiary under the guarantee in the same way as setting out a cause of action in a plaint. A bank guarantee is a commercial document and is neither a statutory notice nor a pleading in a legal proceeding. A bank guarantee may be invoked in a commercial manner. The invocation would be sufficient and proper if the bank concerned understands, that the guarantee is being invoked by the beneficiary, in terms of the guarantee. As a banker, it would be prudent to verify that the invocation made is proper and in deciding whether the invocation made is proper the banker has to see among other things that the following requirements are satisfied:

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1. The invocation is within validity period. 2. The invocation amount is not more than the guaranteed amount. In case it is more then only the maximum amount stipulated in the guarantee need be paid. 3. The authority invoking the guarantee is competent or empowered to invoke the guarantee. In guarantees issued to Government departments the authority to invoke is usually designated by the post, so as to avoid any later problems by change in the person holding the post. The banker has to ensure that the person invoking has the powers to do so. The Supreme Court in its decision in Hindustan Construction Co. Ltd. vs State of Bihar (1999) 8 SCC436 has held that where as per the terms of the guarantee the invocation was to be done by the chief engineer, the invocation by the executive engineer was wholly wrong and the refusal of the bank to make payment was valid. ii. No Injunction Prohibiting Payment: Though Courts are reluctant to interfere with the bank guarantee, there have been instances where Courts have granted injunction restraining the banks from making payment under a guarantee. In one such case that came up before the Calcutta High Court injunction was granted. The facts of the case in Messrs G.S. Atwal Co. Engineers Pvt. Ltd. vs Hindustan Works Construction Limited (AIR 1989 Cal 184) is as follows: Under the terms of the contract entered into between the HWC Ltd. and the GSA Co, the Petitioner was to furnish a bank guarantee for mobilisation advance made by the Respondent to the Petitioner for Rs. 32.50 lakh. The contract did not require the Petitioner to give any bank guarantee for the due performance of the contract. The Petitioner requested the bank to issue a guarantee for Rs. 32.50 lakh to cover the mobilisation advance received by the Petitioner from the Respondent. The bank made use of its standard format of guarantee and did not delete certain clauses therein because of which the guarantee issued by it became a mobilisation advance-cum-performance guarantee. Since the bank and the Respondent, as beneficiaries, were the only parties to the bank guarantee, the Petitioner never knew of the mistake on the part of the bank. The Respondent took advantage of the mistake and although the mobilisation advance was recovered in full, it invoked the bank guarantee for recovery of its claim for damages for loss suffered, as a result of non-performance of the contract by the Petitioner and demanded payment from the bank. On the bank showing its willingness to make payment of the amount guaranteed by it, the Petitioner approached the High Court for an order restraining the bank from making payment. The High Court held that: The Respondent was aware of the mistake on the part of the bank and with ulterior motive took advantage of the mistake by demanding payment in respect of its claim for damages for non-performance and not in respect of any amount due for mobilisation advance given to the Petitioner. The bank has no right to saddle its customer with any additional liability under the guarantee by issuing the same contrary to the instructions by its customer. The Respondent has invoked the guarantee for recovery of loss and damages, alleged to have been suffered due to alleged breach of contract by the Petitioner. Though the general principle of non-interference by the Court in cases of bank guarantee and letter of credit is for the smooth functioning of international trade and commerce, this principle would not apply where the bank has acted negligently and issued bank guarantee contrary to the customer's instructions. Whether the invocation of the bank guarantee was in terms of the guarantee or not will depend upon the terms of the guarantee and the letter of invocation. The bank cannot act arbitrarily or whimsically in deciding whether the invocation was in terms of the guarantee when in fact it was not. In the instant case, the bank guarantee" was for mobilisation advance and not for performance of the contract and the invocation of the bank guarantee was admittedly for recovery of damages for the

alleged non-performance of the contract. The High Court, therefore, held that there was special equity in favour of the Petitioner and he can prevent the beneficiary from enforcing the bank guarantee. It is, therefore, absolutely necessary for the bank to confirm that no injunction order has been issued restraining the bank from making payment.

9.7 LET US SUM UP


A bank guarantee is a contract by which the bank guarantees a certain sum to a person/entity on the customer failing to fulfil any contractual or legal obligation to the said person/entity. Guarantee issued by banks mainly are financial guarantees, performance guarantees, deferred payment guarantees and statutory guarantees. Bank under a contract of guarantee is bound to honour its guarantee and its obligations to pay is primary and independent of the underlying contract between the customer on whose behalf the guarantee is given and the beneficiary. This has been settled by the various decisions of the Courts. The only exception for a bank not to make payment under a guarantee is when a fraud exists, which must be proved beyond doubt or special equity is in favour of the debtor. While issuing a guarantee a bank has to ensure that, the amount guaranteed and the period of the guarantee is specifically stated in the guarantee. Pursuant to the amendment to Section 28 of the Indian Contract Act, the limitation period on a contract of guarantee cannot be restricted to less than the period provided under the Limitation Act. As such, if the guarantee is invoked in time then the beneficiary can sue the bank within thirty years in case the beneficiary is a Government or municipal body or three years in all other cases. The bank while making payment under a guarantee has to ensure that the invocation is proper and that the person invoking the guarantee has the authority to invoke the guarantee. The bank while issuing a guarantee has to obtain a counter guarantee from its customer and if necessary, additional security to protect the bank in case it is required to pay under the guarantee.

9.8 KEYWORDS
Bank guarantee; Beneficiary; Counter guarantee; Debtor; Surety.

9.9 CHECK YOUR PROGRESS


1. 2. 3. 4. 5. State briefly what is a bank guarantee? What purpose does a bank guarantee serve? List the various types of bank guarantees and explain in brief their specific nature. Explain in brief- 'On a bank guarantee the banks duty to pay is primary.' There are two exceptions to the general rule that banks must pay on a guarantee. What are these two exceptions? Explain in brief. 6. Choose the right answer from the choices given: (i) In bank guarantees the bank makes payment on: (a) being convinced that the beneficiary has incurred loss; (b) on being sued by the beneficiary; (c) on the guarantee being invoked and after seeking concurrence of the debtor; (d) merely on demand by the beneficiary. (ii) In case of bank guarantees on behalf of company that is in liquidation the bank on invocation of the guarantee by the beneficiary: (a) must pay the amount to the Liquidator and not the beneficiary; (b) must deposit the amount in the court to avoid any controversy; (c) must pay the beneficiary; (d) need not pay, since the bank guarantee lapses on the company being liquidated.

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7. State in brief the precautions to be taken while issuing a bank guarantee. 8. While issuing a guarantee the bank omits to mention the amount and the period of the guarantee. Can the bank still be held liable? What would be the extent of the liability? 9. What is a validity period and claim period in a bank guarantee? 10. Can the bank in a guarantee issued by it restrict the claim period so as to avoid its liability? 11. What is a counter guarantee and when is it obtained?

9.10 ANSWERS TO 'CHECK YOUR PROGRESS'


6. (i) d; (ii) c.

LETTERS OF CREDIT

STRUCTURE 10.0 Objectives 10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8 10.9 10.10 10.11 Introduction Letters of Credit - General Consideration Parties to a Letter of Credit Types of Letters of Credit Documents Under a Letter of Credit Uniform Customs and Practice for Documentary Credits - UCPDC 600 Payment Under Letter of Credit - Banks Obligation Primary Let Us Sum Up Keywords Check Your Progress Answers to 'Check Your Progress'

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10.0 OBJECTIVES
After studying this unit, you should be able to understand: what is a letter of credit and its purpose; the parties involved in a letter of credit transaction; the various types of letters of credits; the various documents involved in a letter of credit transaction; the law as laid down in UCP 600.

10.1 INTRODUCTION
The simplest form of payment in a business transaction is payment by cash, and then comes payment by cheques, drafts, travellers cheques, etc. However, all these modes of payment require proximity between the buyer and seller and the element of trust between them. In international trade, the buyer and seller are miles apart, having different legal systems and each unaware of the other's financial position. In such cases, it would be preferable that both parties deal through their bankers. This is done when the documents covering the goods traded re-routed through the bankers. However, in this method the seller should have confidence that the buyer would pay for the goods as and when the same is due either immediately or after the agreed period of credit. In case the seller is not fully satisfied about this he may ask for an assurance from a banker that the terms of trade would be complied with and his interest would be protected. One of the methods of achieving this assurance more in international trade is by completing the transaction through the system of a letter of credit. Due of the devices used by the bankers to effect payment for goods supplied or services provided is called Banker's Commercial Credit or Letter of Credit (LC for brevity). Though this device for payment is the creation of the British merchants, it has now become a universally accepted method of payment. As a banker, you will at some point of time in your career, be required to deal with letters of credit. As such, it is necessary that you understand the various provisions relating to LC and the legal aspects involved therein. In this chapter, unless specifically stated so, the term letters of credit is used interchangeably as LC or credits and should not be mistaken as a different term.

10.2 LETTERS OF CREDIT - GENERAL CONSIDERATION


An LC can be compared to a guarantee given by a bank on behalf of its customer to the effect that the bank would make payment to the beneficiary when the beneficiary presents the documents as is required in the LC. They are not negotiable instruments. To understand better a LC transaction, let us consider a practical situation. M/s Bharath & Co. in India want to import certain machinery, which they know is manufactured by M/s Edward & Co. in England. They enter into a contract for purchase of the machinery, payments for which are required to be made by a LC. Since neither party knows the other, they are not sure whether the other will fulfil his part of the obligation. In such a situation, M/s Bharath & Co. will approach its banker, Bank of India and make a request by an application for opening a letter of credit (LC) in favour of M/s Edward & Company. Bank of India, after opening a letter of credit LC in favour of M/s Edward & Co., informs another bank in England, the UK bank with whom Bank of India has an arrangement, to forward the letter of credit LC to M/s Edward & Co. The UK bank (say Barclays Bank) after verifying the authenticity of the LC (letter of credit) and finding it as genuineness forwards the same to M/s Edward & Co. After verifying that the LC has been drawn according to the sale contract M/s Edward & Co. ships the machinery to M/s Bharath & Co. M/s Edward & Co. now collect the bills of lading handed over by the shipping Co. and other documents required as per the LC and draws a bill of

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exchange (Bills) under the LC and presents it to its bankers, the Barclays Bank, for negotiating the bill and to obtain the payment. Barclays Bank, on their part, receive the bill and the documents from M/s Edward & Co. and checks that they are as per the terms of the LC. On finding them to be in order, Barclays Bank negotiates the bill and makes payment to M/s Edward & Co. Barclays Bank thereafter sends the bill and documents to Bank of India. Bank of India on its part verifies the bill and documents and if found in order sends the bill to M/s Bharath & Co. for payment. M/s Bharath & Co. on receiving the bills checks the documents or pays the bill. On M/s Bharath & Co. making payment, Bank of India will release the shipping document so that M/s Bharath & Co. can collect the goods from the shipping company. The above illustrates the simplest form of payment under a letter of credit. The terms of an LC are sometimes complicated and various kinds of LCs have been devised since the concept of LC was introduced, which requires a banker to be very well versed in this aspect of financing. Before we proceed to understand the parties to a letter of credit and the various types of letters of credit, it would be worthwhile to examine the advantages of a letter of credit (LC). As regards the Buyer, i.e. M/s Bharath & Co. in the above illustration the major advantages are as follows: (a) No payment has to be made in advance to the seller. (b) The buyer can induce the seller to give credit from his supplier, which he may not be otherwise willing to give, since there is a guarantee from a banker regarding payment on due date. (c) In most cases the bills are payable over a period of time (called usance bills) thereby giving additional credit to the buyer. (d) The buyer can, while opening the LC insist that the quality of goods are certified by an independent body and such certificate be sent along with the bill for negotiation, thereby assuring himself that the goods meet with the required quality as specified. In case the seller does not enclose such a document then the banks will not make payment on the Bills. He can also stipulate other terms and conditions to protect his interests and which are also acceptable to the seller. As regards the seller, i.e. M/s Edward & Co. in the illustration the advantages are as follows: (a) The seller is assured that he will receive payment on his complying with the terms of the LC. (b) On shipment of the goods the seller can draw and negotiate the bills thereby getting immediate payment in his country, which payment otherwise would be made only after the goods are received by the buyer, which would cause delay in payment. (c) The seller need not bother himself about the import regulations of the buyer's country since this is the responsibility of the buyer. (d) The seller also need not bother about the fluctuations in currency since this will be the responsibility of the buyer.

10.3 PARTIES TO A LETTER OF CREDIT


You have learnt by now that in a letter of credit transaction various parties are involved. Various terms, have been coined to identify these parties, which you, as a banker, will be required to know since, in all transactions involving letters of credit, the terminology used to identify parties will be on these lines. To help us better understand the parties we shall be making use of the illustration given in Para 10.2. (i) Applicant-Buyer-Importer-Opener: He is the person who applies to the bank to open a letter of credit, since he would be either purchasing goods or availing services for which payment has to be made. In the illustration - M/s Bharath & Co. (ii) Issuing Bank: The bank which opens the letter of credit LC on the request of the applicant/ buyer. Also called the opening bank or importers bank. In the illustration - Bank of India.

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(iii) Beneficiary-Exporter-Seller: Is the person who is entitled to receive the benefit under a LC (letter of credit), i.e. the right to receive payment or to draw bills and receive payment as per the terms of the LC. In the illustration - M/s Edward & Co.. (iv) Advising Bank: The bank in the beneficiary/exporters country through which the letter of credit is advised to the beneficiary. The advising bank only forwards the LC to the beneficiary, thereby enabling the beneficiary to rely on its authenticity and genuineness. The advising bank is also sometimes termed as the Notifying Bank. In the illustration - The UK Bank. (v) Negotiating Bank: The bank in the beneficiary/exporters country which negotiates the bills (i.e. makes payment on the bills drawn by the seller and accepts the documents). If the LC specifies a bank then that bank is the negotiating bank and is also called the nominated bank or paying bank. If the LC however does not specify a bank, then any bank can be the negotiating bank, since the issuing banks open invitation contained in the credit is an offer, which is accepted as soon as the negotiating bank negotiates the bills and accepts the documents. In the illustration, Barclays Bank would be the negotiating bank. If Barclays Bank was also specifically mentioned in the credit as the negotiating bank, then Barclays Bank will also be the nominated Bank. (vi) Confirming Bank: The advising bank is only required to advise the credit to the beneficiary. If the seller is not conversant with the issuing bank or not satisfied with his financial position, he may ask for an additional assurance/guarantee from another bank located in his country/place and the second guarantee is called confirming the LC. The seller would look to the confirming bank to pay the amount covered by the bill if drawn as per terms of the LC. If however in addition to' advising the credit the advising bank were to confirm it, then the advising bank will also be the confirming bank. In such case, the confirming bank is deemed to undertake on its part the liabilities of the credit vis-a-vis the beneficiary or the Negotiating bank. (vii) Reimbursing Bank: It is the bank, which is appointed by the Issuing bank to make reimbursement to the negotiating, paying or confirming bank. 10.4 TYPES OF LETTERS OF CREDIT i. Acceptance Credit: Ordinary letters of credit are usually sight credits, i.e. immediate payment should be made of the bills drawn by the beneficiary. However, sometimes as per the terms of the letter of credit (LC) the bills will be payable after an agreed period of time (such bills being called usance bills). Such an LC under which usance bills can be drawn is an acceptance credit or time credit. The bills drawn on the various dates, will be honoured on their maturity. This is one of the methods by which, a buyer can obtain credit from the seller. The seller can either wait until the date of maturity to receive money or he can discount the bills and obtain immediate value for the goods supplied. ii. Irrevocable Credit: An irrevocable credit is a credit, that can neither be amended nor cancelled without the consent of the beneficiary. The issuing/opening bank is bound by the commitments given in the credit. As per the latest uniform customs and practice for documentary credits 600, all credits are irrevocable. iii. Confirmed Credit: If a bank advising the credit to the beneficiary adds its own confirmation to the credit, then the credit would be called a confirmed credit. Only irrevocable letters of credit can be confirmed, since in a revocable credit the issuing bank can amend or cancel the credit without notice, and as such if an advising bank were to confirm it, it would be liable without having any recourse to the 'issuing bank'. Confirmation here means that the confirming bank would fulfil the obligation under the letter of credit if the beneficiary complies with the terms contained therein. A confirming bank accepts this responsibility only on instructions by the issuing bank and as such, if

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any of the terms in the LC have to be changed then the concurrence of all the parties would be necessary. iv. With Recourse and Without Recourse Credits: When a beneficiary draws a bill under a letter of credit, he is generally liable to any negotiating LC bank if the drawee fails to make payment under the Negotiable Instruments Act. In other words, his liability is extinguished only on the drawee making payment. LC calling for these kinds of bills is with recourse LCs. However, the beneficiary can exclude this liability by adding to the bill the following words 'without recourse', which means that the right (recourse) against the drawer under the bill is not available to any endorsee of the bill of exchange. This defence however is available to the beneficiary only on the bills drawn by him. In case there is any discrepancy in the documents submitted then the beneficiary cannot avail any protection on a bill with the endorsement 'without recourse'. However, as per the current guidelines from RBI, banks are not supposed to accept any inland bill drawn 'without recourse' for negotiation. v. Transferable Credits: As stated earlier, a letter of credit is not a negotiable instrument, though the bills of exchange drawn under it are negotiable. As such, the rights under an LC cannot be transferred and is vested in the beneficiary. A transferable credit is one under which the beneficiary can transfer his rights to third parties (secured beneficiaries). Unless specifically stated an LC is not transferable. vi. Back-to-Back Credits: This a credit which is an offshoot of the credit issued to the beneficiary. In a back-to-back credit, the beneficiary in whose favour an LC is issued uses the same to open another credit from his (beneficiary's) bank in favour of his supplier. There are thus three banks involved in a back-to-back credit. First, the bank issuing the original credit to the beneficiary, the second, the advising bank through which the credit has been advised to the beneficiary and the third the bank, which issues an ancillary credit against the security of the original credit, vii. Anticipatory Letter of Credit: (i) Red Clause letter of credit: In a usual LC transaction, the beneficiary will be entitled to receive payment only on his handing over the documents and the bills drawn under the LC to the negotiating bank. However, in certain credits the beneficiary will be entitled to get an advance of the price. These credits contain a 'red clause' (because the clause is printed in red) which authorises an intermediary bank to make an advance to the beneficiary before shipment. Red Clause LCs are however dying out. (ii) Green Clause letter of credits: This is a refinement of the 'Red Clause'. This type of LC not only permits pre shipment advance but also permits advances to the exporter to cover storage at the port of shipment. The red clause and green clause credit are called anticipatory credits since payment of an advance is provided for in anticipation of the seller making shipment. ix. Revolving Letter of Credit: In a regular LC transaction, once the bills are negotiated the entire transaction comes to an end. If fresh shipment is to be made, another LC will have to be drawn. This procedure becomes time consuming especially when there is regular trade between the same parties. In such cases, it is preferable to open a revolving letter of credit. In this type of credit though the amount is fixed, it can be renewed as soon as the earlier bills have been paid. 10.5 DOCUMENTS UNDER A LETTER OF CREDIT One of the two basic doctrines that underlie the letter of credit transaction is the principle of strict compliance. The other being the independent nature of the letter of credit transaction. As per the strict compliance doctrine all the parties to a letter of credit transaction should strictly observe the terms and conditions under which the credit is issued and on failure to do so, the defaulting party would be either liable to the others or have no cause of action to recover any payment if made by the defaulting party.

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Within the sweep of the strict compliance doctrine comes the duty of a banker to "ensure that the documents tendered are strictly those specified in the letter of credit. In this regard it would be worth noting the observation given more than half a century back by LORD SUMNER in Equitable Trust Co. vs Dawson Partners (27 Lloyds Law Reports 49). There is no room for documents which are almost the same or which will do just as well. In this case, the credit required inter alia a certificate testifying to the quality of the purchase that was to be signed by (experts). However, due to a decoding error, the message received by the advising bank required only a certificate signed by 'an expert'. The beneficiary therefore, while presenting the documents submitted a certificate signed by a single expert, which was honoured by the advising bank and accepted by the issuing bank. However, since the goods were defective, the applicant refused to reimburse the issuing bank, which was upheld by the Courts. The issuing bank owes a duty to its customer to ensure that the documents tendered by the beneficiary under the credit comply with the instructions given by its customer. Any default, on the part of issuing bank would forbid the bank from claiming reimbursement from its customer with the added disadvantage that it would not be entitled to claim any remuneration for the transaction. The matter of strict compliance as far as a bank is concerned has been emphasised by Courts of Law all over the world. A bank is not compelled to honour the credit unless the beneficiary pursues and conforms in every material particular to the authority conferred therein. Due to the prime importance given to documents under a letter of credit transaction, it is necessary for a banker to understand the documents that accompany a letter of credit. i. Bill of Exchange: This is a financial document. Payment is made on this document. This for brevity sake is called 'bill' and is sometimes referred to as 'draft' (to be distinguished from a 'demand draft'). In a letter of credit transaction the right to draw a bill is conferred only on the beneficiary. The bill amount should be within the limit fixed in the letter of credit. The tenor, endorsement and the drawee should be the same as given in the letter of credit. This document should be distinguished from 'bills of lading', which is a transport document and is discussed later on in this chapter. Bills or drafts can be payable on presentation (sight bills) or on a certain date (usance bill). ii. Invoice: This is the basic commercial document. This document gives details of the sale. It should be made in the name of the opener/importer unless required otherwise in the letter of credit. All the details mentioned in the invoice must tally with those mentioned in the letter of credit, failing which it may amount to a discrepancy, making the documents liable for rejection. Where the quantities are specified in a letter of credit, the form in which they are specified should be adhered to. For example, if the letter of credit calls for 100 kg of tea, the invoice should be made accordingly and converting the measure to equivalent pounds or quintals would make it liable to be rejected. A further problem posed is whether it would be in order, whereas per the credit the value of the shipment is Rs. 15 lakh and the goods shipped is worth Rs. 20 lakh, with a request that Rs. 15 lakh be paid and excess Rs. 5 lakh collected to be repaid later. This would not comply with the credit terms and the opener/buyer/importer would be legally entitled to reject the documents. iii. Transport Documents: The mode of despatch of goods or the transporting of goods would depend on the terms of contract between the buyer and the seller and the same is incorporated in the letter of credit. The two main modes of transport of goods are either by sea or by air. In case the goods are shipped, the document evidencing the shipment of the goods is called the 'Bill of Lading'. In case the goods are transported by air, the documents evidencing receipt of goods would be the 'Airway Bill' in case the goods are directly handed over to an Airline or its agent. In case goods are transported through postal system or courier service, the document evidencing receipt of goods would be either the 'Post Parcel Receipt' or the 'Courier Receipts'.

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iv. Bills of Lading: Bills of Lading are of two types - one, the traditional ship bill of lading and the other, the 'Combined Transport Bill': a creation of modern age containerisation of shipments which permits more than one means of carriage and is also known as 'Multimodal Transport'. Bill of lading is a document to title to goods, i.e. they are representatives of the goods and holder of the same is entitled to get possession of the goods. A bill of lading, to a certain extent is negotiable inasmuch as a bona fide transfer of the same by endorsement entitles the transferee the right to the goods. A bill of lading is issued in sets of 2, 3, or 4 and all are termed as originals. A banker should see that all the originals are received. Unless otherwise specified in the letter of credit, a bill of lading must be a 'shipped' bill of lading and a 'received for shipment' or 'transportation' bill of lading or a 'charter party' bill of lading is not acceptable. This is because the shipped bill indicates that the goods have been taken on board of a specified ship and the journey has commenced while in the case of received for shipment bill though the goods have been delivered to the transporter the journey is yet to commence. v. Airway Bill: This is a document, which evidences that the goods have been received by an airline company or its agent. Unlike a bill of lading an airway bill does not carry with it the right to the goods, i.e., it is not a document of title to the goods. If however the letter of credit terms permit acceptance of an airway bill then the banker is within his rights to accept it. vi. Post Parcel Receipt and Courier Receipts: When the goods to be sent are small in quantity, then they can be sent through post or courier. The document issued by the postal department or the courier are similar in nature to the airway bill. They are not title to goods and only evidence that the goods have been entrusted for transportation to either the postal department or the courier company and most often than not the goods are addressed directly to the buyer. vii. Insurance Documents: The goods shipped, if required to be insured under the terms of the letter of credit should be so insured and the insurance document as required in the letter of credit should be enclosed with the other documents. Either an insurance company or underwriter or their agents should sign it. The type of insurance cover should be the same as specified in the credit. The requirements of the buyer regarding the amount of the policy, the currency, the risk to be covered and the place of payment in case of claim are to be strictly complied with. viii. Other documents: Over and above, the major documents discussed above which are required in all letters of credit transaction, the letter of credit may also call for certain other documents among which include certificate of origin, certificate of weight or quality or analysis, Health authorities certificate, etc. Such documents/enclosures are mandatory with the other documents, failing which payment can be refused. In interpreting these documents too, the Courts have applied the principle of strict interpretation. 10.6 UNIFORM CUSTOMS AND PRACTICE FOR DOCUMENTARY CREDITS - UCPDC 600 The ICC Banking Commission, approved the UCP 600, ICC's new rules on documentary credits, on 25 October 2006. UCP 600, which came into effect on 1 July 2007, contains significant changes, including: A reduction in the number of articles from 49 of UCP 500 to 39. New articles on 'Definitions' and 'Interpretations' to provide more clarity and precision in the rules. The replacement of the phrase 'reasonable time' for acceptance or refusal of documents by a definite period of five banking days. New provisions which allow for the discounting of deferred payment credits. A definitive description of negotiation as 'purchase' of drafts of documents.

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The new UCP 600 also contains within the text the 12 Articles of the eUCP, ICC's supplement to the UCP governing presentation of documents in electronic or part-electronic form. 10.7 PAYMENT UNDER LETTER OF CREDIT - BANKS OBLIGATION PRIMARY We had earlier while studying the various aspects pertaining to bank guarantees, noted that under a bank guarantee the liability of the bank to make payment is primary and unless a case of fraud is made out or there are special equities in favour of the debtor, Courts would not adjunct a bank from making payment under a guarantee. The same analogy applies to payment by banks under a letter of credit. The Supreme Court had occasion to consider this aspect in various cases and in all these cases, the Court has held that the obligation of a bank to pay under a letter of credit is primary, irrespective of the underlying contract. We shall now refer to some of the decisions of Supreme Court, which have been the touch stone for later judgements of the Supreme Court and also the High Courts. I. Tarapore and Company, Madras vs Messrs v/o Taractor.expert, Moscow, Another (AIR 1970 Supreme Court 891) (i) Facts of the case: The Indian firm opened in favour of the Russian firm a confirmed, irrevocable and divisible letter of credit with the Bank of India for the entire value of the machinery. Under the letter of credit, the bank was required to pay to the Russian firm twenty-five per cent on presentation of documents specified therein and the balance of seventy-five per cent on the expiry of one year from the date of first payment. The Russian firm supplied, and the Indian firm took possession of, the entire machinery to be supplied under the contract. After using the machinery for some time, the Indian firm complained that the performance of the machinery was not satisfactory and was causing considerable loss. With a view to preventing the Russian firm from realising the balance of the amount payable under the letter of credit, the Indian firm filed a suit against the Russian firm, but the same was withdrawn on an agreement having been arrived at between the parties. In pursuance of the said agreement, it was agreed that the Russian firm would instruct its bankers not to make a demand for further payment against the letter of credit for a period of six months from the due dates of the drafts and that, during this period the parties would do their best to reach an amicable settlement. It would appear that the parties did not amicably settle the dispute and when the extended time was about to come to a close, the Indian firm instituted another suit praying that the Russian firm and the Bank of India be restrained from taking any further steps in pursuance of the letter of credit opened by the Indian firm in favour of the Russian firm. (ii) Decision: Rejecting the contention of the Indian firm that the Russian firm should not be allowed to take away the money secured by the letter of credit, since the Russian firm had no assets in India and the Indian firm might not be able to enforce its claims under any decree that might be passed in its favour, the Supreme Court observed: 'An irrevocable letter of credit has a definite implication. It is a mechanism of great importance in international trade. Any interference with that mechanism is bound to have serious repercussions on the international trade of this country. Except, under exceptional circumstances, the Court should not interfere with that mechanism.' The Supreme Court considered some of the important decisions of the Courts in England and America and observed: 'A letter of credit is independent of an unqualified contract of sale or underlying transaction. The autonomy of an irrevocable letter of credit is entitled to protection. As a rule, Courts refrain from interfering with that autonomy.'

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II. In United Commercial Bank vs Bank of India (AIR 1981 SC 1426) (i) Facts of the case: The question, considered by the Supreme Court in this appeal was whether the Court should grant injunction at the instance of the beneficiary of an irrevocable letter of credit, restraining the issuing bank from recalling the amount paid under reserve from the negotiating bank, acting on behalf of the beneficiary, against a document of guarantee/indemnity at the instance of the beneficiary. Facts were rather complicated, but briefly, the relevant facts were that G agreed to supply to B 1000 metric tonnes of 'Sizola Brand Pure Mustard Oil'. A letter of credit was opened in favour of G by the appellant bank. The goods were supplied in two lots. When the documents were presented by G for payment of the amount against first lot, the appellant bank refused to make payment except under reserve on the ground of discrepancies in the documents presented to it. The main discrepancy was that the goods were described in the railway receipts as 'Sizola Brand Pure Mustard Oil "Unrefined"'. Bank of India, under instructions of G, accepted payment under reserve. Regarding the second lot, also payment was made and accepted under guarantee in favour of United Commercial Bank, whereby the Bank of India unconditionally agreed to hold the United Commercial Bank harmless and indemnified for all consequences of non-acceptance and/or non-payment of bills due to the discrepancies in the documents. The goods despatched, were not accepted by B. The United Commercial Bank, therefore, made a demand upon the Bank of India, to refund the amounts paid under reserve. Thereupon G approached the High Court for interim injunction restraining Bank of India from making payment. The single Judge of the High Court made absolute the temporary injunction granted earlier, until the disposal of the suit on the ground that the United Commercial Bank, in terms of the credit, could not unilaterally impose the condition of payment 'under reserve' or refuse to pay against the documents tendered by G merely because of alleged discrepancies. The matter on further appeals finally reached the Supreme Court. After considering the case law on the subject, the Supreme Court allowed the appeal for the following reasons: (a) A letter of credit constitutes the sole contract with the banker and the bank issuing the letter of credit has no concern with any question that may arise between the seller and the purchaser of goods. The judicial authority lays down the necessity of strict compliance both by the seller with the letter of credit and by the banker with his customer's instructions. (b) As pointed out by Halsbury's Laws of England, the documents must be those called for, and not documents which are almost the same or which will do just as well. (c) The banker is not called upon to know or interpret trade customs and terms. (d) In Paget's Law of Banking, 8th Edn. p. 648, it has been stated thus - Unless documents tendered under a credit are in accordance with those for which the credit calls and which are embodied in the promise of the issuing banker, the beneficiary cannot claim against him and it is the banker's duty to refuse payment. (e) The well established rule is that a bank issuing or confirming a letter of credit is not concerned with the underlying contract between the buyer and seller. Duties of a bank under a letter of credit are created by the documents itself, but in any case, it has the power and is subject to the limitations which are given or imposed by it, in absence of the appropriate provisions in the letter of credit. (f) The Courts usually refrain from granting injunction to restrain the performance of a contractual obligation arising out of a letter of credit or a bank guarantee between one bank and another. The whole banking system would fail if the banker making payment under reserve were restrained by injunction from recalling the amount. (g) Buyer-customer cannot instruct the banker not to pay in view of banker's obligations to pay under irrevocable letter of credit. Confirmed letter of credit imposes an absolute obligation to the banker to pay.

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(h) A bank giving a performance guarantee must honour that guarantee according to its terms. (i) It is in exceptional cases that the Court would interfere with the machinery of irrevocable obligations assumed by the banks, such as, clear cases of fraud of which the banks have notice, (j) The payments were made 'under reserve' and against the indemnity or guarantee of Bank of India. Therefore, when the bills of exchange were dishonoured, on being presented, the amount became immediately, payable on demand.

10.8 LET US SUM UP


A letter of credit (LC) otherwise called a banker's commercial credit is a device used for effecting payment by bankers for goods supplied or services provided between two parties and is mostly used in foreign trade. It is similar to a bank guarantee, inasmuch as the bank, issuing the LC, guarantees payment to the seller, in case the terms as required under the LC are complied with. There are various parties to a letter of credit transaction. The opener of the letter of credit otherwise called the Buyer or Importer. The bank, which issues the LC called the Issuing Bank or the Opening Bank or Importer's Bank. The person in whose favour the LC is issued - the Beneficiary, also called the Exporter or Seller. The Advising Bank that advises the LC to the beneficiary, also called the Notifying Bank. The Negotiating Bank,.i.e. the bank that makes payment on the bills drawn by the seller also called the Nominated Bank or Paying Bank. The Confirming Bank, which is the advising bank when it also confirms the credit. The Reimbursing Bank, which reimburses, the negotiating/paying/confirming bank. Letter of credit are classified based on the various terms and conditions they contain. Main among them, are the following Acceptance Credit, where the payment is made after a certain period; Revocable Credit, where the credit terms can be unilaterally altered or cancelled by the issuing bank in contrast to an Irrevocable Credit where any alteration of terms or cancellation requires the concurrence of beneficiary; Confirmed Credit, where the advising bank adds its own confirmation to the credit while advising the beneficiary; With Recourse Credits - where the beneficiary is liable on a bill drawn by him under an LC in contrast to a Without Recourse, where the beneficiary is not liable; Transferable Credits, where rights under an LC can be transferred to third parties; Back-to-Back Credits, where on the basis of LC in favour of the beneficiary, his bank opens another LC in favour of the beneficiary's supplier. Red Clause Credits, where the beneficiary is entitled to advance payment before production of documents; Green Clause Credits wherein addition to advance, the beneficiary is entitled to payment of storage/warehousing charges; Revolving Credits, where the amount is fixed but can be utilised repeatedly as and when the earlier bills drawn are paid. There are two basic principles that underline every LC transaction the first one being that in every transaction strict compliance of terms is required and the other being the independent nature of LC transaction. As such, it is necessary to ensure strict compliance of the documents required under an LC. The documents include bill of exchange (drafts, bills), invoice, transport documents, insurance documents are primary for most transactions. Over and above these documents the credit terms, which may require various certificates and/or other documents. The rights and liabilities of all parties to an LC have been laid down in the UCP 600 a document published by the International Chamber of Commerce. The UCP 600 though not enforceable as law, is incorporated as a part of the credit terms and as such is enforceable as a contractual term. A letter of credit being similar to a bank guarantee, the liability to make payment by a bank under an LC is primary and the Supreme Court has endorsed this view in various decisions.

10.9 KEYWORDS
Acceptance Credit; Advising Bank; Airway Bill; Applicant; Back-to-Back Credit; Bankers Commercial

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Credit; Beneficiary; Bill of Exchange; Bill of Lading; Confirmed Credit; Confirming Bank; Green Clause Credit; Invoice; Issuing Bank; Negotiating Bank; Red Clause Credit; Reimbursing Bank; Revocable Credit; Revolving Credit; Transferable Credit; UCP 600; With Recourse Credit; Without Recourse Credit;

10.10 CHECK YOUR PROGRESS


1. State whether true or false. (i) A letter of credit is a form of guarantee given by banks on behalf of its customer. (ii) Letters of credit are bills of exchange drawn by a seller or a buyer, (iii) LCs are negotiable instruments. 2. Choose the right answer. (a) The letter of credit is opened on the request of (ii) Applicant (iv) (i) Issuing bank (iii) Beneficiary Confirming bank (b) The LC issuing bank is also called (i) the importers bank or the opening bank (ii) the advising bank or the confirming bank (iii) the negotiating bank or the nominated bank (iv) the reimbursement bank (c) The right to receive payment under a letter of credit or the right to draw bills on a letter of credit is vested in (i) the opener of the LC (ii) the issuing bank only (iii) the seller only (iv) all the three parties (d) The advising bank's responsibility is (i) to inform the issuing bank as to whom to issue the letter of credit (ii) to advise the buyer the despatch of documents by the seller (iii) to inform the beneficiary/seller about the letter of credit (iv) none of the above (e) The advising bank is also called the (i) Confirming bank (ii) Notifying bank (iii) Reimbursing bank (iv) None of the above (f) Negotiating bank is the bank which (i) negotiates the preliminary contract of sale between the buyer and the seller (ii) makes payment of the bills drawn by the seller and accepts the documents (iii) guarantees payment by the issuing bank (iv) none of the above (g) When the LC specifies the bank that is to negotiate the bills drawn under the LC then the bank is also called (i) Confirming bank (ii) Reimbursing bank (iii) Nominated bank (iv) None of the above (h) The confirming bank is (i) the issuing bank when it confirms the issue of the LC (ii) the negotiating bank when it confirms the negotiation of the bills (iii) the advising bank when it confirms the LC (iv) none of the above (i) When the confirming bank confirm the credit it (i) does not take any liability

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(ii) undertakes on its part the liability under the LC (iii) undertakes to make timely delivery of the documents and bills to the buyer or his bank (iv) none of the above (j) Reimbursing bank is the bank (i) that reimburses the seller (ii) that reimburses the negotiating/paying or confirmingbank (iii) that reimburse the buyer on the goods being found defective (iv) none of the above 3. Fill in the blanks. (a) Ordinary letters of credit are usually _________ , i.e. the bills drawn hereunder have to be paid immediately. (b) Letter of credit under which usance bills can be drawn is called an __________ . (c) In a revocable LC the credit can be amended or cancelled by the__________ . (d) Only _________ letters of credit can be confirmed. (e) Credit in which the beneficiary is not liable for the bills drawn thereunder is ___________ credit. (f) A back-to-back credit would involve at least bank, viz., the _________ bank, the__________ bank and the _________ bank. 4. State whether true or false. (a) All parties to a letter of credit transaction need to comply with the terms only as far as practical and not strictly. (b) In case the documents submitted by seller do not comply with the terms of letter of credit then the same can be accepted and sent for confirmation of buyer. (c) A bill of exchange is a document to title to goods. (d) A bill of exchange is also called a 'bill' or a 'draft'. (e) Invoice in a letter of credit transaction is a document similar to a quotation based on which the buyer places his order. (f) A bill of lading on a bona fide transfer confers on the transferee a right to the goods. (g) An airway bill is also a document evidencing title to goods. 10.11 ANSWERS TO CHECK YOUR PROGRESS' 1. (i) True; (ii) False; (iii) False 2. (a) ii; (b) i; (c) iii; (d) iii; (e) ii; (f) ii; (g) iii; (h) iii; (i)ii;j)ii 3. (a) Sight credits; (b) Acceptance credits; (c) Issuing bank; (d) Irrevocable; (e) without recourse; (f) Three; issuing, advising, third 4. (a) False; (b) False; (c) False; (d) True; (e) False; (f) True; (g) False

DEFERRED PAYMENT GUARANTEE

STRUCTURE
11.0 11.1 11.2 11.3 11.4 11.5 11.6 11.7 Objectives Introduction Purpose of Deferred Payment Guarantee Method of Payment Let Us Sum Up Keywords Check Your Progress Answers to 'Check Your Progress'

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11.0 OBJECTIVES
After studying this unit, you should be able to understand: a deferred payment guarantee, purpose of a deferred payment guarantee, various methods of payment under a deferred payment guarantee.

11.1 INTRODUCTION
Though we had touched this type of guarantee while studying bank guarantees, we shall deal with it here in more detail, since this type of a guarantee is regularly issued by banks. 'Deferred Payment Guarantee' as the name itself suggests, is a guarantee that indicates that deferred (postponed) payments. Suppose a bank's customer were to import capital goods on a deferred payment credit where the price is to be paid in instalments spread over a five year period, the exporter will have to wait for each instalment to mature until the whole amount is paid. In the meantime, the chances of the importer going bankrupt or failing to pay may arise. To avoid such a situation the exporter can request the importer to obtain a guarantee that the payment in instalments will be made. The importer would therefore, approach his banker to guarantee the payments in instalments. This guarantee of the bank, assuring the exporter of the timely payment of the instalments, is in short, called 'Deferred Payment Guarantee' in brevity referred to as DPG.

11.2 PURPOSE OF DEFERRED PAYMENT GUARANTEE


When import or export of raw materials or consumer goods are made the payment is done either immediately or within 360 days. This period is called short term. However, in the case of capital goods the amount involved being quite substantial, short-term credit would not be of much help to the buyer, unless he has made arrangements to get a term loan. Added to this, the requirement of substantial amount of foreign exchange, may place the buyer at a great disadvantage. To overcome this payment problem, since the fifties the concept of deferred payment was introduced in India. As stated earlier, in a deferred payment arrangement, the buyer/importer is not required to make the entire payment of the goods at one time, instead the price of the goods is paid in instalments over a period of time as per terms mutually agreed to with the seller. In a deferred payment guarantee, a third party, mostly banks and financial institutions, guarantee the payment of the instalments. This guarantee ensures timely payment of the instalments to the seller/ exporter, failing which, the guarantee can be invoked and payment received. To understand better the deferred payment guarantee, it is necessary to understand how a payment is made in a deferred payment contract and how the same is guaranteed by a bank.

11.3 METHOD OF PAYMENT


In a contract for import of goods on deferred payment terms, the importer is required to make payments in instalments over a period of time which may range from one to seven years, in a normal deferred payment contract. The payment, is usually done on the following terms: 1. Advance payment of ten per cent to fifteen per cent of the price of the goods is made by the buyer. 3. Another ten per cent to fifteen per cent on receipt of documents under letter of credit. 3. The balance amount, is paid in instalments spread over a period of one to seven years, which is secured by a 'Deferred Payment Guarantee'. In a deferred payment guarantee, which as stated earlier, issued by banks and financial institutions,

iED PAYMENT GUA

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what is guaranteed, is the timely payment of instalments and interest if provided. This is done by issuing a deferred payment guarantee in which the following terms are mandatory: 1. 2. 3. the supply of goods by the seller to the buyer and the seller agreeing to postpone the payment of the price, this being the consideration of the guarantee; the payment schedule of both the instalment and the interest; the unconditional and irrevocable assurance of the bank that it would make payments on the invocation of the guarantee.

As regards the supply of goods by the seller, it is to be remembered, that banks do not take the responsibility to ensure that the goods shipped are what is required by the buyer/importer. Since the guarantee, is mostly given prior to shipment of the goods, if the documents are, as required under the letter of credit, and are valid, then the guarantee of the bank subsists and the buyer cannot after receipt of the goods, request the bank to stop payment on a deferred payment guarantee on the grounds of defective goods. As regards the payment schedule, it is to be noted that the payment schedule is usually incorporated in the main contract between the buyer/importer and the seller/exporter and the bank guarantees the payment as stipulated in the schedule. Some banks as a matter of abundant caution or to have better clarity of the payment schedule incorporate the same in the guarantee issued by them, though it is, for all purpose a verbatim reproduction of the payment schedule from the main contract. In certain cases the seller/exporter would draw bills on the buyer/importer for the amounts of the deferred instalments including interest, which are usance bills (being payable on a particular date and not immediately) and payment of these bills are guaranteed by the bank. The advantage of this method is that the seller/ exporter can discount these bills with his banker and get immediate finance. In a deferred payment guarantee, like all other bank guarantees, the banks undertake to make payment without any demur or protest, since as per the guarantee, the bank has given an unconditional and irrevocable assurance to the seller/exporter. It is on such assurance that the seller/exporter has sold the goods. It is therefore, of prime importance that the bank honours its commitment. We have studied earlier while dealing with the bank guarantees, that the bank's liability in a bank guarantee is primary and independent of the underlying contract between the buyer/importer and the seller/exporter. These principles apply in toto to a DPG also.

11.4 LET US SUM UP


A deferred payment guarantee (DPG) is an unconditional and irrevocable guarantee given by a bank to a seller/exporter that on his supplying goods to the buyer/importer (who is the bank's customer) on instalment basis the bank would ensure payment on the due dates. DPGs are usually insisted upon, when capital goods are imported and the seller/exporter requires an additional assurance that the instalment payment allowed by him to the buyer/importer is met. In a DPG the bank guarantees either the payment of the instalments and the interest on the due dates or the payment of the bills drawn on various dates by the seller/exporter. A DPG being a guarantee given by a bank, its commitment to honour the same is absolute unless there exists a case of fraud.

11.5 KEYWORDS
Deferred Payment; Deferred Payment Guarantee.

11.6 CHECK YOUR PROGRESS


1. Say whether true or false. (i) In a deferred payment guarantee, the guarantee is to ensure delivery of eoods.

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(ii) A deferred payment guarantee is mostly based on a primary contract between the buyer and the seller, (iii) A deferred payment guarantee differs from other kinds of guarantee issued by banks as regards payment liability of the bank on invocation, (iv) In a deferred payment guarantee the banks liability comes into existence only if all the instalments are not paid and not on the non-payment of any one instalment by the customer.

11.7 ANSWERS TO CHECK YOUR PROGRESS


1. (i) False; (ii) True; (iii) False; (iv) False.

er and nks as ill the tomer.

LAWS RELATING TO BILL FINANCE


STRUCTURE
12.0 12.1 12.2 12.3 12.4 12.5 12.6 12.7 12.8 Objectives Introduction Class of Bills and Law Governing Bills Classification of Bills Various Categories of Bill Finance Bill Finance and Legal Position of a Banker Let Us Sum Up Check Your Progress Answers to 'Check Your Progress'

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12.0 OBJECTIVES

BEGUL/

After studying this unit, you should be able to understand: basic law relating to bill finance; legal position of banker in case of bill finance.

12.1 INTRODUCTION
Bill finance is one of the modes of lending by a banker. As compared to other modes of financing, Bill finance offers a banker an easy mode of lending. From the banker's point of view, bill finance has many advantages. Bill finance involves discounting or purchase of commercial bills arising out of sale of goods. Bill finance, as compared to cash credit and overdraft, has the following advantages: (a) The underlying transactions are easily identifiable (b) There is definite date of repayment (c) The bill will carry more than one signature if it is on usance basis (d) It represents an easily transferable asset and in case of need the same can be rediscounted to improve the liquidity of the bank.

12.2 CLASS OF BILLS AND LAW GOVERNING BILLS


(a) Bills Discounted by banks belong to one of the following categories (i) Clean bills (ii) Documentary bills (iii) Bills drawn under credit (b) Laws Governing Bills: The law on bills deals with the liabilities and rights of parties to a bill is governed by the Negotiable Instruments Act, 1881. (i) What is a BUI? The term 'Bill' is the short form of 'Bill of Exchange'. Section 5 of Negotiable Instruments Act, 1881 defines bill of exchange as 'instruments in writing containing an unconditional order signed by maker, directing a certain person to pay certain sum of money only, to or to the order of a certain person or to the bearer of the instrument.' (ii) 'Drawer', 'Drawee', 'Payee': Section 7 of the Act provides that amaker of 'Bill of Exchange' is called 'Drawer' and the person who is directed to pay is called 'Drawee' and the person entitled to receive payment of amount represented by 'Bill' is called 'Payee', (iii) Relationship of Parties to a Bill: 'Drawer' of bill is a creditor/seller and the 'Drawee' of a bill is the debtor/buyer. If the bill is assigned to third parties, then such assignees will become creditors and drawer would be liable for such assignees in case of default by drawee. (c) A Glimpse of some important provisions of Negotiable Instruments Act relating to Bills: It will have to be noted that a 'Bill' is a negotiable instrument. Any person to whom the bill is transferred in accordance with the provisions of the Act, would become entitled to receive the amounts represented by the bill. We shall now examine certain important provisions of the Act. Section 8 'Holder': Section 8 of the Negotiable Instruments Act defines the word 'Holder'. A Holder of bill of exchange means a person entitled in his own name to possess the bill and recover the amount represented by bill. Section 9 'Holder in Due Course': 'Holder in due course' means any person who for consideration became the possessor of the bill (that is a person to whom the bill is transferred). Section 10 'Payment in Due Course': 'Payment in due course' means payment in accordance with

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the apparent tenor of bill of exchange to the holder or holder in due course in good faith and without negligence. Section 14 'Negotiation': When a bill is transferred for considerations to any person so as to entitle him to claim the amount represented by bill, then such transfer is called 'Negotiation'. Section 15 'Endorsement': If the holder of instrument signs the bill of exchange for the purpose of transferring it, such signing is called 'Endorsement'. Section 30 'Liability of Drawer': The drawer of a bill of exchange or cheque is bound in the case of dishonour (failure to pay) by the drawee or acceptor thereof, to compensate the holder, provided due notice of dishonour has been given to, or received by, the drawer. Section 32 'Liability of Acceptor/Drawee of Bill': An acceptor of bill of exchange is bound to pay the amount thereof at maturity according to apparent tenor of the acceptance. Section 35 'Liability of Endorser': In the absence of contract to the contrary, whoever endorses and delivers a negotiable instrument is bound thereby to every subsequent holder in the case of dishonour unless his liability is excluded. Section 79 'Interest rate Specified': When interest at a specified rate is expressly made payable on a bill of exchange, then interest shall be calculated at such rates specified and payable. Section 80 'Interest when no rate is specified': When no rate of interest is specified in the instrument, interest due thereon shall be calculated at the rate of eighteen per cent p.a. 12.3 CLASSIFICATION OF BILLS 'Bills' used under bill finance can be classified depending upon the place where drawn, period and their nature as under: Place Period Nature 3. Demand bills 1. Inland bills 5 4. Usance bills 2. Foreign bills . Clean bills 4. Usance bills 6. Documentary bills 1. Inland Bills: Bills drawn or made in India and made payable in or drawn upon any person resident in India are inland bills. The necessary requisites of inland bills are: (a) it must be drawn and made payable in India; (or) (b) it must be drawn in India upon some person resident in India, though it may be made payable in a foreign country. Inland instruments are defined in Section 11 of Negotiable Instruments Act, as under - Inland Instrument: "A promissory note, bill of exchange or cheque drawn or made in India and made payable in or drawn upon any person resident in India shall be deemed to be an inland instrument." 2. Foreign Bills: As per Section 12 of the Negotiable Instruments Act, Foreign Bills are: (a) Bills, drawn outside India and made payable in or drawn upon any person, resident in any country outside India; (b) Bills drawn outside India and made payable in or drawn upon any person, resident in India. 3. Demand Bills: Section 19 of the Negotiable Instruments Act, defines 'Demand Bill': It is an instrument payable on demand and no time for payment is specified therein. 'Demand Bill' is otherwise called 'sight bill'. In these bills, the payee is entitled to the value of the bill on demand and on presentation. 4. Usance Bills: A usance bill is a bill payable otherwise than on demand. It specifies nnrmaiiv <. *;~~

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for payment of the value it represents. 'Usance Bills' are otherwise called 'Bills payable after sight'. In these kinds of bills, the drawer draws a bill of exchange and specifies a time within which the payment shall be made and presents the same to drawee for acceptance. Once the drawee accepts the bill, the drawer at the time or date specified on bill for payment can present the same to drawee and demand payment. The date specified for payment is otherwise called 'maturity/due date'. 5. Clean Bills: A clean bill is a bill of exchange drawn as per the requirements of the Negotiable Instruments Act and is not supported by documents of title to goods. Clean bills are drawn normally to effect discharge of a debt or claim. Clean bills also arise when the goods covered by the bill are directly sent to the buyer due to mutual consent e.g. local bills and supply bills. 6. Documentary Bills: A bill of exchange accompanying documents of title to goods, is called 'Documentary Bill'. These bills, are drawn to claim price of goods supplied. (i) Bills drawn with an instruction to deliver against payment: (or) D.P. Bills: In a transaction for supply of goods, a seller draws a bill on the buyer and sends the same to his banker along with document of title to goods like bill of lading, or railway receipt or lorry receipt. The seller instructs the banker to deliver the bill and documents of title to goods only when the buyer pays the price of goods. These types of bills are D.P. bills in other words 'Delivery against Payment Bills'. (ii) Bills drawn with instruction to deliver against acceptance or DA. Bills: An usance bill supported by documents of title to goods bearing an instruction that the documents can be delivered, if the buyer accepts the bill of exchange drawn on him. These are called D.A. Bills or 'Delivery against Acceptance Bills'. Besides the above, when the government department is supplied goods or raw materials a bill is drawn on them for the price of goods supplied. These are called supply bills. They do not squarely fall within the ambit of Negotiable Instruments Act. However, principle underlying to bills is also applied to 'Supply Bills'. 12.4 VARIOUS TYPES OF BILL FINANCE Basically, a banker offers following types of bill finance. 1. Bill Purchase (B.P.) 2. Bill Discount (B.D.) 3. Advance against Bills for Collection (A.B.C.) 1. Bills Purchased: When the bank negotiates bills payable on demand, whether clean or documentary, the facility is known as bill purchase. The face value of the bill, is immediately paid to the holder. The bank, after purchasing the bill, becomes the holder in due course of the bill and acquires all the rights of ownership over the instrument. Bill purchase facility is extended generally in the case of bills payable on demand. However, in the case of usance bills also this is extended when the due date of the bill is not readily known at the time of extending this facility. Such a situation arises when the bill is drawn payable after some days after sight. The due date of such a bill is known when the bill is presented to the drawee and the period of usance commences from the date of presentation. 2. Bills Discounting: This facility is extended by banker when the bills of exchange are payable after a particular period, that is bills payable otherwise on demand. For example, 'A' draws a bill on 'B' payable after three months and 'B' on presentation accepts the same and agrees to pay after three months. Such a bill is called a bill payable, otherwise on demand or usance bill. In this type of facility a banker pays the face value of the bill less discount, becomes holder in due course, and acquires all the rights under the bill.

l i

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3. Advance Against Bills for Collection: When the bank advances against the bills, which are in course of collection, the facility is known as advance against bills for collection. Under this facility, a prescribed margin is kept by the bank and the amount, in consideration of this is allowed to the customer. The bill thereafter is sent for collection. In all these cases, the legal effect is that the banker, who lends money, becomes holder in due course for the bill.

12.5 BILL FINANCE AND LEGAL POSITION OF A BANKER


Bill Discounting and Rights of a Banker: In the case of bills discounting or bills purchase the bill of exchange drawn by the borrower on third parties is presented to banker. Then the banker pays the value of the bill of exchange to the borrower after charging a commission or after a discount and gets the bill transferred to his name. By such transfer, which is made by endorsement by the borrower, the banker becomes the 'Holder in due course' and would be entitled to receive the amounts from the acceptor of the bill. Hence, it is imperative that a banker acquaints himself with the legal aspects of lending through 'Bills discounting'. Legal Relationship in the Case of Bills Discounting: In 'Bills discounting' transactions a banker becomes a lawful holder of the bill by taking a proper endorsement of the bill in his favour. The banker becomes 'payee' of the bill and is entitled to recover the amount represented by the bill. We will study some cases in respect of bills discounting facilities that have been decided by courts. (i) Irinjalakuda Bank Ltd. vs Pourthussery Panchayat (1970) 40 Compo Cases. 767: In this case a document in the form of cheque issued by a Panchayat on a Government treasury payable to 'self or order' was discounted by a bank. It was dishonoured by the treasury, since Panchayat Inspector countermanded the payment. The Court held that the banker is a holder in due course and hence can recover the amount from the Panchayat. (ii) Shambumal Gangaram and Another vs State Bank of Mysore (AIR 1971 Mys. 156): In this case, legal action was initiated by the bank for the recovery of dues from the customer because of the bill discounting facility granted to the customer. The bank was providing 'Local Bill Discounting' (LBD) facility to its customer by discounting the bills drawn by customer and endorsed by the customer in bank's favour. The drawees of the bills generally paid the amounts of bills. However, several bills remained unpaid and bank filed a suit for recovery from the customer. The customer contended that bank should have filed suit against the drawees of bill of exchange. The Court rejected the argument of the customer and directed him to pay the amount to bank holding that customer being drawee is liable to bank who are holders in due course. Discounting of Documentary Bills A banker provides discounting of 'Documentary Bills', as a credit facility to his customer. What is a Documentary Bill? 'Documentary Bill' is a bill which is supported or accompanied by a document of title to goods. A lorry receipt or railway receipt, warehouse receipt, bill of lading, etc., are some of the examples of documents of title to goods. Law relating to Documents of Title to Goods Sale of Goods Act and Bill of Lading Act: Government documents of title to goods. Under these Acts, 'documents of title to goods' is one in which ownership in goods can be transferred by endorsement and delivery. Therefore, a banker as an endorsee of a lorry receipt, railway receipt or bill of lading becomes the owner of goods on transfer of said documents in his name.

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In the case of Morvi Merchantile Bank Ltd. vs Union of India (1965) 35 Compo Cases 629, a Bombay firm, sent by rail (to self) six boxes stated to contain menthol crystals from Thana to Okhla. The railway receipts were endorsed by the firm to a bank against an advance of Rs. 20,000. The boxes were not delivered at Okhla and the bank sued the railway claiming damages amounting to Rs. 35,000 which was stated to be the value of the consignments. The Trial Court dismissed the suit. On appeal by the bank, the Bombay High Court held that the bank as an endorsee of railway receipts was entitled to receive the amount. The Supreme Court confirmed the order of High Court. Drawee Bills Acceptance and Bill Co-acceptance Facilities In 'Drawee Bills Acceptance Facility', the bank agrees to pay the drawer the amount of bills drawn on the borrower on presentation and recovers from the drawee on the respective due dates. This credit facility is normally extended to borrowers who have been granted working capital facilities. This is an alternative to cash credit or overdraft. The amounts of bills accepted by the bank are debited to 'drawee bills' discounting account and the borrower reimburses the bank the amounts paid by bank with interest on the respective due dates. These advances, are also governed by the principles of law under the Negotiable Instruments Act. The bank would be entitled to sue the borrower and recover from him the amount due on bills. The bank will have also an additional advantage of suing the drawer in event of dishonour of bill. In the case of 'Bills Co-acceptance Facility', the banker accepts the bills along with the borrower. Under this facility banker undertakes a joint liability along with the borrower and enters into agreement with the borrower for reimbursement.

12.6 LET US SUM UP


1. Law relating to bills is provided in the Negotiable Act, 1881. 2. Categories of bills financed by banker are: (i) Clean bills (ii) Documentary bills (iii) Bills drawn under credit 3. Maker of bill of exchange is called drawer. 4. Drawee of a bill of exchange is a person who is directed to pay the value of bill, and in the case of usance bill of exchange, the drawee is called acceptor. 5. In the case of bills relationships between the parties are: (i) The drawer of the bill is creditor, (ii) The drawee of a bill is the debtor. 6. Holder in due course means any person who for consideration became the possessor of the bill and is entitled to all the rights of holder of the bill. 7. Payment in due course means payment in accordance the tenor of bill to the holder in due course or to the holder of the bill, in due course and in good faith and without negligence. 8. Endorsement means signing the bill of exchange for the purpose of transfer. 9. Depending upon the place where the bills are made, they can be classified into (i) Inland Bills (ii) Foreign Bills 10. Documentary bill means a bill accompanying documents of title to goods. 12.7 CHECK YOUR PROGRESS 1. Bill of exchange means a unconditional direction to the drawer to pay the moneys. (True/False) 2. The maker of the bill is called __________.

-^ rtrr? ATIM.

3. 4. 5. 6. 7. /

Bill purchase facility is granted in the case of demand bills. (True /False) _________facility is granted in the case of usance bills. _________of the bill is bound in case of dishonour of bill. Ownership of goods can be transferred by endorsement and delivery of __________ . In bills co-acceptance facility the banker becomes a surety for the value of bill. (True/False)

12.8 ANSWERS TO 'CHECK YOUR PROGRESS'


1. True; 2. Drawer; 3. True; 4. Bill Discounting; 5. Drawer; 6. Document of title to goods; 7. True.

VARIOUS TYPES OF SECURITIES

STRUCTURE 13.0 13.1 13.2 13.3 13.4 13.5 13.6 Objectives Introduction Various Kinds of Securities Let Us Sum Up Keywords Check Your Progress Answers to 'Check Your Progress'

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13.0 OBJECTIVES
After studying this unit, you should be able to understand: various kinds of securities; advantages and disadvantages of the various securities.

13.1 INTRODUCTION
An advance made by a banker may be secured by a collateral security. The effectiveness of a security would largely depend on the nature of the security. The effectiveness of the securities can be broadly classified on two aspects, the first being the economic aspect, that is the marketability, valuation and other economic factors that has a bearing on the value of the security. The other the legal aspect is the validity and enforceability of the security. The requisites of a good and acceptable security are as follows: 1. The borrower should have a good title to the security. 2. It should be easily and freely transferable. 3. It should not have any encumbrance or liability for, e.g., partly paid shares. 4. It should be easily marketable. 5. It should not be liable to wide price fluctuations. 6. Its value should be easily ascertainable. 7. Its storing should not be difficult. 8. It should be durable. 9. It should be easily transportable. We shall now study the various kinds of securities in the light of above requisites and understand their advantages and disadvantages.

13.2 VARIOUS KINDS OF SECURITIES


1. Land/Real Estate: Bankers in the olden days were very much averse to accept land and building as a security, but this prejudice has over a period of time changed and land and building as a security has become an acceptable collateral in most advances, more particularly to corporate customers. The advantages and disadvantages of this form of security cannot be universally applied to all lands and it depends on the nature of the land offered. We shall now discuss both the advantages and disadvantages. Advantages (i) The advantage that land has over other types of securities is that its value generally increases with time. With every fall in the value of money, the value of land goes up and due to its scarce availability in developing areas its value is bound to increase. (ii) It cannot be shifted, a fact which sometimes is also a disadvantage. Disadvantages (i) Valuation is at-times difficult: The value of a building depends on several factors such as location, size of property, state of repair, amenities, etc., and in the case of factories and industrial buildings, the machinery, nature of industry, etc. This makes the valuation very difficult. Buildings and the materials used in the buildings are not alike. In fact, buildings must be valued on a conservative basis because of limited market in the event of sale. (ii) Ascertaining the title of the owner: The banker cannot obtain a proper title unless the borrower himself has title to the property to be mortgaged. In India, the laws of succession

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particularly those relating to Hindus and Muslims being very complicated, it is difficult to ascertain whether a person has a perfect title to the property or not. The banker would therefore have to consult solicitors and obtain their opinion before accepting it as a security, which in many cases delays lending. Title verification, must also be done to know whether the property was encumbered. This has to be done by verifying record with the Registrar's office, which involves expense and time. In the case of agricultural land, with the introduction of land ceiling legislation, legislation protecting the tenants' rights, absence of up-to-date and proper land records, it has become less valuable as a security. Added to this there have been a number of legislations in different states giving debt relief to the farmers and prohibiting transfer of land to persons other than agriculturists. (iii) Difficult to realise the security: Land is not easily and quickly realisable due to lack of ready market. It may take months to sell and some times if the market is not favourable, it may fetch a lower price than what was anticipated. (iv) Creating a charge is costly: The security can be charged either by way of legal mortgage or by way of an equitable mortgage. An equitable mortgage may be created by a simple deposit of title deeds with or without a memorandum. Although equitable mortgage is less expensive, a banker always prefers legal mortgage to an equitable mortgage, since the remedies under a legal mortgage are better than those under an equitable mortgage. However, completing a legal mortgage involves expenses including stamp duty and lot of formalities. (v) Difficulty on account of Rent Control Act: In the case of buildings, which come within the purview of the Rent Control Act, it would be difficult to sell the building, particularly when a tenant has been occupying it for a long time. This reduces the marketability and value. Precautions to be taken by the banker (i) Financial soundness of borrower: The banker should place more reliance on the financial soundness of the borrower. (ii) Borrower's title: The banker should get a solicitor to verify the title to the property and the right of the borrower to mortgage. (iii) Enquiry regarding prior charges: The borrower should produce a certificate from the Registrar's office listing the charges over the property over a period of time (generally 30 years) that the property is free from encumbrances. This is commonly understood as nonencumbrance certificate. If any prior charges exist the banker's right will be subject to such prior charges. (iv) Freehold or leasehold: A freeholder is the absolute owner of his land and is able to deal with it as he likes. A leasehold property is one which is taken on lease for a period and a leaseholder derives a legal status for a term of years from the freeholder and is free to deal with the land when acting within the terms of the lease and within the law during that period. When the lease expires, the land reverts to the freeholder. In the case of leasehold property, the unexpired period of the lease is an important consideration. The longer the unexpired period of the lease, greater is the value of the security. The bank should also ensure by verifying a copy of lease deed that there are no onerous covenants such as the necessity of taking the freeholder's consent before mortgaging the property. The banker should also obtain the last ground receipt to ensure that the lease is active. (v) Valuation of the property: Valuation can be done in anyone of the following ways: (a) By utilising the services of recognised valuers who would be engineers or architects. (b) Making enquiries with local real estate agents. (c) By local authorities.

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(d) Latest sale transaction of neighbouring properties. (e) Calculations based on the annual rental value. (vi) Registration: Where the principal money secured is Rs. 100 or more, a mortgage charge is required to be registered unless the charge is an equitable mortgage, (vii) Documentations: The mortgage deed must be drafted carefully considering all the legal stipulations. It should be witnessed by at least two persons. In case of simple mortgage it attracts ad-valorum stamp duty, (viii) Verification of Tax Receipts: The banker should request the borrower to produce latest property tax receipts since any arrears of tax constitute a preferential charge on property, (ix) Insurance of the property: To avoid loss of security by fire, natural calamities, it is prudent that in case of buildings the banker insist on insurance of the property for its full value at the borrower's expense. 2. Stocks and Shares Shares: These may be classified into preference shares (which enjoy preference both with regards the payment of dividend and repayment of capital) and equity shares, i.e., shares which are not preference shares. Banks accept only quoted shares as security. Advantages (i) Value of the security can be ascertained without any difficulty. (ii) In normal times, stocks and shares enjoy stability of value and are not subject to wide fluctuations. (iii) Stocks and shares require very little formalities for taking them as security, (iv) It is easier compared to real estate to ascertain the title, more so with the advent of depositories. (v) Creating a charge of this is less expensive than real estate, (vi) They yield intermittent income by way of dividends, which can be appropriated towards the loan account. (vii) Being a tangible form of securities they are more reliable, (viii) The release of such securities involves very little expense and formality. Disadvantages (i) Being easy to realise, they are fraud prone and as such they must be properly secured, (ii) In the case of partly paid shares, the following demerits are there: (a) The banker may have to pay the calls. (b) Partly paid shares are subject to violent price fluctuations. (c) They are not easily realisable because of the restricted market for such shares. Precautions while taking stocks and shares as security: Banker must take the following precautions while advancing against stocks and shares: (i) In the case of partly paid shares (a) the banker should never register them in his name. (b) He must ensure that pending calls are paid. (c) Sufficient margin should be taken to avoid any future loss or change in the value of the security. (d) The banker should verify share certificate and ensure that the calls are paid properly and entered in the space provided for the same. Other precautions (i) Update the list of shares which the particular bank is willing to lend against on a regular basis.

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(ii) Updating the amount that can be lent against a particular share which is called the card limit at regular intervals, (iii) Yearly review of the portfolio or more frequent review depending upon the volatility in the capital market. 3. Debentures: Debenture is a document issued by a company acknowledging its indebtedness to the bearer or a registered holder. A fixed rate of interest is payable at stated periods on such debentures. In the case of mortgage debentures, a charge is created on the assets of the company issuing such debentures in favour of a trustee who is responsible to take care of the interest of individual investors. Advantages (i) (ii) (iii) (iv) (v) Easy to sell. Not subject to violent price fluctuations. They can be transferred at minimum cost. Bearer debentures are fully negotiable. They rank in priority to shares and mostly secured by a charge on the company's property.

Disadvantages (i) If interest is not paid regularly on the debentures, it would affect its price and marketability, (ii) If the charge on property of company is not registered, the subsequent charges will get a priority, (iii) Debentures may be issued by companies having no power to borrow money. Precautions to be taken while taking debentures as security (i) The nature of the debentures must be ascertained, i.e., whether they are unsecured or secured, the later being preferred, (ii) The borrowing powers of the company issuing the debentures must be ascertained and to verify that the same has not been exceeded. (iii) Deposit of the debentures plus a memorandum of deposit is necessary, (iv) The nature and value of the assets charged must be examined frequently. (v) The banker must find out whether there are any uncancelled redeemed debentures. 4. Goods: Though, earlier, bankers were not forthcoming to advance against goods or documents of title to goods, now more and more secured advances of the scheduled banks in India are against goods. Merits of this Security (i) Goods have a ready market and as such can be easily sold unlike other kinds of security. (ii) Valuation of the goods can be easily done. (iii) The banker gets a tangible form of security compared to unsecured advances, which in case of default by the borrower, can be realised by sale of pledged goods, (iv) Advances against goods are normally given for short periods and therefore the risk of the banker is considerably reduced, (v) Barring a few states where the stamp duty is heavy, creating a charge on the security is less costly and involves minimum formalities, (vi) Banker acquires a good title to the goods when dealing with customers of repute and standing. Demerits of this Security (i) Certain goods are liable to perish or deteriorate in quality over a period of time, thus resulting in reduction of the value of the banker's security.

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(ii) There are possible risks of fraud or dishonesty on the part of the borrower. For example, when 10,000 tins of cashew nuts are shown in the godown as security for an advance, it is not possible for the banker to verify the quality and quantity in every tin. It is not even possible to verify whether all the 10,000 tins contain cashew nuts. A fraudulent borrower may not store the full stocks as declared in the godown. (iii) The value of the security in certain cases more particularly electronic consumer goods are subject to wide fluctuations. Therefore, the valuation of such goods is difficult. Even in the case of necessaries, there being several varieties, unless the banker has expert knowledge, the valuation may be misleading. Disposing of large quantities of goods within a short time may be difficult and may not fetch the expected / declared price. (iv) The banker may find it difficult to store the goods. (v) Transporting the goods from the borrower's premises to the banker's premises and thereafter to the market in case of sale is a considerably costly and time-consuming affair. (vi) When the banker releases goods for sale on the execution of trust receipts, the money realised by the sale of such goods may not be deposited with the banker and the borrowers may default to the bankers. (vii) If the goods are warehoused, the warehouse keeper enjoys a lien over the goods for any unpaid charges. The banker therefore, has to ensure periodically that all charges are duly paid. Valuation of Goods (i) Advances are given based on the stocks and their value declared in monthly stock/statements. The stock/goods are to be inspected at regular intervals and prices verified and tallied with purchase invoices. (ii) By visiting factory/godown by officials and valuers like cost accountants, (iii) Follow up of account ensuring payment to creditors for stock and collection of debtors thus avoiding diversion/misuse of funds. Precautions to be taken (i) Advances against goods should be restricted to genuine traders and not to speculators, (ii) Loans must be given for short periods, since the quality and thereby the value of the security is likely to diminish, (iii) The banker must have a working knowledge and gather information of the different types of goods regarding their character, price movements, storage value, etc. (iv) The banker should confirm the state of goods, (v) The goods should be insured against loss by theft or fire, (vi) The banker should verify and confirm the title of the borrower to the goods by inspecting the invoices or cash memos. (vii) The banker as a Pawnee is liable, if reasonable care is not taken of the goods pledged. He should therefore, take proper care for their storage and also take reasonable steps to protect them from damage and pilferage. (viii) The price of the goods must be accurately ascertained, (ix) Necessary margin must be taken by the banker to protect him against fluctuations in the price of goods. (x) The banker must obtain absolute or constructive possession of the goods, (xi) In the case of hypothecated goods, the bank should obtain from the borrower a written undertaking that the goods are not charged to any bank or creditor and will not be so charged as long as the borrower is indebted to the bank. The banker should obtain at regular

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periods certificates regarding the quantity and valuation of the goods, which should be physically verified by the banker. Documents of Title to Goods: What are Documents of Title to Goods? As per the Section 2(4) of the Sale of Goods Act, 1930, a document of title to goods is 'a document used in the ordinary course of business as a proof of possession or control of goods authorising or purporting to authorise either, by endorsement or delivery, the possessor of the documents to transfer or receive the goods thereby represented.' Thus, the essential requisites of a document of title to goods are: (i) The mere possession of the documents creates a right either by virtue of law or trade usage, to possess the goods represented by the documents, (ii) Goods represented by the documents can be transferred by endorsement and/or delivery of the documents. (iii) The transferee of the documents can take delivery of the goods in his own right, (iv) Although they appear to be negotiable instruments, documents of title to goods are not negotiable instruments. The title of bona fide transferee for value can be affected by defects in the title of transferor. They may be called quasi-negotiable instruments. Examples of documents of title to goods are bills of lading, dock warrant, warehouse-keeper's certificate, railway receipts, delivery orders, etc. Documents of title to goods must be distinguished from other documents like the warehouse-keeper's non-transferable receipts, which are mere acknowledgement of the goods. Documents of title to goods are preferred by bankers because under Section 52(2)(e) of the Presidency Towns Insolvency Act, 1909, and Section 28(3) of the Provincial Insolvency Act, 1920, possession of goods represented by such instruments duly endorsed in his favour are taken out of the order and disposition of the insolvent. The significance of this is that in case the borrower becomes insolvent, the Official Receiver or Official Assignee as the case may be, cannot include such goods in the assets of the insolvent. Merits of this Security (i) By mere pledge of the instruments the goods are pledged and serve as a good security, (ii) The person in possession of the document can transfer the goods by endorsement and/or delivery. The transferee thereafter is entitled to take delivery of the goods in his own right, (iii) The documents are easily transferable, and the formalities involved are less compared to mortgage or assignment. Demerits of this Security (i) Possibility for fraud and dishonesty: Since the bill of lading or a railway receipt or a warehouse-keeper's certificate does not certify or guarantee the correctness of the contents of the bags or packages, the banker will have no remedy against the carrier or warehousekeeper, if they turn out to be containing worthless goods. (ii) Forged and altered documents: The documents might be forged ones, or even if genuine, the quantity may be altered. (iii) Not Negotiable documents: The document being "Not Negotiable", the transferee of such documents will not get a better title than that of the transferor. Therefore, if the person who pledged the documents has a defective title, the banker will not acquire a better title, (iv) Unpaid vendor's right of stoppage in transit: Under the Sale of Goods Act, 1930, an unpaid vendor has the 'right of stoppage in transit' and he is entitled to direct the carrier that the goods need not be delivered, if not already done. If this right is exercised by the unpaid vendor, the banker cannot obtain the goods and his security is of no value.

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(v) In the case of lost documents, delivery of the goods is allowed on the execution of an indemnity bond, this option may be misused by the borrower by selling the goods to some other customer who may take delivery of the goods declaring that he had lost/misplace the document and indemnifying the carrier. To avoid such a contingency, the banker can give notice to the carrier regarding his interest and the pledge. Precautions to be taken by the banker (i) The documents must be examined thoroughly to ensure that they are genuine and of recent origin. In the case of bills of lading, they are prepared generally in triplicate and as such all the copies must be obtained by the banker. Otherwise, the carrier is released from his obligation by delivering the goods on the presentation of any one copy containing ostensibly regular endorsements. (ii) The banker should ensure that the documents do not contain any onerous clauses or prejudicial remarks about the condition of goods received. (iii) Banker should ensure that the goods are adequately covered by insurance for full value against risks of theft, fire, damage in transit, etc., and in the case of goods shipped by sea, all the marine risks should be covered. (iv) Banker should ensure to get consignee copy and banks name being entered as consignee, so that endorsement/transfer of title is specific. Trust Receipt Whenever the bank releases documents of title to goods to the borrower without payment being made, then a 'Letter of Trust' should be taken. So also in the case of goods hypothecated to the bank. The reasons are as follows: (i) The borrower on sale of the goods has to hold proceeds in trust for the banker. (ii) The goods taken under such trust receipts or the sale proceeds thereof, are not available to the official receiver in case the borrower becomes insolvent. A Trust letter incorporates the following clauses (i) Borrower's recognition, of bank's rights in the goods as security and in case of sale, the proceeds, thereof. (ii) Borrower's, undertaking to hold the goods or sale proceeds thereof, in trust for the banker, (iii) Borrower's undertaking, to ensure proper storage and insurance, at his cost. (iv) Borrower's undertaking to direct the buyer to pay the monies directly to the banker, if so required by the banker, (v) Borrower's undertaking to return unsold goods on banker's request or dispose of the same as directed by the banker. 5. Life Policies: Purpose of Life Policy: A life policy is taken for two purposes: (i) It is a source of income for the dependents of the assured in case of his death, (ii) It is an ideal form of saving since along with income tax deduction on the premium, paid loans can be raised on the policies in times of need. Advantages (i) Life insurance business being highly regulated and permitted only to companies having sound financial health, the banker need not doubt the realisation of the policies, which will be done without any difficulty, if the policy and the claim are in order. (ii) The assignment of the policy in favour of the banker requires very little formalities and the banker obtains a perfect title.

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(iii) The longer the period for which the policy has been in force, the greater the surrender value. It is also useful as an additional security because, in the event of the borrower's death, the debt is easily liquidated from the proceeds of the policy. (iv) The security can be realised immediately on the borrower's default of payment by surrendering the policy to the insurance company. (v) The policy is a tangible security and is in the custody of the bank. The banker only has to ensure that regular payment of premiums is made. Disadvantages (i) If the premium is not paid regularly, the policy lapses and reviving the policy is complicated. (ii) Insurance contracts being contracts of utmost good faith, any misrepresentation or nondisclosure of any particulars by the assured would make the policy void and enable the insurer to avoid the contract. (iii) The person (proposer) who has obtained the policy must have an insurable interest in the life of the assured or the contract is void. (iv) The policy may contain special clauses, which may restrict the liability of the insurer. (v) When the banker accepts a policy coming under Married Women Property Act he must ensure that all the parties sign in the bank's form of assignment. (vi) There is facility to obtain the duplicate policy if the original is lost. This can be misused by persons by obtaining duplicate policies. Banker should, therefore, verify that no duplicate policy has been issued and there are no encumbrances on the policy. Advantages (i) The policy must be assigned in favour of the bank and should be sent directly to the insurance company for registration and ensured that only authorised office of Insurance Company has noted assignment. (ii) The bank should see that the age of the assured is admitted. (iii) The banker should ensure the regular payment of premium. Book Debts: Borrowers can take advances by assigning book debts in favour of the bank. Section 130 of the Transfer of Property Act permits assignment of actionable claim and the procedure to be followed is: (i) The assignment must be in writing and signed by the transferor or his duly authorised agent. (ii) Notice of the assignment in writing must be given to the debtor; and. (iii) The assignment may be absolute or by way of charge. Legal implication of assignment (i) The assignee can sue in his/their own name and can give a valid discharge. (ii) The debtor can exercise any right of set off against the assignee, which but for such transfer, he could have exercised against assignor, (iii) As an actionable claim includes future debts, there can be a valid assignment of future debts as well. Precautions to be taken (i) The value of the security depends on the solvency of the debtor and his right of set off, if any. The banker must enquire into both aspects, (ii) The instrument of assignment must be in writing and duly signed in the presence of the banker, signed by the assignor or his duly authorised agent.

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(iii) The banker must serve notices of assignment on debtors, who must be asked to acknowledge its receipt and confirm: (a) The amount of the debt. (b) His right of set off, if any, and (c) Whether he has received notice of prior assignments, if any. (iv) An undertaking from the borrower should be taken that the amount of debts collected directly if any by him will be passed on to the banker, towards the loan account and operations in account be controlled to ensure this compliance. (v) Where the book debts are as assigned by a joint stock company, the charge must be registered with the Registrar of Joint Stock Companies. 7. Fixed Deposit: When money deposited by a customer is not repayable on demand and is payable on the expiry of a specified period from the date of deposit such a deposit is called a 'Fixed Deposit'. The banker evidences a deposit by issuing a receipt known as fixed deposit receipt. Interest is paid at regular intervals at a specified rate on such deposits. Banks usually permit depositors to borrow against the deposit. This security is certainly the most valuable, as the money represented by the receipt is already with the bank and there is no problem of valuation or enquiring the title, or the problem of storage and costs associated with storage. Precautions (i) The banker should grant the advance only to the person in whose name the money is deposited. Banker should not advance against fixed deposit receipts of other banks. This is because the banker who has received the deposit will have a general lien over such monies. Even if the lending bank gives notice to the bank, which has received the deposit, the latter may even refuse to register the lien in favour of the lending bank. (ii) If the deposit is in joint names the request for loan must come from all of them. (iii) When the deposit receipt is taken as security, the banker should ensure that all the depositors duly discharge it on the back of the instrument after affixing the appropriate revenue stamp. In addition to this, the banker should obtain a letter of appropriation which authorises the banker to appropriate the amount of the deposit on maturity or earlier towards the loan amount. (iv) After granting the advance, the banker must note his lien in the fixed deposit register to avoid payment by mistake and the lien, must also be noted on the receipt itself. (v) Advance should preferably not be made against fixed deposit receipt in the name of a minor, unless a declaration is taken from guardian, that loan will be utilised for benefit of the minor. (vi) Where the money is being advanced against the fixed deposit receipt issued by another branch, the FDR duly discharged must be sent to the branch where such money is deposited for the following purposes: (a) To verify the specimen signature of the depositor (b) To ensure that no prior lien exists on the fixed deposit receipt (c) To mark lien on the FDR and the FDR register, in favour of branch advancing money. (vii) Sometimes a person may approach for advances by offering the fixed deposit receipts held by third parties as security. In such a case, the fixed deposit receipt must be duly discharged by the third party, i.e., FD holder and he should declare in writing the bank's right to hold the deposit receipt as security, and also to adjust the deposit amount towards the loan account on maturity or on default in repayment of instalment if any. 8. Supply Bills: Supply bills arise in relation to transactions with the Government and public sector undertakings. A party might have taken a contract for execution, and he is entitled to progressive

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payments based on work done, for which he has to submit bills in accordance with the terms and conditions of the contract. Similarly, parties who have accepted tenders for supply of goods over a period are entitled to payments on the supply of goods, for which they submit bills in accordance with the terms of the contract. These bills are known as supply bills. Procedure followed in respect of supply bills (i) The supplier delivers the goods supported by a delivery challan and produces the documents. The appropriate authority of the government department inspects these goods and accepts for payment on due date and the supplier obtains an inspection note. In the case of contracts, an engineer's certificate regarding work done is obtained. (ii) The supplier or the contractor as the case may be, prepares the bill for obtaining payment. Government departments take quite some time to verify the bills and pass them for payment. Therefore, the supplier or contractor submits these bills together with the accepted delivery challan and inspection note or the engineer's certificates to the appropriate Government department through the banker and requests the banker to advance against such bills. These bills do not enjoy the status of negotiable instruments. They are in the nature of debts and are assigned, in favour of the banker for payment, after affixing a revenue stamp for having received the amount. The bank should also obtain a letter from the supplier or contractor, requesting the appropriate department to make the payment directly to the banker. Risks involved in advancing against supply bills (i) Although the advance is self-liquidating in nature, in certain cases it can take quite some time before the advance is realised because of administrative and other Governmental procedures, (ii) It is virtually a clean advance and the bank may not realise the full amount, because of the possibility of counter claim or the right of set off by the Government, as the charge is only by way of assignment, (iii) Sometimes, the Government may not pass the bills for full payment because of the unsatisfactory quality of goods or defective work done by the contractor or delays in the completion of work. Precautions to be taken by the banker (i) Advances against supply bills should be made only to borrowers who have sufficient experience in Government business and Government regulations. (ii) The contract between the supplier and the Government department should be scrutinised by the banker, to know the volume of transaction, period of supply, rates agreed upon and various other terms and conditions. The Government will not pass the bills unless there is faithful adherence to the terms and conditions by the supplier, (iii) The banker should obtain a power of attorney from the supplier authorising him to receive the money. The same should be registered with the appropriate Government department, (iv) The banker should obtain the inspection note or the engineer's certificates along with the bills. There should be no adverse remarks in the inspection report regarding the quality and quantity of goods supplied, (v) There are two types of bills that are submitted by the suppliers. They are: (a) Interim bills against which Government pays eighty to eighty-five per cent of the amount. (b) Final Bills for the balance of twenty to fifteen per cent which will be paid only after complete verification of goods at the point of destination. Because of the delay involved

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in the settlement of final bills, banks should prefer the interim bills for advancing and final bills only for collection. Keep sufficient margin to cover advance with interest thereon from proceeds to be received. (vi) Banker must reserve the right of demanding the repayment of advance, if the bills remain unpaid for a specified period. The banker, in other words, treats the bills as only items for collection and the advances are recovered. 13.3 LET US SUM UP The effectiveness of a security offered to a banker would largely depend on the nature of the security, which includes its marketability, valuation and other economic factors and certain legal aspects, like the borrower's title, existing encumbrance or liability attached to the security. The various kinds of normally acceptable securities include land/real estate, stocks and shares, debentures, goods, life policies, book debts, fixed deposit receipts and supply bills. The securities depending on their nature have various advantages and disadvantages. The banker however, has to verify the worth of the security and its readability, before accepting it. Of all the kinds of security, fixed deposit receipt of the bank is the best and most reliable compared to other forms of security. The security of goods can be created either by pledging the goods directly or by pledging the title to goods, which in turn is a pledge of the goods or by charge by way of hypothecation. 13.4 KEYWORDS Preference Shares; Equity Share; Debenture; Documents of Title to Goods; Life Policy; Trust Receipt. 13.5 CHECK YOUR PROGRESS 1. State whether true or false. (a) If money lent is more than Rs 100 on the security of land, then the mortgaged (simple) requires registration. (b) A mortgage deed need not be witnessed. (c) Permission from Income Tax Authorities under the Section 230 to create mortgage is required only if the land belongs to a company. (d) Arrears of tax constitute a preferential charge on the property. (e) There are three types of shares - ordinary, equity and preference. (f) Debenture is a kind of share issued by a company and has no voting rights. (g) Borrower can create a valid pledge with documents of title to goods. (h) Bills of lading, dock warrants, warehouse-keeper's certificate, etc., are some examples of documents of title to goods. (i) Documents of title to goods are negotiable instruments. (j) Only Life Insurance Companies can issue life policies, (k) Insurance contracts are contracts of absolute good faith. (1) An assignee of a life policy can sue in his/her own name, (m) For a loan against fixed deposit receipt, the stamp duty is very high, (n) Supply bills are bills of exchange. 13.6 ANSWERS TO 'CHECK YOUR PROGRESS' 1. (a) True; (b) False; (c) False; (d) True; (e) False; (f) False; (g) True; (h) True; (i) False; (j) True; (k) True; (I) True; (m) False; (n) False.

LAW RELATING TO SECURITIES AND MODES OF CHARGING - I

STRUCTURE 14.0 14.1 14.2 14.3 14.4 14.5 Objectives Introduction Mortgage Let Us Sum Up Check Your Progress Answers to 'Check Your Progress'

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14.0 OBJECTIVES
After studying this unit, you should be able to understand: various types of mortgages and law relating thereto; essential features of various types of mortgages.

14.1 INTRODUCTION
When land/building is offered as a security, it is charged to the bank by a mortgage. Mortgages are of six kinds, though as a banker you would be dealing in only three of them. The law, relating to mortgages is dealt with in the Transfer of Property Act, 1882. and more particularly in Sections 58 to 99 and 102 to 104. We shall now study these provisions and see how they affect us, as bankers in our business of lending.

14.2 MORTGAGE
Section 58(a) of the Transfer of Property Act, 1882 defines a mortgage as follows: 'A mortgage is the transfer of interest in specific immoveable property, for the purpose of securing the payment of money advanced or to be advanced by way of loan, on existing or future debt or the performance of an engagement which may give rise to a pecuniary liability.' The transferor is called the 'mortgagor' and the transferee a 'mortgagee' the principal money and interest of which payment is secured is called mortgage money and the instrument by which the transfer is effected is called the 'mortgage deed'. 1. Ingredients of Mortgage: From the above definition of mortgage, the following are the requirements of a mortgage: (i) There should be transfer of interest in the property by the mortgagor (the owner or lessor), (ii) The transfer should be to secure the money paid or to be paid by way of loan. 2. Mortgage of Land - Various Types: The Transfer of Property Act contemplates six different kinds of mortgages. They are: (i) (iii) (v) (vi) Simple mortgage (ii) Mortgage by conditional sale Usufructuary mortgage (iv) English mortgage Mortgage by deposit of title deeds (Equitable mortgage) Anomalous mortgage

Simple mortgage According to Section 58(b) of the Transfer of Property Act, a simple mortgage is a transaction whereby, 'without delivering possession of the mortgaged property, the mortgagor binds himself personally to pay the mortgage money and agrees, expressly or impliedly, that in the event of his failing to pay according to his contract, the mortgagee shall have a right to cause the mortgaged property to be sold by a decree of the Court in a suit and the proceeds of the sale to be applied so far as may be necessary in payment of the mortgage money.' Features of simple mortgage (i) The mortgagee has no power to sell the property without the intervention of the Court. In case there is shortfall in the amount recovered even after sale of the mortgaged property the mortgagor continues to be personally liable for the shortfall, (ii) The mortgagee has no right to get any payments out of the rents and produce of the mortgaged property.

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(iii) The mortgagee is not put in possession of the property. (iv) Registration is mandatory if the principal amount secured is Rs. 100 and above. Mortgage by way of conditional sale As per Section 58(c) of the Transfer of Property Act, a mortgage by way of a conditional sale of the property is a transaction whereby the mortgagor ostensibly sells the mortgaged property on the condition that: (a) on default of payment of the mortgage money on a certain date, the sale shall become absolute, or (b) on such payment being made the sale shall become void; or (c) on such payment being made, the buyer shall transfer the property to the seller. No such transaction shall be deemed to be a mortgage of conditional sale, unless the condition is embodied in the document, which effects or purports to effect the sale. Essential features (i) The sale is ostensible and not real. (ii) If the money is not repaid on the agreed date, the ostensible sale will become absolute upon the mortgagor applying to the Court and getting a decree in his favour. The mortgagor in such a case loses his right to redeem his property, (iii) The mortgagee can sue for foreclosure, but not for sale of the property. Foreclosure, means the loss of the right possessed by the mortgagor to redeem the mortgaged property, (iv) There is no personal covenant for repayment of the debt and therefore bankers do not prefer this type of mortgage. The mortgagee cannot look to the other properties of the mortgagor in case the mortgaged property proves insufficient. Usufructuary mortgage According to Section 58(d) of the Transfer of Property Act, 'a Usufructuary mortgage is a transaction in which (a) the mortgagor delivers possession expressly, or by implication and binds himself to deliver possession of the mortgaged property to the mortgagee; and (b) authorises the mortgagee to retain such possession until payment of the mortgage money and to receive the rents and profits accruing from the property or any part of such rents and profits and to appropriate the same in lieu of interest, or in payment of the mortgage money, or partly in lieu of interest and partly in payment of the mortgage money. Essential features (i) The mortgagee is put in possession of the mortgaged property. Here, by possession it is meant, the legal possession and not the physical possession. For example, the mortgagor may continue to enjoy the physical possession as the lessee of the mortgagee or the mortgagor may be the caretaker of the property directing the tenants to pay rent to the mortgagee. However, the deed must contain a clause providing for the delivery of the property to the mortgagee and authorising him to retain such possession. (ii) The mortgagee has the right to receive the rents and profits accruing from the property. Such rents and profits or part thereof, may be appropriated in lieu, of interest or in payment of the mortgage money or partly for both. (iii) Unless there is a personal covenant for the repayment of the mortgage money, there is no personal liability for the mortgagor. Therefore, the mortgagee cannot sue the mortgagor for repayment of the mortgage debt; nor can he sue mortgagor for the sale or foreclosure of the mortgaged property. (iv) There is no time limit specified and the mortgagee remains in possession of the property until the debt is repaid. The only remedy for the mortgagee is to remain in possession of the mortgaged property and pay themselves out of the rents and or profits of the mortgaged property. If the

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mortgagor fails to sue for redemption within thirty years, the mortgagee becomes the absolute owner of the property. Bankers do not prefer this form of mortgage for the following reasons: (i) There is no personal covenant to repay the debt. (ii) As the mortgaged money can be recovered only by the appropriation of rents and/or profits, it will take a very long time to recover money through this process. English Mortgage According to Section 58(e) of the Transfer of Property Act, an 'English Mortgage' is a transaction in which, the mortgagor binds himself 'to repay the mortgage money on a certain date and transfers the mortgaged property absolutely to the mortgagee, but subject to the provision that he will retransfer it to the mortgagor upon payment of the mortgage money as agreed'. Essential features (i) It provides for a personal covenant to pay on a specified date notwithstanding the absolute transfer of the property to the mortgagee, (ii) There is an absolute transfer of the property in favour of the mortgagee. However, such absolute transfer is subject to a provision that the property shall be re-conveyed to the mortgagor in the event of the repayment of mortgage money, (iii) The mortgagee can sue the mortgagor for the recovery of the money and can obtain a decree for sale. Equitable mortgage or mortgage by deposit of title deeds According to Section 58(f) of the Transfer of Property Act, 'Where a person in any of the following towns - namely, the towns of Kolkata, Chennai and Mumbai and in any other town which the State Government concerned may, by notification in the official gazette, specify in this behalf - delivers to a creditor or his agent documents of title to immoveable property, with intent to create a security thereon, the transaction is called a mortgage by deposit of title deeds.' Documents of title Documents of title or title deed in case of mortgage by deposit of title deeds, shall be documents or instruments which relate to ownership of the mortgagor over the property. In other words, by virtue of a document or instrument, if a person has a right to peaceful possession and enjoyment of the immoveable property, then such a document or instrument is called the title deed. In the case of Syndicate Bank vs Modern Tile and City Works (1980 KL T 550); it was explained by the learned Judges that documents of title or deed means the legal instrument which proves the right of a person in a particular property. Essential features (i) Such a mortgage can be affected only in the towns notified by the State Government. However, the territorial restriction refers to the place where the title deeds are delivered and not to the situation of the property mortgaged. (ii) To create this mortgage, there must be three ingredients i.e. a debt, a deposit of title deeds and an intention that the deeds shall be act as security for the debt. Anomalous mortgage According to Section 58(g) of the Transfer of Property Act, 'a mortgage which is not a simple mortgage, a mortgage by conditional sale and usufructuary mortgage and English mortgage or a mortgage by deposit of title deeds within the meaning of this Section, is called an 'Anomalous Mortgage.' Essential features (i) It must be a mortgage as defined by Section 58 of the Transfer of Property Act. (ii) It is negatively defined and should not be anyone of the mortgages listed above.

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(iii) Anomalous mortgages are usually a combination of two mortgages. Examples of such mortgages are: (a) a simple and usufructuary mortgage, and (b) an usufructuary mortgage accompanied by conditional sale. There may be other forms, moulded by custom and local usage. 3. Merits and Demerits of an Equitable Mortgage Merits (i) The borrower saves the stamp duty on the mortgage deed and the registration charges. It involves minimum formalities, (ii) It involves less time and can be conveniently created. It can be done without much publicity and therefore, the customer's position is not exposed to public gaze. Demerits (i) In case of default, the remedy is to obtain a decree for sale of the property. Since, this involves going to the Court, it is expensive and time consuming. This shortcoming, can be overcome by inserting a covenant by which the mortgagee is given the power of sale. In that case, the mortgage deed must be properly stamped and registered and the mortgage loses the advantage of being simple in procedure and less expensive. (ii) Where the borrower is holding the title deeds in his capacity as a trustee and equitable mortgage of the same is effected, the claim of the beneficiary, under trust will prevail over any equitable mortgage. Therefore, the banker has to make a proper scrutiny of the title deeds before accepting them as a security. (iii) The borrower may create a subsequent legal mortgage in favour of another party. However, this possibility is not there, if the equitable mortgagee holds the original title deeds. In India, there is no difference between the two types of mortgages. According to Section 48 of the Registration Act, 1908, a mortgage by deposit of title deeds prevails against any subsequent mortgage relating to the same property. Similarly, the title of the equitable mortgagee, is not defeated by any subsequent sale without notice. However, to avoid any risk of this type, the equitable mortgage should be accepted only after obtaining the original title deeds. The law in England is slightly different. As between equitable mortgage and legal (simple) mortgage, the latter prevails even though it is effected subsequently. The law, regarding this is, as between law and equity, law prevails. As between the equities, the prior in time prevails. 4. Difference between Equitable Mortgage and Pledge Table 14.1: Difference between Equitable Mortgage and Pledge Pledge Pledgee acquires only a limited interest in the property and ownership remains with the right of pledger. The Pawnee has 'special property' in the goods pledged and can sell the same in the event of default by the pledger of course, after giving reasonable notice. Pawnee has no right of foreclosure. He can only sell the property to realise his dues. Mortgage Here the legal ownership passes to mortgagee, of course, subject to the mortgagor to redeem the property. The mortgagee as a rule takes decree of a Court of Law before having recourse against the property mortgaged. In certain cases, the mortgagee can foreclose the property.

5. Priority of Mortgages: Indian Law of Priorities is provided in Section 48 of the Transfer of Property Act. The rule is based on maxim 'He has a better title who was first in point of time.' It lays the

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general rule regarding priority of rights created by transfer by a person at different times in or over the same immoveable property and provides that, as between such rights, each later created right is subject to the rights previously created. We may further see, as how the rule of priorities operate in respect of different instruments creating mortgages. (a) Priority among registered instruments: Section 47 of the Registration Act, 1908 provides that a registered document operates, not from the date of its registration, but from the time of its execution. Thus, a document executed earlier, though registered later than another, has priority over the documents executed later. (b) Priority between registered and unregistered instruments: Let us now deal with the exceptions to the rule that priority is determined by order of time which either have been created by statute or owe their origin to the ancient rule of Hindu Law, which required delivery of possession in the case of a security of land. There are also some exceptions recognised in the Indian system founded upon those general principles of justice and equity, which in the absence of any express enactment, Indian judges are bound to administer, and which have been mostly borrowed from the English Law. The first exception is that contained in Section 50 of the Registration Act which under certain circumstances allows a registered mortgage priority over unregistered mortgage. However, it may be noted that prior mortgage by deposit of title deeds is not affected by subsequent registered mortgage as the same need not be registered. This is provided in Section 48 of Indian Registration Act. 6. Limitation Period in Mortgages: Article 62 of the Indian Limitation Act, 1963 provides limitation period for filing of suit for recovery of mortgaged debt and sale of mortgaged property in the event of non-payment of the mortgaged debt. Article 63(a) of the said Act provides a limitation period, in case of foreclosure of the mortgaged property. The limitation period for filing a suit for sale of mortgaged property is TWELVE YEARS, from the date the mortgage debt becomes due. The limitation period for filing suit for foreclosure is THIRTY YEARS from the date the money secured by mortgage becomes due. Enforcement of Mortgage - Some Important Aspects We will now learn some important aspects as to enforcement of mortgage. It may be noted that a banker, secures moneys advanced by creating one of the various types of mortgages mentioned above. Popular types of mortgages obtained by a banker are: (i) Mortgage by deposit of title deeds (iii) English mortgage. (ii) Simple mortgage and in some cases

Enforcement of all these types of mortgages is by way of filing a suit for sale of mortgaged properties. The procedure for filing a suit for a sale is provided for in the Code of Civil Procedure, 1908. The Section 16(c) of the Civil Procedure provides that a suit for sale of mortgaged property shall be filed in the Court within whose jurisdiction the mortgaged property is situated. Order 34 of the Code provides for various things to be adhered to while filing suit for sale of mortgaged property. When a suit for sale is filed, the Court after hearing the parties passes a preliminary decree. Through the preliminary decree it directs the mortgagor to pay the mortgage debt within a certain period and in the event of his failure to pay the money due under the mortgage, the Court orders for sale of mortgaged properties by passing a final decree. After passing of the final decree, the mortgagee with the help of the Court gets the mortgaged property sold in execution of the mortgage decree.

14.3 LET US SUM UP


1. Mortgage is a transfer of interest in immoveable property to secure an advanced loan, or an existing debt or a future debt or performance of an obligation.

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2. Transfer of Property Act, contemplates six types of mortgages, they are: (a) Simple mortgage (b) Mortgage by conditional sale (c) Usufructuary mortgage (d) English mortgage (e) Mortgage by deposit of title deeds (f) Anomalous mortgage 3. In Simple mortgage, the mortgage is by deposit of title deeds and in English mortgage, the possession of the mortgaged properties is not given to the mortgagee. 4. In usufructuary mortgage and in mortgage by conditional sale, possession of mortgaged properties is normally given to the mortgagee. 5. In the case of simple mortgage and mortgage by deposit of title deeds, the mortgagee has a right to proceed against the property mortgaged and also personally against the mortgagor. 6. Mortgage is to be created by way of deed and requires to be registered under the Registration Act. 7. Mortgage by deposit of title deeds, is not required to be created by way of a deed and does not require registration. 8. The rule of priority in case of successive mortgages is in the order of time they are created. 9. Limitation period for filing a suit for sale of mortgaged property is twelve years from the date mortgage debt becomes due. 10. Limitation period for filing a suit for foreclosure is thirty years from the date mortgage debt becomes due. 11. Enforcement of mortgage is governed by the Code of Civil Procedure, 1908. Suit for sale of mortgaged properties are to be filed in the Court, within whose jurisdiction the mortgage property is situated. 12. In a suit for sale, of mortgaged properties, the Court first passes a preliminary decree and thereafter a final decree. 14.4 CHECK YOUR PROGRESS 1. Mortgage is in the immoveable property. 2. 3. 4. 5. 6. 7. 8. 9. Simple mortgage is created by an instrument in writing. (True/False) Mortgage by deposit of title deeds is required to be registered. (True/False) In the case of usufructuary mortgage the possession of the properties is given. (True/False) In mortgage by way of conditional sale the property is sold with a condition for re-conveyance. (True/False) All successive mortgages created will rank equally and no mortgage will have a greater priority over the other. (True/False) To decide as to which mortgage will have priority over the other in the case of two or more mortgages on the same immoveable property, the date of _________ mortgage is pertinent. Limitation period for filing a suit for sale of mortgaged properties is__________ years from the date the mortgage debt becomes due. Mortgage suits are filed in the Court within whose jurisdiction the mortgagee resides. (True/ False)

14.5 ANSWERS TO CHECK YOUR PROGRESS'


! transfer of interest; 2. True; 3. False; 4. True; 5. True; 6. False; 7. execution of; 8. twelve; 9. False

LAW RELATING TO SECURITIES AND MODES OF CHARGING - II

STRUCTURE
15.0 15.1 15.2 15.3 15.4 15.5 15.6 Objectives Introduction Pledge Hypothecation Let Us Sum Up Check Your Progress Answers to 'Check Your Progress'

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15.0 OBJECTIVES
After studying this unit, you should be able to understand: the law relating to security of pledge and hypothecation; basic features of pledge and hypothecation.

15.1 INTRODUCTION
A banker, in his business of lending takes security of pledge and hypothecation of moveable goods to secure cash credit and overdraft. These are popular securities obtained by a banker. In this unit, we will learn about the law relating to security of pledge and hypothecation.

15.2 PLEDGE
'Pledge means bailment of goods for purpose of providing security for payment of debt or performance of promise' (as per the Section 172 of Contract Act 1872). As per the above definition to constitute a valid pledge, three requirements are to be satisfied: 1. There must be bailment of goods (bailment means delivery of goods); 2. The bailment must be, by or on behalf of the debtor; and 3. The bailment, must be for the purpose of providing security for the payment of a debt or performance of promise. The person, whose goods are bailed is called the Pawnor, the person who takes the goods as security is called the Pawnee. 1. Legal Implications of a Pledge: The following are the legal implications of a pledge: (a) The ownership of the property is retained by the pawnor, which is subject only to the qualified interest which passes to the pawnee by the bailment. (b) One of the main and most essential requirements of a pledge is the actual or constructive delivery of the goods to the pawnee. By constructive delivery, it is meant that there need be no physical transfer of goods from the custody of the pledger/pawnor to the pawnee. All that is required is, that the goods, must be placed in the possession of the pawnee or of any person authorised to hold them on his behalf. Goods, may be delivered by one of the following ways (as mentioned in the Sale of Goods Act): (i) By handing over the key of the godown in which the goods are kept. (ii) By attornment, i.e. if goods are in public warehouse, the warehouseman acknowledges to the pawnee that he will hold the goods thereafter on behalf of the pawnee. (iii) Handing over the document of title to goods, such as railway receipt, bill of lading, warehouse receipts, etc. (iv) Even if the goods are in possession of the pawnor, he may acknowledge that he holds them thereafter for and on behalf of the pawnee. This is again similar to attornment. Thus, delivery may be physical, when goods are physically transferred or symbolic as in the case of handing over the key to the godown, where the goods are stored so as to be out of the control of the pawnor or constructive as in the case of an attornment. In the case of Co-operative Hindustan Bank Ltd. vs Surendar Nath Dey AIR 1932 Cal 524, it was observed that it is essential in a transaction of pledge that there must be a delivery of goods to the pawnee and he must keep the goods. The delivery need not be simultaneous with lending of money. It may be actual delivery or symbolic delivery, e.g. by delivery of

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key of the warehouse where the goods are stored or something may be done which is equivalent to delivery that is keeping of goods without any actual delivery, as if the pawnee has the possession or effect of possession. (c) Pledge can be created only in the case of existing goods which are in the possession of the pawnor himself. There can be no pledge of future goods or goods which the pawnor is likely to get into his possession subsequently. Since delivery is involved, goods must be specific and identified. (d) Possession of goods is the most important characteristic of pledge and therefore, pledge is lost when possession of the goods is lost. However, the pawnee may release the goods after obtaining a letter of trust from the pawnor. Such a letter of trust is known as the trust receipt. It is an instrument by which the borrower receives the goods or documents of title to goods and undertakes to hold them or the proceeds thereof, in trust for the lender. Because of the trust receipt, the bankers, rights as a pawnee remains unaffected. Even if the borrower becomes insolvent, the Official Receiver cannot claim the goods. (e) An agreement of pledge may be implied from the nature of the transaction or the circumstances of the case. However, an agreement in writing clearly laying down the terms and conditions leaves no ambiguity. 2. Who can create a Pledge? The following persons can make a valid pledge: (a) Owner of the goods (b) A mercantile agent, provided the following conditions are satisfied (i) He should be in possession of the goods, or the documents of title to goods with the consent of the owner. (ii) The goods must have been entrusted to him in his capacity as a mercantile agent, (iii) The mercantile agent should create the pledge in the ordinary course of his business as such agent, (iv) The pawnee acts in good faith and has no notice at the time of pledge that the pawnor has no authority to pledge (as per Section 178 of Contract Act). (c) Persons in possession of goods under a voidable contract, provided the contract, has not been rescinded at the time of pledge (d) Seller of the goods, who continues to be in possession of the goods even after sale, can create a valid pledge. The pawnee must act in good faith and without notice of the previous sale. A pawnee can repledge the goods, but it is valid only to the extent of his interest in such goods. When the original pawnor repays the debt to the first pawnee, he is entitled to the return of the goods although they may be in the hands of the second pawnee to whom the first pawnee has not repaid the debt. 3. Rights of Pawnee (a) Right of retainer: As per Section 173 of the Contract Act, the pawnee can keep the goods pledged not only for the non-payment of the debt or non-performance of the promise, but also for the interest on the debt and for all expenses properly and necessarily incurred for the preservation of the goods pledged. This is similar to the rights of the bailee. (b) Right to claim extraordinary expenses: In respect of such expenditure incurred for taking care of the pledged goods, he cannot claim lien over the goods but can only sue to recover the goods.

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(c) No right to retain in respect of the other debts: In the absence of a contract to the contrary, the pawnee cannot retain the goods for a debt or a promise, other than the promise or debt for which they are pledged. However, in the case of subsequent advances made, such a contract is presumed, in the absence of anything, to the contrary. (d) Rights against third parties: A pawnee has the same remedies against third persons, as the owner himself would have, if he is deprived of his goods. (Morvi Mercantile Bank Ltd. vs Union of India AIR 1965 Supreme Court 1954.) (e) Pawnee's right where Pawnor makes default in payment: In case where the pawnor makes default, the pawnee has three rights: (i) He may sue the pawnor upon the debt or promise; (ii) He may retain the pawned goods as collateral security; or (iii) He may sell it after giving the pawnor reasonable notice of the sale. The right to retain the pawn(pawned goods) and the right to sell it are alternative and not concurrent rights. While the pawnor retains, he does not sell and when he sells he does not retain. However, the pawnee has the right to sue on the debt or the promise concurrently with his right to retain the pawn or sell it. The retention of the pawn does not exclude this right of suit, since the pawn is a collateral security only. In Nanak Chand Ramkrishandas vs Lalchand Ganeshilal AIR 1958 Punj. 222, it was held that a pawnee may keep the goods as security for the debt due to him from the pawnor and although he has got the right to sell after notice to the pawnor, he is not bound to sell at any particular time. The mere fact that the pawnee gave a notice that he would sell the goods cannot possibly be a compelling factor for sale to be effected. If the goods are sold, by the pawnee without a notice, as provided by this Section, they will be deemed to have been converted and an action for conversion of the same would lie against the pawnee; but damages would be assessed, by taking into consideration the market rate of the goods in question as on the date of conversion, which ordinarily, would be the date on which the goods were wrongfully sold. In case of an improper sale, the pawnee is liable for conversion, but the sale cannot be set aside. Whether two notices must be given It was held in A. Srinivasalu vs Gajaraj Mehta & Sons 1990 (II) MLJR 188, that a sale notice is only an intimation of the proposed sale by the pawnee and it is not necessary that such notice must be proceeded by another notice informing the pawnor that on his not making payment the goods would be sold. The sale notice also need not be signed by the pawnee or the amount due be mentioned. If the goods are sold by the pawnee after giving reasonable notice, the pawnor is entitled to receive from him any surplus over and above the debt amount. The pawnor has a right to redeem the goods even though the time stipulated for payment is over, provided the goods have not been sold by the pawnee. Duties of Pawnor: (a) He must disclose to the pawnee any material faults or extra ordinary risks in the goods to which the pawnee may be exposed. Failure to disclose makes him responsible for damages for any loss caused to the pawnee. (b) The pawnor must reimburse the pawnee for any expenses incurred for the preservation of the goods. (c) In the case of forced sale, if the amount realised is less than the debt due from the pawnor, he is liable to make good the balance.

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(d) When the goods are pledged, there is the implied condition that the pawnor has title to the goods pledged. However, in practice the banker obtains the pawnor's signature to a document known as an agreement of pledge. The following are the important points usually covered in the document: (i) The pledge is in respect of all the goods delivered and upon all documents of title to goods deposited by the pawnor (ii) A declaration that the securities deposited would cover the existing and future debt, interest and expenses (iii) The letter stipulates that it will be a continuing security without the operation of the rule in Clayton's case, (iv) Pawnors title to the security is clear, that the goods will be insured adequately at his expense and that sufficient margin will be maintained as agreed upon, (v) A promise to pay all the money secured by the pledge on demand, and in the case of default in repayment, the bank to have the right of sale, (vi) Where the pawnor fails to insure the goods, the banker reserves the right to effect such insurance and debit the premium and other charges to the account of the customer, (vii) A declaration by the pawnor not to hold the bank responsible for the default of any broker employed to sell the goods. The pawnor undertakes to pay the rent and other charges incidental to warehousing, (viii) The banker reserves the right of general lien and nothing in the agreement, shall be construed as excluding such right, (ix) The pawnor undertakes to submit periodical statements of stocks and to allow inspection of the goods and records by the bank, all at his cost. Advantages of Pledge: (a) The goods are in the custody of the pawnee and, therefore, it is easy to sell in case of default. If the banker takes proper precautions, through periodical inspections, it will not be possible for the pawnor to create subsequent charges against the same goods. (b) Because of close supervision, it will not be possible for the pawnor to manipulate the stocks. (c) Even if the goods are lost, the banker can recover the amount under the insurance policy. (d) The formalities connected with the pledge are simpler than in the case of mortgage. Precautions to be taken: (a) To ensure that the pawnor has the title to goods. (b) To ensure that the contract of pledge is complete in all respects and incorporates the already referred to usual clauses. (c) To exercise full and effective control over all the goods pledged. (d) To put up a signboard at the godown prominently displaying, that the goods are pledged to the banker. (e) To take reasonable care of the goods as a man of ordinary prudence would under similar circumstances take of his own goods of the same bulk quantity and value of the goods pledged. Any loss arising to the goods due to failure to take such care must is to be compensated to the pawnor. In his own interest also, the banker must take such care so that the value of security is not eroded. (f) Banker must make periodical inspections to verify the quality, quantity, value, etc., of the goods and ensure the maintenance of reasonable margin throughout the period until the debt is repaid.

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7. Cases Relating to Pledge (a) Morvi Mercantile Bank Ltd. vs Union of India AIR 1965 SC 1954. In this case M/s Harshadrai Mohanlal & Co., a firm, entrusted on 4 Octobe, 1949 to GIP Railway, 4 boxes of menthol crystals belonging to the firm for transport from Thane to Okhla near Delhi. Further, on 11 October 1949 the firm sent two more boxes to Okhla from Thane through the railways. The firm was issued railway receipts. The firm endorsed the railway receipts in favour of Morvi Mercantile Bank. On failure of railways to deliver the goods, the bank, claiming as an endorsee of the railway receipts for valuable consideration, filed a suit against railways for recovery of the value of the goods. The Supreme Court delivering a judgement in appeal, decided that the bank was entitled to recover the value of goods for the following reasons: (i) Valid pledge can be created by endorsement of railway receipts. (ii) For a valid pledge, actual delivery is not necessary and constructive delivery is sufficient, (iii) By endorsing the railway receipts, the firm created a valid pledge in bank's favour, (iv) Pledge being the bailment of goods, the bank as a pledgor will have all the rights of owner of goods, (v) Hence, the bank is entitled to recover value of goods from the railway as a pledge. (b) Lallan Prasad vs Rahmat Ali and Another AIR 1967 SC 1322. The question decided in this case was whether a pawnee can file a suit for recovery of debt due to him if the pawnee lost the goods pledged to him. In this case, on 10 January 1946, Lallan Prasad gave a loan of Rs 20,000 to Rahmat Ali. Lallan Prasad also obtained a pledge of 147 tonnes of aero-scraps from Rahmat Ali. On failure to repay the loan, Lallan Prasad filed a suit against Rahmat Ali for recovery. Rahmat Ali argued that Lallan Prasad is not in a position to deliver the goods pledged and he should not be granted a decree for recovery of money. Supreme Court after analysing the facts of the case rendered a judgement that a pawnee under the Contract Act is entitled to retain the goods pledged and file a suit for recovery of the money. However, this right of pawnee can be countenanced only when pawnee is in a position to return the goods pledged, when pawnor repays the debt. A pawnee cannot be allowed to have a decree for recovery, if he is not willing to return the goods pledged. (c) Bank of Bihar vs State of Bihar AIR 1971 SC 1210. In this case the rights of pawnee came up for consideration of the Court. In this case, Bank of Bihar lent moneys and took security by way of pledge of different varieties of sugar. Government of Bihar seized the bags of sugar from the borrower and sold them to recover Government dues. The bank filed a suit for recovery of moneys due to it against Government of India. The Supreme Court deciding the case, held that right of bank as a pawnee cannot be taken away by government and hence, the Government of Bihar shall pay the amount due to the bank. (d) Standard Chartered Bank vs Custodian AIR 2000 SC 1488. In this case, the Supreme Court held that, if during the pledge there is an increase in value of the goods pledged, the pawnee is entitled to the increase, as an integral part of his security. In this case, the shares and debentures were pledged with the bank and these shares and debentures were entitled to bonus, dividend and interest. The Supreme Court held, that these accretions formed part of the pledged property and as such the pawnee is required to return the same only when the pledged goods were returned and in case of pawnor's default in payment of debt, the pawnee has the right to sell the pledged property along with the accretions after giving reasonable notice to the borrower.

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15.3 HYPOTHECATION
Until recently there was no legislative definition of the term 'hypothecation'. This term came to be defined in the S ARFAESI Act, 2002. As per the definition contained in the Act, the term 'Hypothecation' means a charge in or upon any moveable property, existing or future, created by a borrower in favour of a secured creditor, without delivery of possession of the moveable property to such creditor, as a security for financial assistance and includes floating charge and crystallisation of such charge into fixed charge on moveable property. The mortgage of moveable property is called 'Hypothecation'. It may be described as 'a transaction whereby money is borrowed by the debtor (owner of the goods) on the security of the moveable property without transferring either the property or the possession to the creditor'. Hart describes hypothecation as 'a charge against property for an amount of debt where neither ownership nor possession is passed to the creditor'. Hypothecation differs from pledge because goods remain in the possession of the borrower and are equitably charged in favour of the creditor under documents signed by the borrower. However, the document provides for a covenant, whereby the borrower agrees to give possession of the goods when called upon to do so by the creditor. Once the possession is given up, the charge becomes transformed into pledge. Hypothecation differs from mortgage in two respects. Firstly, mortgage relates to immoveable property whereas hypothecation relates to moveables. Secondly, in a mortgage, there is transfer of interest in the property to the creditor but in hypothecation there is only obligation to repay money and no transfer of interest. Facility limited to respectable customers Law permits hypothecation of assets as a security by sole proprietorships, partnerships, joint stock companies and even individuals. However, the charge being only equitable without possession, the facility is normally granted to customers of undoubted integrity. There is less risk when such a facility is granted to a joint stock company because of the registration of such a charge with the Registrar of Companies. Such a registration constitutes a constructive notice to the world at large, but such a facility is not available in the case of other forms of business. Hypothecation is resorted to in the following cases: (a) When loan is to be raised against work-in-progress, the only way of creating a charge is hypothecation. (b) It is also done in respect of goods which require constant handling in a factory, e.g. rice mills, oil expellers, etc. (c) This charge is also convenient, where lending is to be done against goods in a shop or showroom which are required in day-to-day business. 1. Drawbacks of Hypothecation (a) The fundamental difficulty about this charge is that goods remain in the possession of the borrower and therefore the creditor's control over such goods is almost nil. This may give rise to fraudulent dealings in such goods by the borrower. (b) The borrower may realise stocks hypothecated and pay to other creditors. He may even sell marketable stocks and keep only obsolete and slow moving stocks for the banker to realise. Thus erosion of security can take place. (c) The borrower may hypothecate the same stock with more than one banker or having previously hypothecated, the goods may subsequently be pledged to another creditor. (d) The realisation of the assets in case of default of payment is a difficult, prolonged and costly affair. As stated earlier, the banker may find only obsolete and slow-moving items.

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(e) According to Section 534 of the Companies Act, 1956, any floating charge on the undertaking or property of the company created within a period of twelve months preceding the commencement of the winding up, becomes invalid under certain circumstances. 2. Precautions to be taken in the case of Hypothecation: Although these disadvantages seriously limit the value of hypothecation as a security, the banker can take certain precautions and avoid at least some of the disadvantages. The following precautions usually are taken by banks: (a) Banks ensure that the borrower is not enjoying hypothecation facilities from other banks and is confining his borrowings to only one bank. An undertaking to this effect is obtained from the borrower in writing. Banks also ensure that boards are prominently displayed on the premises where the goods are stored stating that the goods are hypothecated to the bank. (b) In the case the borrower is a company registered under the Companies Act, the charge by way of hypothecation must be registered within a period of thirty days of its creation or a further period of thirty days on payment of fine. If this is not done, the charge would be void against the liquidator or any other creditor of the company. (c) The banker must obtain periodical statements of stocks with a declaration regarding the borrower's clear title to the goods and the correctness of the quality, quantity and valuation. Banks should not merely be content with the receipt of the stock statements, but should also effectively supervise the goods hypothecated and the financial position of the borrower from time to time. Banks should verify in such an inspection that there is no depreciation in the value of the security or any adverse change in the borrower's financial position. If an inspection discloses such a state of affairs, the banker should take appropriate action immediately. Deed of Hypothecation: While lending against hypothecation of goods, bankers obtain a letter of hypothecation which serves as the hypothecation agreement and contains several clauses to protect the banker's interest under all contingencies. It is a very comprehensive document and contains the following important clauses: (a) The request made by the borrower for the grant of accommodation in the form of loan or cash credit on the hypothecation of goods, resulting in the agreement. (b) The description of the goods in a separate statement giving the particulars, quality, rate, quantity, market value and an undertaking that the particulars are true and that the borrowers are the absolute owners of the property and with authority to hypothecate. The statement also declares that the goods are not subject to any lien, claim or charge of any sort. (c) An undertaking that no further charge or encumbrance will be created on the goods and that all money realised by way of sale proceeds or realisation of insurance claims, will be held exclusively as the bank's property and such money will be paid in, to the satisfaction of the balance due and owing on the account kept by the bank in respect of such accommodation. (d) The borrower, whenever required by the bank, must give full particulars of all his assets and of the hypothecated goods. He must, at all times allow the bank or its authorised agent to inspect the hypothecated goods and all records of the borrower. All costs, charges and expenses incurred by the bank in respect of such an inspection are to be paid to the bank on demand, failing which, the amount and interest thereof will be a charge upon the hypothecated goods. (e) The borrower undertakes to insure the goods against risks specified by the banker at his cost. The policy so taken is to be endorsed and assigned in favour of the bank. (f) The borrower undertakes to maintain the agreed,margin of security at all times during the continuance of the security. (g) The borrower undertakes to pay all rents, taxes, payments and outgoings in respect of the immoveable property, in which the hypothecated goods are kept.

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(h) The bank reserves the right to call upon the borrower to pay to the bank the loan amount together with interest and other charges at any time. In the event of default, the bank reserves the right to dispose the hypothecated stocks and apply the proceeds in satisfaction of the loan amount. If the proceeds are insufficient, it reserves the right to recover the balance from the borrower. (i) The borrower undertakes not to dispute the correctness of any sum due to the banker as stated in the demand made by the banker under the hypothecation agreement. (j) A clause stating that the security shall be a continuing security for the balance due to the bank from time to time. Where by any chance, the cash credit results in a credit balance, it is not to be considered to be closed for the purpose of the security. In other words, the security is not treated as exhausted simply because the cash credit showed a credit balance at any time. 15.4 LET US SUM UP 1. 2. 3. 4. 5. Pledge means bailment of goods for the purpose of securing a payment of debt or an obligation. Pawnee has special property rights in the goods pledged. A valid pledge can be created by owner of goods or a mercantile agent. A constructive pledge involves only delivery of keys of the warehouse. Under the contract of pledge, the pawnee can sell the goods pledged after notice or retain the goods and file a suit for recovery of debt. 6. Mortgage of moveable property is called Hypothecation. 15.5 CHECK YOUR PROGRESS 1. Pledge means _________ of goods for purpose of securing a payment of debt or performance of promise, (fill with appropriate words) 2. The most important characteristic of pledge is _________ of goods, (fill with appropriate words) 3. Owner of goods cannot make a pledge. (True/False) 4. Hypothecation is an implied pledge in cases where constructive possession of goods is given. (True/False) 5. Hypothecation letter gives a banker right to possession of goods in the event of default. (True/False)

15.6 ANSWERS TO 'CHECK YOUR PROGRESS'


1. bailment; 2. possession; 3. False; 4. True; 5. True.

DIFFERENT TYPES OF BORROWERS

STRUCTURE 16.0 Objectives 16.1 Introduction 16.2 T^pes of Borrowers 16.3 16.4 16.5 16.6 Let Us Sum Up Keywords Check Your Progress Answers to 'Check Your Progress'

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16.0 OBJECTIVES
After studying this unit, you should be able to understand: the legal aspects pertaining to different borrowers; the laws governing various types of borrowers.

16.1 INTRODUCTION
One of the prime functions of a banker is lending money. In its business of lending money, a banker shall acquaint himself with various laws governing different types of borrowers. The borrowers of a bank may be Individuals, partnership firms, Hindu Undivided Family, Companies' and other Corporate entities. This unit deals with various laws that banker should acquaint himself in his business of lending.

16.2 TYPES OF BORROWERS


Types of borrowers, for the convenience of our study, can be classified as follows: 1. Individual 2. Partnership Firm 3. Hindu Undivided Family 4. Companies 5. Statutory Corporations 6. Trusts and Co-operative Societies 1. Individual: An Individual borrower is one of the constituents of a bank in its business of lending. When a banker lends to an individual, he should verify certain facts, so that the bank's lending is not affected. One of the essential elements of a contract is the capacity of the parties to contract. The bank, while lending to an individual should ensure that he is competent to enter into contract. Money lent to an individual who is not competent to contract cannot be recovered in the following circumstances: (i) If an individual is a. minor: A person who has not attained the age of eighteen years under Indian Majority Act and twenty-one years if he is a ward, under the Guardians and Wards Act, is considered a 'Minor' in the eyes of law. Under the law a 'minor' is not competent to contract. Therefore, if a banker lends money to a minor, then the same, cannot be recovered, if the minor fails to repay. Exceptions: The only exception recognised in a contract with a minor is of supply of necessities to him. If a bank lends money to a minor to meet the expenses for purchasing necessities of life, then bank can recover the money from the estate of the minor. (ii) If an individual is not of sound mind: If a person is not of a sound mind, then he is incompetent to enter into a contract. The Contract Act says that a person will be considered not of sound mind if, at the time when he makes the contract, he is not capable of understanding it and of forming a rational judgement as to its effect upon his interests. Notice that a contract entered, would be invalid if proof is shown that the borrower at the time of entering into contract was not in sound state of mind and could not understand what he was doing and could not understand the implications of entering into contract. (iii) Disqualified persons: There may be statutory disqualifications imposed on certain persons in respect of their capacity to contract. For example, a person, declared as insolvent under the Insolvency Law. As long as the person continues to be a non-discharged insolvent, he cannot enter into contract. The contracts entered into by such a person are not enforceable.

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In our country there are various businesses and economic activities conducted by a single person which are called sole proprietary concerns. In the eyes of the law there is no distinction between the assets and liabilities of the person and the business conducted in the name of the sole proprietor. 2. Partnership Firm: 'Partnership Firm' is another entity with which a banker deals within the course of his business. The Indian Partnership Act, 1932 governs the 'Partnership Firm'. Section 4 of the Act says, that a partnership is the relation between persons who have agreed to share the profits of a business, carried on by all or any of them acting for all. The relationship between the partners is governed by partnership deed. Legal position of a partnership A partnership is not distinct from its partners. Under the law, the name of a partnership firm, is regarded as an abbreviation of the names of partners. The Indian Partnership Act, 1932, provides for registration of a partnership and it is necessary that a banker dealing with a partnership firm should verify as to whether the firm is registered or not. This would help him know all the names of partners and their relationship. Authority of the partners Section 19 of the Indian Partnership Act, 1932 deals with the implied authority of a partner as an agent of the firm and Section 22 deals with the mode of doing acts to bind the firm. In view of the provisions of Sections 19 and 22, it should be noted that the acts of a partner shall be binding on the firm if they are done: 1. in the usual business of the partnership, 2. in the usual way of the business, and 3. as a partner, i.e. on behalf of the firm and not solely on his own behalf. Business of partnership firm; How is it done? In the case of a partnership firm, rights and duties of the partners are determined by the deed of partnership. It provides for opening of bank accounts, borrowing powers, signing of cheques, etc. Generally, there may be a managing partner who conducts the business on behalf of the other partners. A banker dealing with a partnership firm, should ensure that the business is conducted as per the partnership deed. If the managing partner does not have the powers to conduct certain transactions then, it should be ensured, that consent of all partners are obtained. Partnership firm and transactions in immoveable property Section 19 of the Indian Partnership Act, 1932 states that a partner cannot affect the transfer of immoveable property of the firm unless expressly authorised. A banker taking a mortgage security of firm's immoveable property should ensure that the partner who is creating the mortgage is expressly authorised to create the mortgage. If the partner, has no authority to create the mortgage, then the banker should ensure that all the partners jointly create the mortgage. Insolvency of the firm The banker, on receiving notice of insolvency of the firm, must immediately stop any further transactions in the account irrespective of the fact that the account is in credit or debit. In case there is a credit balance, and the banker does not intend to set off the same against the dues in any other account, then the balance has to be handed over to the official receiver appointed by the Court or as directed by the Court. In case the account is in debit then the banker would be required to prove his debt before the Court and thereafter will be entitled to receive the same from the Official Receiver either in full or as per the dividend declared by the Courts.

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Insolvency of the partner If at the time of insolvency of one of the partners, the firm's account is in credit then the other partners can operate the same, but the banker should obtain a fresh mandate and all previous cheques issued by the insolvent partner may be paid provided the other partners confirm the same. In case, the account is in debit then further transactions in the account should be stopped so that the rule in Clayton's case does not apply. Death of a partner In case of death, the principles as stated in Insolvency of a partner applies. Since the death of a partner dissolves the partnership firm, upon receipt of such information, banks are required to stop the transactions of the firm in a running credit facility like cash credit, overdraft to crystllise the liability of the deceased partner and make his/her estate liable for its dues. Banks allow the transactions in a separate account so that the business of the firm is not adversely affected. 3. Hindu Undivided Family: 'Hindu Undivided Family' otherwise known as 'Joint Hindu Family' is a creature of Customary Law among Hindus and is governed by personal laws. In Bengal and other parts of erstwhile Bengal province, a Hindu Undivided Family is governed by Dayabhag Law. In other parts of India, it is governed by Mitakshara Law. Constitution of a Joint Hindu Family A joint Hindu Family consists of male members descended lineally from a common male ancestor, together with their mothers, wives or widows and unmarried daughters bound together by the fundamental principle of family relationship which is the essence and distinguishing feature of institution. The Joint Hindu Family, is purely a creature of law and cannot be created by an act of parties. Law governing Joint Hindu Family Joint Hindu Family is governed basically by two schools of thought. They are Dayabhag and Mitakshara schools. The law governing Joint Hindu Family is codified under Hindu Code and now, succession among Hindus is governed by the Hindu Succession Act, 1956. Though Hindu Code changed the law applicable to Hindus substantially, the spirit of joint family concept is retained; Women are also made members of the Family as its male members. It is to be noted that a woman member also inherits properties at par with a male member and is treated as co-parceners. Management of business of a Joint Hindu Family In a Joint Hindu Family, for as long as members remain undivided, the senior most male member of the family is entitled to manage the family properties. He is called 'Manager' or 'Karta' of the joint family. In a Hindu Family, the 'Karta' or Manager, occupies a position superior to that of the other members insofar as he manages the family property or business or looks after the family interests on behalf of the other members. The managership of the joint family property comes to a person by birth and he does not owe his position as manager on the consent of other co-parceners. The liability of the 'Karta' is unlirftited, whereas the liability of the co-parceners is limited to their shares in the joint family estate. Powers and duties of the manager A manager or 'Karta' of a joint family has the following powers and duties:

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Powers (a) Right to possession and management of the joint family property (b) Right to income from the joint family property (c) Right to represent the joint family (d) Right to sell the joint family property for family purpose. Duties (a) Duty to run the family business and manage the property for the benefit of the family (b) Duty to account for the income from the joint family business and property. Banker and his dealings with joint family (a) A banker dealing with a Hindu Undivided Family, should know the 'Karta' of the family. (b) Banker should ensure that 'Karta' of the joint family deals with the bank and borrows only for the benefit of joint family business. (c) The application to open an account must be signed by all the members and all adult members should be made jointly and severally liable for any borrowings or if the account gets overdrawn. 4. Companies: A company is another type of borrower, which a banker deals with in his business of lending. A company is a juristic person created by law, having a perpetual succession and Common seal distinct from its members. A company, depending upon its constitution is governed by various laws. Basic laws governing company In India, companies are governed by the Companies Act, 1956. Companies as per the Companies Act, 1956 are required to be registered under the Act. Section 11 of the Companies Act provides that an association or partnership consisting of more than ten in the case of banking business and more than twenty in the case of other business, shall be registered under the Companies Act. If not registered, the said association or partnership will be illegal. Incorporation of company Section 12 of the Companies Act, 1956 provides that any seven or more persons or where a company formed is a private company, any two or more persons can form a company, by subscribing their names to the Memorandum of Association. Requirements of forming a company The business and objects of a company and the rules and regulations governing its management are known by two important documents called 'Memorandum of Association' and 'Articles of Association'. Therefore, for the formation of a company these documents are essential. What is Memorandum of Association? The memorandum of association is the charter of the company. Its purpose is to enable the shareholders, creditors and those dealing with the company to know its permitted range of business. Memorandum of Association of a company contains the following details among others: (a) Name of the company (b) State in which the registered office of the company is to be situated (c) Objects of the company (d) Liability of the members and (e) Share capital and its division. What is Articles of Association? Articles of Association are rules and regulations governing the internal management of the company.

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They define the powers of the officers of the company. Articles of Association are subordinate to Memorandum of Association and it contains the following details among other things: (a) Number of directors of the company (b) Procedure for conducting meetings of the shareholders, board of directors, etc. (c) Procedure for transfer and transmission of shares (d) Borrowing powers of the company (e) Officers of the company and other details. Types of companies (a) Private company: According to the Section 3(1) (iii) a private company is one which contains following provisions in its Articles of Association: (i) Restrictions on the right to transfer its shares (ii) Limitation on number of members to fifty, excluding the people, who are employees and ex-employees of the company (iii) Prohibition as to participation by general public in its capital requirements. (b) Public company: A public company is one, which is not a private company. That is, a public company does not have any restrictions of the private company and its main features are as follows: (i) Shares are freely transferable (ii) No restriction on number of members (iii) Public at large can participate in its share capital. The public companies can be further classified as: (i) Limited liability company (ii) Unlimited liability company (iii) Limited by guarantee. It can be seen from the classification itself that in a limited liability company, liability of the members is limited to their contribution of capital. In the case of unlimited liability company, the liability of the members is unlimited. In the case of guarantee companies, the liability of members is not limited to the extent of the amount guaranteed by them. (c) Government company: A company in which Central Government or State Government or both has not less than fifty-one per cent of the share capital, is called Government Company. (d) Other companies: Besides the above, Companies Act, 1956 classifies companies on the basis of time, place of incorporation and nature of working of share capital into the following categories: (i) Existing company (ii) Foreign company (iii) Holding company (iv) Subsidiary company, etc. (i) Existing Company: A company, already existing before the coming into force of the Companies Act, 1956. (ii) Foreign Company: A company registered in a foreign country, (iii) Holding Company: A company owning more than fifty per cent of share capital in another company or a company, which can appoint the majority of directors in another company, (iv) Subsidiary Company: It can be seen that when there is a holding company, the other company is called a subsidiary company. We will study in detail in other chapters about incorporation of companies and the precautions a banker should take while lending to a company.

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5. Statutory Corporations: Besides companies registered under the Companies Act, 1956, there may be corporations established by an Act of Parliament. These are called 'Statutory Corporations'. For example State Bank of India is established under State Bank of India Act, 1955. Nationalised banks are established under the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970. These statutory corporations are governed by the Acts under which they were established. These Acts provide for making rules and regulations by the Government for the corporation. The Act, rules and regulations define the scope, objects and range of business of the corporations. 6. Trusts and Co-operative Societies, etc. (i) Clubs, societies, schools and other non-trading associations: Such bodies, if not incorporated under the laws governing them, cannot enter into any transactions. These bodies are usually governed by the Companies Act or the Co-operative Societies Act and function within the ambit of those laws. For example clubs can be registered either under the Companies Act, 1956 or under the Societies Registration Act or the Co-operative Societies Act. In the case of lending to these bodies, a banker should study the bye-laws, rules and regulations applicable to them and ascertain the legality of lending to them, (ii) Trusts: These are governed by the Indian Trusts Act, 1882, if they are private trusts and by Public Trusts Act if they are public trust, or Religious and Charitable Endowments Act, if they are trusts of Hindus and in the case of Muslims they are governed by Wakf Act. A banker dealing with trusts should acquaint himself with the respective laws applicable to them and should ensure that his lending is within the ambit of those laws, (iii) Trustee: Trustees manage trusts. The powers and duties of the trustees are provided in trust deed and are also regulated by the respective laws applicable to such trusts. For example, in the case of public trusts, Charity commissioners, or commissioner of endowments appointed by the Government, have the power to supervise the activities of the trusts. The trustee of the Muslim Wakf is called Mutawali and his conduct and functions are regulated by the Wakf Board. Therefore, a banker dealing with a trust should ensure that all the permission required for taking a loan is obtained from respective Government authorities. 16.3 LET US SUM UP As a banker, it is necessary to be aware of the various types of borrowers and the laws applicable along with the precautions to be taken while dealing with them. Borrowers can be broadly classified in the following categories: individuals, partnership firms, Hindu Undivided Family, companies, statutory corporations, trusts and co-operative societies. The laws applicable to all these different kinds of borrowers are different. Individuals are governed by the Indian Contract Act, partnership firms by the Indian Partnership Act, Hindu Undivided Family by the customary law pertaining to Hindus, companies by the Companies Act, statutory corporations by the Acts that created them, trusts by the Indian Trusts Act, Public Trusts Act, Religious and Charitable Endowments Act, Wakf Act and co-operative societies by the Co-operative Societies Act or the Societies Registration Act. . 16.4 KEYWORDS Memorandum of Association; Articles of Association; Company; Hindu Undivided Family (HUF); Partnership; Trustee.

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16.5 CHECK YOUR PROGRESS

1. Fill in the blanks. Individual borrowers are governed by the _________ Act. (a) In a Hindu undivided family the business of the family is managed by (b) A company is _________ and __________ from its members. (c) number of members and a maximum (d) A Private Limited Company has minimum ___ (e) of _________ numbers of members. transferable. A Public Limited Company shares are ______ (f) Statutory corporations are established by Acts of___ (g) Private trusts are governed by the _______________________________ (h) Act. Trusts of Hindus are governed by the _ Trusts of (i) Act. Muslims are governed by the

16.6 ANSWERS TO CHECK YOUR PROGRESS'


1. (a) Indian Contract; (b) Karta; (c) separate and distinct; (d) 2, 50; (e) freely; (f) Parliament; (g) Indian Trusts Act; (h) Religious and Charitable Endowments Act; (i) Wakf.

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TYPES OF CREDIT FACILITIES

STRUCTURE 17.0 Objectives 17.1 17.2 :nt; 17.3 17.4 Introduction Types of Credit Facilities Cash Credit and Overdraft Term/Demand Loans

17.5 Bill Finance 17.6 Let Us Sum Up 17.7 Check Your Progress 17.8 Answers to 'Check Your Progress'

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17.0 OBJECTIVES After studying this unit, you should be able to understand: various types of credit facilities and the laws governing them; laws affecting credit facilities granted by the bank. 17.1 INTRODUCTION Lending is a principal activity of a bank. The advances portfolio of a bank indicates its dynamic personality. A banker to grow in the business of banking should have a thorough knowledge of the requirements of his customer and should be in a position to cater to the needs of the customer. It is common knowledge that a bank's existence depends on its customer's need to borrow. A banker should be in a position to identify the needs of the customer for funds and mould the lending tool, according to the requirements of the customer conforming to the laws of the land. Therefore, a banker for his success as a lender is required to acquaint himself with various types of credit facilities that are presently in vogue in business of lending and shall understand the legal relationship existing under different credit facilities. In this unit, we will study different types of credit facilities and their legal aspects. 17.2 TYPES OF CREDIT FACILITIES We have seen earlier that the primary business of a bank is lending. The business of lending is carried on by the bank by offering various credit facilities to its customers. We can classify the credit facilities into 'Fund' based credit facilities and 'Non-Fund' based credit facilities and customised credit facilities in the case of special constituents. We know that Nationalisation of Banks ushered in a new concept in bank's lending and added a dimension of social banking to business of lending by banks. Basically various credit facilities offered by banks are generally repayable on demand. That being the case, a banker, to ensure proper recovery of funds lent by him, should acquaint himself with the nature of legal remedies open to him and law affecting the credit facilities provided by him. Credit facilities are broadly classified into two types based on funds outflow; they are: 1. Fund based credit facilities 2. Non-fund based credit facilities 1. Fund Based Credit Facilities: Fund based credit facilities involve the outflow of funds meaning thereby, the money of the banker is lent to the customer. They can be generally of following types: (a) Cash credits/overdrafts (b) Term loans/Demand loans (c) Bill finance 2. Non-Fund Based Credit Facilities: In this type of credit facility the bank's funds are not directly lent to the customer and they include: (a) Bank guarantee (b) Letter of credit facility (c) Acceptance facility These have already been dealt with elaborately in other units and hence, are only outlined here.

17.3 CASH CREDIT AND OVERDRAFT


A cash credit or overdraft is an arrangement by which a banker allows his customer to borrow money up to a certain limit. This is the most popular mode of borrowing by the large commercial and industrial concerns in India, on account of the inherent advantage. A customer need not borrow at once, the

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whole of the amount up to the limit as the same may not required from day one, but can draw such amounts as and when required. Cash credit/overdraft is a contract of a loan between a bank and its borrower. The contract of cash credit or overdraft can be express or implied. In the case of Bank of Maharashtra vs United Construction Co. & Others (1986),[ 60 Compo Cases 163 (Bom).] a customer overdrew his account. There was no written contract for an overdraft. The bank demanded repayment of the moneys overdrawn with interest. The customer refused to pay interest. The bank therefore, filed a suit for recovery of the monies overdrawn with interest. The Bombay High Court held that there is no need for express contract for an overdraft and directed the borrower to repay the moneys with interest as there is an implied contract of an overdraft. Rule in Clayton's Case The credit facility, given in the form of a cash credit/overdraft is operated normally, through a running account opened and kept by the customer. Whenever a customer withdraws money, the account being debited for the amount and whenever the customer pays, the account being credited. Under the law, each item of debit forms a separate loan and each credit as a repayment of the earliest debits. This aspect of discharge of the debit items by subsequent credits was first enunciated in a case, called the Clayton's case. In that case, the Courts held that the first sum of money paid into the account, is deemed to repay the first item recorded on the debit side of the account. For example, if there are two items on the debit side of the customer's current account. A debit of Rs. 1,000 on 3 March and Rs 500 on 6 March, in a year and the borrower pays Rs. 750 on 12 March; the sum will be appropriated first, by reducing the earlier debit of Rs. 1,000 rather than discreating a charge the later debt of Rs. 500. This creates problems for recovery for the bank. Hence, the bankers, to avoid the rule in the Clayton's case agree on the method of appropriation and treat all debits as one debt. Bank not to Terminate Overdraft Facility without Notice Once a bank grants an overdraft facility, then there is a contract between the bank and the customer that is not be cancellable unilaterally. The Gujarat High Court vs Indian Overseas Bank considered this in M/s Narain Prasad Govindlal Patel (AIR 1980 Guj 158). In this case, a firm was enjoying temporary overdraft facility to a limit of Rs. 5,000 with the bank, for a period of four years. No document was executed nor was any security furnished. The bank unilaterally, without notice, terminated the facility with the result that a cheque drawn by the firm was dishonoured by the bank on the ground that there was insufficient balance in the account. The firm claimed damages for wrongful dishonour of the cheque. Both the Trial Court and the Appellate Court allowed the claim of the firm. A further appeal by the bank to the High Court was dismissed, in which the High Court observed: The bank grants overdraft facility in order to earn interest. Its constituents enjoy the overdraft facility in order to develop their business. Therefore, both are deeply interested in such an arrangement. Such an arrangement - euphemistically called by Mr Chhatrapati as a facility - is nothing but a contract. The contract, if it is well settled, can be inferred from the conduct of the parties. The enjoyment of overdraft facility for a period of four years unfailingly points to the conduct of the bank. A temporary overdraft facility is not one, which can be terminated unilaterally at the sweet will of the bank without giving its constituent a notice thereof. It is temporary because, it is not intended to be a permanent and everlasting arrangement. Sometimes, a constituent is required to square up his account at the end of every half financial year - 30 June and 31 December. Merely because, the overdraft is called temporary overdraft, it does not militate against the plaintiff drawing a cheque upon the bank in favour of its constituent and in getting it honoured by the bank.

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17.4 TERM/DEMAND LOANS
Term/Demand loans are granted to customers generally for meeting the capital expenditure needs of the business. Term loans are granted in one lump sum and are allowed to be repaid over a period in instalments the schedule of which is specified in the agreement itself. Demand loans are those which are repayable on demand through a repayment schedule is agreed upon by the bank. Term loans on the basis of period of repayment are further classified into: (i) Short-term Loans, (ii) Medium-term Loans, (iii) Long-term Loans. Short-term loans are loans that are repayable within one year, medium-term loans within two to seven years and long-term loans above seven years periods. Banks normally grant the short-term and mediumterm loans. The development financial institutions usually grant long-term loans. Banks in certain cases like housing loans sanction long-term loans which are repayable over longer period of 20-25 years. Law relating to term loans Term loans are governed by the agreement entered into between the parties. The loan agreement provides for various eventualities and contains details of the loan, repayment or amortisation schedule and other obligations of the borrower like payment of interests, costs and expenses, etc. We will now consider a case decided by High Court in respect of term loans. (i) Acceleration of Repayment: P.K. Achuthan vs State Bank of Travancore 1974 K.L.T. 806 (FB): A question that came for a decision in this case was, whether a provision in the hypothecation bond to the effect that on a default of the borrower in paying any of the instalments, the lender would be entitled to recover the whole of the debt due, inclusive of the future instalments in one lump sum is legal. The Kerala High Court held that where the contract provides for repayment of money in instalments and also contains a stipulation that on a default being committed in paying any of the instalments, the whole sum shall become payable, then the lender would be entitled to recover the whole sum inclusive of future instalments. (ii) Time within which a suit for recovery shall be filed: We have seen earlier that in the case of term loans, periodical repayment in instalments is allowed. In the event of a default in payment of instalments, the bank can institute a suit for recovery of the unpaid instalment. Besides, the bank is entitled to wait until the due date of the last instalment and then institute a suit for recovery of whole amount. The limitation period for filing a suit in the case of term loans is three years from the date of default of a particular/specific instalment. However, if by doing so the time limit gets over in case of some earlier defaulted instalments, bank looses its right against such unpaid instalments. In the case of a demand loan the time limit is three years from the date of default.

17.5 BILL FINANCE


Bill finance is also one of the important facets of lending by banks. Generally, the bill finance is conducted through discounting of bills of exchange drawn by the borrower or third persons on the customers of borrower. The methods of bill finance, depending upon payment obligations incurred by the bank, can be classified into: (i) Bill discounting and bills purchase; (iii) Bills co-acceptance. (ii) Drawee bill acceptance;

In all these cases, the banker undertakes an obligation and depending on the nature of bill finance, the first two are fund-based facilities and the last is a non-fund based facility. This subject has been dealt with in more detail in the chapter of 'Law Relating to Bill Finance'.

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Non-Fund Based Facilities In the business of lending, a banker also extends non-fund based facilities. Non-fund based facilities do not involve an immediate outflow of funds. The banker undertakes a risk to pay the amounts on happening of a contingency. Non-fund based facilities can be of following types among other: (a) Guarantee facility; (c) Underwriting and credit guarantee. (b) Letter of credit facility;

(a) Guarantee facility: The banker in his business of lending extends various facilities to its constituents. Under this facility, the bank undertakes to discharge the liability of the borrower to third parties. The nature of guarantees includes; performance guarantees, deferred payment guarantees, advance payment guarantees, guarantees to Government departments, etc. (b) Letter of credit facility: Letter of credit or documentary credit facility is another non-fund based facility extended by the bankers to their constituents. Under this facility the banker undertakes to pay on presentation of documents of title to goods. The banks generally adopt the Uniform Customs and Practices relating to Documentary Credits 600 (UCPDC 600) framed by International Chamber of Commerce which defines the obligations and rights of the parties w.e.f. 1 July 2007. (c) Underwriting and credit guarantee: Besides the above non-fund based facilities, some banks also do underwriting and credit guarantee business. The risk under this activity involves the obligation of the banker to provide funds or pay, in the event of the failure of the borrower to raise moneys, or to repay moneys. After the advent of merchant banking, this type of lending by commercial banks is on the decline. (d) Derivative products: In addition to the above traditional non-fund facilities, banks are now increasingly offering the derivative products to their clients to enable them to hedge their currency and interest rate risks. Other credit facilities A banker besides extending fund based and non-fund based credit facilities, also extends various other miscellaneous credit facilities depending upon the constitution of the borrower. For example, in the case of individual borrowers, many of the banks are extending, personal loans for purchase of a house, car, and other consumer durables. This type of lending, otherwise called 'Consumer Credit' has become very popular these days and contributes significantly to the profitability of the bank's business.

17.6 LET US SUM UP


1. Credit facilities are mainly classified into: (i) Fund based facilities (ii) Non-fund based facilities

2. Fund based facilities, among other things, include: (i) Cash credits/Overdrafts (ii) Term loans (iii) Bill finance 3. Non-fund based facilities, among other things, include: (i) Bank guarantee (ii) Letter of credit facility 4. Under customary law of bankers, interest can be charged on the temporary overdrafts granted. 5. As per rule, in the Clayton's case each credit discharges the earliest of the debit entries. 6. Term loans based on period of repayment are classified into: (i) Short-term loan (ii) Medium-term loan (iii) Long-term loan

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17.7 CHECK YOUR PROGRESS 1. Cash Credit facility is a ________ 2. Bills co-acceptance facility is a__________ . 3. Banker is entitled to charge interest on temporary overdraft under __________. 4. Limitation period for filing a suit in term loans is __________ years from the date of default of instalment. 5. Period of repayment in the case of medium-term loan is __________ .

17.8 ANSWERS TO 'CHECK YOUR PROGRESS'


1. Fund based facility; 2. Non-Fund based facility; 3. Banking custom; 4. 3 (Three); 5. 5-7 years.

SECURED AND UNSECURED LOANS, REGISTRATION OF FIRMS, INCORPORATION OF COMPANIES


STRUCTURE
18.0 Objectives 18.1 Introduction 18.2 What are 'Unsecured Loans' and 'Secured Loans'? 18.3 Why a Secured Loan? 18.4 Registration of Firms 18.5 Consequences of Non-registration of Firm 18.6 Incorporation of a Company 18.7 18.8 18.9 Let Us Sum Up Check Your Progress Answers to 'Check Your Progress'

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18.0 OBJECTIVES
After studying this unit, you should be able to understand: what is a secured and unsecured loan; the law governing bankers' securities; the procedure for registration of firms and incorporation of companies.

18.1 INTRODUCTION
In the earlier units, we have studied about type of borrowers, credit facilities and the laws governing them. In this unit, we will endeavour to understand the securities for bank's lending business, legal status of a banker in the case of unsecured loans, and more about law relating to partnership firms and companies, their registration and incorporation.

18.2 WHAT ARE 'UNSECURED LOANS' AND 'SECURED LOANS'? Unsecured Loans
Most of the loans granted by banks in India are generally secured by tangible security being assets purchased out of the bank funds and/or some valuable collateral such as bonds, shares and merchandise deposited either in the bank's godowns or in the godowns of the borrowers under agreement of hypothecation, and immoveable property, but occasionally loans are granted even without any security. An unsecured loan is one for which the banker has to rely upon the personal integrity of the borrower. The chief basis of such transactions is the personal credit or credit worthiness of the customer. In other words, 'creditworthiness' is the confidence of a banker on the future solvency of a person or his future financial strength, which enables him to take a loan at present and pay it in future. All unsecured loans, otherwise called clean loans are dependent on the borrower's financial strength to pay in future. Secured Loans Secured loans are the antithesis to unsecured loans. These loans are given by a banker not merely based on his confidence on the borrower's future financial strength but also based on his present net worth that he is able to give a banker to rely upon and recover the moneys lent in the event of his failure to repay the loan in the ordinary course. We will elaborate it a little further. In the case of secured loans, a banker besides verifying the future solvency of the borrower asks for the charge over property of the borrower so that in the event of failure by the borrower to repay, the banker can sell the property of the borrower charged to him and recover the moneys.

18.3 WHY A SECURED LOAN?


We have seen the difference between an unsecured loan and a secured loan. It would be relevant to know why a 'secured loan' is preferred over 'unsecured loan'. It is common knowledge that lending by a banker is generally for the economic activity of the borrower and recovery of loans given by a banker is mostly dependent on the economic success of the borrower. Success or failure of an economic activity depends on various macro and micro economic factors. A banker lending to a customer can assess only the existing macro and micro economic factors and can only predict success or failure of the borrower's activity in the future reasonably. A banker cannot be absolutely certain about the recovery of the amounts lent, if he solely relies on the economic success of the borrower. Therefore, a banker asks for further security in form of a charge on property of the borrower. The charge created over the property of the borrower acts as cushion to absorb the shocks of economic failure of the borrower as the banker can safely sell the properties charged to him and recover the moneys lent. This is the primary reason for preference of secured loans over unsecured loans.

18.4 REGISTRATION OF FIRMS


We have in an earlier unit, dealt with borrowers who are 'Partnership Firms' and governed by the Indian Partnership Act, 1932. In this unit, we shall study the law relating to registration of partnership firms.

Registration
It is in the interest of the partners themselves to have their firms registered under the Partnership Act. The procedure for the registration of firms and other incidental matters has been dealt in Sections 56 to 68 of the Unit VII of Indian Partnership Act, 1932. For registration, an application is to be submitted to the Registrar of Firms of the area in which any place of business of the firm is conducted, with a statement in the prescribed form and accompanied by the prescribed fee, stating (a) (b) (c) (d) (e) (f) name of the firm, place or principal place of business of the firm, names of any other place where the firm carries on business, date of joining of each of the partners, names in full and permanent addresses of the partners, duration of the firm-length of time for which the firm wants/proposes to conduct the business.

We have to note that the Act contemplates registration of firms, not the registration of partnership deed. The registration of the firm is optional and not compulsory. So a mere non-registration would not affect the carrying on business and giving effect to partnership deed. When the Registrar is satisfied that the provision of Section 58 has been duly complied with, he will record an entry of the statement in the register called the Register of Firms. In addition to making the necessary entries in the Register of Firms, he is required to file the original of every statement submitted to him. The original statement and all subsequent statements and notices will be filed together so that all original papers relating to any firm will be conveniently found together in one file. Note that the registration of the firm takes place only when the Registrar makes the necessary entries in the Register of Firms under-Section 59. In other words, a firm is deemed to be registered only when the certificate of registration is granted.

Alterations
Rules relating to alterations are provided in Section 60 which reads: 1. When alteration is made in the firm's name or in the location of the principal place of business of a registered firm a statement may be sent to the Registrar accompanied by the prescribed fee, specifying the alteration and signed and verified in the manner required under Section 58. 2. When the Registrar is satisfied that the provisions of the sub-Section (1) of the Section 60 has been complied with, he shall amend the entry relating to the firm in the Registrar of Firms in accordance with the statement and shall file it along with the statement filed under the Section 59. There is no time limit fixed as to when notices of alterations have to be given. Section 61 provides that when a registered firm discontinues business in any place or begins to carry on business at any place, such a place, not being its principal place of business, any partner or agent of the firm, may send an intimation thereof 'to the Registrar', who shall make a note of such an intimation in the entry relating to firms in the Registrar of Firms and shall file the intimation along with the statement relating to firm filed under Section 59. Similarly, when any partner in a registered firm, alters his name or permanent address, an intimation of the alteration may be sent by any partner or agent or firm to the Registrar, and he shall deal with it in the manner nrnv
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ib'U Section 63 provides for the recording of a change in and the dissolution of a firm and also the recording of withdrawal of a minor. There is no particular form of notice. If substantial compliance has been made with the provision that would be sufficient for the purpose of the section.
Rectification of Mistake

The Registrar has power at all times to rectify any mistake so as to bring the entry in the Register of firms relating to any firm in conformity with the documents relating to that firm already filed with him. The Registrar may also rectify any mistake on the application made by the parties who had signed the document. However, this power is not a general power, but limited to rectifying the mistakes to bring the entry in conformity with the document filed by the partners or their agents. If there is an omission in the mention of one of the places of business of the firm, the omission is capable of rectification under this provision. Moreover, this omission does not affect the registration; similarly, if certain persons are wrongly noted in the Register, this is a mistake which can be rectified under this provision.
Amendment of Register by Court's Order

Provision is made for a Court deciding any matter relating to a registered firm may direct the Registrar to make any amendment in the entry in the Register of Firms relating to such firms which is consequential upon its decision, and the Registrar shall amend the entry accordingly.
Inspection

The Register of Firms, the statements, notices and intimations filed with the Registrar are open to inspection by any person on payment of a prescribed fee.
Copies

Similarly, any person can obtain a copy of any entry or portion in the Register of Firms by making an application to the Registrar and paying prescribed fee.
Evidentiary Value

Section 68(1) provides, any statement, intimation or notice recorded or noted in the Register of Firms shall, as against any person by whom or on whose behalf such statement, intimation or notice was signed is conclusive proof of any fact stated therein.
Penalty

Section 70 provides that any person who signs any statement, amending statement, notice or intimation under the Unit VII of the Partnership Act containing any particulars, which he knows to be false or does not believe to be true or containing particulars which he knows to be incomplete or does not believe to be complete, shall be punishable with imprisonment which may extend to three month, or with fine or both. 18.5 CONSEQUENCES OF NON-REGISTRATION OF A FIRM Section 69 of Indian Partnership Act, 1932 sets out the effect of non-registration of firm and may be conveniently studied under the following four heads: (i) suits by partners inter se (ii) suits by a firm against third parties (iii) exceptions (iv) non-application of provisions to certain suits, (i) Suits by Partners Inter se: If a firm is not registered under the Indian Partnership Act, then no suit to enforce a right, arising from a contract or conferred by the Partnership Act, shall be

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instituted in any Court, by or on behalf of any person suing as a partner in a firm against the firm or against any other partner of the firm. This prohibition applies to the claim of set off or other proceeding to enforce a right arising from a contract. The Supreme Court in the case of Loon Karan Sethia (AIR 1977 SC 336) has held that this provision for registration is mandatory in character and its effect is to render a suit by the plaintiff in respect of a right vested in him or required by him under contract, which he entered into as a partner of a unregistered firm, whether existing, or dissolved as void. In other words, a partner of an erstwhile un-registered partnership firm cannot bring a suit to enforce a right arising out of a contract falling within the ambit of Section 69 and simply by making an application for registration before instituting a suit is also not sufficient. (ii) Suit by a Firm Against Third Parties: No suit to enforce a right arising from a contract can be instituted in any Court, by or on behalf of a firm against any third party, unless the firm is registered and the persons suing or have been shown in the Register of Firms as partners in the firm. This provision also applies to a claim of set off or other proceeding to enforce a right arising from a contract. Before the bar of the Section 69 can be invoked there should be clear evidence that the plaintiffs were partners as defined in the Section 4 of the Act and the loose use of the term 'partnership' on a firm would not by itself establish that the plaintiffs were partners in the true sense of the term. Moreover, the burden of proof would be on the defendant. The bar under this section applies to rights arising out of a contract only and not in respect of other rights as the sub-Section (i) above. Some of the illustrations of such rights are: the right to enforce a contract embodied in a negotiable instrument, right to eject a landlord, right to determine the liability of the landlord, etc. Section 69(2) requires that the person serving must have been shown in the Register of Firms as a partner, but the mode of proof of that fact is not in anyway restricted. (iii) Exceptions: Sub-Section (3) of the Section 69 provides for two exceptions: (a) The enforcement of right to sue for dissolution of a firm, or for accounts of a dissolved firm or any right or power to realise the property of the dissolved firm. (b) The powers of an official assignee receiver or Court, under the Presidency Towns Insolvency Act, 1909 to realise the property of an insolvent partner. (iv) Non-application of Section 69: Certain Suits: Sub-Section (4) of Section 69 provides that the Section 69 shall not apply (a) to firms to which the Act extends or whose places of business in the said territories are situated in areas to which, by notification under the Section 56 Unit VII of the Partnership Act does not apply; or (b) to any suit or claim of set off not exceeding Rs. 100 in value which, according to the Presidency Towns is not of a kind specified in the Section 19 of the Presidency Small Cause Courts Act, 1882, or outside the presidency towns, is not of the kind specified in the second Schedule to the Provincial Small Cause Courts Act, 1887, or to any proceedings in execution or other proceeding incidental to or arising from any such suit or claim. The bar does not apply to suits of Small Cause nature, value of which not exceeding Rs. 100. But when a suit or cross-objection is not cognisable either by the Presidency Court of Small Causes or by the Small Causes Court, the Section 69(4)(b) will not apply even though the relief for accounts may be value at Rs. 100.

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18.6 INCORPORATION OF A COMPANY
We have seen in the earlier units that among others 'company' is also one of the borrowers of a banker. We have also studied briefly the law governing companies. In this unit, we will study the law relating to companies and their incorporation. 1. Company - Meaning and Characteristics: A company is an artificial person, since it is created by law. It is clothed with many of the rights, liabilities, powers and duties prescribed by law. Among the two most important characteristics of a company, one is its separate individuality and the other is perpetuity within the limits prescribed by law. It can do all acts as a natural person may do. A company has a 'Corporate Personality' separate from all the members who have formed it unlike a partnership firm. Because of this, a company incurs all the liabilities and possesses all rights of a natural person subject to the regulation of law. The classical judgement of the House of Lords in Salomon vs. Salomon & Co. Ltd. (1897) AC 22 lays down the principle of 'corporate personality'. The facts of this case are that one Mr. Salomon who was individually carrying on the business of boot and shoe manufacture, incorporated a company named 'Salomon & Co. Ltd.' which consisted of seven of his family members. This company took over the personal business assets of Mr. Salomon for 38,782 pounds and in turn Mr. Salomon took 20,000 shares of one pound each and debentures worth 10,000 pounds, for which there was a charge on the company's assets and balance in cash. All his family members took one share of a pound each. The company later went into liquidation and various unsecured creditors contended that Mr. Salomon could not be treated as a secured creditor of the company in respect of debentures held by him. The House of Lords after hearing the arguments held that: The company is by law a different person altogether from its shareholders and though it may be that after incorporation, the business is precisely the same as it was before and the same persons are managers and the same hands receive the profits; the company is not in law the agent of the shareholders or trustees for them. Nor are the shareholders liable in any shape or form except to extent and the manner provided in the Act. The Salomon Case for the first time authoritatively and clearly established the fact that a company has its own existence or personality, which is separate and distinct from its members and as a result a shareholder cannot be held liable for the acts of the company, even though he holds virtually the entire share capital. The case also recognised and accepted the concept of limited liability. The legal status and position of a company has been aptly described by Supreme Court in Tata Engineering and Locomotive Company Ltd. vs State of Bihar AIR 1965 SC 40 in the following words: The corporation in law is equal to a natural person and has a legal entity of its own. The entity of the corporation is entirely separate from that of its shareholders; it bears its own name and has a seal of its own; its assets are separate and distinct from those of its members and it can sue and be sued exclusively for its own purpose; its creditors cannot obtain satisfaction from the asset of its members; the liability of the members or the shareholder is limited to the capital invested by them. Similarly, the creditors of the members have no right to the assets of the corporation. The main characteristics of a company are summed up as under: (i) Company is a voluntary association of persons who have come together to carry on some business for profit, (ii) It has a perpetual existence and though members may come and members may go, the company continues forever. Change in its members or in their identity does not affect the legal existence or its identity. Only law can dissolve it, since it is a creation of law.

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(iii) The shares of joint stock companies are freely transferable and in the case of a private limited company, the Companies Act has put certain restrictions on the transferability of shares. Every member who owns fully paid-up shares is free to dispose of his shares according to his choice but subject to any regulation of the company. Any absolute bar or restriction on the right to transfer shares is void. (iv) The member's/shareholder's liability in a company is limited to the extent of the nominal value of the shares held by them. Under no circumstance, is a member/shareholder directed to pay anything more than the unpaid value of his shares. As regards a company limited by guarantee, the members are liable only to the extent of the amount guaranteed by them and not beyond and that too only when the company goes into liquidation. (v) As a corporate person, a company is entitled to own and hold property in its own name. (vi) A company being a body corporate can sue and be sued in its own name. In brief, the most striking features of a company are its distinct legal personality, the easy transferability of its shares, and the limited liability of its members. Incorporation of a Company We shall now in brief understand the various steps to be taken and as to how a company comes into existence. It is to be noted that at the time of formation of the company the promoters have to amongst other things decide the following aspects: (a) Type of company: Under the Companies Act, 1956 only two types of companies can be registered, viz., (i) Public companies (ii) Private companies. These companies may further be classified as follows: (i) Companies limited by shares (ii) Companies limited by guarantee with or without share capital and (iii) Unlimited companies with or without share capital. (b) Name of company: A company is identified by the name under which it is registered. According to Section 13 of the Act, the Memorandum of Association of a company should state the name of the company. To avoid delay and to afford flexibility to the Registrar to decide the availability of names the promoters are required to submit at least three suitable names in the order of preference. The name of a company must necessarily end with the word 'limited' in the case of a public company and the words 'private limited' in case the company is a private company. In case of a Section 25 Company, the inclusion of the word 'limited' can be dispensed with by obtaining a licence from the Regional Director. Section 20 prohibits the registration of a company, the name of which is undesirable or which is identical with or too nearly resembles the name of an existing company. A company will not be permitted to use a name which is prohibited under the Emblems and Names (Prevention of Improper Use) Act, 1950. The Registrar is required by law to make preliminary enquiries so as to ensure that the name permitted by him will not be misleading or is not intended to deceive with reference to its objects clause. (c) Memorandum of Association: The memorandum of association is the constitution of a company and amongst other things, defines the area withiirwhich the company can act. It is, therefore, necessary to state the object for which the company has been formed, the various businesses that it can undertake, the liability of its members, etc. For a banker it is absolutely essential to verify the memorandum and ensure that the business undertaken by the company is within its objects, if not, any loan made to the company would not be recoverable.

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(d) Articles of Association: The other important document of a company is the articles of association, which contains the rules and regulations relating to the internal management of a company. Section 15 of the Companies Act stipulates that every memorandum should be signed by each subscriber who should add his address, description and occupation, if any, in the presence of at least one witness who shall attest the signature and shall likewise add his address, description and occupation, if any. As regards companies having a share capital the subscribers to the memorandum should at least take one share each and they have to state clearly the number and nature of the shares taken by them. The articles of association should similarly be signed separately by persons subscribing to the same. The signatures of the subscribers in the Articles of Association are also to be attested by a witness. (e) Preparation of other documents: The promoters forming the company are also required to submit various other forms and documents prescribed under Companies (Central Governments' General Rules and Forms) Act, 1959. (f) Payment of registration fees: The fee prescribed for registration of a company is required to be paid the quantum of which depends on the nominal capital of the company to be incorporated in the case of companies having share capital. (g) Certificate of Incorporation: Once all the formalities as detailed above are satisfied, the promoters are entitled to get from the Registrar of Companies the certificate of Incorporation. Section 33(3) of the Companies Act states that if the Registrar is satisfied that all the requirements, as stated above have been complied with by the company and that it is authorised to be registered under the Act, he shall retain and register the memorandum, articles, if any. On the registration of the memorandum of a company the Registrar shall certify under his hand that the company is incorporated and, in the case of a limited company that the company is limited. From the date of incorporation mentioned in the certificate of incorporation, such of the subscribers of the memorandum and other persons, as may from time to time be members of the company, shall be a body corporate by the name contained in the memorandum, capable forthwith of exercising all the functions of an incorporated company and having perpetual succession and a common seal, but with such liability on the part of the members to contribute to assets of the company in the event of its being wound up as mentioned in the Act (Section 34). Certificate of Incorporation: Conclusive Evidence Section 35 of the Act states that a certificate of incorporation given by the Registrar in respect of any association shall be conclusive evidence that all the requirements of the Act have been complied with in respect of registration and matters precedent and incidental thereto, and that the association is a company authorised to be registered and duly registered under the Act. The certificate of incorporation is conclusive evidence that everything is in order as regards registration and that the company has come into existence from the earliest moment of the day of incorporation stated therein with rights and liabilities of a natural person, competent to contracts. Once a certificate of incorporation has been issued its validity cannot be impeached. In the case of Moosa vs Ebrahim [ILR (1913)40 Cal.l (PC.)] the memorandum of association of a company was signed by two adults and by a guardian of the other five members, who happened to be minors. The Registrar, however, registered the company and issued under his hand a certificate of incorporation. It was contended that the certificate of incorporation should be declared to be void. Lord Macnaughten deciding the case said: Their Lordships will assume that the conditions of registration prescribed by the Indian Companies Act were not duly complied with; that there were no seven subscribers to the memorandum and that the Registrar ought not to have granted the certificate. But the certificate is conclusive for all purpose. Thus, the certificate prevents anyone alleging that the company does not exist.

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Though the certificate of incorporation makes the existence of a company legally valid, it does not mean that the certificate legalises an illegal object mentioned in the memorandum. In fact, it is for the purpose of incorporation only that the certificate is made conclusive by law. (h) Certificate of Commencement of Business: Once a certificate of incorporation has been issued, a company becomes forthwith capable of exercising all the functions of an incorporated company. This however applies only to private companies and a company having no share capital. In the case of companies other than a private company and a company having no share capital, a further requirement is to be complied with, namely, obtaining a certificate of commencement of business before commencing any business. Thus, whereas a private company and a company having no share capital can commence business right from the date of its incorporation, a public company is required to file either a prospectus or a statement, in lieu of prospectus and the declaration of statutory compliances, as prescribed under Section 149 with the Registrar of Companies of the State where the company is situated and obtain from the Registrar a certificate of commencement of business before the company commences business. Documents to be filed with the Registrar (Section 33) After taking the above steps, the following documents are required to be filed with the Registrar of Companies of the state in which the registered office of the company is to be situated: (i) The memorandum of association duly signed by the prescribed minimum number of subscribers, duly stamped and signed by witness. (ii) The articles of association should also be similarly signed, stamped and witnessed, (iii) Any agreement which the company proposes to enter into with any individual for appointment as its managing or whole time director or manager, (iv) Any other agreement, if referred to in the memorandum and articles of association, in case, it will form part of the memorandum and articles, (v) Letter of authority (stamped as a specific power of attorney) signed by the subscribers authorising a representative to make amendments and/or alterations in the memorandum and articles of association, (vi) A copy of the letter received from the Registrar of Companies intimating the availability of the proposed name, (vii) A statutory declaration in the prescribed form by an advocate, an attorney or pleader entitled to appear in a High Court or a secretary or a chartered accountant practising in India, who is engaged in the formation of the company, or by a person who is named as a director or manager or secretary of the company stating that all requirements of the Act and the Rules thereunder have been complied with in respect of registration and matters precedent and incidental thereto (Section 33). (viii) In case the first directors are appointed by the articles, or named in the prospectus or statement in lieu of prospectus: a written consent of each director to act as such, signed by him or by an agent duly authorised in writing in prescribed form; and an undertaking in the same form as referred above in writing, agreeing to take from the company and pay for his qualification shares, if any, or sign the memorandum for shares not being less than his qualification shares (Section 266). In case, a prospectus is issued in relation to the intended company and proposed directors are named therein, then the consent and undertaking must be filed before the publication of the prospectus.

(i) Payment of the requisite fee for registration Procedure for the incorporation of a company limited by guarantee: Though the procedure involved for the incorporation of a company limited by guarantee is the same as that of the public

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company or a private company, as described above, following must however be noted in this regard: In the memorandum of association of such a company, a clause stating the amount of guarantee will have to be added in addition to the other necessary clauses to this effect. A guarantee company may be a company with the share capital or without the share capital. A company formed with no intention to generate profit is usually formed as a guarantee company. A company limited by guarantee can either be a private or a public company.

18.7 LET US SUM UP 1. An insecured loan is one for which the banker has to rely upon the personal security of the borrower. 2. Secured loans are antithesis to insecured loans. 3. Various methods of securing a loan are pledge, hypothecation, mortgage and assignment of debts of the borrower. 4. If two or more persons come together and agree to share profits of a business, it is called a partnership. 5. A partnership firm can be registered under the Section 58 of Partnership Act, 1932. 6. If a firm is not registered, then a partner cannot sue the other partners or third parties to enforce contractual rights. 7. A company is an artificial person created by law. 8. There are only two types of companies that are registered under the Companies Act. They are: (a) Public Limited Company (b) Private Limited Company 9. Certificate of incorporation is the conclusive evidence of coming into existence of the company. 10. Certificate of commencement of business is required for a public company to start business. 18.8 CHECK YOUR PROGRESS loans. Only personal security of the borrower is available in the case of. Secured loans are normally secured by _________ . Pledge is _________ of goods as a security for debt. Hypothecation is treated as _________ pledge. Personal obligation of mortgagor is a distinct feature of _______ Section 58 of Partnership Act, 1932 provides for __________ . A partner on behalf of firm cannot institute a suit on contract, if the firm is registered. (True/False) 8. Shares of public limited company are freely transferable. (True/False) 9. Certificate of incorporation is a document evidencing existence of company. (True/False) 10. Certificate of commencement of business is required for private limited company to start business. (True/False) 1. 2. 3. 4. 5. 6. 7. 18.10 ANSWERS TO 'CHECK YOUR PROGRESS' 1. Insecured; 2. pledge, hypothecation, mortgage or assignment of debts; 3. bailment; 4. constructive; 5. mortgage by deposit of title deeds; 6. registration of partnership; 7. False; 8. True; 9. True; 10. False.

REGISTRATION AND SATISFACTION OF CHARGES

STRUCTURE 19.0 19.1 19.2 19.3 19.4 19.5 19.6 19.7 19.8 Objectives Introduction What is a Charge? Procedure for Registration of Charge Effect of Non-registration of Charges Provisions of Law Relating to Registration of Charges Let Us Sum Up Check Your Progress Answers to 'Check Your Progress'

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19.0 OBJECTIVES After studying this unit, you should be able to briefly understand: the creation of charge over the properties, registration of charges under different enactments; registration of charges with the various authorities. 19.1 INTRODUCTION We have seen in earlier units, the types of loans granted by a banker and methods of securing a loan. In this unit, we will focus on the meaning of 'charge' under the Companies Act and registration of charges. 19.2 WHAT IS A CHARGE? 1. Before studying the meaning of word 'charge' and provisions relating to the registration of charges, we will learn the general meaning of the word 'charge'. It may be noted that the word 'charge' is used to mean any form of security for debt, unless the word is used otherwise. We have seen in the earlier chapters, that a banker accepts different types of securities to secure a loan granted to borrowers. Section 125(4) of the Companies Act, 1956 provides, that for the purpose of registration under the said Act, it includes all the following charges: (a) A charge for the purpose of securing debentures (b) A charge on uncalled capital of the company (c) A charge on any immoveable property, wherever situated, or any interest therein (d) A charge on any book debts of the company (e) A charge, not being a pledge, on any moveable property of the company (f) A floating charge on the undertaking or any property of the company including stock-intrade (g) A charge on calls made but not paid (h) A charge on a ship or any share in a ship (i) A charge on goodwill, on a patent or a licence under a patent, or a trademark, or on a copyright or a licence under a copyright 2. Types of Charges: 'Charges' registered under the Companies Act can be classified into the two types: (i) Fixed charge (ii) Floating charge (i) Fixed charge- 'Fixed charge' is also called 'specific charge'. It extends over a specific property or properties of the company. In other words, when a particular or a specific property of the company is given as a security for loan, then a 'fixed charge' is said to be created over the property. It may be noted, that charges specified in Section 125(4)(b) ot the Companies Act, 1956, created in conformity with the provisions of the said Act over a specific property gives right to the creditor so secured, to sell the said property and claim the proceeds towards the dues payable by the company. (ii) Floating Charge: A 'floating charge' means a 'charge' that is general and not specific. It can be said to be a charge (a) that floats over the present and future property of the company subject thereto, that means it does not fasten on or attach to any particular or specific property; (b) that does not restrict the company from assigning the property, subject to charge to third persons, whether by way of sale or security; (c) that on happening of an event or contingency, crystallises as a fixed charge.

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From the above, it can be noted that when the charge is floating, the company may, in the ordinary course of business, deal with the property in any manner until the charge attaches. In other words, a floating charge is an equitable charge which does not fasten on any specific property but covers the whole of the company's property whether it is or is not subject to fixed charge. When floating charge becomes fixed or crystallised/attaches When the debtor company ceases to carry on business or goes into liquidation or the debenture holder or creditor, in whose favour charge is created, intervenes by getting a receiver appointed or doing some other act which affects the powers of the company to dispose the assets charged. A floating charge may also crystallise on the happening of an event specified in the creating a charge deed. Effect of floating charge becoming fixed or crystallised When a floating security upon all the property or assets of the company becomes fixed, it constitutes a charge upon all the property or assets then belonging to the company. It has priority over the subsequent equitable charges and over insecured creditors and over money advanced to the liquidator.

19.3 PROCEDURE FOR REGISTRATION OF CHARGE


Companies Act, 1956 under Section 125(1) provides that all the particulars of a charge created by the company shall be filed with the Registrar of Companies together with an instrument, creating charge, for registration within thirty days of the creation of charge. The time limit of thirty days within which the charge shall be registered can be extended by Registrar of Companies by further thirty days. The procedure for registration is provided under the Rule 6 of the Companies (Central Government's) General Rules and Forms: (a) It provides that for the registration of charge, the company shall file the prescribed particulars for creation, modification or satisfaction of the charge in the Form 8, or Form 13 or Form 17 in triplicate. The forms are prescribed under the rules. (b) A copy of every instrument evidencing any charge or modification of charge is required to be filed with the registrar duly verified and certified. (c) The fee prescribed for registration shall be paid. Recently Government of India has introduced electronic filing of returns. This is a centralized registry and all companies are required to file all returns which they were filing with ROC earlier are required to file them with this new registry. Even banks and other charge holders are required to file the particulars of the charges created in their favour by the companies under this method. This is to ensure reduction in delays and one point availability of information about any company.

19.4 EFFECT OF NON-REGISTRATION OF CHARGES


Section 125 of the Companies Act provides that the charge created by the company over the properties, if not registered, would not be valid against the liquidator and any creditor of the company. It has been held in various cases by the Courts that non-registration of charge under Section 125 would not render the security invalid automatically. The only consequence of non-registration is that the charge would not be valid against the liquidator and other creditors of the company in the event of winding up. It must be noted that, as against the company itself, so long as the company does not go into liquidation, the mortgage or charge is good and maybe enforced.

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19.5 PROVISIONS OF LAW RELATING TO REGISTRATION OF CHARGES Sections 124 to 145 of the Companies Act, 1956 provides for the registration of charges. They can be stated briefly as follows: Section 124: This Section provides that 'charge' means and includes mortgage over any or all properties of the company. Section 125: This Section provides that the charge created over the properties of the company shall be registered with the Registrar of Companies within thirty days of creation of charge. It also provides that if the charge is not registered then the charge created would be invalid as against the liquidator and other creditor of the company in its winding up. Section 126: This Section provides that after registration of charge created, any other person acquiring such property charged or any party thereof, shall be deemed to have notice of the charge registered and shall take the property subject to such charge. Section 127: This Section provides that if a company acquires a property charged under Section 125, then the company shall declare the same by filing the particulars of the property, so acquired, subject to charge. Section 128: This Section provides that provision for registration charges is also applicable for securing debentures issued by the company. The registration of charge for securing debentures shall be carried out by filing particulars of the amount of debentures, the date of the resolutions authorising the issue of the series of debentures, general description of property charged, and the names of the trustees. Section 129: This Section provides that the particulars filed for creating the charge for securing debentures shall also contain any commission, allowance or discount paid directly or indirectly by the company to any person in consideration of his subscribing or agreeing to subscribe or procuring subscriptions. Section 130: It is provided under this Section that Registrar of Companies shall keep a register of charges containing particulars of all charges requiring registration. This Section further provides that a copy of particulars contained in the register of charges can be obtained by any person on payment of fee. Section 131: This Section provides that Registrar of Companies shall maintain an index of register of charges. Section 132: This Section provides that the Registrar shall give a certificate under his hand of the registration of any charge registered, stating the amounts thereby secured; and the certificate shall be a conclusive evidence of that the requirements of Companies Act as to registration has been complied with. Section 133: This Section directs that the company, in the case of secured debentures, shall cause a copy of every certificate of registration given under Section 132 to be endorsed on every debenture or certificate of debenture stock. Section 134: This Section imposes duty on a company to register a charge required to be registered under the Act. It also provides that any person interested in registration of charge can also apply for registration. Section 135: This Section provides that the procedure and law of registration of charges is equally applicable to modification of charges. Section 136: This Section requires the company that a copy of an instrument or document creating the charge shall be kept at the registered office of the company. Section 137: Under this Section any person appointed as receiver or manager of the property charged, shall give notice to Registrar of Companies within 30 days of his appointment.

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Section 138: Under this Section, the company shall give intimation to the Registrar of the payment or satisfaction in full, of any charge, relating to the company and requiring registration under this part, within thirty days from the date of such payment or satisfaction. Thereafter the Registrar of Companies shall record such satisfaction of charge. Section 139: Under this Section, Registrar of Companies that on evidence being given to his satisfaction with respect to any registered charge: (a) that the debt for which the charge was given has been paid or satisfied in whole or in part; or (b) that part of the property or undertaking charged has been released from the charge, or has ceased to form part of the company's property or undertaking can record the fact that charge is satisfied or property is released. Section 140: This Section provides that the Registrar after entering memorandum of satisfaction in whole or in part, in pursuance of Section 138 or 139, he shall furnish the company with a copy of memorandum. Section 141: Under this Section the Company Law Board can order for the creation of charge or modification or satisfaction of the charge, if the company due to inadvertence or by accident, omitted filing charges under those provisions. Section 142: This Section empowers Registrar to impose a penalty on the company, if it fails to comply with the provisions of law relating to registration of charges. Section 143: This Section enjoins upon a company to keep at its registered office a register of charges and enter therein all the charges specifically affecting the property of the company. Section 144: This Section provides that any creditor or member of company can inspect the books relating to charges created by the company and it is the duty of the company to keep the register of charges open to inspection. 19.6 LET US SUM UP 1. The word 'charge' means any form of security for debt, unless the word is used otherwise. 2. All charges created by a company are required to be registered with Registrar of Companies under Section 125 of the Companies Act, 1956. 3. Charges can be fixed or floating. 4. Charge will have to be registered within thirty days of creation of the charge. 5. If the charge created is not registered, then the same is invalid against liquidator and other creditors on winding up of the company. 6. Sections 124 to 145 of the Companies Act deal with Registration of Charges. 19.7 CHECK YOUR PROGRESS for (a) Charge means any form of _____ (b) Charges created by company shall be registered with__________ . (c) Under Companies Act a charge includes _________ . (d) Charge, if not registered is not enforceable against company. True/False (e) Charge shall be registered within _________ days from the date of creation of charge.

19.8 ANSWERS TO 'CHECK YOUR PROGRESS'


(a) Security, debt; (b) Registrar of Companies; (c) Mortgage; (d) False; (e) 30

MODULE -C
BANKING RELATED LAWS
SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST, 2002 (SARFAESI ACT, 2002) Unit 20. Introduction to Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest, 2002 (SARFAESI Act, 2002) Unit 21. Definitions of SARFAESI Act, 2002

Unit 22. Regulation of Securitisation and Reconstruction of Financial Assets of Banks and Financial Institutions Unit 23. Enforcement of Security Interest Unit 24. Central Registry Unit 25. Offences and Penalties Unit 26. Miscellaneous Provisions THE BANKING OMBUDSMAN SCHEME, 2006 Unit 27. The Banking Ombudsman Scheme, 2006: Purpose, Extent, Definitions, Establishment and Powers Unit 28. Procedure for Redressal of Grievance RECOVERY OF DEBTS DUE TO BANKS AND FINANCIAL INSTITUTIONS ACT, 1993 (DRT ACT) Unit 29. Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (DRT Act) Preliminary Unit 30. Establishment of Tribunal and Appellate Tribunal Unit 31. Jurisdiction, Powers and Authority of Tribunals Unit 32. Procedure of Tribunals Unit 33. Recovery of Debts Determined by Tribunal and Miscellaneous Provisions THE BANKERS' BOOKS EVIDENCE ACT, 1891 Unit 34. The Bankers' Books Evidence Act, 1891 THE LEGAL SERVICES AUTHORITIES ACT, 1987 Unit 35. The Legal Services Authorities Act, 1987: Lok Adalats

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THE CONSUMER PROTECTION ACT, 1986 Unit 36. The Consumer Protection Act, 1986: Preamble, Extent and Definitions Unit 37. Ponsumer Protection Councils Unit 38. Consumer Disputes Redressal Agencies
THE LAW OF LIMITATION

Unit 39. Limitation of Filing Suits, Appeals and Applications TAXLAWS Unit 40. Income Tax, Banking Cash, Transaction Tax, Fringe Benefit Tax and Service Tax

INTRODUCTION TO SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST, 2002 (SARFAESI ACT, 2002)
STRUCTURE
20.0 20.1 20.2 20.3 20.4 20.5 20.6 20.7 Objectives Introduction Constitutional Validity of the Act Let Us Sum Up Keywords Check Your Progress Answers to 'Check Your Progress' Multiple Choice Terminal Questions

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20.0 OBJECTIVE The objective, of this unit is to see why there was a need for the new legislation, viz., Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest, 2002 (SARFAESI Act 2002) and why it was enacted. The Act has created a new legal framework, new concepts about security and new procedures for recovery of dues by banks and financial institutions. 20.1 INTRODUCTION 1. Banks and Financial institutions lend money by obtaining security, except for the category of clean loans. The security obtained is to act as a protection for the money advanced and in the case of need, the money can be realised by the sale of securities. 2. The lender's rights over the securities, both moveable and immoveable, for realisation of the amount advanced, were limited and less effective since they were required to take help of the legal system which was taking unduly long time to complete prior to the passing of the SARFAESI Act, 2002. This Act introduced major changes in the legal framework for the recovery of dues by laying hands on the securities. 3. The Act is a major step in financial sector reforms. It has brought a legal framework for the following important activities in the credit market: (a) Securitisation of financial assets. (b) Reconstruction of financial assets. (c) Recognition of any 'interest' created in the security for due repayment of a loan as a 'security interest', irrespective of its form and nature but when it is not in the possession of the creditor. (d) Power to enforce such a security for the realisation of money due to banks and the financial institutes in the event of a default, without the intervention of the Courts. (e) Enabling provisions for the setting up a central registry for the purpose of registration of transactions of securitisation, reconstruction and the creation of the security interest. 4. The Act extends to whole of India including the State of Jammu & Kashmir. It is effective from 21 June, 2002. The Act is applicable also to housing finance companies whose names are notified by the Central Government for such applicability. 5. The provisions of the Act, relating to enforcement of the security interest, applies to cases in which the security interests are created for due repayment of financial assistance. The Act has presupposed a simple thing, that there is an obligation on the part of the borrowers to repay loans and if they are unable to repay, then the securities for the loans are liable to be sold for the recovery of loans. The Act has retrospective application, i.e., it applies for loans and securities created prior to the Act coming into operation of the Act. 20.2 CONSTITUTIONAL VALIDITY OF THE ACT 1. In Mardia Chemicals vs Union of India (2004) 21 ILD 521 SC, a three member bench of the Supreme Court has declared this Act as constitutionally valid, except a part of the Section 17(2). The Section 17(2) had laid down that when the lender intends to take action of taking possession of the security asset, the borrower can file an appeal to the DRT only after depositing seventy-five per cent of the amount claimed by the lender. The Supreme Court has declared this condition of the deposit of seventy five per cent of the claim amount as unreasonable, oppressive, arbitrary and violative of the Article 14 of the Constitution. After the Supreme Court decision in the Mardia case and its fall out on the very intention of the legislation giving importance for recovery and prevent long legal battles that borrowers create without

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any payment, the Government of India has issued a notification amending the Section 17(2) of the SARFAESI Act. The amendment now stipulates payment of fifty per cent amount instead of seventy five per cent as originally enacted. An aggrieved person has now a right to refer the matter to DRT and then to the Appellate Tribunal by depositing fifty per cent of the claimed amount. 20.3 LET US SUM UP In this unit, we have seen how new changes are brought in by the Act. The comfort available for the lender for his money to come back will give him a confidence for lending. 20.4 KEYWORDS Security in Possession; Remedy with and/or without Court Intervention; Prudential Norms; Security Interest; Financial Assets; Securitisation of Financial Asset; Reconstruction of Financial Asset; Enforcement of Security; Possession and Sale of Asset. 20.5 CHECK YOUR PROGRESS 1. Banks obtain security while lending, so that in the case of need, the money can be _________ of securities. 2. The SARFAESI Act is applicable to the housing finance companies whose names are notified by the Central Government. (True or False) 3. In Mardia Chemical Case the Supreme Court decided that the condition of deposit of amount is fully invalid. (True or False) 4. After Mardia Chemical Case, the amendment made in the SARFAESI Act stipulates deposit of _________ amount before preferring the appeal to DRT (Appellate Tribunal).

20.6 ANSWERS TO CHECK YOUR PROGRESS'


1. realised by sale; 2. True; 3. True; 4. 50 per cent. 20.7 MULTIPLE CHOICE TERMINAL QUESTIONS 1. Whether moveable securities in possession of the bank can be sold by the bank without the intervention of the Court? (a) Now, a Court order is required to sale the security. (b) Yes, bank can sell as provided in the Contract Act, 1872. (c) Yes, as the SARFAESI Act, 2002 has made provisions to that effect. (d) No, until the account is not declared as NPA by the bank. 2. As per the laws existing today, the mortgaged security cannot be sold without a Court intervention. Is this correct? (a) Yes, Court intervention is required as per the provisions of the Transfer of Properties Act. (b) No, SARFAESI Act, 2002 has now made enabling provisions. (c) Yes, since the Contract Act has made no provisions about any Court intervention. (d) No, due to the recent amendments in the Transfer of Property Act no Court intervention is required. rto-wmxrrseeurifies? (a) Any moveable or immoveable security charged to the bank or financial institution.

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(b) To mortgage securities only. (c) Where the security interests are created for repayment of financial assistance given by the bank or a financial institution. (d) To the properties owned by the defaulter borrower, but those that are not charged to the bank. 4. In the Mardia case what did the Supreme Court declared as invalid? (a) Entire SARFAESI Act, 2002. (b) Creation of security interest. (c) Formation of Reconstruction Companies. (d) Condition to pay seventy-five per cent of the amounts as pre-condition while preferring appeal to the DRT. Ans. I. (b); 2. (b); 3. (c); 4. (d).

UNIT

21
STRUCTURE 21.0 Objective 21.1 Introduction 21.2 Preamble

DEFINITIONS OF SARFAESI ACT, 2002

21.3 Appellate Tribunal 21.4 Asset Reconstruction 21.5 Bank 21.6 Board 21.7 Borrower 21.8 Central Registry 21.9 21.10 21.11 21.12 21.13 Debt Recovery Tribunal Default Financial Assistance Financial Asset Financial Institution

21.14 Hypothecation 21.15 Non-performing Asset 21.16 Originator 21.17 Obligor 21.18 Property 21.19 21.20 21.21 21.22 21.23 Qualified Institutional Buyer Reconstruction Company Scheme Securitisation Securitisation Company

21.24 Security Agreement 21.25 Secured Asset 21.26 Secured Creditor 21.27 Secured Debt

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21.28 21.29 21.30 21.31 Security Interest Security Receipt Sponsor Keywords

21.32 Check Your Progress 21.33 Answers to 'Check Your Progress' 21.34 Multiple Choice Terminal Questions

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21.0 OBJECTIVE

The objectives of this unit, are to understand: The purpose of enacting the Act; Important definitions given in the SARFAESI Act, 2002. 21.1 INTRODUCTION For any Act, different concepts and effects revolve mainly around certain defined words. The Act also takes some definitions from some other Acts, to the extent it is relevant and applicable. The preamble to the Act gives in a nutshell, the purpose of the enactment. 21.2 PREAMBLE The preamble indicates the purpose of the enactment. For the SARFAESI Act, the preamble states 'An Act to regulate securitisation and reconstruction of financial assets and the enforcement of security interest and for the matters connected therewith or incidental thereto.' 21.3 APPELLATE TRIBUNAL Any person aggrieved by the order passed by the 'Debt Recovery Tribunal' can file an appeal to the authority called as the 'Appellate Tribunal', subject to the maintainability of the appeal. These tribunals are constituted by the Central Government for the various States as per the provisions of the Recovery of Debts due to Bank and Financial Institutions Act, 1993. 21.4 ASSET RECONSTRUCTION Acquisition of any right or interest, of any bank or financial institution, in any financial assistance, by any securitisation company or reconstruction company, for the purpose of realisation of such financial assistance, is called as asset reconstruction. In simple words, it is the takeover of loans or advances from the bank or financial institution for the purpose of recovery. 21.5 BANK All the banking companies, Nationalised banks, the State Bank of India as well as its subsidiary banks and co-operative banks are within the meaning of the word bank for the purpose of this Act. This definition has excluded the regional rural banks. So the SARFAESI Act is not applicable to RRBs. 21.6 BOARD The word 'Board' is used in the Act to mean the Securities and Exchange Board of India (SEBI). It is established under the Securities and Exchange Board of India Act, 1992. 21.7 BORROWER The borrower means, (i) any person, who has been granted financial assistance by any bank or financial institution, or (ii) who has given any guarantee, or (iii) who has created any mortgage or pledge as a security for the financial assistance granted by any bank or financial institution, or

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(iv) a person who becomes the borrower of a securitisation company or reconstruction company, consequent upon acquisition by it of any right or interest of any bank or financial institution, in relation to such financial assistance. 21.8 CENTRAL REGISTRY Under this Act, 'Central Registry' means the registering office, set up or caused to be set up by the Central Government. With this proposed set up, all the transactions of asset securitisation, reconstruction as well as transactions of creation of security interests, will have to be registered with this authority. The registration system will operate on a priority of registration basis, i.e., first in time to register gets priority over the person doing registration at a later time. The registry will also serve the purpose of maintaining credit information for the lenders. 21.9 DEBT RECOVERY TRIBUNAL These tribunals were established under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, to deal with the cases of recovery of debts above Rs. 10 lakh due to the banks and financial institutions. 21.10 DEFAULT 1. When the borrower does not pay any principal debt or any interest on the principle debt or any other amount payable to the secured creditor and due to such non-payment the account of such a borrower is classified as a non-performing asset (NPA) in the books of accounts of the secured creditor, as per the RBI guidelines, it is called default. 2. For getting the right of security enforcement, under this Act, there should be a default committed by the borrower. The creditor must also be a secured creditor. Any insecured creditor has no right of any nature in this Act. 3. In the Mardia Chemicals case, it was argued before the Supreme Court by the bank, that bank can classify the account as NPA as per its decision. The Supreme Court rejected this argument and stated that it should be done as per RBI guidelines only. 21.11 FINANCIAL ASSISTANCE Whenever any bank or financial institution grants a loan or advance or makes subscription of debenture or bonds or gives guarantee or issues letters of credit or extends other credit facility, it is called financial assistance. 21.12 FINANCIAL ASSET Financial asset means debt or receivables and includes: (i) (ii) (iii) (iv) (v) a claim to any debt or receivables or part thereof whether secured or insecured, or any debt or receivable secured by mortgage of or charge in immoveable property, or a mortgage charge, hypothecation or pledge of moveable property, or any right or interest in the security, whether full or part, securing debt, or any beneficial interest in any moveable or immoveable property or in debt, receivables, whether such an interest is existing, future, accruing, conditional or contingent, or (vi) any financial assistance.

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21.13 FINANCIAL INSTITUTION The financial institution means: (i) A public financial institution within the meaning of the Companies Act, 1956. (ii) Any institution specified by the Central Government under the Recovery of Debts due to Bank and Financial Institutions Act, 1993. (iii) The 'International Finance Corporation', established under the International Finance Corporation (Status, Immunities and Privileges) Act, 1958. (iv) Any other institution or non-banking financial company as defined in the Reserve Bank of India Act, 1934, which the Central Government may specify as a financial institution for the purpose of this Act. 21.14 HYPOTHECATION 1. Hypothecation means: a charge in or upon any moveable property existing or future created by a borrower in favour of a secured creditor without delivery of possession of the moveable property to such creditor as a security for financial assistance and includes floating charge and crystallisation of such charge into fixed charge on moveable property. 2. Prior to this Act no Indian Law has defined the term hypothecation though hypothecation is a very common type of charge on a security for a banks' lending. 21.15 NON-PERFORMING ASSET It is an asset or account of a borrower classified by a bank or financial institution as sub-standard, doubtful or a loss asset, in accordance with the directions or under guidelines relating to asset classification issued by the Reserve Bank. For classification of any account as NPA it is important that the classification is done as per the RBI directives. 21.16 ORIGINATOR Originator is the owner of a financial asset that is acquired by a securitisation company or reconstruction company for the purpose of securitisation or asset reconstruction. In plain meaning, when the bank or financial institution lends money against security they are the originator. 21.17 OBLIGOR Obligor means a person liable, (i) To pay to the originator, whether under a contract or otherwise, or (ii) To discharge any obligation in respect of a financial asset, whether existing, future, conditional ______ or contingent, or ---------------------------------------(iii) and includes a borrower.

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21.18 PROPERTY 1. Property means: (i) Immoveable property, (ii) Moveable property, (iii) Any debt or any right to receive payment of money whether secured or insecured, (iv) Receivables, whether existing or future, (v) Intangible assets such as; know-how, patents, copyright, trademarks, licence, franchise or any other business or commercial right of a similar nature. 2. Definition of property is made much wider by this Act. Prior to this Act, property has been defined under various Acts such as Transfer of Property Act, Registration Act, etc. By this Act, the addition of properties stated at sub-clauses (iii), (iv) and (v) here above is made. Due to this, now security interest can be created against these properties for raising loans from the banks and financial institutions. 21.19 QUALIFIED INSTITUTIONAL BUYER 1. Such buyer means a financial institution or an insurance company or a bank or a state financial corporation or state industrial development corporation or trustee or any asset management company, making an investment on behalf of a mutual fund or provident fund or gratuity fund or pension fund or a foreign institutional investor, registered under the SEBI Act, 1992 or any other body corporate as may be specified by SEBI. 2. This definition covers several categories of institutional investors but does not include a company registered under the Companies Act, 1956. If any company wants to become a qualified institutional buyer then it will have to get such a registration from SEBI. 21.20 RECONSTRUCTION COMPANY A company formed for the purpose of asset reconstruction and registered under the Companies Act, 1956 is called Reconstruction Company. 21.21 SCHEME The securitisation company or the reconstruction company can raise funds from qualified institutional buyers by formulating schemes. Funds so raised are required to be maintained in, separate and distinct accounts scheme-wise,. The scheme invites subscription to security receipts proposed to be issued by such a company. 21.22 SECURITISATION 1. Securitisation means acquisition of financial asset by the securitisation or reconstruction company from the originator. Such an acquisition may be by raising of funds by such a securitisation or reconstruction company from the qualified institutional buyers by issue of security receipts representing undivided interest in the financial assets or otherwise. 2. The concept and modality of securitisation defined here is new for the Indian laws as well as for the markets. This is a process where non-liquidated financial assets are converted into marketable securities, i.e., security receipts that can be sold to the investors. It is also a process of converting the receivables and other assets into securities, i.e., security receipts that can be placed in the market for trading. In Indian laws, there is no provision for transfer of claims that are secured by

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any security. Now SARFAESI Act has made the loans secured by mortgage or other charges transferable. On acquisition of a financial asset, the securitisation or reconstruction company becomes the owner of the financial asset and steps into the shoes of the lender bank or financial institution. This acquisition can also be said to be, as a sale of asset without recourse to the bank or financial institution. RBI is the regulatory authority for all securitisation or reconstruction companies. 3. As per present guidelines of 29 March, 2004, the minimum capital requirement for the securitisation or reconstruction company is Rs. 2.00 crore at the time of registration and these companies are required to maintain capital adequacy of fifteen per cent of total asset acquired or Rs. 100 crore whichever is less. 21.23 SECURITISATION COMPANY It is a company registered under the Companies Act, 1956 for the purpose of securitisation. The securitisation company also needs a registration from the RBI as per the SARFAESI Act. The securitisation company can set up separate trusts scheme wise and act as trustee for such schemes, as provided in the Securitisation Companies and Reconstruction Companies (Reserve Bank) Guidelines and Directions, 2003. The investors in the securitisation company are the beneficiaries of such trusts. 21.24 SECURITY AGREEMENT Security agreement means an agreement, instrument or any other document or arrangement under which security interest is created in favour of the secured creditor. This includes creation of mortgage by deposit of title deeds with the secured creditors. 21.25 SECURED ASSET Secured asset means the property on which a security interest is created. The powers given by SARFAESI Act for the enforcement of securities are against the secured assets only. If the borrower has any property over which no security interest is created, such a property is outside the purview of enforcement powers under the SARFAESI Act. 21.26 SECURED CREDITOR Any bank or financial institution or any consortium or group of banks or financial institutions in whose favour the security interest is created by the borrower for due repayment is called a secured creditor. It includes debenture trustee appointed by any bank or financial institution or securitisation company or reconstruction company. It also includes, any other trustee holding securities on behalf of a bank or financial institution. 21.27 SECURED DEBT Secured debt means a debt which is secured by any security interest. 21.28 SECURITY INTEREST 1. Any right, title and interest of any kind whatsoever upon the property created in favour of any secured creditor is called as security interest. It includes any mortgage charge, hypothecation, assignment other than those specified in Section 31 of the SARFAESI Act. 2. Whenever any lender takes any security from the borrower, the lender pets i

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The type of interest depends on the nature of charge created over the security. Until now, such interest of the lender in the security was not defined in any law. SARFAESI Act has, for the first time defined this. Now, any type of charge or any type of security has come under one wide scoped definition, called the security interest. 21.29 SECURITY RECEIPT 1. A receipt or another security issued by a securitisation company or reconstruction company to any qualified institutional buyer pursuant to a scheme evidencing the purchase or acquisition by the holder thereof of an undivided right, title or interest in the financial asset involved in securitisation is called the security receipt. 2. The security receipt evidences the purchaser's undivided right, title and interest in the security. These receipts are transferable in the market. By this Act, a new type of transaction in the financial market has been created for transfer of the security interest. 21.30 SPONSOR Sponsor is an entity holding not less than ten per cent of the paid-up equity capital of securitisation or reconstruction company. 21.31 KEYWORDS Appellate Tribunal; Asset Reconstruction; Central Registry; Debt Recovery Tribunal; Non-performing Asset; Notification; Obligor; Originator; Qualified Institutional Borrower; Reconstruction Company; Securitisation; Securitisation Company; Security Agreement; Secured Asset; Security Interest; Security Receipt; Sponsor. 21.32 CHECK YOUR PROGRESS 1. The SARFAESI Act is applicable for pledged securities also. (True or False) 2. For the enforcement of a mortgage security, court intervention is required even for actions under the SARFAESI Act. (True or False) 3. Banks and financial institutions can issue notice for enforcement over security under SARFAESI Act only if these securities are not _________ creditor and only when the account is classified as __________ . 4. If the borrower does not pay within _____ ' days after notice by the secured creditor the creditor can _________ . of the security. 5. After receipt of notice from the secured creditor for repayment of dues by the borrower, the borrower is legally prevented from transferring his property in any way. (True or False) 6. On request of the secured creditor the District Magistrate or the Chief Judicial Magistrate can take possession of the security for handing over it to the creditor. (True or False) 7. When the management of the company is taken over by the secured creditor, the directors of such company are entitled to compensation for loss of office. (True or False) In this unit we have studied various definitions given in the SARFAESI Act, 2002. Some definitions are creating new notions. Definitions for asset reconstruction, borrower, default, financial assistance, hypothecation, property, securitisation, security interest and security receipt are some of the important definitions to clear the concepts of the Act.

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21.33 ANSWERS TO 'CHECK YOUR PROGRESS'
1. False; 2. False; 3. in possession, NPA; 4. Sixty, take possession; 5. True; 6. True; 7. False.

21.34 MULTIPLE CHOICE TERMINAL QUESTIONS


1. When any bank or financial institution obtains a charge against property, with which authority will the transaction have to be registered under the SARFAESI Act, 2002? (a) With the Central Registry. (b) With the ROC. (c) With the Registrar of Assurances within whose jurisdiction the property lies. (d) With the Reserve Bank of India. 2. When can the provisions of SARFAESI Act, 2002 be invoked for proceeding against the charged property? (a) When the bank feels that it is necessary for the recovery at any time. (b) When the RBI directs to do so. (c) When there is default in repayment by the borrower. (d) When there is default in repayment and the bank declares the account as NPA. 3. Whether existing or future receivables are property? (a) Yes. (b) No. (c) Yes, but if and when charged to the lender. (d) No, if hypothecated to the lender. 4. From the following which function is of a securitisation company? (a) Acquisition of loan transaction from the lender. (b) Help the lender in recovery by sale of charged property. (c) Take legal steps against the defaulter borrower on behalf of the lender. (d) Acquisition of financial asset from the originator. Ans. 1. (a); 2. (d); 3. (a); 4. (d)

REGULATION OF SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS OF BANKS AND FINANCIAL INSTITUTIONS
STRUCTURE
22.0 22.1 22.2 22.3 22.4 22.5 22.6 22.7 22.8 22.9 22.10 22.11 22.12 22.13 22.14 22.15 22.16 Objectives Introduction Registration of Securitisation Company or Reconstruction Company Cancellation of Certificate of Registration Acquisition of Rights or Interest in Financial Assets Notices to Obligor and Discharge of Obligation of Such Obligor Issue of Security Receipts and Raising of Funds by Securitisation Company or Reconstruction Company Exemption from Registration of Security Receipt Measures of Assets Reconstruction Other Functions of Securitisation Company or Reconstruction Company Resolution of Dispute Power of Reserve Bank to Determine Policy and Issue Directions Let Us Sum Up Keywords Check Your Progress Answers to 'Check Your Progress' Multiple Choice Terminal Questions

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22.0 OBJECTIVE
The objective of this unit is to understand the regulatory framework, in which the securitisation and reconstruction companies are required to work, how they have to raise the funds, acquisition of assets and other such functional modalities.

22.1 INTRODUCTION
The SARFAESI Act has streamlined the functions of the securitisation and reconstruction companies for dealing with financial assets of banks and financial institutions. For this purpose, procedures as well and regulatory control measures were required. In this unit we will consider these aspects.

22.2 REGISTRATION OFSECURITISATION COMPANY OR RECONSTRUCTION COMPANY


1. The securitisation or reconstruction company can commence or carry business, only after complying the following two conditions: (i) It obtains certification of registration from the Reserve Bank of India by applying in prescribed format; and (ii) It has the owned funds at the time of registration not less than Rs. 2 crore or such other amount not exceeding fifteen per cent of the total financial assets acquired or to be acquired as the RBI may specify. 2. As per the SARFAESI Act the securitisation of an asset or reconstruction of an asset, are treated as similar activities and the provisions relating to the registration of these companies are same. Such registered companies can raise money for their acquisition activities by issue of security receipts for formulating schemes. This Act has provided the legal framework for this activity. Depending on the nature of security asset the Reserve Bank of India has the powers to specify different amounts of owned funds for different class or classes of securitisation companies or reconstruction companies. The Reserve Bank of India may impose such other conditions as it deems fit on the company. If any securitisation or reconstruction company wants to make any substantial change in its management or a change in the registered address or change in the name, then that needs prior approval of the Reserve Bank of India. The scheme of the Act and the guidelines published by the Reserve Bank of India under the Act, gives a business pattern of the securitisation or reconstruction company as under. (i) The company can formulate separate schemes for the acquisition of a financial asset. (ii) Create separate trusts for each scheme and maintain separate and distinct records and accounts in respect of each scheme and issue security receipts to the investors, (iii) The securitisation company or reconstruction company can act as trustees for such trusts and manage the assets held in trust. (iv) As the assets acquired in trust are scheme-wise, the risk of non-realisation of assets will be impacting the investors who are the beneficiaries under the trust. As such there should not be loss to the company. These companies do the activity in such a way that they make arrangements for realisation of money from the asset acquired. They do not invest their own funds in the acquisition of asset but utilise the money invested on risk assessment and act on careful considerations for asset acquisition decision. The risk factors are required to be assessed, anticipated and also disclosed to the investors.

3.

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22.3 CANCELLATION OF CERTIFICATE OF REGISTRATION 1. The registration granted to the securitisation or the reconstruction company by the Reserve Bank of India is cancellable on following grounds: (i) The company ceases to carry on the business of securitisation or asset reconstruction, or (ii) The company ceases to receive or hold any investment from a qualified institutional buyer, or (iii) The company fails to comply with any of the conditions subject to which the certificate of registration was granted, or (iv) The company fails to, (a) comply with any of the directions issued by the Reserve Bank, or (b) maintain accounts in accordance with the requirements of any law or any direction or order issued by the Reserve Bank of India, or (c) submit or offer for inspection its books of accounts or other relevant documents when so demanded by the Reserve Bank of India, or (d) obtain prior approval of the Reserve Bank of India for change in management or change in registered office or change of name. 2. The Act has provided that the cancellation of registration may be of two categories. In the first category the cancellation of registration is without giving any opportunity to the company if the company does any of the following: (i) Ceases to carry on the business of securitisation or reconstruction, or (ii) Ceases to carry or hold any investment from a qualified institutional buyer, or (iii) Fails to comply with RBI directions, or (iv) Fails to maintain accounts in accordance with directions issued by RBI, or (v) Fails to give accounts and documents to RBI for inspection. The second category of cancellation is done with an opportunity to comply with the defaults other than the above. However, even in this second category, the RBI has powers and discretion, to deny opportunity, if the RBI feels that a delay in the cancellation of registration shall be prejudicial to the public interest or the interests of the investors of the company. It is required that the order is with reasons recording the reasons as to why the company has been denied the opportunity. 3. The securitisation or reconstruction company whose registration is cancelled can prefer an appeal within thirty days from the date of communication of order, to the Central Government. The company is required to be given a hearing before rejecting the appeal. 4. Even if the application for registration is rejected or the already existing registration is cancelled, the company shall be deemed as registered, until the company pays the dues of the investors along with interest within the period as the RBI may specify. 22.4 ACQUISITION OF RIGHTS OF INTEREST IN FINANCIAL ASSETS 1. The securitisation company or the reconstruction company can acquire the financial asset of any bank or financial institution by any of the following ways: (i) By issuing a debenture or bond or any other security in the nature of debenture for the agreed consideration and agreed terms and conditions between the bank/financial institution and the securitisation company/reconstruction company as the case may be, (ii) By entering into an agreement with such bank or financial institution for the transfer of financial asset to such company on terms and conditions as may be agreed between them.

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2. The securitisation or the reconstruction company can acquire financial assets without execution of any deed of assignment or transfer in its favour by the concerned bank or the financial institution. Assignment is complete on the acquiring company issuing a debenture or bond and incorporating therein the terms and conditions of acquisition. There is no need for execution of any other document. The document to be executed requires payment of stamp duty as per the Indian Stamp Act, which is an Act of the Union of India. The said document is not required to be stamped as per the State Stamp Duty laws. 3. As stated earlier, the securitisation transaction involves two stages. The first is acquisition of financial assets and undivided interest therein. The second is issue of security receipts in favour of the investors for the purpose of raising money from investors. 4. If the bank or financial institution is a 'lender' in relation to any financial asset acquired by the securitisation or a reconstruction company, then such a company is deemed as lender in context with the acquired property. Therefore, all the rights of such bank or financial institution in the security vest in the company which acquired the assets. 5. The statutory provisions say that acquiring company shall be vested with all the rights of such bank or financial institution. The provisions have excluded the liabilities. Thus, if there is any liability or commitment to be discharged from the side of bank or financial institution, it will not pass on to the securitisation or reconstruction company. Even if there is any commitment to lend further to the borrower, such commitment will not pass on to the asset acquiring company. On this issue, the Reserve Bank of India in the guidance note for securitisation companies and reconstruction companies has provided recommendatory guidance as under: (i) Acquisition of funded assets, should not include takeover of outstanding commitments, if any, of any bank or financial institution to lend further, (ii) Terms of acquisition of the security interest in non-fund-based transactions should provide for the relative commitments to continue with bank or financial institute until demand for further funding arises. 6. In relation to the financial asset all contracts, deeds, bonds, agreements, power of attorney, grants of legal representations, permissions, approvals, consents or no objections under any law or otherwise to which the bank or financial institution is a party or which are in favour of the bank or financial institution are fully enforceable upon in place of bank or financial institution by and in favour of securitisation company or reconstruction company. 7. If at the time of acquisition of an asset by the securitisation company or reconstruction company, any suit, appeal or other proceeding of whatever nature related to the asset is pending by or against the bank or financial institution it does not get discontinued or abated or get in any way prejudicially affected because of the acquisition of asset. In such an event the suit, appeal or other proceeding can be continued, prosecuted and enforced by or against the securitisation or reconstruction company, as the case may be. If a securitisation company or reconstruction company acquires the assets of more than one bank or financial institution, where cases before different Debt Recovery Tribunals are pending, the securitisation company or reconstruction company can file an application to any of the Appellate Tribunal under which, such DRT come for transfer of all applications to anyone of the DRT as the Appellate Tribunal may decide. 8. Following documents are involved in a securitisation transaction. (i) Offer document: The Reserve Bank of India in its guidelines of 2003 has mentioned details about the form of offer and details to be incorporated therein. By and large the full details and particulars about the financial asset, loan details of bank, trustees' details, etc., are included. Some quarterly details are also required to be disclosed. These include details

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about profit-loss, prepayments, expenses, defaults, collection, etc., and also any other material thing affecting the securitisation arrangement. (ii) Debenture: A debenture, for the payment of consideration, is to be paid to the bank or the financial institution for the acquisition of financial asset from it. As per the extant guidelines from RBI, the rate of interest offered in the debenture cannot be less than one and half per cent above the Bank Rate as on the date of issue of the debentures and the period of redemption of debenture cannot exceed six years. (iii) An agreement: It is with the originator to continue to service the assets of the securitisation. (iv) Security receipt: It is in favour of the investors. 22.5 NOTICES TO OBLIGOR AND DISCHARGE OF OBLIGATION OF SUCH OBLIGOR 1. When the bank or financial institution decides, that the financial asset be now acquired by the securitisation or reconstruction company, a notice may be given about such an acquisition to the obligor, i.e., borrower or any other person liable to repay to the bank or financial institution. Giving of such notice is optional and not compulsory under the Act. In case, the obligor is a company and creation of charge has been registered, then also the giving of notice to the respective registrar is optional. Thus, there is no need of modification of charge with the Registrar of Companies. However, if the bank or financial institution decides to give notice to the obligor, then notice to the ROC is required to be given when the obligor is a company. 2. If notice of acquisition as said above is given to the obligor, it is necessary that the obligor should make payments to the concerned securitisation or reconstruction company. Such payments amount to a valid discharge of liability of the obligor making the payment. If notice of acquisition, as said above is not given, the money or property received by the bank or financial institution from the obligor shall be held by such bank or financial institution in trust and shall be handed over to the concerned securitisation company or reconstruction company. 22.6 ISSUE OF SECURITY RECEIPTS AND RAISING OF FUNDS BY SECURITISATION OR RECONSTRUCTION COMPANY 1. The securitisation or reconstruction company raises funds for acquisition of an asset by issue of security receipts. Only the qualified institutional buyers can buy these security receipts. The security receipts are not issued to the public. The investment and financial market in this field is very complex and much risk assessment is required to be done by the investor. The individual investor does not possess such expertise. Therefore, the Act has debarred individuals from making an investment in securitisation or reconstruction company. 2. When the securitisation or reconstruction company decides to raise funds from qualified institutional investors following conditions apply: (i) For each financial asset acquired or to be acquired there should be a separate scheme. (ii) Scheme-wise and asset-wise separate distinct accounts should be maintained. (iii) Realisation of the asset is held and applied towards redemption, i.e., repayment of investments as assured while issuing the security receipt. (iv) In case there is no realisation and repayment as said above, the qualified institutional buyers, holding not less than seventy-five per cent of the total value of the security receipts issued are entitled to call a meeting of all qualified institutional buyers making investments in that scheme and the resolutions passed in such a meeting are binding on the concerned securitisation or reconstruction company.

(v) When the qualified institutional investors call the meeting, as said above, to decide the further course of action due to non-realisation of the asset, they have to follow the same procedure, as nearly as possible as is followed at meetings of the board of directors of the securitisation company or reconstruction company, as the case may be. (vi) The funds raised or assets acquired out of the raised funds by the securitisation or reconstruction company shall be held by such company in trust for the investors. 3. When separate schemes are made and funds are raised by the securitisation or reconstruction company, the provisions of SARFAESI Act do not directly provide for setting up of trusts for each scheme. However, in totality the legal effect is that there are resultant trusts in respect of each scheme. The investors in such schemes become the beneficiaries under the trust and the company framing the scheme is the trustee, managing the trust. The Reserve Bank of India guidelines for securitisation also provide for such an arrangement. Due to such trust arrangement the money held by the company are held in trust and do not form the assets of the company. Due to this, in the eventuality of liquidation of such a company the money does not pass on to liquidator and the beneficiaries get the money on priority and distinctly. 22.7 EXEMPTION FROM REGISTRATION OF SECURITY RECEIPT 1. When the securitisation company or reconstruction company issues security receipts the holder of the security receipts is entitled to an undivided interest in the financial assets. In such an event the security receipt does not require registration that is otherwise compulsory under the Registration Act, 1908. 2. However registration of the security receipt is required in following cases or eventualities, (i) There is a transfer of the security receipt. (ii) If the security receipt is creating, declaring, assigning, limiting or extinguishing any right, title or interest to or in an immoveable property.

22.8 MEASURES OF ASSET RECONSTRUCTION


1. Asset reconstruction means the acquisition of any right or interest of any bank of financial institution in any financial asset for the purpose of realisation. Powers to take various measures for asset reconstruction are given without prejudice to the provisions contained in any other law. Thus, the powers given under the SARFAESI Act are subject to the provisions of all the other existing laws. 2. The measures for asset reconstruction are as under : (i) To change or takeover of the management of the business of the borrower for proper management of business of the borrower. Until now, the recovery actions against the defaulting borrowers were taken as a last stage and as a last resort when the unit is closed and has incurred losses. Such legal actions at the last stage when unit is unable to function do not give desired recovery. With these new provisions under SARFAESI Act, a borrowal unit that has been classified as NPA as per the applicable norms of ninety days default, but is still functioning, can be treated differently by banks and financial institutions. If the cause of default in such a unit is any mismanagement or lack of expertise on the part of the existing management, the securitisation company or reconstruction company has the powers to takeover the management or change the management. This power can be exercised even when there is no default. On realisation of the secured debt in full the management of the business can be restored back to the borrower. When the lender lends money against a security asset and creates charge over the assets, the ownership of the asset still remains with the borrower who has

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created the charge. The lender has charge and the only objective is to have a secured lending and getting repayment by realising the asset, (ii) To sell or lease of a part or whole of the business of the borrower, (iii) Rescheduling of payment of debts payable by the borrower. (iv) Enforcement of security interest in accordance with the provisions of the SARFAESI Act. (v) Settlement of dues payable by the borrower, (vi) Taking possession of secured asset in accordance with the provisions of the SARFAESI Act. 3. In respect of these powers for asset securitisation, the following important operative points need to be kept in mind. (i) The power is not linked with any default by the borrower. Even without there being any default these powers can be exercised, (ii) The exercise of powers is subject to existing laws. (iii) There is no provision for having an overriding effect on the loan agreements between the bank/financial institution and the borrower. (iv) There is no civil appeal provided for against any action under this section. (v) The SARFAESI Act is silent about the grounds or reasons based on which the action of acquisition can be taken. Therefore, loan agreements between the bank/financial institution and the borrower are required to be taken into account as provisions of this section do not have an overriding effect on existing contracts and laws. (vi) The Act does not provide giving notice to the borrower before initiating any action under this section. However, considering a Supreme Court ruling in the Swadeshi Cotton Mills vs Union of India AIR 1981 SC 818, a hearing at pre-decisional stage must be given before resorting to any action. The said ruling is under a different law but on similar powers of taking over of the undertaking by the Central Government. The same principle laid down in the said case, will apply to these actions. Therefore, before taking action, notice to the borrower will be required to be given. (vii) The provisions contained in the SARFAESI Act for taking forcible possession of the assets are applicable to the secured assets only and not to other assets. (viii) Since the actions can be taken in accordance with the loan agreements, it is necessary that defaults as contemplated in such agreements have occurred. (ix) If the contractual power arising out of the loan agreements to takeover or change the management or to sale or to lease the business of the borrower becomes exercisable, the same must be exercised under the provisions of the SARFAESI Act. (x) There are cases that the controlling shares of the promoter directors are pledged with the bank/financial institution with power to transfer and sale of such shares in case of default. In such cases, the power to change or takeover the management or sale of business of the borrower can be done by sale of such shares in accordance with the powers derived under loan agreements and the provisions of the Indian Contract Act. Provisions of SARFAESI Act will not apply to such cases because pledge and enforcement of pledge are kept outside the purview of SARFAESI Act. For such transfer and sale of shares, compliance of SEBI regulations regarding the takeover code and other applicable laws and regulations will have to be done. (xi) The acquisition powers under the SARFAESI Act are exercisable subject to guidelines framed by Reserve Bank of India. This provision is incorporated in the Act itself.

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22.9 OTHER FUNCTIONS OF THE SECURITISATION COMPANY OR RECONSTRUCTION COMPANY 1. Any securitisation company or reconstruction company registered under the SARFAESI Act may, (i) Act as an agent for any bank or financial institution for the purpose of recovering their dues from the borrower on payment of fees or charges as may be mutually agreed upon between them. (ii) Act as a manager for the secured assets, of which the possession is taken by any bank or financial institution for such bank or financial institution on fees as may be mutually agreed upon between the parties. However, if acting such as manager gives rise to any pecuniary liability on the securitisation or reconstruction company, then no such acting as manager can be done. (iii) Act as receiver if appointed by any Court or Tribunal. 2. The securitisation company or reconstruction company can act as stated above without the prior approval of the Reserve Bank of India. For any other acts as well as business other than securitisation or asset reconstruction prior approval of the Reserve Bank of India is required. For the purposes of above said provisions the 'securitisation company' or 'reconstruction company' does not include its subsidiary. 22.10 RESOLUTION OF DISPUTE 1. Any dispute between the bank or financial institution and the securitisation or reconstruction company as well as with or by qualified institutional buyer relating to securitisation or reconstruction or non-payment of any amount due or interest, is required to be settled by conciliation or arbitration as provided in the Arbitration and Conciliation Act, 1996. The dispute may be amongst any of the three parties stated above. The Act provides that settlement of dispute through arbitration and conciliation shall be as if the concerned parties have consented in writing for such a settlement and the provisions of Arbitration and Conciliation Act, 1996 shall apply. 2. Here it should be noted that only the said three parties are mentioned in the provision made in the Act. Obligor or borrower is not mentioned. Therefore, the provisions of mandatory arbitration and conciliation are not applicable to the dispute by or against the borrower. 22.11 POWER OF RESERVE BANK TO DETERMINE POLICY AND ISSUE DIRECTIONS 1. If the Reserve Bank of India is satisfied that it is necessary or expedient so to do, it may determine the policy and give directions, (i) In the public interest, or (ii) To regulate financial system of the country to its advantage, or (iii) To prevent the affairs of any securitisation company or reconstruction company from being conducted in a manner prejudicial to the interest of such securitisation company or reconstruction company. 2. The Reserve Bank of India directions are given to or policies are framed, in respect of the securitisation company or reconstruction company in matters related to, (i) Income recognition, (ii) Accounting standards, (iii) Making provisions for bad and doubtful debts,

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(iv) Capital adequacy based on risk weights for the assets, (v) Deployment of funds by the said companies. Whenever, the Reserve Bank of India decides the policy, and issues directions, the securitisation company or the reconstruction company is bound to follow the same as it has a statutory effect. 3. In addition to the above stated powers vested with the RBI for making policy or giving directions generally, the RBI has the powers to make policy or issue directions to any particular securitisation or reconstruction company or a class of such companies or all such companies. In such cases, in addition to the aspects given above, on which the policy can be framed or directions can be issued, the RBI may do so on the following aspects also: (i) The type of financial asset of a bank or financial institution which can be acquired and procedure for such an acquisition of such assets and valuation thereof. (ii) The aggregate value of financial asset which may be acquired by any securitisation company or reconstruction company. 4. Some important points from the guidelines issued until October 2004 by the RBI are as under: (i) On the acquisition of a financial asset that has been classified by the bank or financial institution as a non-performing asset, the securitisation company or the reconstruction company has to formulate a plan for realisation of such an asset within twelve months. During such a planning period, the asset can be classified as a Standard Asset, (ii) Definition of a non-performing asset, has been linked to an overdue period, which is now ninety days, (iii) Any entity not registered with the Reserve Bank of India under the SARFAESI Act, may conduct the business of securitisation or asset reconstruction outside the purview of SARFAESI Act. (i v) The securitisation company or reconstruction company can undertake activities and functions as given in the SARFAESI Act and no other business. (v) A securitisation company or reconstruction company cannot raise money by way of deposits, (vi) At the time of enforcing securities as per provisions of the SARFAESI Act, the securitisation company or reconstruction company may itself acquire secured assets for use or resale if such resale is through a public auction, (vii) When the asset is acquired for reconstruction there is a limit of five years for such reconstruction, (viii) The securitisation company or reconstruction company is permitted to set up trusts that can issue security receipts. Trusteeship of such trusts vests in the concerned securitisation or reconstruction company, (ix) While issuing security receipts, detailed disclosures are required to be made by the concerned securitisation or reconstruction company, (x) The balance sheet of the asset acquiring company should disclose names and addresses of the banks/financial institutions from whom the assets are acquired with values thereof, industry-wise and sponsor-wise dispersion of assets and related party disclosures, (xi) Maintaining of the capital adequacy of fifteen per cent of total assets acquired or the capital of Rs. 100 crore, whichever is less. 5. The RBI has powers to call for statements and information at any time from the securitisation or reconstruction company, relating to the business and affairs of these companies as the RBI may consider necessary.
L.R.A.D-16

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22.12 LET US SUM UP In this unit, we have seen about the functional part of the securitisation and reconstruction company. It includes the registration of these companies, their functional freedom and the RBI restrictions thereon. There are some stipulations for capital requirements and for raising the same. The existing companies require registration. There are various conditions based on which the registration is considered by the RBI. We have seen when registration of the company can be cancelled and reasons thereof. How financial assets are acquired is important and it involves detailed procedure. The effect of contracts, deeds, suits by or against involving the security asset is also seen. There are specific documents involved and the procedure for securitisation transaction. The acquisition of asset involves the proper notice and procedure. There are conditions for raising funds from the qualified institutional investors. Issuance of security receipts and conditions/exemptions for the same is also seen. The asset reconstruction company can take various measures for realisation from the asset. The Act provides for dispute settlement between the securitisation/reconstruction company and the investor by arbitration. RBI has powers to issue various guidelines under the Act. 22.13 KEYWORDS Securitisation Company and Reconstruction Company; Experienced Professional Directors; Nominees of Sponsor Restrictions; No Conviction; No Controlling Interest; Prudential Norms; Notice of Acquisition; Contents and Procedure; Funds from Institutional Investors; Scheme-wise Trust; Security Receipt; Arbitration. 22.14 CHECK YOUR PROGRESS 1. A securitisation or reconstruction company needs registration from the RBI for commencement of business. (True or False) 2. Right of acquisition of a financial asset by the securitisation or reconstruction company is subject to the prior agreements or contracts about the asset. (True or False) 3. Acquisition of a financial asset by the securitisation company or reconstruction company is with the liability also over such an asset. (True or False) 4. Which are the four documents involved in the securitisation transaction? 5. For each asset acquired or to be acquired, by the securitisation company or the reconstruction company there should be _________ scheme. 6. When the securitisation company or reconstruction company issues security receipts, the holder thereof, is entitled to a _________ in the financial asset. 7. The security receipt issued by the securitisation or reconstruction company requires registration. (True or False) 8. Any direction issued by the RBI under the SARFAESI Act has __________ effect and is _________ on the parties concerned. 22.15 ANSWERS TO 'CHECK YOUR PROGRESS' 1. True; 2. False; 3. False; 4. offer document, debenture, agreement and security receipt; 5. separate; 6. undivided interest; 7. False; 8. statutory, binding. 22.16 MULTIPLE CHOICE TERMINAL QUESTIONS 1. After application of the SARFAESI Act what have the existing companies to do about registration with RBI?

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(a) They are automatically deemed to be registered. (b) They are required to stop functioning. (c) Existing companies do not require registration (d) They have to get registered within six months from the commencement of the Act. 2. Which, from amongst the following, is a reason for the cancellation of registration of the securitisation company and reconstruction company without giving a hearing opportunity? (a) The company does not keep accounts as per the RBI norms. (b) The company ceases to carry on the business of securitisation or reconstruction. (c) The company fails to hold investment from the qualified investor. (d) The company does not fulfil any of the conditions imposed at the time of registration. Ans. 1. (d); 2. (b).

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STRUCTURE
23.0 Objectives 23.1 Introduction

ENFORCEMENT OF SECURITY INTEREST

23.2 Enforcement of Security Interest 23.3 Chief Metropolitan Magistrate or District Magistrate's Assistance for Taking Possession of Secured Asset 23.4 Manner and Effect of Take Over of Management 23.5 No Compensation to Directors for Loss of Office 23.6 Right to Prefer Application to DRT 23.7 23.8 23.9 23.10 23.11 23.12 23.13 Appeals to Appellate Authority Right of Borrower for Compensation and Costs Let Us Sum Up Keywords Check Your Progress Answers to 'Check Your Progress' Multiple Choice Terminal Questions

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23.0 OBJECTIVES We know that when immoveable property is obtained as security by way of mortgage for its sale and realisation of money, Court intervention is required. Similarly, in the case of moveable property also, except for the pledged security, Court intervention is required for sale of property and realisation of money. Now with the provision of this Act, there are changes in the procedures for sale of securities. The creditor can also take the help of the District Magistrate or the Chief Metropolitan Magistrate. We will see all these provisions in this unit. 23.1 INTRODUCTION With introduction of NPA norms and its higher levels on one side and delay in realisation of money by sale of properties through Court intervention on the other side, giving powers to the lender to enforce security was essential, by the introduction of new suitable enactment. The SARFAESI Act empowers banks and financial institutions to enforce securities in the event of default by the borrower without the intervention of either, the Civil Court or the Debt Recovery Tribunal. The powers so given by this Act, have an overriding effect on other laws in this respect. The powers are also over and above other remedies available for recovery, by filling appropriate proceeding either in a Civil Court or Debt Recovery Tribunal. The secured creditor has been given the option to decide which course of action should be adopted in respect of defaulted loans. From the angle of banks and financial institutions this unit is very important. In this unit, see about the powers to enforce the securities obtained, while lending money and realise money therefrom. These powers can be exercised by the creditor, i.e. lender without intervention of the Court. 23.2 ENFORCEMENT OF SECURITY INTEREST 1. Under the SARFAESI Act a secured creditor can enforce the security interest created in his favour without the intervention of the Court or Tribunal. This power given to the secured creditor, has an overriding effect over the provisions related to mortgage in the Transfer of Property Act, 1882, as in that Act Court intervention is required. 2. Section 13(2) of the SARFAESI Act speaks about the notice to be given by the secured creditors to the borrower, who has defaulted in making the repayment and whose account is classified as NPA. The precondition to get the right to serve this notice is that the notice should be given asking the borrower to discharge in full his liabilities to the secured creditors within the sixty days from the date of notice. Failing to do so by the borrower, the secured creditor gets further rights as detailed in the Act, that we will see later herein below. 3. The notice referred to above, should give the details of the amount payable by the borrower and the secured asset intended to be enforced by the secured creditor in the event of non-payment of secured debt by the borrower. Though the Act contemplates giving of only two particulars, viz., details of amount payable and details of securities, in the notice said above, it is more proper to give the details of defaults, overdue period and the date from which the account is classified as NPA, facility-wise securities provided for the loans and particulars of security documents executed.by the borrower. The Act or the rules made there under, have not prescribed any format of notice to be given. However, this notice is a statutory notice having consequence, that the borrower is prohibited from transferring the property mentioned in the notice in any way. Any contravention of these legal consequences, if made, by the borrower is punishable under the SARFAESI Act. So it is advisable that the notice mentions about the legal consequences and the penal provisions.

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4. The Act does not Contemplate a reply from the borrower to the notice. But the borrower may reply or make representation to the notice, so received by him. The Supreme Court in Mardia Chemicals Ltd. case, has laid down certain guidelines about what the bank or the financial institution should do when the borrower submits any reply or representation to the said notice. These guidelines broadly are as under: (i) The secured creditor must apply his mind to the objection raised by the borrower in reply or representation to the notice served on him by the secured creditor. (ii) An internal mechanism must be particularly evolved to consider the reply of the borrower. (iii) There may be some meaningful consideration in the objection raised by the borrower and the rejection of the points raised by the borrower should not be ritually followed by execution of drastic action under the Act. (iv) The reasons for overriding the objections of the borrower must be communicated to him by the secured creditor. (v) While directing that the reasons for the rejection must be conveyed to the borrower, the Supreme Court has clarified that the communication to the borrower giving the reasons for not accepting the objections of the borrower does not give an occasion to resort to any proceedings, such as a stay application, injunction, any other type of suit to restrain the creditor's actions. After this ruling, there has been an amendment to the Act. Now, Section 13(3A) says that if the borrower on receipt of the notice under Section 13(2) from the secured creditor makes any representation or raises any objection, the secured creditor has to consider the representation or the objection and, if it is not tenable or acceptable it has to be communicated within one week to the borrower. The borrower has to be communicated the reasons for non-acceptance of the representation or the objections. However, such communication or reasons mentioned therein by the secured creditor or the likely action as contemplated does not confer any right upon the borrower to prefer an appeal to the DRT or to any Civil Court. 5. If the borrower does not pay in full as per the notice such non-payment by the borrower gives the secured creditor right to take recourse to one or more of the following measures to recover his secured debt: (i) Take possession of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale for the realisation of money from the secured asset. This right can be exercised only when a substantial part of the business of the borrower is held as security for the debt. (ii) Takeover the management of the secured asset of the borrower including the right to transfer by way of lease, assignment or sale and realise the secured asset. (iii) Appoint any person as manager to manage the security assets the possession of which has been taken over by the secured creditor. (iv) Require at any time, by giving a notice in writing, any person who has acquired the secured asset from the borrower and from whom any money is due or may become due to the borrower, to pay to the secured creditor. Such demands from the other person will be to the extent of secured debt. If such other person pays any amount to the secured creditor the person so paying gets a valid discharge as if he has made payment to the borrower. 6. Any transfer of secured asset effected by the secured creditor as provided under this Act, shall vest in the transferee all rights in, or in relation to, the secured asset as if the transfer has been made by the owner of such a secured asset. 7. When sale of the secured asset is made the appropriation of sale proceeds realised are required to be made in the following order:

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(i) Firstly, towards costs, charges and expenses incidental towards preservation and protection of securities, insurance premiums, etc., that are recoverable from the borrower. (ii) Secondly, towards the due of the secured creditors. (iii) Thirdly, if there is any surplus it will be paid to the person entitled thereto, in accordance with the right and interests. The above stated order of payment thus gives the right of secured creditors to realise their securities in preference to all other creditors and even the other preferential payments like the dues payable to the Government labour, etc. If the borrower pays the entire dues, costs charges and expenses incurred by the creditor at any time before the date fixed for sale or transfer, the secured creditor shall not sell or transfer the secured asset and no further steps shall be taken for sale or transfer. In cases of joint finance or consortium finance by two or more secured creditors no secured creditor can take any action of taking possession of secured asset, unless exercise of such right is agreed upon by the secured creditors representing not less than three-fourths in value of the outstanding dues on the record date. The 'outstanding amount' shall include principal, interest and any other dues payable by the borrower to the secured creditors in respect of secured asset as per the books of account of the secured creditors. The 'record date' means the date agreed upon by the secured creditors representing not less than three-fourths in value, of the amount outstanding on such date. Any decision taken by such creditors is then binding on all other remaining creditors. In case the borrower is a company under winding up process, the dues payable to the workmen have pari passu charge with the secured creditors as provided in Sections 529 and 529A of the Companies Act. This is the exception for the priorities the secured creditor otherwise gets when he initiates recovery actions under the SARFAESI Act. The dues of the workmen are required to be deposited from the realised amount with the liquidator. In case the dues are not ascertained or ascertainable at such a time, then the liquidator has to give an estimated amount to be deposited. The liabilities of the secured creditor to payout of the realised amount from the secured asset is not finished due to the payment of the estimated amount but the balance amount on finalisation is required to be paid. If after the sale of the secured asset the entire dues of the secured creditors are not recovered and still there is due balance then the secured creditor can file an application before DRT or a civil suit in a competent Civil Court. Depending on the amount to be recovered the pecuniary jurisdiction will be decided. Apart from the security assets, many times the secured creditor may be holding security by way of pledge of any moveable or guarantee of any person for the due repayment of the loan amount. In such cases, secured creditors are entitled to sell the pledged goods or proceed against the guarantor to recover the defaulted loan without initiating any actions against the security asset. Thus, the right against security under the SARFAESI Act and the one against the pledged security and proceeding against guarantor are kept separate and distinct. The SARFAESI Act has given different rights to the secured creditor. The rights of a secured creditor under the Act may be exercised by one or more of its officers authorised in this behalf in such manner as may be prescribed. As the powers of enforcing securities need to be exercised prudently, fairly, and with due care and caution the Rules framed under the SARFAESI Act provide that the authorised officer should be of the level equivalent to a Chief Manager of a public sector bank or equivalent or any other authorised person exercising powers of superintendence, direction and control of the business or affairs of the creditors, as the case may be.

8.

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12. When the borrower receives the notice from the creditor under Section 13(2), the borrower shall not transfer by way of sale, lease or otherwise, other than in the ordinary course of business, any of his secured assets referred to in the notice without prior written consent of the secured creditor. Non-compliance with this provision attracts penal provisions under the SARFAESI Act that provide for punishment of imprisonment of one year or fine or both. 13. The provision of Section 13 at different sub-sections gives power to the secured creditor for taking the security into possession and then sell the same. This entire process involves several factors of fairness and technicalities. Therefore, the Rules framed under the SARFAESI Act, have laid down certain procedural aspects in this connection. Some broad procedures and precautions as per the Rules are as under: (i) Inventory of the property taken into possession be made and the property must be entrusted to any person authorised or appointed by the secured creditor, (ii) The secured creditor shall take care of the property under his possession as an owner of ordinary prudence, preserve and protect the secured assets and insure the same if necessary until they are sold, (iii) If the property is subject to speedy or natural decay or the expense of keeping such property in custody is likely to exceed its value, then the authorised officer can sell it at once, (iv) For taking of possession and then sale of immoveable property, the secured creditor is required to serve a possession notice as nearly as possible as given in Appendix IV to the Rules on the borrower and by affixing the possession notice on the outer door or at a conspicuous place at the property, (v) The authorised officer is required to obtain a valuation of the immoveable property before sale, fix the reserve price after consulting the secured creditor and sell it by methods permitted under Rule 8. (vi) The authorised officer is required to publish the possession notice in two leading newspapers, one of which should be in the local vernacular language, (vii) Thirty days before sale of the immoveable property, the borrower should be given a notice about the sale. If the sale is by public auction or by inviting tenders from the public, notice is required to be published in two leading newspapers, one of which should be in the local vernacular language, detailing the terms of sale, (viii) If the price for the secured asset is coming to less than the reserve price, the authorised officer can sell the asset at a lower price with the consent of the borrower and secured creditor, (ix) When the offer of sale of property is accepted by the purchaser and the secured creditor accepting the offer confirms the sale, the purchaser has to deposit twenty-five per cent of the offer price, (x) In case of immoveable property, the purchaser has to deposit the amount required to clear the encumbrance. The authorised officer then has to pay and remove the encumbrance after giving notice to the concerned parties. 14. The authorised officer is authorised to issue the sale certificate. Such a certificate is conveyance of immoveable property and requires stamping, as may be required under the relevant State laws.

23.3 CHIEF METROPOLITAN MAGISTRATE OR DISTRICT MAGISTRATE'S ASSISTANCE FOR TAKING POSSESSION OF SECURED ASSET
1. When the secured creditor is required to take possession or control of the secured asset or when the secured asset is required to be sold or transferred under the provisions of the SARFAESI Act,

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the secured creditor can take the help of the Chief Metropolitan Magistrate or the District Magistrate. For seeking such help the secured creditor has to make a request in writing to the said authority within whose jurisdiction the secured asset or documents related to it are situated. 2. On such request being made the Chief Metropolitan Magistrate or the District Magistrate, as the case may be, shall take possession of the security asset and documents relating thereto. For compliance of the provisions of the Act as stated above, the Metropolitan Magistrate or the District Magistrate may take or cause to be taken such steps and use or cause to be used such force as may be in his opinion necessary. Any act of the Metropolitan Magistrate or the District Magistrate for and while taking possession of the security shall not be called in question in any Court or before any authority. A very important aspect of these provisions is that the powers of taking possession, or causing the same, are given to the judicial authority, who will take the possession and hand it over to the secured creditor. 23.4 MANNER AND EFFECT OF TAKE OVER OF MANAGEMENT 1. When the secured creditor takes over the management of business of a borrower, he may publish a notice in a newspaper published in the English language and in a newspaper published in an Indian language in circulation in the place where the principal office of the borrower is situated, for appointment of: (i) If the borrower is a company as defined in the Companies Act, 1956, to be the directors of such company, or (ii) In any other case, to be the administrator of the business of borrower. 2. On publication of such a notice, the directors of the company, in case the borrower is a company and in other cases, the person holding any office having power of superintendence, direction and control of the business of the borrower immediately before the publication of the notice, shall be deemed to have vacated their offices. As an effect of this, any management contract between the borrower and any directors or manager thereof shall be deemed to be terminated. 3. On publication of the above said notice and then after the appointments of directors or the administrators as stated above, all the property and effects of the business of borrower are deemed to be in the custody of the directors or the administrators so appointed, as the case may be. All the directors or the administrators are empowered to take such steps as may be necessary to take into their custody or under their control all the property, effect and actionable claims to which the borrower is entitled. Thereafter, the directors or the administrators are alone entitled to exercise all the powers of superintendence, direction and control of the business of the borrower. Such powers are derived as if from the memorandum or articles of association of the company or from any other source whatsoever. 4. Where the management of the business of a borrower which is a company as defined in the Companies Act, 1956, is taken ever by the secured creditor, then, notwithstanding anything contained in the Companies Act, 1956 or the memorandum or in the articles of association following effects apply: (i) The shareholders of the company can lawfully appoint any person to be a director of the company, (ii) No resolution passed by the shareholders of the company shall be given effect to, unless approved by the secured creditor, (iii) No proceeding for the winding up of such company or for the appointment of a receiver for the company shall lie in any Court, except with the consent of the secured creditor.

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5. Where the management of the business of a borrower has been taken over by 'the secured creditor', on realisation of the debt in full the secured creditor shall restore the management of the business of the borrower to him. 23.5 NO COMPENSATION TO DIRECTORS FOR LOSS OF OFFICE No managing director or director or any person in charge of management of the business of the borrower shall be entitled to any compensation for the loss of office or for premature termination of any contract of management, entered into by him with the borrower. This provision has an overriding effect over any other laws or contract. However, if any director or any other person controlling the management has to recover any amount from borrower, it can be recovered. 23.6 RIGHT TO PREFER APPLICATION TO DRT 1. Any person, including the borrower, aggrieved by any of the measures taken by the secured creditor or his authorised officer for taking possession of the security may make an application along with the prescribed fees, to the Debts Recovery Tribunal having jurisdiction within fortyfive days from the date on which such measures are taken. There can be different prescribed fees for the borrower's application and the application from other than the borrower. The right to file an application is provided not only to the borrower but also to any person aggrieved by the action taken by the secured creditor. 2. The Debts Recovery Tribunal has to dispose of the application, in accordance with the provisions of the recovery of debts due to Banks and Financial Institutions Act, 1993 and the Rules made thereunder. The application has to be disposed as early as possible, but within sixty days. If for any reason it is not possible to so dispose the application, the Tribunal has to record the reasons for delay, but such delay should not be beyond four months from the date of filing of the application. If any such application is not disposed within four months, the aggrieved party can prefer an application to the Appellate Tribunal for seeking directions for the early disposal of the application.

23.7 APPEAL TO APPELLATE AUTHORITY


Any person aggrieved by any order made by the debts recovery tribunal can prefer an appeal along with the prescribed fees to the Appellate Tribunal within thirty days from the date of receipt of the order of debts recovery tribunal. There can be different fees prescribed for the borrower's appeal and an appeal by anyone other than the borrower. The amendments to the Act made in November 2004 have now stipulated that no appeal can lie unless the borrower deposits fifty per cent of the debt claimed by the secured creditor. The tribunal has powers for reasons to be recorded, to reduce this amount to twentyfive per cent of the claim amount. 23.8 RIGHT OF THE BORROWER FOR COMPENSATION AND COSTS 1. If the debt recovery tribunal or the appellate tribunal, as the case may be (i) holds that the possession of secured asset by the secured creditor is not in accordance with the provisions of the Acts or Rules framed thereunder and (ii) directs the secured creditor to return the secured asset to the borrower, then such borrower shall be entitled to payment of such compensation and costs as may be determined by the tribunal or the appellate tribunal.

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2. No pecuniary limit is fixed by the Act for the appellate jurisdiction. The jurisdiction of the DRT is Rs. 10 lakh and above under the Recovery of Debts due to Banks and Financial Institutions Act, 1993. However, the SARFAESI Act does not provide any pecuniary limit. Therefore, appeal before the DRT against the actions initiated by the secured creditors in cases even below Rs. 10 lakh would lie. 23.9 LET US SUM UP In this chapter, we have seen the details about enforcement of securities by banks and financial institutions and the procedural requirements thereof. We have discussed how, on default being committed by the borrower, the creditor can enforce the securities as per provisions of the Act. For this no Court intervention is required as earlier. The service of notice calling for payment and on failing to pay, the creditor can invoke the provisions for the take over of the asset/management. After the notice, transfer by the borrower is prohibited. The reply to the notice needs consideration on lines with Supreme Court directions as in Mardia case. Creditor can also call for payment due to the borrower from a third party. For the remaining dues after sale of assets, the remedy at Civil Court or DRT are open as per jurisdiction. For initiating various actions under the Act there is need of an authorised person. While taking possession of the asset, various precautions are required to be taken. For talcing possession, help of the Chief Metropolitan Magistrate or District Magistrate can be taken. In such an event the possession is taken by such authorities and handed over to the creditor. Against the possession notice, appeal can be made but on payment of the amount as prescribed. If possession is wrongfully taken, the creditor has to pay compensation to the borrower. For appeal to the tribunal fifty per cent of the debt amount is required to be deposited. 23.10 KEYWORDS Enforcement of Security; Notice for Default; Contents; Take Over Management; Payment in Hands of Third Party; Consortium/Joint Finance; Payment of Labour; Pari Passu; Independent Remedy. 23.11 CHECK YOUR PROGRESS 1. Asset reconstruction means _____ by any securitisation company or reconstruction company of any right or interest of the creditor in any 2. SARFAESI Act is applicable to the Regional Rural Banks. (True/False) 3. Mortgage or asset backed debt instruments can be issued by the securitisation company or reconstruction company to the general public. (True/False) 4. A guarantor to the loan is within the meaning of the word borrower under SARFAESI Act. (True/False) 5. SARFAESI Act is applicable only when there is security. (True/False) 6. Has SARFAESI Act defined hypothecation and whether the Act is applicable to hypothecation security? (True/False) 23.12 ANSWERS TO CHECK YOUR PROGRESS' 1. acquisition, financial assistance; 2. False; 3. False; 4. True; 5. True; 6. True 23.13 MULTIPLE CHOICE TERMINAL QUESTIONS 1. On giving of a default notice by the creditor, the borrower gives a reply to it. What should the creditor do?

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)RTis is Act, before )lakh (a) Ignore the notice as the law does not provide for any reply option to the bank. (b) Wait until the borrower initiates any legal action based on his reply. (c) Give due consideration to the reply as per the guidelines issued in the Mardia Chemical case by the Supreme Court and reply to it. (d) Take the matter before DRT for resolving issues raised in the reply. 2. On sale of the security asset, the sale proceeds are appropriated firstly. (a) Towards the satisfaction of dues of secured creditor. (b) Towards the payment of dues of labour. (c) Towards payment of cost, charges and expenses for the preservation and protection of securities, insurance premiums, etc. (d) Towards payment of legal costs incurred by the creditor for taking possession and for effecting sale. Ans. 1. (c); 2. (c).

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CENTRAL REGISTRY

STRUCTURE
24.0 24.1 24.2 24.3 24.4 24.5 24.6 24.7 24.8 24.9 24.10 24.11 24.12 24.13 Objectives Introduction Central Registry Central Registrar Register of Securitisation, Reconstruction and Security Interest Transactions Filing of Transactions of Securitisation, Reconstruction and Creation of Security Interest Modification of Security Interest Registered Satisfaction of Security Interest Right to Inspect Particulars of Securitisation, Reconstruction of Security Interest Transactions Let Us Sum Up Keyword Check Your Progress Answers to 'Check Your Progress' Multiple Choice Terminal Questions

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24.0 OBJECTIVES The SARFAESI Act has brought in a new concept of security and the enforcement of security. For a proper noting and registering of the charges created in favour of the secured creditors against the properties that would eventually be enforced, the charges created need to be noted with authority. It is like the charges noted with the Registrar of Companies in case of charges created against the property of the Company. This unit deals with the central registry created under the SARFAESI Act. 24.1 INTRODUCTION The creation of a security interest in property has gained importance and significance with the provisions of the SARFAESI Act. It has given various powers to the creditor. The securitisation and reconstruction companies will be carrying on transactions of a different nature in accordance with the provisions of the Act. Therefore, both of these need an authentic registration. In this unit, we will see about the central registry with whom the transactions above and the creation of charges over security will be required to be registered. In this unit, we will see the provisions about the same. 24.2 CENTRAL REGISTRY 1. The Central Government is authorised to set up or cause to be set up a 'Central Registry' by issue of notification from such date as may be specified in the notification for the purpose of registration of following transactions: (i) Securitisation and reconstruction of financial assets (ii) Creation of security interest under the SARFAESI Act. Maintaining the records of the 'Registry' on computers is permissible under the Act. The Government can also establish branch offices at other places. The Government has the authority to decide the territorial jurisdiction of these offices for the purpose of registration. 2. There are some other Acts which require registration of certain things and charges. These Acts are: (i) Registration Act, 1908 (ii) Companies Act, 1956 (iii) Merchant Shipping Act, 1958 (iv) Patents Act, 1970 (v) Designs Act, 2000 (vi) Motor Vehicles Act, 1988 The registration contemplated before the central registry is in addition to the respective registrations contemplated under the above stated six Acts or any other Act. Thus, the registration under SARFAESI Act is not in substitution of the other registrations required under different laws. This is obvious because the purpose and effect and consequence of registration are different under different respective Acts. The registration under different laws will have priority of charge depending on the provisions of respective registration laws. 24.3 CENTRAL REGISTRAR The Central Government has to appoint by notification a person as central registrar for the purpose of registration contemplated under the Act. The Central Government is also empowered to appoint such other officers with such designations as it thinks fit for the purpose of discharging various duties for registrations under the Act. 24.4 REGISTER OF SECURITISATION, RECONSTRUCTION AND SECURITY INTEREST TRANSACTIONS A record shall be maintained at the central registrar at the head office of the central registrar in which transactions relating to

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(i) Securitisation of financial assets, (ii) Reconstruction of financial assets, (iii) Creation of security interests shall be maintained. The record of central registrar can be kept fully or partly on computer, floppies, diskettes, or any other electronic form. Any entry made with the central registrar shall be a reference to any such transaction. The central registrar shall have the control and management of the central register.

24.5 FILING OF TRANSACTIONS OF SECURITISATIQN, RECONSTRUCTION AND CREATION OF SECURITY INTEREST


Under the SARFAESI Act, now filing of details of transactions of securitisation, reconstruction and the creation of security interest is required to be filed with the central registrar. The period of filing such details in proper form as may be prescribed, is thirty days after the date of transaction or the creation of security. The central registrar has to prescribe fees for such filing. The particulars are required to be filed as stated above by the securitisation company or the reconstruction company or the secured creditor, as the case may be. The delay in filing the said particulars can be condoned by the central registrar for a period of next thirty days after the first thirty days prescribed, on payment of fees not more than ten times of the prescribed fees.

24.6 MODIFICATION OF SECURITY INTEREST REGISTERED


Whenever any security interest is registered with the central registrar is modified, the modification is required to be filed before central registrar. It is the duty of the securitisation or the reconstruction company or the secured creditor to file the modification. For filing the modification same provisions as are made for registration of charge apply. This means, modification will have to be filed within thirty days in the prescribed forms with prescribed fees. Delay condonation will be for a period of next thirty days on payment of fees not more than ten times of the prescribed fees.

24.7 SATISFACTION OF SECURITY INTEREST


1. The security interest registered with the central registrar is required to be satisfied on the payment of full amount by the borrower. The duty to report satisfaction is on the securitisation or reconstruction company or the secured creditor, as the case may be. The reporting is required to be done within thirty days of payment in full or satisfaction of the charge. 2. On receipt of the satisfaction of the charge the central registrar is required to cause a notice to be issued to the securitisation or reconstruction company or the secured creditor, calling upon to show cause within a time not exceeding fourteen days as to why the payment or satisfaction should not be recorded as intimated. If no cause is shown then the central registrar has to order that a memorandum of satisfaction shall be entered in the central register. If any cause is shown the central registrar shall record a note to that effect in the central register and shall inform to the borrower about it.

24.8 RIGHT TO INSPECT PARTICULARS OF SECURITISATION, RECONSTRUCTION OF SECURITY INTEREST TRANSACTIONS


The particulars of securitisation or reconstruction or security interest entered in the central register are open for inspection by any person during office hours on payment of fees as may be prescribed. Same is applicable if the data is kept in the electronic form at the office of the central registrar.
L.K.A.B-17

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24.9 LET US SUM UP Central Government has to set up or cause to set up central registry for registration of securitisation and reconstruction transaction and creation of security interest. Registration under other applicable laws will continue. All transactions and creation of security interest needs to be noted. Modification and satisfaction also needs noting in prescribed form with payment of fees. 24.10 KEYWORD Central Registry. 24.11 CHECK YOUR PROGRESS 1. After coming into operation, the provisions relating to central registry the banks and financial institutes will have to register all security interests created in the asset. (True/False) 2. The period stipulated in the Act for filing details of security interest is __________ days. 3. Duty to report satisfaction of charge to the central registrar is on creditor or on the borrower? 24.12 ANSWERS TO 'CHECK YOUR PROGRESS' 1. True; 2. 30; 3. Creditor. 24.13 MULTIPLE CHOICE TERMINAL QUESTIONS 1. Besides the SARFAESI Act, some other laws require some registration of charge created in the property. Is such double registration avoidable? (a) Yes, the creditor can choose under which law he needs registration. (b) No, registration under the SARFAESI Act as well as any other applicable law will have to be made as the SARFAESI Act is not substitution of any other law. (c) Yes, if one charge noting is by a registered document. (d) No, as the Civil Courts and DRT still have jurisdiction against the properties both registrations are required. Ans. 1. (b)

tion ible and

OFFENCES AND PENALTIES

STRUCTURE rial 25.0 25.1 25.2 25.3 25.4 25.5 25.6 25.7 25.8 25.9 25.10 Objectives Introduction Penalties Penalties for Non-compliance of Directions of Reserve Bank of India Offences Cognisance of Offences Let Us Sum Up Keyword Check Your Progress Answers to 'Check Your Progress' Multiple Choice Terminal Questions

the )be

ons

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25.0 OBJECTIVE The objective of this unit is to know the penal provision of the Act. For effective implementation of the law and as a deterrent step to prevent improper actions by parties concerned penal provisions are kept in laws. 25.1 INTRODUCTION The Act has given many statutory obligations. If anything said in the law is not acted upon or is not followed there is a breach of the legal provisions. So there are penalties provided in the Act. In this chapter, we will see about the offences and penalties. It also gives details about which Court should be dealt with for imposition of penalty for breach of provisions of the Act. 25.2 PENALTIES Section 23 of the Act provides for filing of the particulars of charge created. Section 24 has provides for modification of the charge filed and the Section 25 has provides that the satisfaction of the charge has to be intimated to the central registrar. If the securitisation or reconstruction company or the secured creditor fails to perform any of the duties as stated above, the company and the officers concerned for the default, as per provisions of this section, are punishable with a fine that may extend to five thousand rupees for each day during which the default continues. 25.3 PENALTIES FOR NON-COMPLIANCE OF DIRECTIONS OF RESERVE BANK OF INDIA Under the Section 12 of the SARFAESI Act, the Reserve Bank of India is statutorily empowered to issue directions to the securitisation or reconstruction company. If any such company fails to comply with any of the directions issued by the Reserve Bank of India, then such company is punishable with a fine not exceeding Rs. 5 lakh for the default. In case of further continuation of the offence, an additional fine up to Rs. 10,000 per day of the default can be imposed. 25.4 OFFENCES If any person: 1. contravenes, or 2. attempts to contravene, or 3. abets the contravention of the provisions of the SARFAESI Act or rules made thereunder, he shall be punishable with imprisonment for a term, which may extend to one year or with a fine or both. The Act has made various provisions where duties are cast on the borrower, the secured creditor, the securitisation and the reconstruction company. Any contravention of these provisions is punishable as stated above under the provisions of this section. 25.5 COGNISANCE OF OFFENCES Section 30 provides that cognisance of the offence under the SARFAESI Act shall be taken by the Metropolitan Magistrate or the Judicial Magistrate of First Class only. No Court below rank than this can take cognisance of such offences.

25.6 LET US SUM UP If the charges created, modified and satisfied are not intimated to the central registrar it is an offence. The securitisation company or the reconstruction company is required to perform various duties under the Act. Breach thereof is also an offence. The punishments are up to Rs. 5,000 for each day of default. Breach of RBI directives is also punishable by a fine up to Rs. 5 lakh and Rs. 10,000 for continuation per day. Any general infringement of provisions of SARFAESI Act is punishable with imprisonment for one year or fine or both. 25.7 KEYWORDS Offences for Breach. 25.8 CHECK YOUR PROGRESS 1. Is there any punishment provided in the Act for not following RBI directions? (Yes/No) 2. Can the Honorary Magistrate take cognisance of offence under the SARFAESI Act?

25.9 ANSWERS TO 'CHECK YOUR PROGRESS'


1. Yes; 2. No
25.10 MULTIPLE CHOICE TERMINAL QUESTIONS 1. Whether breach of RBI directives is punishable offence and to what extent? (a) Yes, a fine up to Rs. 5 lakh and for continuation of offence a fine of up to Rs. 10,000 per day. (b) Yes, by cancellation of licences of the company. (c) No, these are the administrative directions. (d) No, the Act has not provided for any punishment in specific. Ans. 1. (a)

MISCELLANEOUS PROVISIONS

STRUCTURE 26.0 26.1 26.2 26.3 26.4 26.5 26.6 26.7 26.8 26.9 26.10 26.11 26.12 26.13 26.14 Objective Introduction Non-Applicability of the Provisions of the SARFAESI Act in Certain Cases Protection of Action Taken in Good Faith Offences by Companies Civil Court not to have Jurisdiction Overriding Effect on Other Laws Limitation Power of the Central Government to Make Rules Certain Provisions of the Act to Apply after Central Registry is Set Up or Cause to be Set Up Amendments to Certain Other Enactments Let Us Sum Up Check Your Progress Answers to 'Check Your Progress' Multiple Choice Terminal Questions

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26.0 OBJECTIVE The objective of this unit is to understand the exceptions of securities to which this Act is not applicable. At the same time, the person or the organisation utilising the provisions and powers given under this Act should know about the legal protections the Act has given when it is implemented properly and in good faith. At the same time, if any of the provisions are not followed, then it has penal provisions also. 26.1 INTRODUCTION In this unit, we will see some miscellaneous provisions about implementation of the Act. Section 31 gives some exclusions of securities to which the Act is not applicable. For creditor it is important to note these exclusions. The Act has given many strict powers to take possession of security, change of management, etc. These require some hard steps to be taken. So the person exercising the rights under the Act needs a legal protection. Section 32 gives such protection for action taken in good faith under the Act. Similarly, to curb the tendency of the borrowers to go to Civil Court or any other authority and bring injunctions, stay, orders for status quo, etc., the Act has barred the jurisdiction of Civil Court as well as other authorities for the matters covered by this Act. The unit also deals with offences, limitation period for actions, overriding effect on other laws, Central Government powers to make rules and some such provisions for effective implementation of the Act. 26.2 NON-APPLICABILITY OF THE PROVISIONS OF THE SARFAESI ACT IN CERTAIN CASES The object of the SARFAESI Act is to give powers to the banks and financial institutions to enforce the securities given to the loans and advances by the borrowers without the intervention of the Court. It should be noted that the securities not in possession of the bank or financial institution are only covered by this Act. The securities in possession of the secured creditors are not covered by this Act and provisions of the Act are not applicable to them. Therefore, the Section 31 gives the exclusions for securities that can be taken possession of and to some other specific securities to which the Act is not applicable. These exclusions, to which the provisions of the Act are not applicable, are (i) A lien, on any goods, money or security given by or under the Indian Contract Act, 1872 or the Sale of Goods Act, 1930 or any other law for the time being in force. (ii) A pledge of movable, within the meaning of Section 172 of the Indian Contract Act, 1872. (iii) Creation of security interest in any vessel as defined within the meaning of Section 3(55) of the Merchant Shipping Act, 1958. (iv) Creation of security in any aircraft as defined in Section 2 of Aircraft Act 1934. (v) Any conditional sale, hire-purchase or lease or any other contract in which no security interest has been created. (vi) Any rights of unpaid seller under Section 47 of the Sale of Goods Act, 1930. (vii) Any properties not liable for attachment or sale under the first proviso to Section 60(1) of the Civil Procedure Code, 1908. (viii) Any security interest for securing repayment of any financial asset not exceeding one lakh rupees, (ix) Any security interest created in agricultural land, (x) Any case, in which the amount due is less than twenty per cent of the principal amount and interest thereunder. 26.3 PROTECTION OF ACTION TAKEN IN GOOD FAITH The secured creditors and their officers are protected for actions taken in good faith by the provisions made in the Act. For initiating actions under the Act no suit, prosecution or any other legal proceeding

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can be taken against the secured creditor or his officers. This protection is given so that actions contemplated and authorised under SARFAESI Act, can be taken without fear of counteraction from the borrower or any other person having interest in the property. 26.4 OFFENCES BY COMPANIES 1. If a company and its officers commit any offence under the provisions of the SARFAESI Act the same is punishable. There are provisions in the Act that cast some statutory obligations. If these statutory obligations are not observed then there is contravention of the Act which amounts to offence. If any offence is committed under the provisions of this Act by a company, such company, as well as any person who is in charge of the business of the company, are deemed to be guilty of the offence and they are liable to be prosecuted and punished. It is permissible for a person acting for the company to prove that the offence was committed without his knowledge or that he had exercised due diligence to prevent the commission of such offence. In such cases and on proving his stand the person concerned shall not be punishable. If such offence is committed with the consent or connivance of any director or officer of the company, such director or officer shall be deemed to be guilty for the offences along with the company. 2. The penal provisions are applicable to all categories of borrowers such as individuals, partnership firms, companies incorporated under the Companies Act or any other association of individuals. The Act has clarified, that company includes a partnership firm or other association of individuals and the expression director includes a partner of a firm. 26.5 CIVIL COURT NOT TO HAVE JURISDICTION 1. The SARFAESI Act has conferred jurisdiction on many matters to the debts recovery tribunal or the appellate tribunal. Therefore, for any such matters where empowerment and jurisdiction is to the debts recovery tribunal or the appellate tribunal, no Civil Court shall have jurisdiction to entertain any suit or proceedings. Similarly, any Court or authority cannot grant injunction in such matters and actions taken, or to be taken, under this Act as well as under Recovery of Debts Due to Banks and Financial Institutions Act, 1993. Due to such provisions the implementation of the Act becomes effective. 26.6 OVERRIDING EFFECT ON OTHER LAWS The provision of this Act has overriding effect on any other laws if the provisions in the other law are inconsistence with this Act. If for any particular point, the provisions of this Act and in some other Act are inconsistent with each other, a question will come as to which provisions are to be followed, when both such Acts are applicable to that particular point. The Act, therefore, provides that the provisions of the SARFAESI Act will have overriding effect on the other Act. Mainly, such inconsistencies are in the Transfer of Property Act and the Registration Act. The provisions the SARFAESI Act will apply, overriding the provisions in those Acts. 26.7 LIMITATION The actions that secured creditor can take against the security under the SARFAESI Act are required to be taken within the limitation as per Section 36 of the Limitation Act. That means, the action has to be taken within three years from the date on which the cause of action arose. Due to the provisions of this section, all secured creditors are required to take measures such as taking possession of the securities, provided their claim is within the period of limitation. It will be necessary

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for the banks and financial institutions to comply with the limitation aspect. If after sale of securities the claim is not fully satisfied and still there are any dues to be recovered from the borrower, the creditor is required to file civil suit before the Civil Court or a claim before the debt recovery tribunal within the limitation period. Therefore, the secured creditor will have to make an assessment, before taking possession of the security, whether it would be possible to sell the security and make an eventual claim for shortfall within the limitation period.

26.8 POWER OF CENTRAL GOVERNMENT TO MAKE RULES


1. For carrying out the provisions of this Act, the Central Government can frame rules and notify them in the Official Gazette. The Act also allows the Government to notify the rules in the Electronic Gazette as defined in the Information Technology Act, 2000, i.e. on the website of the Government. 2. Whenever the Government makes a rule under the Act, the rule is so required to be kept before each House of Parliament, while in session for a total period of thirty days. Both the Houses should agree to the rules as framed and they can make modifications therein or decide not to make the rules. The rule gets the validity in the manner as decided by both the Houses. If already made rules are modified or cancelled, then any act done under the then existing rule does not get vitiated or modified in any way. 26.9 CERTAIN PROVISIONS OF THE ACT TO APPLY AFTER CENTRAL REGISTRY IS SET UP OR CAUSE TO BE SET UP The provisions contained in sub-Sections (2) to (4) of Sections 20 and 21 to 27 that provide for registration of the security interest created, satisfaction of charge, etc., are applicable only after the central registry is set up or caused to be set up by the Central Government. 26.10 AMENDMENTS TO CERTAIN OTHER ENACTMENTS For effective purpose of this Act, it has amended some related provisions of the Companies Act, 1956, The Securities Contracts (Regulation) Act, 1956 and The Sick Industrial Companies (Special Provisions) Act, 1985. The amendments are as under: 1. Section 4A of the Companies Act, 1956 is amended for the purpose of declaring any securitisation company or reconstruction company registered with the Reserve Bank of India as a Public Financial Institution within the meaning of Section 4A of the Companies Act, 1956. 2. The Securities Contracts (Regulation) Act, 1956 is amended at Clause (h) of Section (2 )for including security receipt as defined in Clause (zg) of Section 2 of the SARFAESI Act. 3. Amendment to The Sick Industrial Companies (Special Provisions) Act, 1985 is made to provide that (i) no reference to the Board for Industrial and Financial Reconstruction (BIFR) shall lie, where financial assets are acquired by any securitisation company or reconstruction company under sub-Section 5 of the SARFAESI Act, and (ii) for the purpose of providing that a reference pending before BIFR shall abate if the secured creditors, representing not less than three-fourths in value of the amount outstanding, take any measures to recover their secured debt under sub-Section (4) of Section 13 of SARFAESI Act.

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26.11 LET US SUM UP The Act is applicable to securities not in possession of the creditors. We have seen a list of securities to which the Act is not applicable. Contravention of the provisions of the Act is punishable. Act has dealt with the situations for offences committed by individuals, partnerships and a company. By debarring Civil Court or any other authority for jurisdiction for giving injunction, etc., the implementation of the Act is made effective by removing legal hindrance, which otherwise the borrower can bring. We have also seen how and when the Act has an overriding effect. The Act has provided that the provisions of the Limitation Act are applicable for the actions under this Act also. The Central Government has powers to make rules for procedural implementation of the Act. The central registry is not yet formed and the provisions relating to the registrations required under Sections 21 to 27 are not yet made applicable. The chapter also has dealt with the powers of the Central Government to remove difficulties that may arise while giving effect to the provisions of the Act and about the amendments made in the other Acts by this Act. 26.12 CHECK YOUR PROGRESS 1. For challenging an action initiated by secured creditor against the defaulting borrower under the SARFAESI Act, the borrower can go to the Civil Court for an injunction. (True/False) 2. Can the bank take action under SARFAESI Act against a deposit under lien with it? (Yes/No) 3. Are hire-purchase and lease contracts covered under SARFAESI Act? (Yes/No) 4. After the bank's notice a defaulting borrower has paid within sixty days a substantial amount and the present dues are Rs. fifteen lakh which is fifteen per cent of the claimed amount. Can bank proceed to take possession of the security? (Yes/No) 5. If on some point the provisions of the Transfer of Property Act and the SARFAESI Act are different, which Act will prevail? 6. Can a bank proceed to take possession of the security after four years of cause of action? (Yes/No) 26.13 ANSWERS TO 'CHECK YOUR PROGRESS' 1. False; 2. No; 3. No; 4. No; 5. SARFAESI Act; 6. No 26.14 MULTIPLE CHOICE TERMINAL QUESTIONS 1. Provisions of the SARFAESI Act are applicable to which of the following? (a) Pledged goods. (b) Only mortgaged properties. (c) Securities that are not otherwise charged to the creditors. (d) Securities charged to creditors and not in possession of the creditor. 2. When the rules, framed by the Central Government, under the Act get validity? (a) After the appellate tribunal of DRT approves them. (b) On Supreme Court approving the same. (c) Immediately on framing of the rules by the Government and notifying the same. (d) When both the Houses of Parliament approve the Rule so framed. Ans. 1. (d); 2. (d)

THE BANKING OMBUDSMAN SCHEME, 2006: PURPOSE, EXTENT, DEFINITIONS, ESTABLISHMENT AND POWERS
STRUCTURE 27.0 27.1 27.2 27.3 27.4 27.5 27.6 27.7 27.8 27.9 27.10 27.11 27.12 Objective Introduction Object of Scheme and Extent Definitions Appointment and tenure Territorial Jurisdiction and Location of Office Secretariat General Powers of Banking Ombudsman LetUsSumUp Keywords Check Your Progress Answers to 'Check Your Progress' Multiple Choice Terminal Questions

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27.0 OBJECTIVE The objective of this unit is to understand the purpose of introduction of the scheme, viz., 'The Banking Ombudsman Scheme 2006, various words and the terms used in the scheme and how the appointment of banking ombudsman is done, its establishment and powers. 27.1 INTRODUCTION In this unit, we will see the definitions of the words used in the scheme. The definitions are important, as they have an assigned meaning in the scheme and these words are used in the scheme in the context of definitions. If the definitions are well mastered, it is easy to understand the scheme. We will also see the provisions relating to establishment of office of banking ombudsman. The RBI decides his appointment and other terms of office, his secretariat, his powers, etc. The RBI also decides the territorial jurisdiction of the banking ombudsman. The scheme has come in force with effect from 1 January 2006. 27.2 OBJECT OF SCHEME AND EXTENT 1. The scheme was introduced with the following objectives: (i) To resolve complaints relating to banking services and to facilitate the satisfaction or settlement of such complaints, (ii) Resolve disputes between a bank and its constituents as well as amongst banks, through the process of conciliation, meditation and arbitration. 2. The scheme extends to the whole of India. It is applicable to the banks in India. The Reserve Bank has the authority to suspend the operation of the scheme fully or partly for such period as may be specified in the order. Such suspension, may be general or in relation to any specified bank. The period of suspension can be extended if deemed fit by the Reserve Bank. 27.3 DEFINITIONS 1. 'Award' means an award passed by the banking ombudsman in accordance with this scheme. 2. 'Appellate Authority' means the Deputy Governor in charge of the department of the RBI implementing the scheme. 3. 'Authorised Representative' means a person duly appointed and authorised by a complainant to act on his behalf and represent him before a banking ombudsman, for consideration of his complaint. 4. 'Banking Ombudsman' means any person appointed under Clause No. 4 of the scheme. 5. 'Bank' means, a banking company, and includes a corresponding new bank, a Regional Rural Bank, State Bank of India and its Subsidiary banks as defined in Part I of the Banking Regulation Act, 1949, and also includes a scheduled primary co-operative bank and included in the second Schedule to the RBI Act, 1934 having a place of business in India. 6. 'Complaint' means a representation in writing or through ELECTRONIC MEANS containing a grievance, alleging deficiency in banking service. 7. 'Settlement' means an agreement reached by the parties either by conciliation or mediation under the Scheme.

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27.4 APPOINTMENT AND TENURE The Reserve Bank may appoint one or more of its officers in the rank of Chief General Manager or General Manager to be known as the banking ombudsmen to carry out the functions entrusted to them by or under the scheme. This appointment may be made for a period not exceeding three years at a time. 27.5 TERRITORIAL JURISDICTION AND LOCATION OF OFFICE 1. The Reserve Bank shall specify the territorial limits to which the authority of each of the banking ombudsman shall extend. 2. The office of the banking ombudsman will be located at such places as may be specified by the Reserve Bank. 3. The banking ombudsman may hold sittings at such places within his area of jurisdiction as may be considered necessary and proper by him, in respect of a complaint or reference before him. 27.6 SECRETARIAT (i) The Reserve Bank shall depute such number of its officers and other staff to the office of the banking ombudsman as considered necessary to function as the secretariat of the banking ombudsman. (ii) The cost of the secretariat will be borne by the Reserve Bank. 27.7 GENERAL POWERS OF BANKING OMBUDSMAN The banking ombudsman shall have the following powers and duties: (a) to receive complaints relating to banking services (b) to consider such complaints relating to the deficiencies in the banking and other services and facilitate their satisfaction or settlement by agreement through conciliation and mediation between the bank and the aggrieved parties or by passing an award in accordance with the scheme. 27.8 LET US SUM UP The object of the scheme makes clear the purpose behind introduction of the scheme. We have seen the definitions of different words used in the scheme. The definition of words have importance as they are used in a particular context in the scheme. We have seen the provisions about appointment and tenure of banking ombudsman. The RBI is the authority for appointment and deciding terms of appointment, etc. RBI also decides the territorial jurisdiction of the banking ombudsman. We have seen about his powers and duties and how he has to deal with the complaint. 27.9 KEYWORDS Conciliation; Meditation. 27.10 CHECK YOUR PROGRESS 1. 2. 3. 4. Disputes amongst two banks can be taken up before the banking ombudsman. (True/False) Co-operative banks are not covered by the banking ombudsman scheme. (True/False) Banking ombudsman is appointed by a committee of Supreme Court Judges. (True/False) It is not within the powers of banking ombudsman to deal with the complaint unless both parties agree for his intervention. (True/False)

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27.11 ANSWERS TO CHECK YOUR PROGRESS' 1. True; 2. False; 3. False; 4. False 27.12 MULTIPLE CHOICE TERMINAL QUESTIONS 1. What is the object of introducing the banking ombudsman scheme, 2006? (a) For effective monitoring of the NPA accounts in the banks. (b) It is the RBI agency to regulate the disputes amongst the banks. (c) To enable resolution of complaints relating to banking services. (d) For executing the orders passed by the DRT. 2. Complaints relating to non-acceptance of small denomination notes by a bank, can be made to a banking ombudsman: (a) Such small denomination notes and coins to be deposited with the Reserve Bank. (b) They may be deposited with a bank having a currency chest facility. (c) Banking ombudsman can deal with the complaints under the scheme. (d) The complainant can seek no remedy at all through banking ombudsman, but has to approach the consumer disputes redressal machinery. 3. Complaints can be made against promises made by sales agents but not fulfilled by the bank represented by them under the banking ombudsman Scheme 2006? (a) No complaint is admissible as he is not the employee of the bank. (b) The sales agent has no authority to make any promise and hence the bank is not bound to fulfil them. (c) The banking ombudsman can entertain the complaint under the scheme. (d) Agency functions are outside the purview of the banking ombudsman scheme. Ans. 1. (c); 2. (c); 3. (c)

PROCEDURE FOR REDRESSAL OF GRIEVANCE

STRUCTURE
28.0 28.1 28.2 28.3 28.4 28.5 28.6 28.7 28.8 28.9 28.10 28.11 28.12 28.13 28.14 Objective Introduction Grounds of Complaint Procedure of Filing Complaint Power to Call for Information Settlement of Complaint by Agreement Award by the Banking Ombudsman Rejection of the Complaint Proceeding Before the Review Authority Banks to Display Salient Features of the Scheme for Common Knowledge of Public Let Us Sum Up Keywords Check Your Progress Answers to 'Check Your Progress' Multiple Choice Terminal Questions

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28.0 OBJECTIVE The objective of this unit is to understand the procedure adopted by the banking ombudsman for dealing with the grievance of the complainant. A banker must know, on what issues and matters complaint can be filed. 28.1 INTRODUCTION From procedural point of filing a complaint and the manner of dealing with it, this unit is very important. The aspects on which a complaint can be filed are exhaustive and cover all of the services the bank offers to its customers. The grounds include some matters related to loans and advances also. Though there cannot be a complaint for not sanctioning a loan, it can be for non-observance of RBI directives, delay in decision, interest rate directives and non-acceptance of a loan application. In a broader sense, the aspects also cover what the customers expect from the bank about its declared services. For effectively dealing with the complaint the banking ombudsman has powers to call for information from the parties concerned. The complaint needs to be in writing and supported by documents and declarations as given in the scheme. The limitation period for filing a complaint is one year. 28.2 GROUNDS OF COMPLAINT A complaint on any of the following grounds alleging deficiency in banking service may be filed with the banking ombudsman having jurisdiction: (i) non-payment/inordinate delay in the payment or collection of cheques, drafts, bills, etc; (ii) non-acceptance, without sufficient cause, of small denomination notes or coins tendered for any purpose, and for creating a charge of commission in respect thereof; (iii) nonpayment or delay in payment of inward remittances; (iv) failure to issue or delay in issue of drafts, pay orders or bankers cheques; (v) failure to honour a guarantee or letter of credit commitments; (vi) failure to provide or delay in providing a banking facility (other than loans and advances) promised in writing by a bank or its direct selling agents; (vii) delays, non-credit of proceeds to parties accounts, non-payment of deposit or non-observance of the Reserve Bank directives, if any, applicable to rate of interest on deposits in any savings, current and other account maintained with a bank; (viii) delay in receipt of export proceeds, handling of export bills, collection of bills etc., for exporters provided that the said complaints pertain to the bank's operations in India; (ix) complaints form non-resident Indians having accounts in India in relation to their remittances from abroad, deposits and other bank related matters; (x) refusal to open deposit accounts without any valid reason for refusal; (xi) levying of charges without adequate prior notice to the customer; (xii) non-adherence by the bank or its subsidiaries to the instructions of Reserve Bank on ATM/ Debit card operations or credit card operations; (xiii) non-disbursement or delay in disbursement of pension (to the extent the grievance can be attributed to the action on the part of the bank concerned, but not with regard to its employees); (xiv) refusal to accept or delay in accepting payment towards taxes, as required by Reserve Bank/Government; (xv) refusal to issue or delay in issuing, or failure to service or delay in servicing or redemption of Government securities; (xvi) forced closure of deposit accounts without due notice or without sufficient reason;

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(xvii) refusal to close or delay in closing the accounts; (xviii) nonadherence to the fair practices code as adopted by the bank; (xix) any other matter relating to the violation of the directives issued by the Reserve Bank of India in relation to banking services. 2. Complaints concerning loans and advances may also be filed, only in so far as they relate to the following: (i) non-observance of Reserve Bank of India directives on interest rates. (ii) delays in sanction, disbursement or non-observance of prescribed time schedule for disposal of loan applications. (iii) non-acceptance of application for loans without furnishing valid reasons to the applicant, (iv) non-observance of any other directions or instructions of the Reserve Bank of India, as may be specified by it from time to time. 3. The banking ombudsman may also deal with such other matter as may be specified by the Reserve Bank of India from time to time in this behalf. 28.3 PROCEDURE FOR FILING COMPLAINT 1. Any person who has a grievance against a bank relating to the banking services for reasons as detailed above, may himself or through his authorised representative other than an advocate make a complaint to the banking ombudsman within whose jurisdiction the branch or office of the bank complained against is located. Complaints arising out of the operation of credit cards shall be filed before the banking ombudsman within whose jurisdiction the billing address of the complainant is located. 2. The complaint shall be in writing, duly signed by the complainant or his authorised representative. The complaint shall be in a form specified in Annexure - A of the scheme and shall state clearly following particulars: (i) The name and address of the complainant (ii) The name and address of the branch or office of the bank against which the complaint is made (iii) The facts giving rise to the complaint (iv) The nature and extent of the loss caused to the complainant (v) The relief sought from the banking ombudsman 3. No complaint to the banking ombudsman shall lie unless (a) the complainant had before making a complaint to the banking ombudsman made a written representation to the bank and either the bank had rejected the complaint or the complainant had not received any reply within a period of one month after the bank concerned received his representation or the complainant is not satisfied with the reply given to him by the bank; (b) the complaint is made not later than one year after the cause of action has arisen as per Clause (a) above; (c) the complaint is not in respect of the same subject matter which was settled through the office of the banking ombudsman in any previous proceedings; (d) the complaint does not pertain to the same subject matter, for which any proceedings before any court, tribunal or arbitrator or any other forum is pending or a decree or award or a final order has already been passed by any such competent court, tribunal, arbitrator or forum; (e) the complaint is not frivolous or vexatious in nature;

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(f) It is made before the expiry of the period of limitation prescribed under the Indian Limitation Act 1963 for such claims. 28.4 POWER TO CALL FOR INFORMATION 1. The banking ombudsman may require the bank named in the complaint or any other related bank to provide any information or furnish certified copies of any document relating to the subject matter of the complaint that is or is alleged to be in the possession of such bank. In the event of the failure of a bank to comply the requisition without any sufficient cause, the banking ombudsman may draw the inference that the information, if provided or copies if furnished, would be unfavourable to such bank. 2. The banking ombudsman shall not disclose any information or document to any person except with the consent of the person furnishing such information or document. However, the banking ombudsman may disclose information or document furnished by a party in complaint to the opposite side of the complaint, to the extent considered by him to be reasonably required to comply with the principles of natural justice and fair play in the proceedings. 28.5 SETTLEMENT OF COMPLAINT BY AGREEMENT 1. The banking ombudsman has to serve a notice of the receipt of complaint along with a copy of the complaint to the branch or office of the bank named in the complaint. He has to attempt for a settlement of the complaint by an agreement between the complainant and the bank through conciliation or mediation. 2. For the purpose of promoting a settlement of the complaint, the banking ombudsman may follow such procedures as he may consider appropriate and he shall not be bound by any legal rule of evidence. 3. The proceedings before the banking ombudsman shall be summary in nature. 28.6 AWARD BY THE BANKING OMBUDSMAN 1. If a complaint is not settled by agreement within a period of one month from the date of receipt of the complaint or such further period as the banking ombudsman may consider necessary, he may pass an award after affording the parties a reasonable opportunity to present their case. He shall be guided by the evidence placed before him by the parties, the principles of banking law and practice, directions, instructions and guidelines issued by the Reserve Bank of India from time to time and such other factors which in his opinion are necessary in the interest of justice. 2. The award passed under the sub-clause above shall state the direction(s), if any, to the bank for specific performance of its obligations in addition to the amount to be paid by the bank to the complainant by way of compensation for the loss suffered by him and may contain any direction to the bank. The banking ombudsman shall not give any direction(s) in the award under sub-clause above regarding payment of compensation in excess of that which is necessary to cover the loss, suffered by the complainant, as a direct consequence of the commission or omission of the bank, or for an amount exceeding Rs. 10 lakh whichever is lower. 3. In case of complaints relating to credit card operations, the banking ombudsman shall take into account the loss of complainant's time, expenses incurred by the complainant, financial loss, harassment and mental anguish suffered by the complainant, while determining the amount of compensation. ;

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4. A copy of the award shall be sent to the complainant and the bank named in the complaint. An award shall not be binding on a bank against which it is passed unless the complainant furnishes to it within a period of fifteen days from the date of receipt of copy of the award, a letter of acceptance of the award in full and final settlement of his claim in the matter. If the complainant does not accept the award passed by the banking ombudsman and fails to furnish his letter of acceptance within such time, without making any request for extension of time to comply with such requirements, the award shall lapse and be of no effect. 5. The bank shall within one month from the date of receipt by it, of the acceptance in writing of the award by the complainant comply with the award and intimate the compliance to the banking ombudsman. 28.7 REJECTION OF THE COMPLAINT 1. The banking ombudsman may reject the complaint at any stage if it appears to him that the complaint made is: (i) frivolous, vexatious, mala-fide; or (ii) without any sufficient cause; or (iii) that it is not pursued by the complainant with reasonable diligence; or ! (iv) prima facie, there is no loss or damage or inconvenience caused to the complainant; or (v) beyond the pecuniary jurisdiction of the banking ombudsman under the scheme 2. The banking ombudsman may reject a complaint at any stage, if after consideration of the complaint and evidence produced before him the banking ombudsman is of the opinion that the complicated nature of the complaint requires consideration of elaborate documentary and oral evidence and the proceedings before the banking ombudsman are not appropriate for adjudication of such a complaint. The decision of the banking ombudsman in this regard shall be final and binding on the complainant of the bank. 28.8 PROCEEDING BEFORE THE APPELLATE AUTHORITY 1. Any person aggrieved by the award has the right to prefer an appeal against the award before the appellate authority within forty-five days form the date of receipt of the award. The appellate authority is empowered to allow a further period not exceeding thirty days on his being satisfied that the appellant had sufficient cause for not preferring the appeal in time. In case the appeal is by the bank, the filing of appeal should have been with the previous sanction of the Chairman or in his absence the Managing Director or Executive Director or the Chief Executive Officer or any other officer of equal rank. 2. The appellate authority after giving the parties a reasonable opportunity of being heard, may pass the following orders: (a) dismiss the appeal; or (b) allow the appeal and set aside the award; or (c) remand the matter to the banking ombudsman for fresh disposal in accordance with such directions as the appellate authority may consider necessary or proper; or (d) modify the award and pass such directions as may be necessary to give effect to the award so modified; or (e) pass any other order as it may deem fit. The order of the appellate authority has also the same effect as that of the award of the banking ombudsman.

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28.9 BANKS TO DISPLAY SALIENT FEATURES OF THE SCHEME FOR COMMON KNOWLEDGE OF THE PUBLIC 1. The banks covered by the scheme shall ensure that the purpose of the scheme and the name and address of the banking ombudsman to whom the complaints are to be made by the aggrieved party are displayed in all the branch/office premises. 2. The banks covered by the scheme are required to ensure that a copy of the scheme is made available with the designated officer of the bank for perusal in the office premises of the bank. There should be a notice displayed at each office of the bank about the availability of the copy of the scheme with such a designated officer. The banks covered by the scheme are required to appoint nodal officers at their Regional/Zonal offices and inform the respective office of the banking ombudsman. The nodal officer appointed shall be responsible for representing the bank and furnishing information to the banking ombudsman in respect of complaints filed against the bank. 28.10 LET US SUM UP We saw the grounds on which a complaint can be filed. It touches all aspects of banking services. It relates to some issues about loans and advances also. The procedural part of filing and dealing with the complaint is material and needs to be well noted. We have seen how the information required by the banking ombudsman can be called and how he deals with the complaint. How an award is passed. For awareness of the public, a notice about the scheme is required to be displayed at each office along with copy of the scheme. 28.11 KEYWORDS Banking Ombudsman. 28.12 CHECK YOUR PROGRESS 1. Bank can refuse acceptance of small denomination notes from the customer and therefore, on this ground there cannot be a complaint to banking ombudsman. (True/False) 2. On valid grounds bank can refuse the opening of a new account, but on this ground, complaint before the banking ombudsman is maintainable. (True/False) 3. Can a prospective borrower go before the banking ombudsman for non-sanction of his loan by the bank? (Yes/No) 4. Banking ombudsman has powers to call for any information and certified copies from bank when he is dealing with the complaint. 5. For settling the complaint the banking ombudsman is bound by legal rules of evidence. (True/False) 6. What is the maximum amount the banking ombudsman can award as compensation? (No limit / 10 lakh) 7. Limitation period for filing of the review application against the award given by the banking ombudsman is _________ days. (60/45 days) 28.13 ANSWERS TO CHECK YOUR PROGRESS' 1. False; 2. False; 3. No; 4. Yes; 5. False; 6. Rs 10 lakh; 7.45

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28.14 MULTIPLE CHOICE TERMINAL QUESTIONS
e and party made bank, pyof 1. Can a customer from whose account someone fraudulently has withdrawn money make a complaint before the banking ombudsman? (a) No, as the offence committed, is of criminal nature, FIR with police has to be filed. (b) Yes, but if the police authorities who have received the FIR permit filing of the complaint with ombudsman. (c) Yes, as this aspect comes under the powers of the banking ombudsman. (d) No, as the loss caused to the customer is of a civil nature for recovery, civil suit is required to be filed. 2. Reserve Bank and the Central Government may forward a complaint to the banking ombudsman? (a) The right to complaint is given to the complainant only. (b) Neither the Reserve Bank nor the Central Government has the right to refer the matter to the banking ombudsman under the scheme. (c) Reserve Bank and the Central Government are empowered to send the complaint received by them to the banking ombudsman. (d) Only an individual's complaint can be sent by the Reserve Bank and the Central Government. 3. Can the complaint be filed through an advocate as the authorised representative of the complainant? (a) Advocates are not allowed to act as authorised representatives of the complainants under the scheme. (b) Advocates can file the complaint, provided he has been given the vakalatnama by the party. (c) Advocates can appear for the parties as they can present the case well before the banking ombudsman. (d) Advocates are allowed to appear only if the party does not stay within the jurisdiction of the banking ombudsman. Ans: 1. (c); 2. (c) and 3. (a).

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UNIT

29
STRUCTURE
29.0 29.1 29.2 29.3 29.4 29.5 29.6 29.7 29.8 Objective

RECOVERY OF DEBTS DUE TO BANKS AND FINANCIAL INSTITUTIONS ACT, 1993 (DRT ACT) PRELIMINARY

Introduction Constitutional Validity of the Act Preamble, Extent, Commencement, Application and Definitions Let Us Sum Up Keywords Check Your Progress Answers to 'Check Your Progress' Multiple Choice Terminal Questions

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29.0 OBJECTIVE The objective of this unit is to understand the purpose of this specific legislation viz., Recovery of Debts due to Banks and Financial Institutions Act, 1993 (DRT Act 1993). This is an Act enacted to cope up with the much felt requirement of time. The Act is quite procedural in nature. 29.1 INTRODUCTION Recovery of the dues from the borrowers through courts was a major cause of concern for the banks and financial institutions due to huge back log of pending cases with various courts. Even in recovery of decreed debts, considerable difficulties were faced by them prior to the passing of this Act in 1993 it was observed and felt that the existing laws are not adequate to solve the issues faced by the banks and financial institutions, and huge assets were blocked as unproductive assets. Besides, in this process of recovery considerable manpower of the banks and financial institutions gets involved wasting their productivity. Because of delays involved in finalising of cases the industrial assets were getting damaged and deteriorating in value in 1991, the Recovery of Debts due to Banks and Financial Institutions Act, 1993 (DRT Act, as commonly known or called) was passed and it came into operation from 24 June 1993. This Act constituted the special, 'Debt Recovery Tribunals' for speedy recovery. In this unit, we will see how the Act received legal challenges and subsequent declaration of the Act as constitutionally valid by the Supreme Court. We will also see the definitions of different words used in the Act. 29.2 CONSTITUTIONAL VALIDITY OF THE ACT The constitutional validity of the Act was challenged by the Delhi High Court Bar Association before the Delhi High Court. The Delhi High Court decided the law to be unconstitutional, void and hit by Article 14 of the Constitution. The High Court held that the Civil Courts who are directly under control and superintendence of the High Court have been deprived of their jurisdiction and, therefore, it is against the theme of the Constitution and independence of the judiciary. However, on appeal in Union of India vs Delhi High Court Bar Association (2002)4 SCC 274, the Supreme Court decided in favour of the constitutional validity of the DRT Act. The Supreme Court observed that the Parliament alone can enact law in regard to banking business which includes recovery of bank's dues and for that purpose setting up adjudicatory body like the Banking Tribunal is valid. A question of applicability was referred to the Supreme Court regarding the applicability of this Act to co-operative banks. However, it was decided that DRT mechanism is not applicable to dues of Cooperative banks since the recovery mechanism in those banks is separate and if working satisfactorily. 29.3 PREAMBLE, EXTENT, COMMENCEMENT, APPLICATION AND DEFINITIONS 1. The preamble to the DRT Act describes the Act as, 'An Act to provide the establishment of tribunals for expeditious adjudication and recovery of debts due to banks and financial institutions and for matters connected therewith or incidental thereto.' 2. The Act is applicable to the whole of India except the State of Jammu & Kashmir. The Act is made applicable from 24 June 1993, through the DRTs were established progressively across the country. The Act is applicable for the debt due to any bank or financial institution or a consortium of them, when the debt is above Rupees ten lakh. The Central Government may, by notification make the Act applicable to such other amount of debt not less than rupees one lakh. At present there is no notification from the Government about any other amount of debt less than Rupees ten lakh. Therefore, the jurisdiction of the DRT Act is to the debt above Rupees ten lakh.

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3. Some important definitions as per this Act are as under: (i) 'Appellate Tribunal'It is a body established for the purpose of preferring an appeal against the order passed by the tribunal. It is established under the sub-Section (1) of Section 8 of the Act. (ii) 'Application' means an application made to a tribunal for recovery of the debt, under section 19. (iii) 'Appointed day' in relation to a tribunal or an appellate tribunal, means the date on which such tribunal is established. (iv) 'Bank' means, a banking company, a corresponding new bank, i.e., bank commonly known as Nationalised Bank established with the Act that Nationalised them, State Bank of India and its subsidiary bank or a Regional Rural Bank. (v) 'Chairperson' means a chairperson of an appellate tribunal appointed under Section 9. (vi) The important definition is about the 'debt'. As the purpose of the Act is to have faster recovery of debts due to banks and financial institutions, it is important to define the debt to decide the jurisdiction of the tribunal under DRT Act As per the definition given at Section 2(g) the expression 'debt' shall cover following categories of debts of the banks and financial institutions: (i) any liability inclusive of interest, whether secured, (ii) any liability inclusive of interest, whether insecured, or (iii) any liability payable under a decree or order of any Civil Court or any arbitration award or otherwise, or (iv) any liability payable under a mortgage and subsisting on and legally recoverable on the date of application. What constitutes debt has been interpreted by different courts in many cases. In G.V. Films vs UTI [2000] 100 Compo Cases 257 (Mad) (HC), it was held that payment made by the bank by mistake is a debt. In the State Bank of India vs S.S. Engineering Corporation [1998] 1 BC 702 (Mad), it was held, that money overdrawn from a bank account without any overdraft facility is a debt recoverable under the DRT Act. The Supreme Court in United Bank of India vs DRT [1999] 4 SCC 69, held that if the bank had alleged in the suit that the amounts were due to it from respondents as the liability of the respondents had arisen during the course of their business activity and the same was still subsisting, it is sufficient to bring such amount within the scope of definition of debt under the DRT Act and is recoverable under that Act. However, if an employee commits fraud and misappropriation of money, the amount recoverable from him is not a debt within the meaning of DRT Act, Bank of India vs Vijay Ramniklal AIR 1997 Guj. 75. (vii) 'Financial institution' means a public financial institution within the meaning of Section 4A of the Companies Act, 1956 and securitisation and reconstruction company and such other institutions as the Central Government may, by notification, specify, (viii) 'Presiding Officer' means the presiding officer of the Debts Recovery Tribunal appointed under sub-Section (1) of Section 4. (ix) 'Recovery Officer' means a recovery officer appointed by the Central Government for each tribunal under the sub-Section (1) of Section 7. These officers are appointed under the Act for implementing the recovery orders passed by the Tribunal. 29.4 LET US SUM UP There was need to have an effective law for recovery. Prior to this Act, the recovery laws were found inadequate. Huge assets of the banks' were involved in recovery because of huge pendency with

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various courts. Introduction of the NPA norms aggravated the problems. This affected the financial sector. The Act was introduced in 1993. Initially, Delhi High Court decided the Act as constitutionally invalid. Supreme Court then decided the Act as valid. Applicability to co-operative banks was decided only recently by Supreme Court. Preamble to Act states that Act is for expeditious adjudication and recovery of debts. The Act is applicable from 24 June 1993 and is applicable to debts above Rs 10 lakh. In this chapter we have seen the definition of words which are very important and used in the context of this Act. 29.5 KEYWORDS Unproductive Assets; DRT Act; Presiding Officer; Recovery Officer. 29.6 CHECK YOUR PROGRESS 1. DRT Act is applicable only if the debt recoverable is above Rs. __ _.(Rs. 151akh/Rs. 10 lakh) 2. The debt recoverable through DRT may be secured or insecured. (True/False) 3. Overdrawn amount in an account is not a debt recoverable under DRT Act. (True/False) 4. If a Civil Court has passed a decree it has to be executed through that court only and cannot come to recovery tribunal. (True/False)

29.7 ANSWERS TO 'CHECK YOUR PROGRESS'


1. Rs. 10 lakh; 2. True; 3. False; 4. False. 29.8 MULTIPLE CHOICE TERMINAL QUESTIONS 1. A bank has allowed a current A/c holder an ad hoc overdraft of Rs. 15 lakh. The amount is due. Whether this is recoverable under provisions of DRT Act? (a) No, as it is not a regular loan. (b) No, as only secured loans can be recovered under the DRT Act. (c) Yes, as it is a legally recoverable amount by the bank. (d) Yes, but if the tribunal grants special permission to lodge the case. Ans. 1. (c)

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ESTABLISHMENT OF TRIBUNAL AND APPELLATE TRIBUNAL


STRUCTURE
30.0 Objective Introduction Establishment of Tribunal Composition of Tribunal Qualification for Appointment as Presiding Officer and Term of Office Staff of Tribunal Establishment and Composition of Appellate Tribunal 30.1 30.2 30.3 30.4 30.5 30.6 30.7

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e.

Qualification for Appointment as Chairperson of the Appellate Tribunal and Term of Office 30.8 Filling up of Vacancies at Tribunal and Appellate Tribunal 30.9 Finality of Orders Constituting Tribunal or an Appellate Tribunal 30.10 Let Us Sum Up 30.11 Keywords 30.12 Check Your Progress 30.12 Answers to 'Check Your Progress' 30.13 Multiple Choice Terminal Questions

272
30.0 OBJECTIVE The objective of this unit is to understand about the appointment of the tribunals, appellate tribunals and their powers. 30.1 INTRODUCTION For implementation of the Act, establishment of the authorities and conferring on them required powers is essential. Their jurisdiction is also to be decided. All these powers are with the Central Government. Appellate authorities are also required to be set up. All the authorities need the appropriate staff. In this unit we will see about all these establishment aspects. 30.2 ESTABLISHMENT OF TRIBUNAL The Central Government is empowered to establish one or more tribunal to be known as debt recovery tribunal to exercise the jurisdiction, powers and authority conferred on such tribunal by or under this Act. The section also empowers the Central Government to decide and specify the areas within which the tribunal may exercise jurisdiction for entertaining and deciding the applications filed before it. When the Government exercises these powers and takes such decisions they are notified in the Official Gazette of the Government. 30.3 COMPOSITION OF TRIBUNAL The tribunal is made up of only one person called presiding officer and the appointment is done by the Central Government by issuing a notification. The Central Government by notification has the powers to authorise the presiding officer of one tribunal to discharge also the functions of the presiding officer of another tribunal. 30.4 QUALIFICATION FOR APPOINTMENT AS PRESIDING OFFICER AND TERM OF OFFICE 1. A person is qualified for appointment as presiding officer of a tribunal if he is, or has been, or is qualified to be appointed as a District Judge. 2. The presiding officer of a tribunal holds office for a term of five years from the date on which he enters upon his office or until he attains the age of sixty-two years, whichever is earlier. 30.5 STAFF OF TRIBUNAL The Central Government shall provide the tribunal with one or more recovery officer and such other officers and employees as the Government may think fit. The staff so appointed shall work under the general superintendence of the presiding officer. 30.6 ESTABLISHMENT AND COMPOSITION OF APPELLATE TRIBUNAL 1. The Central Government is empowered to establish one or more appellate tribunals, to be known as debt recovery appellate tribunal to exercise the jurisdiction, powers and authority conferred on such tribunal by or under this Act. The Central Government is also empowered to decide and specify the areas within which the tribunal may exercise jurisdiction for entertaining and deciding the applications filed before it. The person occupying the office of the appellate tribunal is called as the chairperson, appointed by the Central Government.

273
For administrative convenience, the Central Government has the powers to authorise the chairperson of one appellate tribunal to discharge also the functions of the chairperson of another appellate tribunal. As said earlier the Government decisions are required to be notified in the Official Gazette. Appellate tribunal consists of only one person called as Chairperson and the appointment shall be done by the Central Government.

2.

30.7 QUALIFICATIONS FOR APPOINTMENT AS CHAIRPERSON OF THE APPELLATE TRIBUNAL AND TERM OF OFFICE 1. A person shall not be qualified for appointment as the chairperson of an appellate tribunal unless he (i) is, or has been, or is qualified to be a Judge of a High Court; (ii) has been a member of the Indian legal service and has held a post in grade I of that service for at least three years; or (iii) has held office as the presiding officer of a tribunal for at least three years. 2. The chairperson of an appellate tribunal shall hold office for a term of five years from the date on which he enters upon his office or until he attains the age of sixty-five years, whichever is earlier. 30.8 FILLING UP OF VACANCIES AT TRIBUNAL AND APPELLATE TRIBUNAL If there occurs any vacancy at tribunal or appellate tribunal, that is not of a temporary nature, the Central Government may fill up such vacancy in accordance with the provisions of the Act. When such appointments are made the proceedings going on and continued before the earlier presiding officer of the tribunal and chairperson of the appellate tribunal continue further from the stage where they were. 30.9 FINALITY OF ORDERS CONSTITUTING TRIBUNAL OR AN APPELLATE TRIBUNAL No order of the Central Government appointing any person as the presiding officer of the tribunal or the chairperson of the appellate tribunal shall be called in question in any manner. Similarly, no act or proceeding before the tribunal or the appellate tribunal can be questioned in any manner on the ground, merely of any defect in the constitution of a tribunal or the appellate tribunal. Presiding officer or chairperson can by a three months written notices, resign his office. They cannot be removed, unless by an order of the Central Government on ground of proved misbehaviour or incapacity after inquiry. 30.10 LET US SUM UP Debt recovery tribunals were established by the Central Government. The Government also decides their jurisdiction. The Tribunal consists one member called as presiding officer appointed by the Central Government. Eligibility for appointment as presiding officer is a minimum of a district Judge. The term is five years or sixty-two years. One or more recovery officers are provided to the tribunal by the Central Government. For filing an appeal the Central Government appoints the appellate recovery tribunal and a person heading it is called chairperson. Qualification of chairperson must be a minimum High Court Judge or presiding officer of tribunal for minimum three years. The appointment is for five years or age of sixty-five years. The unit also includes the provisions about filling up of vacancies. The presiding officer and the chairperson can resign from the office. The authorities cannot be removed from the office unless proven misbehaviour or incapacity after enquiry.

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30.11 KEYWORDS Jurisdiction of Tribunal; Appellate Tribunal; Chairperson. 30.12 CHECK YOUR PROGRESS 1. Debt recovery tribunals are established by _______ 2. Debt recovery tribunals consist benches of three persons. (True/False) 3. Jurisdiction of appellate tribunal is with the respective High Courts. (True/False) 30.13 ANSWERS TO 'CHECK YOUR PROGRESS' 1. Central Government; 2. False; 3. False. 30.14 MULTIPLE CHOICE TERMINAL QUESTIONS 1. Can the order of Central Government in the appointment of the presiding officer of the tribunal be challenged in any Court? (a) Yes, before the appellate tribunal. (b) No. (c) No, unless the High Court permits for it. (d) Yes, under Constitution Article 226 before the High Court. Ans. 1. (b)

UNIT

31
STRUCTURE
31.0 31.1 31.2 31.3 31.4 31.5 31.6

JURISDICTION, POWERS AND AUTHORITY OF TRIBUNALS

Objective Introduction Jurisdiction, Powers and Authority of Tribunals Bar of Jurisdiction of Civil Courts Let Us Sum Up Keywords Check Your Progress

L.R.A.B-19

276
31.0 OBJECTIVE I
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The objective of this unit is to know the jurisdiction, powers and authority of the Tribunal and Appellate Tribunal. 31.1 INTRODUCTION In any Act the jurisdiction, powers and authority of the judicial authorities is well defined. In this unit, we will see these points related to Tribunal and Appellate Tribunal. Very important provision is that for the matters where DRT has jurisdiction the Civil Courts are debarred from entertaining any case. 31.2 JURISDICTION, POWERS AND AUTHORITY OF TRIBUNALS 1. Whenever the Tribunal or the Appellate Tribunal is established from its appointed day, i.e., date from which they function is declared in the notification, they exercise jurisdiction, powers and authority to entertain and decide applications or appeals, as the case may be, from the banks and financial institutions for and about recovery of debts due to them. As already seen to have jurisdiction of Tribunal the claim for recovery of the debt must be above Rupees ten lakh, including principal and interest. In Bank of India vs Harshadrai Odhavji Mody [2002] 40 SCL 20, Bombay High Court has held that an application for execution of the decree of foreign court can be entertained by the Debt Recovery Tribunal. 2. Chairperson of Appellate Tribunal is given general power of superintendence and control over the Tribunals under his jurisdiction. The chairperson can transfer any application from any Presiding Officer within his jurisdiction to any other Presiding Officer within his jurisdiction, on receiving application for transfer of case or even on his own motion. However before such transfer, he has to give notice to the parties and hear them. He also has power of appraising work of presiding officers, under his control. 31.3 BAR OF JURISDICTION OF CIVIL COURTS 1. From the date of establishing the Tribunal, i.e., the appointed day, no court or other authority shall have any jurisdiction, powers or authority to deal within any way in recovery cases above Rupees ten lakh. Thus the Civil Courts or any other authority will loose and will not have the jurisdiction for cases where due amount recoverable is above Rupees ten lakh by banks and financial institutions. However, this is not applicable to High Courts and Supreme Courts exercising jurisdiction under Articles 226 and 227 of the Constitution. 2. The relevant date of bar of jurisdiction by the court or other authority is not the date when this Act came into application. The date is since when the Tribunal is established having jurisdiction in that particular area. In Bhanu Construction Company Ltd. vs Andhra Bank [2002] 37 SCL 769, a question came whether the order passed by a Civil Court after coming into force of the DRT Act but before establishing the Tribunal is valid on jurisdiction point or not. The Supreme Court held that order passed by the Civil Court prior to establishment of a Tribunal but after commencement of DRT Act was well within the jurisdiction of the Civil Court. 31.4 LET US SUM UP The Tribunal and Appellate Tribunal function from the appointed day, which is declared in notification. Their powers, duties and jurisdiction is well declared and defined. High Courts and Supreme Courts, however, have jurisdiction under Constitution Articles 226 and 227.

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31.5 KEYWORDS Tribunal; Appointed Day; Jurisdiction; Powers; Authority; High Court; Spreme Court; Jurisdiction. 31.6 CHECK YOUR PROGRESS 1. A decree passed by the foreign court can be executed by the Tribunal. (True or False) 2. For reasons the Chairperson of the Appellate Tribunal can transfer any case from one Tribunal to other Tribunal within his jurisdiction. (True or False) 3. For the matters for which the Tribunals are empowered the Civil Courts have no jurisdiction. (True or False)

PROCEDURE OF TRIBUNALS

STRUCTURE
32.0 32.1 32.2 32.3 32.4 32.5 32.6 32.7 32.8 32.9 32.10 32.11 Objective Introduction Application to the Tribunal Appeal to the Appellate Tribunal Deposit of Amount of Debt Due, for Filing Appeal Procedure and Powers of the Tribunal and the Appellate Tribunal Limitation Let Us Sum Up Keywords Check Your Progress Answers to 'Check Your Progress' Multiple Choice Terminal Questions

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32.0 OBJECTIVE The objective of this unit is to know the procedure followed at the Tribunals for dealing with the cases before them. 32.1 INTRODUCTION Filing of the application before DRT and its dealing with application involves procedural aspects. The procedure has various stages and requirements that need to be followed very strictly. This unit gives such procedure. 32.2 APPLICATION TO THE TRIBUNAL 1. The purpose for filing application is for recovery of the debt due to them. The procedure has to be followed properly and the interim relief and remedies are required to be properly prayed for. 2. When a bank or a financial institution has to recover any debt from any person/entity, it may make an application to the Tribunal [Section 19(1)] within the local limits of whose jurisdiction, (i) the defendant at the time of making application for loan reside or carry on business or personally works for gain; or (ii) any of the defendant, where there are more than one defendant, reside at the time of making application for loan or carry on business or personally works for gain; or (iii) the cause of action, wholly or in part, arises. 3. Where a bank or a financial institution has filed application under Section 19(1) before the Tribunal for recovery of its debt and if from the same person another bank or financial institution has also to recover any debt, then such later bank or financial institution may join the applicant bank or financial institution in already filed application at any stage of the proceedings before the final order is passed [Section 19(2)] by making an application. 4. Every application to be filed before the Tribunal under Section 19(1) or 19(2) shall be in such form and accompanied by such documents or other evidence and by such fee as may be prescribed. However, when the Civil Suit already filed is transferred to the Tribunal as provided in Section 31 (1) of the DRT Act no fees is required to be paid. This is because the plaintiff had already paid courtfees while filing the civil suit and the transfer of cases is due to statutory changes [Section 19(3)]. 5. On receipt of application under sub-Section (1) or (2) the Tribunal has to issue summons to the defendant requiring him to show cause within thirty days of the service of summons as to why the relief prayed for should not be granted [Section 19(4)]. 6. The defendant has to present a written statement on or before the first hearing or within such time as the Tribunal may permit [Section 19(5)]. 7. If the defendant claims any amount from the applicant and to have a set off against the applicant's demand with ascertained sum of money legally recoverable by him from such applicant, the defendant on the first date should make such claim in the written statement. If the claim is not made on the first hearing at the time of filing of written statement then it can be made only if permitted by the Tribunal [Section 19(6)]. 8. When the written statement contains claim and set-off the written statement has the same effect as a plaint in a cross-suit so as to enable the Tribunal to pass a final order in respect of both the original claim and on set off [Section 19(7)]. 9. A defendant in his application, in addition to his right of pleading a set off under sub-Section (6) may set up a counter claim against the claim of the applicant. Such counter-claim can be for any right 6r claim in respect of cause of action accruing to the defendant against applicant. But such

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cause must be accruing either before or after the filing of the application by the applicant but before the defendant submitting his defence in given time. The counter-claim can be for damages also [Section 19(8)J. A counter-claim filed under sub-Section (8) has the same effect as a complaint in a cross-suit so as to enable the tribunal to pass a final order in respect of both the original claim and on counter-claim [Section 19(9)]. The applicant is at liberty to file a written statement to the counter-claim of the defendant within such period as may be fixed by the tribunal [Section 19(10)]. If the applicant wants to contend that the counter-claim made by the defendant ought not to be disposed as a counter-claim but be disposed in an independent action, he should make application to that effect before the tribunal before the issues are settled. The tribunal on hearing such application, may pass such order as it deems fit [Section 19(11)]. The tribunal may pass an interim order against the defendant to debar him from transferring, alienating or otherwise dealing with or disposing of any property or assets belonging to him without the permission of the tribunal. Such an order may be by way of injunction or stay or attachment [Section 19(12)]. If at any stage of the proceeding the tribunal is satisfied by the affidavit or otherwise that the defendant, with intent to obstruct or delay or frustrate the execution of any order, for the recovery of debt that may be passed against him [Section 19(13A and 8)], (i) is about to dispose of the whole or any part of his property, or (ii) is about to remove the whole or any part of the property from the local limits of the jurisdiction of the tribunal, or (iii) is likely to cause any damage or mischief to the property or affect its value by misuse or creating third party interest the tribunal may direct the defendant to furnish security of the value of the property or to place said property at the disposal of tribunal or value of the same, sufficient to satisfy the debt or to appear before the tribunal and show cause why he should not furnish security. If the defendant fails to show cause why he should not furnish security or fails to furnish security required, the tribunal may pass order for attachment of the whole or part of the property offered as security to the applicant or other property owned by the defendant, sufficient for recovery of debt. When the applicant wants that the properties of the defendant should be attached, he is required to specify the property required to be attached and the estimated value thereof [Section 19(14)J. The tribunal can pass a conditional attachment order, of whole or part of the property as the case may be and as required [Section 19(15)]. Sub-Section (13) has contemplated that the attachment order can be passed on satisfying the tribunal on the points mentioned in that sub-Section by affidavit or otherwise. If any attachment order is passed without complying the requirements of sub-Section (13), then such order is void [Section 19(16)]. The tribunal has power to pass interim orders, attachment orders, etc., under sub-Sections (12), (13) and (18). If there is any breach of the orders so passed by the tribunal, the tribunal may order that the properties of the person guilty of the breach of the order be attached and the person be detained in civil prison for a term not exceeding three months [Section 19(17)]. If the tribunal finds it just and convenient, it may by order [Section 19(18)] (i) appoint a receiver of any property, whether before or after grant of certificate for recovery of debt; (ii) remove any person from the custody or possession of the property; (iii) give possession, custody or management of the property to the receiver;

or dealing with the cases 10.

procedural aspects. The strictly. This unit gives

11. 12.

he procedure has to be perly prayed for. )n/entity, it may make se jurisdiction, carry on business or it the time of making ;or ' before the Tribunal institution has also ; applicant bank or :fore the final order all be in such form ay be prescribed. :dedin Section 31 Ireadypaidcourts [Section 19(3)]. summons to the HIS as to why the vithin such time !the applicant's it, the defendant ot made on the emitted by the same effect as ct of both the :b-Section (6) in be for any int. But such

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(iv) confer powers to the receiver in respect of the property given in his possession for bringing suits or defend it, file applications, collection of rents and profits, preservation, realisation, management, protection, execution of documents, etc., and as the tribunal may deem fit; (v) appoint a commissioner for preparation of an inventory of the properties of the defendant or for sale thereof. If the recovery certificate is granted against a company registered under the Companies Act, 1956, the tribunal may order that the sale proceeds of such company be distributed among its secured creditors as provided in Section 529A of the Companies Act, 1956 and surplus, if any, be paid to the company [Section 19(19)]. The tribunal may, on giving opportunity to both the sides of being heard, pass interim or final order for payment of amount including interest thereon [Section 19(20)]. The tribunal is required to send a copy of every order passed by it to the applicant and the defendant [Section 19(21)]. The presiding officer of the tribunal has to issue a certificate under his signature to the recovery officer for recovery of the amount of debt specified in the certificate [Section 19(22)]. When the property of the defendant against whom the certificate of recovery is issued is situated in the local limits of jurisdiction of more than one tribunal, the tribunal issuing the recovery certificate will send copies of the recovery certificate to such other tribunal in whose jurisdiction the property is situated. If the tribunal which receives such certificate finds that it has no jurisdiction to comply with the certificate of recovery, it shall be returned back to the tribunal who has issued the same [Section 19(23)]. The sub-Section provides that the application received by the tribunal for recovery of debt shall be dealt with as expeditiously as possible and it should be attempted that the application is disposed of finally within 180 days from date of receipt of application [Section 19(24)]. The tribunal may make such orders and give such directions as may be necessary or expedient to give effect to its orders as well as to prevent abuse of its process or to secure the ends of justice [Section 19(25)]. In S. Ravindran vs DRT [1999] 95 Compo Cas. 825, the Karnataka High Court has held that the purpose of the Act is to ensure expeditious disposal of application, long and liberal adjournments should not be granted. The DRT (Procedure) Rules at Rule 12(6) provide that DRT can order that any fact may be proved by affidavit and once affidavit is submitted tribunal will allow cross-examination of the witness only, if in the opinion of the tribunal it is necessary to do so. In the event of witness not appearing then the affidavit shall not be taken as evidence. Even prior to this rule coming into operation, due to amendment in the case of Union of India vs Delhi High Court Bar Association AIR 2002SC 1479, the Supreme Court has held, that if evidence is taken by way of an affidavit, it is not mandatory for the tribunal to require production of witness for cross-examination. The Supreme Court also observed that when the Supreme Court and High Courts decide the matters on the basis of documents and affidavits, there is no reason why the Tribunal should not decide likewise. In Keshrimal Jivji Shah and another vs Bank of Maharashtra [2004 (2) D.R.T.C. 682] the Bombay High Court has held that if any transfer of property is made in violation of the injunction order issued by the Court of Law it is no transfer at all as it confers no right, title or interest in transferee and the transfer is void.

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32.3 APPEAL TO THE APPELLATE TRIBUNAL 1. Any person aggrieved by the order passed by the Tribunal or deemed to have been passed by the Tribunal under DRT Act, may prefer an appeal to an Appellate Tribunal having jurisdiction in the

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matter. However, if the order was made by the Tribunal with the consent of the parties no appeal shall lie. The appeal is required to be filed within forty-five days from the date on which copy of the order is received. At the time of filing the appeal as per Section 21 of the DRT Act, 50% of the amount (Max.) shown as due in the order passed by the Tribunal is required to be deposited by the appellant. The appeal is required to be in the form prescribed and along with the prescribed fees. The appeal filed after forty-five days may be entertained by the Appellate Tribunal if it is satisfied about the cause for not filing the appeal in time. On receipt of the appeal the Appellate Tribunal after giving hearing to both the parties pass such orders as it thinks fit either confirming or modifying or setting aside the order passed by the Tribunal. Every order made by the Appellate Tribunal is sent to the parties to the appeal and to the Tribunal concerned. The appeal filed before the Appellate Tribunal shall be dealt with as expeditiously as possible and it should be attempted that the appeal is disposed of finally within six months from date of receipt of appeal. In Anamika vs DRT [2001] 104 Compo Cas. 273 (Kar) (HC) (DB) it was held that when once the case is transferred from the Civil Court to the Tribunal appeal shall lie with the Appellate Tribunal only and the contention of the party that he still continues to be governed by Civil Procedure Code and can file appeal accordingly is not tenable. There is no provision in the Act for further appeal against the order passed by the Appellate Tribunal. However writ jurisdiction of High Court under Article 226 and supervisory jurisdiction of High Court as well as Special Leave Petition before the Supreme Court are not barred.

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32.4 DEPOSIT OF AMOUNT OF DEBT DUE FOR FILING APPEAL 1. When the defendant against whom the Debt Recovery Tribunal has passed recovery order wants to prefer appeal to the Appellate Tribunal, he is required to deposit 75 per cent of the amount determined by the Tribunal. Without such payment no appeal can be filed. However, the Tribunal has right to reduce or waive such payment for the reasons to be recorded in writing. 2. As the purpose of the Act is to have a fast track remedy for recovery of loans given by banks and financial institutions, the condition of deposit of 50% of the amount found due by the Tribunal is in accordance with the purpose of the Act. Otherwise the remedy of the appeal will be routinely used by the borrowers to delay the recovery procedure and actual recovery. 32.5 PROCEDURE AND POWERS OF THE TRIBUNAL AND THE APPELLATE TRIBUNAL 1. The Tribunal and the Appellate Tribunal are not be bound by the procedure laid down by the Civil Procedure Code, 1908. It further provides that they shall be guided by the principles of natural justice and subject to the provisions of this Act and Rules there under, shall have powers to regulate their own procedure. 2. The Tribunal and the Appellate Tribunal are for the purpose of discharging their functions under the Act, have the same powers as are vested in a Civil Court under the Code of Civil Procedure, 1908 while trying a suit. Such powers are in respect of summoning and enforcing the attendance of any person and examining him on oath, requiring the discovery and production of documents, receiving evidence of affidavits, issuing commissions for the examination of witnesses or documents, reviewing its decisions, dismissing an application for default or deciding it ex-parte, setting aside any order of dismissal of any application for default or any order passed by it ex-parte any other matter which may be prescribed.

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3. The Tribunal and the Appellate Tribunal are deemed to be a Civil Court for all purposes of Section 195 and Chapter XXVI of the Code of Criminal Procedure, 1973. Any proceeding before Tribunal and the Appellate Tribunal is deemed to be a judicial proceeding. 32.6 LIMITATION For application to be filed before the Tribunal the Limitation Act, 1963 apply. This means that the application must be filed by the bank or the financial institution within three years from cause of action. 32.7 LET US SUM UP Bank has to file application for recovery of loan taking into consideration jurisdiction and cause of action. Other bank or financial institution can join the application. Application has to be with fees, documents and evidence. For transfer from Civil Court to Tribunal no fresh fee is required as transfer is due to effect of law. The section has given elaborate provisions for summons and hearing. Tribunal can pass interim orders to prevent defendant from transferring his property. The section also gives the procedure for issuing recovery certificate. There are provisions for appeal to Appellate Tribunal. However for preferring appeal 50% of the amount determined by the Tribunal is required to be deposited. The Limitation Act applies for the DRT cases which means bank has to file the recovery application within three of the cause of the action. 32.8 KEYWORDS Application for Recovery; Cause of Action; set off Claim at First Date; Counter-claim; Interim Order; Injunction; Attachment of Property; Receiver; Recovery Certificate. 32.9 CHECK YOUR PROGRESS 1. DRT jurisdiction for a bank is where the head office of the bank is located. (True/False) 2. If a bank has filed recovery application, other bank can join the application if the defendants are same. (True/False) 3. When a case get transferred from Civil Court to tribunal fresh court fee is required to be paid. (True/False) 4. A counterclaim field before DRT has the same effect as a __________ . 5. Since DRT is not a Civil Court it cannot pass interim orders such as attachment, injunction, receiver, etc. (True/False) 6. A person who has to file appeal before the Appellate Tribunal has to pay __________ . 32.10 ANSWERS TO CHECK YOUR PROGRESS' 1. False; 2. True; 3. False; 4. plaint in cross-suit; 5. False; 6. 75 per cent of the debt ordered by the Tribunal. 32.11 MULTIPLE CHOICE TERMINAL QUESTIONS 1. While filing appeal before the appellate tribunal if any amount is required to be deposited? (a) No, amount is required to be deposited until the appellate tribunal decides. (b) Yes, Court-fee on the appeal amount is required to be paid. (c) Yes, 75 per cent of the amount determined by the tribunal is required to be deposited at the timing of filing of the appeal. (d) Yes, after admission of the appeal 75 per cent of the amount determined by the tribunal is required to be deposited. Ans. 1. (c)

m RECOVERY OF DEBTS
DETERMINED BY TRIBUNAL AND MISCELLANEOUS PROVISIONS
33.0 33.1 33.2 33.3 33.4 33.5 33.6 33.7 33.8 Objective Introduction Modes of Recovery of Debts Validity of Recovery Certificate and Amendment Thereof Stay and Amendment for Recovery Proceeding and Certificate Other Modes of Recovery Application of Certain Provisions of the Income Tax Act Appeal Against the Order of Recovery Officer Transfer of Pending Cases

33.9 Power of Tribunal to Issue Certificate of Recovery in Case of Decree or Order 33.10 Chairperson, Presiding Officer and Staff of Appellate Tribunal and Tribunal Public Servants 33.11 Protection of Action Taken in Good Faith 33.12 Overriding Effect of the Act 33.13 Doctrine of Election 33.14 33.15 33.16 33.17 33.18 33.19 Powers to Make Rule Let Us Sum Up Keywords Check Your Progress Answers to 'Check Your Progress' Multiple Choice Terminal Questions

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33.0 OBJECTIVE The objective of this unit is to understand the recovery procedure through the recovery officers appointed under the Act. 33.1 INTRODUCTION The tribunal issues Recovery Certificate to the applicant. There are recovery officers appointed under the Act and attached to the tribunal. They are given adequate powers to recover the amount awarded. These provisions and procedures are required otherwise the award will as mere paper award. This chapter gives provisions and procedure for recovery. There are provisions for transfer of cases from Civil Court to Tribunal established under DRT Act, powers of Tribunal to issue recovery certificate where decree is already passed by a Civil Court and other miscellaneous powers of Tribunal for implementation of the Act. A legal protection is given to the authorities for immunity of any action done in good faith. 33.2 MODES OF RECOVERY OF DEBTS 1. On receipt of the copy of the recovery certificate issued under Section 19(22), the Recovery Officer has to proceed to recover the amount specified in the certificate by one or more of the following modes: (i) attachment and sale of movable and immovable property of the defendants; (ii) arrest of the defendant and his detention in prison; (iii) appointment of a receiver for the management of the movable and immovable properties of the defendant. 2. The Recovery Officer can sell any of the property owned by the defendant. The provision for arrest of the defendant though appears in the Act, its use will have to be made keeping in view the Supreme Court decision in case of George Verghese vs Bank of Cochin AIR 1980 SC 470. In this case the Court has observed that putting a person in prison for his poverty and consequential inability to pay the contractual liability is too much violative of Article 21 of the Constitution, unless there is minimal fair proof of the wilful failure to pay in spite of his sufficient means. 33.3 VALIDITY OF RECOVERY CERTIFICATE AND AMENDMENT THEREOF 1. The defendant is debarred from raising any dispute before the Recovery Officer about the correctness of the amount specified in the recovery certificate issued by the Tribunal. The Recovery Officer also cannot entertain any objection raised by the defendant on any other ground against the certificate. 2. The Presiding Officer of the Tribunal who had issued the recovery certificate is authorised to withdraw the certificate or correct any clerical or arithmetical mistake in the certificate. 3. One of the Rules framed under the Act (5A) says that when any party wants to have a review of the order passed by the Tribunal or the recoyery certificate issued by the Tribunal on the ground that error is apparent on the face of the record, he can make application for review within sixty days of passing the order or issuing the certificate. Such application needs to be supported by affidavit verifying the contents. It is also required that the opposite party is given notice and hearing before the application is granted. 33.4 STAY AND AMENDMENT FOR RECOVERY PROCEEDING AND CERTIFICATE 1. Even though a certificate has been issued to the recovery officer, the Presiding Officer may grant

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time for the payment of the amount. If such time is granted, the recovery officer has to stay the proceedings until expiry of the time granted. 2. If after recovery certificate is issued there is any payment by the defendant or any time is granted for payment, the Presiding Officer has to keep the recovery officer informed. 3. If the order passed by the Presiding Officer of the Tribunal is modified in appeal by the Appellate Tribunal and the amount of recovery certificate is changed, the Presiding Officer who has issued the recovery certificate, has to amend or withdraw the recovery certificate accordingly. 33.5 OTHER MODES OF RECOVERY 1. In addition to the modes of recovery given at Section 25, Section 28 of this Act has given additional modes that can be adopted by the Recovery Officer. These powers are similar to the powers given to the Tax Recovery Officer under Section 226 of the Income Tax Act, 1961. These powers are also similar to passing of garnishee orders in respect of debt, share and other property not in possession of the judgement debtor under Order XXI, Rules 46 and 46A to 461 of the Code of Civil Procedure, 1908. 2. If any amount is due from any person to the defendant the Recovery Officer may ask such person by giving a notice in writing to pay the amount to the Recovery Officer and not to the defendant. It is then obligatory on that person to pay the amount to the Recovery Officer. However for this provision the exemption of the amount from attachment as provided is Section 60 of the Code of Civil Procedure, 1908 applies. 3. When such notice is issued to a bank, post office, financial institution or as insurer, it shall not be necessary to produce any passbook, deposit receipt, policy or any other document for any purpose like entry or endorsement, etc., before making the payment. Even if there is any practice, rule or requirement that before payment any of the said document is required the provisions of this Act have overriding effect on it. 4. When the notice said above is issued in relation to any property, any claim made against that property subsequent to the notice is void. 5. These provisions also apply to any person who is holding any money for or on account of the defendant. In cases if there is joint-holding, then the equal shares of the joint-holders are presumed unless contrary is proved. A copy of notice will be sent to the defendant, as also to all joint holders. 6. If any person receiving the notice from the Recovery Officer is not liable to pay to or is not holding anything for or on behalf of the defendant then he has to object the notice stating such statement on oath. However, if it is found that the statement is false then the person is personally liable to the Recovery Officer to the extent of amount payable or held by him or the liability of the defendant, whichever is less. If any court holds money belonging to the defendant, Recovery Officer may apply to the court for payment to him the money to discharge the amount of debt due. 7. When the person pays to the Recovery Officer in accordance with the notice served on him by the Recovery Officer, he shall be given receipt for payment. The person is then not liable and is discharged from liability to the defendant to the extent of amount paid to the Recovery Officer. 8. If the person after receipt of the notice fails to pay to the Recovery Officer, he is deemed to be defendant in default in respect to the amount mentioned in the notice. 9. The Recovery Officer has powers to order at any stage of the execution of the recovery certificate to require any person against whom the recovery certificate issued, to declare on affidavit the particulars of his assets. If the defendant is a company such order will be issued to its any of the officer to so declare the assets of the company. 10. The Recovery Officer has also powers to sale the movable property by distraint and recover the amount in the same manner as laid down in I the Third Schedule to the Income Tax Act, 1961.

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33.6 APPLICATION OF CERTAIN PROVISIONS OF THE INCOME TAX ACT 1. Provisions of Section 29 of this Act, are linked to certain sections of the Income Tax Act, 1961. For its effective purpose and to avoid its repetition in this Act, it is stated that these provisions will apply as if provided in this Act and Rules framed there under. This also makes it possible that any amendment made in the Income Tax Act to those provisions will automatically become applicable for this Act without there being requirement to amend this Act. The section says that the provisions of the Second Schedule and Third Schedule to the Income Tax Act, 1961 and the Income Tax (Certificate Proceedings) Rule, 1962, as in force from time to time shall, as far as possible, apply with necessary modifications as if those provisions and rules refer to debt due under this Act. Due to this provision the debt due from the defendant to the bank or financial institution is treated on par with Income Tax arrears and can be recovered like the arrears under the income tax. 33.7 APPEAL AGAINST THE ORDER OF RECOVERY OFFICER The Recovery Officer is given powers under Sections 25 and 28 to recover the amount mentioned in the recovery certificate. As per Section 26, the defendant cannot question or dispute before the Recovery Officer about the correctness of the amount mentioned in the recovery certificate. When the Recovery Officer attaches and sells the property it is possible that the third party having any interest in such property may get affected. Therefore, Section 30 provides that any person aggrieved by the order of Recovery Officer may appeal within thirty days to the Tribunal. The period of thirty days is to be counted from the receipt of the copy of the order by such person. On receipt of the appeal, the Tribunal has to hear the appellant and make enquiries as it deems fit. Thereafter the order of the Recovery Officer may be either confirmed or modified or set aside. In R. Advaiah vs Union of India [2000] 102 Compo Cas. (AP) (HC) it was held that since there is remedy of appeal available by way of Section 30 of the Act, no writ can be entertained against the order of the Recovery Officer. 33.8 TRANSFER OF PENDING CASES 1. As the Act is specific one for recovery of dues of banks and financial institutions, it was necessary that the recovery cases to which DRT Act applies should be brought under one forum. Therefore all the suits or other proceedings pending before the Civil Court, where the Tribunal has jurisdiction since establishment of the Tribunal, stand transferred to the Tribunal. Since the establishment of the Tribunal no Civil Court has the jurisdiction on the matters where Tribunal is conferred with the jurisdiction. Such cases stand transferred to the Tribunal from the Civil Court. The Tribunal on receipt of the record has to deal with the suit or proceeding as if it is an application filed under Section 19 of the Act. The Tribunal may deal with it from the stage where it had reached in Civil Court. No de-novo, i.e new from the start, proceedings start after the transfer of case from Civil Court to the Tribunal. The section has used the word suits and proceeding that get transferred from Civil Court to DRT. Proceeding will include execution petitions and they also get transferred to DRT. 2. In Punjab National Bank vs Chajju Ram [2000] 102 Compo Cas. 41, the Supreme Court has held that execution is a proceeding before the Civil Court and hence on coming into operation of the DRT Act, the execution will stand transferred to the DRT.

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33.9 POWER OF TRIBUNAL TO ISSUE CERTIFICATE OF RECOVERY IN CASE OF DECREE OR ORDER 1. If there is a decree or order passed by any court before coming into operation the DRT Act and the decree or order is not yet executed, the decree-holder may apply to the Tribunal for issue of recovery certificate. There is fresh hearing or trial, etc., in such cases and the tribunal has to directly issue the recovery certificate based on the decree of the Civil Court. 33.10 CHAIRPERSON, PRESIDING OFFICER AND STAFF OF APPELLATE TRIBUNAL AND TRIBUNAL PUBLIC SERVANTS The Chairperson of an Appellate Tribunal, the Presiding Officer of a tribunal, the Recovery Officer and other officers of the Appellate Tribunal and Tribunal are deemed public servants within the meaning of Section 21 of the Indian Penal Code. 33.11 PROTECTION OF ACTION TAKEN IN GOOD FAITH When anything is done in good faith under this Act or is intended to be so done, no suit, prosecution or other proceeding shall lie against the Central Government, the Chairperson, Presiding Officer or the Recovery Officer. This protection is given so that the authorities can function without fear as well as hindrances that the borrower otherwise can put while the authorities discharge their duties. 33.12 OVERRIDING EFFECT OF THE ACT The provisions of this Act have overriding effect when there is inconsistency with any other law or in any instrument by virtue of any other law for the time being in force. In Allahabad Bank vs Canara Bank AIR 2000 SC 1535, it is held that this Act is a special Act for recovery of debt due to banks and financial institutions. It has overriding effect over the provisions of Companies Act, 1956 and, therefore, leave of the company court is not necessary even if the company is under winding up proceedings. In Viral Filaments vs Industrial Bank 33 SCL 132, the Bombay High Court has held that a petition for winding up a company against which recovery proceedings are pending in the Debt Recovery Tribunal is admissible, since jurisdiction to wind up a company is wholly not available in the DRT Act. Allahabad Bank vs Canra Bank 2000 AIR sew 1347 In this case one of the issues before the court was whether permission of Company Court is required for filing case before the Debt Recovery Tribunal when winding up proceedings are pending before the Company Court. The Honourable Supreme Court after examining the Company Law and Recovery of Debts Due to banks and financial Institutions Act (DRT Act) held that: (A) Adjudication under DRT Act is exclusive and jurisdiction of Civil Court and Company Court is ousted. (B) DRT proceedings cannot be stayed by Company Court nor proceedings can be transferred to Company Court. (C) DRT Act overrides the Companies Act. (D) In respect of moneys realised under DRT Act out of the assets not charged, distribution between Bank/FIs and other creditors, when no winding up order passed against the company, the priorities have to be decided subject to principles underlying Section 73 of CPC and principles of natural justice, ( Section 73 of CPC mentions about ratable distribution of sale proceeds of execution among decree holders).

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(E) Moneys realised under DRT Act, distribution between bank and other secured creditors, when winding up proceedings pending in company court, priority of secured creditors is subject to provisions of 529A of Companies Act (the said section mentions about priority of secured creditors and workman over other dues and distribution inter se between secured creditors and workmen should be pari-pasu). (F) DRT is a special law; it overrides Companies Act. Leave of Company or Court u/s 446 is neither necessary nor the recovery application needs to be transferred to the Company Court. 33.13 DOCTRINE OF ELECTION By amending Act 30 of 2004, on 11-11-2004, the following provisos were inserted in section 19(1) of the DRT Act, 1993. 'Provided that the bank or financial institution may, with the permission of the Debts Recovery Tribunal, on an application made by it, withdraw the application, whether made before or after the Enforcement of Security interest and Recovery of Debts Laws (Amendment) Act, 2004 for the purpose of taking action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, if no such action had been taken earlier under that Act; 'Provided further that any application made under the first proviso for seeking permission from the Debt Recovery Tribunal to withdraw the application made under sub-Section (1) shall be dealt with by it as expeditiously as possible and disposed of within thirty days from the date of such application; 'Provided also that in case the Debts Recovery Tribunal refuses to grant permission for withdrawal of the application filed under this sub-Section, it shall pass such orders after recording the reasons thereof The question whether withdrawal of the Original Application in terms of the first proviso to the Section 19(1) of the DRT Act, 1993 is condition precedent to taking recourse to the SARFAESI Act, 2002 was decided by the Supreme Court in M/s Transcore vs Union of India and Another (decided on 29-22006). The Supreme Court observed that there are three elements of election, namely, existence of two or more remedies; inconsistencies between such remedies and a choice of one of them. If anyone of the three elements is not there, the doctrine will not apply. There is no repugnancy nor inconsistency between the two remedies and therefore, the doctrine of election does not apply. The SARFAESI Act is enacted to enforce the interest in the financial assets which belongs to the bank/FI by virtue of the contract between the parties or by operation of common law principles or by law. Essentially the Act deals with the right of the secured creditor. DRT is tribunal, a creature of the statue. It has no inherent power which exists in the civil courts. The object behind introducing the first proviso and the third proviso to Section 19(1) of the DRT Act is to align the provisions of the DRT Act, the SARFAESI Act and Order XXIII of the Code of Civil Procedure, 1908. Order XXIII CPC is an exception to the common law principle of non-suit; hence the proviso to Section 19 (1) became a necessity. Withdrawal of the Original Application before the DRT under the DRT Act is not a pre-condition for taking recourse to the SARFAESI Act. It is for banks/Fls to exercise its discretion as to cases in which it may apply for leave and in cases where they may not apply for leave to withdraw. First proviso to Section 19(1) is an enabling provision. In view of the above judgement of the supreme court, the controversy as to whether simultaneous actions under the DRT Act and SARFAESI Act will lie, has been set at rest. 33.14 POWERS TO MAKE RULE The Central Government has the power to frame rules under the Act to carry out the provisions of the Act. These rules are required to be notified and placed before both the Houses of Parliament. The Parliament may accept the rules or may modify the same.

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33.15 LET US SUM UP On receiving recovery certificate the recovery officer has to proceed for the recovery by attachment and sale of movable and immovable property of defendant, arrest and detention in prison of defendant and appointment of receiver. Defendant is debarred from disputing the correctness of the amount given in recovery certificate. The presiding officer can correct the clerical or arithmetical errors. The section has given wide enabling provisions to call money from third party in whose hands defendants money are lying. When amount of defendant is in the hands of third party and recovery officer issues notice calling money the third party failing to pay is deemed as defendant. Orders of recovery officer applicable within thirty days to the Tribunal. If there is already a decree passed by the Civil Court, the DRT can issue recovery certificate thereon. The chairperson, presiding officer and staff of both Tribunals are deemed public servants. They are also protected from any action for their acts done in good faith. The act has overriding effect when there is inconsistency with any other law. 33.16 KEYWORDS Recovery Officer; Deemed Defendant; Recovery as Income Tax Dues as per Provisions of Income Tax Act. 33.17 CHECK YOUR PROGRESS 1. Recovery Officers appointed under DRT Act can attach and sell movable as well as immovable property of the person against whom order is passed even if the property is not charged to the creditor. (True/False) 2. The defendant can raise a plea before the Recovery Officer about correctness of the amount ordered to be paid. (True/False) 3. If the recovery certificate has clerical or arithmetical mistake __________ can correct the same. 4. For recovery the Recovery Officer can adopt the same methods as adopted for recovery of income tax under the Income Tax Act. (True/False) 5. Recovery Officer can ask the defendant to furnish by affidavit particulars of his asset. (True/False) 33.18 ANSWERS TO 'CHECK YOUR PROGRESS' 1. True; 2. False; 3. Presiding Officer of the Tribunal; 4. True; 5. True. 33.19 MULTIPLE CHOICE TERMINAL QUESTIONS 1. A company is under winding up process. Whether High Court permission is required to a bank to proceed against it before DRT? (a)No, as the DRT Act being a special Law having overriding effect over other laws. (b)Yes, as Companies Act specially provides to that effect. t (c)Depends on the stage of winding up process. (d) No permission but concurrence of High Court required. 2. Doctrine of election will come into play (a) when there exixts two or more remedies; (b) when there are inconsistencies between the remedies; (c) when there is choice available to the party to opt for on e of them; (d) when all the aforesaid elements are to be present in a case. Ans: 1. (a); 2. (d). \
L.R.A.U-20

THE BANKERS' BOOKS EVIDENCE ACT, 1891

STRUCTURE
34.0 34.1 34.2 34.3 34.4 34.5 34.6 34.7 34.8 34.9 34.10 34.11 34.12 Objective Introduction Applicability and Definitions Conditions in the Printout Mode of Proof of Certain Entries in Bankers' Books Case in which Officer of Bank not Compellable to Produce Books Inspection of Books by Order of Court or Judge Costs of Application Let Us Sum Up Keywords Check Your Progress Answers to 'Check Your Progress' Multiple Choice Terminal Questions

(I::

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34.0 OBJECTIVE The objective of this unit is to understand the special provisions made for giving evidentiary value to the extracts of the books of bankers while producing any evidence in the courts for proving or establishing anything the original evidence is relied upon. 34.1 INTRODUCTION Banks keep their accounting and its details in various ledgers, registers, etc. When any claim of the bank is required to be established or proved in the Courts of Law or any other such forums, these books are required to be produced in original. It is difficult to do so. Therefore, its extracts and statement of accounts are produced. To facilitate the production of such evidence in easy way and to have evidentiary value to the extracts and copies, 'The Bankers' Books Evidence Act, 1891 was enacted to amend the Law of Evidence with respect to bankers' books. 34.2 APPLICABILITY AND DEFINITIONS 1. The Act extends to the whole of India except the State of Jammu & Kashmir. 2. 'Company' means a company as defined in Section 3 of the Companies Act, 1956 and includes a foreign company within the meaning of that Act. The Companies Act, 1956 gives elaborately the requirements for getting the company registered. It has several prerequisites. 3. 'Corporation' means any body corporate established by any law and includes the Reserve Bank of India, the State Bank of India and any subsidiary bank of the State Bank of India. 4. 'Bank' and 'banker' means (i) any company or corporation carrying on business of banking. (ii) any partnership or individual to whose books, provisions of this Act are made applicable. (iii) any post office saving bank or money order office. 5. 'Bankers' books' include ledgers, day books, cash books, account books and all other records used in the ordinary business of a bank. These records may be kept in written form or stored in a micro-film, magnetic tape or any other form of mechanical or electronic data retrieval mechanism. Such record can be either on site or at any off site location and includes a back-up or disaster recovery site. 6. 'Legal proceeding' means (i) any proceeding or inquiry in which evidence is or may be given; (ii) an arbitration; and (iii) any investigation or inquiry under the Code of Criminal Procedure, 1973 or under any other law for the time being in force for the collection of evidence, conducted by a police officer or any other person authorised for the purpose by the magistrate or by any law. Such other person to be authorised should not be a magistrate. This definition of the word legal proceeding is very wide and covers different types of inquiries, proceedings and investigations. 7. 'Court' means the person or persons before whom a legal proceeding is held or taken. 8. 'Judge' means a judge of a High Court. 9. 'Trial' means any hearing before the Court at which evidence is taken. For this definition also, if the earlier definitions of legal proceeding and Court are considered together, the scope of word 'trial' is much wider. 10. 'Certified copy' means when the books of a bank;

II!

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(i) if maintained in the written form, a copy of any entry in such books together with a certificate written at the foot of such copy mentioning that (a) it is a true copy of such entry (b) that such entry is contained in one of the ordinary books of the bank (c) that such entry was made in the ordinary course of business (d) that such book is still in the custody of the bank (e) and if the copy was obtained by a mechanical or other process that in itself ensures the accuracy of the copy, a further certificate to that effect. If after taking out the copy from the books of the bank, the original books are destroyed in usual course of the bank's business a further certificate to that effect of having destroyed the book is necessary. Each certificate mentioned above shall bear date and should be signed by the principal accountant or manager of the bank with his name and official title, (ii) if maintained in the electronic form (a) consists of printouts of data stored in a floppy, disc, tape or any other electromagnetic data storage device, or (b) a copy of such printout; and it should contain the certificate having all the applicable contents detailed above at sub-Para (i). (iii) if maintained mechanical form (a) a printout of any entry in the books of a bank stored in a microfilm, magnetic tape, or (b) any other form of mechanical or electronic data retrieval mechanism obtained by a mechanical or other process, and it should contain the certificate having all the applicable contents detailed above in sub-Para (i). 34.3 CONDITIONS IN THE PRINTOUT 1. When the books of the bank are not written in the handwritten and copies are taken by way of printout the copy must accompany following: (i) a certificate by the principal accountant or the manager to the effect that it is a printout of such entry or a copy of such printout; and (ii) a certificate by a person in charge of computer system containing a brief description of the computer system and the particulars thereof, (a) the safeguards adopted by the system to ensure that data is entered or any other operation performed is only by authorised person; (b) the safeguards adopted to prevent and detect unauthorised change of data; (c) the safeguards available to retrieve data that is lost due to systemic failure or any other reasons; (d) the manner in which the data is transferred from the system to removable media like floppies, discs, tapes or other electromagnetic data storage devices; (e) the mode of verification in order to ensure that data has been accurately transferred to such removable media; (f) the mode of identification of such data storage device; (g) the arrangement for the storage and custody of such storage devices; (h) the safeguards to prevent and detect any tampering with the system; and (i) any other factor which will vouch for the integrity and accuracy of the system. 2. In addition to the above, a further certificate required is from the person in charge of the computer system to the effect that to the best of his knowledge and belief, such computer system is operated

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properly at the material time, he was provided with all the relevant data and the printout in question represents correctly and is appropriately derived from the relevant data. 34.4 MODE OF PROOF OF CERTAIN ENTRIES IN BANKERS' BOOKS A certified copy of any entry in a bankers' book shall in all legal proceedings be received as prima facie evidence of the existence of such entry. Further it shall be admissible as evidence of all the matters, transactions and accounts therein recorded in every case as the original entry itself. In Chandrahdar Goswami vs Gauhati Bank Ltd. AIR 1967 SC 1058, the Supreme Court has held that to make a person liable mere entries in books of account are not sufficient even though the books of account are kept in regular course of business. There has to be further evidence to prove payment of the money by the bank which appear in the books of account to make the person liable, except where the person accepts the correctness of the books of account. 34.5 CASE IN WHICH OFFICER OF BANK NOT COMPELLABLE TO PRODUCE BOOKS In any proceeding where the bank is not a party, no officer of a bank shall be compellable to produce any bankers' book contents of which can be proved under this Act by production of certified copies. Similarly no officer of the bank shall be called as witness to prove the matters, transactions and accounts recorded in the certified copies. However, the Court may order otherwise for special cause.

34.6 INSPECTION OF BOOKS BY ORDER OF COURT OR JUDGE


1. On application by any party to the legal proceeding, the Court or a Judge may order that, (i) such party be at liberty to inspect and take copies of any entries in a banker's book for any of the purposes of the proceeding; or (ii) the bank to prepare and produce, within time specified in the order, certified copies of all such entries, accompanied by a further certificate that no other entries are to be found in the books of the bank relevant to the matters in issue in such proceeding. This further certificate also should be dated and signed as required for certified copy stated above. 2. An order that bank officer should either produce the books of account or appear as witness can be made by the Court or Judge with or without summoning the bank. The order so passed shall be served on the bank at least three clear working days before the same is to be obeyed. The bank may at any time before the time limited for compliance of any such order either offer to produce their books at the trial or give notice of their intention to show cause against the order. If the bank chooses to give show cause against the order then the order passed by the Court or Judge cannot be enforced without further order. 34.7 COSTS OF APPLICATION 1. The costs of any application to the court (i) under or for the purpose of this Act; and (ii) the costs of anything done or to be done under an order of the court for the purpose of this Act, shall be in the discretion of the court. The court may further order such costs or part thereof to be paid by the bank to the party, if they have been incurred in consequence of any fault or improper delay on the part of the bank. 2. Any order made under this section for payment of cost to or by a bank may be enforced as if the bank were a party to the proceeding.

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3. Any order passed under this section awarding costs may on application to any Court of Civil Judicature be executed by such court as if the order is a decree for money passed by itself. However, the court who passed the order can also have the powers to enforce of its own orders with respect to the payment of costs. 34.8 LET US SUM UP The definition clause gives the meaning of different words in the context of the Act. The certified copy needs a certificate giving some declarations. When the books of bank are taken in printout form they need a further certificate as detailed in the Section. When data is stored in computer form a certificate from person in charge of the computer system is required. Certified copy is a prima facie evidence and admissible in evidence as if original is produced. On production of certified copy no further evidence is required. In any proceeding where bank is not a party and certified copies are produced bank's officer cannot be called as witness as copy is admissible evidence. Court can order inspection of books of accounts. The orders for inspection of books must give three clear days for the bank to arrange for inspection. Court has discretion to award costs for any application under the Act. 34.9 KEYWORDS Certified Copy. 34.10 CHECK YOUR PROGRESS 1. If the books of the bank are maintained in the electronic form, does all the provisions of this Act are applicable to it. (Yes/No) 2. Does this Act apply to any investigation or inquiry under the Criminal Procedure Code? (Yes/No) 3. A certified copy of any entry in a bankers' Book is received in legal proceeding as __________ evidence for existence of such entry. 4. Unless the Court otherwise directs, bank officer cannot be compelled to produce __________ to prove any banker's book's contents when copy is produced. 34.11 ANSWERS TO 'CHECK YOUR PROGRESS' 1. Yes; 2. Yes; 3. prima facie; 4. original books. 34.12 MULTIPLE CHOICE TERMINAL QUESTIONS 1. In a civil suit, to which bank is not a party, one of the parties has produced certified copy of books of account. One party to the suit wants to call bank officer as witness to prove the contents of copy. Can it be done? (a) Yes, as it is the right of the party to get it reaffirmed in evidence. (b) No, as the certified copy is a prima facie evidence that is admissible in evidence. (c) No, unless the bank volunteers to do so. (d) Yes, but if Court allows the application to call the witness. Ans. 1. (b) No

THE LEGAL SERVICES AUTHORITIES ACT, 1987: LOK ADALATS

STRUCTURE
35.0 35.1 35.2 35.3 35.4 35.5 35.6 35.7 35.8 35.9 Objective Introduction Organisation of Lok Adalats Jurisdiction of Lok Adalats Cognisance of Cases by Lok Adalats Disposal of Cases by Lok Adalats Nature of Award of the Lok Adalats Let Us Sum Up Check Your Progress Answers to 'Check Your Progress'

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35.0 OBJECTIVE The objective of this unit is to familiarise the readers with the system of Lok Adalats organised under the Legal Services Authorities Act, 1987 for compromise or settlement of disputes between parties. 35.1 INTRODUCTION The functioning of Lok Adalats, their jurisdiction, the manner in which Lok Adalats take cognisance of cases, the types of disposal of the cases or matters referred to the Lok Adalats and the nature of award that may be passed by the Lok Adalats are discussed in this unit. 35.2 ORGANISATION OF LOK ADALATS Lok Adalat are organised by the State Authority, District Authority or the Supreme Court Legal Services Committee or High Court Legal Services Committee or Taluk Legal Services Committee at such intervals and places for exercising jurisdiction and for such areas as it thinks fit. 35.3 JURISDICTION OF LOK ADALATS A Lok Adalats shall have jurisdiction to determine and arrive at a compromise or settlement between the parties to a dispute. The dispute should be either a pending case before any court for which the Lok Adalat is organised or a matter which is falling within the jurisdiction but not pending in any court. The offences, which are compoundable under any law cannot be brought within the purview of the Lok Adalats. The monetary ceiling of amounts regarding which civil disputes can be settled under this mechanism is presently Rs 20 lakh. 35.4 COGNISANCE OF CASES BY LOK ADALATS Lok Adalats shall deal with the following types of cases or matters, viz., (a) the disputes the parties agree to refer; (b) the disputes where one of the parties makes an application to the court to refer to Lok Adalat and the court is satisfied that there are chances of settlement. In this case the court shall give an opportunity to the other party before deciding the case to be referred to the Lok Adalat; (c) the dispute which, in the opinion of the Court, it is appropriate to be taken cognisance by the Lok Adalat. (d) Where in respect of a potential dispute, the authority or committee organising Lok Adalat on receipt of an application from anyone of the parties is of the opinion that the matter needs to be determined by the Lok Adalat, may refer such matter to the Lok Adalat for determination. 35.5 DISPOSAL OF CASES BY LOK ADALATS The Lok Adalats shall arrive at a compromise or settlement between the parties. They shall act with utmost expedition to arrive at a compromise or settlement between the parties and shall be guided by the principles of justice, equity, fair play and other legal principles. Where no compromise or settlement could be arrived at between the parties, the records of the case shall be returned to the court from which the reference was received. The court shall proceed with the matter from the stage it had reached before making a reference to the Lok Adalat. In respect of disputes which were not before the court, in the absence of compromise or settlement between the parties to seek remedy in a court.

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35.6 NATURE OF AWARD The award of Lok Adalat shall be deemed to be a decree of a civil court or an order of any other court. In case of compromise or settlement arrived at by a Lok Adalat the court fee paid in the case shall be refunded in the manner provided under the Court fees Act, 1870. Every award shall be binding on all the parties to the dispute. No appeal shall lie to any court against the award. 35.7 LET US SUM UP Lok Adalats are organised under the Legal Services Authorities Act, 1987. They are intended to bring about a compromise or settlement in respect of any dispute or potential dispute. Lok Adalats derive jurisdiction by consent of parties or on an application made to the court by one of the parties to the dispute or the court is satisfied that the dispute between the parties could be settled by Lok Adalat. In respect of a potential dispute, any party may request the Authority or Committee organising Lok Adalat to refer the dispute for determination. Lok Adalats shall be guided by the principles of justice, equity, fair play and other legal principles. In case of settlement, the Award shall be binding on the parties to the dispute. No appeal shall lie in any court against the Award. If no settlement, the case shall be remitted back to the court which referred the matter to the Lok Adalat. In case of potential court case, the Lok Adalat shall advise the parties to seek remedy in court. 35.8 CHECK YOUR PROGRESS 1. Lok Adalats are organised under the Lok Adalats Act. (True/False) 2. Lok Adalats are organised to settle only the existing disputes between the parties. (True/False) 3. If one party intends to refer the dispute to Lok Adalat, the consent of the other is not required. (True/False) 4. Lok Adalats shall strive at arriving a compromise or settlement between the parties. (True/False) 5. There shall be no appeal against the award of the Lok Adalat. (True/False)

35.9 ANSWERS TO CHECK YOUR PROGRESS'


1. False; 2. False; 3. False; 4. True; 5. True.

UNIT

36
STRUCTURE
36.0 36.1 36.2 36.3 36.4 36.5 36.6 36.7 36.8 36.9 Objective Introduction

THE CONSUMER PROTECTION ACT, 1986: PREAMBLE, EXTENT AND DEFINITIONS

Purpose of the Act, Preamble and Extent Definitions Act not Overriding on any Other Law Let Us Sum Up Keywords Check Your Progress Answers to 'Check Your Progress' Multiple Choice Terminal Questions

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36.0 OBJECTIVE The objective of this unit is to get the knowledge of the purpose of this special enactment, viz., The Consumer Protection Act, 1986 and the particular word defined for appropriate use therein. 36.1 INTRODUCTION To protect the interests of the consumers, 'The Consumer Protection Act was enacted.' The word consumer and services has been defined in the Act very elaborately. In this unit, we will see the purpose of enacting the Act and various definitions of words used in the context of this Act.

36.2 PURPOSE OF THE ACT, PREAMBLE AND EXTENT


1. The Act was enacted with the objective, 'for better protection of the interests of consumers". Different authorities were established for the settlement of consumers' disputes. The Act is social welfare benefit oriented legislation for the consumer providing self-contained quasi-judicial machinery to provide speedy and simple redressal to consumer disputes. The said quasi-judicial machinery is established at the district, state and central levels. They observe the principles of natural justice and are empowered to give relief of specific nature and, if required, award compensation to the consumers. The Act also provides penalties for non-compliance of the orders given by these authorities. 2. In the preamble, it is made clear about the purpose of the Act. It says that the Act is for, (i) better protection of the interests of the consumers and for that purpose to make provision for the establishment of consumer councils and other authorities for the settlement of consumers' disputes. 3. The Act extends to the whole of India except the State of Jammu & Kashmir. 4. The Act applies to all goods and services, excluding goods for resale or for commercial purpose and services rendered free of charge and under a contract for personal service. 36.3 DEFINITIONS 1. 'Appropriate laboratory' means a laboratory or organisation recognised by the Central Government or by the state government, or any such laboratory or organisation established by or under any law for carrying out analysis or test of any goods with a view to determining whether such goods suffer from any defect. 2. 'Branch office' means any establishment described as a branch by the party or any establishment carrying on either the same or substantially the same activity as that carried on by the head office of the establishment. 3. 'Complainant' means (i) a consumer, or (ii) any voluntary consumer association registered under the Companies Act, 1956 or under any law for the time being in force, or (iii) the Central Government or a state government, who or which makes the complaint, or (iv) one or more consumers, where there are numerous consumers having the same interest, and (v) in case of death of a consumer, his legal heirs or representative. 4. 'Complaint' means any allegation in writing made by a complainant with a view to obtaining any relief provided by or under this Act that,

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(i) an unfair trade practice or a restrictive trade practice has been adopted by any trader or service provider; (ii) the goods brought by him or agreed to be brought by him suffer from one or more defects; (hi) the services hired or availed of or agreed to be hired or availed of by him suffer from deficiency in any respect; (iv) a trader or the service provider has charged for the goods or for the services mentioned in the complaint, at a price in excess of the price (a) fixed by or under any law, or (b) displayed on the goods or any package containing such goods, or (c) displayed on the pricelist exhibited by him by or under any law, or (d) agreed between the parties. (v) the goods which will be hazardous to life and safety when used, are being offered for sale to the public (a) in contravention of any standard relating to safety of such goods as required to be complied with, by or under any law, (b) if the trader could have known with due diligence that the goods so offered are unsafe to the public, (vi) the services which are hazardous or likely to be hazardous to life and safety of the public when used, are being offered by the service provider which such person could have known with due diligence to be injurious to life and safety. 5. 'Consumer' means any person who A. (i) buys any goods for a consideration which has been paid or promised to be paid or partly paid and partly promised, or (ii) under any system of deferred payment, and (iii) includes any user of such goods other than who buys the goods in the manner as said above, or (iv) buys the goods under any system of deferred payment when such use is made with the approval of such person, However, the definition does not include a person who obtains such goods for re-sale or for any commercial purpose. B. (i) hires or avails of any services for a consideration which has been paid or promised or partly paid and partly promised, or (ii) under any system of deferred payment, and (iii) includes any beneficiary of such services other than who hires or avails of the services in the manner as said above, or (iv) avails the services under any system of deferred payment when such services are availed of with the approval of such person. However, the definition does not include a person who avails of such services for any commercial purpose.

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The word 'commercial purpose' herein above does not include use by a person of goods bought and used by him and services availed by him exclusively for the purpose of earning his livelihood, by means of self-employment. The definition of consumer is thus very elaborate and inclusive of many aspects. 6. 'Consumer dispute' means a dispute where the person against whom complaint has been made, denies or disputes the allegations contained in the complaint.

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7. 'Defect' means any fault, imperfection, shortcoming in the quality, quantity, potency, purity or standard which is required to be maintained by or under any law or under any contract, express or implied or as is claimed by the trader in any manner whatsoever in relation to any goods. 8. 'Deficiency' means any fault, imperfection, shortcoming or inadequacy in the quality, nature and manner of performance which is required to be maintained by any law or has been undertaken to be performed by a person in pursuance of a contract or otherwise in relation to any service. In Jagannath Meher vs Branch Manager, State Bank of India (1993) II CPJ 146, it was held that where a loan was sanctioned by the bank but the complaint that the loan was inadequate to start the industry is not tenable. It was held that the Consumer Forum cannot override the decision taken by the bank as that was a power of discretion of the bank and there was no reason that the bank acted otherwise than in good faith. 9. 'District Forum' means a Consumer Dispute Redressal Forum established under Clause (a) of Section 9 under this Act. 10. 'Goods' means goods as defined in the Sale of Goods Act, 1930. The said Act has stated that goods means every kind of moveable property other than actionable claims and money. However, it does not include stocks and shares, growing crops, grass and things attached to or forming part of the land which are agreed to be served before sale or under contract of sale. 11. 'Manufacturer' means a person who (i) makes or manufactures any goods or parts thereof; or (ii) does not make or manufacture any goods but assembles parts thereof made or manufactured by others; or (iii) puts or causes to be put his own marks on any goods made or manufactured by any other manufacturers. 12. 'National Commission' means the National Consumer Disputes Redressal Commission established under Clause (c) of Section 9. 13. 'Notification' means a notification published in Official Gazette by the State or Central Government. 14. 'Person' includes (i) a firm whether registered or not; (ii) a Hindu undivided family; (iii) a co-operative society; (iv) every other association of persons whether registered under the Societies Registration Act, 1860 or not. 15. 'Prescribed' means prescribed by the State or Central Government, as the case may be, under this Act. 16. 'Regulation' means the regulations made by the National Commission under this Act. 17. 'Restrictive trade practice' means (i) a trade practice which tends to bring about manipulation of price, or (ii) its conditions of delivery, or (iii) to affect flow of supplies in the market relating to goods or services in such a manner to impose on the consumers unjustified costs or restrictions and include, (a) delay beyond the period agreed to by a trader on supply of such goods or in providing the services which has led or is likely to lead to rise in the price, and (b) any trade practice which requires a consumer to buy, hire or avail of any goods or services as condition precedent to buying, hiring or availing of other goods or services.

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18. 'Service' means (i) service of any description which is made available to potential users and includes, but not limited to, the provision of facilities in connection with banking, financing, insurance, transport, processing, supply of electrical or any other energy, boarding or lodging or both, housing construction, entertainment, amusement or the surveying of news or other information. However, this does not include the rendering of any service free of charge or under a contract of personal service. The definition gives elaborately what amounts service from various sectors and lines. It has specifically included the services rendered by the bank. 'Spurious goods and services' means such goods and services which are claimed to be genuine but they are actually not so. 'State Commission' means a Consumer Disputes Redressal Commission established in a state under Clause (b) of Section 9 of the Act. 'Trader' in relation to any goods means a person who sells or distributes any goods for sale and includes the manufacturer thereof, and where such goods are sold or distributed in package form, includes the packer thereof. 'Unfair trade practice' means a trade practice which, for the purpose of promoting the sale, use or supply of any goods or for the provision of any service, adopts any unfair method or unfair or deceptive practice. Such unfair practices include: A. the practice of making any statement orally or in writing or visible representation which (i) falsely represents that the goods are of a particular standard, quality, quantity, grade, composition, style or model; (ii) falsely represents that the services are of a particular standard, quality or grade; (iii) falsely represents any rebuilt, second-hand, renovated, reconditioned or old goods as new goods; (iv) represents that the goods or services have sponsorship, approval, performance, characteristic, accessories, uses or benefits which such goods or services do not have; (v) represents that the seller or the supplier has a sponsorship or approval or affiliation which such seller or supplier does not have; (vi) makes a false or misleading representation concerning the need for or the usefulness of any goods or services; (vii) gives to the public any warranty or guarantee of the performance, efficacy, or length of life of a product or of any goods that is not based on an adequate or proper test thereof; (viii) makes to the public a representation in a form that purports to be, (a) a warranty or guarantee of a product or of any goods or services; or (b) a promise to replace, maintain or repair an article or any part thereof or to repeat or continue a service until it has achieved a specified result, if such purported warranty or guarantee or promise is materially misleading or if there is no reasonable prospect that such warranty, guarantee or promise will be carried out; (ix) materially misleads the public concerning the price at which a product like products of goods or services, have been or are, ordinarily sold or provided and for this purpose, a representation as to price shall be deemed to refer to the price at which the product, goods or services are sold or provided; (x) gives false or misleading facts disparaging the goods, services or trade off another person. For the purpose of Clause (1) above, a statement that is: (i) expressed on an article offered or displayed for sale or on it wrapper or container; or

19. 20. 21. 22.

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(ii) expressed on anything attached to, inserted in or accompanying as an article offered or displayed for sale or on anything on which the article is mounted for display or sale; or (iii) contained in or on anything that is sold, sent, delivered, transmitted or in any other manner made available to the public, is deemed to be a statement made to the public by the person who has caused the statement to be so expressed, made or contained. B. Permits the publication of any advertisement for sale of goods or supply of service in the newspaper or otherwise at a bargain price that are in fact not at bargain price. Bargain price means a price stated to be a bargain price by reference to an ordinary price or a price at which the product is ordinarily sold or otherwise. C. Permits (i) offering of gifts, prizes or other items with the intention of not providing them as offered or creating impression that something is being given or offered free of charge when actually it is not so; (ii) the conduct of any contest, lottery, game of chance or skill for the purpose of promoting the sale, use or supply of any product or business interest. D. Withholding of any participants of any scheme offering gifts, prizes or other items free of charge and informing the final results on the closure of the scheme. E. Permits the sale or supply of goods intended to be used by consumers knowing or having reason to believe that the goods do not comply with the standards prescribed by competent authority relating to performance, composition, contents, design, construction, finishing or packaging as are necessary to prevent or reduce the risk of injury to the person using the goods. F. Permits the hoarding or destruction of goods, or refuses to sell the goods or to make them available for sale or to provide any service if such hoarding or destruction or refusal tends to raise the cost of goods or services. G. Manufacture of spurious goods or offering such goods for sale or adopting deceptive practices in the provision of services. The definition of 'unfair trade practice' is very exhaustive. Due to different unfair practices adopted in sale of goods or offering services the definition is required to be done all inclusive and covering various possibilities that amount unfair practice. The fundamental concept underlying the word 'fair' is that the transaction has nothing underhand in it, is honest, just, equitable and upright and that the other party to the contract has not taken any undue advantage. If the transaction lacks any of the contents out of this, it can be termed as 'unfair'.

36.4 ACT NOT OVERRIDING ON ANY OTHER LAW


The provisions of this Act are in addition to other applicable laws and not overriding on any other law, i.e. the provisions of this Act do not supercede any specific provision in other Act. The Act provides additional means of obtaining remedy by a consumer but if the remedy prayed is barred under any other Act, then the Forums constituted under this Act cannot grant such remedy. 36.5 LET US SUM UP The Act has been enacted for the settlement of consumer disputes. The Act is social welfare benefit oriented legislation. It is for speedy disposal of the redressal of consumer disputes. Deciding the consumer types and protections required the Act was made for better protection of the interests of the

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consumers establishing the consumer councils and authorities. The provisions of the Act are not overriding on any other law. 36.6 KEYWORDS Quasi-judicial Authorities; Appropriate Laboratory; District Forum; State Commission; National Commission; Restrictive Trade Practice. 36.7 CHECK YOUR PROGRESS 1. Consumer Protection Act is enacted to protect the manufacturing conditions of the Industries. (True/False) 2. The agencies appointed under Consumer Protection Act are quasi-judicial in nature. (True/False) 3. Can a voluntary consumer association file a complaint on behalf of consumer? (Yes/No) 4. A consumer has purchased goods for resale. Can he file complaint? (Yes/No) 36.8 ANSWERS TO 'CHECK YOUR PROGRESS' 1. False; 2. True; 3. Yes; 4. No. 36.9 MULTIPLE CHOICE TERMINAL QUESTIONS 1. 'N. has purchased a draft from a bank favouring 'B'. The draft is lost in transit and for duplicate draft in lieu of first bank need some formalities to be completed by 'N'. Can 'B' file a consumer case against the formalities as it is delaying payment to him. (a) No, as he is not consumer of the bank and is not taking any service from the bank. (b) No, as he has not paid the demand draft commission. (c) Yes, as because of bank, his payment is getting delayed. (d) Yes, his money is lying in the bank, he is deemed as account holder of the bank. Ans. 1. (a)

UNIT

37
STRUCTURE
37.0 37.1 37.2 37.3 37.4 37.5 37.6 37.7 37.8 37.9 Objective Introduction

CONSUMER PROTECTION COUNCILS

Central Consumer Protection Council Procedure for Meeting of the Central Council Objects of the Councils State Consumer Protection Council District Consumer Protection Council Let Us Sum Up Check Your Progress Answers to 'Check Your Progress'

37.10 Multiple Choice Terminal Questions

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37.0 OBJECTIVE The objective of this unit is to understand the appointment and functions of the consumer councils appointed. They have to discharge the functions and use their power keeping in mind the purpose of the enactment to protect the rights of the consumers. 37.1 INTRODUCTION To promote and protect the right of the consumer councils are established. Their scope is not regarding directly dealing with the consumer complaints at initial or appellate scope but to promote and protect the rights of consumer. The function is more of promoting the rights and spreading awareness by education. The highest council is the Central Council who has the jurisdiction for the entire country. Then below it is the State Council for each state. Below that is the District Council for each district. This unit gives the provisions for establishment of these councils, their objects and procedure for their meetings. 37.2 CENTRAL CONSUMER PROTECTION COUNCIL The Central Government has established a council known as the Central Consumer Protection Council, called as Central Council. The Central Council shall consist of the following: (i) The Minister-in-Charge of the Consumer Affairs in the Central Government, who shall be the Chairman of the Council, and (ii) Such number of other official or non-official members representing such interests as may be prescribed. 37.3 PROCEDURE FOR MEETING OF THE CENTRAL COUNCIL The Central Council shall meet as and when necessary but at least once in a year. For transacting the business of the meeting the procedure shall be as may be prescribed. 37.4 OBJECTS OF THE COUNCILS The objects of the Council shall be to promote and protect the rights of the consumers such as (i) the right to be protected against the marketing of goods and services which are hazardous to life and property; (ii) the right to be informed about the quality, quantity, potency, purity, standard and price of goods or services so as to protect the consumer against" unfair trade practices; (iii) the right to be assured wherever possible for access to a variety of goods and services at competitive price; (iv) the right to be heard and to be assured that consumers' interests will receive due consideration at appropriate forums; (v) the right to seek redressal against unfair trade practices or restrictive trade practices or unscrupulous exploitation of consumers; and (vi) the right to consumer education. 37.5 STATE CONSUMER PROTECTION COUNCIL The State Government shall establish Consumer Protection Councillor the State Council by issuing a notification. The State Council shall consist of following members:

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(i) the Minister-in-Charge of the Consumer Affairs in the State Government who shall be the Chairman of the Council, (ii) such number of official and non-official members representing such interests as may be prescribed by the State Government, (iii) such number of other official and non-official members not exceeding ten, as may be nominated by the Central Government. The State Council shall meet as and when necessary. There has to be at least two meeting every year. For transacting the business of the meeting the procedure shall be as may be prescribed by the State Government. 37.6 DISTRICT CONSUMER PROTECTION COUNCIL 1. For every district the State Government establishes the District Consumer Protection Council called as District Council. The District Council shall consist of following members: (i) the Collector of the district who shall be the Chairman of the Council, (ii) such number of other official and non-official members representing such interests as may be prescribed by the State Government. 2. The District Council shall meet as and when necessary. There has to be at least two meeting every year. For transacting the business of the meeting the procedure shall be as may be prescribed by the State Government. 37.7 LET US SUM UP Central Government has to establish Central Council and notify the same. It consists Minister-inCharge of the Consumer Affairs in the Central Government and such other persons as the government may prescribe. In similar way State Government has to establish State Council and District Council. Compositions of State Council and District Council are different and as laid down in the section. 37.8 CHECK YOUR PROGRESS 1. Central Consumer Protection Council is the apex council having all India jurisdiction. (True/ False) 2. Minister-in-Charge of consumer affairs in the Central Government is the Chairman of Central Consumer Protection Council. (True/False) 3. State Consumer Protection Council is appointed by Central Government. (True/False) 4. State Consumer Protection Council has to meet at least __________ in a year.

37.9 ANSWERS TO "CHECK YOUR PROGRESS'


1. True; 2. True; 3. False; 4. Twice. 37.10 MULTIPLE CHOICE TERMINAL QUESTIONS

1. Who is the Chairman of the Central Consumer Protection Council? (a) Chief Justice of the Supreme Court. (b) Judge of the Supreme Court appointed by the Chief Justice of the Supreme Court. (c) Minister-in-Charge of Law and Judiciary in the Central Government. (d) Minister-in-Charge of Consumer Affairs in the Central Government. Ans. 1. (d)

CONSUMER DISPUTES REDRESSAL AGENCIES

STRUCTURE
38.0 38.1 38.2 38.3 38.4 38.5 38.6 38.7 38.8 38.9 38.10 38.11 38.12 38.13 38.14 38.15 38.16 38.17 38.18 38.19 38.20 38.21 38.22 38.23 38.24 38.25 Objective Introduction Establishment of Consumer Disputes Redressal Agencies Composition of District Forum Jurisdiction of District Forum Form of Complaint Procedure on Admission of Complaint Finding of the District Forum Appeal Composition of the State Commission Jurisdiction and Procedure of State Commission Transfer of Cases Appeals Composition of the National Commission Jurisdiction and Powers of National Commission TVansfer of Cases Finality of Order if no Appeal is Preferred Limitation Period Enforcement of Orders Dismissal of Frivolous or Vexatious Complaints Penalties and Protections Service of Notice Let Us Sum Up Check Your Progress Answers to 'Check Your Progress' Multiple Choice Terminal Questions

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38.0 OBJECTIVE In this unit we are looking at different agencies that function for redressal of the complaints of the consumers. The purpose of the Act itself is the protection of the consumer interest. Therefore the functions of these agencies have much significance. 38.1 INTRODUCTION For resolving and dealing with the consumer complaints different fora are established at district level, state level and national level. These forums have different laid down composition. They have to work and deal with the complaints in the prescribed manner. Their jurisdiction and powers are decided. All these aspects are laid down in the Act in detail giving full procedural particulars. In this unit, we will see these issues. They are on various aspects and with minute details. 38.2 ESTABLISHMENT OF CONSUMER DISPUTES REDRESSAL AGENCIES 1. For the purposes of this Act, there shall be following agencies established by the state government or the Central Government, as the case may be. (i) District Forum established by the state government at each district. The government may establish more than one District Council for any district, (ii) State Commission established by the state government for the state, (iii) National Commission established by the Central Government. 38.3 COMPOSITION OF DISTRICT FORUM 1. Each District Forum shall consist of following: A. A person who shall be or has been qualified to be a District Judge, who shall be the President of the District Forum. B. Two other members, one of whom shall be a woman having qualifications as under: (i) be not less than thirty-five years of age, (ii) possess a bachelor's degree from a recognised university, (iii) be person of ability, integrity and standing, and have adequate knowledge and experience of at least ten years in dealing with problems relating to economics, law, commerce, accountancy, industry, public affairs or administration. 2. Every appointment as member of the District Forum has to be made by the state government on the recommendations of the selection committee consisting of the following: (i) the President of the State Commission, who shall be the Chairman of Selection Committee, (ii) Secretary, Law Department of the state, who shall be the member of Selection Committee, (iii) Secretary-in-Charge of the department dealing with Consumer Affairs in the state, who shall be the member of Selection Committee. If for any reason the President of the State Commission is absent or otherwise, the state government may refer the matter to the Chief Justice of the High Court for nominating a sitting Judge of that High Court to act as Chairman. 3. Every member of the District Forum shall hold office for a term of five years or up to the age of sixty-five years, which ever is earlier. If the member fulfils the qualifications of appointment, he may be reappointed on expiry of initial term of five years. A member may resign from his office in writing under his hand addressed to the state government.

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4. The salary or honorarium and other allowance payable to, and other terms and conditions of service of the member, of the District Forum shall be such as may be prescribed by the state government. 38.4 JURISDICTION OF DISTRICT FORUM 1. Subject to the other provisions of the Act, the District Forum has jurisdiction to entertain complaints where the value of the goods or services and the compensation, if any, claimed does not exceed Rs. 20 lakh. 2. A complaint has to be instituted in a District Forum within the local limits of whose jurisdiction (i) the opposite party actually and voluntarily resides or carries on business or has a branch office or personally works for gain, or (ii) the cause of action, wholly or in part arises. Anyone of opposite parties reside provided District Forum gives permission or party not residing acquiesce in such institution. 38.5 FORM OF COMPLAINT 1. A person aggrieved by any service or whereas consumer his interests are not observed or followed, he can file a complaint. The details about filing such complaint for which the complaint can be filed are as under: 1. A complaint in relation to, (i) any goods sold or delivered; or (ii) agreed to be sold or delivered; or (iii) any service provided; or (iv) any service agreed to be provided may be filed with the District Forum by, (a) the consumer to whom any goods sold or delivered or agreed to be sold or delivered or any service 'provided or any service agreed to be provided; (b) any recognised consumer association whether the consumer to whom any goods sold or delivered or agreed to be sold or delivered or any service provided or any service agreed to be provided is a member of such association or not; (c) one or more of the consumers where there are numerous consumers having same interest, with the permission of the District Forum, on behalf of or for the benefit of all consumers so interested; or (d) the Central Government or the state government, as the case may be, either in its individual capacity or as representative of interests of the consumers in general. 2. The recognised consumer association said above means any voluntary consumer association registered under the Companies Act, 1956 or any other law. 3. The complaint should be accompanied with the prescribed fee. 4. The District Foram has to ordinarily decide within twenty-one days from the date of receipt of the complaint about its admissibility. The complaint cannot be rejected without hearing the complainant. 5. Once the complaint is admitted by the District Foram it cannot be transferred to any other Court or Tribunal or any authority set up under any law. 38.6 PROCEDURE ON ADMISSION OF COMPLAINT 1. If the complaint admitted by the District Foram relates to any goods, the said Foram shall

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(i) Refer a copy of complaint within twenty-one days from the date of admission to the opposite party to give his version of the case. The opposite party is required to give his version within thirty days or extended period of not more than fifteen days. (ii) If the opposite party denies or disputes the allegation contained in the complaint or fails to submit any of his version, then the consumer dispute is dealt with further as provided herein. (iii) Where the complaint alleges a defect in the goods that cannot be determined without proper analysis or test of the goods, the District Forum shall obtain a sample of the goods from the complainant and refer the sample in sealed condition to the appropriate laboratory for analysis or test. The report of the laboratory is required to be received within forty-five days or extended period, if and as, allowed by the District Forum. The sample to be sent to the laboratory has to be sealed and authenticated by the District Forum as prescribed. (iv) Before the sample of the goods is sent to the laboratory for analysis or test the complainant is required to deposit the fees as may be specified for payment to the laboratory for analysis or test. (v) On receipt of the report from the laboratory about the analysis or test of the goods, copy of the laboratory report along with such remarks as the District Forum may feel appropriate are required to be sent to the opposite party. (vi) If any of the party to the complaint dispute in any way the report received from the laboratory about the analysis or test of the goods such party has to submit in writing his objections about the report. (vii) The District Forum after giving reasonable opportunity to both the parties to the complaint for giving their say on the report and the objections has to make appropriate orders thereon. 2. If the complaint relates to services or about the goods for which procedure given above cannot be followed, the District Forum shall refer a copy of the complaint to the opposite party to give his version of the case. The opposite party is required to give his version within thirty days or extended period of not more than 15 days. If the opposite party denies or disputes the allegation contained in the complaint or fails to submit any of his version, then the consumer dispute is settled: (a) on the basis of evidence brought to its notice by the complainant and the opposite party; or (b) ex parte on the basis of the evidence brought to its notice by the complainant where the opposite party has not appeared. (c) If the complainant fails to appear on the date of hearing the District Forum may either dismiss the complaint for default or decide it on merits. 3. No proceedings stated above can be called in question in any Court on the ground that the principles of natural justice have not been complied with. 4. Every complaint has to be heard as expeditiously as possible and there has to be attempt that the complaint is decided within three months from the date of receipt of notice by the opposite party. If the goods under reference to the complaint are required to be analysed or tested then the complaint should be decided within five months. Unless sufficient cause is shown for adjournment and noted in writing, adjournment is ordinarily not granted in proceedings under this Act. The District Forum has to impose cost for the adjournment on the party concerned. If the time limits prescribed above for disposal of any dispute is not observed and the dispute is decided beyond the stipulated time then the District Forum has to mention the reasons for delay while disposing the case. 5. If the District Forum feels appropriate, it can pass suitable necessary interim orders during tendency of any proceedings. 6. For the purposes of this section, the District Forum shall have the same powers as are vested in a

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Civil Court under the Code of Civil Procedure, 1908 while trying a civil suit in respect of the following matters: (i) the summoning and enforcing attendance of any defendant or witness and examining the witness on oath; (ii) the discovery and production of any document or other material object producible as evidence; (iii) the reception of evidence on affidavits; (iv) the requisitioning of the report of the analysis or test concerned from the appropriate laboratory or from any other relevant source; (v) issuing of any commission for the examination of any witness; and (vi) any other matter that may be prescribed. 7. Every proceeding before the District Forum shall be deemed to be a judicial proceeding within the meaning of Sections 193 and 228 of the Indian Penal Code and the District Forum shall be deemed to be a Civil Court for the purposes of 195 and chapter 26 of the Code of Criminal Procedure.

38.7 FINDING OF THE DISTRICT FORUM 1. If after the proceedings under Section 113 are conducted and, the District Forum is satisfied that, (i) the goods complained against suffer from any of the defects specified in the complaint, or (ii) any of the allegations made in the complaint about the service are proved; it shall issue an order to the opposite party directing him to do one or more of the following things to: 1. remove the defect pointed out by the laboratory from the goods in question; 2. replace the goods with new goods of similar description which shall be free from any defect; 3. return to the complainant the price or the charges paid by the complainant, as the case may be; 4. pay such amount as may be awarded by it as compensation to the consumer for any loss or injury suffered by the consumer due to the negligence of the opposite party and if deemed fit grant punitive damages; 5. remove defects in goods or deficiencies in the services in question; 6. discontinue the unfair trade practice or restrictive trade practice or not to repeat them; 7. refraining from offering hazardous goods for sale; 8. withdraw hazardous goods from being offered for sale; 9. cease manufacturing hazardous goods and to desist from offering services that are hazardous in nature; 10. pay such sum, which shall not be less than 5 per cent of the value of such goods sold or services provided as may be determined if loss or injury has been suffered by a large number of consumers who are not identifiable conveniently and pay to such consumer and utilise such sum so obtained as may be prescribed; 11. issue corrective advertisement to neutralise the effect of misleading advertisement at the cost of the opposite party responsible for issuing such misleading advertisement; 12. provide for adequate costs to the parties. 2. Every proceeding as said above has to be conducted by the President of the District Forum and at least one member of the Forum. 3. Every order made under this section has to be signed by the President and the member or members who conducted the proceedings. If the President and one member conduct the proceeding and they differ on any point, the point of difference has to be referred to the other member for hearing on such point and thereafter the opinion of majority shall be the order of the District Forum.

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4. The procedure relating to the conduct of the meetings of the District Forum, its sittings and other matters shall be as may be prescribed by the state government. In Narsuns Battery Manufacturing Company vs General Manager, Andhra Bank 1992 CPC 707 (NC), the National Commission has passed an order that bank asking from a small-scale industry main as well as collateral security four times the values of loan was within the bank's power of advancing money and asking for adequate security. The contention of the applicant-borrower that excessive security was asked and asking collateral security from a small-scale industry was against the guidelines of the IBA was not accepted by the National Commission. 38.8 APPEAL Any person aggrieved by the order passed by the District Forum may prefer as appeal to the State Commission within a period of thirty days from the date of order, in the form and manner as may be prescribed. The State Commission has the powers to condone delay in preferring an appeal on getting satisfied about the cause of delay. If the order of the District Forum involves payment of any amount by the person preferring the appeal, the appeal cannot be filed without payment of 50 per cent or the amount ordered to be paid or Rs. 25,000, whichever is less. 38.9 COMPOSITION OF THE STATE COMMISSION 1. Each State Commission shall consist of following: A. A person who is or has been Judge of a High Court, who shall be its President. His appointment has to be made only after consultation with the Chief Justice of the High Court. B. Not less than two other members and not more than such number of members as may be prescribed, one of whom shall be a woman having qualifications as under, (i) be not less than thirty-five years of age; (ii) possess a bachelor's degree from a recognised university; and (iii) be person of ability, integrity and standing, and have adequate knowledge and experience of at least ten years in dealing with problems relating to economics, law, commerce, accountancy, industry, public affairs or administration. However, not more than 50 per cent of the members shall be from amongst persons having a judicial background, i.e. minimum ten years knowledge and experience as presiding officer of District Court, Tribunal or equivalent level. 2. Every appointment as member of the State Commission has to be made by the state government on the recommendations of the Selection Committee consisting of the following: (i) the President of the State Commission, who shall be the Chairman of Selection Committee, (ii) Secretary, Law Department of the state, who shall be the member of Selection Committee, (iii) Secretary-in-Charge of the department dealing with Consumer Affairs in the state, who shall be the member of Selection Committee. If for any reason the President of the State Commission is absent or otherwise, the state government may refer the matter to the Chief Justice of the High Court for nominating a sitting Judge of that High Court to act as Chairman. 3. The jurisdiction, powers and authority of the State Commission may be exercised by Benches thereof. If the Members of the Bench differ on any point, the point has to be decided by majority. If there

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is equality in differing members, then the point of difference has to be referred to the President. The President may hear the point of difference himself or refer it to some other member for hearing. The point of difference has to be then decided by majority of the members who heard the case initially and after reference of difference. 4. Every member of the State Commission shall hold office for a term of five years or up to the age of sixty-seven years, which ever is earlier. But he will be eligible for appointment for another term of five years or up to the age of 67 years whichever is earlier. A member may resign from his office under his hand addressed to the state government. 38.10 JURISDICTION AND PROCEDURE OF STATE COMMISSION 1. Subject to the other provision of the Act the State Commission has jurisdiction (a) to entertain complaints where the value of the goods or services and compensation, if any, claimed exceeds Rs. 20 lakh but does not exceed Rs. 1 crore and appeals against the orders of any District Forum within the state, and (b) to call for the records and pass appropriate orders in any consumer dispute that is pending before or has been decided by any District Forum within the state where the State Commission is of the opinion that the District Forum has acted without jurisdiction or with material irregularity. 2. A complaint has to be instituted in a State Commission within the local limits of whose jurisdiction, (i) the opposite party actually and voluntarily resides or carries on business or has a branch office or personally works for gain, at the time of the institution of the complaint, or (ii) when one of opposite parties, do not reside or carry business then either with permission of State Commission or acquiescence of such party, (iii) the cause of action, wholly or in part arises. 3. For disposal of disputes by the State Commission same procedure, with necessary modifications, is applicable as given at Sections 12, 13 and 14 for District Forum. 38.11 TRANSFER OF CASES On the application of a complainant or on its own motion the State Commission may transfer any proceeding at any stage from one District Forum to another District Forum if in the interest of justice it so requires. 38.12 APPEALS 1. Any person aggrieved by the order passed by the State Commission may prefer as appeal to the National Commission within a period of thirty days from the date of order, in the form and manner as may be prescribed. The National Commission has the powers to condone delay in preferring an appeal on getting satisfied about the cause of delay. If the order of the State Commission involves payment of any amount by the person preferring the appeal, the appeal cannot be filed without payment of 50 per cent or the amount ordered to be paid or Rs. thirty-five thousand, whichever is less. 2. An appeal filed before the State Commission or the National Commission has to be heard as expeditiously as possible. There has to be an attempt to dispose appeal finally within a period of ninety days of its admission. Ordinarily no adjournment is granted. However the State Commission or the National Commission

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may grant adjournment on sufficient cause shown by the party seeking adjournment and the reasons are recorded. The Sta