Banking Law-Study Material

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BANKING LAW
Master in Business Laws
Banking Law
Course No: II
Module No: I - IX
Distance Education Department
National Law School of India University
(Sponsored by the Bar Council of India and Established
by Karnataka Act 22 of 1986)
Nagarbhavi, Bangalore - 560 072
Phone: 3211010 Fax: 080-3217858
E-mail: mbl@nls.ac.in
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CONTENTS
TOPICS
1. Structure and Functions of Commercial Bankers
and Financial Institutions (Module No. I) ................................................................... 3
2. Reserve Bank of India
Structure and Functions (Module No. II) .................................................................... 34
3. Law of Banking Regulations (Module No. III) ............................................................ 65
4. Negotiable Instruments:
Law and Procedure (Module No. IV & V) ................................................................... 119
5. Banker - Customer Relation (Module No. VI) ............................................................ 191
6. Advances, Loans and Securities (Module No.VII & VIII) ......................................... 228
7. Procedural Aspects of Banking Law (Module No. IX) ............................................... 271
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Banking Law
Course No: II
Module No: I
Structure & Functions
Of
Commercial Banks & Financial Institutions
Phone: 3211010 Fax: 080-3217858
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MATERIALS PREPARED BY:
1. MR.T.V. MOHANDAS PAI, F.C.A.
2. Prof. N.L. MITRA M.Com., LL.M., Ph.D.
MATERIALS CHECKED BY:
1. MS. ARCHANA KAUL LL.M.
2. Mr. SUPRIO DASGUPTA B.Sc.,LL.B.
MATERIALS EDITED BY;
1. MR. HARIHARA AIYAR LL.M., Former General Manager, SBI
2. Prof. P.C. BEDWA LL.M., Ph.D.
Published By:
National Law School of India University,
Post Bag No: 7201
Nagarbhavi, Bangalore, 560 072.
Printed At
Sri Vidya Printers, Bangalore Ph. 23445594
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INSTRUCTIONS
Basic Readings
The materials given in this course are calculated to provide exhaustive basic readings on topics and sub-topics
included in the course. Experts in the area have collected the basic information and thoroughly analysed the same
in topics and sub-topics. Lucid/supportive illustrations and leading cases are also provided. Relevant legislative
provisions are also included. Care has been taken to communicate basic information required for decision making
in problems likely to arise in the course-area. The reader is advised to read atleast three times. In the first reading
information provided are to be selected by making marginal notes using markers. The first reading, therefore,
necessarily has to be very slow and extremely systematic. While so reading the reader has to understand the
implications of those informations. In the second reading the reader has to critically analyse the material supplied
and jot down in a separate note book points stated in the material as well as the critical comments on the same. A
third reading shall be necessary to prepare a Check List so that the check list can be used afterwards for solving
problems like a ready reckoner. (The reader is required to purchase a Bare Act and refer to the relevant sections
at every stage.)
Supplementary Reading
Several supplementary readings are suggested in the materials. It is suggested that the reader should register with
a nearby public library like the British Council Library, the American Library, the Max Muller Bhavan, the
National Library, any University Library where externals are registered for the purpose of library reading, any
commercial library or any other public library run by Government or any private institution. Readers in Metropolitan
and other big cities may have these facilities. It is advised that these basic materials be photocopied, if necessary,
and kept in the course file. Supplementary readings are also required to be read more than once and marginal
notes, marking notes, analytical notes and check lists prepared. Any reader requiring any extra readings not
available in his/ her place may request the Course Coordinator to photocopy the material and send it by post for
which charges at the rate of .50 paise per page for photocopying and the postage charge shall be sent either by
M.O. or by Draft in advance. The Course Coordinator shall take prompt action on receiving the request and the
payment.
Case Law
The course material includes some case materials generally based upon decided cases. These cases are to be
studied several times for,
(a) understanding the issues to be decided (b) decisions given on each issue (c) reasoning specified
It is advised that while reading a case the reader should focus first on the facts of the case and make a self analysis
of the facts. Then he/she should refer the check list prepared earlier for appropriate information relating to law
and practice on the facts. Then the student should prepare a list of arguments for and on behalf of the plaintiff/
appellant. Keeping the arguments for the plaintiff/appellant in view of the reader should try to build up counter
arguments on behalf of the defendant/respondent. These exercise can take days. After these exercises are done
one has to prepare the arguments for or against and then decide on the issues. While deciding it may be necessary
often to evolve a guiding principle which also must be clearly spelt out. Subsequently the reader takes up the
decision given in the case by the judge and compare his/her own exercise with the judgment delivered. A few
exercise of this type shall definitely sharpen the logical ability, the analytical skill and the lawyering competence.
Though it is not compulsory, the reader may send his/ her exercises to the Course Coordinator for evaluation. On
receiving such request the Course Coordinator shall get the exercises evaluated by the experts and send the
experts comment to the students. Through these exercises one can build up an effective dialogue with the
experts of the Distance Education Department (DED).
Problems and Responses
After reading the whole module which is divided into several topics and sub-topics the reader has to solve the
problems specified at the end of the module. The module is designed in such a manner that a reader can take
about a weeks time for completing one module in each of the four courses. It is expected that after finishing the
module over a period of a week the student solves these problems from all possible dimensions to the issue. No
time limit is prescribed for solving a problem though it would be ideal if the reader fixes his/her own time limit
for solving the problem - which may be half an hour per problem - and maintain self discipline. While solving the
problems the candidate is advised to use the check list, the notes and the judicial decisions - which he/she has
already prepared. After completing the exercise the student is directed to send the same to Course Coordinator
for evaluation. Though there is no time stipulation for sending these responses a student is required to complete
these exercises before he/she can be given the certificate of completion to appear for final examination.
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STRUCTURE AND FUNCTIONS OF COMMERCIAL
BANKS & FINANCIAL INSTITUTIONS
TOPICS
1. The Evolution in Banking Services & its History in India. ........................................ 7
2. Role & functions of Banking Institutions. ................................................................... 11
3. Structure of Banking Institutions. ................................................................................ 18
4. Financial Institutions & their Functions. ..................................................................... 20
5. Industrial Development Bank. ...................................................................................... 24
6. National Bank for Agricultural & Rural Development. ............................................. 26
7. Unit Trust of India. ........................................................................................................ 27
8. Case Law. ........................................................................................................................ 29
9. List of Statutes. ............................................................................................................... 31
10. Problems. ......................................................................................................................... 32
11. Supplementary Reading ................................................................................................ 33
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SUB-TOPICS
1.1. Introductory Note.
1.2. History of Banking in India
1.3. Bank Nationalisation
1.4. Various types of Banking Services
1.5. Social control measures on bank
1.6. Narasimham Committee Report
1.7. Concluding Remark
1.1. INTRODUCTORY NOTE
In early societies functions of a Bank were done by the
corresponding institutions dealing with loans and advances. The
modern banking and its networking are the products of modern
western civilization which rapidly developed with the advent
of industrialization. Britishers brought with them this modern
concept of banking in India. The Bank of England was started
in 1694, when the Britishers were carrying on a long war with
France. In 1708, the monopoly and the right to issue notes was
given to Bank of England through an Act. Several joint stock
banking companies started operating early in the nineteenth
century. These banks primarily carried on functions which are
presently known as commercial functions like receiving money
on deposits, lending money, transferring money from place to
place and bill discounting. Banking has now presently become
a globally mobile service and it facilitates the capital movement
from one part of the country to another, one part of the globe
from another.
Obviously it is now difficult to understand the banking system
of a nation in isolation. The present Indian banking system is
required to be studied, viewed and reviewed in the context of
global banking trends.
1.2. HISTORY OF BANKING IN INDIA
Early History
Banking in India has a very hoary origin. The Vedic period has
literature which records the giving of loans to others. Banking
was synonymous with money lending. The Manusmrithi speaks
of deposits, pledges, loans and interest rate. Interest could be
legally charged at between two and five per cent per month in
order of class. The maximum amount of interest collectable on
the principal was laid down by the State. Usury was not allowed.
Payment of debt was made a pious obligation on the heir of a
dead person. With the growth of trade and commerce, the
trading community soon evolved a system of money transfer
throughout the country.
The main instrument through which banking and transfer of
funds was carried out was through the inland bills of exchange
or the Hundi. Indian bankers lent money, financed the rulers
and trade, acted as treasurers of the State and also as insurers of
goods. They also acted as money changers due to the differing
coins circulating all over India. Business developed so well
that certain castes or communities traditionally came to regard
banking as their family business. The power and prestige of
these banks rose and fell with the growth and decline of empires.
Jagirs were granted to select banks and some acted as revenue
collectors for local rulers. However, tenets of modern banking
were not practised as acceptance of deposits was not a regular
part of the business.
Modern History
Modern banking in India began with the rise to power of the
British. The British consolidated their power and became the
most powerful force in India after vanquishing Tipu Sultan in
the battle of Srirangapattanam in 1799. The quest for power
by Lord Mornington (Later Marquess of Wellesly). Governor
General of Fort William in Bengal at that time led to a serious
depletion of the resources of the East India Company. This led
to the Company promoting the Bank of Calcutta in 1806 to
raise resources.
The situation prevailing at that time could be known by the
writing of some Britishers, C.N. Cooke, Deputy Secretary and
Treasurer of the Bank of Bengal, writing in his book Banking
in India, has stated that usury prevailed in India more than in
any other country in the nineteenth century. The native money
lender lent to the farmers at 40, 50 and 60 per cent interest.
The European community was relatively better off. He
attributed the very high rates to the riskiness of many of the
lendings and the difficulties in realising them.
Indian businessmen very often acted as lender to the European
businessmen with a rate of interest lower than the market rate.
Till the advent of the three Presidency Banks, the European
Agency Houses acted as bankers. They accepted deposits from
British Officers serving in India and Europeans who had served
in India and had returned to Europe. They financed trade with
such funds and at certain times even helped the Government.
There was a very effective credit network for flow of funds
from one part of India to the other provided by the Indian
banking firms.
As the Agency Houses had prospered they also sought to operate
Banks. Alexander & Company a leading Agency House started
managing the Bank of Hindustan from 1770s. The exact date
of the founding of that bank is not known. The Bengal Bank
and the General Bank of India, too, were started by the other
Agency Houses in Bengal in the eighteenth century. In 1819
the Commercial Bank and in 1824 the Calcutta Bank were
floated by the Agency Houses. None of these banks enjoyed
limited liability nor were they proper joint stock banks. They
were partnership firms with unlimited liability.
The concept of limited liability was not put on the statute books
till the 1860 Companies Act. Till that date Banks had to either
obtain a special Charter from the Crown to operate or had to
operate under unlimited liability.
1. THE EVOLUTION OF BANKING SERVICES AND
ITS HISTORY IN INDIA
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The Bank of Calcutta started in 1806 was the precursor of the
Bank of Bengal. In 1862 the right of note issue was taken
away from the Presidency Banks. The Government also
withdrew their nominees as Directors on their Board. However,
they were given the privilege of managing the Government
treasury at the Presidency Towns and at their branches.
The Bank of Bombay collapsed in 1867 and was put into
voluntary liquidation in early 1868. It was finally wound up in
1872, but the bank was able to meet its liability in full to the
general public.
Subsequently a new bank, aptly called the New Bank of
Bombay, was started in 1867 to commence banking operations.
The Presidency Banks Act of 1876 was passed in order to have
a common law for all the three Banks in order to enable the
government to regulate the working of these Banks. The
Government had earlier withdrawn its shareholding from these
three banks.
The Swadeshi Movement which prompted Indians to start many
new institutions also provided an impetus for starting new banks.
The number of joint stock banks increased remarkably during
the boom of 1906-13. The Peoples Bank of India Ltd., The
Bank of India, The Central Bank of India, Indian Bank Ltd.
and the Bank of Baroda were started during this period. This
boom continued till it was overtaken by the crash of 1913-17,
the first crisis that the Indian joint stock banks experienced.
In 1921 the three Presidency Banks at Calcutta, Bombay and
Madras were merged into the Imperial Bank by the passing of
the Imperial Bank of India Act 1920. This bank did not have
the power of issuing bank notes,but was permitted to manage
the clearing house and hold government balances. With the
passing of the Reserve Bank of India Act of 1934, the Reserve
Bank of India came into being to act as the Central Bank. It
acquired the right to issue notes and acted as the banker to the
Government in place of the Imperial Bank. However, the
Imperial Bank was given the right to act as the agent of the
Reserve Bank of India in places where the Reserve Bank had
no branches.
By the passing of the State Bank of India Act 1955, the Imperial
Bank was taken over and the assets vested in a new bank, the
State Bank of India.
The Reserve Bank was originally a shareholders bank. It was
nationalised by the Reserve Bank Amendment Act 1948,
consequent to the nationalisation of the Bank of England in
1946.
1.3. BANK NATIONALISATION
The major historical event in the history of banking in India
after independence is undoubtedly the nationalisation of 14
major banks on 19th July 1969. The imposition of social control
on the banks in early 1969 was deemed unsuccessful as the
government felt that the Indian commercial banks did not
increase their lending to the priority sectors like agriculture,
small scale industry etc., Nationalisation was deemed as a major
step in achieving the socialistic pattern of society.
The nationalised banks were to increase lending to areas of
importance to the government and to use their resources for
subserving the common good. A detailed scheme of objectives,
regulations, management, etc. was drawn up for these banks.
In 1980 six more private sector banks were nationalised
extending the public domain further over the banking sector.
Nationalisation was a recognition of the potential of the banking
system to promote broader economic objectives. The banks
had to reach out and expand their network so that the concept
of mass banking was given importance over class banking.
Development of credit in the rural area was a prime objective.
The benefits of nationalisation has indeed been impressive. The
branch network of these banks have spread practically all over
the country especially in the rural and previously unbanked
areas. The branch network which was 8262 in June 1969
expanded to over 60000 by 1992 with a major expansion (80%)
in rural areas. The average number of people served by a branch
came down from over 60000 to 11000. The deployment of
credit is more widely spread all over the country as against
only in the advanced states. In 1969 deposits amounted to 13%
of G.D.P and advances to 10%. By 1990 deposits grew to 30%
and advances 25% of G.D.P. Rural deposits as a percentage of
deposits grew from 3% to 15% making for increased
mobilisation of resources from the rural areas. Deposits grew
from a figure of Rs.4669 crores in July 1969 to Rs. 2,75,000
crores on 31.3.1993. 40% of the total credit was directed to the
priority sector. More than 45% of the total deposits was used
by the government to fund its five year plans.
However, this growth did not come without its costs. The
banking system has grown too large and unmanageable.
Customer service has suffered due to increasing costs and lower
productivity. The directed credit program has led to large
overdues affecting the very viability of the banking system.
1.4 VARIOUS TYPES OF BANKING SERVICES
The flow chart given below shows the following types of
banking services.
1. Central Banking Services
2. Commercial Banking Services
3. Specialized Banking Services
4. Non-banking financial services.
1. Central Banking Services : The Central Bank of any
country (i) issues currency & bank notes; (ii) discharges the
treasury functions of the Government, (iii) manages the money
affairs of the nation & regulates the internal and external value
of money, (iv) acts as the bank of the Government and last but
not the least, acts as the bankers bank.
2. Commercial banking services: Commercial banking
services include (i) receiving various types of deposits; (ii)
giving various types of loans, (iii) extending some non-banking
customer services like facilities of locker, rendering services in
paying directly house rent, electricity bill, share-calls, money
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or insurance premium and the like. Commercial bank also
advises on investment re-investment, allotment or transfer of
funds.
3. Specialized banking services : Special banking institutions
are established for definite specialized banking services like
industrial banks to supply industrial long term credit and
working capital; land mortgage bank for granting loans on
equitable mortgage; Rural Credit Banks for generating funds
for extending rural credit; developmental banks to support any
developmental activities. These types of banks accept all types
of deposits but mobilises the amount in its specially focussed
area.
4. Non-Banking Financial Services: Many institutions are
established for carrying on non-banking financial services.
Mutual funds are institutions accepting finances from its
members and investing in long term capital of companies both
directly in the primary market as well as indirectly in the capital
market. Financial institutions acting as portfolio managers
receive funds from the public and manage the funds for or on
behalf of its depositors. This port-folio managers undertake
the responsibility of managing the funds of the principal so as
to generate maximum return.
1.5. SOCIAL CONTROL MEASURES ON BANK
The Indian economy in the 1960s passed though a stressful
phase due to drought and wars. Political uncertainty and popular
discontent too caused concern. The Government veered around
towards ensuring a socialistic pattern of society. The Banking
Regulation Act was amended in 1968 to provide for social
control over the banks. Under these measures the Board of
Directors of the banks were reconstituted so that 51% of their
number was made of persons having special knowledge or
experience in accountancy, agriculture, rural economy, small
scale industry, co-operation, banking, economic laws etc. A
quota was specified for certain categories. The Reserve Bank
of India (RBI) was given powers to reconstitute the Board. A
full time Chairman was to be appointed who was a professional
banker, with prior approval of the RBI. The Government also
acquired power to acquire any bank in case it failed to comply
with any direction issued to it under the Banking Regulation
Act, as regards banking policy.
1.6 THE NARASIMHAM COMMITTEE REPORT:
The 1980s were the decade of private enterprise all over the
world. The collapse of the USSR at the end of the 1980s is the
end of one experiment of socialism. In India the country went
through traumatic moments in 1990, after the heady economic
growth in the 1980s, due to a foreign exchange crisis on account
of large scale external borrowings in the 1980s, that had
weakened the countrys ability to service its debts.
The government felt that there was a need to initiate reform in
the financial system and banks, as the system had developed
weaknesses. A great part of the savings of the community was
pre-empted by the Government in the form of the Cash Reserve
Ratio (CRR) and the Statutory Liquidity Ratio(SLR). Banks
were burdened by a large percentage of non- performing loans.
Customer service had suffered, and out-moded practices were
in vogue. Internal weakness due to bad house-keeping practices
had increased. The Narasimham Committee was set up to
recommend changes in the financial system.
The Narasimham Committee made revolutionary
recommendation emphasising the need for de-regulation and
Commercial Specialised Institutional Non-Banking
Banks Banks Banks Financial Institutions
Land Mortgage
Rural Credit
Industrial Development
Co-operative
Housing Finance
Export Import
Bank of India
Mutual Funds
UTI
Other MF
and LIC,
GIC
Bank &
Can Bank
Private Sector
Non-Banking
Financial Com.
Various Types of Banks and Banking Functions
Central Bank
IFCI
SFCs
IDBI
ICICI
IRBI
NABARD
HDFC
Nationalised State Bank
Banks (20) LIC Of India &
Associate
Bank
Private Banks
Indian Foreign
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liberalisation. Banks were to be allowed to raise capital from
the public. Also no further nationalisation of banks were to be
made. New private sector banks were to be allowed and no
distinction was to be made between private and public sector
banks. Foreign banks were to be allowed freedom to open
branches. The pattern of banking structure should be broadened
with 3-4 large banks on a international level 8-9 large banks on
a national level and the other as local banks. Control over the
banking system should be centralised with the RBI and not split
between the RBI and the department of banking of the
government. A separate body, quasi autonomous, operating
under the aegis of the RBI is to be formed to supervise the
functioning of the banks. The SLR and the CRR should be
reduced to prudent levels. Concessional lending should be
phased out. Deposit interest rates should be raised along with
the reduction of SLR. The capital base of banks should meet
with international norms of capital adequacy; provision was to
be made for bad debts with special tribunals to be formed for
realising bank debts. The appointment of Chief Executive of
banks needs to be de-politicised and banks should be free to
make their own recruitment of employees and officers.
Some of the recommendations made have already been accepted
and put into practice by the government while others are being
considered.
The wheel appears to have come full circle. While
nationalisation has given immense benefits to the country, it
has also exposed the defects in an excess of State control. At
this present point, the future appears to be towards an open
system based on increased private ownership.
1.7. CONCLUDING REMARKS
The banking system in India is likely to undergo a major change.
Restrictions imposed upon foreign banks to establish Indian
branches are going to be gradually withdrawn. The GATT
multilateral treaty emphasised the role of free operations in the
services sector like banking and insurance. As a result, it is
expected that there shall be more openings in the banking sector.
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SUB-TOPICS
2.1. Role and functions of Central Bank
2.2. Advances to priority sectors and the credit guarantee
schemes
2.3. Role & functions of Commercial Banks
2.4. Role & functions of Specialised and Institutional Banks
2.5. Role & functions of non-banking financial institutions
2.1. ROLE AND FUNCTIONS OF CENTRAL BANKS
Central Bank:
Central Bantral Bank is an apex financial authority. The
essential feature of a Central Bank is its discretionary control
over the monetary system of the country. It occupies a pivotal
position in the monetary and banking structure of the country.
Thus it acts as the leader of the money market and in that
capacity, it controls, regulates and supervises the activities of
the Commercial banks. It is recognised as the highest financial
authority and is a symbol of financial sovereignty and stability
of the country. It holds the ultimate resources of the nation
controls the flow of purchasing power and acts as the banker to
the State.
The principles on which a Central Bank operates are different
from the ordinary banking principles to the extent that :
a. The Central Bank unlike an ordinary Bank does not operate
with the motive or objective of making a profit but is
primarily meant to shoulder the responsibility of safe-
guarding the financial and economic stability of the country.
b. The Central Bank being the reservoir of Credit and lender
of last resort cannot look to or rely on other banking
institutions to come to its aid in case of need and has to
therefore keep its assets as liquid as possible so that other
banks and financial institutions can approach it for
accommodation.
c. The credit machinery of the country needs to be stabilised
quite often. This is done by the Central Bank by
manipulating the bank rate and open market operations.
This power is vested only in the Central Bank.
Functions of Central Bank:
The functions of the Central Bank are briefly discussed below.
A Central Bank acts in the following capacities.
(i) As a currency issuing agency;
(ii) As a banker to the State;
(iii) As a bankers bank;
(iv) As the lender of last resort;
(v) As the guardian of the money market through credit control;
(vi) It undertakes exchange control operations and maintains
the external value of the domestic currency and ensures
the stability of the internal value of currency;
(vii)Ensures economic stability and promotes economic
development; and
(viii) Currency printing and management of mints.
[Details of the functions of the Central Bank in India i.e. the
Reserve Bank of India are discussed in the module on RBI.]
2.2 ADVANCES TO PRIORITY SECTORS AND
CREDIT GUARANTEE SCHEMES
One of the major deficiencies in the banking system in the 60s
related to granting of advances. Bulk of the advances were
being directed to the large and medium scale industries and big
and established business houses while agriculture, small scale
industries and exports were not receiving adequate attention, if
not being neglected. The Reserve Banks credit policy of 1967-
68 sought to set right this anomaly in the system by channelising
the flow of credit to the emerging priority sectors of the economy
in the larger interests of the country. Though the emphasis of
the 1967 credit policy was on overall restraint certain
liberalisation was allowed on a selective basis with a view to
enlarge the flow of credit to the areas of agriculture, exports
and small scale industries. The banks were encouraged to
increase their involvement in lending to the priority sectors by
the extension of various relaxations and incentives in the form
of refinance from the RBI at a concessional rate of interest or
on other special terms not available for other bank lendings.
In order to provide an incentive to lending to small borrowers
the RBI set up the Credit Guarantee Corporation of India Ltd.
in 1971. This institution is now named as the Deposit Insurance
and Credit Guarantee Corporation. The main objective of this
Corporation is to administer a comprehensive credit guarantee
scheme for loans by banks to small individual borrowers in the
priority and other neglected sectors. There are various schemes
in operation which provide cover for direct lendings to small
borrowers who without such support would find institutional
credit highly inaccessible.
The recommendations of the Tandon committee, which went
into the working of the special credit schemes of Commercial
Banks with special reference to their employment potential led
the RBI to issue a set of guidelines which emphasised on need-
based assistance to different categories of self-employed
persons. Banks were asked to make efforts to arrange integrated
financial and management assistance to borrowers, taking into
account the totality of their requirements and the viability of
the proposition being financed.
Since 1977-78, export credit has been excluded for the purposes
of computation of the total priority sector advances of banks,
but it has continued to receive preferential treatment in matters,
such as, refinance facilities from the Reserve Bank, concessional
rates of interest on pre-shipment and post-shipment credit to
exporters etc.
2. ROLE AND FUNCTIONS OF BANKING INSTITUTIONS
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The flow of credit to the neglected sectors were boosted by the
directive of the Government of India in November 1974 to
public sector banks whereby, priority sector lending was to reach
a level of not less than one-third of their outstanding credit by
March 1979.
In March 1980, the Government of India took two major
decisions :-
1) To raise the proportion of advances to the priority sectors
by public sector banks from 33 1/3% to 40% by 1985; and
2) The implementation of the 20 point programme to be
actively promoted by banks.
The Reserve Bank also set up a working committee on priority
sector lending and 20 point economic programme to work out
the modalities of implementation of the above decisions of the
government. Based on the recommendations of the working
group, the RBI issued instructions for implementation. Some
of the important instructions were :-
a) Priority sector advances should constitute 40% of aggregate
bank advances by 1985.
b) 40% of priority sector advances to be earmarked for
agriculture and allied activities.
c) Direct advances to weaker sections in agriculture and allied
activities should reach a level of at least 50% of the total
direct lending to agriculture.
d) Advances to rural artisans, village craftsmen and cottage
industries should constitute 12.5% of the total advances to
small scale industries by 1985.
A series of measures taken with the aim of encouraging the
commercial banks to cater to the credit requirements of the
neglected sectors, particularly the weaker sections of the society
led to the formation of the Credit Guarantee Corporation of
India Ltd.
This is a public limited company floated by the Reserve Bank
of India on 14th January 1971.
The Corporation was visualised as an agency to provide a simple
but wide-ranging system of guarantees for loans granted by the
Credit institutions to small and needy borrowers.
The Corporation has introduced several schemes to cater to the
small borrowers in the non-industrial sector like the Small Loans
Guarantee Scheme 1971; the Small Loans (Financial
Corporations) Guarantee Scheme 1971 and the Small Loans
(Service Co-operative Societies) Guarantee Scheme 1971.
After the take over by the Deposit Insurance Corporation in
July 1978 a fourth scheme was introduced by the Deposit
Insurance and Credit Guarantee Corporation of India Ltd.,
known as the Small Loans (Small Scale Industries) Guarantee
scheme 1981. DICGC is the new name given to Deposit
Insurance Corporation after its take over of the Credit Guarantee
Corporation.
In addition to the above, various other schemes were introduced
for the benefit of the priority sectors like the :-
a) National Rural Employment Programme (NREP) which
basically dealt with the problem of unemployment and
underemployment in the rural areas.
b) Rural Landless Employment Guarantee Programme
(RLEGP) more specifically to tackle the problem of
unemployment among the landless and to create durable
assets for strengthening the rural infrastructure.
c) Crop Insurance Scheme - to provide a measure of financial
support to farmers in the event of crop failure as a result of
natural calamities, to support and stimulate production of
cereals, pulses, oilseeds, etc.
d) Self-employment Scheme for Educated Unemployed Youth
(SEEUY)- to encourage educated unemployed youth to
undertake self-employment ventures in industry, services
etc; and
e) Self-employment Programme for Urban Poor (SEPUP) to
provide self employment to the urban poor.
2.3. ROLE AND FUNCTIONS OF COMMERCIAL
BANKS
The following chart shows the Commercial banking system in
India
Scheduled
Representative Offices
State Bank
of India
Associates of
State Bank of
India
Other
Nationalised
Banks
Private Sector
Public Sector
Scheduled
Non scheduled
Foreign Banks
Indian Banks
Commercial Banking system in India
13
A Scheduled Bank is one which is included in the second
schedule of the RBI Act. A non scheduled Bank is one which is
not included in that schedule.
Utility of Banking Institutions
Banks are extremely useful and indispensable institutions for a
modern community. They are the custodians and distributors
of liquid capital the essential ingredient for commercial and
industrial activities. The utility of banks can be summarised as
follows :-
a) The banks create purchasing power, in the form of bank
notes, cheques, bill, drafts, etc. and economise the use of
metallic money which is very expensive and cumbersome.
b) Banks transfer funds, by bringing lenders and borrowers
together, and by helping funds to move from place to place
and from person to person in a convenient and inexpensive
manner, through the use of cheques, bills and drafts. In
this way, they help trade and industry.
c) The banks encourage the habit of saving among the people
and enable small savings, which otherwise would have been
scattered ineffectively, to be accumulated into large funds
and thus made available for investments of various kinds.
In this way, they promote economic development through
capital formation.
d) By encouraging savings and investment, the banks increase
the productivity of the resources of the country and thus
contribute to general prosperity and welfare by promoting
economic development.
e) The banks agency functions are very useful to the customers
of the bank. They undertake to make payments of various
kinds on behalf of their customers and also make several
types of collections on their behalf.
Thus, banks are useful to both the community in general and
the individual customer in particular.
Role of Banks in the Socio-economic development
Banks play a vital role in the economic development of the
country as explained hereunder :
i) Banks promote capital formation :
In any plan of economic development capital occupies a position
of crucial and strategic importance. Unless there is an adequate
degree of capital formation, economic development is not
possible. Deficiency of capital is a result of inadequate savings
made by the community. The serious handicaps in economic
development arise from capital deficiency. This is where the
banks can play an useful role in making up the deficiency.
The role of banks in economic development is to remove the
deficiency of capital by stimulating savings and investment. A
sound banking system mobilises the small and scattered savings
of the people and makes them available for investment in
productive enterprises. In this connection, the banks perform
two important functions.
a) they attract deposits by offering attractive rates of interest,
thus converting savings which would have remained idle,
into active capital; and
b) they distribute these savings through loans among
enterprises which are connected with economic
development.
ii) Optimum Utilisation of Resources :
In the absence of banks, it would have been very difficult to
mobilise the small savings of the people and distribute these
saving among entrepreneurs. It is through the agency of the
banks that the communitys savings automatically flow into
channels which are productive. The banks exercise a degree of
discrimination which not only ensures their own safety but also
makes for optimum utilisation of the financial resources of the
community.
iii) Financing the priority sectors :
In order to meet additional demands arising out of economic
development, the banking system has undergone changes in its
structure and organisation. The banks and financial institutions
operate in such a manner as to confirm to the priorities of
development and not in terms of return on their capital. The
banks now play a more positive role. Thus, the central bank
does not merely stop at playing a regulatory role i.e., regulation
of bank credit but it also plays a developmental role. It helps to
create a machinery or agency for financial development plans.
It ensures that the available finance is diverted to the right
channels. For successful implementation of the development
programmes, it becomes necessary to make credit facilities
available to high priority sectors and to see that the available
funds are not squandered away in non-essential or non-plan
expenditure.
iv) Banks promote Balanced Regional Development :
By opening branches in backward areas the banks make credit
facilities available there. Also, the funds collected in developed
regions through deposits may be channelised for investment in
the under developed regions of the country. In this way, they
bring about more balanced regional development.
v) Expansion of Credit :
To maintain a high level of economic activity, it is imperative
that credit must expand. In an era of economic developments,
banks create credit more liberally and thereby make funds
available for the development of various projects. Thus, banks
make a valuable contribution to the speed and the level of
economic development in the country.
vi) Banks promote growth with stability :
Banks regulate the rate of investment by influencing the rates
of interest. The primary function of the Reserve Bank of India
was to regulate the issue of bank notes and keep adequate
reserves to ensure monetary stability. Now, it has assumed wider
14
responsibility to help in the task of economic development. In
addition to regulating currency and controlling credit, the RBI
has been playing a vital role in the financing and supervision of
the development programmes for agriculture, trade, transport
and industry. It has created special funds for promoting
agricultural credit and has created special Institutions for
widening facilities for industrial finance. The other banks too
have cooperated in these areas by opening new branches to tap
the savings of the people and lend them to entrepreneurs.
Thus, banks come to play dominant and useful role in promoting
economic development by mobilising the financial resources
of the community and by making them flow into desired
channels.
In recent years, commercial banks in India have been adopting
the strategy of innovative banking in their business operations.
This implies the application of new techniques, new methods
and novel schemes in the areas of deposit mobilisation,
deployment of credit and bank management. To attract more
deposits, Banks have introduced many attractive saving
schemes such as education deposit plan, perennial pension plan
retirement schemes, loan linked recurring deposit schemes etc.,
Mobile bank branches have also been introduced by a number
of banks. Innovations have also been made in the credit side by
introducing education loan schemes, housing finance, credit
cards, packing credit and post shipment credit for exporters,
consumer credit, which pool the investors funds for investing
in a diversified portfolio of securities so as to spread and reduce
risks.
In addition to various activities like innovative banking,
promoting entrepreneurship, retail banking and rural
development, the commercial banks have promoted various
schemes like advances to priority sectors and credit guarantee
schemes. These are discussed in the role and functions of
specialised banks.
2.4 ROLE AND FUNCTIONS OF SPECIALISED AND
INSTITUTIONAL BANKS
The role and functions of the following institutional banks are
discussed below. The role & functions of many other financial
institutions shall be dealt with at the appropriate place of this
module along with their structure. The few institutional banks
that are discussed below operate under various schemes of the
Government along with other Commercial Banks. Some of
these schemes are given below :
(a) Lead Bank Scheme :
The Lead Bank Scheme, under which the leadbanks play the
role of pace setter for banking and credit development, has had
a special significance for banks as agents of change. It has
imparted a new direction to the branch expansion policy. District
credit planning exercises have made blockwise estimates of
credit needs. The scheme has also focussed the attention of the
banks on the concept of the banking needs of the area. The
scheme has opened up new vistas in the field of rural banking.
The credit plans envisage schemes of credit extension, mainly
for the development of priority sectors and for the benefit of
the weaker sections. In terms of the guidelines issued by the
Reserve Bank of India, the Annual Action Plans (AAP) cover
Integrated Rural Development Programme (IRDP), and the lead
banks have assumed a part of the responsibility for formulating
plans which fit into the Rural Development schemes covering
viable economic activities, and which can be pursued by the
IRDP beneficiaries.
(b) Integrated Rural Development Programme :
The Integrated Rural Development Programme (IRDP) is a
major instrument to alleviate rural poverty. Its objective is to
enable selected families in rural areas to cross the poverty line.
This is achieved by providing productive assets and inputs to
the target groups. The assets are provided through financial
assistance in the form of subsidy by the government and term
credit advanced by financial institutions, primarily by banks.
Commercial banks have been the principle agents of IRDP
implementation through their branch network. Commercial
banks have looked upon the IRDP as an opportunity to take
banking to the rural areas and have made earnest endeavors to
contribute to its success.
(c) Poverty Alleviation Programme :
Presently, the programme is limited to the financing of such
traditional activities as dairy, poultry and village industries
including basket making, carpentry, handlooms etc., where the
scale of production is very small and the technology used in
the production process is primitive. Commercial banks, State
Bank of India, in particular, have taken a number of steps to
enable the borrowers to increase the scale of production and
improve the production processes by offering technical support,
demonstration plots, financial and management consultancy etc.,
and by conducting management appreciation programmes and
organising entrepreneurial development programmes. Some
of the institutional banks operating these schemes are as follows:
1. Co-operative Banks:
Cooperative Banks also played a limited but important role in
the banking system of the country. There are a number of such
banks which include State Cooperative Banks (SCBs), Central
Cooperative Banks (CCB), Primary Cooperative Banks
(PCBs), Land Development Banks (LDBs), Primary
Agricultural Credit Societies (PACs) etc.
a) Primary Co-operative Banks:
Commonly called the Urban Cooperative Banks, they are small
sized Cooperatively organized banking units which operate in
metropolitan, urban and semi- urban centres to cater mainly to
the need of small borrowers. The Reserve Bank is responsible
for licensing of existing/new banks and branches, sanctioning
15
of credit limits to SCBs on behalf of PCBs for financing the
SSI unit as well as conducting their statutory inspections.
b) Land Development Banks (LDBs):
In the cooperative credit structure the Land Development Banks
i.e., State Land Development Banks (SCDBs) and Primary
Land Development Banks (PLDBs) provide long term credit
for agriculture.
The major sources of funds for the SLDB are the special
development debentures and ordinary debentures. The ordinary
debentures programme of the SLDB is finalised by the
NABARD.
2. Regional Rural Banks
Objectives :
RRBs are primarily organised to develop the rural economy
by providing, for the purpose of development of agriculture,
trade, commerce, industry and other productive activities in the
rural areas, credit and other facilities, particularly the small and
marginal farmers, agricultural labourers, artisans and small
entrepreneurs and for matters connected therewith and incidental
thereto.
Capital Structure:
The authorised capital of each Regional Rural Bank shall be
Rs.5 crores provided that the Central Government may after
consultation with the National Bank and the sponsor Bank,
increase or reduce such authorised capital. Of the capital, 50%
shall be subscribed by the Central Government, 15% by the
concerned State Government and 35% by the sponsor Bank.
Management :
The general superintendence, direction and management of the
affairs and business of a RRB vests in the Board of Directors
who may exercise all the powers and discharge all the functions
which may be exercised or discharged by the RRB.
OPERATIONS :
During the financial year 1991-92 (upto September 1991) while
the number of RRBs remained unchanged at 196, the total
number of districts covered by RRBs increased to 385 as
compared with 380 in the preceding year.
Aggregate deposits of RRBs rose from Rs.4267 crores to
Rs.5141 crores at the end of September 1991 recording a growth
of 20.5%.
Borrowings of RRBs from sponsor Banks NABARD, SIDBI
and other institutions aggregated Rs.1702 crores as at the end
of September 1991 of which Rs.1471 crores were from
NABARD alone.
NABARD also offered assistance to RRBs for setting up
technical, monitoring and evaluation cells for preparation and
evaluation of schemes under project lending.
3. Role and Functions of an EXIM Bank
The EXIM Bank is established by an Act of 1981 for functioning
as the principal Financial Institution for co-ordinating the
working of institutions engaged in financing export and import
of goods and services with a view to promoting Countrys
international trade. The EXIM bank may grant in or outside
India loans and advances either by itself or in participation with
any other bank or financial institutions. It may also grant loans
and advances to scheduled Banks or Financial Institutions;
underwrite issue of stock, shares, bonds or debentures of a
Company engaged in export or import; accept, collect, discount,
purchase, sell or negotiate bills or promissory notes connected
with export or import; grant issue or endorse letters of credit;
finance export or import of machinery or equipment; buy or
sell foreign exchange; undertake surveys techno-economic or
any other study; provide technical administrative or financial
assistance of any kind of export or import; plan, promote or
develop export oriented concerns; collect, compile and
disseminate market and credit informations and do such other
acts and things necessary to discharge the duties and functions
under the Act [Sec 10].
4. Role and Functions of Re-Construction Bank
Industrial Re-Construction Bank is established by the Act of
1984 with a view to function as the principal credit and re-
construction agency for industrial revival. The bank is to act as
the agent of the central or State Govts,RBI, SBI,State co-
operative bank and other public financial institutions. It may
carry on and transact the following functions; granting of loans
and advances to industrial concerns, guaranting or counter-
guaranteeing or providing indemnity, under-writing issues of
stock shares and debentures; providing credit to State level
agencies for granting industrial loans; providing infra-structure
facilities, machineries and other equipments, consultancy and
merchant banking services; transfering or acquiring any
instrument relating to loans and advances; providing managerial
assistance; granting or opening or issues of letters of credit;
and doing such other acts or things as may be incidental to or
consequential upon the powers and duties under the Act.
[Sec.18]
5. National Housing Bank
This specialised bank was established by an Act of 1987 in
order to promote housing finance institutions. The Bank may
promote, establish, support or aid in the promotion of housing
Finance institutions; make loans and advances for housing
finance, purchase stock shares, bonds and debentures; guarantee
the financial obligation of housing finance institutions; draw,
accept, discount negotiable instrument; provide technical and
administrative assistances to housing finance institutions; do
any other business the Central Govt may on the
recommendations of the RBI authorise the institutions to do.
The above discussions about the functions of the specialised
banks are only illustrative.
16
Country wise
State wise
NABARD
All India Large scale
Agriculture
VARIOUS DEVELOPMENT BANKS & FINANCIAL INSTITUTIONS AT A GLANCE
AFC
SLDB
RRB
Mutual funds
LIC, GIC including UTI and its subsidiaries
SHCI
CRSIL/ CARE / ICRA
DFHI
EXIM BANK
ECGC
Small Scale
State Level
Industrial Development
Export/Import
Capital Market
NSIC
SIDBI
ICICI
IDBI
IFCI
IRBI
SFC
SIDC
SIIC
Housing > NHB & HB of Commercial Banks (HDFC)
Insurance & Credit guarantee > DICGC
NABARD National Bank for Agriculture and Rural Development
AFC Agriculture Finance Corporation
SLDB State Land Development Bank
RRB Regional Rural Banks
SEBI Securities and Exchange Board of India
SHC Stock Holding Corporation of India
CRISIL Credit Rating Information Service of India
ICRA Investment Information and Credit Rating Agency of India
DFHI Discount and Finance House of India
EXIM BANK Export Import Bank of India
ECGC Export Credit and Guarantee Commission
ICICI Industrial Credit and Investment Corporation of India
IDBI Industrial Development Bank of India
IFCI Industrial Finance Corporation of India
IRBI Industrial Reconstruction Bank of India
NSIC National Small Industries Corporation
SIDBI Small Scale Industrial Development Bank of India
SFC State Finance Corporation
SIDC State Industrial Development Corporations
SIIC State Industrial Investment Corporations
NHB National Housing Bank
17
Having regard to the nature and range of activities of the
merchant bankers and their responsibilities to SEBI Investors
and Issuers of securities it has been decided to have four
categories of merchant bankers.
Category I : Those authorised to act in the capacity of issue
manager/co-advisor/consultant and portfolio manager to an
issue and underwriter to an issue as mandatorily required.
Category II : Those authorised to act in the capacity of co-
manager, advisor or consultant to an issue or portfolio manager,
and
Category III : Those authorised to act only in the capacity of
advisor or consultant to an issue.
Category IV : Advisors and consultants who provide
consultancy and guidance to certain terms of authorisation have
also been specified for merchant bankers a few of which are
listed below.
a. All Merchant bankers must obtain the authorisation of SEBI
b. SEBI may collect from the merchant bankers an initial
authorisation fee an annual fee and a renewal fee.
c. The Merchant bankers must have a minimum net worth
which is based on the category into which they are
classified.
Category I - 1 Crore
Category II - 50 Lakhs
Category III - 20 Lakhs
Category IV - NIL
d. Lead Manager/Merchant bankers would be responsible for
ensuing timely refunds and allotment of securities to
the investor.
e. The merchant banker shall make available to SEBI such
information documents returns and reports as may be
prescribed and called for.
f. SEBI has already prescribed a code of conduct for merchant
bankers, which they should adere to.
The above terms of authorisation have been framed to make
merchant bankers more responsible and liable and any
negligence on the part of the merchant bankers can be proceed
against legally.
This will ensure that fake companies whose only intention is to
defraud the Public do not have any access to the stock market
and the investing public at large.
2.5 ROLE AND FUNCTIONS OF NON-BANKING
FINANCIAL INSTITUTIONS
Merchant Banking :
In addition to the Commercial banking and specialised banking
activities merchant banking has also grown in stature and gained
an important place in the financial system of the country.
Merchant Bankers are governed by the Securities and Exchange
Board of India (Merchant Bankers) Rules 1992. Merchant
Banker is defined as any person who is engaged in the business
of issue management either by making arrangement regarding
selling, buying or subscribing to securities as Manager,
Consultant, Adviser or rendering corporate advisory service in
relation to such issue management. Public money plays a vital
role in financing a large number of projects both in public and
private sectors. Hundreds of Crores of rupees are tapped from
Capital market every year to finance industrial projects. To
raise the money from the capital market, promoters have to
bank upon merchant bankers who manage the issue.
Role of Merchant Bankers:
Merchant bankers are designated as managers to the issue. They
are specialised agencies whose main business is to attract public
money to Capital issues. They render the following services.
a) Drafting of prospectus and getting it approved from the
stock exchanges.
b) Appointing, assisting in appointing bankers, underwriters,
brokers, advertisers etc.
c) Obtaining the consent of all the agencies involved in public
issue.
d) Holding brokers conference/investors conference.
e) Deciding the pattern of advertising
f) Deciding the branches where applications money should
be collected.
g) Deciding the dates of opening and closing of the issue.
h) Obtaining the daily report of application money collected
at various branches.
i) Obtaining subscription to the issue and
j) After the close of issue, obtaining consent of stock exchange
for deciding basis of allotment etc.
Merchant Bankers charge a heavy fee for rendering the above
mentioned services. The fees are so lucrative that many
nationalised banks which had separate merchant banking
divisions have now opened separate subsidiary companies for
rendering merchant banking services.
DICGC Deposit Insurance and Credit Guarantee Corporation
LIC Life Insurance Corporation of India
GIC General Insurance Corporation of India
UTI Unit Trust of India.
18
SUB-TOPICS:
3.1. Structure of a Scheduled Commercial Bank.
3.2. Structure of State Bank of India.
3.3. Structure of EXIM Bank
3.4. Structure and Management of a Nationalised Bank
3.1 STRUCTURE OF A SCHEDULED COMMERCIAL
BANK
The composition of a Board of Directors of a Scheduled Bank
shall consist of a whole time Chairman, or a whole time Director
who shall be the Chairman of the Board of Directors and other
elected and nominated part-time members. Of course in a recent
amendment part time Chairman can also be appointed.
According to Sec.10A of Banking Regulation Act (BRA), 1949
as amended in 1968, not less than 51% of the number of
members shall consist of persons having special knowledge in
one or more of the areas, such as accountancy, agriculture and
rural economics, banking, cooperation, economics, finance, law,
small-scale industries or any other special knowledge which in
the opinion of the Reserved Bank be useful in the banking
company. Atleast two of three members must have special
knowledge of practical experience in agriculture or rural
economy cooperation or small-scale industries.
The Chairman and a Director of the Banking Company
appointed by the RBI shall not be required to hold qualification
shares in the banking Company. The management of the whole
affairs of the banking company shall be entrusted with the whole
time Director who is also the Chairman of the Company subject
to superintendence, control and direction of the Board of
Directors. The Chairman must have special knowledge and
practical experience of working of a banking company or of
the SBI or any subsidiary bank or a financial institution
[Sec.10B(4)]. The RBI has the power to remove the Chairman
or the whole time Director or Chief Executive Officer (whatever
name called) for reasons to be recorded in writing with effect
from such date as may be specified by order. Any person
appointed as a Chairman, Director or Chief Executive Officer
shall hold office during the pleasure of RBI and subject thereto
for a period not exceeding three years as the RBI may specify.
The RBI has the power to appoint Additional Director.
Directors of a Banking company other than the whole time
Directors shall not hold office for a period exceeding 8 years.
A Chairman of a whole time Director removed from office shall
cease to be a Director of a Company and shall not to eligible to
be appointed as a Director either by election or by co-option or
otherwise for a period of four years from the date of such
removal. If the office of a Chairman of a Banking Company is
vacant the RBI may appoint a person qualified under
Sec.10B(4). No Banking Company shall employ a Managing
Agent.
3.2 STRUCTURE OF STATE BANK OF INDIA
A flow chart of the Managment of the SBI is given below
Central Chairman
Two Managing Directors
Board (CB) President of the thirteen Local Boards
Four elected Directors
Comprise Ten other Directors
Local Boards at each local Head Office
Chairman Directors Six one elected Chief
ex-offico of CB from nominated member G.M. of
the area members the local
H. Office
SBI which is still a shareholders bank in which RBI is the
majority shareholder and private shareholders are minority
shareholders. The bank shall be managed by the Central Board
of Directors which shall be guided by the Central Government.
All such directions of the Central Government shall be given
through the RBI. The Central Board shall consist of the
Chairman to be appointed by Central Government in
consultation with the RBI, two Managing Directors appointed
by the Central Government in consultation with RBI, presidents
of the Local boards and four elected members elected by the
shareholders other than by the RBI provided the shareholders
hold more than 25% of the share capital. One Director taken
from the workmen to be appointed by the Central Government,
One Director to be appointed by the Central Government from
the employees not less than two and not more then six Director
to be appointed by the Central Government in consultation with
RBI from persons having the special knowledge of the working
of cooperative institutions and of rural economy or experience
in commerce, industry, banking or finance. One nominated
Director by the Central Government and one nominated Director
by the RBI (sec 19 of the SBI Act). The Chairman, and each
managing Director shall hold office for such term not exceeding
5 years as the Central Government may fix. They may however
be eligible for the appointment. The Central Government has
the right to terminate them by serving notice of not less than 3
months or paying 3 months salary in lieu of the notice within
the time.
The local boards of all local head offices comprise of the
Chairman ex officio and Directors of the Central Board coming
from that are ex officio, six members nominated by the Central
Government in consultation with RBI, one elected member
from the shareholders other than RBI and Chief General
Manager of the area. The Governor of the RBI in consultation
with the Chairman of the SBI shall nominate members of the
3. STRUCTURE OF BANKING INSTITUTIONS
19
local board. The member of the local board shall hold office
not exceeding 3 years but shall continue in office until the
successor be nominated.
The local boards shall exercise all powers and perform all
functions and duties of the SBI as may be approved by the
Central board. All questions are decided by the majority.
Similarly local boards are also to meet at such place and time
and observe such rules and procedures as may be prescribed
3.3 STRUCTURE OF EXIM BANK
The management of the EXIM, bank is nested in the board
comprising :
(a) A Chairman and Managing Director appointed by the
Central Government
(b) One Director nominated by the RBI
(c) One Director nominated by the Development Bank
(d) One Director nominated by the Export Credit and Guarantee
Corporation.
(e) Not more than 12 Directors nominated by the Central
Government of whom 5 are Government officials, not more
than 3 are from schedule banks and not more than 4 are
persons having special knowledge of professional
experience in export and import of finance.
The Board may constitute such committees either wholly or
partly by Directors and of other persons. The committees meet
at such time and place and shall observe such rules and
procedures and transact such business as may be prescribed.
Directors of a Board hold office for a period not exceeding 6
years. Nominated Directors hold office during the pleasure of
the authority nominating them. Chairman and Managing
Directors hold office for such term not exceeding 5 years but
eligible for the appointment.
3.4 STRUCTURE AND MANAGEMENT OF A
NATIONALISED BANK
Under Sec 9 of the Banking Companies (Acquisition of Transfer
of Undertakings Act 1970 the Central Government was given
the power to make schemes in consultation with the RBI for
the purpose of :
(a) Management by board of Directors, the appointment of
managing Directors, the holding of board meetings and
allied matters.
(b) Meetings of the Board
(c) Appointment of Committees of the Board
(d) Constitution of Regional Consultative Committees and their
Boards.
Nationalised Banks are managed by the Board of Directors
having 15 nominated members including two fulltime Directors
of whom one is the managing Director. The Composition of
the Board is at follows :
(a) Two whole time Directors including the Managing Director,
(b) One Director from the employer, (c) One Director
representing Workmen, (d) One Director representing
depositors, (e) Three Directors representing farmers, workers
and artisans, (f) One Director who is an official of the RBI, (g)
One Director who is the official of the Central Government,
and (h) not more than 5 Directors having knowledge or practical
experience of the working of nationalised Banks. The Directors
hold office during the pleasure of the Central Government for a
period not exceeding 3 years. They may however be re-
appointed. Clause 13 of the scheme provide provisions for
constituting management of the Board. The Board may
constitute advisory committees consisting Directors or partly
with Directors or partly with other persons for advising the
Board on matters refer to them.
The Board has to meet atleast 6 times in a year and once in each
quarter and the head office of the Bank or at such other place as
the Board may decide. All questions are to be decided by
majority votes.
The scheme also provides for appointment of regional
competitive committees for six regions specified by the
Committee. The Committee shall consist of not more than three
persons nominated by the Central Government and two
representatives from each of the State in respective regions.
One representative to be nominated by the Central Government
as desired by the RBI. Meetings of the consultative Committee
shall be presided over by Minister of Finance or his deputy.
The functions of these committees shall be to review banking
developments within the region and recommend on such matters
as may be referred to it by the Central Government and the
RBI.
20
SUB-TOPICS
4.1 Introductory Note
4.2 Industrial Finance Corporation of India (IFCI)
4.3 State Financial Corporations (SFC's)
4.4 The Industrial Credit and Investment Corporation of India
(ICICI)
4.1 INTRODUCTORY NOTE
The economic development of a country depends inter alia on
its financial system. In the long run, the larger the proportion
of financial assets to real assets, the greater the scope for
economic growth. Investment is a pre-condition for economic
growth. In order to sustain the growth, continued investment
is a prime importance, Finance is a major input in the growth
process. This is where the financial institution play a vital role.
The major function of financial institutions whether short term
or long term, is to provide the maximum financial convenience
to the public. This is achieved in the following manner.
a) Promoting the overall saving of the economy by widening
the financial system.
b) Distributing the existing savings in a more efficient manner
so that those in greater need from the social and economic
point of view, get priority in allotment; and
c) Creating credit and deposit money and facilitating the
transactions of trade, production and distribution in
furtherance of the economy.
The integrated structure of the financial institution in the country
comprises to 12 institutions at the National level and 44 at the
State level. The structure consists of five All India Development
Banks (AIDBs) four Specialized Financial Institutions (SFIs),
three Investment Institutions, 18 State Financial Corporations
(SFCs) and 26 State Industrial Development Corporations
(SIDCs). The AIDBs are Industrial Development Bank of India
(IDBI), Industrial Finance Corporation of India (IFCI),
Industrial Credit and Investment Corporation of India (ICICI),
Small Industries Development Bank of India (SIDBI) and
Industrial Reconstruction Bank of India (IRBI). The SFIs are
Risk Capital and Technology Finance Corporation Ltd, (RCTC),
Technology Development and Investment Company of India
ltd., (TDICI), SCICI Ltd, and Tourism Finance Corporation of
India Ltd (TFCI).
The investment activities are conducted by Life Insurance
Corporation of India (LIC), Unit Trust of India (UTI), and
General Insurance Corporation of India (GIC) and its
subsidiaries and various Mutual Funds.
Among the All India Development Banks, IDBI, IFCI, ICICI
and IRBI provide assistance to medium and large industries
and SIDBI to the tiny and small sector. They also undertake
promotional and developmental activities. Among the
specialised financial institutions, RCTC and TDIC are involved
in risk capital, venture capital and technology development
financing. SCICI, which was originally set up for financing
shipping, deep sea fishing and allied activities has diversified
its operations to other industrial sectors also. TFCI is engaged
in financing hotels tourism and related projects. Of the
investment institutions, LIC and GIC which primarily take care
of the life and general insurance needs of the society and UTI
which is a mutual fund mobilising the savings of the community
for channelising into productive sectors, are active participants
in providing finance to industry both by way of term loans and
subscription to equity and debentures. The SFCs provide
assistance mainly to small sector and SIDCs to the medium
and large sectors in their respective states besides undertaking
promotional and development activities. The Financial
Institutions, evolved over the years have been instrumental in
providing term finance in the form of loan, underwriting and
direct subscription to equity and debentures and guarantees.
Looking to the emerging needs of the industrial sector they
have also introduced a variety of financial products and services.
4.2 INDUSTRIAL FINANCE CORPORATION OF
INDIA (IFCI)
The need for speedier industrial expansion and for
modernisation and replacement of obsolete machinery in already
established industries paved the way for establishment of the
Industrial Finance Corporation of India in 1948. IFCI was the
first development bank to be established for providing medium
and long term credits to industrial concerns. IFCI was
established under such circumstances where normal banking
accommodation was inappropriate and recourse to capital issue
methods were impracticable.
Capital: The Authorised capital of the IFCI was Rs.10 Crores
it was subsequently raised to 20 crores by the IFCI Act, 1972.
Presently the authorised capital is 250 crores Fifty percent of
the share capital of IFCI is held by the IDBI and the remaining
50% is held by commercial and cooperative banks.
The corporation is authorised to issue bonds and debentures in
the open market within certain limits.
Functions: The following are the major functions of the IFCI :
1) To guarantee loans raised by industrial concerns.
2) To grant loans and advances to or subscribe to the
debentures of industrial concerns.
3) To underwrite the issue of stocks, shares, bonds or
debentures by industrial concerns.
4) To extend guarantee in respect of deferred payments by
importers
5) To subscribe directly to the stock or shares of any industrial
concern.
The IFCI caters to the financial needs of large and medium
sized limited companies in the public and private sectors and
cooperative societies engaged in the manufacture, preservation,
4. FINANCIAL INSTITUTIONS AND THEIR FUNCTIONS
21
processing, shipping, mining or hotel industry or in generation
and distribution of electricity or any other form of power.
The IFCI provides assistance in all forms-sanction of rupee loans
and foreign currency loans, underwriting of and subscribing to
share and debenture issues, guaranteeing of deferred payments
etc.
However, the corporation cannot compete with the commercial
banks in financing industrial concerns but supplement their work
by granting loans in such amounts and for such periods as are
outside the scope of ordinary commercial banks.
The corporation now functions as a subsidiary of the IDBI under
its supervision, guidance and control.
Before granting loan to any industrial concern applying for
financial aid, the corporation scrutinizes the application
carefully and the following points are evaluated i.e.,
a) the importance of the industry to the national economy;
b) the feasibility of and the cost of the scheme for which
financial aid is required;
c) technical, financial and economic viability;
d) the competence of the management;
e) the nature of the security offered.
f) the adequacy of the supply of technical personnel and raw
materials; and
g) the quality of the product and the countrys requirements
of the product manufactured.
While lending, the corporation requires the security of fixed
assets such as land, buildings, plant and machinery and it does
not normally lend against raw materials or finished products. It
ordinarily requires the personal guarantee of directors and has
the right to appoint two directors to the board of management
of the borrowing concern in order to ensure efficient
management and also to safeguard the interests of the
corporation. In fact, the corporation has the right to take over
the management of a concern or to sell the property mortgaged
in the event of continuous default in the payment of interest
and of the principal advanced to the concern. It obtains periodic
reports from the borrowing concerns and also undertakes
periodic inspection.
In addition to providing assistance by way of project finance
and financial services like equipment leasing, equipment
procurement, buyers and suppliers credit, finance to leasing
and hire purchase concerns etc., IFCI also provides merchant
banking services. It also helps industrialisation through a range
of promotional activities.
The promotional services cover funds support for technical
consultancy, risk capital venture capital, technology
development, tourism and tourism related activities, housing,
development of securities market and investor protection
upgradation of managerial skills, entrepreneurship development,
science and technology, entrepreneurs perks, research etc, and
subsidy support through promotional schemes of IFCI to help
the entrepreneurs and enterprises in the village and small
industries (VSI) sectors.
Operations:
The Cumulative financial assistance sanctioned by the
Corporation since its inception in 1948 upto end March 1993
aggregated 16650-93 crores against which disbursements
amounted to Rs.8650.6 crores. Among the many industries
which have received financial assistance from the corporation
are those which are of high national priority such as fertilizers,
cement, power generation, paper, industrial machinery, etc.
During the year 1992, IFCI introduced one more scheme of
financial service i.e. Installment credit scheme, with a view to
providing an option to borrowers for availing assistance for
acquiring equipment for industrial use. The scheme is flexible
in regard to repayment and has a simplified procedure for
interest payment.
The above scheme is similar to the soft loan scheme introduced
by the Corporation in 1976 which provided financial assistance
to productive units in selected industries i.e. Cement, Cotton,
Textile, Jute, Sugar and certain engineering industries on
concessional term to overcome the backlog in modernisation
replacement and renovation of their plant and equipment so as
to achieve higher and more economic levels of production. The
scheme is administered by IDBI with financial participation by
IFCI and ICICI. The basic criterion for assistance under the
scheme was the weakness of the units on account of
obsolescence of machinery.
The IFCI has also sponsored the Risk Capital Foundation to
provide assistance in the form of interest free personal loans to
new entrepreneurs including technologists and professionals
for meeting a part of the promoters contribution to equity capital.
With the amendments in 1986-87 to the IFCI Act, the area of
operations of the IFCI has been enlarged. The corporation has
been designated as the nodal point to administer the Jute
Modernisation Fund constituted by the Government of India in
order to revitalise and modernize the jute industry.
The IFCI has also been appointed as the agent of the government
for disbursement of loans from the Sugar Development Fund
for rehabilitation and modernization of sugar units. During
1986-87, the IFCI established a Merchant Banking division to
take up assignment of capital restructuring, merger and
amalgamation, loan syndication with other financial institutions
and trusteeship assignments. It also provides guidance to
entrepreneurs in project formulation, resource management etc.
During the same year, IFCI also introduced a promotional
scheme called the scheme of Interest Subsidy for encouraging
Quality Control measures in the small scale sector.
The Investment Information and Credit Rating Agency of India
Ltd., (IICRA), set up by IFCI, commenced operations in
September 1991 and rated 39 instruments by 31st March 1992.
With a view to provide training facilities for workers in the
industry and organisations connected with industrial
development and for retraining and reorientation of workers in
specific industries covering skills and attitudes to adjust to
technological changes, IFCI established, in January 1992, a
national level institute called the Institute of Labour
Development at Jaipur in Rajasthan.
22
IFCI has been playing the role of a leader by identifying the
varying financial needs of industry and has promoted specialised
institutions to cater to these needs, such as :
Managment Development Institute (MDI)
Risk Capital and Technology Finance Corporation Ltd
(RCTC)
Investment Information and Credit Rating Agency of India
Ltd (ICRA)
Tourism Finance Corporation of India Ltd (TFCI)
Institute of Labour Development (ILD)
IFCI has also co-sponsored national institutions like
Stock Holding Corporation of India (SHCIL)
Entrepreneurship Development Institute of India (EDII)
Over-the-Counter Exchange of India Ltd (OCTCEI)
National Stock Exchange of India Ltd. (NSEIL)
Bio-tech Consortium (India) Ltd.
4.3 STATE FINANCIAL CORPORATIONS (SFCS)
Implementation of programmes for planned industries
development and their success depends, on the availability of
adequate financial resources for a wide variety of projects. Since
the Indian Banking system had confined itself to financing the
working capital requirements of trade and industry, the need to
set up long term financial institutions was greatly felt. This
could ensure adequate flow of assistance in the form of capital
to Industrial projects. However, the IFCI which was set up for
this very purpose could cater only to the corporate sector and
industrial co-operatives.
To reduce the imbalance, it was decided to set up regional
development banks to cater to the needs of the small and
medium enterprises. Thus, the State Financial Corporations
came into existence by an Act of the Parliament passed in 1951
called the State Financial Corporations Act, 1951.
Under the provisions of the Act, SFCs are established by the
respective State Governments for providing term finance to
medium industries operating in 18 different States including
New Delhi
SFCs are under the control of the IDBI and the State
Governments.
SFCs grant financial assistance to public limited Companies,
private limited Companies, partnership firms and proprietary
concerns in the form of loans and advances, subscription to
shares and debentures, underwriting of new issues and guarantee
of loans. They also operate the seed capital scheme on behalf
of IDBI and SIDBI.
The SFCs operating at the State level have grown to be an
integral part of the financial system of the country. They have
been fairly successful in achieving balanced regional socio-
economic growth. they have been instrumental in catalysing
higher investment and generating greater employment
opportunities and widening the ownership base of the industries.
The working group set up by IDBI in 1990-91 to service the
operations of SFCs has made wide-ranging recommendations
for improving the working of SFCs.
4.4 THE INDUSTRIAL CREDIT AND INVESTMENT
CORPORATION OF INDIA (ICICI)
The Company was set up as a Development Finance Institution
on January 5, 1955 under the Indian Companies Act, 1913,
with the support of the Government of India and the active
involvement of the World Bank.
The need for setting up such a finance institution came out
because the existing institutional frame work was not geared to
the job of bringing about a rapid industrial revolution through
private effort. Hence, the basic objective of ICICI at the time
of formation was to assist the countrys industrial development
by providing finance.
ICICI has an unique structure. It is a development agency with
twin objectives i.e. assist in the industrial development of the
country and earn profit for its shareholders.
Capital structure:
The Corporation was registered as a company with an authorised
capital of Rs.25 crores and a subscribed capital of Rs. 5 crores.
Today the capital stands at a whooping Rs.300 crores
(authorised) and a subscribed capital or Rs.171 crores. ICICI
has been meeting its financing requirements through internal
generation of funds and borrowings in the domestic and
international markets. Internal generation of funds by way of
repayment of loans, receipt of interest etc. constitutes a major
source of funding ICICIs resource requirements. ICICI has
been raising rupee resources, within the regulatory framework
of the RBI, mainly by issue of Bonds in the nature of promissory
notes, convertible debentures, equity and loans from institutions
such as Unit Trust of India & Life Insurance Corporation of
India.
In the recent past, however, ICICI has been endeavoring to
diversify its resource base on account of Government policies
encouraging it to seek funds from commercial sources. In this
regard, it has entered the Certificates of Deposit market and
has scrutinised a part of its assets.
Management & Organisation:
ICICI is efficiently managed by a Board of Directors comprising
personalities drawn from such diverse fields as finance and
banking, industry and government service. The day-to-day
affairs are handled by the Managing Director supported by the
senior executives of ICICI.
The organisation is characterised by a high degree of
professionalism, delegation of authority and effective client
servicing through swift communication and computerised data
basis.
Objectives:
The main objects of the company as set out in its Memorandum
of Association are:
23
To carry on the business of assisting industrial enterprises within
the private sector of the industry in India by -
a) assisting in the creation, expansion and modernisation of
such enterprises;
b) encouraging and promoting the participation of private
capital, both internal and eternal, in such enterprises;
c) encouraging and promoting private ownership of industrial
investments and the expansion of investment markets;
d) providing finance in the form of long or medium term loans
orequity participation;
e) sponsoring and underwriting new issues of shares and
securities;
f) guaranteeing loans from other private investment sources;
g) making funds available for re-investment by revolving
investments as rapidly as possible;
h) providing or assisting in obtaining directly or indirectly,
advice or services in various fields including management,
finance, investment, technology, administration, commerce,
law, economics, labour, accountancy, taxation etc;
i) performing and undertaking activities relating to leasing,
giving on hire or hire purchase, warehousing, bill
marketing, factoring and other related fields.
Operations:
ICICI began its activities in the 1950s predominantly as a
foreign currency lender and gradually diversified its activities
to rupee lending over a period of time with the growth of
indigenous capital goods industry.
Till 1985, term lending to industry was the main form of
financial assistance provided by ICICI. So long as the
corporation received rupee funds at special rates by way of
government guaranteed bonds and lent these funds at fixed rates,
it earned reasonable returns. However, the lending rates
remained constant even as the cost of funds were increasing.
This led to a pressure on the margins thereby forcing the
corporation to expand its non-project financing to other areas
like leasing of industrial equipment, asset credit and deferred
payment financing of sale of industrial equipment.
Non project financing showed a faster growth rate than project
financing and the share of this segment in the annual approvals
rose from a mere 13.6% in 1980 to 42.5% in 1991.
In addition to assistance provided to industries, ICICI also
encourages projects in backward areas and those related to
pollution control. ICICI is in the process of carrying out a
comprehensive study to identify the scope for technological
collaboration between companies in India and suitable agencies
in the industrialised countries for instituting more efficient
pollution control measures.
In order to improve the exportability of Indian products, ICICI
has been providing assistance to existing companies for
technology upgradation, modernization and balancing
equipment out of lines of credit obtained from the World Bank.
The Corporation is also making concerted efforts to develop
programmes for the benefit of export oriented companies by
chalking out an export marketing strategy and helping them
produce internationally acceptable quality of products. The
Corporation provides financial support in the form of grants
from the Productivity Fund and Export Development Fund.
During 1991-92, the ICICI initiated the Export Breakthrough
Service in collaboration with Developing Countries Trade
Agency (DCTA) an agency funded by the British Government.
Under the service, exporters who require market and commercial
information necessary for entering new export markets are
introduced to selected market research consultants. Funds are
also provided towards the cost of market research.
ICICI has also moved into merchant banking activity which
has acquired great significance in the emerging environment
for the financial services industry which is poised for further
growth with the establishment of private sector mutual funds
and opening up of the Indian capital markets for foreign portfolio
investors. A comprehensive exercise to reorganize and position
ICICIs merchant banking activity has been undertaken so that
ICICI as a mature merchant banker, can play its due role in he
emerging financial system.
ICICI is today one of the national level institutions through
which the government of India seeks to operationalize its
industrial development policies pertaining to the corporate
sector. It has been extending its vision far beyond its immediate
function of finding industrial projects. It has been looking at
all sectors of the economy and where ever a need was perceived,
has designed either a new concept or a new instrument or even
a new institution to cater it. In this regard, ICICIs development
activities have encompassed such diverse areas as technology
financing, project promotion, rural development, human
resource development and publications. It has also been a
pioneer in setting up specialized institutions in key sectors like:
HDFC - Housing Development Corporation of India.
SCICI - Shipping Credit and Investment Company of India
Ltd.
CRISIL- Credit Rating Information Services of India Ltd.
TDICI - Technology Development and Information Company
of India Ltd.
OTCEI - Over the Counter Exchange of India.
The company has also offered its expertise to Development
Finance Institutions in developing countries such as Bhutan,
Nepal, Ghana, Sri Lanka and Uganda.
The Company also assists organisations such as Institute of
Financial Management and Research (IFMR) and Indian
Institute of Foreman Training (IIFT) and provides financial
assistance towards conducting Entrepreneurship Development
Programmes (EDP) in various states. ICICI has started a
commercial Bank of its own.
24
SUB-TOPICS:
5.1 Industrial Development Bank of India.
5.2 Small Industrial Development Bank of India.
5.1 Industrial Development Bank of India
(IDBI)
The need for an effective mechanism to coordinate and integrate
the activities of the different financial agencies brought into
existence the Industrial Development Bank of India.
The IDBI was set up in 1964, under the Industrial Development
Bank of India Act 1964 as a wholly owned subsidiary of the
RBI. Under the Public Financial Institutions Laws (Amendment)
Act 1976 the Ownership of the IDBI was transferred from the
RBI to the Government of India. Also various other
responsibilities of the RBI vis-a-vis the financial institutions
was vested in the IDBI. Thus it was given the status of an
autonomous body.
Today IDBI is regarded as an apex institution in the area of
development banking.
Capital structure & Management:
Authorised capital shall be 1000 crores and the Central
Government by notification in the Official Gazette increase the
paid up capital up to 2000 crores of rupees and any further
issue shall be wholly subscribed by the Central Government.
Management: The general superintendence, direction and
management of the affairs and business of the Development
Bank is vested in a Board of Directors.
The Board shall consist of -
(a) A Chairman and a Managing Director appointed by the
Central Government.
(b) A Deputy Governor of the Reserve Bank nominated by
that bank.
(c) Not more than 20 Directors nominated by the Central
Government.
Of these 20 Directors :
i) 2 Directors shall be officials of the Central Government,
ii) Not more than five Directors shall from Financial
Institutions,
iii) 2 Directors shall be from amongst the employees of the
Development Bank and the Financial Institutions and of
such Directors one shall be from amongst the Officer
employees and the other from amongst the workmen
employees,
iv) Not more than 6 Directors shall be from the State Bank,
the Nationalised Banks and the SFCs (State Financial
Corporations),
v) Not less than five Directors shall be persons who have
special knowledge of, and professional experience in
science, technology, economics, industry, industrial co-
operatives, law, industrial finance, investment, accountancy
marketing or any other matter, the special knowledge of,
and professional experience in, which would, in the opinion
of the Central Government, be useful to the Development
Bank.
Objective of the IDBI :
(1) Establishing an appropriate working relationship among
financial institutions.
(2) Co-ordinating their activities and building a pattern of inter-
institutional cooperation to effectively meet the changing
needs of the industrial structure.
(3) Undertake market and investment research and surveys as
well as techno-economic studies bearing on the
development of the industry.
(4) Providing technical and administrative assistance for the
promotion, management or expansion of industry.
(5) Plan, promote and develop industries to fill vital gaps in
the industrial structure.
(6) Providing refinancing facilities to the IFCI, SFCs and other
financial institutions approved by the government.
(7) Purchasing or underwriting shares and debentures of
industrial concerns.
(8) Guaranteeing deferred payments due from industrial
concerns for loans raised by them.
Operations:
The IDBI Act was amended in 1986 to provide for a
considerable measure of operational flexibility. Now, the Bank
has been empowered to finance and provide assistance to a
diverse range of industrial activities, irrespective of their form
of organisation. These activities include the service sector
industries like health care, information, storage, generation and
distribution of energy and other value additive services.
The scope of business has also been extended to the fields of
consultancy, merchant banking etc.
There are no restrictions as regards the nature and type of
security. There are no maximum or minimum limits prescribed
either for assistance to a unit or the size of the unit itself.
During the year 1991-92, IDBI made a debut in the field of
equipment leasing to widen its range of services offered to
industrial concerns. A venture capital division was also set up
and is expected to give a wider perspective to the concept of
venture capital by providing risk capital assistance for projects
promoted by technocrats and professional entrepreneurs seeking
to introduce an innovative product or service in the Indian
market.
It has also entered into merchant banking activities.
IDBI has also been appointed as the implementing agency for
the Energy Management Consultation and training Project being
financed by the USA of $ 20 million.
5. INDUSTRIAL DEVELOPMENT BANKS
25
IDBI has also entered into an agreement with the European
community (EC) to function as an intermediary for channelising
foreign currency assistance by way of grant or equity
participation or loan to eligible joint ventures.
The growth of IDBI has been phenomenal in the last few years
to the extent that it is the central co-ordinating agency and is
concerned with the problems and questions relating to the long
and medium term financing of the industry and is now in a
position to adopt and enforce a system of priorities in promoting
future industrial growth.
During the year 1991-92 the privilege given to IDBI of
Exemption from income tax was removed which resulted in
payment of Rs.168.5 crores as taxes comprising of Rs.140 crores
as advance tax and Rs.28.5 crores as interest tax.
5.2 SMALL INDUSTRIAL DEVELOPMENT BANK OF
INDIA (SIDBI)
The Small Industries Development Bank of India (SIDBI) was
set up as the principal financial institution for promotion,
financing and development of industry in the tiny and small
scale sector and to co-ordinate the functions of institutions
engaged in similar activities.
SIDBI is a wholly owned subsidiary of IDBI. It took over the
financing activities relating to small scale sector from IDBI and
commenced operation on April 2, 1990. Since the
commencement of its business, SIDBI has been paying
concentrated attention to the financing and multi-dimensional
growth of industries in the small scale sector with special
emphasis on development of small units in the village, cottage
and tiny sector.
Activities: SIDBIs activities comprise refinancing of term loans
granted by SFCs, SIDCs Banks and other financial institutions,
direct discounting and rediscounting of bills arising out of sale
of machinery and equipments by manufacturers in the small
scale sector on deferred credit and rediscounting of short term
trade bills arising out of sale of products of the small scale sector.
SIDBI also provides assistance for development of marketing
infrastructure, creating new marketing channels for the products
of SSI units and direct assistance for development of Industrial
areas with requisite infrastructure facilities.
SIDBI provides equity type of assistance to special target groups
like new promoters, women and ex-servicemen under National
Equity Fund (NEF), Mahila Udyam Nidhi (MUN) and self
employment scheme for ex-servicemen (SEMFEX). SIDBI
provides resource support to NSIC and SSIDCs for their raw
material supply and marketing of SSI products as well as their
hire-purchase and leasing activities. For promotion,
development and growth of small scale sector, SIDBI extends
technical and related support services.
Operations:
The year 1991-92 saw the introduction by SIDBI of a new
scheme of direct assistance to help widen the supply base of
small scale ancillary units and encouraging the existing units
to undertake technology upgraduation/modernisation for
improving the quality and competitiveness of their products.
A scheme to provide resource support to factoring companies
against their factored debts of small scale industries was also
introduced during the year 1991-92. SIDBI contributed 20%
of the Share Capital of factoring companies promoted by State
Bank of India and Canara Bank. A special refinance scheme
for acquisition of computers including accessories was
introduced during the year for supplementing efforts of SSI
units in improving their productivity and operational efficiency.
SIDBI has identified the need for improving managerial
capabilities of existing entrepreneurs, developing a special cadre
of trained professionals for the sector, promoting rural
entrepreneurship technology upgradation and modernisation of
existing units, strengthening of ancillaries and bringing about
qualitative changes in such direction so as to improve the
competitive strength of the sector. In its supportive role, SIDBI
has also given special attention to tackling the problem of
inadequate marketing infrastructure and delayed payments faced
by SSI units.
In tune with the new SSI policy announced by the Government
of India, SIDBI liberalized the terms and scope of its existing
schemes. Investment limits for tiny units was raised from Rs.2
lakhs to 5 lakhs for the purpose of refinance, independent of
location of the units. Corporate and non-corporate entities and
accredited Non-Governmental Organisations (NGOs) approved
by KVIC (Khadi and Village Industries Commission) were made
eligible for setting up industrial areas/estates in rural areas under
the scheme of assistance for development of Industrial areas/
estates.
During the year 1991-92, SIDBI sanctioned assistance
aggregating Rs.2898.1 crore under all its schemes and disbursed
a sum of Rs.2027.4 crore recording a growth of 20.3% in
sanctions and 10.3% in disbursements over the previous year
1990-91. SIDBI also rediscounted short term bills relating to
SSI units to the tune of Rs.560.7 crores. Assistance sanctioned
under Refinance and Bills Finance schemes (including Direct
Discounting of Bills) accounted for little over 97% of total
sanctions under all schemes and is expected to catalyze
investment of the order of Rs.6700 crores and provide additional
employment opportunities to 17 lakh persons.
SIDBI stepped up its resource support to SSIDCs by providing
Line of Credit during 1991-92 for their raw material
procurement and distribution, marketing and infrastructure
development activities for SSI units. Limits aggregating to
Rs.20.8 crores were sanctioned during the year 1991-92 against
which disbursements amounted to Rs.13.1 crores. An amount
of Rs.5 crores was sanctioned to NSIC to finance its activities
relating to hire-purchase, leasing and supply of raw materials
to SSI units against which disbursements amounted to Rs. 4
crores.
The assets of SIDBI as at end March 1992 stood at Rs.6680
crores comprising outstanding refinance of Rs.4909 crore,
outstanding bills discounted and rediscounted of Rs.1406 crore,
investment in shares and debentures of Rs.160 crore and other
assets of Rs. 205 crore. SIDBI raised resources aggregating
Rs.1168.8 crore of which Rs.362.3 crore were from Overseas
Economic Co-operation fund, Japan, Rs.440 crore from RBI
and Rs.330 crores were loans from IDBI out o SLR market
borrowings and the balance from other sources.
26
SUB-TOPICS
6.1 Objects
6.2 Capital Structure
6.3 Organisation
6.4 Functions
6.1 OBJECTS
NABARD was set up by an Act of Parliament on July 12, 1982
called the NABARD Act. The objective of setting up this Bank
was to provide, by way of refinance to banks, all kinds of
production and investment credit to agriculture, small scale
industries, artisans, cottage and village industries and other allied
economic activities.
Initially, it was sought to act as a decentralised section of the
RBIs functions in the areas of rural credit. But now, NABARD
has taken over the entire operations of the Agricultural
Refinance and Development Corporation (ARDC) as well as
the refinancing functions of the RBI in relation to the State Co-
operative Banks (SCBs) and Regional Rural Banks (RRBs).
6.2 CAPITAL STRUCTURE
The share capital of NABARD is held by the Reserve Bank of
India jointly with the Government of India in equal proportions.
NABARD draws its funds from the Government of India, the
World Bank and other agencies to meet its long term loan
operation. The Bank has also been authorised to accept deposits
for over a year from the Central, State and local governments,
scheduled banks etc. Its short term operations are met mainly
from funds drawn from the Reserve Bank.
6.3 ORGANISATION
NABARD is managed by a Board of Directors, consisting of a
Chairman, Managing Director, 2 Directors from experts in rural
economics, rural development etc., 3 Directors from out of the
Directors of RBI, 3 Directors with experience in the working
of Cooperative Banks, 5 Directors from among the officials of
the Government of India and State Governments.
All these appointments are made by the Central Government.
6.4 FUNCTIONS
Main functions:
1) To provide by way of refinance, credit to the rural sector
for the promotion of agriculture, small scale industrial units,
cottage and village industries, handicrafts, other rural crafts
and allied productive activities in the rural areas with the
primary aim of promoting integrated rural development and
attaining rural prosperity.
2) To give short term as well as long term loans in a composite
form. It also makes loans to State Governments for a
maximum period of 20 years in order to enable them to
subscribe to the Share Capital of Cooperative Credit
Societies.
3) To provide medium term loans ranging from 1
1
/
2
to 7 years
to State Cooperative Banks (SCBs) and Regional Rural
Banks (RRBs) for agricultural and rural development.
Ancillary functions:
1) Inspection of RRBs and Cooperative societies (other than
primary cooperative Banks).
2) Appraisal and forwarding of applications to the RBI for
opening of new branches of RRBs and Cooperative banks.
3) Calling for information and statements from RRBs and
Cooperative banks with regard to their operations etc. (RRBs
and cooperative banks are required to furnish to NABARD
copies of returns submitted to RBI under the Banking Regulation
Act).
4) Undertaking research and development programmes to
alleviate the problems of agricultural and rural development.
5) Providing training to its own staff as well as the staff of
SCBs, RRBs in order to upgrade the technical skills and
competence of the staff.
6) To assume responsibility from the RBI for Coordinating with
the Government of India, the planning commission and other
relevant agencies concerned with the development of rural
industrialisation and putting into practice the various policies
and procedures meant for rural development.
Resources (Net) Mobilised by NABARD April-March
Resources (Rs. In Crores)
1990-91 1991-92
Reserves and Surplus 63 105
NRC (LTO) Fund 775 915
NRC (Stabilisation) Fund 30 40
Deposits 30 69
Bonds and Debentures` 90 99
Borrowings from Govt. of India 194 127
Borrowings from RBI 560 631
ARDR Scheme 1990 692 31
Other Liabilities 21 58
Total 905 1821
[Source: Report on trend and progress of banking in India 1991-
92 (June-July)].
6. NATIONAL BANK FOR AGRICULTURE AND RURAL
DEVELOPMENT (NABARD)
27
SUB-TOPICS:
7.1. Objects
7.2. Capital Structure
7.3. Management
7.4. Operations of the Trust
7.5. Pricing policy
7.6. Advantages
7.7. Conclusion
7.1 OBJECTS
The need for establishment of an investment trust to extend
facilities for growing number of small investors in the middle
income groups of the community led to the formation of Unit
Trust of India.
UTI was established by an Act of parliament in 1964, and it
plays an important role in tapping the savings of the small
investors through sale of units and channelising them into
corporate investments.
The primary objective of the Trust is -
(a) tapping and mobilising the savings of the middle and low
income groups; and
(b) to enable them to share the benefits and prosperity of the
rapidly growing industrialisation in the country.
The Unit Trust achieves its objectives by-
(1) selling units of the Trust among as many investors as
possible in different parts of the country;
(2) by investing the sale proceeds of the units and also the initial
capital fund of Rs.5 crores in industrial and corporate
securities; and
(3) by paying dividends to those who have bought the units of
the Trust.
7.2 CAPITAL STRUCTURE
The initial capital of the UTI was 5 crores which was subscribed
fully by the Reserve Bank of India (Rs.2.5 crores), the Life
Insurance Corporation (Rs. 75 lakhs), the State Bank of India
(Rs. 75 lakhs) and Scheduled banks and other financial
institutions (Rs. 1 Crore).
7.3 MANAGEMENT
The general superintendence, direction and management of the
affairs and business of the Trust is vested in a Board of Trustees,
consisting of a Chairman and nine other Trustees. The Chairman
shall be appointed by the Reserve Bank of India, four trustees
to be nominated by the RBI out of which at least 3 shall be
persons having special knowledge of, or experience in
commerce, industry, banking finance and investment, one trustee
nominated by LIC and one by State Bank, two trustees to be
elected by the contributing institutions and one executive trustee
to be appointed by the Reserve Bank of India.
7.4 OPERATIONS OF THE TRUST
In 28 years of operations upto 1991-92, the Unit Trust of India
has done remarkably well in the area of fund mobilisation and
assistance to industries by way of investments. During the year
1991-92, the total number of unit holders was a phenomenal
20 million and the total investible funds available as at end
June 1992 aggregated Rs. 30550.8 crores.
The Government has also assisted the growth of the Trust by
giving many tax incentives to investors who buy the units issued
by the Trust.
Unit Trust of India has introduced many new kinds of units
suitable for different types of investors. Eight new units were
introduced during the year 1991-92 i.e. the Deferred Income
unit scheme 1991, the Unit growth scheme 5000 Master Equity
Plan 1992, Master plus, Growing monthly Income Unit Scheme
(GMIS) 91, GMIS 91-II, GMIS-92 and Mastergain.
The Trust has built up a portfolio of investments which is
balanced between the fixed income bearing securities and
variable income bearing securities. The main objective of the
Trusts investment policy is to secure maximum income
consistent with safety of capital. The bulk of the investible funds
have been invested in companies which are on regular dividend
paying basis. Barring investments in bonds of public
corporations, the Trusts funds have been invested in financial,
public utility and manufacturing enterprises.
The Trust has now floated its own Bank, UTI Bank Ltd.
7.5 PRICING POLICY
The sale and repurchase prices of the units of the Unit Trust
are fixed according to the rules framed by the Trust. The sale or
the repurchase price is worked out by obtaining the basic value
of the units. This is done by dividing the value of all the assets
of the trust less current liabilities by the number of units deemed
to be in issue. Normal charges like brokerage, commission,
stamp duties etc., are added or subtracted as the case may be
and the final figure is rounded off to the nearest five paise.
7.6 ADVANTAGES
1. Investments in these units is safe, since the risk is spread
over a wide range of securities (fixed income bearing and
variable income bearing)
7. UNIT TRUST OF INDIA (UTI)
28
2. Units holders are assured of a regular and steady income.
3. Dividents are exempt from Income tax under section 80L.
4. Liquidity is high as the investor can encash the units
whenever he wants. The units can also be sold back to the
Trust under the repurchase facility offered by the Trust.
7.7 CONCLUSION
The Unit Trust of India plays an important role in tapping the
savings of the small investors through sale of units and
channelising them into corporate investments. The trust being
a public sector enterprise has created confidence among the
general public. Additionally, the tax concessions provided by
the Government has added to its growth. So also, the benefits
of liquidity and safety of capital over the years, the trust has
extended its operations to other areas like assistance to corporate
sector by way of term loans, bills rediscounting, equipment
leasing and hire-purchase financing.
During the year 1991-92, UTI, in association with the Bank of
Ceylon and others, promoted the Unit Trust management of Sri
Lanka and also provided technical and management support in
designing and marketing of its schemes. UTI also signed a
Memorandum of Understanding with Alliance Capital
Management Ltd. of United States to jointly set up an asset
management company.
29
8. CASE LAW
Sajjan Bank Pvt. Ltd. v RBI (30 Comp. Cases,146)
The petitioner, a banking company which was in existence at
the commencement of the Banking Companies Act, 1949,
applied to Reserve Bank on Sept.14, 1949, under section 22 of
that Act for a licence to carry on banking business. Officers of
the Reserve Bank inspected the banking company under section
22 of the Act in July, 1952, but as the inspection revealed defects
in the method of keeping accounts and contravention of certain
provisions of the Act, the Reserve Bank kept in abeyance
consideration of the question of issuing a licence. A fresh
inspection carried out by the Reserve Bank under section 35 in
September 1956, four years later,also revealed certain defects.
The Reserve bank not being satisfied that the affairs of the
banking company were being conducted in the interests of the
depositors, directed the banking company to show cause against
the refusal of the licence and after considering the
representations of the banking company,declined to grant the
licence. Aggrieved by the refusal,the petitioner applied to the
High Court for the issue of a writ of Certiorari quashing the
order refusing the grant of the licence.
Three conditions were raised in the writ petition: (i) that Section
22 of the Banking Companies Act was unconstitutional in so
far as it proceeded to restrict the fundamental right of the
petitioner to carry on its business,namely the banking
business;(ii) even if the provisions of the Sec 22 of the Act be
held to be in accordance with the constitution,the action of the
respondent was arbitrary;and (iii) in any event the procedure
adopted by the respondent was illegal and in that,after an
inspection under section 35,it could only proceed to act under
Section 35(4) and not refuse the licence altogether.
The court held that the provisions of Section 22 of the Banking
Companies Act prescribed only a system of licensing with a
view of regulating the banking business and was not repugnant
to the provisions of Article 19(1)(g) of the Constitution.
The provisions in Section 22 investing the Reserve Bank with
the power to grant, refuse to grant or cancel, a licence did not
amount to an excessive delegation of legislative power. There
was sufficient legislative guidance for the granting of licence
embodied in the provisions of the Act, and of Section 22 in
particular, and delegation of the power, having been made to
non-political body statutorily concerned with the credit structure
of the country, the restriction imposed in the regulation of the
banking business was nothing but reasonable. The power that
was given to the Reserve Bank under the Act was a wide range
of administrative discretion which it was peculiarly competent
to undertake, and the determination whether the conditions
which were required before the licence could be given or refused
exist, was peculiarly within its competence as an expert statutory
body. The legislature having prescribed the nature of a real
banking institution in this country, it could not be said that there
was any excessive delegation of power.
The provisions of Sec.35 (4) which empowered the Central
Government to prohibit a banking company from continuing
its business on the report of the Reserve Bank after inspection
under Section 35, related to a banking company to which a
licence has already been granted. It was open to the Reserve
Bank to consider the defects revealed in an inspection under
S.35 for disposing of an application for the grant of a licence
under Sec.22.
Finally the court held that the jurisdiction of the Reserve Bank
to refuse to grant a licence to the petitioner was properly
exercised. The powers vested in it under Section 22 of the
Banking Companies Act are not ones invested with a mere
officer of the bank. The standards for the exercise of the power
have been laid down in Section 22 itself. The Reserve Bank is
a non-political body concerned with the finances of the country.
When a power is given to such a body under a statute which
prescribes the regulations of a banking company, it can be
assumed that such power would be exercised so that geniune
banking concerns could be allowed to function as a bank, while
institutions masquerading as banks or those run on unsound
lines or which would affect the interests of the public could be
weeded out. The nature of the power and its exercise after the
investigation prescribed by the statute invested it with a quasi
judicial character. Such a power cannot be said to be an arbitrary
one.
In re Supreme Court of India Ltd. v. Official Liquidator
and Others (37, Comp. Cases. 392.)
Five appeals arose out the order of the learned Company Judge
in misfeasance proceedings against the Directors and Officers
of a banking company by name The Supreme Bank of India
Ltd., taken on an application of the official liquidator during
the course of its winding up proceedings.
On appeal the High Court held that though both Section 196 of
the Companies Act, 1913 & Section 45B of the Banking
Companies Act, 1949, provide for public examination of a
Director or an officer of a company as to promotion, formation
or the conduct of the business of the company or as to his
conduct and dealings as Director or Manager or other officer,
Sec. 196 of the Companies Act enables the liquidator to make
such an application for public examination only when he is of
opinion that fraud had been committed by a Director, while
under Section 45G of the Banking Companies Act, all that is
necessary for the liquidator to make such an application, is that
he should be of opinion that any loss had been caused to the
banking company by any Act or omission of the Director,
whether or not any fraud has been committed by such Act or
Omission.
The duties of the Directors were summarised by the court in
the following terms:
1. The Directors are not bound to give continuous attention
to the affairs of the bank and their duty is of an intermittent
nature to be performed at the periodical Board Meetings
and the Meetings of Sub-committees of the Board. They
are not bound to check the cash of the bank or the books of
account to detect shortage of cash or manipulation of bank
balances;
30
2. To begin with, the Directors are entitled to trust the
Managing Director and other officers of the Bank to perform
their duties honestly. They are entitled to continue to repose
such trust until there are grounds for suspicion;
3. Once there was any ground for suspecting the honesty,
competence or skill of the Managing Director or other
officers of the bank, the Directors are bound to exercise
such reasonable care as an ordinary prudent man would do
in his own case, in order to avert losses to the company.
Even after such ground for suspicion if they shut their eyes
and do not take any effective steps to prevent losses
resulting from their wilful neglect, they would make
themselves liable for the resulting losses;
4. Until there is such ground for suspicion, the directors are
not liable for losses due to the mistake, negligence or
dishonesty of the managing director and other officers of
the company, although such losses could have been averted
if the directors had taken care; and
5. The crucial question in such cases is, therefore, whether
there were any circumstances arousing the suspicion of the
directors and, if so, when should their suspicions have been
aroused.
Sardar Gulab Singh v. Punjab Zamindara Bank Ltd. (AIR
1942 Lah.47)
The plaintiff Managing Director of the company brought a suit
against the company for a declaration that he was the managing
director of the company and for injunction restraining the
company from preventing him from discharging his duties. The
trial court decreed both the declaration and the injunction prayed
for. On appeal the learned Senior Subordinate Judge dismissed
the suit. On second appeal the High Court allowed the appeal
as regards the declaration, but dismissed it with regard to the
injunction. Both parties filed appeals. The plaintiff against the
decision allowing him an injunction and the defendants against
the decision granting the plaintiff declaration.
The Court held that even if the memorandum and articles of
association of a company are held not to constitute a contract
in themselves, an implied contract may be proved by the acts
of the parties on the terms set out in the articles of association
of the company. Where in pursuance of certain articles acted
upon by the company a shareholder was appointed Managing
Director and acted as Managing Director for 11 years and was
remunerated in accordance with the terms set out in the articles,
the articles constituted an implied contract between the company
and the share-holder so as to entitle him to the declaration that
he was the managing director of the company.
With regard to the second point, whether Sardar Gulab Singh
is entitled to an injunction, the court held that it would not be
proper to issue an injunction. In this connection the court
observed that the position of the company and that of Sardar
Gulab Singh as managing director was that of master and
servant. With great respect we do not think that this is correct.
A Director or Managing Director is in no way a servant of the
company, he is the agent of the company for carrying on its
business. But we agree that the same principles which have
been held to apply to the issue of an injunction at the instance
of a dismissed servant ought also to apply in the case of a
dismissed agent. It would be contrary to public policy to impose
upon an unwilling principal an agent whom he does not wish
to employ, especially as there is nothing to prevent an agent
whose contract of agency has been wrongfully broken from
bringing an action for damages.
Andhra Bank Ltd. v. Bonu Narasamma [(1988) 63
Com.Cas.p.328]
In this case an appeal arose out of a suit filed for recovery of
Rs.2,87,681.85 with interest and in default of payment for the
sale of the scheduled properties to realise the suit debt. The
learned counsel for the appellant contended that the levy of
interest by A.P.Bank is linked with and based upon the rate of
interest fixed by the Reserve Bank and the question of charging
penal or unconscionable interest does not arise and in any event
such contention does not survive in view of S.21A of the
Banking Regulation Act. On the other hand learned counsel
for the respondents seeking to sustain the judgements of the
courts contended that the levy of such exorbitant interest by a
nationalised bank is unconstitutional as it is beyond the
legislative competence of Parliament and is in breach of Art.14
of the constitution.
The High Court held that the provisions of Sec.21 A of the
Banking Regulation Act, 1949, declaring that the rates of interest
charged by banking companies shall not be subject to scrutiny
by the courts from the point of view of excessiveness are within
the legislative competence of parliament under entry 45 of list
I of Sch.VII of the Constitution of India, which pertains to
banking. The charging of interest is interwined with banking
business and the element of interest is ingrained in the veins of
all dealings in society. The bank is a dealer in credit. Section
21A strives to safeguard the levy of interst and quantum of
interest charged and Section 21A is essentially concerned with
the banking operation and therefore, within the legislative
competence of Parliament.
The Court further held that Sec. 21A does not violate the
provisions of Art.14 of the Constitution. The modalities and
the quantum of interest is uniform in all the banks as regulated
by the Reserve Bank. The charging of interest is tied up with
the interest fixed by the Reserve Bank. The Reserve Bank is
entrusted with diverse powers for regulating the banking
business in the country and the Reserve Bank taking stock of
the prevalent economic growth, cost of living, index, purchasing
and paying capacity and other factors fixes the rate of interest
chargeable by the banks. Banking Companies are bound to
adhere to the guidelines and directions given by the Reserve
Bank. The rate of interest chargeable by the banks is rooted in
the rate of interest fixed by the Reserve Bank and as a sequel of
the decision of the experts, apparently with a view to having a
uniform rate of interest in all banking companies throughout
the country at all times and situations, The jurisdiction of Civil
Courts is taken away.
31
9. LIST OF STATUTES
The readers are requested to purchase the following Acts for
better understanding of the laws and practice.
1. Reserve Bank of India Act, 1934
2. Banking Regulation Act, 1949
3. Banking Companies (Acquisition and Transfer of
Undertakings) Act, 1970 and Act of 1980
4. State Bank of India Act, 1955
5. Nationalised Banks (Management and Miscellaneous
Provisions) Scheme, 1970 and Scheme of 1980,
6. Export-Import Bank of India Act, 1981
7. Industrial Development Bank of India, 1964
8. Industrial Insurance and Credit Guarantee Corporation Act,
1961
9. Deposit Insurance and Credit Guarantee Corporation Act,
1961
10. Industrial Reconstruction Bank of India Act, 1984
11. National Bank for Agriculture and Rural Development Act,
1981
12. National Housing Bank Act, 1987
13. Regional Rural Banks Act, 1976
14. State Financial Corporations Act, 1951
32
10. PROBLEMS
1. Critically examine the functional and structural relation
between NABARD and RRB.
2. Evaluate the Composition of the Board of Directors both
at the central and local level in so far as maintaining the
operation of efficiency of the State Bank of India.
3. State Bank of India has a distinct role in the banking services
in India. Critically examine the statement.
4. Examine the role of commercial bank in building directly
and indirectly the industrial capital.
5. How far it is justified to attribute government's interference
in the functioning of financial institutions as the cause of
operational inefficiency? Explain your answer with
reference to actual functioning of one financial institution.
6. Compare the management and organisation structure of
IDBI, ICICI and IFC. What is the functional relation
between these three institutions, if any. Do you think
functional commercial competition or better institutional
cooperation will be more beneficial for building up better
industrial climate ?
7. Critically examine the branch banking policy in India. What
alternate do you suggest ?
8. State Bank of India performs part of the RBI function.
Critically examine the statement indicating the function, if
any, done by the SBI on behalf of RBI.
9. Name some of the important Mutual Fund Organisation, in
India and critically look at law and practice relating to
mutual Fund.
10. In recent times many of the Commercial banks indulge more
in non-banking functions than the conventional banking
operations. Critically examine the statement indicating the
non-banking functions undertaken by the commercial
banks.
11. Compare and contrast the management and an organisation
structure of a nationalised bank and a private bank. Do
you think the nationalization of Commercial banks brought
inefficiency and corrupt practice in banking operation ?
Justify your answer with reference to functioning of
Commercial banks in the light of the Report of Narasimham
Committtee.
[Note: Specify Your Name, I.D. No. and address while sending answer papers]
33
11. SUPPLEMENTARY READING
1. Mark Hapgvod, Paget's Law of Banking, 10th edn., 1989, Butterworths London & Edinburg.
2. Saravanavel. P., Banking Theory Law & Practice, 1st edn., 1987, Margham Publications, Madras.
3. Sheldon & Fidler's, Practice & Law of Banking, 11th edn. (Rep.), 1984, Macdonald & Evans Ltd., Plymouth.
4. Suneja H.R., Practice & Law of Banking, Ist edn., 1990, Himalaya Publishing House, New Delhi.
5. Sundaram & Varshney, Banking Theory, Law & Practice, 8th edn. (revised), 1990, Sultan Chand & Sons, New Delhi.
6. Tannan M.L., Banking Law & Practice in India, 18th edn., 1989, Orient Law House, New Delhi.
34
Banking Law
Course No: II
Module No: II
Reserve Bank of India
Structure and Functions
Phone: 3211010 Fax: 080-3217858
35
Materials Prepared By :
1. Mr. K.D. Zachariah, LL.M.
2. Mr. N. L. Mitra, M.Com., LL.M., Ph.D.
Materials Checked By :
1. Mr. V. Vijaykumar, M.A., LL.M., M.Phil.
2. Mr. T. Devidas. LL.M.
3. Ms Archana Kaul, LL.M.
4. Ms Pooja Kaushik, M.A, (Eco)
Materials Edited By :
1. Mr. P.C. Bedwa LL.M., Ph.D.
2. Mr. Sunderajan, A.C.A.
3. Mr. Harihara Ayyar, LL.M., Former General Manager, SBI
Post Bag No : 7201
Nagarbhavi, Bangalore 560 072.
India
36
INSTRUCTIONS
Basic Readings
The materials given in this course are calculated to provide exhaustive basic readings on topics and sub-topics
included in the course. Experts in the area have collected the basic information and thoroughly analysed the same
in topics and sub-topics. Lucid/supportive illustrations and leading cases are also provided. Relevant legislative
provisions are also included. Care has been taken to communicate basic information required for decision making
in problems likely to arise in the course-area. The reader is advised to read atleast three times. In the first reading
information provided are to be selected by making marginal notes using markers. The first reading, therefore,
necessarily has to be very slow and extremely systematic. While so reading the reader has to understand the
implications of those informations. In the second reading the reader has to critically analyse the material supplied
and jot down in a separate note book points stated in the material as well as the critical comments on the same. A
third reading shall be necessary to prepare a Check List so that the check list can be used afterwards for solving
problems like a ready reckoner. (The reader is required to purchase a Bare Act and refer to the relevant sections
at every stage.)
Supplementary Reading
Several supplementary readings are suggested in the materials. It is suggested that the reader should register with
a nearby public library like the British Council Library, the American Library, the Max Muller Bhavan, the
National Library, any University Library where externals are registered for the purpose of library reading, any
commercial library or any other public library run by Government or any private institution. Readers in Metropolitan
and other big cities may have these facilities. It is advised that these basic materials be photocopied, if necessary,
and kept in the course file. Supplementary readings are also required to be read more than once and marginal
notes, marking notes, analytical notes and check lists prepared. Any reader requiring any extra readings not
available in his/ her place may request the Course Coordinator to photocopy the material and send it by post for
which charges at the rate of .50 paise per page for photocopying and the postage charge shall be sent either by
M.O. or by Draft in advance. The Course Coordinator shall take prompt action on receiving the request and the
payment.
Case Law
The course material includes some case materials generally based upon decided cases. These cases are to be
studied several times for,
(a) understanding the issues to be decided (b) decisions given on each issue (c) reasoning specified
It is advised that while reading a case the reader should focus first on the facts of the case and make a self analysis
of the facts. Then he/she should refer the check list prepared earlier for appropriate information relating to law
and practice on the facts. Then the student should prepare a list of arguments for and on behalf of the plaintiff/
appellant. Keeping the arguments for the plaintiff/appellant in view of the reader should try to build up counter
arguments on behalf of the defendant/respondent. These exercise can take days. After these exercises are done
one has to prepare the arguments for or against and then decide on the issues. While deciding it may be necessary
often to evolve a guiding principle which also must be clearly spelt out. Subsequently the reader takes up the
decision given in the case by the judge and compare his/her own exercise with the judgment delivered. A few
exercise of this type shall definitely sharpen the logical ability, the analytical skill and the lawyering competence.
Though it is not compulsory, the reader may send his/ her exercises to the Course Coordinator for evaluation. On
receiving such request the Course Coordinator shall get the exercises evaluated by the experts and send the
experts comment to the students. Through these exercises one can build up an effective dialogue with the
experts of the Distance Education Department (DED).
Problems and Responses
After reading the whole module which is divided into several topics and sub-topics the reader has to solve the
problems specified at the end of the module. The module is designed in such a manner that a reader can take
about a weeks time for completing one module in each of the four courses. It is expected that after finishing the
module over a period of a week the student solves these problems from all possible dimensions to the issue. No
time limit is prescribed for solving a problem though it would be ideal if the reader fixes his/her own time limit
for solving the problem - which may be half an hour per problem - and maintain self discipline. While solving the
problems the candidate is advised to use the check list, the notes and the judicial decisions - which he/she has
already prepared. After completing the exercise the student is directed to send the same to Course Coordinator
for evaluation. Though there is no time stipulation for sending these responses a student is required to complete
these exercises before he/she can be given the certificate of completion to appear for final examination.
37
RESERVE BANK OF INDIA : STRUCTURE
AND FUNCTIONS
TOPICS
1. Organisation ................................................................................................................... 38
2. Functions ......................................................................................................................... 43
3. Issue & Management of Currency................................................................................ 45
4. Banker to the Government ............................................................................................ 47
5. Bankers Bank ................................................................................................................ 49
6. Monetary Control ........................................................................................................... 50
7. Custodian of Foreign Exchange .................................................................................... 54
8. Promotional Functions................................................................................................... 59
9. Case Law......................................................................................................................... 60
10. Problems.......................................................................................................................... 63
11. Bibliography ................................................................................................................... 65
38
1. ORGANISATION
SUB-TOPICS
1.1 Introduction
1.2 Organisational Model
1.3 Central Board
1.4 Local Boards
1.5 Critical Remarks
1.1 INTRODUCTION
Central Banking as a concept is of fairly recent origin. Though
some Latin American countries had a central banking system
in the 19th century, this system really became popular in the
early 20th Century. Generally speaking, a Central Bank is
considered as the leader of the money market, but several
economists emphasize different roles for the Central Bank. For
example, according to Whawtrey,R.G, the essential
characteristic of a Central Bank is its function as the lender of
last resort. According to Kische & Elkin, the main function of
the Central Bank is to maintain the stability of the monetary
standard. On the other hand, Shaw,W.R. lays emphasis on
credit control as the major function of Central Bank. The Bank
of England founded in 1694 is perhaps the oldest Central
Banking institution which provides finance for the government.
The first attempt at Central Banking in India dates back to
General Bank in Bengal & Bihar estd. in January, 1773 at the
instance of Warren Hastings, the then Governor of Bengal. But
this experiment was very short lived. Three Presidency Banks
were established and started functioning in 1866. Alongwith
their commercial functions they undertook some functions on
behalf of the Government also. These Presidency Banks were
amalgamated in 1921 to form the Imperial Bank of India which
was primarily a commercial bank but used to perform certain
central banking functions as well. In 1926 the Royal
Commission on Indian Currency & Finance (Milton Young
Commission) recommended the dichotomy to be ended & the
establishment of a Reserve Bank of India as its Central Bank.
A Bill was introduced in the Legislative Assembly in 1927,
which was later dropped. In the meantime during 1930-31
consideration for constitutional reforms in the country started
being debated. Ultimately, the Reserve Bank of India Act was
passed in 1934, part of which came into operation in 1935 &
the remaining part in 1937. It took over the management of the
currency from the Central Government and of carrying on the
business of banking in accordance with the provisions of the
Act. As stated in the preamble to the Act, the Bank has the
responsibilities of (i) regulating the issue of Bank notes; (ii)
keeping of reserves with a view to securing the monetary
stability in India; and (iii) generally to operate the currency and
credit system of the country to its advantage.
As provided in Section 3(2) of the Act, the 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 of Rs.5.00 crores is at present held by the Central
Government. The Bank has its Central Office in Bombay and
other offices in Bombay, Calcutta, Delhi and Madras and
branches in most of the State capitals and departments at a few
other important places. The matters of policy relating to
banking, monetary management, exchange control, inspection
and supervision of banks, credit control, and economic and
financial matters are formulated at the Central Office of the
Bank at Bombay. The basic function of note issue and general
banking business are discharged by the issue department and
banking department at the local offices/ branches.
1.2. ORGANISATIONAL MODEL
The Reserve Bank of India (RBI) was originally constituted as
a shareholders bank with a share capital of 5 crores divided
into 5 lakh fully paid-up shares of Rs. 100/- each. Only 2,300
shares were held by the Federal Government. The whole
country was divided into 5 areas for the operation of the Bank,
viz., Bombay, Calcutta, Madras, Delhi & Rangoon*. (* closed
since 1947). In 1948, RBI was nationalised by the Reserve
Bank (Transfer to Public Ownership) Act, 1948, and the entire
share capital was acquired by the Central Government.
With the introduction of the Constitution of India in 1950, RBI
was put under entry 38 List I, VII Schedule U/Art.246, thereby
subjecting RBI to the legislative power of the Parliament.
Accordingly, the Act was amended several times by the
Parliament to virtually touch every section. There were some
extremely important amendments which will be discussed
alongwith the concerned subject. It will suffice to give the
following outline of the organisational set-up of RBI as it stands
today.
The RBI was initially designed on the pattern of Bank of
England, theoretically subordinate to the Treasury. The
Governor, 4 Deputy Governors, all Directors of the Central
Board & the Local Boards are either appointed or nominated
by the Central Government. The Governor & the Deputy
Governor are whole time officials and hold office for such term
not exceeding 5 years as may be fixed by Central Government
and are eligible for re-appointment [S.8(4).] They may however
be removed from their office by the Central Government at
anytime. This legal provision has made RBI an almost
subordinate agency of the Ministry of Finance, Government of
India.
There are several models of Central Banking. The dominating
models are :
1) Bank of England, which is in theory as stated earlier
subordinate to the Treasury but in practice has a relationship
of co-operation rather than subordination (Sheldon, p.8).
This model can be called the functionally independent
model.
2) Federal Reserve System, USA - This system can be said to
be both functionally & statutorily independent.
39
3) Deutsche Bundesbank, Germany - This can be said to be
constitutionally & functionally independent. The Central
Bank Council & the Directorate are headed by the President
& Vice President of the Deutsche Bundesbank. The
President & Vice President of this Bank are appointed by
the President of Germany on recommendation of the
Bundesrat (upper House of Parliament). The Bundesbank
is independent of the instructions of the Federal
Government. In order to maintain cooperation between
the Central Bank & the Federal Government, the
government is required under the Constitution to consult
the President of Bundesbank on all matters of basic
monetary policy. There is an autonomous Central Bank
council in whose meetings the Federal government may
take part but cannot participate in the voting.
The operational efficiency of an organisation predominantly
depends upon the organisation structure of the institution.
Several issues are important while determining this
organisational structure. The organisation of RBI was modelled
on the pattern of Bank of England as being subordinate to the
Central Government at a time when imperial power wanted to
have a positive & definite power centralisation. Continuation
of the same structure in a democratic set-up may be examined
in view of the need for a strong monetary system. This requires
an autonomous institution to cooperate with the Central
Government for laying down a strong monetary system. But
the organisational structure of RBI is entirely subordinated to
the Central Government. The Governor, 4 Deputy Governors
and all the Directors of the Central Board and Local Boards are
appointed/nominated by the Central Government (CG) and hold
office during the pleasure of Central Government. In England
a legal prescription of subordination to the treasury is replaced
by close cooperation through establishment of sound
conventions. In India on the other hand, this led to super control,
so much so that even a Deputy Secretary of the Ministry of
Finance became more powerful than the Governor of the RBI.
This is very unscientific and injurious to the nations economy.
As for example, RBI cant refuse to supply any quantity of
money to the government, against Government securities. As
a result, it is unable to maintain the value of money and
effectively manage the monetary affairs of the country, which
is its primary consideration u/s.3 of RBI Act.
The Constitution of India is not merely a political document,
but it also contains the financial aspiration of the country.
Therefore, the responsibility of the leader of the Bank in the
national economy is enormous, which in no way is any less
important than the resource distribution work of the Finance
Commission of the country. As a matter of fact, the present
statutory provision has not merely created an atmosphere of
dependenatia, but has also made the Central Bank (i.e. RBI)
gradually weaker. Since the system of governance could not
build up a strong convention of autonomy and an institution of
co-operation with the Central Government, it may be necessary
to review the organisational structure in the light of experience
of other constitutional institutions.
ORGANISATION CHART OF RBI [SS 8 & 9 OF THE Act]
W.T. GOVERNOR
CENTRAL BOARD
4 DG 10 DIR 4 DIR 1 GO
W.T. NOMINATED BY FROM LBS
C G
CENTRAL OFFICE
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Note : The Department names are given below
LOCAL BOARDS
DELHI BOMBAY CALCUTTA MADRAS
NOTE : Each Local Board consists of 5 Members, appointed by the CG, One of whom
is elected as Chairman
40
Abbreviations used above :
WT Whole Time DG Deputy Governor
DIR Director CG Central Government
LB Local Board GO Government official
Departments in the Central Office
1. Secretariat 2. Banking operations &
development
3. Industrial Credit 4. Agricultural Credit
5. Rural Planning & Credit 6. Exchange Control
7. Currency management 8. Expenditure & budgetary
control
9. Govt. accounts 10. Economic analysis &
policy
11. Credit planning cell 12. Statistical analysis &
Computer
13. Management Service 14. Administration &
Personnel
15. Legal Services 16. Inspection
17. Premises 18. 3 Bankers Training
Colleges, one each at
Bombay, Pune & Madras.
1.3 CENTRAL BOARD & ITS FUNCTIONS
Constitution
The general superintendence and direction of the affairs and
business of the Bank are entrusted to a Central Board of
Directors under Section 7 of the Act. However, the Board has
to abide by any directions that may be given by the Central
Government after consultation with the Governor of the Bank.
Such directions can be given from time to time in public interest.
The Central Board shall consist of the Governor, not more than
4 Deputy Governors to be appointed by the Central Government
and other directors to be nominated by the Central Government
as under :
i) four directors to be nominated by Central Government, one
each from the Local Boards constituted under Section 9.
ii) ten directors to be nominated by Central Government.
iii) one Government official to be nominated by the Central
Government.
The Governor and Deputy Governors are wholetime officials
of the Bank. A Deputy Governor and a Government official
nominated as above [under Section 8(1)(d)] may attend any
meeting of the Central Board and participate in deliberations
but do not have voting rights.
The Governor and Deputy Governors hold office for a term
fixed by the Central Government at the time of appointment,
not exceeding 5 years and are eligible for reappointment. The
Government official nominated under Section 8(1)(d) shall hold
office at the pleasure of the Government. The directors
nominated from the Local Board shall continue during their
membership of the Local Boards. The other directors shall hold
office for 4 years and thereafter until their successors are
nominated. The B R Act prescribes certain qualifications
(Chartered Accountant, Lawyer, Cooperator, etc.) for the
Directors of commercial banks, where as there are no such
qualifications specified for appointment to the Board of
Directors.
Under Section 11, the Central Government may remove from
office the Governor or a Deputy Governor or any other director
or any member of the Local Board. Central Government has
also the power under Section 30 to supercede the Central Board,
if the Bank fails to carry out any of the obligations imposed on
it by or under the Act. In such a case, the general
superintendence and direction of the affairs of the Bank shall
be entrusted to any other agency determined by the Central
Government. A full report of the circumstances leading to such
action has to be laid before the parliament at the earliest and in
any case within 3 months.
Powers
The Central Board has wide powers and may exercise all powers
and do all acts and things which may be exercised or done by
the Bank subject to any directions issued by the Central
Government in public interest after consultation with the
Governor. Further, the Governor or in his absence, the Deputy
Governor nominated by him in this behalf shall also have powers
of general superintendence and direction of the affairs and
business of the Bank, and may exercise all the powers and
functions of the Bank unless otherwise provided in the
regulations made by the Central Board.
Meetings
Meetings of the Central Board have to be held at least six times
a year and at least once in a quarter. The Governor or a Deputy
Governor duly authorised shall preside over such meetings and
he shall have casting vote (or second vote) in the event of
equality of votes.
Regulations
Under Section 58 of the Act, the Central Board has the power
to make regulations for giving effect to the provisions of the
Act. Such regulations are to be made after previous sanction
of the Central Government. These regulations are also required
to be laid before both the Houses of the Parliament.
Functions
For practical convenience the Board delegated some of its
functions by means of statutory regulations to a Committee
called the Committee of the Central Board consisting of the
Governor, Deputy Governors and such other Directors as may
be present at the relevant time in the area where the meeting is
to be held. The Committee meets once a week, generally on
Wednesday at the office of the Bank in which the Governor has
his Head Quarters for the time being, to attend to the current
business of the Bank, approval of the Banks weekly accounts
41
pertaining to the issue and the banking departments. This
Committee is assisted by two sub-committees : one for dealing
with staff and related matters & the other for looking after
matters relating to building projects. Of course, the role of
these sub-committees is purely advisory in nature.
Special Provisions
The Reserve Bank is exempted from income-tax and super-tax
on its profits or gains under Section 48 of the Reserve Bank of
India Act. Further Section 57 provides that the Bank shall not
be placed under liquidation except by an order of the Central
Government and in such manner as it may direct.
Administrative set-up
The Governor has the power of general superintendence and
direction of the affairs of the Bank and may 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. The delegation of powers to different grades of
officers is governed by the Reserve Bank of India General
Regulations, 1949, which are statutory regulations made under
Section 58 of the Act. The officers and other staff are governed
by the Reserve Bank of India (Staff) Regulations, 1948. These
regulations are not statutory. As held by the Supreme Court in
V.T. Khanzode Vs. Reserve Bank, (AIR 1982 SC 917) besides
making statutory regulations under Section 58 of the Act, Bank
could also lay down service conditions of the staff
administratively under Section 7(2) of the Act.
Establishments
The Central office [Head Quarters (H.Qrs.)] of the Bank is
located at Bombay. Formulation of policies concerning banking,
money management, inspection & supervision of Banks,
extension of banking & credit facilities, management of foreign
exchange and rendering of advice to the Central Government -
all these functions are carried out from the Head Quarters.
Besides these the Central office has various departments as
mentioned before in p.5.
The department of banking operations & development
includes Public Accounts Division (PAD), Public Debt Office
(PDO), Deposit Accounts Division (DAD) & Securities
Division (SD). The Head Quarters of the department of non
banking companies is located in Calcutta.
1.4 LOCAL BOARDS AND ITS FUNCTIONS
Constitution
Section 9 of the Act provides for four regional Local Boards
consisting of 5 members each appointed by the Central
Government to represent, as far as possible, territorial and
economic interest and the interests of co-operative and
indigenous banks. The Local Boards have their headquarters
at Bombay, Calcutta, Delhi and Madras. The Local Board has
a Chairman elected from the members. The members of the
Local Boards hold office for 4 years and thereafter until their
successors are nominated. They are also eligible for
reappointment.
Functions
The function of the Local Board is to advise the Central Board
on matters generally or specially referred to it by the Central
Board and also to perform any duties delegated to it by the
Central Board. The advice of the Local Boards is sought on
various matters of local importance, for eg. applications for
opening new branches of commercial banks, opening of offices
in India by foreign banks, directions to be given to the banks
on basis of inspection, granting of license to commercial banks,
etc.. In 1976, financial powers were also delegated to the Local
Boards enabling them to take final decisions in matters relating
to purchase of land, buildings, etc. within the limits fixed by
the Central Board.
Disqualifications
There are certain disqualifications under Section 10 applicable
to Directors of both Central Board and Local Boards. Thus (i)
a person who is a salaried government official; (ii) an
adjudicated insolvent or one who has suspended payment or
has compounded with his creditors; (iii) a person of unsound
mind ; (iv) an officer or employee of any bank or (v) a director
of a banking company or co-operative bank is disqualified to
be a director.
However, this stipulation prohibiting a director from being a
government employee or salaried government official is not
applicable to the Governor, Deputy Governor and the Director
nominated under Section 8(1)(d).
1.5 CRITICAL REMARKS
The efficiency of a Central Banking system is to be judged by
its ability to maintain price stability inside and ouside the
country. Factors affecting this efficiency are (i) the strength of
autonomous decision making power for leading the whole
banking system with the basic objective of money management;
(ii) quick information flow and capability of immediate
assessment of the situation; & (iii) adequate power of system
corrections.
(i) An empirical understanding of the men in the management
of RBI can clearly show the political overtone in the
management structure of the RBI. Appointments to various
senior positions of RBIs management are mere executive
functions of the Ministry of Finance of Government of
India. Instances of appointing persons to the highest post
in the Reserve Bank not having adequate experience in
banking are not unknown. Political considerations often
dominate while constituting Central & Local boards. Such
appointments do not require any legislative or judicial
scrutiny. There is complete lack of transparency in the
constitution & appointment of this highest administrative
setup in the RBI. As such, in designing the monetary policy,
42
regulating & controlling it, the RBI does not have functional
autonomy to the extent required by the leader of a countrys
banking system.
(ii) The RBI Act, 1934, has provisions for information flow in
accordance with the technological standard of 1934. In
most of the cases today, there is a time lag of 4-6 weeks in
between the happening of an incident & submission of the
information to the RBI. These provisions (Secs.26-28 &
31) breed inefficiency and incapacity. In order to effectively
play the role of the leader of the banking system, the Central
Bank must have complete information of all transactions
taking place in the realm of banking within the quickest
possible time. It is unfortunate that sufficient steps are yet
to be taken with this end in view.
(iii) Of course RBI has the power of delicensing any commercial
bank. This is an extreme step. RBI should have other
intermediary power as well, including imposition of fine or
taking disciplinary action or removing from service any person
or any employee who is found negligent.
43
2. FUNCTIONS
SUB- TOPICS
2.1 Introductory note
2.2 Outline of various types of functions
3.3 Concluding remarks
2.1 INTRODUCTORY NOTE
It has already been pointed out that RBI has been constituted as
Central Bank of the country. Classical functions of the Central
bank are the following:
a) Banker to the Government: Reserve Bank of India is the
banker of the Central & State Governments as such it has
treasury functions. It collects money for & on behalf of
the Government and meets the expenses, whereas in the
case of Central Government it may demand any quantity
of money and the RBI is obliged to meet the demand. In
case of State governments the RBI extends a time credit
facility up to a maximum limit which is required to be set
off against future collections.
b) Currency Function: RBI is the sole authority for the issue
of the currency. Of course one rupee coins & notes &
subsidiary coins are issued by the government of India,
they are put into circulation only through RBI.
c) Credit Control & Money Management : RBI regulates the
value of money & controls the credit system through
manipulation of cash reserve ratio, bank rate, open market
buying & selling of securities & statutory liquidity ratio.
d) Bankers Bank : RBI is the apex bank regulating,
controlling & creating opportunities for ordinary
commercial banks to function efficiently. It also gives
constant advice about the various goals of lending,
borrowing & other banking functions. It also monitors the
banking functions of the institutions of commercial banks
& institutional banks.
e) Leadership in institutional banking : RBI provides
leadership to all institutional banking such as NABAD
Rural Bank, IBRD, IFC in industrial banking, National
Housing banking so on & so forth. These banks look
forward to RBI for their policies on loans & advances.
f) Ordinary Commercial Banking Function : RBI carryout
ordinary commercial banking functions for the commercial
banks and the government which many central banks of
other countries do not do. These functions include bill
discounting, giving loans & advances to financial
institutions, dealing with foreign exchange & the like.
Table I
Functions of RBI
Central Banking Ordinary Banking
System Function
Currency Banker Credit Bankers Special Bills Lending Institutional Foreign Other
Management to Govt & Monetary Bank Rural discounting & Borrowing banking & Exchange Banking
(Secs.22-29) (Sec.20, Control Credit (Ss.17&18 of Industrial dealing functions
21A & 21B) Secs. 18 & 42 (National RBI Act) finance (Ss.39&40) (Chapter
RBI Act., Ss.17, Bank for 38 of
18,20,21 & 24 Agriculture and RBI Act)
of the B.R. Act) Rural Development
S.54 of the RBI Act)
Licensing of Banks Banks of the Bankers Supervisors of the
(S.22 of B.R. Act) (Ss.11, 17, 18 & 24 of Banks (Ss.9,19,21,& 22
B.R. Act) of the BR Act)
2.2 OUTLINE OF THE FUNCTIONS
The following table gives the outline of the functions of the
Reserve Bank of India :
44
2.3 CONCLUDING REMARKS
Different functions of the RBI are discussed hereafter in
subsequent topics. In this topic a broad outline is only given.
It may be pointed out in this connection that many central banks
like BUNDS Bank in Germany, Federal Reserve System in
USA, Bank of England, Bank of Mexico & many others do not
carry on any ordinary commercial banking function. From that
Table II
RESERVE BANK OF INDIA
CREDIT CONTROL
By Traditional Measures (quantitative) By Non-Traditional
(qualitative or Selective)
Interest Liquidity Ratio Open Market operations Cash Reserve Ratio Direct Action
System Sec.24(A) Sec. 42, RBI Act (Sec.58(B) of
B.R. Act Sec.18(1), 24(2A) RBI Act)
(a) (ii), B.R. Act)
Bank Rate Rate of Interest Publicity
(Sec.49 [(Sec.21(e) of (Sec.45(E) of RBI
RBI Act 1949 (BRA)] Act)
1934)
Moral Susasion advice,
request & persuasion With
the Commercial Banks
by Central Bank
Directives by the Central
Bank (Sec.21(2) BRA Secs.35A
& 45 K of RBI Act)
Fixation of Marginal Requirement on
secured Loans
(Sec.21(2) (b) of BRA)
Regulation of Consumer
Credit instalment credit system
point of view functions of RBI are multifarious. Some of the
commercial banking functions are being exclusively done by
RBI. As for e.g., RBI exclusively deals with foreign exchange,
of course it may specially permit branches of some other
commercial banks to deal with foreign exchange for or on its
behalf. Thus other commercial banks doing this particular job
at the instance of RBI do it as the agent of RBI.
Effecting on Credit
creating capacity of
Commercial Banks
(Sec.36(1) BRA
Sec.18(3) RBI Act)
Changes in the Prices
of Government securities
(Sec. 17(4A) of RBI Act)
45
SUB- TOPICS
3.1 Currency authority
3.2 Legal tender
3.3 Rupee coin & small coins
3.4 Management of currency
3.5 Refund of notes
3.1 CURRENCY AUTHORITY
Reserve Bank is the sole authority under Section 22 of the RBI
Act, 1934 for the issue and management of currency in India.
Section 3(1) of the Act mentions that taking over of the
management of currency is one of the purposes of constituting
the Reserve Bank. Until the currency function was taken over
by the RBI,, it was under the Controller of Currency in the
Central Government. Although the Central Government issues
one rupee notes, coins and small coins, they are put into
circulation only through the Reserve Bank. To protect the
monopoly of the Reserve Bank for issue of bank notes, section
31(1) of the Act prohibits anybody other than the Reserve Bank
(and the Government of India when expressly authorised) from
issuing bills, hundies and notes payable to bearer on demand
except for drawing on a persons account with a banker, shroff
or agent. Sub-Section (2) of Section 31 further prohibits
specifically the making or issue of a bearer promissory note by
any other person.
Under Section 24 of the Act, the Reserve Bank may issue notes
of denominations varying from two rupees to ten thousand
rupees, as decided by the Central Government based on the
recommendations made by the Central Board of the Reserve
Bank. The design, form and material of these notes has to be
approved by the Central Government on the recommendation
of the Central Board. Further, printing, circulation or issue of
notes of certain denominations may be discontinued, if so
decided by the Central Government as per the recommendations
of RBIs Central Board.
3.2 LEGAL TENDER
Under Section 26 of the Act, every bank note shall be legal
tender at any place in India in payment or on account for the
amount expressed therein. This is guaranteed by the Central
Government. Sub-Section (2) of Section 26 provides that the
Central Government is empowered to notify on the
recommendation of the Central Board of the Bank, that any
series of bank notes of any denomination shall cease to be legal
tender as specified in the notification. Under this provision
certain high denomination notes were demonetised by the
Government in 1946 and also in 1978. This was done to check
unaccounted money, tax evasion and illicit transfer of money
for financing transactions harmful to the national economy.
Reserve Bank is exempted under Section 29 of the Act from
payment of stamp duty in respect of the bank notes issued by it.
The notes issued by the Reserve Bank are referred to as bank
notes in the Act to distinguish them from the notes issued by
the Central Government.
Initially at the time of taking over the management of currency,
the Reserve Bank issued the currency notes of the Central
Government until the bank notes were ready. Now those
currency notes of the Central Government are no longer legal
tender. (Reserve Bank of India, Functions and Working, (Fourth
Edn.) 1983, P.10.)
3.3 RUPEE COINS AND SMALL COINS
One rupee coins and other coins of lower value are issued by
the Central Government under the Indian Coinage Act, 1906.
The one rupee note is governed by the Currency Ordinance of
1940. One rupee notes are treated as rupee coins for all purposes
of the RBI Act. The Central Government is responsible for
minting and supplying these coins to the Bank. The Bank acts
only as an agent of the Central Government in the distribution
and issue of coins as also for with-drawing and remitting them
back to Government. Under Section 38 of the Act, the Central
Government is bound to put into circulation one rupee coins
through the Reserve Bank only. The Central Government has
to supply coins to the Bank on demand under Section 39 of the
Act for exchange with bank notes/currency notes. It is the duty
of the Bank to exchange for currency notes or bank notes of
two rupees or upwards, currency notes or bank notes of lower
value or other coins which are legal tender under the Indian
Coinage Act, 1906. If the Central Government fails to supply
such coins to the Reserve Bank on demand, the Bank is released
from the statutory obligation to supply them to the public.
3.4 MANAGEMENT OF CURRENCY
The matters relating to management of currency are handled
by the Department of Currency Management at the Central
Office in Bombay and the Issue Departments at the Regional
Offices of the Reserve Bank. Under Section 23 of the Act, the
Issue Department has to be separate and wholly distinct from
the Banking Department. However, in practice, such distinction
between the Issue Department and Banking Department has
little economic significance (RBI, 1983, p.14).
At the Regional Offices of the Reserve Bank, the Issue
Department provides facilities of exchange. The Banking
Department, through which the currencies are issued, draws on
the local Issue Department for its requirement of currency. The
currency requirements at other centres are met through currency
chests maintained by the Reserve Bank with banks and treasuries
which act as agents of the Reserve Bank. The currency chest is
a receptacle in which new and reissuable notes, as also rupee
3. ISSUE & MANAGEMENT OF CURRENCY
46
coins are kept. Currency notes and coins withdrawn from
circulation are also deposited in the chest. The balances in the
chest are the property of the Reserve Bank.
The bank notes are fully covered by approved assets. The assets
of the Issue Department are mentioned in Section 33 and the
liabilities in Section 34 of the Act. The assets consisting of
gold coin, gold bullion, foreign securities, rupee coin and rupee
securities should not be less than the total of liabilities, namely
the total amount of currency notes/bank notes for the time being
in circulation. There is no limit or ceiling on the amount of
notes that can be issued at any time.
3.5 REFUND OF NOTES
Under Section 27 of the Act, Reserve Bank has a duty not to
reissue bank notes which are torn, defaced or excessively soiled.
This is to ensure the quality of the notes in circulation. Section
28 stipulates that no person shall have a right to recover from
the Central Government or the Reserve Bank, the value of any
lost, stolen, mutilated or imperfect currency note or bank note.
However, as a matter of grace, the value of such currency notes
or bank notes may be refunded in certain circumstances and
conditions. The conditions for refund are prescribed in the
Reserve Bank of India (Note Refund) Rules framed under the
proviso to Section 28. Refund is available from the Reserve
Bank and also from authorised branches of commercial banks.
47
SUB-TOPICS
4.1 Bank of the Central Government
4.2 Business of State Government
4.3 Ways & means advances
4.4 Public debt
4.5 Adviser to Government
4.6 Agents of the bank
4.1 BANK OF THE CENTRAL GOVERNMENT
The Reserve Bank is the banker to the Central and State
Governments. Under Section 20 of the Act, it is obligatory for
the Reserve Bank to undertake the banking business of the
Central Government, namely acceptance of deposits, making
payments upto the amounts standing to the credit of its account
and also carrying out exchange, remittance and other banking
operations. The Bank also has to manage the public debt of the
Central Government. In turn the Central Government has a
duty to entrust the Reserve Bank with all its money, remittance,
exchange and banking transactions in India and deposit free of
interest all its cash balance with the Bank. As the Reserve Bank
has branches only in a limited number of places, it is open to
the Central Government to carry on money transactions and
hold requisite balances at places where the Reserve Bank or its
agents have no place of business. It is also obligatory for the
Central Government to entrust the management of its public
debt and issue of any new loans to the Reserve Bank. The
terms and conditions of transaction of Government business
including public debt as above are governed by agreement
between the Reserve Bank and the Government. In a case where
the Reserve Bank and the Government fail to reach an
agreement, the Government is empowered to decide the
conditions. Under sub-section (4) of section 20 any agreement
made under this section has to be laid before the Parliament.
4.2 BUSINESS OF STATE GOVERNMENT
The transaction of the business of State Government is not
obligatory unlike in the case of Central Government. However,
under Section 21A, by agreement with Government of any State,
Bank may undertake -
(a all its money, remittance and banking transactions in India
including in particular, the deposit, free of interest, of all
its cash balances with the Bank; and
(b) the management of the public debt and the issue of any
new loans by that State.
Such agreements are also required to be placed before the
Parliament.
4.3 WAYS AND MEANS ADVANCES
Section 17(5) of the Reserve Bank of India Act authorises the
Reserve Bank to make ways and means advances to the Central
and State Governments. Such advances are repayable not later
than 3 months from the date of making the advances. There
are temporary advances to meet the immediate needs when there
is interval between expenditure and the flow of receipt of
revenue. The rate of interest and amount that may be advanced
is regulated by agreements between the Central and State
Governments. State Governments often resort to taking
advances in excess of the limits prescribed by the agreement
with them, which take the form of overdraft. The Government
transactions are carried out all over the country with the Reserve
Bank, State Bank of India, other agency banks and treasuries
and the accounts are maintained at the Central Accounts Section
of the Reserve Bank at Nagpur.
The Reserve Bank closely monitors the utilisation of ways and
means advances by States and has the authority to suspend
payments on account of a State, the accounts of which shows
overdraft for more than a specified number of working days
(RBI, 1983, pp.27-31).
4.4 PUBLIC DEBT
The management of public debt concerns with the raising of
finance by the Government. Under the provisions of the Public
Debt Act, 1944, the management of public debt is with the
Reserve Bank. Sections 20, 21 and 21A of the Reserve Bank
of India Act also confer powers for the management of public
debt and issue of new loans for the Central and State
Governments. For raising public loans Government issues
securities in various forms, namely
i) stocks transferable by registration in the books of the
Reserve Bank.
ii) promissory notes payable to order and
iii) bearer bonds payable to bearer. Government may
also prescribe any other forms as provided in Section
2 of the Public Debt Act.
The public debt functions are carried out through the Public
Debt Office operating at the local branch offices of the Reserve
Bank. The long term objectives of public debt management is
to ensure adequate finance for the Government and avoid
recourse to short term borrowings from the Reserve Bank as
far as possible. Treasury bills are the main instruments of short
term borrowing by the Central Government. As an agent of the
Government, the Reserve Bank issues treasury bills at a discount
which can be rediscounted with the Bank at any time before
maturity. However, the Union Finance Minister has proposed
in the 1994-95 budget to phase out the Central governments
access to unlimited ad hoc treasury bills over a period of three
years by 1997-98. This has been done to bring in greater
financial discipline in the governments expenditure. The budget
deficit is to be limited to two-thirds of 1% of the GDP (Gross
Domestic Product), the deficit should be Rs. 6000 crores for
the financial year 1994-95. A cushion has been provided as the
government can borrow upto Rs 9,000 crs. for a maximum
4. BANKER TO THE GOVERNMENT
48
period of 10 working days at any time during the year. If the
govt. fails to abide by this principle, the RBI will be free to sell
the Treasury bills in the open market so as to reduce the ad hoc
treasury bills in its custody. The government will then have to
find other ways of borrowing, from the market, domestic or
foreign. The Reserve Bank also advises the Central and State
Governments regarding the time, quantum and other aspects of
issue of new loans.
4.5 ADVISER TO GOVERNMENT
Apart from its relations with the Government as banker and
customer, and in the management of public debt, the Reserve
Bank also functions as an adviser to Government in banking
and financial matters. As the fiscal policies of the Government
have a major impact on the monetary and credit system which
the Bank regulates, coordination with the Government is
necessary.
4.6 AGENTS OF THE BANK
Reserve Banks function as banker to the Government is
discharged in the Public Accounts Departments of the local or
branch offices. At other places, government business is handled
by its agents. Under Section 45 of the Reserve Bank of India
Act, National Bank, State Bank of India and its associate banks
or nationalised banks may be appointed as agents for specified
purposes by the RBI.
49
5. BANKERS BANK
SUB-TOPICS
5.1 Lender of last resort
5.2 Clearing Houses of Banks
5.1 LENDER OF LAST RESORT
Section 17 of the Reserve Bank of India Act specifies the several
kinds of business which the Bank may transact. Under sub-section
(1), Reserve Bank may accept deposits without interest from the
Central Government, State Governments, local authorities, banks
and any other persons and also undertake collection of money on
their behalf. Accordingly, it maintains apart from Government
accounts, the accounts of banks, financial institutions, foreign
central banks and international financial institutions. Thus, the
Reserve Bank is the banker of banks.
The Bank also makes loans and advances to banks when necessary,
under various provisions of the Reserve Bank of India Act. When
difficulties arise, Reserve Bank is a lender of last resort for banks.
The availability of credit from the Bank is dependent on the
prevailing credit policy. Section 17 authorises the Reserve Bank
to give financial accommodation to scheduled banks, State Co-
operative Banks and financial institutions. Rediscount facilities
are available under various provisions of section 17(2) of the Act
for financing commercial or trade transactions, agricultural
operations or marketing of crops, production or marketing
activities of cottage and small scale industries etc. For this purpose
the documents eligible for purchase or rediscount are bills of
exchange and promissory notes drawn on and payable in India
bearing two or more good signatures, one of which has to be that
of a scheduled bank, or state co-operative bank or a State Financial
Corporation as stipulated.
Loans and advances are also available under other provisions
of Section 17, namely 17(3A), 17(3B), 17(4)(a) to (d), to
scheduled banks and state co-operative banks against securities
for financing exports, commercial or trade transactions,
agricultural operations, marketing crops, etc. Further, loans
and advances in foreign currency for financing international
trade are available under Section 17(12B). In addition to the
provisions under Section 17 for transaction in normal times,
Section 18 gives emergency powers to purchase, sell or discount
bills of exchange or promissory notes which are not eligible
for purchase or discount under Section 17 and also to make
certain loans and advances to State Co-operative banks and co-
operative societies recommended by them or any other person.
5.2 CLEARING HOUSES OF BANKS
Apart from being the banker to banks as above, the Reserve
Bank also manages the clearing houses of banks at most centres
where it has offices or branches. Under Section 58(2)(p) of the
Act, Reserve Bank is empowered to frame regulations for
regulating the clearing houses for banks including Post Office
Savings Banks. However, no such rules have been framed so
far and the clearing houses continue to work under their own
rules which are adopted by consent of members. (See, RBI,
Uniform Regulations and Rules for Banks Clearing Houses).
The Managers of the local offices of Reserve Bank are the ex-
officio Presidents of the clearing houses. The Reserve Bank is
an ordinary member of the clearing houses like other banks for
clearance of cheques and other instruments. At other places
clearing houses are managed by the State Bank or its associate
banks.
50
6. MONETARY CONTROL
SUB-TOPICS
6.1 Introduction
6.2 Bank rate
6.3 Open market operations
6.4 Cash reserve
6.5 Statutory Liquidity Ratio
6.6 Interest rate
6.7 Selective Credit Control
6.8 Regulation of non-banking institution
6.9 Directions
6.10 Un-incorporated bodies.
6.1 INTRODUCTION
Monetary Control is the main function of the Reserve Bank, as
it is the Central Bank of the country. Formulating and
administering monetary policy involves using of instruments
within its control to influence the level of aggregate demand
for goods and services by regulation of the total money supply
and credit. The Reserve Bank exercises monetary regulation
by influencing the availability and cost of credit by exercising
different types of controls. General or quantitative controls are
the instruments of Bank rate, reserve requirements and open
market operations. These methods affect the total money supply.
The other types of controls called selective credit control
envisage the increase or decrease of margins upto which the
commercial banks can finance sensitive commodities like
foodgrains, edible oils, cotton, pulses,etc. It exercises control
over the direction of credit, namely the flow of credit to a
particular commodity or sector of the economy. Control over
interest rates on acceptance of deposits by non-banking
institution also forms a part of monetary control.
6.2 BANK RATE
Bank rate is defined in Section 49 of the RBI Act as the standard
rate at which the Bank is prepared to buy or re-discount bills of
exchange or other commercial paper eligible for purchase under
the Act. In India Bank Rate has been changed frequently to
effect change in the cost of funds available from Central Bank
to banks and financial institutions. In actual practice, due to
the absence of a genuine bill market, the rate on advance by
Reserve Bank has become important and that rate has been
commonly treated as the equivalent of Bank rate.
The effectiveness of bank rate as an instrument of monetary
control depends on the extent of operation in the money market
and also on how far the commercial banks resort to borrowing
from Reserve Bank. Money market is the centre for dealings
in monetary assets of short term nature. In Indian conditions,
raising or lowering of the bank rate is of little operative
significance as there is no well developed bill market. However,
it is an important indicator of changes in the direction of the
credit policy of the Reserve Bank as it is usually offered along
with the other control measures of the RBI as a package.
6.3 OPEN MARKET OPERATIONS
Section 17(8)of the Reserve Bank of India Act authorises the
Reserve Bank to engage in the purchase and sale of securities
of any maturity of the Central Government and the State
Governments. Securities of local authorities like the State
Electricity Boards, Water Supply and Sewerage Boards,
Housing Boards, etc may also be purchased as specified by the
Central Government on the recommendation of the Central
Board of the Reserve Bank. A security which is fully guaranteed
by the Government or the authority concerned as to the principal
and interest is deemed to be a security of such Government or
authority. Reserve Bank is also authorised to purchase and sell
commercial bills of short-term maturity under Section 17(2) of
the Act.
Open market operations are used by a Central Bank to alter the
liquidity position of banks by dealing directly in the market
instead of indirectly influencing it by variation of cost of credit.
Reserve Bank can influence the resources or cash base of
commercial banks by purchase and sale of Government
securities in the open market. Open market operations can be
carried out by purchase and sale of a variety of assets such as
Government securities, commercial bills of exchange, foreign
exchange, gold and even company shares. In actual practice
they are confined to the buying and selling of Government
securities (RBI, 1983, p80). When securities are purchased from
the open market, the reserves of the banks with the Reserve
Bank increases and they can acordingly expand credit. Similarly
selling of Government securities has the effect of contraction
of credit and reduction in supply of money. The market for
Government securities being very narrow, namely public debt
being held by a few institutions and their operations being
limited, the potency of this instrument of monetary control is
reduced to that extent. Now these operations are used more to
assist Government in its borrowing than as an instrument to
influence the cost of credit. (Tannan, 1987 p 56).
6.4 CASH RESERVE
Section 42 of the Reserve Bank of India Act and Section 18 of
the Banking Regulation Act deal with cash reserves to be kept
with the Reserve Bank by scheduled banks and non-scheduled
banks respectively. Scheduled bank, as defined in Section
2(e) of the Reserve Bank of India Act means a bank included in
the second schedule of the Act.
Under Sub-section (6) of Section 42, a bank operating in India
may be included in the Second Schedule by the Reserve Bank
on the following conditions :
(i) The aggregate value of paid-up capital and reserves
is not less than Rs. 5 lakhs;
51
(ii) Satisfies the Reserve Bank that its affairs are not being
conducted in a manner detrimental to the interests of
its depositors; and
(iii) Is a State Co-operative Bank or a company or an
institution notified by the Central Government in this
behalf or a company, corporation incorporated under
any law in force in any place outside India.
The Bank is also empowered to direct exclusion of any
scheduled bank from the Second Schedule if its paid up capital
and reserve fall below the stipulated minimum, or its affairs
are conducted in a manner detrimental to the interests of
depositors (as found by the Bank after making an inspection of
the Bank under Section 35 of the Banking Regulation Act) or it
goes into liquidation or otherwise ceases to carry on banking
business. The Bank may defer the making of such direction on
an application from the scheduled bank concerned and give
time, subject to suitable conditions, to increase capital and
reserve or to remove the defects in the conduct of its affairs.
Scheduled banks have to maintain under sub-section (1) of
Section 42, an average daily balance of not less than 3% of the
total demand and time liabilities in India of such banks. Further,
the Reserve Bank is empowered to increase the rate of cash
reserve by notification in the official Gazette upto 20% of the
total demand and time liabilities. Liabilities for this purpose
is defined in clause (c) of the explanation to Section 42(1).
The paid up capital, reserves and any credit balance in the profit
and loss account of the bank as also any loan from the RBI, the
Industrial Development Bank of India, Exim Bank and certain
other financial institutions is specially excluded from Liability.
Similarly in the case of State Co-operative Banks certain
liabilities like loans from State Government and in the case of
Regional Rural Banks, loans from Sponsor Banks are excluded.
Further, under sub-section (1C), the Bank may specify from
time to time whether any transaction or transactions shall be
regarded as liability of a scheduled bank for the purpose of
cash reserve or not and in case of any doubt, the decision of the
Bank shall be final.
Sub-Section (1A) of Section 42 empowers the Bank to direct
scheduled banks to maintain a specified additional average daily
balance from any specified date. Such additional balance is
calculated with reference to the excess of the total of the demand
and time liabilities of a bank as shown in its return under sub-
section (2) Section 42 over the total of the demand and time
liabilities at the close of business over the date specified in the
notification. The additional balance should not be more than
such excess and the total cash reserve should not in any case
exceed twenty percent of the banks total demand and time
liabilities.
Where any scheduled bank maintains additional balance as
required under sub-section (1) or (1A), interest is payable at
the rates determined by the Bank. However, no interest is
payable in respect of any balance in excess of the requirement.
Every scheduled bank has to send to the Reserve Bank a return
under Section 42(2) showing the amount of its demand and
time liabilities and the amount of its borrowings from banks in
India classifying them as demand and time liabilities and other
details of its holdings, advances and investments, at the close
of business on each alternate Friday. Such returns have to be
sent not later than seven days after the date to which it relates.
Scheduled banks have also to submit another return as at the
close of business on the last Friday of every month (where it is
not an alternate Friday) under sub-section (2) giving the details
as required in fortnightly returns. However, in practice, it is
found that these returns are not properly compiled and submitted
in time on account of the very large network of branches.
In cases where the cash reserve falls short of the requirement
under sub-section (1) and (1A), such scheduled banks are not
entitled to interest on the reserve maintained and are also liable
to pay panel interest on the short fall initially at the rate of 3%
above Bank rate and thereafter at the rate of 5% above Bank
rate. Continued default will make every director, manager or
secretary of the scheduled bank who is knowingly and willingly
a party to the default punishable with fine. Further, the Bank is
also empowered to prohibit the scheduled bank from receiving
fresh deposits if the default persists. Default in complying with
such prohibition is also punishable with fine. Sub-section (4)
provides for penalty for failure to comply with the provisions
of sub-section (2) regarding returns. Sub-section (5) provides
for realisation of penalties imposed by issuing demand notice
to the scheduled bank. If the amount is not paid within 14
days, Reserve Bank may apply to the principal Civil Court for
a direction to levy the fine. The Court making such direction
shall issue a certificate specifying the sum payable which is
enforceable like a decree in a suit. If the Bank is satisfied that
the defaulting bank had sufficient cause for the default it may
not demand payment of penal interest or penalty.
The requirement of cash reserve under Section 18 of Banking
Regulation Act for non-scheduled banks is also at least 3% of
the total demand and time liabilities in India. Such cash reserve
may be maintained with the bank itself or by way of balance in
a current account with the Reserve Bank or by way of net
balance in current accounts (with State Bank, its subsidiaries
or nationalised banks) or in one or more of the aforesaid ways.
The bank has to submit a return to the Reserve Bank before
20th of every month; a return showing the amount so held on
alternate Fridays during a month with particulars of its demand
and time liabilities in India on such Fridays.
6.5 STATUTORY LIQUIDITY RATIO (SLR)
Banks are required under Section 24(1) of the Banking
Regulation Act, 1949 to maintain in India liquid assets in cash,
gold or unencumbered approved securities amounting to 20%
of its total demand and time liabilities. Approved security, as
defined in Section 5(a) of the Act means securities in which a
trustee may invest money under Clauses (a), (b), (bb), (c) or (d)
of Section 20 of the Indian Trusts Act, 1882 and certain other
securities authorised by the Central Government.
Unencumbered approved securities include approved
securities lodged with another institution for an advance or any
other credit arrangement to the extent to which such securities
have not been drawn against.
52
This provision enabled banks to liquidate their Government
security holdings, to offset the impact of variable cash reserve
requirements. Hence, sub-section (2A) to section 24 was
introduced in 1962 to require all banks to maintain a minimum
amount of liquid assets of not less than 25% of their demand
and time liabilities in India, excluding the cash balances to be
maintained under Section 42 of the Reserve Bank of India Act
in the case of scheduled banks and that under Section 18 of the
Banking Regulation Act in the case of non-scheduled banks.
The Reserve Bank is empowered to increase it up to 40 per
cent. The balances maintained by scheduled banks on their
own in excess of the requirement of cash reserve ratio under
Section 42 of the Reserve Bank of India Act or any balances in
current account with State Bank or any notified bank are counted
for the purpose of statutory liquidity ratio. Deposits of foreign
banks with Reserve Bank under Section 11(2) of the Banking
Regulation Act and any cash balances of non-scheduled banks
with themselves or in current account with Reserve Bank, State
Bank or any notified bank in excess of the requirements under
Section 18 of the Banking Regulation Act and any balances
maintained by a Regional Rural Bank with its sponsor bank are
also counted as liquid assets. The percentage of liquid assets
maintainable by a Regional Rural Bank may be varied by the
Reserve Bank by notification.
Banks have to submit a monthly return to the Reserve Bank
under sub-section (3) of Section 24 for ensuring compliance
with the requirements of liquidity ratio. Sub-section (4) provides
for payment of panel interest by defaulting banks, which is 3
per cent above Bank rate initially and liable to be increased to
5% above Bank rate for continued default. When Reserve Bank
is satisfied that the defaulting bank had sufficient cause for its
default, penal interest may be waived. The penalty is payable
within 14 days of demand by notice failing which the Reserve
Bank may obtain a direction and a certificate from the principal
Civil Court which may be enforced in the manner of a decree
from a civil court. In case of default even after increased penal
interest becomes payable, Section 24(7) provides for
punishment with fine.
6.6 INTEREST RATE
Reserve Bank exercises direct control over the lending rates of
banks by influencing cost of bank credit by increase or decrease
in the lending rates rather than the Bank rate. The relevant
statutory provisions are sections 21 and 35A of the Banking
Regulation Act. Under Section 21, Reserve Bank is empowered
to issue direction to banks in public interest or in the interests
of depositors or banking policy. Such direction may, among
other things, stipulate the rate of interest and other terms and
conditions on which advances may be made. Further, Section
35A authorises the Reserve Bank to issue directions to banks
when it is satisfied that it is necessary to do so, in the public
interest, in the interest of banking policy, to prevent the affairs
of the banks being conducted in a manner detrimental to the
interest of the depositors and also to secure proper management
of the banks. Under these provisions namely Section 21 and
35A, Reserve Bank has issued direction regarding interest rates
on both deposits and advances of banks. Section 21A of the
Banking Regulation Act stipulates that notwithstanding the
Usurious Loans Act, or any other law for the time being in
force in any State relating to indebtedness the transaction
between a bank and its debtor shall not be reopened by any
court on the ground that the rate of interest charged by such
bank is excessive. The Reserve Bank can accordingly fix the
lending rate or the maximum or minimum lending rates.
However, this has no bearing on the courts jurisdiction to give
relief to an aggrieved party when it is established that a bank
has charged interest in excess of limit prescribed by the Reserve
Bank. (H.P. Krishna Reddy v. Canara Bank, AIR 1985 Kant
285; see also Bank of India v. Karnam Renga Rao AIR 1986
Kant 246 regarding compounding of interest on agricultural
loans and Jameela Beevi v. SBT, (1992) 74 Comp. Cas 736
regarding Reserve Banks power to regulate interest rate.)
6.7 SELECTIVE CREDIT CONTROL
Selective Credit Control refers to regulation of distribution
or direction of bank resources to certain sectors of the economy.
This is done in terms of the broad national policies for achieving
developmental goals. Selective Credit Control is used by the
Reserve Bank along with general credit control. The provision
of Sections 21 and 35A of the Banking Regulations Act
empower the Reserve Bank here also. The wide powers
conferred under these provisions enable the Reserve Bank to
determine the policy in relation to advances to be followed by
banks. The directions may, apart from rate of interest, deal
with the following aspects of advances:
(i) The purpose of advances, for example, to prevent hoarding
of sensitive commodities like foodgrains, pulses, edible oils,
etc;.
(ii) Margins to be maintained in case of secured advances and
(iii) Maximum amount of advances or other financial
accommodation to a single borrower.
Such direction may be given to banks generally or to a
specific bank.
Selective credit control is exercised by Reserve Bank by
stipulating (i) minimum margins for lending against selected
commodities (ii) ceilings on the levels of credit and (iii) rates
of interest on stipulated commodities. The first two control the
quantum of credit and the last, the cost of credit. By judicious
use of these instruments, it is possible to regulate the availability
of credit to different sectors of the economy.
6.8 REGULATION OF NON-BANKING
INSTITUTIONS
The fast growth of non-banking institutions in the country and
their accepting deposits from the public at very high rates of
interest raised the question of regulating their activities. As
credit from the banking sector was under the control of the
Reserve Bank, the non-banking institutions had a ready market
and many unhealthy practices developed in course of time.
53
Hence control over the acceptance of deposits by non-banking
institutions was conceived as an adjunct to monetary and credit
policy and also with a view to protecting the interests of
depositors. Chapter III-B of the Reserve bank of India Act was
introduced in 1964 by an amendment of the Act conferring
powers on the Reserve Bank to regulate the acceptance of
deposits by non-banking institutions. Chapter III-C of the Act
which was introduced in 1984 seeks to regulate the acceptance
of deposits by unincorporated bodies. The Prize Chits and
Money Circulation Schemes (Banning) Act, 1978 and the Chit
Funds Act, 1982, were enacted pursuant to the recommendations
of a study group appointed by the Reserve Bank in 1974 to
examine the then existing statutory provisions and the directions
thereunder to suggest further regulatory measures. This statute
on prize chits and money circulation schemes is administered
by the States and Union territories but the rules are required to
be framed in consultation with the Reserve Bank. Further, the
Bank has an advisory role for the winding up of the existing
prize chits and money circulation schemes and generally on
the implementation of the Act. The Chit Funds Act is also
administered by the State Governments and the Reserve Bank
has only advisory role in the framing of rules, giving exemption
from the provisions of the Act and generally on question of
policy.
Sections 45J, 45K and 45L of the Act empower the Reserve
Bank to regulate acceptance of deposits by non-banking
institutions. Deposit as defined in Section 45I(bb) includes
any receipt of money by way of deposit or loan or any other
form except those specifically excluded. The excluded
categories are :-
i) amounts raised by way of share capital.
ii) share capital brought in by partners.
iii amounts received from banks and financial institutions.
iv) amounts received in ordinary course of business by way of
security deposit, dealership deposit,earnest money and
advance for orders of goods and services;and
v) subscriptions to chits.
Non-banking institution as defined in Section 45I(e) means a
company, corporation or co-operative society. Financial
institution as defined in Clause (c) of Section 45-I means any
non-banking institution which carries on the types of business
specified therein.
Section 45J, provides for the Reserve Bank to regulate or
prohibit in public interest issue of prospectus or advertisement
soliciting deposits from the public. Section 45K provides for
collection of information from non-banking institution regarding
deposits and also for issuing directions on matters relating to
receipt of deposits including rates of interest and period of the
deposit. On failure to comply with such directions, acceptance
of deposits may be prohibited.
Under 45L, Reserve Bank may call for information from
financial institutions and give direction relating to the conduct
of the business of financial institutions. Non-banking
institutions have a duty to furnish statements, information and
particulars as called for by the Reserve Bank. There is also
provision under Section 45N for inspection of non-banking
institutions by the Reserve Bank. Further soliciting of deposits
on behalf of a non-banking institution by unauthorised persons
is prohibited. According to Section 45Q, Chapter III B shall
over ride the provisions of other laws. With the amendment to
Companies Act, 1956 introducing Section 58A (See also,
Companies acceptance of Deposit Rules, 1975. For a detailed
discussion, see, Ramaiya, (1988, pp 231-47), regarding
prohibition of prize chits, See AIR 1981 SC 504) the Central
Government is empowered to exercise control over acceptance
of deposits by non-banking non-financial companies and over
advertisements for acceptance of deposits by all clauses of
companies.
6.9 DIRECTIONS
Under the authority of Section 45J, 45K and 45L, the Reserve
Bank has issued the Non-Banking Financial Companies
(Reserve Bank Directions 1977, the Miscellaneous Non-
Banking Companies (Reserve Bank) Directions, 1977 and the
Residuary Non-Banking Companies ( Reserve Bank)
Directions, 1987. These directions are applicable to financial
companies or other non-banking companies as specified in the
directions. These directions impose several restrictions on rate
of interest, period of deposit, maintenance of assets etc. which
are modified from time to time. (See Peerless General Finance
& Investment Company Ltd. v. RBI AIR 1992 SC 1033).
6.10 UNINCORPORATED BODIES
Chapter III C of the Reserve Bank of India Act prohibits
acceptance of deposits by individuals, firms or unincorporated
bodies from more than the number of depositors specified
therein. (See, (1993) 77 Comp. Cas (Part II) p.197).
Accordingly an individual may not accept deposits from more
than 25 persons excluding relatives of the individual. In the
case of firms the ceiling is twentyfive depositors per partner
and two hundred and fifty depositors in all excluding relatives
of partners. In the case of unincorporated associations also the
limit is twenty five depositors per individual and two hundred
and fifty depositors in total excluding relatives of the individuals
forming the association. Relatives for this purpose are defined
in the Explanation to Section 45 S(2). However, any period
not exceeding 6 months in any account relating to mutual
dealings in the ordinary course of trade or business shall not be
deemed to be a depositor on account of such balance.
Under Section 45 T an authorised officer of the Bank or of the
State Government may obtain a warrant from the court for search
of any place where documents regarding acceptance of deposits
in contravention of the provisions of Section 45 S are believed
to be kept. The Bank has no powers to regulate interest rate or
impose other conditions regarding acceptance of deposits by
unincorporated bodies. However, acceptance of deposits from
more depositors than specified being in contravention of the
provisions of the Act, the Bank can initiate prosecution under
Section 58 B read with Section 58 E of the Act.
54
SUB-TOPICS
7.1 Introduction
7.2 Restrictions on dealings in Foreign Exchange
7.3 Authorised dealers & Money changers
7.4 Blocked Accounts
7.5 Import & Export of currency
7.6 Payment for exported goods
7.7 Export & Transfer of Securities
7.8 Appointment of agents
7.9 Establishment of place of business
7.10 Employment of Foreign nationals
7.11 Information & Returns
7.12 Inspection
7.13 Issue of directions
7.14 Rupee Convertibility
7.1 INTRODUCTION
Regulation and conservation of foreign exchange is a major
function of the Reserve Bank under the Foreign Exchange
Regulation Act (FERA), 1973. As observed by the Supreme
Court in Life Insurance Corporation of India vs. Escorts
Ltd., (AIR 1986 SC 1370), it is the custodian general of
foreign exchange.
According to the Preamble, the Act provides for regulation of
certain payments, dealings in foreign exchange and securities,
transactions indirectly affecting foreign exchange and the import
and export of bullion and currency, for the conservation of
foreign exchange resources of the country and the proper
utilisation thereof in the interests of the economic development
of the country. Regulation of foreign exchange was introduced
in India under the Defence of India Rules, 1939 which was
replaced by the Foreign Exchange Regulation Act, 1947 and
later by the Foreign Exchange Regulation Act, 1973 which is
currently in force.
Although the Reserve Bank is the main agency for
administration of FERA, the task of enforcement is left to the
Directorate of Enforcement constituted under Section 3 of the
Act. The Central Government is vested with several powers
under the Act including the power to give general or special
direction to the Reserve Bank under Section 73. The Bank is
obliged to comply with such direction in the discharge of its
functions under the Act. The Act imposes certain restrictions
on dealings in foreign exchange, import and export of currency
and payment for exported goods. Holding of immovable
property outside India by residents of India and in India by non
residents, appointment of non-residents as agents and
establishment of place of business in India by non-residents
are some of the other major areas of control.
7.2 RESTRICTIONS ON DEALINGS IN FOREIGN
EXCHANGE
Under Section 8 of the Act, the previous general or special
permission of the Reserve Bank is necessary for any person,
other than an authorised dealer in India to purchase or otherwise
acquire, borrow, sell, lend, exchange or otherwise transfer any
foreign exchange with any person not being an authorised dealer.
Foreign exchange as defined in Section 2(h) means foreign
currency and includes all deposits, credits and balances payable
in any foreign currency and any drafts, travellers cheques, letters
of credit and bills of exchange, expressed or drawn in Indian
currency but payable in any foreign country. However, letters
of credit can be drawn in foreign currency too. It also includes
any instrument payable, at the option of its drawee or holder or
any other party thereto, either in Indian currency or in foreign
currency or partly in one and partly in the other. These
restrictions apply also to persons resident in India, as defined
in Clause (p) of Section 2 of the Act, other than authorised
dealers in respect of their dealings outside India. This does
not, however, apply to the purchase or sale of foreign currency
in India between any person and a money changer. Conversion
of foreign currency into Indian currency or vice versa, has to
be done at the rates of exchange for the time being determined
and authorised by the Reserve Bank. For conversion at other
rate, previous general or special permission of the Reserve Bank
is necessary. This applies to authorised dealers and money
changers as well.
Section 9(1)(a) prohibits any person in or resident in India from
making any payment to or to the credit of any person resident
outside India except with the general or special exemption of
the Reserve Bank. (Release of foreign exchange under Sections
8 and 9 should not be discriminatory See, Pranab K. Ray v.
RBI (AIR 1993 Cal.50). Such exemption may be granted with
or without conditions. Similar prohibition also extends to
making and receipt of payments of various types mentioned in
Clauses (b) to (g) of Section 9(1). Under Sub-section (3) of
Section 9, remittance of any amount from any foreign country
into India should be through an authorised dealer unless general
or special exemption is granted by the Reserve Bank, with or
without conditions.
7.3 AUTHORISED DEALERS AND MONEY
CHANGERS
Under Section 6 of the Act, Reserve Bank is empowered to
authorise any person to deal in foreign exchange. Persons so
authorised are called authorised dealers as defined in Section
2(b). Such authorisation may be granted subject to conditions
and may be for, (i) dealings in all foreign currencies or restricted
to specified foreign currencies; (ii) transactions of all
descriptions in foreign currencies or restricted to specified
transactions; (iii) a specified period or within specified periods.
Authorised dealers are generally scheduled banks. However,
7. CUSTODIAN OF FOREIGN EXCHANGE
55
Reserve Bank has given restricted licence to Industrial
Development Bank of India and Exim Bank to undertake certain
specified functions. [Exchange Control Manual, 3rd Edn., 1987
Vol. I para 1.4 (Note)]. The Reserve Bank may revoke the
authorisation or licence of any authorised dealer (i) in public
interest or (ii) for non-compliance of the conditions stipulated
or for violation of the provisions of the Act or of any rule,
notification, direction or order made thereunder. Before
revoking an authorisation, except when it is in the public interest
to do so, the authorised dealer has to be given a reasonable
opportunity for making a representation in the matter.
An authorised dealer has to function within the terms of his
authorisation and has to comply with any general or special
directions or instructions as may be given by Reserve Bank
from time to time.
Section 7 of the Act empowers the Reserve Bank to authorise
any person to deal in foreign currency. Persons so authorised
are called money changers. The authorisation given to money
changers may be (i) for all foreign currencies or in respect of
specified foreign currencies, (ii) for all transactions in foreign
currencies or for specified transactions and also may be, (iii)
for operating at a specified place and for a specified time or
within specified amounts. Money changer licences have been
given to certain established firms, hotels and other organisations.
There are full fledged money changers who buy and sell
foreign currency and restricted money changers who only buy
foreign currency and surrender it to authorised dealers. It is
open to the Reserve Bank to impose any conditions while
granting licence to money changers. The Bank is also
empowered to give direction to money changers as also to
revoke the authorisation given to money changers, as in the
case of authorised dealers under Section 6.
7.4 BLOCKED ACCOUNTS
Section 10 of the Act deals with blocked accounts. (Regarding
ordinary Non-resident Accounts, Non-Resident External
Accounts, Foreign Currency Non-Resident Accounts (FCNR),
(Exchange Control Manual, 3rd Edn., 1987 Vol I Chapters 28
& 29). A blocked account is an account opened as a blocked
account at any office or branch of a a bank in India authorised
by the Reserve Bank in this behalf or an account blocked by an
order of the Reserve Bank. While granting exemption to any
person under Section 9 in respect of payment of any sum to a
non-resident, Reserve Bank may stipulate a condition that the
payment be made to a blocked account. In such cases, the
payment shall be made to a blocked account in the name of that
person in the manner as directed by the Reserve Bank by a
special or general order. The crediting of a blocked account as
directed by the Reserve Bank would give a valid discharge to
the person making the payment to the extent of the sum credited.
Withdrawal of any amount from such blocked account is
permissible only with the general or special permission of the
Reserve Bank.
7.5 IMPORT AND EXPORT OF CURRENCY
Import or export of foreign exchange or Indian currency to or
from India is also subject to restrictions imposed under Section
13. General or special permission of the Reserve Bank is
necessary to take or send out of India any Indian currency or
foreign exchange other than foreign exchange obtained from
an authorised dealer or a money changer.
Acquisition of Foreign Exchange
Section 14 authorises the Central Government to order by a
notification in the official Gazette, every person in or resident
in India to sell foreign exchange to the Reserve Bank or to
persons authorised by the Reserve Bank for this purpose. The
sale should be at a price not less than the rate of exchange for
the time being authorised by the Reserve Bank. Such order
may also be made to persons entitled to assign any right to
receive foreign exchange. However, this does not apply to
foreign exchange acquired from an authorised dealer or money
changer and retained with the permission of the Reserve Bank
for any purpose.
Duty of Persons Entitled to Receive Foreign Exchange
Under Section 16(1) of the Act, general or special permission
of the Reserve Bank is necessary for any person having a right
to receive foreign exchange or a rupee-payment from a non-
resident, to do or refrain from doing anything which has the
effect of delaying such payment or ceasing such payment in
whole or part. If any person fails to comply with this provision,
the Reserve Bank is empowered to give suitable directions for
ensuring the receipt of the foreign exchange or payment.
7.6 PAYMENT FOR EXPORTED GOODS
Section 18(1) empowers the Central Government to stipulate
that before exporting any goods from India, the exporter
furnishes to the prescribed authority a declaration in the
prescribed form.(See Govt. Notification dated 1-1-1974 as
amended from time to time, GR, PP and VP/COD Forms
prescribed. Declaration value on some conditions. Ref.
Exchange Control Manual, 3rd Edn. 1987, Vol.I, Chapter II).
The authority prescribed under the Foreign Exchange
Regulation Rules, 1974 is the local Collector of Customs or, in
the case of export through post, the local postal authorities.
Such declaration shall mention the full export value of the goods
or the expected export value thereof and affirm that the full
export value of the goods, has been or will, within the prescribed
period, be paid in the prescribed manner. Such notification
may be in respect of all goods or any goods or any class of
goods as specified therein. It is also open to the Central
Government to direct that in respect of any goods specified,
the exporter shall not sell the goods at a value lesser than the
expected export value already declared, except with the
permission of the Reserve Bank. An application for such
permission shall not be refused without giving a reasonable
opportunity to the exporter for making a representation in the
matter. Rejection of such applications have to be communicated
to the exporter within 20 days of receipt thereof failing which
56
permission from the Reserve Bank shall be presumed. The
period taken by Reserve Bank for giving opportunity to the
exporter to be heard shall not be counted for this purpose.
Permission of the Reserve Bank is also necessary under Section
18(2) for :
(i) payment of goods other than in the prescribed manner;
(ii) delayed payment beyond the prescribed period or
(iii) where proceeds of sale of the goods exported do not
represent full export value of goods subject to any
deduction permitted by the Reserve Bank.
The Reserve Bank may give suitable direction under sub-section
(4) to exporters who fail to realise payments within the
prescribed period, for securing payment (where goods are
already sold) or for sale of goods and payment therefore or
reimport of goods to India as circumstances permit. The time
limit for the purpose may also be specified. Such direction
may also require that the goods, the right to receive the payment
therefore or any other right to enforce payment be transferred
or assigned to the Central Government or a person specified in
the directions.
Where the value of the goods as specified in the declaration
under sub-section (1) is less than the full export value or the
expected export value in the opinion of the Reserve Bank, the
Reserve Bank may intervene under sub-section (6). Thus the
person holding the shipping documents may be ordered to retain
the possession thereof until the exporter has arranged for the
Reserve Bank or its nominee to receive on behalf of the exporter,
the full export value of the goods in the prescribed manner.
Further, the exporter may be required under sub-section (7) to
exhibit the contract with the foreign buyers or any other evidence
to show that the full export value or the expected export value
of the goods has been or will be paid within the prescribed
period and in the prescribed manner.
Section 18(9) empowers the Reserve Bank to issue general or
special orders from time to time for ensuring that the full export
value of goods are received without delay. Such orders may be
in respect of exports of goods to any destination, any class of
export transactions, any class of goods or exporters. These
orders may provide that the exporter shall, prior to export,
comply with certain conditions. Such conditions may be
regarding -
i) registration of contract as specified in the order;
ii) payment to be covered by letter of credit/firm orders
or other document;
iii) certification of the export value declared by a
specified authority;
iv) prior approval of the declaration under sub-section
(1) by the Reserve Bank.
The prior approval as above may be given or withheld or may
be given subject to any condition. However, before withholding
any approval, the exporter has to be given an opportunity to
make a representation in the matter.
The general or special permission of the Bank is required under
Section 18A to take any goods from India to any place on lease,
hire or other arrangement other than sale, the provisions of
Section 18 apply to such cases also in terms of sub-section (2)
of Section 18A.
7.7 EXPORT AND TRANSFER OF SECURITIES
General or special permission of the Reserve Bank is necessary
under Section 19 for the following transactions :
(i) Taking or sending any security to any place outside
India;
(ii) Transfer of any security or creation or transfer of any
interest in a security to or in favour of any non-
resident;
(iii) Issuing in India or outside, any security which is
registered or to be registered in India to a non-resident;
(iv) Acquiring, holding or disposing of any foreign
security.
When the holder of a security is the nominee of a non-resident,
general or special permission of the Reserve Bank is necessary
before he recognises or gives effect to the substitution of another
person as the person from whom he directly receives
instructions. For enforcing this provision, Reserve Bank may
require all transferors and transferees of securities to declare
that the transferee is not a non-resident.
The mere offer of shares to a person by itself does not create
any interest in the shares in favour of the person to whom the
offer is made. Although such offer as observed by the Supreme
Court, (AIR 1981 SC 1298 at 1348) creates fresh rights, such
right is either to accept the offer or to renounce it and it does
not create any interest in the shares in respect of which the
offer is made. Permission of the Reserve Bank is necessary
under sub-section (4) for registering transfer of securities where
the transfer is suspected to involve contravention of Section
19. Further, recording an address outside India in respect of
issue or transfer of security also requires such permission.
Exemption is given for substitution of address in certain cases.
This provision is binding on any registering authority
notwithstanding any other law.
Transfer of any share, bond or debenture of a company registered
in India made by a non-resident or foreign national to a resident
shall be valid only if such transfer is confirmed by the Reserve
Bank on the application of transferor or transferee. It is open
to the Reserve Bank to exempt any transfer or class of transfers
from the operation of this provision in public interest by giving
general or special permission. Any suitable conditions may be
stipulated in this behalf.
Bearer Securities
Section 22 of the Act restricts the issue of bearer securities.
Any person in India and any resident outside India requires the
permission of the Reserve Bank to create or issue any bearer
certificate or coupon or alter any document to become a bearer
certificate or coupon.
57
Gifts and Settlements
Settlement or gift of any property to a non-resident (at the time
of such settlement) without the general or special permission
of the Reserve Bank is prohibited under Section 24. However,
settlement or gift without such permission is not invalid. Further,
it is open to the Reserve Bank to exclude any territories from
the operation of this section by notification.
Holding of Immovable Property outside India
Persons resident in India are prohibited under Section 25 from
acquiring, holding or disposing of (by sale, mortgage, lease,
gift, settlement or otherwise) any immovable property situated
outside India except with the general or special permission of
the Reserve Bank. This provision does not apply to (i) a lease
for a period of upto five years and (ii) nationals of foreign states.
General or special permission of the Reserve Bank is necessary
under Section 26 for a resident to give guarantee in respect of
any debt or other obligation or liability of a resident which is
due or owing to a non-resident or the debt, obligation or liability
of a non-resident.
7.8 APPOINTMENT OF AGENTS
Under Section 28, the following persons require the general or
special permission of the Reserve Bank to act or accept
appointment as agent in India of any person or company in the
trading or commercial transactions of such person or company.
(i) Non-resident (whether citizen of India or not);
(ii) Person who is not a citizen of India but is resident in
India;
(iii) Company which is not incorporated under the Indian
Laws or any branch thereof.
Acting or appointment as agent without such permission is void.
Agent includes any person or company (including its branch)
who or which buys any goods with a view to selling such goods
before any processing thereof. A banking company is excluded
from the operation of this Section. (Banking Companies being
subject to restrictions under B.R. Act).
The Reserve Bank may conduct an inquiry before deciding on
an application for permission under Section 28. It is also open
to the Bank to allow the application imposing any conditions
or to reject it. However, before rejecting any application the
affected party should be allowed to make a representation.
On rejection of an application for permission, acting or
appointment as such agent is void after ninety days of receipt
of the order or such other later date specified in the order.
7.9 ESTABLISHMENT OF PLACE OF BUSINESS
Non residents and other persons referred to in Section 28 require
the general or special permission of the Reserve Bank under
Section 29(1) for various transactions as under :
(i) To establish or carry on in India a place of business
for carrying on trading, commercial or industrial
activity;
(ii) Acquiring the whole or any part of any undertaking
in India of any person or a company carrying on trade,
commerce or industry, or purchasing the shares of
such company in India.
Further, under Sub-section (1A) of Section 29, a company other
than a banking company, in which non-resident interest is more
than 40% requires the general or special permission of the
Reserve Bank to carry on any activity relating to agriculture or
plantation in India. This restriction extends to acquisition by
such company of the whole or any part of any undertaking in
India of any person or company carrying on any activity relating
to agriculture or plantation or purchasing the shares in such
company.
In Life Insurance Corporation vs. Escorts,(AIR 1986 SC
1370) the Supreme Court held that permission under Section
29(1) need not be previous permission in the context of purchase
of shares of an Indian Company by non-resident companies.
The court clarified that ex-post facto permission can also be
granted. However, Reserve Bank is not bound to give ex-post
facto permission when it is found that business has been started
or shares have been purchased without its previous permission.
Where oblique motives are suspected, permission can be refused
and action can be initiated to punish the offender. It is also
open to grant ex-post facto permission subject to conditions,
for instance, that the purchaser shall not be entitled to
repatriation benefits.
In another case (AIR 1981 SC 1298) where the Reserve Bank
granted permission to a company to carry on its business subject
to dilution of non-resident interest in its equity capital to a level
not exceeding 40% within a period of one year, the Supreme
Court held that the permission would cease automatically if
such dilution was not carried out within the stipulated period
or any extended period. Hence the continuance of business
after the stipulated period would be illegal unless the condition
of dilution of non-resident equity was duly complied with.
7.10 EMPLOYMENT OF FOREIGN NATIONALS
Foreign nationals have to obtain prior permission of the Reserve
Bank under section 30 of the Act to practice any profession or
to carry on any occupation, trade or business in India, if they
desire to acquire any exchange intended for remittance out of
India from the earnings of such profession, occupation, trade
or business. In order to obtain such permission, foreign nationals
have to apply to the Reserve Bank in the prescribed form and
manner. After making such enquiry as it deems fit, the Reserve
Bank may allow the applications with or without conditions or
may reject it after giving the applicant an opportunity for
representation.
Acquisition of Immovable Property in India
Section 31 of FERA makes it mandatory for (i) persons who
are not citizens of India; and (ii) companies which are not
incorporated under any Indian law - to obtain prior general or
special permission of the Reserve Bank to acquire or hold or
transfer immovable property situated in India. This does not
58
apply to banking companies and also to lease transactions for a
period of upto 5 years. Any person requiring a special
permission in this regard, has to apply to the Reserve Bank.
On receipt of such application RBI may conduct suitable inquiry
and thereafter either allow it with or without conditions or reject
it. As in other cases discussed earlier, before rejecting any
application, the applicant has to be given an opportunity to
represent his case. It further provided that unless such
application is rejected within 90 days, grant of permission shall
be presumed. The period spent by the Reserve Bank in giving
the applicant an opportunity to be heard shall not be counted
for the purpose. The Reserve Bank has no duty to give a hearing,
to any person other than the applicant. (AIR Manual 4th Edn.
Vol 19,p 543)
7.11 INFORMATION AND RETURNS
Persons owning foreign exchange, foreign securities or
immovable properties held outside India have to submit returns
thereof to the Reserve Bank, if so directed by the Central
Government under Section 33 of the Act. Further, the Reserve
Bank, Central Government and certain offices of enforcement
are empowered to call for any information, or require production
of any book or document in the possession of any person for
examination. The Reserve Bank has also issued directions
regarding various returns to be submitted by authorised dealers
and others which are detailed in the Exchange Control Manual.
7.12 INSPECTION OF AUTHORISED DEALERS AND
MONEY CHANGERS
Under Section 43 of the Act, a duly authorised officer of the
Reserve Bank may inspect the books, accounts and other
documents of an authorised dealer. Similar powers of inspection
are also vested on the officers of Enforcement. The authorised
dealer has to produce all the requisite books and documents
and also furnish any statement or information relating to the
affairs of the authorised dealer as may be required. The
inspecting officer may also examine the authorised dealer, his
agent, or any partner direct or other officer on oath in relation
to its business. Failure to comply with the requirements of the
inspecting officer would amount to contravention of the
provisions of the Act. These provisions apply to money
changers also.
7.13 ISSUE OF DIRECTIONS AND EXCHANGE
CONTROL MANUAL
Reserve Bank is authorised under Section 73 to issue directions
to authorised dealers, money changers and other persons for
the purpose of securing compliance with the provisions of the
Act and of any rules, directions or orders made thereunder. The
directions of a standing nature made to authorised dealers,
money changers, shipping and airlines companies etc. are
contained in the Exchange Control Manual published by the
Reserve Bank.
As observed by the Supreme Court, in Escorts case, (AIR 1986
SC 1370) this Manual is a compendium of various statutory
direction, administrative instruction, advisory opinion,
comments, notes, explanation, suggestion etc. Amendments to
the directions are communicated in the form of circulars to
authorised dealers or the other persons concerned. Section 73A
provides for penalty for contravention of the direction of the
Reserve Bank or for failure to file returns.
7.14 RUPEE CONVERTIBILITY
Currency of a nation is fully convertible when the holder is
free to convert any amount of his/her national currency into
any other foreign currency. Indian Rupee is not totally
convertible because citizens of the country cannot convert their
rupee currency in any foreign currency without obtaining an
approval from the RBI. But Indian rupee is made freely
convertible in Balancing of Payment (BOP) account and in
current account of the business establishments. As such, under
this provision foreign currencies are avilable freely against
Indian rupee to commerical establishments for import of goods
and services as well as for foreign business trips, students,
scholars and researchers.
59
SUB-TOPIC
8.1 A brief account of promotional functions
8.1 A BRIEF ACCOUNT OF PROMOTIONAL
FUNCTIONS
Apart from the key central banking and regulatory functions,
the Reserve Bank also undertakes several promotional functions.
In the past the Bank has promoted several financial institutions
with a view to achieving economic growth of the country
according to the guidelines and policies of the Central
Government.
The Reserve Bank has undertaken the task of building up the
co-operative credit structure in the country for making credit
available to the rural sector which was neglected by the
commercial banks. Steps were also taken to rationalise the
policies adopted by the cooperative credit institutions. State
governments were persuaded to establish state co-operative
banks in states where they were not existing. Amalgamations
of central co-operative banks were encouraged with a view to
establishing a strong central bank for each district. Bank had
also an active role in the reorganisation of primary societies by
helping the state governments to formulate the norms of
viability. Bank has also appointed several study teams and
8. PROMOTIONAL FUNCTIONS
committees with a view to strengthening the co-operative credit
structure and also contributed to research and training in
agricultural and rural credit. The erstwhile Agricultural
Refinance and Development Corporation and the National Bank
for Agriculture and Rural Development were established with
the active support and assistance of the Reserve Bank. So is
the case of Regional Rural Banks.
The Bank has also had a promotional role in other areas of
development as under:
i) Establishment of bill market scheme.
ii) Establishment of institutions for industrial credit like
Industrial Development Bank of India, Industrial
Reconstruction Corporation of India Ltd., Unit Trust of
India etc.
iii) Formulation of credit guarantee schemes for small scale
industries and the establishment of Deposit Insurance and
Credit Guarantee Corporation.
iv) Formulation of export bills credit scheme and various other
schemes for promotion of export credit facilities and the
establishment of the Export Import Bank of India.
Reserve Bank has also promoted several institutions for training
and research in banking and related subjects. (SeeRBI, 1983,
pp 172-77 & pp 244-77; See also Tannan, 1987, p 54)
60
9. CASE LAW
Bank of India v. Karnam Ranga Rao & others AIR 1986
Kant 242.
A suit was instituted by the Bank of India (the bank) which is
the appellant for the recovery of Rs.30,564/- which was due
and outstanding from the defendants 1 and 2 out of the loan of
Rs.10,000/- granted to them for raising sugarcane crop.
Defendant 3 guaranteed repayment of the loan by executing a
letter of guarantee. The documents suggested that defendants
1 and 2 were liable to pay interest at the rate of 4 percent above
the rate prescribed by the RBI subject to the minimum of 13
per cent with quarterly rates. However the Bank has charged
only half yearly rates and also claimed at the same rate in the
suit.
Defendants admitted the loan taken, but denied their liability to
pay interest with quarterly rates on the ground that the loan
was for agricultural purpose & the Bank by the settled practice
has no right to charge periodical compound interest. They also
prayed for grant of instalments to repay the loan in five equal
annual instalments.
The following issues were framed by the trial court on the basis
of the pleadings namely,
i) Whether the plaintiff was not entitled to charge
compound interest ?
ii) Whether the defendants are entitled for five equal
instalments?
The trial court after considering the contentions urged and the
documents produced held:
It has been well settled now that for agricultural loans in
India, the conception of quarterly rate basis i.e., charging of
compound interest does not apply. That being so, the plaintiff
would not be entitled to charge compound interest on the loan
amount advanced to the defendants 1 & 2....
With that conclusion, the court directed the Bank to submit a
revised statement of accounts charging simple interest on the
amount due. Accordingly, the Bank submitted a revised
statement determining Rs.19,851.66 as the sum due from the
defendants. The Court then decreed the suit for the said amount
with future interest at 6 per cent payable in two annual
instalments.
The question raised by this appeal relates to the right of the
Bank to charge compound interest on agricultural advances.
The essential question to be decided by the court was whether
the Bank was justified in charging interest with half yearly rates
on the agricultural loan amount due and outstanding from the
defendants.
The court stated that in the present case, although the terms of
the loan advanced to the respondents authorised the bank to
charge interest with quarterly rates, the bank however, has
charged interest only with half-yearly rates. The Counsel for
the Appellant while justifying the interest charged with half
yearly rates also contended that the directives of the Reserve
Bank impose no constrain on commercial banks from charging
interest with periodical rates, quarterly or half yearly. On the
contrary according to counsel it will be obligatory for banks to
charge interest with quarterly or longer rates. In order to support
his contention he depended upon the circulars/directives issued
by the Reserve Bank relating to charging of interest on
agricultural advances.
The court held that the circulars/directives of the Reserve Bank
direct that the agricultural advances should not be treated at
par with the commercial loans in the matter of application of
the system of compounding interest. The farmers do not have
any regular source of income other than sale proceeds of their
crops is an acknowledged fact. They get income generally only
once a year. They are, therefore, not in a position to pay interest
at usual fixed intervals like monthly, quarterly and half yearly.
Banks should not charge compound interest on current dues.
Banks should not also charge interest with monthly, quarterly
or half yearly rates overdue agricultural loans.
H.P. Krishna Reddy v. Canara Bank AIR 1985 Kant.228.
The appellant was defendant against whom the respondent
Canara Bank (the Bank) instituted the suit for recovery of a
sum of Rs.23,940.97 with current interest at 13 per cent per
annum on the following averments :-
On June 19, 1969 the defendant availed of a loan of Rs.15,500/
- on the security of immovable properties with the deposit of
title deeds so as to create an equitable mortgage in favour of
the Bank. In order to ensure prompt repayment of the loan the
defendant also executed on Demand Promissory Note for a sum
of Rs.15,500/- in favour of the Bank. On October 14, 1969,
the defendant again availed of another loan of Rs.10,500/- by
extending the said security & on executing another Promissory
Note for a sum of Rs.10,500/-. The defendant also hypothecated
his crops and live-stock by executing necessary agreements.
In all, the defendant had taken Rs.26,000/- as loan from the
Bank.
The loan was not repaid as agreed on March 31, 1972. The
defendant was found to owe the bank a sum of Rs.23,940.97
including interest at the rate of 13 per cent per annum. The
defendant admitted the creation of equitable mortgage by
deposit of title deeds of his property as security for the loan
taken from the bank and also the execution of the Promissory
notes, but denied the liability to pay interest at the rest of 13 per
cent per annum. He also disputed the liability of charging higher
rate of interest and the validity of the suit claim without
furnishing the details of the aggregate interest charged.
The trial court framed the following issues :
1) Whether the plaintiff has paid Rs.15,500/- to the defendant
on the transaction of equitable mortgage of A schedule
properties ?
61
2) Whether the plaintiff has paid Rs.10,500/- on the
hypothecation of C & D Schedule properties ?
3) Whether the plaintiff is entitled to claim interest at 13 per
cent ?
4) Whether the accounts furnished by the plaintiff are correct?
5) Whether the defendant was liable only upto a sum of
Rs.6,537.53 on both these transactions as on 17.12.1971 ?
After considering the evidence, the trial court determined all
the above said issues in favour of the bank and finally decreed
the suit in favour of the Bank.
The trial court held that the defendant should pay to the plaintiff
a sum of Rs.23,940.97 together with costs and current interest
at 13 percent per annum from April 1, 1972 to the date of decree
and at 6 per cent per annum from the date of decree till payment,
within a period of six months, failing which the amount due
shall be recovered from such mortgaged properties & balance
if any shall be recovered personally from the defendant.
On appeal two points arose for consideration before the High
Court :
(1) Whether the court below was justified in awarding interest
from April 1, 1972 to the date of the decree at 13 percent
per annum on Rs.23,940-97; and
(2) Whether the Bank is entitled to recover interest with
quarterly rates?
After hearing both sides the High Court observed that in a suit
for recovery of money due under equitable mortgage and
Promissory Note, the plaintiff bank has claimed interest at the
rate of 13 per cent with quarterly rates as per rules of business,
trade, usage and custom. But no evidence has been produced
in proof of such trade practice, usage or custom. It produced a
circular of the RBI issued on 17-8-1978 which in turn made a
reference to an earlier circular dated 5-10-1974, which makes
it clear that the banks have been precluded from receiving
interest with quarterly rates on agricultural advances. The High
Court held that under S.21A which was introduced in Banking
Regulation Act by Banking Laws (Amendment) Act, 1983,
the courts cannot exercise jurisdiction under the Usurious Loans
Act or any other law relating to indebtedness for the purpose of
giving relief to any party. This appears to be the intent of the
Legislature in enacting the Amendment Act, 1983. S.21 A has,
however, no bearing on the jurisdiction of courts to give relief
to an aggrieved party when it is established that the Bank in a
particular case has charged interest in excess of the limit
prescribed by the RBI. Section 46(4) of the Banking Regulation
Act confers power on the Reserve Bank to impose penalty for
contravention of its order, rule, or direction. If, in any case, it
is proved that the Bank has charged interest in violation of the
direction of RBI, the court could give relief to the aggrieved
party notwithstanding S.21A of the Banking Regulation Act.
The interest charged beyond the rate prescribed by the Reserve
Bank would be illegal & void. Therefore the claim of the Bank
on quarterly rates on agricultural loans cannot be allowed.
The High Court allowed the appeal & modified the decree of
the court below. The High Court stated that the Bank shall re-
calculate the interest on the advance given to the appellant at
varied rates, but without quarterly rates and file a memo before
this court. The Bank is entitled to 13 percent interest per annum
from April 1, 1972 till the date of decree and thereafter at 6 per
cent per annum till the date of realisation. The Bank should
also give adjustment to payment, if any, made by the appellant
after filing the suit.
Y. Jameela Beevi v. State Bank of Travancore (1992) 74 Comp.
Cases 736.
The appellants under agreements obtained a loan from the
respondent bank on the basis of a packing credit facility granted
for the purpose of enabling export of cashewnuts. The
agreements, in accordance with a Reserve Bank circular,
provided that if export was made within 180 days of obtaining
the loan, the rate of interest would be only 11% ; and that if the
time was exceeded, the normal rate of 16% interest had to be
paid. The trial court awarded interest to the bank at 16 percent.
On appeal, the question before the High Court was whether the
trial court was justified in awarding 16% interest or whether
11% alone ought to have been allowed.
The Court held that concessions in the matter of interest are
given in obedience to circulars issued by the RBI from time to
time. The Circular directed concessional rate of interest only
in cases where export was made within 180 days. In other
cases, the banks were authorised to levy the normal rate of 16%.
On the facts, the award of interest at 16% was justified.
Pranab Kumar Ray & another v. Reserve Bank of India AIR
1993 Cal.50.
A writ petition challenging the validity of the decision of the
RBI rejecting the request of the petitioner to release foreign
exchange for his son for prosecuting LL.B(Hons) course at the
University of Leeds in United Kingdom.
The issue involved was whether the disclosure of the policy
guidelines contained in the book of Instructions of the RBI
relating to release of Foreign exchange for LL.B Course leading
to Honours degree at Cambridge/Oxford Universities only
justified the action of the RBI.
The Court held that the classification made by RBI in favour of
the Oxford and Cambridge Universities Vis-a-Vis other
Universities of the same country is quite unreasonable and
discriminatory and violative of Art.14 of the Constitution and
accordingly, illegal & void. It must be examined whether there
is any rational & proximate nexus between the object of FERA
and the condition imposed by the RBI in this particular case.
The object of FERA was to conserve & direct to the best uses,
the limited supplies of the countrys foreign exchange and to
control transaction in-foreign exchange, securities & gold. The
whole idea was to see that the countrys foreign exchange
resources were not wasted under any circumstances and were
properly utilised to advance the national interest. In the instant
writ application, the above principle has no rational or proximate
nexus. Here the Foreign exchange has been asked to be utilised
properly for the advancement of national interest by way of
62
prosecution of studies in the University of Leeds and not for
wasting the Foreign exchange for any other purpose. The
authorities are working against the best interests of the country.
V.T. Khanzode & others v. Reserve Bank of India & others
AIR 1982 SC 917.
The decision of the Reserve Bank of India introducing Common
seniority and intergroup mobility amongst different grades of
officers belonging to Group I (Section A), Group II and Group
III was challenged. That decision was contained in
Administrative circular and also in office order and had been
acted upon in the draft combined seniority list of officers in
Grade B and in Grades C, D, E and F.
The contention of the petitioners was that the aforesaid circular,
office order and combined seniority list are violative of their
fundamental rights under Arts. 14 and 16 of the Constitution
and are also ultra vires the power, jurisdiction and competence
of the Reserve Bank of India, being without the authority of
law and in contravention of the provisions of the Reserve Bank
of India Act 1934.
Upholding the decision of RBI, the Supreme Court observed
that this system of grouping had many drawbacks bearing on
the promotional opportunities of offficers in the various groups.
To mention but a few, the drawbacks were (i) Unequal size of
one group as compared to another (ii) Uneven expansion in
one group as compared to another, and (iii) Earlier confirmations
of officers in one group as compared to those in another. Various
Departments of the Reserve Bank were grouped and regrouped
from time to time. Such adjustments in the administrative affair
of the Bank are a necessary sequel to the growing demands of
new situations which are bound to arise in any developing
economy. The group system has never been a closed or static
chapter and it is wrong to think that the officers of the various
groups were kept in quarantine. The group system has been a
continuous process of trial and error and the scheme of
intergroup mobility has emerged as the best solution out of the
experience of the past. Combined seniority has been
recommended by two special committees, whose reports reflect
the expertise and objectivity which was brought to bear on their
sensitive task. It is clear that intergroup mobility and common
seniority are a safe and sound solution to the conflicting
demands of officers belonging to Group I on one hand and those
of Groups II and III on the other. No scheme governing service
matters can be fool-proof and some section or the other of
employees is bound to feel aggrieved on the score of its
expectations being falsified or remaining to be fulfilled. But
the fact that the scheme does not satisfy the expectations of
every employee does not render it arbitrary, irrational, perverse
or malafide. Combined seniority has emerged as the most
acceptable solution as a matter of administrative, historical &
functional necessity.
Peerless General Finance & Investment Co. Ltd v. Reserve
Bank of India AIR 1992 SC 1033.
In this case Residuary Non-Banking Companies (Reserve Bank)
Directions of 1987 issued by Reserve Bank of India under Secs
45-K(3) 45-J, & 45(2) of the Reserve Bank of India Act, 1934
providing for manner in which the deposits received by the
residuary non-banking companies are to be deposited by them
and manner in which such deposits are to be disclosed in balance
sheet or books of accounts of the Company, were challenged.
The Court held that the Reserve Bank was authorised to issue
the impugned directions of 1987. A very wide power is given
to the Reserve Bank of India to issue directions in respect of
any matters relating to or connected with the receipt of deposits.
It cannot be considered as a power restricted or limited to receipt
of deposits. It cannot be said that under this power the Reserve
Bank would only be competent to stipulate that deposits cannot
be received beyond a certain limit or that the receipt of deposits
may be linked with the capital of the Company. Such an
interpretation would be violating the language of S.45K(3)
which furnishes wide powers to the Reserve Bank to give any
directions in respect of any matters relating to or connected
with the receipt of deposits. The Reserve Bank under this
provision is entitled to give directions with regard to the manner
in which the deposits are to be invested and also the manner in
which such deposits are to be disclosed in the balance sheet or
books of accounts of the Company. The directions of 1987 are
fully covered under S.45k(3) of the Act which gives power to
the Reserve Bank to issue such directions.
Srinivasa Enterprises & Others v. Union of India etc AIR
1981 SC 504.
The Prize Chits Money Circulation Schemes (Banning Act)
1978 (Act 43 of 1978) was challenged on the ground that
Categories exempted under Sec.11 of the said Act spell out
discriminatory treatment & therefore violative of Art.14 of the
Constitution.
The Court stated that a bare reading of Sec.11 makes it clear
that the exempted categories do not possess the vices of private
prize chits. For one thing, what are exempted are prize chits
and money circulation schemes promoted by or controlled by
the State-Governments, the Central Government or the State
Bank of India or the Reserve Bank of India. Even Rural Banks
and Co-operatives covered by Sec.11, are subject to public
control. Likewise, Charitable and educational institutions are
exempted only if they are notified by the State Government in
consultation with the Reserve Bank. There are enough
arguments to justify the different classification of these items
and their exemption cannot be called in question on the ground
of violation of Art. 14. Reasonable classification wins
absolution from the charge of discrimination if the differentia
has a nexus with the statutory object.
63
10. PROBLEMS
1. Paul Foundation Ltd. indented to import from a German
firm some raw materials for its fibre glass factory at Kanpur
and kept 200% deposit with the Bank of Karad as per the
guidelines of RBI. After the arrival of goods, the Company
asked the Bank of karad to pay for the same which was
done. Then, the Company asked for refund of the balance
amount. But, in the meanwhile, the Bank was put under a
liquidator and the liquidator refused to pay the balance on
the plea that the unutilised portion was part of the general
assets of the bank available for distribution in the winding
up. The Company files a suit for the refund of the money.
Decide. Give reasons and refer to cases already decided on
the issue, if any.
2a. Has any person got a right to get refund for soiled and
mutilated notes ? If not, is any amount payable at all in
respect of such notes ?
(Ans: Section 28 RBI Act, RBI (Note Refund) Rules, 1975)
2b. Are bank notes promissory notes ? If so, why are they not
stamped ?
(Ans: Section 4 NI Act, Section 29, RBI Act)
2c. Does the Reserve Bank pay interest for money kept in
deposit with it ? Are there any provisions for commercial
banks to get loans from Reserve Bank ?
3. Who manages public debt of the Government ? What are
the obligations of Reserve Bank in the matter ?
(Ans: Sections 20, 21A, RBI Act, and also see Public Debt
Act, 1944)
4a. What are the restrictions on acceptance of deposits by
individuals and firms ? What is RBIs role?
(Clue: Chapter III C RBI Act, Sections 45R, 45S & 45T of
RBI Act)
4b. Does the RBI control acceptance of deposits by companies?
What are the methods of control ?
(Clue: Sections 45J, 45L & 45 N of RBI Act; Section 58A
of Companies Act 1956; Companies (Acceptance of
Deposits) Amendment Rules, 1987; and notifications given
by Department of Financial Companies, RBI, Calcutta)
4c. What is the extent of Government control over acceptance
of deposits by companies ?
(Clue: As above)
[Specify your name, ID No. and address while sending answer papers]
64
11. BIBLIOGRAPHY
LIST OF BOOKS AND CASES REFERRED
1. RBI, Reserve Bank of India - functions and working, 4th Edn., 1983.
2. RBI, Exchange Control Manual, 3rd Edn., 1987.
3. Tannan M.L. "Banking law and Practice in India, 18th Edn., 1989. Orient Law House, New Delhi.
4. A. Ramaiya, Guide of Companies Act, 11th Edn., 1988, Wadhwa and Co., Nagpur.
5. RBI, Uniform Regulations and Rules for Banks Clearing Houses.
6. AIR Manual, 4th Edn., Vol.19.
7. RBI General Regulations, 1949.
65
Banking Law
Course No: II
Module No: III
LAW OF BANKING REGULATIONS
Phone: 3211010 Fax: 080-3217858
66
Materials Prepared By:
1. Mr. Harihar Aiyyar LL.M. General Manager (Retd) SBI.
Materials Checked By:
1. Ms. Archana Kaul LL.M.
2. Ms. Sudha Peri LL.M.
Materials Edited By:
1. Prof. N.L. Mitra M.Com., LL.M., Ph.D.
2. Prof. P.C. Bedwa LL.M., Ph.D.
Published By:
Post Bag No: 7201
Nagarbhavi, Bangalore, 560 072
67
LAW OF BANKING REGULATIONS
TOPICS
1. Regulation of Banking Operations ............................................................................... 68
2. Licensing of Banking Activities .................................................................................... 78
3. Capital, Reserve and Liquid Asset Requirements ...................................................... 82
4. Restrictions on Loans and Advances ............................................................................ 88
5. Regulation on Managerial Organs ............................................................................... 92
6. Amalgamation and Reconstruction .............................................................................. 96
7. Accounts and Audit ........................................................................................................ 101
8. Powers of Reserve Bank ................................................................................................ 104
9. Other Powers of Central Government ......................................................................... 107
10. Winding up of Banking Companies.............................................................................. 111
11. Case Law......................................................................................................................... 115
12. Problems.......................................................................................................................... 117
13. Supplementary Readings ............................................................................................... 118
68
SUB-TOPICS
1.1 Introduction
1.2 Social control and its mechanism
1.3 Narasimham Committee Report : A brief outline
1.4 Concluding remarks
1.1 INTRODUCTION
The preamble to the Banking Companies Act,1949 (name of
the Act changed to Banking Regulation Act with effect from
1.3.1966)states that the Act was passed to consolidate and
amend the law relating to banking.The need for the consolidation
was felt owing to the absence of measures to safegaurd the
interests of the depositors,and the abuse of powers by persons
who controlled some of the banks.
The Act is regulatory, meant to regulate the functioning of the
banking companies and corporations. It is not a legislation to
codify the law relating to Banking.
Section 2 of the Act states that the provisions of this Act shall
be in addition to, and not, save as hereinafter expressly provided,
in derogation of the Companies Act 1956 and any other law for
the time being in force.
The years 1968, 1969 and 1980 witnessed three major events :-
(i) Social control on banking companies imposed through Act
58 of 1968. This was an amending Act to the Banking
Regulations Act 1949 and it came into effect from 01.02.69.
(ii) The nationalisation of 14 major Banks with effect from
19.07.69 by the Banking Companies (Acquisition and
Transfer of Undertakings) Act, 1970.
(iii) Further nationalisation of 6 major Banks under the Banking
Companies (Acquisition and Transfer of Undertakings) Act,
1980.
1.2 SOCIAL CONTROL AND ITS MECHANISM
The Preamble of Act 58 of 1968 states An act further to amend
the Banking Regulation Act, 1949, so as to provide for the
extension of social control over banks and for matters connected
therewith or incidental thereto.
The political situation prevailing in and around 1967 led to the
expression social control in relation to banks and banking
companies. Mismanagement of the banks coupled with the
allegations that a large chunk of the bank loans were sanctioned
to the large and medium scale industries, and big and established
business and industrial houses in which the management had
vested interest compelled the government to effect these social
control measures. In addition, complaints that sectors such as
small scale industries, agriculture and exports were neglected
by the commercial banks also led the government in this
direction. Allegations that the bank directors, who were mostly
industrialists directed the Bank credit to companies in which
they had substantial interests, and that they influenced the banks
to grant such advances in an indiscrete manner compelled the
government to bring in social control measures.
The government at that point of time and particularly, Shri
Morarjee Desai who was then the Dy. Prime Minister of India
holding charge of the Finance Ministry had no intention to
nationalise the Banks. But at the same time the government
wanted to impose such restrictions and controls over the banking
industry, which would determine the priorities of lending and
investment and those that would evolve appropriate guidelines
for the management and promote a reorientation of the decision
making machinery of the banks. The government also did not
desire to leave any opportunity in the hands of the management
and directors to mismanage the affairs of banks.
The proposals evolved to achieve these goals were termed as
social control.
The Deputy Prime Minister made a statement in the Lok Sabha
on 14.12.1967, declaring the views of the government and how
the government proposed to impose the social control. The
two steps taken in this direction were _
1. setting up of a National Credit Council (N.C.C) and
2. introducing legislative control on the banks by suitable
amendments to the Banking Regulation Act.
The National Credit Council now stands dissolved since the
nationalisation of the banks.
Towards achieving the second goal, the government passed Act
58 of 1968 which introduced radical amendments to certain
provisions of the Banking Regulation Act. The Preamble to
the amending Act states to provide for the extension of social
control over the Banks.
The mechanism to achieve the social control, by introducing
additional controls and instructions can be summarised as under:
I. Section 10 A to the Banking Regulation Act states that the
Board of directors was to include persons with professional
or other experience. This amendment was aimed to reduce
the predominance of the industrialists as Directors of a bank.
Not less than 51% of the total number of members of the
Board of Directors of the banking company shall consist
of persons, who_
a) shall have special knowledge of, or practical
experience in respect of one or more of the following
matters, viz,
1. accountancy 2. agriculture and rural economy 3. banking
4. co-operation 5. economics 6. finance 7. law 8. small scale
industry 9. any other matter the special knowledge of and
practical experience in which would in the opinion of the
Reserve Bank of India, be useful to the banking company.
The Proviso to the Section lays down that out of the aforesaid
number of directors, not less than two shall be persons having
1. REGULATION OF BANKING OPERATIONS
69
special knowledge or practical experience in respect of
agriculture or rural economy, co-operation or small scale
industry; and
b) shall not -
1) have substantial interest in or be connected with, whether
as employee or manager, or managing agent of any
company, not being a company registered under the
Companies Act or any firm which carries on any trade,
commerce or industry and which in either case, is not a
small scale industrial concern or
2) be proprietors of any trading, commercial or industrial
concern not been of a small scale industrial concern.
By Act No I of 1984 further restrictions were imposed restricting
the tenure of office of a director for a period of eight years,
other than that of the Chairman or whole time Director. This
amendment also restricts the appointment as a director of a
person who was removed from the position of a Chairman or
whole time Director of a Bank. Such persons who have been
removed by the Reserve Bank of India cannot be co-opted or
elected as director of a Bank for a period of 4 years from their
date of removal.
The added sub-section 2A also made provisions for the
reconstitution of the Board so that the provision of Section 10A
is complied with at all times.
The new sub section also confers sweeping powers to the
Reserve Bank of India to reconstitute the Board.
II. Section 10B of the amended Act lays down for the
management of the affairs of a banking company by a whole-
time Chairman, who has special knowledge of and practical
experience in the working of a bank, or is a specialist in finance,
economics or business administration.
The effect of this new section is to curb the encroachment of
industrialists over experts.
III. Section 20 of the Act places restrictions on loans and
advances by a banking company to its directors or to a company
or a firm in which a director is substantially interested or to an
individual for whom a director is a guarantor.
IV. Additional powers were conferred on the Reserve Bank of
India to enforce and supervise the social control
V. Punishment for the following was provided -
a) obstructing any person from entering or leaving a bank ;
b) holding demonstrations within the bank;and
c) acting to undermine the depositors confidence in a bank.
VI. Special powers of Central Government to acquire
undertakings of a banking company when it is satisfied on a
report from the Reserve Bank of India that the banking company
has committed certain defaults and that it is necessary to do so.
As already stated the prime reason to introduce the social control
measures was that there were complaints that the Indian
commercial banks were directing their advances to large and
medium scale industries and big business houses and that the
sectors demanding priority such as agriculture, small scale
industries and exports were not securing their due share. Hence
the Banking Regulation Act was amended.
Steps were initiated in 1969 to amend the Banking Regulation
Act to impose social controls with a view to remedy the basic
weakness of the Indian banking system and to ensure that the
banks would cater to the needs of the neglected sectors of
economy. It was felt that the social control measures had not
changed the position substantially as there were still complaints
that the commercial banks were continuing to direct their
advances to large and medium scale industries.
On 19th July 1969 14 major Banks, each having a deposit of
more than 50 crores were nationalised and taken over as
undertakings of the Government of India. This revolutionary
measure did not merely signify a change of the ownership of
the Banks, but it was the beginning of a co-ordinated endeavour
to use an important part of the financial mechanism for the
countrys economic development.
The critics of nationalisation argued that the social control on
banks should have been given a fair chance and trial for its
success. It was also argued that in line with the performance of
other public sector undertakings, inefficiency and nepotism
would creep in the banking industry.
On 15th April 1980 six more Banks having demand and time
liabilities of not less than Rs.200 crores were nationalised. The
undertakings of these Banks were transferred to six
corresponding new banks under the Banking Companies
(Acquisition and Transfer of Undertakings) Act of 1980.
The Nationalised banks have definitely functioned to achieve
the goal of economic development.
The Reserve Bank of India and the Government of India
acquired draconian powers under the Acts. However the
concept of mass banking - a change from class banking, the
directed lending policy, and subsidised bank lending over a
period of time has resulted in many of these banks making
losses, and becoming inefficient and incompetent. To
camouflage the public, the asset classifications became illusory.
The Reserve Bank of India and the government under the
dictates of the I.M.F and the World Bank brought in the
prudential norms of asset classification as some of the
nationalised banks became weak and sick and merger of the
weaker and stronger banks started.
1.3 NARASIMHAM COMMITTEE REPORT :
A BRIEF OUTLINE
The social control measures should be analysed with reference
to the recent economic changes. A high power committee under
the chairmanship of Shri.M.Narasimham was constituted to
recommend ways and means.
The terms of reference of the Committee were as follows :-
i) to examine the existing structure of the financial system and
its various components and to make recommendations for
improving the efficiency and effectiveness of the system
70
with particular reference to the economy of operations,
accountability and profitability of the commercial banks
and financial institutions ;
ii) to make recommendations for improving and modernising
the organisational systems and procedures as well as
managerial policies ;
iii) to make recommendations for infusing greater competitive
vitality into the system so as to enable the banks and
financial institutions to respond more effectively to the
emerging credit needs of the economy;
iv) to examine the cost, composition and adequacy of the
capital structure of the various financial institutions and to
make suitable recommendations in this regard ;
v) to review the relative roles of the different types of financial
institutions and to make suitable recommendations in this
regard ;
vi) to review the existing supervisory arrangements relating
to the various entities in the financial sector, in particular
the commercial banks and the term lending institutions and
to make recommendations for ensuring appropriate and
effective supervision ;
vii) to review the existing legislative framework and to suggest
necessary amendments for implementing the
recommendations that may require legislative change ; and
viii)to make recommendations on any other subject matter as
the Committee may consider germane to the subject of
enquiry or any related matter which may be specifically
referred to the Committee by the government of India.
The Committee submitted the summary of its Report on
November 8, 1991 and its main Report on November 16, 1991
to government. The full text of the summary of the Report is
reproduced below :
1. The Committees approach to the issue of financial sector
reform is to ensure that the financial services industry
operates on the basis of operational flexibility and functional
autonomy with a view to enhancing efficiency, productivity
and profitability. A vibrant and competitive financial
system is also necessary to sustain the ongoing reform in
the structural aspects of the real economy. We believe that
ensuring the integrity and autonomy of operations of banks
and DFIs is by far the more relevant issue at present than
the question of their ownership.
2. The Indian banking and financial system has made
commendable progress in extending its geographical spread
and functional reach. The spread of the banking system
has been a major factor in promoting financial
intermediation in the economy and in the growth of financial
savings. The credit reach also has been extensive and
banking system now caters to several million borrowers
especially in agriculture and small industry. The DFIs have
established themselves as a major institutional support for
investment in the private sector. The last decade has
witnessed considerable diversification of money and capital
markets. New financial services and instruments have
appeared on the scene.
3. Despite this commendable progress serious problems have
emerged as reflected in a decline of the profitability of the
banking sector. The major factors responsible for these
are : (a) directed investments ; and (b) directed credit
programmes. In both these cases, rates of interest that were
available to banks were less than the market related rates
or what they could have secured from alternate deployment
of funds. There has been a deterioration in the quality of
the loan portfolio which in turn has come in the way of
banks income generation and enhancement of their capital
funds. Inadequacy of capital has been accompanied by
inadequacy of loan loss provisions. The accounting and
disclosure practices also do not always reflect the true state
of affairs of banks and financial institutions. The erosion
of profitability of banks has also emanated from the side of
expenditure as a result of fast and massive expansion of
branches, many of which are unremunerative especially in
the rural areas, a considerable degree of overmanning
especially in the urban and metropolitan centres and
inadequate progress in updating work technology. Both
management weaknesses and trade union pressures have
contributed to this. There have also been weaknesses in
the internal organisational structure of the banks, lack of
sufficient delegation of authority and inadequate internal
controls and deterioration in what is termed housekeeping
such as balancing of books and reconciliation of inter-
branch and inter-bank entries. The DFIs also suffer from
the degree of portfolio contamination. This is more
pronounced in the case of SFCs. Being smaller institutions
the internal organisational problems of the DFIs have been
less acute than those of the banks. However, both banks
and the DFIs have suffered from excessive administrative
and political interference in individual credit decision
making and internal management. The deterioration in the
financial health of the system has reached a point where
unless remedial measures are taken soon, it could further
erode the real value of and return on the savings entrusted
to them and even have an adverse impact on depositor and
investor confidence. This diagnosis of the problem
indicates the lines of solution which the Committee
proposes with a view as much to improving the health of
the system as for making it an integral part of the ongoing
process of economic reforms.
4. The Committee is of the view that the SLR instrument
should be deployed in conformity with the original intention
of regarding it as a prudential requirement for financing
the public sector. In line with Governments decision to
reduce the fiscal deficit to a level consistent with macro-
economic stability, the Committee recommends that the
SLR be brought down in a phased manner to 25 per cent
over a period of about five years, starting with some
reduction in the current year itself.
5. As regards the cash reserve ratio [CRR], the Reserve Bank
should have the flexibility to operate this instrument to serve
71
its monetary policy objectives. The Committee believes
that given the Governments resolve to reduce the fiscal
deficit, the occassion for the use of cash reserve ratio to
control the secondary expansion of credit should also be
less. The Committee accordingly proposes that the Reserve
Bank consider progressively reducing the cash reserve ratio
from its present high level. With the deregulation of interest
rates there would be more scope for the use of open market
operations by the Reserve Bank with correspondingly less
emphasis on variations in the cash reserve ratio.
6. The Committee proposes that the interest rates paid to banks
on their SLR investments and on CRR in respect of
impounded deposits above the basic minimum should be
increased. As discussed later, the rates on SLR investments
should be progressively market related while that on cash
reserve requirement above the basic minimum should be
broadly relating to the banks average cost of deposits.
However, during the present regime of administered interest
rates, this rate may be fixed at the level of the banks one
year deposit rate.
7. With respect to directed credit programmes, the Committee
is of the view that they have played a useful purpose in
extending the reach of the banking system to cover sectors
which were neglected hitherto. Despite considerable
unproductive lending there is evidence that the contribution
of bank credit to growth of agriculture and small industry
has made an impact. This calls for some re-examination
of the present relevance of directed credit programmes at
least in respect of those who are able to stand on their own
feet and to whom the directed credit programmes with the
element of interest concessionality that has accompanied it
has become a source of economic rent. The Committee
recognises that in the last two decades banking and credit
policies have been deployed with a redistributive objective.
However, the Committee believes that the pursuit of such
objectives should use the instrumentality of the fiscal rather
than the credit system. Accordingly, the Committee
proposes that the directed credit programmes should be
phased out. This process of phasing out would also
recognise the need that for some time it would be necessary
for a measure of special credit support through direction.
The Committee therefore, proposes that the priority sector
be redefined to comprise the small and marginal farmer,
the tiny sector of industry, small business and transport
operators, village and cottage industries, rural artisan, and
other weaker sections. This credit target for this redefined
priority sector should henceforth be fixed at 10 per cent of
aggregate credit which would be broadly in line with the
credit flows to these sectors at present. The Committee
also proposes that a review may be undertaken at the end
of three years to see if directed credit programmes need to
be continued. As regards medium and large farmers, and
the larger among small industries, including transport
operators, etc., who would not now constitute part of the
redefined priority sector, the Committee proposes that to
further encourage banks to provide credit to these erstwhile
constituents of the priority sector, the Reserve Bank and
other refinancing agencies institute a preferential refinance
scheme in terms of which incremental credit to these sectors
would be eligible for preferential refinance subject to
normal eligibility criteria.
8. The Committee is of the view that the present structure of
administered interest rates is highly complex and rigid. This
is so in spite of the recent moves towards deregulation.
The Committee proposes that interest rates be further
deregulated so as to reflect emerging market conditions.
At the same time, the Committee believes that a reasonable
degree of macro-economic balance through a reduction in
the fiscal deficit is necessary for successful deregulation
of interest rates. Premature moves to market determined
interest rates could, as experience abroad has shown, pose
the danger of excessive bank lending at high nominal rates
to borrowers of dubious credit-worthiness, eventually
creating acute problems for both the banks as well as the
borrowers. Accordingly, the Committee recommends that
for the present, interest rates on the bank deposits may
continue to be regulated, the ceilings on such rates being
raised as the SLR is reduced progressively as suggested by
us earlier. Similarly, the interest rate on Government
borrowing may also be gradually brought in line with
market-determined rates which would be facilitated by the
reduction in SLR. Meanwhile, the Committee would
recommend that concessional interest rates would bear a
broad relationship to the Bank rate which should be used
as an anchor to signal the Reserve Banks monetary policy
stance. It would be desirable to provide for what may be
called a prime rate, which would be the floor of the lending
rates of banks and DFIs. The spreads between the bank
rate, the bank deposit rates, the Government borrowing rates
and the prime rate may be determined by the RBI broadly
in accordance with the criteria suggested by the
Chakravarthy Committee so as to ensure that the real rates
of interest remain positive.
9. The inadequacy of capital in the banking system is a cause
for concern. While progress towards BIS norms is
desirable, the Committee recognises that this will have to
be phased over time. The Committee suggests that the
banks and financial institutions should achieve a minimum
4 per cent capital adequacy ratio in relation to risk weighted
assets by March 1993, of which Tier 1 capital should not
be less than 2 percent. The BIS standards of 8 per cent
should be achieved over the period of the following 3 years,
that is, by March 1996. For those banks with an
international presence it would be necessary to reach these
figures even earlier.
10. The Committee believes that in respect of those banks
whose operations have been profitable and which enjoy a
good reputation in the markets, they could straight-away
approach the capital market for enhancement of their
capital. The Committee, therefore, recommends that in
respect of such banks, issue of fresh capital to the public
72
through the capital market should be permitted. Subscribers
to each issues could include mutual funds, profitable public
sector undertakings and employees of the institutions
besides the general public. In respect of other banks, the
Government could meet the shortfall in their capital
requirements by direct subscription to capital or by
providing a loan which could be treated as subordinate debt.
11. Before arriving at the capital adequacy ratio for each bank,
it is necessary that the assets of the banks be evaluated on
the basis of their realisable values. The Committee proposes
that the banks and financial institutions adopt uniform
accounting practices particularly in regard to income
recognition and provisioning against doubtful debts. There
is need also for adopting sound practices in regard to
valuation of investments on the lines suggested by the
Ghosh Committee on Final Accounts.
12. In regard to income recognition the Committee recommends
that in respect of banks and financial institutions which are
following the accrual system of accounting, no income
should be recognised in the accounts in respect of non-
performing assets. An asset would be considered non-
performing if interest on such asset remains past due for a
period exceeding 180 days at the balance sheet date. The
Committee further recommends that banks and financial
institutions be given a period of three years to move towards
the above norms in a phased manner beginning with the
current year.
13. For the purpose of provisioning, the Committee
recommends that, using the health code classification which
is already in vogue in banks and financial institutions, the
assets should be classified into four categories namely,
Standard, Sub-standard, Doubtful and Loss Assets. In
regard to Sub-Standard Assets, a general provision should
be created equal to 10 per cent of the total outstandings
under this category. In respect of Doubtful Debts, provision
should be created to the extent of 100 percent of the security
shortfall. In respect of the secured portion of some Doubtful
Debts, further provision should be created, ranging from
20 percent to 50 percent, depending on the period for which
such assets remain the doubtful category. Loss Assets
should either be fully written off or provision be created to
the extent of 100 percent. The Committee is of the view
that a period of 4 years should be given to the banks and
financial institutions to conform to these provisioning
requirements. The movement towards these norms should
be done in a phased manner beginning with the current
year. However, it is necessary for banks and financial
institutions to ensure that in respect of doubtful debts 100
per cent of the security shortfall is fully provided for in the
shortest possible time.
14. The Committee believes that the balance sheets of banks
and financial institutions should be made transparent and
full disclosures made in the balance sheets as recommended
by the International Accounting Standards Committee. This
should be done in a phased manner commencing with the
current year. The Reserve Bank, however, may defer
implementation of such parts of the standards as it considers
appropriate during the transitional period until the norms
regarding income recognition and provisioning are fully
implemented.
15. The Committee suggests that the criteria recommended for
non-performing assets and provisioning requirements be
given due recognition by the tax authorities. For this
purpose, the Committee recommends that the guidelines
to be issued by the Reserve Bank of India under Section 43
D of the Income Tax Act should be in line with our
recommendations for determination of non-performing
assets. Also, the specific provisions made by the banks
and institutions in line with our recommendations should
be made permissible deductions under the Income Tax Act.
The Committee further suggests that in regard to general
provisions, instead of deductions under Section 36(1) (viia)
being restricted to 5 per cent of the total income and 2 per
cent of the aggregate average advances by rural branches,
it should be restricted to 0.5 per cent of the aggregate
average non-agricultural advances and 2 per cent of the
aggregate average non-agricultural advances and 2 percent
of the aggregate average advances by rural branches. This
exemption should also be available to banks having
operations outside India in respect of their Indian assets, in
addition to the deductions available under Section
36(1)(viii).
16. Banks, at present, experience considerable difficulties in
recoveries of loans and enforcement of security charged to
them. The delays that characterise our legal system have
resulted in the blocking of a significant portion of the funds
of banks and DFIs in unproductive assets, the value of
which deteriorate with the passage of time. The Committee,
therefore, considers that there is urgent need to work out a
suitable mechanism through which the dues to the credit
institutions could be realised without delay and strongly
recommends that Special Tribunals on the pattern
recommended by the Tiwari Committee on the subject to
set up to speed up the process of recovery. The introduction
of legislation for this purpose is long overdue and should
be proceeded with immediately.
17. While the reform of accounting practices and the creation
of Special Tribunals are essential, the Committee believes
that an arrangement has to be worked out under which part
at least of the bad and doubtful debts of the banks and
financial institutions are taken off the balance sheet so that
the banks could recycle the funds realized through this
process into more productive assets. For this purpose, the
Committee proposes for establishment, if necessary by
special legislation, of an Assets Reconstruction Fund (ARF)
which could take over from the banks and financial
institutions a portion of the bad and doubtful debts at a
discount, the level of discount being determined by
independent auditors on the basis of clearly stipulated
guidelines. The ARF should be provided with special
73
powers of recovery somewhat broader than those contained
in Sections 29-32 of the State Financial Corporations Act
1951. The capital of the ARF should be subscribed by the
public sector banks and financial institutions.
18. It is necessary to ensure that the bad and doubtful debts of
the banks and financial institutions are transferred to the
ARF in a phased manner to ensure smooth and effective
functioning of the ARF. To begin with all consortium
accounts where more than one bank or institution is
involved should be transferred to the ARF. The number of
such accounts will not be large but the amounts involved
are substantial to make a difference to the balance sheet of
banks. Gradually, depending on the progress achieved by
the ARF, other bad and doubtful debts could be transferred
over time. Meanwhile banks and institutions should pursue
recovery through the Special Tribunals. Based on the
valuation given in respect of each asset by a panel of at
least two independent auditors, the ARF would issue bonds
to the concerned institution carrying an interest rate equal
to the Government bond rate and repayable over a period
of 5 years. These bonds will need to be guaranteed by the
Government of India and should be treated as qualifying
for SLR purposes. The advantage to banks of this
arrangement would be that their bad and doubtful debts
would be off their books though at a price but they would
have in substitution of these advances bonds upto the
discounted value with a certainty of interest income which
would be an obviously important aspect from the point of
view of income recognition, and further by making these
bond holdings eligible for SLR purposes, banks fresh
resources could become available for normal lending
purposes. We wish to emphasise that this proposal should
be regarded as an emergency measure and not as a
continuing source of relief to the banks and DFIs. It should
be made clear to the banks and financial institutions that
once their books are cleaned up through this process, they
should take normal care and pay due commercial attention
in loan appraisals and supervision and take adequate
provisions for assets of doubtful realisable value.
19. Selling these assets to the Fund at a discount would
obviously mean an obligation on the banks/DFIs to write
off these losses which many of them are in no position to
do now, given their weak capital position. We propose
that to enable the banks to finance the write off represented
by the extent of the discount, the Government of India
would, where necessary, provide, as mentioned earlier a
subordinated loan counting for capital. As far as the
Government of India itself is concerned, we believe that
the rupee counterpart of any external assistance that would
be available for financial sector reform could be used to
provide this type of capital to the banks and DFIs.
20. The ARF would be expected to deal with those assets which
are in the process of recovery. In respect of sick units which
are under nursing or rehabilitation programmes, it is
necessary to work out a similar arrangement to ensure
smooth decision making and implementation in respect of
such nursing programmes. The Committee recommends
that in respect of all such consortium accounts which are
under a nursing programme or in respect of which
rehabilitation programmes are in the process of being
worked out, the concerned lead financial institution and/or
lead commercial bank should take over the term loan and
working capital dues respectively from other participating
institutions and banks. Such acquisitions should be at a
discount based on the realisable value of the assets assessed
by a panel of at least two independent auditors as in the
case of transfer of assets to ARF.
21. In regard to the structure of the banking system, the
Committee is of the view that the system should evolve
towards a broad pattern consisting of :
(a) 3 or 4 large banks (including the State Bank of India)
which could become international in character ;
(b) 8 to 10 national banks with a network of branches
throughout the country engaged in universal
banking ;
(c) local banks whose operations would be generally
confined to a specific region ; and
(d) rural banks (including RRBs) whose operations would
be confined to the rural areas and whose business
would be predominantly engaged in financing of
agriculture and allied activities.
The Committee is of the view that the move towards this
revised system should be market driven and based on
profitability considerations and brought about through a
process of mergers and acquisitions.
22. The Committee is of the view that the structure of rural
credit will have to combine the local character of the RRBs
and the resources skills and organisational/managerial
abilities of the commercial banks. With this end in view
the Committee recommends that each public sector bank
should set up one or more rural banking subsidiaries,
depending on the size and administrative convenience of
each sponsor bank, to take over all its rural branches and,
where appropriate, swap its rural branches with those of
other banks. Such rural banking subsidiaries should be
treated on par with RRBs in regard to CRR/SLR
requirements and refinance facilities from NABARD and
sponsor banks. The 10 per cent target for directed credit
which we have recommended as a transitional meausure
should be calculated on the basis of the combined totals of
the parent banks and their subsidiaries. The Committee
proposes, that while RRBs should be allowed to engage in
all types of banking business, their focus should continue
to be to lend to the target groups to maintain at a minimum
the present level of their lending to these groups. With a
view to improving the viability of their operations, the
Committee proposes that the interest rate structure of the
RRBs should be in line with those of the commercial banks.
The Committee would leave the option open to the RRBs
74
and their sponsor banks as to whether the RRBs should
retain identity so that their focus on lending to the target
groups is not diffused or where both the RRBs and the
sponsor banks wish to do so they could be merged with the
sponsor banks and the sponsor banks in such cases should
take over as 100 per cent subsidiaries by buying out the
shares from other agencies at a token price, and eventually
merge them with the rural banking subsidiaries which we
have proposed. For those RRBs that retain their identity
and whose viability would need to be improved, we propose
that instead of investing in Government bonds as part of
their SLR requirements, they could place the amounts
stipulated under SLR as deposits with NABARD or some
special federal type of agency that might be set up for this
purpose. This would also be consistent with the statutory
requirements in this regard and NABARD or this agency
could pay interest on such balances by investing or
deploying these funds to the best advantage on their behalf
and thus help to augment the income of the RRBs.
23. The Committee proposes that Government should indicate
that there would be no further nationalisation of banks.
Such an assurance will remove the existing disincentive
for the more dynamic among the private banks to grow.
The Committee also recommends that there should not be
any difference in treatment between the public sector and
the private sector banks. The Committee would propose
that there be no bar to new banks in the private sector being
set up provided they conform to the start-up capital and
other requirements as may be prescribed by the Reserve
Bank and the maintenance of prudential norms with regard
to accounting, provisioning and other aspects of operations.
This in conjunction with the relevant statutory requirements
governing their operations would provide adequate
safeguards against misuse of banks resources to the
detriment of the depositors interests.
24. The Committee recommends that branch licensing be
abolished and the matter of opening branches or closing of
branches (other than rural branches for the present) be left
to the commercial judgement of the individual banks.
25. The Committee also believes that, consistent with other
aspects of Government policy dealing with foreign
investment, the policy with regard to allowing foreign banks
to open offices in India either as branches or, where the
Reserve Bank considers it appropriate, as subsidiaries,
should be more liberal, subject to the maintenance of
minimum assigned capital as may be prescribed by the
Reserve Bank and the statutory requirement of the
reciprocity. Joint ventures between foreign banks and
Indian banks could also be permitted, particularly in regard
to merchant and investment banking, leasing and other
newer forms of financial services.
26. Foreign banks when permitted to operate in India should
be subjected to the same requirements as are applicable to
domestic banks. If, in view of certain constraints such as
absence of branch network, the foreign banks are unable
to fulfil certain requirements such as directed credit (of 10
per cent of aggregate credit) the Reserve Bank should work
out alternative methods with a view to ensuring a level
playing field.
27. The Committee is of the view that the foreign operations of
Indian banks need to be rationalised. In line with the
structure of the banking system visualised above, there
would seem to be scope for one or more of the large banks,
in addition to the SBI, to have operations abroad in major
international financial centres and in regions with strong
Indian ethnic presence. Pending the evolution of a few
Indian banks with an international character, the Committee
recommends as an interim measure that those Indian banks
with the largest presence abroad and strong financial
position could jointly set up one or more subsidiaries to
take over their existing branches abroad. The SBI
operations abroad can continue and indeed be strengthened
in the course of time. The Government may also consider
the larger banks increasing their presence abroad by taking
over existing small banks incorporated abroad as a means
of expanding their international operations.
28. The Committee believes that the internal organisation of
banks be best left to the judgment of the managements of
individual banks, depending upon the size of the bank, its
branch spread and range of functions. However, for the
medium and large national banks the Committee proposes
a three-tier structure in terms of head office, a zonal office
and branches. In the case of very large banks, a four-tier
organisation, as is the case with the State Bank, with head
office, zonal office, regional office and branches may be
appropriate. Local banks may not need an intermediate
tier between the branch and the central office.
29. The Committee endorses the view of the Rangarajan
Committee on Computerisation that there is urgent need
for a far greater use of computerised system than at present.
Computerisation has to be recognised as an indispensable
tool for improvement in customer service, the institution
and operation of better control systems, greater efficiency
in information technology and the betterment of the work
environment for employees. These are essential
requirments for banks to function effectively and profitably
in the increasingly complex and competitive environment
which is fast developing in the financial services segment
of the economy.
30. Consistent with the Committees view that the integrity
and internal autonomy of banks and DFIs is far more
important than the question of ownership, the Committee
makes the following recommendations regarding
recruitment of officers and staff and appointments of chief
executives and constitution of the boards of the institutions:
31. The Committee recommends that instead of having a
common recruitment system for officers individual banks
should be free to make their own recruitment. Thus there
is no need for setting up a Banking Service Commission
for centralised recuritment of officers nor for their
75
recruitment, as at present, through Banking Service
Recruitment Boards (BSRBs). This will provide scope for
the banks to scout for talent and impart new skills to their
personnel. The Committee, however, predicates this
recommendation on the assumption that the banks will set
up objective, fair and impartial recruitment procedures and,
wherever appropriate, they could voluntarily come together
to have a joint recruitment system. As regards clerical
grades, the present system of recruitment through BSRBs
may continue but we would urge that the appointment of
the Chairmen of these Boards should be totally left to the
coordinating banks.
32. The Committee believes that there has to be a recognition
on the part of managements and trade unions that the system
cannot hope to be competitive internally and be in step with
the wide-ranging innovations taking place abroad without
a radical change in work technology and culture and greater
flexibility in personnel policies. We have been reassured
to know that organised labour is as much convinced of the
importance of enhancing the viability of the banking
industry and providing efficient customer service. It is
equally incumbent on management of banks to adapt
forward looking personnel policies which would help to
create a satisfying work environment.
33. The Committee recommends that the various guidelines
and directives issued by the Government or the Reserve
Bank in regard to internal administration of the banks should
be reviewed to examine their continuing relevance in the
context of the need to ensure the independence and
autonomy of banks. Such guidelines which relate to matters
of internal administration such as creation and
categorisation of posts, promotion procedures and similar
matters should be rescinded.
34. The Committee believes that the Indian banking system, at
present, is over regulated and over-administered.
Supervision should be based on evolving prudential norms
and regulations which should be adhered to rather than
excessive control over administrative and other aspects of
bank organisation and functioning. The Committee would
also like to place greater emphasis on internal audit and
internal inspection systems of banks. The inspection by
the supervisory authorities should be based essentially on
the internal audit and inspection reports. Their main
concern should be to ensure that audit and inspection
machinery (which will cover the credit appraisal system
and its observance) is adequate and conforms to well laid
down norms.
35. The Committee is firmly of the opinion that the duality of
control over the banking system between the Reserve Bank
and the Banking Division of the Ministry of finance should
end and that the Reserve Bank should be the primary agency
for the regulation of the banking system. The supervisory
function over the banks and other financial institutions, the
Committee believes, should be hived off to a separate
authority to operate as a quasi autonomous body under the
aegis of the Reserve Bank but which would be separate
from other central banking functions of the Reserve Bank.
The Committee recognises that as long as the Government
has proprietory interest in banks and financial institutions,
it would be appropriate for the Ministry of Finance to deal
with other Government departments and Parliament and
discharge its other statutory obligations but not to engage
in direct regulatory functions.
36. Central to the issue of flexibility of operations and autonomy
of internal functioning is the question of depoliticising the
appointment of the chief executive (CMD) of the banks
and the boards of the banks and ensuring security of tenure
for the CMD. The Committee believes that professionalism
and integrity should be the prime considerations in
determining such appointments and while the formal
appointments have to be made by Government, they should
be based on a convention of accepting the recommendations
of a group of eminent persons who could be invited by the
Governor of the Reserve Bank to make recommendations
for such appointments. As regards the boards of public
sector banks and institutions, as long as Government owns
the banks, it would be necessary to have a Government
director to take care of proprietorial concerns but we
believe that there is no need for the Reserve Bank to have
a representative on the boards.
37. As regards development financial institutions,the main issue
with regard to their operations are to ensure operational
flexibility, a measure of competition and adequate internal
autonomy in matters of loan sanctioning and internal
administration. The Committee proposes that the system
recommended for commercial banks in the matter of
appointment of chief executives and boards should also
apply to DFIs. The present system of consortium lending
has been perceived as operating like a cartel. The
Committee believes that consortium lending should be
dispensed with and, in its place, a system of syndication or
participation in lending, at the instance not only, as now, of
the lenders but also of the borrowers, should be introduced.
The Committee also believes that commercial banks should
be encouraged to provide term finance to industry, while at
the same time, the DFIs should increasingly engage in
providing core working capital. This will help to enhance
healthy competition between banks and DFIs. The
Committee proposes that the present system of cross holding
of equity and cross representation on the boards of the DFIs
should be done away with. The Committee welcomes the
removal of the tax concession enjoyed by IDBI as an
important step in ensuring equality of treatment between
various DFIs. As a further measure of enhancing
competition and ensuring a level playing field, the
Committee proposes that the IDBI should retain only its
apex and refinancing role and that its direct lending function
be transferred to a separate institution which could be
incoporated as a company. The infected portion of the DFIs
portfolio should be handed over to the ARF on the same
terms and conditions as would apply to commercial banks.
76
38. In the case of state level institutions, it is necessary to
distance them from the State Governments and ensure that
they function on business principles based on prudential
norms and have a management set-up suited for this
purpose. We propose that an action plan on these lines be
worked out and implemented over the next 3 years.
39. As regards the role of DFIs in corporate take-overs, the
Committee believes that DFIs should lend support to
existing managements who have a record of conducting
the affairs of the company in a manner beneficial to all
concerned, including the shareholders, unless in their
opinion the prospective new management is likely to
promote the interests of the company better. In doing so
we would expect the institutions to exercise their individual
professional judgement.
40. The DFIs should seek to obtain their resources from the
market on competitive terms and their privileged access to
concessional finance through the SLR and other
arrangements should gradually be phased out over a period
of three years.
41. The last decade had witnessed a considerable growth in
capital market operations with the emergence of new
instruments and new institutions. The capital market,
however, is tightly controlled by the Government whose
prior approval is invariably required for a new issue in the
market, the terms of the issue and its pricing. The process
of setting up Securities and Exchange Board of India (SEBI)
for over-seeing the operations of the market is still not
complete with the legislation for this purpose yet to be
enacted. We believe the present restrictive environment is
neither in tune with the new economic reforms nor
conducive to the growth of the capital market itself.
42. The committee strongly favours substantial and speedy
liberalisation of the capital market. Prior approval of any
agency _ either Government or SEBI _ for any issue in the
market should be dispensed with. The issuer should be
free to decide on the nature of the instrument, its terms and
its pricing. We would recommend in this context, that the
SEBI formulate a set of prudential guidelines designed to
protect the interests of investor, to replace the extant
restrictive guidelines issued by the Controller of Capital
Issues (CCI). In view of the above, the office of the CCI
will cease to have relevance. In the Committees view,
SEBI should not become a controlling authority substituting
the CCI, but should function more as a market regulator to
see that the market is operated on the basis of well laid
down principles and conventions. The capital market
should be gradually opened up to foreign portfolio
investment and simultaneously efforts should be initiated
to improve the depth of the market by facilitating issue of
new types of equities and innovative debt instruments.
Towards facilitating securitisation of debt, which could
increase the flow of instruments, appropriate amendments
will need to be carried out in the Stamp Acts.
43. In the last decade several new institutions have appeared
on the financial scene. Merchant banks, mutual funds,
leasing companies, venture capital companies and factoring
companies have now joined hire purchase companies in
expanding the range of financial services available.
However, the regulatory framework for these new set of
institutions has still to be developed.
44. The Committee recommends that the supervision of these
institutions which form an integral part of the financial
system should come within the purview of the new agency
to be set up for this prupose under the aegis of the RBI.
The control of these institutions should be principally
confined to off-site supervision with the on-site supervision
being resorted to cases which call for active intervention.
The SEBI which is charged with the responsibility of
ensuring orderly functioning of the market should have
jurisdiction over these institutions to the extent their
activities impinge on market operations. In regard to mutual
funds there is a good case for enacting new legislation on
the lines obtaining in several countries with a view to
providing an appropriate legal framework for their
constitution and functioning. The present guidelines with
regard to venture capital companies are unduly restrictive,
and affecting the growth of this business and need to be
reviewed and amended.
45. As in the case of the banks and financial institutions there
is need to lay down prudential norms and guidelines
governing the functioning of these institutions. These
prudential guidelines should relate, among other things, to
capital adequacy, debt equity ratio, income recognition
provisioning against doubtful debts, adherence to sound
accounting and assets. The eligibility criteria for entry,
growth and exit should also be clearly stipulated so that
the growth of these institutions takes place on proper lines.
46. The Committee would like to emphasise that a proper
sequencing of reforms is essential. Deregulation of interest
rates can only follow success in controlling fiscal deficits.
Asset reconstruction, institution of capital adequacy and
establishment of prudential norms with a good supervisory
machinery have to be proceeded with in a phased manner
over the next 3 to 5 years but, we believe, it is important
that the process must begin in the current year itself.
47. The above set of proposals would necessitate certain
amendments in existing laws which the Government should
undertake expeditiously.
48. The committees approach thus seeks to consolidate the
gains made in the Indian financial sector while improving
the quality of the portfolio, providing greater operational
flexibility and most importantly greater autonomy in the
internal operations of the banks and financial institutions
so as to nurture a healthy, competitive and vibrant financial
sector. This will, above all else, require depoliticisation of
appointments, implying at the same time a self-denial by
Government and the perception that it has distanced itself
from the internal decision making of the banks and the
77
financial institutions. The proposed deregulation of the
financial sector and the measures aimed at improving its
health and competitive vitality would, in the Committees
view, be consistent with the steps being taken to open up
the Indian economy, enable the Indian financial sector to
forge closer links with the global financial markets, and
enhance Indias ability to take competitive advantage of
the increasing international opportunities for Indian trade,
industry and finance.
In the economy of every country, Commercial Banks have
a very significant role to play. These institutions are the players
in the money market. It is therefore necessary for the Central
Bank of the country to have regulations on these Commercial
Banks, which have been already narrated in the module on RBI.
Over and above these regulations by the Central Bank which
contains
(a) restrictions on loans and advances ; (See S.20 of B.R. Act)
(b) maintenance of percentage of liquid assets ; (See S.24 of
B.R.Act)
(c) maintaining reserve fund and cash reserve ; (See Ss. 17
and 18)
(d) Licensing of banking companies ; (See S. 22)
The Central Govt also has certain regulatory functions. This
module contains all these regulatory requirements excepting
those which relate to the money market discussed in the module
of RBI.
78
SUB TOPICS
2.1 General provisions about Licensing
2.2 RBI Guidelines
2.1 GENERAL PROVISIONS ABOUT LICENSING
Section 22 of the Banking Regulation Act deals with the
Licensing provisions of Banking Companies
1) Save as hereinafter provided, no company shall carry on
banking business in India unless it holds a licence issued
in that behalf by the Reserve Bank, and any such licence
may be issued subject to such conditions as the Reserve
Bank may think fit to impose.
2) Every banking company in existnece on the commencement
of this Act, before the expiry of six months from such
commencement, and every other company before
commencing banking business in India, shall apply in
writing to the Reserve Bank for a licence under this section:
Provided that in the case of a banking company in existence
on the commencement of this Act, nothing in sub-section
(1) shall be deemed to prohibit the company from carrying
on banking business until it is granted a licence in pursuance
of this section or is by notice in writing informed by the
Reserve Bank that a licence cannot be granted to it :
Provided further that the Reserve Bank shall not give a
notice as aforesaid to a banking company in existence at
the commencement of this Act before the expiry of the three
years referred to in sub-section (1) of section 11 or of such
further period as the Reserve Bank may under that sub-
section think fit to allow.
3) Before granting any license under this section, the Reserve
Bank may require to be satisfied by an inspection of the
books of the company or otherwise that the following
conditions are fulfilled, namely :-
a) that the company is or will be in a position to pay its
present or future depositors in full as their claims
accrue ;
b) that the affairs of the company are not being, or are
not likely to be, conducted in a manner detrimental
to the interests of its present or future depositors ;
c) that the general character of the proposed
management of the company will not be prejudicial
to the public interest or the interest of its depositors ;
d) that the company has adequate capital structure and
earning prospects;
e) that the public interest will be served by the grant of
a licence to the company to carry on banking business
in India ;
f) that having regard to the banking facilities available
in the proposed principal area of operations of the
company, the potential scope for expansion of banks
already in existence in the area and other relevant
factors the grant of licence would not be prejudicial
to the operational and consolidation of the banking
system consistent with monetary stability and
economic growth ;
g) any other condition, the fulfilment of which would, in
the opinion of the Reserve Bank, be necessary to
ensure that the carrying on of banking business in
India by the company will not be prejudicial to the
public interest or the interests of the depositors.
3A) Before granting any licence under this section to a company
incorporated outside India, the Reserve Bank may require
to be satisfied by an inspection of the books of the company
or otherwise that the conditions specified in sub-section
(3) are fulfilled and that the carrying on of the banking
business by such company in India will be in the public
interest and that the Government or law of the country in
which it is incorporated does not discriminate in any way
against banking companies registered in India and that the
company complies with all the provisions of this Act
applicable to banking companies incorporated outside India.
4) The Reserve Bank may cancel a licence granted to a banking
company under this section _
i) if the company ceases to carry on banking business
in India ; or
ii) if the company at any time fails to comply with any
of the conditions imposed upon it under sub-section
(1) or
iii) if at any time, any of the conditions referred to in
sub-section (3) and sub-section (3-A) is not fulfilled:
Provided that before cancelling a licence under clause (ii)
or clause (iii) of this sub-section on the ground that the
banking company has failed to comply with or has failed
to fulfil any of the conditions referred to therein, the Reserve
Bank, unless it is of opinion that the delay will be prejudicial
to the interests of the companys depositors or the public,
shall grant to the company on such terms as it may specify,
an opportunity of taking the necessary steps for complying
with or fulfilling such condition.
5) Any banking company aggrieved by the decision of the
Reserve Bank cancelling a licence under this section may,
within 30 days from the date on which such decision is
communicated to it, appeal to the Central Government.
6) The decision of the Central Government where an appeal
has been preferred to it under Sub-section (5) or of the
Reserve Bank where no such appeal has been preferred
shall be final.
This section originated with the demand for licensing of foreign
banks doing business in India and was also recommended by
the Indian Central Banking Enquiry Committee, mainly with
the object of prohibiting the entry of banks started in countries
2. LICENSING OF BANKING ACTIVITIES
79
which discriminated against banks started in India. The above
section, however, introduces a comprehensive system of
licensing of banks incorporated in India is dependent upon the
maintenance of a satisfactory financial condition coupled with
the additional qualification in case of foreign banks, vide sub-
section (3A) which has been inserted by the Banking Laws
(Amendment) Act, 1983 (1 of 1984) on the basis of existing
clause (c) of sub-section (3), that the countries of their origin
do not discriminate in any way against banks registered in India.
It also provides for the issue of conditional licence. Laws of
certain foreign countries such as Switzerland, U.S.A and
Sweden have almost similar provisions. The requirements under
this section may be classified under following three heads :
(a) necessity of licensing and mode of applying for it ;
(b) conditions for granting of licences and compliance with
further condition;
(c) cancellation of licences and appeals from such orders.
No banking company can commence or carry on banking
business in India until it holds a licence granted to it by the
Reserve Bank for the purpose. In the case of banking companies
to be started, before granting a licence to them the Reserve
Bank may require to be satisfied whether the conditions given
in sub-section (3) of section 22 are fulfilled. By the Banking
Laws (Amendment) Act, 1983 clauses (c) to (g) have been
substituted for existing clause (c) w.e.f. 15.2.1984, so as to widen
the scope of the matters which the Reserve Bank may consider
before granting a licence. It amy be added that while a banking
company whose licence is cancelled by the Reserve Bank has
the right to appeal to the Central Government whose decision
is to be regarded as final, no such appeal can be preferred by a
new banking company whose application for licence is turned
down.
In Sajjan Bank (P) Ltd, Vs. Reserve Bank (30 Comp.Cas. 146),
it has been held that the provisions of Section 22 of the Banking
Regulation Act, 1949 prescribe only a system of licensing,
having for its object the regulation of the business of banking
and does not violate fundamental right of any person to carry
on the business of banking. It was also laid down that the powers
vested in the Reserve Bank of India under Section 22 of the
Banking Companies Act, 1949 are not vested with a mere officer
of the Reserve Bank.
Restrictions on opening and transfer of Branches :- Under the
provisions of Section 23, the Reserve Bank has been empowered
to control the opening of new and transfer of existing places of
business of banking companies as follows
1) without obtaining prior permission of the Reserve Bank _
a) no banking company shall open a new place of
business in India or change otherwise than within the
same city, town or village, the location of an existing
place of business situated in India; and
b) no banking company incorporated in India shall open
a new place of business outside India or change,
otherwise than within the same city, town or village
in any country or area outside India, the location of
an existing place of business situated in that country
or area :
Provided that nothing in this sub-section shall apply to the
opening for a period not exceeding one month of a temporary
place of business within a city, town or village or the environs
thereof within which the banking company already has a place
of business, for the purpose of affording banking facilities to
the public on the occasion of an exhibition, a conference or a
mela or any other like occasion.
2) Before granting any permission under this section, the
Reserve Bank may require to be satisfied by an inspection
under section 35 as to the financial condition and history
of the company, the general character of its management,
the adequacy of its capital structure and earning prospects
and that public interest will be served by the opening or, as
the case may be, change of location, of the place of business.
3) The Reserve Bank may grant permission under sub-section
(1) subject to such conditions as it may think fit to impose
either generally or with reference to any particular case.
4) Where, in the opinion of the Reserve Bank, a banking
company has, at any time, failed to comply with any of the
conditions imposed on it under this section, the Reserve
Bank may, by order in writing and after affording reasonable
opportunity to the banking company for showing cause
against the action proposed to be taken against it, revoke
any permission granted under this section.
4A) Any regional rural bank requiring the permission of the
Reserve Bank under this Section shall forward its
application to the Reserve Bank through the National Bank
which shall give its comments on the merits of the
application and send it to the Reserve Bank ;
Provided that the regional rural bank shall also send an advance
copy of the application directly to the Reserve Bank.
5) For the purposes of this section place of business includes
any sub-office, pay-office, sub-pay ofice and any place of
business at which deposits are received, cheques cashed or
moneys lent.
The need for the permission for the opening of a new branch
was first brought into operation by Banking Companies
(Restriction of Branches) Act, 1946. Explanation to section
does not serve to define the words place of business, unless
the money aid was lent at that place. Similarly the words
cheques cashed apply to cheques drawn on the bank at the
place in question. The restrictions imposed by the section are
not applicable to change of location of a place of business in
the same city or village, in which a place of business is already
existing. It is also provided that a banking company may without
the previous permission of the Reserve Bank open a new place
of business, for a period not exceeding a month for the purpose
of affording exhibition, or a fair, if such temporary place of
business is located with the environs of a city, town or village
in which the banking company already has a place of business.
80
Originally the section did not impose any restriction on the
opening of branches of Indian banks outside India. It was,
however, subsequently felt that the maintenance of a satisfactory
financial position, and the observance of sound banking
traditions by foreign branches of Indian banks were of vital
importance not only to the banking prestige abroad but also in
the larger interests of the country, so it is now necessary for
Indian banks to obtain permission of the Reserve Bank before
opening branches in foreign countries. Besides, banks have to
submit a monthly statement regarding the assets and liabilities
of their branches in each foreign country.
After nationalisation the entry of new private Banks was
externally prohibited.
However on the basis of the liberalisation of our economy the
Reserve Bank of India have brought our guidelines on 22.1.1993
for floating new private sector banks.
2.2 RBI GUIDELINES ON ENTRY OF NEW PRIVATE
BANKS
For well over decades, after the nationalisation of 14 larger
banks in 1969, no bank has been allowed to be set up in the
private sector. Progressively, over this period, the public sector
banks have expanded their branch net work considerably and
catered to the socio-economic needs of large masses of the
population, especially the weaker section and those in the rural
area. The public sector banks now have 91 per cent of the total
bank branches and handle 86 per cent of the total banking
business in the country. While recognising the importance and
the role of public sector banks, there is increasing recognition
of the need to introduce greater competititon which can lead to
higher productivity and efficiency of the banking system. A
stage has now been reached when new private sector banks
may be allowed to be set up.
It is necesary that while permitting the entry of new private
sector banks the following considerations have to be kept in
view :
(a) they sub-serve the underlying goals of financial sector
reforms which are to provide competitive, efficient and low
cost financial intermediation services for the society at large;
(b) they are financially viable;
(c) they should result in upgradation of technology in the
banking sector;
(d) they should avoid the shortcomings such as unfair
preemption and concentration of credit, monopolisation of
economic power, cross holdings with industrial groups etc.
which beset the private sector banks prior to nationalisation;
(e) freedom of entry in the banking sector may have to be
managed carefully and judiciously.
Based on these consideration, the Reserve Bank has formulated
the following guidelines for establishment of new banks in the
private sector :-
a) Such a bank shall be registered as a public limited company
under the Companies Act, 1956 ;
b) The RBI may, on merits, grant licence under the Banking
Regulation act, 1949 for such a bank. The bank may also
be included in the Second Schedule of the Reserve Bank
of India Act, 1934 at the appropriate time. The decision of
the RBI in these matters shall be final ;
c) The bank will be governed by the provisions of the Banking
Regulation Act, 1949 in regard to its authorised, subscribed
and paid-up capital. The minimum paid-up capital for such
a bank shall be determined by the RBI and will also be
subject to other applicable regulations ;
d) The shares of the bank should be listed on stock exchanges;
e) To avoid concentration of the headquarters of new banks
in metropolitan cities and other overbanked areas, while
granting a licence preference may be given to those the
headquarters of which are proposed to be located in a centre
which does not have the headquarters of any other bank ;
f) Voting rights of an individual shareholder shall be governed
by the ceiling of 1 per cent of the total voting rights as
stipulated by Section 12(2) of the Banking Regulation Act.
However, exemption from this ceiling may be granted under
section 53 of the said Act, to public financial institutions;
g) The new bank shall not be allowed to have as a director
any person who is a director of any other banking company,
or of companies which among themselves are entitled to
exercise voting rights in excess of twenty per cent of the
total voting rights of all the shareholders of the banking
company, as laid down in the Banking Regulation Act,
1949;
h) The bank will be governed by the provisions of the Reserve
Bank of India Act, 1934, the Banking Regulation Act, 1949
and other relevant statutes, in regard to its management
set-up, liquidity requirements and the scope of its activities.
The directives, instructions, guidelines and advices given
by the RBI shall be applicable to such a bank as in the case
of other banks. It would be ensured that a new bank would
concentrate on core banking activities initially;
i) Such a bank shall be subject to prudential norms in respect
of banking operations, accounting policies and other
policies as are laid down by RBI. The bank will have to
achieve capital adequacy of 8 per cent of the risk weighted
assets from the very beginning. Similarly, norms for income
recognition, asset classification, and provisioning for bad
and doubtful advances will also be applicable to it from
the beginning. So will be the single borrower and group
borrowers exposure limits that will be inforced from time
to time ;
j) The bank shall have to observe priority sector lending
targets applicable to other domestic banks. However, in
recognition of the fact that new entrants may require some
time to lend to all categories of the priority sector, some
modification in the composition of the priority sector
lending may be considered by the RBI for an initial period
of three years
81
k) Such a bank will also have to comply with such directions
of the RBI as is applicable to existing banks in the matter
of export credit. As a facilitation of this it may be issued
an authorised dealers licence to deal in foreign exchange,
when applied for ;
l) A new bank shall not be allowed to set up a subsidiary or
mutual fund for at least three years after its establishment.
The holding of such a bank in the equity of other companies
shall be governed by the existing provisions applicable to
other banks viz . _
i) 30 percent of the banks or the investee companys
capital funds, whichever is less, as set up under
the Banking Regulation Act, 1949, and
ii) 1.5 per cent of the banks incremental deposits during
a year as per RBI guidelines.
The aggregate of such investments in the subsidiaries and
Mutual Fund (if and when set up) and portfolio investments in
other companies shall not exceed 20 percent of the banks own
paid-up capital and reserves.
m) In regard to branch opening, it shall be governed by the
existing policy that banks are free to open branches at
various centres including urban/metropolitan centres
without the prior approval of the RBI once they satisfy the
capital adequacy and prudential accounting norms.
However, to avoid over concentration of their branches in
metropolitan areas and cities, a new bank will be required
to open rural and semi urban branches also, as may be laid
down by RBI.
n) Such a bank shall have to lay down its loan policy within
the several policy guidelines of RBI. While doing so, it
shall specifically provide prudential norms covering related
party transactions.
o) Such a bank shall make full use of modern infrastructural
facilities in office equipments, computer,
telecommunications, etc, in order to provide good customer
service. The bank should have a high powered customer
grievances cell to handle customer complaints ;
p) Such other conditions as RBI may prescribe from time to
time.
In Terms of the Narasimham Committee Recommendations,
the nationalised Banks, under the directions of the RBI and the
government are now aiming at the closure or merger of unviable
branches.
82
SUB TOPICS
3.1 Introduction
3.2 Capital Requirements
3.3 Reserves and Liquid Assets
3.4 Concluding Remarks
3.1 INTRODUCTION
The Banking Regulation Act contains requirements as to
minimum paid up capital (Sec.11), regulation of paid up capital,
subscribed capital and authorised capital (Sec.12), and
prohibition charge on unpaid capital (Sec.14). The Act also
contains prescriptions on reserve fund (Sec.17), Cash reserve
(Sec.18), prohibition of floating charge on asset and assets to
be kept in India (Sec.25).
At the outset a few observations on the concept of capital are
needed to make the terminological content of the word Capital
clear.
Until the acceptance of the Basle Accord, the term Capital
referred to the owned funds of a bank comprising paid up capital
and disclosed free reserves. It served mainly two purposes viz.,
(a) reflecting the owners stake in the enterprise and acting as a
disincentive to them to take up higher risk-investments and (b)
serving as a buffer to absorb adverse effects on a bank of various
risks. Till the Basle Accord, the capital requirements for a bank
differed from one country to another. Virtually, every country
had laid down a minimum capital requirement, but the size of
the amount varied. In addition, certain countries had stipulated
that the banks should maintain an appropriate relationship
between capital on the one hand and total assets, risk assets or
liabilities on the other. Furthermore, some countries, such as
Japan, did not formally prescribe capital adequacy. Others like
the United States, had attempted at judgemental assessment.
Developments in the early eighties had emphasised the need to
strengthen the capital base of banks and to adopt a uniform
standard to assess adequacy among countries. During that
period, there was a general deterioration in the asset portfolio
of major international banks particularly to the debt problems
of the developing countries. Notwithstanding the adverse trend,
banks continued to acquire still high-risk assets to retain their
market share. This tendency had further contaminated their
asset portfolios because of the increased competition both
among banks and between banks and pseudo-banking entities
following world wide lineralisation of financial services sector.
Consequently, the leverage ratios of banks had scaled
unsustainable levels. Furthermore, the difference in capital
requirements for different domestic markets had resulted in
competitive inequalities. Such inequalities in the context of
globalisation of the transactions following widespread
application of new communication and computer technology
and the trend towards liberalisation of international capital
transactions had resulted in major banks attempting to take
greater risks to protect their market shares.
To counteract the trend and to restore health to the system,
authorities in some countries had attempted to strengthen banks
by prescribing simple leverage ratios and in some others, by
laying down on balance sheet risk-asset ratios. These attempts
had proved inadequate because the stipulation of simple leverage
ratios had discouraged banks from holding low-risk assets while
the prescription of on-balance sheet risk-asset ratios had
encouraged them to substitute off-balance sheet exposure for
conventional assets. A more sophisticated and realistic yardstick
was required to measure the adequacy of capital. Also
international co-ordination was considered necessary to prevent
banks taking advantage of differences in national capital
definitions and requirements thereby exposing themselves to
greater risks. In this situation, supervisors in major industrial
countries were naturally prepared to sacrifice elements of their
own capital adequacy requirements in the interest of reaching a
multi-lateral agreement.
One of the notable developments in the banking regulatory
framework in the recent years relates to the stipulation of capital
requirements. Banking supervisors world over have
unanimously agreed on the method for assessing adequacy of
capital as also on the need of harmonise such requirement at
the international level, at least in respect of internationally active
banks. The agreement is known technically as the International
Covergence of Capital, Measurement and Capital Standards,
and popularly as The Basle Accord. The Accord has become
the reference point for policy action among nations. For
example, the Solvency Ratio and Own Funds requirements of
the European Community, which will become effective in 1993,
are based on the norms contained in the Accord. In India, the
Committee on the financial system under the Chairmanship of
Shri. M. Narasimham has not only recommended the adoption
of the Basle Accord but also laid down a time-frame for
compliance. Against this backdrop, an attempt is made to briefly
recapitulate the Basle Accord and its implications to Indian
banks having overseas branches.
The Basle Accord
The new method of assessing adequacy of capital is based on a
system of risk-weighted capital ratio for the banks. The Basle
Banking Supervisory Committee had worked on this since 1987,
and had recommended it for the banks in G-10 countries. The
authorities of these countries had endorsed the recommendations
in July 1989. The new ratio has the following advantages :
i) providing a fairer basis for international comparision
between banking systems with structural differences ;
ii) allowing off-balance sheet exposures to be incorporated
more easily into the measure ; and
iii) non-detering banks from holding liquid or other assets with
low risk.
Capital : New Definition
For supervisory purposes, the Basle Accord has defined capital
in two tiers. The Core Tier 1, Capital comprises fully paid-up
3 CAPITAL, RESERVE AND LIQUID ASSET REQUIREMENTS
83
capital and disclosed reserves and corresponds to the traditional
measure of capital. The Accord has also recognised the
supplementary or Tier II Capital consisting of undisclosed
reserves, revaluation reserves, general provisions, hybrid debt,
capital instruments and subordinated term debt. Besides, the
national authorities are left with the discretion to include/exclude
any items, in the light of their national accounting and
supervisory regulations. This is an improvement over the
conventional definition of capital. However, Tier 1 Capital is
granted greater importance due to certain well recognised facts.
This is the only element common to the banking system the
world over; it is wholly visible in the published account; and it
has a crucial bearing on the profit margins and the banks ability
to compete. Aslo, the strengthening of the Core Capial would
facilitate a progressive enhancement in the quality as well as
the level of the total capital resources maintained by the banks.
Thus, the maximum permissible size of Tier II Capital is limited
to the actual size of Tier I Capital.
Assets and Risk Weighting
For risk-weighting, assets are classified into five broad classes,
each class carrying different weights ranging from 0 percent to
100 percent. The risk-weights attached to a specific assets is
based mainly on the perceived riskiness of the assets. Obviously,
this method has certain caveats. The weighting is not a substitute
for commercial judgement. Further, the risk-weights capture
only credit-risk and hence exclude other risks such as investment
risk, interest rate risk, exchange risk and concentration risk.
Weighting also differs in respect of county exposure.
Industrialised debtor countries, for instance, carry a lower
weight implying thereby that such exposure is safer than that in
respect of LDCs. As for the banks claim on public sector
enterprises, the Accord has allowed discretion to each national
supervisory authority to determine the appropriate weights in
factors. On other assets (both on-and-off balance sheet assets),
the Accord has enumerated each item and has prescribed
different ratios ranging from 20 per cent to 100 per cent.
The Targets
The Accord has provided for a minimum risk-weighted capital/
asset ratio of 8 per cent to be achieved by G-10 countries by the
end of 1992. A transitional minimum ratio of 7.25 per cent
was also stipulated for the end of 1990.
Capital adequacy
Prevailing capital requirements for banks in India are rather
complex. The State Bank of India Act, 1955 prescribes the
capital structure for the State Bank of India (SBI). According
to the provisions in this Act, the authorised capital of SBI is Rs.
1,000 Crores; the actual paid-up captial is Rs.200 Crores. The
issued capital of each of the seven Associate Banks of SBI was
fixed by SBI with the approval of the Reserve Bank of India
(RBI). The capital structure of the nationalised banks is laid
down by the Banking Companies (Acquisition and Transfer of
Undertakings) Act, 1979/80. According to these Acts, the paid-
up capital of these banks are equal to their respective paid-up
capital at the time of their nationalisation. In the case of a foreign
bank, the aggregate value of its paid-up capital and reserves
should not be less than Rs. 15 lakhs and this level is raised to
Rs.20 lakhs if it has a place or places of business in Bombay
and/or Calcutta. The absolute minimum requirement for an
Indian private sector bank, as laid down in the Banking
Regulation Act, 1949, is Rs. 5 lakhs. (Rs. 10 lakhs if it has
offices in more than one State and/or has office(s) in Bombay
and/or Calcutta).
The Committee on the financial system under the Chairmanship
of Shri.M. Narasimham has recognised that the Indian banking
system has inadequately capitalised and the situation is a cause
of concern. It has, therefore, suggested that the banks should
achieve a minimum of 4 per cent capital adequacy ratio in
relation to risk-weighted assets by March 1993. The standards
by the Basle Accord should be achieved by March 1996. For
these banks with an international presence, it would be necessary
to reach these figures even earlier.
3.2 CAPITAL REQUIREMENTS
Section 11 of the Banking Regulation Act, lays down the
requirements regarding the minimum standard of paid-up capital
and reserves as a condition for the commencement of business.
These conditions apply to the banking companies wherever
incorporated, but companies in existence at the time of the
commencement of the Act were given a period of three years
or such further period not exceeding one year as the Reserve
Bank of India extended to comply with the provisions contained
in Section 11, which are shown for easy reference in a tabular
form.
Under the provisions of sub-sections (i) and (ii) of Section 12 it
has been laid down that no banking company shall carry on
business in any State of India, unless (a) the subscribed capital
of the company is not less than half of its authorised capital,
and the paid-up capital is not less than half of its subscribed
capital, provided that when capital is increased this proportion
may be permitted to be secured within a period to be determined
by the Reserve Bank not exceeding two years from the date of
increase; and (b) its share capital does not comprise shares other
than ordinary shares, provided that preference shares, if any,
issued before 1st July 1944 will not operate as a disqualification.
These provisions deal with the minimum ratios between
authorised, subscribed and paid-up capital of a banking
company. The need for these provisions arose from the fact
that the management of some banks used to mislead members
of the public by displaying large figures of authorised capital,
while only a small portion of their capital might have been
subscribed, a still smaller portion might have been called-up.
By calling only a small amount of the subscribed capital the
promoters of banking companies were able to persuade persons
with small means to go in for much larger number of shares
than they could afford to purchase.
84
Requirements of Aggregate Value of Paid-up Capital and
Reserve
Aggregate Value of Paid-up
Capital and Reserve
I. Incorporated in India Rupees
A. (i) For a banking company incorporated in India
having places of business in more than one state .. 5,00,000
(ii) If any such place or places of business is or are
situated in the city of Bombay or Calcutta or both.. 10,00,000
B. If all places of business in one State but none of which
in Bombay city or Calcutta :
(i) For principal place of business in one state .. 1,00,000
(except in City of Bombay and Calcutta)
plus
(ii) For each other place of business in the same .. 10,000
district
(iii) For each place of business situated outside that
district .. 25,000
Subject to a total of .. 5,00,000
(iv) For having only one place of business 50,000
C. If all places of business in one State :
(i) One or more of which is/are in the city of
Bombay or Calcutta .. 5,00,000
plus
(ii) In respect of each place of business situated
outside the city of Bombay or Calcutta .. 25,000
Subject to a total of .. 10,00,000
II. Incorporated outside India
(i) If it has no place of business in Bombay city or .. 15,00,000
Calcutta
(ii) If it has a place of business in Bombay city or
Calcutta or both .. 20,00,000
Note :- Banking companies incorporated outside India have to
deposit the amount required as above either in cash or in
unencumbered approved securities or partly in cash and partly
in such securities with the Reserve Bank.
If a place of business situated in a State other than that in which
the principal place of business of a banking company is situated
and the distance is less than twenty-five miles between these
two places, they will be considered as places of business in
one State.
Place of Business means any office, sub-office, sub-pay office
and any place of business at which deposits are received,
cheques cashed and moneys lent.
Commission on the sale of shares
Section 13 prohibits a banking company from paying out
directly or indirectly by way of commission, brokerage, disocunt
or remuneration in any form in respect of shares issued by it,
any amount exceeding in the aggregate two and half per cent of
the paid-up value of the said shares. Section 76 and 79 of the
Companies Act, 1956 provide for higher percentage of
Commission. The present provisions of the Banking Regulation
Act alter the effect of the provisions of the Companies Act 1956,
so far as banking companies are concerned and to the extent of
commission that can be paid.
Prohibition of charge on Unpaid Capital
No banking company shall create any charge upon its unpaid
capital, and any such charge, if created, shall be invalid (Section
14). It is unusual for banks in India to create any charge on
their future assets. Unpaid capital of a company constitutes its
future asset. However, the provision of this section is based
upon the salutary principle that all the creditors of a banking
company should participate in the future assets which should
not be realised for the benefit of one or more preferred creditors.
The Companies Act, 1956 permits the creation of a charge by a
company on its uncalled capital provided the instrument creating
the said charge is registered with the Registrar of Companies
within 30 days from the date of its creation (Section 125 of the
Companies Act, 1956).
Section 14A prohibits every banking company from creating a
floating charge on its undertaking or any property or any part
thereof unless the creation of such a floating charge is certified
in writing by the Reserve Bank as not being detrimental to the
interests of the depositors of such company. The floating charge
if created without obtaining the Reserve Banks certificate is
invalid.
Restrictions on holding of shares in other Companies
Section 19 lays down that :
Restriction on nature of subsidiary companies -
(1) A banking company shall not form any subsidiary company
except a subsidiary company formed for one or more of
the following purposes, namely:-
(a) the undertaking of any business which, under clauses
(a) to (o) of sub-section (1) of Section 6, is permissible
for a banking company to undertake;
(b) with the previous permission in writing of the Reserve
Bank, the carrying on of the business of banking
exclusively outside India ;
(c) the undertaking of such other business, which the
Reserve Bank may, with the prior approval of the
Central Government, consider to be conducive to the
spread of banking in India or to be otherwise useful
or necessary in the public interest;
Explanation :- For the purposes of Section 8, a banking company
shall not be deemed, by reason of its forming or having a
subsidiary company, to be engaged indirectly, in the business
carried on by such subsidiary company.
(2) Save as provided in sub-section (1), no banking company
shall hold shares in any company, whether as pledgee,
mortgagee or absolute owner, of an amount exceeding thirty
per cent of the paid-up share capital of that company or
85
thirty per cent of its own paid-up share capital and reserves,
whichever is less :
Provided that any banking company which is on the date of
commencement of this Act holding any shares in contravention
of the provisions of this sub-section shall not be liable to any
penalty therefor if it reports the matter without delay to the
Reserve Bank and if it brings its holding of shares into
conformity with the said provisions within such period, not
exceeding two years, as the Reserve Bank may think fit to allow.
(3) Save as provided in sub-section (1) and notwithstanding
anything contained in sub-section (2), a banking company
shall not, after the expiry of one year from the date of the
commencement of this Act, hold shares, whether as pledgee,
mortgagee or absolute owner, in any company in the
management of which any managing director or manager
of the banking company is in any manner concerned or
interested.
This section restricts the scope of formation of subsidiary
companies by a banking company, as well as the holding of
shares in other companies. A banking company may form a
subsidiary company for the purposes referred to in this section,
as well as for other purposes subject to the previous permission
in writing of the Reserve Bank. Sub section (1) has been
substituted by the Banking Laws (Amendment) Act, 1983, w.e.f.
15.2.1984 so as to amplify, in pursuance of the recommendation
of the Banking Commission, the scope of the said section with
a view to enlarging the purposes for which a banking company
can form subsidiaries. A banking company would now be
permitted to form subsidiaries for carrying on one or more kinds
of business which it is permitted to engage in under clauses (a)
to (o) of Section 6(1) of the Banking Regulation Act, 1949.
Prior to the amendment a banking company was not permitted
to form subsidiaries except for undertaking and executing trusts,
administration of estates as executors and for doing banking
business outside India.
It appears, however, that the definition of a subsidiary company
as given in the Companies Act, 1956 excludes the case of a
company holding shares as security, when the ordinary business
of the company so holding shares includes the lending of money.
It may be noted that a company, even though it is not
incorporated under the Companies Act, will be regarded as
subsidiary company within the meaning of that Act, if the
holding banking company incorporated under the Banking
Regulation Act and/or the Companies Act, is interested in it in
such a way that it controls the composition of the Board of
Directors of such a Company.
Under Section 4 of the Companies Act, 1956, a company is
deemed to be a subsidiary of another, if and only if _
(a) that other controls the composition of its Board of
Directors ; or
(b) that other holds more than half in nominal value of
its equity share capital; or
(c) the first mentioned company is subsidiary of any
company which is that others subsidiary.
As regards the second restriction mentioned in Section 19 of
the Banking Regulation Act, it is clear that a banking company
can hold shares in any company (i.e., a company liable to be
wound up under the Companies Act) to the extent of thirty per
cent of the paid-up share capital of the latter, but this should
not exceed thirty per cent of the paid-up share capital and reserve
of the former. Thus, it would appear that a banking company
may hold shares of a foreign company, exceeding thirty per
cent if that company does not operate in India, but such holding
must not exceed fifty per cent as to the close of an accounting
period. The main object of the provision as laid down under
this section is, that a banking company may not enter into non-
banking business by means of a subsidiary company or any
other company in which it is to be largely interested. The
restriction regarding the holding of shares seems to apply only
when the shares are held as pledgee, mortgagee or owner, and
not when they are held as trustee, custodian or agent, or
otherwise than a pledgee, mortgagee or owner.
If on the date of commencement of this Act, a banking company
holds shares beyond the limit stated in the sub-section, provided
it forthwith reports the matter to the Reserve Bank of India, it
can dispose off the excess holding within such period (not
exceeding two years as the Reserve Bank may permit) to comply
with the provisions of Section 19(1). Sub section (3) of the
same section absolutely prohibits the holding after the expiry
of one year from the date of the commencement of the Act of
shares as pledgee, mortgagee or owner, in any company in the
management of which a managing director or manager of the
banking company in question is concerned or interested. This
prohibition, however, does not apply to the shares in a subsidiary
company permitted under sub-section (1) of Section 19. It does
not appear to be quite clear whether the period of one year
referred to above, is automatically allowed to every banking
company or is the maximum period of concession that can be
allowed by the Reserve Bank. It may be observed that the word
concerned or interested appears to have rather wide
meaning. Probably it will be interpreted with reference to
Section 295 and other provisions contained in Sections 297,
299, 300, 301 and 302 of the Companies Act, 1956.
A critique on capital adequacy position of some Nationalised
Banks:
In this context an academic exercise is attempted to assess the
prevailing position of capital in nine Indian banks having
overseas branches vis-a-vis the requirements of the Basle
Accord as also of the Narasimham Committee for 1993. The
nine banks are Bank of India, Bank of Baroda, Bharat Overseas
Bank, Canara Bank, Indian Bank, Indian Overseas Bank, SBI,
Syndicate Bank and UCO Bank. This exercise presents the
position at end-March 1991. Since the published balance sheets
of these banks do not conform to the details of assets as
enumerated in the Basle Accord, available data are treated to
conform broadly to the classification of the Accord. Thus, cash
on hand, balances with other banks and money at call and short-
notice are taken as cash and equivalent having no risk. Total
investments, contra-items and contingent liabilities were allotted
86
50 per cent risk-weight (each). All other assets are given 100
per cent risk-weight.
Aggregate Picture
As on March 31, 1991, the combined owned funds, i.e., paid-
up capital and disclosed reserves of these nine banks aggregated
to Rs. 3,859 crores. Their total assets amounted to Rs. 1,63,994
crores. The risk unadjusted capital asset ratio, therefore, worked
out to Rs. 2.35 percent. On the other hand the risk weighted
assets (including contra-items and contingency liabilities)
totalled Rs. 1,53,172 crores. The capital/risk-weighted alset
ratio stood higher at 2.52 per cent because of the complete
exclusion of cash and equivalent, and one half of investments,
contra-items, and contingent liabilities from the denominator.
While considering Tier I norm of the Basle Accord, therefore,
there was a deficit of 1.48 per cent of Rs. 2,267 crores in respect
of the required capital of these Banks. According to the
prescription of Narasimham Committee, however, the banks
have fulfilled their Tier I needs (2.0 per cent) but fell short of
total capital adequacy by 1.48 percentage points (Rs. 2,267
crores).
Disaggregated position
Bank-wise, the position varied widely. Only three banks, viz.,
Canara Bank, Indian Overseas Bank, and UCO Bank, have
fulfilled the Tier I Capital requirement of the Basle Accord.
The shortfall in respect of other banks ranged from Rs. 5 crores
(Bharat Overseas Bank) to Rs. 1,507 crores (SBI); in percentage
terms, the shortfall ranged from 1.46 per cent (Bank of India)
to 2.41 per cent (Syndicate Bank).
The norms of the Narasimham Committee (2.0 per cent Tier I
Capital) was met by six banks. Only three banks, viz., SBI,
Bank of Baroda, and Syndicate Bank, have fallen short of the
target.
Caveats
It should be reiterated that these computations are illustrative
and at best are indicative of the direction and possible dimension,
the precise amount could be different. The position by end
March 1994 will also depend upon other factors such as the
growth in the balance sheets, contingent liabilities, extent of
asset contamination, etc., of these banks. Again, the role of the
injection of substantial funds by the Government to augment
the capital of weak banks needs to be remembered.
Available options : Tier I capital
Available options to cover the shortfall are rather limited. Tier
I capital refers to purely owned funds consisting paid-up capital
and disclosed reserves. The scope for additional allocation of
operating surplus to reserves is limited because of the
diminishing profitability of the banks. There could also be a
greater need to make larger provision for loan losses from the
available meagre surplus. The scope of augmenting paid-up
capital by the government is also limited since the present
emphasis is on curtailing expenditure as much as possible.
Notional augmentation through issue of special securities, as
had been done hitherto in this context, would hardly serve any
useful purpose. Perhaps, fresh capital could be issued to the
public. Response will, however, depend naturally upon the track
record of the issuer.
Recognising this, the Narasimham Committee has
recommended that in respect of banks which have had a
consistent record of profitability and enjoy a good reputation
in the market, it should be possible to tap the capital market by
issuing fresh capital to the public. Mutual funds, insurance
companies and profitable public sector companies could
subscribe to such equity, besides employees of the banks and
the general public. In respect of other banks, it may be necessary
for the government to supplement the capital by direct
subscription. In this context, it should be remembered that the
paid-up capital of all the nationalised banks have almost reached
their respective authorised levels. hence, legislative measures
may have to be taken to increase the capital structure of these
banks if additional capital funds are to be injected.
Holding company
We could also conceive the establishment of a new holding
company with adequate capital to take care of these banks.
According to the stipulations of the Basle Accord, the Tier I
capital needs of the proposed holding company, as at end-March
1991 would be around Rs. 6,130 crores, as per our estimates.
In the present context of economy measures, perhaps, RBI alone
may be in a position to contribute this amount. In due course,
however, these could be professionally managed. Similarly,
officials for posting to the foreign branches should undergo a
stringent process of selection procedure establishing their
efficiency. Necessary safeguards ought to be built in the
procedure to provide representation to all the participant banks
as also to discourage any possible brain-drain.
Tier II Capital
The components of supplementary capital of Tier II capital are
undisclosed reserves, revaluation reserves, general
provisions,hybrid debt instruments,and subordinate term debt.
Hitherto, the actual financial position of the banks is not fully
clearly reported.With the implementation of new accounting
policies and procedures as well as the adoption of new formats
for the final accounts, it should be possible to effect greater
transparency to the financial status of the reporting banks. Once
these changes are effected, perhaps, the banks could fully satisfy
the needs of Tier II Capital. In cases where shortfalls are noticed,
one could think of issuing subordinate term debts.
CONCLUSION
Indian banks operating abroad need to subject themselves to
the capital regulatory requirements as laid down in the Basle
Accord. It is true that the requirements of the Accord are stiff
for Indian situation. Recommendations made by the
Narasimham Committee in this context are very reasonable,
practicable and achievable. This could be considered as the
transitory provisions and intensive attempts should be made to
attain the BIS standards at the earliest. A precondition in this
87
regard, as noted by the Narasimham Committee, is that the
Indian banks should have their assets revalued on a more
realistic basis and on the basis of their realisable value. Then
alone a clearer picture would emerge facilitating appropriate
action.
3.3 RESERVES AND LIQUID ASSETS
Provisions relating to the building up of reserves are relatively
simple. Indian banks are statutorily required to build up reserves
by transferring sums equivalent to not less than 20 per cent (25
per cent since 1974 as per RBIs advice) of their annual disclosed
profit. Foreign banks need to maintain 20 per cent of their
annual profits in respect of their Indian operations with RBI
either in cash or in unencumbered approved securities. Since
some of these banks have often complied with provision by
transferring securities in their investment portfolio (which
enabled them to remit the entire profit), they are required, since
1989, to retain in a separate account, 20 per cent of the profits
of their Indian operations as disclosed in their annual accounts
every year. This reserve is permanent in nature and forms part
of owned funds of these banks [ See Sec.17].
Every Banking Company shall maintain a cash reserve with
itself or by way of balance in a current account with the Reserve
Bank or by way of net balance partly with itself and partly with
Reserve Bank, a sum equivalent to atleast three percent of the
total of its demand and time liabilities in India as on the last
Friday of the second preceding fortnight and shall submit to
the Reserve Bank before the 20th day of every month a return
to that effect. This is known as CRR or Cash Reserve Ratio.
As has already been stated the RBI instructs the banking
companies to keep a certain CRR. This type of manipulation of
CRR is done for regulating the money market.
Adequate capital and sufficient liquidity are the two hall marks
of success of commercial banks. If the liquidity goes higher
capital remains under-utilised. In fact one of the strongest
criticism of commercial banking in India is that loans and
advances are costlier because of high rate of interest. The interest
rate is high because a big part of the capital is required to be
locked up on account of CRR and SLR. It means that a part of
the capital has to work for the total capital. Liquidity is required
for having confidence on the monetary system and banking
institution. Certain percentage of cash keeps up the thickness
of monetary flow. But keeping reserve higher than that is
counter- productive. Generally speaking this step is used also
for checking the inflation. But theoretically checking flow of
money may lead to stagflation instead of controlling inflation.
88
SUB TOPICS
4.1 Tandon Committee Report on Bank Credit
4.2 Chore Committee Report on Cash Credit
4.3 Restrictions on loans and advances
4.1 TANDON COMMITTEE
1. The study group to frame guidelines for follow-up of bank
credit set up by the Reserve Bank of India (RBI) in July
1974, submitted its report in August 1975. The main
recommendations of the Group relate to :-
i. Norms for inventory and receivables ;
ii. approach to lending ;
iii. style of credit ;
iv. information system; and
v. bill finance
2. The guidelines are to be followed in regard to conduct of
advances to borrowers enjoying aggregate limits in excess
of Rs.10 lacs.
3. The norms for inventory and receivables are applicable to
all industrial borrowers including small-scale industries
with aggregate Working Capital limits from the banking
system in excess of Rs. 10 lacs. In respect of Industries for
which norms have not been suggested, the purpose and
spirit behind the norms should be kept in view. The
deviations from norms should be for known specific
circumstances and situations and allowed for agreed period
which should be relatively small.
4. The purpose of bank credit is only to supplement the
borrowers resources in carrying a reasonable level of
current assets in relation to production requirements.
5. The Working Capital Gap has been defined as the
difference between current assets and current liabilities
other than bank finance.
6. The level of current assets for this purpose should be in
conformity with the norms laid down for inventory and
receivables.
7. The study Group has recommended three alternative
methods for determining the maximum finance that could
be extended for meeting Working Capital requirements.
8. Under the I method, 25% of the Working Capital Gap
should be financed out of long term resources. The
maximum bank finance permissible under this Method
would, therefore, be 75% of the Working Capital Gap.
9. In the II Method, the borrower will have to provide a
minimum of 25% of total current assets from long term
funds; this will give a Current Ratio of at least 1.33:1.
10. In the III Method, the borrowers contribution from long
term funds will be to the extent of the entire core current
assets, as defined, and a minimum of 25% of the balance
current assets, thus strengthening the Current Ratio further.
(It has been decided not to implement this for the time
being).
11. The excess borrowings arising out of (i) excess current
assets levels and (ii) shortfall in the maintenance of Net
Working Capital should be converted into a Working
Capital Term Loan with a specific repayment schedule.
12. The Cash Credit limit can be bifurcated into _
i. a loan, comprising the minimum level of borrowing
which the borrower expects to use throughout the
year; and
ii. a Demand Cash Credit to take care of fluctuating
requirements, both being reviewed annually.
13. Receivables should be financed by way of bills.
14. In order to ensure that borrowers do not use the Cash Credit
facility in an unplanned manner, the financing should be
placed on a quarterly budgeting-reporting system.
15. The actual drawings in the Cash Credit account will be
determined by the borrowers inflow and outflow of funds,
as reflected in the quarterly funds flow statement.
4.2 CHORE COMMITTEE REPORT
1. Reserve Bank of India (RBI) appointed in March 1979, a
Working Group to review the system of Cash Credit in all
its aspects, particularly with reference to the unutilised gap
under sanctioned limits. The Group submitted its Final
Report in August 1979.
2. The major recommendations of the Working Group relate
to :
i. method of lending : II Method to be applied
straightaway to all borrowers with Working Capital
limits of Rs.50 lacs and above ;
ii. information system ;
iii. drawee bill system ; and
iv. follow-up of review/renewal of limits.
3. The information system would apply to all borrowers with
Working Capital Limits of Rs. 50 lacs and over.
4. All Working Capital limits of Rs. 10 lacs and over from the
banking system must be renewed at least once a year.
5. Wherever feasible, separate limits for peak and normal non-
peak level requirements should be fixed.
6. Ad-hoc or temporary limits should be granted under very
exceptional circumstances only and should entail additional
interest of 1% per annum.
7. 50% of the Cash Credit limit against raw materials to
manufacturing units should be granted by way of drawee
bills only.
4. RESTRICTIONS ON LOANS AND ADVANCES
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4.3 RESTRICTIONS ON LOANS AND ADVANCES
Sections 20, 20A and 21 of the Banking Regulation Act deal
with restrictions on loans and advances. The sections read -
Section 20 of the Act, laying down the restrictions on loans
and advances has been wholly amended from 1.2.1969. It is
applicable to the State Bank of India and the 20 nationalised
banks. Under the old section only a secured loan or advance
could be made to a director of a Banking Company or to the
firms or private companies, in which the director was interested
as partner, director or managing agent. A secured loan or
advance is defined in Section 5(n) of the Act which reads :-
5(n) :- Secured loan or advance means a loan or advance made
on the security of assets the market value of which is not at any
time less than the amount of such loan or advance; and
ùnsecured loan or advance means a loan or advance not so
secured.
Section 20 as amended by the Amending Act 58 of 1968 is
much wider in scope; it is the pivot of the so called social control
over Banks. It prohibits a banking company from entering into
any commitment from granting any loan, secured or unsecured,
to any of its directors or to any firm or company or its subsidiary
or holding company in which a director is interested or even to
any individual for whom a director stands as a guarantor with
whom a director is a co partner in a firm.
1) Notwithstanding anything to the contrary contained in
Section 77 of the Companies Act, 1956, no banking
company shall,
(a) grant any loans or advances on the security of its own
shares ;
(b) enter into any commitment for granting any loan or
advance to or in behalf of -
(i) any of its directors; or
(ii) any firm in which any of its directors is interested as
partner, manager, employee or guarantor ; or
(iii) any company (not being a subsidiary of the banking
company or a company registered under Section 25
of the Companies Act, 1956, or a Government
Company) of which, or the subsidiary or the holding
company of which any of the directors of the banking
company is a director, managing agent, manager,
employee or guarantor or in which he holds
substantial interest; or
(iv) any individual in respect of whom any of its directors
is a partner or guarantor.
2) Where any loan or advance granted by a banking company
is such that a commitment for granting it could not have
been made if clause (b) of sub section (1) had been in force
on the date on which the loan or advance was made, or is
granted by a banking company after the commencement of
Section 5 of the Banking Laws (Amendment) Act, 1968,
but in pursuance of a commitment entered into before such
commencement, steps shall be taken to recover the amounts
due to the banking company on account of the loan or
advance together with interest, if any, due thereon within
the period stipulated at the time of the grant of the loan or
advance, or where no such period has been stipulated,
before the expiry of one year from the commencement of
the said Section 5:
Provided that the Reserve Bank may, in any case, on an
application in writing made to it by the banking company in
this behalf, extend the period for the recovery of the loan or
advance until such date, not being a date beyond the period of
three years from the commencement of the said Section 5, and
subject to such terms and conditions, as the Reserve Bank may
deem fit :
Provided further that this sub-section shall not apply if and when
the director concerned vacates the office of the director of the
banking company, whether by death, retirement, resignation or
otherwise.
3) No loan or advance, referred to in sub-section(2), or any
part thereof shall be remitted without the previous approval
of the Reserve Bank, and any remission without such
approval shall be void and of no effect.
4) Where any loan or advance referred to in sub-section (2),
payable by any person, has not been repaid to the banking
company within the period specified in that sub-section,
then, such person shall, if he is a director of such banking
company on the date of the expiry of the said period, be
deemed to have vacated his office as such on the said date.
Explanation : In this section _
(a) loans or advance shall not include any transaction
which the Reserve Bank may, having regard to the
nature of the transaction, the period within which,
and the manner and circumstances in which, any
amount due on account of the transaction is likely to
be realised, the interest of the depositors and other
relevant considerations, specify by general or special
order as not being a loan or advance for the purpose
of the section ;
(b) director includes a member of any board or
committee in India constituted by a banking company
for the purpose of managing, or for the purpose of
advising it in regard to the management of, all or any
of its affairs.
5) If any question arises whether any transaction is a loan or
advance for the purposes of this section, it shall be referred
to the Reserve Bank, whose decision thereon shall be final.
In clause (b) of sub-section (1), the words enter into
commitment for granting a loan or advance appear.
Committing is one step before granting. If a banker committs
to grant a loan, he will, as his reputation stands, in all probability
grant it. But the reason for drawing the line appears in sub
Section (2). There may be a loan violating sub section (1), the
commitment for which would have been entered before the date
on which the new section came into force (i.e. 1.2.1969) but
would have been granted till that date ; in such a case the banking
company can grant loan, but sub-section (2) requires the
90
Banking company to recover the loan within its stipulated period
or if there is no such period within one year from 1.2.1969, or
requires the director concerned to vacate his office. If either
the advance is recovered or the director vacates within the said
period, he shall on the expiry of the period be deemed to be not
a director.
Clause (b) of Sub-section (1) is clear and speaks for itself in all
its sub-clauses except that sub-clause (iv) is somewhat confusing
when it refers to any individual in respect of whom any of its
directors is a partner. A question may be asked : how could
one individual to be a partner in respect of another ? The
sub-clause perhaps intends to refer to an individual who is a
partner of a director in a firm. In any event, it would be safe for
banking companies to read the sub-clause in this sense.
A question may arise whether a loan can be granted to a Hindu
Undivided Family of which a director is a co-parcener or
member. The Section is silent on this and on its strict
construction such a loan would not fall within its mischief.
Explanation (a) sub-section 4, to the Section is more exception
than an explanation. It can even be called a legal fiction.
Although it uses the word transaction, it in effect refers to a
loan or advance, since it talks of an amount due and period
within which it becomes due or is likely to be realised. The
explanation provides to the effect that a loan or advance shall
not be deemed to be a loan or advance for the purpose of the
Reserve Bank so desires by an order, general or special and
also provides that considerations induced it to pass such an order.
On such an order being passed, the disastrous effects of sub
sections 2 and 4 will be suspended. The Reserve Bank did
issue an order on 1.2.1969 specifying that for the purpose of
S.20, loans and advances shall not include (i) loans or advances
against Government securities, Life Insurance policies or fixed
deposits, and (ii) loans or advances to Agricultural finance
Corporation Ltd.
Sec. 20-A : Restrictions on power to remit debts
1) Notwithstanding anything to the contrary contained in
Section 293 of the Companies Act, 1956, a banking
company shall not, except with the prior approval of the
Reserve Bank, remit in whole or in part any debt due to it
by:-
(a) any of its directors, or
(b) any firm or company in which any of its directors is
interested as director, partner, managing agent or
guarantor, or
(c) any individual if any of its directors is his partner or
guarantor.
2) Any remission made in contravention of the provisions of
sub-section(1) shall be void and of no effect.
Sec. 21: Power of Reserve Bank to control advances by
banking companies
(1) Where the Reserve Bank is satisfied that it is necessary or
expedient in the public interest or in the interest of
depositors or banking policy so to do, it may determine the
policy in relation to advances to be followed by banking
companies generally or by any banking company in
particular, and when the policy has been so determined, all
banking companies or the banking company concerned, as
the case may be, shall be bound to follow the policy as so
determined.
(2) Without prejudice to the generality of the power vested in
the Reserve Bank under sub-section (1), the Reserve Bank
may give directions to banking companies, either generally
or to any banking company or group of banking companies
in particular as to :-
(a) the purposes for which the advance may or may not
be made,
(b) the margins to be maintained in respect of secured
advances,
(c) the maximum amount of advances or other financial
accomodation which, having regard to the paid-up
capital, reserves and deposits of a banking company
and other relevant considerations, may be made by
that banking company to any one company, firm,
association of persons or individual,
(d) the maximum amount up to which, having regard to
the considerations referred to in clause (c), guarantees
may be given by a banking company on behalf of
any one company, firm, association of persons or
individual, and
(e) the rate of interest and other terms and conditions in
which advances or other financial accomodation may
be made or guarantees may be given.
(3) Every banking company shall be bound to comply with
any directions given to it under this section.
When a nationalised bank charges a particular rate of interest
in pursuance of Reserve Banks direction it would be a special
circumstance justifying the said interest otherwise the bank
would have violated Section 21 attracting penalty provided in
Section 46. Indian Bank v. V.A.B.Gurukal, [AIR 1982 Mad
296.]
The Banking Laws (Amendment)Act, 1983 (1 of 1984) has
inserted a new section 21A w.e.f. 15.2.1984, so as to provide
that the rates of interest charged by banking companies to the
debtors shall not be re-opened in a court. The section reads as
under :
21-A: Rates of interest charged by banking companies not
to be subject to scrutiny of courts - Notwithstanding anything
contained in the Usurious Loans Act, 1918 (10 of 1918), or
any law relating to indebtedness in force in any State, a
transaction between a banking company and its debtor shall
not be reopened by any Court on the ground that the rate of
interest charged by the banking company in respect of such
transaction is excessive.
In Bank of India v. Karnam Ranga Rao and others, [(1988) 64
Comp.Cas, 477] the Karnataka High Court has held that Section
21-A is a restraint on the power of the court to re-open any
91
account maintained by a bank relating to transactions with its
customers on the ground that the rate of interest charged, in the
opinion of the court, is excessive and unreasonable. However,
if it is proved that the interest charged by the banks on loans
advanced is not in conformity with the rates prescribed by the
Reserve Bank, the court can disallow such excess interest and
give relief to the party notwithstanding the provisions of section
21-A.
Commercial banks keep the monetary system of a country
mobile. Through loans and advances it keeps the investment
line, maintains the productivity and keeps up the productivity.
But regulation of loans or advances is extremely necessary to
maintain an overall economic stability. Banking Regulation
Act provides this regulatory mechanism.
92
SUB TOPICS
5.1 General Regulatory Outline
5.2 Wholetime Chairman
5.3 Additional Directors
5.1 GENERAL REGULATORY OUTLINE
The powers of the Reserve Bank of India over the Management
of Banks is very wide. The Reserve Bank of India has been
armed with Draconian powers under the Banking Regulation
Act 1949 as amended from time to time. These powers are
spread over in a number of sections of the Act.
Section 10A :- This Section was introduced to subserve the
purpose of social control. The Section prescribes the nature
and composition of the Board of Directors who are responsible
for the management of Banking company. Sub sections 5,6,7
& 8 of Section 10 A read _
Sub-section(5). Where the Reserve Bank is of opinion that the
composition of the Board of Directors of a banking company is
such that it does not fulfil the requirements of sub-section(2) it
may, after giving to such banking company a reasonable
opportunity of being heard, by an order in writing, direct the
banking company to so re-constitute its Board of Directors as
to ensure that the said requirements are fulfilled and, if within
two months from the date of receipt of that order, the banking
comapny does not comply with the directions made by the
Reserve Bank, that Bank may, after determining, by lots drawn
in such manner as may be prescribed, the person who ought to
be removed from the membership of the Board of Directors,
remove such person from the office of the director of such
banking company and with a view to complying with the
provisions of sub-section(2), appoint a suitable person as a
member of the Board of directors in the place of the person so
removed whereupon the person so appointed shall be deemed
to have been duly elected by the banking company as its director;
Sub-section(6). Every appointment, removal or reconstitution
duly made, and every election duly held, under this section shall
be final and shall not be called into question in any court ;
Sub-section(7). Every director elected, or, as the case may be,
appointed under this section shall hold the office until the date
upto which his predecessor would have held office, if the
election had not been held, or, as the case may be, the
appointment had not been made;
Sub-section(8). No act or proceeding of the Board of directors
of a banking company shall be invalid by reason only of any
defect in the composition thereof or on the ground that it is
subsequently discovered that any of its members did not fulfil
the requirements of this section.
5.2 WHOLETIME CHAIRMAN
10 B: Banking Companies to be managed by Whole-time
Chairman
(1) Notwithstanding anything contained in any law for the time
being in force or in any contract to the contrary, every
banking company in existence on the commencement of
or which comes into existence thereafter shall have one of
its directors as chairman of its Board of Directors who shall
be entrusted with the management of the whole of the affairs
of the banking company :
Provided that the chairman shall exercise his powers subject
to the superintendence, control and direction of the Board
of Directors:
Provided further that nothing in this sub-section shall apply
to a banking company in existence on the commencement
of the said section for a period of three months from such
commencement.
(2) Every Chairman of the Board of Directors of a banking
company shall be in the whole-time employment of such
company and shall hold the office for such period, not
exceeding five years, as the Board of Directors may fix,
but shall, subject to the provisions of this section, be eligible
for re-election or re-appointment:
Provided that nothing in this sub-section shall be construed
as prohibiting a chairman from being a director of a
subsidiary of the banking comapny or a director of a
company registered under Section 25 of the Companies
Act, 1956.
(3) Every person holding office on the commencement of
as managing director of a banking company shall _
(a) if there is a chairman of its Board of Directors, vacate
office on such commencement, or
(b) if there is no chairman of its Board of Directors, vacate
office on the date on which the chairman of its Board
of Directors is elected or appointed in accordance with
the provisions of this section.
(4) Every chairman of the Board of Directors of a banking
company shall be a person who has special knowledge and
practical experience of _
(a) the working of a banking company, or of the State
Bank of India or any subsidiary bank or a financial
institution, or
(b) financial, economic or business administration :
Provided that a person shall be disqualified for being a chairman,
if he _
(a) is a director of any company other than a company
referred to in the proviso to sub-section (2), or
(b) is a partner of any firm which carries on any trade,
business or industry, or
(c) has substantial interest in any other company or firm,
or
5. REGULATION ON MANAGERIAL ORGANS
93
(d) is a director, manager, managing agent, partner or
proprietor of any trading, commercial or industrial
concern, or
(e) is engaged in any other business or vocation.
(5) A Chairman of the Board of Directors of a banking
company may, by writing under his hand addressed to the
company, resign his office.
(5-A) A Chairman of the Board of Directors whose term of
office has come to an end, either by reason of his resignation
or by reason of expiry of the period of his office, shall,
subject to the approval of the Reserve Bank, continue in
office until his successor assumes office.
(6) Without prejudice to the provisions of Section 36-AA, where
the Reserve Bank is of opinion that any person who is, or
has been elected to be, the Chairman of the Board of
Directors of the banking company is not a fit and proper
person to hold such office, it may, after giving to such person
and to the banking company, a reasonable opportunity of
being heard, by order in writing, require the banking
company to elect or appoint any other person as the
chairman of its Board of Directors and if, within a period
of two months from the date of receipt of such order, the
banking company fails to elect or appoint a suitable person
as the chairman of its Board of Directors, the Reserve Bank
may, by order, remove the first mentioned person from the
office of the chairman of the Board of Directors of the
banking company and appoint a suitable person in his place
whereupon the person so appointed shall be deemed to have
been duly elected or appointed, as the case may be, as the
chairman of the Board of Directors of such banking
company and any person elected or appointed as chairman
under this sub-section shall hold office for the residue of
the period of office of the person in whose place he has
been so elected or appointed.
(7) The banking company and any person against whom an
order of removal is made under sub-section (6) may, within
thirty days from the date of communication to it or to him
of the order, prefer an appeal to the Central Government
and the decision of the Central Government thereon, and
subject thereto, the order made by the Reserve Bank under
sub-section (6), shall be final and shall not be called into
question in any court.
(8 Notwithstanding anything contained in this section, the
Reserve Bank may, if in its opinion it is necessary in the
public interest so to do, permit the chairman to undertake
such part-time honorary work as is not likely to interfere
with his duties as such chairman.
(9) Notwithstanding anything contained in this section, where
a person appointed as chairman dies or resigns or is by
infirmity or otherwise rendered incapable of carrying out
his duties or is absent on leave or otherwise in circumstances
not involving the vacation of his office, the banking
company may, with the approval of the Reserve Bank, make
suitable arrangements for carrying out the duties of
chairman for a total period not exceeding four months.
10-BB : Power of Reserve Bank to appoint Chairman of a
banking company
1) Where the office of the chairman of a banking company is
vacant, the Reserve Bank may, if it is of opinion that the
continuation of such vacancy is likely to adversely affect
the interests of banking company, appoint a person, eligible
under sub-section (4) of Section 10-B to be so appointed,
to be the Chairman of the banking company and where the
person so appointed is not a director of such banking
company, he shall, so long as he holds the office of the
chairman, be deemed to be a director of the banking
company.
2) The Chairman so appointed by the Reserve Bank shall be
in the whole-time employment of the banking company
and shall hold office for such period not exceeding three
years, as the Reserve Bank may specify, but shall, subject
to other provisions of this Act, be eligible for reappointment.
3) The Chairman so appointed by the Reserve Bank shall draw
from the banking company such pay and allowances as the
Reserve Bank may determine and may be removed from
office only by the Reserve Bank.
4) Save as otherwise provided in this section, the provisions
of Section 10-B, shall as far as may be, apply to the
Chairman appointed by the Reserve Bank under sub-section
(1) as they apply to a chairman appointed by a banking
company.
10-D : Provisions of Section 10-A and 10-B to override all
other laws, contracts, ect.
Any appointment or removal of a director or chairman in
pursuance of Section 10-A or Section 10 - B or Section 10BB
shall have effect and any such person shall not be entitled to
claim any compensation for the loss or termination of office,
notwithstanding anything contained in any law or in any
contract, memorandum or articles of association.
Under the above provisions the Reserve Bank of India is vested
with powers to do and undo the composition of Board of
Directors and Chairman of any Bank.
Section 35B: Amendments of provisions relating to
appointments of managing Directors, etc., to be subject to
previous approval of the Reserve Bank-
(1) In the Case of the banking company _
(a) no amendment of any provision relating to the
maximum permissible number of Directors or the
appointment or reappointment or termination of
appointment or remuneration of a chairman, a
managing director or any other director, whole-time
or otherwise or of a manager or a chief executive
officer by whatever name called, whether that
provision be contained in the companys
memorandum or articles of association, or in an
agreement entered into by it, or in any resolution
passed by the Company in general meeting or by its
Board of Directors shall have effect unless approved
by the Reserve Bank ;
94
(b) no appointment or reappointment or termination of
appointment of a chairman, a managing or a whole
time Director, manager or chief executive officer by
whatever name called, shall have effect unless such
appointment is made with the previous approval of
the Reserve Bank.
Explanation : For the purposes of this sub-section, any provision
conferring any benefit or providing any amenity or perquisite,
in whatever form, whether during or after the termination of
the term of office of the chairman or the manager or the chief
executive officer by whatever name called or the managing
Director, or any other Director, whole-time or otherwise, shall
be deemed to be a provision relating to his remuneration.
(2) Nothing contained in Sections 262 and 269, the proviso to
sub-section(3) of Section 309, Sections 310 and 311, the proviso
to Section 387, and Section 388 (in so far as Section 388 makes
the provisions of Sections 269, 310 and 311 apply in relation to
the manager of a company) of the Companies Act, 1956, shall
apply to any matter in respect of which the approval of the
Reserve Bank has to be obtained under sub-section (1).
2-A : Nothing contained in Section 198 of the Companies Act,
1956 (1 of 1956) shall apply to a banking company and the
provisions of sub-section(1) of Section 309 and of Section 387
of that Act shall, in so far as they are applicable to a banking
company, have effect as if no reference had been made in the
said provisions to Section 198 of that Act.
(3) No act done by a person as chairman or a managing or
wholetime director or a director not liable to retire by rotation
or a manager or a chief execuive officer by whatever name
called, shall be deemed to be invalid on the ground that it is
subsequently discovered that his appointment or reappointment
had not taken effect by reason of any of the provisions of this
Act; but nothing in this sub-section shall be construed as
rendering valid any act done by such person after his
appointment or reappointment has been shown to the banking
company not to have had effect.
Decisions of Reserve Bank are subjective. They cannot be
challenged as violative of the prinicples of natural justice. [E.A.
Poyya Vs. Reserve Bank of India, AIR 1966 Ker 6.]
Sections 35B (1)(b) is not violative of Article 19(1) of the
Constitution. [ E.A. Poyya Vs. Reserve Bank of India, AIR
1966 Ker 6.]
Part II A of the Banking Regulation Act inserted by Act 55 of
1963 deals with control over management. These powers are
explained in sections 36 AA, 36AB and 36AC of the Act which
reads:
36AA: Power of Reserve Bank to remove managerial and
other persons from office
(1) Where the Reserve Bank is satisfied that in the public
interest or for preventing the affairs of a banking company
being conducted in a manner detrimental to the interests of
the depositors or for securing a proper management of any
banking company it is necessary so to do, the Reserve Bank
may, for reasons to be recorded in writing, by order, remove
from office, with effect form such date as may be specified
in the order, any chairman, director, chief executive officer
(by whatever name called) or other officer or employee of
the banking company.
(2) No order under sub-section (1) shall be made unless the
chairman, director or chief executive officer or other officer
or employee concerned has been given a reasonable
opportunity of making a representation to the Reserve Bank
against the proposed order :
Provided that if, in the opinion of the Reserve Bank, any delay
would be detrimental to the interests of the banking company
or its depositors, the Reserve Bank may, at the time of giving
the opportunity aforesaid or at any time thereafter, by order
direct that, pending the consideration of the representation
aforesaid, if any, the chairman or, as the case may be, director
or chief executive officer or other officer or employee, shall
not with effect from the date of such order _
(a) act as such chairman or director or chief executive
officer or other officer or employee of the banking
company ;
(b) in any way, whether directly or indirectly, be
concerned with, or take part in the management of
the banking company.
(3) (a) Any person against whom an order of removal has
been made under sub-section (1) may, within thirty
days from the date of communication to him of the
order, prefer an appeal to the Central Government.
(b) The decision of the Central Government on such
appeal, and subject thereto, the order made by the
Reserve Bank under sub-section (1) shall be final and
shall not be called into question in any court.
(4) Where any order is made in respect of a chairman, director
or chief executive officer or other officer or employee of a
banking company under sub-section (1), he shall cease to
be a chairman or, as the case may be, a director, chief
executive officer or other officer or employee of the banking
company and shall not, in any way, whether directly, or
indirectly be concerned with, or take part in the management
of, any banking company for such period not exceeding
five years as may be specified in the order.
(5) If any person in respect of whom an order is made by the
Reserve Bank under sub-section (1) or under the proviso
to sub-section (2) contravenes the provisions of this section,
he shall be punishable with fine which may extend to two
hundred and fifty rupees for each day during which such
contravention continues.
(6) Where an order under sub-section(1) has been made, the
Reserve Bank, may, by order in writing, appoint a suitable
person in place of the chairman or director or chief executive
officer or other officer or employee who has been removed
from his office under that sub-section, with effect from such
date as may be specified in the order.
95
(7) Any person appointed as chairman, director or chief
executive officer or other officer or employee under this
section, shall _
(a) hold office during the pleasure of the Reserve Bank
and subject thereto for a period not exceeding three
years or such further period not exceeding three years
at a time as the Reserve Bank may specify:
(b) not incur any obligation or liability by reason only of
his being a chairman, director or chief executive
officer or other officer or employee or for anything
done or omitted to be done in good faith in the
execution of the duties of his office or in relation
thereto.
(8) Notwithstanding anything contained in any law or in any
contract, memorandum or articles of association, on the
removal of a person from office under this section, that
person shall not be entitled to claim any compensation for
the loss or termination of office.
5.3 ADDITIONAL DIRECTORS
36AB : Power of Reserve Bank to appoint additional
directors
(1) If the Reserve Bank is of opinion that in the interest of
banking policy or in the public interest or in the interests of
the banking company or its depositors it is necessary so to
do, it may, from time to time by order in writing, appoint,
with effect from such date as may be specified in the order,
one or more persons to hold office as additional directors
of the banking company :
(2) Any person appointed as additional director in pursuance
of this section-
(a) 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 ;
(b) shall not incur any obligation or liability by reason only of
his being a director or for anything done or omitted to be
done in good faith in the execution of the duties of his office
or in relation thereto; and
(c) shall not be required to hold qualification-shares in the
banking company.
(3) For the purpose of reckoning any proportion of the total
number of directors of the banking company, any additional
director appointed under this section shall not be taken into
account.
36-AC: Part II-A to override other laws
Any appointment or removal of a director, chief executive officer
or other officer or employee in pursuance of Section 36-AA or
Section 36-AB shall have effect notwithstanding anything to
the contrary contained in the Companies Act, 1956, or any
other law for the time being in force or in any contract or any
other instrument.
The powers conferred are Draconian. Many of these also cannot
be challenged in a court. The Act has saved the applicability of
the other laws through many of these sections. The Reserve
Bank of India have exercised some of these powers. There are
cases when these powers were exercised under political
pressures on the Reserve Bank which is only an extended arm
of the government.
RBI has general regulatory power on the management of the
banking companies in general and Nationalised Banks in
particular. The Central Government has also some controlling
functions. It has been found over the years that the Central
Government having two powers, namely, power in the role of
ownership and power in the role of a controller and the Reserve
Bank having its own powers and control, often may have
conflicting interests. The ownership interest of the Government
and the controlling interest of the RBI may conflict. In most of
these conflict interest situations RBI fails to have its say. This
has weakened the management of the Nationalised Banks.
96
SUB TOPIC
6.1 GENERAL PROVISIONS ON CONTROL OVER
AMALGAMATION
6.1 CONTROL OVER AMALGAMATION AND
SCHEMES OF RECONSTRUCTION
The Procedure for amalgamation of banking companies is
contained in Section 44 A of the Banking Regulations Act. The
Section reads -
44A : Procedure for amalgamation of banking companies
(1) Notwithstanding anything contained in any law for the time
being in force, no bankng company shall be amalgamated
with another banking company, unless a scheme containing
the terms of such amalgamation has been placed in draft
before the shareholders of each of the banking companies
concerned separately, and approved by a resolution passed
by a majority in number representing two-thirds in value
of the shareholders of each of the said companies, present
either or by proxy at a meeting called for the purpose.
(2) Notice of every such meeting as is referred to in sub-section
(1) shall be given to every shareholder of each of the
banking companies concerned in accordance with the
relevant articles of association, indicating the time, place
and object of the meeting, and shall also be published at
least once a week for three consecutive weeks in not less
than two newspapers which circulate in the locality or
localities where the registered offices of the banking
companies concerned are situated, one of such newspapers
being in a language commonly understood in the locality
or localities.
(3) Any shareholder, who has voted against the scheme of
amalgamation at the meeting or has given notice in writing
at or prior to the meeting to the company concerned or to
the presiding officer of the meeting that he dissents from
the scheme of amalgamation, shall be entitled, in the event
of the scheme being sanctioned by the Reserve Bank, to
claim from the banking company concerned, in respect of
the shares held by him in that company, their value as
determined by the Reserve Bank when sanctioning the
scheme and such determination by the Reserve Bank as to
the value of the shares to be paid to the dissenting
shareholder shall be final for all purposes.
(4) If the scheme of amalgamation is approved by the requisite
majority of shareholders in accordance with the provisions
of this section, it shall be submitted to the Reserve Bank
for sanction and shall, if sanctioned by the Reserve Bank
by an order in writing passed in this behalf, be binding on
the banking companies concerned and also on all the
shareholders thereof.
(5) x x x x x x
(6) On the sanctioning of a scheme of amalgamation by the
Reserve Bank, the property of the amalgamated banking
company shall, by virtue of the order of saction, be
transferred to and vest in, and the liabilities of the said
company shall, by virtue of the said order be transferred
to, and become the liabilities of, the banking company
which under the scheme of amalgamation is to acquire the
business of the amalgamated banking company, subject in
all cases to the provisions of the scheme as sanctioned.
(6A) Where a scheme of amalgamation is sanctioned by the
Reserve Bank under the provisions of this section, the
Reserve Bank may, by a further order in writing, direct
that on such date as may be specified therein the banking
company (hereinafter in this section referred as the
amalgamated banking company) which by reason of the
amalgamation will cease to function, shall stand dissolved
and any such direction shall take effect notwithstanding
anything to the contrary contained in any other law.
(6B)Where the Reserve Bank directs a dissolution of the
amalgamated banking company, it shall transmit a copy of
the order directing such dissolution to the Registrar before
whom the banking company has been registered and on
receipt of such order the Registrar shall strike off the name
of the Company.
(6C) An order under sub-section (4), whether made before or
after the commencement of Section 19 of the Banking Laws
(Miscellaneous Provisions) Act, 1963 shall be conclusive
evidence that all the requirements of this section relating
to amalgamation have been complied with, and the copy
of the said order certified in writing by an officer of the
Reserve Bank to be a true copy of such order and the copy
of the scheme certified in the like manner to be a true copy
thereof shall, in all legal proceedings (whether in appeal or
otherwise and whether instituted before or after the
commencement of the said section 19), be admitted as
evidence to the same extent as the original order and the
original scheme.
(7) Nothing in the foregoing provisions of this section shall
affect the power of the Central Government to provide for
the amalgamation of two or more banking companies under
Section 396 of the Companies Act, 1956; Provided that no
such power shall be exercised by the Central Government
except after consultation with the Reserve Bank.
From the above section it can be seen that -
1) A scheme of amalgamation containing its terms to be
approved by a majority of shareholders of both the banks.
The majority of the shareholders should represent two thirds
of the value of shareholders. It should be approved in a
general meeting convened specially for the purpose ;
2) Sub section (2) of the section provides for the issue of notice
to the share holders of both the banks ;
6. AMALGAMATION AND RECONSTRUCTION
97
3) Shareholders who dissent the amalgamators or who vote
against it will be entitled to receive the value of their shares
as decided by the Reserve Bank of India ;
4) When the scheme of amalgamation is approved by the
requisite majority of the shareholders, the scheme should
be submitted to the Reserve Bank of India in writing, it
shall be binding on both the banks and their shareholders;
5) As per sub-section (6) the assets and liabilities of the
transferor bank shall vest in the transferee bank subject to
the provisions of the scheme as sanctioned by the Reserve
Bank of India;
6) In terms of Sub-section (6A), the Reserve Bank will fix a
date from which the transferor or the amalgamated bank
will be dissolved and will cease to function;
(8) Sub-section (6B), provides for the issue of notice to the
Registrar of Companies by the Reserve Bank of India for
striking off the name of the transferor bank;
(9) An order passed by the Reserve Bank of India under sub-
section (4) shall be conclusive evidence that all the
requirements of this section relating to amalgamation has
been complied with;
(10)Sub-section (7) arms the Central Government with powers
to amalgamate two or more banking companies under
section 356 of the Companies Act. The proviso to the sub-
section provides for consultation by the Central
Government with the Reserve Bank of India.
Section 44B of the Act lays down -
Restriction on compromise or arrangement between banking
company and creditors - (1) Notwithstanding anything contained
in any law for the time being in force, no High Court shall
sanction a compromise or arrangement between a banking
company and its creditors or any class of them or between such
company and its members or any class of them or sanction any
modification in any such compromise or arrangement unless
the compromise or arrangement or modification, as the case
may be, is certified by the Reserve Bank in writing as not being
incapable of being worked and as not being detrimental to the
interests of the depositors of such banking company.
(2) Where an application under Section 391 of the Companies
Act, 1956, is made in respect of a banking company, the
High Court may direct the Reserve Bank to make an inquiry
in relation to the affairs of the banking company and the
conduct of its directors and when such a direction is given,
the Reserve Bank shall make such enquiry and submit its
report to the High Court.
(3) Where an application under Section 391 of the Companies
Act, 1956, is made in respect of a banking company,the
High Court may direct the Reserve Bank to make an inquiry
in relation to the affairs of the Banking company and the
conduct of its directors and when such a direction is given,
the Reserve Bank shall make such inquiry and submit its
report to the High Court.
Section 45 of the Banking Regulation Act empowers Reserve
Bank of India to apply to the Central Government for
supervision of business by a banking company and to prepare
scheme of reconstitution or amalgamation.
The section reads _
Power of Reserve Bank to apply to Central Government
for suspension of business by a banking company and to
prepare scheme of reconstitution or amalgamation -
(1) Notwithstanding anything contained in the foregoing
provisions of this part or in any other law of any agreement
or other instrument, for the time being in force, where it
appears to the Reserve Bank that there is good reason so to
do, the Reserve Bank may apply to the Central government
for an order of moratorium in respect of a banking company.
(2) The Central Government, after considering the application
made by the Reserve Bank under sub-section (1), may make
an order or moratorium staying the commencement or
continuance of all actions and proceedings against the
company for a fixed period of time on such terms and
conditions as it thinks fit and proper and may from time to
time extend the period so however that the total period of
moratorium shall not exceed six months.
(3) Except as otherwise provided by any directions given by
the Central Government in the order made by it under sub-
section (2) or at any time thereafter, the banking company
shall not during the period of moratorium make any
payment to any depositors or discharge any liabilities or
obligations to any other creditors.
4) During the period of moratorium, if the Reserve Bank is
satisfied that-
(a) in the public interst or
(b) in the interests of the depositors or
(c) in order to secure the proper management of the banking
company or
(d in the interests of the banking system of the country as a
whole, - it is necessary so to do, the Reserve Bank may
prepare a Scheme -
(i) for the reconstruction of the banking company or
(ii) for the amalgamation of the banking company with
any other banking institution (in this section referred
to as the transferee bank)
5) The schemes aforesaid may contain provisions for all or
any of the following matters, namely -
(a) the constitution, name and registered office, the
capital, assets powers, rights, interests, authorities and
privileges, the laibilities, duties and obligations of the
banking company on its reconstruction or, as the case
may be, of the transferee bank;
(b) in the case of amalgamation of the banking company,
the transfer to the transferee bank of the business,
properties, assets and liabilities of the banking
company on such terms and conditions as may be
specified in the scheme ;
98
(c) any change in the Board of Directors, or the appointment
of a new Board of Directors, of the banking company on
its reconstruction, or as the case may be, of the transferee
bank and the authority by whom, the manner in which, and
the other terms and conditions, on which, such change or
appointment shall be made and in the case of appointment
of a new Board of Directors or of any director, the period
for which such appointment shall be made ;
(d) the alteration of the memorandum and articles of association
of the banking company on its reconstruction or, as the
case may be, the transferee bank, for the purpose of altering
the capital thereof or for such other purposes as may be
necessary to give effect to the reconstruction or
amalgamation;
(e) subject to the provisions of the scheme, the continuation
by or against the banking company on its reconstruction,
or as the case may be, the transferee bank, of any actions
or proceedings pending against the banking company
immediately before the date of the order of moratorium;
(f) the reduction of the interest or rights which the members,
depositors and other creditors have in or against the banking
company before its reconstruction or amalgamation to such
extent as the Reserve Bank considers necessary in the public
interest or in the interest of the members, depositors and
other creditors or for the maintenance of the business of
the banking company;
(g) the payment in cash or otherwise to depositors and other
creditors in full satisfaction of their claim _
(i) in respect of their interest or rights in or against the
banking company before its reconstruction or
amalgamation ; or
(ii) where their interests or rights aforesaid in or against
the banking company has or have been reduced under
clause (f), in respect of such interest or rights as so
reduced ;
(h) the allotment to the members of the banking company for
shares held by them therein before its reconstruction or
amalgamation whether their interest in such shares has been
reduced under clause (f) or not, of shares in the banking
company on its reconstruction or, as the case may be, in
the transferee bank and where any members claim payment
in cash and not allotment of shares, or where it is not
possible to allot shares to any members, the payment in
cash to those members in full satisfaction of their claim _
(i) in respect of their interest in shares in the banking
company before its reconstruction or amalgamation ;
or
(ii) where such interest has been reduced under clause
(f) in respect of their interest in shares as so reduced;
(i) the continuance of the services of all the employees
of the banking company (excepting such of them as
not being workmen specifically mentioned in the
scheme) in the banking company itself on its
reconstruction or, as the case may be, in the transferee
bank at the same remuneration and on the same terms
and conditions of service, which they were getting or
as the case may be, by which they were being
governed, immediately before the date of the order
of the moratorium :
Provided that the scheme shall contain a provision that -
i) the banking company shall pay or grant not later than the
expiry of the period of three years from the date on which
the scheme is sanctioned by the Central Government, to
the said employees the same remuneration and the same
terms and conditions of service as are, at the time of such
payment or grant, applicable to employees of corresponding
rank or status of a comparable banking company to be
determined for this purpose by the Reserve Bank whose
determination in this respect shall be final;
ii) the transferee bank shall pay or grant not later than the
expiry of the aforesaid period of three years, to the said
employees the same remuneration and the same terms and
conditions of service as are, at the time of such payment or
grant, applicable to the other employees of corresponding
rank or status of the transferee bank subject to the
qualifications and experience of the said employees of the
transferee bank:
Provided further that if in any case under clause (ii) of the first
proviso any doubt or difference arises as to the said employees
are the same as or equivalent to the qualifications and experience
of the other employees of corresponding rank or status of the
transferee bank, the doubt or difference shall be referred, before
the expiry of a period of three years from the date of payment
or grant mentioned in that clause to the Reserve Bank whose
decision thereon shall be final;
(j) notwithstanding anything contained in clause (i) where any
of the employees of the banking company not being
workmen within the meaning of the Industrial Disputes
Act, 1947 are specifically mentioned in the scheme under
clause (i), or where any employees of the banking company
or, as the case may be, the transferee bank at any time before
the expiry of one month next following the date on which
the scheme is sanctioned by the Central Government,
intimated their intention of not becoming employees of the
banking company on its reconstruction or, as the case may
be, of the transferee bank, the payment to such employees
of compensation, if any, to which they are entitled under
the Industrial Disputes Act, 1947, and such pension,
gratuity, provident fund and other retirement benefits
ordinarily admissible to them under the rules or
authorisations of the banking company immediately before
the date of the order of moratorium;
(k) any other terms and conditions for the reconstruction or
amalgamation of the banking company ;
(l) such incidental, consequential and supplemental
matters as are necessary to secure that the
reconstruction or amalgamation shall be fuly and
effectively carried out.
99
6) (a) A copy of the scheme prepared by the Reserve Bank
shall be sent in draft to the banking company and
also to the transferee bank and any other banking
company concerned in the amalgamtion, for
suggestions and objections, if any, within such period
as the Reserve Bank may specify for this purpose ;
(b) The Reserve Bank may make such modifications, if
any, in the draft scheme as it may consider necessary
in the light of the suggestions and objections received
from the banking company and also from the
transferee bank, and any other banking company
concerned in the amalgamation and from any
members, depositors or other creditors of each of
those companies and the transferee bank.
7) The Scheme shall thereafter be placed before the Central
Government for its sanction and the Central Government
may sanction the scheme without any modifications or with
such modifications as it may consider necessary; and the
scheme as sanctioned by the Central Government shall
come into force on such date as the Central Government
may specify in this behalf;
Provided that different dates may be specified for different
provisions of the scheme.
7A) the sanction accorded by the Central Government under
sub-section (7) whether before or after the commencement
of Section 21 of the Banking Laws (Miscellaneous
Provisions) Act, 1963, shall be conclusive evidence that
all the requirements of this Section relating to the
reconstruction, or, as the case may be, amalgamation have
been complied with and a copy of the sanctioned scheme
certified in writing by an officer of the Central Governmet
to be true copy thereof, shall, in all legal proceedings
(whether in appeal or otherwise and whether instituted
before or after the commencement of the said Section 21),
be admitted as evidence to the same extent as the original
scheme.
8) On and from the date of the coming into operation of the
scheme or any provision thereof, the scheme or such
provision shall be binding on the banking company or, as
the case may be, on the transferee bank and any other
banking company concerned in the amalgamation and also
on all the members, depositors and other creditors and
employees of each of those companies and of the transferee
bank, and on any other person having any right or liability
in relation to any of those companies or the transferee bank
including the trustees or other persons managing, or
connected in any other manner with, any provident fund or
other fund maintained by any of those companies or the
transferee bank.
9) On and from the date of the coming into operation of, or as
the case may be, the date specified in this behalf in the
scheme, shall be substituted; the properties and assets of
the banking company shall, by virtue of and to the extent
provided in the scheme, stand transferred to, and vest in,
and the liabilities of the banking company shall, by virtue
of and to the extent provided in the scheme, stand
transferred to, and become the liabilities of, the transferee
bank.
10) If any difficulty arises in giving effect to the provisions of
the scheme, the Central Government may by order do
anything not inconsistent with such provisions which
appears to it necessary or expedient for the purpose of
removing the difficulty.
11) Copies of the scheme or of any order made under sub-
section(10) shall be laid before both Houses of Parliament,
as soon as may be, after the scheme has been sanctioned
by the Central Government, or, as the case may be, the
order has been made.
12) Where the scheme is a scheme for amalgamation of the
banking company, any business acquired by the transferee
bank under the scheme or under any provision thereof shall,
after the coming into operation of the scheme or such
provision, be carried on by the transferee bank in
accordance with the law governing the transferee bank,
subject to such modifications in that law or such exemptions
of the transferee bank from the operation of any provisions
thereof as the Central Government on the recommendation
of the Reserve Bank may, by notification in the Offical
Gazette, make for the purpose of giving full effect to the
scheme :
Provided that no such modification or exemption shall be made
so as to have effect for a period of more than seven years from
the date of the acquistion of such business.
13) Nothing in this section shall be deemed to prevent the
amalgamation with a banking institution by a single scheme
of several banking companies in respect of each of which
an order of moratorium has been made under this section.
14) The provisions of this section and of any scheme made
under it shall have effect notwithstanding anything to the
contrary contained in any other provisions of this Act or in
any of the law or any agreement, award or other instrument
for the time being in force.
15) In this section, banking institution means any banking
company and includes the State Bank of India or a
subsidiary bank or a corresponding new bank.
Explanation - References in this section to the terms and
conditions of service as applicable to an employee shall not be
construed as extending to the rank and status of such employee.
The guarantee under clause (i) of Section 45(5) of the Act does
not cover merely the remuneration; it covers the terms and
conditions of service as well, it would be a gross denial of the
guarantee if the employee is not given the rank and status which
he had in the transferor bank. It is not open to the transferee
bank to fit an employee of the transferor bank performing
the duties of a clerk into a subordinate cadre manned by
employees performing duties which are not clerical, but of
peons, watchmen, sweepers and the like. [State Bank of
Travancore Vs. Elias Elias, (1970) 2 SCC 761: (1970) 2 LLJ
424.]
100
The word experience includes the quality of service, efficiency
of organisation, and the range and the volume of business
transacted. [State Bank of Travancore Vs. General Secretary,
(1978)2 LLJ 305:50 Com Cas 412 : 1978 Lab IC 1343.]
Framing of Scheme of amalgamation and giving a direction
under clause (f) of sub-section (5) cannot be treated as an
insolvency. [Simon Thomas Vs. State Bank, 1976 KLT 554
(FB).]
No notice is required to be given to the employee before his
name is included in the schedule of the scheme of amalgamation.
Reserve Bank need not pass speaking order. [Piare Lal Vs.
State Bank of India, 1973 Lab IC 761.]
The period of three years provided in section (45)(5)(i), (ii)
proviso cannot be meant to cover up the deficiencies of the
transferor bank and level up to the disparity between it and the
transferee bank. [State Bank of Travancore Vs. General
Secretary, (1978) 2 LLJ 305:50 Com Cas 412 : 1978 Lab IC
1343.]
To protect the interests of the depositors and to ensure stability
of the banking institutions there have been a number of
amalgamation of weaker banks with stronger banks. Instances
in which a Bank has been fully wound up or liquidated has not
been there in the last three decades.
101
7. ACCOUNTS AND AUDIT
SUB TOPIC
7.1 General Control over Accounts and Audit
7.1 GENERAL CONTROL OVER ACCOUNTS AND
AUDIT
Section 29 of the Banking Regulation Act deals with Accounts
and Balance Sheet of a Banking company. The Section reads -
(1) At the expiration of each calendar year or at the expiration
of a period of twelve months ending with such date as the
Central Government may, by notification in the Official
Gazette, specify in this behalf, every banking company
incorporated in India, in respect of all business transacted
by it, and every banking company incorporated outside
India, in respect of all business transacted through its
branches in India, shall prepare with reference to that year
or period, as the case may be, a balance sheet and profit
and loss account as on the last working day of the year or
the period, as the case may be, in the Forms set out in the
Third Schedule or as near thereto as circumstances admit.
Provided that with a view to facilitating the transition from one
period of accounting to another period of accounting under this
sub-section, the Central Government may, by order published
in the Official Gazette, make such provisions as it considers
necessary or expedient for the preparation of, or for other matters
relating to, the balance sheet or profit and loss account in respect
of the concerned year or period, as the case may be.
Note:- Consequent to the amendment made in the Income-Tax
Act, 1961, every assessee shall follow the uniform Accounting
year beginning as on the 1st of April every year. Accordingly,
Banking companies are required to prepare their balance sheet
and the corrected Financial statements beginning April 1 of
every year. Hence the section has to be read in lieu of what is
stated above in this note.
(2) The balance sheet and profit and loss account shall be
signed-
(a) in the case of a banking company incorporated in
India, by the manager or the principal officer of the
company and where there are more than three
directors of the company, by at least three of those
directors, or where there are not more than three
directors, by all directors, and
(b) in the case of a banking company incorporated outside
India by the manager or agent of the principal office
of the company in India.
(3) Notwithstanding that the balance sheet of a banking
company is under sub-section (I) required to be prepared
in a form other than the form set out in Part I of Schedule
VI to the Companies Act, 1956, the requirements of that
Act relating to the balance sheet and profit and loss account
of a company shall, in so far as they are not inconsistent
with this Act, apply to the balance sheet or profit and loss
account, as the case may be, of a banking company.
(3-A) Notwithstanding anything to the contrary contained in
sub-section (3) of section 210 of the Companies Act, 1956
(1 of 1956), the period to which the profit and loss account
relates shall, in the case of a banking company, be the period
ending with the last working day of the year immediately
preceding the year in which the annual general meeting is
held.
Explanation - In Sub-section (3-A), year means the year or,
as the case may be, the period referred to in sub-section (1).
The third schedule prescribed in the section has undergone a
great change from the Accounting year ending March 1993,
particularly those relating to the classification of assets.
Section 30 of the Banking Regulation Act deals with Audit,
and Sections 31, 32, 33, 34 and 34A deal with the related
provisions -
The sections read -
Section 30 Audit-
The balance sheet and profit and loss account prepared in
accordance with section 29 shall be audited by a person duly
qualified under any law for the time being in force to be an
auditor of companies.
(1A) Notwithstanding anything contained in any law for the
time being in force or in any contract to the contrary, every
banking company shall, before appointing, reappointing
or removing any auditor, or auditors obtain the previous
approval of the Reserve Bank.
(1B) Without prejudice to anything contained in the Companies
Act, 1956, or any other law for the time being in force,
where the Reserve Bank is of opinion that it is necessary in
the public interest or in the interests of the banking company
or its depositors to do so, it may at any time, by order direct
that a special audit of the banking companys accounts, for
any such transaction or class of transactions or for such
period or periods as may be specified in the order, shall be
conducted and may by the same or a different order either
appoint a person duly qualified under any law for the time
being in force to be an auditor of companies or direct the
auditor of the banking company himself to conduct such
special audit, and the auditor shall comply with such
directions and make a report of such audit to the Reserve
Bank and forward a copy thereof to the company.
(1C) The auditor shall have the powers of, exercise the functions
vested in, and discharge the duties and be subject to the
liabilities and penalties imposed on, auditors of companies
by Section 227 of the Companies Act, 1956 and auditors,
if any, appointed by the law establishing, constituting or
forming the banking company concerned.
(3) In addition to the matters which under the aforesaid Act
the auditor is required to state in his report, he shall, in the
case of a banking company incorporated in India, state in
his report -
102
(a) whether or not the information and explanations required
by him have been found to be satisfactory ;
(b) whether or not the transactions of the company which have
come to his notice have been within the powers of the
Company;
(c) whether or not the returns received from branch offices of
the company have been found adequate for the purposes
of his audit ;
(d) whether the profit and loss account shows a true balance of
profit and loss for the period covered by such account ;
(e) any other matter which he considers should be brought to
the notice of the shareholders of the company.
Section 31: Submission of returns
The accounts and balance sheet referred to in Section 29 together
with the auditors report shall be published in the prescribed
manner and three copies thereof shall be furnished as returns to
the Reserve Bank within three months from the end of the period
to which they refer :
Provided that the Reserve Bank may in any case extend the
said period of three months for the furnishing of such returns
by a further period not exceeding three months:
Provided further that a regional rural bank shall furnish returns
also to the National Bank.
Section 32: (1) copies of balance sheets and accounts to be
sent to Registrar
Where a banking company in any year furnished its accounts
and balance sheet in accordance with the provisions of Section
31, it shall at the same time send to the registrar three copies of
such accounts and balance sheet and of the auditors report,
and where such copies are so sent, it shall not be necessary to
file with the registrar, in the case of public company, copies of
accounts and balance-sheet and of the auditors report, and, in
the case of a private company, copies of the balance sheet and
of the auditors report as required by sub-section (1) of Section
220 with the same fee and shall be dealt within all respects as if
they were filed in accordance with that section.
(2) When in pursuance of sub-section (2) of Section 27 the
Reserve Bank requires any additional statement or information
in connection with the balance sheet and accounts furnished
under Section 31, the banking company shall, when supplying
each statement or information, send a copy thereof to the
registrar.
Section 33 : Display of audited balance sheets by companies
incorporated outside India
Every banking company incorporated [outside India] shall, not
later than the first Monday in August of any year in which it
carries on business, display in a conspicuous place in its
principal office and in every branch office [in India] a copy of
its last audited balance sheet and profit and loss account prepared
under Section 29, shall keep the copy so displayed until replaced
by a copy of the subsequent balance sheet and profit and loss
account so prepared, and every such banking company shall
display in like manner copies of its complete audited balance
sheet and profit and loss account relating to its banking business
as soon as they are available, and shall keep the copies so
displayed until copies of such subsequent accounts are available.
Section 34 : Accounting provisions of the Act not
retrospective
Nothing in this Act shall apply to the preparation of accounts
by a banking company and the audit and submission thereof in
respect of any accounting year which has expired prior to the
commencement of this Act, and notwithstanding the other
provisions of this Act, such accounts shall be prepared, audited
and submitted in accordance with the law in force immediately
before the commencement of this Act.
Section 34-A : Production of documents of confidential nature
(1) Notwithstanding anything contained in Section 11 of the
Industrial Disputes Act. 1947, or other law for the time
being in force, no banking company shall, in any proceeding
under the said Act or in any appeal or other proceeding
arising therefrom or connected therewith, be compelled by
any authority before which such proceeding is pending to
produce, or give inspection of, any of its books of account
or other document or furnish or disclose any statement or
information, when the banking company claims that such
document, statement or inspection of such document or the
furnishing of disclosure of such statement or information
would involve disclosure of information relating to -
(a) any reserves not shown in its published balance-sheet;
or
(b) any particulars not shown therein in respect of
provisions made for bad and doubtful debts and other
usual or necessary provisions.
(2) If any such proceeding in relation to any banking company
other than the Reserve Bank of India, any question arises
as to whether any amount out of the reserves or provisions
referred to in sub-section (1) should be taken into account
by the authority before which such proceeding is pending
the authority, may, if it so thinks fit, refer the question to
the Reserve Bank and the Reserve Bank shall, after taking
into account principles of sound banking and all relevant
circumstances concerning the banking company, furnish
to the authority a certificate stating that the authority shall
not take into account any amount as such Reserves and
provisions of the banking company or may take them into
account only to the extent of the amount specified by it in
the certificate, and the certificate of the Reserve Bank on
such question shall be final and shall not be called in
question in any such proceeding.
(3) For the purposes of this section banking company
includes the Reserve Bank, the Development Bank, the
Exim Bank, the Reconstruction Bank, the National Housing
Bank, the national Bank, the Small Industries Bank, the
State Bank of India, a corresponding new bank a regional
rural bank and a subsidiary bank.
103
Section 35: Inspection
(1) Notwithstanding anything to the contrary contained in
Section 235 of the Companies Act, 1956, the Reserve Bank
at any time may, and on being directed so to do by the
Central Government shall, cause an inspection to be made
by one or more of its officers of any banking company and
its books and accounts; and the Reserve Bank shall supply
to the banking company a copy of its report on such
inspection.
1-A : (a) Notwithstanding to the contrary contained in any law
for the time being in force and without prejudice to
the provisions of sub-section (1), the Reserve Bank,
at any time, may also cause a scrutiny to be made by
any one or more of its officers, of the affairs of any
banking company and its books and accounts; and
(b) a copy of the report of the scrutiny shall be furnished
to the banking company if the banking company
makes a request for the same or if any adverse action
is contemplated against the banking company on the
basis of the scrutiny.
(2) It shall be the duty of every director or other officer or
employee of the banking company to produce to any officer
making an inspection under sub-section (1) or a scrutiny
under sub-section (1A) all such books, accounts and other
documents in his custody or power to furnish him with any
statements and information relating to the affairs of the
banking company as the said officer may require of him
within such time as the said officer may specify.
(3) any person making an inspection under sub-section (1) or
a scrutiny under sub-section (1A) may examine on oath
any director or other officer or employee of the banking
company in relation to its business, and may administer an
oath accordingly.
(4) The Reserve Bank shall, if it has been directed by the
Central Government to cause an inspection to be made,
and may, in any other case, report to the Central Government
on any inspection or scrutiny made under this section, and
the Central Government, if it is of opinion after considering
the report that the affairs of the banking company are being
conducted to the detriment of the interest of the depositors,
may, after giving such opportunity to the banking company
to make a representation in connection with the report as,
in the opinion of the Central government, seems reasonable,
by order in writing -
(a) prohibit the banking company from receiving fresh
deposits;
(b) direct the Reserve Bank to apply under Section 38
for the winding up of the banking company;
Provided that the Central Government may defer, for such
period as it may think fit, the passing of an order under this
sub-section, or cancel or modify any such order upon such
terms and conditions as it may think fit to impose.
(5) The Central Government may, after giving reasonable notice
to the banking company, publish the report submitted by the
Reserve Bank or such portion thereof as may appear necessary.
Explanation: For the purposes of this section, the expression
banking company shall include -
i) in the case of a banking company incorporated outside
India, all its branches in India; and
ii) in the case of a banking company incorporated in
India -
a) all its subsidiaries formed for the purpose of carrying on
the business of banking exclusively outside India; and
b) all its branches whether situated in India or outside India.
(6) the powers exercisable by the Reserve Bank under this
section in relation to regional rural banks may without
prejudice to the exercise of such powers by the Reserve
Bank in relation to any regional rural bank whenever it
considers necessary so to do to be exercised by the national
Bank in relation to the regional rural banks as if every
reference therein to the Reserve Bank included also a
reference to the National Bank.
Sub-section (4) of section 35 relates to Bank for which licence
has already been given. [Sajjan Bank (P) Ltd. Vs. Reserve
Bank of India, AIR 1961 Mad 8.]
It is open to the Reserve Bank to consider the defects or
improvements revealed in an application under Section 35 for
disposing of the application for licence as there is nothing in
the Act to prohibit it from taking into consideration all relevant
facts. [Sajjan Bank (P) Ltd Vs. Reserve Bank of India, AIR
1961 Mad 8].
104
8 OTHER POWERS OF R.B.I.
The other powers, which are specifically enacted are detailed
in the following sections of the Banking Regulations Act. These
are -
1) Section 35A of the Banking Regulations Act, 1949 deals
with the Power of Reserve Bank to give directions. The
section reads -
35A : Power of the Reserve Bank to give directions
(1) Where the Reserve Bank is satisfied that -
(a) in the public interest; or
(aa) in the interest of banking policy; or
(b) to prevent the affairs of any banking company being
conducted in a manner detrimental to the interests of
the depositors or in a manner prejudicial to the
interests of the banking company; or
(c) to secure the proper management of any banking
company generally;
It may be required to issue directions to banking companies
generally or to any banking company in particular, RBI from
time to time, issues such directions as it deems fit, and the
banking companies or the banking company, as the case may
be, shall be bound to comply with such directions.
(2) The Reserve Bank may, on representation made to it or on
its own motion, modify or cancel any direction issued under
sub-section (I), and in so modifying or cancelling any
direction may impose such conditions as it thinks fit, subject
to which the modification or cancellation shall have effect.
The Reserve Bank is entitled to give directions to bankers under
Section 20(3) of the Foreign Exchange Regulation Act, 1947
blocking certain accounts. Section 20(3) does not contemplate
the issue of a prior notice before taking such action under that
section. [Mohamed Ayisha Nachiyar Vs. Deputy Director,
Enforcement, (1976) 46 Com Cas 653 (Mad)]
Directions by Reserve Bank cannot prevent payment of higher
bonus in terms of the agreement. [American Express
International Banking Corp. Vs. S.Sundaram, (1978) I SCC
101: 1978 SCC (L & S) 34.]
2) Section 36: Further powers and functions of Reserve
Bank.
The Reserve Bank may -
(a) caution or prohibit companies generally or any banking
company in particular against entering into any particular
transaction or class of transactions, and generally give
advice to any banking company;
(b) on a request by the companies concerned and subject to
the provisions of Section 44A, assist, as intermediary or
otherwise, in proposals for the amalgamation of such
banking companies;
(c) give assistance to any banking company by means of the
grant of a loan or advance to it under clause (3) of sub-
section (1) of Section 18 of the Reserve Bank of India Act,
1934;
(d) at any time, if it is satisfied that in the public interest or in
the interest of banking policy or for preventing the affairs
of the banking company being conducted in a manner
detrimental to the interests of the banking company or its
depositors it is necessary so to do, by order in writing and
on such terms and conditions as may be specified therein-
(i) require the banking company to call a meeting of its
directors for the purpose of considering any matter
relating to or arising out of the banking company, or
require an officer of the banking company to discuss
any such matter with an officer of the Reserve Bank;
(ii) depute one or more of its officers to watch the
proceedings at any meeting of the Board of Directors
of the banking company or of any committee or of
any other body constituted by it; require the banking
company to give an opportunity to the officers so
deputed to be heard at such meetings and also require
such officers to send a report to such proceedings to
the Reserve Bank;
(iii) require the Board of Directors of the banking
company or any committee or any other body
constituted by it to give in writing to any officer
specified by the Reserve Bank in this behalf at this
usual address all notices of, and other communications
relating to, any meeting of the Board, committee or
other body constituted by it;
(iv) appoint one or more of its officers to observe the
manner in which the affairs of the banking company
or of its offices or branches are being conducted and
make a report thereon;
(v) require the banking company to make, within such
time as may be specified in the order, such changes
in the management as the Reserve Bank may consider
necessary.
II. The Reserve Bank shall make an annual report to the Central
Government on the trend and progress of banking in the country,
with particular reference to its activities under clause (2) of
Section 17 of the Reserve Bank of India Act, 1934, including
in such report its suggestions, if any, for the strengthening of
banking business throughout the country.
III. The Reserve Bank may appoint such staff at such places as
it considers necessary for the scrutiny of the returns, statements
and information furnished by banking companies under this
Act, and generally to ensure that efficient performance of its
functions under this Act.
Section 45(P): RBI to tender advice in winding up
proceedings
Where in any proceeding for the winding up of a banking
company in which any person other than the Reserve Bank has
105
been appointed as the official liquidator and the High court has
directed the official liquidator to obtain the advice of the Reserve
Bank on any matter (which it is hereby empowered to do), it
shall be lawful for the Reserve Bank to examine the record of
any such proceeding and tender such advice on the matter as it
may think fit.
Sections 45(Q) and 45(R) lay down :-
Section 45(Q): Power to inspect
(1) The Reserve Bank shall, on being directed so to do by the
Central Government or by the High court, cause an
inspection to be made by one or more of its officers of a
banking company which is being wound up and its books
and accounts.
(2) On such inspection, the Reserve Bank shall submit its report
to the Central Government and the High Court.
(3) If the Central government, on consideration of the report
of the Reserve Bank, is of opinion that there has been a
substantial irregularity in the winding up proceedings, it
may bring such irregularity to the notice of the High court
for such action as the High Court may think fit.
(4) On receipt of the report of the Reserve Bank under sub-
section (2) or on any irregularity being brought to its notice
by the Central government under sub-section (3), the High
court may, if it deems fit, after giving notice to and hearing
the Central Government in regard to the report, give such
directions as it may consider necessary.
45(R): Power to call for returns and information
The Reserve Bank may, at any time by a notice in writing,
require the liquidator of a banking company to furnish it, within
such time as may be specified in the notice or such further time
as the Reserve Bank may allow, any statement or information
relating to or connected with the winding up of the banking
company; and it shall be the duty of every liquidator to comply
with such requirements.
Explanation :
For the purposes of this section and Section 45Q, a banking
company working under a compromise or arrangement but
prohibited from receiving fresh deposits, shall, as far as may
be, deemed to be a banking company which is being wound up.
Section 47: Cognizance of offences
No court shall take cognizance of any offence punishable under
sub-setion (5) of Section 36AA or Section 46 except upon
complaint in writing made by an officer of the Reserve Bank
or, as the case may be, the National Bank generally or specially
authorised in writing in this behalf by the Reserve Bank or, as
the case may be, the National Bank and no court other than that
of a Metropolitan Magistrate or a Judicial Magistrate of the
first class or any court superior thereto shall try any such offence.
47A : Power of Reserve Bank to impose penalty
(1) notwithstanding anything contained in Section 46, if a
contravention or default of the nature referred to in sub-section
(3) or sub-section (4) of Section 46, as the case may be, is made
by a banking company, then, the Reserve Bank may impose on
such banking company -
(a) where the contravention is of the nature referred to
in sub-section (3) of Section 46, a penalty not
exceeding twice the amount of the deposits in respect
of which such contravention was made;
(b) where the contravention or default is of the nature
referred to in Sub-section (4) of Section 46, a penalty
not exceeding two thousand rupees; and where such
contravention or default is a continuing one, a further
penalty which may extend to one hundred rupees for
every day, after the first, during which the
contravention or default continues.
(2) for the purpose of adjudging the penalty under sub-section
(1), the Reserve Bank shall hold an inquiry in the prescribed
manner after giving the banking company a reasonable
opportunity of being heard.
(3) While holding an inquiry under this section, the Reserve
Bank shall have power to summon and enforce the
attendance of any person to give evidence or to produce
any document or any other thing which, in the opinion of
the Reserve Bank, may be useful for, or relevant to, the
subject matter of the enquiry.
(4) No complaint shall be filed against any banking company
in any court of law in respect of any contravention or default
in respect of which any penalty has been imposed by the
Reserve Bank under this section.
(5) Any penalty imposed by the Reserve Bank under this section
shall be payable within a period of fourteen days from the
date on which notice issued by the Reserve Bank demanding
payment of the sum is served on the banking company and
in the event of failure of the banking company to pay the
sum within such period, may be levied on a direction made
by the principal civil court having jurisdiction in the area
where the registered office of the banking company is
situated; or, in the case of a banking company incorporated
outside India, where its principal place of business in India
is situated:
Provided that no such direction shall be made except on an
application made to the Court by the Reserve Bank or any
officer authorised by that Bank in this behalf.
(6) The court which makes a direction under Sub-section (5)
shall issue a certificate specifying the sum payable by the
banking company and every such certificate shall be
enforceable in the same manner as it were a decree made
by the court in a civil suit.
(7) Where any complaint has been filed against any banking
company in any court in respect of the contravention or
default of the nature referred to in sub-section (4) of Section
46, then, no proceedings for the imposition of any penalty
on the banking company shall be taken under this section.
Sections 49A, 49B and 49C deal with the following:
106
49A : Restriction on acceptance of deposits withdrawable
by cheque
No person other than a banking company, the Reserve Bank,
the State Bank of India or any other banking institution, firm or
other person notified by the Central Government in this behalf
on the recommendation of the Reserve Bank shall accept from
the public deposits of money withdrawable by cheque:
Provided that nothing contained in this section shall apply to
any savings bank scheme run by the Government.
49B : Change of name by a banking Company
Notwithstanding anything contained in Section 21 of the
Companies Act 1956, the Central Government shall not signify
its approval to the change of name of any banking company
unless the Reserve Bank certifies in writing that it has no
objection to such change.
49C : Alteration of memorandum of a banking company
Notwithstanding anything contained in the Companies Act,
1956, no application for the confirmation of the alteration of
the memorandum of a banking company shall be maintainable
unless the Reserve Bank certifies that there is no objection to
such alteration.
107
Section 36AE: Power of Central Government to acquire
undertakings of banking companies in the following cases
(1) If upon receipt of a report from the Reserve Bank, the
Central Government is satisfied that a banking company -
(a) has, on more than one occassion, failed to comply
with the directions given to it in writing under Section
21 or Section 35-A, in so far as such directions relate
to banking policy, or
(b) is being managed in a manner detrimental to the
interest of its depositors,
and that -
(i) in the interests of the depositors of such banking
company, or
(ii) in the interest of banking policy, or
(iii) for the better provision of credit generally or of credit
to any particular section of the community or in any
particular area;
It is necessary to acquire the undertaking of such banking
company, the Central Government, may, after such consultation
with the Reserve Bank as it thinks fit, by notified order, acquire
the undertaking of such company (hereinafter referred to as the
acquired bank) with effect from such date as may be specified
in this behalf by the Central Government (hereinafter referred
to as the appointed day) :
Provided that no undertaking of any banking company shall be
so acquired unless such banking company has been given a
reasonable opportunity of showing cause against the proposed
action.
Explanation - In this part,
(a) notiified order means an order published in the
Official Gazette;
(b) undertaking, in relation to a banking company
incorporated outside India, means the undertaking of
the company in India.
(2) Subject to the other provisions contained in this Part, on
the appointed day, the undertaking of the acquired bank
and all the assets and liabilities of the acquired bank shall
stand transferred to, and vest in, the Central Government.
(3) The undertaking of the acquired bank and its assets and
liabilities shall be deemed to include all rights, powers,
authorities and privileges and all property, whether
movable, or immovable, including in particular, cash
balances, reserve funds, investments, deposits and all other
interests and right in, or arising out of such property as
may be in the possession of, or held by, the acquired bank
immediately before the appointed day and all books,
accounts and documents relating thereto, and shall also be
deemed to include all debts, liabilities and obligations, of
whatever kind, then existing of the acquired bank.
(4) Notwithstanding anything contained in sub-section (2), the
Central Government may, if it is satisfied that the
undertaking of the acquired bank and its assets and liabilities
should, instead of vesting in the Central Government, or
continuing to so vest in a company established under any
scheme made under this Part or in any corporation
(hereinafter in this part and in the Fifth Schedule referred
to as the transferee bank) that government may, by order,
direct that the said undertaking, including the assets and
liabilities thereof, shall vest in the transferee bank either
on the publication of the notified order or on such other
date as may be specified in this behalf by the Central
Government.
(5) Where the undertaking of the acquired bank and the assets
and liabilities thereof vest in the transferee bank under sub-
section(4), the transferee bank, shall, on and from the date
of such vesting, be deemed to have become and trasferee
of the acquired bank and all the rights and liabilities in
relation to the acquired bank shall, on and from the date of
such vesting, be deemed to have been the rights and
liabilities of the transferee bank.
(6) Unless otherwise expressly provided by or under this Part,
all contracts, deeds, bonds, agreements, powers of attorney,
grants of legal representation and other instruments of
whatever nature subsisting or having effect immediately
before the appointed day and to which the acquired bank is
a party or which are in favour of the acquired bank shall be
of full force and effect against or in favour of the Central
Government, or as the case may be, of the transferee bank,
and may be enforced or acted upon as fully and effectually
as if in the place of the acquired bank the Central
Government or the transferee bank had been a party thereto
or as if they had been issued in favour of the Central
Government or the transferee bank, as the case may be.
(7) If, on the appointed day, any suit, or other proceeding of
whatever nature is pending by or against the acquired bank,
the same shall not abate, be discontinued or be, in anyway,
prejudicially affected by reason of the transfer of the
undertaking of the acquired bank or of anything contained
in this Part, but the suit, appeal or other proceeding may be
continued, prosecuted and enforced by or against the
Central Government or the transferee bank, as the case may
be.
36AF : Power of the Central government to make scheme
(1) The Central Government may, after consultation with the
Reserve Bank, make a scheme for carrying out the purposes
of this Part in relation to any acquired bank.
(2) In particular, and without prejudice to the generality of the
foregoing power, the said scheme may provide for all or
any of the following matters namely :-
9. OTHER POWERS OF THE CENTRAL GOVERNMENT
108
(a) the Corporation, or the company incorporated for the
purpose, to which the undertaking including the
property, assets and liabilities of the acquired bank
may be transferred, and the capital, constitution, name
and office thereof.
(b) the constitution of the first Board of management (by
whatever name called) of the transferee bank, and all
such matters in connection therewith or incidental
thereto as the Central Government may consider to
be necessary or expedient ;
(c) the continuance of the services of all the employees
of the acquired bank (excepting such of them as, not
being workmen within the meaning of the Industrial
Disputes Act, 1947, are specifically mentioned in the
scheme) in the Central Government or in the
transferee bank, as the case may be, on the same terms
and conditions so far as may be, as are specified in
clauses (i) and (j) of sub-section (5) of Section 45;
(d) the continuance of the right of any person who, on
the appointed day, is entitled to or in receipt of,
pension or other superannuation or compassionate
allowance or benefit, from the acquired bank or any
provident, pension or other fund or any authority
administering such fund, to be paid by, and to receive
from, the Central Government or the transferee bank,
as the case may be, or any provident fund, pension or
other fund or any authority administering such fund,
the same pension, allowance or the benefit so long as
he observes the conditions on which the pension,
allowance or benefit was granted, and if any question
arises whether he has so observed such conditions,
the question shall be determined by the Central
Government and the decision of the Central
Government thereon shall be final;
(e) the manner of payment of compensation payable in
accordance with the provisions of this Part to the
shareholders of the acquired bank, or where the
acquired bank is a banking company incorporated
outside India, to the acquired bank in full satisfaction
of their, or as the case may be, its, claims ;
(f) the provision, if any, for completing the effectual
transfer to the Central Government or the transferee
bank of any asset or any laibility which forms part of
the undertaking of the acquired bank in any country
outside India;
(g) such incidental, consequential and supplemental
matters as may be necessary to secure that the transfer
of the business, property, assets and liabilities of the
acquired bank to the Central Government or transferee
bank, as the case may be, is effectual and complete.
(3) The Central government may, after consultation with the
Reserve Bank, by notification in the Official Gazette, and
to, amend or vary any scheme made under this section.
(4) Every scheme under this section shall be published in the
Official Gazette.
(5) Copies of every scheme made under this section shall be
laid before each House of Parliament as soon as may be
after it is made.
(6) The provisions of this Part and to any scheme made
thereunder shall have effect notwithstanding anything to
the contrary contained in any other provisions of this Act
or in any other law or any agreement, award or other
instrument for the time being in force.
(7) Every scheme made under this section shall be binding on
the Central Government or, as the case may be, on the
transferee bank and also on all members, creditors,
depositors and employees of the acquired bank and of the
transferee bank and on any other person having any right,
liaibility, power or function in relation to, or in connection
with, the acquired bank or the transferee bank, as the case
may be.
36AG: Compensation to be given to shareholders of the
acquired bank
(1) Every person who, immediately before the appointed day,
is registered as a holder of shares in the acquired bank or,
where the acquired bank is a banking company incorporated
outside India, the acquired bank, shall be given by the
Central Government, or the transferee bank, as the case
may be, such compensation in respect of the transfer of the
undertaking of the acquired bank as is determined in
accordance with the principles contained in the Fifth
Schedule.
(2) Nothing contained in sub-section (1) shall affect the rights
inter se between the holder of any share in the acquired
bank and any other person who may have any interest in
such shares and such other persons shall be entitled to
enforce his interest against the compensation awarded to
the holder of such share, but not against the Central
Government, or the transferee bank.
(3) The amount of compensation to be given in accordance
with the principles contained in the Fifth schedule shall be
determined in the first instance by the Central Government,
or the transferee bank, as the case may be, in consultation
with the Reserve Bank, and shall be offered by it to all
those to whom compensation is payable under sub-section
(1) in full satisfaction thereof.
(4) If the amount of compensation offered in terms of sub-
section (3) is not acceptable to any person to whom the
compensation is payable, such person may, before such days
as may be notified by the Central Government in the Official
Gazette, requrest the Central Government in writing, to have
the matter referred to the Tribuanl constituted under Section
36AH.
(5) If, before the date notified under sub-section (4), the Central
Government receives requests, in terms of that sub-section,
109
from not less than one-fourth in number of the share holders
holding not less than one fourth in value of the paid up
share capital of the acquired bank, or, when the acquired
bank is a company incorporated outside India, from the
acquired bank, the Central Government shall have the
matter referred to the Tribunal for decision.
(6) If, before the date notified under sub-section (4), the Central
Government does not receive requests as provided in that
sub-section, the amount of compensation offered under sub-
section (3), and where a reference has been made to the
Tribunal, the amount determined by it, shall be the
compensation payable under sub-section (1) and shall be
final and binding on all parties concerned.
36AH: Constitution of the Tribunal
(1) The Central Government may, for the purpose of this Part,
constitute a Tribunal which shall consist of a chairman and
two other members.
(2) The Chairman shall be a person who is, or has been, a judge
of a High Court or of the supreme court, and, of the two
other members, one shall be a person, who, in the opinion
of the Central Government, has had experience of
commercial banking and the other shall be a person who is
a chartered accountant within the meaning of the Chartered
Accountants Act, 1949.
(3) If, for any reason, a vacancy occurs in the office of the
Chairman or any other member of the Tribunal, the Central
Government may fill the vacancy by appointing another
person thereto in accordance with the provisions of sub-
section (2), and any proceeding may be continued before
the Tribunal, so constituted, from the stage at which the
vacancy occured.
(4) The Tribunal may, for the purpose of determining any
compensation payable under this Part, choose one or more
persons having special knowledge or experience of any
relevant matter to assist in the determination of such
compensation.
36AI: Tribunal to have powers of a civil court
(1) The Tribunal shall have the powers of a civil court, while
trying a suit, under the Code of Civil Procedure,,1908, in
respect of the following matters namely:
(a) summoning and enforcing the attendance of any
person and examining him on oath ;
(b) requiring the discovery and production of documents;
(c) receiving evidence on affidavits ;
(d) issuing commissions for the examination of witnesses
or documents.
(2) Notwithstanding anything contained in sub-section (1), or
in any other law for the time being in force, the Tribunal
shall not compel the Central Government or the Reserve
Bank:
(a) to produce any books of account or other documents which
the Central Government, or the Reserve Bank, claims to be
of a confidential nature;
(b) to make any such books or documents part of the record of
the proceedings before the Tribunal; or
(c) to give inspection of any such books or documents to any
party before it or to any other person.
36AJ: Procedure of the Tribunal
(1) The Tribunal shall have the power to regulate its own
procedure.
(2) The Tribunal may hold the whole or any part of its inquiry
in camera.
(3) Any clerical or arithmetical error in any order of the Tribunal
or any error arising therein from any accidental slip or
omission may, at any time, be corrected by the Tribunal
either of its own motion or on the application of any of the
parties.
Section 45Y: Power of Central Government to make rules
for the preservation of records
The Central government may, after consultation with the
Reserve Bank and by notification in the Official Gazette, make
rules specifying the periods for which
(a) a banking company shall preserve its books, accounts
and other documents; and
(b) a banking company shall preserve and keep with itself
different instruments paid by it.
Section 52: Power of Central Government to make Rules
(1) The Central Government may, after consultation with the
Reserve Bank, make rules to provide for all matters for
which provision is necessary or expedient for the purpose
of giving effect to the provisions of this Act and all such
rules shall be published in the Official Gazette.
(2) In particular, and without prejudice to the generality of the
foregoing power, such rules may provide for the details to
be included in the returns required by this Act and the
manner in which such returns shall be submitted and the
form in which the official liquidator may file lists of debtors
to the Court having jurisdiction under Part III or Part IIIA
and the particulars which such lists may contain and any
other matter which has to be, or may be, prescribed.
(3) The Central Government may, by rules made under this
section annul, alter or add to, all or any of the provisions of
the Fourth Schedule.
(4) Every rule made by the Central government under this Act
shall be laid, as soon as may be after it is made, before
each House of Parliament, while it is in session, for a total
period of thirty days which may be comprised in one session
or in two more successive sessions, and if, before the expiry
of the session immediately following the session or the
successive sessions aforesaid, both Houses agree in making
110
any modification in the rule or both Houses agree that the
rule should not be made, the rule shall thereafter have effect
only in such modified form or be of no effect, as the case
may be; so however, that any such modification or
annulment shall be without prejudice to the validity or
anything previously done under that rule.
Section 53: Power to exempt in certain cases
The Central Government may, on the recommendation of the
Reserve Bank, declare, by notification in the Official Gazette,
that any or all the provisions of this Act shall not apply to any
banking Company or institution or to any class of banking
companies either generally or for such period as may be
specified.
Section 54: Protection of action taken under Act
(1) No suit or other legal proceeding shall lie against the Central
Government, the Reserve Bank or any officer for anything
which is in good faith done or intended to be done in
pursuance of this Act.
(2) Save as otherwise expressly provided by or under this Act,
no suit or other legal proceeding shall lie against the Central
Government, the Reserve Bank or any officer for any
damage caused or likely to be caused by anything in good
faith or intend to be done in pursuance of this Act.
111
Sections 38 to 44 of the Banking Regulation Act deal with the
provisions relating to the winding up of a Banking Company
by Court.
Section 38: Winding up by High Court
1) Notwithstanding anything contained in Section 391, Section
392, Section 433 and Section 583 of the Companies Act,
1956, but without prejudice to its powers under sub-section
(1) of Section 37 of this Act, the High Court shall order
the winding up of a banking company -
(a) if the banking company is unable to pay its debts; or
(b) if an application for its winding up has been made by
the Reserve Bank under Section 37 or this section.
2) The Reserve Bank shall make an application under this
Section for the winding up of a banking company, if it is
directed so to do by an order under clause (b) of sub-section
(4) of Section 35.
3) The Reserve Bank may make an application under this
section for the winding up of a banking company -
(a) if the banking company, -
(i) has failed to comply with the requirements specified in
Section 11; or
(ii) has by reason of the provisions of Section 22 become
disentitled to carry on banking business in India ; or
(iii) has been prohibited from receiving fresh deposits by an
order under clause (a) of sub-section (4) of Section 35 or
under clause (b) of sub-section (3A) of Section 42 of the
Reserve Bank of India Act, 1934; or
(iv) having failed to comply with any requirement of this Act
other than the requirements laid down in Section 11, has
continued such failure, or, having contravened any
provision of this Act has continued such contravention
beyond such period or periods as may be specified in that
behalf by the Reserve Bank from time to time, after notice
in writing of such failure or contravention has been
conveyed to the banking company; or
(b) if in the opinion of the Reserve Bank -
(i) a compromise or arrangement sanctioned by a Court in
respect of the banking company cannot be worked
satisfactorily with or without modifications; or
(ii) the returns, statements or information furnished to it under
or in pursuance of the provisions of this Act disclose that
the banking company is unable to pay its debts; or
(iii) the continuance of the banking company is prejudicial to
the interests of its depositors.
4) without prejudice to the provisions contained in Section
434 of the Companies Act, 1956, 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 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 if the Reserve Bank certifies in
writing that the banking company is unable to pay its debts.
5) A copy of every application made by the Reserve Bank
under sub-section (1) shall be sent by the Reserve Bank to
the registrar.
On application by Reserve Bank under section 38(1), the court
must order winding up. [Reserve Bank of India Vs. Palai
Central Bank, AIR 1961 Ker 268.]
Satisfaction of Reserve Bank under clause (b) of sub-section
(3) is subjective and is not amenable to judicial review.
The word debt in sub-section (1) does not mean banking debt,
[Dwarka Das Vs. Dharam Chand, AIR 1954 Cal 583.]
Sub-section (1) does not preclude the court from taking action
suo motto. [Parfulla Chandra sinha Vs. Chhota Nagpur
Banking Association, AIR 1965 Pat 502.]
Commencement of proceedings for liquidation does not bring
about companys dissolution. [K.V.S.V. Vassan Bros. vs.
Official Liquidator, AIR 1952 Tra-Co. 170.]
From the above section it may be noted that -
The High Court has to order the winding up-
a) if the Bank is unable to pay its debts or
b) if the company is under a moratorium and the Reserve
Bank applied to the High Court for the winding up of
the Bank on the ground that its affairs are conducted
in a manner detrimental to the interests of the
depositors. A Banking Company if it has refused to
meet any lawful demand made at any of its offices
within two days of the Demand and the Reserve Bank
certifies that the Bank is unable to pay its debts, then
the Bank is deemed to be unable to pay its debts.
Other prerequisites are :-
1) there should be a direction from the Central government,
2) An Inspection of the Banking company by the Reserve
Bank, before the order of the Government.
The grounds on which the Reserve Bank of India may apply
for winding up are-
1) the Banking company has failed to comply with the
provisions as to the minimum paid up capital and Reserves
as laid down in Section 11 of the Act;
2) the Banking Company is disentitled to carry on business
of Banking for want of licence under Section 22;
3) the Banking Company has been prohibited by the Reserve
Bank of India and the Central Government from accepting
fresh deposits ;
4) the Banking Company has failed to comply with any
requirement of the Banking Regulation Act, and continues
to do so even after the Reserve Bank of India calls up to do
so by issuing notices;
10. WINDING UP OF BANKING COMPANIES
112
5) the Reserve Bank is of the opinion that a compromise or
arrangement sanctioned by the court cannot be worked out
satisfactorily;
6) the Reserve Bank is satisfied from the Returns furnished
by the Banking Company that it is unable to pay its debts
or its continuance is prejudicial to the interests of its
depositors.
The most important judicial pronouncement in the last 3 decades
is the case relating to the winding up of the [Reserve Bank of
India vs. Palai Central Bank Ltd [AIR 1961 Kerala 268].
From the decision it may be noted that _
1) the court must order the winding up on an application by
the Reserve Bank of India under Section 38(1).
2) the satisfaction of the Reserve Bank of India under clause
(b) of Sub-section 3) is subjective and cannot be challenged
in a court of law.
Section 38A : Court Liquidator
(1) there shall be attached to every High Court a Court
liquidator to be appointed by the Central Government for
the purpose of conducting all proceedings for the winding
up of banking companies and performing such other duties
in reference thereto as the High Court may impose.
(2) x x x
(3) x x x
(4) Where having regard to the number of banking companies
wound up and other circumstances of the case, the Central
Government is of opinion that it is not necessary or
expedient to attach for the time being a court liquidator to
a high court, it may, from time to time, by notification in
the Official Gazette, direct that this section shall not have
effect in relation to that High Court.
Section 39 prescribes that the Reserve Bank of India, State Bank
of India or others to be the official liquidator.
Section 39: Reserve Bank to be Official Liquidator
(1) Notwithstanding anything contained in Section 38A of this
Act or in Section 448 or Section 449 of the Companies Act,
1956, where in any proceeding for the winding up by the High
Court of a banking company, an application is made by the
Reserve Bank in this behalf, the Reserve Bank, the State Bank
of India or any other bank notified by the Central Government
in this behalf or any individual, as stated in such application
shall be appointed as the official liquidator of the banking
company in such proceeding and the liquidator, if any,
functioning in such proceeding shall vacate office upon such
appointment.
(2) Subject to such directions as may be made by the High
Court the remuneration of the official liquidator appointed under
this section, the cost and expenses of his establishment and the
cost and expenses of the winding up shall be met out of the
assets of the banking company which is being wound up,and
notwithstanding anything to the contrary containd in any other
law for the time being in force,no fees shall be payable to the
Central Government,out of the assets of the banking company.
The provisions of the Indian Companies Act are applicable to
the liquidators appointed under the Banking Regulation Act.
Section 39A: Application of Companies Act to liquidators
(1) All the provisions of the Companies Act, 1956, relating to
a liquidator, in so far as they are not inconsistent with this
Act, shall apply to or in relation to a liquidator appointed
under Section 38A or Section 39.
(2) Any reference to the Official liquidator in this Part and
Part IIIA shall be construed as including a reference to any
liquidator of a banking company.
Section 41 of the Act deals with the preliminary report by the
Official Liquidator within 2 months from the date of the winding
up order, on the assets and liabilities of the Banking Company.
The section reads -
Notwithstanding anything to the contrary contained in, Section
455 of the Companies Act, 1956, where a winding up order has
been made in respect of a banking company whether before or
after the commencement of the Banking Companies (Second
Amendment) Act, 1960, the official liquidator shall submit a
preliminary report to the High Court within two months from
the date of the winding up order has been made before such
commencement, within two months from such commencement,
giving the information required by that section so far as it is
available to him and also stating the amount of assets of the
banking company in cash which are in his custody or under his
control on the date of the report and the amount of its assets
which are likely to be collected in cash before the expiry of that
period of two months in order that such assets may be applied
speedily towards the making of preferential payments under
Section 530 of the Companies Act, 1956, and in the discharge,
as far as possible, of the liabilities and obligations of the banking
company to its depositors and other creditors in accordance
with the provisions hereinafter contained; and the official
liquidator shall make for the purposes aforesaid every endeavour
to collect in cash as much of the assets of the banking company
as practicable.
Section 41A deals with the notice of preferential claimants and
secured and unsecured creditors. The Section reads -
(1) Within fifteen days from the date of the winding up order
of a banking company or where the winding up order has
been made before the commencement of the Banking
Companies (Second Amendment) Act, 1960, within one
month from such commencement, the official liquidator
shall, for the purpose of making an estimate of the debts
and liabilities of the banking company (other than its
liabilities and obligations to its depositors), by notice served
in such manner as the Reserve Nank may direct, call upon-
(a) every claimant entitled to preferential payment under
Section 530 of the Companies Act, 1856, and
(b) every secured and every unsecured creditor, to send
the official liquidator within one month from the date
of the service of the notice a statement of the amount
claimed by him.
113
(2) Every notice under sub-setion (1) sent to a claimant having
a claim under section 530 of the Companies Act, 1956,
shall state that if a statement of the claim is not sent to the
official liquidator before the expiry of the period of one
month from the date of the service, the claim shall not be
treated as a claim entitled to be paid under Section 530 of
the Companies Act, 1956, in priority to all other debts but
shall be treated as an ordinary debt due by the banking
company.
(3) Every notice under sub-section (1) sent to a secured creditor
shall require him to value his security before the expiry of
the period of one month from the date of the service of the
notice and shall state that if a statement of the claim together
with the valuation of the security is not sent to the official
liquidator before the expiry of the said period, then, the
official liquidator shall himself value the security and such
valuation shall be binding on the creditor.
(4) If a claimant fails to comply with the notice sent to him
under sub-section (I), his claim will not be entitled to be
paid under Section 530 of the Companies Act, 1956, in
priority to all other debts but shall be treated as an ordinary
debt due by the banking company; and if a secured creditor
fails to comply with the notice sent to him under sub-section
(1), the official liquidator shall himself value the security
and such valuation shall be binding on the creditor.
Section 42 deals with the power to dispense with meetings of
creditors etc. The Section reads -
Notwithstanding anything to the contrary contained in Section
460 of the Companies Act, 1956, the High Court may, in the
proceedings for winding up a banking company, dispense with
any meetings of creditors or contributories if it considers that
no object will be secured thereby sufficient to justify the delay
and expense.
Section 43 lays down the Depositors credits to be deemed
proved. The Section reads -
In any proceeding for the winding up a banking company,
every depositor of the banking company shall be deemed to
have filed his claim for the amount shown in the books of the
banking company as standing to his credit notwithstanding
anything to the contrary contained in Section 474 of the
companies Act, 1956, the High Court shall presume such claims
to have been proved, unless the official liquidator shows that
there is reason for doubting its correctness.
Section 43A deals with Preferential payment to Depositors.
The Section reads-
(1) in every proceeding for the winding up of a banking
company where a winding up order has been made, whether
before or after the commencement of the Banking
companies (Second Amendment) Act, 1960, within three
months from the date of the winding up order or where the
winding up order has been made before such
commencement, within three months therefrom, the
preferential payments referred to in section 530 of the
companies Act, 1956, in respect of which statements of
claims have been sent within one month from the date of
service of the notice referred to in Section 41A, shall be
made by the official liquidator or adequate provision for
such payments shall be made by him.
(2) After the preferential payments as aforesaid have been made
or adequate provision has been made in respect thereof,
there shall be paid within the aforesaid period of three
months -
a) in the first place, to every depositor in the savings
bank account of the banking company a sum of two
hundered and fifty rupees or the balance at his credit,
whichever is less; and thereafter,
b) in the next place, to every other depositor of the
banking company a sum of two hundred and fifty
rupees or the balance at his credit, whichever is less.
In priority to all other debts from out of the remaining assets of
the banking company available for payment to general creditors:
Provided that the sum total of the amounts paid under clause
(a) and clause(b) to any person who in his own name (and not
jointly with any other person) is a depositor in the savings bank
account of the banking company and also a depositor in any
other account, shall not exceed the sum of two hundred and
fifty rupees.
(3) Where within the aforesaid period of three months full
payment cannot be made of the amount required to be paid
under Clause (a) or Clause (b) of sub-section (2) with the
assets in cash, the official liquidator shall pay within that
period to every depositor under clause (a) or, as the case
may be, clause (b) of that sub-section on a pro rata basis so
much of the amount due to the depositor under the clause
as the official liquidator is able to pay with those assets;
and shall pay the rest of that amount to every such depositor
as and when sufficient assets are collected by the official
liquidator in cash.
(4) After payments have been made first to depositors in the
savings bank account and then to the other depositors in
accordance with the foregoing provisions, the remaining
assets of the banking company available for payment to
general creditors shall be utilised for payment on a pro rata
basis of the debts of the general creditors and of the further
sums, if any, due to the depositors, and after making
adequate provision for payment on a pro rata basis as
aforesaid of the debts of the general creditors, the official
liquidator shall as and when the assets of the company are
collected in cash make payment on a pro rata bais as
aforesaid, of the further sums, if any, which may remain
due to the depositors referred to in clause (a) and clause
(b) of sub-section (2).
(5) In order to enable the official liquidator to have in his
custody or under his control in cash as much of the assets
of the banking company as possible, the securities given to
every secured creditor may be redeemed by the official
liquidator -
114
a) Where the amount due to the creditor is more than
the value of the securities as assessed by him or,as
the case may be,as assessed by the official liquidator,
on payment of such value; and
b) where the amount due to the creditor is equal to or
less than the value of the securities as so assessed, on
payment of the amount due;
provided that where the official liquidator is not
satisfied with the valuation made by the creditor,he
may apply to the High Court for making a valuation.
(6) When any claimant,creditor or depositor to whom any
payment is to be made in accordance with the provisions
of this section,cannot be found or is not readily
traceable,adequate provision shall be made by the official
liquidator for such payment.
(7) For the purpose of this section, the payments specified in
each of the following clauses shall be treated as payments
of a different class, namely:-
a) payments to preferential claimants under Section 53
of the Companies Act, 1956;
b) payments under clause (a) of sub-section(2) of the
depositors in the savings bank account;
c) payments under clause (b) of sub-section (2)to the
other depositors;
d) payments to the general creditors and payments to
the depositors in addition to those specified in clause
(a) and clause (b) of sub-section (2).
(8) The payments of each different class specified in sub-
section (7) shall rank equally among themselves and be
paid in full unless the assets are insufficient to meet them,
in which case they shall abate in equal proportion.
(9) Nothing containd in sub-sections (2),(3),(4),(7) and (8)shall
apply to a banking company in respect of the depositors of
which the Deposit Insurance Corporation is liable under
section 16 of the Deposit Insurance Corporation Act, 1961.
(10)After preferential payments referred to in sub section
(1)have been made or adequate provision has been made
in respect thereof, the remaining assets of the banking
company referred to in sub-section (9) available for
payment to general creditors and of the sums due to the
depositors;
Provided that where any amount in respect of any deposit is to
be paid by the liquidator to the Deposit Insurance Corporation
under Section 21 of the Deposit Insurance Corporation Act,
1961, only the balance, if any, left after making the said payment
shall be payable to the depositors.
No banking company shall be wound up voluntarily unless the
Reserve Bank of India certifies that the Company is able to pay
in full all its Debts. The provision and the powers of the High
Court in voluntary winding up is contained in Section 44 of the
Banking Regulation Act which reads -
(1) Notwithstanding anything to the contrary contained in
Section 484 of the Companies Act, 1956, no banking
company may be voluntarily wound up unless the Reserve
Bank certifies in writing that the company is able to pay in
full all its debts to its creditors as they accrue.
(2) The High Court may, in any case where a banking company
is being wound up voluntarily, make an order that the
voluntary winding up shall continue, but subject to the
supervision of the court.
(3) Without prejudice to the provisions contained in Sections
441 and 521 of the Companies Act, 1956, the High Court
may of its own motion and shall on the application of the
Reserve Bank, order the winding up of a banking company
by the High Court in any of the following cases, namely _
(a) Where the banking company is being wound up
voluntarily and at any stage during the voluntary
winding up proceedings the company is able to meet
its debts as they accrue ; or
(b) Where the banking company is being wound up
voluntarily or is being wound up subject to the
supervision of the Court and the High Court is
satisfied that the voluntary winding up or winding
up subject to the supervision of the Court cannot be
continued without detriment to the interests of the
depositors.
115
11. CASE LAW
In the matter of Travancore National & Quilon Bank Ltd,
(in Liquidation) G. Samuel - Applicant. v. Cyril gill and
John Stanley Goodwin - Official Liquidators - Respondents
[AIR 1941 Madras p.622-625]
In this case question of set off was raised. The Travancore
National and Quilon Bank hereinafter called the bank, lent a
sum of Rs.2000 to the applicant Mr. G. Samuel, on a promissory
note dated 7th October 1936. The bank was not willing to lend
this sum to him without security. His mother-in-law Mrs. G.P.
Sathanansham Srinivasan offered to give the necessary security.
On the date of the loan, she had a sum of Rs.4300 in fixed
deposit covered by the fixed deposit receipt bearing the same
date. She gave that amount as security. In her affidavit Mrs.
Srinivasan stated that she gave the said security on the definite
understanding that the bank should adjust the amount due by
Mr. Samuel from and out of the money due to her under the
said deposit at the time of maturity. The terms on which she
gave the loan were reduced to writing and were evidenced by a
letter written by Mrs. Srinivasan to the bank.
It appeared from the affidavit of the Official Liquidator that
along with the said letter a duly receipted fixed deposit receipt
in blank was also lodged with the bank. The fixed deposit was
for a period of two years and on the date when the bank went
into liquidation it had not matured. Mr. Samuel has not paid
anything towards the promissory note, but he claims that he is
entitled to have the amount due by the bank to Mrs. Srinivasan
set off against the amount due by him. Mrs. Srinivasan had
also filed an affidavit stating that she is willing to have the
amount set off.
The question involved was not whether she is willing, but
whether a set off can be allowed in law. Mrs. Srinivasan had
not personally undertaken to repay the debt except giving
security as aforesaid. There were no mutual dealings in this
case, which would entitle the applicant to claim a set off under
S.229, Companies Act, under which in the winding up of an
insolvent company the same rules should prevail and be
observed as are in force for the time being under the law of
insolvency with respect to the estate of person adjudged
insolvent.
It was contended on behalf of the applicant that on the facts it
must be found in this case that there was an agreement to set
off the amount of fixed deposit against the debt due by the
applicant. From the terms of the letter given by Mrs. Srinivasan
the bank was authorized to set off the whole or any portion of
the said deposit and interest accrued thereon. Of course it
confers a right on the bank to set off, if the bank so chose to do.
The Court observed that from the terms of the letter it appears
that the fixed deposit amount was given as security with the
intention that the amount when realized may be appropriated
by the bank towards the debt if they so chose to do. It is one
thing to say that the bank has a right to set off but another thing
to say that the applicant has got a right to set off and there was
an agreement to set off. It was open to the bank to give up the
security if they liked. The Court therefore was of the opinion
that no set off can be allowed in this case but the equity of the
case demands that the bank should adjust the dividend payable
under the deposit towards the amount due and recover only the
balance.
Singheshwar Mandal, Appellant v. Smt. Gita Devi and
another, Respondents [AIR 1975 Patna 81 p.81]
This appeal was by defendant No.1. A money suit was filed
against him by the plaintiff-respondent for recovery of a sum
of Rs. 1541 & 15 annas on the basis of a handnote admitedly
executed by him for a sum of Rs.1133/11 annas in favour of
Dhir Narain Chand, the father of the plaintiff. It was stated in
the plaint, inter alia, that the plaintiffs father had expressed his
desire in presence of the defendant second party that the amount
in respect of this loan would go to the plaintiff alone to which
the defendant second party expressly consented. The defendant
second party were the two widows of Dhir Narain Chand
aforesaid.
Defendant No.1 contested the suit on various grounds, inter
alia, that the plaintiff being not the holder of the handnote in
question, she had no right to institute the suit in question. The
trial court accepted the defence and dismissed the suit but on
appeal, however, the learned Additional Subordinate Judge
decreed the same. Now the second appeal had been filed by
defendant No.1. The learned Additional Subordinate Judge
has overcome this plea of the appellant on the gound that the
plaintiff was an heir of Dhir Nair Chand who had every right to
make arrangement and partition the assets among his heirs. On
referring to the evidence and the circumstances on the record,
he has held that the plaintiffs father did make such an
arrangement according to which this debt was made realisable
by the plaintiff alone.
The Court of appeal below has committed an apparent error of
Law in decreeing the suit. Under the provisions of Section 78
of the Negotiable Instruments Act, payment of the amount due
on a promissory note etc. in order to discharge the maker or
acceptor thereof must be made to the holder of the instrument
or if the same is endorsed then to the endorsee as provided
under Section 82(c) of the Act which is not the case here. The
provisions of the Negotiable Instruments Act are very specific.
The Court held that in this case the handnote in question was
not endorsed in favour of the plaintiff nor does the recital in
any way indicate the intention of the creditor for the payment
of the ultimate dues by the debtor to the plaintiff. The term
Holder has been defined in Section 8 of the Negotiable
Instruments Act, according to which the holder of a promissory
note, inter alia, means a person entitled in his own name to the
possession thereof and to receive or recover the amount due
thereon from the parties thereto. Admittedly, therefore, the
plaintiff does not answer any of the descriptions mentioned
above and the defendant was not bound to make the payment
to her of the dues in question and as such the plaintiff has no
116
right to institute the suit. It is not a case either of any transfer of
this debt or claim which under the provisions of the Transfer of
Prperty Act would be an actionable claim by the father to
the plaintiff. In view of the provisions of Section 130 of the
Transfer of Property Act the transfer of an actionable claim has
to be effected only by the execution of an instrument in writing
signed by the transferor or his duly authorised agent and only
thereafter the rights and remedies of the transferor is transferred.
Additional Subordinate Judge, therefore, was not right in
referring to any other mode of supposed arrangement by the
father of the plaintiff and the different members of the family
which did not answer this requirement of law.
The Court allowed the appeal, and set aside the judgement and
decree of the court of appeal and restored the order of dismissal
of the suit passed by the trial court.
State Bank of India, Petitioner vs. Vathi Samba Murthy,
Respondent. [AIR 1988 Orissa 50]
In this case a civil revision petition was filed against the appellate
judgement confirming the decision of the trial court. The case
of the plaintiff was that the defendant drew Rs.2000/- on the
basis of a cheque from his personal account although he had no
funds available in that account for which the overdrawal was
permitted. In spite of demand, the same not having been repaid,
the suit was filed for recovery of Rs.2000/- as principal amount
and Rs.979.39 paisa towards interest.
The contention of the defendant was that he had two accounts
in the bank. One current account was in his own name and the
other current account was in the name of the partnership firm
of which he was a partner. His case was that in the partnership
account there was enough money and the amount was really
intended to be drawn from that account and there was no
necessity for permitting the overdrawal from his own account
where there was no money.
The trial court applied the principle decided in the case reported
in 1967 SC 1058 (Chandradhar Goswami v. Gauhati Bank
Limited) and held that in absence of the original ledger account
no decree can be granted. The appellate court found as a fact
that the money was given from the personal account. But it
confirmed the dismissal of the suit. It is not disputed by the
defendant in this Court that the amount has been drawn by him
from his personal account, and that he issued the cheque where
no sufficient fund was available. He only stated that the money
should have been adjusted from the partnership account.
The Court held for withdrawal of money from an account any
cheque cannot be issued. It is only the cheque relating to that
account wherefrom money is to be drawn is to be issued. Cheque
of one account cannot be used in respect of another account
even though the same person may be having two accounts.
Accordingly, having drawn money from his personal account
where sufficient funds were not available to honour the cheque,
the defendant shall have the liability of pay back the amount
since it is not a gift by the bank. Both the courts went wrong in
law in dismissing the suit in respect of the principle amount of
Rs.2000/- drawn by the defendant.
There is no material on record that the defendant requested for
overdrawal. There is no general agreement that in absence of
request also, overdrawal may be permitted. If there was no
money available, the banker should have dishonored the cheque
unless specifically requested by the defendant for permitting
overdrawal. If the banker of his own permitted overdrawal, he
has no right to claim interest. However, a person getting benefit
is required to compensate for the benefit rendered to him. In
the absence of any statutory provision relating to payment of
interest on overdrawals, it is a matter for the court to consider
the reasonable rate at which interest can be granted.
It is a common knowledge that business of a banker is to advance
loans and there are varying types of interest in respect of
different types of loans. Similarly for receiving deposits the
bankers give interest of different rates in respect of different
types of deposits. Therefore, the defendant should compensate
the bank for the benefit rendered to him by paying interest at
the rate of 7% from the date of drawal till the payment is made
on the amount of Rs.2000/-.
The court allowed the revision petition, set aside the decisions
of both the courts and decreed the suit partly to the extent of
Rs.2000/- towards principal amount and interest at the rate of
7% from the date of drawal till the date of recovery or payment.
117
12. PROBLEMS
1. A foreign bank wants to open a branch in India and asks
you to advice them on the procedure to be followed. Give
a detailed notice advising the bank the procedure to be
followed and the RBI regulation/guideline on the same.
2. Prepare a detailed list containing types of information that
have to flow from the Commercial Banks to the Reserve
Bank stating the periodicity of the informations and need.
3. If you are asked to point out three issues on which Banking
Regulation Act requires amendment what issues will you
suggest and why ? What amendment will you suggest ?
4. Make a critical study on the legal provision on CRR and
SLR and how the system worked in the last three decades.
Do you suggest any alteration to the present provision ?
Explain.
5. Examine the obstacles on securitization in India. What
remedies do you suggest for healthy growth of
securitization?
6. If you are required to give an advice to the Ministry of
Finance on the issue of regulating Mutual Funds, what
major issues will you suggest where a regulation is required
to be enacted ? What makes you feel that this area requires
regulation ?
7. If an Indian Bank wants to open a Branch at a place, what
procedure should it follow ? On what consideration the
permission is given ?
8. Many of the financial institutions have already established
their own Bank or are initiating the proposal to establish
their own Bank. What according to you are the reasons for
such development ? Do you think the trend is a healthy
one ? Explain. What legal system must the country build
up to regulate the area ?
9. On what consideration a Private Bank is allowed to be
established and run in India ? What procedure a proposed
private Bank must follow to finally establish itself and
commence business ?
10. Can a State Government establish a Bank ? On what
considerations RBI may refuse permission to such a
proposal ?
[Note: Specify Your Name, I.D. No. and address while sending answer papers]
118
1. Gupta, S.N., : The Banking Law in Theory and Practice, 22nd Edn. (1992), Universal Book Traders, New Delhi.
2. Hapgrood, Mark, : Pagets Law of Banking, 10th Edn, (1989), Butterworths, London and Edinburgh.
3. Ramaiaya, A., : A Guide to the Companies Act, 11th Edn. (1992), Wadhwa and Co. Pvt Ltd, Nagpur.
4. Sheldon & Fidlers : Practice & Law of Banking, 11th Edn (1984), Macknald & Evans, Ltd, London and Plymouth.
5. Tannan, M.L., : Banking Law and Practice in India, 18th Edn, (1989), Orient Law House, New Delhi.
13. SUPPLEMENTARY READINGS
119
Banking Law
Course No: II
Module No: IV & V
Negotiable Instruments:
Law and Procedure
Phone: 3211010 Fax: 080-3217858
120
Materials Prepared By :
1. Ms. Sudha Peri
2. Prof. N.L. Mitra
Materials Checked By :
1. Prof. P.C. Bedwa
Materials Edited By :
1. Mr. T. Devidas
Published By
Post Bag No: 7201
121
INSTRUCTIONS
Negotiable Instruments form the axis on which the wheels of commerce revolve, and are the most widely need form of
securitization. The Negotiable Instrument Act itself deals with only three types of instruments, cheques, bills of exchange
and promissory notes. But according to sec. 1 of Act, though it also recognises all instruments in local language and
established by usage from the provisions of the Act. Thus negotiable instruments may be said to be of two types: (1)
those created by the statute and (2) those created by usage or practice of the society.
Though negotiable instruments are widely used by all sections of people for varied purposes, actual knowledge about
these instruments is very low. There is a widespread ignorance about the nature and scope of these instruments, the
rules relating to their presentment, acceptance or dishonour etc. An effort has been made in this module to give a
comprehensive sketch of the various aspects of negotiable instruments.
Students are advised to go through the module carefully and to make a check list at the end of every major aspect of
these instruments for easy understanding, and to keep the bare act besides you while going through the module, to
facilitate easy reference. The subject being a very complicated one you should read up atleast one of the basic books
on the subject, apart from this module so as to come to terms with the intricacies of the subject.
N.L. MITRA
Course co-ordinator
122
Negotiable Instruments : Law and Procedure
TOPICS
1. Securitization .................................................................................................................. 123
2. Negotiable Instrument ................................................................................................... 127
3. Parties to a Negotiable Instrument ............................................................................... 138
4. Rules relating to Negotiable Instruments .................................................................... 145
5. Presentment .................................................................................................................... 152
6. Special Provisions Relating to Cheques ....................................................................... 157
7. Discharge from Liability................................................................................................ 161
8. Of Notice, Noting and Protest ...................................................................................... 164
9. Presumptions and Estoppels ......................................................................................... 168
10. Offences under the Act .................................................................................................. 172
11. Foreign Instruments....................................................................................................... 177
12. Case Law......................................................................................................................... 185
13. Problems.......................................................................................................................... 188
123
1.1 What is Securitisation?
1.2 Procedure
1.3 What assets can be Securitised
1.4 Type of Securities
1.5 Advantages
1.6 Legal Issues
1.7 Role of government
1.8 Creation of international securities
1.1 WHAT IS SECURITISATION
What is Securitisation?
According to Kenneth Cox securitization is a process in which
pools of individual loans or receivables or actionable claims
are packaged, under written and distributed to investors in the
form of securities. It is a process of liquidizing assets appearing
in the balance sheet of a bank or financial institution which
represent long term receivables by issuing markatable securities
there against. It involves conversion into cash flow from a
portfolio of assets in negotiable instruments or assignable debts
which are sold to investors.
Securitization is in vogue in western countries as a very common
method of funding. Mr. B.D. Ushir (Jt. Legal Advisor, IDBI) in
an article gave a clear analysis of such securitisation. A bank
or a financial institution lends money or purchases or discounts
bills. The outstanding loans and bills appear as assets in the
balance sheet. These assets being generally of long term
maturity, the fund invested therein remain locked up. These
loans/bills form portfolio to form a basket or a pool for the
purpose of securitization.
Now, these debts are assigned in writing through a document
(known as security) by which assigner transfers his actionable
claim over the debt to the assignee who will have all rights
such as right to claim the payment of the debt; right to interest;
right to remedies in case the debt is not paid. As such, through
the creation of securities the Bank or financial institutions
liquidizing the long term debts and loans and create funds for
investments.
1.2 PROCEDURE FOR SECURITIZING
Securitizing has several steps involved such as :
(a) Creation of a basket or pool of loans/bills/actionable
claims: The Bank or the financial institution engaged in the
business of louding/bill discounting/having actionable claims,
1. SECURITISATION
creates a portfolio containing a basket or pool of claims fairly
diversified and representative in characer and not necessarily
relate to same industry or from same statistical history. The
package must form an optimal mix so as to ensure marketability
of the instruments created and issued to the investors. Further,
the maturities should also be so selected that they form one
homogenous group or a few homogenous branches. These
loans are backed by collateral securities. The aggregate pool,
therefore, consists of the receivables flowing from the respective
loans and the rights to the various securities which are
commonly in the form of mortgages or charge on the borrower's
assets.
(b) Forming a special purpose vehicle (SPV) : Once the
assets are identified, these are to be passed through a special
purpose vehicle (SPV). It is common for an investment banker
to act as the special purpose vehicle against the sale for a
valuable consideration. On completion of the passing through
transaction, the securitised assets are removed from the balance
sheet of the lending institution (the originator). At this stage it
has to be remembered that the contractual relations under the
loan agreement between the borrowers and the lender (the
originator) continue to subsist even after the passing away of
the securitised loans and bills to SPV. So the originator shall
continue to receive interest and principal amounts from the
borrower which are requested to be passed to the SPV persuant
to the specific covenants under an agreement entered into
between the two.
(3) Splitting into shares or securities : After the securitised
assets are passed to SPV, it divides notionally the whole asset
into small shares or securities and sells these shares/or securities
to investors. These securities are called the Pass Through or
Pay Through Certificate (PTC). PTC's are so structured as to
synchronise, as regards to their maturities, with the maturities
of the securitised loans or bills (receivables) so that cash flowing
from these sources become available to the payment of the PTCs
and their maturities.
PTC holders look to the SPV for payment of interest and the
principal in respect to the PTCs held by them. The SPV will
meet this obligation out of the receivables realised by the lender
(originator) from the borrowers and passed on to the SPV. A
PTC represents a sale of an individual interest to the assets
securitised by the originator and transfered to the SPV. A choice
of appropriate form of the PTC depends on various
considerations such as the incidence of stamp duty,
marketability/transferability aimed at and so on. The whole
process of securitisation happens thus :
124
1.3 WHAT ASSETS CAN BE SECURITISED
All types of assets having a reasonably predictable cash flow
can be securitsed. It has been already pointed out that in
constructing a portfolio to be sold down to the SPV, it will be
important to select assets which are homogenous and diversified.
The assets will also need to have statistically predictable cash
flows, levels of arrears and defaults since these will be key
factos for the investors. The following assets are most common
for the purpose of securitisation
(a) Mortgaged properties & loans ;
(b) Housing loans ;
(c) Car loans ;
(d) Credit card receivables ;
(e) Trade receivables/book debts ;
(f) Bills ;
(g) Actionalbe claims.
1.4 TYPES OF SECURITIES
Securities may generally be of two types, viz:
(i) Securities confined to national boundaries and to be
operated within the country, and
(ii) Securities which are operated internationally. These may
be based upon national assets or international assets which
can be securitised.
National Securities are those which are either negotiable
instruments under the NI Act or transferable but not negotiable.
Common examples are bills, pronotes cheques these being
negotiable ; commercial papers - these being transferable but
non-negotiable.
International securities are GDR (Global Depositing Receipts)
or IDR (International Depository Receipts).
1.5 ADVANTAGES
There are several advantages fo securitization, such as:
(1) Liquidification - It creates liquidity in the market against
assets which are generally sleepng or dorument in character
for sometime, as for example, book debt.
(2) Avenue for investment - It creates opportunities for
investment to the people who want to invest to augment
income, assured securities having opportunity for
encashment as and when required.
(3) Mobilises funds for investment - With floating of new
investments against portfolio, for the purpose of using debt
capital for industrial development.
(4) Foreign funds - Foreign funds can be generated through
the creation of a depository of Indian scrips including shares
and debentures. A global or international depositing is
created with which shares, stocks and debentures can be
deposited for the purpose of creating a SPV against which
Pool of assets
1. Loans & Advances belonging to Originator Receive the loan
2. Bills
(Suppose a Bank or a amount
3. Other Receivables
financial institution
4. Debtors
Passed on to the The SPV may be a Bank Passed on to SPV
Special purpose or a financial insti-
vehicle against tutions
consideration
Asset value in the Shares/Securities sold Share/Securities
pool is divided to investors paid of by SPV
notionally into
small share or
security
125
GDR or IDR is issued to foreign investors through which
foreign funds are mobilised for investment in India.
(5) Easy transferability - Securities may be listed in the stock
exchange for easy transferability which ensures floating
funds to be canalised for industrial and market development.
1.6 LEGAL ISSUES AND LAWS INVOLVED
All legal issues relating to Securitisation need to be examined
in the light of the provisions of various laws like, the Transfer
of Property Act 1882, the Registration Act, 1908, the Indian
Stamp Act 1899; Income Tax Act 1961; Securities Contracts
(Regulation Act) 1958 and SEBI Act 1992.
(1) Transfer of Property Act, 1881 : Many of the recoverables
are classified debts coming within the definition of
immovable property and hence call for the knowledge on
Transfer of Property Act. As for example, an interest of a
mortgagee is an immovable property. Similarly mortgage-
debt is an immovable property which can be transferred
only by an instrument in writing being registered under
sec 17(1)(6) of the Registration Act. As such, Securitisation
of these type of portfolio involves a transfer of an interest
of a mortgage when the underlying securities happen to be
in the form of a mortgage. There are two levels of transfers.
First the portfolio is transfered to SPV and secondly
individual interest is transfered through PTC to the
investors. All such transfers concern mortgage-debts, and
hence attracting transfer of property.
(2) Registration Act, 1988 : All non-testamentary instruments
creating, declaring, assigning or extinguishing, whether in
present or in future, any right title or interest, whether vested
or contingent, of the vlaue of Rs.100 or above, to or in any
immovable property are required to be compulsorily
registered. [sec 17(1)d]. Securitisation involves creation
and/or declaration of an interest in the immovable property
firstly in favour of SPV and secondly in favour of the
investors.
(3) Negotiable instrument Act, 1872 : Instruments which
are negotiable are covered under the N1 Act. One of the
defects of the NI Act is its restrictive nature. Only if an
instrument is drawn in the form of a pro-note or a bill, can
it be covered under NI Act. With the growing securitization,
there has to be a pressure on the government for
accomodating securities under NI Act. All instruments are
tranferable but not negotiable in the sense that transfer can
be made by delivery.
(4) Indian Stamp Act, 1899 : According to sec 2(10) of the
Indian Stamp Act, conveyance includes conveyance on sale
and other instruments relating to properties, movable or
immovable. A conveyance attracts ad-valorem stamp-duty
under Art 23 of Schedule I of the said Act. Apart from the
above, the securities (PTCs) to be issued to the investors
would also attract stamp duty at two stages, viz(1) on issue
of securities and (2) on transfer of securities by the investors.
(5) The Income Tax Act, 1961 : Income Tax Act has several
provisions relating to transfer of income. As for example,
Ss.60, 160-162, 194A of the Act relate to matters involved
in Securitisation. Sec 60 contemplates a transfer of income
without transfering the assets from which the income was
generated. Ss 160-162 provide for imposition and tax on a
person as a representative assessee for the income received
by him for and on behalf of others.
(6) Security Contracts (Regulations) Act, 1958 and
Securities Exchange Board of India Act, 1992 : All PTCs
are securities under the ambit of the defintion in the above
two statutes. SEBI is empowered to regulate the issue of
and trading in all PTCs. Securitisation is a financial
innovation and hence cuts accross the money management
and credit control functions of the RBI which may regulate
the marketing operations of such securities through direct
and indirect methods and guidelines and also through laying
down the standard of disclosure and accounting practice.
Besides the above legal requirements other facilties like listing
of the instrument at the stock market; insurance coverage for
the investors subscribing to securities without recourse; credit
facilities against defaults by borrowers; availability of
intermediary services also require building up of infra-structure
legal system compatible with the requirement of growth of
securitisation needed in the commercial market. It is therefore
necessary to build up a legal system for encouraging the
Securitisation.
1.7 ROLE OF GOVERNMENT
It is now understood that the present legal environment about
securitisation is inadequate, in-appropriate and unfriendly. It
has been rightly observed by an author (Ushir, B.D., 212) that
unless immediate steps are taken to remove the legal hurdles,
there is a danger of this promising instrument being lost. A
two dimensional government action is necessary, viz.,
(i) removal of all legal barriers; and
(ii) providing appropriate incentives and adequate infra-
structural facilities.
Besides, a suitable regulatory mechanism is necessary to
formalise the commercial practice and negotiability. Some of
these requirements are as follows :
(a) Stamp duty remission : The law relating to Stamp duties
are both Central and State subjects. According to Entry 91
of List I of Seventh Schedule under Article 246 of the
Constitution of India Rates of Stamp duty in respect of
bills of Exchange, promissory notes, cheques, bills of lading
, letter of credit, policies of insurance, transfer of shares,
debentures proxies and receipts, shall be determined by
the Union'. But according to Entry 63 of List II it is stated
that in all other cases the Stamp duty is to be fixed by the
State. Thus, based on the above stipulation if PTC's are
classified on the basis of nature of portfolio and there are
several prescriptions for several class of securities such as
an portfolio relating to mortgage debts or relating to debt,
126
In the above process Indian investors are required to put in
their shares, stocks or debentures with a foreign depository to
be created for the purpose of constituting a SPV. The foreign
depository thereafter issues securities called GDR or IDR for
foreign investors against portfolio. Whan a GDR /IDR for
foreign depository releases the Indian papers which goes back
to the Indian investors. GDR/IDR can be listed with the stock
exchanges. The RBI provides a guideline for the issue of this
type of securities and SEBI regulates the creation of these kinds
of securities as well as its dealings in the market.
there will be several confusion. Therefore stamp duty law
for all such securities should be brought under the Central
subjects and the law is simplified. A nominal stamp duty
can be imposed if at all, in order to facilitate securitisation.
If stamp duty is not remitted, market shall in itself create
some duty saving routes which will have two fold danger.
First, the fate of such transactions would always be
uncertain. Second, the states would rush with the
amendments to the stamp laws to bring within their net the
various devices adopted by the market. It is therefore,
necessary to give complete remission on securitisation so
that growth of the market instruments bring more liquidity
which will offset the loss on account of remission of stamp
duty and wide confusion arising out of present law relating
to stamp duty.
(b) Income tax incentives : It is suggested by many market-
friendly economists that securitisation require tax incentives
in the line of sec. 88A of the Income Tax Act.
(c) Development of infra structural facilities : SEBI may
prepare guidelines for listing of such securities and for other
marketing practices. It is necessary for RBI to make
regulations for the management of portfolios with suitable
rules of set off and protection. In US special institutions
were set up in 1970s and 1980s, such as, the Government
National Mortgage Association (GNMA), the Federal
House Loan Mortgage Corporation (FHLMC) based upon
the nature of the portfolio. These institutions took lead
role in popularising securitization. Various tax incentives
can be given institutions for popularising securitisation.
1.8 CREATION OF INTERNATIONAL SECURITIES
Securities may be created for global funding, both by the floating
of equity or through development of securities. The distinction
between the equity participattion and global securitization is
that the former supplies equuity capital which is generally a
long term capital flow, whereas funds to securitization are loan
capital and short term in nature. Generally for the purpose of
floating the securities for the investment of foreign investors,
the following mecahnism is resorted to:
Creation of Institutional Securities
Indian Side Foreign Country
Pooling of repaid to To Foreign Investor
Indian papers llike
Shares
Stocks
Debenture
Debenture-Stock Release of A Foreign Depositing
Depository
Foreign Investor
creating a SPV
Issue of GDR/IDR
Release of
Indian
Investment
into
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2. NEGOTIABLE INSTRUMENT
SUB TOPICS
2.1. Introduction
2.2. Kinds of Negotiable Instruments
2.3. Promissory Note
2.4. Bill of Exchange
2.5. Cheques
2.6. Hundis
2.7 Inland and foreign instruments
2.8 Inchoate Instruments
2.1 INTRODUCTION
The word negotiable might owe its origin to the French word
negoce meaning business, trade or management of affairs.
Blacks Law Dictionary defines the term negotiable as
something which is legally capable of being transferred by
endorsement or delivery, and negotiability is the legal character
of being negotiable.
Instrument on the other hand may be defined as a written
document; or a formal or legal document in writing such as a
contract or a will.
Thus, taken together a negotiable instrument means a written
document capable of being transferred by endorsement or
delivery. Section 13 of the Negotiable Instruments Act, 1882
provides as under:
Negotiable Instrument - A negotiable intrument means a
promissory note, bill of exchange or cheque payable either to
order or to bearer.
Explanation (i) - A promissory note, bill of exchange or cheque
is payable to order which is expressed to be so payable or which
is expressed to be payable to a particular person, and does not
contain words, prohibiting transfer or indicating an intention
that it shall not be transferable.
Explanation (ii) - A promissory note, bill of exchange or cheque
is payable to bearer which is expressed to be so payable or on
which the only or last endorsement is an endorsement in blank.
Explanation (iii) - Where a promissory note, bill of exchange
or cheque, either originally or by endorsement, is expressed to
be payable to the order of a specified person, and not to him or
his order, it is nevertheless payable to him or his order at his
option.
2) A negotiable instrument may be payable to two or more
payees jointly, or it may be made payable in the alternative to
one of two, or one or some of several payees.
A negotiable instrument is an object of rights, i.e., it gives to
the person in lawful possession of such an instrument certain
rights which other instrument do not give him. Further, a
negotiable instrument represents money and possesses the same
characteristics as that of money, namely, (i) it is not tainted by
any defect in title at the source so long as its acquisition is
lawful, i.e., even if the maker of the instrument commits a fraud
or a forgery, a bonafide payee of the instrument is not affected
by such fraud or forgery; (ii) it passes by delivery like cash
does and the person in lawful possession of it can sue on such
instrument in his own name. A negotiable instrument also
embodies some of the basic principles of contract, because it is
either an undertaking or promise or an order to pay money.
Capacity of the parties to such an instrument, their rights and
liabilities etc., are all governed by the basic principles of
contract. A negotiable instrument is one, therefore which when
transferred by delivery or by endorsement and delivery, passes
to the transferee a good title to payment according to its tenor
and irrespective of the title of the transferor, provided he is a
bonafide holder for value without notice of any defect attaching
to the instrument or in the title of the transferor; in other words
the principle 'nemo dat quod non habit' does not apply. It is
this element of negotiability which makes a contract founded
upon paper thus adapted for circulation different in many
particulars from other contracts known to law [Verma, p.2].
Thus in Raephal v. Bank of England [(1855)104 RR 638:25
LJCP 33], some bank notes of the Bank of England were stolen.
The Bank immediately prepared and circulated a list of the stolen
notes. The plaintiff being a money changer in Paris also received
such a list. After a year of his receiving this notice, a man came
to the plaintiff for exchanging a Bank of England note. The
plaintiff having forgotten the year old notice encashed the note,
which was one of the stolen ones. The Bank of England refused
payment to the plaintiff. It was held that the plaintiff, having
taken the note in good faith, was entitled to its payment. He
was no doubt somewhat negligent, but he had acted honestly.
But the principle of 'nemo dat quod non habet' applies only to
negotiable instruments and a holder of an instrument which is
non-negotiable cannot take this defence. For example, in
Whislter v. Forster [143 ER 441], one G fraudulently obtained
a cheque from the defendant Forster. The cheque was made
payable to G or order. G gave the cheque to the plaintiff as
payment for his debt, but forgot to endorse the cheque. Till
then, he had no notice of the fraud but before the plaintiff could
get Gs endorsement on the cheque, he became aware of the
fraud. It was held that the plaintiff could not get a good title.
Erle CJ observed:
According to law merchant, the title of a negotiable instrument
(payable to order) passes by endorsement and delivery. A title
so acquired is good against all the world, provided the instrument
is taken for value and without notice of any fraud. The plaintiffs
title here, therefore, was to be rendered valid by endorsement;
but at the time he obtained the endorsement, he had notice that
the bill had been fraudulently obtained by G from the
defendant.
This brings us to an interesting question, what are the essential
elements or requirements of a negotiable instrument or when
does an instrument become negotiable ? To understand the
128
essential characteristics of a negotiable instrument it is important
to keep in mind the resemblance of these instruments to money.
In the words of Parsons, the most characteristic of money as
distinguished from other species of property is the facility and
freedom with which it circulates. Any one taking it, therefore,
in the course of business, need look no further than to the face
of the coin and the possession of the person from whom he
receives it. These are the qualities which every representative
of money must possess in order to answer its purpose
effectively. [Bhashyam, p.66]. In simpler words what
characterizes money is the certainty which it denotes i.e.,
certainty of denomination and of possession. A negotiable
instrument thus should be very certain as to the amount being
promised or ordered to pay. Further since the instrument also
incorporates principles of contract it should also be clear,
unambigous and concise and should also specify the names of
the person to whom it is being made payable as also the person
making the payment. Thus, a negotiable instrument should be
certain as to: (i) persons making the payment; (ii) persons
receiving the payment; (iii) the amount payable; (iv) the time
and place of payment and (v) conditions of liability (if any).
According to Blacks Law Dictionary, for an instrument to be
negotiable within the meaning of Article 3 of U.C.C. it must -
(1) be in writing and signed by the maker or drawer; (2)
containing an unconditional promise or order; (3) to pay a
specified amount; (4) either on demand or at a definite time;
(5) to the bearer of the instrument or to order, and (6) not contain
any other promise, order, obligation or power given by the maker
or drawer except as authorized. Apart from these general
characteristics each kind of negotiable instrument has its own
set of essential requirements, but these will be dealt with at
appropriate places.
Need for Negotiable Instruments
You may now ask a very pertinent question - the law dealing
with negotiable instruments seems to be very complex, so why
should we deal with it ? More importantly why do we need
negotiable instruments in the first place, why cant be do away
with them ?
The answer to the first question is very simple. Negotiable
instruments form the backbone of todays complex commercial
world. Tradesmen prefer to use cheques, drafts, promissory
notes etc., in their day to day transactions, rather than ready
cash. In fact even the common man has become addicted to the
use of cheques and drafts. These instruments are used as a
mode of payment alongwith application forms, for filing of
tenders, for payment of salary....you name a transaction
involving money and you will find a negotiable instrument in
some form or other exchanging hands. It is because of this
widespread popularity and usage of these instruments that an
indepth study of these instruments becomes essential for every
user of these instruments.
Coming to the second question as to the need or necessity for
the existence of these instruments, let us consider the following
hypothetical conversation between two fictitious persons
Ramesh (who is a money-lender) and Suresh (who is a farmer
needing a loan).
Suresh: Mr.Ramesh I want a loan of Rs.50,000/-.
Ramesh: I will be very happy to loan you that amount but
what is the guarantee that you will return the money?
Suresh: I promise you on everything that I hold sacred that I
will return it.
Ramesh: Promises are not enough. I need some security
against the loan.
Suresh: I have two bullocks which I will give you if I cant
pay the money.
Ramesh: But what will I do with the bullocks ? I stay in the
city and will have no use for them.
Suresh: I will tell you what - Ill write on a piece of paper
that in case I fail to pay the money owed to you, my
bullocks should be sold and the money given to you.
Ramesh: That should be perfectly okay. Here is the money.
Suresh: Thank you - and here is my note.
Though the entire episode described above is fictitous, it must
have been situations like these where the consideration or
security being offered was too unwieldly or inconvenient for
the person to carry around, which gave rise to the birth of these
instruments. Try to imagine, you have sold stock worth say $ 1
million and the person wants to pay you in coins or currency.
How will you carry it and how much care will you have to
extend to see that currency is not stolen. And the situation
would have been even worse in the initial stages i.e., before the
advent of paper currency, when gold & silver coins were in
vogue. A person would really need to be a weight lifter to
carry large amounts of such coins, quite apart from the security
problems involved.
It was to overcome the inconveniences of these kinds of
situations that negotiable instruments started being used and
quickly became popular, so much so that within no time they
became the life and blood of the commercial world. Whether
we like it or not negotiable instruments have come to stay and
we cannot simply wish them away.
Negotiation and Indorsement
Negotiable instruments have a characteristic feature of easy
transferability to a third party by a proces called negotiation.
As mentioned earlier a negotiable instrument contains either a
promise or an order to pay A or his order, or to pay B or bearer.
It is this provision for alternative payment i.e. to one or other,
that makes these instruments really negotiable.
Negotiation may take place in one of the following two ways,
viz ;
(i) When th instrument is payable to bearer it is negotiable by
delivery of it to the third party.
(ii) When the instrument is payable to order, then negotiation
can be done by firstly indorsing it and then delivering it
by the holder.
Payable to order means that the maker may not only specify
the person to whom the money is to be paid say a Mr.X, but
129
also order that the money be paid to any person Mr.X orders it
to be paid to. So every instrument may have a series of parties
each making the money payable to the next succeeding person
or to his order. For example, a bill may be made by A to pay to
B or his order; B may by indorsing make it payable to C or
his order; C making it payable to D or his order and so on
and so forth. This stream will continue till the bill is ultimately
cashed and the amount realized. It may be possible that an
instrument gets circulated so rapidly that it becomes so covered
with indorsements that there is no place for any more fresh
indorsements. In such a situation it is permissible to attach a
piece of paper called an allonge to the bill, and this allonge can
be used for further indorsements.
The question now arises, what is an indorsement ? An
indorsement in simple words may be defined as the signing
on the instrument for the express purpose of negotiation, and
negotiation takes place when the indorsed instrument is
delivered to any person so as to make him the holder of the
instrument. The person signing the bill is known as the
indorser and the person in whose favour indorsement is made
is known as the indorsee. The same person may take on the
character of both the indorser and the indorsee as for example,
if A indorses a bill in favour of B, and B indorses the bill in
favour of C, then B is an indorsee with respect to A and he is an
indorser with respect to C. Once a bill is indorsed and delivered,
the indorsee not only acquires the property in the instrument
but also the right to further negotiating the instrument to other
persons. What is essentially required in cases of indorsement
is the intention to pass the property in the bill. Nowadays a
question that is becoming increasingly important is, how to
sign an indorsement, because the protection of a banker who
either pays or receives an indorsed instrument is dependent on
the form of the endorsement.
Indorsements are of two kinds, viz :
(i) indorsements in blank ie where the indorser merely signs
his name without specifying as to the identity of the
indorsee; and
(ii) 1indorsement in full ie where the indorser specifies the
person or indorsee to whom or on whose order the payment
is to be made.
An instrument with blank indorsement is negotiable by mere
delivery, just as if it was an instrument payable to the bearer. A
blank indorsement may be converted into a full indorsement
by the holder, by writing above the indorsers signature a
direction to pay to any other person. The advantage of pursuing
such a course of action is that the holder does not incur the
liabilities of an indorser. The holder may also exclude his
liability by indorsing the instrument sans recourse or he may
make his liability conditional. He may also restrict the right of
the indorsee to further negotiate the bill by appropriate wording
of the indorsement, as for example, by saying pay B only or
pay B or C.
The indorsement to be valid must be of the entire bill i.e. you
cannot keep part of the bill and indorse the remaining. You
may indorse the bill in toto or realize it in toto. A partial
indorsement or a transfer to two or more indorsees severally
does not operate as negotiation of the bill; but if the bill has
been partly paid then a note to that effect can be made on the
indorsement and it may then be negotiated for the balance.
Who can indorse ?
An indorsement can be done only by the lawful holder of the
instrument. Every single maker, drawer, payee, indorsee etc or
if there are more then all of them jointly can indorse an
instrument provided he or they are in lawful possession of the
instrument. A stranger i.e. someone who is not a holder cannot
indorse an instrument so as to convey a title to the indorsee.
An agent of the indorser can indorse the instrument provided
he signs as an agent of the indorser and not as an indorser.
The Act deals only with transfer of instruments according to
Law Merchants, does not deal with transfer by operation of
law. An important consequence of negotiation envisaged by
the Law Merchants is that, a person taking an instrument
bonafide and for value acquires a good title to it, regardless of
the defects in the title of the transferor. It is this characteristic
combined with its transferability by delivery like cash, which
determines the negotiability of the instrument. In case of
ordinary transfers, for example, in assignment of a debt, the
transferee gets a right to see in his own name, but he does not
get a better title than what his transferor has. But in case of
negotiable instruments, title of the transferee is dependant upon
the manner of his acquisition of the instrument rather than the
title of the transferor. In this respect they resemble the coin of
the realm which may pass from hand to hand without being
tainted by the title of the transferor.
2.2 KINDS OF NEGOTIABLE INSTRUMENTS
The Act itself deals with only three kinds of negotiable
instruments, viz : promissory notes, bill of exchange and
cheques. But this does not mean that these are not other kinds
of instruments. The Act specifically saves or excludes from its
operation local usages in respect of all instruments in an oriental
language unless an intention is expressed in any such instrument
that it would be governed by the Act (sec.1). But the usage has
to be established by the party alleging its existence, otherwise
it will be governed by the provisions of the Act regardless of
the language it is written in, i.e. a negotiable instrument need
not necessarily be in English it can also be written in the oriental
languages. The basic condition differentiating a negotiable
instrument from a non negotiable one is not the langauge in
which the instrument is written, but is the intention to make a
negotiable instrument for the purpose of recording in writing
to pay money to a specified person at a specified time. Hence,
receipts etc, are not a negotiable instrument even if such receipt
is coupled with a promise to pay. We will now deal with these
various kinds of negotiable instruments alongwith their salient
characteristics and their distinction from one another.
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2.3 PROMISSORY NOTES
Section 4 of the Act defines promissory note as an instrument
in writing containing an unconditional undertaking, signed by
the maker, to pay a certain sum of money only to, or to the
order of a certain person or to the bearer of the instrument."
The essential ingredients of a promissory note are as follows :
(1) It must be in writing and signed by the maker
(2) It must contain an unconditional and definite promise to
pay a certain sum, and nothing more.
(3) It must be payable either on demand or after the efflux of a
fixed or deteminable time in future, as for example after 6
months.
(4) It must be payable to, or to the order of a specified person
named in the note or to the bearer of the note.
(5) Most importantly, an instrument to be regarded as a
promissory note must show a prima facie intention to make
such a note and it must be delivered.
Thus before a document can be treated as a promissory note,
two things have to be ascertained : (a) an acknowledgement of
indebtedness and (b) a promise to pay the debt. The illustrations
appended to the section make the meaning clear, and are being
reproduced below.
(i) I acknowledge myself to be indebted to B for Rs.
1000 to be paid on demand for value received.
(ii) Mr. B, I.O.U. Rs. 1000.
The first is a promissory note whereas the second is not, because
in the second illustration though there is an acknowledgement
of indebtedness there is no corresponding promise to pay. In
Raghunath v. Seetaram [1972 Mys. 344] certain tests to
ascertain whether the given document was a promissory note
or not were laid down. The Court observed :
The controlling element in determining the question whether
an instrument is a promissory note or not is the intention of the
parties in drawing up that instrument as a promissory note. A
document might comply with the terms of this section and yet
it may not be a promissory note. For instance, a mere receipt
even if coupled with a promise to pay is never intended to be a
promissory note, and so a deposit note containing words we
promise to pay the said sum. But a document, does not become
a promissory note merely because the parties intended it to be a
promissory note unless it fulfills the terms of this section.
However, if a promissory not falling under section 4 of the Act
and therefore under section 2(22) of the Indian Stamp Act, 1899,
is attested and not payable to order or bearer it would fall under
section 2(5)(b) and would amount to a bond for the purposes of
the Act. The description of the instrument as a promissory
note, the language of the instrument taken as a whole, the
circumstances under which it came to be executed, the intention
of the parties manifest from the face of the document and the
surrounding circumstances have all a cumulative bearing on a
proper construction of the instrument whether it is a promissory
note or not." There is another requisite for a promissory note
to be valid and that is that the note should be properly stamped
as per the requirements of the Indian Stamp Act, 1899, but in
case of a pro note executed in the State of Jammu & Kashmir
must be affixed with requisite stamps prescribed under the J &
K Stamp Act, [Gulam Nabi v. Lal Mohammed, AIR 1975 J
& K. 50]
Kinds of Promissory notes
Section 4 recognises three kinds of promissory notes :
(1) A note containing a promise to pay a certain sum of money
to a person. Originally this was not considered as a
negotiable instrument in India, but it was perfectly valid
between the parties to the document, and it was capable of
being assigned as an ordinary chose-in-action though not
by negotiation [Udayar v. Muthia 7 MLJ 231] but Act
VIII of 1919 made such instruments also negotiable, unless
in the instrument words like only to are included.
(2) A note containing a promise to pay a certain sum to the
order of a certain person. Such notes are however payable
only to the person named or by his order.
(3) A note containing promise to pay the bearer, but such notes
were declared invalid under the Paper Currency Act and
now under the Reserve Bank of India Act.
There is another special kind of promissory note viz:
Government Promissory notes - These are issued by the
Government (either Central or State), for loans raised by them,
and are made payable to order or a bearer bond payable to the
bearer. Though these notes are in the form of negotiable
instruments, their transfer by indorsement and the liability of
the transferor and the renewal, are now regulated by Public
Debts Act, 1944. A transfer of such promissory notes will not
be valid unless it conveys the full title to the security or if it is
of such a nature as to affect the manner in which the security is
to be held as expressed by the Government.
The definition u/sec.4 specifically excludes the following notes,
viz:
Bank notes - A bank note may be defined as any bill, draft or
note issued by a banker, promising to pay a certain sum to the
bearer on demand, and whic entitles the bearer or holder of the
instrument to the payment of the amount without further
indorsement. In its nature it is like cash and differs from bonds
and other securities which are only evidence of money being
due and are not money itself.
Currency notes - A currency note issued by the Government
incorporates an undertaking by the Government to pay the
bearer of the note on demand the specified sum. Though bank
notes and currency notes satisfy all the requirements of
promissory notes, they are themselves money and legal tender
for the amount represented by them, and hence excluded from
the purview of the Act. Bank notes differ from currency notes
in that they are not issued by the Government & sec.26 of the
Paper Currency Act, 1923, prohibits the issue of these notes in
the country, and only RBI has the right to issue bank notes and
131
also has the right to issue currency notes for a period fixed by
the Central Government. All provisions which apply to bank
notes would also apply to currency notes.
Drafting of promissory notes
As mentioned earlier a promissory note should incorporate :
(1) the amount to be paid ; (2) date and place of execution ; (3)
the person to whom the money is to be paid ; (4) the date/time
on which it is to be paid ; (5) by whom it is to be paid. Given
below are a few sample promissory notes which are usually
used in the commercial market.
(i) Promissory note for a loan
Rs.5000 Bangalore, March 24th, 1995
In consideration of the loan of Rs.5000 advanced by Mr.Avtar
Singh to me, I promise to repay the said loan of Rs.Five
Thousand with interest at 6 1/2 % annum to Mr. Avtar Singh or
order
Signed
Pratap Singh son of Biswas Singh
resident of 222, 72 cross, 4th main
Rajajinagar, 6th block
Bangalore.
(ii) Promissory note payable on a fixed date or in instalments
Bangalore, 24th March, 1995
Rs.
I, AB, etc., promise to pay to CD etc., or order the sum
of Rs.________________
(in words) on the ............. (or, ......... month after date) (or, in
twelve equal instalments of Rs. ........... each payable on the
first day of every month commencing from the first day of May,
1995)
(Signed) ..................
AB son of ..................
resident of ..................
(iii) Promissory note in the form of a letter
Bangalore
March 24th, 1995
Dear Shri Cd, etc.,
Whereas you have advanced to me today a loan of Rs .........., I
hereby promise to repay the same to you on demand with interest
at ........ percent per mensem.
Yours Sincerely,
Sd. ..............
Ab s/o ................, resident of ..............
(iv) Joint Promissory Note
Whereas we, AB, CD and EF etc., owe Rs .............. to XY, etc,
as detailed below :
1. ..............
2. ..............
We hereby promise to pay on demand (or ............ years after
date) the said sum of Rs. ...... (in words) to the said XY with
interest at ....... percent per annum.
Dated the 24th March, 1995
Place : Bangalore
Sd. AB ..........................
CD ..........................
EF ..........................
Parties to a promissory note
There are in general two parties to a promissory note - the maker
(i.e. the one who acknowledges this indebtedness and expressly
promises to pay) and the payee (ie the person to whom such
payment is to be made). Where a promissory note is made by 2
or more persons we may have 2 or more makers and if it is
made to 2 or more persons than we have joint payees. The
rights and liabilities which attach to such maker and payee will
be dealt with in a later chapter.
2.4 BILL OF EXCHANGE
A bill of exchange has been defined by sec.5 as, an instrument
in writing containing an unconditional order, signed by the
maker, directing a certain person to pay a certain sum of money
only to, or to the order of a certain person or to the bearer of the
instrument.
A promise or order to pay is not conditional within the
meaning of this section and section 4, by reason of the time for
payment of the amount or any instalment thereof being
expressed to be on the lapse of a certain period after the
occurence of a specified event which, according to the ordinary
expectation of mankind is certain to happen, although the time
of its happening may be uncertain.
The sum payable may be certain within the meaning of this
section and section 4, although it includes future interest or is
payable at any indicated rate of exchange, or is according to
the course of exchange, and although the instrument provides
that, on default of payment of an instalment, the balance unpaid
shall become due.
The person to whom it is clear that the direction is given or that
payment is to be made may be a certain person within the
meaning of this section and section 4, although he is misnamed
or designated by designation only.
The above definition is the result of a number of English
decisions on the topic. A brief of exchange (or BOE) is
sometimes called as a draft drawn by a bank on another or by
itself on one of its other branches.
The essential requirements of a BOE may be said to be as
follows:
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(1) Written: An oral BOE can neither be made nor if made
will it be valid. A BOE being a negotiable instrument should
be in writing and executed by the maker.
(2) Order to pay : A BOE must always contain an order to
pay. In whatever form the order be framed it should be
imperative. Thus in Ruff v. Webb [(1974) 5 RR 773], the
plaintiff a servant of the defendant, was dismissed from his
services by the latter. For the wages due to him the defendant
gave him a draft in the following words :
Mr. Nelson will much oblige Mr. Webb by paying to J.Ruff or
order, twenty guineas on his account. It was held that the
paper ... was a bill of exchange, that it was an order by one
person to another to pay money to the plaintiff or his order. It
is quite apparent that the language of the draft was very polite,
but it has been said that the introduction of the terms of
gratitude does not destroy the promise (or order) to pay.
But where no such order to pay can be ascertained from the
language it will not be a BOE. Thus, in Little v. Slackford
[(1882)31 RR 726], the defendant issued a paper to the plaintiff
containing the following words :
Mr. Little, Please to let the bearer have seven pounds, and to
place them to my account, and you will oblige. Yours humble
servant, R. Stackford. It was held that, ...... the paper does not
purport to be a demand draft made by a party having a right to
call on the other to pay. The fair meaning is you will oblige by
doing it.
(3) Unconditional : The order to pay on the BOE must be
unconditional i.e, the payment must be made under all
circumstances and it should not be dependant on any
contingency. The reason for this was explained in Carlos v.
Fancourt [(1794)5 TR 482] as, it would perplex the
commercial transactions of mankind and diminish and narrow
their credit and negotiability if paper securities of this kind were
issued out into the world, encumbered with conditions and
contingencies, and if the person to whom they were offered in
negotaition were obliged to inquire when these uncertain events
would be reduced to certainty. And hence the general rule is
that the bill of exchange ( or note) always implies a personal
general credit not limited to, or appreciable to particular
circumstances and events which cannot be known to the holder
in the general course of negotiation." Thus a BOE payable
only on contingency is void ab initio, but such contingency or
defect should be apparent on the face of it. In such cases, even
the happening of the contingency cannot make the BOE valid.
A BOE is not based on contingency merely because there is an
uncertainty regarding the person having the right to enforce it
under particular circumstances.
4) Payment of money : The BOE must incorporate an order
to pay and the payment should only be in the form of money i.e
payment in cash not in kind. The same condition also applies
to a promissory note. Further, the amount to be paid must be
certain i.e. you cannot have a BOE with words like pay any
amount or little amount or a certain amount etc. The exact
amount to be paid must be stated clearly. In Smith v
Nightingale [(1818)20 RR 694], a promissory note was made
in the following words : I promise to pay to JE ... the sum of
65 with lawful interest for the same, three months after the
date, and also all other sums which may be due to him. It was
held that "the instrument was too indefinite to be considered a
promissory note. It contained a promise to a pay interest for a
sum not specified and not otherwise ascertained than by
reference to the defendants books." It is to be noted that
wherever in an instrument the rate of interest is specifically
mentioned, the interest is to be calculated at that rate from the
due date to date of debt realisation. But where the interest rate
is not specified in the instrument it is to be calculated at the rate
of 18% according to sec.80 of the Act.
5) Time of payment: The BOE must indicate clearly the time
of payment. Thus in Williamson v. Rider [(1962)2 All ER
268 (CA)] a promise to pay on or before December 31, 1956
was held not to be a promissory note payable at a fixed or
determinable future time within the requirement of section 11
of the Bills of Exchange Act because the option to pay at an
earlier date creates an uncertainty or contingency in the time of
payment.
6) Parties : The names or identities of the parties to the BOE
must be certain. A BOE showing ambiguity regarding the
identity of the persons concerned will not be a valid BOE.
7) Stamp duty: A BOE should be affixed with stamps for
required amount as Specified under the Stamp Act, 1899. In
Bank of Bengal v. Radhakissen [3 M.I.A. 19] it was held that
an instrument which is bad as a bill, note or cheque by reason
of the inclusion thereon of a condition or any other stipulation
may be used as evidence of an agreement, if properly stamped.
Drafting of a BOE
The drafting of a BOE or for that matter a promissory note is a
simple matter as no specific format or use of words is prescribed.
The only point to be remembered is that all the essential
requirements should be included, i.e., in case of BOE it should
contain (i) sum to be paid in cahs; (ii) unconditional order to
pay ; (iii) maker or drawer should be certain and (iv) payee and
draweee should be certain. Given below are a few specimens
of BOEs.
(i) BOE payable on demand
Bangalore
March 25, 1995
Rs. ...............
Pay to X,Y, etc., or order (or, pay to XY, etc., or bearer) (or, pay
to my order) on demand (or, at sight) (or, on presentation) the
sum of Rs ........ (in words).
To
Cd, etc (drawee)
Sd. AB (drawer)
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(ii) BOE payable after date (with interest)
Bangalore
25th March, 1995
Rs. ...............
............. days (months) after date pay to XY, etc., or order (or,
pay to XY, etc., or bearer) (or, pay to my order) (or, pay to
bearer) the sum of Rs ........... (in words), with interest at .... per
cent per annum.
To CD, etc AB (drawer)
(drawee)
(iii) BOE where drawer & drawee is the same person
Bangalore
March 25, 1995
Pay self (or, to my order) the sum of Rs. ........(in words) only.
To
(Sd.) AB
(iv) Foreign Bill of Exchange
(Drawn on set of three parts)
First Part
No. .................... Exchange for
Bangalore, March 25, 1995
......... months after sight of this first of exchange (the second
and third of the same date remaining unpaid), pay to CD, etc.,
or to his order ..... pound sterling (in words) (and charge the
same to the account of XY against your letter of credit No.
........ dated ...........).
To
AB, etc. Sd. ............
(drawee) (drawer)
Second part
No. ................. Exchange for
angalore, March 25, 1995
............. months after sight of this second of exchange (the first
and third of the same date remaining unpaid), pay to CD, etc.,
or to his order ...... pounds sterling (in words) (and charge the
same to the account of XY against your letter of credit No. .....
dated .....)
To Ab etc. Sd. .........
(drawee) (drawer)
Third part
No. ................. Exchange for
Bangalore, March 25, 1995
....... months after sight of this third exchange (the first and
second of the same date remaining unpaid), pay to CD, etc., or
to his order ..... pounds sterling ( in words) (and charge the
same to the account of XY against your letter of credit No.
......... dated ..........)
To
AB, etc. Sd.
(drawee) (drawer)
Distinction of a BOE from a promissory note
Though both are negotiable instruments, there exists three basic
distinctions between the two viz :
(i) In a promissory note there are only two parties the maker
and the payee; whereas in a BOE there are three parties viz the
drawer, drawee and payee.
(ii) A promissory note acknowledges an indebtedness of the
maker to the payee; whereas no such acknowledgement of debt
is there in a BOE.
(iii) In a promissory note the maker or executant makes a
promise to repay the debt himsef; where as in a BOE the
executant directs a third party to pay.
Parties to a BOE
As mentioned earlier, there are three parties to a bill of exchange,
namely, the maker or executant of the bill, the drawer who
is ordered to pay and the payee to whom the money is to be
paid on order. The rights and liabilities attaching to each of
these parties will be discussed in detail in a later chapter.
2.5 CHEQUES
Section 6 of the Act defines cheque as a bill of exchange
drawn on a specified banker and not expressed to be payable
otherwise than on demand.
A cheque being a kind of BOE it must fulfill all the requirements
of a BOE. Thus in Bevins v. London & Smith Western Bank
Ltd [(1900)1 KB 270], a company issued a cheque on its
bankers with a receipt appended to it, and ordering the banker
to make the payment provided the receipt form at foot hereof
is duly signed, stamped, and dated. The cheque was held to
be invalid because its payment was made conditional upon
signature of the receipt.
A cheque is always drawn on a banker. The question now arises,
who is a banker ? This question was answered in R. Pillai v. S.
Ayyar [(1920)43 Mad 816]. Here, a District Board had its
funds in the Government Treasury and used to withdraw money
from that fund by issue of orders in form of cheques. One such
unconditional order being issued the question arose as to
whether it was a cheque. It was held that, Treasury is not a
bank. A banker is one who in the ordinary course of his business
honours cheques drawn upon him by persons from and for
whom he receives money on current accounts. Thus, the order
was held not to be a cheque u/sec.6 but a BOE u/sec.5 of the
Act.
Distinction between cheque and BOE
In Ram Charun Mullick v. Luchmee Chand Radakissen [14
ER 215] it was observed, a cheque is a peculiar sort of
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instrument, in many respects resembling a bill of exchange,
but in some entirely different. A cheque does not require
acceptance, in the ordinary course it is never accepted; it is not
intended for circulation, it is given for immediate payment; it is
not entitled to days of grace ..... Citing this passage in Bank
of Baroda v. Punjab National Bank [(1944) AC 177] Lord
Wright made a further contribution to the distinction between
cheques and BOEs and observed : In addition it is to be
noted, a cheque is presented for payment, whereas a bill in the
first instance is presented for acceptance unless it is a bill on
demand. A bill is dishonoured by non-acceptance, this is not
so in the case of a cheque. These essential differences (besides
others) are sufficient to explain why in practice cheques are not
accepted. Acceptance is not necessary to create liability to pay
as between the drawer and the drawee bank. The liability
depends on contractual relationship between the bank and the
drawer, its customer. Other things being equal, in particular if
the customer has sufficient funds or credit available with the
bank, the bank is bound either to pay a cheque or to dishonour
it at once ... It is different in case of an ordinary bill; the drawee
is under no liability on the instrument until he accepts; his
liability on the bill depends on the acceptance of it.
The distinction between a cheque and BOE can be briefly stated
as below :
a) A cheque is always drawn on a bank or banker ; whereas a
BOE is made to a drawer who is merely a definite or
identifiable person.
b) A cheque is payable immediately on demand without days
of grace; whereas a BOE may be payable on demand or a
future fixed date or at sight or at presentment etc.
c) A cheque requires no acceptance apart from prompt
payment; whereas a BOE in the first instance has to be
presented for acceptance.
d) There is no privity of contract between the banker and the
payee and so the later cannot sue the banker on his
dishonouring the cheque without sufficient cause; whereas
since a drawer of BOE accepts the liability to pay he can
be sued by the payee if he dishonours the BOE i.e. there is
a privity of contract between the drawer and payee.
e) A cheque is supposed to be drawn upon funds in the hands
of the banker belonging to the maker i.e. if there are no
funds the cheque cannot be honoured.
f) A cheque is not noted or protested for dishonour unlike a
BOE.
g) In case of crossed cheques a protection is given to the banker
which is unique only to cheques. This will be discussed
later.
Parties to a Cheque
Like in other BOEs a cheque also involves three parties namely;
the executant or maker of the cheque; the drawee who is always
the bank and the payee in whose favour the cheque is made.
2.6 HUNDIS
As observed earlier though the Act itself recognizes only three
kinds of negotiable instruments by name, it also accepts certain
instruments having wide-spread commercial usage. One such
instrument having a popular usage in India is the Hundi. The
word hundi is derived from the Sanskrit word hund meaning
to collect and explains clearly the purpose for which hundis
are use. Hundis have been in use in India long before the advent
of the Act, and a lot of usages attach to them - the usages
themselves differing from locality to locality. Thus for examples
in Murshidabad interest on hundis drawn payable so many days
after sight is allowed [Dhanput Singh v. Maharaja Jugut
Indur, 4 W.R. 85]; in Dacca the usage is for the gumastas (i.e.
munshis or clerks) to draw hundis on their principals without
thereby incurring liability for the defection of their principals
i.e. the gumastas themselves incur no liability [Muree Mohan
v. Krishna Mohun, 17 W.R. 442]; among the shroffs of
Bombay the usage was that a shroff to whom a hundi was sent
for collection by his customer gave him credit for the amount
and then he acquired all the rights of a holder in due course
[Sugan Chand v. Mulchand, 1 Bom 23]; in Punjab there is a
usage that where a hundi is dishonoured and returned,and a
conditional payment is made,the hundi is to be presented again
within four days or else the amount should be refunded
[Surajaml v. Kashiprasad, 1933 Mag 389]; etc,. The names
in the brackets indicate the cases where these customs have
been upheld by the courts as binding on the parties. A hundi
when paid and cancelled is called a Khokha.
Kinds of Hundis
The very fact that usages attaching to a hundi differ from place
to place proves that there are various kinds of hundis each having
its own specific characteristics, i.e. some may be payable on
sight; some after the elapse of a definite period; some are payable
only to a specific person; etc. We will now discuss these various
kinds of hundis in brief.
(i) Darshini hundi - This is a hundi which is payable on
darshan i.e. at sight or presentment. A specimen of darshini
hundi prevalent in Bombay is given below :
Rs. 5000
At Bombay Sheth ......... please accept salutation of the writer
sheth ........ from . ...... we have received here (Rs 5000) five
thousand only from Sheth ......... Please pay to the presenter at
sight and debit the same to our account. Please pay the double
of two thousand five hundred viz, five thousand only, per rules
of the Bombay Shroff Mahajan.
Date Signature
(ii) Mudati or Thavani hundis - These are hundis which
become payable at a certain period after date or sight. Specimen
of mudati or Thavani hundi is given below.
Muddati (or usance) Hundi (Bengal)
May Sri Durga protect us. Obedient servant Sj. Hari Charan
Dass begs with many salutations to inform you, that a hundi
for Rs.1,000 double of Rupees five hundred (Rupees one
thousand only) is issued upon you from this place. The amount
has been deposited hereby Sri. Amarnath Basu. The Muddat is
25 days and the grace is 3 days, i.e, in all 28 days. On the
135
receipt of this Hundi, you please accept it and pay the sum to a
person with credit on due date after the Muddat and take receipt
on the back of the Hundi. This is the prayer to your auspicious
feet. Thus ends this Hundi.
10th Ashar 1335 Monday,
Signature
Thavanai Hundi for goods sent (Madras)
Due 19
Rs ....... Place and date
At ........ days after sight please pay to ......... or order the sum of
Rupees ......... only for value received against R/R ........... To
Drawee (Address).
Signature
(iii) Shah Jogi hundi - This is a hundi payable only to a
respectable holder, i.e. a man of worth and substance known in
the bazar [Lall Mal v Kesho Das, 26 All 493]. There has been
a division of opinion on the question, whether a shah jogi hundi
is a negotiable instrument ? Some courts held that it is not a
negotiable instrument since the payee is an indeterminate person;
whereas some other courts held that the word shah is not
indeterminate and vague, and that it may be treated as payable
to the drawee or to several payees. In Daulatram v. Bulakidas
[(1861) 6 B.H.C.R.] the Bombay High Court held that at its
inception it was a hundi that passes from hand to hand by
delivery and requires no indorsement. The same Court in
Champaklal v. Keshrichand [50 Bom 765] held that, the hundi
may pass from hand to hand till it reaches a Shah who, after
making due enquiries to secure himelf presents it to the drawee
for acceptance or payment; then its negotiability ceases. The
drawee before paying has to satisfy himself that the person
demanding payment is a Shah, for the payment is made only on
the responsibility of that person [Ganeshdas v.
Lachminarayan, 18 Bomb 570]. A minor may be the holder
of a Shah Jogi hundi and a payment to him will certainly be
recognised [Ramprasad v. Shrinivas, 1925 Bom 527] Though
a Shah Jogi hundi does not technically fall within the definition
of a negotiable instrument under the Act, it is nevertheless a
negotiable instrument. The Act does not apply to it though
many of the provisions which apply to it are similar to that of
provisions applicable to those of instruments covered under
the Act, though that is because of the mercantile usage and not
by virtue of a Act. Given below is a specimen of a Shah Jogi
Hundi.
Shah Jogi Hundi (Bombay)
At Bombay Sheth ...... Please accept salutations of the writer
Sheth
.................... from ................ We have received Rs. 1,000 from
Sheth ............... Please pay the presenter on demand as per rules
of the Bombay Shroff Mahajan after assuring yourself that the
presenter is a Shah:
Date the 12th Dark day of Bhadrapad Samvat year 1911.
Date Signature
(iv) Jokhmi hundi - This is a hundi drawn against the goods
shipped on the vessel named in the hundi by the consignor on
the consignee of the goods. The drawer of the hundi is enabled
to get funds by negotiating the hundi and at the same time effect
an insurance upon the goods against loss. The buyer of the
hundi is the insurer who pays the insurance money down and is
entitled to recover the money if the vessel arrives safe in port.
If the ship is lost then he does not have a remedy against either
the drawer or drawee, and he has to bear the entire loss, while
the drawer & drawee themselves are protected. This kind of
transaction though similar to an ordinary insurance policy differs
from it in the sense that the position of insurer and insured is
reversed and the insured money is paid before hand. The term
Jokhmi itself means against risk or conditional. This custom
however imposes no liability on the drawee to take up the hundi,
even if he takes possession of the goods consigned to him. The
drawer also escapes liability if the goods against which the hundi
is drawn are totally lost [Jadowji Gopal v. Jetha Shamji, 4
Bom 333]. Given below is a specimen of a `Jokhmi hundi.
Jokhmi Hundi (Bombay)
Welfare. To worshipful ........... of Bombay written by Liladhar
Govindji of Nawanagar whose salutations please accept. To
wit. We have received here from Jadowji Gopalji Rs.4,000
(forty hundred only). In respect thereof this Jokhmi hundi (is
drawn) against goods on Board Ganga Hariprasad (Nakkawa
Boja, owner Mr. Dayalji Morarji being 29 bags of sheeps wool
shipped from Tuna, against which this Jokhmi hundi (is drawn)
after said vessel shall have arrived in a safe and sound manner.
After 8 days thereof, do you be good enough to pay to Shah
looking to his means, station and place.
Date : Signature
(Note . This is generally accompanied by a letter of advice).
(v) Nam Jog Hundi - In contradistintion to Shah Jogi Hundi,
there is what is known as the Nam Jog Hundi, that is a hundi
payabele to the party named in the bill or his order. The bill
may or may not be accompanied by a descriptive role of the
party in whose name it is granted. When there is a descriptive
role, it cannot be indorsed or transferred; but when there is no
such description, it can be indorsed. The alteration of a Nam
Jog into a Shah Jogi hundi is a material alteration and renders
the instrument void. Given below is a sample of such a hundi.
To Chunnilal at Madras worthy of alleulogy. Written from
Calcutta by Ramkumar from whom please accept salutations.
To wit. Please pay on receipt of this Hundi to Ramnath Goenka
according to custom of Hundi, the sum of Rs.1,000 (double of
half the sum of five hundred) for value received.
Date Signature
(vi) Dhani Jog Hundi - Dhani Jog hundi is one payable to
Dhani or owner, i.e., a person who purchases it. It is payable to
any owner, holder or bearer. It is a negotiable instrument payable
to bearer. The word dhani is not equivalent to `bearer in the
sense it is used in the Negotiable Instruments Act. A mere
bearer of a Dhani Jog hundi is not as such entitled to payment.
It is not a negotiable instrument within the meaning of this Act.
Given below is a sample of such a hundi.
136
Bow to Shri Ganesh
To Chunilal Murliprasad worshipped and worthy of alleulogy
at Madras blessed by the Goddess of Wealth ....... written from
Calcutta by Ramkumar from whom please accept salutations.
To wit. Pay at once on receipt of this Hundi to Dhani Jog
according to the custom of hundis.
Rs. 1,000 (in words) one thousand, double of half the sum five
hundred on behalf of Chunnilal Prasad of this place for value
received.
Date Signature
(vii) Jowabi Hundi - The transaction known by the name of
Jowabi hundi is as follows :- A person desirous of making a
remittance writes to the payee and delivers the letter to a banker
who either indorses it on to any of his correspondents near the
payees place of residence or negotiates its transfer. On its
arrival, the letter is forwarded to the payee who attends and
gives his receipt in the form of an answer to the letter which is
forwarded by the same channel to the drawer of the order. This,
it will be noticed, is more in the nature of a letter of
recommendation than a bill of exchange. The banker may cancel
the order of payment by advice to his correspondent at any
time before payment, in case the so-called drawer fails in his
promise to provide the banker with the amount of the order.
(viii) Zickri Chit - According to the usage of shroffs in the
case of Marwari hundis, a hundi may be accepted for honour
under what is called Zickri chit. This is a letter of protection
given to a holder by some prior party to the hundi to be used by
him in case the hundi is not accepted. It is generally addressed
to a person in the town where the bill is payable, asking him to
take up the hundi in case of dishonour. Such usage is even now
recognised by the Court, notwithstanding the fact that the
provision of sections 108 and 109 of the Act are not complied
with a specimen of Zickri (Tikry) Chit.(Ajmere)is produced
below.
To good place Dwarka. Letter written to brother Mohal Lal
from Hari Dayal who sends greetings. We had sold hundi for
Rs.65 (sixty-five) from Dwarka on Sanwal Das, by Radha
Krishan favouring Lodhi Pershad, dated 10th day of Bhadon,
Sambat 1911, payable to bona fide person, in the currency ofthe
market, to brother Baldeo Sahai Gopi Nath who informs us
that the hundi is unpaid. If this hundi has been paid, well and
good. If not, please pay this hundi as stated in this letter debiting
the amount to our account and return the hundi unendorsed to
us.
Letter written the 11th day of the latter half of Katak, Sambat
1911.
(Sd.) HARDAYAL (Verma, pp 58-60)
An important point to be remembered in relation to hundis and
other instruments in oriental languages is that if the existance
of a local custom or usage establishing such instrument cannot
be proved, then the provisions of the Act will apply to such
instruments.
2.7 INLAND AND FOREIGN INSTRUMENTS
Sec.11 of the Act which defines inland instrument states as
follows :
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.
For a negotiable instrument to be treated as an inland instrument
it should fulfill one of the following two requirements, viz
(i) it must be drawn and made payable in India; or
(ii) it must be drawn in India upon some person resident in
India, even though it is made payable in a foreign country.
An inland instrument does not lose its character merely
because it is either indorsed by a foreign national or in a
foreign country because it is in circulation in a foreign
country.
Sec.12 of the Act dealing with foreign instruments states as
under :
Any such instrument not so drawn, made or made payable
shall be deemed to be a foreign instrument.
A foreign bill may be any one of the following viz :
i) It is drawn outside India and is made payable in or drawn
upon any person resident in a country other than India;
ii) A bill drawn outside India and made payable in or drawn
upon any person resident in India;
iii) Bills drawn in India upon persons resident outside India
and made payable outside India.
Foreign bills are generally drawn in a set of three or in parts
numbered and containing a refrence to the other parts (see the
specimen foreign bill given on pg. 23). The reason for the this
is to reduce or remove the danger of loss, especially when such
bills are to be sent to foreign or overseas countries.
An important question which now arises is - what is meant by
'resident' in India? Although the term 'resident' has been defined
both in the Income Tax Act and the Civil Procedure Code, such
definitions would be extremely wide for application of these
sections. So for our purpose, resident would mean or suggest a
permanency of staying at a place (even if not domiciled) as
opposed to a temporary stay or a visit to the country. In case of
companies and firms 'residence' means 'place of business.'
Distinction between inland and foreign bills
The major difference between these two bills is that in case of
inland instruments 'protesting for dishonour' is optional, whereas
foreign bills must be protested if the law of the place where it is
drawn so requires. Secondly, the liabilities of a drawer of a
foreign BOE or maker of foreign promissory note are essentially
regulated by the law of the land where they are drawn and made;
and merely because such note or BOE is negotiable in its own
country will not automatically make it negotiable in another
country, i.e., such negotiability will be governed by the usages
of such other country.
137
2.8 INCHOATE INSTRUMENTS
Section 20 of the Act deals with inchoate or blank instruments
and states that, where one person signs and delivers to another
a paper stamped in accordance with the law relating to
negotiable instruments then in force in India, and either wholly
blank or having written thereon an incomplete negotiable
instrument, he thereby gives prima facie authority to the holder
thereof to make or complete, as the case may be, upon it a
negotiable instrument, for any amount specified therein and
not exceeding the amount covered by the stamp. The person
so signing shall be liable upon such instruments, in the capacity
in which he signed the same, to any holder in due course for
such amount : Provided that no person other than a holder in
due course shall recover from the person delivering the
instrument anything in excess of the amount intended by him
to be paid thereunder.
This section imposes a liability upon a person executing a blank
or incomplete negotiable instrument and hence shall be strictly
construed. The object and intent of this section was laid down
in Glenie v. Bruce Smith by Fletcher Molton, L.J., as The
logical order of operations with regard to a bill, is, no doubt,
that the bill should be first filled up, then that it should be signed
by the drawer, then that it should be accepted, then it should be
negotiated, and then that it should be indorsed by the person
who become successively holders; but it is common knowledge
that parties very often vary, in a most substantial manner. The
logical order of those proceedings, and section 20 of the Bills
of Exchange Act is intended to deal with those cases. Very
often in the commercial world, persons having mercantile credit
ie., good business repute, lend it to others by signing their names
on blank papers which is afterwards filled up as a BOE or
promissory note over their signatures making them drawers or
makers. In Montague v. Perkins [(1853)22 LJ (C.P) 187] it
was observed that, By such signatures, they intend to bind
themselves as drawers or makers, acceptors or indorsers, and
the presence of their names on the blank paper purports to be
an authority granted to the holder to fill up the blanks as a
complete negotiable instrument, and when so filled up, such
parties become as absolutely bound in the capacity in which
they signed, as if they had signed them after the bills were written
out, but till the blanks are so filled up the instrument is not a
valid one and no action is maintainable on it. The capacity in
which a party to a blank bill becomes bound (i.e. whether as
drawer or as indorser etc) depends on the mode and place of
signature. For example, if a person signs his name beneath the
word accepted or simply writes his name across the face of
the bill he becomes liable as an acceptor; but if he signs his
name across the back of the blank paper duly stamped and
delivered he becomes liable as indorser. But in no case will
such a person become liable, till he i.e. the person signing
delivers the paper to another.
A person in possession of such a blank bill has a prima facie
authority to fill up the instrument and in this manner he acts as
an agent of the person delivering the blank instrument. So if
the authority of the agent comes to an end before the instrument
is filled, sec.20 becomes inapplicable and no rights attach to
such an instrument except to a holder in due course.
Sec.20 does not give the time within which such an instrument
should be filled up. The corresponding sec.20 in Bills of
Exchange Act in England states that the instrument should be
filled up within a reasonable time, and what is a reasonable
time is a question of fact varying from case to case.
The authority to fill up the blanks is not limited to the person in
possession of the instrument but also extends to those claiming
under him. But this authority does not include the right to stitch
up several signed stamped papers together so as to make one
single instrument [Gokuldas v. Radhakisan, 54 I. C.3], nor
can a person insert a particular place of payment before the
acceptance [Calvent v. Baker, 150 E.R 1492], since this would
amount to material alteration of the instrument. Thus, whenever
a holder exceeds his authority he can derive no benefit from
that instrument. Under the proviso to the section the holder in
such a case is entitled to recover the sum which was intended
to be paid orginally. In Hatch v. Searles [(1854) 2 Sm. & G.
147] it was observed that, as to a bonafide holder, the question
as to the effect of the acceptance or indorsement having been
written on a blank piece of paper can be of no importance unless
he can be fastened with notice of that imperfection. If the holder
has notice of the imperfection, he can be in no better situation
than the person who took it in blank as to any right against the
acceptor or indorser who gave it in blank. Only bonafide
owners are protected under the section, and so if the holder of
the instrument has taken it for betting transactions and realised
the amount on it, the maker is entitled to recover the amount
[Paine v. Bevan, (1914)19 Com.Cas 234].
138
SUB TOPICS
3.1 Introduction
3.2 Parties to a promissory note
3.3 Parties to a BOE and cheque
3.4 Holder an Holder in due course
3.5 Indorser
3.6 Parties
3.1 INTRODUCTION
In the earlier chapter we have repetedly used the words maker,
drawer, drawee or indorser etc. We have also tried to briefly
define the terms, but have not gone into the rights and liabilities
which attach to these parties. We would now deal with these
matters in detail.
3.2 PARTIES TO A PROMISSORY NOTE
A promissory note involves only two parties, viz; the maker
and the payee.
Maker ; The person who executes or makes the promissory
note is called as the maker. It is of paramount importance
that the note should clearly indentify the person entering into
the contract. All persons whose names appear as makers are
primarily and unconditionally liable provided the note clearly
shows an unconditional promise to pay the debt or the amount.
Further the maker should put his signature across the bill.
Though the Act itself does not define the word sign, sec.3(56)
of the General Clauses Act, 1897 defines it as: sign with its
grammatical variations and cognate expressions, shall with
reference to a person who is unable to write his name, inlcude
mark with its grammatical variations and cognate expressions.
Signature may thus be briefly defined as the writing of his
name or putting his mark across a bill by a person in order to
authenticate and accept the contract specified in the bill.
Thus by signing the pro note the maker not only executes the
note but also accepts to be bound by its contents. Thus in Block
v. Bell [(1831)1 Mor. & Rob. 149], an instrument in the form
of a promissory note without any signature of the defendant,
but addressed to him in the margin and accepted by him was
allowed to be declared as a note on the ground that the signature
of the defendant though in the form of an acceptance, was an
adoption of the promise contained in the instrument.
When does the liability arise ?
A makers liability arises when :
a) he signs the promissory note and
b) unconditionally promises to pay
Extent of liability
A maker is liable to pay only that amount which accrues to him
as per the terms of the promissory note. His liability is not
dependant on presentment to any other party on payment or
otherwise unless such condition is expressed in the note itself.
Payee : The person in whose favour the promissory note is
made i.e. the person to whom the money is to be paid is known
as the payee. Just as the maker of the note has to be certain, so
also should the payee be. Thus in Obermeyer v. Barmann
[1911 T.P.D. 79] an instrument containing a promise to pay a
certain sum into the bank but not naming the payee, was held
out to be a promissory note. The payee may be either specified
by name or designation [if by the use of the designation an
identification can clearly be made] or the promissory note may
be made payable to a bearer i.e. the person is in possession of
the note lawfully and presents it for payment. If neither of
these conditions are satisfied then the note is not a promissory
note.
Under sec.4, a note may be made payable to alternative payees
i.e. pay to AB or CD. In such a case either AB or CD can
present the note for payment. This is a good way of limiting
your liability to pay to only the persons mentioned in the note
and to no other.
A note may be issued to more than one person making them
joint payees i.e., payable to A,B, C or their order or the majority
of them. Such a note may be sued upon by all of them. Where
the maker executes a note in favour of a fictitous person then
the note will be treated as payable to bearer and a person in
lawful possession can present it for payment. So also a
promissory note with a blank for the payees name may be filled
up by a bonafide holder in his favour and he can claim on the
note.
Rights of a payee
1. Where the note is a promise to pay, the payee can present
the note for payment. If the maker defaults on the payment
then the payee has the right to sue the maker on the note.
2. Where the note is in the form of payable to AB or order,
the payee can:
- present the note for payment.
- sue the maker in case of default
- indorse the note for negotiation an deliver it to the holder.
3.3 PARTIES TO A BOE OR CHEQUE
Both a bill of exchange and a cheque have three parties to them,
viz ; the drawer, the drawee and the payee.
Drawer : Drawer is the maker of the BOE i.e. he is the person
who orders a third person or promises to pay money to another.
He may make the bill payable on sight i.e. to the bearer of the
bill or on his order.
Liability of a drawer
Section 30 of the Act deals with the liability of the drawer and
states that, The drawer of a bill of exchange or cheque is bound
3 PARTIES TO A NEGOTIABLE INSTRUMENT
139
in case of dishonour by the drawee or acceptor thereof, to
compensate the holder, provided due notice of dishonour has
been given to, or received by, the drawer as hereinafter
provided.
Though the section itself is simply worded it has resulted in a
lot of confusion especially on the interpretation of the term
dishonour. This is because, a BOE may be dishonoured by
the non-acceptance (sec.91) or it may be dishonoured by non-
payment (sec.92). It is only in the later cases that sec.93
providing for notice to the drawer comes into play. So the
question arises which kind of dishonour has been contemplated
under this section. in Jagjivan v. Ranchoddas [AIR 1954 SC
554] the Supreme Cout laid down the law as, In a bill payable
after sight, there are two distinct stages firstly when it is
presented for acceptance and later when it is presented for
payment, section 61 deals with the later. As observed in Rama
Raviji Jambakar v. Pralhaddas Subkaran [ 20 Bom 133],
presentment for acceptance must always and in every case
precede presentment for payment. But when the bill is payable
on demand both the stages synchronise, and there is only one
presentment which is both for acceptance and for payment.
When the bill is paid, it is really dishonoured for non-acceptance:
The liability of the drawer can thus be studied under the
following situations, viz:
(i) Where the bill is payable on sight or demand
If such a bill is not paid by the drawee when it is presented
then, the drawer becomes immediately liable to pay the
full amount to the payee.
(ii) Where the bill is payable a certain period after sight or
date
If such a bill has not been accepted by the drawee, then the
drawer becomes liable to compensate the payee provided
he has presented the bill for acceptance within a reasonable
time as required u/sec.61 [Miller v. The National Bank
of India, 19 Cal.146]
(iii) Where the bill is payable on or after a fixed date
If the payee presents the bill for acceptance before such a fixed
date and the drawee refuses to accept it, it cannot be said that
the bill has been dishonoured u/sec 91. The position under
sec.55(1) of the English Bills of Exchange Act is somewhat
different in these situations. The section provides that, the
drawer of a bill by drawing it is said to contract, among other
things, that it shall be accepted by the drawee if presented for
acceptance and that if it be dishonoured by any refusal on the
part of the drawee, he will compensate the holder or the other
party compelled to pay it, on requisite proceedings on dishonour
being taken. In Ram Ravjis Jambakars case The Bombay
High Court observed as follows : the several sections in chapter
(sic)61 relating to presentment for payment appear to us to pre-
suppose that the bill has not been already dishonoured by non-
acceptance. When it is dishonoured by non-payment the
provisions of Chapter VIII come into play. It is true that there
is no such explicit declaration of the law upon the subject in the
Indian Act as in section 43, clause (2) of the English Act. But
the whole scope and tenor of chapter VIII of the Indian Act
appear to contemplate the same result as is there declared to
follow from non-acceptance.
The position in these cases appears to be as follows :
(a) Even if the drawee refuses to accept the bill because it was
presented before the due date, the payee can treat it as
dishonoured for non payment and claim compensation
from the drawee after giving due notice to him. The
advantage here is he gets the amount much earlier than
what he would have done ordinarily.
(b) The payee may elect to maintain the status quo, wait till
the due date, present the bill to the drawee for acceptance
and if the drawee again refuses to honour it, then, claim
compensation from the drawer after giving him a due notice.
But in such a case he does not get a fresh cause of action
on non-payment on the due date. The cause of action
remains the same ie dishonoured for non payment.
When does the liability arise ?
The liability of a drawer does not arise till he has been given a
notice of the dishonour by the drawee. The purpose of notice
is to make him aware of the facts. The liability of the drawer is
similar to that of a principal debtor under an implied contract
of indemnity. He does not undertake to fulfil the original
contract but only to compensate for the loss or breach, on
condition that the bill is dishonoured and he is informed of that
fact. Thus in Baijnath v. Ramkumar [AIR 1975 Cal 286]
where a hundi was stolen in transit and presented to the drawee,
who paid it without detecting the forgery of indorsement it was
held that the drawers liability had been discharged and he was
no longer liable. Giving of notice has been treated as so essential
that any laches in giving of it releases the drawer from his
liability, and is necessary in all cases except to those falling
under the exceptions given in sec.98 of the Act.
In general the holder is required to give the notice within a
reasonable time, but if he is unable to do so due to some reason
or fails to do so then, he may take advantage of any notice of
dishonour received by the drawer from any other party liable
on the instrument. That means that if the drawer receives notice
of dishonour from a stranger to the instrument, the drawee
cannot take advantage of that fact.
Liability of drawer of a cheque
The holder of a cheque has no remedy against the drawer, till
he has presented the cheque to the drawee and been refused
payment on it. A cheque is presumed to be paid out of the
funds deposited in the drawers account, so he should be
immediately informed of the dishonour of the cheque so that
he can make inquiries about the state of funds in his account
and secure his funds. Just as in case of other BOEs, a cheque
should be presented within a reasonable time (the maximum
time within which it can be encashed is 6 months from the date
of its making) and the drawer should be informed immediately
on its dishonour. The difference in liability of the drawer of a
140
BOEs and of a cheque is that, in the former case if the BOE is
not presented within a reasonable time or the drawer is not
informed of the dishonour of the bill he is discharged from his
liability but in case of cheques the drawer is not discharged
from his liability in such a case unless he can prove that he has
suffered damage due to non presentment or want of notice of
dishonour.
Contract to contrary
The drawers liability may be made subject to the terms of the
contract i.e. he can make stipulations in the contract negating
or limiting his own liability, for example, by use of words sans
recourse or without recourse to me; or if he is the executor
then by stipulating that payment would be out of the assets of
the deceased etc. Similarly he may also waive away the duties
which the holder owes him, as for example, the notice of
dishonour. But where there is no evidence of such contractual
limitations or stipulations, the drawer would be deemed liable
to the fullest extent under the Act, and the right of the holder
against the drawer will not be lost despite the loss of any
collateral security that may have been given to support the
contract.
Drawee : Drawee is the person who is ordered by the drawer
to pay a specified amount to a third person or on his order.
According to sec.33, only a drawee can be an acceptor of a
BOE except in case of need or acceptance for honour. What
does this term acceptor mean ? Every BOE has to be first
presented by the holder to the drawee who may agree to be
bound by the BOE. Once he accepts to be bound by the BOE,
you say that the bill has been honoured by acceptance. Next
comes the presenting of the bill for payment and the holder can
claim payment only from the person who has agreed to be bound
by it. But if the person to whom the bill has been presented for
acceptance, the holder can after giving notice to the drawer
claim compensation from him for dishonour of the bill. In case
of cheques, there is no presentment for acceptance, there is only
a presentment for payment, and if the drawee refuses payment
on the cheque - the holder can claim compensation from the
drawer for dishonour of cheque.
Liability of a drawee
Section 30 only makes the drawer liable in case of dishonour
and does not speak about the liability of the drawee. In a suit
for compensation filed by the holder against the drawer, the
drawee need not even be made a party to the suit. The drawees
liability can be studied under the following two situations viz :
a) When the drawee refuses to accept the bill
In such a case no liability attaches to the drawee since the drawee
becomes liable only when he accepts the BOE and not before.
The holder in such cases can only sue the drawer for
compensation.
b) When the drawee accepts to honour the bill, but later
refuses to pay when it is presented for payment
In such situations, the holder has an option to sue either the
drawer or the drawee or both of them for the bill amount, either
in the same suit or in separate suits [Basant v. Kolahal, 1 All
392], and the drawer himself is not absolved of his responsibility
merely because of a limitation bar against the acceptor
[Ramaswamy v. Sundararajam, 26 Mad 239] or because the
holder has obtained a decree against the drawee which has not
been satisfied. The primary liability on dishonour of a BOE
rests with the drawer and he cannot escape liability because the
holder has chosen to make the drawee liable. The period of
limitation for such suits is 3 years and the period begins to run
from the time of refusal to accept or refusal to pay.
Liability of drawee of a cheque
The drawee in case of a cheque is always the bank. Section 33
dealing with banks liability in case it dishonours a cheques
states as follows :
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.
Thus for a bankers liability to arise the following conditions
must be satisfied, viz :
i) The cheque must have been properly made.
ii) It must have been duly presented within a reasonable time.
iii) There must be sufficient funds in the drawers account to
cover the cheque amount.
iv) The banker must have refused to honour the cheque without
a reasonable or just cause.
If all these conditions are satisfied then the bank's liability is
two folds, viz :
a) The holder of the cheque can sue him either separately or
alongwith the drawer, for the cheque amount with interest,
and
b) The drawer is entitled to sue the bank for damages in lieu of
the damage or loss suffered by him. The quantum of
damages awarded in these cases is decided on the principle
that, lesser the amount or value of the dishonoured cheque
greater are the damages awarded; greater the value of the
cheque, lesser are the damages.
The reason for holding the banker liable is because of the
peculiar relationships which exists between banker and
customer, as was well explained by Lord Atkin in Joachimson
v. Swiss Bank Corporation [(1921)3 KB 110 (CA)]. He
observed as follows :
The bank undertakes to receive money and to collect bills for
its customers account. The proceeds so received are not to be
held in trust for the customer, but the bank borrows the proceeds
and undertakes to repay them. The promise to repay is to repay
at the branch of the bank where the account is kept and during
banking hours. It includes a promise to repay any part of the
amount due, against the written order of the customer addressed
to the bank at the branch and as such written order may be
outstanding in the ordinary course of business for two or three
141
days, it is a term of contract that the bank will not cease to do
business with the customer except upon reasonable notice. The
customer on his part undertakes to exercise reasonable care in
executing his written orders so as not to mislead the bank or
facilitate forgery. I think it is necessarily a term of contract that
the bank is not liable to pay the customer the full amount of his
balance at which the current account is kept.
Thus a banker is entitled to refuse a cheque only when, it is not
drawn up correctly or its legal validity is doubtful; or it is
irregular or undated or unsigned; or if it is required to be stamped
then in case the cheque is unstamped. But wherever the cheque
is properly drawn andpresented at the appropriate place during
appropriate timeing, the banker is honour bound to accept the
cheque for payment, else he becomes guilty of a breach of
contract between himself and the drawer.
Payee : He is the person in whose favour the BOE is in the first
instance made, i.e., he is the person to whom a certain amount
of money is to be paid by the drawee when so ordered by the
drawer. The bill may be made payable to the payee or on his
order, or it might be payable on sight. When the bill is payable
or his order then the payee may indorse the bil in favour of
another person and once he so indorses the bill he ceases to be
the payee. In case the bill is payable on sight the bearer of the
bill in lawful possession becomes the payee. As mentioned
earlier all the parties to the BOE must be clearly identifiable -
any vagueness or ambiguity in the description of the parties
and the bill becomes invalid.
Rights of a payee
(1) A payee has the right to receive money on the bill or cheque
either on presentment or at the fixed time (depending on
the wordings of the bill) provided that :
a) he presents the bill in the proper manner, and
b) within a reasonable time of making of the bill.
(2) He has a right to negotiate the bill further by indorsement,
unless the right is curtailed by specific stipulations made
by the drawer.
(3) He has the right to sue the drawer for compensation if the
bill has been dishonoured for non-acceptance.
(4) He has the right to sue the drawer or the drawee or both for
compensation if the drawee refuses to honour the bill by
payment, after having accepted to do so.
3.4 Holder and Holder in due Course
Section 8 defines the holder of a negotiable instrument as any
person entitled in his own name to the possession thereof and
to receive or recover the amount due thereon from the parties
thereto.
Where the note, bill or cheque is lost or destroyed, its holder is
the person so entitled at the time of such loss or destruction.
The first holder of an instrument is the payee of that instrument
and he is obviously entitled to be in possession of it. The payee
has two options, viz :
a) he can himself present it to the drawee or maker for
payment; or
b) he can transfer the instrument to a third person in satisfaction
of his own debt. Such a transfer can be done either by :
(i) simple delivery in case the instrument is payable to
the bearer ; or
(ii) by indorsement and delivery if the instrument is
payable to order.
When the payee so transfers the instrument he is said to have
negotiated and the person to whom the instrument is delivered
becomes the holder of it. As per sec.14, when an instrument is
transferred to any person so as to constitute that peson the holder
thereof, the instrument is said to be negotiated. Section 2 of
the English Bills of Exchange Act provides that, holder means
the payee or indorsee of a bill or note who is in possession of it
or the bearer thereof. The Indian definition given u/sec.8 is
similar to this definition except for the use of the phrase entitled
in his own name. This phrase originally assumed significance
because of benami transactions and its importance was
highlighted in the case of Sarjio Prasad v. Rampayari Debi
[AIR 1950 Pat 493]. Here, a sum of Rs. 2,459 was advanced
by the plaintiff under a hand note, which was not executed in
his name but in the name of one X who was the benaminder.
On maturity of the note, the plaintiff sued the defendant for
recovery of the amount. The Court rejecting his claim observed
that as he was not entitled to the possession of the note in his
own name he was not the holder. But in the present day context
the significance is somewhat lost because of Benami
Transactions Prohibition Act making benami transactions of
any kind illegal.
To summarise a holdee is a person who :
a) is the bearer of the note or bill ; or
b) is the indorsee under the note or bill.
A holder has the following rights :
i) To present the note or bill for payment
ii) To negotiate the bill by delivery or indorsement unless his
right to do so is restricted.
iii) To claim compensation from the drawer in case the bill or
note is dishonoured by non-acceptance.
iv) To sue either the drawer or the drawee or both in case the
bill is dishonoured by non-payment after the drawees
acceptance of it.
Holder in due course
According to sec.9, holder in due course means any person
who for consideration became the possessor of a promissory
note, bill of exchange or cheque if payable to bearer, or the
payee or indorsee thereof, if payable to order, before the amount
mentioned in it became payable and without having sufficient
cause to believe that any defect existed in the title of the person
from whom he derived his title.
Thus for a person to be considered as a holder in due course the
following conditions will have to be satisfied viz :
142
(i) Consideration
Every negotiable instrument consists of a contract between the
parties and should therefore be supported by real and valuable
consideration as defined under sec.2(d) of the Contract Act. A
person in possession of a bil or note without having given any
consideration for it cannot enforce it unless the lack of
consideration falls under the exceptions given under sec. 25 of
Contract Act. For easy negotiability of these instruments the
doctrine of consideration has been simplified in the following
manner, viz :
a) Consideration is always presumed to have been given unless
proved otherwise [Talbot v. Van Boris, (1911)1 KB 854].
b) It is immaterial in case of negotiable instruments to ascertain
as to where or from whom the consideration has moved -
what is essential is that there should be a consideration.
c) Past consideration is treated as good consideration [J.M.S.
Punto v. A.C. Rodrigues, AIR 1976 Goa 8]
d) Once the holder acquires the instrument for good
consideration the liable party will not be allowed to plead
any defect and want of consideration at any earlier stage.
(ii) Before Maturity
It is essential that the holder must have acquired the instrument
before its maturity date before he can be treated as holder in
due course. In Dawn v. Halling [(1825)KB 107 ER 1082] it
was held that, if a bill or a note or cheque be taken after it is
due the person taking it takes at his peril. He can have no better
title to it than the party from whom he takes it, and, therefore,
cannot recover upon it if it turns out that it has been previously
lost or stolen. Section 59 of our Act embodies this principle
in the following words, the holder of a negotiable instrument,
who has acquired it after dishonour, whether by non-acceptance
or non-payment, with notice thereof, or after maturity, has only,
as against the other parties, the right thereon of his transferor.
The question now arises, when does an instrument become
mature ? An instrument matures in the following situations,
viz :
(1) if it is payable on a fixed date or after a fixed time then at
the expiry of the time; and
(2) an instruments payable on demand does not mature as long
as a demand for payment against it is not made. Thus in
Brooks v. mitchell [(1841) 152 ER 7] a promissory note
made in 1824 was received by the defendant in 1838, who
acting in good faith gave value for the note. The plaintiff
sued him for recovery of the note and contended that a bill
or note payable on demand must not be kept locked up for
an unreasonable time. It was held that, a promissory note
payable on demand could not be treated as overdue as long
as payment was not demanded, because it is intended to
be a continuing security. Section 86(3) of the Bills of
Exchange Act provides that where a note payable on
demand is negotiated, it is not deemed to be overdue, for
the purpose of affecting the holder with defects of title of
what he had no notice by reason that it appears that a
reasonable time for presenting it for payment has elapsed
since its issue. But section 36(3) of the same Act also
provides that a BOE payable on demand is deemed to be
overdue. when it appears on the face of it to have been in
circulation for an unreasonable length of time. What is an
unreasonable length of time is a question of fact i.e. it would
vary from case to case.
(iii) Complete and Regular
For a negotiable instrument to be valid it should be complete
and regular in all respects, i.e. it should not contain any patent
(easily visible or indentifiable) defects. An instrument may be
incomplete because the drawers name is not there or it is not
dated and stamped etc. Similarly an improper indorsement can
render the whole instrument irregular [Arab Bank Ltd v. Ross,
(1952)2 QB 216], but a mere spelling mistake in the indorsee's
name will note affect the indorsee and the bill remains valid
[Leonard v. Wilson, [1834]39 RR 855].
(iv) Good faith
Last but not least is the requirement that the holder should have
acted in good faith. The court is required to apply both the
subjective and objective test to ascertain whether the holder
had acted in good faith, i.e. the court has to find out, (i) whether
he had acted honestly ? (subjective test) and (ii) whether he
had acted as a reasonable and careful or prudent man would
have acted in a similar situation ? (objective test)
Rights and privileges of a holder in due course
1. Presumptions (sec 118) Every holder is deemed prima
facie to be a holder in due course, i.e. the burden of proving
his title does not lie on him, and it is the other party who has to
show that the holder has no title to the instrument, or that there
is defect in his title. It is only when he establishes the defect
that burden of proof shifts to the holder who then has to show
he had acquired the bill or note bonafide and in good faith.
2. Privilege against inchoate stamped instruments (sec.20):
In Glenie v. Bruce Smith [(1908)1 KB 263] it was observed
that, the logical order of operations with regard to a bill is, no
doubt, that the bill should be first filled up, then it should be
signed by the drawer, then it should be accepted, then it should
be negotiated, and then it should be indorsed by the persons
who become successively holders; but it is common knowledge
that parties very often vary, in a most substantial manner, the
logical orde of those proceedings, and section 20 is intended to
deal with those cases. For the section to come into operation,
the defendant must have signed the blank instrument and must
have voluntarily parted with it with the intention that it should
be filled up and issued as such.
3. Fictitous drawer or payee [sec 42] : The acceptor of a
BOE cannot allege as against the holder in due course that the
parties to the bill were fictitous, i.e. persons who were either
not in existence or if they did exist they were never intended by
the drawer to have the payment. But where the drawer intends
the payee to have payment then he is not a fictitous payee and
the forgery of his signature will affect the validity of the cheque.
143
Thus in North & South Wales Bank v. Macbeth [1908)AC
137], W induced M by fraud to draw a cheque payable to K or
order. W obtained the cheque, forged Ks indorsement and
collected proceeds of the cheque through his bankers. The
collecting banker was held liable as Ks title was derived through
forged indorsement. K was not a fictitous payee because the
drawer intended him to receive the payment. The result would
have been different if the payee was not a real person or was
not intended to have the payment [Chitton v. Attenborough,
(1897)AC 90].
4. Prior defects (sec.58): The person who is liable to pay on
an instrument, can contend that he had lost the instrument or
that it was obtained from him by means of an offence.
5. Indorsee from a holder in due course (sec 53): A holder
who receives an instrument from a holder in due course gets
the rights of the holder in due course, even if he had knowledge
of the prior defects, provided he himself was not a party to
them.
3.5 INDORSER
As mentioned earlier any negotiable instrument can be
negotiated further by the holder in favour of a third person by
the simple method of signing the instrument in favour of a third
person and delivering the instrument to him. This process of
negotiation is known as indorsement and the person who
transfers his right to another is known as the indorser. Section
35 dealing with the liability of an indorser states that, In the
absence of a contract to the contrary, whoever indorsers and
delivers a negotiable instrument before maturity, without, in
such indorsement, expressly excluding or making conditional
his own liability, is bound thereby to every subsequent holder,
in case of dishonour by the drawee, acceptor or maker, to
compensate such holder for any loss or damage caused to him
by such dishonour, provided due notice of dishonour has been
given to, or received by, such indorser as hereinafter provide
person who transfers his right to another is known as the
indorser. Section 35 dealing with the liability of an indorser
states that, "In the absence of a contract to the contrary, whoever
indorsers and delivers a negotiable instrument before maturity,
without, in such indorsement, expressly excluding or making
conditional his own liability, is bound thereby to every
subsequent holder, in case of dishonour by the drawee, acceptor
or maker, to compensate such holder for any loss or damage
caused to him by such dishonour, provided due notice of
dishonour has been given to, or received by, such indorser as
hereinafter provided."
Every indorser after dishonour is liable as upon an instrument
payable on demand.
This liability of an indorser cannot arise unless the indorser
delivers the indorsed instrument to the indorsee, because no
contract on the negotiable instrument is complete without such
a delivery.
Indorser is estopped from denying to a holder in due course the
genuineness and regularity in all respects of the drawers
signature and all previous indorsements (sec.122). Further he
cannot deny that at the time of his indorsement it was a valid
and subsisting bill and that he had then a good title and right to
indorse. According to sec.88, an indorser is bound by his
indorsement notwithstanding any previous alteration of the
instrument.
Extent of liability
An indorsers liability does not come into existence till he has
been given a due notice of the dishonour of the instrument by
the indorsee. If the indorsee fails to give him a notice, then the
indorser should have received a notice from some other person
liable on the instrument.
The indorser is liable to not only pay the amount on the bill but
also to compensate the holder in case the instrument has been
dishonoured. The quantum of compensation will be determined
as per the rules laid down in sec.117.
Section 35 does not deal with the nature or extent of an indorsers
liability on a note payable on demand. In Hemadri v. Seshama
[AIR 1931 Mad.113] it was however held that, the holder of a
promissory note payable on demand indorsed after dishonour
is not entitled to a decree against the indorser (the payee) without
giving him a proper notice of dishonour.
Neither the section nor the Act provides for a situation where
the indorser indorses an instrument after maturity, and the
instruments not dishonoured. This situation usually arises
where the indorser has committed laches in presenting for
payment indorsing the instrument before the due date and
indorses it only after maturity. The English and American law
on this point is very clear and states that, such an indorser is
liable as if he had indorsed an instrument payable on demand,
and his liability is conditional on a presentment for payment
and notice of dishonour in the event of non-payment within a
reasonable time.' It is to be presumed that the same law would
apply in India also.
Just as in the case of drawer, the indorser can also limit his
liability by having a contract to the contrary. He may either
exclude his liability, or limit his liability or make his liability
conditional, or he may in exceptional cases even enlarge his
liability.
Liability of prior indorsers
According to sec.36, every prior party to a negotiable
instrument is liable thereon to a holder in due course until the
instrument is duly satisfied.
The general rule is that as between indorsers their liability is
in the order in which their names appear on the instrument.
But this rule may be rebutted by adducing evidence to show
the real intention of parties. Therefore, a prior indorser may
recover from a later one if he can prove that there was an
agreement to that effect between them. Similarly, if a second
indorser mistakenly puts his name above the name of the first
indorser, then he can recover the amount from the first indorser
if he is required to pay on the bill. This liability of the prior
indorser to the subsequent one continues till the instrument is
duly satisfied, i.e. each party pays the subsequent one.
144
3.6 PARTIES
Uptil now we have been talking of the parties to specific kinds
of negotiable instruments, but havent made any mention as to
who actually can be a party to the instrument.
According to sec.26, every person capable of entering into a
contract can become a party to the negotiable instrument. He
may bind himself and be bound by the making, drawing,
acceptance, indorsement, delivery and negotiation of a
promissory note, bill of exchange or cheque.
Minor - According to sec.11 of the Contract Act, every person
is competant to contract who is of the age of majority according
to the law to which he is subject, and who is of sound mind,
and is not disqualified from contracting by any law to which he
is subject.
Obviously therefore a minor or a lunatic cannot be a party to a
negotiable instrument so as to be liable on it. But a negotiable
instrument does not become void merely because a minor is a
party to it. According to sec.26, a minor may draw, indorse,
deliver and negotiate (an) instrument so as to bind all parties
except himself, i.e. the minor's rights under the instrument are
not affected. The law is same for insane persons.
Corporation - The capacity of a corporation to enter into a
contract vide a negotiable instrument, would depend on its
memorandum and articles.
Agent - According to sec.27, a general authority to transact
business or to receive payment or discharge debts on behalf of
the principal, does not give the agent an automatic right to accept
or indorse bills of exchange so as to bind his principal. Further,
an authority to draw BOE does not include the power to indorse
them. Thus, an agent can bind his principal only in the manner
and to the extent he has been authorised. The agent should
furthermore make it clear that he is acting in a representative
character, else he becomes personally liable unless he can show
that the parties induced him to sign in his own name by telling
him that only the principal would be liable.
Partner - A partnership firm can be held liable on a negotiable
instrument drawn by a partneronly when the partner signs the
bill in his capacity as a partner and the name of the firm appears
on the face of the bill. If a bill is not made or drawn in the name
of the firm the other partners can not be make liable on it.
[Rangaraju v. Devichand, AIR 1945 Mad 439]. The signature
of the firm is deemed to be the signature of all its partners be
they working or dormant, based on the principle that every
partner of a firm is entrusted with a general authority to do all
acts beneficial for the firm. Thus in Lona (KA) v. Dada Haji
Ibrahim Hilari & Co. [AIR 1981 Ker. 86], a promissory note
was executed by one of the two partners of the firm using the
words "the promise to pay". The note had been executed on the
letterhead containing the full name and description of the firm.
It was held that both the firm and the second partner were liable
on the pro-note.
Legal representative - According to sec.30, a legal
representative of a deceased person, who signs an instrument
in his own name, becomes personally liable on it, unless he
specifically limits or excludes his liability for examples by use
ofthe words the amount to be paid only from the estate of the
deceased etc.
145
SUB TOPICS
4.1 Introduction
4.2 Ambigous instruments
4.3 Rules relating to maturity
4.4 Rules relating to negotiation
4.5 Rules relating to accomodation bill
4.6 Rules relating to interest payment
4.1 INTRODUCTION
In the previous chapters we have dealt with various kinds of
negotiable instruments; the parties to these instruments, their
rights and liabilities; and to a certain extent the rules relating to
ambigous instruments, indorsement etc. In this chapter we will
try to deal in detail with these general rules applicable to all
kinds of negotiable instruments.
4.2 AMBIGOUS INSTRUMENTS
The ambiguity of an instrument may arise in diffeent ways or
may be of different kinds. Thus we may have ambiguity as to
nature of instrument; as to the parties in the instrument; as to
the amount etc. The term ambiguity itself means lack of clarity
or something of which the meaning is not clear.
Sec.17 states that, where an instrument may be construed either
as a promissory note or bill of exchange, the holder may at his
election treat it as either, and the instrument shall be henceforth
treated accordingly.
Thus where on the face of it the nature of instrument is not
clear, the holder has been given a right to treat it either as a note
or a BOE according to his desire. But he may not treat such an
instrument either as a cheque or as a non negotiable instrument.
So also, merely because on the face of the instrument it is written
that it is a BOE, it need not necessarily be one. For example, in
Harsukdas v. Dhirendra Math [(1941)2 Cal.107], an
instrument on which the word hundi was written was in the
following form :
Sixty days after date we promise to pay AB or order the sum
of Rs.1000 only for value received.
Across the document was written Accepted signed by the
maker XY. It was held that the document was not a BOE but
was a promissory note.
Once the holder makes an election [i.e. to treat it as a promissory
note or a BOE] he cannot retract and must abide .by his decision.
Ambigous instrument vis a vis inchoate instrument
(i) In case of ambigous instrument, the holder having made
an election can institute a suit on it, and he is not prevented
from filing a suit thereby because the instrument is
ambigous.
In case of inchoate instruments, the holder merely gets an
authority to fill in the blanks in the instrument, but till the
instrument is filled he cannot sue on it.
(ii) The court gives ambigous instrument favourable
construction so as to make them valid and construes them
as a bill or a note.
An instrument in the form of a bill having neither the name of
the payee nor that of the drawer is an inchoate instrument, even
if it is addressed to a person and has been accepted by him.
Such instruments cannot be treated as ambigous instruments.
Where amount is stated differently in figures and words
According to sec.18, if the amount undertaken or ordered to
be paid is stated differently in figures and in words, the amount
stated in words shall be the amount undertaken or ordered to be
paid.
Ills ; A bill is drawn for five hundred rupees. In the margin is
superscribed Rs.550. The bill is for Rs.500 only. But if there is
ambiguity in the words in the body itself then help can be taken
from the figures in the margin. [Hutley v. Marshall (1873)46
L.T. 186]. Similarly if there is an ommission in the body of the
instrument which is apparent on the face of it, help may be
taken from the figures in the margin. Thus in R.V. Elliot [(1777),
I Leach CC 175] a bill had the words pay fifty and marginal
figures stated 50, The bill was held to be valid for fifty pounds.
4.3 RULES RELATING TO MATURITY
Maturity of an instrument means the day or time at which the
instrument becomes payable. Some instruments are payable
whenever they are presented, some others becme payable only
after the efflux of a fixed period or only on a fixed day. Sections
22-25 deal with the rules determining the time when the
instrument falls due.
But before dealing with these rules, we should clearly
understand the difference between the following words, viz :
At sight, on presentment and on demand - Broadly
speaking àt sight and òn presentment mean òn demand,
but there are technical differences between these phrases.
Instruments payable òn demand may not necessarily be
presented for payment, but instruments payable àt sight or
òn presentment have to be presented before payment can be
demanded on them. Further, though àt sight does mean òn
demand, the period of limitation for bills payable àt sight is
different from bills payable òn demand. In case of former it
is 3 years from the date of presenting the bill, whereas in case
of later it is 3 years from the date of the bill or note [Arts 32, 35
of Limitation Act, 1963].
After sight, after date - The phrase àfter sight on a bill
or note should alway be accompanied by the period after which
the bill or note would become payable, as for example, ` 6
months after sight etc. An instrument may be expressed as
being payable àfter sight or àfter date or òn occurence of a
specified event. In case of the last, the event should be one
which is certain of happening though the exact date or time of
its happening cannot be predicted, as for example, `payable on
the death of Mr.A etc.
4 RULES RELATING TO NEGOTIABLE INSTRUMENTS
146
After sight in a promissory note means that payment cannot
be demanded till the bill has been exhibited to the maker;
whereas in case of a BOE after sight means that the sight
must appear in a legal way, i.e, after acceptance if the bill has
been accepted or after noting for non-acceptance or protest for
non-acceptance [Homes v. Kerrison, (1810), 2 Taunt, 323].
Let us now deal with the rules relating to maturity. According
to sec.22, the maturity of a promissory note or bill of exchange
is the date at which it falls due.
Days of grace - Every promissory note or BOE which is not
expressed to be payable on demand, at sight or on presentment
is at maturity on the third day after the day on which it is
expressed to be payable.
Days of grace as the name itself implies is the additional period
or time given to the acceptor of a bill to come up with the
payment. Though it originally started as a gratuitous right, it
slowly became a custom so much so that it came to be treated
as a legal right. Such grace period is allowable on all those
bills or notes which are made payable on a specified day or
after a fixed period or on occurence of some specified event
[Brown v. Marraden (1791)4 T.R. 148]. In Oridge v.
Sherborne [(1843),11 M & Co. 374] it was held that in case of
instruments payable in instalments, it must be presented for
payment on the third day after the day fixed for each instalment,
the days of grace being available for each instalment. The
custom of allowing days of grace has become so imbedded in
the law relating to negotiable instruments that an instrument is
not deemed to have been dishonoured for non-payment before
the expiry of the last date of grace [Kennedy v. Thomas,
(1894)2 Q.B. 759]. Parteies to the instrument may however
limit or exclude the days of grace by express stipulation to that
effect, for example, by saying without grace [Valliappa v.
Subramaniam, 26 M.L.J. 494]. Though days of grace are
statutorily allowed in India, they have been abolished in England
for some time now.
Maturity of bills and notes payable after sight - Section 24
of the Act states that , "In calculating the date at which a
promissory note or bill of exchange, made payable a stated
number of months after date or after sight, or after a certain
event, is at maturity, the period stated shall be held to terminate
on the day of the month which corresponds with the day on
which the instrument is dated, or presented for acceptance or
sight, or noted for non-acceptance, or protested for non-
acceptance, or the event happens, or, where the instrument is a
bill of exchange made payable a stated number of months after
sight and has been accepted for honour, with the day on which
it was so accepted. If the month in which the period would
terminate has no corresponding day, the period shall be held to
terminate on the last day of such month. [Parthasarathy pp. 74-
75].
Ills :- A negotiable instrument dated 29th January 1995 is made
payable one month after date. The instrument is at maturity on
the third day after the 28th February 1995 [ie including days of
grace].
This section incorporates the English law as it was before
amendment by the Bills of Exchange Act, s.65(5) which now
provides that, for calculating maturity from the date of noting
for non-acceptance, and not from the date of acceptance of
honour. According to Chalmers Bills of Exchange, This sub-
section brings the law into line with mercantile understanding,
and gets rid of an inconvenient ruling that maturity was to be
calculated from date of acceptance for honour.
It is thus evident that the Indian law still retains the old English
rule. In case of bills which have not been accepted for honour,
the period of payment terminates on that day of the month which
corresponds with the day of the instrument or the day on which
it has been presented for acceptance or noted for non-acceptance.
The last sentence of sec.24 in effect means that the term month
referes to calendar month rathen the lunar month.
Section 25 of the Act is similar to sec.24 and deals with maturity
of bills or notes payable so many days after date or sight. The
section states that, In calculating the date at which a promissory
note or bill of exchange made payable a certain number of days
after date or after sight or after a certain event is at maturity, the
day of the date, or presentment for acceptance or signt, or of
protest for non-acceptance, or on which the event, happens,
shall be excluded."
If the day of maturity of a note or bill is a public holiday, the
next working day succeeding such public holiday shall be deemd
to be the maturity day of the instrument (sec.25). The
explanation to the section adds that public holidays includes
sunday and other days declared by the Central Government
in the Official Gazzette to be a public holiday.
If a negotiable instrument is paid by the acceptor at or maturity,
the bill is discharged, and no action can then be brought upon
it. But if the payment is made before maturity, the maker or
acceptor can re-issue it, since payment before maturity operates
as a purchase of the instrument. The instrument, under such
circumstances, is not discharged, and the acceptor will be liable
to pay again on the instrument in the hands of a bona fide
transferee for value [Burbridge v. Manners, (1812),3 Camp.
193]. Where a payment is made by the maker or acceptor before
maturity, he must get possession of the instrument, in which
case he can re-issue the instrument so as to make himself and
all subsequent parties liable [Morley v. Culverwell (1840), 7
M. & W.174; Attenborough v. Mackenzie (1856), 25 L.J. Ex.
244]. The re-issue may take place any number of times before
the maturity of the instrument. But the above observation as to
premature payment can only apply to instruments which are
payable on demand, since they cannot be prematurely paid being
due the moment they are presented [Parthasarthy, p. 180].
4.4 RULES RELATING TO NEGOTIATION
Sections 46-60 of the Act deal with negotiation.
Delivery (sec-46):
For the negotiable instrument to be legally binding on the parties
to it, it has to be delivered by the maker and accepted by the
147
other party [be it the acceptor, payee, holder or indorsee]. Till
such delivery is effected the instrument is revocable. As
observed by Bovill, C.J. in Abrey v. Crux [(1869)L.R 5 C.P.
42], To constitute a contract there must be a delivery over of
the instrument by the drawer or the indorser for a good
consideration, and as soon as these circumstances take place,
the contract is complete, and it becomes a contract in writing."
The property in the instrument does not pass to the transferee
merely by signing or indorsing the instrument because mere
signature does not constitute a contract. Under sec.46 of the
Act, a cheque is made or completed as soon as it is delivered
either to the payee or to his agent. In Damji Hirji v.
Mohammedali [41 Bom. L.R. 959] it was observed, A person
may sign a promissory note or negotiable instrument in his own
house and keep it there without incurring any obligation to
anyone at all. When such a document is tendered to the payee
and accepted by him there arises a contract between the parties.
The signature on a negotiable instrument becomes necessary
because of the provisions of S.4 of the Negotiable Instrument
Act. It is only a preparation. It does not amount to an offer,
and therefore, does not become any part of the contract.
The delivery of an instrument may be in any one of the following
ways, viz :
Actual delivery - This consists of delivering the instrument
physically or personally by the maker to the payee or to his
agent. There must be an actual change in possession to constitute
actual delivery.
Constructive delivery - Here there is no change in the actual
possession, but the delivery takes place when the maker of the
bill continues to hold possession of the bill as an agent or on
behalf of the payee or the bill is in the possession of the payee's
or indorsee's agent, clerk or servant, who had the bill on behalf
of such payee/indorsee.
Ills :- (i) A holds a bill on his account. He subsequently indorses
it in favour of B and holds the bill as Bs agent.
(ii) A holds a bill as Bs agent. B indorses it in favour of A. A
continues to hold the bill but now on his own account.
Conditional delivery - Wherever an instrument is delivered
conditionally or for a special purpose, oral evidence can be
adduced by the parties to show that the delivery was made and
not for transferring the property in the bill (sec.46). Thus, oral
evidence cannot be used for varying the terms of the contract
but only to show that the writing does not really represent the
contract. In Rajroopram v. Buddoo [1 Hyd. 155] it was
observed that, Delivery of an instrument for a specified
purpose, and on condition that it shall be returned if not applied
for that purpose, constitutes the holder a mere bailee, trustee,
or agent with a limited title and power of negotiating it. Any
subsequent holder with notice of the specific purpose or
condition must apply the instrument accordingly" [emphasis
supplied]. That means, that in case the purpose is not satisfied
or the condition is not fulfilled the true owner of the instrument
is entitled to get it back from the person to whom it was delivered
or anyone else who has taken the bill from such a person and is
aware of the purpose or condition to which the bill is subject.
But a holder in due course who acquires the bill bonafidely
without notice acquires a good title to it and the true owner
cannot compel such holder in due course to return the
instrument.
Negotiation by delivery (sec.47)
According to sec.47, in case of a negotiable instrument which
is payable to bearer, mere delivery of the instrument is sufficient
to transfer the property in the instrument to the person to whom
it is delivered. An indorsement is not necessary for negotiation
of such instruments. A transferor in such cases exonerates
himself from the liability of an endorser of the instrument and
the entire transaction is more in the nature of sale of the
instrument. The transferee therefore gets no right of recovery
against the transferor if per chance the instrument was later
dishonoured, nor can he get back the amount paid by him to the
transferor for failure of consideration. As Lord Kenyon
observed in Fydell v. Clark [(1796)1 Esp. 447], it is extremely
clear that if the holder of a bill sent it to market without indorsing
his name upon it, neither morality nor the law of this country
will compel him to refund the money for which he sold it, if he
did not know at the time he sold it that it was not a good bill.
The important point to note here is that the transferor must
himself be unaware that the bill is bad, because as observed by
Lord Kenyon again in Read v. Hutchinson [(1813)3
Comp.352] if he knew the bill to be bad, it would be like
sending a counterfeit coin for circulation to impose upon the
world instead of the current coin
The exception to the section provides that, in case a negotiable
instrument payable to bearer is delivered on condition that it
will not take effect unless a certain condition is fulfilled, then
negotiation of the instrument does not take effect till such
condition is fullfilled, and no one else who acquires the
instrument with full knowledge of the restrictive condition gets
a good title to it nor can he sue on it. But once again the
exception is not applicable to a bona fide purchaser for good
value.
Negotiable by indorsement (sec 48)
In case of instruments payable to order, negotiation can be done
only by indorsement and subsequent delivery of the instrument.
If the holder of such an instrument merely delivers it without
indorsing it, the transfee only acquires the rights of an assignee
and does not get any of the advantages of negotiability, since
such delivery merely amounts to assignment and not negotiation.
Similarly, if there are more than one payees to a note, an
endorsement and delivery by only one of them, does not amount
to a valid endorsement and does not amount to an effective
negotiation. The other payees can at any time make a fresh and
valid endorsement and negotiation of the same note [Voruganti
v. Venkata, AIR 1953 Mad 840].
Indorsement in blank and its conversion into full
indorsement [Ss.54 and 49]
Even if an instrument has been originally made as being payable
to order, it may be indorsed in blank and delivered to a person.
148
Such blank indorsement and delivery converts the instrument
into one which is payable to bearer and it can then be further
transferred by mere delivery as if it was always made payable
to bearer [Peacock v. Rhodes, (1781)2 Doug. 633].
If the holder of such an instrument (i.e. one with a blank
indorsement) wants to convert it into a fully indorsed instrument,
all he has to do is to write above the indorsers signature a
direction to pay the instrument to another person or his order.
The advantage of following this course of action is that though
the holder transfers the instrument to another he does not incur
the responsibility of an indorser[Hirschfeld v Smith, (1866),
L.R. 1 C.P. 340].
Ills: A is the holder of a bill indorsed by B in blank. A writes
over Bs signature the words pay to C or order and delivers
the instrument to C. A is not liable as an indorser, but the writing
operates as an indorsement in full from B to C [Vincent v.
Horlock, (1808)1 camp.442]
If a negotiable instrument, after having been indorsed in blank,
is indorsed in full, the amount of it cannot be claimed from the
indorser in full, except by the person to whom it has been
indorsed in full, or by one who derives title through such person
[sec.55].
Ills: A is the payee holder of a bill. A indorses it in blank and
delivers it to B, who indorses it in full to C or order. C without
indorsement transfers the bill to D. D as the bearer is entitled
to receive payment or to sue the drawer, acceptor or A who
indorsed the bill in blank, but he cannot sue B or C.
Indorsement as already mentioned earlier should be for the
entire amount on the bill. If an indorsement is made for only
part amount of the bill it would not be valid, unless part of the
amount on the bill has already been paid, in which case partial
indorsement will be valid provided a note to the effect that
remaining amount on the bill has already been paid is added to
the indorsement [sec 56].
Effect of indorsement (sec 50)
The indorsement of a negotiable instrument followed by
delivery transfers to the indorsee the property therein with the
right of further negotiation; but the indorsement may, by express
words, restrict or exclude such right, or may merely constitute
the indorsee an agent to indorse the instrument, or to receive its
contents for the indorser or for some other specified person.
[Parthasarthy pp. 135-136].
This secion must be read with sections 46 and 52 in order to be
fully comprehended. The effect of an indorsement can be briefly
said to be as follows
(i) It transfers the property in the instrument to the indorsee.
(ii) It gives the indorsee the right to sue all those parties whose
names appear on the instrument.
(iii) It gives him the right of further negotiation.
An indorser need not give to the indorsee all of the above rights,
he may make what is known as a restrictive indorsement. A
restrictive indorsement may have any one or all of the following
effects, viz :
a) it may prohibit or exclude further negotiation ; or
b) it may constitute the indorsee an agent to indorse the
instrument, or to receive the contents for the indorser; or
c) constitute the indorsee an agent to receive its contents for
some other specified person.
Generally speaking, in case of restrictive indorsement the
relationship between the indorser and indorsee is that of the
principal and agent. The bill, in fact, comes to the end of its
negotiability in such cases and the last indorsee is the person
who can sue upon it. Thus in Rahmat Bi v. Angappa Raja
[(1969)2 MLJ 518], a promissory note was endorsed for
collection. It was held that, "though the endorsement was not
supported by consideration, the endorsee has the locus standi
to file an insolvency petition against the maker of the note on
the basis of non-payment of the note and the endorser may join
as an additional petitioner. The death of the endorser does not
affect the right of an endorsee for colletion to claim payment."
Who may negotiate ? [sec 51]
According to the section the following persons can negotiate a
negotiable instrument, viz :
a) sole maker
b) drawer
c) payee or indorsee
d) all of several joint makers, payees or indorsees.
The need for a maker or drawer indorsing an instrument arises
when the instrument is made or drawn payable to his own order
i.e. pay to myself or order etc. In case a stranger to an
instrument endorses it, it will not be valid and he cannot be
held liable on it, though he may be held liable as guarantor to
the person in immediate relationships with him. In case of
several payees, it is not required that all of them should indorse
on the same date or at the same time, what is required is that
they should all indorse - they may do it at different dates or
times.
A legal representative cannot complete an indorsement made
by the deceased by mere delivery of instrument, because a legal
representative is not an agent of the deceased. Such an
instrument will have legal effect only if it is re-indorsed and
then delivered. He should however take care to see that while
re-indorsing the instrument he excludes his own personal
liability [ sections 57, 29 & 32].
Further, according to sec.52, the person indorsing the instrument
in order to negotiate it may either exclude or limit his liability
to the holder in any one of the three ways, viz :
(i) By expressly excluding his liability, for example by making
the bill as, pay A or order sans recourse etc.
(ii) By making his liability dependant on the happening of a
specified event which may never happen.
(iii) By making the right of an indorsee to receive the amount
of the instrument dependant on the happening of a specified
event which may never happen. The basic difference
between (ii) & (iii) is, that in the later case as the indorsees
149
rght is dependant on the happening of an event, he is
prevented from suing the prior parties to the bill before the
happening of such event, whereas in the former case he
can do so even before the happening of the event.
Negotiation back," and "Taking up" of a bill
The general rule is that the holder in due course of a negotiable
instrument may sue all prior parties to the instrument. This
rule is, however, subject to an exception the object of which is
to prevent circuity of action. When a bill or note is negotiated
back to a prior party, the prior party is remitted to his former
position and comes within the definiton of a holder. But it is
not necessary that the bill or note should be re-indorsed to him.
He may or may not cancel the indorsements in full subsequent
to that which constituted him the holder, and may further
negotiate the bill or maintain a suit against parties antecedent
to him. Such a transaction is called taking up of the bill.
If the bill, or note, however, is negotiated back to a prior party
by a proper indorsement, the prior party in addition to his rights
of a former holder acquires also the rights of a holder by virtue
of the last indorsement, but he cannot enforce by a suit payment
of the instrument against an intermediate party to whom he was
previously liable by reason of his prior indorsement, for the
law does not permit circuity of action.
Example
A, the holder of a bill indorses it to B. B indorses it to C. C
indorses it to D. D indorses it to A. A by his first indorsement
is liable to B,C and D; and B,C and D are liable to A under the
second indorsement. A, therefore, cannot sue B, C and D but
A may by striking off the indorsements of B,C and D, again
negotiate the bill.
But where an instrument is negotiated back to a prior party, the
holder can enforce payment against all intermediate parties to
whom the holders was not liable as a prior party, as for example,
where the prior indorsement was without recourse. This is
the rule mentioned in the second clause of the section and
illustration (b) to the section is to the same effect [Parthasarthy,
p. 142].
A holder of a negotiable instrument who derives title from a
holder in due course has the rights thereon of that holder in due
course (sec 53).
Ills: A by fraud induces B to make a promissory note in his
favour. A indorses the note to C, who takes it as a holde in due
course. C subsequently indorses the note to A for value. A
cannot sue B on the note.
Thus, in May v. Chapman [(1847)16 M & W. 355], a partner
in a firm fraudulently indorsed a bill to D in payment of a private
debt. F was cognisant of the fraud but was not a party to it. D
endorsed the bill to E, who took it for value and without notice
of fraud. E endorsed it to F. F acquired Es rights. It was held
that, if he had given value to E he could sue all the parties to the
bill, and if he had not given value to E then he could sue all the
parties except E.
Instrument obtained by unlawful means or for unlawful
considerations (sec 58)
When a negotiable instrument has been lost, or has been
obtained from any maker, acceptor or holder thereof by means
of an offence or fraud, or for an unlawful consideration, no
possessor or indorsee who claims through the person who found
or so obtained the instrument is entitled to receive the amount
due thereon from such maker, acceptor or holder, or from any
party prior to such holder, unless such possessor or indorsee is,
or some person through whom he claims was, a holder thereof
in due course [Parthasarthy pp. 146-147].
This section thus deals with two situations, viz :
a) Lost instruments - The rights and duties of the owner of a
lost negotiable instrument are dealt with u/sec.45A and are as
follows -
(1) When a bill or note is lost, the finder acquires no title to it
as against the rightful owner, nor is he entitled to sue the
acceptor or maker in order to enforce payment on it. The
title of the true owner is not affected by the loss of the
instrument, and he is entitled to recover it from the finder.
[Lowell v. Martin (1813),4 Taunt. 799].
(2) If the finder obtains payment on a lost bill or note, the person
who pays it in due course, may be able to get a valid
discharge for it. But the true owner can recover the money
due on the instrument as damages from the finder. [Burn
v. Morris (1834),2 Cr. & W. 579].
(3) If the finder of a lost bill or note, which is payable to bearer
or which is indorsed in blank and is therefore transferable
by mere delivery, negotiates it to a bona fide transferee for
value, the latter acquires a valid title to it, and is entitled
both to retain the instrument as against the rightful owner,
and to compel payment from the parties liable thereon.
(4) If the finder of a lost bill or note, which is payable to order
and is therefore transferable by indorsement and delivery,
forges the indorsement of the loser and negotiates it to a
bona fide transferee for value, the latter acquires no legal
title to it, for a forgery can confer no title; and a payent by
the acceptor or other party liable to a person, claiming under
a forged indorsement, even though made in good faith, will
not exonerate him.
(5) It is advisable that the owner of a lost bill should give notice
of the loss to the parties liable on the bill for they will
thereby be prevented from taking it up without proper
inquiry. Public advertisement of the loss may also be given
if the amount is large.
(6) The party who has lost a bill must make an application to
the drawee for payment at the time it is due, and give notice
of dishonour to all the parties liable, otherwise he will lose
his remedy against the drawer and indorsers.
(7) Under this section the loser can apply for a duplicate of a
lost bill.
In the application of the section, the following points may be
noted:-
(1) The section is confined in its operation to bills only; it
doesnot apply to notes.
150
(2) The section applies to bills before they are overdue.
(3) The remedy given to the owner of the lost bill is againt the
drawer alone. The loser may compel the drawer to give
him a duplicate bill upon an undertaking of indemnity, but
no provision is made as to obtaining a fresh acceptance or
fresh indorsements.
(4) Under the section it is only the holder of a lost bill that can
apply for a duplicate. Therefore, if a bill is payable to order
and is transferred for value but without indorsement, the
transferee, if he looses the bill, cannot apply apply for a
duplicate in his own name, for he is not a holder, that is, a
person entitled in his own name to the possessionof the
bill. [Good v. Walker, (1892) 61L.J.Q.B. 736]
[Parthasarthy pp. 126-128].
b) Instruments obtained by means of an offence
(i) Stolen instruments - A person who steals an instrument
cannot enforce payment of it against any person nor can be
retain it against the party from whom he has stolen it. But a
transferee who bonafidely and for good value acquires such a
stolen instrument from the theif gets a good title to it and can
confer a good title on any one acquiring it from him.
(ii) Instruments obtained by fraud - If the maker or acceptor,
when sued on an instrument, proves that it was obtained from
him fraudulently, the person who has so defrauded him is not
entitled to recover anything from him, because fraud vitiates or
negates all agreements and transactions.
The defence available to a person pleading fraud is that of non
est factum or not my document, but to avail of this defence
he must be able to prove;
(1) that he had not been negligent or careless in signing of the
document; and
(2) that he was induced by the plaintiff to sign it.
(iii) Instruments obtained for unlawful consideration -
Wherever the consideration for a bill, note or cheque is unlawful,
the instrument becomes void. The provisions of Contract Act
would apply to ascertain what could be deemed as unlawful
consideration. But a bona fide holder in due course acquires a
good title to the instrument which was originally made, drawn
or negotiated for an unlawful consideration.
(iv) Forged instruments - Forgery can be defined as the
fradulent making or alteration of a writing on a instrument to
the prejudice or detriment of another. The effect of an instrument
with a forged signature is as follows :
i) The forged signature is void ab initio and the property in
the instrument remains with the person who was the holder
at the time of forgery.
ii) The holder of a forged instrument can neither enforce
payment on it nor can he give a valid discharge.
iii) Where the holder has managed to enforce payment despite
the payment, he cannot retain the money and the true owner
may compel him to return the money.
iv) The true owner may sue in tort the person who has received
money for conversion of bill or for money had and received
to his use.
v) A person who has paid money by mistake on a forged
signature, can recover it from the person to whom he has
paid (sec.72 of Contract Act).
vi) The presumption in favour of holder in due course does
not operate in case of forged instruments, because there is
a difference between defect in title (when he is protected)
and an entire absence of title as in case of forgery (where
he can acquire no title).
vii) Forgery cannot be ratified, but a person whose signature
has been forged may by his conduct, be estopped from
denying the genuineness of his signature later on.
viii)In case of forged indorsements, if the instrument was
indorsed in full, the signature of the person to whom or to
whose order the instrument is negotiated must be genuine
for a title to the instrument can only be through his
indorsement. Therefore, in case of an instrument with
forged indorsement, a person claiming under it cannot
acquire the rights of a holder in due course even if he is a
parchaser for good value.
ix) A banker who pays on a forged bill has no recourse against
his customer ie he has to bear the loss personally.
Instruments acquired after dishonour or when overdue
Section 59 which deals with these situations states that, The
holder of a negotiable instrument, who has acquired it after
dishonour, whether by non-acceptance or non-payment, with
notice thereof, or after maturity, has only, as against the other
parties, the rights thereon of his transferor.
Provided that any person who, in good faith and for
consideration, becomes the holder, after maturity, of a
promissory note or BOE made, drawn or accepted without
consideration, for the purpose of enabling some party thereto
to raise money thereon, may recover the amount of the note or
bill from any prior party.
An instrument remains negotiable till its payment or satisfaction
by the maker, drawer or acceptor of the instrument at or after
maturity, but it cannot be negotiated after such payment or
satisfaction [sec 60].
4.5 RULES RELATING TO ACCOMODATION BILL
These are the main class of bills covered under sub-clause (d).
Accomodation instruments are those that are drawn for the
accomodation of the drawer, and he has undertaken to supply
funds to meet them. Though the sub-section only refers to
drawers there is no reason why it should be so restricted.
The Act itself has not defined an 'accomodation bill'. According
to the commercial practice an accomodation bill is one which
is drawn and accepted for the purpose of accomodation of either
the drawer or the drawee or both. Accordingly an accomodation
bill has certain characteristics viz:
151
1) It is drawn and accepted without any consideration.
2) The object of the bill is to accomodate one or both the
parties, i.e., it essentially creates loan condition between
the parties.
Accomodation bill is in commercial practice created in
following situations: Suppose A requires money and requests
his commercial friend B to support him with a loan. B unable
to provide cash may request A to draw a bill on him (i.e. B).
This bill is known as accomodation bill because this bill has
been drawn for the purpose of accomodating A. A gets the bill
accepted by B and discounts it from C (who may be the bank or
any other third person). On maturity A has to give the money
to B and B has the primary duty to honour the bill.
Legal validity of these bills - Sec. 43 of the Act provides the
general rule about the negotiable instrument made, drawn,
accepted, endorsed and transferred without consideration.
According to this rule such an instrument does not create any
obligation of payment between the parties to the transaction.
But if such a bill is endorsed to a holder for consideration, such
holder and any subsequent holder may recover the amount due
on such instrument from the transferor for consideration or any
prior party thereto. So a bill without consideration is not as
such a legally invalid document. So an accomodation bill is
valid with only the condition that it creates no obligation for
payment between the parties to the transaction. Thus in the above
example, in between A & B, B is not bound to pay on the
instrument to A. But if A discounts the bill with C, A will have
primary liability to see that the bill is honoured by B. That means,
A has to pay his debt to B thereby enabling B to honour the
bill. According to Explanation I of sec. 43, no party for whose
accomodation a negotiable instrument has been made, drawn,
accepted or indorsed, if he has paid the amount thereof, recover
thereon such amount from any person who became a party to
such instrument for his accomodation. Suppose in the above
example, A pays for the bill to C, A cannot realise the money
from B. Suppose B also pays the amount honouring his bill A
cannot realise the amount from C. B alone can realise the amount
from C on the grounds of double payment u/sec. 70 of Contract
Act. In Canara Bank v. Sanjeev Enterprises [AIR 1988 Del
372] it was held that 'the plea of want of failure of consideration
between immediate prior parties cannot be set up against a
holder for consideration or against any subsequent holder
deriving title from him.'
Rights & duties of Parties - As already stated earlier there is
no obligation of payment on the accomodation bill in between
the drawer and drawee, but the primary and secondary liabilities
of the drawee and drawer shall be imposed against a holder for
consideration and all other subsequent holder deriving title
thereafter.
4.6 RULES RELATING TO INTEREST
Sections 78 to 81 deal with the general rules relating to payment
of interest on the bills. These may be briefly stated to be as
follows :
1) Interest should be paid to either the holder of the instrument
or his duly authorized agent. If interest is paid to anyone
else it will not act as a discharge.
2) Similarly, payment of interest will not act as a discharge
unless it is paid either by the maker of the instrument or his
duly authorized agent.
3) Where the instrument itself specifies a rate of interest,
interest will be calculated at that rate from date of instrument
till realization of amount or if a suit has been instituted
then till the date the court directs.
4) When no rate is specified in the instrument, the rate of
interest will be 18% per annum regardless of any agreement
between the parties, from the date at which it ought to have
been paid to the date of realization or such other date as the
court may direct.
5) Any person who is liable to pay on an instrument, and has
been asked by the holder to pay the amount, is entitled to
have the instrument delivered to him on his paying up, or
if it has been lost then he has the right to be indemnified
against any other claims against him on that bill or note.
152
5. PRESENTMENT
SUB TOPICS
5.1 Presentment for acceptance
5.2 Presentment for payment
5.3 When Presentment unnecessary
5.4 Bankers Liability
5.1 PRESENTMENT FOR ACCEPTANCE
Section 61 which deals with presentment for acceptance states
as follows :
A BOE payable after sight must, if no time or place is specified
therein for presentment, be presented to the drawee thereof for
acceptance, if he can, after reasonable search be found, by a
person entitled to demand acceptance, within a reasonable time
after it is drawn, and in business hours on a business day. In
default of such presentment no party thereto is liable thereon to
the person making such default.
If the drawee cannot, after reasonable search be found, the bill
is dishonoured.
If the bill is directed to the drawee at a particular place, it must
be presented at that place; and if at the due date for presentment
he cannot, after reasonable search, be found there, the bill is
dishonoured.
Where authorised by agreement or usage, a presentment through
the post office by means of a registered letter is sufficient.
In Jagjivan Mavji v. Ranchoddas [AIR 1954 SC 554] it was
observed, "in a bill payable after sight thee are two distinct
stages, firstly when it is presented for acceptance (section 61)
and later when it is presented for payment (section 64), but
when the bill is payable on demand both the stages synchronise,
and there is only one presentment, which is both for acceptance
and payment." Thus, presentment for acceptance is a rule
applicable only to those BOE which are payable after sight i.e.
those BOE which are not payable on demand. Acceptance as
the term itself implies is an acceptance or agreement by the
drawee of the liability to pay the amount on BOE whenever it
is presented for payment by the drawee. The reason for this
rule may be two fold, viz:
(i) you cannot make a third person (the drawee) liable for a
sum without his consent or knowledge; and
(ii) it gives the drawee time to make arragements for the amount
which he would have to pay after the elapse of the specified
time limit.
Who may present ?
A BOE has to be presented for acceptance only by a person
who is entitled to demand acceptance. According to sec.78, in
case of BOE payable on demand or at sight the person entitled
to receive payment is the person entitled to present it for
acceptance. Generally, it is the holder of a bill who is entitled
to present it for acceptance, and the drawee can acting on the
presumption that the person in possession of a BOE has the
legal title to it also, accept the bill without any risk. In
Greenwood v. Martins Bank [1933 A.C.J.1] it was held that
if the person presenting turns out to be not a rightful holder,
the drawees acceptance will enure to the benefit of the person
really entitled to the bill. By presenting the bill for acceptance,
the holder does not guarantee that the bill or any documents
attached hereto are genuine.
Presentment for acceptance may be made by the holder himself
or through an agent. Generally speaking, it is bankers who are
employed as agents of their customers both for acceptance and
for payment. A banker is expected to use all possible care and
diligence in the discharge of his duty. In Bank of Van Diemans
Land v. Bank of Victoria [(1871) LR 3 PC 526] the extent of
bankers diligence has been stated thus, the duty of the agent is
to obtain acceptance of the bill, if possible, but not to press
unduly an acceptnace in such a way as to lead to a refusal,
provided that the steps for obtaining acceptance or refusal are
taken within the limit of time which wil preserve the right of
the principal against the drawer. A banker is liable to pay
damages if he is negligent in his duty.
Presentment to whom ?
A presentment should be made either to the drawee or to his
duly authorised agent (sec.75). The demand for acceptance
must be made to the authorised person, in clear and unambigious
manner, and as observed in Check v. Ropper [(1804)5 Esp.
175 170 E.R. 777], it is not sufficient to produce a witness who
went to a place described as the drawees house, and there told
by a stranger to the witness that the drawee would not accept
the bill. There has to be some kind of proof to show that (i) the
presentment was made to the drawee himself or to his duly
authorised agent & (ii) that th BOE was actually exhibited to
the drawee for his acceptance. A drawer is entitled to a period
of 48 hrs to decide whether he wants to accept the bill or not
(sec.63).
In case of there being 2 or more joint drawees, the BOE must
be presented to all of them jointly, unless one of them has been
authorised by the rest to accept the bill on behalf of the rest. A
holder is entitled to have the acceptance of all the drawees and
even if one of them refuses he is entitled to treat the bill as
dishonoured and claim compensation from the drawer.
Place and time of presentment
Although in general the law requires that a presentment should
be the drawee himself there is no specific requirement for the
place of presentment, because at that instance he is only required
to receive the bill, unless a specific place is mentioned in the
bill itself when of course that place has to be adhered to.
A bill has to be presented during business hours, though the
phrase business hours itself has not been defined in the Act or
under any other law for that matter, but may be deemed to be
governed by the usual usage or practice of that trade or in that
area. In England the phrase used is during reasonable hours,
153
which phrase has been used differently for traders, bankers and
non-traders. For the traders the reasonable hours are usual
business hours and for non traders it is upto bed time. No such
varied interpretation is given in India, and the interpretation of
the phrase business hours will depend on the facts and
circumstances of each case. Similarly, the presentment must
not be made on a public holiday (including Sundays) i.e. it
must be presented only on a working day.
In Mohanlal Malpani v. Loan Company of Assam [AIR 1960
Assam 191] it was held that a bill payable after sight should be
presented for acceptance, without unreasonable delay or the
drawer and other persons liable on the bill will be discharged;
for, they have an interest in having the bill accepted immediately,
in order to shorten the time of payment, and thus put a limit to
the period of their liability. A second reason for presenting
the bill within a reasonable time is that if the holder makes an
inordinate delay in presenting, there is a very real risk of the
drawee becoming insolvent in the meantime. Section 105 of
the Act dealing with reasonable time states that In
determining what is a reasonable time for presentment for
acceptance or payment, for giving notice of dishonour and for
noting, regard shall be had to the nature of the instrument and
the usual course of dealing with respect to similar instruments;
and, in calculating such time, public holidays shall be excluded.
In short, what is a reasonable time will depend on the facts of
each case.
Acceptance of overdue bills
Though the Act does not specifically deal with the effects of
acceptnace of overdue bills, but such an acceptance is not per
se void, because under sec.32 a bill which has been accepted
after maturity is payable to the holder on demand. Under the
English law a bill may be accepted when it is overdue [sec.18(2)]
and it becomes payable on demand[sec.10(2)]. It is thus clear
that under the English law a bill should be presented for
acceptance before maturity, and if it is not so presented the
holder may lose his right of recourse against the drawer and
indorser, except in case of bills coming under sec.39(4). Since
in the Indian Act there is no provision inconsistent with the
above stated principle it may be safely stated that mere
acceptance of an overdue bill will not act as a revival of the
liability of a drawer or indorser who may have been discharged
by reason of non-presentment of bill before maturity.
Presentment of promissory note for sight
Section 62 states as follows :
A promissory note, payable at a certain period after sight, must
be presented to the maker thereof for sight (if he can after
reasonable search be found) by a person entitled to demand
payment, within a reasonable time after it is made and in
business hours on a buisness day. In default of such presentment
no party thereto is liable thereon to the person making such
default.
Just as in case of BOE, even in case of notes, the presentment
should be to the maker or his duly authorised agent, and it must
be within a reasonable time. The holder is required to diligently
search for the maker in order to make a presentment, and if
even after such a search the maker cannot be found, the holder
is discharged from his liability of making a presentment.
Where the holder fails to present the instrument without a
reasonable cause the other parties to the instrument are
discharged from their liability to the defaulter, though such
default does not affect the rights and liabilities of such other
parties. But in the opinion of Bhashyam & Adiga (p.491) such
default of the holder also affects the liabilities of other parties
inter se as these liabilities depend upon these of the maker to
the holder.
5.2 PRESENTMENT FOR PAYMENT
Section 64 dealing with presentment for payment states as
follows :
Promissory notes, bills of exchange and cheques must be
presented for payment to the maker, acceptor or drawee thereof
respectively, by or on behalf of the holder as hereinafter
provided. The default of such presentment, the other parties
thereto are not liable thereon to such holder.
[where authorised by agreement or usage, a presentment through
the post office by means of a registered letter is sufficient].
Exception - where a promissory note is payable on demand
and is not payable at a specified place, no presentment is
necessary in order to charge the maker thereof.
This section lays down the general rule that a negotiable
instrument should be presented for payment at maturity but not
before, and in default of such presentment, all the parties except
the maker and the acceptor are discharged from their liability
to the holder [Chandra Dat v. Chandra Sen, AIR 1934 Oudh
254]. The reason for making this distinction is that there is a
distinction between the liability of the maker and acceptor and
that of the drawer and indorser. The former is an absolute
liability, whereas the later is conditional.
To whom is the presentment to be made ?
As per the section, presentment of notes should be to the maker,
BOE to the acceptor and cheques to the drawee-banker. The
section does not cover all situations because it does not deal
with bills which are not required to be presented for payment
before payment is demanded. Section 75 deals with certain
other persons to whom presentment may be made and states as
under
Presentment for acceptance or payment may be made to the
duly authorised agent of the drawee, maker or acceptor, as the
case may be, or where the drawee, maker or acceptor has died,
to his legal representative, or, where he has been declared an
insolvent, to his assignee.
Under the English Bills of Exchange Act in case of serveral
drawees unless there is a contract to the contrary, the presentment
should be made to all of them. But no such provision has been
made in the Indian Act and it is to be presumed that given a
similar fact situation we will follow the English law.
154
Who should make the presentment ?
Just as in case of presentment for acceptnace, presentment for
payment should also be made by the holder or his duly
authorised agent, although the words used in the section, namely
by or on behalf of the holder is also susceptible to the
construction that a presentment may be made even by an
unauthorised person who would be unable to give a valid
discharge. The English law on the other hand explictly states
that presentment should be made by a person who is the holder,
or some one authorised on his behalf. Though the Indian Act
is susceptible to both constructions, care should be taken to
give only that interpretation to the words which would expose
the maker and the acceptor to minimum risk.
Mode of presentment
In Ramuz v. Crowe [(1847)1 Ex. 167], it was observed that
the presentment for payment must be such as would be
sufficient to charge the indorses and other persons collaterally
liable on the bill, and the document itself must be presented so
as to enable the person presenting, to give it up if paid. A
mere registered notice by a pleader demanding payment is not
a good presentment nor is an oral demand for money enough,
though it is not really necessary that the holder should hold the
bill in his hand while demanding payment. What is required is
that the bill should be at hand or easily accessible even if not in
his personal custody. The reason for having the bill accessible
is that the acceptor (or any body) paying the bill has the right
to the possession of the instrument for his own security and as
his voucher and discharge protanto in his account with the
drawer" [per Lord Tenterdon in Hansard v. Robinson, 108
ER 659].
In 1885 the second clause to the section was added whereby
presentment throguh the post office is made valid if agreed to
by the parties or such presentment is in accordance with usage.
An important safeguard made in this regard is that presentment
through post should always be by a registered letter. er. This
safeguard has not been provided for in English law.
Time and place of presentment
Presentment must be made during the usual business hours and
if it is being made to a banker then it should be made within the
banking hours (sec 65).
A note or BOE which is payable at a specified period after date
or sight must be presented for payment after maturity (sec.66).
A note which is payable by instalments should be presented for
payment on the third day after the date fixed for payment of
each instalment; and non-payment on such presentment has the
same effect as non-payment of a note presented after maturity
[sec.67].
In case the note or bill or cheque specifies the place for
presentment, then it must be presented at that particular place
only in order to charge any party to it (sec 68). Sec 69 further
adds that a bill or note made, drawn or accepted as payable at a
specified place must be presented at that place in order to charge
the maker or drawer of the bill or note. But if no place for
presentment has been specified then the bill or note must be
presented for payment either at the place of business (if any) or
the residence of the maker, drawee or acceptor of the bill or
note [sec.70].
What happens if such maker or drawee has no known place of
business or residence ? Sec.71 provides that in such cases
presentment may be made to him in person wherever he can be
found.
Cheques have to be presented at the bank on which it is drawn
so as to charge the drawer, before the relation between the drawer
and his banker gets altered to the prejudice of the drawer
[sec.72]. In case any other person (i.e. apart from the drawer)
is to be charged, then according to sec.73 the cheque must be
presented within a reasonable time after delivery of it by such
person.
Default in presentment
In case the holder makes a default in presentment, the other
parties on the instrument are discharged from their liability to
the holder i.e. the drawers and the indorsers in case of bills and
cheques and indorsers in case of notes. Since their liability is
conditional and is dependant on the presentment of the
instrument the liability is discharged if this condition is not
fulfilled regardless of whether they have actually been
prejudiced by such non-presentment or not.
In case the holder delays the presentment either for acceptance
or payment, such delay is excusable provided it is caused by
circumstances beyond his control i.e, the holder himself has
not been guilty of negligence or misconduct etc resulting in the
delay. After the cause for delay ceases to exist he should make
the presentment within a reasonable time ( sec. 75 A).
5.3 WHEN PRESENTMENT UNNECESSARY
Section 76 provides for situations in which presentment for
payment is unnecessary, and the instrument in such a case is
dishonoured at the due date for presentment. These situations
are as follows :
A) Presentment not necessary
(i) When prevented - Whenever the maker, drawer or acceptor
intentionally prevents the presentment, then the holder need
not present the instrument. The word prevent implies a
positive action of some kind on the part of such maker or
drawer, as for example, by putting obstacles or disabling
the holder in some way.
(ii) When business place closed - If the place of business of
such maker etc is closed on a working day during business
hours the presentment is not necessary, because in such a
case the presumption is that it has been deliberately kept
closed to avoid payment.
(iii) When no person at place of payment - The same rule
applies, if the instrument is payable at a specified place, and
when the holder goes there for presentment there is no person
present who can either authorise payment or refuse it.
155
(iv) When the maker etc cannot be found - The holder is
required to search diligently for the maker etc. If the
instrument does not specify a place of payment. If after
due search the maker etc cannot be found either at his place
of business or his usual residence has to be necessarily
excused and the parties to the instrument are liable on it
without the presentment.
B) Waiver of presentment
(i) By agreement before maturity - If the parties to the bill
or note mutually agree then they may do away with the
presentment at maturity. The waiver of presentment must
be by a person entitled to ask for it and not by any third
person. Such waiver is generally embodied in the
instrument itself and may be incorporated any time ie either
at the time of drawing up the instrument or at any
subsequent time but before the maturity of the instrument.
(ii) Waiver may be express or implied
It is not necessary that the maker should expressly (i.e. either
in writing or by words) waive presentment. Sometimes
his actions or conduct may be such that they create an
impression in the holders mind that the bill or note need
not be presented, then he can dispense with the formality
of presentment by inputing implied waiver.
(iii) Waiver by partner and agent
The Waiver as mentioned above has to be by a person who
is entitled to demand presentment, for the simple reason
that neither can one waive away a right which one does not
have nor can he waive away the right of another. A partner
however is entitled to waive presentment on behalf of his
firm, and in case of joint drawees one of them may be
authorised to waive presentment on behalf of others.
(iv) Promise to stranger no waiver
Just as presentment should be made to a person entitled to
demand it, so also when such a person waives his right it
should be to the person entitled to demand payment. A
waiver to a stranger does not in general amount to waiver
though sometimes it may amount to an admission of the
fact that due presentment was made and notice given
[Potter v. Rayworth, 104 ER 432].
(v) Waiver after maturity
Clause (c) of the section refers to waiver after maturity.
Such waiver may be inferred either from a part payment of
the amount due, or by a promise to pay the amount either
in part or in full or the party may expressly waive his right
or take advantage of any default in the presentment for
payment. [Panchicowri v. Satya Dhenu, AIR 1936 Cal
489]. The promise to pay must be both absolute and
unconditional, otherwise it will not operate as a waiver.
Though no specific words or format of waiver has been
laid down, the words used must be such as to clearly
acknowledge the liability and the promise to pay. Such
promise to pay is a prima facie proof of a presentment
having been made.
A waiver can be made only with full knowledge of facts, ie the
drawer or indorser must be aware that the holder has defaulted
in making a presentment. This is because a waiver is a conscious
act and not a merely automatic or formal gesture.
C Presentment excused
i) When no damage to drawer - Where non-presentment of
an instrument by the holder does not result in any loss or
damage to the drawer or indorser, then the presentment
may be excused. The burden of proof in such cases is on
the person who wants to rely on this excuse i.e. usually the
holder. A common example of this is when the drawer draws
the bill without any right to do so or without any reasonable
ground to expect that the drawee will honour it, i.e. when
he commits a fraud or a folly in drawing the bill, and so he
can suffer no loss or injury by want of presentment, which
would naturally be fruitless in such cases [Terry v. Parker,
112 E.R. 192]. The English law in such cases views it
from the relationship between the drawer and drawee,
whereas the Indian law approaches the issue from the point
of view of future or possible results or consequences of
non-presentment, but as such there is not much diffeence
in the substance of the laws.
(ii) Accomodation instruments
If a bill is drawn for the accomodation of the indorser, or if
he indorsed it for the accomodation of the drawer, knowing
at the time that it will not be honoured at its maturity he
also comes within the reason of the applicable to the drawer,
and presentment to charge him is not necessary
[sec.46(2)(d) of Bill of Exchange Act].
D) In case of specific drawers/drawees
i) When drawer and drawee same
In such situations the holder may treat the instrument as a
promissory note and in which case presentment becomes
unnecessary to charge the maker. But where the holder
wants to charge the indorser, then presentment becomes
necessary. Even if the drawee/acceptor becomes insolvent
before maturity, the holder is not excused from presentment
to drawer.
ii) When drawee is fictitous
Presentment in such cases is dispensed with not only against
the drawer but also against all other parties liable on the
instrument, because a demand cannot be made on a person
who does not exist.
iii) When drawee incompetant
If the drawee is legally incompetant to enter into a contract,
presentment against indorsers is not dispensed with,
although presentment against the drawer becomes
unnecessary. The reason for this is that by drawing on an
incompetant person he has committed a fraud on the holder,
and cannot claim to have suffered damage by want of
presentment. If any of the subsequent indorsers are a party
to the fraud then they also become subject to the same rule.
156
iv) When drawee dead
It is not very certain as to whether presentment is necessary
in such cases, and if yes - then who should it be made to ?
As per sec.75, presentment to the legal representative may
be made, but the holder cannot be compelled to do so. Since
the present section does not excuse non-presentment on
that ground it is presumed that the holder is bound to present
at the specified place of payment (if any) or place of
business or residence of the deceased if ascertainable after
diligent search by the holder. It is perhaps safer to present
it to the legal representatives of the deceased [Cf. Philpot
v. Briant, 172 E.R. 405].
E) Impossibility of presentment
The section does not excuse non presentment due to
circumstances beyond the control of the holder. Sec. 75A
however excuses delayed presentment in such cases. But there
are certain general circumstances where presentment is excused
in all jurisprudential systems and mercantile law. These
circumstances are referred to in sec.46 of Bill of Exch. Act, for
example in cas eof political disturbance amounting to virtual
interruption and destruction of trade and this includes war;
enemy occupation of the holders contry; riots; insurgence; etc.,
where closing of business house becomes necessary for
protection of life and property.
Similarly certain circumstances might occur in the life of a
holder, for example, sudden grave illness or death of the holder
at the time of maturity of instrument, which would render it
impossible for the holder to make a presentment. In such
situations, the drawee should be informed of the circumstances
at the earliest. Another common excuse for not making
presentment on time is miscarriage or delay in transit where
presentment by post is allowed. But such delay or non
presentment is not excusable if the holder himself was negligent
or in some other way responsible for the non presentment. A
point to remember is that in these cases the presentment is not
wholly excused but only delay in presentment is excused, i.e.
the moment the impediment or obstacle is removed presentment
has to be made.
F) Dishonour by non-acceptance
Finally, presentment for payment becomes totally unnecessary
when the instrument has been dishonoured for acceptance. In
such cases, the holder can directly hold the drawer liable on the
instrument.
5.4 BANKERS LIABILITY
Earlier it has been mentioned that in general bankers act as
agents of their customers where presentment is required both
for acceptance as well as payment. The question arises, what is
the liability of a banker in case of loss or damage to the holder.
Section 77 of the Act dealing with this states as follows
When a bill of exchange, accepted payable at a specified bank,
has been duly presented there for payment and dishonoured, if
the banker so negligently or improperly keeps, deals with or
delivers back such bill as to cause loss to the holder, he must
compensate the holder for such loss.
A banker in performance of his duties is required to take due
care. He has to make payment on an accepted bill provided he
has sufficient funds in the drawers account. This section comes
into play when the banker legitimately refuses payment on a
BOE. Once he refuses payment, he is required to take due care
of the instrument and return it to the holder in the same state as
was given to him. If he cancels the acceptance or any other
portion on the bill and the holder suffers some special damage
due to such cancellation, then the banker becomes liable to him
for such loss or damage suffered, unless he can prove that there
was no want of due care or diligence on his part. But a banker
is not liable if a cancellation has been mistakenly made and he
makes a note on the bill cancelled by mistake. Thus in Raper
v. Birkbeck [104 e.r. 750], the acceptance in a bill was cancelled
by mistake by a drawee in case of need under the wrong
impression that it had been payable at his house. It was held
that prior indorsers were not discharged, as the cancellation
was through a mistake which was indicated by the words
cancelled by mistake. Further, if the bill has been returned to
a wrong party because of the holders negligence, the banker is
not liable so long as he himself had taken due care.
Thus a banker apart from being the drawers agent is also in the
position of a bailee to the holder. Its for this reason that he is
held liable in case he keeps and refuses to deliver the bill
improperly or deals with it in such a negligent manner that the
holder suffers a loss or damage. Actually speaking this provision
really falls within the purview of the law of torts, but the Select
Committee inserted this provision with a recommendation that
it might be retained in this Act till the codification of tort law.
157
SUB TOPICS
6.1 Introduction
6.2 Kinds of Crossing
6.3 Payment of Crossed Cheques
6.4 Protection of the Collecting banker
6.1 INTRODUCTION
Crossing is a feature which is unique to cheques and
distinguishes cheques from other negotiable instruments.
Crossing is a usage born of commercial practice. In Bellamy
v. Marjoribanks [155 E.R. 999] it was observed that this
practice originated at the clearing house when the clerks of the
different bankers wh did business there used to write across the
cheques, the name of their employers, so as to enable the clearing
house clerks to make up the accounts. The objective of crossing
a cheque is to introduce or give a direction to the banker that he
is not to pay the cheque across the counter but to pay it only to
another banker. This second banker may be either the drawee
banker or a different one. By paying money to the banker it
becomes easier for the owner of the cheque to detect or find out
as to where the money has gone or for whose use it has been
received. Crossing of a cheque accords a protection or
safeguards to the cheque owner. This is because, even when a
wrongful person secures payment on a crossed cheque it can
be traced because he operates through a banker, i.e., he has to
open an account first (and since he is not the payee, a current
account) with some banker and then pay the cheque into his
account so as to enable the banker to receive payment on his
behalf and credit it to his account. This makes it easy for the
money to be traced to the recipients hand if it is found out later
that he was not entitled to payment on that particular cheque.
6.2 KINDS OF CROSSING
Crossing of a cheque is generally of two kinds, viz:
(1) General crossing and
(2) Special crossing.
But each of these kinds may be several different sub-types.
Apart from these two kinds there are certain other kinds of
crossings also, viz :
(3) Account payee only
(4) Not Negotiable crossing
We will now deal with each of these kinds in detail.
(1) General Crossing
Section 123 defines general crossing as :
where a cheque bears across its face an addition of the words
and company or any abbreviation thereof, between two
parallel transverse lines, or of two parallel transverse lines
simply, either with or without the words Not negotiable, that
addition shall be deemed a crossing, and the cheque shall be
deemed to be crossed generally.
Thus, for a cheque to be treated as being crossed generally, it
should satisfy the following conditions, viz:
(1) two parallel transverse lines on its face;
(2) either with no writing between them or
(3) the words and company; & Co. or Not Negotiable
written between the lines.
Where no words are written the crossing is said to be general.
Drawing of the parallel lines is essential for general crossing.
Some specimens of general corssing are given below.
(1) A/c Payee. Not Negotiable
(2) Under Ten Rupees
(3) Not Negotiable
(4)
2) Special Crossing
Section 124 states as under :
Where a cheque bears across its face an addition of the name
of a banker, either with or without the words Not Negotiable,
that addition shall be deemed a crossing, and the cheque shall
be deemed to be crossed specially, and to be crossed to that
banker.
For a check to be crossed specially therefore the following
conditions should be satisfied.
a) the two transverse parallel lines may or may not be drawn;
b) name of the banker should be written across the cheque;
c) the words Not Negotiable may also be included.
6. SPECIAL PROVISIONS RELATING TO CHEQUES
XY Bank, Ltd
No: Date: 199
Pay..................................................or Bearer.....................
Rupees...................................................... Rs
158
Thus it is seen that unlike general crossing, in case of special
crossing the transverse lines are not compulsory though it is
usual to put them. The only thing necessary is that the name of
the bankers should be written across the face of the cheque.
Given below are a few specimens of special crossing.
(l) Indian Bank
George Town
(2) State Bank of India
(3) Bank of India
Not Negotiable
(4) State Bank of India
Nagarabhavi
Remitted for collection
to Bank of India
3) Account payee crossing
Over the last few years a practice commonly used in crossing
of cheques if making them account payee or account payee
only. The Bill of Exchange Act does not provide for such
kind of crossing. An account payee crossing does not restrict
the negotiability of the instrument but merely provides an
additional safeguard against theft or loss. It is not an addition
to the crossing, but merely directs the receiving bank that as
per the drawers wishes the check should be paid to that bank
where the payee (or holder) has an account. If the banker
receives payment of such a cheque on behalf of a third person
(i.e., other than the payee/holder), he would be guilty of
negligence and cannot seek protection under sec.31.
4) Not Negotiable crossing
In the above paras we have mentioned that both general and
special crossing can also contain the words Not Negotiable.
When this phrase is used while crossing the cheque, we call the
crossing a not negotiable crossing. Sec.130 deals with the
concept of not negotiable crossing and states as under:
A person taking a cheque crossed generally or specially,
bearing in either case the words not negotiable, shall not have,
and shall not be capable of giving, a better title to the cheque
than that which the person from whom he took it had.
Previously under both the Indian and the English law a drawer
was entitled to draw or make a non-transferable cheque by
simply omitting the word order or bearer in the instrument.
But according to sec.13 of the present Act, the absence of these
words do not restrain negotiation, nor does the English law
treat the absence of these words as a restraint, hence the only
way in which a person can draw a non-negotiable or non-
transferable check is by crossing it non-negotiable.
This does not mean that a cheque crossed non-negotiable ceases
to be transferable in entirety-what it means is that transfer of
such cheques are not attended by the same important
consequences as in case of ordinary negotiation. Such cheques
are deprived of the main attribute of negotiability, namely, the
transferability free from equities i.e., the transfree gets a good
title only if transferor has one and if there is defect in the
transferors title such defect is passed on to the transferee. But a
transferee of a non-negotiable cheque is left with the second
attribute of negotiability i.e., of transferability by delivery or
indorsement. In case of such cheques there is only a holder
and no holder in due course. Thus in Great Western
Ry.Co.V.London & County Banking Co., [(1901) AC 414],
H by false pretenses obtained from G.W. a cheque crossed &
Co., & not negotiable and took it to a bank who paid it.
G.W filed a suit against the bank for conversion of the cheque.
It was held that the cheque having been obtained by fraud of
the apparent holder who had no title to the cheque, and could
not give to the bank any title to the cheque or the money, and
that the bank was liable for the amount of cheque. Earl Halsbury,
L.C. observed as follows:
It is very important that every one should know that people
who take a cheque which is upon its face not negotiable and
treat it as a negotiable security must recognise the fact that if
they do so they take the risk of the person for whom they
negotiate it having no title to it. In this case, it cannot be
pretended that Huggins had any title to it at all. I do not
understand what additional security is supposed to be given to
a cheque by putting the words not negotiable upon it, if the
fact of its being negotiated can give a title to any one. The
supposed distinction between the cheque itself and the title to
the money obtained or represented by it seems to me to be
absolutely illusory. The language of the statute seems to me to
be clear enough. It would be absolutely defeated by holding
that a fraudulent holder of the cheque could give a title either to
the cheque or to the money.
In the same case, Lord Brampton observed:
The object of section 81 is obvious. It is to afford to the drawer
or the holder of a cheque who is desirous of transmitting it to
another person as much protection as can be reasonably afforded
to it against dishonesty or accidental miscarriage in the course
of its transit, if he will only take the precaution to cross it, with
the addition of the words not negotiable, so as to make it
difficult to get such cheque so crossed cashed until it reaches
the destination.
It is to be remembered that there is a fine distinction between
cheques crossed non negotiable and cheques which are ab
initio non transferable. The former can be transfered from
person to person though the transferee gets no better title than
the transferor; whereas the latter is payable to the payee only
and no one else and any transfer or indorsement of such cheques
are not recognised. A cheque is non-transferable when it is
drawn payable to Mr.X only and having the words bearer
or order struck out.
Crossing of a cheque after issue
Uptil now we have dealt with the crossing of a cheque by the
drawer i.e., before it was issued to the payee or holder. But a
159
cheque can be crossed after it has been issued by the drawer,
and sec.125 which deals with such cheques states that:
Where a cheque is uncrossed, the holder may cross it generally
or specially.
Where a cheque is crossed generally, the holder may cross it
specially.
Where a cheque is crossed generally or specially, the holder
may add the words not negotiable.
Where a cheque is crossed specially, the banker to whom it is
crossed may again cross it specially to another banker, his agent,
for collection.
Thus under this section two categories of persons can cross a
cheque or change the nature of an already crossed cheque, viz.,
(i) the holder of the cheque; and
(ii) the collecting banker of the cheque.
Such crossing is allowed on the principle that crossing by
itself does not amount to a material alteration vitiating the
instrument. Certain points however have to be rememberd in
this connection, viz.,
(i) A cheque crossed generally by the drawer can be converted
into a specially crossed cheque by the holder.
(ii) A cheque specially crossed cannot be converted into a
generally crossed cheque by the holder by striking out the
name of the banker, because this will amount to a material
alteration u/sec.87 and will vitiate the cheque.
(iii) If the banker is crossing the cheque then he can do so only
in favour of another bank which is its agent for collection
purposes.
(iv) In case of double crossing by the bank, the banker before
payment should ascertain that the second bank is an agent
of the first.
(v) If an uncrossed cheque is indorsed in favour of the banker,
then the banker can cross it specially to himself ie., in his
favour.
A commercial practice has of late developed of cancelling the
crossing by writing please pay cash within the crossing lines
and signing or initiating it. The cheque is then said to be opened.
This practice has no legal basis and it is not really advisable for
the bank to act on its basis because if the bank does pay the
cash over the counter and it turns out that the payment has not
been made to the true owner of the cheque the banker is not
protected. In view of this, the London Clearing House Bankers
have passed the resolution in the following terms;
That no opening of cheques be recognised unless the full
signature be appended to the alteration and then only when
presented for payment by the drawer or by his known agent.
[Bhashyam, P.725].
6.3 PAYMENT OF CROSSED CHEQUE
A) Payment of crossed cheques
A crossed cheque as mentioned before is a direction to the
banker to pay the money only through another banker. The
banker to whom money should be paid is:
a) In case of general crossing - the banker with whom the
payee holder has an account.
b) In case of special crossing - the bankers in whose favour
the cheque is crossed or the agent of such banker (sec.126).
The objective of crossing a cheque cannot be better stated
than in the words of the preamble to the statute of 19 and
20, Victoria Ch.25 which states that: It would conduce to
the case of commerce, the security of property and the
prevention of crimes, if drawers or holders of drafts on
bankers payable to bearer, or order, on demand, were
enabled effectually to direct the payment of the same to be
made only to, or through some banker.
If a cheque has been specially crossed more than once, then
according to sec.127 the banker on whom it is drawn shall refuse
to pay on it, unless the second banker is an agent of the first
and the second crossing has been done for collection purposes.
B) Payment in due course of crossed cheque:
Once a banker on whom a crossed cheque has been drawn has
paid the amount on it in due course, he can debit the drawer
with the said amount in his accounts with him. The drawer or
any other person cannot hold the banker liable or charge him
for having paid that amount, even if the amount has not been
received by the true owner of the cheque (sec.128). But if the
banker makes the payment contrary to the provisions of sections
10 or 126, then the banker cannot charge the drawer with the
amount if it has not been received by the tue owner, i.e., if a
banker does not pay the money as per the rules and by some
mischance the money is not received by the true owner then he
will be personally liable to the true owner for the amount
(sec.129).
The term true owner itself has not been defined by the Act,
but it is logical to assume that there cannot be two true owners
of a cheque. A holder in due course or the payee of a cheque
will of course be considered as true owners. Similarly if the
cheque has been stolen, the person from whom it is stolen
remains the true owner i.e., the thief merely by virtue of being
in possession does not become the true owner. In short therefore,
a true owner is one in lawful possession of the cheque.
6.4 PROTECTION OF THE COLLECTING BANKER
Since a crossed check can be paid only by bankers and to a
banker, the Act also provides certain protection to the banker
who acts with due care and diligence in collecting the payment
on a crossed cheque. This protection is incorporated under
sec.131 which states as under:
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 crosed cheque
for a customer within the meaning of this section not
withstanding that he credits his customers account with the
amount of the cheque before receiving payment thereof.
160
For the application of this section the following conditions have
to be satisfied, viz;
l) For a customer
The first requirement is that the banker should have collected
the money on the crossed cheque on behalf of a customer i.e.,
he should not have collected the amount for himself. A customer
may be loosely defined as a person having an account with the
bank. In Taxation Commissioners v.English, Scotish &
Australian Bank [(1920)AC 683] it was thus observed. The
word customer signifies a relationship in which duration is
not of the essence. A person whose money has been accepted
by a bank on the footing that they undertake to honour cheques
up to the amount standing to his credit is a customer of the
bank in the sense of the statute, irrespective of whether his
connection is of short or long standing. There must be an
existing account at the time when the cheque is received for
collection even if it is opened by means of the same cheque and
for the very purpose of collecting it [Ladbroke & Co.V.Todd,
(l9l4) 111LT 43]. One bank may be customer of another bank.
2) As Agent
Secondly, the payment should be received by him as an agent
of the customer, because the protection is accorded only to
situations where the bank has acted mechanically to provide
collection facility. If the banker receives payment as holder of
a cheque then he loses the protection. It is always a question
of fact as to whether the banker had received payment as an
agent or a holder. In Capital and Counties Bank V.Gordon,
London City and Midland Bank V.Gordon[(1903)AC 240],
one Jones, the plaintiffs clerk, stole a number of cheques
payable to the plaintiff, indorsed them to himself and paid them
into his account with both the above banks. In each case the
amount was immediately credited to his account and he was
either permitted to withdraw the money or his overdraft wiped
out before the cheques were cleared. In both cases, the bankers
were held liable because they had received payment not as
agents but as holders for value of the cheques. It was observed
that As between the customer and the bank, there was an
arrangement or course of practice under which the bank allowed
the customer to draw against the amounts of cheques paid in
and credited before they were cleared. But according to the
explanation appended to the section mere crediting of the
amount to the creditors account does not convert the banker
into a holder. To be deemed a holder there must be an express
or implied agreement between the banker and cutomer allowing
the latter to withdraw the money before it has been actually
collected.
3) Crossed Cheque
The protection is available only in case of crossed cheques. In
case of uncrossed cheques, the banker is not protected if the
customers title is defective. Nor can he seek protection of this
section, if he himself crosses the cheque subsequent to receiving
it.
4) Good faith and without negligence
The last requirement is that the banker should have acted in
good faith i.e., bonafidely and without any negligence. If there
is something about the cheque which is suspicious, then the
bqanker is required to make due inquiries,and if he fails to do
so then he will be guilty of negligence. The extent of inquiry
varies from case to case. Sometimes the banking history of the
customer may become the cause of suspicion. Thus in Motor
Traders Guarantee Corpn. V. Midland Bank [(l937) 157
LT 498], a cheque was collected on behalf of a customer who
had misappropriated it by forging an indorsement. The banker
did make some inquiries but not as much as the antecedant
history of the customer whose cheques had been frequently
dishonoured, demanded or required. The bankers were held
guilty of negligence. This does not mean that a banker should
view every new customer suspiciously as a potential criminal.
Thus an enquiry is necessary only when the circumstances
demand or justify it, because as succintly stated by Scrutton LJ
in A.L.Underwood Ltd., v. Barclays Bank [(l924) 1 KB 775],
If banks for fear of offending their customers will not make
inquiries into unusual circumstances, they must take, with the
benefit of not annoying their customers, the risk of liability
because they will not inquire. In Marfani v. Midland Bank
Ltd.[(l968)1 Lloyds Rep 411] Mield J.lay down the following
guidelines in this regard:
(i) That the standard of care is to be denied from the ordinary
practice of bankers. (ii) That the standard of care required of
bankers did not include the duty to subject the account to
microscopic examination. (iii) The bank must not have been
negligent in accepting a new customer and opening a new
account. (iv) The onus lay on the bank to show that it had acted
without negligence. In Indian Overseas Bank v. Industrial
Chain Concern [(1990) ISCC 484] the Supreme Court
emphasised one more point in connection with this duty, i.e.,
while collecting a cheque for a customer the banker is under
an obligation to present it promptly so as to avoid any loss due
to change of circumstances.
161
SUB TOPICS
7.1 Introduction
7.2 Kinds of discharge
7.1 INTRODUCTION
Discharge in the legal sense means a release from liability.
Discharge of a negotiable instrument therefore means the release
of liability on that instrument. A differentiation must be made
between the discharge of parties to the instrument and discharge
of the instrument itself. Discharge of an instrument means the
extinguishment of all rights of action on it. In such a situation
the bill ceases to be negotiable and if later reaches the hands of
a holder he acquires no right of action on it. But the discharge
of a party does not automatically result in the discharge of the
instrument. For example, merely because one of the indorsers
has been discharged from his liability on the bill does not mean
that the bill itself has been discharged not does it effect the
liability of the other parties to the bill. Sections 82-90 of the
Act deal with various circumstances when the parties to an
instrument are discharged from their liability.
7.2 KINDS OF DISCHARGE
The following flow chart depicts the various situations in which
the liability in discharged.
A] By act of parties
(i) By cancellation: When the holder or his agent deliberately
cancel a bill and the cancellation is apparent on the face of it,
the bill is discharged and the parties to the bill are released
from their liability. If the cancellation is not apparent then the
instrument remains valid in the hands of a bonafide holder. Thus
in Ingham V.Primrose[141 ER 745], A accepted a bill and
gave it to B for the purpose of getting it discounted and handing
over the proceeds to A.B, having failed to discount it, returned
the bill to A, who tore it in half intending to cancel it, threw the
two pieces into the street. B picked them up and afterwards
pasted the two pieces in such a manner that the bill seemed to
have been folded for safe custody rather than cancelled. B
then put the bill into circulation and it finally reached the plaintiff
a holder in due course. The plaintiff sued A on the basis of the
bill. It was held that A was liable, because the tearing of the
bill into two pieces was not so clearly manifested on the face of
the bill as to indicate to a reasonably careful person that it had
been cancelled. Tearing of the instrument must be such that a
man of ordinary intelligence and caution should at once come
to know that it has been cancelled.
Sec.82(a) deals with a situation where the holder with
deliberation cancels out not the instrument as such, but the name
of the acceptor or indorser. When the name of the acceptor is
cancelled, all other subsequent parties being sureties for the
acceptor are also discharged from their liability i.e., the effect
of cancelling the acceptors name is the same as the effect of
cancelling the instrument itself. But, where the holder cancels
out the name of an indorser then the parties subsequent to the
cancelled indorser stand discharged but those prior to such an
indorser remain liable on the instrument.
(ii) By release: A holder of an instrument can release the
acceptor or indorser from their liability either by a separate
agreement or by an act which has the effect of discharging them.
Effect of release is the same as that of cancelling a name.
(iii) By payment: The most obvious way of discharging the
liability is by making the payment on the bill. Payment acts as
discharge only if it is made in due course as defined in sec.10
which states that:
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 do not afford a reasonable ground for
7. DISCHARGE FROM LIABILITY
we will now discuss each one of these kinds.
Discharge
By act of parties By operation of law Other circumstances
(Sec. 82) (Sec. 83-90).
Cancellation Release Payment Insolvency Merger Lapse of Discharge of
time one of joint drawers etc
162
believing that he is not entitled to receive payment of the amount
therein mentioned. Thus payment to be effective must be made
on the maturity of the instrument & payment before maturity
does not act as discharge unless the instrument is cancelled or
on the face of the bill the words paid etc., are prominently
written. Similarly, payment should be .rm 7.5"
made to a person authorised to receive it i.e., the holder in
rightful or lawful possession. Lastly, it should be made in good
faith and without negligence.
B] By Operation of Law
The Act does not make any specific reference to the discharge
of parties by operation of law may be because these situations
are too logical and common place to merit a special mention
i.e., they are situations where it is logical to presume discharge
though no mention is made in the Act iself. These situations
are given below:
i) Due to insolvency: If in an insolvency proceeding, the
maker, acceptor or indorser is discharged by the court he will
be discharged of his liability on the bill.
ii) By merger: Merger as the name implies means joining.
The joining may be of cause of action & of parties. Thus, when
a judgement is obtained against the acceptor maker or indorser,
the debt under the bill is merged with the judgement debt. But
such a merger acts as discharge only when the judgement debt
is paid off i.e., mere obtaining a judgement does not act as a
discharge. Secondly, when the acceptor of a bill becomes the
holder of it also either at or after its maturity in his own right
the bill is discharged.
iii) Lapse of time: If the holder does not file a suit for recovery
of the bill amount till the time prescribed by Limitation Act is
prescribed, his remedy to enforce his right is extinguished. It
is to be noted that his right itself does not get extinguished nor
is the acceptor etc., discharged of his liability but because the
right to enforcement is not there, the acceptor is effectively
discharged unless he wants to pay the time barred debt.
iv) Discharge of one party: In certain exceptional situations
discharge of one of the several joint drawers would release the
remaining also from their liability.
C] Other circumstances
i) Allowing more than 48 hrs for acceptance - If the holder
allows the drawee more than 48 hrs for deciding on whether he
wants to accept it or reject it, then all prior parties who have not
consented to such extended allowance are discharged from their
liability to the holder (sec.83).
ii) Qualified acceptance - The acceptance of a bill should be
unconditional and unqualified. If the holder acquiesces in a
conditional or qualified acceptance from a drawee/indorser then
according to sec.84 the previous parties to the bill are discharged
of their liability.
iii) Delay in presenting cheque - A cheque once issued should
be presented to the banker-drawee within a reasonable time. If
the holder fails to do so and in the meantime something happens
(for ex: failure of the bank) the drawer is discharged of his
liability, provided that he had sufficient balance in the bank to
pay off the cheque if it had been presented at the right time.
Illustration (a) to sec.84 is as follows:
A draws a cheque for Rs.1,000/- and when the cheque ought to
have been presented, he has funds at the bank to meet it. The
bank fails before the cheque is presented. The drawer is
discharged, but the holder can prove against the bank for the
amount of the cheque.
What is a reasonable time depends on the facts and
circumstances of each case. Where the banker and holder are
in the same place, the cheque should be presented the day after
its receipt, as far as possible. But if the holder and banker are
in different places then time for transit has also to be taken into
consideration. A crossed-cheque takes more time to reach the
drawee-banker and therefore, time necessary for clearance is
excluded in determining reasonable time.
iv) Material alteration - Byles on Bills of Exchange has in
relation to effect of alteration observed as follows:
At common law it has been held that a deed, bill of exchange,
promissory note, guarantee, is avoided by an alteration in a
material part, made while it is in the custody of the plaintiff
although that alteration is by a stranger. For a person who has
a custody of an instrument is bound to preserve it in its integrity;
and as it would be avoided by his fraud in altering it himself, so
it shall be avoided by his laches in suffering another to alter it
[Avtar Singh, p.784].
Section 87, 88 & 89 deal with alteration of an instrument and
its effects. For these sections to apply the following conditions
have to be satisfied, viz.,:
a) Intenational - The alteration to the instrument must be
intentional and deliberate i.e., it should not be by mistake or by
accident. Thus in Hongkong and Shanghai Banking Corpn.,
v. Lo Lee Shi [(1928) AC 181 (PC)], the respondent was given
two notes of $ 500 each by her husband. She placed then in the
pockets of her garment and then having forgotten, she washed,
dried, and starched the garments. While proceeding to iron
them she found a wad of paper in the pocket. Subsequently,
the identity of the notes was restored to a certain extent, except
for the numbers on them. When she presented them for payment
the bank refused to pay. The lower courts held the bankers
liable. On appeal, the Privy Council holding the bankers liable
observed, The alternation contemplated is one to which all
parties might assent. It is not reasonable to assume parties
assenting to a part of the document being effected by the
operation of a mouse, by the hot end of a cigarette or by any
other means by which accidental disfigurement can be effected.
It cannot reasonably apply to the ravages of a rat, white-ant or
any other animal pest.
b) Material: For an alteration to act as a discharge it should be
of a material part of the instrument. As observed by Devlin, J
in Qwei Tek Choo v. British Traders and Shippers Ltd.
[(1954) 2 QB 459], One must examine the nature of the
alteration and see whether it goes to the whole or to the essence
163
of the instrument or not. If it does, and if the forger corrupts
the whole of the instrument or its heart, then the instrument is
destroyed; but if he corrupts merely a limb, the instrument
remains alive, though no doubt defective. Our own Supreme
Court in Loonkaran Sethiya V. Ivan E.John [(1977) I SCC
394] observed as follows:
A material alteration is one which varies the rights, liabilities
or legal position of the parties as ascertained by the deed in its
original state, or otherwise varied the legal effect of the
instrument as originally expressed, or which may otherwise
prejudice the party bound by the deed as originally executed.
Sec.64(2) of the English Bills of Exchange Act, l882 states as
follows:
In particular the following alterations are material, namely,
any alteration of the date, the sum payable, the time of payment,
and where a bill has been accepted generally, the addition of a
place of payment without the acceptors assent.
But an alteration which is neither material nor substantial, as
already mentioned does not act as a discharge. Further the Act
itself permits three kinds of alteration as given below:
i) A person to whom a stamped and signed instrument has
been issued either wholly or partly in blank has an authority
under sec.20 to complete the instrument by filling in the
blanks, even if he exceeds the actual authority vested in
him while completing the instrument.
ii) The holder of an instrument indorsed in blank has an
authority under sec.49 to convert it into an indorsement in
full.
iii) The holder of an uncrossed cheque may cross it, or he may
convert the general crossing on the cheque to a special
crossing under sec.125. Further, a bankers to whom a
cheque has been crossed specially, may again specially cross
it in favour of his agent-banker for collection purposes.
Section 88 further does not apply to the following cases viz;
l) An acceptor or indorser cannot complain of any alteration
which was made before his acceptance or indorsement,
because the section itself reads as, An acceptor or indorser
of a negotiable instrument is bound by his aceptance or
indorsement notwithstanding any previous alteration of the
instrument.
2) Alterations which re made in accordance with the common
or mutual intention of the parties cannot be complained of.
3) A party cannot complain of an alteration to which he has
expressly or impliedly assented.
4) An alteration made before it becomes a negotiable
instrument does not vitiate the instrument.
c) Apparent: Lastly, the alteration should be such as is apparent
on the face of the instrument, otherwise it remains as a valid
security in the hands of a holder in due course. Sec.89 dealing
with this issue states that:
Where a promissory note, bill of exchange or 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 same 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.
Thus, if a party makes payment on a bill which has been altered
but not noticeably so, the party paying will be discharged by
payment in due course. But the acceptor in such a case will be
liable only for the original and not the altered tenor of the
instrument. Thus in Scholfield V.The Earl of Londesborough
[(1896) AC 514], a bill for 500 was presented for acceptance
with a stamp of much larger amount than necessary and with
spaces left on it. The acceptor wrote his acceptance and handed
the bill to the drawer, who fraudulently filled in the spaces
turning it into a bill for 3,500/- and negotiated it for that value
to a bonafide holder. In an action against the acceptor it was
held that the acceptor was liable only for what he accepted to
pay, namely 500. The acceptor of a bill of exchange is not
under a duty to take precautions against the fraudulent alteration
in the bill after acceptance.
Extinction of debt
Generally speaking, in cases of material alteration, a holder
loses his rights under the bills but the consideration paid by
him for the bill is not extinguished. Though he cannot enforce
the bill he can still sue on the consideration. But sec.87 provides
that wherever an alteration is made by an indorsee, the indorser
will be discharged from his liability to him even in respect of
the consideration. Thus where alteration is introduced by an
unauthorised person i.e., a stranger and not by the indorsee,
then though the instrument is avoided, the indorsee can still
sue his indorser on the consideration paid by him.
v) By negotiation back: When a BOE comes back to the
original acceptor in the regular course of negotiation, and he
becomes the holder of that instrument, it is known as
negotiation back. When this happens at or after maturity, all
liability on the instrument comes to an end (because of the
merger of acceptor and holder into one person). Sec.90 provides
that If a bill of exchange which has been negotiated is, at or
after maturity, held by the acceptor in his own right, all rights
of action thereon are extinguished. The reason for this principle
can be best stated in the words of Best,CJ, in Meale V.Turton
[(1827) 4 Bing l49: 130 ER 725], There is no principle by
which a man can be at the same time plaintiff and defendent.
The only essential condition for application of this section is
that the acceptor must have become the holder in his own right
and not in any other way.
164
SUB TOPICS
8.1 Introduction
8.2 Notice of Dishonour
8.3 Noting
8.4 Protest
8.1 INTRODUCTION
As mentioned in the earlier chapters a negotiable instrument
can be dishonoured by the drawee, acceptor or maker either
when it is presented for acceptance or for payment. Sections
91 & 92 of the Act dealing with dishonour state as follows 91.
Dishonour by non-acceptance A bill of exchange is said to
be dishonoured by non-acceptance when the drawee, or one of
the several drawees not being partners, makes default in
acceptance upon being duly required to accept the bill, or where
presentment is excused and the bill is not accepted.
Where the drawee is incompetant to contract or the acceptance
is qualified, the bill may be treated as dishonoured.
92. Dishonour by non-payment A promissory note, bill of
exchange or cheque is said to be dishonoured by non-payment
when the maker of the note, acceptor of the bill or drawee of
the cheque makes default in payment upon being duly required
to pay the same.
When a duly accepted instrument is paid up when presented it
is discharged. In the previous chapter we have seen the various
modes of discharge. We would now study the procdure to be
followed if a negotiable instrument is dishonoured either for
acceptance or payment.
8.2 NOTICE OF DISHONOUR
Once a negotiable instrument has been dishonoured whether
for acceptance or payment a notice of such dishonour has to be
given in accordance with the requirements of sec.93 which states
that :
When a promissory note, bill of exchange or cheque is
dishonoured by non-acceptance or non-payment, the holder
thereof, or some party thereto who remains liable thereon, must
give notice that the instrument has been so dishonoured to all
other parties, whom the holder seeks to make severally liable
thereon, and to some one of several parties whom he seeks to
make jointly liable thereon.
Nothing in this section renders it necessary to give notice to
the maker of the dishonoured promissory note, or the drawee
or acceptor of the dishonoured bill of exchange or cheque.
Thus, notice of dishonour must be given by the holder of the
instrument or any other party who has remained liable on it to
all those persons whom he seeks to charge. If such a notice is
not given the parties to the instrument stand discharged.
Reason of the rule
Why the law requires prompt notice of dishonour is to enable
the drawer of the bill and other indorsers to withdraw their effect
from, or prevent them from reaching, the hands of the drawee
or acceptor, and also to enable such persons to protect their
interest by taking the necessary measures for obtaining payment
from all other parties liable to them. The necessity for such
notice will be apparent from the nature of the contract of the
several persons who become parties to a negotiable instrument,
either as drawers or indorsers. All the contracts raised upon
the bill, it is seen, except those with the acceptor are contracts
of suretyship, that is to say, are contracts of indemnity. Probably
from this, though perhaps from other more strictly mercantile
circumstances, as for the purpose of making other preparations
or modifications in business, notice of dishonour is by the law
merchant made a condition of the liability of the surety. The
contracts of indorsement then between the immediate parties
to them are conditional and are by way of indemnity. It follows
from this last, that there can be no valid claim in respect of the
indorsement where there is no liability in respect of it. And the
two together are the reason why a failure by any indorsee to
give due notice of dishonour not only disables him from
recovering against the immediate indorser, but disables a prior
indorser to him from recovering against his indorser or a prior
indorser to him, the indorseee who has failed to give notice
cannot recover, because he has not fulfilled the condition of his
contract. The others cannot recover, because, as they cannot
be made liable, they do not require to be indemnified. For
example, the indorser to him who has failed to give due notice
is not liable to him, and therefore cannot claim against his own
indorser, and therefore, again, such last indorser cannot claim
against his indorser, and so on.
Sec.94 of the Act deals with the mode in which a notice may be
given and states as follows :
Notice of dishonour may be given to a duly authorised agent
of the person to whom it is required to be given, or, where he
has died, to his legal representative, given, or where he has
been declared an insolvent, to his assignee, may be oral or
written; may, if written, be sent by post, and may be in any
form; but it must inform the party to whom it is given, either in
express terms or by reasonable intendment,that the instrument
has been dishonoured, and in what way, and that he will be
held liable thereon; and it must be given within a reasonable
time after dishonour, at the place of business or (in case such
party has no place of business) at the residence of the party for
whom it is intended.
If the notice is duly directed and sent by post and miscarries
such miscarriage does not render the notice invalid.
Given below are two specimen forms of notice of dishonour.
I hereby give you notice that the undermentioned bill upon
which you are liable as drawer (or indorser) has been
dishonoured by non-payment (or non-acceptance) and that you
8. OF NOTICE, NOTING AND PROTEST
165
will be held liable thereon. I have to request immediate payment
of the amount of the said bill Rs.... together with expenses
Rs..... Total Rs......
Particulars of the bill
Amount Rs ..... Date ...... Tenor ....... Due .....
Drawer ............ Acceptor ........ Indorser ......... Payable
at ............ Answer given ...........
Date .............
or
I beg to give you notice that a bill for Rs.170-50/-0, dated 1st
January 1995 drawn by S.Raju upon K. Swami payable 3
months after date and indorsed by you has this day been
dishonoured by non-acceptance (or non-payment) and you will
be held liable thereon.
4th April 1995 Signature of the Holder
Any person who receives a notice of dishonour should give a
further notice of such dishonour within a reasonable time to
parties liable prior to him if he wants them to be charged, unless
such prior parties have also received a due notice by the holder
as per the provisions of sec.93 [sec 95]
When is a notice unnecessary ?
A notice of dishonour is unnecessary in any of the circumstances
mentioned under sec.98, viz :
a) when it is dispensed with by the party entitled to get such a
notice; or
b) when the drawer countermands payment he is not entitled
to receive a notice; or
c) when no damage will occur to the party being charged by
failure of or not giving of such notice; or
d) when the holder is unable to trace the person entitled to a
notice even after a diligent search or the holder is unable to
give a notice for no fault of his; or
e) no notice is needed to charge the drawer in cases where the
drawer himself is an acceptor; or
f) in cases where the promissory note is not negotiable ; and
g) when the party entitled to notice, unconditionally promises
to pay the amount due on the instrument after being made
aware of the facts.
Sec.98 being an exception to the general rule that a holder of
an instrument should give a notice of its dishonour, any person
who wants to rely on it will have to prove that his case fell
under the exceptions specified under the section. Notice means
something more than mere knowledge. [Carter v. Flower,
(1847) 16 M & W. 173] Thus in Re Fenwick Stobart & Co.
[(1902)1 Ch. 507], one man was secretary for two companies,
one of them being the drawer and indorser, and the other the
indorsee of a bill and no notice of the dishonour, it was held
that the knowledge of the secretary was not to be regarded as
equivalent to notice unless it was shown that it was his duty as
regards the indorsee company to communicate his knowledge
to the drawee company.
8.3 NOTING
On a negotiable instrument being dishonoured the holder
acquires an immediate right or recourse against the drawer and
indorser on the instrument. To charge them with liability he
has first to give a notice of dishonour to them as provided for
uunder sec.93. Sec.99 provides for a convenient mode of
authenticating the dishonour of the bill. This section provides
as under : When a promissory note or bill of exchange has
been dishonoured by non-acceptance or non-payment, the
holder may cause such dishonour, to be noted by a notary public
upon the instrument, or upon a paper attached thereto, or partly
upon each.
Such note must be made within a reasonable time after
dishonour, and must specify the date of dishonour, the reason,
if any, assigned for such dishonour, or, if the instrument has not
been expressly dishonoured, the reason why the holder treats it
as dishonoured, and the notarys charges .
A noting is by way of minutes made on the bill or note or
partly on such bill and partly on a separate piece of paper
attached to such bill. A noting should specify the following,
viz :
a) the fact of the bill or note being dishonoured;
b) the date of such dishonour;
c) if some specific reasons have been given for dishonouring
the bill, then such reasons;
d) where the instrument has not been specifically dishonoured,
the reasons for the holder treating the bill or note as being
dishonoured;
e) the notarys charges;
f) a reference to the notarys register; and
g) the notarys initials.
When the holder wants a bill to be noted, he takes it to a notary
public appointed under the Notaries Act, 1952. The Notary
public represents it for acceptance or payment, (as the case may
be) and if the drawee or acceptor still refuses to accept or pay
the bill, he notes the bill giving all the above mentioned
particulars. He also attaches a slip of paper mentioning the
essence or substance of the answer of the drawer or acceptor,
for example, No advice or no effect. The advantage of
following this course of action is that a notary being a person
well versed in the transactions, is better qualified to advise the
holder as to the proper course of action to be followed in
presentment of the bill, and in a trial could be a reliable witness
of the presentment and dishonour of the bill or note. Further in
the words of Bhashyam and Adiga (p.658) noting being so
generally practised, the circumstance of its not having been
done, would tend to render the other parties to the bill or note
suspicions of irregularity and more reluctant to pay; it would
almost certainly raise a prejudice in the minds of jury against
the plaintiff, if upon a trial, the due presentment should be
disputed. Moreover, by the noting, the presentment and
dishonour of the bill may, with ease, at any time, be traced by
reference to the register or protest-book preserved in the notarys
office, if the original should be lost. For this reason, though
166
under the Act itself noting has been made optional, it is better
for the holder to get it done for his own benefit. Under Sec.105,
a notary public should do the noting within a reasonable time
of dishonour, as far as possible on the day of dishonour or on
the next business day, unless the delay is caused by
circumstances beyond the control of the holder.
Thus in Rothschild v. Currie [113 E.R. 1045], a bill drawn on
an acceptor in Paris and payable there, the day on which the
protest had to be made was a holiday when the public registry
was closed in consequence of which owing to pressure on the
office the following day, the notary was unable to effect
registration till after post time that day, it was held that a notice
sent the day was good because due diligence had been used.
Advantages of notice
a) Wherever protest is required to be made within a specified
time, it is sufficient if noting is made within that time though
the protest may be drawn up later [sec 104.A]
b) A BOE may be accepted for honour under sec.108, after
noting through protest is not made.
c) A BOE may be paid for honour after noting, and the person
paying need not wait for protest [sec 113] Further, noting
is of the greatest advantage wher the bill is for a large
amount of where legal proceedings are likely to be instituted
or where there are several indorsers whose liability the
holder seeks to secure.
8.4 PROTEST
The noting by a notary public of a dishonoured negotiable
instrument is called as protest. Sec.100 dealing with protest
states as under :
When a promissory note or bill of exchange has been
dishonoured by non-acceptance or non-payment, the holder
may, within a reasonable time, cause such dishonour to be noted
and certified by a notary public such certificate is called a protest.
Protest for better security
When the acceptor of a bill of exchange has become insolvent,
or his credit has been publicly impeached, before the maturity
of the bill, the holder may, within a reasonable time, cause a
notary public to demand better security of the acceptor, and on
its being refused may, within a reasonable time, cause such
facts to be noted and certified as aforesaid. Such certificate is
called a protest for better security.
The advantages of protest are similar to those of noting, and
the requiring of protest in case of foreign bills is to provide the
foreign drawer or indorser with an authentic and satisfactory
evidence of dishonour, because otherwise such foreign indorser
or drawer would have great difficulty in making inquiries about
the dishonour and would have to rely on the representations
made by the holder in that regard.
Procedure
The procedure to be followed for protest is the same as that for
noting. Chitty in his Chitty on Bills [cf Bhashyam, p.659] has
given a further procedure in case of protest in the following
words :
The next step for the notary to take is to draw the protest which
is a formal declaraton - on production of the bill itself if it can
be obtained; otherwise, on a copy thereof, - that it has been
presented for payment, and how that payment was refused and
why, and that the holder intends to recover all damages and
expenses which he or his principal or any other party to the bill
may sustain on account of its non-payment. The usual practice
is to enter a minute of the demand of payment, and of the
dishonor of the bill, together with a copy of the same in notarial
register of the notary, and afterwards to draw up the formal
protest, dating it of the day when the bill was presented for
payment; and the instrument so drawn up is as much an original
as if it has been drawn up at the time of presentment,and is
equally admissible in our Courts. Similar procedure is to be
followed in case of dishonour by non-acceptance.
According to the second part of sec.100, a protest may also be
made for demanding better security. This may be done when
the acceptor of a BOE becomes insolvent or his credit is publicly
impeached before maturity of the instrument, or the acceptor
of the bill absconds before that date. The procedure to be
followed by the holder is similar to that in case of noting or
protest, i.e, he employs a notary public to make the demand on
the acceptor and if refused, protest is made and the prior parties
are given a due notice of it. Only the holder is entitled to make
a protest for better security, but on the other hand the acceptor
is not bound to give such security. The holder cannot as a matter
of course compel the drawer or indorser to give such security,
nor does he get an immediate right of recourse against them i.e.
he has to wait till the date of maturity before taking action. A
holder is not required under the Act to adopt this procedure,
and failure on his part to do so does not in any way discharge
the parties to the instrument of their liability. The basic
advantage of adopting this procedure is that after protest the
bill may be accepted for honour and enables the drawer and
indorsers of the bill to make arrangements for the payment of
the bill by other means. But a notary, before drawing up a
protest for better security should make full and complete
inquiries and satisfy himself that the acceptor has indeed
become a bankrupt or an insolvent or has suspended payment
within the meaning of the Act. After the bill becomes due and
payment is not made on it, another protest must be made for
non-payment.
Though the section itself does not mention it, a protest should
be made in the place where the bill is dishonoured as far as
possible, except in cases where the bill is returned dishonured
through post, in which case protest should be made at the place
of return. This atleast is the law laid down in sec.51(6) of the
English Bills of Exchange Act.
Contents of protest
According to sec.101 a protest should contain the following
ingredients, viz:
i) Instrument or transcript - A protest should contain either
the actual instrument itself or a literal transcript of it, for
purposes of identification and to later prevent any questions
167
being raised regarding the instrument being dishonoured
and protested.
ii) Names of parties - The names of both the person making
the protest as also the person on whom the demand for
acceptance or payment have to be mentioned.
iii) Reason of dishonour, etc - In cases where the drawee or
acceptor have given reasons for dishonouring the instrument
for acceptance or payment, such reasons must also be
recorded.
iv) Time of demand and dishonour - It is important that the
time of both demand and dishonour should be mentioned
in the notarial certificate, else it would be difficult to know
from the protest whether the bill was duly dishonoured or
not. This is also necessary because the formal protest itself
may be extended at any time after the date of noting.
Similarly, place of dishonour is important in ascertaining
whether there has been a dishonour in law, because if a bill
was payable only at a specified place, the certificate will
be defective unless it states the place of presentment and
demand.
v) Signature and seal - It is logical to assume that for a
certificate to be valid the notary public has to affix his
signature on it. Though the section itself does not lay any
stress on the use of notorial seal it is the usual practice
for the notary public to affix both his seal and signature.
Absence of seal may result in admission of the protest as
evidence in a foreign court and so it is prudent for the holder
to insist that the notarial seal should also be affixed. It
would be well to mention that a form of protest should
conform to the law of the country where it is being made.
Thus, in an action on a bill drawn in England and accepted
by a French house, it was held that it was sufficient if it
was proved that such note of dishonour and protest as was
required by the law of France was given, even though the
parties between whom this was decided (i.e the indorsee
and payee) were domiciled in England [Rouquett v.
Overmann, (1875) L.R. 10 Q.B. 525]
vi) Acceptance for honour - This clause is slightly redundant
now after the amendments to sections 108 and 109, allowing
acceptance for honour and payment for honour to be made
without the notarys intervention.
vii) Demand by notarys clerk or by post - This clause was
added by Act 11 of 1885, and allows a demand to be made
by the notary either through his clerk or by a registered
post if the custom or usage allows such a demand or there
is a specific agreement in this regard.
viii)Mistakes in protest - Absence of any one of the above
ingredients will render the protest invalid. But a small or
trivial mistake, for example, a mistake in the Christian
name of the parties, or a spelling mistake, or an incorrect
date of the bill wrongly inserted, will not render the protest
invalid provided such a mistake does not mislead the other
party.
ix) Stamp for protest - For a protest to be legally valid it
must be duly stamped ie it should be on a One Rupee Stamp
Paper [Art 50 of Indian Stamp Act, 1899] or on such stamp
as may be prescribed under some other relevant statute.
Notice of protest
According to sec.102, whenever notes and bills are required to
be protested, notice of protest must be given instead of notice
of dishonour, for example, in case of foreign bills all those parties
whom the holder wants to charge with liability are entitled to
insist on being served with a notice of protest. But the section
is not clear on whether along with the notice a copy of protest
should also be sent or not. The English law on this issue was
however settled in Goodman v. Harvey [111 E.R. 1011]
wherein it was held that in giving notice of dishonour to the
drawer of a foreign bill resident abroad, it is sufficient to inform
him that the bill had been protested, without actually sending
him a copy of the protest. It is to be presumed that the same
rule of law would apply in India also.
Since the rules governing the giving of notice of protest are the
same as those governing notice of dishonour, therefore a notice
of protest may be waived in the same way as dishonour, either
by expressly dispensing with such notice or by a subsequent
promise to pay the amount of the money due under the
instrument, because as Lord Ellenborough observed in Gibbon
v. Coggen [170 E.R. 1124], By the promise to pay, he admits
his liability; he admits the existence of everything which is
necessary to render him liable. When called upon for payment
of the bill, he ought to have objected that there was no protest.
Instead of that he promises to pay it. I must therefore presume
that he had due notice, and that a protest was regularly drawn
up by a notary. So also any other circumstance whch would
result in dispensing with the notice of dishonour would also act
as a dispensing of a notice of protest. In India, unlike England,
notice of protest may be given either by the holder or by the
notary who makes the protest.
Place of protest
Sec.103 which deals with a situation where a bill has been
protested for non-acceptance, states as under :
All bills of exchange drawn payable at some other place than
the place mentioned as the residence of the drawee, and which
are dishonoured by non-acceptance, may, without further
presentment to the drawee, be protested for non-pament in the
place specified for payment, unless paid before or at maturity.
Under the English law protest must be made at the place of
dishonour. According to sec.103, where a bill payable at a
place different from the drawees residence, is dishonoured by
non-acceptance, there is no need for the holder to make a
demand for payment. He can straightaway protest for non-
payment at the place specified for payment, unless the bill has
been paid up before or at maturity. The basic difference between
the English and Indian law is that in England protest has to be
made at the place where the bill is made payable, whereas in
India protesting at the specified place is left to the option of the
holder.
168
SUB TOPICS
9.1 Definitional aspects
9.2 Presumptions under the Act
9.3 Estoppel under the Act
9.1 DEFINITIONAL ASPECTS
Before dealing with presumptions and estoppels under the
Negotiable Instruments Act it would be better if we first try to
understand the meaning and scope of these words.
Presumptions
A presumption is an inference of the existence of some fact,
which is accepted without evidence because this fact follows
logically from some other fact which has already been proved
or is assumed to exist. When a fact is presumed it does not
mean that it has been actually proved, it is just assumed to have
been proved. It is a rule laid down for reasons of administrative
convenience rather than anything else, because it saves a lot of
time and energy when the judge presumes certain facts without
requiring them to be proved in the regular manner i.e. by
adducing evidence, examination and cross examination of
witnesses etc. Sec.4 of the Indian Evidence Act, 1872 classifies
presumptions under the following categories, viz :-
(1) Presumption of fact;
(2) Presumption of law; and
(3) Conclusive proof
(1) Presumptions of fact (or may presume)
These are inferences which may be naturally or logically drawn
from the experience and observation of the course of nature,
constitution of human mind, the springe of human action, the
usages and habits of society and ordinary course of human
affairs. They are akin to may presume [Syad Akbar v. St. of
Karnataka, AIR 1979 SC 1848]. As the phrase may presume
itself suggests, it is not obligatory on the part of the court to
presume these facts i.e. it is left to the discretion of the court to
decide whether they want particular fact to be proved in the
usual course or whether they want to presume its existence.
(2) Presumptions of law (or shall presume)
These are artificial presumptions of inferences or propositions
established by law. In case of acts which the court shall
presume no discretion has been left to the court, and it is bound
to presume the existence of that fact till evidence is given by
the interested party to rebut or refute or disprove it. The
difference between may presume and shall presume can be
stated in the following words:
Whenever it is provided by this Act that the court may presume
a fact, it may either regard such fact as proved, unless and until
it is disproved, or may call for proof of it. In such a case, the
presumption is not a hard and fast presumptionm incapable of
rebuttal.
Under this Act the term shall presume a fact means court shall
regard such fact as proved, unless and until it is disproved. In
such cases a Court has no option but to take the fact as proved
until evidence is given to disprove it, and the party interested in
disproving it must produce such evidence if he can. The
presumption is not conclusive but rebuttable [Dayal, p.26].
(3) Conclusive proof
One fact is said to be the conclusive proof of another, when, on
the proof of the first fact the court regards the other as
automatically proved and does not allow evidence to be given
to rebut or contradict it. This generally applies to those cass
where the court feels that it would be against governmental or
societal interest to keep the dispute open for further debate or
discussion on it. Thus, presumptions of conclusive proof are
those to disprove which the court does not allow any evidence.
They are inferences, which law lays down in an absolutely
peremptory tone and which cannot be overruled or
contradicted by any evidence howsoever strong. This is
obviously the strongest of presumptions.
Estoppel
Sec.115 of the Evidence Act defines estoppel as :
When one has, by his declaration, act or omission, intentionally
caused or permitted another person to believe, a thing to be
true and to act upon such belief, neither he nor his representative
shall be allowed, in any suit or proceeding between himself
and such person or his representative, to deny the truth of that
thing.
Estoppel is an evidentiary rule based on the principles of justice,
equity and good conscience, because it would be unjust for a
person to suffer loss or damage because of some course of action
which he has undertaken merely on the strength or basis of a
representation made by another.
In Dhipan Singh v. Jugal Kishore [AIR 1952 SC 145] the
essentials of estoppel have been stated as under, viz :
(1) There must be a representation of an existing fact as distinct
from a mere promise defuture made by one party to the
other;
(2) The other party, believing it, must have been induced to
act on the faith of it; and
(3) He must have so acted to his detriment.
Thus, not only should the person have acted on representation
but he must also have suffered a loss or detriment because of
the act. If he profits from the fact or gains an advantage due to
the act he cannot take the defense of this rule of estoppel.
9.2 PRESUMPTIONS UNDER THE ACT
Presumptions relating to negotiable instruments are dealt with
under sections 118 and 119,which state as under :
Sec. 118. Presumptions as to negotiate instruments - until
the contrary is proved, the following presumptions shall be
made:-
9 PRESUMPTIONS AND ESTOPPELS
169
(a) of consideration - that every negotiable instrument was
made or drawn for consideration, and that every such
instrument, when it has been accepted, indorsed, negotiated
or transferred, was accepted, indorsed, negotiated or
transferred, for consideration;
(b) as to date - that every negotiable instrument bearing a date
was made or drawn on such date ;
(c) as to time of acceptance - that every accepted bill of
exchange was accepted within a reasonable time after its
date and before its maturity ;
(d) as to time of transfer - that every transfer of a negotiable
instrument was made before its maturity ;
(e) as to order of indorsement - that the indorsements
appearing upon a negotiable instrument were made in the
order in which they appear thereon;
(f) as to stamp that - a lost promissory note, bill of exchange
or cheque was duly stamped;
(g) that holder is a holder in due course - that the holder of
a negotiable instrument is a holder in due course : provided
that, where the instrument has been obtained from its lawful
owner, or from any person in lawful custody thereof, by
means of an offence or fraud, or has been obtained from
the maker or acceptor thereof by means of an offence or
fraud, or for unlawful consideration, the burden of proving
that the holder is a holder in due course lies upon him.
Sec. 119. Presumption on proof of protest - In a suit upon an
instrument which has been dishonoured, the Court shall, on
proof of the protest, presume the fact of dishonour, unless and
until such fact is disproved.
Thus all the presumptions under the Act are of the nature of
shall presume ie the court has to accept them as proved unless
they are specifically disproved. Referring to sec.118 on Official
Receiver v. Abdul Shakoor [AIR 1965 SC 920] it was observed
that this section is essentially a product of English law, and the
special rules of evidence laid down in this section have been
intended to apply only as between the parties to the instrument
or those claiming under them. Before the presumptions under
this section can be drawn it would first have to be proved and
admitted that the negotiable instrument itself was duly drawn
and executed. In Visvonata Raghunath Audi v. Mariano
Colaco [AIR 1976 GDD 60] it was observed that there is no
presumption about execution of a negotiable instrument and in
case of a denial by the opposite side the party basing its claim
on such instrument must fully prove its execution. Here, the
alleged executants of a hundi had in their written statement
denied their signature and thumb mark on the document. It
was held that the burden of proving the signature and the thumb
mark was on the plaintiff and on the facts on record the execution
of the hundi was not proved. Let us now consider each of those
presumptions in slightly more detail.
a) As to consideration - Under the Common Law, any person
who seeks to enforce a contract has to prove that he had
paid some consideration. For trade purpose, this rule was
relaxed in respect of negotiable instruments by the usage
and practice, and now every such instrument is presumed
to be honest and supported by consideration. Even before
the coming into force of this Act, this particular usage
gained a statutory recognition as is evident from illustration
(c) to sec 114 of the Evidence Act giving the courts a
discretion to the courts to presume that consideration for a
particular bill or note had been exchanged. The
presumption is only relating to the fact that a consideration
must have passed hands but it does not apply to the actual
quantum of consideration which has to be separately
proved. In Marasamma v. Veeraju [AIR 1935 Mad 769]
Varadacharass J., observed : Any presumption as to
quantum of consideration as distinguished from the mere
existence of consideration, has to be drawn, not by virtue
of section 118, Negotiable Instruments Act, or even under
section 114, Evidence Act, but only from the recitals, it
has long been established that being prima facie evidence
against the parties to the instrument, they may operate to
shift on to the party pleading the contrary, the burden of
rebutting the inference raised by them. But the weight due
to recitals may vary according to circumstances and in
particular circumstances the burden of rebutting them may
become very light, especially when the court is not satisfied
that the transaction was honest and bona fide. So also
the presumption against consideration does not apply to a
criminal cases and the prosecution has to prove that
consideration was in fact paid [Sakhawat v. Emperor, 59
I.C. 198].
b) As to discharge - If the maker of a note pleads discharge,
the onus to prove such discharge is on him. This onus is
particularly heavy if the payee produces the note bearing
no marks or signs of discharge. It must be remembered
that when the entire evidence has been taken the question
of presumption is not of much importance [Marasamma
v. Veerarajan, AIR 1935 Mad 769]. This particular view
appears to be in accured with the verb and the Sentintia
legis (the letter and spirit of law).
c) As to date - Though a date as such does not form an
essential part of the negotiable instruments, whenever such
an instrument is dated the presumption is that it has been
or drawn on that date. Even where an instrument has been
indorsed in the blank and the indorsee fills up the blank
left with reference to the date, this presumption would still
apply. In Kirmany v. Aga Ali [AIR 1928 Mad 919] it was
observed that if a promissory note is proved to be genuine,
and it bears the date and place of exeuction, the presumption
is that it was executed at the place and on the date it shows,
and the onus lies on the party pleading a different place
and date to prove it.
d) As to time of acceptance - In general a bill of exchange is
prima facie deemed to have been accepted before its
maturity or due date and within a reasonable time from its
issue. There is no presumption as to the actual date of
acceptance of the bill. This presumption becomes
applicable when the acceptance is not dated; if the
acceptance bears a date, it will prima facie be taken as
170
evidence of the date on which it was made [Glossop v.
Jacob, 171 E.R. 404], but evidence can be given to show
that it was accepted on a different date [Kirmani v. Aga
Ali, AIR 1928 Mad 919].
e) As to time of transfer - In Lewis v. Parker [111 E.R.
999] it was observed that except where indorsement bears
a date after the maturity of the bill, every indorsement is
prima facie deemed to have been effected before the bill
was overdue. Since there is no actual presumption
regarding the exact date of negotiation, surrounding
circumstances or even a very strong suspicion falling just
short of direct evidence may be used to rebut the prima
faice presumption in the clause.
f) As to order of indorsement - In case of two or more
indorsements on a negotiable instrument, each indorsement
is presumed to have been made in the order in which it
appears in the instrument.
g) As to stamp on lost bills, etc - In case a negotiable
instrument is lost or destroyed the presumption is that
particular instrument had been duly stamped and cancelled.
h) As to holder being a holder in due course - A holder (as
defined in Sec.8) is presumed to be a holder in due course,
for instance, an indorsee from the payee must be presumed
until the contrary is shown to have been a holder in due
course and he is unaffected by the failure of consideration
as between the drawer and the payee. [Sakharam v. Gulab
Chand 16 Bomb. L.R. 743] The holder in such cases has
to prove that he had not only given consideration, but that
when he gave it he did not have sufficient cause to believe
that there was some defect in the transferors title. In Jones
v. Gordon [37 L.T. 477] Lord Blackburn made the
following observation : I take it to be perfectly clear that
when a bill of exchange is on the face of it a good bill, and
there is nothing on the face of it to show the contrary, it
prima facie imports value; prima facie a bill of exchange is
a good bill of exchange, and it is necessary to show the
contrary. But then, I think it is clear both upon the
authorities, and also, as it seems to me, upon good sense,
that when it is shown that a bill of exchange was a fraudulent
one, or an illegal one or a stolen one, in any one of those
cases it being known that the person who holds it was a
party to that fraud, to that illegality, or to that theft, and
therefore could not sue upon it himself, the presumption is
so strong that he would part with it to somebody who could
sue for him that shifts the burden. I should be unwilling to
say precisely whether it shifts the onus upon him to show
that he gave value bona fide so that, although he gave
value he must give some affirmative evidence to show that
he was doing it honestly, or that the onus of proving that he
is dishonest, or that he had notice of things that were
dishonest, remains on the other side, although he is bound
to prove value. The language of the quotation from Baron
Parke would seem to show that the onus as to both shifted;
but I do not think that it has ever been decided. I have no
doubt that in proving value, it may be proved that he himself
took the bill under such circumstances, that although he
gave value, he could not sue upon it. It is to be remembered
that it is only when an offence like fraud, illegality etc. is
proved in the first instance that the burden is shifted. If the
allegong is merely as to absence of consideration between
the original parties, there is no automatic presumption as
to absence of consideration and the defendant has to prove
the allegation.
i) Other presumptions - Apart from specific presumptions
laid down in sec.118 there are a couple of other
presumptions drawn in case of negotiable instruments. For
example, unless a contrary intention appears from the face
of a bill, the holder may treat it as an inland bill. Similarly,
when a bill leaves the hands of the party who has signed it
as maker, drawer or indorser etc; the presumption is that
there was a valid and unconditional delivery and this
presumption is conclusive in the hands of a holder in due
course.
k) On proof of protest - This presumption laid down in
sec.119 does not arise unless there is a proper protest
according to the provisions given under sections 99,100
and 101. Thus in Veerappa Chetty v. Vellayan [10 L.W.
39] it was observed that a mere entry of Noted for non-
payment without date of dishonour or certificate of protest
is not a proper protest, and the presumption under the
section does not apply. This presumption is only regarding
the fact of dishonour, and does not extend as an evidence
of notice or of other collateral facts such as the lack of
funds of the drawer in the hands of the drawee etc. Though
in general a protest operates as prima facie evidence of
dishonour it is open to rebuttal by the other side.
9.3 ESTOPPEL UNDER THE ACT
Sections 120, 121 and 122 deal with estoppels relating to
negotiable instruments and states as under :
120 Estoppel against denying original validity of instrument
No maker of a promissory note, and no drawer of a bill of
exchange or cheque and no acceptor of a bill of exchange for
the honour of the drawer shall, in a suit thereon by a holder in
due course be permitted to deny the validity of the instrument
as originally made or drawn.
121. Estoppel against denying capacity of payee to indorsee
No maker of a promissory note and no acceptor of a bill of
exchange [payable to order], shall, in a suit thereon by a holder
in due course, be permitted to deny the payees capacity, at the
date of the note or bill, to indorse the same.
122. Estoppel against denying signature or capacity of prior
party
No indorser of a negotiable instrument shall, in a suit thereon
by a subsequent holder, be permitted to deny the signature or
capacity to contract of any prior party to the instrument.
Thus, the Act deals with the following estoppels, viz :
171
a) As to original validity - An estoppel u/sec 120 becomes
applicable only if the instrument is duly stamped. Speaking
of estoppels in relation to negotiable instruments, Mr.
Caspersz says : The situation of parties to a commercial
instrument is no doubt to be regarded as one of contract,
the parties having agreed that the instrument is to be funded
upon certain facts. When therefore the position of one by
acting on that agreement is altered, the other ought not to
be allowed to deny it. The resemblance to estoppel by
representation is however an artificial one, since there is
no representation beyond what is in the contract itself.
[cf. Bhashyam p,716].
This section is wider in its scope than the provision in the
Evidence Act; because estoppel under this section precludes
both the drawer and the acceptor to honour from denying the
validity of the instrument as originally drawn, and any
circumstance which might vitiate the contract between the
original parties to the bill cannot be set up by persons mentioned
in the section, such as, fraud, coercion, want of consideration,
etc.
This section does not prevent the drawer of a BOE or the maker
of a note from taking the plea in a suit by the holder in due
course, that he had never drawn or made the instrument and
that his name to it had been forged i.e. in short the plea of non
est factum (not my document); or the plea that the note he
had executed was not for a simple unconditional loan but was
based on certain conditions previously agreed upon, and that
those conditions had not been fulfilled [See Bachan Singh v.
Dharam Arth Bank, 1933 Lah. 456].
(i) Estoppel against acceptor for honour - An acceptor for
honour of the drawer is bound by all the estoppels which
bind the drawer, and so even he is estopped from denying
the validity of the original bill. It is not very clear whether
the acceptor for honour of the drawer can set up the plea
for forgery of the name of the drawer for whose honour he
accepted it ? The English authors unanimously agree that
an acceptor for honour cannot set up this plea. The
American authors however seen to be divided on this issue,
some [Daniels in particular] claiming that an acceptor for
honour cannot set up this plea, but others like Parsons etc.
take a contrary view. Under sec.117 of the Indian Evidence
Act, an acceptor can always show that the signature of the
drawer is a forgery, i.e. there is no estoppel against the
drawer in this regard and so an acceptor for honour is also
not estopped from taking the plea that the drawers signature
is a forgery.
(ii) As to acceptors estoppel - An acceptance of a BOE does
not amount to an admission of the drawers signature and
an acceptor can always show even against a holder in due
course that the drawers signature was a forgery (sec.117
of Evidence Act). This principle is directly in conflict with
the English law. In addition to this estoppel an acceptor
under the English law is bound by certain other estoppels
as against a holder in due course : (a) the existence of a
drawer and his capacity and authority to draw the bill, (b)
the capacity of the drawer to indorse in the case of a bill
payable to his order, and (c) the existence and capacity of
the payee. Even under the Indian law an acceptor cannot
deny the existence of the drawer i.e. he cannot plead that
the drawer is a fictitous person, though this conclusion is
more by way of being an inference. Due to sec.117 of the
Evidence Act he can not also deny the authority or capacity
of the drawer but this again is only an interference.
b) As to capacity of payee to indorse - When a person makes
a promissory note, he agrees to pay the amount to the payee
named in the note, and by that act he acknowledges the
payees capacity to receive the money. So in a suit by holder
in due course he cannot take the plea that the payee was an
infant or was insane etc., that is he cannot question the
legal capacity of the payee to indorsee the note. The same
rule applies to the acceptor of a BOE, who by the very act
of acceptance also accepts all that is essential for the validity
or existence of the bill and one such essential factor is the
capacity of the payee named in the bill. In Alcock v. Alcock
[133 ER 1144] it was observed that the case may be
different if the insolvency or the insanity happened after
the making of the note or the indorsing of the bill; for in
such cases, the indorsement by such a person is a mere
nullity and can confer no title on the indorsee, and an
acceptor is not justified in making payments to anyone
whose title is affected by it.
This estoppel applies only to capacity of the payee, and the
maker or acceptor cannot be held to admit the genuineness of
the indorsement of the payee, for he cannot be expected to know
his handwriting; nor does an acceptance admit the agency to
indorse which must be proved by the holder in order to recover
against the acceptor or maker [Robinson v. Garrow, 129 ER
183].
c) Estoppel relating to prior parties - Under sec.122 an
indorser cannot deny either the signature or the capacity
of prior parties to the instrument, because when he indorses
he admits the genuineness of the prior indorsement and
represents that the signature of both the drawer and acceptor
are genuine. He also contracts that the original parties to
the bill or note had the capacity to bind themselves, and so
did the subsequent indorsers (but those prior to him) had
the competance to indorse. Keeping in mind this principle
the indorsee is estopped from denying their signature or
capacity in any suit.
172
10 OFFENCES UNDER THE ACT
SUB TOPICS
10.1 Wrongful dishonour
10.2 Cheating
10.3 Forgery
10.4 Criminal prosecution under N.I. Act, 1881
10.1 WRONGFUL DISHONOUR
A Cheque is said to have been dishonoured when the payee
presents it for payment and the banker refuses to do so. A
bankers refusal may arise for either one of the following
reasons, viz :
a) The funds in the drawers account standing with him are
insufficient to cover the cheque amount; or
b) The presentment is wrongful, for example, when it is made
prematurely or after banking hours or after the elapse of
reasonable time, etc; or
c) The cheque has been improperly drawn or made; or
d) The banker entertains reasonable suspicion on the validity
of a transaction and wants to conduct an enquiry; or
e) For some other just or reasonable cause; or
f) For no reasonable cause but the dishonour is due to the
malice, spite or negligence etc., on the part of the banker.
In situations (a) to (e) above the dishonour of a cheque by a
banker is treated as a valid dishonour and the drawer of the
cheque is not entitled to any compensation from the banker;
i.e. the banker acquires no liability on a valid or rightful
dishonour of cheques. It is situation (f) which amounts to a
wrongful dishonour of a cheque that a liability attaches to the
banker.
Sec.31 of the Act states that the drawee of a cheque having
sufficient funds of the drawer in his hands, properly applicable
to the payment of such cheques 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. A banker thus has a statutory obligation to honour
the cheques drawn by the customers provided the other requisite
conditions are fulfilled. In Kesharichand Jaisukhlal v.
Shillong Banking Corp Ltd. [AIR 1965 SC 1711] it was
observed that when the banker commits mistake in the account
books which produces incorrect balance of the customers
account and consequently the cheque is dishonoured, the banker
will be liable for the wrongful dishonour. When the money is
deposited in the bank, the relationship that is constituted between
the customer and banker is one of debtor and creditor and that
the banker though entitled to use the money deposited with
him without being called upon to account for such user, his
only liability is to return the amount in accordance with the
terms agreed upon between him and the customer.
Liability of the banker
In case of wrongful dishonour of cheques the liability of bankers
is two-fold (i) to compensate the drawer for the actual loss or
damage suffered by him and (2) to compensate him for the loss
of his social status or reputation caused by the dishonour. The
second clause is of more importance to traders and businessmen
rather than ordinary persons. In New Central Hall v. United
Commercial Bank Ltd [AIR 1959 Mad 153] it was held tat
In cases where a cheque issued by a trade customer is
wrongfully dishonoured even special damages could be awarded
without proof of special loss or damage. The fact that such
dishonour took place due to a mistake of the bank is no excuse
nor can the offer of the bank to write and apologise to the payees
of such dishonoured cheques affect the liability of the bank to
pay damages for their wrongful act. The most important point
to be noted in this regard is that the liability of the banker is
only towards the drawer and not towards the payee. This is
because as between the banker and drawer there is a contract
and further the banker stands in a fiduciary relation with respect
to his customer both of these giving rise to a liability in case of
breach. But as between the banker and payee there is no privity
of contract and in case a cheque is dishonoured a payees
recourse is against the drawer alone. He cannot sue the banker.
In case of a non-trader customer, dishonour of a cheque rarely
leads to loss of status or reputation, and hence in such cases
only nominal damages are awarded. Thus, in Evans v. London
and Provincial Bank (1854)9 Ex. 354] a cheque was drawn
by a wife on her husbands behalf payable to the mess steward
of a shop on which he was serving, and the cheque was
dishonoured. It was held that there was no actual damage due
to such dishonour and so damages of only one shilling were
awarded. In Jogendra Math Chakrawarthi v. New Bengal
Bank Ltd. [AIR 1939 Cal. 63] it was observed where the
banker, being bound to honour his customers cheques, has failed
to do so, he will be liable in damages. If special damage,
naturally ensuing from the dishonour is proved, it will be
properly taken into account in assessing the amount of the
damages. If the customer to be a trader, the court may properly
award substantial damages, in the absence of proof of special
damage. In other cases, the customer will be entitled to such
damages as will reasonably compensate him for the injury
which, from the nature of the case, he has sustained. All loss
flowing from the dishonour of a cheque may be taken into
account in estimating the damages.
Quantum of damages
The general rule followed by the courts in awarding damages
is that damages are awarded for forseeable and actual loss
suffered and the quantum of damages is usually based on the
principle of restitutio in intgegram i.e., restoring the person
to the position he would have been in if he had not suffered a
damage. But in case of dishonour of a tradesmans cheque the
damages awarded are inversely proportional to the amount on
the cheque. Thus smaller the amount of the dishonoured
cheque, greater are the damages paid. The reason behind this
rule is very simple a businessmans loss of reputaton or status
or good will is once again inversely proportional to the amount
173
of the cheque. For example, if a well known businessman issues
a check for a petty amount of say Rs.100 and the banker
wrongfully dishonour the cheque. People would immediately
start saying - Oh! what kind of bussinessman is he ? He does
not even have Rs.100 in his account. He must be going
bankrupt. That is, the damage to his goodwill or reputation
may in some cases be irreparable. But, if a cheque for say Rs.5
lakhs is dishonoured, people would be more understanding -
Oh! it was such a big amount. May be due to some reason he
lacked sufficient funds. See in this case damage to his reputation
is not really substantial. Hence the rule that smaller the amount
greater will be the damages; greater the amount lesser will be
the damages.
10.2 CHEATING
Cheating being an offence is defined under sec.415 of the
Indian Penal Code as follows :
Whenever, by deceiving any person, fraudently or dishonestly
induces the person so decieved to deliver any property to any
person, or to consent that any person shall retain any property,
or intentionally induces the person so deceived to do or to omit
to do anything which he would not do or omit if he were not so
deceived, and which act or omission causes or is likely to cause
damage or harm to that person in body, mind, reputation or
property, is said to cheat.
Explanation A dishonest concealment of fact is a deception
within the meanng of this section.
Illustrations
(i) A having knowledge that there are not sufficient funds in
his account, draws a cheque in favour of B. The cheque is
dishonoured. A cheats.
(ii) A issues cheques without having account(s) with any banker
with a dishonest intention to deceive. The cheques are
dishonoured. A cheats.
In Ram Das v. ST. of UP [AIR 1974 SC 1811] the Supreme
Court enumerated the essential ingredients of the offence of
cheating as follows :
(i) There should be a fraudulent or dishonest inducement of a
person by deceiving him.
(ii) (a) The person so deceived should be induced to delive
any property to any person, or to consent that any
person shall retain any property; or
(b) the person so deceived should be intentionally
induced to do or omit to do anything which he would
not do or omit if he were not so deceived.
(ii) In cases covered by item (ii) (b), the act or omission should
be one which causes or is likely to cause damage or harm
to the person induced in body, mind, reputation or property.
Whenever a cheque issued with dishonest intentions is
dishonoured, the drawer of the cheque can be proceeded against
under sections 417 & 420 of IPC by the payee or holder in due
course of the cheque. In Keshavji Madhavji v. Emperor [AIR
1930 Bom 179] it was observed that it was for the prosecution
to establish facts which point prima facie to the conclusion
that the failure to meet the cheque was not accidental but a
consequence expected and therefore, intended by the accused.
It will then be for the accused to establish any facts that may be
in his favour which are specially within his knowledge and as
to which the prosecution could not be expected to have any
information. A mere allegation that a cheque issued by the
accused to the complainant had been dishonoured is not
sufficient to establish the offence of cheating u/sec.415 IPC
[Raman Behan Roy v. Emperor, AIR 1924 Cal 215]. In
Baijnath Sahay v. Emperor [AIR 1933 Pat 183] it was
observed that the act of drawing a cheque implied at least three
elements : (a) that the drawer has an account with the bank in
question ; (b) that he has authority to draw on it for the amount
shown on the cheque ; (c) that the cheque as drawn, is valid
order for the payment of the amount, or that the present state of
affairs is such that in the ordinary course of events, the cheque
will on future presentment be honoured. Drawing of a cheque
does not imply a representation that the drawer already had the
money in the bank to the amount shown on the cheque, for he
may either have authority to overdraw, or have an honest
intention of paying in the necessary money before the cheque
can be presented [Kumar Sain v. Emperor, AIR 1939 Lah
95] Thus mere dishonour for lack of funds does not amount to
cheating; for cheating to be established a mental element to
deceive is necessary. In State of Kerala v. A. Pareed Pillai
[AIR 1973 SC 326] it was observed : To hold a person guilty
of the offence of cheating it has to be shown that his intention
was dishonest at the time of making the promise. Such a
dishonest intention cannot be inferred from the mere fact that
he could not subsequently fulfil the promise.
In Raghunathan v. Balasubramanyam [1967 Ker LT 232],
the defendant gave a post dated cheque as payment against goods
supplied by the plaintiff. The cheque was dishonoured on
maturity and the plaintiff filed a case u/sec.415 IPC. It was
held that: A post-dated cheque in payment of goods already
received is mere promise to pay on a future date and a broken
promise to pay on a future date and a broken promise is not a
criminal offence, though it may amount in certain business
relations to discreditable behaviour. It is well settled that a
mere breach of contract cannot give rise to a criminal
prosecution. The distinction between a case of mere breach of
contract and one of cheating, therefore, depends upon the
intention of he accused at the time of the alleged inducement.
In the instant case, there was no misrepresentation and there
was no consequent parting with the goods believing such
misrepresentation. The dishonest intention which is the
gravement of the offence of cheating is absent. In the
circumstances, the order of acquittal is proper.
In K.P. Shadil v. Kandoth [1988 3 Crimes 600 (Ker)] it was
ovserved that where a person issues a cheque to another and it
is dishonoured, and it appears that the failure to meet payment
is not accidental, the presumption is that the drawer knew that
the cheque would be dishonoured and he is guilty of cheating
under section 420 of IPC. Thus, what is important to establish
this offence is the mental element of deceit or mens rea.
174
Cheating by personation
Sec.416 of IPC defines cheating by personation as follows :
A person is said to cheat by personation if he cheats by
pretending to be some other person, or by knowingly
substituting one person for another, or representing that he or
any other person is a person other than he or such other person
really is.
Explanation The offence is committed whether the individual
personated is a real or imaginary person.
Illustraion
a) A cheats by pretending to be a certain rich banker of the
same name. A cheats by personation.
b) A cheats by pretending to be B, a person who is already
dead. A cheats by personation.
The personation referred to in this section may be either by
words or by conduct. The section does not intend to punish all
cases of personation, but only those cases where the personation
has been used for the purpose of cheating somebody. This
offence u/sec.416 IPC owes its gravity to te fact that it affects
not only the person deceived but also the person personated.
Offence of cheating by personation is punishable under sec.419
IPC whereas general cheating is punishable under sctions 417
and 420. Explaining the distinction between these two sections
it was observed in re Anilesh Chandra [AIR 1951 Assam
122] where in pursuance of the deception, no property passes,
the offence is one of the cheating punishable under Section
417 IPC, but where in pursuance of the deception, property is
delivered, the offence is punishable under section 420.
10.3 FORGERY UNDER THE ACT
Sec.470 of IPC states that a false document made wholly or
in part by forgery is designated a forged document. Sec.471
further observes that the use as genuine of a forged document
has to be with an intent dishonest or fraudulent. A mere
erroneous belief and persistence in a wrong or perverse opinion
cannot be said to be offence tainted with a dishonest or
fraudulent intent [M.Vaghul, (MD), Bank of India Bombay
v. State of Maharashtra, (1988)1 Bank CLR 224 (Bom)].
Sec 463 IPC defines forgery as :
Whoever makes any false document or part of a document
with intent to cause damage or injury, to the public or to any
person, or to support any claim or title, or to cause any person
to part with property, or to enter into any express or implied
contract, or with intent to commit fraud or that fraud may be
committed, commits forgery.
Sec. 464. Making a false document A person is said to make,
a false document
Firstly - Who dishonestly or fruadulently makes, signs, seals
or executes a document or part of a document, or makes any
mark denoting the execution of a document, with the intention
of causing it to be believed that such document or part of the
document was made, signed, sealed or executed by or by the
authority of a person by whom or by whose authority he knows
it was not made, signed, sealed or executed, or at a time at
which he knows that it was not made, signed, sealed or executed;
or
Secondly - Who, without lawful authority, dishonestly or
fraudently, by cancellation or otherwise, alters a document in
any material part thereof, after it has been made or executed
either by himself or by any other person, whether such person
be living or dead at the time of such alteration; or
Thirdly - Who dishonestly or fraudulently causes any person
to sign, seal, execute or alter a document, knowing that such
person by reason of unsoundness of mind or intoxication cannot,
or that by reason of deception practised upon him, he does not
know the contents of the document or the nature of the alteration.
Explanation 1 - A mans signature of his own name may
amount to forgery.
Explanation 2 - The making of a false document in the name
of a fictitous person, intending it to be believed that the
document was made by a real person, or in the name of a
deceased person, intending it to be believed that the document
was made by the person in his lifetime, may amount to forgery.
Illustrations
(1) A picks up a cheque on a banker signed by B, payable to
bearer, but without any sum having been inserted in the
cheque. A fraudulently fills up the cheque by inserting the
sum of Rs.10,000/-. A commits forgery.
(2) A draws a BOE on himself in the name of B without Bs
authority, intending to discount it as a genuine bill with a
banker and intending to take up the bill on its maturity.
Here, as A draws the bill with intent to deceive the banker
by leading him to suppose that he had the authority of B,
and thereby to discount the bill. A is guilty of forgery.
(3) A endorses a government promissory note and makes it
payable to Z or his order and signing the endorsement. B
dishonestly erases the words Pay to Z or his order thereby
converting the special endorsement into a blank
endorsement B commits forgery.
(4) A signs his own name to a bill of exchange, intending that
it may be believed that the bill was drawn by another person
of the same name. A has committed forgery.
(5) A draws a bill of exchange upon a fictitous person, and
fraudulently accepts the bill in the name of such fictitous
person with an intent to negotiate it. A commits forgery.
Bankers liability for payment made on forged cheques
(1) Banker Customer Relationship - As observed earlier the
relationship between a banker and his customer is that of a debtor
and creditor. When a cheque with a forged signature is
presented, the banker has no authority to make payments on it,
and if he does make such payment he would be acting contrary
to the law and would be liable to the customer for the said
amount. A bank in such cases can escape liability only if it can
show that the customer is not entitled to make a claim on account
175
of adoption, estoppel or ratification. The rule of law in this
regard can be stated as follows :
When a cheque duly signed by a customer is presented before
a bank with whom he has an account there is a mandate on the
bank to pay the amount covered by the cheque. However, if
the signature on the cheque is not genuine, there is no mandate
on the bank to pay. The bank when it makes payment on such
a cheque, cannot resist the claims of the customer with the
defence of negligence on his pat such as leaving the cheque
book carelessly so that third parties could easily get hold of it.
This is becase a document in cheque form, on which the
customers name as drawer is forged, is a mere nullity. The
bank can succeed only when it establishes adoption or estoppel
[Awasthi, p.279]
(2) Whether a customer is estopped from disputing the
debits shown in the pass book, where the pass book is
returned without any comment and whether such a conduct
would constitute a stated and settled account? - Before
answering this question it is necessary to examine two other
related querries, namely - does a customer owe a duty to the
bank to inform it about the correctness or otherwise of the entries
made in the pass book within a reasonable time; and whether a
failure to so inform the bank would constitute negligence on
his part to the extent of disentitling him from recovering the
amount paid by the bank on the forged check ? There is a duty
of some kind imposed on the customer to inform the bank within
a reasonable time about any irregularities or mis-statements in
the pass book entries. But merely because he fails to do so,
negligence cannot be automatically attributed to him, nor can it
be presumed that there was a breach of duty by the customer to
the bank. Because the duty imposed on the customer in this
regard is neither a statutory duty nor one inferred from usage
or trade practice, but is more in the nature of being a rule of
administrative convenience. A customer should not by his
conduct facilitate payment of money on forged cheques. In the
absence of corroborating circumstances, a mere negligence on
the customers part will not disentitle him from suing the bank
for the amount. The bank cannot furter take the defuse of
àcquuiescence on the part of the customer, because to sustain
such a plea it is essential to prove that the customer against
whom the plea is raised, had remained silent about the matter
even after becoming aware of the true facts. Thus, in Tali Hing
Cotton Mill Ltd v. Liu Chong Bank Ltd [(1985)2 All ER
947] The Court rejected the plea of implied terms, indirect
constructive notice, and estoppel by negligence, and held that
the company was not under any breach of duty owned by it to
the bank and as such mere silence, omission or failure to act is
not a sufficient ground to establish a case in favour of the bank
to non-suit its customer.
Unless the bank is able to satisfy the Court of either an express
condition in the contract with its customer or an unequivocal
ratification it will not be possible to save the bank from its
liability. The banks do business for their benefit. Customers
also get some benefit. If banks are to insist upon extreme care
by the customers in minutely looking into the pass book and
statements sent by them, no bank perhaps can do profitable
business... There is always an element of trust between the bank
and its cutomer. The banks business depends upon this trust.
Whenever a cheque purporting to be by a customer is presented
before a bank it carries a mandate to the bank to pay. If a cheque
is forged there is no such mandate. The bank can escape liability
only if it can establish knowledge to the customer of the forgery
in the cheques. Inaction for continuously long period cannot
by itself afford a satisfactory ground for the bank to escape
liability ....
In the New Marine Coal Co. (Bengal) Pvt. Ltd. v. Union of
India, suit was for recovery of certain amount representing the
price of coal supplied to the respondent. Inter alia the
respondent pleaded in defence of the suit that the respondent
had issued and sent bills to cover the amount and the intimation
cards in accordance with the usual practice in the ordinary course
of dealings. The respondents it was alleged paid the amount by
cheque to a person authorised by the appellant and no
presentation of proper receipts. It was, pleaded that the
appellants claim having been satisfied, he had no cause of
action. It was established in the course of the trial that the
appellant had not in fact authorised any person to issue the
receipts but a certain person not connected with the appellant
firm without the consent or knowledge of the appellant got hold
of the intimation cards and bills addressed to the appellant,
forged the documents and fraudulently received the cheque from
the respondent and appropriated the amount for himself. We
may usefully read the following passage relating to negligence
in the context of a plea based on estoppel.
Apart from this aspect of the matter there is another serious
objection which has been taken by Mr. Setalvad against the
view which prevailed with Mukharji, J. He argues that when a
plea of estoppel on the ground of negligence is raised,
negligence to which reference is made in support of such a plea
is not the negligence as is understood in popular language or in
common sense; it has a technical denotation. In support of a
plea of estoppel on the ground of negligence, it must be shown
that the party against whom the plea is raised owed a duty to
the party who raises the plea. Just as estoppel can be pleaded
on the ground of misrepresentation or act or omission, so can
estoppel be pleaded on the ground of negligence, but before
such a plea can succeed, negligence must be established in this
technical sense. As Halsbury has observed : Before anyone
can be estopped by a representation inferred from negligent
conduct, there must be a duty to use due care towards the party
misled, or towards the general public of which he is one. There
is another requirement which has to be proved before a plea of
estoppel on the ground of negligence can be upheld and that
requirement is that the negligence on which it is based should
not be indirectly or remotely connected with the misleading
effect assigned to it, but must be the proximate or real cause of
that result. Negligence, according to Halsbury, which can
sustain plea of estoppel must be in the transaction itself and it
should be so connected with the result to which it led that it is
impossible to treat the two separately. This aspect of the matter
has not been duly examined by Mukharji, J when he made his
finding against the appellant [Awasthi, pp. 286-287].
176
Plea of contributory negligence
Sec.131 of the Act does not clothe the collecting banker with
absolute immunity and unless he can show that his case falls
within the ambit of that section, he faces liability under common
law for conversion, in case the person from whom he takes
the cheque has no title or has a defective title. The onus of
showing that he had taken reasonable and due care lies on the
banker. This duty to take care is one imposed by the statute on
the banker for the benefit of the true owner, and it is the price
which the banker has to pay for the protection accorded to him
under the statute. He cannot escape his liability by saying that
even if he had taken reasonable care in all probability he could
not have discovered the defect, because any person who has
not taken such care is outside the purview of this section.
10.4 CRIMINAL PROSECUTION UNDER N.I. ACT,
1881
Chapter XVII containing sections 138-142 was incorporated
in the Negotiable Instruments Act, by the Banking, Public
Financial Institutions and Negotiable Instruments Laws
(Amendment) Act, 1988. These sections deal with prosecution
for dishonour of cheques. Sec.138 of the Act states as follows:
Where any cheque drawn by a person on an account maintained
by him with a banker for payment of any amount of money to
another person from out of that account for the discharge, in
whole or in part, of any debt or other liability, is returned by the
bank unpaid, either because of the amount of money standing
to the credit of that account is insufficient to honour the cheque
or that it exceeds the amount arranged to be paid from that
account by an agreement made with the bank, such person shall
be deemed to have committed an offence and shall, without
prejudice to any other provision of this Act, be punished with
imprisonment for a term which may extend to one year, or with
fine which may extend to twice the amount of cheque or with
both :
Provided that nothing contained in this section shall apply
unless -
(a) the cheque has been presented to the bank within a period
of six months from the date on which it is drawn or within
the period of its validity, whichever is earlier ;
(b) the payee or holder in due course of the cheque, as the case
may be, makes a demand for the payment of the said amount
of money by giving a notice, in writing, to the drawer of
the cheque, within fifteen days of the receipt of the
information by him from the bank regarding the return of
the cheque as unpaid; and
(c) the drawer of such cheque fails to make the payment of the
said amount of money to the payee, or as the case may be,
to the holder in due course of the cheque within fifteen
days of the receipt of the said notice.
Explanation For the purposes of this section, debt or other
liability means a legally enforceable debt or other liability.
Section 140. Defence which may not be allowed in any
prosecution under section 138:
It shall not be a defence in a prosecution for an offence Section
138 that the drawer had no reason to believe when he issued
the cheque that the cheque may be dishonoured on presentment
for reasons stated in that Section.
Limitation for prosecution
Before starting the proceedings against the drawer under sec.138
of the Act, the following conditions have to be fulfilled:
a) a notice of dishonour to be given to the drawer by the payee
within 15 days of receipt of communication form the bank
regarding dishonour of the cheque ;
b) the drawer does not make the payment on that cheque within
15 days of receipt of notice;
c) the payee or holder in due course shall file a complaint within
30 days from the date of failure of the drawer to make the
payment on the dishonoured cheque.
In Richard Samson Sherrat v. Sudhir Kumar Sanghi
[1992(2)APLJ 27], the A.P. High Court held that when the
statute has not laid down any limitation on the number of times
that a cheque may be presented within the period of six months
or any shorter period under clause (a) of proviso to section 138,
it will not be desirable to read into the said clause any such
restriction as to the number of times a cheque may be presented.
It is common knowledge that in commercial practice, a cheque
may be presented any number of times within the period of its
validity. Suppose the payee presents the cheque a second time
and it is again dishonoured, the question that arises is, does the
second dishonour give rise to a second cause of action ?
Answering this question in Kumaresan v. Ameerappa [AIR
1992 Ker 23] the Kerala High Court observed : from the
scheme of the provisions in Chapter XVII of the Act two factors
loom large; first is that more than one cause of action on the
same cheque is not contemplated or envisaged. Second is,
institution of prosecution cannot be made after one month of
the cause of action. If more than one cause of action on the
same cheque can be created, its consequence would be that the
same drawer of the cheque can be prosecuted and even convicted
again and again on the strength of the same cheque. Legislature
cannot be imputed with the intention to subject a drawer of a
cheque to repeated prosecution and convictions on the strength
of the same cheque.
177
11 FOREIGN INSTRUMENTS
SUB TOPICS
11.l. Introduction
11.2. Definitions
11.3. Formal Validity
11.4. Stamp duty
11.5. Presumption
11.6. UN convention on International Bill of Exchange &
Promissory note
11.1 INTRODUCTION
International negotiable instruments dominate in the
international trade activities. With the rapid growth of trade
accross the countries, the business community designed inter-
country instruments, made in one country but payable in another
country. This type of inter-country instruments have been in
practice in the trade & commerce for a long time. As such
definite rules started developing in the inter-country commercial
practice, generally known as principles in the conflict of laws
or private international law. As for example, it has been one of
the common principle that liability of each contracting parties
is governed by the law of the place where each separate contract
is made. There is no right of the contracting parties to select
their own law. This principle is known as locus regit actum.
With growing importance to such instruments multipartite
international agreement has been entered into on December 9,
1988. This agreement is known as the United Nations
Convention on International Bills of Exchange and International
Promissory Notes. The convention commonly known as
UNCITRAL convention contains 90 Articles in IX chapters.
National law of each country relating to inter-country negotiable
instruments, is now falling in line with this convention.
11.2 DEFINITIONS
1. Foreign instrument: According to sec. 12 of the Negotiable
Instrument Act, an instrument not inland instrument is a foreign
instrument. An instrument is called an inland instrument if it is
(i) drawn (in case of a bill) or made (in case of a promissory
note) in India and (ii) payable in or drawn upon any person
resident in India. As such a bill is a foreign bill if it is (i) drawn
in India and payable in India or (ii) drawn in India and drawn
on a person who is resident in India. A foreign note is one if it
is (i) made in India and payable in India.
2. International bill of exchange: According to Article 2(1)
of the Convention, an International bill is one which specifies
atleast two of the following places and indicates that any two
so specified are situated in different states:
(a) the place where the bill is drawn;
(b) the place indicated next to the signature of the drawer;
(c) the place indicated next to the name of the drawer;
(d) the place indicated next to the name of the payee;
(e) the place of payment.
Provided that either the place where the bill is drawn or the
place of payment is specified on the bill and that such place is
situated in a contracting state. There is some difference between
India law on the issue and the above definition. A foreign bill
according to Indian law is one which is drawn in Indian and
payable in India or drawn in India on a resident in India. There
is no consideration for place indicated next to the signature or
drawee or the payee. India, therefore, has a rigid definition.
3) International Promissory Note: Art 2(2) of the convention,
defines a pronote which specifies at least two of the following
places and indicates that any two so specified are situated in
dfferent states:
(a) the place where the note is made;
(b) the place indicated next to the signature of the maker;
(c) the place indicated next to the name of the payee;
(d) the place of payment;
provided that the place of payment is specified on the note and
that such place is situated in a contracting state.
It may be noted in this connection that in the event of an incorrect
or false statement in the bill or the note in respect of places
referred, neither will the instrument be invalid nor the
application of the convention be affected.
Chapter II containing 2 Articles of the UNCITRAL Convention
provides some other definitions which are almost similar to the
definitions given in the NI Act, some of the terms defined are
(a) drawer (Art 5(d); payee (Art 5(e); holder (Art 5(f) and Art
15). There is no definition of guarantor in the NI Act. But
the term is defined in the Contract Act. According to Art 5
(10) a gurantor is a person who undertakes an obligation under
Art 46. According to Art 46, a guarantor for a party or for the
drawee may be a gurantor for the whole or part of the claim on
the instrument. It must be in writing either on the instrument
itself or on a slip affixed thereto. The instrument must
unequivocally mention that the amount is guaranteed. Words
like prior endorsement guaranteed will not be sufficient. It
has to be effected by the signature of the party guarantor on the
instrument, specifying the person for whom he stands guarantor.
11.3 FORMAL VALIDITY
According to sec.134 of the NI Act, in the absence of a contract
to the contrary, the liability of the drawer or maker is regulated
in all essential matters by the law of the place where he made
the instrument, and the respective liabilities of the acceptor and
indorser by the law of the place where the instrument is made
payable. As for example, A drew a bill of exchange in Malaysia
where the rate of interest is25 percent. B accepted the instrument
in Singapore where the rate of interest is 6 percent. The bill is
endorsed in India and dishonoured. An action on the bill is
brought against B in India. He is liable to pay interest at 6%.
But if A is charged as the drawer, he would be liable to pay
178
interest of 25%. According to sec.72 of the Bill of Exchange
Act, 1882 of England, the formal validity of a bill drawn in one
country and accepted, negotiated or payable in another, shall
be determined by the law of the place of issue, and that the
formal validity of each supervening control shall be determined
by the law of the place where such contract is made. That is,
accepted is to be regulated by the law of the country wherein it
is acceptance and similarly negotiability is determined according
to the law of the land where it is negotiated.
Indian law isbased upon the subjective theory of Diecy giving
full liability to the contracting parties to be regulated by the
law of the land they agree to abide by. That is why the section
starts with the clause in the absence of a contract to the
contrary. The choice of law by the parties is conclusive. One
issue in this case is not clear. If the parties, i.e., the drawer and
the drawee of a bill opt for a third country for the choice of the
law, shall it be a valid stipulation ? As for example, can an
Indian and a Malayasian on a bill, stipulate that they would be
governed by the German law ? In Vita Food Products Inc. v.
Units Shipping Co.Ltd., [(1939) AC 277] Lord Wright
observed that the expressed intention of the parties as to the
law to be followed is final and conclusive unless the intention
expressed is bonafide legal and there is no reason for avoiding
the choice on the ground of public policy. In the absence of
any clear law as explained in a precedent in India, it is quite
probable that even in India the situation is not different. That
is, on the ground of public policy parties may be compelled
to submit to the law of the country in which the bill is issued
instead of following the law of any other country. No one be
allowed to voluntarily opt out of the national ambit of a legal
system without any reason.
The contradiction in the policy is attempted to be solved in the
Cheshires objective theory in which he suggests that the choice
of the parties is limited to the law with which the contract has
the most real connection. Where the intetion of the parties are
clear in the contract this principle is not applicable. Where the
intention is not clear as to the proper law to be followed this
principle was followed in number of cases like Bonythan
v.Commonwealth of Australia [(1951) AC 219] and in James
Miller & Partners Ltd., v. Whitworth Streets Estates
(Manchester)Ltd., [(l972)AC 583]. Difficulties arise where
parties do not stipulate the law to which they are subjected to.
In such a case, the Court has to find out proper law to be
followed. The common practice is to presume that proper law
is the law of the country where the contract is made (principle
of situs) and the rule is most common where the contract is to
be performed wholly in the country and is performed wholly in
the country where it is made. But where the performance is to
be in a different state, the proper law of contract may be
presumed to be the law of the country where the performance
is to take place. The principle of private International law, lex
loci contractus corresponds with the above principle of law
(principle of situs). In view of the clear prescription in sec. l34
Indian courts are not bound by principles in the private
international law. But Indian law is not exhaustive. As such,
where Indian law is not clear, courts have to refer to the basic
principles of the private international law to decide the proper
law.
One example may be made to clear the issue. What shall be
law for determining capacity to contract? There are two general
principles followed in private international law, lex domicili;
the law of the domicile or lex contractus, law of the land where
the contract is made. The Law Commission of India (11th
Report, para 28) proposed a simple rule, viz., in the absence
of any contract to the contrary, the capacity of the parties to an
instrument shall be determined by the law of the country where
the contract constituted by the negotiable instrument was made.
This implies that the parties are not prevented from having their
choice in the matter of law which would govern the contract.
In a negotiable instrument several contracts make the
transaction. As for example, one is contract of debt; contract
of payment by the instrument; contract of negotiation and
endorsement and contract of paying the instrument. Dicey
advocated for applying one system of law to the form of each
contract including the capacity determination. But the proposal
of the Law Commission runs contrary to the above accepted
principle and argument. It is based on the status of a party in
the legal set up of a country and as such can not be allowed to
be altered at the option of the parties. This opinion is based on
lex loci contractus.
The formal validity of an instrument is determined by lex loci
contractus elebration is ( or the lex loci actus) i.e., the law of
the place where the contract is made. Indian law follows the
same principle. If a contract is made through correspondence,
the place where the bill is accepted is the place where it is made.
For this purpose, the place where the letter of acceptance is
posted is the place of entering into the contract. According to
sec.135 where a promissory note, bill of exchange or cheque is
made payable in a different place from that in which it is made
or indorsed, the law of the place where it is made payable
determines what constitutes dishonour and what notice of
dishonour is sufficient. As for esample, a bill of exchange drawn
and indorsed in India, but accepted payable in France, is
dishonoured. The indorsee causes it to be protested for such
dishonour, and gives notice thereof in accordance with the law
of France though not in accordance with the rules herein
contained in respect of bills which are not foreign. The notice
is sufficient. This provision is an application of the maxim of
international law, locus regit actum. That is, the obligation in
a bill or a pro-note is to be measured by the law of the place
where the instrument is payable. The duties of the holder is
determined by the law of the place of performance. In Sukhall
v.Eastern Bank (46 Cal 584) the Calcutta High Court held
that the date of performance and the days of grace are to be
determined by the law of the place of performance. Though
the section does not stipulate anything about the demand for
payment, the demand for payment is to be made according to
the place of performance because the demand only initiates the
actual payment.
179
A negotiable instrument contains a series of contracts. Invalidity
of one does not invalidate the other. According to sec.136, if a
negotiable instrument is made (for pro-note), drawan (in case
of a bill), accepted (in case of a bill) or indorsed (both for a
note and a bill) outside India, but in accordance with the law in
India, the circumstance that any agreement evidenced by such
instrument is invalid according to the country wherein it was
entered into, does not invalidate any subsequent acceptance or
indorsement made thereon in India.
11.4 STAMP DUTY
Law relating to stamp is not same in all countries. There are
countries where adequate stamp is a condition for valid
exercise of a contract by a negotiable instrument. An instrument
not carrying stamp or carrying inadequate stamp is a void
agreement in these countries. In other countries stamp is a
procedural requirement i.e., if adequate stamp is not fixed the
instrument is inadmissible in evidence though the instrument is
valid in law in so far as the contract is concerned. In England
the position has been altered by the Bills of Exchange Act.
Earlier, a foreign bill was considered valid and actionable only
if the law of the country of its origin would make such a bill
inadequately stamped or unstamped, valid though not admissible
in evidence. But if in the place of origin the bill would be void
on account of the law of stamp in that country, it would be
inactionable in England as well. In number of Indian cases this
rule was applied because Indian law is not clear on the issue.
As for example, in Venkatrami Reddy v.Sri Maharaja
Seetharama (53 Mad 964; AIR 1930 Mad 1004) it was held
that the foreign bill which was valid in the State of Hyderabad
inspite of in adequate stamp though inadmissible in evidence,
could be sued upon in British India. In Dhandiram v.Sadasiv
(42 Bom 522) the Court held that if the law of the foreign country
provides that by reason of the stamp the agreement in the
instrument itself would be void, the plaintiff could not succeed
in a court in India since the instrument would be void. In
England the present position is that where a bill of exchange is
issued out of the United Kingdom, it is not invalid by reason
only that it is not stamped in accordance with the law of the
place of issue. Though Indian law is not clear, but the general
principle laid down in Stamp Act is that want of stamp makes
any document inadmissible but not void. As such, it is likely
that Indian Courts will conclude in the same way as the Courts
in England do in case of inadequate stamp on a negotiable
instrument. At present British law does not invalidte the
instrument even though in the place of origin it is invalid (sec.
72 of the Bill of Exchange Act).
11.5 PRESUMPTION AS TO FOREIGN LAW
According to sec. 137 of the NI Act, it is presumed in India that
law of any foreign country on negotiable instruments is same
as that in India unless and until the contrary is proved. Courts
in India do not take judicial notice of foreign law. Any person
relying on any foreign law is required to prove it by evidence.
In the absence of such a proof, foreign law is deemed to be in
line with the Indian law. Foreign law may be proved in any of
the following ways :
a) By reference to text of foreign statutes printed and
published under the authority of the Government of
that country;
b) By reference to standard texts of learned writers ;
c) By oral testimony of an expert; and
d) By reference to the judgement or opinion of the
foreign court.
11.6 UN CONVENTION ON THE NEGOTIABLE
INSTRUMENTS
It has been earlier mentioned that United Nation legislated a
Convention on International Bills of Exchange and International
Promissory Notes in order to uniformalise the law and practices
on these instruments. It is to be pointed out that divergence of
state practices on these instruments put several constraints on
the business communities everywhere. It is in the fitness of
things that this Uniform Code is attempted as the guiding
principle for all member states to legislate their municipal law
to be in line with the Convention in order to uniformalise the
commercial practice on these instruments throughout the globe.
The Convention was adopted on December 9, 1988. The last
Chapter of the Convention (Chapter IX, Art 85 to 90) deals
with general clauses like who is to be the depository of the
convention; when it is open for signature ; when it is open for
ratification and accession (Art 86); When the Convention comes
into force (Art 89) etc.
Art.1 of the Convention contains International Bill of
Exchange (UNCITRAL) Convention and International
Promissory Note (UNCITRAL) Convention. Chapter I (Art 1
to 3) relates to sphere of application and form of the instrument.
Art 2 & 3 deals with form of Bill of Exchange and Promissory
Note. Chapter II (Art 4-12) deals with interpretation and formal
requirements. Of these one may take notice of Art 12 dealing
with requirements for completing an incomplete instrument.
Art 5 deals with definitions of `bill; `note; ìnstrument;
`drawee; `payee; `holder; protected holder etc. Art 8 deals
with discrepancy in the sum mentioned in words and figures.
Art 9 defines an instrument payable on demand. Chapter III
(Art 13 to 26) deals with transfer of the instruments by
indorsement and/or delivery. Endorsement is to be in writing
either in blank or specially made (Art 14); unconditional (Art
18); endorsement of a part of the sum being ineffective (Art
19); order of the endorsement ((Art 20) and words contained in
endorsement defined (Art 21). Art 15 & 16 define a holder
and state his rights. Endorsement by delegated authority is
specified in Art 26 whereas forged endorsement and legal
consequences are stipulated in Art 25. Chapter IV deals with
rights and liabilities of various parties in Art 27 to Art 48. These
parties include holder and protected holder (Art 27 to 32);
drawer (Art 38); maker (Art 39); drawer and acceptor (Art 40-
48). Chapter V deals with presentment, dishonour by non-
acceptance and non-payment and recourse in Art 49-71. Chapter
180
VI deals with discharge in Art 72 to 80. Chapter VII stipulates
the limitation period to bring action as 4 years in Art 84.
Some of the important provisions in the Convention are as
follows :
Art 7
The sum payable by an instrument is deemed to be a definite
sum although the instrument states that it is to be paid :
a) with interest;
b) by instalments at successive dates;
c) by instalments at successive dates with a stipulation in the
instrument that upon default in payment of any instalment
the unpaid balance becomes due;
d) according to a rate of exchange indicated in the instrument
or to be determined as directed by the instrument; or
e) in a currency other than the currency in which the sum is
expressed in the instrument.
Art 9
1. An instrument is deemed to be payable on demand :
a) if it states that it is payable at sight or on demand or
on presentment or if it contains words of similar
import; or
b) if no time of payment is expressed.
2. An instrument payable at a definite time which is accepted
or endorsed or guaranteed after maturity is an instrument
payable on demand as regards the acceptor, the endorser
or the guarantor.
3. An instrument is deemed to be payable at a definite time if
it states that it is payable :
(a) on a stated date or at a fixed period after a stated date
or at a fixed period after the date of the instrument;
(b) at a fixed period after sight;
(c) by instalments at successive dates; or
(d) by instalments at successive dates with the stipulation
in the instrument that upon default in payment of any
instalment the unpaid balance becomes due.
4. The time of payment of an instrument payable at a fixed
period after date is determined by reference to the date of
the instrument.
5. The time of payment of a bill payable at fixed period after
sight is determined by the date of acceptance or, if the bill
is dishonoured by non-acceptance, by the date of protest
or, if protest is dispensed with, by the date of dishonour.
6. The time of payment of an instrument payable on demand
is the date on which the instrument is presented for payment.
7. The time of payment of a note payable at a fixed period
after sight is determined by the date of the visa signed by
the maker on the note, if his visa is refused, by the date of
presentment.
8. If an instrument is drawn, or made, payable one or more
months after a stated date or after the date of the instrument
or after sight, the instrument is payable on the corresponding
date of the month when payment must be made. If there is
no corresponding date, the instrument is payable on the
last day of that month.
Art 12
1. An incomplete instrument which satisfies the requirements
set out in paragraph 1 of article 1 and bears the signature of
the drawe or the acceptance of the drawee, or which satisfies
the requirements set out in paragraph 2 of article 1 and
paragraph 2(d) of article 3, but which lacks other elements
pertaining to one or more of the requirements set out in
articles 2 and 3, may be completed, and the instrument so
completed is effective as a bill or a note.
2. If such an instrument is completed without authority or
otherwise than in accordance with the authority given :
a) a party who signed the instrument before the
completion may invoke such lack of authority as a
defence against a holder who had knowledge of such
lack of authority when he became a holder;
b) a party who signed the instrument after the completion
is liable according to the terms of the instrument so
completed.
Art 13
An instrument is transferred :
a) by endorsement and delivery of the instrument by
the endorser to the endorsee: or
b) by mere delivery of the instrument if the last
endorsement is in blank.
Art 14
1. An endorsement must be written on the instrument or on a
slip affixed thereto allonge. It must be signed.
2. An endorsement may be :
a) in blank, that is, by a signature alone or by a signature
accompanied by a statement to the effect that the
instrument is payable to a person in possession of it ;
b) special, that is, by a signature accompanied by an
indicatin of the person to whom the instrument is
payable.
3. A signature alone, other than that of the drawee, is an
endorsement only if placed on the back of the instrument.
Art 15
1. A person is a holder if he is :
a) the payee in possession of the instrument; or
b) in possession of an instrument which has been
endorsed to him, or on which the last endorsement is
in blank, and on which there appears an uninterrupted
series of endorsements, even if any endorsement was
forged or was signed by an agent without authority.
2. If an endorsement in blank is followed by another
endorsement, the person who signed this last endorsement
is deemed to be an endorsee by the endorsement in blank.
181
3. A person is not prevented from being a holder by the fact
that the instrument was obtained by him or any previous
holder under circumstances, including incapacity or fraud,
duress or mistake of any kind, that would give rise to a
claim to, or a defence against liability, on, the instrument.
Art 25
1. If an endorsement is forged, the person whose endorsement
is forged, or a party who signed the instrument before the
forgery, has the right to recover compensation for any
damage that he may have suffered because of the forgery
against:
a) the forger;
b) the person to whom the instrument was directly
transferred by the forger;
c) a party or the drawee who paid the instrument to the
forger directly or through one or more endorsees for
collection.
2. However, an endorsee for collection is not liable under
paragraph 1 of this article if he is without knowledge of
the foregery:
a) at the time he pays the principal or advises him of the
receipt of payment; or
b) at the time he receives payment, if this is later, unless
his lack of knowledge is due to his failure to act in
good faith or to exercise reasonable care.
3. Furthermore, a party or the drawee who pays an instrument
is not liable under paragraph 1 of this article if, at the time
he pays the instrument, he is without knowledge of the
forgery, unless his lack of knowledge is due to his failure
to act in good faith or to exercise reasonable care.
4. Except as against the forger, the damages recoverable under
paragraph 1 of this article may not exceed the amount
referred to in article 70 or article 71.
Art 26
1. If an endorsement is made by an agent without authority or
power to bind his principal in the matter, the principal, or a
party who signed the instrument before such endorsement,
has the right to recover compensation for any damage that
he may have suffered because of such endorsement against:
a) the agent;
b) the person to whom the instrument was directly
transferred by the agent;
c) a party or the drawee who paid the instrument to the
agent directly or through one or more endorsees for
collection.
2. However, an endorsee for collection is not liable under
paragraph 1 of this article if he is without knowledge that
the endorsement does not bind the principal:
a) at the time he pays the principal or advises him of the
receipt of payment or;
b) at the time he recieves payment, if this is later, unless
his lack of knowledge is due to his failure to act in
good faith or to exercise reasonable care.
3. Furthermore, a party or the drawee who pays an instrument
is not liable under paragraph 1 of this article if, at the time
he pays the instrument, he is without knowledge that the
endorsement does not bind the principal, unless his lack of
knowledge is due to his failure to act in good faith or to
exercise reasonable care.
4. Except as against the agent, the damages recoverable under
paragraph 1 of this article may not exceed the amount
referred to in article 70 or article 71.
Art 28
1. A party may set up against a holder who is not a protected
holder :
a) any defence that may be set up against a protected
holder in accordance with paragraph 1 of article 30;
b) any defence based on the underlying transaction
between himself and the drawer or between himself
and his transferee, but only if the holder took the
instrument with knowledge of such defence or if he
obtained the instrument by fraud or theft or
participated at any time in a fraud or theft concerning
it;
c) any defence arising from the circumstances as a result
of which he became a party, but only if the holder
took the instrument with knowledge of such defence
or if he obtained the instrument by fraud or theft or
participated at any time in a fraud or theft concerning
it;
d) any defence which may be raised against an action in
contract between himself and the holder ;
e) any other defence available under this Convention.
2. The rights to an instrument of a holder who is not a protected
holder are subject to any valid claim to the instrument on
the part of any person, but only if he took the instrument
with knowledge of such claim or if he obtained the
instrument by fraud or theft concerning it.
3. A holder who takes an instrument after the expiration of
the time-limit for presentment for payment is subject to
any claim to, or defence against liability on, the instrument
to which his transferor is subject.
4. A party may not raise as a defence against a holder who is
not a protected holder the fact that a third person has a
claim to the instrument unless:
a) the third person asserted a valid claim to the istrument;
or
b) the holder acquired the instrument by theft or forged
the signature of the payee or an endorsee, or
participated in the theft or the forgery.
Art 29
Protected holder means the holder of an instrument which
was complete when he took it or which was incomplete within
the meaning of paragraph 1 of article 12 and was completed in
accordance with authority given, provided that when he became
a holder :
a) he was without knowledge of a defence against liability on
182
the instrument referred to in paragraphs 1 (a), (b), (c) and
(e) of article 28;
b) he was without knowledge of a valid claim to the instrument
of any person;
c) he was without knowledge of the fact that it had been
dishonoured by non-acceptance or by non-payment;
d) the time limit provided by article 55 for presentment of
that instrument for payment had not expired:
e) he did not obtain the instrument by fraud or theft or
participate in a fraud or theft concerning it.
Art 36
1. An instrument may be signed by an agent.
2. The signature of an agent placed by him on an instrument
with the authority of his principal and showing on the
instrument that he is signing in a representative capacity
for that named principal, or the signature of a principal
placed on the instrument by an agent with his authority,
imposes liability on the principal and not on the agent.
3. A signature placed on an instrument by a person as agent
but who lacks authority to sign or exceeds his authority, or
by agent who has authority to sign but who does not show
on the instrument that he is signing in a representative
capacity for a named person, or who shows on the
instrument that he is signing in a representative capacity
but does not name the person whom he represents, imposes
liability on the person signing and not on the person whom
he purports to represent.
4. The question whether a signature was placed on the
instrument in a representative capacity may be determined
only be reference to what appears on the instrument.
5. A person who is liable pursuant to paragraph 3 of this article
and who pays the instrument has the same rights as the
person for whom he purported to act would have had if
that person had paid the instrument.
Art 46
1. Payment of an instrument, whether or not it has been
accepted, may be guaranteed, as to the whole or part of its
amount, for the account of a party of the drawee. A
guarantee may be given by any person, who may or may
not already be a party.
2. A guarantee must be written on the instrument or on a slip
affixed thereto (allonge).3. A guarantee is expressed by
the words guaranteed , aval, good as aval or words
of similar import, accompanied by the signature of the
guarantor. For the purposes of this Convention, the words,
prior endorsements guaranteed or words of similar import
do not constitute a guarantee.
4. A guarantee may be effected by a signature alone on the
front of the instrument. A signature alone on the front of
the instrument, other than that of the maker, the drawer or
the drawee, is a guarantee.
5. A guarantor may specify the person for whom he has
become guarantor. In the absence of such specification,
the person for whom he has become guarantor is the
acceptor or the drawee in the case of a bill, and the maker
in the case of a note.
6. A guarantor may not raise as a defence to his liability the
fact that he signed the instrument before it was signed by
the person for whom he is a guarantor, or while the
instrument was incomplete.
Art 47
1. The liability of a guarantor on the instrument is of the same
nature as that of the party for whom he has become
guarantor.
2. If the person for whom he has becme guarantor is the
drawee, the guarantor engages :
a) to pay the bill at maturity to the holder, or to any
party who takes up and pays the bill;
b) if the bill is payable at a definite time, upon dishonour
by non-acceptance and upon any necessary protest,
to pay it to the holder, or to any party who takes up
and pays the bill.
3. In respect of defences that are personal to himself, a
guarantor may set up :
a) against a holder who is not a protected holder only
those defences which he may set up under paragraphs
1,3 and 4 of article 28;
b) against a protected holder only those defences which
he may set up under paragraph 1 of article 30.
4. In respect of defences that may be raised by the person for
whom he has become a guarantor :
a) a guarantor may set up against a holder who is not a
protected holder only those defences which the person for
whom he has become a guarantor may set up against such
holder under paragraphs 1,3 and 4 of article 28;
b) a guarantor who expresses his guarantee by the words
guaranteed, payment guaranteed or collection
guaranteed, or words of similar import, may set up against
a protected holder only those defences which the person
for whom he has become a guarantor may set up against a
protected holder under paragraph 1 of article 30;
c) a guarantor who expresses his guarantee by the words
aval or good as aval may set up against a protected
holder only :
i) The defence, under paragraph 1 (b) of article 30, that
the protected holder obtained the signature on the
instrument of the person for whom he has become a
guarantor by a fraudulent act;
ii) The defence, under article 53 or article 57, that the
instrument was not presented for acceptance or for
payment;
iii) The defence, under article 63, that the instrument was
not duly protested for non-acceptance or for non-
payment;
iv) The defence, under article 84, that a right of action
may no longer be exercised against the person for
whom he has become guarantor;
d) a guarantor who is not a bank or other financial institution
and who expresses his guarantee by a signature alone may
183
set up against a protected holder only the defences referred
to in subparagraph (b) of this paragraph;
(e) a guarantor which is a bank or other financial institution
and which expresses its guarantee by a signature alone may
set up against a protected holder only the defences referred
to in subparagraph (c) of this paragraph.
Art 55
An instrument is duly presented for payment if it is presented
in accordance with the following rules :
a) the holder must present the instrument to the drawee or the
acceptor or to the maker on a business day at a reasonable
hour;
b) a note signed by two or more makers may be presented to
any one of them, unless the note clearly indicates otherwise;
c) if the drawee or the acceptor or the maker is dead,
presentment must be made to the persons who under the
applicable law are his heirs or the persons entitled to
administer his estate;
d) presentment for payment may be made to a person or
authority other than the drawee, the acceptor or the maker
if that person or authority is entitled under the applicable
law to pay the instrument;
e) an instrument which is not payable on demand must be
presented for payment on the date of maturity or on one of
the two business days which follow ;
f) an instrument which is payable on demand must be
presented for payment within one year of its date;
g) an instrument must be presented for payment;
i) at the place of payment specified on the instrument;
ii) if no place of payment is specified, at the address of
the drawee or the acceptor or the maker indicated in
the instrument; or
iii) if no place of payment is specified and the address of
the drawee or the acceptor or the maker is not
indicated, at the principal place of business or habitual
residence of the drawee or the acceptor or the maker;
h) an instrument which is presented at a clearing house is duly
presented for payment if the law of the place where the
clearing house is located or the rules or customs of that
clearing house so provide.
Art 56
Delay in making presentment for payment is excused if the
dealy is caused by circumstances which are beyond the control
of the holder and which he could neither avoid nor overcome.
When the cause of the delay ceases to operate, presentment
must be made with reasonable diligence.
2. Presentment for payment is dispensed with :
a) if the drawer, an endorser or a guarantor has expressly
waived presentment; such waiver :
i) if made on the instrument by the drawer, binds any
subsequent party and benefits any holder;
ii) if made on the instrument by a party other than the
drawer, binds only that party but benefits any holder.
iii) if made outside the instrument, binds only the party
making it and benefits only a holder in whose favour
it was made ;
b) if an instrument is not payable on demand, and the cause in
delay in making presentment referred to in paragraph 1 of
this article continues to operate beyond thirty days after
maturity ;
c) if an instrument is payable on demand, and the cause of
delay in making presentment referred to in paragraph 1 of
this article continues to operate beyond thirty days after
the expiration of the time-limit for presentment for payment;
d) if the drawee, the maker or the acceptor has no longer the
power freely to deal with his assets by reson of his
insolvency, or is a fictitous person or a person not having
capacity to make payment, or if the drawee, the maker or
the acceptor is a corporation, partnership, association or
other legal entity which has ceased to exist;
e) if thee is no place at which the instrument must be presented
in accordance with subparagraph (g) of article 55.
3. Presentment for payment is also dispensed with as regards
a bill, if the bill has been protested for dishonour by non-
acceptance.
Art 60
1. A protest is a statement of dishonour drawn up at the place
where the instrument has been dishonoured and signed and
dated by a person authorized in that respect by the law of
that place. The statement must specify :
a) the person at whose request the instrument is
protested;
b) the place of protest;
c) the demand made and the answer given,if any, or the
fact that the drawee or the acceptor or the maker could
not be found.
2. A protest may be made :
a) on the instrument or on a slip affixed thereto
(allonge); or
b) as a separate document, in which case it must clearly
identify the instrument that has been dishonoured.
3. Unless the instrument stipulates that protest must be made,
a protest may be replaced by a declaration written on the
instrument and signed and dated by the drawee or the
acceptor or the maker, or, in the case of instrument
domiciled with a named person for payment, by that named
person; the declaration must be to the effect that acceptance
or payment is refused.
4. A declaration made in accordance with paragraph 3 of this
article is a protest for the purpose of this Convention.
Art 67
1. Delay in giving notice of dishonour is excused if the delay
is caused by circumstances which are beyond the control
of the person required to give notice, and which he could
neither avoid nor overcome. When the cause of the delay
184
ceases to operate, notice must be given with reasonable
diligence.
2. Notice of dishonour is dispensed with :
a) if, after the exercise of reasonable diligence, notice cannot
be given;
b) if the drawer, an endorser or a guarantor has expressly
waived notice of dishonour; such waiver;
(i) if made on the instrument by the drawer, binds any
subsequent party and benefits any holder;
ii) if made on the instrument by a party other than the
drawer, binds only that party but benefits any holder;
iii) if made outside the instrument, binds only the party
making it and benefits only a holder in whose favour
it was made;
c) as regards the drawer of the bill, if the drawer and the
drawee or the acceptor are the same person.
Art 73
1. The holder is not obliged to take partial payment.
2. If the holder who is offered partial payment does not take
it, the instrument is dishonoured by non-payment.
3. If the holder takes partial payment from the drawee, the
guarantor of the drawee, or the acceptor or the maker :
a) the guarantor of the drawee, or the acceptor or the
maker is discharged of his liability on the instrument
to the extent of the amount paid;
b) the instrument is to be considered as dishonoured by
non-payment as to the amount unpaid.
4. If the holder takes partial payment from a party to the
instrument other than the acceptor,the maker or the
guarantor of the drawee :
a) the party making payment is discharged of his liability
on the instrument to the extent of the amount paid;
b) the holder must give such party a certified copy of
the instrument and any necessary authenticated
protest in order to enable such party to exercise a right
on the instrument.
5. The drawee or a party making partial payment may require
that mention of such payment be made on the instrument
and that a receipt therefor be given to him.
6. If the balance is paid, the person who receives it and who
is in possession of the instrument must deliver to the payor
the receipted instrument and any authenticated protest.
Art 76
1. Nothing in this Convention prevents a Contracting State
from enforcing exchange control regulations applicable in
its territory and its provisions relating to the protection of
its currency, including regulations which it is bound to apply
by virtue of international agreements to which it is a party.
2. a) If, by virtue of the application of paragraph 1 of this
article, an instrument drawn in a currency which is not that
of the place of payment must be paid in local currency, the
amount payable is to be calculated according to the rate of
exchange for sight drafts (or, if there is no such rate,
according to the appropriate established rate of exchange)
on the date of presentment ruling at the place where the
instrument must be presented for payment in accordance
with subparagraph (g) of article 55.
b) i) If such an instrument is dishonoured by non-
acceptance, the amount payable is to be calculated,
at the option of the holder, at the rate of exchange
ruling on the date of dishonour or on the date of actual
payment.
ii) If such an instrument is dishonoured by non-payment,
the amount is to be calculated, at the option of the
holder, according to the rate of exchange ruling on
the date of presentment or on the date of actual
payment.
iii) Pqragraphs 4 and 5 of article 75 are applicable where
appropriate.
Art 78
1. If an instrument is lost, whether by destruction, theft or
otherwise, the person who lost the instrument has, subject
to the provisions of paragraph 2 of this article, the same
right to payment which he would have had if he had been
in possession of the instrument. The party from whom
payment is claimed cannot set up as a defence against
liability on the instrument the fact that the person claiming
payment is not in possession of the instrument.
2 (a) The person claiming payment of a lost instrument must
state in writing to the party from whom he claims payment
i) the elements of the lost instrument pertaining to the
requirements set forth in paragraph 1 or paragraph 2
of articles 1,2 and 3; for this purpose the person
claiming payment of the lost instrument may present
to that party a copy of that instrument;
ii) the facts showing that, if he had been in possession
of the instrument, he would have had a right to
payment from the party from whom payment is
claimed ;
iii) the facts which prevent production of the instrument.
b) The party from whom payment of a lost instrument is
claimed may require the person claiming payment to give
security in order to indemnify him for any loss which he
may suffer by reason of the subsequent payment of the lost
instrument.
c) The nature of the security and its terms are to be determined
by agreement between the person claiming payment and
the party from whom paymet is claimed. Failing such an
agreement, the court may determine whether security is
called for and, if so, the nature of the security and its terms.
d) If the security cannot be given, the court may order the
party from whom the payment is claimed to deposit the
sum of the lost instrument, and any interest and expenses
which may be claimed under article 70 or article 71, with
the court or any other competent authority or institution,
and may determine the duration of such deposit. Such
deposit is to be considered as payment to the person
claiming payment.
185
12 CASE LAW
Brij Kishore Rai v. Lakhan Tiwari [AIR 1978 ALL 314]
The plaintiff claimed a money due against the defendant on the
ground that the latter had borrowed certain amounts from the
former. The plaintiff claimed the principal sum of Rs.2000
with interest at the rate of 18% per annum. the defence was
that there was, in reality, no borrowing and that the document,
on which the plaintiff placed reliance, [which had been described
as a sarkhat] was executed by the defendant but with some
different purpose and not as evidencing the alleged borrowings
set up by the plaintiff. It was also contended that the document
in question relied on by the plaintiff really amounted to a pronote
in law and was inadmissible in evidence on account of
definciency of stamp.
It was held that irrespective of nature of document, if it is
admitted in evidence, sec 36 will be applicable to the situation.
(2) To examine the validity of a promissory note, the terms
have to be examined and only an express undertaking to pay
amount in the instrument makes it a promissory note. An
implied undertaking by use of the word debt or pronote is not
sufficient. (3) Here the second proviso to sec 92 [Evidence
Act] mentions degrees of formalities, does not mean, every
document is to be on a separate of sheet of paper and stamped.
United Bank of India, Ltd v. Nederlandsche Standard Bank
[AIR 1962 Cal 325]
The defendants opened an irrevocable and confirmed credit in
favour of one corporation whose sole proprietor was D.M.
Sharma. The credit was for 3360, and the transaction related
to the sale of 20 tons of pepper sold by the corporation Jacobson
& Co. under whose order the credit account was opened. The
validity period of this Letter of Credit was till 31-12-47, and
75% was payable against certain documents and 25% on the
arrival of goods and their verification in Amsterdam. On the
basis of this Letter certain payments were made to the plaintiff,
and a final payment was made in Amsterdam before the arrival
of goods or the presentment of the BOE at the bank. This last
cheque was taken back from the plaintiffs predecessor on the
day it was given, and the defendant refused to pay. The plaintiff
filed a suit for the recovery of Rs.36,387/9/3.
It was held that a person who seeks to rely on a letter of credit
must do so in exact compliance with its terms and the Bank is
not bound or indeed entitled to honour drafts presented to it
under a letter of credit unless those drafts with the accompanying
documents are in strict accordance with the credit as opened ...
This was not the kind of letter of credit commonly used in
commercial transactions, where express provision is made for
negotiation of BOE and draft. Neither drawing nor negotiation
of documents was permitted by the terms of this letter of credit.
The specific documents expressly mentioned were only bills
of lading, invoice, weight list and insurance policy, but they
did not include bills of exchange or draft. The validity was till
5-1-48 and 75% of the credit was payable against the delivery
of the specific documents mentioned there. No other rights
could be added under this letter of credit either of drawing or
of negotiating any documents and specially documents other
than those mentioned. The validity period could not be made
to depend on the negotiation of documents at all. Negotiation
being excluded the only alternative left was to make a
presentation of the documents mentioned in it. The letter of
credit being addressed to a particular banker and this could not
be utilised with any other bank. The appeal was hence
dismissed.
Tukarma Bapuji Nikam v. The Belgau Bank Ltd. [AIR 1976
Bom 185]
The plaintiffs had sold certain grain worth Rs.863.94 to Mr.A,
and received Rs.180/- as part payment for it. The grains were
loaded and transported to the place wher Mr.A resided, but the
truck was stopped in between and the grains looted. Both the
plaintiff and M.A were unaware of this fact. A drew a draft for
the balance amount of Rs 683.94 from a branch of the defendant
bank and posted it to the plaintifff. Before the plaintiff could
present the draft for payment, the defendant issued a stop
payment order to the bank because he had become aware of
the possibility of the loss of his goods. As a consequence the
defendant bank refused to make payment when the draft was
presented and so he filed a suit against the bank for the recovery
of that amount. The main issue to be considered was, whether
the purchaser of a draft from a Bank which has been made out
in favour of a third party, has any right to stop payment of that
draft and if so, till what stage could he do so. It was held that as
there was no dispute in the present case in regard to the plaintiffs
title to the draft, the only dispute raised by the defendant being
in regard to the consideration for the said draft the purchaser of
the draft was not entitled to ask the defendant bank to stop
payment on that account and the defendant bank was not entitled
to refuse to pay the amount of that draft to the plaintiff.
National WestMinster Bank Ltd v. Barclays Bank Intnl Ltd
& Anr [(1974) 3 ALL ER 834]
B was a long standing customer of the plaintiff Bank and had
an account at one of their branches in London. The second
defendant a businessman in Nigeria, was looking out for
opportunities to acquire pound sterling. An intermediary
brought to him a cheque stolen from Bs cheque book which
was uncrossed and unendorsed but Bs signature had been
forged; the forgery undetectable except to an expert
graphotogist. The cheque was presented and the bank made
the payment on it. On the forgery being realised the bank sued
the defendant for the amount paid on the forged cheque. It was
held that, S.72 of the Indian Contract Act, 1882, lays down that
a person to whom money has been paid by mistake must repay
it. As a general rule, therefore, a banker can recover from the
recipient money paid away on a forged cheque. It is immaterial
that the recipient has spent the money away, or has altered his
position in reliance of the payment. Where there is no
186
negligence of the banker, the mere payment of a forged cheque
does not operate as an estoppel against him.
Kalianna Gownder v. Palani Gownder, [AIR 1970 SC 1942]
The plaintiff agreed on 4-7-1956 to purchase a land from the
defendant and his son for a sum of Rs.12,000/-. A memorandum
was drafted stating that Rs.2000/- had been paid as advance
and the signatures were attested by the plaintiff. Three days
later, the defendants informed the plaintiff by a letter that since
only Rs.350/- had been paid and not Rs.2000/-as agreed upon,
the agreement was cancelled. On receipt of the letter, the
plaintiff filed a suit for specific performance and also deposited
in the Court Rs.10,000 which according to him was the balance
on purchase price. The defendants contended that since the
plaintiff had paid only Rs.350/- and had obtained possession of
the memorandum on a representation that he will pay the balance
of Rs.1650/- within three days and had failed to do so the
agreement was cancelled. Further, the agreement having been
altered in material particulars, after it was executed by adding
the words : Clear the debts and execute the sale deed free from
encumberance, the suit was not maintainable.
In this second appeal the issues before the Court was : (1)
whether the plaintiff paid Rs.350/- only as contended by the
defendants on 4-7-1956 and obtained possession of the
agreement on a false representation; and (2) whether the
memorandum was altered in maternal particulars after
execution, and was on that account discharged ? It was held
that, a material alteration is one which varies the rights,
liabilities, or legal position of the parties as ascertained by the
deed in its original state. But if the alteration merely expresses
that which was implied by law in the deed as originally written
or which carries out the intention of the parties already apparent
on the face of the deed, it is not material provided that the
alteration does not otherwise prejudice the party liable
thereunder. Ordinarily, when property is agreed to be sold for
a price, it would be the duty of the vendor to clear it of all
encumbrances before executing the sale deed. Hence, even if a
covenant that the vendor would clear the debts and execute the
sale deed free of encumbrances is inserted in a memorandum
of agreement of sale after its execution cannot be regarded as a
material alteration. The appellants were therefore entitled to a
decree of specific performance.
Seth Jagjivan Mavji v. Messrs Ranchhoddas Meghji [AIR
1954 SC 554]
The appellant had instituted a suit on a hundi for Rs.10,000
dated 4-12-1947, drawn in his favour by one H of Basra on the
respondents who were merchants and commission agents in
Bombay. The hundi was sent by registered post to the appellant
in Bombay, and was actually received by one P who presented
it to the respondents on 10-12-1947 and received payment on
it. P had been acting as a commission agent for the appellants.
On 12-1-48 the respondents repudiated the authority of P to act
as their agent and demanded the hundi back. The respondents
denied their liability, stating that P was the agent of the appellant,
and that the amount was paid to him bona fide on his
representation that he was authorised to receive payment. The
appellants filed a suit, and the trial court held in their favour.
On appeal, the decree was reversed and the respondents were
held to be discharged. The appellants filed a second appeal.
It was held that the drawee of a NI was not liable on it to the
payee unless he had accepted it u/sec.32. Under sec.7 of the
Act, the drawee becomes an acceptor only when has signed his
assent on the bill. There cannot be, apart from any mercantile
usage, an oral acceptance of the hundi much less an acceptance
by conduct, where atleast no question of estoppel arises. Hence
the mere fact of possession of a bill by the drawee is not
sufficient to constitute valid acceptance. What is requisite for
fixing the drawee with liability under S.32 is the acceptance by
him of the instrument and not an acknowledgement of liability.
Assuming that a plea of discharge of a hundi implies an
acknowledgement of liability under it, that is not sufficient to
fix the liability on the drawee under S.32 when the
acknowledgement is neither in writing nor signed by him. The
appeal was hence dismissed.
Canara Bank, New Delhi v. M/s Sanjeev Enterprises [AIR
1988 Del 372].
Plaintiff is a nationalized banking company, constituted under
the Banking Companies (Transfer & Acquisition) undertaking
Act, 1970. Plaintiff signed and verified by Ms. Prabhu, Sr.
Manager of the Delhi Branch. Defendant enterprise had
dealings with the bank from 1976, which included a current
account with open cash credit facilities, one of the persons who
had quick personal guarantee being Baljit Kaur. On her death
deposits 2, 3, 4 were liable being her legal representatives and
on March 1981, they executed a fresh deed where they specified
the amount of the firms liability they guaranteed and also
acknowledged this liability under OCC A/C.
Subsequently on the departments request, overdrafts OCC, bill
discounting facilities were granted. 1981 Sept, documents for
the above purpose were drafted. One of the departments bill
of exchange had been dishonoured.
Due to the defendants failure to pay in the manner promised
by them a suit was been filed for various amounts. The issues
which were raised were as follows:
(1) Whether the claim pertains to year 1976 and hence is barred
by limitation. (2) Whether the senior manager had the authority
to verify the plaintiff & file a suit. (3) Whether the amount
claimed by the bank has been inflated. (4) Whether defendants
were entitled to concessional interest rates. (5) Whether the
bank was responsible for the dishonour of the BE? (6) Whether
the signatures of defendants had been obtained on blank papers/
form.
It was held that The transactions in question took place over
1981 -82 as the documents show hence suit is not barred by
limitation.
(2) Mr. Prabhu, was authorized to sign by a power of attorney.
(3) No proof to show that signatures on blank forms had been
obtained
(4) The amounts claimed by the bank were found to be correct.
187
(5) Under sec 64 of Negotiable Instrument Act, non
presentment of Hundi for payment does not except the
acceptor of a Hundi from liability
(6) As per ss 5, 32, 79, 80 interest on a Hundi being dishonoured
must be stipulated in Hundi. Otherwise no interest s
payable.
But as defendants failed to pay amount due on Hundis 6% per
annum interest as under sec 34 C P C has to be paid.
SBI v. J R Mazumdar, [AIR 1970 Cal 503]
The Government of West Bengal, Officer, Principal Agricultural
Officer purchased a demand draft for the amount payable to
the plaintiff and the said draft was lost from the plaintiffs
custody. The loss was reported to all concern including SBI
head office and the branch offices. The SBI informed the
plaintiff that the lost draft was not yet encashed and they would
exercise due caution if it was presented, but stated that giving a
duplicate draft would not be possible unless a duplicate is an
indemnity bond executed by the Principal Agricultural Officer
who refused to do so. The plaintiff filed the present suit stating
that he should be given a duplicate. The lower court decreed
that he was entitled to a duplicate bond and hence the present
appeal by the bank.
The main issues in this appeal where (1) whether the draft is a
negotiable instrument? (2) whether the draft of this nature is a
bill of exchange? It was held that keeping in mind sec 85A and
131A of the Negotiable Instruments Act draft drawn by one
branch of a bank on another is a negotiable instrument. Branches
of any bank are treated as individual entities in certain cases.
The draft in question is hence a bill of exchange and so the
plaintiff is entitled to a duplicate.
Canara Bank v. Canara Sales Corpn. & Others [AIR 1987
SC 1603].
In this case it was held that whenever a cheque purporting to be
by a customer is presented before a bank it carries a mandate to
the bank to pay. If a cheque is forged, there is no such mandate.
The bank can escape liability only if it can establish knowledge
to the customer of the forgery in the cheques. Inaction for
continuously long period cannot itself afford a satisfactory
ground for the bank to escape the liability. Unless the bank is
able to satisfy the court of either an express condition in the
contract with its customer or an unequivocal ratification, it will
not be possible to save the bank from its liability. The banks do
business for their benefit, but the customers also get some
benefits. If the banks are to insist upon extreme care by the
customers in minutely looking into the pass book and the
statements sent by them, no bank perhaps can do profitable
business. It is common knowledge that the entries in the
passbooks and the statements of accounts sent by the bank are
either not readable, decipherable or legible. There is always an
element of trust between the bank and its customer. The banks
business depends upon this trust.
Rai Ram Kishore v. Ram Prasad Mishra [AIR 1952 All 245]
A who was the payee and as such the holder of the promissory
notes when they were executed,lost his status as a holder after
the partition decree under which these promissory notes were
allotted to the share of his (i.e. plaintiffs) brother B. It was
held that the right to recover the money due under them vested
in B and the suit brought by him was therefore clearly
maintainable. If an endorsement to bind the payee or the holder
of a promissory note it must be made either by the payee or the
holder himself or by a duly authorized agent acting in his name
u/s 27 of the N I Act.
Subrahmanyam Chettiyar v. Muthaih Chettiar [AIR 1984
Mad 215].
The suit filed by Muttaiah Chettiar for recovery of sum of Rs.24,
655 due under two promissory notes executed by
Subrahmanyam Chettiar in his favour. Subsequently he
executed the third pronote C for a sum which was equal to the
total sum on the first two pronotes, and endorsed on those two
pronotes that in view of C the sum due under A & B had been
discharged. Suit on pronote C was filed but withdrawn with
liberty to file first suit on same cause of action. It was held that
since C was found to be insufficiently stamped the plaintiff
need not have filed first suit on C and the suit on A & B (i.e.,
the first two pronotes) was maintainable because endorsement
on A and B amounted to an acknowledgement.
188
13. PROBLEMS
1. X has issued a cheque crossed with remark not negotiable
in favour of Y or his order. Y endorsed the cheque to Z by
simply signing his name at the back. Z lost the cheque
which was found by F. F wrote to E in the space above
Ys signature and delivered it to E from who F had
purchased some goods on credit. E paid the cheque into
his account with the SBI. SBI made another crossing
mentioning Andhra Bank. Andhra Bank collected the
amount and credited to the SBI. Z claimed the money from
X and X argued that he was discharged by his Banks
honouring the cheque. Decide.
2. M of Malaysia drew a bill on C of Calcutta for goods
exported to C as per his order. M wrongly affixed the stamp
worth Rs.Four hundred as per Indian Law though M ought
to have fixed stamp worth Rs.one thousand as per Malaysian
law. M endorsed the Bill to B of Bangalore. B sent a
notice to C for paying the Bill. The notice came returned
with remark office kept closed. B filed a claim suit against
C in your court on the instrument. Decide.
3. M a minor drew a bill on N after-sight. M endorsed the bill
to X who made all reasonable attempt to present the bill to
N for acceptance but failing he endorsed it to Y with a
remark Sans recourse. Y placed the bill for payment. N
refused to pay. Y filed a case for recovering the amount
against the drawee, drawer and the endorsee. Decide
4. X lend Rs.5000 to Y on 1/1/82. On 1/12/84, Y gave him a
promissory not for the amount agreeing to pay at 12%
interest per annum. The promissory note was payable after
3 months. X while endorsing the document to Z, made the
instrument payable after 2 months by changing the figure
3. Y refused payment on the ground of material alteration.
x paid the money to z and took upon him the instrument
and filed a suit on the instrument and the debt for realization
of the amount on the plea that: (1) the alteration was not
material and (2) Y was liable on the debt. Prepare a list of
argument on behalf of the defendant.
5. The M D of Abraham & Co., issued a cheque to C, the
cashier of the company, to make a payment of wages to the
workers. C discontinued the cheque with his banker, United
Bank of India. But C did not disburse the wages to the
workers. M D asked the companys banker to stop payment
of the cheque. UBI claimed the amount the instrument.
UBI has also filed a criminal complaint case against M D
and the company. Prepare a list of argument on behalf of
UBI.
6. A, a holder of a bill drawn on B endorsed it to D and posted
it to D, L intercepted while the bill in transit and got hold
of it and forged the signature of D to endorse it to C. C
presented the bill for payment to B. B paid for the same to
C. Meantime D came to know that the bill was posted by
A to him. D wrote back to A about non-receipt of the bill.
A sent a duplicate copy of the bill. D thereafter presented
it to B for payment which was refused. D then asked A to
make payment on the bill.
(i) Is A bound to pay the amount to B? Give reasons.
(ii) Suppose D brought a suit against A for payment and
A was asked by the Court to pay for the same. A after
making the payment brought an action against B, C
and D to recover the amount. Decide giving reasons
in detail on the sustainability or otherwise of the right
to claim the amount as against B, C and D.
(iii) Suppose, the signature of the acceptor is forged, do
you think the decision of the case would be different?
What would in such a case be the rights and duty of
the drawer, drawee, payee and the holder be?
7. A received a cheque from B and paid into his account with
the Nagarabhavi branch of the West bank. This bank sent
the cheque to its collecting bank at Hyderabad who
presented the cheque on the drawee bank. The drawee
bank made payment to the collecting bank. Suppose the
collecting bank before sending the money to As bank at
Nagarabhavi goes into liquidation.
i) Critically examine the claim of A and amount to be
received by him.
ii) suppose the Ngarabhavi branch of west bank credited
the amount to the account of A before sending the
cheque for clearance. Would there be any difference
in the claim of A?
8. A approached B for loan. B was not in a position to give
the amount immediately and as such asked to draw a bill
on him for Rs.5000 for 3 months and accepted it after the
same was drawn on January 5, 1992.
i) Suppose A kept the bill with himself since he could
manage some money from other sources for his
immediate need. On maturity, A presented the bill
for payment to B. Can B refuse payment? Give
reasons.
ii) Suppose A discounted the Bill with the Canara Bank.
Canara Bank presented the bill for payment at
maturity. Can B refuse payment? Give detail
arguments in favour of your decision.
iii) Suppose A lost the bill which was found by C in a
Library book earlier issued to A. C delivered it to D
for paying Cs dues to D on April 9, 1992. Can B
refuse payment?
iv) Suppose A deposited the discounted bill amount into
his account with a bank and bank went into
liquidation. Can A get the toal amount from the
liquidator?
v) Suppose A received from the official liquidator an
amount of Rs.3000 against the claim of Rs.5000. Can
A ask B to receive the same amount in satisfaction
against the claim on the bill?
189
9. Examine the nature and validity of the following documents
with reasons
i) Pay Ramesh an amount of Rs. 5000, sixty days after
the arrival of the ship `Victory at Bombay.
ii) I promise to pay on demand a sum of Rs.10000 at my
convenience.
iii) I promise to pay the bearer a sum of Rs.5000 on
demand.
iv) Rs.1000 balance due to you and I am indebted to
pay on demand.
v) I promise to pay A Rs.1000 and all fines according
to rules.
10. A made a promissory note in a stamp paper sufficient for
Rs.10000 but without stipulating the amount and the date
of making the note. The holder of the note, H presented
the note as it was and on refusal brought an action putting
the note as it was as an evidence. Was A bound to make
payment? Give reasons.
[Note: Please specify your Name, I.D. No., and address while sending in your answers]
190
1. Avtar Singh, Principles of Mercantile law, 1992, Eastern Book Company, Lucknow.
2. Awasthi, S.K., Law of Dishonour of Cheques, Forgery & Cheating (Practice & Procedure), 1993, CTJ Publications,
Pune.
3. Parthasarthy, M. S., Khergamvala - The Negotiable Instrument Act, 1990, N. M. Tripathi Pvt. Ltd., Bombay.
4. Regional seminar on International trade law, 1994, Asian - African Legal consultative committee, New Delhi.
5. Swaroop, R., Cases on Dishonour of Cheques, 1994, Law Pubs, Madras.
6. Suri, R.K., Dishonour of Cheques (Prosecution & Penalties), 1994, ALT Publications, Hyderabad.
7. Verma, J.C., Bhashyam & Adiga - The Negetiable Instrument Act, 1990, Bharat Law House Pvt. Ltd.
191
Banking Law
Course No: II
Module No: VI
Banker-Customer Relation
Phone: 3211010 Fax: 080-3217858
192
Material prepared by:
Mr. Harihar Aiyyar, LL.M., General Manager (Rtd.), State Bank of India.
Material checked by:
Ms. Pooja Kaushik, M.A., (Econ).
Ms. Sudha Peri, M.A., LL.M.
Material edited by;
Dr. N.L. Mitra, M.Com., LL.M., Ph.D.
Dr. P.C. Bedwa, LL.M.,Ph.D.
Published By:
Post Bag No: 7201
193
INSTRUCTIONS
In the subject of Banking and Financial Institutions the banker-customer relation has developed a jurisprudence
based upon litigations. In the classical concept of banking, a banker is the custodian of the deposits made by
the customers. The Common Law Courts describe the relation as a debtor-creditor one. Of course, in the
nineteenth century with the development of equity to be fused with law the role of a banker as a trustee of
the customers fund has also been emphasised in certain situations. But both Common Law Courts and Civil
Law Courts confirm the idea that once the customer deposits the money with the bank the banker becomes
the owner of the money. The developments of banking business as the key of financial institutions is based
upon this principle of ownership of the funds kept with the bank.
In this module we have tried to explain not only some concepts like bank, banker, and banking and
customer but we have discussed about various types of deposits kept by the customers with the bank. We
have discussed in detail the nature of the banking business developed through case laws in the last hundred
years or so. During this time a lot of special category of customers came in the field of trade and commerce
making the banking business not only challenging but also complicated. Discussions have been made about
the functioning of the banking business with the special group of customers.
One of the basic duties of a banker in the duty of secrecy which is presently under attack due to many
practical reasons. Often disclosure is demanded by the tax authority or some other department of the
government on the ground of public interest. It is also found that non-accessibility of information about
doubtful customers leads to a huge drainage of public exchequer. Therefore, often there is a demand for
access to information about a debtor from sister banking institutions.
It is quite certain that with the development of tribunalised justice in the settlement of banking claims and
disputes this duty of maintaining secrecy will come under further attack. A banker has a right of general
lien on the properties of the debtor left with the banker against any of its claim. This right is a general right
unlike the right of a bailee, in the sense that a banker can extend his right of possession on any account or
things in possession for a non-payment of loan on any other account. Similarly the banker has a right to set-
off its claim on any head from the available amount on any other head. You will be benefitted by referring
to the general principles of settlement of accounts as specified in sections 57 to 59 of the Indian Contract Act
as well as principle laid down in Claytons case [(1816) 1 Mer 572].
We must understand that the transaction cost of loans and advances goes higher because the litigational cost
is high. The litigation cost is high on account of system cost involved due to unnecessary, avoidable delay in
settlement of disputes. In some cases the delays are due to a prolonged legal process, specially in the event
of insolvency. The alternative dispute resolution is also not efficiently managing the banker-customer litigation.
The essence of banker customer relation is based on mutual trust and faith but the relation begins with trust
and in many cases ends up with litigations. It is necessary now to think and design a system readjustment so
that the cost of litigation can be restricted and the other operational costs is minimised by increasing efficiency.
Dr. N.L. Mitra
Programme Co-ordinator
194
Banker Customer Relation
TOPICS
1. Introduction .................................................................................................................... 195
2. Nature of Relation .......................................................................................................... 197
3. Special Category Customers ......................................................................................... 208
4. Duty of Secrecy ............................................................................................................... 215
5. Pass Book ........................................................................................................................ 217
6. Bankers Lien and Set off .............................................................................................. 221
7. Case Law......................................................................................................................... 224
8. Problems.......................................................................................................................... 226
195
1 INTRODUCTION
SUB TOPICS
1.1 Definition of Banking
1.2 Definition of a Customer
1.1 DEFINITION OF A BANKER
An attempt was made to find out a statutory definition of the
terms Banker and Customer. In the Indian statutes no
definition is found. However, the term Banking finds a place
in the Banking Regulation Act 1949. Section 5(b) states that
Banking means the accepting for the purpose of lending or
investment, of deposits of money from the public, repayable
on demand or otherwise, and withdrawals by cheque, draft, cash
or otherwise. Again, sub-section (d) states Banking Company
means any company which transacts business of banking in
India.
The banking law in India is a borrowed one from English Law.
The banking law in both the countries have not been codified
and only certain aspects have been codified. The development
of this branch of law is from the case law of the U.K. and the
Indian Judiciary. Other than the Negotiable Instruments Act,
laws such as Bankers Book Evidence Act, Reserve Bank of
India Act, State Bank of India Act, the Banking Regulation
Act, the Transfer of Property Act, the Cheques Act, the Interest
Act and many other statutes also deal with certain aspects of
banking.
Let us see the term Banking as understood in other major
countries:
USA:
In the United States of America, the Federal Law describes a
State Bank as any bank, Banking Association, Trust Company,
Savings Bank (other than mutual Savings Bank) or other
Banking Institution which is engaged in the business of
receiving deposits and which is incorporated under the laws of
any State
The earliest attempt in the United States was when the following
definition was enacted :
By `banking we mean the business of dealing in credits and
by a `bank we include every person, firm or company having
a place of business where credits are opened by the deposits or
collection of money or currency, subject to be paid, remitted on
draft, cheque or order, or money is advanced or loaned on stocks,
bonds, bullion, bills of exchange, or promissory notes, or where
stocks, bonds, bullions or bills of exchange or promissory notes
are received for discount or sale. (Indian Finance and Banking,
Finlay Shirras, second impression, p 336)
Any banking association is empowered, inter-alia, to carry on
the business of banking; by discounting and negotiating
promissory notes, drafts, bills of exchange and other evidences
of debts by receiving deposits, by buying and selling exchange,
coins and bullion, by lending money on personal security; and
by obtaining, issuing and circulating notes.
France :
Institutions whose customary business is to accept from the
public, in the form of deposits or otherwise, funds which they
use for their own account in discount, credit or financial
transactions are considered as banks. The Law of 1945 classifies
banks into three categories: deposit banks, business banks; and
long and medium term banks.
Italy :
The acceptance or deposits from the public in any form and the
granting of credit are activities of public interest governed by
banking law of 1936.
Japan :
Ordinary banks are banks conducting commercial banking
business under the Banking Law of 1927, with deposits as their
major financial resources. Conventionally, banks are classified
with ordinary banks, long term credit banks and trust banks.
Banking Act of 1927 defines banks as institutions which carry
on operations of giving as well as receiving credit.
Switzerland :
The Banking Law of 1934 regards banks as banks in the strictest
sense; private bankers organised as individuals; firms or
industrial partnerships, savings banks and finance companies,
similar to bank which publicly solicit deposits. The Swiss law
defines Banks as Institutions, which appeal to the public for
deposit.
Other Countries
The unauthorised use of bank is prohibited in Argentina,
Belgium, Canada, Denmark, Germany, Italy. Sweden altogether
prohibits the use of the title bank by private banking firms.
1.2 DEFINITION OF CUSTOMER
No definition is in the statute for a Customer. Therefore we
have to look in detail the relationship between a Banker and a
Customer according to the transactions and the variety of
services offered and availed from the bank. This is also not an
easy task as there is a considerable increase in the nature, variety
and services offered by banks.
Although the term as such is not defined, attempts have been
made by courts to define a customer. But no statutory definition
is available either in the Indian Law or in the British Law.
As per English law, two theories are available. The old view
expounded by Sir John Paget terms it as a Time Factor. That
is an individual opening an account for the first time to day
cannot be termed as a customer. To constitute a customer there
must be some recognisable course or habit of dealing in the
nature of regular banking services. It is difficult to reconcile
the idea of a single transaction with that of a customer. The
word surely predicates even grammatically some minimum of
custom and antithetic to an isolated act. It is believed that even
196
a paltry tradesman differentiates between a customer and a
casual purchaser.
It follows therefore that two things are necessary for a person
to be considered a customer ;
1) Some recognisable course or habit of dealing between him
and the bank.
2) The transaction should be in the nature of regular banking
business.
As regards(1) above, it was held in Mathews v. Williams
Brown & Co [10 T.L.R - 1894-386] that in order to constitute
a person a customer of a bank, he should have some sort of an
account with the bank, but that the initial transaction in opening
an account did not set up the relation of a banker and customer,
and there had to be some measure of continuity and custom.
On account of this, banks are even now reluctant to open an
account with crossed cheques.
This theory of time factor has now become archaic. The
second view is that of Heber.L.Hart. According to Hart, a
customer is a person who has an account with a banker. Hart
says, that a person is a customer if he keeps either a current
account or a deposit account with the bank, or, it would seems,
if the bank systematically transacts with him or for him any
kind of banking business. Generally it may be stated that a
customer is any person, who has some sort of an account with
a bank and that relationship normally commences as soon as
the account is opened. A bank customer therefore differs from
the normal understanding of the term in that the word
Customer usually denotes a relationship resulting from habit
or commercial dealings. An isolated purchase by a person from
a trader will not suggest that the purchaser should be described
as a customer. From the banking angle, a habit or continued
dealing will not normally make a person a customer unless there
is an account opened in his name, where as a stranger can
become a customer just as soon as he opens the account. This
view is amply illustrated in Great Western Railway v. County
Banking Co. Ltd [(1901) A.C. 414]. In this case, Mr. Huggins,
a poor law overseer, fraudulently obtained a cheque from the
plaintiff and encashed the same with the defendant bank. He
was well known at the banks branch because it has been his
practice over a number of years to encash cheques with that
bank branch. The stolen (fraudulently obtained) cheque was
crossed not negotiable. This aspect was apparently ignored
till the case came before the House of Lords. It was held that
the bank could not succeed as holder for value because of the
crossing on the cheque and that Section 82 of the Bills of
Exchange Act - which was then the law - would not avail to the
bank as Huggins was not a customer. In this case it was stated
that it is true that there is no definition of customer in the Act,
but it is a well known expression and that THERE MUST BE
SOME SORT OF ACCOUNT, either a deposit or current
account or some similar relation, TO MAKE A MAN A
CUSTOMER OF BANK.
Till the decision in Ladbroke v. Todd [1914) 30 T.L.R. 433] it
was believed that there had to be some continuity of custom as
well as maintenance of an account to constitute a Bank
Customer. In this case, it was laid down that the relation of a
Banker and Customer begins as soon as the first cheque is paid
in and accepted for collection and not merely when it is paid.
Again in commissioners of Taxation v. English Scottish &
Australian Bank [(1920)A.C. 683] their Lordships are of the
opinion that the word Customer signifies a relationship in
which duration is not of the essence. A customer whose money
has been accepted by the bank on the footing that they undertake
to honour cheques upto the amount standing to his credit is, in
view of their Lordships, a customer of the bank in the sense of
the statute irrespective of whether his connection is of short or
long standing.
When there is no statutory definition we have to cull out the
true deposit account or some similar relations.
1) To make a man a customer of the bank there must be either
a current or deposit account or some similar relations.
2) Relationship of Banker and Customer begins as soon as a
sum of money or a cheque is paid in and the bank accepts
it and is prepared to open an account.
3) The word Customer signifies the relationship in which
the duration is not an essence.
In India we have followed the English law on the subject and
in the Indian law also we cannot find a definition. In Bank of
India v. Goparathan Nair [AIR 1970 Kerala 74], it was held
that so far as the banking transactions are concerned, the
customer is one whose money has been accepted on the
understanding that the bank will honour transactions to the
amount standing to his credit, irrespective of his connection
being of short or long standing. Thus, it is not necessary that
the account shall have been operated for some time to merit
that the person is known as a customer and even if there is a
single transaction, it is sufficient. The dealing between the
person and the bank should be relating to banking business.
197
SUB TOPICS
2.1 Nature of Banking business
2.2 Introductory reference
2.3 Debtor - Creditor Relation
2.4 Agency Relation
2.5 Trustee Relation
2.6 Bailor-Bailee Relation
2.7 Other Services
2.1 NATURE OF BANKING BUSINESS
The legal relationship between a banker and a customer arises
out of the various transactions, entered between them. Till India
became independent, the functions and role of commercial banks
were very much restricted. The bankers mainly dealt with the
acceptance of deposits and were lending to well established
customers with full security back up. In the international
scenario also there has been vast progress in the financial
markets in the last 5 to 7 years.
We shall now examine the transactions entered between the
banks and its customers and their nature. These are broadly :
1. Deposit Transactions.
2. Loan Transactions.
3. Services.
DEPOSIT TRANSACTIONS
Banks have been used by the general public as a repository to
keep their surplus funds. The term general public is used in a
wide context. Individual account holders, viz the individuals
who want to keep their savings safely open accounts in the
banks. Their accounts are commercially known as P segment
deposits or Personal Segment Deposits. In addition, proprietory
concerns, partnerships, limited companies, trusts etc., also open
and operate their accounts with the commercial banks. P
segment customers keep their money for safety and earn interest
to ensure that tehy build reserves for meeting unforeseen
contingencies.
P. Segment
These customers generally open Savings Bank accounts.
Savings Bank accounts are of two types viz., (1) bank account
from which money can be withdrawn by cheque. This is called
checking or Cheque book facility a/c. These accounts can be
operated in single names or in joint names. In the case of joint
accounts, there can again be either or survivor or former or
survivor. Again these accounts can be operated either jointly
or individually.
To open a cheque book facility account, banks prescribe that
there should always be a minimum balance of Rs.250/- kept in
the account. There shall not be more than 50 withdrawals in
the account in a calendar year. The banks will pay an interest,
at present 5%, on the minimum balance standing to the credit
of the account between 10th and 30th of the calendar month.
These cheque book facility accounts should be properly
introduced to the bank. The introductory reference can be made
either by an existing customer or by a staff member with more
than 5 years of service. The branch/bank has to forward a letter
of thanks to the introducer. This in practice never happens.
The customer is identified by his specimen signature and an
account number allotted by the bank. Whenever money is paid
out of the account, the banker should verify the signature of the
customer on the cheque with the specimen signature on record
with him.
In case of Savings Bank Accounts a pass book is issued to the
customer and for Current Accounts, periodical statement of
accounts are provided to the customer. At branches with
computer facility, banks do not generally provide pass books;
they only provide the customer with a monthly or weekly
statement of accounts. Banks also stipulate that if amount
exceeding, say, Rs.5,000/- is withdrawn by a single cheque in a
Savings Bank Account, that will cause ineligibility for interest
for the month.
These Savings Bank Accounts can be opened for an individual
singly or jointly, on behalf of a minor by the minors natural
guardian, or for a firm, trust or association. But in any case
banks do not permit the use of Savings Bank Accounts to be
operated as Current Accounts, by the customer.
(2) Another type of Savings Bank Account, is called the
Ordinary Savings Bank Account which can be operated with a
minimum balance of Rs.20. Third party cheques are not
collected, negotiated or credited to this type of account. The
account holder himself should be present for and receive the
withdrawals of monies. No cheque book will be issued to this
type of account holder. All withdrawals are to be accompanied
by the pass book. Generally this type of accounts are opened
for the low income group of people who open account only as
a savings venue.
The interest in the Savings Bank Account is credited at half
yearly intervals.
The above paragraphs summarise how two types of Savings
Bank Accounts are opened and operated.
Fixed Deposits or Term Deposits
Individuals, firms, companies and all legal entities are entitled
to open fixed deposit accounts. The banks accent Fixed or
Term Deposits and pay interests at rates always higher than
that paid on Savings Bank Accounts. Only those who have
surplus money which can be blocked and who want a higher
rate of return on their monies will opt to deposit their monies in
Fixed Deposit Accounts. Banks obtain specimen signature of
the customers. These Fixed Deposit receipts are not negotiable.
On the face of the receipt itself, one can find the legend Not
Transferable. The amount held under this type of account is
repayable only after the period for which the money has been
2 NATURE OF FUNCTION AND RELATION
198
deposited. However, the banks at their discretion grant loans
upto 75% of the amount in Fixed Deposits. These loans carry
an interest at a rate which will be 2% higher than the rate at
which the banks received the money from the depositor. There
is also a facility to withdraw the money prematurely i.e., before
the expiry of the period for which the amount has been
deposited. However the depositors are penalised by the bank
by paying interest at a rate lower than that rate for which the
term deposit has run. There are various types of Fixed or Term
deposits. In one scheme the banks accept smaller amount and
repay a higher or prefixed amount by compounding the interest
payable for the term. In such cases, periodical interest payments
are not made. In another scheme, banks agree to pay interest
monthly or quarterly or half-yearly or on annual basis.
Another type of savings is the Recurring Deposit Scheme,
wherein the investor deposits on a daily (as in the case of pigmy
scheme) or monthly basis a fixed amount and receives back all
monies deposited by him as a lumpsum with interest calculated
on a compounded basis at the end of the period on the date of
maturity.
The rates of interest on deposits are regulated by the Reserve
Bank of India from time to time. Banks accept deposits as per
the regulation of the Reserve Bank of India. However, in fixed
deposit accounts, banks pay the interest for the period at the
same rate agreed upon initially, even if there is an upward or
downward revision in the interest rates.
There are various permutations and combinations of the fixed
deposit accounts invented by the ingenuity of the individual
banks and implemented under various names, after appropriate
approval by the Reserve Bank of India.
From the bankers point of view, the savings bank accounts and
fixed deposit accounts, particularly from the personal segment
are considered as stable deposits and one can find the banks
conducting deposit mobilisation campaigns every year for these
type of deposits.
Current Accounts
Current accounts are generally opened and operated by
individuals and organisations who need to issue cheques in
larger numbers, for example firms, traders, manufacturers,
limited companies, trusts etc. Banks stipulate that the accounts
should always show a minimum balance of Rs.500/-. Some
foreign banks stipulate that the minimum balance in the account
should always be Rs.5000/-. Banks exercise an option to close
the accounts if the balances fall below the stipulated minimum,
although it is doubtful if it can legally do so. Individuals are
supplied with bearer cheque books, firms and companies with
order cheque books. There is no restriction on the number
and amount of withdrawals. No interest is paid on the balances.
However banks levy a charge depending upon the value of the
account and the cost-benefit ratio of running the account to the
bank. Introductory reference is compulsory for Current
Accounts. In the case of limited companies, certified copies of
the Memorandum and Articles of Association, Certificate of
Incorporation, Certificate of Commencement of Business
alongwith a Board Resolution is insisted to open the account.
In such cases introductory reference is not insisted. Banks
provide the customers with periodical statement of accounts.
Banks also record the names of the persons authorised to operate
the accounts and keep the specimen signatures of authorised
persons to operate the accounts.
The above paragraphs briefly mention the nature of various
deposit accounts. There is an association of the banks called
the Indian Banks Association comprising of all scheduled
commercial banks in India. This association has codified
formats for the use by banks such as the account opening forms,
pay-in-slips, cheque formats etc. The association has a rules
committee which prescribes the rules for the conduct of the
various types of accounts from time to time.
2.2 INTRODUCTORY REFERENCE
One of the topics which has not been dealt with in detail is
Introductory Reference to open bank accounts. The banking
custom and practice insist that introductory reference is essential
for opening the Accounts. There is no legal requirement to
obtain such references. It is a matter of practice. The internal
rules of the bank provide for it. It is not proposed to deal with
this topic in detail here. The same will be dealt with in detail
when we see the rights and liabilities of the collecting banker.
The purpose of introductory reference is to identify the
prospecitve customers. This will enable the banker to discover
whether the new cusotmer might use the account for fraudulent
pruposes of encashing cheques belonging to others. The duty
of an introducer is only moral and not legal. It may be pointed
out that it is not incumbent on the part of the bank to obtain
such reference in all cases. The internal rules of the bank and
the Indian Banks Association Rules prescribe for such
references to be obtained. But it is also not mandatory. On
account of the large number of incidence of frauds in banks,
the Indian Parliament is to bring out a bill to insist upon affixing
of a photograph of the customer on the pass books and the
account opening forms. This may to some extent remove the
difficulty for identifying a customer. However, a fraudulent
customer will always find ways to commit frauds. The moral
duty cast upon the customer will put the existing good customers
to exercise caution in introducing all types of persons to open
accounts.
The legal decisions deal with the negligence of the bank in not
obtaining the introductory reference and it is established law
that the introducer will not run into any legal problems only for
having introduced an account holder.
2.3 DEBTOR - CREDITOR RELATION
The primary relationship between a banker and customer is that
of a debtor and creditor. But one of the terms of this implied
contract is that money lent to the banker is not payable except
on demand. There are a good number of legal decisions
maintaining this view by courts in India and in the U.K.
According to Sir John Paget, the relationship of Banker and
199
Customer is primarily of debtor and creditor; the respective
positions being determined by the existing state of the account.
Instead of the money being set apart in a safe room, it is replaced
by a debt due from the banker. The money deposited with him
becomes his property and is absolutely at the disposal of the
bank.
In Foley v. Hill [(1848)2 H.L. 28] an account in the name of
the plaintiff was opened in 1829 with the defendant bank, with
an initial credit of 61, 171 pounds. The agreed rate of interest
on the deposit was 2%. There were two later debits for 1700
pounds and 2000 pounds. Interest entries were shown in
separate columns and interest amount was not credited to the
main account. In 1833 the plaintiff sought to recover the money
outstanding by an action in Chancery for an account. This
account being so simple was held not to be ex-facie a matter
for a Court of Equity, and the plaintiff thereupon claimed that
the relationship of a banker with his customer was analogous
to that of an agent and his principal, and that he was entitled to
an account on that basis, and therefore, the relatioship being a
fiduciary nature, the Statute of Limitation did not apply.
The House of Lords held that the relationship was that of debtor
and creditor and that therefore the matter was not one for an
account in equity. Lord Cottenham L.C. stated that money paid
into a bank, ceases altogether to be the money of the principal;
it is then the money of banker, who is bound to return an
equivalent by paying a similar sum to that deposited with him
he is asked for it. The money paid to the bankers is the money
known by the principal to be placed there for the purpose of
being under the control of the banker. It is then the bankers
money; he is known to deal with it as his own; he makes what
profit of it he can, which profit he retains to himself, paying
back only the principal according to custom of bankers in some
places, or the principal and or a small rate of interest according
to the custom of the bankers in other places.
This decision establishes the relationship of debtor and creditor
and not that of any agent.
The Bombay High Court also holding the debtor-creditor
theory of the relationship has held that the customer cannot,
therefore, claim any amount due from the banker as a
preferential creditor if the bank is wound up [Velji Lakshamsey
& Co v. Dr.Banarjee (1955)25 Comp Cas 395].
In Joachimson v. Swiss Bank Corporation [(1921)3 K.B. 110]
the plaintiff firm was a partnership between two Germans and
a naturalized Englishman. On August 1, 1914 one of the
Germans died and the partnership was thus dissolved. On the
outbreak of war three days later, the other German became an
alien enemy. On August 1, the firms account with the bank
had a credit balance. On June 5, 1919, the naturalised partner
commenced an action in the name of the firm to recover the
amount lying in credit in the bank, the cause of action being
alleged to have arisen on or before August 1, 1914. The firm
had not made any demand on or before that date for payment of
the sum in question and the bank (which had counter-claimed
for a larger sum than the balance in the account) pleaded on the
point here at issue, inter alia that there had thus accrued no
cause of action to the firm on August 1, 1914 and that the action
therefore was not maintainable. On appeal, the court of Appeal
held that where money was standing to the credit of a customer
on current account at the bank a previous demand was necessary
before an action could be maintained against the bank for money
and the court gave a judgement in favour of the defendant bank.
In his judgement Atkin L. J. observed , I think that there is
only one contract made between the bank and its customer. The
terms of that contract involve obligations on both sides. They
include the following provisions. The bank undertakes to
receive money and to collect bills for its customers account.
The proceeds so received are not to be held in trust for the
customer. But the bank borrows the proceeds and undertakes
to repay them. The promise to repay is to repay at the branch
of the bank where the account is kept; and during banking hours.
It includes a promise to repay any part of the amount due against
the written order of the customer addressed to the bank at the
branch, and as such written orders may be outstanding in the
ordinary course of business for 2 or 3 days, it is term of the
contract that the bank will not cease to do business with the
customer except upon reasonable notice. The customer on his
part undertakes to exercise reasonable care in executing his
written orders so as to mislead the bank or to facilitate forgery.
It is necessarily a term of such contract that the bank is liable to
pay the customer the full amount of his balance until he demands
payment from the bank at the branch at which the current
account is kept.
In the same judgement, Bankers L.J.stated that having regard
to the peculiarity of the relation there must be a number of super
added obligations beyond the one specifically mentioned in
Foley v. Hill. Unless this were so, the banker, like an ordinary
debtor must seek out his creditor and repay him his loan as it
immediately becomes due - that is to say, directly after the
customer has paid the money into his account - and the customer,
like any ordinary creditor, can demand repayment of the loan
by his debtor at any time and place. It is impossible to imagine
the relation between banker and customer as it exists, without
the stipulation that, if the customer seeks to withdraw his loan,
he must make an application to the banker for it.
Section 444 of Seven American Jurisprudence mentions the
relationship. It is a fundamental rule of banking law that in
case of a general deposit of money in a bank, the moment the
money is deposited it becomes the property of the bank, and
the bank and the depositor assume the relationship of debtor
and creditor. The legal effect of the transaction is that of a loan
to the bank upon the promise and obligation, usually implied
by bank, to pay or repay the amount deposited usually upon
demand.
Bombay High Court has further elucidated in Velji Lakamsey
& Co v. Dr.Banarjee [(1955) 25 Comp.Cas 395] that the
relation between a banker and its customer is that of a debtor
and creditor and any amount due by the banker to the customer
in that relationship cannot be claimed by the customer from the
bank as a preferential credit if the bank is wound up. But a
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customer may give certain specific direction to the bank and
constitute the bank his agent. If the bank acts as an agent and
not a debtor, then the agency brings about a fiduciary
relationship which lasts until the agency is terminated.
Therefore if the customer were to give directions to the bank
that a certain amount must be paid to a certain person, then till
that amount is paid pursuant to the directions of the customer,
the agency would continue and the bank would hold the amount
not as a debtor of the customer but in the capacity of a trustee
and the amount would be impressed with a trust.
In Santosh Kumar v. King [AIR 1952 CAL 193] it was held
that the relation between a depositor and a bank is the simple
relationship of a creditor and debtor.
When we conclude the relationship between a banker and
customer is that of a debtor and creditor, the statement is not
complete. The debt between a debtor and creditor, and a bank
and its customer, are different. A debt due from a bank to a
customer and debt due from a borrower has two distincitions.
In the first case, there is no necessity of a demand by a creditor
for payment. So far as the bank and customer is concerned, it
is an exception to the rule that a debtor should find his customer.
Here the creditor (customer) has to make a demand on the debtor
(banker). The demand should be made at the branch where the
customer keeps his accounts.
In Delhi Cloth General Mills Co. Ltd v. Harnam Singh [AIR
1955 S.C. 590] it was held that the banker customer contract is
an exception to the rule that a debtor should find his creditor.
2.4 AGENCY RELATION
Another service offered by the bankers to the customers is to
collect the customers cheques and credit other instruments such
as dividend warrants, interest warrants, pension bills etc. In
these cases the relationship between the parties is that of a
principal and an agent. The customer is the principal and the
banker, the agent. In the day to day functioning, the banker
renders many services to the customer viz.,
- buying and selling of stocks and shares on behalf of the
customer;
- collection of various types of instruments for and on behalf
of the customer;
- acting as executor and trustee of customer, acting as a
representative to the customer, filing of I.T. returns of
customer, executing the standing instructions of the
customer.
In performing these services the bank acts as an agent of the
customer.
The case of Travancore National And Quilon Bank [AIR
1940 Madras 139] dealt with an application for payment of a
certain sum of money to the applicant in preference to the
ordinary customer of the bank which went into liquidation. The
applicant paid the amount to the bank on 20th June 1938; the
day on which the bank suspended payment, for remittance as a
telegraphic transfer to a company in Bombay. The remitter had
a current account in the bank. The bank did not remit the amount
but debited to the customers account with the charges for the
proposed remittance. The money was not transferred because
on that very day the bank suspended payment. The High Court
held that on the facts of the case the money was held apart by
the bank as the property of the applicant. The money was
received by the bank in the capacity of a mere agent. This
follows that monies held apart by a banker as the property of
the customer does not form part of the banks assets in
liquidation.
In the case of the Official Assignee of Madras representing
the Estate of S N Firm v. Natesan Pillai [AIR 1940 Madras
441] monies paid by the customer for the purpose of effecting
a specific transaction were credited by the bank in their suspense
account. The bank failed and a point was raised as to whether
the customer is entitled to any preference. It was held that the
amounts were received by the firm in a fiduciary capacity and
not as between a banker and a customer. In such cases where
the bank is in a fiduciary position in respect of monies received
by it for the specific purpose and credits the sums in its suspense
account, the relationship is not that of a debtor and creditor.
In Durga Lal Mohan Lal v. Governor General in Council
[AIR 1952 590] it was held that if a bank received a crossed
cheque from his customer for collection, the bank acts as a
banker and an agent of a customer and not as a holder of the
cheque in due course. But if the cheque is discounted or
negotiated or purchased by the bank the property with it passes
on to the bank. Then he becomes a holder in due course and
ceases to be the customers banker or agent in relation to that
transaction. The distinction between a banker who receives a
cheque or instrument for collection and the bank which
negotiates the cheque is different. In the first case the bank
acts as an agent and in the second case the banker becomes a
holder in due course. When the bank merely acts as a collecting
agent he has no cause of action against the drawee bank if the
drawee bank refuses payment. The cause of action remains
with the customer. When the banker becomes a holder in due
course he is entitled to sue under Section 131 of the Negotiable
Instruments Act which protects the banker who in good faith
and without negligence receives payment for a customer of a
crossed cheque, when the title to the cheque proves defective.
In the Indian Law a banker is deemed to receive payment for a
customer even though he credits the customers account with
the amount before receiving payment.
Banker as an agent is bound to carry out the directions of his
principal viz the customer and conduct the business of the
agency with such skill as is generally possessed by persons
engaged in similar business; unless the principal has notice of
his want of skill.
He should compensate his principal in respect of any loss
incurred by his failure to carry out the directions of his principal
or by his negligence in the conduct of the business of agency.
Another recent case was decided by the Consumer Protection
Forum of Mysore in 1990. In that case, a customer applied for
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a draft from the branch of a bank in Mysore for remittance as
examination fee, to appear for an examination conducted by
the Chartered Accountants Assoicaiton. The branch issued the
demand draft and the customer promptly forwarded the same
to the Institute. The draft was returned by the paying branch
for the reason that the demand draft was not signed by an
authorised official of the issuing branch. The customers
application to sit for the examination was rejected by the Institute
as they did not receive the fee in time. The customer approached
the Consumer Protection Forum and the forum awarded a
compensation of Rs.30,000/- for the negligence of the bank
and held that the bank in the instant case undertook an agency
function and was negligent. The bank paid the compensation
amount.
The principle of law is clearly stated in the maxim - qui per
valium - facit per seipsum facere videtur; that is he who does
an act through another is deemed in law to do it himself.
A reference to Article 63 in Bowstead on Agency illustrates
that this principle - every agent who employs a sub-agent is
liable to the principal for the money received by the sub-agent
to the principals use and is responsible to the principal for the
negligence and other breaches of duty of the sub-agent in the
course of his employment.
In Punjab National Bank Ltd v. R.B.L. Banarasi Das & Co
[AIR 1960 Punjab 590] a reference was made to section 182 of
the Indian Contract Act which defines a Principal and his Agent.
The argument in the case was that the plaintiff bank was the
agent of the defendant. Three cases of sub-agents are defined
in the English Law.
1. Those employed without the authority, express or implicit,
of the principal by whose acts the principal is not bound.
2. Those employed with the express or implied authority of
the principal but between whom and the principal, there is
no privity of contract.
3. Those employed with the principals authority between
whom and the principal there is privity of contract, and a
direct relationship of principal and agent is accordingly
established.
It was argued that the case in question fell under category (2)
above and it was argued by the appellant that the case fell under
category (3). It was stated that if a banker is dilatory in
endeavouring to procure acceptance or payment or is otherwise
negligent in doing the business of agency, and his customer
suffers for the consequences, the banker would be liable to make
good the customers loss. It is also well established that the
collecting banker is under no special duty as such to protect the
interests of the person to whom he presents a draft for acceptance
or payment.
Invariably, banks accept cheques or bills for collection only for
its customers. But there are cases where the customers do not
have accounts, at a particular bank in a particular place. In
such cases, it is by custom that banks accept such instruments
for collection. Being the first agents of the Reserve Bank of
India, the State Bank group was the only bank where
Government/Treasury transactions were conducted. In many
rural places, public, particularly contractors receive Government
bills payable at the district treasury centres and apayble at the
State bank group. The user public in such cases present the
Government bill or cheque to the branch of the State Bank group
to get them collected from the district headquarters branches
and remit the proceeds by means of a pay order or bankers
cheque. In such cases the bank (State Bank Group) acts as an
agent to the tenderer/lodger of the instrument. A decision on
this point is found in The Bank Of India v. The Official
Liquidator [AIR 1950 Bombay 375]. In this case the customer
had no account with the bank. The customer forwarded a cheque
with a covering letter to the bank requesting to collect the
proceeds and remit the same less their charges by a cheque in
lodgers favour on a bank at Bombay. It was held that the bank
in the instant case acted only as an agent.
2.5 TRUSTEE RELATION
The basic relationship between a banker and a customer is that
of a debtor and creditor. In some cases, the relationship is that
of principal and agent. The customer is the principal, and the
banker is the agent. A third relationship of the banker as a
trustee is also evolved. There are number of decisions both by
the English and the Indian courts. For example, a remittance
was sent to a banker with instructions to purchase shares of a
company. Bank bought some shares, but before completing
the rest of the purchase the bank failed. it was held that the
bank stood in the position of a trustee to the remitter and, the
remitter was entitled to a refund of the unspent balance.
Where a banker pursuant to instructions, express or implied
has credited the proceeds of a bill or other document entrusted
to him for collection, the relationship of debtor and creditor
arises from the time of his doing so. Where, the banker has
suspended his business before receipt of such amount, he holds
the money as trustee for his customer, irrespective of whether
or not the latter has an account with him on the date of the
receipt of the money and whether or not the money has been
credited in that account.
When a bank is appointed as a receiver by a court in a partition
suit between the members of a Joint Hindu Family and the
money received by the bank are deposited in a current account
with itself, the bank is acting as a trustee for the amount. When
the bank receives the money for a specific purpose or in a
fiduciary capacity as in the instant case as a court receiver, the
bank will be a trustee for the amount.
Where a sum of money is paid to the general account of the
customer with the direction that it must be applied in a particular
manner as and when the occasion arises, until the said sum of
money is appropriated in the manner directed, no question of
trust would arise.
In cases where the relationship is that of a trustee and beneficiary
of the trust and the banks hold the money in a fudiciary capacity,
it is the duty of the banks not to commit a breach of trust by
putting the money contrary to the terms of the trust.
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A customer of a bank having a deposit executed a power of
attorney in favour of a third person to secure instruments at
higher rate of interest. The amounts were withdrawn by the
power of attorney holder to discharge his own debts to the bank.
In such cases, the depositor can sue both the bank and the power
holder and the power holder becomes a constructive trustee.
Similarly where an employee furnishes security deposit for
employment in banks a trustee relationship is created and the
employee will be entitled to be treated as a preferential creditor
for the security deposit in case the bank fails.
The decision of the Supreme Court of india in New bank of
India v. Peary Lal [AIR 1962 S.C. 1003] is notable. It was
held - where a person dealing with a bank delivers money to
the bank, the intention to create a relationship of creditor and
debtor between him and the bank is presumed. But this
presumption is rebuttable. Where money is paid to a bank with
special instructions to retain the money pending further
instructions or to pay over the same to another person who had
no banking account with the bank and the bank accepts the
instructions and holds the money pending receipt for instructions
from that other person or whose instruction are given by a
customer to his banker that a part of the amount lying in his
account be forwarded to another bank to meet a bill to become
due and payable by him and the amount is sent by the banker as
directed, a trust results and the presumption which ordinarily
arises by reason of payment of money to the bank is rebutted.
Besides, being of the status of a trustee in these circumstances,
a banker will also accept the role of an executor if appointed as
such under a will or a trust. Executorship is a function which
has, of late, become a growing business for the bank for good
fee.
2.6 BAILOR - BAILEE RELATION
One of the many services offered by a commercial bank is called
safe custody facility. Bank accepts from its customers sealed
boxes and packets for safe custody. In most of the cases the
banker can open such safe custody articles, boxes or packets
only as per the instructions of the person who deposits the same
for safe custody. A customer may chose to keep with his bank
his last will and testament. In such a case he may also instruct
his bank to open the packet on receipt of the notice or knowledge
of his death. And if in the will the bank is appointed by the
deceased as his executor or trustee the bank will have to take
care of the assets of the deceased and execute the will in toto.
The contents of the safe deposit article are not made known to
the bank and there will be a narration in the safe custody receipts
issued by the bank Received a `packet, - `box contents not
known. The bank will also record the instructions of the
customer in their books as well as in the safe custody receipt
about the return/delivery of the packets-articles at a later date.
It is usual and accepted practice for one bank branch at a centre
to keep the duplicate keys of the safes and strong rooms of
another bank branch at the same centre. It is also the practice
for a bank branch to keep such keys at a branch in the same
centre or at a nearby centre of the same bank. In all such cases,
the narrations in the safe custody receipts and the registers will
contain the - said to contain the duplicate keys deliverable
against the joint signature of the branch manager and accountant/
cash officer.
The banks may or may not charge for such safe keepings. A
customer who takes a fixed deposit from a bank may like to
keep the receipt with his banker in safe custody for various
reasons. The banks in India do not charge any fees for such
safe custody. The depositors in such cases also instruct the
banks to credit the periodical interest payable to his account.
In all such cases bank as a matter of practice do not charge any
fees for such safe custody.
The legal relationship that arises in case of safe deposit or safe
custody is that of bailment. The customer who deposits with
the bank for safe custody is the bailor and the bank the bailee.
Such safe custody should be under the condition that the article
or property shall be returned to the bailor as soon as the purpose
for which the bailment was created is over.
The law of bailment is explained in the Indian Contract Act.
Section 148 of the Contract Act defines bailment, bailor and
bailee. A bailment is the delivery of goods by one person to
another for some purpose, upon a contract, that they shall, when
the purpose is accomplished, be returned or otherwise disposed
of according to the directions of the person delivering them.
In cases where the bank does not charge any fees for such safe
custody, the bank can be termed as a gratuitous bailee. In cases
where fees are levied, the bank becomes a bailee for reward.
The distinction between these two types of bailment is that the
gratuitous bailee must do his best with what he has got. He
must use all the facilities he has to protect the goods bailed to
him; but he is not bound to do more. He has to take the same
care as he takes for his own property. He is not bound in law to
provide at his cost the means of ensuing a higher degree of
security for the articles deposited with him. As a bailee for
reward, he is bound to adopt at his cost all appliances and
safeguards he can procure. A banker obtains a mandate from
his customer and if he complies with it, he runs no risk; if he
does not, he may be at risk either on the grounds of negligence
or conversion. In a bailment, the bailee may be made liable for
want of care.
The Supreme Court of India in United Commercial Bank v.
Hem Chandra Sarkar [AIR 1990 SC 1329] decided the
question of law, whether in the circumstances of the case the
appellant bank was an agent of the respondent or a bailee in
respect of goods entrusted for delivery to the respondent against
payment.
In 1945, Hem Chandra Sarkar was carrying on the business of
wholesale and retail trade in textiles & yarn and cloth at
Agartala. He was appointed as government nominee to indent
and lift cloth and yarn to Agartala from mills in different parts
of India. For the purpose of that business Hem Chandra Sarkar
maintained a current account in the UCO Bank. The case of
Sarkar was that there was an oral agreement on 2.9.1950 under
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which the latter inter alia was to receive bills, documents and
airway receipts sent by or on behalf of Sarkar from his agents
or suppliers and would release and/or take delivery of goods
sent by them, as and when goods arrive at Agartala.
The bank would keep or hold the said goods stored in its godown
for and on behalf and on account of the customer and for his
benefit. It was also alleged by Sarkar - the plaintiff - that the
payment of bills in respect of goods dispatched to the bank
should be made by the plaintiff. He should be given the delivery
of goods and air receipts by the bank according to his
convenience and requirement. It was further stated that under
the said terms and conditions, the banker consituted himself
and acted as an express trustee and or agent of plaintiff in relation
to the said goods and air receipts and stood in fiduciary
relationship with the plaintiff.
Complaining non-delivery of goods even after receiving
payment thereof, the plaintiff brought a suit for accounts,
damages, compensation and delivery of goods or their
equivalent in money valued at Rs. 2,68,198/97.
The bank denied all allegations and claimed that it never acted
as an agent, trustee or depositee of the plaintiff. The bank also
denied the existence of any fiduciary relationship. The bank
stated that certain parties from Calcutta were supplying goods
to various parties including the plaintiff in Agartala and the
bank used to send the bills along with the respective air bills to
their Agartala branch for presentation to the drawees and the
bank would deliver the same against payment. The bank
maintained that it had dealt with all such goods of the Calcutta
parties, recovered monthly charges at the instructions of the
drawers and the drawee (plaintiff) and debited to the account
of the plaintiff. When funds were not available in the current
account of the plaintiff, the said charges were recovered from
the drawers. The goods in the custody of the bank on behalf of
the Calcutta parties which were paid for by the plaintiff would
be delivered to the plaintiff and the goods for which no payment
was made would be returned to the drawers.
The trial court held that there was an agreement or arrangement
between the parties regarding payment of bills or charges for
the account of the plaintiff and regarding storing of the goods
received by the bank in its godown, of which the plaintiff came
to be the owner and for delivery of those goods as and when
required by the plaintiff. The trial court also held that the bank
acted as an agent of the plaintiff. In this suit, such agency of
the defendant a relation of trust and confidence and the goods
which came to be owned by the plaintiff on payment of the
value thereof and which remained in the branch of the bank
were impressed with trust for the benefit of the plaintiff and
further that there was no escape from the conclusion that the
bank stood in a fiduciary relationship with the plaintiff.
Accordingly, the trial court decreed the suit in part directing
delivery of goods or the value equivalent to Rs. 1,26,500/-. A
commissioner was also appointed by the court to take accounts.
The High Court of Calcutta confirmed the decree of the trial
court. As to the question of legal relationship, the High court
observed that had the plaintiff paid the value of goods and that
the bank neither delivered the goods nor rendered accounts, a
fiduciary relationship could exist between the parties in respect
of the goods for which value was paid by the plaintiff.
The Supreme court held that the High court and trial court were
not justified in holding that a fiduciary relationship had existed.
This inference was drawn primarily from the debit entries in
the plaintiffs current account. The court also held that the
bank took charge of goods, articles, securities as bailee and not
as trustee or agent. Bailment is the delivery or transfer of
possession of a chattel with a specific mandate which requires
the identical res either to be returned to the bailor or to be
dealt with in a particular way by the bailee as per directions of
the bailor. One important distinction between agency and
bailment is that the bailee does not represent the bailor. He
merely exercises, with the leave of the bailor, certain powers of
the bailor in respect of his property. Secondly bailee has no
power to make contracts on behalf of the bailor. Nor can he
make the bailor liable simply as a bailor for any act he does.
There was nothing to indicate that the bank represented the
Calcutta parties or the plaintiff with authority to change the
contractual or legal relationship of the parties and there is no
justification to hold that the bank acted as agent of the plaintiff.
The bank having received the price of the goods had failed to
deliver the same to him. The banker being a bailee, either
gratuitous or for reward, is bound to take the same care of the
property entrusted to him as a reasonably prudent and careful
man may fairly be expected to take care of his own property of
the like description. In fact a paid bailee must use the greatest
possible care and is expected to employ all precautions in respect
of the goods deposited with him. If the property is not delivered
to the true owner the banker cannot avoid his liability for
conversion. The bank could not avoid liability to return the
goods as agreed upon or to pay an equivalent amount to the
plaintiff. Even if we assume that the goods were delivered to a
wrong person, the bank has to own the responsibility to pay the
plaintiff. The liability of a banker to a customer in such a case
is absolute even if no negligence is proved.
The court held that in practice the bankers do not set up the
Statute of Limitations against their customers or their legal
representatives and the court did not see any reason as to why
this case should be an exception to that practice.
In practice, if a current account or savings bank account is not
operated by a customer for a period of three years, the bank
transfers the balances in such accounts to another account called
inoperative account. Operations after that period are permitted
only after making reasonable enquiries and verifying carefully
the signature of the customer.
If the accounts are not operated for 5 to 7 years, the balances
are transferred to the unclaimed deposit account. The law and
instructions also provide that the balances unclaimed over a
period should be transferred to the Central Government.
However, in practice it is seldom done.
Customers in many cases seek the advices of their bank on
matters of investment in securities for booking forward
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contracts to cover their exchange risk etc. It is not mandatory
on the part of the banks to render such advices. Banks also do
not incur any laibility on such advices.
Another service that the banks offer is the hiring out of Safe
Deposit Lockers. The bank charges according to the size of the
lockers. Many bank branches particularly in metropolitan and
urban towns provide this facility to customers. This facility is
provided only to those who have accounts i.e., customers. In
view of the risks involved in keeping valuables at residences
many people utilise these services. These lockers can be opened
only by operating two keys successively. One key will be with
the customer and the other with the bank. The locker agreement
is legally drafted and contains clauses exonerating the bank.
However, when operation in the locker takes place, the practice
provides sufficient precautions to the banker. The bank obtains
the signature of the customer in a format and verifies the same.
The time of operating is also recorded in the format and in a
register kept with the bank. There is ample security. The locking
system of the vaults is such that the key of the banker is not
required to lock the vault. If the customer closes the door and
locks, the bank cannot again open the same without the customer
again operating his key. Banks also take care to ensure that the
locking system is also changed periodically. In short, the legal
relationship in this case is that of a hirer and hiree.
Many banks use the locker facility for deposit mobilisation.
The bank insists that the customer should deposit a fixed amount
in term deposits for availing a locker facility. As the bank hires
out lockers only to customers, it obtains a mandate from the
customer to debit his account for the periodic rentals.
2.7 OTHER SERVICES
The other services commonly utilised by the customers are :
1. Collection of cheques and bills, inland and foreign.
2. Discounting of cheques and bills, inland and foreign.
3. Remittance of funds a) by issue of drafts
b) mail transfers/telegraphic transfers.
4. Acting as executor and trustee.
5. Issue of travellers cheque.
6. Rendering credit information.
7. Rendering trade information.
8. Issue of letters of introduction.
9. Issue of letters of credit, inland and foreign.
10. Providing letters of comfort.
11. Providing training facilities
12. Technical advices, project appraisals.
13. Managers of Public Issues. Acting as bankers to issue and
for payment of interest/dividend warrants/under writers/
syndication of loans etc.
14. Collection of periodical interests on various types of
instruments.
15. Acting as insurance agents/travel agents.
16. Purchase and sale of shares and securities for customers.
17. Factors.
18. Collection of Pensions.
19. Credit cards.
20. Teller Facility
21. Providing a linked Computer Terminal to the customer
22. Providing Credit (loans) to customers
23. Agents to execute standing instructions.
24. Advisor to customer for personal investment.
1) Collection of Cheques and Bills
The bank acts as a collecting agent of the customer to realise
the proceeds of cheques and bills tendered by the customer
payable within India or abroad. In addition to the actual out of
pocket expenses the banks charge a commission at a graduated
scale for rendering this service.
The legal relationship that arises out of this transaction is that
of a principal (customer) and agent (bank). If the cheques and
bills thus sent by bank to its own branches or to their
correspondents are returned unpaid, the bank returns the same
and charges a commission for its service.
2) Discount/Purchase of Cheques/Bills
To discount a cheque or bill for a customer is a credit decision.
This facility is not extended to all customers. The facility is
extended only when the bank is sure that in case the cheque or
bill is returned unpaid, there will not be any difficulty to recover
the amount from the customer. In most of the cases the banks
appraise a proposal for a regular cheque or bill discounting
facility with reference to the credit worthiness, financial standing
and financial position with reference to the balance sheet.
Regular limits are then sanctioned to the customers. Suitable
documentation is done before the extension of the facility. The
banker becomes a holder for value when he discounts or
purchases cheques or bills.
3) Remittances
The customers in all segments, whether he is an individual or
one in business very often require this facility. They require
their monies to be transferred from one station to another within
India or abroad.
The postal department of the Government of India undertakes
money transfers by money orders. However the charges are
very high compared to banks. There is also a limit as to the
amount that can be sent by money order.
a) Issue of Bank Drafts
The banks issue demand drafts payable to the person mentioned
by the applicant to another branch of the same bank or to another
bank with whom the bank has correspondent relationship. These
demand drafts are for value received. The applicant has to remit
the money or authorise the debit of his account with the bank.
It is payable to or to the order of the payee. These are
transferable by endorsement and delivery. If the draft is crossed
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Account Payee then it loses the character of transfer by
endorsement and delivery. These drafts are handed over to the
applicant of the draft/customer, by the bank and are forwarded
by the applicant/customer directly to the beneficiary of the draft.
In case of loss of a draft, there is a provision for issue of a
duplicate draft on the purchaser furnishing an indemnity to the
satisfaction of the bank, for any loss or damage the bank may
incur in case the original is also presented at the paying end.
Generally, banks obtain a confirmation from the paying branch/
bank, that the draft has not been paid and they have noted to
stop payment if the original is presented for payment.
As the banks exchange the drafts for value received they charge
exchange as remuneration at a graduated scale.
This is an agency service.
b) Mail/Telegraphic Transfers
These are generally made between the branches of the same
bank or that of a bank and its correspondent bank branch. Unlike
demand drafts these are not handed over to the customers. Banks
themselves undertake the work and charge an exchange at a
graduated scale to the customers/applicants account.
The mail transfer system is ineffective as there is undue delay
and generally the purpose for which the amount is transferred
becomes frustrated on
account of the delay. In the case of telegraphic transfers also
there is a system of bunching the telegrams and telegrams
generally leave the bank branch only after 5/6 p.m.
This is also another agency function.
4) Executor and Trustee
This service has its origin to the colonial rule. People who
execute wills and keep the same in the custody of banks
authorise the banks to open their sealed envelopes containing
the wills on receipt of the notice of the death. The bank is
instructed to act as a trustee to execute the terms of the will.
5) Travellers Cheques
Whenever a person/customer does not want to carry cash while
on travel, he/she avails of this facility. Banks on receipt of
cash issue the travellers cheques which are payable at all the
branches of the bank in India and at the offices of the encashing
agents appointed by the bank. Before issuing the travellers
cheques the bank obtains the signature of the applicant on the
face of the cheques itself. At the time of encashment, the holder
has to sign again on the face of the cheque at another space
provided for the purpose. Foreign Travellers cheques are also
payable by banks in India. On account of Exchange Control
Regulation, Indian banks issue foreign travellers cheques subject
to various guidelines issued by the Reserve Bank of India. When
the Indian rupee becomes fully convertible we can hope that
the banks in India will also issue travellers cheques payable
abroad across the counters of foreign banks.
There is provision for issue of duplicate travellers cheques, in
case of loss. Banks issue travellers cheques without any charges.
This is because banks could utilise the money in the pipeline.
This is an agency function.
6) Credit Information
This is also a service function where the bank obtain from
another centre in India or abroad about the standing and credit
status of a customer. The banks issuing such information and
the banks who obtain the information on behalf of a customer
do so without any responsibility about the correctness. Only
broad advices such as good for the transaction or the customer
is having a nominal account etc are given. The necessity for
this information arises from the fact the customers at two centres
do not know each other. The necessity arises out of trade
transactions where the customer at one place wants to send
goods to a customer at another place on credit basis or on the
basis that the bills will become payable only after certain number
of days, after acceptance.
Banks call it credit report, opinion report or status report.
7) Trade Information
This service also does not attach any responsibility for the
bankers. Bankers by practice have a bundle of information
about a particular trade, a particular country and the political
stability of another country. To encourage exports, banks
whenever a customer asks for, furnish or obtain from various
sources, this type of information to their customers.
8) Letters of Introduction
Whenever a customer wants to open another account at another
centre, the banks insist on a letter of introduction. Further,
when V.I.P. customers visit another place or country such letters
will be of great help to the customer, not only to open an account
but also to obtain information from the other banks to know the
customers, trade practices etc. This is also a service function
done without any cost.
9) Letter of Credit
When two unknown parties transact business without knowing
each other, the buyers require this facility. Issue of Letters of
Credit is essentially a credit decision. The issuing bank
undertakes the responsibility to honour the bills drawn by the
seller and pay to the sellers bank, provided the documents are
drawn strictly in conformity with terms of the letter of credit.
Bank charges a commission for this facility and issues letter of
credit only after satisfying itself that the customer will have the
resources to honour when the bills are presented to him by the
sellers bank. Here, although it is a financial service, the
relationships between the opener of the letter of credit and his
banker can become a debtor creditor relationship.
10) Letters of Comfort
Valued customers often approach their banks for this facility.
Such valued customers often require the import of heavy
machinery and the seller of the machinery in a foreign country
requires a letter of credit or guarantee for payment before
shipment from a first class banker in the buyers country. In
many cases sanctions from the Government may not have been
206
obtained but would have been applied for by the customer. In
the meantime, the seller from abroad will be threatening the
buyer customer that if he does not receive the letter of credit
within a stipulated time, he will cancel the contract.
In such cases the banks issue a letter of comfort to the supplier
of machinery stating that an unconditional letter of credit will
be issued on production of the required Government permission.
This practice is prevalent more widely in foreign countries. This
is a modern development and issue of such letters of comfort is
basically a credit decision of the bank issuing the same.
11) Training Facilities
With the emergence of modern trends, banks in India and abroad
offer this service to their customers and correspondents with or
without any fees. Underdeveloped countries, mainly from
Africa, utilise these services from banks in India. From India,
bank officials are deputed to first class banks abroad for this
purpose. Banks in India also undertake to depute their officers
abroad to manage banks in their countries as per joint venture
agreements.
In many cases banks also conduct seminars, meetings and
training programmes for their customers and prospective
customers.
12) Technical Advice, Project Appraisals
On account of experience banks achieve the capacity to render
technical advice. After all the success of any project depends
upon the technical feasibility and economic viability of the
project. The technical inputs, the type of machinery and the
technology to be used for a viable or profit making proposition
is advised by the banks to its customers. With the resources
available at the disposal of the promoters banks render technical
advices and appraises the projects so that the projects are
technically feasible and economically viable.
This is an agency function and banks charge a fee.
13) Capital Market Functions
This is also an agency function. The banks after appraising the
projects advise the customers as to how to go ahead with the
financial structuring and requirements of the customers. They
advise the customer about the lines of credit available to the
customer. They agree to underwrite a portion of the public
issue if the customer chooses to go to the public for subscription.
If the public response is not good, the liability under the
underwriting the shares will devolve on the bank.
In case where banks appraise and underwrite they agree to act
as registrars to issue. They collect the public money through
their branches. After the issue is closed they advise the
customers about the total amount collected.
14) Collection of Periodical Interest on Various Types of
Securities
This function and the legal relationship have been already dealt
with in detail. This service is rendered only to customers.
Customers keep their Government bonds, debentures of
companies, fixed deposit receipts of its own or of other banks
in safe custody. The collection of periodical interests require
constant attention and is a time consuming procedure if the
interest to be collected is of a Government security. Even
without keeping them in safe custody, banks undertake to collect
interest for its customers.
A commission is charged on the transaction.
15) Acting as Insurance Agents/Travel Agents
Some banks take agency of Life and General Insurance as well
as an agency from the Airlines. In recent times these facilities
are not utilised by the banks customers as the service from the
banks is not upto the customers expectations. And, insurance
and travel companies have widened their network of agents.
16) Purchase and Sale of Shares
Banks undertake on behalf of their customers to purchase and
sell shares. This function is an agency function. Banks are not
till now members of Stock Exchanges but their merchant
banking subsidiaries may become members. Banks place their
customers orders through brokers approved by the bank. Banks
before entering into purchase transaction on behalf of the
customers ensure that the customer has the capacity to pay for
such purchases. The banks do not speculate on shares but only
carry out the orders placed on them by their customers.
17) Factoring - Forfeiting
This is also of recent origin. Following the success of the
scheme abroad the Government of India/Reserve Bank of India
permitted the opening of State Bank of India/Factors Ltd and
Canara Bank Factors Ltd. Both have not made any headway.
In factoring the factor, that is, the banker purchases the book
debts of a company at a discounted price. In the case of bills
payable abroad the service is called forfeiting. The bank
becomes the sole owner of the factored debt. In almost all
business transactions in U.S.A., these services are very much
in use by the businessmen. The relationship is that of buyer
and seller between the bank and its customer.
18) Collection of Pensions
The collection of pension amount from the Government
Treasuries used to be agonising for the pensioners. They were
required to go and stand in long queues. Banks undertake, as
agents, the collection of Government or other pensions and
charge commission for this agency transaction.
19) Credit Cards
This is known as plastic money abroad. Again, this is an
agency facility provided by the banks. The banks depending
on the value of the customers accounts issue what is called a
credit card. These credit cards enable the holder to purchase
within India or a specified area anything and everything from
shops and business houses authorised by the credit card issuing
bank or organisation. The shops and business houses are
provided with a decoder in most of the cases to prevent the
unlawful use of this facility. The shops and business houses
claim the amount of the bills from the issuing banks or credit
card issuing organisations. The service is charged at periodical
intervals.
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Most of the credit cards used by Indian banks have not met
with success. However the most popular cards are that of
Citibank, American Express and Master Cards. A Plastic card
with the name and a code number is provided to the customers.
In some cases customers photograph is also affixed on the face
of the cards. Banks in India issue their credit cards only to
customers with whom they are confident that there will be no
difficulty to realise the amount.
20) Teller Facility / Automatic Teller Machines
One of the services for quick customer service followed by
banks in India is teller facility. The banks have provided teller
counters at many of their branches. The teller - the official of
the bank - sitting on the teller counter pays on presentation of
the cheque immediately without verifying whether the
customers account has a credit balance. There is a restriction
as to the amount that can be encashed at the teller counter.
Abroad when customers find it difficult to visit a bank branch
to encash a cheque they have the facility of access to Automatic
Teller Machines. ATMs are unmanned computer terminals
which facilitate cash withdrawals and deposits. These machines
are installed at various important places of the city or town by
the banks and are connected through cables to the main computer
at the bank. The banks upon request provide a secret code
number to the customers.
The customers can themselves operate these machines installed
in the booths. The machine checks through the computer
whether the customer has sufficient balance. If there is balance,
currency will come out through a slit in the machine. The service
is available for 24 hours through all days and there is no holiday
for the machine.
In India, the machines have not become popular for want of
branch computerisation. Hongkong Bank, ANZ Grindleys Bank
and Citibank have installed ATMs in Bombay, Bangalore and
other cities.
This is only an added facility to the customer and the debtor-
creditor relationship very much exists in this type of transactions.
21) Customers Computer Terminal
Banks abroad connect a terminal of their computers at the desk
of their customers. The customer will have access to his account
ONLY with the branch. The customer can find out by operating
their computer terminal connected to the bank, the balance in
his account at any point of time and the status of other
transactions.
Banks in India have also started extending this facility to
customers who can bear the charges of a dedicated telephone
line. However the progress in this regard in India is tardy as
branch mechanisation has not progressed; partly due to
Government policies and partly due to opposition from strong
trade unions in the banking industry.
22) Provider of Credit
After collecting the deposits banks must deploy these funds
effectively and profitably. Till 1980, more precisely till the
nationalisation of the banks, banks were security oriented in
their approach for sanctions of loans. There was no social
obligation on banks. Various schemes have come into force
during the last decade to promote social justice, for creating
job opportunities etc.
The legal relationship between the borrower customer and the
lender banker is - that of customer and banker reversed. In
case the customer becomes the borrower and the banker the
lender naturally the bank becomes the lender and the customer
the borrower. A galaxy of loan schemes are available in India
at the hands of the banks.
As this paper is not intended to explain those schemes, it is
sufficient to understand that the bank in all loan transactions is
the creditor and the borrower customer the debtor.
23) Standing Instructions
Customers often expressly instruct the banks to execute their
instructions for periodical payments. These are called Standing
Instructions. Periodical payments of premium on insurance
policies, remittance of funds to friends or relatives, remittance
of money to other banks/its own other branches, to debit his
deposit account and remit periodically to their loan accounts
are the main features covered under this standing instruction.
The legal relationship is that of agency.
24) Advisor to customer for perosnal investment
One of the important functions of a modern banker is to advise
its customers to invest his/her savings in such a way so as to
maximise the return with highest security. Three concerns of
an investor are: (1) security of the investment, (2) liquidity of
the investment, and (3) yield of the investment. Therefore the
matter of investments has become a very complicated affair for
any ordinary investor. A banker been a professional financial
manager gives advice to his/her customer in the proper
deployment of his/her savings. A proper development of this
concept has given rise to portfolio management functions of a
bank and these led to a separate institution of mutual fund. Many
of the commercial banks in India have already established their
mutual funds.
SUMMARY
From the above paragraphs it is clear that the general
relationship between a banker and his customer is that of a debtor
and creditor. However this statement is subject to a number of
super added obligations, one of which is that the bank will
honour its customers cheques, provided that the account has
sufficient credit balance; and an obligation on the part of the
bank that it will not return the customers cheques for want of
funds provided sufficient balance is available in the account.
In addition, many specialised services are undertaken by the
bankers arising from specific provisions in a contract ; and their
contents give rise to various other relationships such as principal
and agent, trustee and beneficiary, bailor and bailee. The range
of services are ever expanding and the relationship can be
decided only in the light of the facts as they exist and on the
terms of the contract.
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SUB TOPICS
3.1 Limited Companies
3.2 Partnership firms
3.3 Joint Hindu Families
3.4 Minors
3.5 Illiterate persons
3.6 Trust
3.7 Executors & Administrators
3.8 Unincorporated bodies
3.9 Joint Accounts
3.10 Liquidators
3.11 Mercantile Agents
3.12 NRI
3.13 Foreigners
3.1 ACCOUNTS OF LIMITED COMPANIES
The accounts of the limited companies form a large and major
portion of the business of the banks. In India, the formation
and conduct of the companies are governed by the Companies
Act, 1956 and in the U.K. by the Companies Act of 1948 and
1967. Most of the provisions of the Indian law are based on
the British law.
When limited companies approach a bank to open an account,
whether as a depositor or as a borrower the following formalities
are to be complied with.
1) An account opening form for the purpose (different one in
the case of limited companies) duly completed.
2) A certified copy of the Memorandum of Association and
Articles of Association.
3) A certified copy of the Certificate of Incorporation issued
by the Registrar of Companies.
4) Certificate of Commencement of Business where
applicable, i.e., only in the case of public company.
5) A certified copy of the resolution to open the bank account
at the bank branch certified by the chairman, or secretary
or a principal officer of the company. Generally, this
resolution is printed on the reverse of the account opening
form and the company need only submit the same duly
signed by the person who acted as the chairman at the
meeting after passing the resolution and after affixing the
company seal.
The account opening form also mentions the name of the persons
authorised to operate the account either singly or jointly and
has to be signed by the persons authorised to operate the
accounts. Some banks obtain the specimen signature of the
persons authorised to operate in a separate specimen signature
card.
In practice, the banks enter on one side of the ledger and in a
register the important provisions of the Memorandum and
Articles of Association of the company. As per Company law,
the Memorandum and Articles of Association are as it were,
the boundaries within which the companies can operate. It is
fundamental and except in certain cases it is unalterable in law.
The Articles of Association contain the regulations which
control the internal management of the company. The Articles
and Memorandum can be altered by the provisions contained
in the Companies Act. Any person dealing with a company is
supposed to know the provisions of the Memorandum and
Articles of Association. The position of the banker vis a vis
the Memorandum and Articles of Association become more
important when the bank is a lender to the company. The banks
must ascertain from Articles that the directors have necessary
powers to borrow. In cases where the bank deals with a company
in accordance with the Memorandum and Articles of
Association and has complied with the other requirements, then
the bank is not concerned with the internal management of the
company. There may be irregularities in the appointment of
directors and passing of various resolutions. It is not the liability
of the banker to verify the correctness of these matters.
Two British cases deal with the doctrine of indoor management.
One is the rule in Turuquands case [Royal British Bank v.
Turuquand (1856)-6 E & B - 327]. A person may be acting as
a managing director, but in fact he may never have been
appointed as a managing director.
In Mahany v. Liquidator of East Holyford Mining Company
[(1975)L.R.7 H.L. 869] the House of Lords applied the rule. A
mining company was formed and it issued shares. The proceeds
were credited to the bank account. No meeting of the directors
were held and no proper appointment of directors and the
company secretary was made. A formal notice was sent to the
bank by a person signing as secretary, authorising the bank to
pay cheques signed by the two of the three directors and counter
signed by the company secretary. A copy of the alleged
resolution authorising this arrangement was also sent to the
bank. Cheques were drawn in this way and the balance disposed
off. The liquidator sued the bank. It was held by the House of
Lords that there was no duty on the bank to inquire whether the
directors and the secretary were properly appointed. The fact
was that the persons making the representations were those who,
under the constitution of the company were entitled to appoint
the directors and the secretary. They had actual authority to
make representations as to who the officers were.
In this case it was held that the bank was not affected by these
internal irregularities and that there was no duty on the bank to
enquire whether the directors and the secretary had been really
appointed. Lord Hatheler stated - when there are persons
conducting the affairs of the company in a manner which appears
to be perfectly consonant with the Articles of Association, then
those dealing with them, externally, are not affected by any
irregularities which may take place in the internal management
of the company. The banker need not pierce the corporate
veil.
3. SPECIAL CATEGORY CUSTOMERS
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This rule is sometimes known as the Doctrine of Indoor
Management or the rule in Turuquands case as it was first laid
down in the Turuquands case. It is also referred to as the rule
in Mahanys case.
In Turuquands case, the company was authorised by its deed
of settlement (Memorandum and Articles of Association), to
borrow money through its directors, such sums as might be
authorised by a resolution passed at a general meeting of the
company. The company arranged to borrow 2000 pounds from
the plaintiff bank and gave the bank a bond for the amount,
under seal and signed by two directors. The bank sued the
defendant as the official manager of the company, to recover
the loan. It was contended for the company that there was no
resolution passed in the general body meeting and that the bank
cannot recover.
It was held by the Court of Exchequer Chamber that as the
power to borrow money on bonds was not inconsistent with
the provisions in the deed of settlement, banks were entitled to
assume that the necessary resolution has been passed by the
share holders. The relationship between the bank and the
company is contractual.
The rule in Turuquands case is important when the bank opens
an account for a company, and accepts the company as its
customer, and later on when the company repudiates the power
of the persons who opened the account for the company.
However, there are many exceptions to this rule.
1. The rule is not applicable in cases of forgery. In Ruben v.
Great Finga [(1960)- A.C. - 439] it was held that when a
document purported to be signed or executed by the
company is a forgery, the rule is not applicable as the forged
certificate is a pure nullity.
2. In Kredit Bank Cassel v. Shenkers Ltd [(1927) 1 Q.B.
826] it was held that the rule in Turuquands case may not
apply if a document signed by a person was purporting to
be on behalf of the company, is signed in excess of his
actual or ostensible authority.
3. In cases where the circumstances are such that the person
dealing with the company has been put to enquiry and
should have made the inquiry but fails to do so, the rule
will not apply.
A limited company is a legal entity. It has no body or soul of its
own. It is an artificial personality. It may be a private limited
company or a public limited company, it may be a company
limited by guarantee, a Govt. company, a company incorporated
under statute.
In case the company becomes a borrower of the bank, the banker
has to satisfy that the company has power to borrow and that
the directors do not act ultra vires the Memorandum and
Articles.
The Companies Act provides that certain charges should be
registered with the Registrar of Companies. Banks may conduct
a search in the books of the Registrar of Companies to find out
the existence of any previous charge and, if so, the nature of
the charge.
Any change in the operation of the accounts with the bank
should be supported by proper resolutions.
3.2 ACCOUNTS OF PARTNERSHIP FIRMS
The law relating to partnership is dealt with in detail in the
Indian Partnership Act. That Act deals with the relationship,
the rights and duties of the partners vis a vis themselves and vis
a vis the outside world. For the sake of brevity it is not proposed
to deal in detail that Act. At this juncture, the salient features
of the Act laid down that the liability of the partners of a firm is
joint, several and not limited to the extent of capital invested
by the partner.
In case a partnership firm approaches a bank to open an account,
the bank generally calls for a certified copy or the original of
the partnership deed and notes the salient features to the deed
in their books. In some cases, all the partners may not have the
right to operate the bank accounts as they will be dormant
partners. The bank records in the account opening form in one
column the signature of all the partners and in another column
the signatures of those who are authorised to operate the bank
account. In case the partnership is not reduced into writing, the
banks go by the words of the partners. There are instances
where the partnership is registered and it is considered advisable
to obtain the original of the deed by the banks and are returned
to the partners after recording the same in the books of the
banks.
The important points that the bank has to note are :
1. In a firms account, one partner has a prima facie right to
draw cheques in the firms name. One partner has the
implied authority to bind the firm by cheques so drawn.
2. In the absence of any custom or usage of the trade to the
contrary, the implied authority of a partner does not
empower him to open a banking account on behalf of the
firm in his own name.
3. Banks do not accept for the credit of the personal account
of a partner, cheques payable to his firm. The bank can do
so after enquiring with the other partners. Bank will
otherwise be liable to what in law is known as conversion.
4. One partner has the authority to stop the payment of a
cheque drawn in the name of the firm by another partner.
5. The death or insolvency of a partner automatically dissolves
the firm. But the partnership deed may provide that as a
result of the death of a partner or on account of the
insolvency of a partner, the firm may not be dissolved if
there is an agreement to that effect between the partners.
A partnership is automatically dissolved.
a. by the adjudication of all the partners or of all partners but
one as insolvents.
b. by the happening of any event which makes it unlawful for
the business of the firm to be carried on or for the partners
to carry it on partnership basis.
210
When there is a change in the constitution of the firm on acount
of the death or insolvency, the partners are liable for a debt
incurred by the firm before the partners death or insolvency,
but not for a debt incurred after the death or insolvency. If on
a date the bank has notice of the death or insolvency of a partner
and there is a debit balance in the account, the banks close the
account of the firm and open a fresh account as per the terms of
the deed. It is the duty of the surviving partners to give notice
to the bank about the death of a partner.
3.3 ACCOUNTS OF JOINT HINDU FAMILIES
The concept of Joint Hindu Family is peculiar in India only.
The concept has almost vanished after the passage of the Hindu
Succession Act, 1956. However there still exist some Joint
Hindu families.
The banks generally follow the under noted precautions while
opening such accounts.
a. A Joint Hindu Family letter is obtained.
b. Proper introduction.
c. The account opening form is signed by the Karta and all
adult (major) coparceners.
d. If there are minors the other adult coparceners should sign
for self and as guardian of the minor/minors.
e. The Karta is given authority to operate the account by all
the corparceners.
A reference should be made to the Hindu Minority &
Guardianship Act also.
3.4 ACCOUNTS OF MINORS
As per the Indian Contract Act, a minor is under a legal disability
to enter into a contract in his own name. There are various
laws for the protection of the minor. However, an account can
be opened on behalf of a minor by the natural guardian or a
guardian appointed by the court. The Contract Act provides
that a minor may draw, endorse, deliver and negotiate such
instrument so as to bind all the parties except himself.
The banks insist on knowing the date of birth of the minor and
diarises the same, and records the same in the account opening
form.
The capacity thus conferred on a minor to draw a valid cheque
provides an exception to the general rule that in India a minors
contract is ab initio void.
A person is a minor till he attains the age of 18 years. A person
whose person or properties are in the superintendence of a
person appointed as a guardian by the Court of Wards, then the
person is deemed to have attained majority only when he
completes 21 years.
In India banks open accounts for minors. In the present day
many bank branches operate in colleges or have their Extension
Counters in the campus. Accounts are opened for students who
stay in hostels, for studies.
The following points are note worthy:
a) A minor can open and operate a bank account.
b) The bank should make clear the implications of opening
an account to a minor. And should exercise sufficient care
while the minor operates the account.
c) The bank should not permit the minor to overdraw his
account.
d) The banker should exercise caution while credit for large
sums and debits for large sums are transacted in the minors
account.
e) A minor can validly draw a cheque and if there is a wrongful
dishonour or wrongful payment for example payment of a
forged cheque, the minor can sue the bank for wrongful
dishonour and for damages.
f) The age of majority of a non-domiciled minor is decided
by the law of the country where the minor is domiciled.
g) The practice relating to secrecy of customers account
equally apply to minors accounts also.
h) With the limited capacity of the minor to contract, there
must be ability to comprehend, before the bank can safely
accept him as a customer. At what age this comprehension
is present on a minor depends on the individual, but the
burden of proof would be probably on the bank to show
that requisite conditions were present.
3.5 ACCOUNTS TO ILLITERATE PERSONS
In a vast country like India which ranks as the worlds second
largest in population, there will be a large number of illiterates.
Such persons approach the banks to open accounts, and the
illiteracy is not considered as an incapacity to open bank
accounts. The banks in India particularly after nationalisation
of the major banks have embarked upon various loan schemes
for the upliftment of the illiterate rural folk.
The precautions taken of the bank include-
1. Obtainment of left hand thumb impression of the account
holder in place of specimen signature.
2. The bank affixes the photograph of the customer on the
customers pass book as well as in their ledgers.
3. The account should be conducted by the illiterates in person.
4. Thumb impression is obtained in all pay-in-slips,
withdrawal forms, cheques etc., as in the case of signature
for literate accounts.
3.6 TRUST ACCOUNTS
Banks permit the opening of trust accounts. A certified copy
of the trust deed is obtained and kept along with the other
formalities file relating to the account. The bank calls for the
original of the trust deed and enters the salient features of the
trust deed in their books. The bank opening the trust account
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should be conversant with the provisions of the Indian Trusts
Act 1882.
Banks permit the operation of the trust account by some or all
trustees; if the trust deed provides specifically for such
operations or confers general authority on the trustees to delegate
their powers to some or one of them. In the absence of such a
provision all trustees have to operate the account jointly. Some
banks permit the operation by some or one of the trustees after
obtaining suitable indemnity from the other trustees if the trust
deed does not have such a provision regarding the operation.
Banks take more than ordinary care in the conduct of Trust
Accounts. The banks have to ensure that they do not become a
party to any breach of trust. When the bank becomes a party to
a breach of trust, it becomes answerable to the beneficiary of
the trust.
An account even if it is not opened as a trust account, if there
are indications to the bank that the balance in the account is
held by the depositor as a trustee, the account becomes mulcted
with trust. Cases may arise when one or some of the trustees
have overdraft accounts at the bank where the trust account is
also maintained. Bank has no right of set off between the
personal account and trust account.
A trustee has to deal with the trust property with the sole purpose
of fulfilling his obligations according to the terms and conditions
of the trust and as carefully as a prudent man would deal with
his own property. Violation of his duty is termed breach of
trust and the beneficiary can hold the trustee personally liable
for any loss that he may suffer due to such breach.
A trust deed may be written or oral, may be express or implied,
may be specific or constructive. Generally, a trust deed is
translated into writing. Sometimes an inference of a trust may
be made from the circumstances. The person who creates the
trust is called the author of the trust and the trustees are those
on whom the author reposes confidence, that they will execute
the terms of the trust without any breach.
When the trust account is opened the trustees become banks
customer and such a relationship starts with the bank. The bank
should take care to see that the account is opened and operated
as per the terms of the trust deed.
To open a bank account, the trustees should pass a resolution
specifically and submit it to the bank.
In case the trust deed contains a specific provision that prohibits
the operation of the bank account on the death of one of the
trustees, the bank should stop operations immediately on receipt
of the information of the death of the trustee. However, in
cases where the trust deed does not contain such a provision
and the deed is silent, the bank can allow the surviving trustees
or the last surviving trustee to operate the account.
Appointment of several trustees by the author of the trust is to
ensure that the trust properties are managed under a combined
control. A trustee has also no authority to delegate the power
he derives from the trust deed. The authority of the trustees to
borrow is also limited. In case the borrowings by the trustees
are ultra vires the deed, the bank loses the right of recovery.
A will or trust deed will give authority to the trustee to carry on
a business for the benefit of the beneficiaries of the trust. The
trustees may borrow for the said purpose and charge the assets
forming part of the trust estate. Unless the trustees have fulfilled
their duties as executors and paid the debts of the testator, the
latters creditors will rank before both the indemnity of the
executors (the right to be exempt from the liability of their act
in continuing the business) and the mortgages of the estate. It
is essential therefore, where bankers are asked to lend against
assets of the estate for the purpose of enabling the executors to
carry on a business, that they ensure that the debts of the testator
have been paid. This applies only to the creditors of the testator,
not to those of the trustees, and only where the business is carried
on for the purpose of effecting a sale for winding up.
Nevertheless, the executors have the power to borrow and
mortgage for purposes of winding up.
3.7 ACCOUNTS OF EXECUTORS &
ADMINISTRATORS
In law, the succession can be testamentory or intestate. In cases
of testamentory succession, a person executes a will and
prescribes in the will how his properties after his death will
have to be partitioned or dealt with. In many cases the will
provides that certain person or persons should execute the terms
of the will after his death. The persons authorised to execute
the will are called the executors of the will. Where no executor
is mentioned in the will, the court will appoint one of the
beneficiaries of the will as administrator. The executor and
administrator of the will, as the case may be, may have to open
a bank account after the death of the testator, either in the name
of the trust or in their own names in their personal capacities.
They have to make it clear that the accounts are opened and
operated for and on behalf of the deceased. In case of doubt as
to the genuineness of a will or the persons claiming to be
executors or administrators, the banker may demand to be shown
the probate or letter of administration, as the case may be. On
application by an executor, court issues a probate proving the
will and a letter of administration confirming appointment of
the administrator.
The executors and administrators have no power to delegate
their authority. But they can appoint attorneys or other
professionals to do their work or for some professional services.
In case the bank knows that the funds deposited belong to a
trust and are being misapplied, the bank cannot escape the
liability.
Banks follow the undermentioned precautions:
a) A proper introduction to open the account.
b) The will should be properly examined to ensure the terms
and powers of the executors and administrators.
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c) All the executors must sign the account opening form and
give a clear mandate for the operation of the account.
d) The cheques and instruments tendered to the bank should
contain the style of the account and should contain a
notation that it is and on behalf of .................
e) The particulars of the will or probate should be recorded in
the banks books.
f) The trust accounts should not be opened in the personal
names of the executors or administrators.
g) The banks should ensure that they do not become parties
to a breach of trust.
h) The cheques drawn by one of the trustees can be stopped
by another.
i) The banks have no right to set off the credit balance in the
trust account against any dues from the administrators or
executors.
j) The executors account is for a limited period that is till the
terms are executed.
3.8 ACCOUNTS OF UNINCORPORATED BODIES,
CLUBS, SOCIETIES, COMMITTEES, ETC.
These bodies are not legal entities as limited companies are.
Nevertheless, banks open accounts for them. These bodies have
their own bye-laws and have their executive committees or
boards elected by the members. For opening account for a co-
operative society, the permission of the Registrar of Co-
operative Societies is essential. The following formalities are
observed by banks while opening accounts.
1. An introduction before opening the account.
2. Account opening form for the account duly filled up.
3. Copy of the resolutions of the committee or governing body,
signed by the Chairman, for opening the account.
4. Copy of the bye laws.
The bank has to stop the operation of the account when it
receives a countermand order. Where one of the signatories
dies, bank suspends the operation of the account till a new
member is elected and his signature recorded at the bank.
In this connection, it is interesting to recall a quote by Lord
Lindley in Wise v. Perpetual Trustee Co. [(1903)A.C. 139]
Clubs are associations of a peculiar nature. They are societies,
the members of which are perpetually changing. They are not
partnerships; they are not associations for gain; and the feature
which distinguishes them from other societies is that no member
as such becomes liable to pay to the funds of the society or to
anyone else any money beyond the subscriptions required by
the rules of the club to be paid so long as he remains a member.
It is upon this fundamental condition, not usually expressed,
but understood by everyone, that clubs are formed; and this
distinguishing feature has often been judicially recognised.
3.9 JOINT ACCOUNTS/NOMINEE ACCOUNTS
Generally banks permit the opening of Joint Accounts. Over
the years, on account of the changes in the banks policy for
and a shift from class banking to mass banking, several problems
have arisen for the banker and customer. In case of joint
accounts, banks are strongly advising the customers to make
such accounts as Either or Survivor or Former or Survivor.
In the case of ordinary joint accounts, without Either or
Survivor or Former or Survivor clause, the difficulties start
after the death of one of the joint account holders. Although
the bank may be right in paying to the survivor, the legal heirs
of the deceased can create problems. Further, the Indian judicial
system, an inheritance of the colonial rule literally denies justice
by delaying justice. Even in the case of individual single
accounts, banks suggest the customers to make them Either or
Survivor or Former or Survivor. This is on account of the
practical difficulty in obtaining a succession certificate from
the courts. Such delays have resulted in banks losing good
customers. In case of individual accounts, Either or Survivor
or Former or Survivor clause may prove beneficial.
Now take an example of A & B who are neither related, nor
executors or trustees, but just ordinary men who for their own
reasons want to open and operate a bank account. They are not
related and are not partners. What precautions the bank should
take ? What happens in the event of the death or insolvency of
one of them ?
1. The bank must obtain proper introductory reference, in the
same way as for opening an account for a stranger. It is
well established that failure to obtain proper introduction
will be construed as negligence on the part of the bank.
There may be instances where one of the joint account
holder is already a customer of the bank and in that case
introduction by him for the other joint account holders will
be sufficient.
2. Any one of the joint account holder may remit money to
the bank. But it is necessary that withdrawals will have to
be made jointly, in the absence of instructions to the
contrary.
3. No mandate is necessary if A & B decide to sign jointly for
withdrawals. But in practice, banks obtain clear instructions
in writing embodying at the same time directions for
security and safe custody transaction, and providing for
their several liability in the event of any overdraft. So a
mandate letter is generally taken.
4. Banks do not obtain a valid discharge if a person pays a
cheque drawn by one joint account holder without the
authority of the other.
5. Generally, banks do not encourage the opening of accounts
when there are more parties than two in a joint account.
Banks warn them of the difficulties which may arise if all
of them want to jointly sign on cheques. If all the members
operate jointly, one of them may be unavailable (on tour or
may be sick) so that he cannot sign, when withdrawals have
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to be made. The bank advises that it will be better that the
signing powers are given to two of them and obtain a
suitably worded mandate to that effect. Any attempt by
the joint holders to introduce a complicated mandate
permitting only certain of them in certain combinations is
also discouraged. It would be difficult, for example, to
keep in step with a mandate in an active joint account of
ABCD and E which enables A and B or B and D or A and
C to sign but not A and E or C and D etc, as such
combinations which are complicated would require special
examination in the case of each withdrawal.
6. One joint holder can stop the payment of a cheque drawn
by another or others; but the removal of countermand should
be signed by all parties or in accordance with the terms of
the mandate.
7. One joint account holder cannot delegate his power to an
agent or power of attorney to operate on the joint account
and such authority must be signed by all parties.
8. Any mandate for a joint account is automatically determined
in the case of death, insolvency or mental incapacity of
other or any party.
9. It is a general rule that on the death of the joint account
holder, the balance devolves on the survivor or survivors;
unless the joint holders indicate otherwise. But claims and
counter claims from the heirs will often arise. Therefore
the mandate should be carefully worded.
These difficulties have given birth to the Nominee accounts.
In the case of nominee accounts, banks obtain a legally drafted
nomination form from the account holders to pay the balance
in the account, upon the death of one or all of them to another
person/persons called nominee. The nominee facility is
available to single individual accounts also. This facility
removes the difficulty of succession certificates etc. The
nomination facility prevents claim by the personal or legal
representations.
10. In the case of death of one of the joint account holders,
there is no obligation on the part of the bank to pay the
estate duty.
11. On the insolvency of one of the joint account holders, the
mandate is automatically determined and the operations in
the account should be immediately stopped because a
portion of the balance in the account may belong to the
Official Receiver and the bank cannot apportion the money
between the solvent and insolvent.
12. Similarly, the death of one of the joint account holders also
detemines the mandate.
In case of loans in joint accounts, the banks should include the
joint and several liability clause in the mandate. With joint
liability there is only one right of action, but with joint and
several liability there are as many rights of actions as there are
parties. The joint and several liability enables the bank to set
off any joint indebtedness against the credit balances in the
individual accounts of any of the joint account holders.
3.10 ACCOUNTS OF LIQUIDATORS
Liquidators are appointed by the courts to liquidate the assets
and liabilities of the insolvent or bankrupt customer.
Various laws such as Companies Act, The Presidency Towns
Insolvency Act, Provincial Insolvency Act deal in detail with
the appointment of a Liquidator or Court Receiver. The
liquidator or official Receiver is an officer of the court and the
bank opens the account in their names. The mode operations
in the account are advised by the Liquidator/Receiver by
production of court orders and have the sanctity as if it is given
by the court. Banks should exercise caution to verify the terms
of the court order and should not aid or abet the Liquidator or
Receiver to commit a breach of trust.
3.11 MERCANTILE AGENTS
A mercantile agent may be defined as an agent having in the
customary course of business as such agent, authority either to
sell goods or to consign goods for the purpose of sale or to buy
goods, or to raise money on security of goods. The authority
that the mercantile agent derives from his principal is a limited
authority.
A mercantile agent is personally liable for a breach of warranty
for any loss or damage sustained by a third party if such agent
makes a representation to the third party that he has the requisite
powers to make such representation. The liability arises when
the third party acts upon such representation, even if the agent
believes or has an impression that he has the authority.
The bank who is authorised by a principal to operate his account
by an agent should suspend operations in the account
immediately on receipt of the information about the death or
insolvency of the principal. An agent should make it clear that
he signs for and on behalf of his principal.
Banker should not allow the agent to overdraw the account
without the express authority of the principal.
Banker also should not be a party to conversion if the agent
credits his personal account by debit to his principals account
through the bank.
3.12 ACCOUNTS OF NON RESIDENT INDIANS
During the early eighties, the remittances from persons of Indian
origin and employed abroad started pouring in and even acted
as an aid to the Government to meet a portion of the balance of
payments deficit. The Government and Reserve Bank of India
issued instructions to commercial banks to open accounts for
the Non Resident Indians (NRIs). These Non Resident Indian
accounts are of two types viz. Ordinary NRI account
denominated in Indian rupees or Foreign Currency Non
Resident accounts. The NRIs are permitted to open fixed deposit
accounts and Savings Bank accounts under the scheme.
214
In the Ordinary NRI account, the bank pay higher rate of interest
than the domestic deposits. The banks convert the foreign
currency amount of the remittance at the rate applicable for the
day and credit the customers account with Indian Rupees.
Foreign Currency Non-Resident accounts, can be opened only
in Sterling Pounds, U.S. Dollars, German Marks (D.M) or
Japanese Yen. The amounts will be held in the books of the
bank in India in foreign currency.
Such accounts will be opened with an introduction from the
Indian embassy abroad, or from a branch of an Indian bank
abroad or from the correspondent banks. The Indian passport
particulars of the Non resident are also noted in the account
opening form and the bank ledger. The customer can repatriate
the amount held in such accounts in the same currency.
The opening and operation of the accounts are similar to other
accounts. However these accounts are regulated by the Reserve
Bank of India, through instructions and clauses in the Exchange
Control Manual.
3.13 ACCOUNTS OF FOREIGNERS
Commercial Banks are designated by the Reserve Bank of India
as Authorised Dealers of Foreign Exchange. The banks have
to obtain permission from the Reserve Bank to open accounts
for foreigners.
This permission is granted by the Reserve Bank of India quickly.
The bank branch obtains a form known as QA 22 from the
foreigner and submits to the Reserve Bank of India. The
operation of the account is controlled by the
Reserve Bank of India.
Detailed instructions are available in the Exchange Control
Manual published by the Reserve Bank of India.
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4. DUTY OF SECRECY
SUB TOPICS
4.1 Bankers general duty
4.2 Duty of disclosure
4.3 Status opinion
4.1 BANKERS GENERAL DUTY
Between an ordinary debtor and creditor there is no duty of
secrecy. When a shirt is stitched by a tailor, the tailor is under
no obligation to preserve the secrecy regarding the cloth. If the
tailor discloses the details of the cloth to any of his other
customers, there is no breach of contract. But a bank cannot
disclose the details of his customers account without just and
proper reason. The duty to maintain secrecy is an added
obligation or an exception to the general rule that the relationship
between a banker and the customer is that of a debtor and
creditor.
All the employees and officers of the bank have to sign and
submit a Declaration of Fidelity and Secrecy at the time of their
joining the service.
The law on the subject has been clearly and comprehensively
laid down by banks, L.J. in Tournier v. National Provincial
and Union Bank of England, [(1924) 1 K.B. 461)]. The
following proposition can be drawn from this case.
The duty of maintaining secrecy is a legal one, arising out of
contracts, not merely a moral one. Breach of it, therefore gives
a claim for nominal damages, or for substantial damages if injury
has resulted from the breach. It is, however not an official
duty, as has been contended, but qualified, being subject to
certain, if not essential exceptions. The obligation to secrecy
does not end even with the closure of the customers account.
Tournier banked at the Finsbury Pavement branch of the
National Provincial Bank, where his account was overdrawn,
and arrangements had been made for reductions of one pound
per week. When these agreed deductions were not made, the
acting manager of the bank telephoned Tournier at the address
of his employer. But unfortunately Tournier was not available
in the office, and the acting manager discussed the matter with
the employer of Tournier. In the course of conversation, the
bank manager revealed the state of the account and that the
cheques had been presented payable to book makers. As a
result of this disclosure, Tournier was discharged by his
employers and he sued the bank for damages. The case went to
appeal and the ruling of banks L.J. provides a basis for future
dealings of this nature. It was stated that the duty of secrecy is
a legal one arising out of contract and the duty is not absolute,
but qualified. The duty continues after the customer has closed
the account and the confidence is not limited to information
derived from the account itself.
Atkin L.J. Said : I further think that the obligation extends to
information obtained from other sources than the customers
actual account if the occasion upon which the information was
obtained arose out of the banking relations of the bank and its
customers - for example, with a view to assisting the bank in
conducting its customers business, or, in coming to decisions
as to its treatment of its customers.
It is therefore clear that the practical banker must always exercise
the greatest care to observe his duty of secrecy. Any inadvertant
disclosure made during the rush of routine business may have
serious consequences.
4.2 DISCLOSURE
The circumstances when the disclosure of a customers affairs
may be made, and where the obligation to maintain secrecy is
not absolute have again been laid down in Tourniers case by
banks L.J. The occasions when disclosure would be justified
are -
I. Where the disclosure is under compulsion of law.
II. Where there is a duty to the public to disclose.
III. Where the interests of the bank require disclosure.
IV. Where the disclosure is made with the express or implied
consent of the customer.
I. COMPULSION OF LAW:
1. The exception may arise where evidence has to be given
by a bank in a court. It does not, however, permit disclosure,
without the express permission of the customer, to a
detective or police officer investigating a case or to an
Income Tax Inspector. An order must be served on the
bank before any party can demand to inspect the books.
Bankers Book of Evidence Act (1891) allows certified
copies of the entries to be produced in legal proceedings in
which the bank is not a party. This provision is again useful
to the bankers as they can avoid attendance in courts with
the actual books of accounts.
2. As the Central Bank of the country, the Reserve Bank of
India has the powers to collect information from bankers.
The Reserve Bank of India may furnish such information
to any other banking company. But the information so
furnished shall not disclose the name of the bank which
forwarded such information.
In Shankarlal Agarwalla v. State Bank of India [AIR 1987
Cal 29], the customer tendered for credit of his account 261
notes of Rs.1000 denomination to State Bank of India with a
declaration form prescribed by The High Denomination Bank
Notes (Demonetisation) Act 1978. The bank made available
this information to the Income Tax Department, who issued a
notice under the Income Tax Act to the customer. The
departments order also attached the amount.
The court held that the disclosure by the bank in this case falls
within the exception to the general rule and the bank has the
right in disclosing the information. In this case, the disclosure
was made under directions from the Reserve Bank of India and
the Finance Ministry.
216
3. The Banking Regulation Act, 1949, requires that every
banking company shall submit a return of unclaimed
deposits to the Reserve Bank of India within 30 days of the
close of each calendar year. The return should contain all
accounts in India which have not been operated for ten
years.
4. The Foreign Exchange Regulations Act, 1973, empowers
the Director of Enforcement or the Reserve Bank of India
to inspect the books of accounts of any authorised dealer.
5. Similar provision is contained in the Companies Act, 1956,
when the Central Government appoints inspectors to
investigate the affairs of a company.
II. DUTY TO THE PUBLIC TO DISCLOSE :
This exception rarely arises. But it is more relevant in a time of
National Emergency. During the World War II it was incumbent
upon a bank to make suitable disclosure if he had evidence of a
customer trading with the enemy. The bank should be sure of
this ground before venturing any revelation for this reason.
III. DISCLOSURE IN THE INTERESTS OF THE BANK:
Pointing to this exception there is only one case law in U.K.
That is the case of Sutherland v. Barclays Bank - [The Times-
Nov.25-1938; 5 LDB 163]. In this case, the customer, a woman,
issued a cheque to her dress maker. The bank dishonoured the
cheque as there were insufficient funds in the account. The
bank knew of the customers bookmaking transactions and did
not wish to allow any overdraft on the account. The customer
protested about the dishonour to her husband, a doctor, and he
told her to take up the matter with the bank. She did so, by
telephone, and after a while, the husband interrupted the
conversation to add his own protest. The bank then disclosed
to him that the cheques had previously been drawn payable to
bookmakers. Upon the wifes bringing an action against the
bank for breach of duty in making this disclosure, the bank
contended that the conversation with the husband was a
continuation of that with the wife and that they had her implied
consent to the disclosure. This the wife denied. It was held
that on the facts of the case that the bank must succeed; the
disclosure being in their interests, and is within the terms of
the qualifications on the duty of secrecy in Tourniers case.
IV. EXPRESS OR IMPLIED CONSENT OF CUSTOMER:
For implied consent, the case discussed in the above paragraph
i.e., Sutherlands case itself is an example.
A customer may expressly authorise his bank to advise his
accountant, the balance of his account and provide him a copy
of the monthly statements. This may be to enable the accountant
to draw up the customers balance sheet. Such information is
given on the basis of a letter in writing by the customer, which
is filed away as evidence in case of need.
In India also, banks do not generally divulge the balance in the
customers account over telephone. All prudent bankers all over
the world discourage customers from making telephonic
enquiries concerning the state of their account. But in these
days of ease of communications, it is helpful for the bank or
customer to communicate through telephone. The need for care
is essential. Banks convey the information to the customers
only and only after satisfying themselves that the voice is that
of the customer. In no case, third parties are given the status of
a customers accounts.
4.3 STATUS OPINION OR OPINION REPORTS
GIVEN BY BANKERS
It is an accepted practice among bankers, which is generally
described as Common Courtesy, whereby one bank enquires
from another bank about a proposed borrower, surety, guarantor
or of an acceptor of a bill. Sometimes customers also require
the status report on their out station purchaser or supplier. The
customers cannot get such a report directly from another bank.
So he approaches his banker to obtain the report from the
outstation bank. This is more relevant in foreign exchange
transactions, where a customer in India may not have seen at
all his buyer/seller abroad. In such cases the banks furnish a
carefully worded and confidential report. The phrase commony
used are - considered excellent, good or satisfactory. This
report is furnished to the other bank without any responsibility
on the part of the issuing bank or its officers. The reports contain
only general information. It is presumed by the banks that it
has the implied consent of the customer.
In the ever expanding financial market the obtention of such
reports help the lending bank and its officials when they are
hauled upon to answer a charge of negligence.
But the modern trend is to get a rating from credit agencies
such as MOODYS or CRISIL, who analyse the financial
position of business houses and give a rating.
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5. PASS BOOK
SUB TOPICS
5.1 General principles
5.2 Entries
5.3 Customers Responsibilities
5.4 Balance Confirmation Letters
5.1 GENERAL PRINCIPLES
In a fast and evergrowing economy all over the world, the
bankers pass books have been replaced to a great extent by
computer statements. Complete computerisation is now
available in all the developed countries like UK, Europe, USA,
Japan and Singapore. Even in India, computerisation is in fast
progress. The State Bank of India is the biggest bank in India
with over 8000 branches. Of these, 100 branches contribute to
80% of the banks entire business. All these branches have
now a Computer set up. Shortly, 1000 branches of the bank
will be fully computerised. So is the case with the other major
commercial banks in India. All the foreign banks having offices
in India are fully automated.
Banks now supply to the customers statement of their accounts
in the form of loose sheets periodically. Some customers are
given daily, weekly, fortnightly or monthly statements. This
has the merit that it raises a presumption that the customer has
notice of his account, though there is no return of the statement
to the bank which was the pass books main claim to be an
account as stated, and from which it derives its name. The pass
book has not yet been completely replaced by the computer
statements. Legal nature of the computer statements, its nature
and contents have not yet been tested by courts. As all the
legal incidents of pass book apply with equal force to a
statement we shall see the position of the pass book. Pass Books
are issued to all customers who keep Savings Bank Accounts.
In the case of current accounts pass books are issued only when
demanded by the customer.
The pass books contain the name or names of the customer/s,
the account number, the ledger number, the name and address
of the customer and the mode of operation. If it is a joint account
it will contain Either or Survivor Former or Survivor or
Any one. It will also contain the date of opening the account,
the name of the branch and signature in full of the branch
manager of the branch.
It is a replica of the ledger at the bank branch. The only change
is that, instead of the word Debit and Credit and balance in
the ledger, the pass book will have columns for amount
withdrawn and amount deposited ; and balance. The pass book
also contains a column initials which indicates that the entries
are authenticated by an authorised person of the bank with his
initials. Some banks print out the extracts of the Savings Bank
Rules in the pass book itself for the convenience of the
customers.
The English law on the subject is relevant to India. In Canara
Bank v. Canara Sales Corporation [(1987)62 Comp.Cas 280],
the Supreme Court has held that it is the law that obtains in
England which has been followed by the Supreme Court and
High courts in this country.
According to Sir John Paget the position of the Pass Book in
law is unsatisfactory from the standpoint of the banker. Saving,
negligence, or reckless disregard on the part of either banker or
customer,its proper function is to constitute a conclusive
unquestionable record of the transactions between them, and it
should be recognised as such. After full opportunity of
examination on the part of the customer, all entries, at least to
his debit, ought, to be final and not liable to be reopened later,
at any rate to the detriment of the banker. Such is, however,
definitely not the effect of the pass book.
In Devaynes v. Noble [(1816) 1 Meriavale 529 at p.535], the
Court of Chancery ordered an enquiry into the nature and effect
of the pass book. The enquiry report stated, that on delivery of
the pass book to the customer, he examines it, and if there
appears any error or omission, brings or sends it back to be
rectified; or, if not, his silence is regarded as an admission that
the entries are correct.
However, in view of the various decisions in England and India,
the position obtaining today is far from what is stated above.
There are a large number of cases on the topic the extracts of
which are not reproduced in this paper. In Chatterton v.
London and County Bank [1891 - The Times Jan 21] the jury
had found for the plaintiff and it was held that there was no
duty on the customer to examine the pass book and thus there
was no negligence. Similarly, in Kepatigalla Rubber Estates
Ltd v. National Bank of India Ltd [(1909) 2 K.B. 1010], it
was held that the company was under no obligation to organise
its business as to make forgeries unpracticable. If this was so,
then according to Bray.J. a secretary of the company, by going
to the bank on his own purpose in order to prevent the discovery
of his own fraud and without knowledge on the part of any of
the directors and getting the pass book, can bind the company
for all purposes. Clearly, an officer of a company cannot bind
the company by approving the balance shown in the companys
pass book. In the case of forged cheques, the primary cause of
the loss is the negligence of the bank in honouring the forgery
and the forger may be in a position to suppress the evidence in
the pass book from his employers.
Any number of decisions by the highest courts in England are
available. A reference to Pagets Law on banking will make all
such references with ease.
So far as Indian law on this topic is concerned, the law has
been clearly laid down by our Supreme Court in Canara Bank
v. Canara Sales Corporation & others [(1987)62 Comp.Cases
280]. The Supreme Court has held that the plea of implied
terms, indirectly constructive notice, and estoppel by negligence,
218
stands rejected. Mere silence, omission or failure to act is not a
sufficient ground to establish a case in favour of the bank to
nonsuit its customer. The relevant portion of the judgement in
the case - Unless the bank is able to satisfy the court of either
an express condition in the contract with its customer or an
unequivocal ratification, it will not be possible to save the bank
from its liability. The banks do business for their benefit.
Customers also get some benefit. If the banks are to insist upon
extreme care by the customers in minutely looking into the pass
book and the statements sent by them, no bank perhaps can do
profitable business. It is common knowledge that the entries in
the pass books and the statements of account sent often by the
bank are not readable, decipherable or legible. There is always
an element of trust between the bank and its customer. The
banks business depends upon this trust. Whenever a cheque
purporting to be by a customer is presented before a bank, it
carries a mandate to the bank to pay. If a cheque is forged there
is no such mandate. The bank can escape liability only if it can
establish knowledge to the customer of forgery in the cheques.
Inaction for continuously long period cannot by itself afford a
satisfactory ground for the bank to escape the liability.
In this case, the position prevailing in the United States of
America was also discussed.
In the U.S.A, it is settled law that it is the duty of the customer
to examine the pass book.
In Morgan v. United States Mortgage and Trust Co [(1913)
208 New York Reports 218] decided by the New York Court of
Appeal, it was stated: The depositor who sends his pass book
to be written up and receives it back with his paid cheques and
vouchers is bound to examine the pass book and vouchers and
to report to the bank without unreasonable delay any errors
which may be discovered. Negligence in this case means the
neglect to do those things dictated by ordinary business custom
and providence and fair dealings towards the bank which, if
done, would have prevented the wrong doing which resulted
from the omission.
5.2 ENTRIES IN THE PASS BOOK
As long as the entries in the pass book are 100 percent correct,
there is no need to examine the debit and credit entries. All the
customers will then be happy and satisfied as also the banks.
But the position that is prevailing is not a position of 100 percent
correctness. Mistakes happen at the bank branch regarding the
posting of the entries and they may sometimes be favourable to
the customers and at other times to some other customers or to
the bank itself. The banks take adequate precautions to prevent
the occurence of such mistakes. But still mistakes happen. Such
mistakes contribute to the following situations :
1. ENTRIES FAVOURABLE TO THE CUSTOMER :
The pass book belong to the customer. But he has no authority
to make entries in the pass book. The entries are made by the
bank. As the entries are made by the bank, the same can be
used as evidence against him. In Akrokerri (Atlantic) Mines
Ltd. v. Economic Bank [(1904) 2 K.B. 471] it was held that
The pass book ...... belongs to the customer and the entries
made in it by the bank are statements on which the customer is
entitled to act. If the position of the customer has not been
adversely affected, by relying upon the pass book, the bank
may show that a certain entry was made erroneously. When an
uncleared cheque has been shown as has been received in cash
entry in the pass book, the bank can show the real nature of the
entry and have the error rectified. If the bank has shown
errorneously a larger credit balance in the pass book than is
actually due to the customer, who, relying upon the accuracy
of the pass book, draws a cheque, the bank is not right in
returning the cheque. If the bank does, it is liable to pay damages
for wrongful dishonour. In detemining this question of fact, a
great deal depends upon whether the customer was led through
the erroneous entry to act in a manner in which he would
otherwise not have done and whether such action has been to
his detriment.
It happens that the bank may erroneously effect double credits
of the same remittance so that the account and the pass book
will show a larger balance. In such cases, when the bank
discovers the mistake, he should inform his customer. By that
time, the customer may have drawn the amount which actually
do not belong to him. Until the customer clears the matter, the
bank should not permit furhter operations by withdrawals in
the account.
A fictitious entry made by a bank employee cannot be relied
upon by a customer who has not received notice of the same, or
acted so as to alter his position.
In State Bank of India v. Shyma Devi [AIR 1978 S.C. 1263],
the bank employee made false entries in the pass book in his
handwriting but embezzled the amounts. In this case, the
respondents husband issued a crossed cheque for Rs.4000/-
and made payable to Self and that cheque was deposited in
the bank by the respondent for being credited to her account.
She did not obtain the counterfoil or a receipt. Another cheque
was issued by her husband for Rs.7000/- for transferring the
amount to her account was also deposited by her. In this instance
also, no counterfoil or receipt was obtained. The employee to
whom these cheques were given was not looking after Savings
Bank counter at the relevant time.
The Supreme Court held that the bank was not liable as the
employee had not acted within the scope of his employment
with the bank. The respondent had not discharged the onus on
her to show that she paid the amount to an employee of the
bank and that the amount was received by the employee in the
course of his employment. The false entry about the deposit of
the amount in the pass book could not shift the onus on the
bank to prove the contrary.
II. ENTRIES FAVOURABLE TO THE BANK
So far as the entries in the pass book are favourable to the bank,
it is difficult to define with certainty the extent to which the
customer is bound by them. From the court rulings, the
following observations could be made.
219
5.3 CUSTOMERS RESPONSIBILITIES
Where the customer has so acted, as to render the entries of the
settled or stated account, and is guilty of negligence in regard
to them and as a result, the bankers position is affected in a
manner disadvantageous to him, probably the customer will
not be allowed to dispute the correctness of the entry. It is
doubtful as to what acts or omissions on the part of the customer
would amount to settlement of accounts, or to negligence in
regard thereto. But it is certain, that the receipt of the pass
book by the customer, showing the balance of his account with
or without the cheque honoured and its return to the bank by
him without taking exception to the entry under dispute, does
not constitute such negligence as will preclude him from
disputing the same. In other words, the customer is not bound
to examine the entries in his pass book and the banker, upon
receipt of the pass book from the customer without any objection
from time to time, is not entitled to infer that the latter has
accepted the entries as correct. This proposition was laid down
in Chatterton v. London and County Bank [Times London -
21 Jan 1891].
As against this proposition which is unfavourable to the bank,
a passage from the case of Vagliano Bros. v. Bank of England
[(1891)23 QBD 243] may now be examined. There is another
point to be considered. The plaintiff from time to time received
from the bank, his pass book, with entries debiting the payments
made, for which the bank sent bills as vouchers, which were
retained by the plaintiff when he returned without objection,
the pass book. It was contended that this was a settlement of
account between him and the bank, and that he had been guilty
of such negligence with respect to the examination of the
vouchers as would have prevented him from being relieved
from the settlement of account. But there was no evidence to
show that, as between a customer and his banker, is an implied
contract as to the settlement of the account by such a dealing
between the banker and his customer, the plaintiff had done
anything which can be considered a neglect of his duty to the
bank or negligence on his part.
In Balakrishna Pramanik v. Bhownipore Banking
Corporation Ltd [(1932) 59 Cal 662], it was held that a
customer must intelligently examine the entries in his pass book
and dispute or call for explanation from the bank, regardng the
entries in the pass book, it was further held that he could not
later complain about the entries in the pass book, where
compound interest at monthly intervals was being charged and
debited. It was considered that continued and persistent
acquiescence of this character gave rise to a presumption that
there was an agreement between the customer and the bank to
charge compound interest, as was done in this case.
We may conclude that if the bankers succeed in establishing a
custom, the courts may give legal recognition to the same :
Lord Halsbury in Vagliano Bros v. Bank of England stated
The false documents were paid, duly debited to the customer
and duly entered in his pass book, and so far as the banker
could know or conjecture, brought to his knowledge on every
occasion upon which the payment was made and the bills were
returned - Was not the customer bound to know the contents of
his own pass book ?
A banker in no case is justified in withholding from his customer
any amount received for his credit, but omitted to enter the
same in the pass book, on the plea of acquiescence on the part
of the customer.
In Essa Ismail v. Indian Bank Ltd [(1963) 1. Comp. L.J. 194]
the Kerala High Court held that unless there is evidence to show
that the practice or custom indicated or stated a settled account,
the customer is not precluded from questioning the debit entries
in the pass book.
In practice, the banks have to ensure that the pass books are
updated and sent back to the customer as often as possible and
should not allow the pass book to remain with him for unduly
long periods, without the customer being given an opportunity
to examine the same. As per internal rules, the pass books
should as far as possible, be collected from the bank by the
account holders on the same day duly filled up and completed
immediately after the transaction. If left overnight, the bank
will issue a receipt in the form of paper token. The pass book
shoudl be collected against this token within a week. If the
account holder fails to collect the pass book within this period,
the pass book will be sent to his address by registered post
acknowledgement due at the customers cost.
Another internal rule of the banks provides that the counter
clerk should enter the undelivered pass books in a register called
the Pass Book Retained Register; which requires to be
scrutinised by the branch manager periodically, to ensure against
the retention of the pass books for unduly long periods. But
these internal rules are always violated and the nonobservance
lead the banks to difficulties.
5.4 BALANCE CONFIRMATION LETTERS
A practice that is prevailing in the banking system in India is to
send a balance information letter to its customer/s with a request
to return the same to the bank. In the case of loan accounts,
banks can use the same as an acknowledgement of the debt.
Limited companies and firms call for such balance confirmation
to satisfy their Auditors about the correctness of the balance.
The bank keeping an account in another bank also call for the
balance confirmation.
The balance confirmation letters are sent by the bank at half
yearly or yearly intervals when they close their accounts.
Having confirmed the balance by returning the confirmation
letter duly signed to the bank, whether the customer can object
to any debit entry preceding the balance, is a question not free
from doubt. The question arises as to whether the
acknowledgement would act as an estoppel because in such
cases the banks defence is more powerful than the entries in
the pass book or statement of accounts. The Kerala High Court
in Essa Ismail v. Indian Bank Ltd. [(1963) 1 Com. L.J. 194]
observed that unless there is evidence to show that the practice
or custom indicated or stated or settled account, the customer
is not precluded from questioning the debit entries in a pass
220
book but, when the confirmation slips are sent to and signed by
the customer, he will be bound by the debit entries made. In
this case, a debit entry in the customers account was questioned,
not by the customer, but by his heirs, several years after the
entry was made, and there was enough evidence to show that
the customer has acquiesced in the entry.
However, if one of the entries consist of payment by the bank
of a forged cheque or arises out of a fraud committed by the
banks employees,the question is whether the customer can
claim reimbursement in spite of his signing the balance
confirmation. From the decision in the case, Allahabad Bank
Ltd v. Kulbhushan and others [AIR 1961 Punjab 571], it
would appear, he can.
In law, the bank cannot compel the customers to sign and return
the balance confirmation letters/slips.
221
SUB TOPICS
6.1 General Principles
6.2 When Banker has no lien
6.3 Right to set off
6.1 GENERAL PRINCIPLES
When we talk of bank and banking, the term bankers lien and
bankers right to set off are talked about. The lien has its origin
in English law. A lien is the right of a creditor in possession of
goods, securities or any other asset belonging to the debtor, to
retain the same till the repayment of a loan, subject to any
contract to the contrary. The Indian Contract Act deals with
liens. But it is not exhaustive and we have to depend on English
case law.
A lien may be, possessory, equitable or maritime. Bankers are
concerned only with possessory lien. Possessory lien may be
either general or particular. A particular lien applied only to a
particular transaction and its scope is limited to the particular
security and the particular transaction.
Bankers lien is a general lien. A lien does not require any special
agreement, written or oral. It arises by operation of law and
should fall within the following broad spectrum.
a. The creditor should be in possession of the goods and
securities, and they should have come to his possession in
the ordinary course of business.
b. The owner of the goods and securities has a lawful debt to
pay to the person in possession.
c. There should not be any contract, express or implied to the
contrary.
Following the English law, a bankers lien is sometimes called
implied pledge. According to Sir John Paget - Lien being the
right to retain another mans property until a debt is paid,
property and lien cannot coexist in the same person with regard
to the same article. The lien peculiar to a banker, with regard to
negotiable securities, is defined in Brandao v. Barnett [(1846)
12 Cl & F 787] as an implied pledge ; but assuming this to be
the case, absolute property is as inconsistent with the rights of
a pledgee as it is with those of a person having a lien.
In Barclays Bank v. Astley Industrial Trust Ltd [(1970) 2
QB 527], banks were held to have obtained a lien on the cheques
that had been paid in for collection. But the idea had already
been questioned. Thus, Paget has argued that money paid into
the bank becomes the property of the bank, which thereafter
owes a corresponding debt to the customer, and a debt is not
suitable subject for lien.
In Hales Owen Press Wrok [(1917) 1 QB 46] Buckley L.J.
took the same view. The money or credit which the bank
obtained as a result of clearing the cheques becomes the property
of the bank, not the property of the company. No man can have
a lien on his own property and consequently no lien can have
arisen affecting that money or that credit. It has of course long
been recognised that a banker has a general lien on all securities
deposited with him as a banker by a customer unless there is an
express contract or circumstances that show an implied contract
inconsistent with the lien. The term Securities is no doubt
used here in a wide sense, but does not, extend to bankers own
indebtedness to the customer.
Therefore, the question of a general lien arises where the bank
is the lender and the customer is the borrower.
Any property which is handed over to a bank for an express
purpose cannot be subject to lien, even when the purpose has
failed. In an old case, Lucas v. Dorrien [(1817) 7 Taunt 278]
deeds were handed over to a bank as security for an advance.
The advance was not granted. The deeds were not taken back
by the depositor. It, was held that they could not be subject to
lien in the bankers hands.
The general principles of law governing lien can be described
as-
A) Bankers lien is the right of retaining things delivered into
his possession as a banker and if and so long as the customer
to whom they belonged or also had the power of disposing
of them when delivered is indebted to the banker on the
balance of account between them, provided the
circumstances in which the banker obtained possession do
not imply that he has agreed that this right shall be excluded.
Bankers lien can be properly said to arise only in respect
of any securities held by the bank. If the customer deposits
certain securities and ultimately there is a sum due to the
bank, the bank has a lien over these securities and it could
hold them against the amount due by the customer.
B) The ownership of the thing in possession of the bank should
be with the customer otherwise the question of lien does
not arise;
C) Bankers lien differs from the right of set off. A lien is
confined to securities and property in the banks custody.
Set off relates to money and may arise from a contract or
from mercantile usage, or by operation of law. The bankers
lien does not extend over the credit balance of a partnership
account for the amounts due to him from one of the partners
in his individual capacity.
D) A bank may not be able to exercise any right of lien over
the money deposited by the customer, as the bank itself
becomes the owner of that deposit. But still he has a right
to adjust such amounts against any debts due to the bank
from the customer. The purpose of the lien in such case is
achieved by the right of set off.
E) The bankers lien is subject to any contract to the contrary.
The existence of such a contract must be proved by the
person who alleges the same.
6.2 CASES WHEN THE BANKER HAS NO LIEN
1. Safe Custody Deposits: When a customer deposits with
his bank his securities and documents of title for safe
custody there is no lien. The deposit in this case is for a
specific purpose and under an express contract. The issue
of the safe custody receipt by the bank itself constitutes a
6 BANKERS LIEN AND SET OFF
222
contract to the contrary to assume against the existence of
any lien. In the case of safe custody, the banker is a bailee.
2. When the bailor has no title to the securities and valuables
deposited, the bailee cannot exercise any right of lien, and
if it can be shown that the bailor had stolen or
misappropriated the securities deposited, the banker hodling
them will be compelled to return them to the true owner,
even without getting back the safe custody receipt.
3. The banker has no lien on bills of exchange or other
documents entrusted to it for special purpose.
4. On the dishonour of a documentary bill, the bank is not
entitled to apply the security accompanying the bill, to any
other debt due from the customer for whom the bank
discounted the bill. Where a customer deposited a life
insurance policy with the bank accompanied by a
memorandum of charge to some overdrafts not exceeding
4000 pounds together with interest, commission and
charges, it was held that the bankers lien was limited to
the amount specified.
5. Credit and liability must be in the same rights. No lien arises
on the current account balance or the deposit account of a
customer in subject of an debt due from a firm, as the credit
on the one hand and the liability on the other do not exist in
the same right.
6. There is no lien in respect of separate accounts where in
one, the customer is a trustee and the other account is held
by him in his personal capacity.
7. Title deeds of immovable property: Customers deposit with
the bank title deeds either for safe custody or as collateral
security for loans by way of an equitable mortgage. A title
deed cannot be sold by the bank. No lien attaches to the
title deeds.
8 The bankers right of lien is not barred by the law of
limitation. The effect of limitation is only to bar the remedy
and not to discharge the debt.
To conclude the topic of lien, the student is advised to refer to
the provisions of the Indian Contract Act particularly sections
171 and 176 and the Banking Regulation Act Sections 5 & 6.
As we are discussing only the banking law, no comment is made
on these provisions.
6.3 RIGHT TO SET OFF
The bankers power to combine different acounts is called the
right to set off. Between an ordinary debtor and creditor, there
is an undoubted right to set off amounts due to and from each
other in the ordinary course of business. For example, A buys
cement from B, a trader for Rs.10,000/-. Later, A sells to B
steel worth Rs.5000/-. B is perfectly entitled to set off the cost
of steel against his liability for cement and need to pay only
Rs.5000/- in settlement of the net debt.
There are cases where a customer may be having 3 or 4 accounts
in the same bank. Some may be deposit accounts and other/s
borrowal accounts. The implied right of the banker at any time
to combine the balances in order to arrive at the net amount due
to or from the customer is known as the bankers right to set
off. But this is not always easy as one thinks and is hedged
with qualifications.
The important requirements for set off are -
All the funds must prima facie belong to the customer. We have
discussed under lien that a bank has no right of lien on the
monies held in the bank by the same customer as an individual
in one account and a member in a partnership account or as a
trustee in another account in the same bank. This rule applies
with equal force in the case of set off also. Notice of such a
trust may be actual or constructive. An overdraft in the
individual current account of A cannot be set off against the
credit balance of a Trust account in which A is a trustee.
However, if A has two accounts styled as A No.I Account, and
A No.II Account or where A has a Current Account and Savings
Bank account, in such cases the bank can exercise the right to
set off.
Unless the partner has contracted to be severally liable for the
indebtedness of the firm, the bank cannot set off the credit
balance on the private account of the partner against the
overdraft of the partnership. Even in such cases there must be
some precise authority from the partner in the absence of the
happening of any event to determine the position. Likewise in
the absence of express agreement, there is no set off between
the joint and separate debts. The overdraft on the joint account
of A & B cannot be set off against the substantial credit balance
on the current account of B, unles, of course, B expressly agrees
or A and B have specifically contracted for several as well as
joint responsibility for their joint overdraft.
Not only must the accounts be in the same rights but the liability
must be accruing due. A credit balance due on current account
or deposit account cannot be held against a contingent liability
on bills discounted. The position is however altered by the
bankruptcy of the customer, which in effect determines the
position and gives the banker the right of set off. Baker v.
Lloyds Bank [(1920) 2 K.B. 322].
A reference may also be made to the full bench decision in
Issac v. Palai Central Bank (in Liquidation) [(1963) 33 Comp.
Case 799]. In this case Issac, the appellant deposited a sum of
Rs.13500/- with the Palai Central Bank Ltd. on 13th January
1959 repayable on 13th January 1961. On June 23, 1959, he
executed a Demand Promissory Note for Rs.10,000/- in favour
of the bank. The Promissory Note was delivered to the bank
along with the fixed deposit receipt, duly discharged by him. A
letter of delivery also was submitted by him to the bank. This
letter stated inter alia, that the proceeds of the fixed deposit
should on maturity be credited to the loan account in respect of
which the promissory note was executed. The bank went into
liquidation on 05.12.1960. The official liquidator filed a suit
against Issac for recovery of the dues on the loan account. Issac
claimed a right of set off of the fixed deposit against the dues
to the bank.
The full bench of the High court held that Issac was entitled to
claim the right to set off. Merely because he handed over the
fixed deposit receipt to be kept by the bank as security for the
loan will not affect his position to claim the right. It was further
held :
223
1) that a question of set off should be considered normally
without reference to the existence of any security;
2) that the arrangement between the customer and banker in
such a case itself was to affect a set off on the maturity of
the fixed deposit;
3) that the fact that the deposit had not matured when the
winding up commenced is not of material consequence ;
4) that the effect of the banks insolvency was to accelarate
the date on which the set off should be effected and to make
the commencement of the winding up the time for that
purpose;
5) that in the light of what has been stated, the appellants
claim to a set off should be admitted.
In the case of Radha Raman Choudhary v. Chota Nagpur
Banking Association Ltd [(1945) Comp.Cas 4] the distinction
between a right of lien and a right of set off was clearly laid
down. The bankers right of lien is part of the law merchant. It
can only attach to money so long as it remains an earmarked
sum of money. Where it ceased to be such a separate earmarked
sum, and is represented only by a balance of account or debt
due from the bank, no lien can continue to attach to it, though
the rights of the bank by way of set off will not thereby be
affected. A clear distinction between lien and set off in the
light of Section 171 of the Indian Contract Act was made in
this case. It was held that the banks have a right to combine
one or more accounts of the same customer but a bank cannot
combine a customers personal account with a joint account of
the customer and another man.
In the question relating to the rule of set off to be applied, courts
have drawn a distinction between the Indian Law and the
English Law in I.S. Machado v. Official Liquidator of
Travancore National and Quilon Bank Ltd. [1941 - 11 Comp.
Cas 221]. In India, if a debt is incurred by the members of a
partnership, they will be jointly and severally liable. So far as
the amounts due to the members of the firm are concerned, the
claim will be a joint claim both in England and in India.
Consequently, if X and Y, who are the members of a firm sue Z,
Z cannot set off a debt due by X alone, whereas if Z sues X &
Y, X can set off a debt due by Z.
The rule of set off in bankruptcy, does not rest on the same
principles as the right of set off between solvent parties. In
(Machados case ) an amount was due to a firm A by the
Travancore National and Quilon Bank and the amount was due
to the bank by another firm B consisting of the firm of A
(Machados firm) and another person. The bank went into
liquidation. On the demand made by the bank against the firm
B, A firm claimed to set off the amount due to them by the bank
due by B to the bank. It was held that the liability of the members
of the Firm B was joint and several and that the set off must be
allowed. In a claim to enforce the joint and several liability it
was pen to A to set off the debt due to them.
This judgement relates to principles governing claims of set
off as between separate debts and a joint and several debts.
The general rule is that a debt owed by the creditor to one of
the debtor. If however the joint debtors liability is not merely
joint but also several a right of set off is available to the debtor.
The position of law is however different in India and in England.
In England, the liability of a joint debtor is only joint, unless
the contract provides otherwise. Similarly the liability of
partners in respect of debt of the partnership is joint, not joint
and several. On the other hand, in India joint promise is related
as a joint and several promise on account of Section 43 of the
Indian Contract Act and unless the agreement provide otherwise,
joint debtors are jointly and severally liable to the creditors; the
liability of the partners is also joint and several. In Machados
case, it was held that a partner can claim a set off a debt due
from his partnership to a bank against the credit balance on a
deposit account in his name with the bank.
The general principle of equity applicable both in England and
in India is that in the case of a voluntary conveyance of property
by a person, without declaration of a trust, there is a resulting
trust in favour of the grantor, unless it can be proved that an
actual gift was intended. An exception has been made in English
Law and a gift to a wife is presumed, where money belonging
to the husband is deposited at a bank in the name of the wife, or
where a deposit, is made, in the joint names of both husband
and wife. This exception has not been admitted in the Indian
Law on account of the different conditions attached to family
life, and where relationships are entirely of a different nature.
In England, whenever money is deposited by a husband in a
bank account in the name of his wife or in the joint names of
himself and his wife, there is a presumption that the husband
has gifted the money to his wife. Such presumption is not
permitted in India. In the absence of evidence to the contrary,
money deposited by a husband in the joint names of himself
and his wife and payable to Either or Survivor, must be presumed
to belong to the husband.
The right of immediate set off is undoubted where the position
is determined and the net figure due to or from the banker has
to be determined.
In the event of the death or insolvency of a customer, all balances
due to or from him in the same right have to be combined to
decide how much is due net to or from the estate. Same is the
case in the liquidation of a company. In all such cases, the
immediate need to combine the balances is obvious and the
power to set off without notice is undoubted.
Although such is the legal position, generally the banks in India
give notice to the customer before exercising the right of set
off.
Any implied right of set off with which the banker may be
endowed must be subject to the obligation to honour cheques
drawn properly by the customer.
In practice, where the customer has more than one account in
the same right, banks obtain an express letter from the customer
to set off the balances in the accounts.
In short, the right to set off can be exercised when -
1) the debts are amounts certain;
2) the debts are due and to the same parties;
3) the debts are in the same right; and
4) there is no contract express or implied to the contrary.
224
7. CASE LAW
Radha Raman Choudhary & Others v. Chota Nagpur Banking
Association Ltd. [(1945) 15 Comp Cas 4]
The plaintiffs father had a fixed deposit with the bank. He had
also executed jointly with certain persons, between 1913 and
1928, four handnotes in favour of the bank. He died in
December 1931. Thereafter the fixed deposit account was
transferred to the names of the plaintiff on 18 April 1932 on
their undertaking all the liabilities of their father to the bank.
On 1 May 1935, the bank, without the knowledge of the
plaintiffs, adjusted the fixed deposit against the dues on the
aforesaid handnotes. The plaintiffs filed a suit against the bank
claiming the amount of the deposit which had been adjusted as
mentioned above. They contended that their father was merely
a surety for the other excutants of the notes and not a principal
debtor. Alternatively, the plaintiffs sought a decree against those
executants (or their legal representatives) for different portions
of the amount adjusted, if the court held that the adjustment
made by the bank was legal. The bank conceded that if it had
brought a suit on the notes on May 1, 1935 it would have been
barred by limitation. But the bank contended that, by making
the adjustment in question, it was only exercising its right of
lien which could be exercised even in respect of a debt a suit
for the recovery of which would be time barred on the date of
such adjustment.
The main issue was whether the banks action was right. High
court held that the bank could not make adjustment because
the debt was time barred.
[Read section 60 of the Indian Contract Act and make a critical
assessment of the decision in this case]
Isaac v. Palai Central Bank Ltd. (In Liquidation) [(1963)33
Comp Cas 799]
The appellant deposited a sum of Rs.13,500 with the bank on
13 January 1959 repayable on 13 January 1961. On 23 June
1959, he executed a demand promissory note for Rs.10,000 in
favour of the bank. The note was delivered along with the fixed
deposit receipt, duly discharged by him, and a letter of delivery
which stated, inter alia, that the proceeds of the fixed deposit
receipt should on maturity be credited to the loan account in
respect of which the promissory note was executed. The bank
was ordered to be wound up on 5 December 1960. In a suit by
the liquidator against the appellant for recovery of the dues on
the loan account, the latter claimed a right of set-off of the fixed
deposit against the dues to the bank. P.T. Raman Nair, J., gave
judgment against the borrower.
The issue for consideration before the full bench was - Can the
appellant claim, set off of the fixed deposit against the sum
dues to the bank. Full bench allowed a set off of the deposit
against the loan.
R.K.V.S.S. Narasayyamma and Others v. Andhra Bank Ltd.
and Others [AIR 1960 AP 273]
As security for certain overdraft facilities granted by the bank
to the plaintiffs husband, he had lodged with the bank the
certificates relating to the shares held by him in a company,
together with blank transfers and an instrument of security
signed by him. On his death, the plaintiffs counsel wrote to
the bank stating that the borrower had left a will appointing the
plaintiff as the executrix of his estate, and asking the bank for
information as to the state of the overdraft accounts. The bank
informed the plaintiff of the amounts due to it on the accounts
and also requested that arrangements be made for paying the
dues and taking delivery of the shares. The bank wrote two
more letters to the plaintiff asking her to take immediate steps
to repay the amounts due to the bank on the overdraft accounts.
No repayment was forthcoming and the bank sold the shares to
the second defendant and advised the plaintiff of the sale. The
plaintiff questioned the sale and instituted a suit against the
bank, the purchaser and the company concerned seeking a
declaration that the sale was void as no notice there of was
given to the plaintiff and therefore did not affect her right to
redeem her husbands pledge of the shares to the bank, and an
injunction restraining the company from recognising the sale
and registering the shares in the name of the purchaser. The
suit was dismissed. Hence this appeal.
Issue for adjudication was whether the plaintiff is entitled for
an injunction.
Plaintiffs appeal was dismissed on a technical ground that as
the plaintiff had not obtained probate of her husbands will so
she could not succeed.
Haridas Mundra v. National and Grindleys Bank Ltd. [AIR 1963
Cal 132]
M was enjoying an overdraft facility with the bank. As security,
he had pledged certain company shares with the bank and had
executed a letter of lien empowering the bank to sell and dispose
of the shares on default by him in the payment of the moneys
due to the bank on its making a demand. The bank instituted a
suit against M for recovery of the balance due on the account.
During the pendency of the suit, the bank served a notice on M
informing him that on a default by him in the payment of his
dues to the bank on or before a specified date the pledged
shares or such of them as the bank might decide to sell would
be sold by the bank in exercise of its rights and powers as the
pledgee and the net proceeds would be applied in reduction of
Ms indebtedness. The suit was decreed and the bank was
given leave under Order II, Rule 2 of the Code of Civil Procedure
to take appropriate proceedings in respect of the shares. M
filed a suit against the bank claiming perpetual injunction
restraining it from selling the shares on the ground that since it
had instituted the aforesaid suit against him, it had no longer
any right to sell the shares. The trial court dismissed the suit
and hence this appeal.
The main issue was whether M is entitled to have perpetual
injunction on the sale of shares.
High Court rejected the appeal by holding that the institution
of a suit by the pledgee against the pledgor does not take away
the pledgees right to sell the pawn after giving the pledgor
reasonable notice of the sale; the two rights are not mutually
exclusive, but are concurrent.
225
M.S. Anirudhan v. Thomcos Bank Ltd. [(1963) 33 Comp.Cas
185]
The Thomcos Bank agreed to grant an overdraft to one S against
the guarantee of A. S executed a promissory note for Rs.20,000
in favour of the bank. The letter of guarantee, with blank spaces
left as to the date, amount of the overdraft limit and the interest
rate, was prepared in the bank and handed over to S to be got
signed by A. Some months later, it was brought by S to the
bank; it had been signed by A and also by S and the overdraft
limit had been mentioned as Rs.25,000. S wanted the overdraft
limit to be raised to Rs.25,000. The bank was not agreeable to
advance more than Rs.20,000 and gave the letter of guarantee
back to him to be got amended. After some time S returned it
to the bank with the amount altered to Rs.20,000.
In an action by the bank against S and A for recovery of its
dues, the latter set up the plea that the letter of guarantee was
executed by him for only Rs.5,000 and that the amount had
been subsequently altered to Rs.25,000 without his knowledge
and consent. This contention was not accepted as the letter
showed that the guaranteed amount had been altered from
Rs.25,000 to Rs.20,000, the alteration being apparent. The
Kerala High Court agreed with the trial court that the guarantee
was originally executed for Rs.25,000 and that the figure was
subsequently changed to Rs.20,000, without As consent,
probably by S. The Court however held that it was probable
that A had erroneously mentioned Rs.25,000 instead of
Rs.20,000 in the letter and that the alteration was made in order
to carry out the common intention of the three parties concerned.
Relying on the principle contained in section 87 of the
Negotiable Instruments Act, the High Court held that the surety
was liable to the bank. Hence this appeal to S.C.
Main issue for determination was whether the guarantor was
liable to the bank despite the alteration of the guaranteed amount
from Rs.25,000 to Rs.20000 in the letter of guarantee.
Supreme Court held by a majority decision that the surety was
not discharged.
Karnataka Bank Ltd. v. Gajanan Shankararao Kulkarni &
another [AIR 1977 Kant 14]
The bank granted a loan of Rs.25,000 to the first defendant,
repayable in instalments, against hypothecation of a truck and
the guarantee of defendants 2 and 3. The hypothecation
agreement gave the bank a right to take possession of the truck
and sell it in the event of a default by the borrower in paying
any of the instalments. The instalments were not paid, but the
bank did not exercise the aforesaid right. It filed a suit against
the borrower and the guarnators for recovery of the advance.
Meanwhile, the truck deteriorated in value and was reduced to
mere scrap. On this ground, the guarantors pleaded discharge
from their liability to the bank. The trial court accepted this
contention and decreed the suit against the borrower alone.
Against this acceptance appeal was filed in the High Court.
Whether the surety is discharged merely because the creditor
did not sue the principal debtor or did not enforce the security
furnished to him by the debtor, was the sole issue.
High Court allowed the appeal of the bank by holding that a
mere forbearance to enforce the security against the principal
debtor will not discharge the surety.
Raghavendra Singh Bhadoria v. State Bank of Indore [AIR
1992 MP 148]
Petitioner purchased two drafts of the value of Rs.10,00,000/-
from the Patrakar Colony branch of State Bank of Indore. These
drafts were drawn on the Marwadi Road, Bhopal branch of the
same bank in favour of McDowell & Do. Ltd. But the drafts
were lost in the transaction and the petitioner informed Patrakar
Colony branch on 22.2.91 requesting them to send instructions
to the drawer branch not to honour the drafts. A report of the
loss was also lodged with the police station, Indore on 26.2.91.
On the same date petitioner also wrote to the Patrakar Colony
branch repeating information about loss of the drafts with a
additional request that the demand drafts be got dishonoured
even if presented by the payee. The Patrakar colony branch
sent the information to the Marwadi Road, Bhopal branch. The
said branch refused to stop payment of drafts and made payment
to the payee who presented the drafts. Hence the petitioner
filed the petition contending that respondent bank was obliged
to dishonour the drafts as the purchaser (petitioner) of the drafts
had instructed to do so before they were honoured and payment
was made to the payee.
Main issue was whether the bank was obliged to dishonour the
payment of drafts presented to it for payment or can the court
issue injunction against bank for not making the payment to
payee.
Court dismissed the petition by holding that unless a serious
allegation of fraud with prima facie evidence is shown, the
court should non interfere in the matter restraining the bank to
honour the documents presented by the payee.
Bank of Maharashtra v. Automatic Engineering Company
[(1993) 77 Comp.Cas 87 (SC)]
Respondent firm had an account with appellant bank. A cheque
of Rs.6500/ presented through another bank to the appellant
was passed by the appellant and the said amount debited to the
respondents account. When the appellant forwarded the
statement of account to the respondent, respondent raised an
objection that the amount had been wrongly debited. Upon the
examining of the cheque under ultra-violet rays, it was found
that the cheque had been chemically altered with regard to the
date, name and amount.
Issue before the Supreme Court was that under the
circumstances bank is guilty of negligence or not.
Court held that on visual examinations no sign of forgery or
tampering with the writings on the cheque could be detected
and through evidence it was also proved that the agent of the
bank took reasonable care to verify the cheque with the specimen
signatures of the constituent. Further, u/s31 of the Negotiable
Instrument Act, 1881, the appellant bank had a liability to
honour the said cheque if it was otherwise in order. There was
nothing on record from which it could be held that the payment
was not in good faith. So the appellant bank could not be held
guilty of negligence.
226
8. PROBLEMS
1. As security for a debt, the debitor deposited a share
certificate in respect of some shares held by him in a joint
stock company. The certificate was not accompanied by a
transfer deed. Discuss whether there can be a valid pledge
of shares by the deposit of the share certificate when it is
not accompanied by an instrument of transfer ?
[See (1942)12 Comp Cas 180]
2. Whether a pawner who has pledged certain company shares
in favour of a bank is entitled to the dividends, and the
bonus and right shares in respect of those shares when the
pledge was subsisting ? Critically examine the rights of
pawner. [See AIR (1969) Del 313]
3. In order to realise the arrears of wages and some
compensation payable to the workers of a company which
had put up it shutters, the payment of wages inspector
moved the Tehsildar to take steps under the provisions of
the Land Revenue Code, to attach the machinery and
movables of the company and bring them to public auction.
A bank which had advanced moneys to the company against
mortgage/pledge of the machinery and movables objected
to the recovery proceedings being instituted before the
companys liability of the bank was discharged. Discuss
the rights of the bank. [See AIR 1977 MP 188]
4. The bank brought an action against L for recovery of a
loan made to C and H, claiming that L was the actual
beneficiary of the loan and was therefore liable to the bank
u/s 70 of the Indian Contract Act, 1872. The section states-
When a person lawfully does anything for another
person or delivers anything to him, not intending to
do gratuitously, and such other person enjoys the
benefit thereof, the later is bound to make
compensation to the former in respect of, or to restore
the thing so done or delivered.
Prepare a brief for L.
[ See AIR 1982 Kant 338]
5. A files a suit for the recovery of the dues from the defendant
on an overdraft account. The defendant pleads that the
debt should be set off against certain deposits with the bank
payable to either or survivor.
Argue for the defendant.
[See (1954)24 Comp.Cas 306].
6. There were 2 partnership firms functioning under different
names but comprising the very same partners. Firm No:1
deposited a sum of Rs.15,000 with the bank for remittance
to a company. The company did not accept the remittance
and the money was returned to the remitting office of the
bank which the bank credited to the overdraft account with
it in the name of Firm No:2. Firm No.1 contends that bank
has no right to make the adjustment. Decide.
[See AIR 1960 Punj 1]
7. The offficial liquidator claimed to appropriate a deposit
made by the applicant with the bank, in part satisfaction of
his liability under a guarantee given by him in respect of
an overdraft account of another customer of the bank. Can
the liquidator make the appropriation although the
applicants debt to the bank is time barred ?
[See (1941) 11 Comp Cas 298].
8. The bank granted an overdraft to R on the security of a
fixed deposit in his Sons name with a firm of bankers.
The son gave the fixed deposit receipt to the bank alongwith
a letter authorising it to collect the amount on maturity and
appropriate to words the over draft. He gave the bank
another letter
addressed to the firm asking it to pay to the bank the amount
of the deposit and the interest thereon. On the due date
when the bank asked for payment, the firm refused to pay
saying that the amount had been adjusted against a debt
due to it from the depositor. Prepare a brief for the bank.
[See (1956)Comp Cas 81]
9. Veloo was the managing director of the managing agents
of a company (Woodbriar Estate Company Ltd). He was
maintaining an account in the name of Wilson & Co. with
a bank. Into this account he deposited two demand drafts
made payable to the company, after endorsing them as
follows :
For Woodbriar Estate Ltd.,
For Krishnan Kutty & Veloo (India) Ltd.,
Sd/ V.N. Veloo,
Managing Director,
Managing Agents.
The drafts were collected by the bank and the amounts were
drawn out and misappropriated by Veloo. Company sued
the bank claiming damages for conversion of the drafts. Is
the bank liable ? If Yes, give reasons.
[See AIR 1958 Ker 316].
[Note: specify your name, I.D. No. and address while sending your answer papers]
227
1. Bhatt, P.R., International Banking, (1991), Common Wealth Publishers; New Delhi.
2. Chatterjee, A., Legal Aspects of Bank Lending, (1992), Skylark Publication; New Delhi.
3. Desai, V.J., Indian Banking Law in Theory & Practice, (1988), Himalaya Publishing House; New Delhi.
4. Fidler, P.J.M., Sheldon & Fidlers Practice & Law of Banking, (1982), Language Book Society & Macdonald & Evans;
London and Plymouth.
5. Gupta, S.M., The Banking Law in Theory and Practice, (1992), Universal Book Traders; New Delhi.
6. Hapgrood, Mark, Pagets Law of Banking, (1989), Butter-worths; London and Edinburgh.
7. Kataria, S.K., Banking and Public Financial Institutions, (1990), Orient Law House; New Delhi.
8. Parthasarathy, M.S., Banking Law, Leading Indian Cases, (1985), N.M. Tripathi; Bombay.
9. Sudarshan & Varshney, Banking Theory, Law and Practice, (1990), Sultan Chand and Sons, Educational Publishers; New
Delhi.
10. Suneja, H.R., Practice and Law of Banking, (1990), Himalaya Publishing House; New Delhi.
228
Banking Law
Course No: II
Module No: VII & VIII
Advances, Loans and Securities
Phone: 3211010 Fax: 080-3217858
229
Materials Prepared by :
Ms. Sudha Peri
Materials Checked by :
Prof. T. Devidas
Materials Edited by :
Prof. N. L. Mitra
Prof. P. C. Bedwa
Published by :
Post Bag No. 7201
230
INSTRUCTIONS
Living in a complex, competitive age has its own disadvantages. People tend to fiercely compete about
everything and anything, be it the extent of their possessions, or assets, the number of degrees they hold, or
even the place of their vacationing. The problem is also compounded by the fact that the market is flooded
with both a variety of consumer goods in seemingly affordable ranges, and also a horde of opportunities
inviting people to invest in something and reap high rewards. The problem arises when a person wants to
buy these goods or invest in these opportunities but lacks the funds to do so. The only option left to him in
such cases is to take a loan, for which purpose he can either approach a private money-lender or public
financial institutions or banks. The option of going to a money-lender is not open to all because of the high
rate of interest charged by them and the accompanying risks.
Banks on the other hand provide a safe haven for such loan takers. A major part of the banking business is
concerned with giving of loans and advances. Depending on the purpose and time period of the loan, the
loans are divided into various categories. The government and the Reserve Bank of India also issue guidelines
from time to time to regulate the giving of advances by the banks. In general, these guidelines are issued
keeping in mind the economic status of the country and the current financial policy of the government, as
for example, at present the banks are required to give loans to agricultural sector and women entrepreneurs
etc.
In the present module, we have dealt with the various types of loans and advances given by the banks. these
loans are generally given against securities, which are taken by the banker to protect himself in case of
default by the debtor. The security against which loans are given are themselves of various kinds and may be
broadly categorised as direct, collateral and miscellaneous, though such a categorisation is only for academic
purposes and does not have any practical basis. An effort has been made to deal with each of these securities
in detail.
This module deals more with the nature and kinds of loans, advances and security - but does not directly
deal with the recovery of loans aspect. This is not because recovery of loans is an unimportant topic, but
more appropriately because that aspect has been dealt with indirectly at various places in the module, as for
example, remedies available to a banker if the debtor to whom a loan has been given against a mortgage has
commited a default. But you would be well advised to study the various problems in loan recovery and the
extent of bad debts of the nationalised banks for a more comprehensive understanding of the topic.
This module refers to various other Acts like the Transfer of Property Act, Contract Act, and Companies Act
while dealing with various types of securities. You would be well advised if you go through the bare acts of
these subjects while doing this module in order to have a better understanding of the subject.
N. L. MITRA
Course Co-ordinator
231
ADVANCES, LOANS AND SECURITIES
TOPICS
1 Advances and Loans ...................................................................................................... 232
2 Direct Securities ............................................................................................................. 239
3 Collateral Securities ....................................................................................................... 250
4 Miscellaneous Securities ................................................................................................ 260
5 Case Law......................................................................................................................... 267
6 Problems.......................................................................................................................... 269
7 Supplementary Readings ............................................................................................... 270
232
1. ADVANCES AND LOANS
SUB TOPICS
1.1 Introduction
1.2 Principles of good lending
1.3 Advances
1.4 Types of Loans
1.5. Procedure of taking Loan
1.1 INTRODUCTION
Before we go into the details of the various kinds of loans given
by a banker it would be interesting to make a brief foray into
the banking history to find out the roots of this money-lending
business of the banks.
It is generally agreed that the grounds for modern banking in
England was paven by the influx of gold from America into
England during the Elizabethan Age resulting in a simultaneous
growth of foreign trade. Merchants and country gentlemen alike
stopped looking at land as the only form of asset/investment
and started retaining part of their capital assets in the form of
Cash. Public banking as a system got an impetus when
Charles I in 1640 seized 130,000 billions left in the Royal Mint
by the city merchants for safe custody.
As a direct consequence the merchants started entrusting their
cashiers with large amount of cash, but the latter started
misappropriating these funds for their own benefit. Thus being
badly burnt by both their king and their employees the merchants
as a last resort started giving their cash for safekeeping to the
goldsmiths who had strong rooms and also employed watchmen.
Whenever the goldsmith received cash for safe-keeping he gave
a signed receipt to his customer known as goldsmiths notes
which embodied an undertaking to return the money either to
the depositor or bearer on demand. This resulted in the
development of two practices which laid the foundation of
issue and deposit banking. Firstly, goldsmiths notes being
payable to bearer on demand started enjoying considerable
circulation. Secondly, the goldsmiths came to the realisation
that large 0909 amounts of money was kept with them very
often for long periods, and so they deciding to follow the
precedent set by Dutch bankers, started lending a part of their
customers money provided such loans were repaid within a
fixed time. Since money lending was a safe and profitable
business the more enterprising of these goldsmiths began
offering an interest on money deposited with them instead of
charging their customers a fee for providing safe keeping
services. This naturally resulted in even larger sums being
deposited with them thereby allowing them to spread their
money-lending business even further. Business grew to such
an extent that they found that they could always spare a certain
proportion of deposits for giving loans regardless of the date
on which their notes fell due.
Thus, keeping other peoples money in custody and lending a
part of it has always been a major part of banking functions.
Though gradually banking functions grew to scale new heights
in varied fields, giving loans still forms a substantial part of
banking business.
In India, a banker has been an indispensable pillar of the society
since time immemorial. Ancient texts contain specific reference
to the concept of like loans, usury, payment of debts, contracting
of debts without intention of repayment etc. Thus, giving and
taking of credit in some form or other has been prevalent in
India since the Vedic period or may be even earlier. But the
transition from simple money lending to banking must have
taken place sometime before the era of Manu, who has devoted
a special section to the subject of deposits and pledges etc. in
his commentaries, in one place he states, A sensible man
should deposit his money with a person of good family, of good
conduct, well-acquainted with law, veracious, having many
relatives wealthy and honorable Arya. He also laid down rules
to govern the policy of loans and interest rates.
With the advent of modern banking system with its myriad rules
and regulations, the bankers in India have settled upon a number
of profitable ways for fund utilization. Thus the funds in the
hands of a banker may be put to use for any one of the following
purposes, viz :
1. Call loans, and loans repayable at a short notice.
2. Investment in gilt edged securities (issued by government
or otherwise).
3. Loans and advances
4. Purchasing and discounting of bills.
But merely because Lending forms a major chunk of banking
functions it does not mean that the banker gives a loan to any
or all person(s) asking for it. Before he sanctions a loan he has
to ascertain whether or not it would be desirable to give a loan
to the applicant. In order to arrive at a conclusion he follows
certain basic principles which we would now deal with.
1.2 PRINCIPLES OF GOOD LENDING
Merely because the applicant is prepared to give valuable
security, the proposed loan does not automatically become
desirable. A banker before granting the loan should seek
information on the following points from the applicant, viz :
a) Capacity of the applicant - A loan transaction being of
contractual nature, the applicant should satisfy the requirements
of sec.11 of Contract Act, i.e
(i) he should be a major;
(ii) of sound mind; and 09+09
(iii) should not otherwise be barred from entering into a contract
by any law for the time being in force.
Similarly, in case of legal persons the banker has to check its
constitutional documents to ascertain whether the legal person
has the capacity to enter into such a transaction. For example,
in case of a company, a banker should carefully scrutinize the
233
memorandum and articles of association to check whether the
directors have the capacity or authority to take a loan, because
if they are not so authorized then the loan they loan they take
would be ultravires. The company would not be liable on it.
b) Purpose of the loan - The loan must be for a purpose
which must be satisfactory from a bankers aspect and must
not be prohibited by any governmental order. A loan transaction
would be satisfactory from a bankers view point if he is certain
of the assured return of the loan alongwith the interest at the
specified rate within the specified period. Though initially
bankers usually preferred to give only short term loans for
commercial or business purposes, they have now extended their
credit/loan facilities to cover practically all kinds of purposes,
like, education, house building, expanding business or setting
up of new business etc, provided the applicant is able to furnish
sufficient security or guarantee to cover the loan.
It may sometimes so happen that though a purpose may be
highly satisfactory from a bankers aspect, the government
(either State or Central) may impose restrictions on loan being
given for that purpose. For example, during the second world
war, the banks were requested by the Chancellor of the
Exchequer not to grant advances for any purpose which was
not in furtherance of the war efforts. Similarly, the Finance
Minister can draw the attention of Banks to desirable lending
policies keeping in mind the current economic status of the
country.
c) Amount of the advance - When a customer asks for a loan
the banker has to consider the request from two angles, viz :
(i) whether the amount requested for would be sufficient for
the purpose mentioned ? It is often seen that customers
usually underestimate their need and then have to go in for
an additional loan.
(ii) Whether the requested amount is reasonable keeping in
mind the economic status of the customer. For example,
Suppose Mr. A drawing a salary of Rs.500/-pm and having
no other source of income, applies for a loan of Rs.5,00,000/
- it would not be very prudent for the banker to lend him
that amount keeping in mind his paying capacity.
While lending money to a company or a partnership concern
the banker should first ascertain whether it is a going concern
or not. If it is then he should next try to calculate the amount of
dividend which it would in all likelihood pay the bank. A careful
analysis of the trading and profit and loss accounts of the concern
should be undertaken to get the following information, viz :
(i) Year by year turnover of the concern (i.e., work done or
goods sold) should be compared with the amount of debtors
as shown in the balance sheets. It is often an unhealthy
sign if the proportion of trade debts to turnover is rising;
this may indicate that some of the customers debtors are
finding at difficult to meet their commitments.
(ii) Turnover should be compared with the amount owing to
creditors. If the proportion of trade creditors to turnover is
rising, this probably means that the customer is not meeting
his liabilities promptly and that some of his creditors are
pressing for payment.
(iii) It is usually a danger signal if the proportion of stock to
turnover rises year by year. An excessive amount of stock
usually indicates either sales resistance or stockpiling
beyond the customers resources. Whether an excessive
amount of stock is being carried depends to some extent
upon the nature of business. As one writer aptly said, a
whisky distillery advertising Not a drop sold till its seven
years old will have a rate of stock turnover much slower
than that of a fishmonger advertising Fresh fish daily
[Holden, p.9] It is only after getting this comprehensive
information that the banker decides on whether to grant
the loan or not. A banker who fails to follow this particular
golden rule would soon find himself on the verge of
bankruptcy due to umpteen bad debts (i.e. debts which have
not been repaid nor is there any chance for their recovery).
d) Duration of advance - The banker also has to take into
consideration the fact whether the loan requested for is for a
long term or a short term. A number of advances are still
repayable on demand regardless of the terms and conditions
agreed upon between the parties. But for the most part so long
as the customer honours his side of the bargain the banks rarely
require the repayment of loan at an earlier date.
e) Source of repayment - This is another important point on
which information would be needed before the banker agrees
to give the loan. In looking at the sources, the banker also has
to take into consideration the value and viability of the security
proposed to be advanced against the loan. The security should
be such as to cover the deficit in case of failure on the customers
part to repay the loan.
f) Profitability of advance - Last but not the least, a banker
should always keep in mind that he is lending money not as a
charity but as a business transaction. So he should advance a
loan only when it results in a profitable business for him. After
dealing briefly with the principles which a banker should keep
in mind while lending money, let us now discuss the various
kinds of loans advanced by the bankers.
1.3 ADVANCES
The most important method by which a banker deploys his funds
as mentioned earlier is through giving of advances, loans and
overdrafts and the purchase and discounting of commercial bills.
The advances by Indian banker are either clean advances against
personal credit with or without a second signature on the pro-
note or against tangible and marketable securities.
Advances usually take one of the following three forms, viz :
(1) Cash Credits: This is an arrangement by which a banker
allows his customer to borrow money upto a certain specified
limit, either against a bond of credit by one or more sureties or
against some other security. This is a widely popular mode of
borrowing amongst the large industrial and commercial
concerns in India, for the basic advantage it offers i.e., a
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customer need not borrow the entire credit amount in a lump
sum but can draw the amount in installments to suit his
requirements. He can also put back into the bank any surplus
amount left from the amount drawn. The banker in these cases
has to estimate the amount which might be required by his
customer, and in case his estimate is much more than the actual
amount needed and drawn by the customer, he may lose interest
on the surplus. To take care of such a contingency, the cash
credit agreements usually have a stipulation one half or one
quarter, interest clause, i.e, the customer would have to pay an
interest on at least one half or quarter of the amount of cash
credit allowed to him regardless of whether he actually uses
that amount or not.
2) Overdrafts : Sometimes it may so happen that a customer
might need a temporary accommodation (i.e., he may need to
withdraw more money than what his account actually holds).
In such cases the bank may allow him to overdraw from his
current account, usually against collateral securities. This
arrangement like the one above is advantageous from the
customers view point because he is required to pay interest only
on the amount actually drawn by him. The basic difference
between an overdraft and a cash credit is that the former is
deemed to be a kind of bank credit to be used only occasionally;
whereas the latter is generally used for long term loans by
commercial and industrial concerns doing regular business. But
this distinction is more academic than practical, because in
practice this distinction is rarely observed and most commercial
banks also set up limits for their overdraft facilities also. In
Indian Overseas Bank, Madras v. Naranprasad Govindlal
Patel, Ahmedabad [AIR 1980 Guj 158] it was observed by
the Gujrat High Court that an overdraft arrangement between
a bank and its customer is a contract and it cannot be terminated
unilaterally by the bank. Merely because the client was not
required to execute any document or to furnish any security
would not make such an arrangement an act of grace on behalf
of the bank. Such an arrangement even though temporary is
not one which can be terminated unilaterally and at the sweet
will of the bank without giving notice to its customer. The
bank was held liable for damages for wrongfully dishonoring a
cheque which could be covered or honoured within the overdraft
limits. Thus, it is clear that no specific form or agreement is
necessary for overdraft and it can be imputed or implied from
the conduct of the parties.
3) Loans : A lumpsum advance made by a banker, the entire
amount being withdrawn by the customer at one stretch, and
which he is expected to repay in one single installment, is called
a loan. Loan accounting have a lower operating cost than the
other two types of advances because the latter involve a larger
amount of operations compared to the loans.
In case the customer repays the same either wholly or partially
and subsequently wants to be accommodated, this would be
treated as a separate transaction entered into (provided the bank
agrees to do so) and would be subject to a new set of terms and
conditions which the bank may seek to impose. The bank thus
does not suffer from any loss of interest as a consequence to
carrying excessive cash essential for a cash credit or overdraft
transaction.
Loans vis a vis Cash Credits
The practice of giving advances by way of cash credits is
somewhat peculiar to India. The practice grew mainly because
of the absence of an organized bill market in the country. The
borrowers find it very convenient as they have to pay interest
on the day to day balances while they have assurance of a higher
limit whenever they want it. From the banks point of view the
system is not very convenient as they have to keep much larger
cash balances in view of the uncertainty about the undrawn
limits. Under the cash credit system there is also a tendency on
the part of the borrowers to ask for a much higher limit than
they actually require as they have to pay interest only on the
actual debit balances.
During the credit squeeze in the busy season of 1973-74 there
was a tendency on the part of the borrowers to draw on their
limits to the hilt fearing that the undrawn limits would be
cancelled or frozen. This revealed another undesirable effect
of giving the advances by way of cash credits.
Some authorities have suggested that banks in India should
follow a combined system of cash credit-cum-loan giving the
hard core requirements of a borrower by way of loan and the
fluctuating requirements by way of cash credit. The practice, it
is believed, would enable banks to judge the borrowers
requirements with greater precision and thus manage their cash
position more efficiently and economically. This was also
recommended by the Tandon Committee.
In view of the recommendation by the Tandon Committee, the
Reserve Bank advised the banks in 1975 to bifurcate the cash
credit limits into a core portion and a 'variable cash credit'
portion with differential interest rate for the two components.
The banks however found it difficult to comply. Therefore in
April 1979 a working group under the Chairmanship of Shri
K.B. Chore was set up to re-examine the cash credit style of
lending. On the recommendation of the Chore Committee the
Reserve Bank rescinded its earlier instructionss and advised
the banks to abolish the differential in interest rate and
bifurcation. The Chore Committee has also given in its report
the advantages, and disadvantages of different styles of lending
and the recommended lending system [Tannan, p. 380].
Since loans from a substantial part of banking transactions
we would now deal in detail with the various kinds of loans
given by the banks.
1.4 TYPES OF LOANS
Having a precise or exact classification of loans is a fairly
difficult job because we might have different types of
classifications depending on the criteria involved. As for
example, based on the time period you may have a short term
loan or a long term loan, based on the security involved you
may have secured loan or unsecured loan; based on the maturity
period you may have loans payable on demand or term loans;
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so on and so forth. So instead of trying to classify loans into
various kinds we will now just try to deal with the various kinds
of loans given by banks.
1) Loans repayable on demand
Bank loans are generally repayable on demand, though as a
general practice the banks do have an informal agreement with
their customer to allow them to use the money for a certain
specified period provided he follows or adheres to the terms of
their agreement. Bankers usually reserve to themselves the right
to cancel the agreement or to reduce the loan amount, but they
are required to give a reasonable notice to the customer before
doing so. For example, suppose a banker has promised his
customer an overdraft to a limit of say Rs.10,000/- and later
wants to reduce the limit to say Rs.5,000/-. He cannot dishonour
the customers cheque issued before he received a notice from
the bank, provided the cheque amount is within the original
overdraft limit. [See Rouse v. Bradford Banking Co., (1894)AC
595].
2) Term Loan
Whenever a bank gives a loan for a period exceeding one year
and the customer is required to repay it according to a fixed
schedule, i.e, the repayment is neither on demand nor is it in a
lumpsum or a single installment, it is known as a term loan.
When the loan period exceeds one year but is less than five
years it is known as medium term loan; and a loan with longer
repayment schedule, i.e., a schedule going beyond 5 to 7 years
is known as long term loan. Since a term loan is generally
granted for fixed capital requirements [for example, construction
of a factory or buying of machinery etc], it requires a more
accurate and sustained or thorough appraisal of all the relevant
factors as compared to simple demand loans.
No term loans to defaulting units -The Reserve bank of India
has directed banks not to consider applications for fresh term
finance [including deferred payment guarantee facility] for
setting up new projects or expansion of existing units from
defaulting concerns which have been persistently defaulting in
the payment of interest or repayment of principal or both. The
banks have also been instructed to ascertain the position of the
applicant regarding the overdue interest or installments from
other lending institutions too. As regards the provision of
working capital facilities to the borrowers, the working capital
assistance should be withheld only in cases wherein the
management is indulging in malpractices such as siphoning off
the concerns funds [Tannan, p.376].
3) Participation loan or consortium advance
In certain circumstances, two or more financing agencies may
grant a single loan to a single customer. Such a loan is termed
as a participation or consortium loan. This practice is resorted
to where the risk involved is too extensive for any single
institution to take it up with equanimity or there are
administrative or other difficulties involved in either sanctioning
or following up the loan. Participation loan is very popular in
America because: (a) the dual banking system prevails there;
(b) the unit banks do not have sufficiently large resources and
have to seek supplementary resources with the larger city banks;
(c) there are legal restrictions on lending, and the National banks
cannot lend more than 10% of their paid up capital and reserves
to one single borrower; and (d)the financing of real estates by
banks which involves greater risks. This kind of loan is slowly
assuming importance in India also and it is logical to presume
that in this era of liberalization resulting in mega joint ventures
this might be the only kind of loans the commercial or industrial
sector would be able to get.
Lending under Consortium Arrangements by Banks for
Working Capital
In December 1973, the Reserve Bank set up a Study Group
with the object of evolving a consortium approach among banks
in providing financial assistance to the borrowers. The Study
Group expressed the view that consortium/participation should
be accepted as a culture and philosophy of banking, and the
evolution of consortium lending could lead to the pooling of
expertise, geographical presence and the total upgradation of
the lending and service capability of the entire banking system.
The Reserve Bank accepted the recommendations of the Study
Group and conveyed to commercial banks in August 1974,
suggesting that they might bear these recommendations in mind
while sanctioning advances to large borrowers. The important
guidelines are reproduced below:
i) large credit limits to any single borrower in the private or
public sector (including Electricity Boards) in excess of
1.5% of a banks deposits should normally be extended on
a participation basis,
ii) in cases where the working capital requirements of a
borrower are financed by a number of banks without a
consortium arrangement, a proper procedure for
coordination amongst the financing banks in regard to the
appraisal of credit needs, review of performance and follow-
up, and exchange of information should be evolved,
iii) any arrangement to finance a borrower on a consortium
basis should normally take care of the entire financial
requirements and other incidental business of the borrower,
and
iv) food credit consortium arrangements should be forged
amongst the banks themselves without the share of each
bank having to be decided under the aegis of the Reserve
Bank as heretofore, and the total banking business of the
Food Corporation of India should be shared between the
participating banks as far as possible.
Following the Tandon Committee recommendations for the
follow-up of bank credit and observance of credit discipline by
the large borrowers having multiple banking arrangements, the
Reserve bank stressed the desirability of the banks forming a
proper consortium with the bank having the maximum share in
the total credit limits to act as a lead bank or as consortium
leader.
However, since the borrowers were found to experience undue
delay in obtaining sanctions, etc., under the consortium
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arrangements, the Reserve Bank framed broad guidelines in
November 1978, to be followed by the banks in lending for
working capital under such arrangements. The banks were
advised as under:
1. while it is desirable to form a consortium wherever there
are multiple banking arrangements, the formation of a
consortium was obligatory where the aggregate credit limits
sanctioned by several banks to a single party amounted to
Rs.5 crores or more,
2. the earlier guideline that where the limits sanctioned by a
bank to a borrower exceeded 1.5% of its deposits, the
advances should be shared by it with the other banks, shall
continue to be in force,
3. the share of each member bank in the consortium should
not normally be less than 10% of the aggregate working
capital limits sanctioned to the borrower.
4. for the sake of operational convenience, the number of
members in the consortium should be kept as low as
possible; it should not normally exceed five, except in the
case of very large credit limits, such as those exceeding
Rs.50 crores, where the number can be increased to the
extent necessary,
5. the bank selected as the leader of the consortium and one
or two other members of the consortium as agreed upon,
should be entrusted with the work of appraisal of the
borrowers credit requirements,
6. the terms and conditions of the advance should be finalized
by the consortium committee and should be uniform for all
the member banks.
In order to avoid delays in the release of funds, the Reserve
Bank stressed the need to obtain acceptance in principle at the
initial stage from the competent authority in each bank for its
participation in the consortium. It was emphasized that the
spirit of the consortium should be maintained by the
participating banks. The member banks should respect the
consortium committees decisions on all operational matters
and also endeavour to maintain the agreed share with regard to
any additional credit that might have to be sanctioned to the
borrower. In the follow-up and supervision of the use of credit,
all the consortium members should be sufficiently involved.
The guidelines were to some extent amplified in December
1979. The clarifications related mainly to: (a) the member banks
should share the ancillary business of the financed units as far
as possible in the same proportion in which the credit lines
were shared, (b) there should be uniformity in the
documentation, and (c) the total drawings from each of the
consortium members should be in the proportion to the
stipulated ratio of sharing.[Tannan, pp 377-378].
4) Personal Loans
Personal loans are comparatively of a recent origin as compared
to loans given for industrial or commercial purposes and mark
another step in the development of modern banking. Personal
loans are given for personal requirements connected to the status
of the individual, for example, purchase of radio, television,
refrigerator, car, construction of a house etc. They may
sometimes even be granted for covering traveling expenses,
vacationing etc. These are for the most unsecured loans and are
repayable in easy monthly installments which may go on for
certain specified years.
Recently the Indian banks have published a scheme for granting
of such personal loans to the middle class populace. This loan
is usually granted for durable consumer goods [like television
or refrigerator etc]. This type of loan is extremely popular with
the customers as it provides them with an easy and affordable
way to a comfortable and convenient life style, while at the
same time allowing the banks to secure the patronage of a
specific class of populace. Personal loans to the weaker sections
of the society are given at a concessional rate under the
Differential Rate of Interest Scheme.
5) Unsecured Loans
Though the banks generally grant loans against some tangible
security, they do sometimes give loans without any outside
security. Such loans which are given only on the strength of
personal security of the borrower are known as unsecured loans.
The customers personal credit forms the backbone of such
transactions. The question arises what is meant by credit ?
Various economists have defined it differently and some of these
are reproduced below.
In its simplest form says Professor Laughlin, it (credit)
is a transfer of commodities involving the return of an
equivalent at a future time.
Kines defined credit as an Exchange in which one party
renders a service in the present while the return made by
another falls in the future.
According to Masse, Credit is the confidence felt in the
future solvency of a person, which enables him to obtain
the property of others for use as a loan, or for consumption.
Macleod speaks of credit as the present right to a future
payment.
Credit as a term originated from the word credre meaning to
believe or to trust; and in its popular usage implies the power
of a person to induce others (without use of any overt force or
violence) to part with their money, goods or services, in return
for an express or implied promise to perform some return service
in future, which is usually a payment in cash or kind. Thus
unsecured loans are given by bankers only to customers of a
good character and unimpeachable integrity and having the
capacity to repay the loan. The basic principle on which these
loans are given or based are `Character, Capacity and Capital
or the three Cs. Some authors put it as three Rs i.e., `Reliability,
Responsibility and Resources, and it is evident that these three
are not totally unconnected. If the borrower is of a dubious
character or has no known resources the prudent banker avoids
giving him an unsecured loan for any amount. Though one
may be hard put to define character, one can certainly say that
`honesty alone does not constitute character. Several other
237
traits contribute to character, for example, the sobriety, the
promptness of payment, good habits, personality, the ability
and willingness to carry a project through from the beginning
to the end and the reputation of the people with whom he deals,
which go to make the character of a customer.
Since the nationalization of banks, there has been a general
trend among the bankers to refrain from insisting on securities
and instead to look at the productivity of the proposal in terms
of future potentiality while granting a loan. Even the Reserve
Bank of India has indicated that banks should relax security
requirements in respect of loans and advances granted to the
weaker and neglected sections of the society. All this does not
mean that the banks should never ask for security or that security
has lost its importance, but the relaxation is made keeping in
mind the financial base of the new type of borrowers. Their
financial status is so weak that if the banks keep insisting on
security, none (or at the most a negligible few) of them would
be eligible for bank loans. To encourage this section of populace
to take up some productive project in order to make them
financially self-sufficient these easy-loan schemes without the
usual security requirements have been formulated. Such loans
are not very risky for the following reasons, viz:
1. Generally the amount advanced is usually small; or
2. They are spread over a large number of people.
Even the minimal risk is safeguarded against by the banks
seeking group guarantees or by obtaining a charge (either fixed
or floating) on the assets obtained by the customer through bank
funds.
6) Secured Loans
These form a major chunk of the loans granted by the banks.
All loans which are not unsecured loans are secured loans, be
the loan payable on demand or be it a term loan. A secured loan
is one where the bank advances the money against some
tangible, valuable, marketable asset of the customer. The asset
may be anything - a house, shop, machinery, stock in trade,
shares, etc., and the value of security is dependent or is in
proportion to the amount of the loan sought. Prior to
nationalization banks generally gave credit only to large
industrial or commercial concern or to rich customers having
extensive resources at their command to advance as securities,
and these were more than sufficient to cover the loan amount.
The advantages of secured loans are as follows:
1. The bank is legally permitted to take possession of the
security, sell it and recover the debt amount from the sale
proceeds, in case the customer defaulted in repayment.
2. Due to the charge on the assets, the banker is able to exercise
a modicum of control on the borrowers behaviour during
the period of loan.
3. Once the bank takes possession (either actual or
construction) of the security, the borrower is restricted from
taking a second loan on the same security. He is thus
prevented from increasing his liabilities beyond his means.
4. Since the borrower advances the security to the bank, he
remains conscious of his obligations to the bank and does
not usually leave the bank to his own mercy.
Since nationalization as mentioned earlier, there has been a
change in the banks attitude towards security, mainly because
of the broad guidelines laid down by the Government and The
Reserve Bank of India with respect to advances to be granted
by banks, keeping in mind the objectives of commercial
banking. The main guideline in this regard are as follows.
a) Credit facilities should be extended to hitherto unbacked
sectors (resulting in growth and progress of new and fresh
enterprises and ventures) and to those persons who lack an
easy access to institutional credit facilities. This approach
would result in correcting sectoral and regional imbalances
and help in a most equitable distribution of economic power.
b) Banks should serve farmers and take a active interest in
promotion of agricultural production and rural development
in general.
c) The legitimate credit needs of trade and private industry
would be met, but certain undesirable features of lending,
such as double financing or over financing would be
eliminated.
d) An emphasis on financing of priority sectors, new
entrepreneurs in backward areas should not be at the
expense of economic viability [i.e., industries should not
be financed merely because they are in a priority sector or
are to be located in a backward area, if there are no chances
of any economic returns from the industry].
1.5 PROCEDURE OF TAKING LOAN
When a person approaches a bank for the purpose of taking a
loan, the banker first tries to ascertain under which of the
following broad category the loan would come, viz
a) Agricultural
b) Small Scale Industry
c) Commercial and Industrial Sector; or
d) Personal.
These categories may differ for each bank. The above is the
SBI categorization. After ascertaining the category, the person
is given the relevant application form [the application form for
each of these categories is different] which he has to fill up and
submit alongwith the required documents at the appropriate
branch. Every branch does not deal with every type of loan, as
for example, a small branch may deal only with personal loans
or a rural branch may deal only with the agricultural, small
scale industry and personal loans. The type of loan which a
bank would give depends on the kind of demands made on it -
if there is no demand for a particular type of loan, say
commercial and industrial, the bank will not have the power to
deal with it and in such a case, if a person approaches that branch
for a loan for commercial purpose, he would be directed to the
appropriate bank branch dealing with that type of loan.
238
Once the application is filed the application is processed, and if
necessary the banker may seek clarification from the applicant
on any issue or may ask for additional information. In general,
depending on the priority/urgency, a loan request is granted
within four to six weeks time if all the requirements are fulfilled.
The above four categories are listed according to their order of
priority. Agricultural loans are given maximum priority [i.e.,
they are granted within the shortest possible time and carry an
extremely low rate of interest]; and personal loans are given
least priority [i.e., they carry the highest rate of interest]. Even
among small scale industries women entrepreneurs are given a
priority over their male counterparts. Similarly, there is an
unwritten policy that commercial ventures which might prove
harmful to the society shall be given extremely low priority, as
for example, a person wanting to open a bar or wanting to put
up a liquor manufacturing unit might get the loan, but the loan
would be given to him only if there are any surplus funds left
over after giving off loans to priority sectors.
A person taking loan for a commercial purpose will have to
submit a project report giving in brief all the relevant data
relating to the product, the manufacturing process, the input
required, expected sales, marketing, etc. The manufacturing
process and sales form an important component of such a report.
At present, approximately 20% of the expected sales is granted
as a loan in general, i.e., if the sales are expected to be about
Rs.1,00,000 then the loan granted will be about Rs.20,000/-.
The period for which the loan is given depends on the type of
loan, as for example, if it is a term loan for 3 years, the loan will
have to be paid back in 3yrs and so on. A loan further is given
against securities which we will now deal with in detail.
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2. DIRECT SECURITIES
SUB-TOPICS
2.1. Pledge
2.2. Hypothecation
2.3. Mortgage
2.4. Charge
2.5. Letters of Credit
2.1 PLEDGE
Pledge and hypothecation form a major chunk of bank financing
especially for trade or commercial purposes. Section 172 of
the Indian Contract Act defines pledge as: The bailment of
goods as security for payment of a debt or performance of a
promise is called pledge. The bailer is in this case called the
Pawner and the bailee is called a Pawnee.
Pledge has the following essential characteristics, viz.,
a) The pledge article must be delivered (either actually or
constructively) to the pawnee.
b) The delivery must be either for payment of a debt or the
performance of a promise.
c) On the pawners repaying the debt or performing his
promise the goods must be returned to him. In Lallan
Prashad v. Rehmat Ali [AIR 1967 SC 1322], it was held
that there are two ingredients of a bond or a pledge namely,
(i) that it is essential to a contract of pawn that the property
pledged should be actually or constructively delivered to
the pawnee, and (ii) a pawnee has only a special property
in the pledge but the general property therein remains in
the pawner and wholly reverts to him on discharge of the
debt. A pawn is thus a security where goods are deposited
as security for a debt or performance of a promise. Since
pledge is a kind of bailment it is evident that only
'immovable property or `goods can be pledged.
As mentioned earlier it is not really necessary to have an actual
delivery of tangible movable property. In Morvi Mercantile
Bank Ltd. by official Liquidator v. Union of India [AIR 1965
SC 1954], a firm borrowed a sum of Rs.20,000 from the bank.
It executed first a promissory note and later endorsed the railway
receipts pertaining to certain goods belonging to the firm in
favour of the bank. In fact, the bank had advanced the said
amount of Rs.20,000/- against the security of these railway
receipts. The question in issue was whether the bank was the
pledgee of the goods or was only the pledgee of the documents
of title by virtue of which it could only keep the documents
against the payment by the firm. It was held that the three
transactions, namely, (1) the advancing of loan, 2) the execution
of the promissory note and 3) the endorsement of the railway
receipts, together formed one transaction. Their combined effect
was that the bank would be in control of the goods till the debt
was discharged. Such a transaction was a pledge. Hence, the
firm by endorsing the railway receipts in favour of the bank for
consideration pledged the goods covered by the said receipts
to the bank.
As observed in Sanjiva Rows Commentaries on Indian
Contract Act: a pledge is a delivery of goods by the pledger
to the pledgee by way of security upon a contract that they
shall, when the debt is paid or the promise is performed, be
returned or otherwise disposed of according to the direction of
the pledger...A pledgee does not have the right of ownership,
though he has the right of a pledger which include only the
right of possession, but not the right of enjoyment; a pledgee
has the right of disposition which is limited to disposition of
pledgees rights only and of sale only after notice and subject
to certain limitations.
Pledge of Shares
In case shares of an incorporated company are pledged it is not
necessary for the pledge to be duly filed in a transfer form. In
re Bengal Silk Mills Case [(1992) 12 Comp. Cas. 206] it was
held that a transferee in the case of a transfer to shares in blank
has the right to fill in the necessary particulars including his
own name as a transferee and the date of the transfer, even after
the death of the original transferor. The transfer so made will b
a valid one and the transferee will be entitled to have his name
registered in the company register as the holder of the shares.
In Nayar Avergal v. P.M.Krishna Patta and others [AIR 1943
mAD 74] it was held that as shares are not tangible things the
legislature must have associated share certificate, which are
marketable when they included shares in the definition of
goods in the Sale of Goods Act. Therefore, when a person
delivers a share certificate to another to be held by him as
security there is under the law of India a valid pledge which he
can enforce but, unless the pledgee at the time of deposit secures
a deed of transfer which he can use in case of necessity or obtain
one from his debtor at a later stage, he must have recourse to
the Court when he wishes to enforce his security. The Court
can confer a full title on the buyer by following the procedure
laid down in Order 21 Rule 80 C.P.C. In Kanhaiya Lal
Jhanwar v. Pandit Shirali and Company and others [(1953)
23 Comp. Cas. 399], it was held that a transferee to whom
share scrips and transfer in blank are given to fill up the names
of the transferee... The deposit of share scrips themselves is
sufficient to create a pledge thereon. Blank transfers, if in order,
have the effect of transferring the title in the shares to the pledger,
but a transfer of title is not necessary to create a pledge, simple
delivery of possession being enough.
The Key Loan System and The Open Credit System
In State Bank of India v. Quality Bread Factory, Batala [AIR
1983 P & H 244] the distinction between the above two systems
of loan was brought about. It was held that the loans are
advanced by the banks to its customers either on key loan system
or the open credit system. In the key loan system, the goods
pledged are under the lock of the pledgee and the pledger has
no access to them whereas in the open credit system the goods
pledged are in actual possession of the pledger and the pledgee
has constructive possession over them. In the former system
the pledger cannot deal with the goods unless the pledgee gives
their possession to him, whereas, in the latter system, he has
240
freedom to deal with them. In the open credit system, however,
the former character of pledge is maintained. The loan advanced
on the basis of key loan system is also called loan by pledge of
goods and the loan advanced on open credit system is also called
factory type loan or loan on the basis of hypothecation. The
distinction between these two types of systems has far-reaching
implications when the distinction is taken in conjunction with
other relevant matters. In the open credit system the pledgor-
debtor is required to furnish a detailed statement of stocks,
manufactured goods, machinery etc., hypothecated at regular/
specified intervals and the pledgee-creditor is entitled to examine
the hypothecated articles and to take them into his possession
at any given time if he feels the debtor is misusing them or
using them negligently. The pledgee-creditor is thus required
to exercise ceaseless vigil on the pledgor-debtor so as to protect
himself and the surety against the illegal or negligent actions of
the debtor.
Loss of the Pledged Goods
When a debtor pledges his goods with the bank the implication
is that the pledge is for the purpose of meeting the liability of
the debtor in case of his default in repaying the pledge-debt.
The question of pledgee exercising control/power or taking any
action arises when the property in the goods is lost either because
of: 1) some act of the pledger; or 2) seizure by the Government
under some statutory power; or 3) failure to take care of the
pledged goods; or 4) on account of the goods being attached
under a Court order for the satisfaction of debt. When the
pledged goods are lost the question arises as to whether the
rights of the State should take preference over the rights of the
pledgee; or as between two innocent parties who should be made
to suffer the loss.
In State of Bihar v. Bank of Bihar Ltd. [AIR 1963 Pat. 344],
money had been advanced by the bank to a sugar factory, and
the sugar bags of the factory were seized by the State
Government orders issued under Section 3 of the Essential
Commodities Act, 1946. The bags were sold and the sale
proceeds were attached by the Cane Commissioner for arrears
of cane cess due from the company. The bank claimed its dues
out of the sale proceeds. It was held that the only remedy of
the bank was against the Directors of the Company and not
against the State Government (through the Cane Commissioner).
On appeal the Supreme Court in Bank of Bihar v. State of
Bihar [AIR 1971 SC 1210] held that the rights of the pawnee
who has parted with money in favour of the pawner on the
security of goods cannot be extinguished even by lawful seizure
of goods by Government and by making money available to
other creditors of the pawner without the claims of the pawnee
being first fully satisfied. After the seizure the government is
bound to pay the amount due to the pawnee. The balance alone
is available for other creditors...if the Government deprived the
pawnee of his amount due, Government is bound to reimburse
him for such amount which he in ordinary course would have
realized by sale of goods pledged with him on the pawner
making a default in payment of debt...the law relating to the
rights of the pawnee vis-a-vis other unsecured creditors of the
pawner was the same in India and in England. The trial Court
had failed to understand that the plaintiffs right as a pawnee
did not come to an end on seizure of the goods. The
Commissioner being an unsecured creditor could not have any
higher rights than the pawner and was entitled only to the surplus
money after satisfaction of the plaintiffs dues'. Various
propositions relating to loss of pledged goods which can be
gleaned from a survey of case laws and a study of the relevant
sections are given below:
1) A pawner being a secured creditor stands on a higher footing
as compared to the unsecured creditors (even if the
unsecured creditor be the government) and his claim has
to be satisfied first before distributing the money among
the other creditors.
2) The pledgee is not liable for the loss of pledged goods
provided he has taken as much care of the goods bailed to
him as a man of ordinary prudence would under similar
circumstances take of his own goods, of the same bulk,
quality and value as the goods bailed [M/s. Gopal Singh
Hira Singh Merchants v. Punjab National Bank, AIR
1976 Del. 115]/
3) In case there is also a surety who has given a guarantee for
the loan, then, if the pawner looses or parts with the security
(i.e., the pledged goods) without the consent of the surety,
the latter is by the express provision contained in section
141 (of Contract Act) discharged to the extent of the value
of the security lost or parted with [See State of Madhya
Pradesh v. Kalu Ram, AIR 1967 SC 1105].
4. In case the goods are lost by the negligence of the pawnee,
the pledgers liability is reduced to the extent of the value
of goods. [Gurbax Rai v. Punjab National Bank, AIR
1984 SC 1012]
Right to sue and right to sell
Section 176 of the Contract Act dealing with pawnees right
where pawner makes a default states as under: If the pawner
makes default in payment of the debt, or performance, of the
stipulated time of the promise, or performance, at the stipulated
time of the promise, in respect of which the goods were pledged,
the pawnee may bring a suit against the pawner upon the debt
or promise, and retain the goods pledged as a collateral security;
or he may sell the thing pledged, on giving the pawner
reasonable notice of the sale.
If the proceeds of such sale are less than the amount due in
respect of the debt or promise, the pawner is still liable to pay
the balance. If the proceeds of the sale are greater than the
amount so due, the pawnee shall pay over the surplus to the
pawner.
Thus in case of the pawner making a default, the pawnee may
sue the pawner on the debt or he may sell the pawned goods
after giving the pawner a notice. These rights of a pawnee are
concurrent or co-existing rights, and merely because the pawnee
has opted for the former course of action it does not close out
the other option. It would be relevant here to refer to the
observations of Bachawat,J., in Haridas Mundra v. National
and Grindlays Bank Ltd. [AIR 1963 Cal 131] who held that:
241
In case the pawner makes default, the pawnee has three rights:
i) he may bring a suit against the pawner upon the debt or
promise, and (ii) he may retain the pawn as a collateral security,
or (iii) he may sell it on giving the pawner a reasonable notice
of the sale. The right to retain the pawn and the right to sell it
are alternative and not concurrent rights, when the pawnee
retains, he does not sell; and when he sells he does not retain.
But 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 pawn does not exclude his right of suit, since the
pawn is a collateral security only. Nor does the sale of the
pawn destroy this right; the pawner is still liable on the original
promise to pay the balance due. The sale does not give a fresh
starting point of limitation for a suit to recover the balance.
Similarly, the institution of a suit upon the debt or promise does
not reduce the pledge to a passive lien and destroy the pawnees
right to sell the pawn. The right of sale is necessary to make
the security effectual for the discharge of the pawners obligation
and the right continues inspite of the institution of the suit. Even
if it be assumed that the right of sale out of court is alternative
to the right to institute a suit on the debt or promise, the two
alternatives are not mutually exclusive and the exercise of one
alternative right does not destroy all future recourse to other
alternatives.
Effect of sale without notice
The giving of a reasonable notice before selling the pawned
goods is a statutory requirement and cannot be excluded by a
contract to the contrary [Prabhat Bank v. Babu Ram, AIR
1966 ALL 134]. Such a sale would be bad in law and the
pawnee cannot claim the deficit amount from the pawner in
case the sale proceeds is not sufficient to cover the debt amount
[L.N. Arjundas v. State Bank of India, AIR 1969 Pat 385].
What is a reasonable time depends on the facts and
circumstances of each case. The pledger has the right to redeem
the pledge and this right is available to him till the time the
pawnee exercising his right sells the goods. He is even entitled
to buy the goods back in the sale but that does not mean that his
liability under the pledge comes to an end merely because he
has got back the possession of goods. The pledgee can still
hold the pledger liable for any deficit in the difference between
the loan amount and the sale proceeds [Dhani Ram and Sons
v. Frontier Bank, AIR 1962 Punj 321].
2.2 HYPOTHECATION
Hypothecation is a transaction where goods are given as security
against a loan without transferring simultaneously by the
property or possession to the creditor i.e., though the goods are
used as a security the debtor retains both the possession and
property in those goods. M.K.Tannan defines hypothecation
in the following words: In law, to create mortgage of movables,
appropriate words of transfer and conveyance are necessary
for a pledge, possession is essential. A transaction intended to
be a security over chattels, in which there are no words of
transfer and where the possession remains with the borrower,
will therefore amount to an equitable charge which is generally
known as hypothecation. Lord Macnaughten has characterized
hypothecation as `being ambulatory and shifting in its nature;
covering over and so to speak, floating with the property until
some event occurs or some act is done which causes it to settle
and fasten on the subject within its grasp. Singularly enough,
according to the Calcutta decisions, a mortgage of movables in
India stands on the same footing as an hypothecation under
English Law.
According to the Corpus Juris Secundum (Vol.XLII)
hypothecation means a contract of mortgage or pledge in which
the subject matter is not delivered into the possession of the
pledgee or pawnee; or, conversely, a right which the creditor
has over a thing belonging to another, and which consists in a
power to cause it to be sold in order to be paid his claim out of
the proceeds. In Halsburys Law of England [4the edn., p.438,
para 635] the expression hypothecation of cargo has been
defined as a pledge of the cargo without immediate change of
possession; it gives right to the person making advances on the
faith of it to have the possession of the goods if the advances
are not paid at the stipulated time; but it leaves to the owner of
the hypothecated, the power of making the repayment, and
thereby freeing them from obligation. Venkataramaiyas Law
Lexicon [5the edn., p.568] explains hypothecation as: A pledge
in which the pledger retained possession of the thing pledged
as security for a debt...It differs from a mortgage in that there is
no actual or executory conveyance or assurance of the property
hypothecated for payment of debt or loan, and from a pledge in
that there is no actual or constructive delivery of the property.
Hypothecation is a mode of creating a security whereby not
merely the ownership, but also the possession of the thing,
remains with the owner.
From the above definitions it is clear that the basic difference
between pledge and hypothecation is that in case of former the
possession of goods is with the creditor, whereas in case of
latter the possession of goods remains with the debtor. In Bank
of Baroda, Ahmedabad v. Rabari Bachu Bhai Hira Bhai
and others [AIR 1987 Guj 1], it was held that hypothecation is
different from pledge. When a property is hypothecated with a
creditor, it is given as security or collateral for a debt without
physical transfer thereof to the creditor. The title to the property
does not pass to the creditor but the creditor has merely the
right to sell the property on default. It differs from a pledge
where possession of the article pledged is transferred to the
pledgee or pawnee. The question to be decided in this case
was whether the hypothecating bank could be held vicariously
liable to pay damages to the injured for the negligent act of the
driver of the hypothecated vehicle. After giving the above
distinction the Gujrat High Court held that the appellant bank
was not liable to pay compensation to the victim of the accident.
The reason for this decision is very simple. When a vehicle is
hypothecated its possession continues with the owner-pawner.
The jural relationship between the bank and the owner is that
of a creditor and debtor, with the bank having the right to sell
off the vehicle in case the owner fails to pay his dues; but the
debtor remains in de jure and de facto possession of the vehicle
242
exercising full control over it. Since the bank has no control
over the use of the vehicle it cannot be made liable to pay
compensation.
Hypothecation is as in the case of pledge always of movable
goods or property. Though movable property is not defined
anywhere, section 3 of the General Clauses Act defines
immovable property as: Immovable property includes land,
benefits to arise out of land and things attached to earth. Sec.
3(vi) of Transfer of Property Act, 1882 defines things attached
to earth as under:
a) rooted in the earth, as in the case of trees and shrubs; or
b) embedded in the earth, as in the case of walls and buildings;
or
c) attached to what is so embedded for the permanent
beneficial enjoyment of that to which it is attached.
All other property is movable. The difficulty arises in deciding
whether a property is movable or immovable in case of objects
like trees and machinery, because when the tree is rooted in the
ground it is immovable the moment it is out it becomes movable.
Similarly, a machinery as such is movable the moment it is
fixed to the floor it becomes immovable. Whether they are
treated as movable or immovable always remains a question of
fact and a matter of proof in each case. A sort of general
principle was laid down in The District Board, Banaras v.
Churhu Rai [AIR 1956 All 680] wherein it was held that the
real test for determining whether a tree is movable or immovable
property is not the nature of the tree, but the way in which it is
intended to be dealt with. If the intention of the parties in respect
of a particular transaction is that the tree is to be cut by the
purchaser and removed, it will be timber and movable property.
But if the intention is that it should after the purchase continue
to grow, it may not be timber, i.e., it will be immovable.
Similarly in Kuppanna Chetty Ambati Ramayya Chetty and
Co. v. Collector of Anantpur and others [AIR 1955 AP 457]
it was held that under Transfer of Property Act, buildings
constitute immovable property and machinery if attached to
the building for the beneficial enjoyment thereof is also attached
to the earth. If the machinery is embedded in the building for
the beneficial use thereof, it must be deemed to be a part of the
building and the land on which the building is situate.
In general, whenever a customer borrows from a the bank
against machinery installed in his factory premises or otherwise,
it is always a case of hypothecation [and in fact most of the
hypothecation cases deal with machinery hypothecation] as the
bank is least interested in keeping the key of the premises where
the machinery is installed. It is thus an open credit system of
loan advance, which is why it becomes necessary to find out
whether the concerned machinery is to be treated as movable
or immovable. In order to help the bank determine this problem
the following two tests may be laid down:
1. What is the intendment, object and purpose of installing
the machinery - whether it is for the beneficial enjoyment
of the building, land or structure, or the enjoyment of the
very machinery?
2. What is the degree and manner of attachment or annexation
of the machinery to the earth whether it is fixed to the earth
with the help of mere bolts and screws (i.e., something
which can be removed with little or no trouble) or whether
it is deeply embedded in a concrete floor (i.e., with the
idea of keeping it permanently affixed there). Machinery
attached by the formed mode can be hypothecated but those
affixed by the latter mode cannot - they can only be
mortgaged.
The risks faced by the banker
1. Since the bank does not obtain actual or constructive
possession of the goods, the degree of control which he
can exercise over the goods is very little or limited, as a
consequence of which the borrower gets sufficient
opportunity to deal with the goods in any manner he wants
(even fraudulently).
2. The second risk arises from the fact that because of the
uncertainty regarding the category of goods, (i.e., movable
or immovable) the banker may find himself in a difficulty
in the transaction he enters because if it is a case for
mortgage then it has to be registered else it will not act as a
notice to the subsequent mortgagee or the purchaser of the
property. This might result in the banker losing his security
through no fault of his.
Precautions to be taken by banker
1. Check thoroughly the credit and standing of the borrower.
2. As far as possible ask for a guarantee as a collateral security.
3. Once the hypothecation has been entered into, be regular
with the follow up and inspection of the hypothecated good,
to check whether the debtor is using it properly or not. In
case, the goods are being misused take an immediate action.
2.3 MORTGAGE
Section 58 of the Transfer of Property Act, 1882 defines
mortgage as under :
(a) A mortgage is the transfer of an interest in specific
immovable property for the purpose of securing the payment
of money advanced or to be advanced by way of loan, an existing
or future debt, or the performance of an engagement which
may give rise to pecuniary liabilities.
The transferor is called a mortgagor, the transferee a mortgagee;
the principal money and interest of which payment is secured
for the time being are called the mortgage money, and the
instrument (if any) by which the transfer is effected is called a
mortgage-debt.
(b) Simple mortgage. Where, 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 mortgage
property to be sold and the proceeds of sale to be applied, so
far as may be necessary, in payment of the mortgage money,
the transaction is called a simple mortgage and the mortgagee a
simple mortgagee.
243
(c) Mortgage by conditional sale. Where the mortgagor
ostensibly sells the mortgaged property - on condition that on
default of payment of the mortgage money on a certain date the
sale shall become absolute, or
on condition that on such payment being made the sale shall
become void, or
on condition that on such payment being made the buyer shall
transfer the property to the seller, the transaction is called a
mortgage by conditional sale;
Provided that no such transaction shall be deemed to be a
mortgage unless the condition is embodied in the document
which effects or purports to effect the sale.
(d) Usufructary mortgage. Where the mortgagor delivers
possession or expressly or by implication binds himself to
deliver possession of the mortgaged property to the mortgagee,
and authorizes him 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 party in
lieu of mortgage money, the transaction is called a usufructuary
mortgage and the mortgagee a usufructuary mortgagee.
(e) English mortgage. Where 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 proviso that he will retransfer it to the mortgagor upon
payment of the mortgage-money as agreed the transaction is
called an English mortgage.
(f) Mortgage by deposit of title deeds. Where a person in
any of the following towns, namely, the towns of Calcutta,
Madras and Bombay, and in any other town which the State
Government concerned may, by notification in the Official
Gazette, specify in this behalf, deliver to a creditor or his agent
documents of title to immovable property, with intent to create
a security thereon, the transaction is called a mortgage by
deposit of title-deeds.
(g) Anomalous Mortgage. A mortgage which is not a simple
mortgage, a mortgage by conditional sale, a usufructuray
mortgage, an English mortgage or a mortgage by deposit of
title-deeds within the meaning of this section is called an
anomalous mortgage.
The rights and interests of the mortgager are transferred to the
mortgagee and the extent of such transfer depend on the nature
and kind of mortgage.
Pledge, Lien and Mortgage
It is stated that a pledge is something between a simple lien and
a mortgage. In the case of a lien there is no transfer of any
interest; the person exercising a lien has only a right to retain
the subject matter of the lien until he is paid. When we consider
the case of mortgage, we find that the property passes to the
mortgagee and the mortgagor has only a right of redemption.
As has been held in Jammu and Kashmir Bank Ltd. v. Tek
Chand,[AIR 1959 J & K 67] in the case of a pledge though the
deposit of goods is made security for payment of a debt or
performance of a promise, the pledgee has only a special
property in the pledge, while the general property therein
remains in the pledgor and wholly reverts to him on the
discharge of the debt or performance of the promise. In the
present case there was a pledge of saving bank pass book to a
third person, and it was held that a pledgee of a savings bank
pass book can also effectively enforce the pledge by laying a
proper action on it in court of law, although there may be some
difficulty in his exercising a right of sale under section 176 of
the Contract Act as in the case of other tangible goods like for
instance a gold ornament. There can be a pledge of shares
unaccompanied by blank transfer deed.
The distinction between pledge, mortgage and sale has also
been brought out in the case M.R.Dhawan v. Madan Mohan
and others [AIR 1969 Delhi 313]. In this case it was held by
Honble. Justice P.N.Khanna that the pledge is kind of bailment
and security for the purpose of enabling the pawnee to reimburse
himself for the money advanced when on becoming due it
remains unpaid, by selling the goods after serving the pawner
with a due notice. The pawnee at no time becomes the owner
of the goods pledged. He has only a right to retain the goods
until his claim for the money advanced thereon has been
satisfied. The pawnee acquires a right after notice to dispose
of the goods pledged. This amounts to his acquiring only a
special property in the goods pledged. The general property
therein remains in the pawner and wholly reverts to him on
payment of the debt or performance of the promise. Any
accretion to the goods pledged will, therefore, be in the absence
of any contract to the contrary, the property of the pawner. In
the case of a mortgage, however, an interest in the mortgaged
property is transferred in favour of the mortgagee subject to
the right of redemption of the mortgagor. In the case of a sale
the property in the goods is transferred from the seller to the
buyer (vide section 4 of the Sale of Goods Act). Property,
according to Section 2(11) of the Sale of Goods Act, means the
general property in goods and not merely a special property.
It is, thus, clear that if only special property passes it may amount
to a pledge. It becomes a sale only when the general property
in the goods passes. [Gupta, pp 481-482]
Mortgage of movables
In United Bank of India v. The New Glenoe Tea Co. Ltd
[AIR 1987 Cal 143] it was held that under the Indian Law there
can be a valid mortgage of movables though such a mortgage
may be different from such mortgage at English Common
Law or under Bills of Sale Act. Such a mortgage when not
accompanied by delivery of possession is still operative save
and except against bona fide purchasers without notice ..... O.34
CPC is applicable to suits on mortgages in respect of immovable
property only and not to suits on mortgages in respect of
movables ..... a suit for enforcement of a mortgage of movable
property will still be a mortgage suit resulting in a mortgage
decree though not in terms of O.34. such a suit will not result
in a simple money decree but in a decree of sale.
Whether or not a transaction amounts to mortgage depends on
the language of the document and intention of parties; but the
244
law relating to the mortgage of movables in India is still very
unsatisfactory. Generally speaking mortgage of movables is
given as a collateral security.
Unpopularity of real estate as security with bankers
Though mortgage or real estate is probably one of the oldest
known sources of raising money on property, it is not very
popular with bankers as a security proposition. The reasons
for this unpopularity are manifold and some of the important
ones are discussed below :
1) Legal hindrances
If the law imposed no hindrance in the transfer of immovable
property it would form a very sound and valuable security. But
where law imposes regulations or restrictions or checks on such
transfers, the bankers advance to his customers is fraught with
complications. As for example, a non-agriculturist cannot
acquire land from an agriculturist; Transfer of Property Act
itself imposes certain restrictions on alienation of property etc.
So before giving an advance a banker has to check and see
whether the property being mortgaged comes under any of these
categories.
2) Difficulties in ascertaining the customers title
Another difficult task which the banker has to undertake is to
ascertain whether the person who is offering the security has a
legal and valid title to it. The term title incorporates two
propositions : (1) ownership of legal interest in the property
and (2) the right to dispose off the property in any manner the
title holder wants to. The second point is extremely important
because a person may be the owner of a property but may not
have the right to deal with it in any manner he chooses. As for
example, a person having a life interest in a property is the
owner of the property during his lifetime but he does not have
the right to permanently alienate/transfer the property. Even if
he gives the property on lease or mortgages the property the
period of such lease/mortgage cannot be beyond his lifetime.
The manner of ascertaining a title is so complicated that only a
highly trained lawyer well-versed in the law and technicalities
can certify whether the person actually has a title or not. Further,
the lawyer has to be an extremely conscientious one, because
he would have to go through the title-deeds, check the land
records etc., and then come to a conclusion. All this takes a lot
of time which the banker may not have and so more often than
not he has to advance the loan based on superficial examination
of records which lays him wide open to the risk of the borrower
having a defective title.
3) Heavy expenses involved
Before a mortgage can be finalized the parties have to incur a
heavy expenditure, which might involve payment of charges
for land survey, valuer charges, lawyers fees, registration
charges etc.
4) Frigid nature of security
Assets which are easily realizable or liquid assets are the ones
which are ideally suited to a banker. Real estate by its very
nature cannot be easily realized, and the banks may not find it
in their interest to keep the security and thereby their money
locked up for a long time. Commercial banks especially whose
liabilities chiefly take the form of deposits payable either on
demand or on short notice cannot afford to have their assets
frozen over any length of time. Further, though real estate
always has a market, it takes a long time to find a suitable buyer,
and even after that completing the process of sale itself takes
an even longer time involving a lot of inconvenience, efforts
and money. All in all real estate as a banks security tends to be
pretty awkward and inconvenient.
5) Variety of land tenures
The banker also has to take into consideration the incidents
which go with various kinds of tenures. In India we have
numerous types of land tenures, as for example, Freehold,
Fazandari, Sanadi, Khoti, Imami, Toka, Ryotwari, Patidari, etc.
The value of these various tenures differs according to the
incidents attached to them, and a banker cannot blindly advance
money on such tenures (merely because they are immovable
property) without obtaining expert legal opinion.
6) Difficulty in valuation
A banker can only advance money after taking into
consideration the market fluctuations, and so he has to have an
expert(s) opinion on the value of the property and its future
prospects (i.e whether the value of property is likely to increase
or decrease in future, etc). A property may be of high value but
due to various reasons it may not fetch that price in the open
market (for example, sometimes a rumor that a particular house
is haunted etc., may so effect the market value, that the house
may not even fetch half of what it is really worth). A banker
has to take all these factors into consideration before advancing
money.
7) Delay in realization of security
The banker cannot suo moto self off the mortgaged property in
the event of the mortgagor failing to pay the loan amount.
There are umpteen procedural requirements (which in most
cases include approaching the courts for grant of remedy) before
he can realize the security, in contra-distinction to pledge where
he merely has to give a reasonable notice to the pawner before
selling the pledged property. In case of mortgage a banker
usually has to wait for years before he can realize the mortgage
money.
8) To pay cost of repairs and find tenants
In case the mortgage is of the type where he acquires possession
of the property, the banker has to undertake the further trouble
of finding suitable tenants for the property and would also have
to undergo additional expenses involved in the maintenance of
the property.
For all of the above reasons bankers do not find the idea of
advancing money against mortgage of immovable property very
appealing. It is not to say that bankers never accept mortgage
as a security, but it definitely is not a security which under
normal circumstances they would give a first preference to.
245
Remedies available to the mortgagee-banker
When the mortgagor customer commits a default in the
repayment of loan, the banker has the following remedies
available to him, viz :
A) Personal remedy against mortgagor
Though in general the banker realizes his debt from the
mortgaged property, in certain circumstances he can sue the
mortgagor for the loan amount. These situations are :
(i) when the mortgagee binds himself personally to repay the
mortgage money, as for example, in case of a simple
mortgage or English mortgage.
(ii) When the mortgaged property is destroyed by vis major
[ie., acts beyond human control] the mortgagee is entitled
to sue the mortgagor for the loan. Before instituting such a
suit, he should make a demand for a fresh security and
give the mortgagor sufficient time to furnish such security
[secs.68(b)]
(iii) if the mortgagor fails to disclose that the mortgaged property
is non-transferable or is subject to the prior mortgage, then
he commits a willful default and the mortgagee is entitled
to sue the mortgagor personally [sec.68(c)].
(iv) if the transaction is one of usufructuary mortgage and the
banker has not been put in possession of the property, he
can sue the mortgagor for the loan amount [sec.68(d)].
B) Remedy of sale through court
A banker can rarely sell the mortgaged property on his own
even if the mortgagor has committed a default in payment. He
has to always approach the court to get an order permitting him
to sell the property. He can cause the property to be sold in the
following situations :
(i) a simple mortgagee is entitled to have the property sold
after the mortgage money becomes due and remains unpaid.
(ii) a right to sell is also available in case of an English mortgage
or the mortgage by deposit of title deeds, or an anomalous
mortgage.
(iii) a right to sell can be expressly provided for in the mortgage
deed, in such cases it would be an express hypothecation
clause. Even in the absence of such an express
hypothecation clause the power of judicial sale [i.e. sale
order passed by a Court of competent jurisdiction]. Thus
in Lal Narsingh v. Yakub Khan [1929 PC 139] Lord
Tomlin observed : Their Lordships are of the opinion that
under Sec.68 the money has become payable and the
plaintiff is entitled to a money-decree for the same, but if
the money has become payable under S.68 their Lordships
are further of the opinion that under S.67 a decree for sale
can be made. Thus, unless there is an express prohibition
on the remedy of sale, once a money decree can be passed
under S.68, the property can also be caused to be sold under
S.67.
C) Remedy of foreclosure
Foreclosure of a mortgage takes place when the mortgagee
obtains a decree from a court of competent jurisdiction that the
mortgagor shall be absolutely debarred or prohibited from
redeeming the mortgage. Such a decree brings to an end the
equity of redemption and results in the mortgagee becoming
the absolute owner of the property - as if the mortgagor had
executed a transfer of his total rights over the property to the
mortgagee.
The basic difference between foreclosure and sale is that in the
former case the mortgagee acquires possession of the mortgaged
property and becomes the owner of the property; whereas in
the latter case the mortgage does not acquire the right of
ownership over the property but only gets a right to sell off the
property and to satisfy his debt out of the sale proceeds. The
right of foreclosure is available to the banker in the following
cases, viz :
a) If the mortgage is one by conditional sale or an anomalous
mortgage under the terms of which he is entitled to
foreclose.
b) Uptil 1929, a mortgagee under an English mortgage was
entitled to foreclose, but since the only remedy available
to an English mortgagee is that of sale.
Restrictions on the remedy
1. In case the mortgaged property is one in which the general
public is interested, as for example, a railway, canal dam,
etc, then the mortgagee can neither exercise the right of
foreclosure nor the right of sale. The only remedy available
would be to sue the mortgagor (in such cases it would either
be the government or some public authority) for the debt
amount.
2. The mortgagor has the right to redeem the property [i.e.
pay off the mortgagor money alongwith interests and other
dues and regain the property] till the court passes a final
decree of sale or foreclosure, i.e. at any time after the
institution of a suit for sale or foreclosure but before the
passing of the decree the mortgagor can redeem his
property.
D) Sale without intervention of Court
If the principal money has become due and the bank has served
a notice to the mortgagor to pay the amount due, and the
mortgager does not pay even after 3 months of service of notice,
then the bank may under sec.69 of T.P. Act exercise the power
of private sale (i.e. sale without intervention of a Court). The
written notice required under sec.69(2) (a) is a mandatory
requirement and the 3 months notice period cannot be shortened
by a contract between the parties. This power of sale can also
be exercised, if the unpaid interest on the mortgage money is
Rs.500/- or more, and such interest amount remains unpaid even
after 3 months of service of notice.
Prior mortgages
There is no restriction in the Act itself as to the number of times
a property can be mortgaged. A single property may have a
first mortgage, a second mortgage, a third mortgage and so on.
The various mortgages can be to the same mortgagee or to
different mortgagees. This will be clear from the following
246
example : Suppose X is the owner of a house mortgaged three
0909 times. X can mortgage it in either of the two ways :
(i) X can mortgage the house three times to the same person
A on three different dates for different amounts, as for
example -
1st mortgage on 1.3.77 for Rs.1,00,000/-
2nd mortgage on 15.5.79 for Rs.55,000/-
3rd mortgage on 31.7.94 for Rs.20,000/-
(ii) X can mortgage his house to three different persons at
different times for varying amounts, for example -
1st mortgage to A on 1.3.77 for Rs.1,00,000/-
2nd mortgage to B on 15.5.79 for Rs.55,000/-
3rd mortgage to C on 31.7.94 for Rs.20,000/-
Whether the different mortgages are to the same person or to
different persons, when the time for redemption comes the first
mortgage has to be redeemed first, than the second, Then the
third and so on, on the principle qui prior est tempore, potior
est jure [i.e. he who is prior in time is stronger in law]
Sec.78 of the Act is an exception to this general rule and states
that : Where through the fraud, misrepresentation or gross
neglect of prior mortgagee, another person has been induced to
advance money on the security of the mortgaged property, the
prior mortgagee shall be postponed to the subsequent
mortgagee.
Thus in the above example if because of As fraud,
misrepresentation or gross negligence B was induced to give
the money to X, then when the time of redemption comes B
will be redeemed first and then A, i.e, their places in the
hierarchy will interchange.
In Lloyds Bank v. Guzder & Co. [56 Cal 868], title deeds
deposited with the bank as security were handed over to the
mortgagor who was thereby enabled to create a second
mortgage by deposit of title deeds. It was held that there was
gross neglect on the part of the bank and that its security
realization was postponed to the second mortgage. Page,J.
observed : in my opinion gross neglect in S.78 means and
involves failure on the part of the prior mortgagee to take
reasonable precautions against the risk of a subsequent
encumbrancer being deceived as in the circumstances renders
it unjust that the earlier mortgage should retain its priority.
2.4 CHARGE
Sec.100 of the Transfer of Property Act defines Charge in the
following words :
"Where immovable property of one person is by act of
parties or operation of law is made security for the payment
of money to another, and the transaction does not amount
to a mortgage, the latter person is said to have a charge on
the property; and all the provisions here-in-before contained
which apply to a simple mortgage shall, so far as may be
apply to such charge.
Nothing in this section applies to the charge of a trustee on
the trust property for expenses properly incurred in the
execution of his trust, and save as otherwise expressly
provided by any law for the time being in force, no charge
shall be enforced against any property in the hands of a
person to whom such property has been transferred for
consideration and without notice of the charge.
Charge vis -a-vis mortgage
(1) A mortgage is a transfer of interest in a specific immovable
property but a charge is not. This distinction has been fully
set out in note unde sec 58. See also Bapurao v. Narayan
[AIR 1950 Nag. 117, ILR 1949 Nag. 802], Dattatreya
Shanker Mote v. Anand Chintaman Datar [(1974) 2
SCC 799].
(2) A charge may be created by act of parties or by operation
of law; but a mortgage can be created only by act of parties.
(3) A simple mortgage carries a personal liability, unless
excluded by express contract. But the same rule does not
apply to a charge; in fact the rule is opposite, because by
the definition of a charge no personal liability is created.
But where a charge is the result of a contract there may be
a personal remedy. Every case must depend upon its own
facts Reghukul v. Pitam [52 All. 901, AIR 1931 All. 99
(100)], Balasubramania v. Sivaguru [21 MLJ 562, 11 IC
629 (632)], Ramabrahman v. Venkatanarasu [23 MLJ
131, 16 IC 209 (210)].
(4) A power to bring the morgaged property to sale is given in
a simple mortgage either expressly or by implication; but a
charge does not contain any works to the effect
Balasubramania v. Sivaguru (Supra). If the date is
specified, the property is specified there is a convenant to
pay and there are words which indicate that the property is
to be sold in case the debt is not paid, then the bond should
be treated as creating a mortgage and not mere charge
Narayanaswamy v. Ramasamy [12 LW 674, 60 IC 611
(613)]. But like a simple mortgage a charge holder has the
right to bring the property to sale.
(5) A charge created by operation of law (e.g., a charge created
by a decree) does not require the formalities (e.g.,
registration) prescribed by sec 59 for a mortgage
Gobinda v. Dwaraka [35 Cal. 837 (841)], Mania v. Bachi
[28 All. 655 (660)]. [But a charge created by act of parties
requires registration Mania v. Bachhi, (supra)].
(6) As regards the relief granted, there is now no distinction
between a charge and a simple mortgage.
(7) In the case of a charge the property need not be specific. A
charge differs from a mortgage not only in form but in
substance. For instance a plea of purchase for value without
notice may be good against a charge, but not against a
mortgage Bapurao v. Narayan [AIR 1950 Nag 117,
ILR 1949 Nag 802].
A charge in India cannot usually be compared with a charge,
legal or equitable in England, because in India such a charge is
defined by statute Dau Bhairoprasad v. Jugal Prasad [AIR
1941 Nag 102].
247
A charge is not exactly identical with a morgage. One
obvious distinction is that a morgage is for a fixed term whereas
charge may be in perpetuity. In the case of morgage it can be
ultimately redeemed whereas a charge in perpetuity cannot be
redeemed at all Matlub v. Mst. Kalawati [AIR 1933 All
934], Jnanendra v. Sashi Mukhi [44 CWN 240, AIR 1940
Cal 60]. In the case of recurring charge even although the
charged property might be sold in execution of a decree for
arrears payable in respect of the sum charged, the liability in
respect of future payments would ordinarily remain after the
sale and as a charge is attached to the property, the auction-
purchaser would ordinarily get the purchased property subject
to the charge.
Charge vis-a-vis lien
(1) The main distinction between the two terms is that a
charge may be created by act of parties or by operation of
law, whereas a lien can arise only by operation of law.
(2) A charge in strictness not only empowers its possessor in
any case to hold the property charged, if in his possession,
but also gives him the right to come into court and sue
actively for the satisfaction of his claim. A lien strictly is
neither a jus in rem nor a jus ad rem, but is simply a right to
possess and retain property until some charge attaching to
it is paid or discharged.
(3) A charge is confined to immovable property but a lien
may be had in respect of movable also. [Gupta, pp 660-
662]
Kinds of Charge
Charge over a property may be of the following two types, viz:
i) Fixed Charge
This is a charge which attaches to a particular immovable
property, as for example, a particular field or building etc. The
owner of the property so charged can only deal with it subject
to the charge. Thus a purchaser who buys the property with
notice of charge, buys it subject to charge, i.e, though there is a
change in ownership the chargee can exercise his right over the
property till his dues are paid off [though this remedy is not
available to him against a bona fide purchase without notice of
charge]. In case of a fixed charge for the recovery of a specific
sum of money from a specific property, a transfer of interest in
the property takes place the moment the charge is created.
ii) Floating Charge
This is a very innovative concept formulated especially for the
benefit of the commercial world. In this type of charge, the
charge is not fixed to a specified object or property but is spread
out to cover a class of property, as for example, a floating charge
over the assets of the company. The advantage of this charge is
that the charger-debtor can continue dealing with the assets over
which there is a floating charge. Thus in the above example,
the debtor can continue selling/trading his stock in trade and
the floating charge continues to fluctuate over his entire stock
in hand and also that he acquires in future. Suppose he is a car
dealer and when the charge was created he had 100 cars in
hand. The charge envelopes all the 100 cars. Now, in that
month he sells 20 cars - so the charge floats over the remaining
80 cars. Later he purchases 50 cars more now the charge
envelopes all the 130 cars. Thus a floating charge is never
stagnant it keeps fluctuating depending on the assets in hand.
Till some event happens to crystallize or fix the floating charge
(in general such an event is the winding up of the company or
insolvency proceedings etc.) When the floating charge
crystallizes it becomes fixed over the assets which the debtor
has in hand at the time of crystallization.
A floating charge has a two fold advantage, viz :
i) The debtor can continue dealing with the charged property
with no restrictions whatsoever; and
ii) The persons who purchase property subject to a floating
charge purchase it free of charge irrespective of whether
they knew of the existence of floating charge or not.
There is of course a risk involved that on the day when the
charge crystallizes the assets on hand may not be sufficient to
cover the debt amount. But this risk is so minimal that it is
negligible, and is anyway far outweighed by the fact that this
method is one way of keeping the wheels of commerce spinning
with no restrictions created by encumbrance.
A charge may be created in the same manner as a simple
mortgage and practically follows the same format.
Every charge on the assets of a company has to be registered
under sec.125 of the Companies Act, within 30days of effecting
or creating the charge (sec.132). But if there is a sufficient
cause for default or delay in filing the particulars of the charge
within the prescribed time limit the Registrar may condone the
delay and allow in to be registered within such extended time
that he may prescribe. In Benares Bank Ltd v. Bank of Bihar
Ltd. [AIR 1947 All 117] it was held that the provisions of the
section will be deemed to be complied with when the particulars
of the charge were sent within 21 days (now the limit is 30
days) to the Registrar, although he had neglected to register it
for two and a half years. Nothing done by the Registrar on his
own account after proper documents have been filed can in any
way effect the validity of the charge.
Effect of registration
Once a charge is registered [Whatever the kind of charge] it
becomes binding on the company, even during its winding up
and also on every subsequent purchaser or encumbrance of the
property covered under the charge (sec.120), i.e., registration
makes the banker (i) a secured creditor, and (ii) gives him a
priority over subsequent encumbrances. But as long as the
company is a going concern any charge or mortgage effected
on its assets would be valid, even if not registered. [Aung Ban
Zeya v. C.R.M.A. Chettiar Firm, AIR 1927 Rang. 288]. In
Maruti v. Rao v. P. Venkatarayadu [(1970)40 Comp.Cas 751]
the purchaser of the assets of a company which were subject to
an unregistered mortgage was held bound by the mortgage.
In case a charge is not registered, and the company goes into
liquidation, the charge would be void against the liquidator and
248
any secured creditor of the company. The lender would not
have the benefit of the charge and the amount advanced by him
will be treated as an ordinary loan and it would become
repayable immediately, though after the claims of the secured
creditors have been satisfied. [See Suryakant Natwarlal Surati
v. Kamani Bros P. Ltd (1985) 58 Comp. Cas. 121 (Bom); Praga
Tools Ltd v. O.L. (1984) 56 Comp.Cas 214 (Cal)].
Precautions to be taken by the banker
1. Check the status and standing of the borrower company.
2. In case of company or firm as far as possible have a floating
charge over the assets to be crystallized when the company/
firm goes in for winding up/dissolution
3. Have the charge registered with the Registrar within the
prescribed time period.
2.5 LETTERS OF CREDIT
In the Thomsons Dictionary of Banking a letter of credit has
been defined as a document issued by a banker authorizing
the banker to whom it is addressed to honour the cheques of
the person named to the extent of a certain amount and to charge
the sums to the account of the grantor; or it may be worded so
as to authorize the person to whom it is addressed to draw on
demand, or at a currency, upon the banker issuing the letter,
and the grantor undertakes, in the letter, to honour all drafts in
accordance with the terms of the credit. The letter also specifies
the period for which it is to remain in force, and is endorsed
with the particulars of every draft drawn under the credit. When
such a letter is issued the amount is debited to the customers
account and is credited to a Letters of Credit account. If the
amount is not debited to the customers current account on issue,
it may be necessary in case of the account being overdrawn, to
require security in order to protect the bank against its
undertaking in the letter of credit to honour all drafts which
may be drawn under it. The letter of credit amount is passed to
two contra accounts in the general ledger and reversing entries
are made every time a payment is made under the letter, so that
at any given moment of time a banker is able to ascertain his
total liability under the letter of credit.
A circular credit is addressed to all the correspondents of a
bank, whereas, a direct credit is addressed only to a specified
correspondent. A marginal letter of credit is one where the
authority to draw a bill is printed on the margin of the form
being used for drawing the bill. In this type of letter, the
authority portion of the bill has words to the effect I authorize
you to draw the annexed bill. These two parts of the instrument
must be together and should not be separated.
A banker before making payment under a letter of credit must
first ascertain that the signature of the drawer is correct and
that the letters terms and conditions are strictly observed. For
this purpose, he must be supplied with a sample of the drawers
signature before hand, and once that is done he will be
responsible for any loss caused due to his having paid on a
forged signature.
According to F.E. Perrys Dictionary of Banking an irrevocable
credit means once this type of credit has been arranged, its
terms cannot be varied or changed without the concurrence of
all the parties to it. Unless specifically stated as being
irrevocable, all letters of credit are revocable. An irrevocable
credit cannot be revoked without the consent of the beneficiary
and the letter, even if the bankers customer i.e., the buyer asks
him to do so. Thus, in Uruguhari Lindsay v. Eastern Bank
[(1921)1 KB 321] the plaintiffs sold certain machinery to BJM
to be shipped to Calcutta. The buyers opened confirmed and
irrevocable credit in favour of the plaintiffs with the defendant
bank. The contract of sale contained a term providing that in
certain events the price payable for the machinery should be
altered. After two shipments had been made and paid for under
the credit, a dispute arose as to whether the price of a third
shipment should not be altered, and the buyers instructed the
defendants not to take up the documents or honour the plaintiffs
drafts. These instructions were carried out, but it was held that
the defendants could not lawfully revoke the credit, and they
were therefore liable to pay damages to the plaintiffs.
To explain in simple terms a letter of credit is an arrangement
made by a bank for its customer, by which he is sure of obtaining
money wherever he may be during his stay abroad. The bank
agrees to a specified total amount with the customer, debits his
account in advance, and then writes to a correspondent bank or
agent authorizing him to cash on demand any cheque or draft
drawn by the beneficiary, and charging the sums of the
customers signature is sent to the agent bank in advance. The
letter of credit is then given to the customer who must present
it to the agent bank every time he draws money, so that the
banker may make a note of the amount drawn by him on the
back. Where only one agent is used the letter of credit may
also be called as a Direct Letter of Credit. But if the customer
is proposing to do a lot of traveling it may not be really feasible
to send individual letters to all the agents whom he may wish
to approach. In such situation a Circular or World-wide Letter
of Credit is issued to the customer which would be available at
the office of any agent of the issuing bank in any country in the
world. The customer is also supplied with a letter of India
containing a specimen of his signature. The customer is required
to keep this letter separately from the letter of credit. He can
use this letter of identification which may be printed in several
languages to identify himself every time he wishes to draw
money.
In the words of Paul R. Verkuil The letter of credit is a contract.
The issuing usually a bank - promises to pay the `beneficiary -
traditionally a seller of goods - on demand if the beneficiary
presents whatever documents may be required by the letter.
They are normally the only two parties involved in the contract.
The bank which issues a letter of credit acts as a principal, not
as agent for its customer, and engages its own credit. The letter
of credit thus evidences - irrevocable obligations to honour the
draft presented by the beneficiary upon compliance with the
terms of credit.
Over a time period spanning more than a century the usage of
letter of credit has grown because of the geographical distances
249
between the parties. This very distance is also the cause of the
one major drawback of these letters. The buyer and seller being
parted with great distances were usually unknown to each other,
and this unfamiliarity facilitated the perpetuation of fraud. This
was because, immediately the seller presented a letter of credit
complete with all requirements, the banker made the payment
on it. The issuing bank was not required to ascertain whether
goods had actually been shipped as per the contract or not, or
whether the goods were in proper condition and order or not.
Thus, in a number of cases the buyer has had to pay for goods
which were either not shipped at all or were of a substandard
quality. To prevent this kind of occurrence, the Courts have
started holding that if there had been a fraud in the transaction,
the bank could dishonour the beneficiarys demand for payment.
The Courts have generally permitted dishonour only on grounds
of fraud of the beneficiary and not of anybody else.
In India, there is no statute governing the rules and regulations
relating to letters of credit, but the judicial pronouncements on
the issue have made it clear that we would be following the
same principles that are applicable in England especially in
connection to irrevocable letters of credit; and the most basic
of the principles followed in the International Banking Practices
that letters of credit are transactions which are independent of
the bargain contract between the parties. Thus the Supreme
Court in M/s. Tarapore and Co. v. V/o. Tractor Export
Moscow and other [AIR 1970 SC 891] observed: Opening
of a confirmed letter of credit constitutes a bargain between the
bank and the vendor of goods which imposes upon the banker
an absolute obligation to pay, irrespective of any dispute which
may be between the parties as to whether the goods are upto
the contract or not. A vendor of the goods selling against a
confirmed letter of credit is selling under the assurance that
nothing will prevent him from receiving the price. If the buyer
has an enforceable claim that adjustment must be made by way
of refund by the seller but not by way of reduction by the buyer.
The letter of credit is independent of and unqualified by the
contract of sale or underlying transactions. The autonomy of a
letter of credit is entitled to protection.
It is only rarely that courts choose to interfere with this
machinery of irrevocable obligations assumed by the bank. The
reason for this is that letters of credit are the life blood of modern
day international commerce, and so they must be honoured free
from interference and restrictions by the courts, or else trust in
international circuit could be irreparably damaged. In State
Bank of India v. The Economy Trading Co. [AIR 1975 Cal.
145] it was held that Courts are slow to interfere in the letters
of credit in its operation not merely due to their importance in
international trade but also on the ground that the beneficiary
is assured of the payment by the bank once he has complied
with the terms and conditions of the letter of credit irrespective
of his non-compliance with the contract into which he had
entered with the third party or in other words on the ground of
autonomy of the letter of credit. In United Commercial Bank
v. Bank of India [AIR 1981 SC 1426] the Supreme Court held
that the rule was well established that a bank issuing or
confirming a letter of credit was not concerned with the
underlying contract between a buyer and seller. Duties of a
bank under the letter of credit were created by a document itself.
Letter of Credit vis-a-vis a guarantee
In Minerals and Metal Trading Corporation of India Ltd.
v. Suraj Balram Sethi [1970 Cal.WN (74) 991] the Calcutta
High Court has held that the distinction between an irrevocable
letter of credit and a Bank Guarantee was not merely one of
function, namely, that the former was important for international
trade and the latter for internal trade. The more important point
of distinction was the autonomy of an irrevocable letter of credit
and dependence of a bank guarantee on a contract between the
beneficiary of the guarantee and a third party. Payment under
an irrevocable letter of credit did not depend on the performance
of obligations on the part of the seller except those which the
letter of credit expressly imposed. There the obligation was
that of the Bank and no third party came into picture. In the
case of a bank guarantee, however, by definition, the third party
was always on the scene. Unless there was always an element
of contingency attached to a bank guarantee. It did not enjoy
the autonomy of a letter of credit.
As mentioned earlier the Indian law of letters of credit for the
most follows the English law, and is governed by the uniform
customs and practice for documentary credits (1974 Revision),
which has been evolved by the International Chamber of
Commerce in collaboration with the United Nations and the
Foreign Trade Banks. Certain principles which have evolved
are deemed to be the law relating to letters of credit and the
banks take these principles as a Bond and honour them totally.
Acceptance under Reserve
When a banker is in doubt about the genuineness or accuracy
of a document, or requires more time to peruse the document
he accepts the document under reserve. This phrase was
considered in banque de I Indochine et De Sue: SA v.
J.H.Rayner (Mining Lane) Ltd. [1983 QB 711] and it was
held that the payments to be made under reserve means that
the beneficiary would be bound to repay the money on demand
if the issuing bank should reject the documents, either on its
own initiative, or on the buyers instructions.
250
3 COLLATERAL SECURITIES
SUB-TOPICS
3.1 Guarantees
3.2 Lien
3.3 Stock-exchange Securities
3.4 Certain other Securities
31. GUARANTEES
An advance against guarantee becomes important when: (1)
the banker is not taking any tangible property as collateral
security, and (2) the personal security of the borrower is
insufficient to cover the loan, or (3) when the financial position
of the customer indebted to the bank has suffered a set-back or
his position is weakened because of the depreciation in the value
of the collateral security deposited by him resulting in the loan
being inadequately covered.
Section 126 of the Indian Contract Act, 1872, defines a contract
of guarantee as: a contract to perform the promise, or discharge
the liability, of a third person in case of his default. As for
example, if Mr.Singh wanting a loan of Rs.50,000/- from the
Bank of India, induces his friend Mr.Menon to promise the bank
that he would repay the loan in case Mr.Singh committed a
default, then it would be a contract of guarantee. The person
giving the loan is known as the creditor [C]; the person taking
the loan is known as the principal debtor [P]; and the person
giving the guarantee is known as the surety [S]. A contract of
guarantee has three contracts as shown in the figure below:
First Contract: - Between P and C
This is the main or principal contract out of which the liability
of the principal debtor arises.
Second Contract: - Between C and S
This is a contract of indemnity whereby the surety promises to
indemnify the creditor in case of the principal debtor committing
a default.
Third Contract: - Between P and S
This is again an implied contract of indemnity where the
principal debtor promises to indemnify the surety in case the
surety discharges the debt which he (i.e. P) himself should have
discharged.
Thus every contract of guarantee incorporates within itself two
contracts of indemnity. A point to be remembered is that in the
present context the creditor is always the banker.
Liability of a Surety
1. In general the liability of the surety is co-extensive with
that of the principal debtor, i.e., if the principal debtor is
liable for Rs.5000/- then the surety would also be liable for
Rs. 5000/-. He cannot be made liable for a single rupee
more than what the principal debtor is liable for.
2. A surety may limit his liability to a certain specified amount,
as for example, by saying I limit my liability to Rs.5000
or I promise to stand surety for Rs.5000 or in the event
of Ps default Ill pay any amount taken by him as loan
subject to a limit of Rs.5000", etc. In such cases the surety
cannot be held liable for even a single rupee above his self-
imposed limit. If P has taken a loan of say Rs.10,000 and
S has given a surety of Rs.3,000 then the bank can claim
only Rs.3000 from S and for the remaining Rs.7000/- it
will have to depend on P (or the second surety if any).
3. Though the general rule is that the surety will be liable
only to the extent of the principal debtors liability, there
are situations where the surety is held liable although the
principal debtor himself is not liable on account of the
original/principal contract between P and C being void, as
for example, when P is a minor. In such cases, the contract
between C and S no longer remains a collateral contract of
indemnity but becomes the main contract, i.e., it would be
treated as if S had taken the debt.
A contract between P and C does not become void only in cases
where P is a minor or a lunatic. In case P is a registered company,
a contract between the company and the bank would be void if
it is ultra vires the company. Similarly, to bind a partnership
firm all the partners of the firm should have consented to the
act or the act must have been done in the usual course of the
firms business.
Scope of Guarantee
The scope of a guarantee depends on whether the guarantee is
a specific guarantee i.e., related to one single transaction or a
continuing guarantee i.e., related to a series of transactions.
In case of a specific guarantee the guarantee is limited to that
particular transaction alone and does not extend to any other
transaction between the debtor and the bank. In case of
continuing guarantee the surety is liable for all those loans taken
by the debtor during the period for which the guarantee holds
good. The surety in such cases will be liable for the balance
amount irrespective of the payments made by the principal
debtor as they would be applied to the repayment of earlier
advances. For this reason a banker prefers to have a continuing
guarantee because then the suretys liability will not be limited
to the original advance alone but would also extend to all
subsequent debts. In case the continuing guarantee is given by
C
P S
251
a firm, the guarantee is revoked as to future transactions from
the date of change in constitution of the firm [section 38 of
Indian Partnership Act], unless there is a contract to the contrary
between the parties. It would be advisable for a banker to
provide for this contingency if he is seeking a continuing
guarantee from a firm.
In Montosh Kumar Chatterjee v. Central Calcutta Bank
Ltd. [(1953) 23 Comp Cas 491 (Cal)] it was held that the effect
of a continuing guarantee was not to secure the amounts
advanced on different occasions but to secure the floating
balance which may be due from time to time and it is the date
of the accrual of that balance which is relevant for the purposes
of limitation when it is sued for. The suretys obligation to pay
would arise immediately on a default occurring on the part of
the principal debtor and once the cause of action against the
surety has arisen the commencement of the running of time is
not further postponed till the making of the demand.
Obligations of the Banker
1. Not to vary the original terms of the contract without consent
of surety, in the absence of a contract to the contrary. In
M.S.Anirudhan v. Thomcos Bank Ltd. [(1963)33 Comp.
Cas. 185] a guarantee letter signed by the surety mentioned
Rs.25,000/-. The bank was later prepared to allow an overdraft
of Rs.20,000/- only, and so the letter was handed back to the
debtor to correct the figure. The debtor corrected the figure
himself and returned it to the bank. The surety filed a suit asking
to be discharged of his liability in view of change in terms. The
Supreme Court held that the principal debtor had acted as an
agent of the surety and so the surety would liable, and the
doctrine of material alteration was not applicable in this case.
Thus a variance in the terms of a contract would discharge the
surety only if such variance is to his disadvantage.
2. Not to release the debtor. In State Bank of Hyderabad v.
Nagabhushanam [(1986) 60 Comp. Cas. 740 (AP)], the bank
gave credit facilities to the borrower against the personal
guarantee of the surety. The borrower executed a pronote of
the loan amount in favour of the surety, who endorsed it in
favour of the bank. The bank filed a suit against the borrower
and the surety but did not press the suit against the borrower.
Held that the bank after giving up its claim against the borrower
cannot lay its claim against the surety. Merely because the surety
had endorsed the note in favour of the bank he did not become
a co-obligant.
3. A banker should handle the securities given to him by the
debtor, prudently and carefully, because if they are lost or
destroyed the suretys liability is discharged to the extent of
the value of the security. In Jose Inacio Lourenco v. Syndicate
Bank and another [(1989)65 Comp. Cas. 698 (Bom)], the bank
advanced money for the purchase of a vehicle. The bank
obtained a decree against the principal debtor and the surety
but was unable to produce the vehicle for the benefit of the
surety nor could the bank state that the charge was registered
with RTO. The Court held that since the bank had parted with
the security, therefore the surety was discharged.
Precautions which a banker should take
1. The contract of guarantee should be signed in the presence
of the bank manager - It is not advisable for the bank to allow
the customer to take away the guarantee form and personally
obtain the suretys signature on it. This is because: 1. the
suretys signature may turn out to be a forgery, or he may later
on allege that he signed the form in ignorance of its contents,
i.e., he can take the plea of non est factum, and 2. the surety
when asked to discharge his obligation may take up the plea
that he had signed under a misrepresentation made by the person
entrusted the job of obtaining his signature by the bank.
2. Notice of Principal debtors death - Death of the debtor-
customer automatically terminates his account and as a result
the guarantee also comes to an end. The banker should formally
demand the repayment of the debt from the surety, unless the
money has been paid by the legal heirs of the deceased.
3. Notice of debtors bankruptcy - A banker should stop all
operations on a guaranteed account on receipt of a notice
(whether actual or constructive) of his debtors bankruptcy, and
demand the repayment of the due amount from the surety. He
is not required to sell off the securities in his possession first
before approaching the surety.
4. Notice of lunacy of debtor or surety - Just as in the above
case the banker should close the account on receipt of notice
that his debtor/surety had become insane. In Bradford Old Bank
v. Sutcliffe [(1918)2 K.B. 833] it was held that the lunacy of a
surety is to be taken as terminating the guarantee so far as future
advances are concerned. Consequently, any advances made by
him after receipt of notice of the lunacy of the customer (or the
surety) was irrecoverable from the estate of the lunatic, even in
cases where the contract itself provides for a months notice
from the surety for the termination of the guarantee.
5. Change in the Constitution of the bank - Unless there is a
contract to the contrary, change in the constitution of the bank
due to merger or amalgamation, would result in the termination
of the guarantee. It is therefore prudent to include a clause in
the contract to provide against this contingency.
Bank Guarantee
It would be in place here to differentiate very briefly between
the bank guarantee discussed in the module on special
contracts and the guarantee asked by the banks discussed here.
In the former, the bank acts as the surety and gives a guarantee
on behalf of a customer-debtor, promising to pay the debt
amount to the creditor irrespective of whether the principal
debtor has made a default or not.
In the latter, the bank acts as the creditor giving a loan to a
customer and seeks a guarantee from a person of good standing
who promises to repay the debt in case the debtor makes a
default.
Statutory restrictions on guarantees by limited companies
The Companies Act imposes certain restrictions on the
guarantees given by a limited company, viz:
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Section 295(1) - A company cannot without the prior approval
of Central Government, either directly or indirectly give any
guarantee or provide any security in connection with a loan
made by a person to a director of the company or any partner or
relative of any such director or any firm in which such director
or relative is a partner or any private company of which any
such director is a director or a member. These restrictions do
not apply to a private company (which is not a subsidiary of a
public company) or a holding company in respect of any loan
made to its subsidiary.
Section 370 - A Company cannot give any guarantee or provide
any security in connection with a loan made by any other person
to any body corporate unless the giving of such guarantee or
providing the security has been previously authorized by a
special resolution of the company. These restrictions do not
apply to a holding company in respect of a loan to its subsidiary
or by a banking company in the ordinary course of its business.
Personal guarantees from directors in advances to limited
companies
The RBI has given certain guidelines in this regard.
Concerned at the growing sickness in industrial units and
increasing loan losses devolving on the banks consequent upon
sticky and stagnant accounts, the Reserve Bank of India has
advised the commercial banks to obtain guarantees from
directors of borrowing companies excluding nominee directors
and other management personnel in their individual capacities,
whenever found necessary. (Journal of the Indian Institute of
Bankers, July-September, 1986, p.164).
The Reserve Bank of India announced clarification in respect
of its earlier directive to commercial banks to obtain guarantee
from directors of borrowing companies excluding nominee
directors while giving loans. RBI has directed that banks need
not insist on personal guarantees from professional directors or
managers who do not have any significant stake in the company
concerned, while extending credit. However, in case serious
malpractices on the part of the management are noticed by the
commercial banks, the right remedy would be to remove or
replace them. (Journal of the Indian Institute of Bankers, April-
June, 1987, p.58).
3.2 LIEN
A lien may be defined as the right of a creditor to retain any
goods or securities belonging to the debtor, which he has in his
possession till his debt is paid off. In Alliance Bank of Simla
Ltd. v. Ghamandi Lal Gaini Lal [AIR 1927 P & H 408] it
was held that general lien confers on the holder any the right to
retain the goods until the payment is made out but it does not
carry with it the right of sale to secure the debt or indemnity. It
is merely a right to retain goods or chattel and does not create a
right as in favour of a pledge. Since the lien with which we are
presently dealing deals with right of possession it is known
as a possessory lien. The other two kinds of lien are equitable
lien and maritime lien.
Possessory lien is of two kinds - general and particular. A
particular lien is very specific in its operation and is limited to
the transaction in question, i.e., the creditor can retain the goods
for expenses incurred by him in relation to those goods. As for
example, a tailor can retain the dress made by him till his
tailoring dues on that dress are paid by the customer. He cannot
retain the dress for any charges accrued in the past, i.e., he cannot
retain the dress for a general balancing of accounts. A general
lien on the other hand is the right of the creditor to retain the
goods not only for discharge of the debt accrued in connection
with them, but also for a general balancing of accounts arising
out of similar transactions arising between the parties in the
past. As for example, a solicitor can retain the legal documents
belonging to his client, not only till his dues on those documents
are paid but also till he is paid all those charges or fees arising
in connection with the professional services rendered by him
to that client. Thus, a general lien empowers the creditor to
retain possession until the entire debt is paid off. A lien arises
out of operation of law rather than by an act of parties, provided
the following conditions are fulfilled, viz:
1. There is a debt in existence;
2. That the creditor is in lawful possession of certain properties
belonging to the debtor;
3. There is no express or implied contract taking away the
right of lien.
Bankers lien
At the time when the Indian Contract Act was being codified,
the Original Bill contained the following observation : In the
absence of any contract to the contrary, bankers, factors and
wharfingers have no right to retain any goods bailed to them as
a security for a general balance of account. The Select
Committee did not find this to be a favourable proposition, and
in Clause 22 of their Report, observed : No reason is given for
the abolition of general lien in these cases, and we think it
expedient to alter the s.171 thus :
Bankers, factors, wharfingers, attorneys of High Court and
policy brokers may, in the absence of a contract to the contrary
retain as a security for a general balance of account, any goods
bailed to them, but no other persons have a right to retain as a
security for such balance, goods bailed to them unless there is
an express contract to that effect.
The recommendation of the Select Committee was accepted
and the amended sec.171 was incorporated in the Contract Act.
Following the precedent set by English law a bankers lien is
sometimes treated as an implied pledge. This was first
recognized by Lord Campbell in Brandoo v. Barnett [1846 3
CB 519], where he observed :
Bankers must undoubtedly have a general lien on all securities
deposited with them, as bankers, by a customer, unless there be
an express contract, or circumstances that show an implied
contract, inconsistent with lien ..... Now it seems to me, that, in
the present case are there was an implied agreement on the part
of the defendants inconsistent with the right of lien which they
claim. (The bills) not only were not entered in any account
253
between Burn and the defendants, but they were not to remain
in the possession of the defendants; and the defendants, in
respect of them, were employed merely to carry and hold till
the deposit in the tin box could be conveniently accomplished
.... Nor, I presume, can any weight be attached to the
circumstances that the tin box ..... remained in the house of
defendants .... I think that the transaction is very much like the
deposit of plate in locked chests at a bankers ....... In both
cases a charge might be made by the bankers if they were not
otherwise remunerated for their trouble.
If this interpretation is taken then a banker apart from retaining
the goods for a general balancing of accounts, can also exercise
the rights of a pledge and sell or dispose off the goods or
securities in his possession in order to realize his debt, unless
the debtor can prove the existence of an express or implied
contract inconsistent with the bankers right to lien. In India
also the right of implied pledge can be imputed from sec.171
Contract Act and the power given under the Banking Regulation
Act, 1949.
Principles governing banker's lien
1. In Chettinad Mercantile Bank Ltd v. P.L.A. Pichammai
Achi [AIR 1945 Mad 447] it was held that the bankers
lien is the right of retaining things delivered into his
possession as a banker, if and so long as the customer to
whom they belonged or who had the power of disposing of
them when so delivered is indebted to the banker on the
balance of account between them provided the
circumstances in which the banker obtain possession do
not imply that he has agreed that this right shall be excluded.
2. The ownership of the property in possession of the bank
must be with the customer debtor, otherwise no right of
lien can arise.
3. A bankers right to lien is different from a bankers right to
set off. The former is related to property or securities in
the banks custody, whereas, the latter is related to money
debts and may arise from a contract, or from a mercantile
usage or by operation of law. Though frequently the word
lien is used in connection with money it is a wrong usage
of the term. Morse on the American Law of Banking has
observed :
The word `lien cannot properly be used in reference to
the claim of the bank upon a general deposit, for the funds
on a general deposit are the property of the bank itself.
The term `set off should be applied in such cases, and
`lien when a claim against paper or valuables on special
or special deposits is referred to. In the cases the words are
used very loosely ... The practical effect of lien and set off
is much the same.
In Halsburys Law of England [Vol.2, 3rd edn. p.210] it is
stated that:
The general lien of bankers is part of the law merchant as
judicially recognized, and attaches to all securities deposited
with them as bankers by a customer, or by a third person
on a customers account, and to money paid in by, or to the
account of, a customer unless there is a contract, express
or implied, inconsistent with the lien.
Money is however not usually the subject of lien not being
coupled or being earmarked and the bankers claim in such
cases is probably more rightly referred to as set-off in
respect of a customers account.
The bank may thus not be able to exercise its right of lien
against the money deposited in the customers account, but
it may adjust the deposit against the debt owned to it from
the customer. The purpose of lien in this case is achieved
through set-off.
4. A bankers right to lien is subject to a contract to the
contrary, and existence of such a contract has to be proved
by the party alleging it (i.e. the customer).
5. Where the bank advances money against securities and the
securities have been left with the banker even after
repayment of loan, the banker can exercise his right of lien
on them against any subsequent advance made by him to
the customer. In such a situation, a separate letter or contract
is not necessary, though bankers do ask for a letter of lien
from the customer by way of abundant caution. This letter
firstly enables a banker to retain the security against all
debts/liabilities of the customer, besides giving the banker
the power to sell or otherwise dispose of the security in
case of default in payment by the customer, and secondly
prevents the customer from taking a plea that the security
had been given for a specific purpose only.
6. The right of lien being a possessory right is lost when the
banker either returns the goods back to the customer before
repayment of debt or otherwise conducts himself in such a
manner as to induce the customer to think that he does not
intend to exercise his right (implied waiver of the right), or
acts in a manner which is in contradiction to his exercise of
the right of lien.
Some cases where a banker has no lien
1. Safe custody deposits cannot be subjected to lien.
2. When customer has no title to the securities deposited.
3. Where bonds with coupons attached are deposited for safe
custody, and the customer gives the coupons to the banker
for collection, he cannot exercise lien.
4. No right of lien for general accounts, when the customer
brings documents like title deeds for raising a fresh loan,
and leaves the deeds by mistake with the banker on his
refusing the loan.
5. No right of lien if the banker returns the securities to the
customer before repayment of loan, even if he again comes
into possession of the self same securities.
6. No lien on bills of exchange or other documents entrusted
for special purpose.
7. On dishonour of a bill, the bank is not entitled to apply the
security attached to the bill, to any other debt due from the
customer for whom the bill was discounted [Latham v.
Chartered Bank of India, (1874)17 Eq 205]
254
8. No lien arises on the personal current account balance of a
partner of a firm in respect of a debt due from the firm, as
the credit and liability do not exist in the same right.
9. No lien arises till the debt is actually due; nor can the banker
retain money of the customers against bills discounted by
him for the customer, but not yet due, except may be if the
customer becomes bankrupt.
10. No right of lien against a separate account maintained by
the customer, and known to the bank as a trust account
[O.R.M. v. Nagappa Chettiar, 43 Bom.LR 440 (PC)]
11. Once the customer pays off the overdraft for which the
securities had been deposited, the banker has to return the
securities, and cannot in general exercise his right of lieu
against them.
12. Title deeds to immovable properties deposited by the
customer with the bank for whatever purpose, cannot be
made a subject matter of general lien or implied pledge.
13. A bankers right of lien is not affected by statute of
Limitation because limitation bars the enforcement of right
after the specified period but does not bar the remedy itself
[London and Midland Bank v. Mitchell AIR 1958 SC 328].
3.3 STOCK EXCHANGE SECURITIES
Stock Exchange Securities in strictu sense is used for all gilt
edged securities [such as, Government loans, Municipal, Port
Trust and Improvement trust bonds, etc] and such other
securities issued by Government and public bodies, and shares
and debentures of industrial and commercial companies, banks
and insurance companies etc. whose shares are listed at the
stock exchange.
Advances against these securities form an important part of the
loans advanced by banks in larger cities having stock exchanges,
not only because speculators keep needing money to invest in
shares which are likely to appreciate but also because large
blocks of these securities are held by rich and upper middle
classes owning to the fact that they feel that money invested in
such shares is easily realizable if needed. From a bankers point
of view these securities find favour as compared to other kinds
because of the following reasons :
1. These securities are generally more reliable as compared
to guarantee because the banker gets something tangible
whereas in the latter case he has to rely on the surety if the
debtor makes a default.
2. Gilt edged securities are more easily realizable than other
types of securities.
3. In normal circumstances, good stock exchange securities
are less susceptible to market fluctuations as compared to
certain other commodities like cotton, sugar etc.
4. It is easier for the banker to satisfy himself of the customers
title to the shares he is offering as security. It is also easy
for him to ascertain the market value of these shares.
5. They can be more easily transferred as compared to certain
other securities like land and buildings.
6. The release of these securities can be effected with the
minimum of expense and formality.
7. These securities almost always yield a dividend interest
which when applied towards the discharge of debt, reduces
the borrowers indebtedness towards both interest and the
principal.
8. If necessary, the banker can easily raise money against them
by pledging them with other bankers.
Disadvantages of these securities
(i) In case of partly paid-up shares the banker may be required
to pay the balance amount if a call is made, provided he/
his nominee is registered in the members register as the
owner of those shares.
(ii) The banker renders himself liable as a bona fide transferee
to indemnify the company against any loss it may suffer, if
the transferors signature turns out to be forged. This risk
can be averted by making the customer sign in the bankers
presence.
(iii) If the articles provide for a right of lien on the shares to the
company; the banker may find himself to be deprived of
the entire benefit if he fails to give the company a notice of
his charge on the shares.
(iv) If the shares are susceptible/liable to wide fluctuations the
banker may suffer a loss.
(v) In case of non-negotiable securities, the transferor cannot
give the transferee-banker a better title than what he himself
possesses.
(vi) Apart from forging the transferors signature, nowadays
the shares and scripts are themselves being forged/
duplicated. If an advance is made against a scrip which is
not genuine then it becomes difficult for the banker to realize
his debt.
Precautions to be taken
1. He should first check up and see to which class the offered
securities belong (i.e. public debts, bonds and debentures
of municipalities etc).
2. As far as possible advance should be made only against
fully-paid up shares.
3. He should study the profit-loss account statements of the
company for the past few years, so as to be able to form a
fairly reliable estimate of its future prospects.
4. He should also carefully study the official market prices of
the scrips so as to get a fair idea of the real market value of
the stocks and shares to be put in the approved list. It would
not be prudent of him to rely on unsubstantiated statements
or statements from untrustworthy persons relating to the
market value of such shares.
5. He should also check whether the securities offered are
debentures or shares; and if shares whether equity or
preferential. As far as possible preference should be given
to debentures over shares; and to preference shares over
equity shares; and to cumulative preference shares over
non-cumulative preference shares.
255
6. Once he is satisfied about the securities offered, he has to
value the shares according to their market price, allowing
for any dividend in the quoted price. In case of shares
which are rarely traded, it is better to contact the company
secretary to ascertain the market price of the shares, and
the date on which the last transfer of its shares was
registered. The banker should keeping the transfer date in
mind consider the effect of any subsequent circumstances
which may influence the prices of the securities.
7. Once he approves of the securities, fixes their price and
determines the necessary margin, he should then decide
the best mode of completing the security. In case of fully
paid, up bearer securities, transfer is complete by mere
delivery, but in case the security is payable to a specified
person or order transfer is complete only by endorsement
and then delivery. Once the transfer is complete, the banker
gets a good title to them if he taken them in good faith and
for value, regardless of the title of the transferor.
8. A banker has to ascertain whether the securities are
negotiable or non-negotiable. According to the Negotiable
Instruments Act, promissory notes, bills of exchange and
cheques come under negotiable instruments. Non-
negotiable securities are either inscribed stocks [i.e. the
name of the holder of such stocks is inscribed alongwith
the extent of his holding, in a book kept either with the
government or corporation issuing the same, or its agent.
Transfer of such stock can be done only by the owner/his
duly constituted attorney going to that office and
authorizing the transfer of the stock]; or registered stock
[i.e. they are registered in the register of the company
issuing them, and to make their transfer valid it has to be
registered in the company register.
Mode of advances against securities
A banker can give an advance against shares and securities
generally in either of the two ways :
1. By effecting equitable mortgage of the securities
This can be done in the following ways :
1. by mere deposit of securities; or
2. by deposit of securities alongwith a memorandum ; or
3. by deposit of securities with a memorandum and a duly
executed blank transfer form.
4. by deposit of securities alongwith a special power of
attorney in favour of the banker authorizing him to sell the
shares in default of payment.
Disadvantages of equitable mortgage
(i) It is liable to be defeated by a prior equitable mortgage or a
subsequent legal mortgage. In India since an equitable
mortgage is statutorily recognized, there is no question of
it being defeated by a subsequent legal title (this provision
is more appropriate in England); but it can definitely be
defeated by a prior mortgage.
(ii) There is a danger that the company may be having a lien
over the stocks and shares against the registered owner of
those shares, or it may have received a notice of charge
from a prior equitable title holder, before the banker takes
the necessary steps to have them registered in his name.
(iii) Though it is desirable for the banker to get himself
registered as owner of the fully paid up shares, such an act
is resisted by the owner because : (a) he will have to bear
the cost of transfer and re-transfer of those share; (b) it
may affect his credit; (c) in case of his being a director
such a transfer may result in his losing the minimum
qualification shares and so deprive him of his place on the
board of directors; (d) the articles may impose a restriction
on transfer of shares.
Precautions to be taken
1. As far as possible, a banker should not accept shares in the
name of a third party i.e. someone other than the borrower.
If he does accept such shares, then he should make the
borrower sign the transfer form in front of a bank official
or some other well known person.
2. The banker should at the earliest send a notice to the
company informing them of his charge over the securities.
3. He should on no account part with shares and securities,
because the customer may then prejudice the banks position
by creating another encumbrance on it.
4. Securities should always be taken in good faith.
5. Generally a banker should obtain a memorandum executed
by the customer, containing a clause, authorizing the banker
to sell the securities in case of default.
6. It is advisable to obtain a mandate from the customer and
addressed to the company, asking them to pay the dividends/
interest to the bank.
2) Pledge of shares
In Kunhunni Elaya Nayar v. P.N. Krishna Pattar and others,
(1942)12 Comp.Cas. 180 (Mad), the Court while considering
the question whether a pledge of shares can be created by the
mere deposit of the share certificate, held that the shares are
goods and therefore pledgeable. They can only be pledged
by the deposit of the share certificate. The Court observed that
it appears that by including shares in the definition of goods in
the Sale of Gods Act, the Legislature must have associated
shares with the share certificate which is marketable. Otherwise,
it is difficult to see how shares can be goods and the subject of
pledge, the essence of which is delivery. The word goods in
the Indian Contract Act should receive the same meaning which
it has in the Sale of Goods Act. The Court also observed that to
say that there can only be a pledge of shares when the share
certificate is accompanied by a deed of transfer is making the
transaction something more than a pledge. Therefore, when a
person delivers a share certificate to another to be held by him
as security, there is under the law of India a pledge which can
be enforced. But unless the pledgee at the time of the deposit
256
secures a deed of transfer which he can use in the case of
necessity or obtains one from his debtor at a later stage, he
must have recourse to the Court when he wishes to enforce his
security.
In re, Bengal Silk Mills Co. Ltd., (1942) 12 Comp.Cas.
206(Cal.), it was held that a transferee in the case of a transfer
of shares in blank has the right to fill in the necessary particulars
including his own name as 0909 transferee and the date of the
transfer, even after the death of the original transferor. The
transfer so made will be a valid one and the transfer will be
entitled to have his name registered in the companys register
as the holder of the shares.
In M.R. Dhawan v. Madan Mohan and others, AIR 1969
Del.313, the Delhi High Court held that It will be seen that the
pawnee acquires a right, after notice, to dispose of the goods
pledged. This amounts to his acquiring onl a special property
in the goods pledged. The general property therein remains in
the pawnor and wholly reverts to him on payment of the debt
or performance of the promise. Any accretion in the shape of
dividends, bonus or right shares, issued in respect of the pledged
shares will, therefore, be in the absence of any contract to the
contrary, the property of the pawnor. The general property of
the shares pledged thus, remains in the pawnor and he remains
entitled to all the dividends that may be declared on the shares
and to the bonus and right shares that may be issued in respect
of the shares pledged; provided that there is no contract to the
contrary. [Tannan p. 489].
Restrictions on advances against shares
The Banking Regulations Act, 1949 has imposed certain
regulations on banks freedom to make advances against
securities, viz :
a) Sec 19(2) - No banking company shall hold shares in any
company whether as pledgee, mortgagee or absolute owner of
an amount exceeding 30% of the paid-up share capital of the
company or 30% of its own paid up capital and reserves,
whichever is less.
b) Sec.19(3) - A banking company cannot hold shares in any
company whether as pledgee, mortgagee or absolute owner in
any company in which its managing director or manager is in
any manner concerned or interested.
c) Sec 20 - No banking company shall make any loans or
advances on the security of its own shares.
Reserve Banks guidelines on advances against shares and
debentures
In January 1968, the Reserve Bank issued the following
guidelines :
1. Statutory provisions regarding the grant of advances against
shares contained in sections 19(2) and (3) and 20(1)(a) of
the Banking Regulation Act, 1949 should be strictly
observed.
2. Banks should exercise due caution and restraint in lending
against shares and debentures. They should, while
considering proposals for advances against shares/
debentures, primarily take into account the nature, purpose
and need for such advances ensuring that bank finance is
not utilised for speculative purposes. Banks should be more
concerned with what the advances are for rather than what
the advances are against. While considering grant of
advances against shares/debentures banks must follow the
normal procedures for pre-sanction appraisal and post-
sanction follow up.
3. Any advance against the primary security of shares and
debentures should be kept distinct and separate and not
combined with any other advance.
4. Banks should satisfy themselves about the marketability
of the shares/debentures and the net worth and working of
the company whose shares/debentures are offered as
security.
5. Shares/debentures should be valued at the average of the
market prices as at the end of last twelve months or the
current market price, whichever is lower. Adequate and
proper margins should be maintained while granting
advances.
6. No advance against the security of partly paid shares shall
be granted.
7. Advances exceeding Rs.5 lakhs against shares and
debentures should be sanctioned by the Board/Committee
of Directors. Suitable powers may be delegated to the Chief
Executive and others for sanctioning advances for lesser
amounts.
The guidelines further contained limits over which the bank
should get the shares transferred in its own name and exercise
voting rights, but these have been revised later on.
In August 1970, the Reserve Bank issued its directives as under:
In exercise of the powers conferred by Section 35A of the
Banking Regulations Act, 1949 the Reserve Bank of India, being
satisfied that it is in the public interest so to do, hereby directs
(i) that every Banking company which grants or renews as
advance limit or Rs.50,000 against the security of shares,
shall stipulate as one of the conditions of such grant or
renewal that the said shares shall be transferred to its name,
that it shall have exclusive voting rights in respect thereof
which it may exercise in any manner whatsoever and get
the said shares transferred to its name expeditiously:
Provided that this clause shall not apply to shares lodged
by a sharebroker as security for an advance :
Provided further that where any such shares are held as
security for such advance in the account of a sharebroker
for a period longer than three months, the provisions of
this clause shall, after the expiry of the said period of three
months, apply to such shares.
257
Explanation - (i) The limit of Rs.50,000/- shall apply to
the aggregate of all limits of advances against shares from
a single banking company extended to a borrower.
(ii) that no banking company shall grant advances against the
security of shares in cases where any condition is imposed
as to the exercise of voting rights by the banking company
in respect of such shares or requiring the banking company
to issue proxies in respect of such shares.
(iii) that no banking company shall, without the prior approval
of the Reserve Bank, grant advances against the security
of partly paid shares :
Provided that this clause shall not apply to advances to a
sharebroker:
Provided further that where advances are granted against
the security of partly paid shares to a sharebroker and such
shares are held in his account for a period longer than three
months, the banking company shall make a reference to
the Reserve Bank and obtain its directions as to whether it
should take steps for the transfer of such shares to its name
or not.
(iv) that in respect of advance limits of over Rs.50,000/- against
shares subsisting on the date of this directive, every banking
company shall,
(A) in case the shares are not transferred to its name, take
immediate steps to have the shares transferred to its
name and further in case there is any restriction on
such transfer or on the exercise of voting rights by
the banking company or any obligation is cast to issue
proxies, the banking company shall give notice to the
borrower about its intention to terminate the relative
agreement on the expiry of 35 days from the date of
issue of the notice by the banking company and
substitute the same by a fresh agreement without any
condition restricting the transfer of the shares to the
name of the banking company or restricting the
banking company from exercising voting rights freely
or requiring it to issue proxies ;
(B) in case the shares are already transferred in the name
of the banking company but there is any restriction
on the exercise of voting rights by it or any obligation
is cast on it to issue proxies, the banking company
shall give notice to the borrower about its intention
to terminate the relative agreement on the expiry of
35 days from the date of issue of the notice by the
banking company and substitute the same by a fresh
agreement without any condition restricting the
banking company from exercising voting rights freely
or requiring it to issue proxies;
And in case the borrower is not agreeable to the
revised terms, the loan shall be recalled forthwith if
it is repayable on demand and, on the expiry of its
term, if it is a term loan :
Provided that this clause shall not apply to shares
lodged by a share broker as security for an advance:
Provided further that where any such shares are held
as security for such advance in the account of a
sharebroker for a period longer than three months,
the provisions of this clause shall, after the expiry of
the said period of three months, apply to such shares:
Provided further that in cases where partly paid shares
which have not already been transferred to the name
of the banking company, are held as security for an
advance the banking company shall make a reference
to the Reserve Bank and obtain its directions as to
whether it should takes steps for the transfer of such
shares to its name or not.
(v) that no banking company shall grant or renew any advance
against shares forming a security composite with any other
security :
Provided that where an advance has been granted or
renewed against the composite security of shares and other
types of securities the advance limit against shares shall be
segragated from the advance limit against other types of
securities and the provisions of this directive would be
applicable to such segregated advance limit against shares;
(vi) that no banking company shall exercise voting rights in
respect of shares held by it as a pledge except with the
prior approval of the Reserve Bank and in accordance with
such directions as may be given by the Reserve Bank.
Explanation
(A) Advance shall include cash credits, overdrafts, loans and
advances of every description.
(B) Advances against security of shares shall include all types
of advances against shares, whether by way of principal
security or collateral security.
(C) Banking Company shall include the State Bank of India,its
subsidiaries and corresponding new banks established
under the Banking Companies (Acquisition and Transfer
of Undertakings) Act, 1970.
(D) Shareholder shall mean a sharebroker who is a membe of
a recognised Stock Exchange.
(E) Shares shall include shares and stock of every description.
The Reserve Bank of India raised the monetary limit for
advances against shares and debentures from Rs.1 Lakh to Rs.
3 Lakhs per individual borrower where the security is required
to be transferred in the banks name. The monetary limit of
Rs.2 lakhs per individual borrower for advances against shares
and debentures has been raised to Rs.3 lakhs. (Journal of the
Indian Institute of Bankers, July-September 1987, p.110).
On November 16, 1987, to provide fillip to the capital market,
the Reserve Bank advised banks to sanction loans and advances
upto Rs. 3 lakhs to individuals for purchase of shares/debentures
258
in the secondary market against the security of existing shares/
debentures. Thus, for the first time, bank credit has been
extended for the purchase of shares and debentures from the
market (Journal of the Indian Institute of Bankers, October-
December 1987, p.160).
Advances to stock brokers
In cities where a stock exchange exists, bankers also make
similar advances to stock brokers, normally for a period of 15
days or less intervening between two successive settlements.
Sometimes these transactions are in the form of budla or carry
over transactions. When a buyer is unable to pay for the shares,
he asks the banker to buy them and to hold them on his behalf
till the next settlement period, when the buyer purchases them
from the bank at a higher rate than what the bank had paid for
them. The difference between the two prices is the interest on
those shares. When the share prices are steadily rising the budla
rate may vary from 6% to 12%, and when the market is
depressed the rate may go down to 3%. Such transactions are
entered into by the banks only with highly reliable and
respectable parties and as far as possible only for gilt edged
securities. By its directive dated 11-3-1960, RBI has prohibited
the banks from directly financing budla transactions in general
have been banned in India by a SEBI directive since about
Feb.95.
3.4 CERTAIN OTHER SECURITIES
1. Units of Unit Trust of India
The units of Unit Trust are either fixed or flexible. In case of
former the portfolios are fixed and any subsequent alteration
can take place only by a special procedure and in specified
circumstances; and in the latter the change in the proportion of
securities can be decided upon by the managers at their
discretion. The unit consists of varied investments in various
securities at the time when the trust is formed. It is then divided
into sub-units which are then sold to investors who thereupon
become unit holders akin to shareholders in a company. Periodic
dividends are distributed. Just like shares, units can also be
offered as security, and, the procedure to be followed or the
precautions to be taken is more or less the same as in case of
shares.
2. Special Bearer Bonds, 1991
The Central Government has issued at par certain bearer bonds
to be known as the Special Bearer Bonds, 1991 of the face
value of Rs.10,000 and redemption value after ten years of
Rs.12,000 so as to canalise for productive purposes black money,
which has become a serious threat to the national economy.
The Reserve Bank has intructed the banks by a letter dated
march 19, 1981 as under:
(1) The commercial banks are authorised to grant advances
against the collateral security of these bearer bonds within
the frame work of credit control. However, the banks are
not permitted to purchase these bonds and thus they will
not form part of the approved Government Securities
statutorily required to be held by them, under section 24 of
the Banking Regulation Act, 1949.
(2) Having regard to the purpose of the Scheme, the banks
may, in appropriate cases, while sanctioning advances for
various productive purposes, accept these bonds as
collateral securities. In doing so, the banks have, however,
to keep in view the prevalent credit policies and norms
applicable for the different types of advances.
(3) These bonds are transferable merely on delivery and will
not carry any evidence as to whom they were originlly
issued. It will, therefore, be desirable for the banks, while
accepting such bonds as security, to obtain from the offerer
a suitable indemnification against the possibility of claims
from third party who may claim the lawful ownership of
the bonds in question.
The author suggests that the indemnity bond may be on the
following lines: I declare that the follwoing bearer bonds each
for Rs.10,000 were acquired by me for a proper consideration
from ..... and exclusively belong to me. No other person has
any right, title or interest therein. I further declare that I had
handed over to .... Bank, .... the said bonds as a collateral security
against the facilities granted to M/s.........[Tannan p. 494].
3. Social Security Certificates
The Reserve Bank vide its letter dated September 10, 1987,
has advised the banks that the rules governing the 10 year
social security certificates (SSCs) permit them to be pledged as
security to the commercial banks and co-operative banks as in
the case of other National Savings Certificates. As such, the
banks can grant loans on the secirity of SSCs to the holders on
margin and interests as follows: (a) A higher margin in the
range of 40% to 50% should be prescribed for granting advances
against the security of the aforesaid certificates as these
certificates are encashable at any time after 3 years of their
purchase, the rate of interest on these works out to 11.3% per
annum and in the event of default the total amount recoverable
could exceed the invested value of the certificates. (b) As
regards the rate of interest to be charged, we advise that it would
be governed by our directives on interest rate of advances and
taking into account the nature and purpose of advance etc.
The salient features of the Scheme are: (1) The SSCs are
available in denomination of Rs.500 and Rs.1,000 at Post
Offices having Savings Banks facility. (2) The maturity period
of the certificate is 10 years. (3) The rate of interest is 11.3%
computed half yearly. (4) The deposit is tripled in the 10 year
period. (5) The scheme offers insurance cover to the investor
[Tannan, p. 494].
4. Shares of Private Companies
These are not much favored as securities by the banks, because
it is practically impossible to gauge accurately the true financial
259
status of the company, because private companies are not
required to publish their balance sheets, though now they are
required to file a audited and certified copy of their balance
sheet u/sec.220(1)(b) of Companies Act. The shares of a private
company are not easily transferable, and so the banker cannot
arrive at an estimate of their market value. A banker also has
to take care and see that transfer in his name is not refused by
the directors of the company. If the need arises he cannot sell
these shares very easily in the market. But despite all these
disadvantages there is nothing to prevent a banker from giving
an advance against them, and he can always take the help of
the Company Secretary to ascertain the market value of the
shares.
5. Letters of Allotment of Shares
Generally there is a time gap between the letter of allotment
and the actual allotment of shares, and so a customer may
require to be accommodated during that period. For all practical
purposes, such an advance is to be considered as advance against
shares and the usual precautions should be taken. Certain
additional precautions which should also be taken are : (1) the
extent of liability on that letter of allotment should be ascertained
; (2) as far as possible a renunciation form in favour of bank
attached to the letter or forming a part of it should be got
executed by the customer or where that is not possible the
borrower should be asked to furnish the bank with duly signed
blank transfer forms so that when shares are actually allotted
the bank can either hold them as equitable mortgage or fill up
the blank forms and send it to the company to have the shares
registered in its own name or in the name of its nominee.
260
SUB TOPICS
4.1. Equitable Mortgage
4.2. Life Policies
4.3. Book debts
4.4. Debentures
4.5. Hire-purchase finance
4.6 Conclusion
4.1 EQUITABLE MORTGAGE
Section 58 of the Transfer of Property Act, 1882 defines
mortgage as the transfer of an interest in specific immovable
property for the purpose of securing the payment of money
advanced or to be advanced by way of loan, an existing or future
debt, or the performance of an engagement which may give
rise to a pecuniary liability. The basic characteristic of a
mortgage is the transfer of interest in a specific immovable
property for the purpose of securing a debt or an obligation. If
the transfer is for the purpose of cancelling an already existing
debt then it is not mortgage.
When such a mortgage is executed by the deposit of title deeds
to the property it is known as a equitable mortgage, because in
this kind of mortgage there is no legal transfer of property. In
Foster v. Barnard [(1916)2 AC 160] Lord Haldane observed
The deposit of title deeds with bankers makes the bankers
mortgagees in the eyes of Equity. Thus, an equitable mortgage
in England was recognized as an exception to the general rule
laid down in the Statute of Frauds requiring mortgage to be in
writing. It can be created either (1) by actual deposit of title
deeds in which case parol (i.e., oral) evidence is admissible to
show the meaning of the deposit and the extent of the security
created, or (2) if there be no deposit of title deeds, then by a
memorandum in writing, purporting, to create a security for
money advanced [Gupta, p. 624]. What is clear is that an
equitable mortgage in England as the name itself suggests was
one which the Common Law did not recognize and the parties
had to approach the Courts of Equity for their remedy.
In India an equitable mortgage has statutory recognition under
section 58(f) of the Transfer of Property Act and is known as
mortgage by deposit of title deeds, and states as under: Where
a person in any of the following towns, namely, the towns of
Calcutta, Madras and Bombay, and an 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 immovable property, with intent
to create a security thereon, the transaction is called a mortgage
by deposit of title deeds.
In Pentala Githavardhana Rao and others v. The Andhra
Bank Ltd. and others [AIR 1973 AP 245] the Andhra Pradesh
High Court has reiterated that the existence of the following
three conditions are essential for a mortgatge by deposit of title
deeds, viz:
i) existence of a debt;
ii) deposit of title deeds in respect of immovable property;
and
iii) intention that the title deeds shall be security for the debt.
Further observing that the delivery or deposit of the title deeds
may be physical or constructive, it held the essence of a
mortgage by deposit of title deeds is the actual handing over of
the document of titles in respect of the immovable property by
a borrower or his agent to the lender. It is the substance of the
entire transaction but not its form that really matters to infer
intention of the contracting parties.
Documents of titles
The question now arises what is a document of title ? All
documents relating to a property do not constitute a document
of title. A test which may be applied to ascertain whether a
particular document is a document of title or not is to find an
answer to the question is the document the only document of
title and whether a better document of title is not available ?
The following documents have been held to be valid documents
of title, viz:
a) Patta of land in the mofussil
b) A mortgage is the document of title of the mortgagee
c) An expired lease is a document of title to the leasehold
when the lesee obtains a renewal of lease.
d) Share certificate.
e) Record by Revenue Surveyor reciting an oral sale, and
revenue tax, receipts.
f) Sold notes by firm from whom machinery of a factory
was purchased, the drafts of the purchase price, and receipts
by the firms for the amounts paid, insurance certificates,
are all documents of title of the factory.
g) Original probate of a will accompanied by a certified copy
of a redemption certificate relating to the property, the
original having been lost, creates a good equitable
mortgage.
The following documents have been held to be not document
of titles, viz:
i) A copy of the jamabandi report.
ii) Documents which are by way of being merely evidence of
title to the property.
iii) Map of the property, and unimportant papers.
iv) A mortgage is not a document of title of the mortgager.
v) Where the original title deed is unavailable, a copy of it
may be good document of title.
vi) A document of title of a movable property (for example,
machinery) does not become the document of title of
immovable property simply because the movable property
has changed its character and has now become an
immovable property (for example, by being permanently
fixed to the ground).
4. MISCELLANEOUS SECURITIES
261
vii) A mutation entry is not a document of title.
viii)A life insurance policy.
With reference to the validity of an equitable mortgage in case
of deposit of a copy of title deeds instead of the original, the
Andhra Pradesh High Court in Kanigalla Prakasa Raoq v.
Nanduri Ramkrishna Rao [AIR 1982 AP 272] observed, The
submission that a valid equitable mortgage can never be made
without delivering the original title deed has to be rejected. Such
original documents of title may, at times, be lost or destroyed
due to natural causes like cyclones and fire-accidents. They
may also be lost either by thefts or due to want of proper care
and sometimes they would have failed in courts and not taken
return of in time. The owners of property who have so lost
their documents of title will, therefore, be not in a position to
deliver such original documents with intent to create an equitable
mortgage. It will be rather anomalous if such persons can validly
execute registered documents of sale, lease and mortgage, but
will not be entitled to raise any monies by creating an equitable
mortgage. The mortgagee in such cases has only to be vigilant
in accepting such representation made to him and should make
the necessary enquiries before agreeing to advance any monies
on the basis of registration extracts of documents of title or
copies of documents. That seems to be underlying principle of
section 78 of the T.P. Act which provided that if the conduct of
a prior mortgagee amounted to gross neglect, the mortgage in
his favour will be postponed to the subsequent mortgagee.
The entire law relating to creation of an equitable mortgage by
means of deposit of title deeds has been laid down in
K.J.Nathan v. S.V.Maruthi Rao and others [AIR 1965 SC
430]. According to their Lordships, whenever there is a
mortgage by deposit of title deeds, one has to see whether there
is an intention to create security or not and this intention is not
a question of law but is a question of fact. So far as the deposit
is concerned, it is not necessary that there should be a physical
delivery. Under the Transfer of Property Act, a mortgage by
deposit of title deeds is one of the forms of mortgage whereunder
there is a transfer of interest in specific immovable property for
the purpose of securing payment of money advanced or to be
advanced by way of loan. Such a mortgage of property takes
effect against a mortgage deed subsequently executed and
registered in respect of the same property. Though there is no
presumption of law that the mere deposit of title deeds
constitutes a mortgage, a court may presume under Section 114
of the Evidence Act that under certain circumstances a loan
and a deposit of title deeds constitute a mortgage but that is
really an inference as to the existence of one fact from the
existence of some other fact or facts. Similarly the fact that at
time the title deeds were deposited, there was an intention to
execute a mortgage deed in itself, or is inconsistent with the
intention to create a mortgage by deposit of title deeds to be
enforced till the mortgage deed was executed. In each case,
the court will have to find out as to whether there is a delivery
of title deeds by the debtor to the creditor or not. In a case the
creditor was already in possession of the title deeds, it would
be only hyper-technical to insist upon the formality of the
creditor delivering the title deeds to the debtor and the debtor
re-delivering them to the creditor. When the principal tells the
agent, from today, you hold my title deeds as security, in
substance, there is a physical delivery. For convenience of
reference, such a delivery can be described as constructive
delivery of title deeds. The law recognizes such constructive
delivery [Gupta, p. 635].
On the question whether a written document was necessary to
constitute a mortgage by deposit of title deeds the Supreme
Court in United Bank of India v. M/s.Lekha Ram Sona Ram
and Co. [AIR 1965 SC 1591], observed, when the debtor
deposits with the creditor, title deeds of his property with intent
to create a security, the law implies a contract between the parties
to create a mortgage and no registered instrument is required
under section as in other classes of mortgage. It is essential to
bear in mind that the essence of a mortgage by deposit of title
deeds is the actual handing over by a borrower to the lender of
documents of title to immovable property with the intention
that those documents shall constitute a security, which will
enable the creditor ultimately to recover the money, which he
has lent. But if the parties choose to reduce the contract to
writing, this implication of law is excluded by their express
bargain, and the document will be the sole evidence of its terms.
In such a case the deposit and the document both form integral
parts of the transaction and are essential ingredients as the
creation of the mortgage. It follows that in such a case the
document which constitutes the bargaining regarding security,
requires registration under Section 17 of the Indian Registration
Act, 1908, as a non-testamentary instrument creating an interest
in immovable property, where the value of such property is one
hundred rupees and upwards. If a document of this character is
not registered, it cannot be used in evidence at all and the
transaction itself cannot be proved by oral evidence either.
This entire reasoning was briefly summed up in
M.G.Manjappa v. M.F.C. Industries (P) Ltd. [AIR 1990 Ker
157] as 'it is only when the parties intend to reduce their bargain
regarding the deposit of title deeds to the form of a document,
that the document requires registration. If, on the other hand,
its proper construction and the surrounding circumstances lead
to the conclusion that the parties did not intend to do so then
there being no express bargain, the contract to create the
mortgage arises by implication of the law from the deposit itself
with the requisite intention, and the document, being merely
evidential does not require registration.
4.2 LIFE POLICIES
In the words of J.W.Smith a contract of life insurance is a
contract by which the insurer, in consideration of a certain
premium, either in a gross sum, or by annual payments,
undertakes to pay to the person for whose benefit the insurance
is made, a certain sum of money or annuity on the death of the
person whose life is insured...Sometimes the amount is made
payable either at death, or at the expiration of a stated number
of years, whichever shall happen first.
262
An insurance contract is one of uberrimae fidei i.e., it is a
contract where the utmost good faith has to be observed, and a
full and complete disclosure of all such facts and circumstances
must be made which might affect the risk. An insurance contract
may be vitiated in the case of non-disclosure of material facts
regardless of whether such non-disclosure was innocent or
fraudulent. This principle was followed in London Assurance
v. Mansel [(1879)11 Ch.D. 363]. Here, the defendant wanted
the plaintiffs to insure his life. He was asked to fill a
questionnaire, where one of the questions was Has a proposal
ever been made on your life at any other office or offices ? If
so, where ? Was it accepted at the ordinary premium or at an
increased premium, or declined ? Mansels answer was:
Insured now in two offices for 16,000 at ordinary rates.
Policies effected last year. The proposal was accepted, but
subsequently the plaintiffs discovered that the defendants life
had been declined by several offices. If was held that the
plaintiffs were entitled to have the contract set aside.
Insurable Interest
Any person can insure the person or property provided he has
an insurable interest. Originally this condition of one having
an insurable interest was absent. This was only laid down in
England by sections 2 and 3 of the Life Assurance Act, 1774
commonly known as the Gambling Act, and states as under:
No insurance shall be made by any person or persons, bodies
politic or corporate, on the life or lives of any person or persons,
or on any other event or events whatsoever, wherein the person
or persons. for whose use, benefit or on whose account such
policy or policies shall be made, shall have no interest, or by
way of gambling or wagering; and every assurance made
contrary to the true intent and meaning hereof, shall be null and
void to all intents and purposes whatsoever.
The Act does not define what is meant by insurable interest
and one has to look to judicial pronouncements to ascertain the
meaning of this phrase. In Glasgow Parish Council v. Martin
[(1990)SCJ 102] Lord Eldon said: It is clear that the assured
must have an interest whatever we understand by that term. In
order to distinguish the intermediate thing between a strict right
or a right derived under a contract and a mere expectation or
hope which has been termed an insurable interest, it has been
said in many cases to be that which amounts to a moral certainty.
I have in vain, however, endeavoured to find a fit definition for
that which is between a certainty and an expectation, nor am I
able to point out what is an interest unless it be a right in the
property or a right deniable out of some contract about the
property insured, which in either case may be lost upon some
contingency affecting the possession or enjoyment of the party.
Expectation though founded upon the highest probability is not
interest, and it is equally not interest whatever might have been
the chances in favour of the expectation. Considering the
caution with which the legislature has provided against
gambling by insurance upon fanciful property, it is certainly
desirable that no purely sentimental interest, such as an
expectation or an anxiety, should be made the ground of a
policy. From these observations it is clear that mere natural
love and affection shall not support the claim of insurable
interest, the insured must be so related to the subject matter of
the insurance that in the event of its loss, he will suffer some
pecuniary loss. It is essential that such an interest should be in
existence when the insurance is effected. In the following
instances the insured is deemed to have an insurable interest,
viz:
i) in his own life;
ii) in the life of his/her spouse;
iii) in the life of his debtor (but only to the extent of the debt
amount).
Reasons for Unpopularity of Life Policies as Securities:
J.W.Gillbert once observed: A banker should never make any
advances upon the life policies.
Even in India life policies are not all that popular with the banker
for the reasons mentioned below:
1) Evasion by insurer for non-disclosure of a material fact
As mentioned earlier a contract of insurance is one of uberrimae
fidei, and requires a full and frank disclosure of the relevant
material facts. Non-disclosure of even a single material fact
can result in the insurance company avoiding the contract. There
is no way in which a banker can ascertain whether the insured
has made the required disclosure or not, or whether the insured
was guilty of fraud or misrepresentation, and if he has been so
guilty then the banker stands to lose his money. The Insurance
Act, 1938 under section 45 states that no insurance policy shall
be disputed after it has been in force for two years from the
date effecting the policy on the ground of any misrepresentation
even as to a material fact, except where the misrepresentation
alleged to have been made as to a material fact was knowingly
made by the insured in order to defraud the insurance company.
Thus, atleast for a period of 2 years minimum this doubt that
the insured person may not have made a full disclosure keeps
on hanging over the bankers head like a Damocles sword.
2) Regular payment of premia required to keep policy alive
A life policy might lapse in case the assured fails to pay the
premia instalments regularly. Unless such a policy has been in
existence for some years, so that its surrender value is sufficient
to cover the loan amount advanced by the banker, he would
have to go on paying the premia on it in order to keep the policy
alive. Surrender value of a policy depends on the kind/class of
policy and the period for which it has been in existence when
the banker pays the premia he has the satisfaction of keeping
the security alive and he can add the premia amount paid by
him to the customers account and the entire premia amount
paid by him will be a charge on the policy.
3) Unsatisfactory nature of law relating to assignments
Under the English Law, if a banker takes a life policy as security
for the advance made by him, and has that policy assigned to
him, his position becomes secure provided that the insurance
company has received no intimation of a prior charge on the
policy. In India, priority in case of assignment is governed not
263
by the date of registration of assignment but by the actual date
of assignment. The situation is better now, because the
Insurance Act of 1938 makes a differentiation between policies
issued before 1.7.1939 and those issued after that date. In case
of former policies, the rights and liabilities etc., of the assignee
and transferee are not affected, but in case of latter ones the
position is that an assignment takes effect only on its being
registered with the insurer.
4) Nomination of life policies
According to section 39 of the Insurance Act, an insurer gets a
good discharge on paying the policy money to a nominee named/
appointed in the policy. But various courts have held that a
nominee has no absolute title to the policy money, i.e., he only
acts as a collecting agent and is required to hand over the money
to the legal heirs of the deceased. In Life Insurance
Corporation of India v. United Bank of India Ltd. [(1971)
41 Comp. Cas. 603 (Cal)], the nominee of the life policy
assigned the policy to the bank against a loan of Rs.10,000. It
was held that on a reading of section 39 of the Insurance Act,
the only right which a nominee of an insurance policy has, is
the right to collect and receive the money, if he is alive at the
date of maturity and if the policy-holder is dead at that time. If
the policy-holder is alive when the policy matures, the nominee
has no right whatsoever and the amount assured by the policy
is payable to the policy-holder. No title to the policy money
passes in present or in future by nomination. Hence, the
assignment by the nominee of his right, title or interest in the
policy in favour of the bank is invalid. The bank would have
no cause of action against the Life Insurance Corporation until
the surrender of policy.
5) Risks in case of suicide
Originally a life policy became null and void on the insureds
committing suicide, or if he reached his death at the hands of
justice. Though in recent times restrictions of this kind have
been modified the banker still has to be very careful about the
wordings of the clause in the policy in this regard.
Redeeming features of life policies as security
Despite all the above mentioned drawbacks, life policies are
nevertheless accepted by bankers as collateral securities for
advances for the following reasons:
a) If the policy is that of a person of some standing, then with
the passage of time it increases in value as a result of bonus
additions and when it matures either on the expiration of
time period or the happening of a specified contingency
[as for examples the death of the insured] the full sum along
with the bonuses becomes immediately available.
Generally, this payment is more than sufficient to clear the
overdraft.
b) It is a liquid and convertible security, atleast to the extent
of the surrender value of the policy, and the banker can
always reserve for himself the right to surrender or
otherwise convert the policy into cash. The banker should
always take the precaution of obtaining such a security
especially in cases of loan granted to persons having a fixed
income terminable at death.
c) This security in general requires no supervision or
additional expenses as opposed to other kinds of securities
like produce, goods, stocks and shares.
Precautions to be taken by bankers
i) Status of insurance company
The banker should primarily satisfy himself as to the financial
status of the insurance company issuing the policy. This
precaution is not really necessary in the present day and age
due to the nationalisation of the insurance companies.
ii) Endowment policies favoured
As the name implies the assured sum becomes payable either
on the death of the insured person or the expiration of a fixed
number of years whichever is earlier. This type of policies are
favoured by the bankers because of them having a definite or
specified maturity date, and the banker need not wait till the
death of the assured to realise his money.
iii) Insurable interest necessary
A banker should satisfy himself that the person taking out the
policy does have an insurable interest in the subject matter of
the policy, else the policy would be void.
iv) Policy must be free from conditions restricting assignment
A banker should carefully scrutinize a policy to check whether
there are any restrictions on the assignment of that particular
policy because there are certain policies which cannot be
assigned, as for example, (a) policy assured under Married
Womens Property Act; (b) policy taken out for the express
purpose of payment of Estate Duty (this has to be assigned to
the President of India); (c) Childrens Deferred Assurance Policy
before its adoption by the life assured.
v) Extent of advance to be made
In a case where the insured person finds it difficult to continue
the premia payment in order to keep the policy alive, the bank
may continue to pay the premia on the surrender of their policy.
The amount so paid is known as the surrender value. Before
making such advance the banker is required to ascertain the
period for which the policy may be kept alive without either
the loss of the surrender value or liability for further premiums
being paid. In general the bankers should not advance more
than 85% of the surrender value of the policy, unless it is an
endowment policy with a comparatively shorter endowment
period.
vi) Admission of the age of the assured
The banker should check to see whether the insurance company
has admitted the age of the person on whose life the policy is
taken. If it is not admitted then he should take all efforts to get
it admitted, because otherwise on the death of the assured person
the banker may find it difficult to produce the necessary evidence
required for the purpose.
264
vii) Legal assignment of policy
It would be better from the bankers view point if the policy is
legally assigned to him, with a provision for reassignment on
the repayment of the loan and other charges. All the interested
parties should join in the assignment. For example, if the
husband takes out a policy in favour of or for the benefit of his
wife, then both should sign the assignment. Once the assignment
is complete a notice to that effect should be given to the
insurance company.
viii) When second charge created
In case the banker receives notice of a second charge on the life
policy deposited with him, he should make sure that the first
charge covers the entire amount of advance or overdraft, and if
it does not then he should ask for an additional security. In
such cases, once his own debt is paid off he should not reassign
the policy to the assured but should continue to hold it in trust
or reassign it in favour of the person holding the second charge.
4.3 BOOK DEBTS
A banker sometimes gives an advance to a customer on the
basis of assignment of debts either due or accruing due to the
latter. For example, the assignor-customer may be expecting
to receive money either for goods sold or services rendered, or
he may be due to receive money under a will. These debts
which are due to him the customer may assign to the banker
against the loan advanced to him. Generally speaking bankers
do not like to advance money against such book debts, because
these transactions are fraught with risk. Further, bankers are
put in the position of debt/money collectors. But where a banker
is satisfied both as to validity of the claim and the solvency and
bonafide intentions of the party, he may agree to give an advance
against such trade debts. In some cases, bankers accept an
assignment of moneys payable from a special fund, as for
example, a legacy under a will, or beneficial interest in a trust.
Sections 130-136 of the Transfer of Property Act deal with
assignment of actionable claims in India.
Form of Assignment - An assignment must be in writing and
signed by the assignor. There is no particular format to be
followed, only an intention on the part of the assignor to pass
on his interest to the assignee (i.e., the person in whose favour
the assignment is made) should clearly be manifested whatever
the words used, i.e., be it may in the form of an order or in the
form of a request it is immaterial.
Consideration not essential - An assignment may be by way
of gift or otherwise and no separate consideration is necessary
to support the assignment. Once the debtor pays off his debt to
a third party on a direction from his creditor, he is entitled to a
valid discharge irrespective of whether there was any
consideration as between the creditor and third party or not.
Notice of assignment to the debtor necessary - If the debtor
is to be made liable to the third party, then he should be given a
notice of the assignment. If he is not notified of the assignment,
then the third party cannot hold him liable if he pays off the
debt to the creditor. Any remedy which the third party seeks
can only be against the creditor and not the debtor. That means,
that a failure to give notice to the debtor in no way invalidates
the assignment itself, but the notice is important only to impose
a liability on the debtor.
Assignees rights subject to equity - An assignee subrogates
the assignor, i.e., he stands in the shoes of the assignor, and
therefore, can have no better rights than the assignor himself is
entitled to. As for example, if the debtor is entitled to a right of
set-off against the assignor, then he can avail himself of the
same right against the assignee. The assignee cannot refuse
him the right and can only seek the deficit amount from the
assignor. This right of the debtor exists regardless of the fact
whether the assignee knew or was aware of the existence of
such a right of set-off or counter-claim or not.
4.4 DEBENTURES
R.S.T. Chorley defines debenture as, debenture is the name
given to the document by which a limited company
acknowledges receipt of money which it promises to repay with
interest at a future date (usually fixed) and mortgages or charges
its assets as security for its borrowings. In general, debentures
like shares are issued only by incorporated bodies though an
unincorporated body is not as such restrained from issuing such
debentures.
Debentures acknowledge a debt owned by the company to the
holder, and also provide for the date on which it is to be paid
off, except when the debenture is an irredeemable one. It also
provides for payment of interest at the specified rate. In most
cases a debenture provides for a charge on the assets of the
company.
When a company issues a debenture it also makes a reference
to the resolution where such issue was authorised. A debenture
may be drawn either directly in favour of the bank or may be in
favour of a nominee of a bank who would then hold it in trust
for the bank. Sometimes a blank debenture may be issued in
which case it becomes payable to the bearer. A debenture may
be either for a fixed or ascertainable fund or it may be to secure
the balance of an account including any advances which may
be made in future. A debenture made for a fixed sum is much
more easily sold (i.e., it has more liquidity) as compared to a
debenture which is not made out for a fixed sum. Debentures
are generally payable on demand along with an interest either
at a fixed rate or a fluctuating rate with a minimum to be payable
quarterly or half-yearly.
As mentioned earlier, a debenture also incorporates the provision
creating a charge (either fixed or floating) on all or specified
assets of the company, and contains a further covenant to the
effect that it would not create any further mortgages or charges
on its undertakings, assets or property, which would either be
on par or rank in priority to the debentures. In Peoples Bank
of Northern India Ltd., Lahore v. Lucknow Sugar Works
Ltd. (in liquidation) [AIR 1936 Oudh 338], the appellant bank
claimed the usufruct of the property of the respondent, given as
265
security for debenture account on grounds that the security had
crystallized as soon as the respondent company went into
liquidation. It was held that the security of the appellant bank
as debenture holder was limited to property only whether it
was floating security or fixed security and did not extend to the
usufruct of the property.
Enforcement of Security
In case of a default in payment by the company, the bank has
the power to enforce the security by not only selling the
mortgaged property conferred on the trustee for the debenture
holder in respect of assets specifically mortgaged, but also by
appointing a receiver for the assets of the company. The latter
power is especially useful when the company is dissipating or
wasting its assets and an action has to be quickly taken by the
bank to protect its own interests.
4.5 HIRE-PURCHASE FINANCE
A banker is very often approached to finance what is known as
a hire-purchase agreement, in which the owner of the article/
movable property hires it to another known as the hirer on an
understanding that on the hirer paying the owner a specified
number of fixed installments, the property would be transferred
by the owner to the hirer who then becomes the owner of the
property. Mr. Maurice Lyall, Q.C. while speaking about the
kind of agreements observed the essential feature of that form
of contract is that although the trader undertakes to hire the
goods to the customer for a fixed term and to transfer the
property to him when all installments of hire rental have been
paid, the customer on his part does not bind himself to continue
the hiring for longer than he wishes and therefore undertakes
no obligation to buy the goods. He has only an option to do
so. Under the English Law the benefit of a hire-purchase
agreement can be assigned but the assignee gets the same title
as the hirer, i.e., he stands on the same footing as the hirer.
Even the Indian Law has sought to confer the right of assignment
on the hirer.
The owner of the property reserves to himself the right to take
back possession of the hired property in case the hirer fails to
pay the installments when they fall due or if he commits any
other default or breach of contract. This peculiar relationship
between the owner and hirer, coupled with the fact that the
hirer has no ownership in the property, makes it a risky
transaction to finance. Despite this drawback financing of hire-
purchase agreements has been quite popular with banks in both
U.K. and U.S.A., though the field is still a bit new in India, and
banks have restricted themselves to financing hire purchase
agreements relating to commercial vehicles. An interesting fact
to note is that State Bank of India Act was specially amended
to provide for hire purchase credit. The Hire-Purchase Act,
1972 governs the hire purchase transactions in India.
The procedure for financing such agreements is not uniform.
In India the banks either finance the dealer directly or through
financing intermediaries which are either finance agencies/
companies or firms. The hire purchase agreement is entered
into between the financier and the hirer and generally also a
guarantor. The dealer of the goods is paid off by the financier
who in turn is financed by the bank, generally against the
security of the agreement, or hypothecation of the article and
any other collateral as may be required. When the borrower is
a limited company there is no difficulty in securing the lenders
interests, but the difficulty in securing the lenders interests,
but the difficulty arises when the borrower is a firm because in
that case there is no legal necessity or compulsion for registration
of a charge over its assets. Some other difficulties which arise
in these agreements are: (i) the property remaining in possession
of the hirer and the claim of an innocent third party who has
bona fide acquired the article from him without notice of the
hire; and (ii) in case of insolvency the property vests in the
official assignee.
Precautions which may be taken by a bank
1. Bank should satisfy itself of the credit and standing of the
person taking the loan and as to the nature of the goods
hired.
2. As far as possible the advance should be for brand new
vehicles, and advances for second-hand goods should be
avoided.
3. The agreement between the financier and hirer should be
carefully scrutinized to find out if it incorporates some
clause which goes contrary to the banks interests.
4. The promissory notes (made by the hirer in favour of the
financier) duly endorsed in favour of the bank along with
the hire purchase agreement and an agreement
hypothecating the article to the bank must be deposited
with the bank.
5. A statement giving the particulars of the hired article and
in case of motor vehicles a letter addressed to the
Registering Authority asking him to register the vehicle in
the name of the financier or the bank, must also be obtained.
It is also advisable to obtain an indemnity policy from an
insurance company.
6. A notice that the article is hypothecated to the bank must
be sent in duplicate to the hirer,and his acknowledgement
obtained on one copy, and the copy must be preserved with
other loan documents.
7. Any default in payment of installments by the hirer must
be taken up immediately.
8. A periodic inspection of the hypothecated article must be
arranged to be carried out to see that the article is being
kept in good shape.
9. Advances should be allowed only after the cash down
installment (which is usually 20% of agreed price) has been
paid, and a reasonable margin on the total due amount
should be maintained.
10. According to the RBI guidelines to banks for financing of
leasing companies: a bank lending to leasing companies
should not exceed 3 times the net owned funds (NOF) of
leasing companies within the prescribed overall ceiling of
266
10 times of their external borrowings. Credit should be
granted by way of cash credit and drawings regulated within
the maximum permissible bank finance on the basis of
overall drawing power [Journal of the Indian Institute of
Bankers, April-June, 1988, page 13].
4.6 CONCLUSION
One has to remember that though the securities have been
divided into three specific categories of: direct, collateral and
miscellaneous, in actual banking transactions there can be no
such divisions. As for example, an equitable mortgage or
mortgage by deposit of title deed can be used as a direct security
though it has been dealt with under miscellaneous securities.
Similarly though guarantee has been dealt with under collateral
security, a banker may as well give the advance on the basis of
the guarantee thereby making it a direct security. Thus the
present categorization is based more on academic convenience,
rather than on any hard and fast rule being followed by the
bankers. Such hard and fast categorization cannot in all honesty
be really made also.
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5. CASE LAW
Margaret Lalita Samuel v. Indo Commercial Bank Ltd. [AIR
1979 SC 102]
An overdraft was given by the bank to the company, and the
director of the company executed a continuing guarantee for
the overdraft. The Supreme Court held that so long as the
account is a live account in the sense that it is not settled and
there is no refusal on the part of the guarantor-director to carry
out the obligation, the period of limitation does not commence
to run. Limitation would run only from the date of breach under
Article 115 of the Schedule to the Indian Limitation Act, 1908.
S.Perumal Reddiar v. Bank of Baroda [AIR 1981 Mad 180]
The blanks in the guarantee deed, in respect of the amount
guaranteed, rate of interest charged and the date of contract
were filled up without the suretys knowledge, i.e., after the
surety had signed the deed. The Court held that if the alteration
is to the disadvantage of surety or it is substantial, the surety
can claim to be discharged. The above alterations made in
respect of the material particulars were therefore held to be
substantial. The court observed: In a printed form of guarantee,
if the signature of the guarantor is obtained prior to the filling
up of blanks relating to material particulars of the contract, The
said filling up of blank spaces in the printed form of guarantee
amounts to material alteration and discharges the contract of
guarantee.
Vijay Kumar v. Jullunder Body Builder [AIR 1981 Delhi 126]
The decreeholder had obtained a decree against the Jullunder
Body Builders and at the execution stage the J.D. agreed to pay
the money in installments and they were required to furnish a
bank guarantee to the sum of Rs.90,000/- and the Syndicate
Bank with whom the J.D. had an overdraft account agreed to
issue the guarantee. They deposited two fixed deposits receipts
with a covering letter with the bank and requested it to issue a
guarantee in favour of the Registrar of the Delhi High Court.
This bank guarantee was later discharged by a Division Bench
as the decree holder did not accept the proposal for payment in
installments. Out of the two F.D.Rs, a sum of Rs.35,000/- was
attached in the hands of the bank. The bank as a garnishee
raised objections to the attachment on the ground that the bank
had a lien on the deposit receipts and that the amount does not
belong to the judgment debtor and cannot therefore be attached.
On 21.1.1980 when the attachment order was issued there was
a debit balance of Rs.1,17,365.95 in that account. The bank
claimed that they have a lien on the amount of Rs.90,000 of the
deposit receipts and they will exercise their right of set off when
the receipts mature against the balance of account. Reliance
was placed by the bank on the covering letter which the
judgment debtor wrote on 17th September, 1980, when they
requested the bank to issue a guarantee in favour of the Registrar
and the last para of the letter which entitled the bank to retain
the receipts, so long as any amount on any account is due to
the bank from us. The decree holder on the other hand relied
on the fixed deposit receipts where on the reverse words
appeared meaning thereby that the deposits receipts were being
held against the guarantee furnished by the bank and thus the
receipts were security which the judgment debtor have given
to the bank for issuing the bank guarantee. It was mentioned
on the back of the receipts lien to BG-11/80. This was the
arrangement in the light of which the letter had to be read and it
was a special contract for a special and exceptional transaction.
The Court held that the claim of the bank was inconsistent with
the terms of the special contract, and the terms of the contract
were inconsistent with the general lien that the bank claimed.
It would claim a particular lien for the bank guarantee but it has
no general lien.
Note: It is to be noted that bankers dont always have a general
lien, and the kind of lien a banker has will depend on the terms
of the securities which have been deposited.
Greenhalagh v. Union Bank of Manchester [(1924)2 KB 153]
A sold goodsto B, and A drew bills of exchange on B for the
price of those goods, and B accepted them. B sold the goods to
C, and in turn drew bills of exchange on C which were accepted
by him. B handed Cs bills to the defendant bank for collection
with directions that the proceeds should be utilised to meet the
bills which he had accepted, payable at the defendant bank.
The bank recognising the special purpose for which bills bearing
Cs acceptance were handed over for collection, opened a
separate account for them called the Provisional Bills Account.
The proceeds of bills accepted by C after collection were held
not to be subject to the bankers lien as they were entrusted for
a special purpose inconsistent with the lien.
Nadar Bank Ltd. v. Canara Bank Ltd. [AIR 1961 Mad 326].
The borrower pledged its godown to two banks with the first
bank the advance was termed as open cash credit and the
borrower was bound to submit periodical returns of the stock
to the bank. When they failed to do so, the banks clerk went to
inspect the godown, and found the doors locked with the locks
of another bank, from whom the borrower took the advances
under the key loan system. The question arose as to the
priority of the claim. The Court held that in order to constitute
a valid pledge it is essential that there must be a delivery of
goods either actual or constructive. Constructive delivery will
be adequate to constitute a pledge and it applies to all cases
where the pledger remains in possession of the goods under the
specific authority of the pledgee or for limited purposes. The
condition that prior consent of the pledgee was necessary for
the pledger to deal with the goods ensure the constructive
possession as well as the character of the pledge. There can be
no hard and fast rule that the delivery of the keys of the
warehouse is essential to ensure constructive possession. There
cannot also be any rigid delimitation of the purposes for which
the pledger is permitted to retain possession of the goods. The
essential test is not the purpose but whether the dominian over
the goods pledged is retained and the physical possession or
268
handling of the goods by the pledger is under the delegated
authority of the pledgee or is independent. Where the possession
of the pledgee is not lost and the possession may be manual or
constructive, a subsequent pledgee even without notice cannot
obtain any preference upon a rule of estoppel.
Gurco Pharma Pvt. Ltd. v. Syndicate Bank
[(1986)60 Comp Cas. 1055]
Certain medicinal goods and raw materials belonging to a
company, some having a validity period, were pledged by the
company with the bank. The pledge was a continuous process.
The bank kept insisting on payment of the debt, but the
Chairman of the company kept requesting the bank for extra
time, promising to pay the debt and releasing the material. In
the meantime, some of the drugs reached their expiry date. The
Chairman died, and the company went into winding up. The
goods were advertised for sale, but there were no takers in the
first instance. The Drug Controller later denied permission to
sell the goods, got a Court order and had the goods destroyed.
The company made an application under Section 446 of the
Companies Act, claiming compensation from the bank in
relation to the goods destroyed.
The Court held that the bank was not guilty of any negligence
in dealing with the goods pledged and the bank could not have
been said to have failed to take reasonable care of the goods.
The bank was under no obligation to dispose of the goods except
at the time of its choice and the duty to take reasonable care of
the goods did not extend to their disposal within the validity
period or within the period beyond which they might perish.
The pledgee, since he is in possession of the pledged property,
is liable for failure to take reasonable care of it if it is stolen
from him. He will be discharged if he can show that he took
ordinary care of it. Similarly he is excused where a thing is
perishable and it did in fact perish.
Bihar State Electricity Board v. Gaya Cotton and Jute Mills
Ltd. [AIR 1976 Pat 372]
The cotton mill had approached the State for a loan of
Rs.4,00,000 against the mortgage of certain properties. Later,
a preliminary decree was passed and liberty was sought for a
final decree within time. On behalf of the company it was
pleaded that no decree could be passed in view of the provisions
of SICA and the litigation was maintainable only against NTC
and not against the cotton company. It was also contended that
the only remedy available was by way of a claim before the
Commissioner. It was argued that since under Section 4(5), no
mortgage could be enforceable against a property vested in the
Central Government, the properties given a security could not
be followed and the state could not enforce its claim by a suit.
It was argued on behalf of the state that the company was
personally liable to pay the debt and its liability did not disappear
under the provisions of the Nationalization Act. It was observed
by the Court that: Whenever a loan is contracted and a
mortgage is executed, the mortgagor subjects the mortgaged
property to a liability of being sold for the realization of the
loan by the creditor, and at the same time, binds himself
personally for payment of loan. ...It follows, therefore, that
when a loan is advanced under a mortgage the creditor is clothed
with two rights, first, to enforce the personal liability and, the
second, to realise the money on the basis of the security. Both
these rights are different though under certain conditions one
suit may be brought to enforce both....The mortgagee was not
bound to sue for realization of his security in a suit to enforce
the personal covenant of the mortgagor as the two claims arose
out of distinct causes of action. The appeal was allowed with
cost.
Amulya Gopal Majumdar v. United Industrial Bank Ltd.
[AIR 1981 Cal 404]
An equitable mortgage was made by deposit of an agreement
for sale under which the mortgager entered into possession.
Sale in favour of the mortgager was completed shortly thereafter
and the mortgagor continued to overdraw from the mortgagee
bank. The Court held that the mortgage is rendered perfection
and from the date the mortgager acquired title to the property
by way of sale in his favour. It was observed that in order to
create a valid equitable mortgage, it is not necessary that the
whole or even the material of the documents of title to the
property should be deposited nor that the document deposited
should show a complete or good title; it is sufficient if the deed
deposited bona fide relate to the property or are material
evidence of title or are shown to have been deposited with the
intention of creating a security thereof.
269
6. PROBLEMS
1. A customer was given a cash credit facility by the bank on
open credit system. The goods hypothecated to the bank
were lost by the negligence of the bank. The surety claims
to be discharged due to this negligence of the bank which
has resulted in the loss of security. The bank contends that
Section 141 of Contract Act does not apply to hypothecation
and to the surety is not discharged. Decide [AIR 1983 P &
H 244]/
2. On the debtor companys going into liquidation, the bank
filed a suit against the company in liquidation and three
guarantors. The banks claim was admitted by the official
liquidator. The bank later decided to proceed against the
guarantors and not the company. The guarantor contend
that since the official liquidator had admitted the claim, the
bank could not proceed against the guarantors. Is this claim
valid ? Decide. [AIR 1983 Cal 335].
3. Certain movable property was pledged and mortgaged in
favour of the bank, though the possession of the goods was
left with the debtor-customer. A judgement-debtor of the
customer wants to attach this movable property and sell it
in order to satisfy his debt. The bank files a suit against the
attachment on the ground that they were secured creditors
and had a prior right over that property even if it was in the
possession of the debtor. Decide [AIR 1980 AP 1]
4. A has a cash credit account with the bank and has pledged
certain goods with the bank, to be stored by the bank in its
godown with the keys and control thereof with the bank.
The goods are found missing and A wants to hold the bank
liable for the loss. Decide [(1971)41 Comp. Cas. 557
(Bom)].
5. A received certain blank shares in transfer. On the death
of the transferor, A filled up the blanks in the share
certificate, including writing his name as the transferee and
submitted them to the company. The company contends
that it is an invalid transfer. Discuss the validity of this
contention [(1942)12 Comp. Cas. 206 (Cal)].
In the above problem, what would be the position if there
is a surety to the transaction who has given a guarantee on
assurance that the shares will be kept blank.
6. A bank advanced money to the borrower against the bills
of military and other authorities. The borrower gave an
irrevocable power of attorney in favour of the bank to
present and obtain payments of bills. The borrower
endorsed one bill in favour of the bank as please pay to
Bharat Bank Ltd., Jabalpur and handed the bill to military
authorities. But before the bank received payment one T
attached the amount due under the bill in execution of a
money decree against the borrower. Is this a valid
attachment ? Discuss [(1969)39 Comp. Cas. 114 (SC)].
7. A loan was given by the firm under a hire-purchase
agreement for purchase of vehicle. The borrower executed
a pronote in favour of the firm advancing the money, which
was assigned to the bank, but the loan covered by hire
purchase agreement was not so assigned. Does the bank
have a locus standi to bring a suit against the borrower on
the basis of collateral security of the pronote ? Discuss
[AIR 1983 Kar 233].
8. A mortgager mortgaged the property in favour of the bank
and deposited the partnership agreement, encumbrance
certificate, and registration extract of sale deed alongwith
a latter informing the bank that the original sale deed was
lost by the contractor. The bank failed to make relevant
enquiries. The contractor subsequently created an equitable
mortgage of the same property in favour of Mr.A and
delivered to him the original sale deed of property. Mr.A
was also informed of the subsisting prior equitable
mortgage. Decide whether Mr.A can have a valid claim
over the claims of the bank.
[Note: Please specify your name, I.D.No., and address while sending in your answer sheets].
270
1. Chatterjeee, A., Legal Aspects of Bank Lending, 1992, Skylark Publications, New Delhi.
2. Gupta, S.N., The Banking Law in Theory and Practice, 1992, Universal Book Traders, New Delhi.
3. Hapgood, Mark, Pagets Law of Banking, 1989, Butterworths, London.
4. Holden, J.M., The Law and Practice of Banking (Vol.2), 1991, ELBS with Pitman, London.
5. Kataria, S.K., Banking and Public Financial Institutions, 1990, Orient Law House, New Delhi.
6. Suneja, H.R., Practice and Law of Banking, 1990, Himalaya Publishing House, New Delhi.
7. Tannan, M.L., Tannans Banking Law and Practice in India, 1991, Orient Law House, New Delhi.
271
Banking Law
Course No: II
Module No: IX
Procedural Aspects
of Banking Law
Phone: 3211010 Fax: 080-3217858
272
Material prepared by:
1. Prof. P.M. Bakshi, Member Law Commission of India, and Director, Indian Law Institute
Material checked by:
1. Ms. Sudha Peri, M.A., LL.M.
Materials edited by;
1. Dr. N.L. Mitra, M.Com., LL.M., Ph.D.
2. Dr. P.C. Bedwa, LL.M., Ph.D.
3. Mr. V. Vijayakumar M.A., M.L., M.Phil.
Published By:
Post Bag No: 7201
273
INSTRUCTIONS
You must have noticed by now that the law of banking has vast procedural matters in it. In fact, in any legal
system, certain heurestic conditions are required to be fulfilled. These are, recognition of members of the
system, easy understandability of the rules, well laid down procedures to be followed, institutions required
for implementation, remedial courses and options available. Jurists divide law into substantive and procedural.
Substantive laws or rules are those which form the basic definition of any action as well as which give
remedies. As for example, what is a fraud or a material alteration? These definitions are given in the substantive
law. Procedural laws on the other hand provide detailed rules outlining how to move a court, how the court
has to deal with the matter and how the court has to come to a decision. In the British common law system,
the person who moves the court has the burden of proof; the proof must be behond doubt; until so proved
nobody is guilty; there has to be a privilege of cross-examination given to the defendant - all these make the
acquisatorial structure. In acquisatorial structure the 'procedural law' plays vital role in meeting justice. In
USA 'due process' is a basic need of justice, which may be said to be 'procedural justice'.
Similarly in India, 'procedure established by law' is equally important because life and liberty of a perosn
cannot be taken away without the 'procedure established by law'. In Banking, the procedure is equally
important. Banking litigations are civil in nature and therefore, these litigations are dealth with in Civil
Procedure Code. It is advisable that you refer to the Civil Procedure Code (CPC) in detail. But in this
module we have dealt with only those sections, orders and rules of CPC that are frequently needed in the
banking litigations.
It may also be noted that the status of documentary evidence is required to be carefully examined in a
banking litigation. In this connection, please note that there is a separate Evidence Act for banking litigations.
This Act was passed in 1891 and is known as Bankers' Books Evidence Act, 1891. In this Act the mode of
proof of entries in banker's book is provided. In this connection you have to also examine the evidentiary
value of entries in books of accounts of a bank as included in the Evidence Act.
In this connection it is also to be noted that debt recovery tribunals are now being constituted in order to quicken
the decision in banking litigations. We have to examine how far our conventional framework of banker-customer
relation can be reconciled with the tribunalised justice. In this module, therefore, we have to learn:
i) What is a money decree, how a money decree is executed?
ii) How can the bank accounts of a judgement-debtor be attached?
iii) In what situations can a Civil or a Criminal Court summon the bank account?
iv) What are the contents of Bankers' Books Evidence Act, 1891?
v) What is the evidentiary value of entries in books of accounts?
vi) How is the bank debt recovery tribunal to be constituted and how shall it function?
vii)What are the equitable remedies available including injunction and where?
While preparing the lesson you can prepare a checklist for yourself at every step. That shall help you at the
end to review your position.
If you have any problem either write to us or raise the issue in the contact programme.
N.L. Mitra
Course Co-ordinator
274
PROCEDURAL ASPECTS OF BANKING LAW
TOPICS
1. General Observations ........................................................................................................ 275
2. Attachment and Freezing of Bank Accounts .................................................................. 276
3. Summoning of Bank Accounts in Civil Cases ................................................................. 282
4. Summoning of Bank Accounts in Criminal Cases.......................................................... 283
5. Bankers' Books Evidence Act, 1891 ................................................................................. 284
6. Evidentiary Value of Entries in Accounts ....................................................................... 286
7. Bank Debts Recovery Tribunals ....................................................................................... 287
8. Bankers' Duty of Secrecy .................................................................................................. 290
9. The Mareva Injunction in English Law .......................................................................... 292
10. Case Law ........................................................................................................................... 293
11. Problems ............................................................................................................................ 295
12. Supplementary Readings ................................................................................................. 296
275
1. GENERAL OBSERVATIONS
SUB TOPICS
1.1 Introduction
1.2 Special rules when applicable to bankers
1.3 Areas of law covered
1.4 Execution of money decrees
1.1 INTRODUCTION
Banking and financial institutions may come into contact with
the law of procedure in one of the following four situations:
(a) The bank may be suing for the recovery of a debt due to it;
(b) The bank may be a defendant in a suit filed against it;
(c) The bank may be called upon to produce certain evidence
in court; and
(d) The bank may be a third party - i.e., it is not directly a party
in a suit or prosecution, but a customer of the bank may be
a judgment-debtor and amounts placed by him in the bank
may be sought to be utilised by the creditor (decre-holder)
through judicial processes.
1.2 SPECIAL RULES WHEN APPLICABLE TO
BANKERS
Where the banker is a plaintiff in a suit, it is also governed by
the same procedure that applies to other plaintiffs. It must show
that it has a cause of action, that its suit is within the limitation
period and that it is entitled to the relief prayed for. However,
attention should be drawn to the Recovery of Debts Due to
Banks and Financial Institutions Act, 1993, seeking to create a
special tribunal for the recovery of debt due to banks etc., where
the amount claimed is not less than Rs.10 lakhs (or such other
amount, being not less than Rs. one lakh, as the Central
Government may notify).
Besides this, all provisions of the Code of Civil Procedure, 1908
that are of special relevance to money suits are of importance
to banks. Most important of these provisions are Order 34 (suits
on mortgages) and Order 37 (summary suits).
Where a bank is a defendant in a suit, there are no special
procedural rules applicable to banks that require notice.
Where the bank is summoned to produce a document, the
Bankers Books Evidence Act comes into operation. It makes
certain special provisions as to such documents. These
supplement (or, in certain cases, override) the general provisions
contained in the two procedural codes.
Where the bank is neither a party nor a witness, it may still be
indirectly involved in the process of litigation, where a customer
having an account with the bank is a defendant or a judgment-
debtor and the question of attaching his money with the bank
arises. There are detailed provisions in the Code of Civil
Procedure, 1908 in this regard. Order 21, rule 46 and Order
21, rules 46A to 46G (newly inserted in 1976) are of particular
importance.
Bankers documents mostly consist of books of account. Section
34 of the Indian Evidence Act, 1872, contains a specific
provision as to admissibility and value of entries made therein.
During recent times, the Mareva injunction has become
popular in England. It has also some interest for bankers.
1.3 AREAS OF LAW COVERED
From the brief narration of the provisions of procedural laws
presented above, it will be evident that the areas that become
relevant comprises inter alia;
(a) the general law of procedure;
(b the general law of evidence;
(c) special enactments as to the forum;
(d special enactments as to evidence; and
(e) the English developments as to Mareva injunction.
All these topics will be discussed in the appropriate places. It
is not proposed to offer any treatment of the general law of
procedure or evidence as such.
1.4 EXECUTION OF MONEY DECREES
The procedure for execution of money decrees may briefly be
adverted to here. The principal modes of execution of such
decrees (in theory) are -
(a) arrest and detention of the judgment-debtor;
(b) attachment and sale, or sale of immovable property
of the judgment- debtor; and
(c) attachment and sale of judgment-debtor's movable
property.
Of the modes of execution mentioned above, arrest is very rarely
resorted to. With regard to immovable property, where a bank
is the creditor, normally it would have taken a mortgage in which
case the mortgaged property can be straight away sold in
execution without attachment.
It is attachment of movable property which assumes practical
significance for banks. There are two situations to be noted:
(i) Where the bank is the attaching creditor; and
(ii) Where the bank is a third party and money in an
account with the bank is to be attached.
The second situation needs detailed examination of the legal
position which will be attempted in due course in this discussion.
276
SUB TOPICS
2.1 Introduction
2.2 Tripartite nature
2.3 Honouring cheques
2.4 Procedural steps in garnishee proceedings
2.5 Order 21, rules 46A to 46G, C.P.C
2.6 Object of rules as to garnishment
2.7 Order of garnishment (O. 21, r. 46B)
2.8 Disputed Liability (O. 21, r. 46C)
2.9 Dispute as to quantum
2.10 Banks objection about title
2.11 Foreign balances
2.12 Uncleared cheques
2.13 Time of operation of attachment
2.14 Attaching creditors rights
2.15 Time for attachment of debt
2.16 Unlimited order
2.17 English Practice (Limited Order)
2.18 More than one account
2.19 Identifying the account
2.20 Transfer of amount
2.21 Debts due to third persons
2.22 Subsequent deposits
2.23 Overdraft
2.24 Floating charge
2.25 Contingent and future debts
2.26 Joint Judgment
2.27 Discretion of court
2.28 Form of notice of garnishment
2.29 Contents of notice and effect
2.30 Fixed deposits and bankers lien
2.31 Cheque, if attachable
2.32 Set off by the banker
2.1 INTRODUCTION
Some practical problems of banking are intimately connected
with procedural law, one example being attachment of money
lying in deposit or other account with a bank. The subject has
its own interest, partly because of the tripartite character of the
process, and partly because of the fact that several minute
questions of detail can arise. When a court order is served on a
bank attaching a customers money in the bank, the bank has
necessarily to suspend payment of cheques drawn by the
concerned customer.
Attachment of money in bank account is technically the
attachment of a debt. The reason is that in law, a banker is a
debtor of the account-holder. Attachment of a debt is generally
done by the issue of a garnishee order. The Code of Civil
Procedure, 1908, in Order 21, rule 46(1)(a), provides that a
debt (if not secured by a negotiable instrument) can be attached
by a written order prohibiting the creditor from recovering the
debt and prohibiting the debtor from making payment thereof
until further orders of the court. The garnishee proceedings have
been explained in 2.4.
2.2 TRIPARTITE NATURE
An order of attachment of money in bank account operates on,
or in favour of, three persons, namely, (1) the decree-holder at
whose instance the attachment takes place; (2) the judgment-
debtor whose account is attached; and (3) the banker, with whom
the judgment-debtor has an account. It is obvious that the
judgment-debtor at (2) above possesses a dual capacity. With
reference to the decree-holder, he is a debtor. But with reference
to the banker, he is a creditor and it is the banker who is the
debtor. The effect of the garnishee order (the attachment order)
is to capture the debt between the account-holder and the bank
and make it available for the benefit of the decree-holder.
2.3 HONOURING CHEQUES
Service of a garnishee order would have the effect of terminating
- or at least suspending - the banks duty to honour the cheques
of the account-holder. That is the very nature of the order,
which prohibits payment. In England, the point was
conclusively determined in the House of Lords. [Rogers v.
Whiteley (1892) A.C. 118, 121. HL]. The bank must not permit
any drawings from the attached balance; to do so would amount
to failure to comply with the order of the court. [Holdern, p
103] Books on banking often give the suggestion that the banker
should notify the account-holder of the situation, so that the
latter can open a new account for future transactions. Any credit
balance in the new account would not be subject to the garnishee
order passed earlier. Of course, there is nothing to prevent the
decree-holder from attaching the money in the new account
also, provided the amount of the debt due exceeds the amount
in the account already attached.
2.4 STAGES IN GARNISHEE PROCEEDINGS
Generally, for securing a garnishee order, the decree-holder
should swear an affidavit, stating the amount remianing unpaid
and adding that the garnishee is within the jurisdiction of the
court and indebted to the judgment - debtor. Besides this, where
the garnishee is a bank having more than one branch, the decree
holder should state the branch where the account is held. These
preliminaries are insisted upon in England by Order 49 of the
Rules of the Supreme Court. In India, they are implicit in the
decree-holders duty to identify the person against whom the
attachment is to operate. The Code of Civil Procedure, in India,
under Order 21, rules 46A to 46-I (as inserted in 1976) lays
2 ATTACHMENT AND FREEZING OF BANK ACCOUNTS
277
down a detailed procedure in several respects regarding the
hearing to be held on an application for attachment of a debt.
Where the decree-holder has sought attachment of a debt (money
in bank) the court issues an order nisi, attaching the account
and calling upon the bank to pay into the court the debt from
the bank to the account holder, or so much thereof as may be
sufficient to satisfy the decree and costs of execution. But the
bank is free to show cause why it should not do so. This
application is made ex parte. The judgment-
debtor or the banker is not notified before the order nisi
(provisional attachment). In fact, secrecy is usually essential,
as pointed out by a well known writer had. [Holden, p. 106]. If
the judgment-debtor learnt what was taking place, he might try
to ensure that the third person paid the amount of debt to him
prior to the service of the garnishee order. If the third person
was a bank, the judgment-debtor could easily withdraw his bank
balance and so prevent the decree-holder from serving an
effective garnishee order upon the bank. The (provisional) order
will immediately be served upon the garnishee. Until it is served,
any payment by the bank to the judgment debtor wil discharge
the banker. [Cooper v. Brayne, (1858) 27 LJ EX. 446].
If the banker does not show cause against confirming the
attachment, the order is made absolute. In this manner, the
decree-holder eventually obtains payment of the decretal debt
in whole or in part. If the bank disputes liability, the court can
try the issue and determine it and then pass appropriate orders.
If there is no such dispute, the bank must pay the amount of the
decree (passed against the account holder) and the costs into
court, failing which, execution can be issued against the bank
as though the decree had been passed against the bank.
2.5 ORDER 21, RULES 46A TO 46G OF CIVIL
PROCEDURE CODE
Provisions of the Code of Civil Procedure (CPC) as to
garnishment are of practical importance for banks. A look at
them in detail would be useful.
(a) Order 21, rule 46A of the Code provides that the court may,
in the case of a debt (other than a debt secured by a mortgage
or a charge), which has been attached under Order 21, rule
46, upon the application of the attaching creditor, issue
notice to the garnishee liable to pay such debt. The notice
calls upon him, either to pay into court the debt due from
him to the judgment-debtor or so much thereof as may be
sufficient to satisfy the decree and costs of execution, or to
appear and show cause why he should not do so.
(b) The application is to be made on an affidavit, verifying the
facts alleged and stating that in the belief of the deponent,
the garnishee is indebted to the judgment-debtor.
(c) Where the garnishee pays in the court the amount due
from him to the judgment-debtor (or so much thereof as is
sufficient to satisfy the decree and costs of the execution),
the court may direct that the amount may be paid to
the decree-holder towards satisfaction of the decree and
costs of the execution. The above provision came into the
CPC in 1976 and substantially implements the
recommendation of the Law Commission of India in the
54th Report, read with the 27th Report. Beofre 1976, certain
High Courts had made local amendments to provide for a
similar procedure.
2.6 OBJECT OF RULES AS TO GARNISHMENT
The object of the rules relating to garnishment is to render that
debt due by the debtor of the judgment-debtor available, in
execution, to the decree-holder. This avoids the need to file a
separate suit. It applies to a debt, which has been attached under
Order 21, rule 46 of CPC. The word may in the rule means
that the power is discretionary and the court may refuse to act
under this rule, if it is inequitable. If a debt attachable under
Order 21, rule 46 of CPC has not, in fact, been attached under
this rule, or if the debt is one which cannot be attached under
that rule, then garnishee proceedings cannot be taken, in respect
of the debt. Thus, garnishee proceedings cannot be taken in
respect of a debt due to a firm, in execution of a decree against
the partners in their individual capacity. [K.H.E. Supply Co.
Ltd v. LakshmiNarayan Sukhani 45 C.W.N. 333: AIR. 1941
Cal. 264]. The foundation of a garnishee proceeding is an
attachment under Order 21, rule 46, of CPC. [Imperial Bank
of India v. Bibi Sayeedan AIR, 1960 Pat. 132]. A decree-
holder can proceed against a garnishee, only where the
judgment-debtor has a present right to recover the debt from
his own judgment-debtor(i.e., the garnishee)
2.7 ORDER OF GARNISHMENT (O.21, R. 46B].
Order 21, rule 46B of the CPC provides that where the garnishee
does not forthwith pay into court the amount due from him to
the judgment-debtor (or so much thereof as is sufficient to satisfy
the decree) and the costs of execution, and does not appear and
show cause in response to the notice, the court may order the
garnishee to comply with the terms of such notice. Where such
order is passed, execution may issue as if such order were a
decree against the person notified.
As stated above, such an order is to be deemed to be a decree
against the garnishee and in favour of the creditor. Further
proceedings are taken in execution of that decree and against
the garnishee. [Lukka Verghese v. D. Varkey, AIR 1965 Ker.
47]. The power to make the order is discretionary and the order
may be refused on sufficient grounds, e.g. where the judgment-
debtors interest in the debt is not personal, but is in his capacity
as a trustee. [Robert v. Death, (1882) 8 Q.B.D. 819].
2.8 DISPUTED LIABILITY (O. 21, R. 46C).
Order 21, rule 46C of the CPC, 1908 deals with the dispute and
regarding liability, where the garnishee disputes his liability.
The court may order that any issue or question necessary for
the determination of his liability shall be tried as if it were an
issue in a suit, and upon the determination of such issue, shall
make such order or orders as it deems fit. But if the debt in
278
respect of which the application under rule 46A is made in
respect of a sum of money beyond the pecuniary jurisdiction of
the court, the court shall send the execution case to the court of
the District Judge to which the said court is subordinate. There
upon, the court of the District Judge or any other competent
court to which it may be transferred by the District Judge shall
deal with it in the same manner as if the case had been originally
instituted in that court.
The effect of such order is that if the garnishee disputes his
indebtedness to the judgment-debtor or alleges that the debt is
not an attachable debt, the court must order an issue to be raised
and tried. Even if there is a reasonable doubt, the matter should
be tried. [Employees Liability Corporation v. Sedgwick,
Collins Co., (1926) 42 TLR 749]. A summary order based on
the affidavit of the decree-holdere can be made only where the
garnishee does not dispute his liability or where the dispute
raised by him is flimsy.
But the garnishee must make out a prima facie case before he
can raise an issue. He must disclose facts from which a
reasonable inference may be drawn that there is a valid dispute
as to his alleged liability to the judgment-debtor. [M.
Mackenzie & Co. v. Anil Kumar, AIR 1975 Cal. 150].
2.9 DISPUTE AS TO QUANTUM
For attaching the debt, it is not necessary that the exact amount
be stated, provided there is a debt actually due at the time of
attachment. [Madho Das v. Ramji (1894) ILR 16 All.286]. If
the garnishee, while admitting the debt, disputes the amount,
the court may attach the debt and try the question of quantum
later. [Aldidas Kawerlal v. Hiriya Gowder, AIR 1961 Mad.
189].
2.10 BANKS OBJECTION ABOUT TITLE
(a) Sometimes a bank may raise an objection -
(i) that a third person owns the account; or
(ii) that a third person has a lien or charge on, or other
interest, in the account.
(b) In such a case, the court may order such third person to
appear and state the nature and particulars of his claim and
prove the same. After inquiry, the court can make
appropriate order. Payment made by the bank in obedience
to the courts order gives full protection to the bank under
Order 21, rules 46A to 46-I, CPC.
Where a bank account is in the joint names of two persons,
their shares are taken as equal, in the absence of any proof to
the contrary. [Balaramam v. Varaadammal, AIR 1987 Mad.
99].
(c) In England where a bank account is opened by a husband
in his wifes name, regard is to be had to the substance of
the matter, i.e., who controls the account. [Harrods Ltd.
v. Tester, (1987) 157 LT 7 (C.A)]. In India, account is to
be taken of the legislation relating to benami transactions.
In an English case, the husband and wife had a joint account
at a bank. A garnishee summons served on the bank named
the husband alone as judgment-debtor. The bank took the
view that the summons did not cover the joint account and
they could not dishonour cheques drawn on it. The Court
of Appeal (majority) upheld this view. [Hirschorn v.
Evans, Barclays Bank Ltd Garnishees, (1938) 2 K.B.
801]. But the Calcutta view recognises an inherent power
in such cases. [Upendra Mohan v. Malini Mohan, AIR
1937 Cal. 199].
(d) A garnishee order nisi naming two judgment-debtors will
attach a balance standing in the name of one of them [Miller
v. Mynn, (1859) 28 LJ QB 324]. The principle is that
attachment can be made only of a debt exclusively due to
the judgment-debtor [Macdonald v. Tacqueeh Gold
Mines, (1884) 13 Q.B.D. 535; Moideen Baldia Rowther
v. Sulaiman Saheb, AIR 1956 Mad. 163; Kaji Abdulla v
Abdul Latif, AIR 1920 Mad 403].
2.11 FOREIGN BALANCES
In England, Order 49, rule 1(1) R.S.C. uses the phrase within
the jurisdiction which is taken to be meaning is indebted
within the jurisdiction. Money held at a branch outside the
courts jurisdiction cannot therefore be attached. [Richardson
v. Richardson, (1927) Probate 328].
According to Indian decisions also, foreign balances cannot be
attached, because they do not constitute a debt recoverable
within the jurisdiction of the courts of the country.
[Padmanabha v. Bank of Kerala, AIR 1956 TC 100]. This
is because, in principle, attachment is only a mode of execution.
Of course, if the branch is within India, Indian courts have
jurisdiction to attach its account, even if the judgement-debtor
resides outside India. [British Transport Co. v. Surajbhan,
AIR 1963 All 313].
2.12 UNCLEARED CHEQUES
Can the proceeds of uncleared cheques, paid by the account
holder, be attached? The answer depends on whether the
account holder has the right to draw against the cheques before
they are cleared, a matter which depends on the express or
implied agreement between the bank and the account holder.
[Jones & Co. v. Coventry, (1909) 2 KB 1029, 1044; Holden,
p. 106 ]. An English case holds that uncleared cheques credited
by the bank as cash are not attached by a garnishee order, since
they do not yet represent money owed by the bank to its
customer. [Fern v. Bishop Burns and Lloyds Bank, Shelden
& Fidler, p. 43].
2.13 TIME OF OPERATION OF ATTACHMENT
In general, an attachment becomes operative when the court
order is served on the bank. From this, it follows that whatever
has already taken place before the attachment, remains valid.
Conversly, after the attachment, the bank cannot deal with the
attached amount - a consequence following from the express
provisions of section 64 of the CPC, 1908.
279
Thus, to illustrate the first aspect, if, before the attachment, the
judgment-debtor (account-holder) had created an equitable
charge, the attaching creditor must take it subject to the charge.
[Gopaldas v. Motichand, AIR, 1953 Sau.127;. Ladgir Nauji
v. Surendra Mohan, AIR 1938 Cal. 606]. If, before the
attachment, there already had been made an equitable
assignment, the attachment will confer no rights. [Mommu
Saheb v. Lakshmi Bai, AIR 1961 Mys. 196; Glegg v. Bromley,
(1912) 3 KB 474].
2.14 ATTACHING CREDITORS RIGHTS
The above propositions follow from the wider principle that a
person claiming under an attachment has no greater rights than
the debtor, with respect to the debt, and must take the debt
subject to all the equities which the garnishee might have against
the debtor. [Government of the United States of Travancore
- Cochin v. Bank of Cochin Ltd AIR 1954 TC 281].
2.15 TIME FOR ATTACHMENT OF DEBT
It is well settled that only a debt can be attached and that the
debt must have accrued. The court cannot make an order on
the garnishee (bank) before the debt has become payable. [Jetha
v. Durga Dutt, AIR 1927 Bom. 365]. If a debt does not become
payable until a contingency happens, then it is a contingent
debt and cannot be attached. [ShantiPrasad v. Director of
Enforcement, AIR 1962 SC 1764].
2.16 UNLIMITED ORDER
An unlimited order covers debts owing or accruing to the
account holder from the bank. [Holden, pp 101-102]. The
law is that when served with an unlimited garnishee order nisi,
a bank may, and should, refuse to pay any cheque drawn by the
account holder, even though it is known that the amount of the
judgment-debt is less than the customers credit balance. The
question arose in Rogers v. Whildey, [(1982) AC 118, 121,
122] wherein the creditor obtained a garnishee order nisi, which
ordered that all debts owing or accruing from the bank to the
customer be attached to answer the judgment recovered against
him. That order was served on the bank, and thereafter the
bank refused to honour any cheque drawn by the customer.
The House of Lords held that the bank had acted correctly. Lord
Walton said: The effect of an order attaching all debts owing
or accruing due by him to the judgment-debtor is to make the
garnishee custodian for the court of the whole funds attached,
and he cannot, except at his own peril, part with any of those
funds without the sanction of the court. To overcome such
hardships, the court can issue a limited order, to the effect that
all debts owing or accruing due from the above named
judgment-debtor not exceeding the sum of ........ to be attached.
2.17 ENGLISH PRACTICE (LIMITED ORDER)
The English banking practice on the subject has been stated
thus: If a banker is served with a `limited order and if the
amount attached is less than the customers credit balance, the
practice is to transfer from the customers account to a suspense
account a sum sufficient to satisfy the order. The balance
remaining on the customers account is at his disposal and the
relationship of banker and customer will continue. The customer
should be notified that a stated sum has been debited to his
account in compliance with the terms of the garnishee order.
[Holdern, p. 103].
2.18 MORE THAN ONE ACCOUNT
It is elementary that only that can be attached, which is due
from the bank to the account holder. This yields the rule that
the moneys that can be attached are those which are standing to
the customers credit at the moment of service of the garnishee
order nisi and for which he could sue. Hence, if a customer has
two accounts, of which, in one the customer has credit balance
while in the other, there is a overdraft, then the attachment has
to be confined to the excess of the credit balance over the
overdraft. If the overdraft is in excess of the credit balance,
nothing can be attached. This follows from the bankers right
of set off. However, the set off must be in respect of an actual,
immediate, recoverable debt due to the garnishee from the
judgment-debtor at the date of service of the garnishee order
nisi, i.e., a debt which, at that moment and without any
preliminaries, the garnishee could have sued for and recovered.
[Tapp v. Jones, (1875) LR 10 Q.B. 591].
2.19 IDENTIFYING THE ACCOUNT
If a garnishee order does not correctly designate the account to
be attached, the banker is entitled to ignore the order. In Koch
v. Mineral Ore Syndicate, [(1910) 54 SJ 600] the bank had no
account in the name designated on the garnishee order. The
bank reported this fact to the decree-holders solicitors, who
designated another account, adding that was the account of the
judgment-debtor and asked the bank to attach it. The bank
refused and continued to allow its customer to draw cheques
on his account. But the solicitors did not immediately seek
from the court an amended order. It was held that the bank was
not liable to the decree holder for having paid cheques out of
the account till the garnishee order was amended. Of course,
this does not entitle the bank to disobey an attachment order
merely on the ground of technicalities, such as spelling mistakes.
[Sheldon and Fiddler, p. 43].
2.20 TRANSFER OF AMOUNT
Where a bank has been asked by a constituent to transfer any
amount from his account to some other persons account, and
his account is attached by a garnishee order before the transfer
could be affected, the amount intended to be transferred would
also be hit by the garnishee order. [Rekstin v. Severo Sibirsko
Gosudarstevennoe Akcionernoe Obschestvne
Kamseverpurti (Bureau) and the Bank for Russian Trade
Ltd, (1933)1 K.B. 47]. When a bank denies its liability, the
denial must be factual, unambiguous and bona fide in order to
280
prevail against the income tax authorities who have issued the
garnishee order in question. If any valid objections are raised,
falling within the scope of the garnishee order, the only way
open to the revenue authorities, who issued the order is to have
the dispute adjudicated upon by a competent court of original
civil jurisdiction. [Sahukar Bank Ltd. v. ITO., (1966) 62
ITR 745 (Punj)].
2.21 DEBTS DUE TO THIRD PARTIES
Where a garnishee order is served by the Income Tax Officer
upon a bank in respect of deposits of a deceased tax payer,
amounts lying to the credit of the daughter-in-law of the
deceased tax payer cannot be attached, except as regards assets
received by her from the deceased tax payer. [Maina Devi
Goenka v. Union of India, (1978) 115 ITR 423 (Cal.)]
2.22 SUBSEQUENT DEPOSITS
A garnishee order may not be operative in respect of deposits
in the bank made subsequent to the service of the order.
[Hoppenstall v. Jackson Barclays Bank Ltd., (1939) 2 All
E.R. 10]. Such deposits do not constitute debts due
from the bank at the time of the order.
2.23 OVERDRAFT
The income-tax authorities cannot freeze an over-draft account
or order the bank to pay them the difference between the limit
of overdraft allowed and the amount over-drawn. An unutilised
overdraft account does not render the banker a debtor in any
sense. [K.M. Adam v. ITO, (1958) 33 ITR 26 (Mad);
Joachimson v. Swiss Bank Corporation, (1921) 2 KB 110].
2.24 FLOATING CHARGE
When proceeds of goods are under a banks floating charge,
garnishee proceedings are not possible for the recovery of the
assessees dues from the purchaser. [Jay Engineering Works
Ltd. v. Syndicate Bank Ltd., (1981) Tax L.R. (NOC) 173
(Cal.)].
2.25 CONTINGENT AND FUTURE DEBTS
If the money is payable to the judgment-debtor only on a certain
contingency, then the decree-holder would be subject to the
same disability as his judgment-debtor, and has to wait till the
happening of that contingency. [Shanti Prasad v.Director of
Enforcement, AIR 1962 SC 1764; K.J. Jung v. Mohd. Ali,
AIR 1972 A.P 70]. The principle is that there must be money
due to the judgment-debtor. Thus, if a builder is paid only on
the certificate of the architect, then the amount does not become
due to the builder until the certificate is obtained. [Dunlop &
Ranken Ltd. v. Hendall Steel Structures Ltd. (1957) 1 All
ER 347]. A mere cause of action (which has not ripened into a
debt) cannot be attached. [Johnson v. Diamond, (1855) 24 LJ
Exch. 217, 219 (Baron Parke)]. It follows that if a debt has
been already assigned by the judgment-debtor, it cannot be
attached. [Wise v. Birkenshaw, (1860) 29 LJ Exch. 240;
Curran v. Newpark Cinemas, (1951) 1 All E.R. 295(CA);
Holt v. Heatherfield, (1942) 2 K.B. 1].
There is, however, a distinction between (i) the case where
there is an existing debt, though its payment is deferred, and
(ii) the case where both the debt and its payment rest in the
future. In the former case, the debt is attachable. In the latter
case, it is not. [ODriscoll v. Manchester Insurance
Committee, (1915) 13 KB 497, 516]. The fact that the amount
of the debt due or accruing is not ascertained, does not prevent
a garnishee order nisi from being made. [De Pass v. Capital
and Industrial Corp., (1891) 1 Q.B. 216].
2.26 JOINT JUDGMENT
If there is a joint judgment against two or more persons, the
decree-holder can attach a debt owing to any of those judgment-
debtors. [Miller v. Myhn, (1859) 28 L.J. Q.B. 324].
2.27 DISCRETION OF COURT
The making of a garnishment order is the discretion of the
court. [Rainbow v. Moorgate Properties Ltd., (1975) 1 WLR
788 (C.A)]. The order may be refused (for example), if the
garnishee would still remain liable in a foreign court. [Martin
v. Nadel, (1906) 2 K.B. 26 (C.A)]. The order is basically an
equitable remedy. [Prichard v. Westminster Bank, (1969) 1
All E.R 999(C.A)].
2.28 FORM OF NOTICE OF GARNISHMENT
Questions have arisen as to the form of the notice required for
garnishment. In a case from Kerala, the garnishee appeared in
court, in response to the letter and filed a counter-affidavit. It
was held that the same could be treated as objections
contemplated by Order 21, rule 46C of the CPC, 1908, even
though a formal notice under Order 21, rule 46A had not been
issued. Hence, the court has a duty under Order 21, rule 46C to
direct that the disputed question be tried as an issue and to decide
the issue. [Executive Engineer, K.S.E. Board, v. I.H. Sharma,
AIR 1988 Ker. 285].
2.29 CONTENTS OF NOTICE AND EFFECT
In a case from Kerala, a money decree was obtained on the
basis of a compromise. At the instance of the decree-holder,
attachment before judgment was affected of a certain sum of
money, said to be belonging to the judgment-debtor in the hands
of the appellant garnishee, by way of a prohibitory order. The
executing court did not, at any stage, issue any notice under
Order 21, rule 46A, CPC to the garnishee. Only a letter was
directed by the court to be written, requesting the garnishee to
remit the amount. The letter did not contain any of the
particulars which are required to be stated in the summons or
notice. It was held that the letter would not attract order 38,
rule 5, CPC. [Executive Engineer, K.S.E. Board v. J.H.
Sharma, AIR 1988 Ker. 285].
281
Service of notice to show cause against the attachment of a
debt does not transfer to the attaching creditor property in the
debt. But if, after receiving the notice, the garnishee pays the
debt to the judgment-debtor, he may have to pay it again to the
attaching creditor. [Galbraith v. Grimshaw and Baxter,
(1910) 1 K.B. 339 (C.A), affirmed (1910) A.C. 508].
2.30 FIXED DEPOSITS AND BANKERS LIEN
The bank is a debtor, in respect of the money in fixed deposit.
It has no right to press into service the doctrine of bankers
lien and to retain the money in fixed deposit. There is no
question of the bank exercising the 'lien for the purpose of
retaining the money in fixed deposit, according to the Kerala
High Court. [Union Bank of India v. K.V. Venugopalan, AIR
1990 Ker 223 (AIR 1956 Mad 570 and AIR 1965 Mad 226
followed)]. The view of Punjab High Court is to the contrary.
[Punjab National Bank v. Satyapal Virmani, AIR 1956 Punj,
118].
According to the view of Kerala High Court, money lodged
with banks as fixed deposits is a loan to the bank. The banker,
in connection with the fixed deposit, is a debtor. Accordingly,
the depositor would cease to be the owner
of the money in fixed deposit. The said money becomes the
money of the bank, enabling the bank to do as it likes, subject
however, to banker's obligations to repay the debt on maturity.
Money in fixed deposit, therefore, constitutes a debt against
the banker and a debt cannot be a suitable subject for a 'lien',
because a lien is a right recognised in a creditor to retain another
mans property until the debt is paid. A 'lien postulates the
property of the debtor in the possession or under the control of
the creditor. A creditor enjoying the 'lien however, has no
right to sell the thing or dispose it of. In other words, he is only
entitled to retain possession.
Section 171 of the Contract Act entitles a banker (in the absence
of contract to the contrary) to retain as security for a general
balance of account any goods bailed to him. To attract this
provision, a bank should establish that it is a bailee within
the meaning of Section 148 of the Act. There will not be a
bailment, if the thing delivered is not to be specifically returned
or accounted for. Hence a transaction evidenced by a fixed
deposit would not constitute a bailment. [Union Bank of India
v. K.V. Venugopalan, AIR 1990 Ker. 223; Presswork &
Assemblies Ltd v. Westminister Bank Ltd., (!971 1 Q.B. 1:
(1970) 3 W.L.R. 625: (1970) 3 All E.R. 473]. This English
case has discussed in detail, the nature of the transaction of
fixed deposit.
2.31 CHEQUE, IF ATTACHABLE
A cheque cannot be attached under the provisions of the CPC
relating to 'debts'. It is a negotiable instrument for which the
proper provision is Order 21, rule 51, C.P.C. [Central Bank of
India v. Rao, AIR 1949 Cal. 144]. The position is different if
payment of the cheque is countermanded before its presentation.
[Cohen v. Hale, (1878) 3 A.B.D. 871].
2.32 SET OFF BY THE BANKER
(a) Banker has the right to set off one account against another.
[United Bank of India v. Venugopaln, AIR 1990 Ker. 223,
225. Compare Satya v. Venkata, AIR 1937 Mad. 848; T.
Yabealli v Atmaram, ILR 38 Bom. 631].
(b) Set off cannot be claimed in respect of an amount becoming
due to the bank after the attachment. [Sankaran Nair v.
Krishna Pillai, AIR 1962 Ker. 233].
282
SUB TOPICS
3.1 Documents of the plaintiff
3.2 Documents relied on by a party
3.1 DOCUMENTS OF THE PLAINTIFF
The general rule laid down in Order 7, rule 17(1), CPC is that
where a document on which the plaintiff sues is an entry in a
shop book or other account in his possession or power, the
plaintiff shall produce the book or account at the time of filing
the plaint, together with a copy of the entry on which he relies.
Thereafter, as provided in Order 7, rule 17(2), the court (or
such officer as it appoints in this behalf) shall forthwith mark
the document for the purpose of identification; and after
examining and comparing the copy with the original shall, if
the copy is found correct, certify it to be so and return the book
to the plaintiff and cause the copy to be filed.
However, Order 7, rule 17(1) makes an exception for bankers'
books. Its opening words are - Save in so far as otherwise
provided by the Bankers Books, is it necessary Evidence Act,
1891". It may be mentioned that the Act of 1891 permits
certified copies of bankers books to be given in evidence
3.2 DOCUMENTS RELIED ON BY A PARTY
With regard to documents relied on by a party(not being a
document sued upon by the plaintiff), Order 13, rule 5(1) of the
Code of Civil Procedure, 1908 provides that where a document
admitted in evidence in the suit is an entry in a letter book or a
shop book or other account in current use, the party on whose
behalf the book or account is produced may furnish a copy of
the entry.
Order 13, rule 5(2) empowers the court to require a person other
than a party to furnish a copy of a record book or account
produced by him; in certain cases. Where a copy is produced
under the above provisions, then the court shall compare the
same and return the original, following the procedure laid down
in Order 7, rule 17. But here again, an exception is made for
bankers books.
3. SUMMONING OF BANK ACCOUNTS IN CIVIL CASES
283
SUB TOPICS
4.1 Provisions in the Code of Criminal Procedure, 1973.
4.2 Savings for Act of 1891 (Bankers Books)
4.1 PROVISIONS IN THE CODE OF CRIMINAL
PROCEDURE, 1973
In criminal proceedings, the power of the court to issue
summons to produce a document or other thing is governed by
Section 91 of the Code of Criminal Procedure, 1973. Sub-
section (1) of that section gives power to the court (or
an officer in charge of a police station) for the specified purpose.
When the court or the officer mentioned above considers that
the production of any document or other thing is necessary or
desirable for the purposes of any investigation, inquiry, trial or
other proceedings under this code by or before such court or
officer, such court may issue summons, or such officer a written
order, to the person in whose possession or power such
document or thing is believed to be, requiring him to attend
and produce it, or to produce it, at the time and place stated in
the summons or order.
4.2 SAVINGS FOR ACT OF 1891 (BANKERS' BOOKS)
But section 91(3) (a) of the Code provides that nothing in the
section shall be deemed to affect the Bankers Books Evidence
Act, 1891. It follows, that the provisions of the Code of Criminal
Procedure, section 91, have to be read as subject to the special
provisions relating to Bankers Books as contained in the Act
of 1891. In particular, notice has to be taken of section 6 of the
Act of 1891, even though it does not seem to include
investigation. Ordinarily, a criminal court should not summon
the original books to which the Act of 1891 applies. The main
object of the Act of 1891 is to avoid disturbance of the business
of banking and inconvenience to the large number of customers
who have to transact business with banks.
4. SUMMONING OF BANK ACCOUNTS IN CRIMINAL CASES
284
SUB TOPICS
5.1 The Act
5.2 Definitions
5.3 Power to extend provisions of the Act (Section 3)
5.4 Mode of proof of entries in bankers books (Section 4)
5.5 Officer of bank when not compellable to produce books
(Section 5)
5.6 Inspection of books by order of Court or Judge (Section 6)
5.1 THE ACT
The Bankers' Books Evidence Act, 1891, in certain respect
modifies, and in a few other respects supplements, the provisions
of the general law of evidence. Most notably, it permits certified
copies of certain books of bankers to be given in evidence
without summoning the original.
5.2 DEFINITIONS
The following definitions given in section 2 of the Act are
important:
(1) company means any company as defined in section 3 of
the Companies Act, 1956, and includes a foreign company
within the meaning of section 591 of that Act;
(1A) corporation means any body corporate established by
any law for the time being in force in India and includes the
Reserve Bank of India, the State Bank of India and any
subsidiary bank as defined in the State Bank of India (Subsidiary
Banks) Act, 1959;
(2) bank and banker mean -
(a) any company or corporation carrying on the business of
banking;
(b) any partnership or individual to whose books the provisions
of this Act shall have been extended as hereinafter provided;
(3) bankers books include ledgers, day-books, cash-books,
account-books and all other books used in the ordinary business
of a bank;
(4) 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 by any other person (not being a magistrate)
authorised in this behalf by a magistrate or by any law for
the time being in force; and
(5) certified copy means a copy of any entry in the books of
a bank together with a certificate written at the foot of such
copy that it is a true copy of such entry; that such entry is
contained in one of the ordinary books of the bank and was
made in the usual and ordinary course of business; and that
such book is still in the custody of the bank; and where the
copy was obtained by a mechanical or other process which in
itself ensured the accuracy of the copy, a further certificate to
the effect, but where the book from which such copy was
prepared has been destroyed in the usual course of the banks
business after the date on which the copy had been so prepared,
a further certificate to the effect, each such certificate being
dated and subscribed by the principal accountant or manager
of the bank with his name and official title.
5.3 POWER TO EXTEND PROVISIONS OF THE ACT
Section 3 of the Act empowers the State Government to extend
the provisions of the Act to the books of any partnership (firm)
or individual carrying on the business of bankers within the
State. The partnership firm must be keeping a set of not less
than three ordinary account-books, namely, a cash-book, a
day-book or journal and a ledger. The Government may in like
manner rescind any such notification.
5.4 PROOF OF ENTRIES IN BANKERS BOOKS
Section 4 of the Act (the operative portion) lays down that 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, and shall be admitted as evidence of
the matters, transactions, and accounts therein recorded in every
case where, and to the same extent as, the original entry itself
is, now by law, admissible, but not further or otherwise.
This section thus permits certified copies to be given in evidence.
Whatever fact can be proved by the original, can be proved by
the certified copy.
5.5 OFFICER OF BANK WHEN NOT COMPELLABLE
TO PRODUCE BOOKS
It is provided in section 5 of the Act that no officer of a bank
shall, in any legal proceeding to which the bank is not a party,
be compellable to produce any bankers book, the contents of
which can be proved under this Act (see section 3 noted above)
or to appear as a witness to prove the matters, transactions, and
accounts therein recorded, unless by order of the court or by a
judge made for special cause.
This section, in effect, dispenses with the original being required
to be produced in court. It goes further than Section 4. Section
4 permits certified copies to be given in evidence. Section 5, in
effect, compels all concerned to make use of section 4 except
where the Court or Judge directs otherwise for special cause.
5.6 INSPECTION OF BOOKS BY ORDER OF COURT
OR JUDGE
Section 6 of the Act provides that on the application of any
party to a legal proceeding, the Court or a Judge may order that
5. BANKERS' BOOKS EVIDENCE ACT,1891
285
such party be at liberty to inspect and take copies of any entries
in a bankers book for any of the purposes of such proceeding,
or may order the bank to prepare and produce, within a time to
be 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, and such further certificate shall be dated and
subscribed in manner herein before directed in reference to
certified copies.
It is further provided that an order under section 6 or section 5
may be made either with or without summoning the bank. The
order must be served on the bank three clear days (exclusive of
bank holidays) before the same is to be obeyed, unless the court
or Judge directs otherwise.
The bank may, at any time before the time limited for obedience
to any such order as aforesaid, either offer to produce their books
at the trial, or give notice of their intention to show cause against
such order, and thereupon the same shall not be enforced without
further order.
286
SUB TOPICS
6.1 Indian Evidence Act, 1872
6.2 Use of Ledger
6.3 Form of Ledger
6.4 Proof
6.1 INDIAN EVIDENCE ACT, 1872
Regarding entries in books of account regularly kept in the
course of business, section 34, Indian Evidence Act, 1872
provides that such entries are relevant evidence, but they shall
not be sufficient to charge any person with liability. Thus, no
liability can be fastened merely on the basis of an entry in the
ledger alone, unless it is corroborated by some other evidence.
6.2 USE OF LEDGER
The effect of section 34, of the Act is that the ledger can be
taken into consideration, but would need corroboration for
establishing liability. This is one of the very few examples of
provisions in the Evidence Act as to the sufficiency of evidence.
6.3 FORM OF LEDGER
In order that section 34, of the Act may be invoked, no particular
form of ledger is required. But the ledger must be one kept in
the ordinary course of business. Hence evidence of business
usage would be very material.
6.4 PROOF
If the entries made in a ledger are denied by the defendant,
corroboration would be required. The nature of proof will vary
from case to case. [Mohan Lal Bodh Raj v. Dwarka Nath,
AIR 1985 J&K 85, 86, 87].
6. EVIDENTIARY VALUE OF ENTRIES IN ACCOUNTS
287
SUB TOPICS
7.1 Introduction
7.2 Application
7.3 Tribunals and their Presiding Officers
7.4 Recovery Officers and Staff
7.5 Appellate Tribunal
7.6 Jurisdiction
7.7 Appeals
7.8 Procedure
7.9 Appearance
7.10 Recovery Procedure
7.11 Adoption of Income Tax Act
7.12 Appeals in Recovery Cases
7.13 Miscellaneous Provisions
7.1 INTRODUCTION
Banks and financial institutions experienced considerable
difficulties in recovering loans and in the enforcement of
security charged with them. The procedure for recovery of
debts due to the banks and financial insitutions had blocked a
significant portion of their funds in unproductive assets, the
value of which deteriorated with the passage of time. The
Committee on the Financial System, headed by Shri. M.
Narasimham, considered the setting up of the special tribunals
with special powers for the adjudication of such matters and
speedy recovery as critical to the successful implementation of
the financial sector reforms. An urgent need was, therefore,
felt to work out a suitable mechanism, through which the
amounts due to the banks and financial institutions could be
realised without delay. In 1981, a Committee under the
Chairmanship of Shri. T.Tiwari had examined the legal and other
difficulties faced by banks and financial institutions and had
suggested remedial measures, including changes in law. The
Tiwari Committee had also suggested the setting up of special
tribunals for the recovery of dues of banks and financial
institutions, by adopting a summary procedure. On 30th
September, 1990 more than fifteen lakhs of cases filed by the
public sector banks, and about 304 cases filed by the financial
institutions, were pending before various courts. These involved
debts of more than Rs.5622 crores in dues of public sector
banks and about Rs.391 crores of dues of the financial
institutions. The locking up of such a huge amount of public
money in litigation prevented the proper utilisation and re-
cycling of the funds for the development of the country. It was
this background which led to the introduction of the 'Recovery
of Debts due to Banks and Financial Institutions Bill 1993'.
Subsequently it has become an Act. (Central Act 51 of 1993).
The Act provides for the establishment of Tribunals and
Appellate Tribunals for the expeditious adjudication and
recovery of debts due to banks and financial institutions. Some
of the important provisions of the Act are given below.
7.2 APPLICATION
Section 1 of the Act provides that the Act applies where the
amount of any debt due to any bank or financial institution or
consortium is not less than Rs.10 lakhs. But the Central
Government can susbstitute, in place of Rs.10 lakhs, any other
amount not being less than Rs.1 lakh.
Section 2 of the Act defines various expressions used in the
Act.
7.3 TRIBUNALS AND THEIR PRESIDING OFFICERS
Under section 3, the Central Government can establish one or
more Debts Recovery Tribunals for adjudicating on disputes to
which the Act applies and can determine the respective
jurisdiction of the Tribunals so established.
Presiding officers of the Tribunals are to be appointed (under
section 4) by the Central Government. Their qualifications are
laid down in section 5. The presiding officer must be a person
who is, or has been, or is qualified to be, a District Judge. Under
section 6, his term of office is five years or until he attains the
age of 60 years, whichever is earlier.
7.4 RECOVERY OFFICERS AND STAFF
For each Tribunal, Recovery Officers and other officers and
employees are to be appointed by the Central Government under
section 7.
7.5 APPELLATE TRIBUNALS
Sections 8 to 16 make provisions for the appointment of Debt
Recovery Appellate Tribunals. The person to be appointed as
presiding officer of the Appellate Tribunal must be:
(a) a person who is, or has been, or is qualified to be a High
Court Judge; or
(b) a member of the Indian Legal Service, who has held a Grade
I post in that service for, or at least three years; or
(c) a person who has held office as a presiding officer of a
Tribunal (established under the Act) for at least 3 years.
Section 11 provides that the Presiding Officer of an Appellate
Tribunal shall hold office for a term of five years or until he
attains the age of sixty-two years, whichever is earlier.
Section 12 makes provisions for the appointment of officers
and other employees of an Appellate Tribunal and seeks to apply
the provisions of section 7 in relation to such appointments.
Section 13 empowers the Central Government to make rules
relating to the salary and allowances payable to, and the other
terms and conditions of service (including pension, gratuity and
other retirement benefits) of the Presiding Officers of Tribunals
or Appellate Tribunals. It further provides that the salary and
allowances and the other terms and conditions of service of the
Presiding Officers shall not be varied to their disadvantage after
appointment.
7. BANK DEBTS RECOVERY TRIBUNALS
288
Section 14 provides for filling up of vacancies in the office of
the Presiding Officer of a Tribunal or an Appellate Tribunal.
In such cases the proceedings may be continued before the
Tribunal or Appellate Tribunal from the stage at which the
vacancy is filled.
Section 15 makes provisions for resignation by the Presiding
Officer of a Tribunal or an Appellate Tribunal and for his
removal.
Section 16 provides that no order of the Central Government
appointing any person as the Presiding Officer of a Tribunal or
an Appellate Tribunal shall be called in question and that no
act or proceeding before a Tribunal or an Appellate Tribunal
shall be called in question on the ground merely of any defect
in the constitution of a Tribunal or an Appellate Tribunal.
7.6 JURISDICTION
Section 17 makes provisions relating to the jurisdiction, powers
and authority of a Tribunal and an Appellate Tribunal.
Section 18 provides that subject to the jurisdiction of the
Supreme Court and of a High Court under Articles 226 and
227 of the Constitution, no court or other authority shall have,
or shall be entitled to exercise any jurisdiction, power or
authority in relation to the matters specified in section 17.
Section 19(1) prescribes the procedure for the filing of an
application before a Tribunal within the local limits of whose
jurisdiction (a) the defendants, or each of the defendants (where
there are more than one), at the time of making the application
actually and voluntarily resides, or carries on business, or
personally works for gain; or (b) any of the defendants (where
there are more than one), at the time of making the application,
actually and voluntarily resides or carries on business, or
personally works for gain; or (c) the cause of action arises wholly
or in part. Section 19(2) empowers the Central Government to
make rules for prescribing the form in which the application
should be made and the documents which should accompany
the application and the fee for filing the application. The fee
may be prescribed, having regard to the amount of debt to be
recovered. Sub-sections (3) to (8) of section 19 lay down, the
procedure for disposal of the application by the Tribunal.
7.7 APPEALS
Section 20 prescribes the procedure for preferring an appeal to
the Appellate Tribunal having jurisdiction in the matter against
any order made, or deemed to have been made, by a Tribunal.
No appeal should lie to the Appellate Tribunal from an order
made by a Tribunal with the consent of the parties. Sub-section
(3) of section 20 empowers the Central Government to make
rules for prescribing the form in which the appeal shall be
preferred and the fee for preferring the appeal. Sub-sections
(4) to (6) of section 20 specify the procedure for the disposal of
the appeal by the Appellate Tribunal.
Section 21 provides that no appeal shall be entertained by the
Appellate Tribunal, unless the appellant has desposited with
the Appellate Tribunal 75% of the amount of the debt due from
him as determined by the Tribunal under section 19. The
Appellate Tribunal may, however, for reasons to be recorded in
writing, waive or reduce the amount to be deposited under this
clause.
7.8 PROCEDURE
Section 22 prescribes the procedure to be followed by the
Tribunals and Appellate Tribunals in respect of applications
made to them or appeals preferred to them. The Tribunals and
Appellate Tribunals shall be guided by the principles of natural
justice and shall have powers to regulate their own procedure
including the places at which they shall have their sittings. The
Tribunals and the Appellate Tribunals will have all the powers
of a civil court in respect of summoning and enforcing the
attendance of any person and examining him on oath, discovery
and production of documents, reviewing its decisions, etc. The
Tribunals and Appellate Tribunals will be deemed to be civil
courts for the purposes of section 195 and Chapter XXVI of
the Code of Criminal Procedure, 1973 and every proceeding
before the Tribunals and Appellate Tribunals shall be deemed
to be a judicial proceeding under certain provisions of the Indian
Penal Code.
7.9 APPEARANCE
Section 23 provides that a bank or a financial institution may
authorise one or more legal practitioners or any of its officers
to act as Presenting Officers before the Tribunals or Appellate
Tribunals. It further provides that the defendant may either
appear in person or authorise one or more legal practitioners or
any of his or its officers to present the case before the Tribunals
or the Appellate Tribunals.
Section 24 applies the provisions of the Limitation Act, 1963
to applications made to a Tribunal.
7.10 RECOVERY PROCEDURE
Section 25 empowers the Recovery Officer to effect recovery
of debts through the modes of attachment and sale of movable
or immovable property, arrest of the defendant and his detention
in prison or appointment of a receiver for the management of
the movable or immovable properties of the defendant.
Section 26 provides that the defendant cannot dispute, before
the Recovery Officer, the amount of debt specified in the
certificate issued by the Tribunal. The Presiding Officer shall,
however, have power to withdraw the certificate or correct any
clerical or arithmetical mistake in the certificate by sending an
intimation to the Recovery Officer.
Section 27 provides that the Presiding Officer may grant time
for the payment of the amount specified in the certificate issued
to the Recovery Officer and thereupon the Recovery Officer
shall stay the proceedings of recovery until expiry of the time
so granted. If, on appeal, the amount of the debt is reduced, the
Presiding Officer shall stay the recovery of such part of the
289
amount of the period for which the appeal remains pending.
where the amount of the outstanding demand is reduced on
appeal, the Presiding Officer shall, amend the certificate or
withdraw it, as the case may be.
7.11 ADOPTION OF INCOME TAX ACT
Section 28 makes provisions for different modes of recovery
of debts by the Recovery Officer on the lines of the provisions
of section 226 of the Income-tax Act, 1961. The Recovery
Officer will be able to recover the amount of debt to
the banks or financial institutions out of the money due from
any person to the defendant and such person shall comply with
the orders of the Recovery Officers and pay the amounts so
due to the credit of the Recovery Officer. Once a notice has
been issued by the Recovery Officer to any person, any claim
respecting any property in relation to which such notice has
been issued, arising after the date of the notice shall be void as
against any demand contained in such notice. Any person
discharging any liability by the defendant after the receipt of
such notice shall be personally liable to the Recovery officer to
the extent of his own liability to the defendant so discharged or
to the extent of the defendants liability for any debt due under
this legislation, whichever is less. The Recovery Officer may
also apply to the court in whose custody there is money
belonging to the defendant for payment to him of the entire
amount of such money, or if it is more than the amount of debt
due, an amount sufficient to discharge the amount of debt so
due. The Recovery Officer may recover any amount of debt
due from the defendant by distraint and sale of his movable
property in the manner laid down in the Third Schedule to the
Income-tax Act, 1961.
Section 29 applies the provisions of the Second and Third
Schedules to the Income Tax Act, 1961 and the Income-tax
(Certificate Proceedings) Rules, 1962 (with necessary
modifications) for the recovery of debts due to the banks and
financial institutions.
7.12 APPEALS IN RECOVERY CASES
Section 30 provides that any order made by the Recovery Officer
in the exercise of his powers under sections 25 to 28 (both
inclusive) shall be deemed to have been made by the Tribunal,
so that an appeal against the order can be made to the Appellate
Tribunal.
Section 31 makes provisions for transfer of cases pending before
any court immediately before the date of establishment of a
Tribunal under this legislation, to the Tribunal which will have
jurisdiction in relation to such cases.
7.13 MISCELLANEOUS PROVISIONS
Sections 32 to 36 contain miscellaneous provisions as to
protection of action taken in good faith overruling effect of the
Act, making of rules etc.
290
SUB TOPICS
8.1 Bankers obligations
8.2 Duty to maintain secrecy
8.3 Analogous situations of confidentiality
8.4 Bankers duty defined
8.5 Duration of the duty
8.6 Matters covered by the obligation of secrecy
8.7 Exceptions to the bankers duty of secrecy
8.8 Duty to the public
8.9 Banks interest
8.10 Customers consent
8.11 Bankers references
8.1 BANKERS OBLIGATIONS
The relationship of a banker and customer gives rise to a number
of obligations. Some of these are contractual - such as, the
duty of the banker to honour cheques issued by the customer
in the proper form. Some of them arise from enactments relating
to negotiable instruments. A few have their origin in the
common law. They do not have their foundation in a specific
contract or statute. Rather, they represent obligations which
the law attaches to the relationship between the parties having
regard to certain important considerations.
8.2 DUTY TO MAINTAIN SECRECY
The bankers duty of secrecy in regard to the customers
transactions came to be recognised on considerations of the
nature mentioned above. The duty arose because the
relationship of banker and customer cannot be smoothly worked,
unless some such duty is recognised. Even though the duty is
sometimes stated to arise out of contract, there is a deeper
consideration justifying its recognition. When a person enters
into transactions with a bank, he necessarily makes known to
the banker a good part of his financial affairs. These may
sometimes relate to his personal life. At other times, they may
relate to his business activities. In either case, he does not desire
that his private affairs may become known to the outside world.
If the banker is not required to maintain secrecy, the relationship
cannot be maintained. In a sense, then, in recognising such a
duty, the law gives importance to the value of privacy.
There can of course, be other considerations also, relevant to
the subject. It may be that in protecting privacy as between the
customer and the banker and in creating a duty of secrecy in
favour of the customer against the banker, the law has also in
mind a wider consideration. If such secrecy is not enforced, the
business of banking may not thrive and the interests of society
may suffer. Here then the law takes into account not only the
sentimental feelings of individuals, but also some facets of
public interest. It may be a mundane, non-sentimental and
business-oriented approach, but it is linked with a certain view
of public interest. The protection of individual interests is
ultimately geared towards the advancement of good of the
society
8.3 ANALOGOUS SITUATIONS OF
CONFIDENTIALITY
The duty of secrecy is not peculiar to the banker-customer
relationship. As between the doctor and the patient, the law
recognises a similar duty. The doctor must not (except in certain
exceptional cases) communicate to a third person what he has,
in the course of his professional work, come to know about the
patients state of health and connected matters. If such a duty
is not recognised by law, a patient may not be able to give the
doctor full and frank information about his body. This would
impede and impair the efficient performance by the doctor of
his functions. As a result, the diagnosis and treatment may not
be as sound as they could have been if a full disclosure had
been made. Such a situation not only harms the patient, it is
also unfair to the doctor who would not be able to give his best.
Since society is also concerned about the health of its members,
the interests of society would also be harmed.
Substantially similar considerations have prevailed with the law,
in its recognition of marital confidence. A spouse cannot be
compelled to disclose - not even in a court of law -
communications made during marriage by the other spouse,
except in very special situations. If that were not the law, the
feeling of mutual trust and confidence, that is the foundation of
a happy marriage, would be destroyed. Loss of such mutual
confidence would mar marital happiness and would ultimately
affect the happiness of society.
8.4 BANKERS DUTY DEFINED
Now to revert to the bankers duty of secrecy. The classical
statement of the law on the subject is to be found in the judgment
of Lord Justice Bankes [Tournier v. National and Provincial
and Union Bank of England, (1924) 1 K.B. 461: (1923) All
E.R. Rep.556 (C.A)]. He held that the duty is not merely a
moral one, but a legal one. But it is subject to certain exceptions.
Elaborating the exceptions, he said:
In my opinion, it is necessary in a case like the present to
direct the Jury what are the limits and what are the qualifications
of the contractual duty of secrecy implied in the relation of
banker and customer. There appears to be no authority on this
point. On principle, I think that the qualifications can be
classified under four heads:
(a) Where disclosure is under compulsion by law.
(b) Where there is a duty to public to disclose.
(c) Where the interests of the bank require disclosure.
(d) Where the disclosure is made by the express or implied
consent of the customer.
Subject to the above exceptions, the bankers duty of secrecy
appears to be strict. Thus, disclosure by a holding bank to its
8 BANKER'S DUTY OF SECRECY
291
subsidiary appears to be illegal. [Bank of Tokyo Ltd. v.
Karoon, (1986) 3 All E.R. 468, 475 (C.A)].
8.5 DURATION OF THE DUTY
(a) The duty of secrecy arises as soon as the relationship of
banker and customer comes into existence. In order that a
person may be a customer of a bank, it is not necessary that
the relationship should be of long duration. If a person has
opened an account and paid in a single cheque, he is a
customer of the bank. [Taxation Commissioner v. English
Scottish and Australian Bank, (1920) A.C. 683, 687
(P.C)].
(b) The bankers duty of secrecy does not, however, cease with
the closure of the account. If that were so, the rationale
underlying recognition of the duty would be substantially
frustrated as the customers confidence would become
vulnerable. On this logic, the duty must continue even
after the customers death. [Paget, p. 255].
8.6 MATTERS COVERED BY THE OBLIGATION OF
SECRECY
There has been some discussion as to the matters to which the
banker's duty of secrecy applies. The point was touched in the
Tournier's case (mentioned above) by the other members of
the Court of Appeal. According to Lord Justice Scrutton, the
duty does not extend to:
(i) knowledge which the banker acquires before the
relationship of banker and customer was in contemplation;
or
(ii) knowledge acquired after the relationship has ceased; or
(iii) knowledge derived from other sources even if it was derived
during the continuance of the relationship.
But according to Lord Justice Atkin, the duty extended to
information obtained from sources other than the customers
actual account. If the occasion upon which the information
was obtained arose out of the banking relations of the bank and
its customers.
8.7 EXCEPTIONS TO THE BANKERS DUTY OF
SECRECY
To the bankers duty of secrecy, there have been recognised
four exceptions, namely:
(a) Compulsion by law
(b) Duty to the public
(c) Bankers interest
(d) Customers consent (to disclosure of the information).
If one may say so, most of these exceptions are recognised in
several other spheres also, where the duty of secrecy is
recognised in regard to particular relationship. In one case
Parry Jones v. Law Society, [(1968) 1 All E.R. 668, 670 (C.A)]
Lord Justice Diplock (as he then was) pointed out that the duty
of confidence exists also between solicitor and client, banker
and customer, doctor and patient and accountant and client.
Again (though in a slightly different context), while speaking
of the duty of care, Lord Finlay, Lord Chancellor, stated as under
in a judgment of the Privy Council [Hanbury v. Bank of
Montreal, (1919) A.C. 626, 659 (P.C)]:
There is, in point of law, no difference between the case of
advice given by a physician and advice given by a solicitor or
banker in the course of his business.
8.8 DUTY TO THE PUBLIC
Duty to public, which constitutes one of the exceptions to the
bankers duty of secrecy, is a vague concept. Lord Chorley
[Lord Chorley, p. 23] gives the example of a customer trading
with the enemy in times of war. Mr. Justice Staughton
(tentatively) in one case [Libyan Arab Foreign Bank v.
Bankers Trust Co., (1988) 3 WLR 314 (Staughton, J)], took
the view that the bank was justified in making disclousures to
the Federal Reserve Bank of New York about payment
instructions received by the bank from the plaintiff.
8.9 BANKS INTEREST
The case of Sutherland v. Barclays Bank Ltd, [(1938) 5 Legal
Decisions affecting Bankers 164(C.A); Paget, p. 257]. is usually
cited as illustrating an exception to the bankers duty of secrecy,
being an exception based on the bankers interest. The bank in
that case had dishonoured a cheque issued by the wife of the
plaintiff, apparently on the ground of insufficient funds but really
because of the banks knowledge that she was betting. On the
husbands inquiry on phone, the fact that most cheques of the
wife were in favour of book makers was disclosed by the bank
to the husband. The wife sued the bank for damages for breach
of secrecy, but the action failed. Interests of the bank were
stated to require disclosure in the circumstances. Further, in
the circumstances, there was an implied consent by the customer.
The grounds given are not very convincing. A preferable ground
would be that disclosure of such matters to a spouse of the
customer should be regarded as a moral duty. Of course, this
should be regarded as a new head of exception distinct from
the exception based on the banks interest.
8.10 CUSTOMERS CONSENT
Where the customer has consented to disclosure of certain
information, the duty of secrecy becomes irrelevant. The
consent is rarely express. It can be implied. In practice it is
not always easy to decide whether, on the facts, consent can be
implied.
8.11 BANKERS REFERENCES
In at least two English cases, [Swift v. Jewsbury and Coddard,
(1874) 9 L.R.A.B. 301; Parsons v. Barclay & Co Ltd., (1910)
103 L.T. 196], the view has been taken that answering quaries
from another bank acting on behalf of a customer is within the
scope of banking business. And, according to Paget, the
practice may be regarded as implicitly authorised by most
customers of banks. [Paget, p. 257].
292
SUB TOPICS
9.1 The traditional approach
9.2 The Mareva cases
9.3 The process
9.4 Ad personam order
9.5 Relevance to bankers
9.1 THE TRADITIONAL APPROACH
Traditionally, English law espoused the principle that a plaintiff
is not entitled to require from the defendant, in advance of
judgment, security to guarantee, the satisfaction of a judgment
[Scott v. Scott, L.R. (1951) Probate 193] that the plaintiff may
eventually obtain. in 1975, a change was brought about by a
pair of Court of Appeal decisions: (i) [Nippon Yusen Kaisha
v. Karageorgis, (1975) 1 WLR 1093 (CA), (ii) Mareva
Compania Naviera SA v. International Bulk Carriers SA,
(1975) 2 Lloyds Rep. 509 (C.A).
9.2 THE MAREVA CASES
The two decisions mentioned above involved claims for
damages arising from shipping contracts, brought against
foreign defendants. In both the cases, the plaintiffs obtained ex
parte orders restraining the defendants from removing their
funds out of the jurisdiction, pending the final adjudication of
the actions. [ Gee, Mareva Injunctions (1990), p. 3 and M.J.
Tilbury, Civil Remedies (1990)].
9.3 THE PROCESS
The Mareva injunctions, (as they have come to be known)
almost invariably involve the following process. [Goldrein
and Wilkinson, Commercial Litigation; Pre-emptive Remedies
(1991), p.129] A plaintiff applied to the court ex parte and
9. THE MAREVA INJUNCTION IN ENGLISH LAW
before serving the writ, for an injunction to restrain the
defendant, and any one with control over the defendants assets,
from disposing of the defendants assets, if, to do so, would
reduce the value of those assets below a certain level (usually
the value of the plaintiffs claim) [CBU (UK) Ltd v. Lambert,
(1983) Ch. 37, 44-45]. The plaintiff must show, by affidavit-
evidence, that there are reasons to believe that the defendant
has assets within the jurisdiction and that there is a danger that,
if the defendant is not restrained from dissipating those assets,
then any judgment that the plaintiff may eventually obtain, may
go unsatisfied.[Searose Ltd v. Seatrain(U.K.) Ltd., (1981) 1
W.L.R. 894]. The order is subject to a cross-undertaking by
the plaintiff, to compensate the defendant for any unwarranted
damage that the latter may suffer and to indemnify third parties
in respect of costs that they may incur in conforming with the
injunction. It commonly states that the defendant is at liberty
to apply, upon notice to the plaintiff, to discharge or vary the
order. [Ocean Software Ltd. v. Kay, (1992) Q.B. 583].
9.4 AD PERSONAM ORDER
A Mareva injunction is an ad personam order, restraining the
defendant from dealing with assets in which the plaintiff claims
no right whatsoever. Consequently, a Mareva order does not
give the plaintiff any precedence over other creditors with
respect to the frozen assets. Although the order has sometimes
been characterised as being in rem, and has, on occasions, been
compared to attachment orders. The fact is that, subject to court
supervision, the defendant remains free to meet his living
expenses and other obligations from the frozen funds.
9.5 RELEVANCE TO BANKERS
The Mareva injunction could be relevant for bankers in so far
as it constitutes a weapon in relation to debts. It could turn out
to be of particular utility against foreign parties.
293
10. CASE LAW
Imperial Bank of India v. Mt. Bibi Sayeedan [AIR 1960 Pat
1321]
An appeal by garnishee arose out of a garnishee proceeding in
which the objection of the appellant was rejected. In this case
the decree-holder respondent who was the widow of one Nadir
Ali, obtained a decree on account of her dower debt against the
heirs of her deceased husband in a money suit brought by her
against them. This decree was put into execution and the decretal
amount was sought to be realised from the assets of Nadir Ali
in the hands of his heirs. When ultimately a decree was passed
in favour of the plaintiff-decree-holder respondent and when it
was put into execution a notice under 0.21, R. 63A was issued
to the appellant. In response to the notice issued to the appellant
under 0.21, R.63A of the C.P.C. the bank appellant filed an
objection before the executing court. The principal objection
of the appellant was that unless Letters of Administration or
Sucession Certificate are produced the bank would not get an
effective discharge in respect of the debts due by
the bank to deceased. There was an objection regarding
attachment. The learned subordinate judge over ruled the
objection of the bank appellant and asked the bank to pay the
amount in question to the decree-holder. Bank filed an appeal
under 0.21, R.63H of the C.P.C.
The Court held that although the heirs of a deceased
Muhammedan are not personally liable for the dower debt,each
heir is liable for the debt to the extent only of a share of the debt
proportionate to the share of the estate. After the death of her
husband, therefore, if a widow brings a suit for recovery of her
dower, it must be brought against all the heirs of her deceased
husband. Where in such a suit, the court issues a prohibitory
order under 0.21, R.46 against a bank in respect of the money
deposited by the deceased husband, the order of the court asking
the bank to pay the amount lying in deposit to the credit of the
deceased to the decree-holder will amount to a valid discharge
and will absolve the bank from all liability , so far as the bank
is concerned in respect of the deposit it has no right to ask the
decree holder to produce the Succession Certificate before
paying the amount into the court.
Under O.21, R.63A the foundation of a garnishee proceeding
is an attachment made under O.21, R.46. Garnishee
proceedings, therefore in respect of a debt, can be started only
after the debt has been attached under O.21, R.46. The mere
absence of the provisions of law, under which a court acts in a
particular case cannot be a ground for urging that the court
acted not in accordance with law, but contrary to the provisions
of law. Where, therefore there is no mention of provision of
law under which a prohibitory order was issued O.38, R.5 does
not apply to the case, but O.21, R.46 applies. It must be
presumed under Sec. 114 of the Evidence Act that the Court
issued the order under O.41, R.46(1).
Sahukara Bank Ltd. v. Income-Tax Officer Ludhiana and
others [(1966) 62 I.T.R 745 (Punjab)].
The petitioner, Suhukara Bank Ltd.,Ludhiana had branches in
Pakistan before 1947. One Mohd. Akram of Ikram-Ullah and
Sons had an account in that Bank. It had a deposit of Rs.10226-
7-6 in January 1948 in the Bank. Due to partition, the depositer
migrated to Pakistan. Depositor owed to Income-Tax department
certain amount of Income-Tax. On enquiry by the I.T.O. from
the bank, I.T.O was informed that the account had been
transferred to the Pakistan branch of the bank. In fact, no
physical transfer was made. I.T.O. issued the necessary
certificate to the petitioner bank as arrears of land revenues in
respect of the tax due from the above Muslim Firm. Against
these proceedings bank filed the petition under Article 226 &
227 of the constitution.
The point in issue was whether the bank is exonerated from its
liability to the income-tax department for the amount of the
assessee held by it, despite the objection of the bank that the
amount is payable to the assessee in Pakistan and not in India?
It was held that bank is not exonerated from its liability to the
income-tax department for the amount of the assessee held by
it.
Balaraman v. Varadammal [AIR 1987 Mad.94]
The petitioner was one of the sons of the judgment-debtor and
3rd respondent in that execution. The respondent decree-holder
obtained a decree for maintenance against her husband
Narayanan. The decree also provided a charge over property
situated in Madras. The said execution was laid against the
legal representatives of her husband viz, his three sons and a
daughter, as the judgment-debtor passed away in the meanwhile.
The amount claimed was rupees 18,384-10 after giving credit
to the payment of rupees 20,300. In the execution a sum of
Rs.36,000 standing to the credit of the judgment-debtor and
his son, the petitioner's account in Punjab National Bank,
Triplicane, Madras was sought to be attached by issue of a
prohibitory order to the bank. All the petitioners objections
were rejected by the court and execution was ordered. The
petitioner filed a revision petition in the Madras High court.
The court held, in an execution of a decree for maintenance
providing charge over property of judgment-debtor filed against
legal representatives of judgment-debtor, the decree-holder is
entitled to attach a moiety of the amount in bank deposit standing
in joint credit of judgment-debtor and his son on either or
survivor terms, as the deposit on such term is a contract between
the persons in whose names the joint account stood and the
bank. If the bank therefore were to pay the whole amount to
the survivor, it gets a valid acquittance, provided, of course, no
order of attachment and the like intercepted. Thus the mere
fact that the account was on the term either or survivor the
survivor would not get automatically the whole amount in the
bank.
294
Lukka Varghese v. Devasia Varkey [AIR 1965 Kerala 47]
In execution of a decree, the appellant judgement-creditor,
attached a debt due to the judgement-debtor, a bank, from the
respondent. On the motion of the appellant, notice under Order
XXI, Rule 46-A, of Civil Procedure Code, was served on the
respondent. The respondent prayed a period of six months to
deposit the amount of the debt which was disallowed by the
court. The Court passed an order under Order XXI, rule 46-B
and directed a warrant to be issued to the respondent. Upon
this, the respondent made an application for
exemption from personal execution. While this was pending
the bank was ordered to be wound up upon a petition. The
respondent then applied for stay of proceedings under Section
446 of the Companies Act, 1956. The court allowed the
application. An appeal was filed and the main question for
decision was whether the final order under Order XXI, Rule
46-B was passed before the winding up proceedings
commenced, the execution of that order can be considered to
be a proceeding against the company so as to be within the ban
imposed by Section 446.
The court held as the order nisi having been served on the
garnishee (respon-dent) and having been made final and
absolute, on the terms of Order 21, R.46-B before the winding
up of the bank (judgment-debtor) the appellant decree holder
is entitled to execute that order as a decree against the garnishee
regardless of the fact, that the right of the decree-holder had
sprung from the judgment recovered against the bank. A
proceeding to execute the final order against the garnishee
cannot be construed to be a proceeding against the bank and is
not within the prohibition of Section 446 of the Companies
Act. The order of the Subordinate Judge confirming that of the
execution, was set aside and the appellant was allowed to
proceed against the respondent according to law.
Mackinnon and Mackenzie and Company Pvt. Ltd., v. Anil
Kumar Sen and another [AIR 1975 Cal 150]
In this case, the appeal was directed against the order whereby
the appellant was directed to pay to the Sheriff of Calcutta a
sum of Rs.1,40,873.15 attached in its hands by an order which
was made earlier. The order was made in garnishee proceeding,
the appellant being the garnishee was served with a notice
whereby it was required to pay to the Sheriff the said amount.
The Court held that in view of the fact that existnece of any
debt due and payable by the garnishee to the judgment-debtor
had not been proved in the instant case. The garnishee was not
called upon to dispute any liability in terms of Rules 2 and 3 of
the Chapter XVIII of the Original Side Rules. The failure to
dispute the debt or the liability by the garnishee in terms of
Rule 3, of Chapter XVIII of the O. S. Rules thus could not
affect the rights of the garnishee in the case.
Alsidass Kaverlal v. J. Hiriya Gowder [AIR 1961 Mad. 189]
An appeal by the petitioner decree-holder was filed against the
order of the learned Subordinate Judge, in an execution
application under O.21 R.46 C.P.C. The brief facts are as
follows.
Originally the appellant decree-holder prayed to the court for
the issue of a prohibitory order in respect of certain amounts
payable by the Garrison Engineer, to the respondent (judgment-
debtor), apparently relating to certain contracts for the Army
executed by the judgment-debtor.
The Garrison Engineer, wrote a letter to the Subordinate Judge,
in respect of his prohibitory order, informing the court that an
amount of Rs.7,237.75 had been withheld in response to the
order that the balance payable, if any, was so far unascertained,
and that the military authorities were therefore unable to state
that any further specific balance was payable to the judgment-
debtor. The Court without taking evidence and without any
further enquiry confirmed the prohibitory order in respect of
the sum of Rs.7237-75. The decree-holder was aggrieved by
this, as, in his view nearly Rs. 20,000 was due to the judgment-
debtor. He filed a fresh application under Order 21, Rule 46
C.P.C. praying for a fresh attachment of bill amounts, deposit
amounts etc. totalling to nearly Rs.20,000. This application was
resisted by the judgment debtor on several grounds. The
grounds were negatived on the merits. The court consequently
dismissed the application as not maintainable.
Allowing the appeal the High Court observed that there was
nothing in the processual law barring the maintainability of such
an application . Hence the Court was wrong in dismissing the
application as not maintainable and holding that the prohibitory
order was effective only upto the amount admitted by the
garnishee.
295
11. PROBLEMS
1. What are the rights of a creditor who has attached a bank
account? How far is his position affected by withdrawals
from the bank account. ( as attached) before or after
attachment, and what is his position as regards subsequent
transactions?
2. A banker is asked by a third person to disclose to him the
state of a customer's account. Examine the legality of doing
so in the following cases:
(a) if the third person is the customer's wife who is
thinking of claiming maintenance from the customer.
(b) if the third person is the customers partner, requiring
the information for the partnership business.
(c) the customer's creditor.
(d) the customer's superior (head of office).
3. A banker has a claim for overdraft against X, who is about
to dispose of most of his assets. How should the bank
proceed to protect its interest?
4. A money decree was obtained on the basis of a compromise.
At the instance of the decree holder attachment before
judgement was effected of certain sum of money said to be
belonging to judgement debtor in the hands of appellant/
garnishee by way of prohibition order. No notice was sent
to the garnishee as required under R.46-A of the C.P.C.
only one letter was sent to him by the court requesting him
to remit the amount. The garnishee appeared in court in
response to letter and filed counter affidavit raising certain
objections. Can the contentions raised by garnishee in
counter-affidavit be treated as objections under R.46-C. (for
reference see AIR 1988 Ker. 285)
5. A decree holder had obtained an attachment before
Judgement of the lorry belonging to the S Judgement
debtors. The attachment raised on the judgment debtors
giving a fixed deposit receipt for certain sum issued by the
bank (petitioner) as security to the court. The brother had
also availed of an agricultural loan from the bank. In
execution of the decree the executing court, treated the bank
as a garnishee, called upon the bank to deposit the amount
and interest thereon. The bank filed application seeking
review of the order of the court by contending that the bank
had the right to retain this money in exercise of its general
power of lien and appropriate the said money towards
amounts due to it under the loan account. Is the order of
the executing court valid. (See AIR 1990 Ker 223].
6. Mr. Ram a decree holder levied execution against Mr.
Sohan, the judgement debtor for recovery of money due
under the decree. In order to realise the decree amount the
decree holder, Ram obtained a prohibitory order restraining
the judgement debtors (Mohan) garnishee from paying the
amount due to the judgement debtor. Though the garnishee
was absent in the first instance, he was finally permitted to
file an affidavit in which he disputed his liability to the
judgment debtor. But on a consideration of the pleas
advanced by the garnishee the court held against him and
directed him to produce the amount in to the court as
required by the decree-holder. Can garnishee be directed
to pay the money.(See AIR 1972 AP 701).
7. Mr. A, a decree holder, attaches a decree for recovery of
money in favour of Mr.B under which money would
become payable to Mr. B, only on the happening of certain
contingencies. Can Mr. A execute the decree against the
judgment debtor of B for the recovery of money before the
happening of the said contingency. Decide. [See AIR 1972
A.P. 70]
8. A decree holder sought to attach some money owing to his
judgement debtor from a third party. The third party
objected to the attachment on the ground that the judgement
debtor owed him a sum of money which extinguished his
debt to the judgement debtor. He further contended that
the set off had been recognised in other cases by the Court.
He claimed that he was entitled in these execution
proceedings to have the question of that set off considered.
The executing court refused to investigate into the question:
(a) Can executive court investigate such matters?
(b) Can the existence of debt owed by garnishee to judgement
debtor be challenged in execution proceedings? (AIR 1937
Mad. 848)
9. Mr. Shyam obtained a decree against Mr. Gopal. Mr. Shyam
attached the amount in a Bank deposit but subsequently
under a scheme framed under Sec.153 of Companies Act
(which was binding on Mr. Gopal) the Bank garnishee was
entitled to pay Mr. Gopal and other depositors in easy
instalments. Mr. Gopal called upon the bank to make full
payment of the amount at once. Can he do so? Discuss.
[See ILR 1956 Assam 301].
10. A railway company issued and delivered to Mr. Rao a
cheque for the provident fund amount which became
payable to him on his retirement from service. The cheque
was in currency. The Bank who was a decree holder against
Rao attached debt under O21 R 46. Will this attachment
entitle the Bank decree holder to initiate garnishee
proceedings.
[Note: Specify your Name, I.D Card No. and address while sending answer papers]
296
1. Gee, S., Mareva Injunction: Law & Practice, (1990), Longman, London
2. Gupta, S.N., The Banking Law in Theory and Practice, 22nd Edn. (1992), Universal Book Traders, New Delhi.
3. Hapgrood, Mark, Pagets Law of Banking, 10th Edn. (1989), Butter-worths, London and Edinburgh.
4. Holden, J.M., The Law and Practice of Banking, 5th Edn. (1991), Vol.I, Pitman, London.
5. Shelden & Fidlers, Practice and Law of Banking, 11th Edn. (1984), Macknald & Evans Ltd, London and Plymouth
6. Tannan, M.L., Banking Law & Practice in India, 18th Edn. (1989), Orient Law House, New Delhi.
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