Banking Law-study Material (1)

Master in Business Laws Banking Law Course No: II Module No: I - IX

BANKING LAW

Distance Education Department

National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 080-3217858 E-mail: [email protected]

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CONTENTS TOPICS 1.

Structure and Functions of Commercial Bankers and Financial Institutions (Module No. I) ...................................................................

3

Reserve Bank of India Structure and Functions (Module No. II) ....................................................................

34

3.

Law of Banking Regulations (Module No. III) ............................................................

65

4.

Negotiable Instruments: Law and Procedure (Module No. IV & V) ...................................................................

119

5.

Banker - Customer Relation (Module No. VI) ............................................................

191

6.

Advances, Loans and Securities (Module No.VII & VIII) .........................................

228

7.

Procedural Aspects of Banking Law (Module No. IX) ...............................................

271

2.

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Master in Business Laws Banking Law Course No: II Module No: I

Structure & Functions Of Commercial Banks & Financial Institutions

Distance Education Department

National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 080-3217858 E-mail: [email protected]

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MATERIALS PREPARED BY: 1.

MR.T.V. MOHANDAS PAI, F.C.A.

2.

Prof. N.L. MITRA M.Com., LL.M., Ph.D.

MATERIALS CHECKED BY: 1.

MS. ARCHANA KAUL LL.M.

2.

Mr. SUPRIO DASGUPTA B.Sc.,LL.B.

MATERIALS EDITED BY; 1.

MR. HARIHARA AIYAR LL.M., Former General Manager, SBI

2.

Prof. P.C. BEDWA LL.M., Ph.D.

© National Law School of India University Published By: Distance Education Department National Law School of India University, Post Bag No: 7201 Nagarbhavi, Bangalore, 560 072.

Printed At Sri Vidya Printers, Bangalore Ph. 23445594

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INSTRUCTIONS Basic Readings The materials given in this course are calculated to provide exhaustive basic readings on topics and sub-topics included in the course. Experts in the area have collected the basic information and thoroughly analysed the same in topics and sub-topics. Lucid/supportive illustrations and leading cases are also provided. Relevant legislative provisions are also included. Care has been taken to communicate basic information required for decision making in problems likely to arise in the course-area. The reader is advised to read atleast three times. In the first reading information provided are to be selected by making marginal notes using markers. The first reading, therefore, necessarily has to be very slow and extremely systematic. While so reading the reader has to understand the implications of those informations. In the second reading the reader has to critically analyse the material supplied and jot down in a separate note book points stated in the material as well as the critical comments on the same. A third reading shall be necessary to prepare a Check List so that the check list can be used afterwards for solving problems like a ready reckoner. (The reader is required to purchase a Bare Act and refer to the relevant sections at every stage.) Supplementary Reading Several supplementary readings are suggested in the materials. It is suggested that the reader should register with a nearby public library like the British Council Library, the American Library, the Max Muller Bhavan, the National Library, any University Library where externals are registered for the purpose of library reading, any commercial library or any other public library run by Government or any private institution. Readers in Metropolitan and other big cities may have these facilities. It is advised that these basic materials be photocopied, if necessary, and kept in the course file. Supplementary readings are also required to be read more than once and marginal notes, marking notes, analytical notes and check lists prepared. Any reader requiring any extra readings not available in his/ her place may request the Course Coordinator to photocopy the material and send it by post for which charges at the rate of .50 paise per page for photocopying and the postage charge shall be sent either by M.O. or by Draft in advance. The Course Coordinator shall take prompt action on receiving the request and the payment. Case Law The course material includes some case materials generally based upon decided cases. These cases are to be studied several times for, (a) understanding the issues to be decided (b) decisions given on each issue (c) reasoning specified It is advised that while reading a case the reader should focus first on the facts of the case and make a self analysis of the facts. Then he/she should refer the check list prepared earlier for appropriate information relating to law and practice on the facts. Then the student should prepare a list of arguments for and on behalf of the plaintiff/ appellant. Keeping the arguments for the plaintiff/appellant in view of the reader should try to build up counter arguments on behalf of the defendant/respondent. These exercise can take days. After these exercises are done one has to prepare the arguments for or against and then decide on the issues. While deciding it may be necessary often to evolve a guiding principle which also must be clearly spelt out. Subsequently the reader takes up the decision given in the case by the judge and compare his/her own exercise with the judgment delivered. A few exercise of this type shall definitely sharpen the logical ability, the analytical skill and the lawyering competence. Though it is not compulsory, the reader may send his/ her exercises to the Course Coordinator for evaluation. On receiving such request the Course Coordinator shall get the exercises evaluated by the experts and send the experts’ comment to the students. Through these exercises one can build up an effective dialogue with the experts of the Distance Education Department (DED). Problems and Responses After reading the whole module which is divided into several topics and sub-topics the reader has to solve the problems specified at the end of the module. The module is designed in such a manner that a reader can take about a week’s time for completing one module in each of the four courses. It is expected that after finishing the module over a period of a week the student solves these problems from all possible dimensions to the issue. No time limit is prescribed for solving a problem though it would be ideal if the reader fixes his/her own time limit for solving the problem - which may be half an hour per problem - and maintain self discipline. While solving the problems the candidate is advised to use the check list, the notes and the judicial decisions - which he/she has already prepared. After completing the exercise the student is directed to send the same to Course Coordinator for evaluation. Though there is no time stipulation for sending these responses a student is required to complete these exercises before he/she can be given the certificate of completion to appear for final examination. 5 (Sys 4) - D:\shinu\lawschool\books\module\contract law

STRUCTURE AND FUNCTIONS OF COMMERCIAL BANKS & FINANCIAL INSTITUTIONS

TOPICS 1.

The Evolution in Banking Services & its History in India. ........................................

7

2.

Role & functions of Banking Institutions. ...................................................................

11

3.

Structure of Banking Institutions. ................................................................................

18

4.

Financial Institutions & their Functions. .....................................................................

20

5.

Industrial Development Bank. ......................................................................................

24

6.

National Bank for Agricultural & Rural Development. .............................................

26

7.

Unit Trust of India. ........................................................................................................

27

8.

Case Law. ........................................................................................................................

29

9.

List of Statutes. ...............................................................................................................

31

10.

Problems..........................................................................................................................

32

11.

Supplementary Reading ................................................................................................

33

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1. THE EVOLUTION OF BANKING SERVICES AND ITS HISTORY IN INDIA SUB-TOPICS 1.1. Introductory Note. 1.2. History of Banking in India 1.3. Bank Nationalisation 1.4. Various types of Banking Services 1.5. Social control measures on bank 1.6. Narasimham Committee Report 1.7. Concluding Remark 1.1. INTRODUCTORY NOTE In early societies functions of a Bank were done by the corresponding institutions dealing with loans and advances. The modern banking and its networking are the products of modern western civilization which rapidly developed with the advent of industrialization. Britishers brought with them this modern concept of banking in India. The Bank of England was started in 1694, when the Britishers were carrying on a long war with France. In 1708, the monopoly and the right to issue notes was given to Bank of England through an Act. Several joint stock banking companies started operating early in the nineteenth century. These banks primarily carried on functions which are presently known as commercial functions like receiving money on deposits, lending money, transferring money from place to place and bill discounting. Banking has now presently become a globally mobile service and it facilitates the capital movement from one part of the country to another, one part of the globe from another. Obviously it is now difficult to understand the banking system of a nation in isolation. The present Indian banking system is required to be studied, viewed and reviewed in the context of global banking trends. 1.2. HISTORY OF BANKING IN INDIA Early History Banking in India has a very hoary origin. The Vedic period has literature which records the giving of loans to others. Banking was synonymous with money lending. The Manusmrithi speaks of deposits, pledges, loans and interest rate. Interest could be legally charged at between two and five per cent per month in order of class. The maximum amount of interest collectable on the principal was laid down by the State. Usury was not allowed. Payment of debt was made a pious obligation on the heir of a dead person. With the growth of trade and commerce, the trading community soon evolved a system of money transfer throughout the country. The main instrument through which banking and transfer of funds was carried out was through the inland bills of exchange or the Hundi. Indian bankers lent money, financed the rulers and trade, acted as treasurers of the State and also as insurers of goods. They also acted as money changers due to the differing

coins circulating all over India. Business developed so well that certain castes or communities traditionally came to regard banking as their family business. The power and prestige of these banks rose and fell with the growth and decline of empires. ‘Jagirs’ were granted to select banks and some acted as revenue collectors for local rulers. However, tenets of modern banking were not practised as acceptance of deposits was not a regular part of the business. Modern History Modern banking in India began with the rise to power of the British. The British consolidated their power and became the most powerful force in India after vanquishing Tipu Sultan in the battle of Srirangapattanam in 1799. The quest for power by Lord Mornington (Later Marquess of Wellesly). Governor General of Fort William in Bengal at that time led to a serious depletion of the resources of the East India Company. This led to the Company promoting the Bank of Calcutta in 1806 to raise resources. The situation prevailing at that time could be known by the writing of some Britishers, C.N. Cooke, Deputy Secretary and Treasurer of the Bank of Bengal, writing in his book “Banking in India”, has stated that usury prevailed in India more than in any other country in the nineteenth century. The native money lender lent to the farmers at 40, 50 and 60 per cent interest. The European community was relatively better off. He attributed the very high rates to the riskiness of many of the lendings and the difficulties in realising them. Indian businessmen very often acted as lender to the European businessmen with a rate of interest lower than the market rate. Till the advent of the three Presidency Banks, the European Agency Houses acted as bankers. They accepted deposits from British Officers serving in India and Europeans who had served in India and had returned to Europe. They financed trade with such funds and at certain times even helped the Government. There was a very effective credit network for flow of funds from one part of India to the other provided by the Indian banking firms. As the Agency Houses had prospered they also sought to operate Banks. Alexander & Company a leading Agency House started managing the Bank of Hindustan from 1770’s. The exact date of the founding of that bank is not known. The Bengal Bank and the General Bank of India, too, were started by the other Agency Houses in Bengal in the eighteenth century. In 1819 the Commercial Bank and in 1824 the Calcutta Bank were floated by the Agency Houses. None of these banks enjoyed limited liability nor were they proper joint stock banks. They were partnership firms with unlimited liability. The concept of limited liability was not put on the statute books till the 1860 Companies Act. Till that date Banks had to either obtain a special Charter from the Crown to operate or had to operate under unlimited liability. 7 (Sys 4) - D:\shinu\lawschool\books\module\contract law

The Bank of Calcutta started in 1806 was the precursor of the Bank of Bengal. In 1862 the right of note issue was taken away from the Presidency Banks. The Government also withdrew their nominees as Directors on their Board. However, they were given the privilege of managing the Government treasury at the Presidency Towns and at their branches.

The nationalised banks were to increase lending to areas of importance to the government and to use their resources for subserving the common good. A detailed scheme of objectives, regulations, management, etc. was drawn up for these banks.

The Bank of Bombay collapsed in 1867 and was put into voluntary liquidation in early 1868. It was finally wound up in 1872, but the bank was able to meet its liability in full to the general public.

Nationalisation was a recognition of the potential of the banking system to promote broader economic objectives. The banks had to reach out and expand their network so that the concept of mass banking was given importance over class banking. Development of credit in the rural area was a prime objective.

Subsequently a new bank, aptly called the New Bank of Bombay, was started in 1867 to commence banking operations. The Presidency Banks Act of 1876 was passed in order to have a common law for all the three Banks in order to enable the government to regulate the working of these Banks. The Government had earlier withdrawn its shareholding from these three banks. The Swadeshi Movement which prompted Indians to start many new institutions also provided an impetus for starting new banks. The number of joint stock banks increased remarkably during the boom of 1906-13. The People’s Bank of India Ltd., The Bank of India, The Central Bank of India, Indian Bank Ltd. and the Bank of Baroda were started during this period. This boom continued till it was overtaken by the crash of 1913-17, the first crisis that the Indian joint stock banks experienced. In 1921 the three Presidency Banks at Calcutta, Bombay and Madras were merged into the Imperial Bank by the passing of the Imperial Bank of India Act 1920. This bank did not have the power of issuing bank notes,but was permitted to manage the clearing house and hold government balances. With the passing of the Reserve Bank of India Act of 1934, the Reserve Bank of India came into being to act as the Central Bank. It acquired the right to issue notes and acted as the banker to the Government in place of the Imperial Bank. However, the Imperial Bank was given the right to act as the agent of the Reserve Bank of India in places where the Reserve Bank had no branches. By the passing of the State Bank of India Act 1955, the Imperial Bank was taken over and the assets vested in a new bank, the State Bank of India. The Reserve Bank was originally a shareholder’s bank. It was nationalised by the Reserve Bank Amendment Act 1948, consequent to the nationalisation of the Bank of England in 1946. 1.3. BANK NATIONALISATION The major historical event in the history of banking in India after independence is undoubtedly the nationalisation of 14 major banks on 19th July 1969. The imposition of social control on the banks in early 1969 was deemed unsuccessful as the government felt that the Indian commercial banks did not increase their lending to the priority sectors like agriculture, small scale industry etc., Nationalisation was deemed as a major step in achieving the socialistic pattern of society. 8 (Sys 4) - D:\shinu\lawschool\books\module\contract law

In 1980 six more private sector banks were nationalised extending the public domain further over the banking sector.

The benefits of nationalisation has indeed been impressive. The branch network of these banks have spread practically all over the country especially in the rural and previously unbanked areas. The branch network which was 8262 in June 1969 expanded to over 60000 by 1992 with a major expansion (80%) in rural areas. The average number of people served by a branch came down from over 60000 to 11000. The deployment of credit is more widely spread all over the country as against only in the advanced states. In 1969 deposits amounted to 13% of G.D.P and advances to 10%. By 1990 deposits grew to 30% and advances 25% of G.D.P. Rural deposits as a percentage of deposits grew from 3% to 15% making for increased mobilisation of resources from the rural areas. Deposits grew from a figure of Rs.4669 crores in July 1969 to Rs. 2,75,000 crores on 31.3.1993. 40% of the total credit was directed to the priority sector. More than 45% of the total deposits was used by the government to fund its five year plans. However, this growth did not come without its costs. The banking system has grown too large and unmanageable. Customer service has suffered due to increasing costs and lower productivity. The directed credit program has led to large overdues affecting the very viability of the banking system. 1.4 VARIOUS TYPES OF BANKING SERVICES The flow chart given below shows the following types of banking services. 1. Central Banking Services 2. Commercial Banking Services 3. Specialized Banking Services 4. Non-banking financial services. 1. Central Banking Services : The Central Bank of any country (i) issues currency & bank notes; (ii) discharges the treasury functions of the Government, (iii) manages the money affairs of the nation & regulates the internal and external value of money, (iv) acts as the bank of the Government and last but not the least, acts as the bankers’ bank. 2. Commercial banking services: Commercial banking services include (i) receiving various types of deposits; (ii) giving various types of loans, (iii) extending some non-banking customer services like facilities of locker, rendering services in paying directly house rent, electricity bill, share-calls, money

or insurance premium and the like. Commercial bank also advises on investment re-investment, allotment or transfer of funds. 3. Specialized banking services : Special banking institutions are established for definite specialized banking services like industrial banks to supply industrial long term credit and working capital; land mortgage bank for granting loans on equitable mortgage; Rural Credit Banks for generating funds for extending rural credit; developmental banks to support any developmental activities. These types of banks accept all types of deposits but mobilises the amount in its specially focussed area.

4. Non-Banking Financial Services: Many institutions are established for carrying on non-banking financial services. Mutual funds are institutions accepting finances from its members and investing in long term capital of companies both directly in the primary market as well as indirectly in the capital market. Financial institutions acting as portfolio managers receive funds from the public and manage the funds for or on behalf of its depositors. This port-folio managers undertake the responsibility of managing the funds of the principal so as to generate maximum return.

Various Types of Banks and Banking Functions Central Bank Commercial Banks

Nationalised Banks (20)

Specialised Banks

LIC

State Bank Of India & Associate Bank

Private Banks Indian

Foreign

Institutional Banks

Non-Banking Financial Institutions

Land Mortgage

IFCI

Rural Credit

SFCs

Industrial Development

IDBI

Co-operative

ICICI

Housing Finance

IRBI

Export Import

NABARD

Bank of India

HDFC

Mutual Funds UTI Other MF and LIC, GIC Bank & Can Bank Private Sector Non-Banking Financial Com.

1.5. SOCIAL CONTROL MEASURES ON BANK

1.6 THE NARASIMHAM COMMITTEE REPORT:

The Indian economy in the 1960’s passed though a stressful phase due to drought and wars. Political uncertainty and popular discontent too caused concern. The Government veered around towards ensuring a socialistic pattern of society. The Banking Regulation Act was amended in 1968 to provide for social control over the banks. Under these measures the Board of Directors of the banks were reconstituted so that 51% of their number was made of persons having special knowledge or experience in accountancy, agriculture, rural economy, small scale industry, co-operation, banking, economic laws etc. A quota was specified for certain categories. The Reserve Bank of India (RBI) was given powers to reconstitute the Board. A full time Chairman was to be appointed who was a professional banker, with prior approval of the RBI. The Government also acquired power to acquire any bank in case it failed to comply with any direction issued to it under the Banking Regulation Act, as regards banking policy.

The 1980’s were the decade of private enterprise all over the world. The collapse of the USSR at the end of the 1980’s is the end of one experiment of socialism. In India the country went through traumatic moments in 1990, after the heady economic growth in the 1980’s, due to a foreign exchange crisis on account of large scale external borrowings in the 1980’s, that had weakened the country’s ability to service its debts. The government felt that there was a need to initiate reform in the financial system and banks, as the system had developed weaknesses. A great part of the savings of the community was pre-empted by the Government in the form of the Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio(SLR). Banks were burdened by a large percentage of non- performing loans. Customer service had suffered, and out-moded practices were in vogue. Internal weakness due to bad house-keeping practices had increased. The Narasimham Committee was set up to recommend changes in the financial system. The Narasimham Committee made revolutionary recommendation emphasising the need for de-regulation and 9 (Sys 4) - D:\shinu\lawschool\books\module\contract law

liberalisation. Banks were to be allowed to raise capital from the public. Also no further nationalisation of banks were to be made. New private sector banks were to be allowed and no distinction was to be made between private and public sector banks. Foreign banks were to be allowed freedom to open branches. The pattern of banking structure should be broadened with 3-4 large banks on a international level 8-9 large banks on a national level and the other as local banks. Control over the banking system should be centralised with the RBI and not split between the RBI and the department of banking of the government. A separate body, quasi autonomous, operating under the aegis of the RBI is to be formed to supervise the functioning of the banks. The SLR and the CRR should be reduced to prudent levels. Concessional lending should be phased out. Deposit interest rates should be raised along with the reduction of SLR. The capital base of banks should meet with international norms of capital adequacy; provision was to be made for bad debts with special tribunals to be formed for realising bank debts. The appointment of Chief Executive of

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banks needs to be de-politicised and banks should be free to make their own recruitment of employees and officers. Some of the recommendations made have already been accepted and put into practice by the government while others are being considered. The wheel appears to have come full circle. While nationalisation has given immense benefits to the country, it has also exposed the defects in an excess of State control. At this present point, the future appears to be towards an open system based on increased private ownership. 1.7. CONCLUDING REMARKS The banking system in India is likely to undergo a major change. Restrictions imposed upon foreign banks to establish Indian branches are going to be gradually withdrawn. The GATT multilateral treaty emphasised the role of free operations in the services sector like banking and insurance. As a result, it is expected that there shall be more openings in the banking sector.

2. ROLE AND FUNCTIONS OF BANKING INSTITUTIONS SUB-TOPICS 2.1. Role and functions of Central Bank 2.2. Advances to priority sectors and the credit guarantee schemes 2.3. Role & functions of Commercial Banks 2.4. Role & functions of Specialised and Institutional Banks 2.5. Role & functions of non-banking financial institutions

(vii)Ensures economic stability and promotes economic development; and (viii) Currency printing and management of mints.

2.1. ROLE AND FUNCTIONS OF CENTRAL BANKS

One of the major deficiencies in the banking system in the 60’s related to granting of advances. Bulk of the advances were being directed to the large and medium scale industries and big and established business houses while agriculture, small scale industries and exports were not receiving adequate attention, if not being neglected. The Reserve Bank’s credit policy of 196768 sought to set right this anomaly in the system by channelising the flow of credit to the emerging priority sectors of the economy

Central Bank: Central Bantral Bank is an apex financial authority. The essential feature of a Central Bank is its discretionary control over the monetary system of the country. It occupies a pivotal position in the monetary and banking structure of the country. Thus it acts as the leader of the money market and in that capacity, it controls, regulates and supervises the activities of the Commercial banks. It is recognised as the highest financial authority and is a symbol of financial sovereignty and stability of the country. It holds the ultimate resources of the nation controls the flow of purchasing power and acts as the banker to the State. The principles on which a Central Bank operates are different from the ordinary banking principles to the extent that : a. The Central Bank unlike an ordinary Bank does not operate with the motive or objective of making a profit but is primarily meant to shoulder the responsibility of safeguarding the financial and economic stability of the country. b. The Central Bank being the reservoir of Credit and lender of last resort cannot look to or rely on other banking institutions to come to its aid in case of need and has to therefore keep its assets as liquid as possible so that other banks and financial institutions can approach it for accommodation. c. The credit machinery of the country needs to be stabilised quite often. This is done by the Central Bank by manipulating the bank rate and open market operations. This power is vested only in the Central Bank. Functions of Central Bank: The functions of the Central Bank are briefly discussed below. A Central Bank acts in the following capacities. (i) As a currency issuing agency; (ii) As a banker to the State; (iii) As a banker’s bank; (iv) As the lender of last resort; (v) As the guardian of the money market through credit control; (vi) It undertakes exchange control operations and maintains the external value of the domestic currency and ensures the stability of the internal value of currency;

[Details of the functions of the Central Bank in India i.e. the Reserve Bank of India are discussed in the module on RBI.] 2.2 ADVANCES TO PRIORITY SECTORS AND CREDIT GUARANTEE SCHEMES

in the larger interests of the country. Though the emphasis of the 1967 credit policy was on overall restraint certain liberalisation was allowed on a selective basis with a view to enlarge the flow of credit to the areas of agriculture, exports and small scale industries. The banks were encouraged to increase their involvement in lending to the priority sectors by the extension of various relaxations and incentives in the form of refinance from the RBI at a concessional rate of interest or on other special terms not available for other bank lendings. In order to provide an incentive to lending to small borrowers the RBI set up the Credit Guarantee Corporation of India Ltd. in 1971. This institution is now named as the Deposit Insurance and Credit Guarantee Corporation. The main objective of this Corporation is to administer a comprehensive credit guarantee scheme for loans by banks to small individual borrowers in the priority and other neglected sectors. There are various schemes in operation which provide cover for direct lendings to small borrowers who without such support would find institutional credit highly inaccessible. The recommendations of the Tandon committee, which went into the working of the special credit schemes of Commercial Banks with special reference to their employment potential led the RBI to issue a set of guidelines which emphasised on needbased assistance to different categories of self-employed persons. Banks were asked to make efforts to arrange integrated financial and management assistance to borrowers, taking into account the totality of their requirements and the viability of the proposition being financed. Since 1977-78, export credit has been excluded for the purposes of computation of the total priority sector advances of banks, but it has continued to receive preferential treatment in matters, such as, refinance facilities from the Reserve Bank, concessional rates of interest on pre-shipment and post-shipment credit to exporters etc. 11 (Sys 4) - D:\shinu\lawschool\books\module\contract law

The flow of credit to the neglected sectors were boosted by the directive of the Government of India in November 1974 to public sector banks whereby, priority sector lending was to reach a level of not less than one-third of their outstanding credit by March 1979.

The Corporation has introduced several schemes to cater to the small borrowers in the non-industrial sector like the Small Loans Guarantee Scheme 1971; the Small Loans (Financial Corporations) Guarantee Scheme 1971 and the Small Loans (Service Co-operative Societies) Guarantee Scheme 1971.

In March 1980, the Government of India took two major decisions :1) To raise the proportion of advances to the priority sectors by public sector banks from 33 1/3% to 40% by 1985; and 2) The implementation of the 20 point programme to be actively promoted by banks.

After the take over by the Deposit Insurance Corporation in July 1978 a fourth scheme was introduced by the Deposit Insurance and Credit Guarantee Corporation of India Ltd., known as the Small Loans (Small Scale Industries) Guarantee scheme 1981. DICGC is the new name given to Deposit Insurance Corporation after its take over of the Credit Guarantee Corporation.

The Reserve Bank also set up a working committee on priority sector lending and 20 point economic programme to work out the modalities of implementation of the above decisions of the government. Based on the recommendations of the working group, the RBI issued instructions for implementation. Some of the important instructions were :a) Priority sector advances should constitute 40% of aggregate bank advances by 1985. b) 40% of priority sector advances to be earmarked for agriculture and allied activities. c) Direct advances to weaker sections in agriculture and allied activities should reach a level of at least 50% of the total direct lending to agriculture. d) Advances to rural artisans, village craftsmen and cottage industries should constitute 12.5% of the total advances to small scale industries by 1985. A series of measures taken with the aim of encouraging the commercial banks to cater to the credit requirements of the neglected sectors, particularly the weaker sections of the society led to the formation of the Credit Guarantee Corporation of India Ltd.

In addition to the above, various other schemes were introduced for the benefit of the priority sectors like the :a) National Rural Employment Programme (NREP) which basically dealt with the problem of unemployment and underemployment in the rural areas. b) Rural Landless Employment Guarantee Programme (RLEGP) more specifically to tackle the problem of unemployment among the landless and to create durable assets for strengthening the rural infrastructure. c) Crop Insurance Scheme - to provide a measure of financial support to farmers in the event of crop failure as a result of natural calamities, to support and stimulate production of cereals, pulses, oilseeds, etc. d) Self-employment Scheme for Educated Unemployed Youth (SEEUY)- to encourage educated unemployed youth to undertake self-employment ventures in industry, services etc; and e) Self-employment Programme for Urban Poor (SEPUP) to provide self employment to the urban poor.

This is a public limited company floated by the Reserve Bank of India on 14th January 1971.

2.3. ROLE AND FUNCTIONS OF COMMERCIAL BANKS

The Corporation was visualised as an agency to provide a simple but wide-ranging system of guarantees for loans granted by the Credit institutions to small and needy borrowers.

The following chart shows the Commercial banking system in India

Commercial Banking system in India

Public Sector

Private Sector

Scheduled State Bank of India

Associates of State Bank of India

Other Nationalised Banks

Non scheduled

Scheduled

Foreign Banks Representative Offices 12 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Indian Banks

A Scheduled Bank is one which is included in the second schedule of the RBI Act. A non scheduled Bank is one which is not included in that schedule.

a) they attract deposits by offering attractive rates of interest, thus converting savings which would have remained idle, into active capital; and

Utility of Banking Institutions

b) they distribute these savings through loans among enterprises which are connected with economic development.

Banks are extremely useful and indispensable institutions for a modern community. They are the custodians and distributors of liquid capital the essential ingredient for commercial and industrial activities. The utility of banks can be summarised as follows :a) The banks create purchasing power, in the form of bank notes, cheques, bill, drafts, etc. and economise the use of metallic money which is very expensive and cumbersome. b) Banks transfer funds, by bringing lenders and borrowers together, and by helping funds to move from place to place and from person to person in a convenient and inexpensive manner, through the use of cheques, bills and drafts. In this way, they help trade and industry. c) The banks encourage the habit of saving among the people and enable small savings, which otherwise would have been scattered ineffectively, to be accumulated into large funds and thus made available for investments of various kinds. In this way, they promote economic development through capital formation. d) By encouraging savings and investment, the banks increase the productivity of the resources of the country and thus contribute to general prosperity and welfare by promoting economic development. e) The banks agency functions are very useful to the customers of the bank. They undertake to make payments of various kinds on behalf of their customers and also make several types of collections on their behalf. Thus, banks are useful to both the community in general and the individual customer in particular. Role of Banks in the Socio-economic development Banks play a vital role in the economic development of the country as explained hereunder : i) Banks promote capital formation : In any plan of economic development capital occupies a position of crucial and strategic importance. Unless there is an adequate degree of capital formation, economic development is not possible. Deficiency of capital is a result of inadequate savings made by the community. The serious handicaps in economic development arise from capital deficiency. This is where the banks can play an useful role in making up the deficiency. The role of banks in economic development is to remove the deficiency of capital by stimulating savings and investment. A sound banking system mobilises the small and scattered savings of the people and makes them available for investment in productive enterprises. In this connection, the banks perform two important functions.

ii) Optimum Utilisation of Resources : In the absence of banks, it would have been very difficult to mobilise the small savings of the people and distribute these saving among entrepreneurs. It is through the agency of the banks that the community’s savings automatically flow into channels which are productive. The banks exercise a degree of discrimination which not only ensures their own safety but also makes for optimum utilisation of the financial resources of the community. iii) Financing the priority sectors : In order to meet additional demands arising out of economic development, the banking system has undergone changes in its structure and organisation. The banks and financial institutions operate in such a manner as to confirm to the priorities of development and not in terms of return on their capital. The banks now play a more positive role. Thus, the central bank does not merely stop at playing a regulatory role i.e., regulation of bank credit but it also plays a developmental role. It helps to create a machinery or agency for financial development plans. It ensures that the available finance is diverted to the right channels. For successful implementation of the development programmes, it becomes necessary to make credit facilities available to high priority sectors and to see that the available funds are not squandered away in non-essential or non-plan expenditure. iv) Banks promote Balanced Regional Development : By opening branches in backward areas the banks make credit facilities available there. Also, the funds collected in developed regions through deposits may be channelised for investment in the under developed regions of the country. In this way, they bring about more balanced regional development. v) Expansion of Credit : To maintain a high level of economic activity, it is imperative that credit must expand. In an era of economic developments, banks create credit more liberally and thereby make funds available for the development of various projects. Thus, banks make a valuable contribution to the speed and the level of economic development in the country. vi) Banks promote growth with stability : Banks regulate the rate of investment by influencing the rates of interest. The primary function of the Reserve Bank of India was to regulate the issue of bank notes and keep adequate reserves to ensure monetary stability. Now, it has assumed wider 13 (Sys 4) - D:\shinu\lawschool\books\module\contract law

responsibility to help in the task of economic development. In addition to regulating currency and controlling credit, the RBI has been playing a vital role in the financing and supervision of the development programmes for agriculture, trade, transport and industry. It has created special funds for promoting agricultural credit and has created special Institutions for widening facilities for industrial finance. The other banks too have cooperated in these areas by opening new branches to tap the savings of the people and lend them to entrepreneurs. Thus, banks come to play dominant and useful role in promoting economic development by mobilising the financial resources of the community and by making them flow into desired channels. In recent years, commercial banks in India have been adopting the strategy of innovative banking in their business operations. This implies the application of new techniques, new methods and novel schemes in the areas of deposit mobilisation, deployment of credit and bank management. To attract more deposits, Banks have introduced many attractive saving schemes such as education deposit plan, perennial pension plan retirement schemes, loan linked recurring deposit schemes etc., Mobile bank branches have also been introduced by a number of banks. Innovations have also been made in the credit side by introducing education loan schemes, housing finance, credit cards, packing credit and post shipment credit for exporters, consumer credit, which pool the investors funds for investing in a diversified portfolio of securities so as to spread and reduce risks. In addition to various activities like innovative banking, promoting entrepreneurship, retail banking and rural development, the commercial banks have promoted various schemes like advances to priority sectors and credit guarantee schemes. These are discussed in the role and functions of specialised banks. 2.4 ROLE AND FUNCTIONS OF SPECIALISED AND INSTITUTIONAL BANKS The role and functions of the following institutional banks are discussed below. The role & functions of many other financial institutions shall be dealt with at the appropriate place of this module along with their structure. The few institutional banks that are discussed below operate under various schemes of the Government along with other Commercial Banks. Some of these schemes are given below : (a) Lead Bank Scheme : The Lead Bank Scheme, under which the leadbanks play the role of pace setter for banking and credit development, has had a special significance for banks as agents of change. It has imparted a new direction to the branch expansion policy. District credit planning exercises have made blockwise estimates of credit needs. The scheme has also focussed the attention of the 14 (Sys 4) - D:\shinu\lawschool\books\module\contract law

banks on the concept of the banking needs of the area. The scheme has opened up new vistas in the field of rural banking. The credit plans envisage schemes of credit extension, mainly for the development of priority sectors and for the benefit of the weaker sections. In terms of the guidelines issued by the Reserve Bank of India, the Annual Action Plans (AAP) cover Integrated Rural Development Programme (IRDP), and the lead banks have assumed a part of the responsibility for formulating plans which fit into the Rural Development schemes covering viable economic activities, and which can be pursued by the IRDP beneficiaries. (b) Integrated Rural Development Programme : The Integrated Rural Development Programme (IRDP) is a major instrument to alleviate rural poverty. Its objective is to enable selected families in rural areas to cross the poverty line. This is achieved by providing productive assets and inputs to the target groups. The assets are provided through financial assistance in the form of subsidy by the government and term credit advanced by financial institutions, primarily by banks. Commercial banks have been the principle agents of IRDP implementation through their branch network. Commercial banks have looked upon the IRDP as an opportunity to take banking to the rural areas and have made earnest endeavors to contribute to its success. (c) Poverty Alleviation Programme : Presently, the programme is limited to the financing of such traditional activities as dairy, poultry and village industries including basket making, carpentry, handlooms etc., where the scale of production is very small and the technology used in the production process is primitive. Commercial banks, State Bank of India, in particular, have taken a number of steps to enable the borrowers to increase the scale of production and improve the production processes by offering technical support, demonstration plots, financial and management consultancy etc., and by conducting management appreciation programmes and organising entrepreneurial development programmes. Some of the institutional banks operating these schemes are as follows: 1. Co-operative Banks: Cooperative Banks also played a limited but important role in the banking system of the country. There are a number of such banks which include State Cooperative Banks (SCB’s), Central Cooperative Banks (CCB), Primary Cooperative Banks (PCB’s), Land Development Banks (LDB’s), Primary Agricultural Credit Societies (PAC’s) etc. a) Primary Co-operative Banks: Commonly called the Urban Cooperative Banks, they are small sized Cooperatively organized banking units which operate in metropolitan, urban and semi- urban centres to cater mainly to the need of small borrowers. The Reserve Bank is responsible for licensing of existing/new banks and branches, sanctioning

of credit limits to SCB’s on behalf of PCB’s for financing the SSI unit as well as conducting their statutory inspections. b) Land Development Banks (LDB’s): In the cooperative credit structure the Land Development Banks i.e., State Land Development Banks (SCDB’s) and Primary Land Development Banks (PLDB’s) provide long term credit for agriculture. The major sources of funds for the SLDB are the special development debentures and ordinary debentures. The ordinary debentures programme of the SLDB is finalised by the NABARD. 2. Regional Rural Banks Objectives : RRB’s are primarily organised to develop the rural economy by providing, for the purpose of development of agriculture, trade, commerce, industry and other productive activities in the rural areas, credit and other facilities, particularly the small and marginal farmers, agricultural labourers, artisans and small entrepreneurs and for matters connected therewith and incidental thereto. Capital Structure: The authorised capital of each Regional Rural Bank shall be Rs.5 crores provided that the Central Government may after consultation with the National Bank and the sponsor Bank, increase or reduce such authorised capital. Of the capital, 50% shall be subscribed by the Central Government, 15% by the concerned State Government and 35% by the sponsor Bank. Management : The general superintendence, direction and management of the affairs and business of a RRB vests in the Board of Directors who may exercise all the powers and discharge all the functions which may be exercised or discharged by the RRB. OPERATIONS : During the financial year 1991-92 (upto September 1991) while the number of RRB’s remained unchanged at 196, the total number of districts covered by RRB’s increased to 385 as compared with 380 in the preceding year. Aggregate deposits of RRB’s rose from Rs.4267 crores to Rs.5141 crores at the end of September 1991 recording a growth of 20.5%. Borrowings of RRB’s from sponsor Banks NABARD, SIDBI and other institutions aggregated Rs.1702 crores as at the end of September 1991 of which Rs.1471 crores were from NABARD alone. NABARD also offered assistance to RRB’s for setting up technical, monitoring and evaluation cells for preparation and evaluation of schemes under project lending.

3. Role and Functions of an EXIM Bank The EXIM Bank is established by an Act of 1981 for functioning as the principal Financial Institution for co-ordinating the working of institutions engaged in financing export and import of goods and services with a view to promoting Country’s international trade. The EXIM bank may grant in or outside India loans and advances either by itself or in participation with any other bank or financial institutions. It may also grant loans and advances to scheduled Banks or Financial Institutions; underwrite issue of stock, shares, bonds or debentures of a Company engaged in export or import; accept, collect, discount, purchase, sell or negotiate bills or promissory notes connected with export or import; grant issue or endorse letters of credit; finance export or import of machinery or equipment; buy or sell foreign exchange; undertake surveys techno-economic or any other study; provide technical administrative or financial assistance of any kind of export or import; plan, promote or develop export oriented concerns; collect, compile and disseminate market and credit informations and do such other acts and things necessary to discharge the duties and functions under the Act [Sec 10]. 4. Role and Functions of Re-Construction Bank Industrial Re-Construction Bank is established by the Act of 1984 with a view to function as the principal credit and reconstruction agency for industrial revival. The bank is to act as the agent of the central or State Govts,RBI, SBI,State cooperative bank and other public financial institutions. It may carry on and transact the following functions; granting of loans and advances to industrial concerns, guaranting or counterguaranteeing or providing indemnity, under-writing issues of stock shares and debentures; providing credit to State level agencies for granting industrial loans; providing infra-structure facilities, machineries and other equipments, consultancy and merchant banking services; transfering or acquiring any instrument relating to loans and advances; providing managerial assistance; granting or opening or issues of letters of credit; and doing such other acts or things as may be incidental to or consequential upon the powers and duties under the Act. [Sec.18] 5. National Housing Bank This specialised bank was established by an Act of 1987 in order to promote housing finance institutions. The Bank may promote, establish, support or aid in the promotion of housing Finance institutions; make loans and advances for housing finance, purchase stock shares, bonds and debentures; guarantee the financial obligation of housing finance institutions; draw, accept, discount negotiable instrument; provide technical and administrative assistances to housing finance institutions; do any other business the Central Govt may on the recommendations of the RBI authorise the institutions to do. The above discussions about the functions of the specialised banks are only illustrative. 15 (Sys 4) - D:\shinu\lawschool\books\module\contract law

VARIOUS DEVELOPMENT BANKS & FINANCIAL INSTITUTIONS AT A GLANCE NABARD

Country wise

AFC SLDB RRB

Agriculture State wise

Capital Market

Export/Import

Mutual funds LIC, GIC including UTI and its subsidiaries SHCI CRSIL/ CARE / ICRA DFHI EXIM BANK ECGC All India

Industrial Development

Large scale Small Scale

State Level

Housing ——>

SFC SIDC SIIC

NHB & HB of Commercial Banks (HDFC)

Insurance & Credit guarantee ——> DICGC NABARD

National Bank for Agriculture and Rural Development

AFC

Agriculture Finance Corporation

SLDB

State Land Development Bank

RRB

Regional Rural Banks

SEBI

Securities and Exchange Board of India

SHC

Stock Holding Corporation of India

CRISIL

Credit Rating Information Service of India

ICRA

Investment Information and Credit Rating Agency of India

DFHI

Discount and Finance House of India

EXIM BANK

Export Import Bank of India

ECGC

Export Credit and Guarantee Commission

ICICI

Industrial Credit and Investment Corporation of India

IDBI

Industrial Development Bank of India

IFCI

Industrial Finance Corporation of India

IRBI

Industrial Reconstruction Bank of India

NSIC

National Small Industries Corporation

SIDBI

Small Scale Industrial Development Bank of India

SFC

State Finance Corporation

SIDC

State Industrial Development Corporations

SIIC

State Industrial Investment Corporations

NHB

National Housing Bank

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ICICI IDBI IFCI IRBI NSIC SIDBI

DICGC

Deposit Insurance and Credit Guarantee Corporation

LIC

Life Insurance Corporation of India

GIC

General Insurance Corporation of India

UTI

Unit Trust of India.

2.5 ROLE AND FUNCTIONS OF NON-BANKING FINANCIAL INSTITUTIONS Merchant Banking : In addition to the Commercial banking and specialised banking activities merchant banking has also grown in stature and gained an important place in the financial system of the country. Merchant Bankers are governed by the Securities and Exchange Board of India (Merchant Bankers) Rules 1992. “Merchant Banker” is defined as any person who is engaged in the business of issue management either by making arrangement regarding selling, buying or subscribing to securities as Manager, Consultant, Adviser or rendering corporate advisory service in relation to such issue management. Public money plays a vital role in financing a large number of projects both in public and private sectors. Hundreds of Crores of rupees are tapped from Capital market every year to finance industrial projects. To raise the money from the capital market, promoters have to bank upon merchant bankers who manage the issue. Role of Merchant Bankers: Merchant bankers are designated as managers to the issue. They are specialised agencies whose main business is to attract public money to Capital issues. They render the following services. a) Drafting of prospectus and getting it approved from the stock exchanges. b) Appointing, assisting in appointing bankers, underwriters, brokers, advertisers etc. c) Obtaining the consent of all the agencies involved in public issue. d) Holding brokers conference/investors conference. e) Deciding the pattern of advertising f) Deciding the branches where applications money should be collected. g) Deciding the dates of opening and closing of the issue. h) Obtaining the daily report of application money collected at various branches. i) Obtaining subscription to the issue and j) After the close of issue, obtaining consent of stock exchange for deciding basis of allotment etc. Merchant Bankers charge a heavy fee for rendering the above mentioned services. The fees are so lucrative that many nationalised banks which had separate merchant banking divisions have now opened separate subsidiary companies for rendering merchant banking services.

Having regard to the nature and range of activities of the merchant bankers and their responsibilities to SEBI Investors and Issuers of securities it has been decided to have four categories of merchant bankers. Category I : Those authorised to act in the capacity of issue manager/co-advisor/consultant and portfolio manager to an issue and underwriter to an issue as mandatorily required. Category II : Those authorised to act in the capacity of comanager, advisor or consultant to an issue or portfolio manager, and Category III : Those authorised to act only in the capacity of advisor or consultant to an issue. Category IV : Advisors and consultants who provide consultancy and guidance to certain terms of authorisation have also been specified for merchant bankers a few of which are listed below. a. All Merchant bankers must obtain the authorisation of SEBI b. SEBI may collect from the merchant bankers an initial authorisation fee an annual fee and a renewal fee. c. The Merchant bankers must have a minimum net worth which is based on the category into which they are classified. Category I - 1 Crore Category II - 50 Lakhs Category III - 20 Lakhs Category IV - NIL d. Lead Manager/Merchant bankers would be responsible for ensuing timely refunds and allotment of securities to the investor. e. The merchant banker shall make available to SEBI such information documents returns and reports as may be prescribed and called for. f. SEBI has already prescribed a code of conduct for merchant bankers, which they should adere to. The above terms of authorisation have been framed to make merchant bankers more responsible and liable and any negligence on the part of the merchant bankers can be proceed against legally. This will ensure that fake companies whose only intention is to defraud the Public do not have any access to the stock market and the investing public at large.

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3. STRUCTURE OF BANKING INSTITUTIONS SUB-TOPICS: 3.1. Structure of a Scheduled Commercial Bank. 3.2. Structure of State Bank of India. 3.3. Structure of EXIM Bank 3.4. Structure and Management of a Nationalised Bank 3.1 STRUCTURE OF A SCHEDULED COMMERCIAL BANK The composition of a Board of Directors of a Scheduled Bank shall consist of a whole time Chairman, or a whole time Director who shall be the Chairman of the Board of Directors and other elected and nominated part-time members. Of course in a recent amendment part time Chairman can also be appointed. According to Sec.10A of Banking Regulation Act (BRA), 1949 as amended in 1968, not less than 51% of the number of members shall consist of persons having special knowledge in one or more of the areas, such as accountancy, agriculture and rural economics, banking, cooperation, economics, finance, law, small-scale industries or any other special knowledge which in the opinion of the Reserved Bank be useful in the banking company. Atleast two of three members must have special knowledge of practical experience in agriculture or rural economy cooperation or small-scale industries. The Chairman and a Director of the Banking Company appointed by the RBI shall not be required to hold qualification shares in the banking Company. The management of the whole affairs of the banking company shall be entrusted with the whole time Director who is also the Chairman of the Company subject to superintendence, control and direction of the Board of Directors. The Chairman must have special knowledge and practical experience of working of a banking company or of the SBI or any subsidiary bank or a financial institution [Sec.10B(4)]. The RBI has the power to remove the Chairman or the whole time Director or Chief Executive Officer (whatever name called) for reasons to be recorded in writing with effect from such date as may be specified by order. Any person appointed as a Chairman, Director or Chief Executive Officer shall hold office during the pleasure of RBI and subject thereto for a period not exceeding three years as the RBI may specify. The RBI has the power to appoint Additional Director. Directors of a Banking company other than the whole time Directors shall not hold office for a period exceeding 8 years. A Chairman of a whole time Director removed from office shall cease to be a Director of a Company and shall not to eligible to be appointed as a Director either by election or by co-option or otherwise for a period of four years from the date of such removal. If the office of a Chairman of a Banking Company is vacant the RBI may appoint a person qualified under Sec.10B(4). No Banking Company shall employ a Managing Agent.

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3.2 STRUCTURE OF STATE BANK OF INDIA A flow chart of the Managment of the SBI is given below Central

Chairman Two Managing Directors

Board (CB)

President of the thirteen Local Boards Four elected Directors

Comprise

Ten other Directors

Local Boards at each local Head Office Chairman Directors Six one elected ex-offico of CB from nominated member the area members

Chief G.M. of the local H. Office

SBI which is still a shareholders’ bank in which RBI is the majority shareholder and private shareholders are minority shareholders. The bank shall be managed by the Central Board of Directors which shall be guided by the Central Government. All such directions of the Central Government shall be given through the RBI. The Central Board shall consist of the Chairman to be appointed by Central Government in consultation with the RBI, two Managing Directors appointed by the Central Government in consultation with RBI, presidents of the Local boards and four elected members elected by the shareholders other than by the RBI provided the shareholders hold more than 25% of the share capital. One Director taken from the workmen to be appointed by the Central Government, One Director to be appointed by the Central Government from the employees not less than two and not more then six Director to be appointed by the Central Government in consultation with RBI from persons having the special knowledge of the working of cooperative institutions and of rural economy or experience in commerce, industry, banking or finance. One nominated Director by the Central Government and one nominated Director by the RBI (sec 19 of the SBI Act). The Chairman, and each managing Director shall hold office for such term not exceeding 5 years as the Central Government may fix. They may however be eligible for the appointment. The Central Government has the right to terminate them by serving notice of not less than 3 months or paying 3 months’ salary in lieu of the notice within the time. The local boards of all local head offices comprise of the Chairman ex officio and Directors of the Central Board coming from that are ex officio, six members nominated by the Central Government in consultation with RBI, one elected member from the shareholders other than RBI and Chief General Manager of the area. The Governor of the RBI in consultation with the Chairman of the SBI shall nominate members of the

local board. The member of the local board shall hold office not exceeding 3 years but shall continue in office until the successor be nominated. The local boards shall exercise all powers and perform all functions and duties of the SBI as may be approved by the Central board. All questions are decided by the majority. Similarly local boards are also to meet at such place and time and observe such rules and procedures as may be prescribed 3.3 STRUCTURE OF EXIM BANK The management of the EXIM, bank is nested in the board comprising : (a) A Chairman and Managing Director appointed by the Central Government (b) One Director nominated by the RBI (c) One Director nominated by the Development Bank (d) One Director nominated by the Export Credit and Guarantee Corporation. (e) Not more than 12 Directors nominated by the Central Government of whom 5 are Government officials, not more than 3 are from schedule banks and not more than 4 are persons having special knowledge of professional experience in export and import of finance. The Board may constitute such committees either wholly or partly by Directors and of other persons. The committees meet at such time and place and shall observe such rules and procedures and transact such business as may be prescribed. Directors of a Board hold office for a period not exceeding 6 years. Nominated Directors hold office during the pleasure of the authority nominating them. Chairman and Managing Directors hold office for such term not exceeding 5 years but eligible for the appointment. 3.4 STRUCTURE AND MANAGEMENT OF A NATIONALISED BANK Under Sec 9 of the Banking Companies (Acquisition of Transfer of Undertakings Act 1970 the Central Government was given the power to make schemes in consultation with the RBI for the purpose of :

(a) Management by board of Directors, the appointment of managing Directors, the holding of board meetings and allied matters. (b) Meetings of the Board (c) Appointment of Committees of the Board (d) Constitution of Regional Consultative Committees and their Boards. Nationalised Banks are managed by the Board of Directors having 15 nominated members including two fulltime Directors of whom one is the managing Director. The Composition of the Board is at follows : (a) Two whole time Directors including the Managing Director, (b) One Director from the employer, (c) One Director representing Workmen, (d) One Director representing depositors, (e) Three Directors representing farmers, workers and artisans, (f) One Director who is an official of the RBI, (g) One Director who is the official of the Central Government, and (h) not more than 5 Directors having knowledge or practical experience of the working of nationalised Banks. The Directors hold office during the pleasure of the Central Government for a period not exceeding 3 years. They may however be reappointed. Clause 13 of the scheme provide provisions for constituting management of the Board. The Board may constitute advisory committees consisting Directors or partly with Directors or partly with other persons for advising the Board on matters refer to them. The Board has to meet atleast 6 times in a year and once in each quarter and the head office of the Bank or at such other place as the Board may decide. All questions are to be decided by majority votes. The scheme also provides for appointment of regional competitive committees for six regions specified by the Committee. The Committee shall consist of not more than three persons nominated by the Central Government and two representatives from each of the State in respective regions. One representative to be nominated by the Central Government as desired by the RBI. Meetings of the consultative Committee shall be presided over by Minister of Finance or his deputy. The functions of these committees shall be to review banking developments within the region and recommend on such matters as may be referred to it by the Central Government and the RBI.

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4. FINANCIAL INSTITUTIONS AND THEIR FUNCTIONS SUB-TOPICS 4.1 Introductory Note 4.2 Industrial Finance Corporation of India (IFCI) 4.3 State Financial Corporations (SFC's) 4.4 The Industrial Credit and Investment Corporation of India (ICICI) 4.1 INTRODUCTORY NOTE The economic development of a country depends inter alia on its financial system. In the long run, the larger the proportion of financial assets to real assets, the greater the scope for economic growth. Investment is a pre-condition for economic growth. In order to sustain the growth, continued investment is a prime importance, Finance is a major input in the growth process. This is where the financial institution play a vital role. The major function of financial institutions whether short term or long term, is to provide the maximum financial convenience to the public. This is achieved in the following manner. a) Promoting the overall saving of the economy by widening the financial system. b) Distributing the existing savings in a more efficient manner so that those in greater need from the social and economic point of view, get priority in allotment; and c) Creating credit and deposit money and facilitating the transactions of trade, production and distribution in furtherance of the economy. The integrated structure of the financial institution in the country comprises to 12 institutions at the National level and 44 at the State level. The structure consists of five All India Development Banks (AIDB’s) four Specialized Financial Institutions (SFI’s), three Investment Institutions, 18 State Financial Corporations (SFC’s) and 26 State Industrial Development Corporations (SIDC’s). The AIDB’s are Industrial Development Bank of India (IDBI), Industrial Finance Corporation of India (IFCI), Industrial Credit and Investment Corporation of India (ICICI), Small Industries Development Bank of India (SIDBI) and Industrial Reconstruction Bank of India (IRBI). The SFI’s are Risk Capital and Technology Finance Corporation Ltd, (RCTC), Technology Development and Investment Company of India ltd., (TDICI), SCICI Ltd, and Tourism Finance Corporation of India Ltd (TFCI). The investment activities are conducted by Life Insurance Corporation of India (LIC), Unit Trust of India (UTI), and General Insurance Corporation of India (GIC) and its subsidiaries and various Mutual Funds. Among the All India Development Banks, IDBI, IFCI, ICICI and IRBI provide assistance to medium and large industries and SIDBI to the tiny and small sector. They also undertake promotional and developmental activities. Among the specialised financial institutions, RCTC and TDIC are involved 20 (Sys 4) - D:\shinu\lawschool\books\module\contract law

in risk capital, venture capital and technology development financing. SCICI, which was originally set up for financing shipping, deep sea fishing and allied activities has diversified its operations to other industrial sectors also. TFCI is engaged in financing hotels tourism and related projects. Of the investment institutions, LIC and GIC which primarily take care of the life and general insurance needs of the society and UTI which is a mutual fund mobilising the savings of the community for channelising into productive sectors, are active participants in providing finance to industry both by way of term loans and subscription to equity and debentures. The SFC’s provide assistance mainly to small sector and SIDC’s to the medium and large sectors in their respective states besides undertaking promotional and development activities. The Financial Institutions, evolved over the years have been instrumental in providing term finance in the form of loan, underwriting and direct subscription to equity and debentures and guarantees. Looking to the emerging needs of the industrial sector they have also introduced a variety of financial products and services. 4.2 INDUSTRIAL FINANCE CORPORATION OF INDIA (IFCI) The need for speedier industrial expansion and for modernisation and replacement of obsolete machinery in already established industries paved the way for establishment of the Industrial Finance Corporation of India in 1948. IFCI was the first development bank to be established for providing medium and long term credits to industrial concerns. IFCI was established under such circumstances where normal banking accommodation was inappropriate and recourse to capital issue methods were impracticable. Capital: The Authorised capital of the IFCI was Rs.10 Crores it was subsequently raised to 20 crores by the IFCI Act, 1972. Presently the authorised capital is 250 crores Fifty percent of the share capital of IFCI is held by the IDBI and the remaining 50% is held by commercial and cooperative banks. The corporation is authorised to issue bonds and debentures in the open market within certain limits. Functions: The following are the major functions of the IFCI : 1) To guarantee loans raised by industrial concerns. 2) To grant loans and advances to or subscribe to the debentures of industrial concerns. 3) To underwrite the issue of stocks, shares, bonds or debentures by industrial concerns. 4) To extend guarantee in respect of deferred payments by importers 5) To subscribe directly to the stock or shares of any industrial concern. The IFCI caters to the financial needs of large and medium sized limited companies in the public and private sectors and cooperative societies engaged in the manufacture, preservation,

processing, shipping, mining or hotel industry or in generation and distribution of electricity or any other form of power. The IFCI provides assistance in all forms-sanction of rupee loans and foreign currency loans, underwriting of and subscribing to share and debenture issues, guaranteeing of deferred payments etc. However, the corporation cannot compete with the commercial banks in financing industrial concerns but supplement their work by granting loans in such amounts and for such periods as are outside the scope of ordinary commercial banks. The corporation now functions as a subsidiary of the IDBI under its supervision, guidance and control. Before granting loan to any industrial concern applying for financial aid, the corporation scrutinizes the application carefully and the following points are evaluated i.e., a) the importance of the industry to the national economy; b) the feasibility of and the cost of the scheme for which financial aid is required; c) technical, financial and economic viability; d) the competence of the management; e) the nature of the security offered. f) the adequacy of the supply of technical personnel and raw materials; and g) the quality of the product and the country’s requirements of the product manufactured. While lending, the corporation requires the security of fixed assets such as land, buildings, plant and machinery and it does not normally lend against raw materials or finished products. It ordinarily requires the personal guarantee of directors and has the right to appoint two directors to the board of management of the borrowing concern in order to ensure efficient management and also to safeguard the interests of the corporation. In fact, the corporation has the right to take over the management of a concern or to sell the property mortgaged in the event of continuous default in the payment of interest and of the principal advanced to the concern. It obtains periodic reports from the borrowing concerns and also undertakes periodic inspection. In addition to providing assistance by way of project finance and financial services like equipment leasing, equipment procurement, buyers’ and suppliers’ credit, finance to leasing and hire purchase concerns etc., IFCI also provides merchant banking services’. It also helps industrialisation through a range of promotional activities. The promotional services cover funds support for technical consultancy, risk capital venture capital, technology development, tourism and tourism related activities, housing, development of securities market and investor protection upgradation of managerial skills, entrepreneurship development, science and technology, entrepreneurs’ perks, research etc, and subsidy support through promotional schemes of IFCI to help the entrepreneurs and enterprises in the village and small industries (VSI) sectors.

Operations: The Cumulative financial assistance sanctioned by the Corporation since its inception in 1948 upto end March 1993 aggregated 16650-93 crores against which disbursements amounted to Rs.8650.6 crores. Among the many industries which have received financial assistance from the corporation are those which are of high national priority such as fertilizers, cement, power generation, paper, industrial machinery, etc. During the year 1992, IFCI introduced one more scheme of financial service i.e. Installment credit scheme, with a view to providing an option to borrowers for availing assistance for acquiring equipment for industrial use. The scheme is flexible in regard to repayment and has a simplified procedure for interest payment. The above scheme is similar to the soft loan scheme introduced by the Corporation in 1976 which provided financial assistance to productive units in selected industries i.e. Cement, Cotton, Textile, Jute, Sugar and certain engineering industries on concessional term to overcome the backlog in modernisation replacement and renovation of their plant and equipment so as to achieve higher and more economic levels of production. The scheme is administered by IDBI with financial participation by IFCI and ICICI. The basic criterion for assistance under the scheme was the weakness of the units on account of obsolescence of machinery. The IFCI has also sponsored the Risk Capital Foundation to provide assistance in the form of interest free personal loans to new entrepreneurs including technologists and professionals for meeting a part of the promoters contribution to equity capital. With the amendments in 1986-87 to the IFCI Act, the area of operations of the IFCI has been enlarged. The corporation has been designated as the nodal point to administer the Jute Modernisation Fund constituted by the Government of India in order to revitalise and modernize the jute industry. The IFCI has also been appointed as the agent of the government for disbursement of loans from the Sugar Development Fund for rehabilitation and modernization of sugar units. During 1986-87, the IFCI established a Merchant Banking division to take up assignment of capital restructuring, merger and amalgamation, loan syndication with other financial institutions and trusteeship assignments. It also provides guidance to entrepreneurs in project formulation, resource management etc. During the same year, IFCI also introduced a promotional scheme called the scheme of Interest Subsidy for encouraging Quality Control measures in the small scale sector. The Investment Information and Credit Rating Agency of India Ltd., (IICRA), set up by IFCI, commenced operations in September 1991 and rated 39 instruments by 31st March 1992. With a view to provide training facilities for workers in the industry and organisations connected with industrial development and for retraining and reorientation of workers in specific industries covering skills and attitudes to adjust to technological changes, IFCI established, in January 1992, a national level institute called the Institute of Labour Development at Jaipur in Rajasthan. 21 (Sys 4) - D:\shinu\lawschool\books\module\contract law

IFCI has been playing the role of a leader by identifying the varying financial needs of industry and has promoted specialised institutions to cater to these needs, such as : — Managment Development Institute (MDI) — Risk Capital and Technology Finance Corporation Ltd (RCTC) — Investment Information and Credit Rating Agency of India Ltd (ICRA) — Tourism Finance Corporation of India Ltd (TFCI) — Institute of Labour Development (ILD) IFCI has also co-sponsored national institutions like — Stock Holding Corporation of India (SHCIL) — Entrepreneurship Development Institute of India (EDII) — Over-the-Counter Exchange of India Ltd (OCTCEI) — National Stock Exchange of India Ltd. (NSEIL) — Bio-tech Consortium (India) Ltd. 4.3 STATE FINANCIAL CORPORATIONS (SFC’S) Implementation of programmes for planned industries development and their success depends, on the availability of adequate financial resources for a wide variety of projects. Since the Indian Banking system had confined itself to financing the working capital requirements of trade and industry, the need to set up long term financial institutions was greatly felt. This could ensure adequate flow of assistance in the form of capital to Industrial projects. However, the IFCI which was set up for this very purpose could cater only to the corporate sector and industrial co-operatives. To reduce the imbalance, it was decided to set up regional development banks to cater to the needs of the small and medium enterprises. Thus, the State Financial Corporations came into existence by an Act of the Parliament passed in 1951 called the State Financial Corporations Act, 1951.

The working group set up by IDBI in 1990-91 to service the operations of SFC’s has made wide-ranging recommendations for improving the working of SFC’s. 4.4 THE INDUSTRIAL CREDIT AND INVESTMENT CORPORATION OF INDIA (ICICI) The Company was set up as a Development Finance Institution on January 5, 1955 under the Indian Companies Act, 1913, with the support of the Government of India and the active involvement of the World Bank. The need for setting up such a finance institution came out because the existing institutional frame work was not geared to the job of bringing about a rapid industrial revolution through private effort. Hence, the basic objective of ICICI at the time of formation was to assist the country’s industrial development by providing finance. ICICI has an unique structure. It is a development agency with twin objectives i.e. assist in the industrial development of the country and earn profit for its shareholders. Capital structure: The Corporation was registered as a company with an authorised capital of Rs.25 crores and a subscribed capital of Rs. 5 crores. Today the capital stands at a whooping Rs.300 crores (authorised) and a subscribed capital or Rs.171 crores. ICICI has been meeting its financing requirements through internal generation of funds and borrowings in the domestic and international markets. Internal generation of funds by way of repayment of loans, receipt of interest etc. constitutes a major source of funding ICICI’s resource requirements. ICICI has been raising rupee resources, within the regulatory framework of the RBI, mainly by issue of Bonds in the nature of promissory notes, convertible debentures, equity and loans from institutions such as Unit Trust of India & Life Insurance Corporation of India.

Under the provisions of the Act, SFC’s are established by the respective State Governments for providing term finance to medium industries operating in 18 different States including New Delhi

In the recent past, however, ICICI has been endeavoring to diversify its resource base on account of Government policies encouraging it to seek funds from commercial sources. In this regard, it has entered the Certificates of Deposit market and has scrutinised a part of its assets.

SFC’s are under the control of the IDBI and the State Governments.

Management & Organisation:

SFC’s grant financial assistance to public limited Companies, private limited Companies, partnership firms and proprietary concerns in the form of loans and advances, subscription to shares and debentures, underwriting of new issues and guarantee of loans. They also operate the seed capital scheme on behalf of IDBI and SIDBI. The SFC’s operating at the State level have grown to be an integral part of the financial system of the country. They have been fairly successful in achieving balanced regional socioeconomic growth. they have been instrumental in catalysing higher investment and generating greater employment opportunities and widening the ownership base of the industries. 22 (Sys 4) - D:\shinu\lawschool\books\module\contract law

ICICI is efficiently managed by a Board of Directors comprising personalities drawn from such diverse fields as finance and banking, industry and government service. The day-to-day affairs are handled by the Managing Director supported by the senior executives of ICICI. The organisation is characterised by a high degree of professionalism, delegation of authority and effective client servicing through swift communication and computerised data basis. Objectives: The main objects of the company as set out in its Memorandum of Association are:

To carry on the business of assisting industrial enterprises within the private sector of the industry in India by a) assisting in the creation, expansion and modernisation of such enterprises; b) encouraging and promoting the participation of private capital, both internal and eternal, in such enterprises; c) encouraging and promoting private ownership of industrial investments and the expansion of investment markets; d) providing finance in the form of long or medium term loans orequity participation; e) sponsoring and underwriting new issues of shares and securities; f) guaranteeing loans from other private investment sources; g) making funds available for re-investment by revolving investments as rapidly as possible; h) providing or assisting in obtaining directly or indirectly, advice or services in various fields including management, finance, investment, technology, administration, commerce, law, economics, labour, accountancy, taxation etc; i) performing and undertaking activities relating to leasing, giving on hire or hire purchase, warehousing, bill marketing, factoring and other related fields. Operations: ICICI began its activities in the 1950’s predominantly as a foreign currency lender and gradually diversified its activities to rupee lending over a period of time with the growth of indigenous capital goods industry. Till 1985, term lending to industry was the main form of financial assistance provided by ICICI. So long as the corporation received rupee funds at special rates by way of government guaranteed bonds and lent these funds at fixed rates, it earned reasonable returns. However, the lending rates remained constant even as the cost of funds were increasing. This led to a pressure on the margins thereby forcing the corporation to expand its non-project financing to other areas like leasing of industrial equipment, asset credit and deferred payment financing of sale of industrial equipment. Non project financing showed a faster growth rate than project financing and the share of this segment in the annual approvals rose from a mere 13.6% in 1980 to 42.5% in 1991. In addition to assistance provided to industries, ICICI also encourages projects in backward areas and those related to pollution control. ICICI is in the process of carrying out a comprehensive study to identify the scope for technological collaboration between companies in India and suitable agencies in the industrialised countries for instituting more efficient pollution control measures. In order to improve the exportability of Indian products, ICICI has been providing assistance to existing companies for technology upgradation, modernization and balancing

equipment out of lines of credit obtained from the World Bank. The Corporation is also making concerted efforts to develop programmes for the benefit of export oriented companies by chalking out an export marketing strategy and helping them produce internationally acceptable quality of products. The Corporation provides financial support in the form of grants from the Productivity Fund and Export Development Fund. During 1991-92, the ICICI initiated the Export Breakthrough Service in collaboration with Developing Countries Trade Agency (DCTA) an agency funded by the British Government. Under the service, exporters who require market and commercial information necessary for entering new export markets are introduced to selected market research consultants. Funds are also provided towards the cost of market research. ICICI has also moved into merchant banking activity which has acquired great significance in the emerging environment for the financial services industry which is poised for further growth with the establishment of private sector mutual funds and opening up of the Indian capital markets for foreign portfolio investors. A comprehensive exercise to reorganize and position ICICI’s merchant banking activity has been undertaken so that ICICI as a mature merchant banker, can play its due role in he emerging financial system. ICICI is today one of the national level institutions through which the government of India seeks to operationalize its industrial development policies pertaining to the corporate sector. It has been extending its vision far beyond its immediate function of finding industrial projects. It has been looking at all sectors of the economy and where ever a need was perceived, has designed either a new concept or a new instrument or even a new institution to cater it. In this regard, ICICI’s development activities have encompassed such diverse areas as technology financing, project promotion, rural development, human resource development and publications. It has also been a pioneer in setting up specialized institutions in key sectors like: HDFC - Housing Development Corporation of India. SCICI - Shipping Credit and Investment Company of India Ltd. CRISIL- Credit Rating Information Services of India Ltd. TDICI - Technology Development and Information Company of India Ltd. OTCEI - Over the Counter Exchange of India. The company has also offered its expertise to Development Finance Institutions in developing countries such as Bhutan, Nepal, Ghana, Sri Lanka and Uganda. The Company also assists organisations such as Institute of Financial Management and Research (IFMR) and Indian Institute of Foreman Training (IIFT) and provides financial assistance towards conducting Entrepreneurship Development Programmes (EDP) in various states. ICICI has started a commercial Bank of its own.

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5. INDUSTRIAL DEVELOPMENT BANKS SUB-TOPICS: 5.1 Industrial Development Bank of India. 5.2 Small Industrial Development Bank of India. 5.1 Industrial Development Bank of India (IDBI) The need for an effective mechanism to coordinate and integrate the activities of the different financial agencies brought into existence the Industrial Development Bank of India. The IDBI was set up in 1964, under the Industrial Development Bank of India Act 1964 as a wholly owned subsidiary of the RBI. Under the Public Financial Institutions Laws (Amendment) Act 1976 the Ownership of the IDBI was transferred from the RBI to the Government of India. Also various other responsibilities of the RBI vis-a-vis the financial institutions was vested in the IDBI. Thus it was given the status of an autonomous body. Today IDBI is regarded as an apex institution in the area of development banking. Capital structure & Management: Authorised capital shall be 1000 crores and the Central Government by notification in the Official Gazette increase the paid up capital up to 2000 crores of rupees and any further issue shall be wholly subscribed by the Central Government. Management: The general superintendence, direction and management of the affairs and business of the Development Bank is vested in a Board of Directors. The Board shall consist of (a) A Chairman and a Managing Director appointed by the Central Government. (b) A Deputy Governor of the Reserve Bank nominated by that bank. (c) Not more than 20 Directors nominated by the Central Government. Of these 20 Directors : i) 2 Directors shall be officials of the Central Government, ii) Not more than five Directors shall from Financial Institutions, iii) 2 Directors shall be from amongst the employees of the Development Bank and the Financial Institutions and of such Directors one shall be from amongst the Officer employees and the other from amongst the workmen employees, iv) Not more than 6 Directors shall be from the State Bank, the Nationalised Banks and the SFC’s (State Financial Corporations), v) Not less than five Directors shall be persons who have special knowledge of, and professional experience in science, technology, economics, industry, industrial co24 (Sys 4) - D:\shinu\lawschool\books\module\contract law

operatives, law, industrial finance, investment, accountancy marketing or any other matter, the special knowledge of, and professional experience in, which would, in the opinion of the Central Government, be useful to the Development Bank. Objective of the IDBI : (1) Establishing an appropriate working relationship among financial institutions. (2) Co-ordinating their activities and building a pattern of interinstitutional cooperation to effectively meet the changing needs of the industrial structure. (3) Undertake market and investment research and surveys as well as techno-economic studies bearing on the development of the industry. (4) Providing technical and administrative assistance for the promotion, management or expansion of industry. (5) Plan, promote and develop industries to fill vital gaps in the industrial structure. (6) Providing refinancing facilities to the IFCI, SFC’s and other financial institutions approved by the government. (7) Purchasing or underwriting shares and debentures of industrial concerns. (8) Guaranteeing deferred payments due from industrial concerns for loans raised by them. Operations: The IDBI Act was amended in 1986 to provide for a considerable measure of operational flexibility. Now, the Bank has been empowered to finance and provide assistance to a diverse range of industrial activities, irrespective of their form of organisation. These activities include the service sector industries like health care, information, storage, generation and distribution of energy and other value additive services. The scope of business has also been extended to the fields of consultancy, merchant banking etc. There are no restrictions as regards the nature and type of security. There are no maximum or minimum limits prescribed either for assistance to a unit or the size of the unit itself. During the year 1991-92, IDBI made a debut in the field of equipment leasing to widen its range of services offered to industrial concerns. A venture capital division was also set up and is expected to give a wider perspective to the concept of venture capital by providing risk capital assistance for projects promoted by technocrats and professional entrepreneurs seeking to introduce an innovative product or service in the Indian market. It has also entered into merchant banking activities. IDBI has also been appointed as the implementing agency for the Energy Management Consultation and training Project being financed by the USA of $ 20 million.

IDBI has also entered into an agreement with the European community (EC) to function as an intermediary for channelising foreign currency assistance by way of grant or equity participation or loan to eligible joint ventures. The growth of IDBI has been phenomenal in the last few years to the extent that it is the central co-ordinating agency and is concerned with the problems and questions relating to the long and medium term financing of the industry and is now in a position to adopt and enforce a system of priorities in promoting future industrial growth. During the year 1991-92 the privilege given to IDBI of Exemption from income tax was removed which resulted in payment of Rs.168.5 crores as taxes comprising of Rs.140 crores as advance tax and Rs.28.5 crores as interest tax. 5.2 SMALL INDUSTRIAL DEVELOPMENT BANK OF INDIA (SIDBI) The Small Industries Development Bank of India (SIDBI) was set up as the principal financial institution for promotion, financing and development of industry in the tiny and small scale sector and to co-ordinate the functions of institutions engaged in similar activities. SIDBI is a wholly owned subsidiary of IDBI. It took over the financing activities relating to small scale sector from IDBI and commenced operation on April 2, 1990. Since the commencement of its business, SIDBI has been paying concentrated attention to the financing and multi-dimensional growth of industries in the small scale sector with special emphasis on development of small units in the village, cottage and tiny sector. Activities: SIDBI’s activities comprise refinancing of term loans granted by SFC’s, SIDC’s Banks and other financial institutions, direct discounting and rediscounting of bills arising out of sale of machinery and equipments by manufacturers in the small scale sector on deferred credit and rediscounting of short term trade bills arising out of sale of products of the small scale sector. SIDBI also provides assistance for development of marketing infrastructure, creating new marketing channels for the products of SSI units and direct assistance for development of Industrial areas with requisite infrastructure facilities. SIDBI provides equity type of assistance to special target groups like new promoters, women and ex-servicemen under National Equity Fund (NEF), Mahila Udyam Nidhi (MUN) and self employment scheme for ex-servicemen (SEMFEX). SIDBI provides resource support to NSIC and SSIDC’s for their raw material supply and marketing of SSI products as well as their hire-purchase and leasing activities. For promotion, development and growth of small scale sector, SIDBI extends technical and related support services. Operations: The year 1991-92 saw the introduction by SIDBI of a new scheme of direct assistance to help widen the supply base of small scale ancillary units and encouraging the existing units to undertake technology upgraduation/modernisation for improving the quality and competitiveness of their products.

A scheme to provide resource support to factoring companies against their factored debts of small scale industries was also introduced during the year 1991-92. SIDBI contributed 20% of the Share Capital of factoring companies promoted by State Bank of India and Canara Bank. A special refinance scheme for acquisition of computers including accessories was introduced during the year for supplementing efforts of SSI units in improving their productivity and operational efficiency. SIDBI has identified the need for improving managerial capabilities of existing entrepreneurs, developing a special cadre of trained professionals for the sector, promoting rural entrepreneurship technology upgradation and modernisation of existing units, strengthening of ancillaries and bringing about qualitative changes in such direction so as to improve the competitive strength of the sector. In its supportive role, SIDBI has also given special attention to tackling the problem of inadequate marketing infrastructure and delayed payments faced by SSI units. In tune with the new SSI policy announced by the Government of India, SIDBI liberalized the terms and scope of its existing schemes. Investment limits for tiny units was raised from Rs.2 lakhs to 5 lakhs for the purpose of refinance, independent of location of the units. Corporate and non-corporate entities and accredited Non-Governmental Organisations (NGOs) approved by KVIC (Khadi and Village Industries Commission) were made eligible for setting up industrial areas/estates in rural areas under the scheme of assistance for development of Industrial areas/ estates. During the year 1991-92, SIDBI sanctioned assistance aggregating Rs.2898.1 crore under all its schemes and disbursed a sum of Rs.2027.4 crore recording a growth of 20.3% in sanctions and 10.3% in disbursements over the previous year 1990-91. SIDBI also rediscounted short term bills relating to SSI units to the tune of Rs.560.7 crores. Assistance sanctioned under Refinance and Bills Finance schemes (including Direct Discounting of Bills) accounted for little over 97% of total sanctions under all schemes and is expected to catalyze investment of the order of Rs.6700 crores and provide additional employment opportunities to 17 lakh persons. SIDBI stepped up its resource support to SSIDC’s by providing Line of Credit during 1991-92 for their raw material procurement and distribution, marketing and infrastructure development activities for SSI units. Limits aggregating to Rs.20.8 crores were sanctioned during the year 1991-92 against which disbursements amounted to Rs.13.1 crores. An amount of Rs.5 crores was sanctioned to NSIC to finance its activities relating to hire-purchase, leasing and supply of raw materials to SSI units against which disbursements amounted to Rs. 4 crores. The assets of SIDBI as at end March 1992 stood at Rs.6680 crores comprising outstanding refinance of Rs.4909 crore, outstanding bills discounted and rediscounted of Rs.1406 crore, investment in shares and debentures of Rs.160 crore and other assets of Rs. 205 crore. SIDBI raised resources aggregating Rs.1168.8 crore of which Rs.362.3 crore were from Overseas Economic Co-operation fund, Japan, Rs.440 crore from RBI and Rs.330 crores were loans from IDBI out o SLR market borrowings and the balance from other sources. 25 (Sys 4) - D:\shinu\lawschool\books\module\contract law

6. NATIONAL BANK FOR AGRICULTURE AND RURAL DEVELOPMENT (NABARD) SUB-TOPICS 6.1 Objects 6.2 Capital Structure 6.3 Organisation 6.4 Functions 6.1 OBJECTS

2) To give short term as well as long term loans in a composite form. It also makes loans to State Governments for a maximum period of 20 years in order to enable them to subscribe to the Share Capital of Cooperative Credit Societies. 3) To provide medium term loans ranging from 11/2 to 7 years to State Cooperative Banks (SCB’s) and Regional Rural Banks (RRB’s) for agricultural and rural development.

NABARD was set up by an Act of Parliament on July 12, 1982 called the NABARD Act. The objective of setting up this Bank was to provide, by way of refinance to banks, all kinds of production and investment credit to agriculture, small scale industries, artisans, cottage and village industries and other allied economic activities.

Ancillary functions:

Initially, it was sought to act as a decentralised section of the RBI’s functions in the areas of rural credit. But now, NABARD has taken over the entire operations of the Agricultural Refinance and Development Corporation (ARDC) as well as the refinancing functions of the RBI in relation to the State Cooperative Banks (SCB’s) and Regional Rural Banks (RRB’s).

3) Calling for information and statements from RRB’s and Cooperative banks with regard to their operations etc. (RRB’s and cooperative banks are required to furnish to NABARD copies of returns submitted to RBI under the Banking Regulation Act).

6.2 CAPITAL STRUCTURE The share capital of NABARD is held by the Reserve Bank of India jointly with the Government of India in equal proportions. NABARD draws its funds from the Government of India, the World Bank and other agencies to meet its long term loan operation. The Bank has also been authorised to accept deposits for over a year from the Central, State and local governments, scheduled banks etc. Its short term operations are met mainly from funds drawn from the Reserve Bank. 6.3 ORGANISATION NABARD is managed by a Board of Directors, consisting of a Chairman, Managing Director, 2 Directors from experts in rural economics, rural development etc., 3 Directors from out of the Directors of RBI, 3 Directors with experience in the working of Cooperative Banks, 5 Directors from among the officials of the Government of India and State Governments. All these appointments are made by the Central Government. 6.4 FUNCTIONS Main functions: 1) To provide by way of refinance, credit to the rural sector for the promotion of agriculture, small scale industrial units, cottage and village industries, handicrafts, other rural crafts and allied productive activities in the rural areas with the primary aim of promoting integrated rural development and attaining rural prosperity. 26 (Sys 4) - D:\shinu\lawschool\books\module\contract law

1) Inspection of RRB’s and Cooperative societies (other than primary cooperative Banks). 2) Appraisal and forwarding of applications to the RBI for opening of new branches of RRB’s and Cooperative banks.

4) Undertaking research and development programmes to alleviate the problems of agricultural and rural development. 5) Providing training to its own staff as well as the staff of SCB’s, RRB’s in order to upgrade the technical skills and competence of the staff. 6) To assume responsibility from the RBI for Coordinating with the Government of India, the planning commission and other relevant agencies concerned with the development of rural industrialisation and putting into practice the various policies and procedures meant for rural development. Resources (Net) Mobilised by NABARD April-March Resources Reserves and Surplus NRC (LTO) Fund NRC (Stabilisation) Fund Deposits Bonds and Debentures` Borrowings from Govt. of India Borrowings from RBI ARDR Scheme 1990 Other Liabilities Total

(Rs. In Crores) 1990-91 1991-92 63 775 30 30 90 194 560 692 21 905

105 915 40 69 99 127 631 31 58 1821

[Source: Report on trend and progress of banking in India 199192 (June-July)].

7. UNIT TRUST OF INDIA (UTI) SUB-TOPICS: 7.1. Objects 7.2. Capital Structure 7.3. Management

persons having special knowledge of, or experience in commerce, industry, banking finance and investment, one trustee nominated by LIC and one by State Bank, two trustees to be elected by the contributing institutions and one executive trustee to be appointed by the Reserve Bank of India.

7.4. Operations of the Trust 7.5. Pricing policy

7.4 OPERATIONS OF THE TRUST

7.6. Advantages

In 28 years of operations upto 1991-92, the Unit Trust of India has done remarkably well in the area of fund mobilisation and assistance to industries by way of investments. During the year 1991-92, the total number of unit holders was a phenomenal 20 million and the total investible funds available as at end June 1992 aggregated Rs. 30550.8 crores.

7.7. Conclusion 7.1 OBJECTS The need for establishment of an investment trust to extend facilities for growing number of small investors in the middle income groups of the community led to the formation of Unit Trust of India. UTI was established by an Act of parliament in 1964, and it plays an important role in tapping the savings of the small investors through sale of units and channelising them into corporate investments. The primary objective of the Trust is (a) tapping and mobilising the savings of the middle and low income groups; and (b) to enable them to share the benefits and prosperity of the rapidly growing industrialisation in the country. The Unit Trust achieves its objectives by(1) selling units of the Trust among as many investors as possible in different parts of the country; (2) by investing the sale proceeds of the units and also the initial capital fund of Rs.5 crores in industrial and corporate securities; and (3) by paying dividends to those who have bought the units of the Trust. 7.2 CAPITAL STRUCTURE The initial capital of the UTI was 5 crores which was subscribed fully by the Reserve Bank of India (Rs.2.5 crores), the Life Insurance Corporation (Rs. 75 lakhs), the State Bank of India (Rs. 75 lakhs) and Scheduled banks and other financial institutions (Rs. 1 Crore). 7.3

MANAGEMENT

The general superintendence, direction and management of the affairs and business of the Trust is vested in a Board of Trustees, consisting of a Chairman and nine other Trustees. The Chairman shall be appointed by the Reserve Bank of India, four trustees to be nominated by the RBI out of which at least 3 shall be

The Government has also assisted the growth of the Trust by giving many tax incentives to investors who buy the units issued by the Trust. Unit Trust of India has introduced many new kinds of units suitable for different types of investors. Eight new units were introduced during the year 1991-92 i.e. the Deferred Income unit scheme 1991, the Unit growth scheme 5000 Master Equity Plan 1992, Master plus, Growing monthly Income Unit Scheme (GMIS) 91, GMIS 91-II, GMIS-92 and Mastergain. The Trust has built up a portfolio of investments which is balanced between the fixed income bearing securities and variable income bearing securities. The main objective of the Trusts investment policy is to secure maximum income consistent with safety of capital. The bulk of the investible funds have been invested in companies which are on regular dividend paying basis. Barring investments in bonds of public corporations, the Trusts funds have been invested in financial, public utility and manufacturing enterprises. The Trust has now floated its own Bank, UTI Bank Ltd. 7.5 PRICING POLICY The sale and repurchase prices of the units of the Unit Trust are fixed according to the rules framed by the Trust. The sale or the repurchase price is worked out by obtaining the basic value of the units. This is done by dividing the value of all the assets of the trust less current liabilities by the number of units deemed to be in issue. Normal charges like brokerage, commission, stamp duties etc., are added or subtracted as the case may be and the final figure is rounded off to the nearest five paise. 7.6 ADVANTAGES 1. Investments in these units is safe, since the risk is spread over a wide range of securities (fixed income bearing and variable income bearing) 27 (Sys 4) - D:\shinu\lawschool\books\module\contract law

2. Units holders are assured of a regular and steady income. 3. Dividents are exempt from Income tax under section 80L. 4. Liquidity is high as the investor can encash the units whenever he wants. The units can also be sold back to the Trust under the repurchase facility offered by the Trust. 7.7 CONCLUSION The Unit Trust of India plays an important role in tapping the savings of the small investors through sale of units and channelising them into corporate investments. The trust being a public sector enterprise has created confidence among the

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general public. Additionally, the tax concessions provided by the Government has added to its growth. So also, the benefits of liquidity and safety of capital over the years, the trust has extended its operations to other areas like assistance to corporate sector by way of term loans, bills rediscounting, equipment leasing and hire-purchase financing. During the year 1991-92, UTI, in association with the Bank of Ceylon and others, promoted the Unit Trust management of Sri Lanka and also provided technical and management support in designing and marketing of its schemes. UTI also signed a Memorandum of Understanding with Alliance Capital Management Ltd. of United States to jointly set up an asset management company.

8. CASE LAW Sajjan Bank Pvt. Ltd. v RBI (30 Comp. Cases,146) The petitioner, a banking company which was in existence at the commencement of the Banking Companies Act, 1949, applied to Reserve Bank on Sept.14, 1949, under section 22 of that Act for a licence to carry on banking business. Officers of the Reserve Bank inspected the banking company under section 22 of the Act in July, 1952, but as the inspection revealed defects in the method of keeping accounts and contravention of certain provisions of the Act, the Reserve Bank kept in abeyance consideration of the question of issuing a licence. A fresh inspection carried out by the Reserve Bank under section 35 in September 1956, four years later,also revealed certain defects. The Reserve bank not being satisfied that the affairs of the banking company were being conducted in the interests of the depositors, directed the banking company to show cause against the refusal of the licence and after considering the representations of the banking company,declined to grant the licence. Aggrieved by the refusal,the petitioner applied to the High Court for the issue of a writ of Certiorari quashing the order refusing the grant of the licence. Three conditions were raised in the writ petition: (i) that Section 22 of the Banking Companies Act was unconstitutional in so far as it proceeded to restrict the fundamental right of the petitioner to carry on its business,namely the banking business;(ii) even if the provisions of the Sec 22 of the Act be held to be in accordance with the constitution,the action of the respondent was arbitrary;and (iii) in any event the procedure adopted by the respondent was illegal and in that,after an inspection under section 35,it could only proceed to act under Section 35(4) and not refuse the licence altogether. The court held that the provisions of Section 22 of the Banking Companies Act prescribed only a system of licensing with a view of regulating the banking business and was not repugnant to the provisions of Article 19(1)(g) of the Constitution. The provisions in Section 22 investing the Reserve Bank with the power to grant, refuse to grant or cancel, a licence did not amount to an excessive delegation of legislative power. There was sufficient legislative guidance for the granting of licence embodied in the provisions of the Act, and of Section 22 in particular, and delegation of the power, having been made to non-political body statutorily concerned with the credit structure of the country, the restriction imposed in the regulation of the banking business was nothing but reasonable. The power that was given to the Reserve Bank under the Act was a wide range of administrative discretion which it was peculiarly competent to undertake, and the determination whether the conditions which were required before the licence could be given or refused exist, was peculiarly within its competence as an expert statutory body. The legislature having prescribed the nature of a real banking institution in this country, it could not be said that there was any excessive delegation of power. The provisions of Sec.35 (4) which empowered the Central Government to prohibit a banking company from continuing

its business on the report of the Reserve Bank after inspection under Section 35, related to a banking company to which a licence has already been granted. It was open to the Reserve Bank to consider the defects revealed in an inspection under S.35 for disposing of an application for the grant of a licence under Sec.22. Finally the court held that the jurisdiction of the Reserve Bank to refuse to grant a licence to the petitioner was properly exercised. The powers vested in it under Section 22 of the Banking Companies Act are not ones invested with a mere officer of the bank. The standards for the exercise of the power have been laid down in Section 22 itself. The Reserve Bank is a non-political body concerned with the finances of the country. When a power is given to such a body under a statute which prescribes the regulations of a banking company, it can be assumed that such power would be exercised so that geniune banking concerns could be allowed to function as a bank, while institutions masquerading as banks or those run on unsound lines or which would affect the interests of the public could be weeded out. The nature of the power and its exercise after the investigation prescribed by the statute invested it with a quasi judicial character. Such a power cannot be said to be an arbitrary one. In re Supreme Court of India Ltd. v. Official Liquidator and Others (37, Comp. Cases. 392.) Five appeals arose out the order of the learned Company Judge in misfeasance proceedings against the Directors and Officers of a banking company by name The Supreme Bank of India Ltd., taken on an application of the official liquidator during the course of its winding up proceedings. On appeal the High Court held that though both Section 196 of the Companies Act, 1913 & Section 45B of the Banking Companies Act, 1949, provide for public examination of a Director or an officer of a company as to promotion, formation or the conduct of the business of the company or as to his conduct and dealings as Director or Manager or other officer, Sec. 196 of the Companies Act enables the liquidator to make such an application for public examination only when he is of opinion that fraud had been committed by a Director, while under Section 45G of the Banking Companies Act, all that is necessary for the liquidator to make such an application, is that he should be of opinion that any loss had been caused to the banking company by any Act or omission of the Director, whether or not any fraud has been committed by such Act or Omission. The duties of the Directors were summarised by the court in the following terms: 1. The Directors are not bound to give continuous attention to the affairs of the bank and their duty is of an intermittent nature to be performed at the periodical Board Meetings and the Meetings of Sub-committees of the Board. They are not bound to check the cash of the bank or the books of account to detect shortage of cash or manipulation of bank balances; 29 (Sys 4) - D:\shinu\lawschool\books\module\contract law

2. To begin with, the Directors are entitled to trust the Managing Director and other officers of the Bank to perform their duties honestly. They are entitled to continue to repose such trust until there are grounds for suspicion; 3. Once there was any ground for suspecting the honesty, competence or skill of the Managing Director or other officers of the bank, the Directors are bound to exercise such reasonable care as an ordinary prudent man would do in his own case, in order to avert losses to the company. Even after such ground for suspicion if they shut their eyes and do not take any effective steps to prevent losses resulting from their wilful neglect, they would make themselves liable for the resulting losses; 4. Until there is such ground for suspicion, the directors are not liable for losses due to the mistake, negligence or dishonesty of the managing director and other officers of the company, although such losses could have been averted if the directors had taken care; and 5. The crucial question in such cases is, therefore, whether there were any circumstances arousing the suspicion of the directors and, if so, when should their suspicions have been aroused. Sardar Gulab Singh v. Punjab Zamindara Bank Ltd. (AIR 1942 Lah.47) The plaintiff Managing Director of the company brought a suit against the company for a declaration that he was the managing director of the company and for injunction restraining the company from preventing him from discharging his duties. The trial court decreed both the declaration and the injunction prayed for. On appeal the learned Senior Subordinate Judge dismissed the suit. On second appeal the High Court allowed the appeal as regards the declaration, but dismissed it with regard to the injunction. Both parties filed appeals. The plaintiff against the decision allowing him an injunction and the defendants against the decision granting the plaintiff declaration. The Court held that even if the memorandum and articles of association of a company are held not to constitute a contract in themselves, an implied contract may be proved by the acts of the parties on the terms set out in the articles of association of the company. Where in pursuance of certain articles acted upon by the company a shareholder was appointed Managing Director and acted as Managing Director for 11 years and was remunerated in accordance with the terms set out in the articles, the articles constituted an implied contract between the company and the share-holder so as to entitle him to the declaration that he was the managing director of the company. With regard to the second point, whether Sardar Gulab Singh is entitled to an injunction, the court held that it would not be proper to issue an injunction. In this connection the court observed that the position of the company and that of Sardar Gulab Singh as managing director was that of master and servant. With great respect we do not think that this is correct. A Director or Managing Director is in no way a servant of the company, he is the agent of the company for carrying on its 30 (Sys 4) - D:\shinu\lawschool\books\module\contract law

business. But we agree that the same principles which have been held to apply to the issue of an injunction at the instance of a dismissed servant ought also to apply in the case of a dismissed agent. It would be contrary to public policy to impose upon an unwilling principal an agent whom he does not wish to employ, especially as there is nothing to prevent an agent whose contract of agency has been wrongfully broken from bringing an action for damages. Andhra Bank Ltd. v. Bonu Narasamma [(1988) 63 Com.Cas.p.328] In this case an appeal arose out of a suit filed for recovery of Rs.2,87,681.85 with interest and in default of payment for the sale of the scheduled properties to realise the suit debt. The learned counsel for the appellant contended that the levy of interest by A.P.Bank is linked with and based upon the rate of interest fixed by the Reserve Bank and the question of charging penal or unconscionable interest does not arise and in any event such contention does not survive in view of S.21A of the Banking Regulation Act. On the other hand learned counsel for the respondents seeking to sustain the judgements of the courts contended that the levy of such exorbitant interest by a nationalised bank is unconstitutional as it is beyond the legislative competence of Parliament and is in breach of Art.14 of the constitution. The High Court held that the provisions of Sec.21 A of the Banking Regulation Act, 1949, declaring that the rates of interest charged by banking companies shall not be subject to scrutiny by the courts from the point of view of excessiveness are within the legislative competence of parliament under entry 45 of list I of Sch.VII of the Constitution of India, which pertains to ‘banking’. The charging of interest is interwined with banking business and the element of interest is ingrained in the veins of all dealings in society. The bank is a ‘dealer in credit’. Section 21A strives to safeguard the levy of interst and quantum of interest charged and Section 21A is essentially concerned with the banking operation and therefore, within the legislative competence of Parliament. The Court further held that Sec. 21A does not violate the provisions of Art.14 of the Constitution. The modalities and the quantum of interest is uniform in all the banks as regulated by the Reserve Bank. The charging of interest is tied up with the interest fixed by the Reserve Bank. The Reserve Bank is entrusted with diverse powers for regulating the banking business in the country and the Reserve Bank taking stock of the prevalent economic growth, cost of living, index, purchasing and paying capacity and other factors fixes the rate of interest chargeable by the banks. Banking Companies are bound to adhere to the guidelines and directions given by the Reserve Bank. The rate of interest chargeable by the banks is rooted in the rate of interest fixed by the Reserve Bank and as a sequel of the decision of the experts, apparently with a view to having a uniform rate of interest in all banking companies throughout the country at all times and situations, The jurisdiction of Civil Courts is taken away.

9. LIST OF STATUTES The readers are requested to purchase the following Acts for better understanding of the laws and practice. 1. Reserve Bank of India Act, 1934 2. Banking Regulation Act, 1949 3. Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 and Act of 1980 4. State Bank of India Act, 1955 5. Nationalised Banks (Management and Miscellaneous Provisions) Scheme, 1970 and Scheme of 1980, 6. Export-Import Bank of India Act, 1981 7. Industrial Development Bank of India, 1964

8. Industrial Insurance and Credit Guarantee Corporation Act, 1961 9. Deposit Insurance and Credit Guarantee Corporation Act, 1961 10. Industrial Reconstruction Bank of India Act, 1984 11. National Bank for Agriculture and Rural Development Act, 1981 12. National Housing Bank Act, 1987 13. Regional Rural Banks Act, 1976 14. State Financial Corporations Act, 1951

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10. PROBLEMS 1. Critically examine the functional and structural relation between NABARD and RRB. 2. Evaluate the Composition of the Board of Directors both at the central and local level in so far as maintaining the operation of efficiency of the State Bank of India. 3. State Bank of India has a distinct role in the banking services in India. Critically examine the statement. 4. Examine the role of commercial bank in building directly and indirectly the industrial capital. 5. How far it is justified to attribute government's interference in the functioning of financial institutions as the cause of operational inefficiency? Explain your answer with reference to actual functioning of one financial institution. 6. Compare the management and organisation structure of IDBI, ICICI and IFC. What is the functional relation between these three institutions, if any. Do you think functional commercial competition or better institutional cooperation will be more beneficial for building up better industrial climate ?

7. Critically examine the branch banking policy in India. What alternate do you suggest ? 8. State Bank of India performs part of the RBI function. Critically examine the statement indicating the function, if any, done by the SBI on behalf of RBI. 9. Name some of the important Mutual Fund Organisation, in India and critically look at law and practice relating to mutual Fund. 10. In recent times many of the Commercial banks indulge more in non-banking functions than the conventional banking operations. Critically examine the statement indicating the non-banking functions undertaken by the commercial banks. 11. Compare and contrast the management and an organisation structure of a nationalised bank and a private bank. Do you think the nationalization of Commercial banks brought inefficiency and corrupt practice in banking operation ? Justify your answer with reference to functioning of Commercial banks in the light of the Report of Narasimham Committtee.

[Note: Specify Your Name, I.D. No. and address while sending answer papers]

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11. SUPPLEMENTARY READING 1. Mark Hapgvod, Paget's Law of Banking, 10th edn., 1989, Butterworths London & Edinburg. 2. Saravanavel. P., Banking Theory Law & Practice, 1st edn., 1987, Margham Publications, Madras. 3. Sheldon & Fidler's, Practice & Law of Banking, 11th edn. (Rep.), 1984, Macdonald & Evans Ltd., Plymouth. 4. Suneja H.R., Practice & Law of Banking, Ist edn., 1990, Himalaya Publishing House, New Delhi. 5. Sundaram & Varshney, Banking Theory, Law & Practice, 8th edn. (revised), 1990, Sultan Chand & Sons, New Delhi. 6. Tannan M.L., Banking Law & Practice in India, 18th edn., 1989, Orient Law House, New Delhi.

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Master in Business Laws Banking Law Course No: II Module No: II

Reserve Bank of India Structure and Functions

Distance Education Department

National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 080-3217858 E-mail: [email protected] 34 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Materials Prepared By : 1. Mr. K.D. Zachariah, LL.M. 2. Mr. N. L. Mitra, M.Com., LL.M., Ph.D. Materials Checked By : 1. Mr. V. Vijaykumar, M.A., LL.M., M.Phil. 2. Mr. T. Devidas. LL.M. 3. Ms Archana Kaul, LL.M. 4. Ms Pooja Kaushik, M.A, (Eco) Materials Edited By : 1. Mr. P.C. Bedwa LL.M., Ph.D. 2. Mr. Sunderajan, A.C.A. 3. Mr. Harihara Ayyar, LL.M., Former General Manager, SBI

Distance Education Department National Law School of India University Post Bag No : 7201 Nagarbhavi, Bangalore 560 072. India

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INSTRUCTIONS Basic Readings The materials given in this course are calculated to provide exhaustive basic readings on topics and sub-topics included in the course. Experts in the area have collected the basic information and thoroughly analysed the same in topics and sub-topics. Lucid/supportive illustrations and leading cases are also provided. Relevant legislative provisions are also included. Care has been taken to communicate basic information required for decision making in problems likely to arise in the course-area. The reader is advised to read atleast three times. In the first reading information provided are to be selected by making marginal notes using markers. The first reading, therefore, necessarily has to be very slow and extremely systematic. While so reading the reader has to understand the implications of those informations. In the second reading the reader has to critically analyse the material supplied and jot down in a separate note book points stated in the material as well as the critical comments on the same. A third reading shall be necessary to prepare a Check List so that the check list can be used afterwards for solving problems like a ready reckoner. (The reader is required to purchase a Bare Act and refer to the relevant sections at every stage.) Supplementary Reading Several supplementary readings are suggested in the materials. It is suggested that the reader should register with a nearby public library like the British Council Library, the American Library, the Max Muller Bhavan, the National Library, any University Library where externals are registered for the purpose of library reading, any commercial library or any other public library run by Government or any private institution. Readers in Metropolitan and other big cities may have these facilities. It is advised that these basic materials be photocopied, if necessary, and kept in the course file. Supplementary readings are also required to be read more than once and marginal notes, marking notes, analytical notes and check lists prepared. Any reader requiring any extra readings not available in his/ her place may request the Course Coordinator to photocopy the material and send it by post for which charges at the rate of .50 paise per page for photocopying and the postage charge shall be sent either by M.O. or by Draft in advance. The Course Coordinator shall take prompt action on receiving the request and the payment. Case Law The course material includes some case materials generally based upon decided cases. These cases are to be studied several times for, (a) understanding the issues to be decided (b) decisions given on each issue (c) reasoning specified It is advised that while reading a case the reader should focus first on the facts of the case and make a self analysis of the facts. Then he/she should refer the check list prepared earlier for appropriate information relating to law and practice on the facts. Then the student should prepare a list of arguments for and on behalf of the plaintiff/ appellant. Keeping the arguments for the plaintiff/appellant in view of the reader should try to build up counter arguments on behalf of the defendant/respondent. These exercise can take days. After these exercises are done one has to prepare the arguments for or against and then decide on the issues. While deciding it may be necessary often to evolve a guiding principle which also must be clearly spelt out. Subsequently the reader takes up the decision given in the case by the judge and compare his/her own exercise with the judgment delivered. A few exercise of this type shall definitely sharpen the logical ability, the analytical skill and the lawyering competence. Though it is not compulsory, the reader may send his/ her exercises to the Course Coordinator for evaluation. On receiving such request the Course Coordinator shall get the exercises evaluated by the experts and send the experts’ comment to the students. Through these exercises one can build up an effective dialogue with the experts of the Distance Education Department (DED). Problems and Responses After reading the whole module which is divided into several topics and sub-topics the reader has to solve the problems specified at the end of the module. The module is designed in such a manner that a reader can take about a week’s time for completing one module in each of the four courses. It is expected that after finishing the module over a period of a week the student solves these problems from all possible dimensions to the issue. No time limit is prescribed for solving a problem though it would be ideal if the reader fixes his/her own time limit for solving the problem - which may be half an hour per problem - and maintain self discipline. While solving the problems the candidate is advised to use the check list, the notes and the judicial decisions - which he/she has already prepared. After completing the exercise the student is directed to send the same to Course Coordinator for evaluation. Though there is no time stipulation for sending these responses a student is required to complete these exercises before he/she can be given the certificate of completion to appear for final examination. 36 (Sys 4) - D:\shinu\lawschool\books\module\contract law

RESERVE BANK OF INDIA : STRUCTURE AND FUNCTIONS

TOPICS 1.

Organisation ...................................................................................................................

38

2.

Functions .........................................................................................................................

43

3.

Issue & Management of Currency................................................................................

45

4.

Banker to the Government ............................................................................................

47

5.

Banker’s Bank ................................................................................................................

49

6.

Monetary Control...........................................................................................................

50

7.

Custodian of Foreign Exchange ....................................................................................

54

8.

Promotional Functions...................................................................................................

59

9.

Case Law .........................................................................................................................

60

10.

Problems..........................................................................................................................

63

11.

Bibliography ...................................................................................................................

65

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1. ORGANISATION SUB-TOPICS 1.1 Introduction 1.2 Organisational Model 1.3 Central Board 1.4 Local Boards 1.5 Critical Remarks 1.1 INTRODUCTION Central Banking as a concept is of fairly recent origin. Though some Latin American countries had a central banking system in the 19th century, this system really became popular in the early 20th Century. Generally speaking, a Central Bank is considered as the leader of the money market, but several economists emphasize different roles for the Central Bank. For example, according to Whawtrey,R.G, the essential characteristic of a Central Bank is its function as the ‘lender of last resort’. According to Kische & Elkin, the main function of the Central Bank is to maintain the ‘stability of the monetary standard’. On the other hand, Shaw,W.R. lays emphasis on ‘credit control’ as the major function of Central Bank. The Bank of England founded in 1694 is perhaps the oldest Central Banking institution which provides finance for the government. The first attempt at Central Banking in India dates back to General Bank in Bengal & Bihar estd. in January, 1773 at the instance of Warren Hastings, the then Governor of Bengal. But this experiment was very short lived. Three Presidency Banks were established and started functioning in 1866. Alongwith their commercial functions they undertook some functions on behalf of the Government also. These Presidency Banks were amalgamated in 1921 to form the Imperial Bank of India which was primarily a commercial bank but used to perform certain central banking functions as well. In 1926 the Royal Commission on ‘Indian Currency & Finance’ (Milton Young Commission) recommended the dichotomy to be ended & the establishment of a Reserve Bank of India as its Central Bank. A Bill was introduced in the Legislative Assembly in 1927, which was later dropped. In the meantime during 1930-31 consideration for constitutional reforms in the country started being debated. Ultimately, the Reserve Bank of India Act was passed in 1934, part of which came into operation in 1935 & the remaining part in 1937. It took over the management of the currency from the Central Government and of carrying on the business of banking in accordance with the provisions of the Act. As stated in the preamble to the Act, the Bank has the responsibilities of (i) regulating the issue of Bank notes; (ii) keeping of reserves with a view to securing the monetary stability in India; and (iii) generally to operate the currency and credit system of the country to its advantage. As provided in Section 3(2) of the Act, the Bank is a body corporate having perpetual succession and common seal and shall sue and be sued in its name. The whole capital of the 38 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Bank of Rs.5.00 crores is at present held by the Central Government. The Bank has its Central Office in Bombay and other offices in Bombay, Calcutta, Delhi and Madras and branches in most of the State capitals and departments at a few other important places. The matters of policy relating to banking, monetary management, exchange control, inspection and supervision of banks, credit control, and economic and financial matters are formulated at the Central Office of the Bank at Bombay. The basic function of note issue and general banking business are discharged by the issue department and banking department at the local offices/ branches. 1.2. ORGANISATIONAL MODEL The Reserve Bank of India (RBI) was originally constituted as a shareholders’ bank with a share capital of 5 crores divided into 5 lakh fully paid-up shares of Rs. 100/- each. Only 2,300 shares were held by the Federal Government. The whole country was divided into 5 areas for the operation of the Bank, viz., Bombay, Calcutta, Madras, Delhi & Rangoon*. (* closed since 1947). In 1948, RBI was nationalised by the Reserve Bank (Transfer to Public Ownership) Act, 1948, and the entire share capital was acquired by the Central Government. With the introduction of the Constitution of India in 1950, RBI was put under entry 38 List I, VII Schedule U/Art.246, thereby subjecting RBI to the legislative power of the Parliament. Accordingly, the Act was amended several times by the Parliament to virtually touch every section. There were some extremely important amendments which will be discussed alongwith the concerned subject. It will suffice to give the following outline of the organisational set-up of RBI as it stands today. The RBI was initially designed on the pattern of Bank of England, theoretically subordinate to the Treasury. The Governor, 4 Deputy Governors, all Directors of the Central Board & the Local Boards are either appointed or nominated by the Central Government. The Governor & the Deputy Governor are whole time officials and hold office for such term not exceeding 5 years as may be fixed by Central Government and are eligible for re-appointment [S.8(4).] They may however be removed from their office by the Central Government at anytime. This legal provision has made RBI an almost subordinate agency of the Ministry of Finance, Government of India. There are several models of Central Banking. The dominating models are : 1) Bank of England, which is in theory as stated earlier subordinate to the Treasury but in practice has a relationship of co-operation rather than subordination (Sheldon, p.8). This model can be called the ‘functionally independent’ model. 2) Federal Reserve System, USA - This system can be said to be both ‘functionally & statutorily independent’.

3) Deutsche Bundesbank, Germany - This can be said to be constitutionally & functionally independent. The Central Bank Council & the Directorate are headed by the President & Vice President of the Deutsche Bundesbank. The President & Vice President of this Bank are appointed by the President of Germany on recommendation of the Bundesrat (upper House of Parliament). The Bundesbank is independent of the instructions of the Federal Government. In order to maintain cooperation between the Central Bank & the Federal Government, the government is required under the Constitution to consult the President of Bundesbank on all matters of basic monetary policy. There is an autonomous Central Bank council in whose meetings the Federal government may take part but cannot participate in the voting.

the Central Government. The Governor, 4 Deputy Governors and all the Directors of the Central Board and Local Boards are appointed/nominated by the Central Government (CG) and hold office during the pleasure of Central Government. In England a legal prescription of subordination to the treasury is replaced by close cooperation through establishment of sound conventions. In India on the other hand, this led to super control, so much so that even a Deputy Secretary of the Ministry of Finance became more powerful than the Governor of the RBI. This is very unscientific and injurious to the nation’s economy. As for example, RBI can’t refuse to supply any quantity of money to the government, against Government securities. As a result, it is unable to maintain the value of money and effectively manage the monetary affairs of the country, which is its primary consideration u/s.3 of RBI Act.

The operational efficiency of an organisation predominantly depends upon the organisation structure of the institution. Several issues are important while determining this organisational structure. The organisation of RBI was modelled on the pattern of Bank of England as being subordinate to the Central Government at a time when imperial power wanted to have a positive & definite power centralisation. Continuation of the same structure in a democratic set-up may be examined in view of the need for a strong monetary system. This requires an autonomous institution to cooperate with the Central Government for laying down a strong monetary system. But the organisational structure of RBI is entirely subordinated to

The Constitution of India is not merely a political document, but it also contains the financial aspiration of the country. Therefore, the responsibility of the leader of the Bank in the national economy is enormous, which in no way is any less important than the resource distribution work of the Finance Commission of the country. As a matter of fact, the present statutory provision has not merely created an atmosphere of dependenatia, but has also made the Central Bank (i.e. RBI) gradually weaker. Since the system of governance could not build up a strong convention of autonomy and an institution of co-operation with the Central Government, it may be necessary to review the organisational structure in the light of experience of other constitutional institutions.

ORGANISATION CHART OF RBI [SS 8 & 9 OF THE Act] W.T. GOVERNOR CENTRAL BOARD 4 DG W.T.

10 DIR NOMINATED BY CG

4 DIR FROM LBS

1 GO

CENTRAL OFFICE 1

2

3

4

5

6

7

8

9

10 11 12 13 14 15 16 17

18

Note : The Department names are given below

LOCAL BOARDS DELHI

BOMBAY

CALCUTTA

MADRAS

NOTE : Each Local Board consists of 5 Members, appointed by the CG, One of whom is elected as Chairman 39 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Abbreviations used above : WT — Whole Time

DG — Deputy Governor

DIR — Director

CG — Central Government

LB — Local Board

GO — Government official

Departments in the Central Office 1. Secretariat 2. Banking operations & development 3. Industrial Credit 4. Agricultural Credit 5. Rural Planning & Credit 6. Exchange Control 7. Currency management 8. Expenditure & budgetary control 9. Govt. accounts 10. Economic analysis & policy 11. Credit planning cell 12. Statistical analysis & Computer 13. Management Service 14. Administration & Personnel 15. Legal Services 16. Inspection 17. Premises 18. 3 Bankers Training Colleges, one each at Bombay, Pune & Madras. 1.3 CENTRAL BOARD & ITS FUNCTIONS Constitution The general superintendence and direction of the affairs and business of the Bank are entrusted to a Central Board of Directors under Section 7 of the Act. However, the Board has to abide by any directions that may be given by the Central Government after consultation with the Governor of the Bank. Such directions can be given from time to time in public interest. The Central Board shall consist of the Governor, not more than 4 Deputy Governors to be appointed by the Central Government and other directors to be nominated by the Central Government as under : i) four directors to be nominated by Central Government, one each from the Local Boards constituted under Section 9. ii) ten directors to be nominated by Central Government. iii) one Government official to be nominated by the Central Government. The Governor and Deputy Governors are wholetime officials of the Bank. A Deputy Governor and a Government official nominated as above [under Section 8(1)(d)] may attend any meeting of the Central Board and participate in deliberations but do not have voting rights. The Governor and Deputy Governors hold office for a term fixed by the Central Government at the time of appointment, not exceeding 5 years and are eligible for reappointment. The Government official nominated under Section 8(1)(d) shall hold office at the pleasure of the Government. The directors 40 (Sys 4) - D:\shinu\lawschool\books\module\contract law

nominated from the Local Board shall continue during their membership of the Local Boards. The other directors shall hold office for 4 years and thereafter until their successors are nominated. The B R Act prescribes certain qualifications (Chartered Accountant, Lawyer, Cooperator, etc.) for the Directors of commercial banks, where as there are no such qualifications specified for appointment to the Board of Directors. Under Section 11, the Central Government may remove from office the Governor or a Deputy Governor or any other director or any member of the Local Board. Central Government has also the power under Section 30 to supercede the Central Board, if the Bank fails to carry out any of the obligations imposed on it by or under the Act. In such a case, the general superintendence and direction of the affairs of the Bank shall be entrusted to any other agency determined by the Central Government. A full report of the circumstances leading to such action has to be laid before the parliament at the earliest and in any case within 3 months. Powers The Central Board has wide powers and may exercise all powers and do all acts and things which may be exercised or done by the Bank subject to any directions issued by the Central Government in public interest after consultation with the Governor. Further, the Governor or in his absence, the Deputy Governor nominated by him in this behalf shall also have powers of general superintendence and direction of the affairs and business of the Bank, and may exercise all the powers and functions of the Bank unless otherwise provided in the regulations made by the Central Board. Meetings Meetings of the Central Board have to be held at least six times a year and at least once in a quarter. The Governor or a Deputy Governor duly authorised shall preside over such meetings and he shall have casting vote (or second vote) in the event of equality of votes. Regulations Under Section 58 of the Act, the Central Board has the power to make regulations for giving effect to the provisions of the Act. Such regulations are to be made after previous sanction of the Central Government. These regulations are also required to be laid before both the Houses of the Parliament. Functions For practical convenience the Board delegated some of its functions by means of statutory regulations to a Committee called the ‘Committee of the Central Board’ consisting of the Governor, Deputy Governors and such other Directors as may be present at the relevant time in the area where the meeting is to be held. The Committee meets once a week, generally on Wednesday at the office of the Bank in which the Governor has his Head Quarters for the time being, to attend to the current business of the Bank, approval of the Banks weekly accounts

pertaining to the issue and the banking departments. This Committee is assisted by two sub-committees : one for dealing with staff and related matters & the other for looking after matters relating to building projects. Of course, the role of these sub-committees is purely advisory in nature. Special Provisions The Reserve Bank is exempted from income-tax and super-tax on its profits or gains under Section 48 of the Reserve Bank of India Act. Further Section 57 provides that the Bank shall not be placed under liquidation except by an order of the Central Government and in such manner as it may direct. Administrative set-up The Governor has the power of general superintendence and direction of the affairs of the Bank and may exercise all powers of the Bank unless otherwise provided in the regulations made by the Central Board. The Deputy Governors, Executive Directors and other officers in different grades assist the Governor. The delegation of powers to different grades of officers is governed by the Reserve Bank of India General Regulations, 1949, which are statutory regulations made under Section 58 of the Act. The officers and other staff are governed by the Reserve Bank of India (Staff) Regulations, 1948. These regulations are not statutory. As held by the Supreme Court in V.T. Khanzode Vs. Reserve Bank, (AIR 1982 SC 917) besides making statutory regulations under Section 58 of the Act, Bank could also lay down service conditions of the staff administratively under Section 7(2) of the Act. Establishments The Central office [Head Quarters (H.Qrs.)] of the Bank is located at Bombay. Formulation of policies concerning banking, money management, inspection & supervision of Banks, extension of banking & credit facilities, management of foreign exchange and rendering of advice to the Central Government all these functions are carried out from the Head Quarters. Besides these the Central office has various departments as mentioned before in p.5. The department of ‘banking operations & development’ includes Public Accounts Division (PAD), Public Debt Office (PDO), Deposit Accounts Division (DAD) & Securities Division (SD). The Head Quarters of the ‘department of non banking companies’ is located in Calcutta. 1.4 LOCAL BOARDS AND ITS FUNCTIONS Constitution Section 9 of the Act provides for four regional Local Boards consisting of 5 members each appointed by the Central Government to represent, as far as possible, territorial and economic interest and the interests of co-operative and indigenous banks. The Local Boards have their headquarters at Bombay, Calcutta, Delhi and Madras. The Local Board has a Chairman elected from the members. The members of the

Local Boards hold office for 4 years and thereafter until their successors are nominated. They are also eligible for reappointment. Functions The function of the Local Board is to advise the Central Board on matters generally or specially referred to it by the Central Board and also to perform any duties delegated to it by the Central Board. The advice of the Local Boards is sought on various matters of local importance, for eg. applications for opening new branches of commercial banks, opening of offices in India by foreign banks, directions to be given to the banks on basis of inspection, granting of license to commercial banks, etc.. In 1976, financial powers were also delegated to the Local Boards enabling them to take final decisions in matters relating to purchase of land, buildings, etc. within the limits fixed by the Central Board. Disqualifications There are certain disqualifications under Section 10 applicable to Directors of both Central Board and Local Boards. Thus (i) a person who is a salaried government official; (ii) an adjudicated insolvent or one who has suspended payment or has compounded with his creditors; (iii) a person of unsound mind ; (iv) an officer or employee of any bank or (v) a director of a banking company or co-operative bank is disqualified to be a director. However, this stipulation prohibiting a director from being a government employee or salaried government official is not applicable to the Governor, Deputy Governor and the Director nominated under Section 8(1)(d). 1.5 CRITICAL REMARKS The efficiency of a Central Banking system is to be judged by its ability to maintain price stability inside and ouside the country. Factors affecting this efficiency are (i) the strength of autonomous decision making power for leading the whole banking system with the basic objective of money management; (ii) quick information flow and capability of immediate assessment of the situation; & (iii) adequate power of system corrections. (i) An empirical understanding of the men in the management of RBI can clearly show the political overtone in the management structure of the RBI. Appointments to various senior positions of RBI’s management are mere executive functions of the Ministry of Finance of Government of India. Instances of appointing persons to the highest post in the Reserve Bank not having adequate experience in banking are not unknown. Political considerations often dominate while constituting Central & Local boards. Such appointments do not require any legislative or judicial scrutiny. There is complete lack of transparency in the constitution & appointment of this highest administrative setup in the RBI. As such, in designing the monetary policy, 41 (Sys 4) - D:\shinu\lawschool\books\module\contract law

regulating & controlling it, the RBI does not have functional autonomy to the extent required by the leader of a country’s banking system. (ii) The RBI Act, 1934, has provisions for information flow in accordance with the technological standard of 1934. In most of the cases today, there is a time lag of 4-6 weeks in between the happening of an incident & submission of the information to the RBI. These provisions (Secs.26-28 & 31) breed inefficiency and incapacity. In order to effectively play the role of the leader of the banking system, the Central

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Bank must have complete information of all transactions taking place in the realm of banking within the quickest possible time. It is unfortunate that sufficient steps are yet to be taken with this end in view. (iii) Of course RBI has the power of delicensing any commercial bank. This is an extreme step. RBI should have other intermediary power as well, including imposition of fine or taking disciplinary action or removing from service any person or any employee who is found negligent.

2. FUNCTIONS SUB- TOPICS 2.1 Introductory note 2.2 Outline of various types of functions 3.3 Concluding remarks 2.1 INTRODUCTORY NOTE It has already been pointed out that RBI has been constituted as Central Bank of the country. Classical functions of the Central bank are the following: a) Banker to the Government: Reserve Bank of India is the banker of the Central & State Governments as such it has treasury functions. It collects money for & on behalf of the Government and meets the expenses, whereas in the case of Central Government it may demand any quantity of money and the RBI is obliged to meet the demand. In case of State governments the RBI extends a time credit facility up to a maximum limit which is required to be set off against future collections. b) Currency Function: RBI is the sole authority for the issue of the currency. Of course one rupee coins & notes & subsidiary coins are issued by the government of India, they are put into circulation only through RBI.

c) Credit Control & Money Management : RBI regulates the value of money & controls the credit system through manipulation of cash reserve ratio, bank rate, open market buying & selling of securities & statutory liquidity ratio. d) Banker’s Bank : RBI is the apex bank regulating, controlling & creating opportunities for ordinary commercial banks to function efficiently. It also gives constant advice about the various goals of lending, borrowing & other banking functions. It also monitors the banking functions of the institutions of commercial banks & institutional banks. e) Leadership in institutional banking : RBI provides leadership to all institutional banking such as NABAD Rural Bank, IBRD, IFC in industrial banking, National Housing banking so on & so forth. These banks look forward to RBI for their policies on loans & advances. f) Ordinary Commercial Banking Function : RBI carryout ordinary commercial banking functions for the commercial banks and the government which many central banks of other countries do not do. These functions include bill discounting, giving loans & advances to financial institutions, dealing with foreign exchange & the like. 2.2 OUTLINE OF THE FUNCTIONS The following table gives the outline of the functions of the Reserve Bank of India :

Table I Functions of RBI Central Banking

Ordinary Banking

System

Function

Currency Banker Management to Govt (Secs.22-29) (Sec.20, 21A & 21B)

Credit Bankers & Monetary Bank Control Secs. 18 & 42 RBI Act., Ss.17, 18,20,21 & 24 of the B.R. Act)

Special Rural Credit (National

Bills Lending discounting & Borrowing (Ss.17&18 of RBI Act) Bank for Agriculture and Rural Development S.54 of the RBI Act)

Licensing of Banks

Banks of the Bankers Supervisors of the

(S.22 of B.R. Act)

(Ss.11, 17, 18 & 24 of Banks (Ss.9,19,21,& 22 B.R. Act)

Institutional banking & Industrial finance

Foreign Exchange dealing (Ss.39&40)

Other Banking functions (Chapter 38 of RBI Act)

of the BR Act)

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Table II RESERVE BANK OF INDIA CREDIT CONTROL

By Traditional Measures (quantitative)

By Non-Traditional (qualitative or Selective)

Interest

Liquidity Ratio

Open Market operations

Cash Reserve Ratio

Direct Action

System Sec.24(A)

Sec. 42, RBI Act

(Sec.58(B) of

B.R. Act

Sec.18(1), 24(2A)

RBI Act)

(a) (ii), B.R. Act) Bank Rate (Sec.49 RBI Act 1934)

Rate of Interest [(Sec.21(e) of 1949 (BRA)]

Effecting on Credit creating capacity of Commercial Banks (Sec.36(1) BRA Sec.18(3) RBI Act)

Changes in the Prices of Government securities (Sec. 17(4A) of RBI Act)

Publicity (Sec.45(E) of RBI Act) Moral Susasion advice, request & persuasion With the Commercial Banks by Central Bank Directives by the Central Bank (Sec.21(2) BRA Secs.35A & 45 K of RBI Act)

Fixation of Marginal Requirement on secured Loans (Sec.21(2) (b) of BRA) Regulation of Consumer Credit instalment credit system

2.3 CONCLUDING REMARKS Different functions of the RBI are discussed hereafter in subsequent topics. In this topic a broad outline is only given. It may be pointed out in this connection that many central banks like BUNDS Bank in Germany, Federal Reserve System in USA, Bank of England, Bank of Mexico & many others do not carry on any ordinary commercial banking function. From that

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point of view functions of RBI are multifarious. Some of the commercial banking functions are being exclusively done by RBI. As for e.g., RBI exclusively deals with foreign exchange, of course it may specially permit branches of some other commercial banks to deal with foreign exchange for or on its behalf. Thus other commercial banks doing this particular job at the instance of RBI do it as the agent of RBI.

3. ISSUE & MANAGEMENT OF CURRENCY SUB- TOPICS 3.1 Currency authority 3.2 Legal tender 3.3 Rupee coin & small coins 3.4 Management of currency 3.5 Refund of notes 3.1 CURRENCY AUTHORITY Reserve Bank is the sole authority under Section 22 of the RBI Act, 1934 for the issue and management of currency in India. Section 3(1) of the Act mentions that taking over of the management of currency is one of the purposes of constituting the Reserve Bank. Until the currency function was taken over by the RBI,, it was under the Controller of Currency in the Central Government. Although the Central Government issues one rupee notes, coins and small coins, they are put into circulation only through the Reserve Bank. To protect the monopoly of the Reserve Bank for issue of bank notes, section 31(1) of the Act prohibits anybody other than the Reserve Bank (and the Government of India when expressly authorised) from issuing bills, hundies and notes payable to bearer on demand except for drawing on a person’s account with a banker, shroff or agent. Sub-Section (2) of Section 31 further prohibits specifically the making or issue of a bearer promissory note by any other person. Under Section 24 of the Act, the Reserve Bank may issue notes of denominations varying from two rupees to ten thousand rupees, as decided by the Central Government based on the recommendations made by the Central Board of the Reserve Bank. The design, form and material of these notes has to be approved by the Central Government on the recommendation of the Central Board. Further, printing, circulation or issue of notes of certain denominations may be discontinued, if so decided by the Central Government as per the recommendations of RBI’s Central Board. 3.2 LEGAL TENDER Under Section 26 of the Act, every bank note shall be legal tender at any place in India in payment or on account for the amount expressed therein. This is guaranteed by the Central Government. Sub-Section (2) of Section 26 provides that the Central Government is empowered to notify on the recommendation of the Central Board of the Bank, that any series of bank notes of any denomination shall cease to be legal tender as specified in the notification. Under this provision certain high denomination notes were demonetised by the Government in 1946 and also in 1978. This was done to check unaccounted money, tax evasion and illicit transfer of money for financing transactions harmful to the national economy.

Reserve Bank is exempted under Section 29 of the Act from payment of stamp duty in respect of the bank notes issued by it. The notes issued by the Reserve Bank are referred to as bank notes in the Act to distinguish them from the notes issued by the Central Government. Initially at the time of taking over the management of currency, the Reserve Bank issued the currency notes of the Central Government until the bank notes were ready. Now those currency notes of the Central Government are no longer legal tender. (Reserve Bank of India, Functions and Working, (Fourth Edn.) 1983, P.10.) 3.3 RUPEE COINS AND SMALL COINS One rupee coins and other coins of lower value are issued by the Central Government under the Indian Coinage Act, 1906. The one rupee note is governed by the Currency Ordinance of 1940. One rupee notes are treated as rupee coins for all purposes of the RBI Act. The Central Government is responsible for minting and supplying these coins to the Bank. The Bank acts only as an agent of the Central Government in the distribution and issue of coins as also for with-drawing and remitting them back to Government. Under Section 38 of the Act, the Central Government is bound to put into circulation one rupee coins through the Reserve Bank only. The Central Government has to supply coins to the Bank on demand under Section 39 of the Act for exchange with bank notes/currency notes. It is the duty of the Bank to exchange for currency notes or bank notes of two rupees or upwards, currency notes or bank notes of lower value or other coins which are legal tender under the Indian Coinage Act, 1906. If the Central Government fails to supply such coins to the Reserve Bank on demand, the Bank is released from the statutory obligation to supply them to the public. 3.4 MANAGEMENT OF CURRENCY The matters relating to management of currency are handled by the Department of Currency Management at the Central Office in Bombay and the Issue Departments at the Regional Offices of the Reserve Bank. Under Section 23 of the Act, the Issue Department has to be separate and wholly distinct from the Banking Department. However, in practice, such distinction between the Issue Department and Banking Department has little economic significance (RBI, 1983, p.14). At the Regional Offices of the Reserve Bank, the Issue Department provides facilities of exchange. The Banking Department, through which the currencies are issued, draws on the local Issue Department for its requirement of currency. The currency requirements at other centres are met through currency chests maintained by the Reserve Bank with banks and treasuries which act as agents of the Reserve Bank. The currency chest is a receptacle in which new and reissuable notes, as also rupee 45 (Sys 4) - D:\shinu\lawschool\books\module\contract law

coins are kept. Currency notes and coins withdrawn from circulation are also deposited in the chest. The balances in the chest are the property of the Reserve Bank. The bank notes are fully covered by approved assets. The assets of the Issue Department are mentioned in Section 33 and the liabilities in Section 34 of the Act. The assets consisting of gold coin, gold bullion, foreign securities, rupee coin and rupee securities should not be less than the total of liabilities, namely the total amount of currency notes/bank notes for the time being in circulation. There is no limit or ceiling on the amount of notes that can be issued at any time.

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3.5 REFUND OF NOTES Under Section 27 of the Act, Reserve Bank has a duty not to reissue bank notes which are torn, defaced or excessively soiled. This is to ensure the quality of the notes in circulation. Section 28 stipulates that no person shall have a right to recover from the Central Government or the Reserve Bank, the value of any lost, stolen, mutilated or imperfect currency note or bank note. However, as a matter of grace, the value of such currency notes or bank notes may be refunded in certain circumstances and conditions. The conditions for refund are prescribed in the Reserve Bank of India (Note Refund) Rules framed under the proviso to Section 28. Refund is available from the Reserve Bank and also from authorised branches of commercial banks.

4. BANKER TO THE GOVERNMENT SUB-TOPICS 4.1 Bank of the Central Government 4.2 Business of State Government 4.3 Ways & means advances 4.4 Public debt 4.5 Adviser to Government 4.6 Agents of the bank 4.1 BANK OF THE CENTRAL GOVERNMENT The Reserve Bank is the banker to the Central and State Governments. Under Section 20 of the Act, it is obligatory for the Reserve Bank to undertake the banking business of the Central Government, namely acceptance of deposits, making payments upto the amounts standing to the credit of its account and also carrying out exchange, remittance and other banking operations. The Bank also has to manage the public debt of the Central Government. In turn the Central Government has a duty to entrust the Reserve Bank with all its money, remittance, exchange and banking transactions in India and deposit free of interest all its cash balance with the Bank. As the Reserve Bank has branches only in a limited number of places, it is open to the Central Government to carry on money transactions and hold requisite balances at places where the Reserve Bank or its agents have no place of business. It is also obligatory for the Central Government to entrust the management of its public debt and issue of any new loans to the Reserve Bank. The terms and conditions of transaction of Government business including public debt as above are governed by agreement between the Reserve Bank and the Government. In a case where the Reserve Bank and the Government fail to reach an agreement, the Government is empowered to decide the conditions. Under sub-section (4) of section 20 any agreement made under this section has to be laid before the Parliament. 4.2 BUSINESS OF STATE GOVERNMENT The transaction of the business of State Government is not obligatory unlike in the case of Central Government. However, under Section 21A, by agreement with Government of any State, Bank may undertake (a all its money, remittance and banking transactions in India including in particular, the deposit, free of interest, of all its cash balances with the Bank; and (b) the management of the public debt and the issue of any new loans by that State. Such agreements are also required to be placed before the Parliament. 4.3 WAYS AND MEANS ADVANCES Section 17(5) of the Reserve Bank of India Act authorises the Reserve Bank to make ways and means advances to the Central

and State Governments. Such advances are repayable not later than 3 months from the date of making the advances. There are temporary advances to meet the immediate needs when there is interval between expenditure and the flow of receipt of revenue. The rate of interest and amount that may be advanced is regulated by agreements between the Central and State Governments. State Governments often resort to taking advances in excess of the limits prescribed by the agreement with them, which take the form of overdraft. The Government transactions are carried out all over the country with the Reserve Bank, State Bank of India, other agency banks and treasuries and the accounts are maintained at the Central Accounts Section of the Reserve Bank at Nagpur. The Reserve Bank closely monitors the utilisation of ways and means advances by States and has the authority to suspend payments on account of a State, the accounts of which shows overdraft for more than a specified number of working days (RBI, 1983, pp.27-31). 4.4 PUBLIC DEBT The management of public debt concerns with the raising of finance by the Government. Under the provisions of the Public Debt Act, 1944, the management of public debt is with the Reserve Bank. Sections 20, 21 and 21A of the Reserve Bank of India Act also confer powers for the management of public debt and issue of new loans for the Central and State Governments. For raising public loans Government issues securities in various forms, namely — i) stocks transferable by registration in the books of the Reserve Bank. ii) promissory notes payable to order and iii) bearer bonds payable to bearer. Government may also prescribe any other forms as provided in Section 2 of the Public Debt Act. The public debt functions are carried out through the Public Debt Office operating at the local branch offices of the Reserve Bank. The long term objectives of public debt management is to ensure adequate finance for the Government and avoid recourse to short term borrowings from the Reserve Bank as far as possible. Treasury bills are the main instruments of short term borrowing by the Central Government. As an agent of the Government, the Reserve Bank issues treasury bills at a discount which can be rediscounted with the Bank at any time before maturity. However, the Union Finance Minister has proposed in the 1994-95 budget to phase out the Central government’s access to unlimited ad hoc treasury bills over a period of three years by 1997-98. This has been done to bring in greater financial discipline in the government’s expenditure. The budget deficit is to be limited to two-thirds of 1% of the GDP (Gross Domestic Product), the deficit should be Rs. 6000 crores for the financial year 1994-95. A cushion has been provided as the government can borrow upto Rs 9,000 crs. for a maximum 47 (Sys 4) - D:\shinu\lawschool\books\module\contract law

period of 10 working days at any time during the year. If the govt. fails to abide by this principle, the RBI will be free to sell the Treasury bills in the open market so as to reduce the ad hoc treasury bills in its custody. The government will then have to find other ways of borrowing, from the market, domestic or foreign. The Reserve Bank also advises the Central and State Governments regarding the time, quantum and other aspects of issue of new loans. 4.5 ADVISER TO GOVERNMENT Apart from its relations with the Government as banker and customer, and in the management of public debt, the Reserve Bank also functions as an adviser to Government in banking

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and financial matters. As the fiscal policies of the Government have a major impact on the monetary and credit system which the Bank regulates, coordination with the Government is necessary. 4.6 AGENTS OF THE BANK Reserve Bank’s function as banker to the Government is discharged in the Public Accounts Departments of the local or branch offices. At other places, government business is handled by its agents. Under Section 45 of the Reserve Bank of India Act, National Bank, State Bank of India and its associate banks or nationalised banks may be appointed as agents for specified purposes by the RBI.

5. BANKER’S BANK SUB-TOPICS 5.1 Lender of last resort 5.2 Clearing Houses of Banks 5.1 LENDER OF LAST RESORT Section 17 of the Reserve Bank of India Act specifies the several kinds of business which the Bank may transact. Under sub-section (1), Reserve Bank may accept deposits without interest from the Central Government, State Governments, local authorities, banks and any other persons and also undertake collection of money on their behalf. Accordingly, it maintains apart from Government accounts, the accounts of banks, financial institutions, foreign central banks and international financial institutions. Thus, the Reserve Bank is the banker of banks. The Bank also makes loans and advances to banks when necessary, under various provisions of the Reserve Bank of India Act. When difficulties arise, Reserve Bank is a lender of last resort for banks. The availability of credit from the Bank is dependent on the prevailing credit policy. Section 17 authorises the Reserve Bank to give financial accommodation to scheduled banks, State Cooperative Banks and financial institutions. Rediscount facilities are available under various provisions of section 17(2) of the Act for financing commercial or trade transactions, agricultural operations or marketing of crops, production or marketing activities of cottage and small scale industries etc. For this purpose the documents eligible for purchase or rediscount are bills of exchange and promissory notes drawn on and payable in India bearing two or more good signatures, one of which has to be that of a scheduled bank, or state co-operative bank or a State Financial Corporation as stipulated.

Loans and advances are also available under other provisions of Section 17, namely 17(3A), 17(3B), 17(4)(a) to (d), to scheduled banks and state co-operative banks against securities for financing exports, commercial or trade transactions, agricultural operations, marketing crops, etc. Further, loans and advances in foreign currency for financing international trade are available under Section 17(12B). In addition to the provisions under Section 17 for transaction in normal times, Section 18 gives emergency powers to purchase, sell or discount bills of exchange or promissory notes which are not eligible for purchase or discount under Section 17 and also to make certain loans and advances to State Co-operative banks and cooperative societies recommended by them or any other person. 5.2 CLEARING HOUSES OF BANKS Apart from being the banker to banks as above, the Reserve Bank also manages the clearing houses of banks at most centres where it has offices or branches. Under Section 58(2)(p) of the Act, Reserve Bank is empowered to frame regulations for regulating the clearing houses for banks including Post Office Savings Banks. However, no such rules have been framed so far and the clearing houses continue to work under their own rules which are adopted by consent of members. (See, RBI, Uniform Regulations and Rules for Bank’s Clearing Houses). The Managers of the local offices of Reserve Bank are the exofficio Presidents of the clearing houses. The Reserve Bank is an ordinary member of the clearing houses like other banks for clearance of cheques and other instruments. At other places clearing houses are managed by the State Bank or its associate banks.

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6. MONETARY CONTROL SUB-TOPICS 6.1 Introduction 6.2 Bank rate 6.3 Open market operations 6.4 Cash reserve 6.5 Statutory Liquidity Ratio 6.6 Interest rate 6.7 Selective Credit Control 6.8 Regulation of non-banking institution 6.9 Directions 6.10 Un-incorporated bodies. 6.1 INTRODUCTION Monetary Control is the main function of the Reserve Bank, as it is the Central Bank of the country. Formulating and administering monetary policy involves using of instruments within its control to influence the level of aggregate demand for goods and services by regulation of the total money supply and credit. The Reserve Bank exercises monetary regulation by influencing the availability and cost of credit by exercising different types of controls. General or quantitative controls are the instruments of Bank rate, reserve requirements and open market operations. These methods affect the total money supply. The other types of controls called selective credit control envisage the increase or decrease of margins upto which the commercial banks can finance sensitive commodities like foodgrains, edible oils, cotton, pulses,etc. It exercises control over the direction of credit, namely the flow of credit to a particular commodity or sector of the economy. Control over interest rates on acceptance of deposits by non-banking institution also forms a part of monetary control. 6.2 BANK RATE Bank rate is defined in Section 49 of the RBI Act as the standard rate at which the Bank is prepared to buy or re-discount bills of exchange or other commercial paper eligible for purchase under the Act. In India Bank Rate has been changed frequently to effect change in the cost of funds available from Central Bank to banks and financial institutions. In actual practice, due to the absence of a genuine bill market, the rate on advance by Reserve Bank has become important and that rate has been commonly treated as the equivalent of Bank rate. The effectiveness of bank rate as an instrument of monetary control depends on the extent of operation in the money market and also on how far the commercial banks resort to borrowing from Reserve Bank. Money market is the centre for dealings in monetary assets of short term nature. In Indian conditions, raising or lowering of the bank rate is of little operative significance as there is no well developed bill market. However, it is an important indicator of changes in the direction of the 50 (Sys 4) - D:\shinu\lawschool\books\module\contract law

credit policy of the Reserve Bank as it is usually offered along with the other control measures of the RBI as a package. 6.3 OPEN MARKET OPERATIONS Section 17(8)of the Reserve Bank of India Act authorises the Reserve Bank to engage in the purchase and sale of securities of any maturity of the Central Government and the State Governments. Securities of local authorities like the State Electricity Boards, Water Supply and Sewerage Boards, Housing Boards, etc may also be purchased as specified by the Central Government on the recommendation of the Central Board of the Reserve Bank. A security which is fully guaranteed by the Government or the authority concerned as to the principal and interest is deemed to be a security of such Government or authority. Reserve Bank is also authorised to purchase and sell commercial bills of short-term maturity under Section 17(2) of the Act. Open market operations are used by a Central Bank to alter the liquidity position of banks by dealing directly in the market instead of indirectly influencing it by variation of cost of credit. Reserve Bank can influence the resources or cash base of commercial banks by purchase and sale of Government securities in the open market. Open market operations can be carried out by purchase and sale of a variety of assets such as Government securities, commercial bills of exchange, foreign exchange, gold and even company shares. In actual practice they are confined to the buying and selling of Government securities (RBI, 1983, p80). When securities are purchased from the open market, the reserves of the banks with the Reserve Bank increases and they can acordingly expand credit. Similarly selling of Government securities has the effect of contraction of credit and reduction in supply of money. The market for Government securities being very narrow, namely public debt being held by a few institutions and their operations being limited, the potency of this instrument of monetary control is reduced to that extent. Now these operations are used more to assist Government in its borrowing than as an instrument to influence the cost of credit. (Tannan, 1987 p 56). 6.4 CASH RESERVE Section 42 of the Reserve Bank of India Act and Section 18 of the Banking Regulation Act deal with cash reserves to be kept with the Reserve Bank by scheduled banks and non-scheduled banks respectively. ‘Scheduled bank’, as defined in Section 2(e) of the Reserve Bank of India Act means a bank included in the second schedule of the Act. Under Sub-section (6) of Section 42, a bank operating in India may be included in the Second Schedule by the Reserve Bank on the following conditions : (i) The aggregate value of paid-up capital and reserves is not less than Rs. 5 lakhs;

(ii)

Satisfies the Reserve Bank that its affairs are not being conducted in a manner detrimental to the interests of its depositors; and (iii) Is a State Co-operative Bank or a company or an institution notified by the Central Government in this behalf or a company, corporation incorporated under any law in force in any place outside India. The Bank is also empowered to direct exclusion of any scheduled bank from the Second Schedule if its paid up capital and reserve fall below the stipulated minimum, or its affairs are conducted in a manner detrimental to the interests of depositors (as found by the Bank after making an inspection of the Bank under Section 35 of the Banking Regulation Act) or it goes into liquidation or otherwise ceases to carry on banking business. The Bank may defer the making of such direction on an application from the scheduled bank concerned and give time, subject to suitable conditions, to increase capital and reserve or to remove the defects in the conduct of its affairs. Scheduled banks have to maintain under sub-section (1) of Section 42, an average daily balance of not less than 3% of the total demand and time liabilities in India of such banks. Further, the Reserve Bank is empowered to increase the rate of cash reserve by notification in the official Gazette upto 20% of the total demand and time liabilities. ‘Liabilities’ for this purpose is defined in clause (c) of the explanation to Section 42(1). The paid up capital, reserves and any credit balance in the profit and loss account of the bank as also any loan from the RBI, the Industrial Development Bank of India, Exim Bank and certain other financial institutions is specially excluded from ‘Liability’. Similarly in the case of State Co-operative Banks certain liabilities like loans from State Government and in the case of Regional Rural Banks, loans from Sponsor Banks are excluded. Further, under sub-section (1C), the Bank may specify from time to time whether any transaction or transactions shall be regarded as liability of a scheduled bank for the purpose of cash reserve or not and in case of any doubt, the decision of the Bank shall be final. Sub-Section (1A) of Section 42 empowers the Bank to direct scheduled banks to maintain a specified additional average daily balance from any specified date. Such additional balance is calculated with reference to the excess of the total of the demand and time liabilities of a bank as shown in its return under subsection (2) Section 42 over the total of the demand and time liabilities at the close of business over the date specified in the notification. The additional balance should not be more than such excess and the total cash reserve should not in any case exceed twenty percent of the bank’s total demand and time liabilities. Where any scheduled bank maintains additional balance as required under sub-section (1) or (1A), interest is payable at the rates determined by the Bank. However, no interest is payable in respect of any balance in excess of the requirement. Every scheduled bank has to send to the Reserve Bank a return under Section 42(2) showing the amount of its demand and time liabilities and the amount of its borrowings from banks in

India classifying them as demand and time liabilities and other details of its holdings, advances and investments, at the close of business on each alternate Friday. Such returns have to be sent not later than seven days after the date to which it relates. Scheduled banks have also to submit another return as at the close of business on the last Friday of every month (where it is not an alternate Friday) under sub-section (2) giving the details as required in fortnightly returns. However, in practice, it is found that these returns are not properly compiled and submitted in time on account of the very large network of branches. In cases where the cash reserve falls short of the requirement under sub-section (1) and (1A), such scheduled banks are not entitled to interest on the reserve maintained and are also liable to pay panel interest on the short fall initially at the rate of 3% above Bank rate and thereafter at the rate of 5% above Bank rate. Continued default will make every director, manager or secretary of the scheduled bank who is knowingly and willingly a party to the default punishable with fine. Further, the Bank is also empowered to prohibit the scheduled bank from receiving fresh deposits if the default persists. Default in complying with such prohibition is also punishable with fine. Sub-section (4) provides for penalty for failure to comply with the provisions of sub-section (2) regarding returns. Sub-section (5) provides for realisation of penalties imposed by issuing demand notice to the scheduled bank. If the amount is not paid within 14 days, Reserve Bank may apply to the principal Civil Court for a direction to levy the fine. The Court making such direction shall issue a certificate specifying the sum payable which is enforceable like a decree in a suit. If the Bank is satisfied that the defaulting bank had sufficient cause for the default it may not demand payment of penal interest or penalty. The requirement of cash reserve under Section 18 of Banking Regulation Act for non-scheduled banks is also at least 3% of the total demand and time liabilities in India. Such cash reserve may be maintained with the bank itself or by way of balance in a current account with the Reserve Bank or by way of net balance in current accounts (with State Bank, its subsidiaries or nationalised banks) or in one or more of the aforesaid ways. The bank has to submit a return to the Reserve Bank before 20th of every month; a return showing the amount so held on alternate Fridays during a month with particulars of its demand and time liabilities in India on such Fridays. 6.5 STATUTORY LIQUIDITY RATIO (SLR) Banks are required under Section 24(1) of the Banking Regulation Act, 1949 to maintain in India liquid assets in cash, gold or unencumbered approved securities amounting to 20% of its total demand and time liabilities. ‘Approved security’, as defined in Section 5(a) of the Act means securities in which a trustee may invest money under Clauses (a), (b), (bb), (c) or (d) of Section 20 of the Indian Trusts Act, 1882 and certain other securities authorised by the Central Government. ‘Unencumbered approved securities’ include approved securities lodged with another institution for an advance or any other credit arrangement to the extent to which such securities have not been drawn against. 51 (Sys 4) - D:\shinu\lawschool\books\module\contract law

This provision enabled banks to liquidate their Government security holdings, to offset the impact of variable cash reserve requirements. Hence, sub-section (2A) to section 24 was introduced in 1962 to require all banks to maintain a minimum amount of liquid assets of not less than 25% of their demand and time liabilities in India, excluding the cash balances to be maintained under Section 42 of the Reserve Bank of India Act in the case of scheduled banks and that under Section 18 of the Banking Regulation Act in the case of non-scheduled banks. The Reserve Bank is empowered to increase it up to 40 per cent. The balances maintained by scheduled banks on their own in excess of the requirement of cash reserve ratio under Section 42 of the Reserve Bank of India Act or any balances in current account with State Bank or any notified bank are counted for the purpose of statutory liquidity ratio. Deposits of foreign banks with Reserve Bank under Section 11(2) of the Banking Regulation Act and any cash balances of non-scheduled banks with themselves or in current account with Reserve Bank, State Bank or any notified bank in excess of the requirements under Section 18 of the Banking Regulation Act and any balances maintained by a Regional Rural Bank with its sponsor bank are also counted as liquid assets. The percentage of liquid assets maintainable by a Regional Rural Bank may be varied by the Reserve Bank by notification. Banks have to submit a monthly return to the Reserve Bank under sub-section (3) of Section 24 for ensuring compliance with the requirements of liquidity ratio. Sub-section (4) provides for payment of panel interest by defaulting banks, which is 3 per cent above Bank rate initially and liable to be increased to 5% above Bank rate for continued default. When Reserve Bank is satisfied that the defaulting bank had sufficient cause for its default, penal interest may be waived. The penalty is payable within 14 days of demand by notice failing which the Reserve Bank may obtain a direction and a certificate from the principal Civil Court which may be enforced in the manner of a decree from a civil court. In case of default even after increased penal interest becomes payable, Section 24(7) provides for punishment with fine. 6.6 INTEREST RATE Reserve Bank exercises direct control over the lending rates of banks by influencing cost of bank credit by increase or decrease in the lending rates rather than the Bank rate. The relevant statutory provisions are sections 21 and 35A of the Banking Regulation Act. Under Section 21, Reserve Bank is empowered to issue direction to banks in public interest or in the interests of depositors or banking policy. Such direction may, among other things, stipulate the rate of interest and other terms and conditions on which advances may be made. Further, Section 35A authorises the Reserve Bank to issue directions to banks when it is satisfied that it is necessary to do so, in the public interest, in the interest of banking policy, to prevent the affairs of the banks being conducted in a manner detrimental to the interest of the depositors and also to secure proper management of the banks. Under these provisions namely Section 21 and 52 (Sys 4) - D:\shinu\lawschool\books\module\contract law

35A, Reserve Bank has issued direction regarding interest rates on both deposits and advances of banks. Section 21A of the Banking Regulation Act stipulates that notwithstanding the Usurious Loans Act, or any other law for the time being in force in any State relating to indebtedness the transaction between a bank and its debtor shall not be reopened by any court on the ground that the rate of interest charged by such bank is excessive. The Reserve Bank can accordingly fix the lending rate or the maximum or minimum lending rates. However, this has no bearing on the court’s jurisdiction to give relief to an aggrieved party when it is established that a bank has charged interest in excess of limit prescribed by the Reserve Bank. (H.P. Krishna Reddy v. Canara Bank, AIR 1985 Kant 285; see also Bank of India v. Karnam Renga Rao AIR 1986 Kant 246 regarding compounding of interest on agricultural loans and Jameela Beevi v. SBT, (1992) 74 Comp. Cas 736 regarding Reserve Bank’s power to regulate interest rate.) 6.7 SELECTIVE CREDIT CONTROL ‘Selective Credit Control’ refers to regulation of distribution or direction of bank resources to certain sectors of the economy. This is done in terms of the broad national policies for achieving developmental goals. Selective Credit Control is used by the Reserve Bank along with general credit control. The provision of Sections 21 and 35A of the Banking Regulations Act empower the Reserve Bank here also. The wide powers conferred under these provisions enable the Reserve Bank to determine the policy in relation to advances to be followed by banks. The directions may, apart from rate of interest, deal with the following aspects of advances: (i) The purpose of advances, for example, to prevent hoarding of sensitive commodities like foodgrains, pulses, edible oils, etc;. (ii) Margins to be maintained in case of secured advances and (iii) Maximum amount of advances or other financial accommodation to a single borrower. Such direction may be given to banks generally or to a specific bank. Selective credit control is exercised by Reserve Bank by stipulating (i) minimum margins for lending against selected commodities (ii) ceilings on the levels of credit and (iii) rates of interest on stipulated commodities. The first two control the quantum of credit and the last, the cost of credit. By judicious use of these instruments, it is possible to regulate the availability of credit to different sectors of the economy. 6.8 REGULATION OF NON-BANKING INSTITUTIONS The fast growth of non-banking institutions in the country and their accepting deposits from the public at very high rates of interest raised the question of regulating their activities. As credit from the banking sector was under the control of the Reserve Bank, the non-banking institutions had a ready market and many unhealthy practices developed in course of time.

Hence control over the acceptance of deposits by non-banking institutions was conceived as an adjunct to monetary and credit policy and also with a view to protecting the interests of depositors. Chapter III-B of the Reserve bank of India Act was introduced in 1964 by an amendment of the Act conferring powers on the Reserve Bank to regulate the acceptance of deposits by non-banking institutions. Chapter III-C of the Act which was introduced in 1984 seeks to regulate the acceptance of deposits by unincorporated bodies. The Prize Chits and Money Circulation Schemes (Banning) Act, 1978 and the Chit Funds Act, 1982, were enacted pursuant to the recommendations of a study group appointed by the Reserve Bank in 1974 to examine the then existing statutory provisions and the directions thereunder to suggest further regulatory measures. This statute on prize chits and money circulation schemes is administered by the States and Union territories but the rules are required to be framed in consultation with the Reserve Bank. Further, the Bank has an advisory role for the winding up of the existing prize chits and money circulation schemes and generally on the implementation of the Act. The Chit Funds Act is also administered by the State Governments and the Reserve Bank has only advisory role in the framing of rules, giving exemption from the provisions of the Act and generally on question of policy. Sections 45J, 45K and 45L of the Act empower the Reserve Bank to regulate acceptance of deposits by non-banking institutions. ‘Deposit’ as defined in Section 45I(bb) includes any receipt of money by way of deposit or loan or any other form except those specifically excluded. The excluded categories are :i) amounts raised by way of share capital. ii) share capital brought in by partners. iii amounts received from banks and financial institutions. iv) amounts received in ordinary course of business by way of security deposit, dealership deposit,earnest money and advance for orders of goods and services;and v) subscriptions to chits. ‘Non-banking institution’ as defined in Section 45I(e) means a company, corporation or co-operative society. ‘Financial institution’ as defined in Clause (c) of Section 45-I means any non-banking institution which carries on the types of business specified therein. Section 45J, provides for the Reserve Bank to regulate or prohibit in public interest issue of prospectus or advertisement soliciting deposits from the public. Section 45K provides for collection of information from non-banking institution regarding deposits and also for issuing directions on matters relating to receipt of deposits including rates of interest and period of the deposit. On failure to comply with such directions, acceptance of deposits may be prohibited. Under 45L, Reserve Bank may call for information from financial institutions and give direction relating to the conduct of the business of financial institutions. Non-banking institutions have a duty to furnish statements, information and

particulars as called for by the Reserve Bank. There is also provision under Section 45N for inspection of non-banking institutions by the Reserve Bank. Further soliciting of deposits on behalf of a non-banking institution by unauthorised persons is prohibited. According to Section 45Q, Chapter III B shall over ride the provisions of other laws. With the amendment to Companies Act, 1956 introducing Section 58A (See also, Companies acceptance of Deposit Rules, 1975. For a detailed discussion, see, Ramaiya, (1988, pp 231-47), regarding prohibition of prize chits, See AIR 1981 SC 504) the Central Government is empowered to exercise control over acceptance of deposits by non-banking non-financial companies and over advertisements for acceptance of deposits by all clauses of companies. 6.9 DIRECTIONS Under the authority of Section 45J, 45K and 45L, the Reserve Bank has issued the Non-Banking Financial Companies (Reserve Bank Directions 1977, the Miscellaneous NonBanking Companies (Reserve Bank) Directions, 1977 and the Residuary Non-Banking Companies ( Reserve Bank) Directions, 1987. These directions are applicable to financial companies or other non-banking companies as specified in the directions. These directions impose several restrictions on rate of interest, period of deposit, maintenance of assets etc. which are modified from time to time. (See Peerless General Finance & Investment Company Ltd. v. RBI AIR 1992 SC 1033). 6.10

UNINCORPORATED BODIES

Chapter III C of the Reserve Bank of India Act prohibits acceptance of deposits by individuals, firms or unincorporated bodies from more than the number of depositors specified therein. (See, (1993) 77 Comp. Cas (Part II) p.197). Accordingly an individual may not accept deposits from more than 25 persons excluding relatives of the individual. In the case of firms the ceiling is twentyfive depositors per partner and two hundred and fifty depositors in all excluding relatives of partners. In the case of unincorporated associations also the limit is twenty five depositors per individual and two hundred and fifty depositors in total excluding relatives of the individuals forming the association. ‘Relatives’ for this purpose are defined in the Explanation to Section 45 S(2). However, any period not exceeding 6 months in any account relating to mutual dealings in the ordinary course of trade or business shall not be deemed to be a depositor on account of such balance. Under Section 45 T an authorised officer of the Bank or of the State Government may obtain a warrant from the court for search of any place where documents regarding acceptance of deposits in contravention of the provisions of Section 45 S are believed to be kept. The Bank has no powers to regulate interest rate or impose other conditions regarding acceptance of deposits by unincorporated bodies. However, acceptance of deposits from more depositors than specified being in contravention of the provisions of the Act, the Bank can initiate prosecution under Section 58 B read with Section 58 E of the Act. 53 (Sys 4) - D:\shinu\lawschool\books\module\contract law

7. CUSTODIAN OF FOREIGN EXCHANGE SUB-TOPICS 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 7.10 7.11 7.12 7.13 7.14

Introduction Restrictions on dealings in Foreign Exchange Authorised dealers & Money changers Blocked Accounts Import & Export of currency Payment for exported goods Export & Transfer of Securities Appointment of agents Establishment of place of business Employment of Foreign nationals Information & Returns Inspection Issue of directions Rupee Convertibility

7.1 INTRODUCTION Regulation and conservation of foreign exchange is a major function of the Reserve Bank under the Foreign Exchange Regulation Act (FERA), 1973. As observed by the Supreme Court in Life Insurance Corporation of India vs. Escorts Ltd., (AIR 1986 SC 1370), it is the ‘custodian general’ of foreign exchange. According to the Preamble, the Act provides for regulation of certain payments, dealings in foreign exchange and securities, transactions indirectly affecting foreign exchange and the import and export of bullion and currency, for the conservation of foreign exchange resources of the country and the proper utilisation thereof in the interests of the economic development of the country. Regulation of foreign exchange was introduced in India under the Defence of India Rules, 1939 which was replaced by the Foreign Exchange Regulation Act, 1947 and later by the Foreign Exchange Regulation Act, 1973 which is currently in force. Although the Reserve Bank is the main agency for administration of FERA, the task of enforcement is left to the Directorate of Enforcement constituted under Section 3 of the Act. The Central Government is vested with several powers under the Act including the power to give general or special direction to the Reserve Bank under Section 73. The Bank is obliged to comply with such direction in the discharge of its functions under the Act. The Act imposes certain restrictions on dealings in foreign exchange, import and export of currency and payment for exported goods. Holding of immovable property outside India by residents of India and in India by non residents, appointment of non-residents as agents and establishment of place of business in India by non-residents are some of the other major areas of control. 54 (Sys 4) - D:\shinu\lawschool\books\module\contract law

7.2 RESTRICTIONS ON DEALINGS IN FOREIGN EXCHANGE Under Section 8 of the Act, the previous general or special permission of the Reserve Bank is necessary for any person, other than an authorised dealer in India to purchase or otherwise acquire, borrow, sell, lend, exchange or otherwise transfer any foreign exchange with any person not being an authorised dealer. Foreign exchange as defined in Section 2(h) means foreign currency and includes all deposits, credits and balances payable in any foreign currency and any drafts, travellers cheques, letters of credit and bills of exchange, expressed or drawn in Indian currency but payable in any foreign country. However, letters of credit can be drawn in foreign currency too. It also includes any instrument payable, at the option of its drawee or holder or any other party thereto, either in Indian currency or in foreign currency or partly in one and partly in the other. These restrictions apply also to persons resident in India, as defined in Clause (p) of Section 2 of the Act, other than authorised dealers in respect of their dealings outside India. This does not, however, apply to the purchase or sale of foreign currency in India between any person and a money changer. Conversion of foreign currency into Indian currency or vice versa, has to be done at the rates of exchange for the time being determined and authorised by the Reserve Bank. For conversion at other rate, previous general or special permission of the Reserve Bank is necessary. This applies to authorised dealers and money changers as well. Section 9(1)(a) prohibits any person in or resident in India from making any payment to or to the credit of any person resident outside India except with the general or special exemption of the Reserve Bank. (Release of foreign exchange under Sections 8 and 9 should not be discriminatory See, Pranab K. Ray v. RBI (AIR 1993 Cal.50). Such exemption may be granted with or without conditions. Similar prohibition also extends to making and receipt of payments of various types mentioned in Clauses (b) to (g) of Section 9(1). Under Sub-section (3) of Section 9, remittance of any amount from any foreign country into India should be through an authorised dealer unless general or special exemption is granted by the Reserve Bank, with or without conditions. 7.3 AUTHORISED DEALERS AND MONEY CHANGERS Under Section 6 of the Act, Reserve Bank is empowered to authorise any person to deal in foreign exchange. Persons so authorised are called ‘authorised dealers’ as defined in Section 2(b). Such authorisation may be granted subject to conditions and may be for, (i) dealings in all foreign currencies or restricted to specified foreign currencies; (ii) transactions of all descriptions in foreign currencies or restricted to specified transactions; (iii) a specified period or within specified periods. Authorised dealers are generally scheduled banks. However,

Reserve Bank has given restricted licence to Industrial Development Bank of India and Exim Bank to undertake certain specified functions. [Exchange Control Manual, 3rd Edn., 1987 Vol. I para 1.4 (Note)]. The Reserve Bank may revoke the authorisation or licence of any authorised dealer (i) in public interest or (ii) for non-compliance of the conditions stipulated or for violation of the provisions of the Act or of any rule, notification, direction or order made thereunder. Before revoking an authorisation, except when it is in the public interest to do so, the authorised dealer has to be given a reasonable opportunity for making a representation in the matter. An authorised dealer has to function within the terms of his authorisation and has to comply with any general or special directions or instructions as may be given by Reserve Bank from time to time. Section 7 of the Act empowers the Reserve Bank to authorise any person to deal in foreign currency. Persons so authorised are called ‘money changers’. The authorisation given to money changers may be (i) for all foreign currencies or in respect of specified foreign currencies, (ii) for all transactions in foreign currencies or for specified transactions and also may be, (iii) for operating at a specified place and for a specified time or within specified amounts. ‘Money changer’ licences have been given to certain established firms, hotels and other organisations. There are ‘full fledged money changers’ who buy and sell foreign currency and ‘restricted money changers’ who only buy foreign currency and surrender it to authorised dealers. It is open to the Reserve Bank to impose any conditions while granting licence to money changers. The Bank is also empowered to give direction to money changers as also to revoke the authorisation given to money changers, as in the case of authorised dealers under Section 6. 7.4 BLOCKED ACCOUNTS Section 10 of the Act deals with blocked accounts. (Regarding ordinary Non-resident Accounts, Non-Resident External Accounts, Foreign Currency Non-Resident Accounts (FCNR), (Exchange Control Manual, 3rd Edn., 1987 Vol I Chapters 28 & 29). A ‘blocked account’ is an account opened as a blocked account at any office or branch of a a bank in India authorised by the Reserve Bank in this behalf or an account blocked by an order of the Reserve Bank. While granting exemption to any person under Section 9 in respect of payment of any sum to a non-resident, Reserve Bank may stipulate a condition that the payment be made to a blocked account. In such cases, the payment shall be made to a blocked account in the name of that person in the manner as directed by the Reserve Bank by a special or general order. The crediting of a blocked account as directed by the Reserve Bank would give a valid discharge to the person making the payment to the extent of the sum credited. Withdrawal of any amount from such blocked account is permissible only with the general or special permission of the Reserve Bank.

7.5 IMPORT AND EXPORT OF CURRENCY Import or export of foreign exchange or Indian currency to or from India is also subject to restrictions imposed under Section 13. General or special permission of the Reserve Bank is necessary to take or send out of India any Indian currency or foreign exchange other than foreign exchange obtained from an authorised dealer or a money changer. Acquisition of Foreign Exchange Section 14 authorises the Central Government to order by a notification in the official Gazette, every person in or resident in India to sell foreign exchange to the Reserve Bank or to persons authorised by the Reserve Bank for this purpose. The sale should be at a price not less than the rate of exchange for the time being authorised by the Reserve Bank. Such order may also be made to persons entitled to assign any right to receive foreign exchange. However, this does not apply to foreign exchange acquired from an authorised dealer or money changer and retained with the permission of the Reserve Bank for any purpose. Duty of Persons Entitled to Receive Foreign Exchange Under Section 16(1) of the Act, general or special permission of the Reserve Bank is necessary for any person having a right to receive foreign exchange or a rupee-payment from a nonresident, to do or refrain from doing anything which has the effect of delaying such payment or ceasing such payment in whole or part. If any person fails to comply with this provision, the Reserve Bank is empowered to give suitable directions for ensuring the receipt of the foreign exchange or payment. 7.6 PAYMENT FOR EXPORTED GOODS Section 18(1) empowers the Central Government to stipulate that before exporting any goods from India, the exporter furnishes to the prescribed authority a declaration in the prescribed form.(See Govt. Notification dated 1-1-1974 as amended from time to time, GR, PP and VP/COD Forms prescribed. Declaration value on some conditions. Ref. Exchange Control Manual, 3rd Edn. 1987, Vol.I, Chapter II). The authority prescribed under the Foreign Exchange Regulation Rules, 1974 is the local Collector of Customs or, in the case of export through post, the local postal authorities. Such declaration shall mention the full export value of the goods or the expected export value thereof and affirm that the full export value of the goods, has been or will, within the prescribed period, be paid in the prescribed manner. Such notification may be in respect of all goods or any goods or any class of goods as specified therein. It is also open to the Central Government to direct that in respect of any goods specified, the exporter shall not sell the goods at a value lesser than the expected export value already declared, except with the permission of the Reserve Bank. An application for such permission shall not be refused without giving a reasonable opportunity to the exporter for making a representation in the matter. Rejection of such applications have to be communicated to the exporter within 20 days of receipt thereof failing which 55 (Sys 4) - D:\shinu\lawschool\books\module\contract law

permission from the Reserve Bank shall be presumed. The period taken by Reserve Bank for giving opportunity to the exporter to be heard shall not be counted for this purpose. Permission of the Reserve Bank is also necessary under Section 18(2) for : (i) payment of goods other than in the prescribed manner; (ii) delayed payment beyond the prescribed period or (iii) where proceeds of sale of the goods exported do not represent full export value of goods subject to any deduction permitted by the Reserve Bank. The Reserve Bank may give suitable direction under sub-section (4) to exporters who fail to realise payments within the prescribed period, for securing payment (where goods are already sold) or for sale of goods and payment therefore or reimport of goods to India as circumstances permit. The time limit for the purpose may also be specified. Such direction may also require that the goods, the right to receive the payment therefore or any other right to enforce payment be transferred or assigned to the Central Government or a person specified in the directions. Where the value of the goods as specified in the declaration under sub-section (1) is less than the full export value or the expected export value in the opinion of the Reserve Bank, the Reserve Bank may intervene under sub-section (6). Thus the person holding the shipping documents may be ordered to retain the possession thereof until the exporter has arranged for the Reserve Bank or its nominee to receive on behalf of the exporter, the full export value of the goods in the prescribed manner. Further, the exporter may be required under sub-section (7) to exhibit the contract with the foreign buyers or any other evidence to show that the full export value or the expected export value of the goods has been or will be paid within the prescribed period and in the prescribed manner. Section 18(9) empowers the Reserve Bank to issue general or special orders from time to time for ensuring that the full export value of goods are received without delay. Such orders may be in respect of exports of goods to any destination, any class of export transactions, any class of goods or exporters. These orders may provide that the exporter shall, prior to export, comply with certain conditions. Such conditions may be regarding i) registration of contract as specified in the order; ii) payment to be covered by letter of credit/firm orders or other document; iii) certification of the export value declared by a specified authority; iv) prior approval of the declaration under sub-section (1) by the Reserve Bank. The prior approval as above may be given or withheld or may be given subject to any condition. However, before withholding any approval, the exporter has to be given an opportunity to make a representation in the matter. 56 (Sys 4) - D:\shinu\lawschool\books\module\contract law

The general or special permission of the Bank is required under Section 18A to take any goods from India to any place on lease, hire or other arrangement other than sale, the provisions of Section 18 apply to such cases also in terms of sub-section (2) of Section 18A. 7.7 EXPORT AND TRANSFER OF SECURITIES General or special permission of the Reserve Bank is necessary under Section 19 for the following transactions : (i) Taking or sending any security to any place outside India; (ii) Transfer of any security or creation or transfer of any interest in a security to or in favour of any nonresident; (iii) Issuing in India or outside, any security which is registered or to be registered in India to a non-resident; (iv) Acquiring, holding or disposing of any foreign security. When the holder of a security is the nominee of a non-resident, general or special permission of the Reserve Bank is necessary before he recognises or gives effect to the substitution of another person as the person from whom he directly receives instructions. For enforcing this provision, Reserve Bank may require all transferors and transferees of securities to declare that the transferee is not a non-resident. The mere offer of shares to a person by itself does not create any interest in the shares in favour of the person to whom the offer is made. Although such offer as observed by the Supreme Court, (AIR 1981 SC 1298 at 1348) creates fresh rights, such right is either to accept the offer or to renounce it and it does not create any interest in the shares in respect of which the offer is made. Permission of the Reserve Bank is necessary under sub-section (4) for registering transfer of securities where the transfer is suspected to involve contravention of Section 19. Further, recording an address outside India in respect of issue or transfer of security also requires such permission. Exemption is given for substitution of address in certain cases. This provision is binding on any registering authority notwithstanding any other law. Transfer of any share, bond or debenture of a company registered in India made by a non-resident or foreign national to a resident shall be valid only if such transfer is confirmed by the Reserve Bank on the application of transferor or transferee. It is open to the Reserve Bank to exempt any transfer or class of transfers from the operation of this provision in public interest by giving general or special permission. Any suitable conditions may be stipulated in this behalf. Bearer Securities Section 22 of the Act restricts the issue of bearer securities. Any person in India and any resident outside India requires the permission of the Reserve Bank to create or issue any bearer certificate or coupon or alter any document to become a bearer certificate or coupon.

Gifts and Settlements Settlement or gift of any property to a non-resident (at the time of such settlement) without the general or special permission of the Reserve Bank is prohibited under Section 24. However, settlement or gift without such permission is not invalid. Further, it is open to the Reserve Bank to exclude any territories from the operation of this section by notification. Holding of Immovable Property outside India Persons resident in India are prohibited under Section 25 from acquiring, holding or disposing of (by sale, mortgage, lease, gift, settlement or otherwise) any immovable property situated outside India except with the general or special permission of the Reserve Bank. This provision does not apply to (i) a lease for a period of upto five years and (ii) nationals of foreign states. General or special permission of the Reserve Bank is necessary under Section 26 for a resident to give guarantee in respect of any debt or other obligation or liability of a resident which is due or owing to a non-resident or the debt, obligation or liability of a non-resident. 7.8 APPOINTMENT OF AGENTS Under Section 28, the following persons require the general or special permission of the Reserve Bank to act or accept appointment as agent in India of any person or company in the trading or commercial transactions of such person or company. (i) Non-resident (whether citizen of India or not); (ii) Person who is not a citizen of India but is resident in India; (iii) Company which is not incorporated under the Indian Laws or any branch thereof. Acting or appointment as agent without such permission is void. ‘Agent’ includes any person or company (including its branch) who or which buys any goods with a view to selling such goods before any processing thereof. A banking company is excluded from the operation of this Section. (Banking Companies being subject to restrictions under B.R. Act). The Reserve Bank may conduct an inquiry before deciding on an application for permission under Section 28. It is also open to the Bank to allow the application imposing any conditions or to reject it. However, before rejecting any application the affected party should be allowed to make a representation. On rejection of an application for permission, acting or appointment as such agent is void after ninety days of receipt of the order or such other later date specified in the order. 7.9 ESTABLISHMENT OF PLACE OF BUSINESS Non residents and other persons referred to in Section 28 require the general or special permission of the Reserve Bank under Section 29(1) for various transactions as under : (i) To establish or carry on in India a place of business for carrying on trading, commercial or industrial activity;

(ii)

Acquiring the whole or any part of any undertaking in India of any person or a company carrying on trade, commerce or industry, or purchasing the shares of such company in India.

Further, under Sub-section (1A) of Section 29, a company other than a banking company, in which non-resident interest is more than 40% requires the general or special permission of the Reserve Bank to carry on any activity relating to agriculture or plantation in India. This restriction extends to acquisition by such company of the whole or any part of any undertaking in India of any person or company carrying on any activity relating to agriculture or plantation or purchasing the shares in such company. In Life Insurance Corporation vs. Escorts,(AIR 1986 SC 1370) the Supreme Court held that permission under Section 29(1) need not be previous permission in the context of purchase of shares of an Indian Company by non-resident companies. The court clarified that ex-post facto permission can also be granted. However, Reserve Bank is not bound to give ex-post facto permission when it is found that business has been started or shares have been purchased without its previous permission. Where oblique motives are suspected, permission can be refused and action can be initiated to punish the offender. It is also open to grant ex-post facto permission subject to conditions, for instance, that the purchaser shall not be entitled to repatriation benefits. In another case (AIR 1981 SC 1298) where the Reserve Bank granted permission to a company to carry on its business subject to dilution of non-resident interest in its equity capital to a level not exceeding 40% within a period of one year, the Supreme Court held that the permission would cease automatically if such dilution was not carried out within the stipulated period or any extended period. Hence the continuance of business after the stipulated period would be illegal unless the condition of dilution of non-resident equity was duly complied with. 7.10

EMPLOYMENT OF FOREIGN NATIONALS

Foreign nationals have to obtain prior permission of the Reserve Bank under section 30 of the Act to practice any profession or to carry on any occupation, trade or business in India, if they desire to acquire any exchange intended for remittance out of India from the earnings of such profession, occupation, trade or business. In order to obtain such permission, foreign nationals have to apply to the Reserve Bank in the prescribed form and manner. After making such enquiry as it deems fit, the Reserve Bank may allow the applications with or without conditions or may reject it after giving the applicant an opportunity for representation. Acquisition of Immovable Property in India Section 31 of FERA makes it mandatory for (i) persons who are not citizens of India; and (ii) companies which are not incorporated under any Indian law - to obtain prior general or special permission of the Reserve Bank to acquire or hold or transfer immovable property situated in India. This does not 57 (Sys 4) - D:\shinu\lawschool\books\module\contract law

apply to banking companies and also to lease transactions for a period of upto 5 years. Any person requiring a special permission in this regard, has to apply to the Reserve Bank. On receipt of such application RBI may conduct suitable inquiry and thereafter either allow it with or without conditions or reject it. As in other cases discussed earlier, before rejecting any application, the applicant has to be given an opportunity to represent his case. It further provided that unless such application is rejected within 90 days, grant of permission shall be presumed. The period spent by the Reserve Bank in giving the applicant an opportunity to be heard shall not be counted for the purpose. The Reserve Bank has no duty to give a hearing, to any person other than the applicant. (AIR Manual 4th Edn. Vol 19,p 543) 7.11 INFORMATION AND RETURNS

agent, or any partner direct or other officer on oath in relation to its business. Failure to comply with the requirements of the inspecting officer would amount to contravention of the provisions of the Act. These provisions apply to money changers also. 7.13 ISSUE OF DIRECTIONS AND EXCHANGE CONTROL MANUAL Reserve Bank is authorised under Section 73 to issue directions to authorised dealers, money changers and other persons for the purpose of securing compliance with the provisions of the Act and of any rules, directions or orders made thereunder. The directions of a standing nature made to authorised dealers, money changers, shipping and airlines companies etc. are contained in the Exchange Control Manual published by the Reserve Bank.

Persons owning foreign exchange, foreign securities or immovable properties held outside India have to submit returns thereof to the Reserve Bank, if so directed by the Central Government under Section 33 of the Act. Further, the Reserve Bank, Central Government and certain offices of enforcement are empowered to call for any information, or require production of any book or document in the possession of any person for examination. The Reserve Bank has also issued directions regarding various returns to be submitted by authorised dealers and others which are detailed in the Exchange Control Manual.

As observed by the Supreme Court, in Escorts case, (AIR 1986 SC 1370) this Manual is a compendium of various statutory direction, administrative instruction, advisory opinion, comments, notes, explanation, suggestion etc. Amendments to the directions are communicated in the form of circulars to authorised dealers or the other persons concerned. Section 73A provides for penalty for contravention of the direction of the Reserve Bank or for failure to file returns.

7.12 INSPECTION OF AUTHORISED DEALERS AND MONEY CHANGERS

Currency of a nation is fully convertible when the holder is free to convert any amount of his/her national currency into any other foreign currency. Indian Rupee is not totally convertible because citizens of the country cannot convert their rupee currency in any foreign currency without obtaining an approval from the RBI. But Indian rupee is made freely convertible in Balancing of Payment (BOP) account and in current account of the business establishments. As such, under this provision foreign currencies are avilable freely against Indian rupee to commerical establishments for import of goods and services as well as for foreign business trips, students, scholars and researchers.

Under Section 43 of the Act, a duly authorised officer of the Reserve Bank may inspect the books, accounts and other documents of an authorised dealer. Similar powers of inspection are also vested on the officers of Enforcement. The authorised dealer has to produce all the requisite books and documents and also furnish any statement or information relating to the affairs of the authorised dealer as may be required. The inspecting officer may also examine the authorised dealer, his

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7.14

RUPEE CONVERTIBILITY

8. PROMOTIONAL FUNCTIONS SUB-TOPIC 8.1 A brief account of promotional functions

8.1 A BRIEF ACCOUNT OF PROMOTIONAL FUNCTIONS Apart from the key central banking and regulatory functions, the Reserve Bank also undertakes several promotional functions. In the past the Bank has promoted several financial institutions with a view to achieving economic growth of the country according to the guidelines and policies of the Central Government. The Reserve Bank has undertaken the task of building up the co-operative credit structure in the country for making credit available to the rural sector which was neglected by the commercial banks. Steps were also taken to rationalise the policies adopted by the cooperative credit institutions. State governments were persuaded to establish state co-operative banks in states where they were not existing. Amalgamations of central co-operative banks were encouraged with a view to establishing a strong central bank for each district. Bank had also an active role in the reorganisation of primary societies by helping the state governments to formulate the norms of viability. Bank has also appointed several study teams and

committees with a view to strengthening the co-operative credit structure and also contributed to research and training in agricultural and rural credit. The erstwhile Agricultural Refinance and Development Corporation and the National Bank for Agriculture and Rural Development were established with the active support and assistance of the Reserve Bank. So is the case of Regional Rural Banks. The Bank has also had a promotional role in other areas of development as under: i) Establishment of bill market scheme. ii) Establishment of institutions for industrial credit like Industrial Development Bank of India, Industrial Reconstruction Corporation of India Ltd., Unit Trust of India etc. iii) Formulation of credit guarantee schemes for small scale industries and the establishment of Deposit Insurance and Credit Guarantee Corporation. iv) Formulation of export bills credit scheme and various other schemes for promotion of export credit facilities and the establishment of the Export Import Bank of India. Reserve Bank has also promoted several institutions for training and research in banking and related subjects. (SeeRBI, 1983, pp 172-77 & pp 244-77; See also Tannan, 1987, p 54)

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9. CASE LAW Bank of India v. Karnam Ranga Rao & others AIR 1986 Kant 242. A suit was instituted by the Bank of India (‘the bank’) which is the appellant for the recovery of Rs.30,564/- which was due and outstanding from the defendants 1 and 2 out of the loan of Rs.10,000/- granted to them for raising sugarcane crop. Defendant 3 guaranteed repayment of the loan by executing a letter of guarantee. The documents suggested that defendants 1 and 2 were liable to pay interest at the rate of 4 percent above the rate prescribed by the RBI subject to the minimum of 13 per cent with quarterly rates. However the Bank has charged only half yearly rates and also claimed at the same rate in the suit. Defendants admitted the loan taken, but denied their liability to pay interest with quarterly rates on the ground that the loan was for agricultural purpose & the Bank by the settled practice has no right to charge periodical compound interest. They also prayed for grant of instalments to repay the loan in five equal annual instalments. The following issues were framed by the trial court on the basis of the pleadings namely, i) Whether the plaintiff was not entitled to charge compound interest ? ii) Whether the defendants are entitled for five equal instalments? The trial court after considering the contentions urged and the documents produced held: “It has been well settled now that for agricultural loans in India, the conception of quarterly rate basis i.e., charging of compound interest does not apply. That being so, the plaintiff would not be entitled to charge compound interest on the loan amount advanced to the defendants 1 & 2....” With that conclusion, the court directed the Bank to submit a revised statement of accounts charging simple interest on the amount due. Accordingly, the Bank submitted a revised statement determining Rs.19,851.66 as the sum due from the defendants. The Court then decreed the suit for the said amount with future interest at 6 per cent payable in two annual instalments. The question raised by this appeal relates to the right of the Bank to charge compound interest on agricultural advances. The essential question to be decided by the court was whether the Bank was justified in charging interest with half yearly rates on the agricultural loan amount due and outstanding from the defendants. The court stated that in the present case, although the terms of the loan advanced to the respondents authorised the bank to charge interest with quarterly rates, the bank however, has charged interest only with half-yearly rates. The Counsel for the Appellant while justifying the interest charged with half 60 (Sys 4) - D:\shinu\lawschool\books\module\contract law

yearly rates also contended that the directives of the Reserve Bank impose no constrain on commercial banks from charging interest with periodical rates, quarterly or half yearly. On the contrary according to counsel it will be obligatory for banks to charge interest with quarterly or longer rates. In order to support his contention he depended upon the circulars/directives issued by the Reserve Bank relating to charging of interest on agricultural advances. The court held that the circulars/directives of the Reserve Bank direct that the agricultural advances should not be treated at par with the commercial loans in the matter of application of the system of compounding interest. The farmers do not have any regular source of income other than sale proceeds of their crops is an acknowledged fact. They get income generally only once a year. They are, therefore, not in a position to pay interest at usual fixed intervals like monthly, quarterly and half yearly. Banks should not charge compound interest on current dues. Banks should not also charge interest with monthly, quarterly or half yearly rates overdue agricultural loans. H.P. Krishna Reddy v. Canara Bank AIR 1985 Kant.228. The appellant was defendant against whom the respondent Canara Bank (the Bank) instituted the suit for recovery of a sum of Rs.23,940.97 with current interest at 13 per cent per annum on the following averments :On June 19, 1969 the defendant availed of a loan of Rs.15,500/ - on the security of immovable properties with the deposit of title deeds so as to create an equitable mortgage in favour of the Bank. In order to ensure prompt repayment of the loan the defendant also executed on Demand Promissory Note for a sum of Rs.15,500/- in favour of the Bank. On October 14, 1969, the defendant again availed of another loan of Rs.10,500/- by extending the said security & on executing another Promissory Note for a sum of Rs.10,500/-. The defendant also hypothecated his crops and live-stock by executing necessary agreements. In all, the defendant had taken Rs.26,000/- as loan from the Bank. The loan was not repaid as agreed on March 31, 1972. The defendant was found to owe the bank a sum of Rs.23,940.97 including interest at the rate of 13 per cent per annum. The defendant admitted the creation of equitable mortgage by deposit of title deeds of his property as security for the loan taken from the bank and also the execution of the Promissory notes, but denied the liability to pay interest at the rest of 13 per cent per annum. He also disputed the liability of charging higher rate of interest and the validity of the suit claim without furnishing the details of the aggregate interest charged. The trial court framed the following issues : 1) Whether the plaintiff has paid Rs.15,500/- to the defendant on the transaction of equitable mortgage of ‘A’ schedule properties ?

2) Whether the plaintiff has paid Rs.10,500/- on the hypothecation of C & D Schedule properties ? 3) Whether the plaintiff is entitled to claim interest at 13 per cent ? 4) Whether the accounts furnished by the plaintiff are correct? 5) Whether the defendant was liable only upto a sum of Rs.6,537.53 on both these transactions as on 17.12.1971 ?

the court below. The High Court stated that the Bank shall recalculate the interest on the advance given to the appellant at varied rates, but without quarterly rates and file a memo before this court. The Bank is entitled to 13 percent interest per annum from April 1, 1972 till the date of decree and thereafter at 6 per cent per annum till the date of realisation. The Bank should also give adjustment to payment, if any, made by the appellant after filing the suit.

After considering the evidence, the trial court determined all the above said issues in favour of the bank and finally decreed the suit in favour of the Bank.

Y. Jameela Beevi v. State Bank of Travancore (1992) 74 Comp. Cases 736.

The trial court held that the defendant should pay to the plaintiff a sum of Rs.23,940.97 together with costs and current interest at 13 percent per annum from April 1, 1972 to the date of decree and at 6 per cent per annum from the date of decree till payment, within a period of six months, failing which the amount due shall be recovered from such mortgaged properties & balance if any shall be recovered personally from the defendant. On appeal two points arose for consideration before the High Court : (1) Whether the court below was justified in awarding interest from April 1, 1972 to the date of the decree at 13 percent per annum on Rs.23,940-97; and (2) Whether the Bank is entitled to recover interest with quarterly rates? After hearing both sides the High Court observed that in a suit for recovery of money due under equitable mortgage and Promissory Note, the plaintiff bank has claimed interest at the rate of 13 per cent with quarterly rates as per rules of business, trade, usage and custom. But no evidence has been produced in proof of such trade practice, usage or custom. It produced a circular of the RBI issued on 17-8-1978 which in turn made a reference to an earlier circular dated 5-10-1974, which makes it clear that the banks have been precluded from receiving interest with quarterly rates on agricultural advances. The High Court held that under S.21A which was introduced in Banking Regulation Act by Banking Laws (Amendment) Act, 1983, the courts cannot exercise jurisdiction under the Usurious Loans Act or any other law relating to indebtedness for the purpose of giving relief to any party. This appears to be the intent of the Legislature in enacting the Amendment Act, 1983. S.21 A has, however, no bearing on the jurisdiction of courts to give relief to an aggrieved party when it is established that the Bank in a particular case has charged interest in excess of the limit prescribed by the RBI. Section 46(4) of the Banking Regulation Act confers power on the Reserve Bank to impose penalty for contravention of its order, rule, or direction. If, in any case, it is proved that the Bank has charged interest in violation of the direction of RBI, the court could give relief to the aggrieved party notwithstanding S.21A of the Banking Regulation Act. The interest charged beyond the rate prescribed by the Reserve Bank would be illegal & void. Therefore the claim of the Bank on quarterly rates on agricultural loans cannot be allowed. The High Court allowed the appeal & modified the decree of

The appellants under agreements obtained a loan from the respondent bank on the basis of a packing credit facility granted for the purpose of enabling export of cashewnuts. The agreements, in accordance with a Reserve Bank circular, provided that if export was made within 180 days of obtaining the loan, the rate of interest would be only 11% ; and that if the time was exceeded, the normal rate of 16% interest had to be paid. The trial court awarded interest to the bank at 16 percent. On appeal, the question before the High Court was whether the trial court was justified in awarding 16% interest or whether 11% alone ought to have been allowed. The Court held that concessions in the matter of interest are given in obedience to circulars issued by the RBI from time to time. The Circular directed concessional rate of interest only in cases where export was made within 180 days. In other cases, the banks were authorised to levy the normal rate of 16%. On the facts, the award of interest at 16% was justified. Pranab Kumar Ray & another v. Reserve Bank of India AIR 1993 Cal.50. A writ petition challenging the validity of the decision of the RBI rejecting the request of the petitioner to release foreign exchange for his son for prosecuting LL.B(Hons) course at the University of Leeds in United Kingdom. The issue involved was whether the disclosure of the policy guidelines contained in the book of Instructions of the RBI relating to release of Foreign exchange for LL.B Course leading to Honours degree at Cambridge/Oxford Universities only justified the action of the RBI. The Court held that the classification made by RBI in favour of the Oxford and Cambridge Universities Vis-a-Vis other Universities of the same country is quite unreasonable and discriminatory and violative of Art.14 of the Constitution and accordingly, illegal & void. It must be examined whether there is any rational & proximate nexus between the object of FERA and the condition imposed by the RBI in this particular case. The object of FERA was to conserve & direct to the best uses, the limited supplies of the country’s foreign exchange and to control transaction in-foreign exchange, securities & gold. The whole idea was to see that the country’s foreign exchange resources were not wasted under any circumstances and were properly utilised to advance the national interest. In the instant writ application, the above principle has no rational or proximate nexus. Here the Foreign exchange has been asked to be utilised properly for the advancement of national interest by way of 61 (Sys 4) - D:\shinu\lawschool\books\module\contract law

prosecution of studies in the University of Leeds and not for wasting the Foreign exchange for any other purpose. The authorities are working against the best interests of the country. V.T. Khanzode & others v. Reserve Bank of India & others AIR 1982 SC 917. The decision of the Reserve Bank of India introducing Common seniority and intergroup mobility amongst different grades of officers belonging to Group I (Section A), Group II and Group III was challenged. That decision was contained in Administrative circular and also in office order and had been acted upon in the draft combined seniority list of officers in Grade ‘B’ and in Grades ‘C’, ‘D’, ‘E’ and ‘F’. The contention of the petitioners was that the aforesaid circular, office order and combined seniority list are violative of their fundamental rights under Arts. 14 and 16 of the Constitution and are also ultra vires the power, jurisdiction and competence of the Reserve Bank of India, being without the authority of law and in contravention of the provisions of the Reserve Bank of India Act 1934. Upholding the decision of RBI, the Supreme Court observed that this system of grouping had many drawbacks bearing on the promotional opportunities of offficers in the various groups. To mention but a few, the drawbacks were (i) Unequal size of one group as compared to another (ii) Uneven expansion in one group as compared to another, and (iii) Earlier confirmations of officers in one group as compared to those in another. Various Departments of the Reserve Bank were grouped and regrouped from time to time. Such adjustments in the administrative affair of the Bank are a necessary sequel to the growing demands of new situations which are bound to arise in any developing economy. The group system has never been a closed or static chapter and it is wrong to think that the officers of the various groups were kept in quarantine. The group system has been a continuous process of trial and error and the scheme of intergroup mobility has emerged as the best solution out of the experience of the past. Combined seniority has been recommended by two special committees, whose reports reflect the expertise and objectivity which was brought to bear on their sensitive task. It is clear that intergroup mobility and common seniority are a safe and sound solution to the conflicting demands of officers belonging to Group I on one hand and those of Groups II and III on the other. No scheme governing service matters can be fool-proof and some section or the other of employees is bound to feel aggrieved on the score of its expectations being falsified or remaining to be fulfilled. But the fact that the scheme does not satisfy the expectations of every employee does not render it arbitrary, irrational, perverse or malafide. Combined seniority has emerged as the most acceptable solution as a matter of administrative, historical & functional necessity.

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Peerless General Finance & Investment Co. Ltd v. Reserve Bank of India AIR 1992 SC 1033. In this case Residuary Non-Banking Companies (Reserve Bank) Directions of 1987 issued by Reserve Bank of India under Secs 45-K(3) 45-J, & 45(2) of the Reserve Bank of India Act, 1934 providing for manner in which the deposits received by the residuary non-banking companies are to be deposited by them and manner in which such deposits are to be disclosed in balance sheet or books of accounts of the Company, were challenged. The Court held that the Reserve Bank was authorised to issue the impugned directions of 1987. A very wide power is given to the Reserve Bank of India to issue directions in respect of any matters relating to or connected with the receipt of deposits. It cannot be considered as a power restricted or limited to receipt of deposits. It cannot be said that under this power the Reserve Bank would only be competent to stipulate that deposits cannot be received beyond a certain limit or that the receipt of deposits may be linked with the capital of the Company. Such an interpretation would be violating the language of S.45K(3) which furnishes wide powers to the Reserve Bank to give any directions in respect of any matters relating to or connected with the receipt of deposits. The Reserve Bank under this provision is entitled to give directions with regard to the manner in which the deposits are to be invested and also the manner in which such deposits are to be disclosed in the balance sheet or books of accounts of the Company. The directions of 1987 are fully covered under S.45k(3) of the Act which gives power to the Reserve Bank to issue such directions. Srinivasa Enterprises & Others v. Union of India etc AIR 1981 SC 504. The Prize Chits Money Circulation Schemes (Banning Act) 1978 (Act 43 of 1978) was challenged on the ground that ‘Categories exempted under Sec.11 of the said Act spell out discriminatory treatment & therefore violative of Art.14 of the Constitution. The Court stated that a bare reading of Sec.11 makes it clear that the exempted categories do not possess the vices of private prize chits. For one thing, what are exempted are prize chits and money circulation schemes promoted by or controlled by the State-Governments, the Central Government or the State Bank of India or the Reserve Bank of India. Even Rural Banks and Co-operatives covered by Sec.11, are subject to public control. Likewise, Charitable and educational institutions are exempted only if they are notified by the State Government in consultation with the Reserve Bank. There are enough arguments to justify the different classification of these items and their exemption cannot be called in question on the ground of violation of Art. 14. Reasonable classification wins absolution from the charge of discrimination if the differentia has a nexus with the statutory object.

10. PROBLEMS 1. Paul Foundation Ltd. indented to import from a German firm some raw materials for its fibre glass factory at Kanpur and kept 200% deposit with the Bank of Karad as per the guidelines of RBI. After the arrival of goods, the Company asked the Bank of karad to pay for the same which was done. Then, the Company asked for refund of the balance amount. But, in the meanwhile, the Bank was put under a liquidator and the liquidator refused to pay the balance on the plea that the unutilised portion was part of the general assets of the bank available for distribution in the winding up. The Company files a suit for the refund of the money. Decide. Give reasons and refer to cases already decided on the issue, if any. 2a. Has any person got a right to get refund for soiled and mutilated notes ? If not, is any amount payable at all in respect of such notes ? (Ans: Section 28 RBI Act, RBI (Note Refund) Rules, 1975) 2b. Are bank notes promissory notes ? If so, why are they not stamped ? (Ans: Section 4 NI Act, Section 29, RBI Act)

2c. Does the Reserve Bank pay interest for money kept in deposit with it ? Are there any provisions for commercial banks to get loans from Reserve Bank ? 3. Who manages public debt of the Government ? What are the obligations of Reserve Bank in the matter ? (Ans: Sections 20, 21A, RBI Act, and also see Public Debt Act, 1944) 4a. What are the restrictions on acceptance of deposits by individuals and firms ? What is RBI’s role? (Clue: Chapter III C RBI Act, Sections 45R, 45S & 45T of RBI Act) 4b. Does the RBI control acceptance of deposits by companies? What are the methods of control ? (Clue: Sections 45J, 45L & 45 N of RBI Act; Section 58A of Companies Act 1956; Companies (Acceptance of Deposits) Amendment Rules, 1987; and notifications given by Department of Financial Companies, RBI, Calcutta) 4c. What is the extent of Government control over acceptance of deposits by companies ? (Clue: As above)

[Specify your name, ID No. and address while sending answer papers]

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11. BIBLIOGRAPHY LIST OF BOOKS AND CASES REFERRED 1. RBI, “Reserve Bank of India - functions and working”, 4th Edn., 1983. 2. RBI, “Exchange Control Manual”, 3rd Edn., 1987. 3. Tannan M.L. "Banking law and Practice in India”, 18th Edn., 1989. Orient Law House, New Delhi. 4. A. Ramaiya, “Guide of Companies Act”, 11th Edn., 1988, Wadhwa and Co., Nagpur. 5. RBI, “Uniform Regulations and Rules for Bank’s Clearing Houses”. 6. AIR Manual, 4th Edn., Vol.19. 7. “RBI General Regulations”, 1949.

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Master in Business Laws Banking Law Course No: II Module No: III

LAW OF BANKING REGULATIONS

Distance Education Department

National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 080-3217858 E-mail: [email protected] 65 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Materials Prepared By: 1. Mr. Harihar Aiyyar LL.M. General Manager (Retd) SBI. Materials Checked By: 1. Ms. Archana Kaul LL.M. 2. Ms. Sudha Peri LL.M. Materials Edited By: 1. Prof. N.L. Mitra M.Com., LL.M., Ph.D. 2. Prof. P.C. Bedwa LL.M., Ph.D.

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LAW OF BANKING REGULATIONS

TOPICS 1.

Regulation of Banking Operations ...............................................................................

68

2.

Licensing of Banking Activities ....................................................................................

78

3.

Capital, Reserve and Liquid Asset Requirements ......................................................

82

4.

Restrictions on Loans and Advances ............................................................................

88

5.

Regulation on Managerial Organs ...............................................................................

92

6.

Amalgamation and Reconstruction ..............................................................................

96

7.

Accounts and Audit ........................................................................................................

101

8.

Powers of Reserve Bank ................................................................................................

104

9.

Other Powers of Central Government .........................................................................

107

10.

Winding up of Banking Companies ..............................................................................

111

11.

Case Law .........................................................................................................................

115

12.

Problems..........................................................................................................................

117

13.

Supplementary Readings ...............................................................................................

118

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1. REGULATION OF BANKING OPERATIONS SUB-TOPICS 1.1 Introduction 1.2 Social control and its mechanism 1.3 Narasimham Committee Report : A brief outline 1.4 Concluding remarks 1.1 INTRODUCTION The preamble to the Banking Companies Act,1949 (name of the Act changed to Banking Regulation Act with effect from 1.3.1966)states that the Act was passed to consolidate and amend the law relating to banking.The need for the consolidation was felt owing to the absence of measures to safegaurd the interests of the depositors,and the abuse of powers by persons who controlled some of the banks. The Act is regulatory, meant to regulate the functioning of the banking companies and corporations. It is not a legislation to codify the law relating to Banking. Section 2 of the Act states that the provisions of this Act shall be in addition to, and not, save as hereinafter expressly provided, in derogation of the Companies Act 1956 and any other law for the time being in force. The years 1968, 1969 and 1980 witnessed three major events :(i) Social control on banking companies imposed through Act 58 of 1968. This was an amending Act to the Banking Regulations Act 1949 and it came into effect from 01.02.69. (ii) The nationalisation of 14 major Banks with effect from 19.07.69 by the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970. (iii) Further nationalisation of 6 major Banks under the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980. 1.2 SOCIAL CONTROL AND ITS MECHANISM The Preamble of Act 58 of 1968 states “An act further to amend the Banking Regulation Act, 1949, so as to provide for the extension of social control over banks and for matters connected therewith or incidental thereto. The political situation prevailing in and around 1967 led to the expression ‘social control’ in relation to banks and banking companies. Mismanagement of the banks coupled with the allegations that a large chunk of the bank loans were sanctioned to the large and medium scale industries, and big and established business and industrial houses in which the management had vested interest compelled the government to effect these social control measures. In addition, complaints that sectors such as small scale industries, agriculture and exports were neglected by the commercial banks also led the government in this direction. Allegations that the bank directors, who were mostly industrialists directed the Bank credit to companies in which 68 (Sys 4) - D:\shinu\lawschool\books\module\contract law

they had substantial interests, and that they influenced the banks to grant such advances in an indiscrete manner compelled the government to bring in social control measures. The government at that point of time and particularly, Shri Morarjee Desai who was then the Dy. Prime Minister of India holding charge of the Finance Ministry had no intention to nationalise the Banks. But at the same time the government wanted to impose such restrictions and controls over the banking industry, which would determine the priorities of lending and investment and those that would evolve appropriate guidelines for the management and promote a reorientation of the decision making machinery of the banks. The government also did not desire to leave any opportunity in the hands of the management and directors to mismanage the affairs of banks. The proposals evolved to achieve these goals were termed as ‘social control’. The Deputy Prime Minister made a statement in the Lok Sabha on 14.12.1967, declaring the views of the government and how the government proposed to impose the ‘social control’. The two steps taken in this direction were _ 1. setting up of a National Credit Council (N.C.C) and 2. introducing legislative control on the banks by suitable amendments to the Banking Regulation Act. The National Credit Council now stands dissolved since the nationalisation of the banks. Towards achieving the second goal, the government passed Act 58 of 1968 which introduced radical amendments to certain provisions of the Banking Regulation Act. The Preamble to the amending Act states “to provide for the extension of social control over the Banks”. The mechanism to achieve the social control, by introducing additional controls and instructions can be summarised as under: I. Section 10 A to the Banking Regulation Act states that the Board of directors was to include persons with professional or other experience. This amendment was aimed to reduce the predominance of the industrialists as Directors of a bank. Not less than 51% of the total number of members of the Board of Directors of the banking company shall consist of persons, who_ a) shall have special knowledge of, or practical experience in respect of one or more of the following matters, viz, 1. accountancy 2. agriculture and rural economy 3. banking 4. co-operation 5. economics 6. finance 7. law 8. small scale industry 9. any other matter the special knowledge of and practical experience in which would in the opinion of the Reserve Bank of India, be useful to the banking company. The Proviso to the Section lays down that out of the aforesaid number of directors, not less than two shall be persons having

special knowledge or practical experience in respect of agriculture or rural economy, co-operation or small scale industry; and b) shall not 1) have substantial interest in or be connected with, whether as employee or manager, or managing agent of any company, not being a company registered under the Companies Act or any firm which carries on any trade, commerce or industry and which in either case, is not a small scale industrial concern or 2) be proprietors of any trading, commercial or industrial concern not been of a small scale industrial concern. By Act No I of 1984 further restrictions were imposed restricting the tenure of office of a director for a period of eight years, other than that of the Chairman or whole time Director. This amendment also restricts the appointment as a director of a person who was removed from the position of a Chairman or whole time Director of a Bank. Such persons who have been removed by the Reserve Bank of India cannot be co-opted or elected as director of a Bank for a period of 4 years from their date of removal. The added sub-section 2A also made provisions for the reconstitution of the Board so that the provision of Section 10A is complied with at all times. The new sub section also confers sweeping powers to the Reserve Bank of India to reconstitute the Board. II. Section 10B of the amended Act lays down for the management of the affairs of a banking company by a wholetime Chairman, who has special knowledge of and practical experience in the working of a bank, or is a specialist in finance, economics or business administration. The effect of this new section is to curb the encroachment of industrialists over experts. III. Section 20 of the Act places restrictions on loans and advances by a banking company to its directors or to a company or a firm in which a director is substantially interested or to an individual for whom a director is a guarantor. IV. Additional powers were conferred on the Reserve Bank of India to enforce and supervise the social control V. a) b) c)

Punishment for the following was provided obstructing any person from entering or leaving a bank ; holding demonstrations within the bank;and acting to undermine the depositors’ confidence in a bank.

sectors demanding priority such as agriculture, small scale industries and exports were not securing their due share. Hence the Banking Regulation Act was amended. Steps were initiated in 1969 to amend the Banking Regulation Act to impose social controls with a view to remedy the basic weakness of the Indian banking system and to ensure that the banks would cater to the needs of the neglected sectors of economy. It was felt that the social control measures had not changed the position substantially as there were still complaints that the commercial banks were continuing to direct their advances to large and medium scale industries. On 19th July 1969 14 major Banks, each having a deposit of more than 50 crores were nationalised and taken over as undertakings of the Government of India. This revolutionary measure did not merely signify a change of the ownership of the Banks, but it was the beginning of a co-ordinated endeavour to use an important part of the financial mechanism for the country’s economic development. The critics of nationalisation argued that the social control on banks should have been given a fair chance and trial for its success. It was also argued that in line with the performance of other public sector undertakings, inefficiency and nepotism would creep in the banking industry. On 15th April 1980 six more Banks having demand and time liabilities of not less than Rs.200 crores were nationalised. The undertakings of these Banks were transferred to six corresponding new banks under the Banking Companies (Acquisition and Transfer of Undertakings) Act of 1980. The Nationalised banks have definitely functioned to achieve the goal of economic development. The Reserve Bank of India and the Government of India acquired draconian powers under the Acts. However the concept of mass banking - a change from class banking, the directed lending policy, and subsidised bank lending over a period of time has resulted in many of these banks making losses, and becoming inefficient and incompetent. To camouflage the public, the asset classifications became illusory. The Reserve Bank of India and the government under the dictates of the I.M.F and the World Bank brought in the prudential norms of asset classification as some of the nationalised banks became weak and sick and merger of the weaker and stronger banks started. 1.3 NARASIMHAM COMMITTEE REPORT : A BRIEF OUTLINE

VI. Special powers of Central Government to acquire undertakings of a banking company when it is satisfied on a report from the Reserve Bank of India that the banking company has committed certain defaults and that it is necessary to do so.

The social control measures should be analysed with reference to the recent economic changes. A high power committee under the chairmanship of Shri.M.Narasimham was constituted to recommend ways and means.

As already stated the prime reason to introduce the social control measures was that there were complaints that the Indian commercial banks were directing their advances to large and medium scale industries and big business houses and that the

The terms of reference of the Committee were as follows :i) to examine the existing structure of the financial system and its various components and to make recommendations for improving the efficiency and effectiveness of the system 69 (Sys 4) - D:\shinu\lawschool\books\module\contract law

with particular reference to the economy of operations, accountability and profitability of the commercial banks and financial institutions ; ii) to make recommendations for improving and modernising the organisational systems and procedures as well as managerial policies ; iii) to make recommendations for infusing greater competitive vitality into the system so as to enable the banks and financial institutions to respond more effectively to the emerging credit needs of the economy; iv) to examine the cost, composition and adequacy of the capital structure of the various financial institutions and to make suitable recommendations in this regard ; v) to review the relative roles of the different types of financial institutions and to make suitable recommendations in this regard ; vi) to review the existing supervisory arrangements relating to the various entities in the financial sector, in particular the commercial banks and the term lending institutions and to make recommendations for ensuring appropriate and effective supervision ; vii) to review the existing legislative framework and to suggest necessary amendments for implementing the recommendations that may require legislative change ; and viii)to make recommendations on any other subject matter as the Committee may consider germane to the subject of enquiry or any related matter which may be specifically referred to the Committee by the government of India. The Committee submitted the summary of its Report on November 8, 1991 and its main Report on November 16, 1991 to government. The full text of the summary of the Report is reproduced below : 1. The Committee’s approach to the issue of financial sector reform is to ensure that the financial services industry operates on the basis of operational flexibility and functional autonomy with a view to enhancing efficiency, productivity and profitability. A vibrant and competitive financial system is also necessary to sustain the ongoing reform in the structural aspects of the real economy. We believe that ensuring the integrity and autonomy of operations of banks and DFIs is by far the more relevant issue at present than the question of their ownership. 2. The Indian banking and financial system has made commendable progress in extending its geographical spread and functional reach. The spread of the banking system has been a major factor in promoting financial intermediation in the economy and in the growth of financial savings. The credit reach also has been extensive and banking system now caters to several million borrowers especially in agriculture and small industry. The DFIs have established themselves as a major institutional support for investment in the private sector. The last decade has witnessed considerable diversification of money and capital 70 (Sys 4) - D:\shinu\lawschool\books\module\contract law

markets. New financial services and instruments have appeared on the scene. 3. Despite this commendable progress serious problems have emerged as reflected in a decline of the profitability of the banking sector. The major factors responsible for these are : (a) directed investments ; and (b) directed credit programmes. In both these cases, rates of interest that were available to banks were less than the market related rates or what they could have secured from alternate deployment of funds. There has been a deterioration in the quality of the loan portfolio which in turn has come in the way of banks income generation and enhancement of their capital funds. Inadequacy of capital has been accompanied by inadequacy of loan loss provisions. The accounting and disclosure practices also do not always reflect the true state of affairs of banks and financial institutions. The erosion of profitability of banks has also emanated from the side of expenditure as a result of fast and massive expansion of branches, many of which are unremunerative especially in the rural areas, a considerable degree of overmanning especially in the urban and metropolitan centres and inadequate progress in updating work technology. Both management weaknesses and trade union pressures have contributed to this. There have also been weaknesses in the internal organisational structure of the banks, lack of sufficient delegation of authority and inadequate internal controls and deterioration in what is termed ‘housekeeping’ such as balancing of books and reconciliation of interbranch and inter-bank entries. The DFIs also suffer from the degree of portfolio contamination. This is more pronounced in the case of SFCs. Being smaller institutions the internal organisational problems of the DFIs have been less acute than those of the banks. However, both banks and the DFIs have suffered from excessive administrative and political interference in individual credit decision making and internal management. The deterioration in the financial health of the system has reached a point where unless remedial measures are taken soon, it could further erode the real value of and return on the savings entrusted to them and even have an adverse impact on depositor and investor confidence. This diagnosis of the problem indicates the lines of solution which the Committee proposes with a view as much to improving the health of the system as for making it an integral part of the ongoing process of economic reforms. 4. The Committee is of the view that the SLR instrument should be deployed in conformity with the original intention of regarding it as a prudential requirement for financing the public sector. In line with Government’s decision to reduce the fiscal deficit to a level consistent with macroeconomic stability, the Committee recommends that the SLR be brought down in a phased manner to 25 per cent over a period of about five years, starting with some reduction in the current year itself. 5. As regards the cash reserve ratio [CRR], the Reserve Bank should have the flexibility to operate this instrument to serve

its monetary policy objectives. The Committee believes that given the Government’s resolve to reduce the fiscal deficit, the occassion for the use of cash reserve ratio to control the secondary expansion of credit should also be less. The Committee accordingly proposes that the Reserve Bank consider progressively reducing the cash reserve ratio from its present high level. With the deregulation of interest rates there would be more scope for the use of open market operations by the Reserve Bank with correspondingly less emphasis on variations in the cash reserve ratio. 6. The Committee proposes that the interest rates paid to banks on their SLR investments and on CRR in respect of impounded deposits above the basic minimum should be increased. As discussed later, the rates on SLR investments should be progressively market related while that on cash reserve requirement above the basic minimum should be broadly relating to the bank’s average cost of deposits. However, during the present regime of administered interest rates, this rate may be fixed at the level of the bank’s one year deposit rate. 7. With respect to directed credit programmes, the Committee is of the view that they have played a useful purpose in extending the reach of the banking system to cover sectors which were neglected hitherto. Despite considerable unproductive lending there is evidence that the contribution of bank credit to growth of agriculture and small industry has made an impact. This calls for some re-examination of the present relevance of directed credit programmes at least in respect of those who are able to stand on their own feet and to whom the directed credit programmes with the element of interest concessionality that has accompanied it has become a source of economic rent. The Committee recognises that in the last two decades banking and credit policies have been deployed with a redistributive objective. However, the Committee believes that the pursuit of such objectives should use the instrumentality of the fiscal rather than the credit system. Accordingly, the Committee proposes that the directed credit programmes should be phased out. This process of phasing out would also recognise the need that for some time it would be necessary for a measure of special credit support through direction. The Committee therefore, proposes that the priority sector be redefined to comprise the small and marginal farmer, the tiny sector of industry, small business and transport operators, village and cottage industries, rural artisan, and other weaker sections. This credit target for this redefined priority sector should henceforth be fixed at 10 per cent of aggregate credit which would be broadly in line with the credit flows to these sectors at present. The Committee also proposes that a review may be undertaken at the end of three years to see if directed credit programmes need to be continued. As regards medium and large farmers, and the larger among small industries, including transport operators, etc., who would not now constitute part of the redefined priority sector, the Committee proposes that to further encourage banks to provide credit to these erstwhile

constituents of the priority sector, the Reserve Bank and other refinancing agencies institute a preferential refinance scheme in terms of which incremental credit to these sectors would be eligible for preferential refinance subject to normal eligibility criteria. 8. The Committee is of the view that the present structure of administered interest rates is highly complex and rigid. This is so in spite of the recent moves towards deregulation. The Committee proposes that interest rates be further deregulated so as to reflect emerging market conditions. At the same time, the Committee believes that a reasonable degree of macro-economic balance through a reduction in the fiscal deficit is necessary for successful deregulation of interest rates. Premature moves to market determined interest rates could, as experience abroad has shown, pose the danger of excessive bank lending at high nominal rates to borrowers of dubious credit-worthiness, eventually creating acute problems for both the banks as well as the borrowers. Accordingly, the Committee recommends that for the present, interest rates on the bank deposits may continue to be regulated, the ceilings on such rates being raised as the SLR is reduced progressively as suggested by us earlier. Similarly, the interest rate on Government borrowing may also be gradually brought in line with market-determined rates which would be facilitated by the reduction in SLR. Meanwhile, the Committee would recommend that concessional interest rates would bear a broad relationship to the Bank rate which should be used as an anchor to signal the Reserve Bank’s monetary policy stance. It would be desirable to provide for what may be called a prime rate, which would be the floor of the lending rates of banks and DFIs. The spreads between the bank rate, the bank deposit rates, the Government borrowing rates and the prime rate may be determined by the RBI broadly in accordance with the criteria suggested by the Chakravarthy Committee so as to ensure that the real rates of interest remain positive. 9. The inadequacy of capital in the banking system is a cause for concern. While progress towards BIS norms is desirable, the Committee recognises that this will have to be phased over time. The Committee suggests that the banks and financial institutions should achieve a minimum 4 per cent capital adequacy ratio in relation to risk weighted assets by March 1993, of which Tier 1 capital should not be less than 2 percent. The BIS standards of 8 per cent should be achieved over the period of the following 3 years, that is, by March 1996. For those banks with an international presence it would be necessary to reach these figures even earlier. 10. The Committee believes that in respect of those banks whose operations have been profitable and which enjoy a good reputation in the markets, they could straight-away approach the capital market for enhancement of their capital. The Committee, therefore, recommends that in respect of such banks, issue of fresh capital to the public 71 (Sys 4) - D:\shinu\lawschool\books\module\contract law

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through the capital market should be permitted. Subscribers to each issues could include mutual funds, profitable public sector undertakings and employees of the institutions besides the general public. In respect of other banks, the Government could meet the shortfall in their capital requirements by direct subscription to capital or by providing a loan which could be treated as subordinate debt. Before arriving at the capital adequacy ratio for each bank, it is necessary that the assets of the banks be evaluated on the basis of their realisable values. The Committee proposes that the banks and financial institutions adopt uniform accounting practices particularly in regard to income recognition and provisioning against doubtful debts. There is need also for adopting sound practices in regard to valuation of investments on the lines suggested by the Ghosh Committee on Final Accounts. In regard to income recognition the Committee recommends that in respect of banks and financial institutions which are following the accrual system of accounting, no income should be recognised in the accounts in respect of nonperforming assets. An asset would be considered nonperforming if interest on such asset remains past due for a period exceeding 180 days at the balance sheet date. The Committee further recommends that banks and financial institutions be given a period of three years to move towards the above norms in a phased manner beginning with the current year. For the purpose of provisioning, the Committee recommends that, using the health code classification which is already in vogue in banks and financial institutions, the assets should be classified into four categories namely, Standard, Sub-standard, Doubtful and Loss Assets. In regard to Sub-Standard Assets, a general provision should be created equal to 10 per cent of the total outstandings under this category. In respect of Doubtful Debts, provision should be created to the extent of 100 percent of the security shortfall. In respect of the secured portion of some Doubtful Debts, further provision should be created, ranging from 20 percent to 50 percent, depending on the period for which such assets remain the doubtful category. Loss Assets should either be fully written off or provision be created to the extent of 100 percent. The Committee is of the view that a period of 4 years should be given to the banks and financial institutions to conform to these provisioning requirements. The movement towards these norms should be done in a phased manner beginning with the current year. However, it is necessary for banks and financial institutions to ensure that in respect of doubtful debts 100 per cent of the security shortfall is fully provided for in the shortest possible time. The Committee believes that the balance sheets of banks and financial institutions should be made transparent and full disclosures made in the balance sheets as recommended by the International Accounting Standards Committee. This should be done in a phased manner commencing with the

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current year. The Reserve Bank, however, may defer implementation of such parts of the standards as it considers appropriate during the transitional period until the norms regarding income recognition and provisioning are fully implemented. 15. The Committee suggests that the criteria recommended for non-performing assets and provisioning requirements be given due recognition by the tax authorities. For this purpose, the Committee recommends that the guidelines to be issued by the Reserve Bank of India under Section 43 D of the Income Tax Act should be in line with our recommendations for determination of non-performing assets. Also, the specific provisions made by the banks and institutions in line with our recommendations should be made permissible deductions under the Income Tax Act. The Committee further suggests that in regard to general provisions, instead of deductions under Section 36(1) (viia) being restricted to 5 per cent of the total income and 2 per cent of the aggregate average advances by rural branches, it should be restricted to 0.5 per cent of the aggregate average non-agricultural advances and 2 per cent of the aggregate average non-agricultural advances and 2 percent of the aggregate average advances by rural branches. This exemption should also be available to banks having operations outside India in respect of their Indian assets, in addition to the deductions available under Section 36(1)(viii). 16. Banks, at present, experience considerable difficulties in recoveries of loans and enforcement of security charged to them. The delays that characterise our legal system have resulted in the blocking of a significant portion of the funds of banks and DFIs in unproductive assets, the value of which deteriorate with the passage of time. The Committee, therefore, considers that there is urgent need to work out a suitable mechanism through which the dues to the credit institutions could be realised without delay and strongly recommends that Special Tribunals on the pattern recommended by the Tiwari Committee on the subject to set up to speed up the process of recovery. The introduction of legislation for this purpose is long overdue and should be proceeded with immediately. 17. While the reform of accounting practices and the creation of Special Tribunals are essential, the Committee believes that an arrangement has to be worked out under which part at least of the bad and doubtful debts of the banks and financial institutions are taken off the balance sheet so that the banks could recycle the funds realized through this process into more productive assets. For this purpose, the Committee proposes for establishment, if necessary by special legislation, of an Assets Reconstruction Fund (ARF) which could take over from the banks and financial institutions a portion of the bad and doubtful debts at a discount, the level of discount being determined by independent auditors on the basis of clearly stipulated guidelines. The ARF should be provided with special

powers of recovery somewhat broader than those contained in Sections 29-32 of the State Financial Corporation’s Act 1951. The capital of the ARF should be subscribed by the public sector banks and financial institutions. 18. It is necessary to ensure that the bad and doubtful debts of the banks and financial institutions are transferred to the ARF in a phased manner to ensure smooth and effective functioning of the ARF. To begin with all consortium accounts where more than one bank or institution is involved should be transferred to the ARF. The number of such accounts will not be large but the amounts involved are substantial to make a difference to the balance sheet of banks. Gradually, depending on the progress achieved by the ARF, other bad and doubtful debts could be transferred over time. Meanwhile banks and institutions should pursue recovery through the Special Tribunals. Based on the valuation given in respect of each asset by a panel of at least two independent auditors, the ARF would issue bonds to the concerned institution carrying an interest rate equal to the Government bond rate and repayable over a period of 5 years. These bonds will need to be guaranteed by the Government of India and should be treated as qualifying for SLR purposes. The advantage to banks of this arrangement would be that their bad and doubtful debts would be off their books though at a price but they would have in substitution of these advances bonds upto the discounted value with a certainty of interest income which would be an obviously important aspect from the point of view of income recognition, and further by making these bond holdings eligible for SLR purposes, banks’ fresh resources could become available for normal lending purposes. We wish to emphasise that this proposal should be regarded as an emergency measure and not as a continuing source of relief to the banks and DFIs. It should be made clear to the banks and financial institutions that once their books are cleaned up through this process, they should take normal care and pay due commercial attention in loan appraisals and supervision and take adequate provisions for assets of doubtful realisable value. 19. Selling these assets to the Fund at a discount would obviously mean an obligation on the banks/DFIs to write off these losses which many of them are in no position to do now, given their weak capital position. We propose that to enable the banks to finance the write off represented by the extent of the discount, the Government of India would, where necessary, provide, as mentioned earlier a subordinated loan counting for capital. As far as the Government of India itself is concerned, we believe that the rupee counterpart of any external assistance that would be available for financial sector reform could be used to provide this type of capital to the banks and DFIs. 20. The ARF would be expected to deal with those assets which are in the process of recovery. In respect of sick units which are under nursing or rehabilitation programmes, it is necessary to work out a similar arrangement to ensure

smooth decision making and implementation in respect of such nursing programmes. The Committee recommends that in respect of all such consortium accounts which are under a nursing programme or in respect of which rehabilitation programmes are in the process of being worked out, the concerned lead financial institution and/or lead commercial bank should take over the term loan and working capital dues respectively from other participating institutions and banks. Such acquisitions should be at a discount based on the realisable value of the assets assessed by a panel of at least two independent auditors as in the case of transfer of assets to ARF. 21. In regard to the structure of the banking system, the Committee is of the view that the system should evolve towards a broad pattern consisting of : (a) 3 or 4 large banks (including the State Bank of India) which could become international in character ; (b) 8 to 10 national banks with a network of branches throughout the country engaged in ‘universal’ banking ; (c) local banks whose operations would be generally confined to a specific region ; and (d) rural banks (including RRBs) whose operations would be confined to the rural areas and whose business would be predominantly engaged in financing of agriculture and allied activities. The Committee is of the view that the move towards this revised system should be market driven and based on profitability considerations and brought about through a process of mergers and acquisitions. 22. The Committee is of the view that the structure of rural credit will have to combine the local character of the RRBs and the resources skills and organisational/managerial abilities of the commercial banks. With this end in view the Committee recommends that each public sector bank should set up one or more rural banking subsidiaries, depending on the size and administrative convenience of each sponsor bank, to take over all its rural branches and, where appropriate, swap its rural branches with those of other banks. Such rural banking subsidiaries should be treated on par with RRBs in regard to CRR/SLR requirements and refinance facilities from NABARD and sponsor banks. The 10 per cent target for directed credit which we have recommended as a transitional meausure should be calculated on the basis of the combined totals of the parent banks and their subsidiaries. The Committee proposes, that while RRBs should be allowed to engage in all types of banking business, their focus should continue to be to lend to the target groups to maintain at a minimum the present level of their lending to these groups. With a view to improving the viability of their operations, the Committee proposes that the interest rate structure of the RRBs should be in line with those of the commercial banks. The Committee would leave the option open to the RRBs 73 (Sys 4) - D:\shinu\lawschool\books\module\contract law

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and their sponsor banks as to whether the RRBs should retain identity so that their focus on lending to the target groups is not diffused or where both the RRBs and the sponsor banks wish to do so they could be merged with the sponsor banks and the sponsor banks in such cases should take over as 100 per cent subsidiaries by buying out the shares from other agencies at a token price, and eventually merge them with the rural banking subsidiaries which we have proposed. For those RRBs that retain their identity and whose viability would need to be improved, we propose that instead of investing in Government bonds as part of their SLR requirements, they could place the amounts stipulated under SLR as deposits with NABARD or some special federal type of agency that might be set up for this purpose. This would also be consistent with the statutory requirements in this regard and NABARD or this agency could pay interest on such balances by investing or deploying these funds to the best advantage on their behalf and thus help to augment the income of the RRBs. The Committee proposes that Government should indicate that there would be no further nationalisation of banks. Such an assurance will remove the existing disincentive for the more dynamic among the private banks to grow. The Committee also recommends that there should not be any difference in treatment between the public sector and the private sector banks. The Committee would propose that there be no bar to new banks in the private sector being set up provided they conform to the start-up capital and other requirements as may be prescribed by the Reserve Bank and the maintenance of prudential norms with regard to accounting, provisioning and other aspects of operations. This in conjunction with the relevant statutory requirements governing their operations would provide adequate safeguards against misuse of banks’ resources to the detriment of the depositors interests. The Committee recommends that branch licensing be abolished and the matter of opening branches or closing of branches (other than rural branches for the present) be left to the commercial judgement of the individual banks. The Committee also believes that, consistent with other aspects of Government policy dealing with foreign investment, the policy with regard to allowing foreign banks to open offices in India either as branches or, where the Reserve Bank considers it appropriate, as subsidiaries, should be more liberal, subject to the maintenance of minimum assigned capital as may be prescribed by the Reserve Bank and the statutory requirement of the reciprocity. Joint ventures between foreign banks and Indian banks could also be permitted, particularly in regard to merchant and investment banking, leasing and other newer forms of financial services. Foreign banks when permitted to operate in India should be subjected to the same requirements as are applicable to domestic banks. If, in view of certain constraints such as absence of branch network, the foreign banks are unable

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to fulfil certain requirements such as directed credit (of 10 per cent of aggregate credit) the Reserve Bank should work out alternative methods with a view to ensuring a level playing field. The Committee is of the view that the foreign operations of Indian banks need to be rationalised. In line with the structure of the banking system visualised above, there would seem to be scope for one or more of the large banks, in addition to the SBI, to have operations abroad in major international financial centres and in regions with strong Indian ethnic presence. Pending the evolution of a few Indian banks with an international character, the Committee recommends as an interim measure that those Indian banks with the largest presence abroad and strong financial position could jointly set up one or more subsidiaries to take over their existing branches abroad. The SBI operations abroad can continue and indeed be strengthened in the course of time. The Government may also consider the larger banks increasing their presence abroad by taking over existing small banks incorporated abroad as a means of expanding their international operations. The Committee believes that the internal organisation of banks be best left to the judgment of the managements of individual banks, depending upon the size of the bank, its branch spread and range of functions. However, for the medium and large national banks the Committee proposes a three-tier structure in terms of head office, a zonal office and branches. In the case of very large banks, a four-tier organisation, as is the case with the State Bank, with head office, zonal office, regional office and branches may be appropriate. Local banks may not need an intermediate tier between the branch and the central office. The Committee endorses the view of the Rangarajan Committee on Computerisation that there is urgent need for a far greater use of computerised system than at present. Computerisation has to be recognised as an indispensable tool for improvement in customer service, the institution and operation of better control systems, greater efficiency in information technology and the betterment of the work environment for employees. These are essential requirments for banks to function effectively and profitably in the increasingly complex and competitive environment which is fast developing in the financial services segment of the economy. Consistent with the Committee’s view that the integrity and internal autonomy of banks and DFIs is far more important than the question of ownership, the Committee makes the following recommendations regarding recruitment of officers and staff and appointments of chief executives and constitution of the boards of the institutions: The Committee recommends that instead of having a common recruitment system for officers individual banks should be free to make their own recruitment. Thus there is no need for setting up a Banking Service Commission for centralised recuritment of officers nor for their

32.

33.

34.

35.

recruitment, as at present, through Banking Service Recruitment Boards (BSRBs). This will provide scope for the banks to scout for talent and impart new skills to their personnel. The Committee, however, predicates this recommendation on the assumption that the banks will set up objective, fair and impartial recruitment procedures and, wherever appropriate, they could voluntarily come together to have a joint recruitment system. As regards clerical grades, the present system of recruitment through BSRBs may continue but we would urge that the appointment of the Chairmen of these Boards should be totally left to the coordinating banks. The Committee believes that there has to be a recognition on the part of managements and trade unions that the system cannot hope to be competitive internally and be in step with the wide-ranging innovations taking place abroad without a radical change in work technology and culture and greater flexibility in personnel policies. We have been reassured to know that organised labour is as much convinced of the importance of enhancing the viability of the banking industry and providing efficient customer service. It is equally incumbent on management of banks to adapt forward looking personnel policies which would help to create a satisfying work environment. The Committee recommends that the various guidelines and directives issued by the Government or the Reserve Bank in regard to internal administration of the banks should be reviewed to examine their continuing relevance in the context of the need to ensure the independence and autonomy of banks. Such guidelines which relate to matters of internal administration such as creation and categorisation of posts, promotion procedures and similar matters should be rescinded. The Committee believes that the Indian banking system, at present, is over regulated and over-administered. Supervision should be based on evolving prudential norms and regulations which should be adhered to rather than excessive control over administrative and other aspects of bank organisation and functioning. The Committee would also like to place greater emphasis on internal audit and internal inspection systems of banks. The inspection by the supervisory authorities should be based essentially on the internal audit and inspection reports. Their main concern should be to ensure that audit and inspection machinery (which will cover the credit appraisal system and its observance) is adequate and conforms to well laid down norms. The Committee is firmly of the opinion that the duality of control over the banking system between the Reserve Bank and the Banking Division of the Ministry of finance should end and that the Reserve Bank should be the primary agency for the regulation of the banking system. The supervisory function over the banks and other financial institutions, the Committee believes, should be hived off to a separate authority to operate as a quasi autonomous body under the

aegis of the Reserve Bank but which would be separate from other central banking functions of the Reserve Bank. The Committee recognises that as long as the Government has proprietory interest in banks and financial institutions, it would be appropriate for the Ministry of Finance to deal with other Government departments and Parliament and discharge its other statutory obligations but not to engage in direct regulatory functions. 36. Central to the issue of flexibility of operations and autonomy of internal functioning is the question of depoliticising the appointment of the chief executive (CMD) of the banks and the boards of the banks and ensuring security of tenure for the CMD. The Committee believes that professionalism and integrity should be the prime considerations in determining such appointments and while the formal appointments have to be made by Government, they should be based on a convention of accepting the recommendations of a group of eminent persons who could be invited by the Governor of the Reserve Bank to make recommendations for such appointments. As regards the boards of public sector banks and institutions, as long as Government owns the banks, it would be necessary to have a Government director to take care of ‘proprietorial’ concerns but we believe that there is no need for the Reserve Bank to have a representative on the boards. 37. As regards development financial institutions,the main issue with regard to their operations are to ensure operational flexibility, a measure of competition and adequate internal autonomy in matters of loan sanctioning and internal administration. The Committee proposes that the system recommended for commercial banks in the matter of appointment of chief executives and boards should also apply to DFIs. The present system of consortium lending has been perceived as operating like a cartel. The Committee believes that consortium lending should be dispensed with and, in its place, a system of syndication or participation in lending, at the instance not only, as now, of the lenders but also of the borrowers, should be introduced. The Committee also believes that commercial banks should be encouraged to provide term finance to industry, while at the same time, the DFIs should increasingly engage in providing core working capital. This will help to enhance healthy competition between banks and DFIs. The Committee proposes that the present system of cross holding of equity and cross representation on the boards of the DFIs should be done away with. The Committee welcomes the removal of the tax concession enjoyed by IDBI as an important step in ensuring equality of treatment between various DFIs. As a further measure of enhancing competition and ensuring a level playing field, the Committee proposes that the IDBI should retain only its apex and refinancing role and that its direct lending function be transferred to a separate institution which could be incoporated as a company. The infected portion of the DFIs portfolio should be handed over to the ARF on the same terms and conditions as would apply to commercial banks. 75 (Sys 4) - D:\shinu\lawschool\books\module\contract law

38. In the case of state level institutions, it is necessary to distance them from the State Governments and ensure that they function on business principles based on prudential norms and have a management set-up suited for this purpose. We propose that an action plan on these lines be worked out and implemented over the next 3 years. 39. As regards the role of DFIs in corporate take-overs, the Committee believes that DFIs should lend support to existing managements who have a record of conducting the affairs of the company in a manner beneficial to all concerned, including the shareholders, unless in their opinion the prospective new management is likely to promote the interests of the company better. In doing so we would expect the institutions to exercise their individual professional judgement. 40. The DFIs should seek to obtain their resources from the market on competitive terms and their privileged access to concessional finance through the SLR and other arrangements should gradually be phased out over a period of three years. 41. The last decade had witnessed a considerable growth in capital market operations with the emergence of new instruments and new institutions. The capital market, however, is tightly controlled by the Government whose prior approval is invariably required for a new issue in the market, the terms of the issue and its pricing. The process of setting up Securities and Exchange Board of India (SEBI) for over-seeing the operations of the market is still not complete with the legislation for this purpose yet to be enacted. We believe the present restrictive environment is neither in tune with the new economic reforms nor conducive to the growth of the capital market itself. 42. The committee strongly favours substantial and speedy liberalisation of the capital market. Prior approval of any agency _ either Government or SEBI _ for any issue in the market should be dispensed with. The issuer should be free to decide on the nature of the instrument, its terms and its pricing. We would recommend in this context, that the SEBI formulate a set of prudential guidelines designed to protect the interests of investor, to replace the extant restrictive guidelines issued by the Controller of Capital Issues (CCI). In view of the above, the office of the CCI will cease to have relevance. In the Committee’s view, SEBI should not become a controlling authority substituting the CCI, but should function more as a market regulator to see that the market is operated on the basis of well laid down principles and conventions. The capital market should be gradually opened up to foreign portfolio investment and simultaneously efforts should be initiated to improve the depth of the market by facilitating issue of new types of equities and innovative debt instruments. Towards facilitating securitisation of debt, which could increase the flow of instruments, appropriate amendments will need to be carried out in the Stamp Acts. 76 (Sys 4) - D:\shinu\lawschool\books\module\contract law

43. In the last decade several new institutions have appeared on the financial scene. Merchant banks, mutual funds, leasing companies, venture capital companies and factoring companies have now joined hire purchase companies in expanding the range of financial services available. However, the regulatory framework for these new set of institutions has still to be developed. 44. The Committee recommends that the supervision of these institutions which form an integral part of the financial system should come within the purview of the new agency to be set up for this prupose under the aegis of the RBI. The control of these institutions should be principally confined to off-site supervision with the on-site supervision being resorted to cases which call for active intervention. The SEBI which is charged with the responsibility of ensuring orderly functioning of the market should have jurisdiction over these institutions to the extent their activities impinge on market operations. In regard to mutual funds there is a good case for enacting new legislation on the lines obtaining in several countries with a view to providing an appropriate legal framework for their constitution and functioning. The present guidelines with regard to venture capital companies are unduly restrictive, and affecting the growth of this business and need to be reviewed and amended. 45. As in the case of the banks and financial institutions there is need to lay down prudential norms and guidelines governing the functioning of these institutions. These prudential guidelines should relate, among other things, to capital adequacy, debt equity ratio, income recognition provisioning against doubtful debts, adherence to sound accounting and assets. The eligibility criteria for entry, growth and exit should also be clearly stipulated so that the growth of these institutions takes place on proper lines. 46. The Committee would like to emphasise that a proper sequencing of reforms is essential. Deregulation of interest rates can only follow success in controlling fiscal deficits. Asset reconstruction, institution of capital adequacy and establishment of prudential norms with a good supervisory machinery have to be proceeded with in a phased manner over the next 3 to 5 years but, we believe, it is important that the process must begin in the current year itself. 47. The above set of proposals would necessitate certain amendments in existing laws which the Government should undertake expeditiously. 48. The committee’s approach thus seeks to consolidate the gains made in the Indian financial sector while improving the quality of the portfolio, providing greater operational flexibility and most importantly greater autonomy in the internal operations of the banks and financial institutions so as to nurture a healthy, competitive and vibrant financial sector. This will, above all else, require depoliticisation of appointments, implying at the same time a self-denial by Government and the perception that it has distanced itself from the internal decision making of the banks and the

financial institutions. The proposed deregulation of the financial sector and the measures aimed at improving its health and competitive vitality would, in the Committee’s view, be consistent with the steps being taken to open up the Indian economy, enable the Indian financial sector to forge closer links with the global financial markets, and enhance India’s ability to take competitive advantage of the increasing international opportunities for Indian trade, industry and finance. 1.4 CONCLUDING REMARKS In the economy of every country, Commercial Banks have a very significant role to play. These institutions are the players in the money market. It is therefore necessary for the Central Bank of the country to have regulations on these Commercial

Banks, which have been already narrated in the module on RBI. Over and above these regulations by the Central Bank which contains (a) restrictions on loans and advances ; (See S.20 of B.R. Act) (b) maintenance of percentage of liquid assets ; (See S.24 of B.R.Act) (c) maintaining reserve fund and cash reserve ; (See Ss. 17 and 18) (d) Licensing of banking companies ; (See S. 22) The Central Govt also has certain regulatory functions. This module contains all these regulatory requirements excepting those which relate to the money market discussed in the module of RBI.

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2. LICENSING OF BANKING ACTIVITIES SUB TOPICS 2.1 General provisions about Licensing 2.2 RBI Guidelines 2.1 GENERAL PROVISIONS ABOUT LICENSING Section 22 of the Banking Regulation Act deals with the Licensing provisions of Banking Companies 1) Save as hereinafter provided, no company shall carry on banking business in India unless it holds a licence issued in that behalf by the Reserve Bank, and any such licence may be issued subject to such conditions as the Reserve Bank may think fit to impose. 2) Every banking company in existnece on the commencement of this Act, before the expiry of six months from such commencement, and every other company before commencing banking business in India, shall apply in writing to the Reserve Bank for a licence under this section: Provided that in the case of a banking company in existence on the commencement of this Act, nothing in sub-section (1) shall be deemed to prohibit the company from carrying on banking business until it is granted a licence in pursuance of this section or is by notice in writing informed by the Reserve Bank that a licence cannot be granted to it : Provided further that the Reserve Bank shall not give a notice as aforesaid to a banking company in existence at the commencement of this Act before the expiry of the three years referred to in sub-section (1) of section 11 or of such further period as the Reserve Bank may under that subsection think fit to allow. 3) Before granting any license under this section, the Reserve Bank may require to be satisfied by an inspection of the books of the company or otherwise that the following conditions are fulfilled, namely :a) that the company is or will be in a position to pay its present or future depositors in full as their claims accrue ; b) that the affairs of the company are not being, or are not likely to be, conducted in a manner detrimental to the interests of its present or future depositors ; c) that the general character of the proposed management of the company will not be prejudicial to the public interest or the interest of its depositors ; d) that the company has adequate capital structure and earning prospects; e) that the public interest will be served by the grant of a licence to the company to carry on banking business in India ; f) that having regard to the banking facilities available in the proposed principal area of operations of the company, the potential scope for expansion of banks 78 (Sys 4) - D:\shinu\lawschool\books\module\contract law

already in existence in the area and other relevant factors the grant of licence would not be prejudicial to the operational and consolidation of the banking system consistent with monetary stability and economic growth ; g) any other condition, the fulfilment of which would, in the opinion of the Reserve Bank, be necessary to ensure that the carrying on of banking business in India by the company will not be prejudicial to the public interest or the interests of the depositors. 3A) Before granting any licence under this section to a company incorporated outside India, the Reserve Bank may require to be satisfied by an inspection of the books of the company or otherwise that the conditions specified in sub-section (3) are fulfilled and that the carrying on of the banking business by such company in India will be in the public interest and that the Government or law of the country in which it is incorporated does not discriminate in any way against banking companies registered in India and that the company complies with all the provisions of this Act applicable to banking companies incorporated outside India. 4) The Reserve Bank may cancel a licence granted to a banking company under this section _ i) if the company ceases to carry on banking business in India ; or ii) if the company at any time fails to comply with any of the conditions imposed upon it under sub-section (1) or iii) if at any time, any of the conditions referred to in sub-section (3) and sub-section (3-A) is not fulfilled: Provided that before cancelling a licence under clause (ii) or clause (iii) of this sub-section on the ground that the banking company has failed to comply with or has failed to fulfil any of the conditions referred to therein, the Reserve Bank, unless it is of opinion that the delay will be prejudicial to the interests of the company’s depositors or the public, shall grant to the company on such terms as it may specify, an opportunity of taking the necessary steps for complying with or fulfilling such condition. 5) Any banking company aggrieved by the decision of the Reserve Bank cancelling a licence under this section may, within 30 days from the date on which such decision is communicated to it, appeal to the Central Government. 6) The decision of the Central Government where an appeal has been preferred to it under Sub-section (5) or of the Reserve Bank where no such appeal has been preferred shall be final. This section originated with the demand for licensing of foreign banks doing business in India and was also recommended by the Indian Central Banking Enquiry Committee, mainly with the object of prohibiting the entry of banks started in countries

which discriminated against banks started in India. The above section, however, introduces a comprehensive system of licensing of banks incorporated in India is dependent upon the maintenance of a satisfactory financial condition coupled with the additional qualification in case of foreign banks, vide subsection (3A) which has been inserted by the Banking Laws (Amendment) Act, 1983 (1 of 1984) on the basis of existing clause (c) of sub-section (3), that the countries of their origin do not discriminate in any way against banks registered in India. It also provides for the issue of conditional licence. Laws of certain foreign countries such as Switzerland, U.S.A and Sweden have almost similar provisions. The requirements under this section may be classified under following three heads : (a) necessity of licensing and mode of applying for it ; (b) conditions for granting of licences and compliance with further condition; (c) cancellation of licences and appeals from such orders. No banking company can commence or carry on banking business in India until it holds a licence granted to it by the Reserve Bank for the purpose. In the case of banking companies to be started, before granting a licence to them the Reserve Bank may require to be satisfied whether the conditions given in sub-section (3) of section 22 are fulfilled. By the Banking Laws (Amendment) Act, 1983 clauses (c) to (g) have been substituted for existing clause (c) w.e.f. 15.2.1984, so as to widen the scope of the matters which the Reserve Bank may consider before granting a licence. It amy be added that while a banking company whose licence is cancelled by the Reserve Bank has the right to appeal to the Central Government whose decision is to be regarded as final, no such appeal can be preferred by a new banking company whose application for licence is turned down. In Sajjan Bank (P) Ltd, Vs. Reserve Bank (30 Comp.Cas. 146), it has been held that the provisions of Section 22 of the Banking Regulation Act, 1949 prescribe only a system of licensing, having for its object the regulation of the business of banking and does not violate fundamental right of any person to carry on the business of banking. It was also laid down that the powers vested in the Reserve Bank of India under Section 22 of the Banking Companies Act, 1949 are not vested with a mere officer of the Reserve Bank. Restrictions on opening and transfer of Branches :- Under the provisions of Section 23, the Reserve Bank has been empowered to control the opening of new and transfer of existing places of business of banking companies as follows 1) without obtaining prior permission of the Reserve Bank _ a) no banking company shall open a new place of business in India or change otherwise than within the same city, town or village, the location of an existing place of business situated in India; and b) no banking company incorporated in India shall open a new place of business outside India or change, otherwise than within the same city, town or village

in any country or area outside India, the location of an existing place of business situated in that country or area : Provided that nothing in this sub-section shall apply to the opening for a period not exceeding one month of a temporary place of business within a city, town or village or the environs thereof within which the banking company already has a place of business, for the purpose of affording banking facilities to the public on the occasion of an exhibition, a conference or a mela or any other like occasion. 2) Before granting any permission under this section, the Reserve Bank may require to be satisfied by an inspection under section 35 as to the financial condition and history of the company, the general character of its management, the adequacy of its capital structure and earning prospects and that public interest will be served by the opening or, as the case may be, change of location, of the place of business. 3) The Reserve Bank may grant permission under sub-section (1) subject to such conditions as it may think fit to impose either generally or with reference to any particular case. 4) Where, in the opinion of the Reserve Bank, a banking company has, at any time, failed to comply with any of the conditions imposed on it under this section, the Reserve Bank may, by order in writing and after affording reasonable opportunity to the banking company for showing cause against the action proposed to be taken against it, revoke any permission granted under this section. 4A) Any regional rural bank requiring the permission of the Reserve Bank under this Section shall forward its application to the Reserve Bank through the National Bank which shall give its comments on the merits of the application and send it to the Reserve Bank ; Provided that the regional rural bank shall also send an advance copy of the application directly to the Reserve Bank. 5) For the purposes of this section ‘place of business’ includes any sub-office, pay-office, sub-pay ofice and any place of business at which deposits are received, cheques cashed or moneys lent. The need for the permission for the opening of a new branch was first brought into operation by Banking Companies (Restriction of Branches) Act, 1946. Explanation to section does not serve to define the words “place of business”, unless the money aid was lent at that place. Similarly the words “cheques cashed” apply to cheques drawn on the bank at the place in question. The restrictions imposed by the section are not applicable to change of location of a place of business in the same city or village, in which a place of business is already existing. It is also provided that a banking company may without the previous permission of the Reserve Bank open a new place of business, for a period not exceeding a month for the purpose of affording exhibition, or a fair, if such temporary place of business is located with the environs of a city, town or village in which the banking company already has a place of business. 79 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Originally the section did not impose any restriction on the opening of branches of Indian banks outside India. It was, however, subsequently felt that the maintenance of a satisfactory financial position, and the observance of sound banking traditions by foreign branches of Indian banks were of vital importance not only to the banking prestige abroad but also in the larger interests of the country, so it is now necessary for Indian banks to obtain permission of the Reserve Bank before opening branches in foreign countries. Besides, banks have to submit a monthly statement regarding the assets and liabilities of their branches in each foreign country. After nationalisation the entry of new private Banks was externally prohibited. However on the basis of the liberalisation of our economy the Reserve Bank of India have brought our guidelines on 22.1.1993 for floating new private sector banks. 2.2 RBI GUIDELINES ON ENTRY OF NEW PRIVATE BANKS For well over decades, after the nationalisation of 14 larger banks in 1969, no bank has been allowed to be set up in the private sector. Progressively, over this period, the public sector banks have expanded their branch net work considerably and catered to the socio-economic needs of large masses of the population, especially the weaker section and those in the rural area. The public sector banks now have 91 per cent of the total bank branches and handle 86 per cent of the total banking business in the country. While recognising the importance and the role of public sector banks, there is increasing recognition of the need to introduce greater competititon which can lead to higher productivity and efficiency of the banking system. A stage has now been reached when new private sector banks may be allowed to be set up. It is necesary that while permitting the entry of new private sector banks the following considerations have to be kept in view : (a) they sub-serve the underlying goals of financial sector reforms which are to provide competitive, efficient and low cost financial intermediation services for the society at large; (b) they are financially viable; (c) they should result in upgradation of technology in the banking sector; (d) they should avoid the shortcomings such as unfair preemption and concentration of credit, monopolisation of economic power, cross holdings with industrial groups etc. which beset the private sector banks prior to nationalisation; (e) freedom of entry in the banking sector may have to be managed carefully and judiciously. Based on these consideration, the Reserve Bank has formulated the following guidelines for establishment of new banks in the private sector :a) Such a bank shall be registered as a public limited company under the Companies Act, 1956 ; 80 (Sys 4) - D:\shinu\lawschool\books\module\contract law

b) The RBI may, on merits, grant licence under the Banking Regulation act, 1949 for such a bank. The bank may also be included in the Second Schedule of the Reserve Bank of India Act, 1934 at the appropriate time. The decision of the RBI in these matters shall be final ; c) The bank will be governed by the provisions of the Banking Regulation Act, 1949 in regard to its authorised, subscribed and paid-up capital. The minimum paid-up capital for such a bank shall be determined by the RBI and will also be subject to other applicable regulations ; d) The shares of the bank should be listed on stock exchanges; e) To avoid concentration of the headquarters of new banks in metropolitan cities and other overbanked areas, while granting a licence preference may be given to those the headquarters of which are proposed to be located in a centre which does not have the headquarters of any other bank ; f) Voting rights of an individual shareholder shall be governed by the ceiling of 1 per cent of the total voting rights as stipulated by Section 12(2) of the Banking Regulation Act. However, exemption from this ceiling may be granted under section 53 of the said Act, to public financial institutions; g) The new bank shall not be allowed to have as a director any person who is a director of any other banking company, or of companies which among themselves are entitled to exercise voting rights in excess of twenty per cent of the total voting rights of all the shareholders of the banking company, as laid down in the Banking Regulation Act, 1949; h) The bank will be governed by the provisions of the Reserve Bank of India Act, 1934, the Banking Regulation Act, 1949 and other relevant statutes, in regard to its management set-up, liquidity requirements and the scope of its activities. The directives, instructions, guidelines and advices given by the RBI shall be applicable to such a bank as in the case of other banks. It would be ensured that a new bank would concentrate on core banking activities initially; i) Such a bank shall be subject to prudential norms in respect of banking operations, accounting policies and other policies as are laid down by RBI. The bank will have to achieve capital adequacy of 8 per cent of the risk weighted assets from the very beginning. Similarly, norms for income recognition, asset classification, and provisioning for bad and doubtful advances will also be applicable to it from the beginning. So will be the single borrower and group borrowers exposure limits that will be inforced from time to time ; j) The bank shall have to observe priority sector lending targets applicable to other domestic banks. However, in recognition of the fact that new entrants may require some time to lend to all categories of the priority sector, some modification in the composition of the priority sector lending may be considered by the RBI for an initial period of three years

k) Such a bank will also have to comply with such directions of the RBI as is applicable to existing banks in the matter of export credit. As a facilitation of this it may be issued an authorised dealers licence to deal in foreign exchange, when applied for ; l) A new bank shall not be allowed to set up a subsidiary or mutual fund for at least three years after its establishment. The holding of such a bank in the equity of other companies shall be governed by the existing provisions applicable to other banks viz . _ i) 30 percent of the bank’s or the investee company’s capital funds, whichever is less, as set up under the Banking Regulation Act, 1949, and ii) 1.5 per cent of the bank’s incremental deposits during a year as per RBI guidelines. The aggregate of such investments in the subsidiaries and Mutual Fund (if and when set up) and portfolio investments in other companies shall not exceed 20 percent of the bank’s own paid-up capital and reserves. m) In regard to branch opening, it shall be governed by the existing policy that banks are free to open branches at various centres including urban/metropolitan centres

without the prior approval of the RBI once they satisfy the capital adequacy and prudential accounting norms. However, to avoid over concentration of their branches in metropolitan areas and cities, a new bank will be required to open rural and semi urban branches also, as may be laid down by RBI. n) Such a bank shall have to lay down its loan policy within the several policy guidelines of RBI. While doing so, it shall specifically provide prudential norms covering related party transactions. o) Such a bank shall make full use of modern infrastructural facilities in office equipments, computer, telecommunications, etc, in order to provide good customer service. The bank should have a high powered customer grievances cell to handle customer complaints ; p) Such other conditions as RBI may prescribe from time to time. In Terms of the Narasimham Committee Recommendations, the nationalised Banks, under the directions of the RBI and the government are now aiming at the closure or merger of unviable branches.

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3 CAPITAL, RESERVE AND LIQUID ASSET REQUIREMENTS SUB TOPICS 3.1 Introduction 3.2 Capital Requirements 3.3 Reserves and Liquid Assets 3.4 Concluding Remarks 3.1 INTRODUCTION The Banking Regulation Act contains requirements as to minimum paid up capital (Sec.11), regulation of paid up capital, subscribed capital and authorised capital (Sec.12), and prohibition charge on unpaid capital (Sec.14). The Act also contains prescriptions on reserve fund (Sec.17), Cash reserve (Sec.18), prohibition of floating charge on asset and assets to be kept in India (Sec.25). At the outset a few observations on the concept of capital are needed to make the terminological content of the word ‘Capital’ clear. Until the acceptance of the Basle Accord, the term ‘Capital’ referred to the owned funds of a bank comprising paid up capital and disclosed free reserves. It served mainly two purposes viz., (a) reflecting the owners’ stake in the enterprise and acting as a disincentive to them to take up higher risk-investments and (b) serving as a buffer to absorb adverse effects on a bank of various risks. Till the Basle Accord, the capital requirements for a bank differed from one country to another. Virtually, every country had laid down a minimum capital requirement, but the size of the amount varied. In addition, certain countries had stipulated that the banks should maintain an appropriate relationship between capital on the one hand and total assets, risk assets or liabilities on the other. Furthermore, some countries, such as Japan, did not formally prescribe capital adequacy. Others like the United States, had attempted at judgemental assessment. Developments in the early eighties had emphasised the need to strengthen the capital base of banks and to adopt a uniform standard to assess adequacy among countries. During that period, there was a general deterioration in the asset portfolio of major international banks particularly to the debt problems of the developing countries. Notwithstanding the adverse trend, banks continued to acquire still high-risk assets to retain their market share. This tendency had further contaminated their asset portfolios because of the increased competition both among banks and between banks and pseudo-banking entities following world wide lineralisation of financial services sector. Consequently, the leverage ratios of banks had scaled unsustainable levels. Furthermore, the difference in capital requirements for different domestic markets had resulted in competitive inequalities. Such inequalities in the context of globalisation of the transactions following widespread application of new communication and computer technology and the trend towards liberalisation of international capital transactions had resulted in major banks attempting to take greater risks to protect their market shares. 82 (Sys 4) - D:\shinu\lawschool\books\module\contract law

To counteract the trend and to restore health to the system, authorities in some countries had attempted to strengthen banks by prescribing simple leverage ratios and in some others, by laying down on balance sheet risk-asset ratios. These attempts had proved inadequate because the stipulation of simple leverage ratios had discouraged banks from holding low-risk assets while the prescription of on-balance sheet risk-asset ratios had encouraged them to substitute off-balance sheet exposure for conventional assets. A more sophisticated and realistic yardstick was required to measure the adequacy of capital. Also international co-ordination was considered necessary to prevent banks taking advantage of differences in national capital definitions and requirements thereby exposing themselves to greater risks. In this situation, supervisors in major industrial countries were naturally prepared to sacrifice elements of their own capital adequacy requirements in the interest of reaching a multi-lateral agreement. One of the notable developments in the banking regulatory framework in the recent years relates to the stipulation of capital requirements. Banking supervisors world over have unanimously agreed on the method for assessing adequacy of capital as also on the need of harmonise such requirement at the international level, at least in respect of internationally active banks. The agreement is known technically as the ‘International Covergence of Capital, Measurement and Capital Standards’, and popularly as ‘The Basle Accord’. The Accord has become the reference point for policy action among nations. For example, the Solvency Ratio and Own Funds requirements of the European Community, which will become effective in 1993, are based on the norms contained in the Accord. In India, the Committee on the financial system under the Chairmanship of Shri. M. Narasimham has not only recommended the adoption of the Basle Accord but also laid down a time-frame for compliance. Against this backdrop, an attempt is made to briefly recapitulate the Basle Accord and its implications to Indian banks having overseas branches. The Basle Accord The new method of assessing adequacy of capital is based on a system of risk-weighted capital ratio for the banks. The Basle Banking Supervisory Committee had worked on this since 1987, and had recommended it for the banks in G-10 countries. The authorities of these countries had endorsed the recommendations in July 1989. The new ratio has the following advantages : i) providing a fairer basis for international comparision between banking systems with structural differences ; ii) allowing off-balance sheet exposures to be incorporated more easily into the measure ; and iii) non-detering banks from holding liquid or other assets with low risk. Capital : New Definition For supervisory purposes, the Basle Accord has defined capital in two tiers. The Core Tier 1, Capital comprises fully paid-up

capital and disclosed reserves and corresponds to the traditional measure of capital. The Accord has also recognised the supplementary or Tier II Capital consisting of undisclosed reserves, revaluation reserves, general provisions, hybrid debt, capital instruments and subordinated term debt. Besides, the national authorities are left with the discretion to include/exclude any items, in the light of their national accounting and supervisory regulations. This is an improvement over the conventional definition of capital. However, Tier 1 Capital is granted greater importance due to certain well recognised facts. This is the only element common to the banking system the world over; it is wholly visible in the published account; and it has a crucial bearing on the profit margins and the banks ability to compete. Aslo, the strengthening of the Core Capial would facilitate a progressive enhancement in the quality as well as the level of the total capital resources maintained by the banks. Thus, the maximum permissible size of Tier II Capital is limited to the actual size of Tier I Capital.

capital at the time of their nationalisation. In the case of a foreign bank, the aggregate value of its paid-up capital and reserves should not be less than Rs. 15 lakhs and this level is raised to Rs.20 lakhs if it has a place or places of business in Bombay and/or Calcutta. The absolute minimum requirement for an Indian private sector bank, as laid down in the Banking Regulation Act, 1949, is Rs. 5 lakhs. (Rs. 10 lakhs if it has offices in more than one State and/or has office(s) in Bombay and/or Calcutta). The Committee on the financial system under the Chairmanship of Shri.M. Narasimham has recognised that the Indian banking system has inadequately capitalised and the situation is a cause of concern. It has, therefore, suggested that the banks should achieve a minimum of 4 per cent capital adequacy ratio in relation to risk-weighted assets by March 1993. The standards by the Basle Accord should be achieved by March 1996. For these banks with an international presence, it would be necessary to reach these figures even earlier’.

Assets and Risk Weighting For risk-weighting, assets are classified into five broad classes, each class carrying different weights ranging from 0 percent to 100 percent. The risk-weights attached to a specific assets is based mainly on the perceived riskiness of the assets. Obviously, this method has certain caveats. The weighting is not a substitute for commercial judgement. Further, the risk-weights capture only credit-risk and hence exclude other risks such as investment risk, interest rate risk, exchange risk and concentration risk. Weighting also differs in respect of county exposure. Industrialised debtor countries, for instance, carry a lower weight implying thereby that such exposure is safer than that in respect of LDCs. As for the bank’s claim on public sector enterprises, the Accord has allowed discretion to each national supervisory authority to determine the appropriate weights in factors. On other assets (both on-and-off balance sheet assets), the Accord has enumerated each item and has prescribed different ratios ranging from 20 per cent to 100 per cent. The Targets The Accord has provided for a minimum risk-weighted capital/ asset ratio of 8 per cent to be achieved by G-10 countries by the end of 1992. A transitional minimum ratio of 7.25 per cent was also stipulated for the end of 1990. Capital adequacy Prevailing capital requirements for banks in India are rather complex. The State Bank of India Act, 1955 prescribes the capital structure for the State Bank of India (SBI). According to the provisions in this Act, the authorised capital of SBI is Rs. 1,000 Crores; the actual paid-up captial is Rs.200 Crores. The issued capital of each of the seven Associate Banks of SBI was fixed by SBI with the approval of the Reserve Bank of India (RBI). The capital structure of the nationalised banks is laid down by the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1979/80. According to these Acts, the paidup capital of these banks are equal to their respective paid-up

3.2 CAPITAL REQUIREMENTS Section 11 of the Banking Regulation Act, lays down the requirements regarding the minimum standard of paid-up capital and reserves as a condition for the commencement of business. These conditions apply to the banking companies wherever incorporated, but companies in existence at the time of the commencement of the Act were given a period of three years or such further period not exceeding one year as the Reserve Bank of India extended to comply with the provisions contained in Section 11, which are shown for easy reference in a tabular form. Under the provisions of sub-sections (i) and (ii) of Section 12 it has been laid down that no banking company shall carry on business in any State of India, unless (a) the subscribed capital of the company is not less than half of its authorised capital, and the paid-up capital is not less than half of its subscribed capital, provided that when capital is increased this proportion may be permitted to be secured within a period to be determined by the Reserve Bank not exceeding two years from the date of increase; and (b) its share capital does not comprise shares other than ordinary shares, provided that preference shares, if any, issued before 1st July 1944 will not operate as a disqualification. These provisions deal with the minimum ratios between authorised, subscribed and paid-up capital of a banking company. The need for these provisions arose from the fact that the management of some banks used to mislead members of the public by displaying large figures of authorised capital, while only a small portion of their capital might have been subscribed, a still smaller portion might have been called-up. By calling only a small amount of the subscribed capital the promoters of banking companies were able to persuade persons with small means to go in for much larger number of shares than they could afford to purchase.

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Requirements of Aggregate Value of Paid-up Capital and Reserve Aggregate Value of Paid-up Capital and Reserve I. Incorporated in India

Rupees

A. (i) For a banking company incorporated in India having places of business in more than one state .. 5,00,000 (ii) If any such place or places of business is or are situated in the city of Bombay or Calcutta or both.. 10,00,000 B. If all places of business in one State but none of which in Bombay city or Calcutta : (i) For principal place of business in one state

.. 1,00,000

(except in City of Bombay and Calcutta) plus (ii) For each other place of business in the same district (iii) For each place of business situated outside that district Subject to a total of (iv) For having only one place of business

.. 10,000

.. 25,000 .. 5,00,000 50,000

C. If all places of business in one State : (i) One or more of which is/are in the city of Bombay or Calcutta

.. 5,00,000

plus (ii) In respect of each place of business situated outside the city of Bombay or Calcutta Subject to a total of

.. 25,000 .. 10,00,000

II. Incorporated outside India (i) If it has no place of business in Bombay city or .. 15,00,000 Calcutta (ii) If it has a place of business in Bombay city or Calcutta or both

.. 20,00,000

Note :- Banking companies incorporated outside India have to deposit the amount required as above either in cash or in unencumbered approved securities or partly in cash and partly in such securities with the Reserve Bank. If a place of business situated in a State other than that in which the principal place of business of a banking company is situated and the distance is less than twenty-five miles between these two places, they will be considered as places of business in one State. “Place of Business” means any office, sub-office, sub-pay office and any place of business at which deposits are received, cheques cashed and moneys lent. Commission on the sale of shares Section 13 prohibits a banking company from paying out directly or indirectly by way of commission, brokerage, disocunt or remuneration in any form in respect of shares issued by it, any amount exceeding in the aggregate two and half per cent of 84 (Sys 4) - D:\shinu\lawschool\books\module\contract law

the paid-up value of the said shares. Section 76 and 79 of the Companies Act, 1956 provide for higher percentage of Commission. The present provisions of the Banking Regulation Act alter the effect of the provisions of the Companies Act 1956, so far as banking companies are concerned and to the extent of commission that can be paid. Prohibition of charge on Unpaid Capital No banking company shall create any charge upon its unpaid capital, and any such charge, if created, shall be invalid (Section 14). It is unusual for banks in India to create any charge on their future assets. Unpaid capital of a company constitutes its future asset. However, the provision of this section is based upon the salutary principle that all the creditors of a banking company should participate in the future assets which should not be realised for the benefit of one or more preferred creditors. The Companies Act, 1956 permits the creation of a charge by a company on its uncalled capital provided the instrument creating the said charge is registered with the Registrar of Companies within 30 days from the date of its creation (Section 125 of the Companies Act, 1956). Section 14A prohibits every banking company from creating a floating charge on its undertaking or any property or any part thereof unless the creation of such a floating charge is certified in writing by the Reserve Bank as not being detrimental to the interests of the depositors of such company. The floating charge if created without obtaining the Reserve Bank’s certificate is invalid. Restrictions on holding of shares in other Companies Section 19 lays down that : “Restriction on nature of subsidiary companies (1) A banking company shall not form any subsidiary company except a subsidiary company formed for one or more of the following purposes, namely:(a) the undertaking of any business which, under clauses (a) to (o) of sub-section (1) of Section 6, is permissible for a banking company to undertake; (b) with the previous permission in writing of the Reserve Bank, the carrying on of the business of banking exclusively outside India ; (c) the undertaking of such other business, which the Reserve Bank may, with the prior approval of the Central Government, consider to be conducive to the spread of banking in India or to be otherwise useful or necessary in the public interest; Explanation :- For the purposes of Section 8, a banking company shall not be deemed, by reason of its forming or having a subsidiary company, to be engaged indirectly, in the business carried on by such subsidiary company. (2) Save as provided in sub-section (1), no banking company shall hold shares in any company, whether as pledgee, mortgagee or absolute owner, of an amount exceeding thirty per cent of the paid-up share capital of that company or

thirty per cent of its own paid-up share capital and reserves, whichever is less : Provided that any banking company which is on the date of commencement of this Act holding any shares in contravention of the provisions of this sub-section shall not be liable to any penalty therefor if it reports the matter without delay to the Reserve Bank and if it brings its holding of shares into conformity with the said provisions within such period, not exceeding two years, as the Reserve Bank may think fit to allow. (3) Save as provided in sub-section (1) and notwithstanding anything contained in sub-section (2), a banking company shall not, after the expiry of one year from the date of the commencement of this Act, hold shares, whether as pledgee, mortgagee or absolute owner, in any company in the management of which any managing director or manager of the banking company is in any manner concerned or interested. This section restricts the scope of formation of subsidiary companies by a banking company, as well as the holding of shares in other companies. A banking company may form a subsidiary company for the purposes referred to in this section, as well as for other purposes subject to the previous permission in writing of the Reserve Bank. Sub section (1) has been substituted by the Banking Laws (Amendment) Act, 1983, w.e.f. 15.2.1984 so as to amplify, in pursuance of the recommendation of the Banking Commission, the scope of the said section with a view to enlarging the purposes for which a banking company can form subsidiaries. A banking company would now be permitted to form subsidiaries for carrying on one or more kinds of business which it is permitted to engage in under clauses (a) to (o) of Section 6(1) of the Banking Regulation Act, 1949. Prior to the amendment a banking company was not permitted to form subsidiaries except for undertaking and executing trusts, administration of estates as executors and for doing banking business outside India. It appears, however, that the definition of a subsidiary company as given in the Companies Act, 1956 excludes the case of a company holding shares as security, when the ordinary business of the company so holding shares includes the lending of money. It may be noted that a company, even though it is not incorporated under the Companies Act, will be regarded as subsidiary company within the meaning of that Act, if the holding banking company incorporated under the Banking Regulation Act and/or the Companies Act, is interested in it in such a way that it controls the composition of the Board of Directors of such a Company. Under Section 4 of the Companies Act, 1956, a company is deemed to be a subsidiary of another, if and only if _ (a) that other controls the composition of its Board of Directors ; or (b) that other holds more than half in nominal value of its equity share capital; or (c) the first mentioned company is subsidiary of any company which is that other’s subsidiary.

As regards the second restriction mentioned in Section 19 of the Banking Regulation Act, it is clear that a banking company can hold shares in any company (i.e., a company liable to be wound up under the Companies Act) to the extent of thirty per cent of the paid-up share capital of the latter, but this should not exceed thirty per cent of the paid-up share capital and reserve of the former. Thus, it would appear that a banking company may hold shares of a foreign company, exceeding thirty per cent if that company does not operate in India, but such holding must not exceed fifty per cent as to the close of an accounting period. The main object of the provision as laid down under this section is, that a banking company may not enter into nonbanking business by means of a subsidiary company or any other company in which it is to be largely interested. The restriction regarding the holding of shares seems to apply only when the shares are held as pledgee, mortgagee or owner, and not when they are held as trustee, custodian or agent, or otherwise than a pledgee, mortgagee or owner. If on the date of commencement of this Act, a banking company holds shares beyond the limit stated in the sub-section, provided it forthwith reports the matter to the Reserve Bank of India, it can dispose off the excess holding within such period (not exceeding two years as the Reserve Bank may permit) to comply with the provisions of Section 19(1). Sub section (3) of the same section absolutely prohibits the holding after the expiry of one year from the date of the commencement of the Act of shares as pledgee, mortgagee or owner, in any company in the management of which a managing director or manager of the banking company in question is concerned or interested. This prohibition, however, does not apply to the shares in a subsidiary company permitted under sub-section (1) of Section 19. It does not appear to be quite clear whether the period of one year referred to above, is automatically allowed to every banking company or is the maximum period of concession that can be allowed by the Reserve Bank. It may be observed that the word “concerned” or “interested” appears to have rather wide meaning. Probably it will be interpreted with reference to Section 295 and other provisions contained in Sections 297, 299, 300, 301 and 302 of the Companies Act, 1956. A critique on capital adequacy position of some Nationalised Banks: In this context an academic exercise is attempted to assess the prevailing position of capital in nine Indian banks having overseas branches vis-a-vis the requirements of the Basle Accord as also of the Narasimham Committee for 1993. The nine banks are Bank of India, Bank of Baroda, Bharat Overseas Bank, Canara Bank, Indian Bank, Indian Overseas Bank, SBI, Syndicate Bank and UCO Bank. This exercise presents the position at end-March 1991. Since the published balance sheets of these banks do not conform to the details of assets as enumerated in the Basle Accord, available data are treated to conform broadly to the classification of the Accord. Thus, cash on hand, balances with other banks and money at call and shortnotice are taken as cash and equivalent having no risk. Total investments, contra-items and contingent liabilities were allotted 85 (Sys 4) - D:\shinu\lawschool\books\module\contract law

50 per cent risk-weight (each). All other assets are given 100 per cent risk-weight. Aggregate Picture As on March 31, 1991, the combined owned funds, i.e., paidup capital and disclosed reserves of these nine banks aggregated to Rs. 3,859 crores. Their total assets amounted to Rs. 1,63,994 crores. The risk unadjusted capital asset ratio, therefore, worked out to Rs. 2.35 percent. On the other hand the risk weighted assets (including contra-items and contingency liabilities) totalled Rs. 1,53,172 crores. The capital/risk-weighted alset ratio stood higher at 2.52 per cent because of the complete exclusion of cash and equivalent, and one half of investments, contra-items, and contingent liabilities from the denominator. While considering Tier I norm of the Basle Accord, therefore, there was a deficit of 1.48 per cent of Rs. 2,267 crores in respect of the required capital of these Banks. According to the prescription of Narasimham Committee, however, the banks have fulfilled their Tier I needs (2.0 per cent) but fell short of total capital adequacy by 1.48 percentage points (Rs. 2,267 crores). Disaggregated position Bank-wise, the position varied widely. Only three banks, viz., Canara Bank, Indian Overseas Bank, and UCO Bank, have fulfilled the Tier I Capital requirement of the Basle Accord. The shortfall in respect of other banks ranged from Rs. 5 crores (Bharat Overseas Bank) to Rs. 1,507 crores (SBI); in percentage terms, the shortfall ranged from 1.46 per cent (Bank of India) to 2.41 per cent (Syndicate Bank). The norms of the Narasimham Committee (2.0 per cent Tier I Capital) was met by six banks. Only three banks, viz., SBI, Bank of Baroda, and Syndicate Bank, have fallen short of the target. Caveats It should be reiterated that these computations are illustrative and at best are indicative of the direction and possible dimension, the precise amount could be different. The position by end March 1994 will also depend upon other factors such as the growth in the balance sheets, contingent liabilities, extent of asset contamination, etc., of these banks. Again, the role of the injection of substantial funds by the Government to augment the capital of weak banks needs to be remembered. Available options : Tier I capital Available options to cover the shortfall are rather limited. Tier I capital refers to purely owned funds consisting paid-up capital and disclosed reserves. The scope for additional allocation of operating surplus to reserves is limited because of the diminishing profitability of the banks. There could also be a greater need to make larger provision for loan losses from the available meagre surplus. The scope of augmenting paid-up capital by the government is also limited since the present emphasis is on curtailing expenditure as much as possible. Notional augmentation through issue of special securities, as 86 (Sys 4) - D:\shinu\lawschool\books\module\contract law

had been done hitherto in this context, would hardly serve any useful purpose. Perhaps, fresh capital could be issued to the public. Response will, however, depend naturally upon the track record of the issuer. Recognising this, the Narasimham Committee has recommended that in respect of banks which have had a consistent record of profitability and enjoy a good reputation in the market, it should be possible to tap the capital market by issuing fresh capital to the public. Mutual funds, insurance companies and profitable public sector companies could subscribe to such equity, besides employees of the banks and the general public. In respect of other banks, it may be necessary for the government to supplement the capital by direct subscription. In this context, it should be remembered that the paid-up capital of all the nationalised banks have almost reached their respective authorised levels. hence, legislative measures may have to be taken to increase the capital structure of these banks if additional capital funds are to be injected. Holding company We could also conceive the establishment of a new holding company with adequate capital to take care of these banks. According to the stipulations of the Basle Accord, the Tier I capital needs of the proposed holding company, as at end-March 1991 would be around Rs. 6,130 crores, as per our estimates. In the present context of economy measures, perhaps, RBI alone may be in a position to contribute this amount. In due course, however, these could be professionally managed. Similarly, officials for posting to the foreign branches should undergo a stringent process of selection procedure establishing their efficiency. Necessary safeguards ought to be built in the procedure to provide representation to all the participant banks as also to discourage any possible brain-drain. Tier II Capital The components of supplementary capital of Tier II capital are undisclosed reserves, revaluation reserves, general provisions,hybrid debt instruments,and subordinate term debt. Hitherto, the actual financial position of the banks is not fully clearly reported.With the implementation of new accounting policies and procedures as well as the adoption of new formats for the final accounts, it should be possible to effect greater transparency to the financial status of the reporting banks. Once these changes are effected, perhaps, the banks could fully satisfy the needs of Tier II Capital. In cases where shortfalls are noticed, one could think of issuing subordinate term debts. CONCLUSION Indian banks operating abroad need to subject themselves to the capital regulatory requirements as laid down in the Basle Accord. It is true that the requirements of the Accord are stiff for Indian situation. Recommendations made by the Narasimham Committee in this context are very reasonable, practicable and achievable. This could be considered as the transitory provisions and intensive attempts should be made to attain the BIS standards at the earliest. A precondition in this

regard, as noted by the Narasimham Committee, is that the Indian banks should have their assets revalued on a more realistic basis and on the basis of their realisable value. Then alone a clearer picture would emerge facilitating appropriate action. 3.3 RESERVES AND LIQUID ASSETS Provisions relating to the building up of reserves are relatively simple. Indian banks are statutorily required to build up reserves by transferring sums equivalent to not less than 20 per cent (25 per cent since 1974 as per RBI’s advice) of their annual disclosed profit. Foreign banks need to maintain 20 per cent of their annual profits in respect of their Indian operations with RBI either in cash or in unencumbered approved securities. Since some of these banks have often complied with provision by transferring securities in their investment portfolio (which enabled them to remit the entire profit), they are required, since 1989, to retain in a separate account, 20 per cent of the profits of their Indian operations as disclosed in their annual accounts every year. This reserve is permanent in nature and forms part of owned funds of these banks [ See Sec.17]. Every Banking Company shall maintain a cash reserve with itself or by way of balance in a current account with the Reserve Bank or by way of net balance partly with itself and partly with

Reserve Bank, a sum equivalent to atleast three percent of the total of its demand and time liabilities in India as on the last Friday of the second preceding fortnight and shall submit to the Reserve Bank before the 20th day of every month a return to that effect. This is known as CRR or Cash Reserve Ratio. As has already been stated the RBI instructs the banking companies to keep a certain CRR. This type of manipulation of CRR is done for regulating the money market. 3.4 CONCLUDING REMARKS Adequate capital and sufficient liquidity are the two hall marks of success of commercial banks. If the liquidity goes higher capital remains under-utilised. In fact one of the strongest criticism of commercial banking in India is that loans and advances are costlier because of high rate of interest. The interest rate is high because a big part of the capital is required to be locked up on account of CRR and SLR. It means that a part of the capital has to work for the total capital. Liquidity is required for having confidence on the monetary system and banking institution. Certain percentage of cash keeps up the thickness of monetary flow. But keeping reserve higher than that is counter- productive. Generally speaking this step is used also for checking the inflation. But theoretically checking flow of money may lead to stagflation instead of controlling inflation.

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4. RESTRICTIONS ON LOANS AND ADVANCES SUB TOPICS 4.1 Tandon Committee Report on Bank Credit 4.2 Chore Committee Report on Cash Credit 4.3 Restrictions on loans and advances 4.4 Concluding Remarks 4.1 TANDON COMMITTEE 1. The study group to frame guidelines for follow-up of bank credit set up by the Reserve Bank of India (RBI) in July 1974, submitted its report in August 1975. The main recommendations of the Group relate to :i. Norms for inventory and receivables ; ii. approach to lending ; iii. style of credit ; iv. information system; and v. bill finance 2. The guidelines are to be followed in regard to conduct of advances to borrowers enjoying aggregate limits in excess of Rs.10 lacs. 3. The norms for inventory and receivables are applicable to all industrial borrowers including small-scale industries with aggregate Working Capital limits from the banking system in excess of Rs. 10 lacs. In respect of Industries for which norms have not been suggested, the purpose and spirit behind the norms should be kept in view. The deviations from norms should be for known specific circumstances and situations and allowed for agreed period which should be relatively small. 4. The purpose of bank credit is only to supplement the borrower’s resources in carrying a reasonable level of current assets in relation to production requirements. 5. The Working Capital Gap has been defined as the ‘difference between current assets and current liabilities other than bank finance’. 6. The level of current assets for this purpose should be in conformity with the norms laid down for inventory and receivables. 7. The study Group has recommended three alternative methods for determining the maximum finance that could be extended for meeting Working Capital requirements. 8. Under the I method, 25% of the Working Capital Gap should be financed out of long term resources. The maximum bank finance permissible under this Method would, therefore, be 75% of the Working Capital Gap. 9. In the II Method, the borrower will have to provide a minimum of 25% of total current assets from long term funds; this will give a Current Ratio of at least 1.33:1. 10. In the III Method, the borrower’s contribution from long term funds will be to the extent of the entire core current 88 (Sys 4) - D:\shinu\lawschool\books\module\contract law

11.

12.

13. 14.

15.

assets, as defined, and a minimum of 25% of the balance current assets, thus strengthening the Current Ratio further. (It has been decided not to implement this for the time being). The excess borrowings arising out of (i) excess current assets levels and (ii) shortfall in the maintenance of Net Working Capital should be converted into a “Working Capital Term Loan” with a specific repayment schedule. The Cash Credit limit can be bifurcated into _ i. a loan, comprising the minimum level of borrowing which the borrower expects to use throughout the year; and ii. a Demand Cash Credit to take care of fluctuating requirements, both being reviewed annually. Receivables should be financed by way of bills. In order to ensure that borrowers do not use the Cash Credit facility in an unplanned manner, the financing should be placed on a quarterly budgeting-reporting system. The actual drawings in the Cash Credit account will be determined by the borrower’s inflow and outflow of funds, as reflected in the quarterly funds flow statement.

4.2 CHORE COMMITTEE REPORT 1. Reserve Bank of India (RBI) appointed in March 1979, a Working Group to review the system of Cash Credit in all its aspects, particularly with reference to the unutilised gap under sanctioned limits. The Group submitted its Final Report in August 1979. 2. The major recommendations of the Working Group relate to : i. method of lending : II Method to be applied straightaway to all borrowers with Working Capital limits of Rs.50 lacs and above ; ii. information system ; iii. drawee bill system ; and iv. follow-up of review/renewal of limits. 3. The information system would apply to all borrowers with Working Capital Limits of Rs. 50 lacs and over. 4. All Working Capital limits of Rs. 10 lacs and over from the banking system must be renewed at least once a year. 5. Wherever feasible, separate limits for peak and normal nonpeak level requirements should be fixed. 6. Ad-hoc or temporary limits should be granted under very exceptional circumstances only and should entail additional interest of 1% per annum. 7. 50% of the Cash Credit limit against raw materials to manufacturing units should be granted by way of drawee bills only.

4.3 RESTRICTIONS ON LOANS AND ADVANCES Sections 20, 20A and 21 of the Banking Regulation Act deal with restrictions on loans and advances. The sections read Section 20 of the Act, laying down the restrictions on loans and advances has been wholly amended from 1.2.1969. It is applicable to the State Bank of India and the 20 nationalised banks. Under the old section only a secured loan or advance could be made to a director of a Banking Company or to the firms or private companies, in which the director was interested as partner, director or managing agent. A “secured loan or advance” is defined in Section 5(n) of the Act which reads :5(n) :- “Secured loan or advance means a loan or advance made on the security of assets the market value of which is not at any time less than the amount of such loan or advance; and `unsecured loan or advance’ means a loan or advance not so secured. Section 20 as amended by the Amending Act 58 of 1968 is much wider in scope; it is the pivot of the so called social control over Banks. It prohibits a banking company from entering into any commitment from granting any loan, secured or unsecured, to any of its directors or to any firm or company or its subsidiary or holding company in which a director is interested or even to any individual for whom a director stands as a guarantor with whom a director is a co partner in a firm. 1) Notwithstanding anything to the contrary contained in Section 77 of the Companies Act, 1956, no banking company shall, (a) grant any loans or advances on the security of its own shares ; (b) enter into any commitment for granting any loan or advance to or in behalf of (i) any of its directors; or (ii) any firm in which any of its directors is interested as partner, manager, employee or guarantor ; or (iii) any company (not being a subsidiary of the banking company or a company registered under Section 25 of the Companies Act, 1956, or a Government Company) of which, or the subsidiary or the holding company of which any of the directors of the banking company is a director, managing agent, manager, employee or guarantor or in which he holds substantial interest; or (iv) any individual in respect of whom any of its directors is a partner or guarantor. 2) Where any loan or advance granted by a banking company is such that a commitment for granting it could not have been made if clause (b) of sub section (1) had been in force on the date on which the loan or advance was made, or is granted by a banking company after the commencement of Section 5 of the Banking Laws (Amendment) Act, 1968, but in pursuance of a commitment entered into before such commencement, steps shall be taken to recover the amounts due to the banking company on account of the loan or

advance together with interest, if any, due thereon within the period stipulated at the time of the grant of the loan or advance, or where no such period has been stipulated, before the expiry of one year from the commencement of the said Section 5: Provided that the Reserve Bank may, in any case, on an application in writing made to it by the banking company in this behalf, extend the period for the recovery of the loan or advance until such date, not being a date beyond the period of three years from the commencement of the said Section 5, and subject to such terms and conditions, as the Reserve Bank may deem fit : Provided further that this sub-section shall not apply if and when the director concerned vacates the office of the director of the banking company, whether by death, retirement, resignation or otherwise. 3) No loan or advance, referred to in sub-section(2), or any part thereof shall be remitted without the previous approval of the Reserve Bank, and any remission without such approval shall be void and of no effect. 4) Where any loan or advance referred to in sub-section (2), payable by any person, has not been repaid to the banking company within the period specified in that sub-section, then, such person shall, if he is a director of such banking company on the date of the expiry of the said period, be deemed to have vacated his office as such on the said date. Explanation : In this section _ (a) “loans or advance” shall not include any transaction which the Reserve Bank may, having regard to the nature of the transaction, the period within which, and the manner and circumstances in which, any amount due on account of the transaction is likely to be realised, the interest of the depositors and other relevant considerations, specify by general or special order as not being a loan or advance for the purpose of the section ; (b) “director” includes a member of any board or committee in India constituted by a banking company for the purpose of managing, or for the purpose of advising it in regard to the management of, all or any of its affairs. 5) If any question arises whether any transaction is a loan or advance for the purposes of this section, it shall be referred to the Reserve Bank, whose decision thereon shall be final. In clause (b) of sub-section (1), the words “enter into commitment for granting a loan or advance” appear. Committing is one step before granting. If a banker committs to grant a loan, he will, as his reputation stands, in all probability grant it. But the reason for drawing the line appears in sub Section (2). There may be a loan violating sub section (1), the commitment for which would have been entered before the date on which the new section came into force (i.e. 1.2.1969) but would have been granted till that date ; in such a case the banking company can grant loan, but sub-section (2) requires the 89 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Banking company to recover the loan within its stipulated period or if there is no such period within one year from 1.2.1969, or requires the director concerned to vacate his office. If either the advance is recovered or the director vacates within the said period, he shall on the expiry of the period be deemed to be not a director. Clause (b) of Sub-section (1) is clear and speaks for itself in all its sub-clauses except that sub-clause (iv) is somewhat confusing when it refers to “any individual in respect of whom any of its directors is a partner”. A question may be asked : how could one individual to be a partner “in respect of” another ? The sub-clause perhaps intends to refer to an individual who is a partner of a director in a firm. In any event, it would be safe for banking companies to read the sub-clause in this sense. A question may arise whether a loan can be granted to a Hindu Undivided Family of which a director is a co-parcener or member. The Section is silent on this and on its strict construction such a loan would not fall within its mischief. Explanation (a) sub-section 4, to the Section is more exception than an explanation. It can even be called a legal fiction. Although it uses the word “transaction”, it in effect refers to a loan or advance, since it talks of an amount due and period within which it becomes due or is likely to be realised. The explanation provides to the effect that a loan or advance shall not be deemed to be a loan or advance for the purpose of the Reserve Bank so desires by an order, general or special and also provides that considerations induced it to pass such an order. On such an order being passed, the disastrous effects of sub sections 2 and 4 will be suspended. The Reserve Bank did issue an order on 1.2.1969 specifying that for the purpose of S.20, loans and advances shall not include (i) loans or advances against Government securities, Life Insurance policies or fixed deposits, and (ii) loans or advances to Agricultural finance Corporation Ltd. Sec. 20-A : Restrictions on power to remit debts 1) Notwithstanding anything to the contrary contained in Section 293 of the Companies Act, 1956, a banking company shall not, except with the prior approval of the Reserve Bank, remit in whole or in part any debt due to it by:(a) any of its directors, or (b) any firm or company in which any of its directors is interested as director, partner, managing agent or guarantor, or (c) any individual if any of its directors is his partner or guarantor. 2) Any remission made in contravention of the provisions of sub-section(1) shall be void and of no effect. Sec. 21: Power of Reserve Bank to control advances by banking companies (1) Where the Reserve Bank is satisfied that it is necessary or expedient in the public interest or in the interest of depositors or banking policy so to do, it may determine the 90 (Sys 4) - D:\shinu\lawschool\books\module\contract law

policy in relation to advances to be followed by banking companies generally or by any banking company in particular, and when the policy has been so determined, all banking companies or the banking company concerned, as the case may be, shall be bound to follow the policy as so determined. (2) Without prejudice to the generality of the power vested in the Reserve Bank under sub-section (1), the Reserve Bank may give directions to banking companies, either generally or to any banking company or group of banking companies in particular as to :(a) the purposes for which the advance may or may not be made, (b) the margins to be maintained in respect of secured advances, (c) the maximum amount of advances or other financial accomodation which, having regard to the paid-up capital, reserves and deposits of a banking company and other relevant considerations, may be made by that banking company to any one company, firm, association of persons or individual, (d) the maximum amount up to which, having regard to the considerations referred to in clause (c), guarantees may be given by a banking company on behalf of any one company, firm, association of persons or individual, and (e) the rate of interest and other terms and conditions in which advances or other financial accomodation may be made or guarantees may be given. (3) Every banking company shall be bound to comply with any directions given to it under this section. When a nationalised bank charges a particular rate of interest in pursuance of Reserve Bank’s direction it would be a special circumstance justifying the said interest otherwise the bank would have violated Section 21 attracting penalty provided in Section 46. Indian Bank v. V.A.B.Gurukal, [AIR 1982 Mad 296.] The Banking Laws (Amendment)Act, 1983 (1 of 1984) has inserted a new section 21A w.e.f. 15.2.1984, so as to provide that the rates of interest charged by banking companies to the debtors shall not be re-opened in a court. The section reads as under : 21-A: Rates of interest charged by banking companies not to be subject to scrutiny of courts - Notwithstanding anything contained in the Usurious Loans Act, 1918 (10 of 1918), or any law relating to indebtedness in force in any State, a transaction between a banking company and its debtor shall not be reopened by any Court on the ground that the rate of interest charged by the banking company in respect of such transaction is excessive. In Bank of India v. Karnam Ranga Rao and others, [(1988) 64 Comp.Cas, 477] the Karnataka High Court has held that Section 21-A is a restraint on the power of the court to re-open any

account maintained by a bank relating to transactions with its customers on the ground that the rate of interest charged, in the opinion of the court, is excessive and unreasonable. However, if it is proved that the interest charged by the banks on loans advanced is not in conformity with the rates prescribed by the Reserve Bank, the court can disallow such excess interest and give relief to the party notwithstanding the provisions of section 21-A.

4.4 CONCLUDING REMARKS Commercial banks keep the monetary system of a country mobile. Through loans and advances it keeps the investment line, maintains the productivity and keeps up the productivity. But regulation of loans or advances is extremely necessary to maintain an overall economic stability. Banking Regulation Act provides this regulatory mechanism.

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5. REGULATION ON MANAGERIAL ORGANS SUB TOPICS 5.1 General Regulatory Outline 5.2 Wholetime Chairman 5.3 Additional Directors 5.4 Concluding Remarks 5.1 GENERAL REGULATORY OUTLINE The powers of the Reserve Bank of India over the Management of Banks is very wide. The Reserve Bank of India has been armed with Draconian powers under the Banking Regulation Act 1949 as amended from time to time. These powers are spread over in a number of sections of the Act. Section 10A :- This Section was introduced to subserve the purpose of social control. The Section prescribes the nature and composition of the Board of Directors who are responsible for the management of Banking company. Sub sections 5,6,7 & 8 of Section 10 A read _ Sub-section(5). Where the Reserve Bank is of opinion that the composition of the Board of Directors of a banking company is such that it does not fulfil the requirements of sub-section(2) it may, after giving to such banking company a reasonable opportunity of being heard, by an order in writing, direct the banking company to so re-constitute its Board of Directors as to ensure that the said requirements are fulfilled and, if within two months from the date of receipt of that order, the banking comapny does not comply with the directions made by the Reserve Bank, that Bank may, after determining, by lots drawn in such manner as may be prescribed, the person who ought to be removed from the membership of the Board of Directors, remove such person from the office of the director of such banking company and with a view to complying with the provisions of sub-section(2), appoint a suitable person as a member of the Board of directors in the place of the person so removed whereupon the person so appointed shall be deemed to have been duly elected by the banking company as its director; Sub-section(6). Every appointment, removal or reconstitution duly made, and every election duly held, under this section shall be final and shall not be called into question in any court ; Sub-section(7). Every director elected, or, as the case may be, appointed under this section shall hold the office until the date upto which his predecessor would have held office, if the election had not been held, or, as the case may be, the appointment had not been made; Sub-section(8). No act or proceeding of the Board of directors of a banking company shall be invalid by reason only of any defect in the composition thereof or on the ground that it is subsequently discovered that any of its members did not fulfil the requirements of this section. 5.2 WHOLETIME CHAIRMAN 10 B: Banking Companies to be managed by Whole-time Chairman 92 (Sys 4) - D:\shinu\lawschool\books\module\contract law

(1) Notwithstanding anything contained in any law for the time being in force or in any contract to the contrary, every banking company in existence on the commencement of Section 3 of the Banking Laws (Amendment) Act, 1968, or which comes into existence thereafter shall have one of its directors as chairman of its Board of Directors who shall be entrusted with the management of the whole of the affairs of the banking company : Provided that the chairman shall exercise his powers subject to the superintendence, control and direction of the Board of Directors: Provided further that nothing in this sub-section shall apply to a banking company in existence on the commencement of the said section for a period of three months from such commencement. (2) Every Chairman of the Board of Directors of a banking company shall be in the whole-time employment of such company and shall hold the office for such period, not exceeding five years, as the Board of Directors may fix, but shall, subject to the provisions of this section, be eligible for re-election or re-appointment: Provided that nothing in this sub-section shall be construed as prohibiting a chairman from being a director of a subsidiary of the banking comapny or a director of a company registered under Section 25 of the Companies Act, 1956. (3) Every person holding office on the commencement of Section 3 of the Banking Laws (Amendment) Act, 1968, as managing director of a banking company shall _ (a) if there is a chairman of its Board of Directors, vacate office on such commencement, or (b) if there is no chairman of its Board of Directors, vacate office on the date on which the chairman of its Board of Directors is elected or appointed in accordance with the provisions of this section. (4) Every chairman of the Board of Directors of a banking company shall be a person who has special knowledge and practical experience of _ (a) the working of a banking company, or of the State Bank of India or any subsidiary bank or a financial institution, or (b) financial, economic or business administration : Provided that a person shall be disqualified for being a chairman, if he _ (a) is a director of any company other than a company referred to in the proviso to sub-section (2), or (b) is a partner of any firm which carries on any trade, business or industry, or (c) has substantial interest in any other company or firm, or

(d) is a director, manager, managing agent, partner or proprietor of any trading, commercial or industrial concern, or (e) is engaged in any other business or vocation. (5) A Chairman of the Board of Directors of a banking company may, by writing under his hand addressed to the company, resign his office. (5-A) A Chairman of the Board of Directors whose term of office has come to an end, either by reason of his resignation or by reason of expiry of the period of his office, shall, subject to the approval of the Reserve Bank, continue in office until his successor assumes office. (6) Without prejudice to the provisions of Section 36-AA, where the Reserve Bank is of opinion that any person who is, or has been elected to be, the Chairman of the Board of Directors of the banking company is not a fit and proper person to hold such office, it may, after giving to such person and to the banking company, a reasonable opportunity of being heard, by order in writing, require the banking company to elect or appoint any other person as the chairman of its Board of Directors and if, within a period of two months from the date of receipt of such order, the banking company fails to elect or appoint a suitable person as the chairman of its Board of Directors, the Reserve Bank may, by order, remove the first mentioned person from the office of the chairman of the Board of Directors of the banking company and appoint a suitable person in his place whereupon the person so appointed shall be deemed to have been duly elected or appointed, as the case may be, as the chairman of the Board of Directors of such banking company and any person elected or appointed as chairman under this sub-section shall hold office for the residue of the period of office of the person in whose place he has been so elected or appointed. (7) The banking company and any person against whom an order of removal is made under sub-section (6) may, within thirty days from the date of communication to it or to him of the order, prefer an appeal to the Central Government and the decision of the Central Government thereon, and subject thereto, the order made by the Reserve Bank under sub-section (6), shall be final and shall not be called into question in any court. (8 Notwithstanding anything contained in this section, the Reserve Bank may, if in its opinion it is necessary in the public interest so to do, permit the chairman to undertake such part-time honorary work as is not likely to interfere with his duties as such chairman. (9) Notwithstanding anything contained in this section, where a person appointed as chairman dies or resigns or is by infirmity or otherwise rendered incapable of carrying out his duties or is absent on leave or otherwise in circumstances not involving the vacation of his office, the banking company may, with the approval of the Reserve Bank, make suitable arrangements for carrying out the duties of chairman for a total period not exceeding four months.

10-BB : Power of Reserve Bank to appoint Chairman of a banking company 1) Where the office of the chairman of a banking company is vacant, the Reserve Bank may, if it is of opinion that the continuation of such vacancy is likely to adversely affect the interests of banking company, appoint a person, eligible under sub-section (4) of Section 10-B to be so appointed, to be the Chairman of the banking company and where the person so appointed is not a director of such banking company, he shall, so long as he holds the office of the chairman, be deemed to be a director of the banking company. 2) The Chairman so appointed by the Reserve Bank shall be in the whole-time employment of the banking company and shall hold office for such period not exceeding three years, as the Reserve Bank may specify, but shall, subject to other provisions of this Act, be eligible for reappointment. 3) The Chairman so appointed by the Reserve Bank shall draw from the banking company such pay and allowances as the Reserve Bank may determine and may be removed from office only by the Reserve Bank. 4) Save as otherwise provided in this section, the provisions of Section 10-B, shall as far as may be, apply to the Chairman appointed by the Reserve Bank under sub-section (1) as they apply to a chairman appointed by a banking company. 10-D : Provisions of Section 10-A and 10-B to override all other laws, contracts, ect. Any appointment or removal of a director or chairman in pursuance of Section 10-A or Section 10 - B or Section 10BB shall have effect and any such person shall not be entitled to claim any compensation for the loss or termination of office, notwithstanding anything contained in any law or in any contract, memorandum or articles of association. Under the above provisions the Reserve Bank of India is vested with powers to do and undo the composition of Board of Directors and Chairman of any Bank. Section 35B: Amendments of provisions relating to appointments of managing Directors, etc., to be subject to previous approval of the Reserve Bank(1) In the Case of the banking company _ (a) no amendment of any provision relating to the maximum permissible number of Directors or the appointment or reappointment or termination of appointment or remuneration of a chairman, a managing director or any other director, whole-time or otherwise or of a manager or a chief executive officer by whatever name called, whether that provision be contained in the company’s memorandum or articles of association, or in an agreement entered into by it, or in any resolution passed by the Company in general meeting or by its Board of Directors shall have effect unless approved by the Reserve Bank ; 93 (Sys 4) - D:\shinu\lawschool\books\module\contract law

(b)

no appointment or reappointment or termination of appointment of a chairman, a managing or a whole time Director, manager or chief executive officer by whatever name called, shall have effect unless such appointment is made with the previous approval of the Reserve Bank.

Explanation : For the purposes of this sub-section, any provision conferring any benefit or providing any amenity or perquisite, in whatever form, whether during or after the termination of the term of office of the chairman or the manager or the chief executive officer by whatever name called or the managing Director, or any other Director, whole-time or otherwise, shall be deemed to be a provision relating to his remuneration. (2) Nothing contained in Sections 262 and 269, the proviso to sub-section(3) of Section 309, Sections 310 and 311, the proviso to Section 387, and Section 388 (in so far as Section 388 makes the provisions of Sections 269, 310 and 311 apply in relation to the manager of a company) of the Companies Act, 1956, shall apply to any matter in respect of which the approval of the Reserve Bank has to be obtained under sub-section (1). 2-A : Nothing contained in Section 198 of the Companies Act, 1956 (1 of 1956) shall apply to a banking company and the provisions of sub-section(1) of Section 309 and of Section 387 of that Act shall, in so far as they are applicable to a banking company, have effect as if no reference had been made in the said provisions to Section 198 of that Act. (3) No act done by a person as chairman or a managing or wholetime director or a director not liable to retire by rotation or a manager or a chief execuive officer by whatever name called, shall be deemed to be invalid on the ground that it is subsequently discovered that his appointment or reappointment had not taken effect by reason of any of the provisions of this Act; but nothing in this sub-section shall be construed as rendering valid any act done by such person after his appointment or reappointment has been shown to the banking company not to have had effect. Decisions of Reserve Bank are subjective. They cannot be challenged as violative of the prinicples of natural justice. [E.A. Poyya Vs. Reserve Bank of India, AIR 1966 Ker 6.] Sections 35B (1)(b) is not violative of Article 19(1) of the Constitution. [ E.A. Poyya Vs. Reserve Bank of India, AIR 1966 Ker 6.] Part II A of the Banking Regulation Act inserted by Act 55 of 1963 deals with “control over management”. These powers are explained in sections 36 AA, 36AB and 36AC of the Act which reads: 36AA: Power of Reserve Bank to remove managerial and other persons from office (1) Where the Reserve Bank is satisfied that in the public interest or for preventing the affairs of a banking company being conducted in a manner detrimental to the interests of the depositors or for securing a proper management of any banking company it is necessary so to do, the Reserve Bank 94 (Sys 4) - D:\shinu\lawschool\books\module\contract law

may, for reasons to be recorded in writing, by order, remove from office, with effect form such date as may be specified in the order, any chairman, director, chief executive officer (by whatever name called) or other officer or employee of the banking company. (2) No order under sub-section (1) shall be made unless the chairman, director or chief executive officer or other officer or employee concerned has been given a reasonable opportunity of making a representation to the Reserve Bank against the proposed order : Provided that if, in the opinion of the Reserve Bank, any delay would be detrimental to the interests of the banking company or its depositors, the Reserve Bank may, at the time of giving the opportunity aforesaid or at any time thereafter, by order direct that, pending the consideration of the representation aforesaid, if any, the chairman or, as the case may be, director or chief executive officer or other officer or employee, shall not with effect from the date of such order _ (a) act as such chairman or director or chief executive officer or other officer or employee of the banking company ; (b) in any way, whether directly or indirectly, be concerned with, or take part in the management of the banking company. (3) (a) Any person against whom an order of removal has been made under sub-section (1) may, within thirty days from the date of communication to him of the order, prefer an appeal to the Central Government. (b) The decision of the Central Government on such appeal, and subject thereto, the order made by the Reserve Bank under sub-section (1) shall be final and shall not be called into question in any court. (4) Where any order is made in respect of a chairman, director or chief executive officer or other officer or employee of a banking company under sub-section (1), he shall cease to be a chairman or, as the case may be, a director, chief executive officer or other officer or employee of the banking company and shall not, in any way, whether directly, or indirectly be concerned with, or take part in the management of, any banking company for such period not exceeding five years as may be specified in the order. (5) If any person in respect of whom an order is made by the Reserve Bank under sub-section (1) or under the proviso to sub-section (2) contravenes the provisions of this section, he shall be punishable with fine which may extend to two hundred and fifty rupees for each day during which such contravention continues. (6) Where an order under sub-section(1) has been made, the Reserve Bank, may, by order in writing, appoint a suitable person in place of the chairman or director or chief executive officer or other officer or employee who has been removed from his office under that sub-section, with effect from such date as may be specified in the order.

(7) Any person appointed as chairman, director or chief executive officer or other officer or employee under this section, shall _ (a) hold office during the pleasure of the Reserve Bank and subject thereto for a period not exceeding three years or such further period not exceeding three years at a time as the Reserve Bank may specify: (b) not incur any obligation or liability by reason only of his being a chairman, director or chief executive officer or other officer or employee or for anything done or omitted to be done in good faith in the execution of the duties of his office or in relation thereto. (8) Notwithstanding anything contained in any law or in any contract, memorandum or articles of association, on the removal of a person from office under this section, that person shall not be entitled to claim any compensation for the loss or termination of office. 5.3 ADDITIONAL DIRECTORS 36AB : Power of Reserve Bank to appoint additional directors (1) If the Reserve Bank is of opinion that in the interest of banking policy or in the public interest or in the interests of the banking company or its depositors it is necessary so to do, it may, from time to time by order in writing, appoint, with effect from such date as may be specified in the order, one or more persons to hold office as additional directors of the banking company : (2) Any person appointed as additional director in pursuance of this section(a) shall hold office during the pleasure of the Reserve Bank and subject thereto for a period not exceeding three years or such further periods not exceeding three years at a time as the Reserve Bank may specify ; (b) shall not incur any obligation or liability by reason only of his being a director or for anything done or omitted to be

done in good faith in the execution of the duties of his office or in relation thereto; and (c) shall not be required to hold qualification-shares in the banking company. (3) For the purpose of reckoning any proportion of the total number of directors of the banking company, any additional director appointed under this section shall not be taken into account. 36-AC: Part II-A to override other laws Any appointment or removal of a director, chief executive officer or other officer or employee in pursuance of Section 36-AA or Section 36-AB shall have effect notwithstanding anything to the contrary contained in the Companies Act, 1956, or any other law for the time being in force or in any contract or any other instrument. The powers conferred are Draconian. Many of these also cannot be challenged in a court. The Act has saved the applicability of the other laws through many of these sections. The Reserve Bank of India have exercised some of these powers. There are cases when these powers were exercised under political pressures on the Reserve Bank which is only an extended arm of the government. 5.4 CONCLUDING REMARKS RBI has general regulatory power on the management of the banking companies in general and Nationalised Banks in particular. The Central Government has also some controlling functions. It has been found over the years that the Central Government having two powers, namely, power in the role of ownership and power in the role of a controller and the Reserve Bank having its own powers and control, often may have conflicting interests. The ownership interest of the Government and the controlling interest of the RBI may conflict. In most of these conflict interest situations RBI fails to have its say. This has weakened the management of the Nationalised Banks.

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6. AMALGAMATION AND RECONSTRUCTION SUB TOPIC 6.1 GENERAL PROVISIONS ON CONTROL OVER AMALGAMATION 6.1 CONTROL OVER AMALGAMATION AND SCHEMES OF RECONSTRUCTION The Procedure for amalgamation of banking companies is contained in Section 44 A of the Banking Regulations Act. The Section reads 44A : Procedure for amalgamation of banking companies (1) Notwithstanding anything contained in any law for the time being in force, no bankng company shall be amalgamated with another banking company, unless a scheme containing the terms of such amalgamation has been placed in draft before the shareholders of each of the banking companies concerned separately, and approved by a resolution passed by a majority in number representing two-thirds in value of the shareholders of each of the said companies, present either or by proxy at a meeting called for the purpose. (2) Notice of every such meeting as is referred to in sub-section (1) shall be given to every shareholder of each of the banking companies concerned in accordance with the relevant articles of association, indicating the time, place and object of the meeting, and shall also be published at least once a week for three consecutive weeks in not less than two newspapers which circulate in the locality or localities where the registered offices of the banking companies concerned are situated, one of such newspapers being in a language commonly understood in the locality or localities. (3) Any shareholder, who has voted against the scheme of amalgamation at the meeting or has given notice in writing at or prior to the meeting to the company concerned or to the presiding officer of the meeting that he dissents from the scheme of amalgamation, shall be entitled, in the event of the scheme being sanctioned by the Reserve Bank, to claim from the banking company concerned, in respect of the shares held by him in that company, their value as determined by the Reserve Bank when sanctioning the scheme and such determination by the Reserve Bank as to the value of the shares to be paid to the dissenting shareholder shall be final for all purposes. (4) If the scheme of amalgamation is approved by the requisite majority of shareholders in accordance with the provisions of this section, it shall be submitted to the Reserve Bank for sanction and shall, if sanctioned by the Reserve Bank by an order in writing passed in this behalf, be binding on the banking companies concerned and also on all the shareholders thereof. (5) x x x x x x 96 (Sys 4) - D:\shinu\lawschool\books\module\contract law

(6) On the sanctioning of a scheme of amalgamation by the Reserve Bank, the property of the amalgamated banking company shall, by virtue of the order of saction, be transferred to and vest in, and the liabilities of the said company shall, by virtue of the said order be transferred to, and become the liabilities of, the banking company which under the scheme of amalgamation is to acquire the business of the amalgamated banking company, subject in all cases to the provisions of the scheme as sanctioned. (6A) Where a scheme of amalgamation is sanctioned by the Reserve Bank under the provisions of this section, the Reserve Bank may, by a further order in writing, direct that on such date as may be specified therein the banking company (hereinafter in this section referred as the amalgamated banking company) which by reason of the amalgamation will cease to function, shall stand dissolved and any such direction shall take effect notwithstanding anything to the contrary contained in any other law. (6B)Where the Reserve Bank directs a dissolution of the amalgamated banking company, it shall transmit a copy of the order directing such dissolution to the Registrar before whom the banking company has been registered and on receipt of such order the Registrar shall strike off the name of the Company. (6C) An order under sub-section (4), whether made before or after the commencement of Section 19 of the Banking Laws (Miscellaneous Provisions) Act, 1963 shall be conclusive evidence that all the requirements of this section relating to amalgamation have been complied with, and the copy of the said order certified in writing by an officer of the Reserve Bank to be a true copy of such order and the copy of the scheme certified in the like manner to be a true copy thereof shall, in all legal proceedings (whether in appeal or otherwise and whether instituted before or after the commencement of the said section 19), be admitted as evidence to the same extent as the original order and the original scheme. (7) Nothing in the foregoing provisions of this section shall affect the power of the Central Government to provide for the amalgamation of two or more banking companies under Section 396 of the Companies Act, 1956; Provided that no such power shall be exercised by the Central Government except after consultation with the Reserve Bank. From the above section it can be seen that 1) A scheme of amalgamation containing its terms to be approved by a majority of shareholders of both the banks. The majority of the shareholders should represent two thirds of the value of shareholders. It should be approved in a general meeting convened specially for the purpose ; 2) Sub section (2) of the section provides for the issue of notice to the share holders of both the banks ;

3) Shareholders who dissent the amalgamators or who vote against it will be entitled to receive the value of their shares as decided by the Reserve Bank of India ; 4) When the scheme of amalgamation is approved by the requisite majority of the shareholders, the scheme should be submitted to the Reserve Bank of India in writing, it shall be binding on both the banks and their shareholders; 5) As per sub-section (6) the assets and liabilities of the transferor bank shall vest in the transferee bank subject to the provisions of the scheme as sanctioned by the Reserve Bank of India; 6) In terms of Sub-section (6A), the Reserve Bank will fix a date from which the transferor or the amalgamated bank will be dissolved and will cease to function; (8) Sub-section (6B), provides for the issue of notice to the Registrar of Companies by the Reserve Bank of India for striking off the name of the transferor bank; (9) An order passed by the Reserve Bank of India under subsection (4) shall be conclusive evidence that all the requirements of this section relating to amalgamation has been complied with; (10)Sub-section (7) arms the Central Government with powers to amalgamate two or more banking companies under section 356 of the Companies Act. The proviso to the subsection provides for consultation by the Central Government with the Reserve Bank of India. Section 44B of the Act lays down Restriction on compromise or arrangement between banking company and creditors - (1) Notwithstanding anything contained in any law for the time being in force, no High Court shall sanction a compromise or arrangement between a banking company and its creditors or any class of them or between such company and its members or any class of them or sanction any modification in any such compromise or arrangement unless the compromise or arrangement or modification, as the case may be, is certified by the Reserve Bank in writing as not being incapable of being worked and as not being detrimental to the interests of the depositors of such banking company. (2) Where an application under Section 391 of the Companies Act, 1956, is made in respect of a banking company, the High Court may direct the Reserve Bank to make an inquiry in relation to the affairs of the banking company and the conduct of its directors and when such a direction is given, the Reserve Bank shall make such enquiry and submit its report to the High Court. (3) Where an application under Section 391 of the Companies Act, 1956, is made in respect of a banking company,the High Court may direct the Reserve Bank to make an inquiry in relation to the affairs of the Banking company and the conduct of its directors and when such a direction is given, the Reserve Bank shall make such inquiry and submit its report to the High Court.

Section 45 of the Banking Regulation Act empowers Reserve Bank of India to apply to the Central Government for supervision of business by a banking company and to prepare scheme of reconstitution or amalgamation. The section reads _ Power of Reserve Bank to apply to Central Government for suspension of business by a banking company and to prepare scheme of reconstitution or amalgamation (1) Notwithstanding anything contained in the foregoing provisions of this part or in any other law of any agreement or other instrument, for the time being in force, where it appears to the Reserve Bank that there is good reason so to do, the Reserve Bank may apply to the Central government for an order of moratorium in respect of a banking company. (2) The Central Government, after considering the application made by the Reserve Bank under sub-section (1), may make an order or moratorium staying the commencement or continuance of all actions and proceedings against the company for a fixed period of time on such terms and conditions as it thinks fit and proper and may from time to time extend the period so however that the total period of moratorium shall not exceed six months. (3) Except as otherwise provided by any directions given by the Central Government in the order made by it under subsection (2) or at any time thereafter, the banking company shall not during the period of moratorium make any payment to any depositors or discharge any liabilities or obligations to any other creditors. 4) During the period of moratorium, if the Reserve Bank is satisfied that(a) in the public interst or (b) in the interests of the depositors or (c) in order to secure the proper management of the banking company or (d in the interests of the banking system of the country as a whole, - it is necessary so to do, the Reserve Bank may prepare a Scheme (i) for the reconstruction of the banking company or (ii) for the amalgamation of the banking company with any other banking institution (in this section referred to as “the transferee bank”) 5) The schemes aforesaid may contain provisions for all or any of the following matters, namely (a) the constitution, name and registered office, the capital, assets powers, rights, interests, authorities and privileges, the laibilities, duties and obligations of the banking company on its reconstruction or, as the case may be, of the transferee bank; (b) in the case of amalgamation of the banking company, the transfer to the transferee bank of the business, properties, assets and liabilities of the banking company on such terms and conditions as may be specified in the scheme ; 97 (Sys 4) - D:\shinu\lawschool\books\module\contract law

(c) any change in the Board of Directors, or the appointment of a new Board of Directors, of the banking company on its reconstruction, or as the case may be, of the transferee bank and the authority by whom, the manner in which, and the other terms and conditions, on which, such change or appointment shall be made and in the case of appointment of a new Board of Directors or of any director, the period for which such appointment shall be made ; (d) the alteration of the memorandum and articles of association of the banking company on its reconstruction or, as the case may be, the transferee bank, for the purpose of altering the capital thereof or for such other purposes as may be necessary to give effect to the reconstruction or amalgamation; (e) subject to the provisions of the scheme, the continuation by or against the banking company on its reconstruction, or as the case may be, the transferee bank, of any actions or proceedings pending against the banking company immediately before the date of the order of moratorium; (f) the reduction of the interest or rights which the members, depositors and other creditors have in or against the banking company before its reconstruction or amalgamation to such extent as the Reserve Bank considers necessary in the public interest or in the interest of the members, depositors and other creditors or for the maintenance of the business of the banking company; (g) the payment in cash or otherwise to depositors and other creditors in full satisfaction of their claim _ (i) in respect of their interest or rights in or against the banking company before its reconstruction or amalgamation ; or (ii) where their interests or rights aforesaid in or against the banking company has or have been reduced under clause (f), in respect of such interest or rights as so reduced ; (h) the allotment to the members of the banking company for shares held by them therein before its reconstruction or amalgamation whether their interest in such shares has been reduced under clause (f) or not, of shares in the banking company on its reconstruction or, as the case may be, in the transferee bank and where any members claim payment in cash and not allotment of shares, or where it is not possible to allot shares to any members, the payment in cash to those members in full satisfaction of their claim _ (i) in respect of their interest in shares in the banking company before its reconstruction or amalgamation ; or (ii) where such interest has been reduced under clause (f) in respect of their interest in shares as so reduced; (i) the continuance of the services of all the employees of the banking company (excepting such of them as not being workmen specifically mentioned in the scheme) in the banking company itself on its reconstruction or, as the case may be, in the transferee 98 (Sys 4) - D:\shinu\lawschool\books\module\contract law

bank at the same remuneration and on the same terms and conditions of service, which they were getting or as the case may be, by which they were being governed, immediately before the date of the order of the moratorium : Provided that the scheme shall contain a provision that i) the banking company shall pay or grant not later than the expiry of the period of three years from the date on which the scheme is sanctioned by the Central Government, to the said employees the same remuneration and the same terms and conditions of service as are, at the time of such payment or grant, applicable to employees of corresponding rank or status of a comparable banking company to be determined for this purpose by the Reserve Bank whose determination in this respect shall be final; ii) the transferee bank shall pay or grant not later than the expiry of the aforesaid period of three years, to the said employees the same remuneration and the same terms and conditions of service as are, at the time of such payment or grant, applicable to the other employees of corresponding rank or status of the transferee bank subject to the qualifications and experience of the said employees of the transferee bank: Provided further that if in any case under clause (ii) of the first proviso any doubt or difference arises as to the said employees are the same as or equivalent to the qualifications and experience of the other employees of corresponding rank or status of the transferee bank, the doubt or difference shall be referred, before the expiry of a period of three years from the date of payment or grant mentioned in that clause to the Reserve Bank whose decision thereon shall be final; (j) notwithstanding anything contained in clause (i) where any of the employees of the banking company not being workmen within the meaning of the Industrial Disputes Act, 1947 are specifically mentioned in the scheme under clause (i), or where any employees of the banking company or, as the case may be, the transferee bank at any time before the expiry of one month next following the date on which the scheme is sanctioned by the Central Government, intimated their intention of not becoming employees of the banking company on its reconstruction or, as the case may be, of the transferee bank, the payment to such employees of compensation, if any, to which they are entitled under the Industrial Disputes Act, 1947, and such pension, gratuity, provident fund and other retirement benefits ordinarily admissible to them under the rules or authorisations of the banking company immediately before the date of the order of moratorium; (k) any other terms and conditions for the reconstruction or amalgamation of the banking company ; (l) such incidental, consequential and supplemental matters as are necessary to secure that the reconstruction or amalgamation shall be fuly and effectively carried out.

6) (a)

A copy of the scheme prepared by the Reserve Bank shall be sent in draft to the banking company and also to the transferee bank and any other banking company concerned in the amalgamtion, for suggestions and objections, if any, within such period as the Reserve Bank may specify for this purpose ; (b) The Reserve Bank may make such modifications, if any, in the draft scheme as it may consider necessary in the light of the suggestions and objections received from the banking company and also from the transferee bank, and any other banking company concerned in the amalgamation and from any members, depositors or other creditors of each of those companies and the transferee bank. 7) The Scheme shall thereafter be placed before the Central Government for its sanction and the Central Government may sanction the scheme without any modifications or with such modifications as it may consider necessary; and the scheme as sanctioned by the Central Government shall come into force on such date as the Central Government may specify in this behalf; Provided that different dates may be specified for different provisions of the scheme. 7A) the sanction accorded by the Central Government under sub-section (7) whether before or after the commencement of Section 21 of the Banking Laws (Miscellaneous Provisions) Act, 1963, shall be conclusive evidence that all the requirements of this Section relating to the reconstruction, or, as the case may be, amalgamation have been complied with and a copy of the sanctioned scheme certified in writing by an officer of the Central Governmet to be true copy thereof, shall, in all legal proceedings (whether in appeal or otherwise and whether instituted before or after the commencement of the said Section 21), be admitted as evidence to the same extent as the original scheme. 8) On and from the date of the coming into operation of the scheme or any provision thereof, the scheme or such provision shall be binding on the banking company or, as the case may be, on the transferee bank and any other banking company concerned in the amalgamation and also on all the members, depositors and other creditors and employees of each of those companies and of the transferee bank, and on any other person having any right or liability in relation to any of those companies or the transferee bank including the trustees or other persons managing, or connected in any other manner with, any provident fund or other fund maintained by any of those companies or the transferee bank. 9) On and from the date of the coming into operation of, or as the case may be, the date specified in this behalf in the scheme, shall be substituted; the properties and assets of the banking company shall, by virtue of and to the extent provided in the scheme, stand transferred to, and vest in, and the liabilities of the banking company shall, by virtue

of and to the extent provided in the scheme, stand transferred to, and become the liabilities of, the transferee bank. 10) If any difficulty arises in giving effect to the provisions of the scheme, the Central Government may by order do anything not inconsistent with such provisions which appears to it necessary or expedient for the purpose of removing the difficulty. 11) Copies of the scheme or of any order made under subsection(10) shall be laid before both Houses of Parliament, as soon as may be, after the scheme has been sanctioned by the Central Government, or, as the case may be, the order has been made. 12) Where the scheme is a scheme for amalgamation of the banking company, any business acquired by the transferee bank under the scheme or under any provision thereof shall, after the coming into operation of the scheme or such provision, be carried on by the transferee bank in accordance with the law governing the transferee bank, subject to such modifications in that law or such exemptions of the transferee bank from the operation of any provisions thereof as the Central Government on the recommendation of the Reserve Bank may, by notification in the Offical Gazette, make for the purpose of giving full effect to the scheme : Provided that no such modification or exemption shall be made so as to have effect for a period of more than seven years from the date of the acquistion of such business. 13) Nothing in this section shall be deemed to prevent the amalgamation with a banking institution by a single scheme of several banking companies in respect of each of which an order of moratorium has been made under this section. 14) The provisions of this section and of any scheme made under it shall have effect notwithstanding anything to the contrary contained in any other provisions of this Act or in any of the law or any agreement, award or other instrument for the time being in force. 15) In this section, “banking institution” means any banking company and includes the State Bank of India or a subsidiary bank or a corresponding new bank. Explanation - References in this section to the terms and conditions of service as applicable to an employee shall not be construed as extending to the rank and status of such employee. The guarantee under clause (i) of Section 45(5) of the Act does not cover merely the remuneration; it covers the terms and conditions of service as well, it would be a gross denial of the guarantee if the employee is not given the rank and status which he had in the transferor bank. It is not open to the transferee bank to “fit” an employee of the transferor bank performing the duties of a clerk into a subordinate cadre manned by employees performing duties which are not clerical, but of peons, watchmen, sweepers and the like. [State Bank of Travancore Vs. Elias Elias, (1970) 2 SCC 761: (1970) 2 LLJ 424.] 99 (Sys 4) - D:\shinu\lawschool\books\module\contract law

The word ‘experience’ includes the quality of service, efficiency of organisation, and the range and the volume of business transacted. [State Bank of Travancore Vs. General Secretary, (1978)2 LLJ 305:50 Com Cas 412 : 1978 Lab IC 1343.] Framing of Scheme of amalgamation and giving a direction under clause (f) of sub-section (5) cannot be treated as an insolvency. [Simon Thomas Vs. State Bank, 1976 KLT 554 (FB).] No notice is required to be given to the employee before his name is included in the schedule of the scheme of amalgamation. Reserve Bank need not pass speaking order. [Piare Lal Vs. State Bank of India, 1973 Lab IC 761.]

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The period of three years provided in section (45)(5)(i), (ii) proviso cannot be meant to cover up the deficiencies of the transferor bank and level up to the disparity between it and the transferee bank. [State Bank of Travancore Vs. General Secretary, (1978) 2 LLJ 305:50 Com Cas 412 : 1978 Lab IC 1343.] To protect the interests of the depositors and to ensure stability of the banking institutions there have been a number of amalgamation of weaker banks with stronger banks. Instances in which a Bank has been fully wound up or liquidated has not been there in the last three decades.

7. ACCOUNTS AND AUDIT SUB TOPIC 7.1 General Control over Accounts and Audit 7.1 GENERAL CONTROL OVER ACCOUNTS AND AUDIT Section 29 of the Banking Regulation Act deals with Accounts and Balance Sheet of a Banking company. The Section reads (1) At the expiration of each calendar year or at the expiration of a period of twelve months ending with such date as the Central Government may, by notification in the Official Gazette, specify in this behalf, every banking company incorporated in India, in respect of all business transacted by it, and every banking company incorporated outside India, in respect of all business transacted through its branches in India, shall prepare with reference to that year or period, as the case may be, a balance sheet and profit and loss account as on the last working day of the year or the period, as the case may be, in the Forms set out in the Third Schedule or as near thereto as circumstances admit. Provided that with a view to facilitating the transition from one period of accounting to another period of accounting under this sub-section, the Central Government may, by order published in the Official Gazette, make such provisions as it considers necessary or expedient for the preparation of, or for other matters relating to, the balance sheet or profit and loss account in respect of the concerned year or period, as the case may be. Note:- Consequent to the amendment made in the Income-Tax Act, 1961, every assessee shall follow the uniform Accounting year beginning as on the 1st of April every year. Accordingly, Banking companies are required to prepare their balance sheet and the corrected Financial statements beginning April 1 of every year. Hence the section has to be read in lieu of what is stated above in this note. (2) The balance sheet and profit and loss account shall be signed(a) in the case of a banking company incorporated in India, by the manager or the principal officer of the company and where there are more than three directors of the company, by at least three of those directors, or where there are not more than three directors, by all directors, and (b) in the case of a banking company incorporated outside India by the manager or agent of the principal office of the company in India. (3) Notwithstanding that the balance sheet of a banking company is under sub-section (I) required to be prepared in a form other than the form set out in Part I of Schedule VI to the Companies Act, 1956, the requirements of that Act relating to the balance sheet and profit and loss account of a company shall, in so far as they are not inconsistent with this Act, apply to the balance sheet or profit and loss account, as the case may be, of a banking company.

(3-A) Notwithstanding anything to the contrary contained in sub-section (3) of section 210 of the Companies Act, 1956 (1 of 1956), the period to which the profit and loss account relates shall, in the case of a banking company, be the period ending with the last working day of the year immediately preceding the year in which the annual general meeting is held. Explanation - In Sub-section (3-A), “year” means the year or, as the case may be, the period referred to in sub-section (1).” The third schedule prescribed in the section has undergone a great change from the Accounting year ending March 1993, particularly those relating to the classification of assets. Section 30 of the Banking Regulation Act deals with ‘Audit’, and Sections 31, 32, 33, 34 and 34A deal with the related provisions The sections read Section 30 AuditThe balance sheet and profit and loss account prepared in accordance with section 29 shall be audited by a person duly qualified under any law for the time being in force to be an auditor of companies. (1A) Notwithstanding anything contained in any law for the time being in force or in any contract to the contrary, every banking company shall, before appointing, reappointing or removing any auditor, or auditors obtain the previous approval of the Reserve Bank. (1B) Without prejudice to anything contained in the Companies Act, 1956, or any other law for the time being in force, where the Reserve Bank is of opinion that it is necessary in the public interest or in the interests of the banking company or its depositors to do so, it may at any time, by order direct that a special audit of the banking company’s accounts, for any such transaction or class of transactions or for such period or periods as may be specified in the order, shall be conducted and may by the same or a different order either appoint a person duly qualified under any law for the time being in force to be an auditor of companies or direct the auditor of the banking company himself to conduct such special audit, and the auditor shall comply with such directions and make a report of such audit to the Reserve Bank and forward a copy thereof to the company. (1C) The auditor shall have the powers of, exercise the functions vested in, and discharge the duties and be subject to the liabilities and penalties imposed on, auditors of companies by Section 227 of the Companies Act, 1956 and auditors, if any, appointed by the law establishing, constituting or forming the banking company concerned. (3) In addition to the matters which under the aforesaid Act the auditor is required to state in his report, he shall, in the case of a banking company incorporated in India, state in his report 101 (Sys 4) - D:\shinu\lawschool\books\module\contract law

(a) whether or not the information and explanations required by him have been found to be satisfactory ; (b) whether or not the transactions of the company which have come to his notice have been within the powers of the Company; (c) whether or not the returns received from branch offices of the company have been found adequate for the purposes of his audit ; (d) whether the profit and loss account shows a true balance of profit and loss for the period covered by such account ; (e) any other matter which he considers should be brought to the notice of the shareholders of the company. Section 31: Submission of returns The accounts and balance sheet referred to in Section 29 together with the auditor’s report shall be published in the prescribed manner and three copies thereof shall be furnished as returns to the Reserve Bank within three months from the end of the period to which they refer : Provided that the Reserve Bank may in any case extend the said period of three months for the furnishing of such returns by a further period not exceeding three months: Provided further that a regional rural bank shall furnish returns also to the National Bank. Section 32: (1) copies of balance sheets and accounts to be sent to Registrar Where a banking company in any year furnished its accounts and balance sheet in accordance with the provisions of Section 31, it shall at the same time send to the registrar three copies of such accounts and balance sheet and of the auditor’s report, and where such copies are so sent, it shall not be necessary to file with the registrar, in the case of public company, copies of accounts and balance-sheet and of the auditor’s report, and, in the case of a private company, copies of the balance sheet and of the auditor’s report as required by sub-section (1) of Section 220 with the same fee and shall be dealt within all respects as if they were filed in accordance with that section. (2) When in pursuance of sub-section (2) of Section 27 the Reserve Bank requires any additional statement or information in connection with the balance sheet and accounts furnished under Section 31, the banking company shall, when supplying each statement or information, send a copy thereof to the registrar. Section 33 : Display of audited balance sheets by companies incorporated outside India Every banking company incorporated [outside India] shall, not later than the first Monday in August of any year in which it carries on business, display in a conspicuous place in its principal office and in every branch office [in India] a copy of its last audited balance sheet and profit and loss account prepared under Section 29, shall keep the copy so displayed until replaced by a copy of the subsequent balance sheet and profit and loss account so prepared, and every such banking company shall 102 (Sys 4) - D:\shinu\lawschool\books\module\contract law

display in like manner copies of its complete audited balance sheet and profit and loss account relating to its banking business as soon as they are available, and shall keep the copies so displayed until copies of such subsequent accounts are available. Section 34 : Accounting provisions of the Act not retrospective Nothing in this Act shall apply to the preparation of accounts by a banking company and the audit and submission thereof in respect of any accounting year which has expired prior to the commencement of this Act, and notwithstanding the other provisions of this Act, such accounts shall be prepared, audited and submitted in accordance with the law in force immediately before the commencement of this Act. Section 34-A : Production of documents of confidential nature (1) Notwithstanding anything contained in Section 11 of the Industrial Disputes Act. 1947, or other law for the time being in force, no banking company shall, in any proceeding under the said Act or in any appeal or other proceeding arising therefrom or connected therewith, be compelled by any authority before which such proceeding is pending to produce, or give inspection of, any of its books of account or other document or furnish or disclose any statement or information, when the banking company claims that such document, statement or inspection of such document or the furnishing of disclosure of such statement or information would involve disclosure of information relating to (a) any reserves not shown in its published balance-sheet; or (b) any particulars not shown therein in respect of provisions made for bad and doubtful debts and other usual or necessary provisions. (2) If any such proceeding in relation to any banking company other than the Reserve Bank of India, any question arises as to whether any amount out of the reserves or provisions referred to in sub-section (1) should be taken into account by the authority before which such proceeding is pending the authority, may, if it so thinks fit, refer the question to the Reserve Bank and the Reserve Bank shall, after taking into account principles of sound banking and all relevant circumstances concerning the banking company, furnish to the authority a certificate stating that the authority shall not take into account any amount as such Reserves and provisions of the banking company or may take them into account only to the extent of the amount specified by it in the certificate, and the certificate of the Reserve Bank on such question shall be final and shall not be called in question in any such proceeding. (3) For the purposes of this section “banking company” includes the Reserve Bank, the Development Bank, the Exim Bank, the Reconstruction Bank, the National Housing Bank, the national Bank, the Small Industries Bank, the State Bank of India, a corresponding new bank a regional rural bank and a subsidiary bank.

Section 35: Inspection (1) Notwithstanding anything to the contrary contained in Section 235 of the Companies Act, 1956, the Reserve Bank at any time may, and on being directed so to do by the Central Government shall, cause an inspection to be made by one or more of its officers of any banking company and its books and accounts; and the Reserve Bank shall supply to the banking company a copy of its report on such inspection. 1-A : (a) Notwithstanding to the contrary contained in any law for the time being in force and without prejudice to the provisions of sub-section (1), the Reserve Bank, at any time, may also cause a scrutiny to be made by any one or more of its officers, of the affairs of any banking company and its books and accounts; and (b) a copy of the report of the scrutiny shall be furnished to the banking company if the banking company makes a request for the same or if any adverse action is contemplated against the banking company on the basis of the scrutiny. (2) It shall be the duty of every director or other officer or employee of the banking company to produce to any officer making an inspection under sub-section (1) or a scrutiny under sub-section (1A) all such books, accounts and other documents in his custody or power to furnish him with any statements and information relating to the affairs of the banking company as the said officer may require of him within such time as the said officer may specify. (3) any person making an inspection under sub-section (1) or a scrutiny under sub-section (1A) may examine on oath any director or other officer or employee of the banking company in relation to its business, and may administer an oath accordingly. (4) The Reserve Bank shall, if it has been directed by the Central Government to cause an inspection to be made, and may, in any other case, report to the Central Government on any inspection or scrutiny made under this section, and the Central Government, if it is of opinion after considering the report that the affairs of the banking company are being conducted to the detriment of the interest of the depositors, may, after giving such opportunity to the banking company to make a representation in connection with the report as,

in the opinion of the Central government, seems reasonable, by order in writing (a) prohibit the banking company from receiving fresh deposits; (b) direct the Reserve Bank to apply under Section 38 for the winding up of the banking company; Provided that the Central Government may defer, for such period as it may think fit, the passing of an order under this sub-section, or cancel or modify any such order upon such terms and conditions as it may think fit to impose. (5) The Central Government may, after giving reasonable notice to the banking company, publish the report submitted by the Reserve Bank or such portion thereof as may appear necessary. Explanation: For the purposes of this section, the expression “banking company” shall include i) in the case of a banking company incorporated outside India, all its branches in India; and ii) in the case of a banking company incorporated in India a) all its subsidiaries formed for the purpose of carrying on the business of banking exclusively outside India; and b) all its branches whether situated in India or outside India. (6) the powers exercisable by the Reserve Bank under this section in relation to regional rural banks may without prejudice to the exercise of such powers by the Reserve Bank in relation to any regional rural bank whenever it considers necessary so to do to be exercised by the national Bank in relation to the regional rural banks as if every reference therein to the Reserve Bank included also a reference to the National Bank. Sub-section (4) of section 35 relates to Bank for which licence has already been given. [Sajjan Bank (P) Ltd. Vs. Reserve Bank of India, AIR 1961 Mad 8.] It is open to the Reserve Bank to consider the defects or improvements revealed in an application under Section 35 for disposing of the application for licence as there is nothing in the Act to prohibit it from taking into consideration all relevant facts. [Sajjan Bank (P) Ltd Vs. Reserve Bank of India, AIR 1961 Mad 8].

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8 OTHER POWERS OF R.B.I. The other powers, which are specifically enacted are detailed in the following sections of the Banking Regulations Act. These are 1) Section 35A of the Banking Regulations Act, 1949 deals with the “Power of Reserve Bank” to give directions. The section reads 35A : Power of the Reserve Bank to give directions (1) Where the Reserve Bank is satisfied that (a) in the public interest; or (aa) in the interest of banking policy; or (b) to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company; or (c) to secure the proper management of any banking company generally; It may be required to issue directions to banking companies generally or to any banking company in particular, RBI from time to time, issues such directions as it deems fit, and the banking companies or the banking company, as the case may be, shall be bound to comply with such directions. (2) The Reserve Bank may, on representation made to it or on its own motion, modify or cancel any direction issued under sub-section (I), and in so modifying or cancelling any direction may impose such conditions as it thinks fit, subject to which the modification or cancellation shall have effect. The Reserve Bank is entitled to give directions to bankers under Section 20(3) of the Foreign Exchange Regulation Act, 1947 blocking certain accounts. Section 20(3) does not contemplate the issue of a prior notice before taking such action under that section. [Mohamed Ayisha Nachiyar Vs. Deputy Director, Enforcement, (1976) 46 Com Cas 653 (Mad)] Directions by Reserve Bank cannot prevent payment of higher bonus in terms of the agreement. [American Express International Banking Corp. Vs. S.Sundaram, (1978) I SCC 101: 1978 SCC (L & S) 34.] 2) Section 36: Further powers and functions of Reserve Bank. The Reserve Bank may (a) caution or prohibit companies generally or any banking company in particular against entering into any particular transaction or class of transactions, and generally give advice to any banking company; (b) on a request by the companies concerned and subject to the provisions of Section 44A, assist, as intermediary or otherwise, in proposals for the amalgamation of such banking companies; (c) give assistance to any banking company by means of the grant of a loan or advance to it under clause (3) of sub104 (Sys 4) - D:\shinu\lawschool\books\module\contract law

section (1) of Section 18 of the Reserve Bank of India Act, 1934; (d) at any time, if it is satisfied that in the public interest or in the interest of banking policy or for preventing the affairs of the banking company being conducted in a manner detrimental to the interests of the banking company or its depositors it is necessary so to do, by order in writing and on such terms and conditions as may be specified therein(i) require the banking company to call a meeting of its directors for the purpose of considering any matter relating to or arising out of the banking company, or require an officer of the banking company to discuss any such matter with an officer of the Reserve Bank; (ii) depute one or more of its officers to watch the proceedings at any meeting of the Board of Directors of the banking company or of any committee or of any other body constituted by it; require the banking company to give an opportunity to the officers so deputed to be heard at such meetings and also require such officers to send a report to such proceedings to the Reserve Bank; (iii) require the Board of Directors of the banking company or any committee or any other body constituted by it to give in writing to any officer specified by the Reserve Bank in this behalf at this usual address all notices of, and other communications relating to, any meeting of the Board, committee or other body constituted by it; (iv) appoint one or more of its officers to observe the manner in which the affairs of the banking company or of its offices or branches are being conducted and make a report thereon; (v) require the banking company to make, within such time as may be specified in the order, such changes in the management as the Reserve Bank may consider necessary. II. The Reserve Bank shall make an annual report to the Central Government on the trend and progress of banking in the country, with particular reference to its activities under clause (2) of Section 17 of the Reserve Bank of India Act, 1934, including in such report its suggestions, if any, for the strengthening of banking business throughout the country. III. The Reserve Bank may appoint such staff at such places as it considers necessary for the scrutiny of the returns, statements and information furnished by banking companies under this Act, and generally to ensure that efficient performance of its functions under this Act. Section 45(P): RBI to tender advice in winding up proceedings Where in any proceeding for the winding up of a banking company in which any person other than the Reserve Bank has

been appointed as the official liquidator and the High court has directed the official liquidator to obtain the advice of the Reserve Bank on any matter (which it is hereby empowered to do), it shall be lawful for the Reserve Bank to examine the record of any such proceeding and tender such advice on the matter as it may think fit. Sections 45(Q) and 45(R) lay down :Section 45(Q): Power to inspect (1) The Reserve Bank shall, on being directed so to do by the Central Government or by the High court, cause an inspection to be made by one or more of its officers of a banking company which is being wound up and its books and accounts. (2) On such inspection, the Reserve Bank shall submit its report to the Central Government and the High Court. (3) If the Central government, on consideration of the report of the Reserve Bank, is of opinion that there has been a substantial irregularity in the winding up proceedings, it may bring such irregularity to the notice of the High court for such action as the High Court may think fit. (4) On receipt of the report of the Reserve Bank under subsection (2) or on any irregularity being brought to its notice by the Central government under sub-section (3), the High court may, if it deems fit, after giving notice to and hearing the Central Government in regard to the report, give such directions as it may consider necessary. 45(R): Power to call for returns and information The Reserve Bank may, at any time by a notice in writing, require the liquidator of a banking company to furnish it, within such time as may be specified in the notice or such further time as the Reserve Bank may allow, any statement or information relating to or connected with the winding up of the banking company; and it shall be the duty of every liquidator to comply with such requirements. Explanation : For the purposes of this section and Section 45Q, a banking company working under a compromise or arrangement but prohibited from receiving fresh deposits, shall, as far as may be, deemed to be a banking company which is being wound up. Section 47: Cognizance of offences No court shall take cognizance of any offence punishable under sub-setion (5) of Section 36AA or Section 46 except upon complaint in writing made by an officer of the Reserve Bank or, as the case may be, the National Bank generally or specially authorised in writing in this behalf by the Reserve Bank or, as the case may be, the National Bank and no court other than that of a Metropolitan Magistrate or a Judicial Magistrate of the first class or any court superior thereto shall try any such offence. 47A : Power of Reserve Bank to impose penalty (1) notwithstanding anything contained in Section 46, if a contravention or default of the nature referred to in sub-section

(3) or sub-section (4) of Section 46, as the case may be, is made by a banking company, then, the Reserve Bank may impose on such banking company (a) where the contravention is of the nature referred to in sub-section (3) of Section 46, a penalty not exceeding twice the amount of the deposits in respect of which such contravention was made; (b) where the contravention or default is of the nature referred to in Sub-section (4) of Section 46, a penalty not exceeding two thousand rupees; and where such contravention or default is a continuing one, a further penalty which may extend to one hundred rupees for every day, after the first, during which the contravention or default continues. (2) for the purpose of adjudging the penalty under sub-section (1), the Reserve Bank shall hold an inquiry in the prescribed manner after giving the banking company a reasonable opportunity of being heard. (3) While holding an inquiry under this section, the Reserve Bank shall have power to summon and enforce the attendance of any person to give evidence or to produce any document or any other thing which, in the opinion of the Reserve Bank, may be useful for, or relevant to, the subject matter of the enquiry. (4) No complaint shall be filed against any banking company in any court of law in respect of any contravention or default in respect of which any penalty has been imposed by the Reserve Bank under this section. (5) Any penalty imposed by the Reserve Bank under this section shall be payable within a period of fourteen days from the date on which notice issued by the Reserve Bank demanding payment of the sum is served on the banking company and in the event of failure of the banking company to pay the sum within such period, may be levied on a direction made by the principal civil court having jurisdiction in the area where the registered office of the banking company is situated; or, in the case of a banking company incorporated outside India, where its principal place of business in India is situated: Provided that no such direction shall be made except on an application made to the Court by the Reserve Bank or any officer authorised by that Bank in this behalf. (6) The court which makes a direction under Sub-section (5) shall issue a certificate specifying the sum payable by the banking company and every such certificate shall be enforceable in the same manner as it were a decree made by the court in a civil suit. (7) Where any complaint has been filed against any banking company in any court in respect of the contravention or default of the nature referred to in sub-section (4) of Section 46, then, no proceedings for the imposition of any penalty on the banking company shall be taken under this section. Sections 49A, 49B and 49C deal with the following: 105 (Sys 4) - D:\shinu\lawschool\books\module\contract law

49A : Restriction on acceptance of deposits withdrawable by cheque No person other than a banking company, the Reserve Bank, the State Bank of India or any other banking institution, firm or other person notified by the Central Government in this behalf on the recommendation of the Reserve Bank shall accept from the public deposits of money withdrawable by cheque: Provided that nothing contained in this section shall apply to any savings bank scheme run by the Government. 49B : Change of name by a banking Company Notwithstanding anything contained in Section 21 of the Companies Act 1956, the Central Government shall not signify

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its approval to the change of name of any banking company unless the Reserve Bank certifies in writing that it has no objection to such change. 49C : Alteration of memorandum of a banking company Notwithstanding anything contained in the Companies Act, 1956, no application for the confirmation of the alteration of the memorandum of a banking company shall be maintainable unless the Reserve Bank certifies that there is no objection to such alteration.

9. OTHER POWERS OF THE CENTRAL GOVERNMENT Section 36AE: Power of Central Government to acquire undertakings of banking companies in the following cases (1) If upon receipt of a report from the Reserve Bank, the Central Government is satisfied that a banking company (a)

has, on more than one occassion, failed to comply with the directions given to it in writing under Section 21 or Section 35-A, in so far as such directions relate to banking policy, or

(b)

is being managed in a manner detrimental to the interest of its depositors,

and that (i) (ii)

in the interests of the depositors of such banking company, or in the interest of banking policy, or

(iii) for the better provision of credit generally or of credit to any particular section of the community or in any particular area; It is necessary to acquire the undertaking of such banking company, the Central Government, may, after such consultation with the Reserve Bank as it thinks fit, by notified order, acquire the undertaking of such company (hereinafter referred to as the acquired bank) with effect from such date as may be specified in this behalf by the Central Government (hereinafter referred to as the appointed day) : Provided that no undertaking of any banking company shall be so acquired unless such banking company has been given a reasonable opportunity of showing cause against the proposed action. Explanation - In this part, (a)

“notiified order” means an order published in the Official Gazette;

(b)

“undertaking”, in relation to a banking company incorporated outside India, means the undertaking of the company in India.

(2) Subject to the other provisions contained in this Part, on the appointed day, the undertaking of the acquired bank and all the assets and liabilities of the acquired bank shall stand transferred to, and vest in, the Central Government. (3) The undertaking of the acquired bank and its assets and liabilities shall be deemed to include all rights, powers, authorities and privileges and all property, whether movable, or immovable, including in particular, cash balances, reserve funds, investments, deposits and all other interests and right in, or arising out of such property as may be in the possession of, or held by, the acquired bank immediately before the appointed day and all books, accounts and documents relating thereto, and shall also be deemed to include all debts, liabilities and obligations, of whatever kind, then existing of the acquired bank.

(4) Notwithstanding anything contained in sub-section (2), the Central Government may, if it is satisfied that the undertaking of the acquired bank and its assets and liabilities should, instead of vesting in the Central Government, or continuing to so vest in a company established under any scheme made under this Part or in any corporation (hereinafter in this part and in the Fifth Schedule referred to as the transferee bank) that government may, by order, direct that the said undertaking, including the assets and liabilities thereof, shall vest in the transferee bank either on the publication of the notified order or on such other date as may be specified in this behalf by the Central Government. (5) Where the undertaking of the acquired bank and the assets and liabilities thereof vest in the transferee bank under subsection(4), the transferee bank, shall, on and from the date of such vesting, be deemed to have become and trasferee of the acquired bank and all the rights and liabilities in relation to the acquired bank shall, on and from the date of such vesting, be deemed to have been the rights and liabilities of the transferee bank. (6) Unless otherwise expressly provided by or under this Part, all contracts, deeds, bonds, agreements, powers of attorney, grants of legal representation and other instruments of whatever nature subsisting or having effect immediately before the appointed day and to which the acquired bank is a party or which are in favour of the acquired bank shall be of full force and effect against or in favour of the Central Government, or as the case may be, of the transferee bank, and may be enforced or acted upon as fully and effectually as if in the place of the acquired bank the Central Government or the transferee bank had been a party thereto or as if they had been issued in favour of the Central Government or the transferee bank, as the case may be. (7) If, on the appointed day, any suit, or other proceeding of whatever nature is pending by or against the acquired bank, the same shall not abate, be discontinued or be, in anyway, prejudicially affected by reason of the transfer of the undertaking of the acquired bank or of anything contained in this Part, but the suit, appeal or other proceeding may be continued, prosecuted and enforced by or against the Central Government or the transferee bank, as the case may be. 36AF : Power of the Central government to make scheme (1) The Central Government may, after consultation with the Reserve Bank, make a scheme for carrying out the purposes of this Part in relation to any acquired bank. (2) In particular, and without prejudice to the generality of the foregoing power, the said scheme may provide for all or any of the following matters namely :107 (Sys 4) - D:\shinu\lawschool\books\module\contract law

the Corporation, or the company incorporated for the purpose, to which the undertaking including the property, assets and liabilities of the acquired bank may be transferred, and the capital, constitution, name and office thereof.

(4) Every scheme under this section shall be published in the Official Gazette.

(b)

the constitution of the first Board of management (by whatever name called) of the transferee bank, and all such matters in connection therewith or incidental thereto as the Central Government may consider to be necessary or expedient ;

(6) The provisions of this Part and to any scheme made thereunder shall have effect notwithstanding anything to the contrary contained in any other provisions of this Act or in any other law or any agreement, award or other instrument for the time being in force.

(c)

the continuance of the services of all the employees of the acquired bank (excepting such of them as, not being workmen within the meaning of the Industrial Disputes Act, 1947, are specifically mentioned in the scheme) in the Central Government or in the transferee bank, as the case may be, on the same terms and conditions so far as may be, as are specified in clauses (i) and (j) of sub-section (5) of Section 45;

(7) Every scheme made under this section shall be binding on the Central Government or, as the case may be, on the transferee bank and also on all members, creditors, depositors and employees of the acquired bank and of the transferee bank and on any other person having any right, liaibility, power or function in relation to, or in connection with, the acquired bank or the transferee bank, as the case may be.

(d)

the continuance of the right of any person who, on the appointed day, is entitled to or in receipt of, pension or other superannuation or compassionate allowance or benefit, from the acquired bank or any provident, pension or other fund or any authority administering such fund, to be paid by, and to receive from, the Central Government or the transferee bank, as the case may be, or any provident fund, pension or other fund or any authority administering such fund, the same pension, allowance or the benefit so long as he observes the conditions on which the pension, allowance or benefit was granted, and if any question arises whether he has so observed such conditions, the question shall be determined by the Central Government and the decision of the Central Government thereon shall be final;

36AG: Compensation to be given to shareholders of the acquired bank

(a)

(e)

(f)

(g)

the manner of payment of compensation payable in accordance with the provisions of this Part to the shareholders of the acquired bank, or where the acquired bank is a banking company incorporated outside India, to the acquired bank in full satisfaction of their, or as the case may be, its, claims ; the provision, if any, for completing the effectual transfer to the Central Government or the transferee bank of any asset or any laibility which forms part of the undertaking of the acquired bank in any country outside India; such incidental, consequential and supplemental matters as may be necessary to secure that the transfer of the business, property, assets and liabilities of the acquired bank to the Central Government or transferee bank, as the case may be, is effectual and complete.

(3) The Central government may, after consultation with the Reserve Bank, by notification in the Official Gazette, and to, amend or vary any scheme made under this section. 108 (Sys 4) - D:\shinu\lawschool\books\module\contract law

(5) Copies of every scheme made under this section shall be laid before each House of Parliament as soon as may be after it is made.

(1) Every person who, immediately before the appointed day, is registered as a holder of shares in the acquired bank or, where the acquired bank is a banking company incorporated outside India, the acquired bank, shall be given by the Central Government, or the transferee bank, as the case may be, such compensation in respect of the transfer of the undertaking of the acquired bank as is determined in accordance with the principles contained in the Fifth Schedule. (2) Nothing contained in sub-section (1) shall affect the rights inter se between the holder of any share in the acquired bank and any other person who may have any interest in such shares and such other persons shall be entitled to enforce his interest against the compensation awarded to the holder of such share, but not against the Central Government, or the transferee bank. (3) The amount of compensation to be given in accordance with the principles contained in the Fifth schedule shall be determined in the first instance by the Central Government, or the transferee bank, as the case may be, in consultation with the Reserve Bank, and shall be offered by it to all those to whom compensation is payable under sub-section (1) in full satisfaction thereof. (4) If the amount of compensation offered in terms of subsection (3) is not acceptable to any person to whom the compensation is payable, such person may, before such days as may be notified by the Central Government in the Official Gazette, requrest the Central Government in writing, to have the matter referred to the Tribuanl constituted under Section 36AH. (5) If, before the date notified under sub-section (4), the Central Government receives requests, in terms of that sub-section,

from not less than one-fourth in number of the share holders holding not less than one fourth in value of the paid up share capital of the acquired bank, or, when the acquired bank is a company incorporated outside India, from the acquired bank, the Central Government shall have the matter referred to the Tribunal for decision. (6) If, before the date notified under sub-section (4), the Central Government does not receive requests as provided in that sub-section, the amount of compensation offered under subsection (3), and where a reference has been made to the Tribunal, the amount determined by it, shall be the compensation payable under sub-section (1) and shall be final and binding on all parties concerned. 36AH: Constitution of the Tribunal (1) The Central Government may, for the purpose of this Part, constitute a Tribunal which shall consist of a chairman and two other members. (2) The Chairman shall be a person who is, or has been, a judge of a High Court or of the supreme court, and, of the two other members, one shall be a person, who, in the opinion of the Central Government, has had experience of commercial banking and the other shall be a person who is a chartered accountant within the meaning of the Chartered Accountants Act, 1949. (3) If, for any reason, a vacancy occurs in the office of the Chairman or any other member of the Tribunal, the Central Government may fill the vacancy by appointing another person thereto in accordance with the provisions of subsection (2), and any proceeding may be continued before the Tribunal, so constituted, from the stage at which the vacancy occured. (4) The Tribunal may, for the purpose of determining any compensation payable under this Part, choose one or more persons having special knowledge or experience of any relevant matter to assist in the determination of such compensation. 36AI: Tribunal to have powers of a civil court (1) The Tribunal shall have the powers of a civil court, while trying a suit, under the Code of Civil Procedure,,1908, in respect of the following matters namely: (a)

summoning and enforcing the attendance of any person and examining him on oath ;

(b)

requiring the discovery and production of documents;

(c)

receiving evidence on affidavits ;

(d)

issuing commissions for the examination of witnesses or documents.

(2) Notwithstanding anything contained in sub-section (1), or in any other law for the time being in force, the Tribunal shall not compel the Central Government or the Reserve Bank:

(a) to produce any books of account or other documents which the Central Government, or the Reserve Bank, claims to be of a confidential nature; (b) to make any such books or documents part of the record of the proceedings before the Tribunal; or (c) to give inspection of any such books or documents to any party before it or to any other person. 36AJ: Procedure of the Tribunal (1) The Tribunal shall have the power to regulate its own procedure. (2) The Tribunal may hold the whole or any part of its inquiry in camera. (3) Any clerical or arithmetical error in any order of the Tribunal or any error arising therein from any accidental slip or omission may, at any time, be corrected by the Tribunal either of its own motion or on the application of any of the parties. Section 45Y: Power of Central Government to make rules for the preservation of records The Central government may, after consultation with the Reserve Bank and by notification in the Official Gazette, make rules specifying the periods for which (a)

a banking company shall preserve its books, accounts and other documents; and

(b)

a banking company shall preserve and keep with itself different instruments paid by it.

Section 52: Power of Central Government to make Rules (1) The Central Government may, after consultation with the Reserve Bank, make rules to provide for all matters for which provision is necessary or expedient for the purpose of giving effect to the provisions of this Act and all such rules shall be published in the Official Gazette. (2) In particular, and without prejudice to the generality of the foregoing power, such rules may provide for the details to be included in the returns required by this Act and the manner in which such returns shall be submitted and the form in which the official liquidator may file lists of debtors to the Court having jurisdiction under Part III or Part IIIA and the particulars which such lists may contain and any other matter which has to be, or may be, prescribed. (3) The Central Government may, by rules made under this section annul, alter or add to, all or any of the provisions of the Fourth Schedule. (4) Every rule made by the Central government under this Act shall be laid, as soon as may be after it is made, before each House of Parliament, while it is in session, for a total period of thirty days which may be comprised in one session or in two more successive sessions, and if, before the expiry of the session immediately following the session or the successive sessions aforesaid, both Houses agree in making 109 (Sys 4) - D:\shinu\lawschool\books\module\contract law

any modification in the rule or both Houses agree that the rule should not be made, the rule shall thereafter have effect only in such modified form or be of no effect, as the case may be; so however, that any such modification or annulment shall be without prejudice to the validity or anything previously done under that rule. Section 53: Power to exempt in certain cases The Central Government may, on the recommendation of the Reserve Bank, declare, by notification in the Official Gazette, that any or all the provisions of this Act shall not apply to any banking Company or institution or to any class of banking companies either generally or for such period as may be specified.

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Section 54: Protection of action taken under Act (1) No suit or other legal proceeding shall lie against the Central Government, the Reserve Bank or any officer for anything which is in good faith done or intended to be done in pursuance of this Act. (2) Save as otherwise expressly provided by or under this Act, no suit or other legal proceeding shall lie against the Central Government, the Reserve Bank or any officer for any damage caused or likely to be caused by anything in good faith or intend to be done in pursuance of this Act.

10. WINDING UP OF BANKING COMPANIES Sections 38 to 44 of the Banking Regulation Act deal with the provisions relating to the winding up of a Banking Company by Court. Section 38: Winding up by High Court 1) Notwithstanding anything contained in Section 391, Section 392, Section 433 and Section 583 of the Companies Act, 1956, but without prejudice to its powers under sub-section (1) of Section 37 of this Act, the High Court shall order the winding up of a banking company (a) if the banking company is unable to pay its debts; or (b) if an application for its winding up has been made by the Reserve Bank under Section 37 or this section. 2) The Reserve Bank shall make an application under this Section for the winding up of a banking company, if it is directed so to do by an order under clause (b) of sub-section (4) of Section 35. 3) The Reserve Bank may make an application under this section for the winding up of a banking company (a) if the banking company, (i) has failed to comply with the requirements specified in Section 11; or (ii) has by reason of the provisions of Section 22 become disentitled to carry on banking business in India ; or (iii) has been prohibited from receiving fresh deposits by an order under clause (a) of sub-section (4) of Section 35 or under clause (b) of sub-section (3A) of Section 42 of the Reserve Bank of India Act, 1934; or (iv) having failed to comply with any requirement of this Act other than the requirements laid down in Section 11, has continued such failure, or, having contravened any provision of this Act has continued such contravention beyond such period or periods as may be specified in that behalf by the Reserve Bank from time to time, after notice in writing of such failure or contravention has been conveyed to the banking company; or (b) if in the opinion of the Reserve Bank (i) a compromise or arrangement sanctioned by a Court in respect of the banking company cannot be worked satisfactorily with or without modifications; or (ii) the returns, statements or information furnished to it under or in pursuance of the provisions of this Act disclose that the banking company is unable to pay its debts; or (iii) the continuance of the banking company is prejudicial to the interests of its depositors. 4) without prejudice to the provisions contained in Section 434 of the Companies Act, 1956, a banking company shall be deemed to be unable to pay its debts if it has refused to meet any lawful demand made at any of its offices or branches within two working days, if such demand is made at a place where there is an office, branch or agency of the

Reserve Bank, or within five working days, if such demand is made elsewhere, and if the Reserve Bank certifies in writing that the banking company is unable to pay its debts. 5) A copy of every application made by the Reserve Bank under sub-section (1) shall be sent by the Reserve Bank to the registrar. On application by Reserve Bank under section 38(1), the court must order winding up. [Reserve Bank of India Vs. Palai Central Bank, AIR 1961 Ker 268.] Satisfaction of Reserve Bank under clause (b) of sub-section (3) is subjective and is not amenable to judicial review. The word “debt” in sub-section (1) does not mean banking debt, [Dwarka Das Vs. Dharam Chand, AIR 1954 Cal 583.] Sub-section (1) does not preclude the court from taking action suo motto. [Parfulla Chandra sinha Vs. Chhota Nagpur Banking Association, AIR 1965 Pat 502.] Commencement of proceedings for liquidation does not bring about company’s dissolution. [K.V.S.V. Vassan Bros. vs. Official Liquidator, AIR 1952 Tra-Co. 170.] From the above section it may be noted that The High Court has to order the winding upa) if the Bank is unable to pay its debts or b) if the company is under a moratorium and the Reserve Bank applied to the High Court for the winding up of the Bank on the ground that its affairs are conducted in a manner detrimental to the interests of the depositors. A Banking Company if it has refused to meet any lawful demand made at any of its offices within two days of the Demand and the Reserve Bank certifies that the Bank is unable to pay its debts, then the Bank is deemed to be unable to pay its debts. Other prerequisites are :1) there should be a direction from the Central government, 2) An Inspection of the Banking company by the Reserve Bank, before the order of the Government. The grounds on which the Reserve Bank of India may apply for winding up are1) the Banking company has failed to comply with the provisions as to the minimum paid up capital and Reserves as laid down in Section 11 of the Act; 2) the Banking Company is disentitled to carry on business of Banking for want of licence under Section 22; 3) the Banking Company has been prohibited by the Reserve Bank of India and the Central Government from accepting fresh deposits ; 4) the Banking Company has failed to comply with any requirement of the Banking Regulation Act, and continues to do so even after the Reserve Bank of India calls up to do so by issuing notices; 111 (Sys 4) - D:\shinu\lawschool\books\module\contract law

5) the Reserve Bank is of the opinion that a compromise or arrangement sanctioned by the court cannot be worked out satisfactorily; 6) the Reserve Bank is satisfied from the Returns furnished by the Banking Company that it is unable to pay its debts or its continuance is prejudicial to the interests of its depositors. The most important judicial pronouncement in the last 3 decades is the case relating to the winding up of the [Reserve Bank of India vs. Palai Central Bank Ltd [AIR 1961 Kerala 268]. From the decision it may be noted that _ 1) the court must order the winding up on an application by the Reserve Bank of India under Section 38(1). 2) the ‘satisfaction’ of the Reserve Bank of India under clause (b) of Sub-section 3) is subjective and cannot be challenged in a court of law. Section 38A : “Court Liquidator” (1) there shall be attached to every High Court a Court liquidator to be appointed by the Central Government for the purpose of conducting all proceedings for the winding up of banking companies and performing such other duties in reference thereto as the High Court may impose. (2) x x x (3) x x x (4) Where having regard to the number of banking companies wound up and other circumstances of the case, the Central Government is of opinion that it is not necessary or expedient to attach for the time being a court liquidator to a high court, it may, from time to time, by notification in the Official Gazette, direct that this section shall not have effect in relation to that High Court. Section 39 prescribes that the Reserve Bank of India, State Bank of India or others to be the official liquidator. Section 39: Reserve Bank to be Official Liquidator (1) Notwithstanding anything contained in Section 38A of this Act or in Section 448 or Section 449 of the Companies Act, 1956, where in any proceeding for the winding up by the High Court of a banking company, an application is made by the Reserve Bank in this behalf, the Reserve Bank, the State Bank of India or any other bank notified by the Central Government in this behalf or any individual, as stated in such application shall be appointed as the official liquidator of the banking company in such proceeding and the liquidator, if any, functioning in such proceeding shall vacate office upon such appointment. (2) Subject to such directions as may be made by the High Court the remuneration of the official liquidator appointed under this section, the cost and expenses of his establishment and the cost and expenses of the winding up shall be met out of the assets of the banking company which is being wound up,and notwithstanding anything to the contrary containd in any other law for the time being in force,no fees shall be payable to the Central Government,out of the assets of the banking company. 112 (Sys 4) - D:\shinu\lawschool\books\module\contract law

The provisions of the Indian Companies Act are applicable to the liquidators appointed under the Banking Regulation Act. Section 39A: Application of Companies Act to liquidators (1) All the provisions of the Companies Act, 1956, relating to a liquidator, in so far as they are not inconsistent with this Act, shall apply to or in relation to a liquidator appointed under Section 38A or Section 39. (2) Any reference to the “Official liquidator” in this Part and Part IIIA shall be construed as including a reference to any liquidator of a banking company. Section 41 of the Act deals with the preliminary report by the Official Liquidator within 2 months from the date of the winding up order, on the assets and liabilities of the Banking Company. The section reads Notwithstanding anything to the contrary contained in, Section 455 of the Companies Act, 1956, where a winding up order has been made in respect of a banking company whether before or after the commencement of the Banking Companies (Second Amendment) Act, 1960, the official liquidator shall submit a preliminary report to the High Court within two months from the date of the winding up order has been made before such commencement, within two months from such commencement, giving the information required by that section so far as it is available to him and also stating the amount of assets of the banking company in cash which are in his custody or under his control on the date of the report and the amount of its assets which are likely to be collected in cash before the expiry of that period of two months in order that such assets may be applied speedily towards the making of preferential payments under Section 530 of the Companies Act, 1956, and in the discharge, as far as possible, of the liabilities and obligations of the banking company to its depositors and other creditors in accordance with the provisions hereinafter contained; and the official liquidator shall make for the purposes aforesaid every endeavour to collect in cash as much of the assets of the banking company as practicable. Section 41A deals with the notice of preferential claimants and secured and unsecured creditors. The Section reads (1) Within fifteen days from the date of the winding up order of a banking company or where the winding up order has been made before the commencement of the Banking Companies (Second Amendment) Act, 1960, within one month from such commencement, the official liquidator shall, for the purpose of making an estimate of the debts and liabilities of the banking company (other than its liabilities and obligations to its depositors), by notice served in such manner as the Reserve Nank may direct, call upon(a) every claimant entitled to preferential payment under Section 530 of the Companies Act, 1856, and (b) every secured and every unsecured creditor, to send the official liquidator within one month from the date of the service of the notice a statement of the amount claimed by him.

(2) Every notice under sub-setion (1) sent to a claimant having a claim under section 530 of the Companies Act, 1956, shall state that if a statement of the claim is not sent to the official liquidator before the expiry of the period of one month from the date of the service, the claim shall not be treated as a claim entitled to be paid under Section 530 of the Companies Act, 1956, in priority to all other debts but shall be treated as an ordinary debt due by the banking company. (3) Every notice under sub-section (1) sent to a secured creditor shall require him to value his security before the expiry of the period of one month from the date of the service of the notice and shall state that if a statement of the claim together with the valuation of the security is not sent to the official liquidator before the expiry of the said period, then, the official liquidator shall himself value the security and such valuation shall be binding on the creditor. (4) If a claimant fails to comply with the notice sent to him under sub-section (I), his claim will not be entitled to be paid under Section 530 of the Companies Act, 1956, in priority to all other debts but shall be treated as an ordinary debt due by the banking company; and if a secured creditor fails to comply with the notice sent to him under sub-section (1), the official liquidator shall himself value the security and such valuation shall be binding on the creditor. Section 42 deals with the power to dispense with meetings of creditors etc. The Section reads “Notwithstanding anything to the contrary contained in Section 460 of the Companies Act, 1956, the High Court may, in the proceedings for winding up a banking company, dispense with any meetings of creditors or contributories if it considers that no object will be secured thereby sufficient to justify the delay and expense”. Section 43 lays down the Depositors’ credits to be deemed proved. The Section reads “In any proceeding for the winding up a banking company, every depositor of the banking company shall be deemed to have filed his claim for the amount shown in the books of the banking company as standing to his credit notwithstanding anything to the contrary contained in Section 474 of the companies Act, 1956, the High Court shall presume such claims to have been proved, unless the official liquidator shows that there is reason for doubting its correctness”. Section 43A deals with Preferential payment to Depositors. The Section reads(1) in every proceeding for the winding up of a banking company where a winding up order has been made, whether before or after the commencement of the Banking companies (Second Amendment) Act, 1960, within three months from the date of the winding up order or where the winding up order has been made before such commencement, within three months therefrom, the preferential payments referred to in section 530 of the

companies Act, 1956, in respect of which statements of claims have been sent within one month from the date of service of the notice referred to in Section 41A, shall be made by the official liquidator or adequate provision for such payments shall be made by him. (2) After the preferential payments as aforesaid have been made or adequate provision has been made in respect thereof, there shall be paid within the aforesaid period of three months a) in the first place, to every depositor in the savings bank account of the banking company a sum of two hundered and fifty rupees or the balance at his credit, whichever is less; and thereafter, b) in the next place, to every other depositor of the banking company a sum of two hundred and fifty rupees or the balance at his credit, whichever is less. In priority to all other debts from out of the remaining assets of the banking company available for payment to general creditors: Provided that the sum total of the amounts paid under clause (a) and clause(b) to any person who in his own name (and not jointly with any other person) is a depositor in the savings bank account of the banking company and also a depositor in any other account, shall not exceed the sum of two hundred and fifty rupees. (3) Where within the aforesaid period of three months full payment cannot be made of the amount required to be paid under Clause (a) or Clause (b) of sub-section (2) with the assets in cash, the official liquidator shall pay within that period to every depositor under clause (a) or, as the case may be, clause (b) of that sub-section on a pro rata basis so much of the amount due to the depositor under the clause as the official liquidator is able to pay with those assets; and shall pay the rest of that amount to every such depositor as and when sufficient assets are collected by the official liquidator in cash. (4) After payments have been made first to depositors in the savings bank account and then to the other depositors in accordance with the foregoing provisions, the remaining assets of the banking company available for payment to general creditors shall be utilised for payment on a pro rata basis of the debts of the general creditors and of the further sums, if any, due to the depositors, and after making adequate provision for payment on a pro rata basis as aforesaid of the debts of the general creditors, the official liquidator shall as and when the assets of the company are collected in cash make payment on a pro rata bais as aforesaid, of the further sums, if any, which may remain due to the depositors referred to in clause (a) and clause (b) of sub-section (2). (5) In order to enable the official liquidator to have in his custody or under his control in cash as much of the assets of the banking company as possible, the securities given to every secured creditor may be redeemed by the official liquidator 113 (Sys 4) - D:\shinu\lawschool\books\module\contract law

a)

Where the amount due to the creditor is more than the value of the securities as assessed by him or,as the case may be,as assessed by the official liquidator, on payment of such value; and b) where the amount due to the creditor is equal to or less than the value of the securities as so assessed, on payment of the amount due; provided that where the official liquidator is not satisfied with the valuation made by the creditor,he may apply to the High Court for making a valuation. (6) When any claimant,creditor or depositor to whom any payment is to be made in accordance with the provisions of this section,cannot be found or is not readily traceable,adequate provision shall be made by the official liquidator for such payment. (7) For the purpose of this section, the payments specified in each of the following clauses shall be treated as payments of a different class, namely:a) payments to preferential claimants under Section 53 of the Companies Act, 1956; b) payments under clause (a) of sub-section(2) of the depositors in the savings bank account; c) payments under clause (b) of sub-section (2)to the other depositors; d) payments to the general creditors and payments to the depositors in addition to those specified in clause (a) and clause (b) of sub-section (2). (8) The payments of each different class specified in subsection (7) shall rank equally among themselves and be paid in full unless the assets are insufficient to meet them, in which case they shall abate in equal proportion. (9) Nothing containd in sub-sections (2),(3),(4),(7) and (8)shall apply to a banking company in respect of the depositors of which the Deposit Insurance Corporation is liable under section 16 of the Deposit Insurance Corporation Act, 1961. (10)After preferential payments referred to in sub section (1)have been made or adequate provision has been made in respect thereof, the remaining assets of the banking

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company referred to in sub-section (9) available for payment to general creditors and of the sums due to the depositors; Provided that where any amount in respect of any deposit is to be paid by the liquidator to the Deposit Insurance Corporation under Section 21 of the Deposit Insurance Corporation Act, 1961, only the balance, if any, left after making the said payment shall be payable to the depositors. No banking company shall be wound up voluntarily unless the Reserve Bank of India certifies that the Company is able to pay in full all its Debts. The provision and the powers of the High Court in voluntary winding up is contained in Section 44 of the Banking Regulation Act which reads (1) Notwithstanding anything to the contrary contained in Section 484 of the Companies Act, 1956, no banking company may be voluntarily wound up unless the Reserve Bank certifies in writing that the company is able to pay in full all its debts to its creditors as they accrue. (2) The High Court may, in any case where a banking company is being wound up voluntarily, make an order that the voluntary winding up shall continue, but subject to the supervision of the court. (3) Without prejudice to the provisions contained in Sections 441 and 521 of the Companies Act, 1956, the High Court may of its own motion and shall on the application of the Reserve Bank, order the winding up of a banking company by the High Court in any of the following cases, namely _ (a) Where the banking company is being wound up voluntarily and at any stage during the voluntary winding up proceedings the company is able to meet its debts as they accrue ; or (b) Where the banking company is being wound up voluntarily or is being wound up subject to the supervision of the Court and the High Court is satisfied that the voluntary winding up or winding up subject to the supervision of the Court cannot be continued without detriment to the interests of the depositors.

11. CASE LAW In the matter of Travancore National & Quilon Bank Ltd, (in Liquidation) G. Samuel - Applicant. v. Cyril gill and John Stanley Goodwin - Official Liquidators - Respondents [AIR 1941 Madras p.622-625] In this case question of set off was raised. The Travancore National and Quilon Bank hereinafter called the bank, lent a sum of Rs.2000 to the applicant Mr. G. Samuel, on a promissory note dated 7th October 1936. The bank was not willing to lend this sum to him without security. His mother-in-law Mrs. G.P. Sathanansham Srinivasan offered to give the necessary security. On the date of the loan, she had a sum of Rs.4300 in fixed deposit covered by the fixed deposit receipt bearing the same date. She gave that amount as security. In her affidavit Mrs. Srinivasan stated that she gave the said security on the definite understanding that the bank should adjust the amount due by Mr. Samuel from and out of the money due to her under the said deposit at the time of maturity. The terms on which she gave the loan were reduced to writing and were evidenced by a letter written by Mrs. Srinivasan to the bank. It appeared from the affidavit of the Official Liquidator that along with the said letter a duly receipted fixed deposit receipt in blank was also lodged with the bank. The fixed deposit was for a period of two years and on the date when the bank went into liquidation it had not matured. Mr. Samuel has not paid anything towards the promissory note, but he claims that he is entitled to have the amount due by the bank to Mrs. Srinivasan set off against the amount due by him. Mrs. Srinivasan had also filed an affidavit stating that she is willing to have the amount set off. The question involved was not whether she is willing, but whether a set off can be allowed in law. Mrs. Srinivasan had not personally undertaken to repay the debt except giving security as aforesaid. There were no mutual dealings in this case, which would entitle the applicant to claim a set off under S.229, Companies Act, under which in the winding up of an insolvent company the same rules should prevail and be observed as are in force for the time being under the law of insolvency with respect to the estate of person adjudged insolvent. It was contended on behalf of the applicant that on the facts it must be found in this case that there was an agreement to set off the amount of fixed deposit against the debt due by the applicant. From the terms of the letter given by Mrs. Srinivasan the bank was authorized to set off the whole or any portion of the said deposit and interest accrued thereon. Of course it confers a right on the bank to set off, if the bank so chose to do. The Court observed that from the terms of the letter it appears that the fixed deposit amount was given as security with the intention that the amount when realized may be appropriated by the bank towards the debt if they so chose to do. It is one thing to say that the bank has a right to set off but another thing to say that the applicant has got a right to set off and there was an agreement to set off. It was open to the bank to give up the

security if they liked. The Court therefore was of the opinion that no set off can be allowed in this case but the equity of the case demands that the bank should adjust the dividend payable under the deposit towards the amount due and recover only the balance. Singheshwar Mandal, Appellant v. Smt. Gita Devi and another, Respondents [AIR 1975 Patna 81 p.81] This appeal was by defendant No.1. A money suit was filed against him by the plaintiff-respondent for recovery of a sum of Rs. 1541 & 15 annas on the basis of a handnote admitedly executed by him for a sum of Rs.1133/11 annas in favour of Dhir Narain Chand, the father of the plaintiff. It was stated in the plaint, inter alia, that the plaintiff’s father had expressed his desire in presence of the defendant second party that the amount in respect of this loan would go to the plaintiff alone to which the defendant second party expressly consented. The defendant second party were the two widows of Dhir Narain Chand aforesaid. Defendant No.1 contested the suit on various grounds, inter alia, that the plaintiff being not the holder of the handnote in question, she had no right to institute the suit in question. The trial court accepted the defence and dismissed the suit but on appeal, however, the learned Additional Subordinate Judge decreed the same. Now the second appeal had been filed by defendant No.1. The learned Additional Subordinate Judge has overcome this plea of the appellant on the gound that the plaintiff was an heir of Dhir Nair Chand who had every right to make arrangement and partition the assets among his heirs. On referring to the evidence and the circumstances on the record, he has held that the plaintiff’s father did make such an arrangement according to which this debt was made realisable by the plaintiff alone. The Court of appeal below has committed an apparent error of Law in decreeing the suit. Under the provisions of Section 78 of the Negotiable Instruments Act, payment of the amount due on a promissory note etc. in order to discharge the maker or acceptor thereof must be made to the holder of the instrument or if the same is endorsed then to the endorsee as provided under Section 82(c) of the Act which is not the case here. The provisions of the Negotiable Instruments Act are very specific. The Court held that in this case the handnote in question was not endorsed in favour of the plaintiff nor does the recital in any way indicate the intention of the creditor for the payment of the ultimate dues by the debtor to the plaintiff. The term “Holder” has been defined in Section 8 of the Negotiable Instruments Act, according to which the holder of a promissory note, inter alia, means a person entitled in his own name to the possession thereof and to receive or recover the amount due thereon from the parties thereto. Admittedly, therefore, the plaintiff does not answer any of the descriptions mentioned above and the defendant was not bound to make the payment to her of the dues in question and as such the plaintiff has no 115 (Sys 4) - D:\shinu\lawschool\books\module\contract law

right to institute the suit. It is not a case either of any transfer of this debt or claim which under the provisions of the Transfer of Prperty Act would be an “actionable claim” by the father to the plaintiff. In view of the provisions of Section 130 of the Transfer of Property Act the transfer of an actionable claim has to be effected only by the execution of an instrument in writing signed by the transferor or his duly authorised agent and only thereafter the rights and remedies of the transferor is transferred. Additional Subordinate Judge, therefore, was not right in referring to any other mode of supposed arrangement by the father of the plaintiff and the different members of the family which did not answer this requirement of law. The Court allowed the appeal, and set aside the judgement and decree of the court of appeal and restored the order of dismissal of the suit passed by the trial court. State Bank of India, Petitioner vs. Vathi Samba Murthy, Respondent. [AIR 1988 Orissa 50] In this case a civil revision petition was filed against the appellate judgement confirming the decision of the trial court. The case of the plaintiff was that the defendant drew Rs.2000/- on the basis of a cheque from his personal account although he had no funds available in that account for which the overdrawal was permitted. In spite of demand, the same not having been repaid, the suit was filed for recovery of Rs.2000/- as principal amount and Rs.979.39 paisa towards interest. The contention of the defendant was that he had two accounts in the bank. One current account was in his own name and the other current account was in the name of the partnership firm of which he was a partner. His case was that in the partnership account there was enough money and the amount was really intended to be drawn from that account and there was no necessity for permitting the overdrawal from his own account where there was no money. The trial court applied the principle decided in the case reported in 1967 SC 1058 (Chandradhar Goswami v. Gauhati Bank Limited) and held that in absence of the original ledger account no decree can be granted. The appellate court found as a fact that the money was given from the personal account. But it confirmed the dismissal of the suit. It is not disputed by the

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defendant in this Court that the amount has been drawn by him from his personal account, and that he issued the cheque where no sufficient fund was available. He only stated that the money should have been adjusted from the partnership account. The Court held for withdrawal of money from an account any cheque cannot be issued. It is only the cheque relating to that account wherefrom money is to be drawn is to be issued. Cheque of one account cannot be used in respect of another account even though the same person may be having two accounts. Accordingly, having drawn money from his personal account where sufficient funds were not available to honour the cheque, the defendant shall have the liability of pay back the amount since it is not a gift by the bank. Both the courts went wrong in law in dismissing the suit in respect of the principle amount of Rs.2000/- drawn by the defendant. There is no material on record that the defendant requested for overdrawal. There is no general agreement that in absence of request also, overdrawal may be permitted. If there was no money available, the banker should have dishonored the cheque unless specifically requested by the defendant for permitting overdrawal. If the banker of his own permitted overdrawal, he has no right to claim interest. However, a person getting benefit is required to compensate for the benefit rendered to him. In the absence of any statutory provision relating to payment of interest on overdrawals, it is a matter for the court to consider the reasonable rate at which interest can be granted. It is a common knowledge that business of a banker is to advance loans and there are varying types of interest in respect of different types of loans. Similarly for receiving deposits the bankers give interest of different rates in respect of different types of deposits. Therefore, the defendant should compensate the bank for the benefit rendered to him by paying interest at the rate of 7% from the date of drawal till the payment is made on the amount of Rs.2000/-. The court allowed the revision petition, set aside the decisions of both the courts and decreed the suit partly to the extent of Rs.2000/- towards principal amount and interest at the rate of 7% from the date of drawal till the date of recovery or payment.

12. PROBLEMS 1. A foreign bank wants to open a branch in India and asks you to advice them on the procedure to be followed. Give a detailed notice advising the bank the procedure to be followed and the RBI regulation/guideline on the same. 2. Prepare a detailed list containing types of information that have to flow from the Commercial Banks to the Reserve Bank stating the periodicity of the informations and need. 3. If you are asked to point out three issues on which Banking Regulation Act requires amendment what issues will you suggest and why ? What amendment will you suggest ? 4. Make a critical study on the legal provision on CRR and SLR and how the system worked in the last three decades. Do you suggest any alteration to the present provision ? Explain. 5. Examine the obstacles on securitization in India. What remedies do you suggest for healthy growth of securitization? 6. If you are required to give an advice to the Ministry of Finance on the issue of regulating Mutual Funds, what major issues will you suggest where a regulation is required

7.

8.

9.

10.

to be enacted ? What makes you feel that this area requires regulation ? If an Indian Bank wants to open a Branch at a place, what procedure should it follow ? On what consideration the permission is given ? Many of the financial institutions have already established their own Bank or are initiating the proposal to establish their own Bank. What according to you are the reasons for such development ? Do you think the trend is a healthy one ? Explain. What legal system must the country build up to regulate the area ? On what consideration a Private Bank is allowed to be established and run in India ? What procedure a proposed private Bank must follow to finally establish itself and commence business ? Can a State Government establish a Bank ? On what considerations RBI may refuse permission to such a proposal ?

[Note: Specify Your Name, I.D. No. and address while sending answer papers]

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13. SUPPLEMENTARY READINGS 1. Gupta, S.N., : The Banking Law in Theory and Practice, 22nd Edn. (1992), Universal Book Traders, New Delhi. 2. Hapgrood, Mark, : Paget’s Law of Banking, 10th Edn, (1989), Butterworths, London and Edinburgh. 3. Ramaiaya, A., : A Guide to the Companies Act, 11th Edn. (1992), Wadhwa and Co. Pvt Ltd, Nagpur. 4. Sheldon & Fidler’s : Practice & Law of Banking, 11th Edn (1984), Macknald & Evans, Ltd, London and Plymouth. 5. Tannan, M.L., : Banking Law and Practice in India, 18th Edn, (1989), Orient Law House, New Delhi.

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Master in Business Laws Banking Law Course No: II Module No: IV & V

Negotiable Instruments: Law and Procedure

Distance Education Department

National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 080-3217858 E-mail: [email protected] 119 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Materials Prepared By : 1.

Ms. Sudha Peri

2.

Prof. N.L. Mitra

Materials Checked By : 1.

Prof. P.C. Bedwa

Materials Edited By : 1.

Mr. T. Devidas

© National Law School of India University

Published By Distance Education Department National Law School of India University, Post Bag No: 7201 Nagarbhavi, Bangalore, 560 072.

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INSTRUCTIONS Negotiable Instruments form the axis on which the wheels of commerce revolve, and are the most widely need form of securitization. The Negotiable Instrument Act itself deals with only three types of instruments, cheques, bills of exchange and promissory notes. But according to sec. 1 of Act, though it also recognises all instruments in local language and established by usage from the provisions of the Act. Thus negotiable instruments may be said to be of two types: (1) those created by the statute and (2) those created by usage or practice of the society. Though negotiable instruments are widely used by all sections of people for varied purposes, actual knowledge about these instruments is very low. There is a widespread ignorance about the nature and scope of these instruments, the rules relating to their presentment, acceptance or dishonour etc. An effort has been made in this module to give a comprehensive sketch of the various aspects of negotiable instruments. Students are advised to go through the module carefully and to make a check list at the end of every major aspect of these instruments for easy understanding, and to keep the bare act besides you while going through the module, to facilitate easy reference. The subject being a very complicated one you should read up atleast one of the basic books on the subject, apart from this module so as to come to terms with the intricacies of the subject.

N.L. MITRA Course co-ordinator

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Negotiable Instruments : Law and Procedure

TOPICS 1.

Securitization ..................................................................................................................

123

2.

Negotiable Instrument ...................................................................................................

127

3.

Parties to a Negotiable Instrument ...............................................................................

138

4.

Rules relating to Negotiable Instruments ....................................................................

145

5.

Presentment ....................................................................................................................

152

6.

Special Provisions Relating to Cheques .......................................................................

157

7.

Discharge from Liability................................................................................................

161

8.

Of Notice, Noting and Protest ......................................................................................

164

9.

Presumptions and Estoppels .........................................................................................

168

10.

Offences under the Act ..................................................................................................

172

11.

Foreign Instruments.......................................................................................................

177

12.

Case Law .........................................................................................................................

185

13.

Problems..........................................................................................................................

188

14.

Supplementary Readings ...............................................................................................

190

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1. SECURITISATION 1.1 What is Securitisation? 1.2 Procedure 1.3 What assets can be Securitised 1.4 Type of Securities 1.5 Advantages 1.6 Legal Issues 1.7 Role of government 1.8 Creation of international securities 1.1 WHAT IS SECURITISATION What is Securitisation? According to Kenneth Cox securitization is a process in which pools of individual loans or receivables or actionable claims are packaged, under written and distributed to investors in the form of securities. It is a process of liquidizing assets appearing in the balance sheet of a bank or financial institution which represent long term receivables by issuing markatable securities there against. It involves conversion into cash flow from a portfolio of assets in negotiable instruments or assignable debts which are sold to investors. Securitization is in vogue in western countries as a very common method of funding. Mr. B.D. Ushir (Jt. Legal Advisor, IDBI) in an article gave a clear analysis of such securitisation. A bank or a financial institution lends money or purchases or discounts bills. The outstanding loans and bills appear as assets in the balance sheet. These assets being generally of long term maturity, the fund invested therein remain locked up. These loans/bills form portfolio to form a basket or a pool for the purpose of securitization. Now, these debts are assigned in writing through a document (known as security) by which assigner transfers his actionable claim over the debt to the assignee who will have all rights such as right to claim the payment of the debt; right to interest; right to remedies in case the debt is not paid. As such, through the creation of securities the Bank or financial institutions liquidizing the long term debts and loans and create funds for investments. 1.2 PROCEDURE FOR SECURITIZING Securitizing has several steps involved such as : (a) Creation of a basket or pool of loans/bills/actionable claims: The Bank or the financial institution engaged in the business of louding/bill discounting/having actionable claims,

creates a portfolio containing a basket or pool of claims fairly diversified and representative in characer and not necessarily relate to same industry or from same statistical history. The package must form an optimal mix so as to ensure marketability of the instruments created and issued to the investors. Further, the maturities should also be so selected that they form one homogenous group or a few homogenous branches. These loans are backed by collateral securities. The aggregate pool, therefore, consists of the receivables flowing from the respective loans and the rights to the various securities which are commonly in the form of mortgages or charge on the borrower's assets. (b) Forming a special purpose vehicle (SPV) : Once the assets are identified, these are to be passed through a special purpose vehicle (SPV). It is common for an investment banker to act as the special purpose vehicle against the sale for a valuable consideration. On completion of the passing through transaction, the securitised assets are removed from the balance sheet of the lending institution (the originator). At this stage it has to be remembered that the contractual relations under the loan agreement between the borrowers and the lender (the originator) continue to subsist even after the passing away of the securitised loans and bills to SPV. So the originator shall continue to receive interest and principal amounts from the borrower which are requested to be passed to the SPV persuant to the specific covenants under an agreement entered into between the two. (3) Splitting into shares or securities : After the securitised assets are passed to SPV, it divides notionally the whole asset into small shares or securities and sells these shares/or securities to investors. These securities are called the Pass Through or Pay Through Certificate (PTC). PTC's are so structured as to synchronise, as regards to their maturities, with the maturities of the securitised loans or bills (receivables) so that cash flowing from these sources become available to the payment of the PTCs and their maturities. PTC holders look to the SPV for payment of interest and the principal in respect to the PTCs held by them. The SPV will meet this obligation out of the receivables realised by the lender (originator) from the borrowers and passed on to the SPV. A PTC represents a sale of an individual interest to the assets securitised by the originator and transfered to the SPV. A choice of appropriate form of the PTC depends on various considerations such as the incidence of stamp duty, marketability/transferability aimed at and so on. The whole process of securitisation happens thus :

123 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Pool of assets 1. Loans & Advances

belonging to Originator (Suppose a Bank or a financial institution

Receive the loan amount

Passed on to the Special purpose vehicle against consideration

The SPV may be a Bank or a financial institutions

Passed on to SPV

Asset value in the pool is divided notionally into small share or security

Shares/Securities sold to investors

Share/Securities paid of by SPV

2. Bills 3. Other Receivables 4. Debtors

1.3 WHAT ASSETS CAN BE SECURITISED All types of assets having a reasonably predictable cash flow can be securitsed. It has been already pointed out that in constructing a portfolio to be sold down to the SPV, it will be important to select assets which are homogenous and diversified. The assets will also need to have statistically predictable cash flows, levels of arrears and defaults since these will be key factos for the investors. The following assets are most common for the purpose of securitisation (a) Mortgaged properties & loans ; (b) Housing loans ; (c) Car loans ; (d) Credit card receivables ; (e) Trade receivables/book debts ; (f) Bills ; (g) Actionalbe claims. 1.4 TYPES OF SECURITIES Securities may generally be of two types, viz: (i) Securities confined to national boundaries and to be operated within the country, and (ii) Securities which are operated internationally. These may be based upon national assets or international assets which can be securitised. 124 (Sys 4) - D:\shinu\lawschool\books\module\contract law

National Securities are those which are either negotiable instruments under the NI Act or transferable but not negotiable. Common examples are bills, pronotes cheques these being negotiable ; commercial papers - these being transferable but non-negotiable. International securities are GDR (Global Depositing Receipts) or IDR (International Depository Receipts). 1.5 ADVANTAGES There are several advantages fo securitization, such as: (1) Liquidification - It creates liquidity in the market against assets which are generally sleepng or dorument in character for sometime, as for example, book debt. (2) Avenue for investment - It creates opportunities for investment to the people who want to invest to augment income, assured securities having opportunity for encashment as and when required. (3) Mobilises funds for investment - With floating of new investments against portfolio, for the purpose of using debt capital for industrial development. (4) Foreign funds - Foreign funds can be generated through the creation of a depository of Indian scrips including shares and debentures. A global or international depositing is created with which shares, stocks and debentures can be deposited for the purpose of creating a SPV against which

GDR or IDR is issued to foreign investors through which foreign funds are mobilised for investment in India. (5) Easy transferability - Securities may be listed in the stock exchange for easy transferability which ensures floating funds to be canalised for industrial and market development. 1.6 LEGAL ISSUES AND LAWS INVOLVED All legal issues relating to Securitisation need to be examined in the light of the provisions of various laws like, the Transfer of Property Act 1882, the Registration Act, 1908, the Indian Stamp Act 1899; Income Tax Act 1961; Securities Contracts (Regulation Act) 1958 and SEBI Act 1992. (1) Transfer of Property Act, 1881 : Many of the recoverables are classified debts coming within the definition of immovable property and hence call for the knowledge on Transfer of Property Act. As for example, an interest of a mortgagee is an immovable property. Similarly mortgagedebt is an immovable property which can be transferred only by an instrument in writing being registered under sec 17(1)(6) of the Registration Act. As such, Securitisation of these type of portfolio involves a transfer of an interest of a mortgage when the underlying securities happen to be in the form of a mortgage. There are two levels of transfers. First the portfolio is transfered to SPV and secondly individual interest is transfered through PTC to the investors. All such transfers concern mortgage-debts, and hence attracting transfer of property. (2) Registration Act, 1988 : All non-testamentary instruments creating, declaring, assigning or extinguishing, whether in present or in future, any right title or interest, whether vested or contingent, of the vlaue of Rs.100 or above, to or in any immovable property are required to be compulsorily registered. [sec 17(1)d]. Securitisation involves creation and/or declaration of an interest in the immovable property firstly in favour of SPV and secondly in favour of the investors. (3) Negotiable instrument Act, 1872 : Instruments which are negotiable are covered under the N1 Act. One of the defects of the NI Act is its restrictive nature. Only if an instrument is drawn in the form of a pro-note or a bill, can it be covered under NI Act. With the growing securitization, there has to be a pressure on the government for accomodating securities under NI Act. All instruments are tranferable but not negotiable in the sense that transfer can be made by delivery. (4) Indian Stamp Act, 1899 : According to sec 2(10) of the Indian Stamp Act, conveyance includes conveyance on sale and other instruments relating to properties, movable or immovable. A conveyance attracts ad-valorem stamp-duty under Art 23 of Schedule I of the said Act. Apart from the above, the securities (PTCs) to be issued to the investors would also attract stamp duty at two stages, viz(1) on issue of securities and (2) on transfer of securities by the investors.

(5) The Income Tax Act, 1961 : Income Tax Act has several provisions relating to transfer of income. As for example, Ss.60, 160-162, 194A of the Act relate to matters involved in Securitisation. Sec 60 contemplates a transfer of income without transfering the assets from which the income was generated. Ss 160-162 provide for imposition and tax on a person as a representative assessee for the income received by him for and on behalf of others. (6) Security Contracts (Regulations) Act, 1958 and Securities Exchange Board of India Act, 1992 : All PTCs are securities under the ambit of the defintion in the above two statutes. SEBI is empowered to regulate the issue of and trading in all PTCs. Securitisation is a financial innovation and hence cuts accross the money management and credit control functions of the RBI which may regulate the marketing operations of such securities through direct and indirect methods and guidelines and also through laying down the standard of disclosure and accounting practice. Besides the above legal requirements other facilties like listing of the instrument at the stock market; insurance coverage for the investors subscribing to securities ‘without recourse’; credit facilities against defaults by borrowers; availability of intermediary services also require building up of infra-structure ‘legal system’ compatible with the requirement of growth of securitisation needed in the commercial market. It is therefore necessary to build up a legal system for encouraging the Securitisation. 1.7 ROLE OF GOVERNMENT It is now understood that the present legal environment about securitisation is inadequate, in-appropriate and unfriendly. It has been rightly observed by an author (Ushir, B.D., 212) that unless immediate steps are taken to remove the legal hurdles, there is a danger of this promising instrument being lost. A two dimensional government action is necessary, viz., (i) removal of all legal barriers; and (ii) providing appropriate incentives and adequate infrastructural facilities. Besides, a suitable regulatory mechanism is necessary to formalise the commercial practice and negotiability. Some of these requirements are as follows : (a) Stamp duty remission : The law relating to Stamp duties are both Central and State subjects. According to Entry 91 of List I of Seventh Schedule under Article 246 of the Constitution of India ‘Rates of Stamp duty in respect of bills of Exchange, promissory notes, cheques, bills of lading , letter of credit, policies of insurance, transfer of shares, debentures proxies and receipts, shall be determined by the Union'. But according to Entry 63 of List II it is stated that in all other cases the Stamp duty is to be fixed by the State. Thus, based on the above stipulation if PTC's are classified on the basis of nature of portfolio and there are several prescriptions for several class of securities such as an ‘portfolio’ relating to mortgage debts or relating to debt, 125 (Sys 4) - D:\shinu\lawschool\books\module\contract law

there will be several confusion. Therefore stamp duty law for all such securities should be brought under the Central subjects and the law is simplified. A nominal stamp duty can be imposed if at all, in order to facilitate securitisation. If stamp duty is not remitted, market shall in itself create some duty saving routes which will have two fold danger. First, the fate of such transactions would always be uncertain. Second, the states would rush with the amendments to the stamp laws to bring within their net the various devices adopted by the market. It is therefore, necessary to give complete remission on securitisation so that growth of the market instruments bring more liquidity which will offset the loss on account of remission of stamp duty and wide confusion arising out of present law relating to stamp duty. (b) Income tax incentives : It is suggested by many marketfriendly economists that securitisation require tax incentives in the line of sec. 88A of the Income Tax Act. (c) Development of infra structural facilities : SEBI may prepare guidelines for listing of such securities and for other

marketing practices. It is necessary for RBI to make regulations for the management of ‘portfolios’ with suitable rules of set off and protection. In US special institutions were set up in 1970s and 1980s, such as, the Government National Mortgage Association (GNMA), the Federal House Loan Mortgage Corporation (FHLMC) based upon the nature of the ‘portfolio’. These institutions took lead role in popularising securitization. Various tax incentives can be given institutions for popularising securitisation. 1.8 CREATION OF INTERNATIONAL SECURITIES Securities may be created for global funding, both by the floating of equity or through development of securities. The distinction between the equity participattion and global securitization is that the former supplies equuity capital which is generally a long term capital flow, whereas funds to securitization are loan capital and short term in nature. Generally for the purpose of floating the securities for the investment of foreign investors, the following mecahnism is resorted to:

Creation of Institutional Securities Indian Side

Foreign Country

Pooling of Indian papers llike Shares Stocks Debenture

repaid to

Release of

Foreign Investor

To Foreign Investor Issue of GDR/IDR creating a SPV

Indian Investment

Debenture-Stock into

Release of Depository

In the above process Indian investors are required to put in their shares, stocks or debentures with a foreign depository to be created for the purpose of constituting a SPV. The foreign depository thereafter issues securities called GDR or IDR for foreign investors against portfolio. Whan a GDR /IDR for

126 (Sys 4) - D:\shinu\lawschool\books\module\contract law

A Foreign Depositing

foreign depository releases the Indian papers which goes back to the Indian investors. GDR/IDR can be listed with the stock exchanges. The RBI provides a guideline for the issue of this type of securities and SEBI regulates the creation of these kinds of securities as well as its dealings in the market.

2. NEGOTIABLE INSTRUMENT SUB TOPICS 2.1. Introduction 2.2. Kinds of Negotiable Instruments 2.3. Promissory Note 2.4. Bill of Exchange 2.5. Cheques 2.6. Hundis 2.7 Inland and foreign instruments 2.8 Inchoate Instruments 2.1 INTRODUCTION The word ‘negotiable’ might owe its origin to the French word ‘negoce’ meaning business, trade or management of affairs. Black’s Law Dictionary defines the term negotiable as something which is ‘legally capable of being transferred by endorsement or delivery‘, and negotiability is the legal character of being negotiable. ‘Instrument’ on the other hand may be defined as a written document; or a formal or legal document in writing such as a contract or a will. Thus, taken together a ‘negotiable instrument’ means ‘a written document capable of being transferred by endorsement or delivery’. Section 13 of the Negotiable Instruments Act, 1882 provides as under: “Negotiable Instrument” - A “negotiable intrument” means a promissory note, bill of exchange or cheque payable either to order or to bearer. Explanation (i) - A promissory note, bill of exchange or cheque is payable to order which is expressed to be so payable or which is expressed to be payable to a particular person, and does not contain words, prohibiting transfer or indicating an intention that it shall not be transferable. Explanation (ii) - A promissory note, bill of exchange or cheque is payable to bearer which is expressed to be so payable or on which the only or last endorsement is an endorsement in blank. Explanation (iii) - Where a promissory note, bill of exchange or cheque, either originally or by endorsement, is expressed to be payable to the order of a specified person, and not to him or his order, it is nevertheless payable to him or his order at his option. 2) A negotiable instrument may be payable to two or more payees jointly, or it may be made payable in the alternative to one of two, or one or some of several payees. A negotiable instrument is an object of rights, i.e., it gives to the person in lawful possession of such an instrument certain rights which other instrument do not give him. Further, a negotiable instrument represents money and possesses the same characteristics as that of money, namely, (i) it is not tainted by

any defect in title at the source so long as its acquisition is lawful, i.e., even if the maker of the instrument commits a fraud or a forgery, a bonafide payee of the instrument is not affected by such fraud or forgery; (ii) it passes by delivery like cash does and the person in lawful possession of it can sue on such instrument in his own name. A negotiable instrument also embodies some of the basic principles of contract, because it is either an undertaking or promise or an order to pay money. Capacity of the parties to such an instrument, their rights and liabilities etc., are all governed by the basic principles of contract. A negotiable instrument is one, therefore which when transferred by delivery or by endorsement and delivery, passes to the transferee a good title to payment according to its tenor and irrespective of the title of the transferor, provided he is a bonafide holder for value without notice of any defect attaching to the instrument or in the title of the transferor; in other words the principle 'nemo dat quod non habit' does not apply. It is this element of negotiability which makes a contract founded upon paper thus adapted for circulation different in many particulars from other contracts known to law [Verma, p.2]. Thus in Raephal v. Bank of England [(1855)104 RR 638:25 LJCP 33], some bank notes of the Bank of England were stolen. The Bank immediately prepared and circulated a list of the stolen notes. The plaintiff being a money changer in Paris also received such a list. After a year of his receiving this notice, a man came to the plaintiff for exchanging a Bank of England note. The plaintiff having forgotten the year old notice encashed the note, which was one of the stolen ones. The Bank of England refused payment to the plaintiff. It was held that the plaintiff, having taken the note in good faith, was entitled to its payment. He was no doubt somewhat negligent, but he had acted honestly. But the principle of 'nemo dat quod non habet' applies only to negotiable instruments and a holder of an instrument which is non-negotiable cannot take this defence. For example, in Whislter v. Forster [143 ER 441], one G fraudulently obtained a cheque from the defendant Forster. The cheque was made payable to G or order. G gave the cheque to the plaintiff as payment for his debt, but forgot to endorse the cheque. Till then, he had no notice of the fraud but before the plaintiff could get G’s endorsement on the cheque, he became aware of the fraud. It was held that the plaintiff could not get a good title. Erle CJ observed: “According to law merchant, the title of a negotiable instrument (payable to order) passes by endorsement and delivery. A title so acquired is good against all the world, provided the instrument is taken for value and without notice of any fraud. The plaintiff’s title here, therefore, was to be rendered valid by endorsement; but at the time he obtained the endorsement, he had notice that the bill had been fraudulently obtained by G from the defendant.” This brings us to an interesting question, what are the essential elements or requirements of a negotiable instrument or when does an instrument become negotiable ? To understand the 127 (Sys 4) - D:\shinu\lawschool\books\module\contract law

essential characteristics of a negotiable instrument it is important to keep in mind the resemblance of these instruments to money. In the words of Parsons, “the most characteristic of money as distinguished from other species of property is the facility and freedom with which it circulates. Any one taking it, therefore, in the course of business, need look no further than to the face of the coin and the possession of the person from whom he receives it. These are the qualities which every representative of money must possess in order to answer its purpose effectively.” [Bhashyam, p.66]. In simpler words what characterizes money is the certainty which it denotes i.e., certainty of denomination and of possession. A negotiable instrument thus should be very certain as to the amount being promised or ordered to pay. Further since the instrument also incorporates principles of contract it should also be clear, unambigous and concise and should also specify the names of the person to whom it is being made payable as also the person making the payment. Thus, a negotiable instrument should be certain as to: (i) persons making the payment; (ii) persons receiving the payment; (iii) the amount payable; (iv) the time and place of payment and (v) conditions of liability (if any). According to Black’s Law Dictionary, for an instrument to be negotiable within the meaning of Article 3 of U.C.C. it must (1) be in writing and signed by the maker or drawer; (2) containing an unconditional promise or order; (3) to pay a specified amount; (4) either on demand or at a definite time; (5) to the bearer of the instrument or to order, and (6) not contain any other promise, order, obligation or power given by the maker or drawer except as authorized. Apart from these general characteristics each kind of negotiable instrument has its own set of essential requirements, but these will be dealt with at appropriate places. Need for Negotiable Instruments You may now ask a very pertinent question - the law dealing with negotiable instruments seems to be very complex, so why should we deal with it ? More importantly why do we need negotiable instruments in the first place, why can’t be do away with them ? The answer to the first question is very simple. Negotiable instruments form the backbone of today’s complex commercial world. Tradesmen prefer to use cheques, drafts, promissory notes etc., in their day to day transactions, rather than ready cash. In fact even the common man has become addicted to the use of cheques and drafts. These instruments are used as a mode of payment alongwith application forms, for filing of tenders, for payment of salary....you name a transaction involving money and you will find a negotiable instrument in some form or other exchanging hands. It is because of this widespread popularity and usage of these instruments that an indepth study of these instruments becomes essential for every user of these instruments. Coming to the second question as to the need or necessity for the existence of these instruments, let us consider the following hypothetical conversation between two fictitious persons Ramesh (who is a money-lender) and Suresh (who is a farmer needing a loan). 128 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Suresh:

Mr.Ramesh I want a loan of Rs.50,000/-.

Ramesh: I will be very happy to loan you that amount but what is the guarantee that you will return the money? Suresh:

I promise you on everything that I hold sacred that I will return it.

Ramesh: Promises are not enough. I need some security against the loan. Suresh:

I have two bullocks which I will give you if I can’t pay the money.

Ramesh: But what will I do with the bullocks ? I stay in the city and will have no use for them. Suresh:

I will tell you what - I’ll write on a piece of paper that in case I fail to pay the money owed to you, my bullocks should be sold and the money given to you.

Ramesh: That should be perfectly okay. Here is the money. Suresh:

Thank you - and here is my note.

Though the entire episode described above is fictitous, it must have been situations like these where the ‘consideration’ or security being offered was too unwieldly or inconvenient for the person to carry around, which gave rise to the birth of these instruments. Try to imagine, you have sold stock worth say $ 1 million and the person wants to pay you in coins or currency. How will you carry it and how much care will you have to extend to see that currency is not stolen. And the situation would have been even worse in the initial stages i.e., before the advent of paper currency, when gold & silver coins were in vogue. A person would really need to be a weight lifter to carry large amounts of such coins, quite apart from the security problems involved. It was to overcome the inconveniences of these kinds of situations that negotiable instruments started being used and quickly became popular, so much so that within no time they became the life and blood of the commercial world. Whether we like it or not negotiable instruments have come to stay and we cannot simply wish them away. Negotiation and Indorsement Negotiable instruments have a characteristic feature of easy transferability to a third party by a proces called ‘negotiation’. As mentioned earlier a negotiable instrument contains either a promise or an order to pay A or his order, or to pay B or bearer. It is this provision for alternative payment i.e. to one or other, that makes these instruments really negotiable. Negotiation may take place in one of the following two ways, viz ; (i) When th instrument is payable to bearer it is negotiable by delivery of it to the third party. (ii) When the instrument is payable to order, then negotiation can be done by firstly ‘indorsing’ it and then delivering it by the holder. ‘Payable to order’ means that the maker may not only specify the person to whom the money is to be paid say a Mr.X, but

also order that the money be paid to any person Mr.X orders it to be paid to. So every instrument may have a series of parties each making the money payable to the next succeeding person or to his order. For example, a bill may be made by A to pay ‘to B or his order’; B may by indorsing make it payable ‘to C or his order’; C making it payable to ‘D or his order’ and so on and so forth. This stream will continue till the bill is ultimately cashed and the amount realized. It may be possible that an instrument gets circulated so rapidly that it becomes so covered with indorsements that there is no place for any more fresh indorsements. In such a situation it is permissible to attach a piece of paper called an allonge to the bill, and this allonge can be used for further indorsements. The question now arises, what is an indorsement ? An ‘indorsement’ in simple words may be defined as the signing on the instrument for the express purpose of negotiation, and negotiation takes place when the indorsed instrument is delivered to any person so as to make him the holder of the instrument. The person signing the bill is known as the ‘indorser’ and the person in whose favour indorsement is made is known as the ‘indorsee’. The same person may take on the character of both the indorser and the indorsee as for example, if A indorses a bill in favour of B, and B indorses the bill in favour of C, then B is an indorsee with respect to A and he is an indorser with respect to C. Once a bill is indorsed and delivered, the indorsee not only acquires the property in the instrument but also the right to further negotiating the instrument to other persons. What is essentially required in cases of indorsement is the intention to pass the property in the bill. Nowadays a question that is becoming increasingly important is, how to sign an indorsement, because the protection of a banker who either pays or receives an indorsed instrument is dependent on the form of the endorsement. Indorsements are of two kinds, viz : (i) indorsements in blank’ ie where the indorser merely signs his name without specifying as to the identity of the indorsee; and (ii) 1indorsement in full’ ie where the indorser specifies the person or indorsee to whom or on whose order the payment is to be made. An instrument with blank indorsement is negotiable by mere delivery, just as if it was an instrument payable to the bearer. A blank indorsement may be converted into a full indorsement by the holder, by writing above the indorser’s signature a direction to pay to any other person. The advantage of pursuing such a course of action is that the holder does not incur the liabilities of an indorser. The holder may also exclude his liability by indorsing the instrument ‘sans recourse’ or he may make his liability conditional. He may also restrict the right of the indorsee to further negotiate the bill by appropriate wording of the indorsement, as for example, by saying ‘pay B only’ or ‘pay B or C’.

The indorsement to be valid must be of the entire bill i.e. you cannot keep part of the bill and indorse the remaining. You may indorse the bill ‘in toto’ or realize it ‘in toto’. A partial indorsement or a transfer to two or more indorsees severally does not operate as negotiation of the bill; but if the bill has been partly paid then a note to that effect can be made on the indorsement and it may then be negotiated for the balance. Who can indorse ? An indorsement can be done only by the lawful holder of the instrument. Every single maker, drawer, payee, indorsee etc or if there are more then all of them jointly can indorse an instrument provided he or they are in lawful possession of the instrument. A stranger i.e. someone who is not a holder cannot indorse an instrument so as to convey a title to the indorsee. An agent of the indorser can indorse the instrument provided he signs as an agent of the indorser and not as an indorser. The Act deals only with transfer of instruments according to Law Merchants, does not deal with transfer by operation of law. An important consequence of negotiation envisaged by the Law Merchants is that, a person taking an instrument bonafide and for value acquires a good title to it, regardless of the defects in the title of the transferor. It is this characteristic combined with its transferability by delivery like cash, which determines the negotiability of the instrument. In case of ordinary transfers, for example, in assignment of a debt, the transferee gets a right to see in his own name, but he does not get a better title than what his transferor has. But in case of negotiable instruments, title of the transferee is dependant upon the manner of his acquisition of the instrument rather than the title of the transferor. In this respect they resemble the coin of the realm which may pass from hand to hand without being tainted by the title of the transferor. 2.2 KINDS OF NEGOTIABLE INSTRUMENTS The Act itself deals with only three kinds of negotiable instruments, viz : promissory notes, bill of exchange and cheques. But this does not mean that these are not other kinds of instruments. The Act specifically saves or excludes from its operation local usages in respect of all instruments in an oriental language unless an intention is expressed in any such instrument that it would be governed by the Act (sec.1). But the usage has to be established by the party alleging its existence, otherwise it will be governed by the provisions of the Act regardless of the language it is written in, i.e. a negotiable instrument need not necessarily be in English it can also be written in the oriental languages. The basic condition differentiating a negotiable instrument from a non negotiable one is not the langauge in which the instrument is written, but is the intention to make a negotiable instrument for the purpose of recording in writing to pay money to a specified person at a specified time. Hence, receipts etc, are not a negotiable instrument even if such receipt is coupled with a promise to pay. We will now deal with these various kinds of negotiable instruments alongwith their salient characteristics and their distinction from one another. 129 (Sys 4) - D:\shinu\lawschool\books\module\contract law

2.3 PROMISSORY NOTES Section 4 of the Act defines promissory note as “an instrument in writing containing an unconditional undertaking, signed by the maker, to pay a certain sum of money only to, or to the order of a certain person or to the bearer of the instrument." The essential ingredients of a promissory note are as follows : (1) It must be in writing and signed by the maker (2) It must contain an unconditional and definite promise to pay a certain sum, and nothing more. (3) It must be payable either on demand or after the efflux of a fixed or deteminable time in future, as for example ‘after 6 months’. (4) It must be payable to, or to the order of a specified person named in the note or to the bearer of the note. (5) Most importantly, an instrument to be regarded as a promissory note must show a prima facie intention to make such a note and it must be delivered. Thus before a document can be treated as a promissory note, two things have to be ascertained : (a) an acknowledgement of indebtedness and (b) a promise to pay the debt. The illustrations appended to the section make the meaning clear, and are being reproduced below. (i) I acknowledge myself to be indebted to B for Rs. 1000 to be paid on demand for value received. (ii) Mr. B, I.O.U. Rs. 1000. The first is a promissory note whereas the second is not, because in the second illustration though there is an acknowledgement of indebtedness there is no corresponding promise to pay. In Raghunath v. Seetaram [1972 Mys. 344] certain tests to ascertain whether the given document was a promissory note or not were laid down. The Court observed : “The controlling element in determining the question whether an instrument is a promissory note or not is the intention of the parties in drawing up that instrument as a promissory note. A document might comply with the terms of this section and yet it may not be a promissory note. For instance, a mere receipt even if coupled with a promise to pay is never intended to be a promissory note, and so a deposit note containing words “we promise to pay the said sum”. But a document, does not become a promissory note merely because the parties intended it to be a promissory note unless it fulfills the terms of this section. However, if a promissory not falling under section 4 of the Act and therefore under section 2(22) of the Indian Stamp Act, 1899, is attested and not payable to order or bearer it would fall under section 2(5)(b) and would amount to a bond for the purposes of the Act. The description of the instrument as a promissory note, the language of the instrument taken as a whole, the circumstances under which it came to be executed, the intention of the parties manifest from the face of the document and the surrounding circumstances have all a cumulative bearing on a proper construction of the instrument whether it is a promissory note or not." There is another requisite for a promissory note 130 (Sys 4) - D:\shinu\lawschool\books\module\contract law

to be valid and that is that the note should be properly stamped as per the requirements of the Indian Stamp Act, 1899, but in case of a pro note executed in the State of Jammu & Kashmir must be affixed with requisite stamps prescribed under the J & K Stamp Act, [Gulam Nabi v. Lal Mohammed, AIR 1975 J & K. 50] Kinds of Promissory notes Section 4 recognises three kinds of promissory notes : (1) A note containing a promise to pay a certain sum of money to a person. Originally this was not considered as a negotiable instrument in India, but it was perfectly valid between the parties to the document, and it was capable of being assigned as an ordinary chose-in-action though not by negotiation [Udayar v. Muthia 7 MLJ 231] but Act VIII of 1919 made such instruments also negotiable, unless in the instrument words like “only to” are included. (2) A note containing a promise to pay a certain sum to the order of a certain person. Such notes are however payable only to the person named or by his order. (3) A note containing promise to pay the bearer, but such notes were declared invalid under the Paper Currency Act and now under the Reserve Bank of India Act. There is another special kind of promissory note viz: Government Promissory notes - These are issued by the Government (either Central or State), for loans raised by them, and are made payable to order or a bearer bond payable to the bearer. Though these notes are in the form of negotiable instruments, their transfer by indorsement and the liability of the transferor and the renewal, are now regulated by Public Debts Act, 1944. A transfer of such promissory notes will not be valid unless it conveys the full title to the security or if it is of such a nature as to affect the manner in which the security is to be held as expressed by the Government. The definition u/sec.4 specifically excludes the following notes, viz: Bank notes - A bank note may be defined as any bill, draft or note issued by a banker, promising to pay a certain sum to the bearer on demand, and whic entitles the bearer or holder of the instrument to the payment of the amount without further indorsement. In its nature it is like cash and differs from bonds and other securities which are only evidence of money being due and are not money itself. Currency notes - A currency note issued by the Government incorporates an undertaking by the Government to pay the bearer of the note on demand the specified sum. Though bank notes and currency notes satisfy all the requirements of promissory notes, they are themselves money and legal tender for the amount represented by them, and hence excluded from the purview of the Act. Bank notes differ from currency notes in that they are not issued by the Government & sec.26 of the Paper Currency Act, 1923, prohibits the issue of these notes in the country, and only RBI has the right to issue bank notes and

also has the right to issue currency notes for a period fixed by the Central Government. All provisions which apply to bank notes would also apply to currency notes. Drafting of promissory notes As mentioned earlier a promissory note should incorporate : (1) the amount to be paid ; (2) date and place of execution ; (3) the person to whom the money is to be paid ; (4) the date/time on which it is to be paid ; (5) by whom it is to be paid. Given below are a few sample promissory notes which are usually used in the commercial market.

1. .............. 2. .............. We hereby promise to pay on demand (or ............ years after date) the said sum of Rs. ...... (in words) to the said XY with interest at ....... percent per annum. Dated the 24th March, 1995 Place : Bangalore Sd. AB .......................... CD ..........................

(i) Promissory note for a loan

EF ..........................

Rs.5000 Bangalore, March 24th, 1995

Parties to a promissory note

In consideration of the loan of Rs.5000 advanced by Mr.Avtar Singh to me, I promise to repay the said loan of Rs.Five Thousand with interest at 6 1/2 % annum to Mr. Avtar Singh or order Signed Pratap Singh son of Biswas Singh resident of 222, 72 cross, 4th main Rajajinagar, 6th block Bangalore.

There are in general two parties to a promissory note - the maker (i.e. the one who acknowledges this indebtedness and expressly promises to pay) and the ‘payee’ (ie the person to whom such payment is to be made). Where a promissory note is made by 2 or more persons we may have 2 or more ‘makers’ and if it is made to 2 or more persons than we have ‘joint payees’. The rights and liabilities which attach to such maker and payee will be dealt with in a later chapter.

(ii) Promissory note payable on a fixed date or in instalments

2.4 BILL OF EXCHANGE

Bangalore, 24th March, 1995

A bill of exchange has been defined by sec.5 as, “an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of a certain person or to the bearer of the instrument.

Rs. I, AB, etc., promise to pay to CD etc., or order the sum of Rs.________________ (in words) on the ............. (or, ......... month after date) (or, in twelve equal instalments of Rs. ........... each payable on the first day of every month commencing from the first day of May, 1995) (Signed)

..................

AB son of

..................

resident of

..................

(iii) Promissory note in the form of a letter Bangalore March 24th, 1995 Dear Shri Cd, etc., Whereas you have advanced to me today a loan of Rs .........., I hereby promise to repay the same to you on demand with interest at ........ percent per mensem. Yours Sincerely,

A promise or order to pay is not “conditional” within the meaning of this section and section 4, by reason of the time for payment of the amount or any instalment thereof being expressed to be on the lapse of a certain period after the occurence of a specified event which, according to the ordinary expectation of mankind is certain to happen, although the time of its happening may be uncertain. The sum payable may be “certain” within the meaning of this section and section 4, although it includes future interest or is payable at any indicated rate of exchange, or is according to the course of exchange, and although the instrument provides that, on default of payment of an instalment, the balance unpaid shall become due. The person to whom it is clear that the direction is given or that payment is to be made may be a “certain person” within the meaning of this section and section 4, although he is misnamed or designated by designation only”.

(iv) Joint Promissory Note

The above definition is the result of a number of English decisions on the topic. A brief of exchange (or BOE) is sometimes called as a ‘draft’ drawn by a bank on another or by itself on one of its other branches.

Whereas we, AB, CD and EF etc., owe Rs .............. to XY, etc, as detailed below :

The essential requirements of a BOE may be said to be as follows:

Sd. .............. Ab s/o ................, resident of ..............

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(1) Written: An oral BOE can neither be made nor if made will it be valid. A BOE being a negotiable instrument should be in writing and executed by the maker. (2) Order to pay : A BOE must always contain an order to pay. In whatever form the order be framed it should be imperative. Thus in Ruff v. Webb [(1974) 5 RR 773], the plaintiff a servant of the defendant, was dismissed from his services by the latter. For the wages due to him the defendant gave him a draft in the following words : “Mr. Nelson will much oblige Mr. Webb by paying to J.Ruff or order, twenty guineas on his account”. It was held that the “paper ... was a bill of exchange, that it was an order by one person to another to pay money to the plaintiff or his order. It is quite apparent that the language of the draft was very polite, but it has been said that “the introduction of the terms of gratitude does not destroy the promise (or order) to pay”. But where no such order to pay can be ascertained from the language it will not be a BOE. Thus, in Little v. Slackford [(1882)31 RR 726], the defendant issued a paper to the plaintiff containing the following words : “Mr. Little, Please to let the bearer have seven pounds, and to place them to my account, and you will oblige. Yours humble servant, R. Stackford. It was held that, “...... the paper does not purport to be a demand draft made by a party having a right to call on the other to pay. The fair meaning is you will oblige by doing it”. (3) Unconditional : The order to pay on the BOE must be unconditional i.e, the payment must be made under all circumstances and it should not be dependant on any contingency. The reason for this was explained in Carlos v. Fancourt [(1794)5 TR 482] as, “it would perplex the commercial transactions of mankind and diminish and narrow their credit and negotiability if paper securities of this kind were issued out into the world, encumbered with conditions and contingencies, and if the person to whom they were offered in negotaition were obliged to inquire when these uncertain events would be reduced to certainty. And hence the general rule is that the bill of exchange ( or note) always implies a personal general credit not limited to, or appreciable to particular circumstances and events which cannot be known to the holder in the general course of negotiation." Thus a BOE payable only on contingency is void ab initio, but such contingency or defect should be apparent on the face of it. In such cases, even the happening of the contingency cannot make the BOE valid. A BOE is not based on contingency merely because there is an uncertainty regarding the person having the right to enforce it under particular circumstances. 4) Payment of money : The BOE must incorporate an order to pay and the payment should only be in the form of money i.e payment in cash not in kind. The same condition also applies to a promissory note. Further, the amount to be paid must be certain i.e. you cannot have a BOE with words like pay “any amount” or “little amount” or “a certain amount” etc. The exact amount to be paid must be stated clearly. In Smith v 132 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Nightingale [(1818)20 RR 694], a promissory note was made in the following words : “I promise to pay to JE ... the sum of £65 with lawful interest for the same, three months after the date, and also all other sums which may be due to him”. It was held that "the instrument was too indefinite to be considered a promissory note. It contained a promise to a pay interest for a sum not specified and not otherwise ascertained than by reference to the defendant’s books." It is to be noted that wherever in an instrument the rate of interest is specifically mentioned, the interest is to be calculated at that rate from the due date to date of debt realisation. But where the interest rate is not specified in the instrument it is to be calculated at the rate of 18% according to sec.80 of the Act. 5) Time of payment: The BOE must indicate clearly the time of payment. Thus in Williamson v. Rider [(1962)2 All ER 268 (CA)] a promise to pay ‘on or before’ December 31, 1956 was held not to be a promissory note payable at a fixed or determinable future time within the requirement of section 11 of the Bills of Exchange Act because the option to pay at an earlier date creates an uncertainty or contingency in the time of payment’. 6) Parties : The names or identities of the parties to the BOE must be certain. A BOE showing ambiguity regarding the identity of the persons concerned will not be a valid BOE. 7) Stamp duty: A BOE should be affixed with stamps for required amount as Specified under the Stamp Act, 1899. In Bank of Bengal v. Radhakissen [3 M.I.A. 19] it was held that ‘an instrument which is bad as a bill, note or cheque by reason of the inclusion thereon of a condition or any other stipulation may be used as evidence of an agreement, if properly stamped”. Drafting of a BOE The drafting of a BOE or for that matter a promissory note is a simple matter as no specific format or use of words is prescribed. The only point to be remembered is that all the essential requirements should be included, i.e., in case of BOE it should contain (i) sum to be paid in cahs; (ii) unconditional order to pay ; (iii) maker or drawer should be certain and (iv) payee and draweee should be certain. Given below are a few specimens of BOEs. (i) BOE payable on demand Bangalore March 25, 1995 Rs. ............... Pay to X,Y, etc., or order (or, pay to XY, etc., or bearer) (or, pay to my order) on demand (or, at sight) (or, on presentation) the sum of Rs ........ (in words). To Cd, etc (drawee) Sd. AB (drawer)

(ii) BOE payable after date (with interest) Bangalore 25th March, 1995 Rs. ............... ............. days (months) after date pay to XY, etc., or order (or, pay to XY, etc., or bearer) (or, pay to my order) (or, pay to bearer) the sum of Rs ........... (in words), with interest at .... per cent per annum. To CD, etc

AB (drawer)

(drawee) (iii) BOE where drawer & drawee is the same person

to his order ..... pounds sterling ( in words) (and charge the same to the account of XY against your letter of credit No. ......... dated ..........) To AB, etc. (drawee)

Sd. (drawer)

Distinction of a BOE from a promissory note Though both are negotiable instruments, there exists three basic distinctions between the two viz : (i) In a promissory note there are only two parties the maker and the payee; whereas in a BOE there are three parties viz the drawer, drawee and payee. (ii) A promissory note acknowledges an indebtedness of the maker to the payee; whereas no such acknowledgement of debt is there in a BOE.

Bangalore March 25, 1995 Pay self (or, to my order) the sum of Rs. ........(in words) only. (Sd.) AB

(iii) In a promissory note the maker or executant makes a promise to repay the debt himsef; where as in a BOE the executant directs a third party to pay.

(iv) Foreign Bill of Exchange

Parties to a BOE

(Drawn on set of three parts)

As mentioned earlier, there are three parties to a bill of exchange, namely, the ‘maker’ or executant of the bill, the ‘drawer’ who is ordered to pay and the ‘payee’ to whom the money is to be paid on order. The rights and liabilities attaching to each of these parties will be discussed in detail in a later chapter.

To

First Part No. .................... Exchange for £ Bangalore, March 25, 1995 ......... months after sight of this first of exchange (the second and third of the same date remaining unpaid), pay to CD, etc., or to his order ..... pound sterling (in words) (and charge the same to the account of XY against your letter of credit No. ........ dated ...........).

2.5 CHEQUES

To

A cheque being a kind of BOE it must fulfill all the requirements of a BOE. Thus in Bevins v. London & Smith Western Bank Ltd [(1900)1 KB 270], a company issued a cheque on its bankers with a receipt appended to it, and ordering the banker to make the payment “provided the receipt form at foot hereof is duly signed, stamped, and dated”. The cheque was held to be invalid because its payment was made conditional upon signature of the receipt.

AB, etc.

Sd. ............

(drawee)

(drawer)

Second part No. ................. Exchange for £ angalore, March 25, 1995 ............. months after sight of this second of exchange (the first and third of the same date remaining unpaid), pay to CD, etc., or to his order ...... pounds sterling (in words) (and charge the same to the account of XY against your letter of credit No. ..... dated .....) To Ab etc.

Sd. .........

(drawee)

(drawer)

Third part No. ................. Exchange for £ Bangalore, March 25, 1995 ....... months after sight of this third exchange (the first and second of the same date remaining unpaid), pay to CD, etc., or

Section 6 of the Act defines cheque as “ a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand”.

A cheque is always drawn on a banker. The question now arises, who is a banker ? This question was answered in R. Pillai v. S. Ayyar [(1920)43 Mad 816]. Here, a District Board had its funds in the Government Treasury and used to withdraw money from that fund by issue of orders in form of cheques. One such unconditional order being issued the question arose as to whether it was a cheque. It was held that, ‘Treasury is not a bank. A banker is one who in the ordinary course of his business honours cheques drawn upon him by persons from and for whom he receives money on current accounts”. Thus, the order was held not to be a cheque u/sec.6 but a BOE u/sec.5 of the Act. Distinction between cheque and BOE In Ram Charun Mullick v. Luchmee Chand Radakissen [14 ER 215] it was observed, “ a cheque is a peculiar sort of 133 (Sys 4) - D:\shinu\lawschool\books\module\contract law

instrument, in many respects resembling a bill of exchange, but in some entirely different. A cheque does not require acceptance, in the ordinary course it is never accepted; it is not intended for circulation, it is given for immediate payment; it is not entitled to days of grace ....”. Citing this passage in Bank of Baroda v. Punjab National Bank [(1944) AC 177] Lord Wright made a further contribution to the distinction between cheques and BOEs and observed : “In addition it is to be noted, a cheque is presented for payment, whereas a bill in the first instance is presented for acceptance unless it is a bill on demand. A bill is dishonoured by non-acceptance, this is not so in the case of a cheque. These essential differences (besides others) are sufficient to explain why in practice cheques are not accepted. Acceptance is not necessary to create liability to pay as between the drawer and the drawee bank. The liability depends on contractual relationship between the bank and the drawer, its customer. Other things being equal, in particular if the customer has sufficient funds or credit available with the bank, the bank is bound either to pay a cheque or to dishonour it at once ... It is different in case of an ordinary bill; the drawee is under no liability on the instrument until he accepts; his liability on the bill depends on the acceptance of it”. The distinction between a cheque and BOE can be briefly stated as below : a) A cheque is always drawn on a bank or banker ; whereas a BOE is made to a drawer who is merely a definite or identifiable person. b) A cheque is payable immediately on demand without days of grace; whereas a BOE may be payable on demand or a future fixed date or at sight or at presentment etc. c) A cheque requires no acceptance apart from prompt payment; whereas a BOE in the first instance has to be presented for acceptance. d) There is no privity of contract between the banker and the payee and so the later cannot sue the banker on his dishonouring the cheque without sufficient cause; whereas since a drawer of BOE accepts the liability to pay he can be sued by the payee if he dishonours the BOE i.e. there is a privity of contract between the drawer and payee. e) A cheque is supposed to be drawn upon funds in the hands of the banker belonging to the maker i.e. if there are no funds the cheque cannot be honoured. f) A cheque is not noted or protested for dishonour unlike a BOE. g) In case of crossed cheques a protection is given to the banker which is unique only to cheques. This will be discussed later. Parties to a Cheque Like in other BOEs a cheque also involves three parties namely; the executant or maker of the cheque; the drawee’ who is always the bank and the ‘payee’ in whose favour the cheque is made. 2.6 HUNDIS As observed earlier though the Act itself recognizes only three kinds of negotiable instruments by name, it also accepts certain 134 (Sys 4) - D:\shinu\lawschool\books\module\contract law

instruments having wide-spread commercial usage. One such instrument having a popular usage in India is the ‘Hundi’. The word hundi is derived from the Sanskrit word ‘hund’ meaning ‘to collect’ and explains clearly the purpose for which hundis are use. Hundis have been in use in India long before the advent of the Act, and a lot of usages attach to them - the usages themselves differing from locality to locality. Thus for examples in Murshidabad interest on hundis drawn payable so many days after sight is allowed [Dhanput Singh v. Maharaja Jugut Indur, 4 W.R. 85]; in Dacca the usage is for the gumastas (i.e. munshis or clerks) to draw hundis on their principals without thereby incurring liability for the defection of their principals i.e. the gumastas themselves incur no liability [Muree Mohan v. Krishna Mohun, 17 W.R. 442]; among the shroffs of Bombay the usage was that a shroff to whom a hundi was sent for collection by his customer gave him credit for the amount and then he acquired all the rights of a holder in due course [Sugan Chand v. Mulchand, 1 Bom 23]; in Punjab there is a usage that where a hundi is dishonoured and returned,and a conditional payment is made,the hundi is to be presented again within four days or else the amount should be refunded [Surajaml v. Kashiprasad, 1933 Mag 389]; etc,. The names in the brackets indicate the cases where these customs have been upheld by the courts as binding on the parties. A hundi when paid and cancelled is called a “Khokha”. Kinds of Hundis The very fact that usages attaching to a hundi differ from place to place proves that there are various kinds of hundis each having its own specific characteristics, i.e. some may be payable on sight; some after the elapse of a definite period; some are payable only to a specific person; etc. We will now discuss these various kinds of hundis in brief. (i) Darshini hundi - This is a hundi which is payable on ‘darshan’ i.e. at sight or presentment. A specimen of darshini hundi prevalent in Bombay is given below : Rs. 5000 At Bombay Sheth ......... please accept salutation of the writer sheth ........ from . ...... we have received here (Rs 5000) five thousand only from Sheth ......... Please pay to the presenter at sight and debit the same to our account. Please pay the double of two thousand five hundred viz, five thousand only, per rules of the Bombay Shroff Mahajan. Date

Signature

(ii) Mudati or Thavani hundis - These are hundis which become payable at a certain period after date or sight. Specimen of mudati or Thavani hundi is given below. Muddati (or usance) Hundi (Bengal) May Sri Durga protect us. Obedient servant Sj. Hari Charan Dass begs with many salutations to inform you, that a hundi for Rs.1,000 double of Rupees five hundred (Rupees one thousand only) is issued upon you from this place. The amount has been deposited hereby Sri. Amarnath Basu. The Muddat is 25 days and the grace is 3 days, i.e, in all 28 days. On the

receipt of this Hundi, you please accept it and pay the sum to a person with credit on due date after the Muddat and take receipt on the back of the Hundi. This is the prayer to your auspicious feet. Thus ends this Hundi. 10th Ashar 1335 Monday, Signature Thavanai Hundi for goods sent (Madras) Due

19

Rs .......

Place and date

At ........ days after sight please pay to ......... or order the sum of Rupees ......... only for value received against R/R ........... To Drawee (Address). Signature (iii) Shah Jogi hundi - This is a hundi payable only to a respectable holder, i.e. a man of worth and substance known in the bazar [Lall Mal v Kesho Das, 26 All 493]. There has been a division of opinion on the question, whether a shah jogi hundi is a negotiable instrument ? Some courts held that it is not a negotiable instrument since the payee is an indeterminate person; whereas some other courts held that the word ‘shah’ is not indeterminate and vague, and that it may be treated as payable to the drawee or to several payees. In Daulatram v. Bulakidas [(1861) 6 B.H.C.R.] the Bombay High Court held that at its inception it was a hundi that passes from hand to hand by delivery and requires no indorsement. The same Court in Champaklal v. Keshrichand [50 Bom 765] held that, the hundi may pass from hand to hand till it reaches a Shah who, after making due enquiries to secure himelf presents it to the drawee for acceptance or payment; then its negotiability ceases. The drawee before paying has to satisfy himself that the person demanding payment is a Shah, for the payment is made only on the responsibility of that person [Ganeshdas v. Lachminarayan, 18 Bomb 570]. A minor may be the holder of a Shah Jogi hundi and a payment to him will certainly be recognised [Ramprasad v. Shrinivas, 1925 Bom 527] Though a Shah Jogi hundi does not technically fall within the definition of a negotiable instrument under the Act, it is nevertheless a negotiable instrument. The Act does not apply to it though many of the provisions which apply to it are similar to that of provisions applicable to those of instruments covered under the Act, though that is because of the mercantile usage and not by virtue of a Act. Given below is a specimen of a Shah Jogi Hundi. Shah Jogi Hundi (Bombay) At Bombay Sheth ...... Please accept salutations of the writer Sheth .................... from ................ We have received Rs. 1,000 from Sheth ............... Please pay the presenter on demand as per rules of the Bombay Shroff Mahajan after assuring yourself that the presenter is a Shah: Date the 12th Dark day of Bhadrapad Samvat year 1911. Date

Signature

(iv) Jokhmi hundi - This is a hundi drawn against the goods shipped on the vessel named in the hundi by the consignor on the consignee of the goods. The drawer of the hundi is enabled to get funds by negotiating the hundi and at the same time effect an insurance upon the goods against loss. The buyer of the hundi is the insurer who pays the insurance money down and is entitled to recover the money if the vessel arrives safe in port. If the ship is lost then he does not have a remedy against either the drawer or drawee, and he has to bear the entire loss, while the drawer & drawee themselves are protected. This kind of transaction though similar to an ordinary insurance policy differs from it in the sense that the position of insurer and insured is reversed and the insured money is paid before hand. The term “Jokhmi” itself means “against risk” or conditional. This custom however imposes no liability on the drawee to take up the hundi, even if he takes possession of the goods consigned to him. The drawer also escapes liability if the goods against which the hundi is drawn are totally lost [Jadowji Gopal v. Jetha Shamji, 4 Bom 333]. Given below is a specimen of a `Jokhmi hundi’. Jokhmi Hundi (Bombay) Welfare. To worshipful ........... of Bombay written by Liladhar Govindji of Nawanagar whose salutations please accept. To wit. We have received here from Jadowji Gopalji Rs.4,000 (forty hundred only). In respect thereof this Jokhmi hundi (is drawn) against goods on Board “Ganga Hariprasad” (Nakkawa Boja, owner Mr. Dayalji Morarji being 29 bags of sheep’s wool shipped from Tuna, against which this Jokhmi hundi (is drawn) after said vessel shall have arrived in a safe and sound manner. After 8 days thereof, do you be good enough to pay to Shah looking to his means, station and place. Date :

Signature

(Note . — This is generally accompanied by a letter of advice). (v) Nam Jog Hundi - In contradistintion to Shah Jogi Hundi, there is what is known as the Nam Jog Hundi, that is a hundi payabele to the party named in the bill or his order. The bill may or may not be accompanied by a descriptive role of the party in whose name it is granted. When there is a descriptive role, it cannot be indorsed or transferred; but when there is no such description, it can be indorsed. The alteration of a Nam Jog into a Shah Jogi hundi is a material alteration and renders the instrument void. Given below is a sample of such a hundi. To Chunnilal at Madras worthy of alleulogy. Written from Calcutta by Ramkumar from whom please accept salutations. To wit. Please pay on receipt of this Hundi to Ramnath Goenka according to custom of Hundi, the sum of Rs.1,000 (double of half the sum of five hundred) for value received. Date

Signature

(vi) Dhani Jog Hundi - Dhani Jog hundi is one payable to Dhani or owner, i.e., a person who purchases it. It is payable to any owner, holder or bearer. It is a negotiable instrument payable to bearer. The word “dhani” is not equivalent to `bearer’ in the sense it is used in the Negotiable Instruments Act. A mere bearer of a Dhani Jog hundi is not as such entitled to payment. It is not a negotiable instrument within the meaning of this Act. Given below is a sample of such a hundi. 135 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Bow to Shri Ganesh

2.7 INLAND AND FOREIGN INSTRUMENTS

To Chunilal Murliprasad worshipped and worthy of alleulogy at Madras blessed by the Goddess of Wealth ....... written from Calcutta by Ramkumar from whom please accept salutations. To wit. Pay at once on receipt of this Hundi to Dhani Jog according to the custom of hundis.

Sec.11 of the Act which defines inland instrument states as follows :

Rs. 1,000 (in words) one thousand, double of half the sum five hundred on behalf of Chunnilal Prasad of this place for value received.

For a negotiable instrument to be treated as an inland instrument it should fulfill one of the following two requirements, viz (i) it must be drawn and made payable in India; or (ii) it must be drawn in India upon some person resident in India, even though it is made payable in a foreign country. An inland instrument does not lose its character merely because it is either indorsed by a foreign national or in a foreign country because it is in circulation in a foreign country.

Date

Signature

(vii) Jowabi Hundi - The transaction known by the name of Jowabi hundi is as follows :- A person desirous of making a remittance writes to the payee and delivers the letter to a banker who either indorses it on to any of his correspondents near the payee’s place of residence or negotiates its transfer. On its arrival, the letter is forwarded to the payee who attends and gives his receipt in the form of an answer to the letter which is forwarded by the same channel to the drawer of the order. This, it will be noticed, is more in the nature of a letter of recommendation than a bill of exchange. The banker may cancel the order of payment by advice to his correspondent at any time before payment, in case the so-called drawer fails in his promise to provide the banker with the amount of the order. (viii) Zickri Chit - According to the usage of shroffs in the case of Marwari hundis, a hundi may be accepted for honour under what is called Zickri chit. This is a letter of protection given to a holder by some prior party to the hundi to be used by him in case the hundi is not accepted. It is generally addressed to a person in the town where the bill is payable, asking him to take up the hundi in case of dishonour. Such usage is even now recognised by the Court, notwithstanding the fact that the provision of sections 108 and 109 of the Act are not complied with a specimen of Zickri (Tikry) Chit.(Ajmere)is produced below. To good place Dwarka. Letter written to brother Mohal Lal from Hari Dayal who sends greetings. We had sold hundi for Rs.65 (sixty-five) from Dwarka on Sanwal Das, by Radha Krishan favouring Lodhi Pershad, dated 10th day of Bhadon, Sambat 1911, payable to bona fide person, in the currency ofthe market, to brother Baldeo Sahai Gopi Nath who informs us that the hundi is unpaid. If this hundi has been paid, well and good. If not, please pay this hundi as stated in this letter debiting the amount to our account and return the hundi unendorsed to us. Letter written the 11th day of the latter half of Katak, Sambat 1911. (Sd.)

HARDAYAL (Verma, pp 58-60)

An important point to be remembered in relation to hundis and other instruments in oriental languages is that if the existance of a local custom or usage establishing such instrument cannot be proved, then the provisions of the Act will apply to such instruments. 136 (Sys 4) - D:\shinu\lawschool\books\module\contract law

“A promissory note, bill of exchange or cheque drawn or made in India and made payable in or drawn upon any person resident in India shall be deemed to be an inland instrument”.

Sec.12 of the Act dealing with foreign instruments states as under : “Any such instrument not so drawn, made or made payable shall be deemed to be a foreign instrument”. A foreign bill may be any one of the following viz : i) It is drawn outside India and is made payable in or drawn upon any person resident in a country other than India; ii) A bill drawn outside India and made payable in or drawn upon any person resident in India; iii) Bills drawn in India upon persons resident outside India and made payable outside India. Foreign bills are generally drawn in a set of three or in parts numbered and containing a refrence to the other parts (see the specimen foreign bill given on pg. 23). The reason for the this is to reduce or remove the danger of loss, especially when such bills are to be sent to foreign or overseas countries. An important question which now arises is - what is meant by 'resident' in India? Although the term 'resident' has been defined both in the Income Tax Act and the Civil Procedure Code, such definitions would be extremely wide for application of these sections. So for our purpose, resident would mean or suggest a permanency of staying at a place (even if not domiciled) as opposed to a temporary stay or a visit to the country. In case of companies and firms 'residence' means 'place of business.' Distinction between inland and foreign bills The major difference between these two bills is that in case of inland instruments 'protesting for dishonour' is optional, whereas foreign bills must be protested if the law of the place where it is drawn so requires. Secondly, the liabilities of a drawer of a foreign BOE or maker of foreign promissory note are essentially regulated by the law of the land where they are drawn and made; and merely because such note or BOE is negotiable in its own country will not automatically make it negotiable in another country, i.e., such negotiability will be governed by the usages of such other country.

2.8 INCHOATE INSTRUMENTS Section 20 of the Act deals with inchoate or blank instruments and states that, “where one person signs and delivers to another a paper stamped in accordance with the law relating to negotiable instruments then in force in India, and either wholly blank or having written thereon an incomplete negotiable instrument, he thereby gives prima facie authority to the holder thereof to make or complete, as the case may be, upon it a negotiable instrument, for any amount specified therein and not exceeding the amount covered by the stamp. The person so signing shall be liable upon such instruments, in the capacity in which he signed the same, to any holder in due course for such amount : Provided that no person other than a holder in due course shall recover from the person delivering the instrument anything in excess of the amount intended by him to be paid thereunder”. This section imposes a liability upon a person executing a blank or incomplete negotiable instrument and hence shall be strictly construed. The object and intent of this section was laid down in Glenie v. Bruce Smith by Fletcher Molton, L.J., as “The logical order of operations with regard to a bill, is, no doubt, that the bill should be first filled up, then that it should be signed by the drawer, then that it should be accepted, then it should be negotiated, and then that it should be indorsed by the person who become successively holders; but it is common knowledge that parties very often vary, in a most substantial manner. The logical order of those proceedings, and section 20 of the Bills of Exchange Act is intended to deal with those cases”. Very often in the commercial world, persons having mercantile credit ie., good business repute, lend it to others by signing their names on blank papers which is afterwards filled up as a BOE or promissory note over their signatures making them drawers or makers. In Montague v. Perkins [(1853)22 LJ (C.P) 187] it was observed that, “By such signatures, they intend to bind themselves as drawers or makers, acceptors or indorsers, and the presence of their names on the blank paper purports to be an authority granted to the holder to fill up the blanks as a complete negotiable instrument, and when so filled up, such parties become as absolutely bound in the capacity in which they signed, as if they had signed them after the bills were written out, but till the blanks are so filled up the instrument is not a valid one and no action is maintainable on it”. The capacity in which a party to a blank bill becomes bound (i.e. whether as

drawer or as indorser etc) depends on the mode and place of signature. For example, if a person signs his name beneath the word “accepted” or simply writes his name across the face of the bill he becomes liable as an acceptor; but if he signs his name across the back of the blank paper duly stamped and delivered he becomes liable as indorser. But in no case will such a person become liable, till he i.e. the person signing delivers the paper to another. A person in possession of such a blank bill has a prima facie authority to fill up the instrument and in this manner he acts as an agent of the person delivering the blank instrument. So if the authority of the agent comes to an end before the instrument is filled, sec.20 becomes inapplicable and no rights attach to such an instrument except to a holder in due course. Sec.20 does not give the time within which such an instrument should be filled up. The corresponding sec.20 in Bills of Exchange Act in England states that the instrument should be filled up within a reasonable time, and what is a reasonable time is a question of fact varying from case to case. The authority to fill up the blanks is not limited to the person in possession of the instrument but also extends to those claiming under him. But this authority does not include the right to stitch up several signed stamped papers together so as to make one single instrument [Gokuldas v. Radhakisan, 54 I. C.3], nor can a person insert a particular place of payment before the acceptance [Calvent v. Baker, 150 E.R 1492], since this would amount to material alteration of the instrument. Thus, whenever a holder exceeds his authority he can derive no benefit from that instrument. Under the proviso to the section the holder in such a case is entitled to recover the sum which was intended to be paid orginally. In Hatch v. Searles [(1854) 2 Sm. & G. 147] it was observed that, “as to a bonafide holder, the question as to the effect of the acceptance or indorsement having been written on a blank piece of paper can be of no importance unless he can be fastened with notice of that imperfection. If the holder has notice of the imperfection, he can be in no better situation than the person who took it in blank as to any right against the acceptor or indorser who gave it in blank”. Only bonafide owners are protected under the section, and so if the holder of the instrument has taken it for betting transactions and realised the amount on it, the maker is entitled to recover the amount [Paine v. Bevan, (1914)19 Com.Cas 234].

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3 PARTIES TO A NEGOTIABLE INSTRUMENT SUB TOPICS 3.1 Introduction 3.2 Parties to a promissory note 3.3 Parties to a BOE and cheque 3.4 Holder an Holder in due course 3.5 Indorser 3.6 Parties 3.1 INTRODUCTION In the earlier chapter we have repetedly used the words maker, drawer, drawee or indorser etc. We have also tried to briefly define the terms, but have not gone into the rights and liabilities which attach to these parties. We would now deal with these matters in detail. 3.2 PARTIES TO A PROMISSORY NOTE A promissory note involves only two parties, viz; the maker and the payee. Maker ; The person who executes or makes the promissory note is called as the ‘maker’. It is of paramount importance that the note should clearly indentify the person entering into the contract. All persons whose names appear as makers are primarily and unconditionally liable provided the note clearly shows an unconditional promise to pay the debt or the amount. Further the maker should put his signature across the bill. Though the Act itself does not define the word ‘sign’, sec.3(56) of the General Clauses Act, 1897 defines it as: “sign” with its grammatical variations and cognate expressions, shall with reference to a person who is unable to write his name, inlcude “mark” with its grammatical variations and cognate expressions. Signature may thus be briefly defined as ‘the writing of his name or putting his mark across a bill by a person in order to authenticate and accept the contract specified in the bill’. Thus by signing the pro note the maker not only executes the note but also accepts to be bound by its contents. Thus in Block v. Bell [(1831)1 Mor. & Rob. 149], an instrument in the form of a promissory note without any signature of the defendant, but addressed to him in the margin and ‘accepted’ by him was allowed to be declared as a note on the ground that the signature of the defendant though in the form of an acceptance, was an adoption of the promise contained in the instrument. When does the liability arise ? A makers liability arises when : a) he signs the promissory note and b) unconditionally promises to pay Extent of liability A maker is liable to pay only that amount which accrues to him as per the terms of the promissory note. His liability is not 138 (Sys 4) - D:\shinu\lawschool\books\module\contract law

dependant on presentment to any other party on payment or otherwise unless such condition is expressed in the note itself. Payee : The person in whose favour the promissory note is made i.e. the person to whom the money is to be paid is known as the payee. Just as the maker of the note has to be certain, so also should the payee be. Thus in Obermeyer v. Barmann [1911 T.P.D. 79] an instrument containing a promise to pay a certain sum into the bank but not naming the payee, was held out to be a promissory note. The payee may be either specified by name or designation [if by the use of the designation an identification can clearly be made] or the promissory note may be made payable to a ‘bearer’ i.e. the person is in possession of the note lawfully and presents it for payment. If neither of these conditions are satisfied then the note is not a promissory note. Under sec.4, a note may be made payable to alternative payees i.e. pay to ‘AB or CD’. In such a case either AB or CD can present the note for payment. This is a good way of limiting your liability to pay to only the persons mentioned in the note and to no other. A note may be issued to more than one person making them joint payees i.e., ‘payable to A,B, C or their order or the majority of them’. Such a note may be sued upon by all of them. Where the maker executes a note in favour of a fictitous person then the note will be treated as ‘payable to bearer’ and a person in lawful possession can present it for payment. So also a promissory note with a blank for the payee’s name may be filled up by a bonafide holder in his favour and he can claim on the note. Rights of a payee 1. Where the note is a promise to pay, the payee can present the note for payment. If the maker defaults on the payment then the payee has the right to sue the maker on the note. 2. Where the note is in the form of ‘payable to AB or order’, the payee can: - present the note for payment. - sue the maker in case of default - indorse the note for negotiation an deliver it to the holder. 3.3 PARTIES TO A BOE OR CHEQUE Both a bill of exchange and a cheque have three parties to them, viz ; the drawer, the drawee and the payee. Drawer : Drawer is the maker of the BOE i.e. he is the person who orders a third person or promises to pay money to another. He may make the bill payable on sight i.e. to the bearer of the bill or on his order. Liability of a drawer Section 30 of the Act deals with the liability of the drawer and states that, “The drawer of a bill of exchange or cheque is bound

in case of dishonour by the drawee or acceptor thereof, to compensate the holder, provided due notice of dishonour has been given to, or received by, the drawer as hereinafter provided”.

Indian Act as in section 43, clause (2) of the English Act. But the whole scope and tenor of chapter VIII of the Indian Act appear to contemplate the same result as is there declared to follow from non-acceptance”.

Though the section itself is simply worded it has resulted in a lot of confusion especially on the interpretation of the term ‘dishonour’. This is because, a BOE may be ‘dishonoured by the non-acceptance’ (sec.91) or it may be ‘dishonoured by nonpayment’ (sec.92). It is only in the later cases that sec.93 providing for notice to the drawer comes into play. So the question arises which kind of dishonour has been contemplated under this section. in Jagjivan v. Ranchoddas [AIR 1954 SC 554] the Supreme Cout laid down the law as, “In a bill payable after sight, there are two distinct stages firstly when it is presented for acceptance and later when it is presented for payment, section 61 deals with the later. As observed in Rama Raviji Jambakar v. Pralhaddas Subkaran [ 20 Bom 133], “presentment for acceptance must always and in every case precede presentment for payment. But when the bill is payable on demand both the stages synchronise, and there is only one presentment which is both for acceptance and for payment. When the bill is paid, it is really dishonoured for non-acceptance: The liability of the drawer can thus be studied under the following situations, viz:

The position in these cases appears to be as follows : (a) Even if the drawee refuses to accept the bill because it was presented before the due date, the payee can treat it as ‘dishonoured for non payment’ and claim compensation from the drawee after giving due notice to him. The advantage here is he gets the amount much earlier than what he would have done ordinarily. (b) The payee may elect to maintain the status quo, wait till the due date, present the bill to the drawee for acceptance and if the drawee again refuses to honour it, then, claim compensation from the drawer after giving him a due notice. But in such a case he does not get a fresh cause of action on non-payment on the due date. The cause of action remains the same ie “dishonoured for non payment”.

(i) Where the bill is payable on sight or demand If such a bill is not paid by the drawee when it is presented then, the drawer becomes immediately liable to pay the full amount to the payee. (ii) Where the bill is payable a certain period after sight or date If such a bill has not been accepted by the drawee, then the drawer becomes liable to compensate the payee provided he has presented the bill for acceptance within a reasonable time as required u/sec.61 [Miller v. The National Bank of India, 19 Cal.146] (iii) Where the bill is payable on or after a fixed date If the payee presents the bill for acceptance before such a fixed date and the drawee refuses to accept it, it cannot be said that the bill has been dishonoured u/sec 91. The position under sec.55(1) of the English Bills of Exchange Act is somewhat different in these situations. The section provides that, ‘the drawer of a bill by drawing it is said to contract, among other things, that it shall be accepted by the drawee if presented for acceptance and that if it be dishonoured by any refusal on the part of the drawee, he will compensate the holder or the other party compelled to pay it, on requisite proceedings on dishonour being taken’. In Ram Ravji’s Jambakar’s case The Bombay High Court observed as follows : “the several sections in chapter (sic)61 relating to presentment for payment appear to us to presuppose that the bill has not been already dishonoured by nonacceptance. When it is dishonoured by non-payment the provisions of Chapter VIII come into play. It is true that there is no such explicit declaration of the law upon the subject in the

When does the liability arise ? The liability of a drawer does not arise till he has been given a notice of the dishonour by the drawee. The purpose of notice is to make him aware of the facts. The liability of the drawer is similar to that of a principal debtor under an implied contract of indemnity. He does not undertake to fulfil the original contract but only to compensate for the loss or breach, on condition that the bill is dishonoured and he is informed of that fact. Thus in Baijnath v. Ramkumar [AIR 1975 Cal 286] where a hundi was stolen in transit and presented to the drawee, who paid it without detecting the forgery of indorsement it was held that the drawer’s liability had been discharged and he was no longer liable. Giving of notice has been treated as so essential that any laches in giving of it releases the drawer from his liability, and is necessary in all cases except to those falling under the exceptions given in sec.98 of the Act. In general the holder is required to give the notice within a reasonable time, but if he is unable to do so due to some reason or fails to do so then, he may take advantage of any notice of dishonour received by the drawer from any other party liable on the instrument. That means that if the drawer receives notice of dishonour from a stranger to the instrument, the drawee cannot take advantage of that fact. Liability of drawer of a cheque The holder of a cheque has no remedy against the drawer, till he has presented the cheque to the drawee and been refused payment on it. A cheque is presumed to be paid out of the funds deposited in the drawer’s account, so he should be immediately informed of the dishonour of the cheque so that he can make inquiries about the state of funds in his account and secure his funds. Just as in case of other BOEs, a cheque should be presented within a reasonable time (the maximum time within which it can be encashed is 6 months from the date of its making) and the drawer should be informed immediately on its dishonour. The difference in liability of the drawer of a 139 (Sys 4) - D:\shinu\lawschool\books\module\contract law

BOEs and of a cheque is that, in the former case if the BOE is not presented within a reasonable time or the drawer is not informed of the dishonour of the bill he is discharged from his liability but in case of cheques the drawer is not discharged from his liability in such a case unless he can prove that he has suffered damage due to non presentment or want of notice of dishonour. Contract to contrary The drawer’s liability may be made subject to the terms of the contract i.e. he can make stipulations in the contract negating or limiting his own liability, for example, by use of words ‘sans recourse’ or ‘without recourse to me’; or if he is the executor then by stipulating that ‘payment would be out of the assets of the deceased’ etc. Similarly he may also waive away the duties which the holder owes him, as for example, the notice of dishonour. But where there is no evidence of such contractual limitations or stipulations, the drawer would be deemed liable to the fullest extent under the Act, and the right of the holder against the drawer will not be lost despite the loss of any collateral security that may have been given to support the contract. Drawee : Drawee is the person who is ordered by the drawer to pay a specified amount to a third person or on his order. According to sec.33, only a drawee can be an acceptor of a BOE except in case of need or acceptance for honour. What does this term acceptor mean ? Every BOE has to be first presented by the holder to the drawee who may agree to be bound by the BOE. Once he accepts to be bound by the BOE, you say that the bill has been honoured by acceptance. Next comes the presenting of the bill for payment and the holder can claim payment only from the person who has agreed to be bound by it. But if the person to whom the bill has been presented for acceptance, the holder can after giving notice to the drawer claim compensation from him for dishonour of the bill. In case of cheques, there is no presentment for acceptance, there is only a presentment for payment, and if the drawee refuses payment on the cheque - the holder can claim compensation from the drawer for dishonour of cheque. Liability of a drawee Section 30 only makes the drawer liable in case of dishonour and does not speak about the liability of the drawee. In a suit for compensation filed by the holder against the drawer, the drawee need not even be made a party to the suit. The drawee’s liability can be studied under the following two situations viz : a) When the drawee refuses to accept the bill In such a case no liability attaches to the drawee since the drawee becomes liable only when he accepts the BOE and not before. The holder in such cases can only sue the drawer for compensation. b) When the drawee accepts to honour the bill, but later refuses to pay when it is presented for payment In such situations, the holder has an option to sue either the drawer or the drawee or both of them for the bill amount, either 140 (Sys 4) - D:\shinu\lawschool\books\module\contract law

in the same suit or in separate suits [Basant v. Kolahal, 1 All 392], and the drawer himself is not absolved of his responsibility merely because of a limitation bar against the acceptor [Ramaswamy v. Sundararajam, 26 Mad 239] or because the holder has obtained a decree against the drawee which has not been satisfied. The primary liability on dishonour of a BOE rests with the drawer and he cannot escape liability because the holder has chosen to make the drawee liable. The period of limitation for such suits is 3 years and the period begins to run from the time of refusal to accept or refusal to pay. Liability of drawee of a cheque The drawee in case of a cheque is always the bank. Section 33 dealing with bank’s liability in case it dishonours a cheques states as follows : “The drawee of a cheque having sufficient funds of the drawer in his hands, properly applicable to the payment of such cheque must pay the cheque when duly required to do so, and in default of such payment, must compensate the drawer for any loss or damage caused by such default”. Thus for a banker’s liability to arise the following conditions must be satisfied, viz : i) The cheque must have been properly made. ii) It must have been duly presented within a reasonable time. iii) There must be sufficient funds in the drawer’s account to cover the cheque amount. iv) The banker must have refused to honour the cheque without a reasonable or just cause. If all these conditions are satisfied then the bank's liability is two folds, viz : a) The holder of the cheque can sue him either separately or alongwith the drawer, for the cheque amount with interest, and b) The drawer is entitled to sue the bank for damages in lieu of the damage or loss suffered by him. The quantum of damages awarded in these cases is decided on the principle that, lesser the amount or value of the dishonoured cheque greater are the damages awarded; greater the value of the cheque, lesser are the damages. The reason for holding the banker liable is because of the peculiar relationships which exists between banker and customer, as was well explained by Lord Atkin in Joachimson v. Swiss Bank Corporation [(1921)3 KB 110 (CA)]. He observed as follows : “The bank undertakes to receive money and to collect bills for its customer’s account. The proceeds so received are not to be held in trust for the customer, but the bank borrows the proceeds and undertakes to repay them. The promise to repay is to repay at the branch of the bank where the account is kept and during banking hours. It includes a promise to repay any part of the amount due, against the written order of the customer addressed to the bank at the branch and as such written order may be outstanding in the ordinary course of business for two or three

days, it is a term of contract that the bank will not cease to do business with the customer except upon reasonable notice. The customer on his part undertakes to exercise reasonable care in executing his written orders so as not to mislead the bank or facilitate forgery. I think it is necessarily a term of contract that the bank is not liable to pay the customer the full amount of his balance at which the current account is kept”. Thus a banker is entitled to refuse a cheque only when, it is not drawn up correctly or its legal validity is doubtful; or it is irregular or undated or unsigned; or if it is required to be stamped then in case the cheque is unstamped. But wherever the cheque is properly drawn andpresented at the appropriate place during appropriate timeing, the banker is honour bound to accept the cheque for payment, else he becomes guilty of a breach of contract between himself and the drawer. Payee : He is the person in whose favour the BOE is in the first instance made, i.e., he is the person to whom a certain amount of money is to be paid by the drawee when so ordered by the drawer. The bill may be made payable to the payee or on his order, or it might be payable on sight. When the bill is payable ‘or his order’ then the payee may indorse the bil in favour of another person and once he so indorses the bill he ceases to be the payee. In case the bill is ‘payable on sight’ the bearer of the bill in lawful possession becomes the payee. As mentioned earlier all the parties to the BOE must be clearly identifiable any vagueness or ambiguity in the description of the parties and the bill becomes invalid. Rights of a payee (1) A payee has the right to receive money on the bill or cheque either on presentment or at the fixed time (depending on the wordings of the bill) provided that : a) he presents the bill in the proper manner, and b) within a reasonable time of making of the bill. (2) He has a right to negotiate the bill further by indorsement, unless the right is curtailed by specific stipulations made by the drawer. (3) He has the right to sue the drawer for compensation if the bill has been dishonoured for non-acceptance. (4) He has the right to sue the drawer or the drawee or both for compensation if the drawee refuses to honour the bill by payment, after having accepted to do so. 3.4 Holder and Holder in due Course Section 8 defines the holder of a negotiable instrument as ‘any person entitled in his own name to the possession thereof and to receive or recover the amount due thereon from the parties thereto’. Where the note, bill or cheque is lost or destroyed, its holder is the person so entitled at the time of such loss or destruction. The first holder of an instrument is the ‘payee’ of that instrument and he is obviously entitled to be in possession of it. The payee has two options, viz :

a) he can himself present it to the drawee or maker for payment; or b) he can transfer the instrument to a third person in satisfaction of his own debt. Such a transfer can be done either by : (i) simple delivery in case the instrument is payable to the bearer ; or (ii) by indorsement and delivery if the instrument is payable to order. When the payee so transfers the instrument he is said to have ‘negotiated’ and the person to whom the instrument is delivered becomes the holder of it. As per sec.14, ‘when an instrument is transferred to any person so as to constitute that peson the holder thereof, the instrument is said to be negotiated’. Section 2 of the English Bills of Exchange Act provides that, “holder means the payee or indorsee of a bill or note who is in possession of it or the bearer thereof”. The Indian definition given u/sec.8 is similar to this definition except for the use of the phrase “entitled in his own name”. This phrase originally assumed significance because of benami transactions and its importance was highlighted in the case of Sarjio Prasad v. Rampayari Debi [AIR 1950 Pat 493]. Here, a sum of Rs. 2,459 was advanced by the plaintiff under a hand note, which was not executed in his name but in the name of one X who was the benaminder. On maturity of the note, the plaintiff sued the defendant for recovery of the amount. The Court rejecting his claim observed that as he was not entitled to the possession of the note ‘in his own name’ he was not the holder. But in the present day context the significance is somewhat lost because of Benami Transactions Prohibition Act making benami transactions of any kind illegal. To summarise a holdee is a person who : a) is the bearer of the note or bill ; or b) is the indorsee under the note or bill. A holder has the following rights : i) To present the note or bill for payment ii) To negotiate the bill by delivery or indorsement unless his right to do so is restricted. iii) To claim compensation from the drawer in case the bill or note is dishonoured by non-acceptance. iv) To sue either the drawer or the drawee or both in case the bill is dishonoured by non-payment after the drawee’s acceptance of it. Holder in due course According to sec.9, holder in due course means “any person who for consideration became the possessor of a promissory note, bill of exchange or cheque if payable to bearer, or the payee or indorsee thereof, if payable to order, before the amount mentioned in it became payable and without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his title”. Thus for a person to be considered as a holder in due course the following conditions will have to be satisfied viz : 141 (Sys 4) - D:\shinu\lawschool\books\module\contract law

(i) Consideration Every negotiable instrument consists of a contract between the parties and should therefore be supported by real and valuable consideration as defined under sec.2(d) of the Contract Act. A person in possession of a bil or note without having given any consideration for it cannot enforce it unless the lack of consideration falls under the exceptions given under sec. 25 of Contract Act. For easy negotiability of these instruments the doctrine of consideration has been simplified in the following manner, viz : a) Consideration is always presumed to have been given unless proved otherwise [Talbot v. Van Boris, (1911)1 KB 854]. b) It is immaterial in case of negotiable instruments to ascertain as to where or from whom the consideration has moved what is essential is that there should be a consideration. c) Past consideration is treated as good consideration [J.M.S. Punto v. A.C. Rodrigues, AIR 1976 Goa 8] d) Once the holder acquires the instrument for good consideration the liable party will not be allowed to plead any defect and want of consideration at any earlier stage. (ii) Before Maturity It is essential that the holder must have acquired the instrument before its maturity date before he can be treated as holder in due course. In Dawn v. Halling [(1825)KB 107 ER 1082] it was held that, “if a bill or a note or cheque be taken after it is due the person taking it takes at his peril. He can have no better title to it than the party from whom he takes it, and, therefore, cannot recover upon it if it turns out that it has been previously lost or stolen”. Section 59 of our Act embodies this principle in the following words, “the holder of a negotiable instrument, who has acquired it after dishonour, whether by non-acceptance or non-payment, with notice thereof, or after maturity, has only, as against the other parties, the right thereon of his transferor”. The question now arises, when does an instrument become mature ? An instrument matures in the following situations, viz : (1) if it is payable on a fixed date or after a fixed time then at the expiry of the time; and (2) an instruments payable on demand does not mature as long as a demand for payment against it is not made. Thus in Brooks v. mitchell [(1841) 152 ER 7] a promissory note made in 1824 was received by the defendant in 1838, who acting in good faith gave value for the note. The plaintiff sued him for recovery of the note and contended that a bill or note payable on demand must not be kept locked up for an unreasonable time. It was held that, ‘a promissory note payable on demand could not be treated as overdue as long as payment was not demanded, because “it is intended to be a continuing security”. Section 86(3) of the Bills of Exchange Act provides that “where a note payable on demand is negotiated, it is not deemed to be overdue, for the purpose of affecting the holder with defects of title of what he had no notice by reason that it appears that a 142 (Sys 4) - D:\shinu\lawschool\books\module\contract law

reasonable time for presenting it for payment has elapsed since its issue”. But section 36(3) of the same Act also provides that a BOE “payable on demand” is deemed to be overdue. when it appears on the face of it to have been in circulation for an unreasonable length of time. What is an unreasonable length of time is a question of fact i.e. it would vary from case to case. (iii) Complete and Regular For a negotiable instrument to be valid it should be complete and regular in all respects, i.e. it should not contain any patent (easily visible or indentifiable) defects. An instrument may be incomplete because the drawer’s name is not there or it is not dated and stamped etc. Similarly an improper indorsement can render the whole instrument irregular [Arab Bank Ltd v. Ross, (1952)2 QB 216], but a mere spelling mistake in the indorsee's name will note affect the indorsee and the bill remains valid [Leonard v. Wilson, [1834]39 RR 855]. (iv) Good faith Last but not least is the requirement that the holder should have acted in good faith. The court is required to apply both the subjective and objective test to ascertain whether the holder had acted in good faith, i.e. the court has to find out, (i) whether he had acted honestly ? (subjective test) and (ii) whether he had acted as a reasonable and careful or prudent man would have acted in a similar situation ? (objective test) Rights and privileges of a holder in due course 1. Presumptions (sec 118) ‘Every holder is deemed prima facie to be a holder in due course”, i.e. the burden of proving his title does not lie on him, and it is the other party who has to show that the holder has no title to the instrument, or that there is defect in his title. It is only when he establishes the defect that burden of proof shifts to the holder who then has to show he had acquired the bill or note bonafide and in good faith. 2. Privilege against inchoate stamped instruments (sec.20): In Glenie v. Bruce Smith [(1908)1 KB 263] it was observed that, “the logical order of operations with regard to a bill is, no doubt, that the bill should be first filled up, then it should be signed by the drawer, then it should be accepted, then it should be negotiated, and then it should be indorsed by the persons who become successively holders; but it is common knowledge that parties very often vary, in a most substantial manner, the logical orde of those proceedings, and section 20 is intended to deal with those cases”. For the section to come into operation, the defendant must have signed the blank instrument and must have voluntarily parted with it with the intention that it should be filled up and issued as such. 3. Fictitous drawer or payee [sec 42] : The acceptor of a BOE cannot allege as against the holder in due course that the parties to the bill were fictitous, i.e. persons who were either not in existence or if they did exist they were never intended by the drawer to have the payment. But where the drawer intends the payee to have payment then he is not a fictitous payee and the forgery of his signature will affect the validity of the cheque.

Thus in North & South Wales Bank v. Macbeth [1908)AC 137], W induced M by fraud to draw a cheque payable to K or order. W obtained the cheque, forged K’s indorsement and collected proceeds of the cheque through his bankers. The collecting banker was held liable as K’s title was derived through forged indorsement. K was not a fictitous payee because the drawer intended him to receive the payment. The result would have been different if the payee was not a real person or was not intended to have the payment [Chitton v. Attenborough, (1897)AC 90]. 4. Prior defects (sec.58): The person who is liable to pay on an instrument, can contend that he had lost the instrument or that it was obtained from him by means of an offence. 5. Indorsee from a holder in due course (sec 53): A holder who receives an instrument from a holder in due course gets the rights of the holder in due course, even if he had knowledge of the prior defects, provided he himself was not a party to them. 3.5

INDORSER

As mentioned earlier any negotiable instrument can be negotiated further by the holder in favour of a third person by the simple method of signing the instrument in favour of a third person and delivering the instrument to him. This process of negotiation is known as indorsement and the person who transfers his right to another is known as the indorser. Section 35 dealing with the liability of an indorser states that, ‘In the absence of a contract to the contrary, whoever indorsers and delivers a negotiable instrument before maturity, without, in such indorsement, expressly excluding or making conditional his own liability, is bound thereby to every subsequent holder, in case of dishonour by the drawee, acceptor or maker, to compensate such holder for any loss or damage caused to him by such dishonour, provided due notice of dishonour has been given to, or received by, such indorser as hereinafter provide person who transfers his right to another is known as the indorser. Section 35 dealing with the liability of an indorser states that, "In the absence of a contract to the contrary, whoever indorsers and delivers a negotiable instrument before maturity, without, in such indorsement, expressly excluding or making conditional his own liability, is bound thereby to every subsequent holder, in case of dishonour by the drawee, acceptor or maker, to compensate such holder for any loss or damage caused to him by such dishonour, provided due notice of dishonour has been given to, or received by, such indorser as hereinafter provided." Every indorser after dishonour is liable as upon an instrument payable on demand. This liability of an indorser cannot arise unless the indorser delivers the indorsed instrument to the indorsee, because no contract on the negotiable instrument is complete without such a delivery. Indorser is estopped from denying to a holder in due course the genuineness and regularity in all respects of the drawer’s

signature and all previous indorsements (sec.122). Further he cannot deny that at the time of his indorsement it was a valid and subsisting bill and that he had then a good title and right to indorse. According to sec.88, an indorser is bound by his indorsement notwithstanding any previous alteration of the instrument. Extent of liability An indorsers liability does not come into existence till he has been given a due notice of the dishonour of the instrument by the indorsee. If the indorsee fails to give him a notice, then the indorser should have received a notice from some other person liable on the instrument. The indorser is liable to not only pay the amount on the bill but also to compensate the holder in case the instrument has been dishonoured. The quantum of compensation will be determined as per the rules laid down in sec.117. Section 35 does not deal with the nature or extent of an indorser’s liability on a note payable on demand. In Hemadri v. Seshama [AIR 1931 Mad.113] it was however held that, the holder of a promissory note payable on demand indorsed after dishonour is not entitled to a decree against the indorser (the payee) without giving him a proper notice of dishonour. Neither the section nor the Act provides for a situation where the indorser indorses an instrument after maturity, and the instrument’s not dishonoured. This situation usually arises where the indorser has committed laches in presenting for payment indorsing the instrument before the due date and indorses it only after maturity. The English and American law on this point is very clear and states that, ‘such an indorser is liable as if he had indorsed an instrument payable on demand, and his liability is conditional on a presentment for payment and notice of dishonour in the event of non-payment within a reasonable time.' It is to be presumed that the same law would apply in India also. Just as in the case of drawer, the indorser can also limit his liability by having a contract to the contrary. He may either exclude his liability, or limit his liability or make his liability conditional, or he may in exceptional cases even enlarge his liability. Liability of prior indorsers According to sec.36, ‘every prior party to a negotiable instrument is liable thereon to a holder in due course until the instrument is duly satisfied’. The general rule is that ‘as between indorsers their liability is in the order in which their names appear on the instrument’. But this rule may be rebutted by adducing evidence to show the real intention of parties. Therefore, a prior indorser may recover from a later one if he can prove that there was an agreement to that effect between them. Similarly, if a second indorser mistakenly puts his name above the name of the first indorser, then he can recover the amount from the first indorser if he is required to pay on the bill. This liability of the prior indorser to the subsequent one continues till the instrument is duly satisfied, i.e. each party pays the subsequent one. 143 (Sys 4) - D:\shinu\lawschool\books\module\contract law

3.6 PARTIES Uptil now we have been talking of the parties to specific kinds of negotiable instruments, but haven’t made any mention as to who actually can be a party to the instrument. According to sec.26, every person capable of entering into a contract can become a party to the negotiable instrument. He “may bind himself and be bound by the making, drawing, acceptance, indorsement, delivery and negotiation of a promissory note, bill of exchange or cheque”. Minor - According to sec.11 of the Contract Act, ‘every person is competant to contract who is of the age of majority according to the law to which he is subject, and who is of sound mind, and is not disqualified from contracting by any law to which he is subject’. Obviously therefore a minor or a lunatic cannot be a party to a negotiable instrument so as to be liable on it. But a negotiable instrument does not become void merely because a minor is a party to it. According to sec.26, “a minor may draw, indorse, deliver and negotiate (an) instrument so as to bind all parties except himself”, i.e. the minor's rights under the instrument are not affected. The law is same for insane persons. Corporation - The capacity of a corporation to enter into a contract vide a negotiable instrument, would depend on its memorandum and articles. Agent - According to sec.27, a general authority to transact business or to receive payment or discharge debts on behalf of the principal, does not give the agent an automatic right to accept or indorse bills of exchange so as to bind his principal. Further,

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an authority to draw BOE does not include the power to indorse them. Thus, an agent can bind his principal only in the manner and to the extent he has been authorised. The agent should furthermore make it clear that he is acting in a representative character, else he becomes personally liable unless he can show that the parties induced him to sign in his own name by telling him that only the principal would be liable. Partner - A partnership firm can be held liable on a negotiable instrument drawn by a partneronly when the partner signs the bill in his capacity as a partner and the name of the firm appears on the face of the bill. If a bill is not made or drawn in the name of the firm the other partners can not be make liable on it. [Rangaraju v. Devichand, AIR 1945 Mad 439]. The signature of the firm is deemed to be the signature of all its partners be they working or dormant, based on the principle that every partner of a firm is entrusted with a general authority to do all acts beneficial for the firm. Thus in Lona (KA) v. Dada Haji Ibrahim Hilari & Co. [AIR 1981 Ker. 86], a promissory note was executed by one of the two partners of the firm using the words "the promise to pay". The note had been executed on the letterhead containing the full name and description of the firm. It was held that both the firm and the second partner were liable on the pro-note. Legal representative - According to sec.30, a legal representative of a deceased person, who signs an instrument in his own name, becomes personally liable on it, unless he specifically limits or excludes his liability for examples by use ofthe words ‘the amount to be paid only from the estate of the deceased’ etc.

4 RULES RELATING TO NEGOTIABLE INSTRUMENTS SUB TOPICS 4.1 Introduction 4.2 Ambigous instruments 4.3 Rules relating to maturity 4.4 Rules relating to negotiation 4.5 Rules relating to accomodation bill 4.6 Rules relating to interest payment 4.1 INTRODUCTION In the previous chapters we have dealt with various kinds of negotiable instruments; the parties to these instruments, their rights and liabilities; and to a certain extent the rules relating to ambigous instruments, indorsement etc. In this chapter we will try to deal in detail with these general rules applicable to all kinds of negotiable instruments. 4.2 AMBIGOUS INSTRUMENTS The ambiguity of an instrument may arise in diffeent ways or may be of different kinds. Thus we may have ambiguity as to nature of instrument; as to the parties in the instrument; as to the amount etc. The term ambiguity itself means ‘lack of clarity’ or ‘something of which the meaning is not clear’. Sec.17 states that, “where an instrument may be construed either as a promissory note or bill of exchange, the holder may at his election treat it as either, and the instrument shall be henceforth treated accordingly”. Thus where on the face of it the nature of instrument is not clear, the holder has been given a right to treat it either as a note or a BOE according to his desire. But he may not treat such an instrument either as a cheque or as a non negotiable instrument. So also, merely because on the face of the instrument it is written that it is a BOE, it need not necessarily be one. For example, in Harsukdas v. Dhirendra Math [(1941)2 Cal.107], an instrument on which the word ‘hundi’ was written was in the following form : ‘Sixty days after date we promise to pay AB or order the sum of Rs.1000 only for value received’. Across the document was written ‘Accepted’ signed by the maker XY. It was held that the document was not a BOE but was a promissory note. Once the holder makes an election [i.e. to treat it as a promissory note or a BOE] he cannot retract and must abide .by his decision. Ambigous instrument vis a vis inchoate instrument (i) In case of ambigous instrument, the holder having made an election can institute a suit on it, and he is not prevented from filing a suit thereby because the instrument is ambigous. In case of inchoate instruments, the holder merely gets an authority to fill in the blanks in the instrument, but till the instrument is filled he cannot sue on it.

(ii) The court gives ambigous instrument favourable construction so as to make them valid and construes them as a bill or a note. An instrument in the form of a bill having neither the name of the payee nor that of the drawer is an inchoate instrument, even if it is addressed to a person and has been accepted by him. Such instruments cannot be treated as ambigous instruments. Where amount is stated differently in figures and words According to sec.18, ‘if the amount undertaken or ordered to be paid is stated differently in figures and in words, the amount stated in words shall be the amount undertaken or ordered to be paid’. Ills ; A bill is drawn for “five hundred rupees”. In the margin is superscribed Rs.550. The bill is for Rs.500 only. But if there is ambiguity in the words in the body itself then help can be taken from the figures in the margin. [Hutley v. Marshall (1873)46 L.T. 186]. Similarly if there is an ommission in the body of the instrument which is apparent on the face of it, help may be taken from the figures in the margin. Thus in R.V. Elliot [(1777), I Leach CC 175] a bill had the words “pay fifty” and marginal figures stated £ 50, The bill was held to be valid for fifty pounds. 4.3 RULES RELATING TO MATURITY ‘Maturity’ of an instrument means the day or time at which the instrument becomes payable. Some instruments are payable whenever they are presented, some others becme payable only after the efflux of a fixed period or only on a fixed day. Sections 22-25 deal with the rules determining the time when the instrument falls due. But before dealing with these rules, we should clearly understand the difference between the following words, viz : “At sight”, “on presentment” and “ on demand” - Broadly speaking `at sight’ and `on presentment’ mean `on demand’, but there are technical differences between these phrases. Instruments payable `on demand’ may not necessarily be presented for payment, but instruments payable `at sight’ or `on presentment’ have to be presented before payment can be demanded on them. Further, though `at sight’ does mean `on demand, the period of limitation for bills payable `at sight’ is different from bills payable `on demand’. In case of former it is 3 years from the date of presenting the bill, whereas in case of later it is 3 years from the date of the bill or note [Arts 32, 35 of Limitation Act, 1963]. “After sight”, “after date” - The phrase `after sight’ on a bill or note should alway be accompanied by the period after which the bill or note would become payable, as for example, ` 6 months after sight’ etc. An instrument may be expressed as being payable `after sight’ or `after date’ or `on occurence of a specified event’. In case of the last, the event should be one which is certain of happening though the exact date or time of its happening cannot be predicted, as for example, `payable on the death of Mr.A’ etc. 145 (Sys 4) - D:\shinu\lawschool\books\module\contract law

‘After sight’ in a promissory note means that payment cannot be demanded till the bill has been exhibited to the maker; whereas in case of a BOE ‘after sight’ means that the sight must appear in a legal way, i.e, after acceptance if the bill has been accepted or after noting for non-acceptance or protest for non-acceptance [Homes v. Kerrison, (1810), 2 Taunt, 323]. Let us now deal with the rules relating to maturity. According to sec.22, ‘the maturity of a promissory note or bill of exchange is the date at which it falls due’. Days of grace - Every promissory note or BOE which is not expressed to be payable on demand, at sight or on presentment is at maturity on the third day after the day on which it is expressed to be payable. ‘Days of grace’ as the name itself implies is the additional period or time given to the acceptor of a bill to come up with the payment. Though it originally started as a gratuitous right, it slowly became a custom so much so that it came to be treated as a legal right. Such grace period is allowable on all those bills or notes which are made payable on a specified day or after a fixed period or on occurence of some specified event [Brown v. Marraden (1791)4 T.R. 148]. In Oridge v. Sherborne [(1843),11 M & Co. 374] it was held that in case of instruments payable in instalments, it must be presented for payment on the third day after the day fixed for each instalment, the days of grace being available for each instalment. The custom of allowing days of grace has become so imbedded in the law relating to negotiable instruments that an instrument is not deemed to have been ‘dishonoured for non-payment’ before the expiry of the last date of grace [Kennedy v. Thomas, (1894)2 Q.B. 759]. Parteies to the instrument may however limit or exclude the days of grace by express stipulation to that effect, for example, by saying ‘without grace’ [Valliappa v. Subramaniam, 26 M.L.J. 494]. Though days of grace are statutorily allowed in India, they have been abolished in England for some time now. Maturity of bills and notes payable after sight - Section 24 of the Act states that , "In calculating the date at which a promissory note or bill of exchange, made payable a stated number of months after date or after sight, or after a certain event, is at maturity, the period stated shall be held to terminate on the day of the month which corresponds with the day on which the instrument is dated, or presented for acceptance or sight, or noted for non-acceptance, or protested for nonacceptance, or the event happens, or, where the instrument is a bill of exchange made payable a stated number of months after sight and has been accepted for honour, with the day on which it was so accepted. If the month in which the period would terminate has no corresponding day, the period shall be held to terminate on the last day of such month. [Parthasarathy pp. 7475]. Ills :- A negotiable instrument dated 29th January 1995 is made payable one month after date. The instrument is at maturity on the third day after the 28th February 1995 [ie including days of grace]. 146 (Sys 4) - D:\shinu\lawschool\books\module\contract law

This section incorporates the English law as it was before amendment by the Bills of Exchange Act, s.65(5) which now provides that, ‘for calculating maturity from the date of noting for non-acceptance, and not from the date of acceptance of honour. According to Chalmers Bills of Exchange, “This subsection brings the law into line with mercantile understanding, and gets rid of an inconvenient ruling that maturity was to be calculated from date of acceptance for honour”. It is thus evident that the Indian law still retains the old English rule. In case of bills which have not been accepted for honour, the period of payment terminates on that day of the month which corresponds with the day of the instrument or the day on which it has been presented for acceptance or noted for non-acceptance. The last sentence of sec.24 in effect means that the term ‘month’ referes to calendar month rathen the lunar month. Section 25 of the Act is similar to sec.24 and deals with maturity of bills or notes payable so many days after date or sight. The section states that, “In calculating the date at which a promissory note or bill of exchange made payable a certain number of days after date or after sight or after a certain event is at maturity, the day of the date, or presentment for acceptance or signt, or of protest for non-acceptance, or on which the event, happens, shall be excluded." If the day of maturity of a note or bill is a public holiday, the next working day succeeding such public holiday shall be deemd to be the maturity day of the instrument (sec.25). The explanation to the section adds that public holidays includes ‘sunday’ and other days declared by the Central Government in the Official Gazzette to be a public holiday. If a negotiable instrument is paid by the acceptor at or maturity, the bill is discharged, and no action can then be brought upon it. But if the payment is made before maturity, the maker or acceptor can re-issue it, since payment before maturity operates as a purchase of the instrument. The instrument, under such circumstances, is not discharged, and the acceptor will be liable to pay again on the instrument in the hands of a bona fide transferee for value [Burbridge v. Manners, (1812),3 Camp. 193]. Where a payment is made by the maker or acceptor before maturity, he must get possession of the instrument, in which case he can re-issue the instrument so as to make himself and all subsequent parties liable [Morley v. Culverwell (1840), 7 M. & W.174; Attenborough v. Mackenzie (1856), 25 L.J. Ex. 244]. The re-issue may take place any number of times before the maturity of the instrument. But the above observation as to premature payment can only apply to instruments which are payable on demand, since they cannot be prematurely paid being due the moment they are presented [Parthasarthy, p. 180]. 4.4 RULES RELATING TO NEGOTIATION Sections 46-60 of the Act deal with negotiation. Delivery (sec-46): For the negotiable instrument to be legally binding on the parties to it, it has to be delivered by the maker and accepted by the

other party [be it the acceptor, payee, holder or indorsee]. Till such delivery is effected the instrument is revocable. As observed by Bovill, C.J. in Abrey v. Crux [(1869)L.R 5 C.P. 42], “To constitute a contract there must be a delivery over of the instrument by the drawer or the indorser for a good consideration, and as soon as these circumstances take place, the contract is complete, and it becomes a contract in writing." The property in the instrument does not pass to the transferee merely by signing or indorsing the instrument because mere signature does not constitute a contract. Under sec.46 of the Act, a cheque is made or completed as soon as it is delivered either to the payee or to his agent. In Damji Hirji v. Mohammedali [41 Bom. L.R. 959] it was observed, “A person may sign a promissory note or negotiable instrument in his own house and keep it there without incurring any obligation to anyone at all. When such a document is tendered to the payee and accepted by him there arises a contract between the parties. The signature on a negotiable instrument becomes necessary because of the provisions of S.4 of the Negotiable Instrument Act. It is only a preparation. It does not amount to an offer, and therefore, does not become any part of the contract”. The delivery of an instrument may be in any one of the following ways, viz : Actual delivery - This consists of delivering the instrument physically or personally by the maker to the payee or to his agent. There must be an actual change in possession to constitute actual delivery. Constructive delivery - Here there is no change in the actual possession, but the delivery takes place when the maker of the bill continues to hold possession of the bill as an agent or on behalf of the payee or the bill is in the possession of the payee's or indorsee's agent, clerk or servant, who had the bill on behalf of such payee/indorsee. Ills :- (i) A holds a bill on his account. He subsequently indorses it in favour of B and holds the bill as B’s agent. (ii) A holds a bill as B’s agent. B indorses it in favour of A. A continues to hold the bill but now on his own account. Conditional delivery - Wherever an instrument is delivered conditionally or for a special purpose, oral evidence can be adduced by the parties to show that the delivery was made and not for transferring the property in the bill (sec.46). Thus, oral evidence cannot be used for varying the terms of the contract but only to show that the writing does not really represent the contract. In Rajroopram v. Buddoo [1 Hyd. 155] it was observed that, “Delivery of an instrument for a specified purpose, and on condition that it shall be returned if not applied for that purpose, constitutes the holder a mere bailee, trustee, or agent with a limited title and power of negotiating it. Any subsequent holder with notice of the specific purpose or condition must apply the instrument accordingly" [emphasis supplied]. That means, that in case the purpose is not satisfied or the condition is not fulfilled the true owner of the instrument is entitled to get it back from the person to whom it was delivered or anyone else who has taken the bill from such a person and is

aware of the purpose or condition to which the bill is subject. But a holder in due course who acquires the bill bonafidely without notice acquires a good title to it and the true owner cannot compel such holder in due course to return the instrument. Negotiation by delivery (sec.47) According to sec.47, in case of a negotiable instrument which is payable to bearer, mere delivery of the instrument is sufficient to transfer the property in the instrument to the person to whom it is delivered. An indorsement is not necessary for negotiation of such instruments. A transferor in such cases exonerates himself from the liability of an endorser of the instrument and the entire transaction is more in the nature of sale of the instrument. The transferee therefore gets no right of recovery against the transferor if per chance the instrument was later dishonoured, nor can he get back the amount paid by him to the transferor for failure of consideration. As Lord Kenyon observed in Fydell v. Clark [(1796)1 Esp. 447], “it is extremely clear that if the holder of a bill sent it to market without indorsing his name upon it, neither morality nor the law of this country will compel him to refund the money for which he sold it, if he did not know at the time he sold it that it was not a good bill”. The important point to note here is that the transferor must himself be unaware that the bill is bad, because as observed by Lord Kenyon again in Read v. Hutchinson [(1813)3 Comp.352] “if he knew the bill to be bad, it would be like sending a counterfeit coin for circulation to impose upon the world instead of the current coin” The exception to the section provides that, in case a negotiable instrument payable to bearer is delivered on condition that it will not take effect unless a certain condition is fulfilled, then negotiation of the instrument does not take effect till such condition is fullfilled, and no one else who acquires the instrument with full knowledge of the restrictive condition gets a good title to it nor can he sue on it. But once again the exception is not applicable to a bona fide purchaser for good value. Negotiable by indorsement (sec 48) In case of instruments payable to order, negotiation can be done only by indorsement and subsequent delivery of the instrument. If the holder of such an instrument merely delivers it without indorsing it, the transfee only acquires the rights of an assignee and does not get any of the advantages of negotiability, since such delivery merely amounts to assignment and not negotiation. Similarly, if there are more than one payees to a note, an endorsement and delivery by only one of them, does not amount to a valid endorsement and does not amount to an effective negotiation. The other payees can at any time make a fresh and valid endorsement and negotiation of the same note [Voruganti v. Venkata, AIR 1953 Mad 840]. Indorsement in blank and its conversion into full indorsement [Ss.54 and 49] Even if an instrument has been originally made as being ‘payable to order’, it may be indorsed in blank and delivered to a person. 147 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Such blank indorsement and delivery converts the instrument into one which is payable to bearer and it can then be further transferred by mere delivery as if it was always made ‘payable to bearer [Peacock v. Rhodes, (1781)2 Doug. 633]. If the holder of such an instrument (i.e. one with a blank indorsement) wants to convert it into a fully indorsed instrument, all he has to do is to write above the indorser’s signature a direction to pay the instrument to another person or his order. The advantage of following this course of action is that though the holder transfers the instrument to another he does not incur the responsibility of an indorser[Hirschfeld v Smith, (1866), L.R. 1 C.P. 340]. Ills: A is the holder of a bill indorsed by B in blank. A writes over B’s signature the words “pay to C or order” and delivers the instrument to C. A is not liable as an indorser, but the writing operates as an indorsement in full from B to C [Vincent v. Horlock, (1808)1 camp.442] If a negotiable instrument, after having been indorsed in blank, is indorsed in full, the amount of it cannot be claimed from the indorser in full, except by the person to whom it has been indorsed in full, or by one who derives title through such person [sec.55]. Ills: A is the payee holder of a bill. A indorses it in blank and delivers it to B, who indorses it in full ‘to C or order’. C without indorsement transfers the bill to D. D as the bearer is entitled to receive payment or to sue the drawer, acceptor or A who indorsed the bill in blank, but he cannot sue B or C.

a) it may prohibit or exclude further negotiation ; or b) it may constitute the indorsee an agent to indorse the instrument, or to receive the contents for the indorser; or c) constitute the indorsee an agent to receive its contents for some other specified person. Generally speaking, in case of restrictive indorsement the relationship between the indorser and indorsee is that of the principal and agent. The bill, in fact, comes to the end of its negotiability in such cases and the last indorsee is the person who can sue upon it. Thus in Rahmat Bi v. Angappa Raja [(1969)2 MLJ 518], a promissory note was endorsed for collection. It was held that, "though the endorsement was not supported by consideration, the endorsee has the locus standi to file an insolvency petition against the maker of the note on the basis of non-payment of the note and the endorser may join as an additional petitioner. The death of the endorser does not affect the right of an endorsee for colletion to claim payment." Who may negotiate ? [sec 51] According to the section the following persons can negotiate a negotiable instrument, viz : a) sole maker b) drawer c) payee or indorsee d) all of several joint makers, payees or indorsees.

Effect of indorsement (sec 50)

The need for a maker or drawer indorsing an instrument arises when the instrument is made or drawn payable to his own order i.e. “pay to myself or order” etc. In case a stranger to an instrument endorses it, it will not be valid and he cannot be held liable on it, though he may be held liable as guarantor to the person in immediate relationships with him. In case of several payees, it is not required that all of them should indorse on the same date or at the same time, what is required is that they should all indorse - they may do it at different dates or times.

The indorsement of a negotiable instrument followed by delivery transfers to the indorsee the property therein with the right of further negotiation; but the indorsement may, by express words, restrict or exclude such right, or may merely constitute the indorsee an agent to indorse the instrument, or to receive its contents for the indorser or for some other specified person. [Parthasarthy pp. 135-136].

A legal representative cannot complete an indorsement made by the deceased by mere delivery of instrument, because a legal representative is not an agent of the deceased. Such an instrument will have legal effect only if it is re-indorsed and then delivered. He should however take care to see that while re-indorsing the instrument he excludes his own personal liability [ sections 57, 29 & 32].

This secion must be read with sections 46 and 52 in order to be fully comprehended. The effect of an indorsement can be briefly said to be as follows (i) It transfers the property in the instrument to the indorsee. (ii) It gives the indorsee the right to sue all those parties whose names appear on the instrument. (iii) It gives him the right of further negotiation.

Further, according to sec.52, the person indorsing the instrument in order to negotiate it may either exclude or limit his liability to the holder in any one of the three ways, viz : (i) By expressly excluding his liability, for example by making the bill as, “pay A or order sans recourse” etc. (ii) By making his liability dependant on the happening of a specified event which may never happen. (iii) By making the right of an indorsee to receive the amount of the instrument dependant on the happening of a specified event which may never happen. The basic difference between (ii) & (iii) is, that in the later case as the indorsee’s

Indorsement as already mentioned earlier should be for the entire amount on the bill. If an indorsement is made for only part amount of the bill it would not be valid, unless part of the amount on the bill has already been paid, in which case partial indorsement will be valid provided a note to the effect that remaining amount on the bill has already been paid is added to the indorsement [sec 56].

An indorser need not give to the indorsee all of the above rights, he may make what is known as a ‘restrictive indorsement’. A restrictive indorsement may have any one or all of the following effects, viz : 148 (Sys 4) - D:\shinu\lawschool\books\module\contract law

rght is dependant on the happening of an event, he is prevented from suing the prior parties to the bill before the happening of such event, whereas in the former case he can do so even before the happening of the event. “Negotiation back," and "Taking up" of a bill The general rule is that the holder in due course of a negotiable instrument may sue all prior parties to the instrument. This rule is, however, subject to an exception the object of which is to prevent circuity of action. When a bill or note is negotiated back to a prior party, the prior party is remitted to his former position and comes within the definiton of a “holder”. But it is not necessary that the bill or note should be re-indorsed to him. He may or may not cancel the indorsements in full subsequent to that which constituted him the holder, and may further negotiate the bill or maintain a suit against parties antecedent to him. Such a transaction is called “taking up” of the bill. If the bill, or note, however, is negotiated back to a prior party by a proper indorsement, the prior party in addition to his rights of a former holder acquires also the rights of a holder by virtue of the last indorsement, but he cannot enforce by a suit payment of the instrument against an intermediate party to whom he was previously liable by reason of his prior indorsement, for the law does not permit circuity of action. Example A, the holder of a bill indorses it to B. B indorses it to C. C indorses it to D. D indorses it to A. A by his first indorsement is liable to B,C and D; and B,C and D are liable to A under the second indorsement. A, therefore, cannot sue B, C and D but A may by striking off the indorsements of B,C and D, again negotiate the bill. But where an instrument is negotiated back to a prior party, the holder can enforce payment against all intermediate parties to whom the holders was not liable as a prior party, as for example, where the prior indorsement was “without recourse”. This is the rule mentioned in the second clause of the section and illustration (b) to the section is to the same effect [Parthasarthy, p. 142]. A holder of a negotiable instrument who derives title from a holder in due course has the rights thereon of that holder in due course (sec 53). Ills: A by fraud induces B to make a promissory note in his favour. A indorses the note to C, who takes it as a holde in due course. C subsequently indorses the note to A for value. A cannot sue B on the note. Thus, in May v. Chapman [(1847)16 M & W. 355], a partner in a firm fraudulently indorsed a bill to D in payment of a private debt. F was cognisant of the fraud but was not a party to it. D endorsed the bill to E, who took it for value and without notice of fraud. E endorsed it to F. F acquired E’s rights. It was held that, if he had given value to E he could sue all the parties to the bill, and if he had not given value to E then he could sue all the parties except E.

Instrument obtained by unlawful means or for unlawful considerations (sec 58) When a negotiable instrument has been lost, or has been obtained from any maker, acceptor or holder thereof by means of an offence or fraud, or for an unlawful consideration, no possessor or indorsee who claims through the person who found or so obtained the instrument is entitled to receive the amount due thereon from such maker, acceptor or holder, or from any party prior to such holder, unless such possessor or indorsee is, or some person through whom he claims was, a holder thereof in due course [Parthasarthy pp. 146-147]. This section thus deals with two situations, viz : a) Lost instruments - The rights and duties of the owner of a lost negotiable instrument are dealt with u/sec.45A and are as follows (1) When a bill or note is lost, the finder acquires no title to it as against the rightful owner, nor is he entitled to sue the acceptor or maker in order to enforce payment on it. The title of the true owner is not affected by the loss of the instrument, and he is entitled to recover it from the finder. [Lowell v. Martin (1813),4 Taunt. 799]. (2) If the finder obtains payment on a lost bill or note, the person who pays it in due course, may be able to get a valid discharge for it. But the true owner can recover the money due on the instrument as damages from the finder. [Burn v. Morris (1834),2 Cr. & W. 579]. (3) If the finder of a lost bill or note, which is payable to bearer or which is indorsed in blank and is therefore transferable by mere delivery, negotiates it to a bona fide transferee for value, the latter acquires a valid title to it, and is entitled both to retain the instrument as against the rightful owner, and to compel payment from the parties liable thereon. (4) If the finder of a lost bill or note, which is payable to order and is therefore transferable by indorsement and delivery, forges the indorsement of the loser and negotiates it to a bona fide transferee for value, the latter acquires no legal title to it, for a forgery can confer no title; and a payent by the acceptor or other party liable to a person, claiming under a forged indorsement, even though made in good faith, will not exonerate him. (5) It is advisable that the owner of a lost bill should give notice of the loss to the parties liable on the bill for they will thereby be prevented from taking it up without proper inquiry. Public advertisement of the loss may also be given if the amount is large. (6) The party who has lost a bill must make an application to the drawee for payment at the time it is due, and give notice of dishonour to all the parties liable, otherwise he will lose his remedy against the drawer and indorsers. (7) Under this section the loser can apply for a duplicate of a lost bill. In the application of the section, the following points may be noted:(1) The section is confined in its operation to bills only; it doesnot apply to notes. 149 (Sys 4) - D:\shinu\lawschool\books\module\contract law

(2) The section applies to bills before they are overdue. (3) The remedy given to the owner of the lost bill is againt the drawer alone. The loser may compel the drawer to give him a duplicate bill upon an undertaking of indemnity, but no provision is made as to obtaining a fresh acceptance or fresh indorsements. (4) Under the section it is only the holder of a lost bill that can apply for a duplicate. Therefore, if a bill is payable to order and is transferred for value but without indorsement, the transferee, if he looses the bill, cannot apply apply for a duplicate in his own name, for he is not a holder, that is, a person entitled in his own name to the possessionof the bill. [Good v. Walker, (1892) 61L.J.Q.B. 736] [Parthasarthy pp. 126-128]. b) Instruments obtained by means of an offence (i) Stolen instruments - A person who steals an instrument cannot enforce payment of it against any person nor can be retain it against the party from whom he has stolen it. But a transferee who bonafidely and for good value acquires such a stolen instrument from the theif gets a good title to it and can confer a good title on any one acquiring it from him. (ii) Instruments obtained by fraud - If the maker or acceptor, when sued on an instrument, proves that it was obtained from him fraudulently, the person who has so defrauded him is not entitled to recover anything from him, because fraud vitiates or negates all agreements and transactions. The defence available to a person pleading fraud is that of ‘non est factum’ or ‘not my document’, but to avail of this defence he must be able to prove; (1) that he had not been negligent or careless in signing of the document; and (2) that he was induced by the plaintiff to sign it. (iii) Instruments obtained for unlawful consideration Wherever the consideration for a bill, note or cheque is unlawful, the instrument becomes void. The provisions of Contract Act would apply to ascertain what could be deemed as unlawful consideration. But a bona fide holder in due course acquires a good title to the instrument which was originally made, drawn or negotiated for an unlawful consideration. (iv) Forged instruments - ‘Forgery’ can be defined as the fradulent making or alteration of a writing on a instrument to the prejudice or detriment of another. The effect of an instrument with a forged signature is as follows : i)

The forged signature is void ab initio and the property in the instrument remains with the person who was the holder at the time of forgery.

ii) The holder of a forged instrument can neither enforce payment on it nor can he give a valid discharge. iii) Where the holder has managed to enforce payment despite the payment, he cannot retain the money and the true owner may compel him to return the money. 150 (Sys 4) - D:\shinu\lawschool\books\module\contract law

iv) The true owner may sue in tort the person who has received money for conversion of bill or for money had and received to his use. v) A person who has paid money by mistake on a forged signature, can recover it from the person to whom he has paid (sec.72 of Contract Act). vi) The presumption in favour of holder in due course does not operate in case of forged instruments, because there is a difference between defect in title (when he is protected) and an entire absence of title as in case of forgery (where he can acquire no title). vii) Forgery cannot be ratified, but a person whose signature has been forged may by his conduct, be estopped from denying the genuineness of his signature later on. viii)In case of forged indorsements, if the instrument was indorsed in full, the signature of the person to whom or to whose order the instrument is negotiated must be ‘genuine’ for a title to the instrument can only be through his indorsement. Therefore, in case of an instrument with forged indorsement, a person claiming under it cannot acquire the rights of a holder in due course even if he is a parchaser for good value. ix) A banker who pays on a forged bill has no recourse against his customer ie he has to bear the loss personally. Instruments acquired after dishonour or when overdue Section 59 which deals with these situations states that, “The holder of a negotiable instrument, who has acquired it after dishonour, whether by non-acceptance or non-payment, with notice thereof, or after maturity, has only, as against the other parties, the rights thereon of his transferor’. Provided that any person who, in good faith and for consideration, becomes the holder, after maturity, of a promissory note or BOE made, drawn or accepted without consideration, for the purpose of enabling some party thereto to raise money thereon, may recover the amount of the note or bill from any prior party. An instrument remains negotiable till its payment or satisfaction by the maker, drawer or acceptor of the instrument at or after maturity, but it cannot be negotiated after such payment or satisfaction [sec 60]. 4.5 RULES RELATING TO ACCOMODATION BILL These are the main class of bills covered under sub-clause (d). Accomodation instruments are those that are drawn for the accomodation of the drawer, and he has undertaken to supply funds to meet them. Though the sub-section only refers to drawers there is no reason why it should be so restricted. The Act itself has not defined an 'accomodation bill'. According to the commercial practice an accomodation bill is one which is drawn and accepted for the purpose of accomodation of either the drawer or the drawee or both. Accordingly an accomodation bill has certain characteristics viz:

1) It is drawn and accepted without any consideration. 2) The object of the bill is to accomodate one or both the parties, i.e., it essentially creates loan condition between the parties. Accomodation bill is in commercial practice created in following situations: Suppose A requires money and requests his commercial friend B to support him with a loan. B unable to provide cash may request A to draw a bill on him (i.e. B). This bill is known as accomodation bill because this bill has been drawn for the purpose of accomodating A. A gets the bill accepted by B and discounts it from C (who may be the bank or any other third person). On maturity A has to give the money to B and B has the primary duty to honour the bill. Legal validity of these bills - Sec. 43 of the Act provides the general rule about the negotiable instrument made, drawn, accepted, endorsed and transferred without consideration. According to this rule such an instrument does not create any obligation of payment between the parties to the transaction. But if such a bill is endorsed to a holder for consideration, such holder and any subsequent holder may recover the amount due on such instrument from the transferor for consideration or any prior party thereto. So a bill without consideration is not as such a legally invalid document. So an accomodation bill is valid with only the condition that it creates no obligation for payment between the parties to the transaction. Thus in the above example, in between A & B, B is not bound to pay on the instrument to A. But if A discounts the bill with C, A will have primary liability to see that the bill is honoured by B. That means, A has to pay his debt to B thereby enabling B to honour the bill. According to Explanation I of sec. 43, no party for whose accomodation a negotiable instrument has been made, drawn, accepted or indorsed, if he has paid the amount thereof, recover thereon such amount from any person who became a party to such instrument for his accomodation. Suppose in the above example, A pays for the bill to C, A cannot realise the money from B. Suppose B also pays the amount honouring his bill A cannot realise the amount from C. B alone can realise the amount from C on the grounds of double payment u/sec. 70 of Contract

Act. In Canara Bank v. Sanjeev Enterprises [AIR 1988 Del 372] it was held that 'the plea of want of failure of consideration between immediate prior parties cannot be set up against a holder for consideration or against any subsequent holder deriving title from him.' Rights & duties of Parties - As already stated earlier there is no obligation of payment on the accomodation bill in between the drawer and drawee, but the primary and secondary liabilities of the drawee and drawer shall be imposed against a holder for consideration and all other subsequent holder deriving title thereafter. 4.6 RULES RELATING TO INTEREST Sections 78 to 81 deal with the general rules relating to payment of interest on the bills. These may be briefly stated to be as follows : 1) Interest should be paid to either the holder of the instrument or his duly authorized agent. If interest is paid to anyone else it will not act as a discharge. 2) Similarly, payment of interest will not act as a discharge unless it is paid either by the maker of the instrument or his duly authorized agent. 3) Where the instrument itself specifies a rate of interest, interest will be calculated at that rate from date of instrument till realization of amount or if a suit has been instituted then till the date the court directs. 4) When no rate is specified in the instrument, the rate of interest will be 18% per annum regardless of any agreement between the parties, from the date at which it ought to have been paid to the date of realization or such other date as the court may direct. 5) Any person who is liable to pay on an instrument, and has been asked by the holder to pay the amount, is entitled to have the instrument delivered to him on his paying up, or if it has been lost then he has the right to be indemnified against any other claims against him on that bill or note.

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5. PRESENTMENT SUB TOPICS 5.1 Presentment for acceptance 5.2 Presentment for payment 5.3 When Presentment unnecessary 5.4 Banker’s Liability 5.1 PRESENTMENT FOR ACCEPTANCE Section 61 which deals with presentment for acceptance states as follows : “A BOE payable after sight must, if no time or place is specified therein for presentment, be presented to the drawee thereof for acceptance, if he can, after reasonable search be found, by a person entitled to demand acceptance, within a reasonable time after it is drawn, and in business hours on a business day. In default of such presentment no party thereto is liable thereon to the person making such default. If the drawee cannot, after reasonable search be found, the bill is dishonoured. If the bill is directed to the drawee at a particular place, it must be presented at that place; and if at the due date for presentment he cannot, after reasonable search, be found there, the bill is dishonoured. Where authorised by agreement or usage, a presentment through the post office by means of a registered letter is sufficient”. In Jagjivan Mavji v. Ranchoddas [AIR 1954 SC 554] it was observed, "in a bill payable after sight thee are two distinct stages, firstly when it is presented for acceptance (section 61) and later when it is presented for payment (section 64), but when the bill is payable on demand both the stages synchronise, and there is only one presentment, which is both for acceptance and payment." Thus, presentment for acceptance is a rule applicable only to those BOE which are payable after sight i.e. those BOE which are not payable on demand. ‘Acceptance’ as the term itself implies is an acceptance or agreement by the drawee of the liability to pay the amount on BOE whenever it is presented for payment by the drawee. The reason for this rule may be two fold, viz: (i) you cannot make a third person (the drawee) liable for a sum without his consent or knowledge; and (ii) it gives the drawee time to make arragements for the amount which he would have to pay after the elapse of the specified time limit. Who may present ? A BOE has to be presented for acceptance only by a person who is entitled to demand acceptance. According to sec.78, in case of BOE payable on demand or at sight the person entitled to receive payment is the person entitled to present it for acceptance. Generally, it is the holder of a bill who is entitled to present it for acceptance, and the drawee can acting on the 152 (Sys 4) - D:\shinu\lawschool\books\module\contract law

presumption that the person in possession of a BOE has the legal title to it also, accept the bill without any risk. In Greenwood v. Martins Bank [1933 A.C.J.1] it was held that ‘if the person presenting turns out to be not a rightful holder, the drawee’s acceptance will enure to the benefit of the person really entitled to the bill. By presenting the bill for acceptance, the holder does not guarantee that the bill or any documents attached hereto are genuine’. Presentment for acceptance may be made by the holder himself or through an agent. Generally speaking, it is bankers who are employed as agents of their customers both for acceptance and for payment. A banker is expected to use all possible care and diligence in the discharge of his duty. In Bank of Van Dieman’s Land v. Bank of Victoria [(1871) LR 3 PC 526] the extent of bankers diligence has been stated thus, “the duty of the agent is to obtain acceptance of the bill, if possible, but not to press unduly an acceptnace in such a way as to lead to a refusal, provided that the steps for obtaining acceptance or refusal are taken within the limit of time which wil preserve the right of the principal against the drawer”. A banker is liable to pay damages if he is negligent in his duty. Presentment to whom ? A presentment should be made either to the drawee or to his duly authorised agent (sec.75). The demand for acceptance must be made to the authorised person, in clear and unambigious manner, and as observed in Check v. Ropper [(1804)5 Esp. 175 170 E.R. 777], it is not sufficient to produce a witness who went to a place described as the drawee’s house, and there told by a stranger to the witness that the drawee would not accept the bill. There has to be some kind of proof to show that (i) the presentment was made to the drawee himself or to his duly authorised agent & (ii) that th BOE was actually exhibited to the drawee for his acceptance. A drawer is entitled to a period of 48 hrs to decide whether he wants to accept the bill or not (sec.63). In case of there being 2 or more joint drawees, the BOE must be presented to all of them jointly, unless one of them has been authorised by the rest to accept the bill on behalf of the rest. A holder is entitled to have the acceptance of all the drawees and even if one of them refuses he is entitled to treat the bill as dishonoured and claim compensation from the drawer. Place and time of presentment Although in general the law requires that a presentment should be the drawee himself there is no specific requirement for the place of presentment, because at that instance he is only required to receive the bill, unless a specific place is mentioned in the bill itself when of course that place has to be adhered to. A bill has to be presented during business hours, though the phrase ‘business hours’ itself has not been defined in the Act or under any other law for that matter, but may be deemed to be governed by the usual usage or practice of that trade or in that area. In England the phrase used is ‘during reasonable hours’,

which phrase has been used differently for traders, bankers and non-traders. For the traders the ‘reasonable hours’ are usual business hours and for non traders it is upto bed time. No such varied interpretation is given in India, and the interpretation of the phrase ‘business hours’ will depend on the facts and circumstances of each case. Similarly, the presentment must not be made on a public holiday (including Sunday’s) i.e. it must be presented only on a working day. In Mohanlal Malpani v. Loan Company of Assam [AIR 1960 Assam 191] it was held that ‘a bill payable after sight should be presented for acceptance, without unreasonable delay or the drawer and other persons liable on the bill will be discharged; for, they have an interest in having the bill accepted immediately, in order to shorten the time of payment, and thus put a limit to the period of their liability’. A second reason for presenting the bill within a reasonable time is that if the holder makes an inordinate delay in presenting, there is a very real risk of the drawee becoming insolvent in the meantime. Section 105 of the Act dealing with ‘reasonable time’ states that “In determining what is a reasonable time for presentment for acceptance or payment, for giving notice of dishonour and for noting, regard shall be had to the nature of the instrument and the usual course of dealing with respect to similar instruments; and, in calculating such time, public holidays shall be excluded”. In short, what is a ‘reasonable time’ will depend on the facts of each case. Acceptance of overdue bills Though the Act does not specifically deal with the effects of acceptnace of overdue bills, but such an acceptance is not per se void, because under sec.32 a bill which has been accepted after maturity is payable to the holder on demand. Under the English law a bill may be accepted when it is overdue [sec.18(2)] and it becomes payable on demand[sec.10(2)]. It is thus clear that under the English law a bill should be presented for acceptance before maturity, and if it is not so presented the holder may lose his right of recourse against the drawer and indorser, except in case of bills coming under sec.39(4). Since in the Indian Act there is no provision inconsistent with the above stated principle it may be safely stated that mere acceptance of an overdue bill will not act as a revival of the liability of a drawer or indorser who may have been discharged by reason of non-presentment of bill before maturity. Presentment of promissory note for sight Section 62 states as follows : “A promissory note, payable at a certain period after sight, must be presented to the maker thereof for sight (if he can after reasonable search be found) by a person entitled to demand payment, within a reasonable time after it is made and in business hours on a buisness day. In default of such presentment no party thereto is liable thereon to the person making such default”. Just as in case of BOE, even in case of notes, the presentment should be to the maker or his duly authorised agent, and it must be within a reasonable time. The holder is required to diligently

search for the maker in order to make a presentment, and if even after such a search the maker cannot be found, the holder is discharged from his liability of making a presentment. Where the holder fails to present the instrument without a reasonable cause the other parties to the instrument are discharged from their liability to the defaulter, though such default does not affect the rights and liabilities of such other parties. But in the opinion of Bhashyam & Adiga (p.491) such default of the holder also affects the liabilities of other parties inter se as these liabilities depend upon these of the maker to the holder. 5.2 PRESENTMENT FOR PAYMENT Section 64 dealing with presentment for payment states as follows : “Promissory notes, bills of exchange and cheques must be presented for payment to the maker, acceptor or drawee thereof respectively, by or on behalf of the holder as hereinafter provided. The default of such presentment, the other parties thereto are not liable thereon to such holder. [where authorised by agreement or usage, a presentment through the post office by means of a registered letter is sufficient]. Exception - where a promissory note is payable on demand and is not payable at a specified place, no presentment is necessary in order to charge the maker thereof”. This section lays down the general rule that a negotiable instrument should be presented for payment at maturity but not before, and in default of such presentment, all the parties except the maker and the acceptor are discharged from their liability to the holder [Chandra Dat v. Chandra Sen, AIR 1934 Oudh 254]. The reason for making this distinction is that there is a distinction between the liability of the maker and acceptor and that of the drawer and indorser. The former is an absolute liability, whereas the later is conditional. To whom is the presentment to be made ? As per the section, presentment of notes should be to the maker, BOE to the acceptor and cheques to the drawee-banker. The section does not cover all situations because it does not deal with bills which are not required to be presented for payment before payment is demanded. Section 75 deals with certain other persons to whom presentment may be made and states as under “Presentment for acceptance or payment may be made to the duly authorised agent of the drawee, maker or acceptor, as the case may be, or where the drawee, maker or acceptor has died, to his legal representative, or, where he has been declared an insolvent, to his assignee”. Under the English Bills of Exchange Act in case of serveral drawees unless there is a contract to the contrary, the presentment should be made to all of them. But no such provision has been made in the Indian Act and it is to be presumed that given a similar fact situation we will follow the English law. 153 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Who should make the presentment ? Just as in case of presentment for acceptnace, presentment for payment should also be made by the holder or his duly authorised agent, although the words used in the section, namely ‘by or on behalf of the holder’ is also susceptible to the construction that a presentment may be made even by an unauthorised person who would be unable to give a valid discharge. The English law on the other hand explictly states that presentment should be made by a person who is the holder, or some one authorised on his behalf’. Though the Indian Act is susceptible to both constructions, care should be taken to give only that interpretation to the words which would expose the maker and the acceptor to minimum risk. Mode of presentment In Ramuz v. Crowe [(1847)1 Ex. 167], it was observed that ‘the presentment for payment must be such as would be sufficient to charge the indorses and other persons collaterally liable on the bill, and the document itself must be presented so as to enable the person presenting, to give it up if paid’. A mere registered notice by a pleader demanding payment is not a good presentment nor is an oral demand for money enough, though it is not really necessary that the holder should hold the bill in his hand while demanding payment. What is required is that the bill should be at hand or easily accessible even if not in his personal custody. The reason for having the bill accessible is that “the acceptor (or any body) paying the bill has the right to the possession of the instrument for his own security and as his voucher and discharge protanto in his account with the drawer" [per Lord Tenterdon in Hansard v. Robinson, 108 ER 659]. In 1885 the second clause to the section was added whereby presentment throguh the post office is made valid if agreed to by the parties or such presentment is in accordance with usage. An important safeguard made in this regard is that presentment through post should always be by a registered letter. er. This safeguard has not been provided for in English law. Time and place of presentment Presentment must be made during the usual business hours and if it is being made to a banker then it should be made within the banking hours (sec 65). A note or BOE which is payable at a specified period after date or sight must be presented for payment after maturity (sec.66). A note which is payable by instalments should be presented for payment on the third day after the date fixed for payment of each instalment; and non-payment on such presentment has the same effect as non-payment of a note presented after maturity [sec.67]. In case the note or bill or cheque specifies the place for presentment, then it must be presented at that particular place only in order to charge any party to it (sec 68). Sec 69 further adds that a bill or note made, drawn or accepted as payable at a specified place must be presented at that place in order to charge the maker or drawer of the bill or note. But if no place for 154 (Sys 4) - D:\shinu\lawschool\books\module\contract law

presentment has been specified then the bill or note must be presented for payment either at the place of business (if any) or the residence of the maker, drawee or acceptor of the bill or note [sec.70]. What happens if such maker or drawee has no known place of business or residence ? Sec.71 provides that in such cases presentment may be made to him in person wherever he can be found. Cheques have to be presented at the bank on which it is drawn so as to charge the drawer, before the relation between the drawer and his banker gets altered to the prejudice of the drawer [sec.72]. In case any other person (i.e. apart from the drawer) is to be charged, then according to sec.73 the cheque must be presented within a reasonable time after delivery of it by such person. Default in presentment In case the holder makes a default in presentment, the other parties on the instrument are discharged from their liability to the holder i.e. the drawers and the indorsers in case of bills and cheques and indorsers in case of notes. Since their liability is conditional and is dependant on the presentment of the instrument the liability is discharged if this condition is not fulfilled regardless of whether they have actually been prejudiced by such non-presentment or not. In case the holder delays the presentment either for acceptance or payment, such delay is excusable provided it is caused by circumstances beyond his control i.e, the holder himself has not been guilty of negligence or misconduct etc resulting in the delay. After the cause for delay ceases to exist he should make the presentment within a reasonable time ( sec. 75 A). 5.3 WHEN PRESENTMENT UNNECESSARY Section 76 provides for situations in which presentment for payment is unnecessary, and the instrument in such a case is dishonoured at the due date for presentment. These situations are as follows : A) Presentment not necessary (i) When prevented - Whenever the maker, drawer or acceptor intentionally prevents the presentment, then the holder need not present the instrument. The word ‘prevent’ implies a positive action of some kind on the part of such maker or drawer, as for example, by putting obstacles or disabling the holder in some way. (ii) When business place closed - If the place of business of such maker etc is closed on a working day during business hours the presentment is not necessary, because in such a case the presumption is that it has been deliberately kept closed to avoid payment. (iii) When no person at place of payment - The same rule applies, if the instrument is payable at a specified place, and when the holder goes there for presentment there is no person present who can either authorise payment or refuse it.

(iv) When the maker etc cannot be found - The holder is required to search diligently for the maker etc. If the instrument does not specify a place of payment. If after due search the maker etc cannot be found either at his place of business or his usual residence has to be necessarily excused and the parties to the instrument are liable on it without the presentment. B) Waiver of presentment (i) By agreement before maturity - If the parties to the bill or note mutually agree then they may do away with the presentment at maturity. The waiver of presentment must be by a person entitled to ask for it and not by any third person. Such waiver is generally embodied in the instrument itself and may be incorporated any time ie either at the time of drawing up the instrument or at any subsequent time but before the maturity of the instrument. (ii) Waiver may be express or implied It is not necessary that the maker should expressly (i.e. either in writing or by words) waive presentment. Sometimes his actions or conduct may be such that they create an impression in the holders mind that the bill or note need not be presented, then he can dispense with the formality of presentment by inputing implied waiver. (iii) Waiver by partner and agent The Waiver as mentioned above has to be by a person who is entitled to demand presentment, for the simple reason that neither can one waive away a right which one does not have nor can he waive away the right of another. A partner however is entitled to waive presentment on behalf of his firm, and in case of joint drawees one of them may be authorised to waive presentment on behalf of others. (iv) Promise to stranger no waiver Just as presentment should be made to a person entitled to demand it, so also when such a person waives his right it should be to the person entitled to demand payment. A waiver to a stranger does not in general amount to waiver though sometimes it may amount to an admission of the fact that due presentment was made and notice given [Potter v. Rayworth, 104 ER 432]. (v) Waiver after maturity Clause (c) of the section refers to waiver after maturity. Such waiver may be inferred either from a part payment of the amount due, or by a promise to pay the amount either in part or in full or the party may expressly waive his right or take advantage of any default in the presentment for payment. [Panchicowri v. Satya Dhenu, AIR 1936 Cal 489]. The promise to pay must be both absolute and unconditional, otherwise it will not operate as a waiver. Though no specific words or format of waiver has been laid down, the words used must be such as to clearly acknowledge the liability and the promise to pay. Such promise to pay is a prima facie proof of a presentment having been made.

A waiver can be made only with full knowledge of facts, ie the drawer or indorser must be aware that the holder has defaulted in making a presentment. This is because a waiver is a conscious act and not a merely automatic or formal gesture. C Presentment excused i) When no damage to drawer - Where non-presentment of an instrument by the holder does not result in any loss or damage to the drawer or indorser, then the presentment may be excused. The burden of proof in such cases is on the person who wants to rely on this excuse i.e. usually the holder. A common example of this is when the drawer draws the bill without any right to do so or without any reasonable ground to expect that the drawee will honour it, i.e. when he commits a fraud or a folly in drawing the bill, and so he can suffer no loss or injury by want of presentment, which would naturally be fruitless in such cases [Terry v. Parker, 112 E.R. 192]. The English law in such cases views it from the relationship between the drawer and drawee, whereas the Indian law approaches the issue from the point of view of future or possible results or consequences of non-presentment, but as such there is not much diffeence in the substance of the laws. (ii) Accomodation instruments If a bill is drawn for the accomodation of the indorser, or if he indorsed it for the accomodation of the drawer, knowing at the time that it will not be honoured at its maturity he also comes within the reason of the applicable to the drawer, and presentment to charge him is not necessary [sec.46(2)(d) of Bill of Exchange Act]. D) In case of specific drawers/drawees i) When drawer and drawee same In such situations the holder may treat the instrument as a promissory note and in which case presentment becomes unnecessary to charge the maker. But where the holder wants to charge the indorser, then presentment becomes necessary. Even if the drawee/acceptor becomes insolvent before maturity, the holder is not excused from presentment to drawer. ii) When drawee is fictitous Presentment in such cases is dispensed with not only against the drawer but also against all other parties liable on the instrument, because a demand cannot be made on a person who does not exist. iii) When drawee incompetant If the drawee is legally incompetant to enter into a contract, presentment against indorsers is not dispensed with, although presentment against the drawer becomes unnecessary. The reason for this is that by drawing on an incompetant person he has committed a fraud on the holder, and cannot claim to have suffered damage by want of presentment. If any of the subsequent indorsers are a party to the fraud then they also become subject to the same rule. 155 (Sys 4) - D:\shinu\lawschool\books\module\contract law

iv) When drawee dead It is not very certain as to whether presentment is necessary in such cases, and if yes - then who should it be made to ? As per sec.75, presentment to the legal representative may be made, but the holder cannot be compelled to do so. Since the present section does not excuse non-presentment on that ground it is presumed that the holder is bound to present at the specified place of payment (if any) or place of business or residence of the deceased if ascertainable after diligent search by the holder. It is perhaps safer to present it to the legal representatives of the deceased [Cf. Philpot v. Briant, 172 E.R. 405]. E) Impossibility of presentment The section does not excuse non presentment due to circumstances beyond the control of the holder. Sec. 75A however excuses delayed presentment in such cases. But there are certain general circumstances where presentment is excused in all jurisprudential systems and mercantile law. These circumstances are referred to in sec.46 of Bill of Exch. Act, for example in cas eof ‘political disturbance’ amounting to virtual interruption and destruction of trade and this includes war; enemy occupation of the holder’s contry; riots; insurgence; etc., where closing of business house becomes necessary for protection of life and property. Similarly certain circumstances might occur in the life of a holder, for example, sudden grave illness or death of the holder at the time of maturity of instrument, which would render it impossible for the holder to make a presentment. In such situations, the drawee should be informed of the circumstances at the earliest. Another common excuse for not making presentment on time is miscarriage or delay in transit where presentment by post is allowed. But such delay or non presentment is not excusable if the holder himself was negligent or in some other way responsible for the non presentment. A point to remember is that in these cases the presentment is not wholly excused but only delay in presentment is excused, i.e. the moment the impediment or obstacle is removed presentment has to be made. F) Dishonour by non-acceptance Finally, presentment for payment becomes totally unnecessary when the instrument has been dishonoured for acceptance. In such cases, the holder can directly hold the drawer liable on the instrument.

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5.4 BANKER’S LIABILITY Earlier it has been mentioned that in general banker’s act as agents of their customers where presentment is required both for acceptance as well as payment. The question arises, what is the liability of a banker in case of loss or damage to the holder. Section 77 of the Act dealing with this states as follows “When a bill of exchange, accepted payable at a specified bank, has been duly presented there for payment and dishonoured, if the banker so negligently or improperly keeps, deals with or delivers back such bill as to cause loss to the holder, he must compensate the holder for such loss”. A banker in performance of his duties is required to take due care. He has to make payment on an accepted bill provided he has sufficient funds in the drawer’s account. This section comes into play when the banker legitimately refuses payment on a BOE. Once he refuses payment, he is required to take due care of the instrument and return it to the holder in the same state as was given to him. If he cancels the acceptance or any other portion on the bill and the holder suffers some special damage due to such cancellation, then the banker becomes liable to him for such loss or damage suffered, unless he can prove that there was no want of due care or diligence on his part. But a banker is not liable if a cancellation has been mistakenly made and he makes a note on the bill ‘cancelled by mistake’. Thus in Raper v. Birkbeck [104 e.r. 750], the acceptance in a bill was cancelled by mistake by a drawee in case of need under the wrong impression that it had been payable at his house. It was held that prior indorsers were not discharged, as the cancellation was through a mistake which was indicated by the words “cancelled by mistake”. Further, if the bill has been returned to a wrong party because of the holder’s negligence, the banker is not liable so long as he himself had taken due care. Thus a banker apart from being the drawer’s agent is also in the position of a bailee to the holder. It’s for this reason that he is held liable in case he keeps and refuses to deliver the bill improperly or deals with it in such a negligent manner that the holder suffers a loss or damage. Actually speaking this provision really falls within the purview of the law of torts, but the Select Committee inserted this provision with a recommendation that it might be retained in this Act till the codification of tort law.

6. SPECIAL PROVISIONS RELATING TO CHEQUES SUB TOPICS 6.1 Introduction 6.2 Kinds of Crossing 6.3 Payment of Crossed Cheques 6.4 Protection of the Collecting banker

(3) Account payee only (4) ‘Not Negotiable’ crossing We will now deal with each of these kinds in detail. (1) General Crossing Section 123 defines general crossing as :

6.1 INTRODUCTION ‘Crossing’ is a feature which is unique to cheques and distinguishes cheques from other negotiable instruments. Crossing is a usage born of commercial practice. In Bellamy v. Marjoribanks [155 E.R. 999] it was observed that ‘this practice originated at the clearing house when the clerks of the different bankers wh did business there used to write across the cheques, the name of their employers, so as to enable the clearing house clerks to make up the accounts’. The objective of crossing a cheque is to introduce or give a direction to the banker that he is not to pay the cheque across the counter but to pay it only to another banker. This second banker may be either the drawee banker or a different one. By paying money to the banker it becomes easier for the owner of the cheque to detect or find out as to where the money has gone or for whose use it has been received. Crossing of a cheque accords a protection or safeguards to the cheque owner. This is because, even when a wrongful person secures payment on a crossed cheque it can be traced because he operates through a banker, i.e., he has to open an account first (and since he is not the payee, a current account) with some banker and then pay the cheque into his account so as to enable the banker to receive payment on his behalf and credit it to his account. This makes it easy for the money to be traced to the recipient’s hand if it is found out later that he was not entitled to payment on that particular cheque.

Thus, for a cheque to be treated as being crossed generally, it should satisfy the following conditions, viz: (1) two parallel transverse lines on its face; (2) either with no writing between them or (3) the words “and company”; ‘& Co.” or “Not Negotiable” written between the lines. Where no words are written the crossing is said to be general. Drawing of the parallel lines is essential for general crossing. Some specimens of general corssing are given below. (1) A/c Payee. Not Negotiable

(2) Under Ten Rupees

(3) Not Negotiable

(4)

XY Bank, Ltd No:

“where a cheque bears across its face an addition of the words “and company” or any abbreviation thereof, between two parallel transverse lines, or of two parallel transverse lines simply, either with or without the words ‘Not negotiable”, that addition shall be deemed a crossing, and the cheque shall be deemed to be crossed generally’.

Date: 199

Pay..................................................or Bearer..................... Rupees...................................................... Rs

6.2 KINDS OF CROSSING Crossing of a cheque is generally of two kinds, viz: (1) General crossing and (2) Special crossing. But each of these kinds may be several different sub-types. Apart from these two kinds there are certain other kinds of crossings also, viz :

2) Special Crossing Section 124 states as under : “Where a cheque bears across its face an addition of the name of a banker, either with or without the words “Not Negotiable”, that addition shall be deemed a crossing, and the cheque shall be deemed to be crossed specially, and to be crossed to that banker”. For a check to be crossed specially therefore the following conditions should be satisfied. a) the two transverse parallel lines may or may not be drawn; b) name of the banker should be written across the cheque; c) the words ‘Not Negotiable’ may also be included.

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Thus it is seen that unlike general crossing, in case of special crossing the transverse lines are not compulsory though it is usual to put them. The only thing necessary is that the name of the bankers should be written across the face of the cheque. Given below are a few specimens of special crossing. (l) Indian Bank George Town (2) State Bank of India (3) Bank of India Not Negotiable (4) State Bank of India Nagarabhavi Remitted for collection to Bank of India

consequences as in case of ordinary negotiation. Such cheques are deprived of the main attribute of negotiability, namely, ‘the transferability free from equities’ i.e., the transfree gets a good title only if transferor has one and if there is defect in the transferors title such defect is passed on to the transferee. But a transferee of a ‘non-negotiable’ cheque is left with the second attribute of negotiability i.e., of transferability by delivery or indorsement. In case of such cheques there is only a holder and no holder in due course. Thus in Great Western Ry.Co.V.London & County Banking Co., [(1901) AC 414], H by false pretenses obtained from G.W. a cheque crossed “& Co.,” & “not negotiable” and took it to a bank who paid it. G.W filed a suit against the bank for conversion of the cheque. It was held that the cheque having been obtained by fraud of the apparent holder who had no title to the cheque, and could not give to the bank any title to the cheque or the money, and that the bank was liable for the amount of cheque. Earl Halsbury, L.C. observed as follows:

Over the last few years a practice commonly used in crossing of cheques if making them “account payee” or “account payee only”. The Bill of Exchange Act does not provide for such kind of crossing. An “account payee” crossing does not restrict the negotiability of the instrument but merely provides an additional safeguard against theft or loss. It is not an addition to the crossing, but merely directs the receiving bank that as per the drawer’s wishes the check should be paid to that bank where the payee (or holder) has an account. If the banker receives payment of such a cheque on behalf of a third person (i.e., other than the payee/holder), he would be guilty of negligence and cannot seek protection under sec.31.

“It is very important that every one should know that people who take a cheque which is upon its face ‘not negotiable’ and treat it as a negotiable security must recognise the fact that if they do so they take the risk of the person for whom they negotiate it having no title to it. In this case, it cannot be pretended that Huggins had any title to it at all. I do not understand what additional security is supposed to be given to a cheque by putting the words “not negotiable” upon it, if the fact of its being negotiated can give a title to any one. The supposed distinction between the cheque itself and the title to the money obtained or represented by it seems to me to be absolutely illusory. The language of the statute seems to me to be clear enough. It would be absolutely defeated by holding that a fraudulent holder of the cheque could give a title either to the cheque or to the money”.

4) “Not Negotiable” crossing

In the same case, Lord Brampton observed:

In the above paras we have mentioned that both general and special crossing can also contain the words “Not Negotiable”. When this phrase is used while crossing the cheque, we call the crossing a “not negotiable” crossing. Sec.130 deals with the concept of “not negotiable” crossing and states as under:

“The object of section 81 is obvious. It is to afford to the drawer or the holder of a cheque who is desirous of transmitting it to another person as much protection as can be reasonably afforded to it against dishonesty or accidental miscarriage in the course of its transit, if he will only take the precaution to cross it, with the addition of the words “not negotiable”, so as to make it difficult to get such cheque so crossed cashed until it reaches the destination”.

3) Account payee crossing

“A person taking a cheque crossed generally or specially, bearing in either case the words “not negotiable”, shall not have, and shall not be capable of giving, a better title to the cheque than that which the person from whom he took it had”. Previously under both the Indian and the English law a drawer was entitled to draw or make a non-transferable cheque by simply omitting the word “order or bearer” in the instrument. But according to sec.13 of the present Act, the absence of these words do not restrain negotiation, nor does the English law treat the absence of these words as a restraint, hence the only way in which a person can draw a non-negotiable or nontransferable check is by crossing it “non-negotiable”. This does not mean that a cheque crossed non-negotiable ceases to be transferable in entirety-what it means is that transfer of such cheques are not attended by the same important 158 (Sys 4) - D:\shinu\lawschool\books\module\contract law

It is to be remembered that there is a fine distinction between cheques crossed “non negotiable” and cheques which are ab initio ‘non transferable’. The former can be transfered from person to person though the transferee gets no better title than the transferor; whereas the latter is payable to the ‘payee only’ and no one else and any transfer or indorsement of such cheques are not recognised. A cheque is ‘non-transferable’ when it is drawn payable to “Mr.X only” and having the words ‘bearer’ or ‘order’ struck out. Crossing of a cheque after issue Uptil now we have dealt with the crossing of a cheque by the drawer i.e., before it was issued to the payee or holder. But a

cheque can be crossed after it has been issued by the drawer, and sec.125 which deals with such cheques states that:

Where a cheque is crossed specially, the banker to whom it is crossed may again cross it specially to another banker, his agent, for collection”.

a) In case of general crossing - the banker with whom the payee holder has an account. b) In case of special crossing - the bankers in whose favour the cheque is crossed or the agent of such banker (sec.126). The objective of crossing a cheque cannot be better stated than in the words of the preamble to the statute of 19 and 20, Victoria Ch.25 which states that: “It would conduce to the case of commerce, the security of property and the prevention of crimes, if drawers or holders of drafts on bankers payable to bearer, or order, on demand, were enabled effectually to direct the payment of the same to be made only to, or through some banker”.

Thus under this section two categories of persons can cross a cheque or change the nature of an already crossed cheque, viz., (i) the holder of the cheque; and (ii) the collecting banker of the cheque.

If a cheque has been ‘specially crossed’ more than once, then according to sec.127 the banker on whom it is drawn shall refuse to pay on it, unless the second banker is an agent of the first and the second crossing has been done for collection purposes.

Such crossing is allowed on the principle that ‘crossing’ by itself does not amount to a material alteration vitiating the instrument. Certain points however have to be rememberd in this connection, viz., (i) A cheque crossed generally by the drawer can be converted into a ‘specially crossed’ cheque by the holder. (ii) A cheque specially crossed cannot be converted into a generally crossed cheque by the holder by striking out the name of the banker, because this will amount to a material alteration u/sec.87 and will vitiate the cheque. (iii) If the banker is crossing the cheque then he can do so only in favour of another bank which is its agent for collection purposes. (iv) In case of double crossing by the bank, the banker before payment should ascertain that the second bank is an agent of the first. (v) If an uncrossed cheque is indorsed in favour of the banker, then the banker can cross it specially to himself ie., in his favour.

B) Payment in due course of crossed cheque:

“Where a cheque is uncrossed, the holder may cross it generally or specially. Where a cheque is crossed generally, the holder may cross it specially. Where a cheque is crossed generally or specially, the holder may add the words “not negotiable”.

A commercial practice has of late developed of cancelling the crossing by writing “please pay cash” within the crossing lines and signing or initiating it. The cheque is then said to be opened. This practice has no legal basis and it is not really advisable for the bank to act on its basis because if the bank does pay the cash over the counter and it turns out that the payment has not been made to the true owner of the cheque the banker is not protected. In view of this, the London Clearing House Bankers have passed the resolution in the following terms; “That no opening of cheques be recognised unless the full signature be appended to the alteration and then only when presented for payment by the drawer or by his known agent”. [Bhashyam, P.725]. 6.3 PAYMENT OF CROSSED CHEQUE A) Payment of crossed cheques A crossed cheque as mentioned before is a direction to the banker to pay the money only through another banker. The banker to whom money should be paid is:

Once a banker on whom a crossed cheque has been drawn has paid the amount on it in due course, he can debit the drawer with the said amount in his accounts with him. The drawer or any other person cannot hold the banker liable or charge him for having paid that amount, even if the amount has not been received by the true owner of the cheque (sec.128). But if the banker makes the payment contrary to the provisions of sections 10 or 126, then the banker cannot charge the drawer with the amount if it has not been received by the tue owner, i.e., if a banker does not pay the money as per the rules and by some mischance the money is not received by the true owner then he will be personally liable to the true owner for the amount (sec.129). The term ‘true owner’ itself has not been defined by the Act, but it is logical to assume that there cannot be two ‘true owners’ of a cheque. A holder in due course or the payee of a cheque will of course be considered as true owners. Similarly if the cheque has been stolen, the person from whom it is stolen remains the true owner i.e., the thief merely by virtue of being in possession does not become the true owner. In short therefore, a true owner is one in lawful possession of the cheque. 6.4 PROTECTION OF THE COLLECTING BANKER Since a crossed check can be paid only by bankers and to a banker, the Act also provides certain protection to the banker who acts with due care and diligence in collecting the payment on a crossed cheque. This protection is incorporated under sec.131 which states as under: “A banker who has in good faith and without negligence received payment for a customer of a cheque crossed generally or specially to himself shall not, in case the title to the cheque proves defective, incur any liability to the true owner of the cheque by reason only of having received such payment. Explanation: A banker receives payment of a crosed cheque for a customer within the meaning of this section not withstanding that he credits his customer’s account with the amount of the cheque before receiving payment thereof”. 159 (Sys 4) - D:\shinu\lawschool\books\module\contract law

For the application of this section the following conditions have to be satisfied, viz;

collected.

l) For a customer

The protection is available only in case of crossed cheques. In case of uncrossed cheques, the banker is not protected if the customer’s title is defective. Nor can he seek protection of this section, if he himself crosses the cheque subsequent to receiving it.

The first requirement is that the banker should have collected the money on the crossed cheque on behalf of a customer i.e., he should not have collected the amount for himself. A customer may be loosely defined as ‘a person having an account with the bank’. In Taxation Commissioners v.English, Scotish & Australian Bank [(1920)AC 683] it was thus observed. “The word ‘customer’ signifies a relationship in which duration is not of the essence. A person whose money has been accepted by a bank on the footing that they undertake to honour cheques up to the amount standing to his credit is a customer of the bank in the sense of the statute, irrespective of whether his connection is of short or long standing”. There must be an existing account at the time when the cheque is received for collection even if it is opened by means of the same cheque and for the very purpose of collecting it [Ladbroke & Co.V.Todd, (l9l4) 111LT 43]. One bank may be customer of another bank. 2) As Agent Secondly, the payment should be received by him as an agent of the customer, because the protection is accorded only to situations where the bank has acted mechanically to provide collection facility. If the banker receives payment as holder of a cheque then he loses the protection. It is always a ‘question of fact’ as to whether the banker had received payment as an agent or a holder. In Capital and Counties Bank V.Gordon, London City and Midland Bank V.Gordon[(1903)AC 240], one Jones, the plaintiff’s clerk, stole a number of cheques payable to the plaintiff, indorsed them to himself and paid them into his account with both the above banks. In each case the amount was immediately credited to his account and he was either permitted to withdraw the money or his overdraft wiped out before the cheques were cleared. In both cases, the bankers were held liable because they had received payment not as agents but as holders for value of the cheques. It was observed that “As between the customer and the bank, there was an arrangement or course of practice under which the bank allowed the customer to draw against the amounts of cheques paid in and credited before they were cleared”. But according to the explanation appended to the section mere crediting of the amount to the creditor’s account does not convert the banker into a holder. To be deemed a holder there must be an express or implied agreement between the banker and cutomer allowing the latter to withdraw the money before it has been actually

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3) Crossed Cheque

4) Good faith and without negligence The last requirement is that the banker should have acted in good faith i.e., bonafidely and without any negligence. If there is something about the cheque which is suspicious, then the bqanker is required to make due inquiries,and if he fails to do so then he will be guilty of negligence. The extent of inquiry varies from case to case. Sometimes the banking history of the customer may become the cause of suspicion. Thus in Motor Traders’ Guarantee Corpn. V. Midland Bank [(l937) 157 LT 498], a cheque was collected on behalf of a customer who had misappropriated it by forging an indorsement. The banker did make some inquiries but not as much as the antecedant history of the customer whose cheques had been frequently dishonoured, demanded or required. The bankers were held guilty of negligence. This does not mean that a banker should view every new customer suspiciously as a potential criminal. Thus an enquiry is necessary only when the circumstances demand or justify it, because as succintly stated by Scrutton LJ in A.L.Underwood Ltd., v. Barclays Bank [(l924) 1 KB 775], “If banks for fear of offending their customers will not make inquiries into unusual circumstances, they must take, with the benefit of not annoying their customers, the risk of liability because they will not inquire”. In Marfani v. Midland Bank Ltd.[(l968)1 Lloyd’s Rep 411] Mield J.lay down the following guidelines in this regard: “(i) That the standard of care is to be denied from the ordinary practice of bankers. (ii) That the standard of care required of bankers ‘did not include the duty to subject the account to microscopic examination’. (iii) The bank must not have been negligent in accepting a new customer and opening a new account. (iv) The onus lay on the bank to show that it had acted without negligence”. In Indian Overseas Bank v. Industrial Chain Concern [(1990) ISCC 484] the Supreme Court emphasised one more point in connection with this duty, i.e., “while collecting a cheque for a customer the banker is under an obligation to present it promptly so as to avoid any loss due to change of circumstances”.

7. DISCHARGE FROM LIABILITY SUB TOPICS 7.1 Introduction 7.2 Kinds of discharge 7.1 INTRODUCTION ‘Discharge’ in the legal sense means a ‘release from liability’. Discharge of a negotiable instrument therefore means the release of liability on that instrument. A differentiation must be made between the discharge of parties to the instrument and discharge of the instrument itself. Discharge of an instrument means the extinguishment of all rights of action on it. In such a situation

the bill ceases to be negotiable and if later reaches the hands of a holder he acquires no right of action on it. But the discharge of a party does not automatically result in the discharge of the instrument. For example, merely because one of the indorsers has been discharged from his liability on the bill does not mean that the bill itself has been discharged not does it effect the liability of the other parties to the bill. Sections 82-90 of the Act deal with various circumstances when the parties to an instrument are discharged from their liability. 7.2 KINDS OF DISCHARGE The following flow chart depicts the various situations in which the liability in discharged.

Discharge By act of parties (Sec. 82)

Cancellation

Release

By operation of law

Payment

Insolvency

Merger

Other circumstances (Sec. 83-90).

Lapse of Discharge of time

one of joint drawers etc

we will now discuss each one of these kinds.

A] By act of parties (i) By cancellation: When the holder or his agent deliberately cancel a bill and the cancellation is apparent on the face of it, the bill is discharged and the parties to the bill are released from their liability. If the cancellation is not apparent then the instrument remains valid in the hands of a bonafide holder. Thus in Ingham V.Primrose[141 ER 745], A accepted a bill and gave it to B for the purpose of getting it discounted and handing over the proceeds to A.B, having failed to discount it, returned the bill to A, who tore it in half intending to cancel it, threw the two pieces into the street. B picked them up and afterwards pasted the two pieces in such a manner that the bill seemed to have been folded for safe custody rather than cancelled. B then put the bill into circulation and it finally reached the plaintiff a holder in due course. The plaintiff sued A on the basis of the bill. It was held that ‘A was liable, because the tearing of the bill into two pieces was not so clearly manifested on the face of the bill as to indicate to a reasonably careful person that it had been cancelled. Tearing of the instrument must be such that a man of ordinary intelligence and caution should at once come to know that it has been cancelled’.

Sec.82(a) deals with a situation where the holder with deliberation cancels out not the instrument as such, but the name of the acceptor or indorser. When the name of the ‘acceptor’ is cancelled, all other subsequent parties being sureties for the acceptor are also discharged from their liability i.e., the effect of cancelling the acceptor’s name is the same as the effect of cancelling the instrument itself. But, where the holder cancels out the name of an ‘indorser’ then the parties subsequent to the cancelled indorser stand discharged but those prior to such an indorser remain liable on the instrument. (ii) By release: A holder of an instrument can release the acceptor or indorser from their liability either by a separate agreement or by an act which has the effect of discharging them. Effect of release is the same as that of cancelling a name. (iii) By payment: The most obvious way of discharging the liability is by making the payment on the bill. Payment acts as discharge only if it is made in due course as defined in sec.10 which states that: “ ‘Payment in due course’ means payment in accordance with the apparent tenor of the instrument in good faith and without negligence to any person in possession thereof under circumstances which do not afford a reasonable ground for 161 (Sys 4) - D:\shinu\lawschool\books\module\contract law

believing that he is not entitled to receive payment of the amount therein mentioned”. Thus payment to be effective must be made on the maturity of the instrument & payment before maturity does not act as discharge unless the instrument is cancelled or on the face of the bill the words “paid” etc., are prominently written. Similarly, payment should be .rm 7.5" made to a person authorised to receive it i.e., the holder in rightful or lawful possession. Lastly, it should be made in good faith and without negligence. B] By Operation of Law The Act does not make any specific reference to the discharge of parties by operation of law may be because these situations are too logical and common place to merit a special mention i.e., they are situations where it is logical to presume discharge though no mention is made in the Act iself. These situations are given below: i) Due to insolvency: If in an insolvency proceeding, the maker, acceptor or indorser is discharged by the court he will be discharged of his liability on the bill. ii) By merger: Merger as the name implies means ‘joining’. The joining may be of cause of action & of parties. Thus, when a judgement is obtained against the acceptor maker or indorser, the debt under the bill is merged with the judgement debt. But such a merger acts as discharge only when the judgement debt is paid off i.e., mere obtaining a judgement does not act as a discharge. Secondly, when the acceptor of a bill becomes the holder of it also either at or after its maturity in his own right the bill is discharged. iii) Lapse of time: If the holder does not file a suit for recovery of the bill amount till the time prescribed by Limitation Act is prescribed, his remedy to enforce his right is extinguished. It is to be noted that his right itself does not get extinguished nor is the acceptor etc., discharged of his liability but because the right to enforcement is not there, the acceptor is effectively discharged unless he wants to pay the time barred debt. iv) Discharge of one party: In certain exceptional situations discharge of one of the several joint drawers would release the remaining also from their liability. C] Other circumstances i) Allowing more than 48 hrs for acceptance - If the holder allows the drawee more than 48 hrs for deciding on whether he wants to accept it or reject it, then all prior parties who have not consented to such extended allowance are discharged from their liability to the holder (sec.83). ii) Qualified acceptance - The acceptance of a bill should be unconditional and unqualified. If the holder acquiesces in a conditional or qualified acceptance from a drawee/indorser then according to sec.84 the previous parties to the bill are discharged of their liability. iii) Delay in presenting cheque - A cheque once issued should be presented to the banker-drawee within a reasonable time. If the holder fails to do so and in the meantime something happens 162 (Sys 4) - D:\shinu\lawschool\books\module\contract law

(for ex: failure of the bank) the drawer is discharged of his liability, provided that he had sufficient balance in the bank to pay off the cheque if it had been presented at the right time. Illustration (a) to sec.84 is as follows: A draws a cheque for Rs.1,000/- and when the cheque ought to have been presented, he has funds at the bank to meet it. The bank fails before the cheque is presented. The drawer is discharged, but the holder can prove against the bank for the amount of the cheque. What is a ‘reasonable time’ depends on the facts and circumstances of each case. Where the banker and holder are in the same place, the cheque should be presented the day after its receipt, as far as possible. But if the holder and banker are in different places then time for transit has also to be taken into consideration. A crossed-cheque takes more time to reach the drawee-banker and therefore, time necessary for clearance is excluded in determining reasonable time. iv) Material alteration - Byles on Bills of Exchange has in relation to effect of alteration observed as follows: “At common law it has been held that a deed, bill of exchange, promissory note, guarantee, is avoided by an alteration in a material part, made while it is in the custody of the plaintiff although that alteration is by a stranger. For a person who has a custody of an instrument is bound to preserve it in its integrity; and as it would be avoided by his fraud in altering it himself, so it shall be avoided by his laches in suffering another to alter it” [Avtar Singh, p.784]. Section 87, 88 & 89 deal with alteration of an instrument and its effects. For these sections to apply the following conditions have to be satisfied, viz.,: a) Intenational - The alteration to the instrument must be intentional and deliberate i.e., it should not be by mistake or by accident. Thus in Hongkong and Shanghai Banking Corpn., v. Lo Lee Shi [(1928) AC 181 (PC)], the respondent was given two notes of $ 500 each by her husband. She placed then in the pockets of her garment and then having forgotten, she washed, dried, and starched the garments. While proceeding to iron them she found a wad of paper in the pocket. Subsequently, the identity of the notes was restored to a certain extent, except for the numbers on them. When she presented them for payment the bank refused to pay. The lower courts held the bankers liable. On appeal, the Privy Council holding the bankers liable observed, “The alternation contemplated is one to which all parties might assent. It is not reasonable to assume parties assenting to a part of the document being effected by the operation of a mouse, by the hot end of a cigarette or by any other means by which accidental disfigurement can be effected. It cannot reasonably apply to the ravages of a rat, white-ant or any other animal pest”. b) Material: For an alteration to act as a discharge it should be of a material part of the instrument. As observed by Devlin, J in Qwei Tek Choo v. British Traders and Shippers Ltd. [(1954) 2 QB 459], “ One must examine the nature of the alteration and see whether it goes to the whole or to the essence

of the instrument or not. If it does, and if the forger corrupts the whole of the instrument or its heart, then the instrument is destroyed; but if he corrupts merely a limb, the instrument remains alive, though no doubt defective”. Our own Supreme Court in Loonkaran Sethiya V. Ivan E.John [(1977) I SCC 394] observed as follows: “A material alteration is one which varies the rights, liabilities or legal position of the parties as ascertained by the deed in its original state, or otherwise varied the legal effect of the instrument as originally expressed, or which may otherwise prejudice the party bound by the deed as originally executed”. Sec.64(2) of the English Bills of Exchange Act, l882 states as follows: “In particular the following alterations are material, namely, any alteration of the date, the sum payable, the time of payment, and where a bill has been accepted generally, the addition of a place of payment without the acceptor’s assent”. But an alteration which is neither material nor substantial, as already mentioned does not act as a discharge. Further the Act itself permits three kinds of alteration as given below: i) A person to whom a stamped and signed instrument has been issued either wholly or partly in blank has an authority under sec.20 to complete the instrument by filling in the blanks, even if he exceeds the actual authority vested in him while completing the instrument. ii) The holder of an instrument indorsed in blank has an authority under sec.49 to convert it into an indorsement in full. iii) The holder of an uncrossed cheque may cross it, or he may convert the general crossing on the cheque to a special crossing under sec.125. Further, a bankers to whom a cheque has been crossed specially, may again specially cross it in favour of his agent-banker for collection purposes. Section 88 further does not apply to the following cases viz; l) An acceptor or indorser cannot complain of any alteration which was made before his acceptance or indorsement, because the section itself reads as, “An acceptor or indorser of a negotiable instrument is bound by his aceptance or indorsement notwithstanding any previous alteration of the instrument”. 2) Alterations which re made in accordance with the common or mutual intention of the parties cannot be complained of. 3) A party cannot complain of an alteration to which he has expressly or impliedly assented. 4) An alteration made before it becomes a negotiable instrument does not vitiate the instrument. c) Apparent: Lastly, the alteration should be such as is apparent on the face of the instrument, otherwise it remains as a valid security in the hands of a holder in due course. Sec.89 dealing with this issue states that:

“Where a promissory note, bill of exchange or cheque has been materially altered but does not appear to have been so altered, or where a cheque is presented for payment which does not at the time of presentation appear to be crossed or to have had a crossing which has been obliterated, payment thereof by a person or banker liable to pay, and paying the same according to the apparent tenor thereof at the time of payment and otherwise in due course, shall discharge such person or banker from all liability thereon; and such payment shall not be questioned by reason of the instrument having been altered, or the cheque crossed”. Thus, if a party makes payment on a bill which has been altered but not noticeably so, the party paying will be discharged by payment in due course. But the acceptor in such a case will be liable only for the original and not the altered tenor of the instrument. Thus in Scholfield V.The Earl of Londesborough [(1896) AC 514], a bill for £ 500 was presented for acceptance with a stamp of much larger amount than necessary and with spaces left on it. The acceptor wrote his acceptance and handed the bill to the drawer, who fraudulently filled in the spaces turning it into a bill for £3,500/- and negotiated it for that value to a bonafide holder. In an action against the acceptor it was held that ‘the acceptor was liable only for what he accepted to pay, namely £500. The acceptor of a bill of exchange is not under a duty to take precautions against the fraudulent alteration in the bill after acceptance’. Extinction of debt Generally speaking, in cases of material alteration, a holder loses his rights under the bills but the consideration paid by him for the bill is not extinguished. Though he cannot enforce the bill he can still sue on the consideration. But sec.87 provides that wherever an alteration is made by an indorsee, the indorser will be discharged from his liability to him even in respect of the consideration. Thus where alteration is introduced by an unauthorised person i.e., a stranger and not by the indorsee, then though the instrument is avoided, the indorsee can still sue his indorser on the consideration paid by him. v) By negotiation back: When a BOE comes back to the original acceptor in the regular course of negotiation, and he becomes the ‘holder’ of that instrument, it is known as “negotiation back’. When this happens at or after maturity, all liability on the instrument comes to an end (because of the merger of acceptor and holder into one person). Sec.90 provides that “If a bill of exchange which has been negotiated is, at or after maturity, held by the acceptor in his own right, all rights of action thereon are extinguished”. The reason for this principle can be best stated in the words of Best,CJ, in Meale V.Turton [(1827) 4 Bing l49: 130 ER 725], “There is no principle by which a man can be at the same time plaintiff and defendent”. The only essential condition for application of this section is that the acceptor must have become the holder in his own right and not in any other way.

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8. OF NOTICE, NOTING AND PROTEST SUB TOPICS 8.1 Introduction 8.2 Notice of Dishonour 8.3 Noting 8.4 Protest 8.1 INTRODUCTION As mentioned in the earlier chapters a negotiable instrument can be dishonoured by the drawee, acceptor or maker either when it is presented for acceptance or for payment. Sections 91 & 92 of the Act dealing with dishonour state as follows 91. Dishonour by non-acceptance A bill of exchange is said to be dishonoured by non-acceptance when the drawee, or one of the several drawees not being partners, makes default in acceptance upon being duly required to accept the bill, or where presentment is excused and the bill is not accepted. Where the drawee is incompetant to contract or the acceptance is qualified, the bill may be treated as dishonoured. 92. Dishonour by non-payment A promissory note, bill of exchange or cheque is said to be dishonoured by non-payment when the maker of the note, acceptor of the bill or drawee of the cheque makes default in payment upon being duly required to pay the same. When a duly accepted instrument is paid up when presented it is discharged. In the previous chapter we have seen the various modes of discharge. We would now study the procdure to be followed if a negotiable instrument is dishonoured either for acceptance or payment. 8.2 NOTICE OF DISHONOUR Once a negotiable instrument has been dishonoured whether for acceptance or payment a notice of such dishonour has to be given in accordance with the requirements of sec.93 which states that : “When a promissory note, bill of exchange or cheque is dishonoured by non-acceptance or non-payment, the holder thereof, or some party thereto who remains liable thereon, must give notice that the instrument has been so dishonoured to all other parties, whom the holder seeks to make severally liable thereon, and to some one of several parties whom he seeks to make jointly liable thereon. Nothing in this section renders it necessary to give notice to the maker of the dishonoured promissory note, or the drawee or acceptor of the dishonoured bill of exchange or cheque”. Thus, notice of dishonour must be given by the holder of the instrument or any other party who has remained liable on it to all those persons whom he seeks to charge. If such a notice is not given the parties to the instrument stand discharged.

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Reason of the rule Why the law requires prompt notice of dishonour is to enable the drawer of the bill and other indorsers to withdraw their effect from, or prevent them from reaching, the hands of the drawee or acceptor, and also to enable such persons to protect their interest by taking the necessary measures for obtaining payment from all other parties liable to them. The necessity for such notice will be apparent from the nature of the contract of the several persons who become parties to a negotiable instrument, either as drawers or indorsers. All the contracts raised upon the bill, it is seen, except those with the acceptor are contracts of suretyship, that is to say, are contracts of indemnity. Probably from this, though perhaps from other more strictly mercantile circumstances, as for the purpose of making other preparations or modifications in business, notice of dishonour is by the law merchant made a condition of the liability of the surety. The contracts of indorsement then between the immediate parties to them are conditional and are by way of indemnity. It follows from this last, that there can be no valid claim in respect of the indorsement where there is no liability in respect of it. And the two together are the reason why a failure by any indorsee to give due notice of dishonour not only disables him from recovering against the immediate indorser, but disables a prior indorser to him from recovering against his indorser or a prior indorser to him, the indorseee who has failed to give notice cannot recover, because he has not fulfilled the condition of his contract. The others cannot recover, because, as they cannot be made liable, they do not require to be indemnified. For example, the indorser to him who has failed to give due notice is not liable to him, and therefore cannot claim against his own indorser, and therefore, again, such last indorser cannot claim against his indorser, and so on. Sec.94 of the Act deals with the mode in which a notice may be given and states as follows : “Notice of dishonour may be given to a duly authorised agent of the person to whom it is required to be given, or, where he has died, to his legal representative, given, or where he has been declared an insolvent, to his assignee, may be oral or written; may, if written, be sent by post, and may be in any form; but it must inform the party to whom it is given, either in express terms or by reasonable intendment,that the instrument has been dishonoured, and in what way, and that he will be held liable thereon; and it must be given within a reasonable time after dishonour, at the place of business or (in case such party has no place of business) at the residence of the party for whom it is intended. If the notice is duly directed and sent by post and miscarries such miscarriage does not render the notice invalid. Given below are two specimen forms of notice of dishonour. “I hereby give you notice that the undermentioned bill upon which you are liable as drawer (or indorser) has been dishonoured by non-payment (or non-acceptance) and that you

will be held liable thereon. I have to request immediate payment of the amount of the said bill Rs.... together with expenses Rs..... Total Rs...... Particulars of the bill Amount Rs ..... Date ...... Tenor ....... Due ..... Drawer ............ Acceptor ........ Indorser ......... Payable at ............ Answer given ........... Date ............. or “I beg to give you notice that a bill for Rs.170-50/-0, dated 1st January 1995 drawn by S.Raju upon K. Swami payable 3 months after date and indorsed by you has this day been dishonoured by non-acceptance (or non-payment) and you will be held liable thereon. 4th April 1995

Signature of the Holder

Any person who receives a notice of dishonour should give a further notice of such dishonour within a reasonable time to parties liable prior to him if he wants them to be charged, unless such prior parties have also received a due notice by the holder as per the provisions of sec.93 [sec 95] When is a notice unnecessary ? A notice of dishonour is unnecessary in any of the circumstances mentioned under sec.98, viz : a) when it is dispensed with by the party entitled to get such a notice; or b) when the drawer countermands payment he is not entitled to receive a notice; or c) when no damage will occur to the party being charged by failure of or not giving of such notice; or d) when the holder is unable to trace the person entitled to a notice even after a diligent search or the holder is unable to give a notice for no fault of his; or e) no notice is needed to charge the drawer in cases where the drawer himself is an acceptor; or f) in cases where the promissory note is not negotiable ; and g) when the party entitled to notice, unconditionally promises to pay the amount due on the instrument after being made aware of the facts. Sec.98 being an exception to the general rule that a holder of an instrument should give a notice of its dishonour, any person who wants to rely on it will have to prove that his case fell under the exceptions specified under the section. Notice means something more than mere knowledge. [Carter v. Flower, (1847) 16 M & W. 173] Thus in Re Fenwick Stobart & Co. [(1902)1 Ch. 507], one man was secretary for two companies, one of them being the drawer and indorser, and the other the indorsee of a bill and no notice of the dishonour, it was held that the knowledge of the secretary was not to be regarded as equivalent to notice unless it was shown that it was his duty as regards the indorsee company to communicate his knowledge to the drawee company.

8.3 NOTING On a negotiable instrument being dishonoured the holder acquires an immediate right or recourse against the drawer and indorser on the instrument. To charge them with liability he has first to give a notice of dishonour to them as provided for uunder sec.93. Sec.99 provides for a convenient mode of authenticating the dishonour of the bill. This section provides as under : “When a promissory note or bill of exchange has been dishonoured by non-acceptance or non-payment, the holder may cause such dishonour, to be noted by a notary public upon the instrument, or upon a paper attached thereto, or partly upon each. Such note must be made within a reasonable time after dishonour, and must specify the date of dishonour, the reason, if any, assigned for such dishonour, or, if the instrument has not been expressly dishonoured, the reason why the holder treats it as dishonoured, and the notary’s charges “. A noting is by way of ‘minutes’ made on the bill or note or partly on such bill and partly on a separate piece of paper attached to such bill. A noting should specify the following, viz : a) the fact of the bill or note being dishonoured; b) the date of such dishonour; c) if some specific reasons have been given for dishonouring the bill, then such reasons; d) where the instrument has not been specifically dishonoured, the reasons for the holder treating the bill or note as being dishonoured; e) the notary’s charges; f) a reference to the notary’s register; and g) the notary’s initials. When the holder wants a bill to be noted, he takes it to a notary public appointed under the Notaries Act, 1952. The Notary public represents it for acceptance or payment, (as the case may be) and if the drawee or acceptor still refuses to accept or pay the bill, he notes the bill giving all the above mentioned particulars. He also attaches a slip of paper mentioning the essence or substance of the answer of the drawer or acceptor, for example, “No advice” or “no effect”. The advantage of following this course of action is that a notary being a person well versed in the transactions, is better qualified to advise the holder as to the proper course of action to be followed in presentment of the bill, and in a trial could be a reliable witness of the presentment and dishonour of the bill or note. Further in the words of Bhashyam and Adiga (p.658) “noting being so generally practised, the circumstance of its not having been done, would tend to render the other parties to the bill or note suspicions of irregularity and more reluctant to pay; it would almost certainly raise a prejudice in the minds of jury against the plaintiff, if upon a trial, the due presentment should be disputed. Moreover, by the noting, the presentment and dishonour of the bill may, with ease, at any time, be traced by reference to the register or protest-book preserved in the notary’s office, if the original should be lost.” For this reason, though 165 (Sys 4) - D:\shinu\lawschool\books\module\contract law

under the Act itself noting has been made optional, it is better for the holder to get it done for his own benefit. Under Sec.105, a notary public should do the noting within a reasonable time of dishonour, as far as possible on the day of dishonour or on the next business day, unless the delay is caused by circumstances beyond the control of the holder. Thus in Rothschild v. Currie [113 E.R. 1045], a bill drawn on an acceptor in Paris and payable there, the day on which the protest had to be made was a holiday when the public registry was closed in consequence of which owing to pressure on the office the following day, the notary was unable to effect registration till after post time that day, it was held that a notice sent the day was good because due diligence had been used. Advantages of notice a) Wherever protest is required to be made within a specified time, it is sufficient if noting is made within that time though the protest may be drawn up later [sec 104.A] b) A BOE may be accepted for honour under sec.108, after noting through protest is not made. c) A BOE may be paid for honour after noting, and the person paying need not wait for protest [sec 113] Further, noting is of the greatest advantage wher the bill is for a large amount of where legal proceedings are likely to be instituted or where there are several indorsers whose liability the holder seeks to secure. 8.4 PROTEST The noting by a notary public of a dishonoured negotiable instrument is called as ‘protest’. Sec.100 dealing with protest states as under : “When a promissory note or bill of exchange has been dishonoured by non-acceptance or non-payment, the holder may, within a reasonable time, cause such dishonour to be noted and certified by a notary public such certificate is called a protest. Protest for better security When the acceptor of a bill of exchange has become insolvent, or his credit has been publicly impeached, before the maturity of the bill, the holder may, within a reasonable time, cause a notary public to demand better security of the acceptor, and on its being refused may, within a reasonable time, cause such facts to be noted and certified as aforesaid. Such certificate is called a protest for better security. The advantages of protest are similar to those of noting, and the requiring of protest in case of foreign bills is to provide the foreign drawer or indorser with an authentic and satisfactory evidence of dishonour, because otherwise such foreign indorser or drawer would have great difficulty in making inquiries about the dishonour and would have to rely on the representations made by the holder in that regard. Procedure The procedure to be followed for protest is the same as that for noting. Chitty in his Chitty on Bills [cf Bhashyam, p.659] has given a further procedure in case of protest in the following words : 166 (Sys 4) - D:\shinu\lawschool\books\module\contract law

“The next step for the notary to take is to draw the protest which is a formal declaraton - on production of the bill itself if it can be obtained; otherwise, on a copy thereof, - that it has been presented for payment, and how that payment was refused and why, and that the holder intends to recover all damages and expenses which he or his principal or any other party to the bill may sustain on account of its non-payment. The usual practice is to enter a minute of the demand of payment, and of the dishonor of the bill, together with a copy of the same in notarial register of the notary, and afterwards to draw up the formal protest, dating it of the day when the bill was presented for payment; and the instrument so drawn up is as much an original as if it has been drawn up at the time of presentment,and is equally admissible in our Courts”. Similar procedure is to be followed in case of dishonour by non-acceptance. According to the second part of sec.100, a protest may also be made for demanding better security. This may be done when the acceptor of a BOE becomes insolvent or his credit is publicly impeached before maturity of the instrument, or the acceptor of the bill absconds before that date. The procedure to be followed by the holder is similar to that in case of noting or protest, i.e, he employs a notary public to make the demand on the acceptor and if refused, protest is made and the prior parties are given a due notice of it. Only the holder is entitled to make a protest for better security, but on the other hand the acceptor is not bound to give such security. The holder cannot as a matter of course compel the drawer or indorser to give such security, nor does he get an immediate right of recourse against them i.e. he has to wait till the date of maturity before taking action. A holder is not required under the Act to adopt this procedure, and failure on his part to do so does not in any way discharge the parties to the instrument of their liability. The basic advantage of adopting this procedure is that after protest the bill may be accepted for honour and enables the drawer and indorsers of the bill to make arrangements for the payment of the bill by other means. But a notary, before drawing up a protest for better security’ should make full and complete inquiries and satisfy himself that the acceptor has indeed become a bankrupt or an insolvent or has suspended payment within the meaning of the Act. After the bill becomes due and payment is not made on it, another protest must be made for non-payment. Though the section itself does not mention it, a protest should be made in the place where the bill is dishonoured as far as possible, except in cases where the bill is returned dishonured through post, in which case protest should be made at the place of return. This atleast is the law laid down in sec.51(6) of the English Bills of Exchange Act. Contents of protest According to sec.101 a protest should contain the following ingredients, viz: i) Instrument or transcript - A protest should contain either the actual instrument itself or a literal transcript of it, for purposes of identification and to later prevent any questions

being raised regarding the instrument being dishonoured and protested. ii) Names of parties - The names of both the person making the protest as also the person on whom the demand for acceptance or payment have to be mentioned. iii) Reason of dishonour, etc - In cases where the drawee or acceptor have given reasons for dishonouring the instrument for acceptance or payment, such reasons must also be recorded. iv) Time of demand and dishonour - It is important that the time of both demand and dishonour should be mentioned in the notarial certificate, else it would be difficult to know from the protest whether the bill was duly dishonoured or not. This is also necessary because the formal protest itself may be extended at any time after the date of noting. Similarly, place of dishonour is important in ascertaining whether there has been a dishonour in law, because if a bill was payable only at a specified place, the certificate will be defective unless it states the place of presentment and demand. v) Signature and seal - It is logical to assume that for a certificate to be valid the notary public has to affix his signature on it. Though the section itself does not lay any stress on the use of ‘notorial seal’ it is the usual practice for the notary public to affix both his seal and signature. Absence of seal may result in admission of the protest as evidence in a foreign court and so it is prudent for the holder to insist that the notarial seal should also be affixed. It would be well to mention that a form of protest should conform to the law of the country where it is being made. Thus, in an action on a bill drawn in England and accepted by a French house, it was held that it was sufficient if it was proved that such note of dishonour and protest as was required by the law of France was given, even though the parties between whom this was decided (i.e the indorsee and payee) were domiciled in England [Rouquett v. Overmann, (1875) L.R. 10 Q.B. 525] vi) Acceptance for honour - This clause is slightly redundant now after the amendments to sections 108 and 109, allowing acceptance for honour and payment for honour to be made without the notary’s intervention. vii) Demand by notary’s clerk or by post - This clause was added by Act 11 of 1885, and allows a demand to be made by the notary either through his clerk or by a registered post if the custom or usage allows such a demand or there is a specific agreement in this regard. viii)Mistakes in protest - Absence of any one of the above ingredients will render the protest invalid. But a small or trivial mistake, for example, a mistake in the Christian name of the parties, or a spelling mistake, or an incorrect date of the bill wrongly inserted, will not render the protest invalid provided such a mistake does not mislead the other party. ix) Stamp for protest - For a protest to be legally valid it must be duly stamped ie it should be on a One Rupee Stamp

Paper [Art 50 of Indian Stamp Act, 1899] or on such stamp as may be prescribed under some other relevant statute. Notice of protest According to sec.102, whenever notes and bills are required to be protested, notice of protest must be given instead of notice of dishonour, for example, in case of foreign bills all those parties whom the holder wants to charge with liability are entitled to insist on being served with a notice of protest. But the section is not clear on whether along with the notice a copy of protest should also be sent or not. The English law on this issue was however settled in Goodman v. Harvey [111 E.R. 1011] wherein it was held that in giving notice of dishonour to the drawer of a foreign bill resident abroad, it is sufficient to inform him that the bill had been protested, without actually sending him a copy of the protest. It is to be presumed that the same rule of law would apply in India also. Since the rules governing the giving of notice of protest are the same as those governing notice of dishonour, therefore a notice of protest may be waived in the same way as dishonour, either by expressly dispensing with such notice or by a subsequent promise to pay the amount of the money due under the instrument, because as Lord Ellenborough observed in Gibbon v. Coggen [170 E.R. 1124], “By the promise to pay, he admits his liability; he admits the existence of everything which is necessary to render him liable. When called upon for payment of the bill, he ought to have objected that there was no protest. Instead of that he promises to pay it. I must therefore presume that he had due notice, and that a protest was regularly drawn up by a notary”. So also any other circumstance whch would result in dispensing with the notice of dishonour would also act as a dispensing of a notice of protest. In India, unlike England, notice of protest may be given either by the holder or by the notary who makes the protest. Place of protest Sec.103 which deals with a situation where a bill has been protested for non-acceptance, states as under : “All bills of exchange drawn payable at some other place than the place mentioned as the residence of the drawee, and which are dishonoured by non-acceptance, may, without further presentment to the drawee, be protested for non-pament in the place specified for payment, unless paid before or at maturity.” Under the English law protest must be made at the place of dishonour. According to sec.103, where a bill payable at a place different from the drawee’s residence, is dishonoured by non-acceptance, there is no need for the holder to make a demand for payment. He can straightaway protest for nonpayment at the place specified for payment, unless the bill has been paid up before or at maturity. The basic difference between the English and Indian law is that in England protest has to be made at the place where the bill is made payable, whereas in India protesting at the specified place is left to the option of the holder.

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9 PRESUMPTIONS AND ESTOPPELS SUB TOPICS 9.1 Definitional aspects 9.2 Presumptions under the Act 9.3 Estoppel under the Act

Under this Act the term ‘shall presume a fact’ means court shall regard such fact as proved, unless and until it is disproved. In such cases a Court has no option but to take the fact as proved until evidence is given to disprove it, and the party interested in disproving it must produce such evidence if he can. The presumption is not conclusive but rebuttable” [Dayal, p.26].

9.1 DEFINITIONAL ASPECTS

(3) Conclusive proof

Before dealing with presumptions and estoppels under the Negotiable Instruments Act it would be better if we first try to understand the meaning and scope of these words.

One fact is said to be the conclusive proof of another, when, on the proof of the first fact the court regards the other as automatically proved and does not allow evidence to be given to rebut or contradict it. This generally applies to those cass where the court feels that it would be against governmental or societal interest to keep the dispute open for further debate or discussion on it. Thus, presumptions of ‘conclusive proof’ are those to disprove which the court does not allow any evidence. They are inferences, which law lays down in an absolutely ‘peremptory tone’ and which cannot be overruled or contradicted by any evidence howsoever strong. This is obviously the strongest of presumptions.

Presumptions A presumption is an inference of the existence of some fact, which is accepted without evidence because this fact follows logically from some other fact which has already been proved or is assumed to exist. When a fact is presumed it does not mean that it has been actually proved, it is just assumed to have been proved. It is a rule laid down for reasons of administrative convenience rather than anything else, because it saves a lot of time and energy when the judge presumes certain facts without requiring them to be proved in the regular manner i.e. by adducing evidence, examination and cross examination of witnesses etc. Sec.4 of the Indian Evidence Act, 1872 classifies presumptions under the following categories, viz :(1) Presumption of fact; (2) Presumption of law; and (3) Conclusive proof (1) Presumptions of fact (or ‘may presume’) These are inferences which may be naturally or logically drawn from the experience and observation of the course of nature, constitution of human mind, the springe of human action, the usages and habits of society and ordinary course of human affairs. They are akin to “may presume” [Syad Akbar v. St. of Karnataka, AIR 1979 SC 1848]. As the phrase “may presume” itself suggests, it is not obligatory on the part of the court to presume these facts i.e. it is left to the discretion of the court to decide whether they want particular fact to be proved in the usual course or whether they want to presume its existence. (2) Presumptions of law (or ‘shall presume’) These are artificial presumptions of inferences or propositions established by law. In case of acts which the court ‘shall presume’ no discretion has been left to the court, and it is bound to presume the existence of that fact till evidence is given by the interested party to rebut or refute or disprove it. The difference between ‘may presume’ and ‘shall presume’ can be stated in the following words: “Whenever it is provided by this Act that the court may presume a fact, it may either regard such fact as proved, unless and until it is disproved, or may call for proof of it. In such a case, the presumption is not a hard and fast presumptionm incapable of rebuttal. 168 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Estoppel Sec.115 of the Evidence Act defines estoppel as : “When one has, by his declaration, act or omission, intentionally caused or permitted another person to believe, a thing to be true and to act upon such belief, neither he nor his representative shall be allowed, in any suit or proceeding between himself and such person or his representative, to deny the truth of that thing”. Estoppel is an evidentiary rule based on the principles of justice, equity and good conscience, because it would be unjust for a person to suffer loss or damage because of some course of action which he has undertaken merely on the strength or basis of a representation made by another. In Dhipan Singh v. Jugal Kishore [AIR 1952 SC 145] the essentials of estoppel have been stated as under, viz : (1) There must be a representation of an existing fact as distinct from a mere promise defuture made by one party to the other; (2) The other party, believing it, must have been induced to act on the faith of it; and (3) He must have so acted to his detriment. Thus, not only should the person have acted on representation but he must also have suffered a loss or detriment because of the act. If he profits from the fact or gains an advantage due to the act he cannot take the defense of this rule of estoppel. 9.2 PRESUMPTIONS UNDER THE ACT Presumptions relating to negotiable instruments are dealt with under sections 118 and 119,which state as under : Sec. 118. Presumptions as to negotiate instruments - until the contrary is proved, the following presumptions shall be made:-

(a) of consideration - that every negotiable instrument was made or drawn for consideration, and that every such instrument, when it has been accepted, indorsed, negotiated or transferred, was accepted, indorsed, negotiated or transferred, for consideration; (b) as to date - that every negotiable instrument bearing a date was made or drawn on such date ; (c) as to time of acceptance - that every accepted bill of exchange was accepted within a reasonable time after its date and before its maturity ; (d) as to time of transfer - that every transfer of a negotiable instrument was made before its maturity ; (e) as to order of indorsement - that the indorsements appearing upon a negotiable instrument were made in the order in which they appear thereon; (f) as to stamp that - a lost promissory note, bill of exchange or cheque was duly stamped; (g) that holder is a holder in due course - that the holder of a negotiable instrument is a holder in due course : provided that, where the instrument has been obtained from its lawful owner, or from any person in lawful custody thereof, by means of an offence or fraud, or has been obtained from the maker or acceptor thereof by means of an offence or fraud, or for unlawful consideration, the burden of proving that the holder is a holder in due course lies upon him. Sec. 119. Presumption on proof of protest - In a suit upon an instrument which has been dishonoured, the Court shall, on proof of the protest, presume the fact of dishonour, unless and until such fact is disproved. Thus all the presumptions under the Act are of the nature of ‘shall presume’ ie the court has to accept them as proved unless they are specifically disproved. Referring to sec.118 on Official Receiver v. Abdul Shakoor [AIR 1965 SC 920] it was observed that this section is essentially a product of English law, and the special rules of evidence laid down in this section have been intended to apply only as between the parties to the instrument or those claiming under them. Before the presumptions under this section can be drawn it would first have to be proved and admitted that the negotiable instrument itself was duly drawn and executed. In Visvonata Raghunath Audi v. Mariano Colaco [AIR 1976 GDD 60] it was observed that ‘there is no presumption about execution of a negotiable instrument and in case of a denial by the opposite side the party basing its claim on such instrument must fully prove its execution’. Here, the alleged executants of a hundi had in their written statement denied their signature and thumb mark on the document. It was held that the burden of proving the signature and the thumb mark was on the plaintiff and on the facts on record the execution of the hundi was not proved. Let us now consider each of those presumptions in slightly more detail. a) As to consideration - Under the Common Law, any person who seeks to enforce a contract has to prove that he had paid some consideration. For trade purpose, this rule was relaxed in respect of negotiable instruments by the usage

and practice, and now every such instrument is presumed to be honest and supported by consideration. Even before the coming into force of this Act, this particular usage gained a statutory recognition as is evident from illustration (c) to sec 114 of the Evidence Act giving the courts a discretion to the courts to presume that consideration for a particular bill or note had been exchanged. The presumption is only relating to the fact that a consideration must have passed hands but it does not apply to the actual ‘quantum’ of consideration which has to be separately proved. In Marasamma v. Veeraju [AIR 1935 Mad 769] Varadacharass J., observed : “Any presumption as to quantum of consideration as distinguished from the mere existence of consideration, has to be drawn, not by virtue of section 118, Negotiable Instruments Act, or even under section 114, Evidence Act, but only from the recitals, it has long been established that being prima facie evidence against the parties to the instrument, they may operate to shift on to the party pleading the contrary, the burden of rebutting the inference raised by them. But the weight due to recitals may vary according to circumstances and in particular circumstances the burden of rebutting them may become very light, especially when the court is not satisfied that the transaction was honest and bona fide”. So also the presumption against consideration does not apply to a criminal cases and the prosecution has to prove that consideration was in fact paid [Sakhawat v. Emperor, 59 I.C. 198]. b) As to discharge - If the maker of a note pleads discharge, the onus to prove such discharge is on him. This onus is particularly heavy if the payee produces the note bearing no marks or signs of discharge. It must be remembered that when the entire evidence has been taken the question of presumption is not of much importance [Marasamma v. Veerarajan, AIR 1935 Mad 769]. This particular view appears to be in accured with the verb and the Sentintia legis (the letter and spirit of law). c) As to date - Though a date as such does not form an essential part of the negotiable instruments, whenever such an instrument is dated the presumption is that it has been or drawn on that date. Even where an instrument has been indorsed in the blank and the indorsee fills up the blank left with reference to the date, this presumption would still apply. In Kirmany v. Aga Ali [AIR 1928 Mad 919] it was observed that if a promissory note is proved to be genuine, and it bears the date and place of exeuction, the presumption is that it was executed at the place and on the date it shows, and the onus lies on the party pleading a different place and date to prove it. d) As to time of acceptance - In general a bill of exchange is prima facie deemed to have been accepted before its maturity or due date and within a reasonable time from its issue. There is no presumption as to the actual date of acceptance of the bill. This presumption becomes applicable when the acceptance is not dated; if the acceptance bears a date, it will prima facie be taken as 169 (Sys 4) - D:\shinu\lawschool\books\module\contract law

evidence of the date on which it was made [Glossop v. Jacob, 171 E.R. 404], but evidence can be given to show that it was accepted on a different date [Kirmani v. Aga Ali, AIR 1928 Mad 919]. e) As to time of transfer - In Lewis v. Parker [111 E.R. 999] it was observed that except where indorsement bears a date after the maturity of the bill, every indorsement is prima facie deemed to have been effected before the bill was overdue. Since there is no actual presumption regarding the exact date of negotiation, surrounding circumstances or even a very strong suspicion falling just short of direct evidence may be used to rebut the prima faice presumption in the clause. f) As to order of indorsement - In case of two or more indorsements on a negotiable instrument, each indorsement is presumed to have been made in the order in which it appears in the instrument. g) As to stamp on lost bills, etc - In case a negotiable instrument is lost or destroyed the presumption is that particular instrument had been duly stamped and cancelled. h) As to holder being a holder in due course - A holder (as defined in Sec.8) is presumed to be a holder in due course, for instance, an indorsee from the payee must be presumed until the contrary is shown to have been a holder in due course and he is unaffected by the failure of consideration as between the drawer and the payee. [Sakharam v. Gulab Chand 16 Bomb. L.R. 743] The holder in such cases has to prove that he had not only given consideration, but that when he gave it he did not have sufficient cause to believe that there was some defect in the transferor’s title. In Jones v. Gordon [37 L.T. 477] Lord Blackburn made the following observation : “I take it to be perfectly clear that when a bill of exchange is on the face of it a good bill, and there is nothing on the face of it to show the contrary, it prima facie imports value; prima facie a bill of exchange is a good bill of exchange, and it is necessary to show the contrary. But then, I think it is clear both upon the authorities, and also, as it seems to me, upon good sense, that when it is shown that a bill of exchange was a fraudulent one, or an illegal one or a stolen one, in any one of those cases it being known that the person who holds it was a party to that fraud, to that illegality, or to that theft, and therefore could not sue upon it himself, the presumption is so strong that he would part with it to somebody who could sue for him that shifts the burden. I should be unwilling to say precisely whether it shifts the onus upon him to show that he gave value bona fide so that, although he gave value he must give some affirmative evidence to show that he was doing it honestly, or that the onus of proving that he is dishonest, or that he had notice of things that were dishonest, remains on the other side, although he is bound to prove value. The language of the quotation from Baron Parke would seem to show that the onus as to both shifted; but I do not think that it has ever been decided. I have no doubt that in proving value, it may be proved that he himself 170 (Sys 4) - D:\shinu\lawschool\books\module\contract law

took the bill under such circumstances, that although he gave value, he could not sue upon it”. It is to be remembered that it is only when an offence like fraud, illegality etc. is proved in the first instance that the burden is shifted. If the allegong is merely as to absence of consideration between the original parties, there is no automatic presumption as to absence of consideration and the defendant has to prove the allegation. i) Other presumptions - Apart from specific presumptions laid down in sec.118 there are a couple of other presumptions drawn in case of negotiable instruments. For example, unless a contrary intention appears from the face of a bill, the holder may treat it as an inland bill. Similarly, when a bill leaves the hands of the party who has signed it as maker, drawer or indorser etc; the presumption is that there was a valid and unconditional delivery and this presumption is conclusive in the hands of a holder in due course. k) On proof of protest - This presumption laid down in sec.119 does not arise unless there is a proper protest according to the provisions given under sections 99,100 and 101. Thus in Veerappa Chetty v. Vellayan [10 L.W. 39] it was observed that a mere entry of ‘Noted for nonpayment’ without date of dishonour or certificate of protest is not a proper protest, and the presumption under the section does not apply. This presumption is only regarding the fact of dishonour, and does not extend as an evidence of notice or of other collateral facts such as the lack of funds of the drawer in the hands of the drawee etc. Though in general a protest operates as prima facie evidence of dishonour it is open to rebuttal by the other side. 9.3 ESTOPPEL UNDER THE ACT Sections 120, 121 and 122 deal with estoppels relating to negotiable instruments and states as under : 120 Estoppel against denying original validity of instrument No maker of a promissory note, and no drawer of a bill of exchange or cheque and no acceptor of a bill of exchange for the honour of the drawer shall, in a suit thereon by a holder in due course be permitted to deny the validity of the instrument as originally made or drawn. 121. Estoppel against denying capacity of payee to indorsee No maker of a promissory note and no acceptor of a bill of exchange [payable to order], shall, in a suit thereon by a holder in due course, be permitted to deny the payee’s capacity, at the date of the note or bill, to indorse the same. 122. Estoppel against denying signature or capacity of prior party No indorser of a negotiable instrument shall, in a suit thereon by a subsequent holder, be permitted to deny the signature or capacity to contract of any prior party to the instrument. Thus, the Act deals with the following estoppels, viz :

a)

As to original validity - An estoppel u/sec 120 becomes applicable only if the instrument is duly stamped. Speaking of estoppels in relation to negotiable instruments, Mr. Caspersz says : “The situation of parties to a commercial instrument is no doubt to be regarded as one of contract, the parties having agreed that the instrument is to be funded upon certain facts. When therefore the position of one by acting on that agreement is altered, the other ought not to be allowed to deny it”. The resemblance to estoppel by representation is however an artificial one, since there is no representation beyond what is in the contract itself”. [cf. Bhashyam p,716].

This section is wider in its scope than the provision in the Evidence Act; because estoppel under this section precludes both the drawer and the acceptor to honour from denying the validity of the instrument as originally drawn, and any circumstance which might vitiate the contract between the original parties to the bill cannot be set up by persons mentioned in the section, such as, fraud, coercion, want of consideration, etc. This section does not prevent the drawer of a BOE or the maker of a note from taking the plea in a suit by the holder in due course, that he had never drawn or made the instrument and that his name to it had been forged i.e. in short the plea of ‘non est factum’ (not my document); or the plea that the note he had executed was not for a simple unconditional loan but was based on certain conditions previously agreed upon, and that those conditions had not been fulfilled [See Bachan Singh v. Dharam Arth Bank, 1933 Lah. 456]. (i) Estoppel against acceptor for honour - An acceptor for honour of the drawer is bound by all the estoppels which bind the drawer, and so even he is estopped from denying the validity of the original bill. It is not very clear whether the acceptor for honour of the drawer can set up the plea for forgery of the name of the drawer for whose honour he accepted it ? The English authors unanimously agree that an acceptor for honour cannot set up this plea. The American authors however seen to be divided on this issue, some [Daniels in particular] claiming that an acceptor for honour cannot set up this plea, but others like Parsons etc. take a contrary view. Under sec.117 of the Indian Evidence Act, an acceptor can always show that the signature of the drawer is a forgery, i.e. there is no estoppel against the drawer in this regard and so an acceptor for honour is also not estopped from taking the plea that the drawers signature is a forgery. (ii) As to acceptors’ estoppel - An acceptance of a BOE does not amount to an admission of the drawers’ signature and an acceptor can always show even against a holder in due course that the drawer’s signature was a forgery (sec.117

of Evidence Act). This principle is directly in conflict with the English law. In addition to this estoppel an acceptor under the English law is bound by certain other estoppels as against a holder in due course : (a) the existence of a drawer and his capacity and authority to draw the bill, (b) the capacity of the drawer to indorse in the case of a bill payable to his order, and (c) the existence and capacity of the payee. Even under the Indian law an acceptor cannot deny the existence of the drawer i.e. he cannot plead that the drawer is a fictitous person, though this conclusion is more by way of being an inference. Due to sec.117 of the Evidence Act he can not also deny the authority or capacity of the drawer but this again is only an interference. b) As to capacity of payee to indorse - When a person makes a promissory note, he agrees to pay the amount to the payee named in the note, and by that act he acknowledges the payees capacity to receive the money. So in a suit by holder in due course he cannot take the plea that the payee was an infant or was insane etc., that is he cannot question the legal capacity of the payee to indorsee the note. The same rule applies to the acceptor of a BOE, who by the very act of acceptance also accepts all that is essential for the validity or existence of the bill and one such essential factor is the capacity of the payee named in the bill. In Alcock v. Alcock [133 ER 1144] it was observed that ‘the case may be different if the insolvency or the insanity happened after the making of the note or the indorsing of the bill; for in such cases, the indorsement by such a person is a mere nullity and can confer no title on the indorsee, and an acceptor is not justified in making payments to anyone whose title is affected by it’. This estoppel applies only to capacity of the payee, and the maker or acceptor cannot be held to admit the genuineness of the indorsement of the payee, for he cannot be expected to know his handwriting; nor does an acceptance admit the agency to indorse which must be proved by the holder in order to recover against the acceptor or maker [Robinson v. Garrow, 129 ER 183]. c) Estoppel relating to prior parties - Under sec.122 an indorser cannot deny either the signature or the capacity of prior parties to the instrument, because when he indorses he admits the genuineness of the prior indorsement and represents that the signature of both the drawer and acceptor are genuine. He also contracts that the original parties to the bill or note had the capacity to bind themselves, and so did the subsequent indorsers (but those prior to him) had the competance to indorse. Keeping in mind this principle the indorsee is estopped from denying their signature or capacity in any suit.

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10 OFFENCES UNDER THE ACT SUB TOPICS 10.1 Wrongful dishonour 10.2 Cheating 10.3 Forgery 10.4 Criminal prosecution under N.I. Act, 1881 10.1 WRONGFUL DISHONOUR A Cheque is said to have been dishonoured when the payee presents it for payment and the banker refuses to do so. A banker’s refusal may arise for either one of the following reasons, viz : a) The funds in the drawers account standing with him are insufficient to cover the cheque amount; or b) The presentment is wrongful, for example, when it is made prematurely or after banking hours or after the elapse of reasonable time, etc; or c) The cheque has been improperly drawn or made; or d) The banker entertains reasonable suspicion on the validity of a transaction and wants to conduct an enquiry; or e) For some other just or reasonable cause; or f) For no reasonable cause but the dishonour is due to the malice, spite or negligence etc., on the part of the banker. In situations (a) to (e) above the dishonour of a cheque by a banker is treated as a valid dishonour and the drawer of the cheque is not entitled to any compensation from the banker; i.e. the banker acquires no liability on a valid or rightful dishonour of cheques. It is situation (f) which amounts to a wrongful dishonour of a cheque that a liability attaches to the banker. Sec.31 of the Act states that “the drawee of a cheque having sufficient funds of the drawer in his hands, properly applicable to the payment of such cheques must pay the cheque when duly required to do so, and in default of such payment, must compensate the drawer for any loss or damage caused by such default”. A banker thus has a statutory obligation to honour the cheques drawn by the customers provided the other requisite conditions are fulfilled. In Kesharichand Jaisukhlal v. Shillong Banking Corp Ltd. [AIR 1965 SC 1711] it was observed that “when the banker commits mistake in the account books which produces incorrect balance of the customer’s account and consequently the cheque is dishonoured, the banker will be liable for the wrongful dishonour. When the money is deposited in the bank, the relationship that is constituted between the customer and banker is one of debtor and creditor and that the banker though entitled to use the money deposited with him without being called upon to account for such user, his only liability is to return the amount in accordance with the terms agreed upon between him and the customer.” Liability of the banker In case of wrongful dishonour of cheques the liability of bankers is two-fold (i) to compensate the drawer for the actual loss or 172 (Sys 4) - D:\shinu\lawschool\books\module\contract law

damage suffered by him and (2) to compensate him for the loss of his social status or reputation caused by the dishonour. The second clause is of more importance to traders and businessmen rather than ordinary persons. In New Central Hall v. United Commercial Bank Ltd [AIR 1959 Mad 153] it was held tat “In cases where a cheque issued by a trade customer is wrongfully dishonoured even special damages could be awarded without proof of special loss or damage. The fact that such dishonour took place due to a mistake of the bank is no excuse nor can the offer of the bank to write and apologise to the payees of such dishonoured cheques affect the liability of the bank to pay damages for their wrongful act”. The most important point to be noted in this regard is that the liability of the banker is only towards the drawer and not towards the payee. This is because as between the banker and drawer there is a contract and further the banker stands in a fiduciary relation with respect to his customer both of these giving rise to a liability in case of breach. But as between the banker and payee there is no privity of contract and in case a cheque is dishonoured a payee’s recourse is against the drawer alone. He cannot sue the banker. In case of a non-trader customer, dishonour of a cheque rarely leads to loss of status or reputation, and hence in such cases only nominal damages are awarded. Thus, in Evans v. London and Provincial Bank (1854)9 Ex. 354] a cheque was drawn by a wife on her husband’s behalf payable to the mess steward of a shop on which he was serving, and the cheque was dishonoured. It was held that ‘there was no actual damage due to such dishonour’ and so damages of only one shilling were awarded. In Jogendra Math Chakrawarthi v. New Bengal Bank Ltd. [AIR 1939 Cal. 63] it was observed “where the banker, being bound to honour his customers cheques, has failed to do so, he will be liable in damages. If special damage, naturally ensuing from the dishonour is proved, it will be properly taken into account in assessing the amount of the damages. If the customer to be a trader, the court may properly award substantial damages, in the absence of proof of special damage. In other cases, the customer will be entitled to such damages as will reasonably compensate him for the injury which, from the nature of the case, he has sustained. All loss flowing from the dishonour of a cheque may be taken into account in estimating the damages”. Quantum of damages The general rule followed by the courts in awarding damages is that damages are awarded for forseeable and actual loss suffered and the quantum of damages is usually based on the principle of ‘restitutio in intgegram’ i.e., restoring the person to the position he would have been in if he had not suffered a damage. But in case of dishonour of a tradesman’s cheque the damages awarded are inversely proportional to the amount on the cheque. Thus smaller the amount of the dishonoured cheque, greater are the damages paid. The reason behind this rule is very simple a businessman’s loss of reputaton or status or good will is once again inversely proportional to the amount

of the cheque. For example, if a well known businessman issues a check for a petty amount of say Rs.100 and the banker wrongfully dishonour the cheque. People would immediately start saying - Oh! what kind of bussinessman is he ? He does not even have Rs.100 in his account. He must be going bankrupt. That is, the damage to his goodwill or reputation may in some cases be irreparable. But, if a cheque for say Rs.5 lakhs is dishonoured, people would be more understanding Oh! it was such a big amount. May be due to some reason he lacked sufficient funds. See in this case damage to his reputation is not really substantial. Hence the rule that ‘smaller the amount greater will be the damages; greater the amount lesser will be the damages’. 10.2

CHEATING

Cheating being an offence is defined under sec.415 of the Indian Penal Code as follows : “Whenever, by deceiving any person, fraudently or dishonestly induces the person so decieved to deliver any property to any person, or to consent that any person shall retain any property, or intentionally induces the person so deceived to do or to omit to do anything which he would not do or omit if he were not so deceived, and which act or omission causes or is likely to cause damage or harm to that person in body, mind, reputation or property, is said to “cheat”. Explanation A dishonest concealment of fact is a deception within the meanng of this section. Illustrations (i) A having knowledge that there are not sufficient funds in his account, draws a cheque in favour of B. The cheque is dishonoured. A cheats. (ii) A issues cheques without having account(s) with any banker with a dishonest intention to deceive. The cheques are dishonoured. A cheats. In Ram Das v. ST. of UP [AIR 1974 SC 1811] the Supreme Court enumerated the essential ingredients of the offence of cheating as follows : (i) There should be a fraudulent or dishonest inducement of a person by deceiving him. (ii) (a) The person so deceived should be induced to delive any property to any person, or to consent that any person shall retain any property; or (b) the person so deceived should be intentionally induced to do or omit to do anything which he would not do or omit if he were not so deceived. (ii) In cases covered by item (ii) (b), the act or omission should be one which causes or is likely to cause damage or harm to the person induced in body, mind, reputation or property. Whenever a cheque issued with dishonest intentions is dishonoured, the drawer of the cheque can be proceeded against under sections 417 & 420 of IPC by the payee or holder in due course of the cheque. In Keshavji Madhavji v. Emperor [AIR

1930 Bom 179] it was observed that ‘it was for the prosecution to establish facts which point prima facie to the conclusion that the failure to meet the cheque was not accidental but a consequence expected and therefore, intended by the accused. It will then be for the accused to establish any facts that may be in his favour which are specially within his knowledge and as to which the prosecution could not be expected to have any information’. A mere allegation that a cheque issued by the accused to the complainant had been dishonoured is not sufficient to establish the offence of cheating u/sec.415 IPC [Raman Behan Roy v. Emperor, AIR 1924 Cal 215]. In Baijnath Sahay v. Emperor [AIR 1933 Pat 183] it was observed that the act of drawing a cheque implied at least three elements : (a) that the drawer has an account with the bank in question ; (b) that he has authority to draw on it for the amount shown on the cheque ; (c) that the cheque as drawn, is valid order for the payment of the amount, or that the present state of affairs is such that in the ordinary course of events, the cheque will on future presentment be honoured. Drawing of a cheque does not imply a representation that the drawer already had the money in the bank to the amount shown on the cheque, for he may either have authority to overdraw, or have an honest intention of paying in the necessary money before the cheque can be presented [Kumar Sain v. Emperor, AIR 1939 Lah 95] Thus mere dishonour for lack of funds does not amount to cheating; for cheating to be established a mental element to deceive is necessary. In State of Kerala v. A. Pareed Pillai [AIR 1973 SC 326] it was observed : “To hold a person guilty of the offence of cheating it has to be shown that his intention was dishonest at the time of making the promise. Such a dishonest intention cannot be inferred from the mere fact that he could not subsequently fulfil the promise”. In Raghunathan v. Balasubramanyam [1967 Ker LT 232], the defendant gave a post dated cheque as payment against goods supplied by the plaintiff. The cheque was dishonoured on maturity and the plaintiff filed a case u/sec.415 IPC. It was held that: “A post-dated cheque in payment of goods already received is mere promise to pay on a future date and a broken promise to pay on a future date and a broken promise is not a criminal offence, though it may amount in certain business relations to discreditable behaviour. It is well settled that a mere breach of contract cannot give rise to a criminal prosecution. The distinction between a case of mere breach of contract and one of cheating, therefore, depends upon the intention of he accused at the time of the alleged inducement. In the instant case, there was no misrepresentation and there was no consequent parting with the goods believing such misrepresentation. The dishonest intention which is the gravement of the offence of cheating is absent. In the circumstances, the order of acquittal is proper. In K.P. Shadil v. Kandoth [1988 3 Crimes 600 (Ker)] it was ovserved that ‘where a person issues a cheque to another and it is dishonoured, and it appears that the failure to meet payment is not accidental, the presumption is that the drawer knew that the cheque would be dishonoured and he is guilty of cheating under section 420 of IPC.’ Thus, what is important to establish this offence is the mental element of deceit or mens rea. 173 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Cheating by personation Sec.416 of IPC defines cheating by personation as follows : A person is said to cheat by personation if he cheats by pretending to be some other person, or by knowingly substituting one person for another, or representing that he or any other person is a person other than he or such other person really is. Explanation The offence is committed whether the individual personated is a real or imaginary person. Illustraion a) A cheats by pretending to be a certain rich banker of the same name. A cheats by personation. b) A cheats by pretending to be B, a person who is already dead. A cheats by personation. The personation referred to in this section may be either by words or by conduct. The section does not intend to punish all cases of personation, but only those cases where the personation has been used for the purpose of cheating somebody. This offence u/sec.416 IPC owes its gravity to te fact that it affects not only the person deceived but also the person personated. Offence of cheating by personation is punishable under sec.419 IPC whereas general cheating is punishable under sctions 417 and 420. Explaining the distinction between these two sections it was observed in re Anilesh Chandra [AIR 1951 Assam 122] ‘where in pursuance of the deception, no property passes, the offence is one of the cheating punishable under Section 417 IPC, but where in pursuance of the deception, property is delivered, the offence is punishable under section 420’. 10.3

FORGERY UNDER THE ACT

Sec.470 of IPC states that ‘ a false document made wholly or in part by forgery is designated “a forged document”. Sec.471 further observes that the use as genuine of a forged document has to be with an intent dishonest or fraudulent. A mere erroneous belief and persistence in a wrong or perverse opinion cannot be said to be offence tainted with a dishonest or fraudulent intent [M.Vaghul, (MD), Bank of India Bombay v. State of Maharashtra, (1988)1 Bank CLR 224 (Bom)]. Sec 463 IPC defines forgery as : “Whoever makes any false document or part of a document with intent to cause damage or injury, to the public or to any person, or to support any claim or title, or to cause any person to part with property, or to enter into any express or implied contract, or with intent to commit fraud or that fraud may be committed, commits forgery”. Sec. 464. Making a false document A person is said to make, a false document Firstly - Who dishonestly or fruadulently makes, signs, seals or executes a document or part of a document, or makes any mark denoting the execution of a document, with the intention of causing it to be believed that such document or part of the document was made, signed, sealed or executed by or by the 174 (Sys 4) - D:\shinu\lawschool\books\module\contract law

authority of a person by whom or by whose authority he knows it was not made, signed, sealed or executed, or at a time at which he knows that it was not made, signed, sealed or executed; or Secondly - Who, without lawful authority, dishonestly or fraudently, by cancellation or otherwise, alters a document in any material part thereof, after it has been made or executed either by himself or by any other person, whether such person be living or dead at the time of such alteration; or Thirdly - Who dishonestly or fraudulently causes any person to sign, seal, execute or alter a document, knowing that such person by reason of unsoundness of mind or intoxication cannot, or that by reason of deception practised upon him, he does not know the contents of the document or the nature of the alteration. Explanation 1 - A man’s signature of his own name may amount to forgery. Explanation 2 - The making of a false document in the name of a fictitous person, intending it to be believed that the document was made by a real person, or in the name of a deceased person, intending it to be believed that the document was made by the person in his lifetime, may amount to forgery. Illustrations (1) A picks up a cheque on a banker signed by B, payable to bearer, but without any sum having been inserted in the cheque. A fraudulently fills up the cheque by inserting the sum of Rs.10,000/-. A commits forgery. (2) A draws a BOE on himself in the name of B without B’s authority, intending to discount it as a genuine bill with a banker and intending to take up the bill on its maturity. Here, as A draws the bill with intent to deceive the banker by leading him to suppose that he had the authority of B, and thereby to discount the bill. A is guilty of forgery. (3) A endorses a government promissory note and makes it payable to Z or his order and signing the endorsement. B dishonestly erases the words “ Pay to Z or his order” thereby converting the special endorsement into a blank endorsement B” commits forgery. (4) A signs his own name to a bill of exchange, intending that it may be believed that the bill was drawn by another person of the same name. A has committed forgery. (5) A draws a bill of exchange upon a fictitous person, and fraudulently accepts the bill in the name of such fictitous person with an intent to negotiate it. A commits forgery. Bankers liability for payment made on forged cheques (1) Banker Customer Relationship - As observed earlier the relationship between a banker and his customer is that of a debtor and creditor. When a cheque with a forged signature is presented, the banker has no authority to make payments on it, and if he does make such payment he would be acting contrary to the law and would be liable to the customer for the said amount. A bank in such cases can escape liability only if it can show that the customer is not entitled to make a claim on account

of adoption, estoppel or ratification. The rule of law in this regard can be stated as follows : “When a cheque duly signed by a customer is presented before a bank with whom he has an account there is a mandate on the bank to pay the amount covered by the cheque. However, if the signature on the cheque is not genuine, there is no mandate on the bank to pay. The bank when it makes payment on such a cheque, cannot resist the claims of the customer with the defence of negligence on his pat such as leaving the cheque book carelessly so that third parties could easily get hold of it. This is becase a document in cheque form, on which the customers name as drawer is forged, is a mere nullity. The bank can succeed only when it establishes adoption or estoppel” [Awasthi, p.279] (2) Whether a customer is estopped from disputing the debits shown in the pass book, where the pass book is returned without any comment and whether such a conduct would constitute a “stated and settled account”? - Before answering this question it is necessary to examine two other related querries, namely - does a customer owe a duty to the bank to inform it about the correctness or otherwise of the entries made in the pass book within a reasonable time; and whether a failure to so inform the bank would constitute negligence on his part to the extent of disentitling him from recovering the amount paid by the bank on the forged check ? There is a duty of some kind imposed on the customer to inform the bank within a reasonable time about any irregularities or mis-statements in the pass book entries. But merely because he fails to do so, negligence cannot be automatically attributed to him, nor can it be presumed that there was a breach of duty by the customer to the bank. Because the duty imposed on the customer in this regard is neither a statutory duty nor one inferred from usage or trade practice, but is more in the nature of being a rule of administrative convenience. A customer should not by his conduct facilitate payment of money on forged cheques. In the absence of corroborating circumstances, a mere negligence on the customer’s part will not disentitle him from suing the bank for the amount. The bank cannot furter take the defuse of `acquuiescence’ on the part of the customer, because to sustain such a plea it is essential to prove that the customer against whom the plea is raised, had remained silent about the matter even after becoming aware of the true facts. Thus, in Tali Hing Cotton Mill Ltd v. Liu Chong Bank Ltd [(1985)2 All ER 947] The Court rejected the plea of implied terms, indirect constructive notice, and estoppel by negligence, and held that “the company was not under any breach of duty owned by it to the bank and as such mere silence, omission or failure to act is not a sufficient ground to establish a case in favour of the bank to non-suit its customer. Unless the bank is able to satisfy the Court of either an express condition in the contract with its customer or an unequivocal ratification it will not be possible to save the bank from its liability. The banks do business for their benefit. Customers also get some benefit. If banks are to insist upon extreme care by the customers in minutely looking into the pass book and

statements sent by them, no bank perhaps can do profitable business... There is always an element of trust between the bank and its cutomer. The bank’s business depends upon this trust. Whenever a cheque purporting to be by a customer is presented before a bank it carries a mandate to the bank to pay. If a cheque is forged there is no such mandate. The bank can escape liability only if it can establish knowledge to the customer of the forgery in the cheques. Inaction for continuously long period cannot by itself afford a satisfactory ground for the bank to escape liability .... “ In the New Marine Coal Co. (Bengal) Pvt. Ltd. v. Union of India, suit was for recovery of certain amount representing the price of coal supplied to the respondent. Inter alia the respondent pleaded in defence of the suit that the respondent had issued and sent bills to cover the amount and the intimation cards in accordance with the usual practice in the ordinary course of dealings. The respondents it was alleged paid the amount by cheque to a person authorised by the appellant and no presentation of proper receipts. It was, pleaded that the appellant’s claim having been satisfied, he had no cause of action. It was established in the course of the trial that the appellant had not in fact authorised any person to issue the receipts but a certain person not connected with the appellant firm without the consent or knowledge of the appellant got hold of the intimation cards and bills addressed to the appellant, forged the documents and fraudulently received the cheque from the respondent and appropriated the amount for himself. We may usefully read the following passage relating to negligence in the context of a plea based on estoppel. “Apart from this aspect of the matter there is another serious objection which has been taken by Mr. Setalvad against the view which prevailed with Mukharji, J. He argues that when a plea of estoppel on the ground of negligence is raised, negligence to which reference is made in support of such a plea is not the negligence as is understood in popular language or in common sense; it has a technical denotation. In support of a plea of estoppel on the ground of negligence, it must be shown that the party against whom the plea is raised owed a duty to the party who raises the plea. Just as estoppel can be pleaded on the ground of misrepresentation or act or omission, so can estoppel be pleaded on the ground of negligence, but before such a plea can succeed, negligence must be established in this technical sense. As Halsbury has observed : Before anyone can be estopped by a representation inferred from negligent conduct, there must be a duty to use due care towards the party misled, or towards the general public of which he is one. There is another requirement which has to be proved before a plea of estoppel on the ground of negligence can be upheld and that requirement is that “the negligence on which it is based should not be indirectly or remotely connected with the misleading effect assigned to it, but must be the proximate or real cause of that result. Negligence, according to Halsbury, which can sustain plea of estoppel must be in the transaction itself and it should be so connected with the result to which it led that it is impossible to treat the two separately. This aspect of the matter has not been duly examined by Mukharji, J when he made his finding against the appellant” [Awasthi, pp. 286-287]. 175 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Plea of contributory negligence Sec.131 of the Act does not clothe the collecting banker with absolute immunity and unless he can show that his case falls within the ambit of that section, he faces liability under common law for ‘conversion’, in case the person from whom he takes the cheque has no title or has a defective title. The onus of showing that he had taken reasonable and due care lies on the banker. This duty to take care is one imposed by the statute on the banker for the benefit of the true owner, and it is the price which the banker has to pay for the protection accorded to him under the statute. He cannot escape his liability by saying that even if he had taken reasonable care in all probability he could not have discovered the defect, because any person who has not taken such care is outside the purview of this section. 10.4 CRIMINAL PROSECUTION UNDER N.I. ACT, 1881 Chapter XVII containing sections 138-142 was incorporated in the Negotiable Instruments Act, by the Banking, Public Financial Institutions and Negotiable Instruments Laws (Amendment) Act, 1988. These sections deal with prosecution for dishonour of cheques. Sec.138 of the Act states as follows: “Where any cheque drawn by a person on an account maintained by him with a banker for payment of any amount of money to another person from out of that account for the discharge, in whole or in part, of any debt or other liability, is returned by the bank unpaid, either because of the amount of money standing to the credit of that account is insufficient to honour the cheque or that it exceeds the amount arranged to be paid from that account by an agreement made with the bank, such person shall be deemed to have committed an offence and shall, without prejudice to any other provision of this Act, be punished with imprisonment for a term which may extend to one year, or with fine which may extend to twice the amount of cheque or with both : Provided that nothing contained in this section shall apply unless (a) the cheque has been presented to the bank within a period of six months from the date on which it is drawn or within the period of its validity, whichever is earlier ; (b) the payee or holder in due course of the cheque, as the case may be, makes a demand for the payment of the said amount of money by giving a notice, in writing, to the drawer of the cheque, within fifteen days of the receipt of the information by him from the bank regarding the return of the cheque as unpaid; and (c) the drawer of such cheque fails to make the payment of the said amount of money to the payee, or as the case may be,

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to the holder in due course of the cheque within fifteen days of the receipt of the said notice. Explanation For the purposes of this section, “debt or other liability” means a legally enforceable debt or other liability. Section 140. Defence which may not be allowed in any prosecution under section 138: It shall not be a defence in a prosecution for an offence Section 138 that the drawer had no reason to believe when he issued the cheque that the cheque may be dishonoured on presentment for reasons stated in that Section. Limitation for prosecution Before starting the proceedings against the drawer under sec.138 of the Act, the following conditions have to be fulfilled: a) a notice of dishonour to be given to the drawer by the payee within 15 days of receipt of communication form the bank regarding dishonour of the cheque ; b) the drawer does not make the payment on that cheque within 15 days of receipt of notice; c) the payee or holder in due course shall file a complaint within 30 days from the date of failure of the drawer to make the payment on the dishonoured cheque. In Richard Samson Sherrat v. Sudhir Kumar Sanghi [1992(2)APLJ 27], the A.P. High Court held that “when the statute has not laid down any limitation on the number of times that a cheque may be presented within the period of six months or any shorter period under clause (a) of proviso to section 138, it will not be desirable to read into the said clause any such restriction as to the number of times a cheque may be presented. It is common knowledge that in commercial practice, a cheque may be presented any number of times within the period of its validity”. Suppose the payee presents the cheque a second time and it is again dishonoured, the question that arises is, does the second dishonour give rise to a second cause of action ? Answering this question in Kumaresan v. Ameerappa [AIR 1992 Ker 23] the Kerala High Court observed : “from the scheme of the provisions in Chapter XVII of the Act two factors loom large; first is that more than one cause of action on the same cheque is not contemplated or envisaged. Second is, institution of prosecution cannot be made after one month of the cause of action. If more than one cause of action on the same cheque can be created, its consequence would be that the same drawer of the cheque can be prosecuted and even convicted again and again on the strength of the same cheque. Legislature cannot be imputed with the intention to subject a drawer of a cheque to repeated prosecution and convictions on the strength of the same cheque”.

11 FOREIGN INSTRUMENTS SUB TOPICS 11.l. Introduction 11.2. Definitions 11.3. Formal Validity 11.4. Stamp duty 11.5. Presumption 11.6. UN convention on International Bill of Exchange & Promissory note 11.1

INTRODUCTION

International negotiable instruments dominate in the international trade activities. With the rapid growth of trade accross the countries, the business community designed intercountry instruments, made in one country but payable in another country. This type of inter-country instruments have been in practice in the trade & commerce for a long time. As such definite rules started developing in the inter-country commercial practice, generally known as principles in the conflict of laws or private international law. As for example, it has been one of the common principle that “liability of each contracting parties is governed by the law of the place where each separate contract is made”. There is no right of the contracting parties to select their own law. This principle is known as locus regit actum. With growing importance to such instruments multipartite international agreement has been entered into on December 9, 1988. This agreement is known as the United Nations Convention on International Bills of Exchange and International Promissory Notes. The convention commonly known as UNCITRAL convention contains 90 Articles in IX chapters. National law of each country relating to inter-country negotiable instruments, is now falling in line with this convention. 11.2

DEFINITIONS

1. Foreign instrument: According to sec. 12 of the Negotiable Instrument Act, an instrument not inland instrument is a foreign instrument. An instrument is called an inland instrument if it is (i) drawn (in case of a bill) or made (in case of a promissory note) in India and (ii) payable in or drawn upon any person resident in India. As such a bill is a foreign bill if it is (i) drawn in India and payable in India or (ii) drawn in India and drawn on a person who is resident in India. A foreign note is one if it is (i) made in India and payable in India. 2. International bill of exchange: According to Article 2(1) of the Convention, an International bill is one which specifies atleast two of the following places and indicates that any two so specified are situated in different states: (a) the place where the bill is drawn; (b) the place indicated next to the signature of the drawer; (c) the place indicated next to the name of the drawer; (d) the place indicated next to the name of the payee;

(e)

the place of payment.

Provided that either the place where the bill is drawn or the place of payment is specified on the bill and that such place is situated in a contracting state. There is some difference between India law on the issue and the above definition. A foreign bill according to Indian law is one which is drawn in Indian and payable in India or drawn in India on a resident in India. There is no consideration for place indicated next to the signature or drawee or the payee. India, therefore, has a rigid definition. 3) International Promissory Note: Art 2(2) of the convention, defines a pronote which specifies at least two of the following places and indicates that any two so specified are situated in dfferent states: (a) the place where the note is made; (b) the place indicated next to the signature of the maker; (c) the place indicated next to the name of the payee; (d) the place of payment; provided that the place of payment is specified on the note and that such place is situated in a contracting state. It may be noted in this connection that in the event of an incorrect or false statement in the bill or the note in respect of places referred, neither will the instrument be invalid nor the application of the convention be affected. Chapter II containing 2 Articles of the UNCITRAL Convention provides some other definitions which are almost similar to the definitions given in the NI Act, some of the terms defined are (a) drawer (Art 5(d); payee (Art 5(e); holder (Art 5(f) and Art 15). There is no definition of ‘guarantor’ in the NI Act. But the term is defined in the Contract Act. According to Art 5 (10) a gurantor is a person who undertakes an obligation under Art 46. According to Art 46, a guarantor for a party or for the drawee may be a gurantor for the whole or part of the claim on the instrument. It must be in writing either on the instrument itself or on a slip affixed thereto. The instrument must unequivocally mention that the amount is guaranteed. Words like ‘prior endorsement guaranteed’ will not be sufficient. It has to be effected by the signature of the party guarantor on the instrument, specifying the person for whom he stands guarantor. 11.3 FORMAL VALIDITY According to sec.134 of the NI Act, in the absence of a contract to the contrary, the liability of the drawer or maker is regulated in all essential matters by the law of the place where he made the instrument, and the respective liabilities of the acceptor and indorser by the law of the place where the instrument is made payable. As for example, A drew a bill of exchange in Malaysia where the rate of interest is25 percent. B accepted the instrument in Singapore where the rate of interest is 6 percent. The bill is endorsed in India and dishonoured. An action on the bill is brought against B in India. He is liable to pay interest at 6%. But if A is charged as the drawer, he would be liable to pay 177 (Sys 4) - D:\shinu\lawschool\books\module\contract law

interest of 25%. According to sec.72 of the Bill of Exchange Act, 1882 of England, the formal validity of a bill drawn in one country and accepted, negotiated or payable in another, shall be determined by the law of the place of issue, and that the formal validity of each supervening control shall be determined by the law of the place where such contract is made. That is, accepted is to be regulated by the law of the country wherein it is acceptance and similarly negotiability is determined according to the law of the land where it is negotiated. Indian law isbased upon the subjective theory of Diecy giving full liability to the contracting parties to be regulated by the law of the land they agree to abide by. That is why the section starts with the clause ‘in the absence of a contract to the contrary’. The choice of law by the parties is conclusive. One issue in this case is not clear. If the parties, i.e., the drawer and the drawee of a bill opt for a third country for the choice of the law, shall it be a valid stipulation ? As for example, can an Indian and a Malayasian on a bill, stipulate that they would be governed by the German law ? In Vita Food Products Inc. v. Units Shipping Co.Ltd., [(1939) AC 277] Lord Wright observed that the expressed intention of the parties as to the law to be followed is final and conclusive unless ‘the intention expressed is bonafide legal and there is no reason for avoiding the choice on the ground of public policy’. In the absence of any clear law as explained in a precedent in India, it is quite probable that even in India the situation is not different. That is, on the ground of ‘public policy’ parties may be compelled to submit to the law of the country in which the bill is issued instead of following the law of any other country. No one be allowed to voluntarily opt out of the national ambit of a legal system without any reason. The contradiction in the policy is attempted to be solved in the Cheshire’s objective theory in which he suggests that the choice of the parties is limited to the law with which the contract has the most real connection. Where the intetion of the parties are clear in the contract this principle is not applicable. Where the intention is not clear as to the ‘proper law’ to be followed this principle was followed in number of cases like Bonythan v.Commonwealth of Australia [(1951) AC 219] and in James Miller & Partners Ltd., v. Whitworth Streets Estates (Manchester)Ltd., [(l972)AC 583]. Difficulties arise where parties do not stipulate the law to which they are subjected to. In such a case, the Court has to find out ‘proper law’ to be followed. The common practice is to presume that proper law is the law of the country where the contract is made (principle of situs) and the rule is most common where the contract is to be performed wholly in the country and is performed wholly in the country where it is made. But where the performance is to be in a different state, the ‘proper law’ of contract may be presumed to be the law of the country where the performance is to take place. The principle of private International law, lex loci contractus corresponds with the above principle of law (principle of situs). In view of the clear prescription in sec. l34 Indian courts are not bound by principles in the private international law. But Indian law is not exhaustive. As such, 178 (Sys 4) - D:\shinu\lawschool\books\module\contract law

where Indian law is not clear, courts have to refer to the basic principles of the private international law to decide the ‘proper law’. One example may be made to clear the issue. What shall be law for determining capacity to contract? There are two general principles followed in private international law, lex domicili; the law of the domicile or lex contractus, law of the land where the contract is made. The Law Commission of India (11th Report, para 28) proposed a simple rule, viz., “ in the absence of any contract to the contrary, the capacity of the parties to an instrument shall be determined by the law of the country where the contract constituted by the negotiable instrument was made. This implies that the parties are not prevented from having their choice in the matter of law which would govern the contract. In a negotiable instrument several contracts make the transaction. As for example, one is contract of debt; contract of payment by the instrument; contract of negotiation and endorsement and contract of paying the instrument. Dicey advocated for applying one system of law to the form of each contract including the capacity determination. But the proposal of the Law Commission runs contrary to the above accepted principle and argument. It is based on the status of a party in the legal set up of a country and as such can not be allowed to be altered at the option of the parties. This opinion is based on lex loci contractus. The formal validity of an instrument is determined by lex loci contractus elebration is ( or the lex loci actus) i.e., the law of the place where the contract is made. Indian law follows the same principle. If a contract is made through correspondence, the place where the bill is accepted is the place where it is made. For this purpose, the place where the letter of acceptance is posted is the place of entering into the contract. According to sec.135 where a promissory note, bill of exchange or cheque is made payable in a different place from that in which it is made or indorsed, the law of the place where it is made payable determines what constitutes dishonour and what notice of dishonour is sufficient. As for esample, a bill of exchange drawn and indorsed in India, but accepted payable in France, is dishonoured. The indorsee causes it to be protested for such dishonour, and gives notice thereof in accordance with the law of France though not in accordance with the rules herein contained in respect of bills which are not foreign. The notice is sufficient. This provision is an application of the maxim of international law, locus regit actum. That is, the obligation in a bill or a pro-note is to be measured by the law of the place where the instrument is payable. The duties of the holder is determined by the law of the place of performance. In Sukhall v.Eastern Bank (46 Cal 584) the Calcutta High Court held that the date of performance and the days of grace are to be determined by the law of the place of performance. Though the section does not stipulate anything about the ‘demand for payment’, the demand for payment is to be made according to the place of performance because the demand only initiates the actual payment.

A negotiable instrument contains a series of contracts. Invalidity of one does not invalidate the other. According to sec.136, if a negotiable instrument is made (for pro-note), drawan (in case of a bill), accepted (in case of a bill) or indorsed (both for a note and a bill) outside India, but in accordance with the law in India, the circumstance that any agreement evidenced by such instrument is invalid according to the country wherein it was entered into, does not invalidate any subsequent acceptance or indorsement made thereon in India. 11.4

STAMP DUTY

Law relating to stamp is not same in all countries. There are countries where ‘adequate stamp’ is a condition for valid exercise of a contract by a negotiable instrument. An instrument not carrying stamp or carrying inadequate stamp is a void agreement in these countries. In other countries ‘stamp’ is a procedural requirement i.e., if adequate stamp is not fixed the instrument is inadmissible in evidence though the instrument is valid in law in so far as the contract is concerned. In England the position has been altered by the Bills of Exchange Act. Earlier, a foreign bill was considered valid and actionable only if the law of the country of its origin would make such a bill inadequately stamped or unstamped, valid though not admissible in evidence. But if in the place of origin the bill would be void on account of the law of stamp in that country, it would be inactionable in England as well. In number of Indian cases this rule was applied because Indian law is not clear on the issue. As for example, in Venkatrami Reddy v.Sri Maharaja Seetharama (53 Mad 964; AIR 1930 Mad 1004) it was held that the foreign bill which was valid in the State of Hyderabad inspite of in adequate stamp though inadmissible in evidence, could be sued upon in British India. In Dhandiram v.Sadasiv (42 Bom 522) the Court held that if the law of the foreign country provides that by reason of the stamp the agreement in the instrument itself would be void, the plaintiff could not succeed in a court in India since the instrument would be void. In England the present position is that where a bill of exchange is issued out of the United Kingdom, it is not invalid by reason only that it is not stamped in accordance with the law of the place of issue. Though Indian law is not clear, but the general principle laid down in Stamp Act is that want of stamp makes any document inadmissible but not void. As such, it is likely that Indian Courts will conclude in the same way as the Courts in England do in case of inadequate stamp on a negotiable instrument. At present British law does not invalidte the instrument even though in the place of origin it is invalid (sec. 72 of the Bill of Exchange Act). 11.5

line with the Indian law. Foreign law may be proved in any of the following ways : a) By reference to text of foreign statutes printed and published under the authority of the Government of that country; b) By reference to standard texts of learned writers ; c) By oral testimony of an expert; and d) By reference to the judgement or opinion of the foreign court.

PRESUMPTION AS TO FOREIGN LAW

According to sec. 137 of the NI Act, it is presumed in India that law of any foreign country on negotiable instruments is same as that in India unless and until the contrary is proved. Courts in India do not take judicial notice of foreign law. Any person relying on any foreign law is required to prove it by evidence. In the absence of such a proof, foreign law is deemed to be in

11.6 UN CONVENTION ON THE NEGOTIABLE INSTRUMENTS It has been earlier mentioned that United Nation legislated a Convention on International Bills of Exchange and International Promissory Notes in order to uniformalise the law and practices on these instruments. It is to be pointed out that divergence of state practices on these instruments put several constraints on the business communities everywhere. It is in the fitness of things that this Uniform Code is attempted as the guiding principle for all member states to legislate their municipal law to be in line with the Convention in order to uniformalise the commercial practice on these instruments throughout the globe. The Convention was adopted on December 9, 1988. The last Chapter of the Convention (Chapter IX, Art 85 to 90) deals with general clauses like who is to be the depository of the convention; when it is open for signature ; when it is open for ratification and accession (Art 86); When the Convention comes into force (Art 89) etc. Art.1 of the Convention contains “International Bill of Exchange (UNCITRAL) Convention” and “International Promissory Note (UNCITRAL) Convention”. Chapter I (Art 1 to 3) relates to sphere of application and form of the instrument. Art 2 & 3 deals with form of Bill of Exchange and Promissory Note. Chapter II (Art 4-12) deals with interpretation and formal requirements. Of these one may take notice of Art 12 dealing with requirements for completing an incomplete instrument. Art 5 deals with definitions of `bill’; `note’; `instrument’; `drawee’; `payee’; `holder’; “protected holder” etc. Art 8 deals with discrepancy in the sum mentioned in words and figures. Art 9 defines an instrument payable on demand. Chapter III (Art 13 to 26) deals with transfer of the instruments by indorsement and/or delivery. Endorsement is to be in writing either in blank or specially made (Art 14); unconditional (Art 18); endorsement of a part of the sum being ineffective (Art 19); order of the endorsement ((Art 20) and words contained in endorsement defined (Art 21). Art 15 & 16 define a holder and state his rights. Endorsement by delegated authority is specified in Art 26 whereas forged endorsement and legal consequences are stipulated in Art 25. Chapter IV deals with rights and liabilities of various parties in Art 27 to Art 48. These parties include holder and protected holder (Art 27 to 32); drawer (Art 38); maker (Art 39); drawer and acceptor (Art 4048). Chapter V deals with presentment, dishonour by nonacceptance and non-payment and recourse in Art 49-71. Chapter 179 (Sys 4) - D:\shinu\lawschool\books\module\contract law

VI deals with discharge in Art 72 to 80. Chapter VII stipulates the limitation period to bring action as 4 years in Art 84. Some of the important provisions in the Convention are as follows : Art 7 The sum payable by an instrument is deemed to be a definite sum although the instrument states that it is to be paid : a) with interest; b) by instalments at successive dates; c) by instalments at successive dates with a stipulation in the instrument that upon default in payment of any instalment the unpaid balance becomes due; d) according to a rate of exchange indicated in the instrument or to be determined as directed by the instrument; or e) in a currency other than the currency in which the sum is expressed in the instrument. Art 9 1. An instrument is deemed to be payable on demand : a) if it states that it is payable at sight or on demand or on presentment or if it contains words of similar import; or b) if no time of payment is expressed. 2. An instrument payable at a definite time which is accepted or endorsed or guaranteed after maturity is an instrument payable on demand as regards the acceptor, the endorser or the guarantor. 3. An instrument is deemed to be payable at a definite time if it states that it is payable : (a) on a stated date or at a fixed period after a stated date or at a fixed period after the date of the instrument; (b) at a fixed period after sight; (c) by instalments at successive dates; or (d) by instalments at successive dates with the stipulation in the instrument that upon default in payment of any instalment the unpaid balance becomes due. 4. The time of payment of an instrument payable at a fixed period after date is determined by reference to the date of the instrument. 5. The time of payment of a bill payable at fixed period after sight is determined by the date of acceptance or, if the bill is dishonoured by non-acceptance, by the date of protest or, if protest is dispensed with, by the date of dishonour. 6. The time of payment of an instrument payable on demand is the date on which the instrument is presented for payment. 7. The time of payment of a note payable at a fixed period after sight is determined by the date of the visa signed by the maker on the note, if his visa is refused, by the date of presentment. 8. If an instrument is drawn, or made, payable one or more months after a stated date or after the date of the instrument 180 (Sys 4) - D:\shinu\lawschool\books\module\contract law

or after sight, the instrument is payable on the corresponding date of the month when payment must be made. If there is no corresponding date, the instrument is payable on the last day of that month. Art 12 1. An incomplete instrument which satisfies the requirements set out in paragraph 1 of article 1 and bears the signature of the drawe or the acceptance of the drawee, or which satisfies the requirements set out in paragraph 2 of article 1 and paragraph 2(d) of article 3, but which lacks other elements pertaining to one or more of the requirements set out in articles 2 and 3, may be completed, and the instrument so completed is effective as a bill or a note. 2. If such an instrument is completed without authority or otherwise than in accordance with the authority given : a) a party who signed the instrument before the completion may invoke such lack of authority as a defence against a holder who had knowledge of such lack of authority when he became a holder; b) a party who signed the instrument after the completion is liable according to the terms of the instrument so completed. Art 13 An instrument is transferred : a) by endorsement and delivery of the instrument by the endorser to the endorsee: or b) by mere delivery of the instrument if the last endorsement is in blank. Art 14 1. An endorsement must be written on the instrument or on a slip affixed thereto “allonge”. It must be signed. 2. An endorsement may be : a) in blank, that is, by a signature alone or by a signature accompanied by a statement to the effect that the instrument is payable to a person in possession of it ; b) special, that is, by a signature accompanied by an indicatin of the person to whom the instrument is payable. 3. A signature alone, other than that of the drawee, is an endorsement only if placed on the back of the instrument. Art 15 1. A person is a holder if he is : a) the payee in possession of the instrument; or b) in possession of an instrument which has been endorsed to him, or on which the last endorsement is in blank, and on which there appears an uninterrupted series of endorsements, even if any endorsement was forged or was signed by an agent without authority. 2. If an endorsement in blank is followed by another endorsement, the person who signed this last endorsement is deemed to be an endorsee by the endorsement in blank.

3. A person is not prevented from being a holder by the fact that the instrument was obtained by him or any previous holder under circumstances, including incapacity or fraud, duress or mistake of any kind, that would give rise to a claim to, or a defence against liability, on, the instrument. Art 25 1. If an endorsement is forged, the person whose endorsement is forged, or a party who signed the instrument before the forgery, has the right to recover compensation for any damage that he may have suffered because of the forgery against: a) the forger; b) the person to whom the instrument was directly transferred by the forger; c) a party or the drawee who paid the instrument to the forger directly or through one or more endorsees for collection. 2. However, an endorsee for collection is not liable under paragraph 1 of this article if he is without knowledge of the foregery: a) at the time he pays the principal or advises him of the receipt of payment; or b) at the time he receives payment, if this is later, unless his lack of knowledge is due to his failure to act in good faith or to exercise reasonable care. 3. Furthermore, a party or the drawee who pays an instrument is not liable under paragraph 1 of this article if, at the time he pays the instrument, he is without knowledge of the forgery, unless his lack of knowledge is due to his failure to act in good faith or to exercise reasonable care. 4. Except as against the forger, the damages recoverable under paragraph 1 of this article may not exceed the amount referred to in article 70 or article 71. Art 26 1. If an endorsement is made by an agent without authority or power to bind his principal in the matter, the principal, or a party who signed the instrument before such endorsement, has the right to recover compensation for any damage that he may have suffered because of such endorsement against: a) the agent; b) the person to whom the instrument was directly transferred by the agent; c) a party or the drawee who paid the instrument to the agent directly or through one or more endorsees for collection. 2. However, an endorsee for collection is not liable under paragraph 1 of this article if he is without knowledge that the endorsement does not bind the principal: a) at the time he pays the principal or advises him of the receipt of payment or; b) at the time he recieves payment, if this is later, unless his lack of knowledge is due to his failure to act in good faith or to exercise reasonable care.

3. Furthermore, a party or the drawee who pays an instrument is not liable under paragraph 1 of this article if, at the time he pays the instrument, he is without knowledge that the endorsement does not bind the principal, unless his lack of knowledge is due to his failure to act in good faith or to exercise reasonable care. 4. Except as against the agent, the damages recoverable under paragraph 1 of this article may not exceed the amount referred to in article 70 or article 71. Art 28 1. A party may set up against a holder who is not a protected holder : a) any defence that may be set up against a protected holder in accordance with paragraph 1 of article 30; b) any defence based on the underlying transaction between himself and the drawer or between himself and his transferee, but only if the holder took the instrument with knowledge of such defence or if he obtained the instrument by fraud or theft or participated at any time in a fraud or theft concerning it; c) any defence arising from the circumstances as a result of which he became a party, but only if the holder took the instrument with knowledge of such defence or if he obtained the instrument by fraud or theft or participated at any time in a fraud or theft concerning it; d) any defence which may be raised against an action in contract between himself and the holder ; e) any other defence available under this Convention. 2. The rights to an instrument of a holder who is not a protected holder are subject to any valid claim to the instrument on the part of any person, but only if he took the instrument with knowledge of such claim or if he obtained the instrument by fraud or theft concerning it. 3. A holder who takes an instrument after the expiration of the time-limit for presentment for payment is subject to any claim to, or defence against liability on, the instrument to which his transferor is subject. 4. A party may not raise as a defence against a holder who is not a protected holder the fact that a third person has a claim to the instrument unless: a) the third person asserted a valid claim to the istrument; or b) the holder acquired the instrument by theft or forged the signature of the payee or an endorsee, or participated in the theft or the forgery. Art 29 “Protected holder” means the holder of an instrument which was complete when he took it or which was incomplete within the meaning of paragraph 1 of article 12 and was completed in accordance with authority given, provided that when he became a holder : a) he was without knowledge of a defence against liability on 181 (Sys 4) - D:\shinu\lawschool\books\module\contract law

b) c) d) e)

the instrument referred to in paragraphs 1 (a), (b), (c) and (e) of article 28; he was without knowledge of a valid claim to the instrument of any person; he was without knowledge of the fact that it had been dishonoured by non-acceptance or by non-payment; the time limit provided by article 55 for presentment of that instrument for payment had not expired: he did not obtain the instrument by fraud or theft or participate in a fraud or theft concerning it.

Art 36 1. An instrument may be signed by an agent. 2. The signature of an agent placed by him on an instrument with the authority of his principal and showing on the instrument that he is signing in a representative capacity for that named principal, or the signature of a principal placed on the instrument by an agent with his authority, imposes liability on the principal and not on the agent. 3. A signature placed on an instrument by a person as agent but who lacks authority to sign or exceeds his authority, or by agent who has authority to sign but who does not show on the instrument that he is signing in a representative capacity for a named person, or who shows on the instrument that he is signing in a representative capacity but does not name the person whom he represents, imposes liability on the person signing and not on the person whom he purports to represent. 4. The question whether a signature was placed on the instrument in a representative capacity may be determined only be reference to what appears on the instrument. 5. A person who is liable pursuant to paragraph 3 of this article and who pays the instrument has the same rights as the person for whom he purported to act would have had if that person had paid the instrument. Art 46 1. Payment of an instrument, whether or not it has been accepted, may be guaranteed, as to the whole or part of its amount, for the account of a party of the drawee. A guarantee may be given by any person, who may or may not already be a party. 2. A guarantee must be written on the instrument or on a slip affixed thereto (“allonge”).3. A guarantee is expressed by the words “guaranteed” , “aval”, “good as aval” or words of similar import, accompanied by the signature of the guarantor. For the purposes of this Convention, the words, “prior endorsements guaranteed” or words of similar import do not constitute a guarantee. 4. A guarantee may be effected by a signature alone on the front of the instrument. A signature alone on the front of the instrument, other than that of the maker, the drawer or the drawee, is a guarantee. 5. A guarantor may specify the person for whom he has become guarantor. In the absence of such specification, the person for whom he has become guarantor is the acceptor or the drawee in the case of a bill, and the maker 182 (Sys 4) - D:\shinu\lawschool\books\module\contract law

in the case of a note. 6. A guarantor may not raise as a defence to his liability the fact that he signed the instrument before it was signed by the person for whom he is a guarantor, or while the instrument was incomplete. Art 47 1. The liability of a guarantor on the instrument is of the same nature as that of the party for whom he has become guarantor. 2. If the person for whom he has becme guarantor is the drawee, the guarantor engages : a) to pay the bill at maturity to the holder, or to any party who takes up and pays the bill; b) if the bill is payable at a definite time, upon dishonour by non-acceptance and upon any necessary protest, to pay it to the holder, or to any party who takes up and pays the bill. 3. In respect of defences that are personal to himself, a guarantor may set up : a) against a holder who is not a protected holder only those defences which he may set up under paragraphs 1,3 and 4 of article 28; b) against a protected holder only those defences which he may set up under paragraph 1 of article 30. 4. In respect of defences that may be raised by the person for whom he has become a guarantor : a) a guarantor may set up against a holder who is not a protected holder only those defences which the person for whom he has become a guarantor may set up against such holder under paragraphs 1,3 and 4 of article 28; b) a guarantor who expresses his guarantee by the words “guaranteed”, “payment guaranteed” or “collection guaranteed”, or words of similar import, may set up against a protected holder only those defences which the person for whom he has become a guarantor may set up against a protected holder under paragraph 1 of article 30; c) a guarantor who expresses his guarantee by the words “aval” or “good as aval” may set up against a protected holder only : i) The defence, under paragraph 1 (b) of article 30, that the protected holder obtained the signature on the instrument of the person for whom he has become a guarantor by a fraudulent act; ii) The defence, under article 53 or article 57, that the instrument was not presented for acceptance or for payment; iii) The defence, under article 63, that the instrument was not duly protested for non-acceptance or for nonpayment; iv) The defence, under article 84, that a right of action may no longer be exercised against the person for whom he has become guarantor; d) a guarantor who is not a bank or other financial institution and who expresses his guarantee by a signature alone may

set up against a protected holder only the defences referred to in subparagraph (b) of this paragraph; (e) a guarantor which is a bank or other financial institution and which expresses its guarantee by a signature alone may set up against a protected holder only the defences referred to in subparagraph (c) of this paragraph.

b)

Art 55 An instrument is duly presented for payment if it is presented in accordance with the following rules : a) the holder must present the instrument to the drawee or the acceptor or to the maker on a business day at a reasonable hour; b) a note signed by two or more makers may be presented to any one of them, unless the note clearly indicates otherwise; c) if the drawee or the acceptor or the maker is dead, presentment must be made to the persons who under the applicable law are his heirs or the persons entitled to administer his estate; d) presentment for payment may be made to a person or authority other than the drawee, the acceptor or the maker if that person or authority is entitled under the applicable law to pay the instrument; e) an instrument which is not payable on demand must be presented for payment on the date of maturity or on one of the two business days which follow ; f) an instrument which is payable on demand must be presented for payment within one year of its date; g) an instrument must be presented for payment; i) at the place of payment specified on the instrument; ii) if no place of payment is specified, at the address of the drawee or the acceptor or the maker indicated in the instrument; or iii) if no place of payment is specified and the address of the drawee or the acceptor or the maker is not indicated, at the principal place of business or habitual residence of the drawee or the acceptor or the maker; h) an instrument which is presented at a clearing house is duly presented for payment if the law of the place where the clearing house is located or the rules or customs of that clearing house so provide. Art 56 Delay in making presentment for payment is excused if the dealy is caused by circumstances which are beyond the control of the holder and which he could neither avoid nor overcome. When the cause of the delay ceases to operate, presentment must be made with reasonable diligence. 2. Presentment for payment is dispensed with : a) if the drawer, an endorser or a guarantor has expressly waived presentment; such waiver : i) if made on the instrument by the drawer, binds any subsequent party and benefits any holder; ii) if made on the instrument by a party other than the

drawer, binds only that party but benefits any holder. if made outside the instrument, binds only the party making it and benefits only a holder in whose favour it was made ; if an instrument is not payable on demand, and the cause in delay in making presentment referred to in paragraph 1 of this article continues to operate beyond thirty days after maturity ; if an instrument is payable on demand, and the cause of delay in making presentment referred to in paragraph 1 of this article continues to operate beyond thirty days after the expiration of the time-limit for presentment for payment; if the drawee, the maker or the acceptor has no longer the power freely to deal with his assets by reson of his insolvency, or is a fictitous person or a person not having capacity to make payment, or if the drawee, the maker or the acceptor is a corporation, partnership, association or other legal entity which has ceased to exist; if thee is no place at which the instrument must be presented in accordance with subparagraph (g) of article 55. Presentment for payment is also dispensed with as regards a bill, if the bill has been protested for dishonour by nonacceptance. iii)

c)

d)

e) 3.

Art 60 1. A protest is a statement of dishonour drawn up at the place where the instrument has been dishonoured and signed and dated by a person authorized in that respect by the law of that place. The statement must specify : a) the person at whose request the instrument is protested; b) the place of protest; c) the demand made and the answer given,if any, or the fact that the drawee or the acceptor or the maker could not be found. 2. A protest may be made : a) on the instrument or on a slip affixed thereto (“allonge”); or b) as a separate document, in which case it must clearly identify the instrument that has been dishonoured. 3. Unless the instrument stipulates that protest must be made, a protest may be replaced by a declaration written on the instrument and signed and dated by the drawee or the acceptor or the maker, or, in the case of instrument domiciled with a named person for payment, by that named person; the declaration must be to the effect that acceptance or payment is refused. 4. A declaration made in accordance with paragraph 3 of this article is a protest for the purpose of this Convention. Art 67 1. Delay in giving notice of dishonour is excused if the delay is caused by circumstances which are beyond the control of the person required to give notice, and which he could neither avoid nor overcome. When the cause of the delay 183 (Sys 4) - D:\shinu\lawschool\books\module\contract law

2. a) b)

c)

ceases to operate, notice must be given with reasonable diligence. Notice of dishonour is dispensed with : if, after the exercise of reasonable diligence, notice cannot be given; if the drawer, an endorser or a guarantor has expressly waived notice of dishonour; such waiver; (i) if made on the instrument by the drawer, binds any subsequent party and benefits any holder; ii) if made on the instrument by a party other than the drawer, binds only that party but benefits any holder; iii) if made outside the instrument, binds only the party making it and benefits only a holder in whose favour it was made; as regards the drawer of the bill, if the drawer and the drawee or the acceptor are the same person.

Art 73 1. The holder is not obliged to take partial payment. 2. If the holder who is offered partial payment does not take it, the instrument is dishonoured by non-payment. 3. If the holder takes partial payment from the drawee, the guarantor of the drawee, or the acceptor or the maker : a) the guarantor of the drawee, or the acceptor or the maker is discharged of his liability on the instrument to the extent of the amount paid; b) the instrument is to be considered as dishonoured by non-payment as to the amount unpaid. 4. If the holder takes partial payment from a party to the instrument other than the acceptor,the maker or the guarantor of the drawee : a) the party making payment is discharged of his liability on the instrument to the extent of the amount paid; b) the holder must give such party a certified copy of the instrument and any necessary authenticated protest in order to enable such party to exercise a right on the instrument. 5. The drawee or a party making partial payment may require that mention of such payment be made on the instrument and that a receipt therefor be given to him. 6. If the balance is paid, the person who receives it and who is in possession of the instrument must deliver to the payor the receipted instrument and any authenticated protest. Art 76 1. Nothing in this Convention prevents a Contracting State from enforcing exchange control regulations applicable in its territory and its provisions relating to the protection of its currency, including regulations which it is bound to apply by virtue of international agreements to which it is a party. 2. a) If, by virtue of the application of paragraph 1 of this article, an instrument drawn in a currency which is not that of the place of payment must be paid in local currency, the amount payable is to be calculated according to the rate of exchange for sight drafts (or, if there is no such rate, 184 (Sys 4) - D:\shinu\lawschool\books\module\contract law

according to the appropriate established rate of exchange) on the date of presentment ruling at the place where the instrument must be presented for payment in accordance with subparagraph (g) of article 55. b) i) If such an instrument is dishonoured by nonacceptance, the amount payable is to be calculated, at the option of the holder, at the rate of exchange ruling on the date of dishonour or on the date of actual payment. ii) If such an instrument is dishonoured by non-payment, the amount is to be calculated, at the option of the holder, according to the rate of exchange ruling on the date of presentment or on the date of actual payment. iii) Pqragraphs 4 and 5 of article 75 are applicable where appropriate. Art 78 1. If an instrument is lost, whether by destruction, theft or otherwise, the person who lost the instrument has, subject to the provisions of paragraph 2 of this article, the same right to payment which he would have had if he had been in possession of the instrument. The party from whom payment is claimed cannot set up as a defence against liability on the instrument the fact that the person claiming payment is not in possession of the instrument. 2 (a) The person claiming payment of a lost instrument must state in writing to the party from whom he claims payment i) the elements of the lost instrument pertaining to the requirements set forth in paragraph 1 or paragraph 2 of articles 1,2 and 3; for this purpose the person claiming payment of the lost instrument may present to that party a copy of that instrument; ii) the facts showing that, if he had been in possession of the instrument, he would have had a right to payment from the party from whom payment is claimed ; iii) the facts which prevent production of the instrument. b) The party from whom payment of a lost instrument is claimed may require the person claiming payment to give security in order to indemnify him for any loss which he may suffer by reason of the subsequent payment of the lost instrument. c) The nature of the security and its terms are to be determined by agreement between the person claiming payment and the party from whom paymet is claimed. Failing such an agreement, the court may determine whether security is called for and, if so, the nature of the security and its terms. d) If the security cannot be given, the court may order the party from whom the payment is claimed to deposit the sum of the lost instrument, and any interest and expenses which may be claimed under article 70 or article 71, with the court or any other competent authority or institution, and may determine the duration of such deposit. Such deposit is to be considered as payment to the person claiming payment.

12 CASE LAW Brij Kishore Rai v. Lakhan Tiwari [AIR 1978 ALL 314] The plaintiff claimed a money due against the defendant on the ground that the latter had borrowed certain amounts from the former. The plaintiff claimed the principal sum of Rs.2000 with interest at the rate of 18% per annum. the defence was that there was, in reality, no borrowing and that the document, on which the plaintiff placed reliance, [which had been described as a sarkhat] was executed by the defendant but with some different purpose and not as evidencing the alleged borrowings set up by the plaintiff. It was also contended that the document in question relied on by the plaintiff really amounted to a pronote in law and was inadmissible in evidence on account of definciency of stamp. It was held that irrespective of nature of document, if it is admitted in evidence, sec 36 will be applicable to the situation. (2) To examine the validity of a promissory note, the terms have to be examined and only an express undertaking to pay amount in the instrument makes it a promissory note. An implied undertaking by use of the word debt or pronote is not sufficient. (3) Here the second proviso to sec 92 [Evidence Act] mentions degrees of formalities, does not mean, every document is to be on a separate of sheet of paper and stamped. United Bank of India, Ltd v. Nederlandsche Standard Bank [AIR 1962 Cal 325] The defendants opened an irrevocable and confirmed credit in favour of one corporation whose sole proprietor was D.M. Sharma. The credit was for £ 3360, and the transaction related to the sale of 20 tons of pepper sold by the corporation Jacobson & Co. under whose order the credit account was opened. The validity period of this Letter of Credit was till 31-12-47, and 75% was payable against certain documents and 25% on the arrival of goods and their verification in Amsterdam. On the basis of this Letter certain payments were made to the plaintiff, and a final payment was made in Amsterdam before the arrival of goods or the presentment of the BOE at the bank. This last cheque was taken back from the plaintiffs predecessor on the day it was given, and the defendant refused to pay. The plaintiff filed a suit for the recovery of Rs.36,387/9/3. It was held that a person who seeks to rely on a letter of credit must do so in exact compliance with its terms and the Bank is not bound or indeed entitled to honour drafts presented to it under a letter of credit unless those drafts with the accompanying documents are in strict accordance with the credit as opened ... This was not the kind of letter of credit commonly used in commercial transactions, where express provision is made for negotiation of BOE and draft. Neither drawing nor negotiation of documents was permitted by the terms of this letter of credit. The specific documents expressly mentioned were only bills of lading, invoice, weight list and insurance policy, but they did not include bills of exchange or draft. The validity was till 5-1-48 and 75% of the credit was payable against the delivery

of the specific documents mentioned there. No other rights could be added under this letter of credit either of drawing or of negotiating any documents and specially documents other than those mentioned. The validity period could not be made to depend on the negotiation of documents at all. Negotiation being excluded the only alternative left was to make a presentation of the documents mentioned in it. The letter of credit being addressed to a particular banker and this could not be utilised with any other bank. The appeal was hence dismissed. Tukarma Bapuji Nikam v. The Belgau Bank Ltd. [AIR 1976 Bom 185] The plaintiffs had sold certain grain worth Rs.863.94 to Mr.A, and received Rs.180/- as part payment for it. The grains were loaded and transported to the place wher Mr.A resided, but the truck was stopped in between and the grains looted. Both the plaintiff and M.A were unaware of this fact. A drew a draft for the balance amount of Rs 683.94 from a branch of the defendant bank and posted it to the plaintifff. Before the plaintiff could present the draft for payment, the defendant issued a ‘stop payment’ order to the bank because he had become aware of the possibility of the loss of his goods. As a consequence the defendant bank refused to make payment when the draft was presented and so he filed a suit against the bank for the recovery of that amount. The main issue to be considered was, whether the purchaser of a draft from a Bank which has been made out in favour of a third party, has any right to stop payment of that draft and if so, till what stage could he do so. It was held that as there was no dispute in the present case in regard to the plaintiffs title to the draft, the only dispute raised by the defendant being in regard to the consideration for the said draft the purchaser of the draft was not entitled to ask the defendant bank to stop payment on that account and the defendant bank was not entitled to refuse to pay the amount of that draft to the plaintiff. National WestMinster Bank Ltd v. Barclays Bank Intnl Ltd & Anr [(1974) 3 ALL ER 834] B was a long standing customer of the plaintiff Bank and had an account at one of their branches in London. The second defendant a businessman in Nigeria, was looking out for opportunities to acquire pound sterling. An intermediary brought to him a cheque stolen from B’s cheque book which was uncrossed and unendorsed but B’s signature had been forged; the forgery undetectable except to an expert graphotogist. The cheque was presented and the bank made the payment on it. On the forgery being realised the bank sued the defendant for the amount paid on the forged cheque. It was held that, S.72 of the Indian Contract Act, 1882, lays down that a person to whom money has been paid by mistake must repay it. As a general rule, therefore, a banker can recover from the recipient money paid away on a forged cheque. It is immaterial that the recipient has spent the money away, or has altered his position in reliance of the payment. Where there is no 185 (Sys 4) - D:\shinu\lawschool\books\module\contract law

negligence of the banker, the mere payment of a forged cheque does not operate as an estoppel against him. Kalianna Gownder v. Palani Gownder, [AIR 1970 SC 1942]

appellants filed a suit, and the trial court held in their favour. On appeal, the decree was reversed and the respondents were held to be discharged. The appellants filed a second appeal.

The plaintiff agreed on 4-7-1956 to purchase a land from the defendant and his son for a sum of Rs.12,000/-. A memorandum was drafted stating that Rs.2000/- had been paid as advance and the signatures were attested by the plaintiff. Three days later, the defendants informed the plaintiff by a letter that since only Rs.350/- had been paid and not Rs.2000/-as agreed upon, the agreement was cancelled. On receipt of the letter, the plaintiff filed a suit for specific performance and also deposited in the Court Rs.10,000 which according to him was the balance on purchase price. The defendants contended that since the plaintiff had paid only Rs.350/- and had obtained possession of the memorandum on a representation that he will pay the balance of Rs.1650/- within three days and had failed to do so the agreement was cancelled. Further, the agreement having been altered in material particulars, after it was executed by adding the words : “Clear the debts and execute the sale deed free from encumberance’, the suit was not maintainable.

It was held that the drawee of a NI was not liable on it to the payee unless he had accepted it u/sec.32. Under sec.7 of the Act, the drawee becomes an acceptor only when has signed his assent on the bill. There cannot be, apart from any mercantile usage, an oral acceptance of the hundi much less an acceptance by conduct, where atleast no question of estoppel arises. Hence the mere fact of possession of a bill by the drawee is not sufficient to constitute valid acceptance. What is requisite for fixing the drawee with liability under S.32 is the acceptance by him of the instrument and not an acknowledgement of liability. Assuming that a plea of discharge of a hundi implies an acknowledgement of liability under it, that is not sufficient to fix the liability on the drawee under S.32 when the acknowledgement is neither in writing nor signed by him. The appeal was hence dismissed.

In this second appeal the issues before the Court was : (1) whether the plaintiff paid Rs.350/- only as contended by the defendants on 4-7-1956 and obtained possession of the agreement on a false representation; and (2) whether the memorandum was altered in maternal particulars after execution, and was on that account discharged ? It was held that, a material alteration is one which varies the rights, liabilities, or legal position of the parties as ascertained by the deed in its original state. But if the alteration merely expresses that which was implied by law in the deed as originally written or which carries out the intention of the parties already apparent on the face of the deed, it is not material provided that the alteration does not otherwise prejudice the party liable thereunder. Ordinarily, when property is agreed to be sold for a price, it would be the duty of the vendor to clear it of all encumbrances before executing the sale deed. Hence, even if a covenant that the vendor would clear the debts and execute the sale deed free of encumbrances is inserted in a memorandum of agreement of sale after its execution cannot be regarded as a material alteration. The appellants were therefore entitled to a decree of specific performance.

Plaintiff is a nationalized banking company, constituted under the Banking Companies (Transfer & Acquisition) undertaking Act, 1970. Plaintiff signed and verified by Ms. Prabhu, Sr. Manager of the Delhi Branch. Defendant enterprise had dealings with the bank from 1976, which included a current account with open cash credit facilities, one of the persons who had quick personal guarantee being Baljit Kaur. On her death deposits 2, 3, 4 were liable being her legal representatives and on March 1981, they executed a fresh deed where they specified the amount of the firm’s liability they guaranteed and also acknowledged this liability under OCC A/C.

Seth Jagjivan Mavji v. Messrs Ranchhoddas Meghji [AIR 1954 SC 554] The appellant had instituted a suit on a hundi for Rs.10,000 dated 4-12-1947, drawn in his favour by one H of Basra on the respondents who were merchants and commission agents in Bombay. The hundi was sent by registered post to the appellant in Bombay, and was actually received by one P who presented it to the respondents on 10-12-1947 and received payment on it. P had been acting as a commission agent for the appellants. On 12-1-48 the respondents repudiated the authority of P to act as their agent and demanded the hundi back. The respondents denied their liability, stating that P was the agent of the appellant, and that the amount was paid to him bona fide on his representation that he was authorised to receive payment. The 186 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Canara Bank, New Delhi v. M/s Sanjeev Enterprises [AIR 1988 Del 372].

Subsequently on the department’s request, overdrafts OCC, bill discounting facilities were granted. 1981 Sept, documents for the above purpose were drafted. One of the department’s bill of exchange had been dishonoured. Due to the defendant’s failure to pay in the manner promised by them a suit was been filed for various amounts. The issues which were raised were as follows: (1) Whether the claim pertains to year 1976 and hence is barred by limitation. (2) Whether the senior manager had the authority to verify the plaintiff & file a suit. (3) Whether the amount claimed by the bank has been inflated. (4) Whether defendant’s were entitled to concessional interest rates. (5) Whether the bank was responsible for the dishonour of the BE? (6) Whether the signatures of defendants had been obtained on blank papers/ form. It was held that The transactions in question took place over 1981 -82 as the documents show hence suit is not barred by limitation. (2) Mr. Prabhu, was authorized to sign by a power of attorney. (3) No proof to show that signatures on blank forms had been obtained (4) The amounts claimed by the bank were found to be correct.

(5) Under sec 64 of Negotiable Instrument Act, non presentment of Hundi for payment does not except the acceptor of a Hundi from liability (6) As per ss 5, 32, 79, 80 interest on a Hundi being dishonoured must be stipulated in Hundi. Otherwise no interest s payable. But as defendants failed to pay amount due on Hundis 6% per annum interest as under sec 34 C P C has to be paid. SBI v. J R Mazumdar, [AIR 1970 Cal 503] The Government of West Bengal, Officer, Principal Agricultural Officer purchased a demand draft for the amount payable to the plaintiff and the said draft was lost from the plaintiff’s custody. The loss was reported to all concern including SBI head office and the branch offices. The SBI informed the plaintiff that the lost draft was not yet encashed and they would exercise due caution if it was presented, but stated that giving a duplicate draft would not be possible unless a duplicate is an indemnity bond executed by the Principal Agricultural Officer who refused to do so. The plaintiff filed the present suit stating that he should be given a duplicate. The lower court decreed that he was entitled to a duplicate bond and hence the present appeal by the bank. The main issues in this appeal where (1) whether the draft is a negotiable instrument? (2) whether the draft of this nature is a bill of exchange? It was held that keeping in mind sec 85A and 131A of the Negotiable Instruments Act draft drawn by one branch of a bank on another is a negotiable instrument. Branches of any bank are treated as individual entities in certain cases. The draft in question is hence a bill of exchange and so the plaintiff is entitled to a duplicate. Canara Bank v. Canara Sales Corpn. & Others [AIR 1987 SC 1603]. In this case it was held that whenever a cheque purporting to be by a customer is presented before a bank it carries a mandate to the bank to pay. If a cheque is forged, there is no such mandate. The bank can escape liability only if it can establish knowledge to the customer of the forgery in the cheques. Inaction for continuously long period cannot itself afford a satisfactory

ground for the bank to escape the liability. Unless the bank is able to satisfy the court of either an express condition in the contract with its customer or an unequivocal ratification, it will not be possible to save the bank from its liability. The banks do business for their benefit, but the customers also get some benefits. If the banks are to insist upon extreme care by the customers in minutely looking into the pass book and the statements sent by them, no bank perhaps can do profitable business. It is common knowledge that the entries in the passbooks and the statements of accounts sent by the bank are either not readable, decipherable or legible. There is always an element of trust between the bank and its customer. The bank’s business depends upon this trust. Rai Ram Kishore v. Ram Prasad Mishra [AIR 1952 All 245] ‘A” who was the payee and as such the holder of the promissory notes when they were executed,lost his status as a holder after the partition decree under which these promissory notes were allotted to the share of his (i.e. plaintiff’s) brother B. It was held that the right to recover the money due under them vested in B and the suit brought by him was therefore clearly maintainable. If an endorsement to bind the payee or the holder of a promissory note it must be made either by the payee or the holder himself or by a duly authorized agent acting in his name u/s 27 of the N I Act. Subrahmanyam Chettiyar v. Muthaih Chettiar [AIR 1984 Mad 215]. The suit filed by Muttaiah Chettiar for recovery of sum of Rs.24, 655 due under two promissory notes executed by Subrahmanyam Chettiar in his favour. Subsequently he executed the third pronote ‘C’ for a sum which was equal to the total sum on the first two pronotes, and endorsed on those two pronotes that in view of C the sum due under ‘A & B’ had been discharged. Suit on pronote C was filed but withdrawn with liberty to file first suit on same cause of action. It was held that since C was found to be insufficiently stamped the plaintiff need not have filed first suit on C and the suit on A & B (i.e., the first two pronotes) was maintainable because endorsement on A and B amounted to an acknowledgement.

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13. PROBLEMS 1. X has issued a cheque crossed with remark ‘not negotiable’ in favour of Y or his order. Y endorsed the cheque to Z by simply signing his name at the back. Z lost the cheque which was found by F. F wrote to ‘E’ in the space above Y’s signature and delivered it to E from who F had purchased some goods on credit. E paid the cheque into his account with the SBI. SBI made another crossing mentioning ‘Andhra Bank’. Andhra Bank collected the amount and credited to the SBI. Z claimed the money from X and X argued that he was discharged by his Bank’s honouring the cheque. Decide. 2. M of Malaysia drew a bill on C of Calcutta for goods exported to C as per his order. M wrongly affixed the stamp worth Rs.Four hundred as per Indian Law though M ought to have fixed stamp worth Rs.one thousand as per Malaysian law. M endorsed the Bill to B of Bangalore. B sent a notice to C for paying the Bill. The notice came returned with remark ‘office kept closed’. B filed a claim suit against C in your court on the instrument. Decide. 3. M a minor drew a bill on N after-sight. M endorsed the bill to X who made all reasonable attempt to present the bill to N for acceptance but failing he endorsed it to Y with a remark ‘Sans recourse’. Y placed the bill for payment. N refused to pay. Y filed a case for recovering the amount against the drawee, drawer and the endorsee. Decide 4. X lend Rs.5000 to Y on 1/1/82. On 1/12/84, Y gave him a promissory not for the amount agreeing to pay at 12% interest per annum. The promissory note was payable after 3 months. X while endorsing the document to Z, made the instrument payable after 2 months by changing the figure 3. Y refused payment on the ground of material alteration. x paid the money to z and took upon him the instrument and filed a suit on the instrument and the debt for realization of the amount on the plea that: (1) the alteration was not material and (2) Y was liable on the debt. Prepare a list of argument on behalf of the defendant. 5. The M D of Abraham & Co., issued a cheque to C, the cashier of the company, to make a payment of wages to the workers. C discontinued the cheque with his banker, United Bank of India. But C did not disburse the wages to the workers. M D asked the company’s banker to stop payment of the cheque. UBI claimed the amount the instrument. UBI has also filed a criminal complaint case against M D and the company. Prepare a list of argument on behalf of UBI. 6. A, a holder of a bill drawn on B endorsed it to D and posted it to D, L intercepted while the bill in transit and got hold of it and forged the signature of D to endorse it to C. C presented the bill for payment to B. B paid for the same to C. Meantime D came to know that the bill was posted by A to him. D wrote back to A about non-receipt of the bill. A sent a duplicate copy of the bill. D thereafter presented 188 (Sys 4) - D:\shinu\lawschool\books\module\contract law

it to B for payment which was refused. D then asked A to make payment on the bill. (i) Is A bound to pay the amount to B? Give reasons. (ii) Suppose D brought a suit against A for payment and A was asked by the Court to pay for the same. A after making the payment brought an action against B, C and D to recover the amount. Decide giving reasons in detail on the sustainability or otherwise of the right to claim the amount as against B, C and D. (iii) Suppose, the signature of the acceptor is forged, do you think the decision of the case would be different? What would in such a case be the rights and duty of the drawer, drawee, payee and the holder be? 7. A received a cheque from B and paid into his account with the Nagarabhavi branch of the West bank. This bank sent the cheque to its collecting bank at Hyderabad who presented the cheque on the drawee bank. The drawee bank made payment to the collecting bank. Suppose the collecting bank before sending the money to A’s bank at Nagarabhavi goes into liquidation. i) Critically examine the claim of A and amount to be received by him. ii) suppose the Ngarabhavi branch of west bank credited the amount to the account of A before sending the cheque for clearance. Would there be any difference in the claim of A? 8. A approached B for loan. B was not in a position to give the amount immediately and as such asked to draw a bill on him for Rs.5000 for 3 months and accepted it after the same was drawn on January 5, 1992. i) Suppose A kept the bill with himself since he could manage some money from other sources for his immediate need. On maturity, A presented the bill for payment to B. Can B refuse payment? Give reasons. ii) Suppose A discounted the Bill with the Canara Bank. Canara Bank presented the bill for payment at maturity. Can B refuse payment? Give detail arguments in favour of your decision. iii) Suppose A lost the bill which was found by C in a Library book earlier issued to A. C delivered it to D for paying C’s dues to D on April 9, 1992. Can B refuse payment? iv) Suppose A deposited the discounted bill amount into his account with a bank and bank went into liquidation. Can A get the toal amount from the liquidator? v) Suppose A received from the official liquidator an amount of Rs.3000 against the claim of Rs.5000. Can A ask B to receive the same amount in satisfaction against the claim on the bill?

9. Examine the nature and validity of the following documents with reasons i) “Pay Ramesh an amount of Rs. 5000, sixty days after the arrival of the ship `Victory’ at Bombay. ii) I promise to pay on demand a sum of Rs.10000 at my convenience.” iii) “I promise to pay the bearer a sum of Rs.5000 on demand”.

iv)

“Rs.1000 balance due to you and I am indebted to pay on demand”. v) “I promise to pay A Rs.1000 and all fines according to rules”. 10. A made a promissory note in a stamp paper sufficient for Rs.10000 but without stipulating the amount and the date of making the note. The holder of the note, H presented the note as it was and on refusal brought an action putting the note as it was as an evidence. Was A bound to make payment? Give reasons.

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14. SUPPLEMENTARY READINGS 1. Avtar Singh, Principles of Mercantile law, 1992, Eastern Book Company, Lucknow. 2. Awasthi, S.K., Law of Dishonour of Cheques, Forgery & Cheating (Practice & Procedure), 1993, CTJ Publications, Pune. 3. Parthasarthy, M. S., Khergamvala - The Negotiable Instrument Act, 1990, N. M. Tripathi Pvt. Ltd., Bombay. 4. Regional seminar on International trade law, 1994, Asian - African Legal consultative committee, New Delhi. 5. Swaroop, R., Cases on Dishonour of Cheques, 1994, Law Pubs, Madras. 6. Suri, R.K., Dishonour of Cheques (Prosecution & Penalties), 1994, ALT Publications, Hyderabad. 7. Verma, J.C., Bhashyam & Adiga - The Negetiable Instrument Act, 1990, Bharat Law House Pvt. Ltd.

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Master in Business Laws Banking Law Course No: II Module No: VI

Banker-Customer Relation

Distance Education Department

National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 080-3217858 E-mail: [email protected] 191 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Material prepared by: Mr. Harihar Aiyyar, LL.M., General Manager (Rtd.), State Bank of India. Material checked by: Ms. Pooja Kaushik, M.A., (Econ). Ms. Sudha Peri, M.A., LL.M. Material edited by; Dr. N.L. Mitra, M.Com., LL.M., Ph.D. Dr. P.C. Bedwa, LL.M.,Ph.D.

© National Law School of India University Published By: Distance Education Department National Law School of India University, Post Bag No: 7201 Nagarbhavi, Bangalore, 560 072.

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INSTRUCTIONS In the subject of Banking and Financial Institutions the banker-customer relation has developed a jurisprudence based upon litigations. In the classical concept of banking, a banker is the custodian of the deposits made by the customers. The Common Law Courts describe the relation as a debtor-creditor one. Of course, in the nineteenth century with the development of equity to be fused with law the role of a banker as a trustee of the customer’s fund has also been emphasised in certain situations. But both Common Law Courts and Civil Law Courts confirm the idea that once the customer deposits the money with the bank the banker becomes the owner of the money. The developments of banking business as the key of financial institutions is based upon this principle of ownership of the funds kept with the bank. In this module we have tried to explain not only some concepts like ‘bank’, ‘banker’, and ‘banking and customer’ but we have discussed about various types of deposits kept by the customers with the bank. We have discussed in detail the nature of the banking business developed through case laws in the last hundred years or so. During this time a lot of special category of customers came in the field of trade and commerce making the banking business not only challenging but also complicated. Discussions have been made about the functioning of the banking business with the special group of customers. One of the basic duties of a banker in the duty of secrecy which is presently under attack due to many practical reasons. Often disclosure is demanded by the tax authority or some other department of the government on the ground of public interest. It is also found that non-accessibility of information about doubtful customers leads to a huge drainage of public exchequer. Therefore, often there is a demand for access to information about a debtor from sister banking institutions. It is quite certain that with the development of tribunalised justice in the settlement of banking claims and disputes this duty of maintaining secrecy will come under further attack. A banker has a right of ‘general lien’ on the properties of the debtor left with the banker against any of its claim. This right is a general right unlike the right of a bailee, in the sense that a banker can extend his right of possession on any account or things in possession for a non-payment of loan on any other account. Similarly the banker has a right to setoff its claim on any head from the available amount on any other head. You will be benefitted by referring to the general principles of settlement of accounts as specified in sections 57 to 59 of the Indian Contract Act as well as principle laid down in Clayton’s case [(1816) 1 Mer 572]. We must understand that the transaction cost of loans and advances goes higher because the litigational cost is high. The litigation cost is high on account of system cost involved due to unnecessary, avoidable delay in settlement of disputes. In some cases the delays are due to a prolonged legal process, specially in the event of insolvency. The alternative dispute resolution is also not efficiently managing the banker-customer litigation. The essence of banker customer relation is based on mutual trust and faith but the relation begins with trust and in many cases ends up with litigations. It is necessary now to think and design a system readjustment so that the cost of litigation can be restricted and the other operational costs is minimised by increasing efficiency. Dr. N.L. Mitra

Programme Co-ordinator

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Banker Customer Relation

TOPICS 1.

Introduction ....................................................................................................................

195

2.

Nature of Relation ..........................................................................................................

197

3.

Special Category Customers .........................................................................................

208

4.

Duty of Secrecy ...............................................................................................................

215

5.

Pass Book ........................................................................................................................

217

6.

Banker’s Lien and Set off ..............................................................................................

221

7.

Case Law .........................................................................................................................

224

8.

Problems..........................................................................................................................

226

9.

Supplementary Readings ...............................................................................................

227

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1 INTRODUCTION SUB TOPICS 1.1 Definition of Banking 1.2 Definition of a Customer 1.1 DEFINITION OF A BANKER An attempt was made to find out a statutory definition of the terms ‘Banker’ and ‘Customer’. In the Indian statutes no definition is found. However, the term ‘Banking’ finds a place in the Banking Regulation Act 1949. Section 5(b) states that Banking “means the accepting for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawals by cheque, draft, cash or otherwise”. Again, sub-section (d) states “Banking Company means any company which transacts business of banking in India”. The banking law in India is a borrowed one from English Law. The banking law in both the countries have not been codified and only certain aspects have been codified. The development of this branch of law is from the case law of the U.K. and the Indian Judiciary. Other than the Negotiable Instruments Act, laws such as Bankers Book Evidence Act, Reserve Bank of India Act, State Bank of India Act, the Banking Regulation Act, the Transfer of Property Act, the Cheques Act, the Interest Act and many other statutes also deal with certain aspects of banking. Let us see the term ‘Banking’ as understood in other major countries: USA: In the United States of America, the Federal Law describes a State Bank as “any bank, Banking Association, Trust Company, Savings Bank (other than mutual Savings Bank) or other Banking Institution which is engaged in the business of receiving deposits and which is incorporated under the laws of any State” The earliest attempt in the United States was when the following definition was enacted : ‘By `banking’ we mean the business of dealing in credits and by a `bank’ we include every person, firm or company having a place of business where credits are opened by the deposits or collection of money or currency, subject to be paid, remitted on draft, cheque or order, or money is advanced or loaned on stocks, bonds, bullion, bills of exchange, or promissory notes, or where stocks, bonds, bullions or bills of exchange or promissory notes are received for discount or sale. (Indian Finance and Banking, Finlay Shirras, second impression, p 336) Any banking association is empowered, inter-alia, “to carry on the business of banking; by discounting and negotiating promissory notes, drafts, bills of exchange and other evidences of debts by receiving deposits, by buying and selling exchange, coins and bullion, by lending money on personal security; and by obtaining, issuing and circulating notes.

France : Institutions whose customary business is to accept from the public, in the form of deposits or otherwise, funds which they use for their own account in discount, credit or financial transactions are considered as banks. The Law of 1945 classifies banks into three categories: deposit banks, business banks; and long and medium term banks. Italy : The acceptance or deposits from the public in any form and the granting of credit ‘are activities of public interest’ governed by banking law of 1936. Japan : Ordinary banks are banks conducting commercial banking business under the Banking Law of 1927, with deposits as their major financial resources. Conventionally, banks are classified with ordinary banks, long term credit banks and trust banks. Banking Act of 1927 defines banks as institutions which carry on operations of giving as well as receiving credit. Switzerland : The Banking Law of 1934 regards banks as banks in the strictest sense; private bankers organised as individuals; firms or industrial partnerships, savings banks and finance companies, similar to bank which publicly solicit deposits. The Swiss law defines Banks as Institutions, which appeal to the public for deposit. Other Countries The unauthorised use of ‘bank’ is prohibited in Argentina, Belgium, Canada, Denmark, Germany, Italy. Sweden altogether prohibits the use of the title ‘bank’ by private banking firms. 1.2 DEFINITION OF CUSTOMER No definition is in the statute for a ‘Customer’. Therefore we have to look in detail the relationship between a Banker and a Customer according to the transactions and the variety of services offered and availed from the bank. This is also not an easy task as there is a considerable increase in the nature, variety and services offered by banks. Although the term as such is not defined, attempts have been made by courts to define a customer. But no statutory definition is available either in the Indian Law or in the British Law. As per English law, two theories are available. The old view expounded by Sir John Paget terms it as a ‘Time Factor”. That is an individual opening an account for the first time to day cannot be termed as a customer. To constitute a customer there must be some recognisable course or habit of dealing in the nature of regular banking services. It is difficult to reconcile the idea of a single transaction with that of a customer. The word surely predicates even grammatically some minimum of custom and antithetic to an isolated act. It is believed that even 195 (Sys 4) - D:\shinu\lawschool\books\module\contract law

a paltry tradesman differentiates between a customer and a casual purchaser. It follows therefore that two things are necessary for a person to be considered a customer ; 1) Some recognisable course or habit of dealing between him and the bank. 2) The transaction should be in the nature of regular banking business. As regards(1) above, it was held in Mathews v. Williams Brown & Co [10 T.L.R - 1894-386] that in order to constitute a person a customer of a bank, he should have some sort of an account with the bank, but that the initial transaction in opening an account did not set up the relation of a banker and customer, and there had to be some measure of continuity and custom. On account of this, banks are even now reluctant to open an account with crossed cheques. This theory of ‘time factor’ has now become archaic. The second view is that of Heber.L.Hart. According to Hart, a customer is a person who has an account with a banker. Hart says, that a person is a customer if he keeps either a current account or a deposit account with the bank, or, it would seems, if the bank systematically transacts with him or for him any kind of banking business. Generally it may be stated that a customer is any person, who has some sort of an account with a bank and that relationship normally commences as soon as the account is opened. A bank customer therefore differs from the normal understanding of the term in that the word ‘Customer’ usually denotes a relationship resulting from habit or commercial dealings. An isolated purchase by a person from a trader will not suggest that the purchaser should be described as a customer. From the banking angle, a habit or continued dealing will not normally make a person a customer unless there is an account opened in his name, where as a stranger can become a customer just as soon as he opens the account. This view is amply illustrated in Great Western Railway v. County Banking Co. Ltd [(1901) A.C. 414]. In this case, Mr. Huggins, a poor law overseer, fraudulently obtained a cheque from the plaintiff and encashed the same with the defendant bank. He was well known at the bank’s branch because it has been his practice over a number of years to encash cheques with that bank branch. The stolen (fraudulently obtained) cheque was crossed “not negotiable”. This aspect was apparently ignored till the case came before the House of Lords. It was held that the bank could not succeed as holder for value because of the crossing on the cheque and that Section 82 of the Bills of

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Exchange Act - which was then the law - would not avail to the bank as Huggins was not a customer. In this case it was stated that it is true that there is no definition of customer in the Act, but it is a well known expression and that THERE MUST BE SOME SORT OF ACCOUNT, either a deposit or current account or some similar relation, TO MAKE A MAN A CUSTOMER OF BANK. Till the decision in Ladbroke v. Todd [1914) 30 T.L.R. 433] it was believed that there had to be some continuity of custom as well as maintenance of an account to constitute a Bank Customer. In this case, it was laid down that the relation of a Banker and Customer begins as soon as the first cheque is paid in and accepted for collection and not merely when it is paid. Again in commissioners of Taxation v. English Scottish & Australian Bank [(1920)A.C. 683] their Lordships are of the opinion that the word “Customer” signifies a relationship in which duration is not of the essence. A customer whose money has been accepted by the bank on the footing that they undertake to honour cheques upto the amount standing to his credit is, in view of their Lordships, a customer of the bank in the sense of the statute irrespective of whether his connection is of short or long standing. When there is no statutory definition we have to cull out the true deposit account or some similar relations. 1) To make a man a customer of the bank there must be either a current or deposit account or some similar relations. 2) Relationship of Banker and Customer begins as soon as a sum of money or a cheque is paid in and the bank accepts it and is prepared to open an account. 3) The word ‘Customer’ signifies the relationship in which the duration is not an essence. In India we have followed the English law on the subject and in the Indian law also we cannot find a definition. In Bank of India v. Goparathan Nair [AIR 1970 Kerala 74], it was held that so far as the banking transactions are concerned, the customer is one whose money has been accepted on the understanding that the bank will honour transactions to the amount standing to his credit, irrespective of his connection being of short or long standing. Thus, it is not necessary that the account shall have been operated for some time to merit that the person is known as a customer and even if there is a single transaction, it is sufficient. The dealing between the person and the bank should be relating to banking business.

2 NATURE OF FUNCTION AND RELATION SUB TOPICS 2.1 Nature of Banking business 2.2 Introductory reference 2.3 Debtor - Creditor Relation 2.4 Agency Relation 2.5 Trustee Relation 2.6 Bailor-Bailee Relation 2.7 Other Services 2.1 NATURE OF BANKING BUSINESS

of the account between 10th and 30th of the calendar month. These cheque book facility accounts should be properly introduced to the bank. The introductory reference can be made either by an existing customer or by a staff member with more than 5 years of service. The branch/bank has to forward a letter of thanks to the introducer. This in practice never happens. The customer is identified by his specimen signature and an account number allotted by the bank. Whenever money is paid out of the account, the banker should verify the signature of the customer on the cheque with the specimen signature on record with him.

The legal relationship between a banker and a customer arises out of the various transactions, entered between them. Till India became independent, the functions and role of commercial banks were very much restricted. The bankers mainly dealt with the acceptance of deposits and were lending to well established customers with full security back up. In the international scenario also there has been vast progress in the financial markets in the last 5 to 7 years.

In case of Savings Bank Accounts a pass book is issued to the customer and for Current Accounts, periodical statement of accounts are provided to the customer. At branches with computer facility, banks do not generally provide pass books; they only provide the customer with a monthly or weekly statement of accounts. Banks also stipulate that if amount exceeding, say, Rs.5,000/- is withdrawn by a single cheque in a Savings Bank Account, that will cause ineligibility for interest for the month.

We shall now examine the transactions entered between the banks and its customers and their nature. These are broadly : 1. Deposit Transactions. 2. Loan Transactions. 3. Services.

These Savings Bank Accounts can be opened for an individual singly or jointly, on behalf of a minor by the minor’s natural guardian, or for a firm, trust or association. But in any case banks do not permit the use of Savings Bank Accounts to be operated as Current Accounts, by the customer.

DEPOSIT TRANSACTIONS Banks have been used by the general public as a repository to keep their surplus funds. The term ‘general public’ is used in a wide context. Individual account holders, viz the individuals who want to keep their savings safely open accounts in the banks. Their accounts are commercially known as ‘P’ segment deposits or Personal Segment Deposits. In addition, proprietory concerns, partnerships, limited companies, trusts etc., also open and operate their accounts with the commercial banks. ‘P’ segment customers keep their money for safety and earn interest to ensure that tehy build reserves for meeting unforeseen contingencies. ‘P’. Segment These customers generally open Savings Bank accounts. Savings Bank accounts are of two types viz., (1) bank account from which money can be withdrawn by cheque. This is called checking or Cheque book facility a/c. These accounts can be operated in single names or in joint names. In the case of joint accounts, there can again be ‘either or survivor’ or ‘former or survivor’. Again these accounts can be operated either jointly or individually. To open a cheque book facility account, banks prescribe that there should always be a minimum balance of Rs.250/- kept in the account. There shall not be more than 50 withdrawals in the account in a calendar year. The banks will pay an interest, at present 5%, on the minimum balance standing to the credit

(2) Another type of Savings Bank Account, is called the Ordinary Savings Bank Account which can be operated with a minimum balance of Rs.20. Third party cheques are not collected, negotiated or credited to this type of account. The account holder himself should be present for and receive the withdrawals of monies. No cheque book will be issued to this type of account holder. All withdrawals are to be accompanied by the pass book. Generally this type of accounts are opened for the low income group of people who open account only as a savings venue. The interest in the Savings Bank Account is credited at half yearly intervals. The above paragraphs summarise how two types of Savings Bank Accounts are opened and operated. Fixed Deposits or Term Deposits Individuals, firms, companies and all legal entities are entitled to open fixed deposit accounts. The banks accent Fixed or Term Deposits and pay interests at rates always higher than that paid on Savings Bank Accounts. Only those who have surplus money which can be blocked and who want a higher rate of return on their monies will opt to deposit their monies in Fixed Deposit Accounts. Banks obtain specimen signature of the customers. These Fixed Deposit receipts are not negotiable. On the face of the receipt itself, one can find the legend ‘Not Transferable’. The amount held under this type of account is repayable only after the period for which the money has been 197 (Sys 4) - D:\shinu\lawschool\books\module\contract law

deposited. However, the banks at their discretion grant loans upto 75% of the amount in Fixed Deposits. These loans carry an interest at a rate which will be 2% higher than the rate at which the banks received the money from the depositor. There is also a facility to withdraw the money prematurely i.e., before the expiry of the period for which the amount has been deposited. However the depositors are penalised by the bank by paying interest at a rate lower than that rate for which the term deposit has run. There are various types of Fixed or Term deposits. In one scheme the banks accept smaller amount and repay a higher or prefixed amount by compounding the interest payable for the term. In such cases, periodical interest payments are not made. In another scheme, banks agree to pay interest monthly or quarterly or half-yearly or on annual basis. Another type of savings is the Recurring Deposit Scheme, wherein the investor deposits on a daily (as in the case of pigmy scheme) or monthly basis a fixed amount and receives back all monies deposited by him as a lumpsum with interest calculated on a compounded basis at the end of the period on the date of maturity. The rates of interest on deposits are regulated by the Reserve Bank of India from time to time. Banks accept deposits as per the regulation of the Reserve Bank of India. However, in fixed deposit accounts, banks pay the interest for the period at the same rate agreed upon initially, even if there is an upward or downward revision in the interest rates. There are various permutations and combinations of the fixed deposit accounts invented by the ingenuity of the individual banks and implemented under various names, after appropriate approval by the Reserve Bank of India. From the bankers point of view, the savings bank accounts and fixed deposit accounts, particularly from the personal segment are considered as stable deposits and one can find the banks conducting deposit mobilisation campaigns every year for these type of deposits. Current Accounts Current accounts are generally opened and operated by individuals and organisations who need to issue cheques in larger numbers, for example firms, traders, manufacturers, limited companies, trusts etc. Banks stipulate that the accounts should always show a minimum balance of Rs.500/-. Some foreign banks stipulate that the minimum balance in the account should always be Rs.5000/-. Banks exercise an option to close the accounts if the balances fall below the stipulated minimum, although it is doubtful if it can legally do so. Individuals are supplied with ‘bearer’ cheque books, firms and companies with ‘order’ cheque books. There is no restriction on the number and amount of withdrawals. No interest is paid on the balances. However banks levy a charge depending upon the value of the account and the cost-benefit ratio of running the account to the bank. Introductory reference is compulsory for Current Accounts. In the case of limited companies, certified copies of the Memorandum and Articles of Association, Certificate of Incorporation, Certificate of Commencement of Business 198 (Sys 4) - D:\shinu\lawschool\books\module\contract law

alongwith a Board Resolution is insisted to open the account. In such cases introductory reference is not insisted. Banks provide the customers with periodical statement of accounts. Banks also record the names of the persons authorised to operate the accounts and keep the specimen signatures of authorised persons to operate the accounts. The above paragraphs briefly mention the nature of various deposit accounts. There is an association of the banks called the ‘Indian Banks Association’ comprising of all scheduled commercial banks in India. This association has codified formats for the use by banks such as the account opening forms, pay-in-slips, cheque formats etc. The association has a rules committee which prescribes the rules for the conduct of the various types of accounts from time to time. 2.2 INTRODUCTORY REFERENCE One of the topics which has not been dealt with in detail is ‘Introductory Reference’ to open bank accounts. The banking custom and practice insist that introductory reference is essential for opening the Accounts. There is no legal requirement to obtain such references. It is a matter of practice. The internal rules of the bank provide for it. It is not proposed to deal with this topic in detail here. The same will be dealt with in detail when we see the rights and liabilities of the collecting banker. The purpose of introductory reference is “to identify the prospecitve customers”. This will enable the banker to discover whether the new cusotmer might use the account for fraudulent pruposes of encashing cheques belonging to others. The duty of an introducer is only moral and not legal. It may be pointed out that it is not incumbent on the part of the bank to obtain such reference in all cases. The internal rules of the bank and the Indian Banks Association Rules prescribe for such references to be obtained. But it is also not mandatory. On account of the large number of incidence of frauds in banks, the Indian Parliament is to bring out a bill to insist upon affixing of a photograph of the customer on the pass books and the account opening forms. This may to some extent remove the difficulty for identifying a customer. However, a fraudulent customer will always find ways to commit frauds. The moral duty cast upon the customer will put the existing good customers to exercise caution in introducing all types of persons to open accounts. The legal decisions deal with the negligence of the bank in not obtaining the introductory reference and it is established law that the introducer will not run into any legal problems only for having introduced an account holder. 2.3 DEBTOR - CREDITOR RELATION The primary relationship between a banker and customer is that of a debtor and creditor. But one of the terms of this implied contract is that money lent to the banker is not payable except on demand. There are a good number of legal decisions maintaining this view by courts in India and in the U.K. According to Sir John Paget, the relationship of Banker and

Customer is primarily of debtor and creditor; the respective positions being determined by the existing state of the account. Instead of the money being set apart in a safe room, it is replaced by a debt due from the banker. The money deposited with him becomes his property and is absolutely at the disposal of the bank. In Foley v. Hill [(1848)2 H.L. 28] an account in the name of the plaintiff was opened in 1829 with the defendant bank, with an initial credit of 61, 171 pounds. The agreed rate of interest on the deposit was 2%. There were two later debits for 1700 pounds and 2000 pounds. Interest entries were shown in separate columns and interest amount was not credited to the main account. In 1833 the plaintiff sought to recover the money outstanding by an action in Chancery for an account. This account being so simple was held not to be ex-facie a matter for a Court of Equity, and the plaintiff thereupon claimed that the relationship of a banker with his customer was analogous to that of an agent and his principal, and that he was entitled to an account on that basis, and therefore, the relatioship being a fiduciary nature, the Statute of Limitation did not apply. The House of Lords held that the relationship was that of debtor and creditor and that therefore the matter was not one for an account in equity. Lord Cottenham L.C. stated that money paid into a bank, ceases altogether to be the money of the principal; it is then the money of banker, who is bound to return an equivalent by paying a similar sum to that deposited with him he is asked for it. The money paid to the bankers is the money known by the principal to be placed there for the purpose of being under the control of the banker. It is then the banker’s money; he is known to deal with it as his own; he makes what profit of it he can, which profit he retains to himself, paying back only the principal according to custom of bankers in some places, or the principal and or a small rate of interest according to the custom of the bankers in other places. This decision establishes the relationship of debtor and creditor and not that of any agent. The Bombay High Court also holding the ‘debtor-creditor’ theory of the relationship has held that the customer cannot, therefore, claim any amount due from the banker as a preferential creditor if the bank is wound up [Velji Lakshamsey & Co v. Dr.Banarjee (1955)25 Comp Cas 395]. In Joachimson v. Swiss Bank Corporation [(1921)3 K.B. 110] the plaintiff firm was a partnership between two Germans and a naturalized Englishman. On August 1, 1914 one of the Germans died and the partnership was thus dissolved. On the outbreak of war three days later, the other German became an alien enemy. On August 1, the firm’s account with the bank had a credit balance. On June 5, 1919, the naturalised partner commenced an action in the name of the firm to recover the amount lying in credit in the bank, the cause of action being alleged to have arisen on or before August 1, 1914. The firm had not made any demand on or before that date for payment of the sum in question and the bank (which had counter-claimed for a larger sum than the balance in the account) pleaded on the

point here at issue, inter alia that there had thus accrued no cause of action to the firm on August 1, 1914 and that the action therefore was not maintainable. On appeal, the court of Appeal held that where money was standing to the credit of a customer on current account at the bank a previous demand was necessary before an action could be maintained against the bank for money and the court gave a judgement in favour of the defendant bank. In his judgement Atkin L. J. observed , “I think that there is only one contract made between the bank and its customer. The terms of that contract involve obligations on both sides. They include the following provisions. The bank undertakes to receive money and to collect bills for its customer’s account. The proceeds so received are not to be held in trust for the customer. But the bank borrows the proceeds and undertakes to repay them. The promise to repay is to repay at the branch of the bank where the account is kept; and during banking hours. It includes a promise to repay any part of the amount due against the written order of the customer addressed to the bank at the branch, and as such written orders may be outstanding in the ordinary course of business for 2 or 3 days, it is term of the contract that the bank will not cease to do business with the customer except upon reasonable notice. The customer on his part undertakes to exercise reasonable care in executing his written orders so as to mislead the bank or to facilitate forgery. It is necessarily a term of such contract that the bank is liable to pay the customer the full amount of his balance until he demands payment from the bank at the branch at which the current account is kept”. In the same judgement, Bankers L.J.stated that having regard to the peculiarity of the relation there must be a number of super added obligations beyond the one specifically mentioned in Foley v. Hill. Unless this were so, the banker, like an ordinary debtor must seek out his creditor and repay him his loan as it immediately becomes due - that is to say, directly after the customer has paid the money into his account - and the customer, like any ordinary creditor, can demand repayment of the loan by his debtor at any time and place. It is impossible to imagine the relation between banker and customer as it exists, without the stipulation that, if the customer seeks to withdraw his loan, he must make an application to the banker for it. Section 444 of Seven American Jurisprudence mentions the relationship. It is a fundamental rule of banking law that in case of a general deposit of money in a bank, the moment the money is deposited it becomes the property of the bank, and the bank and the depositor assume the relationship of debtor and creditor. The legal effect of the transaction is that of a loan to the bank upon the promise and obligation, usually implied by bank, to pay or repay the amount deposited usually upon demand. Bombay High Court has further elucidated in Velji Lakamsey & Co v. Dr.Banarjee [(1955) 25 Comp.Cas 395] that the relation between a banker and its customer is that of a debtor and creditor and any amount due by the banker to the customer in that relationship cannot be claimed by the customer from the bank as a preferential credit if the bank is wound up. But a 199 (Sys 4) - D:\shinu\lawschool\books\module\contract law

customer may give certain specific direction to the bank and constitute the bank his agent. If the bank acts as an agent and not a debtor, then the agency brings about a fiduciary relationship which lasts until the agency is terminated. Therefore if the customer were to give directions to the bank that a certain amount must be paid to a certain person, then till that amount is paid pursuant to the directions of the customer, the agency would continue and the bank would hold the amount not as a debtor of the customer but in the capacity of a trustee and the amount would be impressed with a trust.

a current account in the bank. The bank did not remit the amount but debited to the customer’s account with the charges for the proposed remittance. The money was not transferred because on that very day the bank suspended payment. The High Court held that on the facts of the case the money was held apart by the bank as the property of the applicant. The money was received by the bank in the capacity of a mere agent. This follows that monies held apart by a banker as the property of the customer does not form part of the bank’s assets in liquidation.

In Santosh Kumar v. King [AIR 1952 CAL 193] it was held that the relation between a depositor and a bank is the simple relationship of a creditor and debtor.

In the case of the Official Assignee of Madras representing the Estate of S N Firm v. Natesan Pillai [AIR 1940 Madras 441] monies paid by the customer for the purpose of effecting a specific transaction were credited by the bank in their suspense account. The bank failed and a point was raised as to whether the customer is entitled to any preference. It was held that the amounts were received by the firm in a fiduciary capacity and not as between a banker and a customer. In such cases where the bank is in a fiduciary position in respect of monies received by it for the specific purpose and credits the sums in its suspense account, the relationship is not that of a debtor and creditor.

When we conclude the relationship between a banker and customer is that of a debtor and creditor, the statement is not complete. The debt between a debtor and creditor, and a bank and its customer, are different. A debt due from a bank to a customer and debt due from a borrower has two distincitions. In the first case, there is no necessity of a demand by a creditor for payment. So far as the bank and customer is concerned, it is an exception to the rule that a debtor should find his customer. Here the creditor (customer) has to make a demand on the debtor (banker). The demand should be made at the branch where the customer keeps his accounts. In Delhi Cloth General Mills Co. Ltd v. Harnam Singh [AIR 1955 S.C. 590] it was held that the banker customer contract is an exception to the rule that a debtor should find his creditor. 2.4 AGENCY RELATION Another service offered by the bankers to the customers is to collect the customers’ cheques and credit other instruments such as dividend warrants, interest warrants, pension bills etc. In these cases the relationship between the parties is that of a principal and an agent. The customer is the principal and the banker, the agent. In the day to day functioning, the banker renders many services to the customer viz., - buying and selling of stocks and shares on behalf of the customer; - collection of various types of instruments for and on behalf of the customer; - acting as executor and trustee of customer, acting as a representative to the customer, filing of I.T. returns of customer, executing the standing instructions of the customer. In performing these services the bank acts as an agent of the customer. The case of Travancore National And Quilon Bank [AIR 1940 Madras 139] dealt with an application for payment of a certain sum of money to the applicant in preference to the ordinary customer of the bank which went into liquidation. The applicant paid the amount to the bank on 20th June 1938; the day on which the bank suspended payment, for remittance as a telegraphic transfer to a company in Bombay. The remitter had 200 (Sys 4) - D:\shinu\lawschool\books\module\contract law

In Durga Lal Mohan Lal v. Governor General in Council [AIR 1952 590] it was held that if a bank received a crossed cheque from his customer for collection, the bank acts as a banker and an agent of a customer and not as a holder of the cheque in due course. But if the cheque is discounted or negotiated or purchased by the bank the property with it passes on to the bank. Then he becomes a holder in due course and ceases to be the customer’s banker or agent in relation to that transaction. The distinction between a banker who receives a cheque or instrument for collection and the bank which negotiates the cheque is different. In the first case the bank acts as an agent and in the second case the banker becomes a holder in due course. When the bank merely acts as a collecting agent he has no cause of action against the drawee bank if the drawee bank refuses payment. The cause of action remains with the customer. When the banker becomes a holder in due course he is entitled to sue under Section 131 of the Negotiable Instruments Act which protects the banker who in good faith and without negligence receives payment for a customer of a crossed cheque, when the title to the cheque proves defective. In the Indian Law a banker is deemed to receive payment for a customer even though he credits the customer’s account with the amount before receiving payment. Banker as an agent is bound to carry out the directions of his principal viz the customer and conduct the business of the agency with such skill as is generally possessed by persons engaged in similar business; unless the principal has notice of his want of skill. He should compensate his principal in respect of any loss incurred by his failure to carry out the directions of his principal or by his negligence in the conduct of the business of agency. Another recent case was decided by the Consumer Protection Forum of Mysore in 1990. In that case, a customer applied for

a draft from the branch of a bank in Mysore for remittance as examination fee, to appear for an examination conducted by the Chartered Accountants Assoicaiton. The branch issued the demand draft and the customer promptly forwarded the same to the Institute. The draft was returned by the paying branch for the reason that the demand draft was not signed by an authorised official of the issuing branch. The customer’s application to sit for the examination was rejected by the Institute as they did not receive the fee in time. The customer approached the Consumer Protection Forum and the forum awarded a compensation of Rs.30,000/- for the negligence of the bank and held that the bank in the instant case undertook an agency function and was negligent. The bank paid the compensation amount. The principle of law is clearly stated in the maxim - qui per valium - facit per seipsum facere videtur; that is “he who does an act through another is deemed in law to do it himself”. A reference to Article 63 in Bowstead on Agency illustrates that this principle - every agent who employs a sub-agent is liable to the principal for the money received by the sub-agent to the principal’s use and is responsible to the principal for the negligence and other breaches of duty of the sub-agent in the course of his employment. In Punjab National Bank Ltd v. R.B.L. Banarasi Das & Co [AIR 1960 Punjab 590] a reference was made to section 182 of the Indian Contract Act which defines a Principal and his Agent. The argument in the case was that the plaintiff bank was the agent of the defendant. Three cases of sub-agents are defined in the English Law. 1. Those employed without the authority, express or implicit, of the principal by whose acts the principal is not bound. 2. Those employed with the express or implied authority of the principal but between whom and the principal, there is no privity of contract. 3. Those employed with the principal’s authority between whom and the principal there is privity of contract, and a direct relationship of principal and agent is accordingly established. It was argued that the case in question fell under category (2) above and it was argued by the appellant that the case fell under category (3). It was stated that if a banker is dilatory in endeavouring to procure acceptance or payment or is otherwise negligent in doing the business of agency, and his customer suffers for the consequences, the banker would be liable to make good the customer’s loss. It is also well established that the collecting banker is under no special duty as such to protect the interests of the person to whom he presents a draft for acceptance or payment. Invariably, banks accept cheques or bills for collection only for its customers. But there are cases where the customers do not have accounts, at a particular bank in a particular place. In such cases, it is by custom that banks accept such instruments for collection. Being the first agents of the Reserve Bank of India, the State Bank group was the only bank where

Government/Treasury transactions were conducted. In many rural places, public, particularly contractors receive Government bills payable at the district treasury centres and apayble at the State bank group. The user public in such cases present the Government bill or cheque to the branch of the State Bank group to get them collected from the district headquarters branches and remit the proceeds by means of a pay order or bankers cheque. In such cases the bank (State Bank Group) acts as an agent to the tenderer/lodger of the instrument. A decision on this point is found in The Bank Of India v. The Official Liquidator [AIR 1950 Bombay 375]. In this case the customer had no account with the bank. The customer forwarded a cheque with a covering letter to the bank requesting to collect the proceeds and remit the same less their charges by a cheque in lodger’s favour on a bank at Bombay. It was held that the bank in the instant case acted only as an agent. 2.5 TRUSTEE RELATION The basic relationship between a banker and a customer is that of a debtor and creditor. In some cases, the relationship is that of principal and agent. The customer is the principal, and the banker is the agent. A third relationship of the banker as a trustee is also evolved. There are number of decisions both by the English and the Indian courts. For example, a remittance was sent to a banker with instructions to purchase shares of a company. Bank bought some shares, but before completing the rest of the purchase the bank failed. it was held that the bank stood in the position of a trustee to the remitter and, the remitter was entitled to a refund of the unspent balance. Where a banker pursuant to instructions, express or implied has credited the proceeds of a bill or other document entrusted to him for collection, the relationship of debtor and creditor arises from the time of his doing so. Where, the banker has suspended his business before receipt of such amount, he holds the money as trustee for his customer, irrespective of whether or not the latter has an account with him on the date of the receipt of the money and whether or not the money has been credited in that account. When a bank is appointed as a receiver by a court in a partition suit between the members of a Joint Hindu Family and the money received by the bank are deposited in a current account with itself, the bank is acting as a trustee for the amount. When the bank receives the money for a specific purpose or in a fiduciary capacity as in the instant case as a court receiver, the bank will be a trustee for the amount. Where a sum of money is paid to the general account of the customer with the direction that it must be applied in a particular manner as and when the occasion arises, until the said sum of money is appropriated in the manner directed, no question of trust would arise. In cases where the relationship is that of a trustee and beneficiary of the trust and the banks hold the money in a fudiciary capacity, it is the duty of the banks not to commit a breach of trust by putting the money contrary to the terms of the trust. 201 (Sys 4) - D:\shinu\lawschool\books\module\contract law

A customer of a bank having a deposit executed a power of attorney in favour of a third person to secure instruments at higher rate of interest. The amounts were withdrawn by the power of attorney holder to discharge his own debts to the bank. In such cases, the depositor can sue both the bank and the power holder and the power holder becomes a constructive trustee. Similarly where an employee furnishes security deposit for employment in banks a trustee relationship is created and the employee will be entitled to be treated as a preferential creditor for the security deposit in case the bank fails. The decision of the Supreme Court of india in New bank of India v. Peary Lal [AIR 1962 S.C. 1003] is notable. It was held - where a person dealing with a bank delivers money to the bank, the intention to create a relationship of creditor and debtor between him and the bank is presumed. But this presumption is rebuttable. Where money is paid to a bank with special instructions to retain the money pending further instructions or to pay over the same to another person who had no banking account with the bank and the bank accepts the instructions and holds the money pending receipt for instructions from that other person or whose instruction are given by a customer to his banker that a part of the amount lying in his account be forwarded to another bank to meet a bill to become due and payable by him and the amount is sent by the banker as directed, a trust results and the presumption which ordinarily arises by reason of payment of money to the bank is rebutted. Besides, being of the status of a trustee in these circumstances, a banker will also accept the role of an executor if appointed as such under a will or a trust. Executorship is a function which has, of late, become a growing business for the bank for good fee. 2.6 BAILOR - BAILEE RELATION One of the many services offered by a commercial bank is called safe custody facility. Bank accepts from its customers sealed boxes and packets for safe custody. In most of the cases the banker can open such safe custody articles, boxes or packets only as per the instructions of the person who deposits the same for safe custody. A customer may chose to keep with his bank his last will and testament. In such a case he may also instruct his bank to open the packet on receipt of the notice or knowledge of his death. And if in the will the bank is appointed by the deceased as his executor or trustee the bank will have to take care of the assets of the deceased and execute the will in toto. The contents of the safe deposit article are not made known to the bank and there will be a narration in the safe custody receipts issued by the bank ‘Received a `packet’, - `box’ contents not known”. The bank will also record the instructions of the customer in their books as well as in the safe custody receipt about the return/delivery of the packets-articles at a later date. It is usual and accepted practice for one bank branch at a centre to keep the duplicate keys of the safes and strong rooms of another bank branch at the same centre. It is also the practice for a bank branch to keep such keys at a branch in the same 202 (Sys 4) - D:\shinu\lawschool\books\module\contract law

centre or at a nearby centre of the same bank. In all such cases, the narrations in the safe custody receipts and the registers will contain the - “said to contain the duplicate keys deliverable against the joint signature of the branch manager and accountant/ cash officer”. The banks may or may not charge for such safe keepings. A customer who takes a fixed deposit from a bank may like to keep the receipt with his banker in safe custody for various reasons. The banks in India do not charge any fees for such safe custody. The depositors in such cases also instruct the banks to credit the periodical interest payable to his account. In all such cases bank as a matter of practice do not charge any fees for such safe custody. The legal relationship that arises in case of safe deposit or safe custody is that of bailment. The customer who deposits with the bank for safe custody is the bailor and the bank the bailee. Such safe custody should be under the condition that the article or property shall be returned to the bailor as soon as the purpose for which the bailment was created is over. The law of bailment is explained in the Indian Contract Act. Section 148 of the Contract Act defines bailment, bailor and bailee. A bailment is the delivery of goods by one person to another for some purpose, upon a contract, that they shall, when the purpose is accomplished, be returned or otherwise disposed of according to the directions of the person delivering them. In cases where the bank does not charge any fees for such safe custody, the bank can be termed as a gratuitous bailee. In cases where fees are levied, the bank becomes a bailee for reward. The distinction between these two types of bailment is that the gratuitous bailee must do his best with what he has got. He must use all the facilities he has to protect the goods bailed to him; but he is not bound to do more. He has to take the same care as he takes for his own property. He is not bound in law to provide at his cost the means of ensuing a higher degree of security for the articles deposited with him. As a bailee for reward, he is bound to adopt at his cost all appliances and safeguards he can procure. A banker obtains a mandate from his customer and if he complies with it, he runs no risk; if he does not, he may be at risk either on the grounds of negligence or conversion. In a bailment, the bailee may be made liable for want of care. The Supreme Court of India in United Commercial Bank v. Hem Chandra Sarkar [AIR 1990 SC 1329] decided the question of law, whether in the circumstances of the case the appellant bank was an agent of the respondent or a bailee in respect of goods entrusted for delivery to the respondent against payment. In 1945, Hem Chandra Sarkar was carrying on the business of wholesale and retail trade in textiles & yarn and cloth at Agartala. He was appointed as government nominee to indent and lift cloth and yarn to Agartala from mills in different parts of India. For the purpose of that business Hem Chandra Sarkar maintained a current account in the UCO Bank. The case of Sarkar was that there was an oral agreement on 2.9.1950 under

which the latter inter alia was to receive bills, documents and airway receipts sent by or on behalf of Sarkar from his agents or suppliers and would release and/or take delivery of goods sent by them, as and when goods arrive at Agartala.

observed that had the plaintiff paid the value of goods and that the bank neither delivered the goods nor rendered accounts, a fiduciary relationship could exist between the parties in respect of the goods for which value was paid by the plaintiff.

The bank would keep or hold the said goods stored in its godown for and on behalf and on account of the customer and for his benefit. It was also alleged by Sarkar - the plaintiff - that the payment of bills in respect of goods dispatched to the bank should be made by the plaintiff. He should be given the delivery of goods and air receipts by the bank according to his convenience and requirement. It was further stated that under the said terms and conditions, the banker consituted himself and acted as an express trustee and or agent of plaintiff in relation to the said goods and air receipts and stood in fiduciary relationship with the plaintiff.

The Supreme court held that the High court and trial court were not justified in holding that a fiduciary relationship had existed. This inference was drawn primarily from the debit entries in the plaintiff’s current account. The court also held that the bank took charge of goods, articles, securities as bailee and not as trustee or agent. Bailment is the delivery or transfer of possession of a chattel with a specific mandate which requires the identical ‘res’ either to be returned to the bailor or to be dealt with in a particular way by the bailee as per directions of the bailor. One important distinction between agency and bailment is that the bailee does not represent the bailor. He merely exercises, with the leave of the bailor, certain powers of the bailor in respect of his property. Secondly bailee has no power to make contracts on behalf of the bailor. Nor can he make the bailor liable simply as a bailor for any act he does. There was nothing to indicate that the bank represented the Calcutta parties or the plaintiff with authority to change the contractual or legal relationship of the parties and there is no justification to hold that the bank acted as agent of the plaintiff. The bank having received the price of the goods had failed to deliver the same to him. The banker being a bailee, either gratuitous or for reward, is bound to take the same care of the property entrusted to him as a reasonably prudent and careful man may fairly be expected to take care of his own property of the like description. In fact a paid bailee must use the greatest possible care and is expected to employ all precautions in respect of the goods deposited with him. If the property is not delivered to the true owner the banker cannot avoid his liability for conversion. The bank could not avoid liability to return the goods as agreed upon or to pay an equivalent amount to the plaintiff. Even if we assume that the goods were delivered to a wrong person, the bank has to own the responsibility to pay the plaintiff. The liability of a banker to a customer in such a case is absolute even if no negligence is proved.

Complaining non-delivery of goods even after receiving payment thereof, the plaintiff brought a suit for accounts, damages, compensation and delivery of goods or their equivalent in money valued at Rs. 2,68,198/97. The bank denied all allegations and claimed that it never acted as an agent, trustee or depositee of the plaintiff. The bank also denied the existence of any fiduciary relationship. The bank stated that certain parties from Calcutta were supplying goods to various parties including the plaintiff in Agartala and the bank used to send the bills along with the respective air bills to their Agartala branch for presentation to the drawees and the bank would deliver the same against payment. The bank maintained that it had dealt with all such goods of the Calcutta parties, recovered monthly charges at the instructions of the drawers and the drawee (plaintiff) and debited to the account of the plaintiff. When funds were not available in the current account of the plaintiff, the said charges were recovered from the drawers. The goods in the custody of the bank on behalf of the Calcutta parties which were paid for by the plaintiff would be delivered to the plaintiff and the goods for which no payment was made would be returned to the drawers. The trial court held that there was an agreement or arrangement between the parties regarding payment of bills or charges for the account of the plaintiff and regarding storing of the goods received by the bank in its godown, of which the plaintiff came to be the owner and for delivery of those goods as and when required by the plaintiff. The trial court also held that the bank acted as an agent of the plaintiff. In this suit, such agency of the defendant a relation of trust and confidence and the goods which came to be owned by the plaintiff on payment of the value thereof and which remained in the branch of the bank were impressed with trust for the benefit of the plaintiff and further that there was no escape from the conclusion that the bank stood in a fiduciary relationship with the plaintiff.

The court held that in practice the bankers do not set up the Statute of Limitations against their customers or their legal representatives and the court did not see any reason as to why this case should be an exception to that practice. In practice, if a current account or savings bank account is not operated by a customer for a period of three years, the bank transfers the balances in such accounts to another account called inoperative account. Operations after that period are permitted only after making reasonable enquiries and verifying carefully the signature of the customer.

Accordingly, the trial court decreed the suit in part directing delivery of goods or the value equivalent to Rs. 1,26,500/-. A commissioner was also appointed by the court to take accounts.

If the accounts are not operated for 5 to 7 years, the balances are transferred to the unclaimed deposit account. The law and instructions also provide that the balances unclaimed over a period should be transferred to the Central Government. However, in practice it is seldom done.

The High Court of Calcutta confirmed the decree of the trial court. As to the question of legal relationship, the High court

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contracts to cover their exchange risk etc. It is not mandatory on the part of the banks to render such advices. Banks also do not incur any laibility on such advices. Another service that the banks offer is the hiring out of Safe Deposit Lockers. The bank charges according to the size of the lockers. Many bank branches particularly in metropolitan and urban towns provide this facility to customers. This facility is provided only to those who have accounts i.e., customers. In view of the risks involved in keeping valuables at residences many people utilise these services. These lockers can be opened only by operating two keys successively. One key will be with the customer and the other with the bank. The locker agreement is legally drafted and contains clauses exonerating the bank. However, when operation in the locker takes place, the practice provides sufficient precautions to the banker. The bank obtains the signature of the customer in a format and verifies the same. The time of operating is also recorded in the format and in a register kept with the bank. There is ample security. The locking system of the vaults is such that the key of the banker is not required to lock the vault. If the customer closes the door and locks, the bank cannot again open the same without the customer again operating his key. Banks also take care to ensure that the locking system is also changed periodically. In short, the legal relationship in this case is that of a hirer and hiree. Many banks use the locker facility for deposit mobilisation. The bank insists that the customer should deposit a fixed amount in term deposits for availing a locker facility. As the bank hires out lockers only to customers, it obtains a mandate from the customer to debit his account for the periodic rentals. 2.7 OTHER SERVICES The other services commonly utilised by the customers are : 1. Collection of cheques and bills, inland and foreign. 2. Discounting of cheques and bills, inland and foreign. 3. Remittance of funds a) by issue of drafts b) mail transfers/telegraphic transfers. 4. Acting as executor and trustee. 5. Issue of travellers cheque. 6. Rendering credit information. 7. Rendering trade information. 8. Issue of letters of introduction. 9. Issue of letters of credit, inland and foreign. 10. Providing letters of comfort. 11. Providing training facilities 12. Technical advices, project appraisals. 13. Managers of Public Issues. Acting as bankers to issue and for payment of interest/dividend warrants/under writers/ syndication of loans etc. 14. Collection of periodical interests on various types of instruments. 15. Acting as insurance agents/travel agents. 204 (Sys 4) - D:\shinu\lawschool\books\module\contract law

16. 17. 18. 19. 20. 21. 22. 23. 24.

Purchase and sale of shares and securities for customers. Factors. Collection of Pensions. Credit cards. Teller Facility Providing a linked Computer Terminal to the customer Providing Credit (loans) to customers Agents to execute standing instructions. Advisor to customer for personal investment.

1) Collection of Cheques and Bills The bank acts as a collecting agent of the customer to realise the proceeds of cheques and bills tendered by the customer payable within India or abroad. In addition to the actual out of pocket expenses the banks charge a commission at a graduated scale for rendering this service. The legal relationship that arises out of this transaction is that of a principal (customer) and agent (bank). If the cheques and bills thus sent by bank to its own branches or to their correspondents are returned unpaid, the bank returns the same and charges a commission for its service. 2) Discount/Purchase of Cheques/Bills To discount a cheque or bill for a customer is a credit decision. This facility is not extended to all customers. The facility is extended only when the bank is sure that in case the cheque or bill is returned unpaid, there will not be any difficulty to recover the amount from the customer. In most of the cases the banks appraise a proposal for a regular cheque or bill discounting facility with reference to the credit worthiness, financial standing and financial position with reference to the balance sheet. Regular limits are then sanctioned to the customers. Suitable documentation is done before the extension of the facility. The banker becomes a holder for value when he discounts or purchases cheques or bills. 3) Remittances The customers in all segments, whether he is an individual or one in business very often require this facility. They require their monies to be transferred from one station to another within India or abroad. The postal department of the Government of India undertakes money transfers by money orders. However the charges are very high compared to banks. There is also a limit as to the amount that can be sent by money order. a) Issue of Bank Drafts The banks issue demand drafts payable to the person mentioned by the applicant to another branch of the same bank or to another bank with whom the bank has correspondent relationship. These demand drafts are for value received. The applicant has to remit the money or authorise the debit of his account with the bank. It is payable to or to the order of the payee. These are transferable by endorsement and delivery. If the draft is crossed

“Account Payee” then it loses the character of transfer by endorsement and delivery. These drafts are handed over to the applicant of the draft/customer, by the bank and are forwarded by the applicant/customer directly to the beneficiary of the draft. In case of loss of a draft, there is a provision for issue of a duplicate draft on the purchaser furnishing an indemnity to the satisfaction of the bank, for any loss or damage the bank may incur in case the original is also presented at the paying end. Generally, banks obtain a confirmation from the paying branch/ bank, that the draft has not been paid and they have noted to stop payment if the original is presented for payment. As the banks exchange the drafts for value received they charge exchange as remuneration at a graduated scale. This is an agency service. b) Mail/Telegraphic Transfers These are generally made between the branches of the same bank or that of a bank and its correspondent bank branch. Unlike demand drafts these are not handed over to the customers. Banks themselves undertake the work and charge an exchange at a graduated scale to the customers/applicant’s account. The mail transfer system is ineffective as there is undue delay and generally the purpose for which the amount is transferred becomes frustrated on account of the delay. In the case of telegraphic transfers also there is a system of bunching the telegrams and telegrams generally leave the bank branch only after 5/6 p.m. This is also another agency function. 4) Executor and Trustee This service has its origin to the colonial rule. People who execute wills and keep the same in the custody of banks authorise the banks to open their sealed envelopes containing the wills on receipt of the notice of the death. The bank is instructed to act as a trustee to execute the terms of the will. 5) Travellers Cheques Whenever a person/customer does not want to carry cash while on travel, he/she avails of this facility. Banks on receipt of cash issue the travellers cheques which are payable at all the branches of the bank in India and at the offices of the encashing agents appointed by the bank. Before issuing the travellers cheques the bank obtains the signature of the applicant on the face of the cheques itself. At the time of encashment, the holder has to sign again on the face of the cheque at another space provided for the purpose. Foreign Travellers cheques are also payable by banks in India. On account of Exchange Control Regulation, Indian banks issue foreign travellers cheques subject to various guidelines issued by the Reserve Bank of India. When the Indian rupee becomes fully convertible we can hope that the banks in India will also issue travellers cheques payable abroad across the counters of foreign banks. There is provision for issue of duplicate travellers cheques, in case of loss. Banks issue travellers cheques without any charges. This is because banks could utilise the money in the pipeline.

This is an agency function. 6) Credit Information This is also a service function where the bank obtain from another centre in India or abroad about the standing and credit status of a customer. The banks issuing such information and the banks who obtain the information on behalf of a customer do so without any responsibility about the correctness. Only broad advices such as ‘good’ for the transaction or the ‘customer is having a nominal account’ etc are given. The necessity for this information arises from the fact the customers at two centres do not know each other. The necessity arises out of trade transactions where the customer at one place wants to send goods to a customer at another place on credit basis or on the basis that the bills will become payable only after certain number of days, after acceptance. Banks call it ‘credit report’, ‘opinion report’ or ‘status report’. 7) Trade Information This service also does not attach any responsibility for the bankers. Bankers by practice have a bundle of information about a particular trade, a particular country and the political stability of another country. To encourage exports, banks whenever a customer asks for, furnish or obtain from various sources, this type of information to their customers. 8) Letters of Introduction Whenever a customer wants to open another account at another centre, the banks insist on a letter of introduction. Further, when V.I.P. customers visit another place or country such letters will be of great help to the customer, not only to open an account but also to obtain information from the other banks to know the customers, trade practices etc. This is also a service function done without any cost. 9) Letter of Credit When two unknown parties transact business without knowing each other, the buyers require this facility. Issue of Letters of Credit is essentially a credit decision. The issuing bank undertakes the responsibility to honour the bills drawn by the seller and pay to the seller’s bank, provided the documents are drawn strictly in conformity with terms of the letter of credit. Bank charges a commission for this facility and issues letter of credit only after satisfying itself that the customer will have the resources to honour when the bills are presented to him by the seller’s bank. Here, although it is a financial service, the relationships between the opener of the letter of credit and his banker can become a debtor creditor relationship. 10) Letters of Comfort Valued customers often approach their banks for this facility. Such valued customers often require the import of heavy machinery and the seller of the machinery in a foreign country requires a letter of credit or guarantee for payment before shipment from a first class banker in the buyer’s country. In many cases sanctions from the Government may not have been 205 (Sys 4) - D:\shinu\lawschool\books\module\contract law

obtained but would have been applied for by the customer. In the meantime, the seller from abroad will be threatening the buyer customer that if he does not receive the letter of credit within a stipulated time, he will cancel the contract.

constant attention and is a time consuming procedure if the interest to be collected is of a Government security. Even without keeping them in safe custody, banks undertake to collect interest for its customers.

In such cases the banks issue a letter of comfort to the supplier of machinery stating that an unconditional letter of credit will be issued on production of the required Government permission. This practice is prevalent more widely in foreign countries. This is a modern development and issue of such letters of comfort is basically a credit decision of the bank issuing the same.

A commission is charged on the transaction.

11) Training Facilities With the emergence of modern trends, banks in India and abroad offer this service to their customers and correspondents with or without any fees. Underdeveloped countries, mainly from Africa, utilise these services from banks in India. From India, bank officials are deputed to first class banks abroad for this purpose. Banks in India also undertake to depute their officers abroad to manage banks in their countries as per joint venture agreements.

15) Acting as Insurance Agents/Travel Agents Some banks take agency of Life and General Insurance as well as an agency from the Airlines. In recent times these facilities are not utilised by the bank’s customers as the service from the banks is not upto the customer’s expectations. And, insurance and travel companies have widened their network of agents. 16) Purchase and Sale of Shares

In many cases banks also conduct seminars, meetings and training programmes for their customers and prospective customers.

Banks undertake on behalf of their customers to purchase and sell shares. This function is an agency function. Banks are not till now members of Stock Exchanges but their merchant banking subsidiaries may become members. Banks place their customers orders through brokers approved by the bank. Banks before entering into purchase transaction on behalf of the customers ensure that the customer has the capacity to pay for such purchases. The banks do not speculate on shares but only carry out the orders placed on them by their customers.

12) Technical Advice, Project Appraisals

17) Factoring - Forfeiting

On account of experience banks achieve the capacity to render technical advice. After all the success of any project depends upon the technical feasibility and economic viability of the project. The technical inputs, the type of machinery and the technology to be used for a viable or profit making proposition is advised by the banks to its customers. With the resources available at the disposal of the promoters banks render technical advices and appraises the projects so that the projects are technically feasible and economically viable. This is an agency function and banks charge a fee. 13) Capital Market Functions This is also an agency function. The banks after appraising the projects advise the customers as to how to go ahead with the financial structuring and requirements of the customers. They advise the customer about the lines of credit available to the customer. They agree to underwrite a portion of the public issue if the customer chooses to go to the public for subscription. If the public response is not good, the liability under the underwriting the shares will devolve on the bank. In case where banks appraise and underwrite they agree to act as registrars to issue. They collect the public money through their branches. After the issue is closed they advise the customers about the total amount collected. 14) Collection of Periodical Interest on Various Types of Securities This function and the legal relationship have been already dealt with in detail. This service is rendered only to customers. Customers keep their Government bonds, debentures of companies, fixed deposit receipts of its own or of other banks in safe custody. The collection of periodical interests require 206 (Sys 4) - D:\shinu\lawschool\books\module\contract law

This is also of recent origin. Following the success of the scheme abroad the Government of India/Reserve Bank of India permitted the opening of State Bank of India/Factors Ltd and Canara Bank Factors Ltd. Both have not made any headway. In factoring the factor, that is, the banker purchases the book debts of a company at a discounted price. In the case of bills payable abroad the service is called forfeiting. The bank becomes the sole owner of the factored debt. In almost all business transactions in U.S.A., these services are very much in use by the businessmen. The relationship is that of buyer and seller between the bank and its customer. 18) Collection of Pensions The collection of pension amount from the Government Treasuries used to be agonising for the pensioners. They were required to go and stand in long queues. Banks undertake, as agents, the collection of Government or other pensions and charge commission for this agency transaction. 19) Credit Cards This is known as ‘plastic money’ abroad. Again, this is an agency facility provided by the banks. The banks depending on the value of the customer’s accounts issue what is called a credit card. These credit cards enable the holder to purchase within India or a specified area anything and everything from shops and business houses authorised by the credit card issuing bank or organisation. The shops and business houses are provided with a decoder in most of the cases to prevent the unlawful use of this facility. The shops and business houses claim the amount of the bills from the issuing banks or credit card issuing organisations. The service is charged at periodical intervals.

Most of the credit cards used by Indian banks have not met with success. However the most popular cards are that of Citibank, American Express and Master Cards. A Plastic card with the name and a code number is provided to the customers. In some cases customers photograph is also affixed on the face of the cards. Banks in India issue their credit cards only to customers with whom they are confident that there will be no difficulty to realise the amount. 20) Teller Facility / Automatic Teller Machines One of the services for quick customer service followed by banks in India is teller facility. The banks have provided teller counters at many of their branches. The teller - the official of the bank - sitting on the teller counter pays on presentation of the cheque immediately without verifying whether the customer’s account has a credit balance. There is a restriction as to the amount that can be encashed at the teller counter. Abroad when customers find it difficult to visit a bank branch to encash a cheque they have the facility of access to Automatic Teller Machines. ATMs are unmanned computer terminals which facilitate cash withdrawals and deposits. These machines are installed at various important places of the city or town by the banks and are connected through cables to the main computer at the bank. The banks upon request provide a secret code number to the customers. The customers can themselves operate these machines installed in the booths. The machine checks through the computer whether the customer has sufficient balance. If there is balance, currency will come out through a slit in the machine. The service is available for 24 hours through all days and there is no holiday for the machine. In India, the machines have not become popular for want of branch computerisation. Hongkong Bank, ANZ Grindleys Bank and Citibank have installed ATMs in Bombay, Bangalore and other cities. This is only an added facility to the customer and the debtorcreditor relationship very much exists in this type of transactions. 21) Customer’s Computer Terminal Banks abroad connect a terminal of their computers at the desk of their customers. The customer will have access to his account ONLY with the branch. The customer can find out by operating their computer terminal connected to the bank, the balance in his account at any point of time and the status of other transactions. Banks in India have also started extending this facility to customers who can bear the charges of a dedicated telephone line. However the progress in this regard in India is tardy as branch mechanisation has not progressed; partly due to Government policies and partly due to opposition from strong trade unions in the banking industry. 22) Provider of Credit After collecting the deposits banks must deploy these funds effectively and profitably. Till 1980, more precisely till the nationalisation of the banks, banks were security oriented in

their approach for sanctions of loans. There was no social obligation on banks. Various schemes have come into force during the last decade to promote social justice, for creating job opportunities etc. The legal relationship between the borrower customer and the lender banker is - that of customer and banker ‘reversed’. In case the customer becomes the borrower and the banker the lender naturally the bank becomes the lender and the customer the borrower. A galaxy of loan schemes are available in India at the hands of the banks. As this paper is not intended to explain those schemes, it is sufficient to understand that the bank in all loan transactions is the creditor and the borrower customer the debtor. 23) Standing Instructions Customers often expressly instruct the banks to execute their instructions for periodical payments. These are called Standing Instructions. Periodical payments of premium on insurance policies, remittance of funds to friends or relatives, remittance of money to other banks/its own other branches, to debit his deposit account and remit periodically to their loan accounts are the main features covered under this standing instruction. The legal relationship is that of agency. 24) Advisor to customer for perosnal investment One of the important functions of a modern banker is to advise its customers to invest his/her savings in such a way so as to maximise the return with highest security. Three concerns of an investor are: (1) security of the investment, (2) liquidity of the investment, and (3) yield of the investment. Therefore the matter of investments has become a very complicated affair for any ordinary investor. A banker been a professional financial manager gives advice to his/her customer in the proper deployment of his/her savings. A proper development of this concept has given rise to portfolio management functions of a bank and these led to a separate institution of mutual fund. Many of the commercial banks in India have already established their mutual funds. SUMMARY From the above paragraphs it is clear that the general relationship between a banker and his customer is that of a debtor and creditor. However this statement is subject to a number of super added obligations, one of which is that the bank will honour its customer’s cheques, provided that the account has sufficient credit balance; and an obligation on the part of the bank that it will not return the customer’s cheques for want of funds provided sufficient balance is available in the account. In addition, many specialised services are undertaken by the bankers arising from specific provisions in a contract ; and their contents give rise to various other relationships such as principal and agent, trustee and beneficiary, bailor and bailee. The range of services are ever expanding and the relationship can be decided only in the light of the facts as they exist and on the terms of the contract. 207 (Sys 4) - D:\shinu\lawschool\books\module\contract law

3. SPECIAL CATEGORY CUSTOMERS SUB TOPICS 3.1 Limited Companies 3.2 Partnership firms 3.3 Joint Hindu Families 3.4 Minors 3.5 Illiterate persons 3.6 Trust 3.7 Executors & Administrators 3.8 Unincorporated bodies 3.9 Joint Accounts 3.10 Liquidators 3.11 Mercantile Agents 3.12 NRI 3.13 Foreigners 3.1 ACCOUNTS OF LIMITED COMPANIES The accounts of the limited companies form a large and major portion of the business of the banks. In India, the formation and conduct of the companies are governed by the Companies Act, 1956 and in the U.K. by the Companies Act of 1948 and 1967. Most of the provisions of the Indian law are based on the British law. When limited companies approach a bank to open an account, whether as a depositor or as a borrower the following formalities are to be complied with. 1) An account opening form for the purpose (different one in the case of limited companies) duly completed. 2) A certified copy of the Memorandum of Association and Articles of Association. 3) A certified copy of the Certificate of Incorporation issued by the Registrar of Companies. 4) Certificate of Commencement of Business where applicable, i.e., only in the case of public company. 5) A certified copy of the resolution to open the bank account at the bank branch certified by the chairman, or secretary or a principal officer of the company. Generally, this resolution is printed on the reverse of the account opening form and the company need only submit the same duly signed by the person who acted as the chairman at the meeting after passing the resolution and after affixing the company seal. The account opening form also mentions the name of the persons authorised to operate the account either singly or jointly and has to be signed by the persons authorised to operate the accounts. Some banks obtain the specimen signature of the persons authorised to operate in a separate specimen signature card. In practice, the banks enter on one side of the ledger and in a register the important provisions of the Memorandum and 208 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Articles of Association of the company. As per Company law, the Memorandum and Articles of Association are as it were, the boundaries within which the companies can operate. It is fundamental and except in certain cases it is unalterable in law. The Articles of Association contain the regulations which control the internal management of the company. The Articles and Memorandum can be altered by the provisions contained in the Companies Act. Any person dealing with a company is supposed to know the provisions of the Memorandum and Articles of Association. The position of the banker vis a vis the Memorandum and Articles of Association become more important when the bank is a lender to the company. The banks must ascertain from Articles that the directors have necessary powers to borrow. In cases where the bank deals with a company in accordance with the Memorandum and Articles of Association and has complied with the other requirements, then the bank is not concerned with the internal management of the company. There may be irregularities in the appointment of directors and passing of various resolutions. It is not the liability of the banker to verify the correctness of these matters. Two British cases deal with the doctrine of indoor management. One is the rule in Turuquand’s case [Royal British Bank v. Turuquand (1856)-6 E & B - 327]. A person may be acting as a managing director, but in fact he may never have been appointed as a managing director. In Mahany v. Liquidator of East Holyford Mining Company [(1975)L.R.7 H.L. 869] the House of Lords applied the rule. A mining company was formed and it issued shares. The proceeds were credited to the bank account. No meeting of the directors were held and no proper appointment of directors and the company secretary was made. A formal notice was sent to the bank by a person signing as secretary, authorising the bank to pay cheques signed by the two of the three directors and counter signed by the company secretary. A copy of the alleged resolution authorising this arrangement was also sent to the bank. Cheques were drawn in this way and the balance disposed off. The liquidator sued the bank. It was held by the House of Lords that there was no duty on the bank to inquire whether the directors and the secretary were properly appointed. The fact was that the persons making the representations were those who, under the constitution of the company were entitled to appoint the directors and the secretary. They had actual authority to make representations as to who the officers were. In this case it was held that the bank was not affected by these internal irregularities and that there was no duty on the bank to enquire whether the directors and the secretary had been really appointed. Lord Hatheler stated - when there are persons conducting the affairs of the company in a manner which appears to be perfectly consonant with the Articles of Association, then those dealing with them, externally, are not affected by any irregularities which may take place in the internal management of the company. The banker need not “pierce the corporate veil”.

This rule is sometimes known as the Doctrine of Indoor Management or the rule in Turuquand’s case as it was first laid down in the Turuquand’s case. It is also referred to as the rule in Mahany’s case.

Any change in the operation of the accounts with the bank should be supported by proper resolutions.

In Turuquand’s case, the company was authorised by its deed of settlement (Memorandum and Articles of Association), to borrow money through its directors, such sums as might be authorised by a resolution passed at a general meeting of the company. The company arranged to borrow 2000 pounds from the plaintiff bank and gave the bank a bond for the amount, under seal and signed by two directors. The bank sued the defendant as the official manager of the company, to recover the loan. It was contended for the company that there was no resolution passed in the general body meeting and that the bank cannot recover.

The law relating to partnership is dealt with in detail in the Indian Partnership Act. That Act deals with the relationship, the rights and duties of the partners vis a vis themselves and vis a vis the outside world. For the sake of brevity it is not proposed to deal in detail that Act. At this juncture, the salient features of the Act laid down that the liability of the partners of a firm is joint, several and not limited to the extent of capital invested by the partner.

It was held by the Court of Exchequer Chamber that as the power to borrow money on bonds was not inconsistent with the provisions in the deed of settlement, banks were entitled to assume that the necessary resolution has been passed by the share holders. The relationship between the bank and the company is contractual. The rule in Turuquand’s case is important when the bank opens an account for a company, and accepts the company as its customer, and later on when the company repudiates the power of the persons who opened the account for the company. However, there are many exceptions to this rule. 1. The rule is not applicable in cases of forgery. In Ruben v. Great Finga [(1960)- A.C. - 439] it was held that when a document purported to be signed or executed by the company is a forgery, the rule is not applicable as the forged certificate is a pure nullity. 2. In Kredit Bank Cassel v. Shenkers Ltd [(1927) 1 Q.B. 826] it was held that the rule in Turuquand’s case may not apply if a document signed by a person was purporting to be on behalf of the company, is signed in excess of his actual or ostensible authority. 3. In cases where the circumstances are such that the person dealing with the company has been put to enquiry and should have made the inquiry but fails to do so, the rule will not apply. A limited company is a legal entity. It has no body or soul of its own. It is an artificial personality. It may be a private limited company or a public limited company, it may be a company limited by guarantee, a Govt. company, a company incorporated under statute. In case the company becomes a borrower of the bank, the banker has to satisfy that the company has power to borrow and that the directors do not act ultra vires the Memorandum and Articles. The Companies Act provides that certain charges should be registered with the Registrar of Companies. Banks may conduct a search in the books of the Registrar of Companies to find out the existence of any previous charge and, if so, the nature of the charge.

3.2 ACCOUNTS OF PARTNERSHIP FIRMS

In case a partnership firm approaches a bank to open an account, the bank generally calls for a certified copy or the original of the partnership deed and notes the salient features to the deed in their books. In some cases, all the partners may not have the right to operate the bank accounts as they will be dormant partners. The bank records in the account opening form in one column the signature of all the partners and in another column the signatures of those who are authorised to operate the bank account. In case the partnership is not reduced into writing, the banks go by the words of the partners. There are instances where the partnership is registered and it is considered advisable to obtain the original of the deed by the banks and are returned to the partners after recording the same in the books of the banks. The important points that the bank has to note are : 1. In a firm’s account, one partner has a prima facie right to draw cheques in the firm’s name. One partner has the implied authority to bind the firm by cheques so drawn. 2. In the absence of any custom or usage of the trade to the contrary, the implied authority of a partner does not empower him to open a banking account on behalf of the firm in his own name. 3. Banks do not accept for the credit of the personal account of a partner, cheques payable to his firm. The bank can do so after enquiring with the other partners. Bank will otherwise be liable to what in law is known as “conversion”. 4. One partner has the authority to stop the payment of a cheque drawn in the name of the firm by another partner. 5. The death or insolvency of a partner automatically dissolves the firm. But the partnership deed may provide that as a result of the death of a partner or on account of the insolvency of a partner, the firm may not be dissolved if there is an agreement to that effect between the partners. A partnership is automatically dissolved. a. by the adjudication of all the partners or of all partners but one as insolvents. b. by the happening of any event which makes it unlawful for the business of the firm to be carried on or for the partners to carry it on partnership basis.

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When there is a change in the constitution of the firm on acount of the death or insolvency, the partners are liable for a debt incurred by the firm before the partner’s death or insolvency, but not for a debt incurred after the death or insolvency. If on a date the bank has notice of the death or insolvency of a partner and there is a debit balance in the account, the banks close the account of the firm and open a fresh account as per the terms of the deed. It is the duty of the surviving partners to give notice to the bank about the death of a partner. 3.3 ACCOUNTS OF JOINT HINDU FAMILIES The concept of Joint Hindu Family is peculiar in India only. The concept has almost vanished after the passage of the Hindu Succession Act, 1956. However there still exist some Joint Hindu families. The banks generally follow the under noted precautions while opening such accounts. a.

A Joint Hindu Family letter is obtained.

b. Proper introduction. c.

The account opening form is signed by the Karta and all adult (major) coparceners.

d. If there are minors the other adult coparceners should sign for self and as guardian of the minor/minors. e.

The Karta is given authority to operate the account by all the corparceners.

A reference should be made to the Hindu Minority & Guardianship Act also. 3.4 ACCOUNTS OF MINORS As per the Indian Contract Act, a minor is under a legal disability to enter into a contract in his own name. There are various laws for the protection of the minor. However, an account can be opened on behalf of a minor by the natural guardian or a guardian appointed by the court. The Contract Act provides that a minor may draw, endorse, deliver and negotiate such instrument so as to bind all the parties except himself. The banks insist on knowing the date of birth of the minor and diarises the same, and records the same in the account opening form. The capacity thus conferred on a minor to draw a valid cheque provides an exception to the general rule that in India a minor’s contract is ab initio void. A person is a minor till he attains the age of 18 years. A person whose person or properties are in the superintendence of a person appointed as a guardian by the Court of Wards, then the person is deemed to have attained majority only when he completes 21 years. In India banks open accounts for minors. In the present day many bank branches operate in colleges or have their Extension Counters in the campus. Accounts are opened for students who 210 (Sys 4) - D:\shinu\lawschool\books\module\contract law

stay in hostels, for studies. The following points are note worthy: a) A minor can open and operate a bank account. b) The bank should make clear the implications of opening an account to a minor. And should exercise sufficient care while the minor operates the account. c) The bank should not permit the minor to overdraw his account. d) The banker should exercise caution while credit for large sums and debits for large sums are transacted in the minors account. e) A minor can validly draw a cheque and if there is a wrongful dishonour or wrongful payment for example payment of a forged cheque, the minor can sue the bank for wrongful dishonour and for damages. f)

The age of majority of a non-domiciled minor is decided by the law of the country where the minor is domiciled.

g) The practice relating to secrecy of customers account equally apply to minor’s accounts also. h) With the limited capacity of the minor to contract, there must be ability to comprehend, before the bank can safely accept him as a customer. At what age this comprehension is present on a minor depends on the individual, but the burden of proof would be probably on the bank to show that requisite conditions were present. 3.5 ACCOUNTS TO ILLITERATE PERSONS In a vast country like India which ranks as the world’s second largest in population, there will be a large number of illiterates. Such persons approach the banks to open accounts, and the illiteracy is not considered as an incapacity to open bank accounts. The banks in India particularly after nationalisation of the major banks have embarked upon various loan schemes for the upliftment of the illiterate rural folk. The precautions taken of the bank include1. Obtainment of left hand thumb impression of the account holder in place of specimen signature. 2. The bank affixes the photograph of the customer on the customer’s pass book as well as in their ledgers. 3. The account should be conducted by the illiterates in person. 4. Thumb impression is obtained in all pay-in-slips, withdrawal forms, cheques etc., as in the case of signature for literate accounts. 3.6 TRUST ACCOUNTS Banks permit the opening of trust accounts. A certified copy of the trust deed is obtained and kept along with the other formalities file relating to the account. The bank calls for the original of the trust deed and enters the salient features of the trust deed in their books. The bank opening the trust account

should be conversant with the provisions of the Indian Trusts Act 1882. Banks permit the operation of the trust account by some or all trustees; if the trust deed provides specifically for such operations or confers general authority on the trustees to delegate their powers to some or one of them. In the absence of such a provision all trustees have to operate the account jointly. Some banks permit the operation by some or one of the trustees after obtaining suitable indemnity from the other trustees if the trust deed does not have such a provision regarding the operation. Banks take more than ordinary care in the conduct of Trust Accounts. The banks have to ensure that they do not become a party to any breach of trust. When the bank becomes a party to a breach of trust, it becomes answerable to the beneficiary of the trust. An account even if it is not opened as a trust account, if there are indications to the bank that the balance in the account is held by the depositor as a trustee, the account becomes mulcted with trust. Cases may arise when one or some of the trustees have overdraft accounts at the bank where the trust account is also maintained. Bank has no right of set off between the personal account and trust account. A trustee has to deal with the trust property with the sole purpose of fulfilling his obligations according to the terms and conditions of the trust and as carefully as a prudent man would deal with his own property. Violation of his duty is termed breach of trust and the beneficiary can hold the trustee personally liable for any loss that he may suffer due to such breach. A trust deed may be written or oral, may be express or implied, may be specific or constructive. Generally, a trust deed is translated into writing. Sometimes an inference of a trust may be made from the circumstances. The person who creates the trust is called the author of the trust and the trustees are those on whom the author reposes confidence, that they will execute the terms of the trust without any breach. When the trust account is opened the trustees become bank’s customer and such a relationship starts with the bank. The bank should take care to see that the account is opened and operated as per the terms of the trust deed. To open a bank account, the trustees should pass a resolution specifically and submit it to the bank. In case the trust deed contains a specific provision that prohibits the operation of the bank account on the death of one of the trustees, the bank should stop operations immediately on receipt of the information of the death of the trustee. However, in cases where the trust deed does not contain such a provision and the deed is silent, the bank can allow the surviving trustees or the last surviving trustee to operate the account. Appointment of several trustees by the author of the trust is to ensure that the trust properties are managed under a combined control. A trustee has also no authority to delegate the power

he derives from the trust deed. The authority of the trustees to borrow is also limited. In case the borrowings by the trustees are ultra vires the deed, the bank loses the right of recovery. A will or trust deed will give authority to the trustee to carry on a business for the benefit of the beneficiaries of the trust. The trustees may borrow for the said purpose and charge the assets forming part of the trust estate. Unless the trustees have fulfilled their duties as executors and paid the debts of the testator, the latter’s creditors will rank before both the indemnity of the executors (the right to be exempt from the liability of their act in continuing the business) and the mortgages of the estate. It is essential therefore, where bankers are asked to lend against assets of the estate for the purpose of enabling the executors to carry on a business, that they ensure that the debts of the testator have been paid. This applies only to the creditors of the testator, not to those of the trustees, and only where the business is carried on for the purpose of effecting a sale for winding up. Nevertheless, the executors have the power to borrow and mortgage for purposes of winding up. 3.7 ACCOUNTS OF EXECUTORS & ADMINISTRATORS In law, the succession can be testamentory or intestate. In cases of testamentory succession, a person executes a will and prescribes in the will how his properties after his death will have to be partitioned or dealt with. In many cases the will provides that certain person or persons should execute the terms of the will after his death. The persons authorised to execute the will are called the executors of the will. Where no executor is mentioned in the will, the court will appoint one of the beneficiaries of the will as administrator. The executor and administrator of the will, as the case may be, may have to open a bank account after the death of the testator, either in the name of the trust or in their own names in their personal capacities. They have to make it clear that the accounts are opened and operated for and on behalf of the deceased. In case of doubt as to the genuineness of a will or the persons claiming to be executors or administrators, the banker may demand to be shown the probate or letter of administration, as the case may be. On application by an executor, court issues a probate proving the will and a letter of administration confirming appointment of the administrator. The executors and administrators have no power to delegate their authority. But they can appoint attorneys or other professionals to do their work or for some professional services. In case the bank knows that the funds deposited belong to a trust and are being misapplied, the bank cannot escape the liability. Banks follow the undermentioned precautions: a) A proper introduction to open the account. b) The will should be properly examined to ensure the terms and powers of the executors and administrators. 211 (Sys 4) - D:\shinu\lawschool\books\module\contract law

c) All the executors must sign the account opening form and give a clear mandate for the operation of the account. d) The cheques and instruments tendered to the bank should contain the style of the account and should contain a notation that it is and on behalf of “................”. e) The particulars of the will or probate should be recorded in the banks’ books. f)

The trust accounts should not be opened in the personal names of the executors or administrators.

g) The banks should ensure that they do not become parties to a breach of trust. h) The cheques drawn by one of the trustees can be stopped by another. i)

The banks have no right to set off the credit balance in the trust account against any dues from the administrators or executors.

j)

The executors account is for a limited period that is till the terms are executed.

3.8 ACCOUNTS OF UNINCORPORATED BODIES, CLUBS, SOCIETIES, COMMITTEES, ETC. These bodies are not legal entities as limited companies are. Nevertheless, banks open accounts for them. These bodies have their own bye-laws and have their executive committees or boards elected by the members. For opening account for a cooperative society, the permission of the Registrar of Cooperative Societies is essential. The following formalities are observed by banks while opening accounts. 1. An introduction before opening the account. 2. Account opening form for the account duly filled up. 3. Copy of the resolutions of the committee or governing body, signed by the Chairman, for opening the account. 4. Copy of the bye laws. The bank has to stop the operation of the account when it receives a countermand order. Where one of the signatories dies, bank suspends the operation of the account till a new member is elected and his signature recorded at the bank. In this connection, it is interesting to recall a quote by Lord Lindley in Wise v. Perpetual Trustee Co. [(1903)A.C. 139] “Clubs are associations of a peculiar nature. They are societies, the members of which are perpetually changing. They are not partnerships; they are not associations for gain; and the feature which distinguishes them from other societies is that no member as such becomes liable to pay to the funds of the society or to anyone else any money beyond the subscriptions required by the rules of the club to be paid so long as he remains a member”. It is upon this fundamental condition, not usually expressed, but understood by everyone, that clubs are formed; and this distinguishing feature has often been judicially recognised.

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3.9 JOINT ACCOUNTS/NOMINEE ACCOUNTS Generally banks permit the opening of Joint Accounts. Over the years, on account of the changes in the bank’s policy for and a shift from class banking to mass banking, several problems have arisen for the banker and customer. In case of joint accounts, banks are strongly advising the customers to make such accounts as ‘Either or Survivor’ or ‘Former or Survivor’. In the case of ordinary joint accounts, without ‘Either or Survivor’ or ‘Former or Survivor’ clause, the difficulties start after the death of one of the joint account holders. Although the bank may be right in paying to the survivor, the legal heirs of the deceased can create problems. Further, the Indian judicial system, an inheritance of the colonial rule literally denies justice by delaying justice. Even in the case of individual single accounts, banks suggest the customers to make them ‘Either or Survivor’ or ‘Former or Survivor’. This is on account of the practical difficulty in obtaining a succession certificate from the courts. Such delays have resulted in bank’s losing good customers. In case of individual accounts, ‘Either or Survivor’ or ‘Former or Survivor’ clause may prove beneficial. Now take an example of A & B who are neither related, nor executors or trustees, but just ordinary men who for their own reasons want to open and operate a bank account. They are not related and are not partners. What precautions the bank should take ? What happens in the event of the death or insolvency of one of them ? 1. The bank must obtain proper introductory reference, in the same way as for opening an account for a stranger. It is well established that failure to obtain proper introduction will be construed as negligence on the part of the bank. There may be instances where one of the joint account holder is already a customer of the bank and in that case introduction by him for the other joint account holders will be sufficient. 2. Any one of the joint account holder may remit money to the bank. But it is necessary that withdrawals will have to be made jointly, in the absence of instructions to the contrary. 3. No mandate is necessary if A & B decide to sign jointly for withdrawals. But in practice, banks obtain clear instructions in writing embodying at the same time directions for security and safe custody transaction, and providing for their several liability in the event of any overdraft. So a mandate letter is generally taken. 4. Banks do not obtain a valid discharge if a person pays a cheque drawn by one joint account holder without the authority of the other. 5. Generally, banks do not encourage the opening of accounts when there are more parties than two in a joint account. Banks warn them of the difficulties which may arise if all of them want to jointly sign on cheques. If all the members operate jointly, one of them may be unavailable (on tour or may be sick) so that he cannot sign, when withdrawals have

to be made. The bank advises that it will be better that the signing powers are given to two of them and obtain a suitably worded mandate to that effect. Any attempt by the joint holders to introduce a complicated mandate permitting only certain of them in certain combinations is also discouraged. It would be difficult, for example, to keep in step with a mandate in an active joint account of ABCD and E which enables A and B or B and D or A and C to sign but not A and E or C and D etc, as such combinations which are complicated would require special examination in the case of each withdrawal. 6. One joint holder can stop the payment of a cheque drawn by another or others; but the removal of countermand should be signed by all parties or in accordance with the terms of the mandate. 7. One joint account holder cannot delegate his power to an agent or power of attorney to operate on the joint account and such authority must be signed by all parties. 8. Any mandate for a joint account is automatically determined in the case of death, insolvency or mental incapacity of other or any party. 9. It is a general rule that on the death of the joint account holder, the balance devolves on the survivor or survivors; unless the joint holders indicate otherwise. But claims and counter claims from the heirs will often arise. Therefore the mandate should be carefully worded. These difficulties have given birth to the “Nominee” accounts. In the case of nominee accounts, banks obtain a legally drafted nomination form from the account holders to pay the balance in the account, upon the death of one or all of them to another person/persons called nominee. The nominee facility is available to single individual accounts also. This facility removes the difficulty of succession certificates etc. The nomination facility prevents claim by the personal or legal representations. 10. In the case of death of one of the joint account holders, there is no obligation on the part of the bank to pay the estate duty. 11. On the insolvency of one of the joint account holders, the mandate is automatically determined and the operations in the account should be immediately stopped because a portion of the balance in the account may belong to the Official Receiver and the bank cannot apportion the money between the solvent and insolvent. 12. Similarly, the death of one of the joint account holders also detemines the mandate. In case of loans in joint accounts, the banks should include the joint and several liability clause in the mandate. With joint liability there is only one right of action, but with joint and several liability there are as many rights of actions as there are parties. The joint and several liability enables the bank to set off any joint indebtedness against the credit balances in the

individual accounts of any of the joint account holders. 3.10 ACCOUNTS OF LIQUIDATORS Liquidators are appointed by the courts to liquidate the assets and liabilities of the insolvent or bankrupt customer. Various laws such as Companies Act, The Presidency Towns Insolvency Act, Provincial Insolvency Act deal in detail with the appointment of a Liquidator or Court Receiver. The liquidator or official Receiver is an officer of the court and the bank opens the account in their names. The mode operations in the account are advised by the Liquidator/Receiver by production of court orders and have the sanctity as if it is given by the court. Banks should exercise caution to verify the terms of the court order and should not aid or abet the Liquidator or Receiver to commit a breach of trust. 3.11 MERCANTILE AGENTS A mercantile agent may be defined as an agent having in the customary course of business as such agent, authority either to sell goods or to consign goods for the purpose of sale or to buy goods, or to raise money on security of goods. The authority that the mercantile agent derives from his principal is a limited authority. A mercantile agent is personally liable for a breach of warranty for any loss or damage sustained by a third party if such agent makes a representation to the third party that he has the requisite powers to make such representation. The liability arises when the third party acts upon such representation, even if the agent believes or has an impression that he has the authority. The bank who is authorised by a principal to operate his account by an agent should suspend operations in the account immediately on receipt of the information about the death or insolvency of the principal. An agent should make it clear that he signs for and on behalf of his principal. Banker should not allow the agent to overdraw the account without the express authority of the principal. Banker also should not be a party to conversion if the agent credits his personal account by debit to his principal’s account through the bank. 3.12 ACCOUNTS OF NON RESIDENT INDIANS During the early eighties, the remittances from persons of Indian origin and employed abroad started pouring in and even acted as an aid to the Government to meet a portion of the balance of payments deficit. The Government and Reserve Bank of India issued instructions to commercial banks to open accounts for the Non Resident Indians (NRIs). These Non Resident Indian accounts are of two types viz. Ordinary NRI account denominated in Indian rupees or Foreign Currency Non Resident accounts. The NRIs are permitted to open fixed deposit accounts and Savings Bank accounts under the scheme. 213 (Sys 4) - D:\shinu\lawschool\books\module\contract law

In the Ordinary NRI account, the bank pay higher rate of interest than the domestic deposits. The banks convert the foreign currency amount of the remittance at the rate applicable for the day and credit the customer’s account with Indian Rupees.

Bank of India, through instructions and clauses in the Exchange Control Manual.

Foreign Currency Non-Resident accounts, can be opened only in Sterling Pounds, U.S. Dollars, German Marks (D.M) or Japanese Yen. The amounts will be held in the books of the bank in India in foreign currency.

Commercial Banks are designated by the Reserve Bank of India as Authorised Dealers of Foreign Exchange. The banks have to obtain permission from the Reserve Bank to open accounts for foreigners.

Such accounts will be opened with an introduction from the Indian embassy abroad, or from a branch of an Indian bank abroad or from the correspondent banks. The Indian passport particulars of the Non resident are also noted in the account opening form and the bank ledger. The customer can repatriate the amount held in such accounts in the same currency.

This permission is granted by the Reserve Bank of India quickly. The bank branch obtains a form known as QA 22 from the foreigner and submits to the Reserve Bank of India. The operation of the account is controlled by the Reserve Bank of India.

The opening and operation of the accounts are similar to other accounts. However these accounts are regulated by the Reserve

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3.13 ACCOUNTS OF FOREIGNERS

Detailed instructions are available in the Exchange Control Manual published by the Reserve Bank of India.

4. DUTY OF SECRECY SUB TOPICS 4.1 Banker’s general duty 4.2 Duty of disclosure 4.3 Status opinion 4.1 BANKER’S GENERAL DUTY Between an ordinary debtor and creditor there is no duty of secrecy. When a shirt is stitched by a tailor, the tailor is under no obligation to preserve the secrecy regarding the cloth. If the tailor discloses the details of the cloth to any of his other customers, there is no breach of contract. But a bank cannot disclose the details of his customer’s account without just and proper reason. The duty to maintain secrecy is an added obligation or an exception to the general rule that the relationship between a banker and the customer is that of a debtor and creditor. All the employees and officers of the bank have to sign and submit a Declaration of Fidelity and Secrecy at the time of their joining the service. The law on the subject has been clearly and comprehensively laid down by banks, L.J. in Tournier v. National Provincial and Union Bank of England, [(1924) 1 K.B. 461)]. The following proposition can be drawn from this case. “The duty of maintaining secrecy is a legal one, arising out of contracts, not merely a moral one. Breach of it, therefore gives a claim for nominal damages, or for substantial damages if injury has resulted from the breach. It is, however not an official duty, as has been contended, but qualified, being subject to certain, if not essential exceptions. The obligation to secrecy does not end even with the closure of the customer’s account”. Tournier banked at the Finsbury Pavement branch of the National Provincial Bank, where his account was overdrawn, and arrangements had been made for reductions of one pound per week. When these agreed deductions were not made, the acting manager of the bank telephoned Tournier at the address of his employer. But unfortunately Tournier was not available in the office, and the acting manager discussed the matter with the employer of Tournier. In the course of conversation, the bank manager revealed the state of the account and that the cheques had been presented payable to book makers. As a result of this disclosure, Tournier was discharged by his employers and he sued the bank for damages. The case went to appeal and the ruling of banks L.J. provides a basis for future dealings of this nature. It was stated that the duty of secrecy is a legal one arising out of contract and the duty is not absolute, but qualified. The duty continues after the customer has closed the account and the confidence is not limited to information derived from the account itself. Atkin L.J. Said : “I further think that the obligation extends to information obtained from other sources than the customer’s actual account if the occasion upon which the information was

obtained arose out of the banking relations of the bank and its customers - for example, with a view to assisting the bank in conducting its customer’s business, or, in coming to decisions as to its treatment of its customers”. It is therefore clear that the practical banker must always exercise the greatest care to observe his duty of secrecy. Any inadvertant disclosure made during the rush of routine business may have serious consequences. 4.2 DISCLOSURE The circumstances when the disclosure of a customer’s affairs may be made, and where the obligation to maintain secrecy is not absolute have again been laid down in Tournier’s case by banks L.J. The occasions when disclosure would be justified are I. Where the disclosure is under compulsion of law. II. Where there is a duty to the public to disclose. III. Where the interests of the bank require disclosure. IV. Where the disclosure is made with the express or implied consent of the customer. I. COMPULSION OF LAW: 1. The exception may arise where evidence has to be given by a bank in a court. It does not, however, permit disclosure, without the express permission of the customer, to a detective or police officer investigating a case or to an Income Tax Inspector. An order must be served on the bank before any party can demand to inspect the books. Bankers Book of Evidence Act (1891) allows certified copies of the entries to be produced in legal proceedings in which the bank is not a party. This provision is again useful to the bankers as they can avoid attendance in courts with the actual books of accounts. 2. As the Central Bank of the country, the Reserve Bank of India has the powers to collect information from bankers. The Reserve Bank of India may furnish such information to any other banking company. But the information so furnished shall not disclose the name of the bank which forwarded such information. In Shankarlal Agarwalla v. State Bank of India [AIR 1987 Cal 29], the customer tendered for credit of his account 261 notes of Rs.1000 denomination to State Bank of India with a declaration form prescribed by The High Denomination Bank Notes (Demonetisation) Act 1978. The bank made available this information to the Income Tax Department, who issued a notice under the Income Tax Act to the customer. The department’s order also attached the amount. The court held that the disclosure by the bank in this case falls within the exception to the general rule and the bank has the right in disclosing the information. In this case, the disclosure was made under directions from the Reserve Bank of India and the Finance Ministry. 215 (Sys 4) - D:\shinu\lawschool\books\module\contract law

3. The Banking Regulation Act, 1949, requires that every banking company shall submit a return of unclaimed deposits to the Reserve Bank of India within 30 days of the close of each calendar year. The return should contain all accounts in India which have not been operated for ten years. 4. The Foreign Exchange Regulations Act, 1973, empowers the Director of Enforcement or the Reserve Bank of India to inspect the books of accounts of any authorised dealer. 5. Similar provision is contained in the Companies Act, 1956, when the Central Government appoints inspectors to investigate the affairs of a company. II. DUTY TO THE PUBLIC TO DISCLOSE : This exception rarely arises. But it is more relevant in a time of National Emergency. During the World War II it was incumbent upon a bank to make suitable disclosure if he had evidence of a customer trading with the enemy. The bank should be sure of this ground before venturing any revelation for this reason. III. DISCLOSURE IN THE INTERESTS OF THE BANK: Pointing to this exception there is only one case law in U.K. That is the case of Sutherland v. Barclays Bank - [The TimesNov.25-1938; 5 LDB 163]. In this case, the customer, a woman, issued a cheque to her dress maker. The bank dishonoured the cheque as there were insufficient funds in the account. The bank knew of the customer’s bookmaking transactions and did not wish to allow any overdraft on the account. The customer protested about the dishonour to her husband, a doctor, and he told her to take up the matter with the bank. She did so, by telephone, and after a while, the husband interrupted the conversation to add his own protest. The bank then disclosed to him that the cheques had previously been drawn payable to bookmakers. Upon the wife’s bringing an action against the bank for breach of duty in making this disclosure, the bank contended that the conversation with the husband was a continuation of that with the wife and that they had her implied consent to the disclosure. This the wife denied. It was held that on the facts of the case that the bank must succeed; the disclosure being in their interests, and is within the terms of the qualifications on the duty of secrecy in Tournier’s case. IV. EXPRESS OR IMPLIED CONSENT OF CUSTOMER: For implied consent, the case discussed in the above paragraph i.e., Sutherland’s case itself is an example.

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A customer may expressly authorise his bank to advise his accountant, the balance of his account and provide him a copy of the monthly statements. This may be to enable the accountant to draw up the customer’s balance sheet. Such information is given on the basis of a letter in writing by the customer, which is filed away as evidence in case of need. In India also, banks do not generally divulge the balance in the customer’s account over telephone. All prudent bankers all over the world discourage customers from making telephonic enquiries concerning the state of their account. But in these days of ease of communications, it is helpful for the bank or customer to communicate through telephone. The need for care is essential. Banks convey the information to the customers only and only after satisfying themselves that the voice is that of the customer. In no case, third parties are given the status of a customer’s accounts. 4.3 STATUS OPINION OR OPINION REPORTS GIVEN BY BANKERS It is an accepted practice among bankers, which is generally described as ‘Common Courtesy’, whereby one bank enquires from another bank about a proposed borrower, surety, guarantor or of an acceptor of a bill. Sometimes customers also require the status report on their out station purchaser or supplier. The customers cannot get such a report directly from another bank. So he approaches his banker to obtain the report from the outstation bank. This is more relevant in foreign exchange transactions, where a customer in India may not have seen at all his buyer/seller abroad. In such cases the banks furnish a carefully worded and confidential report. The phrase commony used are - considered ‘excellent’, ‘good’ or ‘satisfactory’. This report is furnished to the other bank without any responsibility on the part of the issuing bank or its officers. The reports contain only general information. It is presumed by the banks that it has the implied consent of the customer. In the ever expanding financial market the obtention of such reports help the lending bank and its officials when they are hauled upon to answer a charge of negligence. But the modern trend is to get a rating from credit agencies such as MOODYS or CRISIL, who analyse the financial position of business houses and give a rating.

5. PASS BOOK SUB TOPICS 5.1 General principles 5.2 Entries 5.3 Customer’s Responsibilities 5.4 Balance Confirmation Letters 5.1 GENERAL PRINCIPLES In a fast and evergrowing economy all over the world, the banker’s pass books have been replaced to a great extent by computer statements. Complete computerisation is now available in all the developed countries like UK, Europe, USA, Japan and Singapore. Even in India, computerisation is in fast progress. The State Bank of India is the biggest bank in India with over 8000 branches. Of these, 100 branches contribute to 80% of the bank’s entire business. All these branches have now a Computer set up. Shortly, 1000 branches of the bank will be fully computerised. So is the case with the other major commercial banks in India. All the foreign banks having offices in India are fully automated. Banks now supply to the customers statement of their accounts in the form of loose sheets periodically. Some customers are given daily, weekly, fortnightly or monthly statements. This has the merit that it raises a presumption that the customer has notice of his account, though there is no return of the statement to the bank which was the pass book’s main claim to be an account as stated, and from which it derives its name. The pass book has not yet been completely replaced by the computer statements. Legal nature of the computer statements, its nature and contents have not yet been tested by courts. As all the legal incidents of pass book apply with equal force to a statement we shall see the position of the pass book. Pass Books are issued to all customers who keep Savings Bank Accounts. In the case of current accounts pass books are issued only when demanded by the customer. The pass books contain the name or names of the customer/s, the account number, the ledger number, the name and address of the customer and the mode of operation. If it is a joint account it will contain ‘Either or Survivor’ ‘Former or Survivor’ or ‘Any one’. It will also contain the date of opening the account, the name of the branch and signature in full of the branch manager of the branch. It is a replica of the ledger at the bank branch. The only change is that, instead of the word “Debit” and “Credit” and balance in the ledger, the pass book will have columns for amount withdrawn and amount deposited ; and balance. The pass book also contains a column “initials” which indicates that the entries are authenticated by an authorised person of the bank with his initials. Some banks print out the extracts of the Savings Bank Rules in the pass book itself for the convenience of the customers.

The English law on the subject is relevant to India. In Canara Bank v. Canara Sales Corporation [(1987)62 Comp.Cas 280], the Supreme Court has held that it is the law that obtains in England which has been followed by the Supreme Court and High courts in this country. According to Sir John Paget “the position of the Pass Book in law is unsatisfactory from the standpoint of the banker. Saving, negligence, or reckless disregard on the part of either banker or customer,its proper function is to constitute a conclusive unquestionable record of the transactions between them, and it should be recognised as such. After full opportunity of examination on the part of the customer, all entries, at least to his debit, ought, to be final and not liable to be reopened later, at any rate to the detriment of the banker. Such is, however, definitely not the effect of the pass book”. In Devaynes v. Noble [(1816) 1 Meriavale 529 at p.535], the Court of Chancery ordered an enquiry into the nature and effect of the pass book. The enquiry report stated, that on delivery of the pass book to the customer, he examines it, and if there appears any error or omission, brings or sends it back to be rectified; or, if not, his silence is regarded as an admission that the entries are correct. However, in view of the various decisions in England and India, the position obtaining today is far from what is stated above. There are a large number of cases on the topic the extracts of which are not reproduced in this paper. In Chatterton v. London and County Bank [1891 - The Times Jan 21] the jury had found for the plaintiff and it was held that there was no duty on the customer to examine the pass book and thus there was no negligence. Similarly, in Kepatigalla Rubber Estates Ltd v. National Bank of India Ltd [(1909) 2 K.B. 1010], it was held that the company was under no obligation to organise its business as to make forgeries unpracticable. If this was so, then according to Bray.J. a secretary of the company, by going to the bank on his own purpose in order to prevent the discovery of his own fraud and without knowledge on the part of any of the directors and getting the pass book, can bind the company for all purposes. Clearly, an officer of a company cannot bind the company by approving the balance shown in the company’s pass book. In the case of forged cheques, the primary cause of the loss is the negligence of the bank in honouring the forgery and the forger may be in a position to suppress the evidence in the pass book from his employers. Any number of decisions by the highest courts in England are available. A reference to Paget’s Law on banking will make all such references with ease. So far as Indian law on this topic is concerned, the law has been clearly laid down by our Supreme Court in Canara Bank v. Canara Sales Corporation & others [(1987)62 Comp.Cases 280]. The Supreme Court has held that the plea of implied terms, indirectly constructive notice, and estoppel by negligence, 217 (Sys 4) - D:\shinu\lawschool\books\module\contract law

stands rejected. Mere silence, omission or failure to act is not a sufficient ground to establish a case in favour of the bank to nonsuit its customer. The relevant portion of the judgement in the case - “Unless the bank is able to satisfy the court of either an express condition in the contract with its customer or an unequivocal ratification, it will not be possible to save the bank from its liability. The banks do business for their benefit. Customers also get some benefit. If the banks are to insist upon extreme care by the customers in minutely looking into the pass book and the statements sent by them, no bank perhaps can do profitable business. It is common knowledge that the entries in the pass books and the statements of account sent often by the bank are not readable, decipherable or legible. There is always an element of trust between the bank and its customer. The bank’s business depends upon this trust. Whenever a cheque purporting to be by a customer is presented before a bank, it carries a mandate to the bank to pay. If a cheque is forged there is no such mandate. The bank can escape liability only if it can establish knowledge to the customer of forgery in the cheques. Inaction for continuously long period cannot by itself afford a satisfactory ground for the bank to escape the liability”. In this case, the position prevailing in the United States of America was also discussed. In the U.S.A, it is settled law that it is the duty of the customer to examine the pass book. In Morgan v. United States Mortgage and Trust Co [(1913) 208 New York Reports 218] decided by the New York Court of Appeal, it was stated: The depositor who sends his pass book to be written up and receives it back with his paid cheques and vouchers is bound to examine the pass book and vouchers and to report to the bank without unreasonable delay any errors which may be discovered. Negligence in this case means the neglect to do those things dictated by ordinary business custom and providence and fair dealings towards the bank which, if done, would have prevented the wrong doing which resulted from the omission. 5.2 ENTRIES IN THE PASS BOOK As long as the entries in the pass book are 100 percent correct, there is no need to examine the debit and credit entries. All the customers will then be happy and satisfied as also the banks. But the position that is prevailing is not a position of 100 percent correctness. Mistakes happen at the bank branch regarding the posting of the entries and they may sometimes be favourable to the customers and at other times to some other customers or to the bank itself. The banks take adequate precautions to prevent the occurence of such mistakes. But still mistakes happen. Such mistakes contribute to the following situations : 1. ENTRIES FAVOURABLE TO THE CUSTOMER : The pass book belong to the customer. But he has no authority to make entries in the pass book. The entries are made by the bank. As the entries are made by the bank, the same can be used as evidence against him. In Akrokerri (Atlantic) Mines 218 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Ltd. v. Economic Bank [(1904) 2 K.B. 471] it was held that “The pass book ...... belongs to the customer and the entries made in it by the bank are statements on which the customer is entitled to act”. If the position of the customer has not been adversely affected, by relying upon the pass book, the bank may show that a certain entry was made erroneously. When an uncleared cheque has been shown as has been received in cash entry in the pass book, the bank can show the real nature of the entry and have the error rectified. If the bank has shown errorneously a larger credit balance in the pass book than is actually due to the customer, who, relying upon the accuracy of the pass book, draws a cheque, the bank is not right in returning the cheque. If the bank does, it is liable to pay damages for wrongful dishonour. In detemining this question of fact, a great deal depends upon whether the customer was led through the erroneous entry to act in a manner in which he would otherwise not have done and whether such action has been to his detriment. It happens that the bank may erroneously effect double credits of the same remittance so that the account and the pass book will show a larger balance. In such cases, when the bank discovers the mistake, he should inform his customer. By that time, the customer may have drawn the amount which actually do not belong to him. Until the customer clears the matter, the bank should not permit furhter operations by withdrawals in the account. A fictitious entry made by a bank employee cannot be relied upon by a customer who has not received notice of the same, or acted so as to alter his position. In State Bank of India v. Shyma Devi [AIR 1978 S.C. 1263], the bank employee made false entries in the pass book in his handwriting but embezzled the amounts. In this case, the respondent’s husband issued a crossed cheque for Rs.4000/and made payable to “Self” and that cheque was deposited in the bank by the respondent for being credited to her account. She did not obtain the counterfoil or a receipt. Another cheque was issued by her husband for Rs.7000/- for transferring the amount to her account was also deposited by her. In this instance also, no counterfoil or receipt was obtained. The employee to whom these cheques were given was not looking after Savings Bank counter at the relevant time. The Supreme Court held that the bank was not liable as the employee had not acted within the scope of his employment with the bank. The respondent had not discharged the onus on her to show that she paid the amount to an employee of the bank and that the amount was received by the employee in the course of his employment. The false entry about the deposit of the amount in the pass book could not shift the onus on the bank to prove the contrary. II. ENTRIES FAVOURABLE TO THE BANK So far as the entries in the pass book are favourable to the bank, it is difficult to define with certainty the extent to which the customer is bound by them. From the court rulings, the following observations could be made.

5.3 CUSTOMER’S RESPONSIBILITIES Where the customer has so acted, as to render the entries of the settled or stated account, and is guilty of negligence in regard to them and as a result, the banker’s position is affected in a manner disadvantageous to him, probably the customer will not be allowed to dispute the correctness of the entry. It is doubtful as to what acts or omissions on the part of the customer would amount to settlement of accounts, or to negligence in regard thereto. But it is certain, that the receipt of the pass book by the customer, showing the balance of his account with or without the cheque honoured and its return to the bank by him without taking exception to the entry under dispute, does not constitute such negligence as will preclude him from disputing the same. In other words, the customer is not bound to examine the entries in his pass book and the banker, upon receipt of the pass book from the customer without any objection from time to time, is not entitled to infer that the latter has accepted the entries as correct. This proposition was laid down in Chatterton v. London and County Bank [Times London 21 Jan 1891]. As against this proposition which is unfavourable to the bank, a passage from the case of Vagliano Bros. v. Bank of England [(1891)23 QBD 243] may now be examined. “There is another point to be considered. The plaintiff from time to time received from the bank, his pass book, with entries debiting the payments made, for which the bank sent bills as vouchers, which were retained by the plaintiff when he returned without objection, the pass book. It was contended that this was a settlement of account between him and the bank, and that he had been guilty of such negligence with respect to the examination of the vouchers as would have prevented him from being relieved from the settlement of account. But there was no evidence to show that, as between a customer and his banker, is an implied contract as to the settlement of the account by such a dealing between the banker and his customer, the plaintiff had done anything which can be considered a neglect of his duty to the bank or negligence on his part”. In Balakrishna Pramanik v. Bhownipore Banking Corporation Ltd [(1932) 59 Cal 662], it was held that a customer must intelligently examine the entries in his pass book and dispute or call for explanation from the bank, regardng the entries in the pass book, it was further held that he could not later complain about the entries in the pass book, where compound interest at monthly intervals was being charged and debited. It was considered that continued and persistent acquiescence of this character gave rise to a presumption that there was an agreement between the customer and the bank to charge compound interest, as was done in this case. We may conclude that if the bankers succeed in establishing a custom, the courts may give legal recognition to the same : Lord Halsbury in Vagliano Bros v. Bank of England stated “The false documents were paid, duly debited to the customer and duly entered in his pass book, and so far as the banker could know or conjecture, brought to his knowledge on every occasion upon which the payment was made and the bills were

returned - Was not the customer bound to know the contents of his own pass book ? “ A banker in no case is justified in withholding from his customer any amount received for his credit, but omitted to enter the same in the pass book, on the plea of acquiescence on the part of the customer. In Essa Ismail v. Indian Bank Ltd [(1963) 1. Comp. L.J. 194] the Kerala High Court held that unless there is evidence to show that the practice or custom indicated or stated a settled account, the customer is not precluded from questioning the debit entries in the pass book. In practice, the banks have to ensure that the pass books are updated and sent back to the customer as often as possible and should not allow the pass book to remain with him for unduly long periods, without the customer being given an opportunity to examine the same. As per internal rules, the pass books should as far as possible, be collected from the bank by the account holders on the same day duly filled up and completed immediately after the transaction. If left overnight, the bank will issue a receipt in the form of paper token. The pass book shoudl be collected against this token within a week. If the account holder fails to collect the pass book within this period, the pass book will be sent to his address by registered post acknowledgement due at the customer’s cost. Another internal rule of the banks provides that the counter clerk should enter the undelivered pass books in a register called the Pass Book Retained Register; which requires to be scrutinised by the branch manager periodically, to ensure against the retention of the pass books for unduly long periods. But these internal rules are always violated and the nonobservance lead the banks to difficulties. 5.4 BALANCE CONFIRMATION LETTERS A practice that is prevailing in the banking system in India is to send a balance information letter to its customer/s with a request to return the same to the bank. In the case of loan accounts, banks can use the same as an acknowledgement of the debt. Limited companies and firms call for such balance confirmation to satisfy their Auditors about the correctness of the balance. The bank keeping an account in another bank also call for the balance confirmation. The balance confirmation letters are sent by the bank at half yearly or yearly intervals when they close their accounts. Having confirmed the balance by returning the confirmation letter duly signed to the bank, whether the customer can object to any debit entry preceding the balance, is a question not free from doubt. The question arises as to whether the acknowledgement would act as an estoppel because in such cases the bank’s defence is more powerful than the entries in the pass book or statement of accounts. The Kerala High Court in Essa Ismail v. Indian Bank Ltd. [(1963) 1 Com. L.J. 194] observed that unless there is evidence to show that the practice or custom indicated or stated or settled account, the customer is not precluded from questioning the debit entries in a pass 219 (Sys 4) - D:\shinu\lawschool\books\module\contract law

book but, when the confirmation slips are sent to and signed by the customer, he will be bound by the debit entries made. In this case, a debit entry in the customer’s account was questioned, not by the customer, but by his heirs, several years after the entry was made, and there was enough evidence to show that the customer has acquiesced in the entry. However, if one of the entries consist of payment by the bank of a forged cheque or arises out of a fraud committed by the bank’s employees,the question is whether the customer can

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claim reimbursement in spite of his signing the balance confirmation. From the decision in the case, Allahabad Bank Ltd v. Kulbhushan and others [AIR 1961 Punjab 571], it would appear, he can. In law, the bank cannot compel the customers to sign and return the balance confirmation letters/slips.

6 BANKER’S LIEN AND SET OFF SUB TOPICS 6.1 General Principles 6.2 When Banker has no lien 6.3 Right to set off

deposited with him as a banker by a customer unless there is an express contract or circumstances that show an implied contract inconsistent with the lien. The term “Securities” is no doubt used here in a wide sense, but does not, extend to banker’s own indebtedness to the customer.

6.1 GENERAL PRINCIPLES

Therefore, the question of a general lien arises where the bank is the lender and the customer is the borrower.

When we talk of bank and banking, the term banker’s lien and bankers right to set off are talked about. The lien has its origin in English law. A lien is the right of a creditor in possession of goods, securities or any other asset belonging to the debtor, to retain the same till the repayment of a loan, subject to any contract to the contrary. The Indian Contract Act deals with liens. But it is not exhaustive and we have to depend on English case law.

Any property which is handed over to a bank for an express purpose cannot be subject to lien, even when the purpose has failed. In an old case, Lucas v. Dorrien [(1817) 7 Taunt 278] deeds were handed over to a bank as security for an advance. The advance was not granted. The deeds were not taken back by the depositor. It, was held that they could not be subject to lien in the bankers hands.

A lien may be, possessory, equitable or maritime. Bankers are concerned only with possessory lien. Possessory lien may be either general or particular. A particular lien applied only to a particular transaction and its scope is limited to the particular security and the particular transaction. Bankers lien is a general lien. A lien does not require any special agreement, written or oral. It arises by operation of law and should fall within the following broad spectrum. a. The creditor should be in possession of the goods and securities, and they should have come to his possession in the ordinary course of business. b. The owner of the goods and securities has a lawful debt to pay to the person in possession. c. There should not be any contract, express or implied to the contrary. Following the English law, a banker’s lien is sometimes called implied pledge. According to Sir John Paget - ‘Lien’ being the right to retain another man’s property until a debt is paid, property and lien cannot coexist in the same person with regard to the same article. The lien peculiar to a banker, with regard to negotiable securities, is defined in Brandao v. Barnett [(1846) 12 Cl & F 787] as an ‘implied pledge’ ; but assuming this to be the case, absolute property is as inconsistent with the rights of a pledgee as it is with those of a person having a lien. In Barclays Bank v. Astley Industrial Trust Ltd [(1970) 2 QB 527], banks were held to have obtained a lien on the cheques that had been paid in for collection. But the idea had already been questioned. Thus, Paget has argued that money paid into the bank becomes the property of the bank, which thereafter owes a corresponding debt to the customer, and a debt is not suitable subject for lien. In Hales Owen Press Wrok [(1917) 1 QB 46] Buckley L.J. took the same view. The money or credit which the bank obtained as a result of clearing the cheques becomes the property of the bank, not the property of the company. No man can have a lien on his own property and consequently no lien can have arisen affecting that money or that credit. It has of course long been recognised that a banker has a general lien on all securities

The general principles of law governing ‘lien’ can be described asA) Banker’s lien is the right of retaining things delivered into his possession as a banker and if and so long as the customer to whom they belonged or also had the power of disposing of them when delivered is indebted to the banker on the balance of account between them, provided the circumstances in which the banker obtained possession do not imply that he has agreed that this right shall be excluded. Banker’s lien can be properly said to arise only in respect of any securities held by the bank. If the customer deposits certain securities and ultimately there is a sum due to the bank, the bank has a lien over these securities and it could hold them against the amount due by the customer. B) The ownership of the thing in possession of the bank should be with the customer otherwise the question of lien does not arise; C) Banker’s lien differs from the right of ‘set off’. A lien is confined to securities and property in the bank’s custody. ‘Set off’ relates to money and may arise from a contract or from mercantile usage, or by operation of law. The banker’s lien does not extend over the credit balance of a partnership account for the amounts due to him from one of the partner’s in his individual capacity. D) A bank may not be able to exercise any right of lien over the money deposited by the customer, as the bank itself becomes the owner of that deposit. But still he has a right to adjust such amounts against any debts due to the bank from the customer. The purpose of the lien in such case is achieved by the right of ‘set off’. E) The banker’s lien is subject to any contract to the contrary. The existence of such a contract must be proved by the person who alleges the same. 6.2 CASES WHEN THE BANKER HAS NO LIEN 1. Safe Custody Deposits: When a customer deposits with his bank his securities and documents of title for safe custody there is no lien. The deposit in this case is for a specific purpose and under an express contract. The issue of the safe custody receipt by the bank itself constitutes a 221 (Sys 4) - D:\shinu\lawschool\books\module\contract law

contract to the contrary to assume against the existence of any lien. In the case of safe custody, the banker is a bailee. When the bailor has no title to the securities and valuables deposited, the bailee cannot exercise any right of lien, and if it can be shown that the bailor had stolen or misappropriated the securities deposited, the banker hodling them will be compelled to return them to the true owner, even without getting back the safe custody receipt. The banker has no lien on bills of exchange or other documents entrusted to it for special purpose. On the dishonour of a documentary bill, the bank is not entitled to apply the security accompanying the bill, to any other debt due from the customer for whom the bank discounted the bill. Where a customer deposited a life insurance policy with the bank accompanied by a memorandum of charge to some overdrafts not exceeding 4000 pounds together with interest, commission and charges, it was held that the banker’s lien was limited to the amount specified. Credit and liability must be in the same rights. No lien arises on the current account balance or the deposit account of a customer in subject of an debt due from a firm, as the credit on the one hand and the liability on the other do not exist in the same right. There is no lien in respect of separate accounts where in one, the customer is a trustee and the other account is held by him in his personal capacity. Title deeds of immovable property: Customers deposit with the bank title deeds either for safe custody or as collateral security for loans by way of an equitable mortgage. A title deed cannot be sold by the bank. No lien attaches to the title deeds. The banker’s right of lien is not barred by the law of limitation. The effect of limitation is only to bar the remedy and not to discharge the debt.

off. But this is not always easy as one thinks and is hedged with qualifications.

To conclude the topic of lien, the student is advised to refer to the provisions of the Indian Contract Act particularly sections 171 and 176 and the Banking Regulation Act Sections 5 & 6. As we are discussing only the banking law, no comment is made on these provisions.

The banker’s power to combine different acounts is called the right to set off. Between an ordinary debtor and creditor, there is an undoubted right to set off amounts due to and from each other in the ordinary course of business. For example, A buys cement from B, a trader for Rs.10,000/-. Later, A sells to B steel worth Rs.5000/-. B is perfectly entitled to set off the cost of steel against his liability for cement and need to pay only Rs.5000/- in settlement of the net debt.

A reference may also be made to the full bench decision in Issac v. Palai Central Bank (in Liquidation) [(1963) 33 Comp. Case 799]. In this case Issac, the appellant deposited a sum of Rs.13500/- with the Palai Central Bank Ltd. on 13th January 1959 repayable on 13th January 1961. On June 23, 1959, he executed a Demand Promissory Note for Rs.10,000/- in favour of the bank. The Promissory Note was delivered to the bank along with the fixed deposit receipt, duly discharged by him. A letter of delivery also was submitted by him to the bank. This letter stated inter alia, that the proceeds of the fixed deposit should on maturity be credited to the loan account in respect of which the promissory note was executed. The bank went into liquidation on 05.12.1960. The official liquidator filed a suit against Issac for recovery of the dues on the loan account. Issac claimed a right of set off of the fixed deposit against the dues to the bank.

There are cases where a customer may be having 3 or 4 accounts in the same bank. Some may be deposit accounts and other/s borrowal accounts. The implied right of the banker at any time to combine the balances in order to arrive at the net amount due to or from the customer is known as the banker’s right to set

The full bench of the High court held that Issac was entitled to claim the right to set off. Merely because he handed over the fixed deposit receipt to be kept by the bank as security for the loan will not affect his position to claim the right. It was further held :

2.

3. 4.

5.

6.

7.

8

6.3 RIGHT TO SET OFF

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The important requirements for set off are All the funds must prima facie belong to the customer. We have discussed under lien that a bank has no right of lien on the monies held in the bank by the same customer as an individual in one account and a member in a partnership account or as a trustee in another account in the same bank. This rule applies with equal force in the case of set off also. Notice of such a trust may be actual or constructive. An overdraft in the individual current account of A cannot be set off against the credit balance of a Trust account in which A is a trustee. However, if A has two accounts styled as A No.I Account, and A No.II Account or where A has a Current Account and Savings Bank account, in such cases the bank can exercise the right to set off. Unless the partner has contracted to be severally liable for the indebtedness of the firm, the bank cannot set off the credit balance on the private account of the partner against the overdraft of the partnership. Even in such cases there must be some precise authority from the partner in the absence of the happening of any event to determine the position. Likewise in the absence of express agreement, there is no set off between the joint and separate debts. The overdraft on the joint account of A & B cannot be set off against the substantial credit balance on the current account of B, unles, of course, B expressly agrees or A and B have specifically contracted for several as well as joint responsibility for their joint overdraft. Not only must the accounts be in the same rights but the liability must be accruing due. A credit balance due on current account or deposit account cannot be held against a contingent liability on bills discounted. The position is however altered by the bankruptcy of the customer, which in effect determines the position and gives the banker the right of set off. Baker v. Lloyds Bank [(1920) 2 K.B. 322].

1) that a question of set off should be considered normally without reference to the existence of any security; 2) that the arrangement between the customer and banker in such a case itself was to affect a set off on the maturity of the fixed deposit; 3) that the fact that the deposit had not matured when the winding up commenced is not of material consequence ; 4) that the effect of the bank’s insolvency was to accelarate the date on which the set off should be effected and to make the commencement of the winding up the time for that purpose; 5) that in the light of what has been stated, the appellant’s claim to a set off should be admitted. In the case of Radha Raman Choudhary v. Chota Nagpur Banking Association Ltd [(1945) Comp.Cas 4] the distinction between a right of lien and a right of set off was clearly laid down. The banker’s right of lien is part of the law merchant. It can only attach to money so long as it remains an earmarked sum of money. Where it ceased to be such a separate earmarked sum, and is represented only by a balance of account or debt due from the bank, no lien can continue to attach to it, though the rights of the bank by way of set off will not thereby be affected. A clear distinction between lien and set off in the light of Section 171 of the Indian Contract Act was made in this case. It was held that the banks have a right to combine one or more accounts of the same customer but a bank cannot combine a customer’s personal account with a joint account of the customer and another man. In the question relating to the rule of set off to be applied, courts have drawn a distinction between the Indian Law and the English Law in I.S. Machado v. Official Liquidator of Travancore National and Quilon Bank Ltd. [1941 - 11 Comp. Cas 221]. In India, if a debt is incurred by the members of a partnership, they will be jointly and severally liable. So far as the amounts due to the members of the firm are concerned, the claim will be a joint claim both in England and in India. Consequently, if X and Y, who are the members of a firm sue Z, Z cannot set off a debt due by X alone, whereas if Z sues X & Y, X can set off a debt due by Z. The rule of set off in bankruptcy, does not rest on the same principles as the right of set off between solvent parties. In (Machado’s case ) an amount was due to a firm A by the Travancore National and Quilon Bank and the amount was due to the bank by another firm B consisting of the firm of A (Machado’s firm) and another person. The bank went into liquidation. On the demand made by the bank against the firm B, A firm claimed to set off the amount due to them by the bank due by B to the bank. It was held that the liability of the members of the Firm B was joint and several and that the set off must be allowed. In a claim to enforce the joint and several liability it was pen to A to set off the debt due to them. This judgement relates to principles governing claims of set off as between separate debts and a joint and several debts. The general rule is that a debt owed by the creditor to one of the debtor. If however the joint debtors liability is not merely joint but also several a right of set off is available to the debtor.

The position of law is however different in India and in England. In England, the liability of a joint debtor is only joint, unless the contract provides otherwise. Similarly the liability of partners in respect of debt of the partnership is joint, not joint and several. On the other hand, in India joint promise is related as a joint and several promise on account of Section 43 of the Indian Contract Act and unless the agreement provide otherwise, joint debtors are jointly and severally liable to the creditors; the liability of the partners is also joint and several. In Machado’s case, it was held that a partner can claim a set off a debt due from his partnership to a bank against the credit balance on a deposit account in his name with the bank. The general principle of equity applicable both in England and in India is that in the case of a voluntary conveyance of property by a person, without declaration of a trust, there is a resulting trust in favour of the grantor, unless it can be proved that an actual gift was intended. An exception has been made in English Law and a gift to a wife is presumed, where money belonging to the husband is deposited at a bank in the name of the wife, or where a deposit, is made, in the joint names of both husband and wife. This exception has not been admitted in the Indian Law on account of the different conditions attached to family life, and where relationships are entirely of a different nature. In England, whenever money is deposited by a husband in a bank account in the name of his wife or in the joint names of himself and his wife, there is a presumption that the husband has gifted the money to his wife. Such presumption is not permitted in India. In the absence of evidence to the contrary, money deposited by a husband in the joint names of himself and his wife and payable to Either or Survivor, must be presumed to belong to the husband. The right of immediate set off is undoubted where the position is determined and the net figure due to or from the banker has to be determined. In the event of the death or insolvency of a customer, all balances due to or from him in the same right have to be combined to decide how much is due net to or from the estate. Same is the case in the liquidation of a company. In all such cases, the immediate need to combine the balances is obvious and the power to set off without notice is undoubted. Although such is the legal position, generally the banks in India give notice to the customer before exercising the right of set off. Any implied right of set off with which the banker may be endowed must be subject to the obligation to honour cheques drawn properly by the customer. In practice, where the customer has more than one account in the same right, banks obtain an express letter from the customer to set off the balances in the accounts. In short, the right to set off can be exercised when 1) the debts are amounts certain; 2) the debts are due and to the same parties; 3) the debts are in the same right; and 4) there is no contract express or implied to the contrary. 223 (Sys 4) - D:\shinu\lawschool\books\module\contract law

7. CASE LAW Radha Raman Choudhary & Others v. Chota Nagpur Banking Association Ltd. [(1945) 15 Comp Cas 4] The plaintiff’s father had a fixed deposit with the bank. He had also executed jointly with certain persons, between 1913 and 1928, four handnotes in favour of the bank. He died in December 1931. Thereafter the fixed deposit account was transferred to the names of the plaintiff on 18 April 1932 on their undertaking all the liabilities of their father to the bank. On 1 May 1935, the bank, without the knowledge of the plaintiffs, adjusted the fixed deposit against the dues on the aforesaid handnotes. The plaintiffs filed a suit against the bank claiming the amount of the deposit which had been adjusted as mentioned above. They contended that their father was merely a surety for the other excutants of the notes and not a principal debtor. Alternatively, the plaintiffs sought a decree against those executants (or their legal representatives) for different portions of the amount adjusted, if the court held that the adjustment made by the bank was legal. The bank conceded that if it had brought a suit on the notes on May 1, 1935 it would have been barred by limitation. But the bank contended that, by making the adjustment in question, it was only exercising its right of lien which could be exercised even in respect of a debt a suit for the recovery of which would be time barred on the date of such adjustment. The main issue was whether the bank’s action was right. High court held that the bank could not make adjustment because the debt was time barred. [Read section 60 of the Indian Contract Act and make a critical assessment of the decision in this case] Isaac v. Palai Central Bank Ltd. (In Liquidation) [(1963)33 Comp Cas 799] The appellant deposited a sum of Rs.13,500 with the bank on 13 January 1959 repayable on 13 January 1961. On 23 June 1959, he executed a demand promissory note for Rs.10,000 in favour of the bank. The note was delivered along with the fixed deposit receipt, duly discharged by him, and a letter of delivery which stated, inter alia, that the proceeds of the fixed deposit receipt should on maturity be credited to the loan account in respect of which the promissory note was executed. The bank was ordered to be wound up on 5 December 1960. In a suit by the liquidator against the appellant for recovery of the dues on the loan account, the latter claimed a right of set-off of the fixed deposit against the dues to the bank. P.T. Raman Nair, J., gave judgment against the borrower. The issue for consideration before the full bench was - Can the appellant claim, set off of the fixed deposit against the sum dues to the bank. Full bench allowed a set off of the deposit against the loan. R.K.V.S.S. Narasayyamma and Others v. Andhra Bank Ltd. and Others [AIR 1960 AP 273] As security for certain overdraft facilities granted by the bank to the plaintiff’s husband, he had lodged with the bank the certificates relating to the shares held by him in a company, 224 (Sys 4) - D:\shinu\lawschool\books\module\contract law

together with blank transfers and an instrument of security signed by him. On his death, the plaintiff’s counsel wrote to the bank stating that the borrower had left a will appointing the plaintiff as the executrix of his estate, and asking the bank for information as to the state of the overdraft accounts. The bank informed the plaintiff of the amounts due to it on the accounts and also requested that arrangements be made for paying the dues and taking delivery of the shares. The bank wrote two more letters to the plaintiff asking her to take immediate steps to repay the amounts due to the bank on the overdraft accounts. No repayment was forthcoming and the bank sold the shares to the second defendant and advised the plaintiff of the sale. The plaintiff questioned the sale and instituted a suit against the bank, the purchaser and the company concerned seeking a declaration that the sale was void as no notice there of was given to the plaintiff and therefore did not affect her right to redeem her husband’s pledge of the shares to the bank, and an injunction restraining the company from recognising the sale and registering the shares in the name of the purchaser. The suit was dismissed. Hence this appeal. Issue for adjudication was whether the plaintiff is entitled for an injunction. Plaintiffs appeal was dismissed on a technical ground that as the plaintiff had not obtained probate of her husband’s will so she could not succeed. Haridas Mundra v. National and Grindleys Bank Ltd. [AIR 1963 Cal 132] M was enjoying an overdraft facility with the bank. As security, he had pledged certain company shares with the bank and had executed a letter of lien empowering the bank to sell and dispose of the shares on default by him in the payment of the moneys due to the bank on its making a demand. The bank instituted a suit against M for recovery of the balance due on the account. During the pendency of the suit, the bank served a notice on M informing him that on a default by him in the payment of his dues to the bank on or before a specified date “the pledged shares or such of them as the bank might decide to sell would be sold by the bank in exercise of its rights and powers as the pledgee and the net proceeds would be applied in reduction of M’s indebtedness”. The suit was decreed and the bank was given leave under Order II, Rule 2 of the Code of Civil Procedure to take appropriate proceedings in respect of the shares. M filed a suit against the bank claiming perpetual injunction restraining it from selling the shares on the ground that since it had instituted the aforesaid suit against him, it had no longer any right to sell the shares. The trial court dismissed the suit and hence this appeal. The main issue was whether M is entitled to have perpetual injunction on the sale of shares. High Court rejected the appeal by holding “that the institution of a suit by the pledgee against the pledgor does not take away the pledgee’s right to sell the pawn after giving the pledgor reasonable notice of the sale; the two rights are not mutually exclusive, but are concurrent”.

M.S. Anirudhan v. Thomco’s Bank Ltd. [(1963) 33 Comp.Cas 185] The Thomco’s Bank agreed to grant an overdraft to one S against the guarantee of A. S executed a promissory note for Rs.20,000 in favour of the bank. The letter of guarantee, with blank spaces left as to the date, amount of the overdraft limit and the interest rate, was prepared in the bank and handed over to S to be got signed by A. Some months later, it was brought by S to the bank; it had been signed by A and also by S and the overdraft limit had been mentioned as Rs.25,000. S wanted the overdraft limit to be raised to Rs.25,000. The bank was not agreeable to advance more than Rs.20,000 and gave the letter of guarantee back to him to be got amended. After some time S returned it to the bank with the amount altered to Rs.20,000. In an action by the bank against S and A for recovery of its dues, the latter set up the plea that the letter of guarantee was executed by him for only Rs.5,000 and that the amount had been subsequently altered to Rs.25,000 without his knowledge and consent. This contention was not accepted as the letter showed that the guaranteed amount had been altered from Rs.25,000 to Rs.20,000, the alteration being apparent. The Kerala High Court agreed with the trial court that the guarantee was originally executed for Rs.25,000 and that the figure was subsequently changed to Rs.20,000, without A’s consent, probably by S. The Court however held that it was probable that A had erroneously mentioned Rs.25,000 instead of Rs.20,000 in the letter and that the alteration was made in order to carry out the common intention of the three parties concerned. Relying on the principle contained in section 87 of the Negotiable Instruments Act, the High Court held that the surety was liable to the bank. Hence this appeal to S.C. Main issue for determination was whether the guarantor was liable to the bank despite the alteration of the guaranteed amount from Rs.25,000 to Rs.20000 in the letter of guarantee. Supreme Court held by a majority decision that the surety was not discharged. Karnataka Bank Ltd. v. Gajanan Shankararao Kulkarni & another [AIR 1977 Kant 14] The bank granted a loan of Rs.25,000 to the first defendant, repayable in instalments, against hypothecation of a truck and the guarantee of defendants 2 and 3. The hypothecation agreement gave the bank a right to take possession of the truck and sell it in the event of a default by the borrower in paying any of the instalments. The instalments were not paid, but the bank did not exercise the aforesaid right. It filed a suit against the borrower and the guarnators for recovery of the advance. Meanwhile, the truck deteriorated in value and was reduced to mere scrap. On this ground, the guarantors pleaded discharge from their liability to the bank. The trial court accepted this contention and decreed the suit against the borrower alone. Against this acceptance appeal was filed in the High Court. Whether the surety is discharged merely because the creditor did not sue the principal debtor or did not enforce the security furnished to him by the debtor, was the sole issue.

High Court allowed the appeal of the bank by holding that a mere forbearance to enforce the security against the principal debtor will not discharge the surety. Raghavendra Singh Bhadoria v. State Bank of Indore [AIR 1992 MP 148] Petitioner purchased two drafts of the value of Rs.10,00,000/from the Patrakar Colony branch of State Bank of Indore. These drafts were drawn on the Marwadi Road, Bhopal branch of the same bank in favour of McDowell & Do. Ltd. But the drafts were lost in the transaction and the petitioner informed Patrakar Colony branch on 22.2.91 requesting them to send instructions to the drawer branch not to honour the drafts. A report of the loss was also lodged with the police station, Indore on 26.2.91. On the same date petitioner also wrote to the Patrakar Colony branch repeating information about loss of the drafts with a additional request that the demand drafts be got dishonoured even if presented by the payee. The Patrakar colony branch sent the information to the Marwadi Road, Bhopal branch. The said branch refused to stop payment of drafts and made payment to the payee who presented the drafts. Hence the petitioner filed the petition contending that respondent bank was obliged to dishonour the drafts as the purchaser (petitioner) of the drafts had instructed to do so before they were honoured and payment was made to the payee. Main issue was whether the bank was obliged to dishonour the payment of drafts presented to it for payment or can the court issue injunction against bank for not making the payment to payee. Court dismissed the petition by holding that unless a serious allegation of fraud with prima facie evidence is shown, the court should non interfere in the matter restraining the bank to honour the documents presented by the payee. Bank of Maharashtra v. Automatic Engineering Company [(1993) 77 Comp.Cas 87 (SC)] Respondent firm had an account with appellant bank. A cheque of Rs.6500/ presented through another bank to the appellant was passed by the appellant and the said amount debited to the respondents account. When the appellant forwarded the statement of account to the respondent, respondent raised an objection that the amount had been wrongly debited. Upon the examining of the cheque under ultra-violet rays, it was found that the cheque had been chemically altered with regard to the date, name and amount. Issue before the Supreme Court was that under the circumstances bank is guilty of negligence or not. Court held that on visual examinations no sign of forgery or tampering with the writings on the cheque could be detected and through evidence it was also proved that the agent of the bank took reasonable care to verify the cheque with the specimen signatures of the constituent. Further, u/s31 of the Negotiable Instrument Act, 1881, the appellant bank had a liability to honour the said cheque if it was otherwise in order. There was nothing on record from which it could be held that the payment was not in good faith. So the appellant bank could not be held guilty of negligence. 225 (Sys 4) - D:\shinu\lawschool\books\module\contract law

8. PROBLEMS 1. As security for a debt, the debitor deposited a share certificate in respect of some shares held by him in a joint stock company. The certificate was not accompanied by a transfer deed. Discuss whether there can be a valid pledge of shares by the deposit of the share certificate when it is not accompanied by an instrument of transfer ? [See (1942)12 Comp Cas 180] 2. Whether a pawner who has pledged certain company shares in favour of a bank is entitled to the dividends, and the bonus and right shares in respect of those shares when the pledge was subsisting ? Critically examine the rights of pawner. [See AIR (1969) Del 313] 3. In order to realise the arrears of wages and some compensation payable to the workers of a company which had put up it shutters, the payment of wages inspector moved the Tehsildar to take steps under the provisions of the Land Revenue Code, to attach the machinery and movables of the company and bring them to public auction. A bank which had advanced moneys to the company against mortgage/pledge of the machinery and movables objected to the recovery proceedings being instituted before the company’s liability of the bank was discharged. Discuss the rights of the bank. [See AIR 1977 MP 188] 4. The bank brought an action against L for recovery of a loan made to C and H, claiming that L was the actual beneficiary of the loan and was therefore liable to the bank u/s 70 of the Indian Contract Act, 1872. The section states“When a person lawfully does anything for another person or delivers anything to him, not intending to do gratuitously, and such other person enjoys the benefit thereof, the later is bound to make compensation to the former in respect of, or to restore the thing so done or delivered”. Prepare a brief for L. [ See AIR 1982 Kant 338] 5. A files a suit for the recovery of the dues from the defendant on an overdraft account. The defendant pleads that the debt should be set off against certain deposits with the bank payable to either or survivor. Argue for the defendant. [See (1954)24 Comp.Cas 306]. 6. There were 2 partnership firms functioning under different names but comprising the very same partners. Firm No:1

deposited a sum of Rs.15,000 with the bank for remittance to a company. The company did not accept the remittance and the money was returned to the remitting office of the bank which the bank credited to the overdraft account with it in the name of Firm No:2. Firm No.1 contends that bank has no right to make the adjustment. Decide. [See AIR 1960 Punj 1] 7. The offficial liquidator claimed to appropriate a deposit made by the applicant with the bank, in part satisfaction of his liability under a guarantee given by him in respect of an overdraft account of another customer of the bank. Can the liquidator make the appropriation although the applicant’s debt to the bank is time barred ? [See (1941) 11 Comp Cas 298]. 8. The bank granted an overdraft to R on the security of a fixed deposit in his Son’s name with a firm of bankers. The son gave the fixed deposit receipt to the bank alongwith a letter authorising it to collect the amount on maturity and appropriate to words the over draft. He gave the bank another letter addressed to the firm asking it to pay to the bank the amount of the deposit and the interest thereon. On the due date when the bank asked for payment, the firm refused to pay saying that the amount had been adjusted against a debt due to it from the depositor. Prepare a brief for the bank. [See (1956)Comp Cas 81] 9. Veloo was the managing director of the managing agents of a company (Woodbriar Estate Company Ltd). He was maintaining an account in the name of Wilson & Co. with a bank. Into this account he deposited two demand drafts made payable to the company, after endorsing them as follows : For Woodbriar Estate Ltd., For Krishnan Kutty & Veloo (India) Ltd., Sd/ V.N. Veloo, Managing Director, Managing Agents. The drafts were collected by the bank and the amounts were drawn out and misappropriated by Veloo. Company sued the bank claiming damages for conversion of the drafts. Is the bank liable ? If Yes, give reasons. [See AIR 1958 Ker 316].

[Note: specify your name, I.D. No. and address while sending your answer papers] 226 (Sys 4) - D:\shinu\lawschool\books\module\contract law

9. SUPPLEMENTARY READINGS 1. Bhatt, P.R., International Banking, (1991), Common Wealth Publishers; New Delhi. 2. Chatterjee, A., Legal Aspects of Bank Lending, (1992), Skylark Publication; New Delhi. 3. Desai, V.J., Indian Banking Law in Theory & Practice, (1988), Himalaya Publishing House; New Delhi. 4. Fidler, P.J.M., Sheldon & Fidler’s Practice & Law of Banking, (1982), Language Book Society & Macdonald & Evans; London and Plymouth. 5. Gupta, S.M., The Banking Law in Theory and Practice, (1992), Universal Book Traders; New Delhi. 6. Hapgrood, Mark, Paget’s Law of Banking, (1989), Butter-worths; London and Edinburgh. 7. Kataria, S.K., Banking and Public Financial Institutions, (1990), Orient Law House; New Delhi. 8. Parthasarathy, M.S., Banking Law, Leading Indian Cases, (1985), N.M. Tripathi; Bombay. 9. Sudarshan & Varshney, Banking Theory, Law and Practice, (1990), Sultan Chand and Sons, Educational Publishers; New Delhi. 10. Suneja, H.R., Practice and Law of Banking, (1990), Himalaya Publishing House; New Delhi.

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Master in Business Laws Banking Law Course No: II Module No: VII & VIII

Advances, Loans and Securities

Distance Education Department

National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 080-3217858 E-mail: [email protected] 228 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Materials Prepared by : Ms. Sudha Peri Materials Checked by : Prof. T. Devidas Materials Edited by : Prof. N. L. Mitra Prof. P. C. Bedwa

© National Law School of India University Published by : Distance Education Department National Law School of India University Post Bag No. 7201 Nagarbhavi, Bangalore - 560 072

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INSTRUCTIONS Living in a complex, competitive age has its own disadvantages. People tend to fiercely compete about everything and anything, be it the extent of their possessions, or assets, the number of degrees they hold, or even the place of their vacationing. The problem is also compounded by the fact that the market is flooded with both a variety of consumer goods in seemingly affordable ranges, and also a horde of opportunities inviting people to invest in something and reap high rewards. The problem arises when a person wants to buy these goods or invest in these opportunities but lacks the funds to do so. The only option left to him in such cases is to take a loan, for which purpose he can either approach a private money-lender or public financial institutions or banks. The option of going to a money-lender is not open to all because of the high rate of interest charged by them and the accompanying risks. Banks on the other hand provide a safe haven for such loan takers. A major part of the banking business is concerned with giving of loans and advances. Depending on the purpose and time period of the loan, the loans are divided into various categories. The government and the Reserve Bank of India also issue guidelines from time to time to regulate the giving of advances by the banks. In general, these guidelines are issued keeping in mind the economic status of the country and the current financial policy of the government, as for example, at present the banks are required to give loans to agricultural sector and women entrepreneurs etc. In the present module, we have dealt with the various types of loans and advances given by the banks. these loans are generally given against securities, which are taken by the banker to protect himself in case of default by the debtor. The security against which loans are given are themselves of various kinds and may be broadly categorised as direct, collateral and miscellaneous, though such a categorisation is only for academic purposes and does not have any practical basis. An effort has been made to deal with each of these securities in detail. This module deals more with the nature and kinds of loans, advances and security - but does not directly deal with the recovery of loans aspect. This is not because recovery of loans is an unimportant topic, but more appropriately because that aspect has been dealt with indirectly at various places in the module, as for example, remedies available to a banker if the debtor to whom a loan has been given against a mortgage has commited a default. But you would be well advised to study the various problems in loan recovery and the extent of bad debts of the nationalised banks for a more comprehensive understanding of the topic. This module refers to various other Acts like the Transfer of Property Act, Contract Act, and Companies Act while dealing with various types of securities. You would be well advised if you go through the bare acts of these subjects while doing this module in order to have a better understanding of the subject.

N. L. MITRA Course Co-ordinator

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ADVANCES, LOANS AND SECURITIES

TOPICS 1

Advances and Loans ......................................................................................................

232

2

Direct Securities .............................................................................................................

239

3

Collateral Securities .......................................................................................................

250

4

Miscellaneous Securities ................................................................................................

260

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Case Law .........................................................................................................................

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Problems..........................................................................................................................

269

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Supplementary Readings ...............................................................................................

270

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1. ADVANCES AND LOANS SUB TOPICS 1.1 Introduction 1.2 Principles of good lending 1.3 Advances 1.4 Types of Loans 1.5. Procedure of taking Loan 1.1 INTRODUCTION Before we go into the details of the various kinds of loans given by a banker it would be interesting to make a brief foray into the banking history to find out the roots of this money-lending business of the banks. It is generally agreed that the grounds for modern banking in England was paven by the influx of gold from America into England during the Elizabethan Age resulting in a simultaneous growth of foreign trade. Merchants and country gentlemen alike stopped looking at land as the only form of asset/investment and started retaining part of their capital assets in the form of “Cash”. Public banking as a system got an impetus when Charles I in 1640 seized 130,000 billions left in the Royal Mint by the city merchants for safe custody. As a direct consequence the merchants started entrusting their cashiers with large amount of cash, but the latter started misappropriating these funds for their own benefit. Thus being badly burnt by both their king and their employees the merchants as a last resort started giving their cash for safekeeping to the goldsmiths who had strong rooms and also employed watchmen. Whenever the goldsmith received cash for safe-keeping he gave a signed receipt to his customer known as “goldsmith’s notes” which embodied an undertaking to return the money either to the depositor or bearer on demand. This resulted in the development of two practices which laid the foundation of “issue” and “deposit” banking. Firstly, goldsmith’s notes being payable to bearer on demand started enjoying considerable circulation. Secondly, the goldsmith’s came to the realisation that large 09é09 amounts of money was kept with them very often for long periods, and so they deciding to follow the precedent set by Dutch bankers, started lending a part of their customer’s money provided such loans were repaid within a fixed time. Since money lending was a safe and profitable business the more enterprising of these goldsmith’s began offering an interest on money deposited with them instead of charging their customers a fee for providing safe keeping services. This naturally resulted in even larger sums being deposited with them thereby allowing them to spread their money-lending business even further. Business grew to such an extent that they found that they could always spare a certain proportion of deposits for giving loans regardless of the date on which their notes fell due. Thus, keeping other people’s money in custody and lending a part of it has always been a major part of banking functions. 232 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Though gradually banking functions grew to scale new heights in varied fields, giving loans still forms a substantial part of banking business. In India, a banker has been an indispensable pillar of the society since time immemorial. Ancient texts contain specific reference to the concept of like loans, usury, payment of debts, contracting of debts without intention of repayment etc. Thus, giving and taking of credit in some form or other has been prevalent in India since the Vedic period or may be even earlier. But the transition from simple money lending to banking must have taken place sometime before the era of Manu, who has devoted a special section to the subject of deposits and pledges etc. in his commentaries, in one place he states, “A sensible man should deposit his money with a person of good family, of good conduct, well-acquainted with law, veracious, having many relatives wealthy and honorable Arya”. He also laid down rules to govern the policy of loans and interest rates. With the advent of modern banking system with its myriad rules and regulations, the bankers in India have settled upon a number of profitable ways for fund utilization. Thus the funds in the hands of a banker may be put to use for any one of the following purposes, viz : 1. Call loans, and loans repayable at a short notice. 2. Investment in gilt edged securities (issued by government or otherwise). 3. Loans and advances 4. Purchasing and discounting of bills. But merely because ‘Lending’ forms a major chunk of banking functions it does not mean that the banker gives a loan to any or all person(s) asking for it. Before he sanctions a loan he has to ascertain whether or not it would be desirable to give a loan to the applicant. In order to arrive at a conclusion he follows certain basic principles which we would now deal with. 1.2 PRINCIPLES OF GOOD LENDING Merely because the applicant is prepared to give valuable security, the proposed loan does not automatically become desirable. A banker before granting the loan should seek information on the following points from the applicant, viz : a) Capacity of the applicant - A loan transaction being of contractual nature, the applicant should satisfy the requirements of sec.11 of Contract Act, i.e (i) he should be a major; (ii) of sound mind; and 09+09 (iii) should not otherwise be barred from entering into a contract by any law for the time being in force. Similarly, in case of legal persons the banker has to check its constitutional documents to ascertain whether the legal person has the capacity to enter into such a transaction. For example, in case of a company, a banker should carefully scrutinize the

memorandum and articles of association to check whether the directors have the capacity or authority to take a loan, because if they are not so authorized then the loan they loan they take would be ultravires. The company would not be liable on it. b) Purpose of the loan - The loan must be for a purpose which must be satisfactory from a banker’s aspect and must not be prohibited by any governmental order. A loan transaction would be satisfactory from a banker’s view point if he is certain of the assured return of the loan alongwith the interest at the specified rate within the specified period. Though initially bankers usually preferred to give only short term loans for commercial or business purposes, they have now extended their credit/loan facilities to cover practically all kinds of purposes, like, education, house building, expanding business or setting up of new business etc, provided the applicant is able to furnish sufficient security or guarantee to cover the loan. It may sometimes so happen that though a purpose may be highly satisfactory from a banker’s aspect, the government (either State or Central) may impose restrictions on loan being given for that purpose. For example, during the second world war, the banks were requested by the Chancellor of the Exchequer not to grant advances for any purpose which was not in furtherance of the war efforts. Similarly, the Finance Minister can draw the attention of Banks to desirable lending policies keeping in mind the current economic status of the country. c) Amount of the advance - When a customer asks for a loan the banker has to consider the request from two angles, viz : (i) whether the amount requested for would be sufficient for the purpose mentioned ? It is often seen that customers usually underestimate their need and then have to go in for an additional loan. (ii) Whether the requested amount is reasonable keeping in mind the economic status of the customer. For example, Suppose Mr. A drawing a salary of Rs.500/-pm and having no other source of income, applies for a loan of Rs.5,00,000/ - it would not be very prudent for the banker to lend him that amount keeping in mind his paying capacity. While lending money to a company or a partnership concern the banker should first ascertain whether it is a “going concern” or not. If it is then he should next try to calculate the amount of dividend which it would in all likelihood pay the bank. A careful analysis of the trading and profit and loss accounts of the concern should be undertaken to get the following information, viz : (i) Year by year turnover of the concern (i.e., work done or goods sold) should be compared with the amount of debtors as shown in the balance sheets. It is often an unhealthy sign if the proportion of trade debts to turnover is rising; this may indicate that some of the customer’s debtors are finding at difficult to meet their commitments. (ii) Turnover should be compared with the amount owing to creditors. If the proportion of trade creditors to turnover is rising, this probably means that the customer is not meeting

his liabilities promptly and that some of his creditors are pressing for payment. (iii) It is usually a danger signal if the proportion of stock to turnover rises year by year. An excessive amount of stock usually indicates either sales resistance or stockpiling beyond the customer’s resources. Whether an excessive amount of stock is being carried depends to some extent upon the nature of business. As one writer aptly said, ‘a whisky distillery advertising ”Not a drop sold till it’s seven years old” will have a rate of stock turnover much slower than that of a fishmonger advertising ”Fresh fish daily” [Holden, p.9] It is only after getting this comprehensive information that the banker decides on whether to grant the loan or not. A banker who fails to follow this particular golden rule would soon find himself on the verge of bankruptcy due to umpteen bad debts (i.e. debts which have not been repaid nor is there any chance for their recovery). d) Duration of advance - The banker also has to take into consideration the fact whether the loan requested for is for a long term or a short term. A number of advances are still repayable on demand regardless of the terms and conditions agreed upon between the parties. But for the most part so long as the customer honours his side of the bargain the banks rarely require the repayment of loan at an earlier date. e) Source of repayment - This is another important point on which information would be needed before the banker agrees to give the loan. In looking at the sources, the banker also has to take into consideration the value and viability of the security proposed to be advanced against the loan. The security should be such as to cover the deficit in case of failure on the customer’s part to repay the loan. f) Profitability of advance - Last but not the least, a banker should always keep in mind that he is lending money not as a charity but as a business transaction. So he should advance a loan only when it results in a profitable business for him. After dealing briefly with the principles which a banker should keep in mind while lending money, let us now discuss the various kinds of loans advanced by the bankers. 1.3 ADVANCES The most important method by which a banker deploys his funds as mentioned earlier is through giving of advances, loans and overdrafts and the purchase and discounting of commercial bills. The advances by Indian banker are either clean advances against personal credit with or without a second signature on the pronote or against tangible and marketable securities. Advances usually take one of the following three forms, viz : (1) Cash Credits: This is an arrangement by which a banker allows his customer to borrow money upto a certain specified limit, either against a bond of credit by one or more sureties or against some other security. This is a widely popular mode of borrowing amongst the large industrial and commercial concerns in India, for the basic advantage it offers i.e., a 233 (Sys 4) - D:\shinu\lawschool\books\module\contract law

customer need not borrow the entire credit amount in a lump sum but can draw the amount in installments to suit his requirements. He can also put back into the bank any surplus amount left from the amount drawn. The banker in these cases has to estimate the amount which might be required by his customer, and in case his estimate is much more than the actual amount needed and drawn by the customer, he may lose interest on the surplus. To take care of such a contingency, the cash credit agreements usually have a stipulation ”one half or one quarter, interest clause”, i.e, the customer would have to pay an interest on at least one half or quarter of the amount of cash credit allowed to him regardless of whether he actually uses that amount or not. 2) Overdrafts : Sometimes it may so happen that a customer might need a temporary accommodation (i.e., he may need to withdraw more money than what his account actually holds). In such cases the bank may allow him to overdraw from his current account, usually against collateral securities. This arrangement like the one above is advantageous from the customers view point because he is required to pay interest only on the amount actually drawn by him. The basic difference between an overdraft and a cash credit is that the former is deemed to be a kind of bank credit to be used only occasionally; whereas the latter is generally used for long term loans by commercial and industrial concerns doing regular business. But this distinction is more academic than practical, because in practice this distinction is rarely observed and most commercial banks also set up limits for their overdraft facilities also. In Indian Overseas Bank, Madras v. Naranprasad Govindlal Patel, Ahmedabad [AIR 1980 Guj 158] it was observed by the Gujrat High Court that “an overdraft arrangement between a bank and its customer is a contract and it cannot be terminated unilaterally by the bank. Merely because the client was not required to execute any document or to furnish any security would not make such an arrangement an act of grace on behalf of the bank. Such an arrangement even though temporary is not one which can be terminated unilaterally and at the sweet will of the bank without giving notice to its customer”. The bank was held liable for damages for wrongfully dishonoring a cheque which could be covered or honoured within the overdraft limits. Thus, it is clear that no specific form or agreement is necessary for overdraft and it can be imputed or implied from the conduct of the parties. 3) Loans : A lumpsum advance made by a banker, the entire amount being withdrawn by the customer at one stretch, and which he is expected to repay in one single installment, is called a loan. Loan accounting have a lower operating cost than the other two types of advances because the latter involve a larger amount of operations compared to the loans. In case the customer repays the same either wholly or partially and subsequently wants to be accommodated, this would be treated as a separate transaction entered into (provided the bank agrees to do so) and would be subject to a new set of terms and conditions which the bank may seek to impose. The bank thus does not suffer from any loss of interest as a consequence to 234 (Sys 4) - D:\shinu\lawschool\books\module\contract law

carrying excessive cash essential for a cash credit or overdraft transaction. Loans vis a vis Cash Credits The practice of giving advances by way of cash credits is somewhat peculiar to India. The practice grew mainly because of the absence of an organized bill market in the country. The borrowers find it very convenient as they have to pay interest on the day to day balances while they have assurance of a higher limit whenever they want it. From the bank’s point of view the system is not very convenient as they have to keep much larger cash balances in view of the uncertainty about the undrawn limits. Under the cash credit system there is also a tendency on the part of the borrowers to ask for a much higher limit than they actually require as they have to pay interest only on the actual debit balances. During the credit squeeze in the busy season of 1973-74 there was a tendency on the part of the borrowers to draw on their limits to the hilt fearing that the undrawn limits would be cancelled or frozen. This revealed another undesirable effect of giving the advances by way of cash credits. Some authorities have suggested that banks in India should follow a combined system of cash credit-cum-loan giving the hard core requirements of a borrower by way of loan and the fluctuating requirements by way of cash credit. The practice, it is believed, would enable banks to judge the borrowers’ requirements with greater precision and thus manage their cash position more efficiently and economically. This was also recommended by the Tandon Committee. In view of the recommendation by the Tandon Committee, the Reserve Bank advised the banks in 1975 to bifurcate the cash credit limits into a ‘core’ portion and a 'variable cash credit' portion with differential interest rate for the two components. The banks however found it difficult to comply. Therefore in April 1979 a working group under the Chairmanship of Shri K.B. Chore was set up to re-examine the cash credit style of lending. On the recommendation of the Chore Committee the Reserve Bank rescinded its earlier instructionss and advised the banks to abolish the differential in interest rate and bifurcation. The Chore Committee has also given in its report the advantages, and disadvantages of different styles of lending and the recommended lending system [Tannan, p. 380]. Since ‘loans’ from a substantial part of banking transactions we would now deal in detail with the various kinds of loans given by the banks. 1.4 TYPES OF LOANS Having a precise or exact classification of loans is a fairly difficult job because we might have different types of classifications depending on the criteria involved. As for example, based on the time period you may have a short term loan or a long term loan, based on the security involved you may have secured loan or unsecured loan; based on the maturity period you may have loans payable on demand or term loans;

so on and so forth. So instead of trying to classify loans into various kinds we will now just try to deal with the various kinds of loans given by banks. 1) Loans repayable on demand Bank loans are generally repayable on demand, though as a general practice the banks do have an informal agreement with their customer to allow them to use the money for a certain specified period provided he follows or adheres to the terms of their agreement. Bankers usually reserve to themselves the right to cancel the agreement or to reduce the loan amount, but they are required to give a reasonable notice to the customer before doing so. For example, suppose a banker has promised his customer an overdraft to a limit of say Rs.10,000/- and later wants to reduce the limit to say Rs.5,000/-. He cannot dishonour the customer’s cheque issued before he received a notice from the bank, provided the cheque amount is within the original overdraft limit. [See Rouse v. Bradford Banking Co., (1894)AC 595]. 2) Term Loan Whenever a bank gives a loan for a period exceeding one year and the customer is required to repay it according to a fixed schedule, i.e, the repayment is neither on demand nor is it in a lumpsum or a single installment, it is known as a term loan. When the loan period exceeds one year but is less than five years it is known as medium term loan; and a loan with longer repayment schedule, i.e., a schedule going beyond 5 to 7 years is known as long term loan. Since a term loan is generally granted for fixed capital requirements [for example, construction of a factory or buying of machinery etc], it requires a more accurate and sustained or thorough appraisal of all the relevant factors as compared to simple demand loans. No term loans to defaulting units -The Reserve bank of India has directed banks not to consider applications for fresh term finance [including deferred payment guarantee facility] for setting up new projects or expansion of existing units from defaulting concerns which have been persistently defaulting in the payment of interest or repayment of principal or both. The banks have also been instructed to ascertain the position of the applicant regarding the overdue interest or installments from other lending institutions too. As regards the provision of working capital facilities to the borrowers, the working capital assistance should be withheld only in cases wherein the management is indulging in malpractices such as siphoning off the concern’s funds [Tannan, p.376]. 3) Participation loan or consortium advance In certain circumstances, two or more financing agencies may grant a single loan to a single customer. Such a loan is termed as a participation or consortium loan. This practice is resorted to where the risk involved is too extensive for any single institution to take it up with equanimity or there are administrative or other difficulties involved in either sanctioning or following up the loan. Participation loan is very popular in America because: (a) the dual banking system prevails there;

(b) the unit banks do not have sufficiently large resources and have to seek supplementary resources with the larger city banks; (c) there are legal restrictions on lending, and the National banks cannot lend more than 10% of their paid up capital and reserves to one single borrower; and (d)the financing of real estates by banks which involves greater risks. This kind of loan is slowly assuming importance in India also and it is logical to presume that in this era of liberalization resulting in mega joint ventures this might be the only kind of loans the commercial or industrial sector would be able to get. Lending under Consortium Arrangements by Banks for Working Capital In December 1973, the Reserve Bank set up a Study Group with the object of evolving a consortium approach among banks in providing financial assistance to the borrowers. The Study Group expressed the view that consortium/participation should be accepted as a culture and philosophy of banking, and the evolution of consortium lending could lead to the pooling of expertise, geographical presence and the total upgradation of the lending and service capability of the entire banking system. The Reserve Bank accepted the recommendations of the Study Group and conveyed to commercial banks in August 1974, suggesting that they might bear these recommendations in mind while sanctioning advances to large borrowers. The important guidelines are reproduced below: i) large credit limits to any single borrower in the private or public sector (including Electricity Boards) in excess of 1.5% of a bank’s deposits should normally be extended on a participation basis, ii) in cases where the working capital requirements of a borrower are financed by a number of banks without a consortium arrangement, a proper procedure for coordination amongst the financing banks in regard to the appraisal of credit needs, review of performance and followup, and exchange of information should be evolved, iii) any arrangement to finance a borrower on a consortium basis should normally take care of the entire financial requirements and other incidental business of the borrower, and iv) food credit consortium arrangements should be forged amongst the banks themselves without the share of each bank having to be decided under the aegis of the Reserve Bank as heretofore, and the total banking business of the Food Corporation of India should be shared between the participating banks as far as possible. Following the Tandon Committee recommendations for the follow-up of bank credit and observance of credit discipline by the large borrowers having multiple banking arrangements, the Reserve bank stressed the desirability of the banks forming a proper consortium with the bank having the maximum share in the total credit limits to act as a ‘lead’ bank or as ‘consortium leader’. However, since the borrowers were found to experience undue delay in obtaining sanctions, etc., under the consortium 235 (Sys 4) - D:\shinu\lawschool\books\module\contract law

arrangements, the Reserve Bank framed broad guidelines in November 1978, to be followed by the banks in lending for working capital under such arrangements. The banks were advised as under: 1. while it is desirable to form a consortium wherever there are multiple banking arrangements, the formation of a consortium was obligatory where the aggregate credit limits sanctioned by several banks to a single party amounted to Rs.5 crores or more, 2. the earlier guideline that where the limits sanctioned by a bank to a borrower exceeded 1.5% of its deposits, the advances should be shared by it with the other banks, shall continue to be in force, 3. the share of each member bank in the consortium should not normally be less than 10% of the aggregate working capital limits sanctioned to the borrower. 4. for the sake of operational convenience, the number of members in the consortium should be kept as low as possible; it should not normally exceed five, except in the case of very large credit limits, such as those exceeding Rs.50 crores, where the number can be increased to the extent necessary, 5. the bank selected as the leader of the consortium and one or two other members of the consortium as agreed upon, should be entrusted with the work of appraisal of the borrower’s credit requirements, 6. the terms and conditions of the advance should be finalized by the consortium committee and should be uniform for all the member banks. In order to avoid delays in the release of funds, the Reserve Bank stressed the need to obtain acceptance in principle at the initial stage from the competent authority in each bank for its participation in the consortium. It was emphasized that the spirit of the consortium should be maintained by the participating banks. The member banks should respect the consortium committee’s decisions on all operational matters and also endeavour to maintain the agreed share with regard to any additional credit that might have to be sanctioned to the borrower. In the follow-up and supervision of the use of credit, all the consortium members should be sufficiently involved. The guidelines were to some extent amplified in December 1979. The clarifications related mainly to: (a) the member banks should share the ancillary business of the financed units as far as possible in the same proportion in which the credit lines were shared, (b) there should be uniformity in the documentation, and (c) the total drawings from each of the consortium members should be in the proportion to the stipulated ratio of sharing.[Tannan, pp 377-378]. 4) Personal Loans Personal loans are comparatively of a recent origin as compared to loans given for industrial or commercial purposes and mark another step in the development of modern banking. Personal loans are given for personal requirements connected to the status 236 (Sys 4) - D:\shinu\lawschool\books\module\contract law

of the individual, for example, purchase of radio, television, refrigerator, car, construction of a house etc. They may sometimes even be granted for covering traveling expenses, vacationing etc. These are for the most unsecured loans and are repayable in easy monthly installments which may go on for certain specified years. Recently the Indian banks have published a scheme for granting of such personal loans to the middle class populace. This loan is usually granted for durable consumer goods [like television or refrigerator etc]. This type of loan is extremely popular with the customers as it provides them with an easy and affordable way to a comfortable and convenient life style, while at the same time allowing the banks to secure the patronage of a specific class of populace. Personal loans to the weaker sections of the society are given at a concessional rate under the Differential Rate of Interest Scheme. 5) Unsecured Loans Though the banks generally grant loans against some tangible security, they do sometimes give loans without any outside security. Such loans which are given only on the strength of personal security of the borrower are known as unsecured loans. The customer’s personal credit forms the backbone of such transactions. The question arises what is meant by credit ? Various economists have defined it differently and some of these are reproduced below. ”In its simplest form” says Professor Laughlin, “it (credit) is a transfer of commodities involving the return of an equivalent at a future time”. Kines defined credit as an “Exchange in which one party renders a service in the present while the return made by another falls in the future.” According to Masse, “Credit is the confidence felt in the future solvency of a person, which enables him to obtain the property of others for use as a loan, or for consumption.” Macleod speaks of credit as “the present right to a future payment.” Credit as a term originated from the word “credre” meaning to believe or to trust; and in its popular usage implies the power of a person to induce others (without use of any overt force or violence) to part with their money, goods or services, in return for an express or implied promise to perform some return service in future, which is usually a payment in cash or kind. Thus unsecured loans are given by bankers only to customers of a good character and unimpeachable integrity and having the capacity to repay the loan. The basic principle on which these loans are given or based are `Character, Capacity and Capital’ or the three C’s. Some authors put it as three R’s i.e., `Reliability, Responsibility and Resources’, and it is evident that these three are not totally unconnected. If the borrower is of a dubious character or has no known resources the prudent banker avoids giving him an unsecured loan for any amount. Though one may be hard put to define character, one can certainly say that `honesty’ alone does not constitute character. Several other

traits contribute to character, for example, “the sobriety, the promptness of payment, good habits, personality, the ability and willingness to carry a project through from the beginning to the end and the reputation of the people with whom he deals, which go to make the character of a customer.” Since the nationalization of banks, there has been a general trend among the bankers to refrain from insisting on securities and instead to look at the productivity of the proposal in terms of future potentiality while granting a loan. Even the Reserve Bank of India has indicated that banks should relax security requirements in respect of loans and advances granted to the weaker and neglected sections of the society. All this does not mean that the banks should never ask for security or that security has lost its importance, but the relaxation is made keeping in mind the financial base of the new type of borrowers. Their financial status is so weak that if the banks keep insisting on security, none (or at the most a negligible few) of them would be eligible for bank loans. To encourage this section of populace to take up some productive project in order to make them financially self-sufficient these easy-loan schemes without the usual security requirements have been formulated. Such loans are not very risky for the following reasons, viz: 1. Generally the amount advanced is usually small; or 2. They are spread over a large number of people. Even the minimal risk is safeguarded against by the banks seeking group guarantees or by obtaining a charge (either fixed or floating) on the assets obtained by the customer through bank funds. 6) Secured Loans These form a major chunk of the loans granted by the banks. All loans which are not unsecured loans are secured loans, be the loan payable on demand or be it a term loan. A secured loan is one where the bank advances the money against some tangible, valuable, marketable asset of the customer. The asset may be anything - a house, shop, machinery, stock in trade, shares, etc., and the value of security is dependent or is in proportion to the amount of the loan sought. Prior to nationalization banks generally gave credit only to large industrial or commercial concern or to rich customers having extensive resources at their command to advance as securities, and these were more than sufficient to cover the loan amount. The advantages of secured loans are as follows: 1. The bank is legally permitted to take possession of the security, sell it and recover the debt amount from the sale proceeds, in case the customer defaulted in repayment. 2. Due to the charge on the assets, the banker is able to exercise a modicum of control on the borrower’s behaviour during the period of loan. 3. Once the bank takes possession (either actual or construction) of the security, the borrower is restricted from taking a second loan on the same security. He is thus prevented from increasing his liabilities beyond his means.

4. Since the borrower advances the security to the bank, he remains conscious of his obligations to the bank and does not usually leave the bank to his own mercy. Since nationalization as mentioned earlier, there has been a change in the bank’s attitude towards security, mainly because of the broad guidelines laid down by the Government and The Reserve Bank of India with respect to advances to be granted by banks, keeping in mind the objectives of commercial banking. The main guideline in this regard are as follows. a) Credit facilities should be extended to hitherto unbacked sectors (resulting in growth and progress of new and fresh enterprises and ventures) and to those persons who lack an easy access to institutional credit facilities. This approach would result in correcting sectoral and regional imbalances and help in a most equitable distribution of economic power. b) Banks should serve farmers and take a active interest in promotion of agricultural production and rural development in general. c) The legitimate credit needs of trade and private industry would be met, but certain undesirable features of lending, such as double financing or over financing would be eliminated. d) An emphasis on financing of priority sectors, new entrepreneurs in backward areas should not be at the expense of economic viability [i.e., industries should not be financed merely because they are in a priority sector or are to be located in a backward area, if there are no chances of any economic returns from the industry]. 1.5 PROCEDURE OF TAKING LOAN When a person approaches a bank for the purpose of taking a loan, the banker first tries to ascertain under which of the following broad category the loan would come, viz a) Agricultural b) Small Scale Industry c) Commercial and Industrial Sector; or d) Personal. These categories may differ for each bank. The above is the SBI categorization. After ascertaining the category, the person is given the relevant application form [the application form for each of these categories is different] which he has to fill up and submit alongwith the required documents at the appropriate branch. Every branch does not deal with every type of loan, as for example, a small branch may deal only with personal loans or a rural branch may deal only with the agricultural, small scale industry and personal loans. The type of loan which a bank would give depends on the kind of demands made on it if there is no demand for a particular type of loan, say commercial and industrial, the bank will not have the power to deal with it and in such a case, if a person approaches that branch for a loan for commercial purpose, he would be directed to the appropriate bank branch dealing with that type of loan. 237 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Once the application is filed the application is processed, and if necessary the banker may seek clarification from the applicant on any issue or may ask for additional information. In general, depending on the priority/urgency, a loan request is granted within four to six weeks time if all the requirements are fulfilled. The above four categories are listed according to their order of priority. Agricultural loans are given maximum priority [i.e., they are granted within the shortest possible time and carry an extremely low rate of interest]; and personal loans are given least priority [i.e., they carry the highest rate of interest]. Even among small scale industries women entrepreneurs are given a priority over their male counterparts. Similarly, there is an unwritten policy that commercial ventures which might prove harmful to the society shall be given extremely low priority, as for example, a person wanting to open a bar or wanting to put

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up a liquor manufacturing unit might get the loan, but the loan would be given to him only if there are any surplus funds left over after giving off loans to priority sectors. A person taking loan for a commercial purpose will have to submit a ‘project report’ giving in brief all the relevant data relating to the product, the manufacturing process, the input required, expected sales, marketing, etc. The manufacturing process and sales form an important component of such a report. At present, approximately 20% of the expected sales is granted as a loan in general, i.e., if the sales are expected to be about Rs.1,00,000 then the loan granted will be about Rs.20,000/-. The period for which the loan is given depends on the type of loan, as for example, if it is a term loan for 3 years, the loan will have to be paid back in 3yrs and so on. A loan further is given against securities which we will now deal with in detail.

2. DIRECT SECURITIES SUB-TOPICS 2.1. Pledge 2.2. Hypothecation 2.3. Mortgage 2.4. Charge 2.5. Letters of Credit 2.1 PLEDGE Pledge and hypothecation form a major chunk of bank financing especially for trade or commercial purposes. Section 172 of the Indian Contract Act defines pledge as: “The bailment of goods as security for payment of a debt or performance of a promise is called pledge.” The bailer is in this case called the “Pawner” and the bailee is called a “Pawnee”. Pledge has the following essential characteristics, viz., a) The pledge article must be delivered (either actually or constructively) to the pawnee. b) The delivery must be either for payment of a debt or the performance of a promise. c) On the pawner’s repaying the debt or performing his promise the goods must be returned to him. In Lallan Prashad v. Rehmat Ali [AIR 1967 SC 1322], it was held that there are two ingredients of a bond or a pledge namely, (i) that it is essential to a contract of pawn that the property pledged should be actually or constructively delivered to the pawnee, and (ii) a pawnee has only a special property in the pledge but the general property therein remains in the pawner and wholly reverts to him on discharge of the debt. A pawn is thus a “security” where goods are deposited as ”security” for a debt or performance of a promise. Since pledge is a kind of bailment it is evident that only 'immovable property’ or `goods’ can be pledged. As mentioned earlier it is not really necessary to have an actual delivery of tangible movable property. In Morvi Mercantile Bank Ltd. by official Liquidator v. Union of India [AIR 1965 SC 1954], a firm borrowed a sum of Rs.20,000 from the bank. It executed first a promissory note and later endorsed the railway receipts pertaining to certain goods belonging to the firm in favour of the bank. In fact, the bank had advanced the said amount of Rs.20,000/- against the security of these railway receipts. The question in issue was whether the bank was the pledgee of the goods or was only the pledgee of the documents of title by virtue of which it could only keep the documents against the payment by the firm. It was held that the three transactions, namely, (1) the advancing of loan, 2) the execution of the promissory note and 3) the endorsement of the railway receipts, together formed one transaction. Their combined effect was that the bank would be in control of the goods till the debt was discharged. Such a transaction was a pledge. Hence, the firm by endorsing the railway receipts in favour of the bank for consideration pledged the goods covered by the said receipts to the bank.

As observed in Sanjiva Row’s ‘Commentaries on Indian Contract Act’: ”a ‘pledge’ is a delivery of goods by the pledger to the pledgee by way of security upon a contract that they shall, when the debt is paid or the promise is performed, be returned or otherwise disposed of according to the direction of the pledger...A pledgee does not have the right of ownership, though he has the right of a pledger which include only the right of possession, but not the right of enjoyment; a pledgee has the right of disposition which is limited to disposition of pledgee’s rights only and of sale only after notice and subject to certain limitations.” Pledge of Shares In case shares of an incorporated company are pledged it is not necessary for the pledge to be duly filed in a transfer form. In re Bengal Silk Mills Case [(1992) 12 Comp. Cas. 206] it was held that a transferee in the case of a transfer to shares in blank has the right to fill in the necessary particulars including his own name as a transferee and the date of the transfer, even after the death of the original transferor. The transfer so made will b a valid one and the transferee will be entitled to have his name registered in the company register as the holder of the shares. In Nayar Avergal v. P.M.Krishna Patta and others [AIR 1943 mAD 74] it was held that as shares are not tangible things the legislature must have associated share certificate, which are marketable when they included ‘shares’ in the definition of ‘goods’ in the Sale of Goods Act. Therefore, when a person delivers a share certificate to another to be held by him as security there is under the law of India a valid pledge which he can enforce but, unless the pledgee at the time of deposit secures a deed of transfer which he can use in case of necessity or obtain one from his debtor at a later stage, he must have recourse to the Court when he wishes to enforce his security. The Court can confer a full title on the buyer by following the procedure laid down in Order 21 Rule 80 C.P.C. In Kanhaiya Lal Jhanwar v. Pandit Shirali and Company and others [(1953) 23 Comp. Cas. 399], it was held that ‘a transferee to whom share scrips and transfer in blank are given to fill up the names of the transferee... The deposit of share scrips themselves is sufficient to create a pledge thereon. Blank transfers, if in order, have the effect of transferring the title in the shares to the pledger, but a transfer of title is not necessary to create a pledge, simple delivery of possession being enough.’ ‘The Key Loan System’ and ‘The Open Credit System’ In State Bank of India v. Quality Bread Factory, Batala [AIR 1983 P & H 244] the distinction between the above two systems of loan was brought about. It was held that the loans are advanced by the banks to its customers either on key loan system or the open credit system. In the key loan system, the goods pledged are under the lock of the pledgee and the pledger has no access to them whereas in the open credit system the goods pledged are in actual possession of the pledger and the pledgee has constructive possession over them. In the former system the pledger cannot deal with the goods unless the pledgee gives their possession to him, whereas, in the latter system, he has 239 (Sys 4) - D:\shinu\lawschool\books\module\contract law

freedom to deal with them. In the open credit system, however, the former character of pledge is maintained. The loan advanced on the basis of key loan system is also called loan by pledge of goods and the loan advanced on open credit system is also called factory type loan or loan on the basis of hypothecation. The distinction between these two types of systems has far-reaching implications when the distinction is taken in conjunction with other relevant matters. In the open credit system the pledgordebtor is required to furnish a detailed statement of stocks, manufactured goods, machinery etc., hypothecated at regular/ specified intervals and the pledgee-creditor is entitled to examine the hypothecated articles and to take them into his possession at any given time if he feels the debtor is misusing them or using them negligently. The pledgee-creditor is thus required to exercise ceaseless vigil on the pledgor-debtor so as to protect himself and the surety against the illegal or negligent actions of the debtor. Loss of the Pledged Goods When a debtor pledges his goods with the bank the implication is that the pledge is for the purpose of meeting the liability of the debtor in case of his default in repaying the pledge-debt. The question of pledgee exercising control/power or taking any action arises when the property in the goods is lost either because of: 1) some act of the pledger; or 2) seizure by the Government under some statutory power; or 3) failure to take care of the pledged goods; or 4) on account of the goods being attached under a Court order for the satisfaction of debt. When the pledged goods are lost the question arises as to whether the rights of the State should take preference over the rights of the pledgee; or as between two innocent parties who should be made to suffer the loss. In State of Bihar v. Bank of Bihar Ltd. [AIR 1963 Pat. 344], money had been advanced by the bank to a sugar factory, and the sugar bags of the factory were seized by the State Government orders issued under Section 3 of the Essential Commodities Act, 1946. The bags were sold and the sale proceeds were attached by the Cane Commissioner for arrears of cane cess due from the company. The bank claimed its dues out of the sale proceeds. It was held that the only remedy of the bank was against the Directors of the Company and not against the State Government (through the Cane Commissioner). On appeal the Supreme Court in Bank of Bihar v. State of Bihar [AIR 1971 SC 1210] held that ‘the rights of the pawnee who has parted with money in favour of the pawner on the security of goods cannot be extinguished even by lawful seizure of goods by Government and by making money available to other creditors of the pawner without the claims of the pawnee being first fully satisfied. After the seizure the government is bound to pay the amount due to the pawnee. The balance alone is available for other creditors...if the Government deprived the pawnee of his amount due, Government is bound to reimburse him for such amount which he in ordinary course would have realized by sale of goods pledged with him on the pawner making a default in payment of debt...the law relating to the rights of the pawnee vis-a-vis other unsecured creditors of the pawner was the same in India and in England. The trial Court 240 (Sys 4) - D:\shinu\lawschool\books\module\contract law

had failed to understand that the plaintiff’s right as a pawnee did not come to an end on seizure of the goods. The Commissioner being an unsecured creditor could not have any higher rights than the pawner and was entitled only to the surplus money after satisfaction of the plaintiff’s dues'. Various propositions relating to loss of pledged goods which can be gleaned from a survey of case laws and a study of the relevant sections are given below: 1) A pawner being a secured creditor stands on a higher footing as compared to the unsecured creditors (even if the unsecured creditor be the government) and his claim has to be satisfied first before distributing the money among the other creditors. 2) The pledgee is not liable for the loss of pledged goods provided he has taken as much care of the goods bailed to him as a man of ordinary prudence would under similar circumstances take of his own goods, of the same bulk, quality and value as the goods bailed [M/s. Gopal Singh Hira Singh Merchants v. Punjab National Bank, AIR 1976 Del. 115]/ 3) In case there is also a surety who has given a guarantee for the loan, then, if the pawner looses or parts with the security (i.e., the pledged goods) without the consent of the surety, the latter is by the express provision contained in section 141 (of Contract Act) discharged to the extent of the value of the security lost or parted with [See State of Madhya Pradesh v. Kalu Ram, AIR 1967 SC 1105]. 4. In case the goods are lost by the negligence of the pawnee, the pledger’s liability is reduced to the extent of the value of goods. [Gurbax Rai v. Punjab National Bank, AIR 1984 SC 1012] Right to sue and right to sell Section 176 of the Contract Act dealing with pawnee’s right where pawner makes a default states as under: “If the pawner makes default in payment of the debt, or performance, of the stipulated time of the promise, or performance, at the stipulated time of the promise, in respect of which the goods were pledged, the pawnee may bring a suit against the pawner upon the debt or promise, and retain the goods pledged as a collateral security; or he may sell the thing pledged, on giving the pawner reasonable notice of the sale. If the proceeds of such sale are less than the amount due in respect of the debt or promise, the pawner is still liable to pay the balance. If the proceeds of the sale are greater than the amount so due, the pawnee shall pay over the surplus to the pawner.” Thus in case of the pawner making a default, the pawnee may sue the pawner on the debt or he may sell the pawned goods after giving the pawner a notice. These rights of a pawnee are concurrent or co-existing rights, and merely because the pawnee has opted for the former course of action it does not close out the other option. It would be relevant here to refer to the observations of Bachawat,J., in Haridas Mundra v. National and Grindlays Bank Ltd. [AIR 1963 Cal 131] who held that:

“In case the pawner makes default, the pawnee has three rights: i) he may bring a suit against the pawner upon the debt or promise, and (ii) he may retain the pawn as a collateral security, or (iii) he may sell it on giving the pawner a reasonable notice of the sale. The right to retain the pawn and the right to sell it are alternative and not concurrent rights, when the pawnee retains, he does not sell; and when he sells he does not retain. But the pawnee has the right to sue on the debt or the promise concurrently with his right to retain the pawn or sell it. The retention of pawn does not exclude his right of suit, since the pawn is a collateral security only. Nor does the sale of the pawn destroy this right; the pawner is still liable on the original promise to pay the balance due. The sale does not give a fresh starting point of limitation for a suit to recover the balance. Similarly, the institution of a suit upon the debt or promise does not reduce the pledge to a passive lien and destroy the pawnee’s right to sell the pawn. The right of sale is necessary to make the security effectual for the discharge of the pawner’s obligation and the right continues inspite of the institution of the suit. Even if it be assumed that the right of sale out of court is alternative to the right to institute a suit on the debt or promise, the two alternatives are not mutually exclusive and the exercise of one alternative right does not destroy all future recourse to other alternatives.” Effect of sale without notice The giving of a “reasonable notice” before selling the pawned goods is a statutory requirement and cannot be excluded by a contract to the contrary [Prabhat Bank v. Babu Ram, AIR 1966 ALL 134]. Such a sale would be bad in law and the pawnee cannot claim the deficit amount from the pawner in case the sale proceeds is not sufficient to cover the debt amount [L.N. Arjundas v. State Bank of India, AIR 1969 Pat 385]. What is a reasonable time depends on the facts and circumstances of each case. The pledger has the right to redeem the pledge and this right is available to him till the time the pawnee exercising his right sells the goods. He is even entitled to buy the goods back in the sale but that does not mean that his liability under the pledge comes to an end merely because he has got back the possession of goods. The pledgee can still hold the pledger liable for any deficit in the difference between the loan amount and the sale proceeds [Dhani Ram and Sons v. Frontier Bank, AIR 1962 Punj 321]. 2.2 HYPOTHECATION Hypothecation is a transaction where goods are given as security against a loan without transferring simultaneously by the property or possession to the creditor i.e., though the goods are used as a security the debtor retains both the possession and property in those goods. M.K.Tannan defines hypothecation in the following words: “In law, to create mortgage of movables, appropriate words of transfer and conveyance are necessary for a pledge, possession is essential. A transaction intended to be a security over chattels, in which there are no words of transfer and where the possession remains with the borrower, will therefore amount to an equitable charge which is generally

known as hypothecation. Lord Macnaughten has characterized hypothecation as `being ambulatory and shifting in its nature; covering over and so to speak, floating with the property until some event occurs or some act is done which causes it to settle and fasten on the subject within its grasp.’ Singularly enough, according to the Calcutta decisions, a mortgage of movables in India stands on the same footing as an hypothecation under English Law.” According to the Corpus Juris ‘Secundum’ (Vol.XLII) hypothecation means ”a contract of mortgage or pledge in which the subject matter is not delivered into the possession of the pledgee or pawnee; or, conversely, a right which the creditor has over a thing belonging to another, and which consists in a power to cause it to be sold in order to be paid his claim out of the proceeds.” In Halsbury’s Law of England [4the edn., p.438, para 635] the expression hypothecation of cargo has been defined as “a pledge of the cargo without immediate change of possession; it gives right to the person making advances on the faith of it to have the possession of the goods if the advances are not paid at the stipulated time; but it leaves to the owner of the hypothecated, the power of making the repayment, and thereby freeing them from obligation”. Venkataramaiya’s Law Lexicon [5the edn., p.568] explains hypothecation as: “A pledge in which the pledger retained possession of the thing pledged as security for a debt...It differs from a mortgage in that there is no actual or executory conveyance or assurance of the property hypothecated for payment of debt or loan, and from a pledge in that there is no actual or constructive delivery of the property. Hypothecation is a mode of creating a security whereby not merely the ownership, but also the possession of the thing, remains with the owner. From the above definitions it is clear that the basic difference between pledge and hypothecation is that in case of former the possession of goods is with the creditor, whereas in case of latter the possession of goods remains with the debtor. In Bank of Baroda, Ahmedabad v. Rabari Bachu Bhai Hira Bhai and others [AIR 1987 Guj 1], it was held that hypothecation is different from pledge. When a property is hypothecated with a creditor, it is given as security or collateral for a debt without physical transfer thereof to the creditor. The title to the property does not pass to the creditor but the creditor has merely the right to sell the property on default. It differs from a pledge where possession of the article pledged is transferred to the pledgee or pawnee. The question to be decided in this case was whether the hypothecating bank could be held vicariously liable to pay damages to the injured for the negligent act of the driver of the hypothecated vehicle. After giving the above distinction the Gujrat High Court held that the appellant bank was not liable to pay compensation to the victim of the accident. The reason for this decision is very simple. When a vehicle is hypothecated its possession continues with the owner-pawner. The jural relationship between the bank and the owner is that of a creditor and debtor, with the bank having the right to sell off the vehicle in case the owner fails to pay his dues; but the debtor remains in de jure and de facto possession of the vehicle 241 (Sys 4) - D:\shinu\lawschool\books\module\contract law

exercising full control over it. Since the bank has no control over the use of the vehicle it cannot be made liable to pay compensation. Hypothecation is as in the case of pledge always of movable goods or property. Though movable property is not defined anywhere, section 3 of the General Clauses Act defines immovable property as: “Immovable property includes land, benefits to arise out of land and things ”attached to earth”. Sec. 3(vi) of Transfer of Property Act, 1882 defines things “attached to earth” as under: a) rooted in the earth, as in the case of trees and shrubs; or b) embedded in the earth, as in the case of walls and buildings; or c) attached to what is so embedded for the permanent beneficial enjoyment of that to which it is attached. All other property is movable. The difficulty arises in deciding whether a property is movable or immovable in case of objects like trees and machinery, because when the tree is rooted in the ground it is immovable the moment it is out it becomes movable. Similarly, a machinery as such is movable the moment it is fixed to the floor it becomes immovable. Whether they are treated as movable or immovable always remains a question of fact and a matter of proof in each case. A sort of general principle was laid down in The District Board, Banaras v. Churhu Rai [AIR 1956 All 680] wherein it was held that the real test for determining whether a tree is movable or immovable property is not the nature of the tree, but the way in which it is intended to be dealt with. If the intention of the parties in respect of a particular transaction is that the tree is to be cut by the purchaser and removed, it will be timber and movable property. But if the intention is that it should after the purchase continue to grow, it may not be timber, i.e., it will be immovable. Similarly in Kuppanna Chetty Ambati Ramayya Chetty and Co. v. Collector of Anantpur and others [AIR 1955 AP 457] it was held that ‘under Transfer of Property Act, buildings constitute immovable property and machinery if attached to the building for the beneficial enjoyment thereof is also attached to the earth. If the machinery is embedded in the building for the beneficial use thereof, it must be deemed to be a part of the building and the land on which the building is situate.’ In general, whenever a customer borrows from a the bank against machinery installed in his factory premises or otherwise, it is always a case of hypothecation [and in fact most of the hypothecation cases deal with machinery hypothecation] as the bank is least interested in keeping the key of the premises where the machinery is installed. It is thus an open credit system of loan advance, which is why it becomes necessary to find out whether the concerned machinery is to be treated as movable or immovable. In order to help the bank determine this problem the following two tests may be laid down: 1. What is the intendment, object and purpose of installing the machinery - whether it is for the beneficial enjoyment of the building, land or structure, or the enjoyment of the very machinery? 242 (Sys 4) - D:\shinu\lawschool\books\module\contract law

2. What is the degree and manner of attachment or annexation of the machinery to the earth whether it is fixed to the earth with the help of mere bolts and screws (i.e., something which can be removed with little or no trouble) or whether it is deeply embedded in a concrete floor (i.e., with the idea of keeping it permanently affixed there). Machinery attached by the formed mode can be hypothecated but those affixed by the latter mode cannot - they can only be mortgaged. The risks faced by the banker 1. Since the bank does not obtain actual or constructive possession of the goods, the degree of control which he can exercise over the goods is very little or limited, as a consequence of which the borrower gets sufficient opportunity to deal with the goods in any manner he wants (even fraudulently). 2. The second risk arises from the fact that because of the uncertainty regarding the category of goods, (i.e., movable or immovable) the banker may find himself in a difficulty in the transaction he enters because if it is a case for mortgage then it has to be registered else it will not act as a notice to the subsequent mortgagee or the purchaser of the property. This might result in the banker losing his security through no fault of his. Precautions to be taken by banker 1. Check thoroughly the credit and standing of the borrower. 2. As far as possible ask for a guarantee as a collateral security. 3. Once the hypothecation has been entered into, be regular with the follow up and inspection of the hypothecated good, to check whether the debtor is using it properly or not. In case, the goods are being misused take an immediate action. 2.3 MORTGAGE Section 58 of the Transfer of Property Act, 1882 defines mortgage as under : (a) A mortgage is the transfer of an interest in specific immovable property for the purpose of securing the payment of money advanced or to be advanced by way of loan, an existing or future debt, or the performance of an engagement which may give rise to pecuniary liabilities. The transferor is called a mortgagor, the transferee a mortgagee; the principal money and interest of which payment is secured for the time being are called the mortgage money, and the instrument (if any) by which the transfer is effected is called a mortgage-debt. (b) Simple mortgage. Where, without delivering possession of the mortgaged property, the mortgagor binds himself personally to pay the mortgage money, and agrees expressly or impliedly, that in the event of his failing to pay according to his contract, the mortgagee shall have a right to cause the mortgage property to be sold and the proceeds of sale to be applied, so far as may be necessary, in payment of the mortgage money, the transaction is called a simple mortgage and the mortgagee a simple mortgagee.

(c) Mortgage by conditional sale. Where the mortgagor ostensibly sells the mortgaged property - on condition that on default of payment of the mortgage money on a certain date the sale shall become absolute, or on condition that on such payment being made the sale shall become void, or on condition that on such payment being made the buyer shall transfer the property to the seller, the transaction is called a mortgage by conditional sale; Provided that no such transaction shall be deemed to be a mortgage unless the condition is embodied in the document which effects or purports to effect the sale. (d) Usufructary mortgage. Where the mortgagor delivers possession or expressly or by implication binds himself to deliver possession of the mortgaged property to the mortgagee, and authorizes him to retain such possession until payment of the mortgage money, and to receive the rents and profits accruing from the property or any part of such rents and profits and to appropriate the same in lieu of interest, or in payment of the mortgage money, or partly in lieu of interest and party in lieu of mortgage money, the transaction is called a usufructuary mortgage and the mortgagee a usufructuary mortgagee. (e) English mortgage. Where the mortgagor binds himself to repay the mortgage money on a certain date, and transfers the mortgaged property absolutely to the mortgagee, but subject to the proviso that he will retransfer it to the mortgagor upon payment of the mortgage-money as agreed the transaction is called an English mortgage. (f) Mortgage by deposit of title deeds. Where a person in any of the following towns, namely, the towns of Calcutta, Madras and Bombay, and in any other town which the State Government concerned may, by notification in the Official Gazette, specify in this behalf, deliver to a creditor or his agent documents of title to immovable property, with intent to create a security thereon, the transaction is called a mortgage by deposit of title-deeds. (g) Anomalous Mortgage. A mortgage which is not a simple mortgage, a mortgage by conditional sale, a usufructuray mortgage, an English mortgage or a mortgage by deposit of title-deeds within the meaning of this section is called an anomalous mortgage. The rights and interests of the mortgager are transferred to the mortgagee and the extent of such transfer depend on the nature and kind of mortgage. Pledge, Lien and Mortgage It is stated that a pledge is something between a simple lien and a mortgage. In the case of a lien there is no transfer of any interest; the person exercising a lien has only a right to retain the subject matter of the lien until he is paid. When we consider the case of mortgage, we find that the property passes to the mortgagee and the mortgagor has only a right of redemption. As has been held in Jammu and Kashmir Bank Ltd. v. Tek Chand,[AIR 1959 J & K 67] in the case of a pledge though the

deposit of goods is made security for payment of a debt or performance of a promise, the pledgee has only a special property in the pledge, while the general property therein remains in the pledgor and wholly reverts to him on the discharge of the debt or performance of the promise. In the present case there was a pledge of saving bank pass book to a third person, and it was held that a pledgee of a savings bank pass book can also effectively enforce the pledge by laying a proper action on it in court of law, although there may be some difficulty in his exercising a right of sale under section 176 of the Contract Act as in the case of other tangible goods like for instance a gold ornament. There can be a pledge of shares unaccompanied by blank transfer deed. The distinction between pledge, mortgage and sale has also been brought out in the case M.R.Dhawan v. Madan Mohan and others [AIR 1969 Delhi 313]. In this case it was held by Hon’ble. Justice P.N.Khanna that the pledge is kind of bailment and security for the purpose of enabling the pawnee to reimburse himself for the money advanced when on becoming due it remains unpaid, by selling the goods after serving the pawner with a due notice. The pawnee at no time becomes the owner of the goods pledged. He has only a right to retain the goods until his claim for the money advanced thereon has been satisfied. The pawnee acquires a right after notice to dispose of the goods pledged. This amounts to his acquiring only a ‘special property’ in the goods pledged. The general property therein remains in the pawner and wholly reverts to him on payment of the debt or performance of the promise. Any accretion to the goods pledged will, therefore, be in the absence of any contract to the contrary, the property of the pawner. In the case of a mortgage, however, an interest in the mortgaged property is transferred in favour of the mortgagee subject to the right of redemption of the mortgagor. In the case of a sale ‘the property’ in the goods is transferred from the seller to the buyer (vide section 4 of the Sale of Goods Act). ‘Property’, according to Section 2(11) of the Sale of Goods Act, means the ‘general property in goods and not merely a special property’. It is, thus, clear that if only special property passes it may amount to a pledge. It becomes a sale only when the general property in the goods passes. [Gupta, pp 481-482] Mortgage of movables In United Bank of India v. The New Glenoe Tea Co. Ltd [AIR 1987 Cal 143] it was held that under the Indian Law there can be a valid mortgage of movables though such a mortgage may be different from such mortgage at English Common Law or under Bills of Sale Act. Such a mortgage when not accompanied by delivery of possession is still operative save and except against bona fide purchasers without notice ..... O.34 CPC is applicable to suits on mortgages in respect of immovable property only and not to suits on mortgages in respect of movables ..... a suit for enforcement of a mortgage of movable property will still be a mortgage suit resulting in a mortgage decree though not in terms of O.34. such a suit will not result in a simple money decree but in a decree of sale. Whether or not a transaction amounts to mortgage depends on the language of the document and intention of parties; but the 243 (Sys 4) - D:\shinu\lawschool\books\module\contract law

law relating to the mortgage of movables in India is still very unsatisfactory. Generally speaking mortgage of movables is given as a collateral security. Unpopularity of real estate as security with bankers Though mortgage or real estate is probably one of the oldest known sources of raising money on property, it is not very popular with bankers as a security proposition. The reasons for this unpopularity are manifold and some of the important ones are discussed below : 1)

Legal hindrances

If the law imposed no hindrance in the transfer of immovable property it would form a very sound and valuable security. But where law imposes regulations or restrictions or checks on such transfers, the banker’s advance to his customers is fraught with complications. As for example, a non-agriculturist cannot acquire land from an agriculturist; Transfer of Property Act itself imposes certain restrictions on alienation of property etc. So before giving an advance a banker has to check and see whether the property being mortgaged comes under any of these categories. 2)

Difficulties in ascertaining the customer’s title

Another difficult task which the banker has to undertake is to ascertain whether the person who is offering the security has a legal and valid title to it. The term ‘title’ incorporates two propositions : (1) ownership of legal interest in the property and (2) the right to dispose off the property in any manner the title holder wants to. The second point is extremely important because a person may be the owner of a property but may not have the right to deal with it in any manner he chooses. As for example, a person having a life interest in a property is the owner of the property during his lifetime but he does not have the right to permanently alienate/transfer the property. Even if he gives the property on lease or mortgages the property the period of such lease/mortgage cannot be beyond his lifetime. The manner of ascertaining a title is so complicated that only a highly trained lawyer well-versed in the law and technicalities can certify whether the person actually has a title or not. Further, the lawyer has to be an extremely conscientious one, because he would have to go through the title-deeds, check the land records etc., and then come to a conclusion. All this takes a lot of time which the banker may not have and so more often than not he has to advance the loan based on superficial examination of records which lays him wide open to the risk of the borrower having a defective title. 3)

Heavy expenses involved

Before a mortgage can be finalized the parties have to incur a heavy expenditure, which might involve payment of charges for land survey, valuer charges, lawyer’s fees, registration charges etc. 4)

Frigid nature of security

Assets which are easily realizable or liquid assets are the ones which are ideally suited to a banker. Real estate by its very 244 (Sys 4) - D:\shinu\lawschool\books\module\contract law

nature cannot be easily realized, and the banks may not find it in their interest to keep the security and thereby their money locked up for a long time. Commercial banks especially whose liabilities chiefly take the form of deposits payable either on demand or on short notice cannot afford to have their assets frozen over any length of time. Further, though real estate always has a market, it takes a long time to find a suitable buyer, and even after that completing the process of sale itself takes an even longer time involving a lot of inconvenience, efforts and money. All in all real estate as a bank’s security tends to be pretty awkward and inconvenient. 5)

Variety of land tenures

The banker also has to take into consideration the incidents which go with various kinds of tenures. In India we have numerous types of land tenures, as for example, Freehold, Fazandari, Sanadi, Khoti, Imami, Toka, Ryotwari, Patidari, etc. The value of these various tenures differs according to the incidents attached to them, and a banker cannot blindly advance money on such tenures (merely because they are immovable property) without obtaining expert legal opinion. 6)

Difficulty in valuation

A banker can only advance money after taking into consideration the market fluctuations, and so he has to have an expert(s) opinion on the value of the property and its future prospects (i.e whether the value of property is likely to increase or decrease in future, etc). A property may be of high value but due to various reasons it may not fetch that price in the open market (for example, sometimes a rumor that a particular house is haunted etc., may so effect the market value, that the house may not even fetch half of what it is really worth). A banker has to take all these factors into consideration before advancing money. 7)

Delay in realization of security

The banker cannot suo moto self off the mortgaged property in the event of the mortgagor failing to pay the loan amount. There are umpteen procedural requirements (which in most cases include approaching the courts for grant of remedy) before he can realize the security, in contra-distinction to pledge where he merely has to give a reasonable notice to the pawner before selling the pledged property. In case of mortgage a banker usually has to wait for years before he can realize the mortgage money. 8)

To pay cost of repairs and find tenants

In case the mortgage is of the type where he acquires possession of the property, the banker has to undertake the further trouble of finding suitable tenants for the property and would also have to undergo additional expenses involved in the maintenance of the property. For all of the above reasons bankers do not find the idea of advancing money against mortgage of immovable property very appealing. It is not to say that bankers never accept mortgage as a security, but it definitely is not a security which under normal circumstances they would give a first preference to.

Remedies available to the mortgagee-banker When the mortgagor customer commits a default in the repayment of loan, the banker has the following remedies available to him, viz : A)

Personal remedy against mortgagor

Though in general the banker realizes his debt from the mortgaged property, in certain circumstances he can sue the mortgagor for the loan amount. These situations are : (i) when the mortgagee binds himself personally to repay the mortgage money, as for example, in case of a simple mortgage or English mortgage. (ii) When the mortgaged property is destroyed by vis major [ie., acts beyond human control] the mortgagee is entitled to sue the mortgagor for the loan. Before instituting such a suit, he should make a demand for a fresh security and give the mortgagor sufficient time to furnish such security [secs.68(b)] (iii) if the mortgagor fails to disclose that the mortgaged property is non-transferable or is subject to the prior mortgage, then he commits a willful default and the mortgagee is entitled to sue the mortgagor personally [sec.68(c)]. (iv) if the transaction is one of usufructuary mortgage and the banker has not been put in possession of the property, he can sue the mortgagor for the loan amount [sec.68(d)]. B)

Remedy of sale through court

A banker can rarely sell the mortgaged property on his own even if the mortgagor has committed a default in payment. He has to always approach the court to get an order permitting him to sell the property. He can cause the property to be sold in the following situations : (i) a simple mortgagee is entitled to have the property sold after the mortgage money becomes due and remains unpaid. (ii) a right to sell is also available in case of an English mortgage or the mortgage by deposit of title deeds, or an anomalous mortgage. (iii) a right to sell can be expressly provided for in the mortgage deed, in such cases it would be an express hypothecation clause. Even in the absence of such an express hypothecation clause the power of judicial sale [i.e. sale order passed by a Court of competent jurisdiction]. Thus in Lal Narsingh v. Yakub Khan [1929 PC 139] Lord Tomlin observed : ”Their Lordships are of the opinion that under Sec.68 the money has become payable and the plaintiff is entitled to a money-decree for the same, but if the money has become payable under S.68 their Lordships are further of the opinion that under S.67 a decree for sale can be made”. Thus, unless there is an express prohibition on the remedy of sale, once a money decree can be passed under S.68, the property can also be caused to be sold under S.67. C)

Remedy of foreclosure

Foreclosure of a mortgage takes place when the mortgagee obtains a decree from a court of competent jurisdiction that the

mortgagor shall be absolutely debarred or prohibited from redeeming the mortgage. Such a decree brings to an end the equity of redemption and results in the mortgagee becoming the absolute owner of the property - as if the mortgagor had executed a transfer of his total rights over the property to the mortgagee. The basic difference between foreclosure and sale is that in the former case the mortgagee acquires possession of the mortgaged property and becomes the owner of the property; whereas in the latter case the mortgage does not acquire the right of ownership over the property but only gets a right to sell off the property and to satisfy his debt out of the sale proceeds. The right of foreclosure is available to the banker in the following cases, viz : a) If the mortgage is one by conditional sale or an anomalous mortgage under the terms of which he is entitled to foreclose. b) Uptil 1929, a mortgagee under an English mortgage was entitled to foreclose, but since the only remedy available to an English mortgagee is that of sale. Restrictions on the remedy 1. In case the mortgaged property is one in which the general public is interested, as for example, a railway, canal dam, etc, then the mortgagee can neither exercise the right of foreclosure nor the right of sale. The only remedy available would be to sue the mortgagor (in such cases it would either be the government or some public authority) for the debt amount. 2. The mortgagor has the right to redeem the property [i.e. pay off the mortgagor money alongwith interests and other dues and regain the property] till the court passes a final decree of sale or foreclosure, i.e. at any time after the institution of a suit for sale or foreclosure but before the passing of the decree the mortgagor can redeem his property. D)

Sale without intervention of Court

If the principal money has become due and the bank has served a notice to the mortgagor to pay the amount due, and the mortgager does not pay even after 3 months of service of notice, then the bank may under sec.69 of T.P. Act exercise the power of private sale (i.e. sale without intervention of a Court). The written notice required under sec.69(2) (a) is a mandatory requirement and the 3 months notice period cannot be shortened by a contract between the parties. This power of sale can also be exercised, if the unpaid interest on the mortgage money is Rs.500/- or more, and such interest amount remains unpaid even after 3 months of service of notice. Prior mortgages There is no restriction in the Act itself as to the number of times a property can be mortgaged. A single property may have a first mortgage, a second mortgage, a third mortgage and so on. The various mortgages can be to the same mortgagee or to different mortgagees. This will be clear from the following 245 (Sys 4) - D:\shinu\lawschool\books\module\contract law

example : Suppose X is the owner of a house mortgaged three 09ß09 times. X can mortgage it in either of the two ways : (i) X can mortgage the house three times to the same person A on three different dates for different amounts, as for example 1st mortgage on 1.3.77 for Rs.1,00,000/2nd mortgage on 15.5.79 for Rs.55,000/3rd mortgage on 31.7.94 for Rs.20,000/(ii) X can mortgage his house to three different persons at different times for varying amounts, for example 1st mortgage to A on 1.3.77 for Rs.1,00,000/2nd mortgage to B on 15.5.79 for Rs.55,000/3rd mortgage to C on 31.7.94 for Rs.20,000/Whether the different mortgages are to the same person or to different persons, when the time for redemption comes the first mortgage has to be redeemed first, than the second, Then the third and so on, on the principle qui prior est tempore, potior est jure [i.e. he who is prior in time is stronger in law] Sec.78 of the Act is an exception to this general rule and states that : ”Where through the fraud, misrepresentation or gross neglect of prior mortgagee, another person has been induced to advance money on the security of the mortgaged property, the prior mortgagee shall be postponed to the subsequent mortgagee”. Thus in the above example if because of A’s fraud, misrepresentation or gross negligence B was induced to give the money to X, then when the time of redemption comes B ‘will be redeemed first and then A, i.e, their places in the hierarchy will interchange. In Lloyds Bank v. Guzder & Co. [56 Cal 868], title deeds deposited with the bank as security were handed over to the mortgagor who was thereby enabled to create a second ‘mortgage by deposit of title deeds’. It was held that there was gross neglect on the part of the bank and that its security realization was postponed to the second mortgage. Page,J. observed : “in my opinion “gross neglect” in S.78 means and involves failure on the part of the prior mortgagee to take reasonable precautions against the risk of a subsequent encumbrancer being deceived as in the circumstances renders it unjust that the earlier mortgage should retain its priority. 2.4 CHARGE Sec.100 of the Transfer of Property Act defines Charge in the following words : "Where immovable property of one person is by act of parties or operation of law is made security for the payment of money to another, and the transaction does not amount to a mortgage, the latter person is said to have a charge on the property; and all the provisions here-in-before contained which apply to a simple mortgage shall, so far as may be apply to such charge. 246 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Nothing in this section applies to the charge of a trustee on the trust property for expenses properly incurred in the execution of his trust, and save as otherwise expressly provided by any law for the time being in force, no charge shall be enforced against any property in the hands of a person to whom such property has been transferred for consideration and without notice of the charge”. Charge vis -a-vis mortgage (1) A mortgage is a transfer of interest in a specific immovable property but a charge is not. This distinction has been fully set out in note unde sec 58. See also Bapurao v. Narayan [AIR 1950 Nag. 117, ILR 1949 Nag. 802], Dattatreya Shanker Mote v. Anand Chintaman Datar [(1974) 2 SCC 799]. (2) A charge may be created by act of parties or by operation of law; but a mortgage can be created only by act of parties. (3) A simple mortgage carries a personal liability, unless excluded by express contract. But the same rule does not apply to a charge; in fact the rule is opposite, because by the definition of a charge no personal liability is created. But where a charge is the result of a contract there may be a personal remedy. Every case must depend upon its own facts — Reghukul v. Pitam [52 All. 901, AIR 1931 All. 99 (100)], Balasubramania v. Sivaguru [21 MLJ 562, 11 IC 629 (632)], Ramabrahman v. Venkatanarasu [23 MLJ 131, 16 IC 209 (210)]. (4) A power to bring the morgaged property to sale is given in a simple mortgage either expressly or by implication; but a charge does not contain any works to the effect Balasubramania v. Sivaguru (Supra). If the date is specified, the property is specified there is a convenant to pay and there are words which indicate that the property is to be sold in case the debt is not paid, then the bond should be treated as creating a mortgage and not mere charge — Narayanaswamy v. Ramasamy [12 LW 674, 60 IC 611 (613)]. But like a simple mortgage a charge holder has the right to bring the property to sale. (5) A charge created by operation of law (e.g., a charge created by a decree) does not require the formalities (e.g., registration) prescribed by sec 59 for a mortgage — Gobinda v. Dwaraka [35 Cal. 837 (841)], Mania v. Bachi [28 All. 655 (660)]. [But a charge created by act of parties requires registration — Mania v. Bachhi, (supra)]. (6) As regards the relief granted, there is now no distinction between a charge and a simple mortgage. (7) In the case of a charge the property need not be specific. A charge differs from a mortgage not only in form but in substance. For instance a plea of purchase for value without notice may be good against a charge, but not against a mortgage — Bapurao v. Narayan [AIR 1950 Nag 117, ILR 1949 Nag 802]. A charge in India cannot usually be compared with a charge, legal or equitable in England, because in India such a charge is defined by statute — Dau Bhairoprasad v. Jugal Prasad [AIR 1941 Nag 102].

A charge is not exactly identical with a morgage. One obvious distinction is that a morgage is for a fixed term whereas charge may be in perpetuity. In the case of morgage it can be ultimately redeemed whereas a charge in perpetuity cannot be redeemed at all — Matlub v. Mst. Kalawati [AIR 1933 All 934], Jnanendra v. Sashi Mukhi [44 CWN 240, AIR 1940 Cal 60]. In the case of recurring charge even although the charged property might be sold in execution of a decree for arrears payable in respect of the sum charged, the liability in respect of future payments would ordinarily remain after the sale and as a charge is attached to the property, the auctionpurchaser would ordinarily get the purchased property subject to the charge. Charge vis-a-vis lien (1) The main distinction between the two terms is that a ‘charge’ may be created by act of parties or by operation of law, whereas a ‘lien’ can arise only by operation of law. (2) A ‘charge in strictness not only empowers its possessor in any case to hold the property charged, if in his possession, but also gives him the right to come into court and sue actively for the satisfaction of his claim. A ‘lien’ strictly is neither a jus in rem nor a jus ad rem, but is simply a right to possess and retain property until some charge attaching to it is paid or discharged. (3) A charge is confined to immovable property but a lien may be had in respect of movable also. [Gupta, pp 660662] Kinds of Charge Charge over a property may be of the following two types, viz: i)

Fixed Charge

This is a charge which attaches to a particular immovable property, as for example, a particular field or building etc. The owner of the property so charged can only deal with it subject to the charge. Thus a purchaser who buys the property with notice of charge, buys it subject to charge, i.e, though there is a change in ownership the chargee can exercise his right over the property till his dues are paid off [though this remedy is not available to him against a bona fide purchase without notice of charge]. In case of a fixed charge for the recovery of a specific sum of money from a specific property, a transfer of interest in the property takes place the moment the charge is created. ii) Floating Charge This is a very innovative concept formulated especially for the benefit of the commercial world. In this type of charge, the charge is not fixed to a specified object or property but is spread out to cover a class of property, as for example, a floating charge over the assets of the company. The advantage of this charge is that the charger-debtor can continue dealing with the assets over which there is a floating charge. Thus in the above example, the debtor can continue selling/trading his stock in trade and the floating charge continues to fluctuate over his entire stock in hand and also that he acquires in future. Suppose he is a car dealer and when the charge was created he had 100 cars in

hand. The charge envelopes all the 100 cars. Now, in that month he sells 20 cars - so the charge floats over the remaining 80 cars. Later he purchases 50 cars more now the charge envelopes all the 130 cars. Thus a floating charge is never stagnant it keeps fluctuating depending on the assets in hand. Till some event happens to crystallize or fix the floating charge (in general such an event is the winding up of the company or insolvency proceedings etc.) When the floating charge crystallizes it becomes fixed over the assets which the debtor has in hand at the time of crystallization. A floating charge has a two fold advantage, viz : i) The debtor can continue dealing with the charged property with no restrictions whatsoever; and ii) The persons who purchase property subject to a floating charge purchase it free of charge irrespective of whether they knew of the existence of floating charge or not. There is of course a risk involved that on the day when the charge crystallizes the assets on hand may not be sufficient to cover the debt amount. But this risk is so minimal that it is negligible, and is anyway far outweighed by the fact that this method is one way of keeping the wheels of commerce spinning with no restrictions created by encumbrance. A charge may be created in the same manner as a simple mortgage and practically follows the same format. Every charge on the assets of a company has to be registered under sec.125 of the Companies Act, within 30days of effecting or creating the charge (sec.132). But if there is a sufficient cause for default or delay in filing the particulars of the charge within the prescribed time limit the Registrar may condone the delay and allow in to be registered within such extended time that he may prescribe. In Benares Bank Ltd v. Bank of Bihar Ltd. [AIR 1947 All 117] it was held that the provisions of the section will be deemed to be complied with when the particulars of the charge were sent within 21 days (now the limit is 30 days) to the Registrar, although he had neglected to register it for two and a half years. Nothing done by the Registrar on his own account after proper documents have been filed can in any way effect the validity of the charge. Effect of registration Once a charge is registered [Whatever the kind of charge] it becomes binding on the company, even during its winding up and also on every subsequent purchaser or encumbrance of the property covered under the charge (sec.120), i.e., registration makes the banker (i) a secured creditor, and (ii) gives him a priority over subsequent encumbrances. But as long as the company is a going concern any charge or mortgage effected on its assets would be valid, even if not registered. [Aung Ban Zeya v. C.R.M.A. Chettiar Firm, AIR 1927 Rang. 288]. In Maruti v. Rao v. P. Venkatarayadu [(1970)40 Comp.Cas 751] the purchaser of the assets of a company which were subject to an unregistered mortgage was held bound by the mortgage. In case a charge is not registered, and the company goes into liquidation, the charge would be void against the liquidator and 247 (Sys 4) - D:\shinu\lawschool\books\module\contract law

any secured creditor of the company. The lender would not have the benefit of the charge and the amount advanced by him will be treated as an ordinary loan and it would become repayable immediately, though after the claims of the secured creditors have been satisfied. [See Suryakant Natwarlal Surati v. Kamani Bros P. Ltd (1985) 58 Comp. Cas. 121 (Bom); Praga Tools Ltd v. O.L. (1984) 56 Comp.Cas 214 (Cal)]. Precautions to be taken by the banker 1. Check the status and standing of the borrower company. 2. In case of company or firm as far as possible have a floating charge over the assets to be crystallized when the company/ firm goes in for winding up/dissolution 3. Have the charge registered with the Registrar within the prescribed time period. 2.5 LETTERS OF CREDIT In the Thomson’s ‘Dictionary of Banking’ a letter of credit has been defined as ‘a document issued by a banker authorizing the banker to whom it is addressed to honour the cheques of the person named to the extent of a certain amount and to charge the sums to the account of the grantor; or it may be worded so as to authorize the person to whom it is addressed to draw on demand, or at a currency, upon the banker issuing the letter, and the grantor undertakes, in the letter, to honour all drafts in accordance with the terms of the credit’. The letter also specifies the period for which it is to remain in force, and is endorsed with the particulars of every draft drawn under the credit. When such a letter is issued the amount is debited to the customer’s account and is credited to a ‘Letters of Credit’ account. If the amount is not debited to the customer’s current account on issue, it may be necessary in case of the account being overdrawn, to require security in order to protect the bank against its undertaking in the letter of credit to honour all drafts which may be drawn under it. The letter of credit amount is passed to two contra accounts in the general ledger and reversing entries are made every time a payment is made under the letter, so that at any given moment of time a banker is able to ascertain his total liability under the letter of credit. A ‘circular credit’ is addressed to all the correspondents of a bank, whereas, a ‘direct credit’ is addressed only to a specified correspondent. A ‘marginal letter of credit’ is one where the authority to draw a bill is printed on the margin of the form being used for drawing the bill. In this type of letter, the authority portion of the bill has words to the effect ‘I authorize you to draw the annexed bill’. These two parts of the instrument must be together and should not be separated. A banker before making payment under a letter of credit must first ascertain that the signature of the drawer is correct and that the letters terms and conditions are strictly observed. For this purpose, he must be supplied with a ‘sample’ of the drawer’s signature before hand, and once that is done he will be responsible for any loss caused due to his having paid on a forged signature. 248 (Sys 4) - D:\shinu\lawschool\books\module\contract law

According to F.E. Perry’s ‘Dictionary of Banking’ an irrevocable credit means ‘once this type of credit has been arranged, its terms cannot be varied or changed without the concurrence of all the parties to it.’ Unless specifically stated as being irrevocable, all letters of credit are revocable. An irrevocable credit cannot be revoked without the consent of the beneficiary and the letter, even if the banker’s customer i.e., the buyer asks him to do so. Thus, in Uruguhari Lindsay v. Eastern Bank [(1921)1 KB 321] the plaintiff’s sold certain machinery to BJM to be shipped to Calcutta. The buyers opened ‘confirmed and irrevocable credit’ in favour of the plaintiffs with the defendant bank. The contract of sale contained a term providing that in certain events the price payable for the machinery should be altered. After two shipments had been made and paid for under the credit, a dispute arose as to whether the price of a third shipment should not be altered, and the buyer’s instructed the defendants not to take up the documents or honour the plaintiff’s drafts. These instructions were carried out, but it was held that the defendants could not lawfully revoke the credit, and they were therefore liable to pay damages to the plaintiffs. To explain in simple terms a letter of credit is an arrangement made by a bank for its customer, by which he is sure of obtaining money wherever he may be during his stay abroad. The bank agrees to a specified total amount with the customer, debits his account in advance, and then writes to a correspondent bank or agent authorizing him to cash on demand any cheque or draft drawn by the beneficiary, and charging the sums of the customer’s signature is sent to the agent bank in advance. The letter of credit is then given to the customer who must present it to the agent bank every time he draws money, so that the banker may make a note of the amount drawn by him on the back. Where only one agent is used the letter of credit may also be called as a Direct Letter of Credit. But if the customer is proposing to do a lot of traveling it may not be really feasible to send individual letters to all the agents whom he may wish to approach. In such situation a Circular or World-wide Letter of Credit is issued to the customer which would be available at the office of any agent of the issuing bank in any country in the world. The customer is also supplied with a letter of India containing a specimen of his signature. The customer is required to keep this letter separately from the letter of credit. He can use this letter of identification which may be printed in several languages to identify himself every time he wishes to draw money. In the words of Paul R. Verkuil “The letter of credit is a contract. The issuing usually a bank - promises to pay the `beneficiary’ traditionally a seller of goods - on demand if the beneficiary presents whatever documents may be required by the letter. They are normally the only two parties involved in the contract. The bank which issues a letter of credit acts as a principal, not as agent for its customer, and engages its own credit. The letter of credit thus evidences - irrevocable obligations to honour the draft presented by the beneficiary upon compliance with the terms of credit.’ Over a time period spanning more than a century the usage of letter of credit has grown because of the geographical distances

between the parties. This very distance is also the cause of the one major drawback of these letters. The buyer and seller being parted with great distances were usually unknown to each other, and this unfamiliarity facilitated the perpetuation of fraud. This was because, immediately the seller presented a letter of credit complete with all requirements, the banker made the payment on it. The issuing bank was not required to ascertain whether goods had actually been shipped as per the contract or not, or whether the goods were in proper condition and order or not. Thus, in a number of cases the buyer has had to pay for goods which were either not shipped at all or were of a substandard quality. To prevent this kind of occurrence, the Courts have started holding that if there had been a ‘fraud in the transaction’, the bank could dishonour the beneficiary’s demand for payment. The Courts have generally permitted dishonour only on grounds of fraud of the beneficiary and not of anybody else. In India, there is no statute governing the rules and regulations relating to letters of credit, but the judicial pronouncements on the issue have made it clear that we would be following the same principles that are applicable in England especially in connection to irrevocable letters of credit; and the most basic of the principles followed in the International Banking Practices that letters of credit are transactions which are independent of the bargain contract between the parties. Thus the Supreme Court in M/s. Tarapore and Co. v. V/o. Tractor Export Moscow and other [AIR 1970 SC 891] observed: “Opening of a confirmed letter of credit constitutes a bargain between the bank and the vendor of goods which imposes upon the banker an absolute obligation to pay, irrespective of any dispute which may be between the parties as to whether the goods are upto the contract or not. A vendor of the goods selling against a confirmed letter of credit is selling under the assurance that nothing will prevent him from receiving the price. If the buyer has an enforceable claim that adjustment must be made by way of refund by the seller but not by way of reduction by the buyer. The letter of credit is independent of and unqualified by the contract of sale or underlying transactions. The autonomy of a letter of credit is entitled to protection.” It is only rarely that courts choose to interfere with this machinery of irrevocable obligations assumed by the bank. The reason for this is that letters of credit are the life blood of modern day international commerce, and so they must be honoured free from interference and restrictions by the courts, or else trust in international circuit could be irreparably damaged. In State Bank of India v. The Economy Trading Co. [AIR 1975 Cal. 145] it was held that Courts are slow to interfere in the letters of credit in its operation not merely due to their importance in

international trade but also on the ground that the beneficiary is assured of the payment by the bank once he has complied with the terms and conditions of the letter of credit irrespective of his non-compliance with the contract into which he had entered with the third party or in other words on the ground of autonomy of the letter of credit. In United Commercial Bank v. Bank of India [AIR 1981 SC 1426] the Supreme Court held that the rule was well established that a bank issuing or confirming a letter of credit was not concerned with the underlying contract between a buyer and seller. Duties of a bank under the letter of credit were created by a document itself. Letter of Credit vis-a-vis a guarantee In Minerals and Metal Trading Corporation of India Ltd. v. Suraj Balram Sethi [1970 Cal.WN (74) 991] the Calcutta High Court has held that the distinction between an irrevocable letter of credit and a Bank Guarantee was not merely one of function, namely, that the former was important for international trade and the latter for internal trade. The more important point of distinction was the autonomy of an irrevocable letter of credit and dependence of a bank guarantee on a contract between the beneficiary of the guarantee and a third party. Payment under an irrevocable letter of credit did not depend on the performance of obligations on the part of the seller except those which the letter of credit expressly imposed. There the obligation was that of the Bank and no third party came into picture. In the case of a bank guarantee, however, by definition, the third party was always on the scene. Unless there was always an element of contingency attached to a bank guarantee. It did not enjoy the autonomy of a letter of credit. As mentioned earlier the Indian law of letters of credit for the most follows the English law, and is governed by the uniform customs and practice for documentary credits (1974 Revision), which has been evolved by the International Chamber of Commerce in collaboration with the United Nations and the Foreign Trade Banks. Certain principles which have evolved are deemed to be the law relating to letters of credit and the banks take these principles as a Bond” and honour them totally. Acceptance under Reserve When a banker is in doubt about the genuineness or accuracy of a document, or requires more time to peruse the document he accepts the document ‘under reserve’. This phrase was considered in banque de I’ Indochine et De Sue: SA v. J.H.Rayner (Mining Lane) Ltd. [1983 QB 711] and it was held that the payments to be made ‘under reserve’ means that the beneficiary would be bound to repay the money on demand if the issuing bank should reject the documents, either on its own initiative, or on the buyer’s instructions.

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3 COLLATERAL SECURITIES Thus every contract of guarantee incorporates within itself two contracts of indemnity. A point to be remembered is that in the present context the creditor is always the banker.

SUB-TOPICS 3.1 Guarantees 3.2 Lien 3.3 Stock-exchange Securities 3.4 Certain other Securities 31. GUARANTEES An advance against guarantee becomes important when: (1) the banker is not taking any tangible property as collateral security, and (2) the personal security of the borrower is insufficient to cover the loan, or (3) when the financial position of the customer indebted to the bank has suffered a set-back or his position is weakened because of the depreciation in the value of the collateral security deposited by him resulting in the loan being inadequately covered. Section 126 of the Indian Contract Act, 1872, defines a contract of guarantee as: “a contract to perform the promise, or discharge the liability, of a third person in case of his default.” As for example, if Mr.Singh wanting a loan of Rs.50,000/- from the Bank of India, induces his friend Mr.Menon to promise the bank that he would repay the loan in case Mr.Singh committed a default, then it would be a contract of guarantee. The person giving the loan is known as the creditor [C]; the person taking the loan is known as the principal debtor [P]; and the person giving the guarantee is known as the surety [S]. A contract of guarantee has three contracts as shown in the figure below:

A contract between P and C does not become void only in cases where P is a minor or a lunatic. In case P is a registered company, a contract between the company and the bank would be void if it is ultra vires the company. Similarly, to bind a partnership firm all the partners of the firm should have consented to the act or the act must have been done in the usual course of the firm’s business.

C

P

S

First Contract: - Between P and C This is the main or principal contract out of which the liability of the principal debtor arises. Second Contract: - Between C and S This is a contract of indemnity whereby the surety promises to indemnify the creditor in case of the principal debtor committing a default. Third Contract: - Between P and S This is again an implied contract of indemnity where the principal debtor promises to indemnify the surety in case the surety discharges the debt which he (i.e. P) himself should have discharged. 250 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Liability of a Surety 1. In general the liability of the surety is co-extensive with that of the principal debtor, i.e., if the principal debtor is liable for Rs.5000/- then the surety would also be liable for Rs. 5000/-. He cannot be made liable for a single rupee more than what the principal debtor is liable for. 2. A surety may limit his liability to a certain specified amount, as for example, by saying “I limit my liability to Rs.5000” or “I promise to stand surety for Rs.5000” or “in the event of P’s default I’ll pay any amount taken by him as loan subject to a limit of Rs.5000", etc. In such cases the surety cannot be held liable for even a single rupee above his selfimposed limit. If P has taken a loan of say Rs.10,000 and S has given a surety of Rs.3,000 then the bank can claim only Rs.3000 from S and for the remaining Rs.7000/- it will have to depend on P (or the second surety if any). 3. Though the general rule is that the surety will be liable only to the extent of the principal debtor’s liability, there are situations where the surety is held liable although the principal debtor himself is not liable on account of the original/principal contract between P and C being void, as for example, when P is a minor. In such cases, the contract between C and S no longer remains a collateral contract of indemnity but becomes the main contract, i.e., it would be treated as if S had taken the debt.

Scope of Guarantee The scope of a guarantee depends on whether the guarantee is a ‘specific guarantee’ i.e., related to one single transaction or a ‘continuing guarantee’ i.e., related to a series of transactions. In case of a specific guarantee the guarantee is limited to that particular transaction alone and does not extend to any other transaction between the debtor and the bank. In case of continuing guarantee the surety is liable for all those loans taken by the debtor during the period for which the guarantee holds good. The surety in such cases will be liable for the balance amount irrespective of the payments made by the principal debtor as they would be applied to the repayment of earlier advances. For this reason a banker prefers to have a continuing guarantee because then the surety’s liability will not be limited to the original advance alone but would also extend to all subsequent debts. In case the continuing guarantee is given by

a firm, the guarantee is revoked as to future transactions from the date of change in constitution of the firm [section 38 of Indian Partnership Act], unless there is a contract to the contrary between the parties. It would be advisable for a banker to provide for this contingency if he is seeking a continuing guarantee from a firm. In Montosh Kumar Chatterjee v. Central Calcutta Bank Ltd. [(1953) 23 Comp Cas 491 (Cal)] it was held that the effect of a continuing guarantee was not to secure the amounts advanced on different occasions but to secure the floating balance which may be due from time to time and it is the date of the accrual of that balance which is relevant for the purposes of limitation when it is sued for. The surety’s obligation to pay would arise immediately on a default occurring on the part of the principal debtor and once the cause of action against the surety has arisen the commencement of the running of time is not further postponed till the making of the demand. Obligations of the Banker 1. Not to vary the original terms of the contract without consent of surety, in the absence of a contract to the contrary. In M.S.Anirudhan v. Thomco’s Bank Ltd. [(1963)33 Comp. Cas. 185] a guarantee letter signed by the surety mentioned Rs.25,000/-. The bank was later prepared to allow an overdraft of Rs.20,000/- only, and so the letter was handed back to the debtor to correct the figure. The debtor corrected the figure himself and returned it to the bank. The surety filed a suit asking to be discharged of his liability in view of change in terms. The Supreme Court held that the principal debtor had acted as an agent of the surety and so the surety would liable, and the doctrine of material alteration was not applicable in this case. Thus a variance in the terms of a contract would discharge the surety only if such variance is to his disadvantage. 2. Not to release the debtor. In State Bank of Hyderabad v. Nagabhushanam [(1986) 60 Comp. Cas. 740 (AP)], the bank gave credit facilities to the borrower against the personal guarantee of the surety. The borrower executed a pronote of the loan amount in favour of the surety, who endorsed it in favour of the bank. The bank filed a suit against the borrower and the surety but did not press the suit against the borrower. Held that the bank after giving up its claim against the borrower cannot lay its claim against the surety. Merely because the surety had endorsed the note in favour of the bank he did not become a co-obligant. 3. A banker should handle the securities given to him by the debtor, prudently and carefully, because if they are lost or destroyed the surety’s liability is discharged to the extent of the value of the security. In Jose Inacio Lourenco v. Syndicate Bank and another [(1989)65 Comp. Cas. 698 (Bom)], the bank advanced money for the purchase of a vehicle. The bank obtained a decree against the principal debtor and the surety but was unable to produce the vehicle for the benefit of the surety nor could the bank state that the charge was registered with RTO. The Court held that since the bank had parted with the security, therefore the surety was discharged.

Precautions which a banker should take 1. The contract of guarantee should be signed in the presence of the bank manager - It is not advisable for the bank to allow the customer to take away the guarantee form and personally obtain the surety’s signature on it. This is because: 1. the surety’s signature may turn out to be a forgery, or he may later on allege that he signed the form in ignorance of its contents, i.e., he can take the plea of ‘non est factum’, and 2. the surety when asked to discharge his obligation may take up the plea that he had signed under a misrepresentation made by the person entrusted the job of obtaining his signature by the bank. 2. Notice of Principal debtor’s death - Death of the debtorcustomer automatically terminates his account and as a result the guarantee also comes to an end. The banker should formally demand the repayment of the debt from the surety, unless the money has been paid by the legal heirs of the deceased. 3. Notice of debtors bankruptcy - A banker should stop all operations on a guaranteed account on receipt of a notice (whether actual or constructive) of his debtor’s bankruptcy, and demand the repayment of the due amount from the surety. He is not required to sell off the securities in his possession first before approaching the surety. 4. Notice of lunacy of debtor or surety - Just as in the above case the banker should close the account on receipt of notice that his debtor/surety had become insane. In Bradford Old Bank v. Sutcliffe [(1918)2 K.B. 833] it was held that the lunacy of a surety is to be taken as terminating the guarantee so far as future advances are concerned. Consequently, any advances made by him after receipt of notice of the lunacy of the customer (or the surety) was irrecoverable from the estate of the lunatic, even in cases where the contract itself provides for a month’s notice from the surety for the termination of the guarantee. 5. Change in the Constitution of the bank - Unless there is a contract to the contrary, change in the constitution of the bank due to merger or amalgamation, would result in the termination of the guarantee. It is therefore prudent to include a clause in the contract to provide against this contingency. Bank Guarantee It would be in place here to differentiate very briefly between the ‘bank guarantee’ discussed in the module on ‘special contracts’ and the guarantee asked by the banks discussed here. In the former, the bank acts as the surety and gives a guarantee on behalf of a customer-debtor, promising to pay the debt amount to the creditor irrespective of whether the principal debtor has made a default or not. In the latter, the bank acts as the creditor giving a loan to a customer and seeks a guarantee from a person of good standing who promises to repay the debt in case the debtor makes a default. Statutory restrictions on guarantees by limited companies The Companies Act imposes certain restrictions on the guarantees given by a limited company, viz: 251 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Section 295(1) - A company cannot without the prior approval of Central Government, either directly or indirectly give any guarantee or provide any security in connection with a loan made by a person to a director of the company or any partner or relative of any such director or any firm in which such director or relative is a partner or any private company of which any such director is a director or a member. These restrictions do not apply to a private company (which is not a subsidiary of a public company) or a holding company in respect of any loan made to its subsidiary. Section 370 - A Company cannot give any guarantee or provide any security in connection with a loan made by any other person to any body corporate unless the giving of such guarantee or providing the security has been previously authorized by a special resolution of the company. These restrictions do not apply to a holding company in respect of a loan to its subsidiary or by a banking company in the ordinary course of its business. Personal guarantees from directors in advances to limited companies The RBI has given certain guidelines in this regard. Concerned at the growing sickness in industrial units and increasing loan losses devolving on the banks consequent upon sticky and stagnant accounts, the Reserve Bank of India has advised the commercial banks to obtain guarantees from directors of borrowing companies excluding nominee directors and other management personnel in their individual capacities, whenever found necessary. (Journal of the Indian Institute of Bankers, July-September, 1986, p.164). The Reserve Bank of India announced clarification in respect of its earlier directive to commercial banks to obtain guarantee from directors of borrowing companies excluding nominee directors while giving loans. RBI has directed that banks need not insist on personal guarantees from professional directors or managers who do not have any significant stake in the company concerned, while extending credit. However, in case serious malpractices on the part of the management are noticed by the commercial banks, the right remedy would be to remove or replace them. (Journal of the Indian Institute of Bankers, AprilJune, 1987, p.58). 3.2 LIEN A lien may be defined as ‘the right of a creditor to retain any goods or securities belonging to the debtor, which he has in his possession till his debt is paid off. In Alliance Bank of Simla Ltd. v. Ghamandi Lal Gaini Lal [AIR 1927 P & H 408] it was held that general lien confers on the holder any the right to retain the goods until the payment is made out but it does not carry with it the right of sale to secure the debt or indemnity. It is merely a right to retain goods or chattel and does not create a right as in favour of a pledge. Since the lien with which we are presently dealing deals with ‘right of possession’ it is known as a possessory lien. The other two kinds of lien are equitable lien and maritime lien. 252 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Possessory lien is of two kinds - general and particular. A particular lien is very specific in its operation and is limited to the transaction in question, i.e., the creditor can retain the goods for expenses incurred by him in relation to those goods. As for example, a tailor can retain the dress made by him till his tailoring dues on that dress are paid by the customer. He cannot retain the dress for any charges accrued in the past, i.e., he cannot retain the dress for a general balancing of accounts. A general lien on the other hand is the right of the creditor to retain the goods not only for discharge of the debt accrued in connection with them, but also for a general balancing of accounts arising out of similar transactions arising between the parties in the past. As for example, a solicitor can retain the legal documents belonging to his client, not only till his dues on those documents are paid but also till he is paid all those charges or fees arising in connection with the professional services rendered by him to that client. Thus, a general lien empowers the creditor to retain possession until the entire debt is paid off. A ‘lien’ arises out of operation of law rather than by an act of parties, provided the following conditions are fulfilled, viz: 1. There is a debt in existence; 2. That the creditor is in lawful possession of certain properties belonging to the debtor; 3. There is no express or implied contract taking away the right of lien. Banker’s lien At the time when the Indian Contract Act was being codified, the Original Bill contained the following observation : “In the absence of any contract to the contrary, bankers, factors and wharfingers have no right to retain any goods bailed to them as a security for a general balance of account”. The Select Committee did not find this to be a favourable proposition, and in Clause 22 of their Report, observed : “No reason is given for the abolition of general lien in these cases, and we think it expedient to alter the s.171 thus : “Bankers, factors, wharfingers, attorneys of High Court and policy brokers may, in the absence of a contract to the contrary retain as a security for a general balance of account, any goods bailed to them, but no other persons have a right to retain as a security for such balance, goods bailed to them unless there is an express contract to that effect”. The recommendation of the Select Committee was accepted and the amended sec.171 was incorporated in the Contract Act. Following the precedent set by English law a banker’s lien is sometimes treated as an implied pledge. This was first recognized by Lord Campbell in Brandoo v. Barnett [1846 3 CB 519], where he observed : “Bankers must undoubtedly have a general lien on all securities deposited with them, as bankers, by a customer, unless there be an express contract, or circumstances that show an implied contract, inconsistent with lien ..... Now it seems to me, that, in the present case are there was an implied agreement on the part of the defendants inconsistent with the right of lien which they claim. (The bills) not only were not entered in any account

between Burn and the defendants, but they were not to remain in the possession of the defendants; and the defendants, in respect of them, were employed merely to carry and hold till the deposit in the tin box could be conveniently accomplished .... Nor, I presume, can any weight be attached to the circumstances that the tin box ..... remained in the house of defendants .... I think that the transaction is very much like the deposit of plate in locked chests at a banker’s ....... In both cases a charge might be made by the bankers if they were not otherwise remunerated for their trouble”. If this interpretation is taken then a banker apart from retaining the goods for a general balancing of accounts, can also exercise the rights of a pledge and sell or dispose off the goods or securities in his possession in order to realize his debt, unless the debtor can prove the existence of an express or implied contract inconsistent with the banker’s right to lien. In India also the right of implied pledge can be imputed from sec.171 Contract Act and the power given under the Banking Regulation Act, 1949. Principles governing banker's lien 1. In Chettinad Mercantile Bank Ltd v. P.L.A. Pichammai Achi [AIR 1945 Mad 447] it was held that the banker’s lien is the right of retaining things delivered into his possession as a banker, if and so long as the customer to whom they belonged or who had the power of disposing of them when so delivered is indebted to the banker on the balance of account between them provided the circumstances in which the banker obtain possession do not imply that he has agreed that this right shall be excluded. 2. The ownership of the property in possession of the bank must be with the customer debtor, otherwise no right of lien can arise. 3. A banker’s right to lien is different from a banker’s right to set off. The former is related to property or securities in the bank’s custody, whereas, the latter is related to money debts and may arise from a contract, or from a mercantile usage or by operation of law. Though frequently the word lien is used in connection with money it is a wrong usage of the term. Morse on the American Law of Banking has observed : “The word `lien’ cannot properly be used in reference to the claim of the bank upon a general deposit, for the funds on a general deposit are the property of the bank itself. The term `set off’ should be applied in such cases, and `lien’ when a claim against paper or valuables on special or special deposits is referred to. In the cases the words are used very loosely ... The practical effect of lien and set off is much the same”. In Halsbury’s Law of England [Vol.2, 3rd edn. p.210] it is stated that: “The general lien of bankers is part of the law merchant as judicially recognized, and attaches to all securities deposited with them as bankers by a customer, or by a third person

on a customer’s account, and to money paid in by, or to the account of, a customer unless there is a contract, express or implied, inconsistent with the lien”. “Money is however not usually the subject of lien not being coupled or being earmarked and the banker’s claim in such cases is probably more rightly referred to as set-off in respect of a customer’s account”. The bank may thus not be able to exercise its right of lien against the money deposited in the customer’s account, but it may adjust the deposit against the debt owned to it from the customer. The purpose of lien in this case is achieved through set-off. 4. A banker’s right to lien is subject to a contract to the contrary, and existence of such a contract has to be proved by the party alleging it (i.e. the customer). 5. Where the bank advances money against securities and the securities have been left with the banker even after repayment of loan, the banker can exercise his right of lien on them against any subsequent advance made by him to the customer. In such a situation, a separate letter or contract is not necessary, though banker’s do ask for a letter of lien from the customer by way of abundant caution. This letter firstly enables a banker to retain the security against all debts/liabilities of the customer, besides giving the banker the power to sell or otherwise dispose of the security in case of default in payment by the customer, and secondly prevents the customer from taking a plea that the security had been given for a specific purpose only. 6. The right of lien being a possessory right is lost when the banker either returns the goods back to the customer before repayment of debt or otherwise conducts himself in such a manner as to induce the customer to think that he does not intend to exercise his right (implied waiver of the right), or acts in a manner which is in contradiction to his exercise of the right of lien. Some cases where a banker has no lien 1. Safe custody deposits cannot be subjected to lien. 2. When customer has no title to the securities deposited. 3. Where bonds with coupons attached are deposited for safe custody, and the customer gives the coupons to the banker for collection, he cannot exercise lien. 4. No right of lien for general accounts, when the customer brings documents like title deeds for raising a fresh loan, and leaves the deeds by mistake with the banker on his refusing the loan. 5. No right of lien if the banker returns the securities to the customer before repayment of loan, even if he again comes into possession of the self same securities. 6. No lien on bills of exchange or other documents entrusted for special purpose. 7. On dishonour of a bill, the bank is not entitled to apply the security attached to the bill, to any other debt due from the customer for whom the bill was discounted [Latham v. Chartered Bank of India, (1874)17 Eq 205] 253 (Sys 4) - D:\shinu\lawschool\books\module\contract law

8. No lien arises on the personal current account balance of a partner of a firm in respect of a debt due from the firm, as the credit and liability do not exist in the same right. 9. No lien arises till the debt is actually due; nor can the banker retain money of the customers against bills discounted by him for the customer, but not yet due, except may be if the customer becomes bankrupt. 10. No right of lien against a separate account maintained by the customer, and known to the bank as a trust account [O.R.M. v. Nagappa Chettiar, 43 Bom.LR 440 (PC)] 11. Once the customer pays off the overdraft for which the securities had been deposited, the banker has to return the securities, and cannot in general exercise his right of lieu against them. 12. Title deeds to immovable properties deposited by the customer with the bank for whatever purpose, cannot be made a subject matter of general lien or implied pledge. 13. A banker’s right of lien is not affected by statute of Limitation because limitation bars the enforcement of right after the specified period but does not bar the remedy itself [London and Midland Bank v. Mitchell AIR 1958 SC 328]. 3.3 STOCK EXCHANGE SECURITIES Stock Exchange Securities in strictu sense is used for all gilt edged securities [such as, Government loans, Municipal, Port Trust and Improvement trust bonds, etc] and such other securities issued by Government and public bodies, and shares and debentures of industrial and commercial companies, banks and insurance companies etc. whose shares are listed at the stock exchange. Advances against these securities form an important part of the loans advanced by banks in larger cities having stock exchanges, not only because speculators keep needing money to invest in shares which are likely to appreciate but also because large blocks of these securities are held by rich and upper middle classes owning to the fact that they feel that money invested in such shares is easily realizable if needed. From a banker’s point of view these securities find favour as compared to other kinds because of the following reasons : 1. These securities are generally more reliable as compared to ‘guarantee’ because the banker gets something tangible whereas in the latter case he has to rely on the surety if the debtor makes a default. 2. Gilt edged securities are more easily realizable than other types of securities. 3. In normal circumstances, good stock exchange securities are less susceptible to market fluctuations as compared to certain other commodities like cotton, sugar etc. 4. It is easier for the banker to satisfy himself of the customer’s title to the shares he is offering as security. It is also easy for him to ascertain the market value of these shares. 5. They can be more easily transferred as compared to certain other securities like land and buildings. 254 (Sys 4) - D:\shinu\lawschool\books\module\contract law

6. The release of these securities can be effected with the minimum of expense and formality. 7. These securities almost always yield a dividend interest which when applied towards the discharge of debt, reduces the borrower’s indebtedness towards both interest and the principal. 8. If necessary, the banker can easily raise money against them by pledging them with other bankers. Disadvantages of these securities (i) In case of partly paid-up shares the banker may be required to pay the balance amount if a call is made, provided he/ his nominee is registered in the ‘member’s register’ as the owner of those shares. (ii) The banker renders himself liable as a bona fide transferee to indemnify the company against any loss it may suffer, if the transferor’s signature turns out to be forged. This risk can be averted by making the customer sign in the banker’s presence. (iii) If the articles provide for a right of lien on the shares to the company; the banker may find himself to be deprived of the entire benefit if he fails to give the company a notice of his charge on the shares. (iv) If the shares are susceptible/liable to wide fluctuations the banker may suffer a loss. (v) In case of non-negotiable securities, the transferor cannot give the transferee-banker a better title than what he himself possesses. (vi) Apart from forging the transferor’s signature, nowadays the shares and scripts are themselves being forged/ duplicated. If an advance is made against a scrip which is not genuine then it becomes difficult for the banker to realize his debt. Precautions to be taken 1. He should first check up and see to which class the offered securities belong (i.e. public debts, bonds and debentures of municipalities etc). 2. As far as possible advance should be made only against fully-paid up shares. 3. He should study the profit-loss account statements of the company for the past few years, so as to be able to form a fairly reliable estimate of its future prospects. 4. He should also carefully study the official market prices of the scrips so as to get a fair idea of the real market value of the stocks and shares to be put in the approved list. It would not be prudent of him to rely on unsubstantiated statements or statements from untrustworthy persons relating to the market value of such shares. 5. He should also check whether the securities offered are debentures or shares; and if shares whether equity or preferential. As far as possible preference should be given to debentures over shares; and to preference shares over equity shares; and to cumulative preference shares over non-cumulative preference shares.

6. Once he is satisfied about the securities offered, he has to value the shares according to their market price, allowing for any dividend in the quoted price. In case of shares which are rarely traded, it is better to contact the company secretary to ascertain the market price of the shares, and the date on which the last transfer of its shares was registered. The banker should keeping the transfer date in mind consider the effect of any subsequent circumstances which may influence the prices of the securities. 7. Once he approves of the securities, fixes their price and determines the necessary margin, he should then decide the best mode of completing the security. In case of fully paid, up bearer securities, transfer is complete by mere delivery, but in case the security is payable to a ‘specified person or order’ transfer is complete only by endorsement and then delivery. Once the transfer is complete, the banker gets a good title to them if he taken them in good faith and for value, regardless of the title of the transferor. 8. A banker has to ascertain whether the securities are negotiable or non-negotiable. According to the Negotiable Instruments Act, promissory notes, bills of exchange and cheques come under negotiable instruments. Nonnegotiable securities are either ‘inscribed stocks’ [i.e. the name of the holder of such stocks is ‘inscribed alongwith the extent of his holding, in a book kept either with the government or corporation issuing the same, or its agent. Transfer of such stock can be done only by the owner/his duly constituted attorney going to that office and authorizing the transfer of the stock]; or ‘registered stock’ [i.e. they are registered in the register of the company issuing them, and to make their transfer valid it has to be registered in the company register. Mode of advances against securities A banker can give an advance against shares and securities generally in either of the two ways : 1.

By effecting equitable mortgage of the securities

This can be done in the following ways : 1. by mere deposit of securities; or 2. by deposit of securities alongwith a memorandum ; or 3. by deposit of securities with a memorandum and a duly executed blank transfer form. 4. by deposit of securities alongwith a special power of attorney in favour of the banker authorizing him to sell the shares in default of payment. Disadvantages of equitable mortgage (i) It is liable to be defeated by a prior equitable mortgage or a subsequent legal mortgage. In India since an equitable mortgage is statutorily recognized, there is no question of it being defeated by a subsequent legal title (this provision is more appropriate in England); but it can definitely be defeated by a prior mortgage.

(ii) There is a danger that the company may be having a lien over the stocks and shares against the registered owner of those shares, or it may have received a notice of charge from a prior equitable title holder, before the banker takes the necessary steps to have them registered in his name. (iii) Though it is desirable for the banker to get himself registered as owner of the fully paid up shares, such an act is resisted by the owner because : (a) he will have to bear the cost of transfer and re-transfer of those share; (b) it may affect his credit; (c) in case of his being a director such a transfer may result in his losing the minimum qualification shares and so deprive him of his place on the board of directors; (d) the articles may impose a restriction on transfer of shares. Precautions to be taken 1. As far as possible, a banker should not accept shares in the name of a third party i.e. someone other than the borrower. If he does accept such shares, then he should make the borrower sign the transfer form in front of a bank official or some other well known person. 2. The banker should at the earliest send a notice to the company informing them of his charge over the securities. 3. He should on no account part with shares and securities, because the customer may then prejudice the bank’s position by creating another encumbrance on it. 4. Securities should always be taken in good faith. 5. Generally a banker should obtain a memorandum executed by the customer, containing a clause, authorizing the banker to sell the securities in case of default. 6. It is advisable to obtain a mandate from the customer and addressed to the company, asking them to pay the dividends/ interest to the bank. 2)

Pledge of shares

In Kunhunni Elaya Nayar v. P.N. Krishna Pattar and others, (1942)12 Comp.Cas. 180 (Mad), the Court while considering the question whether a pledge of shares can be created by the mere deposit of the share certificate, held that the shares are “goods” and therefore pledgeable. They can only be pledged by the deposit of the share certificate. The Court observed that it appears that by including shares in the definition of goods in the Sale of Gods Act, the Legislature must have associated shares with the share certificate which is marketable. Otherwise, it is difficult to see how shares can be goods and the subject of pledge, the essence of which is delivery. The word “goods” in the Indian Contract Act should receive the same meaning which it has in the Sale of Goods Act. The Court also observed that to say that there can only be a pledge of shares when the share certificate is accompanied by a deed of transfer is making the transaction something more than a pledge. Therefore, when a person delivers a share certificate to another to be held by him as security, there is under the law of India a pledge which can be enforced. But unless the pledgee at the time of the deposit 255 (Sys 4) - D:\shinu\lawschool\books\module\contract law

secures a deed of transfer which he can use in the case of necessity or obtains one from his debtor at a later stage, he must have recourse to the Court when he wishes to enforce his security. In re, Bengal Silk Mills Co. Ltd., (1942) 12 Comp.Cas. 206(Cal.), it was held that a transferee in the case of a transfer of shares in blank has the right to fill in the necessary particulars including his own name as 0909 transferee and the date of the transfer, even after the death of the original transferor. The transfer so made will be a valid one and the transfer will be entitled to have his name registered in the company’s register as the holder of the shares. In M.R. Dhawan v. Madan Mohan and others, AIR 1969 Del.313, the Delhi High Court held that “It will be seen that the pawnee acquires a right, after notice, to dispose of the goods pledged. This amounts to his acquiring onl a ”special property” in the goods pledged. The general property therein remains in the pawnor and wholly reverts to him on payment of the debt or performance of the promise. Any accretion in the shape of dividends, bonus or right shares, issued in respect of the pledged shares will, therefore, be in the absence of any contract to the contrary, the property of the pawnor”. The general property of the shares pledged thus, remains in the pawnor and he remains entitled to all the dividends that may be declared on the shares and to the bonus and right shares that may be issued in respect of the shares pledged; provided that there is no contract to the contrary. [Tannan p. 489]. Restrictions on advances against shares The Banking Regulations Act, 1949 has imposed certain regulations on banks freedom to make advances against securities, viz : a) Sec 19(2) - No banking company shall hold shares in any company whether as pledgee, mortgagee or absolute owner of an amount exceeding 30% of the paid-up share capital of the company or 30% of its own paid up capital and reserves, whichever is less. b) Sec.19(3) - A banking company cannot hold shares in any company whether as pledgee, mortgagee or absolute owner in any company in which its managing director or manager is in any manner concerned or interested. c) Sec 20 - No banking company shall make any loans or advances on the security of its own shares. Reserve Bank’s guidelines on advances against shares and debentures In January 1968, the Reserve Bank issued the following guidelines : 1. Statutory provisions regarding the grant of advances against shares contained in sections 19(2) and (3) and 20(1)(a) of the Banking Regulation Act, 1949 should be strictly observed. 256 (Sys 4) - D:\shinu\lawschool\books\module\contract law

2. Banks should exercise due caution and restraint in lending against shares and debentures. They should, while considering proposals for advances against shares/ debentures, primarily take into account the nature, purpose and need for such advances ensuring that bank finance is not utilised for speculative purposes. Banks should be more concerned with what the advances are for rather than what the advances are against. While considering grant of advances against shares/debentures banks must follow the normal procedures for pre-sanction appraisal and postsanction follow up. 3. Any advance against the primary security of shares and debentures should be kept distinct and separate and not combined with any other advance. 4. Banks should satisfy themselves about the marketability of the shares/debentures and the net worth and working of the company whose shares/debentures are offered as security. 5. Shares/debentures should be valued at the average of the market prices as at the end of last twelve months or the current market price, whichever is lower. Adequate and proper margins should be maintained while granting advances. 6. No advance against the security of partly paid shares shall be granted. 7. Advances exceeding Rs.5 lakhs against shares and debentures should be sanctioned by the Board/Committee of Directors. Suitable powers may be delegated to the Chief Executive and others for sanctioning advances for lesser amounts. The guidelines further contained limits over which the bank should get the shares transferred in its own name and exercise voting rights, but these have been revised later on. In August 1970, the Reserve Bank issued its directives as under: In exercise of the powers conferred by Section 35A of the Banking Regulations Act, 1949 the Reserve Bank of India, being satisfied that it is in the public interest so to do, hereby directs— (i) that every Banking company which grants or renews as advance limit or Rs.50,000 against the security of shares, shall stipulate as one of the conditions of such grant or renewal that the said shares shall be transferred to its name, that it shall have exclusive voting rights in respect thereof which it may exercise in any manner whatsoever and get the said shares transferred to its name expeditiously: Provided that this clause shall not apply to shares lodged by a sharebroker as security for an advance : Provided further that where any such shares are held as security for such advance in the account of a sharebroker for a period longer than three months, the provisions of this clause shall, after the expiry of the said period of three months, apply to such shares.

Explanation - (i) The limit of Rs.50,000/- shall apply to the aggregate of all limits of advances against shares from a single banking company extended to a borrower. (ii) that no banking company shall grant advances against the security of shares in cases where any condition is imposed as to the exercise of voting rights by the banking company in respect of such shares or requiring the banking company to issue proxies in respect of such shares. (iii) that no banking company shall, without the prior approval of the Reserve Bank, grant advances against the security of partly paid shares : Provided that this clause shall not apply to advances to a sharebroker: Provided further that where advances are granted against the security of partly paid shares to a sharebroker and such shares are held in his account for a period longer than three months, the banking company shall make a reference to the Reserve Bank and obtain its directions as to whether it should take steps for the transfer of such shares to its name or not. (iv) that in respect of advance limits of over Rs.50,000/- against shares subsisting on the date of this directive, every banking company shall, — (A) in case the shares are not transferred to its name, take immediate steps to have the shares transferred to its name and further in case there is any restriction on such transfer or on the exercise of voting rights by the banking company or any obligation is cast to issue proxies, the banking company shall give notice to the borrower about its intention to terminate the relative agreement on the expiry of 35 days from the date of issue of the notice by the banking company and substitute the same by a fresh agreement without any condition restricting the transfer of the shares to the name of the banking company or restricting the banking company from exercising voting rights freely or requiring it to issue proxies ; (B) in case the shares are already transferred in the name of the banking company but there is any restriction on the exercise of voting rights by it or any obligation is cast on it to issue proxies, the banking company shall give notice to the borrower about its intention to terminate the relative agreement on the expiry of 35 days from the date of issue of the notice by the banking company and substitute the same by a fresh agreement without any condition restricting the banking company from exercising voting rights freely or requiring it to issue proxies; And in case the borrower is not agreeable to the revised terms, the loan shall be recalled forthwith if it is repayable on demand and, on the expiry of its term, if it is a term loan :

Provided that this clause shall not apply to shares lodged by a share broker as security for an advance: Provided further that where any such shares are held as security for such advance in the account of a sharebroker for a period longer than three months, the provisions of this clause shall, after the expiry of the said period of three months, apply to such shares: Provided further that in cases where partly paid shares which have not already been transferred to the name of the banking company, are held as security for an advance the banking company shall make a reference to the Reserve Bank and obtain its directions as to whether it should takes steps for the transfer of such shares to its name or not. (v) that no banking company shall grant or renew any advance against shares forming a security composite with any other security : Provided that where an advance has been granted or renewed against the composite security of shares and other types of securities the advance limit against shares shall be segragated from the advance limit against other types of securities and the provisions of this directive would be applicable to such segregated advance limit against shares; (vi) that no banking company shall exercise voting rights in respect of shares held by it as a pledge except with the prior approval of the Reserve Bank and in accordance with such directions as may be given by the Reserve Bank. Explanation (A) ‘Advance’ shall include cash credits, overdrafts, loans and advances of every description. (B) ‘Advances against security of shares’ shall include all types of advances against shares, whether by way of principal security or collateral security. (C) ‘Banking Company’ shall include the State Bank of India,its subsidiaries and corresponding new banks established under the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970. (D) ‘Shareholder’ shall mean a sharebroker who is a membe of a recognised Stock Exchange. (E) ‘Shares’ shall include shares and stock of every description. The Reserve Bank of India raised the monetary limit for advances against shares and debentures from Rs.1 Lakh to Rs. 3 Lakhs per individual borrower where the security is required to be transferred in the bank’s name. The monetary limit of Rs.2 lakhs per individual borrower for advances against shares and debentures has been raised to Rs.3 lakhs. (Journal of the Indian Institute of Bankers, July-September 1987, p.110). On November 16, 1987, to provide fillip to the capital market, the Reserve Bank advised banks to sanction loans and advances upto Rs. 3 lakhs to individuals for purchase of shares/debentures 257 (Sys 4) - D:\shinu\lawschool\books\module\contract law

in the secondary market against the security of existing shares/ debentures. Thus, for the first time, bank credit has been extended for the purchase of shares and debentures from the market (Journal of the Indian Institute of Bankers, OctoberDecember 1987, p.160). Advances to stock brokers In cities where a stock exchange exists, bankers also make similar advances to stock brokers, normally for a period of 15 days or less intervening between two successive settlements. Sometimes these transactions are in the form of ‘budla or carry over’ transactions. When a buyer is unable to pay for the shares, he asks the banker to buy them and to hold them on his behalf till the next settlement period, when the buyer purchases them from the bank at a higher rate than what the bank had paid for them. The difference between the two prices is the interest on those shares. When the share prices are steadily rising the budla rate may vary from 6% to 12%, and when the market is depressed the rate may go down to 3%. Such transactions are entered into by the banks only with highly reliable and respectable parties and as far as possible only for gilt edged securities. By its directive dated 11-3-1960, RBI has prohibited the banks from directly financing budla transactions in general have been banned in India by a SEBI directive since about Feb.95. 3.4 CERTAIN OTHER SECURITIES 1.

Units of Unit Trust of India

The units of Unit Trust are either fixed or flexible. In case of former the portfolios are fixed and any subsequent alteration can take place only by a special procedure and in specified circumstances; and in the latter the change in the proportion of securities can be decided upon by the managers at their discretion. The unit consists of varied investments in various securities at the time when the trust is formed. It is then divided into sub-units which are then sold to investors who thereupon become unit holders akin to shareholders in a company. Periodic dividends are distributed. Just like shares, units can also be offered as security, and, the procedure to be followed or the precautions to be taken is more or less the same as in case of shares. 2.

Special Bearer Bonds, 1991

The Central Government has issued at par certain bearer bonds to be known as the Special Bearer Bonds, 1991 of the face value of Rs.10,000 and redemption value after ten years of Rs.12,000 so as to canalise for productive purposes black money, which has become a serious threat to the national economy. The Reserve Bank has intructed the banks by a letter dated march 19, 1981 as under: (1) The commercial banks are authorised to grant advances against the collateral security of these bearer bonds within the frame work of credit control. However, the banks are 258 (Sys 4) - D:\shinu\lawschool\books\module\contract law

not permitted to purchase these bonds and thus they will not form part of the approved Government Securities statutorily required to be held by them, under section 24 of the Banking Regulation Act, 1949. (2) Having regard to the purpose of the Scheme, the banks may, in appropriate cases, while sanctioning advances for various productive purposes, accept these bonds as collateral securities. In doing so, the banks have, however, to keep in view the prevalent credit policies and norms applicable for the different types of advances. (3) These bonds are transferable merely on delivery and will not carry any evidence as to whom they were originlly issued. It will, therefore, be desirable for the banks, while accepting such bonds as security, to obtain from the offerer a suitable indemnification against the possibility of claims from third party who may claim the lawful ownership of the bonds in question. The author suggests that the indemnity bond may be on the following lines: “I declare that the follwoing bearer bonds each for Rs.10,000 were acquired by me for a proper consideration from ..... and exclusively belong to me. No other person has any right, title or interest therein. I further declare that I had handed over to .... Bank, .... the said bonds as a collateral security against the facilities granted to M/s........”.[Tannan p. 494]. 3.

Social Security Certificates

The Reserve Bank vide its letter dated September 10, 1987, has advised the banks that “the rules governing the 10 year social security certificates (SSCs) permit them to be pledged as security to the commercial banks and co-operative banks as in the case of other National Savings Certificates. As such, the banks can grant loans on the secirity of SSCs to the holders on margin and interests as follows: (a) A higher margin in the range of 40% to 50% should be prescribed for granting advances against the security of the aforesaid certificates as these certificates are encashable at any time after 3 years of their purchase, the rate of interest on these works out to 11.3% per annum and in the event of default the total amount recoverable could exceed the invested value of the certificates. (b) As regards the rate of interest to be charged, we advise that it would be governed by our directives on interest rate of advances and taking into account the nature and purpose of advance etc.” The salient features of the Scheme are: (1) The SSCs are available in denomination of Rs.500 and Rs.1,000 at Post Offices having Savings Banks facility. (2) The maturity period of the certificate is 10 years. (3) The rate of interest is 11.3% computed half yearly. (4) The deposit is tripled in the 10 year period. (5) The scheme offers insurance cover to the investor [Tannan, p. 494]. 4.

Shares of Private Companies

These are not much favored as securities by the banks, because it is practically impossible to gauge accurately the true financial

status of the company, because private companies are not required to publish their balance sheets, though now they are required to file a audited and certified copy of their balance sheet u/sec.220(1)(b) of Companies Act. The shares of a private company are not easily transferable, and so the banker cannot arrive at an estimate of their market value. A banker also has to take care and see that transfer in his name is not refused by the directors of the company. If the need arises he cannot sell these shares very easily in the market. But despite all these disadvantages there is nothing to prevent a banker from giving an advance against them, and he can always take the help of the Company Secretary to ascertain the market value of the shares. 5.

require to be accommodated during that period. For all practical purposes, such an advance is to be considered as advance against shares and the usual precautions should be taken. Certain additional precautions which should also be taken are : (1) the extent of liability on that letter of allotment should be ascertained ; (2) as far as possible a ‘renunciation form’ in favour of bank attached to the letter or forming a part of it should be got executed by the customer or where that is not possible the borrower should be asked to furnish the bank with duly signed blank transfer forms so that when shares are actually allotted the bank can either hold them as equitable mortgage or fill up the blank forms and send it to the company to have the shares registered in its own name or in the name of its nominee.

Letters of Allotment of Shares

Generally there is a time gap between the letter of allotment and the actual allotment of shares, and so a customer may

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4. MISCELLANEOUS SECURITIES SUB TOPICS 4.1. Equitable Mortgage 4.2. Life Policies 4.3. Book debts 4.4. Debentures 4.5. Hire-purchase finance 4.6 Conclusion 4.1 EQUITABLE MORTGAGE Section 58 of the Transfer of Property Act, 1882 defines mortgage as ”the transfer of an interest in specific immovable property for the purpose of securing the payment of money advanced or to be advanced by way of loan, an existing or future debt, or the performance of an engagement which may give rise to a pecuniary liability.” The basic characteristic of a mortgage is the transfer of interest in a specific immovable property for the purpose of securing a debt or an obligation. If the transfer is for the purpose of cancelling an already existing debt then it is not mortgage. When such a mortgage is executed by the deposit of title deeds to the property it is known as a equitable mortgage, because in this kind of mortgage there is no legal transfer of property. In Foster v. Barnard [(1916)2 AC 160] Lord Haldane observed “The deposit of title deeds with bankers makes the bankers’ mortgagees in the eyes of Equity.” Thus, an equitable mortgage in England was recognized as an exception to the general rule laid down in the Statute of Frauds requiring mortgage to be in writing. It can be created either (1) by actual deposit of title deeds in which case parol (i.e., oral) evidence is admissible to show the meaning of the deposit and the extent of the security created, or (2) if there be no deposit of title deeds, then by a memorandum in writing, purporting, to create a security for money advanced [Gupta, p. 624]. What is clear is that an equitable mortgage in England as the name itself suggests was one which the Common Law did not recognize and the parties had to approach the Courts of Equity for their remedy. In India an equitable mortgage has statutory recognition under section 58(f) of the Transfer of Property Act and is known as ‘mortgage by deposit of title deeds’, and states as under: “Where a person in any of the following towns, namely, the towns of Calcutta, Madras and Bombay, and an any other town which the State Government concerned may, by notification in the Official Gazette, specify in this behalf, delivers to a creditor or his agent documents of title to immovable property, with intent to create a security thereon, the transaction is called a mortgage by deposit of title deeds.” In Pentala Githavardhana Rao and others v. The Andhra Bank Ltd. and others [AIR 1973 AP 245] the Andhra Pradesh High Court has reiterated that the existence of the following three conditions are essential for a mortgatge by deposit of title deeds, viz: 260 (Sys 4) - D:\shinu\lawschool\books\module\contract law

i) existence of a debt; ii) deposit of title deeds in respect of immovable property; and iii) intention that the title deeds shall be security for the debt. Further observing that the delivery or deposit of the title deeds may be physical or constructive, it held ‘the essence of a mortgage by deposit of title deeds is the actual handing over of the document of titles in respect of the immovable property by a borrower or his agent to the lender. It is the substance of the entire transaction but not its form that really matters to infer intention of the contracting parties’. Documents of titles The question now arises what is a document of title ? All documents relating to a property do not constitute a document of title. A test which may be applied to ascertain whether a particular document is a document of title or not is to find an answer to the question ‘is the document the only document of title and whether a better document of title is not available ? The following documents have been held to be valid documents of title, viz: a) Patta of land in the mofussil b) A mortgage is the document of title of the mortgagee c) An expired lease is a document of title to the leasehold when the lesee obtains a renewal of lease. d) Share certificate. e) Record by Revenue Surveyor reciting an oral sale, and revenue tax, receipts. f) ‘Sold notes’ by firm from whom machinery of a factory was purchased, the drafts of the purchase price, and receipts by the firms for the amounts paid, insurance certificates, are all documents of title of the factory. g) Original probate of a will accompanied by a certified copy of a redemption certificate relating to the property, the original having been lost, creates a good equitable mortgage. The following documents have been held to be not document of titles, viz: i) A copy of the ‘jamabandi’ report. ii) Documents which are by way of being merely evidence of title to the property. iii) Map of the property, and unimportant papers. iv) A mortgage is not a document of title of the mortgager. v) Where the original title deed is unavailable, a copy of it may be good document of title. vi) A document of title of a movable property (for example, machinery) does not become the document of title of immovable property simply because the movable property has changed its character and has now become an immovable property (for example, by being permanently fixed to the ground).

vii) A mutation entry is not a document of title. viii)A life insurance policy. With reference to the validity of an equitable mortgage in case of deposit of a copy of title deeds instead of the original, the Andhra Pradesh High Court in Kanigalla Prakasa Raoq v. Nanduri Ramkrishna Rao [AIR 1982 AP 272] observed, “The submission that a valid equitable mortgage can never be made without delivering the original title deed has to be rejected. Such original documents of title may, at times, be lost or destroyed due to natural causes like cyclones and fire-accidents. They may also be lost either by thefts or due to want of proper care and sometimes they would have failed in courts and not taken return of in time. The owners of property who have so lost their documents of title will, therefore, be not in a position to deliver such original documents with intent to create an equitable mortgage. It will be rather anomalous if such persons can validly execute registered documents of sale, lease and mortgage, but will not be entitled to raise any monies by creating an equitable mortgage. The mortgagee in such cases has only to be vigilant in accepting such representation made to him and should make the necessary enquiries before agreeing to advance any monies on the basis of registration extracts of documents of title or copies of documents. That seems to be underlying principle of section 78 of the T.P. Act which provided that if the conduct of a prior mortgagee amounted to gross neglect, the mortgage in his favour will be postponed to the subsequent mortgagee.” The entire law relating to creation of an equitable mortgage by means of deposit of title deeds has been laid down in K.J.Nathan v. S.V.Maruthi Rao and others [AIR 1965 SC 430]. According to their Lordships, whenever there is a mortgage by deposit of title deeds, one has to see whether there is an intention to create security or not and this intention is not a question of law but is a question of fact. So far as the deposit is concerned, it is not necessary that there should be a physical delivery. Under the Transfer of Property Act, a mortgage by deposit of title deeds is one of the forms of mortgage whereunder there is a transfer of interest in specific immovable property for the purpose of securing payment of money advanced or to be advanced by way of loan. Such a mortgage of property takes effect against a mortgage deed subsequently executed and registered in respect of the same property. Though there is no presumption of law that the mere deposit of title deeds constitutes a mortgage, a court may presume under Section 114 of the Evidence Act that under certain circumstances a loan and a deposit of title deeds constitute a mortgage but that is really an inference as to the existence of one fact from the existence of some other fact or facts. Similarly the fact that at time the title deeds were deposited, there was an intention to execute a mortgage deed in itself, or is inconsistent with the intention to create a mortgage by deposit of title deeds to be enforced till the mortgage deed was executed. In each case, the court will have to find out as to whether there is a delivery of title deeds by the debtor to the creditor or not. In a case the creditor was already in possession of the title deeds, it would be only hyper-technical to insist upon the formality of the

creditor delivering the title deeds to the debtor and the debtor re-delivering them to the creditor. When the principal tells the agent, ”from today, you hold my title deeds as security”, in substance, there is a physical delivery. For convenience of reference, such a delivery can be described as constructive delivery of title deeds. The law recognizes such constructive delivery [Gupta, p. 635]. On the question whether a written document was necessary to constitute a mortgage by deposit of title deeds the Supreme Court in United Bank of India v. M/s.Lekha Ram Sona Ram and Co. [AIR 1965 SC 1591], observed, “when the debtor deposits with the creditor, title deeds of his property with intent to create a security, the law implies a contract between the parties to create a mortgage and no registered instrument is required under section as in other classes of mortgage. It is essential to bear in mind that the essence of a mortgage by deposit of title deeds is the actual handing over by a borrower to the lender of documents of title to immovable property with the intention that those documents shall constitute a security, which will enable the creditor ultimately to recover the money, which he has lent. But if the parties choose to reduce the contract to writing, this implication of law is excluded by their express bargain, and the document will be the sole evidence of its terms. In such a case the deposit and the document both form integral parts of the transaction and are essential ingredients as the creation of the mortgage. It follows that in such a case the document which constitutes the bargaining regarding security, requires registration under Section 17 of the Indian Registration Act, 1908, as a non-testamentary instrument creating an interest in immovable property, where the value of such property is one hundred rupees and upwards. If a document of this character is not registered, it cannot be used in evidence at all and the transaction itself cannot be proved by oral evidence either.” This entire reasoning was briefly summed up in M.G.Manjappa v. M.F.C. Industries (P) Ltd. [AIR 1990 Ker 157] as 'it is only when the parties intend to reduce their bargain regarding the deposit of title deeds to the form of a document, that the document requires registration. If, on the other hand, its proper construction and the surrounding circumstances lead to the conclusion that the parties did not intend to do so then there being no express bargain, the contract to create the mortgage arises by implication of the law from the deposit itself with the requisite intention, and the document, being merely evidential does not require registration.’ 4.2 LIFE POLICIES In the words of J.W.Smith a contract of life insurance is “a contract by which the insurer, in consideration of a certain premium, either in a gross sum, or by annual payments, undertakes to pay to the person for whose benefit the insurance is made, a certain sum of money or annuity on the death of the person whose life is insured...Sometimes the amount is made payable either at death, or at the expiration of a stated number of years, whichever shall happen first.” 261 (Sys 4) - D:\shinu\lawschool\books\module\contract law

An insurance contract is one of uberrimae fidei i.e., it is a contract where the utmost good faith has to be observed, and a full and complete disclosure of all such facts and circumstances must be made which might affect the risk. An insurance contract may be vitiated in the case of non-disclosure of material facts regardless of whether such non-disclosure was innocent or fraudulent. This principle was followed in London Assurance v. Mansel [(1879)11 Ch.D. 363]. Here, the defendant wanted the plaintiffs to insure his life. He was asked to fill a questionnaire, where one of the questions was ‘Has a proposal ever been made on your life at any other office or offices ? If so, where ? Was it accepted at the ordinary premium or at an increased premium, or declined ? Mansel’s answer was: ‘Insured now in two offices for £ 16,000 at ordinary rates. Policies effected last year’. The proposal was accepted, but subsequently the plaintiff’s discovered that the defendant’s life had been declined by several offices. If was held that the plaintiff’s were entitled to have the contract set aside.

love and affection’ shall not support the claim of insurable interest, the insured must be so related to the subject matter of the insurance that in the event of its loss, he will suffer some pecuniary loss. It is essential that such an interest should be in existence when the insurance is effected. In the following instances the insured is deemed to have an insurable interest, viz: i) in his own life; ii) in the life of his/her spouse; iii) in the life of his debtor (but only to the extent of the debt amount).

Insurable Interest

1) Evasion by insurer for non-disclosure of a material fact

Any person can insure the person or property provided he has an insurable interest. Originally this condition of one having an insurable interest was absent. This was only laid down in England by sections 2 and 3 of the Life Assurance Act, 1774 commonly known as the Gambling Act, and states as under: “No insurance shall be made by any person or persons, bodies politic or corporate, on the life or lives of any person or persons, or on any other event or events whatsoever, wherein the person or persons. for whose use, benefit or on whose account such policy or policies shall be made, shall have no interest, or by way of gambling or wagering; and every assurance made contrary to the true intent and meaning hereof, shall be null and void to all intents and purposes whatsoever.”

As mentioned earlier a contract of insurance is one of uberrimae fidei, and requires a full and frank disclosure of the relevant material facts. Non-disclosure of even a single material fact can result in the insurance company avoiding the contract. There is no way in which a banker can ascertain whether the insured has made the required disclosure or not, or whether the insured was guilty of fraud or misrepresentation, and if he has been so guilty then the banker stands to lose his money. The Insurance Act, 1938 under section 45 states that ‘no insurance policy shall be disputed after it has been in force for two years from the date effecting the policy on the ground of any misrepresentation even as to a material fact, except where the misrepresentation alleged to have been made as to a material fact was knowingly made by the insured in order to defraud the insurance company.’ Thus, atleast for a period of 2 years minimum this doubt that the insured person may not have made a full disclosure keeps on hanging over the banker’s head like a Damocles sword.

The Act does not define what is meant by ‘insurable interest’ and one has to look to judicial pronouncements to ascertain the meaning of this phrase. In Glasgow Parish Council v. Martin [(1990)SCJ 102] Lord Eldon said: “It is clear that the assured must have an interest whatever we understand by that term. In order to distinguish the intermediate thing between a strict right or a right derived under a contract and a mere expectation or hope which has been termed an insurable interest, it has been said in many cases to be that which amounts to a moral certainty. I have in vain, however, endeavoured to find a fit definition for that which is between a certainty and an expectation, nor am I able to point out what is an interest unless it be a right in the property or a right deniable out of some contract about the property insured, which in either case may be lost upon some contingency affecting the possession or enjoyment of the party. Expectation though founded upon the highest probability is not interest, and it is equally not interest whatever might have been the chances in favour of the expectation. Considering the caution with which the legislature has provided against gambling by insurance upon fanciful property, it is certainly desirable that no purely sentimental interest, such as an expectation or an anxiety, should be made the ground of a policy.” From these observations it is clear that mere ‘natural 262 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Reasons for Unpopularity of Life Policies as Securities: J.W.Gillbert once observed: “A banker should never make any advances upon the life policies.” Even in India life policies are not all that popular with the banker for the reasons mentioned below:

2) Regular payment of premia required to keep policy alive A life policy might lapse in case the assured fails to pay the premia instalments regularly. Unless such a policy has been in existence for some years, so that its surrender value is sufficient to cover the loan amount advanced by the banker, he would have to go on paying the premia on it in order to keep the policy alive. Surrender value of a policy depends on the kind/class of policy and the period for which it has been in existence when the banker pays the premia he has the satisfaction of keeping the security alive and he can add the premia amount paid by him to the customer’s account and the entire premia amount paid by him will be a charge on the policy. 3) Unsatisfactory nature of law relating to assignments Under the English Law, if a banker takes a life policy as security for the advance made by him, and has that policy assigned to him, his position becomes secure provided that the insurance company has received no intimation of a prior charge on the policy. In India, priority in case of assignment is governed not

by the date of registration of assignment but by the actual date of assignment. The situation is better now, because the Insurance Act of 1938 makes a differentiation between policies issued before 1.7.1939 and those issued after that date. In case of former policies, the rights and liabilities etc., of the assignee and transferee are not affected, but in case of latter ones the position is that an assignment takes effect only on its being registered with the insurer.

especially in cases of loan granted to persons having a fixed income terminable at death. c) This security in general requires no supervision or additional expenses as opposed to other kinds of securities like produce, goods, stocks and shares.

4) Nomination of life policies

The banker should primarily satisfy himself as to the financial status of the insurance company issuing the policy. This precaution is not really necessary in the present day and age due to the nationalisation of the insurance companies.

According to section 39 of the Insurance Act, an insurer gets a good discharge on paying the policy money to a nominee named/ appointed in the policy. But various courts have held that a nominee has no absolute title to the policy money, i.e., he only acts as a collecting agent and is required to hand over the money to the legal heirs of the deceased. In Life Insurance Corporation of India v. United Bank of India Ltd. [(1971) 41 Comp. Cas. 603 (Cal)], the nominee of the life policy assigned the policy to the bank against a loan of Rs.10,000. It was held that ‘on a reading of section 39 of the Insurance Act, the only right which a nominee of an insurance policy has, is the right to collect and receive the money, if he is alive at the date of maturity and if the policy-holder is dead at that time. If the policy-holder is alive when the policy matures, the nominee has no right whatsoever and the amount assured by the policy is payable to the policy-holder. No title to the policy money passes in present or in future by nomination. Hence, the assignment by the nominee of his right, title or interest in the policy in favour of the bank is invalid. The bank would have no cause of action against the Life Insurance Corporation until the surrender of policy’. 5) Risks in case of suicide Originally a life policy became null and void on the insured’s committing suicide, or if he reached his death at the hands of justice. Though in recent times restrictions of this kind have been modified the banker still has to be very careful about the wordings of the clause in the policy in this regard. Redeeming features of life policies as security Despite all the above mentioned drawbacks, life policies are nevertheless accepted by bankers as collateral securities for advances for the following reasons: a) If the policy is that of a person of some standing, then with the passage of time it increases in value as a result of bonus additions and when it matures either on the expiration of time period or the happening of a specified contingency [as for examples the death of the insured] the full sum along with the bonuses becomes immediately available. Generally, this payment is more than sufficient to clear the overdraft. b) It is a liquid and convertible security, atleast to the extent of the surrender value of the policy, and the banker can always reserve for himself the right to surrender or otherwise convert the policy into cash. The banker should always take the precaution of obtaining such a security

Precautions to be taken by bankers i) Status of insurance company

ii) Endowment policies favoured As the name implies the assured sum becomes payable either on the death of the insured person or the expiration of a fixed number of years whichever is earlier. This type of policies are favoured by the bankers because of them having a definite or specified maturity date, and the banker need not wait till the death of the assured to realise his money. iii) Insurable interest necessary A banker should satisfy himself that the person taking out the policy does have an insurable interest in the subject matter of the policy, else the policy would be void. iv) Policy must be free from conditions restricting assignment A banker should carefully scrutinize a policy to check whether there are any restrictions on the assignment of that particular policy because there are certain policies which cannot be assigned, as for example, (a) policy assured under Married Women’s Property Act; (b) policy taken out for the express purpose of payment of Estate Duty (this has to be assigned to the President of India); (c) Children’s Deferred Assurance Policy before its adoption by the life assured. v) Extent of advance to be made In a case where the insured person finds it difficult to continue the premia payment in order to keep the policy alive, the bank may continue to pay the premia on the surrender of their policy. The amount so paid is known as the surrender value. Before making such advance the banker is required to ascertain the period for which the policy may be kept alive without either the loss of the surrender value or liability for further premiums being paid. In general the bankers should not advance more than 85% of the surrender value of the policy, unless it is an endowment policy with a comparatively shorter endowment period. vi) Admission of the age of the assured The banker should check to see whether the insurance company has admitted the age of the person on whose life the policy is taken. If it is not admitted then he should take all efforts to get it admitted, because otherwise on the death of the assured person the banker may find it difficult to produce the necessary evidence required for the purpose.

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vii) Legal assignment of policy It would be better from the banker’s view point if the policy is legally assigned to him, with a provision for reassignment on the repayment of the loan and other charges. All the interested parties should join in the assignment. For example, if the husband takes out a policy in favour of or for the benefit of his wife, then both should sign the assignment. Once the assignment is complete a notice to that effect should be given to the insurance company. viii) When second charge created In case the banker receives notice of a second charge on the life policy deposited with him, he should make sure that the first charge covers the entire amount of advance or overdraft, and if it does not then he should ask for an additional security. In such cases, once his own debt is paid off he should not reassign the policy to the assured but should continue to hold it in trust or reassign it in favour of the person holding the second charge. 4.3 BOOK DEBTS A banker sometimes gives an advance to a customer on the basis of assignment of debts either due or accruing due to the latter. For example, the assignor-customer may be expecting to receive money either for goods sold or services rendered, or he may be due to receive money under a will. These debts which are due to him the customer may assign to the banker against the loan advanced to him. Generally speaking banker’s do not like to advance money against such book debts, because these transactions are fraught with risk. Further, bankers are put in the position of debt/money collectors. But where a banker is satisfied both as to validity of the claim and the solvency and bonafide intentions of the party, he may agree to give an advance against such trade debts. In some cases, bankers accept an assignment of moneys payable from a special fund, as for example, a legacy under a will, or beneficial interest in a trust. Sections 130-136 of the Transfer of Property Act deal with assignment of ‘actionable claims’ in India. Form of Assignment - An assignment must be in writing and signed by the assignor. There is no particular format to be followed, only an intention on the part of the assignor to pass on his interest to the assignee (i.e., the person in whose favour the assignment is made) should clearly be manifested whatever the words used, i.e., be it may in the form of an order or in the form of a request it is immaterial. Consideration not essential - An assignment may be by way of gift or otherwise and no separate consideration is necessary to support the assignment. Once the debtor pays off his debt to a third party on a direction from his creditor, he is entitled to a valid discharge irrespective of whether there was any consideration as between the creditor and third party or not. Notice of assignment to the debtor necessary - If the debtor is to be made liable to the third party, then he should be given a notice of the assignment. If he is not notified of the assignment, then the third party cannot hold him liable if he pays off the 264 (Sys 4) - D:\shinu\lawschool\books\module\contract law

debt to the creditor. Any remedy which the third party seeks can only be against the creditor and not the debtor. That means, that a failure to give notice to the debtor in no way invalidates the assignment itself, but the notice is important only to impose a liability on the debtor. Assignee’s rights subject to equity - An assignee subrogates the assignor, i.e., he stands in the shoes of the assignor, and therefore, can have no better rights than the assignor himself is entitled to. As for example, if the debtor is entitled to a right of set-off against the assignor, then he can avail himself of the same right against the assignee. The assignee cannot refuse him the right and can only seek the deficit amount from the assignor. This right of the debtor exists regardless of the fact whether the assignee knew or was aware of the existence of such a right of set-off or counter-claim or not. 4.4 DEBENTURES R.S.T. Chorley defines debenture as, “debenture is the name given to the document by which a limited company acknowledges receipt of money which it promises to repay with interest at a future date (usually fixed) and mortgages or charges its assets as security for its borrowings.” In general, debentures like shares are issued only by incorporated bodies though an unincorporated body is not as such restrained from issuing such debentures. Debentures acknowledge a debt owned by the company to the holder, and also provide for the date on which it is to be paid off, except when the debenture is an irredeemable one. It also provides for payment of interest at the specified rate. In most cases a debenture provides for a charge on the assets of the company. When a company issues a debenture it also makes a reference to the resolution where such issue was authorised. A debenture may be drawn either directly in favour of the bank or may be in favour of a nominee of a bank who would then hold it in trust for the bank. Sometimes a blank debenture may be issued in which case it becomes payable to the bearer. A debenture may be either for a fixed or ascertainable fund or it may be to secure the balance of an account including any advances which may be made in future. A debenture made for a fixed sum is much more easily sold (i.e., it has more liquidity) as compared to a debenture which is not made out for a fixed sum. Debentures are generally payable on demand along with an interest either at a fixed rate or a fluctuating rate with a minimum to be payable quarterly or half-yearly. As mentioned earlier, a debenture also incorporates the provision creating a charge (either fixed or floating) on all or specified assets of the company, and contains a further covenant to the effect that “it would not create any further mortgages or charges on its undertakings, assets or property, which would either be on par or rank in priority to the debentures. In Peoples Bank of Northern India Ltd., Lahore v. Lucknow Sugar Works Ltd. (in liquidation) [AIR 1936 Oudh 338], the appellant bank claimed the usufruct of the property of the respondent, given as

security for debenture account on grounds that the security had crystallized as soon as the respondent company went into liquidation. It was held that the security of the appellant bank as debenture holder was limited to property only whether it was floating security or fixed security and did not extend to the usufruct of the property. Enforcement of Security In case of a default in payment by the company, the bank has the power to enforce the security by not only selling the mortgaged property conferred on the trustee for the debenture holder in respect of assets specifically mortgaged, but also by appointing a receiver for the assets of the company. The latter power is especially useful when the company is dissipating or wasting its assets and an action has to be quickly taken by the bank to protect its own interests. 4.5 HIRE-PURCHASE FINANCE A banker is very often approached to finance what is known as a hire-purchase agreement, in which the owner of the article/ movable property hires it to another known as the ‘hirer’ on an understanding that on the hirer paying the owner a specified number of fixed installments, the property would be transferred by the owner to the hirer who then becomes the owner of the property. Mr. Maurice Lyall, Q.C. while speaking about the kind of agreements observed “the essential feature of that form of contract is that although the trader undertakes to hire the goods to the customer for a fixed term and to transfer the property to him when all installments of hire rental have been paid, the customer on his part does not bind himself to continue the hiring for longer than he wishes and therefore undertakes no obligation to buy the goods. He has only an option to do so.” Under the English Law the benefit of a hire-purchase agreement can be assigned but the assignee gets the same title as the hirer, i.e., he stands on the same footing as the hirer. Even the Indian Law has sought to confer the right of assignment on the hirer. The owner of the property reserves to himself the right to take back possession of the hired property in case the hirer fails to pay the installments when they fall due or if he commits any other default or breach of contract. This peculiar relationship between the owner and hirer, coupled with the fact that the hirer has no ownership in the property, makes it a risky transaction to finance. Despite this drawback financing of hirepurchase agreements has been quite popular with banks in both U.K. and U.S.A., though the field is still a bit new in India, and banks have restricted themselves to financing hire purchase agreements relating to commercial vehicles. An interesting fact to note is that State Bank of India Act was specially amended to provide for hire purchase credit. The Hire-Purchase Act, 1972 governs the hire purchase transactions in India. The procedure for financing such agreements is not uniform. In India the banks either finance the dealer directly or through financing intermediaries which are either finance agencies/ companies or firms. The hire purchase agreement is entered

into between the financier and the hirer and generally also a guarantor. The dealer of the goods is paid off by the financier who in turn is financed by the bank, generally against the security of the agreement, or hypothecation of the article and any other collateral as may be required. When the borrower is a limited company there is no difficulty in securing the lender’s interests, but the difficulty in securing the lender’s interests, but the difficulty arises when the borrower is a firm because in that case there is no legal necessity or compulsion for registration of a charge over its assets. Some other difficulties which arise in these agreements are: (i) the property remaining in possession of the hirer and the claim of an innocent third party who has bona fide acquired the article from him without notice of the hire; and (ii) in case of insolvency the property vests in the official assignee. Precautions which may be taken by a bank 1. Bank should satisfy itself of the credit and standing of the person taking the loan and as to the nature of the goods hired. 2. As far as possible the advance should be for brand new vehicles, and advances for second-hand goods should be avoided. 3. The agreement between the financier and hirer should be carefully scrutinized to find out if it incorporates some clause which goes contrary to the bank’s interests. 4. The promissory notes (made by the hirer in favour of the financier) duly endorsed in favour of the bank along with the hire purchase agreement and an agreement hypothecating the article to the bank must be deposited with the bank. 5. A statement giving the particulars of the hired article and in case of motor vehicles a letter addressed to the Registering Authority asking him to register the vehicle in the name of the financier or the bank, must also be obtained. It is also advisable to obtain an indemnity policy from an insurance company. 6. A notice that the article is hypothecated to the bank must be sent in duplicate to the hirer,and his acknowledgement obtained on one copy, and the copy must be preserved with other loan documents. 7. Any default in payment of installments by the hirer must be taken up immediately. 8. A periodic inspection of the hypothecated article must be arranged to be carried out to see that the article is being kept in good shape. 9. Advances should be allowed only after the cash down installment (which is usually 20% of agreed price) has been paid, and a reasonable margin on the total due amount should be maintained. 10. According to the RBI guidelines to banks for financing of leasing companies: a bank lending to leasing companies should not exceed 3 times the net owned funds (NOF) of leasing companies within the prescribed overall ceiling of 265 (Sys 4) - D:\shinu\lawschool\books\module\contract law

10 times of their external borrowings. Credit should be granted by way of cash credit and drawings regulated within the maximum permissible bank finance on the basis of overall drawing power [Journal of the Indian Institute of Bankers, April-June, 1988, page 13]. 4.6 CONCLUSION One has to remember that though the securities have been divided into three specific categories of: direct, collateral and miscellaneous, in actual banking transactions there can be no such divisions. As for example, an equitable mortgage or

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mortgage by deposit of title deed can be used as a direct security though it has been dealt with under miscellaneous securities. Similarly though guarantee has been dealt with under collateral security, a banker may as well give the advance on the basis of the guarantee thereby making it a direct security. Thus the present categorization is based more on academic convenience, rather than on any hard and fast rule being followed by the bankers. Such hard and fast categorization cannot in all honesty be really made also.

5. CASE LAW Margaret Lalita Samuel v. Indo Commercial Bank Ltd. [AIR 1979 SC 102] An overdraft was given by the bank to the company, and the director of the company executed a continuing guarantee for the overdraft. The Supreme Court held that so long as the account is a live account in the sense that it is not settled and there is no refusal on the part of the guarantor-director to carry out the obligation, the period of limitation does not commence to run. Limitation would run only from the date of breach under Article 115 of the Schedule to the Indian Limitation Act, 1908. S.Perumal Reddiar v. Bank of Baroda [AIR 1981 Mad 180] The blanks in the guarantee deed, in respect of the amount guaranteed, rate of interest charged and the date of contract were filled up without the surety’s knowledge, i.e., after the surety had signed the deed. The Court held that if the alteration is to the disadvantage of surety or it is substantial, the surety can claim to be discharged. The above alterations made in respect of the material particulars were therefore held to be substantial. The court observed: “In a printed form of guarantee, if the signature of the guarantor is obtained prior to the filling up of blanks relating to material particulars of the contract, The said filling up of blank spaces in the printed form of guarantee amounts to material alteration and discharges the contract of guarantee. Vijay Kumar v. Jullunder Body Builder [AIR 1981 Delhi 126] The decreeholder had obtained a decree against the Jullunder Body Builders and at the execution stage the J.D. agreed to pay the money in installments and they were required to furnish a bank guarantee to the sum of Rs.90,000/- and the Syndicate Bank with whom the J.D. had an overdraft account agreed to issue the guarantee. They deposited two fixed deposits receipts with a covering letter with the bank and requested it to issue a guarantee in favour of the Registrar of the Delhi High Court. This bank guarantee was later discharged by a Division Bench as the decree holder did not accept the proposal for payment in installments. Out of the two F.D.R’s, a sum of Rs.35,000/- was attached in the hands of the bank. The bank as a garnishee raised objections to the attachment on the ground that the bank had a lien on the deposit receipts and that the amount does not belong to the judgment debtor and cannot therefore be attached. On 21.1.1980 when the attachment order was issued there was a debit balance of Rs.1,17,365.95 in that account. The bank claimed that they have a lien on the amount of Rs.90,000 of the deposit receipts and they will exercise their right of set off when the receipts mature against the balance of account. Reliance was placed by the bank on the covering letter which the judgment debtor wrote on 17th September, 1980, when they requested the bank to issue a guarantee in favour of the Registrar and the last para of the letter which entitled the bank to retain the receipts, ‘so long as any amount on any account is due to the bank from us’. The decree holder on the other hand relied

on the fixed deposit receipts where on the reverse words appeared meaning thereby that the deposits receipts were being held against the guarantee furnished by the bank and thus the receipts were security which the judgment debtor have given to the bank for issuing the bank guarantee. It was mentioned on the back of the receipts ‘lien to BG-11/80. This was the arrangement in the light of which the letter had to be read and it was a special contract for a special and exceptional transaction. The Court held that the claim of the bank was inconsistent with the terms of the special contract, and the terms of the contract were inconsistent with the general lien that the bank claimed. It would claim a particular lien for the bank guarantee but it has no general lien. Note: It is to be noted that bankers don’t always have a general lien, and the kind of lien a banker has will depend on the terms of the securities which have been deposited. Greenhalagh v. Union Bank of Manchester [(1924)2 KB 153] A sold goodsto B, and A drew bills of exchange on B for the price of those goods, and B accepted them. B sold the goods to C, and in turn drew bills of exchange on C which were accepted by him. B handed C’s bills to the defendant bank for collection with directions that the proceeds should be utilised to meet the bills which he had accepted, payable at the defendant bank. The bank recognising the special purpose for which bills bearing C’s acceptance were handed over for collection, opened a separate account for them called the ‘Provisional Bills Account’. The proceeds of bills accepted by C after collection were held not to be subject to the banker’s lien as they were entrusted for a special purpose inconsistent with the lien. Nadar Bank Ltd. v. Canara Bank Ltd. [AIR 1961 Mad 326]. The borrower pledged its godown to two banks with the first bank the advance was termed as ”open cash credit” and the borrower was bound to submit periodical returns of the stock to the bank. When they failed to do so, the bank’s clerk went to inspect the godown, and found the doors locked with the locks of another bank, from whom the borrower took the advances under the ”key loan system”. The question arose as to the priority of the claim. The Court held that in order to constitute a valid pledge it is essential that there must be a delivery of goods either actual or constructive. Constructive delivery will be adequate to constitute a pledge and it applies to all cases where the pledger remains in possession of the goods under the specific authority of the pledgee or for limited purposes. The condition that prior consent of the pledgee was necessary for the pledger to deal with the goods ensure the constructive possession as well as the character of the pledge. There can be no hard and fast rule that the delivery of the keys of the warehouse is essential to ensure constructive possession. There cannot also be any rigid delimitation of the purposes for which the pledger is permitted to retain possession of the goods. The essential test is not the purpose but whether the dominian over the goods pledged is retained and the physical possession or 267 (Sys 4) - D:\shinu\lawschool\books\module\contract law

handling of the goods by the pledger is under the delegated authority of the pledgee or is independent. Where the possession of the pledgee is not lost and the possession may be manual or constructive, a subsequent pledgee even without notice cannot obtain any preference upon a rule of estoppel. Gurco Pharma Pvt. Ltd. v. Syndicate Bank [(1986)60 Comp Cas. 1055] Certain medicinal goods and raw materials belonging to a company, some having a validity period, were pledged by the company with the bank. The pledge was a continuous process. The bank kept insisting on payment of the debt, but the Chairman of the company kept requesting the bank for extra time, promising to pay the debt and releasing the material. In the meantime, some of the drugs reached their expiry date. The Chairman died, and the company went into winding up. The goods were advertised for sale, but there were no takers in the first instance. The Drug Controller later denied permission to sell the goods, got a Court order and had the goods destroyed. The company made an application under Section 446 of the Companies Act, claiming compensation from the bank in relation to the goods destroyed. The Court held that the bank was not guilty of any negligence in dealing with the goods pledged and the bank could not have been said to have failed to take reasonable care of the goods. The bank was under no obligation to dispose of the goods except at the time of its choice and the duty to take reasonable care of the goods did not extend to their disposal within the validity period or within the period beyond which they might perish. The pledgee, since he is in possession of the pledged property, is liable for failure to take reasonable care of it if it is stolen from him. He will be discharged if he can show that he took ordinary care of it. Similarly he is excused where a thing is perishable and it did in fact perish. Bihar State Electricity Board v. Gaya Cotton and Jute Mills Ltd. [AIR 1976 Pat 372] The cotton mill had approached the State for a loan of Rs.4,00,000 against the mortgage of certain properties. Later, a preliminary decree was passed and liberty was sought for a final decree within time. On behalf of the company it was pleaded that no decree could be passed in view of the provisions

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of SICA and the litigation was maintainable only against NTC and not against the cotton company. It was also contended that the only remedy available was by way of a claim before the Commissioner. It was argued that since under Section 4(5), no mortgage could be enforceable against a property vested in the Central Government, the properties given a security could not be followed and the state could not enforce its claim by a suit. It was argued on behalf of the state that the company was personally liable to pay the debt and its liability did not disappear under the provisions of the Nationalization Act. It was observed by the Court that: ”Whenever a loan is contracted and a mortgage is executed, the mortgagor subjects the mortgaged property to a liability of being sold for the realization of the loan by the creditor, and at the same time, binds himself personally for payment of loan”. ...It follows, therefore, that when a loan is advanced under a mortgage the creditor is clothed with two rights, first, to enforce the personal liability and, the second, to realise the money on the basis of the security. Both these rights are different though under certain conditions one suit may be brought to enforce both....The mortgagee was not bound to sue for realization of his security in a suit to enforce the personal covenant of the mortgagor as the two claims arose out of distinct causes of action”. The appeal was allowed with cost. Amulya Gopal Majumdar v. United Industrial Bank Ltd. [AIR 1981 Cal 404] An equitable mortgage was made by deposit of an agreement for sale under which the mortgager entered into possession. Sale in favour of the mortgager was completed shortly thereafter and the mortgagor continued to overdraw from the mortgagee bank. The Court held that the mortgage is rendered perfection and from the date the mortgager acquired title to the property by way of sale in his favour. It was observed that in order to create a valid equitable mortgage, it is not necessary that the whole or even the material of the documents of title to the property should be deposited nor that the document deposited should show a complete or good title; it is sufficient if the deed deposited bona fide relate to the property or are material evidence of title or are shown to have been deposited with the intention of creating a security thereof.

6. PROBLEMS 1. A customer was given a cash credit facility by the bank on open credit system. The goods hypothecated to the bank were lost by the negligence of the bank. The surety claims to be discharged due to this negligence of the bank which has resulted in the loss of security. The bank contends that Section 141 of Contract Act does not apply to hypothecation and to the surety is not discharged. Decide [AIR 1983 P & H 244]/ 2. On the debtor company’s going into liquidation, the bank filed a suit against the company in liquidation and three guarantors. The banks claim was admitted by the official liquidator. The bank later decided to proceed against the guarantors and not the company. The guarantor contend that since the official liquidator had admitted the claim, the bank could not proceed against the guarantors. Is this claim valid ? Decide. [AIR 1983 Cal 335]. 3. Certain movable property was pledged and mortgaged in favour of the bank, though the possession of the goods was left with the debtor-customer. A judgement-debtor of the customer wants to attach this movable property and sell it in order to satisfy his debt. The bank files a suit against the attachment on the ground that they were secured creditors and had a prior right over that property even if it was in the possession of the debtor. Decide [AIR 1980 AP 1] 4. A has a cash credit account with the bank and has pledged certain goods with the bank, to be stored by the bank in its godown with the keys and control thereof with the bank. The goods are found missing and A wants to hold the bank liable for the loss. Decide [(1971)41 Comp. Cas. 557 (Bom)]. 5. A received certain blank shares in transfer. On the death of the transferor, A filled up the blanks in the share certificate, including writing his name as the transferee and submitted them to the company. The company contends

that it is an invalid transfer. Discuss the validity of this contention [(1942)12 Comp. Cas. 206 (Cal)]. In the above problem, what would be the position if there is a surety to the transaction who has given a guarantee on assurance that the shares will be kept blank. 6. A bank advanced money to the borrower against the bills of military and other authorities. The borrower gave an irrevocable power of attorney in favour of the bank to present and obtain payments of bills. The borrower endorsed one bill in favour of the bank as “please pay to Bharat Bank Ltd., Jabalpur” and handed the bill to military authorities. But before the bank received payment one T attached the amount due under the bill in execution of a money decree against the borrower. Is this a valid attachment ? Discuss [(1969)39 Comp. Cas. 114 (SC)]. 7. A loan was given by the firm under a hire-purchase agreement for purchase of vehicle. The borrower executed a pronote in favour of the firm advancing the money, which was assigned to the bank, but the loan covered by hire purchase agreement was not so assigned. Does the bank have a locus standi to bring a suit against the borrower on the basis of collateral security of the pronote ? Discuss [AIR 1983 Kar 233]. 8. A mortgager mortgaged the property in favour of the bank and deposited the partnership agreement, encumbrance certificate, and registration extract of sale deed alongwith a latter informing the bank that the original sale deed was lost by the contractor. The bank failed to make relevant enquiries. The contractor subsequently created an equitable mortgage of the same property in favour of Mr.A and delivered to him the original sale deed of property. Mr.A was also informed of the subsisting prior equitable mortgage. Decide whether Mr.A can have a valid claim over the claims of the bank.

[Note: Please specify your name, I.D.No., and address while sending in your answer sheets].

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7. SUPPLEMENTARY READINGS 1. Chatterjeee, A., Legal Aspects of Bank Lending, 1992, Skylark Publications, New Delhi. 2. Gupta, S.N., The Banking Law in Theory and Practice, 1992, Universal Book Traders, New Delhi. 3. Hapgood, Mark, Paget’s Law of Banking, 1989, Butterworths, London. 4. Holden, J.M., The Law and Practice of Banking (Vol.2), 1991, ELBS with Pitman, London. 5. Kataria, S.K., Banking and Public Financial Institutions, 1990, Orient Law House, New Delhi. 6. Suneja, H.R., Practice and Law of Banking, 1990, Himalaya Publishing House, New Delhi. 7. Tannan, M.L., Tannan’s Banking Law and Practice in India, 1991, Orient Law House, New Delhi.

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Master in Business Laws Banking Law Course No: II Module No: IX

Procedural Aspects of Banking Law

Distance Education Department

National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 080-3217858 E-mail: [email protected] 271 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Material prepared by: 1.

Prof. P.M. Bakshi, Member Law Commission of India, and Director, Indian Law Institute

Material checked by: 1.

Ms. Sudha Peri, M.A., LL.M.

Materials edited by; 1.

Dr. N.L. Mitra, M.Com., LL.M., Ph.D.

2.

Dr. P.C. Bedwa, LL.M., Ph.D.

3.

Mr. V. Vijayakumar M.A., M.L., M.Phil.

© National Law School of India University Published By: Distance Education Department National Law School of India University, Post Bag No: 7201 Nagarbhavi, Bangalore, 560 072.

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INSTRUCTIONS You must have noticed by now that the law of banking has vast procedural matters in it. In fact, in any legal system, certain heurestic conditions are required to be fulfilled. These are, recognition of members of the system, easy understandability of the rules, well laid down procedures to be followed, institutions required for implementation, remedial courses and options available. Jurists divide law into substantive and procedural. Substantive laws or rules are those which form the basic definition of any action as well as which give remedies. As for example, what is a fraud or a material alteration? These definitions are given in the substantive law. Procedural laws on the other hand provide detailed rules outlining how to move a court, how the court has to deal with the matter and how the court has to come to a decision. In the British common law system, the person who moves the court has the burden of proof; the proof must be behond doubt; until so proved nobody is guilty; there has to be a privilege of cross-examination given to the defendant - all these make the acquisatorial structure. In acquisatorial structure the 'procedural law' plays vital role in meeting justice. In USA 'due process' is a basic need of justice, which may be said to be 'procedural justice'. Similarly in India, 'procedure established by law' is equally important because life and liberty of a perosn cannot be taken away without the 'procedure established by law'. In Banking, the procedure is equally important. Banking litigations are civil in nature and therefore, these litigations are dealth with in Civil Procedure Code. It is advisable that you refer to the Civil Procedure Code (CPC) in detail. But in this module we have dealt with only those sections, orders and rules of CPC that are frequently needed in the banking litigations. It may also be noted that the status of documentary evidence is required to be carefully examined in a banking litigation. In this connection, please note that there is a separate Evidence Act for banking litigations. This Act was passed in 1891 and is known as Bankers' Books Evidence Act, 1891. In this Act the mode of proof of entries in banker's book is provided. In this connection you have to also examine the evidentiary value of entries in books of accounts of a bank as included in the Evidence Act. In this connection it is also to be noted that debt recovery tribunals are now being constituted in order to quicken the decision in banking litigations. We have to examine how far our conventional framework of banker-customer relation can be reconciled with the tribunalised justice. In this module, therefore, we have to learn: i) What is a money decree, how a money decree is executed? ii) How can the bank accounts of a judgement-debtor be attached? iii) In what situations can a Civil or a Criminal Court summon the bank account? iv) What are the contents of Bankers' Books Evidence Act, 1891? v) What is the evidentiary value of entries in books of accounts? vi) How is the bank debt recovery tribunal to be constituted and how shall it function? vii)What are the equitable remedies available including injunction and where? While preparing the lesson you can prepare a checklist for yourself at every step. That shall help you at the end to review your position. If you have any problem either write to us or raise the issue in the contact programme. N.L. Mitra Course Co-ordinator 273 (Sys 4) - D:\shinu\lawschool\books\module\contract law

PROCEDURAL ASPECTS OF BANKING LAW

TOPICS 1. General Observations ........................................................................................................

275

2. Attachment and Freezing of Bank Accounts ..................................................................

276

3. Summoning of Bank Accounts in Civil Cases .................................................................

282

4. Summoning of Bank Accounts in Criminal Cases ..........................................................

283

5. Bankers' Books Evidence Act, 1891 .................................................................................

284

6. Evidentiary Value of Entries in Accounts .......................................................................

286

7. Bank Debts Recovery Tribunals .......................................................................................

287

8. Bankers' Duty of Secrecy ..................................................................................................

290

9. The Mareva Injunction in English Law ..........................................................................

292

10. Case Law ...........................................................................................................................

293

11. Problems ............................................................................................................................

295

12. Supplementary Readings .................................................................................................

296

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1. GENERAL OBSERVATIONS SUB TOPICS 1.1 Introduction 1.2 Special rules when applicable to bankers 1.3 Areas of law covered 1.4 Execution of money decrees

arises. There are detailed provisions in the Code of Civil Procedure, 1908 in this regard. Order 21, rule 46 and Order 21, rules 46A to 46G (newly inserted in 1976) are of particular importance.

1.1 INTRODUCTION

During recent times, the “Mareva” injunction has become popular in England. It has also some interest for bankers.

Banking and financial institutions may come into contact with the law of procedure in one of the following four situations: (a) The bank may be suing for the recovery of a debt due to it; (b) The bank may be a defendant in a suit filed against it; (c) The bank may be called upon to produce certain evidence in court; and (d) The bank may be a third party - i.e., it is not directly a party in a suit or prosecution, but a customer of the bank may be a judgment-debtor and amounts placed by him in the bank may be sought to be utilised by the creditor (decre-holder) through judicial processes. 1.2 SPECIAL RULES WHEN APPLICABLE TO BANKERS Where the banker is a plaintiff in a suit, it is also governed by the same procedure that applies to other plaintiffs. It must show that it has a cause of action, that its suit is within the limitation period and that it is entitled to the relief prayed for. However, attention should be drawn to the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, seeking to create a special tribunal for the recovery of debt due to banks etc., where the amount claimed is not less than Rs.10 lakhs (or such other amount, being not less than Rs. one lakh, as the Central Government may notify). Besides this, all provisions of the Code of Civil Procedure, 1908 that are of special relevance to money suits are of importance to banks. Most important of these provisions are Order 34 (suits on mortgages) and Order 37 (summary suits). Where a bank is a defendant in a suit, there are no special procedural rules applicable to banks that require notice. Where the bank is summoned to produce a document, the Bankers’ Books Evidence Act comes into operation. It makes certain special provisions as to such documents. These supplement (or, in certain cases, override) the general provisions contained in the two procedural codes. Where the bank is neither a party nor a witness, it may still be indirectly involved in the process of litigation, where a customer having an account with the bank is a defendant or a judgmentdebtor and the question of attaching his money with the bank

Bankers’ documents mostly consist of books of account. Section 34 of the Indian Evidence Act, 1872, contains a specific provision as to admissibility and value of entries made therein.

1.3 AREAS OF LAW COVERED From the brief narration of the provisions of procedural laws presented above, it will be evident that the areas that become relevant comprises inter alia; (a) the general law of procedure; (b the general law of evidence; (c) special enactments as to the forum; (d special enactments as to evidence; and (e) the English developments as to Mareva injunction. All these topics will be discussed in the appropriate places. It is not proposed to offer any treatment of the general law of procedure or evidence as such. 1.4 EXECUTION OF MONEY DECREES The procedure for execution of money decrees may briefly be adverted to here. The principal modes of execution of such decrees (in theory) are (a) arrest and detention of the judgment-debtor; (b) attachment and sale, or sale of immovable property of the judgment- debtor; and (c) attachment and sale of judgment-debtor's movable property. Of the modes of execution mentioned above, arrest is very rarely resorted to. With regard to immovable property, where a bank is the creditor, normally it would have taken a mortgage in which case the mortgaged property can be straight away sold in execution without attachment. It is attachment of movable property which assumes practical significance for banks. There are two situations to be noted: (i) Where the bank is the attaching creditor; and (ii) Where the bank is a third party and money in an account with the bank is to be attached. The second situation needs detailed examination of the legal position which will be attempted in due course in this discussion.

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2 ATTACHMENT AND FREEZING OF BANK ACCOUNTS SUB TOPICS 2.1 Introduction 2.2 Tripartite nature 2.3 Honouring cheques 2.4 Procedural steps in garnishee proceedings 2.5 Order 21, rules 46A to 46G, C.P.C 2.6 Object of rules as to garnishment 2.7 Order of garnishment (O. 21, r. 46B) 2.8 Disputed Liability (O. 21, r. 46C) 2.9 Dispute as to quantum 2.10 Bank’s objection about title 2.11 Foreign balances 2.12 Uncleared cheques 2.13 Time of operation of attachment 2.14 Attaching creditor’s rights 2.15 Time for attachment of debt 2.16 Unlimited order 2.17 English Practice (Limited Order) 2.18 More than one account 2.19 Identifying the account 2.20 Transfer of amount 2.21 Debts due to third persons 2.22 Subsequent deposits 2.23 Overdraft 2.24 Floating charge 2.25 Contingent and future debts 2.26 Joint Judgment 2.27 Discretion of court 2.28 Form of notice of garnishment 2.29 Contents of notice and effect 2.30 Fixed deposits and banker’s lien 2.31 Cheque, if attachable 2.32 Set off by the banker

‘debtor’ of the account-holder. Attachment of a debt is generally done by the issue of a ‘garnishee order’. The Code of Civil Procedure, 1908, in Order 21, rule 46(1)(a), provides that a debt (if not secured by a negotiable instrument) can be attached by a written order prohibiting the creditor from recovering the debt and prohibiting the debtor from making payment thereof until further orders of the court. The garnishee proceedings have been explained in 2.4.

2.1 INTRODUCTION

2.4 STAGES IN GARNISHEE PROCEEDINGS

Some practical problems of banking are intimately connected with procedural law, one example being attachment of money lying in deposit or other account with a bank. The subject has its own interest, partly because of the tripartite character of the process, and partly because of the fact that several minute questions of detail can arise. When a court order is served on a bank attaching a customer’s money in the bank, the bank has necessarily to suspend payment of cheques drawn by the concerned customer.

Generally, for securing a garnishee order, the decree-holder should swear an affidavit, stating the amount remianing unpaid and adding that the garnishee is within the jurisdiction of the court and indebted to the judgment - debtor. Besides this, where the garnishee is a bank having more than one branch, the decree holder should state the branch where the account is held. These preliminaries are insisted upon in England by Order 49 of the Rules of the Supreme Court. In India, they are implicit in the decree-holder’s duty to identify the person against whom the attachment is to operate. The Code of Civil Procedure, in India, under Order 21, rules 46A to 46-I (as inserted in 1976) lays

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2.2 TRIPARTITE NATURE An order of attachment of money in bank account operates on, or in favour of, three persons, namely, (1) the decree-holder at whose instance the attachment takes place; (2) the judgmentdebtor whose account is attached; and (3) the banker, with whom the judgment-debtor has an account. It is obvious that the judgment-debtor at (2) above possesses a dual capacity. With reference to the decree-holder, he is a debtor. But with reference to the banker, he is a creditor and it is the banker who is the debtor. The effect of the garnishee order (the attachment order) is to capture the debt between the account-holder and the bank and make it available for the benefit of the decree-holder. 2.3 HONOURING CHEQUES Service of a garnishee order would have the effect of terminating - or at least suspending - the bank’s duty to honour the cheques of the account-holder. That is the very nature of the order, which prohibits payment. In England, the point was conclusively determined in the House of Lords. [Rogers v. Whiteley (1892) A.C. 118, 121. HL]. The bank must not permit any drawings from the attached balance; to do so would amount to failure to comply with the order of the court. [Holdern, p 103] Books on banking often give the suggestion that the banker should notify the account-holder of the situation, so that the latter can open a new account for future transactions. Any credit balance in the new account would not be subject to the garnishee order passed earlier. Of course, there is nothing to prevent the decree-holder from attaching the money in the new account also, provided the amount of the debt due exceeds the amount in the account already attached.

down a detailed procedure in several respects regarding the hearing to be held on an application for attachment of a debt. Where the decree-holder has sought attachment of a debt (money in bank) the court issues an order nisi, attaching the account and calling upon the bank to pay into the court the debt from the bank to the account holder, or so much thereof as may be sufficient to satisfy the decree and costs of execution. But the bank is free to show cause why it should not do so. This application is made ex parte. The judgmentdebtor or the banker is not notified before the order nisi (provisional attachment). In fact, secrecy is usually essential, as pointed out by a well known writer had. [Holden, p. 106]. If the judgment-debtor learnt what was taking place, he might try to ensure that the third person paid the amount of debt to him prior to the service of the garnishee order. If the third person was a bank, the judgment-debtor could easily withdraw his bank balance and so prevent the decree-holder from serving an effective garnishee order upon the bank. The (provisional) order will immediately be served upon the garnishee. Until it is served, any payment by the bank to the judgment debtor wil discharge the banker. [Cooper v. Brayne, (1858) 27 LJ EX. 446]. If the banker does not show cause against confirming the attachment, the order is made absolute. In this manner, the decree-holder eventually obtains payment of the decretal debt in whole or in part. If the bank disputes liability, the court can try the issue and determine it and then pass appropriate orders. If there is no such dispute, the bank must pay the amount of the decree (passed against the account holder) and the costs into court, failing which, execution can be issued against the bank as though the decree had been passed against the bank. 2.5 ORDER 21, RULES 46A TO 46G OF CIVIL PROCEDURE CODE Provisions of the Code of Civil Procedure (CPC) as to “garnishment” are of practical importance for banks. A look at them in detail would be useful. (a) Order 21, rule 46A of the Code provides that the court may, in the case of a debt (other than a debt secured by a mortgage or a charge), which has been attached under Order 21, rule 46, upon the application of the attaching creditor, issue notice to the garnishee liable to pay such debt. The notice calls upon him, either to pay into court the debt due from him to the judgment-debtor or so much thereof as may be sufficient to satisfy the decree and costs of execution, or to appear and show cause why he should not do so. (b) The application is to be made on an affidavit, verifying the facts alleged and stating that in the belief of the deponent, the garnishee is indebted to the judgment-debtor. (c) Where the garnishee pays in the court the amount due from him to the judgment-debtor (or so much thereof as is sufficient to satisfy the decree and costs of the execution), the court may direct that the amount may be paid to the decree-holder towards satisfaction of the decree and costs of the execution. The above provision came into the

CPC in 1976 and substantially implements the recommendation of the Law Commission of India in the 54th Report, read with the 27th Report. Beofre 1976, certain High Courts had made local amendments to provide for a similar procedure. 2.6 OBJECT OF RULES AS TO GARNISHMENT The object of the rules relating to garnishment is to render that debt due by the debtor of the judgment-debtor available, in execution, to the decree-holder. This avoids the need to file a separate suit. It applies to a debt, which has been attached under Order 21, rule 46 of CPC. The word “may” in the rule means that the power is discretionary and the court may refuse to act under this rule, if it is inequitable. If a debt attachable under Order 21, rule 46 of CPC has not, in fact, been attached under this rule, or if the debt is one which cannot be attached under that rule, then garnishee proceedings cannot be taken, in respect of the debt. Thus, garnishee proceedings cannot be taken in respect of a debt due to a firm, in execution of a decree against the partners in their individual capacity. [K.H.E. Supply Co. Ltd v. LakshmiNarayan Sukhani 45 C.W.N. 333: AIR. 1941 Cal. 264]. The foundation of a garnishee proceeding is an attachment under Order 21, rule 46, of CPC. [Imperial Bank of India v. Bibi Sayeedan AIR, 1960 Pat. 132]. A decreeholder can proceed against a garnishee, only where the judgment-debtor has a present right to recover the debt from his own judgment-debtor(i.e., the garnishee) 2.7 ORDER OF GARNISHMENT (O.21, R. 46B]. Order 21, rule 46B of the CPC provides that where the garnishee does not forthwith pay into court the amount due from him to the judgment-debtor (or so much thereof as is sufficient to satisfy the decree) and the costs of execution, and does not appear and show cause in response to the notice, the court may order the garnishee to comply with the terms of such notice. Where such order is passed, execution may issue as if such order were a decree against the person notified. As stated above, such an order is to be deemed to be a “decree” against the garnishee and in favour of the creditor. Further proceedings are taken in execution of that decree and against the garnishee. [Lukka Verghese v. D. Varkey, AIR 1965 Ker. 47]. The power to make the order is discretionary and the order may be refused on sufficient grounds, e.g. where the judgmentdebtor’s interest in the debt is not personal, but is in his capacity as a trustee. [Robert v. Death, (1882) 8 Q.B.D. 819]. 2.8 DISPUTED LIABILITY (O. 21, R. 46C). Order 21, rule 46C of the CPC, 1908 deals with the dispute and regarding liability, where the garnishee disputes his liability. The court may order that any issue or question necessary for the determination of his liability shall be tried as if it were an issue in a suit, and upon the determination of such issue, shall make such order or orders as it deems fit. But if the debt in 277 (Sys 4) - D:\shinu\lawschool\books\module\contract law

respect of which the application under rule 46A is made in respect of a sum of money beyond the pecuniary jurisdiction of the court, the court shall send the execution case to the court of the District Judge to which the said court is subordinate. There upon, the court of the District Judge or any other competent court to which it may be transferred by the District Judge shall deal with it in the same manner as if the case had been originally instituted in that court. The effect of such order is that if the garnishee disputes his indebtedness to the judgment-debtor or alleges that the debt is not an attachable debt, the court must order an issue to be raised and tried. Even if there is a reasonable doubt, the matter should be tried. [Employees’ Liability Corporation v. Sedgwick, Collins Co., (1926) 42 TLR 749]. A summary order based on the affidavit of the decree-holdere can be made only where the garnishee does not dispute his liability or where the dispute raised by him is flimsy. But the garnishee must make out a prima facie case before he can raise an issue. He must disclose facts from which a reasonable inference may be drawn that there is a valid dispute as to his alleged liability to the judgment-debtor. [M. Mackenzie & Co. v. Anil Kumar, AIR 1975 Cal. 150]. 2.9 DISPUTE AS TO QUANTUM For attaching the debt, it is not necessary that the exact amount be stated, provided there is a debt actually due at the time of attachment. [Madho Das v. Ramji (1894) ILR 16 All.286]. If the garnishee, while admitting the debt, disputes the amount, the court may attach the debt and try the question of quantum later. [Aldidas Kawerlal v. Hiriya Gowder, AIR 1961 Mad. 189]. 2.10 BANK’S OBJECTION ABOUT TITLE (a) Sometimes a bank may raise an objection (i) that a third person owns the account; or (ii) that a third person has a lien or charge on, or other interest, in the account. (b) In such a case, the court may order such third person to appear and state the nature and particulars of his claim and prove the same. After inquiry, the court can make appropriate order. Payment made by the bank in obedience to the court’s order gives full protection to the bank under Order 21, rules 46A to 46-I, CPC. Where a bank account is in the joint names of two persons, their shares are taken as equal, in the absence of any proof to the contrary. [Balaramam v. Varaadammal, AIR 1987 Mad. 99]. (c) In England where a bank account is opened by a husband in his wife’s name, regard is to be had to the substance of the matter, i.e., who controls the account. [Harrods Ltd. v. Tester, (1987) 157 LT 7 (C.A)]. In India, account is to be taken of the legislation relating to benami transactions. In an English case, the husband and wife had a joint account 278 (Sys 4) - D:\shinu\lawschool\books\module\contract law

at a bank. A garnishee summons served on the bank named the husband alone as judgment-debtor. The bank took the view that the summons did not cover the joint account and they could not dishonour cheques drawn on it. The Court of Appeal (majority) upheld this view. [Hirschorn v. Evans, Barclays Bank Ltd Garnishees, (1938) 2 K.B. 801]. But the Calcutta view recognises an inherent power in such cases. [Upendra Mohan v. Malini Mohan, AIR 1937 Cal. 199]. (d) A garnishee order nisi naming two judgment-debtors will attach a balance standing in the name of one of them [Miller v. Mynn, (1859) 28 LJ QB 324]. The principle is that attachment can be made only of a debt exclusively due to the judgment-debtor [Macdonald v. Tacqueeh Gold Mines, (1884) 13 Q.B.D. 535; Moideen Baldia Rowther v. Sulaiman Saheb, AIR 1956 Mad. 163; Kaji Abdulla v Abdul Latif, AIR 1920 Mad 403]. 2.11 FOREIGN BALANCES In England, Order 49, rule 1(1) R.S.C. uses the phrase “within the jurisdiction” which is taken to be meaning “is indebted within the jurisdiction”. Money held at a branch outside the court’s jurisdiction cannot therefore be attached. [Richardson v. Richardson, (1927) Probate 328]. According to Indian decisions also, foreign balances cannot be attached, because they do not constitute a debt recoverable within the jurisdiction of the courts of the country. [Padmanabha v. Bank of Kerala, AIR 1956 TC 100]. This is because, in principle, attachment is only a mode of execution. Of course, if the branch is within India, Indian courts have jurisdiction to attach its account, even if the judgement-debtor resides outside India. [British Transport Co. v. Surajbhan, AIR 1963 All 313]. 2.12 UNCLEARED CHEQUES Can the proceeds of uncleared cheques, paid by the account holder, be attached? The answer depends on whether the account holder has the right to draw against the cheques before they are cleared, a matter which depends on the express or implied agreement between the bank and the account holder. [Jones & Co. v. Coventry, (1909) 2 KB 1029, 1044; Holden, p. 106 ]. An English case holds that uncleared cheques credited by the bank as cash are not attached by a garnishee order, since they do not yet represent money owed by the bank to its customer. [Fern v. Bishop Burns and Lloyds Bank, Shelden & Fidler, p. 43]. 2.13 TIME OF OPERATION OF ATTACHMENT In general, an attachment becomes operative when the court order is served on the bank. From this, it follows that whatever has already taken place before the attachment, remains valid. Conversly, after the attachment, the bank cannot deal with the attached amount - a consequence following from the express provisions of section 64 of the CPC, 1908.

Thus, to illustrate the first aspect, if, before the attachment, the judgment-debtor (account-holder) had created an equitable charge, the attaching creditor must take it subject to the charge. [Gopaldas v. Motichand, AIR, 1953 Sau.127;. Ladgir Nauji v. Surendra Mohan, AIR 1938 Cal. 606]. If, before the attachment, there already had been made an equitable assignment, the attachment will confer no rights. [Mommu Saheb v. Lakshmi Bai, AIR 1961 Mys. 196; Glegg v. Bromley, (1912) 3 KB 474].

amount attached is less than the customer’s credit balance, the practice is to transfer from the customer’s account to a suspense account a sum sufficient to satisfy the order. The balance remaining on the customer’s account is at his disposal and the relationship of banker and customer will continue. The customer should be notified that a stated sum has been debited to his account in compliance with the terms of the garnishee order. [Holdern, p. 103]. 2.18 MORE THAN ONE ACCOUNT

2.14 ATTACHING CREDITOR’S RIGHTS The above propositions follow from the wider principle that a person claiming under an attachment has no greater rights than the debtor, with respect to the debt, and must take the debt subject to all the equities which the garnishee might have against the debtor. [Government of the United States of Travancore - Cochin v. Bank of Cochin Ltd AIR 1954 TC 281]. 2.15 TIME FOR ATTACHMENT OF DEBT It is well settled that only a ‘debt’ can be attached and that the debt must have accrued. The court cannot make an order on the garnishee (bank) before the debt has become payable. [Jetha v. Durga Dutt, AIR 1927 Bom. 365]. If a debt does not become payable until a contingency happens, then it is a contingent debt and cannot be attached. [ShantiPrasad v. Director of Enforcement, AIR 1962 SC 1764]. 2.16 UNLIMITED ORDER An unlimited order covers debts owing or accruing to the account holder from the bank. [Holden, pp 101-102]. The law is that when served with an unlimited garnishee order nisi, a bank may, and should, refuse to pay any cheque drawn by the account holder, even though it is known that the amount of the judgment-debt is less than the customer’s credit balance. The question arose in Rogers v. Whildey, [(1982) AC 118, 121, 122] wherein the creditor obtained a garnishee order nisi, which ordered that ‘all debts owing or accruing’ from the bank to the customer be attached to answer the judgment recovered against him. That order was served on the bank, and thereafter the bank refused to honour any cheque drawn by the customer. The House of Lords held that the bank had acted correctly. Lord Walton said: “The effect of an order attaching ‘all debts’ owing or accruing due by him to the judgment-debtor is to make the garnishee “custodian for the court of the whole funds attached, and he cannot, except at his own peril, part with any of those funds without the sanction of the court”. To overcome such hardships, the court can issue a limited order, to the effect that “all debts owing or accruing due from the above named judgment-debtor not exceeding the sum of ........ to be attached”. 2.17 ENGLISH PRACTICE (LIMITED ORDER) The English banking practice on the subject has been stated thus: “If a banker is served with a `limited’ order and if the

It is elementary that only that can be attached, which is due from the bank to the account holder. This yields the rule that the moneys that can be attached are those which are standing to the customer’s credit at the moment of service of the garnishee order nisi and for which he could sue. Hence, if a customer has two accounts, of which, in one the customer has credit balance while in the other, there is a overdraft, then the attachment has to be confined to the excess of the credit balance over the overdraft. If the overdraft is in excess of the credit balance, nothing can be attached. This follows from the banker’s right of set off. However, the set off must be in respect of an actual, immediate, recoverable debt due to the garnishee from the judgment-debtor at the date of service of the garnishee order nisi, i.e., a debt which, at that moment and without any preliminaries, the garnishee could have sued for and recovered. [Tapp v. Jones, (1875) LR 10 Q.B. 591]. 2.19 IDENTIFYING THE ACCOUNT If a garnishee order does not correctly designate the account to be attached, the banker is entitled to ignore the order. In Koch v. Mineral Ore Syndicate, [(1910) 54 SJ 600] the bank had no account in the name designated on the garnishee order. The bank reported this fact to the decree-holder’s solicitors, who designated another account, adding that was the account of the judgment-debtor and asked the bank to attach it. The bank refused and continued to allow its customer to draw cheques on his account. But the solicitors did not immediately seek from the court an amended order. It was held that the bank was not liable to the decree holder for having paid cheques out of the account till the garnishee order was amended. Of course, this does not entitle the bank to disobey an attachment order merely on the ground of technicalities, such as spelling mistakes. [Sheldon and Fiddler, p. 43]. 2.20 TRANSFER OF AMOUNT Where a bank has been asked by a constituent to transfer any amount from his account to some other person’s account, and his account is attached by a garnishee order before the transfer could be affected, the amount intended to be transferred would also be hit by the garnishee order. [Rekstin v. Severo Sibirsko Gosudarstevennoe Akcionernoe Obschestvne Kamseverpurti (Bureau) and the Bank for Russian Trade Ltd, (1933)1 K.B. 47]. When a bank denies its liability, the denial must be factual, unambiguous and bona fide in order to 279 (Sys 4) - D:\shinu\lawschool\books\module\contract law

prevail against the income tax authorities who have issued the garnishee order in question. If any valid objections are raised, falling within the scope of the garnishee order, the only way open to the revenue authorities, who issued the order is to have the dispute adjudicated upon by a competent court of original civil jurisdiction. [Sahukar Bank Ltd. v. ITO., (1966) 62 ITR 745 (Punj)]. 2.21 DEBTS DUE TO THIRD PARTIES Where a garnishee order is served by the Income Tax Officer upon a bank in respect of deposits of a deceased tax payer, amounts lying to the credit of the daughter-in-law of the deceased tax payer cannot be attached, except as regards assets received by her from the deceased tax payer. [Maina Devi Goenka v. Union of India, (1978) 115 ITR 423 (Cal.)] 2.22 SUBSEQUENT DEPOSITS A garnishee order may not be operative in respect of deposits in the bank made subsequent to the service of the order. [Hoppenstall v. Jackson Barclays Bank Ltd., (1939) 2 All E.R. 10]. Such deposits do not constitute “debts” due from the bank at the time of the order. 2.23 OVERDRAFT The income-tax authorities cannot freeze an over-draft account or order the bank to pay them the difference between the limit of overdraft allowed and the amount over-drawn. An unutilised overdraft account does not render the banker a debtor in any sense. [K.M. Adam v. ITO, (1958) 33 ITR 26 (Mad); Joachimson v. Swiss Bank Corporation, (1921) 2 KB 110]. 2.24 FLOATING CHARGE When proceeds of goods are under a bank’s floating charge, garnishee proceedings are not possible for the recovery of the assessee’s dues from the purchaser. [Jay Engineering Works Ltd. v. Syndicate Bank Ltd., (1981) Tax L.R. (NOC) 173 (Cal.)]. 2.25 CONTINGENT AND FUTURE DEBTS If the money is payable to the judgment-debtor only on a certain contingency, then the decree-holder would be subject to the same disability as his judgment-debtor, and has to wait till the happening of that contingency. [Shanti Prasad v.Director of Enforcement, AIR 1962 SC 1764; K.J. Jung v. Mohd. Ali, AIR 1972 A.P 70]. The principle is that there must be money due to the judgment-debtor. Thus, if a builder is paid only on the certificate of the architect, then the amount does not become due to the builder until the certificate is obtained. [Dunlop & Ranken Ltd. v. Hendall Steel Structures Ltd. (1957) 1 All ER 347]. A mere cause of action (which has not ripened into a debt) cannot be attached. [Johnson v. Diamond, (1855) 24 LJ Exch. 217, 219 (Baron Parke)]. It follows that if a debt has been already assigned by the judgment-debtor, it cannot be 280 (Sys 4) - D:\shinu\lawschool\books\module\contract law

attached. [Wise v. Birkenshaw, (1860) 29 LJ Exch. 240; Curran v. Newpark Cinemas, (1951) 1 All E.R. 295(CA); Holt v. Heatherfield, (1942) 2 K.B. 1]. There is, however, a distinction between (i) the case where there is an existing debt, though its payment is deferred, and (ii) the case where both the debt and its payment rest in the future. In the former case, the debt is attachable. In the latter case, it is not. [O’Driscoll v. Manchester Insurance Committee, (1915) 13 KB 497, 516]. The fact that the amount of the debt due or accruing is not ascertained, does not prevent a garnishee order nisi from being made. [De Pass v. Capital and Industrial Corp., (1891) 1 Q.B. 216]. 2.26 JOINT JUDGMENT If there is a joint judgment against two or more persons, the decree-holder can attach a debt owing to any of those judgmentdebtors. [Miller v. Myhn, (1859) 28 L.J. Q.B. 324]. 2.27 DISCRETION OF COURT The making of a garnishment order is the discretion of the court. [Rainbow v. Moorgate Properties Ltd., (1975) 1 WLR 788 (C.A)]. The order may be refused (for example), if the garnishee would still remain liable in a foreign court. [Martin v. Nadel, (1906) 2 K.B. 26 (C.A)]. The order is basically an equitable remedy. [Prichard v. Westminster Bank, (1969) 1 All E.R 999(C.A)]. 2.28 FORM OF NOTICE OF GARNISHMENT Questions have arisen as to the form of the notice required for garnishment. In a case from Kerala, the garnishee appeared in court, in response to the letter and filed a counter-affidavit. It was held that the same could be treated as “objections” contemplated by Order 21, rule 46C of the CPC, 1908, even though a formal notice under Order 21, rule 46A had not been issued. Hence, the court has a duty under Order 21, rule 46C to direct that the disputed question be tried as an issue and to decide the issue. [Executive Engineer, K.S.E. Board, v. I.H. Sharma, AIR 1988 Ker. 285]. 2.29 CONTENTS OF NOTICE AND EFFECT In a case from Kerala, a money decree was obtained on the basis of a compromise. At the instance of the decree-holder, attachment before judgment was affected of a certain sum of money, said to be belonging to the judgment-debtor in the hands of the appellant garnishee, by way of a prohibitory order. The executing court did not, at any stage, issue any notice under Order 21, rule 46A, CPC to the garnishee. Only a letter was directed by the court to be written, requesting the garnishee to remit the amount. The letter did not contain any of the particulars which are required to be stated in the summons or notice. It was held that the letter would not attract order 38, rule 5, CPC. [Executive Engineer, K.S.E. Board v. J.H. Sharma, AIR 1988 Ker. 285].

Service of notice to show cause against the attachment of a debt does not transfer to the attaching creditor property in the debt. But if, after receiving the notice, the garnishee pays the debt to the judgment-debtor, he may have to pay it again to the attaching creditor. [Galbraith v. Grimshaw and Baxter, (1910) 1 K.B. 339 (C.A), affirmed (1910) A.C. 508]. 2.30 FIXED DEPOSITS AND BANKER’S LIEN The bank is a debtor, in respect of the money in fixed deposit. It has no right to press into service the doctrine of “banker’s lien” and to retain the money in fixed deposit. There is no question of the bank exercising the 'lien’ for the purpose of retaining the money in fixed deposit, according to the Kerala High Court. [Union Bank of India v. K.V. Venugopalan, AIR 1990 Ker 223 (AIR 1956 Mad 570 and AIR 1965 Mad 226 followed)]. The view of Punjab High Court is to the contrary. [Punjab National Bank v. Satyapal Virmani, AIR 1956 Punj, 118]. According to the view of Kerala High Court, money lodged with banks as fixed deposits is a loan to the bank. The banker, in connection with the ‘fixed deposit’, is a debtor. Accordingly, the depositor would cease to be the owner of the money in fixed deposit. The said money becomes the money of the bank, enabling the bank to do as it likes, subject however, to banker's obligations to repay the debt on maturity. Money in fixed deposit, therefore, constitutes a debt against the banker and a debt cannot be a suitable subject for a 'lien', because a lien is a right recognised in a creditor to retain another man’s property until the debt is paid. A 'lien’ postulates the property of the debtor in the possession or under the control of the creditor. A creditor enjoying the 'lien’ however, has no right to sell the thing or dispose it of. In other words, he is only entitled to retain possession.

Section 171 of the Contract Act entitles a banker (in the absence of contract to the contrary) to retain as security for a general balance of account any goods bailed to him. To attract this provision, a bank should establish that it is a “bailee” within the meaning of Section 148 of the Act. There will not be a bailment, if the thing delivered is not to be specifically returned or accounted for. Hence a transaction evidenced by a fixed deposit would not constitute a bailment. [Union Bank of India v. K.V. Venugopalan, AIR 1990 Ker. 223; Presswork & Assemblies Ltd v. Westminister Bank Ltd., (!971 1 Q.B. 1: (1970) 3 W.L.R. 625: (1970) 3 All E.R. 473]. This English case has discussed in detail, the nature of the transaction of fixed deposit. 2.31 CHEQUE, IF ATTACHABLE A cheque cannot be attached under the provisions of the CPC relating to 'debts'. It is a negotiable instrument for which the proper provision is Order 21, rule 51, C.P.C. [Central Bank of India v. Rao, AIR 1949 Cal. 144]. The position is different if payment of the cheque is countermanded before its presentation. [Cohen v. Hale, (1878) 3 A.B.D. 871]. 2.32 SET OFF BY THE BANKER (a) Banker has the right to set off one account against another. [United Bank of India v. Venugopaln, AIR 1990 Ker. 223, 225. Compare Satya v. Venkata, AIR 1937 Mad. 848; T. Yabealli v Atmaram, ILR 38 Bom. 631]. (b) Set off cannot be claimed in respect of an amount becoming due to the bank after the attachment. [Sankaran Nair v. Krishna Pillai, AIR 1962 Ker. 233].

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3. SUMMONING OF BANK ACCOUNTS IN CIVIL CASES SUB TOPICS 3.1 Documents of the plaintiff 3.2 Documents relied on by a party 3.1 DOCUMENTS OF THE PLAINTIFF The general rule laid down in Order 7, rule 17(1), CPC is that where a document on which the plaintiff sues is an entry in a shop book or other account in his possession or power, the plaintiff shall produce the book or account at the time of filing the plaint, together with a copy of the entry on which he relies. Thereafter, as provided in Order 7, rule 17(2), the court (or such officer as it appoints in this behalf) shall forthwith mark the document for the purpose of identification; and after examining and comparing the copy with the original shall, if the copy is found correct, certify it to be so and return the book to the plaintiff and cause the copy to be filed. However, Order 7, rule 17(1) makes an exception for bankers' books. Its opening words are - “Save in so far as otherwise

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provided by the Bankers’ Books, is it necessary Evidence Act, 1891". It may be mentioned that the Act of 1891 permits certified copies of bankers’ books to be given in evidence 3.2 DOCUMENTS RELIED ON BY A PARTY With regard to documents relied on by a party(not being a document sued upon by the plaintiff), Order 13, rule 5(1) of the Code of Civil Procedure, 1908 provides that where a document admitted in evidence in the suit is an entry in a letter book or a shop book or other account in current use, the party on whose behalf the book or account is produced may furnish a copy of the entry. Order 13, rule 5(2) empowers the court to require a person other than a party to furnish a copy of a record book or account produced by him; in certain cases. Where a copy is produced under the above provisions, then the court shall compare the same and return the original, following the procedure laid down in Order 7, rule 17. But here again, an exception is made for bankers’ books.

4. SUMMONING OF BANK ACCOUNTS IN CRIMINAL CASES SUB TOPICS 4.1 Provisions in the Code of Criminal Procedure, 1973. 4.2 Savings for Act of 1891 (Bankers Books) 4.1 PROVISIONS IN THE CODE OF CRIMINAL PROCEDURE, 1973 In criminal proceedings, the power of the court to issue summons to produce a document or other thing is governed by Section 91 of the Code of Criminal Procedure, 1973. Subsection (1) of that section gives power to the court (or an officer in charge of a police station) for the specified purpose. When the court or the officer mentioned above considers that the production of any document or other thing is necessary or desirable for the purposes of any investigation, inquiry, trial or other proceedings under this code by or before such court or officer, such court may issue summons, or such officer a written order, to the person in whose possession or power such

document or thing is believed to be, requiring him to attend and produce it, or to produce it, at the time and place stated in the summons or order. 4.2 SAVINGS FOR ACT OF 1891 (BANKERS' BOOKS) But section 91(3) (a) of the Code provides that nothing in the section shall be deemed to affect the Bankers’ Books Evidence Act, 1891. It follows, that the provisions of the Code of Criminal Procedure, section 91, have to be read as subject to the special provisions relating to Bankers’ Books as contained in the Act of 1891. In particular, notice has to be taken of section 6 of the Act of 1891, even though it does not seem to include “investigation”. Ordinarily, a criminal court should not summon the original books to which the Act of 1891 applies. The main object of the Act of 1891 is to avoid disturbance of the business of banking and inconvenience to the large number of customers who have to transact business with banks.

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5. BANKERS' BOOKS EVIDENCE ACT,1891 SUB TOPICS 5.1 The Act 5.2 Definitions 5.3 Power to extend provisions of the Act (Section 3) 5.4 Mode of proof of entries in banker’s books (Section 4) 5.5 Officer of bank when not compellable to produce books (Section 5) 5.6 Inspection of books by order of Court or Judge (Section 6) 5.1 THE ACT The Bankers' Books Evidence Act, 1891, in certain respect modifies, and in a few other respects supplements, the provisions of the general law of evidence. Most notably, it permits certified copies of certain books of bankers to be given in evidence without summoning the original. 5.2 DEFINITIONS The following definitions given in section 2 of the Act are important: (1) “company” means any company as defined in section 3 of the Companies Act, 1956, and includes a foreign company within the meaning of section 591 of that Act; (1A) “corporation” means any body corporate established by any law for the time being in force in India and includes the Reserve Bank of India, the State Bank of India and any subsidiary bank as defined in the State Bank of India (Subsidiary Banks) Act, 1959; (2) “bank” and “banker” mean (a) any company or corporation carrying on the business of banking; (b) any partnership or individual to whose books the provisions of this Act shall have been extended as hereinafter provided; (3) “banker’s books” include ledgers, day-books, cash-books, account-books and all other books used in the ordinary business of a bank; (4) “legal proceeding” means (i) any proceeding or inquiry in which evidence is or may be given; (ii) an arbitration; and (iii) any investigation or inquiry under the Code of Criminal Procedure, 1973, or under any other law for the time being in force for the collection of evidence, conducted by a police officer or by any other person (not being a magistrate) authorised in this behalf by a magistrate or by any law for the time being in force; and (5) “certified copy” means a copy of any entry in the books of a bank together with a certificate written at the foot of such copy that it is a true copy of such entry; that such entry is contained in one of the ordinary books of the bank and was 284 (Sys 4) - D:\shinu\lawschool\books\module\contract law

made in the usual and ordinary course of business; and that such book is still in the custody of the bank; and where the copy was obtained by a mechanical or other process which in itself ensured the accuracy of the copy, a further certificate to the effect, but where the book from which such copy was prepared has been destroyed in the usual course of the bank’s business after the date on which the copy had been so prepared, a further certificate to the effect, each such certificate being dated and subscribed by the principal accountant or manager of the bank with his name and official title. 5.3 POWER TO EXTEND PROVISIONS OF THE ACT Section 3 of the Act empowers the State Government to extend the provisions of the Act to the books of any partnership (firm) or individual carrying on the business of bankers within the State. The partnership firm must be keeping a set of not less than three ordinary account-books, namely, a cash-book, a day-book or journal and a ledger. The Government may in like manner rescind any such notification. 5.4 PROOF OF ENTRIES IN BANKER’S BOOKS Section 4 of the Act (the operative portion) lays down that a certified copy of any entry in a banker’s book shall, in all legal proceedings, be received as prima facie evidence of the existence of such entry, and shall be admitted as evidence of the matters, transactions, and accounts therein recorded in every case where, and to the same extent as, the original entry itself is, “now by law”, admissible, but not further or otherwise. This section thus permits certified copies to be given in evidence. Whatever fact can be proved by the original, can be proved by the certified copy. 5.5 OFFICER OF BANK WHEN NOT COMPELLABLE TO PRODUCE BOOKS It is provided in section 5 of the Act that no officer of a bank shall, in any legal proceeding to which the bank is not a party, be compellable to produce any banker’s book, the contents of which can be proved under this Act (see section 3 noted above) or to appear as a witness to prove the matters, transactions, and accounts therein recorded, unless by order of the court or by a judge made for special cause. This section, in effect, dispenses with the original being required to be produced in court. It goes further than Section 4. Section 4 permits certified copies to be given in evidence. Section 5, in effect, compels all concerned to make use of section 4 except where the Court or Judge directs otherwise “for special cause”. 5.6 INSPECTION OF BOOKS BY ORDER OF COURT OR JUDGE Section 6 of the Act provides that on the application of any party to a legal proceeding, the Court or a Judge may order that

such party be at liberty to inspect and take copies of any entries in a banker’s book for any of the purposes of such proceeding, or may order the bank to prepare and produce, within a time to be specified in the order, certified copies of all such entries, accompanied by a further certificate that no other entries are to be found in the books of the bank relevant to the matters in issue in such proceeding, and such further certificate shall be dated and subscribed in manner herein before directed in reference to certified copies.

It is further provided that an order under section 6 or section 5 may be made either with or without summoning the bank. The order must be served on the bank three clear days (exclusive of bank holidays) before the same is to be obeyed, unless the court or Judge directs otherwise. The bank may, at any time before the time limited for obedience to any such order as aforesaid, either offer to produce their books at the trial, or give notice of their intention to show cause against such order, and thereupon the same shall not be enforced without further order.

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6. EVIDENTIARY VALUE OF ENTRIES IN ACCOUNTS SUB TOPICS 6.1 Indian Evidence Act, 1872 6.2 Use of Ledger 6.3 Form of Ledger 6.4 Proof 6.1 INDIAN EVIDENCE ACT, 1872 Regarding entries in books of account regularly kept in the course of business, section 34, Indian Evidence Act, 1872 provides that such entries are relevant evidence, but they shall not be sufficient to charge any person with liability. Thus, no liability can be fastened merely on the basis of an entry in the ledger alone, unless it is corroborated by some other evidence. 6.2 USE OF LEDGER The effect of section 34, of the Act is that the ledger can be taken into consideration, but would need corroboration for

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establishing liability. This is one of the very few examples of provisions in the Evidence Act as to the sufficiency of evidence. 6.3 FORM OF LEDGER In order that section 34, of the Act may be invoked, no particular form of ledger is required. But the ledger must be one kept in the ordinary course of business. Hence evidence of business usage would be very material. 6.4 PROOF If the entries made in a ledger are denied by the defendant, corroboration would be required. The nature of proof will vary from case to case. [Mohan Lal Bodh Raj v. Dwarka Nath, AIR 1985 J&K 85, 86, 87].

7. BANK DEBTS RECOVERY TRIBUNALS SUB TOPICS 7.1 Introduction 7.2 Application 7.3 Tribunals and their Presiding Officers 7.4 Recovery Officers and Staff 7.5 Appellate Tribunal 7.6 Jurisdiction 7.7 Appeals 7.8 Procedure 7.9 Appearance 7.10 Recovery Procedure 7.11 Adoption of Income Tax Act 7.12 Appeals in Recovery Cases 7.13 Miscellaneous Provisions 7.1 INTRODUCTION Banks and financial institutions experienced considerable difficulties in recovering loans and in the enforcement of security charged with them. The procedure for recovery of debts due to the banks and financial insitutions had blocked a significant portion of their funds in unproductive assets, the value of which deteriorated with the passage of time. The Committee on the Financial System, headed by Shri. M. Narasimham, considered the setting up of the special tribunals with special powers for the adjudication of such matters and speedy recovery as critical to the successful implementation of the financial sector reforms. An urgent need was, therefore, felt to work out a suitable mechanism, through which the amounts due to the banks and financial institutions could be realised without delay. In 1981, a Committee under the Chairmanship of Shri. T.Tiwari had examined the legal and other difficulties faced by banks and financial institutions and had suggested remedial measures, including changes in law. The Tiwari Committee had also suggested the setting up of special tribunals for the recovery of dues of banks and financial institutions, by adopting a summary procedure. On 30th September, 1990 more than fifteen lakhs of cases filed by the public sector banks, and about 304 cases filed by the financial institutions, were pending before various courts. These involved debts of more than Rs.5622 crores in dues of public sector banks and about Rs.391 crores of dues of the financial institutions. The locking up of such a huge amount of public money in litigation prevented the proper utilisation and recycling of the funds for the development of the country. It was this background which led to the introduction of the 'Recovery of Debts due to Banks and Financial Institutions Bill 1993'. Subsequently it has become an Act. (Central Act 51 of 1993). The Act provides for the establishment of Tribunals and Appellate Tribunals for the expeditious adjudication and recovery of debts due to banks and financial institutions. Some of the important provisions of the Act are given below.

7.2 APPLICATION Section 1 of the Act provides that the Act applies where the amount of any debt due to any bank or financial institution or consortium is not less than Rs.10 lakhs. But the Central Government can susbstitute, in place of Rs.10 lakhs, any other amount not being less than Rs.1 lakh. Section 2 of the Act defines various expressions used in the Act. 7.3 TRIBUNALS AND THEIR PRESIDING OFFICERS Under section 3, the Central Government can establish one or more Debts Recovery Tribunals for adjudicating on disputes to which the Act applies and can determine the respective jurisdiction of the Tribunals so established. Presiding officers of the Tribunals are to be appointed (under section 4) by the Central Government. Their qualifications are laid down in section 5. The presiding officer must be a person who is, or has been, or is qualified to be, a District Judge. Under section 6, his term of office is five years or until he attains the age of 60 years, whichever is earlier. 7.4 RECOVERY OFFICERS AND STAFF For each Tribunal, Recovery Officers and other officers and employees are to be appointed by the Central Government under section 7. 7.5 APPELLATE TRIBUNALS Sections 8 to 16 make provisions for the appointment of Debt Recovery Appellate Tribunals. The person to be appointed as presiding officer of the Appellate Tribunal must be: (a) a person who is, or has been, or is qualified to be a High Court Judge; or (b) a member of the Indian Legal Service, who has held a Grade I post in that service for, or at least three years; or (c) a person who has held office as a presiding officer of a Tribunal (established under the Act) for at least 3 years. Section 11 provides that the Presiding Officer of an Appellate Tribunal shall hold office for a term of five years or until he attains the age of sixty-two years, whichever is earlier. Section 12 makes provisions for the appointment of officers and other employees of an Appellate Tribunal and seeks to apply the provisions of section 7 in relation to such appointments. Section 13 empowers the Central Government to make rules relating to the salary and allowances payable to, and the other terms and conditions of service (including pension, gratuity and other retirement benefits) of the Presiding Officers of Tribunals or Appellate Tribunals. It further provides that the salary and allowances and the other terms and conditions of service of the Presiding Officers shall not be varied to their disadvantage after appointment. 287 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Section 14 provides for filling up of vacancies in the office of the Presiding Officer of a Tribunal or an Appellate Tribunal. In such cases the proceedings may be continued before the Tribunal or Appellate Tribunal from the stage at which the vacancy is filled.

the Appellate Tribunal 75% of the amount of the debt due from him as determined by the Tribunal under section 19. The Appellate Tribunal may, however, for reasons to be recorded in writing, waive or reduce the amount to be deposited under this clause.

Section 15 makes provisions for resignation by the Presiding Officer of a Tribunal or an Appellate Tribunal and for his removal.

7.8 PROCEDURE

Section 16 provides that no order of the Central Government appointing any person as the Presiding Officer of a Tribunal or an Appellate Tribunal shall be called in question and that no act or proceeding before a Tribunal or an Appellate Tribunal shall be called in question on the ground merely of any defect in the constitution of a Tribunal or an Appellate Tribunal. 7.6 JURISDICTION Section 17 makes provisions relating to the jurisdiction, powers and authority of a Tribunal and an Appellate Tribunal. Section 18 provides that subject to the jurisdiction of the Supreme Court and of a High Court under Articles 226 and 227 of the Constitution, no court or other authority shall have, or shall be entitled to exercise any jurisdiction, power or authority in relation to the matters specified in section 17. Section 19(1) prescribes the procedure for the filing of an application before a Tribunal within the local limits of whose jurisdiction (a) the defendants, or each of the defendants (where there are more than one), at the time of making the application actually and voluntarily resides, or carries on business, or personally works for gain; or (b) any of the defendants (where there are more than one), at the time of making the application, actually and voluntarily resides or carries on business, or personally works for gain; or (c) the cause of action arises wholly or in part. Section 19(2) empowers the Central Government to make rules for prescribing the form in which the application should be made and the documents which should accompany the application and the fee for filing the application. The fee may be prescribed, having regard to the amount of debt to be recovered. Sub-sections (3) to (8) of section 19 lay down, the procedure for disposal of the application by the Tribunal. 7.7 APPEALS Section 20 prescribes the procedure for preferring an appeal to the Appellate Tribunal having jurisdiction in the matter against any order made, or deemed to have been made, by a Tribunal. No appeal should lie to the Appellate Tribunal from an order made by a Tribunal with the consent of the parties. Sub-section (3) of section 20 empowers the Central Government to make rules for prescribing the form in which the appeal shall be preferred and the fee for preferring the appeal. Sub-sections (4) to (6) of section 20 specify the procedure for the disposal of the appeal by the Appellate Tribunal. Section 21 provides that no appeal shall be entertained by the Appellate Tribunal, unless the appellant has desposited with 288 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Section 22 prescribes the procedure to be followed by the Tribunals and Appellate Tribunals in respect of applications made to them or appeals preferred to them. The Tribunals and Appellate Tribunals shall be guided by the principles of natural justice and shall have powers to regulate their own procedure including the places at which they shall have their sittings. The Tribunals and the Appellate Tribunals will have all the powers of a civil court in respect of summoning and enforcing the attendance of any person and examining him on oath, discovery and production of documents, reviewing its decisions, etc. The Tribunals and Appellate Tribunals will be deemed to be civil courts for the purposes of section 195 and Chapter XXVI of the Code of Criminal Procedure, 1973 and every proceeding before the Tribunals and Appellate Tribunals shall be deemed to be a judicial proceeding under certain provisions of the Indian Penal Code. 7.9 APPEARANCE Section 23 provides that a bank or a financial institution may authorise one or more legal practitioners or any of its officers to act as ‘Presenting Officers’ before the Tribunals or Appellate Tribunals. It further provides that the defendant may either appear in person or authorise one or more legal practitioners or any of his or its officers to present the case before the Tribunals or the Appellate Tribunals. Section 24 applies the provisions of the Limitation Act, 1963 to applications made to a Tribunal. 7.10 RECOVERY PROCEDURE Section 25 empowers the Recovery Officer to effect recovery of debts through the modes of attachment and sale of movable or immovable property, arrest of the defendant and his detention in prison or appointment of a receiver for the management of the movable or immovable properties of the defendant. Section 26 provides that the defendant cannot dispute, before the Recovery Officer, the amount of debt specified in the certificate issued by the Tribunal. The Presiding Officer shall, however, have power to withdraw the certificate or correct any clerical or arithmetical mistake in the certificate by sending an intimation to the Recovery Officer. Section 27 provides that the Presiding Officer may grant time for the payment of the amount specified in the certificate issued to the Recovery Officer and thereupon the Recovery Officer shall stay the proceedings of recovery until expiry of the time so granted. If, on appeal, the amount of the debt is reduced, the Presiding Officer shall stay the recovery of such part of the

amount of the period for which the appeal remains pending. where the amount of the outstanding demand is reduced on appeal, the Presiding Officer shall, amend the certificate or withdraw it, as the case may be. 7.11 ADOPTION OF INCOME TAX ACT Section 28 makes provisions for different modes of recovery of debts by the Recovery Officer on the lines of the provisions of section 226 of the Income-tax Act, 1961. The Recovery Officer will be able to recover the amount of debt to the banks or financial institutions out of the money due from any person to the defendant and such person shall comply with the orders of the Recovery Officers and pay the amounts so due to the credit of the Recovery Officer. Once a notice has been issued by the Recovery Officer to any person, any claim respecting any property in relation to which such notice has been issued, arising after the date of the notice shall be void as against any demand contained in such notice. Any person discharging any liability by the defendant after the receipt of such notice shall be personally liable to the Recovery officer to the extent of his own liability to the defendant so discharged or to the extent of the defendant’s liability for any debt due under this legislation, whichever is less. The Recovery Officer may also apply to the court in whose custody there is money belonging to the defendant for payment to him of the entire amount of such money, or if it is more than the amount of debt due, an amount sufficient to discharge the amount of debt so

due. The Recovery Officer may recover any amount of debt due from the defendant by distraint and sale of his movable property in the manner laid down in the Third Schedule to the Income-tax Act, 1961. Section 29 applies the provisions of the Second and Third Schedules to the Income Tax Act, 1961 and the Income-tax (Certificate Proceedings) Rules, 1962 (with necessary modifications) for the recovery of debts due to the banks and financial institutions. 7.12 APPEALS IN RECOVERY CASES Section 30 provides that any order made by the Recovery Officer in the exercise of his powers under sections 25 to 28 (both inclusive) shall be deemed to have been made by the Tribunal, so that an appeal against the order can be made to the Appellate Tribunal. Section 31 makes provisions for transfer of cases pending before any court immediately before the date of establishment of a Tribunal under this legislation, to the Tribunal which will have jurisdiction in relation to such cases. 7.13 MISCELLANEOUS PROVISIONS Sections 32 to 36 contain miscellaneous provisions as to protection of action taken in good faith overruling effect of the Act, making of rules etc.

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8 BANKER'S DUTY OF SECRECY SUB TOPICS 8.1 Banker’s obligations 8.2 Duty to maintain secrecy 8.3 Analogous situations of confidentiality 8.4 Banker’s duty defined 8.5 Duration of the duty 8.6 Matters covered by the obligation of secrecy 8.7 Exceptions to the banker’s duty of secrecy 8.8 Duty to the public 8.9 Bank’s interest 8.10 Customer’s consent 8.11 Banker’s references 8.1 BANKER’S OBLIGATIONS The relationship of a banker and customer gives rise to a number of obligations. Some of these are contractual - such as, the duty of the banker to honour cheques issued by the customer in the proper form. Some of them arise from enactments relating to negotiable instruments. A few have their origin in the common law. They do not have their foundation in a specific contract or statute. Rather, they represent obligations which the law attaches to the relationship between the parties having regard to certain important considerations. 8.2 DUTY TO MAINTAIN SECRECY The banker’s duty of secrecy in regard to the customer’s transactions came to be recognised on considerations of the nature mentioned above. The duty arose because the relationship of banker and customer cannot be smoothly worked, unless some such duty is recognised. Even though the duty is sometimes stated to arise out of contract, there is a deeper consideration justifying its recognition. When a person enters into transactions with a bank, he necessarily makes known to the banker a good part of his financial affairs. These may sometimes relate to his personal life. At other times, they may relate to his business activities. In either case, he does not desire that his private affairs may become known to the outside world. If the banker is not required to maintain secrecy, the relationship cannot be maintained. In a sense, then, in recognising such a duty, the law gives importance to the value of privacy. There can of course, be other considerations also, relevant to the subject. It may be that in protecting privacy as between the customer and the banker and in creating a duty of secrecy in favour of the customer against the banker, the law has also in mind a wider consideration. If such secrecy is not enforced, the business of banking may not thrive and the interests of society may suffer. Here then the law takes into account not only the sentimental feelings of individuals, but also some facets of public interest. It may be a mundane, non-sentimental and business-oriented approach, but it is linked with a certain view 290 (Sys 4) - D:\shinu\lawschool\books\module\contract law

of public interest. The protection of individual interests is ultimately geared towards the advancement of good of the society 8.3 ANALOGOUS SITUATIONS OF CONFIDENTIALITY The duty of secrecy is not peculiar to the banker-customer relationship. As between the doctor and the patient, the law recognises a similar duty. The doctor must not (except in certain exceptional cases) communicate to a third person what he has, in the course of his professional work, come to know about the patient’s state of health and connected matters. If such a duty is not recognised by law, a patient may not be able to give the doctor full and frank information about his body. This would impede and impair the efficient performance by the doctor of his functions. As a result, the diagnosis and treatment may not be as sound as they could have been if a full disclosure had been made. Such a situation not only harms the patient, it is also unfair to the doctor who would not be able to give his best. Since society is also concerned about the health of its members, the interests of society would also be harmed. Substantially similar considerations have prevailed with the law, in its recognition of marital confidence. A spouse cannot be compelled to disclose - not even in a court of law communications made during marriage by the other spouse, except in very special situations. If that were not the law, the feeling of mutual trust and confidence, that is the foundation of a happy marriage, would be destroyed. Loss of such mutual confidence would mar marital happiness and would ultimately affect the happiness of society. 8.4 BANKER’S DUTY DEFINED Now to revert to the banker’s duty of secrecy. The classical statement of the law on the subject is to be found in the judgment of Lord Justice Bankes [Tournier v. National and Provincial and Union Bank of England, (1924) 1 K.B. 461: (1923) All E.R. Rep.556 (C.A)]. He held that the duty is not merely a moral one, but a legal one. But it is subject to certain exceptions. Elaborating the exceptions, he said: “In my opinion, it is necessary in a case like the present to direct the Jury what are the limits and what are the qualifications of the contractual duty of secrecy implied in the relation of banker and customer. There appears to be no authority on this point. On principle, I think that the qualifications can be classified under four heads: (a) Where disclosure is under compulsion by law. (b) Where there is a duty to public to disclose. (c) Where the interests of the bank require disclosure. (d) Where the disclosure is made by the express or implied consent of the customer”. Subject to the above exceptions, the banker’s duty of secrecy appears to be strict. Thus, disclosure by a holding bank to its

subsidiary appears to be illegal. [Bank of Tokyo Ltd. v. Karoon, (1986) 3 All E.R. 468, 475 (C.A)]. 8.5 DURATION OF THE DUTY (a) The duty of secrecy arises as soon as the relationship of banker and customer comes into existence. In order that a person may be a customer of a bank, it is not necessary that the relationship should be of long duration. If a person has opened an account and paid in a single cheque, he is a customer of the bank. [Taxation Commissioner v. English Scottish and Australian Bank, (1920) A.C. 683, 687 (P.C)]. (b) The banker’s duty of secrecy does not, however, cease with the closure of the account. If that were so, the rationale underlying recognition of the duty would be substantially frustrated as the customer’s confidence would become vulnerable. On this logic, the duty must continue even after the customer’s death. [Paget, p. 255]. 8.6 MATTERS COVERED BY THE OBLIGATION OF SECRECY There has been some discussion as to the matters to which the banker's duty of secrecy applies. The point was touched in the Tournier's case (mentioned above) by the other members of the Court of Appeal. According to Lord Justice Scrutton, the duty does not extend to: (i) knowledge which the banker acquires before the relationship of banker and customer was in contemplation; or (ii) knowledge acquired after the relationship has ceased; or (iii) knowledge derived from other sources even if it was derived during the continuance of the relationship. But according to Lord Justice Atkin, the duty extended to information obtained from sources other than the customer’s actual account. “If the occasion upon which the information was obtained arose out of the banking relations of the bank and its customers”. 8.7 EXCEPTIONS TO THE BANKER’S DUTY OF SECRECY To the banker’s duty of secrecy, there have been recognised four exceptions, namely: (a) Compulsion by law (b) Duty to the public (c) Banker’s interest (d) Customer’s consent (to disclosure of the information). If one may say so, most of these exceptions are recognised in several other spheres also, where the duty of secrecy is recognised in regard to particular relationship. In one case Parry Jones v. Law Society, [(1968) 1 All E.R. 668, 670 (C.A)] Lord Justice Diplock (as he then was) pointed out that the duty of confidence exists also between solicitor and client, banker and customer, doctor and patient and accountant and client.

Again (though in a slightly different context), while speaking of the duty of care, Lord Finlay, Lord Chancellor, stated as under in a judgment of the Privy Council [Hanbury v. Bank of Montreal, (1919) A.C. 626, 659 (P.C)]: “There is, in point of law, no difference between the case of advice given by a physician and advice given by a solicitor or banker in the course of his business”. 8.8 DUTY TO THE PUBLIC Duty to public, which constitutes one of the exceptions to the banker’s duty of secrecy, is a vague concept. Lord Chorley [Lord Chorley, p. 23] gives the example of a customer trading with the enemy in times of war. Mr. Justice Staughton (tentatively) in one case [Libyan Arab Foreign Bank v. Banker’s Trust Co., (1988) 3 WLR 314 (Staughton, J)], took the view that the bank was justified in making disclousures to the Federal Reserve Bank of New York about payment instructions received by the bank from the plaintiff. 8.9 BANK’S INTEREST The case of Sutherland v. Barclays Bank Ltd, [(1938) 5 Legal Decisions affecting Bankers 164(C.A); Paget, p. 257]. is usually cited as illustrating an exception to the banker’s duty of secrecy, being an exception based on the banker’s interest. The bank in that case had dishonoured a cheque issued by the wife of the plaintiff, apparently on the ground of insufficient funds but really because of the bank’s knowledge that she was betting. On the husband’s inquiry on phone, the fact that most cheques of the wife were in favour of book makers was disclosed by the bank to the husband. The wife sued the bank for damages for breach of secrecy, but the action failed. Interests of the bank were stated to require disclosure in the circumstances. Further, in the circumstances, there was an implied consent by the customer. The grounds given are not very convincing. A preferable ground would be that disclosure of such matters to a spouse of the customer should be regarded as a moral duty. Of course, this should be regarded as a new head of exception distinct from the exception based on the bank’s interest. 8.10 CUSTOMER’S CONSENT Where the customer has consented to disclosure of certain information, the duty of secrecy becomes irrelevant. The consent is rarely express. It can be implied. In practice it is not always easy to decide whether, on the facts, consent can be implied. 8.11 BANKER’S REFERENCES In at least two English cases, [Swift v. Jewsbury and Coddard, (1874) 9 L.R.A.B. 301; Parsons v. Barclay & Co Ltd., (1910) 103 L.T. 196], the view has been taken that answering quaries from another bank acting on behalf of a customer is within the scope of banking business. And, according to Paget, “the practice may be regarded as implicitly authorised by most customers of banks”. [Paget, p. 257]. 291 (Sys 4) - D:\shinu\lawschool\books\module\contract law

9. THE MAREVA INJUNCTION IN ENGLISH LAW SUB TOPICS 9.1 The traditional approach 9.2 The Mareva cases 9.3 The process 9.4 Ad personam order 9.5 Relevance to bankers 9.1 THE TRADITIONAL APPROACH Traditionally, English law espoused the principle that a plaintiff is not entitled to require from the defendant, in advance of judgment, security to guarantee, the satisfaction of a judgment [Scott v. Scott, L.R. (1951) Probate 193] that the plaintiff may eventually obtain. in 1975, a change was brought about by a pair of Court of Appeal decisions: (i) [Nippon Yusen Kaisha v. Karageorgis, (1975) 1 WLR 1093 (CA), (ii) Mareva Compania Naviera SA v. International Bulk Carriers SA, (1975) 2 Lloyds Rep. 509 (C.A). 9.2 THE MAREVA CASES The two decisions mentioned above involved claims for damages arising from shipping contracts, brought against foreign defendants. In both the cases, the plaintiffs obtained ex parte orders restraining the defendants from removing their funds out of the jurisdiction, pending the final adjudication of the actions. [ Gee, Mareva Injunctions (1990), p. 3 and M.J. Tilbury, Civil Remedies (1990)]. 9.3 THE PROCESS The ‘Mareva’ injunctions, (as they have come to be known) almost invariably involve the following process. [Goldrein and Wilkinson, Commercial Litigation; Pre-emptive Remedies (1991), p.129] A plaintiff applied to the court ex parte and

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before serving the writ, for an injunction to restrain the defendant, and any one with control over the defendant’s assets, from disposing of the defendant’s assets, if, to do so, would reduce the value of those assets below a certain level (usually the value of the plaintiff’s claim) [CBU (UK) Ltd v. Lambert, (1983) Ch. 37, 44-45]. The plaintiff must show, by affidavitevidence, that there are reasons to believe that the defendant has assets within the jurisdiction and that there is a danger that, if the defendant is not restrained from dissipating those assets, then any judgment that the plaintiff may eventually obtain, may go unsatisfied.[Searose Ltd v. Seatrain(U.K.) Ltd., (1981) 1 W.L.R. 894]. The order is subject to a cross-undertaking by the plaintiff, to compensate the defendant for any unwarranted damage that the latter may suffer and to indemnify third parties in respect of costs that they may incur in conforming with the injunction. It commonly states that the defendant is at liberty to apply, upon notice to the plaintiff, to discharge or vary the order. [Ocean Software Ltd. v. Kay, (1992) Q.B. 583]. 9.4 AD PERSONAM ORDER A ‘Mareva’ injunction is an ad personam order, restraining the defendant from dealing with assets in which the plaintiff claims no right whatsoever. Consequently, a ‘Mareva’ order does not give the plaintiff any precedence over other creditors with respect to the frozen assets. Although the order has sometimes been characterised as being in rem, and has, on occasions, been compared to attachment orders. The fact is that, subject to court supervision, the defendant remains free to meet his living expenses and other obligations from the frozen funds. 9.5 RELEVANCE TO BANKERS The ‘Mareva’ injunction could be relevant for bankers in so far as it constitutes a weapon in relation to debts. It could turn out to be of particular utility against foreign parties.

10. CASE LAW Imperial Bank of India v. Mt. Bibi Sayeedan [AIR 1960 Pat 1321]

Sahukara Bank Ltd. v. Income-Tax Officer Ludhiana and others [(1966) 62 I.T.R 745 (Punjab)].

An appeal by garnishee arose out of a garnishee proceeding in which the objection of the appellant was rejected. In this case the decree-holder respondent who was the widow of one Nadir Ali, obtained a decree on account of her dower debt against the heirs of her deceased husband in a money suit brought by her against them. This decree was put into execution and the decretal amount was sought to be realised from the assets of Nadir Ali in the hands of his heirs. When ultimately a decree was passed in favour of the plaintiff-decree-holder respondent and when it was put into execution a notice under 0.21, R. 63A was issued to the appellant. In response to the notice issued to the appellant under 0.21, R.63A of the C.P.C. the bank appellant filed an objection before the executing court. The principal objection of the appellant was that unless Letters of Administration or Sucession Certificate are produced the bank would not get an effective discharge in respect of ‘the debts’ due by the bank to deceased. There was an objection regarding attachment. The learned subordinate judge over ruled the objection of the bank appellant and asked the bank to pay the amount in question to the decree-holder. Bank filed an appeal under 0.21, R.63H of the C.P.C.

The petitioner, Suhukara Bank Ltd.,Ludhiana had branches in Pakistan before 1947. One Mohd. Akram of Ikram-Ullah and Sons had an account in that Bank. It had a deposit of Rs.102267-6 in January 1948 in the Bank. Due to partition, the depositer migrated to Pakistan. Depositor owed to Income-Tax department certain amount of Income-Tax. On enquiry by the I.T.O. from the bank, I.T.O was informed that the account had been transferred to the Pakistan branch of the bank. In fact, no physical transfer was made. I.T.O. issued the necessary certificate to the petitioner bank as arrears of land revenues in respect of the tax due from the above Muslim Firm. Against these proceedings bank filed the petition under Article 226 & 227 of the constitution.

The Court held that although the heirs of a deceased Muhammedan are not personally liable for the dower debt,each heir is liable for the debt to the extent only of a share of the debt proportionate to the share of the estate. After the death of her husband, therefore, if a widow brings a suit for recovery of her dower, it must be brought against all the heirs of her deceased husband. Where in such a suit, the court issues a prohibitory order under 0.21, R.46 against a bank in respect of the money deposited by the deceased husband, the order of the court asking the bank to pay the amount lying in deposit to the credit of the deceased to the decree-holder will amount to a valid discharge and will absolve the bank from all liability , so far as the bank is concerned in respect of the deposit it has no right to ask the decree holder to produce the Succession Certificate before paying the amount into the court.

Balaraman v. Varadammal [AIR 1987 Mad.94]

Under O.21, R.63A the foundation of a garnishee proceeding is an attachment made under O.21, R.46. Garnishee proceedings, therefore in respect of a debt, can be started only after the debt has been attached under O.21, R.46. The mere absence of the provisions of law, under which a court acts in a particular case cannot be a ground for urging that the court acted not in accordance with law, but contrary to the provisions of law. Where, therefore there is no mention of provision of law under which a prohibitory order was issued O.38, R.5 does not apply to the case, but O.21, R.46 applies. It must be presumed under Sec. 114 of the Evidence Act that the Court issued the order under O.41, R.46(1).

The point in issue was whether the bank is exonerated from its liability to the income-tax department for the amount of the assessee held by it, despite the objection of the bank that the amount is payable to the assessee in Pakistan and not in India? It was held that bank is not exonerated from its liability to the income-tax department for the amount of the assessee held by it. The petitioner was one of the sons of the judgment-debtor and 3rd respondent in that execution. The respondent decree-holder obtained a decree for maintenance against her husband Narayanan. The decree also provided a charge over property situated in Madras. The said execution was laid against the legal representatives of her husband viz, his three sons and a daughter, as the judgment-debtor passed away in the meanwhile. The amount claimed was rupees 18,384-10 after giving credit to the payment of rupees 20,300. In the execution a sum of Rs.36,000 standing to the credit of the judgment-debtor and his son, the petitioner's account in Punjab National Bank, Triplicane, Madras was sought to be attached by issue of a prohibitory order to the bank. All the petitioner’s objections were rejected by the court and execution was ordered. The petitioner filed a revision petition in the Madras High court. The court held, in an execution of a decree for maintenance providing charge over property of judgment-debtor filed against legal representatives of judgment-debtor, the decree-holder is entitled to attach a moiety of the amount in bank deposit standing in joint credit of judgment-debtor and his son on either or survivor terms, as the deposit on such term is a contract between the persons in whose names the joint account stood and the bank. If the bank therefore were to pay the whole amount to the survivor, it gets a valid acquittance, provided, of course, no order of attachment and the like intercepted. Thus the mere fact that the account was on the term “either or survivor” the survivor would not get automatically the whole amount in the bank. 293 (Sys 4) - D:\shinu\lawschool\books\module\contract law

Lukka Varghese v. Devasia Varkey [AIR 1965 Kerala 47] In execution of a decree, the appellant judgement-creditor, attached a debt due to the judgement-debtor, a bank, from the respondent. On the motion of the appellant, notice under Order XXI, Rule 46-A, of Civil Procedure Code, was served on the respondent. The respondent prayed a period of six months to deposit the amount of the debt which was disallowed by the court. The Court passed an order under Order XXI, rule 46-B and directed a warrant to be issued to the respondent. Upon this, the respondent made an application for exemption from personal execution. While this was pending the bank was ordered to be wound up upon a petition. The respondent then applied for stay of proceedings under Section 446 of the Companies Act, 1956. The court allowed the application. An appeal was filed and the main question for decision was whether the final order under Order XXI, Rule 46-B was passed before the winding up proceedings commenced, the execution of that order can be considered to be a proceeding against the company so as to be within the ban imposed by Section 446. The court held as the order nisi having been served on the garnishee (respon-dent) and having been made final and absolute, on the terms of Order 21, R.46-B before the winding up of the bank (judgment-debtor) the appellant decree holder is entitled to execute that order as a decree against the garnishee regardless of the fact, that the right of the decree-holder had sprung from the judgment recovered against the bank. A proceeding to execute the final order against the garnishee cannot be construed to be a proceeding against the bank and is not within the prohibition of Section 446 of the Companies Act. The order of the Subordinate Judge confirming that of the execution, was set aside and the appellant was allowed to proceed against the respondent according to law. Mackinnon and Mackenzie and Company Pvt. Ltd., v. Anil Kumar Sen and another [AIR 1975 Cal 150] In this case, the appeal was directed against the order whereby the appellant was directed to pay to the Sheriff of Calcutta a sum of Rs.1,40,873.15 attached in its hands by an order which was made earlier. The order was made in garnishee proceeding, the appellant being the garnishee was served with a notice whereby it was required to pay to the Sheriff the said amount.

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The Court held that in view of the fact that existnece of any debt due and payable by the garnishee to the judgment-debtor had not been proved in the instant case. The garnishee was not called upon to dispute any liability in terms of Rules 2 and 3 of the Chapter XVIII of the Original Side Rules. The failure to dispute the debt or the liability by the garnishee in terms of Rule 3, of Chapter XVIII of the O. S. Rules thus could not affect the rights of the garnishee in the case. Alsidass Kaverlal v. J. Hiriya Gowder [AIR 1961 Mad. 189] An appeal by the petitioner decree-holder was filed against the order of the learned Subordinate Judge, in an execution application under O.21 R.46 C.P.C. The brief facts are as follows. Originally the appellant decree-holder prayed to the court for the issue of a prohibitory order in respect of certain amounts payable by the Garrison Engineer, to the respondent (judgmentdebtor), apparently relating to certain contracts for the Army executed by the judgment-debtor. The Garrison Engineer, wrote a letter to the Subordinate Judge, in respect of his prohibitory order, informing the court that an amount of Rs.7,237.75 had been withheld in response to the order that the balance payable, if any, was so far unascertained, and that the military authorities were therefore unable to state that any further specific balance was payable to the judgmentdebtor. The Court without taking evidence and without any further enquiry confirmed the prohibitory order in respect of the sum of Rs.7237-75. The decree-holder was aggrieved by this, as, in his view nearly Rs. 20,000 was due to the judgmentdebtor. He filed a fresh application under Order 21, Rule 46 C.P.C. praying for a fresh attachment of bill amounts, deposit amounts etc. totalling to nearly Rs.20,000. This application was resisted by the judgment debtor on several grounds. The grounds were negatived on the merits. The court consequently dismissed the application as not maintainable. Allowing the appeal the High Court observed that there was nothing in the processual law barring the maintainability of such an application . Hence the Court was wrong in dismissing the application as not maintainable and holding that the prohibitory order was effective only upto the amount admitted by the garnishee.

11. PROBLEMS 1. What are the rights of a creditor who has attached a bank account? How far is his position affected by withdrawals from the bank account. ( as attached) before or after attachment, and what is his position as regards subsequent transactions? 2. A banker is asked by a third person to disclose to him the state of a customer's account. Examine the legality of doing so in the following cases: (a) if the third person is the customer's wife who is thinking of claiming maintenance from the customer. (b) if the third person is the customer’s partner, requiring the information for the partnership business. (c) the customer's creditor. (d) the customer's superior (head of office). 3. A banker has a claim for overdraft against X, who is about to dispose of most of his assets. How should the bank proceed to protect its interest? 4. A money decree was obtained on the basis of a compromise. At the instance of the decree holder attachment before judgement was effected of certain sum of money said to be belonging to judgement debtor in the hands of appellant/ garnishee by way of prohibition order. No notice was sent to the garnishee as required under R.46-A of the C.P.C. only one letter was sent to him by the court requesting him to remit the amount. The garnishee appeared in court in response to letter and filed counter affidavit raising certain objections. Can the contentions raised by garnishee in counter-affidavit be treated as objections under R.46-C. (for reference see AIR 1988 Ker. 285) 5. A decree holder had obtained an attachment before Judgement of the lorry belonging to the S Judgement debtors. The attachment raised on the judgment debtors giving a fixed deposit receipt for certain sum issued by the bank (petitioner) as security to the court. The brother had also availed of an agricultural loan from the bank. In execution of the decree the executing court, treated the bank as a garnishee, called upon the bank to deposit the amount and interest thereon. The bank filed application seeking review of the order of the court by contending that the bank had the right to retain this money in exercise of its general power of ‘lien’ and appropriate the said money towards amounts due to it under the loan account. Is the order of the executing court valid. (See AIR 1990 Ker 223]. 6. Mr. Ram a decree holder levied execution against Mr. Sohan, the judgement debtor for recovery of money due

under the decree. In order to realise the decree amount the decree holder, Ram obtained a prohibitory order restraining the judgement debtors (Mohan) garnishee from paying the amount due to the judgement debtor. Though the garnishee was absent in the first instance, he was finally permitted to file an affidavit in which he disputed his liability to the judgment debtor. But on a consideration of the pleas advanced by the garnishee the court held against him and directed him to produce the amount in to the court as required by the decree-holder. Can garnishee be directed to pay the money.(See AIR 1972 AP 701). 7. Mr. A, a decree holder, attaches a decree for recovery of money in favour of Mr.B under which money would become payable to Mr. B, only on the happening of certain contingencies. Can Mr. A execute the decree against the judgment debtor of B for the recovery of money before the happening of the said contingency. Decide. [See AIR 1972 A.P. 70] 8. A decree holder sought to attach some money owing to his judgement debtor from a third party. The third party objected to the attachment on the ground that the judgement debtor owed him a sum of money which extinguished his debt to the judgement debtor. He further contended that the set off had been recognised in other cases by the Court. He claimed that he was entitled in these execution proceedings to have the question of that set off considered. The executing court refused to investigate into the question: (a) Can executive court investigate such matters? (b) Can the existence of debt owed by garnishee to judgement debtor be challenged in execution proceedings? (AIR 1937 Mad. 848) 9. Mr. Shyam obtained a decree against Mr. Gopal. Mr. Shyam attached the amount in a Bank deposit but subsequently under a scheme framed under Sec.153 of Companies Act (which was binding on Mr. Gopal) the Bank garnishee was entitled to pay Mr. Gopal and other depositors in easy instalments. Mr. Gopal called upon the bank to make full payment of the amount at once. Can he do so? Discuss. [See ILR 1956 Assam 301]. 10. A railway company issued and delivered to Mr. Rao a cheque for the provident fund amount which became payable to him on his retirement from service. The cheque was in currency. The Bank who was a decree holder against Rao attached debt under O21 R 46. Will this attachment entitle the Bank decree holder to initiate garnishee proceedings.

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12 SUPPLEMENTARY READINGS 1.

Gee, S., Mareva Injunction: Law & Practice, (1990), Longman, London

2.

Gupta, S.N., The Banking Law in Theory and Practice, 22nd Edn. (1992), Universal Book Traders, New Delhi.

3.

Hapgrood, Mark, Paget’s Law of Banking, 10th Edn. (1989), Butter-worths, London and Edinburgh.

4.

Holden, J.M., The Law and Practice of Banking, 5th Edn. (1991), Vol.I, Pitman, London.

5.

Shelden & Fidler’s, Practice and Law of Banking, 11th Edn. (1984), Macknald & Evans Ltd, London and Plymouth

6.

Tannan, M.L., Banking Law & Practice in India, 18th Edn. (1989), Orient Law House, New Delhi.

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