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.)