TABLE OF CONTENTS

Module I: Origin, Structure, and Functions of Banking Institutions...............................................3

History of Banking......................................................................................................................3
History of Banking in India.........................................................................................................3
Bank Nationalization...................................................................................................................4
Narsimham Committee I (NSC)..................................................................................................8
Narsimham Committee II (NSC).................................................................................................9
Impact of NSC...........................................................................................................................11
Module II: Banker Customer Relationship....................................................................................12
Who is a banker?.......................................................................................................................12
Who is a customer of the bank?.................................................................................................13
Theories and definitions:.......................................................................................................13
Cases:.....................................................................................................................................14
Nature of Banker-Customer relationship...................................................................................14
i. Debtor Creditor relationship...........................................................................................14
ii. Banker as a trustee..........................................................................................................16
iii. Bailor-Bailee relationship...............................................................................................17
iv. Mortgager-mortgagee relationship..................................................................................19
v. Lessor-lessee relationship...............................................................................................20
vi. Principal- Agent relationship..........................................................................................20
vii. Hypothecator-hypothecatee.........................................................................................21
viii. Assignor-Assignee.......................................................................................................21
Duties of a banker......................................................................................................................21
i. Duty to maintain secrecy or confidentiality of customer’s account................................21
ii. Duty to honour cheques drawn by customers on their account and collect cheques and
bills on their behalf................................................................................................................24
Rights of a Banker.....................................................................................................................26
i. General lien.....................................................................................................................26
ii. Set off..............................................................................................................................28

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 iii. Appropriation..................................................................................................................28
Historical background................................................................................................................30
Specific Provisions of the BR Act.............................................................................................31
Module IV: Debt Recovery...........................................................................................................42
History and background.............................................................................................................42
Differences between RDB Act and SARFAESI........................................................................42
Union of India v. Delhi High Court Bar Association................................................................42
Miscellaneous Provisions..........................................................................................................43
SARFAESI Act..............................................................................................................................49
Background of SARFAESI........................................................................................................49
Conditions of Applicability of the Act......................................................................................49
Overview of the Act be..............................................................................................................49
Mardia Chemicals v. Union of India.........................................................................................50
Registration and Cancellation....................................................................................................51
Securitization Process................................................................................................................53
Asset Reconstruction.................................................................................................................54
Dispute redressal (remedies)......................................................................................................55
Enforcement of Security Interest...............................................................................................56
Rights of Banker v. Rights of Tenants.......................................................................................58

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 Module I: Origin, Structure, and Functions of Banking Institutions

HISTORY OF BANKING

Italy has been given the credit for the origin of commercial banking ad modern banking. The
word banco means bench and the word ‘bankrupt’ was derived from the phrase banca rotta
which meant- an out of business bank, which would be physically broken.

Two families, the Bardi and Peruzzi, are given credit for making banking an industry. The most
famous Italian bank was the Medici Bank. They grew as an institution as opposed to providing
just money lending services. Banco di San Giorgio founded in 1407 is the earliest known state
deposit bank.

HISTORY OF BANKING IN INDIA

Central Banking Inquiry Committee (1931)- “money lending cud be traced back to the Vedic
period” // Kautilya’s Arthashastra contained references to creditors, lenders, and lending rates.

Royal Commission on Indian Currency and Finance/ Hilton Young Commission (1926)-
Mr. Preston, Member- “It may be accepted as a system of banking that was eminently suited to
India’s then requirements, was in force in that country many centuries before it was done in
England.

[Fun fact, sponsored by Aditi- Allahabad Bank (1865) was the first bank with all Indian
shareholders]. Beginning of joint stock commercial banking- happened in the early 18th
century. Bank of Bombay (1720) was the first joint stock bank. Others included Hindustan Bank,
Calcutta (1770) and General Bank of Bengal and Bihar (1773).

Warren Hastings was responsible for pushing the talk on a ‘central regulatory bank’ and said that
an apex institution is necessary to administer and control all the other banking units in India. He
suggested converting the General Bank into the central bank.

The EIC established three Presidency banks: Bank of Bengal(1809), Bank of Bombay (1840),
Bank of Madras (1843). SBI was created by the amalgamation of these three banks. It was
initially called the Imperial Bank of India when it was first amalgamated in 1921 but renamed
post independence in 1955. In 1959, through the SBI Subsidiary Act, 1959, various banks
became its subsidiaries. The Imperial Bank played the role of a central bank for a while.

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The Hilton Young Commission suggested the establishment of the RBI as a private shareholders
bank in 1926. Warren Hastings suggested the establishment of the RBI as an apex institution and
presented the Reserve Bank Bill in 1927 (which failed).

The Central Banking Inquiry Committee (1931) advocated for having RBI as an apex institution
due to the number of banks which needed to be regulated and controlled. The RBI Act was
eventually passed in 1934. RBI was established in 1935 and nationalized after independence
(1949) by way of the RBI (Transfer of Public Ownership in India) Act, 1948.

Phases of Indian Banking:

Phase 1: 1720-1969 [Inception of first bank till bank nationalization]

Phase 2: Post nationalization till Banking Reforms [impact in terms of efficiency, development
etc of related laws]

Phase 3: Post banking reforms phase

BANK NATIONALIZATION

The objective of nationalization was to uplift the poorest sections of society by providing
monetary resources to the weaker sections of society (credit facilities and other services), and
controlling private banks.

Background:

 The Indo China War in 1962 resulted in the depletion of the Treasury, forex was
dwindling, and the morale of the people was low
 Death of Jawaharlal Nehru in 1964 led to a shift in power as Lal Bahadur Shastri
assumed office
 In 1965, Indo-Pak war had a severe impact on the resources of the country. There was a
great famine and grains had to be imported, in whatever poor quality they were available.
We did not have enough monetary resources to implement the 3rd 5 year plan.
 In 1966, Lal Bahadur passed away and Indira Gandhi (“IG”) was appointed as the PM.
 In 1967, Congress lost many important seats in the General Election because people had
lost faith in the government
 IG wanted to restore people’s faith and hence was keen on nationalization in order to
provide monetary resources to the poorest of the poor.

Reasons for opposition by Morarji Desai: (2 primary reasons leading up to his resignation)

 [Context to the Banking Regulations Act, 1949- enacted on the basis of recommendation
by the CBIC. In BR Act, only section 10 dealt with the constitution of the Board of
Directors and did not specify the requirement of equal representation. The government

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 later realized that there was a major imbalance in terms of representation. The BR Act
was applicable to all banks except the RBI until nationalization. Post nationalization, all
nationalized banks were regulated through the legislations that nationalized them.]

The concept of “Social Control” was then introduced in 1968 but implemented in 1969.
In 1968, the following amendment(s) to the BR Act were introduced-
Sec 10A: BoD to include persons with professional or other experience. 51% of the
Board should constitute members from agriculture, small scale industries, economics,
rural economy, finance etc. At least 2% should consist of rural economy and small scale
industries to ensure that resources are effectively channelized to these sectors.

RBI, as a regulator of the banks was given the power to ensure adherence to the sections
enacted through the amendment. If within a specified time, the Board is not constituted as
per the prescribed composition, a notice will be served and if modification still doesn’t
occur, RBI will compulsorily reconstitute the Board.

Morarji Desai acknowledged that the objectives of Bank Nationalization (“BN”) were the
same as that of Social Control. The aims of social control were- “to regulate our social
and economic life so as to attain the optimum growth rate for our economy and to prevent
at the same time, monopolistic trend, concentration of economic power, and misdirection
of resources.”
Since the amendment to the BR Act was only introduced in 1968, it should be given
enough time to have an impact. Thus, BN was premature in light of Social Control.

 Desai believed that the compensation prescribed under the scheme of BN was a waste of
limited resources that could otherwise be used to revitalize the economy.

Process of Nationalization:

The objective(s) of nationalization- Banks shouldn’t target a specific section of society;

movement from class banking. [Industries’ share in loans almost doubled between 1951 and
1968 from 34% to 68%. On the other hand, agriculture, which was a major occupation, received
less that 2% of the total credit].

On the 19th July, 1969, 14 major banks with a deposit equal to or higher than 50 crore were
nationalized to serve the purpose of social welfare. The Act was fully enacted in 1970 as it was
challenged in the SC and it was made effective, with retrospective operation, after the R.C.
Cooper case.

Class to mass banking could be achieved by branching out to increase the reach of banks.
Branching license and policy in India even today is reflective of this to reduce regional
imbalance and the banks are to open branches in unbaked and under-banked areas to promote
banking. It was supposed that once BN occurs, efficiency and profit earning capacity of banks

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would increase. Drawbacks- Due to red-tapism, increased involvement of the government etc,
these objectives were not fulfilled.

R.C. Cooper v. Union of India:

R.C. Cooper was the Director of the Central Bank of India (a bank proposed to be nationalized),
a shareholder of CBI, and a depositor and customer of other banks that were nationalized.

The following changes, among others, were brought about by the initial ordinance, which during
the course of this case turned into an act:

 All the Directors and Chairpersons shall vacate their office once nationalization occurs-
done as part of social control measure.
 The Chairman/person of the old bank would serve as the custodian of the corresponding
bank temporarily.
 The banks will no longer be able to operate privately and hence would not only be unable
to carry out banking functions, but will also lose their status as banks.
 The mode of compensation for the acquisition of the banks was government marketable
securities.
 Either the existing banks would agree with the compensation amount and form OR if the
banks did not agree, then a tribunal would be formed to decide the compensation amount.

Issues raised:

 Power of the President to promulgate the ordinance under Art. 123

 Legislative competence of the Parliament to enact the BN Act
 Constitutionality of the Act on the basis of violation of Arts. 14, 19(1)(g), 19(1)(f), 31(2)

Contentions of the petitioner:

R.C. contended that once nationalization occurs, the 14 selected banks would lose their identity
as a banking company. This is because Sec 7 of the BR Act prohibits the use of the words
“bank”, “banker”, and “banking company” except by those that operate in the banking industry
as per the definition given in Sec 5 of the BR Act. Nationalization means that all the existing
undertaking would be assumed by the new entity, including assets and liabilities. All officers and
employees would be absorbed into the sector but the top level management would not be taken
over entirely by the newly established, corresponding bank. Thus, Cooper who was a Director
and shareholder said that he was affected and unable to make profits.

As for legislative competence, he stated that the Union does not have the complete legislative
competence to enact a law on this subject since nationalization also falls under the State List.

Promulgation of ordinance requires that the Parliament not be in session and that certain
circumstances that warrant immediate action exist. Cooper contended that since there was no
urgency, the President had no necessity to promulgate the ordinance. Moreover, his fundamental

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rights under Art 14(other banks were not subject to similar treatment) and 19 (stripped of bank
identity and unable to make profits) were being violated by this ordinance.

SC held:

 As far as the satisfaction of the Prez under Art 123 was concerned, it could not be
challenged unless he had exercised an action with malafide intentions. Moreover,
acquisition of property can be done with an ordinance and legislation is not necessary.
 As for the competency of the Parliament- Entry 45 of List I is wide enough to give the
Union government power to enact a Banking Ordinance and to nationalize banks.
 With respect to compensation, the Court held that ‘government marketable securities’ did
not constitute reasonable compensation as is required under Art 31(2). Since the
securities cannot be accessed immediately or encashed for ten years, they are not
reasonable.
 Conclusion- The Banking Company (Acquisition and Transfer of Undertakings) Act is
void so far as compensation is concerned. However, since that component is inseparable
from the Act itself, the entire Act is void.

Q. How did the banks remain nationalized irrespective of the Act being declared void?
A. IG enacted a new law where the compensation was changed as per the holding of the SC.
Moreover, she gave the Act retrospective operation from July 19, 1969. She also changed the Act
to state that the SC could no longer encroach on matters of compensation determined under the
Act. The 25th Amendment was a result of R.C. Cooper.

Outcome:

Priority sector lending- Banks were privately owned and managed and this hampered the growth
of the primary sector. Post the first dose of nationalization, the government had control over a
large number of them and 85% of resources were directed towards the primary sector + increase
in no. of bank branches. The government’s intention was to prioritize and direct certain
percentages for each sector. RBI revises this priority sector list from time to time.

Demerits and limitations of nationalization:

 Inadequate banking facilities- Most banks were forced to open branches in rural areas.
Banks struggled for a few years after BN because expansion to under-banked areas only
increased the government’s monetary burden.
 Increased expenditure- ^^
 Limited resources allocated and mobilized- Due to red tapism, bureaucracy, excessive
government involvement, the decision making powers of the bank reduced. Banks failed
to channelize the funds properly due to such excessive interference
 Political and administrative interference - ^^

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  Lowered efficiency and profits + poor competitiveness- competitiveness was lacking in
the first phase of nationalization and this affected efficiency. The nationalized banks had
no competition because- the old private banks were not as big as the newly nationalized
banks and the newer banks were only established post liberalization. The issue with
public banks was that non-performing assets were invested in them. The Narsimham
Committee mentioned the need for private players in Report I and foreign banks in
Report II to enhance competitiveness.

NARSIMHAM COMMITTEE I (NSC)

In the early 1990s, India experienced a grave financial crisis. Balance of payments (BoP) was
haywire, heavy borrowing from other institutions, severe drought induced famine etc. This
resulted in an analysis and review of the banking sector, and an urgent need for reformation was
felt by the Indian government. For this purpose, the govt constituted the NSC. The chairman was
proposed by the RBI in 1999- M. Narsimham, former RBI Governor. Dr. Manmohan Singh
constituted the first NSC.

Major recommendations by the committee:

 Reduction in SLR and CRR- Statutory Liquidity Ratio refers to the specific percentage of
reserve (gold, govt securities, bonds) that the bank keeps with itself. Cash Reserve Ratio
is the percentage of cash a bank (every scheduled bank) has to maintain with the RBI. If
CRR and SLR are added, it amounts to the percentage of reserves that a bank is supposed
to maintain and the remaining is used for investment and lending purposes.
Bank rates-
CRR: 15% (1991); 4% (2013-14)
SLR: 38.5% (1991); 23% (2013-14)

 Asset classification and defining NPAs- need for defining and understanding NPAs was
highlighted. Rationale behind classification was to treat different kinds of assets and
defaulters differently. Classification is as follows:
 Standard asset- banks expect timely payment and recovery is not an issue
 Special mention account- if the dues are not paid within 90 days, the loan becomes an
NPA and is termed as special mention account
 Sub-standard asset- remained an NPA for a period of 12 months (90 days to 12
months)
 Doubtful asset- debt remains as sub-standard asset for 12 more months
 Loss asset- 36 month period of NPA. Banks do not completely write off these debts
but recovery is difficult

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  The priority sector- Schemes and programmes were created for the public sector to avail
credit through these schemes.
Redefinition of priority sector occurred to ensure aid was given to all PSs post
nationalization. Also done to check that previously categorized PSs which have
developed are not classified as PS post nationalization. Highlighted that 'priority sector
lending' was leading to the buildup of non-performing assets of the banks and thus it
recommended it to be phased out.

 Deregulation of interest rates- The control exercised by the govt through the Ministry of
Finance should be reduced and whole control should be transferred to the RBI. // Banks
should be allowed to come up with their own investment rates. // Prime lending rate or
benchmark may be set up by the RBI but the banks should be able to regulate their own
interest rates. This ensures efficiency and profitability by way of increased competition.

 Transparency in the banking system- Excessive interference by the govt was realized
when analyzing the banking system and hence the Committee focused on Corporate
Governance in the banking sector. The need to enhance corporate governance was
expressed. According to the first report of the Adrian Cadbury Committee, corp
governance is the mechanism through which a particular company is governed or
managed. Some of the pillars of corp gov are independent directors, transparency, and
accountability.

 Suggested setting up of “Debt Recovery Tribunals” to ensure expeditious recovery of

debts

 Reconstruction of banks- Top banks should practice the best international practices and
standards to become giant banks so that Indian banks are able to give competition to
foreign banks. (something about ‘too big to fail’ but was irrelevant)

 Entry of private banks- nationalization saw a dearth of competition and sluggish growth
of the banking sector. To introduce competition to the big nationalized banks, the
committee suggested allowing more private players. This would help banks gain profits
and increase efficiency.

NARSIMHAM COMMITTEE II (NSC)

Committee set up in 1998 by the then Finance Minister, P. Chidambaram. It suggested a number
of banking reforms and reviewed the progress made by NSC I. Major recommendations include:

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 Greater autonomy proposed for public sector banks in terms of management and
ownership to ensure that they performed at par with their international counterparts. They
recommended that recruitment procedures, training and remuneration policies of public
sector banks be brought in line with the best-market-practices of professional bank
management + review of functions of banks boards with a view to make them responsible
for enhancing shareholder value + govt stake in public sector banks should be brought
down to 33%
 Merger of banks- The Committee recommended the use of mergers, of weak banks with
strong ones, to build the size and strength of operations for each bank + recommended a
three tier system to enhance international trade

 Need for zero NPAs for all Indian banks- highlighted the need for 'zero' NPAs. It
blamed poor credit decisions, behest-lending and cyclical economic factors among other
reasons for the buildup of the NPAs. Recommended creation of Asset Reconstruction
Funds or Asset Reconstruction Companies to take over the bad debts of banks.

 Creation of ARFs or ARCs- An ARC is a non banking financial company regulated by

the RBI. RBI Act deals with non financial banking companies but not with ARCs directly
which can be found in SARFAESI. ARCs take over NPAs from banks. They approve
schemes which are also approved by the RBI’s Internal Advisory Committee (should not
have a pecuniary interest in the matter). The schemes can be floated for investors and the
returns gained from these schemes are used to pay the banks. Then they attempt to
recover the money from the borrower and finally the investors are paid.
Not even huge economies like China are free from NPAs. When faced with the problem
of bad debts, China came up with ARCs which are completely owned and managed for
the major banks by the government. In this endevour, China received great success while
India did not.

 Entry of foreign banks- The committee suggested that the foreign banks seeking to set
up business in India should have a minimum start-up capital of $25 million as against the
existing requirement of $10 million. It said that foreign banks can be allowed to set up
subsidiaries and joint ventures that should be treated on a par with private banks. This
was done to further increase competition.

 Universal banking- Most international banks provide universal banking facilities, above
and beyond the typical deposit and withdrawal schemes. [Fun fact- ICICI was India’s
first universal bank]

 Capital Adequacy Ratio- prescribed raising the capital adequacy norms in order to
improve risk taking abilities. To implement these recommendations, the RBI in Oct 1998,

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 initiated the second phase of financial sector reforms by raising the banks' capital
adequacy ratio by 1% and tightening the prudential norms for provisioning and asset
classification in a phased manner.
Presently, most banks maintain a CAR of 12% which is 4% higher than the Committee’s
8% rec.
 Computerization of public sector banks- strengthening infrastructure etc.

IMPACT OF NSC

 Competition increased because the banking sector reforms that suggested entry of private
and foreign banks. This acted as an impetus to increase efficiency and competition.
 Provided for the setting up of DRTs
 ARCs
 The committee's recommendations let to introduction of a new legislation which was
subsequently implemented as the Securitisation and Reconstruction of Financial Assets
and Enforcement of Security Interest Act, 2002 (SARFAESI Act)
 CAR is now a requirement of Basel norms
 Redefined priority sector to ensure proper distribution of funds among different sectors.
 Mergers of weak+strong and strong+strong banks occurred.
 Virtual banking and universal banking
 Modernization and computerization of public sector banks

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 Module II: Banker Customer Relationship

Relationship between a banker and customer is contractual or transactional in nature and depends
on the nature of service provided by the bank. “Trust” plays an important role in maintaining
healthy relationships. Instances of services provided include:

 Bank gives loan to customer/ customer deposits money with the bank- Creditor & Debtor
 When collateral in the form of immovable property is given for taking a loan- Mortgager
& Mortgagee
 When locker facility is availed- Lesser & Lessee
 When movable property is deposited with the bank as collateral- Pawner & Pawnee
 Articles given to bank for maintenance- Bailor & Bailee
 When bank provides motor vehicle loan- Hypothecator & Hypothecatee
 When insurance policy is issued- Assignor & Assignee
 Money deposited but instructions not given for its disposal; Payee of draft- Trustee &
Beneficiary
 Standing instruction; sale, purchase of securities; shares given for sale- Agent & Principal

WHO IS A BANKER?

Dr. Herbert Hart- “A banker is one who in the ordinary course of business, honours cheques,
draws upon by him by persons from and from whom he receives money on current account” (so
called bc debit and credit transactions, both are recorded)

Halsbury’s Laws of England- “An individual, partnership, or corporation whose sole

predomination business is banking i.e., the receipt of money on current account or deposit
account of the payment of cheques drawn and the collection of cheques paid in by a customer.”

United Dominion Trust Ltd. (UDT) v. Kirwood (1966)

Money was borrowed for a car business by Kirkwood which was sanctioned in his favour by
UTD, a financial institution. On failure of Kirkwood to pay debt, UDT approached the Court.
Kirkwood claimed that UDT could not be called a ‘banker’ because it was actually a ‘money
lender’. It had also not been registered in, the then prevailing, Money Lenders’ Act in the UK
and the exception to registration was provided in sec 6 which exempted banking commpanies.
Therefore, UDT couldn’t claim repayment.

Lord Denning held- “There are therefore two characteristics usually found in bankers today.
They accept money from and collect cheques from their customers. They honour cheques on
order drawn on them by their customers. Accordingly, these two characteristics bring with them

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a third, that they keep current account or something of that nature in their books in which the
credit and debit are entered.”

In the case, UDT had a great deal of goodwill as a banking company and had also portrayed
itself to be one to the people. Thus, it had a right to recover its money from Kirkwood.

Conclusion- A banker must (a) accept deposits and (b) issue and honour cheques. Non banking
financial companies only accept deposits and don’t fulfill the first criterion. The second feature is
unique only to banks.

In the event of a bank run, banks issue the deposits made in case of liquidation to be able to pay
back a specific percentage. If not the bank, the insurance company shall pay back a part of the
deposit (depositor’s insurance).

BR Act, Section 5(b)- Banking means “accepting for the purpose of lending or investment of
deposits of money from the public repayable on demand or otherwise and withdrwable by
cheque, draft, order, or otherwise.”

Bills of Exchange Act, 1882- Banker includes a body of persons whether incorporated or not
carrying on the business of banking.

BR Act, Section 5(c)- ‘Banking company’ transacts the business of banking in India

WHO IS A CUSTOMER OF THE BANK?

Why ‘customer’ and not ‘consumer’? Section 2(d) of the Consumer Protection Act defines a
consumer as “a person who buys goods or avails services or who uses the goods/services so
availed.”

Since banks provide services to their customers, no other person may operate that account a
customer may be anyone who avails these services. However, the bank provides a fiduciary
relationship with the customer of the bank. (a customer maintains an account with the bank)

Theories and definitions:

 Sir John Pajet- to constitute a customer, there must be some recognizable course or habit
of dealing in the nature of regular banking business. This definition lays emphasis on the
duration of the dealings between the banker and customer and is therefore called the
Duration Theory.
 Dr. Hart- A customer is one who has an account with the bank or whom a banker
habitually undertakes to acts as such.
 KYC norms defined a customer as:

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  A person or entity that maintains an account and/or has a business relationship with a
bank
 One on whose behalf the account is maintained (beneficial owner)
 Beneficiaries of transactions conducted by professional intermediaries such as stock
brokers, chartered accountants, solicitors etc
 Any person or entity connected with a financial transaction which can pose
significant ___________________________________.

Cases:

Great Western Railway Co. v. London & County Banking Co- Where a bank cashed cheques
for about 20 years for a man who had no account with the bank. Both trial judge and Court of
Appeals held that the man was a customer on the basis of Duration Theory. But the House of
Lords took the opposite view since he had no actual account and was merely following the
directions given by his employers

Commissioners of Taxation v. English, Scottish, and Australian Bank Ltd.- Held that
“continuous dealing” was not the essence and that a customer is one who opens an account with
the bank for the purpose of transacting banking business.

NATURE OF BANKER-CUSTOMER RELATIONSHIP

i. Debtor Creditor relationship

Where a banking account is in credit which we may regard as being the normal case, the banker
is the debtor. The relationship between the customer having an account and the banker is:

 Depositor is the lender, banker is the borrower

 Depositor is the creditor, banker is the debtor
 The money entrusted to the bank is a debt
 The money once deposited in the bank becomes the money of the bank and it is the
prerogative of the bank to use the money as it deems fit. The depositor remains an
unsecured creditor in this transaction because the banks give no collateral for the deposit
made.

Folley v. Hill

Facts: Customer opened an account with the bank and the bank did not pay back the interest
when he demanded it. Customer raised issue wanting interest and he wanted to know how and
what purpose the bank utilized his deposit. He contended that on deposit, the relationship was
that of a trustee and beneficiary, not that of a debtor and creditor. This was to gain the details of
the bank’s profit making activity using his deposit

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Held: the deposit is a debt and therefore, a trustee-beneficiary relationship does not arise. The
customer has no authority to ask for the details of how the deposited money was utilized by the
bank. The only obligation that the bank has, is to return the deposited money when it is
demanded by the customer.

Lord Cottenham observed- “Money paid into a banker’s money is money known by the principal
to be placed there for the purpose of being under the control of the banker; it is then, the banker’s
money. He is known to deal with it as his own and he makes whatever profit he can and retains
such profit to himself. He has contracted, having received that money, to repay to the principal
when he demanded a sum equivalent to that sum paid into his hands.”

Joachimson v. Swiss Bank Corporation

Facts: Two German brothers, Sr. and Jr. Joachimson lived in the 1900s and along with a Briton,
formed a partnership firm which was established in London. During the time of World War I,
Britain and Germany became enemies. One brother passed away while the other returned to
Germany. British law stated that on the death of a partner, the firm would dissolve.// The firm
maintained an account with the Swiss Bank. After a few years, the Briton filed a suit against the
bank for the recovery of the amount that was kept in the bank. The basis of filing the suit was the
debtor-creditor relationship but there was no cause of action as such.

The Bank said that it agreed to the debtor-creditor relationship but there was no obligation to
return the money till there was a specific demand made by the customer asking for repayment.
The Court agreed with the position of the bank.

Banks are privileged debtors (for the following reasons):

 Customer cannot demand to know how the banker uses the deposit because the money,
once deposited, belongs to the bank.
 Banker is under the obligation to return the deposited sum only when a request to that
effect is made by the customer.

i. Creditor-Debtor relationship

When a customer avails a loan or an advance then his relationship with the banker undergoes a
change to what it is when he is a deposit holder. Since the funds are now being lent to the
customer, he becomes the debtor and the bank assumes the role of a creditor. The loan may be
secured or unsecured, depending on whether the customer leaves any collateral with the bank on
taking the loan.

The customer, unlike the banker, is not a privileged debtor. He is required to repay the creditor
and cannot afford to wait till the banker demands repayment.

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Difference between approaching DRT and SARFAESI provision for secured and unsecured debts

SARFAESI provides for recovery for only secured debts when the value of the debt is more than 1
lakh. The banker enforces the security interest against the customer since collateral is kept with the
bank.

On the other hand, secured and unsecured debts can be recovered through the DRT Act after an
application has been filed before the DRT.

In Transcore v. UoI it was held that a bank can initiate an action under SARFAESI even if it has
already filed an original application before the DRT.

ii. Banker as a trustee

A trustee holds money or assets and performs certain functions for the benefit of some other
person called the beneficiary. A relationship between the banker and customer as a trustee and
beneficiary depends on the specific instructions given by the latter to the former regarding the
purpose of the use of money.

Some provisions of the Indian Trust Act that apply to this situation are- Section 3, 15, 32.

Examples:

 Bank appointed as receiver: Order 40 of the CPC deals with the Rights, Obligations, and
Appointment of the Receiver of the court. If the court decides that some independent
person shall be appointed to manage the property which is in dispute, the receiver
becomes accountable to the Court.
Banks may be appointed as receivers. However, they cannot utilize the profits or rent
which is received from the property when it is appointed. It is assumed that the bank will
function as the trustee for the party who owns the land/property since that party’s trust is
reposed in the Court.

 Money deposited without any instructions for its disposal on pending further instructions.
New Bank of India v. Pearey Lal (1962)- NBI had its original registered head office in
Lahore which later shifted to Amritsar. Respondent maintained an account with the bank
at Lahore but he was desperate to shift the money to India in lieu of the impending
partition. He quickly disposed of his properties, invested Rs. 1,25,000 (or 1.4 check!)
with the bank in Lahore. While making the deposit, he informed the bank that he
intended to shift to Calcutta where an NBI branch was supposed to be opened. He stated
that once the Calcutta branch was operational, the bank could transfer the money to it.
But the caveat attached was that the bank had to wait for his specific standing instruction
to effect the transfer. He also received a receipt for the same.

16
 Due to the partition, internal disturbance ensued and the govt issued a moratorium on
deposits. Hence, no one could withdraw any money till the particular period had elapsed.
When Lal moved to Calcutta, he discovered that the Lahore branch had already effected
the transfer without waiting for his instruction.

Under the Companies Act, a govt order was issued which stated that all deposits could
not be withdrawn entirely. Only 70.5% of the amount could be withdrawn and the
remaining would be repaid as securities. Feeling aggrieved, Lal approached Cal HC
which gave a ruling in his favour. NBI approached the SC.
SC held: when money was given by Lal to the bank for transfer but the bank was
specifically asked to wait for instructions, the relationship which would arise would be
that of a trustee and beneficiary.

 Unspent balance- Official Assignee of Madras v. J.W. Iron

Facts: a customer credited some amount to the bank for the bank to make an investment
as per the direction of the customer. The bank invested a part of the remitted sum
however a part was left as “unspent balance”. The bank was left liquidated.
Held: the customer would be a beneficiary and the banker must hold the unspent balance
as a trustee. This is due to the fiduciary nature of the trust reposed in the bank by the
customer.

 When a bank receives a cheque from the customer for the collection from another bank,
the bank becomes a trustee till the amount of money is realized.

 If the bank has been unjustly enriched, then it becomes a constructive trustee by
operation of law who will hold the sum till it can repay the party who has been unjustly
deprived.

iii. Bailor-Bailee relationship

For availing locker facilities, the customer enters into a “memorandum of letting” with the bank
i.e. the property is deposited with the bank and the customer pays for this service. The nature of
lending a locker creates the relationship of a lesser and lessee between the bank and the
customer. However, what sort of relationship is created w.r.t. the contents of the locker being
placed with the bank since the bank shrugs responsibility if any loss, destruction, or theft occurs?

In 2006, the RBI issued a notification on locker use and safe custody vaults which was
applicable to all scheduled commercial banks. In that, the RBI acknowledged that the
relationship between the banker and customer was that of a bailor and bailee [there is delivery of

17
goods for the specific purpose of safekeeping and possession is with the bank itself]. However,
in 2007 another notification, with an overriding effect was issued by the RBI which was identical
to the 2006 notification but made no mention of the bailor-bailee relationship. The notification
also stated that the banks are required to take all reasonable measures to ensure safety of the
contents within the locker if they are providing locker facilities.

[Look into- will the bank be held liable for loss caused to the locker property due to its own
negligence?

Ans. The RBI and 19 PSU banks answered in a recent RTI that banks will have no liability
whatsoever irrespective of the cause of the damage incurred]

---

The process of entering into a contract of bailment with the bank-

Banks secure their advances by obtaining tangible securities. Customer is creating a security
interest in favour of the bank by way of depositing movable property (for the purpose of
bailment, the nature of property has to be movable) for the bank to use if the customer fails to
repay the debt. In certain cases, banks hold the physical possession of secured goods, cash credit
against inventories, valuables, bonds, shares etc. Thus, a pawner-pawnee relationship is created
between the customer and the banker [Pledge, according to Sec 172 of the Indian Contract Act].

The pawnee is required to take reasonable care of the properties in his possession like an
ordinary prudent man. This is because all pledges follow the essentials of a bailment and one of
the duties of a bailee, according to Sec 151 of the ICA, 1872, is to take reasonable care of the
property delivered to him.

Balakrishnan R. Dayma v. Bank of Jaipur (pledge)

Facts: Customer pledged the contents of his godown to the bank to secure a debt he incurred. The
customer used to carry on the business and stored cotton bales in his godown. He handed the key
of the godown to the authorized bank personnel, thus transferring possession. The agreement
entered into by the bank and the customer had the following essential elements-

 The customer could continue to carry on business with the contents of the godown by
making prior payment to the bank
 To secure the interests of the bank, the customer had to maintain at least 30% of the
total contents of the godown at all times
 The bank would facilitate the suppliers of cotton bales to dump the goods in the
godown

Once, when the customer visited the godown for an inspection, he found that out of the 53 bales,
17 were missing. Upon inquiry from the bank, the bank disclaimed any responsibility for the

18
matter. But the customer approached the court claiming that since the bank had possession of the
goods, it was their responsibility to maintain it safely.

Held: the Court observed that the nature of the relationship between the bank and customer in the
case was that of a bailor and bailee. The bank had the duty to take reasonable care of the goods
transferred to its possession by way of a contract of bailment. The bank had failed its duty and
was thus made liable.

UCO Bank v. Hema Chandra Sarkar (1990)- bailee for reward

Facts: Hema was related to the textiles industry and maintained a commercial account with UCO
bank. He was appointed as a govt nominee in Agartala and was entrusted with collecting
consignments and ensure that the consignments reached Agartala in time. He entered into an
agreement with UCO which in turn it was agreed that the bank would allow him to withdraw and
keep any goods in the godown in his capacity as a govt nominee. A few months later, UCO
prevented him from accessing the godown which led to Hema and the govt incurring losses.

Held: where any person gives possession to the bank, it is the duty of the banker to allow the
customer to take delivery of goods. Banker was held as a bailee and made to pay compensation
coupled with interest--- for non delivery of goods even after receiving payment.

iv. Mortgager-mortgagee relationship

When it comes to collecting immovable property in the form of collateral, the relationship
becomes that of mortgager-mortgagee. Sec 58 of ToPA defines mortgage as creating an interest
in favour of the creditor when a loan is availed by the debtor from the creditor. One of the most
common forms of mortgage involves deposit of title deed. // A mortgager is also allowed to lease
out the property which is deposited as collateral since Sec 65A of ToPA provides that a
property which has been mortgaged in favour of a mortgagee can also be leased out to the
lessee. This is allowed because a lease does not involve a transfer of title but only possession.
However, 65A states that period of lease should not exceed 3 years.//

Q. A borrows money from a bank B and deposits title deed of property as collateral. A later
leases out the property to C. If A defaults, can the bank still take possession of property? Is there
no remedy that C as a tenant has?

A. Sec 17 of SARFAESI deals with “any person aggrieved by any of the measures referred to in
Sec 13(14).” If the tenant falls within the meaning of “aggrieved person”, then such a person can
file a securitization application before the DRT. Relief can be claimed under Sec 17(3).

Post 2016 when the DRT got the power to deal with such matters arising out of mortgage, the
scenario is that if the bank takes possession of property, then the DRT can rule that such
possession was invalid since there existed a valid lease agreement between A and C. The DRT
has such power under section 17 (4A).

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This resolves the issue wherein the lessee had no right to property prior to 2016 and the tribunal
would generally restore property to the borrower. Post 2016, the DRT got exclusive jurisdiction
to offer remedies to the tenant in these matters even though earlier civil courts entertained
complaints and even HCs allowed writ petitions.

v. Lessor-lessee relationship

Sec 105 of ToPA defines lessor (transferor), lessee (transferee), lease, premium (price), and rent
(money, shares, and services to be rendered).

Providing safe deposit lockers is an ancillary service provided by banks to their customers. The
question of banker’s liability wrt lockers’ content is still not settled. However, providing lockers
has been considered as lease since it is the transfer of right of possession in immovable property.
(relationship is that of transferor and transferee).

As far as rent is concerned, it is provided in the memorandum of letting (the agreement that the
bank enters into with the customer). Premium refers to the initial amount that is required to be
deposited by the customer. A 2007 RBI notification clearly states that the initial deposit that the
bank can demand cannot exceed the rent amount payable for three years. Banks have generally
ignored this notification and demanded exorbitant sums like 25,000-1 lakh.

vi. Principal- Agent relationship

Sec 182 of the ICA, 1872 defines “agent” as a person employed to do any act for another or to
represent another in dealings with third persons. The person for whom such act is done or who is
so represented is called the “principal”. A banker acts as the agent of the customer by performing
functions for the convenience of customers –trades securities, makes and collects payments,
collects dividends.

The banker acts in a fiduciary capacity in this relationship. Sec 212 of the ICA speaks of duty of
the agent to take reasonable care and exercise due diligence otherwise the agent can me made
liable for loss sustained by principal. In the following cases, the bank was held liable under Sec
212 for failing to take reasonable care and employ skill and diligence.

In re Travancore National and Quilon Bank (AIR 1940 MadHC)

The customer gave direction to the bank to remit funds in favour of New India Company,
Bombay. Bank did not actually pay but deducted the charges for the transaction. The customer,
thus, suffered loss because of delay in making payment.

Bharat Bank v. Kashyap Industries (1958, J&K)

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The customer authorized the banker to collect sale proceeds from a third party to which the
customer had sold certain goods. The third party submitted a draft and instructed the customer to
ensure that the draft be encashed within ten days. The customer relayed the instructions to the
bank but the bank failed to follow them. The third party later refused to pay the amount which
resulted in losses to the customer.

vii. Hypothecator-hypothecatee
When the customer borrows money but is allowed to keep possession of movable property which
is the collateral, the relationship with the bank is based on hypothecation.

viii. Assignor-Assignee
Assignment is merely a simple contract which creates a right or interest in favour of another
person. Essentially, I have a right in some property and I can assign the my right in that property
to another person by way of a contract.

 Eg- A sold a TV set to B at an EMI for 2000 payable monthly. A has also borrowed
money from a bank. A can assign his right of rent collection to the bank and hence make
the bank his assignee.
 Eg- Customer can keep his life insurance as a security with the bank and this becomes an
assignment of his interest to the bank. This is permissible under Sec 38 or 39 (pls check)
of the Insurance Act which provides for nomination. In the event of death or maturity, the
bank will be able to reap the benefits from the insurance company first and then the
customer or nominees will get the rest.

Assignment can be partial or absolute. In partial assignment, the insurance amount is greater
than the loan amount and hence the bank only avails a part of the policy. In absolute or compete
assignment, the insurance amount is equal to the loan amount where on death/maturity, the
nominee will receive nothing because the bank’s right will extinguish the amount.

DUTIES OF A BANKER

i. Duty to maintain secrecy or confidentiality of customer’s account

This duty of non disclosure is essential but not absolute.

Tournier v. National Provincial Board, Union Bank of England (1924)

This landmark judgment gave exceptions to the rule of non disclosure- (a) under compulsion of
law; (b) when there is a duty to the public to disclose; (c) where the interest of the bank requires
disclosure; (d) disclosure made by the express or implied consent of the customer.

Facts: Tournier had an account with the bank. He was a contractual employee for eight months
in Keenyan & Co. and his agreement stated that if the company is satisfied with his performance,
he would be made a permanent employee. He continued to perform well and received informal
assurances from the other employees.

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He borrowed money from the bank by availing overdraft facility and agreed to pay the bank in
weekly installments. Eventually, Tournier stopped making his regular payments and the bank
found the address and phone number in the agreement belonged to the Company. Before
contacting the company, the bank conducted an internal inquiry where the transactions of
Tournier were reviewed and found that many of the payments made and received were from
bookmakers.

When the bank called the company director to procure Tournier’s contact details, they happened
to mention Tournier’s transactions with bookmakers which led to his employers terminating his
contract with them because they believed him to be heavily involved in betting. The plaintiff
brought a suit against the defendant on the basis that the latter had breached their duty not to
disclose to any third person either the state of plaintiff's account or any information the defendant
had acquired regarding the plaintiff (plus he alleged slander).

Held: The Court held the bank to be liable for breach of confidentiality. However, the Court
recognized that the duty of non disclosure was not absolute and carved out the above mentioned
exceptions. Tournier had specifically proven that he was not a bookie and thus, the court found
that none of the exceptions applied to the current case.

Shankara Agarwalla v. State Bank of India (1987)- under compulsion of law

Facts: Higher Denomination Bank Notes (Demonetization) Act, 1978 was introduced by which
500 and 1000 rupee notes were demonetized. Agarwalla deposited 261 notes of 1000 rupees each
in his current account for which he filed a declaration that the notes were his + also received an
acknowledgment from SBI. Later, he received a notice from Income Tax authorities informing
him that his account had been attached (i.e. his money had been seized).

Upon inquiry from the bank, he discovered that the bank had to share details of all deposits with
the authorities in light of the demonetization scheme. Since he was a businessman, his
creditworthiness went down because he could not pay off his suppliers on time. Thus, he filed a
suit against SBI for breaching section 44 of the SBI Act. In the meanwhile, the IT department
discovered that Agarwalla had, in fact, paid his taxes.

Held: Bank was not liable for breach because the details were provided under compulsion of law
which is a noted exception.

Kottabomman Transport Co. Ltd. v. State Bank of Travancore (1992)-

Facts: A PSU dismissed an employee after conducting an inquiry and in an appeal, the HC
Division Bench upheld his dismissal. The issue before the court was from which date the
monetary benefit could be given to the employee. The employee claimed that it should be the
date of dismissal as he was unable to meet his daily expenses. KTC made a counterclaim base on
an internal counterclaim that he was employed at a firm in Doha and had also remitted funds to
the Associate Bank/ State Bank of Trav. (subsidiary of SBI). The Corporation wanted the bank to

22
share details of the transactions pertaining to that account but the bank refused. The Bank stated
that under Section 52 of the SBI Subsidiary Act said that information and transactions could not
be divulged to the Manager of the Corp.

Held: Court held that the Transportation company had sufficient grounds to believe that the
dismissed person was gainfully employed in Doha. The Court, thus, agreed to issue directions to
the bank asking them to reveal the information that the company needed.---the duty of non
disclosure is not absolute.

Sunderland v. Barclays Bank (1938)- disclosure in bank’s interest

Facts: A lady, customer of the bank, would frequently issue cheques to someone which the bank
would always honour. But the bank figured out that she was issuing the cheques to a bookmaker,
so they dishounoured the cheque. The lady told her husband (not about the bookie) who then
called the bank manager who politely refused to honour the cheque because it was made in
favour of a bookmaker + she did not have enough balance. The manager, in the process of the
conversation, revealed to the husband the transactions of his wife. Subsequently, she filed a suit
against the bank for breaching duty of confidentiality by leaking information to her husband.

Held: Husband was defending wife’s position in the matter and hence it became necessary for
the bank to justify why it had not honoured her cheque. Therefore, the disclosure was reasonable.

Statutory banking law in India

In India, provisions for fidelity and secrecy are given with their exceptions within various
legislations.

 SBI Act, 1955: Section 44 imposes an obligation upon the bank (directors, employees,
offices etc.) to maintain duty of secrecy and fidelity. But Section 44 has exceptions such
as compulsion by law and customary practice or usage.
 SBI Subsidiaries Act, 1959: Section 52
 Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970: Section 13
 Credit Information Companies Act, 2005: Section 29
 Public Financial Institutions (Obligations as to Fidelity and Secrecy) Act, 1983: Section 3
 Payment and Settlements Systems Act, 2007: Section 22
 RBI Guidelines+ Indian Banks Association (IBA) establishes a body called Banking
Codes and Standards Board of India to evolve a set of voluntary norms which banks
would have to enforce on their own.

A banker will be justified in disclosing information relating to a customer’s account on

reasonable and proper occasions such as:

 Income Tax Act, 1961 Section 131: IT Authorities have the power to conduct inqury
against a person from whom taxes are due. W.r.t. tax evasion, the authorities have the
power to compel banks to disclose information for the purpose of the inquiry.

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  Companies Act, 2013, Chapter 14: deals with inquiry, investigation, inspection. It can be
conducted by the Registrar on the order of the Central Govt. In the process, the inspector
or registrar can ask the bank to disclose information under Companies Act and this
applies to all private banks because they are essentially banking companies.
 Gift Tax Act, 1958, Section 36: Authorities have the power to seek information to look at
evasion of gift tax (similar power to Sec 131 of ITA)
 Income Tax Act , Section 133(6): specifically related to banks, banking companies and
states that IT authorities have power, not in pending inquiry, in other circumstances to
acquire information pertaining to a customer.
 Banking Regulation Act, 1949, Section 27(2): RBI can call for the disclosure of any
information related to the business of banks. Section 28 gives RBI the power to publish
such information to other banks and credit agencies. Section 45 is similar to 27(2) and 28.
For Regional Rural Banks, disclosure can be sought by NABARD also.
 Banker’s Books Evidence Act, 1891: It protects the bank from submitting the original
copies to the Court when called for, certified copies suffice according to section 44.
Section 6 states that if a bank is not a party to the case, but certain information is required
to be produced, the Court needs to order the bank to submit books of accounts etc.
 CrPC, 1973, Section 91: If the court deems it essential to get information from the Bank,
it can pass an order for it
 FEMA, 1999: RBI has a number of powers under this Act. Section 10 dealing with
‘authorized persons’ states that not everyone can deal in foreign exchange and securities,
only authorized persons can. Banks and financial institutions fall under the ambit of such
persons. Section 12 speaks of the power of the RBI over an authorized person i.e. RBI
can conduct investigations and inquiries on such authorized persons.
 IDBI Act, Section 29: Duty of secrecy and fidelity. Section 29 (1A) states that IDBI has
the power to collect information from any bank or banking company and have the power
to disclose its information as well.
 Prevention of Money Laundering Act, 2002, Section 12: Every bank and banking
company has to maintain accounts for 10 years. It further says that authorities under
PMLA require information, banks have to produce it expeditiously.

ii. Duty to honour cheques drawn by customers on their account and collect
cheques and bills on their behalf

3 important parties in a transaction- (a) drawer [issuer, maker of cheques]; (b) drawee [always a
bank or financial institution with whom the drawer maintains an account]; (c) payee [the person
to whom the cheque is paid].

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Section 31 of the N.I. Act imposes an obligation upon the drawee to honour a cheque whenever
sufficient balance is present in the account and if due to negligence they fail to honour the
cheque, the drawee will be held responsible.

Exceptions to this liability are:

 Stop payment instructions from account holder: when a cheque is issued, any person
holding it can encash it unless it is crossed (crossed cheque means that only the payee can
encash it). In the event that the cheque gets lost, the customer will give the bank
countermanding or stop payment instruction so that the cheque will no longer be payable.
This is generally done when the customer has sufficient balance.
Q. What if this instruction is used to escape liability?
Eg. A owes B some money and B demands repayment. A issues a cheque despite not
having sufficient balance. Thus, A issues a countermanding instruction to avoid attracting
sec 138 of the N.I. Act. Pls figure out actual legal position on this

 Notice about death of the drawer- when bank gets constructive or explicit notice of the
death
 Income Tax authorities can attach account of customer where dues are present in favour
of IT department. Authorities under Section 226(3) of the IT Act can direct the banks to
attach account which does not allow them to honour cheques

 Garnishee order (Order 21, Rule 46a CPC): A borrowed 3000 rupees from B. B has the
right to recover the debt and debtor has the duty to repay. But A did not repay B. B will
now approach the Court. The Court will issue a decree in favour of B and the execution
proceedings will start. Thus, A is a judgment debtor and B is a decree holder/judgment
creditor.
B gets wind of the fact that A maintains an account with SBI and it has some money. B
will file another application under Order 21, Rule 46 to ask for a garnishee order. A
garnishee order is always passed against the judgment debtor’s debtor, which in this case
would be the bank (since the primary relationship of opening an account creates a debtor-
creditor relationship). This will ensure that the funds in the account are frozen upto the
debt amount, i.e. 3000.
Garnishee order is issued in two phases- order nisi or interim order and Absolute/final
order. When order nisi is furnished, the bank is given the opportunity to explain why the
money should not be attached to make payment towards B. As was held in Quist Close
Trust v. Barclays Bank, the bank has a primary right of set off against the customer (if
customer has a credit and debit account with the bank, the bank can settle its debt against
the debit account of the customer). Thus, if bank has a right of set-off, then that claim
will be entertained first but if not, then B can avail the funds in A’s account under the
order. The bank is allowed to make a representation before the Court.
However, once a final order is passed, no representation is allowed to the bank.

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  Stale cheque: Cheque presented at the paying bank after the prescribed period of its
payment date, which according to an RBI notification is three months. A stale cheque is
not an invalid cheque, but it may be deemed an irregular bill of exchange. A bank may
refuse to honour it unless the drawer reconfirms its payment either by inserting a new
payment date or by issuing a new cheque.

i. Duty to pay bills as per standing instructions of the customer

ii. Duty to provide proper services
iii. Duty to act as per the instructions of the customer (if instructions are not given, then the
banker is supposed to act according to how he is expected to act)
iv. Duty to submit periodical statements informing the customer of the state of his account
v. Articles kept should not be released to a third party without due authorization

RIGHTS OF A BANKER

i. General lien
Lien is a right of the bailee to retain. Section 171 of the ICA confers the right of general lien to
banks and there are only five categories of people who can exercise a right of general lien-
bankers, factors, wharfingers, attorneys of a HC, policy brokers. In the absence of a contract to
the contrary, these people may retain, as a security for a general balance of account any goods
bailed to them, but no other persona have a right to retain, as security for such balance goods
bailed to them.

Q. Can a right to general lien be equated to implied pledge?

A. Section 176 of the ICA pledgee can sell off the pledged goods to recover the money. Section
6(1)(f) of Banking Regulation Act states that a banker can manage, sell, and realize any property
which may come into the possession of the banking company in satisfaction or partial
satisfaction of any of its claims. Thus, general lien of the bank can be equated to an implied
pledge.

Exceptions to right of general lien

 A contract where the banker agrees not to exercise general lien

 Goods/securities received as a trustee or agent
 Safe custody deposits
 Cannot exercise lien over securities lodged with the bank to secure a loan before the loan
is actually granted
 Securities left with the banker negligently
 Money- it is not a good (according to SoGA) and the banks can exercise a right of set off
but not that of lien. Moreover, the Jochamison case the Court acknowledged that once
deposited, the money becomes the property of the bank. For exercising the right of

26
 general lien, the possession should be with the bailee while the ownership remains with
the bailor.

Relevant case laws:

Nakulam v. Dep. Gen. Manager, Canara Bank (2013)

Facts: Customer availed a personal loan which was unsecured. Customer also availed a gold
backed loan. Customer defaulted in repaying both loans. After the bank threatened to sell off the
gold, the customer agreed to pay off the gold loan but the bank refused, claiming that the
customer should pay off both debts since the bank has a right of general lien. The customer
contended that bank has a right to particular lien in this case.

Held: the Court decided in favour of the bank and acknowledged the right of general lien.

SBI, Kanpur v. Deepak Malviya (1996)- same as Nakulam

Stephen v. Chandra Mohan & Ors. (1990)

Facts: A customer availed a secured loan from the Bank. It was also a security for another loan
from the same bank. The customer paid off the loan but the principle debtor of the other loan
failed. The bank contended that it can claim the right of general lien for not giving bank the
secured goods for the first loan.

Held: liability is co-extensive, i.e., the customer’s

M. Mallika v. SBI (2006)- similar to Stephen case

Syndicate Bank v. Vijay Kumar

Facts: Jalandar Body Building Co. borrowed a sum from Vijay Kumar. The company defaulted
and Vijay Kumar went to Delhi HC. The HC decided in favour of Vijay Kumar. During the legal
process, Vijay Kumar discovered that the company had an account with a Bank and prayed for
the Court to issue a garnishee order.

The company had agreed to pay back in installments monthly but Vijay Kumar demanded a bank
guarantee. Syndicate bank was approached for the same. The company had to deposit 2 FDRs to
get the guarantee. The Bank also made the company sign a cover letter, a clause which stated
that the Bank shall retain the FDRs until the entire amount is paid back. Due to a disagreement
between the company and Vijay Kumar wrt monthly installments. Vijay asked the Court for a
garnishee order for the fixed deposits—order nisi was issued by the Court to the Bank.

Bank contended that the company had taken overdrafts, so they could not hand over the FDRs
since they exercised right of general lien. But Delhi HC ordered that the bank could not use it fr
overdraft because it had not kept any security for that.

27
Held: The SC held that once the FDRs mature, the Bank can exercise set-off since it was a case
of general lien. Even though the FDRs had something written wrt the specific area for which
they were to be used, there was no express agreement. The general lien of banks cannot be
extinguished except by way of express contract in this case.

ii. Set off

The right of set-off is also known as combination of accounts. The right arises when the
customer maintains two or more accounts with the banks, one which is in credit with the other in
debit. In the exercise of this right, the banker, in effect, combines two or more accounts of the
customer and uses the credit in one to offset the deficit in another account.

Conditions while exercising right to set off:

 The account should be in the sole name of the customer

 The amount of debt must be certain and measurable
 There should not be any agreement to the contrary
 Funds should not be held in trust accounts
 The right cannot be exercised in respect of future or contingent debts
 The banker has the right to exercise this right before a garnishee order is received by it

Shimla Banking and Tading Co. Ltd. v. Bhagwan Kumar

Customer borrowed money from the Bank and also had a joint account with the same bank. The
bank exercised set-off on the joint account. The Court held that unless both the owners of a joint
account have not borrowed jointly, joint account will be an exception to the right of set off.

Firm Jaikishen Das Jinda Ram & Ors. v. Central Bank of India AIR 1960 PH1

Two firms with the same set of partners have an account each in the same bank. Can the bank
exercise its right of set-off against the account of one firm when the other has defaulted in
repayment? The Court held that the partners collectively came together to form the firms and the
partnership firm by itself has no separate legal identity. The partners are jointly liable for the
firm’s liabilities and hence set-off can be exercised.

Devendra Kumar Lalchandji v. Gulab Singh Nekhe Singh (1946)- right of set-off was
acknowledged

iii. Appropriation
Section 59, 60, 61 of the ICA, 1872 regulates the appropriation of payments. Applies where the
same debtor has more than two distinct debts with the same creditor. Eg- A has three loans, for
rupees 3000, 4000, and 5000. There are three situations that can arise:

 The debtor pays some amount to the creditor with specific instructions and then the
creditor will utilize the funds accordingly

28
 If the debtor gives no specific instruction as to which debt is supposed to be paid off with
the amount paid, the bank can use its own discretion. For instance, if A has paid rupees
3000, then the bank will wipe off the first debt for rupees 3000.
 If the debtor gives no specific instruction as to which debt is supposed to be paid off with
the amount paid, but the bank has failed to apply discretion, the debt that will paid will be
the first in time. The first in first out (FIFO) or Clayton’s Rule was laid down in
Devaynes v. Noble.

29
 Module III: Banking Regulation Act

HISTORICAL BACKGROUND

 The National Credit Council was set up in 1967 and was a key feature of the social
control scheme dissolved post nationalization. It had 25 permanent members and the
Finance Minister served as the Chairman and RBI Governor served as VC and
representatives of agriculture, trade, industry, banks and professional groups. Objectives
of NCC:
a. To assess the requirement of bank credit in various sectors of the country
b. To determine the priorities of sectors of economy based on requirements of the
various sectors. It would priortise sectors based on available resources,
infrastructure and need
c. To coordinate in relation to priority sectors b/w commercial, cooperative and other
specialized banks
Summation: National Credit Council set up to provide a forum to discuss and assess
credit priorities on an all India basis. Council was to assist RBI and government to
allocate credit. NCC reflected social control aims of the govt which were later seen in the
1968 Amendment to the BR Act **

 The BRA (haha no) was created as an effort to consolidate existing banking laws to
facilitate regulation of banks. Before this they were merely regulated by the Companies
Act.
 BRA deals with various aspects of banking such as winding up, paid up capital
requirement, licensing, regulation, expansion of banking, powers and composition of RBI
in the regulation process etc. (over and above the RBI Act also)
 The Act governs all institutions carrying on banking activities in India such as private
banks and foreign banks
 **Some of the provisions of the BRA that were amended with social control in mind
were:
a. Sec 10 A- BoD to be diversified and include members from different areas (refer page
29)
b. Sec 10 B- Every banking company should be managed by a full time chairman who
shall have expertise in working of business management, banks and financial
institutions.
c. Sec 20- Loan restrictions to Directors of banks (unsure about this)
d. Sec 30- Audits conducted by the RBI- imp because it encourages transparency and
enables the RBI to be in the loop about the activities carried out by banks in general
interest of the public. RBI could conduct special audit in addition to general audit if it
had doubts regarding the bank, even in internal aspects.
Substitutions and changes to Sec 30

30
 e. Sec 35 B- No banking company shall appoint/ remove, MDs, Directors w/o the prior
approval of the RBI
f. Sec 36(1)(d)- Sec 36 deals with “further powers and functions of the RBI”—Sec
36(1)(d) for instance, allows the RBI to take certain steps if the company is being
conducted in a manner that is detrimental to the interests of the company or its
depositors such as-
 Require company to call a meeting of directors
 Depute one or more RBI officers to such meetings and be given an opportunity to
be heard at these meetings and send a copy of a report made to the RBI
 Board must keep the appointed officer abreast with its meetings by way of regular
communications
 Appoint one or more of its officers to observe the functioning of the company and
make a report about it
g. Sec 47 A- power of RBI to impose penalty on the banking company– a provision
which was inserted in 1968.

2SPECIFIC PROVISIONS OF THE BR ACT

(must read bare act; no alternative)

Applicability: The act applies to

1.Nationalized Banks(S.51)

2. Non-nationalized banks (private and others).

3. cooperative banks (by way of 1965 amendment)

Does not apply to

1. Primary agricultural credit society

2. Cooperative land mortgage society
3. Any other Co-Op unless to the extent in Part V

Relating to business of banks

Section 6- Forms of Business which banking companies may engage in- an exhaustive list is
provided in sec 6(1) + Sec 6(2) prohibits BCs from carrying on any other businesses.

(a) Exhasutive list of buying selling and ossues various stuff

(b) Agents for any government or local authority or persons, and carrying on the business of
agency including attorney but excluding Managing Agent or Secretary or Treasurer
(c) Contracting for public and private loans and negotiating and issuing the same
(d) Effecting/Insuring, underwriting carrying out any issue, (public, private, of state
municipal or other loans) or of shares, stock, debentures etc
(e) Every kind of guarantee and indemnity

31
Some exceptions to business, i.e., the modes of business that cannot be adopted by banks can be
found in

Section 8 Prohibition on trading (-- buying, selling or bartering prohibited unless done for bills
of exchange or realization of security etc). Goods mean movable property other than actionable
claims such as securities.

Section 9 Disposal of non-banking assets (-- bank cant own immovable property for more than
seven years, except such as is required for its own use). In 7 years it may trade in any such
property for it’s disposal+RBI can allow extension not exceeding 5 years.

Section 7- there is a prohibition on the usage of the terms “bank”, “banker”, “banking”, and
“banking company” in the names of companies that are not banking companies. The exceptions
are subsidiaries and associations of Banks formed under S.25 of Companies Act.

Section 10: Prohibition of employment of Managing Agents and restrictions on certain forms of employment

Sec 10 provides that no banking company

 shall employ or be managed by a managing agent

 shall not employ/continue employment of a person convicted of offence relating to moral
turpitude, insolvent, etc [read 10(1)(b)(i)]
 shall not employ/continue employment of a person receiving remuneration through
commission or profits in the company.

(Commission doesn’t include bonus-

-No bar on payment of commission to actual agent like auctioner or those under contract. )

or whose remuneration the RBI deems to be excessive (this is final and binding). How to
determine “excessive rem”—

a. if rem is detrimental to interest of depositors of the company

b. financial soundness depending on volume, size of business, earning capacity
c. number of branches- more branches = more likely to be financially sound
d. qualifications, age, expertise, academic standing of person
e. industry practice
 It shall not be managed by:
a. Someone who is the director of another banking company. Exceptions:
o Subsidiary of the BC
o Company under Sec 25 of the Companies Act, 1956 which is essentially a non
profit company.
b. Engaged in another business

32
 c. Manage the company for more than five years at a time. Proviso says this can be
extended but before 2 years of such position coming into force

Section 10 A- BoD to include persons with professional or other experience.

 51% of the Board should should reflect- accountancy, agriculture and rural economy,
banking, cooperative sector, economics, finance, law, small scale industries.
 At least 2 should consist of agriculture, rural economy, Co-operation and small scale
industries to ensure that resources are effectively channelized to these sectors
 Director cannot be sole proprietor (other than that of a small scale industry). He cannot
have substantial interest in or be employee of
 Person cannot serve as director for more than 8 years but re-election and re-appointment
are not disallowed.
-If he is removed from office, then no reappointment by relectino or cooption can be
done for fours from such removal
-If a director of one BC is temporarily appointed director for another (three months, can
be extended to 9 months), it might be allowed
 RBI monitors compliance. In case of non-compliance with these provisions, RBI can
direct the company to re-constitute its BoD after an opportunity to be heard is provided//
if after 2 months, the BoD is still not re-constituted, the Board may decide by draw of
lots, which members are to retire and remove them from office with a view to comply
with the provisions.
 Process is as follows (GIVEN BY GARIMA)
 3 months given to reconstitute the BoD
 RBI will then give reasonable opportunity of being heard and serve written notice
to constitute Board in 2 months
 If not done in 2 months, that Bank may determine by draw of lots and appoint a
new person who shall be deemed director
 If not done in two months, RBI itself will reconstitute the Board and the decision
ill be final and binding.
 Every appointment, removal, reconstitution, election duly held under section 10A shall be
final and cannot be questioned before a court [ sub sec 6]
 The final and binding nature of RBI decision under 10 and 10A should be differentiated –
10 speaks only about deciding on remuneration while 10A deals with the ability to alter
the constitution of the entire board itself

Section 10B- Banking company to be managed by whole time Chairman

 The bank can appoint either a whole time Chairman or a part time Chairman (for PTC,
they will have to appoint a Managing Director with the approval of RBI). The WTC and
MD are involved in the day to day affairs of the Bank.
 Can be appointed for 5 years with reappointment.
 DISQUALIFICATIONS

33
  The WTC and MD are required to possess special knowledge and practical experience of
the working of BCs, or finance, economics, business administration.
 Power of the RBI- if the RBI doesn’t find the WTC or the MD to be fit and proper for that
position, it can after giving written notice and an opportunity of being heard, allow two
months for fresh appointment. Failing which, the RBI itself can remove the person in
question and appoint a new person to that position.
 Appeal- the aggrieved person and BC can appeal the order of removal before the Central
Govt. within 30 days post which the decision of the RBI becomes final and binding.
 The WTC or MD shouldn’t accept directorship is another company (exceptions are
subsidiary of the BC or Sec 25 of the Companies Act)

Section 10BB- Power of RBI to appoint WTC or MD

 The banking company has a vacant seat, and the RBI must be of the opinion that it is
against the interest of the depositors. He shall be a deemed director if not already
 RBI can accordingly appoint a WTC or MD whose tenure is 3 years
 RBI appoints such person and only RBI can remove him/her

Section 10C- Chairman exempt from Qualification shares

 Qualification shares were a requirement prescribed under the Companies Act 1956. It
was a requirement to be a Director that the said person must hold qualification shares to
nominal value of Rs 5000. This requirement is not found in the 2013 Act.
 10C states that any Chairman or MD, or director appointed by the RBI is exempt from
satisfying the requirement of qualification shares

Q. Can a banking company list its shares in a stock exchange?

A. Yes, they can. Banking companies refer to private sector banks which can list their
securities on the stock exchange.

[for an understanding of stock exchanges, and the relevance of the terms- corporatisez,
demutualized and regularized, refer to pages 21-23 of Dashan’s notes

Section 11: Requirement as to minimum paid-up capital

 The deposit is to ensure the safety of the depositors of the bank.In case of BC
incorporated outside India
 Min paid up capital= 15 lakh
 Min PC if it has a place of business is in Bombay or Calcutta or both= 20 lakh
 This capital amt + 20% of its yearly profits have to be deposited with the RBI.
Read sub clause 2(b) in cash or securities.
 In case of Indian banking company

34
  (if more than one state) Min paid up capital= 5 lakh
 Min PC if place of business is in Bombay or Calcutta or both= 10 lakh
 1 lakh rupees which is in one state and not in Bom or Cal= 1 l+10k+ 25K not
exceeding 5 lakhs.
 If it has only one place of business= 50K

Section 12: Regulation of paid-up capital, subscribed capital and authorised capital and voting
rights of shareholders

 Authorized capital- also called registered capital is the maximum amount which a
company can issue through its securities in its lifetime.
 Subscribed capital- when a company goes for an issue of shares, the amount allowed to
be issued is called "issued capital", while the amount actually subscribed to is called
"subscribed capital". The BC will issue prospectus and the interested shareholders who
will give EoI for shareholding will be the subscribed shareholders
Sub capital cannot be less than ½ of the authorized capital
 Paid up capital- the amount which a company gets from its subscribed shareholders who
have actually subscribed to the securities of the company.
Paid up capital cannot be less than ½ of the subscribed capital

Can only consist of equity or preference shares

 Equity shareholders have voting rights in the company personally or by proxy. Sec 12(2)
deals with the extent of voting rights in a banking company. General principle of corp
law is that voting rights are proportionate to total shares. Sec 12(2) however makes it
clear that irrespective of the proportion of shares held, one person shall not vote in excess
of 10% of the total voting rights of the all the shareholders.
 The 2013 amendment sought to increase to 10% threshold to 26% in a phased manner.
Currently, the ceiling is at 15%
 In nationalized banks, the government holds maximum shares and the max voting rights
of equity shareholders is 1%. Sought to be increased to 10% in a phased manner.
 Every chairman and MD must disclose his holding of shares whether directly or
indirectly or any change in his holding

Section 12B- Regulation of acquisition of shares or voting rights

If the person who wishes to acquire shares, along with his shareholding, his associate enterprise,
relative and person acting in concert taken together amounts to more than 5% of the shares or
voting rights -whether institutional or non-institutional person shall be allowed to hold shares
only with the prior approval of the RBI. RBI will monitor as to who has a substantial interest in
the company’s shareholding. If approval is given by RBI, only then can that proportion of shares
be allotted to one person.

35
 Approval is based on interest of public, detrimental etc.

 If approval not given, then RBI may issue order not to cancel the shares or nullify the effect
of cancellation and he would not exercise voting rights.

 If any person holds more than 5% of shares which RBI believes to be unfit, after hearing
opportunity may direct not ot hold the same.

Random sections mentioned

 Sec 16- restricts director of one company from being the director of another
 Sec 17- a reserve fund is to be created every year out of the profits generated by the
BC
 Sec 20- restriction upon a BC wrt loans and advances- prohibits giving loan to any of its
directors, any firm in which the director may be interested, any company of which the
director is a director/manager etc
 Sec 27, 28, 29 (Secrecy related)- only mentioned in passing

Section 22- Bank licensing

 Bank licensing was started with the recommendation of the Central Banking Inquiry
Committee, before which there was no such requirement and BCs were treated like
regular companies. Thus, power was given to the RBI to issue licenses to BCs.
 All BCs that existed prior to the 1949 Act were required to make an application the RBI
within six months of the Act coming into force. All such BCs that came up afterwards
could not start banking business until they had obtained their licenses.

 Licensing window was open from 1949-1950something, post which it was closed. Then
Nationalization led to the constitution of the Narsimham committee which recommended
licensing windows again. Window opened again in 1993 and some licenses were granted

 Window closed later and re-opened in 2003-04

 ‘on tap’ licensing policy is followed for Universal Banks for which RBI released
guidelines in 2016
 RBI conducts its own inspection before granting licenses in order to assess financial
soundness. It will inspect books of account and financial statements of the applicant bank
in addition to assessing their documents.
 If bank is aggrieved by the decision of the RBI, it can appeal to the central govt within 30
days.
 Sec 22 (3A) deals with Banks incorporated outside India that wish to carry on business in
the country. If any foreign bank enters Indi through wholly owned subsidiaries, this
provisions requires an application to be made to RBI for licensing. The same procedure
would be applicable here.
 Sec 22 is not applicable to nationalized banks

36
Sajjan Bank Ltd v. RBI (Madras HC)

Facts: Sajjan Pvt. Ltd. was incorporated under in 1944 and was involved in money lending
activities in 1946 and then the company also started doing banking business. In 1949, Banking
Companies Act came into force and according to Section 22, Sajjan Bank made an application
for license within six months to the RBI. RBI took more than 2-3 years and conducted an
inspection in 1952. RBI became aware of a number of defects and irregularities and found that
the bank was financially unsound. It forwarded the report to the bank and asked the bank to
correct the noted defects.

Another inspection was carried out in 1956 which revealed similar irregularities. RBI issued
show cause notice asking bank to explain why license shouldn’t be refused. After listening to the
representation of the bank, RBI refused to grant license.

Petitioner’s Contentions:

a. Sec 22 is unconstitutional because it infringes the right of the petitioners to carry on trade
under 19(1)(g)
b. Sec 22 id arbitrary because excessive power has been given to the RBI
c. When RBI decided not to grant license, it formed its opinion based on the inspection and
the two reports made during said inspections. The power to conduct inspections is under
Sec 35. The petitioner contended that under Sec 35(4) it was said that where on the basis
of report submitted by RBI to the Central govt, the RBI finds that it is detrimental for the
people for the bank to carry on banking activities, two actions can be taken:
 Banking company shall be asked not to accept any fresh deposits
 RBI may file winding up petitions under Section 38 before a competent court.

Section 35(4) did not allow for RBI to refuse granting of license on the basis of the
report

Respondent’s Contention:

a. Reasonable restrictions could be imposed by the State under Art 19(6). The restrictions in
this case were placed upon banking activities and the petitioner wasn’t precluded from
continuing money lending activities.
b. Sec 22 isnt arbitrary because the RBI decided eligibility according to proper guidelines
made by it. RBI makes recommendation and the Advisory committee decides whether of
not the license should be granted.
c. Sec 35 would be applicable wrt inspection which could be done by the RBI only in
relation to companies which were already in existence and license had already been
granted. The petitioner’s company did not meet the specifications and hence section 35
was not attracted.

Court held:

37
The petition was dismissed and the Court said that sec 35 would only be applicable to companies
which were already in existence and license had already been granted. RBI could revoke
license under Sec 22 in the following circumstances:

 Where the BC ceases to carry on banking business

 When RBI imposes guidelines, it also contains certain restrictions. License is generally
not granted immediately on application but there is an approval period of one year and
the bank must adhere to the conditions laid out by the RBI. If conditions are not followed,
then the license can be revoked after that one year period.
 RBI would have to satisfy sec 22(3) of the BRA

Section 23: Restrictions on opening of new, and transfer of existing, places of business

 No BC shall be allowed to expand its banking by branches without the prior permission
of the RBI whereby an extension plan needs to be submitted to the RBI.
 Sec 23 is read with Rule 12 of Banking Regulation Rules which deals with the
contents that are required to be submitted.

 Inspection is conducted by the RBI wrt the financial soundness 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

 BRANCH AUTHORIZATOIN: the bank and only nce the extension plan has received
the approval of the RBI (on the basis of adherence with branch authorization policy)
can the branch be established
 Branch authorization deals with merger of branches in addition to establishment of new
branches.

RURAL BRANCHES

 RBI learnt in 1999 that only 5% of the branches of banks were located in rural/semi rural
areas. This was rectified with 2011 guidelines that state that 25% of branches must be in
rural and semi rural areas (in tier 5 and tier 6 cities). This section is applicable to foreign
banks in addition of private banks
 RBI decision is final and binding wrt branch extension and cannot be challenged
before the Central Govt.

Section 26: Return of unclaimed deposits

At the end of every calendar year, the BC is required to submit a return to the RBI with the
names of all such accounts that have been operated for ten years. Such accounts constitute
unclaimed deposits.

38
 Section 26A: Establishment of Depositor Education and Awareness Fund

 Cover accounts which have not been operated for 10 years or the deposit of which has not
been claimed
 This provision was inserted by the 2013 amendment act to ensure proper utilization of
unclaimed deposits lying with BCs- special emphasis was laid on its creation in the 2013-
14 Monetary Policy.
 These unclaimed deposits get transferred to a fund that is maintained and managed by the
RBI within 3 months of the deposits being declared unclaimed.

Q. If unclaimed deposit if transferred to the RBI, what will happen to the depositor’s claim over it?

A. Proviso to 26A(2) reads- nothing contained in this sub-section (sub sec 2 of 26A) shall prevent a depositor
or any other claimant to claim his deposit or unclaimed amount or operate his account or deposit account from
or with the banking company after the expiry of said period of ten years and such banking company shall be
liable to repay such deposit or amount at such rate of interest as may be specified by the Reserve Bank in this
behalf.

 REPAYMENT: When the bank as repaid any such claimed amount, refund from Fund
will get.
 USE: for the promotion of depositor’s interests.
 The funds are to managed by an authority or committee which is required to be notified
in the Official Gazette [26A(5)]. The composition of such committee is decided by the
RBI and the tenure is 2 years with scope for re-appointment.
 Ex-officio chairman- deputy governor of RBI
 2 members who shouldn’t be below Chief General Manager
 Chairman and MD or CEO of a bank nominated on rotation basis
 Expert
 One person to represent interest to depositors and customers of a Bank
 One Member Secretary not below the rank of Chief General Manager

Section 30: Auditing

 The balance-sheet and profit and loss acc 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.
 Every BC shall, before appointing, re-appointing or removing any auditor(s) seek the
permission of the RBI
 Auditor’s independence is crucial for corporate governance. Auditor(s) should not have
any relation including substantial interest in the company. To ensure independence,
Companies Act 2013 has even prescribed for periodic rotation of auditors

39
  Section 30 also talks about special audit which may be directed against a BC if the RBI
feels that it is necessary in the interest of the depositors. RBI can appoint a person on its
own discretion for this purpose.
 Requirements in the report of a BC’s auditor:
 Whether explanation and information furnished to Auditor are satisfactory
 Whether transaction and activities of BC are within the powers of the company
 Whether returns received from branch offices of the company have been found to
be adequate
 Whether profit and loss account reflects true balance for that period
 Any other matter which he thinks should be brought to the notice of the BC’s
shareholders

Section 35: Inspection (no test or criteria for this)

 When there is an order of the Central Govt asking for inspection of a BC, only then shall
RBI conduct inspection. Whenever a public sector bank is concerned, RBI will take
action in consultation with the govt.
 Under this section when RBI officers inspect, every Director or officer must furnish any
information or document under his custody to him. RBI officers can also examine such
officer or Director on oath.
 CG after directing RBI to understake inspection and on the basis of such report if
convinced that its in the interest of deposit holders, AFTER giving opportunity of
hearing, direct:
 Banking company shall be asked not to accept any fresh deposits
 Direct RBI to file winding up petitions under Section 38 before a competent
court.

Section 35A: Power of the RBI to give directions

 RBI can issue general (general policy) or specific (to a particular BC) directions based on
depositors interest, public interest, securing proper management of the BC
 RBI must be satisfied of public/banking interest, to prevent affairs being conducted
predjuicial
Banking Amendmentto interest of depositers or banking company; or secure proper management
Bill, 2017
 Eg of general policy- KYC, Banking ombudsman
 Egseeks
of to insert Section
Specific policy- 35AA and 35AB.
RBI recently This has
issued been direction
specific proposed toin lieu of the IBC
Bhilwara Mahila
and in relation
Cooperative Bank to stressed assets fresh
to not accept and for their expeditious
deposits, not issue recovery.
loans, not to enter into new
 settlements
These sections will also
without the apply
prior to Public Sector
approval of thebanks
RBI. This was done because several
 irregularities
Sec 35AA giveswere power
found to
withthethe
central govt-section
BC and Central35A
govtacted
mayasissue directions
a remedial to the as
measure
RBI so tothat
opposed the RBI can
cancellation take necessary action for triggering the IBC and recover
of license.
stressed assets through the Code.
 Sec 35AB gives power to the RBI in two clauses (Which is super important in cases
wherein banks themselves cannot take action against defaulters due to political
reasons like Kingfisher) :
1. Gives power to the RBI to trigger the code and issue directions
2. Advise BCs and RBI may constitute advisory 40 committee to the trigger IBC
 Section 51 of the BRA should include Sec 35AA and AB and make them applicable
to Nationalized banks
SECTION 35AA (PROPOSED): The Central Government may, by order, authorise the Reserve Bank to issue
directions to any banking company or banking companies to initiate insolvency resolution process in respect of a
default, under the provisions of the Insolvency and Bankruptcy Code, 2016. Explanation.—For the purposes of this
section, “default” has the same meaning assigned to it in clause (12) of section 3 of the Insolvency and Bankruptcy
Code, 2016.

SECTION 35BB (PROPOSED): 35AB. (1) Without prejudice to the provisions of section 35A, the Reserve
Bank may, from time to time, issue directions to any banking company or banking companies for resolution of
stressed assets. (2) The Reserve Bank may specify one or more authorities or committees with such members as the
Reserve Bank may appoint or approve for appointment to advise any banking company or banking companies on
resolution of stressed assets.'.

Section 36: Further powers of the RBI

 RBI may prohibit banks from entering into transactions which are detrimental to the
interest of depositors
 On request, RBI may advise BCs on compromise arrangement including Mergers,
Acquisitions etc.
 RBI may also give assistance to BCs in the form of loans and advances as per Sec 18 of
the RBI Act
 RBI can appoint an observer to observe the dealings of a BC and depute officer to attend
meetings of the BC
 RBI may also direct that all notices, meetings, and minutes of meetings of the BoD be
justified to it---where RBI is of the opinion that action is required, it may do so under Sec
36.
 Sec 36(2) makes it mandatory for the RBI to come up with an annual report on Trends
and Progress of Banks in a financial year with particular reference to activities under sec
17(2) of the RBI Act. The document contains number of banks, data of banking, stressed
assets, NPAs etc.

41
Part IIA: Control over Management

Section 36AA-

 deals with the power of the RBI to remove managerial and other persons from office if it
goes against public interest, depositors’ interest or prevents affairs of a BC from being
carried out--- for reasons recorded in writing.
 The decision will not be acted upon unless reasonable opportunity of hearing has been
provided to the Bank.
 The person removed, shall vacate his office. He shall cease to have that position or be
related directly or indirectly in any way with the management of the BC. The person so
removed is prevented from holding a position in the same or another BC for 5 years.
=Power of fine Rs.250
=No compensation for termination
 The person so removed can prefer an appeal before the central govt within 30 days of the
communication to him of the order
 Reserve Bank may, by order in writing, appoint a suitable person in place of the person
so removed
=for a period of 3 years
= not incur any obligation or liability by reason only of his being
a 1[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.

Section 36AB- gives power to appoint additional directors where interest of the depositors has to
be protected. These additional directors can hold office for max 3 years

Sec 36ACA-

 RBI, in consultation with the government, on usual grounds- decide to supersede. Period
of 6 months, not exceeding 12 months.
-Appoints an administrator in consultation with the Government who has experience in
all of the above fields
-RBI power to issue directions to the Administrator
 Gives the RBI the power to supersede the management of a BC for a max period of 12
months. Provision was inserted by 2012 amendment.
 This provision is similar to Section 18A of the Nationalization Act of 1970 and 1980
which allows the Central Govt to supersede the Board of a nationalized bank in
consultation with the RBI
 Power is also similar to some provision under SCRA which gives SEBI the authority to
supersede the board of a stock exchange
 Palai Central Bank anecdote: Palai Central Bank (PCB) was a well renowned Bank with
a large depositor base in south India. The initially strong BoD deteriorated and ended up

42
 falsifying financial statements. RBI discovered this during an inspection and served a
show cause notice without taking stringent action (such as cancellation of license) that
would disturb the vast client base. The RBI could only remove members of the Board and
appoint additional directors in their place for a max period of 3 years. At that time, RBI
did not have the power to supersede the Board of a Bank. Thus, the powers of the RBI in
the management of a BC are essential and their importance can be seen through this
example where it was difficult for the RBI to act.
 From the day the notice is served, the entire bank is to be vacated. Administrator who is
qualified in banking finance should be appointed by RBI in consultation with central govt
who will have responsibility of the bank--- people so removed cannot claim
compensation
 A 3 member committee having experience in banking will assist and advise the
administrator in managing the BC
 The Administrator must ensure that the BoD is removed by calling a general meeting

Section 36AE- deals with the Power of the Central govt to acquire undertaking of BC in certain
cases.

 Sec 35AE(1) states that if a BC fails to comply with the guidelines issued under 35A and
21, the Central govt based on an RBI report may go to the extent of acquiring the BC.
Undertaking refers to assets, liabilities--- similar process to nationalization.
 This power must be exercised reasonably and not arbitrarily.

43
 Module IV: Debt Recovery

HISTORY AND BACKGROUND

 Expeditious method of debt recovery was not available to banks or FIs prior to 1993 and
banks had only the regular recourse of civil courts
 In 1981, Tiwari Committee recommended setting up of a tribunal for debt recovery but
the govt failed to act on it
 However, action was taken once recommendation came from the Narsimham Comm and
the RDB Act was enacted in 1993.
 The entire debt recovery process under the Act can be divided into two headings:
a. Adjudicatory process- handles by adjudicatory officer officer who will grant
certificate of recovery. However, that person will not carry out the actual recovery
b. Recovery process- Recovery officer as per Sec 25 and 28 can recover debt from
defaulters against whom recovery certificate has been passed

DIFFERENCES BETWEEN RDB ACT AND SARFAESI

 The RDB Act covers both secured and unsecured creditors whereas SARFAESI covers
only secured creditors
 The Acts function in different spheres. The RDB Act is adjudicatory in nature i.e., the
tribunal does the adjudication and that’s how the money is recovered. Original
application may be filed by Banks and FIs under Sec 19 of the RDB Act
But SARFAESI is executory in nature. Things were directed through the tribunal when
under Sec 17, aggrieved persons were allowed to move the DRT to file a securitization
application.

India and Nepal Comparison on Tribunals for debt recovery

 In India, the qualifications for judges are:

DRT: District Judge
DRAT: HC judge
 In Nepal , a three member committee is constituted and one member is an expert in
banking and finance
 Takeaway: specialized knowledge in the field should be encouraged in such forums

UNION OF INDIA V. DELHI HIGH COURT BAR ASSOCIATION

Constitutional validity of the RDB Act was assailed. Delhi HC struck down the Act and UoI
filed an appeal before SC

Issues:

44
  Union does not have legislative competence because Art 323A and 323B do not provide
for any matter which would warrant the setting up of such a tribunal. Since 323A/B did
not deal with recovery of debt, such a tribunal could not be established
 Act was violative of Art 14 bc it was arbitrary and unreasonable. The powers of the
Recovery Officer were contested to be unreasonable since he could attach property, sell it
off etc
 Act eroded independence of judiciary and truncated power of the HC and vested it with
DRT

SC Held (contentions are also mentioned where necessary):

 Powers of the RO aren’t arbitrary. Anyone aggrieved by the actions of the RO can file an
application before the DRT under Sec 30. (this differs from other provisions relating to
appeal which has to be filed before the DRAT)
 Wrt the contention regarding Article 323A and B, Sc rejected it. SC referred to List I,
Entry 45- Banking and Entry 11A, List III- Administration of Justice. Both gave wide
powers to the Parliament to establish DRTs and DRATs. Banking was construed
broadly to include debt recovery mechanisms too. Thus, a tribunal could be set up to
that effect
 As far Independence of Judiciary was concerned, it was contested that:
 Jurisdiction of ordinary civil courts was being taken away and conferred upon
DRTs under Section 1 and 17.
 Moreover, there was no involvement of judiciary in the appointment of the
presiding officers of the DRT or DRAT. Thus, independence of judiciary was
eroded and truncated. In the Rules pertaining to appointment of presiding officers,
it is stated that eh Chairperson of DRAT shall be appointed only on the
recommendation of Selection Committee. This committee includes:
a. CJI or his nominee judge of SC
b. Governor or dep. Gov of RBI
c. 2 representatives from the Ministry of Finance
d. 2 representatives from the Ministry of law and justice
SC observed that there was nothing arbitrary or unreasonable about this statutory
provision. The powers of the HC were not taken away by it. There was no bar under
jurisdiction of HC as per Article 227 and an exception was carved out under Sec 18 of
the RDB Act where writ petitions may be filed.

 Insofar as Article 14 was concerned, section 1 of the Act talks about pecuniary
jurisdiction where the value of the debt should be above 10 lakh. (don’t have this Vrn,
sorry. Pls add it when you find it and send it to me also thnx. But essentially, the Court
held that it wasn’t violative of Article 14)

45
MISCELLANEOUS PROVISIONS
 (Sections 3-12, 15- read bare act or Darshan’s notes from page 23-24)
Jurisdiction of DRT

 Jurisdiction of the Tribunal can be found in Section 1 (pecuniary), Sec 17 (subject

matter), Sec 19 (territorial) + Section 18 bars jurisdiction of civil courts (exceptions-
Supreme Court, and a High Court exercising jurisdiction under articles 226 and 227 of
the Constitution).
 [17A. Power of Chairperson of Appellate Tribunal.—(1) The Chairperson of an Appellate Tribunal shall
exercise general power of superintendence and control over the Tribunals under his jurisdiction including
the power of appraising the work and recording the annual confidential reports of Presiding
Officers.
 (2) The Chairperson of an Appellate Tribunal having jurisdiction over the Tribunals may, on the
application of any of the parties or on his own motion after notice to the parties and after hearing them,
transfer any case from one Tribunal for disposal to any other Tribunal.]

2016 amdendment:
"(1A) For the purpose of exercise of general powers of superintendence and control over Tribunals under sub-
section (1), the Chairperson may—
(i) direct the Tribunals to furnish, in such form, at such intervals and within such time, information
relating to pending cases both under this Act and the Securitisation and Reconstruction of Financial
Assets and Enforcement of Security Interest Act, 2002, or under any other law for the time being in
force, number of cases disposed of, number of new cases filed and such other information as may be
considered necessary by the Chairperson;
(ii) (ii) convene meetings of the Presiding Officers of Tribunals periodically to review their performance.
(1B) Where on assessment of the performance of any Presiding Officer of the Tribunal or otherwise, the
Chairperson is of the opinion that an inquiry is required to be initiated against such Presiding Officer for
misbehaviour or incapacity, he shall submit a report to the Central Government recommending action against such
Presiding Officer, if any, under section 15, and for reasons to be recorded in writing for the same.".

 Section 17A deals with the Power of the Chairperson of the Appellate Tribunal. It is
stated that the tribunal shall have general superintendence. But 2016 Amendment Act has
inserted specific powers and now the Chairperson of the DRAT may:
“direct the Tribunals to furnish, in such form, at such intervals and within such time,
information relating to pending cases both under this Act and the Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, or
under any other law for the time being in force, number of cases disposed of, number of
new cases filed and such other information as may be considered necessary by the
Chairperson” + convene meetings of the Presiding officers of tribunals periodically to
review their performance

Central Bank of India v. State of AP (APHC) + State Bank of India v. Madhumita

Construction (some HC)

46
Both Courts held that HCs should not entertain petitions where alternative efficacious remedy
was possible. These two cases were in relation to Sec 18 and Banks had filed petitions before
HC. HC had dismissed the petitions and held that alternative remedy was possible.

Note: Section 19-24 are Procedure of the Tribunal.

Section 19: Application to the Tribunal (might be incomplete, please cross reference)

1. Any bank or FI may file an original application before the DRT having jurisdiction
2. Sec 19(1) defines the territorial juris of the tribunal. [read bare act]
a. 2016 amendment added – “the branch or any other office of the bank or financial
institution is maintaining an account in which debt claimed is outstanding, for the
time being”—to determine territorial jurisdiction
3. DISPOSAL TIME: Prior to 2016: The tribunal should try to dispose of an application
within 180 days.
a. Post 2016: Tribunal should try to dispose the matter within 2 hearings
overambitious lol
4. PARTICULARS: In the application, the bank/FI must give a proper description of the
property of the debtor since it is not possible for the tribunal to come up with an estimate
on its own. Moreover, it may happen that the Bank cant make a full estimate, it can ask
the Tribunal to direct the debtor to give specifications of the property in the written
statement.
5. WITHDRAWAL: The bank or FI can withdraw its original application by filing another
application which should be disposed off in 30 days (2016 Amendment)
6. ALIENATION: The debtor cannot alienate property by creating third party interest over it
after demand notice has been served, notwithstanding anything contained in Sec 65A
7. RECEIVER: Much like a civil court, the Tribunal can also appoint a receiver for the
management of the property
8. WRITTEN STATEMENT: the defendant shall within a period of thirty days from the date
of service of summons, present a written statement of his defence including claim for set-
off (2016 Amendment)
9. SECURITY AMOUNT: Where the tribunal thinks that the debtor is going to damage his
property to affect the interest of the creditor, dispose a part or whole of the property,
remove property from jurisdiction of tribunal--- tribunal can ask person to deposit a
security amount by an order/ place the property or its value equivalent before the court to
satisfy the amount in the certificate of recovery
10. (something about how DRT hearings are supposed to be conducted daily once issues are
framed- could not find this in the amendment act or the actual act
a. Additionally, adjournment related provision not found.)

Section 20: Appeal to Appellate Tribunal

47
  Decision of the presiding officer of the DRT could be challenged before the DRAT
within 30 days of the order being passed. This period was 45 days before it was amended
to 30
 The reason for reducing time period was that DRAT was to receive appeals from original
applications under RDB Act as well as Securitization Applications under SARFAESI.
The appeal period in SARFAESI was 30 days. Thus, for the sake of uniformity and in the
interest of expeditious recovery, the period in RDB Act was also shortened
 The DRAT must dispose off the appeal within 6 months
Section 21: Deposit of amount of debt due, on filing appeal

 No appeal shall be entertained unless 75% of the amount of debt due from him is
deposited with the Appellate Tribunal. This was subsequently lowered to 50% in the
2016 amendment
 Discretion was given to the tribunal to waive off the amount if required. This was
subsequently altered to discretion to lower the percentage of deposit to 25% but a right of
absolute waiver wasn’t given
 To keep the legislations on equal footing, SARFAESI and RDB Act deposit amounts
were reduced to 50% by the amendment and right of absolute waiver was made into 25%
of the debt amount.

Punjab National Bank v. O.C. Krishnan & Ors (2001)

Facts: OC Krishnan was a guarantor and he, along with the debtor, borrowed money from PNB
which was a secured creditor in the case. When dispute arose, the matter was taken to the District
Court by the Bank but after the enactment of the RDB Act, it was transferred to Calcutta DRT
which gave an order in favour of the bank

The moment Recovery Officer initiated recovery proceedings, the guarantor filed a petition
before the HC stating that the RO could attach the secured property because it was not located
within the jurisdiction of the tribunal. However, the HC rejected this since DRT had jurisdiction
due to cause of action arising in that pace. Thus, appeal was preferred before SC

Held: SC highlighted that it was not right of the HC to entertain the petition when alternate
remedy was available under the statute. SC held that there is a hierarchy of appeal provided in
the Act—appeal has to be made under Section 20 first. This fast track procedure cannot be
allowed to be derailed by taking recourse to remedies such as Article 226 and 227.

M/s Kidland v. Indusind Bank Ltd. (2005, Bom HC)

Facts: the constitutional validity of Section 21 was challenged in the background of Mardia
Chemicals wherein the precondition under Sec 17(2) of SARFAESI had been struck down. The
requirement of deposit under sec 21 of the RDB act was under challenge before the Bom HC for
the same reasons (arbitrary, unreasonable restriction on remedy).

48
Held: There is a stark difference between Sec 21 of RDB and 17 of SARFAESI. While section
21 relates to appeal on original application, sec 17 required the deposit to be made at the very
initial stage of sectn application. They could not be compared on the same footing. Thus, the
case was dismissed and the Court upheld the validity of Sec 21.

Section 22: Procedure and Powers of the Tribunal and Appellate tribunal

 Sec 22 says that the Tribunals aren’t bound by CPC and are expected to follow principles
of natural justice (this is bc these tribunals are quasi-judicial authorities)
 , subject to the other provisions of this Act and of any rules, the Tribunal and the Appellate Tribunal shall
have powers to regulate their own procedure including the places at which they shall have their sittings

 SAME POWERS S THAT OF A CIVIL CASE

 Sec 22(2) provides that the tribunals have the same powers as a civil court in the
following cases:
(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;
(e) reviewing its decisions;
(f) dismissing an application for default or deciding it ex parte;
(g)setting aside any order of dismissal of any application for default or any order passed
by it ex parte;
(h) any other matter which may be prescribed

Industrial Credit and Investment Company of India v. GrapCo Industries

Case pertained to power of passing ex parte order given that ex parte order was antithetical to
PNJ. This contention was rejected by the Court and the Court observed that passing an ex parte
order wouldn’t amount to an infraction of PNJ since ex parte order is only passed when the
opposing party fails to appear despite sufficient notice. Such an nex parte order 1. can be set
aside and 2. even appeal might be allowed if the other party can show sufficient cause for non-
appearance.

Gargya Research Instruments v. SBI

Facts: Petitioner borrowed money from SBI and defaulted. Bank filed an original application
under Sec 14. After filing written statement, the respondent appeared only once in the tribunal
and did not appear in person after notices were issued. The tribunal thus passed an ex parte order

An application was filed for setting aside of ex parte order but DRT and DRAT both rejected it.
He approached Delhi HC and stated that due to the marriage of his daughter and a death in the
family he couldn’t appear in person.

Held: HC observed that

49
 1. he had sufficient time upon analysis of dates but still failed to appear in person.
2. While marriage and death in the family were sufficient reasons, there was enough time
between the dates.
3. The Court made a strong remark in this case about the dilatory tactics adopted by persons
and companies to drag cases on in the DRT.

Sadashiv Prasad Singh v. Harendra Singh (2014)

Facts: There was a partnership firm, Ama Timber Co., and it borrowed loan in 1989 and it
hypothecate machinery—defaulted on loan later. In 1998, an OA was filed by Allahabad Bank
against Timber Co. The DRT passed an order and issued a certificate of recovery in which the
amount to be recovered was mentioned. In between, one of the 3 partners died. Not enough
money could be recovered from demand notice and RO began to attach the properties of the
partners and land of the deceased partner was attached.

The brother of the deceased, Harendra, said that the land could not be attached because the
deceased had transferred the land by agreement of sale but the deed had not been registered. RO
upon hearing this said that since the legal requirements were not complied with. RO took over
possession of the property and decided to auction the property and Sadashiv was the highest
bidder. He paid the amount and fulfilled the legal requirements.

Single judge stage- Harendra filed a writ petition before the Patna HC. The Single judge refused
to accept the WP because the Court did not have the jurisdiction. Harendra had contended that
recovery proceedings were not as per law and enough opportunity was not given to him.
Notwithstanding such contentions, the WP was dismissed.

Division bench stage- Harendra filed an LPA before a Division bench which disagreed with the
findings of the single judge. The said that the SJ hadn’t taken into the account the contention of
Harendra.

 The Division Bench introduced equity between the parties and said that both parties must
settle the matter.

 The court suggested that if Harendra paid the bank and bank returned Sadashiv’s money, the
property could be transferred to Harendra. Since Sadashiv was aggrieved here, he filed an SLP
before the SC

SC Held: Division bench was incorrect in taking cognizance of matter and unnecessarily
dragging the matter on. The SC appreciated the judgment of the Single Judge and emphasized
that remedy was available under Sec 30 of the RDB Act and that if Harendra was aggrieved, he
could have appealed the action of the RO.

(where is the protection for the interest of a bonafide auction purchaser?)

50
SECTION 25: The Recovery Officer shall, on receipt of copy of the certificate under sub-section (7) of section
19, proceed to recover the amount of debt specified in the certificate by one or more of the following modes,
namely:-- (a) attachment and sale of the movable or immovable property of the defendant; (b)arrest of the defendant
and his detention in prison; (c) appointing a receiver for the management of the movable or immovable properties of
the defendant

SECTION 28:

Section 30: Appeal against order of RO

 If any person is aggrieved by the order of an RO, order here being under Sec 25 or 28,
can prefer an appeal before the tribunal within 30 days from the date of issue of order
 The tribunal must give an opportunity to the appellant to be heard before making
appropriate order

Section 30A: Deposit of Amount of Debt due for filing an appeal against the orders of RO

 A person aggrieved by the order of the RO under section 25 or 28 may appeal to DRT but
has to deposit 50% of the amount as prescribed in the demand notice (2016 amendment)

Section 31B: Priority to secured creditors

Explanation says that on commencement of IBC, 2016 in cases where insolvency proceedings
are pending in respect of secured creditors, priority will be given to them—subject to the
conditions in IBC.

51
 SARFAESI Act

BACKGROUND OF SARFAESI
 The major recommendation of Narsimham Comm II was ‘intervention free mechanism’
of debt recovery.
 In 2000, the Andhyarujina Comm re-emphasized NC II recs and added an important
element—enforcement of security interest for which they relied on the US model [US
Commercial Courts Act 9 provides for enforcement of security interest.]
 Andh. Comm recommended that 3 things had to be done immediately:
a. Securititization of debt recovery
b. Intervention free recovery
c. Enforcement of security interest
 SARFAESI deals with 3 major concepts- Securititization (Sectn), Enforcement of
security interest, Reconstruction (Recon)
 Object and scope of the Act
An Act to regulate sectn, recon of financial assets and enforcement of SI to provide for a
central database of SI created on property rights, and for matters connected therewith or
incidental thereto.

CONDITIONS OF APPLICABILITY OF THE ACT

 Bank or financial institution (FI) has to be a secured creditor.
 Min value of debt to enforce measures under the Act- 1 lakh
 In order to initiate any action, the account should have been classified as an NPA by the
bank or FI
 Non-application the Act:
 Where SI is created on agricultural land
 Where amount to recovered is less than 1 lakh
 In cases where the amount due is less than 20% of the principal and interest
thereon

OVERVIEW OF THE ACT

1. Registration and regulation of ARCs
2. Facilitates sectn of financial assets of banks and FIs
3. Facilitates easy transferability of financial assets of banks and FIs to ARCs
4. Empowers ARCs to raise funds by issuing security receipts to Qualified Institutional
Buyers [now it is just Qualified Buyers after the 2016 amendment]
5. Facilitates recon of acquired financial assets by ARCs, by exercising powers given under
Sec 9 of the Act
6. Empowers banks and FIs to take possession of securities as per Sec 13

52
 7. Aggrieved persons may file an application before DRT & thereafter DRAT under sec 17
& 18 respectively.
8. Act deals with the requirement of having a central registry for registration of transactions
related to asset recon, sectn, creation of SI in favor of secured creditor

MARDIA CHEMICALS V. UNION OF INDIA

 The constitutional validity of SARFAESI was assailed, in particular Sections 13, 15, 17,
34 on the basis that these sections are unreasonable and arbitrary.
 IDBI Bank served a notice upon Mardia when the Act came into force. Mardia defaulted
—approached Court where a number of similar petitions were clubbed together and
answered together.

Issues:

 Whether it was open to challenge SARFAESI on the ground that it was not necessary to
enact it in the prevailing background, particularly when another statute was already in
operation?
 Whether Section 13 of the Act was ultra vires of the constitution
 Whether Sec 17 , particularly Sec 17(2) is unreasonable and arbitrary, therefore violative
of the Consti

Petitioners’ Argument:

1. Sec 13 gave all rights to banks and FIs and neglects the rights of the defaulters. Sec 13
did not take borrower interest into account at all. Moreover, there was no right of
representation or adjudicatory mechanism that could be availed by the borrowers.
2. Sec 17(2) stated that 75% of the amount had to be deposited by the defaulter in order to
prefer and appeal—amount was too much and hence restricted access to judicial recourse
of appeal—it was like a implied bar had been created // to this, UoI contended that there
were several other legislations that provided for such preconditions// Pet argued that
those were for appeal and not for application of first instance// UoI tried to refute that by
stating that the marginal heading of Section 17 was “appeal”
3. Sec 15 dealt with the procedure for taking over the business and management of the
entity, especially a company
4. Sec 34 was pari materiae to RDB Act which stated that DRTs have exclusive jurisdiction
i.e., bar on civil courts for mattes under SARFAESI+ no civil court shall grant any order
or injunction against a bank availing rights under the Act.
5. Since there was already a legislation dealing with this particular area, SARFAESI was
unnecessary and multiple legislations were not required to address the same subject
matter. It was also pointed out that the most problematic debt bracket was 25,000-1 lakh
—didn’t require separate legislation.

53
SC held:

 Emphasized the superiority of the Parliament is determining the necessity to enact a

legislation.
 Rejected the comparison drawn between RDB Act and SARFAESI since the latter deals
with the very specific matter of NPAs (among other differences such as the latter dealing
only with secured creditors). Therefore, it is for the Parliament to adjudge the need to
legislate
 As for Section 13, the Court held that it was constitutionally valid.
 Secured creditor is only exercising his right because the default leading to sec 13
measure may be looked at as a ‘second default’—NPA toh hai hi pehle se + 60
days additional time was given to repay post notice.
 Prior to 2016 Amendment, Section 13 sort of recognized the Right of
Redemption. Rule 8 & 9 of SI Rules required that bank should serve a notice
confirming sale of secured property and the borrower to could pay off the debt
and regain possession any time before the actual sale had occurred
 While SC upheld validity of the section, it strongly pushed for right of
representation being made available to borrowers
 Section 17(2) was found to be arbitrary and SC directed that the heading be changed from
“appeal” to “application”

Impact of the judgement

 Now section 13 says that the bank has to consider all representations of a borrower and
has to reply within 7 days (which was later changed to 15 days).
 Under section 17, although marginal heading remained the same, the word “appeal” was
replaced by “application” within the section (wow). The marginal heading was changed
in 2016 and the appeal was replaced by application.
 Now DRTs have jurisdiction for rights of tenants in a property which is kept as security.
In such cases, the one who files the application (if he fulfills the requirements), gets the
property.
 Section 18 was also substituted slightly. When an appeal is preferred before the DRAT,
50% of amount has to be deposited which can be reduced to 25%. A similar right of
waiver was also given to DRT under Section 17
This was later changed in 2016 and DRT cannot waive off the deposit amount, although
it can be reduced to 25%

REGISTRATION AND CANCELLATION

Three parts of the definition of reconstruction to remember:

"asset reconstruction" means acquisition by any securitisation company or reconstruction company of any right or
interest of any bank or financial institution in any financial assistance for the purpose of realisation of such financial
assistan

54
  Non banking financial companies
 Incorporated under Companies Act
 Require certificate of registration from RBI

Section 3: Registration requirements for ARCs

 An application has to be made to the RBI to carry on sectn or recon activities

 An ARC must have net owned fund of Rs 2 crore. Guidelines state that the RBI may give
a company upto 3 months to meet this requirement.
 RBI may conduct inspection before granting certificate.
 Persons running: ARC must ensure that the persons involved in the management must
have expertise in finance, recon and sectn etc. Directors of the company shouldn’t have
been convicted of a crime relating to moral turpitude
 Financial soundness of the company is important to ensure redeeming the interest of
those persons investing in them and thus, the management should be well equipped to
carry on sectn and recon activities.
-Adequate arrangements for securitisations
-Fulfilling prudential norms
-Meeting all the guidelines by RBI
 The Sponsors must be fit and proper(2016) - shouldn’t have been convicted of criminal
offences or barred by the RBI etc.
 Section 3(6) talks about substantial change. After getting a certificate from the RBI, a
company must seek the prior approval of the RBI before making substantial changes such
as change in management, appointment of board members/CEO, compromise, takeover,
amalgamation, change n the name of the company etc.

2003 Guidelines (don’t know the name here)

 Planning period- every ARC after acquiring the financial asset from a bank or FI will be
given 6 months to formalize a plan to recover the debt
 Once a certificate is issued to an ARC, it is empowered to carry on both recon and sectn
activities
 Once a certificate has been issued to an ARC it must commence its activities within 6
months. With the approval of RBI, this period may be extended for 12 months.
 Functions of the ARCs: ARCs may undertake only the securitisation and asset
reconstruction activities and the functions provided for in Section 10 of the Act.
 Additional functions that ARCs can perform and charge fees for include:
 They can be appointed as ‘receivers’ by Courts or Tribunals
 They can act as recovery agents for Banks or FIs
 They can act as managers under Sec 13(4)

Section 4: Power to cancel certificate of registration

55
  Ceases to carry on the business of Sect and ARC
 When company fails to get investment from qualified buyers
 If the RBI imposes certain conditions while granting certificate which were later not
followed through.
 When ARC fails to furnish documents asked for w/o reasonable grounds
 When ARC fails to adhere to prudential norms and guidelines etc issued by RBI
 When substantial change is introduced without prior permission of the RBI [Sec 3(6)]
 Fails to comply any direction given by RBI

--

 Reasonable opportunity of being heard has to be provided before cancelling license

 A company aggrieved by the decision of the RBI may prefer an appeal before the Central
Govt
 Until such time as it holds investment of QIB’s notwithstanding rejection or cancellation,
it is deemd to be SC until all investments are paid up.

SECURITIZATION PROCESS
This is only an acquisition process by virtue of being a special purpose vehicle (SPV).

"securitisation" means acquisition of financial assets by any securitisation company or reconstruction company from
any originator, whether by raising of funds by such securitisation company or reconstruction company from
qualified institutional buyers by issue of security receipts representing undivided interest in such financial assets or
otherwise

Section 5: Acquisition of financial assets

 Any bank or FI may transfer its financial assets to any ARC. ARC, post acquisition, may
issue bonds or debentures in favour of the bank or FI
 Note: Newly inserted provision- Stamp duty shall not be paid during the process of
acquisition. The payment of huge stamp duties acted as a hurdle during the process of
acquiring debt from banks or FIs
 Section 5(2)- After securitization process is over, ARCs are to be treated as ‘deemed
secured creditors’. Essentially, all rights of the originator will be transferred to the ARC
when the asset is acquired by it.
 In circumstances where any proceedings are pending before the DRT, the ARC with the
consent of the bank or FI can fill an application before the DRT or DRAT as the case
may be to substitute its name in the proceedings

Section 6: Notice to an obliger

 Bank or FI may serve a notice upon the obliger before his/her assets are transferred to an
ARC. This is a discretionary and not mandatory power.

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  Where bank decides not to give notice or is unable to give notice and the customer makes
a payment towards the repayment of the loan, not knowing that his assets have been
securititzed, the bank must keep the money and serve as a constructive trustee (i.e., it
cannot refuse the amount and neither can it appropriate it)

Section 7: Issue of Securities by ARCs

 SCRA defines security receipts and states that only an ARC can issue them [Sec 2(h)(i)
(c)]. ARCs raise funds by issuing securities.

(zg) "security receipt" means a receipt or other security, issued by a securitisation company or
reconstruction company to any qualified institutional buyer pursuant to a scheme, evidencing
the purchase or acquisition by the holder thereof, of an undivided right, title or interest in the
financial asset involved in securitisation;

 (not sure about this) Section 7 gives two ways:

 ARC will acquire the asset directly
 ARC will set up a trust- on the book of the trust, assets can be acquired. The ARC
would be the trustee and the trust would be treated as an SPV
 (2) A securitisation company or reconstruction company may raise funds from the qualified
institutional buyers by formulating schemes for acquiring financial assets and shall keep and
maintain separate and distinct accounts in respect of each such scheme for every financial asset
acquired out of investments made by a qualified institutional buyer and ensure that realisations of
such financial asset is held and applied towards redemption of investments and payment of returns
assured on such investments under the relevant scheme.

 Section 7 earlier only allowed Qualified Institutional Buyers which was changed to
Qualified Buyers. This was so because QIBs were large institutions with the ability to
absorb high amounts of risk. But this small group of subscribers was reducing the amount
of subscribers that ARCs could attract. However, this is no longer the position and hence
even non-institutional buyers can purchase security receipts.

 The RBI in consultation with the SEBI will frame guidelines and release a list of who
would be included in the category of ‘qualified buyer’ – but such list has not been
released yet.

IMPORTANT: (3) In the event of non-realisation under sub-section (2) of financial

assets, the qualified institutional buyers of a securitisation company or
reconstruction company, holding security receipts of not less than
seventy-five per cent. of the total value of the 11[security receipts issued
under a scheme by such company], shall be entitled to call a meeting of
all the qualified institutional buyers and every resolution passed in such
meeting shall be binding on the company.

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The 2003 Guidelines provide:

 Every ARC shall with the consultation and approval of the BoD, come up with a financial assets acquisition
policy within 90 days of receiving the certificate from RBI
 No ARC will enter into a bilateral agreement to acquire/buy financial assets from its sponsors
 An ARC is given 2 weeks to carry out due diligence to find out the reliability and returns attached to a
particular asset
 ARCs are given 5 years to realize the debt after acquiring the asset from the Bank or FI

ASSET RECONSTRUCTION

Section 9: Reconstruction Measures

(Without prejudice to any other law, but subject to RBI Guidelines)

a) Taking over management of the borrower company

b) Lease or sale of business of borrower- absence of guidelines or directions in this regard.
Thus, this right cannot be exercised by ARCs yet
c) Enforcement of SI as per Sec 13(4) of the Act
d) Rescheduling of debts- this is the most preferred method where the installments of debt
can be adjusted.
a. Eg- If earlier, I had to pay 10 installments for Rs. 3000, the ARC can plan it so
that I will have to pay 20 installments of Rs. 1500
e) Conversion of debt into equity- 2013 amendment act aslo introduced one more measure
i.e. conversion of debt into equity if the defaulter is a company. It may partially or wholly
convert the debt into equity. But ARC cannot acquire majority shares of the Company.
RBI in its guidelines says that post conversion, ARC's shareholding in the compnay to go
beyond 26%
f) Settlement of dues between the company and the borrower- Eg: if the value of NPA
acquired is 40 lakh and the discounted rate at which the ARC purchased it is 25 lakh.
ARC may ask borrower to pay 33 lakh. Thus, ARC earns a profit and the borrower also
profits
g) Right to take over possession of borrower’s property

Sec 9(a): Taking Over Management of the Borrower Company

 Sec 9(a) should be read with Sec 15 + relevant guidelines (in this case- Change in or
Takeover of the Business of the Borrower by Securitization Company and Reconstruction
Company Guidelines, 2010)
 Under Sec 9(a), the BoD of the borrower company has to step down and ARC appointed
members substitute them
 Under what circumstances should an ARC be allowed to take over management? The Act
is silent on this but he 2010 guidelines provide:

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  Management cannot be taken over unless the debt owed due to the ARC is not
less than 25% of the total assets of the borrower
 In cases of consortium lending, any ARC shouldn’t be allowed to initiate action
unless 60% of the secured creditors (in value, not number) agree to such action
being taken
 Grounds specifically mentioned in the guidelines:
1. In those circumstances where the borrower is a willful defaulter
2. Where the company is routing its transactions through other banks or FIs (eg- consortium
lending)
3. Shifting of funds- improper utilization of funds issued by the bank or FI
4. Where the management of the borrower company isn’t professionally sound or the key
managerial officers have been appointed for only one year (summary- inefficient
management)
5. Where borrower company has, without the permission of the creditor, alienated its
property
6. Where the borrower company is threatening to cause damage to its own business
7. Where the borrower company has utilized its loan for any purpose other than the
purpose for which it was borrowed
8. Where ARC is certain that disputes have arisen between the management and employees
which may materially disturb the ability of the company to repay the loan advanced to it

 POLICY: Every ARC has to prepare a policy of takeover of management of the borrower
—how the ARC will give effect to the takeover, qualifications of those involved in the
process, whether appropriate measures for the restoration of business of the borrower
company have been put in place in the event that the debt amount is realized by the
company

 This plan has to be approved by the BoD of the ARC

 An independent advisory committee has to be constituted to review the policy approved
by the BoD—green signal would be given if the takeover would lead to debt actually
being realized
 Any recs of the IAC are placed before the BoD again for review. The panel of the BoD
should consist of at least 2 independent directors
 NOTICE: 60 days notice has to be given to the borrower. According to Sec 15, notice has
to be published in 2 newspapers.
 REPRESENTATION: The borrower may make representation or objection before the
ARC. These objections would be laid down before the IAC and then BoD--- decision on
them has to be made within 30 days- then it is finally communicated to the borrower.

DISPUTE REDRESSAL (REMEDIES)

 Sec 17 says that any person aggrieved by any action taken under Sec 13(4)-- in cases of
reconstruction, only writ can be filed as no alternate remedy is given

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  But if ARC is approaching the borrower to enforce SI, then aggrieved borrower may go
to the DRT
 Sec 11- under what circumstances will dispute be solved by arbitration? if action is
regarding acquiring of assets or sectn, there can be Arb between Bank/ARC and borrower
 When ARC is doing recon and dispute arises between the ARC and obliger, then writ
petition has to be filed
Dispute between Relief against Forum/Method Section
Bank/FI – obliger Enforcement of SI DRT 17
ARC – Bank Sectn/ recon/ non- Arbitration or 11
payment of dues Conciliation
ARC – obliger Reconstruction Civil Court Art 226
ARC – obliger Enforcement of SI DRT 17

ENFORCEMENT OF SECURITY INTEREST

Steps under Section 13:

 Bank or FI as secured creditor should classify the asset as NPA

 Demand notice should be served and payment should be made within 60 days by
defaulter
 The amount yet to be recovered should exceed 20% of total dues and be more than
Rs. 1 lakh
 The defaulter is allowed to make a representation before the Bank or FI and the response
should to it should be given within 15 days
 If within 60 days, the money is not recovered, the creditor is entitled to take any of the
measure in Sec 13(4):
 Take over management of property
 Take possession of defaulter’s property
 Appoint a manager
 Notice to borrower of borrower to pay the bank/FI, not the obliger

(9) In the case of financing of a financial asset by more than one secured creditors or joint
financing of a financial asset by secured creditors, no secured creditor shall be entitled to
exercise any or all of the rights conferred on him under or pursuant to sub-section (4) unless
exercise of such right is agreed upon by the secured creditors representing not less than three-
fourth in value of the amount outstanding as on a record date and such action shall be binding on
all the secured creditors:

(10) Where dues of the secured creditor are not fully satisfied with the sale proceeds of the secured assets, the
secured creditor may file an application in the form and manner as may be prescribed to the Debts Recovery
Tribunal having jurisdiction or a competent court, as the case may be, for recovery of the balance amount from the
borrower.

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(11) Without prejudice to the rights conferred on the secured creditor under or by this section,
the secured creditor shall be entitled to proceed against the guarantors or sell the pledged
assets without first taking any of the measures specified in clauses (a) to (d) of subsection (4) in
relation to the secured assets under this Act.

(13) No borrower shall, after receipt of notice referred to in sub-section (2), transferby way of
sale, lease or otherwise (other than in the ordinary course of his business) anyof his secured
assets referred to in the notice, without prior written consent of the securedcreditor.

Relevant Rules that are read together with Sec 13:

 Rule 3- Demand Notice- procedure of securing demand notice in physical form, email,
fax, courier
 Rule 3A- Reply to Representation- messed up bc the Rules haven’t been amended at this
rule still warrants a response in 7 days, not 15.
 Rule 6- Taking over possession of movable property
 Rule 8- Taking over possession of immovable property
 Rule 9- requirement of public notice—what all it should have; how auction will take
place, reserve price (lowest price which is decided by the valuer) etc should be in the
notice
 Three types of deposits are supposed to be made
 Caution fee
 Earnest Money Deposit (EMD)- The highest bidder will have to deposit 25% of
the sale price the and there with the auctioneer of the bank
 Remaining amount must be deposited within 15 days and the bank may give a 15
day extension
 If after such extension also, the purchaser is unable to make the payment, the EMD is
forfeited.
 Banks sell the property generally at a “what is where is basis” i.e., whatever defect
wherever it is in the property, the buyer will have to buy it as it is.

If the auction purchaser was unaware of encumbrances when he purchased the property, but
found out subsequently, what remedy does he have? Does this attract the principle of caveat
emptor or caveat vendetor?

V. Sambandhan v. Punjab National Bank

Facts: Sambodhan was an auction purchaser in an auction organized by PNB and he had
deposited the EMD. Later, he found that the property was not free from encumbrances. The bank
claimed to be unaware of such encumbrances.

Sambodhan went to the Court and contested that there is no way the bank couldn’t have known
about the encumbrances if he could find out through his short investigation. Pursuant to Rule 8,

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the Bank was expected to reveal all material information including defects about the property up
for auction.

Bank took the defense of the “what is where is” clause inserted in auction notice

Held: The Court ruled in favour of the Bank and said that the rule to be observed in such cases
was “caveat emptor”. The buyer was expected to carry out his due diligence before making the
purchase. Thus, the EMD was non-refundable.

Jai Logistics v. Syndicate Bank

Madras HC was faced with similar facts but took the opposite view that the rule applicable
would be caveat vendetor and not caveat emptor.

It emphasized that under Rule 8, Bank is expected to apprise all prospective purchasers with
the material information, defects, and encumbrances. The bank cannot force buyer to buy
property without full knowledge of it.

Directed that EMD be returned.

Chemstar Chemicals & Intermediates v. CTO, Chennai & State Bank of Mysore

Facts: On the auction property, sales tax officer had already issued an order of attachment. The
bank had not informed the customer about this.

Court held that every participant should be able to access information about the property on a
non-discriminatory basis. (generally available knowledge)

Another issue that came up was- HCs don’t have jurisdiction to deal with such matters as the
DRT should’ve been approached under Section 17 of the SARFAESI

Court held that an ‘auction purchaser’ cannot be treated as an aggrieved person. This is because
the auction is not related to section 13 + the purchaser is not a relevant party who has been
affected by measures taken by the bank under 13(4). Therefore, Courts have jurisdiction.

Madhu Sudan Ghosh v. Bank of Baroda

There were irregularities in the demand notice served upon the borrower. Additionally, the bank
had initiated proceedings against the borrower without responding to the representation that they
had made.

The Court held that all relevant information should be reflected clearly in the demand notice and
it representation has been made by the defaulter, the bank necessarily has to respond within 15
days as per Section 13(3)(a).

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RIGHTS OF BANKER V. RIGHTS OF TENANTS
A number of innocent lessees were getting caught up in the process of the bank taking possession
of property that the lessor had kept as security. There were a few major issues that Courts were
faced with:

1. Whether the Bank could get tenants evicted from the secured properties under
SARFAESI
2. Whether tenants had any remedies under local tenancy laws
3. Whether tenants could be called ‘aggrieved persons’ under Section 17 of SARFAESI
(yes- now the 2016 amendment also brings them under Sec 17)
4. If a bank files an application before a district magistrate, does the magistrate, under
Section 14, have to hear the tenant before issuing relevant order-

Harshad Govardhan Sondagar v. Intl. Asset Reconstruction Co.

The Court categorized tenants into three categories and rights were decided accordingly:

 Tenant inducted into property before it was mortgaged to the bank- in such a case, bank
cannot evict tenant unless the lease comes to an end. Thus, the tenant has first charge
over the property.
 Tenant was inducted after mortgaging property to bank (pursuant to Sec 65 of ToPA) but
before notice of default was issued by the bank- cannot evict tenant unless the agreement
between the bank and borrower clearly stated that Sec 65 of ToPA would not be
applicable or excluded the possibility of creating lease over property in any other way
 Tenant inducted after borrower receiving demand notice- As per Section 13(3), no third
party right can be created after the demand notice is served.
 The case also held that section 35 of the Act shouldn’t be interpreted in a way that it
would override Rent Control Act which was a welfare legislation, otherwise the entire
purpose of the Act would be defeated.
 In this case, the magistrate had passed an order without giving the tenant the opportunity
to be heard. SC held that Magistrate must be careful and must adhere to PNJs (answers
the 4th issue)

Vishal N. Kalsaria v. Bank of India

 SARFAESI cannot override provisions of Rent Control Act because the purpose of
enacting them was protecting the interests of bonafide tenants.
 The Court found that the ambit of both legislations was different or that they didn’t
function in the same realm. SARFAESI gives rights to banks etc whereas RCA is welfare
legislation
 Court also highlighted that SARFAESI was silent on third party rights and thus banker
rights were heavily favoured.
 Q. What if tenancy agreement is not registered?

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 A. Rent Control laws impose an obligation upon the landlord to register the agreement
and the onus does not lie on the tenant. Banker cannot hold tenant responsible for the
fault of the landlord.

2016 Amendment Act

 Section 17 has been amended to read “restoration of property will be given to the
borrower or aggrieved person..”
 Section 4A has been inserted which gives DRT the power to issue effective remedy.
 DRT has the power, authority and jurisdiction to determine whether:
 Lease or tenancy agreement has been determined
 Lease created was created according to 65A of ToPA
 Mortgage deed between borrower and bank contained a clause preventing
borrower from creating 3rd party right over it
 The lease right was created after demand notice under Sec 13(2)

Random things about Section 13 she taught towards the end

1. 2013 amendment inserted sub sec 5A: In those circumstances when banks have made
arrangement for auction but has been unable to secure a purchaser willing to buy the
property above the reserve price, the bank can purchase the property on its own
2. Any time prior to the date of publication of auction notice/ tender notice, if any borrower
is ready with the debt amount, the bank can restore possession to the borrower. Prior to
2016, the buyer could get his property by paying the debt off any time before the final
sale.
3. When banks fail to recover amount even under Sec 13(4), banks can approach DRT for
the remaining amount (not sure what this is supposed to mean)
4. Section 13(13) talks about how no third party interest in a mortgaged property can be
created after demand notice has been served
5. Ambit of Section 13 has been increased to include debt instruments like listed debt
securities
6. In Transcore v. UoI it was held that withdrawal of original debt recovery application
before DRT is not a necessary precondition for initiating action under SARFAESI (only
if recovery hasn’t already happened through application by that point).

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