Category Archives: Banking Law

The Recovery of Loans

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The accepted practice is for people to approach civil courts for relief in respect of civil offences and for criminal offences to be tried in criminal courts. In addition to this, no one can be sent to gaol because of having committed a civil offence. Neither can people be jailed merely because they are unable to repay debts. This has been accepted not only at the national level but has in fact been enshrined in international covenants which have been signed by a vast majority of the world’s countries.

However, there are times when some financial entities and assorted money lenders have been accused of trying to turn civil wrongs into criminal offences by abusing the legal process. In all probability
this is done to pressurize borrowers to repay money.

The method which is apparently usually used is to accuse the borrower of having cheated and having committed a criminal breach of trust. Both cheating and criminal breaches of trust are offences under the Indian Penal Code, the former in the infamous Section 420 and the latter in Section 406.

High Courts are of course empowered to stop this from happening and frequently do. In the case of Alpic Finance v. Sadasivam, the Supreme Court upheld the order of the High Court quashing a criminal complaint against a borrower under such circumstances.

Also, although lawyers often use the ‘cheating and criminal breach of trust’ template, it is unclear exactly how it is possible to be guilty of both offences at the same time considering that, as the Madras High Court held in the 1936 case of R v. McIver, the two are incompatible. One rests on an intention to deceive while the other rests on a foundation of trust, so to speak.

Even if it is somehow possible to commit the offences simultaneously, the fact remains that civil wrongs are not to be disguised as criminal offences, and ordinarily, it should be possible to prevent this from happening by approaching the High Court.

India and Inflation

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Inflation in Hungary, 1946With the price of virtually everything having gone up, there’s little to be said about the impact of inflation in recent times on the general Indian public that isn’t readily visible.

Inflation in India touched a thirteen-year high of 11.42 per cent in the week which ended on June 14. A far cry from the 4 percent it was at in January 2008.

The issue, as the IMF had recognised in April itself, is a ‘politically hot issue’ with General Elections being scheduled to take place early next year. If not anything else, this isn’t an ideal time for the Government to be forced to deal with popular discontent because of rising prices not just because of the direct effects of inflation but also because of the actions its been forced to take to deal with complementary problems including the rise in fuel prices.

Some of the Government’s measures such as reducing fuel subsidies almost across the board have had a direct adverse impact on individual consumers and have done nothing to create the frame of mind which the Government would presumably like to see in voters.

Individuals are not the only ones to have been affected though. The performance of nearly 38 per cent of Indian companies has deteriorated over the last six months and, for many of them, things are predicted to get quite a bit worse before they get any better.

One of the underlying problems has been the phenomenal global increase in oil prices. No one seems to be entirely certain what caused the increase and there has been little agreement on how it should be dealt with. Even leaving aside the fact that petroleum and other similar products are used to synthesize thousands of modern materials right from plastic to chewing gum, the increase has caused the cost of transporting goods to go up significantly, and consumers have had to bear the brunt of the increase. Although, in the long term, the solution is to decrease dependence on oil, short term solutions which have been suggested involve the grant of tax breaks.

Moving back to India, whether or not imported inflation is influencing the rise in domestic prices, what has become increasingly clear is that India needs to create its own comprehensive policy on how to deal with the issue.

The Raghuram Rajan Committee suggested that the Reserve Bank of India focus on controlling inflation. In Europe, the European Central Bank tried to do this by not slashing interest rates to revive growth. Some experts have, however, warned that this may not work in India considering that inflation (which, for example, in India generally rises after every draught) could well be dependent on far more than the country’s monetary policy alone.

On its part, the Government has banned the export of a number of products including non-basmati rice, pulses, edible oil and cement. However, it has refused the recalibrate the rupee in the interest of maintaining a transparent foreign exchange regime.

Only time will tell if the measures the Government has taken will help ensure that the economy doesn’t sink into a depression. What is almost certain though is that its measures will do little to stimulate any form of growth or help to immediately ease the burden which has been placed on individuals.

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Supreme Court Comes to the Aid of Coop. Societies

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In the case of Indian Bank v. Godhara Nagrik Cooperative Credit Society Ltd. and another, decided on May 16, 2008, a Bench of the Supreme Court comprising Justices S B Sinha and Lokeshwar Singh Panta devised a formula to ensure that genuine cooperative societies are not caused hardship because of a scam.

In this case, some cooperative societies which had deposited certain amounts in cash in fixed deposits of Banks for which Fixed Deposit Receipts (FDRs) were to be issued through some so-called Commission Agents of the Banks on payment of huge commission. This is ordinarily not allowed by the Nationalized Banks.

Applications for grant of loans by various persons were filed before the prescribed authorities of the banks on the basis of the FDRs. Allegedly a large number of officers of the banks were involved in a scam whereby unofficial investments of the said amount were being made.

As and when the FDRs matured, the investors requested the Banks for their encashment. The banks refused to accede thereto stating that the amount under the FDRs had already been paid by way of loans and, thus, no further amount was payable. It was contended that a fraud on the banks has been practiced to which the depositors and the officers of the banks were parties.

The Cooperative Societies filed a writ petition in the High Court. Neither party disputed that Writ Petitions against the banks being `State’ within the meaning of Article 12 of the Constitution of India were maintainable. The Supreme Court also said that a writ petition indisputably would be maintainable even in relation to a matter arising out of contract qua contract.

A Committee was set up to investigate the matter. It was found that principally the officers of the banks were involved in the matter of commission of the alleged fraud on the Banks.

Relying on and/or on the basis of the report of the Committee, the Division Bench of the High Court opined that as the writ petitioners were not parties to the fraud, subject to any other or further orders that may be passed in the criminal case, appellant-banks should be directed to pay the amounts under the FDRs to the depositors.

The core question which arose for consideration in the writ petitions was whether, keeping in view the apprehension in the mind of the Bank that it has been subjected to fraud by its own officers possibly with the connivance of the cooperative societies, it unfair and unreasonable of the Bank to refuse to make payment. The Supreme Court said that the answer to that question prima facie must be rendered in the negative. The next question was: if the cooperative societies were not parties to the fraud, whether even in a matter involving private law, as a trustee of the investors’ money, the Bank may be held to be liable to refund the amount.

Indisputably, whether as a public sector undertakings or otherwise the banks cannot refuse to accede to the just demand of the investors to pay any amount lawfully due to them inter alia on the premise that their officers are guilty of commission of any fraud.

However, it is one thing to say that fraud has been committed by their officers to cause wrongful loss to the bank but it is another thing to say that the banks are constructively liable for the acts of their officers.

Adopting the Alter Ego approach adopted in the theory of corporate liability, the Supreme Court assumed, for the purpose of this case, in theory, not only that the Banks are constructively liable for acts of their employees but also that the Banks are liable to pay the amount under the contract for which the FDRs were issued.

In this case, however, it was unclear if some of the cooperative societies were parties to the fraud.

And so, with regard to this particular case, the court asked, “Could those cooperative societies which had absolutely no role to play in the entire episode should suffer in any manner whatsoever? The cooperative societies/cooperative banks for the purpose of their day-to-day functioning, require the amount which they have invested in FDRs on their maturity. Should they wait till the criminal cases are over? Should they be pushed to institute civil suits? They can indisputably be compensated by grant of interest. What, however, happens if in the meanwhile in the absence of the requisite funds being available to them, they find it difficult to run the day-to-day affairs?”

The Supreme Court issued directions saying:

The Bank being a `State’ within the meaning of Article 12 of the Constitution of India with the assistance of officer(s) of the Central Bureau of Investigation should make all attempts to ascertain as to which of the cooperative societies/cooperative banks are in no way involved with the scam, and subject to such precautions as may be found necessary to be taken, release the amount in their favour.

The quantum of the amount which all the depositors would have otherwise received, in the event their investment in FDRs is found to be genuine, should be informed thereabout. Once the liability of the bank is determined, the bank may invest the said amount in its own account and issue fresh FDRs therefor. Whereas the bank may keep the original FDRs with itself, it may issue the duplicate copies thereof to the eligible cooperative bank. Such an exercise should be completed within a period of four weeks.

In the event, the cooperative society intending to avail loan facilities from the banks for running their business, may approach them which may apart from usual conditions release the same on a further condition that the amount of FDR would remain with them and on that basis, loans may be granted of such amount. The usual precautions in regard thereto may also be taken by the Bank(s).

The Court, however, specifically said that it not intend to lay down any law and that the directions it had given in this case should not be treated to be precedent.

(This article is an edited extract of the judgment.)

The Dishonour of Cheques

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A cheque is a negotiable instrument which is not expressed to be payable otherwise than on demand and is drawn on a banker. When a cheque is dishonoured, the person ‘victimised’ by the dishonour can file a civil suit against the drawer of the cheque for the recovery of the amount. However, considering how slowly the wheels of justice can turn, this is often not the best option available.

The Criminal Offence

The Negotiable Instruments Act, 1881 makes the dishonour of cheques a criminal offence. Under Section 138, if anyone draws a cheque on an account maintained by him with a banker to pay someone else money, and the cheque bounces, that person is guilty of having committed an offence under the Section if certain conditions are met.

Firstly, the cheque should have been drawn to discharge a legally enforceable debt or other liability either wholly or partially.

Secondly, the cheque should have bounced because the amount of money standing to the credit of that account is insufficient to honour the cheque or because it exceeds the amount arranged to be paid from that account by an agreement made with that bank. So, if, for example, a cheque bounces because the signature on the cheque does not match that in the Bank’s records, Section 138 is not applicable.

A person who commits an offence under Section 138 may be punished with imprisonment for up to two years, or with a fine which may extend to twice the amount of the cheque, or with both.

However, no one can be punished unless the cheque has been, presented to the bank within six months from the date on which it is drawn or within the period of its validity, whichever is earlier.

Further, the payee or the holder in due course of the cheque as the case may be, must make 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 after the bank tells him that that cheque has been dishonoured, and the drawer of the cheque must fail to pay the amount of money to the payee or, as the case may be, to the holder in due course of the cheque, within fifteen days after he receives the notice.

Presumptions

Under Section 139, a court must presume that the holder of a cheque received it for the discharge, in whole or in part, of a legally enforceable debt or other liability. This presumption is rebuttable.

Defences

Under Section 140, a person being prosecuted for drawing a cheque which has bounced cannot defend himself by saying that he had no reason to believe when he issued the cheque that it may be dishonoured on presentment for the reasons stated in Section 138.

Offences by Companies

Under Section 141, if the person committing an offence under Section 138 is a company, every person who, at the time the offence was committed, was in charge of, and was responsible to, the company for the conduct of the business of the company, as well as the company, shall be deemed to be guilty of the offence and shall be liable to be proceeded against and punished accordingly.
However, no person is liable to punishment if he proves that the offence was committed without his knowledge, or that he had exercised all due diligence to prevent the commission of the offence.
If any offence under the Negotiable Instruments Act is committed by a company and it is proved that the offence is committed with the consent or connivance of, or is attributable to, any neglect on the part of, any director, manager, secretary or other officer of the company, he is also be deemed to be guilty of that offence and is liable to be proceeded against and punished accordingly.

Under Section 141, a ‘company’ means any body corporate and includes a firm or other association of individuals; and a director, in relation to a firm, means a partner in the firm.

Cognisance of Offences

Under Section 142, courts take cognizance of offences punishable under Section 138 only upon a complaint made by the payee or, as the case may be, the holder in due course of the cheque. The complaint must be in writing and be made within one month of the date on which the cause of action i.e. after the person drew the cheque fails to pay the amount within 15 days of the receipt of notice of its dishonour. No court inferior to that of a Metropolitan Magistrate or a Judicial Magistrate of the first class has the power to try any offence punishable under section 138.

Summons

Under Section 144, a Magistrate issuing a summons to an accused or a witness may direct a copy of summons to be served at the place where the accused or witness ordinarily resides or carries on business or personally works for gain, by speed post or by such courier services as are approved by a Court of Session.

The Court issuing the summons may declare that the summons has been duly served if it receives:
• an acknowledgment purporting to be signed by the accused or the witness or
• an endorsement purported to be made by any person authorised by the postal department or the courier services that the accused or the witness refused to take delivery of summons.

Trial

Under Section 143, a trial regarding the dishonour of a cheque is carried out in the manner of a summary trial and the Magistrate may pass a sentence of imprisonment for a term not exceeding one year and an amount of fine exceeding five thousand rupees. The Magistrate may, however, after hearing the parties, choose not to try a case in the manner of a summary trial and thereafter recall any witness who may have been examined and proceed to hear or rehear the case in the manner provided by the Code of Criminal Procedure.

The trial should, if practicable, be continued from day to day till its conclusion, unless the Court finds that it should be adjourned for reasons recorded in writing. It should ideally be concluded within six months from the date of the filing of the complaint.

Under Section 145, the complainant may give his evidence on affidavit. The Court may, if it thinks fit, and shall, on the application of the prosecution or the accused, summon and examine any person giving evidence on affidavit as to the facts contained therein.

Under Section 146, the bank’s slip or memo having thereon the official mark denoting that the cheque has been dishonoured is prima facie evidence that the cheque has been dishonoured although the fact of dishonour may be disproved.

Compoundable Offence

By an amendment introduced in 2002, under Section 147, an offence related to the dishonour of a cheque -– and every other offence punishable under the Negotiable Instruments Act, 1881 –- can be privately settled.

The Recovery of Loans by Banks

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In the case of ICICI Bank v. Shanti Devi Sharma & Others a Bench of the Supreme Court comprising Dalveer Bhandari, J. and Tarun Chatterjee, J. warned ICICI (on May 15, 2008) against the use of musclemen to recover loans.

The Supreme Court went on to remind financial institutions that they are bound by law. The recovery of loans or seizure of vehicles can only be done through legal means; we live in a civilized country and are governed by the rule of law.

It said:

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI”) and the Security Interest (Enforcement) Rules, 2002 (“SIER”) framed thereunder provide some of the procedures by which security interests may be recovered. In addition to SARFAESI and SIER, the Reserve Bank of India (“RBI”) has promulgated Guidelines on the subject. The RBI Guidelines on Fair Practices Code for Lenders dated 5.5.2003 provides at (v)(c) that: “In the matter of recovery of loans, the lenders should not resort to undue harassment viz. persistently bothering the borrowers at odd hours, use of muscle power for recovery of loans, etc.”

A more comprehensive version of these Guidelines was recently released on April 24, 2008. The Guidelines expressly reference the 5.5.2003 Guidelines at (i)(x) with regard to the methods by which recovery agents collect on security interests. In addition, the April 24, 2008 Guidelines further referred paragraph 6 of the “Code of Bank’s Commitment to Customers” (BCSBI Code) pertaining to collection of dues.

The BCSBI Code at para 6 inter alia provides:

“All the members of the staff or any person authorized to represent our bank in collection or/and security repossession would follow the guidelines set out below:

1. You would be contacted ordinarily at the place of your choice and in the absence of any specified place at the place of your residence and if unavailable at your residence, at the place of business/occupation.

2. Identity and authority to represent would be made known to you at the first instance.

3. Your privacy would be respected.

4. Interaction with you would be in a civil manner.

5. Normally our representatives will contact you between 0700 hours and 1900 hrs, unless the special circumstances of your business or occupation require otherwise.

6. Your requests to avoid calls at a particular time or at a particular place would be honored as far as possible.

7. Time and number of calls and contents of conversation would be documented.

8. All assistance would be given to resolve disputes or differences regarding dues in a mutually acceptable and in an orderly manner.

9. During visits to your place for dues collection, decency and decorum would be maintained.

10. Inappropriate occasions such as bereavement in the family or such other calamitous occasions would be avoided for making calls/visits to collect dues.

As noted above, this Code as well as others has been incorporated into the April 24, 2008 Guidelines:

“(ix) A reference is invited to (a) Circular DBOD.Leg.No.BC.104/ 09.07.007 /2002-03 dated May 5, 2003 regarding Guidelines on Fair Practices Code for Lenders (b) Circular DBOD.No.BP. 40/ 21.04.158/ 2006-07 dated November 3, 2006 regarding outsourcing of financial services and (c) Master Circular DBOD.FSD.BC.17/ 24.01.011/2007-08 dated July 2, 2007 on Credit Card Operations.

Further, a reference is also invited to paragraph 6 of the ‘Code of Bank’s Commitment to Customers’ (BCSBI Code) pertaining to collection of dues. Banks are advised to strictly adhere to the guidelines / code mentioned above during the loan recovery process.”

RBI has expressed its concern about the number of litigations filed against the banks in the recent past for engaging recovery agents who have purportedly violated the law. In the letter accompanying its April 24th, 2008 Guidelines on Engagement of Recovery Agents, RBI stated: “In view of the rise in the number of disputes and litigations against banks for engaging recovery agents in the recent past, it is felt that the adverse publicity would result in serious reputational risk for the banking sector as a whole.” RBI has taken this issue seriously, as evidenced by the penalty that banks could face if they fail to comply with the Guidelines.

The relevant portion of the Guidelines formulated by RBI is set out as under:

“3. Banks, as principals, are responsible for the actions of their agents. Hence, they should ensure that their agents engaged for recovery of their dues should strictly adhere to the above guidelines and instructions, including the BCSBI Code, while engaged in the process of recovery of dues.

4. Complaints received by Reserve Bank regarding violation of the above guidelines and adoption of abusive practices followed by banks’ recovery agents would be viewed seriously. Reserve Bank may consider imposing a ban on a bank from engaging recovery agents in a particular area, either jurisdictional or functional, for a limited period. In case of persistent breach of above guidelines, Reserve Bank may consider extending the period of ban or the area of ban. Similar supervisory action could be attracted when the High Courts or the Supreme Court pass strictures or impose penalties against any bank or its Directors/ Officers/ agents with regard to policy, practice and procedure related to the recovery process.

5. It is expected that banks would, in the normal course ensure that their employees or agents also adhere to the above guidelines during the loan recovery process.”

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No Musclemen to Recover Loans

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People have spoken about banks employing musclemen to recover loans. Usually, it’s been in undertones which though impossible to miss are rarely repeated anything but sotto voce.

That seems to have changed though. In a recent case, the Delhi High Court made observations against ICICI Bank with reference to allegations which a plaintiff had made against it. The Supreme Court then refused to strike them down.

In the case of ICICI Bank v. Shanti Devi Sharma and Others, a Bench of the apex Court comprising Dalveer Bhandari, J. and Tarun Chatterjee, J. warned ICICI (on May 15, 2008) against the use of musclemen to recover loans.

In this case, the Supreme Court’s decision says, Mrs Sharma has alleged that her son, Rahul Dev Sharma, 34, committed suicide as a result of the manner in which ICICI Bank’s recovery agents had repossessed his motorcycle. In an FIR, she alleged that on October 16, 2005 at about 1.00 p.m., two recovery agents (referred to as ‘goons’) forcibly entered her son’s bedroom and started harassing and humiliating him for loan payments that were overdue on his two wheeler and on his personal loan. They repossessed the bike in the presence of his friends who ridiculed him for having lost it.

Rahul had used the motorcycle to get vegetables for his small restaurant and after it was repossessed, he had to carry the vegetables on his back. When his neighbours realised this, they allegedly made snide comments. Rahul finally broke down before his wife and saying that he had never faced such a humiliation and disgrace in his entire life. On that very day, while his wife was washing clothes, he went hung himself to death.

The High Court ordered the Police to file reports as to the status of their investigation against the bank. After finding two status reports unsatisfactory, the High Court directed the Investigating Officer to: “conclude the investigation into the matter as expeditiously as possible and take necessary action against those who may be found guilty of abetting the deceased to commit suicide.”

In addition, the High Court stated:

“Para 1: “… the vehicle for which the loan was taken was repossessed by the musclemen employed by ICICI Bank.

Para 3: “…the proximate cause of death of the deceased that led him to commit suicide was on account of humiliation caused by the Bank people from where loan was taken by him.”

Para 4: “The modus-operandi employed by the banks like ICICI for realization of their loan amount and for recovering the possession of the vehicle against which loans are given is extra legal and by no stretch of imagination they can be permitted to employ musclemen and goons for recovery of their dues even from a defaulting party.”

Not too surprisingly, ICICI Bank claimed that it was aggrieved by these observations made by the High Court and asked the High Court to clarify or delete them. In an order dated 11.8.2006, the High Court declined to expunge the observations because it had made them “… consciously and there are no reasons to expunge the same.” Nevertheless, the High Court clarified the matter by stating that the observations made against ICICI Bank would not influence or affect the proceedings, if any, taken against the bank or its employees.

ICICI Bank then approached the Supreme Court for relief.

The Supreme Court said that given that the investigation had not been completed, the High Court could have prefaced its observations by stating that the facts were alleged. Recognizing as much, the High Court clarified that its observations were not to influence or affect the proceedings.

The Supreme Court reiterated that the observations would have no bearing on the ongoing investigation and said that it did not feel that ICICI Bank had been substantially aggrieved. Nor did it believe that expunging the observations would have much of an effect; in any scenario, no one could rely on the observations.

Considering the gravity of the allegations, the Court said that it expects the matter to be investigated as expeditiously as possible and, in any event, be concluded within three months.

ICICI was also directed to pay 25000/- INR as the costs of the litigation .

In addition to this, the Supreme Court went on to remind financial institutions that they are bound by law. The recovery of loans or seizure of vehicles can only be done through legal means; we live in a civilized country and are governed by the rule of law.

Also see: The Law on the Recovery of Loans

Obligations under Bank Guarantee Unconditional

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The Bank of India refused to pay a bank guarantee to a construction company when its client committed a breach of contract.

Calling the action of the Bank unprofessional, a Bench of the Supreme Court comprising Justices Tarun Chatterjee and Dalveer said, “In case the banks are permitted to dishonour their commitments by adopting such subterfuges, the entire commercial and business transactions will come to a grinding halt.”

The Bank claimed that it had no obligation to pay since the two companies involved had substituted their original contact and by doing so, they made the original contract inoperative.

It had earlier been directed to pay the guarantee by both a single judge and a Bench of the Delhi High Court which had said, “It is surprising that a nationalised bank wants to use delays of law in order not to comply with its unconditional obligations under a bank guarantee.”

The Supreme Court spoke in similar terms saying, “It is unfortunate that a nationalised bank is finding excuses for refusing to make the payment on totally untenable and frivolous grounds. … The entire trust, faith and confidence of people depend on the conduct and credibility of the nationalised bank.”

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